Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caeb-2_15-ap-02130/USCOURTS-caeb-2_15-ap-02130-0/pdf.json

Parties Involved:
Beverly N. McFarland
Plaintiff
General Electric Capital Corporation
Defendant

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FILED 

SEP 102015 

UNITED STATES BANKRUPTCY COURT 

EASTERN DISTRICT OF CALIFORNIA 

UNITED STATES HANKRUPTCY COURT 

EASTERN DISTRICT OF CALIFORNIA 

In re: Case No. 14-25820-D-11 

INTERNATIONAL MANUFACTURING 

GROUP, INC., 

Debtor. 

BEVERLY N. McFARLAND, 

Chapter 11 Trustee, 

Plaintiff, 

V. 

GENERAL ELECTRIC CAPITAL 

CORPORATION, 

Defendant. 

Adv. Pro. No. 15-2130-D 

Docket Control No. JRD-1 

DATE: September 9, 2015 

TIME: 10:00 a.m. 

DEPT: D 

bMORANDUN DECISION 

This is the motion of defendant General Electric Capital 

Corporation ("GECC") to dismiss the complaint of the plaintiff, 

Beverly McFarland, who is also the trustee in the chapter 11 case 

in which this adversary proceeding is pending (the "trustee"), 

pursuant to Fed. R. Civ. P. 9(b) and 12(b) (1), made applicable in 

this proceeding by Fed. R. Bankr. P. 7009 and 7012(b), for 

failure to plead fraud with particularity and failure to state a 

claim upon which relief can be granted. The plaintiff has filed 

opposition, GECC has filed a reply, and the court has heard oral 

argument. For the following reasons, the motion will be denied. 

/// 

Case 15-02130 Filed 09/10/15 Doc 26
In ruling on a Rule 12(b) (6) motion, a court "accept[s] as 

true all facts alleged in the complaint, and draw[s] all 

reasonable inferences in favor of the plaintiff." al-Kidd v. 

Ashcroft, 580 F.3d 949, 956 (9th Cir. 2009), citing Newcal 

Indus., Inc. v. Ikon Office Solution, 513 F.3d 1038, 1043 n.2 

(9th Cir. 2008) . The court assesses whether the complaint 

contains "sufficient factual matter, accepted as true, to 'state 

a claim to relief that is plausible on its face.'" al-Kidd, 580 

F.3d at 949, citing Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949, 

(2009), in turn quoting Bell Ati. Corp. v. Twombly, 550 U.S. 544, 

570 (2007) 

By her complaint, the trustee seeks to avoid four transfers 

of $500,000 each made by an entity named Olivehurst Glove 

Manufacturers, LLC ("Olivehurst") to GECC as actual fraudulent 

conveyances, pursuant to § 548(a) (1) (A) of the Bankruptcy Code,' 

and to recover the value of the transfers from GECC, pursuant to 

§ 550. The transfers were made within the year prior to the 

filing of the chapter 11 petition of International Manufacturing 

Group, Inc. ("1MG"), the debtor in the case in which this 

adversary proceeding is pending. Olivehurst has been 

substantively consolidated into IMG's bankruptcy estate. GECC 

makes five arguments in support of its contention that the 

complaint fails to state a claim upon which relief can be 

1. Unless otherwise indicated, all statutory references are 

to the United States Bankruptcy Code, Title 11, United States 

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granted. The court will take them in the order presented by 

GECC. 2 

I. The Fraudulent Transfer Versus Preference Issue 

First, GEOC contends the trustee's claim is a preference 

claim, not a fraudulent transfer claim, and that, as a preference 

claim, it is time-barred because all of the transfers were made 

more than 90 days before the date 1MG filed its petition, May 30, 

2014. There is no dispute that the transfers were made outside 

the 90-day period, and therefore cannot be recovered as 

preferences. The question is whether, even if they could have 

been recovered as preferences if they had been made within the 90 

days, they might be fraudulent transfers as well. GECC cites 

Boston Trading Group, Inc. v. Burnazos, 835 F.2d 1504 (1st Cir. 

1987), for the proposition that "fraudulent transfer laws cannot 

be used to recover payments to legitimate lenders where the 

transferee engaged in fraud to raise the money used to repay the 

lender." GECC's Motion, filed July 24, 2015 ("Mot."), at 

10:15-17. 

In Boston Trading, a court-appointed receiver for a company 

that managed the funds of commodities investors sought to recover 

as actual fraudulent conveyances payments made by the company's 

owners, Shaw and Kepreos, from the company's funds, to the 

individual who had sold them the company, Burnazos, toward the 

purchase price. The evidence showed that Shaw and Kepreos had 

l been churning investors' accounts by making unnecessary trades in 

2. GECC's contention that the complaint fails to state 

fraud with particularity is woven throughout the motion, not 

separately treated; the court addresses it in like fashion. 

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1 order to generate commissions; the receiver alleged Burnazos knew 

2 or should have known about their dishonest activity. 

3 The court held that where an individual uses his 

4 corporation's money, which he obtained dishonestly, to pay his 

5 debt to a creditor "who knows of, but did not participate in, 

6 [the] dishonesty," the payment is not recoverable as an actual 

7 fraudulent conveyance. 835 F.2d at 1510. The court's discussion 

8 and holding both strongly suggest the court believed that a 

9 preference, which the payments to Burnazos clearly were, cannot 

10 also be a fraudulent transfer. The court made this blanket 

11 statement: "The cases and the commentators . . . state that 

12 fraudulent conveyance law does not seek to void transfers in a 

13 circumstance known as a 'preference.'" Id. In explanation, 

14 the court stated that the purpose of the fraudulent transfer laws 

15 is not to achieve an equal distribution among creditors (id. at 

16 1508-09), but "to see that the debtor uses his limited assets to 

17 satisfy some of his creditors . . . ." at 1509. The court 

18 added that "to find an actual intent to defraud creditors when 

19 an insolvent debtor prefers a less worthy creditor, would 

20 tend to deflect fraudulent conveyance law from one of its basic 

21 functions (to see that an insolvent debtor's limited funds are 

22 used to pay some worthy creditor), while providing it with a new 

23 function (determining which creditor is the more worthy) ." Id. 

24 ' In short, the Boston Trading court came very close to 

25 holding, if it did not actually do so, that a transfer that would 

26 constitute a preference if made within the preference period 

27 I cannot also be an actual fraudulent conveyance. However, the 

28 court did not also find that a preference cannot be a 

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constructive fraudulent conveyance. Instead, it remanded for a 

retrial on the issue of whether Burnazos gave a "fair equivalent" 

in exchange for the payments. 835 F.2d at 1513-14. The court 

did hold, as to the "good faith" defense to a constructive 

fraudulent transfer claim, that lack of good faith cannot be 

found from the mere fact that the creditor received a preference, 

even where the creditor knew the payment was made with improperly 

obtained funds. Id. at 1511-12. 

Whatever "good faith" may mean . . . we believe it does 

not ordinarily refer to the transferee's knowledge of 

the source of the debtor's monies which the debtor 

obtained at the expense of other creditors. To find a 

lack of "good faith" where the transferee does not 

participate in, but only knows that the debtor created 

the other debt through some form of, dishonesty is to 

void the transaction because it amounts to a kind of 

'preference' - concededly a most undesirable kind of 

preference, one in which the claims of alternative 

creditors differ considerably in their moral worth, but 

a kind of preference nonetheless. And all the reasons 

that militate against finding a § 7 violation ('actual 

fraud') in such circumstances . . . militate with at 

least equal force against finding a § 4 violation 

('constructive fraud') 

Id. at 1512 (citations omitted) . 

GECC's reliance on Boston Trading is not persuasive in this 

case for several reasons. First, as the trustee points out, the 

case involved only state fraudulent transfer law (in particular, 

the law of Massachusetts); the cases the court cited in support 

of its conclusion that a preference cannot also be an actual 

fraudulent conveyance involved only state law, not § 548 of the 

Bankruptcy Code. GECC's only response on this point is to note 

that "Section 548 is based on the Uniform Fraudulent Conveyance 

3. As discussed below, this analysis of the good faith 

standard appears to be contrary to Ninth Circuit law. 

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Case 15-02130 Filed 09/10/15 Doc 26
1 Act" (GECC's Reply, filed Sept. 2, 2015 ("Reply"), at 4:25), on 

2 which the state fraudulent transfer laws are also based. The 

3 answer is too pat. Although the state and federal statutes are 

4 "similar in form and substance" (In re United Energy Corp., 944 

5 F.2d 589, 594 (9th Cir. 1991)), they are not identical. See 

6 Plotkin v. Pomona Valley Imports (In re Cohen), 199 B.R. 709, 712 

7 (9th Cir. BAP 1996) ["The differences between the fraudulent 

8 transfer provisions in the Bankruptcy Code and the Uniform 

9 Fraudulent Transfer Act are central to this appeal."]; see also 

10 Jobin v. McKay (In re M & L Bus. Mach. Co.), 84 F.3d 1330, 1338 

11 (10th Cir. 1996) ["[W]e are not persuaded . . . that the 

12 definitions of good faith under . . . state fraudulent conveyance 

13 laws should be adopted in interpreting § 548 (c) . Many of these 

14 provisions contain language different than the language used in § 

15 548(c) and . . . involve policy concerns not applicable here."]. 

16 Second, as the trustee points out, the statutory language 

17 itself strongly suggests that a transfer may be avoidable as both 

18 a preference and a fraudulent transfer under federal bankruptcy 

19 law. The Bankruptcy Code provides: "Except to the extent that a 

20 transfer . . . voidable under this section is voidable under 

21 section . . . of this title," a transferee that takes for 

22 value and in good faith may retain the property transferred. § 

23 548 (c) (emphasis added) . Were preferences and fraudulent 

24 transfers mutually exclusive, this language would be meaningless. 

25 Third, as the trustee also points out, if preferences and 

26 fraudulent transfers were mutually exclusive, trustees in Ponzi 

27 I scheme cases would be unable to recover payments made to earlier 

28 I investors at the expense of later ones except those made in the 

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90-day preference period. Yet "[c]ourts have routinely applied 

[state fraudulent transfer law] to allow receivers or trustees in 

bankruptcy to recover monies lost by Ponzi scheme investors. The 

Ponzi scheme operator is the 'debtor,' and each investor is a 

'creditor.' The profiting investors are the recipients of the 

Ponzi scheme operator's fraudulent transfer." Donell v. Kowell, 

533 F.3d 762, 767 (9th Cir. 2008) (citations omitted) . "The 

policy justification is ratable distribution of remaining assets 

among all the defrauded investors." Id. at 770. 1 As the trustee 

puts it, "[i]f creditor status were enough to immunize a transfer 

from section 548 avoidance by magically transforming it into a 

preference, then a trustee could never avoid transfers made as 

return of principal under section 548" (Trustee's Opposition, 

filed Aug. 26, 2015, at 16:20-17:1), which trustees can do in 

cases of actual fraudulent transfers to transferees not acting in 

good faith. Id. at 771 ["Under the actual fraud theory, the 

receiver may recover the entire amount paid to the winning 

investor, including amounts which could be considered 'return of 

principal.' However, there is a 'good faith' defense that 

I permits an innocent winning investor to retain funds up to the 

amount of the initial outlay."]. 

Fourth, a close analysis of Boston Trading reveals that it 

does not stand for the proposition for which GECC cites it. As 

stated in its reply, GECC cites the case as "establish[ing] that 

fraudulent transfer claims do not lie against legitimate 

4. This latter statement blunts GECC's insistence on the 

differing purposes behind preference and fraudulent conveyance 

law as decisive. 

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1 

creditors receiving payment on legitimate debt, even where the 

2 transferee may have had reason to suspect the source of the funds 

3 and knew that the transferor was a fraudster." Reply at 3:16-18. 

4 Where GECC goes wrong is in focusing on the status, knowledge, 

5 and behavior of the transferee - as, for example, a "legitimate 

6 creditor receiving payment on legitimate debt" and the 

7 transferee's knowledge "that the transferor was a fraudster," 

8 whereas for purposes of an actual fraudulent conveyance, the 

9 initial focus is on the transferor and only the transferor. That 

10 is, the first question the court must decide is whether the 

11 transferor made the transfer "with actual intent to hinder, 

12 delay, or defraud" his or her creditors. § 548(a)(1)(A). There 

13 is nothing in the statute to suggest that a payment on a 

141 legitimate debt to a legitimate creditor cannot be an actual 

15 fraudulent conveyance if it was made with the actual intent on 

16 the part of the transferor to hinder, delay, or defraud his or 

17 I her creditors. 

18 This is where GECC departs from the actual holding in Boston 

19 Trading; that is, the holding as applied to the facts in the 

20 case, as opposed to the court's general conclusions about 

21 fraudulent transfers and preferences. The court acknowledged 

22 that the Massachusetts statute it was considering "makes 

23 'fraudulent' every transfer made 'with actual intent' (as opposed 

24 to 'intent presumed in law') to 'hinder, delay or defraud . . 

25 creditors.'" Boston Trading, 835 F.2d at 1510. The court then 

26 held, with regard to the specific facts in the case: 

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1 In effect, the Receiver argues that Shaw and Kepreos 

took the $ 473,000 from BTG by fraud (or other 

2 dishonest means) and paid it to Burnazos who had full 

knowledge of their dishonesty. 

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We rephrase the legal question slightly both to reflect 

4 the evidence and to avoid the potentially confusing 

coincidence that we are dealing with a form of initial 

5 dishonesty (i.e., the 'churning' of accounts by Shaw 

and Kepreos) that itself happens to be called fraud. 

6 Suppose that S & K, officers of Corporation C, obtain 

C's money through dishonest means (larceny, fraud, 

7 etc.) and use it to pay a debt that S & K owe B, a 

transferee who knows of, but did not participate in,. S 

8 & K's dishonesty. Does [the Massachusetts actual 

fraudulent transfer statute] permit C to recover its 

9 money from B? We think the district court correctly 

ruled that [it] does not. 

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First, we have found no modern case . . . that has 

11 found a fraudulent conveyance in such circumstances. 

That is not surprising, for the fraud or dishonesty in 

12 this example concerns not S & K's transfer to B, but 

the manner in which the oriQinal debt to C arose. 

13 Fraudulent conveyance law is basically concerned with 

transfers that 'hinder, delay or defraud' creditors; it 

14 is not ordinarily concerned with how such debts were 

created. 

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16 Id. (first emphasis added) . In other words, the court found no 

17 actual intent to defraud in the transfer the receiver was 

18 challenging, only in the manner in which the transferors had 

19 l acquired the money in the first place. 

20 The court later referred to the facts before it, "where the 

21 only fraud concerns the source of the funds transferred" (id. at 

22 1513 (emphasis in original)), and concluded that "the only 

23 'fraud' shown in respect to Shaw and Kepreos concerns the source 

24 of the debt to NIS, not the transfer to Burnazos. That kind of 

25 fraud - dishonesty in the creation of the debt - is (in the 

26 circumstances present here) not the kind of fraud that the 

27 [Massachusetts actual fraudulent transfer statute] addresses." 

28 Id. at 1517 (emphasis in original) . In other words, the only 

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1 fraud the court found was in the way the transferors had acquired 

2 the money they transferred to the transferee; there was no 

3 evidence the transferors made the transfer - the one challenged 

4 by the receiver - with the actual intent to hinder, delay, or 

5 defraud creditors. The case simply does not support the 

6 conclusion GECC draws from it - that regardless of the 

7 transferor's intent in making the challenged transfers, "where, 

8 as here, the transfers at issue are used to pay a legitimate 

9 creditor a legitimate debt those transfers are not 'voidable' in 

10 the first instance . . . ." Reply at 3:13-15. 

11 GECC fares no better with the second case it cites, although 

12 the facts appear at first glance more similar to those in this 

13 case. Sharp Int'l Corp. v. State St. Bank & Trust Co. (In re 

14 Sharp Int'l Corp.), 403 F.3d 43 (2nd Cir. 2005), involved a 

15 debtor company that "was looted by its controlling shareholders." 

16 403 F.3d at 46. The bankruptcy trustee then sued, under New York 

17 fraudulent transfer law, one of the debtor's lenders, State 

18 I Street Bank, "which suspected the fraud and extricated itself in 

19 a way that, according to [the trustee], facilitated the 

20 victimization of other lenders and the continued looting of [the 

21 debtor] itself." Id. The bankruptcy court dismissed the 

22 trustee's complaint on a Rule 12(b) (6) motion; the district court 

23 affirmed, holding, with respect to the trustee's actual 

24 fraudulent transfer claims, that the trustee, although he had 

25 alleged actual knowledge of the fraud on the part of State 

26 Street, "had not alleged that State Street 'participated in' or 

27 'induced' the [controlling shareholders'] fraud." Id. at 49. 

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1 

The factual allegations in Sharp Int'l are similar to those 

2 in the present case. In that case, the controlling shareholders 

3 "falsified sales, inventory, and accounts receivable, and 

4 invented customers, in order to report fictitious revenue on [the 

5 company's] nonpublic financial records" (403 F.3d at 46), 

6 fraudulently reporting that its sales were much higher than they 

7 were, thus enabling the shareholders to borrow more and more 

8 money, which they then diverted to themselves. After its loans 

9 were made, State Street began to suspect problems from the 

10 company's "refusal to comply with accounting procedures required 

11 under the [parties'] loan agreement," its "fast growth and 

12 voracious consumption of cash" (id. at 47), and State Street's 

13 responsible officer's experience with a fraud at another company. 

14 State Street hired both outside counsel and a financial 

15 investigation firm to conduct a formal investigation. It also 

16 asked for more information about the company's customers, asked 

17 to see its outside auditor's work papers, requested formal 

18 confirmation of accounts receivable, reviewed checks for insider 

19 payments, and reviewed Dun & Bradstreet reports on several of the 

20 company's customers. When this information was either refused or 

21 turned up yet more suspicious circumstances, the trustee alleged, 

22 State Street "arranged quietly for [the shareholders] to repay 

23 the State Street loan from the proceeds of new loans from 

24 unsuspecting creditors . . . ." Id. 

25 The court of appeals found these allegations insufficient to 

26 support a claim against State Street for aiding and abetting 

27 breaches of fiduciary duty because they did not sufficiently 

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1 fraud. 403 F.3d at 50. Although it assumed for purposes of its 

2 decision that "State Street knew about the looting as well as 

3 about the use of phony books and records to obtain loans" (j), 

4 the court found that "the complaint says no more than that State 

5 Street relied on its own wits and resources to extricate itself 

6 from peril, without warning persons it had no duty to warn." Id. 

7 at 51. As to the actual fraudulent conveyance claim, however, 

8 the focus was, as in Boston Trading, on the absence of fraud in 

9 the particular transfer the trustee sought to avoid. The court 

10 held that the claim "fails for the . . . reason that [the 

11 trustee] inadequately alleges fraud with respect to the 

12 transaction that [he] seeks to void, i.e., [the debtor's] $ 12.25 

13 million payment to State Street." Sharp Int'l, 403 F.3d at 56, 

14 citing Boston Trading, 835 F.2d at 1510, for the proposition that 

15 "[f]raudulent conveyance law is basically concerned with 

16 transfers that 'hinder, delay or defraud' creditors; it is not 

17 ordinarily concerned with how such debts were created." "The 

18 I fraud alleged in the complaint relates to the manner in which 

19 [the debtor] obtained new funding from the Noteholders, not [the 

20 debtor's] subsequent payment of part of the proceeds to State 

21 Street." Sharp Int'l, 403 F.3d at 56. 

22 In contrast, in the present case, the complaint contains 

23 detailed allegations that, taken as true, would support a finding 

24 that the transfers to GECC were made with the actual intent on 

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creditors. 5 The complaint alleges, first, that each of the 

transfers was made in furtherance of the Ponzi scheme in that, by 

causing the transfers to be made, its mastermind, Deepal 

Wannakuwatte, "hoped to appease GECC, thereby prolonging the 

duration of the fraudulent scheme by: (a) avoiding any adverse 

final judgment or findings of fact in litigation; (b) preventing 

knowledge of his various fraudulent schemes—and by extension, the 

'wholesale' division fraud—from becoming more widespread; and/or 

(c) otherwise enabling 1MG to remain in operation and the fraud 

to continue." Trustee's Complaint, filed June 16, 2015 

("Compl."), at 15:15-19. The complaint goes on: 

at the time each of the Settlement Transfers was made, 

Deepal Wannakuwatte understood that causing those 

transfers to be made would inevitably harm IMG's and 

Olivehurst's creditors. Wannakuwatte knew that he had 

operated a Ponzi scheme, that he had repeatedly 

defrauded investors into providing financing for TMG's 

functionally non-existent "wholesale" division, and 

that IMG's investors would not be repaid when his 

scheme ended. Wannakuwatte further knew that 

Olivehurst, 1MG, and Relyaid were hopelessly insolvent. 

Deepal Wannakuwatte knew that causing the Settlement 

Transfers would harm investors by both: (a) prolonging 

the scheme and (b) reducing the amount of funds 

available to repay creditors. Finally, Wannakuwatte 

knew that using funds to pay off GECC, rather than 

invest in product, constituted a fraud upon the 

investors whom had provided funds to Olivehurst. 

JId. at 16:1-3. The complaint also alleges sufficient ownership 

and control by Wannakuwatte over Relyaid, 1MG, and Olivehurst to 

I impute his intent to them. 

S. It is important to note that the verbs, as used in § 

548(a) (1) (A), are in the disjunctive; thus, the trustee need 

establish only one of the three with respect to the payments to 

GECC - that they were made with the actual intent to hinder 

creditors, the actual intent to delay creditors, or the actual 

intent to defraud creditors. In re Stanton, 457 B.R. 80, 93-94 

(Bankr. D. Nev. 2011); In re Roca, 404 B.R. 531, 543-44 (Bankr. 

D. Ariz. 2009) 

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1 These allegations are more than sufficient to state a claim 

2 under §§ 548 and 550 upon which relief can be granted. To be 

3 clear, there was no indication in either the Boston Trading or 

4 the Sharp Int'l decision that the plaintiff's complaint contained 

5 such allegations. For the reasons stated, the court rejects 

6 GECC's contention that the trustee's claim is nothing more than a 

7 time-barred preference claim. 

8 II. The Question of Duty 

9 Next, GECC contends the complaint cannot stand because "the 

10 Trustee can never plead facts which would create the duty upon 

11 which her fraudulent transfer claim is premised." Not. at 4:6-7. 

12 The problem with the argument is simple: duty is not an element 

13 of a fraudulent conveyance claim. Thus, there is no requirement 

14 that the plaintiff plead or prove the transferee had any sort of 

15 duty. 

16 GECC frames the issue in terms of law other than the law of 

17 I fraudulent conveyances: 

18 GE Capital did not owe a duty to its borrower and 

guarantors beyond any duties expressed in the 

19 underlying Equipment Loan Agreement. . . . A lender's 

decision to exercise rights granted by contract cannot 

20 form the basis of a fraudulent transfer claim because 

no duty to a guarantor or other creditors is breached 

21 under these circumstances. The Trustee does not and 

cannot allege that anything in the Equipment Loan 

22 Agreement created a duty to 1MG or its creditors 

requiring GE Capital to disclose anything to anyone 

23 about its efforts to collect on the loan. Furthermore, 

even assuming a failure to disclose material facts 

24 known only to one party, no cause of action lies unless 

there is a fiduciary duty or confidential relationship 

25 imposing a duty to disclose. The Trustee does not 

allege any duty or confidential relationship which 

26 required GE Capital to disclose anything to IMG's 

creditors. 

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GECC cites for these propositions, Sipe v. Countrywide Bank, 690 

F. Supp. 2d 1141, 1153 (E.D. Cal. 2010), and Cal. Civ. Code 

1710(3), has nothing to do with fraudulent conveyance law. 6 

In its reply, GECC seems to back away from its theory that a 

breach of duty is an element the trustee must plead and instead 

frame the duty issue more in terms of whether GECC acted in good 

faith when it took the payments. The court will return to this 

aspect of the discussion below. 

III. The Ponzi Scheme Presumption 

Next, GECC claims the trustee's complaint fails because it 

does not "includ[e] specific facts supporting a reasonable 

inference that the challenged transfers are connected to a Ponzi 

scheme" (Mot. at 14:4-5), and therefore, the Ponzi scheme 

presumption of actual fraud does not apply. GECC relies heavily 

on the fact that it is not alleged to have been an investor in 

I the Ponzi scheme. First, the court has already concluded that 

the trustee's complaint sufficiently alleges actual fraud on the 

part of the transferor to state a claim; thus, application of the 

Ponzi scheme presumption is not necessary. 

However, the court will also deny the motion on the 

independent basis that the allegations of the complaint are 

sufficient to state a claim based on the Ponzi scheme 

presumption. The trustee has cited a number of cases supporting 

the proposition that, depending on the connections between the 

Ponzi scheme and the payments to the lenders, the presumption may 

6. GECC also cites Sharp Int'l, 403 F.3d at 52, n.2, which, 

as discussed above, was a fraudulent conveyance case; however, 

GECC's citation is to a section of the opinion concerning a claim 

for aiding and abetting the breach of a fiduciary duty. 

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1 be applied against commercial lenders who were not investors in 

2 the Ponzi scheme. GECC, on the other hand, cites Klein v. Bd. of 

3 Trs. of the Cal. State Univ. (In re Moriarty), 2014 Bankr. LEXIS 

4 4802 (Bankr. C.D. Cal. 2014) . In that case, a couple named 

5 Moriarty made a donation to Cal Poly which Cal Poly agreed to and 

6 did use to purchase a new video scoreboard for its stadium and to 

7 put the name of the couple's business at the top of the 

8 scoreboard. When the couple later filed bankruptcy, the trustee 

9 in their case sued to avoid the transfer under § 544 of the 

10 Bankruptcy Code and California fraudulent transfer law. The 

11 court granted Cal Poly's Rule 12(b) (6) motion - with leave to 

12 amend - because the 

13 complaint does not contain facts describing the 

Moriarty Ponzi Scheme nor does it contain specific 

14 facts to support a reasonable inference that the 

subject transfers were connected to the Moriarty Ponzi 

15 Scheme. Furthermore, Klein's complaint does not allege 

sufficient facts to form the basis for a finding that 

16 the subject transfers actually hindered, delayed or 

defrauded a creditor of the Debtor or that the Debtor 

17 intended the subject transfers to do so on the date of 

the transfer. 

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19 12014 Bankr. LEXIS 4802, at *27. 

20 The case does not support GECC's position here because, 

21 unlike the trustee in Moriarty, the trustee has alleged 

22 sufficient connections between the Ponzi scheme and the payments 

23 to GECC to state a claim to relief based on the Ponzi scheme 

24 presumption. First, she has made detailed allegations concerning 

25 the Ponzi scheme itself. She has also alleged 1MG routinely used 

26 the name of consolidated debtor Relyaid (GECC's borrower) in its 

27 marketing materials to potential investors in the scheme; that 

28 Wannakuwatte pled guilty and was convicted for his role in the 

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scheme; that a large portion of the loan proceeds from GECC were 

deposited into "the primary bank account through which Ponzi 

scheme payments to investors were made" (Compi. at 11:16); that 

other proceeds went to Wannakuwatte, his spouse, 1MG, and another 

consolidated entity; that the funds used to make the payments to 

GECC came from 1MG investors; and that, based on the facts 

alleged above, the payments were made in furtherance of the Ponzi 

scheme. 

IV. GECC as a Net Loser 

GECC next argues that "[t]he Trustee cannot have it both 

ways." Mot. at 16:13. "She relies on the Ponzi scheme 

presumption while refusing to recognize that the net winner rule 

applies. Were the Ponzi scheme presumption applicable, and the 

transfers at issue were part of the underlying scheme, thus 

giving rise to the presumption, that presumption operates only 

against 'net winners.'" Mot. at 16:13-16. (It is undisputed 

that the payments made to GECC totaled less than the amount GECC 

loaned Relyaid.) 

This argument improperly conflates the Ponzi scheme 

I presumption and the "net winner rule." 7 The Ponzi scheme 

7. The presumption is simply stated: "[T]he mere 

existence of a Ponzi scheme is sufficient to establish actual 

intent to defraud." Donell, 533 F.3d at 770 (citations omitted, 

internal quotation marks omitted). The net winner "rule," more 

accurately called the "netting rule," is simple as well: 

Amounts transferred by the Ponzi scheme perpetrator to 

the investor are netted against the initial amounts 

invested by that individual. If the net is positive, 

the receiver has established liability, and the court 

then determines the actual amount of liability, which 

may or may not be equal to the net gain, depending on 

factors such as whether transfers were made within the 

limitations period or whether the investor lacked good 

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presumption comes into play only with respect to the transferor's 

intent in making the challenged transfers; that is, it is 

relevant solely to the trustee's case-in-chief for avoidance of 

an actual fraudulent conveyance. The "net winner rule," in 

contrast, concerns only the issue whether the recipient of the 

transfer gave reasonably equivalent value to the transferor in 

exchange for the transfer. Thus, it comes into play solely in 

connection with (1) the trustee's case-in-chief for avoidance of 

a constructive fraudulent conveyance under § 548(a) (1) (B) and/or 

the related state law provision, and (2) the "for value" portion 

of the transferee's "good faith and for value" defense under § 

548(c) and/or related state law provisions. The "net winner" 

rule is really nothing more than the recognition that a Ponzi 

scheme investor has a restitution claim against the debtor for 

the amounts the investor paid into the scheme, the satisfaction 

of which constitutes reasonably equivalent value for the payments 

the investor received back before the scheme collapsed. This 

brings the court to GECC's final argument. 

V. The Issue of Good Faith 

GECC's final argument is that "[a]ssuming the Trustee 

adequately pled a fraudulent transfer claim, the complaint must 

be dismissed as GE Capital is a good faith creditor which took 

for value." Not. at 18:17-18. The problem here is that GECC's 

faith. If the net is negative, the good faith investor 

is not liable because payments received in amounts less 

than the initial investment, being payments against the 

good faith losing investor's as-yet unsatisfied 

restitution claim against the Ponzi scheme perpetrator, 

are not avoidable within the meaning of UFTA. 

I Id. at 771. 

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good faith is a component of its good faith and for value 

defense, which, in the context of an actual fraudulent 

conveyance, is an affirmative defense. "It is not incumbent on 

the plaintiffs to plead lack of good faith on defendants' part 

because lack of good faith is not an element of a plaintiff's 

claim under Section 548 (a) (1) [(A)] ." Bayou Superfund, LLC v. WAM 

Long/Short Fund II, L.P. (In re Bayou Grp., LLC), 362 B.R. 624, 

8 639 (Bankr. S.D.N.Y. 2007); see also Brandt v. KLC Fin., Inc. (In 

9 re Equip. Acguisition Res., Inc.), 481 B.R. 422, 429 (Bankr. N.D. 

10 Ill. 2012); Picard v. Merkin (In re Bernard L. Madoff mv. Sec. 

11 LLC), 440 B.R. 243, 256 (Bankr. S.D.N.Y. 2010). 

12 Whether GECC acted in good faith is a question of fact that 

13 would ordinarily not be appropriately resolved on a motion to 

14 dismiss. "The element of good faith under section 548(c) of the 

15 Code, bearing upon a transferee's motivations, is indisputably a 

16 factual question that may not be determined on the face of [a] 

17 complaint." In re Bernard L. Madoff mv. Sec., 440 B.R. at 256. 

18 However, GECC contends that "based on the allegations in the 

19 Complaint viewed in the light most favorable to the Trustee, GE 

20 Capital satisfies its burden to establish good faith under 

21 I section 548(c) ." Mot. at 19:16-18. 

22 "Dismissal under Rule 12(b) (6) on the basis of an 

23 affirmative defense is proper only if the defendant shows some 

24 obvious bar to securing relief on the face of the complaint." 

25 Asarco, LLC v. Union Pac. R.R. Co., 765 F.3d 999, 1004 (9th Cir. 

26 2014) (citations omitted). On the other hand, "[i]f, from the 

27 allegations of the complaint as well as any judicially noticeable 

28 materials, an asserted defense raises disputed issues of fact, 

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dismissal under Rule 12(b) (6) is improper." Id. (citation 

omitted) . In GECC' s view, the complaint fails because it does 

not allege GECC knew of the Ponzi scheme and because the "red 

flags" alleged in the complaint "do not come close to suggesting 

knowing or reckless participation" in the Ponzi scheme. Mot. at 

19:19-20. The argument fails for two reasons. First, as 

discussed below, "knowing or reckless participation" in the Ponzi 

scheme is not the appropriate standard for the good faith test in 

9 this circuit. GECC's reliance in its motion on Sharp Int'l and 

10 in its reply on B.E.L.T., Inc. v. Wachovia Corp., 403 F.3d 474 

11 (7th Cir. 2005), is misplaced. Both cases were decided under 

12 state fraudulent transfer laws (New York and Illinois, 

13 respectively), and both applied a standard for assessing good 

14 faith that is not the standard in the Ninth Circuit under § 

15 548 (c) . Second, the court is not inclined to determine the 

16 factual issues attendant to a good faith defense on a Rule 

17 12(b) (6) motion. 

18 "[G]ood faith is not susceptible of precise definition" LL 

19 re Agricultural Research & Tech. Group, Inc., 916 F.2d 528, 536 

20 (9th Cir. 1990) ("Agretech") (citation omitted, internal 

21 quotation marks omitted)), and the analysis, being intensely 

22 factual, must be made on a case-by-case basis. Meeks v. Red 

23 River Entm't (In re Armstrong), 285 F.3d 1092, 1096 (8th Cir. 

24 2002) . Nevertheless, the courts have provided guidance. Thus, 

25 "courts look to what the transferee objectively 'knew or should 

26 I have known' in questions of good faith, rather than examining 

27 what the transferee actually knew from a subjective standpoint." 

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reasonable person on notice of a fraudulent scheme, which would 

have been discovered through a diligent inquiry, constitute bad 

faith in receiving fraudulent transfers. j at 539; see also 

Woods & Erickson, LLP v. Leonard (In re AVI, Inc.), 389 B.R. 721, 

736 (9th Cir. BAP 2008) [looking to what the transferee 

objectively "knew or should have known," not what he knew from a 

subjective standpoint]; Plotkin, 199 B.R. 709 at 720 ["Facts 

sufficient to warrant a finding of inquiry notice are . 

sufficient to defeat the good faith that is essential to the § 

548(c) safe harbor."]. 8 

GECC's framing of the issue in its reply crystallizes the 

distinction between its view of the applicable good faith 

standard and the one just described, which applies in the Ninth 

Circuit. In GECC's view, "'bad faith' is encouraging, aiding, 

abetting, or concealing a further fraud, embezzlement or Ponzi 

scheme . . . ." Reply at 2:27. As just discussed, the standard 

in this circuit for a transferee's good faith defense is not 

limited to someone who "encouraged, aided, abetted, or concealed" 

a fraud. 

8. Other circuits apply the same or a similar standard. 

Thus, "[a] transferee does not act in good faith when he has 

sufficient [actual] knowledge to place him on inquiry notice of 

the debtor's possible insolvency." Goldman v. Capital City 

MortQ. Corp. (In re Nieves), 648 F.3d 232, 238 (4th Cir. 2011) 

(citation omitted). "[G]ood faith under § 548(c) should be 

measured objectively and . . . if the circumstances would place a 

reasonable person on inquiry of a debtor's fraudulent purpose, 

and a diligent inquiry would have discovered the fraudulent 

purpose, then the transfer is fraudulent." Jobin, 84 F.3d at 

1338 [10th Circuit]. "[T]he recipient of a voidable transfer may 

lack good faith if he possessed enough knowledge of the events to 

induce a reasonable person to investigate." Bonded Fin. Servs. 

v. European Am. Bank, 838 F.2d 890, 897-98 (7th Cir. 1988) 

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For the reasons stated, the court concludes the plaintiff's 

2 complaint contains factual allegations sufficient to state a 

3 claim to relief under § 548(a) (1) (A), and the motion will be 

4 denied. The court will issue a minute order. 

5 

Dated: September (ca, 2015 _________________________________ 

6 ROBERT S. BARDWIL 

United States Bankruptcy Judge 

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Instructions to Clerk of Court 

Service List - Not Part of Order/Judgment 

The Clerk of Court is instructed to send the Order/Judgment or other court 

generated document transmitted herewith to the parties below. The Clerk of 

Court will send the Order via the BNC. 

Christopher Daniel Sullivan Jonathan R. Doolittle 

150 California Street, Ste. 2200 101 2nd St #1800 

San Francisco CA 94111 San Francisco CA 94105 

Case 15-02130 Filed 09/10/15 Doc 26