Opinion ID: 4564821
Heading Depth: 1
Heading Rank: 2

Heading: The MUFTA Issue

Text: In both cases, the Trustee seeks to avoid under “applicable law,” MUFTA, the transfer of interest PCI paid to Defendants on outstanding promissory notes. 11 U.S.C. § 544(b)(1). MUFTA provides that a transfer made by a debtor is voidable if the transfer is tainted by actual fraud, defined as “actual intent to hinder, delay, or defraud any creditor of the debtor,” or by constructive fraud, defined as a financially distressed debtor not “receiving a reasonably equivalent value in exchange for the -7- transfer or obligation.” Minn. Stat. § 513.44(a); see Citizens State Bank Norwood Young Am. v. Brown, 849 N.W.2d 55, 60 & n.5 (Minn. 2014).4 We focus this opinion on whether the interest payments constituted “actual fraud.” Given our resolution of the actual fraud issues, we need not consider the Trustee’s alternative claims of constructive fraud, though they will likely be relevant on remand. A. Actual Fraud. The jury found that each PCI interest payment to Boosalis was made with intent “to hinder, delay, or defraud” PCI creditors. The district court adopted this as a conclusion of law in granting summary judgment against Papadimos and Kanios. “Because the intent to defraud creditors is rarely susceptible of direct proof,” courts applying MUFTA and the uniform fraudulent transfer laws in other States often rely on circumstantial evidence -- known as “badges of fraud” -- to determine whether the debtor had the requisite fraudulent intent. Citizens State, 849 N.W.2d at 60; see Minn. Stat. § 513.44(b)(3), (9); Ritchie Capital Mgmt., 779 F.3d at 863. The trial and other sworn testimony of Coleman and Martens provided substantial evidence of PCI’s overall fraudulent intent in conducting a twelve-year Ponzi scheme in which PCI used new loan proceeds to repay early lenders, rather than to finance legitimate transactions. Papadimos and Kanios argue the direct evidence was too generalized to support summary judgment and the circumstantial evidence was insufficient. They posit that a reasonable jury might decide that their loans and loan proceeds were tied to Petters entities that conducted legitimate business. But given the summary judgment record, this is “speculation and conjecture . . . insufficient to defeat summary judgment.” Bloom v. Metro Heart Grp. of St. Louis, Inc., 440 F.3d 1025, 1028 (8th Cir. 2006). 4 Whether there are unsecured PCI creditors with allowable claims on whose behalf the Trustee can seek avoidance is disputed by Boosalis, but not by Papadimos and Kanios. We reject Boosalis’s contention in Part III, infra. -8- Given the overwhelming evidence of PCI’s overall intent to operate a fraudulent Ponzi scheme, we will not disturb the jury’s finding and the district court’s conclusion regarding PCI’s actual intent to hinder, delay, or defraud its creditors. However, the Trustee’s evidence in both cases emphasized a “Ponzi churn” theory of fraudulent transfers that in our view was contrary to Minnesota law. MUFTA requires that each fraudulent transfer claim “be determined in light of the facts and circumstances of each case” on a “transfer-by-transfer” basis. Finn, 860 N.W.2d at 647. Therefore, we leave the actual fraud issue open for reconsideration and new evidence on remand. B. The Affirmative Defense to Actual Fraud: MUFTA provides an affirmative defense to a claim of actual fraud under Minn. Stat. § 513.44(a)(1): “A transfer or obligation is not voidable under [§ 513.44(a)(1)] against a person that took in good faith and for a reasonably equivalent value.” § 513.48. All Defendants asserted this affirmative defense. The Trustee stipulated that Papadimos and Kanios took in good faith. The jury found that Boosalis did not; he challenges the district court’s jury instruction on that issue. All Defendants challenge the district court’s interpretation of “reasonably equivalent value” under MUFTA. This critical issue also affects whether a transfer is avoidable under the constructive fraud provisions of § 513.44(a)(2). Therefore, we will first consider the reasonably equivalent value component of the actual fraud affirmative defense under Minnesota law. 1. Reasonably Equivalent value -- Papadimos and Kanios. In Finn, the Supreme Court of Minnesota rejected a broad “Ponzi-scheme presumption” adopted by many courts that have considered claw back actions under the fraudulent transfer provision in the federal Bankruptcy Code, 11 U.S.C. § 548, and § 544(b) claw back actions based on the Uniform Federal Transfer Acts adopted in other States.5 The 5 Claims under 11 U.S.C. § 548 are subject to a one-year statute of limitations, which is doubtless why the Trustee chose to proceed under § 544(b) in these cases. -9- Court refused to conclude as a matter of law “that a debtor operating a Ponzi scheme cannot receive reasonably equivalent value for the ‘interest’ or ‘profits’ it pays to investors.” 860 N.W.2d at 649. Finn held, instead, that whether an individual transfer was made for reasonably equivalent value “depends on the facts and circumstances of each case.” Id. at 650. In the Boosalis trial, the district court instructed the jury that “[v]alue may be reasonably equivalent where the payment made to the investor satisfies a valid antecedent debt,” but “[a]ny payment above the amount of the principal investment is not in satisfaction of a valid antecedent debt if it was made in furtherance of a fraud, enabled by a fraud, or paid on a dishonestly-incurred debt.” Kelley v. Boosalis, No. 0:18-cv-00868, 2018 WL 6322631, at  (D. Minn. Dec. 3, 2018). In granting summary judgment against Papadimos and Kanios, the district court explained the premises underlying this instruction. First, the district court concluded that, though the Supreme Court of Minnesota rejected the use of the Ponzi-scheme presumption adopted by many federal courts, Finn did not discard the “equity-driven bankruptcy law” on which the presumption was based. The equity-based decisions conclude that an investor who profits from a Ponzi scheme, even if an unwitting accomplice to fraud against other lenders or investors, does not have a contractual right to keep interest payments made as a direct result of that illegal scheme. See, e.g., Scholes v. Lehmann, 56 F.3d 750, 757 (7th Cir. 1995). This principle was not categorically rejected by the Court in Finn, the district court concluded. Rather, Finn held only that “any legally enforceable right to payment against the debtor is sufficient to qualify as an antecedent debt under MUFTA.” 860 N.W.3d at 651 (emphasis added). Second, the court noted Minnesota cases stating that a contract that aims to deceive third parties is void as against public policy. In a Ponzi scheme, payment of interest using other investors’ money plainly See In re Carrozzella & Richardson, 286 B.R. 480, 483 n.3 (Bankr. D. Conn. 2003). -10- aims to deceive those other investors. Therefore, the contract is not legally enforceable under Minnesota law because it furthered the on-going fraud. Because Defendants “failed to adduce evidence showing that any one of their interest payments was not made in furtherance of a fraud, enabled by a fraud, or paid on dishonestly-incurred debt,” no antecedent debt was satisfied by the interest payments, and Defendants did not provide reasonably equivalent value for the interest payments they received.6 (a) We agree with Defendants that the district court’s analysis misinterpreted the unanimous decision of the Supreme Court of Minnesota in Finn.7 In Finn, the receiver of a Ponzi-scheme operator’s bankruptcy estate sought to claw back interest earned by a bank from a “participation interest” in a loan made by the Ponzi-scheme operator. See 860 N.W.2d at 642-43. The Court entered summary judgment in favor of the defendant transferee because it had provided reasonably equivalent value for the interest payments it received, namely, “satisfaction of the debt owed . . . under the participation agreement between the parties.” Id. at 655. Consistent with Minn. Stat. § 513.43(a), the Court held that “the satisfaction of an antecedent debt can constitute reasonably equivalent value” and “any legally enforceable right to payment against the debtor is sufficient to qualify as an antecedent debt under MUFTA.” 860 N.W.2d at 650, 651. 6 This analysis avoided a critical holding in Finn: “[A]ny enforceable right to payment against the debtor is sufficient to qualify as an antecedent debt under MUFTA. . . . Without a legally enforceable contractual claim, any payment made to an investor beyond its principal investment is not for antecedent debt, and therefore cannot be in exchange for reasonably equivalent value.” Finn, 860 N.W.2d at 651. Thus, Finn confirmed that, in defending a fraudulent transfer claim under MUFTA, a bona fide debt investor is in a stronger position than a bona fide equity investor. 7 The Trustee successfully urged the district court not to certify this question to the Minnesota Supreme Court. -11- The district court’s global approach to the issues of antecedent debt and reasonably equivalent value is contrary to the clear directive in Finn that each fraudulent transfer claim “be determined in light of the facts and circumstances of each case” on a “transfer-by-transfer” basis. 860 N.W.2d at 647. The transfers at issue were payments of interest owed to Defendants on loans reflected by promissory notes and security agreements. Concluding that each loan was void ab initio because PCI was engaged in a Ponzi scheme, and therefore each periodic interest payment was not for an antecedent debt, simply repackages the Ponzi-scheme presumption that Finn refused to adopt as Minnesota law. Cf. Stoebner v. Opportunity Fin., LLC, 909 F.3d 219, 226 (8th Cir. 2018). Finn expressly rejected the basis for equity-based decisions the district court followed that were not governed by Minnesota law: [E]quality among a debtor’s creditors, even if they are victims of a Ponzi scheme, is not the purpose of MUFTA. Rather, its purpose is to prevent debtors from putting property which is available for the payment of their debts beyond the reach of their creditors. . . . [P]ayment of an honest debt is not fraudulent under the general statutes against fraudulent conveyances, although it operates as a preference. . . . Mere preferences are different from fraudulent transfers because the basic object of fraudulent conveyance law is to see that the debtor uses his limited assets to satisfy some of his creditors; it normally does not try to choose among them. Boston Trading Grp., Inc. v. Burnazos, 835 F.2d 1504, 1509 (1st Cir. 1987) (Breyer, J.). Id. at 652-53 (emphasis in original; cleaned up). Consistent with other equity-based decisions, the district court concluded that each PCI loan transaction was void as against public policy because it furthered the Ponzi scheme, and each preferential interest payment was a fraudulent transfer under MUFTA because it was paid with money stolen from other investors. See Janvey v. Brown, 767 F.3d 430, 441-42 (5th Cir. 2014) (certificate of deposit lending contracts with Ponzi-scheme operator “void” because recovery of promised returns in excess of investor’s undertaking furthers debtor’s fraudulent scheme at the expense of other -12- investors, applying Tex. UFTA); Donell v. Kowell, 533 F.3d 762, 770 (9th Cir. 2008) (“[W]inners in the Ponzi scheme, even if innocent of any fraud themselves, should not be permitted to enjoy an advantage over later investors sucked into the Ponzi scheme who were not so lucky,” applying Cal. UFTA, quotation omitted). This analysis sweeps as broadly as the Ponzi-scheme presumption Finn rejected. See 860 N.W.2d at 651-53. (b) We agree with the district court that Finn limited its antecedent debt analysis to “legally enforceable” contracts and “honest debt,” leaving open the question whether recovery of “profits” by early investors in a Ponzi scheme may be so entangled in the debtor’s fraud as to be void ab initio under Minnesota law, in which case there is no antecedent debt that was satisfied by the debtor’s payments at issue. However, we conclude that the Supreme Court of Minnesota would rule, if faced with this precise issue, that the promissory notes at issue in this case were not void ab initio under Minnesota law. See EMC Ins. Cos. v. Entergy Ark., Inc., 924 F.3d 483, 485 (8th Cir. 2019) (standard of review). In Finn, the Court noted that courts applying the Ponzi-scheme presumption “effectively deem a contract between the operator of a Ponzi scheme and an investor to be unenforceable as a matter of public policy.” Id. at 651. The Court rejected that categorical approach and, having “set aside” the presumption, granted summary judgment in favor of transferee Alliance Bank because it received interest payments at a “commercially reasonable rate of return” on a loan that was “real and not oversold.” Therefore, satisfaction of debtor’s antecedent debt was reasonably equivalent value under MUFTA. Id. at 655-56. Under Minnesota law, a contract is void against public policy only if “it is injurious to the interests of the public or contravenes some established interest of society,” or if “illegality has so tainted the contract that enforcing the contract would be against public policy.” Isles Wellness, Inc. v. Progressive N. Ins. Co., 725 N.W.2d -13- 90, 93 (Minn. 2006) (cleaned up). This is an extraordinary measure that “should be only exercised in cases free from doubt.” Id. Whether a contract is void as against public policy is an issue of law. Id. at 92. In concluding that every loan transaction between PCI and Defendants was legally unenforceable, the district court relied on the principle “that a contract is void which has for its object the practice of deception or fraud upon a third party.” Torpey v. Murray, 101 N.W. 609, 610 (Minn. 1904); accord Geo. Benz & Sons v. Hassie, 293 N.W. 133, 136 (Minn. 1940); Horbach v. Coyle, 2 F.2d 702, 706 (8th Cir. 1924). However, in these cases, both parties entered into the contract at issue with the purpose of deceiving a third party. For example, in Torpey, where the plaintiff agreed with the defendant to manipulate a third party into purchasing an asset from the plaintiff in exchange for an illegal kickback, the plaintiff’s contractual claim to recover the kickback was rejected on this ground. 101 N.W. at 610. Here, there is no evidence that Papadimos and Kanios, whose good faith the Trustee has conceded, worked with PCI to deceive other lenders or investors. Neither the Trustee nor the district court cited a Minnesota case that invalidated a contract based on one party’s unilateral acts of deception. In the case cited by the Trustee at oral argument, State v. Tauer, the Court held that a contract between rival newspapers to rig a county bidding process was void against public policy because it unlawfully destroyed economic competition. 227 N.W. 499, 500 (Minn. 1929). The Trustee asserted and the district court concluded that the promissory notes are void because they enabled an on-going fraud, an illegal purpose. But they cite no Minnesota case invalidating an otherwise valid contract on this ground, and there are many cases to the contrary. In Johnstown Land Co. v. Brainerd Brewing Co., for example, the Supreme Court of Minnesota held that “mere knowledge by the lender of [the borrower’s unlawful] purpose will not bar his recovery of the amount loaned.” 172 N.W. 211, 212 (Minn. 1919). In Anheuser-Busch Brewing Ass’n v. Mason, the Court refused to void a purchase contract for beer because the beer would be -14- consumed by patrons of a brothel, noting that a contract “is not void simply because there is something immoral or illegal in its surroundings or connections.” 46 N.W. 558, 558-59 (Minn. 1890). Similarly, in Hart Pubs. v. Kaplan, the Court held that a contract for the sale of tickets for an illegal lottery was not void; “bare knowledge of the purpose for which the tickets could be used was not enough to raise a valid defense of illegality.” 37 N.W.2d 814, 818-19 (Minn. 1949). The promissory notes held by Defendants fit comfortably within this group of decisions. Defendants supplied PCI financing, not knowing PCI would used the loan proceeds to further a fraudulent Ponzi scheme rather than to purchase merchandise in which Defendants were promised a security interest. Defendants received interest payments to which they were contractually entitled. The fact that the interest was paid out of PCI’s Ponzi churn was immaterial to the validity of the promissory notes. Though the district court “decline[d] to imply a strict mens rea requirement” from prior cases, that decision was squarely contrary to well established Minnesota law: Even if it be granted that the record might warrant the drawing of an inference that [the transferor] was actuated by an actual fraudulent intent, we find nothing which would permit such an intent to be found in the grantee. To be entitled to have a deed upon fair consideration adjudged void as to a creditor of the insolvent grantor it is necessary to prove actual intent to defraud on the part of both grantor and grantee. Watson v. Goldstein 219 N.W. 550, 551 (Minn. 1928); see Skinner v. Overend, 252 N.W. 418, 419 (Minn. 1934); Petersdorf v. Malz, 162 N.W. 474, 477 (Minn. 1917). The district court thus erred as a matter of law in declaring the promissory notes void and incapable of creating legally enforceable antecedent debts that would provide reasonably equivalent value for the interest payments Defendants received. Since the grant of summary judgment rejecting the actual fraud affirmative defense of Papadimos and Kanios turned on this determination, summary judgment must be -15- reversed. On their face, the secured promissory notes held by Defendants were valid and enforceable contracts -- “honest debts,” as described in governing Supreme Court of Minnesota opinions -- in which case interest payments Defendants received satisfied PCI’s antecedent debts. Whether those payments were nonetheless not received “for a reasonably equivalent value” under MUFTA must now be determined by the district court on remand. 2. Reasonably Equivalent value -- Boosalis. On appeal, Boosalis challenges Jury Instruction 18, which defined “reasonably equivalent value” for the jury: Value may be reasonably equivalent where the payment made to the investor satisfies a valid antecedent debt. Any payment above the amount of the principal investment is not in satisfaction of a valid antecedent debt if it was made in furtherance of a fraud, enabled by a fraud, or paid on a dishonestly-incurred debt. If you find that an interest payment made by Petters Company, Inc. to Mr. Boosalis was made in furtherance of a fraud, enabled by a fraud, or paid on dishonestly incurred debt, then that payment does not satisfy a valid antecedent debt, and is not for reasonably equivalent value. We have explained why the italicized portion of this instruction did not fairly and adequately instruct the jury as to the substantive law under MUFTA. That error does not resolve Boosalis’s appeal, however, because the jury also found that he did not act in good faith, the other component of the actual fraud affirmative defense. We turn next to that issue. 3. Good Faith -- Boosalis. On appeal, Boosalis challenges Jury Instruction 17, which addressed the good faith element of his affirmative defense to actual fraud avoidance: To determine whether Mr. Boosalis received a particular payment from Petters Company, Inc. in good faith, you must determine (1) whether -16- Mr. Boosalis was on inquiry notice of Petters Company, Inc.’s insolvency or fraud; and, if so, (2) whether Mr. Boosalis conducted a diligent investigation. Mr. Boosalis was on inquiry notice if he had sufficient facts, or sufficient red flags existed, to cause a reasonable person to question whether Petters Company, Inc. was insolvent or paying money to Mr. Boosalis for a fraudulent purpose. Sufficient facts or red flags may include delinquent payments, reversed checks, relatively high interest rates on loans, and a lack of formal paperwork surrounding business transactions. The presence of such signs must place a reasonable person on inquiry notice and require him or her to diligently investigate. If you find Mr. Boosalis was not on inquiry notice at the time he received a particular payment from Petters Company, Inc., then Mr. Boosalis has established the element of good faith with respect to that particular payment. If you find Mr. Boosalis was on inquiry notice at the time he received a particular payment from Petters Company, Inc., you must determine whether Mr. Boosalis conducted a diligent investigation as to the facts or red flags that placed him on inquiry notice and whether his investigation was reasonable under the circumstances. If you find Mr. Boosalis did not conduct a diligent investigation that was reasonable under the circumstances, then Mr. Boosalis has failed to establish the element of good faith. If you find that Mr. Boosalis did conduct a diligent investigation that was reasonable under the circumstances, then Mr. Boosalis has established the element of good faith. (Emphasis added.) (a) The Trustee argues Boosalis waived this objection before the district court. We disagree. At the instructions conference, counsel objected: -17- COUNSEL: Your Honor, I didn’t have any issues up until Instruction Number 16.8 If we could go to that on page 12. THE COURT: 16. Good faith, yep. COUNSEL: Yes, Your Honor. If you go to the second paragraph, we would ask that the language starting with “sufficient facts or red flags may include delinquent payments, reversed checks, relatively high interest rates on loans, and lack of formal paperwork surrounding business transactions.” I would ask that that language be stricken. THE COURT: And why is that? COUNSEL: I think it’s prejudicial here, Your Honor. I mean, there could be a list, you know, a thousand items long. The problem I have with this is it includes basically, you know, all of the issues that are present here in this case. And I think it’s kind of an all or nothing where if we’re going to list these red flags, you know, it can’t just be these few. So, you know, I would just prefer that we take that language out completely. THE COURT: Okay. Do you think it’s an incorrect statement? COUNSEL: Your Honor, I don’t -- I’m not going to argue that it’s an incorrect statement. Again, I think it’s context. I think if you’re going to put a list in, this list is highly prejudicial because it basically lays out a few elements and all the elements are what are argument in this case. If we’re going to do a list, I would prefer that we have an exhaustive list. What that would look like I don’t know, but it would certainly be more than just this. And in light of that and I think the confusion it would cause, I would just like this language stricken. That’s my request. 8 The instructions were renumerated after the charge conference, such that Jury Instruction 16 became Jury Instruction 17. -18- Counsel renewed that objection prior to closing arguments and the court’s final instructions to the jury. Even correct statements of the law can mislead the jury if they unduly emphasize a matter favorable to a party’s case. See Rosebud Sioux Tribe v. A & P Steel, Inc., 733 F.2d 509, 518-19 (8th Cir.), cert. denied, 469 U.S. 1072 (1984). That was the objection made, and counsel explained it sufficiently to preserve the error for appellate review. See Fed. R. Civ. P. 51; Bauer v. Curators of Univ. of Missouri, 680 F.3d 1043, 1044-45 (8th Cir. 2012); Brown v. Sandals Resorts Int’l, 284 F.3d 949, 953 n.6 (8th Cir. 2002). (b) While a district court has broad discretion in formulating jury instructions, it “must be careful if it intends to tie in principles of law to the facts.” Vanskike v. ACF Indus., Inc., 665 F.2d 188, 202 (8th Cir. 1981), cert. denied, 455 U.S. 1000 (1982). “An instruction is argumentative if it does not include all the elements of the doctrine, or singles out the testimony of one witness while disregarding other relevant evidence, or unduly highlights certain features of a case.” Id. at 201-02 (citations omitted); see Caviness v. Nucor-Yamato Steel Co., 105 F.3d 1216, 1221-22 (8th Cir. 1997). Such instructions “effectively require[] unjustified commentary on the evidence” and are “virtually verdict-directing in their character,” in contrast to more preferable, “neutral instruction[s] directing the jury to consider such factors.” Cent. Microfilm Serv. Corp. v. Basic/Four Corp., 688 F.2d 1206, 1219 (8th Cir. 1982), cert. denied, 459 U.S. 1204 (1983); compare Mems v. City of St. Paul, Dep’t of Fire & Safety Servs., 327 F.3d 771, 782-83 (8th Cir. 2003) (approving an instruction listing “hypothetical examples” of a non-hostile work environment), cert. denied, 540 U.S. 1106 (2004); Nat’l Auto. Trading Corp. of China v. Pioneer Trading Co., 46 F.3d 842, 843-44 (8th Cir. 1995) (approving an instruction listing facts that “tend to establish” abuse of corporate privilege). Jury Instruction 17 was that type of error. It singled out facts most favorable to the Trustee. Worse yet, it stated that, if the jury found the presence of such signs, it “must” find that Boosalis was on inquiry notice, in effect, a directed verdict on a -19- critical element of the good faith issue. Good faith is not defined in MUFTA. See Minn. Stat. § 513.41. The term has no recognized meaning under the Uniform Fraudulent Transfers Act. See For Your Ease Only, Inc. v. Calgon Carbon Corp., 560 F.3d 717, 721 (7th Cir. 2009); UFTA § 8 cmt. (1) (Unif. L. Comm’n 1984); cf. Kansas City Power & Light Co. v. Ford Motor Credit Co., 995 F.2d 1422, 1430 (8th Cir. 1993) (“What good faith means depends on the situation in which the term is used.”). By singling out “signs” favorable to the Trustee and then instructing that those facts are “sufficient,” the instruction confused facts that support a finding with facts that require it in every case. (c) Not every erroneous instruction results in a new trial. We reverse only if the error affected the substantial rights of the parties. See Fed. R. Civ. P. 61. There is no prejudice if the evidence was “overwhelming.” Vanskike, 665 F.2d at 203. Here, the impact of the error in Instruction 17 must be considered in combination with the error in Instruction 18 on the issue of reasonably equivalent value, and with the way in which the Trustee relied on the combined errors in his final argument. As we explained in Part II.B., the district court erred in instructing the jury in Instruction 18 that any payment of interest on PCI’s promissory notes “is not in satisfaction of a valid antecedent debt if it was made in furtherance of a fraud, enabled by a fraud, or paid on a dishonestly-incurred debt.” Relying on this instruction, the Trustee declared in closing argument: PCI was a Ponzi scheme. . . . The nature of a Ponzi scheme is that PCI defrauds new investors to pay old investors, right? It’s the churn. And Gus Boosalis was in the churn. He was defrauded. His money was taken and used to pay old investors, and then later he was paid with money that was stolen from new investors.