Perkins v. Haines - Initial Brief

8/3/2019 Perkins v. Haines - Initial Brief

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UNITED STATES COURT OF APPEALSFOR THE ELEVENTH CIRCUIT

_____________________________________________________________

NO. 10-10683-BB

_________________________________________

WILLIAM F. PERKINS, PLAN TRUSTEE FOR INTERNATIONALMANAGEMENT ASSOCIATES, LLC

Appellant,

v.

AENA Y. HAINES, ET AL

Appellees._________________________________________

ON DIRECT APPEAL FROM THE UNITED STATES BANKRUPTCY COURTFOR THE NORTHERN DISTRICT OF GEORGIA, ATLANTA DIVISION___________________________________________________________

BRIEF OF APPELLANT WILLIAM F. PERKINS, PLAN TRUSTEE FOR

INTERNATIONAL MANAGEMENT ASSOCIATES, LLC

____________________________________________________________

Colin M. BernardinoGeorgia Bar No. 054879KILPATRICK STOCKTON, LLP1100 Peachtree Street, Suite 2800Atlanta, Georgia 30309Tel: (404) 815-6500Fax: (404) 815-6555

Mark S. KaufmanGeorgia Bar No. 409194Bryan E. BatesGeorgia Bar No. 140856MCKENNA LONG & ALDRIDGE LLP303 Peachtree Street, N.E., Suite 5300Atlanta, Georgia 30308Tel: (404) 527-4000

Fax: (404) 527-4198

Case: 10-10683 Date Filed: 04/23/2010 Page: 1 of 84


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William Perkins v. Haines, et al; Docket No. 10-10683

CERTIFICATE OF INTERESTED PERSONS AND CORPORATE

DISCLOSURE STATEMENT

Abdur-Rabbani, Ibrahim

Adams, Edwana

Anand, Esq., Justin

Anderson, Ivy

Atlanta Perinatal Associates, P.C.

Atlanta Verve, LLC

Atwater, Stephen

Bailey, Erroll J.

Bailey, Esq., Gregory T.

Baker, Scott G.

Barrett, ThomasBates, Esq. Bryan E., counsel to Committee of Investors formed pursuant to Plan

of Reorganization

Bernardino, Esq., Colin Michael, counsel to William F. Perkins, Plan Trustee

Bishop, Blaine E., member of Committee of Investors formed pursuant to Plan ofReorganization

Bishop, J. Michael

Bonapfel, Judge Paul W., Bankruptcy Judge

Bond, Annette K.

Braxton, James



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Broadfoot, Esq., Herbert C.

Bronner, James

Bronner, Nathaniel

Bronner, Simone

Brossard, Mario & Charisse

Brumbaugh, Esq., Thomas D.

Bryan, Delmena

Burkes, K.

Burnett, Theodore

Busskohl, Charles, member of Committee of Investors formed pursuant to Plan ofReorganization

Byrne, Esq., Thomas M.

Carter, Michael

Central Georgia Anesthesia Services, PC

Champagne, Jessie & Joyce

Coleman, Esq., Michael V.

Coleman, Marco D.

Costell, Esq., Jeffrey Lee

Cranshaw, Esq., David W.

Culton, Leroy

Curtis, George

Curtis, George Russell



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Cutright, Eric

Daniels, Jerry A.

Daniels, LLC, Jerry A.

Danowitz, Esq., Edward F.

Davis, Craig

Davis, Jo Ann Braxton

Dawson, Esq., Heather D.

Dearing, Jr., PC, James E.

DeCarlo, A. Eskridge

DeCarlo, Amanda Eskridge

Delk, Esq., Glenn A.

DeRobbio, Paul

Eason, Esq., Rodney L.

Edwards, Cheryl

Edwards, III, Robert L.

Edwards, Joan

Edwards, Terrence J.

Elko, Alison M., former counsel to William F. Perkins, Plan Trustee

Emerald II Fund, LP, Debtor

Fain, Esq., Jonathan H.

Farmer, Esq., Kevin M.

Flint, Cara



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Friday, Kheisha

Frison, Jr., Lee A.

Gallassero, William J.

Gardner, Joseph and Lydia

Gayle, Raquel M.

Gebhardt, Esq., Guy G.

Geddes, Dr., Lloyd

Georgia Department of Revenue

Gist, Keenan P.

Gordon, David E., counsel to Committee of Investors formed pursuant to Plan ofReorganization

Greenberg Traurig LLP

Grover, Jaswinder S., member of Committee of Investors formed pursuant to Planof Reorganization

GTO Development, LLC

Haines, Aena Y.

Hall, Duvall & Claude

Hall, Evelyn

Hall, Keeling

Harley-Lewis, Erinn F.

Hays & Associates

Herbert, Glenn M.

Hinckson, Terrence



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Hines, Bruce A. and Cynthia

Holbein, Esq., Michael F.

Hooper, Gregory and Lawrence

IMA Real Estate Fund, LLC, Debtor

Internal Revenue Service

International Management Associates, LLC, Debtor

International Management Associates Advisory Group, LLC, Debtor

International Management Associates Platinum Group, LLC, Debtor

International Management Associates Emerald Fund, LLC, Debtor

International Management Associates Taurus Fund, LLC, Debtor

International Management Associates Growth & Income Fund, LLC, Debtor

International Management Associates Sunset Fund, LLC, Debtor

International Medical Systems, LLC

Jackson, Linda C.

Jeffries, Martin D.

Jeter, George L.

Johnson, William E., member of Committee of Investors formed pursuant to Planof Reorganization

Jones, Laverne

Jones, Vicki L.

July, Clarence & Valerie

Kaufman, Esq., Mark S., counsel to Committee of Investors formed pursuant toPlan of Reorganization



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Kelley, Esq., Mark A.

Kilpatrick Stockton LLP, counsel to William F. Perkins, Plan Trustee

Knight, Jr., James K.

LaBriola, Esq., Stephen T.

Laird, David

Laird, David & Deborah H.

Layne, Esq., Bernadine H.

Lester, Esq., William R.

Lewonski, Esq., Sharon M.

Louis, Charles H.

Mair, Manuel F.

Mair, Suzanne

Maughan, John & Roxanne

McBryan, Esq., Louis G.

McDade, William

McDonnell, Esq., Robert H.

McKenna Long & Aldridge LLP, counsel to Committee of Investors formedpursuant to Plan of Reorganization

McManners, Thomas P.

Meir, Esq., Dennis S., counsel to William F. Perkins, Plan Trustee

Miller, Hyacinth

Mills, III, Esq., John W., former counsel to William F. Perkins, Plan Trustee



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Monnin, Esq., Paul

Moore, Joseph

Mottern, Robert J.

Mt. Nebo Baptist Life Center, Inc.

Mungovan, Esq., Timothy W.

Noble, Horace

ONeal, Roger L., member of Committee of Investors formed pursuant to Plan ofReorganization

Office of United States Trustee

Paris, Calvin

Passyn, Esq., Juanita A.

Peoples, Valerie

Peoples-Wisneski, Michelle

Perkins, William F., Plan Trustee

Perkins, William T.

Perman, Jenny Lynn

Perman, Todd

Phillips, Chris D.

Phillips, Christopher D.

Pinkney, Carol

Pinkney, Laura

Pinkney, Roland



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Platinum II Fund, LP, Debtor

Pollack, Charles I.

Porter, Jr., John C.

Qudsi, Mustafa

Randolph, Erich G.

Redfern, Fred C. & Sherri D.

Reese, James Eric

Regan, Sr., Stephen

Ricciardi, Anthony

Robison, David and Joni

Roger ONeal Family Trust

Rossi, Elayne R.

Rue, James A.

Sacca, Esq., James R.

Sblendorio, Esq., Sblend A.

Secret, Esq., Akil Kenneth

Seymour, Booker T.

Shelton, Cornell

Shelton, III, J.

Shelton, J.

Spikes, Takeo

Spizzirri, Esq., Paul M.



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Star 6 Investments, Ltd.

Steele, Algernon O.

Stein, Esq., Grant T.

Stine, Esq., Kevin

Tarabadkar, Dr., Sanjiwan

TBC Capital, Inc.

Thompkins, Karen

Tillett, Colleen H., former counsel to William F. Perkins, Plan Trustee

Treace, R. Jeneane

Trigg, Esq., Mark G.

U.S. Securities and Exchange Commission

Wang, Ben Chang

Whonder, Ernest

Williams, Chasta N.

Williams-Cochrane, Rodney

Williamson, J. Robert

Wilson, Craig A. & Carole

Wisneski, David

Withers, Bruce & Renee

Work, Frederick T.

Worthy-Pickett, Cheryl

X-Spurts Investment



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STATEMENT REGARDING ORAL ARGUMENT

Appellant William F. Perkins, Plan Trustee, respectfully requests oral

argument. As grounds for his request, Appellant states that his appeal is not

frivolous, the dispositive issues in this appeal have not been authoritatively

decided, and Appellant respectfully asserts that oral argument will significantly aid

this Court in its consideration of this appeal.



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TABLE OF CONTENTS

CERTIFICATE OF INTERESTED PERSONS AND CORPORATEDISCLOSURE STATEMENT.......................................................................1

STATEMENT REGARDING ORAL ARGUMENT ...............................................iTABLE OF CONTENTS......................................................................................... ii

TABLE OF CITATIONS ....................................................................................... iv

STATEMENT OF JURISDICTION....................................................................... ix

STATEMENT OF THE ISSUES..............................................................................1

STATEMENT OF THE CASE.................................................................................2

A. Preliminary Statement ..........................................................................2

B. Course of Proceedings and Disposition Below....................................3C. Statement of the Relevant Facts...........................................................6

D. Standard of Review ..............................................................................7

SUMMARY OF THE ARGUMENT .......................................................................7

ARGUMENT AND CITATIONS OF AUTHORITY ...........................................11

I. Fraudulent Transfer Claims and Defenses Generally: Repayment ofan Antecedent or Present Debt is Deemed to be For Value, andTherefore is Shielded from Avoidance.........................................................13

A. The determination of value focuses on the specific value ofthe property exchanged in the transfer at issue: where theexchange was for a worthless equity interest, the exchangecannot be for value..........................................................................14

II. Fraudulent Transfer Claims and Defenses in the Context of FraudulentInvestment Schemes: a Critical Analysis of the Historically DecidedCases .............................................................................................................16

A. The factual distinction in this case relative to the Claim2 cases

is critical because of the fundamental manner in which the lawdistinguishes the treatment of equity from the treatment of debt. .....26

1. Rooted in American legal traditions are clear distinctionsbetween equity interests and debt claims.................................26



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2. The clear distinctions between equity and debt arereinforced by the treatment of inter se debt claims ascompared to the treatment of inter se equity positions............31

B. A single court has improperly extended the Claim2 reasoning to

the facts at bar, misinterpreting the principles in Eby as actuallysupporting recharacterization of transfers in respect of equityinstruments to be in satisfaction of debt claims, without anymeaningful substantive analysis to undergird that conclusion ..........36

1. Neither the Ninth Circuit in AFI nor the BankruptcyCourt adequately analyzed the fundamental distinctions

between debt and equity...........................................................42

2. Moreover, neither the Ninth Circuit in AFI nor theBankruptcy Court adequately analyzed that the Claim2

analysis permits the full recognition and satisfaction of atort claim that was never even asserted, let alone provenin a court of law, in contravention of all notions of due

process and requirement of articulation of claims...................46

(i) Transmutation without articulation contravenesSection 510(b) of the Bankruptcy Code, whichreflects Congressional intent regardingrecharacterization of claims...........................................50

(ii) Transmutation without Articulation contravenesSections 1123 and 1129 of the Bankruptcy Code,which reflect Congressional intent to assure theratable treatment of articulated claims of similarlysituated parties ...............................................................53

3. Finally, neither the Ninth Circuit in AFI nor theBankruptcy Court analyzed that the retroactiverecognition and satisfaction of a tort claim contravenesthe operation of Section 548(c) of the Bankruptcy Code ........55

CONCLUSION.......................................................................................................57CERTIFICATE OF COMPLIANCE......................................................................60

CERTIFICATE OF SERVICE ...............................................................................61



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TABLE OF CITATIONS

Page(s)

CASES

Adelphia Communications Corp. v. Rigas(In re Adelphia Communications Corp.), 323 B.R. 345 (Bankr. S.D.N.Y.2005) ...................................................................................................................15

Alley v. Miramon,614 F.2d 1372 (5th Cir. 1980) ............................................................................34

Begier v. IRS,496 U.S. 53, 110 S.Ct. 2258, 110 L.Ed.2d 46 (1990) ........................................53

Boesky v. CX Partners, L.P.,1988 WL 42250 (Del. Ch. 1988) ........................................................................29

Cordes & Co. Financial Services, Inc. v. A.G. Edwards & Sons, Inc.,502 F.3d 91 (2d Cir. 2007) .................................................................................47

Crimmins & Peirce Co. v. Kidder Peabody Acceptance Corp.,282 Mass. 367, 185 N.E. 383, 88 A.L.R. 1122 (1933).......................................34

Donell v. Kowell,

533 F.3d 762 (9th Cir. 2008) ..................................................................22, 24, 25

Eby v. Ashley,1 F.2d 971 (4th Cir. 1924), cert. denied, 266 U.S. 631, 45 S.Ct. 197, 69L.Ed. 478 (1925)..........................................................................................passim

Fraser v. Major League Soccer, L.L.C.,97 F. Supp 2d 130 (D. Mass. 2000) ....................................................................33

Grymes v. Sanders,

93 U.S. 55, 23 L.Ed. 798 (1876).........................................................................47

Hayes v. Palm Seedlings Partners-A(In re Agricultural Research and Tech. Group, Inc.),916 F.2d 528 (9th Cir. 1990) ..................................................................37, 38, 40



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HBE Leasing Corp. v. Frank,61 F.3d 1054 (2d Cir. 1995) ...............................................................................48

Hillman v. Hillman,910 A.2d 262 (Del. Ch. 2006) ............................................................................33

In re AFI Holding, Inc.,525 F.3d 700 (9th Cir. 2008) .......................................................................passim

In re Bayou Group, LLC,362 B.R. 624 (Bankr. S.D.N.Y. 2007)................................................................47

In re Ben Franklin Hotel Assoc.,1998 WL 94808 (E.D. Pa. 1998) ........................................................................28

In re Charter Company,44 B.R. 256 (Bankr. M.D. Fla. 1984) .................................................................28

In re Churchill Mortg. Inv. Corp.,256 B.R. 664 (Bankr. S.D.N.Y. 2000)..........................................................14, 15

In re Fin. Federated Title & Trust, Inc.,309 F.3d 1325 (11th Cir. 2002) ......................................................................7, 14

In re Geneva Steel Co.,281 F.3d 1173 (10th Cir. 2002) ..........................................................................26

In re Granite Partners, L.P.,208 B.R. 332 (Bankr. S.D.N.Y. 1997)..........................................................26, 27

In re Hedged-Investments Associates, Inc.,

84 F.3d 1267 (10th Cir. 1996) ......................................................................28, 36

In re Jeffrey Bigelow Design Group, Inc.,956 F.2d 479 (4th Cir. 1992) ..............................................................................34

In re Lake States Commodities, Inc.,253 B.R. 866 (Bankr. N.D. Ill. 2000) ...........................................................48, 49

In re M & L Business Machine Co.,84 F.3d 1330 (10th Cir. 1996) ................................................................17, 22, 24



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In re Richards & Conover Steel, Co.,267 B.R. 602 (8th Cir. BAP 2001) .....................................................................14

In re Roco Corp.,701 F.2d 978 (1st Cir. 1983)...............................................................................15

In re Sentry Operating Co. of Texas, Inc.,264 B.R. 850 (Bankr. S.D. Tex. 2001) ...............................................................53

In re Terry Mfg. Co., Inc.,2007 WL 274319 (Bankr. M.D. Ala. 2007) .................................................42, 43

In re United Energy Corp.,944 F.2d 589 (9th Cir. 1991) .......................................................................passim

In re USA Commercial Mortgage Co.,377 B.R. 608 (BAP 9th Cir. 2007) .....................................................................51

Jezarian v. Raichle(In re Stirling Homex Corp.), 579 F.2d 206 (2d Cir. 1978) ...............................51

Merrill v. Abbott

(In re Independent Clearing House Co.), 77 B.R. 843 (D. Utah 1987)17, 22, 23, 56

Schafer v. Hammond,456 F.2d 15 (10th Cir. 1972) ..............................................................................15

Scholes v. Ames,850 F.Supp. 707 (N.D. Ill 1994)...................................................................36, 37

Scholes v. Lehmann,56 F.3d 750 (7th Cir 1995) .................................................................................54

Slappey Drive Indus. Park v. United States,561 F.2d 572 (5th Cir. 1977) ..............................................................................30

The Pepsi-Cola Bottling Co. of Salisbury, Md. v. Handy,2000 WL 364199 (Del. Ch. 2000) ..........................................................16, 28, 35

Wolfensohn v. Madison Fund, Inc.,253 A.2d 72 (Del. 1969) .....................................................................................30



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STATUTES

11 U.S.C. 101(5) and (12).....................................................................................27

11 U.S.C. 101(16) and (17)...................................................................................27

11 U.S.C. 501(a) ...................................................................................................28

11 U.S.C. 510(b) ............................................................................................passim

11 U.S.C. 548.................................................................................................passim

11 U.S.C. 1102(a) ...................................................................................................3

11 U.S.C. 1123(a)(4).............................................................................................53

11 U.S.C. 1129(b) .................................................................................................26

11 U.S.C. 1129(b)(1).............................................................................................53

28 U.S.C. 158(d)(2)(A)....................................................................................... viii

28 U.S.C. 158(d)(2)(A)(i) and (iii) ..................................................................... viii

Section 548(d)(2)(A) of the Bankruptcy Code ........................................................13

Sections 1123 and 1129 of the Bankruptcy Code....................................................52

Sections 1129(b) and 1123(a)(4) of the Bankruptcy Code......................................54

Bankruptcy Reform Act of 1978..............................................................................51

Chapter 11 of Title 11 of the United States Code (the Bankruptcy Code) ............3

DEL. CODE ANN. tit. 6, 17-601, 17-604, 18-503 .................................................33

DEL. CODE ANN. tit. 6, 17-607, 17-804, 18-607 .................................................28

DEL. CODE ANN. tit. 6, 17-607, 18-607.........................................................15, 35

O.C.G.A. 14-9-503, 14-9A-46, 14-11-407 ...................................................15, 35

O.C.G.A. 14-9A-46, 14-11-407, 14-2-1405(3) and (4) ......................................28

O.C.G.A. 14-11-403, 14-9-503, 14-9A-42(b) ....................................................33



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O.C.G.A. 18-2-73(a) .............................................................................................13

O.C.G.A. 18-2-78..............................................................................................4, 13

OTHERAUTHORITIES

Bruce A. Markell,A New Perspective on Unfair Discrimination in Chapter11, 72 Am. Bankr. L.J. 227 (1998).....................................................................53

Fed. R. Bankr. P. 7001(2), (8)..................................................................................48

Fed. R. Bankr. P. 7056 ...............................................................................................5



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STATEMENT OF JURISDICTION

This Court has jurisdiction of this appeal pursuant to 28 U.S.C.

158(d)(2)(A). Pursuant to 28 U.S.C. 158(d)(2)(A)(i) and (iii), the United States

Bankruptcy Court for the Northern District of Georgia, Atlanta Division (the

Bankruptcy Court), certified for direct appeal to this Court that certain Order

entered by the Bankruptcy Court on December 1, 2009 Denying Trustees Motion

for Partial Summary Judgment (the Order). Following the Bankruptcy Courts

certification of the Order, acting in accordance with Fed. R. Bankr. P. 8001(f)(5)

and Fed. R. App. P. 5, Appellant filed a petition for permission for direct appeal to

this Court, which petition this Court granted by order dated February 17, 2010.

Accordingly, by its authorizing the direct appeal from the Bankruptcy Courts

Order, this Court has jurisdiction of this appeal.



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STATEMENT OF THE ISSUES

Whether an investor who invested as an equity holder in an enterprise (as

opposed to being a claimholder holding a debt claim against the enterprise), which

enterprise is later revealed to have been a fraudulent scheme, can establish that he

or she tendered value to the transferor-enterprise in exchange for the cash

transfer that the investor received from the enterprise prior to the discovery of the

fraudulent scheme and its subsequent bankruptcy filing, and thereby establish a

required element of the investors affirmative defense to a fraudulent transfer claim

asserted by the bankruptcy trustee, assuming that, at the time of each subject

transfer, the investor: (i) tendered to the enterprise the investors essentially

worthless equity interest in the enterprise in exchange for the transfer; and (ii) held

what a court would have found to be an unasserted claim against the enterprise

based on fraudulent inducement that arose at the time the investor originally

invested as an equity holder in the enterprise.



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STATEMENT OF THE CASE

A. Preliminary StatementThe instant appeal concerns adversary proceedings that Appellant William

F. Perkins, Plan Trustee (the Trustee) for International Management Associates,

LLC, the substantively consolidated post-confirmation debtor (the Debtor or

Debtors, or generally IMA1), filed against numerous persons who had invested

as equity members and/or limited partners in the Debtors (the Investor

Defendants) to avoid and recover transfers made to them during the pre-

bankruptcy operation of the Debtors, on the basis that such transfers were actually

and/or constructively fraudulent pursuant to 11 U.S.C. 548 and correlative state

law fraudulent transfer statutes (the Investor Avoidance Actions). Through the

filing of the Investor Avoidance Actions, the Trustee attempts to recover sums

distributed by the Debtors to certain of theirequity investors prior to the discovery

that the Debtors were being operated as a fraudulent scheme, in order to distribute

most equitably the limited assets of the scheme for the benefit of all the schemes

defrauded investors.

1 By order dated April 27, 2008, the Bankruptcy Court consolidated all of therelated debtors of International Management Associates, LLC into onesubstantively consolidated bankruptcy estate.



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With the advice of the Plan Committee (the Committee),2

as duly formed

pursuant to the confirmed Third Amended Trustees Plan of Liquidation (the Plan

of Liquidation), the Trustee submits this brief (the Brief) in support of the

Trustees appeal from that certain Order Denying Trustees Motion for Partial

Summary Judgment entered on December 1, 2009 (the Order) by the United

States Bankruptcy Court for the Northern District of Georgia, Atlanta Division (the

Bankruptcy Court).

B. Course of Proceedings and Disposition BelowOn March 16, 2006 (the Petition Date), the Debtors each filed voluntary

petitions for relief under Chapter 11 of Title 11 of the United States Code (the

Bankruptcy Code). On March 27, 2006, the United States Trustee appointed a

committee of investors pursuant to 11 U.S.C. 1102(a). On April 20, 2006, the

United States Trustee appointed William F. Perkins as chapter 11 trustee of the

Debtors. On August 27, 2008, the Bankruptcy Court entered an Order Confirming

the Trustees Plan of Liquidation. Pursuant to the terms of the Plan of Liquidation,

William F. Perkins was appointed as the Plan Trustee for the substantively

consolidated Debtor, and the Plan Committee was duly formed.

2 Counsel for the Committee has prepared this Brief. By agreement with theTrustee, Committee counsel will take the lead role in arguing the matters raisedherein.



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In order to distribute most equitably the limited assets of the IMA scheme

for the benefit of all the schemes defrauded investors, the Trustee filed the

Investor Avoidance Actions to avoid and recover transfers made to the Investor

Defendants, on the basis that such transfers were actually and/or constructively

fraudulent. In response, the Investor Defendants asserted the affirmative defense

provided by Section 548(c) of the Bankruptcy Code and correlative provisions of

state law fraudulent transfer statutes. Specifically, Section 548(c) of the

Bankruptcy Code provides that a transferee that takes for value and in good faith

... may retain any interest transferred ... to the extent that such transferee gave

value to the debtor in exchange for such transfer. 11 U.S.C. 548(c) (emphasis

added). Under applicable state law, [a] transfer is not voidable against a

person who took in good faith and for a reasonably equivalent value. O.C.G.A.

18-2-78 (emphasis added). Thus, the Bankruptcy Code and state law afford an

affirmative defense to a fraudulent transfer only where the defendant transferee can

establish both that the transferee acted in good faith and that the transferee

provided the transferor value in exchange for the transfer. See, e.g., id.; 11

U.S.C. 548(c). Because the Bankruptcy Code and state law require proof of an

exchange for value, necessarily a transferees showing of good faith alone is

insufficient to premise an affirmative defense to avoidance of the transfer.

Accordingly, unless the Investor Defendants can establish that they provided the



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Debtors value in exchange for the transfers made to them, such transfers should

properly be avoided even if the Investor Defendants can show that they acted in

good faith.

Pursuant to Rule 7056 of the Federal Rules of Bankruptcy Procedure, the

Trustee filed a motion (the Motion for Partial Summary Judgment) seeking a

ruling by the Bankruptcy Court that, as a matter of law, the Investor Defendants

cannot meet their burden to establish the necessary value element of their

affirmative defense on the basis that the distributions to the Investor Defendants

were not transfers for value where such distributions were made solely in

exchange for the Investor Defendants tendering back to the transferor Debtors the

Investor Defendants essentially worthless equity interests in one or more of the

Debtors. Doc 4, Pgs 1-2. Solely for purposes of considering the Motion for Partial

Summary Judgment, the Bankruptcy Court consolidated the Trustees adversary

proceedings against the Investor Defendants into a single Miscellaneous

Proceeding.3 Doc 1, Pgs 1-3. On December 1, 2009, the Bankruptcy Court

entered an Order denying the Trustees Motion for Partial Summary Judgment, and

certified the legal question presented therein for immediate review by this Court.

Doc 38, Pg 13. The Trustee then filed a Petition for Leave to Appeal from the

3 Miscellaneous Proceeding No. 09-MP-601, United States Bankruptcy Courtfor the Northern District of Georgia.



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Bankruptcy Courts Order, which petition this Court granted by order dated

February 17, 2010.

C. Statement of the Relevant FactsAs set forth in the Bankruptcy Courts Order and certification for direct

appeal, for the purposes of this appeal it is assumed that the following facts have

been established: Kirk Wright formed the Debtors purportedly to manage and

operate as hedge funds, each of which was structured either as a limited liability

company or a limited partnership. In reality, Wright used the Debtors at all

material times to operate a fraudulent Ponzi scheme whereby capital

contributions made into the Debtors by later equity investors were used to

knowingly pay earlier investors more than their equity investments were actually

worth, including nonexistent principal and fictitious profits, to perpetuate the

illusion that the Debtors had positive investment gains, to keep existing investors

from seeking recovery of their equity investments, and to induce prospective

investors to make new equity investments. Each of the Investor Defendants made

a capital contribution through execution of a limited liability company agreement,

a limited partnership agreement, and/or a subscription agreement with one or more

of the Debtors such that the Investor Defendant held an equity interest in, not a

debt claim against, one or more of the Debtors denominated as a membership unit

or a limited partnership interest. During the operation of the scheme, investors



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requested and received transfers from the Debtors, representing returns of principal

and/or purported profits on their equity investments. At some time during the

operation of the scheme, each Investor Defendant received one or more transfers of

property from one or more of the Debtors on account of such Investor Defendants

equity interest in one or more of the Debtors. Doc 39, Pgs 2-3.

D. Standard of ReviewThe facts set forth above are presumed to have been established for purposes

of the Bankruptcy Courts Order and this appeal; accordingly, the only issues on

appeal involve the legal conclusions to be reached upon application of the law to

the assumed facts. Appellant respectfully asserts that the Bankruptcy Court erred

in formulating and applying the rule of law applicable to these facts. This Court

reviews the legal conclusions of the lower courts de novo. In re Fin. Federated

Title & Trust, Inc., 309 F.3d 1325, 1328-29 (11th Cir. 2002).

SUMMARY OF THE ARGUMENT

The issue on appeal is whether an Investor Defendant, as a holder of an

equity interestin a Debtor (as opposed to being a claimholder holding a debt claim

againsta Debtor) can establish that the Investor Defendant tendered value to the

transferor-Debtor in exchange for the cash transfer that the Investor Defendant

received from the Debtor, and thereby establish a required element of the Investor

Defendants affirmative defense to the Trustees fraudulent transfer claims,



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assuming that, at the time of each subject transfer the Investor Defendant: (i)

tendered to the Debtor the Investor Defendants essentially worthless equity

interest in the Debtor in exchange for the transfer; and (ii) held what a court would

have found to be an unasserted claim against the Debtor based on fraudulent

inducement that arose at the time the Investor Defendant originally invested as an

equity holder in the Debtor.

Courts universally recognize that (i) equity interests in an enterprise with

little or no net worth are essentially worthless, and (ii) where the equity interests of

an enterprise are worthless or of a value substantially below the amounts

distributed to the enterprises equity investors, those distributions are not

exchanges for value within the meaning of the Bankruptcy Code or state law.

Meanwhile, there also has arisen a general rule in the fraudulent investment

scheme context that defrauded investors who recovered their investments from a

fraudulent enterprise prior to the frauds discovery are entitled to retain all of what

they recovered up to the full amount of the principal they invested, based on a legal

fiction whereby payments made to the schemes victims in respect of their

principal investments are retroactively recharacterized as having been paid to

satisfy unasserted fraudulent inducement claims-- i.e., unknown to the investor at

the time of redemption -- that arose when the investor initially invested in the

scheme. This general rule, however, arose in the factual context where the



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defrauded investors held from their inception debt claims against the fraudulent

investment scheme, as compared to the case at bar where the defrauded investors

were, at the very inception of their investments, clearly holders ofequity interests

in the fraudulent enterprise.

Despite the well-established law that the exchange of a worthless equity

interest is not an exchange for value, and without any analysis of the clear

distinctions that exist between equity and debt (and how legal fundamentals govern

the treatment of equity and debt in materially distinct ways), at least one court has

extended the general rule that arose in cases where the defrauded investors held

original debt claims against the fraudulent investment scheme and applied that

general rule to the factual circumstances found in the case at bar where the

defrauded investors were, at the very inception of their investments, clearly equity

holders in the fraudulent enterprise.

Though technically not bound by the reasoning of that decision, and

notwithstanding the fact that the Bankruptcy Court agreed that the relief sought by

the Trustee arguably represents a more equitable result and should apply in all

Ponzi scheme cases, the Bankruptcy Court apparently felt constrained by the

seeming weight of the general rule, and denied the Trustees Motion for Partial

Summary Judgment. Doc 38, Pg 13. Reasoning that [t]he substance, not the

form, of the [investment] transactions properly governs, and that the general rule



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that a Ponzi victim has a fraud claim, the satisfaction of which to the extent of

repayment of principal constitutes value in exchange for the transfer, applies

regardless of whether the investment, in form, is debt or equity, the Bankruptcy

Court concluded that no sound basis exists for creating a different rule [than the

general rule] based on the equity nature of the fraudulently induced

investments. Doc 38, Pgs 12-13.

The Trustee respectfully disagrees with the Bankruptcy Courts reasoning.

First, sufficient authority exists to mandate here a result different from the general

rule, based on the fact that the Investor Defendants held equity interests in the

Debtors, and given the universally accepted proposition that the exchange of the

Investor Defendants worthless equity interests in the Debtors for the cash

distributions that they received from the Debtors is not an exchange for value.

Second, both the substance andthe form of the transfers sought to be avoided here

were in the nature of equity-based transfers, whereby cash was transferred in

exchange for the Investor Defendants tendering to the Debtors their worthless

equity interests. The law fundamentally distinguishes between debt and equity,

and does not permit silent, automatic, retroactive recharacterization of distributions

in respect of an equity position to be deemed to be in satisfaction of a debt claim.

In the Bankruptcy Courts attempt to look beyond the equity form of the

transaction, the Bankruptcy Court mistakenly disregarded the equity substance of



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the transaction, and wholly failed to consider the myriad fundamental legal

considerations that govern the treatment of equity investments.

Despite the seeming appeal of leaving those who were fortunate enough to

avoid losses to the Ponzi scheme free from claims to recover the distributions that

they received, the proper application of both state and bankruptcy law relating to

the rights ofequity holders requires that such fraudulent distributions be avoided

so that other equity investors in the Ponzi scheme can likewise share in the

avoidance proceeds so that, as close as possible, all equity investor victims of the

scheme can recover on a ratable basis their investment in the fraudulent enterprise.

Such a result in especially compelling and warranted in this case because the

parties who would most benefit from such a ratable distribution are the very parties

whose investments actually funded the distributions the Trustee seeks to avoid.

ARGUMENT AND CITATIONS OF AUTHORITY

At its essence, the legal issue before this Court involves a moral dilemma

not solvable by equitable principles alone because, no matter the remedy

fashioned, some significant proportion of the parties affected will protest the

outcome as patently unfair based on their particular factual circumstances and

resultant perspective on the matters at bar. In the absence of one undeniably

correct answer, courts must look to the law to fashion relief most equitable to all

parties. Looking to the law of fraudulent transfers in the Ponzi scheme context,



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there exists a well-established line of decisional authority that seemingly comes to

bear on the facts of this case; however, there is at least one critical factual

distinction between the cases in that line of authority and the case at bar -- namely,

as further detailed below, those cases involved investors who held claims against

the fraudulent scheme in which they invested, whereas the instant case involves

investors who held equity interests in the fraudulent scheme in which they

invested, and affirmatively exchanged such equity interests for the distributions

received from the scheme. Naturally, the question is why that distinction matters,

and why this Court should not simply apply the line of decisional authority that

arose in the context of original debt-based investment claims to the facts at bar?

The answer lies in the fundamental distinctions in the manner in which the law

treats debt-based claims as compared to how the law treats equity interests. The

Trustee will show this Court how, when the law is appropriately applied to the

assumed facts at bar, it is fundamentally inappropriate to extend the reasoning

found in the cases involving original debt-based investment claims to this case.

The Trustee will further show why the one court that extended such reasoning to

facts similar to the instant case erred in its reasoning, which reasoning was utterly

devoid of any meaningful analysis of the fundamental legal distinctions applicable

to the treatment of debt-based claims versus equity interests, and accordingly, why



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the Bankruptcy Court erred when it relied on the reasoning from that case to deny

the Trustees Motion for Partial Summary Judgment.

I. Fraudulent Transfer Claims and Defenses Generally: Repayment of anAntecedent or Present Debt is Deemed to be For Value, and

Therefore is Shielded from Avoidance.

As set forth above, pursuant to 11 U.S.C. 548 and correlative state law

fraudulent transfer statutes, the Trustee filed claims against the Investor

Defendants to avoid and recover transfers made to them during the pre-bankruptcy

operation of the Debtors, on the basis that such transfers were actually and/or

constructively fraudulent. The Investor Defendants have asserted the affirmative

defense provided by Section 548(c) of the Bankruptcy Code and correlative state

law provisions. Section 548(c) of the Bankruptcy Code provides that a transferee

that takes for value and in good faith ... may retain any interest transferred ... to

the extent that such transferee gave value to the debtor in exchange for such

transfer. State fraudulent conveyance law operates to the same effect. See, e.g.,

O.C.G.A. 18-2-78. Section 548(d)(2)(A) of the Bankruptcy Code defines

value as property, or satisfaction or securing of a present or antecedent debt of

the debtor. Similarly, under state law, [v]alue is given for a transfer or an

obligation if, in exchange for the transfer or obligation, property is transferred or

an antecedent debt is secured or satisfied. O.C.G.A. 18-2-73(a). Thus, where

what originally was a loan or a contractual agreement giving rise to a claim in an



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undisputed amount, its repayment is deemed by clear statutory language to have

been a payment for value, and in that context, no further inquiry into whether the

transfer was reasonably equivalent is necessary. Simply stated, generally the

repayment of an undisputed claim outside a statutorily based preference period is

insulated, and even if the repayment arises where the transferor is found to have

engaged in a fraudulent transfer, the transferee may keep the repayment provided

that the transferee received the payment in good faith.

A. The determination of value focuses on the specific value of theproperty exchanged in the transfer at issue: where the exchange

was for a worthless equity interest, the exchange cannot be for

value.

The determination of whether value was provided to the transferor under

Section 548 of the Bankruptcy Code and state law fraudulent conveyance statutes

focuses on the value of the specific property provided by the transferee to the

transferor in exchange for the subject transfer. See, e.g.,In re Financial Federated

Title & Trust, Inc., 309 F.3d 1325, 1332 (11th Cir. 2002). Courts reason that a

transfer was for value if what was transferred in exchange was the reasonable

equivalent of what was received. See, e.g.,In re Richards & Conover Steel, Co.,

267 B.R. 602, 612 (8th Cir. BAP 2001). The United States Bankruptcy Court for

the Southern District of New York, inIn re Churchill Mortg. Inv. Corp., 256 B.R.

664 (Bankr. S.D.N.Y. 2000), analyzed state and bankruptcy fraudulent conveyance

statutes in the context of a fraudulent investment scheme, stating, The statutes are



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quite clear. The focus of the inquiry is the specific transaction the trustee seeks

to avoid, i.e., the quid pro quo exchange between the debtor and transferee, rather

than an analysis of the transaction's overall value to a debtor as it relates to the

welfare of the debtor's business. Id. at 678.

Accordingly, where the transfer is a distribution in respect of an equity

interest, the transfer must be supported by the fair valuation of the equity interest

tendered in exchange for the distribution at the time the distribution was made.

Courts recognize the basic proposition that equity interests of an insolvent

company have no value. See, e.g.,Adelphia Communications Corp. v. Rigas (In re

Adelphia Communications Corp.), 323 B.R. 345, 377 (Bankr. S.D.N.Y. 2005)

(citingPereira v. Equitable Life Ins. Society (In re Trace Int'l Holdings, Inc.), 289

B.R. 548, 560-61 (Bankr. S.D.N.Y. 2003). Thus, courts uniformly conclude that

when an equity holder redeems his shares in what, at the time of the transfer, was

an insolvent company, the equity holder failed to supply reasonably equivalent

value to the transferor in exchange for the transfer. See, e.g., id.; In re Roco Corp.,

701 F.2d 978, 982 (1st Cir. 1983); Schafer v. Hammond, 456 F.2d 15, 17-18 (10th

Cir. 1972). By these principles, distributions to equity holders of an insolvent

entity are contrary to basic limited liability company and partnership law

provisions. See, e.g., O.C.G.A. 14-9-503, 14-9A-46, 14-11-407; DEL. CODE



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ANN. tit. 6, 17-607, 18-607; The Pepsi-Cola Bottling Co. of Salisbury, Md. v.

Handy, 2000 WL 364199, pp. 4-5 (Del. Ch. 2000).

II. Fraudulent Transfer Claims and Defenses in the Context of FraudulentInvestment Schemes: a Critical Analysis of the Historically Decided

Cases.

The standards set forth above applicable to fraudulent transfer cases

generally also apply to determine whether distributions from fraudulent investment

schemes may be avoided. In the wake of typical Ponzi scheme cases, courts

routinely examine fraudulent transfer claims and their correlative defenses in the

context of a trustee seeking to avoid and recover fraudulent distributions from the

scheme. Often cited as having provided the seminal analysis in the area of

fraudulent transfer recoveries in the context of a fraudulent investment scheme is

Eby v. Ashley, 1 F.2d 971 (4th Cir. 1924), cert. denied, 266 U.S. 631, 45 S.Ct. 197,

69 L.Ed. 478 (1925), in which the United States Court of Appeals for the Fourth

Circuit reasoned that, from the moment an investor was deceived into investing in

a fraudulent scheme, that investor held a fraud claim against the scheme in an

amount equal to his investment. Id. at 973. Citing this reasoning fromEby, many

courts since have shielded defrauded recovering investors from claims asserted

against them seeking to avoid transfers they received in respect of their original

principal investments, reasoning that any transfer to defrauded investors up to the

amount of their principal investment was an exchange for value on the basis that



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the transfer was made in exchange for the investors fraud claim that arose at the

moment of his investment (or more appropriately, should retroactively and

automatically be deemed to have been made in exchange for the investors fraud

claim that arose at the moment of his investment). See, e.g., Merrill v. Abbott(In

re Independent Clearing House Co.), 77 B.R. 843, 857 (D. Utah 1987);In re M &

L Business Machine Co., 84 F.3d 1330, 1340-41 (10th Cir. 1996); In re United

Energy Corp., 944 F.2d 589, 596 (9th Cir. 1991).

The Trustee does not contest theanalysis that a fraudulent inducement claim

arose at the time the defrauded investor made his investment into the scheme. In

fact, the Trustee agrees that each Investor Defendant likely possessed a fraudulent

inducement claim arising as of the date upon which each investor was induced to

invest in the scheme, which claim could have been asserted at the time each

Investor Defendant redeemed his investment. Moreover, the Trustee does not even

contest the ultimate resultinEby (or in the cases cited above that follow Eby, its

progeny) that the transfers to those recovering investors -- who were holders of

debt claims from the outset -- were deemed to be exchanges for value. However,

the Trustee absolutely contests (i) any argument that the reasoningof those cases

requires that the distributions to the recovering investors in fact be retroactively

deemed to have been in affirmative satisfaction of the latent fraud claims held by

the recovering investors, and (ii) the extension of the reasoning from those cases to



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the case at bar, considering that each of those cases was decided in the factual

context of recovering investors who held original debt-based claims against the

Ponzi scheme, and by contrast, the recovering investors in the instant case held

original equity-based interests in the Ponzi scheme, a factual distinction

necessitating a fundamentally different legal analysis.

Despite the apparent perception that the reasoning in Eby stands for the

proposition that, for purposes of a value exchange analysis, an investors original

investment is transmuted into a claim based on an unasserted fraud claim, that

rationale was neither necessary to Ebys holding nor found by the court in Eby.

Actually, Eby (and later its progeny) simply acknowledged the existence of two

separate and distinct bases for claims against the scheme -- one based on the initial

nature of the investment that gave rise to a rightof repayment, and the other on

account of the investors fraudulent inducement claim.

Looking to the facts in Eby, those investors held claims against the scheme

from the outset. In exchange for sums that investors paid into the scheme, the

operator issued to each investor a receipt providing: (i) that the sums were to be

placed in an account managed by the operator, (ii) the sums were credited to the

investor, and (iii) the investor had the right to withdraw any or all of the investors

account on thirty days written notice. Id. at 971. Settlements to the investors

were to be made monthly, and with each settlement a new receipt issued showing



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the investors new investment amount for the next thirty days -- effectively a new

relationship began each month and ended thirty days later. Id. at 972. Thus, there

is no evidence in Eby that the investors were equity holders in the scheme, but

rather they were clearly claimants against the scheme. In fact, the Eby court

specifically referred to the obligation of the scheme to its investors as a debt

equal to the amount each investor invested into the scheme. Id. at 973.

According to those investment terms, an investor, Ashley, deposited $3,000

into the scheme. Over a period of approximately two years, Ashley received

$1,576 in payments from the scheme as a return on his investment ( i.e., profit),

then Ashley requested and received the return of his original $3,000 investment.

The bankruptcy trustee sued Ashley for return of the entire $4,576 in transfers that

Ashley received from the scheme, on the basis that payment of the $1,576 was a

fraudulent transfer of false profits, and that the repayment of his $3,000 principal

investment was an unlawful preference. Id. at 971-72. In dicta, at least with

respect to any fraudulent transfer analysis, the Eby court reasoned that Ashley had

the right to recover from the scheme his entire $3,000 investment from the moment

he was deceived into investing, presuming that he acted in good faith. Id. at 973.

The court then reasoned that the schemes debt owed to Ashley was reduced by

the transfers to him, and that the primary inquiry was whether the payment



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constituted an unlawful preference of one creditorover another. Id. (emphasis

added).

Accordingly, the Eby court clearly and specifically contemplated the

existence of two different claims by the investor -- one debt claim that arose

from the initial investment in the scheme, and another fraudulent inducement claim

that arose as a result of the fraud. Id. at 973. Accordingly, when the recovering

investors inEby redeemed their investments, by their affirmative exchange of their

legitimate, original antecedent debt claims against the scheme based on their

investments, unquestionably there was an exchange for value for purposes of a

fraudulent transfer analysis. The existence ofanotherclaim based on a latent fraud

claim in Eby in no way affects the ultimate outcome of the value exchange

analysis, given that the exchange was already fully for value based on the

redemption of the legitimate debt-based investment claim. Therefore,Eby did not

require that the distributions to the recovering investors in fact be retroactively

deemed to have been in affirmative satisfaction of the latent fraud claims held by

recovering investors. Fairly assessed, although some courts have misinterpreted it,

Eby merely contains non-controversial reasoning allowing a claimant to recover

the principal amount that was initially invested in the scheme where the investor

had a right to repayment -- a claim from the outset -- while recognizing the



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existence of an alternate basis on which to assert an extant, though unasserted,

antecedent debt claim.

As noted, the Trustee does not contest the existence of a defrauded

investors latent fraud claim, or even the recognition of such claim in an initially

debt-based investment case, because the recognition of such an additional claim

simply has no effect on the ultimate outcome of the value exchange analysis

where the original investment already gave rise to a claim, pursuant to which the

value exchange analysis was already satisfied. As such, for purposes of a

value exchange analysis, the dual-prong claim reasoning inEby that a fraudulent

inducement claim provides a separate basis on which to establish a claim by the

transferee against the transferor must be recognized as surplusage. It adds nothing,

as the transferee had a claim at the inception of his investment based on his

investment contract claim, and his receipt of repayment as such was, ipso facto, for

value. (This dual basis for a claim scenario evidenced byEby and its progeny

will be examined in numerous instances herein below, juxtaposed against

situations, such as are present in the casesub judice, where the investment initially

was in the nature of the acquisition of an equity interest. For simplicity of

reference, the reasoning where the initial investment gave rise to a claim, and

where the fraudulent inducement argument simply affords a separate, independent



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and redundant basis for a claim, will be referred to below from time to time as the

claim squared -- Claim2 -- concept.)

Naturally, the Investor Defendants have cited toEby and its progeny for the

proposition that investors should be shielded from claims asserted against them

seeking to avoid transfers in respect of their original principal investments. See,

e.g., Merrill v. Abbott ( In re Independent Clearing House Co.), 77 B.R. 843 (D.

Utah 1987);In re M & L Business Machine Co., 84 F.3d 1330 (10th Cir. 1996);In

re United Energy Corp., 944 F.2d 589 (9th Cir. 1991);Donell v. Kowell, 533 F.3d

762 (9th Cir. 2008). Doc 23, Pgs 9-20. When critically examined, however, each

of these decisions cited by the Investor Defendants essentially just followed the

Claim2 concept originated in Eby, and reasoned that distributions made in

satisfaction of one debt claim could also be in satisfaction of another distinct basis

for a debt claim by the same party arising from the same transaction. In each of

those cases, the defrauded investors clearly maintained a debt relationship with the

Ponzi scheme from the outset; thus, while each of those cases recognized an

alternate antecedent debt claim for purposes of satisfying a value exchange

analysis, none of those cases in any way addressed factual circumstances found in

the instant case where the original investments were in the nature of equity

interests.



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The Trustee will address each of the primary cases cited by the Investor

Defendants in turn, and will show that none of these cases can be appropriately

cited as support for the extension of the Claim2 reasoning to the case at bar. Cited

by the Investor Defendants, and often cited by courts in Ebys line of reasoning as

protecting the return of principal to Ponzi scheme investors, is Merrill v. Abbott(In

re Independent Clearing House Co.), 77 B.R. 843 (D. Utah 1987). Independent

Clearing House explicitly followedEby, and reasoned that the Bankruptcy Codes

definition of debt is sufficiently broad to cover the obligation of the fraudulent

investment enterprise to return a defrauded investors paid-in principal amounts on

the basis of the investors latent fraud claim. Id. at 857. Importantly, in

Independent Clearing House however, the defrauded investors were denominated

as undertakers who signed debt-based contracts committing their invested sum

for a specific period of time, after which the sum was to be repaid to the investor.

Id. at 848. Hence, like inEby, any reasoning by theIndependent Clearing House

court that transfers to investors satisfied antecedent debt claims based on their

latent fraud claims against the fraudulent enterprise simply characterized payment

in respect of the original antecedent debt obligation to also be in payment of the

same amount based upon a separate theory to premise a claim -- the schemes

inducing fraud. Simply put,Independent Clearing House is a Claim2 case.



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Similarly, inIn re M & L Business Machine Co., another case inEbys line,

the defrauded investors were holders of debt-based promissory notes promising

specific returns over specific periods. 84 F.3d at 1332. While the M & L court

may have reasoned that the passive, retroactive recognition of previously

unasserted fraud claims can support the value analysis in the Claim2 context, the

court never explored whether unasserted fraud claims can be the basis for the

recharacterization of a transfer made in respect to what was originally an equity

investment as having been made in respect to the payment of a fraud-based debt

claim. Therefore, this Court should refuse to accept M & L as support for the

extension of the Claim2 reasoning to the instant case, wherein the Investor

Defendants seek to apply the conventional debt-based reasoning to equity transfers.

The recent decision by the United States Court of Appeals for the Ninth

Circuit in Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008) follows in this line of

Claim2 cases, as the investors therein were holders of promissory notes with a

three-month maturity period, guaranteed a twenty percent return during that period.

Id. at 767. Like inEby, any conclusion inDonellthat distributions from the Ponzi

scheme up to the value of the initial investment are to be considered as exchanges

for reasonably equivalent value (because they proportionally reduce the

investors' rights to restitution) was surplusage because, independent of whether the

repayment reduced the investors fraud-restitution claim, the investors held



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antecedent debt claims to begin with. As such, the investors could retain the

amounts repaid regardless of whether they had fraud claims, because under Section

548(c) and state law, an antecedent debt holder is deemed to have given value up

to the principal invested as a claim. Thus, no reasonably equivalent value test

needs to be separately satisfied in a Claim2 circumstance, likeDonell, to justify the

repayment of a principal claim.

Likewise, the Ninth Circuit case, In re United Energy Corp., 944 F.2d 589

(9th Cir. 1991), involved factual circumstances where defrauded investors were

debt holders from the outset, having been promised contractual payments in

connection with the purchase of items of equipment. 944 F.2d at 590. Like the

foregoing cases relied upon by the Investor Defendants, United Energy neither

addressed nor in any way involved the recharacterization of a transfer made in

respect of what was originally an equityinvestmentas having been made in respect

of the payment of a fraud-based debt claim. Thus, this Court should deem such

cases inapposite to the case at bar, as Eby and its progeny clearly do not stand for

the proposition that transfers made to investors can legitimately and fairly be

recharacterized from transfers in respect of a equity interests into transfers made in

respect of unarticulated fraud-based debt claims.



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A. The factual distinction in this case relative to the Claim2 cases iscritical because of the fundamental manner in which the law

distinguishes the treatment of equity from the treatment of debt.

To fully examine the importance of the factual distinctions of this case from

the historically decided Ponzi scheme cases, it is appropriate to view the instant

case against the backdrop both of well-established legal distinctions that exist in

the recognition and treatment of debt relative to equity, as well as legal distinctions

that exist between how debt holders are treated relative to similarly situateddebt

holders as compared to how equity holders are treated relative to similarly situated

equity holders.

1. Rooted in American legal traditions are clear distinctionsbetween equity interests and debt claims.

Equity holders and debt holders have materially dissimilar expectations and

rights, accepting insolvency risk and the potential for upside prosperity to a

significantly different degree. SeeIn re Granite Partners, L.P., 208 B.R. 332, 336

(Bankr. S.D.N.Y. 1997). The absolute priority rule, codified in 11 U.S.C.

1129(b), reflects the allocation of the risk among equity holders and debt holders.

Id. The Tenth Circuit has recognized the tension between equity and debt in the

bankruptcy context, and the transmutation from one to the other, stating, When a

corporation becomes bankrupt, the temptation to lay aside the garb of a

shareholder, on one pretense or another, and to assume the role of a creditor, is

very strong, and all attempts of that kind should be viewed with suspicion. In re



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Geneva Steel Co., 281 F.3d 1173 (10th Cir. 2002) (citingJezarian v. Raichle (In re

Stirling Homex Corp.), 579 F.2d 206, 213 (2d Cir. 1978)). Moreover, even if

equity holders successfully transmute their positions into fraud claims, such claims

cannot be treated equally with the claims of debt holders, because doing so would

improperly reallocate risk to debt holders who relied on the equity cushion in

extending credit. Granite Partners, 208 B.R. at 336; 11 U.S.C. 510(b)

(discussed infra sec. II.(B)(2)(ii)).

The Bankruptcy Code is crafted to provide clear definitional distinctions

between equity and debt. The Bankruptcy Code defines equity security holder as

the holder of an equity security of the debtor, and equity security as (A) share

in a corporation, whether or not transferable or denominated stock, or similar

security; (B) interest of a limited partner in a limited partnership; or (C) warrant or

right, other than a right to convert, to purchase, to sell, or subscribe, to a share,

security, or interest of a kind specified in subparagraph (A) or (B) of this

paragraph. 11 U.S.C. 101(16) and (17). The Bankruptcy Code defines debt

as liability on a claim, and claim as (A) right to payment, whether or not such

right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured,

unmatured, disputed, undisputed, legal, equitable, secured or unsecured; or (B)

right to an equitable remedy for breach of performance if such breach gives rise to

a right of payment . 11 U.S.C. 101(5) and (12). The Bankruptcy Code



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further distinguishes debt from equity by the manner in which holders assert such

positions, requiring debt holders to file proofs of claim while equity holders are to

file proofs of interest. See 11 U.S.C. 501(a); In re Charter Company, 44 B.R.

256, 258 (Bankr. M.D. Fla. 1984).

Courts have recognized this obvious distinction, reasoning, An ownership

interest is not a debt of the partnership. Partners own the partnership subject to the

profits or losses. Creditors, however, hold claims regardless of the performance of

the partnership business. Thus, an ownership interest is not a claim against the

partnership. In re Ben Franklin Hotel Assoc., 1998 WL 94808, *2 (E.D. Pa.

1998) (quotingIn re Riverside-Linden Investment Co., 925 F.2d 320, 323 (9th Cir.

1991)); see also In re Hedged-Investments Associates, Inc., 84 F.3d 1267, 1272

(10th Cir. 1996) (finding that a limited partner Ponzi scheme investor could not be

considered a creditor solely on the basis of his equity investment in the

partnership). Moreover, contemporary state law statutes governing limited liability

companies and limited partnerships clearly distinguish between equity and debt,

requiring that holders of debt instruments have priority rights over equity holders

with regard to distribution of corporate assets. See, e.g., O.C.G.A. 14-9A-46,

14-11-407, 14-2-1405(3) and (4); DEL. CODE ANN. tit. 6, 17-607, 17-804, 18-

607; see also Handy, 2000 WL 364199 at pp. 4-5 (indicating that one of the

primary purposes of section 18-607 of the Delaware LLC Act is to enable creditors



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of a limited liability company to be remunerated before company members receive

distributions, which purpose prevents members from stripping the company of

corporate assets and rendering the company insolvent); Boesky v. CX Partners,

L.P., 1988 WL 42250, p. 2 (Del. Ch. 1988) (noting that, in accordance with section

17-804 of the Delaware Revised Uniform Limited Partnership Act, the duties of a

limited partnerships liquidating partner is to gather the company assets, pay off

creditor claims and distribute any remaining funds to the companys equity

holders).

Given the existence of such essential, irrefutable distinctions between debt

and equity, courts cannot simply dismiss the form of the instruments at issue in any

case, but rather must give due consideration to the legal implications created by the

relevant documents. Because of the fundamental distinctions between debt

positions and equity interests, and the resultant distinctions in any analysis

regarding distributions in respect of an equity interest versus a debt claim, courts

routinely are tasked to examine and interpret whether a particular instrument

creates an equity or debt relationship between an enterprise and the holders of the

subject instrument. In so doing, courts consider: (1) the name given to the

instrument; (2) the intent of the parties; (3) the presence or absence of a fixed

maturity date; (4) the right to enforce payment of principal and interest; (5) the

presence or absence of voting rights; (6) the status of the contribution in relation to



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regular corporate contributors; and (7) certainty of payment in the event of the

corporation's insolvency or liquidation. See Wolfensohn v. Madison Fund, Inc.,

253 A.2d 72, 75 (Del. 1969); Slappey Drive Indus. Park v. United States, 561 F.2d

572, 581-82 (5th Cir. 1977). In conducting this analysis, courts recognize that both

the form and substance of the relationship between the entity and its parties in

interest are vitally important with respect to the determination of the rights of those

parties with respect to the entity. To disregard the form and substance of the

relationship taken by the parties, in the name of equity or some similar basis,

would improperly reduce that which the parties purposefully created into a nullity.

If courts are so empowered, then agreements between parties are rendered

meaningless, contrary to all notions of law.

Here, each Debtor was a separate legal entity organized under state law,

structured either as a limited partnership or a limited liability company. Doc 6, Pg

3. For purposes of the Bankruptcy Courts Order and this appeal, it is assumed that

each Investor Defendant affirmatively executed a limited partnership agreement or

limited liability company agreement with one or more of the Debtors.4 Doc 6, Pg

4 By the terms of such agreements, (i) Investor Defendants were grantedlimited partnership interests or membership units in one or more of the Debtors(Doc 6, Ex. C (Limited Partnership Agreement), Ex. E (Limited PartnershipSubscription Agreement), Ex. G (Limited Partnership Confidential PrivateOffering Memorandum), Exhibit D (Limited Liability Company Agreement), Ex. F(Limited Liability Company Membership Agreement Form), Ex. H (Limited

(footnote continued on next page)



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3. Pursuant to their equity relationships created by these agreements, the Investor

Defendants affirmatively exchanged their equity interests in one or more of the

Debtors for the cash distributions they received from one or more of the Debtors.

To ignore the legal form and substance of the Investor Defendants equity interests

in the Debtors would be to ignore the form and substance of the relationship that

the Investor Defendants knowingly and purposefully took in the Debtors, in which

they shared in the value of the Debtors, both upside and downside.

2. The clear distinctions between equity and debt arereinforced by the treatment of inter se debt claims as

compared to the treatment ofinter se equity positions.

The legal principles set forth above address distinctions in the treatment of

equity holders relative to debt holders. Just as important, however, are the legal

(footnote continued from previous page)Liability Company Confidential Offering Memorandum); (ii) Investor Defendantsmade capital contributions into one or more of the Debtors, with no fixed maturitydate for return of any paid-in capital (Doc 6, Exhibit C (Limited PartnershipAgreement 5.01), Exhibit D (Limited Liability Company Agreement 8.1); (iii)Investor Defendants equity interests were valued in proportion to the value of thelimited partnership or limited liability company in which they invested, subject toallocation of the net profits or losses of the respective Debtor (Doc 6, Exhibit C(Limited Partnership Agreement 6.01), Ex. G (Limited Partnership Confidential

Private Offering Memorandum, p.7), Exhibit D (Limited Liability CompanyAgreement 4.2), Ex. H (Limited Liability Company Confidential OfferingMemorandum, p.3); and (iv) distribution rights of Investor Defendants weresubordinated to creditors upon liquidation (Doc 6, Pgs 3-4, Exhibit C (LimitedPartnership Agreement 9.03), Exhibit D (Limited Liability Company Agreement 9.4).



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principles that dictate the distinctions in the treatment of debt holders relative to

other similarly situateddebt holders from the treatment of equity holders relative

to other similarly situatedequity holders. As further described below, whereas the

claim of a holder of a legitimate debt against an enterprise may properly be paid

prior to and in preference over other similarly situated debt holders, outside some

statutory preference period, by contrast, state and bankruptcy law clearly mandate

that no payment can ever be made to satisfy the interest of one equity holder over

the interests of other similarly situated equity holders. This distinction exists

because the value of any particular debt position is determined by the rights and

privileges provided in the terms of the unique contract instrument between the

entity and the debt holder; accordingly, the value of such debt holders claim does

not depend in any way on the valuation of any claims of similarly situated debt

holders. By contrast, the value of an equity interest is determined as a proportion

of the value of the subject enterprise in which the holder has an ownership interest,

which enterprise value is determined on some appropriate metric of EBITDA5

multiples or similar valuation algorithms. The proportionate value of any equity

interest in the enterprise is determined in relation to other similarly situated equity

holders in the enterprise; accordingly, distributions in respect of any equity interest

5 Earnings Before Interest Depreciation Taxes & Amortization.



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must be made in a ratable fashion among similarly situated equity holders, per

contemporary state law statutes governing limited liability companies and limited

partnerships that explicitly require that distributions to holders of equity

instruments follow a highly constrained order. See O.C.G.A. 14-11-403, 14-9-

503, 14-9A-42(b); DEL. CODE ANN. tit. 6, 17-601, 17-604, 18-503; see also

Hillman v. Hillman, 910 A.2d 262, 272-74 (Del. Ch. 2006) (a partner in a limited

partnership is entitled to receive the ratable fair value of such partners partnership

interest absent provisions in a partnership agreement specifying an alternative

method of calculating distribution amounts); Fraser v. Major League Soccer,

L.L.C., 97 F. Supp 2d 130, 134 (D. Mass. 2000) (members of an LLC share in

overall company profits and losses ratably according to their investment or as

otherwise provided by the organizing [a]greement).

When applied to a fraudulent transfer analysis, these distinctions manifest to

create materially different outcomes depending on whether the underlying transfer

involved a debt claim or an equity interest. Looking first to the analysis applicable

to the avoidance of a transfer in satisfaction of a debt claim, other than through a

preference claim, there is no basis in law to challenge a transfer to the holder of a

valid, undisputed debt where the transferee acted in good faith, given that an asset

(such as cash) was used to satisfy a liability (an obligation) in an equal amount.

Such a transfer does not in any way impair the rights of other debt holders because



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the transaction had no effect on the net assets and liabilities of the transferor. See

In re Jeffrey Bigelow Design Group, Inc., 956 F.2d 479 (4th Cir. 1992) (when

determining whether a transfer is avoidable, the focus must be on the net effect of

the transfer on the debtor's estate, and the funds available to unsecured creditors; as

long as other unsecured creditors are no worse off because the debtor has received

an amount reasonably equivalent to what it paid, then no constructive fraudulent

transfer has occurred).

In contrast, looking to the analysis applicable to the avoidance of a transfer

in satisfaction of an equity interest, in the absence of an agreement to the contrary,

all equity shares in an enterprise are to be treated equally, such that the value of

any particular equity interest depends entirely on the valuation of all similarly

situated equity interests, and the assets of an entity may not be distributed to

certain equity holders in preference to other similarly situated equity holders in that

entity. See, e.g., Crimmins & Peirce Co. v. Kidder Peabody Acceptance Corp.,

282 Mass. 367, 185 N.E. 383, 88 A.L.R. 1122 (1933);Alley v. Miramon, 614 F.2d

1372 (5th Cir. 1980). Any transfer of assets to an equity holder in excess of the

pro rata value of the equity interest (valued in relation to all similarly situated

equity holders) operates as an improper preference of one equity holder over other

similarly situated equity holders. Necessarily, any distributions to equity holders

of an insolvent entity are manifestly disproportionate because there is no equity



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value in the insolvent entity, and no equity-based distributions to shareholders can

be justified as they are contrary to basic limited liability company and partnership

law provisions. See, e.g., O.C.G.A. 14-9-503, 14-9A-46, 14-11-407; DEL.

CODE ANN. tit. 6, 17-607, 18-607;Handy, 2000 WL 364199 at pp. 4-5.

By these principles, it is clear that the application of the Claim2 reasoning

differs materially depending on whether the underlying investments are debt-based

or equity-based. The recognition and satisfaction of a debt-based investors latent,

unasserted fraud claim as a second antecedent debt claim, through application of

the Claim2 reasoning, has no practical impact on the value exchange analysis

where the original debt-based investment claim provided an independent basis to

satisfy the value exchange analysis in any event. Moreover, in the context of

original debt claims, the Claim2 reasoning operates consistently with the general

legal premise that debt holders may properly be preferred over other debt holders.

By contrast, the recognition and satisfaction of an equity investors latent,

unasserted fraud claim, through application of the Claim2 reasoning, as the one and

only true antecedent debt claim of that investor for purposes of the value exchange

analysis, would completely change the outcome of the value exchange analysis.

Save for the transmutation of an equity interest into a fraud based claim, the

exchange of the original equity interest would not have been deemed to be for

value, given that the investor had affirmatively tendered his essentially worthless



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equity interest for the transfer. Perhaps the surplusage reasoning inEby could be

ignored where application of the reasoning in no way materially alters the outcome

of the value exchange analysis; however, the surplusage reasoning from Eby

absolutely cannot be ignored where its application creates a result entirely different

from that which would otherwise obtain, shielding avoidance of a transfer that

otherwise would be, and should be, avoidable.

B. A single court has improperly extended the Claim2 reasoning tothe facts at bar, misinterpreting the principles in Eby as actually

supporting recharacterization of transfers in respect of equityinstruments to be in satisfaction of debt claims, without any

meaningful substantive analysis to undergird that conclusion.

From a diligent review, a single court appears to have extended the general

rule (that principal distributions from a Ponzi scheme are shielded from

avoidance) to factual circumstances very similar to the facts of the instant case,

where investors had invested at the outset purely as equity holders in the Ponzi

scheme and the trustee was seeking return of transfers in redemption of principal

investment amounts.6 The United States Court of Appeals for the Ninth Circuit, in

6 Two other courts appear to have generally accepted the principle ofshielding the avoidance of distributions by a Ponzi scheme to its investors of their

principal investment amounts in the specific factual circumstance where theinvestors invested at the outset purely as equity holders in the Ponzi scheme. Oneof these cases, Scholes v. Ames, 850 F.Supp. 707 (N.D. Ill 1994), is inapposite

because it do

Perkins v. Haines - Initial Brief

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