11th Circuit Curtails Receivers’ Ability to Bring Ponzi Scheme-Related Claims Against Banks

June 29, 2020

On June 1, 2020, the U.S. Court of Appeals for the 11th Circuit issued Isaiah v. JPMorgan Chase Bank, N.A., a precedential opinion that draws sharp limits on court-appointed receivers’ ability to bring claims against financial institutions that provided banking services to customers later discovered to be running a Ponzi scheme.

As the economy transitions from its nearly decade-long bull run to a swift and unanticipated recession, Ponzi schemes previously kept afloat by investments of new money are likely to collapse as investors seek to withdraw their principal. When these schemes collapse, investors often sue the companies created by the fraudsters in an attempt to recoup their investments. Because these companies are often nothing more than sham fronts with no assets of their own, state courts appoint receivers and empower them to bring litigation to marshal the companies’ assets to satisfy judgments for creditors. These receivers, in turn, frequently bring claims against the banks utilized by the fraudsters. Such lawsuits present significant exposure for financial institutions, as large-scale Ponzi schemes can involve the movement of tens or even hundreds of millions of dollars through bank accounts set up by the schemers.

The 11th Circuit’s decision in Isaiah curtails receivers’ ability to bring Ponzi scheme-related claims against banks. The decision limits banks’ liability for the provision of routine banking services and draws an important demarcation regarding receivers’ standing to bring claims.

I. The Facts of Isaiah

Isaiah presented a familiar fact pattern. A Ponzi scheme perpetrated by schemers and their sham companies collapsed, and defrauded investors sued. A Florida state court appointed a receiver over the entities to marshal their assets. The receiver, in turn, sued JPMorgan Chase based on two principal theories of liability commonly seen in Ponzi litigation. First, the receiver alleged that the movement of funds through Chase accounts constituted fraudulent “transfers” under the Florida Uniform Fraudulent Transfer Act (FUFTA), Fla. Code Ch. 726, and thus were subject to avoidance and recovery. Second, the receiver alleged JPMorgan Chase aided and abetted the Ponzi schemers’ breach of fiduciary duty, conversion of funds and fraud. The district court dismissed the complaint, and the receiver appealed to the 11th Circuit.

II. The 11th Circuit’s Decision

A. Routine Banking Activity Does Not Constitute a “Transfer” to a Bank Under FUFTA

FUFTA provides a statutory scheme through which a plaintiff creditor may, in certain circumstances, avoid and recover fraudulent transfers. The statute, which is analogous to the fraudulent-transfer provisions of the Bankruptcy Code, ensures debtors cannot place their assets out of creditors’ reach by transferring them to third parties. In the event of such a transfer, the creditor may avoid the transfer and recover funds owed to her. Receivers use FUFTA — or equivalent fraudulent-transfer statutes in other jurisdictions — to attempt to recover from banks used by fraudsters, on the theory that deposits constitute “transfers” of funds to the bank. They seek to “recover” the “transferred” funds from the bank, even if the funds were wired to a third party or withdrawn by the fraudsters themselves.

Prior to Isaiah, courts in the 11th Circuit dealt with this issue in varying fashions, with some finding the absence of a transfer, others reasoning that a bank could be an initial transferee, and still others considering the issue under the rubric of the “mere conduit” equitable affirmative defense.

In Isaiah, the 11th Circuit clarified the issue and confirmed that the deposit of funds into a bank account does not constitute a transfer to the bank. In determining whether a “transfer” occurred, “the relevant inquiry is not one of ownership or title but of control.” When an accountholder makes a deposit into an unrestricted bank account, he “never relinquishes his interest in or control over the funds” and thus no transfer occurs. In a footnote, the court further noted that even if money was deposited into an account and then wired to a third party, the sole “transfer” avoidable under FUFTA would be the “transfer to the third party that owns the account, not to” the bank. Because no transfer occurs in these circumstances, a FUFTA claim against a bank cannot lie and the “mere conduit” defense need not be adjudicated.

B. Receivers of Sham Companies Lack Standing to Bring Tort Claims Against Third Parties

The receiver in Isaiah also alleged JPMorgan Chase aided and abetted the Ponzi schemers’ conduct, another frequent claim in this type of litigation. Courts considering these claims at the motion to dismiss stage usually review the complaint to determine if the receiver has plausibly alleged facts showing the bank had “actual knowledge” of the underlying fraud. The threshold question of which claims the receiver has standing to bring is rarely considered.

In Isaiah, however, the 11th Circuit recognized that the standing question is a critical one and dispositive of receivers’ attempts to bring tort claims against third parties. The court first explained that while a receiver is appointed to protect creditors’ rights (because it is marshaling assets for distribution to those creditors), it “cannot pursue claims owned directly by the creditors” and is “limited to bringing only those actions previously owned by the party in receivership.” That is, the receiver “stands in the shoes” of the entities over which it is appointed and can bring only the claims that those entities themselves could have brought.

The court then proceeded to distinguish between two types of claims commonly brought by receivers. First, the receiver may bring fraudulent-transfer claims to recoup the assets of the corporation which, although it was created as part of a Ponzi scheme, “is still in the eyes of the law a separate legal entity with rights and duties.” The receiver may validly bring those claims and the in pari delicto defense — that the corporation participated in the wrongdoing — “would not apply to claims brought by a receiver,” which “cleanses” the wrongdoing.

Separately, receivers also bring “common law tort claims against third parties to recover damages for the fraud perpetrated by the corporation’s own insiders” — such as the aiding and abetting claims in Isaiah. The court held that receivers lack standing to bring these types of claims because “the corporation, whose primary existence was as a perpetrator of the Ponzi scheme, cannot be said to have suffered injury from the scheme it perpetrated.” In reaching this holding, the court drew a careful distinction between a receiver’s charge to protect the assets of the entities placed under receivership and the rights of creditors to bring their own claims for losses from the Ponzi scheme. Allowing receivers to bring tort claims against third parties “purportedly for the benefit of the entities’ creditors is really to usurp the claims that properly belong to those creditors.” Accordingly, the court held that the receiver could not assert tort claims against third parties like JPMorgan Chase arising from the underlying fraud.

III. Isaiah’s Impact

The 11th Circuit’s decision narrows the potential claims receivers may bring against financial institutions following the collapse of a Ponzi scheme. The court’s holding that deposits are not “transfers” protects banks providing routine deposit accounts from fraudulent-transfer claims. And the court’s holding that receivers for sham companies lack standing to bring aiding and abetting claims removes a commonly asserted cause of action from the Ponzi litigation playbook.

McGuireWoods’ Financial Institutions Team closely monitors industry trends and legal and regulatory developments relevant to banks, bank holding companies and other financial institutions. For further information, please contact the authors of this article or any member of the firm’s Financial Institutions Team.

Subscribe
Back to top