By Tom McCurnin
Barton, Klugman & Oetting
Misery Loves Company. Equipment Lessors Flocked to EAR Seven Years Ago, Now Face Fraudulent Conveyance Charges by Trustee;
Bankruptcy Judge Wants More Details But Allows Case to Continue.
In re Equipment Acquisition Resources, Inc. 2012 WL 4755028 (Bankruptcy N.D.Ill.,2012)
Like Lemmings rushing to a cliff, equipment lessors flocked to Sheldon Players' Equipment Acquisition Resources in 2004 to finance refurbished semiconductor-making machinery for Player. The losses for the lessors approached $175 million dollars. If that isn't injury enough, EAR's Bankruptcy Trustee has filed a series of lawsuits against the lessors for fraudulent conveyance. The lawsuits are identical in every respect to those filed against credit card companies and other entities that received payments from EAR in its waning years.
An Illinois Bankruptcy Court, while granting about 18 Motions to Dismiss, allowed EAR to file an amended pleading, breathing new life into this action, and stretching the case into the New Year. The question for the lessors is whether they can convince the bankruptcy judge that legitimate lease obligations should not be fraudulent transfers. The challenge for the lessors is a patchwork of inconsistent case law for Ponzi scheme. This case could go either way. This is why many of the credit card issuers, also sued under identical Complaints, have settled for about 50 cents on the dollar.
The complaint against the lessors is oddly written and it remains to be seen whether it has legs, but for now, even though the lessors won a Motion to Dismiss, the victory was largely pyric victory, because the Bankruptcy Court allowed the Trustee to amend its Complaint, and it quickly took up the Court's opportunity, and we are likely to see a more substantive ruling on the merits of the Trustee's claims by Christmas. The facts follow:
Sheldon Player ran a Ponzi scheme, double and triple financing imaginary equipment to about 20 equipment lessors. When the Ponzi scheme crashed, Player and his wife resigned, and a turn-around group took over management of EAR. EAR filed bankruptcy in 2009, and earlier this year, the Debtor in Possession filed suit against the lessors for fraudulent conveyance.
I've read the Complaint, and it is not entirely clear to me what the Debtor is claiming, but here is an excerpt which is paraphrased for easier reading:
"Player caused EAR to agree to enter into the Leases because doing so furthered his fraudulent scheme. As a result of the misconduct, EAR creditors that had financing and leases which were part of Player's scheme have been unable to identify what, if any, equipment that was previously located at EAR's facilities was subject to a valid security agreement or lease."
"EAR entered into the Leases and made required payments Because EAR owned the equipment in question prior to the date of the Leases, the transactions were unnecessary from a business standpoint. Rather, EAR entered into the Leases in order to generate cash for use in paying other outstanding lease obligations as part of the Ponzi scheme."
Essentially the Debtor is claiming that the payments EAR made to the lessors are fraudulent conveyances. Certainly the payments were transfers, that is without question. Moreover, EAR was insolvent at the time. The question for me was whether the lessors gave EAR "reasonably equivalent value," which seems to be a missing element. After all the lessors did give EAR cash for the non-existent equipment. Why isn't that reasonably equivalent value?
Special Rules for Ponzi Scheme in Bankruptcy
The answer lies in some special rules for bankruptcy courts developed for handling Ponzi schemes like EAR. Those special rules allow the trustee to sue "winning investors" on behalf of "losing investors" Essentially, the trustees attempts to recover legitimate payments of monies for all the parties, under the theory that the whole enterprise was a fraud. Presumably, the lessors which received lease payments are "winning investors" and the other creditors are "losing investor." However, since most Ponzi scheme litigation is against investors, not legitimate creditors, this case is one of first impression for me at least.
The problem with this case is that Ponzi scheme cases often don't fit into neat little classifications like reasonably equivalent value and arm's length transactions. Moreover, there are no specific statutes governing Ponzi schemes, just a patchwork of preference law, avoiding powers, and fraudulent conveyance statutes. In addition, most Bankruptcy trustees use the State Uniform Fraudulent Conveyance Act which provides different grounds and remedies. In short, the bankruptcy treatment of this issue is a mess.
Recently, Golden Gate University hosted a symposium on Ponzi schemes, much of which has been published, including fraudulent transfers, claimslitigation, and Many of the speakers called out for a uniform treatment of Ponzi scheme litigation in the bankruptcy statutes, which have no direct statutory guidelines.
The Motions to Dismiss and Ruling
The lessors (Pentech, U.S. Bancorp, Alliance Commercial Capital, SunTrust Leasing, IBM Credit Comerica Leasing, SunTrust, and Leasing One) filed a series of Motions to Dismiss, claiming that the lessors' obligations were arms-length leases, the fraud was not spelled out with specificity, there were no badges of fraud, and that payments on antecedent debts are preferences, not fraudulent conveyances.
The trial court granted the motions in part, but allowed the Debtor to re-file the action with additional specificity, which it immediately did. This means another round of law and motion, stretching into next year. The Bankruptcy Judge has consolidated the briefing schedule and issued one identical ruling in the 18 cases. There is no reason to expect that the Court will do it different this time around.
The Amended Complaint sets forth the existence of the Ponzi scheme and essentially makes the argument that "but for" the actions of the lessors in making the leases and accepting payments, the Ponzi scheme would have been detected earlier. There is no allegation of overt fraud, other than on the part of Sheldon Player.
Quite frankly, the Complaint is a bit of a stretch for me. I simply don't buy the idea that the 18 or so equipment lessors are singularly responsible for the Sheldon Player Ponzi scheme.
What Does the Future Hold for the
EAR Fraudulent Conveyance Litigation?
I'm not good at predicting the future, but I can safely say that there will be three things that will occur over the next 90 days:
• Expenditure of Significant Legal Expenses. Without question, there will be a second, and more important round of Motions to Dismiss, with each lessor putting forth its own reasons for getting the case thrown out. We've handled several of these here in California, and one of the best strategies is to form a litigation steering committee, so that strategies and paperwork can be spread out at reduced costs.
• Uncertain Risk. If EAR's Complaint survives this second round, costs and the uncertainty of a result will make for some sleepless nights for some. While I am very familiar with Ponzi scheme litigation involving investors, going after creditors presents a new wrinkle,
• Potential Settlements. The credit card issuers, by in large, have settled the claims for 50%, which is awfully high, but then again, legal fees could dwarf the payment pool that the credit card issuer received. Certainly, if the lessors could get EAR into a settlement number which was equal to or less than costs of defense, it might make sense to settle this matter. The Golden Gate Symposium I made reference to earlier had a whole section on mediation tips and strategies.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.