Kriegman v. Nelson et al

Filing 95

FINDINGS OF FACT AND CONCLUSIONS OF LAW. Signed by Chief Judge Rosanna Malouf Peterson. (RG, Case Administrator)

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UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF WASHINGTON

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In Re:
NO: 12-CV-488-RMP

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LLS AMERICA, LLC,
Bankr. Case No. 09-06194-FPC11
Debtor,

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BRUCE P. KRIEGMAN, solely in his
capacity as court-appointed Chapter 11
Trustee for LLS America, LLC,

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Adv. Proc. No. 11-80285-FPC11
FINDINGS OF FACT AND
CONCLUSIONS OF LAW

Plaintiff,

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v.

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DORIS NELSON and ADAM
NELSON, and the marital community
comprised thereof; et al.,

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Defendants.

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A bench trial was held on October 1, 2014. Plaintiff was represented by

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Thomas Cochran and Daniel Gibbons from Witherspoon Kelly. Pro se defendants

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Harold Johanson and Colt Johanson were not present. Plaintiff stated that the pro

FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 1

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se defendants had been given notice of the trial and that they did not respond. For

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reasons explained on the record and in a prior order, Plaintiff did not present

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evidence concerning any defendants other than Harold Johanson and Colt

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Johanson. See ECF No. 91.

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The Court heard witness testimony and, having reviewed the admitted

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exhibits and being fully informed, makes the following findings of fact and

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conclusions of law:

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PREVIOUS RULINGS
1.

Ponzi Scheme and Insolvency

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On July 1, 2013, the Bankruptcy Court issued its Report and

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Recommendation Re Plaintiff’s Motion for Partial Summary Judgment on

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Common Issues (“Report and Recommendation”) recommending that the District

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Court grant the Trustee’s Amended Motion for Partial Summary Judgment on two

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“Common Issues”: (1) Debtor operated a Ponzi scheme; and (2) Debtor was

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insolvent at the time of its transfers to Defendants. On August 19, 2013, this

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Court adopted the Bankruptcy Court’s Report and Recommendation and entered

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an order granting the Trustee’s Amended Motion for Partial Summary Judgment

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on the Common Issues (“Order Adopting Report and Recommendation”). See

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2:11-cv-00357-RMP, ECF No. 92. Therefore, this Court has determined that

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FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 2

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Debtor operated a Ponzi scheme and was insolvent at the time of each of the

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transfers to Defendants.

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All of the findings and conclusions set forth in the Report and

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Recommendation and the Order Adopting Report and Recommendation are

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incorporated by this reference and are the law of this case.

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2.

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On January 31, 2014, this Court entered its Order Granting Plaintiff’s

Omnibus Hearing for the Testimony of Charles B. Hall

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Motion for Omnibus Hearing. ECF No. 42. Pursuant to that Order, the court-

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appointed examiner, Mr. Charles B. Hall, testified at an Omnibus Hearing in open

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court commencing on February 25, 2014. His testimony consists of written direct

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examination testimony that was filed on or about February 17, 2014, and the oral

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testimony that he gave at the Omnibus Hearing. Mr. Hall was cross examined by

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several defense attorneys and by some pro se defendants. Mr. Hall’s testimony at

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the Omnibus Hearing is part of the record in this adversary action.

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FINDINGS OF FACT
1.

Debtor is the Little Loan Shoppe group of companies, which was

formed originally in 1997. PO-1 at 11.
2.

Debtor operated a Ponzi scheme, whereby investors’ loans sometimes

were used to pay other investors’ promised returns on investments. PO-1 at 16.

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FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 3

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3.

Over the course of its existence, Debtor acquired approximately

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$135.4 million in funds invested by individual lenders, documented by promissory

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notes promising interest in the range of 40% to 60% per annum. PO-1 at 7 n.2, 15.

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4.

Debtor accumulated payday loan bad debts of approximately $29

million, which were written off in 2009. PO-1 at 41.
5.

Debtor was never profitable at any time during its existence, and at no

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time did it generate sufficient profits to pay the amounts due the lenders. PO-1 at

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16, 53.

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6.

All of the transfers that the Trustee seeks to avoid were made within

the period of September 1997 to July 21, 2009. P-81; P-91.

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7.

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include:

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Indicia and characteristics of the Ponzi scheme present in this case

a.

Proceeds received from new investors masked as profits from

running a payday loan business; PO-1 at 16, 22;
b.

Promise of a high rate of return, usually between 40% to as

much as 60%, on the invested funds; PO-1 at 19;
c.

Debtor paid commissions to third parties who solicited new

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lenders, typically 10% annually of the amount received from the new

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lender; PO-1 at 20-21;

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FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 4

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d.

Debtor solicited funds as loans evidenced by promissory notes

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but demonstrated a pattern of “rolling over” the promissory notes when due

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onto new notes instead of paying off the obligation; PO-1 at 26;

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e.

Debtor, throughout its history, made false and misleading

statements to current and potential lenders; PO-1 at 53-54;

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f.

Debtor was insolvent from its inception to the filing of its

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bankruptcy; PO-1 at 67.

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8.

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The court-appointed examiner, Charles B. Hall, by way of education,

experience, and vocation, is qualified to analyze and review the legitimacy of an
enterprise’s operation and to detect a fraud based on Ponzi scheme operations.

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9.

Mr. Hall’s expert opinion is credible.

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10.

Curtis Frye’s testimony, which pertained to Debtor’s record keeping

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and the accounting, is credible.

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11.

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Nelson’s brother.

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12.

Harold Johanson is Doris Nelson’s father. Colt Johanson is Doris

Harold Johanson received multiple payments from Debtor. See P-81.

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Plaintiff argued that Harold Johanson received a total of $7,762.66. However, a

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check offered in support of a $473.66 transfer to Harold Johanson was made

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payable to Andrea Barnett. P-81 at 5. Although a note on the bottom of the check

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states “Johanson,” it is unclear whether the funds were intended for Harold

FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 5

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Johanson. The Court finds that evidence of this payment to Harold Johanson is

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insufficient. Therefore, the Court will not include this payment in its accounting.

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Other payments to Harold Johanson are supported by checks that are

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payable to “Cash” and that indicate that they are “for H. Johanson.” See, e.g., P-81

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at 3. The Court finds that Plaintiff offered sufficient evidence to establish that

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Harold Johanson received $6,122.34 in Canadian currency, shown by checks

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drawn on a Canadian bank, and $1,166.66 in United States currency, proven by the

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receipt for a cashier’s check that Little Loan Shoppe America purchased from

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Bank of America. See P-81.

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14.

There is no evidence that Harold Johanson worked for Debtor in

exchange for the transfers.
15.

A demand letter written in May 2001 by Harold Johanson’s attorney

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indicates that Debtor issued Harold Johanson promissory notes for a total of

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$20,000 and owed him $5,000 that he had advanced to Debtor. P-81 at 12.

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However, Mr. Frye testified that he could not find any evidence that Debtor had

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received anything in exchange for the payments to Harold Johanson. The Court

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finds that there is not sufficient evidence to show that Harold Johanson contributed

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funds to Debtor.

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16.

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Colt Johanson was employed by Debtor. Chris Snyder, a former

employee of Debtor’s, testified that he had seen Colt Johanson sitting in front of a

FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 6

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computer at Debtor’s place of business over a three-month period, although Mr.

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Snyder was unsure of the extent of Colt Johanson’s work. Mr. Frye, who also

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worked for Debtor, indicated that he was not aware of anything of value that

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resulted from Colt Johanson’s services to Debtor.

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17.

Evidence of payments to Colt Johanson includes W-2 wage and tax

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statements indicating that $21,983.17 in wages were reported for the years 2007

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and 2008. P-91 at 1. Debtor’s payroll records for the same period indicate that

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Colt Johanson was paid $18,158.99, which is roughly consistent with the amount

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of Colt Johanson’s wages reported on the W-2 forms, after the withheld taxes are

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subtracted. See P-91 at 1, 2. Debtor also paid $2,568.06 for a truck purchased in

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Colt Johanson’s name. P-91 at 4, 5. The evidence further reflects an additional

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$800.00 payment from Debtor to Colt Johanson, without any indication of whether

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the funds were transferred as payment for Colt Johanson’s services to Debtor. See

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P-91 at 6.

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Plaintiff also offered an accounting record as evidence of a $1,113.25

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payment that Debtor made to Colt Johanson, apparently for wages. See P-91 at 3.

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However, the accounting record does not indicate the date of payment or whether

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the payment is reflected also in the other payroll records. The Court finds that

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Plaintiff has not offered sufficient evidence of this payment and excludes the

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payment from its accounting of transfers that Colt Johanson received from Debtor.

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There is no evidence that Colt Johanson invested funds in Debtor or

was aware of Debtor’s Ponzi scheme.

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Johanson:

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The following summarizes the evidence of transfers made to Harold

Transfers of $6,122.34 CAD
Transfers of $1,166.66 USD

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21.

The following summarizes the evidence of transfers made to Colt

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Johanson:
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Wages net of taxes and withholdings
Member withdrawal
Partial payment for a truck

$18,158.99 USD
$800.00 USD
$2,568.06 USD

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22.
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Total transfers to Defendants are as follows:

• Harold Johanson for $6,122.34 CAD and $1,166.66 USD; and

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• Colt Johanson for $21,527.05 USD
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23.

All transfers to Defendants were made with actual fraudulent intent

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to hinder, delay or defraud creditors and in furtherance of a Ponzi scheme.
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24.

All transfers were made to Defendants while Debtor was insolvent.

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CONCLUSIONS OF LAW
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1.

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

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1334 and 28 U.S.C. § 157(d).
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2.

This Court has jurisdiction over Defendants.

3.

This action was timely commenced.

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FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 8

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4.

At least one unsecured creditor existed who triggered the strong arm

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power of 11 U.S.C. § 544(b)(1) because the creditor did not and should not

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reasonably have discovered the fraudulent nature of Debtor’s Ponzi scheme

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transfers within one year before the bankruptcy petition was filed. See 2:11-cv-

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00362-RMP, ECF No. 197.

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5.

Defendants are insiders of Debtor.

See 11 U.S.C. § 101(31)(A)

(“insider” includes a “relative of the debtor”).

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6.

Washington State law governing fraudulent transfers applies.

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7.

Under the statutes relating to fraudulent transfers, 11 U.S.C. § 548

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and RCW 19.40, et seq., payments received from Debtor are recoverable from

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each Defendant by the Trustee, subject to the defense of good faith pursuant to 11

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U.S.C. § 548(c) and RCW 19.40.081(a).

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8.

Transfers made in furtherance of a Ponzi scheme constitute actual

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fraud under the Bankruptcy Code and Washington’s version of the Uniform

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Fraudulent Transfer Act (UFTA). See Bankr. Adv. Proc. No. 11-80299-FPC, ECF

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No. 378 at 21-25. “Where causes of action are brought under UFTA against Ponzi

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scheme investors, the general rule is that to the extent innocent investors have

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received payments in excess of the amounts of principal that they originally

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invested, those payments are avoidable as fraudulent transfers . . . .” Donell v.

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Kowell, 533 F.3d 762, 770 (9th Cir. 2008).

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A transferee of a fraudulent transfer may keep funds that it took for

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reasonably equivalent value and in good faith. See 11 U.S.C. § 548(c); RCW

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19.40.081(a). As recipients of transfers that constitute actual fraud, the burden of

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proof in establishing the affirmative defense of good faith is on Defendants. In re

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Agric. Research and Tech. Grp., Inc., 916 F.2d 528, 535 (9th Cir. 1990); 5

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COLLIER ON BANKRUPTCY ¶ 548.09[2][c] at 548-98.2 (16th ed. 2011).

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10.

Although “good faith” is not defined precisely in case law, at least

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one court has noted that the absence of good faith is shown by a transferee who

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knows that a debtor is operating a Ponzi scheme. See In re Agric. Research, 916

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F.2d at 535 (citing In re Indep. Clearing House, 77 B.R. 843, 861 (D. Utah

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1987)). The Ninth Circuit has quoted favorably an explanation in an early case

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that a transferee’s “knowledge or actual notice of circumstances sufficient to put

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him, as a prudent man, upon inquiry as to whether his brother intended to delay or

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defraud his creditors . . . should be deemed to have notice . . . as would invalidate

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the sale as to him.” Id. (quoting Shauer v. Alterton, 151 U.S. 607, 621 (1894)).

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Courts measure good faith by an objective standard, looking to what

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a transferee “‘knew or should have known’ in questions of good faith, rather than

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examining what the transferee actually knew from a subjective standpoint.” Id. at

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536.

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FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 10

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12.

Under the Bankruptcy Code, Washington’s UFTA, as well as

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relevant case law, the Court does not contemplate a recipient’s intent when

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deciding whether to avoid fraudulent transfers. 5 COLLIER

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548.04[2] at 548-63; Thompson v. Hanson, 168 Wn.2d 738, 749 (2009).

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Accordingly, a transfer that constitutes actual fraud is avoided in its entirety

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unless the transferee establishes that a reasonable person in the transferee’s

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position would not and should not have known of the fraud, not simply whether he

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or she actually acted in good faith.

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13.

ON

BANKRUPTCY ¶

Transfers made by Debtor in furtherance of its Ponzi scheme are

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transfers made with actual intent to hinder, delay and/or defraud creditors under

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both state law, RCW Ch. 19.40, and federal law, 11 U.S.C. § 548(a)(1).

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The Court is mindful that Defendant Colt Johanson did not appear at

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trial or propose any exhibits to meet his burden of establishing that he acted in

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good faith when he received payments from Debtor. However, after carefully

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reviewing the exhibits and testimony, the Court concludes that the preponderance

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of the evidence establishes that Colt Johanson acted in good faith. Unlike other

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defendants in related adversary proceedings, there is no evidence that Colt

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Johanson invested any funds in Debtor, which might have shown that he was

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aware of factors that made Debtor’s business fraudulent. Nor is there evidence

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that Colt Johanson was involved in recruiting lenders for Debtor or otherwise

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orchestrating the fraudulent aspects of the business. The evidence showed that

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Colt Johanson was employed by Debtor, and indeed the majority of the transfers

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that he received were wages.

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The Court also finds that Colt Johanson gave Debtor reasonably

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equivalent value for the wages that he received in exchange for employment with

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Debtor. Although Plaintiff argued at trial that Colt Johanson’s pay was unusually

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high in light of the fact that he was employed by Debtor for only a few months,

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the evidence showed that his paychecks were comparable to those received by

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Debtor’s other employees. See P-91 at 7-8, 10-13. Moreover, a former employee

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testified that he had seen Colt Johanson at Debtor’s workplace, and documentary

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evidence indicates that federal taxes were withheld from his wages.

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Plaintiff speculated at trial that Debtor did not derive reasonably equivalent value

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from Colt Johanson’s services, the evidence indicates that this in fact was a

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standard employment relationship. The Court concludes that the evidence shows

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that Colt Johanson met the affirmative defense of good faith as to the $18,158.99

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USD that he received as wages.

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16.

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However, there is no evidence that Colt Johanson gave reasonably

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equivalent value for the $800.00 member withdrawal or for the $2,568.06 truck

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payment. Thus, Colt Johanson has not met the affirmative defense as to $3,368.06

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USD.

FINDINGS OF FACT AND CONCLUSIONS OF LAW ~ 12

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17.

There is not sufficient evidence to show that Harold Johanson gave

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reasonably equivalent value in exchange for the transfers that he received from

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Debtor.

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18.

Under RCW 19.40.041(a)(1), RCW 19.40.091(a) and the “strong arm

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powers” that 11 U.S.C. § 544(b)(1) grants to bankruptcy trustees, all of Debtor’s

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transfers to Defendant Harold Johanson, regardless of the date of transfer, are

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hereby set aside and avoided.

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Under RCW 19.40.041(a)(1), RCW 19.40.091(a) and the “strong arm

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powers” that 11 U.S.C. § 544(b)(1) grants to bankruptcy trustees, Debtor’s

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transfers to Defendant Colt Johanson for the member withdrawal and car payment,

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totaling $3,368.06 USD, regardless of the date of transfer, are hereby set aside and

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avoided.

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20.

The Trustee is entitled to claw back and recover the transfers to

Defendants, in the amounts described above.
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The Trustee is entitled to pre-judgment interest at the applicable

federal rate from July 21, 2009, when the bankruptcy case commenced.
22.

Pursuant to 11 U.S.C. § 548(a), 544, 550 and 551 and RCW

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19.40.041(1) and 19.40.071, the Trustee is entitled to and is granted a judgment

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for the benefit of the Liquidating Trust of Debtor against Harold Johanson in the

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amount of $6,122.34 CAD and $1,166.66 USD, plus pre-judgment interest from

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July 21, 2009, at the applicable federal judgment rate and post-judgment interest

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at the federal judgment rate from the date of judgment to the date the judgment is

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paid in full, see 28 U.S.C. § 1961.

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Pursuant to 11 U.S.C. § 548(a), 544, 550 and 551 and RCW

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19.40.041(1) and 19.40.071, the Trustee is entitled to and is granted a judgment

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for the benefit of the Liquidating Trust of Debtor against Colt Johanson in the

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amount of $3,368.06 USD, plus pre-judgment interest from July 21, 2009, at the

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applicable federal judgment rate and post-judgment interest at the federal

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judgment rate from the date of judgment to the date the judgment is paid in full,

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see 28 U.S.C. § 1961.
24.

The Trustee is entitled to reimbursement of its costs for pursuing this

action.
25.

Trustee is awarded all applicable interest, costs and disbursements of

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this action against each Defendant.

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IT IS SO ORDERED.

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The District Court Executive is directed to enter this Order and to provide

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copies to counsel and to pro se defendants.
DATED this 18th day of November 2014.
s/ Rosanna Malouf Peterson
ROSANNA MALOUF PETERSON
Chief United States District Court Judge

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