This issue was recently addressed by the 5th Circuit Court of Appeals in SEC v. Res. Dev. Int'l LLC, 2007 U.S. App. LEXIS 11603 (5th Cir. 2007).

The 5th Circuit Court of Appeals found that the district court did not err in holding that several members of a Ponzi scheme, after having its assets frozen by the SEC, were guilty of fraudulent transfers, but the appellate court vacated the lower courts ruling that its judgment could not be discharged in Bankruptcy. The district court reached its decision on fraudulent transfer pursuant to state law, however the appellate court ruled that the district court’s dischargeability determination was premature, as the Defendant’s had not yet even filed for Bankruptcy.

Benjamin Cook’s (“Cook”) assets were frozen after the SEC brought a lawsuit against him and various other members of a Ponzi scheme (“The Dennel Program”). Anthony Martella, the sole shareholder of M&M Engraving Co. and business associate to Cook in the Dennel Program, agreed to pay Cook’s legal fees, $60,000, through his company’s account. Cook promised to immediately reimburse Martella’s company, M&M Engraving and Manufacturing Co. (“M&M”). Soon thereafter, M&M received a wire transfer for $60,000, the exact amount of Cook’s legal fees, from International Educational Research Foundation (“IERC”), an entity whose assets were tied to “the Dennel Program.” Warfield, the court appointed receiver charged with protecting the remainder of the Dennel Program’s assets, sued Martella and M&M for the fraudulent transfer it received from IERC, holding them joint and severally liable.

Under Tex. Bus. & Com. Code Ann. § 24.005(a)(1), the district court found this to be a fraudulent transfer and awarded joint-and-several recovery from Martella and M&M in the amount of $60,000 plus pre-judgment interests and costs. The basis of the joint-and-several liability determination was formed by the district court’s finding that M&M corporation was Martella’s alter ego, since inter alia he was its only shareholder. The district court also declared that this judgment could not be discharged in a future bankruptcy, which the defendants will likely face.

The 5th Circuit Court of Appeals upheld the district court’s state law fraudulent transfer ruling and additionally found that Martella’s and M&M’s wire transfer was fraudulent under Tex. Bus. & Com. Code Ann. § 24.005(a)(2). Although, the appellate court upheld the district court’s determination that Martella and M&M are to be joint and severally liable, it did so not on the basis of alter-ego (the first ground used to pierce the corporate veil), but on the basis that the corporation was used for an illegal purpose (the second ground used to pierce the corporate veil). However, because of the fact that the Defendants had not yet filed for bankruptcy nor sought to have the judgment set aside in bankruptcy, the 5th Circuit Court of Appeals vacated the district court’s determination that the judgment against the defendants may not be discharged in a future bankruptcy.

Hunter