The Fifth Circuit Slices The Golf Channel Into The Pond - Forbes

I have previously written about the misadventures of the notorious Ponzi schemer Allen Stanford, a blustering Texas real estate developer who bought his way into the Knight Commander of the Order of the Nation (KCN) for the Caribbean island nation of Antigua and Barbuda, ceremoniously conferred in 2006 by no less of a figure than Prince Edward, the Earl of Wessex, and then revoked in 2010 after Stanford had revealed Antigua and Barbuda to be the bad joke of the offshore financial world when his $7 billion pyramid came crashing down.

Stanford was for a few years legitimately known as Sir Allen Stanford, but these days he is referred to as Sir Scam-A-Lot while serving his 110-year prison sentence, trading in his intended retirement on the tropical Antiguan and Barbudian beaches for the prison yard of the U.S. SuperMax facility in Sumterville, Florida. Stanford left behind a trail of financial disaster that has taken â€" and will continue to take â€" many years to clean up by the court-appointed receiver of Stanford’s Evil Empire Empire, Ralph S. Janvey.

Stanford’s scam was an old one, which was selling Certificates of Deposit offering a higher rate of return than could be legitimately obtained in the ordinary financial markets. What made Stanford scheme different was its sophistication and breadth. Stanford created approximately 130 entities in various countries as part of a complex book-cooking mechanism for his Stanford International Bank, which provided glowing (and wholly false) financial statements to depositors.

The scheme was so sophisticated that both the Republican and Democratic party organs dropped dough into Stanford’s scheme (Stanford doubtless thought that he was buying political cover by selling to them), but eventually had to cough up their phony investment profits.

Allen Stanford a/k/a Sir Scam-A-Lot displays the Royal Cuffs

Most of Stanford’s victims (including the politicos) were sucked into Sir Scam-A-Lot’s scheme by that classic combination of greed and naivety, or stupidity if you prefer. But other of Stanford’s victims were not investors at all, just honest businesses trying to make an honest buck.

That brings me to the instant case.

A Ponzi scheme operates by paying an initial group of victims a high return, so that they encourage others to invest. The pyramid thus starts at the top with a few investors, and then attempts to expand quickly at the bottom with new investors so that there is always enough money both to pay back the old investors and profit the scammer. The bigger the pyramid, the more aggressively it has to expand at the bottom, as the number of old investors who must be paid keeps growing. Ultimately, as happens with every pyramid scheme, the new investors  become outnumbered by the old investors â€" whereupon, the old investors aren’t paid, commence an investigation, and the scheme collapses.

Sir Scam-A-Lot’s pyramid scheme was no different, and by 2005 Stanford’s pyramid was so large that he had to turn to mass-marketing his phony Certificates of Deposits. He did so, among other ways, by targeting the typically affluent sports audience.

Stanford International Bank thus became the title sponsor of the Stanford St. Jude’s Championship, which was a PGA Tour event held in Memphis. This event was regularly broadcast by The Golf Channel, Inc., (now owned by Comcast Corp. ) and, as quite normal with major sponsors, The Golf Channel offered Stanford International Bank an advertising package.

The Golf Channel and Stanford International Bank agreed in October 2006 to a two-year deal, that included no less than 682 commercials annually, and a bunch of other advertising goodies. Later, Stanford International Bank renewed the package for an additional four years. All told, the Golf Channel received $5.9 million from Stanford International Bank.

By February of 2009, however, U.S. Securities & Exchange Commission was on to Sir Scam-A-Lot’s pyramid, and initiated a lawsuit that resulted in all of the assets of the Stanford entities being frozen. The aforementioned Janvey was appointed as Receiver.

For his part, Sir Scam-A-Lot attempted to flee the U.S. to Antigua, but the owner of the private jet that he chartered would accept only a wire transfer (and Stanford’s assets were frozen). He told Stanford to take a hike on his offer of a credit card, thus leaving our Knight Commander stranded in the Lone Star State where he was very soon taken under what would be the quite permanent custody of Los Federales.

Meanwhile, back on the 7th green, the Receiver in the course of his investigation stumbled upon the $5.9 million paid by Stanford International Bank, and in 2011 filed a lawsuit in the U.S. District Court against The Golf Channel, alleging that the $5.9 million was a fraudulent transfer. The Golf Channel countered, and proved at trial, that it had acted in good faith when it received the $5.9 million, and that it gave “reasonably equivalent value” back to Stanford International Bank by way of the market value of its advertising.

The District Court agreed with the Golf Channel and found that it had not been a fraudulent transferee, explaining that the “Golf Channel looks more like an innocent trade creditor than a salesman perpetrating and extending the Stanford Ponzi scheme.”

The Receiver appealed the decision to the U.S. Circuit Court of Appeals for the Fifth Circuit, resulting in the Opinion which I shall now relate.

The parties stipulated that Stanford International Bank has committed a fraudulent transfer.  Similarly, the District Court found that The Golf Channel had acted in good faith, and the Receiver did not challenge that finding on review. The sole issue, therefore, was whether The Golf Channel had given “reasonably equivalent value” in exchange for the $5.9 million when it rendered advertising services to Stanford International Bank.

Questions of “reasonably equivalent value” have basically two parts: (1) whether there was any “value” given, and, if so, then (2) whether that value was in the ballpark of what the debtor gave to the transferee. Contrary to what many CPAs who fancy themselves as lawyers seem to believe, “reasonably equivalent value” does not require anything like dollar-for-dollar equivalence, but it needs to just be roughly the same as what was transferred â€" close counts with horseshoes, hand grenades, nuclear weapons, and “reasonably equivalent value”.

That does not mean that there is no guidance for the courts to determine whether “value” exists. The Uniform Fraudulent Transfer Act (now known as the Uniform Voidable Transaction Act) states in the comment to the definition of “value” that the meaning of that word:

is to be determined in light of the purpose of the Act to protect a debtor’s estate from being depleted to the prejudice of the debtor’s unsecured creditors. Consideration having no utility from a creditor’s viewpoint does not satisfy the statutory definition.

The Fifth Circuit took all of this into consideration, and then looked to see whether The Golf Channel’s advertising was of any benefit to the Sanford’s Ponzi scheme victims, and concluded that it was not. Thus:

While Golf Channel’s services may have been quite valuable to the creditors of a legitimate business, they have no value to the creditors of a Ponzi scheme.* * * Services rendered to encourage investment in such a scheme do not provide value to the creditors.

The Golf Channel countered that the $5.9 million it provided in advertising was the reasonable market value of those services. The Fifth Circuit said this didn’t matter, but instead the Court is to look at the value of the services through the eyes of the debtor’s particular creditors. Here the advertising was of no benefit at all to the Sanford victims.

Importantly, the Fifth Circuit felt compelled to caveat the result it was reaching:

We note that our conclusion here does not rest upon a conclusion that the advertising services themselves lacked value in the abstract. In granting Golf Channel’s motion for summary judgment, the district court compared Golf Channel’s services to consumables and speculative investments which have been held to have value under UFTA. The district court stated that “[i]t seems wrong … to hold that every transaction in which a debtor acquires consumables is a fraudulent transfer.” We agree. As the district court explained, we have held that a debtor purchasing jet fuel to keep an affiliated airline in business is an exchange for reasonably equivalent value even though the value to the debtor is merely the potential proceeds of a possible sale of that affiliated airline. * * * Here, however, the advertising services did not provide even a speculative economic benefit to Stanford’s creditors.

With that, the Fifth Circuit reversed the District Court, and entered judgment for the Receiver and against The Golf Channel.

ANALYSIS

This case illustrates the dangers to a business that deals with a debtor, even unwittingly. If this decision is followed, it creates tremendous risk for any service business that deals with a debtor, since between the business and creditors, the creditors may win. This decision imposes what amounts to a significant duty on businesses to “Know Your Customer” and to thoroughly investigate a large customer’s affairs before taking their money.

How realistic is such a requirement? Not very. Just think about this case: Was The Golf Channel supposed to divine that our world renown Knight Commander was just another Bernie Madoff before the SEC did? As silly as that sounds, it is what the Black Robes sitting on high at the Fifth Circuit just told us.

I wrote on on a similar result just last week,  where the Venetian casino was zinged for nearly $400,000 in a similar case, resulted from a failed real estate developer who transferred money to the casino while he was bust, and the Venetian ended up having to repay it to the Bankruptcy Trustee. So, in fairness to the Fifth Circuit panel, they are not the only ones reaching this conclusion.

The businesses most at risk are service and leisure businesses. Under this decision, if a debtor buys a week cruising the Aegean, it is the cruise line that is out the bucks.

That is, if this decision is followed.

There are good reasons why other courts might not choose to follow this decision. Arguably, the Fifth Circuit (and the Medici court) missed an opportunity to conduct a much deeper analysis into what “utility to creditors” and “viewpoint of creditors” really means.

To paraphrase noted law professor Kenneth C. Kettering, the Official Reporter for the 2014 Revisions to the Uniform Fraudulent Transfer Act and certainly the leading expert in the area, in the law of fraudulent transfers there is an inevitable tension between creditors and the merchants who innocently deal with debtors. This tension manifests itself, as here, in the transferee’s good faith defense. Merchants have a right to expect to be paid by the customers that they legitimately deal with. Creditors have a right to be paid on their judgments, including by those who received a fraudulent transfer from the debtor.

So who wins?

Normally, the merchant should win. So long as the merchant is in good faith and conducting business as usual, and there is nothing particularly egregious from the viewpoint of creditors, then the merchant’s interests should be respected. From the creditor’s viewpoint, nothing unsound or unsavory has occurred â€" from the creditor’s viewpoint, reasonably equivalent value has been exchanged.

This doesn’t mean the creditor necessarily loses, since the creditor still holds an unsatisfied judgment and can continue to seek collection against other assets. The creditor just doesn’t get to collect against the particular assets transferred to the merchant.

But does this analysis still hold with Ponzi scheme victims? The whole problem with Ponzi schemes is that there is never enough money to pay back all creditors, since the scheme was underwater the moment the first investors were paid.

The Fifth Circuit effectively elevated Ponzi scheme creditors to what amounts to a higher level of creditors who have a greater chance of recovering transfers made by the scammer to ordinary and innocent merchants, such as to the The Golf Channel in this case. It is almost as if the Fifth Circuit said “We have a tough choice to make between victims and The Golf Channel, and we decide the victims should recover.”

That may not be the best analysis.

First, it is probably a bad idea to create a higher level of creditors that can discomfort merchants, since the latter will now have to worry about seemingly ordinary customers that they deal with, i.e., it has the potential to disrupt the normal business expectation of merchants.

Second, one might suggest that the victims of a Ponzi scheme are not wholly without sin, since they themselves certainly failed to conduct adequate due diligence before getting into the scheme. Victims should have known that chasing higher returns necessarily means higher risk, recalling the late Will Rogers’ famous saying that “I’m not so concerned about the return on my money, as I am about the return of my money.”

And that is advice that you can take to the bank, just not the Sanford International Bank.

CITE AS

Janvey v. Golf Channel, 2015 WL 1058022 (5th Cir., Mar. 11, 2015). Full Opinion at http://goo.gl/84pPql

This article at http://onforb.es/1EuSMaU and http://goo.gl/Zp1ODL