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In Kelley v. Boosalis (In re Petters), 974 F.3d 884 (8th Cir. 2020), the Eighth Circuit reversed summary judgment against the defendants (investors who were paid more than they invested), holding, among other things, that Finn v. Alliance Bank, 860 N.W.2d 638 (Minn. 2015), provides that a contract is void based on fraud only if “both parties entered into the contract at issue with the purpose of deceiving a third party.” The court also reversed and remanded for a new trial because of prejudicially erroneous jury instructions on the MUFTA elements of “good faith” and “reasonably equivalent value.”

In addition, the Eighth Circuit rejected one defendant’s argument that a principal may be charged, for statute of limitations purposes, with knowledge an agent acquired at a time when neither the agency relationship nor the principal itself existed.  It rejected another defendant’s argument that she was not the “transferee” of payments that were deposited into her 401(k) plan. Finally, the Eighth Circuit held that the district court erred in concluding that Minnesota rather than federal law governed the award of prejudgment interest.

The MUFTA Issue

The Eighth Circuit rejected the trustee’s and the district court’s “Ponzi churn” theory of fraudulent transfers. The court reaffirmed the “transfer-by-transfer” framework set out in Finn, holding that not every transaction is necessarily fraudulent simply because the transferor was perpetrating a Ponzi scheme.

The Eighth Circuit also held that the district court erred in its instructions to the jury regarding the affirmative defense provided by Minn. Stat. 513.44(a)(1).  Specifically, the Eighth Circuit held that the district court erred in instructing the jury that “any payment above the amount of the principal investment is not in satisfaction of a valid antecedent debt [for the purposes of “reasonably equivalent value”] if it was made in furtherance of a fraud, enabled by a fraud, or paid on a dishonestly incurred debt” because one party’s unilateral act of deception does not invalidate a contract.  Because the promissory notes were valid and enforceable contracts on their face, interest payments at a “commercially reasonable rate of return may be “reasonably equivalent value.”

The Eighth Circuit also held that the district court erred in instructing the jury that the defendant did not take in good faith if “sufficient red flags existed, to cause a reasonable person to question whether Petters Company, Inc. was insolvent or paying money to [defendant] for a fraudulent purpose” and “[s]ufficient facts or red flags may include delinquent payments, reversed checks, relatively high interest rates on loans, and a lack of formal paperwork surrounding business transactions.” Reasoning that this jury instruction singled out facts most favorable to the trustee and, by stating that these facts are “‘sufficient,’ the instruction confused facts that support a finding with facts that require it in every case.” Therefore, the Eighth Circuit remanded for a new trial on these issues.

The Predicate Creditor Issue

The Bankruptcy Code authorizes the Trustee to avoid a transfer of the debtor “that is voidable” by a creditor who could have pursued avoidance of the transfer outside of bankruptcy, i.e. a “predicate creditor.” The trustee argued that a predicate creditor, which was formed in 2008, qualified as the predicate creditor. The appellee-defendant argued that the predicate creditor could not have pursued avoidance outside of bankruptcy because an executive of the predicate creditor was aware of “red flags” more than six years before the bankruptcy filing, and was thus barred by a six-year statute of limitations. The court rejected the argument that a principal may be charged, for statute of limitations purposes, with knowledge an agent acquired at a time when neither the agency relationship nor the principal itself existed.

Personal Liability of 401(k) Investor

One defendant appealed on the basis that she was not a “transferee” because PCI paid all interest to her 401(k) plan. The Eighth Circuit affirmed the district court in rejecting this argument because the defendant was the sole beneficiary of the plan, and the interest payments from PCI were in the possession of the defendant the instant they were received by the 401(k) plan. The tax penalties for taking out the payments from the 401(k) were irrelevant. Also, the Eighth Circuit determined that the trustee did not need to have standing under ERISA to recover from the plan since the trustee was not seeking a remedy under ERISA’s “comprehensive civil enforcement scheme” and there is no basis for ERISA preempting a federal cause of action.

The Prejudgment Interest Issue

As a matter of first impression, the Eighth Circuit clarified that federal law, rather than Minnesota law governed the trustee’s right to recover prejudgment interest. Noting that a proceeding to avoid a fraudulent conveyance under § 544 is a “core proceeding,” the Eighth Circuit held that 544(b)(1) “permits a trustee to pursue a federal cause of action in bankruptcy court” even though it applies state law. (quoting In re DBSI, Inc., 869 F.3d 1004, 1015 (9th Cir. 2017)). In addition, recovery of an avoided transfer is made pursuant to § 550 rather than state law. Because the court’s jurisdiction is under federal law, and not diversity or supplemental jurisdiction, federal law governs any award of prejudgment interest.

Co-Editors in Chief
Alexander J. Beeby, Larkin Hoffman Daly & Lindgren Ltd.
Kesha Tanabe, Tanabe Law