United States Court of Appeals For the First Circuit
No. 18-2001
IN RE: TELEXFREE, LLC; TELEXFREE, INC.; TELEXFREE FINANCIAL, INC.,
Debtors.
STEPHEN DARR, as Trustee of the Estates of TelexFree, LLC, TelexFree, Inc., and TelexFree Financial, Inc.,
Plaintiff, Appellee,
v.
RITA DOS SANTOS, individually and as putative class representative; MARIA MURDOCH, individually and as putative class representative; ANGELA BATISTA-JIMENEZ, individually and as putative class representative; ELISANGELA OLIVEIRA, individually and as putative class representative; DIOGO DE ARAUGO, individually and as putative class representative,
Defendants,
PLAINTIFFS' INTERIM EXECUTIVE COMMITTEE,
Interested Party, Appellant.
APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Timothy S. Hillman, U.S. District Judge]
Before
Lynch, Selya, and Barron, Circuit Judges. Robert J. Bonsignore, with whom Lisa Sleboda, Bonsignore Trial Lawyers, PLLC, William R. Baldiga, James W. Stoll, and Brown Rudnick LLP were on brief, for Appellant. Harold B. Murphy, with whom Charles R. Bennett, Jr., Andrew G. Lizotte, Shawn Lu, and Murphy & King, P.C. were on brief, for Appellee.
October 29, 2019 LYNCH, Circuit Judge. This appeal is from bankruptcy
court orders adopted by the district court arising out of the
bankruptcies of TelexFree, LLC; TelexFree, Inc.; and TelexFree
Financial, Inc. (collectively, "TelexFree"), one of the largest
Ponzi/pyramid schemes in U.S. history. The dispute in this case
is over who will be allowed to seek to recover payments made by
new participants in the scheme to the existing participants who
recruited them (the "Contested Funds"). Trustee Stephen Darr is
attempting to recoup these Contested Funds through avoidance
actions, while victims represented by the Plaintiffs' Interim
Executive Committee ("PIEC") are asserting unjust enrichment
claims to recover the same sums.
Adopting the bankruptcy court's analysis, the district
court stayed the unjust enrichment claims under 11 U.S.C.
§ 362(a)(3) based on the following findings:
(1) that the trustee has standing to bring the avoidance actions
because the Contested Funds were "interests of the debtor in
property" under 11 U.S.C. §§ 547 and 548;
(2) that these avoidance actions were themselves "property of the
estate" under 11 U.S.C. § 541; and
(3) that the unjust enrichment claims were acts to "obtain" or
"control" property of the estate (i.e., the avoidance actions) --
and thus barred by 11 U.S.C. § 362(a)(3) -- because they are
"derivative" of the avoidance actions under the analyses set forth
- 3 - in the Second Circuit's Madoff cases. See Picard v. Fairfield
Greenwich Ltd. ("Madoff III"), 762 F.3d 199 (2d Cir. 2014);
Marshall v. Picard (In re Bernard L. Madoff Inv. Sec. LLC) ("Madoff
II"), 740 F.3d 81 (2d Cir. 2014).
The net effect of these rulings was to permit the trustee to pursue
the Contested Funds and to stop PIEC's efforts to pursue those
funds.
We assess and reject the only arguments that the
appellant makes as to why the bankruptcy court erred in ruling
that their unjust enrichment claims are stayed pursuant to
§ 362(a)(3). Those arguments, which we reject, are: (1) that the
avoidance action claims are not "property of the estate" within
the meaning of that stay provision because the bankruptcy court's
"standing" finding is flawed; and (2) that, in any event, the
unjust enrichment claims do not seek to "obtain" or "control" the
"property of the estate" within the meaning of that stay provision
because those claims are not "derivative" of the avoidance action
claims under the derivative analyses the Second Circuit employed
in the Madoff cases.
We affirm, write narrowly, and do not reach other
arguments or potential arguments. We describe below the facts
and, more explicitly, the nature of the dispute between Darr and
PIEC.
- 4 - I.
A. The TelexFree Scheme
TelexFree was a hybrid Ponzi and pyramid scheme that
operated in the United States from 2012 until 2014, when its
founders were criminally charged, its operations closed, and it
declared bankruptcy. It is considered one of the largest such
schemes in U.S. history, with approximately $1.7 billion lost and
one million participants, many of them immigrants, defrauded.
The material facts are not disputed by the parties.
TelexFree held itself out as a multi-level marketing company that
sold international phone subscription packages. Participants paid
membership fees to join the TelexFree scheme and have the right to
sell phone subscription packages to others.1 Each participant,
including new participants, was assigned an online user account by
the company. Many participants had multiple accounts, as they
were encouraged to do by the economic incentives of the scheme.
The participants, for bankruptcy purposes, later were divided into
"Net Winners" and "Net Losers," important concepts which we explain
below.
The actual phone subscriptions sold were tangential to
TelexFree's true purpose, like all pyramid schemes. TelexFree's
1 The phone subscription service offered by TelexFree allowed customers to make inexpensive calls to other countries using a technology called Voice over Internet Protocol ("VoIP") instead of a traditional phone line.
- 5 - operations, rather, were geared towards recruiting new
participants into the scheme. New participants, on signing up,
owed a membership fee to TelexFree. Instead of paying TelexFree,
new participants could pay the existing members directly, and the
existing members could redeem some accumulated "credits" to settle
the new members' obligations to TelexFree. New participants then
themselves often recruited additional participants into the
scheme. Participants who joined early in the scheme could make
significant money from all the "downstream" participants, while
many newer participants lost money, sometimes their entire life
savings.
TelexFree combined these classic pyramid scheme features
with the features of a classic Ponzi scheme. The company
advertised that participants could receive guaranteed returns on
the money they put into TelexFree, without ever having to sell a
VoIP subscription package or even to sign up a new participant.
To keep up the facade of a legitimate business, the company
required participants to post commercially-useless internet
advertisements.
For example, participants who joined the scheme through
the "AdCentral Plan" paid TelexFree $339 -- a $50 membership fee
and a $289 contract fee. In return, they were allowed to sell ten
VoIP subscription packages (although they were not required to)
and were required to post one internet advertisement a day. If
- 6 - the participants met their advertising quota, they would earn the
right to sell another VoIP subscription package each week. Or,
instead of selling it, they could turn the extra VoIP subscription
package back into TelexFree in exchange for twenty dollars' worth
of credits. In that way, participants could reliably transform a
$339 investment into $1,040, or a 207% annual rate of return.
Other membership plans had even higher rates of return. This was
not true compensation for labor but was instead an astronomical
guaranteed return on investment, paid for by newer recruits'
membership fees.
Ostensibly, there were three main ways to make money
through the TelexFree scheme: selling phone subscription packages,
posting internet advertisements, and signing up new participants.
Often, TelexFree participants were not paid in cash directly but
through digital "credits" that they, under the terms of their
subscription contracts, could redeem for cash at a later point.2
The Contested Funds at issue relate to the signing up of
new participants. When an existing participant recruited someone
new into the scheme, TelexFree would send an invoice to the new
participant for the membership fee. One way the new participant
2 PIEC disputes whether participants regularly converted credits into cash, but PIEC concedes that participants were regularly paid commissions and bonuses in the form of credits and "it's conceivable" that at least some participants received cash payment from TelexFree.
- 7 - could satisfy the invoice was by paying the company the membership
fee directly, although only about twelve percent of membership
fees were paid that way.
The much more common method used was that the new
participant paid her membership fee directly to the participant
who recruited her. TelexFree then would remove from the recruiting
participant's account credits of equal value to the membership fee
that this recruiting participant retained. TelexFree then
considered the new participant's invoice satisfied and, once
annually, issued an Internal Revenue Service Form 1099 to the
recruiting participant for the value of the credits he redeemed.
Existing TelexFree participants could monetize their accumulated
credits this fast and reliable way.
The parties disagree about how to properly characterize
these transactions. The bankruptcy and district courts adopted
the trustee's characterization. The trustee characterizes this
series of transactions as a single "triangular transaction." He
argues that the payments made by the new participants to the
recruiting participants were integral to the economics of the
TelexFree scheme and are best understood as an indirect way for
the new participants to pay TelexFree membership fees and TelexFree
simultaneously to pay the recruiting participants for their
accumulated credits. The concept of one "triangular transaction"
was adopted by the bankruptcy court when it approved the net equity
- 8 - formula, discussed below. It is that formula which the trustee
will use to distribute estate assets to the TelexFree victims.
In contrast, PIEC characterizes the triangular
transaction as three separate transactions. In its view, since
the credits assigned to participants were fictitious and the entire
scheme criminal, the bankruptcy court was required to look to only
the so-called "participant-to-participant payments" between the
new and recruiting participants when analyzing what was an
"interest in property" of the debtor for purposes of both Darr's
avoidance action claims and whether Darr has standing to recover
the Contested Funds. In PIEC's view, the "victims" PIEC represents
who want to exercise their "personal rights" against recruiters
who "pocketed their hard-earned savings" were the persons harmed,
not TelexFree. PIEC wants to recover the Contested Funds through
its unjust enrichment claims, but it does not say it will prove
its claims on an individual-by-individual basis. Rather, it seeks
to prove its claims by reference to the fraudulent scheme.
B. Procedural History
When the scheme collapsed in 2014, TelexFree filed a
voluntary petition for relief under chapter 11 of the U.S.
Bankruptcy Code. Stephen Darr was appointed the trustee of the
jointly administered estates on June 6, 2014.
Darr sought and received two initial rulings from the
bankruptcy court: (1) that TelexFree was a Ponzi and pyramid
- 9 - scheme, and (2) that a "net equity formula" should be used to
calculate TelexFree victims' potential claims. The net equity
formula, which the bankruptcy court approved on January 26, 2016,
divides TelexFree participants into groups of "Net Winners" and
"Net Losers." Only Net Losers will be creditors in the TelexFree
bankruptcy cases.
Under the net equity formula adopted, the unredeemed
credits assigned to participants' user accounts are disregarded,
and all of a participant's user accounts are aggregated. Then,
"the total amount a participant paid, whether to Telex[F]ree or to
a recruiting participant, minus the amount of money that the
participant received, whether from Telex[F]ree or a recruiting
participant, results in the amount of the participant's claim."
"Net Winners," then, are participants who paid less into the scheme
than they got out, including through participant-to-participant
payments. "Net Losers" are those who paid more into the scheme
than they got out. Similar net equity formulas based on the same
"net investment method" have been adopted in other Ponzi scheme
cases. See Donell v. Kowell, 533 F.3d 762, 771-72 (9th Cir. 2008);
Sec. Inv'r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re
Bernard L. Madoff Inv. Sec. LLC), 424 B.R. 122, 125 (Bankr.
S.D.N.Y. 2010), aff'd sub nom. In re Bernard L. Madoff Inv. Sec.
LLC, 654 F.3d 229 (2d Cir. 2011).
- 10 - In 2016, Darr filed two avoidance class actions in the
bankruptcy proceedings against groups of foreign and domestic Net
Winners, respectively, seeking to use preferential or fraudulent
transfer theories under 11 U.S.C. §§ 547 and 548 (collectively,
"Avoidance Actions"). Any recovery from these class actions will
be ratably distributed to all Net Losers.
Separately, in 2014, putative classes of TelexFree
victims, coordinated by PIEC, had initiated lawsuits against
financial institutions, lawyers, leaders of the TelexFree scheme,
and others. Many of these lawsuits have been consolidated into
multidistrict litigation ("MDL") pending in the U.S. District
Court for the District of Massachusetts. Darr did not initially
object to these PIEC lawsuits, but did when two putative classes
of Net Losers, led by Rita Dos Santos, Maria Murdoch, Elisangela
Oliveira, and others (collectively, the "Defendants"), brought
claims for unjust enrichment against the Net Winners of the scheme,
also seeking to recover the Contested Funds.3
In an adversary proceeding in the U.S. Bankruptcy Court
for the District of Massachusetts, Darr sought to enjoin the PIEC
3 The first action was originally filed in district court and was later consolidated into the MDL. Plaintiffs in that action tried to amend the MDL's consolidated complaint to add a claim for unjust enrichment against the Net Winners. The motion to amend was denied. PIEC plaintiffs then filed a second action containing an unjust enrichment claims in district court, separate from the MDL. The court overseeing the MDL stayed the second action as an attempt to circumvent his ruling denying the motion to amend.
- 11 - Defendants, individually and as putative class representatives,
from pursuing their unjust enrichment claims against the Net
Winners. Darr argued that such a claim is an improper attempt to
"control" property of the TelexFree estates in violation of the
automatic stay imposed in bankruptcy proceedings by § 362(a) of
the Bankruptcy Code. The U.S. District Court for the District of
Massachusetts withdrew the reference of the adversary proceeding
to the bankruptcy court but returned the proceeding to the
bankruptcy court to draft "proposed findings of fact and
conclusions of law."
PIEC moved for summary judgment against Darr, contending
that it was not violating the automatic stay because Darr lacked
standing to bring his Avoidance Actions since TelexFree, as a
criminal enterprise, never had a property interest in the Contested
Funds, in contrast to the Net Loser Defendants PIEC represents,
who had suffered direct, particularized harm at the hands of Net
Winners.
Darr filed a cross-motion for summary judgment,
requesting a declaratory judgment that the Contested Funds are
property of the estate and that PIEC's unjust enrichment claims
violate the automatic stay, and, in addition or in the alternative,
an injunction under § 105(a) of the Bankruptcy Code preventing
PIEC from further prosecuting unjust enrichment claims against the
Net Winners.
- 12 - The bankruptcy court, on December 18, 2017, found that
Darr, in his capacity as trustee of the TelexFree estates, has the
requisite property interest under 11 U.S.C. §§ 547 and 548,
rejecting PIEC's argument that the criminal nature of TelexFree's
"business" and TelexFree's lack of actual possession of the funds
meant Darr lacked standing to bring the Avoidance Actions. The
court also found the Defendants' unjust enrichment claims are
derivative of Darr's Avoidance Actions and barred by the automatic
stay provision of the Bankruptcy Code. See 11 U.S.C. § 362(a)(3).
The bankruptcy court recommended granting summary judgment for
Darr, including permanently enjoining the Defendants from further
prosecuting their claims. The district court adopted the
bankruptcy court's proposed findings and entered summary judgment
for Darr, including as to the injunctive relief.
PIEC appeals, arguing that the district court erred in
adopting the bankruptcy court's proposed findings. PIEC makes the
following three arguments, each of which it maintains is
independently sufficient to require a reversal: (1) TelexFree
cannot have had a property interest in the Contested Funds under
§§ 547 and 548 because any such interest would arise from
"unenforceable, illegal contract[s]" with participants; (2) even
if a property interest theoretically could arise from illegal
contracts, TelexFree did not have one because it never had
"physical possession or valid legal control of [the] funds"; and
- 13 - (3) the harm suffered by the Defendants was particularized to them
and not derivative of Darr's Avoidance Actions, so the Defendants'
claims against the Net Winners should not be enjoined or considered
stayed.
II.
The district court, as said, adopted the bankruptcy
court's findings and conclusions and entered summary judgment. We
review a district court's ruling on cross-motions for summary
judgment de novo. Sch. Union No. 37 v. United Nat'l Ins. Co., 617
F.3d 554, 558-59 (1st Cir. 2010).
Because we reject PIEC's arguments, we affirm the
district court's order. We hold that TelexFree had a property
interest in the Contested Funds for purposes of 11 U.S.C. §§ 547
and 548, such that the trustee had standing to bring his Avoidance
Actions. Darr's Avoidance Actions themselves are property of the
estate for purposes of § 362(a)(3), the unjust enrichment claims
are derivative of the Avoidance Actions, and the Defendants are
impermissibly attempting to "obtain possession of" and/or
"exercise control over property of the estate" in violation of the
automatic stay. 11 U.S.C. § 362(a)(3).
A. TelexFree Had an Interest in Property in the Contested Funds Sufficient To Give Darr Standing to Bring His Avoidance Actions
Sections 547 and 548 of the Bankruptcy Code allow Darr
to recover certain "transfer[s] of an interest of the debtor in
- 14 - property." 11 U.S.C. § 547(b); id. § 548(a)(1) (similar).4
"[I]nterest of the debtor in property" is not defined in either
4 Section 547(b), governing preferential transfers, states: (b) Except as provided in subsections (c) and (i) of this section, the trustee may . . . avoid any transfer of an interest of the debtor in property -- (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) made while the debtor was insolvent; (4) made -- (A) on or within 90 days before the date of the filing of the petition; or (B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and (5) that enables such creditor to receive more than such creditor would receive if -- (A) the case were a case under chapter 7 of this title; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title. 11 U.S.C. § 547(b) (emphasis added). Section 548(a)(1), governing fraudulent transfers, states, in relevant part: (a)(1) The trustee may avoid any transfer
- 15 - section. In Begier v. IRS, 496 U.S. 53, 58 (1990), the Supreme
Court explained that "property," for purposes of avoidance actions
such as Darr's, is "best understood as that property that would
have been part of the estate had it not been transferred before
the commencement of bankruptcy proceedings." The Court then looked
to § 541(a)(1) of the Bankruptcy Code for the definition of
"property of the estate." Id. at 59.
Section 541(a)(1) defines "property of the estate" as
including "all legal or equitable interests of the debtor in
property as of the commencement of the case." 11 U.S.C.
§ 541(a)(1). This includes property "wherever located and by
whomever held," id. § 541(a), and both "tangible or intangible
property," S. Rep. No. 95-989, at 82 (1978), as reprinted in 1978
U.S.C.C.A.N. 5787, 5868. The section incorporates interests in
property "made available to the estate by other provisions of the
Bankruptcy Code," including in some instances "property in which
. . . of an interest of the debtor in property . . . that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily -- (A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted . . . . 11 U.S.C. § 548(a)(1) (emphasis added).
- 16 - the debtor did not have a possessory interest." United States v.
Whiting Pools, Inc., 462 U.S. 198, 205 (1983). The definition of
"transfer" is also broad and includes "each mode, direct or
indirect, absolute or conditional, voluntary or involuntary." 11
U.S.C. § 101(54)(D).
Ordinarily, state law creates and defines the underlying
property interests, see Butner v. United States, 440 U.S. 48, 55
(1979), but federal bankruptcy law determines whether those
interests are "property of the estate," see Rine & Rine
Auctioneers, Inc. v. Douglas Cty. Bank & Tr. Co. (In re Rine &
Rine Auctioneers, Inc.), 74 F.3d 854, 857-58 (8th Cir. 1996).
We affirm the district court's finding that TelexFree
had a property interest in the Contested Funds for the purposes of
Darr's Avoidance Actions under both §§ 547 and 548, and therefore
that Darr has standing to bring his claims. The bankruptcy court
carefully evaluated the substance of the TelexFree scheme when it
approved the trustee's net equity formula. The formula recognizes
that membership fees paid directly to TelexFree -- in which
TelexFree indisputably would have had a property interest -- are
functionally the same as membership fees that were paid to
recruiting participants as part of a triangular transaction. Where
membership fees were paid directly to TelexFree, recruiting
participants were compensated with credits which, according to the
terms of the contract, they could redeem for cash at a later point
- 17 - using money generated largely from membership fees. In the
triangular model, new participants gave their membership fees in
cash directly to already-recruited participants.
In both situations, participants engaged in a system
designed and implemented by TelexFree. New participants knew, or
should have known, that the recruiting participant was acting at
TelexFree's behest and that the recruiting participant had no
authority to let a new participant into the TelexFree scheme
unilaterally. On joining the scheme, the new participant received
an invoice and user account from TelexFree. Membership in the
scheme was governed by a contract that TelexFree wrote. The new
participants would have never paid the recruiting participants but
for TelexFree's promise that they could join the scheme.
PIEC argues that such a property interest cannot exist
in a Ponzi scheme like TelexFree because the entire scheme, and
any contracts made pursuant to it, are fraudulent and therefore
void ab initio. The court, it argues, should not enforce an
illegal contract or treat any part of the Ponzi scheme as
legitimate.
This argument fails here. The individual transactions
that make up the triangular transaction at the heart of this case
under the relevant state law are at most voidable, not void. The
bankruptcy court correctly recognized that under Nevada,
Massachusetts, and many other states' laws, fraud in the inducement
- 18 - merely renders a contract voidable.5 Proposed Findings of Fact
and Conclusions of Law, Darr v. Dos Santos, No. 15-04055 (Bankr.
D. Mass. Dec. 18, 2017), ECF No. 98 at 18-19 (citing Bishop v.
Stewart, 13 Nev. 25, 42 (1878); Shaw's Supermarkets, Inc. v.
Delgiacco, 575 N.E.2d 1115, 1117 (Mass. 1991)). And it is
undisputed that none of the participants attempted to void their
membership with TelexFree pre-petition.
In In re Ogden, the Tenth Circuit concluded, as we do
here, that a debtor operating a Ponzi scheme has a property
interest in the form of defeasible, or voidable, title in funds
that were obtained fraudulently from an investor, notwithstanding
the underlying fraud. Bailey v. Big Sky Motors, Ltd. (In re
Ogden), 314 F.3d 1190, 1197-98 (10th Cir. 2002) (applying Utah
law). Other cases conclude the same.6 TelexFree's particular
hybrid business model was unusual, but as the Second Circuit
recognized in In re Bernard L. Madoff Investment Securities LLC
5 "[W]hen the result in a case will not be affected by the choice of law, an inquiring court, in its discretion, may simply bypass the choice." Lexington Ins. Co. v. Gen. Accident Ins. Co. of Am., 338 F.3d 42, 46 (1st Cir. 2003). That is appropriate here, where the parties have not objected to the choice of law. 6 See Merrill v. Allen (In re Universal Clearing House Co.), 60 B.R. 985, 994-97 (D. Utah 1986); Guttman v. Fabian (In re Fabian), 458 B.R. 235, 259-60 (Bankr. D. Md. 2011), aff'd, 475 B.R. 463 (D. Md. 2012), aff'd sub nom. Fabian v. Guttman ex rel. Strategic Partners Int'l, Inc., 491 F. App'x 420 (4th Cir. 2012) (per curiam); Dicello v. Jenkins (In re Int'l Loan Network, Inc.), 160 B.R. 1, 11 (Bankr. D.D.C. 1993).
- 19 - ("Madoff I"), 654 F.3d 229, 238 n.7 (2d Cir. 2011), fraud comes in
many forms.
The district court also correctly rejected the argument
that the doctrine of in pari delicto supports PIEC's position that
the scheme precluded TelexFree obtaining a valid property
interest. In pari delicto is "[t]he principle that a plaintiff
who has participated in wrongdoing may not recover damages
resulting from the wrongdoing." In pari delicto doctrine, Black's
Law Dictionary (11th ed. 2019). PIEC urges us not to "lend [our]
good offices to mediating disputes among wrongdoers." Nisselson
v. Lernout, 469 F.3d 143, 151 (1st Cir. 2006) (quoting Bateman
Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306 (1985)).
Certainly, in pari delicto may sometimes be asserted as
an affirmative defense against a bankruptcy trustee. See id. at
153; see also Official Comm. of Unsecured Creditors of PSA, Inc.
v. Edwards, 437 F.3d 1145, 1151 (11th Cir. 2006) (collecting
cases). But we hold that in pari delicto doctrine does not defeat
Darr's standing to bring avoidance actions.
PIEC advances a distorted definition of Net Winners to
argue that in pari delicto bars TelexFree and its participant
victims from engaging as "co-conspirators to a massive fraud."
They define "Net Winners" as any participant who got more in
participant-to-participant payments than that person gave out.
That definition was properly rejected by the bankruptcy court. It
- 20 - is also inconsistent with the net equity formula that the court
did approve, which includes payments from TelexFree as well as
other participants when calculating who is a Net Winner. Many of
the recruiting participants are themselves victims of the scheme.
Further, PIEC mistakenly relies on the principle that "a
trustee in bankruptcy cannot and does not acquire rights or
interests superior to, or greater than, those possessed by the
debtor." Nisselson, 469 F.3d at 153. For the reasons already
explained, TelexFree had an interest in the Contested Funds.
PIEC separately argues that a defeasible property
interest cannot be created in a Ponzi scheme without the debtor
having physical possession of the funds.7 As described above, the
definition of interest in property for purposes of §§ 547 and 548
was intended by Congress to be broad. The text of §§ 547 or 548
does not say that physical possession is required. 11 U.S.C.
§§ 547-548. To the contrary, it is clear the interest in property
may include property "wherever located and by whomever held." Id.
§ 541(a). And that it includes intangible property. S. Rep. 95-
989, at 82. This argument fails as well.8
7 The bankruptcy court acknowledged that the debtor physically possessed the funds at issue in the cases cited by PIEC in which a court allowed a bankruptcy trustee to bring avoidance actions to recover transferred funds in a Ponzi scheme. None of those cases say that physical possession is a requirement; indeed, none of them involved facts raising the issue. 8 Our understanding of the phrase "interest of the debtor in property" in §§ 547 and 548 accords with the purpose of
- 21 - A contrary holding denying Darr the ability to recover
the funds on the estates' behalf would ignore the economic
substance of the TelexFree scheme. See Pepper v. Litton, 308 U.S.
295, 305 (1939) ("[F]raud will not prevail, . . . substance will
not give way to form, [and] technical considerations will not
prevent substantial justice from being done."). Unless forbidden
by text, we interpret statutes on the assumption that Congress
would not have wanted the form of a transaction to overwhelm its
substance, particularly in the context of criminal, fraudulent, or
sham transactions. See Santander Holdings USA, Inc. v. United
States, 844 F.3d 15, 21-23 (1st Cir. 2016).9
bankruptcy law more generally. See Cunningham v. Brown, 265 U.S. 1, 13 (1924) ("[E]quality is equity, and this is the spirit of the bankrupt law."). Allowing one group of victims to bring its claims first "thwarts the policy of ratable distribution" at the heart of bankruptcy law. XL/Datacomp, Inc. v. Wilson (In re Omegas Grp., Inc.), 16 F.3d 1443, 1451 (6th Cir. 1994) (quotation omitted). 9 We do not address arguments, not made in this case, as to other possible limitations (including timing limitations) on the trustee's avoidance power. We do take note of a comment by Judge Easterbrook: [I]n 1972 the Supreme Court used the phrase "lacks standing" to describe its conclusion that a bankruptcy trustee may not sue on behalf of investors who thought that a third party's acts had injured them and the debtor jointly. Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416 (1972). The Court used the language of "standing" to refer, not to injury, causation, and redressability, the three ingredients of standing, see Steel Co. v. Citizens for a Better Environment, 523 U.S. 83, 102-04 (1998), but to whether Congress had authorized a trustee to pursue a given kind of
- 22 - B. The Defendants' Unjust Enrichment Claims Are Derivative
At summary judgment, the district court granted Darr's
request to enjoin the Defendants from further prosecuting their
unjust enrichment claims based on the finding that such claims
were derivative of Darr's Avoidance Actions and in violation of
the Bankruptcy Code's automatic stay provision. We understand the
bankruptcy court, in performing this derivative analysis, to have
been addressing PIEC's contention that PIEC's unjust enrichment
claims are not an effort to exercise control over or obtain
possession of even the Avoidance Actions within the meaning of
§ 362(a)(3), as Darr had contended before that court. We affirm.
PIEC focuses most of its appeal on undermining Darr's
standing to bring his Avoidance Actions, and then argues as to
this second issue that the Defendants' unjust enrichment claims
cannot be stayed or enjoined as derivative of Darr's claims if
Darr's claims cannot be brought in the first place for lack of
standing. Since we hold TelexFree had a property interest in the
Contested Funds, we affirm the bankruptcy court's finding that
Darr has standing to bring his Avoidance Actions. This resolves
most of PIEC's arguments.
action. Whether a given action is within the scope of the Code is a question on the merits rather than one of justiciability. Grede v. Bank of N.Y. Mellon, 598 F.3d 899, 900 (7th Cir. 2010).
- 23 - Nonetheless, we briefly analyze the meaning of a
derivative claim under § 362. Besides arguing that the unjust
enrichment claims are not derivative, PIEC does not make any
arguments independently challenging the issuance of the injunctive
relief under § 105(a), so we do not engage that issue.
Section 362(a)(3) automatically stays any act to "obtain
possession of property of the estate or of property from the estate
or to exercise control over property of the estate." 11 U.S.C.
§ 362(a)(3). Darr argues that the avoidance causes of action
themselves constitute the "property of the estate" as defined in
11 U.S.C. § 541. PIEC does not argue that such actions cannot
constitute property of the estate. We accept Darr's contention
and do not address alternative theories of what else could
constitute such property. We hold that at least actions under
§§ 547 and 548 can constitute property of the estate. Because
PIEC's arguments for why the trustee lacks standing to pursue the
Avoidance Actions fail, we treat the Avoidance Actions at issue as
property of the estate.10
10 Collier on Bankruptcy explains: There is a conflict regarding whether a trustee's avoiding powers are property of the estate, an issue that arises when a trustee attempts to sell them to a third party. Two courts of appeals have held that avoiding power causes of action (at least those asserted under the strong-arm powers of section 544) are assets of the estate, while Official Committee of Unsecured Creditors of
- 24 - This circuit has long recognized that causes of action
can be property of the estate even though they are not specifically
enumerated in the statute. See Regan v. Vinick & Young (In re
Rare Coin Galleries of Am., Inc.), 862 F.2d 896, 900 (1st Cir.
1988) ("Causes of action belonging to the debtor are included as
property of the estate . . . .").
More recently, we found that this general rule applies
to fraudulent conveyance claims specifically. See Morley v. Ontos,
Inc. (In re Ontos, Inc.), 478 F.3d 427, 431 (1st Cir. 2007) ("It
is well established that a claim for fraudulent conveyance [brought
pursuant to § 544] is included within [§ 541(a)(1)] property.");
see also Cadle Co. v. Mims (In re Moore), 608 F.3d 253, 259-62
(5th Cir. 2010) (recognizing that avoidance claims under § 544 are
property under § 541 and can be sold by the trustee); Briggs v.
Kent (In re Prof'l Inv. Props. of Am.), 955 F.2d 623, 626 (9th
Cir. 1992) (same). Although Ontos dealt with fraudulent transfers
Cybernetics Corp. v. Chinery (In re Cybernetics Corp.)[, 226 F.3d 237, 244-47 (3d Cir. 2000),] is to the contrary. The problem is created because section 541(a)(3) provides that proceeds of the avoiding power causes of action are property of the estate, but there is no corresponding provision with respect to the causes of action themselves. 5 Collier on Bankruptcy ¶ 541.12[4] (Richard Levin & Henry J. Sommer eds., 16th ed. 2018) (footnotes omitted).
- 25 - claims brought under § 544, we think its reasoning extends as well
to other avoidance actions under §§ 547 and 548.
This brings us to the issue of whether PIEC's unjust
enrichment claims are derivative of Darr's Avoidance Actions and
thus an impermissible attempt to obtain possession of or exercise
control over Darr's Avoidance Actions in violation of 11 U.S.C.
§ 362(a)(3). The bankruptcy court ruled the unjust enrichment
claims brought by PIEC are derivative of the trustee's Avoidance
Actions because they seek to accomplish the same thing as the
trustee's actions and to go about it in the same way. That is,
PIEC has admitted that the proposed classes' efforts to prove
unjust enrichment will not focus on any supposed wrongdoing by
individual Net Winners. Rather, PIEC seeks to prove its unjust
enrichment case through the overall fraudulent scheme created by
TelexFree. That is what the trustee seeks to do.
PIEC seeks to undermine this analysis by pointing us to
Caplin and other cases dealing with whether particular causes of
action are best understood as belonging to the estate or individual
creditors in terms of who is injured. See Caplin v. Marine Midland
Grace Tr. Co. of N.Y., 406 U.S. 416, 434 (1972) (finding that a
trustee did not have standing to assert creditors' claims); see
also Steinberg v. Buczynski, 40 F.3d 890, 892 (7th Cir. 1994)
(asking whether the debtor or creditor owned the claim by asking
who was injured). But for the reasons just discussed, under the
- 26 - framework adopted by the bankruptcy court, the unjust enrichment
claims are best understood as avoidance actions in disguise. The
bankruptcy estate as a whole was harmed, not any individual Net
Loser. See Madoff II, 740 F.3d at 91 ("We are . . . wary of
placing too much significance on the labels appellants attach to
their complaints . . . .").
PIEC relies on its understanding of Madoff III, where
the Second Circuit allowed investors in Madoff feeder funds to
settle their lawsuits with these funds over objections by the
Madoff trustee that these suits were derivative of his own
fraudulent transfer actions. 762 F.3d at 209-11. But Madoff III
is easily distinguishable. The claims here, in contrast, do not
attempt to target individual Net Winners because of their own
particular actions but seek to prove the claims through the Net
Winners' membership in the TelexFree scheme. The court in Madoff
III found that "none of [the defendants'] liability to the
plaintiffs depends on the wrongfulness of Madoff's conduct." Id.
at 210. In Madoff III, the court held that a claim alleging that
a third party violated an independent duty owed to the plaintiff
was not derivative of a trustee's claim seeking to avoid a transfer
to that third party. Id. at 209-10. Here, PIEC's claims
- 27 - necessarily compete with Darr's claims; they are not at all
independent.11
Thus, PIEC has failed to show that the district court
erred in concluding, in adopting the bankruptcy court's
recommendations, that the unjust enrichment claims are
"indistinguishable" from Darr's Avoidance Actions. The putative
PIEC classes were harmed in the same way the rest of the TelexFree
Net Loser creditors were harmed: they purchased worthless
membership plans in a fraudulent Ponzi/pyramid scheme.
Because we reject the PIEC Defendants' argument that the
unjust enrichment claims are not derivative of Darr's Avoidance
Actions, we reject their challenge to the bankruptcy court's
conclusion that their attempt to assert unjust enrichment claims
is an attempt to exercise "control" over the Avoidance Actions,
and thus property of the estate, in violation of the automatic
stay. 11 U.S.C. § 362(a)(3). We have dealt with the arguments
PIEC has raised and are not persuaded.
III.
Affirmed. Costs are awarded to Darr.
11We note, also, that the court in Madoff III analyzed the fraudulent transfer claims under § 362(a)(1), not § 362(a)(3) as we do here. In fact, the court cast doubt on whether a derivative analysis would be appropriate under § 362(a)(3). See Madoff III, 762 F.3d at 208. We need not resolve that issue to reject PIEC's argument as meritless.
- 28 -