Clawback proceedings in bankrupt Ponzi schemes

Canada Publication October 2019

Golden Oaks Enterprises Inc. was advertised as a “Rent2Own” business and promoted to investors as a means to turn a quick profit through short-term loans. In reality, the business was a Ponzi scheme and from 2009 to 2013, 85% of the money collected by Golden Oaks came from investors. The scheme collapsed in July 2013 as Golden Oaks went into receivership.

In 2013, Doyle Salewski Inc. was appointed as receiver, manager, and trustee in bankruptcy of Golden Oaks. During its investigation, Doyle Salewski found that Golden Oaks had made payments to certain individuals in its final year. In 2015, Doyle Salewski brought several lawsuits against creditors, including individuals and companies who received payments from Golden Oaks in 2012 and 2013. These 17 actions were consolidated and heard together.

The court in Doyle Salewski Inc. v Scott, 2019 ONSC 5108 granted claims of unjust enrichment for recovery of usurious interest against most of the defendants as well as statutory claims under sections 95 and 96 of the Bankruptcy and Insolvency Act (BIA) against three defendants.

Key take-aways from the decision include the following:

  • The court referenced the Alberta Court of Queen’s Bench decision in Re Titan Investments Ltd. Partnership (Titan), and the British Columbia Supreme Court’s decision in Boale, Wood & Company Ltd. v Whitmore (Whitmore), in its understanding and analysis of the Ponzi scheme. (We considered the Whitmore decision in a previous legal update.) With reference to Whitmore and Titan, the court found that Golden Oaks, as a Ponzi scheme, was insolvent by definition.

  • Inadequate pleading resulted in many of the preference claims under the BIA being struck. The pleadings did not allege specific preference claims against most of the defendants. Subsequent written submissions and amended pleadings specified claims under s.95 of the BIA, but failed to allege material facts. The court found that the pleadings had only plead a conclusion of law, unsupported by any allegations of material fact, and accordingly dismissed the claims.

  • Section 95(1)(b) of the BIA allows the court to set aside payments made to creditors not dealing at arm’s length. In allowing relief under s.95(1)(b) of the BIA, the court required evidence, such as employment or a consultant relationship with Golden Oaks, awareness of Golden Oaks’ financial situation , and solicitation of funds from investors.

  • Through analyzing the limitation period, the court allowed unjust enrichment claims by Doyle Salewski that arose more than two years before the claim was filed. An important consideration for the court was to separate the interests of the principal of Golden Oaks from those of the company. The court noted that the principal was the only corporate officer and director of Golden Oaks and had no motivation to begin lawsuits on the company’s behalf, as they would expose and end the Ponzi scheme from which he was benefitting. The court found that when Golden Oaks became insolvent, the principal ceased to have unfettered control over it, such that the company could then discover and make the unjust enrichment claims.

Claims against beneficiaries of Ponzi schemes involve complex issues of pleadings, limitations, fraudulent preferences, and equity. Early and focused investigations by a receiver or trustee, followed by skillfully managed claims, are essential to effective recovery in bankruptcy.

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