In Re: Derivium Capital, LLC, No. 12-1518

Decided: May 24, 2013

The Fourth Circuit affirmed the district court’s grant of summary judgment in favor of the defendants following the bankruptcy and collapse of an alleged Ponzi scheme. The court held that the bankruptcy trustee was not entitled to recover securities transfers, cash transfers, nor commissions, fees, and margin interest payments paid to the defendants as fraudulent conveyances under the Bankruptcy code, 11 U.S.C. §§ 544 and 548. The court also dismissed the debtor’s tort claims under the doctrine of in pari delicto.

The trustee’s claims stem from a “stock-loan program” whereby customers transferred stock to the debtor in exchange for three-year non-recourse loans worth ninety percent of the stocks’ market value. The customers of the “stock-loan program” transferred their stocks into the defendants’ brokerage accounts (“Customer Transfers”). The debtor, instead of managing the stocks, directed the defendants to liquidate the stock and used the proceeds to fund its own ventures (“Cash Transfers”).  When the loans matured, customers could either repay the principal loan amount with interest or refinance the loan for an additional term. As a result, the debtor could not meet the obligation to return their customers’ stock when the loans matured, forcing the debtor to file for Bankruptcy. The bankruptcy trustee sought to recover three categories of transactions with the defendant: (1) the Customer Transfers, (2) the Cash Transfers, and (3) certain commissions, fees, and margin interest paid to the defendants. Defendants moved for summary judgment. The bankruptcy court granted summary judgment and the district court affirmed.

On appeal, the trustee first argued that the district court erred in affirming the bankruptcy court’s determination that the Customer Transfers were not “transfers of debtor property” that the trustee could recover under the Bankruptcy code. The Fourth Circuit disagreed. The court found that the debtor’s customers transferred stock directly from their personal accounts into the brokerage accounts of the defendants to be managed by the debtor. Although the debtor directed the customers to make the transfer, the debtor acquired no property right to the customers’ stock when transferred to the defendants. Therefore, the trustee could not recover the customer transfers.

Second, the trustee contended that the district court erred in affirming the bankruptcy court’s grant of summary judgment for defendants on the Cash Transfers claim.  The Fourth Circuit affirmed the lower court’s decision because the defendants were not the “initial transferee” as required by the Bankruptcy Code. The Fourth Circuit applied the “dominion and control” test to determine whether the defendants were an initial transferee.” Under that test, an initial transferee must have legal dominion and control over the property and exercise this legal dominion and control. The court held that, regardless of whether the defendants had the requisite dominion and control over the property, the defendants could not be initial transferees because they exercised no control over the property. Each time the defendant made a Cash Transfer, it acted at the direction and with the consent of the account holder.

Third, the trustee argued that the district court erred in affirming the bankruptcy court’s determination that the defendants’ commissions and fees were protected as “settlement payments” under 11 U.S.C. § 546(e). The trustee submitted that § 546(e) did not protect commissions and, even if it did, the defendants’ commissions were too uncommonly low to be protected. The court disagreed. Congress’ amendments to the Bankruptcy Code in 2006 explicitly cover settlement payments “made to or for the benefit of stockbrokers.” While the court acknowledged that § 546(e) might not protect all commissions, the court found that the commissions in this case qualified as “settlement payments” made to brokers as part of a regular securities transaction. Furthermore, the court found that it was not unusual for defendants to offer steep discounts to customers, such as the debtor, that provided a great deal of business. Therefore, the commissions and fees paid in this case were protected by § 546(e). Additionally, the court held that the margin interest payments to the defendants were protected “margin payments.” The court also rejected the trustee’s argument that the court should adopt an exception under § 546(e) for fraudulent transfers.

Finally, the trustee contended that the district court and the bankruptcy court erred in dismissing its tort claims under the doctrine of in pari delicto.  The Fourth Circuit disagreed. The court defined in pari delicto as “an affirmative defense that precludes a plaintiff who participated in the same wrongdoing as the defendant from recovering damages from that wrongdoing.” As the bankruptcy trustee, the trustee could only assert tort claims that the debtor could bring. Thus, standing in the shoes of the debtor, the trustees claimed were barred by their wrongdoing under the doctrine of in pari delicto. Furthermore, the trustee could not claim the “adverse interest exception” to in pari delicto because the trustee was the debtor’s “sole actor.”

Full Opinion

– Wesley B. Lambert

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