48 F.

3d 470
32 Collier Bankr.Cas.2d 1786, 26 Bankr.Ct.Dec. 944

In re HEDGED-INVESTMENTS ASSOCIATES, INC.,

Debtor.
Harvey SENDER, Trustee, Appellee,
v.
The NANCY ELIZABETH R. HEGGLAND FAMILY TRUST,
and Radoy W.
Heggland, Appellants.
No. 94-1027.

United States Court of Appeals,

Tenth Circuit.
Feb. 13, 1995.

Bruce E. Rohde (John W. Himmelmann with him, on the briefs) of Davis

& Ceriani, P.C., Denver, CO, for appellants.
Melody Lavonne Dawson (John Wasserman with her, on the brief) of
Katch, Sender & Wasserman, P.C., Denver, CO, for appellee.
Before BRORBY, McWILLIAMS and EBEL, Circuit Judges.
BRORBY, Circuit Judge.

The Nancy Elizabeth R. Heggland Family Trust and Radoy W. Heggland

(referred to collectively as the "Heggland Trust") appeal the district court's
decision affirming the bankruptcy court's determination that a payment made to
the Heggland Trust by Hedged Investments Associates, Inc., was void as a
preference. We have jurisdiction under 28 U.S.C. Sec. 158(d), and affirm.

BACKGROUND1
2

This case arises from an investment "Ponzi" scheme2 perpetrated by James

Donahue and his wholly-owned corporation, Hedged Investments Associates,
Inc. (HIA), via three limited partnerships: Hedged Investments Associates, LP;

Hedged Securities Associates II, LP; and Hedged Securities Associates, LP

(HSA). The essence of the scheme was to attract investors by guaranteeing
substantial returns from stock options trading. Mr. Donahue paid "profits" to
earlier investors with the investment capital of later investors, publicly
reporting false earnings as "proof" of his success. Despite making some
profitable trades, Mr. Donahue and HIA amassed approximately $136 million
in trading losses over the thirteen year life of the scheme. From 1977 until the
scheme's collapse in August 1990, Mr. Donahue and HIA fraudulently enticed
1,636 investors to place their funds with him. The bankruptcy files indicate that
1,373 people have filed proofs of claims in excess of $400 million. Actual cash
losses by investors in the scheme are approximately $200 million.
3

According to Leslie Patten, plaintiff's expert witness, all investor funds and
lender funds were deposited into and paid out of HIA's bank account. Mr.
Patten testified that HIA had the only bank account of any of the "Hedged
Investment entities." He opined there was no way to trace the funds which were
paid out of HIA's account to individual investors or limited partnerships. HIA
did not allocate net trading gains or losses to investors.

James Collins, defendants' expert witness, testified that Mr. Donahue's books
and records were not reliable since all funds from the limited partnerships were
commingled in the same account. Mr. Donahue admitted all of the funds from
all of the investors had been commingled into HIA's account.

In August 1986, the Heggland Trust invested $200,000 in a limited partnership

known as JDB Group II, whose name was later changed to BCD Group, LP.
This limited partnership was one of a number of "sub-limited" partnerships
formed for the purpose of investing in HIA's various limited partnerships. In
this case, JDB Group II was to use the funds invested by the Heggland Trust to
purchase limited partnership interests in HSA.

In May 1990, the trustee for the Heggland Family Trust, Mr. Radoy W.
Heggland, requested the investment be liquidated. On June 9, 1990, HIA issued
a check from its account payable to "BCD Group--FBO Nancy Heggland
Family Trust," in the amount of $50,000. Mr. Heggland testified he negotiated
the check, and that it cleared on June 18 or 19, 1990.

On August 30, 1990, HIA filed a voluntary petition under Chapter 11 of the
Bankruptcy Code. On September 7, 1990, the case was converted to a Chapter
7 petition and Harvey Sender was appointed Trustee. This adversary proceeding
is one of more than 180 such cases commenced by the Trustee to avoid and

collect preferential payments, avoidable transfers, and overpayments of limited

partners' capital accounts. The Trustee's complaint asserted a claim under 11
U.S.C. Sec. 547 to recover the $50,000 payment made to the Heggland Trust
within ninety days of HIA's bankruptcy petition on the grounds the transfer was
a preference. Alternatively, the complaint stated a claim under 11 U.S.C. Sec.
548(a)(2) to recover amounts paid to the Heggland Trust as a fraudulent
transfer.
8

Trial to the bankruptcy court was held May 3, 1993. The court entered
judgment in favor of the Trustee on the preferential transfer claim.
Additionally, the court rejected the defenses raised by the Heggland Trust.
Specifically, it held the Trustee was not collaterally estopped from contending
the Heggland Trust was a creditor of HIA and that the operations of HIA and
the limited partnerships should be considered separate. Finally, the court
rejected the Heggland Trust's argument that the transfer occurred in the
ordinary course of business and is therefore immune from recovery under 11
U.S.C. Sec. 547(c)(2). The district court, sitting as an appellate court, see
Fed.R.Bankr.P. 8013, affirmed, and this appeal followed.3

In reviewing a district court's decision affirming the decision of a bankruptcy

court, this court will not disturb the bankruptcy court's findings of fact unless
they are clearly erroneous; however, conclusions of law are reviewed de novo.
In re Reliance Equities, Inc., 966 F.2d 1338, 1340 (10th Cir.1992).

DISCUSSION
A. COLLATERAL ESTOPPEL
10

The Heggland Trust first argues the Trustee should be collaterally estopped
from relitigating the issue of HIA's solvency at the time of the transfer.4 In
support, they rely on Sender v. Johnson, Adversary Proceeding No. 91-1795
SBB (Bankr.D.Colo., Oct. 6, 1992). In Sender, the bankruptcy court concluded
HIA and the limited partnerships were a single operation and the investors were
limited partners. However, the court also held the operation's obligations to the
investors, on account of their equity contributions, did not constitute debt. Thus,
the court concluded the HIA operation was not insolvent and the Trustee's Secs.
547 and 548 claims should fail. The Heggland Trust argues the bankruptcy
court erred in refusing to apply the doctrine of collateral estoppel and reaching
the merits of the Trustee's claims.

11

Assuming, arguendo, the bankruptcy court erred in refusing to apply collateral

estoppel, subsequent events have rendered that error moot. After the

commencement of this appeal, the United States District Court for the District
of Colorado reversed Sender. Sender v. Johnson, No. 92-C-2287 (D.Colo. Sept.
6, 1994). As such, there is no longer any "final decision on the merits" as
required to apply the doctrine of collateral estoppel. See Clough v. Rush, 959
F.2d 182, 187 (10th Cir.1992).
12

The Heggland Trust maintains, however, the reversal of Sender does not change
the fact that the bankruptcy court erred in refusing to apply collateral estoppel
because at the time the court's decision was handed down, Sender was good
law. While perhaps technically correct, Timberlake v. Southern Pac. Co., 420
F.2d 482 (10th Cir.1970) (per curiam), elucidates the practical fallacy of this
argument.

13

In Timberlake, the appellant sought to quiet title in certain lands under a theory
of abandonment. The trial court dismissed the action as subject to the rule of res
judicata on the basis of two state court decisions that had rejected appellant's
claims. Id. at 483. Prior to perfecting the appeal before this court, the New
Mexico Supreme Court reversed one of the lower state court judgments and
held the question of abandonment was not to be regarded as res judicata. Id.
Thus, we held, "[i]t follows that the premise of the federal district court's
judgment is no longer valid under state law and that the judgment must be
vacated and the cause remanded for further consideration in light of the
judgment and opinion of the New Mexico Supreme court." Id.

14

As in Timberlake, the prior decision that the Heggland Trust would have bind
the bankruptcy court is no longer valid. Thus, if the district court had relied on
Sender, we would be compelled to reverse that decision because it would be
based on invalid law, and remand the case for further proceedings. Those
proceedings would, of course, require consideration of the merits of the
Trustee's claims as they would no longer be subject to the rule of collateral
estoppel. The fact the bankruptcy court refused to apply collateral estoppel and
passed on the merits of those claims illustrates the fallacy of the Heggland
Trust's argument. The allegation of error concerning application of the doctrine
of collateral estoppel is rendered irrelevant as no final judgment exists.

B. SECTION 547(b) CLAIM

15

The Heggland Trust argues the bankruptcy court erred in concluding the
$50,000 transfer was a preference under 11 U.S.C. Sec. 547(b), and therefore
voidable. The Heggland Trust maintains the monies received were not the
property of the estate of HIA, but of the limited partnerships.5 More
specifically, the argument rests on the conclusion that the monies deposited

with HIA by the limited partnerships created a trust under Colorado law, and as
such, did not constitute the property of HIA but remained that of the limited
partnerships.
Section 547(b) provides:
16 Except as provided in subsection (c) of this section, the trustee may avoid any
(b)
transfer of an interest of the debtor in property-(1) to or for the benefit of a creditor;
17
18 for or on account of an antecedent debt owed by the debtor before such transfer
(2)
was made;
(3) made while the debtor was insolvent;
19
(4) made-20
(A) on or within 90 days before the date of the filing of the petition; or
21
22 between ninety days and one year before the date of the filing of the petition, if
(B)
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-23
24

(A) the case were a case under chapter 7 of this title;(B) the transfer had not
been made; and

25

(C) such creditor received payment of such debt to the extent provided by the
provisions of this title.

26

The bankruptcy court determined the elements of Sec. 547(b) were met. This
conclusion hinged on its finding that the monies invested via the limited
partnerships were the property of HIA. While the Heggland Trust argues the
entirety of the bankruptcy court's Sec. 547(b) analysis is erroneous, it takes
issue only with the finding that the funds held by HIA were the property of
HIA.

27

The Heggland Trust argues that under Colorado law, when property held by a
general corporate partner of a limited partnership or partnerships is commingled
with the general partner's property, all of the property is presumed to be
partnership property held in trust for the partnerships. Thus, the Heggland Trust
concludes that all of the money in HIA's bank account was held in trust by HIA

for HSA and the other limited partnerships, and unless the Trustee proved some
of it belonged to HIA, it should be deemed trust property.
28

"It is beyond peradventure that, as a general rule, any party seeking to impress a
trust upon funds for purposes of exemption from a bankrupt estate must
identify the trust fund in its original or substituted form." First Federal of
Michigan v. Barrow, 878 F.2d 912, 915 (6th Cir.1989); see also, Cunningham
v. Brown, 265 U.S. 1, 11, 44 S.Ct. 424, 426, 68 L.Ed. 873 (1924); In re Mahan
& Rowsey, Inc., 817 F.2d 682, 684 (10th Cir.1987); Rosenberg v. Collins, 624
F.2d 659, 663 (5th Cir.1980); In re Cardian Mortgage Co., 122 B.R. 255, 259
(Bankr.E.D.Va.1990); In re Dobbs, 115 B.R. 258, 271 (Bankr.D.Idaho 1990).

29

When property of the estate is alleged to be held in trust, the burden rests upon
the claimant to establish the original trust relationship. He must prove his title,
identify the trust fund or property, and where the fund or property has been
mingled with the general property of the debtor, the claimant must sufficiently
trace the property.

30

....

31

Once the trust relationship has been established, one claiming as a cestui que
trust thereunder must identify the trust fund or property in the estate, and, if
such fund or property has been mingled with the general property of the debtor,
sufficiently trace the trust property. If the trust fund or property cannot be
identified in its original or substituted form, the cestui becomes merely a
general creditor of the estate....

32

4 Collier on Bankruptcy, p 541.13, at 541-76 to 79 (15th ed. 1994) (footnotes

omitted). See also Elliott v. Bumb, 356 F.2d 749, 753 (9th Cir.), cert. denied,
385 U.S. 829, 87 S.Ct. 67, 17 L.Ed.2d 66 (1966); Sonnenschein v. Reliance Ins.
Co., 353 F.2d 935, 937 (2d Cir.1965); In re Independent Clearing House Co.,
77 B.R. 843, 854 (Bankr.D.Utah 1987) (holding, in the context of a Ponzi
scheme, that "when a debtor obtains money by fraud and mingles it with other
money ... the money is 'property' of the debtor within the meaning of sections
547 and 548 of the Code"). This principle holds true regardless of whether the
funds are held in an express or constructive trust. In re Bullion Reserve of N.
Am., 836 F.2d 1214, 1217 n. 3 (9th Cir.), cert. denied, 486 U.S. 1056, 108 S.Ct.
2824, 100 L.Ed.2d 925 (1988).

33

It is undisputed that the commingling of all the invested funds by HIA has
made it impossible to trace any of those funds. Thus, even if the Heggland

Trust is correct in asserting that a trust was created under Colorado law, it
cannot claim trust funds of the bankrupt estate because there is no way to trace
those funds. We conclude, therefore, the bankruptcy court did not err in finding
the $50,000 transfer to the Heggland Trust constituted a preference and is thus
avoidable under Sec. 547(b).
C. SECTION 547(c)(2) DEFENSE
34

Finally, the Heggland Trust argues the $50,000 transfer occurred in the
ordinary course of business between HIA and its limited partnerships, and is
therefore immune from recovery under 11 U.S.C. Sec. 547(c)(2)(B). We are not
persuaded.

35

Section 547(c)(2) creates one of a number of exceptions to the general

avoidance provision of Sec. 547(b). Section 547(c)(2) provides:

(c) The trustee may not avoid under this section a transfer-36
....
37
(2) to the extent that such transfer was-38
39

(A) in payment of a debt incurred by the debtor in the ordinary course of

business or financial affairs of the debtor and the transferee;

40

(B) made in the ordinary course of business or financial affairs of the debtor
and the transferee; and

41

(C) made according to ordinary business terms[.]

42

The purpose of this section is to leave undisturbed normal financial relations,

because doing so does not detract from the general policy of the preference
section to discourage unusual action by either the debtor or his creditors during
the debtor's slide into bankruptcy. See 11 U.S.C.A. Sec. 547 at 141. "This
section is intended to protect recurring, customary credit transactions that are
incurred and paid in the ordinary course of business of the debtor and the
debtor's transferee." 4 Collier on Bankruptcy, p 547.10 (15th ed. 1991).

43

Several courts have considered applicability of the ordinary course of business

defense in the context of a Ponzi scheme. The Trustee urges we adopt the rule
of the Ninth Circuit holding the defense does not apply to transfers made in the

course of a Ponzi scheme. E.g., In re Bullion Reserve, 836 F.2d at 1219

("transfers made in a 'Ponzi' scheme are not made in the ordinary course of
business" (footnote omitted) (citing Graulty v. Brooks, 819 F.2d 214, 216-17
(9th Cir.1987)); accord Wider v. Wootton, 907 F.2d 570, 572 (5th Cir.1990)
(holding Sec. 547(c)(2) does not apply in the context of a Ponzi scheme, relying
exclusively on ninth circuit precedent); In re Montgomery, 123 B.R. 801, 81415 (Bankr.M.D.Tenn.1991) (same); In re American Continental Corp., 142 B.R.
894, 900 (D.Ariz.1992) (same); In re Baker & Getty Fin. Serv., Inc., 88 B.R.
792, 799 (Bankr.N.D.Ohio 1988) (same); In re Southern Indus. Banking Corp.,
87 B.R. 524, 525 (Bankr.E.D.Tenn.1988) (same).
44

The Heggland Trust argues we should reject this line of authority on the
grounds that prohibiting application of the ordinary course of business defense
for all transfers made in the course of a Ponzi scheme cannot be squared with
either the terms or purposes of Sec. 547(c)(2). We agree.

45

The authorities cited above adopt the bright line rule that because " 'Congress
intended the ordinary course of business exception to apply only to transfers by
legitimate business enterprises,' " In re American Continental, 142 B.R. at 900
(quoting In re Bullion Reserve, 836 F.2d at 1219), the exception has no
application in the context of a Ponzi scheme. Strikingly, however, none of those
cases cite any language or legislative history in support of this proposition.
Rather, it appears to us that this bright line rule has developed solely from
precedent which does not support it.

46

In re American Continental cites In re Bullion Reserve which in turn cites

Graulty for the bright line rule. The holding of Graulty, apparently the first case
to adopt the rule, is based on two bankruptcy cases: In re Independent Clearing
House Co., 41 B.R. 985 (Bankr.D.Utah 1984), and In re Western World
Funding, Inc., 54 B.R. 470 (Bankr.D.Nev.1985). Neither of those cases
supports the proposition that transfers made in the course of a Ponzi scheme
cannot be protected by the ordinary course of business exception. On the
contrary, In re Independent Clearing House, specifically holds:

47

While "ordinary course of business" is not expressly defined in the Bankruptcy

Code, it appears that the purpose of Section 547(c)(2) was to protect from
preference liability ordinary trade credit transactions that are kept current,
including payment of monthly utility bills.... Congress found in Section 547(c)
(2) a means to protect normal financial relations between the debtor and its
creditors.

48

....

48

....

49 is clear that Congress did not intend to protect one group of investors in a
[I]t
"Ponzi" scheme over the rest.
50

Id., 41 B.R. at 1014 (emphasis added, citations omitted). Likewise, Western

World held that Sec. 547(c)(2) could not be applied to fraudulent investment
and repayment transactions for "[t]o apply (c)(2) to immunize these activities
'would lend judicial support to "Ponzi" schemes by rewarding early investors at
the expense of later victims.' " In re Western World Funding, 54 B.R. at 481
(emphasis added) (quoting In re Independent Clearing House, 41 B.R. at 1004).

51

Thus, the precedent relied on by the Ninth Circuit in Graulty and its progeny do
not support the sweeping rule that Sec. 547(c)(2) has absolutely no application
in the context of a Ponzi scheme. Rather, that precedent supports only the
narrower proposition that transfers to investors are not entitled to the ordinary
course of business exception. This narrower rule is not based, however, on the
grounds that Congress did not intend to cover illegitimate businesses under Sec.
547(c), but on the grounds that transfers to investors in a Ponzi scheme are not
transfers made "according to ordinary business terms." 11 U.S.C. Sec. 547(c)
(2)(C). The ordinary business terms of investment companies does not include
payment of fraudulent "profits" to early investors that those investors did not
earn, but are made possible only by the investments of later investors--the sine
qua non of a Ponzi scheme. Thus, the literal terms of Sec. 547(c)(2)(C)
preclude application of the ordinary course of business defense to transfers
made to investors in the course of a Ponzi scheme.

52

In contrast, none of the provisions of Sec. 547(c)(2) preclude its application to

transfers made to noninvestor-creditors in the ordinary course of business and
according to ordinary business terms. Moreover, the purposes of Sec. 547(c)(2)
clearly are served by permitting its application to noninvestor-creditors whose
transfers are received in the ordinary course of business. Again, the purposes of
Sec. 547(c)(2) are to leave undisturbed normal financial relations, because
doing so does not detract from the general policy of the preference section to
discourage unusual action by either the debtor or his creditors during the
debtor's slide into bankruptcy, see 11 U.S.C.A. Sec. 547 at 141, and to protect
recurring, customary credit transactions that are incurred and paid in the
ordinary course of business of the debtor and the debtor's transferee. 4 Collier
on Bankruptcy, p 547.10 (15th ed. 1991). If, for instance, a Ponzi scheme uses
telephone services, is billed for that service, and pays the phone company,
disallowing the avoidance of that payment following a bankruptcy petition is
consistent with the purposes of Sec. 547. In addition, it is consistent with the
over arching purpose of the preference provision to avoid a creditors'-rush to

the bank to dismember a debtor as it slides into bankruptcy. In re Independent

Clearing House, 77 B.R. at 870. Because such a transfer would be according to
ordinary business terms as well as in the ordinary course of business, it would
be defensible against a preference avoidance action.
53

In sum, we reject the rule of the Ninth Circuit that any transfers made in the
course of a Ponzi scheme cannot be made in the ordinary course of business
under Sec. 547(c)(2). Transfers made to noninvestor-creditors, in the ordinary
course of business and according to ordinary business terms, may be protected
from preference avoidance under Sec. 547(c)(2). Because the $50,000 transfer
to the Heggland Trust was a transfer to an investor in a Ponzi scheme, however,
that transfer was not made according to ordinary business terms and thus,
cannot be defended under Sec. 547(c)(2).

CONCLUSION
54

The $50,000 transfer to the Heggland Trust was a preference under Sec. 547(b)
and did not occur in the ordinary course of business. Consequently, we
AFFIRM the district court's affirmance of the bankruptcy court's decision
permitting the Trustee to avoid the transfer to the Heggland Trust.

Both parties have failed to include citations to the record in their briefs when
laying out the underlying facts of this case in violation of Fed.R.App.P. 28(a)
and 28(e), and 10th Cir.R. 28.1. Those facts are, however, undisputed. Nearly
all of the facts in the following section have been taken from the bankruptcy
court's opinion

A "Ponzi" scheme, as that term is generally used, refers to an investment

scheme in which returns to investors are not financed through the success of the
underlying business venture, but are taken from principal sums of newly
attracted investments. Typically, investors are promised large returns for their
investments. Initial investors are actually paid the promised returns, which
attract additional investors
In re Independent Clearing House Co., 41 B.R. 985, 994 n. 12 (Bankr.D.Utah
1984) (citations omitted).

The district court affirmed the bankruptcy court's decision without a written
opinion. Although the district court's order dismissing the appeal indicates that
oral conclusions of law were made at the end of oral arguments, that portion of
the record has not been provided to this court. As such, we refer to the

bankruptcy court's decision as the one under review in this proceeding

4

More specifically, the Heggland Trust maintains:

[T]he Trustee should be estopped from [relitigating the issue] that HIA, Inc.
[was] an investment pool composed of it and the Hedged Limited Partnerships
[that] was solvent at the time of the subject transfer [because] if the investment
pool would be split apart, and if HIA, Inc. and the Hedged Limited Partnerships
were to be viewed separately, then they received the property of the Hedged
Limited Partnerships--not HIA, Inc.--and that the Hedged Limited Partnerships
were solvent at the time of the transfer....

Thus, the Heggland Trust argues the applicable date of filing for bankruptcy
for determining whether the transfer was received within ninety days of that
filing is that of the limited partnerships. HIA filed its petition for bankruptcy
protection on August 30, 1990. The first petition in bankruptcy filed on behalf
of a limited partnership occurred on September 28, 1990. Thus, the trust argues
the transfer took place 111 days before the applicable filing date. It concedes
that the transfer occurred within ninety days of HIA's filing