In a significant victory for former Georgia football coach Jim Donnan, a Bankruptcy Judge has ruled that the evidence at trial did not support a finding that Donnan knowingly participated in a fraudulent Ponzi Scheme. The case is Fennell v. Donnan, Adv. No. 11-3088, 2013 Bankr. LEXIS 3110 (Bankr. M.D. Ga. August 1, 2013) (Judge Smith) (click here for Opinion). After a trial, the United States Bankruptcy Court for the Middle District of Georgia has held that the plaintiff failed to carry her burden in proving that a debt owed by former Georgia football coach Jim Donnan was non-dischargeable in his Chapter 11 Bankruptcy case.
The Plaintiff is the administrator of the estate of Dr. Stephen S. Fennell, and investor in Global Liquidation Company, or Global Liquidation Center (“GLC”). GLC, which filed a Chapter 11 petition in the Southern District of Ohio, was operated as a classic Ponzi Scheme with investment funds used to pay phantom returns to previous investors (see prior post on GLC and Donnan). For several years Donnan was allegedly the primary person responsible for raising fund for GLC, and he and his family were among the most successful “investors.” Donnan also received over $2 million in commissions for raising money for GLC. Fennell, a successful surgeon, was a golf buddy of Donnan and was persuaded by Donnan to invest money in GLC. GLC, as with any such scheme, ultimately collapsed and filed its Chapter 11 petition. Donnan and his spouse subsequently filed a Chapter 11 petition in the Middle District of Georgia (Case No. 11-31083). In May 2011, Dr. Fennell passed away.
On October 27, 2011, Plaintiff, on behalf of the Fennell estate, filed her complaint objecting to the dischargeability of the claim of $427,5005 which Dr. Fennell’s estate allegedly held against Donnan (click here for Complaint). Plaintiff sought to bar discharge of the claim on the grounds that the claim was incurred as a result of false pretenses, false representation or actual fraud (11 U.S.C. § 523(a)(2)(A)), embezzlement (§ 523(a)(4)) and willful and malicious injury § 523(a)(6)).
The Court, after a multi-day trial, held that the Plaintiff failed to prove her case under a preponderance of evidence standard.
Plaintiff contends that Donnan acted with intent to deceive when he made representations to Dr. Fennell about investing in GLC for the purpose of purchasing inventory when Donnan knew that GLC was operating a Ponzi scheme. However, there was no direct evidence introduced at trial to show that Donnan had prior knowledge of the Ponzi scheme. Donnan testified that he did not learn that Crabtree was funding investor repayments from later investments until October 2010, when Crabtree made the confession to Donnan and other investors. There was no direct evidence to contradict Donnan’s testimony.
The Plaintiff argued that Courts have uniformly held that the mere existence of a Ponzi Scheme establishes fraudulent intent for purposes of 11 U.S.C. §548 (fraudulent transfers). However, the Court stated that “Plaintiff has not cited, nor has this Court found, any case where a court has held that proof of the existence of a Ponzi scheme is sufficient to supply the required fraudulent intent under section 523(a)(2)(A) where the debtor has not admitted, or been found by the court, to have knowingly participated in the scheme.” For purposes of dischargeability, the fraud of a third party is not imputed to the debtor except in limited circumstances not applicable in this case. See Schweig v. Hunter (In re Hunter), 780 F.2d 1577, 1579 (11th Cir. 1986).
To “punish” a debtor who has not knowingly participated in a fraud would be contrary to the purposes of the bankruptcy laws. Accordingly, the Court rejects Plaintiff’s argument that proof of the Ponzi scheme alone, without proof of Donnan’s knowing participation therein, is sufficient to supply the element of intent required under section 523(a)(2)(A).
The Plaintiff also failed in her argument that Donnan should have known about the Ponzi Scheme.
Donnan testified at trial that he was not familiar with the purchase and sales aspect of the business. Rather, when he first started investing in GLC, he simply followed the lead of [friend and successful GLC investor Maurice] Koury and Koury’s financial officer, who was conducting due diligence. In addition, several investors testified that they had conducted their own investigation of GLC and thereafter met with [GLC Founder Greg] Crabtree and Donnan to discuss expanding the GLC business. One of these investors, who had considerable experience in the inventory liquidation business, testified that the high rates of return being realized on the GLC investments were not out of line with returns that he had obtained in his own business. Further, in early 2010, Donnan had accompanied Crabtree and another investor to Las Vegas to a convention involving the liquidation business at which over 7,000 people were in attendance. They met with a representative of a large national retailer who discussed with them deals that he had done with Crabtree and discussed possible future deals. They also observed Crabtree negotiating several deals for the purchase and sale of inventory. All of this information led not only Donnan, but several sophisticated and successful businessmen to believe that GLC was a legitimate business. Accordingly, the evidence does not establish that Donnan should have known of the Ponzi scheme or acted with reckless disregard for the truth.
The Plaintiff also failed to carry her burden under section 523(a)(4) (embezzlement), as the evidence was undisputed that the invested funds were never in Donnan’s possession or control. Finally, because the Court determined that Plaintiff failed to establish that Donnan knowingly participated in the Ponzi scheme, the Plaintiff’s claim under section 523(a)(6) (willful or malicious injury), also failed.
For the above-stated reasons, the Plaintiff’s Complaint was dismissed with prejudice. Unfortunately, not all is well with Donnan, as he was earlier indicted for participating in the GLC Ponzi Scheme.