Clawback rulings suggest direction of cases

In what is viewed as a test case in U.S. District Court in Albuquerque, Judge William Johnson ruled against most legal arguments in a motion to dismiss a clawback lawsuit stemming from the Doug Vaughan Ponzi scheme. (Jim Thompson/Albuquerque Journal.)

Prospects for a quick legal victory are disappearing for investors targeted by clawbacks in the Vaughan Company Realtors bankruptcy case.

A series of rulings in federal courts in Albuquerque has brushed aside more than a half-dozen motions to dismiss individual clawbacks, finding that most of the legal arguments justifying the clawbacks are sound enough to go to trial.

In bankruptcy cases, clawbacks are civil lawsuits filed by court-appointed trustees seeking the return of payments made by the debtor before the filing of the bankruptcy petition. In the Vaughan Company Realtors case, clawbacks have a controversial aspect because most defendants are fraud victims.

Many of the defendants appear to fighting the clawback lawsuits on principle. Up to nine of them are fighting maximum clawbacks of less than $20,000, an amount they could end up spending on legal fees as the litigation drags on.

At the opposite end of the spectrum, defendants in three lawsuits face maximum clawbacks of more than $1 million.

Former real-estate executive Doug Vaughan, now serving a 12-year prison sentence, used Vaughan Company Realtors to run a Ponzi scheme that bilked $75 million from upwards of 600 investors. When the scheme collapsed in early 2010, Vaughan and his company filed bankruptcy.

A Ponzi scheme is an investment swindle where money put up by later investors is used to pay fake profits to earlier ones.

Judith Wagner, trustee in charge of the Vaughan Company Realtors bankruptcy estate, launched the clawback campaign as a matter of course or protocol. More than a quarter of the 160 clawbacks that were filed have reached negotiated settlements, according to court records.

In early December, Wagner and her lawyers, James Askew and Edward Mazel, filed a report in Bankruptcy Court that provided data on 84 settlements, covering all types of legal actions as well as out-of-court settlements.

The average settlement amount was $38,449, according to an unofficial analysis of the data. If the six biggest settlements are taken out, the average drops to $21,363.

Last month in what is widely viewed as a test case in U.S. District Court, Judge William P. Johnson ruled against most of the legal arguments in a motion to dismiss the clawback lawsuit against Albuquerque retiree and former Vaughan investor Michael Menke.

The motion to dismiss was spearheaded by Helen Davis Chaitman, a New York City lawyer who has figured prominently in clawback litigation surrounding the bankruptcy liquidation of notorious Ponzi schemer Bernie Madoff’s firm.

Filed in February 2012, the lawsuit against Menke contains 10 counts that cite legal grounds for the return of payments made by Vaughan to Menke going back four years. Five of the legal grounds are in the federal Bankruptcy Code and five are under state law in the New Mexico Fraudulent Transfers Act.

Johnson ruled the Menke lawsuit could proceed on eight of the 10 counts. In essence, he said the legal arguments behind those eight counts were plausible enough to require more fact finding.

The complaint against Menke is typical of complaints filed against most defendants in the clawbacks.

Within a week of the complaint’s filing, Menke’s lawyers exercised a rarely used legal right to have the case transferred from Bankruptcy Court to U.S. District Court. Other lawyers followed suit and eventually just under half of the approximately 125 clawback cases pending at the time wound up in District Court.

Two months later, Menke’s lawyers filed the 37-page motion to dismiss Wagner’s complaint. A majority of the defendants in the 58 clawbacks in District Court joined Menke’s motion to dismiss, making it something of a class-action attempt to nip the clawbacks in the bud.

The motion to dismiss contained a variety of legal defense arguments, many of which had been brought up in clawbacks in the Bernard L. Madoff Investment Securities bankruptcy case in New York City. In simple terms, here’s a sample of the arguments:

♦ The so-called “stockbroker defense” which says Vaughan Company Realtors functioned as a stockbroker selling securities. As a result, or so the argument goes, payments made to investors are protected because they were made to settle a securities contract.

♦ Menke, as well as other defendants in the clawbacks, did nothing to injure Vaughan Company Realtors and thus the trustee has no grounds to sue them.

♦ Vaughan Company Realtors never owned the money put up by investors because Vaughan stole it. Thus the company’s bankruptcy estate has no standing to sue to recover money that the company never had.

♦ Menke, like many other defendants, was not an equity investor in Vaughan Company Realtors but rather an individual lender who lost a substantial amount of money, over $180,000, in the Ponzi scheme.

Not all of the defense arguments were invalidated. Some will eventually be measured against the evidence in the case.

Johnson’s ruling in the Menke case, which was his first in the clawbacks before him, followed along the same legal lines as rulings and opinions by Judge Robert H. Jacobvitz, who is presiding over clawbacks in parallel proceedings in Bankruptcy Court.