IN RE: TELEXFREE, LLC; TELEXFREE, INC.; TELEXFREE FINANCIAL, INC., Debtors.
RITA DOS SANTOS, individually and as putative class representative; MARIA MURDOCH, individually and as putative class representative; ANGELA BATISTA-JIMENEZ, individually and as putative class representative; ELISANGELA OLIVEIRA, individually and as putative class representative; DIOGO DE ARAUGO, individually and as putative class representative, Defendants, STEPHEN DARR, as Trustee of the Estates of TelexFree, LLC, TelexFree, Inc., and TelexFree Financial, Inc., Plaintiff, Appellee, PLAINTIFFS' INTERIM EXECUTIVE COMMITTEE, Interested Party, Appellant.
FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF
MASSACHUSETTS Hon. Timothy S. Hillman, U.S. District Judge
J. Bonsignore, with whom Lisa Sleboda, Bonsignore Trial
Lawyers, PLLC, William R. Baldiga, James W. Stoll, and Brown
Rudnick LLP were on brief, for Appellant.
B. Murphy, with whom Charles R. Bennett, Jr., Andrew G.
Lizotte, Shawn Lu, and Murphy & King, P.C. were on brief,
Lynch, Selya, and Barron, Circuit Judges.
appeal is from bankruptcy court orders adopted by the
district court arising out of the bankruptcies of TelexFree,
LLC; TelexFree, Inc.; and TelexFree Financial, Inc.
(collectively, "TelexFree"), one of the largest
Ponzi/pyramid schemes in U.S. history. The dispute in this
case is over who will be allowed to seek to recover payments
made by new participants in the scheme to the existing
participants who recruited them (the "Contested
Funds"). Trustee Stephen Darr is attempting to recoup
these Contested Funds through avoidance actions, while
victims represented by the Plaintiffs' Interim Executive
Committee ("PIEC") are asserting unjust enrichment
claims to recover the same sums.
the bankruptcy court's analysis, the district court
stayed the unjust enrichment claims under 11 U.S.C. §
362(a)(3) based on the following findings:
the trustee has standing to bring the avoidance actions
because the Contested Funds were "interests of the
debtor in property" under 11 U.S.C. §§ 547 and
these avoidance actions were themselves "property of the
estate" under 11 U.S.C. § 541; and
the unjust enrichment claims were acts to "obtain"
or "control" property of the estate (i.e., the
avoidance actions) --and thus barred by 11 U.S.C. §
362(a)(3) -- because they are "derivative" of the
avoidance actions under the analyses set forth in the Second
Circuit's Madoff cases. See Picard
v. Fairfield Greenwich Ltd.
("Madoff III"), 762 F.3d 199 (2d Cir.
2014); Marshall v. Picard (In
re Bernard L. Madoff Inv. Sec. LLC)
("Madoff II"), 740 F.3d 81 (2d
Cir. 2014). The net effect of these rulings was to permit the
trustee to pursue the Contested Funds and to stop PIEC's
efforts to pursue those funds.
assess and reject the only arguments that the appellant makes
as to why the bankruptcy court erred in ruling that their
unjust enrichment claims are stayed pursuant to §
362(a)(3). Those arguments, which we reject, are: (1) that
the avoidance action claims are not "property of the
estate" within the meaning of that stay provision
because the bankruptcy court's "standing"
finding is flawed; and (2) that, in any event, the unjust
enrichment claims do not seek to "obtain" or
"control" the "property of the estate"
within the meaning of that stay provision because those
claims are not "derivative" of the avoidance action
claims under the derivative analyses the Second Circuit
employed in the Madoff cases.
affirm, write narrowly, and do not reach other arguments or
potential arguments. We describe below the facts and, more
explicitly, the nature of the dispute between Darr and PIEC.
The TelexFree Scheme
was a hybrid Ponzi and pyramid scheme that operated in the
United States from 2012 until 2014, when its founders were
criminally charged, its operations closed, and it declared
bankruptcy. It is considered one of the largest such schemes
in U.S. history, with approximately $1.7 billion lost and one
million participants, many of them immigrants, defrauded.
material facts are not disputed by the parties. TelexFree
held itself out as a multi-level marketing company that sold
international phone subscription packages. Participants paid
membership fees to join the TelexFree scheme and have the
right to sell phone subscription packages to
others. Each participant, including new
participants, was assigned an online user account by the
company. Many participants had multiple accounts, as they
were encouraged to do by the economic incentives of the
scheme. The participants, for bankruptcy purposes, later were
divided into "Net Winners" and "Net
Losers," important concepts which we explain below.
actual phone subscriptions sold were tangential to
TelexFree's true purpose, like all pyramid schemes.
TelexFree's operations, rather, were geared towards
recruiting new participants into the scheme. New
participants, on signing up, owed a membership fee to
TelexFree. Instead of paying TelexFree, new participants
could pay the existing members directly, and the existing
members could redeem some accumulated "credits" to
settle the new members' obligations to TelexFree. New
participants then themselves often recruited additional
participants into the scheme. Participants who joined early
in the scheme could make significant money from all the
"downstream" participants, while many newer
participants lost money, sometimes their entire life savings.
combined these classic pyramid scheme features with the
features of a classic Ponzi scheme. The company advertised
that participants could receive guaranteed returns on the
money they put into TelexFree, without ever having to sell a
VoIP subscription package or even to sign up a new
participant. To keep up the facade of a legitimate business,
the company required participants to post
commercially-useless internet advertisements.
example, participants who joined the scheme through the
"AdCentral Plan" paid TelexFree $339 -- a $50
membership fee and a $289 contract fee. In return, they were
allowed to sell ten VoIP subscription packages (although they
were not required to) and were required to post one internet
advertisement a day. If the participants met their
advertising quota, they would earn the right to sell another
VoIP subscription package each week. Or, instead of selling
it, they could turn the extra VoIP subscription package back
into TelexFree in exchange for twenty dollars' worth of
credits. In that way, participants could reliably transform a
$339 investment into $1, 040, or a 207% annual rate of
return. Other membership plans had even higher rates of
return. This was not true compensation for labor but was
instead an astronomical guaranteed return on investment, paid
for by newer recruits' membership fees.
there were three main ways to make money through the
TelexFree scheme: selling phone subscription packages,
posting internet advertisements, and signing up new
participants. Often, TelexFree participants were not paid in
cash directly but through digital "credits" that
they, under the terms of their subscription contracts, could
redeem for cash at a later point.
Contested Funds at issue relate to the signing up of new
participants. When an existing participant recruited someone
new into the scheme, TelexFree would send an invoice to the
new participant for the membership fee. One way the new
participant could satisfy the invoice was by paying the
company the membership fee directly, although only about
twelve percent of membership fees were paid that way.
much more common method used was that the new participant
paid her membership fee directly to the participant who
recruited her. TelexFree then would remove from the
recruiting participant's account credits of equal value
to the membership fee that this recruiting participant
retained. TelexFree then considered the new participant's
invoice satisfied and, once annually, issued an Internal
Revenue Service Form 1099 to the recruiting participant for
the value of the credits he redeemed. Existing TelexFree
participants could monetize their accumulated credits this
fast and reliable way.
parties disagree about how to properly characterize these
transactions. The bankruptcy and district courts adopted the
trustee's characterization. The trustee characterizes
this series of transactions as a single "triangular
transaction." He argues that the payments made by the
new participants to the recruiting participants were integral
to the economics of the TelexFree scheme and are best
understood as an indirect way for the new participants to pay
TelexFree membership fees and TelexFree simultaneously to pay
the recruiting participants for their accumulated credits.
The concept of one "triangular transaction" was
adopted by the bankruptcy court when it approved the net
equity formula, discussed below. It is that formula which the
trustee will use to distribute estate assets to the TelexFree
contrast, PIEC characterizes the triangular transaction as
three separate transactions. In its view, since the credits
assigned to participants were fictitious and the entire
scheme criminal, the bankruptcy court was required to look to
only the so-called "participant-to-participant
payments" between the new and recruiting participants
when analyzing what was an "interest in property"
of the debtor for purposes of both Darr's avoidance
action claims and whether Darr has standing to recover the
Contested Funds. In PIEC's view, the "victims"
PIEC represents who want to exercise their "personal
rights" against recruiters who "pocketed their
hard-earned savings" were the persons harmed, not
TelexFree. PIEC wants to recover the Contested Funds through
its unjust enrichment claims, but it does not say it will
prove its claims on an individual-by-individual basis.
Rather, it seeks to prove its claims by reference to the
the scheme collapsed in 2014, TelexFree filed a voluntary
petition for relief under chapter 11 of the U.S. Bankruptcy
Code. Stephen Darr was appointed the trustee of the jointly
administered estates on June 6, 2014.
sought and received two initial rulings from the bankruptcy
court: (1) that TelexFree was a Ponzi and pyramid scheme, and
(2) that a "net equity formula" should be used to
calculate TelexFree victims' potential claims. The net
equity formula, which the bankruptcy court approved on
January 26, 2016, divides TelexFree participants into groups
of "Net Winners" and "Net Losers." Only
Net Losers will be creditors in the TelexFree bankruptcy
the net equity formula adopted, the unredeemed credits
assigned to participants' user accounts are disregarded,
and all of a participant's user accounts are aggregated.
Then, "the total amount a participant paid, whether to
Telex[F]ree or to a recruiting participant, minus the amount
of money that the participant received, whether from
Telex[F]ree or a recruiting participant, results in the
amount of the participant's claim." "Net
Winners," then, are participants who paid less
into the scheme than they got out, including through
participant-to-participant payments. "Net Losers"
are those who paid more into the scheme than they
got out. Similar net equity formulas based on the same
"net investment method" have been adopted in other
Ponzi scheme cases. See Donell v.
Kowell, 533 F.3d 762, 771-72 (9th Cir. 2008);
Sec. Inv'r Prot. Corp. v. Bernard
L. Madoff Inv. Sec. LLC (In re Bernard L. Madoff
Inv. Sec. LLC), 424 B.R. 122, 125 (Bankr. S.D.N.Y.
2010), aff'd sub nom. In re Bernard L. Madoff Inv.
Sec. LLC, 654 F.3d 229 (2d Cir. 2011).
2016, Darr filed two avoidance class actions in the
bankruptcy proceedings against groups of foreign and domestic
Net Winners, respectively, seeking to use preferential or
fraudulent transfer theories under 11 U.S.C. §§ 547
and 548 (collectively, "Avoidance Actions"). Any