Ponzi Schemes: Can Liquidators Claw Back 600% of Payouts?

“MTl's business clearly amounted to an unlawful ponzi-scheme, i.e. a fraudulent investing scam promising high rates of return to investors and generating returns for earlier investors with investments taken from later investors.” (Extract from the MTI judgment)

Recent media reports of the MTI (Mirror Trading International) liquidators making repayment demands of investors highlight once again the dangers of falling for “too good to be true” investment schemes. 

The problem is that by their very nature, all pyramid schemes (including “ponzi” schemes) eventually fail, leaving the vast majority of investors with nothing but the hope of being awarded a partial dividend on their claims when the holding entity is eventually liquidated. 

But what if an investor is one of the “lucky early birds” who got paid out before the scheme’s collapse?

Debunking the “early bird investor catches the worm” myth

A common myth is that the only losers in a collapsed pyramid scheme are those investors who didn’t get their money out in time, and that the “early birds” who did act quickly are winners in the equation.

The problem for them is that liquidators have wide powers to reclaim payouts made to investors (as creditors) before liquidation. The idea is that payouts by definition come from new money paid in by new investors, and that to be fair to them it is necessary to put everything back into the pot for all investors and other creditors to share according to their claims. But of course they only share in what’s left after all the liquidation costs and fees have been settled, and in a large and complex liquidation like MTI’s those costs will be particularly substantial.

The practical issue is that whatever was paid out to investors/creditors – both by way of the original investment and the “profit” on it – is likely to be claimed back by the liquidator. And the investor forced to repay everything is left with nothing but a concurrent claim in the liquidation. 

Of course a liquidator’s prospects of recovery will be boosted if they can obtain a court declaration of unlawfulness of the scheme and invalidity of the investment contracts (as has already happened in the MTI liquidation), but let’s see how that could then play out in practice.

The liquidator’s options for recovery

To summarise the options available to a liquidator in recovering payouts made before liquidation - 

• “Voidable preference”: If the payout was made within six months prior to liquidation and immediately thereafter the company’s liabilities exceeded its assets, it is repayable to the liquidator unless the investor can prove that that the disposition was made “in the ordinary course of business” and without intention to prefer one creditor above another. That could be hard to prove in the case of a pyramid scheme.
  
  
• “Undue preference”: If at any time a payout was made by the company with the intention of preferring one creditor above another, it is repayable to the liquidator if the company’s liabilities exceeded its assets at that stage. In this case, the onus is on the liquidator to prove the intention to prefer, but that may perhaps be easier to prove in a pyramid scheme scenario than in other corporate failure scenarios.
  
  
• “Disposition without value”: Monies paid out to a creditor at any time must be repaid to the liquidator if the company received no “value” in return, subject to – 
  
  
  •  Where the payout was made more than two years prior to liquidation, the liquidator must prove that immediately thereafter the company’s liabilities exceeded its assets. 
    
    
  • But if the payout was made within those two years, the onus switches to the creditor to prove that immediately thereafter the company’s assets exceeded its liabilities. In the case of a pyramid scheme that may be impossible to prove.
    
    
  Note that the creditor in such a case will also generally lose their claim against the company.
  
  
• “Collusive dealing”: If the liquidator can prove that a creditor colluded with the company to pay out monies with the effect of prejudicing creditors or of preferring one creditor above another, the colluder will not only forfeit their claim but can also be ordered to pay in a penalty of up to the same amount. A liquidator could for example try to prove that the investor/creditor was aware of the unlawfulness of the scheme at the time of the payout. 

Even worse, could investors lose a lot more than they put in?

Media reports suggest that an MTI investor, who invested R20,000 and was paid out R21,000 shortly before liquidation, received a demand from the liquidators to repay not just his initial investment and profit, but for 600% of what he put in. The sum claimed (at date of writing) is R122,000, that being the current value of the bitcoin he initially invested – the argument being presumably that what was disposed of was “property” (bitcoin), in which case the liquidators would be entitled to reclaim either the bitcoin or its value at the date the disposition is set aside. The justification will no doubt be that that is what the company and its creditors as a whole have actually lost as a result of the disposition. If our courts agree with that view, being sued for a great deal more than the original investment will be a particular risk when the investment is a volatile asset like bitcoin. 

The High Court has previously declared MTI an illegal and unlawful scheme and all agreements between it and investors unlawful and void, but that of course is only the first step for the liquidators in proving their claims against investors. Media reports suggest that many investors are lawyering up to oppose the claims so we must wait and see how it all plays out in the courts. 

Regardless, the risk of not only losing the original investment but then also having to cough up a great deal more over and above that certainly does fire yet another warning shot across the bows of anyone tempted to invest in any scheme promising unrealistic returns. Prospective investors shouldn’t part with a cent until they confirm that the scheme is actually legitimate.