Calculating the Winners and Losers in a Ponzi Scheme

In Alberta a recent alleged Ponzi scheme has helped clarify how trust funds deposited into a single bank account should be distributed to creditors.

The Alberta Court of Appeal in Easy Loan Corporation v Wiseman, 2017 ABCA 58 recently upheld an earlier decision directing that when investor funds held in trust are later commingled in one account they should be distributed according to the Lowest Intermediate Balance Rule (LIBR), unless another method of distribution is agreed upon.

Based on the ordinary law of trust, it is necessary to prove that a valid trust existed and that the arrangement had three certainties: certainty of intent, certainty of subject matter, and certainty of object. These attributes are lost when funds that are supposed to be held in trust becomes co-mingled when it is deposited into one general bank account.

In the Ponzi scheme that allegedly deprived investors of over $80 million, the issue circled around a bank account that held around $1 million of investor money. The method as to how to distribute these funds became the subject of the appeal.

Based on recent jurisprudence there are three potential methods  used to trace comingled trust funds deposited into a bank account; (1) the rule in Clayton’s Case, (2) the pro rata approach, and (3) the LIBR approach.

  1. Clayton’s Case is generally known as the “first in, first out rule”, where the first funds to become deposited into a comingled account are the first to come out.
  2. The pro- rata approach divides the balance of the comingled account between the claimants based on the size of their investment.
  3. Under LIBR a claimant can’t trace the investment in a comingled account once the balance of the account drops below the amount of the investment. The beneficiaries are limited to the lowest account following their contribution. The Court decision provided the example below;

Investor X deposits $100 to a comingled account and the account balance later drops to $5, the most Investor X can claim is $5, the lowest balance. The ability to trace anything greater than $5 is lost because anything greater than $5 has come from a funding source other than Investor X.

The Intermediate in the LIBR acronym refers to the period between Investor X’s contribution and the time when X makes the claim. Once the lowest intermediate balance is determined for each party, each party is entitled to claim only the lowest balance‘s proportional share of the remaining balance in the account.

In deciding what method to use the Court’s emphasise the principles of fairness balanced against practicalities as there will be times when the LIBR approach will not be the best method where there are numerous contributors, poor documentation, or the timeframe is long. This case upholds the principles of tracing by finding that the general rule (i.e., LIBR) precludes early investors from unfairly benefitting from the funds of a later investor in a Ponzi scheme.

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Graeme HamiltonGraeme Hamilton, BA (Hons), B.Ed., O.C.T., Analyst — Corporate Recovery & Insolvency. Graeme is an analyst with Crowe Soberman’s Corporate Recovery & Insolvency Group. You can reach him at 416.963.7140.

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