Distributing Ponzi scheme funds: Court of Appeal provides guidance to liquidators

Articles, Restructuring + Insolvency

In the recent decision of Caron and Seidlitz v Jahani and McInerney in their capacity as liquidators of Courtenay House Pty Ltd (in liq) & Courtenay House Capital Trading Group Pty Ltd (in liq) [2020] NSWCA 117, the NSW Court of Appeal considered the appropriate method for distributing funds in the winding up of two companies in circumstances where the relevant companies administered a Ponzi scheme.

What is a Ponzi scheme?

A Ponzi scheme is a fraudulent scheme whereby investors are typically convinced to invest in a company with the promise of significant, above average returns. In reality, the initial investors receive a return from funds invested by later investors rather than the profits from the sale of the product / services which the company conveys to the investors as its business. The scheme will inevitably collapse when investors demand full repayment of their investment (usually following discovery of the scheme).

Background to these proceedings

Courtenay House Capital Trading Group Pty Ltd (in liquidation) and Courtenay House Pty Ltd (in liquidation) (collectively, CH) sought investment from the public for the ostensible purpose of investing in foreign exchange trading, including a number of “financial products” which sought to make profits leveraging off volatile financial markets caused by events such as the US Presidential election and the Brexit fall-out.

In reality, CH operated a Ponzi scheme whereby it used capital obtained from new investors to pay “returns” to earlier investors (purportedly as returns on the funds invested and repayment of the investment). The Ponzi scheme administered by CH turned over approximately $213 to $248 million, having invested minimal amounts in foreign exchange markets.

The Australian Securities and Investment Commission (ASIC) subsequently obtained ex parte freezing orders over CH’s assets, including ancillary orders restraining CH from conducting business providing financial services. CH’s assets included two bank accounts, one maintained with National Australia Bank and the other with Westpac.

Despite the freezing order obtained by ASIC, investors continued to deposit funds into the Westpac account (being the Appellants to the appeal). The Appellants were split into two classes: those who deposited funds after the freezing order came into effect, but on the same day as a withdrawal of $60,000 was made (described by the Court as the Category E Investors); and those who deposited funds after the freezing orders were made and the $60,000 withdrawal taking place (described by the Court as the Category F Investors). The funds invested by the Category E Investors and Category F Investors were able to be easily identified in the Westpac account due to the timing of those deposits.

Liquidators were subsequently appointed to CH. At the date of the liquidators’ appointment the Westpac account had approximately $21 million. The liquidators applied for orders and directions as to the manner in which they were to distribute the funds to, in summary, the investors who has invested prior to the freezing orders being made (being the Respondents to the appeal) and the Appellants. The Respondents had invested approximately $57 million, whilst the Appellants had invested approximately $475,000.

Decision at first instance

At first instance, Black J held that the funds in the Westpac account were held on separate trusts for the Appellants and Respondents (as either express trusts or as Quistclose trusts), however concluded that there was no basis for distinguishing between the two main classes of investors. In the circumstances, his Honour ordered the funds in the Westpac should be applied pari passu (i.e. rateably by reference to the sums invested by the individual investors).

Issues before the Court of Appeal

The principal issue on appeal was whether an alternative method for distributing the funds in the Westpac account should have been ordered. Specifically, the Court of Appeal was required to consider three possible methods of distribution:

  1. The “first in, first out” method (i.e. the rule established by Devaynes v Noble [1816] 35 ER 767 (Clayton’s Case));
  2. The pari passu basis for distribution, as ordered at first instance; and
  3. The “lowest intermediate balance” rule.

The rule in Clayton’s Case provides a method for distribution whereby the earliest deposits made to the account are presumed to have been the first withdrawn. Given that method largely favours later investors, it has been rejected in Australia in the context of dealing with the interests of parties who have suffered loss as a result of a fraud, breach of trust or incompetent management.

A pari passu distribution will favour earlier investors as it disregards prior withdrawals from the relevant fund which invariably has the result of reducing the quantum of the funds relating to investments made prior to the withdrawals.

The “lowest intermediate balance” rule is somewhat a variation of the pari passu approach. An investor’s share is treated as being rateably reduced whenever there is any withdrawal from the relevant fund. The method reflects the rules of tracing and has regard to accounting realities such as the running account balance of the particular account from which the distribution is to be made. Whilst it has a tendency to favour later investors, this is reflective of the position that the later investors’ funds are unlikely to have been dissipated to the degree of the earlier investors. The principles establishing the rule were summarised in Law Society of Upper Canada v Toronto Dominion Bank (1998) 169 DLR as follows:

“…a claimant to a mixed fund cannot assert a proprietary interest in that fund in excess of the smallest balance in the fund during the interval between the original contribution and the time when a claim with respect to that contribution is being made against the fund.”

The issue with the “lowest intermediate balance” rule however, is the complexity that arises where there are a large number of parties with an interest in a co-mingled fund and there are significant movements in the fund over time (deposits/investments and withdrawals/dividends). In the context of insolvency, the costs of undertaking this calculation may become entirely uncommercial and dissipate the fund entirely.

What the Court of Appeal held

The Court held that the primary judge erred in applying the simple pari passu method of distribution.

Neither CH, the liquidators or the investors (being both the Appellants and Respondents) had a legal interest in the funds in the Westpac account (CH/the liquidators’ interest being a chose in action against the bank, who owed a debt to CH). CH owed equitable obligations to the investors as trustee of the relevant trusts impressed on the funds in the account, which were secured by an equitable charge.

Had all of the investments been received at the one time (or prior to any material withdrawals), adopting a pari passu method for distribution may have been appropriate. In the circumstance of this case, to allow a distribution on a pari passu basis would have the result that the Appellants would effectively be subsidising the Respondents in respect to their loss.

Where the fund is mixed with the monies of multiple investors at different points in time and the fund fluctuated, the Court will characterise the equitable charge as a “rolling charge” the value of which is commensurate to the amount of the investment which remained (which would be calculated by the liquidators tracing those funds utilising reliable evidence that may be available). In those circumstances, the equitable proprietary interest of the relevant investor could be identified.

Where the individual charges are inadequate security where the blended fund has been depleted by earlier withdrawals/distributions, then it will be necessary to calculate any distribution rateably by reference to the interest identified. This is likely to be the common outcome in an insolvency context where liquidators legitimately expend part of the fund, including for the purpose of conducting the tracing exercise/calculation and bringing any application to the Court for directions.

Having regard to the circumstances of this case, the Court of Appeal overturned the decision at first instance ordering that:

  1. the withdrawal of $60,000 was to be deducted pro-rata across all of the Respondents and Category E Investors;
  2. the Category E Investors were entitled to the amount of their investment, less the pro-rata deduction referred to above and any contribution for costs; and
  3. the Category F Investors were entitled to the amount of their investment, less any contribution for costs.


Although the Court of Appeal found that the lowest intermediate balance method was appropriate to apply in these circumstances it indicated that liquidators may be justified and entitled in certain circumstances to distribute on a pari passu basis (e.g. if applying the the lowest intermediate balance method would be fraught with complexities). Given the contentious nature of distributing funds in the context of a fraud or breach of trust insolvency practitioners should always exercise caution and seek directions from the Court.


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