Bankruptcy trustee's claim for return of money from persons making profit through the business so called "pyramid schemes"

The following shows a case where a bankruptcy trustee for a bankrupt company which had operated a pyramid scheme demanded return of money against members of the business who had received dividends from the bankrupt company.

The lower court judged that the dividend paid by the company to the members were gained under the illegal contract, so it is not possible to demand the return of said money based on Article 708 of the Civil Code.

The Supreme Court, however, affirmed the demand by the bankruptcy trustee, judging as follows: "Under the mechanism of the business, some members made profit based on the losses incurred by many other members. It is impermissible under the principle of good faith to refuse to return said money, by reason that the payment of said dividend constitutes performance of illegal cause"(Judgment by the Supreme Court on October 28, 2014 (website of the Supreme Court)).

Summary of the case

Plaintiff / Appellant / Appellant of final appeal:

X (bankruptcy trustee)

Defendant / Appellee / Appellee of final appeal:

Y (members who received dividends)

Parties involved in a suit:

A (bankrupt company which had operated a pyramid scheme)

From around February 2010, A commenced the business involving contribution and distribution of money (hereinafter called "the business").

The business is the operation of an organization for distribution of money which was designed to appropriate money that has been collected exclusively from newly recruited members for payment of dividends to persons who become members earlier, and it falls within the scope of pyramid scheme provided in Article 2 of the Act on Prevention of Pyramid Schemes.

In March 2010, Y concluded a contract with A to become a member of the Business. Until December 2010, Y paid about 8 million 200 thousand yen to A as contribution under said contract, and received about 29 million 500 thousand yen from the bankrupt company as dividend. In conducting the Business, A recruited at least 4,035 members and received approximately 2,561 million 30 thousand yen in total as contribution from them. In February 2011, A went bankrupt, and X was appointed as the bankruptcy trustee. In the bankruptcy proceedings, persons who incurred losses due to the business account for the majority of the bankruptcy creditors.

X, a bankruptcy trustee of A, claimed payment of the balance between the contribution and the dividend, amounting to about 21 million 500 thousand yen on the ground that the contract between Y and A for the business, different from that between general contract signatories, is illegal and void, and that Article 708 of the Civil Code which states "a person who has tendered performance of an obligation for an illegal cause may not demand the return of the thing tendered" is not applied to the case where a bankruptcy trustee demands debt recovery on behalf of bankrupts.

The judgment in first instance dismissed X's claim on the ground that "payment of the dividend in this case falls under Article 708 of the Civil Code, so refund of the money may not be demanded. It is not possible to claim against Y for a refund even in the case where X, a bankruptcy trustee claims for a refund on behalf of the bankrupt company".

Appeal court decision also dismissed X's claim stating the following reason: "If Article 708 of the Civil Code is not applied to the case where a bankruptcy trustee claims for a refund of the dividend and if the damages of new members can be compensated by the dividend refunded by old members, it will decrease the debt of the bankrupt company which led the business. If so, the bankrupt company which had operated illegal business will be legally protected, which is against the intent of Article 708 of the Civil Code".

X appealed against this decision and claimed that Article 708 of the Civil Code should not be applied even to the case where the dividend was based on the illegal cause if a bankruptcy trustee claims for a refund of dividend.

Reasons

It was determined as follows: "The Dividend was paid to Y in the course of the business which falls within the scope of pyramid scheme in which no person is allowed to be involved, and due to the mechanism of the business, the money that other members contributed was the source of the dividend. A considerable portion of the members of the business incurred losses due to the failure of the bankrupt company, without receiving money that is equivalent to the amount of money they contributed, and they account for the majority of the bankruptcy creditors who have been unable to receive remedies for their damage.

Given such facts, it would serve the principle of equity for X, who is the bankruptcy trustee for the bankrupt company, to seek the return of the dividend from Y and aim for proper and fair liquidation by using the dividend to make distributions through the bankruptcy proceedings to the bankruptcy creditors including those members who incurred losses.

If Y were allowed to refuse to return the dividend to the bankruptcy trustee, this would be equal to endorsing Y retaining unjust profit based on the losses incurred by other members who are victims. Such consequence is far from being considered reasonable.

Consequently, under the abovementioned circumstances, it is appropriate to construe that it is impermissible under the principle of good faith for Y to refuse to return the dividend, by reason that the payment of the dividend constitutes performance for illegal cause.

According to the abovementioned facts, there are grounds for X's claim for payment of the amount equivalent to the dividend, i.e. about 21 million 50 thousand yen, with delay damages accrued thereon".

Explanation

(1) Concept in Article 708 of the Civil Code and problems thereof

If a person who has benefited in bad faith (e.g. under an unfair contract), the benefit is regarded as unjust enrichment under Articles 703 and 704 of the Civil Code. However, Article 708 of the Civil Code states "a person who has tendered performance of an obligation for an illegal cause may not demand the return of the thing tendered". The latter article specifies the Clean Hands Doctrine, under which the nation does not support persons involved in unfair conduct and as a result unfair conduct is expected to be deterred.
While the doctrine does not protect a person who has tendered performance of an obligation for an illegal cause, it virtually helps protect a beneficiary of unjust enrichment in a way. Although the court recognizes that the defendant gained unjust enrichment, the doctrine allows the defendant to gain unjust enrichment by dismissing the demand of plaintiff. Consequently, it is injustice. Although it is appropriate to apply Article 708 of the Civil Code to the distributor of money, it is impermissible to allow unjust enrichment based on the losses incurred by the third party under the principle of good faith. Judgments in the past are split over this point.

(2) Not allowed to claim on behalf of the party concerned

The reference precedent (1) is a case where an action was judged as an offense due to concealment of property under Article 388 of the old criminal code based on the following reason: ""obligee's subrogation right" specified by Article 423 of the Civil Code is the right vested in the obligor to the third party which can be exercised by an obligee. Therefore, an obligee cannot demand those which an obligor cannot demand from the third party". This concept aligns with the judgement in first instance on this article.
Even in the case of subrogation right exercised by an obligee on behalf of an obligor, it is against the principle of good faith that unjust enrichment of beneficiaries is protected based on the losses incurred by obligors who are the third parties as for the illegal contract. It is even more so when beneficiaries gained unjust profit based on the property of the third parties who are victims and there is a close relation between the profit and the losses. With regard to subrogation right, there is no precedent which modifies the judgement of the reference precedent (1).

(3) Exercise of right by a bankruptcy trustee

Exercise of right by a bankruptcy trustee can be considered in the same way. In the case of demand by a bankruptcy trustee (reference precedent (2)), the court denied the restriction in case of right of avoidance stated on Article 708 of the Civil Code based on the following reason: "With regard to those which fall under Article 708 of the Civil Code and may not demand the return under the law, it is not possible to demand the return even by exercising the right of avoidance under the Bankruptcy Act (Article 160 and afterwards)".

(4) Cases where unjust enrichment is closely related with the losses incurred by victims

The reference precedent (3) is a case of demand by a bankruptcy trustee of Toyota Shoji, which is similar to the said case on the point that unjust enrichment was based on the property of victims. The court affirmed the demand for return based on the following reason: "While affirming the return without applying Article 708 of the Civil Code leads to repairing part of the damage incurred by the bankruptcy debtors who are victims, there is no ground that it is impermissible in light of the legislative intent".

Also in the reference precedent (4), the court affirmed demand for return by a bankruptcy trustee based on the right of a bankruptcy trustee on Article 78, paragraph 1 of the Bankruptcy Act, stating that "it should be said that the intent of Article 708 of the Civil Code is not applied in a case where a bankruptcy trustee demands for return on behalf of a bankrupt".

The reference precedent (5) is a case similar to the said case but with a different type of defendant. The court affirmed the demand for return based on the reason same with that of reference precedent (4).

(5) Significance of the said judgement

This judgment can be a reference for similar cases in the future as a precedent where the court judged "Exercise of right by a bankruptcy trustee is not restricted by performance of an obligation for an illegal cause if there is a close relation between the property of victims and the profit of beneficiaries".

Reference precedents

1. Judgment by Daishin-in (present Japanese Supreme Court) on November 21, 1916
   (Page 2250, 22 Shu of Minji Hanketsuroku (exercise of subrogation right))
2. Judgment by Daishin-in (present Japanese Supreme Court) on May 15, 1931
   (Page 327, Vol.10 of Minji Hanreishu (exercise of right of avoidance))
3. Judgment by the Osaka District Court on April 30, 1987
   (Page 166, Vol.38, No.2 of Roudoukankei Minjisaiban Hanreishu (case of inseparable relation))
4. Judgment by the Tokyo District Court on May 23, 2006
   (Page 102, Hanrei Jiho No.1937 (case of inseparable relation))
5. Judgement by the Tokyo High Court on May 31, 2012
   (Page 97, Kinyuhomu Jijo No.1981 (case of inseparable relation, similar case with a different type of defendant))