Bankruptcy Law Insights : Kelley Drye & Warren LLP Bankruptcy and Restructuring Practice Group

Judge Burton Lifland, the bankruptcy judge overseeing the liquidation proceedings of Bernard L. Madoff Investment Securities LLC (“BLMIS”) made a shrewd decision last week in appointing, on his own initiative, former Governor Mario Cuomo to act as mediator in the lawsuit brought by Irving Picard, the BLMIS trustee, against Fred Wilpon and Saul Katz, the owners of the New York Mets, and their families and affiliated enterprises (the “Wilpon/Katz Group”). 

Judge Lifland has a history of acting on his own to bring highly regarded individuals in to mediate seemingly intractable situations. Many years ago, for example, he asked former Secretary of State Cyrus Vance to step into the Macy’s chapter 11 case. Bringing in a neutral party of Cuomo’s stature at this early stage can only help tone down the rhetoric on both sides and perhaps get a derailed settlement process back on track. 

A review of the 365 page complaint filed by Picard, unsealed last week after its contents were leaked to the news media, makes clear the enormous complexity of the case and the risks facing both sides. 

Although enormous media attention has focused on Picard’s efforts to seek recovery of at least $300 million in “fictitious profits” and perhaps as much $1 billion for amounts withdrawn from BLMIS by the Wilpon/Katz Group, only $162 million represents fictitious profits over the six years prior to the bankruptcy case – the maximum “look back” period. Even if Picard is able to prove fully his allegations regarding the willful disregard by the Wilpon/Katz Group of the red flags concerning BLMIS, it would be an aggressive (and questionable) expansion of the fraudulent transfer provisions of the Bankruptcy Code and New York State law to recover any fictitious profits or other withdrawals going back more than six years. 

For the Wilpon/Katz Group, on the other hand, the possible turnover of hundreds of millions withdrawn from BLMIS constitutes only part of its exposure. As Picard’s lawyers begin conducting discovery in earnest in anticipation of trial, the full costs will be staggering -- both in terms of legal fees, and the time and attention that will be required of so many individual members of the Wilpon/Katz Group to the detriment of other interests. In addition, the inner workings of the Wilpon/Katz Group’s businesses will be fully exposed. As embarrassing as the disclosures in Picard’s complaint doubtless have been to Wilpon and Katz, they are likely only a portion of what would be revealed during the course of full blown litigation.           

Accordingly, both sides have strong incentives to settle, rather than have this case proceed to trial. Moreover, with a case docket that includes some of the largest and most complex bankruptcy cases in the country, such as Blockbuster, JudgeLifland in all likelihood was not relishing the prospect of a single trial tying up his courtroom for the better part of several weeks at a minimum. The appointment of former Gov. Cuomo serves everyone’s interests here.

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Fred Wilpon, the owner of the New York Mets, was a close friend of Bernie Madoff, and it has been generally believed since the outset of the scandal that Wilpon, his family and affiliated enterprises lost hundreds of millions in the great Ponzi scheme. It has also been known that the Wilpon group was a so-called “net winner”, as it had collectively withdrawn more over the years from Bernard L. Madoff Investment Securities LLC (“BLMIS”) than it had invested, and it has been expected that Irving Picard, the BLMIS trustee, would seek to recover the difference – an amount believed to be in the tens of millions -- on behalf of the BLMIS bankruptcy estate as a “fraudulent conveyance”. (Kelley Drye & Warren LLP represents other Madoff investors from whom recovery is being sought.) However, as has been widely reported over the past several days, the Wilpon group could be at risk for much more. While the details remain unclear because of the “sealing” of the trustee’s lawsuit, it appears that Picard is seeking to recover hundreds of millions withdrawn from BLMIS by the Wilpon group, rather than simply the difference between such withdrawn amounts and the invested principal.     

Courts going back centuries have permitted the avoidance of transfers made by a debtor with the intent to “delay, hinder or defraud” creditors. Section 548(a) of the Bankruptcy Code allows a trustee to avoid transfers made up to two years prior to the commencement of the bankruptcy case, if made either with deliberate fraudulent intent, or made while the debtor was insolvent and for which the debtor received less than “reasonably equivalent value” in return. Picard can also recover transfers made up to six years prior to the bankruptcy under New York State law.     

However, the rights of a good faith transferee are recognized and protected under Section 548(c). That section provides that a transferee “that takes for value and in good faith” may retain the property transferred to it “to the extent that such transferee . . . gave value to the debtor in exchange” for such transfer. “Value” is defined under the Bankruptcy Code to include the “satisfaction or securing of a present or antecedent debt[.]” 

Amounts paid out by BLMIS to investors over the many years of the Ponzi scheme satisfy the requirement of actual fraud under Section 548(a) of the Bankruptcy Code. Under Section 548(c), investors can defeat a trustee’s efforts to recovery such distributions to the extent that they can show that they provided value in exchange for such distributions, and capital deposited in an investment fund constitutes antecedent debt. The key issue for the Wilpon group is whether or not it invested money in BLMIS “in good faith”. Since there is virtually no chance that Fred Wilpon had any actual knowledge of Madoff’s scheme, the question will turn on whether, under the totality of the circumstances, Wilpon and the Wilpon group somehow “should have known” about Madoff’s fraudulent activity.    

Were there sufficient “red flags” that ought to have alerted a sophisticated investor such as the Wilpon group? In view of the close relationship between Madoff and Fred Wilpon, Picard clearly believes that the Wilpon group will be unable to satisfy the “good faith” element of Section 548(c), and thus will have no defense to the recovery of all moneys withdrawn during the six year look back period.

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