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

Irving Picard, the trustee overseeing the liquidation of Bernard L. Madoff Investment Securites (“BLMIS”), has filed an amended complaint (the “Amended Complaint”) that seeks to buttress his allegations against Fred Wilpon and Saul Katz, the owners of the New York Mets, and their families and affiliated enterprises (the “Wilpon/Katz Group”). Among other things, the Amended Complaint details an alleged deliberate mischaracterization of a $54 million bridge loan from Madoff to one of the businesses controlled by the Wilpon/Katz Group, and cites the episode as further evidence of supposed wrongful behavior that demonstrates the complicity of the Wilpon/Katz Group in Madoff’s fraudulent activity.  

The Wilpon/Katz Group, in the meantime, in its first legal counter-attack, has filed a motion to dismiss the Amended Complaint (the “Dismissal Motion”). Also, an article in today’s New York Times details the jousting taking place with respect to the massive trove of documentary information gathered by Picard prior to the commencement of the lawsuit.  

The Amended Complaint and the Dismissal Motion reveal flaws and risks that each side faces.

The Amended Complaint seeks the repayment of over $1 billion. However, over $700 million constitutes the return to the Wilpon/Katz Group of invested principal, and Picard’s many allegations and inferences may simply not add up to the level of malfeasance or knowledge on the part of the Mets’ owners that he needs to demonstrate in order to recover those funds. Although a number of bad or grossly negligent actions are alleged, the Dismissal Motion refutes Picard’s factual allegations regarding many of the so-called “red flags” that Picard believes should have given the Wilpon/Katz Group reason to suspect Madoff. Some of Picard’s efforts to show mendacity, such as the $54 million transfer that helped the Wilpon/Katz Group to avoid a delay in closing an important deal and then was immediately repaid, come off on closer examination as somewhat thin gruel (or “bad stuff”, as one fictitious former Mets player might have put it).

In addition, of the remaining $295 million in “fictitious profits” that Picard is looking to recover, nearly $133 million was transferred outside of the six year look-back period. Picard contends that the six year limitation under New York law should not apply because “the fraudulent scheme perpetrated by BLMIS was not reasonably discoverable by at least one unsecured creditor of BLMIS[,]” an argument that seems to be discordant with his allegations regarding the plethora of “red flags” that the Wilpon/Katz Group ignored. 

The Dismissal Motion, on the other hand, while strongly rebutting many of Picard’s allegations, shows the challenge that the Wilpon/Katz Group will have in fending off the demand for the return of $163 million in “fictitious profits” during the six year look-period. The bulk of the legal arguments in the Dismissal Motion raise nearly precisely the same issues that were recently argued before the Second Circuit Court of Appeals on Picard’s method for determining which customers hold claims against BLMIS. The Wilpon/Katz Group forcefully contends again that customers of BLMIS should hold claims based on the fictitious statements furnished to them by BLMIS, rather than being determined by the straight-forward mathematical calculation of invested principal less funds withdrawn. However, Judge Burton Lifland, the U.S. Bankruptcy Court judge overseeing the BLMIS case, has already rejected this argument, and the Second Circuit panel that heard the appeal earlier this month betrayed a fair degree of skepticism.   

The incentives for both sides to work with former Governor Cuomo and reach a settlement remain strong.

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As discussed in previous posts on this site, back in December the Second Circuit Court of Appeals issued a summary order that reversed the bankruptcy court’s confirmation of the reorganization plan (the “Plan”) of DBSD North America, f/k/a ICO North America (“DBSD”). The Court sustained a challenge to the Plan brought by Sprint-Nextel, an unsecured creditor, against the proposed “gift” of value from second lien secured creditors down to DBSD’s equity holder, by-passing holders of unsecured claims. However, it denied the appeal brought by senior secured creditor DISH Network (“DISH”), the holder of all of DBSD’s first lien debt, against its unfavorable treatment under the Plan.  The summary order stated that an opinion would follow “in due course”. (Kelley Drye & Warren LLP represents the agent to the lenders that previously held the first lien debt purchased by DISH, but has taken no part in the litigation over the confirmation of the Plan or the appeals before the Second Circuit).   

The opinion has now come out and has appropriately garnered wide attention. The decision to prohibit the long-standing practice of “gifting” value to a junior class of creditors or interests over the objection of a non-consenting intermediate class will certainly shape the contours of plan negotiations in chapter 11 cases going forward. The determination to uphold the “designation” (i.e., disallowance) of DISH’s vote against the Plan, for its alleged “bad faith” in pursuing a “strategic purpose”, will also affect the purchase and sale of claims for purposes of acquiring control of companies as they emerge from bankruptcy (although this ruling was fact specific and narrowly focused). 

However, the Second Circuit’s opinion is equally important for what it did not say. The bankruptcy court had ruled that because DISH was the sole member of its Plan class and its vote against the Plan was disallowed, the Plan class should be deemed to have accepted the Plan. The bankruptcy court concluded that the Plan therefore did not have to satisfy the cramdown standards of Section 1129(b)(2)(A) of the Bankruptcy Code with respect to DISH. Nevertheless, the bankruptcy court alternatively ruled that the proposed Plan treatment of DISH’s first lien did in fact meet the cramdown standard of Section 1129(b)(2)(A)(iii), by providing DISH with the “indubitable equivalent” of its claim. The Second Circuit, in upholding the bankruptcy court’s decision ruling regarding vote designation, specifically stated that it would not address the bankruptcy court’s alternate ruling that DISH could be crammed down.   

The “indubitable equivalent” standard under Section 1129(b)(2)(A)(iii) allows a debtor to confirm a plan over a secured creditor’s objection so long as it gives the creditor the present value of its secured claim and provides substitute collateral that is of equal value and of no greater risk than its existing collateral.  The first lien debt purchased by DISH was a one year note that paid cash interest, and was secured by all of DBSD’s operating assets plus its only liquid assets -- a portfolio of auction rate securities (the “Securities”). The Plan proposed to provide a new note with a four year maturity, non-cash (i.e., payment in kind (“PIK”)) interest, and liens on all of reorganized DBSD’s operating assets -- but not on the Securities, which are to be used to help fund ongoing operations. In addition to appealing the designation of its Plan vote, DISH argued to the Second Circuit that it could not be forced to accept the heightened risk of a four year note and a diminished collateral package that deprived it of its lien on the Securities with no substitution. 

A ruling by the Second Circuit affirming the cramdown judgment by the bankruptcy court -- a determination that a one year loan facility secured by liquid assets could be replaced under the “indubitable equivalent” standard by a four year PIK facility with non-liquid collateral -- would have had a huge impact in future cases, altering the relative leverage among secured creditors, debtors and junior creditors. The decisions on gifting and designation make DBSD a significant opinion. A ruling on cramdown would have made it a seminal one.

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