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

On the surface, Irving Picard, the trustee of Bernard L. Madoff Investment Securities LLC (“BLMIS”), had a very good day. Judge Jed S. Rakoff granted Picard’s motion for summary judgment against Fred Wilpon and Saul Katz, the owners of the New York Mets, and their families and affiliated enterprises (the “Wilpon/Katz Group”) with respect to the $83 million of fictitious profits received by the Wilpon/Katz Group in the two year period before the filing of the BLMIS case. At the same time, Judge Rakoff denied the Wilpon/Katz Group’s summary judgment motion that sought to prevent Picard from clawing back any payments other than fictitious profits on the grounds that he could not prove that the Wilpon/Katz Group acted in bad faith in investing in BLMIS. 

The Wilpon/Katz Group can take some comfort, however, from Judge Rakoff’s blunt skepticism regarding Picard’s ability to recover any further amounts. The ruling with respect to fictitious profits was hardly a surprise. In a ruling last September, Judge Rakoff had issued what amounted to a virtually gold-plated invitation when he said, “[T]he Trustee might well prevail on summary judgment seeking recovery of [such] profits.” However, with respect to the $300 million of invested principal that the Wilpon/Katz Group received from BLMIS during the two year period, Judge Rakoff reiterated his earlier expressed doubts in even stronger terms, stating that Picard’s efforts to demonstrate bad faith amounted to “nothing but bombast.” 

The trial is scheduled to begin in two weeks on March 19. At this point, however, a settlement very likely makes sense for both parties. Although Picard has virtually no chance of recovering invested principal, Rakoff is going to allow him to present his evidence with respect to bad faith to a jury. The Wilpon/Katz Group, even if victorious after what will undoubtedly be an embarrassing and widely publicized trial, will thereafter face a lengthy appeal period. Picard has been successful before the Second Circuit, and may very well prevail in his appeal of Judge Rakoff’s earlier ruling from last September that, among other things, reduced the amount of fictitious profits which could be recovered from approximately $295 million. 

The mediation efforts of former Governor Mario Cuomo may yet succeed.

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Irving Picard, the trustee of Bernard L. Madoff Investment Securities LLC (“BLMIS”), and Fred Wilpon and Saul Katz, the owners of the New York Mets, and their families and affiliated enterprises (the “Wilpon/Katz Group”), each submitted their final arguments last week in support of their respective motions for summary judgment. As previously discussed on this site, Judge Jed S. Rakoff’s rulings on the motions could largely resolve this year-long legal battle. 

Judge Rakoff’s decision last September dismissed most of the counts set forth in Picard’s complaint and substantially narrowed the focus of Picard’s adversary proceeding. 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 with deliberate fraudulent intent. 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.

The briefs filed last week showed each side closely adhering to the paths provided by Judge Rakoff in his ruling last year. Rakoff strongly intimated that no value was provided with respect to the $83 million of fictitious profits received by the Wilpon/Katz Group in the two year period before the filing of the BLMIS case, and Picard accordingly contends now that no material facts or valid defenses exist with respect to those payments. On the other hand, Rakoff ruled that the Wilpon/Katz Group’s invested principal clearly did provide “value” to BLMIS, thus requiring Picard to demonstrate a lack of “good faith” in order to recover payments that constituted the return of such principal. The Wilpon/Katz Group argues strenuously that Picard’s mélange of supposed “red flags” fails to approach the standard of “willful blindness” that Judge Rakoff stated must be shown in order to show an absence of good faith. 

Judge Rakoff must find with respect to each motion that there are no genuine factual issues to be determined at a full trial. Picard would appear to have the stronger chance for immediate success here.  Unless Judge Rakoff determines to apply a different legal standard now than he did last year, the issue of fictitious profits looks to be clear and straight forward. On the other hand, the issue of good faith appears to be less susceptible to immediate disposition. While it does not appear that Picard will be able to satisfy Rakoff’s “willful blindness” standard, Judge Rakoff will probably allow Picard to present his evidence to a jury.

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Judge Jed S. Rakoff this week denied the request of Irving Picard, the trustee of Bernard L. Madoff Investment Securities LLC (“BLMIS”), to pursue an immediate appeal of Judge Rakoff’s recent decision to dismiss most of the counts set forth in Picard’s adversary proceeding against Fred Wilpon and Saul Katz, the owners of the New York Mets, and their families and affiliated enterprises (the “Wilpon/Katz Group”). He reaffirmed that the trial on Picard’s claims against the Wilpon/Katz Group will begin on March 19, 2012.   

In his earlier ruling, Judge Rakoff held that the “safe harbor” provisions in Section 546(e) of the Bankruptcy Code limit Picard’s power to recover any transfer from a “stockbroker” that was a “settlement payment” made “in connection with a securities contract”. Crucially, this interpretation of 546(e) only permits a recovery of intentionally fraudulent transfers pursuant to Section 548(a)(1)(A) of the Bankruptcy Code, which has a two-year look back period.  It completely eliminates Picard’s ability to rely on the six-year look back period under New York state law fraudulent transfer provisions, and reduces the maximum amount that Picard could possibly recover from the Wilpon/Katz Group from nearly $1 billion to approximately $384 million.        

In yesterday’s opinion, Judge Rakoff held that Picard had failed to show the necessary “extraordinary circumstances” which would warrant the “interlocutory” appeal and justify the indefinite delay of the pending trial. He directed Picard to wait until after the trial, when “an appellate court will be able to review, on a full record, not just [the] rulings of which the Trustee now complains, but all relevant rulings in this [complicated] proceeding[.]” Judge Rakoff disregarded Picard’s contention that the Second Circuit’s recent opinion, rejecting customer claims based upon Madoff’s fabricated BLMIS account statements, should prevent Ponzi scheme transfers from qualifying for “safe harbor” protection under Section 546(e), because no stocks or securities were actually ever sold. Judge Rakoff noted that the extent of the Wilpon/Katz Group defendants’ knowledge of Madoff’s activities, “one of the key issues in the forthcoming trial,” could be highly relevant to the question of whether transfers made as part of a Ponzi scheme should qualify for “safe harbor” treatment, and that “the factual record thus developed will be useful for assessing [those] issues now raised by the Trustee.”   

Judge Rakoff’s earlier decision also set a very high standard for Picard to meet in order to recover any distributions to the Wilpon/Katz Group other than “fictitious profits”.  As previously discussed on this site, while amounts paid out by BLMIS to investors such as the Wilpon/Katz Group as part of the Ponzi scheme can satisfy the requirement of actual fraud under Section 548(a) of the Bankruptcy Code, under Section 548(c) the Wilpon/Katz Group defendants can defeat Picard’s efforts to recover such distributions to the extent that they can show that they provided value, such as invested principal, in exchange for such distributions. Judge Rakoff has not yet ruled on the key question of how much of the $384 million in aggregate distributions during the two-year look back period should constitute “fictitious profits” and how much should be deemed to be the return of invested principal. He requested the parties to brief this issue following his earlier decision. Insofar as Judge Rakoff noted in the earlier decision that Picard “might very well prevail on summary judgment seeking recovery of the [fictitious] profits”, his ruling on the method for the calculation of such profits will likely be the determinative issue in this case.

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Judge Jed S. Rakoff last week largely sided with Fred Wilpon and Saul Katz, the owners of the New York Mets, and their families and affiliated enterprises (the “Wilpon/Katz Group”) on their motion to dismiss the adversary proceeding brought by Irving Picard, the trustee of Bernard L. Madoff Investment Securities LLC (“BLMIS”). Judge Rakoff’s decision will affect not only this particular lawsuit, but also many of the other lawsuits Picard has commenced seeking the recovery of funds from former investors of BLMIS. (Kelley Drye & Warren LLP represents other Madoff investors who may benefit from this ruling.)  

Judge Rakoff dismissed most of the counts against the Wilpon/Katz Group based on his reading of the “safe harbor” provisions Section 546(e) of the Bankruptcy Code. That section limits a trustee’s powers to recover any transfer from a “stockbroker” that was a “settlement payment” made “in connection with a securities contract” to transfers made with actual fraudulent intent.  Crucially, this interpretation of 546(e) only permits a recovery of intentionally fraudulent transfers pursuant to Section 548(a)(1)(A) of the Bankruptcy Code, which has a two-year look back period. It completely eliminates Picard’s ability to rely on the six-year look back period under New York state law fraudulent transfer provisions. 

The ruling constitutes a huge victory for the Wilpon/Katz Group. In addition to substantially reducing Picard’s potential recovery by reducing the look back period from six years to two years, Judge Rakoff set a very high standard for Picard to meet in order to recover any payments other than “fictitious profits”. As has been widely-publicized, Picard has sought the return of all transfers made from BLMIS to the Wilpon/Katz Group, including those that constituted the return of invested principal, due to a lack of “good faith”, based on the so-called “red flags” that Picard believes should have given the Wilpon/Katz Group reason to suspect Madoff. In Judge Rakoff’s view, however, Picard can only recover payments evidencing a return of principal by showing a lack of good faith tantamount to “willful blindness”.    

Judge Rakoff did leave open one issue that could somewhat mitigate the Wilpon/Katz Group’s victory here. Although the “fictitious profits” they received from BLMIS during the two year look back period totaled $83 million, Rakoff stated in a footnote that he would not resolve “whether the Trustee can avoid as profits only what the defendants received in excess of their investment during the two year look back period . . . or instead the excess they received over the course of their investment with Madoff.” In a separate order issued the following day, directing the parties to set a briefing schedule, he elaborated, “[T]he total of all transfers made during the two-year [look back] period . . . appears to be $386 million. However, it remains an open question whether, in determining what portion of that sum should be considered principal and what portion profits, reference should be made only to that period or should be made to earlier transfers as well.”   

An appeal by Picard is a near-certainty. Even if Picard and the Wilpon/Katz Group reach a settlement, it will affect too many other adversary proceedings brought by Picard for him to let stand. The Second Circuit Court of Appeals recently handed Picard a major victory by rejecting the ability of Madoff investors to rely on the fabricated account statements for the purpose of asserting claims against the BLMIS estate. He will undoubtedly look to try his luck there again.

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Fred Wilpon, Saul Katz, and their families and affiliated enterprises (the “Wilpon/Katz Group”) last week formally requested the dismissal of the adversary proceeding commenced by Irving Picard, the trustee of Bernard L. Madoff Investment Securities LLC (“BLMIS”). In a two hour hearing before U.S. District Court Judge Jed Rakoff, the Wilpon/Katz Group argued that Picard has no basis to seek the return of approximately $1 billion received over the years by the Wilpon/Katz Group from BLMIS. 

Picard’s complaint seeks to avoid all transfers made by BLMIS to the Wilpon/Katz Group as “fraudulent conveyances”, and to recover such amounts on behalf of the BLMIS estate. Both the U.S. Bankruptcy Code and New York State law permit a trustee to recover transfers made up to six years prior to the bankruptcy case by an insolvent debtor for less than “reasonably equivalent value” or which were made with fraudulent intent. However, a “good faith” transferee can retain such property or funds to the extent it gave value to the debtor in exchange for the challenged transfer, such as the satisfaction of antecedent debt.    

The Wilpon/Katz Group argued that “reasonably equivalent value” existed for the $300 million of fictitious profits that the Wilpon/Katz Group received from BLMIS. Since the account statements issued by BLMIS prior to the discovery of Madoff’s fraud evidenced substantial account balances, the Wilpon/Katz Group contends that such payments constituted the satisfaction of antecedent debt as reflected by those statements. Unfortunately for the Wilpon/Katz Group, the U.S. Court of Appeals for the Second Circuit last week squarely rejected the ability of Madoff investors to rely on the fabricated account statements for the purpose of asserting claims against the BLMIS estate, and it is highly unlikely that Judge Rakoff would view the account statements any differently in this context.   

The hearing’s primary focus centered on Picard’s highly aggressive efforts to claw back $700 million of payments that were constituted the return of invested principal. Insofar as invested principal typically constitutes “reasonably equivalent value” or value given in “good faith”, Picard’s efforts turn on whether his many allegations and inferences regarding the so-called “red flags” regarding Madoff’s fraud, which he contends were willfully ignored by the Wilpon/Katz Group, add up to a level of malfeasance or knowledge on the part of the Wilpon/Katz group sufficient to vitiate “good faith”. While Picard seems to have an uphill battle on this issue, a ruling that would allow him to proceed to trial would put immense pressure to settle on the Wilpon/Katz Group. Because Judge Rakoff went ahead and scheduled a March trial date, even though he has expressly reserved his decision on the motion to dismiss, some commentators have taken this as an indication that he is going to allow Picard the chance to prove his allegations that the Wilpon/Katz Group knew or should have known about Madoff’s fraud, thus putting the entire $1 billion at risk for the Wilpon/Katz Group.         

However, a trial may be necessary even if Judge Rakoff rules in favor of the Wilpon/Katz Group with respect to the $700 million. One highly material issue remarkably has received very little attention so far even from the parties themselves; in the briefs filed ahead of the hearing it was addressed solely in footnotes. Of the $300 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 discordant with his allegations about the plethora of “red flags” that the Wilpon/Katz Group supposedly ignored. A ruling by Judge Rakoff directing a trial solely on the amount of fictitious profits which may be recovered would in fact be a favorable outcome for the Wilpon/Katz Group. 

Judge Rakoff probably will not rule until late September. At that time, the Wilpon/Katz Group may be looking at a trial with $1 billion at stake. Picard may just as easily be looking at a trial that would reduce his likely recovery to $167 million. 

Former Governor Mario Cuomo, the mediator appointed in this proceeding, will likely be very busy over the next few weeks.

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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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