Non-Madoff Defendants

The BLMIS Liquidation

On Dec.11, 2008, Bernie Madoff was arrested for his criminal operation of a decades-long Ponzi scheme, through which he and his business, Bernard L. Madoff Investment Securities LLC (BLMIS), defrauded customers of approximately $20 billion. On Dec. 15, 2008, the Securities Investor Protection Corporation commenced the liquidation of BLMIS. Irving Picard is the appointed Securities Investor Protection Act (SIPA) Trustee for BLMIS in proceedings transferred to the United States Bankruptcy Court for the Southern District of New York.

Since his appointment, the SIPA Trustee has brought over 1,000 adversary proceedings to recover money for the benefit of BLMIS's defrauded customers. In those proceedings, the SIPA Trustee has pursued, or is pursuing, preference and fraudulent conveyance avoidance claims under Sections 547 and 548 of the Bankruptcy Code, as well as claims under applicable non-bankruptcy law. See Figures from The Madoff Recovery Initiative, http://bit.ly/1UYzuVY.

To date, the SIPA Trustee has recovered, or reached agreements to recover, $11.079 billion, and has distributed approximately $8.6 billion to defrauded customers holding allowed claims in the liquidation proceeding.

Victims of BLMIS also have sued non-BLMIS parties, including investment funds, advisers and other professionals who allegedly contributed to the damage caused by BLMIS and/or directly caused the victims injury. The SIPA Trustee has sought injunctive relief in some of those actions to prevent interference with his own recovery efforts, facilitate his resolution of claims, and preserve and maximize available funds for recovery.

Recent decisions illustrate the courts' willingness to allow a plaintiff to proceed with claims arising out of particular harm to that creditor, and reluctance to allow a sole plaintiff to pursue claims arising out of injury to the estate as a whole.

Fairfield Greenwich Limited And Merkin Agreements

In August 2014, the U.S. Court of Appeals for the Second Circuit, in Picard v. Fairfield Greenwich Limited, et al., rejected in a single decision the SIPA Trustee's requests to enjoin two separate settlement agreements involving multiple actions.

The first was a December 2008 class action brought on behalf of investors against Fairfield Greenwich Limited, the operator of several financial vehicles, a.k.a. “feeder funds,” that had directed investments to BLMIS, as well as several auditors, administrators and custodians of the funds, alleging securities law, tort and breach of contract claims. After nearly two years of litigation, the parties entered into a settlement agreement involving payment by the defendants of, potentially, $80.25 million. That agreement was presented to the district court for approval in November 2012.

The second settlement agreement arose in separate actions by the New York attorney general and a receiver against Ezra Merkin, his investment company and several feeder funds, alleging breach of fiduciary duties, misrepresentation and fraud, based in part on the defendants' practice of collecting fees for management of investor funds, despite turning the funds and investment decisions over to BLMIS.

Those actions were brought in April 2009 and September 2010. The parties reached a settlement agreement in June 2012, under which the defendants would pay $410 million.

Prior to final approval of the settlement agreements, the SIPA Trustee initiated adversary proceedings in the bankruptcy court, requesting an injunction to avoid interference with fraudulent conveyance claims, in the aggregate of nearly $3.7 billion, that he previously filed against the Fairfield Greenwich Limited and Merkin defendants. The SIPA Trustee argued that the settlement agreements “implicated” property of the BLMIS estate in violation of the automatic stay, SIPA and prior court orders, and should be declared void ab initio; alternatively, the bankruptcy court should exercise its equitable powers under Section 105 of the Bankruptcy Code and issue a preliminary injunction of the settlement agreements; and SIPA preempted the underlying litigation to the extent the litigation or the settlement agreements interfered with the SIPA Trustee's ability to recover funds from the defendants.

Following the court's rejection of those arguments, the SIPA Trustee appealed to the Second Circuit, which held that the SIPA Trustee could not successfully invoke the automatic stay under Section 362 of the Bankruptcy Code or the earlier court orders. Both the automatic stay and those orders enjoined interference only with property “owned, controlled or in the possession of” BLMIS or its estate, and the underlying claims did not fall within the scope of the stay. Rather, they arose out of duties owed directly by the defendants to the plaintiffs, were independent of the SIPA Trustee's fraudulent conveyance claims, and were based on separate facts and legal theories. Unlike the SIPA Trustee's claims, the plaintiffs' claims against the defendants were not dependent on any claim against BLMIS.

Further, while the plaintiffs' claims, and the consummation of the settlement agreements, might have some impact on BLMIS, such impact was not inevitable, and the plaintiffs' claims, therefore, could not be said to be impermissibly “intertwined” with the SIPA Trustee's claims so as to constitute “control over property of the estate.”

Additionally, the SIPA Trustee failed to show that the BLMIS estate was likely to suffer irreparable harm if the injunction were denied and, therefore, an injunction was not warranted. Finally, while recognizing the possibility that satisfying the obligations under the settlement agreements might render the defendants incapable of paying a future judgment awarded to the SIPA Trustee, that mere possibility was insufficient to enjoin or strike the settlement agreements.

The Goldman Actions

On Feb. 17, 2016, the bankruptcy court granted the SIPA Trustee's request for an injunction of the third in a series of class actions filed in Florida District Court. The bankruptcy court's decision was rendered against the backdrop of a prior settlement agreement among the SIPA Trustee and 17 feeder fund defendants (the Picower Parties).

In May 2009, the SIPA Trustee sued the Picower Parties to recover, ultimately, $7.2 billion in alleged preferences and fraudulent conveyances. The parties ultimately entered into a settlement agreement, under which the Picower Parties would pay $5 billion to the BLMIS estate, and would forfeit an additional $2.2 billion to the federal government in settlement of related forfeiture claims.

The settlement agreement provided for a permanent injunction in favor of the Picower Parties, enjoining all BLMIS customers and creditors of the BLMIS estate, and anyone whose claims arise from or are related to the BLMIS Ponzi scheme from asserting any claim against the Picower Parties that is “duplicative or derivative of the claims brought by the Trustee, or which could have been brought by the Trustee,” against the Picower Parties. The settlement agreement was approved by the bankruptcy court, and that decision was affirmed on appeal.

While the appeal was pending, investors A & G Goldman Partnership and Pamela Goldman (the Goldman Parties) sought leave from the bankruptcy court to file to class actions in Florida against the Picower Parties, which request the bankruptcy court denied. The Goldman Parties commenced a second action three months later, and the SIPA Trustee obtained an injunction of that action. The bankruptcy court's Feb. 17, 2016, decision relates to the Goldman Parties' third action against the Picower Parties.

The Goldman Parties alleged that the Picower Parties were “control persons” under section 20(a) of the Securities and Exchange Act with respect to BLMIS, and were therefore jointly and severally liable with BLMIS for violations of Rule 10b-5 of the Act.

As with the two prior instances, the SIPA Trustee filed an adversary proceeding in the bankruptcy court to enforce the permanent injunction under the settlement agreement, arguing that the Goldman Parties' claims were merely derivative of the claims that the SIPA Trustee previously asserted and settled. The bankruptcy court agreed, finding that the Goldman Parties' claims were all derivative of the SIPA Trustee's claims and, therefore, within the scope of the permanent injunction. Derivative claims, the court reasoned, relate to harm committed upon the estate, i.e, “wrongful acts that harmed every BLMIS investor in the same way.”

Non-derivative claims, conversely, are premised on injury that is directly traceable to the third-party-defendant's conduct, and directed at the plaintiff, specially, rather than creditors as a whole. No matter how many times the Goldman Parties tried to restate their claims to “plead around” the force of the permanent injunction, their claims could have been raised equally by any other BLMIS customer.

Pending any petition for writ of certiorari, the court's decision concludes the third attempt by the Goldman Parties since 2011 to sue the Picower Parties directly, and the SIPA Trustee's successful efforts to enjoin those suits. The decision demonstrates the courts' desire, generally, to prevent improper interference with the SIPA Trustee's recovery efforts, where the SIPA Trustee is pursuing claims on behalf of and for the benefit of all injured BLMIS customers as a whole.

John K. Rezac is a partner and business lawyer at Taylor English Duma LLP (Atlanta). Reach him at [email protected].