In re Llp

• Decision Date: 16 June 2011
• Docket Number: Adversary No. 10–03524 (MG).,Bankruptcy No. 09–15051 (SMB).
• Citation: 452 B.R. 391
• Parties: In re DREIER LLP, Debtor.Sheila M. Gowan, Chapter 11 Trustee of Dreier LLP, Plaintiff,v.The Patriot Group, LLC, et al., Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

452 B.R. 391

In re DREIER LLP, Debtor.Sheila M. Gowan, Chapter 11 Trustee of Dreier LLP, Plaintiff,

v.The Patriot Group, LLC, et al., Defendants.

Bankruptcy No. 09–15051 (SMB).

Adversary No. 10–03524 (MG).

United States Bankruptcy Court, S.D. New York.

June 16, 2011.

Diamond McCarthy LLP, By: Howard D. Ressler, Esq., New York, NY, J. Benjamin King, Esq. (argued), Dallas, TX, Stephen T. Loden, Esq., Houston, TX, Attorneys for Sheila M. Gowan, Chapter 11 Trustee for Dreier LLP.Wachtell, Lipton, Rosen & Katz, By: Emil A. Kleinhaus, Esq. (argued), United States Department of Justice, United States Attorney's Office, By: Matthew L. Schwartz, Esq. (argued), New York, NY, Attorneys for Defendants The Patriot Group, LLC, The Washington Special Opportunities Fund, LLC, and The Washington Special Opportunities Fund, Inc.Klestadt & Winters, LLP, By: Tracy L. Klestadt, Esq. (argued), Brendan M. Scott, Esq., New York, NY, Attorneys for Official Committee of Unsecured Creditors.

MEMORANDUM OPINION AND ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTIONS TO DISMISS

MARTIN GLENN, Bankruptcy Judge.

Before the Court is a motion to dismiss filed by The Patriot Group, LLC, The Washington Special Opportunity Fund, LLC and The Washington Special Opportunity Fund, Inc. (collectively, “Patriot” or “Defendants”) asserting that the complaint fails to state a claim upon which relief can be granted pursuant to Federal Rule of Civil Procedure (“Rule”) 12(b)(6), made applicable by Federal Rule of Bankruptcy Procedure (“Bankruptcy Rule”) 7012 (the “Motion to Dismiss”). Pursuant to the actual and constructive fraudulent conveyance provisions of §§ 544, 548(a), 550 of the Bankruptcy Code (the “Code”) and various sections of New York Debtor and Creditor Law ¹ (the “NYDCL”), the chapter 11 trustee, Sheila Gowan (“Gowan” or the “Trustee”) seeks to avoid and recover prepetition transfers by Dreier LLP to the Defendants in the course of the Ponzi scheme perpetrated by Marc Dreier.²

Among the recent spate of frauds and Ponzi schemes, the crimes of Marc Dreier (“Dreier”) stand out as among the most brazen. Dreier built a successful 200–plus lawyer firm based in New York—Dreier LLP (“Dreier LLP” or the “Debtor”)—unique in that he was the firm's sole equity partner. Dreier's fraud shared much in common with frauds of other corrupt lawyers who have stolen client funds deposited in their law firm's bank accounts, although the amount of stolen client funds was very large.³ But what sets Dreier apart, perhaps in a class of his own, is the Ponzi scheme he developed, as his thirst for cash and need to cover-up earlier thefts increased, by selling bogus forged promissory notes of one of his firm's corporate clients, Solow Realty Development Corp. (“Solow”), to supposedly-sophisticated hedge funds (the “Solow Note” or “Notes” or “Solow Notes”). Solow is a privately-held real estate development and investment firm based in New York which had no knowledge of Dreier's fraud.

Over the course of several years Dreier succeeded in selling over $700 million in bogus Solow Notes with maturities of approximately one year or less at allegedly above-market interest rates.⁴ The new Solow Note investors wired funds to purchase the Notes to Dreier LLP, which deposited the funds in the firm's account entitled “Dreier LLP Escrow Account” with the last four digits of “5966” (the “5966 Account”). It is undisputed that the 5966 Account contained commingled funds from firm clients, Note investors and law firm operating revenue. Marc Dreier controlled deposits and withdrawals from the 5966 Account, and used the funds in the account at will to pay for his lavish lifestyle, to fund the operations of his law firm, when necessary, and to make payments to earlier clients and Note investors whose funds he had earlier stolen from the 5966 Account. The scheme fell apart when Marc Dreier was arrested in Canada for impersonating another client in an effort to raise additional funds needed to prevent his scheme from unraveling when currently-due obligations could not be paid. Shortly after Dreier's arrest, Dreier LLP was forced into bankruptcy, and a chapter 11 trustee, Sheila Gowan, was appointed. An involuntary chapter 7 bankruptcy was also commenced against Marc Dreier personally, and a chapter 7 trustee was appointed.

On May 11, 2009, Dreier was convicted upon his guilty plea to a multi-count federal indictment and sentenced to 20 years in prison. Additionally, upon his criminal conviction, a civil forfeiture order was entered, not only forfeiting Marc Dreier's personal assets, but also assets of Dreier LLP, including any funds in the 5966 Account.

The Trustee has commenced numerous adversary proceedings, including the three cases that are pending before me.⁵ The Dreier LLP chapter 11 case and the Marc Dreier chapter 7 case, as well as numerous other avoidance actions, are pending before my colleague Judge Stuart M. Bernstein. The defendants in the cases before me are hedge funds that purchased bogus Solow Notes.⁶ The defendants in the Patriot and Amaranth cases are so-called “net winners,” having been repaid the full amount of principal and interest on the Notes before the scheme unraveled; the defendants in the Novator and Xerion cases are so-called “net losers,” having been repaid some but less than the full amount of the principal on the Notes. The Trustee sued the defendants in the Patriot, Novator and Xerion cases on actual and constructive fraudulent conveyance avoidance claims under both federal and New York law to recover the transfers from the 5966 Account repaying principal and interest; in the Amaranth case, because the challenged transfers occurred more than two years before the chapter 11 filing, the Trustee sued the defendants only under New York law because of the longer statute of limitations. The defendants in the four cases moved to dismiss the complaints, raising mostly the same arguments. The Court entered a common briefing and argument schedule, heard argument on the motions to dismiss on April 5, 2011 (the “Hearing”), and took the motions under submission.

Two potentially case-dispositive issues are raised in these cases: (1) whether the forfeiture order, entered by the district court in Marc Dreier's criminal case upon his guilty plea, had the effect of forfeiting all funds in the 5966 Account, or traceable to the account, including the funds transferred to the defendants before the forfeiture order was entered, thereby precluding the Trustee from recovering the payments to defendants because, as a result of the forfeiture, the funds were not “property of the debtor,” an essential element under federal and state avoidance claims; and (2) whether the defendants' deposits into the 5966 Account and the funds repaid to the defendants from the 5966 Account were held by Dreier LLP in an “express trust,” precluding the Trustee from recovering the payments because funds held in an express trust are not “property of the debtor”? Additionally, the defendants' motions to dismiss raise other arguments, some common to all three cases and some specific to the individual cases.⁷

This opinion addresses the two potentially case-dispositive issues and the additional common arguments, as well as the case-specific issues in this case. The motions to dismiss in the other two cases are resolved in separate opinions that incorporate this opinion, to the extent applicable, and address case-specific issues raised in each of those cases.

For the reasons explained below, the Court denies the motions to dismiss with respect to the two potentially case-dispositive issues, and grants the motions in part and denies the motions in part with respect to the common arguments and the case-specific issues in this case. As explained, the forfeiture order issue raises only an issue of law, resolved against the defendants in this opinion, and therefore foreclosing the issue to defendants as the cases proceed. The “express trust” issue, however, raises mixed questions of fact and law that cannot be resolved on the motions to dismiss, and must await further developments in these cases.

As to the common issues among the defendants, the Court reaches the following conclusions: First, the “Ponzi scheme presumption” applies to the transfers made to defendants during the course of Dreier's fraud sufficient to state a claim for actual fraudulent conveyance under § 548(a)(1)(A) of the Bankruptcy Code. Second, to state a claim for actual fraudulent conveyance under NYDCL § 276, the Court concludes that the Trustee has adequately pled the fraudulent intent of the transferor and need not plead the fraudulent intent of the transferee—“mutual fraudulent intent” is not necessary. Third, as to the claims for constructive fraudulent conveyance under § 548(a)(1)(B) of the Bankruptcy Code, the Court concludes that the complaints are dismissed as to the repayment of principal because the Trustee concedes that such repayment extinguished a common law claim, such as restitution, that defendants may have had against the estate; however, the claims for constructive fraudulent conveyance under the Bankruptcy Code are permitted to go forward as to the repayments in excess of principal because the Debtor did not receive “reasonably equivalent value” for such transfers. Fourth, as to the claims for constructive fraudulent conveyance under the NYDCL, the Court concludes that the Trustee's concession that the repayment of principal satisfied an antecedent debt precludes, as a matter of law, avoidance of such transfers; under controlling law, whether the defendants lacked “good faith,” an indisputably thorny inquiry, is not an issue under the NYDCL where the transfers satisfied a valid antecedent debt. Fifth, the Trustee may seek recovery of the repayments in excess of principal because the Debtor did not receive “fair equivalent” value for the transfers. Sixth, consideration of the defendants'...