Picard v. Katz

• Decision Date: 27 September 2011
• Docket Number: No. 11 Civ. 3605 (JSR).Adversary No. 10–05287.,11 Civ. 3605 (JSR).Adversary No. 10–05287.
• Citation: 462 B.R. 447,55 Bankr.Ct.Dec. 133
• Parties: Irving H. PICARD, Plaintiff, v. Saul B. KATZ, et al., Defendants.
• Court: U.S. District Court — Southern District of New York

462 B.R. 447

55 Bankr.Ct.Dec. 133

Irving H. PICARD, Plaintiff,

v.Saul B. KATZ, et al., Defendants.

No. 11 Civ. 3605 (JSR).Adversary No. 10–05287.

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

Sept. 27, 2011.

Fernando A. Bohorquez, Jr., David J. Sheehan, Baker & Hostetler LLP, New York City, NY, for Plaintiff.

Dana Meredith Seshens, Karen E. Wagner, Davis Polk & Wardwell L.L.P., New York, NY, for Defendants.

OPINION AND ORDER

JED S. RAKOFF, District Judge.

Pending before the Court is the motion of defendants Saul B. Katz, et al., made pursuant to Fed. R. Bankr.P. 7012(b) and Fed.R.Civ.P. 12(b)(6), to dismiss the Amended Complaint filed against them on March 18, 2011, by Irving H. Picard (the “Trustee”), who was appointed under the Securities Investor Protection Act (“SIPA”), 15 U.S.C. §§ 78aaa et seq., to liquidate the business of Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC (“Madoff Securities”).¹ In a “short and plain statement” ² of 373 pages, the Amended Complaint seeks to recover over a billion dollars from the defendants on theories of actual fraud, constructive fraud, preferential transfer, and the like, in violation of various provisions of federal bankruptcy law and New York State debtor and creditor law. For the following reasons, the Court dismisses all claims except those alleging actual fraud and equitable subordination and narrows the standard for recovery under the remaining claims.

Although this lawsuit raises important and in some respects unsettled issues of the interaction of securities law with bankruptcy law, given the public interest in this case it is well to begin with the basics. A debtor with assets less than its obligations is considered insolvent in the eyes of the law and may apply for, or be forced into, bankruptcy. See generally, Bankruptcy Code, 11 U.S.C. §§ 101 et seq. Issues then arise regarding whether prior payments made by the debtor can be, in effect, rescinded—or, in the language of bankruptcy law, “avoided”—and the money returned (“clawed back”) to the bankrupt's estate, from where it can be distributed among creditors in accordance with legal and equitable principles of bankruptcy law.

Some of the avoided payments may take the form of “preferences.” If, prior to the bankruptcy filing, the bankrupt transfers some or all of its remaining assets to some of its creditors in preference to the other creditors, this transfer, known as a “preference,” may be “avoided”—regardless of the facial validity of the transfer or the intent of the parties to the transfer—if it occurred within 90 days of the filing for bankruptcy. See 11 U.S.C. § 547(b). The idea is that, while an ongoing business may freely decide which of its creditors to pay first, an insolvent business cannot be allowed to deplete its remaining assets in favor of one creditor over another.

Other avoided payments may take the form of “fraudulent transfers.” For example, if an insolvent debtor intentionally seeks to defraud his creditors—as when a debtor who has a huge judgment filed against him intentionally seeks to hinder recovery by transferring all of his assets to a friend—the transfer can be avoided as an actually fraudulent transfer. See 11 U.S.C. § 548(a)(1)(A). Still other transfers can be avoided as “constructively fraudulent,” i.e., as fraudulent in effect, even if not in intent. Thus, if the insolvent debtor, regardless of intent, transfers his remaining assets to his friend in return for plainly inadequate consideration, that transfer can be avoided as “constructively fraudulent.” See 11 U.S.C. § 548(a)(1)(B).

Under the Bankruptcy Code, fraudulent transfers (whether actual or constructive) can be avoided if they occurred within 2 years of the bankruptcy filing. 11 U.S.C. § 548(a)(1). But the Bankruptcy Code also adopts for these purposes the “applicable [state] law,” see 11 U.S.C. § 544(b)—which means in this case New York Debtor and Creditor Law, under which fraudulent transfers can be avoided if they occurred within 6 years of the filing. See N.Y. C.P.L.R. § 213(8).

In the case of the bankruptcy of Madoff Securities, however, these basic principles are affected by several special features. First, Madoff Securities was a registered securities brokerage firm, a fact that directly invokes certain “safe harbor” provisions of the Bankruptcy Code, permits the appointment of a SIPA Trustee, and indirectly implicates certain principles of the securities laws. Second, Madoff and Madoff Securities were, at all times here relevant, engaged in the special kind of fraud known as a “Ponzi scheme,” by which customers of Madoff Securities, who were led to believe that their monies were being invested in profitable securities transactions, were paid their profits from new monies received from customers, without any actual securities trades taking place.

Because Madoff Securities was a registered stockbrokerage firm, the liabilities of customers like the defendants here are subject to the “safe harbor” set forth in section 546(e) of the Bankruptcy Code. “By restricting a bankruptcy trustee's power to recover payments that are otherwise avoidable under the Bankruptcy Code, the safe harbor stands ‘at the intersection of two important national legislative policies on a collision course—the policies of bankruptcy and securities law.’ ” In re Enron Creditors Recovery Corp., 651 F.3d 329, 334 (2d Cir.2011) (quoting In Re Resorts Int'l, Inc., 181 F.3d 505, 515 (3d Cir.1999)). Specifically, section 546(e) of the Bankruptcy Code provides that “[n]otwithstanding sections 544, 545, 547, 548(a)(1)(B) and 548(b) of this title [ i.e., all the sections dealing with preferences and constructive fraud under the Bankruptcy Code and, by reference, all applicable sections of New York State law], the trustee may not avoid a transfer that is a ... settlement payment, as defined in section ... 741 of this title, made by or to (or for the benefit of) a ... stockbroker ... or that is a transfer made by or to (or for the benefit of) a ... stockbroker, in connection with a securities contract, as defined in section 741(7) ... except under section 548(a)(1)(A) of this title [dealing with actual fraud].” 11 U.S.C. § 546(e) (emphasis supplied). Section 741(7) defines a “securities contract” as a “contract for the purchase, sale, or loan of a security,” which is the kind of contract Madoff Securities had with its customers. Section 741(8) defines “settlement payment” as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade”—an “extremely broad” definition, see Enron, at 334 (collecting cases), which clearly includes all payments made by Madoff Securities to its customers. Furthermore, any payment by Madoff Securities to its customers that somehow does not qualify as a “settlement payment” qualifies as a “transfer” made “in connection with a securities contract.” By its literal language, therefore, the Bankruptcy Code precludes the Trustee from bringing any action to recover from any of Madoff's customers any of the monies paid by Madoff Securities to those customers except in the case of actual fraud.

Notwithstanding the plain language of section 546(e), the Trustee argues that it should not be applied here, because doing so would (supposedly) not accord with the statute's purpose. Congress enacted § 546(e) “to minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries.” In re Manhattan Inv. Fund Ltd., 310 B.R. 500, 513 (Bankr.S.D.N.Y.2002) (quoting H.R.Rep. No. 97–420 (1982), reprinted in 1982 U.S.C.C.A.N. 583, 583). Although the Trustee argues that avoiding Madoff Securities' transfers to customers cannot cause the “displacement” that § 546(e) aims to prevent, this seems at variance with his own Amended Complaint, which alleges that the Madoff fraud involved approximately $68 billion and 4,900 customers. See Amended Complaint ¶ 39. As in Enron, this Court sees “no reason to think that undoing” such large transfers involving so many customers from so long ago as 2002 “would not also have a substantial and similarly negative effect on the financial markets.” Enron, 651 F.3d at 338.

In any event, resort to legislative history is inappropriate where, as here, the language of the statute is plain and controlling on its face. “[C]ourts must presume that a legislature says in a statute what it means and means in a statute what it says there.” Conn. Nat'l Bank v. Germain, 503 U.S. 249, 253–54, 112 S.Ct. 1146, 117 L.Ed.2d 391 (1992). Indeed, to deviate from what Congress has clearly and constitutionally decreed is a power the judiciary does not possess. See Lamie v. U.S. Trustee, 540 U.S. 526, 534, 124 S.Ct. 1023, 157 L.Ed.2d 1024 (2004). Thus, here, as in Enron, there is neither a need nor a basis “to address ... arguments regarding [the] legislative history [of § 546(e) ].” Enron, 651 F.3d at 338.³

Accordingly, the Court grants the defendants' motion to dismiss all claims predicated on principles of preference or constructive fraud under the Bankruptcy Code, as well as all claims under New York law, collectively corresponding to Counts 2 through 9 of the Amended Complaint.

This leaves, principally, the Trustee's claim for actual fraud under § 548(a)(1)(A) of the Bankruptcy Code (Count 1 of the Amended Complaint).⁴ Section 548(a)(1)(A) permits the Trustee to avoid any payment made by Madoff Securities to its customers within two years of the filing of the bankruptcy petition if the debtor (Madoff Securities) “made such transfer ... with actual intent to hinder, delay, or defraud any entity to which the debtor was or became ... indebted.” Since it is undisputed that Madoff's Ponzi scheme began more than two years before the filing of the bankruptcy petition and continued...