Academic journal article Fordham Journal of Corporate & Financial Law

On the Clawbacks in the Madoff Liquidation Proceeding

Academic journal article Fordham Journal of Corporate & Financial Law

On the Clawbacks in the Madoff Liquidation Proceeding

Article excerpt

At a Meeting of Creditors held on February 20, 2009, counsel for the trustee overseeing the liquidation of Bernard L. Madoff Investment Securities, LLC, announced the advent of "clawback" suits seeking to recover sums paid out to defrauded investors. l This Essay explains the legal framework for the clawback suits and anticipates that many investors in the Ponzi scheme2 will not have submitted claims by the July 2, 2009 deadline, which may result in clawback litigation before multiple courts. The Essay then discusses ways to streamline clawbacks and other Madoff-related litigation so that investors who have already been defrauded are not further damaged by the measures taken to compensate them. It closes with an invitation for additional proposals.

I. CLAWBACKS IN THE MADOFF LIQUIDATION PROCEEDING: AN OVERVIEW

While the liquidation proceeding of Bernard L. Madoff Investment Securities, LLC is pending before the Bankruptcy Court,3 it is not a proceeding under the Bankruptcy Code.4 It is a proceeding under the Securities Investor Protection Act of 1970, as amended ("SIPA").5 On December 15, 2008, the United States District Court for the Southern District of New York appointed Irving Piccard to serve as the SIPA trustee and transferred the SIPA proceeding to the Bankruptcy Court.6

A SIPA trustee can bring avoidance actions, colloquially referred to as "clawbacks," pursuant to the preference and fraudulent transfer provisions of the Bankruptcy Code.7 Preference actions and fraudulent transfer actions can reach both payments of fictitious profits and withdrawals of principal.8 On April 8, 2009, the trustee filed the first clawback action against investors in the Ponzi scheme.9

A. Avoidance of Preferences

Through a preference action, the trustee can seek to recover transfers (including transfers of money) made while Bernard L. Madoff Investment Securities, LLC was insolvent, on or within the 90 days before the December 11, 2008 commencement of the SIPA proceedings (or in the case of transfers to an insider, within a year) provided that the transfers were made to or for the benefit of a creditor and for or on account of an antecedent debt, and allowed the targeted creditor to receive more than it would have received in a hypothetical chapter 7 liquidation.10 As one of the leading treatises on bankruptcy explains:

[P]reference law reaches back over a defined period prior to bankruptcy and restructures transactions so as to level out the overall treatment received by similar creditors. This does not imply that the prepetition transfers avoided to accomplish this leveling were immoral or improper when made. Rather, they are avoided because their effect contravenes bankruptcy law concepts as to the economic effects sought in a distribution of assets or income.11

The most commonly invoked defenses are that the challenged transfer was made in the "ordinary course of business"12 or the recipient gave "new value" after the challenged transfer was made.13 The Bankruptcy Code sets out the ordinary course of business defense and excepts from avoidance:

[T]ransfer[s]...in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee [if the] transferts were] -

(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or

(B) made according to ordinary business terms.14

It remains to be determined how the ordinary course of business defense will be applied in the context of a cash-in, cash-out Ponzi scheme, in which debts were incurred as part of an extraordinary and unlawful enterprise and payments came from other people's money. More straightforward, although also likely to be controversial in highstakes preference litigation, is the "new value" defense. Under Section 547(c)(4) of the Bankruptcy Code, a recipient of a challenged transfer must show that "(i) the debtor received new value after the transfer, and (ii) such new value remained unpaid" to establish a new value defense. …

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