If a preference theory fails, the trustee can amend the complaint years later to attack the same transactions as fraudulent transfers without running afoul of the two-year statute of limitations, according to District Judge Rebecca R. Pallmeyer of Chicago.

The case arose from the liquidation of money manager Sentinel Management Group Inc. As a registered futures commission merchant, Sentinel should have kept investments in two different segregated accounts for two different types of customers. The company committed several types of fraud, including the use of customers’ funds as collateral security for Sentinel’s principals’ personal trading accounts.

As the scheme was unraveling shortly before bankruptcy, Sentinel began giving preferred treatment to one group of customers at the expense of the other. After his appointment, the trustee started a test-case lawsuit against one customer to recover $15.6 million, representing money received from Sentinel just before and after the bankruptcy filing in August 2007.

The trustee won in federal district court but lost on appeal when the Seventh Circuit ruled that the safe harbor in Section 546(e) prevented the trustee from suing to recover preferences, even though the broker was committing fraud and violating securities law. (N.B.: The Supreme Court will rule on the scope of the safe harbor this term in Merit Management Group LP v. FTI Consulting Inc., 16-784 (Sup. Ct.), where oral argument was held on Nov. 6. To read ABI’s report, click here.)

While the test case was progressing through multiple appeals, similar suits were put on hold. In one suit filed in 2009, the trustee sought $81 million in preferences from another customer. When it became evident that the preference claims would fail as a matter of law, the trustee amended the complaint in June 2017, this time seeking to recover about $31 million on account of the same transfers, but this time on an actual fraud theory under Section 548(a)(1)(A), where the safe harbor does not apply.

The customer filed a motion to dismiss, contending, among other things, that the amended complaint filed eight years later was barred by the two-year statute of limitations under Section 546(a)(1).

Judge Pallmeyer denied the dismissal motion in an opinion on Jan. 5.

Under F.R.C.P. 15(c)(1)(B), the trustee’s amended complaint “relates back” if it “asserts a claim . . . that arose out of the conduct . . . in the original pleading.” The Seventh Circuit, Judge Pallmeyer said, has held that relation-back amendments must be “freely allowed.”

Judge Pallmeyer said the amended complaint “easily meets that standard” because it “covers the same ‘common core of operative facts.’”

The customer argued there should be no relation back because the fraudulent transfer claim added a new element: Sentinel’s fraudulent intent, which was not an issue with respect to a preference. Although new facts are required, Judge Pallmeyer said “the core facts concerning the specific transfers . . . remain the same.”

Judge Pallmeyer said that “numerous courts” have allowed plaintiffs to recharacterize transfers as fraudulent when the original attack had been on a preference theory.

Judge Pallmeyer also rejected the customer’s laches defense because the suit had been officially and unofficially on hold while the test case was winding its way up the appellate ladder several times.