Bankruptcy Court Dismisses Pre-2001 Avoidance Claims Based on Separation of Madoff and SIPA Debtor Entity: In re Bernard L. Madoff Investment Securities LLC

In the case of Irving H. Picard, Trustee v. Frank J. Avellino, et al. (In re Bernard L. Madoff Investment Securities LLC), the trustee filed an amended complaint asserting 13 counts to, in sum, avoid preferential and fraudulent transfers and subsequent transfers against multiple defendants and to subordinate and disallow certain defendants’ claims.[1] The trustee served as both the trustee for the liquidation of the estate of Bernard L. Madoff Investment Securities LLC (BLMIS) and the estate of Bernard L. Madoff, the estates for which had been substantively consolidated.[2] The bankruptcy court acknowledged from the outset that the proceeding arose from “the massive Ponzi scheme masterminded by Bernard L. Madoff that was executed using BLMIS.”[3]

All but one defendant moved to dismiss the amended complaint.[4] The arguments these defendants raised to dismiss the avoidance actions included one based on the applicable statute of limitations; specifically that, pursuant to New York state law, applicable under 11 U.S.C. § 544(b)(1), the statute of limitations had expired to avoid the transfers that occurred more than six years prior to the filing date, Dec. 11, 2008.[5] Additionally, the defendants argued that the trustee could not recover transfers that were made when Madoff’s financial business was a sole proprietorship, rather than BLMIS, the later formed LLC and Securities Investor Protection Act (SIPA) debtor.[6] Regarding the latter argument, the trustee argued that because the estates had been consolidated and BLMIS was the successor to the sole proprietorship, such distinction was immaterial.

The U.S. Bankruptcy Court for the Southern District of New York dismissed the avoidance and liability claims arising from initial transfers that occurred prior to Jan. 1, 2001, based on certain limits of the trustee’s ability to reach back prior to that date in this case.[7] The limitations arose because (1) BLMIS commenced operations on Jan. 1, 2001, and therefore could not make any transfers of customer property prior to that date, and (2) prior to Jan. 1, 2001, Madoff operated his business as a sole proprietorship, the operations of which were wholly separate from the separate-entity BLMIS, and importantly, the sole proprietorship was not the SIPA debtor.[8] Additionally, the bankruptcy court recognized that despite substantive consolidation, the SIPA trustee’s avoidance powers remained separate from the avoidance powers of the chapter 7 trustee for Madoff’s estate.[9] Thus, the trustee for the Madoff estate could not exercise the powers of the separate SIPA trustee. For these reasons, the bankruptcy court found that the trustee could not recover transfers of customer property made by Madoff’s sole proprietorship.[10]

However, the bankruptcy court found that the trustee’s count for equitable subordination was not subject to the same statute of limitations argument because equitable subordination arises from 11 U.S.C. § 510(c), not state law.[11] Therefore, the same argument did not apply to dismiss this count.[12] Other counts that survived myriad dismissal arguments included preferential transfers (post-Jan. 1, 2001); certain subsequent transfers; disallowance and subordination counts; equitable claims of disallowance, one based on general equitable principles and one based under the applicable provisions of SIPA; and a claim to impose general partner liability.[13]

The result in this case emphasizes the importance of the identity and existence of an entity-transferor at the time of the alleged transfers, and whether such entity constitutes the debtor in bankruptcy such that the transfers made by it fall within the trustee’s avoidance powers.