The same day as his victory in the Second Circuit, the Madoff trustee prevailed in bankruptcy court over a customer with a creative appeal to the court’s equity powers.
Although the bankruptcy court is a court of equity, Bankruptcy Judge Stuart M. Bernstein of New York was obliged to rule against the customer because his theories flew in the face of provisions of the Bankruptcy Code.
The customer had withdrawn $7 million in so-called fictitious profits from his Madoff account within two years before bankruptcy. Naturally, Madoff trustee Irving Picard sued the customer in bankruptcy court for receipt of fraudulent transfers.
Were there no affirmative defenses, the customer conceded that the trustee was entitled to recover the fictitious profits under Section 548(a). The trustee admitted that the customer was entitled to the good faith defense under the safe harbor in Section 546(e), limiting his recovery to the $7 million in payments the customer received within two years of bankruptcy.
The customer claimed that he reinvested every penny of the profits he took out of his Madoff account with so-called feeder funds that in turn reinvested his money in the funds’ own Madoff accounts. The funds ended up with valid customers claims in the Madoff liquidation under the Securities Investor Protection Act because they were so-called net losers who took out less than they invested in the Ponzi scheme.
Proposing several theories as affirmative defenses, the customer argued that he should have credit for the $7 million to offset the trustee’s fraudulent transfer claims because he ended up losing every dime of profit he had taken out — since he reinvested in the feeder funds that, in turn, lost the money in the Ponzi scheme.
The trustee moved for partial summary judgment striking the affirmative defenses based on reinvestment of the profits. The trustee won in Judge Bernstein’s June 1 opinion.
The customer urged Judge Bernstein to allow him an “equitable credit” under Section 105(a), even though the Bankruptcy Code does not “permit the court to limit the trustee’s recovery of a cash transfer for equitable reasons.”
Judge Bernstein said that the credits sought by the customer were “inconsistent with the express provisions of the Bankruptcy Code and SIPA which give the credit they seek to the entity that gave the value to the debtor.” He said that the feeder funds were net losers entitled to valid customer claims for their net investment in the fraud.
Judge Bernstein said that the credits given to the funds “are not just theoretical” because the trustee has already distributed about 60% of the funds’ losses in the Madoff scheme. He said the customer’s “invocation of equity would force the [trustee] to give a second round of credits based on the same deposits.”