The Emily Litella Principle Governs the Withdrawal of Proofs of Claim

The Emily Litella principle will not divest the bankruptcy court of equitable jurisdiction, according to an opinion by Bankruptcy Judge Stuart M. Bernstein of Manhattan.

Created for Saturday Night Live by the late Gilda Radner, the character Emily Litella would rant about a topic of social significance, based on misapprehension of a critical fact, e.g., “What’s all this fuss I hear about making Puerto Rico a steak?” When corrected, she would say, “Never mind.”

And so it is with equitable jurisdiction. A creditor cannot say, “Never mind,” withdraw a proof of claim, and divest the bankruptcy court of equitable jurisdiction over a fraudulent transfer suit filed by the trustee after the creditor filed the claim.

The Emily Litella principle applied in a second aspect of Judge Bernstein’s January 18 opinion. Having considered the issue more thoroughly, Judge Bernstein reversed a position he had taken three years earlier when he ruled that disallowance of a claim terminates the bankruptcy court’s jurisdiction.

The Facts

The jurisdictional dispute arose in one of the hundreds of adversary proceedings to recover fraudulent transfers occurring when Bernard Madoff paid more cash to a customer than the customer had invested in what turned out to be a $19 billion Ponzi scheme.

In several litigations that went to the Second Circuit, the appeals court ruled that a Madoff customer’s claim is limited to the difference between the actual cash invested by the customer, less whatever the customer withdrew before bankruptcy. When calculating a customer’s claim, the court therefore must ignore fictitious profits shown on the customer’s brokerage statement.

As a corollary, customers who took out more cash than they invested were exposed to lawsuits for receipt of actually fraudulent transfers under Section 548(a)(1)(A). If the customer had not turned a “blind eye” to Madoff’s fraud, the customer’s maximum liability would be the so-called fictitious profits taken out of the account within two years of bankruptcy, according to rulings by District Judge Jed Rakoff.

The two customers at issue had filed timely claims aggregating about $8 million. They were so-called net winners, because they had withdrawn some $7 million more in cash than they had invested with Madoff.

About a year after the customers filed their claims, the Madoff trustee sued in 2010, seeking about $3 million in fictitious profits they had withdrawn from their Madoff accounts within two years of bankruptcy. The trial was scheduled for December 2018.

In the last pretrial conference in 2018, Judge Bernstein allowed the customers to withdraw their claims with prejudice, because binding precedent from the Second Circuit proved they had no valid claims for fictitious profits. As a result of the withdrawal of the claims, the customers argued that the bankruptcy court lost jurisdiction over the $3 million in fraudulent transfer suits.

As Judge Bernstein put it, the customers’ “claims were pending for nearly ten years, but they sought to withdraw them with prejudice at the court’s invitation only a few days before the trial was scheduled to begin.”

Judge Bernstein’s Ratio Decidendi

Judge Bernstein grounded his decision on Supreme Court authority, such as Langenkamp v. Culp, 498 U.S. 42, 45 (1990), where the high court held that the filing of a claim brings the creditor within the bankruptcy court’s equitable jurisdiction, allowing the bankruptcy judge to determine an avoidance action without a jury.

“The majority of cases that have considered the issue,” Judge Bernstein said, have concluded that withdrawal of claims on the eve of trial will not strip the bankruptcy court of equitable jurisdiction. With one exception, he said that cases cited by the creditors to the contrary “are distinguishable or incorrectly decided.”

The creditors’ best authority was one of Judge Bernstein’s own decisions, SIPC v. BLMIS, 531 B.R. 439, 455 (Bankr. S.D.N.Y. 2015), where he said that the bankruptcy court would not have power to enter a final judgment against a creditor whose claim had been disallowed.

“In light of the fuller briefing on this issue submitted by the parties, the Court is persuaded to revisit its reasoning . . . and reach a different conclusion . . . ,” Judge Bernstein said.

Agreeing that “timing matters,” Judge Bernstein said, “it is the time of filing rather than the time of trial that determines the existence of the bankruptcy court’s equitable jurisdiction.” He cited Supreme Court authority for the proposition that events after the filing of a suit do not oust the court of diversity jurisdiction. The time-of-filing rule, he said, “also governs the bankruptcy court’s subject matter jurisdiction,” citing Second Circuit authority.

To close the circle, Judge Bernstein said that the time-of-filing rule should also apply to equitable jurisdiction, otherwise a defendant could lie in the weeds and terminate the bankruptcy court’s jurisdiction by withdrawing the claim moments before the commencement of trial.

Judge Bernstein held that the bankruptcy court had equitable jurisdiction because the Madoff trustee sued after the creditors filed their claims. The withdrawal of the claims, he said, “did not strip the Court of its equitable jurisdiction that attached at the time of filing.”