A creditor being sued for receipt of a fraudulent transfer cannot offset the fraudulent transfer liability against a claim the creditor holds against the debtor, as explained in an opinion by Bankruptcy Judge Cecelia G. Morris in the liquidation arising from the Bernard Madoff Ponzi scheme under the Securities Investor Protection Act.
In her October 4 opinion, Judge Morris also explained why unjust enrichment can’t be raised as a defense to a claim of fraudulent transfer.
The Trustee’s Claims to Recover Stolen Customer Property
Madoff’s fraud was disclosed in 2008, followed quickly by a liquidation in the Manhattan Bankruptcy Court under SIPA, which incorporates large swaths of the Bankruptcy Code, including avoidance actions for the recovery of fraudulent transfers with “actual intent” under Section 548.
Several of Madoff’s largest investors were so-called offshore feeder funds that took money from their own investors and gave it to Madoff. A foreign bank invested with a pair of feeder funds to ensure that the investments would end up with Madoff.
The Madoff trustee is suing the bank under Sections 548(a)(1)(A) and 550(a)(2) as a subsequent recipient of fraudulent transfers with “actual intent.” The complaint aims to recover more than $300 million that the bank received as the subsequent transferee from the offshore feeder funds, which were Madoff’s direct customers. The trustee alleges that the $300 million was so-called customer property stolen from other investors.
After a long hiatus, the suit was revivified when the Second Circuit reversed the district court and allowed the Madoff trustee to sue subsequent recipients who were offshore. With the lawsuit once again on the front burner, the trustee and the bank were amending the complaint and the answer.
Recently, the bank filed a motion for leave to amend the answer by adding affirmative defenses of offset, recoupment and unjust enrichment. The trustee objected to the motion, alleging that the affirmative defenses were “futile.” For the most part, the trustee came out on top.
Setoff
In the proposed affirmative defense, the bank asserted a right to offset any fraudulent transfer liability against claims it held against the Madoff estate.
Judge Morris explained that setoff is not created by the Bankruptcy Code but is preserved by Section 553. To have a valid right of setoff, the claims going both ways must both arise before bankruptcy and must be “mutual.” The claims can arise from different transactions, as long as the debts between the two parties are mutual.
Citing bankruptcy court decisions from New York and Delaware, Judge Morris said that a creditor being sued for receipt of a fraudulent transfer cannot assert a right of setoff for lack of mutuality, because the creditor’s claim is pre-petition while the trustee’s claim is post-petition.
Judge Morris denied the motion to amend the answer to include a setoff defense as being futile. She held:
There is no mutuality between the post-petition obligation for liability to the Trustee on account of the transfers and the prepetition claims as they are not in the same right and between the same parties, standing in the same capacity.
Unjust Enrichment
The Madoff trustee also objected to permitting a defense for unjust enrichment.
Judge Morris said that unjust enrichment is “typically” a claim, not a defense. She cited authorities for the notion that unjust enrichment fails as a matter of law when raised as an affirmative defense. Furthermore, she found “nothing inequitable, in bad conscience, or unjust in allowing the Trustee to proceed in marshalling and preserving the assets of the estate.”
Recoupment
The bank was also proffering an affirmative defense for recoupment. Judge Morris said that recoupment differs from setoff in that recoupment requires that the mutual debts must have arisen from the same transaction.
Based on the state of the pleadings, Judge Morris said she could not bar the recoupment defense, although she insinuated that she might revisit the issue on a motion for summary judgment.
A creditor being sued for receipt of a fraudulent transfer cannot offset the fraudulent transfer liability against a claim the creditor holds against the debtor, as explained in an opinion by Bankruptcy Judge Cecelia G. Morris in the liquidation arising from the Bernard Madoff Ponzi scheme under the Securities Investor Protection Act.
In her October 4 opinion, Judge Morris also explained why unjust enrichment can’t be raised as a defense to a claim of fraudulent transfer.