Federal Court: Judge Had Power to Block Madoff Claims

, New York Law Journal

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A bankruptcy judge had the authority to block private plaintiffs from suing the estate of Jeffry Picower in the Bernard Madoff Ponzi scheme because their claims were derivative to those brought by a trustee working to recover money for all Madoff investors, a federal appeals court ruled Monday.

The U.S. Court of Appeals for the Second Circuit said the late Southern District Bankruptcy Judge Burton Lifland was right to halt two actions in Florida federal court which sought direct recovery from the Picower defendants and that the judge did not exceed the limitations on his authority under Article III of the United States Constitution.

Judges Jose Cabranes, Reena Raggi and Susan Carney made those rulings in In re: Bernard L. Madoff Investment Securities, 12-1645, the latest in a series of appeals where the court was asked to review liquidation proceedings for Bernard L. Madoff Investment Securities, (BLMIS), and the actions taken by BLMIS trustee Irving Picard as he tries to recover over $17.5 billion in principal lost by investors in the scheme.

Picower was considered to be the largest winner in the Ponzi scheme by withdrawing billions from BLMIS before its collapse in 2008. He was sued by Picard, the trustee overseeing liquidation of BLMIS under the Securities Investor Protection Act, (SIPA), in the bankruptcy court in 2009.

Picard alleged fraudulent conveyance—that the Picower defendants withdrew billions from BLMIS knowing they were profiting from Madoff's fraud.

Picower died later that year and Picard settled in 2010 with his estate, which agreed to return $5 billion to the BLMIS bankruptcy estate out of a $7.2 billion forfeiture it agreed to make to the U.S. Attorney's office.

All told, Picard, of BakerHostetler, has recovered about $9.7 billion, or 55.9 percent of the $17.5 billion he is chasing (NYLJ, Jan. 8).

Lifland, who passed away this Sunday, had issued an injunction barring all claims that were "derivative" of claims being pursued by Picard in his court.

There were two actions at issue in the appeal decided Monday by the Second Circuit.

One action, filed by claimant Susanne Stone Marshall, was brought on behalf of BLMIS account holders who either had not filed SIPA claims with Picard or had their claims denied.

The second action, brought by claimant Adele Fox, challenged Picard's method of calculating who the "net winners" were in the Ponzi scheme—those not entitled to any recovery because they were paid more than they invested.

Lifland enjoined the actions on May 3, 2010, saying they violated his protective order, usurped the automatic stay provision of the Bankruptcy Code and undermined his jurisdiction. Lifland then entered a permanent injunction on Jan. 12, 2011, when he approved the Picard-Picower settlement. Southern District Judge John Koeltl affirmed the decision in March 2012 and attorneys for Marshall and Fox appealed to the Second Circuit.

On their appeal, Marshall and Fox argued that their claims were non-derivative because the Picower defendants directly participated in stealing BLMIS customer funds.

But in the Second Circuit's opinion, Cabranes said the "respective Florida complaints echo those made by the Trustee," and were an impermissible attempt to "plead around" the Lifland injunction. He said their alleged injuries are "inseparable from, and predicated upon, legal injury to the estate—namely, the Picower defendants' fraudulent withdrawals from their BLMIS accounts of what turned to be other BLMIS customers' funds."

Regardless of how they framed their claims, Cabranes said, their damages "still remain secondary harms flowing from" the Picower withdrawals.

The next question was on the limits of the court's power under Article III, where both Marshall and Fox argued there claims should be allowed because of the U.S. Supreme Court's decision in Stern v. Marshall, 131 S.Ct. 2594.

In Stern, widow Anna Nicole Smith filed a state law counterclaim in her Chapter 11 bankruptcy case to recover from her stepson for his alleged interference with the inheritance she expected from her late husband.

The Supreme Court, Cabranes said, invalidated the authority of bankruptcy judges to enter final judgments on claims and counterclaims that are based exclusively on legal rights guaranteed by state law.

Fox claimed the Stern decision meant that Lifland was improperly exercising powers reserved for Article III judges, but the court rejected the argument, with Cabranes saying that "appellants' purported tort claims are, in essence, disguised fraudulent transfer actions, which belong exclusively to the Trustee."

Marshall had argued that Lifland lacked the jurisdiction to enter a final judgment on Picard's fraudulent transfer action against the Picower defendants. But here, Cabranes said, the critical fact was that the Picower defendants had filed a proof of claim against the BLMIS estate.

"In order to rule on that claim, the Bankruptcy Court was required to first resolve the fraudulent transfer issue," Cabranes said, so Lifland's authority under the Bankruptcy Code to approve the settlement and "to permanently enjoin appellants' disguised fraudulent transfer claims does not run afoul of Article III of the United States Constitution."

Helen Davis Chapman of Becker & Poliakoff argued for claimant Susanne Stone Marshall. Lisa Blatt of Arnold & Porter argued for claimant Adele Fox.

David Sheehan of BakerHostetler argued for Picard.

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