The Second Circuit recently issued an important decision on a “related to” jurisdiction case arising out of the Bernie Madoff Ponzi scheme. SPV Osus, Ltd. v. UBS AG, 2018 U.S. App. LEXIS 3088 (2d Cir. Feb. 9, 2018).
SPV originally sued in New York state court, alleging that the defendants aided and abetted the Madoff fraud by supporting two feeder funds. The defendants removed the case to federal court. A motion by SPV to remand it back to state court was denied. The federal judge ruled that the case could stay in federal court because it was related to the Madoff case in federal bankruptcy court. On appeal, the Second Circuit affirmed.[i]
Federal courts have “original but not exclusive jurisdiction of all civil proceedings arising under title 11 [the U.S. Bankruptcy Code], or arising in or related to cases under title 11.” The U.S. Supreme Court has noted that “Congress did not delineate the scope of ‘related to’ jurisdiction, but its choice of words suggests a grant of some breadth.”[ii] Related to jurisdiction includes “suits between third parties which have an effect on the bankrupt estate.”[iii] “An action is related to bankruptcy if the outcome could alter the debtor’s rights, liabilities, options, or freedom of action (either positively or negatively) and which in any way impacts upon the handling and administration of the bankruptcy estate.”[iv] In the Second Circuit, “a civil proceeding is related to a title 11 case if the action’s outcome might have any conceivable effect on the bankrupt estate.”[v]
Significantly, the Madoff bankruptcy estate was not even a party to the SPV lawsuit. So on what basis was the case related to the bankruptcy case? The Second Circuit held that if SPV proved its case, then the defendants could bring a contribution claim against the bankruptcy estate.
SPV argued that related to jurisdiction based on a possible contribution claim was both “too remote” and “illusory” because the deadline for parties to file claims had passed and the Madoff estate had insufficient funds to pay a contribution claim. The Second Circuit rejected these arguments.
The court said SPV’s argument about the claims deadline was not “fatal to the potential claims at issue here.” Contribution claims accrue after liability is found, and bankruptcy courts can permit parties to file late claims. In addition, the court said motion practice to determine if a late claim could be filed would have an “effect on the estate” because it would “result in the estate incurring costs.”[vi] And if SPV won its lawsuit, then that would reduce the amount owed by the Madoff estate.
The Second Circuit’s decision, authored by Judge Rosemary Pooler, noted that its ruling differs from a key the Third Circuit opinion, Pacor, Inc. v. Higgins, 743 F. 2d 984, 995 (3d Cir. 1984), where that court said related to jurisdiction doesn’t exist unless the litigation “automatic[ally] creat[es] liability” for the bankruptcy estate. The Second Circuit’s “more flexible” approach (2018 LEXIS 3088 at *14) follows holdings in the Fourth, Fifth, and Sixth Circuits.[vii]
The Second Circuit also said the record didn’t support SPV’s argument that the Madoff bankruptcy estate would lack funds to pay a contribution claim. SPV had sued for $2.9 billion. Even so, the district judge had noted that the bankruptcy estate had recovered “$1 billion in 2014 alone” and was “aggressively pursuing numerous other recoveries.”[viii]
The key takeaway from the decision is that the Second Circuit has reached a more expansive ruling on related to jurisdiction than the Third Circuit. For bankruptcy cases filed in New York and Delaware, the possibility of a contribution claim against a bankruptcy estate will be enough in the Second Circuit, but not the Third Circuit, to keep matters before the federal court.