The Bottom Line

In Picard v. BAM LP (In re Bernard L. Madoff Investment Securities LLC), Adv. Pro. No. 10-04390 (Bankr. S.D.N.Y. Jan. 18, 2019), a matter arising out of the Ponzi scheme perpetrated by Bernard Madoff through Bernard L. Madoff Investment Securities LLC (“BLMIS”), the Bankruptcy Court for the Southern District of New York considered the issue of whether a bankruptcy court loses its equitable jurisdiction over a fraudulent transfer action because the defendant-creditor withdraws his proof of claim after the adversary proceeding was filed but before the bankruptcy court has tried the matter. The bankruptcy court concluded that it acquired equitable jurisdiction over the Trustee’s fraudulent transfer action when it was commenced under the time-of-filing rule, and the defendants’ withdrawal of their claims did not destroy it.

What Happened?

On Dec. 15, 2008, the Securities Investor Protection Corporation (“SIPC”) commenced a liquidation against BLMIS under the Securities Investor Protection Act (“SIPA”). The district court appointed Irving H. Picard, Esq., as trustee (“Trustee”) and removed the liquidation to the bankruptcy court to be conducted in accordance with SIPA.

Michael Mann and Meryl Mann (the “Manns”) served the Trustee with a statement of claim in the amount of $7,192,467.45, based on the handwritten, corrected balance shown on the Manns’ last customer statement (the “Mann Claim”). Similarly, BAM L.P. (or “BAM,” and together with the Manns, the “Defendants”) served the Trustee with a statement of claim in the amount of $714,333.85, which was also based on the handwritten, corrected balance shown on BAM’s last customer statement (the “BAM Claim,” and together with the Mann Claim, the “Claims”). The Trustee denied the Claims (the “Determinations”), explaining that no securities were ever purchased for the Defendants’ BLMIS accounts, and the Defendants withdrew more than they deposited into their accounts over the lives of the accounts. The Defendants objected to denial of their Claims (the “Objections”).

The Trustee initiated an adversary proceeding seeking to avoid and recover the excess transfers to the Defendants under bankruptcy and state fraudulent transfer law (the “Adversary Proceeding”). The Trustee calculated that the Manns and BAM had received $2.25 million and $563,000, respectively, within two years of the bankruptcy filing date.

Following years of litigation regarding the correct method to calculate clawback liability, the court scheduled the Adversary Proceeding trial. The parties submitted a proposed joint pretrial order in which they stipulated to the amounts of $2.25 million from the Mann account and $563,000 from the BAM account. Putting aside the objection relating to the legal sufficiency of the Determinations, it seemed that the Defendants’ Objections had been resolved through judicial determinations or by stipulation.

Since the Objections appeared to be resolved, and because there was no point to forcing the Defendants to litigate their claims when they no longer asserted a right to payment, the court offered the Defendants the opportunity to make an oral motion to withdraw the Defendants’ Claims with prejudice. The Defendants agreed, and the court granted the motion. However, the order made clear that it did not determine the court’s jurisdiction over the Adversary Proceeding or any other issues in that case. In addition, the Trustee announced his intention to move for summary judgment, and the court stated that it would deal with the question of its equitable jurisdiction, which the parties had already briefed, either before or in the context of the summary judgment motion.

The court held that it had equitable jurisdiction over the Trustee’s fraudulent transfer claims because (i) the Trustee commenced the Adversary Proceeding after the Defendants filed their claims (and after they objected to the Determinations); (ii) the avoidance of the transfers to the Defendants would result in the disallowance of their claims; and (iii) the withdrawal of the Defendants’ Claims did not strip the court of its equitable jurisdiction that attached at the time of filing.

The court recognized that the majority of cases that have considered the issue are in agreement with its reasoning. In one case to the contrary, Messer v. Magee (In re FKF 3, LLC), Case No. 13-CV-3601 (KMK), 2016 WL 4540842 (S.D.N.Y. Aug. 30, 2016), one of the debtors’ principals filed a claim for breach of fiduciary duty that was eventually expunged. Before the claim was expunged, the trustee commenced an adversary proceeding against the principal on a variety of common law and fraudulent transfer theories and sought disallowance of the principal’s claims. The district court concluded that the bankruptcy court lacked adjudicative authority over the breach of fiduciary duty claims because the claim had been expunged and there was no possibility that resolving the principal’s claim would resolve the trustee’s state law counterclaims. The court noted that “[i]n other words, timing matters.”

In reaching its conclusion regarding timing, the Messer court cited a decision of the Bankruptcy Court for the Southern District of New York that reached the same conclusion. See SIPC v. BLMIS, 531 B.R. 439, 455 (Bankr. S.D.N.Y. 2015). The court explained that “[i]n light of the fuller briefing on this issue submitted by the parties, the [c]ourt is persuaded to revisit its reasoning regarding the timing issue and reach a different conclusion.”

While the court agrees that timing matters, it is the time of filing rather than the time of trial that determines the existence of the bankruptcy court’s equitable jurisdiction for several reasons. First, a concern animating the time-of-filing rule — improper manipulation of federal jurisdiction — is equally applicable to a situation such as the present one involving the court’s equitable jurisdiction. Second, the application of the time-of-filing rule is consistent with the premerger rule that a court’s equitable jurisdiction was determined at the time of filing. Third, the application of the time-of-filing rule is consistent with the Supreme Court’s analysis in Stern v. Marshall, 564 U.S. 462 (2011), because in contrast to Stern v. Marshall, from the outset it was clear that a ruling in the Trustee’s favor, avoiding as fraudulent the transfers to the Defendants, would result in the disallowance of the Claims.

Why This Case Is Interesting

By holding that withdrawing a proof of claim will not divest the bankruptcy court of jurisdiction to try an avoidance action, this decision clarifies the bankruptcy court’s jurisdictional authority. As the court explained, “If equitable jurisdiction depended on the status of the defendant-creditor’s claim, the defendant-creditor could manipulate the bankruptcy jurisdiction at any time simply by withdrawing the claim.” This decision prevents defendants in adversary proceedings from forum-shopping if the case is progressing in a manner they dislike. Time of filing is more relevant than time of trial, and events that transpire (such as the withdrawal of a proof of claim) after the commencement of the adversary proceeding are not germane to the analysis.