The long anticipated avoidable transfer recovery proceedings against former clients of Bernard L. Madoff commenced being filed on November 26, 2010 and by December 4, 2010, the total number of complaints filed reached 887 (update April 05, 2011 – a total of 1057 avoidance actions were filed after November 26, 2010).  The complaints were filed by  Irving H. Picard, as trustee (the “Trustee”)  in the substantively consolidated proceeding brought under the Securities Investor Protection Act (“SIPA”) for the liquidation of the business of Bernard L. Madoff Investment Securities LLC and the bankruptcy estate of Bernard L. Madoff , individually (collectively “Madoff”).  The statutory grounds for the avoidance actions include Sections 547- Preferences and 548 – Fraudulent Transfers – under the Bankruptcy Code.  This note provides a cursory overview of the avoidance actions.

The Victim Defendants of Avoidable Transfer Claims

The Trustee had identified two categories of  avoidance actions, which were described by the the President of the Securities Investor Protection Corporation (“SIPC”), Stephen Harbeck, in his letter of September 7, 2010 to Representative Paul E. Kanjorski and Scott Garrett, the Chariman and Ranking Member, respectively, of the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises (the “Harbeck Response to House Subcommittee”).   The Subcommittee had submitted 10 questions to the SIPC, one of which requested details of the number of claims, claim amounts and expected recovery from avoidance actions.  Harbeck responded that the Trustee had advised the SIPC that, in addition to the 19 recovery actions brought prior to September 7, 2010, the Trustee expected to pursue 2 categories of avoidance actions.

One category would involve customers who received other customers’ money, withdrew more than they deposited with Madoff, and as to whom knowledge is not a factor. At this time, the Trustee is reviewing the facts of approximately 1,000 possible avoidance actions that could result in the recovery of approximately $4,800,000,000.00 for the benefit of customers who have yet to be repaid their principal.

The other category consists of avoidance actions in which the Trustee alleges that the customer had enough information to be on inquiry notice of the fraud. At this time, the Trustee is considering the commencement of about 100 avoidance actions seeking the recovery of at least $2,000,000,000.00 for the benefit of customers who have yet to recover their principal,

With limited exception, the nearly 900 avoidance actions filed in the 10 days after Thanksgiving appear to fall in the first category.

The Statutory Grounds for the Trustee’s Recovery

The stated statutory grounds for the adversary proceedings are: sections 78fff(b), 78fff-1(a) and 78fff-2(c)(3) of SIPA; Sections 105(a), 502(d), 544, 547, 548(a), 550(a) and 551 of the Bankruptcy Code; and  the New York Fraudulent Conveyance Act (New York Debtor and Creditor Law § 270 et seq. (“DCL”)). To see an overview of the adversary proceedings and a listing of the complaints, click this link.

Each of Sections 547, and 548 are found in Bankruptcy Code “Chapter 5–Creditors, the Debtor, and the Estate – Subchapter III–The Estate.”  The “Estate” refers to the totality of the interests of the debtor in property.  To that end, each of  Section 547 and 548 are intended to give the trustee the necessary tools to muster together all interests of the debtor in property.  Section 547 provides that “the trustee may avoid any transfer of an interest of the debtor in property… .” Section 548 provides:  “The trustee may avoid any transfer … of an interest of the debtor in property…”  Under Bankruptcy Code Section 544, the trustee the right to avoid any transfer of property under any other applicable law that grants any creditor a right to avoid a transfer, and in these proceedings, essentially incorporates the New York Fraudulent Conveyance Act.

[Updated April 5, 2011] – Each of these sections is subject to a different look back period.   The avoidance period under Section 547 is 90 days; under 548(a) is 2 years; and Section 544  incorporates the New York Fraudulent Conveyance Act look back period of 6 years, in each case counting backwards from December 11, 2008.

Of the 1057 avoidance action defendants, 1047 have been subject to claims under Section 544 (incorporating  the New York Fraudulent Conveyance Act), 880 have claims based on Section 548, only 165 have been identified as receiving avoidable transfers under Section 547 during the 90 days prior to the petition date.  Of these 165 preference defendants, only 116 also face claims under Section 548, while 160 (all but 5) also face claims under Section 544.

The Madoff Trustee’s Real Sticks

The above numbers show that the success of the Trustee’s recovery efforts likely will be derived from and determined by the state fraudulent conveyance laws.  The sticks afforded the trustee by these statutes are substantial and its incorporation into Section 544 gives the Trustee the broad jurisdictional reach he needs.

The bottom line is that Madoff really is not a bankruptcy preference case under 547.

1. The amount of recovery that the trustee expects under Section 547 is only a small fraction of the amounts recoverable under the much longer look back periods of Sections 548 and 544.
2. All of the 547 preference claim defendants also are subject to claims under Section 548 or the New York Fraudulent Conveyance Act/Section 544.
3. The Trustee really is in no need of the “presumption of insolvency” under Section 547.
4. The additional burden of proving lack of reasonably equivalent value outside of Section 547 is really no burden at all given the true Ponzi scheme presented by Madoff.