06/01/2011 – Defendant’s Memorandum of Law in Support of Motion to Dismiss filed in the Bernard L. Madoff Bankruptcy Adversary Proceedings brought by Irving H. Picard against Weiner et al before Judge Lifland in the Southern District of New York (Manhattan).

This is a probing, broad based motion to dismiss, challenging every count of the Trustee’s 7 count complaint. The motion to dismiss initially attacks the Trustee pleading of actual fraudulent transfers and in particular the element of actual fraudulent intent. However, the focus of the motion to dismiss is heavily weighted toward Picard’s claims based on the transfers being constructive fraudulent conveyances under the New York Debtor and Creditor Law (“NYDCL”). It is this aspect of the motion that most makes it noteworthy.

The Trustee bases 3 of the 7 counts of the complaint on the transfers being constructively fraudulent under Sections 273-275 of the NYDCL. The Defendants challenge the Trustee’s pleading of these counts based on the following argument.

To prevail in a complaint to avoid transfers as constructively fraudulent to creditors under New York law, the Trustee has the burden of proving a lack of fair consideration and with it a lack of good faith. As courts have found, good faith is “essential” to a finding of fair consideration. See In re Actrade Financial Technologies Ltd., 337 B.R. 791, 802 (Bankr. S.D.N.Y. 2005) (citing United States v. McCombs, 30 F.3d 310, 326 (2d Cir. 1994)); see also In re Jacobs, 394 B.R. 646, 662 (Bankr. E.D.N.Y. 2008) (fair consideration has a good faith component under New York Constructive Fraud claims). Thus, Defendants note that the NYDCL differs from the Bankruptcy Code in the additional element of good faith, as plaintiff need not plead lack of good faith as an element of a 548 claim under the Code.

However, the Bankruptcy Code does provide that good faith is relevant in a constructive fraud case, as section 548 of the Code “designates the transferee’s good faith as an affirmative defense which may be raised and proven by the transferee at trial.” Accordingly, the sufficiency with pleading constructive fraud claims must be pled under Section 548 and the NYDCL is quite similar. In fact, the Court has previously noted that the two statutes should be interpreted similarly by the courts. In re Churchill Mortgage Inv. Corp., 256 B.R. at 677 (citing HBE Leasing Corp. v. Frank, 48 F.3d 623, 638 (2d Cir. 1995)). “Although the terminology used by the D & CL differs from that used in the Bankruptcy Code, both ultimately require a trustee to establish that the debtor did not receive ‘reasonably equivalent value’ or ‘fair consideration’ in the transaction.” In re Churchill Mortgage Inv. Corp., 256 B.R. at 677, aff’d, 264 B.R. 303 (S.D.N.Y. 2001). In fact, it has been found that terms—‘reasonably equivalent value’ in Section 548(a)(1)(b), ‘fair consideration’ in the D & CL and ‘value’ in Section 548(c)—have the same fundamental meaning.” Id.

Applying the above standard in this case, it has consistently been determined in the Second Circuit that a debtor receives “reasonably equivalent value” under Section 548 when the transfers do not exceed the investor’s principal. See, e.g., In re Churchill Mortgage, 256 B.R. at 682 (emphasis added) (recognizing the “universally accepted rule” that investors may retain distributions from an entity engaged in a Ponzi scheme to the extent of their investments). However, the Second Circuit courts have also noted that, to determine if debtor received “reasonably equivalent value” for a transfer, a fact-finder must first attempt to measure the economic benefit that the debtor “indirectly” received from the entire transaction, and then compare that benefit to the value of property that the debtor transferred. See In re Actrade Financial Technologies Ltd., 337 B.R. at 804 (citing United States v. McCombs, 30 F.3d 310, 326 (2d Cir. 1994)). Indirect benefits, thought to constitute “fair consideration”, may include consideration flowing from debtor to transferee, synergy, increased access to capital, and protection of customer relationships. See In re Nirvana Restaurant Inc., 337 B.R. 495, 502 (Bankr. S.D.N.Y. 2006).

The Trustee seeks to avoid transfers in the amount of $2,975,025 from defendant Marvin Wiener despite not identifying his principal investment. The Trustee seeks to avoid $530,000 in from defendants Charles and Carolyn Wiener despite not specifically identifying their principal investment. Finally the Trustee seeks to avoid $1,715,000 in Transfers to the WFLP and others, despite not identifying their principal investment. The Trustee never actually identifies the full extent of any of Defendants’ investments in BLMIS in its Complaints, therefore, it is unclear and pure speculation if a constructive fraudulent conveyance actually occurred. In fact, it is possible that there is no disparity between the principal investments and transfers sought to be avoided and, thus, the claims could be moot.

Further, the Trustee fails to account for the indirect benefits that the investments provided that could offset the alleged fraudulent transfers. The Trustee is in the best position to know the extent of indirect benefits the debtor received from Defendants’ investments. It is unclear if the debtor received synergy, increased access to capital, protection of customer relationships or other indirect benefits simply by Defendants’ participation in BLMIS. As such, it is unclear if the indirect benefits contributed to the offset of the transfers. The constructive fraud claims, thus, under New York law, are not plead with sufficient specificity, and should be dismissed because under well settled law “fair consideration” under NYDCL includes not only the monetary value exchanged, but the indirect benefits that the debtor received as well. Thus, Counts Four, Five, and Six of the MW and WFLP Complaints, and also Counts Five, Six, and Seven in the CW Complaint should be dismissed because they were not plead with sufficient specificity.

Additionally, even if this Court finds that an inadequate transfer occurred which exceeded the principal investment, and that indirect benefits are too ambiguous to be considered at the pleading stage, the Trustee’s claims, pursuant to NYDCL 273, 274, and 275, should be re-pled because the Trustee failed to specify a fundamental element of the constructive fraud claim, good faith. Trustee has failed to adequately plead the required element of good faith that is an additional aspect of “fair consideration.” Pursuant to In re sharp Int’l Corp., a creditor’s receipt of funds from a debtor, in dollar-for-dollar repayment of loan, did not give rise to constructive fraudulent transfer claim under New York law, although the creditor allegedly knew that debtor’s management had raised the funds for repayment from fraudulent sales. 302 B.R. 760 (E.D.N.Y. 2003) aff’d. 403 F.3d 43 (2d Cir. 2005). The court held that the creditor’s knowledge of the fraudulent acts of debtor in connection with the repayment of the debt did not affect its “good faith,” for purpose of constructive fraudulent transfer claim, absent any allegation of creditor actually participated in the fraud. Id. See also In re Actrade Financial Technologies Ltd., 337 B.R. at 805 (recognizing that under Sharp “[t]he Court […] indicated that to establish a lack of good faith under the DCL, the plaintiff must make an initial showing in the pleadings that the defendant was not only aware of the fraud but actually participated in it.”) Thus, the claims should be dismissed, since the Defendants are not different than those in Sharp as they too were innocent lenders, who acted in good faith at the time they invested with the Debtor and the investment constituted fair consideration under the NYDCL.

Further, the Trustee has failed to plead that the Defendant transferees in this case received the payments in bad faith because there is no allegation whatsoever that the transferees actually participated in the fraud. In fact, except for the allegations that Defendants are alleged insiders and that Charles Wiener was a person thought to have knowledge of the Debtors’ scheme, the Complaints do not contain any particularized allegations where it could be inferred that the Defendants had actual knowledge of the fraud. (See CW Complaint ¶¶8-9; MW Complaint ¶9; WFLP Complaint ¶¶ 9-12). Conveniently, the Trustee omits any factual support for this disingenuous claim.

Accordingly counts Four, Five, and Six of the MW and WFLP Complaints, and also counts Five, Six, and Seven in the CW Complaint should be dismissed or in the alternative repled because the Trustee has failed to state all the elements of a constructive fraud claim.

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