07/26/2011 – Memorandum of Law in Support of Citibank N.A., Citicorp North America, Inc. and Citigroup Global Markets Limiteds Motion to Dismiss the Trustees Complaint filed in the Bernard l. Madoff Investment Securities LLC Adversary Proceedings by Citibank, N.A. et al before Judge U.S. Bankrutpcy Judge Burton R. Lifland in the Southern District of New York (Manhattan) filed by  Cleary Gottlieb Steen & Hamilton LLP Carmine D. Boccuzzi, Jr. (New York, New York) attorneys David Y. Livshiz, Jr. and David Y. Livshiz.

Defendants Citibank, N.A., Citicorp North America, Inc.’ (“CNAI,” and together with Citibank, N.A., “Citibank”) and Citigroup Global Markets Limited (“CGML” and collectively with Citibank, “the Citi Defendants”) challenge Trustee Irving H. Picard’s effort to “clawback” four transfers, in the aggregate amount of $430 million, received by CGMI, and Citibank as purported subsequent transferees from Fairfield Sentry Limited (“Sentry”) and the Rye Select Broad Market Prime Fund, L.P. (“Prime Fund”). Defendants make three arguments in support of their motion to dismiss the Trustee’s thirteen count complaint to recover transfers on preference, constructive fraudulent conveyance and state law theories. The Defendants argue that the “safe harbors” of sections 546(e) and (g) of the Code protect the Defendants from avoidance the transfers at issue. Additionally, the Defendants claim that the Complaint fails to adequately plead recovery of the transfers under Section 550. However, this memorandum of law is significant for argument that, in the case of Sentry, “the Trustee has expressly relinquished his ability to ever avoid the initial transfers by entering into a settlement agreement with Sentry and agreeing to the entry of a consent judgment that does not avoid the alleged initial transfers.” Registered users click here to see a copy of this brief.

Defendants substantive challenge to the ability of the Trustee to recovery the transfers under Section 550 is made in the following paragraphs of their brief.


The Trustee’s failure to avoid the initial transfers to Sentry and Prime Fund prevents him from recovering the value of these transfers from the Citi Defendants, who are alleged to be subsequent transferees. Compl. ¶¶ 14-20. Section 550 of the Code permits the Trustee to recover property or its value from a subsequent transferee only “to the extent that [the] transfer [to the initial transferee] is avoided . . . .” 11 U.S.C. § 550(a) (emphasis added). In this Circuit, the only district court to consider this issue expressly held that the plaintiff must avoid the transfers as to the initial transferee before seeking recovery from a subsequent transferee. See Enron Creditors Recovery Corp. v. Int’l Fin. Corp. (In re Enron Creditors Recovery Corp.), 388 B.R. 489, 490 (S.D.N.Y. 2008); Hr’g Tr. 27:21-28:3; 34:7-13, Apr. 16, 2008 (Dkt. 32) (explicitly incorporated by reference into the court’s written decision), attached as Exhibit A.

In Enron, the Bankruptcy Court held that “the plain language of section 550(a) requires that the transfer first be established as improper and avoided under one of the avoidance sections of the Bankruptcy Code” prior to recovery from any subsequent transferee. Enron Corp. v. Int’l Fin. Corp., 343 B.R. 75, 84 (Bankr. S.D.N.Y. 2006) (emphasis added). On appeal to the district court, Judge Hellerstein largely upheld the Bankruptcy Court’s analysis, agreeing that, as a general rule, the plaintiff must obtain a “declaration of avoidance” as to a particular transfer to an initial transferee “before” seeking recovery from any subsequent transferee. Ex. A (Tr. at 27­28); id. at 38:4-7 (“I agree with Judge Gonzalez that the rule he states is the better rule . . . and the rule more consistent with the statutory framework . . . .”). The only exception to this general rule is the unique circumstance—not present (and certainly not pleaded) here—where, at the time the plaintiff brought suit, it was “impossible or impractical to satisfy the precondition of avoidance.” Id. at 38:9-10.

Judge Hellerstein’s ruling is consistent with substantial judicial authority, finding that a “transfer of the debtor’s interest to the initial transferee” must be “avoided” for the debtor to “recover [the transfer] from a subsequent transferee.” Weinman v. Simons (In re Slack-Horner Foundries Co.), 971 F.2d 577, 580 (10th Cir. 1992) (emphasis added); Geltzer v. Fur  Warehouse, Ltd. (In re Furs by Albert & Marc Kaufman, Inc.), Adv. Pro. No. 05-1838, 2006 WL 3735621, at *8 (Bankr. S.D.N.Y. Dec.14, 2006) (“The Trustee cannot recover the value of the transfer from any of the transferees or beneficiaries unless he first avoids the underlying transfer . . . . The Trustee has not avoided these transfers, and accordingly, has failed to prove an essential element of his right to recover under § 550(a).”).9

The legislative history of section 550 further supports Enron’s reasoning. The House and Senate Reports accompanying the Bankruptcy Reform Act of 1978 make clear that “[s]ection 550 prescribes the liability of a transferee of an avoided transfer, and enunciates the separation between the concepts of avoiding a transfer and recovering from the transferee.” H.R. Rep. No. 95-595, at 375 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6331; S. Rep. No. 95-989, at 90 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5876. Moreover, while section 550 of the Code, which governs recovery, provides defenses to subsequent transferees, it provides no defenses to the initial transferee. Instead, the initial transferee’s defenses derive from other Code provisions, like section 548, that govern the avoidance of transfers. This allocation of defenses further demonstrates Congressional intent to treat avoidance and recovery as separate concepts.

Finally, this plain-meaning interpretation of section 550(a)—requiring avoidance as a precondition to recovery—is also necessary to give effect to section 550(f) of the Code. Perez v. Westchester Cnty. Dep’t of Corr., 587 F.3d 143, 155 (2d Cir. 2009) (“[W]e construe statutes to avoid surplusage whenever possible.”); see also In re Stable Mews Assocs., 35 B.R. 603, 606 (Bankr. S.D.N.Y. 1983) (“The plain meaning of statutory language controls its interpretation.”). Under section 546, the Trustee must initiate an avoidance proceeding within two years after entry of the bankruptcy petition. 11 U.S.C. § 546(a). Under section 550(f), the Trustee must then initiate recovery actions against subsequent transferees within “one year after the avoidance of the transfer.” 11 U.S.C. § 550(f). If the Trustee was not required to initiate an avoidance proceeding and avoid the transfer to the initial transferee before seeking recovery from subsequent transferees, section 550(f)’s limitations provision would be no limit at all, because its trigger—avoidance of the transfer—would never occur. Congress did not intend, and its legislation should not be interpreted, to render a limitations period meaningless by obviating the Trustee’s need to undertake the predicate action that would trigger that period. See In re  Enron Corp., 343 B.R. at 82; In re Morgan, 276 B.R. at 790; In re Trans-End Tech., Inc., 230 B.R. at 104.

In sum, judicial authority, including the only district court to consider the issue in this District, together with the plain meaning of section 550, its legislative history, and the overall statutory scheme of the Code, point to a single conclusion: before seeking recovery from a subsequent transferee, the plaintiff must first obtain a judgment of avoidance with respect to the transfer to the initial transferee. The fact that some courts—and only one (non-binding) bankruptcy court decision in this District—have held otherwise is of no avail. Both Felt Manufacturing and International Administrative Services incorrectly treat “avoid” and “avoidable” as synonyms.11 See 371 B.R. at 638; 408 F.3d at 707. In fact, the two words have clearly different meanings, as recognized by Congress itself, which used the term “avoidable” in section 502(d) but chose to use the term “avoided” in section 550. Compare Black’s Law Dictionary 146 (8th ed. 2004) (“Black’s”) (defining “avoid” as a verb that means “[t]o render void”), with Black’s at 2562 (defining avoidable, or “voidable,” as an adjective that describes a transaction that can be voided but that is “[v]alid until annulled”); see also Ex. A (Tr. at 8:19-21) (“Avoid and avoidable are different words used differently in fraudulent conveyance law.”). Where, as here, the Trustee has failed to avoid the transfer to the initial transferees, he is statutorily precluded from recovering the value of the transfers from the subsequent transferees.

The Sentry Transfers. The Trustee has not avoided the transfers to Sentry, the initial transferee, and can no longer do so. In settling his dispute with Sentry, the Trustee strategically decided to forgo avoiding the transfers to Sentry. The Consent Judgment entered against Sentry does not avoid the initial transfers to Sentry. See Consent Judgment. This is not surprising. Under the Settlement Agreement, the Trustee is entitled to a significant percentage of any recovery made by Sentry in the hundreds of so-called Redeemer Actions brought in this Court by Fairfield’s Joint Liquidators (the “Redeemer Actions”). See In re Fairfield Sentry Ltd.,B.R. —, No. 10-13164, 2011 WL 1998374, at *3 (Bankr. S.D.N.Y. May 23, 2011). A judgment avoiding the initial transfers to Sentry would necessarily include a finding of bad faith on the part of Sentry. See Picard v. Chais (In re Bernard L. Madoff Inv. Sec. LLC), 445 B.R. 206, 228 (Bankr. S.D.N.Y. 2011) (“Under the NYDCL provisions governing constructively fraudulent transfers, the Trustee may avoid those transfers for which BLMIS did not receive ‘fair consideration.’ Fair consideration’ requires not only ‘fair equivalent’ property, but also that the transferee [here, Sentry] receive the transfer in good faith.” (internal citation omitted)); Slone v.  Lassiter (In re Grove-Merritt), 406 B.R. 778, 811 (Bankr. S.D. Ohio 2009) (avoiding transfer under Bankruptcy Code where defendant was “not a ‘good faith’ transferee”). A finding of bad faith on the part of Sentry would prevent Sentry from prevailing on its equitable claims in the Redeemer Actions, with the result that the Trustee would be unable to collect his percentage of the potential recovery. Laugh Factory, Inc. v. Basciano, 608 F. Supp. 2d 549, 560 (S.D.N.Y. 2009) (“It is well-established that a court of equity will not exercise its power in favor of a plaintiff whose actions show inequitable conduct or bad faith . . . .”); see also Picard v. Merkin  (In re Bernard L. Madoff Inv. Sec. LLC), 440 B.R. 243, 262-63 (Bankr. S.D.N.Y. 2010) (a plaintiff who acted in bad faith cannot recover on an equitable claim). The Trustee cannot now claim that the initial transfers to Sentry have been or can be avoided, because he has elected to pursue recoveries through Sentry’s Redeemer Actions and has purported to preserve those actions by agreeing to the Settlement Agreement with Sentry and the accompanying Consent Judgment—neither of which avoids the initial transfers to Sentry.

Apart from being required by the plain language of section 550, this result is fair and equitable. See Momentum Mfg. Corp. v. Emp. Mfg. Corp. (In re Momentum Mfg. Corp.), 25 F.3d 1132, 1136 (2d Cir. 1994) (“It is well settled that bankruptcy courts are courts of equity, empowered to invoke equitable principles to achieve fairness and justice in the reorganization process.”). The Trustee, through his settlement with Sentry, has reduced Sentry’s claim against the BLMIS estate to twenty percent of its original claim (from $1.2 billion to $230 million). The Trustee should not be allowed to nevertheless seek 100 percent of Sentry transfers from an investor in Sentry (especially one like CGML that lost approximately $130 million to Madoff s fraud). This is particularly true as the settlement reduces Sentry’s customer claim against BLMIS, and thereby drastically reduces the recovery of the holders of Sentry’s shares, such as CGML. (This Court has already held that subsequent transferees from Sentry, like CGML, have no customer claim of their own against BLMIS. See SIPC v. Bernard L. Madoff Inv. Sec. LLC  (In re Bernard L. Madoff), No. 08-01789, 2011 WL 2546211 (Bankr. S.D.N.Y. June 28, 2011)).

Prime Fund Transfer. With respect to the transfer Citibank allegedly received from Prime Fund, the Trustee has also not avoided the transfer from BLMIS to Prime Fund, the purported initial transferee. Until he does so, this action cannot be maintained, because on its face the Complaint has failed to fulfill the requirements of section 550 and cannot do so. To permit the Trustee to pursue his recovery action against Citibank when he has only recently commenced the avoidance action against Tremont and Prime Fund (indeed, to date, neither Tremont nor Prime Fund have responded to the Trustee’s complaint) risks substantial prejudice to Citibank. For instance, if the Trustee is permitted to proceed against Citibank now but ultimately fails to avoid the initial transfers to Prime Fund, Citibank will have incurred substantial legal fees and disruption to its business by being forced to participate in what is likely to be an expensive and time-consuming litigation. Moreover, permitting the Trustee’s action against Citibank to proceed before his action against Prime Fund is resolved creates a risk of inconsistent adjudication that should be avoided. Orange Chicken, L.L.C. v. Nambe Mills, Inc., No. 00 Civ. 4730 (AGS), 2000 WL 1858556, at *9 (S.D.N.Y. Dec. 19, 2000) (“[A] stay of the instant action is warranted in the interests of the parties and judicial economy, and in order to avoid possible inconsistent results.”).

In sum, the Trustee’s recovery claims against the Citi Defendants must be dismissed. The Trustee’s claims against CGML must be dismissed with prejudice because he has not avoided, and now cannot avoid, the transfers from BLMIS to Sentry. Similarly, the Trustee’s claims against Citibank should be dismissed as premature, or at the very least, these claims should be stayed pending adjudication of an action for avoidance as to the alleged initial transfer to Prime Fund.