Irving H. Picard v. Saul B. Katz et al

Filing 70

REPLY MEMORANDUM OF LAW re: 63 Memorandum of Law in Support, 61 Memorandum of Law, /REPLY MEMORANDUM OF LAW REGARDING DETERMINATION OF "FOR VALUE" AND NET EQUITY DECISION. Document filed by Charles 15 Associates, Charles 15 LLC, Charles Sterling LLC, Charles Sterling Sub LLC, College Place Enterprises LLC, Coney Island Baseball Holding Company LLC, Estate of Leonard Schreier, FFB Aviation LLC, FS Company LLC, Fred Wilpon Family Trust, Arthur Friedman, Ruth Friedman, Iris J. Katz and Saul B. Katz Family Foundation, Inc., Judy and Fred Wilpon Family Foundation, Inc., Amy Beth Katz, David Katz, Dayle Katz, Gregory Katz, Howard Katz, Iris Katz, 157 J.E.S. LLC, Air Sterling LLC, BAS Aircraft LLC, Jason Bacher, Bon Mick Family Partners LP, Bon-Mick, Inc., Brooklyn Baseball Company LLC, C.D.S. Corp., Michael Katz, Saul B. Katz, Todd Katz, Katz 2002 Descendants' Trust, Heather Katz Knopf, Natalie Katz O'Brien, Mets II LLC, Mets Limited Partnership, Mets One LLC, Mets Partners, Inc., Minor 1 (REDACTED), Minor 2 (REDACTED), L. Thomas Osterman, Phyllis Rebell Osterman, Realty Associates Madoff II, Red Valley Partners, Robbinsville Park LLC, Ruskin Garden Apartments LLC, Saul B. Katz Family Trust, Michael Schreier, Deyva Schreier Arthur, See Holdco LLC, See Holdings I, See Holdings II, Sterling 10 LLC, Sterling 15C LLC, Sterling 20 LLC, Sterling Acquisitions LLC, Sterling American Advisors II LP, Sterling American Property III LP, Sterling American Property IV LP, Sterling American Property V LP, Sterling Brunswick Corporation, Sterling Brunswick Seven LLC, Sterling Dist Properties LLC, Sterling Equities, Sterling Equities Associates, Sterling Equities Investors, Sterling Heritage LLC, Sterling Internal V LLC, Sterling Jet II Ltd., Sterling Jet Ltd., Sterling Mets Associates, Sterling Mets Associates II, Sterling Mets LP, Sterling Pathogenesis Company, Sterling Third Associates, Sterling Thirty Venture LLC, Sterling Tracing LLC, Sterling Twenty Five LLC, Sterling VC IV LLC, Sterling VC V LLC, Edward M. Tepper, Elise C. Tepper, Jacqueline G. Tepper, Marvin B. Tepper, Valley Harbor Associates, Kimberly Wachtler, Philip Wachtler, Bruce N. Wilpon, Daniel Wilpon, Debra Wilpon, Fred Wilpon, Jeffrey Wilpon, Jessica Wilpon, Judith Wilpon, Richard Wilpon, Scott Wilpon, Valerie Wilpon, Wilpon 2002 Descendants' Trust, Robin Wilpon Wachtler. (Wagner, Karen)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
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:
IRVING H. PICARD,
:
:
Plaintiff,
:
:
11-CV-03605 (JSR)
- against :
:
SAUL B. KATZ, et al.,
:
:
Defendants.
:
:
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REPLY MEMORANDUM OF LAW REGARDING DETERMINATION
OF “FOR VALUE” AND NET EQUITY DECISION

TABLE OF CONTENTS
PAGE
ARGUMENT.......................................................................................................................1
THE TRUSTEE AND SIPC IGNORE CUSTOMER RIGHTS UNDER
NON-BANKRUPTCY LAW AND THE TWO-YEAR LIMITATION OF
SECTION 548(a)(1)(A) .......................................................................................................1
CONCLUSION....................................................................................................................6
TABLE OF AUTHORITIES
CASES
Armstrong v. Collins,
No. 01 Civ. 2437, 2010 U.S. Dist. LEXIS 28075 (S.D.N.Y. Mar. 24, 2010)................3
Barnhill v. Johnson, 503 U.S. 393 (1992) ...........................................................................3
BFP v. Resolution Trust Corp., 511 U.S. 531 (1994)..........................................................2
Butner v. United States, 440 U.S. 48 (1979)....................................................................2, 4
Cunningham v. Brown, 265 U.S. 1 (1924)...........................................................................4
Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008) ..................................................................3
English v. Gen. Elec. Co., 496 U.S. 72 (1990) ....................................................................2
In re Adler, Coleman Clearing Corp., 277 B.R. 520 (Bankr. S.D.N.Y. 2002) ...................4
In re Bayou Group, LLC, 362 B.R. 624 (Bankr. S.D.N.Y. 2007) .......................................3
In re Bayou Group, LLC, 439 B.R. 284 (S.D.N.Y. 2010) ...................................................2
In re Carrozzella & Richardson, 286 B.R. 480 (D. Conn. 2002)........................................3
In re Dreier LLP, 452 B.R. 391 (Bankr. S.D.N.Y. 2011)....................................................3
In re Hedged-Investments Assocs., Inc., 84 F.3d 1286 (10th Cir. 1996) .........................2, 3
In re M&L Bus. Mach. Co., 59 F.3d 1078 (10th Cir. 1995) ................................................4
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PAGE
In re Nat’l Liquidators, Inc., 232 B.R. 915 (Bankr. S.D. Ohio 1998) .................................3
In re Unified Commercial Capital, Inc., 260 B.R. 343 (Bankr. W.D.N.Y. 2001)...........5, 6
In re Unified Commercial Capital,
No. 01-MBK-6004L, 2002 WL 32500567 (W.D.N.Y. June 21, 2002).........................3
Picard v. Katz,
No. 11 Civ. 3605, 2011 U.S. Dist. LEXIS 109595 (S.D.N.Y. Sept. 27, 2011) .............5
Raleigh v. Ill. Dep’t of Revenue, 530 U.S. 15 (2000) ..........................................................4
STATUTES & RULES
11 U.S.C. § 548(a)(1)(A) ........................................................................................... passim
11 U.S.C. § 548(c) ...............................................................................................................1

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Defendants respectfully submit this reply memorandum of law in response to the
memoranda of the Trustee and the Securities Investor Protection Corporation (“SIPC”)
regarding the determination of “value” with respect to avoidance claims under 11 U.S.C.
§ 548(a)(1)(A). The Trustee and SIPC propose entirely different rationales for
disregarding the two-year limitations period of 11 U.S.C. § 548(a)(1)(A), but neither
recognizes customers’ rights under the law governing transactions with brokers, or offers
any authority to justify retroactively eviscerating those rights to avoid transfers prior to
the two-year period.
ARGUMENT
THE TRUSTEE AND SIPC IGNORE CUSTOMER RIGHTS
UNDER NON-BANKRUPTCY LAW AND THE TWO-YEAR
LIMITATION OF SECTION 548(a)(1)(A)
In their opening brief, Defendants demonstrated both that Article 8 of the New
York Uniform Commercial Code governed transactions between BLMIS and its
customers before its filing under the Securities Investor Protection Act (“SIPA”), and that
transfers before the two-year limitations period of 11 U.S.C. § 548(a)(1)(A) are outside
the reach of the Trustee’s avoidance powers. Consequently, each Defendant’s account
balance immediately before the start of the two-year period, together with any deposits
within the period, must be recognized as “value” when evaluating the avoidability of any
transfer within the period as fraudulent.
Indeed, Defendants contend that any withdrawal that discharged BLMIS’
antecedent debt to its customers was “for value.” And, in its opening brief, SIPC agrees,
arguing that the satisfaction of “antecedent debt” constitutes “value” for purposes of
11 U.S.C. § 548(c) and that “debt” is to be construed broadly under the Bankruptcy Code.
1

(SIPC Br. at 3-5.) But SIPC argues that because BLMIS was engaged in fraud, the
“antecedent debt” owed by BLMIS to its customers is limited to net cash deposited—a
contention that would permit the Trustee to ignore Article 8 and effectively to challenge
transfers made long before the relevant two-year period of Section 548(a)(1)(A).
SIPC’s position is legally unfounded. Prior to the SIPA filing, a customer could
have sued BLMIS under Article 8 for the full value owed pursuant to his brokerage
statement, and BLMIS could not have argued that, because it was engaged in fraud,
BLMIS was liable only for net cash deposited over time.1 The SIPA filing did not
retroactively alter BLMIS’ liability. On the contrary, the avoidability of a pre-petition
transfer is evaluated under non-bankruptcy law. See, e.g., Butner v. United States, 440
U.S. 48, 55 (1979) (“Property interests are created and defined by state law. Unless some
federal interest requires a different result, there is no reason why such interests should be
analyzed differently simply because an interested party is involved in a bankruptcy
proceeding.”); BFP v. Resolution Trust Corp., 511 U.S. 531, 544-45 (1994) (rejecting
avoidance of state foreclosure sale as fraudulent under 11 U.S.C. § 548 because state law
precluded trustee’s avoidance claim; “the Bankruptcy Code will be construed to adopt,
rather than to displace, pre-existing state law” unless Congress’s intent to the contrary is
“‘clear and manifest’” (quoting English v. Gen. Elec. Co., 496 U.S. 72, 79 (1990)));

1

The cases offered by SIPC do not generally arise in the broker/customer context,
and are in any event inapposite. See, e.g., In re Hedged-Investments Assocs., Inc., 84
F.3d 1286, 1290 (10th Cir. 1996) (equity investor identified no pre-existing legal right to
payments in excess of principal); In re Bayou Group, LLC, 439 B.R. 284, 337 (S.D.N.Y.
2010) (recognizing, in the context of avoidance claims against equity investors, that if
party had contracted for payment in excess of principal, payment consistent with contract
would be for reasonably equivalent value).
2

Barnhill v. Johnson, 503 U.S. 393, 399-400 (1992) (relying upon the UCC to determine
when a “transfer” by check occurred for purposes of preference avoidance).
Neither SIPC nor the Trustee provides authority for avoiding as fraudulent a
transfer on account of pre-existing debt, or for retroactively altering that debt.2 In fact,
cases cited by both hold that where a transfer satisfies a pre-existing legal obligation, the
transfer is “for value” and is not subject to avoidance as fraudulent. See, e.g., In re
Carrozzella & Richardson, 286 B.R. 480, 491 (D. Conn. 2002) (where payment by Ponzi
schemer extinguished debt, payment could not be avoided as fraudulent); In re Unified
Commercial Capital, No. 01-MBK-6004L, 2002 WL 32500567, at *8-9 (W.D.N.Y. June
21, 2002) (where debtor received value from loan, repayment not avoidable as
fraudulent).
The argument put forward by the Trustee is entirely different, but equally
unfounded. Making reference to no Bankruptcy Code provision, including those that
2

The Net Equity Decision provides no support for SIPC or the Trustee, as it
addresses only the priority of, and distributions on, claims against BLMIS. The other
authorities relied upon by the Trustee are plainly inapposite because each of them
concerns repayments to investors in schemes that bear no resemblance to brokerage
contracts between customers and their registered broker. See, e.g., Donell v. Kowell, 533
F.3d 762, 767-69 (9th Cir. 2008) (seeking avoidance of transfers made to investors in
scheme related to Malaysian latex glove manufacturers); In re Hedged-Investments
Assocs., 84 F.3d at 1287 (seeking avoidance of transfers to equity investors who provided
non-broker with money for purposes of trading in stock options); Armstrong v. Collins,
No. 01 Civ. 2437, 2010 U.S. Dist. LEXIS 28075, at *1-9 (S.D.N.Y. Mar. 24, 2010)
(federal receiver seeking avoidance of transfers to investors in a scheme involving,
among other things, fake rubies, worthless baseball memorabilia, and stock
manipulation); In re Dreier LLP, 452 B.R. 391, 398-99 (Bankr. S.D.N.Y. 2011) (seeking
avoidance of transfers from law firm to hedge funds that invested in fraudulent scheme);
In re Bayou Group, LLC, 362 B.R. 624, 626-27 (Bankr. S.D.N.Y. 2007) (seeking
avoidance of payments on equity investments); In re Nat’l Liquidators, Inc., 232 B.R.
915, 917 (Bankr. S.D. Ohio 1998) (seeking avoidance of transfers to equity investors in a
fraudulent business).
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define “value,” “debt,” or “claim,” or to any other statutory support, the Trustee contends
instead that he must be permitted to ignore customer rights under Article 8, and make
calculations going back twenty-five years instead of two, to prevent “arbitrary and unfair
results.”3 (Trustee Br. at 3-4.) But where a matter is governed by a statute, the Supreme
Court has rejected resort to “equitable” powers to reach a result not contemplated by the
statute. The Trustee is not “authorized in the name of equity to make wholesale
substitution of underlying law controlling the validity of creditors’ entitlements.”
Raleigh v. Ill. Dep’t of Revenue, 530 U.S. 15, 24-25 (2000). “[U]ndefined considerations
of equity” provide no basis for departing from the plain terms of a statute. Butner, 440
U.S. at 55-56.
The Trustee makes the particularly puzzling argument that the Bankruptcy Code’s
policy of equal treatment provides a basis for disregarding the two-year period. Section
548(a)(1)(A) permits avoidance, within the two-year period, of fraudulent conveyances.
Yet the Trustee justifies this avoidance action by reference to Cunningham v. Brown, 265
U.S. 1 (1924), a preference case.4 (Trustee Br. at 8-9 & n.5.) But, as this Court has

The Trustee actually suggests that he would be entitled to assume that the value
in a customer account at the start of the relevant period is zero. (Trustee Br. at 4.) There
is no legal or practical basis for such a proposition. Further, that methodology would
arbitrarily increase customer liability. If, for example, a customer deposited $10 before
the period began, and withdrew nothing until he withdrew $5 within the period, that $5
transfer would be avoidable under the two-year period but not under an unlimited period.
The Trustee’s absurd proposition does not sanction any evasion of the two-year limit of
Section 548(a)(1)(A).
3

4

The other cases cited by SIPC and the Trustee are entirely irrelevant. See In re
M&L Bus. Mach. Co., 59 F.3d 1078, 1079 (10th Cir. 1995) (proceeding involving only
Section 549, which governs post-filing conduct); In re Adler, Coleman Clearing Corp.,
277 B.R. 520, 523 (Bankr. S.D.N.Y. 2002) (subordinating claims of complicit claimant
under Section 510).
4

observed, preference and fraudulent conveyance concepts are different, as are the policies
they serve. See Picard v. Katz, No. 11 Civ. 3605, 2011 U.S. Dist. LEXIS 109595, at *7-8
(S.D.N.Y. Sept. 27, 2011).
The preference provision is the Bankruptcy Code’s principal mechanism for the
achievement of equality among creditors. A payment on existing debt may be avoided as
preferential if it results in one valid creditor being paid more than other valid creditors.
Such a transfer is not avoidable, however, because it is not “for value”—it is avoidable
only because an insolvent debtor may not choose among valid creditors within the ninety
days preceding an insolvency filing.
But this is a fraudulent conveyance case. A fraudulent conveyance, by definition,
was not made to discharge a valid debt or for any other “value.” Fraudulent transfers are
avoidable because they place assets beyond the reach of any and all creditors, without
obtaining in exchange either new consideration or a concomitant reduction of antecedent
debt. A transfer that repays valid debt cannot be avoided as fraudulent, and certainly
cannot be avoided if it occurred before the temporal limit of Section 548(a)(1)(A). In this
case, even SIPC agrees that transfers in satisfaction of antecedent debt, at least to the
extent of net cash investment, or “principal,” cannot be avoided. Therefore, unless a
customer was willfully blind to BLMIS’ fraud when he deposited funds with BLMIS,
rendering the debt itself invalid, a transfer extinguishing BLMIS’ obligation to that
customer cannot be avoided as fraudulent.
The Trustee is trying to “force the square peg facts of a ‘Ponzi’ scheme into the
round holes of the fraudulent conveyance statutes in order to accomplish a further
reallocation and redistribution to implement a policy of equality of distribution in the
5

name of equity.” In re Unified Commercial Capital, Inc., 260 B.R. 343, 350 (Bankr.
W.D.N.Y. 2001). This he cannot do. Neither SIPC nor the Trustee has offered a credible
rationale for permitting the avoidance of transfers prior to the start of the two-year limit
of Section 548(a)(1)(A), or for displacing Article 8 with respect to the calculation of
“value” at the start of the period.
CONCLUSION
For the reasons set forth above and in their opening memorandum, Defendants
respectfully submit that the methodology for calculating “value” put forward by SIPC
and the Trustee is contrary to law. Even using the Trustee’s methodology, transfers
during the two-year period are not subject to avoidance under Section 548(a)(1)(A)
unless they exceeded the sum of the customer’s account balance at the start of the twoyear period and any deposits within that period.
Dated:

New York, New York
November 4, 2011
DAVIS POLK & WARDWELL LLP
By: /s/ Karen E. Wagner
Karen E. Wagner
Dana M. Seshens

Of Counsel:
Robert B. Fiske, Jr.
Robert F. Wise, Jr.

450 Lexington Avenue
New York, New York 10017
Telephone:
[phone]
Facsimile:
[phone]
Attorneys for Defendants

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