Madoff Trustee Seeks to Block New York's $410 Million Settlement With Madoff Investor

The court-appointed trustee overseeing the liquidation of Bernard Madoff's former brokerage firm has filed a lawsuit seeking to block a recently announced $410 million settlement between the New York Attorney General's Office and hedge fund manager J. Ezra Merkin.  The trustee, Irving Picard, claims that the settlement encroaches on his exclusive authority to recover assets for the benefit of Madoff's victims, many of whom stand to receive nothing from the complaint.   Instead, only select investors in Merkin's hedge funds will be entitled to share in the proceeds, which will be doled out through the establishment of a separate complex distribution process.  According to Picard, the settlement will leave little, if any, remaining funds to satisfy Picard's pending claims against Merkin and his hedge funds that total $500 million.  

The suit names the parties to the settlement as defendants, which include the New York Attorney General, Eric T. Schneiderman, as well as Merkin, his four hedge funds, and the court-appointed receivers for two of those hedge funds.  Reached in late June, the settlement pending litigation instituted by the New York Attorney General's ("NYAG") Office and the court-appointed receiver for two of Merkin's funds (the "Settlement").  Both sought damages from Merkin and his funds, seeking hundreds of millions of dollars in fees "earned" by Merkin for investing customer funds when, in reality, nearly all of those funds were turned over to Madoff.  Merkin, according to the lawsuits, failed to adequately investigate Madoff's operation or oversee the investment of customer funds with Madoff.  Consequently, when Madoff's scheme collapsed in December 2008, Merkin's investors lost hundreds of millions of dollars, even though many had no idea that they were indirectly investing with Madoff.  

The Settlement would compensate investors in Merkin's funds depending on a determination as to whether they were aware that Merkin was investing their funds with Madoff.  Those investors who were unaware of this delegation would be eligible to receive over 40% of their cash losses, while investors who were aware of Madoff's role would be entitled to a smaller recovery.  

Picard makes his frustration evident, claiming that the Settlement is "nothing less than an out and out assault on this Court's jurisdiction over the BLMIS estate and the equitable distribution scheme put into place by this Court and affirmed by the Second Circuit."  No doubt aware of the ramifications of the settlement, the NYAG resisted efforts by Picard's office to obtain a copy of the settlement agreement despite lengthy negotiations that included a proposed confidentiality agreement, eventually deeming the request as "premature."  

The focal point of Picard's argument appeals to the Bankruptcy Court's exclusive jurisdiction under the Bankruptcy Code to institute actions and recover assets for the benefit of Madoff's victims.  Allowing the Settlement would not only undermine the Court's jurisdiction, argues Picard, but would also circumvent the claims process overseen by Picard.  This exclusive jurisdiction includes an automatic stay provision under 11 U.S.C. 362(a), which prevents third-parties from interfering with the trustee's exclusive right to seek recovery of fraudulently transferred property of the bankruptcy debtor. 

Under the Bankruptcy Code, a trustee is permitted to institute "avoidance actions" to recover transfers made by the debtor to outside parties within time periods statutorily imposed by state and federal law.  The Bankruptcy Code permits the recovery of these "fraudulent transfers", as they are known, made within two years of the bankruptcy petition date, while New York State law allows recovery for transfers made within six years of the petition date.  Because most, if not all, of the funds held by the Hedge Funds consist of fraudulent transfers from Madoff, Picard argues that the funds rightfully belong to the bankruptcy estate.  According to Picard, "The recovery of these amounts by the NYAG would significantly reduce the Merkin Defendants’ assets, and possibly exhaust available liquid assets, rendering any victory by the Trustee in his litigation pyrrhic." 

Picard is seeking a declaration that the Settlement violates the automatic stay provision, as well as injunctive relief prohibiting the payment of funds to satisfy the Settlement or institution of any claims process by the NYAG. 

A copy of the Complaint is here.

Previous coverage of the Settlement is here.