STUART M. BERNSTEIN, United States Bankruptcy Judge:
The defendants David Ivan Lustig ("Lustig") and the Lustig Family 1990 Trust ("Lustig Trust," and collectively with Lustig, the "Lustig Defendants") withdrew approximately $7 million in fictitious profits from their customer accounts maintained at Bernard L. Madoff Investment Securities LLC ("BLMIS"). They claim that they reinvested the withdrawn sums indirectly back into BLMIS through a series of transfers among other feeder funds that invested with Madoff, and all of the reinvested money was lost as a result of Madoff's Ponzi scheme.
Irving H. Picard (the "Trustee"), as trustee for the liquidation of BLMIS under the Securities Investor Protection Act, 15 U.S.C. §§ 78aaa, et seq. ("SIPA"), sued the Lustig Defendants in separate adversary proceedings to recover the fictitious profits they withdrew. The Lustig Defendants asserted numerous affirmative defenses, several of which revolve around the concept that they are entitled to a credit for the amounts that others reinvested into BLMIS. The Trustee has moved to strike those defenses, (Notice of Trustee's Motion to Strike Affirmative Defenses, dated Feb. 28, 2017 (ECF Doc. # 73)),
The background to Madoff's Ponzi scheme has been recounted in numerous opinions, e.g. SIPC v. BLMIS (In re BLMIS), 424 B.R. 122, 125-32 (Bankr. S.D.N.Y. 2010), aff'd, 654 F.3d 229 (2d Cir. 2011), cert. denied, 567 U.S. 934, 133 S.Ct. 25, 183 L.Ed.2d 675 (2012), and need not be restated here as they are not in dispute on this motion. The Lustig Defendants maintained separate customer accounts with BLMIS. Between June 26, 2007 and September 25, 2008, the Lustig Trust withdrew $8.8 million from BLMIS Account 1ZB268, of which $4,241,336 constituted fictitious profits. On July 25, 2007, Lustig withdrew $2 million from BLMIS Account 1ZR297, of which $1,863,225 constituted fictitious profits.
According to the Lustig Defendants, they reinvested all of the withdrawn fictitious profits, totaling approximately $7 million, with Lakeview Investment, LP ("Lakeview").
The Lustig Defendants denied the material allegations in the Complaints, and in relevant part, asserted identical affirmative defenses. (See Answer, dated May 2, 2016 (ECF Doc. # 58); Answer, dated May 2, 2016 (ECF Adv. Proc. No. 10-04554 Doc. # 61).) The Eighth through Twelfth Affirmative Defenses alleged that the entire sum that was withdrawn by the Lustig Defendants was reinvested with BLMIS through Lakeview, the reinvested sums were lost as a result of Madoff's fraud, the Lustig Defendants did not actually receive any fictitious profits, and in fact, they lost money as a result of Madoff's fraud. Based on these allegations, the Lustig Defendants contend that the Court should use its equitable powers to dismiss the claims, (Eight Affirmative Defense), and/or grant them an "equitable credit," (Ninth Affirmative Defense), the claims are barred by the single satisfaction rule under 11 U.S.C. § 550(d), (Tenth Affirmative Defense), they are entitled to a credit under the theory of recoupment, (Eleventh Affirmative Defense), and they are entitled to a set off under 11 U.S.C. § 553 (Twelfth Affirmative Defense). The Lustig Defendants subsequently withdrew the set off defense, (Defendants' Memorandum of Law in Opposition to Trustee's Motion to Strike Certain Affirmative Defenses, dated Mar. 31, 2017 ("Lustig Memo"), at 17 n. 5 (ECF Doc. # 76)), and the motion directed at the Twelfth Affirmative Defense requires no further consideration.
The Trustee moved to strike these defenses as legally insufficient pursuant to Rule 12(f) of the Federal Rules of Civil Procedure. The Lustig Defendants submitted a substantial amount of documentary evidence and Lustig's affidavit in opposition, and at the Court's suggestion, the parties agreed to treat the motion as one for partial summary judgment dismissing these defenses. To expedite consideration of the legal issues, I will assume solely for the purposes of the motion that the series of transfers occurred as the Lustig Defendants claim, the fictitious profits they withdrew were subsequently deposited by the Funds in their own BLMIS accounts, and the value of those accounts was effectively zero when the Madoff scandal was revealed.
Through his motion, the Trustee contends that the Bankruptcy Code does not authorize equitable defenses or an "equitable credit" to offset a fraudulent transfer. (Memorandum of Law in Support of the Trustee's Motion to Strike Affirmative Defenses, dated Feb. 28, 2017 ("Trustee Memo"), at 5-7 (ECF Doc. # 74).) Further, the single satisfaction rule codified in 11 U.S.C. § 550(d) is inapplicable because we are dealing with separate initial transfers to the Lustig Defendants and the Funds, (id. at 7-8), and the doctrine of recoupment does not apply because the Trustee's claims and the Lustig Defendants' claims arise out of different transactions. (Id. at 9-10.) The Lustig Defendants' opposition takes the contrary view on each of these points. (See Lustig Memo at 22-40.) The Trustee's reply emphasized that "[a]llowing Defendants to avoid liability in
Bankruptcy Code § 548(a) authorizes a bankruptcy trustee to avoid a fraudulent transfer made by the debtor, and SIPA extends that authority to the Trustee. 15 U.S.C. § 78fff-2(c)(3) ("[T]he trustee may recover any property transferred by the debtor which, except for such transfer, would have been customer property if and to the extent that such transfer is voidable or void under the provisions of Title 11"). If the trustee avoids the transfer under § 548, Bankruptcy Code § 550(a) permits him to recover the initial transfer or its value, "if the court so orders," from the initial transferee, any subsequent transferees or the entity for whose benefit the transfer was made. The purpose of § 550(a) is to restore the estate to the condition it would have been in if the transfer had never occurred. Hirsch v. Gersten (In re Centennial Textiles, Inc.), 220 B.R. 165, 176 (Bankr. S.D.N.Y. 1998), supplemented by 220 B.R. 177 (Bankr. S.D.N.Y. 1998); accord Nisselson v. Salim (In re Big Apple Volkswagen, LLC), Adv. Proc. No. 11-2251 (JLG), 2016 WL 1069303, at *14 (Bankr. S.D.N.Y. Mar. 17, 2016); 5 ALAN N. RESNICK & HENRY J. SOMMER, COLLIER ON BANKRUPTCY ¶ 550.02[3], at 550-10 (16th ed. 2016) ("COLLIER"). The choice under § 550(a) between ordering the return of the property or its value gives the Court flexibility to grant the appropriate remedy when the value is uncertain or has changed since the transfer. "The factors which the Court should consider in determining whether to order turnover of the property rather than payment of the value include whether the value of the property (1) is contested; (2) is not readily determinable; or (3) is not diminished by conversion or depreciation." Centennial Textiles, 220 B.R. at 177; accord Andrew Velez Constr., Inc. v. Consol. Edison Co. of New York, Inc. (In re Andrew Velez Constr., Inc.), 373 B.R. 262, 274 (Bankr. S.D.N.Y. 2007); 5 COLLIER ¶ 550.02[3], at 550-10 to 550-11. Where the transfer involves cash, the Court's discretion does not come into play.
Finally, "[t]he trustee is entitled to only a single satisfaction under [550(a)]." 11 U.S.C. § 550(d). Thus, although the trustee can sue many defendants, his total recovery is limited to the initial transfer or its value. For example, if the debtor transferred $1.00 fraudulently, and that $1.00 was transferred and re-transferred fifty times, the Trustee can sue the initial transferee and the fifty subsequent transferees, but can only recover $1.00.
The Lustig Defendants do not dispute, again for the purposes of the Trustee's motion, that the transfers of fictitious profits they received are avoidable under Bankruptcy Code § 548(a).
The Eighth and Ninth Affirmative Defenses ask the Court to use its general equity powers under § 105(a)
We are frequently reminded that the equitable powers of the bankruptcy court "must and can only be exercised within the confines of the Bankruptcy Code." Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988); accord Law v. Siegel, ___ U.S. ___, 134 S.Ct. 1188, 1194, 188 L.Ed.2d 146 (2014); Solow v. Kalikow (In re Kalikow), 602 F.3d 82, 96 (2d Cir. 2010); Smart World Techs., LLC v. Juno Online Servs., LLC (In re Smart World Techs., LLC), 423 F.3d 166, 184 (2d Cir. 2005); Schwartz v. Aquatic Dev. Grp., Inc. (In re Aquatic Dev. Grp., Inc.), 352 F.3d 671, 680 (2d Cir. 2003) (Straub, J., concurring). Section 105(a) "does not authorize the bankruptcy courts to create substantive rights that are otherwise unavailable under applicable law, or constitute a roving commission to do equity," Kalikow, 602 F.3d at 96 (citation and internal quotation marks omitted); New England Dairies, Inc. v. Dairy Mart Convenience Stores, Inc. (In re Dairy Mart Convenience Stores, Inc.), 351 F.3d 86, 92 (2d Cir. 2003) (quoting United States v. Sutton, 786 F.2d 1305, 1308 (5th Cir.1986)), and extends only to the exercise of equity "in carrying out the provisions of the Bankruptcy Code, rather than to further the purposes of the Code generally, or otherwise to do the right thing." Dairy Mart, 351 F.3d at 92 (emphasis in original); accord Kalikow, 602 F.3d at 97.
Here, the credits that the Lustig Defendants seek are inconsistent with express provisions of the Bankruptcy Code and SIPA which give the credit they seek to the entity that gave the value to the debtor. Bankruptcy Code § 548(c) provides a defense to the extent that the initial transferee takes in good faith and "gave value to the debtor in exchange for such transfer or obligation." The Funds gave the value through the deposits that the Lustig Defendants are trying to conscript for their own benefit, and the Funds are entitled to the credit for those deposits under § 548(c). Similarly, the Funds received a credit for those deposits under SIPA. The Funds are net losers, and under the "Net Investment Method" approved by the Second Circuit, see In re BLMIS, 654 F.3d 229, 239 (2d Cir. 2011), cert. denied, 567 U.S. 934, 133 S.Ct. 24, 25, 183 L.Ed.2d 675 (2012), they are entitled to net equity claims based on the difference between the amount they deposited and the amount they withdrew from their BLMIS accounts. The deposits increased the allowable net equity claims asserted by the Funds, and the Lustig Defendants' invocation
Moreover, the credits given to the Funds on account of these deposits are not just theoretical; the Trustee has distributed cash to the Funds based on the deposits. The Trustee sued the Tremont Group, including Rye Broad Market, and in July 2011, the parties reached a settlement.
The Trustee also sued Senator to recover $95 million withdrawn over the life of its account and to disallow its customer net equity claim. In November 2014, the parties reached a settlement.
Through eight interim distributions, the Funds as well as other net losers have received slightly more than 60% of the allowed amounts of their claims. (See Motion for an Order Approving Eighth Allocation of Property to the Fund of Customer Property and Authorizing Eighth Interim Distribution to Customers, Dec. 14, 2016, at ¶ 7 (ECF Case No. 08-01789 Doc. # 14662).)
The Lustig Defendants also contend through their Tenth Affirmative Defense that permitting the Trustee to recover against them would violate the single satisfaction rule embodied in 11 U.S.C. § 550(d). As noted, Section 550(a) allows the Trustee to recover an avoided transfer or its value, but under § 550(d), "[t]he trustee is entitled to only a single satisfaction under subsection (a) of this section." The single satisfaction rule is a limitation on recovery rather than a defense to the avoidance of the fraudulent transfer, but the effect is the same.
As explained earlier, Section 550(d) applies to limit a trustee's recovery in those situations where he sues multiple defendants to recover the value of the avoided initial transfer. See White v. Jones (In re Butler Innovative Solutions, Inc.), Adv. Proc. No. 10-10021, 2015 WL 1926814, at *8 (Bankr. D.D.C. Apr. 27, 2015), supplemented by Adv. Proc. No., 10-10021, 2015 WL 5118684 (Bankr. D.D.C. Aug. 28, 2015). The Trustee sued the Funds as initial transferees based on their withdrawals from their BLMIS accounts. He did not sue them as subsequent transferees of the Lustig Defendants, who are liable to the estate on account of the initial transfers that they received. Thus, even if the Trustee recovered the entire initial transfers made to the Funds, Bankruptcy Code § 550(d) does not foreclose the Trustee from recovering the full amount of the initial transfers made to the Lustig Defendants.
The Eleventh Affirmative Defense relies on the doctrine of recoupment. Recoupment rights are determined pursuant to nonbankruptcy law. New York State Elec. & Gas Corp. v. McMahon (In re McMahon), 129 F.3d 93, 96 (2d Cir. 1997). Under New York law,
Id. (quoting Nat'l Cash Register Co. v. Joseph, 299 N.Y. 200, 86 N.E.2d 561, 562 (1949)); accord Westinghouse Credit Corp. v. D'urso, 278 F.3d 138, 146 (2d Cir. 2002).
In bankruptcy, "recoupment seeks to avoid the unjust result that would occur
Assuming that the doctrine of recoupment could ever serve as a defense to a fraudulent transfer claim, it is not available to the Lustig Defendants because the parties' claims arise from different transactions. The Trustee's claims against the Lustig Defendants arise from their withdrawal of fictitious profits from their BLMIS accounts. Their recoupment credit is based on their investment of the withdrawn funds in Lakeview which is an entirely different transaction. Even if one accepted that the credit arises from the Funds' reinvestment of money traceable back to those withdrawals, the reinvestment is still a separate transaction governed by whatever account agreements the Funds had with BLMIS.
Finally, the Lustig Defendants' authorities are distinguishable. They rely mainly on two cases. In Dobin v. Presidential Fin. Corp. of Delaware Valley (In re Cybridge Corp.), 312 B.R. 262 (D.N.J. 2004), the Cybridge Corporation ("Cybridge") entered into a pre-petition "factoring" agreement with Presidential Financial Corporation of Delaware Valley ("Presidential"). Presidential advanced up to 80% of the value of Cybridge's eligible accounts receivable, and Presidential's loan was secured, inter alia, by a first lien on the accounts receivable. Presidential collected the receivables from the customer and applied the payments to the outstanding debt. Id. at 265.
Cybridge filed a chapter 11 case, but did not list Presidential as a creditor or provide it with notice of the bankruptcy. As a result, Presidential continued to advance funds and collect the accounts receivable. Cybridge, 312 B.R. at 265. During the chapter 11 period, Presidential collected $163,847.00 but advanced $192,200.00 in new loans.
The Bankruptcy Court granted summary judgment and the District Court affirmed. It ruled that the recovery was barred by Bankruptcy Code § 550(d) which "empowers courts to prohibit a trustee from recovering under Section 550(a) from a transferee that has already returned to the estate that which was taken in violation of the Code." Cybridge, 312 B.R. at 271. "Cash is fungible," and Presidential had returned the cash it collected through new advances. This limited the
The Lustig Defendants' other authority, Bakst v. Sawran (In re Sawran), 359 B.R. 348 (Bankr. S.D. Fla. 2007), extended Cybridge's rationale to subsequent transferees. There, the debtor's father supported the debtor, and the debtor paid $20,000.00 to her father from the proceeds of the settlement of a personal injury claim. When the father's health deteriorated and he could no longer care for the debtor, he transferred $10,000.00 to his son and daughter-in-law and $10,000.00 to his daughter, instructing them to pay the debtor's rent and living expenses. They paid an aggregate of $12,000.00 to the debtor before the bankruptcy and an additional $8,000.00 after the bankruptcy. Id. at 350-51.
The trustee sued the father, obtained a $20,000 preference judgment, and sued the son, the son's wife and the daughter (collectively, the "Defendants") as subsequent transferees. Relying on Cybridge, the Bankruptcy Court concluded that permitting the Trustee to recover $20,000.00 from the Defendants after they had returned $12,000.00 to the debtor pre-petition would create a $12,000.00 windfall that violated the single satisfaction rule under § 550(d). Id. at 353. The Defendants were also entitled to an equitable credit under Bankruptcy Code § 105(a). Granting the equitable credit was consistent with the Bankruptcy Code because the Defendants restored the debtor to the financial condition she would have been if the $12,000.00 transfer had never occurred. Id. at 354. Further, the Defendants accepted the $20,000, not for personal gain, but to take care of the debtor after her father became incapacitated, and disbursed the money to the debtor at the father's request. Id.
Assuming that the cases were correctly decided, they are distinguishable. In both cases, the party sued by the trustee had already returned part or all of the initial transfer to the debtor or the estate before the bankruptcy had been commenced or converted. These payments cured the diminution in the value and made the debtor or the estate whole. Moreover, the parties had acted in good faith, and in fact, Presidential had been duped into continuing to collect accounts receivable and advance fresh funds during the chapter 11.
Here, in contrast, the Lustig Defendants did not repay BLMIS, the Funds did and received the credit for those payments. Instead, the Lustig Defendants withdrew their funds, obtained complete dominion and control over the money and were free to use it as they saw fit. No one forced them to invest in Lakeview, and they are
Accordingly, the Eighth through Eleventh Affirmative Defenses are stricken, and the Twelfth Affirmative Defense is withdrawn. Settle order on notice.