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On January 24, 2017, victims of Bernard Madoff’s Ponzi scheme lost their appeal of a bankruptcy court decision barring them from suing an alleged Madoff co-conspirator because of a third-party injunction contained in a settlement between the alleged co-conspirator and the Trustee liquidating Madoff’s scheme. See A & G Goldman Partnership v. Capital Growth Company (In re Bernard L. Madoff Investment Securities LLC), 565 B.R. 510, 514-515 (S.D.N.Y. Jan. 24, 2017) (Woods, J.) (herein, Goldman III).1 The Goldman III securities claims were held to be “incident to” and a “secondary effect of” a broader fraudulent transfer scheme and, ergo, considered settled by the Trustee’s fraudulent transfer claims. This language from Goldman III could be read to effectively swallow up many other claims in any Ponzi scheme scenario, but that language is tempered by the facts and procedural history, as detailed herein.  

In 2009, the Trustee2 had sued certain parties affiliated with Jeffry M. Picower (herein, Picower) for fraudulent transfers, avoidable preferences, and turnover of property of the estate. Picower had withdrawn $7.2 billion from Madoff’s scheme (herein, BLMIS).3 The Trustee alleged that, in the course of making those withdrawals, going back to 1995, Picower knew or should have known that BLMIS was a Ponzi scheme and actively participated by giving directions to BLMIS to create fictitious trading records for their accounts.

In 2010, Picower settled with the Trustee, with Picower agreeing to contribute about twice the amount that the Trustee had thus far recovered on behalf of the BLMIS estate.4 Picower’s settlement was approved by the bankruptcy court and accompanied by an injunction barring any other party from bringing claims that were “duplicative or derivative” of those brought by the Trustee against Picower.  

In 2014, certain former customers (the Goldman Parties) brought a class action alleging that Picower was a “control person” of BLMIS under Section 20(a) of the Securities Exchange Act of 1934. The Trustee had never brought securities claims against Picower. The Goldman Parties alleged that Picower was a “control person” of BLMIS under the Act by virtue of, inter alia, making loans to “prop up” the Ponzi scheme and agreeing to act as a counterparty in phony options contracts to deceive auditors, regulators and customers. Goldman III was one of a series of attempts by the Goldman Parties and others to sue Picower. 

Goldman III held that the Goldman Parties’ securities claims were derivative of the Trustee’s fraudulent transfer claims, applying a Second Circuit framework from St. Paul Fire & Marine Insurance Co. v. PepsiCo., Inc., 884 F.2d 688, 701 (2d Cir. 1989). The St. Paul framework distinguishes between “general” claims to be brought by the trustee of a bankrupt estate and “particularized” ones to be brought by individual creditors of the estate. The trustee brings a claim if it “is a general one, with no particularized injury arising from it, and if that claim could be brought by any creditor of the debtor." Goldman III, 565 B.R. at 516 (citing St. Paul). By contrast, a particularized claim “can be directly traced to the third party’s conduct” and is “specific to that plaintiff, in that his injury is ‘directly traced to’ the non-debtor’s conduct.” Id.

Goldman III concluded that the facts alleged in the Goldman Parties’ securities claims were merely “incident to” the fraudulent transfer claims brought by the Trustee. The allegations tying Picower’s involvement to the harm alleged by the Goldman Parties were described as “wholly conclusory.” 565 B.R. at 521. “What the complaint does not allege are particular instances in which Picower, through the conduct described in the complaint, directed BLMIS to provide false or misleading information to [the Goldman Parties] (or the proposed class members).” Id. at 524.  Instead, the complaint alleged that Picower “engaged in various categories of fraudulent conduct which had the purpose and effect of further effectuating Madoff’s Ponzi scheme.” Id. at 523. As the Goldman III opinion concluded, “at its core, those actions amounted to two generalized categories of conduct that ‘pushed the debtor into bankruptcy.’” Id. at 524. 

The opinion noted that courts applying the St. Paul framework have looked to substance over form in rejecting attempts by other former BLMIS customers to “side step” the injunction that was part of the settlement with the Trustee. Id. at 515.5 Goldman III recounts the history of parties (repeatedly attempting to) plead around an injunction granted in connection with the largest settlement in the Madoff case. That history involved courts applying St. Paul so as to avoid a “formalistic approach” that would “look only to the titular cause of action” because parties could “easily plead around” such an approach “by deceptively labeling their claims” and “repackag[ing] the same facts.” Id. at 517.6  

Goldman III could be cited as an example of how third-party injunctions may be broadly construed when entered to prevent a collective action problem and maximize an estate. The opinion contains broad language that could subsume many other claims. Where a trustee sues for a general scheme of fraud that puts a debtor into bankruptcy, the facts that would support many other claims could be – at least at a certain level of generality – characterized as “incident to” that scheme or a “secondary effect” of it. Such language could be used as a sword by any party seeking to enforce an injunction, or perhaps in bargaining to obtain a settlement like that in Goldman III.  But the case’s procedural history blunts that sword. As its title suggests, Goldman III involved attempts to sue Picower before, during, and after the Trustee’s suit. And the claims contained only “wholly conclusory” allegations tying Picower to the Goldman Parties, unlike the suits involving a particularized and direct harm, such as when an accounting firm “took the lead” in distributing memos that placed investors in the deals. Id. at 525 (internal citations omitted). Ultimately, a take-away for those seeking to obtain, or to avoid, such an injunction may be to pay close attention to how the facts are alleged in the respective suit, with a particular attention to whether there a harm can be alleged to be particular, or not.


1 The appeal generating the Goldman III decision was taken from the U.S. Bankruptcy Court for the Southern District of New York to the U.S. District Court for the Southern District of New York.

2 Irving Picard, the Trustee appointed pursuant to the Securities Investor Protections Act and provided with the powers and duties of a bankruptcy trustee, had a duty to liquidate the Madoff scheme and ratably distribute what could be recovered to the “net losers” in the scheme.

3 BLMIS stands for the Bernard L. Madoff Investment Securities, LLC.

4 Picower paid $7.2 billion, with $5 billion going to the BLMIS estate and the remainder to the U.S. Government.  The Trustee reports recovering $11.564 billion as of Goldman III; at the time of the settlement, the Trustee had only recovered 2.17 billion., accessed February 20, 2017. 

5 Courts invoke the notion of substance over form in various contexts, such as discerning whether a lease is really a security interest, whether debt is really equity, or what the real economic substance of a transaction is for tax purposes. Such contexts involve courts inquiring whether a legal label fits certain facts. Goldman III, however, involved a comparison of facts to other facts to assess whether the Goldman Parties’ claims were part or derivative of a broader set of facts, i.e., the Trustee’s claims that were already settled. 

6 For instance, other former customers had brought claims under Florida law for conversion, unjust enrichment, conspiracy, and state RICO violations. Id. at 516 (citing St. Paul and discussing Fox I). Those Florida law claims were deemed to be “substantively duplicative” of the Trustee’s fraudulent transfer action. Id. at 515. The alleged wrongful acts harmed every customer in the same way: by withdrawing billions of dollars from BLMIS and pushing BLMIS closer to bankruptcy. Id. at 515-516. The Second Circuit affirmed that decision, holding that a derivative injury is “‘based upon a secondary effect of harm done to the debtor,’ while an injury ‘is said to be particularized’ when it can be ‘directly traced to the third party’s conduct.’” Id.