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Madoff Trustee Wins, Loses With Rakoff: Bankruptctcy

Dec. 10 (Bloomberg) -- The trustee liquidating Bernard L. Madoff Investment Securities Inc. scored one victory and incurred two losses late last week at the pen of U.S. District Judge Jed Rakoff.

On a fourth issue, Rakoff left the door open a crack for Madoff trustee Irving Picard to sue executives of so-called feeder funds who collected money from their own customers which they in turn invested in the Madoff Ponzi scheme.

Picard might end up victorious on that issue depending on how the U.S. Supreme Court rules in a case argued before the high court in early October.

Rakoff’s ruling on Dec. 6 regarding feeder funds was in large part pre-ordained by a decision he wrote in September when sitting by designation as one of three judges in the U.S. Court of Appeals reviewing another district judge’s dismissal of a lawsuit against JPMorgan Chase & Co. and Bank of New York Mellon Corp.

The September decision was in a suit filed by investors who contended the banks were aware of Madoff’s fraud and should be liable because they continued providing banking services. The district court dismissed the suits, citing the 1998 federal Securities Litigation Uniform Standards Act, or SLUSA.

Rakoff wrote the decision in September finding that SLUSA applied and upheld dismissal. For a discussion of the opinion, click here for the Sept. 19 Bloomberg bankruptcy report.

Rakoff’s decision Dec. 6 resulted from several lawsuits he took out of bankruptcy court where Picard is suing feeder fund managers. In district court, Rakoff heard argument in October 2012 and issued his opinion last week.

Following the September ruling involving JPMorgan, Rakoff said that Picard doesn’t have the right to file suit based on claims belonging to individual customers. It didn’t matter, Rakoff said, that Picard is a different brand of trustee appointed under the Securities Investor Protection Act.

As with JPMorgan, Rakoff said Picard is barred from suing under what’s known as the in pari delicto rule. That rule prevents one perpetrator of a fraud from suing another. Picard is barred from suing because the law views the trustee as infected with Madoff’s fraud since the trustee steps into the bankrupt’s shoes.

This time, Picard advanced a somewhat different argument. As trustee, Picard said, he received assignments of claims that otherwise could have been brought by individual defrauded customers.

In a fleeting victory, Rakoff said the in pari delicto rule only barred Picard from bringing suits that belonged to the fraud-riddled firm. It doesn’t bar Picard from suing based on claims belonging to customers, Rakoff said in his opinion.

Even so, the feeder fund managers argued that the suits are nonetheless barred by SLUSA.

In accord with the September decision, Rakoff said that SLUSA does apply. However, Rakoff couldn’t dismiss the suits because there are issues peculiar to each suit that weren’t before him.

Specifically, Rakoff sent the feeder fund suits back to bankruptcy court for decisions on other SLUSA issues.

U.S. Bankruptcy Judge Burton Lifland was assigned to decide whether the suits are based on a misrepresentation in connection with the sale of a “covered security.” If a covered security was involved, the suits would be dismissed under SLUSA.

Back in bankruptcy court, Picard can argue there were no purchases of covered securities because customers’ money was used entirely to pay other customers.

In addition, the U.S. Supreme Court will soon decide whether covered securities are involved simply because customers thought there were securities when in fact none were ever purchased.

In October, the Supreme Court heard argument in an appeal involving the R. Allen Stanford Ponzi scheme. The court will decide if SLUSA applies to bar a suit even if no securities were purchased. For details on the Supreme Court case, click here for the Nov. 13 Bloomberg bankruptcy report.

Picard is currently asking the Supreme Court to hear an appeal from a ruling in June from the U.S. Court of Appeals in Manhattan. The appeals court upheld a ruling originally made by Rakoff, like the one last week, that the law views the bankruptcy trustee as tainted by the fraud Madoff committed.

Picard’s second loss involved his suit against Stephanie Mack, widow of Bernard Madoff’s son Mark, and Deborah Madoff, wife of Madoff’s son Andrew.

Picard argued that the in pari delicto defense shouldn’t preclude him from suing Madoff family members. Rakoff disagreed and dismissed the suit as to the two women. The judge said that an exception to in pari delicto allowing suit against family is a “novel proposition unsupported by any legal authority.”

Picard wanted to sue the two women for recovery of money given them by their husbands that was originally stolen from customers.

The one clear-cut victory for Picard involved Credit Suisse AG, Barclays Plc and 17 other foreign banks. They wanted an immediate appeal from Rakoff’s Oct. 29 opinion giving Picard the right to sue them as feeder-fund customers.

In the October ruling, Rakoff said Picard isn’t required to obtain a judgment first against the feeder funds before he can sue the banks. Rakoff interpreted bankruptcy law to mean that Picard can sue feeder-fund customers even if the time limit has lapsed for suing the funds themselves.

After ruling in October, Rakoff sent the cases back to Lifland for further processing. Last week, Rakoff refused to allow an appeal before the suits are finished entirely because there is no “substantial ground” for believing his October ruling was in error.

Picard and his lawyers are reviewing Rakoff’s rulings and have no comment at this time, according to an e-mail from Amanda Remus, the trustee’s spokeswoman.

The Madoff firm began liquidating in December 2008 with the appointment of Picard as trustee under the Securities Investor Protection Act. Madoff individually went into an involuntary Chapter 7 liquidation in April 2009, and his case was later consolidated with the investment firm’s liquidation. He’s serving a 150-year prison sentence following a guilty plea.

So far, Picard has recovered about $9.5 billion, or about 54 percent of customers’ investments.

The decisions last week by Rakoff are part of In re Bernard L. Madoff Investment Securities LLC, 12-mc-00115, U.S. District Court, Southern District New York (Manhattan). The Madoff liquidation in bankruptcy court is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, 08-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The criminal case is U.S. v. Madoff, 09-cr-00213, U.S. District Court, Southern District of New York (Manhattan).


Nortel Assets to Be Allocated by Courts, Not in Arbitration

Although Nortel Networks Inc. generated $7.5 billion from liquidation of its assets and those of subsidiaries around the world, a dispute over allocation is preventing distributions to creditors.

How the assets will be allocated among the various Nortel companies and their creditors will be decided by courts, not in arbitration, according to a Dec. 6 ruling from the U.S. Court of Appeals in Philadelphia.

The Nortel companies filed for bankruptcy reorganization in January 2009 in the U.S., Canada and London. They reported $11.6 billion in consolidated assets against debt totaling $11.8 billion as of Sept. 30, 2008.

Mediation failed to resolve disputes about how sale proceeds should be distributed among Nortel companies around the world.

Liquidators in the U.K. contended that an agreement to allow sales of assets also included a commitment to arbitrate how proceeds should be distributed. The bankruptcy court in Delaware and the court in Canada both concluded there was no commitment to arbitrate.

In the Dec. 6 opinion, the Philadelphia appeals court looked at the agreement and it too found no commitment to arbitrate. Dividing the assets is therefore up the courts.

U.S. Bankruptcy Judge Kevin Gross previously said the allocation dispute is keeping the case “tied up in knots seemingly forever.”

Originally, the judges in the U.S. and Canada scheduled an allocation trial to begin Jan. 6. The date was pushed back several times, and is now set to begin on May 12 and continue for 19 trial days.

Reports from experts, previously due this month, were pushed back to Jan 24. Examinations of experts, once scheduled for Feb. 28, will now take place from March 17 to April 4.

The appeal is In re Nortel Networks Inc., 13-2739, U.S. Third Circuit Court of Appeals (Philadelphia).

The bankruptcy case is In re Nortel Networks Inc., 09-10138, and the parent’s Chapter 15 case is In re Nortel Networks Corp., 09-10164, both in U.S. Bankruptcy Court, District of Delaware (Wilmington).

Detroit Ruling on Appeal Scheduled for Dec. 16

Whether Detroit’s progress toward a debt-adjustment plan is delayed by six months or possibly more will be decided at a Dec. 16 hearing in U.S. Bankruptcy Court.

That’s the day the bankruptcy judged scheduled a hearing to decide if he will grant a request by city workers and pension systems for an immediate appeal to the U.S. Circuit Court of Appeals in Cincinnati from his ruling last week that the city is eligible for Chapter 9 municipal bankruptcy.

It’s not clear that the workers and pension funds are even entitled to an appeal at this juncture. That’s an issue either the bankruptcy judge or district judge also must determine.

If the bankruptcy judge or district judge grants an immediate appeal to the circuit court, there will be no intermediate appeal in district court.

The city’s emergency manager has said he will file a plan in January. Practically speaking, whether he could move ahead with the plan if there is an appeal is yet to be seen. Although procedures can be expedited, appeals to circuit courts ordinarily take a minimum of about six months.

For discussion of the decision finding Detroit eligible for municipal bankruptcy, click here for the Dec. 9 Bloomberg bankruptcy report. For a story on the workers’ and pension systems’ desire for appeal to the circuit court, click here for the Dec. 6 Bloomberg bankruptcy report.

Detroit began the country’s largest-ever Chapter 9 municipal bankruptcy in July with $18 billion in debt, including $5.85 billion in special revenue obligations, $6.4 billion in post-employment benefits, $3.5 billion for underfunded pensions, $1.13 billion on secured and unsecured general obligations, and $1.43 billion on pension-related debt, according to a court filing. Debt service consumes 42.5 percent of revenue.

The city has 100,000 creditors and 20,000 retirees.

The case is City of Detroit, Michigan, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).

AMR Emerges from Chapter 11, Merges with US Airways Group

AMR Corp. and US Airways Group Inc. merged yesterday, to become American Airlines Group Inc., the world’s largest airline.

Simultaneously, the parent of American Airlines Inc. implemented AMR’s Chapter 11 reorganization plan. As an initial distribution, AMR stockholders are receiving 0.665 share in the merged airline for each share of AMR stock.

There can be more distributions to AMR shareholders depending on the value at which the new stock trades during the first four months. For other Bloomberg coverage, click here.

The airline announced that outgoing Chief Executive Officer Thomas Horton will receive a combination of bonus, severance and incentive awards valued at as much as $13.2 million in cash, plus 171,000 shares of stock. The bankruptcy judge declined to approve the awards as part of the Chapter 11 plan.

AMR, based in Fort Worth, Texas, listed assets of $24.7 billion and debt totaling $29.6 billion in the Chapter 11 reorganization begun in November 2011.

The Chapter 11 case is In re AMR Corp., 11-bk-15463, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The antitrust suit is U.S. v. US Airways Group Inc., 13-cv-1236, U.S. District Court, District of Columbia.

California Lawyer Claims Credit for JeffCo Plan’s Success

Jefferson County, Alabama, wouldn’t have been able to negotiate a $1.4 billion reduction in debt on the sewer system “but for” his intervention in the municipal bankruptcy, Calvin B. Grigsby said in a court filing last week.

Grigsby, a California lawyer, wants the bankruptcy judge to award him $340,000 for making a “substantial contribution” to the county’s municipal debt-adjustment plan that was implemented this month.

It “strains credulity,” Grigsby said, to believe that sewer debt holders would have allowed a reduction in debt without the lawsuit he initiated on behalf of sewer customers and his other activities in the Chapter 9 municipal bankruptcy.

The county’s plan was approved on Nov. 22 when the U.S. Bankruptcy Judge in Birmingham signed a confirmation order. To implement the plan, the county sold $1.8 billion in bonds to fund the plan. It reduced sewer debt from $3.2 billion to about $1.7 billion.

In November 2011, Jefferson County began what was then the largest Chapter 9 municipal bankruptcy, listing long-term debt of $4.23 billion, including about $3.2 billion in defaulted sewer debt where the debt holders could look only to the sewer system for payment.

The Chapter 9 case is In re Jefferson County, Alabama, 11-bk-05736, U.S. Bankruptcy Court, Northern District Alabama (Birmingham).

FirstBank Loses Attempt at Dismissing Scrub Island

FirstBank Puerto Rico, the secured lender, failed to win quick dismissal of the newly filed Chapter 11 reorganization for the Scrub Island Resort, Spa & Marina in the British Virgin Islands.

On top of failing to achieve what it set out to accomplish, the bank walked out of bankruptcy court saddled with an injunction for continuing foreclosure despite the resort’s bankruptcy filing.

The bank, owed about $120 million including interest, initiated foreclosure and had a receiver appointed by a court in the British Virgin Islands on Nov. 1. Eighteen days later, Scrub Island’s owner filed a Chapter 11 petition in Tampa, Florida, intending to set aside the receivership.

The San Juan, Puerto Rico-based bank went to bankruptcy court, telling U.S. Bankruptcy Judge Michael G. Williamson he should dismiss the bankruptcy promptly because the resort “manufactured” jurisdiction in the U.S. to halt the receivership under way in the British Virgin Islands.

Williamson read a 30-minute decision in open court Dec. 6. Not only did Williamson refuse to dismiss the bankruptcy, he also signed an injunction barring the bank from proceeding with the receivership.

The U.S. judge said the receivership wasn’t a proceeding for the collective benefit of creditors. Rather, only the bank would benefit by taking ownership through foreclosure, leaving nothing for other creditors.

Williamson said the case is properly in the U.S. because the headquarters for the resort’s owner is in Florida, where the bank accounts are maintained. The property is marketed to U.S. citizens. He said the British Virgin Islands wouldn’t qualify to be a so-called foreign main proceeding.

The resort’s U.S. bankruptcy wasn’t filed in bad faith, Williamson said, simply because the purpose is to reverse a receivership. The judge refused to dismiss the U.S. bankruptcy because it wouldn’t be in the best interests of the larger creditor body.

The 230-acre resort operates as a Marriott Autograph Collection property. It has 52 rooms and suites, a spa and a 55-slip marina. Revenue for 10 months this year was $8.4 million, not including lot sales. Assets are on the books for about $135 million.

In addition to the bank debt, more than $10 million is owing to unsecured creditors, according to a court filing.

The case is In re Scrub Island Development Group Ltd., 13-bk-15285, U.S. Bankruptcy Court, Middle District of Florida (Tampa).

Revstone Blames Acrimony on Creditors’ Committee

Acrimony between Revstone Industries LLC and the official unsecured creditors’ committee is mostly the result of the “oppositional posture adopted” by the committee, according to papers the company filed opposing appointment of a trustee at a hearing tomorrow in U.S. Bankruptcy Court in Delaware.

In November, the committee sought appointment of a Chapter 11 trustee or conversion of the reorganization to liquidation. Revstone makes truck-engine parts.

Revstone said the committee’s reliance on alleged misdeeds by former Chief Executive Officer George Hofmeister is misplaced because he was removed from office early this year and isn’t even on the board any more. He was replaced by a chief restructuring officer.

Although the company and the committee have competing liquidating Chapter 11 plans on file, there is “no fundamental difference” between the two proposals, according to Revstone.

On those issues where there was litigation with the committee, the company said it prevailed on the “vast majority.”

The request for a trustee is the committee’s second. The committee said that chances of recovery by unsecured creditors are “increasingly dim.”

The committee first sought takeover by a trustee in February. That controversy was settled under an arrangement kept secret. It’s known that Revstone violated the settlement, allowing the committee to file a reorganization plan in July.

Revstone followed by submitting its own competing plan. The committee has said neither plan can be approved because there isn’t enough cash to pay professional costs. A hearing to consider approval of disclosure materials for the two plan has been put off until Jan. 22.

The bankruptcy judge warned he would appoint a trustee if there is “acrimony and deadlock between debtors and stakeholders.”

Lexington, Kentucky-based Revstone said in a court filing that assets are $47.5 million with debt totaling $88.9 million. Liabilities included $15.9 million on secured debt owing to Wells Fargo Capital Finance LLC. Revstone was hit with a $27.6 million judgment in April 2012 in favor of Boston Finance Group LLC.

The parent’s case is In re Revstone Industries LLC, 12-bk-13262, U.S. Bankruptcy Court, District of Delaware Wilmington). The subsidiary’s case is In re Metavation, 13-bk-11831, in the same court.

Atlantic Club Casino Bonuses Opposed by U.S. Trustee

The Atlantic Club Casino Hotel in Atlantic City, New Jersey, hasn’t shown why seven executives qualify for $2.1 million in bonuses, according to the U.S. Trustee.

Last month the casino received court approval to conduct an auction this month. Two days later, Atlantic Club filed papers setting up a hearing on Dec. 16 for bonus approval.

The proposal would pay the executives $875,000 if the property fetches $25 million at auction to be conducted Dec. 17. If the price rises to $35 million, the aggregate bonuses top out at $2.1 million.

In her objection, the U.S. Trustee said the casino failed to show the “degree of difficulty” in attaining the trigger prices. The time for the creditors’ committee to object to the bonuses has been extended.

Bids for the casino are due initially on Dec. 16. A hearing to approve sale is set for Dec. 19.

The Chapter 11 reorganization begun on Nov. 6 is pending in U.S. Bankruptcy Court in Camden, New Jersey. Financing is being supplied by Northlight Financial LLC. The loan requires a quick sale.

The property has 801 rooms, 75,000 square feet of gaming space, and seven restaurants, generating revenue of $103.8 million last year. The 2012 net loss was $43.3 million. In the first three quarters this year, revenue of $88.6 million resulted in a $7.4 million loss before interest, taxes, depreciation and amortization.

The ultimate parent, Resorts International Holding LLC, acquired the project along with three others in 2005 from Caesar’s Entertainment Inc. and Harrah’s Entertainment Inc. The other casinos were sold or given to secured lenders.

The official lists shows asset for $17.8 million against debt totaling $16.8 million, including $8.1 million in secured debt.

The case is In re RHI Acquisitions NJ LLC, 13-bk-34483, U.S. Bankruptcy Court, District of New Jersey (Camden).

Physiotherapy Holding Paying Trade Suppliers in Full

Physiotherapy Holdings Inc., a provider of outpatient physical therapy, took the burden of bankruptcy off the shoulders of unsecured trade suppliers.

At the company’s request, the bankruptcy court in Delaware authorized the company to pay trade suppliers in full. PHI has the right to withhold payment to any creditor not providing credit.

The company can’t spend more than $4.5 million, according to the order signed by the bankruptcy judge on Dec. 6.

PHI is paying unsecured creditors because it intends to emerge from bankruptcy by the year’s end under a prepackaged reorganization plan accepted by affected creditors before the Nov. 12 Chapter 11 filing.

Last week, the Exton, Pennsylvania-based company also received final court approval to use lenders’ cash collateral until the reorganization is completed.

The confirmation hearing for approval of the plan is set for Dec. 17. The plan gives noteholders all the stock in exchange for debt. Their recovery is estimated at 40.3 percent. For details, click here for the Nov. 13 Bloomberg bankruptcy report.

The company has 581 outpatient clinics in 29 states. It was acquired in May 2012 by Court Square Capital Partners LP in a $535.1 million transaction.

The case is In re Physiotherapy Holdings Inc., 13-bk-12965, U.S. Bankruptcy Court, District of Delaware (Wilmington).

Bankruptcy Reform News

ABI Commission to Propose Bankruptcy Reform in 2014

Today’s bankruptcy law, adopted by Congress 35 years ago, is “antiquated,” according to Al Togut, co-chairman of the commission established by the American Bankruptcy Institute to study reform of the U.S. Bankruptcy Code.

One year from now, the ABI commission will issue its report offering “specific reform in the Bankruptcy Code” with respect to individuals, small business, and large companies, Togut said in a press conference yesterday. The ABI is a non-for-profit organization with 13,000 members.

Robert J. Keach, co-chairman, said that testimony taken by the commission suggests that Chapter 11 is working less well for middle-market companies than it is for large enterprises attempting to reorganize. He said the commission is “thinking seriously” that the “one size fits all” concept in the 1978 bankruptcy law isn’t working now.

Togut, a bankruptcy lawyer in New York, said he too has a “very definite understanding” that the law is “not working right” for smaller companies. Togut cautioned that neither he nor the commission has drawn any hard conclusions as yet.

Keach said the rights of secured creditors “need to be looked at very carefully and calibrated very carefully,” given the perception in some quarters that it’s now the secured lender who’s in possession, not the bankrupt company, known as debtor in possession.

There will be an analysis, Keach said, about whether some provisions currently contained in loan agreements for bankrupt companies should be barred or limited.

Times have changed, Togut explained, because 35 years ago the entire creditor body remained in place through a Chapter 11 reorganization. Now, ownership of debt can turn over, sometimes more than once.

Likewise, there was little secured debt 35 years ago, almost always leaving unsecured creditors with some equity in the company above what was then one layer of secured debt.

Now, it’s not unusual for there to be three layers of secured debt, with nothing left for unsecured creditors.

Keach said the commission is also studying the so-called safe harbor and other exceptions to the automatic stay where creditor actions are halted with the filing of bankruptcy. Keach also said he was given an “earful” about preference reform.

Previously, Keach said, preference suits were filed to even out recoveries by unsecured creditors. Now, he said, preference suits are brought to pay costs of running the Chapter 11 case or to increase recoveries for secured creditors.

The ABI does not lobby Congress, and it won’t propose a bill, Keach and Togut said. Other organizations, they said, may take the commission’s proposals to Congress.


Indianapolis Power & Light Demoted to Highest Junk

Indianapolis Power & Light Co. lost investment-grade status for itself and its immediate parent Ipalco Enterprises Inc. when Standard & Poor’s moved their ratings down one level yesterday to BB+, the highest junk grade.

S&P said the two companies are nonetheless entitled to higher ratings than the ultimate parent, AES Corp., which currently is rated BB-, or two grades below the subsidiaries.

S&P said the subsidiaries have “provisions in place to protect its credit quality” and thus are entitled to rating higher than their “weaker parent,” AES.

Arlington, Virginia-based AES was downgraded to its current level in May 2011 as a consequence of the $3.5 billion acquisition of the parent of Dayton Power & Light Co.

Coal Producer Alpha Downgraded on Weak Demand

Alpha Natural Resources Inc., the third-largest U.S. coal producer, received a downgrade yesterday from Standard & Poor’s lowering the corporate grade by one step to B.

S&P took the senior unsecured notes down two levels to B-.

The action by S&P matches a downgrade issued in October by Moody’s Investors Service.

On the plus side, S&P said the company has “strong liquidity.” S&P isn’t predicting a “material improvement” in coal prices.

Bristol, Virginia-based Alpha is the largest U.S. producer of metallurgical coal. Consequently, the company’s finances could improve with growth in European economies, S&P said.

The stock closed yesterday at $7.53, up 15 percent in New York Stock Exchange trading. The three-year closing high was $67.38 on Jan 11, 2011. The closing low in the period was $4.92 on Aug. 6.

Advance Sheets

Unconfirmed Arbitration Has No Preclusive Effect

Courts are split on the question of whether an arbitration award, not yet confirmed in federal court, can be given preclusive effect in bankruptcy or other federal actions.

U.S. District Judge Margaret M. Morrow in Los Angeles parted company with several lower courts, including a bankruptcy court in New York in the 1998 bankruptcy of Texaco Inc. She ruled in her Sept. 11 opinion that an unconfirmed award isn’t entitled to preclusive effect in a later bankruptcy.

She relied in large part on a 1984 U.S. Supreme Court case called McDonald which held that arbitration is not a judicial proceeding.

In the case before her, the arbitration award was confirmed later in state court after the bankruptcy court had ruled, incorrectly in her view, that the arbitration had preclusive effect.

Even though confirmation of the award came after the judgment in bankruptcy court, that was sufficient to give the award preclusive effect.

The case is Houng v. Tatung Co. (In re Houng), 12-01341, U.S. Bankruptcy Court, Central District California (Los Angeles).

To contact the reporter on this story: Bill Rochelle in New York at

To contact the editor responsible for this story: Andrew Dunn at

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