Restructuring

Contributed by Andrea Saavedra
Canons of statutory construction are used frequently to resolve ambiguities in the Bankruptcy Code. In a recent decision arising out of the Madoff liquidation, Judge Rakoff of the Southern District of New York had to implement more than a few to creatively resolve a potential conflict between the Bankruptcy Code and the Securities Investor Protection Act (SIPA). He also had to take a practical, yet expansive, view of what the word “prompt” can mean when managing the untangling of one of the largest financial frauds in American history.
The Facts
Certain customers had filed net equity claims with the Madoff SIPA trustee. In other words, they asserted that they had received less in withdrawals from their Madoff securities accounts than they initially invested and were seeking compensation for the remainder of their principal. The Madoff SIPA trustee, however, sought disallowance of their claims pursuant to section 502(d) of the Bankruptcy Code, which, in short, permits disallowance of an entity’s claim if it is the recipient or subsequent transferee of estate property that is subject to the claw back provisions of the Bankruptcy Code, unless the creditor has already returned the property to the estate or paid any amounts due. In other words, until the customers returned their withdrawals (again, even though these amounts were less than the principal that they had deposited), the Madoff SIPA trustee refused to pay them either a statutory permissible advance or any interim distribution. The customers moved to dismiss the trustee’s disallowance actions, arguing: (i) section 502(d) was inapplicable to their net equity claims as they were filed pursuant to SIPA’s claim allowance provisions, instead of those of the Bankruptcy Code; (ii) the trustee’s position was incompatible with multiple provisions of SIPA which, in short, required “prompt” return or payment of customer funds; (iii) under the expression unius est exclusio alterius (or “expression of one implies exclusion of another”) canon of statutory construction, the absence of a specific exception to the payment of net equity claims and advances on account of section 502(d)’s requirement of the return of avoided transfers prior to allowance should not be read into SIPA; and (iv) that it would be inequitable to disallow their net equity claims given that they withdrew less than they had deposited.
The Law
Judge Rakoff found that the alleged conflict between the statutes was “purely a question of statutory interpretation” and began his analysis with the assumption that, absent any indication to the contrary, he was required to read SIPA’s provisions in pari materia (or “in the same matter”) with those of the Bankruptcy Code to determine how the customers’ net equity claims should be treated.
He disposed of the customers’ first argument in two quick steps. First, he determined that the SIPA claims allowance process was more akin to the prepetition claims allowance process incorporated into chapter 5 of the Bankruptcy Code. Next, because chapter 5 of the Bankruptcy Code is made generally applicable to SIPA, he concluded that he would have to find an inconsistency or conflict in order to grant defendants’ dismissal motion.
However, he could not find such an inconsistency. First, Judge Rakoff did not read SIPA’s requirement of “prompt” payment of net equity claims to be incompatible with the temporary disallowance provisions of section 502(d) given that the adjudication and payment of avoidance claims could affect the final calculation of a given customer’s net equity. He further found that section 502(d) was an “ordering” provision, which reflected the underlying “logic that the estate should receive property due to it before a liable creditor of the estate may obtain payment on its own claims.” He further found that it would be inequitable to allow customers “who effectively owe money to their fellow customers to be permitted to retain those funds and at the same time receive payments from the estate,” especially where it seemed unlikely that net equity claims would be satisfied in full. Indeed, Judge Rakoff found that other provisions of SIPA supported this equitable rationale, such as the trustee’s right to delay return of customer securities if a customer otherwise owes a debt to the estate.
Further, as to the defendants’ expressio unius argument, Judge Rakoff concluded that it applied “poorly” to the provisions at issue, as there was no statutory list of exceptions to prompt payment that would result in exclusion of section 502(d) from their ranks. While the court was not unsympathetic to the defendants’ final argument that permitting temporary disallowance, in some sense, permits a double-penalty on account of their customer withdrawals (first, against their net equity calculation, and second, as the basis for disallowance), he concluded that he could not “override” the statutory scheme to on the basis of such alleged inequities. He further noted that, to the extent any setoff argument was appropriately raised and preserved, the parties could raise them in the adjudication of the avoidance actions.
The Takeaway
The decision reinforces the importance of understanding the interplay between SIPA and the Bankruptcy Code. It also reminds customers that while SIPA is meant to protect their investment, it does so equitably. Where fraud is involved, even individuals who did not make a profit and may not have known of the fraud, should not anticipate the “prompt” return of their securities or cash investments within a few months — or even a few years.