Bloomberg News

Madoff, Borders, Lehman, Giordano’s, Spansion: Bankruptcy

July 29, 2011

(This report contains items about companies both in bankruptcy and not in bankruptcy. Updates Madoff and adds Giordano’s, Wilmington Diocese, Vallejo and Edscha in Updates and Jefferson County in Watch List.)

July 29 (Bloomberg) -- The Bernard L. Madoff Investment Securities Inc. trustee yesterday brought home a $1.03 billion settlement, suffered dismissal of the larger part of his $9 billion lawsuit against HSBC Holdings Plc, and argued to keep hundred of suits against customers in bankruptcy court.

The trustee had sued HSBC, alleging that the London-based bank “enabled” Madoff’s Ponzi scheme and engaged in “financial fraud and misconduct” by being “willfully and deliberately bind to the fraud.” The complaint sought $9 billion, including $2.3 billion for receipt of fraudulent transfers.

Yesterday, U.S. District Judge Jed Rakoff wrote a 26-page opinion dismissing what he said were $6.6 billion of common law claims for unjust enrichment, aiding and abetting fraud, and aiding and abetting breach of fiduciary duty. Rakoff previously ruled it was proper for a district court to make threshold decisions on whether the trustee has standing, or the right to sue based on the common-law claims.

As he promised he would do, Rakoff sent the remnants of the lawsuit back to bankruptcy court for “further proceedings” so the Madoff trustee can pursue $2.2 billion in fraudulent- transfer claims.

Rakoff opened his opinion yesterday by stating the familiar rule that bankruptcy trustees don’t have the right “to assert claims against third parties on behalf of the estate’s creditors.” Rakoff dismissed all of the trustee’s arguments contending that a brokerage’s trustee has greater power to sue based on claims typically belonging to individual creditors.

The opinion rejected the trustee’s “convoluted theories.” Of one, Rakoff said, “To say this argument is a stretch would be to give it more credence than it deserves.”

The trustee had argued that the Securities Investor Protection Act allows him to take over customers’ claims that he paid. Rakoff rejected the argument, saying the trustee “cannot recover as subrogee until the customers are made whole.”

Rakoff also dismissed the common-law claims based on what’s known as the in pari delicto defense. The doctrine means that when a company commits fraud, the company’s bankruptcy trustee can’t sue third parties for aiding and abetting the fraud unless the company officers who committed the fraud totally abandoned the company’s interests.

The defense, which had been moribund, was recently rejuvenated by state and federal courts in New York. For a discussion of the issue, click here and here for the Nov. 19 and Oct. 26 Bloomberg bankruptcy reports.

Common-law claims dismissed, Rakoff found it unnecessary to decide if the suit was precluded by the federal Securities Litigation Uniform Standards Act.

The trustee announced yesterday that he negotiated a settlement to recover $1.03 billion in cash from the second- largest group of feeder funds that funneled money into the Madoff Ponzi scheme.

In December, the Madoff trustee sued Tremont Group Holdings Inc., Oppenheimer Acquisition Corp., Massachusetts Mutual Life Insurance Co. and affiliates. Oppenheimer owns the Tremont hedge fund. The trustee’s complaint, unsealed in March, was seeking a recovery of about $2.1 billion that the funds received directly from the Madoff firm.

In return for the $1.03 billion payment into escrow, the foreign and domestic investment funds will receive about $3 billion in approved customer claims. The settlement is structured so that distributions on the funds’ claims will be paid directly to the funds’ customers, the trustee said.

The trustee’s complaint against the funds that settled sought $2.1 billion from the inception of the relationship with Madoff. Within six years of bankruptcy, the funds received $1.9 billion, which might have been the most the trustee could have recovered.

For payments within two years of bankruptcy covered by federal fraudulent transfer law, the trustee was seeking about $960 million. For so-called preferences received within 90 days of bankruptcy, the trustee was pursuing a $325 million recovery.

Combined with the $2.6 billion the trustee has on hand and the $5 billion he will receive on final approval of the settlement with the late Jeffrey M. Picower, the trustee will have $8.6 billion, or enough to pay almost half the $17.3 billion in principal that customers lost with Madoff.

The money on hand doesn’t include an additional $2.2 billion through the government’s portion of the Picower settlement. Under arrangements with the government, the trustee will distribute the $2.2 billion.

The trustee alleged in his complaint that Tremont earned $180 million in fees in the six years before the Madoff firm imploded. The complaint argued that Tremont ignored “red flags” indicating a fraud was being conducted.

The trustee said his settlement “sends a strong message that the financial community cannot deliberately ignore indicia of fraud.” The hearing to approve the settlement will take place Sept. 13.

Rakoff heard oral argument yesterday where a customer named Greiff filed a motion to remove the lawsuit from bankruptcy court where the Madoff trustee is seeking to recover fictitious profits the customer took out of his account before the fraud surfaced. Where Rakoff was quick to jerk other lawsuits out of bankruptcy court, on the Greiff suit he had reservations.

Given that the lawsuit on its face seeks to recover fraudulent transfers that are ordinary bankruptcy claims, Rakoff pressed Greiff’s lawyer to explain the non-bankruptcy claims that warranted removal from bankruptcy court.

Rakoff noted that the customer suit had no common-law claims like the HSBC case, where the trustee didn’t have the right to sue. He said the customer dispute was unlike the suit against Mets owner Fred Wilpon because there are no allegations the customer was blind to fraud.

Greiff’s lawyer said there are almost 1,000 other suits against customers that likewise should be taken away from the bankruptcy judge because the trustee is asserting a novel theory of recovery. Rakoff said that taking an unusual position on bankruptcy law isn’t a basis for withdrawing a suit from bankruptcy court.

Greiff’s lawyer argued that the suit should be in bankruptcy court because the trustee incorrectly calculates claims. Rakoff said there would be no purpose in withdrawing the case on that issue because the question is already before the U.S. Court of Appeals.

Rakoff said he would decide the Greiff motion by Sept. 15. The judge said he has two other Madoff rulings to make before then, including the Wilpon suit.

The Madoff firm began liquidating in December 2008 with the appointment of the trustee under the Securities Investor Protection Act. Bernard Madoff individually went into an involuntary Chapter 7 liquidation in April 2009.

His bankruptcy case was consolidated with the firm’s liquidation. Madoff is serving a 150-year prison sentence following a guilty plea.

The HSBC suit in U.S. District Court is Picard v. HSBC Bank Plc, 11-763, U.S. District Court, Southern District of New York (Manhattan). The withdrawal motion argued yesterday is Picard v. Greiff, 11-03775, U.S. District Court, Southern District of New York (Manhattan).

The Madoff liquidation case is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities Inc., 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 for the Southern District of New York (Manhattan).

Updates

Borders to Auction Leases, Trademarks, Website

Borders Group Inc., the liquidating bookseller, filed papers yesterday to sell the trademarks, website, and store leases.

There will be a hearing on Aug. 10 to approve auction and sale procedures. For the trademarks and the website, Borders wants bids initially by Sept. 8 in advance of a Sept. 14 auction. The hearing for approval of the sale would be Sept. 20, if the judge goes along.

Should a buyer step forward to make the first bid and become the so-called stalking horse, it would be eligible for reimbursement of $250,000 in expenses if outbid at auction.

The store leases would be sold in two chunks. The first auction, on Aug. 31, will sell leases where Borders must vacate the premises by Sept. 30. The other leases will go up for auction Sept. 13, if the judge agrees with the schedule.

The hearing to approve the first slug of store-lease sales would take place Sept. 8. The second group of lease sale approvals would be on Sept. 20, assuming the judge ratifies the proposed schedule.

Borders began liquidating the store inventory through going-out-of-business sales that commenced on July 22. The creditors’ committee said before the liquidation began that Borders expected to generate $252 million to $284 million in cash from GOB sales.

Ann Arbor, Michigan-based Borders had 642 stores on entering bankruptcy in February and was operating 399 when the liquidation began. It listed assets of $1.28 billion and liabilities totaling $1.29 billion. Debt included $196 million on a revolving credit and $48.6 million on a term loan. Trade suppliers were owed $302 million for inventory.

The case is In re Borders Group Inc., 11-10614, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Lehman Brokerage Trustee Makes Full Recovery from IDB

The trustee liquidating the remnants of the brokerage subsidiary of Lehman Brothers Holdings Inc. negotiated a settlement where he will recover all of the approximately $80 million he was seeking from Israel Discount Bank Ltd.

The dispute arose out of funds frozen in Israel immediately after the Lehman bankruptcy with regard to foreign exchange trading. The Lehman brokerage trustee filed suit in December 2009, alleging that a freeze on the funds amounted to a violation of the so-called automatic stay.

In court papers filed yesterday, the trustee said the settlement amounted to a full recovery, “with no concessions.” The hearing to approve the settlement will take place Aug. 17.

Yesterday, the court approved an arrangement where neither Barclays Bank Plc nor the Lehman brokerage trustee will be required to post bonds while they cross-appeal from bankruptcy court judgments against both of them.

In an opinion on Feb. 22 and from a courtroom ruling on June 6, the Lehman broker was given the right to recover $2.054 billion from Barclays Capital Inc. on account of so-called margin assets. The Lehman brokerage trustee was ordered to pay Barclays more than $1.1 billion on account of the so-called clearance box assets.

To avoid the expense and difficulty in obtaining multi- billion dollar bonds, Barclays Bank will stand behind any award eventually upheld on appeal against Barclays Capital. If Barclays suffers even a one-notch downgrade to its credit rating, the bank will post collateral in an account to cover any potential final judgment.

The Lehman trustee will not be required to post a bond. For a summary of the June 6 ruling, click here for the June 7 Bloomberg bankruptcy report. For a summary of the Feb. 22 opinion, click here for the April 13 Bloomberg bankruptcy report.

The Lehman holding company filed under Chapter 11 in New York on Sept. 15, 2008, and sold office buildings and the North American investment-banking business to Barclays Plc one week later. The remnants of the Lehman brokerage operations went into liquidation on Sept. 19, 2008, in the same court, with a trustee appointed under the Securities Investor Protection Act.

For a summary of Lehman’s compromise reorganization plan, click here for the June 30 Bloomberg bankruptcy report. The hearing for approval of the disclosure statement explaining the plan will take place Aug. 30. The plan represents settlement between creditors favoring substantive consolidation and those opposed.

The Lehman holding company Chapter 11 case is In re Lehman Brothers Holdings Inc., 08-13555, while the liquidation proceeding under the Securities Investor Protection Act for the brokerage operation is Securities Investor Protection Corp. v. Lehman Brothers Inc., 08-01420, both in U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Giordano’s Sues to Stop Franchisees’ ‘Royalty Strike’

The trustee for Giordano’s Enterprises Inc., the owner of Chicago’s World Famous Stuffed Pizza, filed a lawsuit in bankruptcy court aiming to enjoin about 30 franchisees from interfering with sale efforts by refusing to pay royalties.

The complaint on July 27 says that the operators of stores under franchise agreements are conducting a “royalty strike” guided by one lawyer who represents them all. The trustee contends the refusal to pay royalties is intended to force a sale to the franchisees at a below-market price.

The trustee says the royalty strike is interfering with his efforts to sell the business to a third party at a higher price.

The trustee wants the bankruptcy judge to enter an injunction requiring the franchisees to pay royalties. He also wants to enjoin the franchisees from interfering with sale efforts by refusing to pay royalties.

The franchisees contend they are excused from paying royalties by breaches of the franchise agreements.

The franchisees might argue that the lawsuit can’t be heard in bankruptcy court under a decision in June from the U.S. Supreme Court in a case called Stern v. Marshall. In that case, the high court ruled that a bankruptcy court doesn’t have jurisdiction to make a final order in a lawsuit against a third party based on state law. For a discussion of Stern v. Marshall, click here for the June 24 Bloomberg bankruptcy report.

The pizza maker filed to reorganize in February. The Chapter 11 trustee was appointed in May after Giordano’s fired its bankruptcy lawyers and failed to pay $47,450 in fees owing to the U.S. Trustee system. In addition, Giordano’s hadn’t filed any required operating reports since filing in Chapter 11.

Giordano’s filed in Chapter 11 with six company-owned stores and joint ventures for four more. In addition, 35 stores were operated at the time by franchisees. The company owns the real estate for 20 of the stores.

Fifth Third Bank was owed $45.5 million on two loans, court papers said. The business was acquired in 1988 by the Apostolou family.

The case is In re Giordano’s Enterprises Inc., 11-06098, U.S. Bankruptcy Court, Northern District Illinois (Chicago).

Wilmington Diocese Confirms Plan for Abuse-Victim Payments

The Catholic Diocese of Wilmington Inc. won the signature of the bankruptcy judge yesterday on a confirmation order approving the Chapter 11 plan.

The plan was the product of settlement reached through mediation in February with representatives of abuse claimants, the official creditors’ committee and the diocese’s insurance carriers.

The plan creates a trust funded with $77.4 million. The contribution to the trust from insurance companies is $15.6 million, according to the disclosure statement. In return for receiving releases, non-bankrupt Catholic entitles are contributing $62 million to the trust.

The average payment to a sexual-abuse claimant would be $509,000, according to the disclosure statement. In aggravated cases, a payment may reach $3 million. For other Bloomberg confirmation coverage, click here.

The plan was the indirect result of a decision by the bankruptcy judge in June 2010 adverse to the diocese. The judge ruled that $75 million wasn’t held in trust for the parishes and parochial schools. The diocese appealed.

The diocese’s Chapter 11 filing in October 2009 automatically stopped 136 abuse suits involving 147 plaintiffs, according to court filings by the diocese. The Delaware diocese at the time was the seventh of eight Roman Catholic dioceses to file for Chapter 11 protection to deal with lawsuits for sexual abuse.

The case is In re Catholic Diocese of Wilmington, 09-13560, U.S. Bankruptcy Court, District of Delaware, (Wilmington).

Vallejo, California, to Emerge from Municipal Reorganization

The city of Vallejo, California was told by the bankruptcy judge at a hearing yesterday that he would sign a confirmation order approving the Chapter 9 municipal reorganization.

Almost all objections to the plan were settled in the weeks leading up to the hearing. Confirming the plan will allow the city to end the bankruptcy that began in May 2008.

The plan restructures $50 million of publicly held debt secured by leases on public buildings. Without affecting pensions, the plan also adjusts the claims and benefits of current and former city employees.

For details on the plan when it was first filed, click here for the Jan. 20 Bloomberg bankruptcy report. For other Bloomberg coverage on confirmation, click here.

With a population of 117,000, Vallejo is the largest California city to seek bankruptcy protection. Assets were more than $500 million while debt was less than $500 million, according to the petition.

The case is In re City of Vallejo, 08-26813, U.S. Bankruptcy Court, Eastern District of California (Sacramento).

Edscha, Former Auto-Parts Maker, Confirms Plan

Former auto-parts maker Edscha North America Inc. persuaded the bankruptcy judge at a hearing yesterday to sign a confirmation order approving the liquidating Chapter 11 plan proposed by the company and the official creditors’ committee.

The disclosure statement showed the company as having about $1.76 million cash, with $683,000 remaining for payment of about 6 percent to unsecured creditors with claim totaling $12.4 million.

The Pension Benefit Guaranty Corp. will receive $694,000 cash on account of its $11.8 million claim.

Secured creditors were already paid in part from sales of assets. For other Bloomberg coverage of confirmation, click here.

Edscha ceased operating in June 2009 and filed under Chapter 11 in October of that year. It was liable on a $628 million guarantee of the parent’s bank debt.

The Chapter 11 filing came more than eight months after the parent company, Edscha AG, began its own insolvency proceedings in Germany. The companies are ultimately owned by Carlyle Group. The U.S. company listed assets of $6.4 million against debt totaling $672 million, including $629 million in secured claims.

The case is Edscha North America Inc., 09-39055, U.S. Bankruptcy Court, Northern District of Illinois (Chicago).

Spansion’s Settlement With Samsung Approved by Court

Spansion Technology Inc., a manufacturer of flash memory semiconductors, was given bankruptcy court approval this week to settle with Samsung Electronics Co.

The $150 million settlement calls for Korea-based Samsung to pay Spansion $25 million in August. The remainder of the $150 million will be paid in 20 quarterly installments.

As part of the settlement, Spansion and Samsung will cross- license their patent portfolios to each other for seven years. Spansion will purchase Samsung’s claim in the bankruptcy for $30 million, enabling Spansion to retire from 1.65 million to 1.85 million shares.

The claim will be purchased with a credit against the first $30 million Samsung owes in the settlement.

Spansion, a manufacturer of flash memory semiconductors, implemented its Chapter 11 plan in May 2010. The bankruptcy judge disapproved a settlement two years ago. For details, click here for the June 23 Bloomberg bankruptcy report.

Spansion’s plan reduced debt from $1.5 billion to less than $480 million. To read about the plan, click here for the Dec. 31, 2009 Bloomberg bankruptcy report.

Before filing under Chapter 11 in March 2009, Sunnyvale, California-based Spansion hadn’t reported a profit since being spun off by Advanced Micro Devices Inc. in 2005.

The case is Spansion Inc., 09-10690, U.S. Bankruptcy Court, District of Delaware (Wilmington).

Former Bankruptcy Trustee Gets Almost 7-Year Prison Sentence

A so-called panel trustee from Hollywood, Florida, named Markia Tolz was sentenced on July 27 to almost seven years in federal prison plus three years of supervised release. In addition, she agreed to a $2.4 million judgment.

Tolz also agreed to forfeit almost $1.2 million cash along with eight parcels of real property. She is to begin serving her sentence on Sept. 27.

She was charged in March with mishandling $16 million from bankrupt estates she was administering. She pleaded guilty in May. Prosecutors in the Southern District of Florida allege that Tolz committed wire fraud from 2003 to 2010.

As a panel trustee, Tolz was among the lawyers who are regularly assigned to be trustees in Chapter 7 cases.

The case is US v. Markia Tolz, 11-20160, U.S. District Court, Southern District Florida (Miami).

Watch List

Alabama’s Jefferson County Negotiating, Not Filing Bankruptcy

Bondholders gave Jefferson County, Alabama, a new offer to cut debt on sewer bonds by a third. In return, the county commissioners canceled a meeting that would have been held yesterday to vote on filing for municipal reorganization under Chapter 9 of federal bankruptcy laws.

Click here to read Bloomberg coverage about the new offer and the one-week extension to permit negotiations.

The county, which includes Birmingham, is dealing with $3 billion in defaulted sewer bonds.

Advance Sheets

Child-Support Ruling Not Binding Outside Bankruptcy

When a bankruptcy court fixes the amount of child support owing, the issue can be re-litigated outside bankruptcy court, the U.S. Circuit Court of Appeals in Atlanta ruled on July 27.

The 11th Circuit also ruled that limitations on the doctrine of a states’ sovereign immunity, as a general matter, permit holding state authorities in contempt for alleged violations of an order discharging debt in Chapter 13.

The case involved an individual who confirmed a Chapter 13 plan providing for full payment of child support obligations. The bankruptcy judge sustained the bankrupt’s objection to the $67,000 claim filed by state authorities to collect past-due child support. The bankruptcy judge allowed the claim for $47,000. The difference, $20,000, represented interest on unpaid support.

The bankrupt made all payments under his plan and was given a discharge order. Later, the state took action to collect additional child support. The bankruptcy court held the state in contempt for violating the automatic stay and the discharge injunction. For contempt, the court assessed $46,600 in actual damages and $25,000 in punitive damages. The district court affirmed.

In a 36-page opinion by Circuit Judge David M. Ebel, appeals court reversed. Although it found the contempt action was not barred by the state’s sovereign immunity, it concluded that the discharge injunction couldn’t bar the collection of child support, a debt not discharged in bankruptcy.

Ebel, sitting by designation from the U.S. Court of Appeals in Denver, said that “no part of child-support debt is dischargeable under any circumstances in a Chapter 13 case.” He said that the bankruptcy court’s determination of the amount of the claim was only to decide how much would be paid under the Chapter 13 plan.

Consequently, Ebel said that doctrines of res judicata and collateral estoppel didn’t bar the state from arguing the extent of the bankrupt’s “personal liability for child support post- bankruptcy.”

On the separate issue of sovereign immunity, Ebel interpreted a 2006 opinion from the U.S. Supreme Court called Central Virginia Community College v. Katz. He said Katz means that the states, when they ratified the U.S. Constitution, acquiesced in the loss of sovereign immunity “to effectuate the in rem jurisdiction of the bankruptcy court.” In rem jurisdiction refers to the power of courts over property of the bankruptcy estate.

Ebel said that the Katz doctrine “generally” means that a state can be held in contempt for violation of a discharge injunction or the automatic stay. Because the automatic stay was replaced by the discharge injunction, Ebel said there could be no contempt of the automatic stay. He went on to rule that the Katz doctrine meant that the state waived sovereign immunity on a claim for violation the discharge injunction.

As discussed previously, Ebel held there was no contempt because child-support liability was entirely excepted from discharge.

The case is Florida Department of Revenue v. Diaz (In re Diaz), 10-14426, U.S. 11th Circuit Court of Appeals (Atlanta).

--With assistance from Don Jeffrey in New York and Dawn McCarty, Steven Church, and Michael Bathon in Wilmington, Delaware. Editors: Mary Romano, Fred Strasser

To contact the reporter on this story: Bill Rochelle in New York at wrochelle@bloomberg.net.

To contact the editor responsible for this story: John Pickering at jpickering@bloomberg.net.


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