Bloomberg News

Madoff, L.A. Dodgers, Hussey, Lehman, Solyndra: Bankruptcy

September 28, 2011

(This report contains items about companies both in bankruptcy and not in bankruptcy. Updates 12th and 13th paragraphs in Madoff item.)

Sept. 28 (Bloomberg) -- New York Mets owner Fred Wilpon failed to win dismissal of the entire $1 billion lawsuit filed against him by the trustee liquidating Bernard L. Madoff Investment Securities Inc.

Yesterday’s 18-page opinion by U.S. District Judge Jed Rakoff, if upheld on appeal, means that the trustee will suffer dismissal of the better part of hundreds of lawsuits against other customers seeking recovery of fictitious profits taken out more than two years before the fraud surfaced.

The trustee sued Wilpon and his friends, family and associates to recover about $300 million for fictitious profits and $700 million of principal repayments received within six years before the Madoff firm’s bankruptcy in December 2008. Rakoff dismissed all of the trustee’s claim except for actual fraud on the receipt of principal and profits for two years before bankruptcy under the fraudulent transfer law contained in the U.S. Bankruptcy Code.

Rakoff dismissed all of the trustee’s claims under New York state fraudulent transfer law, where the look-back period for recovery would have been six years.

Rakoff dismissed the state and federal law claims for so- called constructive fraudulent transfer in view of the provision in bankruptcy law known as the safe harbor. The provision prevents a trustee from recovering transfers made by a stockbroker.

The trustee “might well prevail on summary judgment seeking recovery of the profits,” Rakoff said in a footnote. With little in the way of explanation, Rakoff said in the same footnote that the trustee might be able to recover profits going back six years, even though elsewhere in the opinion he said recovery would be limited to two years.

It is unclear from the opinion exactly what the trustee’s maximum recovery might be. In an e-mailed statement last night, the Wilpon group stated their view that the recovery is limited to money taken out within two years.

Yesterday’s ruling also upheld the trustee’s effort to subordinate the Wilpon group’s claims. According to Rakoff, the claims could be subordinated if the trustee proves investments were made with “reckless disregard” of fraud.

The opinion theoretically allows the recovery of principal repayments if the trustee can show the Wilpon group wasn’t acting in good faith. Because the case involves securities law, where there is generally a higher standard for showing knowledge, Rakoff established a low standard for the Wilpons to meet in demonstrating their good faith.

Rakoff said it wasn’t sufficient for the trustee to show that the Wilpons had seen enough indications of suspicious activity to cause them to investigate further. Because a customer has no inherent duty to investigate a broker, the trustee must prove “willful blindness,” which means having seen enough “red flags” to “suggest a high probability of fraud,” Rakoff said. Simply being “confronted with suspicious circumstances” isn’t enough, he said.

Rakoff is yet to decide another case involving a customer named Greiff who is being sued for recovery of false profits. The Greiff suit, like hundreds of others, is based partly on so- called constructive fraud. The Wilpon opinion dismissed all state and federal constructive-fraud claims, indicating that the Greiff suit and others like it will be dismissed on that ground, thus limiting the trustee’s recovery to two years at best.

Rakoff’s opinion appears to mean that perpetrators of brokerage Ponzi schemes can manipulate the system to profit customers while making them immune from being required to disgorge some false profits.

A brokerage customer gratuitously given profits could retain principal and some profits taken out, so long as the customer hadn’t seen enough to indicate a high probability of fraud. For non-brokerage Ponzi schemes where the safe harbor doesn’t apply, giving back all false profits from as long as six years is an almost foregone conclusion.

Consequently, customers of a hedge-fund Ponzi scheme, such as Bayou Group LLC, have greater liability, as do those who deal with a Ponzi scheme law firm like Dreier LLP. Rakoff’s decision means there are now two fraudulent-transfer laws, one for brokers with a narrow scope for recovery and another for all other forms of Ponzi schemes.

Rakoff’s ruling didn’t discuss an opinion from late August by Kimba M. Wood, another U.S. district judge in New York, in a case involving another Madoff customer. Wood upheld six-year claims for constructive fraud and rejected the safe-harbor defense.

Rakoff didn’t explain why he dismissed the six-year claims under state law, which are functionally similar to the two-year federal-law claims he upheld.

Rakoff likewise didn’t discuss an opinion from this month in the Madoff case where U.S. Bankruptcy Judge Burton R. Lifland explained why the safe harbor doesn’t apply to a broker that is a through-going fraud.

The trustee or Wilpon, or perhaps both, may wish to appeal. Given that the lawsuit isn’t completed, there is no absolute right to appeal at this juncture in the federal court system. There can be a so-called interlocutory appeal if the courts permit.

There well may be an appeal at this point to the U.S. Court of Appeals, with regard to another customer, if not Wilpon. In a case like the Greiff suit, where the trustee seeks only false profits, there would be a right to an immediate appeal if Rakoff dismisses the suit entirely.

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 Wilpon suit in district court is Picard v. Katz, 11- 03605, U.S. District Court, Southern District New York. 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).

New Filing

Hussey Copper From Pittsburgh Files in Delaware to Sell

Hussey Copper Corp. filed a Chapter 11 petition yesterday in Delaware after working out a contract for selling the business to a buyer named KHC Acquisition Corp.

Family-owned Hussey, in business since 1848, makes a variety of copper products from plants in Leetsdale, Pennsylvania, and Eminence, Kentucky. Revenue of $454 million in 2008 shrank to $382 million in 2010. Last year, the net loss was $3 million, according to court papers.

The revolving credit matured, with $38.2 million now owing. PNC Bank NA is agent for the secured lenders. There is also a $2.4 million subordinated loan. In addition, the company owes $29 million to trade suppliers, the papers say.

The lenders are providing financing for the Chapter 11 case.

SSG Capital Advisors LLC was retained to find a buyer or work out refinancing of the matured bank debt.

The Leetsdale plant is near Pittsburgh.

The case is In re Hussey Copper Corp., 11-13010, U.S. Bankruptcy Court, District of Delaware (Wilmington).

Updates

Dodgers Ask for Delay on Baseball Exclusivity Motion

The Los Angeles Dodgers baseball club filed papers in bankruptcy court yesterday asking the bankruptcy judge to delay a hearing on the motion by Major League Baseball Commissioner Bud Selig for permission to file a Chapter 11 plan so the team could be sold out from underneath the current owner, Frank McCourt.

Selig filed two motions on Sept. 23, the first to end the team’s exclusive right to file a plan and the second to disqualify the two law firms representing the Dodgers. Yesterday, the team responded with a request it hopes to make in bankruptcy court today. The Dodgers want the judge to delay the exclusivity motion until 60 days after he rules on whether the laws firms should be disqualified.

Currently, the commissioner’s motions are both on the bankruptcy court calendar for hearing on Oct. 12. The team says they need time to perform an investigation into the commissioner’s grounds for attempting to end the Dodgers’ plan- filing exclusivity.

Turning the tables on the commissioner, the team intends on investigating whether Selig was in good faith when he says he would disapprove any sale of television broadcasting rights beginning with the 2014 season. Similarly, the Dodgers intend to investigate whether the commissioner violated the team’s rights when he nixed an extension of the television agreement before the Chapter 11 filing.

The Dodgers also want time to investigate whether the commissioner is correct in contending that the existing franchise with Major League Baseball is incapable of being assumed on account of breaches that allegedly can’t be cured.

For the details on the commissioner’s two motions, click here for the Sept. 26 Bloomberg bankruptcy report.

The Dodgers filed under Chapter 11 on June 27 when faced with missing payroll because the commissioner refused to approve an agreement to sell Fox Entertainment Group Inc. an extension on the existing broadcasting license. For a summary of the pre- bankruptcy agreement with Fox, click here for the June 28 Bloomberg bankruptcy report.

In mid-September the team filed papers designed to set up an auction and sale procedure for telecasting rights beginning in 2014. The hearing on the sale-procedure motion is set for Oct. 12, the same day when the commissioner has his motions on the calendar to end exclusivity and disqualify the team’s two law firms, Dewey & LeBoeuf LLP and Young Conaway Stargatt & Taylor LLP.

The team’s Chapter 11 petition said assets are more than $500 million while debt is less than $500 million.

The case is In re Los Angeles Dodgers LLC, 11-12010, U.S. Bankruptcy Court, District of Delaware (Wilmington).

JPMorgan, Lehman Again Differ About Who Rules on Suit

JPMorgan Chase Bank NA wants a U.S. District judge to take away the multibillion dollar lawsuit filed in May 2010 where Lehman Brothers Holdings Inc. and its creditors’ committee allege that the bank used its “immense leverage” as Lehman’s clearing bank to secure new guarantees and billions in assets.

U.S. Bankruptcy Judge James M. Peck himself flagged the issue in August about whether he has the right to preside over the lawsuit in light of a June decision from the U.S. Supreme Court called Stern v. Marshall. In a motion filed this week, New York-based JPMorgan wants a district judge to remove the suit from bankruptcy court even before Peck decides whether the case should be handled upstairs.

Lehman and JPMorgan filed a new set of papers this week staking out starkly differing positions on whether the bankruptcy court can hear the case in view of the Stern decision. Even if Stern means the bankruptcy court can’t make a final ruling, Lehman contends that Peck may hold a trial and give a recommended ruling to a district judge who would review the record and make an independent determination about who wins and who loses.

JPMorgan, by contrast, believes that Stern “prevents the bankruptcy court from adjudicating any of the causes of action.”

Lehman doesn’t even concede that the Supreme Court’s Stern opinion ousts Peck from the right to make a final ruling. Lehman argues that Stern still allows a bankruptcy judge to rule on a lawsuit against a creditor so long as passing on the creditors’ claim would resolve all the issues in the lawsuit.

Lehman therefore argues in its papers that when Peck rules on JPMorgan’s claim he will of necessity dispose of all issues required for deciding on the lawsuit.

Either Peck or a district judge could latch onto another resolution. As sometimes happened even before the Stern ruling, the bankruptcy court might handle the case up until it’s ready for trial, and then send the suit to a district judge to preside over trial.

The lawsuit is based on Lehman’s allegation that JPMorgan had no right under the clearing agreement to demand more collateral.

Both sides already submitted papers on the question of whether Lehman makes a good claim or the complaint should be dismissed. If a district judge removes the suit from bankruptcy court quickly, Peck may not have an opportunity to rule on JPMorgan’s motion to dismiss.

For details on arguments Lehman and JPMorgan previously made on the bankruptcy court’s ability to hear the lawsuit, click here for the Aug. 8 Bloomberg bankruptcy report. For a discussion of the Stern decision, click here for the June 24 Bloomberg bankruptcy report.

Even if the suit remains in bankruptcy court, a trial isn’t scheduled until August 2012.

JPMorgan contends the suit should be dismissed as being protected by the so-called safe harbor which insulates swap agreements and securities transactions from being attacked as fraudulent transfers. Lehman believes there are loopholes allowing the suit to stand.

The disclosure statement approved, Lehman creditors will be voting on the Chapter 11 plan in anticipation of a Dec. 6 confirmation hearing. 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.

The lawsuit is Lehman Brothers Holdings Inc. v. JPMorgan Chase Bank NA, 10-03266, U.S. Bankruptcy Court, Southern District New York (Manhattan).

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).

Innkeepers Offers New Theory Forcing Cerberus to Buy

Innkeepers USA Trust isn’t giving up on the hope it can persuade the bankruptcy judge in New York to compel Cerberus Capital Management LP and Chatham Lodging Trust to complete a $1.12 billion acquisition of 64 hotels. If the sale isn’t finished, Innkeeper’s Chapter 11 reorganization plan may unravel, even though it was approved in a June confirmation order.

Innkeepers sued at the end of August, asking the bankruptcy judge to compel the buyers to purchase the 64 hotels. In addition to contending they have an escape clause in the contract, Cerberus and Chatham point to a so-called liquidated damages clause, which they believe makes them liable for nothing beyond the loss of their $20 million deposit.

From the outset of the suit, Innkeepers has contended the judge can either compel the buyers to complete the sale or assess damages in excess of $20 million.

In a revised complaint filed yesterday, Innkeepers argued that the judge has the right to compel compliance with a confirmation order and thus may force the buyers to finish the acquisition. Absent settlement, a trial is set to be held Oct. 10 through 12.

Innkeepers’ plan was based on a sale of the hotels to deal with the claims of the primary secured creditors, Lehman Ali Inc., a non-bankrupt subsidiary of Lehman Brothers Holdings Inc., and Midland Loan Services Inc., the servicer for $825 million of fixed-rate mortgages. For details on the plan, click here for the June 24 Bloomberg bankruptcy report.

The buyers terminated the contract on Aug. 19, contending there was a material adverse change in the business. For a summary of Innkeepers’ lawsuit before the amendment, click here for the Aug. 30 Bloomberg bankruptcy report.

Apollo Investment Corp. acquired Palm Beach, Florida-based Innkeepers in July 2007 in a $1.35 billion transaction. It had 72 extended-stay and limited-service properties with 10,000 rooms in 20 states. The Chapter 11 petition filed in July 2010 listed assets of $1.5 billion against debt totaling $1.52 billion.

The lawsuit is Innkeepers USA Trust v. Cerberus Four Holdings LLC (In re Innkeepers USA Trust), 11-02557, U.S. Bankruptcy Court, Southern District New York (Manhattan). The Chapter 11 case is In re Innkeepers USA Trust, 10-13800, in the same court.

Solyndra to Auction Non-Core Assets on Nov. 2

Solyndra LLC overcame opposition from the creditors’ committee which sought more time for marketing the shuttered business. At a hearing yesterday, the bankruptcy judge sided with the maker of solar energy panels and scheduled a sale of the business on October 27. For Bloomberg coverage of the hearing, click here.

The company filed a separate set of papers yesterday aiming to hold an auction on Nov. 2 for what it calls “non-core assets” that wouldn’t be needed by anyone who purchases the business a whole.

Solyndra says that the non-core asset sale should generate somewhere in the neighborhood of $5 million. The auction would be conducted by Heritage Global Partners, if the bankruptcy judge in Delaware agrees with the proposal at an Oct. 17 hearing.

Having the main auction in late October will allow the successful bidder to pick up additional equipment at the non- core auction.

Solyndra is proposing that successful bidders at the non- core auction pay Heritage an additional 15 percent buyer’s premium. Heritage would also receive a 5 percent commission.

Solyndra filed for Chapter 11 reorganization on Sept. 6 after halting operations in late August. The start-up business was funded partly with a $535 million loan guaranteed by the U.S. government.

Based in Fremont, California, Solyndra said assets were $859 million while debt totaled $749 million as of Jan. 1, 2011. When the petition was filed, Solyndra said secured debt was $783.8 million. The business was financed in part with $709 million from eight issues of preferred stock, plus $179 million in convertible notes.

Construction of the plant began in September 2009. Production commenced in January 2011, to halt in late August when new financing failed to materialize. Revenue in 2010 of $142 million resulted in a $329 million net loss.

The case is In re Solyndra LLC, 11-12799, U.S. Bankruptcy Court, District of Delaware (Wilmington.)

Statistics

Only $5 Billion of Junk Debt to Refinance 2011

Junk-rated companies used favorable credit markets in the first half 2011 to reduce debt maturities from 2011 to 2015 by more than 30 percent. Where $276 billion in junk debt would have matured by 2015, the total has been reduced to $191 billion, according to a September 23 report by Moody’s Investors Service.

In the near term, only $5 billion of junk debt remains to mature this year. Including maturities in 2012, $24 billion in junk remains for refinancing.

At the beginning of 2011, junk maturities through 2012 totaled $45 billion, Moody’s said.

Junk-debt markets dried up midyear. The issuance of $1.6 billion in junk corporate bonds in August represented a 92 percent decline from the year before and a 90 percent drop from July, Moody’s said in a Sept. 16 report.

Daily Podcast

5th Circuit, L.A. Dodgers, Howrey, Bald Eagle: Bankruptcy Audio

The discourse between circuit judges during oral argument at the U.S. Court of Appeals in New Orleans was like the pot calling the kettle black, as explained on the bankruptcy podcast with Bloomberg Law’s Lee Pacchia and Bloomberg News bankruptcy columnist Bill Rochelle. Rochelle analyzes the pros and cons of a motion by the Commissioner of Major League Baseball to sell the Los Angeles Dodgers baseball club. The podcast ends with an obituary for the law firm Howrey LLP and an observation on the fishing talents of bald eagles. To listen, click here.

Advance Sheets

Joint-Client Privilege Not Applicable to Trustee

A lawyer who represented a company that went bankrupt and non-bankrupt affiliates was compelled to turn over communications with the company’s non-bankrupt principal.

U.S. Bankruptcy Judge Bruce A. Markell from Las Vegas wrote a 24-page opinion this month in the Chapter 7 liquidation of Hotels Nevada LLC. A year ago, Markell cut the bankruptcy lawyers’ fees by 95 percent. To read about the earlier opinion, click here for the Oct. 1, 2010 Bloomberg bankruptcy report.

In last year’s opinion, Markell concluded that the bankruptcy lawyers’ services primarily benefitted non-bankrupt affiliates. In the new case, the law firm that represented the company before bankruptcy refused to turn over communications with the bankrupt company, contending that the joint-client privilege precluded disclosure. The pre-bankruptcy law firm contended that the non-bankrupt principal, who was being represented jointly, didn’t consent to turnover.

Markell noted that the joint-client privilege ordinarily prevents disclosure of privileged communications to third parties. The bankrupt company’s trustee, however, is not a third party, Markell said. In compelling the law firm to turn over communications with the non-bankrupt principal, Markell said that the privilege didn’t “override the responsibilities owed by the attorney to each client.”

Even if the trustee didn’t succeed to the rights of the company itself to obtain communications with the lawyers, Markell also ruled that the adversary exception applied, also requiring turnover. Markell said that “when there is a contest between the parties who jointly received the communication, there is no confidentiality.”

The new case is In re Hotels Nevada LLC, 09-31131, U.S. Bankruptcy Court, District of Nevada (Las Vegas).

--With assistance from Dawn McCarty, Steven Church and Michael Bathon in Wilmington, Delaware. Editors: Mary Romano, Peter Blumberg

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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