Creditor’s Subsequent  Withdrawal of  Claim Did Not Deprive Court of Equitable Jurisdiction  to Hear Avoidance Adversary

   Eric Gruber

Myles Alderman & Eric Gruber – January, 2019

This is yet another case in the long history of litigation related to the trail of financial destruction left by the Bernard Madoff’s Ponzi scheme.

While the decision offers a well written survey of the law established by  Granfinanciera, Germain v. Conn. Nat’l Bank, and Stern v. Marshall, the most salient holding is the Court’s application of the “Time-of-Filing” rule to equitable jurisdiction in the context of adversary proceedings

The defendants had filed proofs of claims in the Chapter 7 of the debtor Bernard L. Madoff Investment Securities, LLC (“BLMIS”) with hopes of recovering some of the money they had lost. The chapter 7 Trustee responded by bringing adversary proceedings against them alleging the right to avoid transfers to them  from BLMIS under a fraudulent transfer theory.   Before trial commenced on the avoidance claims against them, the defendants resolved their claims against the estate.  The Bankruptcy Court invited the defendants to withdraw the proofs of claims, since the issues were resolved.  The defendants did withdraw their proofs of claims, but the Bankruptcy Court noted that it was reserving until a later date, the question of whether the withdrawal of the proofs of claims had an impact on the Court’s jurisdiction to hear the fraudulent transfer adversary proceeding.

The Court starts with an analysis of how Section 502(d) of the Bankruptcy Code mandates the disallowance of any claim filed by a creditor who received a fraudulent transfer unless and until the creditor restores the property or its value to the estate.  The Court then looks to the Supreme Court’s decision in  Lagenkamp v Culp,  for the proposition  that even if a creditor would have otherwise been entitled to a jury trial pursuant to Granfinanciera,  the filing of the proof of claim brings the creditor within the Bankruptcy Court’s jurisdiction to determine the avoidance action without a jury.  Judge Bernstein cites Bankr. Serv. Inc. v Ernst & Young (“CBI Holdings”), and Germain v Nat’l Bank for the proposition that the filing of a proof of claim is necessary for a creditor to forfeit the right to a jury trial, but may not alone be sufficient.   The Court quoted CBI Holdings and cited to Stern v. Marshall for the law  that “a creditor loses its jury trial right only with respect to claims whose resolution affects the allowance or disallowance of the creditor’s proof of claim or is otherwise so integral to restructuring the debtor-creditor relationship.”

The Court cites a line of Supreme Court cases from 1824 through 1991 for the law that facts at the time-of-filing rather than at the time of trial determine questions of diversity jurisdiction.  The court looked to 28 U.S.C § 1334 and a series of cases, including Nuveen Mun. Tr. v. WithumSmith Brown, PC and WorldCom, Inc., Sec. Lit. for the proposition that bankruptcy court jurisdiction  is similarly determined based upon the facts at the time a lawsuit is filed.

The Court reasoned that the same time-of-filing rule that has consistently been applied to subject matter jurisdiction cases also applies to this case of equitable jurisdiction.

“If equitable jurisdiction depended on the status of the defendant-creditor’s claim, the defendant-creditor could manipulate the bankruptcy jurisdiction at any time simply by withdrawing the claim. Taking this argument to its logical conclusion, the defendant could seek to withdraw the claim at any time prior to final judgment if the defendant did not like the way the proceedings were unfolding.”   See In re: Bernard L. Madoff, Debtor.  Irving Picard,  Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC  v. BAM L.P., Michael Mann and Meryl Mann.

SDNY Bankruptcy Court Holds That Time-of-Filing Applies to Equitable Jurisdiction