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Commercial Fraud

Debtor’s Bankruptcy Filing Serves to Limit Creditor’s Liability to Third Parties

By: Ryan Dolan

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Ritchie Capital Structure Management Trading, LTD., v. General Electric Capital Corporation, the United States Court of Appeals for the Second Circuit held that investors in a debtor’s Ponzi scheme did not have standing to sue the debtor’s lender.

Innocent Transferees Involved in Ponzi Scheme Must Return Transfers in Excess of Principal Deposits

By: Allison N. Smalley

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Securities Investor Protection Corporation v. Bernie L. Madoff Investment Securities, LLC,[1] the Bankruptcy Court for the Southern District of New York concluded that a recipient should return fictitious profits he gained through the Ponzi scheme operated by Bernard L. Madoff Investment Securities (“BLMIS”).[2] Andrew Cohen withdrew approximately $4 million from his account at BLMIS between January 18, 1996 and December 11, 2008.[3] Of that withdrawal, approximately $1.1 million was fictitious profit.[4] Irving Picard, as the trustee of BLMIS,[5] sought to recover the fictitious profits from several recipients, including Cohen, under Section 548 of the Bankruptcy Code.[6] As a defense, Cohen asserted that he gave “value” to BLMIS when he received the fictitious profits.[7] The bankruptcy court, however, rejected this defense and concluded that the District Court should find in favor of Picard.[8]

Law Firms Can Be Liable For Failing to Advise Clients of Risks Resulting From Filing for Bankruptcy

By: Nicole Strout

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Peterson v. Katten Muchin Rosenman LLP. , the Seventh Circuit held that the allegations in a legal malpractice complaint by the trustee for Lancelot Investors Fund and other entities in bankruptcy (collectively “the Funds”), was plausible on its face.[1] In Peterson , the trustee filed suit against the Funds’ law firm for failing to detect the peril and curtail the risks pertaining to the Funds.[2] The Funds loaned money to and invested in vehicles owned by Thomas Petters, which, in turn, was supposed to finance Costco’s consumer-electronics inventory.[3] The Funds’ advances were to be secured by deposits made by Costco, not Peters, into a lockbox bank account.[4] However, Costco never deposited money into the account.[5] All the money came from a Petters entity.[6] In reality, Petters never had any dealings with Costco, and the whole set up was a Ponzi scheme.[7] Once the scheme collapsed, the Funds also collapsed.[8] Consequently, the Funds filed for relief under chapter 7 of the Bankruptcy Code.[9] The chapter 7 trustee for the Funds brought a cause of action against Katten, the law firm which acted as transactions counsel for the Funds, claiming that the law firm had a duty to inform its clients that the actual arrangement posed a risk because Petters was not actually running a real business.[10] In granting the law firm’s motion to dismiss, the district court held the Funds “knowingly took the risk and cannot blame the firm for failing to give business advice.”[11] After the trustee appealed the motion to dismiss, the court of appeals reversed the district court decision, holding the firm was liable not for failing to provide business advice but for failing to inform its clients of “the different legal forms that are available to carry out the business and how risks differ with different legal forms.”[12] Clients do not have to take the advice of their attorneys, but attorneys need to advise clients.[13]

Innocence is Required to Discharge a Debt Created by Agent’s Fraud

By: Arielle Cummings

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

With certain limited exceptions, an individual debtor may have his debts discharged in bankruptcy. Debts resulting from a debtor’s fraud, however, are generally not dischargeable. In In re Glenn, the United States Court of Appeals Seventh Circuit affirmed the lower court’s holding that if a debt is the result of fraud, the court can discharge the debt in bankruptcy if the debtor was not complicit in the fraud and that the court can still discharge the debt even if the fraud was created by the debtor’s agent, provided, again, that the debtor was not complicit in it. In Glenn, the defendants, the Glenns, asked a loan broker, Karen Chung to get them a short-term “bridge” loan of $250,000. Chung told the Glenns that a bank had agreed to give the Glenns a $1 million line of credit, but that the line for credit would not be available for a few weeks—hence the need for the “bridge” loan. Brian Sullivan, a lawyer and friend of Chung, agreed to lend the Glenns the $250,000. The loan was never repaid and the $1 million line of credit was never approved because Chung never applied for it in the first place. The Glenns declared bankruptcy and the lower court found that neither of the Glenns had committed fraud and refused to impute Chung’s fraud to either of them under an agency theory. The court granted the Glenn’s discharge. The court reasoned that “[p]roof that a debtor’s agent obtains money by fraud does not justify the denial of discharge to the debtor, unless it is accompanied by proof which demonstrates or justifies an inference that the debtor knew or should have known of the fraud.”