According to The Wall Street Journal, Michael Roseman, who was in charge of controlling risks, expressed serious concerns to both Corzine and MF Global’s board of directors several times last year before eventually resigning.

The revelation that MF Global had $6.3 billion in net exposure to the bonds of troubled countries like Italy and Spain triggered a run on the bank that eventually forced the futures brokerage into bankruptcy on October 31.

Roseman, who was brought on in 2008 to overhaul MF Global’s risk systems after a rogue trader cost the company $140 million, warned that MF Global didn’t have enough cash to buffer against these risky positions and also presented scary scenarios about the ripple effects of a credit rating downgrade, the Journal reported.

However, Corzine argued these scenarios were too extreme and likely impossible and that the company’s exposure was limited and worth the risks, the paper reported. Corzine also suggested he might leave MF Global if the board didn’t trust his judgment about the bets, the Journal said.

Corzine, the former governor of New Jersey and CEO of Goldman Sachs (GS: 105.13, +3.97, +3.92%), is expected to testify on the MF Global collapse at a House Agriculture Committee hearing on Thursday.

Each time Corzine wanted to increase the bullish eurozone bets above previously-established risk thresholds, Roseman had to ask the board for permission, the Journal reported. Roseman detailed the risks that made him feel uncomfortable, the paper reported.

Eventually, Roseman was replaced by a new chief risk officer in January, prompting him to leave the company in March.

Corzine was denied permission by the board at least one time this year to increase the eurozone bets further, the Journal reported.

After suffering key ratings downgrades in October, MF Global eventually succumbed to the pressures, becoming one of the top 10 bankruptcies in U.S. history.

In the transfer, Giddens would pay out from 80 percent to 85 percent of all assets remaining in his control, keeping $800 million in reserve, according to his court filing today. Two previous payouts to commodity customers totaled about $2 billion.

To deal with many of the objections, which “raise common concerns,” Giddens said he “made some language changes” in a proposed order he will ask the judge to sign approving the transfer. To satisfy administrators of MF Global’s U.K. and other foreign affiliates who objected that the transfer might deplete funds available to pay them, he would make future transfers based on available assets and not ask the judge to let him simply use his own discretion, he said in the filing.

“The trustee believes it would be more prudent, relieve uncertainty, and better inform the expectations of customers to make further bulk transfers, if any, only upon further motion and order of the court based on facts and circumstances and availability of property,” he said.

British Unit

MF Global UK Ltd. said yesterday it has $250 million remaining in accounts at the MF Global brokerage, of which $230 million is in segregated commodity accounts for customers. The U.K. company hasn’t received any money from the trustee of the U.S. brokerage and isn’t in line to get any in the third planned payout of $2.1 billion, the administrators of the bankrupt company said in a court filing.

The judge handling the MF Global brokerage liquidation in New York “must adequately protect” all former customers in any order he signs approving Giddens’s next transfer, they said. The judge is Martin Glenn.

Some customers faulted the transfer because it covered only U.S. customers. The brokerage trustee treats foreign futures customers “differently,” favoring U.S. clients, said RWA Raiffeisen Ware Austria AG, a cooperative agricultural group.

In the filing, Giddens said he had excluded customers whose assets are held in foreign accounts “because virtually all of it is not under the trustee’s control, but rather under the control of MFGI’s foreign former affiliates,” which also are being liquidated in their home countries.

What and When

RWA has asked Giddens what he’s doing to recover the funds from administrators of the U.K. affiliate, and when he might return assets to these customers.

“We are urgently working on responses to all our objectors,” said Kent Jarrell, a Giddens spokesman, in an e- mail.

Creditors of the MF Global parent said Giddens is planning the distribution without explaining why he thinks the funds are customer property or verifying that the customers are entitled to receive the funds.

Paying the wrong people or paying out too much will hurt the bankrupt parent company’s estate, which has claims against the brokerage and owns its equity, MF Global Holdings Ltd. creditors lawyer Martin Bienenstock said in a Dec. 5 court filing.

The shortfall in the MF Global brokerage’s U.S. segregated customer accounts may exceed $1.2 billion, more than double what was previously expected, Giddens has said.

Prudent and Sufficient

“The trustee believes that the amount held back from transfer is prudent and sufficient to address the known potential claims while maintaining further amounts to account for the potential of unknown claims against these same funds,” Giddens said today, referring to the $800 million he plans to hold on to.

CME Group Inc., which runs a futures exchange and has guaranteed some of the trustee’s transfers, said it supports more U.S. customer payouts.

“The proposed distribution will leave the trustee with an ample customer segregated cash reserve,” it said in a court filing today.

Including funds already distributed, Giddens controlled $4.9 billion in U.S. segregated commodity customer funds, CME said. It calculated that an additional $900 million in customer funds were traded on foreign exchanges, putting the total at about $5.8 billion. Previous estimates put the segregated accounts at about $5.4 billion.

Like Giddens, CME said the foreign futures accounts aren’t in the trustee’s control.

CME said the creditors committee in the holding company’s bankruptcy doesn’t have the legal right to object to the trustee’s distributions.

Transfers

Giddens, who is liquidating the brokerage, has transferred about 38,000 commodity accounts to other firms, and said he plans to sell 330 securities accounts. Three transfers of collateral made and pending will give commodity customers about $4 billion of their assets, according to court filings.

The parent company’s Oct. 31 bankruptcy filing, the eighth- largest in U.S. history, listed assets of $41 billion. Jon Corzine, the former co-chief executive officer of Goldman Sachs Group Inc., quit as MF Global’s CEO on Nov. 4.

The brokerage case is Securities Investor Protection Corp. v. MF Global Inc., 11-02790, U.S. District Court, Southern District of New York (Manhattan). The parent’s bankruptcy case is MF Global Holdings Ltd., 11-bk-15059, U.S. Bankruptcy Court, Southern District of New York

In an order dated Friday and made public on Monday, U.S. District Judge Deborah Batts in Manhattan threw out 2008 lawsuits alleging fraud and misrepresentation by the Ascot Fund, the Gabriel Fund and the Ariel Fund. Another defendant was BDO Seidman LLP, the auditor of the Ascot Fund.

“No misrepresentation was made when defendants relied on Madoff, as a third-party manager, to follow the investment strategies that aligned with the stated investment strategies of the funds,” the judge’s order said.

Batts also said allegations that the funds should have recognized “red flags” alerting them to Madoff’s fraud “are unavailing given the opposing considerations of Madoff’s immense reputation and deep deception.”

Madoff, 73, was arrested in December 2008 and pleaded guilty in March 2009 to running a multibillion-dollar fraud over decades. He is serving a 150-year prison term.

In the wake of the Madoff scandal, Merkin, a money manager, philanthropist and art collector, resigned as non-executive chairman of GMAC LLC, the financing unit of General Motors. GMAC is now Ally Financial.

The plaintiffs in the lawsuit included New York Law School, a pension fund and two other investors. They invested a total of $18 million in Merkin’s hedge funds, money that was in turn invested in Madoff’s firm.

The Statute of Limitations for Bringing Bankruptcy Preference Actions

The statute of limitations period for bringing preference actions is ofter quoted as being 2 years from the date of the filing of the bankruptcy.  Actually, the calculation of the statute of limitations is more complicated.  

Section 546(a) of the Bankruptcy Code has a 2 part test for determining the time limit for bringing of bankruptcy preference actions.  Bankruptcy preference claims are time barred after the later of (1) 2 years after the bankruptcy filing or (2) 1 year after the appointment of a trustee.  Under this calculation, if a trustee is appointed in the second year of a bankruptcy, it will have a full year to decide whether to bring preference claims.  For example, if a debtor’s bankruptcy is converted from a Chapter 11 to a Chapter 7 18 months after the bankruptcy if filed, the statute of limitations or the trustee to bring preference actions is extended to 30 months (2 1/2 years) from the original petition date.

Because most trustees are appointed within the first year of a bankruptcy filing, as a general rule of thumb, 2 years from the date of filing of the bankruptcy is going to be the cut off date for filing of bankruptcy preference claims.  However, to properly determine the statute of limitations in a case that has been converted from Chapter 11 to Chapter 7, it is necessary to know the date a trustee was appointed or, more specifically, whether the date of the trustee “interim” or “permanent” appointment is controlling.

For example, in the Third Circuit (which includes Delaware), the date of appointment of the permanent trustee under Section 702 is the controlling date for purposes of the statute of limitations. Singer v. Franklin Boxboard Co. (In re American Pad & Paper ), 478 F.3d 546 (3rd Cir. 2007)  Under Section 702, the interim trustee appointed by the US Trustee on or about the date of the conversion of a case to Chapter 7, automatically becomes the permanent trustee at the Section 341 meeting of creditors if creditors do not elect a trustee under Section 702.

Ironically, every once in a while, potential preference claim defendants will benefit from the “permanent appointment” requirement.   If the conversion of a Chapter 11 case to a Chapter 7 case occurs too near to the expiration of the 2 year statute of limitations, there will be insufficient time for the trustee’s appointment to be made permanent before the statute of limitations expires.  In any such late conversion instances, it is important to check the date of the Section 341 meeting to see if it occurred before or after the 2 year statute of limitations ran.

Finally, bankruptcy preference claims in all instances must be brought before the case is closed or dismissed.  The scenario seldom comes into play, but it does happen.  The typical context is one where a motion is filed to reopen a case after it is closed.  Reopening of a closed case can occur for any number of reasons.  When the bankruptcy court allows a case to be reopened does the period for bringing preference claims also reopen?  The answer to this question unfortunately is “maybe”.

Although Section 546(a)(2) provides that a proceeding to recover preferential transfers “may not be commenced after … the time the case is closed or dismissed”, bankruptcy courts have interpreted this to require that the case have been “properly and finally” closed.  See, e.g., Gross v. Petty (In re Petty), 93 B.R. 208, 212 (B.A.P. 9th Cir. 1988).  Using this qualifier, the courts have allowed preference actions to be brought in a reopened bankruptcy case if assets are concealed or transfers that were required to be disclosed were not disclosed.

The Debtor’s Desire to Re-Establish Goodwill with the Supply Base

The intent to pursue bankruptcy claims is often kept hush, hush or at least obscure until well after the plan of reorganization is approved. The reason? The bankrupt customer often needs to maintain supplier relationships in the months following bankruptcy in order to continue business.   Needless to say, these relationships would be strained if the suppliers knew that they would be receiving a demand for return of payments.

One of the best articles describing this phenomenon in real- life terms is a Today in Finance article in CFO.com “Delphi Files Secret Preference Claims” dated October 2, 2007. In this article, the customer’s bankruptcy representative’s motivations are summarized as follows:

Under the law, a trustee must file a preference claim within two years of the company’s Chapter 11 filing, in most cases. But trustees usually wait until the last possible moment to file a preference suit so as not to ruin the company’s relationship with vendors while negotiating bankruptcy settlements with them. Indeed, if the company emerges from Chapter 11, it will need strong vendor relationships to keep the operation viable.

This failure to mention the prospect of preference claims is not seen as an effort to “hide the ball” from the creditor. The creditor is presumed to be sophisticated and to know that the prospect of preference claims exists. As one Bankruptcy Court noted when talking about the separation of preference claims from the resolution of other matters with a creditor:

“[I]n large chapter 11 cases sophisticated creditors typically are well aware of prospects and risks of preference litigation. In this chapter 11 case when the petition was filed creditors knew that it was a liquidation case that would very likely result in preference actions. Thus, it seems unlikely that creditors could be surprised or caught off guard when such preference complaints are finally filed.

TWA Inc. Post Confirmation Estate v. City and County of San Francisco Airports Commission, 305 B.R. 221 (Bankr. D. Del. 2004).

In representing clients who are concerned about exposure to bankruptcy preference claims, we continually try to determine the status of the bankruptcy preference claims process. We are sometimes told by the bankrupt customer’s counsel that the answer is in the plan of reorganization. But the plan of reorganization will only contain language “reserving” the right to pursue preference actions. For example, in a recent case the plan of reorganization, in addressing preference actions said:

Avoidance Actions shall be prosecuted, settled, or compromised as deemed appropriate by the board of directors of Reorganized Debtor in an exercise of its business judgment under applicable corporate law.

The Discontinuation of Debtor’s Business Operations

The discontinuation of the debtor’s business operations is the third factor affecting the timing of bankruptcy preference claims.   Discontinuation of business operations puts an end to a debtor’s efforts to reorganize.  The most common instances where a debtor ceases operations are:

• conversion of the Chapter 11 case to a Chapter 7; and
• completion of a section 363 sale in which all or substantially all of the operating assets are sold.

We have only seen one instance in the past 2 years where bankruptcy preference claims were brought before the debtor ceased business operations.  We view that case as an aberration.

The need to fund operations will usually determine how quickly bankruptcy preference claims are brought after discontinuation of business operations.  If there is cash available to pay for the continued wind up of operations, then there may be a futher delay in bringing of preference claims.  If there is no cash available, then it is common for bankruptcy preference claims to be brought quickly.

Lessons for Bankruptcy Preference Negotiation

From a negotiation perspective, only the bankrupt customer and the customer’s bankruptcy representative are benefited by the separation of bankruptcy preference claims from the process of negotiating the terms of a continued supply of goods and services.  From the supplier’s perspective, giving up the leverage of negotiating terms of a continued relationship before resolving a preference claim puts the supplier at a big disadvantage.

For this reason, it is critical that supplier’s counsel: (1) look for and evaluate any opportunity to include the resolution of preference claims as part of negotiations on other matters; and (2) include a release of preference claims, where appropriate, in any settlement documentation resolving matters with the customer’s bankruptcy representative.