Personal Bankruptcy for Madoff More Likely

Over the objections of the government, a federal judge cleared the way on Friday for Bernard L. Madoff to be forced into personal bankruptcy, a ruling that could help those who invested with one of the many big hedge funds that lost money in his vast Ponzi scheme.

Judge Louis L. Stanton of Federal District Court in Manhattan removed a roadblock to a bankruptcy filing that he had put in place in December, ruling that the advantages of forcing Mr. Madoff into personal bankruptcy outweighed the possible increase in time and expenses.

Lawyers in the case said the bankruptcy petition would be filed on Monday against Mr. Madoff, who is in jail awaiting sentencing after pleading guilty to a fraud involving client accounts totaling almost $65 billion. His lawyer, Ira Lee Sorkin, declined to comment on the ruling.

The judge determined that a bankruptcy filing would protect all of Mr. Madoff’s victims, not just those who were his customers and who are consequently eligible to file claims in the existing bankruptcy case involving his brokerage firm.

The Madoff firm’s bankruptcy is being overseen by a trustee whose expenses are covered by the Securities Investors Protection Corporation, an industry-financed insurance fund. That trustee, Irving H. Picard, opposed a personal bankruptcy filing as an unnecessary expense.

But Judge Stanton disagreed, noting that the trustee’s distributions, by law, can go only to those who were customers of Mr. Madoff’s brokerage firm “rather than a substantial number of those whose losses stemmed from investments made through intermediaries.”

To be sure, those feeder funds — like the giant Fairfield Sentry fund, run by the Fairfield Greenwich Group, and the private hedge funds run by the prominent investor J. Ezra Merkin — were Mr. Madoff’s customers, and they ultimately will be eligible to recover the same percentage of their losses as his individual customers. They could then use that money to compensate their own investors.

But their investors are not eligible for the $500,000 in SIPC insurance coverage that is being distributed to the brokerage firm’s customers.

Judge Stanton also rejected government arguments that criminal forfeiture laws were a more powerful and less expensive way to gather assets for Mr. Madoff’s victims, because his personal assets were almost certainly the fruits of his crime and therefore subject to forfeiture.

The government submitted no proof for that conjecture, the judge noted. Moreover, Mr. Madoff’s victims have no role in forfeiture proceedings, as they do in bankruptcy court, he said.

John Nestor, a spokesman for the Securities and Exchange Commission, said the agency wanted to maximize returns for investors “in the most efficient and cost-effective manner possible” but would work with a bankruptcy trustee when one was appointed.

Jonathan M. Landers at Milberg, the law firm that asked Judge Stanton to permit the bankruptcy filing, said the need to protect the feeder-fund investors was not one of the arguments his firm made to the judge.

Rather, the firm argued that the bankruptcy court was the best place to weigh competing claims from creditors, which are barred from suing to seize the debtor’s assets in other jurisdictions — as various victims have already done in the Madoff case.

Moreover, Mr. Landers said, the bankruptcy court is the most effective forum for tracking down Mr. Madoff’s personal assets abroad, where the reach of federal forfeiture laws may be disputed. He added: “What are you going to do — send the Marines over to seize the French château?”

But the search for foreign assets has certainly not been neglected by Mr. Picard, the Madoff brokerage firm’s trustee.

Since early February, he has engaged a half-dozen foreign law firms — in Ireland, the Cayman Islands, London and Luxembourg — to pursue fresh assets and defend those already recovered.

On Thursday, he sued an offshore bank, Banque Jacob Safra in Gibraltar, and one of its hedge fund clients, Vizcaya Partners, to recover $150 million that was withdrawn from the Madoff firm for Vizcaya’s benefit at the end of October.

But people close to the case said it did not signal the beginning of a campaign of so-called clawback lawsuits — cases aimed at recovering money from investors who withdrew more from their Madoff accounts, over time, than they had put in.

There are many individual investors of limited means, as well as some large charities, who fear they fall in that category, and many of them have said publicly that the threat of clawback litigation has been their nightmare for months.

Those lawsuits may come, of course — but the Vizcaya complaint is not one of them. Indeed, Vizcaya would not normally be vulnerable to a clawback suit at all because, according to the complaint, it invested $327 million and withdrew only $150 million.

Cases like the one filed against Vizcaya involve a simpler and less controversial aspect of the bankruptcy code, James Sprayregen, a bankruptcy law specialist with Kirkland & Ellis in Chicago, explained.

To prevent devious debtors from transferring money for their own use and then filing for bankruptcy when the piggy bank is empty, all bankruptcy trustees have a broad right to sue to recover money transferred from the debtor’s estate within 90 days of the bankruptcy filing, he said.

Payments made during that 90-day window are called “preference” payments, and they are the low-hanging fruit in any insolvency — but they may be particularly significant in this case, where the trustee has so far recovered only about $1 billion.

Criminal charges filed against Mr. Madoff in December quoted him as telling employees soon before his arrest that he was worried about recent redemption demands totaling $7 billion. If he honored those redemption requests within the 90-day window, the Vizcaya complaint could be the first in a worldwide siege of these “preference” lawsuits.