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In the Matter of v. D. Canale Beverages

February 6, 2012

IN THE MATTER OF BAYOU GROUP, LLC, ET AL., DEBTORS. BAYOU SUPERFUND, LLC, PLAINTIFF,
v.
D. CANALE BEVERAGES, INC., DEFENDANT. BAYOU SUPERFUND, LLC, PLAINTIFF,
v.
JOHN D. CANALE, III, DEFENDANT. BAYOU SUPERFUND, LLC, PLAINTIFF,
v.
MARY P. SMYTHE RESIDUARY TRUST, DEFENDANT. BAYOU SUPERFUND, LLC, PLAINTIFF,
v.
MARVIN E. BRUCE LIVING TRUST, DEFENDANT.



The opinion of the court was delivered by: Paul G. Gardephe, U.S.D.J.

Jointly Administered

MEMORANDUM OPINION & ORDER

These actions arise from adversary proceedings the Bayou hedge funds ("Plaintiff" or the "Funds") brought under §§ 548(a) and 544 of the Bankruptcy Code, and §§ 273-76 of the New York Debtor and Creditor Law to recover -- as fraudulent conveyances -- redemption payments the Funds made to certain investors within two years of August 2005, when the Funds' fraudulent nature was disclosed. The investors named here redeemed their Bayou investments in June 2004, before the fraud was uncovered and the Funds collapsed.*fn1

These actions proceeded to trial on May 3, 2011, and a jury returned a verdict in Plaintiff's favor on May 12, 2011. Four of the seven Bayou investors who went to trial -- D. Canale Beverages, Inc., John D. Canale, III, the Mary P. Smythe Residuary Trust, and the Marvin E. Bruce Living Trust ("Defendants") -- have moved pursuant to Fed. R. Civ. P. 50 for judgment as a matter of law. The three remaining investors at trial -- the Christian Brothers High School Endowment, Redwood Growth Partners, and the Heritage Hedged Equity Fund, L.P. -- have not moved for judgment as a matter of law.

PROCEDURAL HISTORY

These actions came before this Court as a result of Defendants' appeals from Bankruptcy Court orders granting Plaintiff summary judgment on its fraudulent conveyance claims and denying Defendants' cross-motions for summary judgment on their good faith defense under 11 U.S.C. § 548(c).

In In re Bayou Group, LLC, 439 B.R. 284 (S.D.N.Y. 2010), this Court reversed the Bankruptcy Court's orders granting Plaintiff summary judgment on its actual fraudulent conveyance claims. The Bankruptcy Court had found that Defendants' good faith defense failed as a matter of law because (1) Defendants had "requested redemption after learning of a 'red flag' which, under an 'objective' standard, should have put [them] on 'inquiry notice' of some infirmity in Bayou or the integrity of its management"; and (2) Defendants had not diligently investigated the "red flag" issues before redeeming their investments. In re Bayou Group, LLC, 396 B.R. 810, 848, 852 (Bankr. S.D.N.Y. 2008).

This Court concluded that the Bankruptcy Court's test for inquiry notice represented a significant expansion of the scope of information traditionally found sufficient to trigger inquiry notice, and was not supported by the case law. 439 B.R. at 290, 314-15. This Court held that the proper test here is whether the alleged "red flag" information would have put a reasonably prudent institutional hedge fund investor on inquiry notice that Bayou was insolvent or that it had a fraudulent purpose in making the redemption payments to [Defendants].

Id. at 313 (emphasis omitted).

Once a transferee is placed on inquiry notice, it must conduct a diligent investigation of the facts that put it on inquiry notice, or demonstrate that a diligent inquiry would not have uncovered the transferor's insolvency or fraudulent purpose in making the payment. Id. at 311, 315-17, 328. Finding that questions of fact remained as to both the inquiry notice and diligent investigation prongs of the good faith test, this Court scheduled these actions for trial. *fn2 Id. at 322-23, 325, 328

At trial, the verdict sheet asked the jury to answer the following questions:

Question 1 -- Inquiry Notice

1. As to each defendant listed below, indicate -- by checking YES or NO -- whether that defendant has proven by a preponderance of the evidence that it was not aware -- at the time of its redemption request in late June 2004 -- of information that would have put a reasonably prudent hedge fund investor on notice that the Bayou hedge funds might be insolvent or that the Bayou hedge fund manager authorizing the redemption payment might do so with a fraudulent purpose? * * * *

If you answered "YES" to Question 1 as to any defendant, do not answer Question 2 as to that defendant. If you answered "NO" to Question 1 as to any defendant, please proceed to Question 2 as to that defendant.

Question 2 -- Diligent Investigation

2. As to each defendant for which you answered "NO" to Question 1: has that defendant proven by a preponderance of the evidence that it conducted a diligent investigation of the information that placed it on inquiry notice, or has that defendant proven by a preponderance of the evidence that a diligent investigation would not have led to discovery of the Bayou hedge funds' insolvency or the manager's fraudulent purpose in authorizing the redemption payment?

On May 12, 2011, the jury returned a Plaintiff's verdict, answering "No" as to both questions as to all Defendants. (Tr. 1378-80) The Court entered judgment for ...


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