Court ruling keeps Mets owners in limbo regarding Madoff lawsuit

It's been a lousy year for the New York Mets, who despite a $143 million payroll are headed for a fourth-place finish in the National League East. But it has been the equivalent of a last-place finish for the team's owners, brothers-in-law Fred Wilpon and Saul Katz. The two, along with others connected to the team's ownership group -- Sterling Equities -- are facing a nine-figure lawsuit over whether they fraudulently earned money through investments with imprisoned Ponzi scheme artist Bernie Madoff. The lawsuit is sought by Irving Picard, the court-appointed trustee of assets seized from Madoff, and it threatens Wilpon and Katz's capacity to own and operate the Mets.

Wilpon and Katz received decidedly mixed legal news on Tuesday. U.S. District Judge Jed Rakoff dismissed nine of the lawsuit's 11 counts, including all counts relating to allegations of constructive fraud, which had referred to Wilpon and Katz entering into transactions with Madoff that were not intentionally fraudulent, but were fraudulent in effect. Claims arising under New York law were also dismissed.

Rakoff reasoned that these claims were incompatible with various provisions of the federal Bankruptcy Code. Rakoff also reduced by more than half Picard's potential recovery for the two remaining counts, but declined Wilpon and Katz's efforts to dismiss the counts altogether. And they are the most damaging counts: that Wilpon and Katz earned $295 million in fictitious profits through investing in a scheme that they knew to be too good to be true -- that is, they knew to be fraudulent -- and that they should return their $700 million principal, as well. According to Rakoff's ruling, Picard could recover as much as $83 million in fictitious profits and $303 million in principal. Unless the parties agree on a settlement that would likely require Wilpon and Katz to pay tens of millions, if not hundreds of millions, a trial scheduled for March 2012 will occur. The parties, who were ordered back to court on Wednesday to discuss scheduling matters, will have pre-trial hearings as well.

Rakoff also supplied a mixed ruling on the amount of proof that Picard would need to show in a trial. For purposes of recovering the allegedly fictitious profits, Picard would only have to prove that Wilpon and Katz did not provide value for the monies received. To do so, Picard would argue that Sterling's "profits" with Madoff should be clawed back because they were never actually earned, only fictitiously invented by Madoff through stealing money from his other investors. Picard will attempt to portray Wilpon and Katz as sophisticated investors who obviously knew that their profits with Madoff were unrealistic given the amount of money they invested. Picard has a strong argument to recover the profits, even if the amount of profits he can obtain has been dramatically reduced to $83 million by Rakoff.

More positively for Wilpon and Katz, Rakoff ruled that Picard can only go after the principal if he proves that Wilpon and Katz were intentionally blind -- as opposed to unreasonably inattentive -- to Madoff's fraudulent actions and their relationship to Sterling. (Picard had hoped to only have to show that Wilpon and Katz were liable for failing to reasonably investigate the fraud.) Picard will thus have to establish that Wilpon and Katz had substantial and informed suspicions. He would likely need to show considerable evidence pointing to what Wilpon and Katz actually thought. Picard could still prevail on that principal, however. He intends, for instance, to claim that Wilpon and Katz went so far as to look into purchasing fraud insurance while actively investing with Madoff. But mental states are often difficult to prove, so Wilpon and Katz have reason to feel confident that they won't have to pay $303 million for the principal.

Along those lines, expect Wilpon and Katz to argue that many of Madoff's investors stuck by him to the end, and they should not be singled out for acting as others did. Wilpon and Katz can also question the math that Picard used to devise the profits and principal amounts, which the Mets owners argue are excessive and based on unjustifiable calculations.

What does this all mean? Wilpon and Katz were unable to get the most damaging claims against them dismissed, and they are headed for a trial that, if they lose, could cost them almost $400 million. They are not without options however.

First, they can try to settle the claims with Picard out-of-court. A settlement would provide closure and prevent additional litigation, but would probably be costly. Picard has a duty to maximize recovery for Madoff's victims, and if he believes that he can beat Wilpon and Katz in court -- and Rakoff's latest ruling helps him in some ways, especially in regards to clawing back profits -- he may hold out for a hefty settlement figure that Wilpon and Katz refuse to pay.

Second, they can raise capital by selling minority equity stakes in the team to new investors. They have already tried to do so, as they were reportedly close to selling a minority interest to hedge fund manager David Einhorn for $200 million. The deal, however, fell apart about a month ago. Still, the Mets play in the nation's top media market and are likely to draw other potential investors. An infusion of new capital would help Wilpon and Katz maintain control and stability over the franchise as Madoff-related events play out.

Wilpon and Katz also have to worry about Major League Baseball's interest in the matter. Commissioner Bud Selig has already taken over the Los Angeles Dodgers this season from Frank and Jamie McCourt because of the team's financial woes. The commissioner is armed with several legal weapons -- the best interests of the game clause, which provides Selig with wide discretion to regulate any aspect of the game, including ownership interests; the waiver of recourse clause found in ownership purchase agreements, which nominally prevents owners from suing Major League Baseball; and the historical exemption enjoyed by Major League Baseball under federal antitrust law -- that make it possible for him to wrestle control of privately-owned teams from their owners. Although Selig has a much better relationship with Wilpon than with the McCourts, he cannot ignore the potential fallout of the Mets mired in a lawsuit involving hundreds of millions of dollars.

For Mets players, front office staff and fans, Tuesday's news only further clouds a rainy season. With the offseason set to begin, the Mets owners may have to act cautiously while the litigation continues.