In Re: Bernard L. Madoff Investment Securities LLC

Background

Irving H. Picard served as trustee for the Bernard L. Madoff Investment Securities LLC estate and the related consolidated estate. He sought to recover subsequent transfers totaling $265.5 million from ABN AMRO Bank (Ireland) Ltd. and ABN AMRO Custodial Services (Ireland) Ltd., which the opinion collectively calls ABN Ireland. The Trustee brought the recovery effort under Section 550 of the Bankruptcy Code.

Section 550(b)(1) generally prevents recovery from a later recipient that received property for value, in good faith, and without knowledge that the original transfer could be invalidated. The earlier standard applied in this dispute treated good faith as an issue the Trustee had to address in the complaint. It required the Trustee to plausibly allege that the recipient either actually knew about the fraud or was deliberately ignoring it.

Bankruptcy Court ruling and appeal

The Trustee asked the Bankruptcy Court for permission to file a proposed second amended complaint. ABN Ireland opposed the request, arguing that amendment would be futile because the proposed complaint could not survive a motion to dismiss. The Bankruptcy Court agreed, finding that the Trustee had not adequately pleaded deliberate ignorance of Madoff’s fraud. It denied the motion to amend, and a final judgment later dismissed the amended complaint with prejudice.

The Trustee appealed. While the appeal was pending, the Second Circuit issued a decision in a related proceeding involving the same broader litigation. That decision rejected the standard used below. It held that good faith is an affirmative defense, meaning the transferee must raise and prove it, rather than an element that the Trustee must plead as part of the initial claim. The Trustee satisfies the pleading requirement by alleging that the transfer was avoided and that the defendant was an initial or later transferee.

The Second Circuit also held that the relevant standard is inquiry notice, not deliberate ignorance. The analysis asks: what facts did the transferee know; would those facts have led a reasonable person in the transferee’s position to investigate possible fraud; and would a diligent investigation have uncovered the fraudulent purpose? The adequacy of the investigation is fact-intensive and depends on the circumstances of the particular transferee.

District Court’s analysis

Judge McMahon concluded that the Bankruptcy Court had applied a legal standard that the Second Circuit had since rejected. She answered both appeal questions in the Trustee’s favor: the Trustee did not have to plead the transferee’s lack of good faith as part of the initial claim, and the correct standard was inquiry notice rather than deliberate ignorance.

The Court declined ABN Ireland’s request to affirm the dismissal on the alternative ground that the proposed complaint itself established ABN Ireland’s good faith. Judge McMahon stated that good faith was not apparent from the face of the proposed complaint and that deciding it required a fact-based inquiry that could not be resolved from the limited record at this stage. The Court also noted that discovery had not occurred.

Disposition

The Court vacated the Bankruptcy Court’s decision denying the Trustee’s motion to amend and remanded for further proceedings consistent with the Second Circuit’s decision. The clerk was directed to close the district-court appeal.