In Re: Bernard L. Madoff Investment Securities LLC

Background

Irving Picard, the trustee overseeing the liquidation of Bernard L. Madoff Investment Securities LLC and the Chapter 7 estate of Bernard L. Madoff, brought adversary proceedings against funds and financial institutions that received money from Fairfield Sentry Limited. Fairfield was a Madoff feeder fund that pooled investor money and invested it with Madoff Securities. The trustee alleged that Fairfield knew about Madoff’s fraud, but did not allege that the defendants in these appeals knew about the fraud.

The trustee seeks first to show that transfers from Madoff Securities to Fairfield can be avoided—that is, legally undone in the bankruptcy proceeding—and then to recover later transfers from Fairfield to its investors. The defendants moved to dismiss, arguing that the Bankruptcy Code’s securities safe harbor, found in 11 U.S.C. § 546(e), protected the original transfers. The Bankruptcy Court denied those motions. The defendants then asked the District Court for permission to appeal that non-final ruling immediately.

Legal standard

The District Court applied the standard generally used for immediate appeals from non-final orders: the defendants had to show a controlling legal question, substantial grounds for disagreement, and that an immediate appeal could materially advance the end of the litigation. The court noted that such appeals are meant to be rare.

Analysis

The court rejected the defendants’ main argument. Section 546(e)’s safe harbor is a defense to avoiding the original transfer, not a defense whose availability changes based on the knowledge of a later recipient. Under the court’s prior decisions, a later recipient may assert defenses that were available to the original recipient, but the later recipient does not gain a broader defense than the original recipient would have had.

The defendants’ lack of knowledge could still matter to whether the trustee could ultimately recover from them. For example, 11 U.S.C. § 550(b) provides a good-faith defense for certain subsequent transferees who took the transfer for value, in good faith, and without knowledge that the transfer could be avoided. But that defense did not make the original transfer from Madoff Securities to Fairfield unavoidable.

The court also considered the defendants’ argument that the original transfers might be protected because they were made in connection with securities contracts between Fairfield and the defendants. The court stated that this theory was legally possible under its earlier decision, but whether a particular transfer was sufficiently connected to such a contract depended on facts—for example, whether a transfer was made in response to a specific client’s redemption request or was instead part of a general distribution or cash-pooling process. The complaints did not provide enough facts to resolve that issue, and the Bankruptcy Court should consider it first after development of the factual record.

The court further concluded that an immediate appeal would not speed up the litigation. It could produce piecemeal results, with some claims dismissed and others continuing, and could delay or complicate the long-running proceedings.

Disposition

On October 31, 2022, the court denied the defendants’ respective motions seeking permission for an interlocutory appeal. In the November 3 opinion and order, Judge Jed S. Rakoff reaffirmed that decision and directed the Clerk to close each of the above-captioned district-court cases. The ruling did not decide whether the trustee will ultimately recover from the defendants; the opinion stated that the trustee still must prove that the original transfers were avoidable and that the defendants may raise defenses to recovery.