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, sued several funds and financial institutions that received transfers from Fairfield Sentry Limited. Fairfield was described as a Madoff “feeder fund” that pooled investors’ money and invested it in Madoff’s Ponzi scheme. 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 to establish that transfers from Madoff Securities to Fairfield can be avoided under the Bankruptcy Code and then to recover later transfers from Fairfield to its investors. “Avoidance” means setting aside a transfer for purposes of bankruptcy recovery. The defendants are subsequent transferees, meaning they received money after Fairfield received it from Madoff Securities.

The defendants relied on the securities safe harbor in 11 U.S.C. § 546(e), which can protect certain securities-related transfers from avoidance. The Bankruptcy Court denied their motions to dismiss, ruling at the pleading stage that the safe harbor did not apply based on the allegations then before it. The defendants asked the District Court to allow an immediate, non-final appeal of that ruling.

Legal standard

Under 28 U.S.C. § 158(a)(3), a district court may allow an appeal from an interlocutory, or non-final, order entered by a bankruptcy judge. The parties relied on the standard in 28 U.S.C. § 1292(b), which requires a controlling legal question, substantial grounds for disagreement about that question, and a determination that an immediate appeal may materially advance the litigation. The court emphasized that interlocutory appeals are meant to be rare and reserved for exceptional circumstances.

The court’s analysis

The defendants’ primary argument was that the trustee’s failure to allege their knowledge of Madoff’s fraud meant that the Section 546(e) safe harbor protected the original transfers from Madoff Securities to Fairfield. Judge Rakoff rejected that argument as a basis for interlocutory review. He explained that the safe harbor is a defense to avoidance of the initial transfer, so the avoidability of that transfer cannot depend on the later recipient’s knowledge. A subsequent transferee may raise defenses available to the initial transferee, but the court found no support for allowing a subsequent transferee to assert a defense unavailable to the initial transferee.

The defendants’ lack of knowledge could still matter later under 11 U.S.C. § 550(b), which provides defenses to recovery against certain subsequent transferees who took for value, in good faith, and without knowledge that the transfer could be avoided. But that potential defense would not make the initial transfer unavoidable.

The defendants also argued that the original transfers could be protected because they were made “in connection with” securities contracts between Fairfield and the defendants. The court recognized that this theory could potentially apply under the reasoning of an earlier related proceeding, but held that its application would depend on the facts of each transfer. For example, a transfer might be sufficiently related to a specific investor’s redemption request, while a regularly scheduled or general cash transfer might not be.

The court concluded that the complaints did not provide enough factual detail to resolve that issue and that discovery and a fuller factual record were needed. It also reasoned that immediate review would likely cause delay and produce piecemeal results, because some claims might be dismissed while others continued.

Disposition

Judge Jed S. Rakoff denied each defendant-appellant’s motion seeking an interlocutory appeal. The court reaffirmed its earlier bottom-line order denying those motions and directed the Clerk to close each of the captioned district-court cases. The opinion did not determine that the trustee will ultimately recover from the defendants. The trustee still must prove that the initial transfers were avoidable, and the defendants may raise defenses to recovery. The Bankruptcy Court was left to address the fact-dependent safe-harbor arguments in the first instance.