In Re: Bernard L. Madoff Investment Securities LLC

Background

Irving Picard, the trustee overseeing the liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff’s Chapter 7 estate, brought actions seeking to avoid transfers made from Madoff Securities to Fairfield Sentry Limited and to recover later transfers from Fairfield to its investors. The defendants in these consolidated matters were subsequent transferees of Fairfield. The opinion states that the Trustee did not allege that these defendants knew about Madoff’s fraud.

The Bankruptcy Court denied the defendants’ motions to dismiss. The defendants then asked the District Court for permission to take an interlocutory appeal, meaning an appeal before the Bankruptcy Court’s proceedings were finished. The District Court applied the standard generally used for such appeals: whether the order presented a controlling legal question, whether there was substantial disagreement about that question, and whether immediate review could materially advance the litigation.

Section 546(e) safe harbor

The defendants relied on 11 U.S.C. § 546(e), known as the securities safe harbor. The provision can protect certain margin payments, settlement payments, and transfers involving specified financial entities from avoidance by a bankruptcy trustee. Avoidance is the legal process by which a trustee challenges certain transfers so that funds can be available for distribution to creditors.

The defendants argued that the Trustee’s failure to allege their knowledge of Madoff’s fraud allowed them to invoke the safe harbor against the original transfers from Madoff Securities to Fairfield. Judge Rakoff rejected that argument. He explained that the safe harbor is a defense to avoiding the initial transfer, so the defendants’ lack of knowledge could not make the initial transfers protected when the defense would have been unavailable to Fairfield, the initial transferee, based on Fairfield’s alleged knowledge.

The court distinguished between avoidance and recovery. Even if the Trustee proves that the initial transfers to Fairfield were avoidable, the Trustee must still satisfy the requirements for recovering funds from later transferees. The defendants may raise defenses under 11 U.S.C. § 550(b), including a defense based on taking the transfer for value and in good faith without knowledge that the transfer was subject to avoidance.

Third-party securities contracts

Some defendants separately argued that the safe harbor applied because the transfers from Madoff Securities to Fairfield were made in connection with securities contracts between Fairfield and the defendants. Judge Rakoff stated that this theory was legally possible under the court’s earlier reasoning, because the relevant securities contract need not necessarily have been between Madoff Securities and Fairfield.

But the court concluded that this issue did not justify an immediate appeal. Whether a particular transfer was sufficiently related to a third-party securities contract was fact-intensive and could not generally be resolved from the pleadings. The complaints did not provide enough information about whether particular withdrawals by the defendants were connected to specific redemption requests or instead were part of general distributions or cash-pooling activities.

Ruling

The court held that the defendants had not shown a sufficient basis for interlocutory review. Their primary argument presented no fair ground for disagreement, and their third-party-contract argument required factual development in Bankruptcy Court. The court also reasoned that immediate review could produce piecemeal decisions, delay the long-running litigation, and interfere with proceedings below.

Judge Jed S. Rakoff denied each of the defendants’ motions seeking an interlocutory appeal, reaffirmed the October 31, 2022 bottom-line order denying those motions, and directed the Clerk to close each of the captioned cases. The opinion did not decide whether the Trustee will ultimately recover from any defendant or whether particular transfers are protected by the securities safe harbor.