In Re: Bernard L. Madoff Investment Securities LLC.

Background

The opinion concerns several adversary proceedings arising from the liquidation of Bernard L. Madoff Investment Securities LLC. Irving Picard, the trustee for the liquidation and Bernard L. Madoff’s Chapter 7 estate, seeks to avoid transfers made by Madoff Securities to Fairfield Sentry Limited and recover later transfers that Fairfield made to investors and financial institutions. The defendants-appellants were subsequent transferees of Fairfield. The Trustee did not allege that these defendants knew about Madoff’s fraud.

The Bankruptcy Court denied the defendants’ motions to dismiss, concluding at the pleading stage that the Bankruptcy Code’s securities safe harbor, 11 U.S.C. § 546(e), did not apply based on the allegations then before it. The defendants asked the district court for permission to take an immediate, or interlocutory, appeal from that non-final order.

Legal framework

Section 546(e) generally protects certain qualifying securities-related transfers from avoidance in bankruptcy. Avoidance means invalidating a transfer so that a trustee may seek recovery. The opinion explains that avoidance of an initial transfer and recovery from a later transferee are related but separate issues. Even if the Trustee proves that the initial transfer from Madoff Securities to Fairfield was avoidable, later transferees may assert defenses under 11 U.S.C. § 550(b), including a defense based on receiving the transfer for value and in good faith without knowledge that it could be avoided.

For an interlocutory appeal from a Bankruptcy Court order, the court applied the standard commonly used under 28 U.S.C. § 1292(b). That standard requires a controlling legal question, substantial grounds for disagreement, and a likelihood that immediate review would materially advance the end of the litigation. Such appeals are generally reserved for exceptional circumstances.

Primary safe-harbor argument

The defendants argued that the Trustee’s failure to allege their knowledge of Madoff’s fraud meant that the initial transfers from Madoff Securities to Fairfield were protected by Section 546(e). The court rejected that argument. It explained that the safe-harbor defense concerns the avoidability of the initial transfer, which depends on facts concerning that transfer—not on the later recipient’s subjective knowledge.

Under the court’s earlier decision in Cohmad, subsequent transferees may assert defenses to the initial transfer that were available to the initial transferee. But the court found no support for allowing a subsequent transferee to assert a defense that would not have been available to Fairfield itself. The defendants’ lack of knowledge could matter to their separate defenses against recovery under Section 550(b), but it could not make an otherwise avoidable initial transfer unavoidable.

The court also rejected the defendants’ alternative characterization of Cohmad as creating an equitable exception to Section 546(e). The court explained that Cohmad instead held that the safe harbor did not apply under its own terms when a transferee knew that the payments were not genuine settlement payments or transfers connected to actual securities contracts. A later transferee’s knowledge could not retroactively make the initial transfer qualify for the safe harbor.

Third-party securities-contract argument

Several defendants separately argued that the safe harbor could apply because the transfers from Madoff Securities to Fairfield were connected to securities contracts between Fairfield and the defendants. The court recognized that Cohmad had held that Section 546(e) does not expressly require the relevant securities contract to be between the debtor and the immediate transferee. A transfer might qualify if, for example, a withdrawal from Madoff Securities was made because a particular Fairfield investor requested redemption under an investment contract.

But the court concluded that this issue was fact-intensive and could not justify an immediate appeal. The complaints did not provide enough information about the circumstances of the defendants’ withdrawals from Fairfield to determine whether those withdrawals were sufficiently related to Fairfield’s earlier withdrawals from Madoff Securities. The court also noted that some transfers might qualify for the safe harbor while others might not, making an immediate appeal unlikely to end the litigation and potentially causing piecemeal decisions and delay.

The court stated that the Bankruptcy Court may need to address this theory later, after development of a fuller factual record. It did not decide whether any particular transfer qualifies for the Section 546(e) safe harbor.

Disposition

The court denied each defendant-appellant’s motion seeking permission for an interlocutory appeal. It reaffirmed its October 31, 2022 bottom-line order and directed the Clerk to close each of the captioned cases. The opinion did not decide whether the Trustee will ultimately prove that the initial transfers were avoidable or recover funds from any defendant.