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 proceedings seeking to avoid certain transfers made by Madoff Securities to Fairfield Sentry Limited and to recover later transfers Fairfield made to its investors. The defendants in these related appeals were subsequent transferees of Fairfield. The opinion identifies them as Multi-Strategy Fund Limited, Banque Syz & Co. SA, Lloyds TSB Bank PLC, Banque Cantonale Vaudoise, Bordier & Cie, Barclays Bank (Suisse) S.A., and Delta National Bank and Trust Company.

The Bankruptcy Court denied the defendants’ motions to dismiss. The defendants then sought permission for an interlocutory appeal, meaning an appeal before the Bankruptcy Court’s proceedings were finished. The District Court issued a bottom-line order denying those requests on October 31, 2022, and issued this opinion explaining why.

The securities safe harbor

The dispute centered on 11 U.S.C. § 546(e), commonly called the securities safe harbor. It protects certain securities-related transfers from being avoided by a bankruptcy trustee. The defendants argued that the safe harbor protected the initial transfers from Madoff Securities to Fairfield, even though the defendants themselves received money later from Fairfield.

The opinion explained that proving an initial transfer avoidable is only a prerequisite to recovering later transfers. Even if the trustee proves that the initial transfer can be avoided, later transferees may assert defenses to recovery, including a good-faith defense under 11 U.S.C. § 550(b). The court therefore distinguished between the avoidability of the initial transfer and the defendants’ potential defenses against recovery from them.

Whether the defendants’ lack of alleged knowledge required dismissal

The defendants argued that because the trustee did not allege that they knew about Madoff’s fraud, the § 546(e) safe harbor protected the initial transfers to Fairfield. Judge Rakoff rejected that argument. The safe harbor is a defense concerning the avoidability of the initial transfer, and the defendants’ lack of knowledge could not make an otherwise avoidable transfer from Madoff Securities to Fairfield protected.

The court relied on its earlier ruling in a prior related proceeding, which held that subsequent transferees may raise defenses to avoidance available to the initial transferee. But the court found no support for the defendants’ position that subsequent transferees could assert a defense that would not have been available to the initial transferee. The defendants’ lack of knowledge could matter to their separate defenses against recovery under § 550(b), but it could not retroactively make the initial transfer unavoidable.

The court also rejected the defendants’ argument that the earlier ruling had created an equitable exception to § 546(e). According to Judge Rakoff, that ruling instead interpreted the safe harbor’s text to mean that a transferee who knew the payments were stolen proceeds could not treat them as protected settlement payments or transfers made in connection with a genuine securities contract. A later transferee’s knowledge could not retroactively change whether the earlier transfer fell within the safe harbor.

Transfers connected to third-party securities contracts

Some defendants separately argued that the initial transfers from Madoff Securities to Fairfield were protected because they were made in connection with securities contracts between Fairfield and the defendants. The court recognized that its earlier precedent allowed a securities contract between an initial transferee and a later transferee to potentially provide an independent basis for applying § 546(e), even when Madoff Securities was not a party to that contract.

However, the court concluded that this issue was fact-intensive rather than a pure controlling question of law. Whether an initial transfer was sufficiently related to a later securities contract could depend on facts such as whether a specific withdrawal from Madoff Securities was immediately caused by a particular investor’s redemption request. A regularly scheduled distribution or a transfer made to maintain a general pool of funds might present a different question.

The complaints did not provide enough facts about the circumstances of the defendants’ withdrawals from Fairfield to resolve these issues at the pleading stage. The court stated that the Bankruptcy Court should address the issue first, after development of a full factual record. The court also noted that an immediate appeal could produce piecemeal rulings and delay the decade-plus litigation rather than advance its termination.

Disposition

Judge Jed S. Rakoff denied each of the defendants-appellants’ motions seeking an interlocutory appeal. The court reaffirmed that decision and directed the Clerk to close each of the related cases. The opinion did not decide whether the trustee would ultimately recover from any defendant. It stated that the trustee still had to prove that the initial transfers were avoidable and that the defendants could still assert applicable defenses to recovery.