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, pursued adversary proceedings against 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 defendants were subsequent recipients of money that Fairfield Sentry Limited had received from Madoff Securities. The trustee alleged that Fairfield knew about Madoff’s fraud, but did not allege that these defendants knew about it.

The trustee sought to establish that transfers from Madoff Securities to Fairfield could be avoided under the Bankruptcy Code and then recover later transfers from Fairfield to the defendants. A transfer must be avoidable before the trustee can generally seek recovery from a later recipient, and later recipients may have separate defenses to recovery, including a defense for recipients who took the transfer for value, in good faith, and without knowledge that it could be undone.

The defendants relied on the Bankruptcy Code’s securities safe harbor in 11 U.S.C. § 546(e). That provision protects certain securities-related transfers from avoidance. They argued that the trustee’s failure to allege their knowledge of Madoff’s fraud meant that the safe harbor defeated the trustee’s claims at the pleading stage. Some defendants also argued that the original transfers were connected to securities contracts between Fairfield and those defendants.

The bankruptcy court denied the defendants’ motions to dismiss. The defendants asked the district court for permission to take an immediate appeal from that nonfinal ruling. On October 31, 2022, the district court denied the motions by bottom-line order; this opinion explained the reasons.

Legal standard

The district court considered whether to allow an interlocutory appeal—an appeal before the bankruptcy court’s proceedings were complete. Because the governing bankruptcy provision does not provide detailed standards, the court applied the similar standard used for interlocutory appeals under 28 U.S.C. § 1292(b). Under that standard, the defendants had to show, among other things, a controlling legal question, substantial grounds for disagreement, and that an immediate appeal could materially advance the end of the litigation.

Analysis

The court rejected the defendants’ primary argument. The Section 546(e) safe harbor is a defense to avoidance of the initial transfer from Madoff Securities to Fairfield. The defendants’ lack of alleged knowledge of the fraud could matter to their own later defenses to recovery, but it could not make an otherwise avoidable initial transfer protected. The court found no support for allowing a later recipient’s knowledge—or lack of knowledge—to change whether the earlier transfer was avoidable.

The court also rejected the defendants’ attempt to expand an earlier ruling concerning a later recipient who knowingly participated in the fraud. That earlier ruling did not create an equitable exception to an otherwise applicable safe harbor. Instead, it concluded that a transfer known to be part of the fraud did not fall within the safe harbor’s terms. A later recipient’s knowledge could not retroactively make the original transfer qualify for the safe harbor.

The court recognized that the defendants’ separate argument concerning third-party securities contracts might have merit in some circumstances. Under the court’s earlier interpretation, a transfer from Madoff Securities to Fairfield might be connected to a securities contract between Fairfield and one of its clients even if Madoff Securities was not a party to that contract. But whether a particular transfer had a sufficient connection was fact-dependent. The complaints did not provide enough information to resolve that issue, and the bankruptcy court should consider it first after development of a fuller factual record.

Because the defendants did not show a sufficient basis for disagreement with the bankruptcy court’s ruling, and because an immediate appeal could produce piecemeal decisions and delay the long-running litigation, the district court denied each motion seeking an interlocutory appeal. Judge Jed S. Rakoff reaffirmed that denial and directed the clerk to close each of the related district-court cases. The opinion did not decide whether the trustee would ultimately recover from any defendant.