Case Update: Second Circuit Breathes New Life Into Madoff Trustee's Efforts To Recover Ponzi Scheme Payments

• Published date: 16 November 2021
• Subject Matter: Corporate/Commercial Law, Criminal Law, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Insolvency/Bankruptcy, Securities, White Collar Crime, Anti-Corruption & Fraud
• Law Firm: Jones Day
• Author: Mr Mark Douglas

In In re Bernard L. Madoff Investment Securities LLC, 12 F.4th 171 (2d Cir. 2021), the U.S. Court of Appeals for the Second Circuit revived litigation filed by the trustee administering the assets of defunct investment firm Bernard L. Madoff Inv. Sec. LLC ("MIS") seeking to recover hundreds of millions of dollars in allegedly fraudulent transfers made to former MIS customers and certain other defendants as part of the Madoff Ponzi scheme. The court of appeals vacated a 2019 bankruptcy court ruling dismissing the trustee's claims against certain defendants because he failed to allege that they had not received the transferred funds in "good faith."

The Second Circuit also reversed a 2014 district court decision in holding that: (i) "inquiry notice," rather than "willful blindness," is the proper standard for pleading a lack of good faith in fraudulent transfer actions commenced as part of a stockbroker liquidation case under the Securities Investor Protection Act, 15 U.S.C. ' 78aaa et seq. ("SIPA"); and (ii) the defendants, rather than the SIPA trustee, bear the burden of pleading on the issue of good faith. The ruling, which involves test cases for approximately 90 dismissed actions, breathes new life into avoidance litigation seeking recovery of $3.75 billion from global financial institutions, hedge funds, and other participants in the global financial markets.

Good-Faith Defense to Avoidance of Fraudulent Transfers

Section 548(a)(1) of the Bankruptcy Code authorizes a bankruptcy trustee to avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor "on or within 2 years before the date of the filing of the petition" if: (i) the transfer was made, or the obligation was incurred, "with actual intent to hinder, delay, or defraud" any creditor; or (ii) the debtor received "less than a reasonably equivalent value in exchange for such transfer or obligation" and was, among other things, insolvent, undercapitalized, or unable to pay its debts as such debts matured.

Section 548(c) provides a defense to avoidance of a fraudulent transfer for a "good faith" transferee or obligee who gives value in exchange for the transfer or obligation at issue:

Except to the extent that a transfer or obligation voidable under this section is voidable under section 544, 545, or 547 of this title [dealing with a trustee's power to avoid, respectively, transfers that are voidable under state law, statutory liens, and preferential transfers], a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.

11 U.S.C. ' 548(c).

Section 550(a) of the Bankruptcy Code provides that, after avoidance of a transfer, the trustee may recover the property transferred or its value from the initial transferee (or the entity for whose benefit such transfer was made) or any "immediate or mediate transferee" of the initial transferee. However, pursuant to section 550(b), the trustee may not recover the property transferred or its value from an initial or subsequent ("immediate" or "mediate") transferee "that takes for value, including satisfaction or securing of a present or antecedent debt, in good...