In re Bernie Madoff Inv. Secs.

Summary of Argument

This case presents an important opportunity for this Court to clarify the meaning of the term “good faith” as used in Sections 548(c) and 550(b) of the Bankruptcy Code and applied in the context of the Bernard Madoff SIPA liquidation. 
Section 548(a) of the Bankruptcy Code permits a bankruptcy trustee to avoid transfers made with the intent to hinder, delay or defraud creditors, or transfers made for lack of reasonably equivalent value while the debtor is in a compromised financial condition. 11 U.S.C. § 548(a). Section 548(c), however, prevents avoidance of a transfer under Section 548(a) when the transferee takes the transfer “for value and in good faith.” 11 U.S.C. § 548(c). 

Section 550(a) permits the trustee to recover an avoided transfer not only from the initial transferee but also from “any immediate or mediate transferee of such initial transferee.” 11 U.S.C. § 550(a)(2). But under Section 550(b), the transfer may not be recovered if such a subsequent transferee “takes for value, including satisfaction or securing of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided.” 11 U.S.C. § 550(b)(1). 

Accordingly, under both Sections 548(c) and 550(b), the transferee’s “good faith” will be decisive — and will prevent liability from being imposed — only when the transferee has given “value” for the transfer at issue. If the transferee has not given value in exchange for the property received, and the other prerequisites for avoidance are met, transferees are subject to liability regardless of their good faith. Thus, in determining the meaning of “good faith,” the Court is being asked to decide when a transferee’s conduct is so reprehensible that it should have liability despite having provided value equivalent to what it received. 

The meaning of “good faith” has taken on great significance in the Madoff liquidation. That is because, under the so-called Ponzi scheme presumption, all transfers by Bernard L. Madoff Investment Securities, LLC (“BLMIS”) are deemed to have been made by BLMIS with actual intent to hinder, delay and defraud creditors.2 At the same time, under now-settled law, BLMIS’s return to customers of amounts originally invested, as opposed to “fictitious profits,” are considered to be for “value,” because the customers have a valid “net equity” claim for those amounts.3 Thus, in cases against initial transferee customers to recover principal rather than profits, Section 548(c)’s “good faith” requirement is decisive. 

In cases such as the Citibank case — where the Trustee has pursued claims against subsequent transferees, the “good faith” question is likewise critical. Various subsequent transferees, including Citibank, indisputably provided “value” for what they received, because they made loans to the initial transferees that were repaid. SPA60. Thus, any liability again depends on the transferee-lender’s “good faith” under Section 550(b). 
In the decisions on appeal, the courts below applied a subjective “good faith” test under which a transferee’s good faith turns on whether the transferee was willfully blind to or had actual knowledge of the Madoff Ponzi Scheme. SPA4-5. In adopting that construction, the district court emphasized that this is a SIPA liquidation and that BLMIS was a broker-dealer. The district court thus drew on federal securities law, and the expectations of securities-market participants, to buttress its interpretation of good faith, observing that a “securities investor has no inherent duty to inquire about his stockbroker” and that “[t]he Trustee’s approach would impose a burden of investigation on investors totally at odds with the investor confidence and securities market stability that SIPA is designed to enhance.” SPA7. On the other hand, “that does not mean that an investor may purposely close her eyes to what is plainly to be seen,” and therefore an investor may be held liable if the investor has actual knowledge of fraud or “willfully blinded himself to circumstances indicating a high probability of fraud.” SPA8-9. 

SIFMA and ABA respectfully submit that the district court was correct in holding that lack of good faith requires actual knowledge of, or at least willful blindness to, the debtor’s fraud. As a general matter, and setting aside the particular circumstances of this case, there is no sound basis to equate “good faith” with “inquiry notice” or the “reasonableness” of an investigation. Rather, as a matter of plain meaning and ordinary usage, “good faith” is a subjective concept that turns on a person’s knowledge and culpability. Moreover, limiting findings of bad faith to situations involving knowledge of wrongdoing avoids punitive and unfair results. See Point I, below. 

Regardless of the general standard, the “inquiry notice” test was correctly rejected in this particular case, which involves repayment of loans made by a bank (Citibank) to customers of a broker-dealer (Madoff investors). Application of an inquiry-notice standard on these facts would depart from longstanding case law interpreting “good faith” in the context of debt repayments, under which receiving repayment of a valid debt is not “bad faith” absent culpability in fraud. See Point II, below.

The district court was also justified in looking to securities law both in construing good faith and deciding the good-faith issue on the pleadings. In the context of a SIPA proceeding, where the debtor was an SEC-registered broker-dealer, allowing the Trustee to bring claims against anyone who received a transfer — while imposing the burden on the transferee to defend its failure to detect a decades-long fraud that escaped the notice of regulators and countless others — would create substantial uncertainty while imposing burdens on investors that have no legal foundation. See Point III, below.

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