Bernard Madoff’s Ponzi scheme was exposed in 2008. Yet litigation regarding transfers made by entities related to Madoff continues to wind its way through the courts, including numerous bankruptcy cases. Fairfield Sentry, Ltd. was one such related entity. It was likely the largest “feeder fund” for Bernard L. Madoff Investment Securities (“BLIMIS”) and was forced into liquidation in the British Virgin Islands once its investment in BLIMIS was found to be illusory. Fairfield also obtained recognition for a Chapter 15 proceeding in the United States District Court for the Southern District of New York.

Fairfield’s liquidators filed actions in the United States seeking to claw back approximately $6 billion in payments made to investors prior to the collapse of the Ponzi scheme. The defendants in this case raised several defenses, including the so-called “safe harbor” provisions in 11 U.S.C. § 546(e). Section 546(e) provides:

Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is … [a] settlement payment, as defined in section 101 or 741 of this title, made by or to (or for the benefit of) a … financial institution … in connection with a securities contract, as defined in section 741(7), … except under section 548(a)(1)(A) of this title.

Thus, in bankruptcy cases, settlement payments made by or to a financial institution are generally shielded from avoidance in the absence of actual fraudulent intent.

Lower courts had held that § 546(e) barred claims under Bermudian statutory law, but not those based on common law. On appeal, the United States Court of Appeals for the Second Circuit held that § 546(e) applies extraterritorially and shielded the payments from recovery.  

In determining that § 546(e) applied extraterritorially, the court found that § 561 of the Bankruptcy Code served to rebut the presumption against application of US law does not apply extraterritorially. Section 561 expressly provides that the bankruptcy law that is “relating to securities contracts” and that “limit[s] avoidance powers” is applicable in Chapter 15. The Second Circuit reasoned that if this provision is to have any effect at all, it must apply extraterritorially. Thus, the Second Circuit held that it was “implausible” that Congress meant for a foreign representative to be able to bring avoidance claims insulated from the safe harbor, while domestic debtors could not bring similar claims. The Second Circuit next addressed the plaintiffs’ argument that the safe harbor did not apply because the claims were for actual fraudulent transfers.  The court rejected this argument because the plaintiffs had plausibly alleged that the transfers were made with the actual intent to hinder, delay, or defraud creditors.  Instead, a fair reading of the complaint was that the transfers were negligent or reckless with respect to the risk of fraud, but that they did not know Madoff was engaged in fraud.

Finally, the Second Circuit rejected the argument that the plaintiff’s claims were not avoidance actions and therefore not subject to the safe harbor. In doing so, the court found that the safe harbor covers all avoidance claims, including those based upon unjust enrichment or constructive trust. Therefore, the safe harbor language of Section 546(e) precludes all “claims under foreign statutory or common law that seek to avoid the same category of covered transactions.”

Fairfield is one of a series of recent cases that provide a broad scope for Section 546(e). This safe harbor is a powerful tool for defending avoidance claims in the financial industry. Nelson Mullins attorneys have extensive experience in defending avoidance actions of all types.