SUMMARY
In
In re Bernard L. Madoff Investment Securities LLC, ___ F.3d ___,
2014 WL 6863608 (2d Cir. 2014), the U.S. Court of Appeals for the Second
Circuit considered whether the “safe harbor” provision of Bankruptcy
Code section 546(e) provides a defense against
a trustee’s claims to avoid Ponzi scheme payments under
state fraudulent transfer law made applicable by section 544(b), and
under Bankruptcy Code provisions allowing the avoidance
of “constructive” fraudulent transfers. The court ruled that section
546(e) did apply, and affirmed the dismissal of such claims against the
recipients of the transfers.
FACTUAL BACKGROUND
For
some time, the bankruptcy trustee of a Ponzi scheme perpetrator has
been able to recover from investors the "fictitious profits" paid to
them in excess of their
investments. In Madoff, the trustee appointed to oversee the
SIPA liquidation of Madoff Securities’ investment advisory unit
(“BLMIS”) sought to avoid payments of fictitious profits to investors as
“actual” and “constructive” fraudulent transfers under
bankruptcy and state law. Certain customers defended on the ground that
the transfers were protected by the safe harbor provision of section
546(e), prohibiting the trustee from clawing back their distributions
because the payments were made by a stockbroker
“in connection with a securities contract” or, alternatively, because
they were “settlement payments” made by a stockbroker.
After
withdrawing the reference in multiple adversary proceedings, the U.S.
District Court for the Southern District of New York (the “District
Court”) dismissed
the trustee’s “constructive” fraudulent transfer claims under section
548(a)(1)(B) and his state law fraudulent transfer claims (asserted
pursuant to section 544) due to the applicability of section 546(e)’s
safe harbor.
SIPC v. BLMIC, 476 B.R. 715, 722 (S.D.N.Y. 2012). The District
Court also ruled that section 546(e) did not bar the trustee from
avoiding “actual” fraudulent transfer claims asserted under section
548(a)(1)(A).
Id. The trustee appealed as to the first ruling, and the Second Circuit affirmed.
REASONING
Section
546(e) provides, in part, that notwithstanding sections 544 and
548(a)(1)(B) of the Bankruptcy Code, a trustee may not avoid a
prepetition transfer that is
a “settlement payment” made by or to (or for the benefit of) a
stockbroker, or that is a transfer made by or to (or for the benefit of)
a stockbroker “in connection with a securities contract.” This safe
harbor has been steadily expanded to embrace more transactions.
The Second Circuit and other courts interpreting section 546(e) have
acknowledged the breadth of the coverage of this safe harbor and have
largely applied the plain language of the provision to broadly
immunize enumerated transactions from avoidance even where
the transactions at issue arguably did not impact the financial
markets.
In
Madoff, the Second Circuit imposed a broad and literal
interpretation of section 546(e) in examining whether the agreements
between BLMIS and its customers constituted “securities contracts” as
defined in section 741(7) of the Bankruptcy Code, and whether
the payments were made “in connection with” a securities contract. The
trustee argued, among other things, that section 546(e) did not apply
because BLMIS never actually initiated, executed, completed or settled
any securities transactions. But the Second
Circuit found that section 546(e) does not require an actual purchase
or sale of a security. Rather, the transfer need only be broadly related
to a securities contract and not an actual securities transaction. The
Second Circuit also concluded that the interpretation
of section 546(e) espoused by the trustee would in that case risk the
very sort of market disruption Congress was concerned with when it
enacted the provision. Noting that BLMIS’ clients had every reason to
believe that BLMIS was engaged in actual securities
transactions, the Second Circuit ruled that they had every right to
avail themselves of the protections afforded by section 546(e) because
their agreements were “securities contracts” and because the payments
made to them were “settlement payments,” as defined
in section 741(8). The Second Circuit also rejected SIPC’s argument
that Ponzi scheme payments are, by definition, not made “in connection
with” a securities contract.
AUTHOR’S COMMENTARY
This
is the latest in a string of decisions from the Second Circuit
that broadly construe the section 546(e) safe harbor in accordance with
the statute’s plain language.
There is a certain irony in the court’s holding, given that the profits
of the Ponzi scheme were fictitious because the investment account was
itself fictitious. This decision should provide comfort to recipients
of transfers made in connection with both actual
or purported securities transactions.
These
materials were written by Iain A. Macdonald, the senior partner of
MACDONALD | FERNANDEZ LLP in San Francisco, California. Editorial
contributions were provided by John N. Tedford, IV, of Danning, Gill,
Diamond & Kollitz, LLP, in Los Angeles, California.
