October 5, 2021

$3.75 Billion in Madoff Case Restarted for Trust's Bankruptcy Attorney

On August 30, the Second Circuit Court of Appeals heard an appeal in one of the longest-lasting Bernard Madoff Ponzi scheme cases. In the appeal, the Madoff trustee claimed that the District Court used the wrong standard when determining what “good faith” meant in bankruptcy. They also claimed the defendants were required to raise this issue as an affirmative defense. This appeal was a test case, brought by the Madoff trustee, to clear the way for a larger group of cases by bankruptcy attorneys.

$3.75 billion in claims against Bernie Madoff have been revived. Photo by Blogging Guide on Unsplash

On August 30, the Second Circuit Court of Appeals heard an appeal in one of the longest-lasting Bernard Madoff Ponzi scheme cases. In the appeal, the Madoff trustee claimed that the District Court used the wrong standard when determining what “good faith” meant in bankruptcy. They also claimed the defendants were required to raise this issue as an affirmative defense. This appeal was a test case, brought by the Madoff trustee, to clear the way for a larger group of cases by bankruptcy attorneys.

The Second Circuit ruled against the District Court and for the trustee on both issues. In bankruptcy, good faith means the net winners in a scheme like this had to prove that they did not accept the money while knowing that a reasonable person would have looked further into the issue. In other words, the court ruled that the law requires the inquiry notice standard and not the willful blindness standard in cases of this type.‌

Case Background

‌Bernie Madoff ran the largest Ponzi scheme in history, defrauding individuals and companies of $19.5 billion. The protracted untangling of the Madoff bankruptcy case has been ongoing for some time. The case has even outlived Madoff himself, who died in jail in 2010.

The three defendants (securities investors Citibank/Citicorp, Legacy Capital Ltd., and Khronos LLC) invested money in Bernie Madoff’s Ponzi scheme. These net winners later received money back from Madoff and made “profits”. Effectively, Madoff stole the money from other investors to pay these net winners. The Madoff Trustee sued the defendants to retrieve the money paid to them, so the trust could use it to pay out those harmed by Madoff.

District Judge Jed Rakoff held that good faith, in a bankruptcy or SIPA case, means the defendant acted without willful blindness. That the net winners could have missed big red flags, but unless they took action to ignore seeing the problem, they had good faith. He also held that the trustee needed to plead that the net winners acted without good faith. Following this, the bankruptcy court dismissed the actions.

Good Faith Implies the Inquiry Notice Stanard, Not Willful Blindness

However, the Second Circuit reversed this decision by the District Court. Section 550(b) of the Bankruptcy Code states that a trustee cannot get money back from the person who received the money if that person took the money for value in good faith and without knowledge of the crime. This is not up for debate — the question to the court was merely concerning the definition of “good faith”.

The Second Circuit held that inquiry notice is the proper standard. “Inquiry notice” means that a reasonable person would have examined the transfer more thoroughly. This differs from the “willful blindness” standard that the district court adopted. Willful blindness means that the person receiving the money took deliberate actions to avoid seeing what was happening. Inquiry notice, though, implies that it was negligent for them not to have taken action to see where the money actually came from. The arrangement ought to have been suspicious to all involved, but they, in bad faith, decided not to look into it.‌

Burden of Pleading Good Faith Is on the Defendant

The Second Circuit also reversed the District Court on whom it required to plead the issue of good faith. The Second Circuit ruled that good faith was an affirmative defense, leaving it to the defendants to raise the issue.‌

Conclusion

Having to appeal this test case to the district court added seven years to the case and others waiting on it. This decision brought around 90 claims back to life against the Madoff estate, worth $3.75 billion. This set of suits would close off nearly all the Madoff bankruptcy claim cases.

Sources

American Bankruptcy Institute, "Second Circuit Revives $3.75 Billion in Lawsuits by the Madoff Trustee Against Financial Institutions," Sept. 1, 2021

Picard v. Citibank NA (In re Bernard L. Madoff Investment Securities LLC), 20-1333 (2d Cir. Aug. 30, 2021)