Death by a Thousand Cuts: Cumulative Trustee-Favorable Rulings on Bankruptcy Code Clawback Provisions Unfairly Burden Subsequent Assignees


The Supreme Court recently denied certiorari in Picard versus Citibank, in which the petitioner sought review of a Second Circuit decision on a seemingly obscure point of law: the burden of pleading “good faith” under Section 550 of the Bankruptcy Code. The Second Circuit decision is part of and underscores a larger systemic problem in the evolution of bankruptcy law over the past decade: the proliferation of trustee-friendly interpretations of the Bankruptcy Code which, when combined, leave innocent subsequent assignees unfairly vulnerable to unmerited clawbacks. Many of these rulings emerged in the Second Circuit against the backdrop of the collapse of Bernard Madoff’s $20 billion investment firm, but the rulings may have wider ramifications for subsequent assignees in bankruptcy proceedings. smaller bankruptcies.

Good Faith and Madoff Litigation

The Bankruptcy Code provides the trustee with many tools to ensure that a debtor has not transferred his assets to third parties in a manner that unfairly favors some creditors or fraudulently enriches others. Under Section 548 of the Bankruptcy Code, a trustee can “avoid” or reverse transfers of a debtor that were made with fraudulent intent or were constructively fraudulent because the transfer was not made. in return for fair consideration at a time when the debtor was insolvent or undercapitalized. Under Section 550 of the Bankruptcy Code, the trustee may recover voidable assets from the original assignee or from any third party who may subsequently have received the asset (a “subsequent assignee”).

Since the subsequent assignee may be quite distant from the debtor, not know that the funds he received came from the debtor, or have no way of knowing the fraudulent intent of a debtor, the Bankruptcy Code no does not authorize recovery by the trustee where the subsequent assignee has accepted the disputed transfer “for valuable consideration”, “in good faith” and without knowledge of the fraudulent nature of the transfer. In this context, “good faith” depends on what the transferee knew when he accepted the transfer, i.e. if the transferee did not know that the initial transfer was fraudulent and paid a fair price for the transfer, he is entitled to keep the property he received.

In various ensuing litigation following Bernard Madoff’s 2008 Ponzi scheme, Madoff’s investment company trustee sought to recover billions of dollars in transfers from subsequent transferees. Many of these subsequent assignees are large, sophisticated financial institutions. They raised a number of challenges to the trustee’s claims, almost all of which were dismissed by the courts. And the cumulative effect of these rulings has been to undermine the protections afforded to subsequent assignees by the Bankruptcy Code in the Second Circuit.

Consider, for example, the following decisions:

  • In Picard versus Citibankthe Second Circuit held that a trustee bringing a recovery action against a subsequent assignee need not rely on that assignee’s lack of good faith in its claim. [1] The result is that a trustee need only assert two things to argue a recovery action: (i) that a particular initial transfer is avoidable, and (ii) that the defendant indirectly received those funds. Unlike a defendant in a non-bankruptcy fraud case, where the plaintiff must plead fraud with precision, the subsequent assignee defendant here has little reason to win a motion to dismiss and will often be forced to litigate the case by way of discovery. until summary judgment. or trial.
  • Courts have held that trustees do not have to avoid an initial transfer before bringing a recovery action against a subsequent transferee. [2] These rulings remove another layer of protection for a subsequent assignee – the apparent first step of bringing an action against the original assignee. Moreover, they require the subsequent transferee to bear the burden of arguing that the initial transfer should not be avoided, despite the subsequent transferee’s lack of involvement in (and therefore, lack of knowledge of) that transfer.

The effect of these decisions is that a trustee can directly sue a subsequent assignee without alleging the bad faith of that subsequent assignee. In such a lawsuit, the subsequent transferee will paradoxically be forced to plead and prove his own good faith (i.e. he was not advised of the possible fraudulent character of the initial transfer) – although he is distant from the debtor and he has little knowledge of the initial transfer to which he was not a party.

Not what Congress intended

The cumulative effect of these and other decisions – which may be reasonable when considered each in isolation – is to seriously disadvantage innocent subsequent directors. This burden goes against the intent of Congress when it drafted the Bankruptcy Code, which was “to avoid litigation and injustice to innocent purchasers.” [3] Politically, too, it makes no sense to burden subsequent assignees in this way – as remote parties from the debtor and from any fraudulent transfer, they have few tools to monitor whether the funds they accept in the normal course of their activities the business emanating from a debtor and should therefore rather benefit from a presumption of good faith. But as it stands, the law does not provide innocent subsequent assignees with the protections that Congress provides.


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