The debtor (Madoff Securities) made payments to “feeder funds” that provided its funding, and the feeder funds in turn made payments to their investors, fund managers, and other entities. The trustee sought to avoid transfers from Madoff Securities, and to recover the transfers from both the feeder funds and their subsequent transferees. This decision addressed the parameters for recovery from the subsequent transferees.
Pursuant to Section 550(a) of the Bankruptcy Code, “to the extent that a transfer is avoided” under specified sections of the Bankruptcy Code, a trustee may recover the property or the value of the property from the initial transferee or “any immediate or mediate transferee of such initial transferee.” The court’s decision turned to a large extent on its interpretation of the meaning of the phrase “to the extent a transfer is avoided” – which it interpreted to mean that a transfer could be avoided in part, as opposed to imposing a condition that a transfer be avoided.
The court emphasized that the transfer that must be avoidable is the initial transfer, not the subsequent transfer; and avoidance and recovery are distinct concepts with different defenses, including statutes of limitations. Generally, under Section 546(a) the statute of limitations for avoidance actions is two years, and under Section 550(f) the statute of limitations for recovery actions is the earlier of (1) one year after avoidance of the transfer and (2) closure or dismissal of the case.
The district court focused on two issues: (1) whether the trustee was required to obtain a “fully litigated, final judgment of avoidance” against an initial transferee as a condition of pursuing a subsequent transferee, or (2) whether the trustee must obtain a judgment or must assert a claim against the subsequent transferee for avoidance of the initial transfer by the two year deadline for commencing avoidance actions in Section 546(a).
On the first issue, the subsequent transferees argued that the trustee could never obtain an actual avoidance of some of the transfers because he had settled with the initial transferees. However, the court agreed with the majority view that a trustee does not have to avoid a transfer against the initial transferee before recovering from the subsequent transferee. Although the trustee must prove that the transfer he seeks to recover is avoidable, this does not require a judgment against the initial transferee.
Requiring serial avoidance and recovery actions would create various problems, including increased costs of litigation and delay. If the trustee can establish an avoidable transfer “he can then skip over the initial transferee and recover from those next in line.” In essence, avoidability “is an attribute of the transfer and not the party.” This also means that a subsequent transferee can assert the defenses available to the initial transferee (unless barred by collateral estoppel res judicata) even if the initial transferee did not raise those defenses.
The court noted that the avoidance and recovery actions could be brought either in the same proceeding or sequentially, as long as the recovery action is within one year of a timely avoidance action and it is proved that the transfer can be avoided at least contemporaneously with the recovery. With respect to timing in connection with the settled case, the district court agreed with the bankruptcy court that the settlement provided finality sufficient to trigger the one-year statute of limitations under Section 550(f), so that the recovery action was timely as long as it was within one year of the settlement.
On the second issue, the defendants contended that the trustee must bring timely avoidance actions against not only the initial transferees, but also the subsequent transferees. Thus, some of the recovery proceedings should be dismissed because the trustee did not bring avoidance actions against the subsequent transferees within the two-year statute of limitations.
The court agreed that the trustee must prove that the transfers were avoidable, and the subsequent transferees could raise all appropriate defenses, but the avoidance statute of limitations defense was applicable only if the trustee failed to bring any avoidance action (whether against the initial or subsequent transferee) within the two-year limitations period.
Note that although an avoidance action must be commenced within the two years, the one year recovery limitations period doesn’t start to run until the transfer is avoided. If an avoidance action takes a long time to resolve, there could be recovery exposure for substantially more than three years. The court noted an example where a trustee was allowed to add a subsequent transferee as a defendant after seven years where the Section 550 limitations period had not even been triggered, let alone expired.
Vicki R. Harding, Esq.
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