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Actual Knowledge Bars Section 546(e) Safe Harbor Defense

By: Amanda Tersigni

St. John’s Law Student

American Bankruptcy Institute Law Review, Staff

        Section 546(e) of the Bankruptcy Code generally provides that a trustee may not avoid a “settlement payment” as a preference or a fraudulent transfer.[1] This so-called “safe harbor,” a defense to a trustee’s avoidance power, is designed to avoid uncertainty in security trading and to prevent an ultimate instability in the financial markets.[2] The United States Bankruptcy Court for the Southern District of New York in Picard v. Avellino (In re Bernard L. Madoff Inv. Sec. LLC),[3] held that having actual knowledge of fraudulent nature of a security trading precluded a defendant from using the safe harbor defense under Section 546(e).[4]

        Frank J. Avellino and Michael Bienes (collectively, the “Defendants”) were accountants who engaged in fictitious activity with Bernard L. Madoff Investment Securities LLC (“BLMIS”).[5] From 1994 through 2007, the Defendants performed calculations on their investment advisory accounts to track whether their rate of return matched what Madoff promised.[6] The Defendants notified Madoff when the amount was inconsistent with what was promised, and then money was subsequently paid to specific accounts through fictitious payments that equaled the promised guaranteed rate of return.[7] In addition, the Defendants even identified how to allocate the payments among the accounts.[8]

        On March 12, 2009, Madoff plead guilty and admitted that he operated a Ponzi scheme through BLMIS.[9] Thereafter, the trustee for the liquidation of BLMIS (“Trustee”) sued the Defendants to avoid and recover preferences and fraudulent transfers.[10] In addition, the Trustee pleaded that the Defendants had actual knowledge that BLMIS was not engaged in trading.[11] The Defendants responded that the Trustee failed to adequately allege that the Defendants had any actual knowledge about whether BLMIS engaged in trading.[12] Further, the Defendants contended any transfers made were protected by the safe harbor defense of section 546(e).[13]

        Pursuant to section 548(a)(1)(A) of the Bankruptcy Code, a transferee that had actual knowledge of Madoff’s Ponzi scheme cannot avail itself of the section 546(e) safe harbor defense.[14] According to the court, the Defendants had actual knowledge of Madoff’s Ponzi scheme because they directly and actively engaged in the fictitious payments, and by virtue of being the individuals that did this, the Defendants were not entitled to the safe harbor defense.[15]

        Additionally, under Bankruptcy Code section 546(e), the safe harbor is typically available for a defendant to protect a settlement payment.[16] But the mere existence of a Ponzi scheme will raise a presumption of actual fraud so that safe harbor will not be applicable for those with actual knowledge.[17] Section 546(e) specifically excludes “actual fraudulent transfers” from the safe harbor defense.[18] In In re Bernard L. Madoff Inv. Sec. LLC, the court found that a person’s knowledge must be considered when determining whether that individual should be awarded safe harbor protection.[19]  Because the Defendants had actual knowledge of Madoff’s Ponzi scheme, they were not afforded such protection.[20] The notion of disallowing section 546(e) safe harbor defense and considering the extent of one’s knowledge is consistent with other decisions concerned with the applicability of this section.[21] Consequently, a court will consider all the relevant facts and circumstances when determining whether to grant a defendant safe harbor from particular claims relating to fictitious acts.[22]  



[1] See Craig M. LaChance, Major Event Litigation: Madoff Securities Fraud Litigation Under Securities Investor Protection Act (SIPA) 15 U.S.C.A. §§ 78aaa et seq., Am. Law Rep. (2015). Explaining Section 546(e) of the Bankruptcy Code and further discussing this section in the context of the Second Circuit’s decision in In re Bernard L. Madoff Inv. Sec.

[2] See Daniel J. Merrett and Danielle Barav-Johnson, Taking Stock: United States Supreme Court Presented With Opportunity to Settle Meaning of Section 546(e), 25 Norton J. of Bankr. Law and Prac. (2008).

[3] See generally In re Bernard L. Madoff Inv. Sec. LLC, 557 B.R. 89 (Bankr. S.D.N.Y. July 21, 2016) (hereinafter referred to as “In re Bernard L. Madoff Inv. Sec. LLC I”)

[4] See id. at 112, 119.

[5] See id. at 102.

[6] See id. at 102, 116.

[7] See id.

[8] See id.

[9] See id. at 95.

[10] See id. at 94.  

[11] See id. at113. The court outlined what it means to have “actual knowledge,” which implies a high level of certainty and absence of any substantial doubt regarding the existence of a fact.

[12] See id. at 107.  

[13] See id.

[14] See In re Bernard L. Madoff Inv. Sec. LLC, 515 B.R. 117, 138 (Bank. S.D.N.Y. August 12, 2014) (hereinafter referred to as “In re Bernard L. Madoff Inv. Sec. LLC II”) (discussing how actual knowledge of the Ponzi scheme would bar someone from utilizing the Section 546(e) safe harbor).

[15]See In re Bernard L. Madoff Inv. Sec. LLC I, 557 B.R. at 116–119.

[16] See id. at 112, 119.

[17] See Peter Spero, Fraudulent Transfers, Prebankrutpcy Planning and Exemptions §8.4, 2016 edition 2016. 

[18] 3 Collier on Bankruptcy, ¶546.06[1], at 546-47 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2009).

[19] See In re Bernard L. Madoff Inv. Sec. LLC I, 557 B.R. at 119.  The court emphasized that “the safe harbor provided by 11 U.S.C. § 546(e) . . . does not apply because of Avellino’s actual knowledge.”

[20] See id.

[21] See generally In re Bernard L. Madoff Inv. Sec. LLC, 2016 WL 5415505 (Bankr. S.D.N.Y. Sept. 28, 2016); see also In re Bernard L. Madoff Inv. Sec. LLC II, 515 B.R. at 138; see also In re Viola, 469 B.R. 1, 10 (B.A.P. 9th Cir. Apr. 6, 2012).

[22] See In re Bernard L. Madoff Inv. Sec. LLC I, 557 B.R. at 119