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Inquiry Notice Applies to A Transferee’s Good Faith Defense to a Trustee’s Fraudulent Avoidance Action


On August 30, 2021, the Second Circuit decided in Irving Picard, trustee for the Liquidation of Bernard L. Madoff Investment Securities, LLC v. Citibank N.A., 20-1334, on “appeals of the latest installment in the long-running litigation arising from Bernard Madoff’s Ponzi scheme” whether the District Court properly dismissed actions brought against initial and subsequent transferees, to avoid and recover transfers, inter alia, under Sections 548 and 550 of the Bankruptcy Code.

Section 548 (a) (1) permits a trustee to “avoid” any transfer made or incurred within 2 years of the filing of the bankruptcy petition if the debtor made the transfer with actual intent to hinder, delay or defraud any entity to which the debtor was or became indebted. Section 550 authorizes a trustee to recover the property transferred by the debtor to any transferee (initial or subsequent) to the extent the transfer is avoidable. Section 548 is applicable to initial transferees and Section 550 is applicable to subsequent transferees. Under both sections, a transferee who takes for value, in good faith and without knowledge of the voidability of the transfer can retain the property transferred if a subsequent transferee or be given a lien to the extent of value given under Section 548.  The Second Circuit faced two issues: 1) the definition of good faith and 2) which party bears the burden of pleading good faith or lack thereof.

The Second Circuit embraced the inquiry notice standard, rather than the willful blindness standard used by the District Court, as to whether a transferee acted in good faith. The court opined that inquiry notice “signifies accrual awareness of suspicious facts that would have led a reasonable (transferee), acting diligently, to investigate further and by doing so discover a debtor’s-transferor’s fraud.” The court concluded there is a three-step inquiry as to a good faith defense. First, a court must examine what facts the defendant knew. Second, a court must determine whether those facts put the transferee on inquiry notice of the fraudulent purpose behind the transaction–whether a reasonable person would conduct further inquiry into a possible fraud. Third, if the court determines that a transferee had been put on inquiry notice, whether diligent inquiry by the transferee would have discovered the fraudulent purpose of the transfer.

The Second Circuit further decided that inquiry notice does not universally impose an affirmative duty to investigate. That duty arises only when a transferee is actually aware of suspicious facts that would lead a reasonable person to inquire further into a debtor-transferor’s potential fraud. The adequacy of the investigation is fact-intensive.

Finally, the Second Circuit reasoned that good faith is an affirmative defense under both Sections 548 and 550. Accordingly, the defendant bears the burden of pleading that affirmative defense. The trustee does not bear the burden of pleading a lack of good faith.

The Second Circuit earlier reversed the District Court by holding that Sections 548 and 550 can be applied extraterritorially to recover fraudulent transfers even if subsequent transfers occurred abroad. In re Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, 917 F.3d 85 (2d Cir. Feb. 25, 2019). Now, those transfers can only be defended if the transferees can show they took the transfers in good faith. This opens up recovery for trustees both domestically and internationally from those receiving funds directly from the debtor and those who received funds via the initial transferees, who fail to show upon inquiry notice that they acted in good faith.


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