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Subsequent Transferee Liability in Cryptocurrency Bankruptcies


In the new year, cryptocurrency bankruptcies will be breaking new ground over the ability to recover customer deposits. An understanding of the ruling in the Bernie Madoff SIPC liquidation could provide guidance for such recoveries.

Bankruptcy Code sections 548 (a) and 550 (a) give chapter 11 debtors, appointed trustees and post-confirmation liquidating trustees the power to sue and recover money and other forms of property the debtor sold, loaned, gifted, or otherwise transferred to third parties within two years of the bankruptcy filing if the transfers were designed to defraud other creditors. A section 550 (a) claim gives a trustee the ability to recover from not only initial transferees but also subsequent transferees down the chain of transfers. Section 550 (b) contains a “good faith” defense that protects subsequent transferees if that transferee “takes for value, including satisfaction or securing of a present or antecedent debt in good faith, and without knowledge of the voidability of the transfer”.

The decision by the Second Circuit in In re Bernard L Madoff Investment Securities LLC, 12 F. 4th 171 (2d Cir. 2021), gives guidance. That court held that the trustee is not required to allege that the subsequent transferee lacked good faith or had any level of notice or knowledge of an underlying fraud. Instead, the court decided that the good faith defense is an affirmative defense, placing the burden on the subsequent transferee of proving that it received the transfer in good faith. The court went further to find that to prove good faith the subsequent transferee must show it lacked “inquiry notice” of possible fraud. In other words, did the transferee know of any suspicious facts that would prompt a reasonable period to investigate whether there was actual or constructive fraud in the underlying transfer.

In the crypto world, customers transfer cryptocurrency into a cryptocurrency exchange. To earn a return, it has been uncovered that the cryptocurrency exchange deposits the cryptocurrency with a crypto lender. The lender converts the cryptocurrency into fiat, U.S. dollars and then lends those dollars to an end borrower, a fintech company.

If the Madoff ruling is adopted as the controlling precedent, to prosecute the fraudulent transfer against the borrower, the trustee will not be required to allege the borrower’s lack of good faith. Rather, the borrower will have the burden to prove its good faith and lack of knowledge to support an affirmative defense under section 550 (b).

Notwithstanding, subsequent transferees such as the borrower could raise a defense that section 550 (a) does not permit recovery of fiat proceeds of fraudulently transferred crypto currency. Courts are split over whether a trustee may recover from an immediate or subsequent transferee if the recipient received proceeds from a fraudulent transfer but not the fraudulently transferred property itself (see Rajala v. Busch Blackwell (In re Generation Res. Holding Co., LLC), 604 B.R. 896, 898 (Bankr. D. Kan. 2019) (holding that a trustee may recover from the transferee without regard to what property the transferee received); but see Lassman v. Santosusso (In re Ruthaford), 2015 WL 1510566, at *12 (Bankr. D. Mass. Mar. 30, 2015) (holding that section 550(a) does not extend the right of recovery to the proceeds of the property transferred)). However, the U.S. Court of Appeals for the Tenth Circuit reversed and remanded In re Generation Resources Holding Co., LLC, holding that proceeds from fraudulently transferred property are not recoverable from a subsequent transferee under section 550(a) who, as the court found, does not qualify as a “transferee” because it does not possess the fraudulently transferred property itself (see Rajala v. Spencer Fane LLP (In re Generation Res. Holding Co., LLC), 964 F.3d 958, 967 (10th Cir. 2020)).

Thus, it remains to be developed what can be recovered in a bankruptcy as a result of a complex series of cryptocurrency transactions that convert the nature of the proceeds involved. The likelihood is that any litigation will be expansive and not decided at the initial pleading stage.


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