In the recent case of Securities Investor Protection Corp. v. Bernard Madoff Inv. Sec. (“Securities”), the Second Circuit ruled that § 550[1] of the Bankruptcy Code does not apply extraterritorially to allow avoidance of fraudulent transfers that occur entirely outside of the United States.[2] Securities involved the efforts of Irving H. Picard, the trustee appointed under the Securities Investor Protection Act (SIPA)[3] to recover funds transferred from Madoff Investment Securities LLC[4] to foreign “feeder funds,” which then transferred those funds to other foreign persons or entities.
Background
Among these subsequent transferees were CACEIS Bank Luxembourg and CACEIS Bank (together, “CACEIS”).[5] CACEIS had invested with Fairfield Century Ltd. and Harley Int’l., which are foreign feeder funds.[6] Fairfield and Harley, in turn, invested CACEIS assets in Madoff Securities.[7] Picard alleged that CACEIS, as a customer of Fairfield and Harley, received $50 million in subsequent transfers originating from Madoff Securities,[8] and so sought to avoid these transfers under 11 U.S.C. § 550(a)(2).[9] CACEIS argued that neither SIPA, nor the Bankruptcy Code as incorporated by SIPA, could apply extraterritorially to avoid these foreign transfers.[10]
Extraterritorial Application of Trustee’s Avoidance Powers
The Securities court noted, “It is a ‘long-standing principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.’”[11]Courts use a two-prong test to determine whether the presumption applies: first, whether the factual circumstances require extraterritorial application of the relevant statutory provisions, and second, whether Congress intended for the statue to apply extraterritorially.[12]
Addressing the first prong, the court reviewed the “focus of congressional concern” — that is, what transactions Congress sought to regulate.[13] Picard urged that the “focus” of SIPA was to regulate the U.S. broker-dealer (i.e., Madoff), meaning that the application of SIPA and its incorporated Bankruptcy Code provisions is inherently domestic.[14] The court, however, disagreed:
It cannot be that any connection to a domestic debtor, no matter how remote, automatically transforms every use of the various provisions of the Bankruptcy Code in a SIPA bankruptcy into purely domestic application of those provisions…. Accordingly, a mere connection to a US debtor, be it tangential or remote, is insufficient on its own to make every application of the Bankruptcy Code domestic.[15]
The court found that Congress sought to regulate the transfer of property, not the relationship of property to a “perhaps-distant debtor.”[16] And although the chain originated with Madoff Securities in New York, the Securities court noted the foreign nature of the transfers: “foreign feeder funds transferred assets abroad to foreign customers and other foreign transferees.”[17] The court thus found that the subsequent transfers the trustee sought to avoid required an extraterritorial application of § 550(a).[18]
The court then turned to the second prong: whether Congress intended an extraterritorial application of § 550(a). It found no such intention. “‘[U]nless there is an affirmative intention of the Congress clearly expressed to give a statue extraterritorial effect,’ we must presume it is primarily concerned with domestic conditions.”[19] Because § 550(a) does not explicitly reference foreign transfers, the court looked to the surrounding provisions to determine contextually whether Congress intended § 550(a) to apply extraterritorially.[20]
Picard argued that § 541 of the Bankruptcy Code provided this intent by defining “property of the estate” to include property “wherever located and by whomever held.”[21] Unpersuaded, the court noted that Second Circuit jurisprudence considers fraudulently transferred property as property of the estate only after the trustee recovers it.[22] Thus, the court held that the “extraterritorial” language of § 541 could not apply to property that the trustee had not yet recovered.
International Comity Also Precluded Avoidance of the Transfers
The court held that even if § 550(a) applied extraterritorially, principles of international comity still prevented the avoidance action. Comity “is the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protection of its laws.”[23] It explained:
As is the case with Fairfield Sentry and Harley, many of the feeder funds are currently involved in their own liquidation proceedings in their home countries ... [i]ndeed, the BVI courts have already determined that Fairfield Sentry could not reclaim transfers made to its customers under certain common-law theories — a determination in conflict with what the Trustee seeks to accomplish here.[24]
The court found that the trustee infringed on international comity by “seeking to use SIPA to reach around such foreign liquidations in order to make claims to assets on behalf of SIPA customer-property estate....”[25]
Going Forward: The Foreign Loophole
The Securities court recognized the policy issues raised by its ruling. “[T]he Trustee argues that a contrary result [i.e., not allowing extraterritorial application of § 550(a)] would allow a U.S. debtor to fraudulently transfer all of his assets offshore and then retransfer those assets to avoid the reach of U.S. bankruptcy law.”[26] Unmoved, the court stated, “the desire to avoid such loopholes in the law ‘must be balanced against the presumption against extraterritoriality, which serves to protect against unintended clashes between our laws and those of other nations, which could result in international discord.’”[27]
Until Congress amends § 550(a) to make its extraterritorial application clear, this “foreign loophole” will remain open to U.S. debtors, who could decide to evade a trustee’s avoidance powers by engineering subsequent fraudulent transfers to occur entirely outside of the U.S. Creditors must be aware of this extraterritorial limitation, and should be ready to hire counsel who are well experienced in navigating international jurisdictions and who possess the capabilities to avoid these transfers in the countries where they took place.
[1] 11 U.S.C. § 550(a)(2).
[2] See generally Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec., 513 B.R. 222 (S.D.N.Y. 2014) (“Securities”).
[3] 15 U.S.C. §§ 78aaa-78lll.
[4] As repeated ad nauseam in other places, Bernard “Bernie” Madoff, chairman of the Wall Street firm Bernard L. Madoff Investment Securities LLC, admitted to running a Ponzi scheme that defrauded thousands of investors of billions of dollars.
[5] Securities, 513 B.R. at 225.
[6] Id.
[7] Id. The trustee settled with Fairfield for a fraction of the initial claim. Fairfield is currently in liquidation in the British Virgin Islands. In addition, the trustee had obtained a default judgment against Harley for more than $1 billion in November 2010. Id. at 225-26.
[8] Id. at 226.
[9] Id.
[10] Id.
[11] Id. (citing Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247, 130 S. Ct. 2869 (2010)) (quoting EEOC v. Arabian American Oil Co. (“Aramco”)), 499 U.S. 244, 248 (1991)).
[12] Id. (citing Morrison, 130 S. Ct. at 2877-88) (other citations omitted).
[13] Id. (citing Morrison, 130 S. Ct. at 2884).
[14] Id. at 227.
[15] Id. (first emphasis in original; second emphasis added) (citations omitted).
[16] Id. at 227.
[17] Id. at 227–28 (emphasis added).
[18] Id. at 228.
[19] Id. (citing Morrison, 130 S. Ct. at 2877) (quoting Aramco, 499 U.S. at 248).
[20] Id. (citing Morrison, 130 S. Ct. at 2883).
[21] Id. (citing 11 U.S.C. § 541(a)) (emphasis added).
[22] Id. at 229 (citing In re Colonial Realty Co., 980 F.2d 125, 131 (2d Cir. 1992).
[23] Id. at 231 (citing In re Maxwell Commc’n Corp., 93 F.2d 1036, 1046 (2d Cir. 1996)) (other citations omitted).
[24] Id. at 232 (citing In re Fairfield Sentry Ltd. Litg., 458 B.R. 665, 672 (S.D.N.Y. 2011)).
[25] Id. (citing Maxwell, 93 F.3d at 1051).
[26] Id. at 231 (emphasis added).
[27] Id. (citing In re Midland Euro Exch. Inc., 347 B.R. 708, 718 (Bankr. C.D. Cal. 2006)) (emphasis added).