The Curious Case of Extraterritoriality and Fraudulent Transfer under the Bankruptcy Code
The fraudulent transfer provisions of the Bankruptcy Code give trustees broad power to avoid transfers of property that were made by the debtor before the bankruptcy case if either (1) the debtor transferred the property with actual intent to hinder, delay or defraud creditors or (2) the debtor received less than reasonably equivalent value in exchange for the transferred property. 11 U.S.C. §548(a)(1). If the transfer is avoidable, then a separate provision of the Bankruptcy Code gives trustees power to recover the property from the initial transferee or any subsequent transferee who received the property directly or indirectly from the initial transferee. 11 U.S.C. §550(a). In cases where trustees seek to recover property from subsequent transferees located outside the United States who received the property from transferors also located outside the United States, the question arises whether the Bankruptcy Code’s fraudulent transfer recovery provision reaches that transaction—in other words, whether §550(a) applies extraterritorially to allow trustees to recover property from foreign subsequent transferees.
The U.S. Court of Appeals for the Second Circuit recently issued an opinion in In re Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities, Case No. 17-2992 (2d Cir. Feb. 25, 2019) (BLMIS) concluding that trustees can pursue recovery from foreign subsequent transferees who received property in transactions that occurred entirely outside the United States. The opinion reversed two lower court rulings and arguably conflicts with Supreme Court precedent on extraterritoriality of U.S. legislation.
Extraterritoriality and Fraudulent Transfer
Courts are divided on the issue of whether the fraudulent transfer recovery provision applies extraterritorially. In re CIL Ltd., 582 B.R. 46, 92-93 (Bankr. S.D.N.Y. 2018) (collecting cases); see also R. Antonoff et al., New York Bankruptcy Courts Grapple With Territorial Limits of U.S. Bankruptcy Code, Pratt’s J. Bankr. L. 185 (June 2018). Most cases hold that it does not apply extraterritorially. See In re CIL Ltd., 582 B.R. at 95-96. Other cases allowed recovery from foreign subsequent transferees in certain circumstances. See In re Arcapita Bank B.S.C.(c), 575 B.R. 329 (Bankr. S.D.N.Y. 2017); In re Lyondell Chem. Co., 543 B.R. 127 (Bankr. S.D.N.Y. 2016). The rulings are generally based upon two principal doctrines: (1) The presumption against extraterritoriality and (2) international comity.
The presumption against extraterritoriality provides that the reach of U.S. legislation applies only domestically unless a contrary congressional intent is apparent. See RJR Nabisco v. European Cmty., 136 S. Ct. 2090, 2100 (2016); Morrison v. Nat’l Australian Bank Ltd., 561 U.S. 247, 255 (2010). “When a statute gives no clear indication of an extraterritorial application, it has none.” Morrison, 561 U.S. at 255. To determine if a statute applies extraterritorially, courts conduct a two-part analysis. First, courts determine whether the statue “gives a clear, affirmative indication that it applies extraterritorially.” RJR Nabisco, 136 S. Ct. at 2101. If it does, the inquiry ends there. In re CIL Ltd., 582 B.R. at 83-84. If not, then courts look to the statute’s focus and the facts of the case to determine whether the conduct the statute regulates occurred domestically or not.
International comity is when a court in the United States declines to act in deference to the judicial proceedings pending in another country. See In re Maxwell Communication, 93 F.3d 1036, 1046 (2d Cir. 1996). International comity is “a discretionary rule of practice, convenience, and expediency.” Royal & Sun Alliance Ins. Co. v. Century Int’l Arms, 466 F.3d 88, 92 (2d Cir. 2006) (internal quotation marks and citations omitted). Indeed, comity may preclude the application of an otherwise extraterritorial statute. In the Second Circuit, “comity is especially important in the context of the Bankruptcy Code.” Maxwell, 93 F.3d at 1048.
Cases addressing extraterritoriality of fraudulent transfer recovery agree that the relevant provisions of the Bankruptcy Code—§§548(a) and 550(a)—do not indicate congressional intent to apply them extraterritorially. Courts therefore rely on the “focus” test, identifying the conduct the statute regulates and determining if that conduct occurred domestically or outside the United States.
BLMIS involved transfers of money to investors prior to the collapse of Madoff Securities. The initial transfers were made by Madoff Securities from the United States to its feeder fund customers in the British Virgin Islands and the Cayman Islands. The feeder funds subsequently transferred the money to their investors also outside the United States. In December 2008, Madoff Securities was placed into liquidation under the Securities Investor Protection Act and a trustee was appointed to liquidate the company. The liquidation is proceeding in the U.S. Bankruptcy Court for the Southern District of New York under the stockbroker liquidation provisions of the Bankruptcy Code. 11 U.S.C. §§741-753; 15 U.S.C. §78eee(b)(4).
The trustee filed fraudulent transfer actions against the feeder funds under Bankruptcy Code §548(a) seeking to avoid the initial transfers. He also filed actions against foreign investors under §550(a) seeking to recover money transferred to them by the feeder funds. Many of the feeder funds had invested and lost all their assets in Madoff Securities and were themselves in liquidation proceedings in BVI and Cayman. The foreign investors filed motions to dismiss the trustee’s actions on several grounds, including that §550(a) does not apply extraterritorially to transactions between the feeder funds and the foreign investors. The U.S. District Court for the Southern District of New York withdrew the reference from the bankruptcy court to rule on the motions to dismiss.
In considering whether §550(a) applies extraterritorially under the “focus,” the court found that the statute seeks to regulate
the transfer of property to a subsequent transferee, not the relationship of that property to a perhaps-distant debtor … . Here, the relevant transfers and transferees are predominately foreign: foreign feeder funds transferring assets abroad to their foreign customers and other foreign transferees.
Securities Investor Protection v. Bernard L. Madoff Investment Securities, 513 B.R. 222, 227 (S.D.N.Y. 2014). The court therefore concluded that the presumption against extraterritoriality was not rebutted and “the Trustee may not use §550(a) to pursue recovery of purely foreign subsequent transfers.” Id. at 232.
The court also found that international comity precluded the trustee from seeking recovery from foreign subsequent transferees. The court noted that the feeder funds were involved in their own liquidation proceedings in BVI and Cayman, and rulings have been made in those cases that could conflict with the relief the trustee is seeking in the United States. The district court dismissed the trustee’s actions “to the extent they seek to recover purely foreign transfers” and remanded the cases to the bankruptcy court to develop a factual record of the extent to which the transfers were purely foreign.
On remand, the bankruptcy court dismissed the trustee’s claims on grounds of comity and the presumption against extraterritoriality. On comity, the bankruptcy court found that BVI and Cayman courts have a greater interest than the United States in regulating transfers between the feeder funds and their investors. The bankruptcy court also concluded that the presumption against extraterritoriality required dismissal because the property the trustee sought to recover was transferred outside the United States. The trustee appealed the bankruptcy court and district court orders.
The Second Circuit Ruling
Whereas the district court found that applying §550(a) to foreign transfers is an impermissible extraterritorial reach, the Second Circuit held that §550(a) works “in tandem” with §548(a) so that the focus of the statute is the initial transfer which occurred in the United States. Therefore, applying §550(a) to recover from foreign transferees of property initially transferred in an avoidable transfer under §548(a), is a domestic application of §550(a), not extraterritorial.
The court reached this conclusion largely based on a recent Supreme Court opinion, WesternGeco v. ION Geophysical, 138 S. Ct. 2129 (2018), involving unlawful export of component parts of patented products and whether a claim for infringement includes damages for lost foreign sales under the Patent Act. One section of the Patent Act prohibits the export of such parts (§271(f)) and a separate section provides for recovery of damages (§284). In WesternGeco, the court characterized the two provisions as working “in tandem” and held that the focus of §284 (the damages provision) is on the act of exporting component parts from the United States, which is domestic infringement. The damages are “merely the means by which the statute achieves its end of remedying infringements.” 138 S. Ct. at 2138.
Applying this reasoning to Bankruptcy Code §§548(a) and 550(a), the Second Circuit concluded that they also work in tandem and that the focus of §550(a), like that of §548(a), is domestic. When §550(a) operates in tandem with §548(a), recovery of property is ‘merely the means by which the statute achieves its end of’ regulating and remedying the fraudulent transfer of property.” BLMIS, Case No. 17-2992 at 21-22 (citing WesternGeco, 138 S. Ct. at 2138). The court held that recovering property from foreign subsequent transferees is a domestic application of §550(a) and therefore permissible.
On the issue of comity, the Second Circuit disagreed with the lower courts and found that “[t]he United States has a compelling interest in allowing domestic estates to recover fraudulently transferred property” and that the United States’ interest “outweighs the interest of any foreign state.” The court noted that although the feeder funds were in liquidation, Madoff Securities itself was not the subject of a foreign liquidation proceeding and “the absence of such proceedings seriously diminishes the interest of any foreign state in our resolution of the Trustee’s claims.” BLMIS, Case No. 17-2992 at 35.
The foreign investors stated that they intend to seek Supreme Court review of the Second Circuit ruling and obtained a stay pending a decision on whether review will be granted. They note that the ruling potentially subjects foreign investors to double liability if both the Madoff Securities trustee and liquidators for the feeder funds seek recovery from them for the same transfer. See UBS AG NY v. Fairfield Sentry Ltd. (In Liquidation), Privy Council Appeal No. 0082 of 2018 (UKPC, May 20, 2019) (ruling that BVI liquidators may pursue recovery against investors of Fairfield Sentry). They also note the possibility of inconsistent rulings in the foreign courts, a result comity means to avoid. On the other hand, dismissing the trustee’s claims could open the door to mischievous manipulation by debtors to shield money from being recovered by arranging subsequent transfers abroad. If the Supreme Court reverses the Second Circuit’s ruling, then Congress may consider expressing its intention to apply §550(a) extraterritorially.
"The Curious Case of Extraterritoriality and Fraudulent Transfer under the Bankruptcy Code," by Rick Antonoff was published in the New York Law Journal on June 07, 2019.
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