United States: The Reach Of Avoidance – Second Circuit Court Of Appeals Holds In Madoff That Bankruptcy Code Can Be Used To Recover Subsequent Extraterritorial Transfers

On February 25, 2019, the United States Court of Appeals for the Second Circuit issued a decision holding that a trustee is not barred by either the presumption against extraterritoriality or by international comity principles from recovering property from a foreign subsequent transferee that received the property from a foreign initial transferee. In reversing the District Court's Decision, the Court of Appeals concluded that, because section 550(a) of the Bankruptcy Code1 is designed to remedy a debtor's fraudulent (or preferential) transfer of property, the proper focus for determining the impact of the statute should be on the location of the initial transfer, not on the location of the recipient of the transfer or of any subsequent transferee. The Court of Appeals found that, because the initial fraudulent transfer from Madoff took place in the United States, the general presumption against the extraterritorial reach of a statute did not apply. The Court of Appeals further held that comity considerations did not limit the reach of the Bankruptcy Code avoidance provisions in these actions, noting that the United States has a compelling interest in allowing domestic estates to recover fraudulently transferred property.  On April 3, 2019, the Court of Appeals denied the appellees' petition for rehearing.

Background

Certain foreign investment funds (so-called "feeder funds") that had pooled their customers' assets for the purpose of investing with Madoff withdrew funds from their Madoff accounts prior to the unraveling of Madoff's Ponzi scheme. Those feeder funds (most of which landed in liquidation proceedings in their home countries) then transferred those funds—which, as withdrawals from a Ponzi scheme, were subject to avoidance as fraudulent conveyances—to their own investors, many of whom were foreign entities. The Madoff trustee sued both the feeder funds and the subsequent transferees under section 550 of the Bankruptcy Code in an attempt to recover the transferred assets. Although section 550 authorizes trustees to recover a debtor's fraudulent transfers not only from the direct recipients of the transfers, but also, in some instances, from subsequent transferees, the subsequent transferees moved to dismiss the complaint on the grounds that section 550 does not apply extraterritorially and thus does not enable the trustee to set aside transfers from a foreign transferor to a foreign transferee.

In July of 2014, the United States District Court for the Southern District of New York held that the trustee could not proceed with the avoidance actions on two grounds. First, it held that the presumption against extraterritoriality limits the scope of section 550(a)(2), such that a trustee may not use it to recover property that one foreign entity received from another foreign entity. Alternatively, the District Court held that international comity principles limit the scope of section 550(a)(2) on these facts. The District Court remanded to the Bankruptcy Court for further proceedings consistent with its opinion. On remand, the Bankruptcy Court applied the District Court's reasoning and dismissed the trustee's claims. The Madoff trustee appealed to the Court of Appeals.

Decision

The Court of Appeals first considered the presumption against extraterritoriality, a canon of statutory construction that provides that absent clearly expressed Congressional intent to the contrary, federal laws will be construed as having only domestic application. The Court of Appeals concluded that section 550(a) of the Bankruptcy Code (the statutory provision that enables the trustee to recover from initial and subsequent transferees of the fraudulent conveyance) provides a remedy for actions under section 548(a) of the Bankruptcy Code (the statutory provision that enables the trustee to avoid the fraudulent transfer in the first place). The Court of Appeals held, therefore, that the proper starting point for determining whether or not section 550 was being applied domestically was to look at the underlying transaction that was being avoided under section 548. The Court of Appeals then pointed to the fact that the debtor, Madoff Securities, was a domestic entity that transferred property from a U.S. bank account. On those facts, the Court of Appeals concluded that because the debtor's initial transfer was made from the U.S., section 550 actually was being applied domestically as a remedy for a domestic debtor's fraudulent transfer, avoidable under section 548(a) of the Bankruptcy Code.

The Court of Appeals also considered whether the District Court erred in dismissing the actions on international comity grounds2. The Court of Appeals noted that deference to foreign insolvency proceedings often will facilitate equitable and orderly distribution of the debtor's assets, and indeed, Congress explicitly recognized the importance of comity in transnational insolvency situations when it revised the bankruptcy laws to incorporate Chapter 15. At the same time, the Court of Appeals stated that the United States has a compelling interest in allowing domestic estates to recover fraudulently transferred property in order to enable creditors to receive their fair share in the event that a U.S. entity enters into bankruptcy.  

Turning to the facts at hand, the Court of Appeals noted that when a debtor in U.S. courts also is in liquidation proceedings in a foreign court, that foreign state has an interest in adjudicating property disputes. The Court of Appeals, however, concluded that no such parallel proceedings exist in the Madoff case. In reaching that conclusion, the court observed that this case did not involve parallel proceedings because Madoff Securities (the transferor) itself is not a debtor in proceeding in foreign courts. In addressing the foreign insolvency proceedings of the  feeder funds, the Court of Appeals determined that although the courts in those proceedings arguably could have an interest in the dispute, the court did not find such an interest compelling on the basis that the Madoff trustee is not a creditor in those cases, and, therefore, the trustee's claims are not the subject of a foreign bankruptcy proceeding. Under these circumstances, the Court of Appeals found that consolidating the trustee's claims in federal court is more equitable and orderly than forcing him to litigate different claims in different countries. As a result, the Court of Appeals held that the interests of the United States in applying its laws outweighs the interests of any foreign state, and, as a result, that comity considerations did not prevent the trustee from recovering property that was transferred from an initial foreign transferee to a subsequent foreign transferee. 

Discussion

The Court of Appeals, by focusing on the first step in an avoidable transfer—the transfer of property in the United States—moved towards a near-universal approach to the reach of section 550 and the recovery of transfers from subsequent transferees. As the Court of Appeals noted, its decision is designed to prevent a fact pattern that it found unacceptable: a fraudster, anticipating his downfall, transfers property to a foreign entity that then transfers it to another foreign entity, rendering the property recovery-proof. The universal approach taken by the Court of Appeals also makes it possible that courts relying on it may take an even broader view of other rights and protections afforded a debtor's estate under the Bankruptcy Code, such as the automatic stay, which has been generally regarded as having worldwide applicability.

Footnotes

1 Section 550(a) of the Bankruptcy Code provides in relevant part that "to the extent that a transfer is avoided under [certain specified sections of the Bankruptcy Code, including section 548 relating to fraudulent transfers], the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from – (1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or (2) any immediate or mediate transferee of such initial transferee." 11 U.S.C. § 550(a).

2 The Court of Appeals stated that international comity only comes into play when there is a true conflict between American law and foreign law, but assumed here, without deciding the matter, that a true conflict exists.

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