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New York District Court Prohibits Trustee’s Use of Bankruptcy Code Avoiding Powers with respect to Certain Foreign Transactions


09 July 2014


On July 7, 2014, U.S. District Court Judge Jed Rakoff held that the trustee of Bernard Madoff’s securities firm cannot recover from foreign entities that received payments from foreign feeder funds even if those payments were found to be preferential or fraudulent transfers made by the now bankrupt firm.1 Section 550(a)(2) of the U.S. Bankruptcy Code would permit the recovery of such transfers if they occurred in the U.S., but Judge Rakoff concluded that the provision does not apply extraterritorially.
The dispute arose out of the collapse of Bernard L. Madoff Investment Securities LLC (Madoff Securities), a registered stockbroker. The trustee appointed by the Securities Investor Protection Corporation who has been overseeing the liquidation of the Madoff Securities estate sought to recover as fraudulent transfers and preferences certain payments made by Madoff Securities to its so-called “feeder funds,” foreign investment funds that pooled their customers' assets for investment into Madoff Securities. These feeder funds periodically withdrew funds from Madoff Securities and transferred the funds to their customers. The trustee challenged the withdrawal payments made to the feeder funds, as well as the subsequent payments to the feeder funds’ customers and their transferees. The Court held that allowing the trustee to rely on section 550(a)(2) of the Bankruptcy Code would constitute an extraterritorial application of the provision and that that was not intended by the U.S. Congress. The Court further concluded that even if the section could be applied extraterritorially, such application in the Madoff Securities case would be precluded by considerations of international comity.

Summary of Decision

Section 550(a)(1) of the Bankruptcy Code provides that a trustee may seek to recover a preference, fraudulent transfer or other voidable transfer from a debtor to an “initial transferee.” Section 550(a)(2) provides further that a trustee may seek to recover that same transfer from “any immediate or mediate transfer of such initial transferee.” The trustee charged with marshaling the assets of defunct Madoff Securities brought actions in the Southern District of New York seeking to recover funds that were allegedly fraudulently conveyed from Madoff Securities to certain “feeder funds.”
The Court first determined that the trustee’s proposed use of section 550(a)(2) would constitute an extraterritorial application of the statute since the subsequent transfers the trustee sought to recover were foreign transfers between non-U.S. feeder funds and their non-U.S. clients. For such application to be permissible, under long-standing principles of U.S. law a court must determine that Congress intended to displace the presumption against the extraterritorial application of domestic legislation. The Court concluded that nothing in the language of section 550(a) suggests that Congress intended that section to apply to foreign transfers. The Court also rejected the trustee’s argument that the expansive definition of “property of the estate” under section 541(a) of the Bankruptcy Code (which defines property of the estate to include property “wherever located and by whomever held”) evidenced congressional intent that section 550 has extraterritorial effect. The Court found this argument to be novel, but irrelevant as under well-settled case authority preferential or fraudulent transfers from a U.S. debtor do not become property of the debtor’s estate until such transfers are actually recovered by a trustee.
While the Court considered its analysis with respect to the impermissibility of extraterritorial application of section 550(a)(2) to be dispositive, it observed that even if the presumption against extraterritoriality was successfully rebutted, the trustee’s use of the statute would be precluded by concerns of international comity and deference to foreign judicial proceedings. The Court noted that many of the Madoff feeder funds are themselves subject to their own liquidation proceedings in their home jurisdictions, which proceedings impose their own rules with respect to how and when fund transfers may be avoided. The Court expressed the concern that if it were to adopt the trustee’s reasoning there was a high likelihood of conflict with foreign law and judicial rulings—indeed the Court noted that the courts in the British Virgin Islands overseeing the liquidation of certain Madoff feeder funds incorporated there had already rendered decisions concluding that transfers from BVI feeder funds to their customers could not be reclaimed under applicable BVI law. The Court therefore concluded that adopting the trustee’s reading of section 550(a)(2) would amount to condoning an end-run around the foreign liquidations, a result that long-established principles of international comity would not permit.
The Court drew support for its conclusion that section 550(a)(2) does not apply extraterritorially from the analysis found in the District Court’s earlier decision in In re Maxwell Communication Corporation PLC (Maxwell I).² In Maxwell I, the District Court held that section 547 of the US Bankruptcy Code, which provides a trustee with authority to avoid certain preferential transfers, did not apply extraterritorially. On appeal, the Second Circuit declined to adopt the District Court’s reasoning in Maxwell I with respect to extraterritoriality, but affirmed on what had been an alternative basis for the District Court’s decision that applying the preference statute extraterritorially on the facts of the Maxwell case would have contravened principles of comity.³


It remains unclear at this time if the trustee will seek leave to take an interlocutory appeal of the District Court’s decision under 28 U.S.C. 1229(b). The trustee has previously attempted to bring such interlocutory appeals of adverse decisions issued by the lower courts, thus far unsuccessfully. For now, foreign creditors and investors have another barrier limiting their exposure to U.S. bankruptcy avoiding powers. The Court’s approach in the Madoff Securities case also represents a notable extension of the logic of the District Court’s decision in Maxwell I to section 550(a)(2) of the Bankruptcy Code. There has been a relative dearth of case law on this issue since Maxwell I, and the Court's decision reinforces the position set out in that case that a trustee's avoidance and recovery powers are limited in important respects by the presumtion against extraterritorial application of domestic legislation.
1 Securities Investor Protection Corporation v. Bernard L. Madoff Investment Securities LLC (In re Madoff Securities), 12-00115(JSR) [Opinion and Order; Dkt. No. 551] (S.D.N.Y. July 7, 2007).
² 186 B.R. 807 (S.D.N.Y. 1995).
³ In re Maxwell Commc’n Corp., 93 F.3d 1036 (2d Cir. 1996).

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