On November 22, Judge Stuart Bernstein of the United States Bankruptcy Court for the Southern District of New York dismissed a series of claims brought by the bankruptcy trustee (Trustee) responsible for liquidating Bernard L. Madoff Investment Securities LLC (BLMIS), which sought to claw back and recover over $4 billion in transfers made by certain nonU.S. hedge funds to their non-U.S. investors.
The decision arose out of the now infamous Madoff Ponzi scheme. Seeking to bolster recoveries for Madoff’s defrauded investors, the Trustee sued dozens of foreign financial institutions and investment funds (Subsequent Transferees) which had invested in a number of off-shore investment funds (Initial Transferees) set up to funnel investments to BLMIS. The Trustee argued that, because certain transfers from the Initial Transferees to the Subsequent Transferees (for example, redemptions of their shareholdings in the Initial Transferees) had allegedly originated with BLMIS, they were recoverable by the BLMIS estate under Section 550 of the U.S. Bankruptcy Code. The Trustee had separately brought avoidance claims against the Initial Transferees.
The Court dismissed most of the Trustee’s claims, finding that they were barred by the doctrine of international comity. Specifically, the Court held that, because the Initial Transferees were subject to their own liquidation proceedings in their home jurisdictions, and the Initial Transferees’ liquidators had brought similar claims against the Subsequent Transferees in those proceedings, permitting the Trustee’s claims to proceed would interfere with the Initial Transferees’ insolvency proceedings.
The Court also found that the presumption against extraterritorial application of U.S. law barred clawback claims seeking recovery of foreign transactions—in other words, cases where the transfers were made from a foreign entity using a foreign bank account1 to a foreign entity using a foreign bank account. The Court held that the use of a correspondent bank account was not sufficient to make a transaction “domestic”.
The Court dismissed the majority of the Trustee’s attempted clawback claims on the ground of international comity. In so doing, Judge Bernstein drew a distinction between the doctrines of “comity among courts” in which a U.S. court declines jurisdiction on the basis that a parallel proceeding is pending in a foreign court, and “comity among nations” in which a U.S. court exercises its discretion to abstain from hearing a case because a foreign jurisdiction has a greater interest in applying its law to the dispute than the United States does.
The Court held that abstention on comity grounds was appropriate in this case because the three primary Initial Transferees—Fairfield Sentry, Kingate, and Harley—were each based outside the United States (in the British Virgin Islands, Bermuda, and Cayman Islands, respectively) and all were subject to liquidation proceedings in their home jurisdictions. The Court further found that the Initial Transferees could have (and that some had) brought claims similar to the Trustee’s, seeking to claw back investment redemption payments from the Initial Transferees to the Subsequent Transferees. Judge Bernstein also noted that courts in the BVI, Bermuda, and Cayman Islands had all asserted jurisdiction over their respective Initial Transferees and determined that their own law governed the transfers and any clawback claims arising therefrom.
On this basis, Judge Bernstein held that the Initial Transferees’ jurisdiction in which these entities had been organized had a stronger interest in addressing issues surrounding the relationship between these funds and their investors (i.e., the Subsequent Transferees), including whether transfers to the Subsequent Transferees could be clawed back. He therefore dismissed all of the claims relating to transfers from feeder funds which were the subject of foreign liquidation proceedings, including all claims against investors in Fairfield Sentry, Kingate and Harley.
The Court dismissed most of the Trustee’s few remaining claims on the basis that they were barred by the presumption against extraterritoriality—a canon of statutory construction which dictates that, absent legislative intent (which can be expressed explicitly or implicitly), U.S. law does not apply to conduct occurring outside the United States. In so doing, the Court applied Judge Rakoff’s previous ruling that the Bankruptcy Code’s avoidance and recovery provisions are not applicable to “foreign” transfers.
The Trustee argued that the Court should review a series of nineteen factors associated with each transaction in order to determine whether it was foreign or domestic. These included choice of law provisions in contracts, the knowledge or intentions of the Subsequent Transferees regarding the ultimate destination of their funds, and the availability of personal jurisdiction over the Subsequent Transferees in the United States. The defendants countered that only the place of organization of the transferee and transferor should be considered.
Judge Bernstein dismissed many of the Trustee’s factors as “patently irrelevant” to the location of the transfers, holding that there were “only four possibly relevant facts to consider in determining whether the Trustee has rebutted the presumption against extraterritoriality: (i) the location of the account from which the transfer was made, (ii) the location of the account to which the transfer was made, (iii) the location or residence of the subsequent transferor and (iv) the location or residence of the Subsequent Transferee”. A transfer by a U.S. resident from a U.S. bank account, for example, would be deemed a domestic transfer even if made to a foreign account. A transfer from a foreign resident using a foreign bank account to another foreign resident using a foreign bank account, on the other hand (even if made through a correspondent account in the United States, as decided by Judge Rakoff), would be foreign.
As a result of this holding, if the Trustee failed to allege one of these four “relevant facts” with respect to any given claim, that transfer would be deemed foreign, and therefore the Trustee’s attempt to recover it would be dismissed. Judge Bernstein addressed each of the claims in turn to determine whether the Trustee had made the requisite allegations. In most cases, he found that the Trustee had failed to do so, and dismissed the claims with prejudice. However, in a small number of cases, he held that further factual development would be necessary, and that dismissal was therefore not appropriate (for example, because it was not clear on the record whether an account in question was a correspondent account or a standard account).
While the Trustee is sure to appeal the Bankruptcy Court’s decision the decision nevertheless provides important guidance as to how U.S. courts will analyze attempts to claw back transfers made outside of the United States.
As a threshold matter, non-U.S. entities considering a Chapter 11 filing should understand that their ability to claw back prebankruptcy transfers—whether under preference, fraudulent conveyance, or subsequent transferee theories—may now be limited by the Court’s extraterritoriality analysis.
On the other hand, defendants from whom the debtor seeks to claw back foreign transfers will be able to rely on this decision to argue that such claims must fail as a matter of law.
Time will tell whether the Court’s standard for what constitutes a “foreign,” as opposed to a “domestic,” transfer will be accepted by other courts.