A foreign company makes a foreign distribution to foreign shareholders shortly before merging with a U.S. company in a highly-leveraged LBO. The resulting company files a chapter 11 petition in the United States Bankruptcy Court for the Southern District of New York 13 months later. Can the foreign transfer be avoided as a fraudulent conveyance under section 548 of the Bankruptcy Code? Previously, the answer was almost certainly not (at least in the Southern District of New York). Now, after a decision in In re Lyondell Chemical Company, the answer is – it depends on which judge you ask. Avoidance actions are among the primary protections of creditors. Because it is not uncommon for foreign jurisdiction to have different avoidance laws (or similar laws with different substantive standards), this choice of law and jurisdictional issue can drive litigation outcomes and shift significant value between a debtor’s creditors and the transferees of the extraterritorial transfer. So let’s take a closer look and see when U.S. law will be applied.
The background facts in Lyondell are straightforward and parallel the hypothetical at the outset of this blog entry, and on those facts the bankruptcy court (Judge Gerber) held that extraterritorial transactions can be subject to avoidance as fraudulent transfers under section 548 of the Bankruptcy Code. In so holding, the court parted with precedent decisions in Southern District of New York from two district court judges (Rakoff and Scheindlin) and another bankruptcy judge (Brozman). In those cases, the courts had held that, given a lack of clear Congressional intent to the contrary, avoidance and collection provisions of the Bankruptcy Code (specifically, sections 547 and 550) only applied to domestic transactions. In ruling otherwise, the Lyondellcourt reminds readers that at least in some jurisdictions, bankruptcy judges are not bound by decisions reached on appeal to the district court. For that same reason, the law on this topic in the Southern District of New York will remain unsettled.
Although a different conclusion was reached, the Lyondell court applied the same analytical framework used by prior courts in its district. This analysis was premised on a judicially-created canon used to interpret the reach of statutes, the long-accepted presumption against extraterritoriality.
The first analytical step is to determine whether a transaction is “extraterritorial” – if not, then the Bankruptcy Code provisions apply. This involves an inquiry into the geographical “center of gravity” of a transaction, which will be determined by all of its components, including participants, acts, targets, and effects. If the gravitational center falls outside of the United States, the transaction is extraterritorial. Obviously, this is not an exercise in Newtonian physics but a looser and more subjective analysis – cases provide data points and outcomes are more predictable on the fringes, but there is a substantial gray area.
Assuming a transaction is extraterritorial, the presumption against extraterritoriality kicks in and, unless it is overcome, the extraterritorial transaction cannot be avoided under the Bankruptcy Code. Briefly stated, under this canon, courts will presume that a law only applies domestically unless, after inquiring into Congressional intent, they determine that Congress intended the relevant statute to apply extraterritorially. This is a strictly legal conclusion regarding the intended reach of a law; it theoretically should not vary from case to case if the same statute is being considered. Yet, this step is also where the Lyondell court came down differently than others, holding that– for section 548 – the presumption was overcome and foreign fraudulent transfers could be avoided. Notably, though various judges reached opposite conclusions, all were carefully-reasoned and were of equal stature in terms of precedential effect. (For readers that are interested, the different conclusions depended, in part, on the how the definition of “property of the estate” – which includes property the world-over and is clearly extraterritorial in reach – was read against provisions for bringing property into the estate through avoidance actions).
Judicial disagreement is not a unique circumstance, and is in fact one that frequently gives rise to topics for this blog. But there are important implications when differing opinions on a question of law come to a head within the same jurisdiction. Analytically, for the issue at hand, there is now one more branch in the probability tree (i.e., which theoretical camp a judge will join) plus additional considerations if the Lyondell holding is adopted and the Bankruptcy Code’s avoidance provisions are given extraterritorial reach. Even if the law does apply extraterritorially, readers should note that its application may be tempered, for example by principles of international “comity” under which a court will recognize and defer to the laws of another nation (a topic beyond the scope of this blog post).
The Lyondell decision opens an issue that is sure to rear its head in the future and creates an important consideration for a variety of players in international cases and transactions, including debtors choosing a forum, sponsors structuring an acquisition or harvest, investors looking for a legal trade, and lenders considering the risks of a credit.