In a world of free-ranging capital and cross-border transactions, the question of whether US courts will apply US law to transactions taking place in other countries is important. It is therefore a matter of both interest and concern that judges in the Southern District of New York have reached opposite conclusions when asked to give extraterritorial effect to the avoidance or 'clawback' provisions of the Bankruptcy Code.
Canon of statutory construction
US courts presume that Congress does not ordinarily make laws that reach beyond the nation's borders, even though it has the power to do so. This presumption gives rise to a seemingly simple canon of statutory construction: "When a statute gives no clear indication of an extraterritorial application, it has none."(1)
To bring this canon to bear, a court first determines whether applying the statute in question would entail extraterritorial effects. If it would, the court examines the language of that statute to discern whether it clearly evinces that Congress intended such effects. This does not mean that the statute itself must explicitly announce such an intent; the canon is not a 'clear statement rule'. Rather, if the language of the statute is inconclusive, the court looks to its context – including its broader statutory scheme – to discern the legislative intent.(2)
Bankruptcy Code clawback statutes in context
Sections 544(b) and 548(a) of the Bankruptcy Code empower bankruptcy trustees to avoid fraudulent transfers of a debtor's interests in property.(3) When such a transaction is avoided, Section 550(a) authorises the recovery of either the property transferred or its value, for the benefit of the bankruptcy estate. The persons liable for the recovery include the initial transferee or beneficiaries of the transfer, and any subsequent or "immediate or mediate transferee of such initial transferee". A good-faith defence is available to such subsequent transferees in the chain: the trustee cannot recover from them transfers it received for value, in good faith and without knowledge of the voidability of the underlying transfer.(4)
By their express terms, Sections 544(a) and 548(b) reach "any transfer" that satisfies their respective elements, but neither statute uses any geographical terms or refers specifically to territorial scope. Section 550(a) applies to the property transferred in an avoided transaction, without referring to the location of the property before or after the transfer.
Since these provisions fall short of any clear indication that extraterritorial effect is intended, it is necessary to consider whether their context and related Bankruptcy Code provisions give such an indication. The code provides for the administration of property that ought to be responsible for the debtor's obligations, so as to maximise the distributions to creditors while affording the honest debtor an opportunity to be discharged. The clawback provisions exist to gather into the estate assets that, under recognised legal standards, should be made available to fund distributions to creditors, even though they were divested by the debtor before bankruptcy.
In Lyondell the bankruptcy court applied the canon of construction and ruled that Section 548(a) of the Bankruptcy Code could reach transfers that had taken place in Europe in the run-up to a leveraged buy-out, which had left the debtor in a US reorganisation case deeply insolvent.(5) The court therefore denied the defendants' motions to dismiss the clawback claims alleged against them.
The court recognised that "[t]he text of section 548 does not contain any express language or indication that Congress intended the statute to apply extraterritorially",(6) and addressed the question of legislative intent with reference to the broader scheme of the Bankruptcy Code, noting as follows:
- A bankruptcy court "has in rem jurisdiction over all of a debtor's property, whether foreign or domestic".
- Section 541 provides that the debtor's estate encompasses certain property "wherever located and by whomever held" (Congress included this phrase in the bankruptcy law in 1952 to clarify that "a trustee in bankruptcy is vested with the title of the bankrupt in property which is located without, as well as within, the United States").
- Section 548 provides that a trustee may avoid any fraudulent transfer "of an interest of the debtor in property" that occurred no more than two years before the filing of the bankruptcy petition.
- Section 550 authorises a trustee to "recover transferred property for the benefit of the estate to the extent that a transfer is avoided, inter alia, as fraudulent under either section 544 or section 548".
- Section 541 specifies that the debtor's estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case" and "[a]ny interest in property that the trustee recovers under section… 550".(7)
In deference to precedent set in a different context, the Lyondell court assumed that fraudulently conveyed property must be recovered before it is considered property of the estate.(8) But the court viewed this mere "matter of timing" in the light of Congress's explicit recognition in Section 541 that the estate may be augmented during the bankruptcy by the recovery of fraudulently conveyed property through Section 550. The court concluded that:
"[i]t would be inconsistent (such that Congress could not have intended) that property located anywhere in the world could be property of the estate once recovered under section 550, but that a trustee could not avoid the fraudulent transfer and recover that property if the center of gravity of the fraudulent transfer were outside of the United States."(9)
Handed down in January 2016, the Lyondell ruling was written against the backdrop of a split of authority in other districts(10) and the following two prior decisions in the Lyondell court's district:
- A 2012 decision by another bankruptcy judge in an adversary proceeding related to the Madoff bankruptcy; and
- A 2014 decision by the district court in a consolidation of many other adversary proceedings brought by the Madoff trustee.(11)
Lyondell aligns with the first of these Madoff rulings, but runs counter to the second.
The court in Madoff II addressed offshore feeder funds that collected money from both European and non-European customers, and pooled those funds for investment with Madoff Securities. Over time, the feeder funds withdrew proceeds from these investments and disposed of them in various ways, including the payment of investment returns to customers. When Madoff Securities collapsed, many of the feeder funds entered liquidation proceedings in their home countries. The trustee of Madoff Securities then sought to recover both the allegedly fraudulent transfers made by that debtor to the feeder funds and the funds' subsequent re-transfers of the proceeds to their customers and managers. The legal question was whether the Bankruptcy Code's recovery provision (Section 550(a)) could reach those subsequent re-transfers abroad.
The district court ruled that the presumption against extraterritoriality was not rebutted, and dismissed the trustee's Section 550(a) claims as to foreign transfers. The trustee argued that, taken together, the structure and language of relevant Bankruptcy Code provisions show that Congress intended the clawback powers to apply on an extraterritorial basis; they effectively incorporate into Sections 548 and 550 the 'wherever located' standard by which Section 541 delineates the property interests that make up the bankruptcy estate.
Although the same argument had prevailed in Madoff I, and would later hold sway in Lyondell, the district court rejected it in Madoff II. The court in Madoff II reasoned that the 'wherever located' phrase of Section 541 applies to transferred property only after the transfer has been set aside, and therefore has no bearing on whether the Bankruptcy Code permits avoidance and recovery of the transfer to begin with. Indeed, the ruling in Madoff II suggests that the significance of Section 541's 'wherever located' phrase lies chiefly in the absence of any similar language in the clawback provisions.(12)
Beyond such formal reasoning, the district court was influenced by concerns about overreaching on the part of the trustee. The court found it "disingenuous" that the trustee would attempt to subject "indirect customers" of Madoff Securities to avoidance powers that exist for the equitable distribution of a debtor's assets to its creditors, when he had insisted that, for other purposes, they were not creditors of Madoff Securities at all, but only of the feeder funds.(13) Driving home considerations about foreign rights and foreign proceedings, the court ruled – as an alternative holding – that "the Trustee's use of section 550(a) to reach these foreign transfers would be precluded by concerns of international comity".(14)
As the court acknowledged, the doctrine of international comity is a separate and distinct matter from the presumption against extraterritorial application of a statute and can be "especially important in the context of the Bankruptcy Code".(15) For a court to give effect to international comity is to defer within its own territory to the legislative, judicial or executive acts of another nation, based on a choice of law analysis that compares the interests of the countries involved.(16)
Many of the feeder funds implicated in Madoff II were involved in liquidation proceedings in their home jurisdictions, where tribunals applied their own law to determine whether these funds had the right to claw back funds from their direct transferees. The district court noted, for example, that courts in the British Virgin Islands had already rejected efforts by a fund to reclaim transfers from its customers. The trustee's pursuit of those same transferees, by characterising their receipts from the feeder funds as re-transfers of proceeds stemming from Madoff Securities, threatened to subject those persons to inconsistent obligations and defeat their reasonable expectations. The court deemed it inappropriate for the trustee to "reach around such foreign liquidations" to recover funds from remote persons who lacked any direct relationship with Madoff Securities, when their own jurisdictions had a greater interest in regulating their transactions.
The 'clear indication' test for overcoming the presumption against extraterritoriality is itself less than clear when applied to the Bankruptcy Code's provisions for avoiding and recovering fraudulent transfers.
Lyondell offers strong reasoning for courts to give extraterritorial effect to those provisions:
- Bankruptcy jurisdiction exists to enable the centralised administration of an estate consisting of all interests of the debtor in property "wherever located", including assets situated outside the United States.
- Such estates are to be augmented by recovery of voidable transfers.
- Reading the Bankruptcy Code's clawback provisions as stopping short of transfers that occurred in other countries seriously undermines the bankruptcy court's ability to exercise its jurisdiction vigorously and effectively.
By comparison, it is formalistic and misguided to allow the extraterritoriality question to turn on the difference that Section 541 draws (in defining the bankruptcy estate) between property that the debtor holds at the outset of the bankruptcy and property that would be in the estate if the debtor had not transferred it away before bankruptcy. The intent of Congress can be more reliably discerned if the clawback provisions are read with an emphasis on their essential purposes and not on technicalities.(17) The fact that a transfer in fraud of creditors has yet to be avoided does not indicate whether Congress did or did not intend the clawback powers to apply if the transfer took place outside the United States.
There is still the potential for mischief, including conflicts between US and non-US legal systems and the disruption of settled expectations under foreign law. In Madoff II the district court confronted overreaching on the part of the trustee. But rules circumscribing personal jurisdiction, the selection of the forum and choice of law, as well as the requirement that plaintiffs must plead fraud claims with particularity, may be invoked in cases where applying the Bankruptcy Code's clawback provisions to foreign transactions would entail abuse.
Moreover, to the extent that a person situated outside the United States is neither the initial recipient nor the beneficiary of a challenged transfer from the debtor, the remoteness of that person (physically or otherwise) from the underlying alleged fraud may bolster the defence of good faith as a factual matter. Most important, as Madoff II highlights, courts can resort to the doctrine of international comity to trump otherwise applicable Bankruptcy Code provisions where foreign law and proceedings in other countries should hold sway.
The presumption against extraterritoriality "applies regardless of whether there is a risk of conflict between the American statute and a foreign law".(18) Where that presumption gives way because a statute – read in context – expresses Congress's intention for the statute to have extraterritorial effect, it is not for the courts to substitute their own contrary policy preferences. Judges have other effective tools for protecting the fairness and integrity of judicial processes while preventing unnecessary conflicts with the legal systems of other countries.
For further information on this topic please contact Trevor Swett at Caplin & Drysdale by telephone (+1 202 862 5000) or email (firstname.lastname@example.org). The Caplin Drysdale website can be accessed at www.capdale.com.
(7) Id at 151-52 and 105. See 28 USC Section 1334 (defining the scope of bankruptcy jurisdiction); USC Section 541(a) (1), (3) (delineating the composition of a bankruptcy estate, including recoveries by the trustee); id Sections 544(b), 548(a) and 550(a) (bankruptcy clawback provisions). See also Hong Kong & Shanghai Banking Corp, Ltd v Simon (In re Simon), 153 F3d 991, 996 (9th Cir 1998) (discussing in rem bankruptcy jurisdiction); French v Liebmann (In re French), 440 F3d 145, 151 (4th Cir 2006) (discussing section 541 as indicative of extraterritorial application of clawback provisions); HR Rep 82-2320, at 15 (1952), as reprinted in 1952 USCCAN 1960, 1976 (origins of the 'wherever located and by whomever held' phrase now codified in Section 541(a)).
(10) Compare French v Liebmann (In re French), 440 F3d 145, 151 (4th Cir 2006) (followed in Lyondell), with Barclay v Swiss Fin Corp Ltd (In re Bankr Estate of Midland Euro Exch Inc), 347 BR 708, 717 (Bankr CD Cal 2006) (criticised in Lyondell).
(11) In re Sec Inv'r Prot Corp v Bernard L Madoff Inv Sec LLC (In re Bernard L Madoff), 480 BR 501, 5228 (Bankr SDNY 2012) ('Madoff I'); Sec Inv'r Prot Corp v Bernard L Madoff Inv Sec LLC (In re Madoff Sec), 513 BR 222 (SDNY 2014) ('Madoff II'), supplemented, 12-MC-115, 2014 WL 3778155 (SDNY July 28 2014).
(12) Madoff II, 513 BR at 229-30. Under essentially the same analysis, the court in Madoff II found no indication of extraterritorial intent in relevant provisions of the Securities Investor Protection Act of 1970, 15 USC Sections 78aaa-lll (West), which incorporates Bankruptcy Code clawback provisions for the protection of customer funds.
(17) Id at 58. See Begier v IRS, 496 US 53, 59 (1990). There, in construing section 547(b) of the Bankruptcy Code, which authorises the trustee to set aside preferential transfers, the Supreme Court stated:
"Because the purpose of the avoidance provision is to preserve the property includable within the bankruptcy estate – the property available for distribution to creditors – "property of the debtor" is best understood as that property that would have been part of the estate had it not been transferred before the commencement of bankruptcy proceedings."
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