Do Bankruptcy Code clawback provisions reach transactions occurring in other countries?
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.
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In a world of free-ranging capital and cross-border transactions, the question of whether US courtswill apply US law to transactions taking place in other countries is important. It is therefore a matterof both interest and concern that judges in the Southern District of New York have reached oppositeconclusions when asked to give extraterritorial effect to the avoidance or ‘clawback’ provisions of theBankruptcy Code.Canon of statutory constructionUS courts presume that Congress does not ordinarily make laws that reach beyond the nation’sborders, even though it has the power to do so. This presumption gives rise to a seemingly simplecanon of statutory construction: “When a statute gives no clear indication of an extraterritorialapplication, it has none.”(1)To bring this canon to bear, a court first determines whether applying the statute in question wouldentail extraterritorial effects. If it would, the court examines the language of that statute to discernwhether it clearly evinces that Congress intended such effects. This does not mean that the statuteitself must explicitly announce such an intent; the canon is not a ‘clear statement rule’. Rather, if thelanguage of the statute is inconclusive, the court looks to its context – including its broader statutoryscheme – to discern the legislative intent.(2)Bankruptcy Code clawback statutes in contextSections 544(b) and 548(a) of the Bankruptcy Code empower bankruptcy trustees to avoidfraudulent 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 benefitof the bankruptcy estate. The persons liable for the recovery include the initial transferee orbeneficiaries of the transfer, and any subsequent or “immediate or mediate transferee of such initialtransferee”. A good-faith defence is available to such subsequent transferees in the chain: the trusteecannot recover from them transfers it received for value, in good faith and without knowledge of thevoidability of the underlying transfer.(4)By their express terms, Sections 544(a) and 548(b) reach “any transfer” that satisfies their respectiveelements, 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 thelocation of the property before or after the transfer.Since these provisions fall short of any clear indication that extraterritorial effect is intended, it isnecessary to consider whether their context and related Bankruptcy Code provisions give such anindication. The code provides for the administration of property that ought to be responsible for theAUTHORTrevor Swettdebtor’s obligations, so as to maximise the distributions to creditors while affording the honestdebtor an opportunity to be discharged. The clawback provisions exist to gather into the estateassets that, under recognised legal standards, should be made available to fund distributions tocreditors, even though they were divested by the debtor before bankruptcy.LyondellIn Lyondell the bankruptcy court applied the canon of construction and ruled that Section 548(a) ofthe Bankruptcy Code could reach transfers that had taken place in Europe in the run-up to aleveraged buy-out, which had left the debtor in a US reorganisation case deeply insolvent.(5) Thecourt 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 orindication that Congress intended the statute to apply extraterritorially”,(6) and addressed thequestion of legislative intent with reference to the broader scheme of the Bankruptcy Code, noting asfollows:l A bankruptcy court “has in rem jurisdiction over all of a debtor’s property, whether foreign ordomestic”.l Section 541 provides that the debtor’s estate encompasses certain property “wherever locatedand by whomever held” (Congress included this phrase in the bankruptcy law in 1952 to clarifythat “a trustee in bankruptcy is vested with the title of the bankrupt in property which islocated without, as well as within, the United States”).l Section 548 provides that a trustee may avoid any fraudulent transfer “of an interest of thedebtor in property” that occurred no more than two years before the filing of the bankruptcypetition.l Section 550 authorises a trustee to “recover transferred property for the benefit of the estateto the extent that a transfer is avoided, inter alia, as fraudulent under either section 544 orsection 548”.l Section 541 specifies that the debtor’s estate includes “all legal or equitable interests of thedebtor in property as of the commencement of the case” and “[a]ny interest in property thatthe trustee recovers under section… 550”.(7)In deference to precedent set in a different context, the Lyondell court assumed that fraudulentlyconveyed property must be recovered before it is considered property of the estate.(8) But thecourt viewed this mere “matter of timing” in the light of Congress’s explicit recognition in Section 541that the estate may be augmented during the bankruptcy by the recovery of fraudulently conveyedproperty through Section 550. The court concluded that:”[i]t would be inconsistent (such that Congress could not have intended) that propertylocated anywhere in the world could be property of the estate once recovered under section550, but that a trustee could not avoid the fraudulent transfer and recover that property ifthe 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 ofauthority in other districts(10) and the following two prior decisions in the Lyondell court’s district:l A 2012 decision by another bankruptcy judge in an adversary proceeding related to theMadoff bankruptcy; andl A 2014 decision by the district court in a consolidation of many other adversary proceedingsbrought by the Madoff trustee.(11)Lyondell aligns with the first of these Madoff rulings, but runs counter to the second.Madoff IIThe court in Madoff II addressed offshore feeder funds that collected money from both Europeanand non-European customers, and pooled those funds for investment with Madoff Securities. Overtime, the feeder funds withdrew proceeds from these investments and disposed of them in variousways, 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 ofMadoff Securities then sought to recover both the allegedly fraudulent transfers made by that debtorto the feeder funds and the funds’ subsequent re-transfers of the proceeds to their customers andmanagers. 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, anddismissed the trustee’s Section 550(a) claims as to foreign transfers. The trustee argued that, takentogether, the structure and language of relevant Bankruptcy Code provisions show that Congressintended the clawback powers to apply on an extraterritorial basis; they effectively incorporate intoSections 548 and 550 the ‘wherever located’ standard by which Section 541 delineates the propertyinterests that make up the bankruptcy estate.Although the same argument had prevailed in Madoff I, and would later hold sway in Lyondell, thedistrict 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, andtherefore has no bearing on whether the Bankruptcy Code permits avoidance and recovery of thetransfer 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 clawbackprovisions.(12)Beyond such formal reasoning, the district court was influenced by concerns about overreaching onthe 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 equitabledistribution of a debtor’s assets to its creditors, when he had insisted that, for other purposes, theywere not creditors of Madoff Securities at all, but only of the feeder funds.(13) Driving homeconsiderations about foreign rights and foreign proceedings, the court ruled – as an alternativeholding – that “the Trustee’s use of section 550(a) to reach these foreign transfers would be precludedby concerns of international comity”.(14)As the court acknowledged, the doctrine of international comity is a separate and distinct matterfrom the presumption against extraterritorial application of a statute and can be “especiallyimportant in the context of the Bankruptcy Code”.(15) For a court to give effect to internationalcomity is to defer within its own territory to the legislative, judicial or executive acts of anothernation, based on a choice of law analysis that compares the interests of the countries involved.(16)Many of the feeder funds implicated in Madoff I I were involved in liquidation proceedings in theirhome jurisdictions, where tribunals applied their own law to determine whether these funds had theright to claw back funds from their direct transferees. The district court noted, for example, thatcourts in the British Virgin Islands had already rejected efforts by a fund to reclaim transfers from itscustomers. The trustee’s pursuit of those same transferees, by characterising their receipts from thefeeder funds as re-transfers of proceeds stemming from Madoff Securities, threatened to subjectthose persons to inconsistent obligations and defeat their reasonable expectations. The courtdeemed it inappropriate for the trustee to “reach around such foreign liquidations” to recover fundsfrom remote persons who lacked any direct relationship with Madoff Securities, when their ownjurisdictions had a greater interest in regulating their transactions.CommentThe ‘clear indication’ test for overcoming the presumption against extraterritoriality is itself less thanclear when applied to the Bankruptcy Code’s provisions for avoiding and recovering fraudulenttransfers.Lyondell offers strong reasoning for courts to give extraterritorial effect to those provisions:l Bankruptcy jurisdiction exists to enable the centralised administration of an estate consistingof all interests of the debtor in property “wherever located”, including assets situated outsidethe United States.l Such estates are to be augmented by recovery of voidable transfers.l Reading the Bankruptcy Code’s clawback provisions as stopping short of transfers thatoccurred in other countries seriously undermines the bankruptcy court’s ability to exercise itsjurisdiction vigorously and effectively.By comparison, it is formalistic and misguided to allow the extraterritoriality question to turn on thedifference that Section 541 draws (in defining the bankruptcy estate) between property that thedebtor holds at the outset of the bankruptcy and property that would be in the estate if the debtorhad not transferred it away before bankruptcy. The intent of Congress can be more reliably discernedif the clawback provisions are read with an emphasis on their essential purposes and not ontechnicalities.(17) The fact that a transfer in fraud of creditors has yet to be avoided does notindicate whether Congress did or did not intend the clawback powers to apply if the transfer tookplace outside the United States.There is still the potential for mischief, including conflicts between US and non-US legal systems andthe disruption of settled expectations under foreign law. In Madoff II the district court confrontedoverreaching on the part of the trustee. But rules circumscribing personal jurisdiction, the selectionof the forum and choice of law, as well as the requirement that plaintiffs must plead fraud claims withparticularity, may be invoked in cases where applying the Bankruptcy Code’s clawback provisions toforeign transactions would entail abuse.Moreover, to the extent that a person situated outside the United States is neither the initialrecipient 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 afactual matter. Most important, as Madoff II highlights, courts can resort to the doctrine ofinternational comity to trump otherwise applicable Bankruptcy Code provisions where foreign lawand proceedings in other countries should hold sway.The presumption against extraterritoriality “applies regardless of whether there is a risk of conflictbetween the American statute and a foreign law”.(18) Where that presumption gives way because astatute – read in context – expresses Congress’s intention for the statute to have extraterritorialeffect, it is not for the courts to substitute their own contrary policy preferences. Judges have othereffective tools for protecting the fairness and integrity of judicial processes while preventingunnecessary 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 ([email protected]). The Caplin Drysdale website can be accessedat www.capdale.com.Endnotes(1) Morrison v Nat’l Australia Bank Ltd, 561 US 247, 255 (2010).(2) Id at 265 (quoting and taking exception to the concurring opinion in Morrison, 561 US at 278-79;internal quotation marks omitted).(3) 11 USC Sections 544(b) and 548(a).(4) 11 USC Section 550(a), (b).(5) See Weisenfelner v Blavatnik (In re Lyondell Chem Co), 543 BR 127 (Bankr SDNY 2016)(‘Lyondell’).(6) Id at 151.(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 recoveriesby the trustee); id Sections 544(b), 548(a) and 550(a) (bankruptcy clawback provisions). See alsoHong 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 clawbackprovisions); 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)).(8) Lyondell, 543 BR at 152-53 (citing FDIC v Hirsch (In re Colonial Realty Co), 980 F2d 125, 131 (2dCir 1992)); see also Rajala v Gardner, 709 F3d 1031, 1038 (10th Cir 2013).(9) Lyondell, 543 BR at 154-55.(10) Compare French v Liebmann (In re French), 440 F3d 145, 151 (4th Cir 2006) (followed inLyondell), with Barclay v Swiss Fin Corp Ltd (In re Bankr Estate of Midland Euro Exch Inc), 347 BR708, 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 reMadoff 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 foundno indication of extraterritorial intent in relevant provisions of the Securities Investor ProtectionAct of 1970, 15 USC Sections 78aaa-lll (West), which incorporates Bankruptcy Code clawbackprovisions for the protection of customer funds.(13) Id at 231.(14) Id.(15) Id at 231-32 (quoting In re Maxwell Commc’n Corp, 93 F.3d 1036, 1048 (2d Cir 1996)).(16) Id.(17) Id at 58. See Begier v IRS, 496 US 53, 59 (1990). There, in construing section 547(b) of theBankruptcy Code, which authorises the trustee to set aside preferential transfers, the Supreme Courtstated:”Because the purpose of the avoidance provision is to preserve the property includablewithin 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 theestate had it not been transferred before the commencement of bankruptcy proceedings.”(18) Morrison, 561 US at 255.The materials contained on this website are for general information purposes only and are subject to thedisclaimer.