Extraterritoriality and the Bankruptcy Code: the uncertain reach of US avoiding powers

The world continues to shrink. Whether dealing with large, multinational corporations or smaller national (or even regional) concerns, businesses continue to seek growth and opportunity in the global marketplace. While cross-border deals create unique opportunities for firms, they bring with them unique legal risk. Counterparties in cross-border deals must take special care when dealing with insolvent or struggling companies that could soon seek bankruptcy protection under US law. The US Bankruptcy Code provides trustees and debtors in possession with broad avoiding powers to unwind pre-bankruptcy transactions to recover value for creditors. A given cross-border transaction’s structure could have far-reaching implications in a US bankruptcy proceeding, sometimes even if that transaction was executed outside of US territory.

There is little circuit-level authority addressing the extraterritorial application of the US Bankruptcy Code’s avoiding powers and lower-court decisions have been inconsistent.¹ Recently, however, a handful of decisions from respected judges in the country’s busiest courts have deepened the divide as to the reach of Bankruptcy Code’s avoidance provisions and created a split within the Southern District of New York.

The presumption against extraterritoriality: limiting the reach of US law

Under US law, federal statutes—including the US Bankruptcy Code—are presumed to apply only within US territorial jurisdiction. That convention is formally called the “presumption against extraterritoriality”; a longstanding principle of “American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.” EEOC v. Arabian Am. Oil Co., 499 U.S. 244, 248 (1991). The presumption guards against unintended conflicts between domestic and foreign laws. In Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247 (2010), the Supreme Court clarified the analytical framework for determining whether “the presumption forecloses [a] claim.” To determine whether the presumption against extraterritoriality requires dismissal, courts engage in a two-step inquiry. First, a court determines whether the presumption applies by identifying the conduct regulated by the statue and considering whether that conduct occurred outside the US. Second, if the presumption applies, a court must then examine the statute to determine if Congress intended extraterritorial application of that statute. Congressional intent for extraterritorial application does not require express statutory language; rather, courts can infer meaning from a statute’s legislative purpose or context.

The presumption against extraterritoriality has become increasingly important in bankruptcy-related litigations and, in recent years, has played a prominent role in a number of high-profile cases, beginning with the liquidation of Bernard L. Madoff Investment Securities LLC (“BLMIS”).

Madoff: US avoiding powers do not apply to predominately foreign transfers

In December 2008, BLMIS—the vehicle Bernie Madoff used to perpetrate his multi-billion-dollar Ponzi scheme—collapsed, and a SIPA trustee was appointed to administer the estate for the benefit of BLMIS’s customers, primarily through the pursuit of claw back actions. Among BLMIS’s largest customers were the so-called “feeder funds,” which were foreign investment funds that pooled their customers’ assets for investment (often exclusively) with BLMIS. The trustee sought to recover transfers made by various foreign feeder funds to their own foreign customers pursuant to Bankruptcy Code section 550 (which permits trustees to recover from subsequent transferees). A handful of those defendants filed motions to dismiss on grounds that section 550 does not apply extraterritorially. In July 2014, US District Judge Rakoff issued his decision dismissing the trustee’s section 550(a) claims, finding that the statute cannot reach foreign transfers.² See Sec. Inv’r Protection Corp. v. Bernard L. Madoff Inv. Sec. LLC, 513 B.R. 222 (S.D.N.Y. 2014) (“Madoff I”).

Judge Rakoff’s analysis and holdings were largely consistent with prior caselaw in the Southern District of New York, particularly the seminal bankruptcy court decision regarding the avoiding powers’ extraterritorial application—Maxwell I. Judge Rakoff looked to Maxwell I and focused on the “the location of the transfers as well as the component events of those transactions.” Maxwell I, 186 B.R. at 817. With respect to Congress’s intent, Judge Rakoff found that nothing in the statute’s language “suggest[ed] that Congress intended for this section to apply to foreign transfers.” The trustee argued the global reach of section 541 was incorporated into the Bankruptcy Code’s avoidance provisions, “which [provisions] use the phrase ‘an interest of the debtor in property’ to define the transfers that may be avoided, a phrase that is repeated in section 541 in defining ‘property of the estate.’” Judge Rakoff rejected the argument, stating that “fraudulently transferred property becomes property of the estate only after it has been recovered by the [t]rustee, so section 541 cannot supply any extraterritorial authority that the avoidance and recovery provisions lack on their own.” And while the initial fraudulent transfers (i.e., payments made by BLMIS to feeder funds) were domestic transactions, here, Judge Rakoff observed that the subsequent transfers (i.e., payments made by feeder funds to their customers) were predominately foreign.

Lyondell: congress must have intended that US avoiding powers reach foreign transactions

After Madoff I, Judge Gerber of the US Bankruptcy Court for the Southern District of New York addressed the extraterritorial application of Bankruptcy Code avoiding powers in Weisfelner v. Blavatnik (In re Lyondell Chem. Co.), 543 B.R. 127 (Bankr. S.D.N.Y. 2016) (“Lyondell”). Judge Gerber broke with Maxwell I and its progeny and held that the subject transfer was primarily a foreign transaction that required the extraterritorial application of section 548, and further, that Congress intended that section 548 could be given extraterritorial effect.

Lyondell concerned claims arising out of Basell AF S.C.A.’s purchase of Lyondell Chemical Co. in a multi-billion dollar leveraged buyout and merger. Two weeks before the merger, Basell, a Luxembourg company, distributed $100 million to its shareholders (the “Pre-LBO Payment”), which, allegedly, was capital Basell badly needed. Basell then distributed a portion of those funds to its own shareholders, among them, BI S.à.r.l., another Luxembourg company. Lyondell and certain affiliates were later forced to seek protection under Chapter 11 of the Bankruptcy Code. After Lyondell’s Chapter 11 plan was confirmed, the litigation trustee sued Basell’s shareholders to avoid the Pre-LBO Payment, arguing that it was an avoidable transfer under Bankruptcy Code section 548, and to recover the same under Bankruptcy Code section 550. The shareholders moved to dismiss the complaint arguing that, among other things, the Pre-LBO Payment was an extraterritorial transfer between two Luxembourg entities and therefore, Bankruptcy Code sections 548 and 550 did not apply. The trustee argued that Congress intended that section 548 would apply to certain foreign transfers, but nevertheless, the Pre-LBO Payment was a domestic transfer because its “center of gravity” was in the US.

Judge Gerber first reviewed whether the Pre-LBO Payment was foreign, thus invoking the presumption. As the bankruptcy court noted, the mere fact that both the transferor and transferee were foreign entities did not render the Pre-LBO Payment a foreign transaction. Instead, courts in the Southern District employ the flexible “center of gravity” test to determine whether a transaction is domestic or foreign. See Maxwell I, 186 B.R. 807. Under this test, courts “look at the facts . . . to determine whether they have a center of gravity outside the US,” which may include “consideration of all component events of the transfer, such as whether the participants, acts, targets, and effects involved in the transaction at issue are primarily foreign or primarily domestic.” Judge Gerber found that section 548 focuses on the nature of the transaction in which property is transferred, and in this case, the Pre-LBO Payment’s connections to the U.S. were too minimal to “overcome the [transaction’s] substantially foreign nature.” Therefore, the presumption against extraterritorial effect applied. For the trustee’s avoidance claim to survive there must be clear evidence that Congress intended that section 548 apply to extraterritorial transfers.

Although section 548’s text does not expressly indicate a contrary intent, the bankruptcy court looked to the statute’s context (i.e., other Bankruptcy Code provisions) to rebut the presumption. Citing the Fourth Circuit’s decision in French, Judge Gerber read section 548 in conjunction with section 541 to find clear evidence of congressional intent to apply section 548 to foreign transfers. Parallel language in section 541 (which defines estate property as “all . . . interests of the debtor in property, wherever located”) and section 548 (which permits avoidance of transfers of an “interest of the debtor in property”) demonstrates that section 548 “applies extraterritorially not because it provides for recovery of property that is already property of the estate, but rather, because section 548 provides for the recovery of property that would have been property of the estate . . . but for the fraudulent transfer.” Judge Gerber explained that Congress could not have intended that property anywhere in the world come into the estate once recovered under the Bankruptcy Code, and at the same time, precluded the extraterritorial application of section 548. According to Judge Gerber, this reasoning protects bankruptcy courts’ in rem jurisdiction over assets that Congress declared would become property of the estate when recovered under section 541(a)(3).

In Lyondell, Judge Gerber created a split within the Southern District that mirrors the national trend. In 2017, that chasm grew both within and without the Southern District.

Ampal: deepening the nationwide divide

Months after Judge Bernstein’s Madoff II decision, he again confronted the extraterritorial application of avoidance actions—this time writing on a clean slate—and agreed that the Bankruptcy Code’s “avoidance provisions . . . do not apply extraterritorially.” See In re Ampal-Am. Israel Corp., 562 B.R. 601, 612 (Bankr. S.D.N.Y. 2017) (“Ampal”). In Ampal, the Chapter 7 trustee for Ampal-American Israel Corp., sought to avoid and recover an alleged preferential transfer made by Ampal, a New York company managed by offices in Israel, to law firm Goldfarb Seligman & Co, an Israeli law firm. Shortly before Ampal commenced its US bankruptcy proceedings, it instructed a bank in Tel Aviv, Israel to transfer $89,110.41 from its account to Goldfarb’s account at the same bank. The trustee filed a complaint against Goldfarb asserting claims for the avoidance and recovery of the transfer pursuant to Bankruptcy Code sections 547 and 550. Judge Bernstein held that the trustee’s avoidance claims were barred by the presumption against extraterritoriality.

Judge Bernstein reviewed and analyzed the leading decisions that construed the presumption against extraterritoriality (including Madoff I and Lyondell). Judge Bernstein concluded (i) Congress did not intend that sections 547 and 550 would apply extraterritorially, (ii) the transfer was “foreign” and therefore, (iii) it could not be avoided under the US Bankruptcy Code. Judge Bernstein found that the “only two categories of property mentioned in Bankruptcy Code [section] 541(a)(1)” are “property of the estate” and “property of the debtor” and found that property transferred prepetition to satisfy an antecedent debt is neither. He then reasoned that, under applicable caselaw, the phrases “property of the estate” or “property of the debtor” should be construed as a limitation—not an expansion—on avoiding powers under Bankruptcy Code section 547. Judge Bernstein, contrary to the decision in Lyondell, concluded that section 547’s context and surrounding provisions further demonstrate a lack of congressional intent to apply the statute extraterritorially. Sections 541(a) and 28 U.S.C. § 1334(e)(1), for example, contain clear language commanding extraterritorial application,and section 547 simply does not. Here, the subject transfer was purely foreign as it “occurred in Israel between a US transferor headquartered in Israel and an Israeli transferee accomplished entirely between accounts at the same Tel Aviv bank.”

The Ampal decision seemed to have firmly established Judge Gerber’s Lyondell ruling as a local outlier and nationally, a notable (and arguably, a minority) position. Just a few months later, however, in the collective wake of Madoff and Ampal, the US Bankruptcy Court for the District of Delaware became the latest to grapple with the extraterritorial application of Bankruptcy Code’s avoiding powers, and this time, expressly adopted Judge Gerber’s reasoning and holding in Lyondell that Congress intended that section 548 apply extraterritorially. See In re FAH Liquidating Corp., Case No. 13–13087 (KG) (Bankr. D. Del.).

Conclusion: while uncertainty persists, these divergent views will continue to influence cross-border transactions and the administration of us bankruptcy cases

These decisions make clear that the avoidability of foreign transactions under US law is uncertain and that the extraterritorial application of US avoiding powers is likely to remain hotly disputed for the foreseeable future. This uncertainty is likely to persist without more circuit-level decisions or clear direction from Supreme Court. On September 27, 2017, the US Court of Appeals for the Second Circuit entered an order granting a joint petition by the BLMIS trustee and certain defendants seeking a direct appeal of Judge Bernstein’s Madoff II ruling. These decisions demonstrate the unpredictability in “divining congressional intent” underpinning the Bankruptcy Code’s avoiding powers. Each judge reviewed the same collection of statutes but drew irreconcilably different inferences regarding Congress’s intent from the texts. And courts are no more predictable in considering whether the transfer or transaction was domestic or foreign in nature. As caselaw interpreting the presumption against extraterritoriality continues to develop, the implications for international businesses, foreign investors, and bankruptcy estate representatives could be far reaching.

For example, some have argued that absent the extraterritorial application of the Bankruptcy Code’s avoiding provisions, counterparties could structure deals around offshore transfers that cannot be avoided under US law and later re-transfer those funds to the US. Often, a bankruptcy estate’s most significant assets are litigation claims to unwind or avoid prepetition transactions and transfers; creative structuring like that could affect the value of those claims under US bankruptcy law and ultimately compromise a debtor’s ability to confirm a Chapter 11 plan. Some, including Judge Rakoff, have suggested that these policy arguments are unconvincing and that trustees may be able to use foreign laws “to avoid such an evasion while at the same time avoiding international discord.”³ Indeed, some US bankruptcy courts have shown a willingness to hear foreign law avoidance claims.⁴ Still, there are clear practical limitations to pursuing avoidance claims under foreign law or in foreign courts, many of which would be obviated by a clear rule finding that US avoidance claims apply overseas. Accordingly, practitioners and prospective counterparties alike await any new authority regarding the extraterritorial application of the US Bankruptcy Code’s avoiding powers.

¹ Compare Societe Gen. plc v. Maxwell Commc’n Corp. plc (In re Maxwell Commc’n Corp. plc), 186 B.R. 807, 818-20 (S.D.N.Y. 1995) (“Maxwell I”) (holding that Congress did not clearly express an intent that Bankruptcy Code section 547 (dealing with avoidable preferences) apply to foreign transfers),aff’d on other grounds, Maxwell Commc’n Corp. plc v. Societe Gen. plc (In re Maxwell Commc’n Corp. plc), 93 F.3d 1036, 1054-55 (2d Cir. 1996) (“Maxwell II”) and Barclay v. Swiss Fin. Corp. Ltd. (In re Midland Euro Exch. Inc.), 347 B.R 708 (Bankr. C.D. Cal. 2006) (holding that Congress did not intend that section 548 would apply extraterritorially), with French v. Liebmann (In re French), 440 F.3d 145, 151-52 (4th Cir. 2006) (holding that “Congress made manifest its intent that [Bankruptcy Code section] 548 (dealing with fraudulent transfers) apply to all property that, absent a prepetition transfer, would have been property of the estate, wherever that property is located.”).

² Madoff I includes an important alternative holding dismissing the trustees’ section 550 claims on comity grounds. Many feeder funds were being, or had been, liquidated in foreign insolvency proceedings where the foreign court had determined that, under foreign law, the feeder funds’ liquidators could not recover monies the funds transferred to their customers. According to Judge Rakoff, the BLMIS trustee had only an indirect interest in those transfers, and those foreign jurisdictions had a greater interest in applying their own laws than did the US.  See Madoff I, 513 B.R. at 231-32.

³ Madoff I, 513 B.R. at 231.

⁴ See Hosking v. TPG Capital Mgmt., L.P. (In re Hellas Telecommunications), 535 B.R. 543 (Bankr. S.D.N.Y. 2015) (permitting foreign representatives’ UK avoidance claims to proceed).