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Insolvency Alert >> Recent SDNY Decision Limiting Madoff Trustee’s Ability to Recover Foreign Transfers Comports with Ninth Circuit Decision Allowing Bankruptcy Trustee to Recover Foreign Property

September 3, 2014

On July 7, 2014, Judge Jed S. Rakoff, U.S. District Judge for the Southern District of New York, issued a decision in SIPC v. Bernard L. Madoff Inv. Sec. LLC (Madoff), holding that the trustee (the Madoff Trustee) overseeing the liquidation of Bernard L. Madoff Investment Securities LLC (Madoff Securities) may not use Section 550(a)(2) of the U.S. Bankruptcy Code (the Code) to recover funds transferred between foreign entities because it would constitute an impermissible extraterritorial application of the Code, thus providing some comfort to foreign investors that transfers from foreign entities that emanated from a U.S. debtor may not be clawed back as part of the liquidation of such debtor in U.S. bankruptcy court, even where the debtor engaged in fraudulent activity.

In the same week, the Ninth Circuit issued a decision in In re Icenhower (Icenhower) allowing for extraterritorial application of the Code to recover the transfer of real property located in Mexico.  Because the cases had different outcomes, the question has been raised as to whether the decisions are in conflict.  In fact, the legal reasoning of the decisions is consistent, but led to opposite results based on differences in the facts, as discussed below. 

The Madoff Trustee oversees the liquidation of Madoff Securities pursuant to the Securities Investor Protection Act (SIPA), which incorporates the Code to the extent not inconsistent with SIPA.  Section 550(a)(2) of the Code provides in certain limited circumstances for recovery of a debtor’s fraudulently transferred assets from entities that received them indirectly through intermediary transfers.  The Madoff Trustee has invoked section 550(a)(2) to sue foreign banks and investors who received transfers not from Madoff Securities directly but from foreign so-called feeder funds—investment vehicles that pooled customer assets to invest in Madoff Securities and which made payments from those investments. These foreign subsequent transferees moved to dismiss the Madoff Trustee’s lawsuits on multiple grounds, including that section 550(a)(2) does not apply extraterritorially to permit recovery of funds transferred between foreign entities.  The issue of extraterritorial application of section 550(a)(2) of the Code is governed by the Supreme Court’s 2010 decision in Morrison v. National Australia Bank, in which the Court confirmed the presumption against extraterritorial application of a U.S. statute in the absence of clear Congressional intent.  

Judge Rakoff’s Madoff Decision
As required by Morrison, Judge Rakoff considered two questions in his Madoff decision: 

  1. Whether the facts at issue require an extraterritorial application of section 550(a)(2); and
  2. If so, whether Congress intended for the statute to apply extraterritorially.

In answer to the first question, Judge Rakoff held that “the transaction being regulated by section 550(a)(2) is the transfer of property to a subsequent transferee, not the relationship of that property to a perhaps-distant debtor,” and thus “the court considers the location of the transfers as well as the component events of those transactions” to determine whether they occurred extraterritorially.  Under this standard, where “complaints allege that both the transferor and the transferee reside outside of the United States, there is no plausible inference that the transfer occurred domestically.”

Turning next to the question of whether Congress intended extraterritorial application, Judge Rakoff held that since neither SIPA nor section 550(a)(2) contain the “clear indication” of Congressional intent required under Morrison, the presumption against extraterritoriality applies.  Notably, Judge Rakoff rejected the Madoff Trustee’s argument that the definition of “property of the estate” under section 541(a) of the Code, which includes debtor property “wherever located,” indicates that Congress intended extraterritorial application of a trustee’s ability under section 550(a)(2) to recover “any transfer…of an interest of the debtor in property.”  Judge Rakoff concluded that the definition of “property of the estate” is irrelevant to this inquiry because transferred property would not become “property of the estate” unless and until it is actually recovered by a trustee.

Finally, Judge Rakoff held that even if Congress had intended for extraterritorial application, the use of section 550(a)(2) to reach purely foreign transfers would be precluded by concerns of international comity, because the foreign jurisdictions in which the transfers occurred have a greater interest in applying their own laws than does the United States.

The Ninth Circuit’s Icenhower Decision
In In re Icenhower, the Ninth Circuit upheld a bankruptcy court’s application of section 550(a)(2) to allow the recovery of real property located in Mexico, which had once belonged to the U.S. debtors at issue.  While at first glance this decision appears in conflict with the Madoff decision, the crucial difference between the cases is the ownership of the property at issue at the time of the subsequent transfer.  In Icenhower, prior to filing for bankruptcy, the debtors transferred the property to a domestic shell company they controlled, which then resold the Mexican property to subsequent transferees after the debtors filed for bankruptcy.  The Ninth Circuit held that because the transferor in the subsequent transfer was the debtor’s alter ego and was substantively consolidated with the debtors’ estate, the property at issue was “property of the estate” at the time of the subsequent transfer, and “Congress intended extraterritorial application of the Code as it applies to property of the estate.”  

Accordingly, while Icenhower reflects a specific situation in which a foreign transfer may be recovered, it leaves undisturbed the notion that a bankruptcy trustee’s ability to recover foreign transfers is limited.


The Bottom Line

Although the ultimate results in the Madoff and Icenhower cases were different, the decisions are consistent in that they are both guided in part by whether the property at issue was “property of the estate” at the time of the transfer.