February 28, 2019

Second Circuit in Madoff Enables Trustee To Recover Under Bankruptcy Code For Fraudulent Transfers Initially Sent Offshore from the U.S.

Authored by Eric (Rick) Rein

 in International Asset Recovery

On February 25, 2019, the Second Circuit in the Madoff liquidation decided that Sections 548 and 550 of the Bankruptcy Code can be applied extraterritorially to recover fraudulent transfers. There, offshore feeder funds were recipients of investors' fraudulent transfers and contended that U.S. fraudulent transfer law did not apply abroad.

The Second Circuit reasoned that Section 548 allows a trustee, for the protection of an estate and its creditors, to avoid a debtor's fraudulent, hindersome or delay-causing property transfer that depletes the estate. Section 550 works in tandem with Section 548 by enabling a trustee to recover fraudulently transferred property. In essence, Section 550 is a "utility provision", helping the policy of section 548 to trace the fraudulent transfer to its ultimate resting place. Thus, it is the initial transfer that depletes the estate and must be avoided. Since the debtor's initial fraudulent transfer of Madoff Securities took place in the United States, it is a domestic activity for purposes of Sections 548 and 550, regardless of where any initial or subsequent transferee is located. Hence, "the relevant conduct … is the debtor's fraudulent transfer of property, not the transferee's receipt  of property." The presumption against extraterritoriality did not bar the lawsuits.

The Second Circuit further dealt with international comity as grounds for dismissal. Comity is relevant where there is a "true conflict" between American law and that of a foreign jurisdiction. The court noted that the United States "has a compelling interest in allowing domestic estates to recover fraudulently transferred property." The court held that the United States' interest in applying its laws in these disputes outweighs the interest of any foreign jurisdiction. "Prescriptive comity" (shortening the reach of a statute) poses no bar to recovery when a trustee of a domestic debtor uses Section 550 to recover property from a foreign subsequent transferee on the theory that the debtor's initial transfer of property from within the United States is avoidable under Section 548 (a) (1) (A), even if the initial transferee is in liquidation in a foreign nation." The court concluded that the feeder funds should have expected U.S. law to apply. "When these investors chose to buy into feeder funds that placed all or substantially all of their assets with Madoff Securities, they knew where their money was going."

The conclusion on extraterritoriality was based on a) the Madoff firm was a domestic entity and b) the fraud occurred when Madoff transferred funds from a U.S. bank account. The question remains whether a trustee of a domestic debtor can pursue a fraudulent transfer made from an offshore bank account. Nonetheless, the significance of this decision is that the presumption against extraterritoriality is not a bar where a fraudulent transfer is initiated from the United States.

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