Ponzi Scheme Trustee’s Claws Do Not Always Reach Overseas

 Bankruptcy trustees often sue to avoid and recover fraudulent transfers pursuant to the provisions of the Bankruptcy Code. These are often referred to as “clawback” actions. Transfers of property of a debtor may be avoided pursuant to section 548 and may be recovered from the initial transferee pursuant to section 550(a)(1) or from subsequent transferees pursuant to section 550(a)(2).

In the Bernard Madoff Ponzi scheme case, the Trustee sued overseas feeder funds that had withdrawn funds from the Madoff scheme (the initial transferees). The Trustee also sued the customers and managers of the feeder funds who were transferred funds from those feeder funds (the subsequent transferees). At first glance, the Trustee’s claims appear to be consistent with the provisions of the Bankruptcy Code.

A district court recently held, however, that the Trustee may not sue to recover from the subsequent transferees. In an opinion dated July 7, 2014 (attached here), the court held that section 550(a) does not permit “the recovery of subsequent transfers received abroad by a foreign transferee from a foreign transferor.” The stated:

The Court concludes that (1) the application of section 550(a)(2) here would constitute an extraterritorial application of the statute, and (2) Congress did not clearly intend such an application. Moreover, given the factual circumstances at issue in these cases, even if section 550(a)(2) could be applied extraterritorially, such an application would be precluded here by considerations of international comity.

The court evaluated whether the presumption against extraterritoriality should apply and, if so, “whether Congress intended for the statute to apply extraterritorially.” It considered, among other things, the following:

[T]he 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.

[T]he relevant transfers and transferees are predominantly foreign: foreign feeder funds transferring assets abroad to their foreign customers and other foreign transferees.

Although the chain of transfers originated with Madoff Securities in New York, that fact is insufficient to make the recovery of these otherwise thoroughly foreign subsequent transfers into a domestic application of section 550(a).

[A] mere connection to a U.S. debtor, be it tangential or remote, is insufficient on its own to make every application of the Bankruptcy Code domestic.

The Trustee is seeking to use SIPA to reach around such foreign liquidations in order to make claims to assets on behalf of the SIPA customer-property estate — a specialized estate created solely by a U.S. statute, with which the defendants here have no direct relationship. Without any agreement to the contrary (which the Trustee does not suggest exists), investors in these foreign funds had no reason to expect that U.S. law would apply to their relationships with the feeder funds.

The holding of the case appears limited to the use of “section 550(a) to pursue recovery of purely foreign subsequent transfers.”    

The court did, however acknowledge the Trustee’s policy concern that if section 550(a) does not apply extraterritorially, this “would allow a U.S. debtor to fraudulently transfer all of his assets offshore and then retransfer those assets to avoid the reach of U.S. bankruptcy law.” This does seem to be a disturbing prospect. Yet, the court dismissed the argument, stating that, “the desire to avoid such loopholes in the law ‘must be balanced against the presumption against extraterritoriality, which serves to protect against unintended clashes between our laws and those of other nations which could result in international discord.’”

The court’s solution to this potential intentional fraud problem may be a boon for lawyers in foreign jurisdictions. The court stated, “Assuming that any such intentional fraud occurred, the Trustee here may be able to utilize the laws of the countries where such transfers occurred to avoid such an evasion while at the same time avoiding international discord.” However, a few paragraphs later, the court noted that, for example, BVI courts have prohibited recovery by a feeder fund from its customers under certain common law theories – “a determination in conflict with what the Trustee seeks to accomplish here.” In other words, a trustee can use the laws in foreign jurisdictions to combat actual fraudulent transfers, but may not do so if the laws in those other jurisdictions prohibit such actions.

The consequences of the decision, particularly if upheld by the Second Circuit or ultimately the Supreme Court, will be the increased use of laws and lawyers in foreign jurisdictions to pursue recovery of transfers that took place overseas. Organizations such as the International Chamber of Commerce’s FraudNet (http://www.icc-ccs.org/home/fraudnet), of which the author is a member, are great resources to locate asset recovery specialists in jurisdictions across the globe.

 Read additional articles at The Ponzi Scheme Blog

Kathy Bazoian Phelps is the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes  (LexisNexis 2012), along with Hon. Steven Rhodes.  The Ponzi Book, recently reviewed by the ABI Journal and Commercial Crime International, is available for purchase at www.lexisnexis.com/ponzibook, and more information about the book can be found at www.theponzibook.com

Kathy is also the author of is Ponzi-Proof Your Investments: An Investor’s Guide to Avoiding Ponzi Schemes and Other Fraudulent Scams. For more information, or to purchase the book, click here.

Watch Kathy’s interview on The Not So Legal Show.

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