The Restructuring Report

Should the laws of the United States have effect outside of the United States? For that matter, should the laws of other countries have effect outside of their borders, and inside the United States? These are pretty fundamental questions about what should be the world order. A recent decision of the Second Circuit Court of Appeals, a bankruptcy case with a high likelihood of reaching the U.S. Supreme Court, takes on that issue. It is a case to watch.

The case is In re Picard, Trustee for the Liquidation of the Bernard L. Madoff Investment Securities LLC, another case arising from the enormous Madoff Ponzi scheme. In this case, the trustee seeks to recover billions of dollars that were withdrawn from the Madoff entities by foreign investors. It is one thing, for example, to pursue the foreign “feeder funds” such as those in the British Virgin Islands, which invested directly in the Madoff funds located in the United States and then withdrew those funds before the Madoff bankruptcy.  It is another thing to pursue foreign investors who invested in the feeder funds and later withdrew money from those foreign feeder funds. In the latter transactions, both the transferors and transferees are outside of the United States. From one point of view, expecting the law of the U.S. to control a transfer from the foreign feeder fund to an individual foreign investor is a step too far. That was the view of the District Court. But that view has recently been overruled by the Circuit Court.

It takes hubris for a country to declare that its laws apply in other countries and expect them to be enforced, potentially in derogation of the laws of that foreign country. For that reason, Supreme Court authority arising in other bodies of law treads cautiously, holding that absent clearly expressed congressional intent to the contrary, U.S. federal laws will be construed to have only domestic application. Of course, congressional intent on any topic is only rarely clearly expressed.

There are a few cases that have addressed the extraterritorial reach of U.S. bankruptcy laws – not a minor or unimportant question in a world of complex international finance and common international business failure. The Bankruptcy Code provides that the bankruptcy estate is “comprised of all of the following property, wherever located and by whomever held.” In this one area, congressional intent appears to be clear. Also, there is U.S. case law to support the extraterritorial application of U.S. bankruptcy law with respect to the automatic stay and to the discharge injunction, but overall the extent of extraterritorial reach of bankruptcy law is not well mapped out. Most experts have thought that the avoiding powers, including the type of fraudulent transfer litigation involved in the Madoff case, was not included in extraterritorial reach of the U.S. law.

The Second Circuit ruled that as to §§ 548 and 550 of the Bankruptcy Code regarding fraudulent transfers, on the particular facts of that case, congressional intent was clear and that rules of international “comity” would not be breached by applying U.S. law to the subsequent transferee, “an immediate or mediate transferee of such initial transferee,” in the language of the statute.

A request for a hearing en banc has not been ruled upon, and we do not know yet whether the Supreme Court will accept certiorari if it is sought. If the Supreme Court accepts the case and affirms, it may seek to limit its ruling to a narrow set of facts and a narrow extraterritorial reach, but the topic hangs out there and consequences of such a decision could be very significant, not just for bankruptcy law but to an understanding of how the laws of the nations relate to each other, a matter of world order.