Rakoff Shields Foreign Banks From Madoff Trustee Suits

Law360, New York (July 07, 2014, 12:22 PM ET) — The trustee for Bernard L. Madoff’s defunct firm suffered a huge setback Sunday in efforts to claw back money from banks that collected foreign feeder funds’ Ponzi scheme proceeds when U.S. District Judge Jed S. Rakoff held that such asset transfers are outside the reach of the U.S. Bankruptcy Code.

Judge Rakoff effectively killed scores of claims filed by Bernard L. Madoff Investment Securities LLC trustee Irving Picard to recover supposedly fraudulent transfers of BLMIS money that foreign Madoff feeder funds made to other foreign funds, mostly banks.

The avoidance and recovery mechanisms in Section 550(a)(2) of the Bankruptcy Code cannot be applied extraterritorially, the judge said. The decision sustained the defendants’ claim that as foreign entities they are not subject to U.S. bankruptcy law or the Securities Investor Protection Act, which Picard said empowered him to use Section 550 to pursue Madoff victim assets housed in foreign banks.

“The court concludes that the presumption against extraterritorial application of federal statutes has not been rebutted here,” the judge said. “The trustee therefore may not use Section 550(a) to pursue recovery of purely foreign subsequent transfers.”

Picard had pegged the disputed foreign transfers at close to $60 billion in previous bankruptcy claims. BNP Paribas SA, UniCredit Bank Austria AG, HSBC Holdings PLC and scores of other international heavyweights were facing claims.

Filed in bankruptcy court, the claims landed before Judge Rakoff at the defendant’s request for a determination of whether SIPA or the Bankruptcy Code permitted the trustee to avoid the initial transfers from BLMIS to the mostly bankrupt Madoff feeder funds or recover from “initial, immediate or mediate foreign transferees.”

Ruling nearly two years after the September 2012 oral arguments, the judge rejected the trustee’s contention that the recovery actions did not require an extraterritorial application of the statute, finding the tenuous connection to the U.S.-based debtor insufficient to characterize the transactions as domestic.

Under the test laid out in the U.S. Supreme Court‘s 2010 Morrison v. National Australia Bank Ltd. decision, the transactions at issue are not the initial transfers between BLMIS and its feeders but rather the subsequent transfers from one foreign fund to another foreign entity, according to the order.

“It cannot be that any connection to a domestic debtor, no matter how remote, automatically transforms every use of the various provisions of the Bankruptcy Code in a SIPA bankruptcy into purely domestic applications of those provisions,” the judge said. “Although the chain of transfers originated with [BLMIS] 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).”

Picard had tried to use the Bankruptcy Code’s definition of a debtor’s property as property “wherever located and by whomever held” to argue that Congress intended for SIPA and the Bankruptcy Code to apply overseas. Allowing Section 550 to apply extraterritorially aligned with its overriding purpose of helping U.S.-based broker-dealers liquidate, the trustee argued.

Picard fared no better with his argument that a ruling for the defendants would give U.S.-based debtors a path for putting their assets out of the reach of trustees and creditors.

While acknowledging the potential for a debtor to fraudulently transfer assets offshore to avoid U.S. bankruptcy law, Judge Rakoff held that the concern over this “loophole” was not enough to justify imposing U.S. bankruptcy law on the foreign courts handling BLMIS feeder liquidations.

“These foreign jurisdictions have their own rules concerning on what bases the recipient of a transfer from a debtor should be required to disgorge it,” the judge said. “Given the indirect relationship between Madoff Securities and the transfers at issue here, these foreign jurisdictions have a greater interest in applying their own laws than does the United States.”

The judge remanded the avoidance actions back to the bankruptcy court.

Amanda Remus, a spokesperson for Picard, did not indicate whether the trustee would file an appeal but said that his attorneys are reviewing the decision to determine “what further course of action to take.”

The funds are represented by Sullivan & Cromwell LLP, Skadden Arps Slate Meagher & Flom LLP, Sullivan & Worcester LLP, Cleary Gottlieb Steen & Hamilton LLP, Cravath Swaine & Moore LLP, Debevoise & Plimpton LLP, Kelley Drye & Warren LLP, Paul Hastings LLP, Shearman & Sterling LLP, Simpson Thacher & Bartlett LLP and Willkie Farr & Gallagher LLP.

Picard is represented by BakerHostetler, Windels Marx Lane & Mittendorf LLP and Young Conaway Stargatt & Taylor LLP.

The Securities Investor Protection Corp. is represented by its own attorneys Josephine Wang, Kevin H. Bell and Christopher H. Larosa.

The case is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, case number 1:12-mc-00115, in the U.S. District Court for the Southern District of New York.

–Editing by Katherine Rautenberg.