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Home / Case News / Second Circuit Allows Madoff Trustee to Pursue Fraudulent Transfer Claims Against Foreign Entities Who Invested with Madoff Securities Through Overseas “Feeder Funds”

Second Circuit Allows Madoff Trustee to Pursue Fraudulent Transfer Claims Against Foreign Entities Who Invested with Madoff Securities Through Overseas “Feeder Funds”

25 February, 2019, New York–  Bernard L. Madoff Investment Securities LLC (“Madoff Securities”) allegedly transferred billions of dollars to foreign investors, involving the feeder funds. These feeder funds, the initial transferees of the funds, subsequently transferred it to other foreign investors (subsequent transferees), a group that includes the hundreds of appellees. Irving H. Picard, the Trustee for the Liquidation of Madoff Securities, alleged these transfers as fraudulent, and thus avoidable under § 548(a)(1)(A) of the Bankruptcy Code. The Trustee sued the appellees to recover the property invoking § 550(a)(2) of the Bankruptcy Code.

At dispute was the issue – whether the presumption against extraterritoriality or international comity principles limit the reach of § 550(a)(2) when a trustee seeks to avoid an initial fund transfer under § 548(a)(1)(A). More specifically, whether a trustee can recover property from a subsequent foreign transferee that it received from an initial foreign transferee under §550(a)

Previously, there had been conflicting decisions at the lower court level concerning whether foreign transactions are subject to fraudulent transfer claims under the U.S. Bankruptcy Code. The United States District Court for the Southern District of New York and the United States Bankruptcy Court for the Southern District of New York had dismissed the trustee’s actions holding that either the presumption against extraterritoriality or international comity principles prevented the trustee from using § 550(a)(2) to recover the alleged funds. The trustee appealed the orders dismissing the recovery actions. The Second Circuit held that the lower courts erred by dismissing the actions under the presumption against extraterritoriality and international comity. Under the Second Circuit’s holding, foreign investors may be subject to avoidance liability in U.S. bankruptcy courts even if they have not participated in any U.S. transactions.

The Court stated that when working in tandem with § 548(a)(1)(A), § 550(a) regulates a debtor’s fraudulent transfer of property, and it, therefore, focuses on the debtor’s initial transfer. In other words, Madoff Securities was a domestic entity, and it fraudulently transferred funds to feeder funds from a U.S. bank account. The alleged transfers were thus a domestic activity. Since §550(a) regulates domestic conduct, the court opined that these cases involve domestic applications of the statute.

Next, the Second Circuit held that the District Court’s premise that investors in the foreign funds had no reason to expect that U.S. law would apply to their relationships with the feeder funds was inaccurate. The Court reasoned that the U.S. law was not regulating the investors’ relationships with the feeder funds; rather it was regulating the Debtor’s fund transfers to the feeder funds. Thus, the Court stated that although regulating these transfers with recovery actions will affect the subsequent transferees, that consequence should not unfairly surprise them because 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 Court also held that the reason § 550(a)(2)’s tracing provision applies to subsequent transferees ensures that a trustee can recover from entities with no direct relationship to the debtor. The Court added that if the directness of a transfer were relevant to a trustee’s ability to recover property under § 550(a)(2), there is no way as to how a trustee could ever recover property from any subsequent transferee, foreign or domestic.

The Court thus ruled that the prescriptive comity considerations did not limit the reach of the Bankruptcy Code provisions. The Court vacated the lower court judgment and remanded for further proceeding.