Irving Picard (left), the trustee administering the Madoff estate, and Judge Jed Rakoff.
Irving Picard (left), the trustee administering the Madoff estate, and Judge Jed Rakoff. ()

Transfers made abroad between a foreign transferor and a foreign transferee cannot be recovered by the trustee administering the estate of Bernard L. Madoff Investment Securities, a federal judge has ruled.

Dealing a win to foreign banks and investment service providers, Southern District Judge Jed Rakoff (See Profile) held that the recovery provision of the Bankruptcy Code, §550(a)(2), is subject to the same limits on the extraterritorial reach of U.S. laws that apply to securities transactions and other federal laws under Morrison v. Nat’l Australia Bank Ltd., 130 S.Ct. 2869 (2010).

In Morrison, the Supreme Court held that the presumption against the extraterritorial application of U.S. laws applies against entirely foreign securities transactions, and the courts have since applied Morrison in other contexts.

Rakoff was confronted with the efforts of Irving Picard, the trustee appointed under the Securities Investor Protection Act (SIPA), to claw back monies from Bernard Madoff’s allies and “feeder funds” for victims of Madoff’s multi-billion dollar Ponzi scheme.

In Securities Investor Protection Corporation v. Bernard L. Madoff Investment Securities, 12-mc-115, Picard, a partner at Baker Hostetler, was seeking to recover billions of dollars that were transferred to the foreign feeder funds, and were then in turn sent along to banks and other service providers.

The defendant banks and service providers moved to dismiss claims against them, saying that §550(a)(2), which allows for such recovery, has no application extraterritorially.

Rakoff consolidated dozens of cases for decision on the issue and heard oral argument in the case on Sept. 21, 2012.

His conclusion, in an opinion issued Sunday, was that application of §550(a)(2) would be extraterritorial, and “Congress did not clearly intend such an application.”

“The trustee and SIPC argued that the ‘focus’ of congressional concern in a SIPA liquidation is the regulation of the SIPC-member U.S. broker-dealers, so that the application of any of the incorporated provisions of the Bankruptcy Code is inherently domestic,” Rakoff said. “But this argument proves too much. 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.”

Picard argued that §541 of the code, which defines “property of the estate” to include specific property “wherever located and by whomever held,” is incorporated into the code’s avoidance and recovery provisions—indicating that Congress intended to have those provisions apply to property outside of the United States.

“Though clever, the theory is neither logical nor persuasive,” Rakoff said.

Picard also contended §550 should be applied outside of the United States because a debtor could otherwise fraudulently shift his or her assets abroad to duck U.S. bankruptcy law. Rakoff disagreed.

“However, as other courts have found, 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,’” In re Midland Euro Exch. Inc., 347 B.R. 708 (Bankr. C.D. 2006).

And even if the presumption against extraterritoriality were rebutted by the trustee, Rakoff said, Picard’s use of §550(a) to pursue subsequent foreign transfers “would be precluded by international comity”­—the desire to avoid conflict with the legal systems of foreign nations.

Rakoff said courts that engage in comity analysis use a “choice-of-law analysis to determine whether the application of U.S. law would be reasonable under the circumstances, comparing the interests of the United States and the relevant foreign state.”

Here, the judge said, many of the feeder funds are engaged in their own liquidation proceedings in their own countries.

“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,” he said. “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.”

Frank Velie of Sullivan & Worcester, one of the attorneys for the defendants who argued the motion before Rakoff, said Monday, “We are gratified by this ruling which is eminently correct in view of the Supreme Court’s Morrison decision.”

“We do not know the extent of what the trustee was seeking in clawbacks from the service providers, but based on his public statements in the courts, we believe he was seeking several billions dollars,” Velie added.

Regina Griffin and Thomas Long, partners at Baker Hostetler, represented the trustee.

The firm released a statement saying its attorneys are reviewing the decision “to determine what further course of action to take on behalf of defrauded customers of Bernard L. Madoff Investment Securities.”