On July 6, 2014, in SIPC v. Bernard L. Madoff Investment Securities LLC, the US District Court for the Southern District of New York held that a trustee cannot use section 550(a)(2) of the Bankruptcy Code to recover fraudulent transfers of funds that occurred entirely outside of the US (513 B.R. 222 (S.D.N.Y. 2014)).

Foreign investment funds, or "feeder funds," which pooled their customers' assets to invest with Madoff Securities, withdrew funds from their Madoff accounts and subsequently transferred the funds abroad to various foreign entities. Following the collapse of Madoff Securities in 2008, many of these feeder funds entered into liquidation in their home countries.

Madoff Securities' trustee sued to recover the allegedly fraudulent transfers made to the feeder funds and the subsequent transfers made by those funds to their immediate and mediate transferees under section 550 of the Bankruptcy Code. Only the subsequent transfers made between a foreign transferor and a foreign transferee were at issue in this case. The subsequent transferees moved to dismiss the complaint, arguing that, because section 550 does not apply extraterritorially, the trustee could not set aside transfers made by a foreign transferor to a foreign transferee.

The Court held that the trustee may not recover the fraudulent transfers of funds that were made to the foreign subsequent transferees. Under the two-prong test set forth by the US Supreme Court in Morrison v. National Australia Bank Ltd. (561 U.S. 247 (2010), the Court determined that the strong presumption against extraterritorial application of federal laws applied because:

Concerning the first prong, the Court looked at the regulatory focus of the Bankruptcy Code's avoidance and recovery provisions and noted that both sections 550(a) and 548 of the Bankruptcy Code focus on "the property transferred" and the nature of the transfer, rather than on the debtor itself. Therefore, the Court held that the required application of section 550 was extraterritorial because the transfers and transferees in question were predominantly foreign.

The Court rejected the trustee's argument that section 550(a) applied domestically because the focus of congressional concern in a Securities Investors Protection Act (SIPA) liquidation is the regulation of the SIPC-member US broker-dealer. The Court explained that a remote connection to a US debtor is insufficient to automatically make every use of the various Bankruptcy Code provisions in a SIPA bankruptcy a domestic application of those provisions.

Next, the Court concluded that Congress did not intend that section 550 apply extraterritorially. The Court explained that under Morrison, a statute has extraterritorial application only where Congress has clearly expressed this intent. Here, the Court found nothing in the language of section 550(a), or its context in the surrounding provisions of the Bankruptcy Code, indicating that Congress intended for this section to apply to foreign transfers. The Court rejected the trustee's argument that section 541 of the Bankruptcy Code, which defines "property of the estate" to include certain specified property "wherever located and by whomever held," provides the necessary intent for extraterritorial application because it is incorporated into sections 548 and 550(a). The Court explained that this broad definition of estate property does not necessarily imply that transferred property is to be treated as "property of the estate" under section 541. Under Second Circuit precedent, fraudulently transferred property becomes property of the estate only after it has been recaptured by the trustee (see In re Colonial Realty Co., 980 F.2d 125, 131 (2d Cir. 1992)). Therefore, the Court held that nothing in the Bankruptcy Code overcame the presumption against the extraterritorial application of section 550. Similarly, the Court found nothing in SIPA, which incorporates the avoidance and recovery provisions of the Bankruptcy Code and has a primarily domestic focus, that overcame the presumption against extraterritoriality.

The Court also rejected the trustee's argument that if section 550 could not be applied to foreign transactions, a US debtor could avoid the reach of the Bankruptcy Code by fraudulently transferring its assets overseas and then retransferring them. The Court held that the policy against avoiding this potential loophole does not overcome the presumption against extraterritoriality, which serves to prevent disputes between nations in the application of their laws. The Court explained that even if any intentional fraud occurred, the trustee could pursue his rights under the laws of the countries where the transfers occurred.

Finally, the Court held, in the alternative, that even if the trustee had rebutted the presumption against extraterritoriality, principles of international comity would preclude him from using section 550 to reach these foreign transfers. In this case, many of the feeder funds are currently involved in liquidation proceedings in their home countries. Given the indirect relationship between Madoff Securities and the transfers at issue, these countries have a greater interest in applying their own laws than does the US.

While this case involved a narrow issue, the Court's decision could have far-reaching ramifications on the extraterritorial application of other provisions of the Bankruptcy Code. Here, the Court applied principles of comity and the presumption against extraterritoriality of federal laws to significantly limit the ability of a trustee to recover from foreign entities. The foreign applicability of other debtor rights and protections, such as the automatic stay, may also be in jeopardy.