On January 4, 2016, the US Bankruptcy Court for the Southern District of New York, in Weisfelner v. Blavatnik (In re Lyondell Chemical Co.), held that the fraudulent transfer avoidance provision under section 548 of the Bankruptcy Code could be given extraterritorial application to avoid a transfer from a foreign entity to its foreign parent (543 B.R. 127 (Bankr. S. D. N.Y. 2016)). This ruling creates a split of interpretation within the Southern District of New York, with other courts having previously ruled that the Bankruptcy Code avoidance provisions could not be used to recover property transferred outside of the US (see Legal Update, SIPC v. Madoff Investment Securities LLC: Fraudulent Transfers between Foreign Parties Not Recoverable under Section 550(a)(2)).

In 2007, Basell AF S.C.A. (Basell), a Luxembourg entity controlled by defendant Leonard Blavatnik (Blavatnik) purchased Lyondell Chemical Company (Lyondell), a Delaware company, in a leveraged buyout (LBO) 100% financed with debt secured with the assets of Lyondell (the LBO). The LBO resulted in a new company being formed, LyondellBasell Industries AF S.C.A. (LBI). As part of the leveraged buyout, Lyondell took on $21 billion in secured debt, $12.5 billion of which was paid out to shareholders including to Basell's parent company, BI S.a.r.l. (Basell Parent)

Just over a year later, Lyondell became insolvent. As a result, the unsecured creditors were subordinate to $21 billion of secured debt, $12.5 billion of which had been used to deplete the assets of Lyondell through shareholder dividends. The LBO also depleted Lyondell's assets through the payment of about $575 million of transaction fees and expenses, and another $337 million in payments to Lyondell officers and employees under change of control provisions and management benefits.

The series of transactions ultimately resulted in five avoidance actions, including three actions against Lyondell shareholder recipients of the $12.5 billion dividends, one unrelated action, and the present action for the avoidance of various payments to parties related to Lyondell. This action was commenced under the umbrella of the jointly administered Chapter 11 cases of Lyondell, LBI, and their affiliates and was taken against Blavatnik, his companies, Lyondell's officers and directors, and certain others. The complaint includes 21 claims in all, however, the present decision addresses Blavatnik's motion to dismiss the bankruptcy trustee's attempt to avoid a $100 million distribution that Basell made to Basell Parent two weeks before the close of the LBO, which left Basell with inadequate funds to continue its operations and meet its obligations.

The trustee brought this avoidance action under sections 548 and 550 of the Bankruptcy Code to recover that $100 million transfer as a fraudulent conveyance, because the highly leveraged financing of the merger, along with the distributions, left LBI and its affiliates insolvent, inadequately capitalized, and overleveraged.

The Court addressed two issues in the case:

The Court dismissed, with leave to amend, the counts due to various issues with personal jurisdiction over Basell and Basell Parent. Specifically, while the Court had jurisdiction over Blavatnik because he worked in New York, the complaint violated due process requirements by failing to assert that the subject companies were alter egos of Blavatnik.

However, given that the counts were dismissed without prejudice, the court went on to address the substantive issue of the extraterritorial application of the section 548 avoidance powers abroad. Blavatnik argued that the Bankruptcy Code should not allow the recovery of the $100 million distribution because it was authorized and paid by a foreign company to a foreign parent, and no clear congressional intent exists to apply avoidance powers to such extraterritorial transactions.

The Court held that the avoidance power under section 548 of the Bankruptcy Code could be applied to foreign transfers to bring funds back into the bankruptcy estate that would have been part of the estate but for the fraudulent transfer.

The Court began by noting that, while congressional power may extend beyond US territories, there is a longstanding presumption against extraterritorial application of US laws unless a contrary congressional intent appears to extend the law's reach.

To determine the proper reach of the law, courts engage in a two-step analysis:

The Court first found that the transaction was indeed foreign. Both the transferor and transferee were Luxembourg entities, and while certain components of the transfer took place in the US, such as the decision to make the transfer and the post-transfer merger (which was the reason that the distribution was potentially subject to avoidance), the center of gravity of the transaction was not in the US.

Next, the Court turned to whether Congress intended that section 548 of the Bankruptcy Code apply to transfers that occurred outside of the US. While section 548 itself does not clearly demonstrate congressional intent, the Court found that the surrounding sections provided insight. Section 541 of the Bankruptcy Code grants in rem jurisdiction to Bankruptcy courts over all property of the debtor's estate, foreign and domestic. Further, section 541(a)(3) provides that any property that a trustee recovers under section 550 is also property of the estate. Section 550 authorizes a debtor to recover transferred property to the extent that section 548 allows the avoidance of the transfer.

Adopting the reasoning of the US Court of Appeals for the Fourth Circuit, the Court found that together these sections indicate congressional intent to apply section 548 to extraterritorial transfers (see In re French, 440 F.3d 145 (4th Cir. 2006)). It would be inconsistent, the Court found, for Congress to determine that property located anywhere in the world was property of the estate once it was recovered, but could not be subject to recovery in the first place. Instead, the Court held that section 548 of the Bankruptcy Code provides for the recovery of property that would have been property of the estate (property in which the debtor's estate would have had an interest) but for the fraudulent transfer.

The Court acknowledged that differing opinions on the issue exist in different jurisdictions. For example, the US Court of Appeals for the Second Circuit, in In re Colonial Realty, determined that under section 541, property does not become property of the estate until it has actually been recovered (980 F.2d 125 (2d Cir. 1992)). This has led some courts to determine that foreign property that has not yet been recovered is not subject to a Bankruptcy Court's in rem jurisdiction (see In re Bankr. Estate of Midland Euro Exch. Inc., 347 B.R. 708 (Bankr. C.D. Cal. 2006)). However, the Court distinguished these cases, noting that:

Since section 548 did indeed have extraterritorial application, the Court permitted the plaintiffs to refile the complaint with more specific allegations of personal jurisdiction over Basell and Basell Parent.

This case demonstrates the long reach that avoidance actions can have when examining whether to bring assets back into the bankruptcy estate. This decision appears to be in conflict with previous decisions in the Southern District of New York, in which courts have previously determined that no congressional intent existed to apply avoidance and recovery provisions of the Bankruptcy Code to completely foreign transactions (see Legal Update, SIPC v. Madoff Investment Securities LLC: Fraudulent Transfers between Foreign Parties Not Recoverable under Section 550(a)(2)). In that case, the court held that property that had not yet been recovered was not "property of the estate" and therefore was not included in the reach of the avoidance provisions.

Here, the Court took a different view, holding that the issue of when an asset becomes property of the estate did not prevent the Court from reaching the asset that would have been subject to the Bankruptcy Code provisions had the fraudulent transfer not occurred in the first place.

It should also be noted that the particular facts of this case do not make for a sympathetic defendant in the recovery action. Blavatnik, from an office in New York, directed the distribution then engaged in a leveraged buyout of a target company that resulted in more than half of $21 billion in loan proceeds being paid out to shareholders. The series of transactions then sent the target into insolvency, leaving unsecured creditors with little prospect of recovery as they sit behind secured lenders that funded the dividend payment.

For more information on fraudulent transfers, see Practice Note, Fraudulent Conveyances in Bankruptcy: Overview.