The largest fraud in history, the Bernard Madoff Ponzi scheme continues making important law, often in the cross-border sphere. A district judge in New York has given greater definition about the extent to which the safe harbor in Section 546(e) limits the claims that a foreign liquidator can make in a U.S. court.
Several of Madoff’s largest investors were so-called feeder funds located in the British Virgin Islands. They took money from their own investors and gave it to Madoff. In return for their money, the feeder funds issued shares to their investors.
Of course, the feeder funds blew up when the Madoff fraud surfaced. The feeder funds ended up in liquidations in the BVI. The liquidators filed 300 lawsuits in the U.S., aiming to recover $6 billion that the investor-shareholders had taken out of the feeder funds by redeeming their stock.
Based on several theories under BVI law, the liquidators contended that the redemptions were based in bogus determinations about the value of the feeder funds’ position with Madoff. Later, the liquidators filed chapter 15 petitions in New York and received so-called foreign main recognition. The lawsuits were removed to bankruptcy court.
Litigation proceeded for years both in the U.S. and all the way up to the Privy Council in England on appeal from decisions by the BVI court. The focus of this report is an August 24 opinion by District Judge Vincent S. Broderick affirming the bankruptcy court’s dismissal in favor of the defendant-investors in the feeder funds.
Judge Broderick’s opinion dealt with a plethora of issues, like personal jurisdiction on facts peculiar to the case. We shall focus on his rulings regarding the safe harbor in Section 546(e), which says that “the trustee may not avoid a transfer that is a . . . settlement payment . . . made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract, . . . except under section 548(a)(1)(A) of this title.”
In broad brush, the investors in the feeder funds argued that their redemptions of stock in the feeder funds were payments on securities contracts immunized from avoidance by the safe harbor.
Before delving into the intricacies of Section 546(e), Judge Broderick explained the types of suits that a foreign liquidator can or cannot bring in the U.S. in chapter 15. Prominently, Section 1521(a)(7) bars a trustee from mounting preference or fraudulent transfer suits under Sections 547 and 548.
Citing authorities, Judge Broderick said that foreign liquidators “cannot raise avoidance claims under the U.S. Bankruptcy Code.” However, he said that lawsuits liquidators may bring under foreign law are “nevertheless subject to the Bankruptcy Code’s limitations” by virtue of Section 561(d).
That section says that “[a]ny provisions of [the Bankruptcy Code] relating to securities contracts . . . shall apply in a case under chapter 15.”
The liquidators, whose suits were dismissed by the bankruptcy court, argued that the safe harbor could not apply because the redemptions were foreign transactions. They also relied on the presumption against extraterritorial application because there is no indication in Section 546(e) that Congress intended for it to apply to foreign transactions.
Like the bankruptcy court, Judge Broderick said it didn’t matter whether Section 546(e) had extraterritorial application. He held that “Congress has expressed a clear intent to apply Section 546(e) extraterritorially through Section 561(b).” He went on to state the “natural conclusion . . . that the safe harbor from the foreign representatives’ avoidance powers applies to extraterritorial transfers as well.”
Judge Broderick said that foreign liquidators “cannot have it both ways” by availing themselves of a forum under chapter 15 while avoiding the limitations that chapter 15 imposes.
Next, the liquidators argued that their suits were based on “actual fraud” and that the safe harbor did not apply because their claims were akin to actual fraud under Section 548(a)(1)(A).
Judge Broderick agreed. “If there are exceptions to the limitation of the domestic trustee’s avoidance powers, then it should be the same with those of the foreign representative,” he said.
Still, Judge Broderick poured the claims down the drain, because the liquidators were not alleging claims for actual fraud. Instead, they were making claims for unfair preference or undervalued payment under BVI law.
Because the claims were not akin to Section 548(a)(1)(A), Judge Broderick upheld dismissal.
The liquidators are appealing to the Second Circuit.