Vol 12 (2015) - Issue 1

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Madoff: Some Comfort for Foreign Investors Indirectly Investing in U.S. Companies

In a case stemming from the collapse of the infamous Madoff Ponzi scheme, the Unites States District Court for the Southern District of New York (the 'Court') ruled that foreign entities that indirectly invested in the Madoff fund through foreign feeder funds could not be targeted in avoidance actions brought under the United States Bankruptcy Code ('Bankruptcy Code'). The Court found that Bankruptcy Code section 550(a), which allows a trustee to recover avoided transfers from subsequent transferees, (i) cannot be extended to extraterritorial transactions involving foreign transferees receiving funds from foreign transferors, and (ii) even if section 550(a) could be invoked extraterritorially, in this case, such application would be precluded by international comity.

Background
The massive scale of Madoff ’s fraud affected investors across the globe. Bernard L. Madoff Investment Securities LLC ('Madoff Securities') was partly funded by so-called 'feeder funds', which pooled their own customers’ assets and invested them with Madoff Securities. For example, two foreign custodian banks engaged in asset management (together, 'Foreign Banks') both invested in two of Madoff Securities’ largest feeder funds, Fairfield Sentry Limited ('Fairfield') and Harley International (Cayman) Limited ('Harley'), which in turn invested these assets in Madoff Securities.
After the largest, longest-running Ponzi scheme in history was uncovered in December 2008, a liquidation under the Securities Investor Protection Act ('SIPA') was commenced, and Irving H. Picard was appointed trustee ('Trustee') of the Madoff Securities estate. The Trustee commenced several 'avoidance actions', i.e. proceedings under the Bankruptcy Code, SIPA, and other applicable law5 seeking the avoidance and recovery of certain transfers, including preferences and fraudulent transfers, for the benefit of the debtor’s estate. The Trustee settled its avoidance and recovery action against Fairfield, and obtained a default judgment against Harley for more than USD 1 billion.

Proceedings against the Foreign Banks
In October 2011, the Trustee filed adversary proceedings against the Foreign Banks to recover, pursuant to Bankruptcy Code section 550(a)(2), USD 50 million in subsequent transfers of alleged Madoff Securities customer property the Foreign Banks received as a customer of Fairfield and Harley.
Bankruptcy Code section 550(a) provides:

Except as otherwise provided in this section, to the extent that a transfer is avoided … the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from-
(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or
(2) any immediate or mediate transferee of such initial transferee.