Debate Intensifies as to Whether the Bankruptcy Code’s Avoidance Provisions Apply Extraterritorially

The ability to avoid fraudulent or preferential transfers is a fundamental part of U.S. bankruptcy law. However, when a transfer by a U.S. entity to a non-U.S. transferee takes place outside the U.S.- as is increasingly common in the global economy - courts disagree as to whether the U.S. Bankruptcy Code’s avoidance provisions apply extraterritorially to avoid the transfer and recover the transferred assets. In our article, we describe how several U.S. bankruptcy courts have addressed this issue in recent years, with inconsistent results.

In a recent example, in In re CIL Limited, 582 B.R. 46 (Bankr. S.D.N.Y. 2018), the U.S. Bankruptcy Court for the Southern District of New York, disagreeing with other courts both within and outside its own district, ruled that the ‘transfer of an equity interest in a U.K. entity to a Marshall Islands entity was a foreign transfer’ and that the Bankruptcy Code’s avoidance provisions do not apply extraterritorially because ‘[n]othing in the language of sections 544, 548 and 550 of the Bankruptcy Code suggests that Congress intended those provisions to apply to foreign transfers.’

The decision further muddies the waters on an issue that has become increasingly prominent, as the volume of cross-border bankruptcy cases continues to grow and cross-border transactions become ubiquitous. The split on this issue exists not merely between courts in different jurisdictions, but also among courts in the Southern District of New York, where the majority of cross-border bankruptcy cases have traditionally been filed.

Without the ability to avoid extraterritorial transfers by U.S. debtors to non-U.S. entities under U.S. law, the only recourse available to many bankruptcy trustees, chapter 11 debtors-in-possession, or other representatives of U.S. debtors (such as chapter 11 plan trustees or the representative of a U.S. debtor in a case filed in another country that has enacted the UNCITRAL Model Law on Cross-Border Insolvency) would likely be litigation abroad, to seek avoidance and recovery of transferred property under foreign law.

Although at least two courts have ruled that a U.S. bankruptcy court can adjudicate foreign law avoidance claims, relatively few countries have avoidance laws as comprehensive and well-developed as those in the U.S. This means that non-U.S. transferees in many cases face less avoidance liability exposure than if they were subject to U.S. law.

Failing congressional action, the U.S. Court of Appeals for the Second Circuit could resolve the uncertainty on this issue, at least in the Southern District of New York, by definitively ruling one way or another. However, even if the Second Circuit were to hold that the Bankruptcy Code’s avoidance provisions apply extraterritorially, practical problems would remain. For example, a U.S. court may lack personal jurisdiction over a non-U.S. transferee, a fact that would significantly complicate efforts to enforce any avoidance ruling.

This post comes to us from Charles M. Oellermann and Mark G. Douglas, Jones Day.