US CORNER. In re French: Extraterritorial Application of the US Bankruptcy Code s Fraudulent Conveyance Provisions

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1 US CORNER In re French: Extraterritorial Application of the US Bankruptcy Code s Fraudulent Conveyance Provisions Lynette C. Kelly, Counsel, Bankruptcy & Reorganization Group, Shearman & Sterling LLP, New York, USA Introduction Given the increasingly global nature of business and thus of corporate bankruptcies the extent to which the United States Bankruptcy Code (the Bankruptcy Code ) 1 will be applied extraterritorially to address US debtors assets and interests in other jurisdictions is an issue of critical importance. Although the US Supreme Court has not squarely addressed the issue, a number of lower court decisions, while somewhat inconsistent in their analysis, have moved in the direction of enforcing key Bankruptcy Code provisions extraterritorially in order to fulfil the purposes of the Bankruptcy Code. The US Court of Appeals for the Fourth Circuit (the Fourth Circuit ) continued this trend in its recent decision in In re French, 2 holding that a debtor s prepetition transfer of foreign real property may be set aside as a constructively fraudulent transfer under the Bankruptcy Code, and that neither the presumption against extraterritoriality nor the doctrine of international comity warranted a different result. Background A. The presumption against extraterritoriality Although it is clear that the US Congress has the authority to enforce its laws beyond the borders of the United States, 3 it is not always clear whether Congress intended this result with respect to particular statutes. United States courts have long been mindful that extraterritorial enforcement involves practical difficulties as well as issues of respect for the sovereignty of other nations, and that unintended clashes between our laws and those of other nations could result in international discord. 4 These concerns, as well as the need to establish a framework within which to discern congressional intent, gave rise to the longstanding principle of US law referred to as the presumption against extraterritoriality : the rebuttable presumption that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States. 5 A frequently cited US Supreme Court case, Equal Employment Opportunity Commission v. Arabian American Oil Company ( Aramco ), 6 defined the necessary intent as the affirmative intention of the Congress clearly expressed. 7 This test, sometimes referred to as the clear statement standard, suggested that the requisite intent must appear in the language of the statutory provision at issue. Subsequent Supreme Court cases, however (as well as recent lower court rulings such as the Fourth Circuit decision in In re French), have explained that it is not a clear statement but rather clear evidence of congressional intent 8 that is required, and have looked to all available evidence, including legislative history and the overall statutory scheme, to determine whether there exists a clear expression of congressional intent. 9 Moreover, cases have held that laws may be applied extraterritorially even where congressional intent cannot be discerned if the activities being regulated would have substantial effects in the United States or if failure to apply the statute extraterritorially would result in 1 11 U.S.C. 101, et seq. 2 French v. Liebmann (In re French), 440 F.3d 145 (4th Cir. 2006), petition for cert. filed, 75 U.S.L.W (U.S. 15 May 2006) (No ). 3 EEOC v. Arabian Am. Oil Co., 499 U.S. 244, 248 (1991) (citing Foley Bros., Inc. v. Filardo, 336 U.S. 281, (1949)). 4 Id. (citing McCulloch v. Sociedad Nacional de Marineros de Honduras, 372 U.S. 10, (1963)). 5 Id. (quoting Foley, 336 U.S. at 285). 6 Aramco, 499 U.S. 244 (1991). 7 Id. at 248 (quoting Benz v. Compania Naviera Hidalgo, S.A., 353 U.S. 138, 147 (1957)). 8 Smith v. United States, 507 U.S. 197, 204 (1993). 9 E.g., Sale v. Haitian Ctrs. Council, Inc., 509 U.S. 155, 177 (1993); In re French, 440 F.3d at

2 In re French: Extraterritorial Application of the US Bankruptcy Code s Fraudulent Conveyance Provisions adverse effects in the United States. 10 Thus, the nature and purpose of the particular statute or the nature of the activities regulated could effectively overcome the presumption. B. Extraterritorial application of the Bankruptcy Code Although the Supreme Court has not ruled on the extraterritorial application of the Bankruptcy Code, a number of lower courts have held that key Bankruptcy Code provisions should be applied extraterritorially, at least in the particular circumstances of those cases. For example, courts have held that the discharge injunction under section 524 enjoined a foreign creditor from commencing collection actions against estate property located outside the United States, 11 that the automatic stay of section 362 may be enforced against foreign creditors or a foreign receiver 12 and that a permanent channelling injunction may be applied against a foreign defendant. 13 The approaches relied upon by these courts vary, and include analysis not only of congressional intent, but also of the adverse effects that failure to enforce these provisions extraterritorially would have in the United States. In particular, in reaching these decisions, courts have noted the importance of extraterritorial application of bankruptcy laws in order to achieve the purposes underlying the Bankruptcy Code, including preventing the uncontrolled scramble for debtors assets and ensuring equality of treatment among creditors. 14 In addition, courts have considered the impact of extraterritorial application on the foreign jurisdiction, including whether parallel bankruptcy proceedings exist and whether enforcement of United States laws would result in discord between the jurisdictions. 15 The Fourth Circuit s decision in In re French In In re French, a creditor commenced an involuntary chapter 7 bankruptcy case against an individual, Betty Irene French (the Debtor ), and the bankruptcy court appointed a chapter 7 trustee (the Trustee ). Prior to the bankruptcy, the Debtor had transferred certain real property located in Nassau, the Bahamas by a deed of gift to her two children (the Transferees ). The deed had been executed and delivered to the Transferees in the United States, and both of the Transferees were residents of the United States and subject to the personal jurisdiction of the bankruptcy court. Although the deed was dated 25 December 1981, the Transferees had not recorded the deed with the Bahamas Registrar General until 21 June 2000, four months prior to the 20 October 2000 bankruptcy filing. 16 The Trustee filed an action under section 548 of the Bankruptcy Code seeking to avoid the transfer of the Nassau property as a fraudulent conveyance. A fraudulent conveyance has been described as a transfer which has the effect of improperly placing assets beyond the reach of creditors. 17 The Bankruptcy Code s fraudulent conveyance provisions allow a bankruptcy trustee (or, in a chapter 11 case where no trustee has been appointed, a debtor in possession) to avoid and recover for the benefit of the estate a transaction that is found to have been actually or constructively fraudulent. Section 548 of the Bankruptcy Code provides that a transfer is fraudulent when a debtor (1) made such transfer with actual intent to hinder, delay, or defraud any creditor ( actual fraud) or (2) received less than a reasonably equivalent value in exchange for such transfer and (a) was insolvent on the date that such transfer was made or became insolvent as a result of such transfer, (b) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was unreasonably small capital, or (c) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor s ability to pay as such debts matured ( constructive fraud). 18 Under the version of section 548 in effect at the time In re French 10 See, e.g., Steele v. Bulova Watch Co., 344 U.S. 280 (1952) (applying US trademark law extraterritorially to defendant who was a US national); Hong Kong & Shanghai Banking Corp., Ltd. v. Simon (In re Simon), 153 F.3d 991, 996 (9th Cir. 1998) (enforcing Bankruptcy Code s discharge injunction against foreign creditor because of substantial effects in the United States), cert. denied, 525 U.S (1999). 11 In re Simon, 153 F.3d at E.g., Underwood v. Hilliard (In re Rimsat, Ltd.), 98 F.3d 956, 961 (7th Cir. 1996); Lykes Bros. S.S. Co., Inc. v. Hanseatic Marine Serv. (In re Lykes Bros. S.S. Co., Inc.), 207 B.R. 282 (Bankr. M.D. Fla. 1997); Nakash v. Zur (In re Nakash), 190 B.R. 763 (Bankr. S.D.N.Y. 1996). 13 In re Chiles Power Supply Co., Inc., 264 B.R. 533 (Bankr. W.D. Mo. 2001). 14 E.g., In re French, 440 F.3d at 154; In re Simon, 153 F.3d at 996; In re Rimsat, Ltd., 98 F.3d at 961; In re Nakash, 190 B.R. at In re Simon, 153 F.3d at The Transferees asserted that the deed was presented to them as a gift at a Christmas party in Maryland in 1981, but they declined to register it immediately in order to avoid high Bahamian recording taxes; it was only after their father began to experience financial difficulties that they elected to register the deed in order to shield the property Collier on Bankr (15th ed.). 18 See 11 U.S.C

3 Lynette C. Kelly was commenced, a trustee could avoid transfers under the Bankruptcy Code made within one year prior to the commencement of the bankruptcy case. 19 In In re French, the Transferees conceded that the Debtor did not receive reasonably equivalent value in exchange for the gift and that the Debtor was insolvent at the time the deed was recorded. Moreover, all parties acknowledged that, pursuant to Bankruptcy Code section 548(d)(1), the transfer occurred in 2000 when the deed was recorded, not in 1981 when it was delivered. Although these facts ordinarily would establish a constructive fraud under section 548, the Transferees filed a motion to dismiss on two grounds: first, that section 548 should not apply to a transfer of foreign property because of the presumption against extraterritoriality, and secondly, that principles of international comity warranted the application of Bahamian, rather than United States, law, which the Transferees contended would allow them to retain the property. The bankruptcy court rejected the Transferees arguments, denied their motion to dismiss, and granted the Trustee s motion for summary judgment, finding that the transfer was constructively fraudulent. The district court affirmed. On appeal, the Fourth Circuit rejected the Transferees arguments and affirmed the lower court s decision, holding that the presumption against extraterritoriality, if it applied at all in the circumstances of the case, did not preclude the Trustee from recovering foreign real property under section 548 of the Bankruptcy Code and that the doctrine of international comity did not warrant the application of Bahamian, rather than United States, law. The Fourth Circuit first considered whether the presumption against extraterritoriality applied in the circumstances of the case. The court noted that, although the presumption is a longstanding principle of American law, it applies only when a party seeks to enforce a statute beyond the territorial boundaries of the United States ; thus, it has no bearing on regulated conduct that is domestic rather than extraterritorial. 20 Given the mix of foreign and domestic elements in the case, the court found that it was necessary in the first instance to determine whether in fact the alleged transfer occurred extraterritorially an exercise it described as a flexible test that includes consideration of all component events of the transfer. 21 In performing this test, the court found it significant that the facts and conduct establishing the elements of section 548 the Debtor s assets and debts establishing its insolvency and decision not to provide reasonably equivalent value occurred in the United States. In addition, the court noted that the effects of the transfer would be felt most strongly in the United States where the Debtor, the Transferees and all but one creditor were located. The court acknowledged that two aspects of the transaction involved foreign conduct: the actual recording of the deed and the location of the real property in the Bahamas. Although the court regarded the recording as incidental, the location of the real property was more troubling. The court noted that, although section 548 focuses on the fraudulent transfer rather than on the property transferred, it is well established that sovereigns have a strong interest in real property within their borders and, therefore, the potential effect on Bahamian real property perhaps merits special weight. 22 Ultimately, the court stated that it need not resolve what it called the slippery question 23 of whether the transfer of Bahamian real property could be characterised as domestic rather than extraterritorial, since it determined that, even if extraterritorial application were assumed, the presumption against extraterritoriality did not preclude such an application in this case. In analysing whether the presumption against extraterritoriality would bar the application of section 548 to the Bahamian transfer, the Fourth Circuit, applying the broad test developed by the Supreme Court in nonbankruptcy cases, considered whether all available evidence, including the text of the statute, the overall statutory scheme, and legislative history, 24 showed a clear congressional intention that the provision be applied extraterritorially. The court found that several indicia of congressional intent rebutted the presumption in this case. First, the court noted that section 541 of the Bankruptcy Code defines the property of the estate subject to the in rem jurisdiction of the bankruptcy court as including all property wherever located. 25 In the legislative history of this provision, Congress explained that the words wherever located were added in 1952 to make[] clear that a trustee in bankruptcy is vested with the title of the bankrupt in property which is located without, as well as within, the United States For all cases filed after 20 April 2006, the relevant look back period is extended to two years prior to the commencement of a bankruptcy case, pursuant to recent amendments to the Bankruptcy Code. 20 In re French, 440 F.3d. at 149 (quoting Aramco, 499 U.S. at 248). 21 Id. at (quoting Maxwell Commc n Corp. PLC v. Societe General PLC (In re Maxwell Commc n Corp.), 186 B.R. 807, 816 (S.D.N.Y. 1995)). 22 Id. at Id. at Id. (internal citation omitted) U.S.C. 541(a). 26 In re French, 440 F.3d at 151 (quoting H.R. Rep. No , at 15 (1952), reprinted in 1952 U.S.C.C.A.N. 1960, 1976). 296

4 In re French: Extraterritorial Application of the US Bankruptcy Code s Fraudulent Conveyance Provisions In addition, the court considered that section 541 defines property of the estate as including all interests of the debtor in property the same language used in section 548 to describe the property that the Trustee may recover as a fraudulent conveyance. The court concluded that, by incorporating this language into section 548, Congress made manifest its intent that 548 apply to all property that, absent a prepetition transfer, would have been property of the estate, wherever that property is located. 27 Finally, the court noted that the interpretation of section 548 as extending to property outside the United States furthers the fundamental purpose of the Bankruptcy Code s avoidance provisions of preventing debtors from improperly depleting the estate of assets that should be available to creditors. The court found that these facts taken as a whole provided sufficient evidence of congressional intent to rebut the presumption against extraterritoriality. The Fourth Circuit next considered the Transferees argument that it should refrain from applying section 548 to the transfer of the Bahamian property based upon principles of international comity. Comity has been defined by the Supreme Court as the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protection of its laws. 28 Citing this definition, the Fourth Circuit stated that at base comity involves the recognition that there are circumstances in which the application of foreign law may be more appropriate than the application of [United States] law and that this determination involves the consideration of several factors, including the extent to which the regulated activity takes place within the United States, the connections between the persons taking the regulated actions and the United States, the extent to which other nations regulate the activities, the likelihood of conflict between United States law and those of other jurisdictions, and the importance to the regulating state of applying its laws. 29 Upon considering all the important components of the transfer, the court determined that the application of US law, and not Bahamian law, was appropriate. 30 First, the court found that even the Transferees strongest argument, that the real property was situated in the Bahamas, did not warrant applying Bahamian law. 31 Although it acknowledged that there are circumstances in which the law of the situs should govern the determination of interests in real property, the court rejected the Transferees argument that this is a per se rule. Given the context of bankruptcy, the court found a more apt analogy in the conflict of laws rule that the law of the situs does not necessarily govern the allocation of interests in land [between] debtor and creditor if regulation of the relationship is of greater concern to a state other than the situs, noting that [t]his is particularly true when the land is part of an aggregate of property which it is desirable to deal with as a unit. 32 Applying this rule, the court found that the Bahamian property was part of an aggregate the bankruptcy estate that was best dealt with as a whole pursuant to the Bankruptcy Code, and that the United States had a greater interest than the Bahamas in regulating that property in order to fulfil the purposes of the Bankruptcy Code, including protecting the rights of both debtors and creditors. This factor tipped even more strongly in favour of United States law given that most of the creditors were US residents in whom the Bahamas would have little interest. Secondly, the court found that the other relevant factors favoured the application of United States law. Most of the conduct involved, as well as the Debtor, the Transferees and most of the creditors, was located in the United States. Moreover, unlike dual proceeding cases such as In re Maxwell Communications Corp., 33 there was no possibility that the avoidance laws of the two jurisdictions would conflict because there was no parallel bankruptcy case in the Bahamas. 34 Accordingly, the court held that the application of section 548 was appropriate. Conclusion The Fourth Circuit s opinion leaves intact the presumption against extraterritoriality while further expanding the exceptions to that rule in the area of bankruptcy. As discussed in the concurring opinion in In re French, the Bankruptcy Code is materially different from statutes that have been found not to apply extraterritorially, in that [e]ase and centrality of administration are foundational characteristics of bankruptcy law and thus interference with that central administration in 27 Id. at Hilton v. Guyot, 159 U.S. 113, 164 (1895). 29 In re French, 440 F.3d at (citing Restatement (Third) of Foreign Relations Law 403 (1987)). 30 Id. at Id. at Id. (quoting Restatement (Second) of Conflict of Laws ch. 9, topic 2, introductory note). 33 In re Maxwell Commc n Corp., 93 F.3d 1036 (2d Cir. 1996). 34 In re French, 440 F.3d at 154 (citing In re Simon, 153 F.3d at 999). 297

5 Lynette C. Kelly foreign jurisdictions may cause serious adverse effects in the United States. 35 The concurrence was careful to note, however, that the majority opinion does not suggest that every portion of the Bankruptcy Code invariably applies to conduct abroad. Instead, it represents a sensitive recognition of the administrative exigencies that are bound up with the avoidance of this fraudulent transfer. 36 Thus, in In re French, the Fourth Circuit leaves open the question of whether other key provisions of the Bankruptcy Code should be applied extraterritorially or, indeed, whether the same result would obtain in a different factual setting In re French, 440 F.3d at Id. 37 A petition for certiorari has been filed but not yet decided; thus, the US Supreme Court may ultimately provide further guidance on the extraterritorial application of section 548 in this case. 298