In Depth: US Bankruptcy Code Safe Harbors Protect Against Foreign Law Evasion Claims Under Chapter 15 | Cadwalader, Wickersham & Taft LLP

The United States Bankruptcy Code’s safe harbor provisions reassure financial institutions that transfers made under protected financial contracts generally will not be subject to cancellation or “recovery” if the transferor files subsequently file for bankruptcy protection under Chapter 7 or Chapter 11 of the United States Bankruptcy Code. But is it the same when the assignor is a foreign debtor whose main insolvency proceeding takes place outside the United States and whose representatives merely seek “recognition” of the foreign proceeding in the United States in under Chapter 15 of the Code? The United States District Court for the Southern District of New York recently confirmed that safe harbors also provide protection in these circumstances, even with respect to foreign law claims based on foreign transactions. See Fairfield Sentry Ltd. vs. Citibank, NA London2022 WL 3644436 (SDNY 24 Aug 2022).


Fairfield involved three investment funds organized in the British Virgin Islands (“BVI”) that invested in Bernard Madoff’s Ponzi scheme. After Madoff’s scheme collapsed, the funds went through insolvency proceedings in a BVI court, which appointed liquidators to recover and fairly distribute the assets on behalf of the funds’ members. The liquidators, acting as “foreign representatives” of the funds, obtained recognition of the BVI insolvency proceeding in SDNY Bankruptcy Court under Chapter 15. The liquidators also initiated proceedings in the United States under BVI insolvency law, seeking to avoid certain allegedly preferential actions or fraudulent payments constructively made to investors who had cashed out their investments in the funds before the collapse of the Madoff scheme. The bankruptcy court ultimately dismissed such claims under BVI law as barred by Section 546(e) of the Bankruptcy Code, which generally precludes avoidance of a “settlement payment… made by or to ( or for the benefit of) a… financial institution… in connection with a securities contract.

The call

On appeal, the district court upheld the bankruptcy court’s ruling that claims to avoid BVI law were barred by the 546(e) safe harbor.

In doing so, the district court rejected the liquidators’ argument that Section 546(e) applied only to transactions within the United States and not “extraterritorially” to foreign transactions. The Court recognized a general presumption against the extraterritorial application of a law, but held that 546(e) applied notwithstanding this presumption as part of a two-step analysis developed by the United States Supreme Court which examines (i) whether the law gives a clear indication that it applies extraterritorially, and (ii) whether the case involves domestic application of the law, as determined by examining the “focus” of the law .

With respect to the first step, the Court found that Congress had expressed a clear intention to apply 546(e) extraterritorially through Section 561(d) of the Bankruptcy Code, which provides that ‘Under Chapter 15, safe harbors “limit evasive powers to the same extent as in a proceeding under Chapters 7 or 11.” 11 USC § 561(d). The Court held that, because the Section 561(d) requires safe harbors to apply under Chapter 15 “to the same extent” as under Chapter 7 or 11, and because under Chapter 7 or 11 safe harbors safe harbor would prohibit any preference and constructive fraudulent conveyance claims about protected parties and contracts, the 546(e) safe harbor must also prohibit all similar claims in a Chapter 15 matter, even if they relate to non-U.S. transactions and under foreign law.

With respect to the second step, the Court found that the application of the 546(e) safe harbor was domestic rather than extraterritorial, as the purpose of the safe harbor was ultimately to limit the powers avoidance of foreign representatives in US court.

Importantly, the Court also recognized that under Chapter 15, as in Chapters 7 and 11, the Section 546(e) safe harbor does not bar claims based on intentional fraud. , as opposed to constructive fraud. However, the Court concluded that the Fairfield the liquidators had not asserted any claim for intentional fraud, as their claims under BVI law only related to unfair preferences and fraudulent transfers by construction. Therefore, the exception for intentional fraud did not apply in this case.

Take away food

The Fairfield The ruling provides financial institutions with added assurance that under Chapter 15, just like Chapters 7 and 11, the safe harbor provisions of the U.S. Bankruptcy Code should render transactions under financial contracts protected under the free from “recovery” based on preference or implied fraudulent transfer claims. However, just as under Chapters 7 and 11, this Chapter 15 immunity does not extend to claims based on intentional fraud.

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