New York Bankruptcy Court Decision Illustrates the Risk That Routing Payments Through U.S. Banks Could Bring a Foreign Transaction Within the Reach of U.S. Bankruptcy Litigation

October 20, 2017

Several courts have held that the doctrine of international comity and the presumption against the extraterritorial application of U.S. law protect foreign transactions from avoidance actions in U.S. bankruptcy proceedings. However, on October 13, 2017, Judge Sean Lane of the United States Bankruptcy Court for the Southern District of New York held that the official committee of unsecured creditors could seek to avoid payments from the debtor, a Bahraini investment bank, to two Bahraini banks because the payments were routed through U.S. bank accounts and it was unclear whether the creditors’ committee could pursue similar claims in a foreign jurisdiction.[1] The decision illustrates the risk that routing a payment through U.S. bank accounts could unwittingly bring a foreign transaction within the reach of U.S. bankruptcy litigation in the event that the transferor subsequently files for bankruptcy, particularly when the transferee directs the payment to its U.S. bank account, and there is no foreign proceeding to which the U.S. court may defer.

I.     Background

Less than a month before the debtor commenced it chapter 11 case, the debtor and two foreign banks entered into investment agreements whereby the debtor agreed to transfer funds to the banks in connection with commodity transactions, and the banks agreed to repay the debtor on the designated maturity date. The parties negotiated and signed the agreements in Bahrain, which provided that they were governed by the laws of the Kingdom of Bahrain (except to the extent of a conflict with Islamic Shari’ah law, in which case Shari’ah law would prevail). The banks contended that they never maintained offices or conducted business in the U.S., and neither bank filed a proof of claim in the debtor’s bankruptcy case.[2] The banks allegedly directed the debtor to transfer the funds in U.S. dollars to bank accounts in New York maintained by the banks (or one of their affiliates). The debtor transferred the funds to the banks’ New York bank accounts from its own bank in New York.

After the debtor made these transfers—but before the time for repayment by the banks—it commenced its chapter 11 case.[3] Thereafter, when the investment agreements matured, the banks refused to repay the debtor and sought to “set off” the amounts that they owed to the debtor against other debts that the debtor owed to the banks. The creditors’ committee appointed in the debtor’s bankruptcy case sued the banks seeking to recover the payments as, among other things, avoidable preferences pursuant to sections 547 and 550 of the Bankruptcy Code, seeking $10 million from one bank and $18.5 million from the other.[4]

II.     The District Court Reverses the Bankruptcy Court’s Dismissal for Lack of Personal Jurisdiction Over the Banks

The bankruptcy court dismissed the creditors’ committee actions for lack of personal jurisdiction over the banks, holding that their mere receipt of funds through New York bank accounts was insufficient contact with New York to establish personal jurisdiction over them.[5] The bankruptcy court reasoned that “the use of the accounts was not central to the alleged wrong,” which occurred when the banks refused to repay the debtor and asserted their right to a setoff, not the initial transfers to the banks.[6] The bankruptcy court also noted that “the money here passed through these correspondent bank accounts once, but only as part of a transaction that began in Bahrain between Bahraini parties under a Bahraini contract and that ended overseas.”[7]

The district court reversed the dismissal, holding that the bankruptcy court had personal jurisdiction over the banks because a preference action focuses on the “transfer” of property by the debtor, and thus “[t]he Banks’ New York contacts−i.e., the receipt of the transferred funds in New York correspondent bank accounts−are at the heart of this cause of action. The receipt of the funds in New York is precisely the conduct targeted by the Committee, and the activity that the cause of action seeks to have voided.”[8] The district court further reasoned that “[t]he Banks selected U.S. dollars as the currency in which to execute the transaction” and “the selection of the New York correspondent bank accounts that received the funds originated with the Banks; they actively directed the funds at issue into those New York accounts.”[9] Thus, they “can hardly claim” that they could not foresee “being haled into court” in New York.[10] The district court acknowledged that, “[h]ad the record demonstrated that Arcapita [the debtor], as opposed to the Banks, selected the U.S. dollar and the New York accounts to effectuate the Placements, the Banks’ contacts with the United States would have been adventitious, and jurisdiction would not have lied.”[11] The district court also noted that it was reasonable for the bankruptcy court to exercise jurisdiction over the banks because there was no ancillary insolvency proceeding (e.g., a parallel insolvency proceeding in Bahrain), and it was unclear whether the creditors’ committee could bring similar claims in a foreign jurisdiction.[12] Thus, a failure to exercise jurisdiction would give the banks “priority over domestic creditors based simply on their foreign status.”[13]

III.     On Remand, the Bankruptcy Court Denies the Banks’ Motion to Dismiss Based on the Doctrine of International Comity and the “Presumption Against Extraterritoriality”

On remand to the bankruptcy court, the banks again moved to dismiss the creditors’ committee actions based on the doctrine of international comity and the presumption against extraterritorial application of U.S. law. Denying the motions, the bankruptcy court followed the district court’s analysis in holding that dismissal was not warranted because the banks had directed the payments to the U.S. bank accounts and it was unclear whether the creditors’ committee could pursue similar claims in a foreign jurisdiction.

A.     The Doctrine of International Comity

Under the doctrine of international comity, a court may refuse to exercise jurisdiction over a matter involving the affairs of a foreign nation “when the exercise of such jurisdiction is unreasonable.”[14] The bankruptcy court held that it is reasonable to assert jurisdiction over the banks because, quoting the district court, “the receipt of the transferred funds in New York correspondent bank accounts … are at the heart of this cause of action,” and a defendant “can hardly claim that it could not have foreseen being haled into court in the forum in which the correspondent bank account it had selected is located.”[15] It further reasoned that, while the debtor is a foreign entity, it “avail[ed] itself of U.S. law through its filing for bankruptcy and creating an estate pursuant to the Bankruptcy Code,” and “[t]he potential application of Bahraini law also does not mandate abstention based on comity given that the Court is competent to apply foreign law.”[16]

The bankruptcy court distinguished previous authority that had declined to exercise jurisdiction over foreign defendants in avoidance actions, including In re Maxwell Commc’n Corp. plc by Homan, 93 F.3d 1036 (2d Cir. 1996), on the basis that “the Second Circuit’s international comity decisions primarily emphasize the doctrine’s bankruptcy significance in the context of parallel insolvency proceedings.”[17] But in the case at hand, “[g]iven the lack of foreign insolvency proceeding, it is questionable whether the Committee would be able to obtain relief under Bahraini law.”[18] Thus, declining to exercise jurisdiction would enable “foreign creditors to potentially obtain priority over domestic creditors based simply on their foreign status,” and also “allow[] parties to do an end run [of] the Code by simply arrang[ing] to have the transfer made overseas, thereby shielding them from United States law and recovery by creditors.”[19]

B.     The “Presumption Against Extraterritoriality”

The bankruptcy court explained that “[t]he presumption against extraterritoriality is a longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.”[20] The bankruptcy court held that it “need not resolve whether the avoidance provisions of the Bankruptcy Code apply extraterritorially” because the banks’ receipt of the funds in New York was the “heart of this cause of action” and thus “the transfers … were domestic rather than foreign.”[21] Recognizing that some cases had reached the opposite result in similar circumstances, the bankruptcy court explained that “the question of extraterritoriality depends very heavily on the specific facts of each case,” and “importantly, some of these cases did not involve instances where, as here, both sides of the challenged transfer used a U.S. bank to complete the transfer.”[22]

IV.     Conclusion

The Arcapita decision illustrates the risk of unwittingly bringing a foreign transaction within the reach of U.S. bankruptcy litigation by routing payments through U.S. bank accounts, particularly where the transferee (as putative defendant) directed payment to a U.S. bank account, both sides of the transfer are routed through U.S. bank accounts, and there is no foreign proceeding to which a bankruptcy court might defer. When, as in Arcapita, the litigation focuses on avoidance of a transfer by the debtor to a third party, the location of the transfer in the U.S. may be sufficient to overrule the presumption against extraterritorial application of avoidance powers extant in chapter 5 of the Bankruptcy Code.


   [1]   The Memorandum of Decision (“Decision“) was filed in two adversary proceedings pending in the chapter 11 case of In re Arcapita Bank B.S.C.(c), Case No. 12-11076 (Bankr. S.D.N.Y.): Official Committee of Unsecured Creditors of Arcapita Bank B.S.C.(c) et al. v. Bahrain Islamic Bank, Case No. 13-01434, Dkt. No. 54; and Official Committee of Unsecured Creditors of Arcapita Bank B.S.C.(c) et al. v. Tadhamon Capital B.S.C., Case No. 13-01435, Dkt. No. 50.

   [2]   In re Arcapita Bank B.S.C.(c), 529 B.R. 57, 61 (Bankr. S.D.N.Y. 2015).

   [3]   Gibson Dunn represented Arcapita Bank B.S.C.(c) and affiliated debtors in their chapter 11 cases.

   [4]   The creditors’ committee obtained standing to bring avoidance claims against the banks pursuant to the debtor’s chapter 11 plan, which the bankruptcy court confirmed in June 2013. In re Arcapita Bank B.S.C.(c), 529 B.R. at 63.

   [5]   Id. at 73.

   [6]   Id. at 71.

   [7]   Id.

   [8]   Official Comm. of Unsecured Creditors of Arcapita v. Bahrain Islamic Bank, 549 B.R. 56, 69 (S.D.N.Y. 2016).

   [9]   Id. at 68-69 (emphasis in original).

[10]   Id. at 68 (“[W]hen a defendant purposely selects and uses a correspondent bank account to effectuate a particular transaction, and a plaintiff later files a lawsuit asserting a cause of action arising out of that transaction, the defendant can hardly claim that it could not have foreseen being haled into court in the forum in which the correspondent bank account it had selected is located.”) (citation omitted).

[11]   Id. at 71.

[12]   Id. at 72.

[13]   Id.

[14]   Decision at 8 (“International comity is 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. Under international comity, states normally refrain from prescribing laws that govern activities connected with another state when the exercise of such jurisdiction is unreasonable.”) (quotations and citations omitted).

[15]   Id. at 12 (quotations and citations omitted); see also id. at 17 (“[T]his case involves parties who structured their deal the way they wanted−using U.S. banks−and are merely being held accountable for the consequences of that structure.”).

[16]   Id. at 12.

[17]   Id. at 15; see also id. at 15-16 (“Importantly, the Second Circuit in Maxwell II observed that ‘a different result [than dismissal based on comity] might be warranted were there no parallel proceeding in England−and, hence, no alternative mechanism for voiding preferences….’ Maxwell II, 93 F.3d at 1052.”).

[18]   Id. at 16.

[19]   Id. at 13 (quoting the district court), 16 (citations and quotations omitted).

[20]   Id. at 17 (citations and quotations omitted).

[21]   Id. at 21, 27 n 12.

[22]   Id. at 24.

 


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