It’s hard to think of a worse time to pop the bubble of U.S. global bankruptcy dominance than the 4th of July holiday weekend – our annual celebration of American exceptionalism. But that is precisely what happened in the latest Madoff opinion. In an opinion signed on Sunday, July 6th, Judge Rakoff applied the presumption against extraterritorial application to the Bankruptcy Code and held that section 550(a)(2), which imposes liability on subsequent recipients of avoided transfers, cannot be applied to transfers between two foreign entities. See SIPC v. Bernard L. Madoff Investment Securities LLC (In re Madoff Securities), No. 12-mc-115 (S.D.N.Y. July 7, 2014) (Rakoff, D.J.).

While the facts involve a very foreign transaction, the reasoning is broadly stated and would limit all avoidance powers to only domestic transactions. Further, once the presumption is let out of its box, it is hard to articulate a limiting principle that prevents it from neutering other, more critical, Bankruptcy Code provisions. The strongest argument for extraterritorial application of the Bankruptcy Code is the “wherever located” language that appears in the section 541 property of the estate provision and the 28 U.S.C. § 1334(3)(1) jurisdictional grant. Arguably this language demonstrates that Congress intended for the entire Code to apply globally. Judge Rakoff rejects that holistic approach and instead adopts a section-by-section approach that looks to whether the specific section (here section 550) has any language suggesting extraterritorial reach. Finding none (and you will find none in almost all Code provisions) he then considers the argument that the 541 language broadly defining property of the estate is incorporated into section 550. That argument fails here, according to the Court, because fraudulently transferred property does not become property of the estate until it is actually recovered.

This approach may provide a way to apply property-related Code sections extraterritorially, but many important Code provisions (e.g., discharge and adjustment of debts) do not relate to property and, presumably, cannot apply extraterritorially. While the Madoffanalysis obviously presents new challenges in cases where foreign entities try to use Chapter 11 to reorganize their global operations, it may also present problems for United States businesses with extensive foreign operations. Under the Madoff approach, the application of a particular Code provision to a party or transaction will turn on a factually-intensive inquiry as to the foreignness of the relationship or the transaction.

The irony in the avoiding powers context is that under Chapter 15, U.S. courts apply the foreign nation’s avoiding powers when a foreign debtor attacks U.S.-based transactions involving U.S. defendants. See In re Condor, 601 F.3d 319 (5th Cir. 2010); see also 11 U.S.C. § 1521(a)(7) (limiting use of U.S. avoiding powers). This makes sense because the scope and nature of avoiding powers should be based on the structure of the relevant insolvency scheme. The Madoff opinion upsets that equilibrium.

While Judge Rakoff’s aggressive application of the presumption against extraterritoriality threatens to upend our understanding of how our law applies to global enterprises, his interpretation of the presumption against extraterritoriality may be correct. The Supreme Court has greatly expanded the presumption in recent years, most recently deciding that the Alien Tort Statute doesn’t apply to some alien torts! See Kiobel v. Royal Dutch Petroleum Co., ___ U.S. ___, 133 S.Ct. 1659 (2013). It was only a matter of time before the Supreme Court’s hostility to extraterritoriality seeped into bankruptcy law.