In a groundbreaking decision of particular importance to participants in Chapter 15 proceedings, the United States Court of Appeals for the Second Circuit issued an opinion making clear that defendants in Chapter 15 proceedings may have Safe Harbor defenses even when a liquidator brings non-U.S. common law claims. This decision, issued on August 5, 2025 in Fairfield Sentry, holds that when a liquidator uses a US Bankruptcy Court to pursue non-U.S. common law claims, it must abide by the safe harbor afforded by Section 546(e) of the U.S. Bankruptcy Code (the “Safe Harbor”). Relying on a brief submitted by Freshfields on behalf of the Securities Industry and Financial Markets Association (“SIFMA”),[1], the Court held when liquidators winding up non-U.S. entities use Chapter 15 of the US Bankruptcy Code, they may not bring a non-US common law claim when similar claims based on U.S. state law are barred by the Safe Harbor. The Court’s decision in Fairfield Sentry adds a key defense for those facing claw back actions brought pursuant to Chapter 15.
Fairfield Sentry is a case pending under Chapter 15 of the U.S. Bankruptcy Code. The case is ancillary to insolvency proceedings pending in the British Virgin Islands (the “BVI”) for various funds (“Funds”) that had invested with Bernard Madoff's enterprise. While the Funds were operational, shares in the Funds were redeemable. After Madoff's fraud was discovered, the Funds ceased making redemption payments and became the subject of the BVI liquidation proceedings. Liquidators were appointed by the BVI court. The Liquidators commenced Chapter 15 cases in the U.S. Bankruptcy Court for the Southern District of New York.
The Liquidators brought adversary proceedings in the Chapter 15 cases, seeking to recover certain redemption payments that had been made by the Funds. The Liquidators sought to recover "unfair preferences" and "undervalue transactions" under BVI statutory insolvency law (the “BVI Statutory Avoidance Claims”) and asserted claims under BVI common law for, inter alia, the imposition of a constructive trust (the “BVI Constructive Trust Claims” and, with the BVI Statutory Avoidance Claims, the “Claims”).
The defendants moved to dismiss the Claims based on the Safe Harbor. Section 546(e) of the Bankruptcy Code provides that “notwithstanding” certain sections of the Bankruptcy Code that permit a bankruptcy trustee to pursue certain fraudulent transfers or other avoidance actions, the trustee may not pursue a transfer that is protected by the Safe Harbor – e.g., “a transfer that is a . . . settlement payment . . . made by or to (or for the benefit of) a . . . financial institution [or] financial participant . . . , or that is a transfer made by or to (or for the benefit of) a . . . financial institution [or] financial participant . . . in connection with a securities contract,” unless the claim is asserted under the Bankruptcy Code’s statutory provision allowing a trustee to avoid a transfer made with the actual intent to hinder, delay or defraud creditors. Section 561(d) of the Bankruptcy Code, in turn, makes the Safe Harbor applicable in a Chapter 15 case “to limit avoidance powers to the same extent as in a proceeding under” Chapter 11 of the Bankruptcy Code.
The Bankruptcy Court ruled that Section 561(d) barred the BVI Statutory Avoidance Claims, finding that this section of the Bankruptcy Code “necessarily” barred avoidance claims asserted pursuant to the provisions of BVI’s statutory insolvency laws.
In a novel analysis, the Bankruptcy Court declined to dismiss the BVI Constructive Trust Claims. Basing its analysis on the Supremacy Clause of the U.S. Constitution, the Bankruptcy Court declined to apply the doctrine of implied preemption to the BVI Constructive Trust Claims, relying on cases holding that “courts do not assume that otherwise applicable [non-U.S.] law is preempted absent express [U.S.] statutory language to that effect." Because the defendants had not identified any U.S. statutory language that expressly preempted the BVI Constructive Trust Claims, the Bankruptcy Court denied the motion to dismiss these claims. On appeal, the District Court for the Southern District of New York affirmed the Bankruptcy Court’s decision, and the defendants appealed to the Court of Appeals for the Second Circuit.
The Second Circuit reversed these decisions. The Second Circuit found that Section 546(e) applied to U.S. domestic common law claims “irrespective of implied-preemption principles.” The Second Circuit held that the Safe Harbor in Section 546(e) “directly bars a [U.S. bankruptcy] trustee from avoiding a transaction within the scope of the safe harbor no matter whether it is asserting statutory or common-law claims.” Consequently, the Second Circuit determined that Section 561(d) of the Bankruptcy Code likewise makes the Safe Harbor apply to “[non-U.S.] common law avoidance claims fall[ing] with the scope of the [Section 546(e)] safe harbor in cases under Chapter 15.”
The Second Circuit’s decision is a significant contribution to emerging Chapter 15 jurisprudence. It eliminates an anomaly in which certain claims would be barred by the Safe Harbor if asserted under a U.S. state’s common law, but not barred if asserted under non-U.S. common law. Agreeing with the brief that Freshfields submitted on behalf of SIFMA, the Second Circuit decided that it “cannot be” that, in enacting the Safe Harbor, the U.S. Congress “intended to hobble investors by leaving them exposed to the risk of avoidance litigation brought by bankruptcy estates of failed [non-U.S.] companies, especially when the Bankruptcy Code bars domestic trustees from bringing the exact same claims.”
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[1] SIFMA is a securities industry trade association representing the interests of hundreds of securities firms, banks, and asset managers. SIFMA champions policies and practices that foster a strong financial industry while promoting investor opportunity, capital formation, job creation, economic growth, and trust and confidence in financial markets.
