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New York’s International Banks Obtain Relief as Second Circuit Restricts Ability of Creditors to Use Maritime Rule B to Attach Electronic Fund Transfers

On Friday, October 16, 2009, the United States Court of Appeals for the Second Circuit issued a decision that will drastically reduce the ability of maritime creditors to intercept electronic fund transfers (“EFT”) passing through New York banks. Giving notable deference to an amicus brief filed by The Clearing House Association L.L.C., the court held in The Shipping Corp. of India Ltd. v. Jaldhi Overseas Pte Ltd, ___ F.3d ___, Slip Op. 08-3477-cv(L)(October 16, 2009)(“Jaldhi”), that EFTs being processed by an intermediary bank are not “defendant’s property” subject to attachment under Rule B of the Supplemental Rules for Admiralty or Maritime Claims and Asset Forfeiture Actions (“Rule B”). In doing so, the court overruled its own decision in Winter Storm Shipping Ltd. v. TPI, 310 F.3d 263 (2d Cir. 2002)(“Winter Storm”). Winter Storm and several subsequent rulings led to the filing of thousands of Rule B actions in the Southern District of New York (“SDNY”) intended to intercept EFTs as security for claims being pursued in arbitrations and court actions around the globe. The frequency of such actions exploded during 2008’s fall economic meltdown. In the view of some commentators, Rule B attachments of EFTs had reached the point of threatening the U.S. dollar’s status as the primary reserve currency. They also threatened New York City’s standing as a center of international banking and finance.

The Scope of Rule B

Rule B has ancient origins and provides a remedy to creditors who might otherwise be frustrated by the “here today, gone tomorrow” nature of international shipping. Maritime attachment is a feature of admiralty law older than the congressional grant of admiralty jurisdiction to the federal district courts in the 1790s and the Supreme Court’s promulgation of the first admiralty rules in the 1840s. The rule allows creditors to obtain quasi in rem jurisdiction over absent defendants, and it also provides a device to assure satisfaction of a judgment by attaching property that is unrelated to the underlying dispute. For example, a London bank owed money by a defaulting Scandinavian company with an oil rig operating in Mexican waters could obtain jurisdiction over its defaulting borrower in New York if the bank could identify and attach property of the borrower held by a third party located in Manhattan. In recent years, a lucrative target has been EFTs flickering in an electronic heartbeat through New York banks. Plaintiff creditors have obtained attachment orders seizing funds in transit originating from the accounts of their defaulting counterparties as well as funds in transit from third parties intended to pay wholly unrelated debts owed to those defaulting counterparties.

The elements of Rule B are relatively straightforward. An attachment can issue if the plaintiff shows that (1) it has a valid prima facie admiralty claim against the defendant (e.g., a multimillion-dollar charter party of an oil tanker or a drilling rig); (2) the defendant cannot be found within the district; (3) the defendant’s property may be found within the district; and (4) there is no statutory or maritime law bar to the attachment. Until the Second Circuit’s decision in Jaldhi, most courts hearing Rule B motions have taken the broad view that EFT funds in the virtual hands of an intermediary bank are “property” of the defendant.

Winter Storm: Attachment of EFTs at Intermediary Banks

In Winter Storm, the Second Circuit confronted “the interplay between a centuries-old admiralty law procedure and present day banking technology…involved in electronic fund transfer…between banks.” In that case, a Maltese corporation chartered its vessel to a Thai company to carry oil from Saudi Arabia to Thailand. The defendant allegedly failed to pay the freight owed, and the plaintiff vessel owner commenced an arbitration in London as required under the charter party. In addition, however, the plaintiff obtained a Rule B attachment aimed at electronically transferred funds in the hands of the Chase Manhattan Bank and/or the Bank of New York (“BNY”). As events unfolded, the Thai defendant happened to order its bank in Bangkok to pay a wholly unrelated third party $1 million in a completely unrelated commercial transaction. That payment, intended ultimately for the third party’s account with the Royal Bank of Scotland (“RBS”), was attached while passing through BNY, which was merely serving as the intermediary corresponding bank for the EFT from the Thai bank to RBS.

TPI moved to vacate the attachment on the grounds (1) that the order was unconstitutional (i.e., an EFT passing electronically through a New York bank constituted insufficient contact to establish in personam jurisdiction over TPI in New York) and (2) that the EFT in the hands of an intermediary bank was not “defendant’s property” within the meaning of Rule B. The district court (Shira A. Scheindlin, Judge) granted the motion, but the Second Circuit reversed. Relying heavily upon an earlier case that allowed the in rem seizure of an EFT allegedly related to a drug deal and attached under the drug civil forfeiture statute, the Winter Storm appellate panel held that EFT funds in the hands of an intermediary bank were sufficiently property of the defendant to be subject to attachment under Rule B.

Winter Storm’s Aftermath: An Explosion of EFT Attachments

Winter Storm created a thriving cottage industry for the New York admiralty bar and a big, expensive headache for New York’s international banking community. The impact on the international fund transfer system became particularly severe as the economy collapsed in the last quarter of 2008. One aspect of that collapse was a sharp downturn in commodity transactions, and that downturn caused the bottom to fall out of the rates for ship charters. The charter hire market went from an unprecedented boom in the summer of 2008 to a tidal wave of defaults and a record-setting amount of excess shipping tonnage by year’s end. Defaults under charter parties and contracts of affreightment, while the subject of arbitration clauses requiring dispute resolution in London and other international commercial centers, all found their way to the SDNY in the form of actions seeking Rule B attachments of EFTs aimed at seizing security that might ultimately satisfy a judgment rendered elsewhere. According to the amicus brief filed by The Clearing House Association, 962 Rule B actions were filed in the SDNY between October 1, 2008 and January 31, 2009. These actions sought to attach $1.35 billion worth of EFTs and constituted 33 percent of the lawsuits filed in the SDNY. The crush of attachments was on top of the 800 to 900 writs that were already outstanding. The Second Circuit cited this information in Jaldhi and was certainly influenced by the logistical and financial impacts these actions were having on both the courts and the banks.

Jaldhi Holds That EFTs Being Processed by an Intermediary Bank Are Not “Property” Subject to Attachment Under Rule B

In Jaldhi itself, the Shipping Company of India chartered a bulk carrier to Jaldhi Overseas Shipping in March 2008 to transport iron ore from India to China. While loading cargo in Kolkata, India, a ship’s crane collapsed and killed the crane operator. The ship went off-hire because of the accident and subsequently a dispute involving $4.5 million in charter hire, legal fees and costs erupted between the parties. The Shipping Company of India initiated a Rule B action in New York, and initially obtained a writ that was served upon New York’s international banks. Five different EFTs amounting to $4.5 million and sent by three different originators for the benefit of Jaldhi were attached at intermediary banks. A sixth EFT originated by Jaldhi in the amount of $282,726 was also attached. Slip Op. at 12 n.6.

Jaldhi promptly moved to vacate the attachments, and the court (Jed S. Rakoff, Judge) granted the motion. The court held that a Rule B attachment “only applies to a defendant’s property, and EFTs directed by third parties to a defendant do not become the defendant’s property until the transfer is completed.” 2008 WL 2596229 (S.D.N.Y. June 27, 2008). Judge Rakoff relied squarely on his own prior decision in Seamar Shipping Corp. v. Kremikovtzi Trade Ltd., 461 F.Supp.2d 222 (S.D.N.Y. 2006), wherein he had ruled that neither Winter Storm nor Aqui Stoli Shipping Ltd. v. Gardner Smith Pty Ltd., 460 F.3d 434 (2d Cir. 2006), had resolved the question of whether or not a Rule B attachment could reach EFTs of which the defendant was the beneficiary rather than the originator.

On appeal, the Second Circuit affirmed Judge Rakoff’s decision and warmly embraced the arguments put forward in the Clearing House’s amicus brief. In fact, the court of appeals went so far as to “conclude, with the consent of all of the judges of the Court in active service, that Winter Storm was erroneously decided and therefore should no longer be binding precedent in” the Second Circuit. Slip. Op. at 4.

The court of appeals explained that it had mistakenly relied upon United States v. Daccarett, 6 F.3d 37 (2d Cir. 1993), which was an in rem forfeiture case. On closer review in Jaldhi, the court determined that while forfeiture statutes allow the government to attach property that is “traceable” to an illegal activity, that seemingly analogous action does not provide a sound basis for the conclusion that an EFT in the hands of an intermediary bank is property of the defendant within the meaning of Rule B. Forfeiture is a broader concept, and the government is not required to demonstrate that money traceable to an illegal activity is anyone’s property. In distinct contrast, a necessary element of a Rule B maritime attachment is that the plaintiff demonstrate that the money to be attached is the property of the defendant.

Having rejected the forfeiture analogy, the court of appeals took the next step and rejected Winter Storm. The earlier court held that it did not need to consider state law concerning EFTs because it viewed the federal forfeiture example as a sufficient federal basis for the property analysis. Jaldhi, however, having decided that the analogy did not hold, looked to state law in the absence of controlling admiralty holdings on the property issue. This is standard practice for courts sitting in admiralty and confronted with issues to which no controlling admiralty principle applies. As noted, the relevant New York U.C.C. provisions of Article 4A of the New York Commercial Code, dealing with electronic funds transfers, dictate that neither the originating party nor the beneficiary party has title to the money while it is in the hands of the correspondent intermediary bank. In fact, this point had been stressed by a Commentary issued only last July by the Permanent Editorial Board of the Uniform Commercial Code disapproving the result in Winter Storm

Although a bit chagrined at overruling its own “relatively recent case,” the Second Circuit did not hesitate to overturn Winter Storm once it determined that reliance on the forfeiture cases was misplaced. The court declared: The “effects of Winter Storm on the federal courts and international banks in New York are too significant to let this error go uncorrected simply to avoid overturning a recent precedent.” Slip Op. at 16.

Barring any further review, the judges in the SDNY probably have one more flood to wade through. No doubt there will be motions to vacate filed in a great many of the still pending cases in which EFT funds have been attached as security for judgments yet to be awarded in arbitrations and trials. New York’s banks, however, should see a dramatic drop in the number of writs that arrive daily at their doorsteps. Additionally, the urge to denominate international commercial transactions in Euros, Yen or other currencies in order to circumvent Rule B should be abated.

© 2009 Bingham McCutchen LLP

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About this Author

Robert E. McDonnell, environmental attorney, land use lawyer, Bingham McCutchen, law firm

Bob McDonnell has been with the firm since 1983. Bob concentrates his practice on environmental, land use and real estate matters. He counsels clients on compliance and permitting, defends them in enforcement cases, and represents them in trials in the state and federal courts and in hearings before administrative agencies and boards.

Bob represents a number of Fortune 500 companies, but also devotes a significant amount of his time to privately held companies and family-owned businesses. He has represented fiduciaries in various matters, and represents clients in commercial...

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