Fairfield Sentry liquidators win key ruling in battle to secure better deal for the sale of Sentry’s claim in the estate of BLMIS
Second Circuit Clarifies Application of Section 363 in Chapter 15 Proceedings
In a landmark decision, the Second Circuit Court of Appeals (“Second Circuit”) has confirmed the applicability of section 363 of the US Bankruptcy Code (the “Code”) to dispositions of property within the United States by foreign liquidators of insolvency proceedings recognised under Chapter 15 of the Code. In reaching its decision, the Second Circuit rejected the suggestion that comity considerations altered the standard of review which must be performed and made clear that a section 363 review in a Chapter 15 context will follow the same principles as those applicable to Chapter 7 and Chapter 11 domestic proceedings. Significantly, and in contrast to the position in English common law jurisdictions, this review must take into account factors which arise after the conclusion of any contract for the disposition of property.
This opens the way for those administering foreign insolvency proceedings who have obtained recognition of those proceedings under Chapter 15 to disclaim contracts which subsequently can be seen to provide bad value for stakeholders in the foreign proceedings where (for example) unforeseen circumstances cause an increase in value of the asset to be sold. In this case, the liquidators of Fairfield Sentry Limited (“Sentry”) may now be able to seek a vastly improved return for its stakeholders in respect of its claim in the estate of Bernard L. Madoff Investment Securities LLC (“BLMIS”).
Sentry is a collective investment fund registered in the British Virgin Islands (“BVI”) and was the largest feeder fund into BLMIS. As is well known, in December 2008, BLMIS was revealed to be a Ponzi scheme. Sentry immediately suspended calculation of its Net Asset Value and was subsequently placed into liquidation in the BVI. Sentry’s liquidators subsequently petitioned in the US for recognition of Sentry’s BVI proceeding as a “foreign main proceeding” pursuant to Chapter 15 of the Code. In what was itself a landmark decision (ultimately affirmed by the Second Circuit), the US Bankruptcy Court granted such recognition, holding that the relevant period for determining a foreign debtor’s centre of main interests (“COMI”) is the time of the filing of the Chapter 15 petition and not when the underlying foreign proceeding was commenced, such that the US courts were entitled to look at the post-liquidation activity of Sentry (which centred in the BVI) when determining COMI.
Soon after their appointment, Sentry’s liquidators entered into settlement negotiations with Irving Picard, the Trustee in the Securities and Investment Protection Act (“SIPA”) proceedings of BLMIS. In around May 2011 the liquidators concluded a settlement with Mr Picard, pursuant to which, amongst other things, Sentry was granted an allowed claim in BLMIS’s SIPA proceedings in the fixed amount of US$230 million. In the meantime, and in anticipation of the settlement with Mr Picard, the liquidators entered into an agreement with Farnum Place LLC (“Farnum”), a Delaware company incorporated by some distressed credit traders, by which Sentry agreed to sell its eventual admitted SIPA claim to Farnum for a price of 32.125% of the admitted value of the claim (i.e. the value that Mr Picard accepted in the SIPA liquidation of BLMIS). That price was in line with general market prices of BLMIS SIPA claims at the time the deal was concluded – but a mere three days later Picard concluded a settlement with the widow of Jeffry Picower, a large beneficiary of the Madoff fraud, that was very much larger than had been expected. The Picower settlement recovered US$7.2 billion for the benefit of the victims of the Madoff fraud, US$5 billion of which would be made available for distribution through the BLMIS SIPA proceedings (the remaining US$2.2 billion flowed to the US Department of Justice-run Madoff Victim Fund). News of the settlement caused an immediate spike in the trading prices of BLIMS SIPA claims – which then began trading at more than double the price the liquidators had agreed with Farnum.
The contract signed with Farnum (referred to as the “trade confirmation”) provided for the assignment of the SIPA claim to Farnum to be conditional upon Sentry’s liquidators obtaining approval of its terms by the BVI and US Courts. In addition, as the Second Circuit has now confirmed, regardless of the express terms of the agreement, section 1520 of the Code affected the parties’ bargain and required that the assignment of the SIPA claim, being an interest in US property, was conditional upon approval of the US courts pursuant to section 363 of the Code. In the circumstances, the liquidators of Sentry felt that it was no longer consistent with their duties to complete the sale of the SIPA claim to Farnum, and declined to seek the necessary approvals.
Farnum forces the issue
Farnum brought a claim under section 273 of the BVI Insolvency Act 2003 (pursuant to which persons who are “aggrieved” by an act or omission of a BVI liquidator may apply to the court for relief). Farnum sought BVI court approval for the trade confirmation. The BVI court granted its approval, applying a Greenhaven Motors-type test, which examines whether the deal was one that a reasonable liquidator would have entered into at the time at when it was entered into, or whether the agreement is otherwise objectionable on policy grounds. Mr Justice Bannister, the BVI Commercial Court judge, did not consider himself entitled to take into account the subsequent price spike, and because it was not disputed that the liquidators had acted reasonably and in the best interests of Sentry’s stakeholders when they entered into the deal with Farnum, Justice Bannister felt bound to approve the deal.
In the same proceedings, Farnum sought to argue that Sentry was not obliged to seek any further approval of the US courts for the deal, either by the express terms of the agreement itself or under any overriding and mandatory provisions of the Code. After hearing several days of expert evidence of US bankruptcy law and New York state law (which governed the agreement between Sentry and Farnum), Justice Bannister declined to make a finding in that regard and directed the liquidators to apply to the US Bankruptcy Court to determine questions relating to US approval.
Sentry’s liquidators, acting in accordance with those directions, made an application to the US Bankruptcy Court for approval of the contract with Farnum, recommending that the US Bankruptcy Court decline to grant such approval.
The late Judge Lifland, then the supervising judge of Sentry’s Chapter 15 proceedings (as well as the BLMIS SIPA proceedings), approved the contract. Judge Lifland’s decision was, in essence, based on dual grounds that: (1) the transfer of Sentry’s SIPA claim would not involve an interest of a debtor in property in the United States, because the SIPA claim was not located in the United States; and (2) in any event, the principles of comity required deference to the BVI judgment, which had approved the transfer of the SIPA claim to Farnum. Judge Lifland reasoned that, under New York law, the location of an intangible asset is a flexible test based on considerations of “justice, convenience and common sense.” Judge Lifland then further ruled that Sentry’s SIPA claim is a BVI asset because the liquidators, having been appointed by and answering to the BVI court, have custody and control over all of Sentry’s assets, and the proceeds of Sentry’s SIPA claim will be administered in the BVI.
Sentry’s liquidators, with permission from the BVI court, appealed Judge Lifland’s decision to the District Court, where Judge Hellerstein approved Judge Lifland’s earlier decision albeit at least in part on substantially different reasoning. Judge Hellerstein declined to determine whether the SIPA Claim was in fact US property under the applicable law, but proceeded upon the assumption that it was and that, accordingly, section 363 of the Code did apply to dispositions of SIPA claims. Nevertheless, Judge Hellerstein held that the section 363 review which was required was not “the same analysis that is required without some kind of foreign proceeding…”. Judge Hellerstein ruled that Judge Lifland had satisfied the requirements of section 363 by relying on and importing the BVI Judgment approving the contract between Sentry and Farnum, provided that Judge Lifland had appropriately determined that that decision was sound and that the transaction (evaluated at the time the contract was concluded) was fair. Judge Hellerstein then ruled that Judge Lifland had made such a determination, and “that was his obligation under the rules of comity.”
Second Circuit Decision and proceedings in the BVI
Once again, the liquidators sought to appeal the District Court’s decision – this time to the Second Circuit, resulting in its recent ruling, vacating and reversing the earlier decisions of the lower courts.
At this point, the litigation contest shifted focus to the BVI. As in the case of all proceedings brought by the liquidators in the name of Sentry, the liquidators needed the sanction of the BVI Commercial Court in order to pursue an appeal to the Second Circuit. Such sanction relates only to the ability of the liquidators to recover their costs from the estate of Sentry, and does not affect the standing or authority of the liquidators to pursue the claims. Nevertheless, for obvious commercial reasons, a liquidator would normally wish to have the appropriate sanction.
The liquidators therefore sought sanction from the BVI Commercial Court, but sanction was refused at first instance by Justice Bannister. The liquidators appealed that decision to the Eastern Caribbean Court of Appeal (“ECCA”). In accordance with a direction by Justice Bannister, the liquidators gave notice of the ECCA appeal to Farnum. In an unusual move, and despite having no interest in the liquidation of Sentry as a member or creditor, Farnum sought to intervene in the ECCA appeal. The ECCA granted Farnum exceptional permission to do so in October 2013, taking the view that the circumstances were “unique”. Farnum was therefore allowed to attend and make representations at the hearing of the ECCA appeal, which took place in July 2014. A decision in that appeal is still pending. However, the ECCA had also granted the liquidators interim sanction, which was extended at various points and eventually covered all steps in the SCCA proceedings up to and including the oral arguments.
The Second Circuit oral hearing took place on 21 May 2014. After reserving judgment, the Second Circuit gave its reasoned judgment on 26 September 2014 and concluded unequivocally that Sentry’s SIPA claim was US property and that principles of comity did not vitiate the obligatory review under section 363 of the Code. In reaching that conclusion, the Second Circuit applied the definition of US property set out in section 1503 of the Code which deems “any property subject to attachment or garnishment that may be properly seized or garnished by an action in the United States” to be property located in the United States. The Second Circuit held that the SIPA claim was capable of garnishment or attachment in the United States. Judge Walker, giving the written decision, reasoned that, for attachment purposes, with respect to intangible property that has as its subject a legal obligation to perform, the situs is the location of the party of whom that performance is required pursuant to that obligation. Sentry’s SIPA Claim was in essence a legal obligation on the part of the BLMIS SIPA Trustee to distribute to Sentry its pro rata share of the BLMIS estate and was thus within the United States.
Having decided that the SIPA claim was US property, it followed inescapably (in light of the express words of section 1520 of the Code) that any disposition of the SIPA Claim, such as the disposition to Farnum, MUST be subject to a section 363 review.
The Second Circuit then considered and rejected the argument that the standard of section 363 review which was required in the context of a Chapter 15 proceeding differed in substance from that which is required in domestic proceedings such as Chapter 11 or Chapter 7 proceedings. The Second Circuit considered that argument to be contradicted by the express wording of section 1520, which states that section 363 should apply in Chapter 15 proceedings “to the same extent” as in Chapter 11 or Chapter 7 proceedings. In any event, the Second Circuit noted, the BVI court had not requested or expected deference to its decision to approve the contract with Farnum, having expressly left the question of whether a section 363 review was required to the US courts.
Remitting the matter to the US Bankruptcy Court for a section 363 review to be undertaken, the Second Circuit set out guidance as to the principles which must apply to the review. The Second Circuit made clear that the Bankruptcy Court must consider all salient factors including whether the price of the asset is increasing or decreasing, adding that the Bankruptcy Court’s role is to ensure that the best possible deal is achieved for the benefit of the debtor’s estate. Significantly, the Second Circuit specifically directed that any section 363 review of Sentry’s deal with Farnum must take into account the increase in the price of SIPA Claims shortly after the deal was concluded. The US review process (should it take place) will therefore differ dramatically from that in the BVI courts, where the court would be bound NOT to consider price changes after the signing of the contract.
The decision therefore opens the way for Sentry’s liquidators to argue that the US Bankruptcy Court should withhold approval for the trade confirmation, thereby preventing the trade confirmation from becoming effective, and thus achieving significantly enhanced value for Sentry’s stakeholders.
Forbes Hare acts as BVI counsel for the liquidators of Fairfield Sentry. The team includes partners William Hare and Alistair Abbott and associates Sinead Harris and Daniel Mitchell. The Forbes Hare team instructed Gabriel Moss QC of South Square Chambers to represent the liquidator in respect of the appeal to the Eastern Caribbean Court of Appeal.
The Liquidator was represented in the US proceedings by David Molton, Dan Saval, May Orenstein and Marek Krzyzowski of Brown Rudnick LLP, and Paul Clement of Bancroft PLLC, an appellate specialist and a former Solicitor General of the United States, represented the Liquidator, with Brown Rudnick LLP, at oral argument before the United States Court of Appeals for the Second Circuit.