On June 14, 2010, the joint liquidators of Fairfield Sentry Ltd.—the largest Madoff “feeder fund”—filed a chapter 15 petition with the U.S. Bankruptcy Court for the Southern District of New York seeking recognition of the fund’s British Virgin Islands (BVI)-based insolvency proceedings. On July 22, 2010, the funds’ joint liquidators, with their BVI and U.S.-based counsel, walked out of bankruptcy court with the benefit of a bench ruling in their favor granting the relief requested in full, and heralding a new dawn for cross-border recognition in Manhattan.
The rosy fingers of this new dawn are truly remarkable. Fairfield seems to take the heft out of the evidentiary burden imposed by cases such as Bear Stearns and Basis Yield,and to allow practitioners to place greater reliance on the presumption that a debtor’s “center of main interests” (COMI) will be deemed to be the location of the debtor’s registered office. There are even shades of SPhinX in the new dawn, insofar as the bankruptcy court apparently proceeded from the starting point that some form of recognition was due and then determined its nature.
Indeed, Fairfield bodes well for expediency all around. Hon. Burton R. Lifland, ruling from a hot bench, declined to hold an evidentiary hearing. Rather, the court entertained oral arguments then basically ruled that the liquidators had acted in good faith and, as such, the COMI had become “lodged” with them in the BVI.
Considering the implications of the Fairfield recognition ruling, perhaps its most remarkable aspect is the opaqueness of the underlying record. The objection to the relief sought by the petitioners was filed under seal. The petitioners’ reply papers were filed in redacted form, with sealed exhibits. Due to a new judicial conference policy on access to official transcripts, the transcript of the recognition hearing will not be available on the bankruptcy court’s electronic docket until 90 days after it was filed.
The Chapter 15 Cases and The Recognition Ruling
On Dec. 11, 2008, Bernard Madoff was arrested by FBI agents and charged with securities fraud. Following the arrest it became publicly known that Madoff had orchestrated a multi-billion dollar Ponzi scheme for many years. His investors were led to believe that they were profiting as a result of a “nontraditional options trading strategy” described as a “split-strike conversion” when, in fact, their money was being misappropriated by Madoff to fund payments to other investors, and for other purposes.
In the wake of these disclosures, a number of funds that were heavily invested with Madoff collapsed. Among them were Fairfield Sentry Limited (Sentry), a BVI-based fund that invested substantially all of its assets with Madoff, and Fairfield Sigma Ltd. (Sigma) and Fairfield Lambda Ltd. (Lambda), BVI-based funds established, respectively, for Euro and Swiss franc investments with Madoff through purchase of shares of Sentry.
During the months immediately following the Madoff disclosures, these Fairfield funds were run by a litigation committee of their boards, comprised of non-conflicted directors. Most of the meetings of the boards of directors of the funds originated telephonically from the offices of the funds’ BVI-based counsel. The directors reached out to the funds’ shareholders by letters sent from the BVI, to apprise them of developments. Between February and April 2009, stakeholders of the funds successfully applied to the Commercial Division of the High Court of Justice, BVI for appointment of liquidators over the funds.
The court-appointed liquidators subsequently labored mightily to marshal the assets of the funds. By order of Hon. Mr. Justice Bannister dated May 7, 2010, the liquidators were authorized to seek recognition of their BVI-based insolvency proceedings in the U.S. under chapter 15 of the Bankruptcy Code. About a month later, the liquidators filed their recognition petitions.
By then, a derivative action had been brought, allegedly on Sentry’s behalf, against Sentry’s directors, investment manager (and related parties), auditors and administrators. The plaintiffs in that lawsuit were the sole objectors to recognition, objecting only to Sentry’s recognition because recognition would likely result in the staying of the lawsuit they had brought and shepherded for over a year and, ultimately, the displacement of the plaintiffs and their counsel from the lawsuit. They argued to the judge, who authored the seminal Bear Stearns recognition ruling, that he was looking at Bear Stearns number two—a letterbox company with a very low profile offshore, without a BVI COMI (or an establishment in the BVI), whose true COMI was New York.
If the location of the COMI of Sentry was the BVI or if Sentry had an establishment in the BVI, as the petitioners contended, then the bankruptcy court could grant recognition of Sentry’s foreign insolvency proceeding as a “foreign main proceeding” or a “foreign non-main proceeding” under, respectively, Code §§ 1517(b)(1) or 1517(b)(2). If the court concluded, as the objectors contended, that the COMI was in New York—that there was not a COMI, much less an establishment, in the BVI— then Sentry would be ineligible for chapter 15 recognition. The bankruptcy court boiled the parties’ dispute down to the following:
At bottom, the main point of contention between the parties seems to be whether, as the Petitioners argue…the Debtors’ [COMI] should be measured as of the date of the Petition and the Court should consider the liquidation proceeding as ongoing business activity, or, as the Objectors argue, COMI should include the period prior to and leading up to the filing of the Petition and the Court should focus only on the Debtors’ business activities prior to the liquidation [as those were the economic and business functions contemplated by their charters]. The contentions of both parties are misplaced, as a review of the relevant factors places the COMI focus in the BVI for the pre- and post-liquidation periods.
The bankruptcy court concluded that the COMI of each of the Fairfield debtor funds was in the BVI. In providing its analysis, the court did not compare the facts at bar with those presented its own prior seminal Bear Stearns decision. The absence of a comparison is curious because the Bear Stearns funds that were denied recognition, like the Fairfield debtor funds, were registered in the Caribbean (in that case, the Cayman Islands), and like the Fairfield debtor funds, their business was predominantly operated out of New York prior to their collapse and liquidation.
The court placed the COMI of the Fairfield debtor funds in the BVI because it concluded that the funds’ “nerve center” was there starting in December 2008, when the Madoff Ponzi scheme collapsed. The court did not discuss the location of the COMI prior to December 2008, when the debtors were engaging in the “business functions contemplated by their charters.” Satisfied that there had not been an “opportunistic shift to establish COMI,” the court focused on events post-Madoff collapse.
Implications of the Recognition Ruling
The bankruptcy court’s focus suggests that, in the absence of a public policy issue, if (1) a fund that is registered offshore and managed in the U.S. collapses, (2) its directors continue to follow pre-collapse corporate formalities post-collapse and (3) a few months later, the fund becomes the subject of insolvency proceedings in the offshore jurisdiction in which it is registered, especially involuntary proceedings—then (4) the fund’s offshore insolvency proceedings will likely be eligible for recognition because they will not be deemed an opportunistic shift to establish COMI. At least where the evidence supports a finding of good faith.
This ruling leaves several questions. What constitutes an “opportunistic shift to establish COMI”? What is the tell of a manufactured COMI? What necessarily is so wrong with “opportunistically” moving a COMI anyway? If it is in the interests of creditors, why shouldn’t you? Indeed, could a liquidator (or pre-liquidation, a board) conceivably be under a duty to do so, if so advised? Besides, is there not a sliding scale of innocent, good faith, convenient, opportunistic and forum shopaholic, along which the boundaries are never going to be clear cut? Yet, given that sliding-scale determinations seem inherently subjective, has not Fairfield revived subjective considerations as to the COMI determination once epitomized by SPhinX but buried beneath Bear Stearns for the past several years?
We may soon have guidance on the international level and from federal appellate courts. One of the issues that the U.S. delegation has raised for the consideration of the United Nations Commission on International Trade Law’s (UNCITRAL’s) Working Group V (Insolvency Law) is:
5. Should the time period in which a company maintains its COMI in a jurisdiction be a factor in determining the COMI of a debtor?
(a) Should the COMI of a debtor be determined as of the date on which the company was actually transacting business and conducting business operations prior to insolvency or thereafter when the company is insolvent and under the direction of a liquidator?
Also, on Aug. 5, 2010, the parties filing the sole objection to the recognition of Fairfield Sentry Ltd.’s BVI-based insolvency proceedings filed a notice of appeal. Stay tuned as the ruling makes its way up through the appellate process and, perhaps lands on the U.N.’s radar.
1. Modified Bench Memorandum and Order Granting Chapter 15 Petitions of Fairfield Sentry Ltd., Fairfield Sigma Ltd. and Fairfield Lambda Ltd. for Recognition of Foreign Proceedings, In re Fairfield Sentry Ltd., et al., Case No. 10-13164 (Bankr. S.D.N.Y. July 22, 2010) (Lifland, J.).
2. In re Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd., 374 B.R. 122, 129-30 (Bankr. S.D.N.Y. 2007) (Lifland, J.), aff’d, 389 B.R. 325 (S.D.N.Y. 2008) (Sweet, J.) (sua sponte concluding that debtors’ verified petitions demonstrated evidence rebutting presumption under 11 U.S.C. § 1516(c) that their COMI was country in which debtors kept their registered offices (Cayman Islands), and ruling that their “real seat” was United States).
3. In re Basis Yield Alpha Fund (Master), 381 B.R. 37 (Bankr. S.D.N.Y. 2008) (Gerber, J.) (requiring petitioners to come forward with extensive evidentiary presentation after declining to grant summary judgment based on 11 U.S.C. § 1516(c) presumption).
4. In Fairfield, the 1516(c) presumption carried the day for the two debtor “feeder funds” into Sentry (Fairfield Sigma Ltd. and Fairfield Lambda Ltd.) seeking recognition, although these funds’ BVI-based activities were, at one time, subject to statutory restrictions. See Modified Bench Memorandum, p. 5 n. 2 (discussing restrictions) and p. 10 (“with respect to Sigma and Lambda, there being no rebuttal to the registered office presumption, nor any objection to their recognition, the Sigma and Lambda BVI Liquidation Proceedings are recognized as foreign main proceedings.”).
5. Compare Modified Bench Memorandum at 4 (“The parties have agreed on the record that this case concerns (i) whether the BVI Liquidation Proceedings should be recognized as foreign main proceedings or, in the alternative, foreign main proceedings pursuant to Chapter 15 of the Bankruptcy Code, and (ii) if the Debtors’ foreign main proceedings are so recognized, whether Petitioners are entitled to other relief as requested in the Verified Petition filed by the Petitioners.”) with In re SPhinX Ltd., 351 B.R. 103, 106 (Bankr. S.D.N.Y. 2006) (Drain, J.), aff’d, Krys v Official Comm. of Unsecured Creditors of Refco Inc. (In re SPhinX, Ltd.), 371 B.R. 10 (S.D.N.Y. 2007) (Sweet, J.) (recognizing that Cayman Islands-based proceedings at issue as foreign proceedings, as initial matter, and later ruling on whether they should be recognized as foreign main or foreign non-main proceedings).
6. See Modified Bench Memorandum at 2 (citing Fed. R. Bankr. P. 1011).
7. Id. at 6-7.
8. As detailed in progress reports available on www.fairfieldsentry.com, www.fairfieldsigma.com and www.fairfieldlambda.com.
9. Sentry could conceivably be subject to involuntary proceedings under chapters 7 or 11 of the Code, though a drafting inconsistency between §§ 303(b)(4) and 1511(b), noted by Judge Lifland in Bear Stearns, at a minimum, calls the availability of chapters 7 and 11 relief to non-recognized funds into question. See Bear Stearns, 374 B.R. at 132 n. 15.
10. Modified Bench Memorandum, at p. 3. Note that while the Fairfield court phrases its analysis as presenting only a COMI issue, the same analysis would seem critical to determining whether an “establishment” existed, thereby making the Fairfield analysis applicable to determining “non-main” qualifications as well. Importantly, this seemingly would make Bear Stearn’s outcome (i.e., no recognition at all) less likely to occur.
11. Id. at 6 (citing Hertz Corp v. Friend, 130 S.Ct. 1181, 1193-94 (2010)).
12. Id. at 8.
13. See 11 U.S.C. § 1506 (public policy exception).
14. Modified Bench Memorandum, at p. 8 n. 5 (“Of note, the procurement of the Sentry BVI Liquidation Proceedings was at the behest of shareholders, and not management.”).
15. Insolvency Law: possible future work, Addendum, Proposal by the delegation of the United States of America [to the United Nations Commission on International Trade Law Working Group V (Insolvency Law)]: background paper, dated Feb. 17, 2010, p. 17. The U.S. delegation does not pose the question—but perhaps it should—“Why not adopt the bright-line temporal approach of In re Betcorp Ltd., 400 B.R. 266 (Bankr. D. Nev. 2009), and Lavie v. Ran (In re Ran), No. 09-20288, 2010 WL 2106638 (5th Cir. May 27, 2010), i.e., as of the time the petition is filed?” Note also that the U.S. delegation phrases the temporal questions, like Fairfield, as only COMI-related, see supra n. 9.