In re Fairfield Sentry Ltd: Second Circuit Holds Sale of SIPA Claim by Chapter 15 Debtor Subject to Section 363 Review

Practical Law Legal Update 4-583-3985 (Approx. 6 pages)

In re Fairfield Sentry Ltd: Second Circuit Holds Sale of SIPA Claim by Chapter 15 Debtor Subject to Section 363 Review

by Practical Law Finance

Background

Fairfield Sentry Limited (Debtor) is a British Virgin Islands (BVI) investment fund that invested about 95% of its assets with Bernard L. Madoff Investment Securities LLC (BLMIS), a limited liability company wholly owned by Bernard Madoff. In December 2008, Madoff revealed that he used customer funds to perpetuate a massive Ponzi scheme, leading to the collapse of BLMIS. The US Bankruptcy Court for the Southern District of New York (Bankruptcy Court) placed BLMIS into liquidation (BLMIS Liquidation) under the SIPA.

In July 2009, the Debtor was placed into liquidation in the BVI (BVI Liquidation). On June 22, 2010, the Bankruptcy Court granted the request of the Debtor's court-appointed liquidator (Liquidator), for recognition of the BVI Liquidation as a "foreign main proceeding" under Chapter 15 of the Bankruptcy Code. Upon recognition of the BVI Liquidation as a foreign main proceeding, an automatic stay was imposed on all proceedings against the Debtor in the US.

The Debtor's assets included a SIPA claim (SIPA Claim) in the BLMIS Liquidation. During the summer of 2010, the Liquidator held an auction to sell the SIPA Claim. The winning bidder, Farnum Place, LLC (Farnum), offered to purchase the SIPA Claim for 32.125% of the claim's allowed amount. The Liquidator and Farnum negotiated, documented and signed a trade confirmation setting forth the material terms and conditions of the sale of the SIPA Claim (Trade Confirmation).

The terms and conditions of the Trade Confirmation stated, among other things, that the contract between the parties was governed by the laws of the State of New York and that the transaction was subject to approvals by the BVI Court and the Bankruptcy Court. The Trade Confirmation also stated that the Liquidator would promptly seek the BVI Court's approval of its terms and conditions. However, he failed to do so.

Three days after the parties signed the Trade Confirmation, the BLMIS Trustee announced that he had entered into a settlement agreement with the estate of Jeffrey Picower, an unrelated third party. Under the settlement, the BLMIS Trustee received an influx of $5 billion, which increased the value of the SIPA Claim from 32% to more than 50% of the $230 million allowed amount of the claim. This represented an increase of about $40 million.

On March 27, 2012, the BVI Court approved the terms and conditions of the Trade Confirmation and the assignment to Farnum of the SIPA Claim at the price stipulated for in the trade confirmation (BVI Judgment). The BVI Court also expressly declined to rule on whether the Trade Confirmation required approval under section 363 of the Bankruptcy Code from the Bankruptcy Court. Under section 363 of the Bankruptcy Code, a bankruptcy court must expressly find a good business reason to approve a sale of an interest in a debtor's property.

On April 18, 2012, the Liquidator filed an application with the Bankruptcy Court, seeking review of the Trade Confirmation under section 363 of the Bankruptcy Code and an order disapproving the trade. The Bankruptcy Court denied the application, characterizing it as "seller's remorse" and a "last-ditch effort" to undo the transaction. It held that a section 363 review was not warranted because the sale did not involve the transfer of an interest in property within the US, as required by section 1520(a)(2) of the Bankruptcy Code, and that comity required that it defer to the BVI Judgment.

The Liquidator appealed to the US District Court for the Southern District of New York (District Court), which affirmed the Bankruptcy Court's decision. The Liquidator then appealed the District Court's decision to the Second Circuit.

Outcome

The Second Circuit vacated the District Court's order affirming the Bankruptcy Court's decision because:

The sale of the SIPA Claim was a transfer of an interest of the Debtor in property that was within the territorial jurisdiction of the US, and therefore under section 1520(a)(2) of the Bankruptcy Code, the Bankruptcy Court was required to apply section 363 of the Bankruptcy Code.
Comity did not require deference to the BVI Court's approval of the sale because the plain language of section 1520(a)(2) requires that the bankruptcy court conduct a section 363 review when a debtor seeks to transfer an interest in property within the territorial jurisdiction of the US.

Application of Section 1520(a)(2)

The Second Circuit held that the sale of the SIPA Claim was a "transfer of an interest of the debtor in property within the territorial jurisdiction of the United States," within the meaning of section 1520(a)(2) of the Bankruptcy Code and therefore the Bankruptcy Court must conduct a section 363 review.

First, the Second Circuit concluded that the "property" in this case was the SIPA Claim itself, and not the funds in the BLMIS estate. By selling its SIPA Claim, the Debtor sold its "rights, title and interest in and to [the Debtor's] claims against BLMIS" in the BLMIS proceedings. The SIPA Claim was a "chose in action," meaning the right to bring an action to recover a debtor, money or thing.

Next, the Second Circuit concluded that the SIPA Claim was within the territorial jurisdiction of the US. The Second Circuit disagreed with the "incomplete" analysis of the Bankruptcy Court, which concluded that "justice, convenience and common sense dictate . . . that the SIPA Claim [was] located with the debtor in the BVI." Rather, under section 1502(8) of the Bankruptcy Code, any property subject to attachment or garnishment that may properly be seized or garnished under applicable nonbankruptcy law by an action in a US federal or state court is "within the territory of the United States."

The Second Circuit reasoned that the SIPA Claim was subject to attachment or garnishment because, under New York law, any property which could be assigned or transferred is subject to attachment and garnishment. Although the Debtor and the SIPA Trustee did not have a contractual relationship, the SIPA Trustee was statutorily obligated to distribute to the Debtor its pro rata share of the recovered assets. Therefore, the situs of the SIPA Claim was the location of the SIPA Trustee, which was New York.

Comity

The Second Circuit then held that the Bankruptcy Court erred in deferring to the BVI Court's approval of the transfer of the SIPA Claim and in failing to conduct a review under section 363 of the Bankruptcy Code. The Second Circuit rejected the Bankruptcy Court's holding that the role of comity dictates deference to the BVI Court's judgment approving the sale.

The Second Circuit reasoned that:

The language of section 1520(a)(2) of the Bankruptcy Code is plain in stating that a bankruptcy court is required to conduct a section 363 review when a debtor seeks a transfer of an interest in property within the territorial jurisdiction of the US.
It was not apparent at all that the BVI Court expected or desired deference in this case; rather, the BVI Court expressly declined to rule on whether the Trade Confirmation required approval under section 363.

Section 363 Review

For the reasons set forth above, the Second Circuit vacated and remanded to the District Court with instructions to remand to the Bankruptcy Court to conduct a section 363 review. While offering no view on the merits of the section 363 review, the Second Circuit noted that the Bankruptcy Court is required to expressly find a good business reason to approve the sale, and that in doing so it should:

Consider all salient factors pertaining to the proceeding, including whether the asset is increasing or decreasing in value.
Exercise its broad discretion and flexibility to enhance the value of the estate and secure the best possible bid for the benefit of creditors.
Consider as part of its section 363 review the increase in value of the SIPA Claim between the signing of the Trade Confirmation and approval by the Bankruptcy Court, as nothing in the language of section 363 or applicable case law limits the Bankruptcy Court's review to the date of the signing of the Trade Confirmation.

Practical Implications

Chapter 15 of the Bankruptcy Code generally grants broad deference to foreign courts presiding over foreign main proceedings. However, this case demonstrates that this deference does not extend to transfers of property within the territorial jurisdiction of the US. Therefore, when considering the sale of US assets, bankruptcy courts should not defer to sale approvals granted by foreign courts on the basis of comity. Instead, they are required to review the sale under section 363 to the same extent as they would in a sale of property in a domestic bankruptcy case. As a result, this may allow a Chapter 15 debtor to avoid a foreign-approved sale if it finds that the property has increased in value or if it finds another valid strategic business reason not to proceed with the sale. However, the precedential value of the decision may be limited by the fact that in this case the sale agreement required the approval of the US bankruptcy court and that the foreign court explicitly deferred to the US bankruptcy court.

For more information on Chapter 15, see Practice Note, Chapter 15 Overview: US Bankruptcy Cases Ancillary to Foreign Proceedings.

In re Fairfield Sentry Ltd: Second Circuit Holds Sale of SIPA Claim by Chapter 15 Debtor Subject to Section 363 Review | Practical Law