Restructuring

Contributed by Katherine Doorley and Alexander Woolverton
If at first you don’t succeed, try and try again. In most bankruptcy cases, the location of a claim never comes into play. In In re Fairfield Sentry Ltd., however, the foreign representative of a debtor in liquidation in the British Virgin Islands sold its claim in the SIPA liquidation of Bernard L. Madoff Investment Securities, Inc. Despite the foreign representative’s efforts to undo the sale, the BVI court approved the sale, and the foreign representative sought collateral review of the BVI court order in the New York bankruptcy court. Central to the bankruptcy court’s decision was the location of the claim that was sold. Despite the fact that the funds to pay the claim are located in the United States, the court held that the claim is located outside of the United States, and therefore the BVI court judgment was entitled to comity from the bankruptcy court.
Background
On December 15, 2008, after the exposure of Bernard L. Madoff’s infamous Ponzi scheme, the United States District Court for the Southern District of New York commenced the liquidation of Bernard L. Madoff Investment Securities (“BLMIS”) under the Securities Investor Protection Act (“SIPA”), appointed a trustee to oversee the liquidation, and referred the case to the bankruptcy court. In July 2009, Fairfield Sentry Ltd., a British Virgin Islands Madoff feeder fund, was placed into liquidation in the Eastern Caribbean Supreme Court in the High Court of Justice, Commercial Division, of the British Virgin Islands.  Approximately one year later, the United States Bankruptcy Court for the Southern District of New York granted Fairfield Sentry’s motion under chapter 15 of the Bankruptcy Code for recognition of the BVI liquidation as a “foreign main proceeding.” Recognition as a foreign main proceeding allows a foreign debtor access to certain relief provided by the Bankruptcy Code such as the automatic stay or, as particularly relevant in this proceeding, review of sales under section 363.
In the SIPA liquidation, the trustee sought approximately $3 billion from Fairfield Sentry and others, and Fairfield Sentry’s foreign representative sought approximately $1.2 billion from BLMIS. Eventually, the parties settled their respective claims and agreed that Fairfield Sentry would receive an allowed claim in the SIPA liquidation of approximately $230 million in exchange for a payment by Sentry to the BLMIS estate of about $70 million.
Fairfield Sentry later decided to sell its claim. Because the SIPA trustee had not yet recovered all customer losses, however, at the time of the sale, Fairfield Sentry’s claim in the SIPA liquidation was worth significantly less than $230 million face value of the claim.  Eventually, Fairfield Sentry signed an agreement to sell the claim to Farnum Place, LLC for approximately $74 million. 
The terms of the sale agreement were subject to approval by the BVI Court, and the assignment of the claim was subject to approval by the bankruptcy court and the BVI Court. After the agreement was signed, but before it could be presented to either court, however, the SIPA trustee announced he had negotiated a settlement that would bring approximately $5 billion into the BLMIS estate. Consequently, the value of the claim increased precipitously.
Fairfield Sentry tried and failed to undo in the BVI Court the sale of the claim, and Farnum sued to force consummation of the sale. The BVI Court held a three-day evidentiary hearing and issued a judgment validating the sale agreement. Upon Fairfield Sentry’s urging, however, the BVI Court gave Fairfield Sentry a “Hail Mary, last-ditch [chance] to renew [its] challenge before” the bankruptcy court.
A Chapter 15 Foreign Representative’s SIPA Claim is Not Located in the U.S.
The foreign representative argued that the sale of the SIPA claim was a transfer of property within the territorial jurisdiction of the United States under section 1520(a)(2) of the Bankruptcy Code which, in a foreign main proceeding, mandates application of Bankruptcy Code sections 363, 549 and 552 to a request to transfer an interest of a debtor in property that is located within the territorial jurisdiction of the United States. The foreign representative argued that the sale of the SIPA claim was a transfer of property located within the United States and therefore must be approved under sections 1520(a)(2) and 363 of the Bankruptcy Code. The foreign representative’s rationale was that the “interest” was its claim to Madoff customer funds, and the “property” was the Madoff funds themselves, located in the United States. Farnum argued that the “interest” and the “property” were both the SIPA claim, which was located in the BVI. Consequently, according to Farnum, section 1520(a)(2) was inapplicable.
The bankruptcy court held the sale did not implicate section 1520(a)(2) because the claim constituted an intangible asset located in the BVI. Under section 1502(8) of the Bankruptcy Code, the bankruptcy court applied relevant non-bankruptcy law—in this case New York law—in determining whether the claim was located “within the territorial jurisdiction of the United States.”
Because the property being transferred was the claim and Fairfield Sentry’s ownership rights in the claim, the bankruptcy court found that, under New York law, Fairfield Sentry’s claim against BLMIS was a “general intangible.” To determine the location of the claim, the bankruptcy court applied the relatively flexible test articulated in Severnoe and applied in the bankruptcy context in Iroquois:

The situs of intangibles is in truth a legal fiction, but there are times when justice or convenience requires that a legal situs be ascribed to them. . . . At the root of the selection is generally a common sense appraisal of the requirements of justice and convenience in particular conditions.

Severnoe, 255 N.Y. at 123–24. The bankruptcy court held that justice, convenience and common sense all led to the conclusion that the claim was located with Fairfield Sentry in the BVI, not with BLMIS. The transfer of the claim by Fairfield Sentry—a BVI incorporated entity—was administered by the BVI Court, and was in the custody of a liquidator deemed to have “custody and control of all the assets” of Fairfield Sentry pursuant to a prior order of the BVI Court. The bankruptcy court further emphasized that the foreign representative was seeking relief against his claim to BLMIS customer funds, not against the funds themselves. The bankruptcy court concluded that “in undertaking a common sense[,] appraisal of the requirements of justice and convenience in the instant circumstances . . . the [claim] is not within the territorial jurisdiction of the United States . . . .” Accordingly, the bankruptcy court concluded that the sale of the Claim did not involve a transfer under section 1520(a)(2).
Comity Precluded the Bankruptcy Court from Reversing the Sale
The bankruptcy court refused to disturb the BVI Judgment, writing that “Chapter 15 emanates from and was designed around [the] central concept of comity, as evidenced by its primary purpose and deferential framework for international judicial cooperation.” In its decision, the bankruptcy court embraced the reasoning adopted by the Fifth Circuit in Vitro, which elevated comity to a “principal objective” and departed sharply from the reasoning in the Delaware bankruptcy court’s Elpida decision, which found that comity was “not the end all be all of the statute.”
The bankruptcy court reasoned that the BVI Court “has the paramount interest” in the sale of Fairfield Sentry’s claim, the bankruptcy court “lacks a meaningful interest in the disposition” of Fairfield Sentry’s claim, and finally “the transaction at issue is BVI-centric for purposes of [the bankruptcy court’s] review.” Accordingly, the bankruptcy court concluded that “comity dictates that [the bankruptcy court] defer to the BVI Judgment.”
Conclusions
This most recent Fairfield decision was highly fact-specific, but offers a cautionary tale to those who choose to deal in the speculative world of claims trading. While assets may be located in a particular jurisdiction, the claim to those assets is likely to be located with the holder of the claim rather than with the assets themselves.