Madoff: Investors 2 v 0 Fairfield
The juggernaut that is the worldwide litigation brought by the liquidator of the Fairfield Funds (Fairfield Sentry, Fairfield Sigma and Fairfield Lambda; collectively “Fairfield” or the “Funds”) rumbles on, but in the British Virgin Islands (“BVI”) he has suffered a second defeat in his attempt to claw back redemption proceeds from investors who exited the Funds before the Madoff fraud was discovered.
The Court of Appeal ruled on 13 June 2012, that the decision of the BVI Commercial Court was correct, and that the investors had given good consideration (the surrender of their shares) to the Funds in return for the redemption monies. The Court also gave helpful guidance as to what constituted a certificate of net asset value (“NAV”) under the respective Funds' articles.
It will be recalled that Fairfield had argued that the NAVs were calculated under a mistake of fact and were in fact nil, in the alternative that both fund and redeeming investors had thought that the fund was investing in the Madoff split strike conversion strategy, when in fact nothing of the kind was taking place – in other words, a mutual mistake. The Funds sought to recover the redemptions on both bases.
Fairfield argued that the shares and the rights attaching to them were worthless, that the real NAV was therefore nil, and that upon redemption of the shares, the respective fund therefore owed nothing. As a result of the payment out of millions of dollars in redemption proceeds, when in fact what the fund owed was nothing, the redeeming investors had been unjustly enriched and must repay. Fairfield also argued that it was time for the courts to move away from general principles of good consideration when one was looking at whether someone had been unjustly enriched, and that the court should in fact value both sides of the bargain. The investors pointed out that the surrender of contractual obligations is regarded as good consideration, and that contractual rights trump restitutionary principles such that a sum paid to discharge a contractual debt cannot be recovered unless the contract pursuant to which the sums are paid is itself void or is rescinded – however different in actual value the rights surrendered and the money paid for them might be. The Court of Appeal agreed with the investors. It held that on receipt of a redemption request given pursuant to the Funds Articles of Association, the Funds were under an obligation to redeem the shares and pay the redemption price based on the NAV determined by the respective fund. There was a debt owed to the investors, for which the investors gave good consideration by performing their part of the bargain and surrendering their shares. The actual value of those shares was irrelevant. Furthermore, said the Court of Appeal, Fairfield itself was not a Ponzi scheme, and it got what it bargained for, namely its shares. It had not bargained for a specific value or interest in Bernard L Madoff Investment Securities LLC (“BLMIS”), indeed the risk factors in its offering documents specifically mentioned the possibility that subscription funds might be misappropriated by BLMIS employees. The Court of Appeal agreed with leading textbook writers that the law of unjust enrichment should not be used to overturn the parties' own allocations of risk and value.
The Court of Appeal concluded its judgment on good consideration by observing that certainty is key in commercial transactions, particularly in the modern day when such transactions have a global dimension with far reaching consequences. That is why the doctrine of unjust enrichment can only step in to adjust relationships between parties when the contract between them does not deal with their rights. In this case it was simply not open to Fairfield to recover the redemption monies because it had discovered that its NAVs were struck using unreliable information from BLMIS which had nothing to do whatsoever with any of its investors.
The Court's findings in relation to good consideration were sufficient to dispose of the clawback claims. The investors had, however, appealed the decision of the court below that Fairfield's NAVs were not certified under the Articles, and were therefore not final and binding for that reason. Fairfield's Articles – in common with a number of BVI fund documents – provided that a certificate of NAV given in good faith by or on behalf of the directors was binding on all parties. Again in common with a number of BVI funds, the NAV was communicated to investors in a number of ways, ranging from contract notes and monthly statements, to emails from the administrator, and information available on the investment manager's website. It was accepted that none of the documents bore an original signature and that none were actually entitled "certificate".
Despite the emphasis it placed on commercial certainty, the Court of Appeal remained unpersuaded that any of the documents relied on by investors constituted a certificate pursuant to the Articles. The Court agreed with investors that a certificate did not need to be signed, but held that the Articles did not require every publication of the Funds' NAV to be certified as to its accuracy. Neither had it been demonstrated that the function of certifying the NAV (as opposed to calculating it or determining it) had been delegated by the directors. The Court said it could not be right that every statement of a precise NAV given by the administrator or the investment manager amounted to certification by the directors, otherwise there would be no need for a separate provision requiring a certificate. Although it accepted that recalculating the NAV might be burdensome and difficult, the Court said that exercise would not be impossible, particularly since the Funds were not in fact seeking a recalculation, merely a revaluation of the NAV to nil.
The Court of Appeal's decision has wide ranging implications which extend beyond the shores of the BVI. There are hundreds of clawback claims on foot in the United States, where the courts have put them on hold pending the BVI ruling, and in other jurisdictions. And of course, the Fairfield Funds are not the only feeder funds which collapsed in the wake of the Madoff scandal: other liquidators will be watching with interest to see whether the claims can be sustained.
For now, the Court of Appeal has confirmed that the BVI's Commercial Court got it absolutely right, endorsing the quality of justice that is available in commercial disputes.
Both sides have one more possible appeal, to the Privy Council in London.