Globe_RoadSigns_496192563Bernard Madoff and his company Bernard L Madoff Investment Securities LLC (BLMIS) operated what seems likely to be the largest Ponzi scheme in history. BLMIS accepted sums estimated between US$17 billion and US$50 billion and Fairfield Sentry Ltd was one of the largest feeder funds which placed about 95% of its assets (US$7.2 billion) in the scheme. Investors participated indirectly in these placements by subscribing for shares in Fairfield at a price dependent on the fund’s “net asset value” per share (NAV). Investors could withdraw funds by redeeming their shares. It represents an intrinsic unfairness of such schemes that those who withdraw their funds before the schemes collapse may escape without loss (and often with substantial profit) and those who fail to withdraw their money on time shoulder the burden of the debt.

The proceedings in Fairfield Sentry Limited (in Liquidation) v Migani & Ors (British Virgin Islands) before the Privy Council were brought by the fund’s liquidators against a number of investors who redeemed their shares before the Madoff scheme collapsed. The liquidators intended to reclaim the amounts paid out on the basis that the amounts paid were based on fictitious financial statements from BLMIS and in reality there were no such assets. The liquidators intended to then distribute any recovery on this basis rateably between all of the investors in Fairfield regardless of whether or not they redeemed the shares before the collapse of BLMIS.

The principal arguments arose from two issues:

1)      the “Article 11” question; and

2)      the “Good Consideration” question.

The “Article 11” question required the Court to decide whether certain transaction documents issued to investors recording the NAV per share or the redemption price were binding on Fairfield under Article 11 of its Articles of Association, which dealt with the effect of certain certificates.  If the documents were binding on Fairfield, the liquidators’ claims against the investors would fail because those investors received the amount properly due under the Articles.

If the Court decided that the transaction documents were not binding, it would then need to consider the “Good Consideration” question — whether the defendants had provided good consideration for the money they received on redemption by surrendering their shares.

In respect of the “Article 11” question, the Court determined the documents were binding on Fairfield, finding that the directors’ determination of the NAV price must be treated as conclusive and that the ordinary transaction documents recording the NAV price could be considered as a certificate for the purposes of Article 11. In respect of the “Good Consideration” question, the Court rejected the appeal of the decision from the lower court which had held in favour of the investors.

What is interesting about this decision is that it differs greatly from the approach taken across the Atlantic. On 7 June 2011, the United States Bankruptcy Court for the Southern District of New York approved a settlement agreement with the Joint Liquidators of Fairfield Sentry Limited, Fairfield Sigma Limited and Fairfield Lambda Limited. The settlement agreement aligned the interests of the SIPA Trustee and the Joint Liquidators of the Fairfield funds as it strengthened both parties’ abilities to recover additional claims against the owners and management of the Fairfield funds and against transferees of customer property.

Arguably, it represents an intrinsic unfairness that investors affected by the New York decision may be pursued for transfers prior to the Madoff Ponzi Scheme collapse but investors affected by the BVI decision may retain their redeemed share capital. It will be interesting to see if this jurisdictional loop hole is ever closed up.

For a different analysis, see re Bernard Madoff Inv. Sec. LLC.