The Second Circuit in Krys v. Farnum Place (In re Fairfield Sentry Ltd.)1 denied a petition for rehearing or rehearing en banc by Appellee Farnum Place, LLC (Farnum), a hedge fund that sought to protect its purchase of a $230 million claim against the bankruptcy estate of Bernard L. Madoff Investment Securities LLC (BLMIS), which was threatened as a result of the Second Circuit’s panel decision in September 2014. Thus, the entire Second Circuit endorsed its prior panel holding that enhanced the US bankruptcy courts’ authority to reexamine foreign transactions in Chapter 15 cases by requiring US bankruptcy courts to conduct review of a sale of a property that is within the territorial jurisdiction of the United States under 11 U.S.C. § 363.

On September 26, 2014, in Krys v. Farnum Place (In re Fairfield Sentry Ltd.),2 Judge John M. Walker, Jr. of the United States Court of Appeals for the Second Circuit, writing for the court of appeals, held that, in a Chapter 15 case, a sale of a claim under Securities Investor Protection Act (SIPA) must be reviewed by bankruptcy courts under Section 363 of the Bankruptcy Code because it is a “transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States” under Section 1520 of the Bankruptcy Code. The Second Circuit also held that, in a Chapter 15 case, bankruptcy courts cannot defer under comity to a foreign court’s order approving such sale because bankruptcy courts must conduct their independent review of the sale under Section 363 of the Bankruptcy Code.

Background

In December 2008, BLMIS was placed into liquidation under SIPA in the United States Bankruptcy Court for the Southern District of New York (Bankruptcy Court).

Fairfield Sentry Ltd. (Sentry), a British Virgin Islands fund that invested 95 percent of its assets with BLMIS, filed three customer claims in the SIPA liquidation, totaling approximately $960 million. Irving Picard (Picard), the trustee of BLMIS, objected and counterclaimed with its own claims totaling over $3 billion. The parties settled their disputes so that Sentry was allowed a $230 million claim (SIPA Claim), subject to a $70 million cash payment into the MBLIS estate.

In July 2009, Sentry was placed into liquidation in the High Court of Justice of the Eastern Caribbean Supreme Court (BVI Court). On June 14, 2010, Kenneth Krys (Krys), the liquidator appointed by the BVI Court, filed a Chapter 15 petition for recognition of the BVI proceeding as a foreign main proceeding in the Bankruptcy Court. On July 22, 2010, the Bankruptcy Court entered an order granting recognition.

In summer of 2010, Krys held an auction to sell the SIPA Claim. Farnum offered to purchase the SIPA Claim for 32.124 percent of the claim’s allowed amount. Farnum’s bid was several percentage points higher than the other bids. Krys accepted the offer. The sale, however, remained subject to approval by the BVI Court and the Bankruptcy Court.

In December 2010, Krys and Farnum negotiated the terms and conditions of the sale of the SIPA Claim and signed a trade confirmation (Trade Confirmation), which was expressly governed by the laws of the State of New York and again was subject to approval by both the BVI Court and the Bankruptcy Court.

Three days after the Trade Confirmation was signed, Picard announced that he had entered into a settlement agreement with the estate of Jeffrey Picower for the forfeiture and repayment of approximately $7.2 billion, of which $5 billion would be paid to the BLMIS estate. The news quickly affected the market, and so the $5 billion influx into the BLMIS estate increased the value of Sentry’s SIPA Claim from 32 percent to more than 50 percent of the $230 million allowed amount of the claim.

In October 2011, after Krys failed to satisfy conditions of the Trade Confirmation, Farnum filed an application with the BVI Court seeking an order compelling Krys to comply with the Trade Confirmation, or authorizing to commence proceedings against Sentry for specific performance. Krys objected to the approval of the transfer of the SIPA Claim to Farnum at the agreed bid price, arguing that the transfer was not in the best interest of the Sentry’s estate due to the sudden, significant increase in the value of the SIPA Claim. Further, Krys argued that the sale of the SIPA Claim required approval of the Bankruptcy Court under Sections 1520(a)(2) and 363 of the Bankruptcy Code.

After a three-day evidentiary hearing, the BVI Court approved the sale of the SIPA Claim to Farnum and directed Krys to take the necessary steps to bring the matter before the Bankruptcy Court. The BVI Court made it expressly clear that Krys must present a choice for the Bankruptcy Court whether to approve the sale under Sections 1520(a)(2) and 363 of the Bankruptcy Code.

On April 18, 2012, Krys filed an application seeking review of the Trade Confirmation under Section 363(b) and an order disapproving the sale. On January 10, 2013, the Bankruptcy Court denied Krys’ application. The Bankruptcy Court characterized Krys’ application as “seller’s remorse” and “last-ditch effort” to undo the sale. The Bankruptcy Court held that it did not have to review the sale under Section 363 of the Bankruptcy Code because the sale did not involve a transfer of an interest in property within the United States. Moreover, the Bankruptcy Court concluded that the doctrine of international comity required that the Bankruptcy Court defer to the judgment of the BVI Court.

Krys appealed the Bankruptcy Court’s decision to the United States District Court for the Southern District of New York (District Court), which affirmed the Bankruptcy Court’s order denying Krys’ application. The District Court stated that it was not clear whether Section 363 applies to the sale of the SIPA Claim, but found that the Bankruptcy Court’s denial of Krys’ application was proper because “[c]ourts should be loath to interfere with corporate decisions absent a showing of bad faith, self-interest, or gross negligence.” Krys appealed the District Court’s decision to the Second Circuit seeking a determination whether bankruptcy courts must conduct a review under Section 363.

Second Circuit’s Decision

The Second Circuit concluded that the Bankruptcy Court erred in finding that the SIPA Claim was not within the territorial jurisdiction of the United States. The Second Circuit thus vacated and remanded the District Court’s decision and held that the sale of the SIPA Claim was a “transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States,” under Section 1520(a)(2), and thus the sale must be reviewed under Section 363 of the Bankruptcy Code.

The Second Circuit’s analysis turned on whether the SIPA Claim is a transfer of an interest under section 1520(a)(2). Section 1520(a)(2) provides that bankruptcy courts must apply Section 363 to a “transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States.” As defined under Section 1502(8), the term “within the territorial jurisdiction of the United States” refers to a debtor’s “tangible property located within the territory of the United States and intangible property deemed under applicable nonbankruptcy law to be located within the territory, including any property subject to attachment or garnishment that may properly be seized or garnished by an action in a Federal or State court in the United States.”

The Second Circuit found that the SIPA Claim was subject to attachment or garnishment and may be properly seized by an action in a federal or state court in the United States. Under New York law, any property which could be assigned or transferred is subject to attachment and garnishment. For attachment purposes, with respect to intangible property that has as its subject a legal obligation to perform, the situs is the location of the party who is required to perform under the obligation. In this case, Picard was statutorily obligated to distribute to Sentry its pro rata share of the assets recovered in the SIPA proceeding on account of the SIPA Claim. Thus, the Second Circuit concluded that the situs of the SIPA Claim is New York, where Picard is located, and thus it is within the territorial jurisdiction of the United States under Section 1520(a)(2). The sale of the SIPA Claim was therefore subject to review under Section 363 of the Bankruptcy Code.

As for comity, the Second Circuit found that bankruptcy courts must conduct a Section 363 review when a debtor seeks a transfers of an interest in property within the territorial jurisdiction of the United States, under the plain language of Section 1520(a)(2). Moreover, the Second Circuit noted that it was not even apparent that the BVI Court expected or desired the Bankruptcy Court to defer to its judgment under the circumstances. Thus, the Second Circuit concluded that the Bankruptcy Court erred when it deferred to the BVI Court’s judgment approving the sale of the SIPA Claim and failed to conduct its own review under Section 363 of the Bankruptcy Code.

Second Circuit’s Guiding Principles Regarding Section 363 Review

In addition, the Second Circuit provided the Bankruptcy Court with some guiding principles for review of the sale under Section 363 on remand. The Second Circuit noted that when conducting a 363 review, bankruptcy courts have “broad discretion and flexibility ... to enhance the value of the estates” and their “principal responsibility ... is to secure for the benefit of creditors the best possible bid.” Thus, bankruptcy courts must “expressly find from the evidence presented ... a good business reason to grant” a 363 application and consider “all salient factors pertaining to the proceeding [including] whether the asset is increasing or decreasing in value.”

The Second Circuit noted that “[n]othing in the language of section 363 or our case law limits the bankruptcy court’s review to the date of signing the Trade Confirmation” and thus, the Bankruptcy Court was required to look beyond the date when Krys accepted the offer and the deal was signed. The Second Circuit therefore concluded that the Bankruptcy Court must consider, as part of its Section 363 review, the increase in value of the SIPA Claim between the date the Trade Confirmation was signed and the bankruptcy court’s approval of the sale.

Conclusion

Bankruptcy courts in the Second Circuit will not simply defer to a foreign order approving a sale of assets located within the territorial jurisdiction of the United States. Rather, in a Chapter 15 case, when presented with a motion for approval of a sale of assets located within the United States, US bankruptcy courts must review the terms of the sale under Section 363 of the US Bankruptcy Code. Thus, when structuring their transactions, investors and purchasers of claims or other assets located in the United States must be aware that there may be multiple courts and legal regimes involved in the approval of the deal.