On September 26, 2014, in the Farnum case (Krys v. Farnum Place, LLC (In re Fairfield Sentry Ltd.), 768 F.3d 239 (2d Cir. 2014)) the Court of Appeals for the Second Circuit held that Bankruptcy Code section 363 review applied to a transfer of a Securities Investor Protection Act (“SIPA”) claim held by an off-shore entity in foreign liquidation proceedings recognized in the United States. The decision is significant for two reasons. First, the Second Circuit Court of Appeals concluded that Bankruptcy Code section 1502(a) (2) required section 363 review of the sale of the SIPA claim because it was a sale of property within the territorial jurisdiction of the United States. Second, the Court of Appeals expressly rejected the argument that the “role of comity, codified in Chapter 15,” nonetheless dictated approval of the sale because it was approved in a foreign proceeding.

Fairfield Sentry Limited (“Fairfield”) was a British Virgin Islands (“BVI”) investment fund that was a “feeder” for Bernard L. Madoff Investment Securities LLC (“BLMIS”). After Madoff’s Ponzi scheme news became public, BLMIS collapsed, and its liquidation under SIPA commenced. Subsequently, the Fairfield and the BLMIS estates settled numerous claims against each other, fixing Fairfield’s SIPA claim against BLMIS at $230 million in exchange for a payment of $70 million.

In June 2009, Fairfield went into liquidation under BVI law. In July 2010, the Fairfields’s BVI proceedings received Chapter 15 recognition in the Bankruptcy Court for the Southern District of New York, and consequently, the Fairfield estate received the benefits of the automatic stay. The SIPA claim against BLMIS was Fairfield’s major asset, and in December 2010 Fairfield agreed to sell the SIPA claim to Farnum Place, LLC (“Farnum”), an affiliate of a U.S.-based hedge fund Baupost Group LLC, for slightly above the market price of 32% of its face value. By its terms, the trade confirmation was subject to the BVI court approval.

Days after the deal was signed, Irving Picard, the SIPA trustee for BLMIS, announced a settlement with a major investor, bringing $5 billion into the BLMIS estate. Instantly, the value of Fairfield’s SIPA claim increased to over 50% of its face value. Fairfield’s liquidating trustee (the “Trustee”), sought to unwind the transaction as being not in the best interests of the Fairfield estate. The Trustee was unsuccessful in the BVI proceedings, and having exhausted all appeals in the Caribbean court system, the Trustee turned to the Bankruptcy Court in the Southern District of New York arguing that the sale of the SIPA claim had to be approved under the Bankruptcy Code section 363. In January 2013, the Bankruptcy Court denied the request, calling Trustee’s efforts “seller’s remorse” and a “last-ditch effort” to undo the transaction. The District Court affirmed, and the Trustee appealed to the Court of Appeals for the Second Circuit.

On appeal, the Court of Appeals for the Second Circuit identified the key issue as the location for the SIPA claim because the Bankruptcy Code section 1502(a)(2) expressly requires court approval of sales of property “within the territorial jurisdiction of the United States” under Bankruptcy Code section 363. On this issue, the Court of Appeals sided with the Trustee, finding that any property that may be seized or garnished by an action in a U.S. court is deemed to be located in the United States (Farnum, 768 F.3d at 244). Next, the Court of Appeals determined that the situs of intangible property is the location of the party that would be required to act if such property were garnished or attached (Id. at 244-45 (citing ABKCO Industries, Inc. v. Apple Films, Inc., 350 N.E.2d 899 (N.Y. 1976)). Consequently, because the Court of Appeals concluded that the BLMIS SIPA trustee was the party that had to act, it concluded that the SIPA claim was located in New York and, thus, the sale of the SIPA claim required the approval of the Bankruptcy Court (Id. at 245). 

Additionally, the Court of Appeals rejected any argument that comity allowed the Bankruptcy Court to defer to the BVI court’s approval of the sale. Specifically, the Court of Appeals held that deference is not a per se rule, and that section 1502(a)(2) was one section that expressly limited a Bankruptcy Court’s discretion (Id. at 246 (citing In re Vitro S.A.B. de C.V., 701 F.3d 1031, 1054 (5th Cir. 2012)). Thus, even though it was not clear whether the BVI Court expected or desired deference, the Court of Appeals found no deference could be given based on comity.

If it stands, the Farnum decision could have far-reaching implications, especially with respect to sales of intangible property and the limits of comity in Chapter 15 cases. On October 10, 2014, Farnum filed a petition for rehearing en banc, and, on November 21, 2014, the Trustee filed a brief in opposition to the petition for rehearing.