On April 16, 2014, the Judicial Committee of the Privy Council (the final court of appeals for British Overseas Territories, including the British Virgin Islands), issued an opinion in the liquidation proceedings for Fairfield Sentry Limited (“the fund”), which was a “feeder” fund for Bernard Madoff’s fraudulent securities scheme. The Privy Council held that the Net Asset Values (“NAVs”) calculated by the fund at the time of redemption were final and binding, and that investors who had received redemption payments based on such NAV determinations prior to the discovery of Madoff’s fraud would not be required to pay back those amounts to the fund under the theory of restitution.
The fund, through its liquidators, argued that the fund was entitled to recover the redemption proceeds paid to investors because the NAVs were allegedly incorrect in light of Madoff’s Ponzi scheme. The fund argued that the NAV determinations on which the redemption payments to investors were based were not final and binding on all parties. If the NAVs were final and binding, the investors would be deemed to have received the correct amount upon redemption and the restitution claims would fail. The fund also argued that the investors had not given consideration for the redemption proceeds when they surrendered their shares in the fund. Proper consideration would also defeat the fund’s restitution claim. The intermediate appellate court held that the NAVs calculated at the time of the redemption were not final and binding on the fund and its investors, but ultimately upheld the trial court’s dismissal of the restitution claim based on its determination that supplying the shares being redeemed was consideration for the redemption payment. On appeal, the Judicial Committee of the Privy Council affirmed, without discussion, the intermediate appellate court’s opinion on the consideration issue, and further held that the appeal of the decision on the redemption finality issues should be allowed.
The Privy Council held that the case turned on the question of whether the fund was obligated to pay (1) the “true” NAV “ascertained in the light of information which subsequently became available about Madoff’s frauds” or (2) the NAV determined by the Directors of the fund at the time of the redemption. The fund argued that the NAV was not definitive unless the directors of the fund chose to issue a certificate under the Articles of Association providing that the NAV would be binding on all parties. The Privy Council rejected that argument. As part of its reasoning, the Privy Council stated:
“If it were correct, an essential term of both the subscription for shares and their redemption, namely the price, would not be definitively ascertained at the time when the transaction took effect, nor at a time when the price fell to be paid. Indeed, it would not be definitively ascertained for an indefinite period after the transaction had ostensibly been completed, because unless a certificate was issued it would always be possible to vary the determination of the NAV per share made by the Directors at the time and substitute a different one based on information acquired long afterwards about the existence or value of assets. This would not only expose Members who had redeemed their shares to an open-ended liability to repay part of the price received if it subsequently appeared that the assets were worth less than was thought at the time. It would confer on them an open-ended right to recover more (at the expense of other Members) if it later appeared that they were worth more.”
The Privy Council further stated that “[i]f, as the Articles clearly envisage, the Subscription Price and the Redemption Price are to be definitively ascertained at the time of the subscription or redemption, then the NAV per share on which those prices are based must be the one determined by the Directors at the time.” And more broadly, the Privy Council noted that the redemption process, which entails determining an NAV for the redeemed shares as of a certain date that is used to calculate the redemption amount, “depends upon the price being definitively ascertained by the [designated date] and known to the parties shortly thereafter. It is unworkable on any other basis.”
The Privy Council’s decision has important consequences for funds and investors who are involved with clawback, breach of contract, unjust enrichment or other actions based on an argument that redemption payments were improperly inflated due to incorrect NAV calculations (typically alleged to result from fraud impacting the value of the fund’s investments). The Privy Council articulated a strong preference for establishing finality in redemption payments – and against the creation of open-ended and uncertain time periods during which redeemed investors, or funds, may face liability due to later-discovered information regarding the valuation of the underlying fund assets at the time of redemption. This decision could serve as helpful precedent for parties taking the position that a completed redemption should not be disturbed.