Fund investors and the fund industry globally should take note of the recent decision of the Eastern Caribbean Supreme Court Appellate Division’s (the “Court of Appeal”) in Madoff related litigation.  Essentially the Court of Appeal found that monies could not be recovered from former investors by the liquidators of Fairfield Sentry Limited (“Fairfield”) a BVI investment fund and investor in Bernard L Madoff Investments Securities limited (“BLMIS”), where those investors had redeemed their shares for significant value before BLMIS collapsed.. 

The Court of Appeal in making that decision upheld the judgment of Justice Edward Bannister Q.C. (“Bannister J.”) in the BVI Commercial Court which dismissed the restitutionary claims brought by Fairfield. BLMIS collapsed in December 2008 when its proprietor, Bernard L Madoff, admitted that it had been run as a Ponzi scheme and was placed in liquidation in the United States. The BLMIS collapse and liquidation adversely affected Fairfield, whose case stated that it invested 95% of its funds in BLMIS.

Fairfield was placed in liquidation in the BVI on 21 July 2009. 

Subsequently, Fairfield’s liquidators, with the permission of the BVI Commercial Court, issued a number of claims in the BVI and other jurisdictions against a number of its investors who had previously redeemed their shares in Fairfield before December 2008 (“the Redeeming Investors”).  Fairfield sought to recover the monies which Fairfield paid out to the Redeeming Investors on the redemption of their shares (the “Clawback Actions”).

In the Clawback Actions, Fairfield claimed recovery on the grounds that:

  1. The NAV was calculated under a mistake of fact as, unbeknown to Fairfield, BLMIS was in fact operating a Ponzi scheme and its investments in BLMIS were therefore lost from the date of its investment. As such, the net asset value (“NAV”) of Fairfield was at all times nil or a nominal value and the total sum which was redeemed by the Redeeming Investors (the “Aggregate Redemption Sum”) should, accordingly have been nil, or in the alternative, a nominal sum.
  2. the Redeeming Investors had been unjustly enriched at Fairfield’s expense, and they were liable to make restitution of the Aggregate Redemption Sum to Fairfield or in the alternative the difference between that sum and the said nominal amount (“Unjust Enrichment Claim”)
  3. Fairfield is entitled to set aside the redemption of the Redeeming Investors’ shares on the ground that the payment of the Aggregate Redemption Sum was effected under a mutual mistake as to the true NAV (“Mutual Mistake Claim”)

Decision of the Court below

In the Clawback Actions a number of the Redeeming investors (the “Defendants”) four of whom were represented by O’Neal Webster, raised certain preliminary issues which were decided by Bannister J. as follows:

  1. Certain documents issued by agencies (including Fairfield’s Fund Administrator) to whom Fairfield had delegated power to calculate NAV, containing statements of NAV (the “Documents”) did not constitute certificates of the NAV under Article 11 of Fairfield’s Articles of Association and therefore did not bind Fairfield.  Accordingly, it was open to Fairfield to claim that its NAV was other than that contained in the Documents (the “Certification Issue”); and
  2. In relation to the Unjust Enrichment claims, the Defendants bore no fault for the incorrect calculation of NAV and provided good consideration when they surrendered their rights to their shares.  Accordingly, the transactions could not be set aside simply because Fairfield calculated the NAV on information as to value that subsequently turned out to be incorrect (the “Good Consideration Issue”).

Summary Judgment was entered in favour of the Defendants on the Good Consideration Issue and the Mutual Mistake claim

The Court of Appeal Decision

Fairfield appealed the Court’s finding on the Good Consideration Issue and the decision to enter summary judgment, and the Defendants appealed the decision on the Certification Issue.

Appeal on the Good Consideration Issue

The Court of Appeal dismissed Fairfield’s appeal on this issue and held that:

  1. the surrender of the rights to their shares by the former shareholders of Fairfield Sentry Limited (“Fairfield”) was good consideration which defeated Fairfield’s Unjust Enrichment  Claim;
  2. Fairfield’s Mutual Mistake claim is defeated on the grounds that:
    1. The alleged mistaken calculation of the net asset value (“NAV”) did not undermine Fairfield’s contractual obligation pursuant to its subscription agreement to pay the redemption price to the former shareholders of Fairfield upon their request, and did not render the contract between Fairfield and its former shareholders impossible to perform; and
    2. The alleged mistaken calculation of the NAV was solely Fairfield’s mistake and it cannot be said that there was anything essentially different about the quality of the thing contracted for, since the subscription agreement was for the shares and the redemption payment was for the surrender of those shares.

The Court of Appeal agreed with Justice Bannister’s reasons for granting summary judgment and also dismissed Fairfield’s appeal in that regard.

Appeal on the Certification Issue

The appeal of the Defendants was also dismissed.  The Court of Appeal held that the Documents did not amount to certificates on the grounds that inter alia:

  1. the plain wording of Article 11 is that there can be a determination published without it having been certified;
  2. there is no reason why under Article 11 there cannot be an uncertified determination which is not binding;
  3. the plain meaning of the wording of the Article is that not every determination is intended to be binding on the parties;
  4. the mere stating of a precise price will not suffice for any Document to amount to a certificate. The certificate must be something more than a simple statement.
  5. the certificate must have been issued either by the Directors or by some agency to whom the power to certify was delegated. The Documents were not issued by the Directors, nor was there any delegation of the power to certify to the agencies issuing the Documents - only the power to calculate the NAV had been delegated.

The Court also held that Article 11(1) does not require that a certificate be signed. The absence of a signature on a Document would not necessarily preclude it from being deemed a certificate for the purpose of Article 1 1(1).

Effects of Decision

The effect of the Court of Appeal Decision is that restitutionary claims by liquidators of investment funds are likely to fail where (a) the former investors give good consideration for the redemption proceeds when they surrender their rights to the shares and (b) any alleged mistake as to the NAV of the fund does not undermine the legal obligation on the investment fund has under the contract which requires it to pay the redemption price and does not render the contract between the investment fund and the former investors impossible to perform. Both Fairfield and the Defendants have applied for permission to appeal to the Privy Council.

Conclusion

The robust regulatory and legal system and the availability of specialist counsel in the British Virgin Islands, along with a dedicated commercial court that is well equipped to deal with complex commercial matters, is a key reason why BVI still leads the world in company incorporations. A BVI company is easily formed, has a flexible organizational structure, and is exempt from taxation.  Company incorporation procedures are well-established and clear with no nationality or residency requirements for beneficial shareholders and directors. Ordinarily, incorporation is completed within 3-5 business days, and is extremely cost effective.  A BVI company can transfer cash, capital and assets without exchange control or other restrictions and may also change its domicile from the BVI to that of another jurisdiction. Companies incorporated elsewhere may be domiciled to the BVI, if the laws of that jurisdiction permit. The financial reporting and public filing requirements are not onerous. These are a few of the many factors which contribute to the BVI’s continuing attractiveness as an incorporation center.