Madoff-related claims in the BVI and the Saad litigation in the Cayman Islands are keeping the Caribbean’s litigators busier than ever. LB analyses the key cases and speaks to the main players to find out what is likely to happen next
Following Bernie Madoff’s arrest on 11 December 2008, Fairfield Sentry, the fund said to have had the largest exposure to Madoff’s multibillion-dollar fraud, was placed into liquidation in the British Virgin Islands (BVI) in July 2009. Consequently Fairfield’s liquidators, KRyS Global, issued over 175 claims in the BVI against investors that had redeemed their investments out of Fairfield. Forbes Hare acted for KRyS Global, led by founding partner William Hare.
As Fairfield had invested most of its assets in the Ponzi scheme Bernard L. Madoff Investment Securities (BLMIS), the liquidators claimed that the real net asset value of Fairfield shares was $0 and not what was agreed when the redemptions were made. The liquidators declared that investors who had received redemption payments during Fairfield’s lifetime had received the payments by mistake.
Several defendant investors applied to the BVI Commercial Court for the determination of preliminary issues. In September 2011, the court decided that the investors had given Fairfield good consideration in redeeming the shares and that this was an absolute bar to the claim. Harneys litigation head Phillip Kite and partner Kissock Laing; Ogier managing associate Robert Foote; Maples and Calder partner Arabella Di Iorio; and O’Neal Webster senior partner Paul Webster QC all acted for the defendants bringing the preliminary issues application.
After the BVI court’s September decision, the investors applied for summary judgment on the liquidators’ BVI claims. In October 2011, the court ruled that the Madoff-related claim brought by Fairfield’s liquidators should be dismissed. The second application was brought by a Harneys client, ABN AMRO, to dismiss the full claim against it, represented by both Kite and Laing.
‘The decision of the court did not come as a surprise’
Hundreds of complex, cross-border cases were issued in the BVI and New York. In 2011 alone, Harneys filed around 30 different defences, all of which were slightly different. And because of the sheer number of clients, the logistics have been especially challenging. Harneys had to ringfence a full-time team of three litigators, including Kite. Nonetheless, by co-ordinating its submissions with the other law firms primarily involved in the defence, the courts were relieved of some of the pressure associated with such an enormous dispute.
With the Madoff litigation focusing minds on clawback claims like never before, it is by no means set in stone that the other Caribbean courts will adopt the same approach as the court in the Fairfield claim. Even if the BVI, Cayman and Bermuda courts agree that a redeemed investor is a creditor for the redemption price, not a shareholder, they are likely to differ on other issues.
Domino effect
‘The decision of the court, upholding the defence of good consideration, did not come as a surprise,’ says Eliot Simpson, Appleby’s BVI litigation and insolvency practice head. ‘What is particularly impressive, however, is the speed and efficiency with which the court dealt with these cases, most of which were finally determined at first instance in favour of the defendants within about nine months from issue.’
If the Fairfield litigation continues to go the way of the defendants, other liquidators faced with a similar scenario will ask themselves if they really do wish to sue everybody who has received a redemption based on the original net asset value. And because the legal principles are based on English common law, Fairfield’s consequences are far-reaching and will affect other jurisdictions where similar types of claims have been made. ‘If the court’s decision is followed elsewhere,’ says Simpson, ‘this will mean that common law mistake as a basis for seeking to clawback windfall redemptions will no longer be available.’
This is good news for the defendants, even if these decisions are likely to go to the Court of Appeal and then the Privy Council. Yet if the litigation starts to go in the other direction, investors in feeder funds will remain concerned about liquidators clawing back redemption monies years down the line, arguing that redemption monies were paid out by mistake. Nonetheless, the 2011 BVI decisions have already affected Madoff litigation in other jurisdictions: recently the parallel New York proceedings were effectively stayed.
Although the recent judgments make it less likely that the feeder funds can launch successful clawback claims against their investors, it is likely that 2012 will be another active year in the BVI for the Fairfield claims, due to the appeals process and the remaining cause of action in New York possibly being transferred to the BVI. In addition, Anton Goldstein, an associate in Conyers Dill & Pearman’s BVI office, says that the liquidators are still pursuing clawback claims based on the voidable transactions provisions of Part VIII of the Insolvency Act. Although it is not clear when these claims will be heard, such provisions allow a liquidator to claw back payments if they were made at a time when the company was insolvent or caused the company to become insolvent.
‘The effect of an assignment of redemption proceeds in the context of liquidation remains an active one,’ says Conyers BVI partner Richard Evans, who is appearing in two appeals before the Eastern Caribbean Supreme Court of Appeal, where it is being argued against a Conyers’ client, Spectrum Galaxy Fund, that an assignee is in a better position than a redeemed member, who cannot bring a liquidation application. ‘This issue will be central,’ adds Evans. One case will go to appeal, while in the other the court has granted a time extension in which to appeal, demonstrating the court’s apparent interest in the issue.
‘Almost every Cayman firm of any size has been involved with the Al-Sanea litigation’
Under scrutiny
Although most of the Madoff-related court action has been BVI-dominated, Cayman is not immune. Ogier Cayman acts for funds facing clawback claims, following investments directly or indirectly into Madoff, while Mourant Ozannes has defended funds against clawback claims advanced by Irving Picard, the court-appointed trustee for BLMIS and a partner at Baker & Hostetler.
Naturally, the BVI’s October Fairfield decision is of particular interest. ‘It provides some guidance,’ says Peter Hayden, a Cayman-based partner at Mourant Ozannes. ‘But that decision relates to claims based on mistake, and there are a number of other bases for the claims being advanced by the Madoff trustee in Cayman.’ For example, the claims also raise interesting questions relating to the international reach of insolvency proceedings.
The BVI and Cayman courts are now adopting different approaches when considering whether funds should be wound up for loss of substratum. In the BVI case of Aris Multi-Strategy Lending Fund Ltd v Quantek Opportunity Fund, Ltd (see ‘Riding High’, LB218, page 72), the traditional approach to winding up for loss of substratum was adopted, finding that a winding up order should only be made where it was impossible for the fund to continue to operate. But in the Cayman case of Re Heriot African Trade Finance Limited, the court held that an order could be made not only where it was impossible for the fund to continue to operate, but also where that was impractical. ‘Ultimately,’ says Hayden, ‘because many of the issues are common law issues, the approach in both jurisdictions should be consistent, but it may take appeals, possibly all the way up to the Privy Council, to clarify the position.’
In addition, Cayman’s Commercial Court and financial services division have begun to manage the massive compensation claims brought by the Madoff feeder funds’ liquidators against former service providers. Appleby is representing the leading audit firms in those proceedings.
All aboard
Cayman also has other big fish to fry, its disputes market is dominated by the Maan Al-Sanea $9.6bn fraud claim, involving 43 defendants – 17 of which are now in liquidation – and related litigation in at least nine jurisdictions. It is believed to be the largest and most complex piece of litigation before the Cayman courts.
‘Almost every Cayman firm of any size has been involved with the Al-Sanea litigation in one way or another,’ says Ogier Cayman partner Chris Russell. Russell acted for the court-appointed receivers of numerous Saad company (the Saudi Arabian group of privately owned diversified businesses) defendants, and has also represented a number of investors, direct and indirect, into various Saad entities involved with the litigation. Appleby’s Jeremy Walton, litigation and insolvency department head in Cayman, represents Maan Al-Sanea; Mourant Ozannes, led by Hayden, acts for plaintiff Ahmad Hamad Algosaibi & Bros; and the 34th defendant (a feeder fund now in liquidation) instructed Harneys partner David Herbert.
‘It’s been an exciting time for litigation in the Caribbean’
In November 2011, the Grand Court of the Cayman Islands ordered Maan Al-Sanea to pay damages to the plaintiff for conspiracy and breach of fiduciary duty. Al-Sanea failed to file a defence but is seeking an appeal to the Privy Council against the Cayman court’s exercise of jurisdiction.
As with the BVI, in addition to Madoff and Al-Sanea, Cayman’s legal community is also busy with substantial trust disputes, with instructions originating from, among other places, Hong Kong, the Middle East and Russia. Additionally, there are large numbers of hedge funds currently in liquidation. The growth of related litigation has been relatively slow, but as the expiry of limitation periods draws closer and pressure increases to make recoveries, there are likely to be more claims by liquidators and funds.
Completing the triangle
Bermuda has not been quiet either. Picard is suing Bermuda-based Kingate Management (which was BVI-incorporated and had three employees running an outfit that fed $1.7bn to Madoff’s company in New York), as well as feeder funds Kingate Global and Kingate Euro Funds. In June 2011, Bermuda-based Citi Hedge Fund Services, the administrator of the Kingate funds was also served with a summons, being accused of not performing any meaningful, substantive or reasonable due diligence on the Kingate Funds or BLMIS’ operations and its returns.
Both Kingate funds are now in liquidation. The liquidators have filed several actions in Bermuda, Picard alleging that Kingate and its founders, Federico Ceretti and Carlo Grosso and their company FIM, should return $975m of redemption monies.
As for Kingate’s investors, in late 2009 in the case of Kingate Global Fund Ltd v Knightsbridge (USD) Fund Limited, the Bermuda Court of Appeal considered the situation where a prospective investor in the fund sent in subscription monies and a share subscription application form shortly before the Madoff fraud was discovered and the fund suspended subscriptions.
The liquidators argued that the share subscription monies belonged to the fund and they were generally available for distribution to unsecured creditors, even though shares had not yet been issued. The investor maintained that the share subscription monies should be treated as being held on trust on the basis that the investment had not materialised and shares were not issued.
‘We’re not used to local cases becoming global precedents’
Auditors have also been hit with claims. In Bermuda, Appleby, led by Hamilton-based partner John Riihiluoma, represents PricewaterhouseCoopers (PwC) in proceedings brought by Kingate Global Fund and Kingate Euro Fund’s liquidators. A Court of Appeal decision in March 2011 considered the funds’ attempt to compel PwC to turn over documents, the court ruling in the funds’ favour. This is now subject to a petition to the Privy Council in London. Sedgwick’s Mark Chudleigh again acted for the liquidators.
What next?
As a result of Madoff, fund managers are thinking carefully about the consequences of how they structure their funds and the importance of document construction. And in an increasingly competitive market the selection of fund service providers, including fund fiduciaries such as independent directors (see box, ‘Weavering away’, page 76), has also been influenced. The focus is not just on whether funds have a board of directors independent from the investment manager, but also on the identities and experience of those directors – including the number of other directorships that they might hold.
On the investor side, the importance of due diligence on funds has also become particularly apparent, believes Ogier’s BVI partner Simon Schilder, with the scope of due diligence undertaken by potential investors on the funds and their service providers significantly enhanced from the standard pre-financial crisis model. Investors used to think that the worst-case scenario was that the fund lost all its money. Now they know that they could not only potentially lose the entire investment, but also have to pay back monies redeemed before the collapse.
‘It’s been an exciting time for litigation in the Caribbean,’ says Conyers’ Bermuda-based chairman John Collis. ‘We’re not used to local cases becoming global precedents.’ LB
Weavering away
The Madoff fallout has also thrown the spotlight firmly on directors and how they perform their supervisory role. In the late 2011 case of Weavering Macro Fixed Income Fund Limited (In Liquidation) v Stefan Peterson and Hans Ekstrom (Weavering), the Grand Court of the Cayman Islands produced a judgment that brought into focus best practices within the investment funds industry for all participants. ‘The need for funds to demonstrate good corporate governance in structuring themselves and raising investor capital has therefore moved into the foreground,’ says Ogier’s BVI-based partner Simon Schilder.
In Weavering, the liquidators of the fund successfully sued the fund’s two independent non-executive directors for wilful default in the discharge of their duties. The judge awarded damages of $111m against each director to the fund’s liquidators in compensation for the losses suffered. The directors are appealing. Ogier Cayman acted for the successful plaintiff liquidators in the Weavering litigation. Cayman law firm Campbells represented the director defendants, led by litigation head J Ross McDonough.
Many consider that the Weavering judgment will have a long-term impact on the role and duties of directors precisely because it lays out in detail what they can and cannot do on a day-to-day basis. ‘It is causing somewhat of a stir among both onshore and offshore fund boards, which will have to reflect carefully on their positions,’ says Conyers Dill & Pearman’s Bermuda-based chairman John Collis.
Ogier’s Cayman partner Chris Russell finds the decision a very helpful and welcome analysis. But he also believes that it adds little in the way of lessons to well-advised directors. ‘The case turned very much on its facts,’ he says, ‘and on the meaning and effect of an exculpation clause.’
Ogier’s advice to clients when structuring investment funds is that they should have appropriate checks in place, an independent board, administrator and auditors. ‘Although our advice has not changed in that respect,’ says Russell, ‘our experience is that in the aftermath of Madoff, investors have become more assertive in insisting on these protections.’ Over at Cayman firm Thorp Alberga, it’s a similar tale. ‘We are certainly seeing more clients question whether the one-stop shop model that grew rapidly in the boom years does in fact best serve their interests and those of their investors,’ says partner Linda Martin.