What happens when avoidance claims under foreign insolvency law face off against US bankruptcy law’s safe harbor provisions? Can service on non-US parties be proper even when conceded to be inconsistent with the Hague Convention?1 On December 14, 2020, the US Bankruptcy Court for the Southern District of New York (the “Court”) issued a memorandum decision in In re Fairfield Sentry Ltd. (the “Decision”)2 applying US law to preempt foreign law claims and sanctioning an alternative means of international service. On February 23, 2021, the Court denied a motion for reconsideration of one of the Decision’s rulings (the “Reconsideration Order”).3 The significance of the Decision and the Reconsideration Order regarding both issues is set forth below.
Fairfield Sentry has made headlines for more than a decade. Filed under chapter 15 of the US Bankruptcy Code (the “Bankruptcy Code”)4 in 2010,5 the case arose from the December 2008 discovery that Bernard Madoff had perpetrated perhaps the largest Ponzi scheme in recorded history, having defrauded thousands of investors of billions of dollars through his former investment advisory firm, Bernard L. Madoff Investment Securities LLC (“BLMIS”). Fairfield Sentry Limited and its affiliates (“Sentry”) played its part in the saga by having sold shares in investment funds created under the laws of the British Virgin Islands (“BVI”) to foreign investors, and in turn investing virtually all of the proceeds with BLMIS. Shortly after BLMIS was placed into liquidation in the US pursuant to the Securities Investor Protection Act,6 certain Sentry fund creditors and shareholders commenced insolvency proceedings against Sentry in the BVI. Liquidators (the “Liquidators”) were appointed in the BVI proceeding and subsequently recognized as Sentry’s foreign representatives in the corresponding US chapter 15 proceedings filed with the Court.
At the core of Fairfield Sentry have been the Liquidators’ actions to avoid certain redemption activity by investors (the “Defendants”) under BVI law as “unfair preferences,” “undervalued transactions” (together, the “BVI Avoidance Claims”), and constructive trust (the “BVI Constructive Trust Claims,” and together with the BVI Avoidance Claims, the “Claims”),7 and recover amounts transferred thereunder.
Relevant to the Decision, the Defendants moved to dismiss the Claims, arguing that: (1) the Claims are barred by the Bankruptcy Code’s safe harbor provisions; and (2) service of the complaints alleging the Claims was insufficient under the Hague Convention.
Held: The safe harbor provisions apply to foreign avoidance claims that are expressly preempted
The first element of the Decision is the Court’s express application of US bankruptcy law safe harbor provisions to avoidance claims brought under chapter 15 pursuant to foreign insolvency laws.
The Bankruptcy Code provides a debtor or debtor’s representative with the ability to avoid or claw back certain transfers upon entering a proceeding filed thereunder.8 However, the Bankruptcy Code also provides for certain of those otherwise voidable transfers to be “safe harbored” or insulated from avoidance.9 “Put simply, the safe harbor applies where two requirements are met: (1) there is a qualifying transaction (i.e., there is a ‘settlement payment’ or a ‘transfer payment . . . made in connection with a securities contract) and (2) there is a qualifying participant (i.e., the transfer was ‘made by or to (or for the benefit of) a . . . financial institution’).”10 The US Supreme Court further directed courts’ focus “on the transferor and transferee of the overarching transfer”—i.e., the safe harbor is not triggered where the qualifying participant is “a mere conduit or intermediary in connection with the overarching transaction between non-qualifying participants.”11 As a threshold matter, the Court found the transfers underlying the Claims to be qualifying transactions (settlement payments in connection with a securities contract) involving a qualifying participant (financial institution).
In the Decision, the Court held that the safe harbor applies in chapter 15 cases to bar foreign law avoidance claims to the extent they are analogous to the categories of US avoidance claims safe-harbored.12 Specifically, the Court held that the BVI Avoidance Claims were barred as those claims—which alleged that (i) Sentry had insufficient assets at the time of the redemptions, (ii) the funds were essentially insolvent when the payments were made, and (iii) the funds received no or insufficient consideration in exchange for the payments—were analogous to preference claims or constructive fraudulent claims under the US Bankruptcy Code, which are safe harbored from avoidance.
However, the Court found that the BVI Constructive Trust Claims, which alleged that certain Defendants knew they were redeeming at a fraudulently inflated price, were not shielded by the safe harbor provisions, noting that “courts do not assume that otherwise applicable foreign law is preempted absent express statutory language to that effect.”13 Given that the BVI Constructive Trust Claims were unlike claims to recover avoidable preferences or fraudulent conveyances under the relevant US law, and were not expressly preempted, the Court refused to dismiss those claims. Defendants sought reconsideration of this particular ruling (the “Constructive Trust Ruling”), which the Court denied14 on account of movants’ “hav[ing] failed to identify any controlling authority or facts [the Court] overlooked, clear error or manifest injustice.”15 The Court also rejected a new argument that the BVI Constructive Trust Claims were actually avoidance claims as they “require proof of different elements” and “proceed on different theories” even if they “may ultimately lead to the same result” in remedy.16 Alternatively, the Court noted that if Defendants believed the BVI Constructive Trust Claims were not “true constructive claims,” they should move to dismiss based on failure to state a claim rather than try to make them into “avoidance claims.”17 Defendants currently have until March 30, 2021 to file their anticipated appeal of the Constructive Trust Ruling and the Reconsideration Order.
Held: Hague Convention Not Exclusive Means of International Service
The second ruling within the Decision is the Court’s sanction of an alternative means of international service outside the Hague Convention.
The Liquidators served the complaints on the foreign Defendants by mail, including by international registered mail, at addresses listed in Sentry’s records. The Liquidators also served the complaints by mail on the Defendants’ counsel at their New York offices. The Liquidators conceded that mail service failed to satisfy the requirements of the Hague Convention but requested retroactive approval of their service by mail as being permissible under applicable law, or—alternatively—permission to re-effectuate service.
The Court held that a plaintiff is not precluded from attempting service through alternative means as the Court is permitted to order service pursuant to “any means not prohibited by international agreement.”18 The Court noted that the statute required the Liquidators to seek prior approval of such alternative methods, so it could not in this instance grant retroactive approval. However, the Court noted it had the discretion to approve the requested service on US counsel prospectively. First, service on counsel was arguably service on a “domestic conduit”19 and not prohibited by international agreement. Second, there were attempts to serve Defendants and any insistence on service under the Hague Convention would have been prohibitively expensive. Finally, given that the Liquidators had exercised due diligence to serve Defendants in a timely manner and the Defendants’ participation over the previous ten years through their local US counsel in defending the claims which were the subject of the Liquidators’ complaints, the Court saw no reason not to authorize additional time to re-effectuate service on local counsel in the US.
In a short order following the parties’ submission of orders based on the Decision, the Court emphasized its authority to authorize service on US counsel in general, but reiterated that its ruling in the Decision was specific to the facts before the Court, which related to only one set of Defendants.20 For all other Swiss Defendants otherwise subject to the Hague Convention, the Court reminded the Liquidators they would need to prove the level of contact with and participation by US counsel before mail service thereon—to the exclusion of service on the Defendants themselves under the Hague Convention—would be authorized.
In the Decision, the Court noted it was following the “majority” in what it labeled a “split” among the courts on “whether domestic service on a foreign defendant’s US counsel can constitute service ‘at a place not within’ the US under Rule 4(f)(3),” and cited several cases from the US District Court for the Southern District of New York in support of that position.21 On March 8, 2021, the US Bankruptcy Court for the District of Delaware issued an order similarly authorizing service on US counsel for Japanese defendants otherwise subject to the Hague Convention.22 In so doing, the Delaware bankruptcy court focused primarily on “adequate and recent contact” and “the requirements of Due Process,” while also looking to the necessity and efficiency of complying with the Hague Convention in light of expense and delay.23
1 The Hague Convention on the Service Abroad of Judicial and Extrajudicial Documents (the “Hague Convention”) is a multinational treaty standardizing foreign service of process among member jurisdictions.
2 Fairfield Sentry Ltd. v. Theodoor GGC Amsterdam (In re Fairfield Sentry Ltd.), Adv. Proc. No. 10-03496 (SMB), 2020 WL 7345988, at *1 (Bankr. S.D.N.Y. December 15, 2020), motion for reconsideration denied, 2021 WL 771677 (Feb. 23, 2021).
3 The author of the Decision is US Bankruptcy Judge Stuart M. Bernstein, who also issued the Reconsideration Order. On February 28, 2021, the case was reassigned to US Bankruptcy Judge Cecelia G. Morris. Notice, Adv. Proc. No. 10-03496, Docket No. 3081 (Bankr. S.D.N.Y. Feb. 28, 2021). Defendants (defined below) have disclosed their intention to appeal the Decision and the Reconsideration Order, but currently have an extension until March 30, 2021. Stipulated Order, Adv. Proc. No. 10-03496, Docket No. 3089 (Bankr. S.D.N.Y. Mar. 8, 2021).
4 11 U.S.C. §§ 101, et seq.
5 In re Fairfield Sentry Ltd., Case No. 10-13164 (SMB) (Bankr. S.D.N.Y. June 14, 2010).
6 15 U.S.C. §§ 78aaa, et seq.
7 The Court had previously dismissed the Liquidators’ other claims. See id. at *1.
8 See 11 U.S.C. §§ 544-45, 547-49, 553.
9 See 11 U.S.C. § 546(e).
10 Fairfield Sentry, 2020 WL 7345988, at *5 (quoting In re Nine West Sec. Litig., 20 MD. 2941 (JSR), 2020 WL 5049621, at *6 (S.D.N.Y. Aug. 27, 2020), appeal docketed, No. 20-3941 (2d Cir. Nov.
23, 2020)) (emphasis in original).
11 Id. at *3 (quoting Merit Mgmt. Grp. LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018)) (emphasis added).
12 Id. at *5 (citing 11 U.S.C. § 561(d)).
13 Id. at *10.
14 Reconsideration Order, 2021 WL 771677, at *1.
15 Id. at *1, *2, *4 (quoting In re Asia Glob. Crossing, Ltd., 332 B.R. 520, 524 (Bankr. S.D.N.Y. 2005); Perez v. Progenics Pharm, Inc., 46 F. Supp. 3d 310, 314 (S.D.N.Y. 2014)).
16 Id. at *3.
18 Fairfield Sentry, 2020 WL 7345988, at *12.
20 Order, Adv. Proc. No. 10-03496, Docket No. 3076 (Bankr. S.D.N.Y. Feb. 22, 2021); see also Fairfield Sentry, 2020 WL 7345988, at *10 (referring to these Defendants as “a test case”).
21 Fairfield Sentry, 2020 WL 7345988, at *12.
22 Green v. Mitsui Sumitomo Ins. Co. (In re TK Holdings, Inc.), Adv. Proc. No. 20-51004 (BLS), 2021 WL 954827 (Bankr. D. Del. Mar. 8, 2021).
23 Id. at *4-*5