In a recent Madoff-related decision,1 the Second Circuit ruled that a bankruptcy court in a chapter 15 case must conduct an independent review of an asset sale by a foreign liquidator, previously approved by a foreign court. In doing so, the Second Circuit also ruled that the bankruptcy court must perform that independent review as of the date the asset sale comes before the court, and not as of the date the asset sale was agreed by the parties or the date it was approved by the foreign court. Through this decision in the Fairfield case, the Second Circuit appears to expand the role of the bankruptcy court in chapter 15 cases and aligns, in some respects, with a recent decision of the Delaware bankruptcy court on similar matters.
Lower Courts Cast a Cold Eye on Fairfield's "Seller's Remorse"
We reported in earlier alerts2 on the decisions of
the Southern District of New York bankruptcy court and district
court in respect of the transfer of a claim of Fairfield Sentry
Limited, a Madoff feeder fund ("Fairfield"), against the
liquidation estate of Bernard L. Madoff Investment Securities, LLC
("BLMIS"). In brief, Fairfield had agreed to sell its
$230 million claim against BLMIS to Farnum Place, LLC
("Farnum") for a price equal to 32.125% of the face
amount of the claim. That agreement to sell came just days before
the BLMIS trustee announced a litigation settlement that increased
the market value of the claim to more than 50% of its face
amount.
The sale of the claim from Fairfield to Farnum was expressly
subject to the approval of both the British Virgin Islands (BVI)
court overseeing the liquidation of Fairfield and the US bankruptcy
court overseeing the related chapter 15 bankruptcy case of
Fairfield. The BVI court approved the sale, despite Fairfield's
attempt to unwind its own agreement, subject to the further
approval of the US court.3 The US bankruptcy court
declined to re-evaluate the sale, again over Fairfield's
objection, and deferred to the BVI court's prior
approval.4
The US bankruptcy court's decision was based on two principles:
(1) that the claim was not an asset located in the United States,
and therefore its transfer was not properly analyzed under US
bankruptcy law, and (2) the US bankruptcy court should extend
comity to the BVI court's decision to approve the sale, and not
question the BVI court's judgment. The US bankruptcy court
refused to allow Fairfield to get a "second bite at the
apple." It did not permit Fairfield to question the price at
which it had agreed to sell the claim based on an increase in the
market value of the claim between the date the deal was signed and
the date the transaction came before the US bankruptcy court for
approval. The US district court affirmed the US bankruptcy
court's decision.5
Second Circuit Adopts a Broader Rule for US Review of Sale Transactions
On appeal to the Second Circuit, the US district court's
ruling was reversed. In a decision entered on September 26, 2014,
the Second Circuit first ruled that the transferred claim was
located in the US, under section 1502(8) of the US Bankruptcy Code,
because the claim is property that could be attached through an
action in a US court. The claim was subject to such attachment in a
US court because the obligor on the claim, the liquidation trustee
for BLMIS, is located in New York, and because the situs
of the obligor controls the ability to attach the asset in a US
court action.
The Second Circuit next ruled that US courts reviewing sales of
assets in chapter 15 cases need not defer, on the basis of comity,
to prior court approvals of asset sales involving US assets.
Indeed, the Second Circuit held that US courts are
required to review such assets sales under the standards
for asset sale review contained in section 363 of the US Bankruptcy
Code, because of the mandate contained in section 1520(a)(2) of the
US Bankruptcy Code. They may not use comity as an excuse to avoid
that statutory mandate.6 Moreover, the Second Circuit
explained that on the facts of the case at hand, the BVI court
actually invited a separate review by the US courts of the claim
sale—so any discretion that may have existed for the US court
to decline such a separate view was not properly exercised
here.
If the Second Circuit's decision stopped here—with a
ruling that the BLMIS claim was a US asset subject to section 363
review—then it would be interesting to that extent alone. It
would more closely align the approach in New York bankruptcy courts
to the approach in Delaware bankruptcy courts in cases such as
Elpida,7 in which separate review of asset
sales previously approved by foreign courts seems more liberally
conducted. But the Second Circuit did not stop there. In addition
to remanding to the lower courts for review of the asset sale under
section 363, the Second Circuit went the extra step to say that the
lower courts must take into account the increase in the
value of the claim between the time the asset sale transaction was
agreed between the parties and the time that the proposed sale
transaction was brought to the US court for approval. In other
words, the lower courts cannot limit their review to whether the
32.125% price was a good deal for Fairfield when that deal was
signed. Rather, the lower courts must consider whether the increase
in price following the date the deal was signed gives reason to
decline approval of the deal. On the facts of the Fairfield case
itself, it is hard to believe that the lower court review ordered
by the Second Circuit will result in approval of the sale, because
the increase in the market value of the claim would—if the
sale at the lower, agreed price were approved—result in a
substantial lost opportunity to the creditors of the Fairfield
estate. For this reason, the Second Circuit's opinion, when
applied to the Fairfield facts, may result in both a further review
and a disapproval of the sale, in contrast to Elpida,
where the further review of the sale did not disrupt its prior
Japanese court approval.
The section 363 analysis of the Second Circuit could have
implications beyond the chapter 15 context as well. For example, on
some occasions, the value of assets subject to a pending section
363 sale increases from the time an auction ends to the time the
sale approval hearing occurs (whether because of extrinsic events,
as in Fairfield, or because a new buyer or offer emerges).
The Second Circuit's "second bite" ruling in
Fairfield could be cited by seller debtors and trustees
seeking to revisit such a sale even following the conclusion of an
auction (though counterarguments regarding the sanctity of a
court-approved auction process may also exist). The ruling also
encourages buyers to obtain court approval as soon as possible
after an agreement to purchase an asset in bankruptcy (or after the
conclusion of an auction), because the "second bite" is
not an option that is equally afforded to buyers.
The Bottom Line
The Second Circuit has taken a relatively aggressive stance on US court review of asset sales in chapter 15 cases. The Second Circuit has not just mandated separate review of certain asset sales by US courts following approval of those sales by the courts overseeing the related foreign liquidations. The Second Circuit has also mandated a standard of review that seems less likely, in some instances, to result in the US court affirming the foreign court's approval of the asset sale. While these mandates only apply where sales of US assets are at issue, the location of intangible assets continues to be a somewhat flexible concept. Therefore, at least in some respects, the Second Circuit's recent decision in Fairfield appears, directionally, to be expanding the role of US courts in chapter 15 cases, at the marginal expense of a more "universalist" approach to cross-border insolvency. In addition, the Second Circuit's ruling on the standard of review under section 363 may have effects in bankruptcy cases outside chapter 15.
1 Krys v. Farnum Place, LLC (In re Fairfield
Sentry Ltd.), No. 13-3000, 2014 WL 4783370 (2d Cir. Sept. 26,
2014).
2Jurisdictional Mix-and-Match: Vitro,
Elpida and Fairfield Demonstrate the
Uncertainties of Cross-Border Bankruptcy for US Bondholders and
Buyers (Feb. 13, 2013); Cross-Border Bankruptcy in 2013: 10 Decisions
Shaping Chapter 15 (Jan. 30, 2014).
3See In re Fairfield Sentry Ltd., 484 B.R. 615,
622 (Bankr. S.D.N.Y. 2013).
4Id. at 627-628.
5Krys v. Farnum Place, LLC (In re Fairfield Sentry
Ltd.), No. 13 Civ. 1524 (AKH) (S.D.N.Y. Jul 3, 2013).
6 Section 1520(a)(2) of the US Bankruptcy Code specifies
those sections of the Bankruptcy Code that are mandatorily
applicable in a chapter 15 case recognized as a foreign main
proceeding, including section 363.
7In re Elpida Memory, Inc., Case No. 12-10947
(CSS), 2012 WL 6090194 (Nov. 20, 2012).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.