Privy Council upholds dismissal of claims against former shareholders in Madoff feeder fund

09/05/14

The Judicial Committee of the Privy Council has delivered a crucial judgment in favour of former shareholders of Fairfield Sentry Ltd (‘Sentry’), the largest of the Madoff feeder funds, in the multi-billion dollar claims brought against them for the recovery of payments made upon the redemption of their shares over a number of years before the exposure of the Madoff fraud.

Following the discovery in December 2008 that Bernard L Madoff Investment Securities LLC had been run as a massive Ponzi scheme, Sentry went into liquidation in the British Virgin Islands in July 2009. At the instance of its liquidators, Sentry brought hundreds of claims against its former shareholders in the British Virgin Islands, the United States of America and other jurisdictions, seeking to recover redemption payments made in the period from 1997 to 2008. Sentry alleged that it made these payments under a mistake as to the net asset value per share, and that as a result of the Madoff fraud the true net asset value per share was at all times nil or nominal. Similar claims were brought by two other Fairfield funds which are also in liquidation in the British Virgin Islands. The total amount claimed by the funds was more than US$7 billion.

Under Sentry’s Articles of Association, the redemption price was to be based upon the net asset value per share determined by the directors of Sentry. The defendants pleaded that various documents issued to them on behalf of the directors were “certificates” as to the net asset value per share and/or the redemption price which were binding on Sentry under Article 11 of its Articles of Association. These documents included e-mails, contract notes and statements of account that were routinely generated and sent to the shareholders when their shares were redeemed.

On a trial of preliminary issues and a subsequent application for summary judgment, Bannister J, the commercial judge in the British Virgin Islands, found that the documents relied upon by the defendants did not have the character of “certificates”. However, he held that the defendants had given good consideration for the redemption payments by surrendering their shares and that this provided a complete defence to Sentry’s claims in restitution. He therefore dismissed the claims. The Eastern Caribbean Court of Appeal affirmed the decision of Bannister J, holding that the documents were not “certificates”, but that the defendants had given good consideration because the alleged mistake did not nullify Sentry’s contractual obligation to pay the redemption price that Sentry itself had determined.

The Privy Council dismissed Sentry’s appeal on the good consideration issue and allowed the appeal of the defendants on the certification issue. The Board held that the Articles of Association clearly envisaged that the redemption price was to be definitively ascertained at the time of redemption. The net asset value per share upon which that price was based was to be the one determined by the directors at the time, whether or not the determination was correctly carried out. The provision in the Articles of Association for the issue of a “certificate” as to the net asset value per share or redemption price was to be understood as referring to the ordinary transaction documents which would necessarily be generated and communicated to the shareholder at the time of redemption, and not to some special document issued at the discretion of the directors.

Although the judgment was based on the construction of Sentry’s Articles of Association, it may prove to be of considerable importance for investors in other similarly constituted funds, in particular because of the Board’s recognition that the scheme for subscriptions and redemptions depended upon the price being definitively ascertained at the time, and was unworkable on any other basis.

The judgment is here.