The case concerned a BVI company, Fairfield Sentry Limited (the “Fund”), which was the largest feeder fund to have invested in Bernard L. Madoff Investment Securities LLC (“BLMIS”). The Fund’s liquidators brought claims in the BVI High Court against a number of investors which had redeemed their shares in the Fund prior to the discovery of the Madoff fraud. More than 300 similar actions in the USA were stayed pending the Privy Council’s decision.
Bannister J heard the claims in the BVI and determined two preliminary issues. Firstly, whether transaction documents issued to shareholders recording the NAV per share or Redemption Price were “certificates” within the meaning of Article 11 of the Fund’s Articles, and if so whether these were binding so as to preclude recovery since the certified amounts exceeded the true redemption price. Secondly, whether by surrendering its shares a member gave good consideration for the redemption proceeds which it received, thereby also precluding recovery. Bannister J found that none of the documents constituted a certificate but that good consideration had been given. His decisions on both issues were affirmed by the Eastern Caribbean Court of Appeal, albeit with different reasoning.
The decisions of the Eastern Caribbean Court of Appeal were appealed to the Privy Council, at which stage the Fund accepted that if the certificates were binding under Article 11, its claims would fail. Lord Sumption gave the unanimous advice of the Privy Council. He referred to the well settled principle of the English law of restitution that a payee of money cannot be said to have been unjustly enriched if he was entitled to receive the sum paid to him, and that to the extent that a payment made under a mistake discharges a contractual debt of the payee, it cannot be recovered unless (which was not suggested) the mistake is such as to avoid the contract.
As a result, the Fund’s claim depended on whether it was bound to make the payments. This turned on whether the Fund was obliged upon redemption to pay the true NAV per share as ascertained in light of Madoff’s fraud (as argued by the Fund) or to pay the NAV per share determined by the directors at the time (as argued by the redeemed shareholders). If the latter, the shares had been surrendered in exchange for the amount properly due under the Articles, and such amounts could not be recovered under a claim for restitution.
The starting point was the Articles which determined the Subscription and Redemption Prices (based on the NAV per share under Article 11) and the timing of determination and payment. Lord Sumption commented that “the whole of this scheme depends upon the price being definitively ascertained by the Dealing Day and known to the parties shortly thereafter. It is unworkable on any other basis.” The Fund argued that the directors’ determination was not definitive unless they chose to issue a certificate under Article 11 which provided that “Any certificate… shall be binding on all parties.” This construction was rejected by Lord Sumption for reasons of certainty:
“If it were correct, an essential term of both the subscription for shares and their redemption, namely the price, would not be definitively ascertained at the time when the transaction took effect, nor at the time when the price fell to be paid… This would not only expose Members who had redeemed their shares to an open-ended liability to repay part of the price received if it subsequently appeared that the assets were worth less than was thought at the time. It would confer on them an open-ended right to recover more (at the expense of other Members) if it later appeared that they were worth more. Corresponding problems would arise out of the retrospective variation of the Subscription Price long after the shares had been allotted.”
Since under the Articles the Subscription and Redemption Prices were to be definitively ascertained at the time, the NAV per share had to be the one determined by the directors at the time whether or not carried out in accordance with Article 11. This meant that either the determination must (i) be treated as conclusive whether or not there was a certificate; or (ii) the reference in Article 11 to a certificate must refer to the ordinary transaction documents communicated to members at the time. The Privy Council considered that, where such a certification provision was included, the correct approach was the second one, on the basis that:
“…the word “certificate” has no standard meaning and … the question what constitutes a certificate is dependent on the commercial or legal context in which the certification clause appears… As a matter of language, a “certificate” ordinarily means (i) a statement in writing, (ii) issued by an authoritative source, which (iii) is communicated by whatever method to a recipient or class of recipients intended to rely on it, and (iv) conveys information, (v) in a form or context which shows that it is intended to be definitive. There is no reason to think that a document must satisfy any further formal requirements, unless its purpose or legal context plainly requires them. There is nothing in the context of these Articles which does.”
The Privy Council considered that the monthly emails and statements of account sent to members, and the contract notes sent to a redeeming member, were “certificates” since they communicated information in documentary form to Members. It was held these were issued by an authoritative source being sent by the Fund’s Administrator pursuant to the functions delegated to it by the directors under the administration agreement. In addition, in the context the documents were intended to be definitive. The Privy Council, however, declined to express an opinion on whether statements on the Administrator’s website constituted “certificates” since this depended on considerations upon which evidence had not been adduced.
Accordingly, the Privy Council allowed the appeal on the issue of certificates (save as to the website information) and dismissed the appeal on the question of good consideration.
It is clear that the judgment was heavily influenced by the need for certainty and finality in the subscription and redemption of shares in hedge funds. The Privy Council did not favour “open-ended” liability to repay redemption prices based on an overvalued NAV. Lord Sumption may have been influenced by the reality he accepted that it “is inherent in a Ponzi scheme that those who withdraw their funds before the scheme collapses escape without loss, and quite possibly with substantial fictitious profits… The loss will in principle be borne entirely by those who were still Members of the Fund at that date.”
The breadth of the judgment’s application is not yet certain, since the focus was the interpretation of specific articles of association and in particular their provision for certificates, which will not be shared by all investment funds. Whilst the guidance on what will constitute a certificate is welcome, in each case this will be fact specific. In addition, although the Privy Council dismissed the appeal regarding good consideration, Lord Sumption did not directly address it as a defence. Instead he decided it alongside the interpretation of the Articles, on the basis that a redemption could not be unjust where the fund was obliged to pay the amount determined by its directors, and therefore an essential requirement for unjust enrichment would not be present.
It should also be noted that the Fund’s claims were based exclusively on common law. Depending on the jurisdiction, a liquidator may be able to bring claims based on company law legislation to recover an unauthorised return of capital or unlawful share redemption, or under insolvency avoidance provisions. There is also potential for claims to be based on knowing receipt by shareholders where the directors breached their duties in determining and paying redemptions and where the shareholder’s knowledge was such as to make it unconscionable for them to retain the payment.
This advisory has been prepared as a summary of the law and is for general guidance only. It is not intended to be, nor should it be used for, a substitute for specific legal advice on any particular transaction or set of circumstances.
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