Judge Bernstein Reserves Decision on Assignment of Management Claims (Fairfield Sentry)

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Judge Bernstein Reserves Decision on Assignment of Management Claims Under Settlement Agreement Between Fairfield Sentry, Madoff Trustee

Notice of Hearing

Judge Stuart Bernstein heard argument yesterday regarding the proposed assignment of the Fairfield debtors’ claims against former investment managers – individuals and entities that compose the Fairfield Greenwich group – to Irving Picard, the Bernard L. Madoff Investment Securities SIPA trustee. Counsel for shareholders Morning Mist Holdings Ltd. and Miguel Lomeli, both of which are plaintiffs in a stayed derivative action on behalf of Fairfield Sentry as well as the lone objectors to the motion, argued against the proposed assignment. At the conclusion of argument, Judge Bernstein requested supplemental briefing on the standing issues addressed during the hearing and reserved decision on the assignment motion.

The hearing primarily focused on the issues of whether the objectors had standing to challenge the assignment; whether the assignment motion is a reasonable exercise of the business judgment of Kenneth Krys, one of the joint liquidators and foreign representatives of the Fairfield debtors; and, when deciding whether to move forward with the assignment motion, whether Krys adequately considered the events that have occurred between the execution of the settlement agreement in 2011 and the filing of the motion to assign the management claims. Krys ultimately took the stand to defend the settlement.

David Molton of Brown Rudnick, counsel for the foreign representatives, defended the assignment of the management clams provided under the settlement agreement. Beginning with the issue of standing, Molton argued that the objectors lacked standing to raise their challenge to the assignment because they are not official registered shareholders under British Virgin Islands law and therefore are not entitled to any distribution from the Fairfield estate. In response to Judge Bernstein’s question regarding whether he needs to exercise judgment over the objection, Molton charged that “the objections, whatever they are, need not be considered.”

Shifting to approval of the assignment of claims, Molton argued that the court was authorized to review and approve a component of the 2011 settlement agreement and that the motion seeking approval of the management claims assignment was an exercise of the foreign representatives’ business judgment to which the court should defer. Molton also explained the benefits that Fairfield already received under the settlement, which were outlined in both the motion and the reply, stressing the level of uncertainty that would arise if the settlement agreement were not in place. Counsel also noted that by entering into the settlement, both Picard and the Fairfield foreign representatives have engaged in cooperative efforts that have resulted in “huge consideration” for the estate.

Molton warned that if the settlement were not in place, the Farfield debtors may be in a position similar to the Kingate feeder fund, which faces the possibility of equitable subordination and has been unable to obtain dismissal of any of the avoidance actions filed against it. Counsel also noted the issue of “collectibility” in anticipation of the objectors’ arguments that the settlement should be revisited on the basis of the estimated amount of the management claims, as provided for in the amended complaint, of more than $900 million.

Disapproval of the settlement, Molton argued, “would lead us to the abyss.” He also characterized the lone objection as one that is “based on speculation” that the foreign representatives’ litigation position has been improved by decisions that are not yet final, adding that the objectors have engaged in “cherry-picking” decisions while “ignoring” others. Molton added that if the assignment is not approved and the settlement is not in effect, an upcoming distribution proposed by the foreign representatives cannot go forward.

In response to Molton’s argument, Robert Wallner of Milberg, counsel for the objectors, stressed that his clients had standing on the basis of their interest in the stayed derivative action. The court asked Wallner several questions related to Morning Mist’s standing beyond the derivative claim, and Wallner noted that although Morning Mist is not a registered shareholder, it will “get money ultimately” from any distribution made. Disagreeing that BVI law determined standing for purposes of objecting to the assignment motion, Wallner asserted that having an interest under the Bankruptcy Code was sufficient. Judge Bernstein also pointed out that the objectors have the burden to prove standing.

At the point where Wallner was prepared to address the change in circumstances between when the deal was negotiated and the filing of the motion, Judge Bernstein suggested calling on Krys to testify regarding whether he considered the recent changes in law when deciding to go forward with the assignment now.

During his testimony, Krys echoed the points raised earlier in the hearing by his counsel, stressing the benefits of the settlement agreement and the potential negative consequences of not entering into an agreement with Picard. Addressing the question of whether the settlement should be revisited, Krys concluded that the settlement “still made a lot of commercial sense,” adding that it would be “unwise” for the foreign representatives to tell Picard that they were no longer interested in the settlement and were seeking to unwind it. Krys added that, absent the agreement, he would no longer be in the position to make distributions, noting the potential for disputes over funds in escrow. Krys explained that the source of a potential upcoming distribution to Fairfield shareholders would be unlikely absent the settlement, noting that a significant source of the funds for distribution is Fairfield’s SIPC claim.

On cross-examination, Wallner questioned Krys over whether he considered approaching Picard to renegotiate the settlement, and Krys stated that he did not. In challenging Krys’ decision, Wallner focused on other legal decisions, both at the bankruptcy court and district court level, and whether Picard’s causes of action against Fairfield were affected by those rulings. During a brief re-direct by Molton, Krys stressed that he takes his job “very seriously” and explained that the settlement with Picard “was the best decision for Fairfield Sentry.”

After Krys’ testimony, Wallner returned to finish his opening argument, stressing that the settlement agreement should “reflect what is happening today” and that Krys “never sought to renegotiate the deal.” However, Judge Bernstein pointed to Krys’ testimony, noting that Krys “considered factors” and “still concluded” that, on the basis of his business judgment, he “still supports the settlement.” In response to Wallner’s comments that Picard “is a winner” and would be “a fool to walk away,” Judge Bernstein noted that Krys “doesn’t want to walk away either.” According to Wallner, it is “highly likely that a better deal would be obtained for Fairfield Sentry” if the parties went back to negotiation or mediation.

The court was also unreceptive of Wallner’s arguments that Picard’s complaint against the Fairfield debtors, in its current state, falls “woefully short,” noting Picard’s right to file an amended complaint. Judge Bernstein observed that in the new complaints already filed by Picard following the changes in law, the allegations have been “vastly” different, adding that it “makes no sense” to look at the allegations in the complaint on file and “say ‘Aha!’”

Molton returned briefly to make closing remarks, stressing that Krys’ business judgment should be afforded deference under the circumstances. He also discounted the need to speculate as to whether a better deal was possible and noted the possibility that Picard would not be amenable to negotiating the settlement. Returning to the standing issue, Molton argued that it is “absolutely clear” under BVI law that the objectors do not have standing.

At the close of the hearing, Judge Bernstein requested supplemental briefing from the parties on the issue of standing. In more specific direction provided earlier in the hearing, the court asked the parties to address the question of whether the objectors “really have” a financial interest such that they have standing to object to the assignment.