Liquidators for Fairfield Sentry Ltd. may not be able to sue foreign customers in US Bankruptcy Court

Bloomberg–Liquidators for Fairfield Sentry Ltd. and affiliated funds, which had been the largest feeder funds for Bernard L. Madoff Investment Securities Inc., may not be able to sue foreign customers in the U.S. Bankruptcy Court in New York as the result of a Sept. 19 ruling by Chief U.S. District Judge Loretta A. Preska in New York. The liquidators might have a tactical advantage were they able to keep the more than 200 lawsuits in bankruptcy court.

In May Bankruptcy Judge Burton R. Lifland ruled that liquidators for the Fairfield Sentry funds from the British Virgin Islands have the right to bring lawsuits in bankruptcy court under the umbrella of the funds’ Chapter 15 cases. Under the Advance Sheets heading in today’s report, we discuss a ruling by another federal district judge ruling that Lifland was correct in allowing the liquidators to use the U.S. Bankruptcy Court under Chapter 15.

The liquidators filed lawsuits in state courts before they sought bankruptcy court assistance in Chapter 15. All together, the liquidators had more than 200 suits which they brought into the bankruptcy court after they received Chapter 15 relief. Lifland in May ruled that customers, even those located abroad, could be sued in bankruptcy court.

Defendants in 41 lawsuits filed an appeal, contending the suits should be sent back to state courts. In the 41 lawsuits, the liquidators are suing the investors to recover $3 million.

Lifland didn’t fare so well in Preska’s opinion as he did in the other opinion reported today on Fairfield Sentry’s eligibility for Chapter 15. Preska began by granting customers the right to appeal.

Reaching the merits of the case, she reversed Lifland by holding that a suit in Chapter 15 against a foreign customer isn’t a so-called core matter. She also ruled that attempting to exercise core jurisdiction against foreign customers would offend the doctrine handed down in June by the U.S. Supreme Court in Stern v. Marshall. In that case, the high court ruled that a bankruptcy court doesn’t have the right under the U.S. Constitution to make final rulings on state-law claims against creditors. Preska said that foreignlaw claims, like those brought by the liquidators, are the same as state claims.

Preska rested much of her opinion on territorial restrictions in Chapter 15. Where Chapter 11 cases can affect property anywhere in the world, Chapter 15, Preska said, deals only with property in the U.S. As to claims against foreigners, she said there was no U.S. property giving rise to core jurisdiction.

Just like a foreign liquidator may not sue to void transfers under Chapter 15 without filing a petition in Chapters 7 or 11, Preska said they don’t have the right to use the bankruptcy court to make final rulings voiding transfers under foreign law when the property sought is outside the U.S.

Preska didn’t decide whether the bankruptcy court has so- called related-to jurisdiction because she sent the case back to bankruptcy court so Lifland could decide if it’s mandatory for him to abstain and send the cases to state courts. Preska read most the issues on mandatory abstention as pointing toward sending the cases back to state court.

For details on the suits and the bankruptcy court’s ruling in May, see the May 31 Bloomberg bankruptcy report.

The appeal in district court is In re Fairfield Sentry Ltd., 11-mc-224, U.S. District Court, Southern District New York (Manhattan). The liquidators’ lawsuit in bankruptcy court is Fairfield Sentry Ltd. v. Theodoor GGC Amsterdam (In re Fairfield Sentry Ltd.), 10-03496, U.S. Bankruptcy Court, Southern District New York.