You Are Now Entering the Twilight Zone: The British Virgin Islands, The Only Place Where Madoff, Stern, and Chapter 15 Meet

Contributed by Dana Hall
Although Stern v. Marshall, chapter 15 of the Bankruptcy Code, and the Madoff SIPA liquidations have each, independently, led to a substantial degree of speculation, a large number of lengthy legal opinions, and, in some instances, a general state of confusion in the legal profession, In re Fairfield Sentry Ltd. impressively manages to combine all three into a real mind-twister.  So, that said, I welcome you to the Twilight Zone, In re Fairfield Sentry Ltd., a recent case in which the United States District Court for the Southern District of New York determined that a bankruptcy court lacks “core jurisdiction” over both state law and foreign law claims asserted in a case under chapter 15 of the Bankruptcy Code to recover assets located outside the territorial jurisdiction of the United States.  The Fairfield court also found that assertion of subject matter jurisdiction over state law claims by an Article I court would offend the separation of powers contemplated under Article III of the Constitution.  Although certainly not the first significant decision to result from the Madoff fallout (and likely not the last), Fairfield presents unique issues with respect to the interaction between the relatively new statutory scheme of chapter 15 and post-Stern v. Marshall subject matter jurisdiction and is, therefore, likely to be the subject of abundant commentary, discussion, and, no doubt, further confusion.
Background and Bankruptcy Court Ruling
Prior to the exposure of the Madoff scandal and subsequent commencement of insolvency proceedings against Fairfield Sentry in the British Virgin Islands (“BVI”), Fairfield Sentry had served as a Madoff feeder fund organized under BVI laws.  Following the commencement of the BVI insolvency proceedings, various foreign representatives (BVI court-appointed liquidators of the debtors’ estates) initiated state law causes of action in U.S. state courts for, among other things, unjust enrichment and money had and received, against various Madoff investors who had allegedly obtained false profits by redeeming their shares prior to the revelation of the Madoff ponzi scheme.  Subsequently, the foreign representatives commenced a chapter 15 case in the United States Bankruptcy Court for the Southern District of New York and began commencing new, identical actions in the bankruptcy court, removing the fund’s state court actions to the bankruptcy court, and amending those actions to include statutory claims under BVI law for “unfair preferences” and “undervalue transactions.”  The defendants in those actions moved the bankruptcy court to remand the actions back to state court or to abstain from adjudicating the actions.  The bankruptcy court, however, determined that it had core jurisdiction over the BVI avoidance actions, in particular, and the state law actions as well, because such actions affected the core bankruptcy function of “providing ancillary assistance under chapter 15.”  The bankruptcy court ruled that, in the alternative, it had “related to” jurisdiction because the state law and foreign law actions, if successful, would enhance the value of the BVI estates created in the foreign main proceeding.  Accordingly, the bankruptcy court denied requests for permissive and mandatory abstention.
“Arising Under” Jurisdiction
On appeal, the Fairfield court gave short shrift to the issue of whether the BVI avoidance actions and state law claims arose under title 11.  The court determined that chapter 15 “merely gives foreign representatives standing to use United States courts to assert claims under law other than chapter 15” and that because none of the asserted causes of action were created by chapter 15 of the Bankruptcy Code, such causes of action did not arise under title 11.
“Arising In” Jurisdiction
The Fairfield court also held that the redeemer actions did not “arise in” a case under title 11 on either a statutory basis or a more general “form and substance” basis.  The court rejected the Bankruptcy Court’s finding of core jurisdiction under sections 1521(a)(5) and (7) of the Bankruptcy Code and held that because the assets sought in the redeemer actions were not located within the territorial jurisdiction of the United States, section 1521 could not be used to pursue such assets under state and foreign laws. The court held that section 1521(a)(5), by its explicit terms, only applies if the debtor’s assets are “within the territorial jurisdiction of the United States” and that, because none of the tangible assets sought by the plaintiffs were located in the United States, core jurisdiction could not hinge upon section 1521(a)(5).  The Fairfield court further held that the chapter 15 cases themselves constituted intangible assets and, accordingly, were located where the plaintiff was domiciled, the BVI.  Consequently, the court rejected the foreign representatives’ assertions that the chapter 15 cases themselves could satisfy the territorial limitations of section 1521(a)(5).  The court similarly rejected the foreign representatives’ argument that core jurisdiction could hinge upon the section 1521(a)(7) catchall provision providing “any additional relief that may be available to a trustee.”  Despite the broad language of section 1521(a)(7), the court found that permitting a foreign representative to use foreign avoidance laws in a chapter 15 case to retrieve assets outside the territorial jurisdiction of the United States would be inconsistent with the purpose and structure of chapter 15.  The court also noted that, under sections 1521(a)(7) and 1528, a debtor is only permitted to utilize title 11 avoidance powers if the debtor commences a plenary case within the chapter 15 case and, even then, the application of such powers is limited exclusively to assets within the territorial jurisdiction of the United States.  Indeed, it would be an odd result if a debtor could end-run these chapter 15 strictures by seeking to apply foreign avoidance laws against assets located outside of the United States without commencing a plenary case.
Additionally, the Fairfield court determined that none of the statutory bases enumerated in 28 U.S.C. § 157 applied to the redeemer actions.  The actions did not constitute turnover actions because the debtors’ entitlement to the property sought was subject to significant dispute and, because the commencement of a chapter 15 case does not create an “estate,” the actions could not concern or affect the administration or liquidation of the assets of the estate under section 157.  Accordingly, because the court found that there was no statutory basis for conferring core jurisdiction upon the redeemer actions, such actions would only be considered “core” if the “form and substance of the claims implicated the bankruptcy court’s core jurisdiction.”
Citing Granfinanciera S.A. v. Norberg, the Fairfield court determined that the state law claims and the avoidance actions asserted under BVI law were not core in “form and substance” because such actions were “quintessentially suits at common law . . . .”  Significant to the court’s decision were the facts that such claims could have been brought in the BVI cases and in state court (and had indeed been previously asserted in such courts) and that such claims could have been adjudicated finally and completely in such courts.  The court, however, pointed out that a foreign debtor may still avail itself of title 11 avoidance powers by commencing a plenary case within a chapter 15 case.
For an explanation of what might have been the foreign representatives’ motivation for seeking to apply BVI law in the chapter 15 cases, see this recent blog post discussing a recent ruling in the BVI cases denying debtor actions seeking the return of money from early redeemers on the basis of “mistake.”
Constitutional Issues
Although the Fairfield court found that there was no statutory basis for core jurisdiction over the state law and foreign law actions, the Fairfield court, nonetheless, went on to also state that the adjudication of the state law causes of action by an Article I court would offend the separation of powers embodied in the U.S. Constitution.  In the Fairfield court’s view, the redeemer actions were nothing more than “classic common law claims . . . brought by a bankrupt corporation to augment the bankruptcy estate.”  The fact that such claims might inure to the benefit of the debtors’ estates could not overcome the fact that such claims were not created under title 11 and involved a “nucleus of fact” arising before, and independent of, the chapter 15 case.  It is unclear whether the Fairfield court’s discussion of Article III applied to the foreign law claims asserted in the redeemer actions.  Notably, the Fairfield court did not attempt to address the issue of whether Congress could constitutionally empower Article I courts to adjudicate foreign law claims.
The Fairfield court did not reach the issue of whether the bankruptcy court might have had “related to” jurisdiction over the redeemer actions.  Because the bankruptcy court had relied on the “core” nature of the actions in rejecting the foreign representatives’ argument for mandatory abstention, the Fairfield court remanded to the bankruptcy court for reconsideration of mandatory abstention, and in particular, whether the state courts could timely adjudicate the cases.
In light of the Fairfield decision, state law and foreign-law causes of action asserted in a chapter 15 case against property located outside the territorial jurisdiction ofthe United States are not likely to be considered “core” matters and, as a constitutional matter, the extent to which state law or foreign law claims may be adjudicated by Article I courts will likely continue to be the subject of significant debate.  That said, if you’ve made it this far, it should now be quite evident that the only thing clear is just how very, very, unclear all of this remains.  The good news for readers is that Bernie and Anna Nicole won’t be meeting again . . . at least not in this life.