Until his arrest and subsequent imprisonment Bernard Madoff operated what is thought to have been the biggest Ponzi scheme in history. Redemptions were funded by incoming investments. Those fortunate enough to withdraw their money in good time lost nothing; indeed, many exited with substantial returns. But as all Ponzi schemes ultimately do, the scheme came crashing down.
Fairfield Sentry ("the Fund") was a BVI feeder fund, having 95% of its assets invested with Bernard L Madoff Securities (Madoff). Following Madoff's arrest, the Fund suspended redemptions. It was placed into liquidation in the British Virgin Islands on 21 July 2009.
Amongst the investors in the Fund were a large number of institutional investors holding positions in the Fund as intermediaries for their own customers. The Fund alleged that the Net Asset Value at which those investors, amongst others, had redeemed was based upon a mistake: that being a mistaken reliance upon statements made by Madoff as to the value of the Fund's shares in Madoff. The liquidators of the Fund therefore sought the return of redemption payments made prior to the collapse of Madoff's venture. They alleged that the investors had been unjustly enriched at the Fund's expense, and that orders for restitution should be made as a result of that mistake.
In the BVI Commercial Court, Bannister J ordered the trial of a series of preliminary issues. Amongst those issues were two key questions: firstly, on the basis of the Fund's articles, was the Fund bound by the net asset value ("NAV") that it recorded in emails and redemption documents at the time that redemption payments were made? Pursuant to the articles, it would be so bound if these documents constituted "certificates" under those articles ("the Certificate Issue"). Secondly, did the redeemed former members have good defences to the Fund's claims in unjust enrichment on the basis that they had given good consideration for the redemption payments? ("the Good Consideration Issue").
Bannister J decided the Certificate Issue in favour of the Fund, and the Good Consideration Issue against it. He was upheld in both respects by the Eastern Caribbean Court of Appeal.
The matter came before the Privy Council in March 2014 with the Board's Opinion delivered by Lord Sumption on 16 April.
The Privy Council dealt with the Good Consideration Issue first, approaching it as follows. If the Fund was obliged to pay the true value of the shares upon redemption, as calculated when the real nature of its investments with Madoff was discovered, then the excess paid to redeemers was paid by mistake and would be recoverable as unjust enrichment. If, however, on the true construction of the Fund's articles, the Fund was obliged to pay whatever NAV was calculated by its managers on the relevant redemption date, and the redeemers were entitled to receive such sums (regardless of the "true" worth of the shares), then the claim in unjust enrichment must fail, since a person cannot be unjustly enriched by a sum he is contractually entitled to receive.
The Privy Council agreed with Bannister J and the Court of Appeal that the Fund's construction of the articles was misconceived. An obligation to pay the "true" value of the shares – even when that differed substantially from the value calculated by the Fund's managers – would result in intolerable uncertainty. An essential term of the redemption would not be ascertained at the time that the transaction took effect. Exiting members would have either open-ended liabilities for overpayments (if the NAV were revised down) or open-ended claims for underpayments (if revised up). Accordingly, the appeal on this element was dismissed.
As to the Certificate Issue, the Privy Council held that "certificate" is not a legal term of art. Its meaning depends on the commercial context. "As a matter of language, '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."
The Privy Council held that a series of emails, contract notes and monthly statements fulfilled all of the above criteria. The context in which they were delivered supported the conclusion that they were intended to be definitive. The consequence was that since those documents constituted certificates under the Articles, the NAV certified by them was binding and conclusive. The Board left open the question as to whether statements made on the Fund's website could amount to a certificate. Since the Fund was liable to pay the redemption sums, no question of mistake or unjust enrichment could therefore arise.
We have suggested before that the Privy Council's decision is likely to be closely watched, not just by the many hundreds of investors subject to claw back actions in the British Virgin Islands and elsewhere, but also by funds lawyers keen to see what lessons can be learned in relation to the drafting of offering documentation. A key lesson is surely that investors in the future will wish to see well drafted clauses, which not only provide for certifications to be conclusive, but are also clear about the circumstances in which that clause will engage.
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