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In re Fairield Sentry Ltd. Litigation

September 19, 2011

IN RE FAIRFIELD SENTRY LTD., ET AL. LITIGATION
THIS DOCUMENT APPLIES TO ALL ACTIONS



The opinion of the court was delivered by: Loretta A. Preska, Chief United States District Judge

Opinion & Order

Defendants in adversary proceedings before the Bankruptcy Court moved this Court for leave to appeal from an order of the Bankruptcy Court denying Defendants' motions to remand these cases to state court or abstain from asserting jurisdiction. In re Fairfield Sentry Ltd. (Fairfield III), 452 B.R. 64, 69 (Bankr. S.D.N.Y. 2011). For the reasons set forth below, the motion for leave to appeal [dkt. no. 1] is granted.

Following a hearing on the motion for leave to appeal, the parties agreed to use their submissions to the Bankruptcy Court on the substantive issues as their briefs on the merits of the issues in this Court if leave to appeal were granted. In re Fairfield Sentry, Ltd., No. 11 MC 224 (S.D.N.Y. Aug. 22, 2011). This opinion and order also addresses Defendants' appeal of the Bankruptcy Court's order denying Defendants' motions to remand or abstain. After careful consideration of all of the parties' submissions in the Bankruptcy Court and in this Court as well as the arguments made in the hearing before this Court, the order of the Bankruptcy Court is reversed.

I. BACKGROUND

The facts involved in this appeal are laid out in prior orders of the Bankruptcy Court and this Court, and the Court assumes familiarity with those facts. In re Fairfield Sentry Ltd. (Fairfield I), 440 B.R. 60, 64-66 (Bankr. S.D.N.Y. 2010); In re Fairfield Sentry, Ltd. (Fairfield II), No. 10 Civ. 7340, 2010 WL 4910119, at *1 (S.D.N.Y. Nov. 22, 2011); Fairfield III, 452 B.R. at 68-73. The Court rehearses only the facts germane to this appeal.

Plaintiffs, Fairfield Sentry Limited, Fairfield Sigma Limited, and Fairfield Lambda Limited (the "Funds"), are three Funds organized under the laws of the British Virgin Islands ("BVI"). The Funds sold shares to foreign investors and "invested" the proceeds with Bernard L. Madoff Investment Securities LLC ("BLMIS"). The Funds' shareholders could redeem their shares at will. After Madoff's fraud was exposed, the Funds' "investments" were eviscerated. As a result, each of the Funds entered liquidation proceedings in either February or April of 2009 in the BVI.

The BVI courts appointed liquidators and foreign representatives of the Plaintiffs. Beginning in April 2010, the foreign representatives began filing numerous lawsuits for Plaintiffs in the New York state courts against these and other Defendants. These Defendants are, generally, banks and the unknown beneficial holders of the interests in the Funds. Many banks purchased shares in the Funds (and were the registered owners) then resold them to individual clients, who were the beneficial owners of the shares. Plaintiffs originally made only state-law claims for money had and received, unjust enrichment, mistaken payment, and constructive trust. The theory of all of these claims, however titled, is the same: because of Madoff's fraud, the Funds miscalculated the net asset value ("NAV") of shares, which resulted in inflated share prices upon redemption. Plaintiffs challenge the transfers made to redeem shares because the amounts paid on redemption were allegedly too high.

On June 14, 2010, the foreign representatives commenced an ancillary proceeding in the Bankruptcy Court under Chapter 15 of title 11, United States Code, seeking recognition of the BVI liquidation proceedings as "foreign main proceedings." 11 U.S.C. §§ 1502(4), 1515. That petition was granted on July 22, 2010. Fairfield I, 440 B.R. at 66.

After this, the foreign representatives began filing substantially identical claims in the Bankruptcy Court rather than in state court. To date, over 200 substantially similar lawsuits have been filed in the state and federal courts. After recognition, the foreign representatives, under 28 U.S.C. § 1452(a), removed the actions that had been filed in state court to this Court, which referred them automatically to the Bankruptcy Court. Not all of the actions were removed simultaneously. Now, all of these lawsuits have been consolidated in the Bankruptcy Court.

Before recognition, the foreign representatives commenced in the New York state courts the 41 lawsuits against the present Defendants, claiming over $3 billion. These Defendants filed the motions to remand or abstain in the Bankruptcy Court on October 4, 2010, arguing that the Bankruptcy Court lacked subject matter jurisdiction and that it should abstain from hearing these cases. In addition, certain defendants claimed that the removal of the actions against them was untimely.

After the remand motions were filed, the foreign representatives amended 34 of the instant actions in January 2011 to include statutory claims under BVI law for "unfair preferences" and "undervalue transactions." These claims target transfers made within the vulnerability period under BVI law. Nevertheless, the essential facts to be determined are identical to the state-law claims for mistaken payment.

On May 23, 2011, the bankruptcy court denied the remand motion. Fairfield III, 452 B.R. at 69. The bankruptcy court ruled that it had "core" bankruptcy jurisdiction under 28 U.S.C. § 1334(a) "over the BVI Avoidance Claims in particular, and the Actions as a whole" because they "directly affect[] this Court's core bankruptcy functions under chapter 15." Id. at 74; see id. at 74-82. In the alternative, the court ruled that it had "related to" jurisdiction because the actions are related to the Plaintiffs' Chapter 15 case. Id. at 82. The court also ruled that it would not abstain under either the mandatory or permissive standards. Id. at 83-86. It also sua sponte enlarged the time period for removal of the allegedly untimely removed actions. Id. at 87-91. This Court granted Defendants' motion for a stay pending leave to appeal on July 14, 2011, and extended that stay at oral argument until a decision on the motion for leave to appeal was rendered.

II. LEAVE TO APPEAL

This Court has discretion to grant an interlocutory appeal of an order of the Bankruptcy Court. 28 U.S.C. § 158(a)(3). In exercising that discretion, courts have looked for guidance to 28 U.S.C. § 1292(b) and have granted such leave where (a) the order involves a controlling question of law; (b) there is a substantial ground for difference of opinion; and (c) an immediate appeal may materially advance the ultimate termination of the litigation. In re Adelphia Commc'ns Corp., 333 B.R. 649, 658 (S.D.N.Y. 2005). "[T]he 'question of law' must refer to a 'pure' question of law that the reviewing court could decide quickly and cleanly without having to study the record. The question must also be 'controlling' in the sense that reversal of the bankruptcy court would terminate the action, or at a minimum that determination of the issue on appeal would materially affect the litigation's outcome." Id. A "'substantial ground for a difference of opinion' must arise out of a genuine doubt as to the correct applicable legal standard relied on in the order. Substantial ground would exist if the issue is difficult and of first impression." Id. at 658-59. Normally, leave to appeal is granted where "exceptional circumstances" are present. Id. at 658.

This case presents issues of first impression regarding federal subject matter jurisdiction of the bankruptcy courts in a Chapter 15 case. The issues, as the discussion below shows, are nuanced and difficult, involve a new statutory scheme, and reach questions about the limits of the bankruptcy court's jurisdiction. There are substantial grounds for differences of opinion not only with respect to the Bankruptcy Court's determinations as to jurisdiction but also with respect to its determination as to abstention. Moreover, the issues are pure issues of law. The litigation has barely progressed, and little, if any, discovery has even been conducted. Fairfield II, 2010 WL 4910119, at *1. The substantive issues can be decided on the basis of the amended complaints. Finally, the determination of subject matter jurisdiction is not only of utmost importance in federal court but also would materially affect the litigation's outcome. Wynn v. AC Rochester, 273 F.3d 153, 157 (2d Cir. 2001). In short, leave to appeal is granted because this case presents the sort of exceptional circumstances other courts have found when granting such a motion. See In re DPH Holdings Corp., 437 B.R. 88, 93-94 (S.D.N.Y. 2010). The Court grants Defendants' motions for leave to appeal.

III. MERITS OF THE APPEAL

On appeal, Defendants' primary argument is that the Bankruptcy Court erred in determining that it had subject matter jurisdiction. First, Defendants argue that there is no "core" bankruptcy jurisdiction because these actions have no connection to the United States and are not cases arising "in" or "under" title 11. See 28 U.S.C. § 1334(b). They say that Plaintiffs' claims are independent of the United States Bankruptcy Code (and bankruptcy generally) and involve foreign plaintiffs seeking foreign transfers from foreign entities. Second, Defendants argue that the Bankruptcy Court erred in determining that it has "related to" or "non-core" jurisdiction over these actions. Defendants also argue that the Bankruptcy Court erred in failing to abstain from exercising jurisdiction under either the mandatory or permissive standards governing the decision to abstain. Certain Defendants finally argue that the Bankruptcy Court erred in sua sponte enlarging the time period for filing a notice of removal.

After outlining the standard of review and principles of federal subject matter jurisdiction in the bankruptcy context, the Court addresses Defendants' arguments in turn, beginning with "core" jurisdiction.

A. Standard of Review

When reviewing a decision of the Bankruptcy Court, this Court sits as an appellate court. It reviews the Bankruptcy Court's conclusions of law de novo but its findings of fact for clear error. In re Quigley Co., 449 B.R. 196, 200-01 (S.D.N.Y. 2010) (citing In re Bayshore Wire Prods. Corp., 209 F.3d 100, 103 (2d Cir. 2000)). Questions about the Bankruptcy Court's subject matter jurisdiction and questions of statutory interpretation are legal questions that are reviewed de novo. In re Marconi PLC, 363 B.R. 361, 363 & n.2 (S.D.N.Y. 2007).

B. Legal Landscape of Subject Matter Jurisdiction in

Bankruptcy Court

Subject matter jurisdiction over bankruptcy cases is a creature of statute. "Statutory interpretation always begins with the plain language of the statute, which [the Court] consider[s] in the specific context in which that language is used, and the broader context of the statute as a whole." In re Ames Dep't Stores, Inc. (In re Ames II), 582 F.3d 422, 427 (2d Cir. 2009) (internal quotation marks and citations omitted). The Court also considers binding precedents that "provide definitive interpretations of otherwise ambiguous language." SEC v. Dorozhko, 574 F.3d 42, 46 (2d Cir. 2009). "Where the statutory language remains ambiguous, [the Court] resort[s] to canons of construction and, if the meaning still remains ambiguous, to legislative history." Id.

The district court has "original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11." 28 U.S.C. § 1334(b). Jurisdiction of the full array of bankruptcy cases may be referred to the bankruptcy court. Id. § 157(a).

To satisfy constitutional limitations on the subject matter jurisdiction of the Article I bankruptcy courts, bankruptcy jurisdiction is divided into "core" and "non-core" jurisdiction. See 28 U.S.C. § 157; N. Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 84, 87 (1982) (plurality op.); id. at 91-92 (Rehnquist, J., concurring in the judgment); Mt. McKinley Ins. Co. v. Corning, Inc., 399 F.3d 436, 447-48 (2d Cir. 2005). A bankruptcy court may "hear and enter final judgments in" all "core" proceedings. Stern v. Marshall, 131 S. Ct. 2594, 2603 (2011). In a non-core case, a bankruptcy court "may only" submit proposed findings of fact and conclusions of law to the district court, which may enter final judgment "after reviewing de novo any matter to which a party objects." Id. at 2604; see 28 U.S.C. § 157(c)(1).

Core claims are those proceedings "arising under title 11" and proceedings that "arise in" cases under title 11. 28 U.S.C. § 157(a)-(b); In re Ames Dep't Stores Inc., No. 06 Civ. 5394, 2008 WL 7542200, at *4 (S.D.N.Y. June 4, 2008). Cases "arise under" title 11 when the cause of action or substantive right claimed is created by the Bankruptcy Code. MBNA Am. Bank, N.A. v. Hill, 436 F.3d 104, 108-09 (2d Cir. 2006); see In re Housecraft Indus. USA, Inc., 310 F.3d 64, 70 (2d Cir. 2002). Cases "arise in" a title 11 proceeding if they "are not based on any right expressly created by title 11, but nevertheless, would have no existence outside of the bankruptcy." Baker v. Simpson, 613 F.3d 346, 351 (2d Cir. 2010) (per curiam) (quoting In re Wood, 825 F.2d 90, 97 (5th Cir. 1987)) (internal quotation marks and alteration omitted). Thus, a claim that is "an essential part of administering the estate" implicates the Bankruptcy Court's core jurisdiction. In re Ben Cooper, Inc., 896 F.2d 1394, 1400 (2d Cir. 1990). The Court of Appeals has "held that core proceedings should be given a broad interpretation that is close to or congruent with constitutional limits." Mt. McKinley, 399 F.3d at 448 (internal quotation marks omitted).

Sixteen different types of matters are listed in the statute, providing a non-exclusive list of what claims are included within the bankruptcy court's core jurisdiction. 28 U.S.C. § 157(b)(2); Stern, 131 S. Ct. at 2603. However, "the determination of whether a particular proceeding is core or non-core cannot be made by simply consulting that list." In re Ames, 2008 WL 7542200, at *6. Whether a claim is core or non-core is determined on a "case-by-case basis by evaluating both the form and the substance of the particular proceeding" under the standards above. Id.

Non-core claims are those that are "related to" a bankruptcy case. See 28 U.S.C. § 157(c)(1). "[A] civil proceeding is 'related to' a title 11 case if the action's outcome might have any conceivable effect on the bankrupt estate." Parmalat Capital Fin. Ltd. v. Bank of Am. Corp., 639 F.3d 572, 579 (2d Cir. 2011) (internal quotation marks omitted).

C. Core Jurisdiction

Although asserted in several state- and foreign-law guises, all of the claims involved in these cases rest on the same essential theory: redemptions from the Funds prior to the discovery of Madoff's fraud - and prior to the commencement of the BVI liquidation proceedings - were based on inaccurate and falsely inflated calculations of the Funds' NAV because of the fraud. Therefore, the theory goes, portions of these redemption payments should be clawed back or rescinded for the benefit of the Funds' now-bankrupt estates because the redemption payments were mistakenly too high.*fn1

After reviewing the parties' submissions to the Bankruptcy Court and to this Court, the Court concludes that these cases do not fall within the Bankruptcy Court's core jurisdiction for two reasons. First, these cases do not "arise under" title 11 nor do they "arise in" a title 11 case. Second, the assertion of subject matter jurisdiction over these cases by an Article I court contravenes the principle of separation of ...


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