BVI Constructive Trust Claims: Are they Avoidance Claims?
The U.S. Bankruptcy Court for the S.D.N.Y. provided further clarity in the Fairfield Sentry litigation on whether foreign constructive trust claims are avoidance claims in assessing the applicability of Sections 546(e) and 561(d), the U.S. bankruptcy safe harbor laws which generally immunizes securities transactions from bankruptcy avoidance actions. Judge Stuart M. Bernstein — in one of his last decisions before retiring from the bench — authored the opinion.
Denying a motion by defendants to reconsider his December 14, 2020 decision on the topic, Judge Bernstein reaffirmed that Bankruptcy Code Section 546(e) — the securities “safe harbor” — did not apply to BVI constructive trust claims. In that earlier decision, Judge Bernstein had ruled that the safe harbor could not reach foreign common law claims, because the safe harbor did not expressly bar them, and the U.S. federal law doctrine of “implied preemption” was inapplicable because the U.S. Constitution’s Supremacy Clause, on which the doctrine is based, applies only to U.S. state law and not foreign law. In yesterday’s ruling, Judge Bernstein rejected a new argument made by defendants in their motion for reconsideration — i.e., that the constructive trust claims asserted in the case actually constitute “avoidance claims” — emphasizing that, to the contrary, BVI constructive trust claims and BVI avoidance claims require proof of different elements. For example, to establish a constructive trust claim under English law, which would apply in the BVI, “the plaintiff must show, first, a disposal of his assets in breach of fiduciary duty; second, the beneficial receipt by the defendant of assets which are traceable as representing the assets of the plaintiff; and third, knowledge on the part of the defendant that the assets he received are traceable to a breach of fiduciary duty.” Neither breach of fiduciary duty nor the defendant’s knowledge, two of the three elements of the constructive trust claims, are elements of the foreign avoidance claims. Judge Bernstein observed that conversely, insolvency is an element of foreign avoidance claims but not the foreign constructive trust claims. Furthermore, he noted that while the defendant’s knowledge is an element of the constructive trust claims, it is part of the “good faith for value” affirmative defense available to fraudulent transferees that a transferee can assert or waive but the plaintiff need not prove. Thus, while the two sets of claims could in some instances ultimately lead to the same result, a money judgment for the amount of the redemption payments, the foreign constructive trust and foreign avoidance claims proceed on different theories and different proof.
Judge Bernstein’s reaffirmation and further explanation of his December 14, 2020 decision is good news for foreign office holders who have a cause of action they are considering the possibility of pursuing in the United States against a financial institution based on knowledge on the part of the financial institution.