Hedge Fund Fight Over Madoff Claims Shows Contract Woes

Hedge Fund Fight Over Madoff Claims Spotlights Contract Dispute
The fight between the hedge fund firms comes as prices for larger claims on the con man’s estate have climbed to about 65 cents on the dollar, from the low 60s. Photographer: Jin Lee/Bloomberg News

Hedge funds Perry Capital LLC and Solus Alternative Asset Management LP are fighting over whether they had a contract when they agreed to trade $195 million of claims on Bernard Madoff’s bankrupt firm, amid rising prices on the claims.

Solus sued Perry July 3 for $20 million after the trade fell apart, saying they had a legally enforceable deal, sealed by phone and “instant messages” on Bloomberg LP terminals. Perry denied there was a deal, “let alone one that can be enforced in court.”

In a bankruptcy, a trader can’t get paid without a signed document showing the seller “unconditionally and irrevocably” sold, transferred and assigned the claim, with all rights attached. Under New York State contract law, trillions of dollars in debt trade telephonically with a confirmation by e-mail or on electronic systems such as a Bloomberg terminal.

“A contract for the sale of debt doesn’t have to be in writing,” said Robert E. Scott, a professor at Columbia Law School in New York. “There are no statutory bars to enforcement if there was a meeting of minds and a final understanding.”

The fight between the hedge fund firms comes as prices for larger claims on the con man’s estate have climbed to about 65 cents on the dollar, from the low 60s, according to Joseph Sarachek, managing director of claims trading at CRT Capital Group LLC, which buys and sells distressed debt. Solus claims that Perry backed off from the trade because it “apparently realized that it made a bad deal” and was “suffering a case of seller’s remorse.”

Conditional Nature

Perry said it wasn’t motivated by a change in Madoff claim prices. Its clients hadn’t booked a gain or loss on the claims because of the “conditional nature” of its deal with the bank selling the claims to Perry, it said.

There never was “even a draft agreement” to close the trade, nor a “meeting of minds” over essential aspects of the trade, it said in an Aug. 3 court filing.

“Simply put, legally and commercially, there has never been a contract, let alone one that can be enforced in court,” according to the filing.

David Rosner, a lawyer for Solus, didn’t immediately respond to a call seeking comment on Perry’s answer.

Richard Perry founded his hedge fund firm in November 1988, after working at Goldman Sachs Group Inc. A so-called event-driven manager, he trades stocks and debt of companies involved in mergers and spinoffs and those emerging from bankruptcy.

Event Specialty

Solus, led by ex-Morgan Stanley analyst Christopher Pucillo, also specializes in “event and credit-related” investments and manages $2.5 billion in assets, the New York-based firm said in a February statement.

More than $43 billion of claims on bankrupt companies traded in the past 12 months, according to SecondMarket Holdings Inc., which tracks court filings that disclose the trades. Defunct investment bank Lehman Brothers Holdings Inc. accounted for more than $41 billion of that amount, with brokerage MF Global Inc. placing second, with around $1 billion of claims changing hands.

The volume in Madoff claims is harder to track, as the size of trades and names of buyers and sellers are mostly blacked out in filings. CRT’s Sarachek estimates the number at about $200 million in the past 12 months, using his own list of trades and data from the Madoff trustee.

Based on that estimate, the Solus-Perry trade would have doubled the volume. Perry could argue that agreeing to sell claims in bankruptcy implies an agreement to sign the final papers needed to disclose the trade in court, said bankruptcy lawyer Chip Bowles of Bingham Greenebaum Doll LLP in Louisville, Kentucky.

Procedural Provisions

“Generally the claim transfer provisions of the bankruptcy code are considered procedural,” so that Solus might be able to enforce the deal under New York State contract law, Bowles said.

The Solus-Perry negotiations were complicated by the fact that Perry didn’t own $195 million of claims, only an interest in them bought from a Deutsche Bank AG unit. Deutsche Bank Securities Inc. didn’t own the claims either because it hadn’t closed the trade with its seller, a so-called feeder fund to the Ponzi scheme, Kingate Global Fund Ltd. and a related fund -- which are suing the German bank for backing off the deal.

With the Deutsche Bank unit’s help, Solus and Perry were ready to close their trade by early June, Solus said in the July 3 lawsuit.

Even though Solus has made repeated demands since then, “Perry Capital has refused to honor the binding contract,” Solus said in its filing.

Accepted Practice

According to Solus, “It is a common and accepted practice for traders in this industry to negotiate and finalize legally binding trades orally (i.e., telephonically) and confirm and/or corroborate agreed-upon trades through Bloomberg instant messages. That is precisely what happened here,” it said in the lawsuit.

Perry says it “repeatedly” told Solus the deal was subject to negotiation. Perry wanted Solus to step in and do the trade with Deutsche Bank, freeing Perry of its obligations. Solus preferred to leave Perry “in the middle,” so it could buy an interest in the claims if it was potentially profitable, and otherwise change its mind, according to Perry.

A written contract might help avoid such disputes, even if traders who habitually work without one can fall back on state law, experts said.

Not Great

Even with state law protection, doing without a written contract is “not a great idea,” said Stephen Lubben, a bankruptcy law professor at Seton Hall University School of Law in Newark, New Jersey.

Deutsche Bank took a cautious route, also “consistent with longstanding industry practice,” it said, when Kingate a year ago offered to sell $1.6 billion of Madoff claims at 66 cents on the dollar, or about $1 billion.

Answering the feeder fund’s lawsuit over the broken trade in January, Deutsche Bank said it had made clear from the start that the deal was “expressly subject to” a signed sale document, which was never agreed on or executed.

“If that was the case, then under New York law the contract is not enforceable until that’s done,” said Columbia’s Scott.

Kingate, which is being liquidated in the British Virgin Islands, said in its December suit that Deutsche Bank signed a confirmation letter and assured the seller there wouldn’t be problems with the already drafted purchase and sale agreement. The confirmation letter states that it is a “firm, irrevocable and binding agreement,” it said.

Trustee Suit

The bank said it backed away from the trade because Kingate, which also is fighting a lawsuit by the Madoff trustee, didn’t fulfill its side of the bargain, which was to deliver claims that would hold up when payday came round.

“Given the expected purchase price of approximately $1 billion, any entity interested in buying the Kingate funds’ claims would reasonably insist on appropriate legal protections,” including valid claims and “a mutually agreeable purchase and sale agreement,” it said in a filing in U.S. District Court in Manhattan.

A June 1 letter to the judge from a Kingate lawyer that was filed in court says the litigants have been exploring “a possible solution” and are “hopeful” they can resolve the dispute. That hasn’t happened yet, said a person familiar with the talks who declined to be named.

Madoff trustee Irving Picard, who so far has paid the con man’s investors just $333 million from a customer fund, said July 26 he will ask a judge to approve a second payment of $1.5 billion to $2.4 billion. Madoff is serving a 150-year prison sentence.

The Solus case is Solus v. Perry Corp., 652341/2012, Supreme Court of New York (Manhattan.) The Kingate suit is Kingate Global Fund Ltd. v. Deutsche Bank Securities Inc., 11-cv-09364, U.S. District Court, Southern District (Manhattan).

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