Madoff Securities International Ltd v Raven [2013] EWHC 3147 (Comm)

MSIL's liquidators sued former directors and Mrs Kohn over payments made by the London subsidiary of Bernard Madoff's business. The court dismissed all claims, finding directors acted honestly and reasonably, payments were funded by BLMIS making them cash neutral, and Mrs Kohn was not dishonest in receiving payments for legitimate services.

Facts

Madoff Securities International Limited (MSIL), the London subsidiary of Bernard Madoff’s business empire, was placed into liquidation following the revelation of Madoff’s notorious Ponzi scheme in December 2008. The liquidators brought claims against five former directors and Mrs Sonja Kohn regarding three categories of payments: payments to entities connected with Mrs Kohn totalling approximately US$27 million for services including research and introductions (the ‘MSIL Kohn Payments’); interest payments of approximately US$14 million under subordinated loan agreements; and lifestyle payments for Bernard Madoff’s personal benefit totalling approximately €5.3 million, US$566,000 and £180,000.

None of the defendant directors knew of or suspected the Ponzi scheme fraud. MSIL operated legitimate proprietary trading and market making activities in London. The MSIL Kohn Payments were made regularly from 1992 to 2007 and were funded by BLMIS in New York, making them cash neutral for MSIL. The payments were openly recorded in the company’s books, known to the auditors KPMG, and approved by Bernard Madoff as chairman and controlling shareholder.

Issues

The principal issues were: (1) Whether the directors breached their fiduciary duties in making or permitting the MSIL Kohn Payments; (2) Whether Mrs Kohn was liable for dishonest assistance or knowing receipt; (3) Whether the subordinated loan agreements and interest payments constituted breaches of directors’ duties; (4) Whether the lifestyle payments were improper; (5) Whether various defences including the Duomatic principle, no loss, limitation and relief from sanction applied.

Directors’ Duties

The court considered whether directors breached duties to act in good faith in the interests of the company, to exercise powers for proper purposes, not to make unlawful distributions of capital, and to exercise reasonable care skill and diligence.

Judgment

Popplewell J dismissed all claims against each defendant. Regarding the directors, the court found they honestly and reasonably believed the MSIL Kohn Payments were in MSIL’s interests, given that the payments were cash neutral for the company due to funding from BLMIS, Bernard Madoff as chairman and controlling shareholder wanted them made, and the directors were entitled to defer to his judgment on their value.

“The starting point for the present inquiry is that Mr Flax honestly and reasonably believed that the MSIL Kohn payments were being fully funded by BLMIS and were cash neutral for MSIL. There was, so far as he was concerned, no significant risk of MSIL being in a position of having to make the payments without such funding.”

The court rejected the allegation that the payments were unlawful distributions of capital:

“If one ignores the funding of the payments, there is considerable force in the Claimant’s submission that the substance of the arrangement was one in which there was payment by MSIL for what were substantially, although not exclusively, benefits to BLMIS rather than MSIL… But one cannot ignore the funding of the payments by BLMIS.”

Regarding Mrs Kohn, the court found she was not dishonest:

“If secrecy is the badge of dishonesty, in the memorable phrase of Millet J in Agip v Jackson… at 294, the converse is true: transparency is the hallmark of honesty.”

The research she provided was not worthless, and she honestly believed her services benefited MSIL. The Duomatic defence succeeded as both voting shareholders (Bernard Madoff and Peter Madoff) knew of and approved the payments. The no loss defence also succeeded because the payments were funded by BLMIS and were cash neutral for MSIL.

Implications

This judgment provides important guidance on directors’ duties in the context of companies controlled by a dominant shareholder. It confirms that directors may legitimately defer to the judgment of more experienced fellow directors and that acting in accordance with the wishes of a controlling shareholder can be treated as acting in the company’s interests where the company is solvent and not acting unlawfully. The case also clarifies that when assessing whether payments constitute unlawful distributions of capital, courts must consider the substance of the entire transaction including any funding arrangements. The judgment emphasises that allegations of dishonesty require cogent evidence and that transparency in conduct is inconsistent with findings of dishonesty.

Verdict: All claims against each defendant were dismissed. The directors were found to have acted honestly and reasonably, the Duomatic defence and no loss defence succeeded, Mrs Kohn was found not to have been dishonest, and relief from sanction would have been granted had any breach been established.

Source: Madoff Securities International Ltd v Raven [2013] EWHC 3147 (Comm)