Opinion
Case No. 99-42404 (ALG)
December 19, 2002
Counsel for Tom Grace, Official Liquidator, ALLEN C. KADISH, ESQ., FULBRIGHT JAWORSKI, L.L.P., New York, New York
Co-Counsel for German Investors, JONATHAN D. FISHBANE, ESQ., GOODLETTE, COLEMAN JOHNSON, P.A., Naples, Florida
Co-Counsel for German Investors, WALLACE W. WALKER, ESQ., WALLACE WALKER CO., L.P.A., Brecksville, Ohio
Counsel for Sentinel Management International Limited, NEAL M. ROSENBLOOM, ESQ., FINKEL GOLDSTEIN BERZOW, ROSENBLOOM NASH, LLP, New York, New York
MEMORANDUM OF DECISION
This is a dispute over interest earned on a fund (the "Fund") that has been held under court order since 1999 by Sentinel Management International Ltd. ("Sentinel"). A motion for turnover of the post-maturity interest earned on the Fund was filed by Tom Grace as Official Liquidator (the "Liquidator") of the estate of Financial Future Corporation ("FFC"). It is supported by German Investors (the "Investors") who invested the cash that made up the Fund. The parties have filed extensive memoranda of law, statements, affidavits, and a comprehensive set of exhibits. The Court grants the motion for the reasons stated below.
BACKGROUND/FACTS
This is the final chapter in litigation that dates back to 1999, when the Liquidator brought an ancillary proceeding, pursuant to 11 U.S.C. § 304 of the United States Bankruptcy Code (the "Code"), seeking a turnover of funds that had been collected by FFC from the Investors and then transferred to Sentinel for investment. According to the § 304 Petition, FEC was incorporated in 1993 and provided discretionary portfolio management services to individual investors. FFC had its principal place of business in Ireland and maintained an office in Germany, where it utilized approximately fifty agents to solicit investments from individuals. Among these were the Investors, who invested in "investment pools," designated A-1 through A-5 and differing principally in the term of the investment and the amount to be paid at maturity. For example, the "A-1" investment had a term of twelve months and a minimal "guarantee" of return on investment, the "A-3" investment was for a term of thirty-six months with 75 percent of the investor's capital guaranteed, and the "A-5" investment was for a term of sixty months with 100 percent of the investor's capital guaranteed. Between October 1993 and November 1995, FFC collected funds from the Investors totaling US $1,279,407 and transferred these to Sentinel in a total of 18 tranches.
FFC and Sentinel entered into 18 guarantee agreements (the "Guarantee Agreements") that set forth the rights and responsibilities of the parties with regard to the funds represented by tranches 1 to 18. Each of the Guarantee Agreements was identical, except for the amount and maturity date of the investments and the amount to be paid at that time. All of the funds received by Sentinel represented in tranches 1 to 18 were invested by Sentinel in United States Treasury bonds. Sentinel was required to pay, at maturity, an amount equal to the "capital guarantees" given by FFC to its investors (meaning in substance principal plus a pre-maturity interest component). Under the Guarantee Agreements, and upon maturity of the securities, Sentinel was required to collect the proceeds of the securities and remit the appropriate amount to Peter Legenhausen, as trustee, for the benefit of the Investors. The first tranche was to mature in or about April 1999, with the rest to follow in sequence at various intervals.
In December 1996, the High Court of Dublin authorized an investigation to determine whether FFC was holding itself out as an investment business without the authorization required under Section 64 of the Investment Intermediaries Act of Ireland (the "Act'"). The investigation revealed that FFC was not appropriately authorized to provide investment business services and was in violation of Section 9 of the Act. As a result, on December 20, 1996, the High Court entered an order appointing Tom Grace as Official Liquidator of FFC to wind up its affairs. Pursuant to an order granted by the High Court dated November 30, 1998, the Liquidator retained counsel in order to obtain the proceeds of the securities held by Sentinel.
The matter came before this Court when the Liquidator filed a Petition pursuant to 11 U.S.C. § 304 to commence a case ancillary to the foreign proceeding seeking an injunction and turnover of the Fund. On April 15, 1999, then Chief Judge Brozman entered an Order to Show Cause with a Temporary Restraining Order that, pending a hearing on the Liquidator's motion for a preliminary injunction, enjoined Sentinel from dissipating the Fund. The temporary restraining order also provided:
[A]ll persons and entities are enjoined and restrained from (a) transferring, releasing, relinquishing or disposing of any property in the United States m which FFC asserts an interest, or the proceeds of such property, to any person or entity pending further Order of the Court. (at 3)
The Temporary Restraining Order was obtained shortly before the maturity of the first of the 18 tranches. It was apparently entered without notice to Sentinel, but Sentinel received notice of the hearing on the Liquidator's motion for a preliminary injunction and did not object thereto. On April 26, 1999 the Court granted a Preliminary Injunction Order, which continued the temporary restraining order in effect.
There followed years of litigation between the Liquidator and the Investors as to entitlement to the Fund. After lengthy negotiations, the Liquidator and the Investors agreed to an even split of the Fund, after payment of contractual fees due to Sentinel. By Order dated July 2, 2001, this Court approved a settlement (the "Settlement") as to disposition of the Fund, dividing it equally between the Liquidator and the Investors. Sentinel declined to participate in the settlement but the parties agreed that Sentinel would be paid its fees, which were uncontested, and it was further agreed that the issue of rights to post-maturity interest on the Fund would be submitted to the Court for later resolution. On July 23, 2001 Sentinel did in fact distribute the Fund in accordance with the Settlement, net of its fees.
The Liquidator and the Investors maintain they are entitled to the post-maturity interest because: (1) "interest follows principal," (2) a constructive trust was created, (3) Sentinel would be unjustly enriched if granted post-maturity interest, (4) Sentinel violated its fiduciary duty to FFC and the Investors, and (5) Sentinel was an investment advisor with a fiduciary duty to pay interest to investors. Sentinel maintains it is entitled to the post-maturity interest because: (1) it fulfilled all contractual obligations, and (2) the maxim that "interest follows principal" does not apply when the parties' obligations are set forth in an express contract.
In addition to briefing the issue of right to interest, the parties engaged in discovery to determine what Sentinel did, in fact, earn on the Fund after the maturity of the tranches. The Court has received the report of the Liquidator's accountant, Crowe Chizek, LLP, on this issue.
DISCUSSION
Resolution of this dispute as to entitlement to post-maturity interest begins with the salient fact that since April 15, 1999, Sentinel has held the Fund pursuant to a temporary restraining order and preliminary injunction entered by this Court. Such injunctive relief is granted because there is an urgent need for action to protect the plaintiffs potential rights. Citibank, N.A. v. Citytrust, 756 F.2d 273, 276 (2d Cir. 1985). In a bankruptcy proceeding, a preliminary injunction may be granted to ensure the protection or preservation of the debtor's estate. See In re Alert Holdings, 148 B.R. 194, 200 (Bankr. S.D.N.Y. 1992); see also In re McLean Industries, Inc. 113 B.R. 149, 151 (Bankr. S.D.N.Y. 1987) (to "[p]rotect the Plaintiffs' right . . ."). The need for a preliminary injunction may be particularly acute in a § 304 proceeding such as this, and one is often granted. "Because a section 304 proceeding is not a full blown bankruptcy, in that the filing does not trigger an automatic stay, the foreign representative generally seeks an immediate injunction in the nature of a stay on the day he or she files the ancillary petition." In re Caldas, 274 B.R. 583, 591 (Bankr. S.D.N.Y. 2002) (citing In re MMG LLC, 256 B.R. 544, 549 (Bankr. S.D.N.Y. 2000)); see also In re Rukavina, 227 B.R. 234 (Bankr. S.D.N.Y. 1998) (granting a preliminary injunction to foreign representative of holding company to protect debtor's United States assets). Notwithstanding the fact that a § 304 proceeding does not automatically trigger the automatic stay, a number of courts have likened the injunctive relief available pursuant to § 304 to the protection afforded by the automatic stay under § 362(a). See In re Bird, 229 B.R. 90, 94 (Bankr. S.D.N.Y. 1999); In re Banco Nacional de Obras y Servicios Publicos, S.N.C., 91 B.R. 661, 664 (Bankr. S.D.N.Y. 1988); In re Kingscroft Ins. Co., 150 B.R. 77, 81 (Bankr. S.D. Fla. 1992); In re Artimm, 278 B.R. 832, 842 (Bankr. C.D. Cal. 2002).
Section 362 of the Code provides that the filing of a petition in bankruptcy automatically stays certain actions directed against the debtor or debtor's property.
In this case, the preliminary injunction prohibited Sentinel from transferring, diverting or paying itself from the Fund, and it also enjoined all others from interfering with or disposing of any property in which FFC asserted an interest unless otherwise permitted by this Court. The purpose of the preliminary injunction was to protect and preserve the Fund as a potential asset of the FFC estate, and it was issued after the Liquidator made a showing of probability of success on the merits of his claim that the Fund was part of the estate. In effect, therefore, the funds were held in custodia legis, a concept that is often applied in the bankruptcy context to bar efforts of third parties to obtain preferential status. As the Supreme Court held in Cameron v. United States, 231 U.S. 710, 717 (1914), "In addition to providing a stay for certain actions against the debtor, the filing of a petition in bankruptcy operates to place the property of the alleged bankrupt effectively in custodia legis, and prevents any creditor from attaching it; . . . It is placed at the time of the filing of the petition under the control of the court with a view to its ultimate distribution among creditors." See also Straton v. New, 283 U.S. 318, 321 (1931); In re Petrusch, 667 F.2d 297, 299-300 (2d Cir. 1981), cert. denied, 456 U.S. 974 (1982)("[c]oncern for the preservation of estates in bankruptcy and prevention from interference in their status quo has had a long history and effective remedies bottomed on the concept of custodia legis . . ."). While the preliminary injunction issued in this case did not direct that the Fund be turned over to the custody of the Court, it nonetheless placed the Fund in the Court's control until distribution.
The filing of a § 304 petition does not create a U.S. bankruptcy estate but recognizes that a foreign estate is entitled to certain rights and protections if, as here, the factors authorizing relief are satisfied. See In re Koreag, Controle et Revision, S.A., 961 F.2d 341, 348 (2d Cir. 1992), cert denied, 506 U.S. 865 (1992), ("The purpose of a § 304 petition is to prevent the piecemeal distribution of assets in the United States . . ."); Universal Casualty Surety Co. Ltd. v. Gee (In re Gee), 53 B.R. 891, 898 (Bankr. S.D.N.Y. 1985).
Sentinel contends it was ready, willing and able to remit the guaranteed amounts as each tranche matured but was prevented from doing so by the preliminary injunction issued by this Court. While this may be true, the conclusion that Sentinel draws that it is entitled to the post-maturity interest—is a non sequitur. Sentinel has never asserted any rights in the principal and pre-maturity interest components that comprised the Fund; it was entitled to its fees, and it received them. The only parties that have ever claimed a right to the Fund are the Liquidator and the Investors, and their right to the Fund entitles them to the interest earned while the Fund was in the custody of the Court. This follows from the rule that "interest follows principal," which has been recognized since at least the mid-1700's. Beckford v. Tobin, 1 Ves.Sen. 308, 310, 27 Eng. Rep 1049, 1051 (Ch. 1749). ("[I]nterest shall follow the principal, as the shadow the body."). Over the years, this rule has been applied repeatedly. See, e.g., Webb's Fabulous Pharmacies, Inc., 449 U.S. 155, 165, n. 5 (1980); Phillips v. Washington Legal Foundation, 524 U.S. 156, 168 (1998); Flanigan v. General Electric Co., 93 F. Supp.2d 236, 257-58 (D. Conn. 2000).
In Webb's, the Supreme Court found unconstitutional a Florida statute pursuant to which a county seized the interest accruing on an interpleader fund deposited with the state court. Significant to the Court's holding was that the interest was not a fee for services, as the county's fee had already been satisfied. In finding the Florida state statute unconstitutional, the Court asked, "What would justify the county's retention of that interest?" See Webb's 449 U.S. at 162. The Court found there was no such justification. Here, Sentinel has not suggested anything that would justify its retention of post-maturity interest. It argues the "maxim" that "interest follows principal" does not apply when the parties' obligations are set forth in an express contract. But the language of the Guarantee Agreements does not state that any post-maturity interest is payable to Sentinel. The Agreements provided that the Fund was to be held "for the benefit of the Trustee for identified investors until maturity." There is no implication that the Fund was to be held for Sentinel's benefit after maturity or that Sentinel has any rights other than to its fees. As was the case in Webb's, the Guarantee Agreements in this case specifically provided the terms by which Sentinel was to be compensated.
Paragraph 5 of each Guarantee Agreement provides, "For its services and guarantee hereunder, FFC and the investors will pay SMI an annual sum equal to 1 percent of the amount guaranteed the investors."
The rights of the parties under the Guarantee Agreements were reiterated in a letter from Eric A. Bloom, President and CEO of Sentinel International, dated May 13, 1997, to the Liquidator and cited in Sentinel's Reply Brief. It states:
Please let this letter serve as our confirmation that the Securities with a maturity value of USD 1,729,406.68 will be held for your benefit . . . and will not be released unless compelled to do so by a court of competent jurisdiction. (emphasis added)
Sentinel cites the letter as proof that it fulfilled all contractual obligations in this matter, and that it was ready, willing and able to remit the Fund to FFC and the Investors but was "prohibited" from doing so by the Court. Sentinel's fulfillment of all contractual obligations and its willingness to distribute the Fund does not provide it with the right to retain interest in a Fund held pursuant to Court order. Nor does it matter that the preliminary injunction order did not provide for payment of interest on the Fund. In Webb's, a state statute was struck down as an unconstitutional attempt to intercept interest earned on a fund held in custodia legis. Here, it cannot be significant that the preliminary injunction was silent on the subject of interest.
Sentinel cites Surge Licensing v. Copyright Promo Ltd., 258 A.D.2d 257, 685 N.Y.S.2d 175 (1999), which involved a licensor/licensee relationship in which the defendant was obligated to remit to the plaintiffs a percentage of royalties it collected from third-party licensees on a quarterly basis, and where plaintiffs sought the interest earned on such collected royalties. The New York court held that plaintiffs were not entitled to "possession of, or other legal interest in, the royalties funds prior to the date upon which their remittance was due, [and] can derive no benefit from the maxim that interest follows principal." Surge, 685 N.Y.S.2d at 257. The facts in this case are in stark contrast. Unlike the defendant in Surge, Sentinel had no legal interest in the Fund at the time post-maturity interest accrued, whereas FFC and the Investors were entitled to the Fund.
Sentinel further argues that if it had held the proceeds in a non-interest bearing account or if it had lost money investing the Fund, the Liquidator and Investors would have no claim to post-maturity interest. This argument is irrelevant as Sentinel did invest the proceeds in interest-bearing accounts and did not lose money. Moreover, the Liquidator and Investors have never asked for anything more than what was actually earned.
FFC and the Liquidator also argue that if Sentinel is awarded post-maturity interest, it will be unjustly enriched. In view of the decision above, it is not necessary to reach this argument. FFC and the Liquidators appear to have withdrawn their contention that Sentinel violated the Investment Advisers Act of 1940 and otherwise breached a fiduciary duty owed to FFC and the Investors.
CONCLUSION
Post-maturity interest earned on the Fund is to be turned over to the Liquidator and Investors, in the 50/50 split provided in the Settlement Agreement. The Liquidator is directed to settle an appropriate order on ten days' notice providing for a turnover of interest or, if the parties cannot agree on the amount to be turned over, scheduling a hearing on that issue.
At the hearing held on November 6, 2002, counsel for the Liquidator and the Investors represented to the Court that the post-maturity interest would be split in the same manner as the Fund, under the terms of the Settlement, if they were to prevail on this Motion.