The Cayman Islands Court of Appeal handed down a judgment last week that rules how leftover funds connected to Bernie Madoff’s multibillion-dollar Ponzi scheme should be distributed.

The case stems from two Cayman-registered investment companies – the Primeo Fund and the Herald Fund – that invested their assets in Bernard L. Madoff Investment Securities LLC. When Mr. Madoff confessed to his scam in the U.S. in Dec. 2008, the investment companies went into voluntary liquidation.

Although the fraud had “financially catastrophic consequences” for the funds, not all the assets of Primeo and Herald were lost, according to court documents.

However, liquidators for the funds are disputing how the assets should be distributed to investors.

The liquidators for Primeo argued that the assets should be distributed to members by reference to their shareholdings as they exist at the beginning of the liquidation, which is generally how liquidations are conducted in Cayman.

But the additional liquidator for Herald, Michael Pearson of FFP, argued that the distribution of assets should be “rectified” so that some shareholders won’t be unfairly paid at the expense of others, due to the fact that the funds were invested in a Ponzi scheme, according to court documents. If the funds’ assets are distributed to investors in the usual way, then some investors might profit from the Madoff scam while others become victims and receive nothing, court documents state.

“It has been said that, so far as possible, parity between investors should be achieved, not only as a matter of fairness to them, but also in order to avoid the offence to justice which will occur from sanction being given to the enjoyment of profits of fraud,” the Court of Appeal stated in its judgment, adding, “The court has been asked to recognise the degree to which a lack of parity will create injustice for Herald’s investors, and to approach a solution by giving full effect to the concept that fraud can unravel all.”

The Court of Appeal acknowledged that this argument presents “powerful and challenging considerations” that has “some measure of factual support.”

Nevertheless, the funds have to be liquidated in accordance with the law, the court stated.

According to the Court of Appeal, the Companies Law allows liquidators to rectify how assets are distributed to shareholders under certain situations, such as when net asset values of a fund were fraudulently miscalculated. But while the net asset values of Primeo and Herald were miscalculated because of the Madoff scam, there is no evidence that the directors of the funds themselves knowingly participated in wrongdoing, the court stated.

“The [Herald] liquidator’s argument that the [law] renders any [net asset values] affected by fraud or default not binding is not sustainable,” the Court of Appeal stated. “It is contrary to the plain meaning of the words and would produce results which could not be intended by the rule-making authority.”

In a press release on the decision, the advisory firm Kalo, the liquidator for Primeo, touted the court’s decision as a victory for investors rights in the Cayman Islands.

“This is an important ruling as it clarifies the circumstances in which rectification can be used, and represents the administration of justice and fairness by respecting existing legal rights, thereby increasing the confidence that investors can place in the bargains that they struck,” stated Kalo Managing Director Gordon MacRae.

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