Cross-Border Insolvency in the U.S. under Chapter 15 of the Bankruptcy Code

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1 Volume 29, No. 3 April 2013 Section Insolvency Law Cross-Border Insolvency in the U.S. under Chapter 15 of the Bankruptcy Code By Garry M. Graber 1 Introduction On April 20, 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was passed, and consequently Chapter 15 was added to the Bankruptcy Code of the U.S. Chapter 15 is the U.S. adoption and implementation of the Model Law: replacing section 304 of the Bankruptcy Code. By looking at Chapter 15 and the recent case law surrounding it, this article aims to provide insight into how Chapter 15 works, how recent cases have implemented Chapter 15 and what interested parties should consider before they decide whether to apply for Chapter 15 recognition. Chapter 15: A Brief Recap A. The Five Objectives The intention of Chapter 15 is to realize the vision of international cooperation in insolvency proceedings that underpins the Model Law, and provide a vehicle suitable for effectively dealing with insolvency cases when more than one international jurisdiction is involved. The five objectives contained at the beginning of the text outline how the provisions of Chapter 15 intends to achieve this: Cooperation between the United States and other interested parties, and the courts or other competent authorities of foreign countries involved in cross-border insolvency cases; Greater legal certainty for trade and investment; Fair and efficient administration of cross-border insolvencies that protects the interests of all interested parties including the debtor and the creditor. 1 Garry is a Partner at Hodgson Russ LLP in Rochester, New York. 1

2 Protection and maximization of the value of the debtors assets; Facilitation of the rescue of financially troubled businesses, thereby protecting investment and preserving employment. 2 B. Commencement of a Proceeding under Chapter 15 In order to exercise the rights available under Chapter 15, the primary point of contact of the foreign insolvency proceeding ( the foreign representative ) must file a petition for recognition of a foreign proceeding with the bankruptcy court, 3 accompanied by documents proving the existence of a foreign proceeding, and the appointment and authority of the foreign representative. 4 The court will then issue an order recognizing the foreign proceeding as either a foreign main proceeding or a foreign non-main proceeding after notice and a hearing. Once an application for recognition under 1515 is granted, an ancillary case under 1504 may proceed: thus, giving the foreign representative the right to sue and be sued in the courts of the United States, and to apply for the appropriate relief in that court. 5 Whether the case received recognition as a main proceeding under 1517(b)(1), or is considered to be a non-main proceeding under 1517(b)(2) determines the type and amount of relief available to the foreign representative. The main point of determination for this is the Centre of Main Interests (COMI) 6 of the defaulting individual or company. C. Orders that May be Made A recognition of a foreign proceeding as a foreign main proceeding entitles the debtor to an automatic set of reliefs under 1520, including an automatic stay on proceedings. A non-main proceeding is not entitled to automatic relief and instead must rely on 1521, which allows debtors granted main and non-main recognition to seek the discretional relief necessary to effectuate the purpose of chapter 15, and to protect the assets of the debtor or the interests of the creditors from the non-exhaustive list contained in 1521(a). The broad spectrum of relief available under 1521(a) is somewhat checked by 1522 which states that the court may only administer, modify or terminate relief if the interests of the creditors and other interested entities, including the debtor, are sufficiently protected. D. Cooperation and Communication At all times the courts are to cooperate and directly communicate with the foreign representatives and foreign courts from the trustee and the U.S. courts. 7 Suggested forms of cooperation are included in 1527 and include provisions such as agreements to cooperate, whilst 1528 limits (a) (b) 6 Under both a main and a non-main proceeding there is a rebuttable presumption under 1516 that a debtors COMI is the place of the registered office. However, as we have seen in case law under Chapter 15, the courts have utilized a wide variety of factors when determining a debtors COMI. This article will discuss this issue at a later point and

3 the U.S. Courts from interfering in the foreign proceeding by restricting jurisdiction of the bankruptcy court to assets within the U.S. In order to allow the U.S. Courts to maintain some degree of power and control in relation to enforcing the cooperation and comity intended in the legislation, Congress included 1506 which allows the court to refuse to take any action if the action would be manifestly contrary to the public policy of the United States. Recent Chapter 15 Cases A number of interesting cases were decided in 2011 that highlighted the U.S. Courts interpretation of Chapter 15. A selection of such cases are summarized below. The cases highlight the ongoing evolution of how the courts are considering the various aspects of Chapter 15. A. The Disclosure of Information Under Chapter 15 Glitnir Bank HF 8 Glitnir Bank was undergoing liquidation in Iceland in a wind up before the Financial Supervisory Authority of Iceland and the District Court of Reykjavik. After receiving recognition as a foreign main proceeding on January 7 th, 2009, the Court signed the revised amended order recognizing foreign main proceeding of Glitnir Bank and granting permanent injunction on March 18 th, Pursuant to 1521(a)(4) and paragraph 6 of the second recognition order, which tracked the statute, this allowed the foreign representative to take evidence, examine witness, seek the production of documents and information concerning the debtors assets, affairs, rights, obligations or liabilities. On March 23 rd, 2011 the foreign representatives filed a motion for an order permitting the foreign representative to conduct discovery, compelling RBC, Citibank and 50 Gramercy Park North Owners Corp. to produce documents in relation to the defendants. The Court authorized it on April 7 th Some of the requests involved disclosure of personal financial information of two individuals related to Glitnir Bank. The foreign representative brought a motion to compel disclosure and the two individuals opposed and moved to quash the motion. In its decision, the court recognized that 1521(a)(4) allows for discovery but the court retains the power to quash or modify a subpoena to protect an individual or non-party against the disclosure of personal, private financial information to avoid undue annoyance, embarrassment or oppression, 9 and that when making its decision the court must balance the relevance of the information sought against the harm to the individuals Glitnir BankI HF., (U.S. Dist. S.D.N.Y) Case No Supra Fn 7 at page Supra Fn 7 at page 12 3

4 The Court also addressed the application of Rule 2004 of the Bankruptcy Code to 1521(a)(4) stating that although Bankruptcy Rule 2004 compliments those rights, 11 the Court may not authorize the fishing expeditions associated with Rule After assessing the facts the Court allowed some of the subpoenas in line with 1521(a)(4), where the requests concerned Icelandic affiliates, the bank s interests or company information the court allowed the subpoenas, but refused others on the grounds that some of the information sought had nothing to do with bankruptcy, and had more to do with the personal information of the individuals. Awal Bank 13 The Central Bank of Bahrain placed Awal Bank in an administration proceeding on July 30, 2009, and recognition as a foreign main proceeding was granted by the U.S. Bankruptcy Court on October 27, A year later the foreign representative filed under Chapter 11 in order to bring an action to avoid a set-off by HSBC Bank, and to request relief from 521 of the Bankruptcy Code requiring a list of creditors and certain statements and schedules. Awal opted to pursue an action under the more rigorous Chapter 11 even though Chapter 15 offers adequate relief with less red tape, because in this case Awal wanted to utilize reliefs that are unavailable under 1521(a)(7). On January 5, 2011 the foreign representative filed a statement of financial affairs (SOFA), and schedule of assets and liabilities that omitted some of the information required and typically provided pursuant to 521, on the grounds that disseminating foreign creditor information would directly conflict with duties and procedures of the foreign main proceeding. In addition on February 24, 2011 the foreign representative sought an action to recover the set off of $12,996, from the $75,071, owed to HSBC Bank by Awal under a credit agreement. The court allowed Awal to omit certain information in this proceeding because the court concluded that doing otherwise would harm the foreign main proceeding in Bahrain and the court ordered HSBC to repay the set-off under 553(b), thus recognizing the importance of comity. Another point to note in this case is that the court opted to use the original Chapter 15 petition date as the relevant date for the purposes of 553(b), citing the protection and maximization of value of the debtors assets in pursuance to the objectives of Chapter In reaching its judgment the court argued that the Chapter 15 proceeding remains ancillary to the foreign proceeding, and therefore the foreign representative may be relieved of duties under Chapter 7 or Chapter Supra Fn 7 at page Supra Fn 7 at page In re Awal Bank, BSC, (Bankr. S.D.N.Y.) Case No (ALG) (a)(4) 4

5 B. Notification of a Change of Circumstances Pursuant to 1518 Daewoo Logistics Corporation 15 Daewoo Logistics is a Republic of Korea (ROK) company primarily involved in the shipping and trading businesses. On July 3, 2009, Daewoo applied for rehabilitation under the ROK s debtor Rehabilitation and Bankruptcy Act, and the Korean court issued commencement orders on July 23, The Southern District of New York Bankruptcy Court recognized this as a foreign main proceeding on October 21, 2009 and granted an automatic stay of proceedings pursuant to 1520(a). On June 8, 2011, the proceeding in ROK was closed, and subsequently a creditor filed a complaint in the Southern District of Texas Bankruptcy Court to arrest a vessel for unpaid services supplied to the vessel, pursuant to its in rem maritime lien on it. In response Daewoo filed a motion to prohibit this action. The Texas court entered an order to show cause but ordered Daewoo to file a 1518 statement clarifying the status of the Korean proceeding. Daewoo argued in the Southern District of New York bankruptcy court on October 5, 2011 that this outcome violated the recognition order stays, and requested the creditor release Daewoo of its obligation, and that the court find the creditor in contempt of the recognition order and seek costs accordingly. The court held that Daewoo could not prevent the creditor from enforcing it s lien because the proceeding in ROK had finished, and therefore the protections of Chapter 15 had expired also - a stay imposed pursuant to chapter 15 is normally coterminous with the stay in corresponding foreign proceeding and, accordingly, the Stay is terminated at the close of the ROK Rehabilitation. 16 Additionally, the foreign representative had not complied with 1518 and notified the U.S. court of any changes in the foreign proceeding. Foreign representatives should be aware that they have an obligation under 1518 to inform the court of any changes in the foreign proceeding. A failure to do so could result in the court terminating or changing previously awarded relief under the powers conferred to the court under This case illustrates the risks associated with overlooking the statutory obligations of the foreign representative, and the different kinds of relief available to them. Not only did the foreign representative fail to notify the court of a change in proceedings under 1518 and incur the wrath of the courts, but the foreign representative also failed to utilize the powers of 1507 which allow the foreign representative to request extra assistance from the court where necessary. Had Daewoo requested this extra assistance from the court instead of inadvertently contradicting the ancillary nature of Chapter 15, they may have avoided action by the creditors. 15 In re Daewoo Logistics Corporation (Bankr. S.D.N.Y.) Case No (brl) 16 Supra Fn 14 at page 3 5

6 C. Application of Chapter 15 Protection to Subsidiaries of Debtors Vitro SAB 17 Vitro SAB is a holding company that conducts most of its business through subsidiaries and is the largest manufacturer of glass containers and flat glass in Mexico. When consolidated third party indebtedness rose to approximately $1.71billion (of which $1.216billion was owed on previously issued notes), Vitro SAB entered a voluntary Mexican proceeding under the Mexican Business Reorganization Act. An application for Chapter 15 recognition was filed with the Northern District of Texas bankruptcy court on June 24, 2011 and recognition was granted on July 22, 2011 as a foreign main proceeding. It was held that the court has jurisdiction to impose the automatic stay under 1520 and reliefs under 1519 and 1521 to protect the assets of Vitro SAB, but not to extent the protection related to entities other than Vitro SAB and its assets. The court recognized that in this case it was Vitro SAB s subsidiaries that owned the assets and contracted with the creditors, and that Vitro SAB was looking to protect every member of the corporate group with Chapter 15 reliefs, and therefore would not extend the reliefs past Vitro SAB and the subsidiaries in question in the case. In its analysis, the court highlighted that Chapter 15 focuses on protecting the debtors, not the not-debtor subsidiaries, and that they were against setting an unwanted precedent allowing parent companies a blanket protection to protect non-debtor subsidiaries. 18 A definitive feature of this case is that it is a case of first impression under Chapter 15, and due to the national importance of the issue, large amounts of money involved, and the number of parties effected, it is not surprising that there are appeals pending in the 5 th U.S. Circuit Court of Appeals (New Orleans), U.S. District Court, Northern District Texas (Dallas, and the New York State Supreme Court, Country of New York (Manhattan). 19 D. Protection of the Public Interest Under 1506 Qimonda AG 20 Qimonda is a manufacturer of semiconductor memory devices for use in predominantly automotive and electronic goods. An application was filed in a Munich insolvency court on January 23, 2009 and received foreign main recognition under Chapter 15 on July 22, Along with a recognition order in the U.S. came a supplementary order which, amongst other things, made 356(n) of the Bankruptcy Code (allowing licensees to either terminate or enforce rights afforded to them under the patent agreement) applicable in this proceeding. This was contrary to German law whereby contracts are automatically unenforceable unless the insolvency practitioner elects to perform them. 17 In re Vitro, S.A.B. de C.V., (Bankr. N.D. Tex. ) Case No HDH Supra Fn 16 at page Supra Fn 16 at page In re QIMONDA AG (Bankr. E.D.V.A) Case No SSM 6

7 After receiving communications from licensees looking to enforce their rights under 365(n) the foreign representative applied and succeeded in having the order modified to reduce the effect of 365(n). Consequently the licensees objected on the grounds that it was manifestly contrary to the public policy of the United States to follow German law on this occasion. The bankruptcy court of the Eastern District of Virginia decided that ensuring that U.S. companies had access to Qimonda s patents was in the public interest, and therefore under 1506 it was contrary to the public interest to allow Qimonda to elect not to perform the patent contracts. The court pointed to two provisions in Chapter 15 for justifying its decision: 1522 requires the court to ensure the interests of creditor, other interested parties and the debtor are sufficiently protected; 1506 allows the court to refuse to take action governed by Chapter 15 where the action is manifestly contrary to the public policy of the U.S. Not only would the creditors interests lack sufficient protection, but also there is a large risk to the substantial investment made by the objectors in the research and manufacturing facilities in the U.S. that could result in widespread loss of employment and wasted financial resources; clearly a consideration in the current economic environment. The court, though, was careful to point out that 1506 should only be used where the action in question would effect the most fundamental policies of the U.S., and not just because the foreign law gives a different result to the U.S. law. Foreign representatives should note the contrast between this case and Awal Bank, whereby comity in this case came second to the U.S. public policy of promoting innovation, unlike in the Awal Bank case, where comity came first. Even though the court recognized that Germany clearly has a mature and well-developed system of insolvency law with goals congruent to those of the U.S. bankruptcy law, 21 the court felt that although the technology industry wouldn t collapse if the licenses were terminated, it would nevertheless slow the pace of innovation, to the detriment of the U.S. economy, 22 and would thereby undermine the fundamental U.S. public policy promoting technological innovation. 23 It highlights that the although the U.S. courts will follow the intention of Chapter 15 in most cases, they will still have the best intentions of the U.S. at heart; especially in tough economic times such as these. E. Determining the Centre of Main Interest Millennium Global Emerging Credit Master Fund Limited Supra Fn 19 at page Supra Fn 19 at page Supra Fn 19 at page In re Millenium Global Emerging Credit Master Fund Limited, et al. (Bankr. S.D.N.Y.) Case No

8 Both Millennium Master Fund and Feeder Fund were seeking foreign main recognition in the U.S. courts after liquidation occurred in Bermuda due to Millennium Master Funds inability to meet a margin call of the prime broker, Credit Suisse on October 6, BCP Securities challenged that the COMI of Millennium was not in Bermuda and therefore the application lacked standing and should be refused, thus preventing liquidators investigating and prosecuting claims against BCP and others in U.S. courts. The court allowed foreign main recognition in this case because the facts showed that Bermuda was the COMI on the basis that 2 of the 3 directors lived in Bermuda; the company was registered in Bermuda; Bermuda is the location of the Bank, auditors and legal advisors; and Bermuda it is the location most ascertainable by third parties - even though Millennium was managed by a Guernsey company with a manager in London. When deciding where the COMI of the company was located, the court primarily based its decision on where third parties would ascertain the location to be based on the criteria listed in the paragraph above. This objective standard is logical, fair and offers pragmatic guidelines for the determination of the COMI where the model law and Chapter 15 lacks them, as recommended by the UNCITRAL working group. 25 One controversial point worth noting is that the court stated that although there are decisions that rigidly assert that equitable factors should play no role at the recognition phase of a chapter 15 case, it would seem that a determination relative to recognition and to the center of main interests of an enterprise should take into account the existence of a fair and impartial judicial system and a sophisticated body of law, as aspects of the bona fide proceedings. 26 Foreign representatives should also note that in this case the court reaffirmed the decision in Awal Bank that the relevant date for reliefs in Chapter 15 cases is the date of the Chapter 15 application, whether the relief sought is expressly provided for in Chapter 15 or not. 25 UNCITRAL working paper A/CN.9/WG.V/WP.101 August 4, 2011, paragraph 1 26 Supra Fn 16 at page 23 8

9 F. Jurisdiction of the Bankruptcy Court Fairfield Sentry 27 Fairfield was a British Virgin Islands company that was the main feeder fund for BLMIS (Bernard L. Madoff Investment Securities LLC). When fraud was discovered, shareholders and creditors commenced insolvency proceedings in the BVIs in February The proceedings were awarded foreign main recognition by the U.S. courts on July 22, All of the state court actions filed before Chapter 15 recognition were moved to the Southern District of New York bankruptcy court, where currently approximately 200 actions seek nearly $6 billion from subscribers and investment advisors. In this case the defendants filed remand notices on October 4, 2010 arguing that the bankruptcy court lacked subject matter jurisdiction and it should abstain from hearing the cases. After the foreign representative amended some of the instant actions in January 2011, the bankruptcy court denied the remand motions on May 23, 2011 on the grounds that it had related to jurisdiction under title 28 of the United States Code (U.S.C) 157(b)(2) and 1334(b), and that the relief sought in the Actions strikes directly at the core bankruptcy functions of this Court under chapter On September 19, 2011 the defendants exercised their leave to appeal and appealed to the U.S. District Court of the Southern District of New York, citing the grounds that the bankruptcy court wrongly denied the defendants motion to remand these cases to state court, and refused to abstain from asserting jurisdiction even though it lacked jurisdiction. The district court clarified the position of when the bankruptcy court has jurisdiction, stating that the bankruptcy court may enter final judgments when it has core jurisdiction: whereby cases arise under title 11of the U.S.C (when a substantive right is created by the bankruptcy code) and arise in title 11 (when they are not based on any right expressly created by title 11, but nevertheless wouldn t exist outside of the bankruptcy). When the court lacks core jurisdiction they may only submit final proposals of fact and conclusions of law to the district court, who will then enter a final judgment. In its decision, the district court asserted that the state law claims did not arise under Title 11 because neither the causes of action or the substantive rights claimed in the cases are created by the Bankruptcy Code. The court felt that the situation presented in this case cuts against the grain of Chapters 15 s text, structure, purpose, the legislative history and prior case law. 29 The claims in this case are standard common law claims for money had and received, mistaken payment, or unjust enrichment: 30 the claims are independent of bankruptcy and contain facts antecedent to bankruptcy. 31 Additionally, by claiming jurisdiction the bankruptcy court was in fact breaching the fundamental U.S. principle of the separation of powers contained in Article III of the Constitution. 32 Upon clarifying the jurisdiction issue, the court noted that despite the broad language of the reliefs available pursuant to 1521(a)(7), allowing a foreign representative to use foreign avoidance laws in a Chapter 15 case to retrieve non-u.s. assets would be inconsistent with the purpose and structure of 27 In re Fairfield Sentry Ltd., et al. Litigation (USDC SDNY) Case 11 MC 224 (LAP) 28 In re Fairfield Sentry Limited, et al. (Bankr. SDNY) Case No (BRL) page 3 29 Supra Fn 26 at page Supra Fn 26 at page Supra Fn 26 at page Supra Fn 26 at page 12

10 10 Chapter 15. To enjoy avoidance powers under U.S. law the foreign representative must start a plenary proceeding within Chapter 15, and even then it is limited to assets within the U.S. jurisdiction, as stated in One other thing that can be drawn from this decision is that foreign representatives should take heed that although the bankruptcy courts appear to be prepared to broadly interpret the provisions of Chapter 15, the state courts may not. Conclusion The cases above highlight recent developments under Chapter 15 and the Court s continued effort to clarify aspects of the law under it. By embracing the intentions of BAPCPA whilst maintaining the interests of the U.S. at heart, the Courts have created greater cohesion and certainty during economically uncertain times and hinted that smoother cross-border insolvency proceedings are on the horizon. 33 Supra Fn 26 at page 22 10