Recent Developments in Ancillary Proceedings in the United States Bankruptcy Courts

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1 INTERNATIONAL BAR ASSOCIATION C OMMITTEE J NEWS VOL.XIII, NO.2, SEPTEMBER 2003 Recent Developments in Ancillary Proceedings in the United States Bankruptcy Courts By Christopher R. Donoho, Brian M. Cogan and Claude G. Szyfer You are representing a non-u.s. entity which is contemplating initiating a reorganization or insolvency proceeding in its home jurisdiction, and which has assets and creditors in the United States. How do you prevent creditors from seizing assets or gaining some unfair advantage, which would subvert the home jurisdiction s scheme of distribution? Section 304 of the United States Bankruptcy Code (the Code ) allows a representative of a foreign estate, such as a liquidator or receiver, to file a petition with a United States Bankruptcy Court initiating a proceeding ancillary to a pending foreign insolvency proceeding. Section 304 was specifically intended to address the complex problem of the legal effect the United States Bankruptcy Court will give to a foreign insolvency proceeding and orders entered in that proceeding. In this article, we review certain of the basic principles of ancillary proceedings, and focus on certain recent developments and some of the strategic decisions that counsel for Foreign Representatives can make prior to initiating an ancillary proceeding. ANCILLARY PROCEEDINGS PURSUANT TO SECTION 304 A petition filed under Section 304 of the Code does not commence a full and conventional bankruptcy case in the United States. Typically, it initiates a limited proceeding aimed at administering assets located in the United States, or barring creditors from taking action against the foreign debtor s assets in the United States. 1 A Section 304 proceeding is also often used by the Foreign Representative to marshal assets in the United States, and eventually repatriate them, or to obtain discovery in the United States and to otherwise protect the administration of the foreign proceeding from collateral attack in the United States. This article first appeared in the September 2003 issue of the Newsletter of the Insolvency and Creditors' Rights Committee of the Section on Business Law of the International Bar Association (Vol 13, No 2), published by the International Bar Association, London, UK.

2 The legislative history and the relevant caselaw all demonstrate that Section 304 was intended to provide United States courts with broad authority and flexibility to enable foreign representatives to marshal or administer assets located in the United States. 2 Indeed, one court has gone so far as to state that pursuant to section 304(b), the court is free to broadly mold appropriate relief in near blank check fashion. 3 REQUIREMENTS FOR INITIATING A SECTION 304 PROCEEDING To qualify for ancillary relief, there must first be a foreign proceeding, and the party seeking relief must be a foreign representative. Both of these terms are defined in Section 101 of the Code. 4 A foreign proceeding means any proceeding, whether judicial or administrative and whether or not under bankruptcy law, in a foreign country in which the debtor s domicile, residence, principal place of business, or principal assets were located at the commencement of such proceeding, for the purpose of liquidating an estate, adjusting debts by composition, extension, or discharge, or effecting a reorganization. 5 That definition has been broadly construed, encompassing a wide variety of proceedings, including those types of reorganization proceedings not involving a foreign jurisdiction s traditional bankruptcy laws. 6 Generally, so long as the proceeding (i) entails an administrative or judicial process involving insolvency or reorganization, (ii) is conducted for the purpose of liquidating an estate, adjusting its debts or effecting a reorganization, and (iii) is pending in a foreign country where the debtor maintains its residence, domicile or principal place of business, Section 304 relief will be available. 7 In addition, U.S. bankruptcy courts will also analyze the amount of judicial involvement and supervision over the foreign proceeding. 8 Recently, proceedings as varied as a supervisory action pursuant to Peruvian banking law, In re Caldas, 274 B.R. 583 (Bankr. S.D.N.Y. 2002), and a proceeding under the Polish Arrangement Proceedings Law, In re Netia Holdings, S.A., have been found to qualify as a foreign proceeding. In short, the types of proceedings being recognized by U.S. bankruptcy courts continues to grow. Section 101(24) defines foreign representative as a duly selected trustee, administrator, or other representative of an estate in a foreign proceeding. 9 Generally, Section 304 actions are brought by court-appointed liquidators or receivers, but certain courts have stated that despite the duly selected language in Section 101(24), nothing in the statute requires the foreign representative to be appointed by a court. 10 There are strong arguments, however, that a foreign representative must be court-appointed, based on the legislative history of Sections 101(24) and 304. No U.S. Circuit Court of Appeal has ever decided this issue, and it remains an open question. SECTION 1410: VENUE STATUTE FOR A SECTION 304 PROCEEDING Of course to initiate a Section 304 Proceeding, venue must be properly laid. Section 1410 of Title 28 of the United States Code governs venue of cases ancillary to a foreign proceeding, and is divided into three subsections, which are keyed to the general categories of relief available under Section 304: enjoining suits against the foreign debtors estates; turnover and lien enforcement proceedings; and a catch-all omnibus section for other forms of relief. Section 1410(a), which involves the enjoining of actions against the estate of the foreign debtor, is an ambiguously drafted statute, described by one court as an example of draftsmanship calling to mind Lewis Carroll s fading Cheshire cat. 11 Specifically, Section 1410(a) states: 2

3 A case under section 304 of title 11 to enjoin the commencement or continuation of an action or proceeding in a State or Federal court, or the enforcement of a judgment, may be commenced only in the district court for the district where the State or Federal court sits in which is pending the action or proceeding against which the injunction is sought. 12 Based on the text of the provision, Section 1410(a) speaks of enjoin[ing] the commencement or continuation of an action, thus contemplating the prevention of suits yet to be filed. But, the latter part of the statute states that the action may be commenced only where the action is pending an inherent contradiction with the first clause of the statute, that has caused courts and lawyers trying to establish venue significant headaches. Courts, in dicta, have stated that to read the statute literally would make no sense, because it would require the Foreign Representative to anticipate the various jurisdictions where a creditor might file suit. 13 Such a result would defeat the purposes of Section 304 and to have an efficient and expeditious resolution of issues relating to a foreign party undergoing a reorganization procedure. Based on such reasoning, on behalf of a Monitor appointed by a Canadian Court in a CCAA proceeding pending in Toronto, despite the absence of any filed actions against the Foreign Debtors, we recently filed petitions seeking Section 304 relief predicating venue under Section 1410(a) on certain indentures issued by the Foreign Debtors containing forum selection clauses providing for a New York forum, arguing that U.S. bondholders holding the notes might initiate litigation against the Foreign Debtor-issuer in New York. The Petitions and the injunctive relief sought in that case were granted without any objection by any creditors; thus, the Court never specifically addressed the issue of whether venue in that district was proper. Nonetheless, some controversy remains because, as yet, no reported case has definitively held that a party may predicate venue on 1410(a) based on anticipated, as opposed to filed, litigation in that district. Section 1410(b) is drafted more clearly, and provides that venue may be proper in actions involving the enforcement of a lien against property or in turnover proceedings in the district where the property is located. 14 For all other types of relief, Section 1410(c) states that a case may be commenced in the district in which is located the principal place of business in the U.S., or the principal assets in the U.S.,of the estate that is the subject of such case. 15 Selecting a venue which is convenient and cost effective for the Foreign Representative and the Foreign Debtor becomes particularly more important when the Foreign Representative anticipates seeking multiple forms of relief. For example, assume a Foreign Debtor, whose principal place of business is in the Bahamas, has been sued in New York, but knows that it will also seek the turnover of funds maintained in a bank in Los Angeles. Based on Section 1410, the Foreign Representative could initiate the Section 304 proceeding in either New York or Los Angeles. For any number of reasons, like the fact that local counsel is in New York, or even simple geography - it s a lot easier to fly to New York than Los Angeles from the Bahamas - New York is the far more convenient forum for the Foreign Representative and the Foreign Debtor. Despite the fact that both Section 1410(a) and (b) appear to involve one shot situations involving specific forms of relief, Courts have held that when venue is properly laid for the Section 304 proceeding in a district, that proceeding can serve as the base for future requests for other forms of judicial relief, and the 3

4 Foreign Representative will not be required to initiate Section 304 proceedings in other U.S. states to implement other types of relief. 16 Indeed, requiring the Foreign Representative to continually initiate new Section 304 proceedings each time it sought additional or new relief (which is similarly not required in U.S. based insolvency proceedings) would contravene the goals of economizing and expediting the orderly and equitable distribution of the foreign estate, and avoid the proliferation of litigation and the waste of valuable judicial resources. 17 Thus, in our example above, the Foreign Representative could file its Section 304 petition in New York, seeking nationwide injunctive relief barring all suits against the Foreign Debtors, and then file a subsequent turnover proceeding in New York, seeking the repatriation of the funds located in the Los Angeles bank. GRANTING INJUNCTIVE RELIEF PURSUANT TO SECTION 304 Section 304(c) provides certain factors that Courts analyze, on a case-by-case basis, in order to determine whether it will issue the requested relief under Section 304(b). 18 These factors include: the just treatment of all holders of claims against or interests in such estate (304(c)(1)); protection of claim holders in the United States against prejudice and inconvenience in the processing of claims in such foreign proceeding (304(c)(2)); prevention of preferential or fraudulent dispositions of property of such estate (304(c)(3)); distribution of proceeds of such estate substantially in accordance with the order prescribed by the Code (304(c)(4)); and comity (304(c)(5)). 19 In applying these factors, and the principles underpinning Section 304,courts in the United States acknowledge that the foreign court presiding over the original or primary proceeding is in the better position to decide when and where claims should be resolved in order to conserve resources and maximize assets of the foreign estates. 20 Courts are required to undertake a case-by-case balancing of the statutory factors, rather than be constricted by bright-line rules. 21 Courts generally weigh each of these factors equally, with comity being the ultimate consideration. 22 As to the issue of comity, courts generally refer to the decision of the Supreme Court, issued over one hundred years ago, in Hilton v. Guyot, 159 U.S. 113, (1895), explaining that comity in the legal sense: Is neither a matter of absolute obligation on the one hand, nor of mere courtesy and good will on the other. But it is the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protection of its laws. In the Section 304 context, comity is characterized as the mechanism through which United States courts may defer to and facilitate foreign insolvency proceedings. 23 Such respect is not automatic, however, as comity has never been interpreted to mean categorical deference to foreign proceedings, nor will it automatically override the other factors enumerated in Section 304(c). 24 Critical to the comity analysis is that the rules applicable in the Foreign Proceeding comport with United States notions of due process. 25 The protections and procedures need not be identical to those found under the United States Bankruptcy Code. Similarly, application of foreign law must not contradict or contravene important U.S. public policies. In addition,u.s. 4

5 Courts have consistently and routinely granted comity to reorganization and liquidation proceedings based in sister common law countries like England, Canada and the Bahamas. 26 Section 304(c)(4), the factor stating that a U.S. Bankruptcy Court should determine whether the distribution of proceeds of such estate is substantially in accordance with the order prescribed by this title, has received increased judicial scrutiny recently. The Second Circuit in Bank of New York v.treco (In re Treco), 240 F.3d 148, 156 (2d Cir. 2001), held that when a claim or claimant is treated in a manner not substantially in accord with the order prescribed by the United States Bankruptcy Code, then relief pursuant to Section 304 should not issue. In Treco, the liquidators of a Bahamian company filed a Section 304 petition seeking the turnover of certain assets held in a U.S. bank by an alleged secured creditor, the Bank of New York ( BONY ). BONY objected to the issuance of Section 304 relief because it claimed that under Bahamian law, its secured claim would be subordinated to, among other things, the administrative expenses of the liquidation. BONY further pointed to the fact that the high administrative expenses in the Bahamian case threatened to consume a substantial amount of the estate s assets, thereby endangering the possibility of any recovery of its secured claim in the Bahamian proceeding. Thus, BONY argued, distribution of its cash collateral would not be substantially in accordance with the order prescribed by the United States Bankruptcy Code, where its secured claim would receive enhanced protections, and the Second Circuit agreed. 27 The Second Circuit underscored that Section 304 analysis did not lend itself to categorical rules, and that the Bankruptcy Courts should examine the facts of each case separately. Moreover, the Second Circuit emphasized that the lower courts should eschew macro-system concepts and consider the effect of the difference in law on each individual creditor. 28 Application of Treco has proven slippery for Bankruptcy Courts and one Bankruptcy Court was recently criticized for essentially eviscerating Treco by improperly circumscribing its holding. In In re Board of Directors of Compañia General de Combustibles, S.A., 269 B.R. 104 (Bankr. S.D.N.Y. 2001), aff d on other grounds, Slip Op., No. 01 Civ (KMW) (S.D.N.Y. Oct. 11, 2002) ( In re CGC ), an American oil trader ( HETCO ) entered into two ISDA swap agreements relating to the purchase of oil with an Argentine oil company ( CGC ). After a number of months, CGC owed HETCO over $8 million, and defaulted on its payments. HETCO terminated the swap agreements in accordance with their terms and sought the delinquent funds and termination damages. CGC then filed a concurso preventivo,a reorganization proceeding under Argentine law, in Buenos Aires, which triggered an automatic stay barring any creditors from taking any action against CGC s assets in Argentina. CGC then filed a Section 304 proceeding seeking to enjoin an action filed by HETCO in New York State Court seeking payment of the $8 million, and an additional $9.1 million termination damages under the ISDA Agreements. HETCO argued that Section 304 relief should not issue because, like in Treco, the application of foreign law - Argentine law - threatened to destroy over half of HETCO s $17.1 million claim. HETCO demonstrated that Argentine law failed to provide similar protections to swap agreements as those found under the Code, like Section The absence of those protections, argued HETCO, threatened to destroy over $9.1 million of HETCO s claim because the Argentine judge presiding over CGC s concurso preventivo ruled that only $8.007 million of HETCO s claim would be 5

6 recognized unless HETCO could prove its termination of the swap agreements was lawful under Argentine law. Accordingly, HETCO argued, it was suffering the ultimate subordination of its claim destruction of its claim. The Bankruptcy Court rejected HETCO s arguments, holding that Treco only required the denial of Section 304 relief where the court finds clear evidence of maladministration or corruption, in the foreign proceeding. 30 In CGC, despite the fact the Bankruptcy Court found that Argentine law and U.S. law differed dramatically, the Bankruptcy Court stated that HETCO failed to demonstrate any sort of maladministration or corruption of any kind in the Argentine concurso preventivo, and, accordingly, issued injunctive relief pursuant to Section 304 barring HETCO from litigating its claim against CGC in New York. Moreover, the Court rejected HETCO s arguments relating to the enhanced protections for swap agreements found in the Code, denigrating those provisions as special interest legislation. 31 In a subsequent appeal to the District Court, that Court found that the Bankruptcy Court s holding improperly circumscribed Treco,but affirmed the issuance of Section 304 relief on other grounds. 32 CONCLUSION We have simply scratched the surface of the critical issues involved in ancillary proceedings brought pursuant to Section 304. The importance of decisions regarding venue and the selection of the Foreign Representative may have a critical impact on the outcome of the proceeding, as well as effects on the Foreign Debtor itself. In this article we have attempted to highlight some of these issues, in light of recent case law in the United States. Certainly, if you would like additional information and insights relating to Section 304 proceedings in the United States, please feel free to contact any of the authors of this article listed above. 6

7 Notes 1. 2 Collier on Bankruptcy [1] (15th ed. 1996). 2. In re Petition of Hughes, 281 B.R. 224, 228 (Bankr. S.D.N.Y. 2002). 3. In re Culmer, 25 B.R. 621, 624 (Bankr. S.D.N.Y. 1982) U.S.C. 101(23), (24) (West 2003) U.S.C. 101(23) (West 2003). 6. In re MMG LLC 256 B.R. 544, 549 (Bankr. S.D.N.Y. 2000). 7. Id. 8. In re Netia Holdings, S.A., 277 B.R. 571 (Bankr. S.D.N.Y. 2002) U.S.C. 101(24) (West 2003). 10. In re Petition of the Bd. of Directors of Hopewell Int l Ins. Ltd., 238 B.R. 25, 52 (S.D.N.Y. 1999) ( Hopewell I ), aff d, 275 B.R. 699 (S.D.N.Y. 2002). 11. Hopewell (I) 238 B.R. at U.S.C. 1410(a) (2003). 13. In re Officina Conti, S.R.L., 118 B.R. 392, 394 (Bankr. D.S.C. 1989) (the Court rejected this nonsensical construction of 1410(a) that would require the action to be pending before the debtor could seek an injunction to prevent its commencement ). The Court in Hopewell reached a similar conclusion, but in that case also found that venue was appropriate based on Section 1410(c), to be discussed infra U.S.C. 1410(b) (West 2003). 15. Id. 1410(c). 16. In re Evans, 177 B.R. 193, (Bankr. S.D.N.Y. 1995). 17. Victrix S.S. Co. v. Salen Dry Cargo A.B., 825 F.2d 709, (2d Cir. 1987) U.S.C. 304(c) (2003). 19. Id. A sixth factor, ensuring the opportunity for a fresh start for the individual that such foreign proceeding concerns, is by its plain terms, applicable only in proceedings involving foreign individuals, and not foreign corporations. 11 U.S.C. 304(c)(6) (West 2003). 20. In re MMG LLC, 256 B.R. at In re Treco, 240 F.3d at 154; In re Caldas 274 B.R. at In re Treco, 240 F.3d at Id. 24. Id. at In re Caldas, 274 B.R. at See, e.g., Canada Southern Ry. Co. v. Gebhard, 109 U.S. 527, (1883); Cornfeld v. Investors Overseas Serv., 471 F. Supp. 1255, 1259 (S.D.N.Y.), aff d, 614 F.2d 1286 (2d Cir. 1979); Clarkson Co., Ltd. v. Shaheen, 544 F.2d 624 (2d Cir. 1976); Hopewell I, 238 B.R. 25, 66 (Bankr. S.D.N.Y. 1999), aff d, 275 B.R. 699 (S.D.N.Y. 2002); Smith v. Dominion Bridge Corp., No. 96 Civ. 7580, 1999 WL , at * 4 (E.D. Pa. March 2, 1999). 27. In re Treco, 240 F.3d at Id. at Section 560 of the Bankruptcy Code provides that The exercise of any contractual right of any swap participant to cause the termination of a swap agreement because of a condition of the kind described in section 365(e)(1) of this title or to offset or net out any termination values or payment amounts arising under or in connection with any swap agreement shall not be stayed, avoided, or otherwise limited by operation of any provision of this title or by order of a court or administrative agency. 11 U.S.C. 560 (West 2003). 30. In re CGC, 269 B.R at Id. at Messrs. Cogan and Szyfer represented HETCO in this matter. This publication offers general information and should not be taken or used as legal advice for specific situations which depend on the evaluation of precise factual circumstances. Stroock & Stroock & Lavan LLP is a law firm with market leadership in financial services, providing transactional and litigation expertise to leading investment banks, venture capital firms, multinational corporations and entrepreneurial businesses in the U.S. and abroad. Stroock s practice areas concentrate in corporate finance, legal service to financial institutions, energy, insolvency & restructuring, intellectual property and real estate. For more information, visit 7