The Assault on Offshore Havens in Bear Stearns Undermines New Chapter 15
Introduction to Part Two: As this second part went to press, the Bear Stearns appeal had just been argued in the United States District Court for the Southern District of New York, and taken under advisement by the Hon. Robert W. Sweet. Since the publication of Part One, two amici briefs were filed against the appeal and supporting the sua sponte opinion and order denying recognition by the distinguished Bankruptcy Judge, the Hon. Burton L. Lifland. The author respectfully disagrees with amici, including the brief by Daniel Glosband, Esq., Prof. Jay L. Westbrook and Prof. Kenneth N. Klee, and maintains that Bear Stearns, by orphaning cross-border insolvency cases brought by would-be debtors in the offshore “Haven” jurisdictions of their incorporation, frustrates the purposes of the Model Law and chapter 15.
In In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd., the United States Bankruptcy Court for the Southern District of New York held that two debtor hedge funds’ Cayman Islands insolvency cases were unworthy of recognition under the new chapter 15 either as foreign “main” or “nonmain” proceedings. [1] Bear Stearns would thus deny legitimacy to certain insolvency cases filed in offshore “haven” jurisdictions of debtors incorporated there. [2] This article endeavors to show that Bear Stearns will undermine the purposes of chapter 15 and the efficient administration of cross-border insolvency cases. [3]
The Universalist Framework of Chapter 15 and the Earlier SPhinX Decision
Chapter 15, and the Model Law [4] upon which it is based, reflects an international adaptation of a “universalist” framework for handling cross-border insolvencies. [5] The key issue to a universalist framework is determining which jurisdiction will become the central court that will administer a transnational debtor’s global insolvency. [6] Chapter 15 directs that this single, central court is to be the court of the nation in which the debtor has its “Center of Main Interests” or “COMI”. [7] In chapter 15 parlance, the bankruptcy court recognizes the bankruptcy case filed in the COMI jurisdiction as the “foreign main proceeding.” [8] A case filed elsewhere can be recognized as a “foreign nonmain proceeding.” [9]
Understanding Bear Stearns requires some familiarity with an opinion to which it is irreconcilably opposed, SPhinX, an earlier attempt by another judge from the same bankruptcy court to address COMI. [10] The SPhinX debtors were also Cayman hedge funds administered in the U.S., which, outside of fulfilling their legal duties to maintain Cayman corporate citizenship, had few contacts with Cayman. The funds sought recognition, as foreign main proceedings, of their Cayman insolvency cases, in order to obtain the automatic stay and frustrate a settlement the funds had entered into in the Refco case. [11]
In a nuanced opinion ultimately affirmed on appeal, [12] the SPhinX Court took account of the debtors’ particular nature in light of the purposes of chapter 15. Because the funds’ ties to Cayman were scant, their COMI likely lay elsewhere. [13] Yet, there had been no objection, beyond that of the Refco parties, to the foreign representative seeking recognition of the Cayman action as a foreign main proceeding. The court recognized that “someone needs to manage the Debtors’ winding up. And the Court notes that no one, including the objectors, has questioned the JOLs’ ability to wind up the Debtors or that the Cayman Court would supervise the foreign proceedings fairly.” [14] As to the funds’ COMI, the SPhinX Court concluded: “because these are liquidation cases in which competent JOLs under the supervision of the Cayman Court are the only parties ready to perform the winding up function, and, importantly, the vast majority of the parties in interest tacitly support that approach, normally the Court would recognize the Cayman Islands proceedings as main proceedings.” [15] The court, however, relegated the Cayman action to foreign nonmain status because recognition, with its automatic stay, was sought for an improper purpose. “[W]here so many objective factors point to the Cayman Islands not being the Debtors’ COMI, and no negative consequences would appear to result from recognizing the Cayman Islands proceedings as nonmain proceedings, that is the better choice.” [16]
Criticism of SPhinX Lays the Groundwork for Bear Stearns
Prof. Westbrook and a bankruptcy practitioner, Mr. Daniel M. Glosband, provided the framework for Bear Stearns by arguing that the SPhinX Court erred in dodging the threshold COMI determination. [17] Moreover, they argued that the SPhinX Court should not have cited improper motive as such was an extraneous factor unrelated to COMI. [18] For his part, Glosband concluded that the Cayman case deserved no chapter 15 recognition at all, arguing:
The objective facts found by the SPhinX court, other than place of registration, put SPhinX Funds’ COMI in the United States. The objective facts did not show any “establishment” in Cayman Islands. [19] This should have ended the matter. The Cayman Islands proceeding, while a foreign proceeding, is not eligible for chapter 15 recognition at all. The foreign proceeding is not pending in a country where the debtor has the center of its main interests, thus it is not eligible for recognition as a foreign main proceeding under §1517(b)(1); the debtor has no establishment in the Cayman Islands, thus the foreign proceeding is not eligible for recognition as a foreign non-main proceeding under §1517(b)(2). [20]
Glosband admitted, however, that the SPhinX Court’s deviations from the statute’s text and what he construed as Congress’ intent had caused no harm to the SPhinX debtors.
Bear Stearns Departs from SPhinX
By following the lead of Prof. Westbrook and Mr. Glosband in woodenly adhering to the words of chapter 15, the Bear Stearns Court, by contrast, has caused harm, to the funds in question, to the purposes of chapter 15 and to the spirit of comity in which it was created.
In Bear Stearns, the Cayman hedge fund debtors were managed in the U.S. and the sole investor in one of the funds was a U.K. entity. [21] The funds, buffeted by exposure to the sub-prime lending crisis, went into default and faced asset seizures and sales. The funds filed for insolvency in Cayman and the petitioners were appointed as debtors’ foreign representatives, or Joint Provisional Liquidators (“JPLs”). The JPLs filed a chapter 15 petition in the bankruptcy court for the Southern District of New York, seeking recognition of the Cayman action as a foreign main proceeding. There were no objections filed.
The Bear Stearns Court, on its own initiative ruled that recognition is “not to be rubber stamped by the courts.” [22] It cited Prof. Westbrook’s critique of SPhinX to hold that COMI comprised a threshold determination that could not be avoided and, moreover, could not be established by the parties’ mere acquiescence to the § 1516(c) presumption. [23] From the petitioners’ pleadings, the court perceived the required evidence that the debtors’ COMI was outside Cayman, and rebutted the § 1516(c) presumption sua sponte. The court found COMI to be in the U.S., requiring denial of the Cayman action as a foreign main proceeding.
The court then followed Glosband’s lead and also denied the Cayman action recognition as a foreign nonmain proceeding. [24] Because the Bear Stearns funds were “exempt” Cayman entities, i.e., allowed to conduct offshore business offshore from Cayman but to not engage in local business there, the debtors, as a matter of law, could not have engaged in the “nontransitory economic activity” required for an “establishment” there. [25] Without a Cayman establishment, the case there was thus not even eligible for nonmain recognition. Both SPhinX opinions were distinguished, if not criticized, because neither had addressed “establishment.”
The Bear Stearns Court justified its strict application of the ostensible requirements for recognition because, as opposed to repealed § 304, which it replaced, “Chapter 15 . . . imposes a rigid procedural structure for recognition of foreign proceedings as either main or nonmain and thus the jurisprudence developed under section 304 is of no assistance in determining the issues relating to the presumption for recognition under chapter 15.” [26] The court advised the JPLs to file involuntary petitions against the funds to commence plenary U.S. proceedings, giving them a month to do so. [27] The court also cited § 1509(f) as an additional avenue of possible relief, this latter provision preserving the foreign representatives’ right to “sue in a court in the United States to collect or recover a claim which is the property of the debtor.” [28]
Section 303 is of Little Help to a Rejected Foreign Representative
The Bear Stearns Court asserted that § 303(b)(4) “does not require that the foreign proceeding be recognized” [29] in order for a foreign representative to commence an involuntary chapter 11 case. Not so. Section 1511(a) requires chapter 15 recognition as a pre-condition to filing a plenary case under §§ 301 or 303: “Upon recognition, a foreign representative may commence: (1) an involuntary case under section 303, or (2) a voluntary case under section 301 or 302, if the foreign proceeding is a foreign main proceeding.” [30]
The Bear Stearns Court tries in vain to explain away § 1511: “[ i ]t would appear that the failure to repeal section 303(b)(4) along with section 304 may be a drafting error in view of the newly enacted section 1511(b) which likewise addresses the commencement of a case under sections 301 and 303. The inconsistencies of the two statutes have not been conformed.” [31] The statutes are not inconsistent, however. Recognition as precursor to § 303 is mandated not only by § 1511’s plain language, but also by the relevant legislative history: “an order granting recognition is required as a prerequisite to the use of sections 301 and 303 by a foreign representative.” [32]
Certain Foreign Entities may not be “Debtors” in Plenary Cases
A foreign entity may not qualify as a “debtor” even though it would under chapter 15. Under § 109(a), a plenary case may only be commenced against a person who qualifies as a “debtor,” i.e., an entity that is domiciled (incorporated), has a place of business, or owns property in the U.S. Section 1502(1), however, broadens “debtor” for chapter 15 purposes to include any “entity that is the subject of a foreign proceeding.” [33] Bear Stearns thus creates an insurmountable legal hurdle for certain rejected foreign representatives.
Plenary Cases are More Expensive and Difficult, Even if Possible
Assuming that filing an involuntary plenary case is possible, it is unclear how it would be commenced in practice. Because the entity may not have a registered agent in the U.S. able to accept service of process on its behalf by regular mail, [34] the foreign representative would have to serve the entity pursuant to Fed. R. Civ. P. 4(h). [35] At the very least, the foreign representative would have to comply with any applicable “internationally agreed means reasonably calculated to give notice,” such as the Hague Convention. [36] If the target nation was not a signatory to any such treaty, the foreign representative must then comply with the laws pertaining to service in the foreign country. [37] Thus, effecting service of an involuntary petition abroad would, at the very least, be an enormous inconvenience and, at worst, might be a legal or practical impossibility. [38]
Chapter 15, like its § 304 predecessor, was meant to lighten the procedural burden and expense of commencing and pursuing an ancillary proceeding. Inconvenience was one reason why a different judge in Southern District of New York bankruptcy court denied a motion to dismiss an ancillary proceeding filed by the American bondholders of an Argentinian debtor, who argued that their rights under the Trust Indenture Act (TIA) could not be impaired. The court disposed of their argument that the Argentinian debtor be ordered to commence a domestic plenary case because such an “approach ignores a fundamental purpose of § 304, which is to avoid the inconvenience and expense of a full U.S. Chapter 11 proceeding.” [39]
Chapter 15, like § 304, concerns ancillary proceedings: “The title ‘ancillary’ in the title of this section [i.e., § 1504] and in the title of this chapter emphasizes the United States policy in favor of a general rule that countries other than the home country of the debtor, where a main proceeding would be brought, should usually act through ancillary proceedings in aid of the main proceedings, in preference to a system of full bankruptcies (often called ‘secondary’ proceedings) in each state where assets are found.” [40] Lacking foreign nonmain recognition and the ability to file an ancillary proceedings in the U.S., offshore entities will be forced to file multiple full bankruptcy cases in multiple countries. Such inefficiency will shrink the assets ultimately available for distribution, violating at least two of chapter 15’s express purposes. [41]
This is not to say that even recognized foreign representatives can avoid all of the perils and costs involved with dealing with entities abroad. For example, since foreign representatives of foreign nonmain proceedings may only file, via § 1511(a)(1), an involuntary case under § 303, they would still face service issues if they wanted to commence a plenary case. The importance of nonmain recognition, however, is that such foreign representatives are not forced to open a plenary case if the foreign debtor can attain an appropriate level of protection and relief through chapter 15. Without such recognition, the foreign representative has no authority, and the debtor no protection or relief barring the filing of a plenary petition.
[End of Part One.]
[Part Two]
Comity and Judicial Discretion Must Remain Relevant to the Recognition Process
Comity is the principle through which courts recognize within their nations’ borders the “legislative, executive or judicial acts of” fellow sovereign states. [42] Such deference reflects the realization that “[w]e cannot have trade and commerce in world markets and international waters exclusively on our terms, governed by our laws, and resolved in our courts.” [43] In the insolvency context, comity serves such American policy interests as the “distribution of the debtor’s assets in an equitable, orderly, efficient, and systematic manner, rather than in a haphazard, erratic, or piecemeal fashion.” [44] Over a century ago, the U.S. Supreme Court held that comity requires U.S. courts to honor the consequences of a foreign debtor’s insolvency proceedings in its home jurisdiction, i.e., the jurisdiction of incorporation according to whose laws it was created and remains subject to, even if the interests of domestic creditors would have to be compromised:
“Unless all parties in interest, wherever they reside, can be bound by the arrangement which it is sought to have legalized, the scheme may fail. All home creditors can be bound. What is needed is to bind those who are abroad. Under these circumstances the true spirit of international comity requires that schemes of this character, legalized at home, should be recognized in other countries.” [45]
Conversely, the amici noted in the Introduction agree with Bear Stearns that comity is now to be subordinated to the restrictive “plain language” of chapter 15 where the threshold issue of recognition is concerned. [46] To this observer, this seems far too narrow a role for such a historically and internationally significant principle. After all, comity was the overriding theme of chapter 15, as shown by its purposes explicitly set forth in § 1501 and the legislative history of § 1507. [47] Moreover, while the plain language and legislative history indeed focus on the import of COMI and “establishment,” in neither did Congress explicitly banish considerations of comity from the recognition process. [48]
Bear Stearns violates the “true spirit of international comity” by using chapter 15 to deny the transnational effect of the debtors’ insolvency proceedings in their Haven-home jurisdiction. It thus runs afoul of long-established precedents, including Gebhard, the holding of which does not qualify or restrict comity in any way—if anything, Gebhard requires the recognition of a duly-commenced insolvency case brought within a debtor’s jurisdiction of incorporation. U.S. Bankruptcy Judges thus properly retain the discretion to apply comity in the first instance to petitions seeking recognition under chapter 15. [49]
Non-Recognition of a Haven Entity’s Home Court Insolvency Proceeding Infringes the Haven’s Sovereignty and Could Lead to Cross-Border Uncertainty
Bear Stearns will create a class of unprotected orphaned debtors as well as possibly threaten the future viability of the global Model Law system itself. Stakeholders wishing to voluntarily wind-up an offshore entity may prefer to do so using the laws and courts of the Haven country of incorporation; or, alternatively, may be required to do so under the Haven’s laws. [50] Moreover, an entity incorporated under a jurisdiction’s laws remains subject to its laws and regulators: if the entity runs afoul of such laws, regulators can put it into involuntary liquidation in the Haven.
The non-recognition of properly commenced insolvency cases convened in the courts of their Haven-home jurisdictions not only creates uncertainty in the international financial system, but amounts to an assault on the Havens’ sovereignty, as it harms the interests and justifiable expectations of the entity’s stakeholders and hampers the Havens’ regulators and liquidators from policing and winding-up their corporate citizens. [51] A debtor whose home jurisdiction insolvency is unrecognized will find its U.S.-based assets vulnerable, perhaps unprotected. Moreover, once the “bell has been rung”, that is, once the entity’s prior management has been displaced by the commencement of the offshore case, there might be no one outside of these foreign representatives having the legal authority, ability or desire to act on the entity’s behalf in the U.S. [52] Yet, refusing recognition will not necessarily put things right by forcing the foreign entity to re-file in the ostensibly “correct” COMI jurisdiction. [53] Its Haven-appointed foreign representatives, vested with fiduciary duties by the courts of their sovereign, could be expected to proceed with administering the entity’s bankruptcy estate despite the difficulties created by non-recognition by the U.S. bankruptcy court. Would they have any choice but to abide by their own laws?
The uncertainty created here could spread abroad, infringing the efficient administration of the global estates of insolvent offshore entities. Displaced managers might retain apparent authority to file a voluntary § 301 petition, assuming the entity otherwise qualified under § 109. Similarly, with the entity’s U.S. assets unprotected, U.S.-based creditors could be tempted to file an involuntary § 303 petition. Either such instance would commence a plenary U.S. case, which would have, assuming no recognized foreign main proceeding existed, world-wide jurisdiction. [54]
At best, this scenario would return us to the world of ad hoc inter-court protocols decided on a case-by-case basis. Yet, such cooperation has historically been more prevalent in the “mega cases” where “the enormous sums and forces at play give no choice for the parties but to play out their self-interests through a co-operative protocol.” [55] Since the “‘normal’ case measured in millions rather than billions . . . present[s] the grist for a co-operative oriented process,” Bear Stearns will deprive “normal” offshore debtors of the benefits that the Model Law was intended to give cross-border debtors. [56] Instead, offshore debtors are now faced with such burdens as: the potential global res judicata effects of non-recognition by the U.S. bankruptcy court; the resulting, perhaps unbearable, duplicative expenses of commencing multiple parallel full plenary cases, both in the U.S. and elsewhere; and, perhaps no obligation on the part of the U.S. bankruptcy court to cooperate with the unrecognized foreign representatives and the Haven’s courts. [57]
At worst, a globally-chaotic situation could ensue. Especially in the “mega” cases where many different interests could be implicated, [58] other foreign courts may choose to recognize the entity’s Haven insolvency case, ignoring the conflicting U.S. determinations as to COMI or establishment. The U.S. bankruptcy trustee and the foreign representatives could thus get embroiled in litigation in any number of debilitating ancillary proceedings in third-party countries as each vies for the debtor’s assets there. This would be territorialism, but not of any “cooperative” kind. [59] All in all, the complete non-recognition of an offshore debtor’s duly-appointed foreign representatives will likely create a host of absurd results, [60] above all, insofar as Haven jurisdictions are concerned, the cross-border undermining of sovereignty and the rule of law itself, and the possible collapse of the Model Law and chapter 15 in practice.
Comity Would Counsel that an Entity Should Always be Considered to have an “Establishment” in the Jurisdiction Where it is Incorporated
While applying comity principles might not fundamentally have altered Bear Stearns’ COMI analysis and outcome, its “establishment” analysis should have yielded to such principles and to recognizing debtors’ Cayman insolvency cases as at least “foreign nonmain proceedings.” Although nonmain recognition affords more limited immediate relief than main recognition, [61] chapter 15 still affords the foreign representative of a foreign nonmain proceeding certain rights in the U.S., such as to commence an involuntary plenary case [62] or otherwise protect and administer U.S. assets. [63]
The lynchpin of Bear Stearns’ non-recognition is its holding that the debtors failed to show the “establishment” in Cayman required for foreign nonmain recognition. As “letterbox” entities, their only business consisted of “activities necessary to their offshore ‘business.’” [64] Yet, such business should have supported a finding of at least “nonmain” status: “Nontransitory” [65] implies sustained economic activity, which is certainly generated by an offshore entity operating out of a Haven and complying with the latter’s laws, not least by the filing fees, regulatory functions and professional services created and provided there.
While Cayman law bars exempt entities from conducting local business, it allows them to incorporate in, and to conduct their offshore business through, a Caymans registry. By rejecting this type of locally-authorized economic activity as an insufficient “establishment,” Bear Stearns second-guesses the policy choices of a fellow sovereign. [66] No form of recognition whatsoever is granted, in derogation of decades of section 304 comity precedents. Considerations of comity should thus inform the recognition analysis at this level, with the foreign entity always being allowed to show the minimal “establishment” required for nonmain recognition in its jurisdiction of incorporation. [67]
Bear Stearns’ Sua Sponte Rebuttal of the Section 1516(c) Presumption Increases Foreign Representatives’ Procedural Burden Beyond that Envisioned by Congress
The Bear Stearns court sua sponte raised both the COMI and “establishment” issues and, by using the petitioners’ own submissions, rebutted the § 1516(c) presumption that the debtors’ COMI was in Cayman, despite no objections being raised on this issue. Greater circumspection in this regard rightly has been urged by another esteemed bankruptcy jurist, the Hon. Samuel L. Bufford: “Courts must make their decisions based on the evidence presented to them. Courts are simply not at liberty to search out their own evidence, or even to tell the parties what evidence to present. Given the presumption that a corporation’s CoMI is found where its registered office is located, evidence of the location of its registered office should be sufficient unless a party in interest contests the application of the presumption.” [68]
Congress has observed that the “presumption that the place of the registered office is also the center of the debtor’s main interest is included for speed and convenience of proof where there is no serious controversy.” [69] As in Bear Stearns, there was no serious controversy among the relevant parties in another Southern District of New York chapter 15 bankruptcy case, In re Basis Yield Alpha Fund (Master), that COMI was in Cayman. Yet, the Basis Yield court ordered the petitioners to “use best efforts to introduce evidence sufficient for the Court to make factual findings with respect to at least the following matters,” listing twenty-one different categories of evidence sought. [70] Such evidence would assist the court in “developing a factual record” it deemed necessary to address the “JPLs’ motion for recognition,” regardless of the lack of any objections, through a full “evidentiary hearing.” [71] Despite the lack of party opposition to the foreign representatives’ subsequent motion for summary judgment requesting that they finally receive the benefit of the § 1516(c) presumption, [72] the Basis Yield court denied the motion, but allowed the foreign representatives to continue their long march towards an eventual evidentiary hearing. [73] Thus, even though the Basis Yield foreign representatives have received and retain a chance at attaining recognition, the path set for them has been anything but convenient or quick; instead, the path has become complex, expensive and ill-suited for “normal” cross-border cases, manifold as these are. [74]
Section 1509(f) Offers Only Scant Affirmative Relief, and is of No Help Where Only Fraud Related Discovery is Being Sought
Bear Stearns’ observation that the foreign representatives still had recourse to § 1509(f) might be accurate, but is of little consolation. [75] Without the right of direct access to U.S. courts and real party-in-interest status that recognition allows, it is unclear whether an unrecognized foreign representative would have standing under a state’s law to bring an action on the entity’s behalf. [76] Moreover, state courts might shy away from allowing suits otherwise authorized by §1509(f) in the face of a bankruptcy court order issued under § 1509(d) (“If the court denies recognition under this chapter, the court may issue any appropriate order necessary to prevent the foreign representative from obtaining comity or cooperation from courts in the United States.”). [77]
Regardless, the scope of § 1509(f) relief is scant. [78] Notably, it offers no protection to an unrecognized debtor. Further, it grants no discovery rights; chapter 15 allows, after recognition, the bankruptcy court to “provid[e] for the examination of witnesses, the taking of evidence or the delivery of information concerning the debtor’s assets, affairs, rights, obligations or liabilities.” [79] Discovery might be the most important—or only—relief needed in the U.S. by the foreign representatives in a “normal” case. [80] This need takes on special relevance in insolvency cases where fraud is suspected. [81] Unrecognized foreign representatives thus may never know the extent of the debtor’s assets and claims, with all of the loss and waste this entails.
Bear Stearns Unnecessarily Casts Doubt about the Legitimacy and Efficacy of Financial Architecture Utilizing Havens
Bear Stearns potentially undermines a viable cross-border business model. The SPhinX court recognized the good non-bankruptcy reasons for investors to incorporate entities in Havens, i.e., “to attract non-U.S. and U.S. tax exempt investors in the light of favorable . . . tax benefits and regulations.” [82] Foreign investors abroad may wish to avoid both U.S. laws as well as those of their home governments. To the extent U.S. policy concerns are met, the U.S. has no right to second-guess this choice, or the ability and willingness of Havens to facilitate non-U.S. citizen investors. Developing nations pose special challenges for investors: their laws, capital markets and financial institutions might be weak and local corporate governance and courts ineffective. Offshore citizenship, however, can afford investors with access to standards of transparency, financial stability and market integrity that their developing nations’ courts and governments might not offer. [83]
Greater Haven involvement in cross-border insolvencies does not necessarily mean a “race to the bottom” of Havens pandering to case-placers. [84] There may actually be benefits to respecting Haven-hosted insolvencies. Havens have strong incentives to offer efficient and honest courts; if it does not, their corporate citizens will depart and new entities will organize elsewhere. [85] Havens conceivably could streamline the efficient administration of certain cases, such as hedge fund wind-ups, by developing local expertise.
By contrast, the court systems of many large non-Haven nations are suspect. One Model Law critic notes that § 1506 was intended to provide U.S. bankruptcy judges with a way to shield U.S. creditors from the worst effects of insolvency proceedings filed in incompetent and corrupt courts abroad, with China’s court system noted as just such a threat. [86] Allowing the recognition of Cayman insolvencies brought by Cayman entities funded with Chinese capital would seem a far better proposition than continually having to contend with the substantive results of a blindly mechanical recognition process. Bear Stearns would, on the other hand, force investors back into the very arms of the governments and courts that they strived so hard to avoid in the first place, even when there is no U.S. interest at stake. This is not just damaging to the predictable and equitable implementation of the Model Law, but amounts to an unnecessary encroachment of a U.S. policy choice on the business judgment of participants and investors in offshore entities and the sovereignty of those nations hosting them.
Conclusion
Bear Stearns, by treating Havens and their offshore corporate citizens as lepers, confounds chapter 15’s purposes. Instead of comity, it offers disregard. Instead of encouraging greater certainty for investment, it sows uncertainty. Instead of protecting debtors’ assets, it exposes them to jeopardy, especially in the U.S. The SPhinX court recognized that someone needs to wind-up a debtor, even if that someone was appointed by the courts of a Haven. Its flexibility at least did no harm. Conversely, the Bear Stearns rather mechanical denial of any recognition whatsoever to a Haven entity’s home court insolvency proceeding has jeopardized both the debtor funds and the future implementation of chapter 15.
[1] Nos. 07-12383 & 07-12384, Slip Op. at 17-19 (Bankr. S.D.N.Y Aug. 30, 2007).
[2] Prof. Jay L. Westbrook uses the term “haven” pejoratively to describe those small sovereign entities, like the Cayman Islands, that allow “exempt” entities to incorporate under their laws and conduct their offshore business under their auspices. See Jay L. Westbrook, Locating the Eye of the Financial Storm, 32 BROOK. J. INT’L L. 1019, 1029 (2007) (“[C]ompanies are often incorporated in legal havens—tax havens, bank secrecy havens, and the rest.”). I use the term “Haven” as well, but mindful of its non-pejorative connotation, in that a “haven” can also afford legitimate protections to those choosing to do business there.
Those interested in learning more about the developing role of “Havens” in the realm of cross-border insolvencies should attend the ABI’s 2008 Caribbean Insolvency Symposium on Jan. 17th and 18th, 2008 in Florida. See http://www.abiworld.net/meetings/caribbean-insolvency-symposium/intro.html Speakers and attendees at this conference will include a large contingent of world-class Cayman insolvency professionals.
[3] “The purposes of Chapter 15 are to maintain cooperation between American and foreign courts, to promote greater legal certainty for trade and investment, to administer cross-border insolvencies fairly and efficiently, to protect and maximize the value of the debtor’s assets, and to rescue troubled businesses.” Aaron Kaufman, The European Union Goes COMI-tose: Hazards of Harmonizing Corporate Insolvency Laws in the Global Economy, 29 HOUS. J. INT’L L. 625 (2007) (citing 11 U.S.C. 1501(a)). Bear Stearns undermines them all.
[4] The United Nations’ UNCITRAL Model Law on Cross Border Insolvency (“Model Law”). The Model Law has become the law of the European Union in the form of the E.U. Regulation on Cross-Border Insolvency. Council Reg. 1346/2000 O.J. (L 160)) 1 (EC) (“E.U. Regulation”).
[5] See Edward J. Janger, Universal Proceduralism, 32 BROOK. J. INT’L L. 819, 824 (2007). Foreign caselaw is to be given precedential value in interpreting chapter 15, as § 1508 directs that the chapter is to be interpreted consistently “with the application of similar statutes adopted by foreign jurisdictions.”
[6] This article assumes some familiarity with the “territorialism” / “universalism” debate. Under territorialism, the traditional approach, transnational insolvencies are dealt with nation-by-nation through independent plenary bankruptcy cases opened in each country. The courts in each nation administer the bankrupt’s local assets, determine creditors’ claims and make distributions according to local insolvency law. Transnational cooperation between sovereign courts is possible, even laudable, under the “cooperative” version of territorialism. Prof. Lynn LoPucki is the greatest current proponent of the territorialist model. See Lynn M. LoPucki, Universalism Unravels, 79 AM. BANKR. L. J. 143, 160-64 (2005).
As already noted, universalism seeks to centralize the administration of an insolvency case concerning a transnational entity in the bankruptcy court of one jurisdiction, whose rulings and distributions would be global in scope, especially as to estate administration. The greatest proponent of universalism is Prof. Westbrook.
[7] See John A. E. Pottow, The Myth (and Realities) of Forum Shopping in Transnational Insolvency, 32 BROOK. J. INT’L L. 785, 786 (2007).
[8] 11 U.S.C. § 1502(4).
[9] 11 U.S.C. § 1502(5); see also supra n.19.
[10] See In re SPhinX, Ltd., 351 B.R. 103, 117 (Bankr. S.D.N.Y. 2006) (Drain, J.), aff’d, 371 B.R. 10 (S.D.N.Y. 2007) (Sweet, J.).
[11] Id. at 109-12 & 121-22.
[12] 371 B.R. 10 (S.D.N.Y. 2007). The district court approved of the bankruptcy court’s COMI analysis, including the latter’s concern as to the debtors’ improper purpose, and concluded that “Overall, it was appropriate for the Bankruptcy Court to consider the factors it considered, to retain its flexibility, and to reach a pragmatic resolution supported by the facts found.” Id.
[13] SPhinX, 351 B.R. at 118-20.
[14] Id. at 120. Judge Drain thereby acknowledged the Model Law’s rebuttable presumption that an entity’s jurisdiction of incorporation is the COMI jurisdiction: “[ i ]n the absence of evidence to the contrary, the debtor’s registered office . . . is presumed to be the center of the debtor’s main interests.” 11 U.S.C. § 1516(c). So long as the presumption holds, domicile suffices for COMI: “[t]he presumption that the place of the registered office is also the center of the debtor’s main interest is included for speed and convenience of proof where there is no serious controversy.” H.R. Rep. 109-31, pt. 1, 109th Cong. 1st Sess. at 112-13 (2005). The ultimate burden of showing each element for recognition, including COMI, however, always remains with the foreign representative seeking it. See id.
[15] SPhinX, 351 B.R. at 121 (emphasis added).
[16] Id. at 122. The court thereby applied the “Eurofood” standard, pertaining to how the § 1516(c) presumption might be rebutted. See id. at 117-19 & nn. 20-21. In Eurofood, i.e., Bondi v. Bank of America, N.A. (In re Eurofood IFSC Ltd.), Case 341/04, 2006 E.C.R. 1-3813 at pp. 34-35, 2006 WL 1142304 (E.C.J. May 2, 2006) (“Eurofood”), the European Court of Justice (“E.C.J”), the high court of the European Union, held that:
in determining the center of the main interests of a debtor company, the simple presumption laid down by the [European] Community legislature in favour of the registered office of that company can be rebutted only if factors which are both objective and ascertainable by third parties enable it to be established that an actual situation exists which is different from that which locating it at that registered office is deemed to reflect.
That could be so in particular in the case of a “letterbox” company not carrying out any business in the territory of the Member State in which its registered office is situated.
Id.; see generally, The Hon. Samuel L. Bufford, U.S.B.J., Center of Main Interests, International Insolvency Venue, and Equality of Arms: the Eurofood Decision of the European Court of Justice, 27 NW. J. INT’L L. & BUS. 351 (2007).
[17] See Westbrook, Eye at 1024-28, Daniel M. Glosband, Sphinx Chapter 15 Opinion Misses the Mark, 25-JAN AM. BANKR. INST. J. 44 (2007).
[18] See id. Prof. Westbrook and Glosband argue that whether the SPhinX foreign representative sought the automatic stay for improper reasons was irrelevant to the COMI analysis; procedurally, the court should have granted relief from the automatic stay after granting recognition to the Cayman proceeding as a foreign main proceeding, even though the latter would have been, in their estimation, substantively incorrect.
[19] A foreign insolvency case filed in a non-COMI jurisdiction may be recognized as a “foreign nonmain proceeding,” which chapter 15 defines as a “foreign proceeding, other than a foreign main proceeding, pending in a country where the debtor has an establishment.” 11 U.S.C. § 1502(5). Chapter 15 defines “establishment” as “any place of operations where the debtor carries out a nontransitory economic activity.” 11 U.S.C. § 1502(2).
The key difference between a recognized foreign main, versus nonmain, proceeding, is the enhanced rights automatically vested in a foreign representative for the former, including the automatic § 362 stay. 11 U.S.C. § 1520(a)(1). However, the foreign representatives accorded only “nonmain” status may still receive “any appropriate relief”, including protective injunctive relief. See 11 U.S.C. § 1521.
[20] Glosband at 45 (emphasis added).
[21] Bear Stearns, Slip Op. at 3.
[22] Id.
[23] Id. at 6-8, 14 (citing, inter alia, Westbrook, Eye at 6-7).
[24] See, e.g., Glosband at 45.
[25] Bear Stearns, Slip Op. at 15-16.
[26] Id. at 17.
[27] If debtors did not file within the month, the preliminary injunction entered earlier that month enjoining their creditors would automatically dissolve. The court has recently allowed the debtors a temporary reprieve by allowing the injunction to remain pending the petitioners’ appeal. See No. 35 on 07-12383 Dkt. (9/26/07 Ord.).
[28] Bear Stearns, Slip Op. at 18.
[29] Id.
[30] 11 U.S.C. § 1511(a). Section 1511(b) also requires the foreign representative to append a certified copy of the order granting recognition to the plenary petition, a legal impossibility if the petition was denied.
[31] Bear Stearns, Slip Op. at 17 n.15.
[32] H.R. Rep. No. 109-31, at 106 (footnotes omitted) (emphasis added). This is not to say that there are no inconsistencies in the Code, post-BAPCPA, requiring further conforming. The § 101(42) definition of “petition,” for example, still includes a reference to petitions filed under “section 304,” despite that section’s repeal.
[33] 11 U.S.C. § 1502(1). However, certain foreign entities may not be chapter 15 debtors either. See 11 U.S.C. 1501(c).
[34] See Bankr. R. 7004(b)(3).
[35] Fed. R. Civ. P. 4(f) is incorporated into the Bankruptcy Rules by Bankr. R. 7004 and, in turn, applies to foreign corporations the service requirements set forth for foreign individuals set forth in Fed. R. Civ. P. 4(f).
[36] Fed. R. Civ. P. 4(f)(1).
[37] See Fed. R. Civ. P. 4(f)(2).
[38] The foreign authorities may refuse to cooperate with the foreign representative, such as by not responding to a letter rogatory or letter of request to the foreign government. See Fed. R. Civ. P. 4(f)(2)(B).
[39] In re Board of Directors of Multicanal S.A., 307 B.R. 384, 392 (Bankr. S.D.N.Y. 2004) (Gropper, J.)
[40] H.R. Rep. No. 109-31, at 108 (interpreting § 1504).
[41] See 11 U.S.C. § 1501(a)(3) & (4).
[42] Hilton v. Guyot, 159 U.S. 113, 163-64, 16 S.Ct. 139, 40 L.Ed. 95 (1895).
[43] The M/S Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 9, 92 S.Ct. 1907, 32 L.Ed.2d 513 (1972).
[44] In re Artimm, S.r.L., 335 B.R. 149, 161 (Bankr. C.D. Cal. 2005).
[45] Canada Southern Railway v. Gebhard, 109 U.S. 527, 539, 3 S.Ct. 363, 370, 27 L.Ed. 1020 (1883) (“Gebhard”)). Having knowingly contracted with a company known to be subject to the laws of its different sovereign, such U.S. creditors would likewise be bound, “[ i ]t follows, therefore, that anything done at the legal home of the corporation, under the authority of such laws, which discharges it from liability there, discharges it everywhere.” Id. at 537-38, 3 S. Ct. 363.
[46] These amici argue that comity is only relevant to what discretionary “additional assistance” may be granted under § 1507, and only after the foreign insolvency case has been recognized, if at all, as a foreign main or nonmain proceeding. In re Bear Stearns, No. 07-8730, Amicus Br. of Prof. Westbrook, et al., Dkt. No. 7, at 14-15 (“Acad. Amicus Br.”). These amici are especially interesting because Glosband and Westbrook laid the theoretical groundwork for Bear Stearns. See supra Part One, nn.17-20 and associated text.
[47] Congress noted, as to § 1507, that “[a]lthough the case law construing section 304 makes it clear that comity is the central consideration, its physical placement as one of six factors in subsection (c) of section 304 is misleading, since those factors are essentially elements of the grounds for granting comity. Therefore, in subsection (2) of this section, comity is raised to the introductory language to make it clear that it is the central concept to be addressed.” H.R.Rep. No. 109-31, at 109 (footnote omitted).
[48] For example, while Congress did state that “only a main proceeding or a non-main proceeding meeting the standards of section 1502 . . . [is] entitled to recognition,” H.R. Rep. No. 109-31 at 114, even this statement does not rise to an explicit directive that comity has no role in recognition. “Congress legislates against a backdrop that includes those international norms that guide comity analysis, absent a contrary legislative direction the doctrine may properly be used to interpret any statute.” In re Maxwell Comm. Corp., 93 F.3d 1036, 1048 (2d Cir. 1996).
[49] Comity is a “discretionary” doctrine. Windt v. Qwest Communications Intern., Inc., No. 04-3026, 2006 WL 2987097, *15 (D.N.J. Oct 17, 2006). That district court noted that “[t]he availability of [the] wide range of relief [automatically available under chapter 15] is effectively a codification of previously existing international ‘comity’ in the area of insolvency proceedings.” Id.
[50] For example, Cayman law requires this of Cayman offshore entities. In re Philadelphia Alternative Asset Fund, Cause No. 440 of 2005 at 2-3 (Cayman Grand Court, J. Henderson, Feb. 22, 2006) (winding-up of a Cayman-domiciled entity must take place in the Cayman courts).
[51] The Cayman Islands are a British Overseas Territory with a British Governor. U.S. State Dept., Background Note: Cayman Islands (June 2007) at http://www.state.gov/r/pa/ei/bgn/5286.htm. Yet, the “islands today are self-governed in nearly all respects.” Id.
[52] Admittedly, rejected representatives retain rights to pursue certain of the debtor’s claims under § 1509(f), but this provision is very limited. See infra. Moreover, the text and legislative history of § 1511 would appear to bar rejected foreign representatives from filing a voluntary or involuntary plenary petition under § 301 or § 303. See supra Part One.
[53] This is the position the academic amici appear to espouse: “New York is the center of the financial world and should be the center of judicial management of the current crisis involving United States funds.” Acad. Amicus Br. at 31. Bear Stearns, however, is not limited to debtors that are “in fact American companies in every economic sense.” Id. It would also force debtors without U.S. assets or operations—and thus raising none of the U.S. policy implications raised by these amici that are more properly addressed through § 1506—from filing their main insolvency cases in their Haven jurisdictions.
[54] See 11 U.S.C. § 541. With the foreign proceeding unrecognized, the jurisdiction of such a subsequent U.S. plenary case would not be limited to the entity’s U.S. assets or operations. See 11 U.S.C. § 1528. Admittedly, recognized foreign nonmain proceedings also do not preclude the filing of a subsequent plenary U.S. case. See 11 U.S.C. § 1528. Yet, the obligation by the U.S. bankruptcy court to cooperate with the foreign court and the foreign representatives in a foreign nonmain proceeding cannot be questioned. See 11 U.S.C. § 1529.
T
[55] The Hon. Burton L. Lifland, Comments, UNCITRAL – INSOL International Multinational Judicial Colloquium: Evaluation Session, Toronto, March 22-23, 1995.
[56] Id.
[57] Sections 1525 through 1527 oblige a U.S. bankruptcy court or trustee to cooperate with a “foreign court or a foreign representative,” without an explicit predicate of recognition. However, the Bear Stearns analysis appears to assume that either recognition or a plenary U.S. case is required for the obligation to cooperate to be triggered. See, e.g., Bear Stearns, Slip Op. at 18 (“Section 303(b)(4) does not require that the foreign proceeding be recognized. This flexibility leaves open the potential coordination of a case filed here under Title 11 with the Foreign Proceeding. See 11 U.S.C. § 1529.”).
[58] See supra nn. 55-56 and accompanying text.
[59] See supra Part One, n.6. Even a “territorialist” should take issue with Bear Stearns’ violation of comity as an attack on sovereignty, perhaps the core territorialist value. See John J. Chung, The New Chapter 15 of the Bankruptcy Code: A Step Toward Erosion of National Sovereignty, 27 NW. J. INT’L L. & BUS. 89, 119 (2006).
[60] “[W]here the plain language, even if literally applicable, would yield absurd results at odds with the statutory design, courts may look beyond the printed word to the law as a whole and its purposes and policy.” Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R. 406, 478 (S.D.N.Y.2001) (citing Mass. v. Morash, 490 U.S. 107, 115, 109 S.Ct. 1668, 104 L.Ed.2d 98 (1989)).
[61] See supra Part One, n.19.
[62] See 11 U.S.C. § 1511.
[63] See 11 U.S.C. §§ 1521, 1528 & 1529(3). Recognition hurdles aside, and assuming neither a recognized foreign main proceeding pending anywhere in the world or a plenary U.S. case exists, this observer roughly equates a recognized foreign nonmain proceeding in the U.S. with an old § 304 proceeding. In other words, in repealing § 304 and embracing chapter 15, Congress abandoned neither comity nor decades of § 304 precedent.
Section 1521(a)(5) vests in U.S. bankruptcy courts discretion to grant foreign representatives, “whether main or nonmain,” the power to administer “all or part of the debtor’s assets within the territorial jurisdiction of the United States.” 11 U.S.C. § 1521(a)(5); see also 11 U.S.C. §1521(b). Section 1521(c), which requires the U.S. bankruptcy court to be satisfied that the relief granted a foreign nonmain representative “relates to assets that, under the law of the United States, should be administered in the foreign nonmain proceeding” thus cannot mean that a foreign nonmain representative’s authority is necessarily limited only to assets within the nonmain jurisdiction.
[64] Bear Stearns, Slip Op. at 15-16.
[65] See supra Part One, n.19.
[66] “Some will now undoubtedly decry the irony that, while the U.S. will accept full jurisdiction over a peppercorn, the U.S. will not recognize the existence of a Cayman peppercorn as being sufficient to comprise an establishment.” Evan Flaschen & Kurt Mayr, U.S. Bankruptcy Judge Decides that a Cayman Liquidation of a Cayman Company Does Not Qualify as Either a Foreign Main Proceeding or Foreign Nonmain Proceeding.
[67] This approach finds some support in In re Schefenacker, Plc., where non-main recognition was construed as the default floor. In re Schefenacker, Plc, No. 07-11482. There, a different Southern District of New York bankruptcy judge was faced with overt bankruptcy forum-shopping. Because of objections to the asserted U.K. COMI, the court refused to find the U.K. as COMI without trial. It was acknowledged, however, that the case merited at least nonmain recognition: “At a minimum, this is a non-main proceeding.” Id. at 32-24 to 32-25. Schefenacker, No. 07-11482, Final Ord. 6-14-07, Dkt. No. 91, at 2-3, (g). The foreign representatives acceded to this demotion because they still received the desired ultimate relief with non-main status: a permanent injunction, as authorized by § 1507. Id. at 29-10 to 33-12 & 35-6 to 36-23. As in SPhinX, the Schefenacker COMI analysis was tied to the relief sought and broader circumstances shown. Bear Stearns thus acknowledges this unpublished case as a contrary authority on the “establishment” requirement. See Bear Stearns, Slip Op. at 7 n.4.
[68] The Hon. Samuel L. Bufford, U.S.B.J., Center of Main Interests, International Insolvency Venue, and Equality of Arms: the Eurofood Decision of the European Court of Justice, 27 NW. J. INT’L L. & BUS. 351, 415 (footnote omitted). The Guide to Enactment of the UNCITRAL Model Law on Cross-Border Insolvency (“Guide”) notes that the § 1516(c) presumption does “not prevent, in accordance with applicable procedural law, calling for or assessing other evidence if the conclusion suggested by the presumption is called into question by the court or an interested party.” U.N. Gen. Ass., UNCITRAL 30th Sess., U.N. Doc. A/CN 9/442 (1997) (emphasis added). If the Bear Stearns court had serious initial doubts as to the debtors’ COMI, minimally it should have given the foreign representatives more of an opportunity to present additional “other evidence” on this point, although, for the record on appeal, it is unclear whether this opportunity was afforded the foreign representatives.
[69] H.R. Rep. No. 109-31 at 113.
[70] In re Basis Yield Alpha Fund (Master), 07-12762, 9-12-07 Ord., Dkt. No. 16, at 1. Unlike in Bear Stearns, however, there was apparently little in the exhibits accompanying the debtor’s initial petition evincing evidence that COMI was anywhere but in Cayman.
[71] Id. at 1, 1.
[72] In re Basis Yield Alpha Fund (Master), 07-12762, Debtor’s Mot. for S.J., Dkt. No. 27. The irony here is double: the Basis Yield foreign representatives were forced to move for summary judgment to get the benefit of a presumption that should have always been theirs as of right, and even then it was denied.
[73] In re Basis Yield Alpha Fund (Master), 07-12762, 1-15-08 Oral Arg. Minutes on Petitioners’ S.J. Mot.
[74] See supra nn. 55-56 and accompanying text.
[75] Bear Stearns, Slip Op. at 15-16.
[76] See 11 U.S.C. §§ 1509 & 1512.
[77] 11 U.S.C. § 1509(d). Sub-section (d) was intended to “ensure that a foreign representative cannot seek relief in courts in the United States after being denied recognition by the court under this chapter.” H.R. Rep. No. 109-31, at 110.
[78] Congress noted that subsection (f) is only a “limited exception to the prior recognition requirement” that allows for “collection of a claim which is property of the debtor, for example an account receivable.” H.R. Rep. No. 109-31, at 110-11.
[79] 11 U.S.C. § 1521(a)(4).
[80] See supra nn.55-56 and accompanying text.
[81] Some commentators have recently noted that:
[I]n fraud investigations and insolvencies, the existence of a place of business or the location of assets abroad may not be known so much as suspected. Insolvency office-holders will often attach a much higher priority to obtaining access to information and documentation than to the immediate gathering of assets, particularly in circumstances where it is believed that a much bigger pot of gold can be tapped eventually.
Martin S. Kenney, et al., Utilizing Cross-Border Insolvency Laws to Attack Fraud: An Analysis of how it Could Work in the British Virgin Islands, the United States, and Germany, 13 LAW & BUS. REV. OF THE AMERICAS 569, 585 (2007).
[82] SPhinX, 351 B.R. at 107.
[83] For its part, “The Cayman Islands’ political system is very stable, bolstered by a tradition of restrained civil governance, sustained economic prosperity, and its relative isolation from foreign policy concerns . . . .”U.S. State Dept., Background Note: Cayman Islands (June 2007) at http://www.state.gov/r/pa/ei/bgn/5286.htm. Bear Stearns could bring more business to Havens by forcing offshore entities to establish a greater local presence there.
[84] See Lynn M. LoPucki, Universalism Unravels, 79 AM. BANKR. L. J. 143, 152 (2005). Prof. LoPucki foresees the global extension of flawed U.S. model worldwide, i.e., one in which the American bankruptcy system has been corrupted by U.S. bankruptcy courts competing with their sister court in Delaware to cater to case-placers. See generally Lynn M. LoPucki, Global and Out of Control? 79 Am. Bankr. L. J. 79 (2005), published as Chapter 8 of COURTING FAILURE: HOW COMPETITION FOR BIG CASES IS CORRUPTING THE BANKRUPTCY COURTS (2006).
Some scholars have pointed out that “Delawarization,” i.e., the recourse of many Delaware-incorporated entities to file under chapter 11 there in the 1990s, had benefits on administering bankruptcies in the U.S. Above all, Delaware is fast to respond to the regulatory and legal needs of its corporate citizens, achieving “this with efficient regulation, expert judges and a streamlined judicial process.” David A. Skeel, Jr., What’s so Bad About Delaware? 54 VAND. L. REV. 309, 325 (2001).
[85] Although the governments and courts of Havens can still vary widely, Cayman’s courts and laws stack up well, and its insolvency law of which has been found to be “generally in harmony with the [U.S.] Code.” In re Gee, 53 B.R. 891, 904 (Bankr. S.D.N.Y. 1985); see also In re Blackwell, 270 B.R. 814, 829 (Bankr. W.D. Tex. 2001). Cayman, in particular, has striven to be a good global citizen: “In June 2000, The Cayman Islands was listed by multilateral organizations as a tax haven and a non-cooperative territory in fighting money laundering. The country’s swift response in enacting laws limiting banking secrecy, introducing requirements for customer identification and record keeping, and for banks to cooperate with foreign investigators led to its removal from the list of non-cooperative territories in June 2001.” U.S. State Dept., Background Note: Cayman Islands (June 2007) at http://www.state.gov/r/pa/ei/bgn/5286.htm.
[86] “China’s ability to handle reasonably complex cases is suspect due to its weak courts and poorly qualified judges.” Chung, 27 NW. J. INT’L L. & BUS. at 116 n. 120.