Avoidance and Recovery
Property of the Estate
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Posts Tagged ‘Chapter 15 Title 11 United States Code’
Avoidance and Recovery
Property of the Estate
Chapter 15 of the US Bankruptcy Code, enacted in 2005, was Congress’ effort to make cross-border insolvency proceedings just a little more predictable.
Specifically, the statute’s policy objective was to “recognize” the efforts of foreign insolvency administrators and trustees to administer their debtors’ US-based assets – thereby helping to “standardize” the way assets and claims are treated in non-US insolvency proceedings.
Chapter 15 reflects a strong Congressional preference for what has been described as a “universalist” (rather than a “territorial”) approach to cross-border insolvency administration. But have US Bankruptcy Courts actually followed through on this “universalist” policy?
That is the question behind an empirical study on Chapter 15 recently published by Jeremy Leong, an advocate and solicitor with Singapore’s Wong Partnership. According to Mr. Leong, the study (entitled IS CHAPTER 15 UNIVERSALIST OR TERRITORIALIST? EMPIRICAL EVIDENCE FROM UNITED STATES BANKRUPTCY COURT CASES, and forthcoming in the Wisconsin International Law Journal) and its results indicate that, despite its ostensibly “universalist” objectives:
Based on this data, Mr. Leong goes on to conclude that “when deciding Chapter 15 cases, United States courts seldom grant entrustment [of assets for foreign distributions] without [protective] qualifications when United States creditors may be adversely affected.” Consequently, “Chapter 15 is not as universalist as its proponents claim it to be and exposes the inability of Chapter 15 to resolve conflicting priority rules between the United States and foreign proceedings.”
Mr. Leong’s study is commendable as one of the earliest pieces of empirical work on how Chapter 15 is actually applied. But it raises some questions along the way. For example:
- Is a 45.5% “entrustment” rate really accurate? Mr. Leong’s claim that “courts entrusted United States assets to foreign proceedings for distribution in only 45.5% of cases where foreign proceedings were recognized” does not really compare apples to apples. That is, it measures the “entrustment” of assets across all recognized foreign proceedings – and not the smaller subset of proceedings where entrustment was actually requested.
According to Mr. Leong’s study results, “of the 88 cases where recognition was granted, the [US bankruptcy] court made orders for [e]ntrustment in only 40 cases. Of the remaining 48 cases where [e]ntrustment was not granted, [e]ntrustment had been requested by foreign representatives in 25 of these cases.” In other words, “entrustment” of assets was requested in 65 of the cases in Mr. Leong’s sample – and in those cases, it was granted in 40, providing a 61.5% success rate for the “entrustment” of assets, rather than the study’s advertised 45.5% success rate.
- Is a 45.5% “entrustment” rate really all that bad? Success rates – like many other statistics – are significant only by virtue of their relative comparison to other success rates. Assuming for the moment that the 45.5% “entrustment” rate observed where US courts apply Chapter 15 was indeed accurate, how does that rate compare against similar requests in the insolvency courts of other sophisticated business jurisdictions applying their own recognition statutes?
Without such benchmarks or relative rankings, the conclusion that US courts are not “universal” seems premature.
- Is “asset entrustment” really the true measure of “universalism?” Finally, and perhaps most fundamentally, Mr. Leong’s focus on the “entrustment” of assets – i.e., the turnover of US-based assets for distribution in a foreign insolvency case – seems to neglect the other reasons for which a US bankruptcy court’s recognition of cross-border insolvency might be sought. Such reasons include the “automatic stay” of US-initiated litigation against the debtor, access to US courts for the purpose of gaining personal jurisdiction over US-based defendants and the recovery of assets, and access to the “asset sale” provisions of the US Bankruptcy Code which automatically apply along with recognition under Chapter 15.
Given the breadth of strategic reasons for seeking recognition of a foreign insolvency in the United States (many of which are unrelated, at least directly, to the ultimate distribution of assets), the study’s focus on “entrustment” as a measure of “universalism” may be over-narrow.
These questions aside, however, Mr. Leong’s study asks thought-provoking and empirically-grounded questions about the true nature of “universalism” as applied in US bankruptcy courts. It is an important initial step in framing the proper assessment of cross-border insolvencies in coming years.
JSC BTA Bank (BTA), one of Khazakstan’s largest banks, sought restructuring under the guidance of the Kazakh government early this year. A prior post on BTA’s protective filing is available here. BTA’s recognition order granted BTA “all of the relief set forth in section 1520 of the Bankruptcy Code including, without limitation, the application of the protection afforded by the automatic stay under section 362(a) of the Bankruptcy Code to the Bank worldwide and to the Bank’s property that is within the territorial jurisdiction of the United States.”
Among its obligations, BTA was in default on a $20 million advance from Banque International de Commerce – BRED Paris, succursale de Geneve, Switzerland (“BIC-BRED”) for the construction of an entertainment complex in Moscow. BIC-BRED commenced Swiss arbitration proceedings regarding this obligation.
After BTA commenced its Khazakh restructuring and obtained recognition in the US, it submitted a statement in the arbitration, requesting a stay of the arbitration and claiming the universal application of the automatic stay. BIC-BRED refused to acknowledge the reach of the stay in BTA’s ancillary case. Apparently, so did the arbitrator: An award in the Swiss proceedings was entered in July 2010 against BTA.
BTA sought a determination that the automatic stay did, in fact, apply – and that BIC-BRED ought to be sanctioned for its continued prosecution of the Swiss arbitration.
In a decision issued late last month, Presiding Judge James Peck summarized the basis for his restrictive reading of the automatic stay as follows:
Instead, he concluded that
This is not to say, however, that the automatic stay arising under the US Bankruptcy Code is limited to the territorial reach of the US.
After reviewing – and rejecting – the administrator’s interpretation of how the automatic stay ought to apply in ancillary cases “to the debtor and the property of the debtor that is within the territorial jurisdiction of the United States” Judge Peck went on to offer two possible legitimate interpretations (the Court had previously reviewed – and rejected – the administrator’s alternative interpretation):
An alternative, and better “reading of section 1520(a)(1), and one that is consistent with the plain meaning of the words as written, is that the stay arising in a chapter 15 case upon recognition of a foreign main proceeding applies to the debtor within the United States for all purposes and may extend to the debtor as to proceedings in other jurisdictions for purposes of protecting property of the debtor that is within the territorial jurisdiction of the United States. This more limited extraterritorial application of the automatic stay to the debtor entity fulfills the cross-border purposes of chapter 15 within the United States without broadly imposing a stay on all actions or proceedings against the debtor including those lacking any proper connection to the chapter 15 case.”
Under the latter reading, then, the automatic stay is applicable world-wide, but only where necessary to protect the US Bankruptcy Court’s in rem jurisdiction over the foreign debtor’s domesticated property.
The BTA decision is noteworthy in a broader context as well:
- This decision is one of several recent cases in which Bankruptcy Courts have sought to negotiate otherwise difficult applications of the Code’s other provisions within the context of Chapter 15 through an appeal to interpretation based on the statute’s “international aspects.” “International” in these cases really means “universal” – Courts applying this statute have gone to some lengths to employ Chapter 15 as a vehicle for extending universal administration of the “main case,” wherever that case is located.
- But “universalism” only goes so far: In Judge Peck’s view, “The bankruptcy court, at least in the setting of an ancillary chapter 15 case, should not stand in the way of a foreign arbitration process when the outcome will have no foreseeable impact on any property of the foreign debtor in the United States.” But what if the outcome of such litigation did have foreseeable impact on such property? The answer, according to Judge Peck, is clear: The US Bankruptcy Court’s in rem jurisdiction may not be trifled with, no matter where such efforts might occur.
- This decision nevertheless suggests an additional area of “section shopping” – i.e., the strategic employment of plenary or ancillary procedures to take advantage of various protections or remedies arising under the laws of the jurisdictions involved. Similar considerations attend the availability and application of avoidance powers arising under Sections 1521 and 1523 and Section 544 (which affords recoveries to unsecured creditors that would be available under “non-bankruptcy law”). See Tacon v.Petroquest Res. Inc. (In re Condor Ins. Ltd.), 601 F.3d 319, 329 (5th Cir. 2010) (foreign representative of foreign proceeding authorized to pursue non-US avoidance claims against US defendants through ancillary proceeding), and a related post here.
A number of advanced commercial jurisdictions – such as the US, the UK, Germany, and Japan – permit a debtor’s bankruptcy administrator or trustee to pursue and recover preferential or fraudulent transfers. Unwinding such transfers, typically made from the debtor to a third party located in the same country, is often an important source of recovery for creditors.
But what happens when the transfer crosses international borders? More specifically, which country’s avoidance law applies: The law of the jurisdiction where the transfer was initiated? Or the law of the “destination” jurisdiction?
An important decision issued last Thursday by the Fifth Circuit Court of Appeals provides a preliminary answer for at least a portion of this question.
“Before” Chapter 15.
Prior to the enactment of Chapter 15, US bankruptcy courts disagreed on whether – and how – the administrator of a foreign insolvency proceeding could pursue such transfers in the US. Some courts permitted non-US administrators to pursue such recovery efforts directly (through an ancillary proceeding), under the fraudulent transfer law of the debtor’s home jurisdiction. Others permitted such recoveries only under US law, and only through a separately filed (and far more expensive and time-consuming) Chapter 11 or 7 bankruptcy case.
“After” Chapter 15.
Chapter 15 resolved at least a portion of this debate. Section 1521(a)(7) provides that upon recognition of a foreign proceeding, the court may grant “any appropriate relief” including “additional relief that may be available to a trustee, except for relief available under [the avoidance sections of the US Bankruptcy Code].” Section 1523(b) authorizes the bankruptcy court to order relief necessary to avoid acts that are “detrimental to creditors,” providing that, upon recognition of a foreign proceeding, a foreign representative has “standing in [the debtor’s US bankruptcy] case . . . to initiate [avoidance] actions.” In other words, Congress appeared to clear up the question where recovery efforts are initiated under US law: A full Chapter 11 (or 7) case is required.
But what about recovery efforts commenced under non-US law?
Courts visiting this issue under Chapter 15 appear almost as divided as those who looked at it prior to the Bankruptcy Code’s 2005 amendments.
Two cases, both addressing the question in dicta, have gone in opposite directions. In one, the Bankruptcy Court forbade a sale “free and clear” of an avoidable English lien on procedural grounds – but along the way, acknowledged that avoidance actions under the US Bankruptcy Code are cognizable only if the debtor is the subject of a case under another chapter of the Bankruptcy Code. In another, the Bankruptcy Court denied a request by the administrator of a Danish insolvency proceeding for turnover of previously-garnished funds on the grounds that such turnover provisions were not applicable in Chapter 15 – but nevertheless went out of its way to note that nothing in Chapter 15’s legislative history – or in prior US cross-border law – prohibited avoidance actions commenced under the law of the debtor’s home jurisdiction.
To date, however, only one case has addressed the issue directly.
Condor Insurance and the Bankruptcy Code’s Deafening Silence.
Condor Insurance, Limited (“Condor”), a Nevis-incorporated insurer and surety bond issuer, was placed into a winding-up proceeding in its home jurisdiction in 2007. The following year, Condor’s liquidators sought recognition in Mississippi – in part, to pursue alleged fraudulent transfers aggregating more than $313 million to Condor affiliates and principals.
The Bankruptcy Court and District Court Decisions.
The Condor defendants moved to dismiss, claiming the Bankruptcy Court lacked jurisdiction to grant the relief requested. The Bankruptcy Court agreed, and – on appeal, and in a published decision – the District Court affirmed. Central to the District Court’s reasoning was the idea that, in US courts, “the choice of law that is to be applied to a lawsuit is determined by a court having jurisdiction over the case, and the parties are not permitted to choose whatever law they wish when filing a lawsuit.” As a result, the District Court found it lacked jurisdiction to hear the avoidance action. Instead, it suggested that the liquidators commence and resolve the avoidance claims in Nevis – and then, upon procurement of a judgment, seek enforcement under principles of international comity.
The Fifth Circuit Decision.
In a decision issued last week, the Fifth Circuit Court of Appeals respectfully disagreed. Writing for a 3-judge panel, Judge Patrick Higgenbotham observed Chapter 15’s “international origins” to encompass “international law.” For the panel, Chapter 15 is not merely a procedural vehicle by which foreign administrators may cost-effectively protect assets domiciled, or control litigation originating, in the US. Instead, foreign administrators may import the substantive insolvency law of foreign jurisdictions into US courts, which have jurisdiction to apply such law to disputes pending in the US. See pp. 8-9 (“Whatever its full reach, Chapter 15 does not constrain the federal court’s exercise of the powers of foreign law it is to apply.”).
As a result, the statute’s silence speaks volumes. Once recognized in the US court system through Chapter 15, foreign administrators have direct access to the panoply of federal judicial powers available to assist their administration of insolvency-related matters in the US, limited only by the specific “carve-outs” for US avoidance actions reserved in Section 1521:
- What About “Section Shopping?”
The Fifth Circuit recognized the appellees’ concern over “section shopping” – i.e., the strategic use of Chapter 15 (rather than Chapter 11 or Chapter 7) by foreign administrators to leverage the benefits of foreign avoidance law in US forums. But where Congress had not taken further steps to guard against this threat, the Fifth Circuit overruled the District Court’s own efforts to do so. In fact, Judge Higgenbotham and his colleagues did not appear bothered by the spectre of “section shopping,” noting that in the case before it – that of a foreign insurance company – Chapters 7 and 11 were not eligible relief. Moreover, the District Court’s suggestion that the foreign administrator should simply obtain an avoidance judgment in Nevis, then seek enforcement of that judgment in the US, was “no answer. Not all defendants are necessarily within the jurisdictional reach of the Nevis court.” Decision at p.14.
- What Of “Mixing and Matching?”
Instead of “section shopping,” Judge Higgenbotham saw the danger of “mixing and matching” foreign insolvency proceedings with US avoidance law, arising in connection with a Chapter 11 or Chapter 7 case. See p. 11 (“When courts mix and match different aspects of bankruptcy law, the goals of any particular bankruptcy regime may be thwarted and the end result may be that the final distribution is contrary to the result that either system applied alone would have reached.”). The Fifth Circuit traced the development of the UNCITRAL’s efforts to address choice of law in avoidance actions while drafting the model law that forms the basis for Chapter 15, concluding:
The Fifth Circuit panel also found its own approach more consistent with that of US cross-border law that pre-dated Chapter 15, noting Bankruptcy Courts could – and sometimes did – apply either US avoidance law or foreign avoidance law to an action pending in an ancillary case under former Section 304. At least one court, however, had criticized this approach for the same “mixing and matching” of foreign and domestic insolvency law noted by the Fifth Circuit. See p.16 (citing and discussing In re Metzeler, 78 B.R. 674, 677 (Bankr. S.D.N.Y. 1987)):
- Wholesale Importation of Foreign Avoidance Actions?
As for concerns that US insolvency courts – and US businesses – might find themselves awash in avoidance claims arising under non-US law, the Fifth Circuit again reverted to the international policies undergirding the legislation:
The Unanswered Question.
The Fifth Circuit’s Condor decision leaves unanswered the question of whether avoidance actions commenced under Section 544 of the Bankruptcy Code – which itself references “applicable [non-bankruptcy] law” – includes foreign law. Section 1521, by its terms, excludes avoidance actions predicated on this section. But the Bankruptcy Court, the District Court, and the Fifth Circuit all ducked this issue.
One Manhattan bankruptcy judge recently observed, in dicta, that Section 544(b) gives the trustee the standing of a judgment lien creditor. Because a preference action under foreign law would not appear to depend on status as a judgment lien creditor, this section would appear inapplicable to preference claims. A preference action under foreign law might therefore be available as “additional assistance” under § 1507. See In re Atlas Shipping A/S, 404 B.R. 726, 744 at n.16 (Bankr. S.D.N.Y. 2009).
But Condor’s brief analysis didn’t address preference claims. It addressed avoidance actions, which – at least in the US – do depend upon judgment lien creditor status. As a result, the availability of foreign avoidance actions, while resolved in the Fifth Circuit – remains likely unanswered elsewhere.