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:
“The structure of Chapter 15 provides authority to the district court to assist foreign representatives once a foreign proceeding has been recognized by the district court. Neither text nor structure suggests additional exceptions to available relief. Though the language does not explicitly address the use of foreign avoidance law, it suggests a broad reading of the powers granted to the district court in order to advance the goals of comity to foreign jurisdictions. And this silence is loud given the history of the statute including the efforts of the United States to create processes for transnational businesses in extremis.” Decision at pp. 9-10.
– 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 application of foreign avoidance law in a Chapter 15 ancillary proceeding raises fewer choice of law concerns as the court is not required to create a separate bankruptcy estate. It accepts the helpful marriage of avoidance and distribution whether the proceeding is ancillary applying foreign law or a full proceeding applying domestic law—a marriage that avoids the more difficult depecage rules of conflict law presented by avoidance and distribution decisions governed by different sources of law.” Decision at p.13.
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)):
“In sum, under section 304, avoidance actions under foreign law were permitted when foreign law applied and would provide for such relief. Congress essentially made explicit In re Metzeler’s articulation of the bar on access to avoidance powers created by the U.S. Code by foreign representatives in ancillary proceedings.” Decision at p.16.
– 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:
“Providing access to domestic federal courts to proceedings ancillary to foreign main proceedings springs from distinct impulses of providing protection to domestic business and its creditors as they develop foreign markets. Settled expectations of the rules that will govern their efforts on distant shores is an important ingredient to the risk calculations of lenders and corporate management. In short, Chapter 15 is a congressional implementation of efforts to achieve the cooperative relationships with other countries essential to this objective.”
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.