Conflicting Decisions Create Uncertainty on Key Chapter 15 Issue

, New York Law Journal

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John J. Rapisardi
John J. Rapisardi

In opinions entered within a week of each other in mid-December, the U.S. Court of Appeals for the Second Circuit and the U.S. Bankruptcy Court for the District of Delaware reached opposite conclusions on the question of whether a foreign debtor must have assets located in the United States in order for a U.S. bankruptcy court to "recognize" its foreign insolvency proceeding under chapter 15 of the U.S. Bankruptcy Code.1 These decisions, discussed in detail below, should be carefully reviewed by investors holding foreign distressed debt, as they draw into question the extent to which the automatic stay and other benefits of recognition of a foreign proceeding may be extended to foreign debtors. Such protections are especially important where similar protections are not available under applicable international insolvency laws or where such protections do not extend to foreign assets or enjoin foreign creditors.

Recognition

Chapter 15 of the U.S. Bankruptcy Code, enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and based on the United Nations Commission for International Trade Model Law on Cross Border Insolvency, cites cooperation between U.S. and foreign courts involved in cross-border insolvency cases and "fair and efficient administration of cross-border insolvencies that protects the interests of all creditors, and other interested entities" as two of its principle objectives.2

Under chapter 15, the authorized representative of a "foreign proceeding" may file a petition requesting recognition of the foreign proceeding by a U.S. bankruptcy court.3 The term "foreign proceeding" is defined broadly in section 101 of the Bankruptcy Code to include any "collective, judicial or administrative proceeding in a foreign country, including an interim proceeding, under a law relating to insolvency or adjustment of debt in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganization or liquidation."4

Proceedings that fall within this definition may be recognized as either a "foreign main proceeding," if pending in the country where the debtor's "center of main interests" is located, or a "foreign non-main proceedings," if pending in a country where the debtor simply has an "establishment."5 This distinction is noteworthy as entry of an order recognizing a foreign main proceeding automatically entitles the debtor to many of the rights and protections available to debtors in U.S. chapter 7 or chapter 11 cases, including the breathing space created by the automatic stay and the right to sell assets free and clear of existing liens under section 363 of the Bankruptcy Code (such protections and rights may be extended to the representative of a foreign non-main proceeding but only upon entry of a subsequent order by the bankruptcy court).

'In re Barnet'

In In re Barnet, the U.S. Court of Appeals for the Second Circuit considered whether, in addition to satisfying the requirements set forth in the definition of "foreign proceeding," a foreign debtor must have assets located in the United States in order to obtain chapter 15 recognition. Barnet involved an appeal of an order of the U.S. Bankruptcy Court for the Southern District of New York recognizing an Australian liquidation proceeding as a "foreign main proceeding," which was entered over the objection of Drawbridge Special Opportunities Fund. Affiliates of Drawbridge are defendants in a litigation filed in Australia by the debtors in the liquidation proceeding, and the foreign representative of such proceeding had hoped to utilize chapter 15 to facilitate discovery from the American directors of the defendants.6

In contesting entry of the recognition order, Drawbridge had argued that in addition to the discussed recognition requirements set forth in chapter 15, a debtor must also satisfy the section 109(a) eligibility requirements generally applied in chapter 7 and chapter 11 filings. Section 109(a) provides that "notwithstanding any other provision of this section, only a person that resides or has a domicile, a place of business, or property in the United States, or a municipality, may be a debtor under this title."7

In finding in favor of Drawbridge and vacating the recognition order, the bankruptcy court stressed that there was no precedent controlling its conclusion "that a debtor within the meaning of chapter 15 is not required to have a domicile, residence, place of business or property in the United States."8 It added that the issue was a matter of public importance and that finding otherwise would "dramatically impact the jurisdiction of the United States bankruptcy courts and the use of Chapter 15 to assist in the administration of cross-border insolvency cases and the legitimate investigation of claims and assets in the United States."9

The Second Circuit further stressed that the plain meaning of section 109 and other applicable provisions in section 1 of the Bankruptcy Code clearly suggested that Congress intended section 109 to be applicable in chapter 15 proceedings. In so holding, it relied primarily on section 103(a), which generally provides that all sections of chapter 1 of the Bankruptcy Code "apply in a case under chapter 15."10 Additionally, the Second Circuit rejected the argument that section 109(a) was inapplicable because recognition of a foreign proceeding is sought by a foreign representative (which is not "a debtor under this title," as such phrase is used in section 109).

Specifically, the court found that it "stretches credulity" to argue that section 109 is inapplicable simply because a recognition motion is filed by a representative of the debtor and not the debtor itself, adding that "the presence of a debtor is inextricably intertwined with the very nature of a chapter 15 proceeding, both in terms of how such a proceeding is defined and in terms of the relief that can be granted."11

Finally, the Second Circuit noted that the foreign representative came "closer to the mark" with its argument premised on 28 U.S.C. §1410, which "provides a venue for Chapter 15 cases even when 'the debtor does not have a place of business or assets in the United States.'"12 However, it characterized the federal venue statute as "purely procedural," adding that "given the unambiguous nature of the substantive and restrictive language used in sections 103 and 109 of chapter 15, to allow the venue statute to control the outcome would be to allow the tail to wag the dog."13

'Bemarmara Consulting'

Six days after the Second Circuit's ruling in Barnet, Judge Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware issued an order recognizing a foreign proceeding as a foreign main proceeding and rejected the Second Circuit's finding that section 109's eligibility requirements apply to chapter 15 recognition motions. Bemarmara Consulting is presently a debtor in a proceeding commenced under the Czech Republic's Insolvency Act in County Court in Prague. It is also a defendant in litigation pending in the U.S. District Court for the District of Delaware. Terex USA, LLC, a plaintiff in the district court litigation, objected to a recognition motion filed in the Delaware bankruptcy court, arguing, among other things, that the proceeding should not be recognized because Bemarmara lacked U.S. assets.

In rejecting this argument, Judge Gross relied primarily on the fact that chapter 15 recognition is sought by a foreign representative of the debtor and not the debtor itself, a distinction the Second Circuit noted and deemed irrelevant in Barnet. Gross went as far as noting that any language in section 109 suggesting its applicability to chapter 15 proceeding may have been "scrivener's error" and added that "the intent was that 109(a) not apply."14 He also stressed that section 1502 defines a debtor as "an entity that is the subject of a foreign proceeding" and cited the absence of any reference to U.S. assets in Chapter 15's definition of a debtor as further support for his conclusion that the section 109 eligibility requirements were inapplicable. Finally, Gross acknowledged the Second Circuit's finding in In re Barnet but noted that the decision was "not controlling" and added that "it is the Court's belief that there is a strong likelihood that the Third Circuit, likewise, would not agree with that decision."15

In a separate but equally interesting part of the decision, Gross rejected Terex's alternative argument that recognition should be denied because the motion was filed in bad faith in an attempt to disrupt the district court proceeding. Gross stressed that where a foreign representative can establish that all elements in the Bankruptcy Code definition of a foreign proceeding are satisfied, recognition is mandatory unless the bankruptcy court determines that recognition is manifestly contrary to public policy. Despite noting certain irregularities in the Czech proceeding, Gross added that the public policy exception should only apply in "exceptional circumstances…where the procedural fairness of the foreign proceeding is in doubt or cannot be cured by the adoption of additional protections or where recognition would impinge severely a U.S. Constitutional or statutory right."16

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