A newly issued decision of a leading appellate court has concluded that a foreign company with an insolvency proceeding pending in a non-U.S. court must have property or a place of business in the United States in order to qualify for assistance (or “ancillary relief”) from a U.S. bankruptcy court under chapter 15 of the United States Bankruptcy Code.
On December 11, 2013, the United States Court of Appeals for the Second Circuit (the Second Circuit) decided that the eligibility requirements for a bankruptcy debtor, set forth in section 109(a) of the United States Bankruptcy Code (the Bankruptcy Code, or the Code) are applicable to foreign debtors seeking recognition of foreign proceedings under chapter 15 of the Bankruptcy Code, which governs cases ancillary to foreign proceedings. Drawbridge Special Opportunities Fund LP v. Katherine Elizabeth Barnet (In re Barnet), No. 13-612, 2013 WL 6482499 (2d Cir. December 11, 2013). The question arrived on direct appeal from the United States Bankruptcy Court for the Southern District of New York (the Bankruptcy Court), and was a matter of first impression. The Court held that the Bankruptcy Court erred in concluding that a debtor in a chapter 15 proceeding need not satisfy Code section 109(a)’s requirement that a debtor have a domicile, place of business, or property within the United States.
The case involved the foreign liquidators of Octaviar Administration Pty Ltd. (OA) acting as foreign representatives (the Foreign Representatives) of the pending Australian liquidation proceedings (the Debtor), and Drawbridge Special Opportunities Fund, LP. Drawbridge unsuccessfully filed an objection to the Debtor’s petition for recognition as a foreign main proceeding pursuant to section 1515 of the Code and appealed to the District Court. The Bankruptcy Court issued the order recognizing the Debtor’s petition (the Recognition Order). While Drawbridge’s appeal was pending, the Foreign Representatives filed a motion seeking discovery from Drawbridge and other parties. Drawbridge sought to stay the discovery motion pending appeal. The Bankruptcy Court denied Drawbridge’s motion, issued an order granting discovery (the Discovery Order), and granted the parties’ joint application for certification of the Recognition Order for direct appeal to the Circuit Court.
The Direct Appeal
The Bankruptcy Court issued an opinion explaining its decision to grant the certification of the Recognition Order for direct appeal based upon, among other things, the absence of controlling precedent.
The Second Circuit granted the direct appeal, and while it held Drawbridge lacked standing to directly appeal the Recognition Order, it found that Drawbridge could appeal the Discovery Order. That, in turn, opened the door for the Second Circuit to consider the Recognition Order, as a “ruling that led up to the [Discovery Order] judgment.”
Second Circuit Review
In considering whether section 109(a) applies to a chapter 15 debtor, the Second Circuit employed a methodical analysis regarding the plain meaning of the relevant statutory language and the breadth of chapter 15’s application, as follows: Section 103(a) of the Bankruptcy Code provides that chapter 1 of the Code applies to a case under chapter 15. Section 109(a) is part of chapter 1, and establishes eligibility requirements for all debtors. An eligible debtor is “a person that resides or has a domicile, a place of business, or property in the United States or a municipality....” The Second Circuit therefore concluded that an entity can only be a chapter 15 debtor by satisfying section 109(a)’s requirements. OA did not establish its eligibility as a debtor because the Foreign Representatives failed to submit proof of any assets or place of business in the United States. Therefore, the Second Circuit reversed.
The Second Circuit rejected the Foreign Representatives’ arguments. The Foreign Representatives had contended that section 109(a) applied to all debtors “under this title,” and a chapter 15 debtor in a foreign main proceeding, in this case OA, was not a debtor under title 11, but rather a debtor under the Australian Corporations Act. The Foreign Representatives were not seeking recognition of OA as a debtor; they sought recognition of OA’s Australian liquidation proceeding.
The Second Circuit was unpersuaded. The presence of a debtor is “inextricably entwined with the very nature of a [c]hapter 15 proceeding, both in terms of how such proceeding is defined and in terms of the relief that can be granted.” Chapter 1 defines a “debtor” and a “foreign proceeding”, and those definitions explicitly apply to chapter 15. While foreign representatives do submit petitions for recognition, they are not independent of the debtor for whom they represent. According to the Second Circuit, the argument that the references to a “debtor” in chapter 15 are different from the references within the rest of the Code “stretches credulity.”
As evidence of its position, the Second Circuit noted that the key form of provisional relief in U.S. bankruptcy, the automatic stay, functions to insulate a debtor from creditor collection efforts, whether judicial or out of court. This provision is explicitly included in section 1520(a). This section further applies sections 361-63, 549 and 552, which all refer to “the debtor,” “property of the debtor,” or “an interest of the debtor in property” for automatic relief. Discretionary relief under section 1521 is likewise consistent with that view, according to the Second Circuit. It provides that a court may grant relief in the form of entrusting the foreign representative the authority to protect the debtor’s assets within the territorial jurisdiction of the United States, or staying execution against the debtor’s assets. In every instance, the statute refers to the debtor and its property.
The Second Circuit addressed a second argument against section 109(a)’s application. The Foreign Representatives suggested that even if OA must qualify as a debtor, it need only qualify as a chapter 15-specific debtor. They relied on the language of section 1502 as the basis for the point. Specifically, they asserted that a debtor is defined “for the purposes of this chapter” as “an entity that is subject of a foreign proceeding.” The Second Circuit rejected this argument as well, pointing to the explicit instructions of section 103(a) to apply chapter 1 to chapter 15. According to the Second Circuit, even under the broadest reading of section 1502, the definitions of “foreign proceeding” and “foreign representative” both found in chapter 1 would be unaffected.
The weakness in this argument, tacitly acknowledged by the Second Circuit, is that chapter 15 defines “a debtor” using the phrase “the term ‘debtor’ means.” The Court acknowledged that within the chapter 15 context, this language effectively displaces the chapter 1 definition, contained in section 101(13) of the Code, which is linguistically identical to section 1502, also defining what “the term ‘debtor’ means.” Nevertheless, the Second Circuit determined that section 109(a) was applicable to establish eligibility requirements for debtors under section 101(13) as well as debtors under section 1502.
The Foreign Representatives had another, arguably stronger, textual argument deriving not from the Bankruptcy Code itself, but from 28 U.S.C. § 1410, which governs venue in bankruptcy cases. Section 1410 assigns a venue even for those chapter 15 cases in which “the debtor does not have a place of business or assets in the United States.” If debtors without assets in the United States were not entitled to be chapter 15 debtors, it wouldn’t have made much sense for Congress to provide venue options in those situations. Still, the Second Circuit dismissed the argument, on the grounds that, given contradictory authority in section 109(a), “to allow the venue statute to control the outcome would be to allow the tail to wag the dog.”
After rejecting additional arguments made by the Foreign Representatives, the Second Circuit addressed, and denied, their contention that the purpose of chapter 15 would be undermined by the application of section 109(a). The purposes of chapter 15 enumerated in section 1501 were unaffected by the presence or absence of the section 109(a) requirements and “could all be accomplished with or without imposition of section 109(a).”
The Second Circuit’s decision may or may not have significant implications for cross-border insolvencies going forward. In the spirit of cooperation and collaboration between courts internationally, chapter 15 is considered intentionally flexible and accommodating to the foreign main court. This precedent, on its face would appear to bar many foreign debtors from protections otherwise afforded by the Code. On the other hand, section 109(a) does not establish a threshold on the quantum of “property” necessary to qualify for relief, nor does it even require that such property be substantial or meaningful. Thus, it would appear that technical jurisdiction may be available to otherwise un-propertied foreign debtors by the simple expedient of creating a bank account in the United States just prior to filing. Note, however, that the creation of a bank account or the placement of other assets in the United States just prior to a filing for the purpose of clearing section 109(a)’s eligibility standard has sometimes been challenged as a basis for dismissal for bad faith, or on other grounds. Representatives of foreign estates will want to consult closely with counsel to ensure that eligibility requirements are satisfied in a way that makes them least susceptible to post-filing challenges.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:Wilamowsky-Steven
This article was originally published by Bingham McCutchen LLP.