On August 30, 2007, in twin decisions in recent cases involving two Bear Stearns hedge funds (available here and here), Judge Burton R. Lifland of the U.S. Bankruptcy Court for the Southern District of New York made clear that recognizing a foreign insolvency proceeding in a Chapter 15 cross-border bankruptcy case is not to be "rubber stamped by the courts."  The decision is of particular interest because Judge Lifland was one of the authors of Chapter 15 and the Model Law on Cross-Border Insolvency on which it is based.

The Bankruptcy Court’s Ruling. In a nutshell, the Bankruptcy Court held that although the two hedge funds were organized under the laws of the Cayman Islands, their business operations were in New York and not in the Cayman Islands. As such, the Bankruptcy Court would not recognize the Cayman Islands insolvency proceeding as either a "foreign main proceeding" or a "foreign nonmain proceeding." If you’re unfamiliar with this terminology, keep reading for an overview of Chapter 15 and more details on the decision.

A Chapter 15 Refresher. On October 17, 2005, as part of the Bankruptcy Abuse Prevention and Consumer Protection Act (known as BAPCPA), a new Chapter 15 of the Bankruptcy Code went into effect governing ancillary and other cross-border cases. (For those already familiar with ancillary proceedings, Section 304 of the Bankruptcy Code, which previously governed those proceedings, was repealed although many of its concepts were retained in Chapter 15.)

  • The main purpose of enacting Chapter 15 was to incorporate the Model Law on Cross-Border Insolvency as part of the Bankruptcy Code. 11 U.S.C. § 1501(a). My partner Adam Rogoff, who has significant experience with international insolvency matters, has prepared a very helpful chart comparing Chapter 15 and the Model Law’s provisions.
  • Chapter 15 is used principally by representatives of, or creditors in, foreign insolvency proceedings to obtain assistance in the United States, by a debtor or others seeking to obtain assistance in a foreign country regarding a bankruptcy case in the United States, or when both a foreign proceeding and a bankruptcy case in the United States are pending with respect to the same debtor. 11 U.S.C. § 1501(b). 

Several important terms involving the different types of foreign insolvency proceedings are key to understanding the scope of Chapter 15 and Judge Lifland’s ruling. 

  • A “foreign proceeding” means “a collective judicial or administrative proceeding in a foreign country, including an interim proceeding, under a law relating to insolvency or adjustment of debts 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.” 11 U.S.C. § 101(23). 
  • For purposes of Chapter 15, “debtor” means “an entity that is the subject of a foreign proceeding.” 11 U.S.C. § 1502(1). 
  • A "foreign main proceeding" means a foreign proceeding pending in the country where the debtor has the center of its main interests which, in the absence of contrary evidence, is presumed to be the location of the debtor’s registered office. 11 U.S.C. §§ 1502(4) and 1516(c). 
  • A "foreign nonmain proceeding" means a foreign proceeding, other than a foreign main proceeding, pending in a country in which the debtor has an “establishment,” defined as a place of operations where the debtor carries out a nontransitory economic activity. 11 U.S.C. §§ 1502(2) and (4). 

Chapter 15’s basic procedure is straightforward. A case is commenced when a foreign representative, often a liquidator or provisional liquidator, files a petition for recognition of a foreign proceeding. 11 U.S.C. §§ 1504 and 1515(a). If properly filed, the bankruptcy court is entitled to presume that the facts stated in the petition are correct and the attached documents are authentic. 11 U.S.C. §§ 1516(a) and (b). As long as recognition would not be manifestly contrary to the public policy of the United States, the court must enter an order recognizing the foreign proceeding (here’s an example order). 11 U.S.C. §§ 1506 and 1517(a). 

Evidence Trumps Presumptions. With all this in mind, Judge Lifland held that the Cayman Islands proceeding could not be considered either a "foreign main" or a "foreign nonmain" proceeding. Despite Chapter 15’s presumption that the registered office or place of incorporation, here the Cayman Islands, would be a debtor’s "center of main interests" (known in the trade as the "COMI"), other evidence showed that the actual center of their activity was in New York. This, Judge Lifland held, precluded recognition of the Cayman Island proceeding as a foreign main proceeding. Also, without a true business presence there, the Bankruptcy Court could not conclude that the Cayman Islands was a place where the funds had "nontransitory economic activity," precluding foreign nonmain recognition. Judge Lifland held that even in the absence of objection, Chapter 15 places the burden of proof on these issues on the foreign representatives. Here, the facts in the petition and related papers showed that New York, and not the Cayman Islands, was the COMI for the funds.

Is Non-Recognition The End Of The Road? One of the most interesting aspects of Judge Lifland’s decision is the door he left open to the foreign representatives. Although the two hedge funds could not get protection under Chapter 15 of the Bankruptcy Code based on their filing in the Cayman Islands, they have the option of filing an involuntary Chapter 7 or Chapter 11 bankruptcy case in the United States.

  • Although Section 304 of the Bankruptcy Code, the old "ancillary proceedings" section, was repealed when Chapter 15 was enacted, Section 303 — and the ability of foreign representatives to file an involuntary Chapter 7 or Chapter 11 bankruptcy case — was not repealed.
  • Judge Lifland noted that Section 303(b)(4) of the Bankruptcy Code allows a foreign representative, such as the provisional liquidators appointed by the Cayman Islands court, to file an involuntary bankruptcy petition against the hedge funds and obtain bankruptcy protection in this manner.

Additional Reading In The Blogs. For more on the case, be sure to read Jordan Bublick’s informative post on his Miami Florida Bankruptcy Law blog and Chris Laughton’s commentary on his Insolvency Blog out of the UK. For the hedge fund industry’s perspective, you may find this post on the Hedgefunds Weblog of interest.

A Few Observations. With many offshore investment funds operating in the United States, Chapter 15 filings may become even more commonplace in the future, especially if we continue to encounter the kind of turbulence recently seen in the financial markets. Although the enactment of Chapter 15 made it easier for foreign representatives to get bankruptcy protection in the United States, the process is not automatic. As Judge Lifland’s decision shows, bankruptcy courts will scrutinize the facts — even in essentially unopposed cases — before agreeing to formally recognize a foreign proceeding. Without such recognition, foreign representatives will have to fall back on the more cumbersome involuntary bankruptcy process or find themselves with no U.S. bankruptcy protection at all.