Arcapita Bank: The Bankruptcy Court Closes an Escape Valve for Foreign Defendants
Last Friday, October 13, Judge Sean H. Lane of the United States Bankruptcy Court for the Southern District of New York issued an opinion addressing the presumption against extraterritoriality of US law as well as the limits of the doctrine of international comity. The opinion, issued in an adversary proceeding pending in the Arcapita Bank Chapter 11 bankruptcy case, is certain to have a dramatic impact in adversary proceedings involving foreign defendants. Unfortunately for those foreign defendants, it may now be much more difficult to escape from those proceedings.
The Underlying Facts
Arcapita is licensed as an Islamic wholesale bank by the Central Bank of Bahrain. On March 19, 2012, Arcapita filed a Chapter 11 petition. Approximately one month prior to the bankruptcy, Arcapita made short-term investments (the “Placements”) through Defendants Bahrain Islamic Bank (“BisB”) and Tadhamon Capital B.S.C. (“Tadhamon” and with BisB, the “Defendants”). The Placements were made pursuant to two separate investment agreements (the “Placement Agreements”) between Arcapita and the Defendants. Both of the Placement Agreements were negotiated and signed in Bahrain and provided that the laws of the Kingdom of Bahrain govern, except to the extent that such laws conflicted with the principles of Islamic Shari’ah law in which case Shari’ah law would prevail. Under the Placement Agreements, the Defendants served as Arcapita’s agents in the purchase of the Placement investments. The Defendants were required to transfer the proceeds from the Placements (the “Placement Proceeds”) to Arcapita on the maturity date of the Placements.
In one transaction, Arcapita transferred approximately $10 million to a correspondent bank account maintained by BisB at JP Morgan Chase Bank in New York. In the second transaction, Arcapita transferred approximately $18 million to a correspondent account held by Tadhamon at HSBC Bank in New York. When the Placement investments matured, the Defendants refused to deliver the Placement Proceeds to Arcapita as required by the Placement Agreements. Instead, the Defendants informed Arcapita that, pursuant to Bahraini law, they were setting off the Placement Proceeds against prepetition debt owed to them by Arcapita.
The Official Committee of Unsecured Creditors (the “Committee”) filed separate adversary proceedings against the Defendants, alleging breach of contract, turnover, avoidance of a preferential transfer, violation of the automatic stay and claims disallowance. The Defendants each filed a motion to dismiss arguing in part that given the foreign aspects of the transactions at issue in the complaints, the claims should be dismissed based on the presumption against extraterritoriality and the principle of international comity.
The Court’s Holding and Rationale
Judge Lane rejected the Defendants’ arguments and declined to dismiss the complaints. In his opinion, Judge Lane relied on an earlier ruling by the United States District Court for the Southern District of New York where the District Court reversed the Bankruptcy Court’s dismissal of the Committee’s complaints for lack of personal jurisdiction. The District Court ruled that the Defendants’ use of the New York correspondent bank accounts to receive funds from Arcapita met the threshold of minimum contacts necessary to exercise personal jurisdiction over them. The District Court also held that the Committee’s avoidance claims under section 547 of the Bankruptcy Code arose from the use of the correspondent bank accounts. With this prior ruling in mind, Judge Lane turned his attention to the issues of international comity and extraterritoriality.
Under the doctrine of international comity, nation states normally refrain from prescribing laws that govern activities connected with another state when the exercise of such jurisdiction is unreasonable. Essentially, the doctrine is concerned with maintaining amicable working relationships between nations. The decision whether to grant comity is a matter left to the court’s discretion, but the burden of proof is on the party asserting the applicability of the doctrine.
The Defendants argued that the Committee’s claims should be dismissed because there is a conflict between US bankruptcy law and the laws of Bahrain and that it would be unreasonable to apply US law in the present circumstances. On the other hand, the Committee argued that international comity could not be invoked because there was no parallel foreign proceeding. The Court rejected the Committee’s blanket prescription against applying international comity when no parallel proceeding exists. Nonetheless, referring to the Restatement (Third) of Foreign Relations, the Court found that the factors set out in the Restatement weighed in favor of asserting jurisdiction and against abstention based on international comity. In support of its conclusion, the Court noted the following:
The use by the Defendants of the correspondent bank accounts in the US and the prior ruling by the District Court that the receipt of the transferred funds using the New York correspondent bank accounts was at the heart of the causes of action asserted by the Committee. Given the use of the US correspondent bank accounts, the Defendants could not reasonably be surprised to be litigating in the US.
The potential application of Bahraini law did not mandate abstention since the Court is competent to apply foreign law.
The Bankruptcy Code sections at issue (sections 362, 542, 547 and 550) were designed to protect and pool the assets of a debtor’s estate for the benefit of all of its creditors, and are the “bedrock of the protections afforded to creditors under the Bankruptcy Code.”
There was no parallel foreign proceeding and it was questionable whether the Committee could obtain relief under Bahraini law. This raised the “grave concern” that parties could do an “end run” around the Bankruptcy Code by simply having transfers made overseas beyond the reach of the US courts.
Similarly, the Court rejected the Defendants’ argument that the transfers at issue took place overseas and that there is no clear indication of Congressional intent for the sections of the Bankruptcy Code at issue in the complaints to be applied extraterritorially. With regard to the avoidance claim under section 547 and the recovery claim under section 550, the Court focused on the initial transfers into the US bank accounts and concluded that the conduct touched and concerned the US in a sufficient manner to rebut the presumption against extraterritoriality of the Bankruptcy Code sections. Key to the Court’s conclusion was the District Court’s prior holding that the transfers in New York are central to the Committee’s preference claim, as well as prior holdings by other courts that the use of bank accounts in the US is sufficient to displace the presumption against extraterritoriality of other US statutes. With regard to the turnover and automatic stay claims under sections 542 and 362, respectively, the Court found that the worldwide definition of property of the estate under section 541, which underlies both claims, indicates Congress’s intention to apply these sections extraterritorially.
Judge Lane’s decision is certain to have a dramatic impact upon foreign defendants in chapter 11 adversary proceedings. The opinion underscores just how difficult it is to argue that claims should be dismissed on international comity grounds or that sections of the Bankruptcy Code should not apply extraterritorially. And while this case was unique in that the District Court had already found that the Defendants’ use of US correspondent bank accounts made them subject to personal jurisdiction in the United States, Judge Lane’s decision was not entirely dependent upon the District Court’s decision. So, while the Supreme Court may have made it more difficult for US courts to exercise personal jurisdiction over foreign defendants (Daimler AG v. Bauman, 571 U.S. 20 (2014) (addressing general jurisdiction); Walden v. Fiore, 571 U.S. 12 (2014) (addressing specific jurisdiction)), Judge Lane’s decision in Arcapita removes an escape valve for those foreign defendants over whom the US courts have personal jurisdiction. It will now be more difficult for those defendants to argue that the courts should abstain under principles of international comity, or that the courts should not apply key provisions of the Bankruptcy Code extraterritorially. In other words, these foreign defendants may now have to litigate in the US courts.