Cross-Border Bankruptcy Cases: Chapter 15 of the Bankruptcy Code and Parameters of a Discovery Tool
Chapter 15 of the United States Bankruptcy Code was enacted in 2005 and represents the United States’ adoption of the “Model Law on Cross-Border Insolvency so as to provide effective mechanisms for dealing with the cases of cross-border insolvency.” 11 U.S.C. § 1501. Section 1501 sets out five objectives: (1) to promote cooperation between U.S. courts and parties in interest and courts and other competent authorities of foreign countries involved in cross-border insolvency cases; (2) to establish greater legal certainty for trade and investment; (3) to provide for the fair and efficient administration of cross-border insolvencies that protect the interest of all creditors and other interested entities, including the debtor; (4) to afford protection and maximization of the value of the debtor’s assets; and (5) to facilitate the rescue of financially troubled businesses, thereby protecting investment and preserving employment.
Comity is a principle objective of chapter 15 and is found in sections 1507 (in determining whether to provide additional assistance, “the court shall consider whether such additional assistance, consistent with the principles of comity …”) and 1509 (“[a] request for comity or cooperation by a foreign representative ….”). Yet, section 1506 is an exception to the concept of comity, “if the action would be manifestly contrary to the public policy of the United States.” Section 1525 of the Bankruptcy Code encourages U.S. Bankruptcy Court’s to communicate directly with, and inquire of, the foreign court in order effectuate the objectives of section 1501 of the Bankruptcy Code. This section may also be read as an effort at providing comity to the rulings of a foreign court.
A case ancillary to a pending insolvency proceeding in a foreign country is commenced by a “foreign representative” under chapter 15. The foreign representative has the right of direct access to United States courts for the purpose of filing a petition for recognition of a “foreign proceeding.” 11 U.S.C. §§ 1504 and 1509. Typically, the petition for recognition will be accompanied by either (1) a certified copy of the decision commencing the foreign proceeding and appointing the foreign representative or (2) a certificate from the foreign court affirming the existence of the foreign proceeding and the appointment of the foreign representative, translated into English if necessary. 11 U.S.C. § 1515.
For chapter 15 to apply, the entity must qualify as a debtor under section 109(b) of the Bankruptcy Code. 11 U.S.C. § 1501(c)(1). Generally, a foreign corporation must have a place of business or property in the United States, but minimal property, like a retainer in a law firm’s trust account has be considered sufficient property in the United States to qualify for Chapter 15. See In re Octaviar Administration Pty Ltd., 511 B.R. 361, 372-74 (Bankr. S.D.N.Y. 2014) (holding that $10,000 in a client trust account was sufficient to satisfy requirements of §109(a) of the Bankruptcy Code); In re Suntech Power Holdings Co. Ltd., 520 B.R. 399, 413 (Bankr. S.D.N.Y.) (Nov. 17, 2014). In addition, the foreign proceeding in which the debtor is involved must qualify as a “foreign proceeding” as defined in section 101(23) of the Bankruptcy Code. “The term ‘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 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.” 11 U.S.C. §101(23).
After meeting the foregoing, the foreign representative must then show that the foreign proceeding is either a “main” or “non-main” proceeding. Section 1502(4) provides that a “foreign main proceeding” is a foreign proceeding “pending in the country where the debtor has the center of its main interests [COMI].” Section 1516 provides the rebuttable presumption that the location of the debtor’s registered office (or the debtor’s habitual residence, if the debtor is an individual) is the center of its main interests. This presumption applies, however, only “in the absence of evidence to the contrary.” Also, 11 U.S.C. § 1502(5) defines a “foreign non-main proceeding” as a foreign proceeding “pending in a country where the debtor has an establishment.” “Establishment,” in turn, is defined in § 1502(2) as “any place of operations where the debtor carries out nontransitory economic activity.”
The determination of whether a foreign proceeding is main or non-main dictates the extent to which relief may be available to the foreign representative. 11 U.S.C. § 1520 provides certain automatic protections upon recognition of a foreign main proceeding. After recognition of a foreign proceeding as a non-main proceeding, all relief that the bankruptcy court may grant is discretionary. Such relief may be granted upon a showing that it is “necessary to effectuate the purpose of this chapter and to protect the assets of the debtor or the interest of creditors....” 11 U.S.C. § 1521. If the foreign proceeding is neither main nor non-main, then the foreign proceeding may not be recognized.
After notice and a hearing, the court is authorized to enter an order recognizing the foreign proceeding as either a “foreign main proceeding” or a “foreign non-main proceeding.” 11 U.S.C. § 1517. Upon recognition, the automatic stay and various other provisions of the Bankruptcy Code automatically apply as to the debtor’s assets within the United States with respect to a foreign main proceeding, and may be applied by the bankruptcy court with respect to a foreign non-main proceeding. 11 U.S.C. §§ 1520 and 1521. The foregoing discussion will relate to the situation where there has been recognition that the proceeding is a “foreign main proceeding.”
Even after a bankruptcy court enters an order of recognition, the order may be revisited based on a change of status. 11 U.S.C. § 1518. In fact, the foreign representative has a duty to the bankruptcy court to report such a change of status, including the termination of the foreign proceeding.
Effects of Recognition
Section 1520 of the Bankruptcy Code relates to the effects of recognition of a foreign main proceeding. This section provides that upon recognition of a foreign main proceeding, §§ 361 and 362 of the Bankruptcy Code, which deal with “adequate protection” and the “automatic stay,” apply with respect to the foreign debtor and the property of that debtor that is within the territorial jurisdiction of the United States. 11 U.S.C. § 1520 (a)(1). Sections 363, 549 and 552 of the Bankruptcy Code apply to a transfer of an interest of the foreign debtor in property that is within the territorial jurisdiction of the United Sates to the same extent that sections would apply to property of the estate in a United States. bankruptcy case. 11 U.S.C. § 1520 (a)(2). The foreign representative in a foreign main proceeding may also operate the debtor’s business and may exercise the rights and powers of a trustee under and to the extent provided in §§ 363 and 552 of the Bankruptcy Code unless ordered otherwise by the bankruptcy court. 11 U.S.C. § 1520 (a)(3). Finally, § 552 of the Bankruptcy Code, which addresses the effect of a security interest in property of a debtor after the filing of a bankruptcy case, applies in a foreign main proceeding to property of a foreign debtor that is within the territorial jurisdiction of the United States. 11 U.S.C. § 1520 (a)(4).
In addition to these provisions available to a foreign representative under §1520 of the Bankruptcy Code, the foreign representative in a foreign main proceeding may also apply for “appropriate relief” under §1521 or seek “additional assistance” under §1507 of the Bankruptcy Code. Carved out of the additional relief provided under §1521(a)(7), is the “relief available under sections 522, 544, 545, 547, 548, 550, and 724(a).” These bankruptcy code provisions include most of the statutory bases to seek claw back claims such as preferential and fraudulent transfer claims. Instead, a foreign representative is left pursuing avoidance actions under the law applicable to the foreign estate, also known as a “Condor Action.” See Fogerty v. Condor Guar. Inc. (In re Condor Ins. Ltd.), Adv. No. 07-05049 ERG, 2008 WL 2858943 (Bankr. S.D. Miss. July 17, 2008).
In certain instances, the foreign representative seeks to recover assets within the territorial jurisdiction of the United States, which may often include pursuit of causes of action or collection of evidence against United States’ based parties. Once the case is recognized, the Bankruptcy Rules provide that other matters should be presented to the court by motion and are treated as “contested matters” in which certain rules relevant to adversary proceedings apply. See Fed. R. Bankr. P. 9014.
Chapter 15 Discovery
Upon recognition of either a main or non-main proceeding, a bankruptcy court is empowered to permit a foreign representative to collect evidence. Section 1521(a)(4) provides:
(a) Upon recognition of a foreign proceeding, whether main or nonmain, where necessary to effectuate the purpose of this chapter and to protect the assets of the debtor or the interests of the creditors, the court may at the request of the foreign representative, grant any appropriate relief, including —
* * *
(4) providing for the examination of witnesses, the taking of evidence or the delivery of information concerning the debtor’s assets, affairs, rights, obligations or liabilities;…
And this section along with sections 1521(a)(7) (providing the basis for the bankruptcy court to grant “additional relief that may be available to a [bankruptcy] trustee”) and 1507(a) (authorizing the bankruptcy court, on recognition, to "provide additional assistance to a foreign representative”), generally make available to a foreign representative Rule 2004 and the subpoena power under Federal Rule of Civil Procedure 45 incorporated by Federal Rule of Bankruptcy Procedure 9016 as discovery devices. But a foreign representative’s entitlement to discovery in a Chapter 15 case is not unfettered.
In In re Petroforte Brasileiro de Petroleo Ltda., 542 B.R. 899 (Bankr. S.D. Fla. 2015), one of Brazil’s largest gas and ethanol distributors before entering bankruptcy, the Southern District of Florida Bankruptcy Court, which had recognized the foreign main proceeding, analyzed the scope of a foreign representative’s discovery rights. Certain of the discovery targets objected on two main grounds: first, they argued that the Chapter 15 court should refuse to recognize the Brazilian extension order, which had extended the Brazilian bankruptcy case to the putative transferees, on public policy grounds; and second, they argued that the foreign representative could not use Chapter 15 to obtain discovery against the transferees because they were not “debtors.” The United States bankruptcy court rejected the first argument, noting that U.S. courts grant a similar type of relief under the equitable remedy of substantive consolidation, and thus the Brazilian extension order was not substantively offensive as a matter of public policy. As to the scope of discovery assistance under Chapter 15, the court had to interpret the scope of “debtor” under section 1521(a)(4), which provides that a court may authorize the “the examination of witnesses, the taking of evidence or the delivery of information concerning the debtor’s assets, affairs, rights, obligations or liabilities.” The court held that the entities that were subject to the Brazilian extension order were “debtors” subject to section 1521’s discovery powers. As to third parties who were not subject to the Brazilian extension order, the bankruptcy court in Petroforte held the trustee may be entitled to broad discovery to the extent the debtor is a majority stockholder in the non-debtor discovery target. Such broad discovery “allows the Trustee to determine whether the stock, which is an asset of the estate, has sufficient value to induce the Trustee to take control of the entity, and attempt to derive value by selling or liquidating the entity.” Also see Petroforte for a discussion regarding the limitations imposed in the foreign representative seeking a seal and gag order in respect to third-party discovery.
In In re SAM Industrias, S.A., 2019 WL 1012790 (Bankr. S.D. Fla. March 1, 2019), the Southern District of Florida Bankruptcy Court held that as to the non-debtor corporate entities, the foreign representative was entitled to broad discovery not only as to those entities in which the debtor had a majority interest but also in those entities found to have participated in the debtor’s asset concealment scheme. Again, in defining the scope of relief available to the foreign representative, the Chapter 15 court examined the findings of the Brazilian courts. The Brazilian courts had found that the debtor had concealed assets through certain corporate pass-through entities owned and controlled by the debtor. The foreign representative was thus entitled to discovery related to these corporate pass-throughs. The foreign representative, though, was not entitled to discovery related to the non-debtor entities whose connections to the debtor had not yet been established in the Brazilian courts. Accordingly, the court concluded that the foreign representative is not entitled to “carte-blanche in his inquiries of non-debtors,” but that he is entitled to obtain information narrowly tailored “to discover ‘the legal entities created in purely fictional form’ which are part of a ‘complex corporate structure’ obscuring” the debtor’s ownership of corporate assets.
As reflected above, once a foreign representative obtains a recognition order in a United States Bankruptcy Court, the Chapter 15 case provides a fulsome platform to engage in discovery relating to the debtor’s assets here as well as a potent avenue to investigate potential causes of action. But such discovery tools are not without limits. And importantly, because the recognition process is typically a unilateral affair without contest, if a client becomes subject of such discovery or the target of investigation, one needs to review the propriety of the recognition order itself and its continuing efficacy.