This article was first published by INSOL International on March 16, 2015.

Upholds Extraterritorial Application of 11 U.S.C. § 362 Automatic Stay

The United States Bankruptcy Court for the Northern District of Texas (Bankruptcy Court) declined to grant comity to a decision of the Mexican labor board thereby refusing to recognize a foreclosure sale of assets belonging to Elcoteq, Inc., a US corporation in US bankruptcy proceedings (Elcoteq, or Debtor).1 The Bankruptcy Court concluded that the forced sale of Elcoteq’s assets that were located in Mexico occurred without sufficient notice to the US Chapter 7 trustee of Elcoteq. The refusal of the Bankruptcy Court to extend comity to Mexican foreclosure sale also cleared the way for the Chapter 7 trustee to pursue avoidance claims against the acquirer of the assets in order to recover the value of Elcoteq’s assets that were sold in Mexico.

Background

Elcoteq had international manufacturing operations in various locations, including a facility located in the city of Juarez, Mexico, which Elcoteq acquired from Philips Electronics North America Corporation on September 2, 2008.

Elcoteq participated in a Mexican program allowing non-Mexican companies access to Mexican labor without incurring significant tax liability in Mexico. Under the program, Elcoteq entered into an agreement with PCE Mexicana, S.A. de C.V. (PCE), a Mexican Corporation, pursuant to which Elcoteq supplied and owned all of PCE’s equipment and inventory (Assets) and paid PCE’s operating costs plus a profit margin.

On August 31, 2011, Elcoteq’s creditors filed an involuntary bankruptcy petition in the Western District of Texas. Thereafter, Elcoteq filed a voluntary bankruptcy petition under Chapter 7 of Title 11 of the United States Code (Bankruptcy Code) in the Northern District of Texas. On January 26, 2012, the bankruptcy cases were consolidated before the Bankruptcy Court.

Mexican Labor Board’s Decision

While Elcoteq’s bankruptcy case was pending, PCE’s employees in Mexico (Workers) sought to enforce their labor claims against PCE through two separate proceedings before the Local Labor Board of Juarez, Mexico (Labor Board). First, the Workers filed a notice of intent to strike against PCE and successfully obtained strike summons from the Labor Board (Labor Strike Summons), which in effect created a lien against the Assets as of August 31, 2011. Second, on October 31, 2011, the Workers filed a formal labor complaint against PCE and two Philips entities, Philips Mexican, S.A. de C.V. and Philips Holding, S.A. de C.V. (Labor Lawsuit). None of the documents filed in the Labor Strike Summons or the Labor Lawsuit contained any reference to Elcoteq, its pending bankruptcy, or its ownership of the Assets.

As a result of the Labor Lawsuit, the Labor Board entered first a “provisional embargo” in the amount of approximately $65.3 million and later a “definitive embargo” in the amount of $4 million against the Assets, based on an agreement the Workers reached with a representative of PCE. Further, the Labor Board authorized the Assets to be sold by foreclosure at an auction. After no bidders participated at the auction, the Assets were awarded to the Workers. The Labor Board issued a “legal invoice” on December 16, 2011, stating that the Assets were foreclosed on December 6, 2011.

Once the Workers took ownership of the Assets, they immediately sold the Assets to Philips Lighting Electronics North America for $2.2 million pursuant to an agreement dated December 2, 2011 which, among other things, contained a recital that all parties were aware of Elcoteq’s bankruptcy case. On the day Philips signed the agreement with the Workers, Philips also executed a separate agreement with Tekmart International, Inc. to sell the Assets for $1.2 million.

Adversary Complaint of Chapter 7 Trustee of Elcoteq against Philips

A Chapter 7 trustee was appointed in Elcoteq’s bankruptcy case (Trustee). The Trustee commenced an adversary proceeding by filing a complaint against Philips Lighting Electronics North America and Philips Electronics North America Corporation (collectively, Philips). The Trustee asserted that Philips was the subsequent transferee of the Assets and sought to avoid and recover the value of the Assets under Sections 544, 545, 547, 548, 549, and 550 of the Bankruptcy Code.

In response, Philips filed a motion to dismiss the Trustee’s adversary proceeding based on, among other things, the doctrine of international comity under Rule 12(b)(1) of the Federal Rules of Civil Procedure (Federal Rule(s)). Philips sought to shield itself from defending against the trustee’s allegations of improper transfers of the estate’s assets on the basis of international comity under Bankruptcy Rule 12(b)(1). The Trustee opposed Philips’ motion and filed its own motion for leave to amend the adversary complaint.

At the Bankruptcy Court’s request, the parties filed supplemental briefs on the issues of international comity. The parties disputed the extent of the Trustee’s knowledge about the proceedings before the Mexican Labor Board. The parties agreed, however, that the Trustee had general knowledge of a labor proceeding against PCE in Juarez, Mexico in late 2011. The Trustee’s knowledge was apparent based on the various filings on the court docket of the Elcoteq’s bankruptcy case. For example, the Debtor’s Statement of Financial Affairs referred to Juarez proceedings and alluded to a potential transfer of property.

Bankruptcy Court’s Decision

Following the hearing and submission of the parties’ supplemental briefs, the Bankruptcy Court issued its decision, beginning its analysis by considering Philips’ challenge to the court’s subject matter jurisdiction as a matter of international comity under Federal Rule 12(b)(1).

The Bankruptcy Court noted that Philips did not contest the court’s jurisdiction over Elcoteq’s bankruptcy case or over the Trustee’s adversary proceeding. In arguments before the Bankruptcy Court, Philips agreed that the Bankruptcy Court had subject matter jurisdiction over the Trustee’s avoidance claims. Philips nonetheless urged the Bankruptcy Court not to exercise its jurisdiction as a matter of international comity to the Mexican Labor Board’s decision in the Labor Lawsuit, which approved the foreclosure sale and auction of the Debtor’s Assets. The Bankruptcy Court therefore considered Philips’ request to dismiss under Federal Rule 12(b)(1) based on the international comity issue.

5-Factor Comity Test

In considering the international comity issue, the Bankruptcy Court applied a five factor test (the 5-Factor Comity Test) set forth by the United States Court of Appeals for the Fifth Circuit.2 Under the 5-Factor Comity Test, a foreign court’s judgment is conclusive in a federal court when:

  1. Foreign judgment was rendered by a court of competent jurisdiction, which had jurisdiction over the cause and the parties;
  2. Judgment is supported by due allegations and proof;
  3. Relevant parties had an opportunity to be heard (due process);
  4. Foreign court follows procedural rules; and
  5. Foreign proceedings are stated in a clear and formal record.3

The Trustee argued that Philips failed to meet its burden of proof on several of these factors. The Bankruptcy Court raised some additional questions, including whether the Labor Board should properly be considered a “court” for the purposes of granting international comity. The Bankruptcy Court did not need to resolve all such questions, however, because it concluded that Philips failed to satisfy its burden on the due process factor under the 5-Factor Comity Test.

According to the Bankruptcy Court, Philips failed to carry its burden to prove that the Trustee had notice and an opportunity to be heard before the Labor Board in the Labor Lawsuit that resulted in the foreclosure of the Debtor’s assets. While there is no requirement that the Mexican law of due process match that of the United States before a federal court decides to grant comity to a Mexican court, the Bankruptcy Court was required to determine whether the Trustee received the “bare minimum requirements of notice” or whether a “reasonable method of notification was employed.”4

The Bankruptcy Court’s analysis was consistent with the Fifth Circuit’s holding requiring a court’s finding that plaintiff had the opportunity to be heard before the court could dismiss the case based on the doctrine of international comity.5 Specifically, the Bankruptcy Court concluded that Philips failed to carry its burden to prove that the Trustee had notice and an opportunity to be heard before the Mexican Labor Board in the Labor Lawsuit that resulted in foreclosure of the Debtor’s Assets, regardless of whether the Trustee had actual notice of the Labor Lawsuit.6

The Bankruptcy Court explained that, based on the evidence, the Trustee admittedly knew about the labor proceedings in Mexico involving the Debtor’s plant and the Workers and “most clearly had notice related to the Strike Summons of August 31, 2011.”7 According to the Bankruptcy Court, however, the foreclosure sale of the Debtor’s Assets in December 2011 was a result of the Labor Lawsuit, not the Strike Summons — and notice of one proceeding is not notice of the other.

Moreover, the Bankruptcy Court concluded that, even if it found that the Trustee had been given documents related to the Labor Lawsuit, none of the documents would have been sufficient to give notice to the Trustee that the Debtor’s Assets were subject to a foreclosure sale. Specifically, the Bankruptcy Court found that there was no document filed in the Labor Lawsuit that named the Debtor as a party or identified the Debtor’s property interests as subject to a foreclosure sale. The provisional and definitive embargos that were issued in the Labor Lawsuit specifically referred to assets of PCE. However, the Assets at issue before the Labor Board did not belong to PCE — rather, the Assets belonged to the Debtor, as Philips admitted.

According to the Bankruptcy Court, by seeking dismissal of the adversary proceeding, Philips sought application of international comity to the decision of the Mexican labor board, which considered neither Philips’ acts nor applicable US law, and to which neither Philips nor the Trustee (or the Debtor) were a party. Under the circumstances, the Bankruptcy Court concluded that Philips failed to meet its burden of proof on one of the five factors under the 5-Factor Comity Test, and the Bankruptcy Court therefore could not decline to hear the Trustee’s claims.

Alleged Violation of the Automatic Stay under Section 362 of the Bankruptcy Code

The Bankruptcy Court further concluded that, even if Philips had met its burden of proof on all five factors, the court would find it difficult to decline to exercise its jurisdiction over the Trustee’s allegations of improper post-petition transfers of the Debtor’s property in violation of the automatic stay under Section 362 of the Bankruptcy Code.8

The Bankruptcy Court considered the automatic stay under Section 362 of the Bankruptcy Code as “one of the fundamental debtor protections provided by the bankruptcy laws,” protecting both debtors and their creditors by allowing for an equitable distribution of estate property.9 “Without the stay, creditors might seek to gain advantage by taking more from the estate than they are entitled.”10

The Bankruptcy Court acknowledged that the “presumption against extraterritoriality” is a canon of construction against reading domestic law to apply outside the United States, unless Congress clearly indicated otherwise.11 According to the Bankruptcy Code, however, “by including property of the debtor ‘wherever located’ in the bankruptcy estate [under Section 541(a) of the Bankruptcy Code], Congress explicitly indicated its intent for property located outside the territory of the United States to be considered property of the estate and thus protected by the automatic stay.”12

Citing the decision of the US Bankruptcy Court for the Southern District of New York,13 the Bankruptcy Court explained that a party that violates the stay and is subject to the personal jurisdiction of a US bankruptcy court may be liable for such act, even when the act involved property located elsewhere. According to the Bankruptcy Court, acts in violation of the stay are invalid and voidable under Section 362 of the Bankruptcy Code.

Thus, the Bankruptcy Court concluded that it should hear the merits of the proceedings over which it had proper jurisdiction and which involves allegations of unauthorized post-petition transfers of the Chapter 7 estates’ property.

Conclusion

The Bankruptcy Court’s decision is notable and has several key implications on cross-border insolvency issues.

First, purchasers need to exercise extra care when buying assets of a US company that are sited outside the United States. When proceeding with such a transaction, it is necessary to ensure that the US owner has notice of the sale. This is especially important when the sale is pursuant to a foreign court ordered process. Although this may not be required under the laws of the jurisdiction where the sale is taking place, it is necessary should the parties ever need to rely on a comity argument in the United States.

Second, this notice requirement is also critical when parties deal with foreign assets of a company they know is subject to US bankruptcy proceedings. In this case, the Chapter 7 trustee is vested with avoidance powers that can result in the assets (or the value of the assets) being “clawed back.”

Finally, when acquiring property of a company in US bankruptcy proceedings, purchasers need to be aware of the extraterritorial effect of US bankruptcy laws, specifically, 11 U.S.C. § 362 (the automatic stay). The automatic stay extends to and protects all property of the bankruptcy estate wherever located. Any property that a US bankruptcy debtor has a beneficial or legal interest in is protected by US bankruptcy laws. Therefore, self-help, foreclosure and other remedies under foreign law could be severely limited. Moreover, what seems at first to be a simple sale of property in a foreign jurisdiction could actually involve significant cross-border insolvency issues leading to unforeseen liability and exposure.