A recent decision by the United States Bankruptcy Court for the Southern District of New York may make it easier for debtors to obtain some relief from preferential payments to a foreign entity, even if the recipient of the transfer has no address in the United States. 

As readers of the Weil Bankruptcy Blog know, payments made by a debtor within 90 days of the petition date may be avoidable as preferences under section 547 of the Bankruptcy Code and may be recovered by the bankruptcy estate under section 550.  But to actually recover a preferential payment, a debtor needs to commence an adversary proceeding and properly serve a summons and complaint on the defendant.  This is full scale litigation, and in some cases, the expense of prosecuting an adversary proceeding may not be warranted – for example, where the cost is greater than the expected recovery.

When the recipient of a preferential transfer is a foreign entity with no address in the United States, commencing an adversary proceeding is even more complicated.  Under Bankruptcy Rule 7004, the standard for service of a summons and complaint upon an individual in a foreign country is governed byRule 4(f)(1) of the Federal Rules of Civil Procedure, made applicable to adversary proceedings byBankruptcy Rule 7004(a).  Unless the defendant waives service of process, service must be “by any internationally agreed means reasonably calculated to give notice, such as those means authorized by the Hague Convention . . . .”  Service of process through the Hague Convention can be time consuming and costly, and enforcing a judgment against a foreign defendant can be challenging if the defendant does not have property in the United States.

This was the conundrum facing the debtors in the Vivaro Corporation cases.  The debtors filed their chapter 11 petitions in September of 2012.  By January of the following year, the bankruptcy court entered an order approving the sale of substantially all of the debtors’ assets.  The sale closed in February of 2013, after which the court approved a stipulation entrusting the creditors’ committee with the authority to pursue preference claims (and other avoidance actions) on behalf of the debtors’ estates while the debtors liquidated the remainder of their assets and prosecuted objections to claims.

Adversary proceedings were commenced against several claimants that also had filed proofs of claim against the debtors to recover, as preferences, payments made by the debtors during the 90-day period preceding the petition date.  Each of the claimants with a preference complaint was a foreign entity with no business address in the United States.  Because the debtors never properly served the complaints in compliance with Bankruptcy Rule 7004(a), the bankruptcy court dismissed the complaints.

The debtors, however, thought of an alternative means of mitigating their losses from the preferential transfers.  If the recipient of a preferential transfer also has filed claims in the bankruptcy case, the debtor can object to the claims pursuant to section 502(d) of the Bankruptcy Code.  Section 502(d) prevents an entity in possession of property of a bankruptcy estate, or that received an avoidable transfer from a debtor, from receiving any further distribution from the estate on a claim filed in such a bankruptcy case, unless the entity first turns over the property or repays the avoidable transfer.  The amount of the property received as a preference does not matter – if a court finds that any amount was received as a preference, the claimant’s entire claim may be expunged.  Depending on the amounts involved, cost, and likelihood of success in litigation, a claim objection may make more economic sense for the debtor.

In Vivaro, at around the same time that the court dismissed the adversary complaints, the debtors filed objections to each of the foreign claimants’ proofs of claim.  Unlike the adversary proceedings, which sought to affirmatively recover the preferential transfers from the claimants, the claim objections merely sought to expunge the claimants’ proofs of claim.  Instead of complying with the more complicated procedures under Bankruptcy Rule 7004(a), the debtors followed the requirements of Bankruptcy Rule 3007 and sent notice of the objections to each of the foreign claimants by U.S. mail.

Clearly, when attempting to serve foreign entities, the requirements of Rule 3007 are much less costly and time-consuming than going through the Hague Convention under Rule 7004.  As the bankruptcy court noted, “the Second Circuit has not addressed whether Rule 7004 or Rule 3007 applies to service of claims objections,” and (as we have reported previously in our post, A Tale of Two Rules: The Questionable Applicability of Rule 7004(b)(3) to Claim Objections), “lower courts in other circuits have split on this issue.”  At the heart of this disagreement is Bankruptcy Rule 9014, which requires a contested matter “not otherwise governed by” the Bankruptcy Rules to be requested by a motion, and a motion to be served in the same manner as a summons and complaint under Bankruptcy Rule 7004.

Siding with what the court described as “more recent and persuasive authority,” the bankruptcy court held that claims objections are “otherwise governed by” Bankruptcy Rule 3007 and that service by mail was sufficient.  The court added, “While none of the earlier cases dealt with claims filed by foreign entities, there is no reason for requiring a different rule for service of claims objections on foreign entities so long as the estate or estate representative establishes that service by mail was made on the creditor.”

Although the split in authority remains, the decision in Vivaro adds greater weight to the line of cases that permit service of claim objections by mail.  More importantly, the decision clarifies that Bankruptcy Rule 3007 can be applied equally to foreign and domestic claimants, thus obviating the need to comply with the Hague Convention when serving claim objections.  This includes claim objections under section 502(d) that seek to disallow and expunge the claims of claimants that have received a preferential transfer.

Thus, for debtors seeking to mitigate preferences to foreign claimants, the Vivaro decision illustrates a cheaper and faster alternative to an adversary proceeding, albeit with some limitations.  First, as noted by the bankruptcy court, a claim objection that seeks to disallow and expunge a claim based on section 502(d) requires more than mere allegations by the debtor that the claimant received a preferential transfer; a judicial determination is required.  Second, once a claimant’s liability has been established, “the claimant must be provided with a reasonable opportunity to turn over the property to the debtor’s estate in compliance with section 502(d) before the claims may be disallowed.”  All things considered, however, these limitations may be worth accepting to avoid navigating the byzantine path of international service of process.