Chapter 15 of the Bankruptcy Code is designed to provide an effective mechanism to aid insolvency proceedings in foreign countries that involve a foreign debtor with assets, creditors and other parties in interest located in the foreign country as well as in United States. A foreign representative that is authorized to administer the foreign reorganization or liquidation or act as a representative of the foreign proceeding is the party who applies to the US bankruptcy court for recognition of the foreign proceeding.
The distinction between being recognized as a main proceeding or a non-main proceeding is material. The Bankruptcy Code extends certain automatic, nondiscretionary protections to debtors — such as the automatic stay — with petitions recognized as foreign main proceedings.1 By contrast, upon recognition of a foreign nonmain proceeding, the US bankruptcy court may, but is not required to, grant the same protections. A main proceeding is a proceeding “pending in the country where the debtor has the center of its main interests,” or “COMI,” as courts have referred to it. Conversely, a foreign nonmain proceeding is any foreign proceeding (except for a foreign main proceeding) pending in any country where the debtor has an establishment.2
In Fairfield Sentry, the Second Circuit rules COMI should be determined at time of Chapter 15 petition filing, with possible look-back period to combat bad faith.
In Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.), 2013 U.S. App. LEXIS 7608 (2d. Cir. Apr. 16, 2013), the Second Circuit for the first time conducted a COMI analysis for purposes of determining whether a foreign proceeding — involving Fairfield Sentry Limited (and its affiliates), funds that are involved with the Madoff scandal — is a foreign main or nonmain proceeding. In that case, the court affirmed the decisions of the United States District Court and Bankruptcy Court of the Southern District of New York (collectively, the Recognition Opinions) that the liquidation proceedings in the British Virgin Islands of three foreign debtors were foreign main proceedings under Chapter 15 of the Bankruptcy Code.
The Second Circuit held that COMI should be analyzed not based upon the debtors’ activities prior to or as of the date of the foreign insolvency petition but, instead, as of the date the Chapter 15 petition was filed in the US, with a possible look-back period to combat any attempt to manipulate COMI. The Second Circuit also outlined various factors relevant for locating a COMI, holding that the debtor’s liquidation-related activities should be considered in that determination.
Background Provided in the Recognition Opinions
In December 2008, it was revealed that Bernard Madoff’s investment business, run primarily through Bernard L. Madoff Investment Securities, LLC (BLMIS), was a massive fraud. The revelation ultimately forced a number of funds that invested with BLMIS for the benefit of their shareholders, so-called “feeder funds,” into liquidation. Three of those feeder funds are the debtors at issue in these opinions — Fairfield Sentry Limited (Fairfield Sentry), Fairfield Sigma Limited and Fairfield Lamba Limited (collectively, the Fairfield Funds) — each of which was organized and incorporated in the BVI in 1990.3 Fairfield Sentry’s day-to-day operations were handled by its investment manager, Fairfield Sentry Fairfield Greenwich Group (FGG), which was based in New York City. Fairfield Sentry’s investments in BLMIS comprised approximately 95 percent of Fairfield Sentry’s assets, totaling over $7 billion invested with BLMIS. One of Fairfield Sentry’s three directors resided in New York; the other two resided in Europe.
Fairfield Sentry’s Liquidation Activities
Following the announcement of Madoff’s fraudulent scheme, Fairfield Sentry stopped its normal course operations and changed its business purpose to “‘preserv[ing] and realiz[ing] ... its assets for purposes of ultimate, orderly and equitable distribution, in compliance with the BVI insolvency law, to creditors and other lawful claimants.’”4 Starting in December 2008, the Fairfield Funds began severing their business relationships, including their contractual relationship with FGG. Fairfield Sentry’s FGG-related director participated in only two board meetings between December 2008 and July 2009. Fairfield Sentry’s formal termination of the FGG contract became effective June 2009.
By late December 2008, Fairfield Sentry’s board began corresponding with its shareholders from its registered office in the BVI. In February 2009, Fairfield Sentry established a Litigation Committee of independent, non-United States based directors. The Committee ran Fairfield Sentry temporarily, and was given the power to, inter alia, initiate, defend and settle litigation related to Fairfield Sentry.
Fairfield Funds’ Insolvency Proceedings and Petitions for Recognition Under Chapter 15 of the Bankruptcy Code
In early 2009, various shareholders and creditors of Fairfield Funds petitioned the High Court of Justice of the Eastern Caribbean Supreme Court in the BVI to place the Fairfield Funds into liquidation proceedings (the BVI Proceedings). The petitions were granted in July 2009 and a liquidator was appointed (the Liquidator). The BVI Proceedings remain pending in the BVI courts.5
In May 2009, Morning Mist Holdings Limited (Morning Mist), a Fairfield Sentry shareholder, filed a derivative action in New York state court against Fairfield Sentry’s officers and directors for breaches of their fiduciary duties. In June 2010, the Liquidator petitioned the United States Bankruptcy Court for the Southern District of New York (the Bankruptcy Court) for recognition of the BVI Proceedings as “foreign main proceedings” under Chapter 15 of the Bankruptcy Code (the Chapter 15 Petition), arguing that Fairfield Funds’ COMI is the BVI. Morning Mist objected to the Chapter 15 Petition, arguing that the BVI Proceedings were foreign non-main proceedings under Chapter 15 since Fairfield Sentry’s COMI was not the BVI, but New York.
As of June 2010, Fairfield Sentry held approximately $17 million in a BVI bank account, $73 million in Ireland and $22 million in the United Kingdom. Additionally, US citizens held less than 10 percent of the shares of Fairfield Sentry and comprised about 17 percent of Fairfield Sentry’s record shareholders. The Liquidator employed employees in the BVI and had “undertaken to transfer significant books and records to office space leased by [the Fairfield Funds] in the BVI.”6
The Bankruptcy Court and District Court Decisions
On July 22, 2010, the Bankruptcy Court recognized the BVI Proceedings as foreign main proceedings, finding that Fairfield Funds’ COMI was the BVI. The Bankruptcy Court noted that the only real issue of contention between the Liquidator and Morning Mist was the time period as of which Fairfield Funds’ COMI should be measured. In determining COMI, the Bankruptcy Court focused on Fairfield Funds’ “pre- and post-liquidation periods.” However, the Bankruptcy Court recognized the potential for COMI manipulation, and for this reason, the Bankruptcy Court stated that there is no preclusion from “looking into a broader temporal COMI assessment where there may have been an opportunistic shift to establish COMI[.]”
In affirming the Bankruptcy Court’s decision, the District Court created a more definitive temporal rule for determining COMI. The District Court first noted that the Bankruptcy Code is written in present tense, and Congress’ choice to use that tense “requires courts to view the COMI determination in the present, i.e., at the time the recognition petition was filed [in the United States].” The District Court also recognized the potential for COMI-shopping and, therefore, affirmed the Bankruptcy Court’s application of a look-back period, as discussed below, where evidence of bad faith exists.
The Second Circuit’s Affirmance
The Second Circuit affirmed the lower courts’ recognition of the BVI Proceedings as foreign main proceedings. The Second Circuit focused first on the relevant time frame for a COMI determination and, second, on the factors relevant to a COMI determination. Ultimately, the Second Circuit concluded that:
COMI lies where the debtor conducts its regular business, so that the place is ascertainable by third parties. ... Among [the] factors that may be considered are [the debtor’s registered office,] the location of headquarters, decision-makers, assets, creditors, and the law applicable to most disputes. [A] debtor’s COMI is determined as of the time of the filing of the Chapter 15 petition. To offset a debtor’s ability to manipulate its COMI, a court may also look at the time period between the initiation of the foreign liquidation proceeding and the filing of the Chapter 15 petition.
In addition to its COMI arguments, Morning Mist also argued, inter alia, that due to the secrecy of the BVI Proceedings, recognition of the Fairfield Sentry case would be against public policy, and thus would be precluded from gaining Chapter 15 recognition under Section 1506 of the Bankruptcy Code. But the Second Circuit held that Section 1506 only creates an exception for actions that are “manifestly contrary” to public policy, which the court found did not apply in this case.
Each issue is discussed below.
Timing of a COMI Determination
The Second Circuit held that a debtor’s COMI should not be based upon its entire operational history or, for that matter, the date the foreign insolvency proceedings began. Instead, “the relevant time period is the time of the Chapter 15 petition, subject to an inquiry into whether the process has been manipulated.” In support of this holding, the Second Circuit first considered the text of Chapter 15, noting that the relevant sections of the Bankruptcy Code were written in the present tense. Section 1517 provides that a “foreign proceeding shall be recognized ... as a foreign main proceeding if it is pending in the country where the debtor has the center of its main interests” (emphasis in original). Thus, “the filing date of the Chapter 15 petition should serve to anchor the COMI analysis.”7
The Second Circuit also took guidance from the fact that almost all federal courts, including the Fifth Circuit (the only other Circuit Court to address the proper timing for a COMI analysis), had found that COMI should be determined as of the filing of the petition for recognition and not by analyzing the debtor’s prior operational history.8 The Second Circuit agreed with the Fifth Circuit that “a meandering and never-ending inquiry into the debtor’s past interests could lead to a denial of recognition in a country where a debtor’s interests are truly centered...” The Second Circuit rejected the notion that courts should employ the jurisdictional concept of “principal place of business,” which allows courts to consider a company’s operational history, in determining the appropriate time frame for a COMI analysis. The Second Circuit noted that the drafters of Chapter 15 intentionally chose to use the term “COMI” in lieu of “principal place of business” in order to foster a uniform jurisdictional test in all the countries that enact a version of the UNCITRAL Model Law on Cross-Border Insolvency, which forms the basis of Chapter 15.9
The Second Circuit also agreed, however, that COMI is open to manipulation. In order to preclude COMI-shopping, the court found that it is important to allow courts to look at the debtor’s activities leading up to the petition for recognition. In support of its decision to allow a look-back period, the Second Circuit noted that international sources (which the court refused to consider on the question of the proper timing for a COMI analysis), including relevant European Union case law on COMI, focused on “the regularity and ascertainability of a debtor’s COMI ... [which] is not easily subject to tactical removal.” Consequently, the Second Circuit held that “a court may consider the period [between] commencement of the foreign insolvency proceeding and the filing of the Chapter 15 petition to ensure that a debtor has not manipulated its COMI in bad faith.”
After determining the appropriate time frame for a COMI analysis, the Second Circuit addressed which factors should pertain to a COMI determination. Ultimately, the Second Circuit held that “any relevant activities, including liquidation activities and administrative functions, may be considered in the COMI analysis.” The court set forth a non-exclusive list of factors that courts have used but warned that the list is merely a guide. Notably, the Second Circuit concluded that, in determining a debtor’s COMI (unlike when analyzing the proper timing for a COMI analysis), a court may apply the American concept of a company’s “principal place of business,” which looks at the company’s “nerve center.” The Second Circuit also suggested that a court could analogize COMI to the European principle of “...the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties.” Ultimately, the Second Circuit stated that because COMI is not defined in the Bankruptcy Code, “the text is open-ended, and invites development by the courts, depending on the facts presented, without prescription or limitation.”
Section 1506’s Public Policy Exception
To defeat recognition of the BVI Proceedings, Morning Mist also attempted to invoke Section 1506, which provides that “[n]othing in this chapter prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States.” Specifically, Morning Mist argued that the BVI court restricted access to the Fairfield Sentry pleadings, contrary to the general policy of US courts towards open proceedings. The court held, however, that Section 1506 is only implicated in situations that are “manifestly” contrary to the public policy of the United States. The Second Circuit stated that “unfettered public access to court records is [not] so fundamental in the United States that recognition of the BVI liquidation constitutes one of the exceptional circumstances contemplated by Section 1506.”
Analysis and Implications
The Second Circuit’s decision leaves important legal and practical questions unanswered. For instance, there may be practical limitations on a court’s ability to ferret out bad faith debtors if the court’s look-back period is limited to the period of time between the initiation of the foreign insolvency proceeding and the date the petition for recognition was filed. Similarly, what look-back period will a court be able to employ if a liquidator has been appointed for only a short period of time before filing for recognition under Chapter 15? In such a case, should the bankruptcy courts consider some of the debtor’s operational history leading up to the foreign insolvency proceeding? If the debtor is only a single entity within a worldwide corporate enterprise, should a bankruptcy court consider the operational history solely of the single debtor entity or of the business enterprise as a whole?
Another remaining question is what actions or circumstances would be egregious enough to preclude recognition of a petition due to Chapter 15’s public policy exception under Section 1506? For instance, one court refused to recognize a foreign petition under Chapter 15, citing public policy concerns, because the foreign receiver seeking recognition had violated the automatic stay when the same debtor previously filed for Chapter 11 protection in the United States.10 Another court, also on public policy grounds, refused to grant a foreign representative’s request to recognize a German court’s order allowing the foreign representative to intercept the debtor’s emails secretly.11 Under the Second Circuit’s analysis, however, the fact that court filings were under seal in the foreign proceeding will not per se require application of the public policy exception.
Ultimately, where courts draw the line on extending Chapter 15 protections to large enterprise debtors, particularly those with significant assets located in the United States, remains to be seen. How these questions and others are answered as the courts continue to wrestle with the COMI analysis will continue to be scrutinized by the legal and business communities alike.