Forum bias, along with some technical issues, are still challenges in cross-border insolvencies in Australia
Just over ten years ago, Lehman Brothers filed for bankruptcy in the US, which turned out to be one of the largest cross-border insolvency cases in history.
Last year also marks:
- the tenth anniversary of the commencement of the Cross-Border Insolvency Act 2008 (Cth) (CBI Act) in Australia, by which the UNCITRAL Model Law on Cross-Border Insolvency (Model Law) became part of the domestic law in Australia; and
- the year in which UNCITRAL adopted and published the Model Law on the Recognition and Enforcement of Insolvency-Related Judgments (Model Law on Recognition and Enforcement).
These milestones make it timely to explore, from an Australian law perspective:
- some of the practical issues (of private international law) faced by different players in a cross-border insolvency; and
- which issues have emerged, or have become increasingly common, over the last ten years.
Foreign creditors participating in an Australian external administration
It is not uncommon for foreign creditors to become caught up in the insolvency and external administration of their Australian debtors. Before the formal appointment of an external administrator, the dealings between a foreign creditor and its Australian counterpart will, in many cases, be regulated by their contractual arrangements. And where the contract specifies a foreign law as its governing law, that foreign law will typically determine all questions associated with that contract, including the enforceability of the parties' contractual rights and obligations.
However, once the Australian debtor enters into external administration, the foreign creditor becomes subject to the Australian insolvency law regime. For example, a voluntary administrator may, on the basis of section 440B of the Corporations Act, seek to preclude the foreign creditor from enforcing its security interests against the debtor company or recovering the creditor's property that is in the company's possession. More recently, with the introduction of the stay on enforcement of ipso facto rights, external administrators may also raise the ipso facto stay against any attempts by a foreign creditor to terminate or otherwise enforce its contract with the Australian debtor.
There is no blanket rule that all issues arising out of an insolvency proceeding are to be dealt with either by the law of the forum (lex fori) or the law of the jurisdiction in which the insolvency proceeding was initiated. However, there appears to be a tendency on the part of Australian Courts to apply the law of the forum to all insolvency law issues, without any consideration as to whether the law of the cause (lex causae) should apply to specific questions arising in, or connected with, an insolvency. This is evidenced by the paucity of Australian Court cases dealing with choice of law issues in the context of cross-border insolvencies.
At a practical level, this may be because the parties tend not to turn their minds to, let alone raise, choice of law issues, or because the Courts prefer to apply the familiar laws of their own forum (including, most significantly, the Corporations Act), rather than foreign laws, when determining insolvency issues. More fundamentally, this forum bias may reflect:
- an instinctive – but potentially misplaced – view that many issues arising in an external administration are procedural in nature, and hence governed by the law of the forum, rather than issues of substance to which the law of the cause applies; and/or
- the judicial conviction that Australian insolvency law embodies a number of important public policies which the Courts are entrusted to uphold. And in the context of a cross-border insolvency, this means the Courts are generally resistant to the idea of allowing a foreign substantive law to govern the parties' rights and expectations.
Notwithstanding the steady increase in the volume of international transactions and cases of cross-border insolvencies over the last decade, it appears that this forum bias has persisted; and it may take a couple of legal challenges (including by foreign creditors) against the default application of lex fori in insolvency cases, in order for the Australian Courts to move away from this inclination towards applying forum law.
Foreign representatives and enforcement of foreign insolvency judgments
One of the challenges faced by a foreign representative coming to Australia is the difficulty associated with enforcing foreign insolvency-related judgments in this country, including, for example, judgments for recovery of unfair preferences or voidable transactions (or similar concepts under foreign law).
Traditionally, foreign judgments can be enforced in Australia via one of two avenues:
- through registration under the Foreign Judgments Act 1991 (Cth); or
- enforcement at common law.
There are various limitations to both of these avenues. For instance, judgments obtained in certain countries such as the United States cannot be registered under the Foreign Judgments Act, because those countries do not fall within the compass of that legislation. And at common law, enforcement is precluded if, amongst other things, the judgment creditor (in this case, the foreign representative) fails to establish that the foreign court exercised jurisdiction in the "international sense", because the defendant had not voluntarily submitted to the foreign jurisdiction (including by appearance in the foreign proceedings) and it had no presence or residence in that jurisdiction.
There have been cases (primarily in the UK) which considered whether, in addition to the two avenues above, the Court may enforce foreign insolvency judgments that are neither registrable under the Foreign Judgments Act (or its UK equivalent) nor enforceable at common law, through:
- assistance provisions such as section 581 of the Corporations Act and section 426 of the Insolvency Act 1986 (UK), by which forum Courts must aid courts of certain prescribed countries and may aid courts of other (non-prescribed) countries; and/or
- the Model Law, including the ancillary relief provision in Article 21 and the court-to-court co-operation provisions in Articles 25 and 27.
In Rubin, the UK Supreme Court ruled that neither the assistance provisions nor the relevant Articles in the Model Law can be utilised to enforce (substantive) foreign insolvency judgments. Those assistance provisions and the Model Law are not concerned with enforcement of foreign judgments and, as such, cannot be interpreted as outflanking the settled principles of substantive private international law in respect of that subject matter.
So far, this issue has yet to be determined by any Australian Court. However, should the question arise in this country, it is likely that the Australian Courts will decide it the same way as in Rubin. In other words, a foreign representative seeking to enforce a foreign insolvency judgment in Australia (for the purposes of enlarging the hotchpot) will not enjoy any special treatment or relief by reason of the intercession of an insolvency administration. Instead, they will be required to go through the same hurdles as any other foreign judgment creditor enforcing in Australia. This is most problematic where the foreign representative obtained default judgment in a foreign jurisdiction against a judgment debtor that is neither present nor resident in that jurisdiction. In that scenario, but subject to the "exception" established by the Rubin case (discussed below), the foreign court would have lacked jurisdiction in the "international sense" and recognition/enforcement of the judgment would likely be refused.
Model Law on the Recognition and Enforcement of Insolvency-Related Judgments
The recently published Model Law on Recognition and Enforcement has the potential of making it easier for foreign representatives to enforce foreign insolvency judgments in Australia and, through that, maximising the value of assets in the insolvency estate for the benefit of creditors. However, unless and until the Model Law on Recognition and Enforcement is formally enacted and incorporated into Australian law, which could be some years away, its effects on the insolvency landscape of this country remain negligible and foreign representatives will continue to face obstacles (as outlined above) when enforcing foreign judgments here.
Limitations on access to avoidance actions under forum laws
Given the difficulties associated with enforcing foreign insolvency judgments, foreign representatives may consider commencing recovery or clawback proceedings directly in Australia, especially if the defendant resides or has assets in this jurisdiction. However, that course presents its own problems. In addition to the inconvenience and costs of prosecuting a recovery proceeding in an unfamiliar jurisdiction, a recent decision of the Federal Court of Australia further confirmed two points:
- avoidance actions under Division 2 of Part 5.7B of the Corporations Act are not available to a foreign representative, unless the foreign corporation to which he is appointed is a "company" under section 9 of the Corporations Act; and
- a foreign corporation, which is not registered under the Corporations Act and does not carry on business in Australia, is not a "company" for the purposes of Part 5.7B of that Act.
The fact that the foreign insolvency proceeding in respect of the foreign corporation is recognised in Australia under the Model Law does not, in itself, provide the foreign representative with access to the voidable transactions regime under the Corporations Act. The requirement in section 588FF(1) that the transaction in question be a transaction of a "company" remains and is not displaced by the Model Law.
These limitations to the availability of avoidance actions (under local laws) arguably compound the difficulties associated with enforcing foreign insolvency judgments in Australia, and leave foreign representatives with little options when it comes to pursuing clawbacks and other recoveries against persons or properties in this country.
Foreign companies being wound up in Australia
With the steady increase in foreign investment in this country over the last decade, it is not surprising to see more and more insolvencies of foreign corporations (that is, companies incorporated overseas) in Australia. Under Part 5.7 of the Corporations Act, an Australian Court may order the winding up of a foreign company that is either registered under that Act or carries on business in Australia (ie. a "Part 5.7 body"), on the basis of insolvency or on just and equitable grounds.
The directors (or members) of a foreign company may defend against a Part 5.7 winding up application brought against it by one or more local creditors. However, if they seek to impede the application by commencing a competing insolvency proceeding overseas, they may find themselves out of favour with the Australian Courts. This was the case in Legend International Holdings Inc (in liq) v Indian Farmers Fertiliser Co-op Ltd  VSCA 151, where the Victorian Supreme Court ordered (and the Court of Appeal upheld) the Australian winding up of a company incorporated in Delaware, which was registered under the Corporations Act and had its principal place of business in Melbourne. The winding up order was made even though the company had filed a voluntary bankruptcy petition in the US. In so finding, the Court rejected the company's argument that – by reason of the Court's duty under section 581(2) of the Corporations Act to act in aid of foreign courts in relation to insolvency matters – it was obliged to refrain from exercising its discretionary power under Part 5.7 to wind up a company once the company had filed for bankruptcy in the US.
For foreign companies (and their directors and shareholders), the lesson to be learnt from this case is that doing business in Australia carries with it the inherent risk of being wound up in this country and, generally speaking, the Australian Court will not refrain from exercising its discretionary powers to wind up foreign companies solely by reason of comity. In Legend, the company had no presence in the US, and all its activities and almost all of its creditors were in Australia. The Australian Court was therefore the most appropriate forum for supervising Legend’s insolvency. By filing a bankruptcy petition in the US after the winding up application in Australia had commenced, it was obvious that Legend was forum-shopping in an attempt to defeat the applicant's claims. The Australian Court was not prepared to condone this practice, especially since Legend had previously failed in its application for Model Law recognition of the US bankruptcy proceeding and was clearly attempting to achieve de facto Model Law relief by invoking section 581.
Australian creditors participating in foreign external administration
One of the many things that an Australian creditor will need to consider when a debtor goes into external administration in a foreign jurisdiction is the lodgement of a proof of debt in the foreign insolvency proceeding. Complexities may arise in relation to how and when such a proof is to be lodged, its requisite contents and its treatment by the foreign representatives. Most of these issues will be governed by the laws of the foreign jurisdiction. For example, under US bankruptcy laws, the bankruptcy court may set a "bar date" by which all creditors' proofs must be filed. Failure to prove a claim by this date may bar the creditor from claiming against the debtor in the future and, in that way, adversely affect the substantive rights of that creditor.
Furthermore, by lodging a proof of debt in a foreign insolvency proceeding, the (Australian) creditor runs the risk of being found to have submitted to the foreign court's jurisdiction in the context of, say, an avoidance action commenced against that creditor in the foreign jurisdiction and the subsequent enforcement of the foreign court's judgment in Australia. Thus, in Rubin the UK Supreme Court found that a default judgment of an Australian Court, obtained by a company that is in liquidation in Australia (New Cap) against a syndicate of insurers, should be recognised and enforced in the UK on the basis that the syndicate had submitted to the jurisdiction of the Australian Court by filing proofs of debt in the Australian liquidation and participating in creditors' meetings:
"having chosen to submit to New Cap's Australian insolvency proceeding, the Syndicate should be taken to have submitted to the jurisdiction of the Australian court responsible for the supervision of that proceeding. It should not be allowed to benefit from the insolvency proceedings without the burden of complying with the orders made in that proceeding."
This position was subsequently endorsed by the Full Court of the Federal Court of Australia in Akers v DCT (although that endorsement was not part of the essential reasoning in the case).
"Extraterritorial reach" of avoidance provisions
Recently, in In re Picard the US Court of Appeal for the Second Circuit overturned a number of lower courts' decisions and found that a US bankruptcy trustee may rely on:
- the avoidance provision in section 548(a)(1)(a) of the US Bankruptcy Code (in respect of fraudulent transfers of property away from the US debtor's estate); and
- the associated recovery provision in section 550(a)(2) (which enables the trustee to recover property, the subject of an avoided transfer, from the initial transferee as well as any subsequent transferee),
to recover property from a foreign subsequent transferee who received property from a foreign initial transferee. In particular, the Court held that:
- the presumption against extraterritoriality was no bar to such recovery action, because the initial (fraudulent) transfer, the "focus" of the avoidance and recovery provisions, took place domestically; and
- international comity considerations do not limit the reach of the Bankruptcy Code provisions with respect to recoveries from foreign subsequent transferees, because, amongst other things, the US has a compelling interest in applying its laws to such transactions which interest outweighs that of any foreign states.
This decision arguably aggravates the risk for non-US creditors/transferees of property from a US debtor (eg. Australian trade creditors), who could inadvertently submit to the US Court's jurisdiction by lodging a proof in the US bankruptcy and later find themselves at the receiving end of an avoidance action commenced by the bankruptcy trustee pursuant to the US Bankruptcy Code. Such inadvertent submission could subsequently allow the US trustee to enforce any US Court judgment in Australia with relative ease, given the Rubin decision.
Mitigation of risk
It may be possible for an Australian creditor, who is contemplating lodgement of a proof of debt in a foreign insolvency proceeding, to mitigate this risk by including a disclaimer in the proof to the effect that the proof is filed solely to protect the creditor from forfeiture of its claims (for example, by reason of any applicable bar date) and that the filing should not be construed as submission or consent by the creditor to the foreign court's jurisdiction with respect to any proceedings commenced against the creditor. However, the effectiveness of such a disclaimer has not yet been confirmed by any Australian authority.
Australian companies undergoing cross-border restructurings
In recent years, we have seen an increasing number of cross-border restructurings being achieved in Australia through schemes of arrangement (and, perhaps less
frequently, through deeds of company arrangement (DOCAs)). An important development (in terms of private international law) which featured in some of those transactions, including the restructuring of Emeco Holdings, Boart Longyear and Bis Industries, is the recognition of the Australian schemes of arrangement in the United States, under Chapter 15 of the US Bankruptcy Code (which largely corresponds with the Model Law).
One issue of legal uncertainty previously faced by restructuring professionals was whether, and to what extent, a scheme of arrangement or a DOCA (being statutory procedures prescribed by the Australian Corporations Act) could bind foreign creditors and release debts or claims that are governed by foreign law. To address that issue, recognition of the Australian schemes under Chapter 15 was sought in the context of the restructures mentioned above. Such recognition had the effect of making the schemes binding and enforceable as a matter of US law, and with respect to persons and properties located in the US. More specifically, it prevented any dissenting scheme creditors from commencing proceedings or taking other actions in the US, which would potentially jeopardise the restructuring.
Presumably, the restructuring professionals involved in Emeco Holdings, Boart Longyear and Bis Industries only applied for recognition in the US because the relevant dissident creditors were all based on the US. However, these cases have set an important precedent for future restructurings, in respect of which applications for Model Law recognition may be made in multiple different jurisdictions if, for example, it becomes necessary for an Australian scheme to have binding effect across the globe.
Of course, the feasibility of having a globally binding scheme may be limited by a number of factors, including the fact that the Model Law has not been adopted in a number of jurisdictions (such as Hong Kong and China). In addition, the continued application of the "Gibbs rule" in England (and potentially in other common law jurisdictions) will likely detract from the effectiveness of any Model Law recognition. The rule in Gibbs is a long-standing, but much criticised, principle of English common law, which provides that a discharge of a debt is not effective unless it is in accordance with the law governing the debt. As recently as December 2018, the English Court of Appeal has upheld and reaffirmed the rule in Gibbs, and held that there is nothing in the English equivalent of the CBI Act to suggest that the procedural powers granted by the Model Law could be used to extinguish the substantive rights of creditors whose debts are governed by English law. What this means is that, even if an Australian scheme administrator was able to obtain Model Law recognition of the Australian scheme in England, that will not have the effect of rendering the scheme binding on creditors whose debts are governed by English law.
Separately, while it is now clear that an Australian scheme (and a voluntary administration under Part 5.3A of the Corporations Act) are recognisable in the US; as far as the writers are aware, there are currently no reported decisions in which an Australian DOCA has been recognised by a US or Canadian Court. And there is no guarantee that an Australian DOCA will be recognised by the US/Canadian Courts (or other foreign courts) – for example, the minimal involvement of the Australian Courts in the deed administration process may cast doubt on whether a DOCA qualifies as a foreign insolvency proceeding, in which the assets and affairs of the debtor "are subject to control or supervision by a foreign court". Interestingly, in the case of QRX Pharma Ltd, an Australian pharmaceutical company was sued in an investor class action in the United States, and subsequently entered into voluntary administration in Australia. That administration was recognised in the US as a "foreign main proceeding" under Chapter 15. The company then executed a DOCA (in Australia) which purported to release all creditors' claims against the company (including those of its US investors). It was recorded in a later judgment (admittedly as a passing comment) that:
"On February 10, 2016, the Bankruptcy Court entered an order dismissing this case as to QRX. See Dkt. 53. It did so pursuant to the ‘‘Deed of Company Arrangement of QRX’’ effectuated in the Australian insolvency proceeding, which brought that proceeding to a close and expunged all shareholder claims existing as of May 22, 2015."
It appears that, in dismissing the investor class action and accepting the intended effect of the DOCA – namely, the extinguishment of all creditors' claims (including claims of US investors) against the company – the US Bankruptcy Court gave little or no consideration to the issue of whether an Australian DOCA can have extra-territorial effect, absent a Chapter 15 recognition of the DOCA itself, as distinct from the preceding administration. Thus, the way the US Court resolved this particular case provides little guidance on how this issue will be determined in the future should it arise for proper consideration.
There are, obviously, many other private international law issues arising in the context of cross-border insolvency matters, and it is not possible to cover all of them here. What this article has sought to do is simply present a sample of such issues and highlight some of the complexities that different parties ought to be aware of, as cross-border insolvencies become increasingly common in our globalised world.