At a glance
- The US Bankruptcy Court has declined to recognise Cayman provisional liquidation proceedings (opened where the company was incorporated) as foreign main or non-main proceedings under Chapter 15 of the Bankruptcy Code (which replaced the regime under section 304 with which many will be familiar).
- The US court will not rubber stamp applications for recognition. Chapter 15 contains definitional requirements for recognition and the US court will determine if these have been met
- Following this decision, off-shore companies, often used for tax sheltering purposes, may struggle to gain US recognition of any local insolvency proceedings. The concepts of ‘centre of main interests’ and ‘establishment’, as interpreted by the US court, require a degree of business or non-transitory economic activity to be carried out locally. Such off-shore companies are often prohibited from carrying out any economic activity in their home jurisdiction in order to maintain their beneficial off-shore tax status. This restricted activity is likely to be a bar, therefore, to recognition of off-shore proceedings under Chapter 15.
- Where Chapter 15 recognition is not available and a US stay is needed, the US court suggested filing for main US Chapter 7 (liquidation) or Chapter 11 (reorganisation) proceedings in order to gain access to the remedies of the US Bankruptcy Court.
- The decision is subject to appeal. We will update you of any interesting developments arising from the appeal.
The case involved two Bear Stearns hedge funds (the Funds) with registered offices in the Cayman Islands. The Funds invested in complex financial instruments and in early 2007 began to be affected by problems in the US sub-prime lending market. In July, the directors of both of the Funds filed for provisional liquidation in the Cayman Islands and the Cayman Grand Court entered orders appointing the petitioners in this US case as the Funds’ joint provisional liquidators (JPLs).
Lifland J was asked to consider the petitions presented by the JPLs under Chapter 15 (see box overleaf) for recognition of the Cayman insolvency proceedings as foreign main proceedings or, alternatively, as foreign non-main proceedings. The JPLs sought recognition so as to obtain the US Bankruptcy Court’s assistance in identifying, realising and properly administering the assets of the Funds for the benefit of their stakeholders. In particular, by seeking recognition of the Cayman proceedings as foreign main proceedings, the JPLs sought the benefit of the US automatic stay of actions against the Funds. If, however, recognition was only as non-main proceedings, the JPLs also asked the US court to exercise its discretion to grant such relief.
Recognition as main proceedings
The JPLs essentially relied on the presumption that a debtor’s centre of main interests (COMI) is at the place of its registered office. They argued that because no objections had been filed and the Funds’ registered offices were in the Cayman Islands, the US court should recognise the Cayman provisional liquidation proceedings as main proceedings. They relied, for this purpose, on dicta in the US Bankruptcy Court’s decision in Re SPhinx, which also involved a petition for recognition of Cayman provisional liquidation proceedings.
Lifland J rejected this approach and declined to grant recognition of the Cayman proceedings as main proceedings on the basis of non objection. Recognition was not a ‘rubber stamp exercise’. To the extent the dicta in Re SPhinx suggested mere non objection was sufficient, he disagreed with it.
The US judge also emphasised that the presumption that COMI was at the place of the debtor’s registered office was only ‘[i]n the absence of evidence to the contrary’. Lifland J agreed with Re Tri-Continental Exchange Ltd in stating that the burden of proof remained with the foreign representative seeking recognition as a main proceeding – the registered office did not have special evidentiary value. In this case, there was ample evidence – provided by the JPLs’ own pleadings – that the Funds’ COMI was in the US, not the Cayman Islands. Some of the factors cited were as follows:
- there were no employees or managers in the Cayman Islands;
- the investment manager for the Funds was located in New York;
- the back-office operations were run in the US along with the Funds’ books and records;
- all of the Funds’ liquid assets were located in the US (until some were transferred post petition);
- accounts receivables were located throughout Europe and the US; and
- there were apparently pre-petition transactions conducted in the US that may have been voidable under US law.
Lifland J held that the presumption that COMI was in the Cayman Islands had been rebutted. The evidence showed that both Funds’ COMIs was in the US and, accordingly, he refused to grant recognition of the Cayman provisional liquidation proceedings as foreign main proceedings.
Recognition as non-main proceedings
The JPLs’ alternative submission was that the Funds had an establishment in the Cayman Islands that entitled the provisional liquidation proceedings to be recognised as non-main proceedings.
On this point also, Lifland J disagreed. The Funds were Cayman exempted limited liability companies. As such, they were prohibited by statute from engaging in business in the Cayman Islands except in furtherance of their business otherwise carried on outside of the Cayman Islands. To demonstrate some form of non-transitory economic activity in these circumstances would be difficult and, indeed, the JPLs failed to do so. Lifland J found that the only activities carried out locally were those activities necessary to the Funds’ offshore business. Any cash account funds on deposit in the Caymans arrived only after the Cayman Islands proceedings were initiated. Accordingly, he held that the JPLs should fail on their alternative submission – the proceedings were not foreign non-main proceedings.
Where did this leave the JPLs?
As the US Bankruptcy Court refused to recognise the Cayman provisional liquidation proceedings as foreign main or non-main proceedings, none of the relief available under Chapter 15, discretionary or otherwise, was available to the JPLs.
Despite this, Lifland J stated that the JPLs could obtain relief from the US courts if they commenced plenary proceedings under Chapter 7 (liquidation) or Chapter 11 (reorganisation). There would then be some flexibility under the Bankruptcy Code to co-ordinate with the foreign proceeding.
Appeal against refusal
On 26 September, Lifland J granted a stay pending appeal by the JPLs of the US court’s decision. Part of the terms of granting the stay was that the JPLs for each of the Funds are required to deposit with the court, or in separate bank accounts, the sums and property transferred to the Cayman Islands after the filing of the Chapter 15 petition. As an alternative, the order provides that the JPLs may deposit $4m for each Fund into separate bank accounts. While the stay pending appeal is in force, the Funds have the benefit of the injunction staying any actions or proceedings against their assets in the US.
What does this mean for you?
This decision makes it clear that recognising a foreign proceeding in the US under Chapter 15 is not a rubber stamping exercise. Rather, the determination of a foreign proceeding requires the US court to look at whether the definitions for main or non-main have been satisfied. It will not be sufficient merely that there are no objections to recognition.
Chapter 15 directs the US court to seek guidance from the application of similar statues by foreign jurisdictions. Lifland J noted that the US was where the Funds conducted the administration of their interests on a regular basis and was therefore ascertainable by third parties – the test used for determining COMI under the EC Regulation on Insolvency Proceedings. As with previous decisions of the US Bankruptcy Court, such as Re SPhinx, the ECJ’s decision in Re Eurofood was also cited to assist the court in its finding on COMI.
However, it appears from the judgment that the US court’s approach differs from that adopted by the ECJ in Re Eurofood when considering COMI. In referring to the test under Chapter 15 that COMI is presumed to be the debtor’s registered office ‘[i]n the absence of evidence to the contrary’, Lifland J examined its legislative history. This indicated that the presumption was included for speed and convenience of proof where there is no serious controversy. This contrasts with the ECJ’s decision, which held that the COMI presumption would be rebutted only by reference to criteria that are ‘both objective and ascertainable by third parties’. It would seem, therefore, that there is a subtle difference in the weight given to the presumption by the two courts.
Commentators expect further corporate collapses in view of the current market turmoil, and it is inevitable that there will be cross-border elements to many of these where recognition of foreign insolvency proceedings is sought in the US (among other jurisdictions). This decision is helpful in clarifying a few of the issues regarding Chapter 15 recognition and in reasserting the need for the US court to consider the definitional requirements of recognition as main or non-main proceedings that dicta in Re SPhinx had suggested were not always necessary.
However, the decision is unhelpful in that it means offshore insolvency officeholders may need to open main US Chapter 7 or Chapter 11 proceedings to obtain the benefit of a US stay. Although the US court is still able to assist, a main Chapter 7 or Chapter 11 application is typically more involved (and therefore expensive) than a Chapter 15 recognition application.
Following this decision, off-shore companies, often used for tax structuring, may struggle to gain recognition in the US of any local insolvency proceedings. The concepts of ‘centre of main interests’ and ‘establishment’, as interpreted by the US court, require a degree of business or non-transitory economic activity to be carried out locally. Such vehicles are often prohibited from carrying out any meaningful economic activity in their local jurisdiction in order to maintain their beneficial tax status. This restricted activity is likely to be a bar, therefore, to recognition under Chapter 15, potentially pushing some foreign insolvency office holders into filing for Chapter 7 or Chapter 11 instead
What is Chapter 15?
Chapter 15 of the US Bankruptcy Code implemented the UNCITRAL Model Law on Cross Border Insolvency in October 2005, replacing the old US section 304. In line with the Model Law, it seeks to encourage judicial co-operation and communication in transnational insolvency cases. A foreign representative may seek recognition in the US of the foreign insolvency proceedings either as foreign main or non-main proceedings. Chapter 15 also applies to cases brought in the US for assistance in a foreign jurisdiction.
What are foreign main or non-main proceedings?
A foreign main proceeding is one pending in the country where the debtor has its COMI. There is a rebuttable presumption that a debtor’s COMI is at the place of its registered office. A foreign non-main proceeding is any other proceeding pending in a country where the debtor has an ‘establishment’ – defined as ‘any place of operations where the debtor carries out a non-transitory economic activity’. Those familiar with the EC Regulation on Insolvency Proceedings will recognise the concepts of COMI and establishment and, indeed, the US Bankruptcy Court has used case law under the regulation to assist in its interpretation of these concepts (in particular, the European Court of Justice (ECJ) decision in Re Eurofood).
What are the implications of recognition?
Recognition brings with it certain relief and the foreign representative is granted various rights. The extent of such relief and the nature of these rights will depend on whether the proceedings are recognised as main or non-main proceedings. For example, main proceedings will have the benefit of the automatic stay of actions against the debtor, whereas in the case of non-main proceedings such a stay is at the discretion of the US Bankruptcy Court. Notably, recognition means that foreign creditors will have the same rights as domestic creditors.