In a recent opinion,1 the U.S. District Court for the Southern District of New York emphasized that foreign confidentiality statutes do not deprive an American court of the power to order a party subject to its jurisdiction to produce evidence — even though the act of production may be considered a criminal offense in a foreign jurisdiction and subject the party to serious consequences, including imprisonment and fines.
In 1997, Investcorp, a private equity fund, purchased a controlling interest in Werner Holding Co. (PA), Inc., a well-established, privately held company that had been manufacturing and selling ladders and other climbing equipment for decades.2 As is often the case, Investcorp utilized multiple foreign entities, primarily companies located in the Cayman Islands, to hold the Werner stock for its investors.
Werner and its subsidiaries and affiliates, filed for bankruptcy protection on June 12, 2006 and are no longer operating entities.3
On January 24, 2008, a liquidating trust established pursuant to Werner's Chapter 11 plan of reorganization, in performance of its duties under the plan to bring and prosecute all claims belonging to the bankruptcy estate, initiated a fraudulent conveyance action in the US District Court for the Southern District of New York.4
The complaint seeks, among other things, to recover transfers made from Werner to shareholders, insiders and others, of over $330 million in 1997 and over $150 million in 2003, on the grounds that the transfers were fraudulent conveyances under state and federal law. The complaint alleges that various Investcorp entities were the initial recipients of over $100 million of fraudulent conveyances.
Invoking Section 550 of the Bankruptcy Code, which allows the recovery of property transferred to subsequent transferees, plaintiff also named numerous unknown individuals who invested in the defendant Investcorp entities as "Doe" defendants, alleging that they were the ultimate recipients of the fraudulent conveyances.
After filing the complaint, the plaintiff asked Investcorp to identify the individuals to whom it had transferred funds. Investcorp refused and opposed plaintiff's subsequent discovery motion on the grounds that the Court lacked jurisdiction over the individuals and expedited discovery was unwarranted.
The Investcorp defendants later argued that the ultimate parent company of the Investcorp defendants (one of three main Investcorp entities over which Investcorp admitted the Court had jurisdiction), Investcorp Bank B.S.C., is a Bahraini corporation subject to Article 117 of the Central Bank of Bahrain and Financial Institutions Law, which prohibits disclosure of the names and addresses of the Bank's customers. They argued that, under Bahraini law, disclosure of the information by Investcorp, or its affiliated entities, could be a criminal offense resulting in imprisonment, fines and suspension of the Bank's license. They, and their expert, argued that this foreign secrecy law applied even though the investors at issue invested in Cayman entities (not a Bahraini bank) and the identifying information was in the possession of non-Bahraini entities that are not licensees under Article 117.
The District Court's Analysis
The District Court observed that the first question to be resolved in the case was whether the information in question is, in fact, subject to secrecy laws (here, Bahraini law). The Court explained that in making such determination it could consider any relevant material — without regard to its admissibility — including expert opinions, but advised that it was not bound by such opinions, even if uncontradicted. After analyzing competing expert opinions presented by the parties and the text of the Bahraini statute, the Court determined that, for the most part, the information sought by the plaintiff is not subject to the confidentiality provisions of Bahraini law.
The Court went on to explain that, even if foreign law did prohibit disclosure of the information, such foreign law would not necessarily preclude the hedge fund from being ordered to produce it. The Court cited various factors that US courts have considered in determining whether to order a party to disclose information where the party's disclosure of the information would or might violate foreign law. Taking these factors into consideration, the Court held that the United States had a strong interest in enforcing its statutes and the balancing test tipped in favor of plaintiffs, even if Bahraini law prohibited disclosure. The Court required the non-Bahraini Investcorp defendants to produce the names and addresses of the hedge fund's investors that were the ultimate recipients of the alleged fraudulent conveyances.
The Court's analysis demonstrates both Section 550's far-reaching power to look beyond the initial transferee and hold the ultimate recipient of fraudulently transferred property accountable and the Court's power to order a party to produce information even if compliance could potentially lead to criminal penalties under foreign law. Although the specific facts of any situation may alter the analysis, the core elements in this case could apply to many other private equity funds. Funds, particularly those working with foreign entities or investors, should take notice that if a company in their private equity portfolio files for bankruptcy protection, foreign confidentiality laws may not protect the funds from being ordered to identify their investors. Similarly, individual investors should know that foreign confidentiality laws may not protect them from being identified as the ultimate recipient of funds and being named as individual defendants in a lawsuit in the United States.5