The November/December 2007 issue of Insolvency Notes featured an article highlighting a Manhattan-based federal bankruptcy court's refusal to officially recognize proceedings commenced in the Cayman Islands to liquidate two Bear Stearns-managed hedge funds that collapsed in June of that year. Given the number of funds managed on-shore but registered in the Caymans and other off-shore jurisdictions, the bankruptcy court's opinion has received considerable attention, as recognition can have major effects on the rules and procedures governing the restructuring or liquidation of such funds, including who will control the process.1 As noted in our article, the Cayman liquidators appealed the ruling. The United States District Court for the Southern District of New York considered the appeal and has recently affirmed the bankruptcy court's holdings in all respects.2
Recognition of Foreign Insolvency Proceedings
Recognition of a foreign proceeding, in its current form, is a relatively new concept that materialized in U.S. law when Congress added chapter 15 to the Bankruptcy Code as Title VIII of the Bankruptcy Abuse and Prevention and Consumer Protection Act of 2005. Prior to the enactment of chapter 15, American courts did not focus on “recognition” so much as on specific requests for relief from representatives of foreign proceedings (e.g., foreign trustees, administrators and liquidators), evaluating such requests subjectively by relying on the principles of comity of nations. Chapter 15, by contrast, requires a foreign representative of a foreign proceeding to obtain a bankruptcy court order granting recognition to the foreign proceeding in order for the foreign representative to access nearly any kind of non-provisional relief available in courts in the United States.
Under chapter 15, a bankruptcy court should recognize a foreign proceeding as the main insolvency proceeding respecting the debtor if the proceeding is pending in the country in which the debtor has the "center of its main interests," or "COMI." If the debtor's COMI is in another country but the debtor has a place of business operations in the country where the proceeding is pending, recognition of the proceeding is still possible but the relief available to the foreign representative is more limited in scope, as the law assumes the jurisdiction where the debtor has its COMI should take the lead in coordinating the debtor's insolvency. Chapter 15 also establishes a presumption that a debtor's registered office is its COMI. At issue in the Bear Stearns cases were the appropriate standards and procedures for recognition and the role of the bankruptcy judge when there are no objections to recognition.3
The Cayman Liquidators Seek Recognition
The Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd. and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Master Fund, Ltd. are each Cayman Islands-registered, “exempted,” open investment limited liability companies. After the Funds' assets dramatically decreased in value as a result of the subprime mortgage crisis in the United States, various secured creditors of the Funds realized on their collateral, and certain buyers under repurchase agreements with the Funds sold the subject purchased assets, cutting off the Funds' ability to repurchase them. The Funds then filed winding-up petitions under the Cayman Companies Law and obtained the appointment of the Cayman liquidators. On the same day, the liquidators, as foreign representatives of the Cayman proceedings, filed petitions in the United States Bankruptcy Court for the Southern District of New York for recognition of those proceedings.
The bankruptcy court declined to recognize the Cayman proceedings, holding that information included with the liquidators' petitions indicated that the Funds' COMI was in the United States, overcoming the presumption that the COMI was in the Cayman Islands, and that the Funds lacked a place of business operations in the Cayman Islands, even though no party objected to recognition. The information included, among other things, evidence that the Funds' asset manager and their administrator of back-office operations are located in the United States together with their books and records and that virtually all the liquid assets of the Funds were located in the United States before commencement of the proceedings. The bankruptcy court also found that the Funds' investors, to the extent they were registered in the Cayman Islands, were entities with the same minimum profile as the Funds, and it noted that there were no employees or managers there. Ultimately, the court found that the Funds engaged in no economic activity in the Cayman Islands and thus denied the requests for recognition.
The District Court Decision
On appeal, the liquidators argued that the bankruptcy court failed to take principles of comity and international cooperation properly into account and that it erroneously failed to apply the COMI presumption. In rejecting the first argument, the district court held that considerations of comity and cooperation do not come directly into play in determining whether to recognize a foreign insolvency proceeding. In order to foster increased predictability and reliability, chapter 15 requires that objective eligibility requirements be met for recognition to result. While the district court acknowledged that courts retain considerable discretion to decide whether and how to grant a foreign representative's requests for relief, it held that the ability of a foreign representative to gain access to the courts under chapter 15 or general principles of comity is now conditioned on recognition and its objectively ascertainable prerequisites.
The district court also disagreed with the liquidators' argument that the COMI presumption should be conclusive if recognition is unopposed. It held that a bankruptcy court may infer the location of a debtor's COMI from the location of its registered office unless other evidence calls that supposition into question. Unfortunately for the liquidators, the district court found no fault with the bankruptcy court's evaluation of facts that led the bankruptcy court to the conclusion that the Funds' COMI was in the United States. Significantly, the district court noted that the Funds' "exempted" status under Cayman law severely limits the kind of activities that they may undertake in the Cayman Islands, essentially restricting them to transaction of business in other countries. Since the activities of the Funds in the Cayman Islands (auditing, preparation of legal documents and investigation of insider transactions) were not economic in nature, they could not form a basis for recognition. Accordingly, the bankruptcy court properly denied the petitions for recognition.
The affirmance of the holdings of the bankruptcy court in the Bear Stearns case in the influential Southern District of New York sends a strong signal to those engaged in transactions involving off-shore funds, particularly those organized as "exempted" companies under Cayman law: it may be impossible for liquidators of such funds to obtain US recognition of local insolvency proceedings concerning them. Without recognition, foreign representatives of insolvency proceedings concerning the funds generally will be cut-off from judicial relief in the United States, which may lead to the commencement of full-scale chapter 7 or chapter 11 bankruptcy cases in the United States concerning them. That, in turn, may significantly impact the administration of the assets of such funds as well as the distribution to creditors and investors.