On April 16, 2013, in Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.),1 the US Court of Appeals for the Second Circuit issued an important decision informing fundamental concepts of cross-border insolvency law as implemented pursuant to Chapter 15 of the Bankruptcy Code. In an issue of first impression for the court, the Second Circuit provided guidance on the determination of a foreign debtor’s “center of main interests” (COMI) for purposes of determining whether to grant recognition of a foreign insolvency proceeding as a “foreign main proceeding” in an ancillary case under Chapter 15.

The court held that the relevant period for determining a foreign debtor’s COMI is the time of the filing of the Chapter 15 petition and not when the underlying foreign proceeding was commenced, provided that a court may evaluate the gap period between the commencement of the foreign proceeding and the filing of the Chapter 15 petition to determine whether a COMI was manufactured in bad faith. Also, in another issue of first impression, the Second Circuit provided guidance on the application of the “public policy exception” to granting relief under Chapter 15 found in Section 1506 of the Bankruptcy Code. The court’s holding was consistent with a majority of courts construing the Section 1506 public policy exception narrowly.

Background of Chapter 15

Chapter 15 largely incorporates the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law; it was enacted to facilitate cooperation and coordination with foreign proceedings, to facilitate fair and efficient administration of cross-border insolvencies and to protect and maximize a foreign debtor’s USbased assets. Under Chapter 15, a foreign representative of the foreign debtor files a petition for recognition by the US bankruptcy court of a foreign insolvency proceeding as either a “foreign main proceeding” or a “foreign nonmain proceeding.” Recognition of a foreign insolvency proceeding as a “foreign nonmain proceeding” enables a foreign representative to seek broad discretionary relief from the US bankruptcy court, while recognition of a foreign proceeding as a “foreign main proceeding” affords a foreign representative certain automatic relief, including application of the “automatic stay” of Section 362 of the Bankruptcy Code to the debtor and property of the debtor within the territorial jurisdiction of the United States.2

Section 1502 of the Bankruptcy Code defines a foreign main proceeding as a “foreign proceeding pending in the country where the debtor has the center of its main interests,” and defines a foreign nonmain proceeding as a “foreign proceeding, other than a foreign main proceeding, pending in a country where the debtor has an establishment.” Accordingly, an important determination in the context of a Chapter 15 petition is the location of the debtor’s COMI. The Bankruptcy Code creates a rebuttable presumption that a debtor’s COMI is the country where the debtor has its registered office; however, the Bankruptcy Code does not otherwise define COMI. Morning Mist clarifies the issue of the relevant time period for determining a debtor’s COMI.

Under Section 1506 of the Bankruptcy Code, the bankruptcy court may deny a foreign representative relief to which it is otherwise entitled under Chapter 15 if such relief is “manifestly contrary to the public policy of the United States” (i.e., the “public policy exception”). Morning Mist also provides clarity as to the appropriate interpretation of the public policy exception.

Morning Mist

FACTUAL BACKGROUND

The case arose from the Chapter 15 filing of Fairfield Sentry Ltd. (Sentry), the largest of the “feeder funds” that invested roughly 95 percent of its assets, or more than US$7 billion, with Bernard L. Madoff Investment Securities LLC (BLMIS). Sentry administered its business interests from the British Virgin Islands (BVI), where its registered office, registered agent, registered secretary and corporate documents, among other things, were located. When Bernard Madoff was arrested in December 2008, Sentry’s independent directors refocused Sentry’s administration on the wind down of its business and the preservation of assets in anticipation of litigation and bankruptcy.

In July 2009, a BVI court commenced liquidation proceedings under BVI law and appointed liquidators with custody and control of all assets of Sentry (the BVI Proceeding). On June 14, 2010 (the Petition Date), Sentry’s authorized representatives petitioned the US Bankruptcy Court for the Southern District of New York (the Bankruptcy Court) for recognition of the BVI Proceeding as a “foreign main proceeding” under Chapter 15.

As of the Petition Date, Sentry had millions of dollars of liquid assets in Ireland, the United Kingdom and the BVI, as well as billions of dollars of claims on account of customer funds, redemption for false profits and similar redemption claims. The Bankruptcy Court found that Sentry had no place of business, no management and no tangible assets located in the United States; the Bankruptcy Court further found that Sentry had severed its ties with BLMIS and other US businesses long before the Petition Date. The Bankruptcy Court ultimately granted the petition for recognition of the BVI Proceeding as a “foreign main proceeding.”

Morning Mist Holdings Ltd. (Morning Mist), a Sentry shareholder that had filed a derivative action on behalf of Sentry in a New York state court prior to the commencement of the BVI Proceeding, appealed the recognition order of the Bankruptcy Court. Morning Mist argued that, when considering Sentry’s full operational history, Sentry’s COMI was not in the BVI and that, accordingly, Sentry should not enjoy the benefit of the US-based stay of proceedings that would follow such a finding. The US District Court for the Southern District of New York affirmed the order of the Bankruptcy Court. Morning Mist appealed to the Second Circuit, and the Second Circuit affirmed.

OPINION OF THE SECOND CIRCUIT

The primary issue before the Second Circuit was whether Sentry’s COMI was in the BVI. The court held that the determination is based on a debtor’s COMI at the time of filing of the Chapter 15 petition, not at the commencement of the foreign proceeding. The Second Circuit further held, however, that a court may look at the period between the commencement of the foreign proceeding and the filing of the Chapter 15 petition to ensure that the debtor has not manipulated its COMI in bad faith. Aside from temporal considerations, the Second Circuit held that courts may consider any number of factors in determining COMI, including the debtor’s liquidation activities in anticipation of litigation and bankruptcy.

Recognizing that few courts have examined the meaning of COMI under Chapter 15 with respect to the applicable time frame for determining COMI, the Second Circuit looked to the text of the statute, the opinions of other federal courts and international sources to reach its holding.The court found that the reference to COMI in the present tense in Section 1517 of the Bankruptcy Code (which speaks to the requirements for granting a Chapter 15 petition) suggests that a court should examine a debtor’s COMI at the time of the filing of the Chapter 15 petition.3 This interpretation is consistent with the interpretation of the Fifth Circuit in In re Ran, 607 F.3d 1017 (5th Cir. 2010).

The court also rejected the argument that the “principal place of business” test, which is an American jurisdictional concept that requires consideration of a debtor’s full operational history, should control the COMI analysis; however, the court noted that the “principal place of business” test may be useful in this analysis. Lastly, the court found international sources informative because such sources underscored the importance of factors that indicate regularity and ascertainability of a debtor’s COMI to third parties, but the court otherwise found these international sources to be of limited use in determining the relevant time frame for assessing COMI under Chapter 15.

The Second Circuit provided no limits on what other factors could be examined by a court in determining COMI. The Second Circuit held that any relevant activities, including liquidation activities and administrative functions, may be considered in the COMI analysis. In sum, a debtor’s COMI will be determined upon the facts and circumstances of each unique case. The Second Circuit ultimately found no clear error in the Bankruptcy Court’s findings of fact, which supported the conclusion that Sentry’s COMI was in the BVI as of the Petition Date and that Sentry had not manufactured its COMI in bad faith.

PUBLIC POLICY EXCEPTION

Morning Mist also argued that the BVI court restricted public access to the BVI Proceeding in several ways and that the private and confidential nature of the BVI Proceeding was “manifestly contrary to the public policy of the United States” within the meaning of Section 1506 of the Bankruptcy Code.

The application of Section 1506 was an issue of first impression before the Second Circuit, which applied the exception narrowly, consistent with a majority of other US federal courts. The Second Circuit cited the legislative history, which states that “[t]he word ‘manifestly’ in international usage restricts the public policy exception to the most fundamental policies of the United States.” Although the preservation of the right to inspect and copy judicial records is an important public policy objective of US law, the Second Circuit noted that such right is a qualified right, not an absolute right. The court further noted that public summaries of the BVI Proceeding were available, and that nonparties could have applied to the BVI court for access to sealed documents. The court, therefore, concluded that there was no basis to hold that the recognition of the BVI Proceeding was manifestly contrary to US public policy.

Implications of the Morning Mist Decision

In addition to applying the Section 1506 public policy exception narrowly, Morning Mist importantly provides circuit-level guidance on the determination of a foreign debtor’s COMI. Morning Mist holds that the relevant period for determining a foreign debtor’s COMI is the time of the filing of the Chapter 15 petition and not when the underlying foreign proceeding commenced, and that a court also may evaluate the period between the commencement of the foreign proceeding and the filing of the Chapter 15 petition to determine whether a COMI was manufactured in bad faith. Although COMI jurisprudence will continue to develop on a case-by-case basis, leaving much of the outcome dependent on the factual findings made by the bankruptcy court, Morning Mist undoubtedly provides clarity to such jurisprudence by establishing temporal guidelines for the analysis.