Chapter 15 is based on the Model Law on Cross Border Insolvency (the “Model Law”), which had been prepared by the United Nations Commission on International Trade Law (“UNCITRAL”), with significant input from insolvency practitioners all over the world.1 It was designed to create procedures for cooperation among foreign courts where insolvency proceedings are pending in more than one country and establish guidelines for the protection of assets internationally, while being sensitive to the political issues and differing legal systems of the countries involved. Any determination of a request for assistance under Chapter 15 must be “consistent with the principles of comity.”2

“Comity,” in the legal sense, is neither a matter of absolute obligation, on the one hand, nor of mere courtesy and good will, upon the other. But it is the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protection of its laws.3

The grant of comity is not discretionary; however, the determination of whether a court should grant comity is balanced by the language of § 1506, which provides that “[n]othing in this chapter prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States.”4 Whether a request for relief or assistance is “manifestly contrary” to United States public policy is within the discretion of the bankruptcy court to determine.5 The following are summaries of cases that have directly addressed the issues that surround § 1506 and its public policy exception. The summaries begin with those cases that have found certain relief would be manifestly contrary to public policy, followed by cases where the requested relief would not be manifestly contrary to public policy, and lastly a case where the issue may arise fairly soon.

In re Qimonda AG

In re Qimonda AG is probably the most prominent case to delve into the issue of whether relief requested of the court was manifestly contrary to public policy. On October 28, 2011, the Bankruptcy Court for the Eastern District of Virginia issued an opinion in the Chapter 15 case of Qimonda AG

(“Qimonda”).6 The bankruptcy court held that the application of § 365(n)7 to executory licenses to U.S. patents was required to sufficiently protect the interests of U.S. patent licensees under Chapter 15 of the Bankruptcy Code and that the failure of German insolvency law to protect patent licensees was “manifestly contrary” to United States public policy.

Factual Background

Qimonda, a manufacturer of semiconductor memory devices headquartered in Munich, Germany, filed an insolvency proceeding in Munich (the “Munich Proceeding”), and Dr. Michael Jaffé (“Jaffé”) was appointed as the insolvency administrator. Jaffé then filed a petition for recognition under Chapter 15 of the Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of Virginia. The bankruptcy court recognized the Munich Proceeding as a foreign main proceeding.8

Qimonda owned thousands of patents, including U.S. patents. After being unable to sell small packages of the patents, Jaffé decided the best way to realize the value of the patent portfolio was to license the patents and renegotiate existing patent agreements to achieve greater royalties. Jaffé provided notice that Qimonda would not perform under their existing patent licenses pursuant to German Insolvency Code § 103, which provides that executory contracts are automatically unenforceable unless the insolvency administrator, in this case Jaffé, affirmatively elects to perform the contracts. German Insolvency Code § 103 does not provide the same type of protection that is available under Bankruptcy Code § 365(n).

Two U.S. patent licensees, Samsung Electronics Co., Ltd. (“Samsung”) and Elpida Memory, Inc. (“Elpida”) (the “U.S. Licensees”), responded to Jaffé’s notice by asserting that they were entitled to the protections of Bankruptcy Code § 365(n). In an effort to convince the bankruptcy court that he did not intend to take advantage of the U.S. Licensees, Jaffé filed pleadings committing to re-license Qimonda’s patent portfolio at a reasonable and non-discriminatory royalty to be determined through good faith negotiations or through arbitration.

The Bankruptcy Court’s Decision

The court explained that the semiconductor industry is characterized by the existence of a “patent thicket,” such that any given semiconductor device may incorporate technologies covered by a multitude of patents not owned by the manufacturer, and it is difficult, if not impossible, to identify all potential patents or design around each and every patented technology. As a result, semiconductor manufacturers must obtain licenses to many different patents prior to developing new technologies to avoid infringement claims.

Congress’ included § 365(n) in the Bankruptcy Code to remove what had become an unintended burden on American technological development. The court explained that in the absence of appropriate cross-license agreements in the semiconductor industry, “design freedom” gives way to a “hold-up premium” because manufacturers must attempt to license patented technology after potential infringement has already occurred and after an initial, nonrecoverable investment has been made in anticipation of new production.

Jaffé’s expert testified that there was no reason to believe that innovation would be harmed given Jaffé’s commitment to re-license the Qimonda patent portfolio on reasonable and non-discriminatory terms. Jaffé’s expert also explained that a decision applying § 365(n) would only preserve rights in the licensing of U.S. patents, not the non-U.S. patents, which would have to be renegotiated. Jaffé’s expert calculated that Qimonda would lose approximately $47 million dollars in revenues if the U.S. Licensees did not have to pay for the continued right to use the U.S. patents.

The court first addressed whether limiting the applicability of § 365(n) “appropriately balanced” the interests of Qimonda and the U.S. Licensees. The court determined that the application of § 365(n) to the U.S. patents was required to ensure that the interests of the U.S. Licensees were “sufficiently protected” under Bankruptcy Code § 1522(a). While the court recognized that the “hold-up premium” caused by requiring the re-license of the U.S. patents was lessened by Jaffé’s promise to re-license the U.S. patents on reasonable and non-discriminatory terms, the risk to the substantial investments that the U.S. Licensees had made in research and manufacturing facilities in reliance on the design freedom provided by the agreements outweighed any loss of revenue to the Qimonda estate.

The court then addressed whether granting comity to German insolvency law would be “manifestly contrary to the public policy of the United States” within the meaning of Bankruptcy Code § 1506. The court explained that the public policy exception to granting comity to applicable foreign law must be limited to the most fundamental policies of the United States, and the fact that application of foreign law results in a different outcome than applying U.S. law is insufficient to deny comity. The court explained that in order to be manifestly contrary to public policy, foreign law must either (i) be procedurally unfair or (ii) severely impinge a U.S. statutory or Constitutional right in a way that would offend the most fundamental policies and purposes of such right.

The court acknowledged that no party had claimed, nor was there any reason to find, that German insolvency law or proceedings were procedurally unfair. Instead, the court focused on the second basis for the public policy exception to comity. The court determined that German insolvency law, as it applies to licenses to U.S. patents, implicated the statutory right found in Bankruptcy Code § 365(n). While the bankruptcy court recognized that Congress did not make the protection of § 365(n) automatic upon recognition in a Chapter 15 proceeding, and that the harm discussed in the legislative history of § 365(n) differed from the “hold-up premium” discussed by the U.S. Licensees, the court determined that the uncertainty resulting from not applying § 365(n) would slow the pace of innovation to the detriment of the U.S. economy and that under the circumstances of this case and this industry the failure to apply § 365(n) would “severely impinge” an important statutory protection accorded licensees of U.S. patents and thereby undermine a fundamental U.S. public policy promoting technological innovation.

There is some question as to whether the bankruptcy court’s holdings in Qimonda will be affirmed on appeal given the high threshold regarding the meaning of “manifestly contrary.” Additionally, questions remain as to whether other courts would reach the same conclusions in other Chapter 15 cases involving intellectual property given the Qimonda court’s limitation of its holdings to these particular circumstances and the semiconductor industry.9

In re Toft

On July 22, 2011, Bankruptcy Judge Allan L. Gropper for the Southern District of New York issued an opinion in the Chapter 15 case of In re Dr. Jürgen Toft. The court declined to grant recognition to a German administrator because the “order of recognition on the terms requested would be manifestly contrary to U.S. public policy.”10

Factual Background

Creditors of Dr. Jürgen Toft (“Toft”) filed a bankruptcy petition in a German insolvency court hoping to collect debts owed by Toft. The German court appointed Dr. Martin Prager (“Prager”) as insolvency administrator to investigate Toft’s affairs and attempt to locate Toft’s assets. Toft proved to be uncooperative and evasive and began selling estate assets without the German court’s permission, squandering the opportunity for his creditors to receive any sort of recovery. In an effort to prevent further loss of estate assets, Prager obtained orders in Germany and England that allowed Prager to intercept Toft’s postal mail and e-mail, providing information for Prager’s investigation.

Prager filed a Chapter 15 petition for recognition of a foreign main proceeding with the Bankruptcy Court for the Southern District of New York. Along with the petition, Prager sought ex parte interim relief in the form of a court order allowing him access to Toft’s two e-mail accounts stored on servers located in the U.S. as well as the redirection of future e-mails from these accounts.

The Bankruptcy Court’s Decision

In support of the requested interim relief, Prager appealed to the principle of comity and argued that the court should enter an ex parte order similar to the German and English orders already obtained and grant Prager access to Toft’s e-mail accounts. The court held that the requested relief would be manifestly contrary to public policy because disclosure of Toft’s e-mails would violate the Electronic Communications Privacy Act, a bankruptcy trustee would not be entitled to such relief, and Chapter 15 relief cannot ordinarily be obtained without notice to the debtor.

The court began by addressing the Wiretap Act and the Stored Communications Act, each a subpart of the Electronic Communications Privacy Act (the “Privacy Act”).11 The Wiretap Act imposes criminal and civil penalties on a person who intentionally intercepts electronic communications. The court found that allowing Prager secret access to Toft’s e-mail accounts would compromise Toft’s privacy rights, which are protected by a comprehensive statutory scheme founded on the fundamental rights protected by the Fourth Amendment and many of the States’ constitutions.12

The court next looked to the powers typically granted to a representative of an estate under U.S. law. Prager sought the right to inspect Toft’s e-mail accounts by pointing to (i) the broad nature of Federal Rule of Bankruptcy Procedure 2004, (ii) case law supporting a bankruptcy trustee’s ability to obtain a court order to search an uncooperative debtor’s home, and (iii) cases that allowed a bankruptcy trustee to intercept a debtor’s postal mail. The court declined to see the parallels in each instance. While Rule 2004 is broad and may be commenced by an ex parte motion, the procedures do not remain secret once an order is entered. Additionally, in the context of e-mails, the plain language of the Privacy Act provides procedures that allow for “wiretaps,” which are only available to law enforcement officials and, in most instances, are only available to those parties who can obtain a search warrant under Federal Rule of Criminal Procedure 41(a). A bankruptcy trustee is not one of those parties. Finally, the court pointed to differences between each of the cases allowing a trustee to inspect a home or intercept postal mail and the secret nature of the relief Prager requested. In each case, the debtor was either notified prior to the inspection of the home or the mail or other measures were made to maintain privacy interests. Prager’s request did not include these safeguards.

The court last addressed Prager’s request to refrain from providing notice to Toft. The court noted that Bankruptcy Rule 2002(q) was specifically included to require notice in Chapter 15 cases; thus, presumably only a rare situation would allow for the court to disregard Rule 2002(q). The court decided this was not such a situation.

The court found that under all three principles, privacy, powers of estate representatives, and notice, not only would the requested relief be contrary to United States law, it would be manifestly contrary to public policy to grant such relief. In contrast to the German and English rulings, the United States court denied Prager’s motion for ex parte relief in its entirety.

In re Ephedra Products Liability Litigation

On July 22, 2011, United States District Judge Jed S. Rakoff for the Southern District of New York issued an opinion relating to the Chapter 15 case of In re Muscletech Research and Development, Inc. and in general the In re Ephedra Products Liability Litigation.13 The district court held that the Claims Resolution Procedures negotiated in the Canadian Proceeding and enforced through the Chapter 15 proceeding in the U.S. were not manifestly contrary to United States public policy.

Factual Background

Muscletech Research and Development, Inc. (“Muscletech”) marketed products that contained ephedra prior to the FDA banning the substance in 2004. The sometimes harmful side-effects of ephedra led more than thirty separate actions for personal injury and wrongful death to be brought against Muscletech in both state and federal court. Assumedly as a means of managing its liability, Muscletech commenced an insolvency proceeding in Canada (the “Canadian Proceeding”). RSM Richter, Inc. was appointed as Monitor (the “Monitor”) of Muscletech and eventually sought and was granted recognition of the Canadian proceeding as a foreign main proceeding under Chapter 15. As a result of recognition under Chapter 15, the state and federal civil actions were transferred and consolidated in the district court before Judge Rakoff.

In the Canadian Proceeding, the Monitor negotiated a procedure for speedily assessing and valuing creditors’ claims, including those of the U.S. plaintiffs, all of which had filed claims in the Canadian Proceeding. The Monitor then sought enforcement of these procedures in the U.S. through the Chapter 15 by filing a motion under §§ 105(a) and 1521(a) of the Bankruptcy Code. Four parties objected to the motion arguing that enforcement of such an order in the U.S. would be manifestly contrary to public policy because it deprives the objectors of due process and the right to a jury trial.

The Bankruptcy Court’s Decision

The district court, due to a few amendments having already been made to the order the objectors were attacking, quickly dismissed any arguments that the procedures would violate due process rights. Regarding the right to trial by a jury, the Monitor argued that the objectors waived their right when they filed claims in the Canadian Proceeding. The district court addressed the issue by reflecting upon the limited nature of the public policy exception provided by § 1506. Referring to Hilton v. Guyot and a long line of other cases, the district court explained that not affording the objectors the right to a jury trial does not inherently make the procedures manifestly contrary to U.S. public policy.

Although 28 U.S.C. § 1411 represents the importance the U.S. has placed in retaining the right to jury trials in the context of personal injury cases, the lack of a jury does not prevent a verdict from being fair and impartial. The district court explained that the objectors’ main thrust of their argument was that the lack of a right to a jury trial would weaken their bargaining position in settlement negotiations. “Deprivation of such bargaining advantage hardly rises to the level of imposing on plaintiffs some fundamental unfairness.” Because the objectors would still retain the right to a fair and impartial proceeding, the district court held that the enforcement of the procedures would not be manifestly contrary to public policy.

In re Gold & Honey, Ltd.

In In re Gold & Honey, Ltd. the Bankruptcy Court for the Eastern District of New York issued an opinion that denied the recognition of foreign main proceedings because they were pursued in violation of the automatic stay.14 Following the seizure of assets and the commencement of an Israeli receivership proceeding in July of 2008, Gold & Honey, Ltd. and Gold & Honey (1995) L.P. (the “Debtors”) filed for Chapter 11 relief in the Eastern District of New York in September of 2008. The court entered an order specifying that the automatic stay applied to all assets of the Debtors, wherever they are located. Despite the application of the automatic stay, the Debtor’s lender continued to pursue the receivership in Israel, and eventually obtained the appointment of receivers, who subsequently filed Chapter 15 petitions in the United States.

The court refused to recognize the Israeli receivers’ petitions because they were appointed in violation of the automatic stay and because the proceedings were not “foreign proceedings” under the Bankruptcy Code because they were not collective in nature. The court explained that acquiescing to a creditor’s offensive violation of the automatic stay would “ensue in derogation of fundamental United States policies” and would be manifestly contrary to public policy under § 1506.15

In re Petition of Ernst & Young, Inc.

Ernst & Young, Inc. filed a petition for recognition of a foreign main proceeding on behalf of Klytie’s Developments, Inc. (“KDI”), a Canadian entity formed by two Israeli citizens for the development of real estate throughout the world.16 The parties opposing the petition argued that the recognition of KDI’s foreign proceeding would be manifestly contrary to public policy because (1) Colorado and American investors would receive less in the foreign proceeding than they would receive in a proceeding run in Colorado or federal court and (2) the costs of running the proceeding outside of the United States would deplete the assets of KDI. The court did not find either argument persuasive and held that there was no evidence to support a finding that recognition of the foreign proceeding would be manifestly contrary to public policy.

In re think3 Inc.

In re think3 Inc. is a Chapter 11 case filed in the Bankruptcy Court for the Western District of Texas. think3 is a Delaware corporation and a global leader in the computer-aided design and product lifecycle management software market. A dispute arose when Italian creditors (including the Italian government) filed an involuntary insolvency against think3 and its Italian subsidiary in Italy and the Italian court appointed a trustee in Italy (the “Italian Trustee”). Shortly after commencement of proceedings in Italy, think3 filed for relief under Chapter 11 in the Western District of Texas. The Italian Trustee sought recognition of the Italian proceeding as the foreign main proceeding under Chapter 15 in the Western District of Texas.

The court ultimately denied the Italian Trustee’s petition for recognition, refusing to grant recognition as a foreign main proceeding or a foreign nonmain proceeding. Although the court’s decision was not based on whether recognition would be manifestly contrary to public policy, think3 argued that recognition would be manifestly contrary within its objection to the Italian Trustee’s petition. think3 raised the argument because (1) the Italian Trustee had refused to comply with discovery requests, (2) the Italian Trustee’s unilateral termination of a License Agreement violated 365(n) under the same theory as Qimonda, and (3) the Italian Trustee continued to take actions in violation of the automatic stay.

In re Vitro, S.A.B. de C.V.

On June 13, 2012, the United States Bankruptcy Court for the Northern District of Texas (the “Bankruptcy Court”) published an opinion ruling on whether the Mexican Plan of Reorganization (the “Concurso Plan”) of the Mexican glass-manufacturing company, Vitro, S.A.B. de C.V., approved by the Federal District Court in Mexico, should be enforced under Chapter 15 of United States Bankruptcy Code.17 The Bankruptcy Court concluded that the Concurso Plan should not be accorded comity to the extent that it extinguishes the guaranties held by the Debtor’s non-debtor subsidiaries in favor of thirdparty noteholders. In the Bankruptcy Court’s view, such an order would be manifestly contrary to the public policy of the United States. The Bankruptcy Court’s opinion joins a very short list of cases that address the public policy exception under § 1506 of the Bankruptcy Code.

Case Background

The Vitro Concurso Plan, as originally proposed and ultimately approved in Mexico, eliminated any recourse certain noteholders held against Vitro’s non-debtor subsidiaries. The noteholders were not pleased. Vitro then filed a petition in the United States seeking recognition of the Mexican reorganization case as a foreign main proceeding under Chapter 15 of the Bankruptcy Code. Recognition was granted on July 21, 2011.

In August 2011, a group of noteholders filed suit in New York state court against the subsidiaries. The New York court ruled in favor of the noteholders, finding that the indentures prevented non-consensual modification of the subsidiaries’ guaranties because the subsidiaries expressly waived any rights under Mexican law.

The Mexican court approved the Concurso plan on February 3, 2012, and Vitro proceeded to consummate the plan, issuing new notes and debentures, effectively discharging the obligations of Vitro’s non-debtor subsidiaries, and funding trusts for the payment of claims. Approval of the Concurso plan discharged Vitro’s obligations to the noteholders under the original notes and released claims against the subsidiaries under the guaranties. Vitro then filed its motion to enforce the Concurso Plan in the United States and sought a permanent injunction of collection efforts against its subsidiaries pursuant to §§ 105, 1507, and 1521 of the Bankruptcy Code. Certain noteholders filed objections to the enforcement motion (the “Objecting Parties”).

The Bankruptcy Court’s Conclusions

The Bankruptcy Code does not define “manifestly contrary to public policy” but the public policy exception of § 1506 is meant to be narrowly construed and used only to defend the most fundamental policies of the United States. The courts primarily focus on two factors:

  1. whether the foreign proceeding was procedurally unfair; and
  2. whether the application of foreign law or the recognition of a foreign main proceeding under Chapter 15 would “severely impinge the value and import” of a U.S. statutory or constitutional right, such that granting comity would “severely hinder United States bankruptcy courts’ abilities to carry out . . . the most fundamental policies and purposes of these rights.18

The Bankruptcy Court rejected the arguments of the noteholders regarding corruption of the Mexican judiciary, impact on the credit markets from approval of the Concurso Plan, and general unfairness of the Mexican proceedings and noted that these objections would more appropriately be handled by the Mexican courts, noting that an appeal of the Concurso had already been filed in Mexico.

The Bankruptcy Court recognized that the United States has a general policy against the discharge of entities other than a debtor in an insolvency proceeding and denied the enforcement motion for three reasons. First, the Concurso Plan does not substantially comply with the distribution scheme prescribed by the Bankruptcy Code. Under the Bankruptcy Code, the Objecting Parties would receive distributions from Vitro and also be able to recover any deficiencies from the non-debtor subsidiary guarantors. The Concurso Plan, however, provides for drastically smaller recoveries and extinguishes guarantor liability. Second, the Concurso Plan does not sufficiently protect creditors’ interests as required by § 1521(a) in a manner that is balanced with the interests of Vitro. Third, protection of third party claims in a bankruptcy case is a fundamental policy of the United States, and because the Concurso Plan extinguishes these claims, it is manifestly contrary to that public policy and is unenforceable.

The Bankruptcy Court also noted, but did not rule on, two other “meritorious” arguments of the Objecting Parties. Insiders, including intercompany claims, were allowed to vote on the Concurso Plan even though bonds were issued shortly before the Concurso proceeding under questionable circumstances. Also, the Concurso plan arguably violated the absolute priority rule because the holders of equity in Vitro retained significant value when the creditors were not paid in full.

The Bankruptcy Court stated that generally, Concurso plans would be enforced in the United States; however, the Vitro plan was unenforceable. The Bankruptcy Court stayed its decision until June 29th to allow Vitro an opportunity to appeal the Bankruptcy Court’s decision and seek a stay on appeal. Vitro filed a request for a direct appeal to the Fifth Circuit pursuant to 11 U.S.C. § 158(d), and the Bankruptcy Court granted Vitro’s request on June 21, 2012. Shortly after, the Fifth Circuit entered an order keeping the temporary restraining order entered by the Bankruptcy court in place during the pendency of the appeal.

Continued Uncertainty

Case law regarding § 1506’s public policy exception is sparse; however, the drastic departure of the Vitro Concurso Plan from confirmable Chapter 11 plans may prove to be enough to establish a fundamental public policy regarding the dischargability of third-party claims.