Those of us old enough to remember the passage of the North American Free Trade Agreement (or NAFTA) recall its promise of free movement of goods, services, persons, and capital between Canada, the United States, and Mexico, and greater economic prosperity in each of these countries. Regardless of whether you think that promise was fulfilled, the free movement of goods, services, people, and capital across those territorial boundaries seems to have been fertile ground for international litigation regarding the enforcement of foreign judgments and the continued development of jurisprudence on international comity. Such is the case in Milbank v. Philips Lighting Electronics North America (In re Elcoteq, Inc.), a recent decision where the Bankruptcy Court for the Northern District of Texas tackled issues of comity and the extraterritorial reach of the automatic stay with regard to a Mexican foreclosure of a U.S. debtor’s assets in the “free trade zone.”

Background

Prior to its bankruptcy, Elcoteq, Inc. acquired from Philips Lighting Electronics North America Corporation a manufacturing facility in Juarez, Mexico. The Juarez facility was a participant in the maquiladora program with Mexico, pursuant to which Elcoteq entered into a Maquila Agreement with PCE Mexicana, S.A. de C.V., a Mexican corporation. Under the Maquila Agreement, Elcoteq owned and supplied all of PCE’s equipment and inventory, and paid PCE’s operating costs plus a profit margin. Elcoteq owned 0.2% of PCE; the other 99.8% of PCE (and 100% of Elcoteq) was owned by Elcoteq Holdings, Inc. (Holdings).

Creditors of Elcoteq filed an involuntary petition against it in the Bankruptcy Court for the Western District of Texas. While the involuntary case was pending, Elocoteq and Holdings each commenced a chapter 7 case in the Bankruptcy Court for the Northern District of Texas. After the order for relief was entered in the involuntary case, it was transferred to the Northern District of Texas, where the involuntary and voluntary cases against Elcoteq were consolidated and jointly administered with Holdings’ case, and a trustee was appointed.

While the bankruptcy cases were getting underway, PCE’s workers in Mexico initiated proceedings under Mexican labor law by filing a notice of intent to strike with the local Labor Board in Juarez. The notice named PCE and Philips but not Elcoteq or Holdings. The workers then filed a labor lawsuit for unpaid severance, wages, and other benefits against PCE with the Labor Board and named as defendants PCE and two Philips entities. Only PCE was served with process in the labor lawsuit; neither Philips entity was served. None of the documents associated with the strike or the labor lawsuit mentioned Elcoteq or its ownership of the Juarez maquila.

The labor lawsuit led to the Labor Board entering a “provisional embargo” against the Juarez maquila (which the Board seemed to believe was owned by PCE). A PCE representative signed an agreement with the workers to settle the labor lawsuit for $4 million, but no settlement payment was ever made. Shortly thereafter, the Labor Board sought to foreclose on the Juarez facility assets. Notice of the auction of the assets was posted at the local tax office and city hall. After no bidders showed up, the workers were awarded the assets.

After the workers took ownership of the assets, they immediately sold them to Philips for $2.2 million. The parties indicated in a recital in the purchase agreement that they were aware of Elcoteq’s bankruptcy case. Philips then sold the assets it acquired from the workers to a third party for $1.2 million.

The trustee in Elcoteq’s bankruptcy filed an adversary proceeding to avoid any transfer related to the Mexican labor proceedings and sought to recover from Philips on the basis that it was a subsequent transferee under section 550 of the Bankruptcy Code.

Comity

Philips sought dismissal of the adversary proceeding against it on the grounds of international comity. Philips raised this argument in the context of a Rule 12(b)(1) motion, urging the court to decline to exercise its jurisdiction to hear the merits of the adversary proceeding, on the basis of international comity. (Practice note: although some courts have held that comity seems to have nothing to do with subject matter jurisdiction, the bankruptcy court found a Rule 12(b)(1) motion an appropriate way for Philips to raise the issue of international comity in the adversary proceeding.)

“Comity” is a somewhat complex and nebulous concept. Courts still look to a Supreme Court decision issued over 100 years ago, Hilton v. Guyot, to define comity. In Hilton, the Court stated that comity 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.” Comity is discretionary, but, in general, courts accord comity to another sovereign state’s laws or proceedings if it will not materially prejudice U.S. interests.

The bankruptcy court looked primarily to a Fifth Circuit case, International Transactions Limited v. Embotelladora Agral Regiomontana, SA de CV, which established a five factor test to determine whether to grant international comity: (1) if the foreign judgment was rendered by a court of competent jurisdiction, which had jurisdiction over the cause and the parties; (2) the judgment is supported by due allegations and proof; (3) the relevant parties had an opportunity to be heard; (4) the foreign court follows procedural rules; and (5) the foreign proceedings are stated in a clear and formal record. If these factors are met, then a foreign court’s judgment is conclusive in a federal court, under principles of international comity.

The bankruptcy court began by noting that there is no requirement that Mexican law be identical to U.S. law with respect to due process and notice. However, the court looked to U.S. law for guidance as to what the bare minimum requirements of notice would be to satisfy due process.

The court denied Philip’s motion after finding that Elcoteq did not receive an opportunity to appear and be heard before the Labor Board in the proceeding that resulted in foreclosure of the Juarez maquila – it was never named as a party, and even though the trustee may have been generally aware of the labor lawsuit and may have received notice of the strike proceeding, there was no evidence that the trustee received actual notice of the proposed foreclosure of Elcoteq’s assets or of its right to appear and object. In other words, Elcoteq did not receive actual notice of the particular proceeding in Mexico to which Philips wanted the court to grant comity, and so Philips could not meet its burden of proof under the third factor of the International Transactions test.

Automatic Stay

The court also noted that even if Philips had satisfied every factor of the International Transactions test, it would “find it difficult to decline to exercise its jurisdiction over allegations of improper transactions involving property of a debtor’s bankruptcy estate in violation of the automatic stay.” Although there is a general “presumption against extraterritoriality” with respect to U.S. law, the bankruptcy court concluded that Congress explicitly intended that property of a debtor located outside the territory of the U.S. be considered property of the estate and thus subject to the automatic stay. Thus, where the party that violates the stay is subject to the personal jurisdiction of the bankruptcy court in the United States (as Philips was), that party can be liable for the stay violation, even if the property is located abroad (e.g., Mexico). (Another practice note: the bankruptcy court indicated that in the Fifth Circuit, acts in violation of the automatic stay are voidable, but in this case, no party sought retroactive relief to annul the stay and validate the acts.)

After considering these principles, the bankruptcy court determined that it should hear the merits of the adversary proceeding, which involved allegations of unauthorized transfers of property of the estate after the petition date. To rule otherwise, the court found, would shield Philips from allegations of improper transactions with respect to Elcoteq’s property. Thus, the adversary proceeding against Philips remains pending.

Conclusion

The focus of the bankruptcy court’s analysis of international comity was notice. As the Fifth Circuit stated in International Transactions, “[n]otice is an element of our notion of due process and the United States will not enforce a judgment obtained without the bare minimum requirements of notice.” This case suggest that, under Fifth Circuit law, at a minimum, the notice has to be of the particular judicial action that is the basis for the request for comity; constructive notice of the proceedings (or actual notice of related proceedings) without the opportunity to be heard in the particular proceeding at issue will not suffice. The Elcoteq court’s decision on whether to exercise jurisdiction was likely made easier by the facts here – Elcoteq was not even named as a party in the labor lawsuit, it was materially prejudiced by the foreign proceedings, the foreclosure and sale took place after Elcoteq’s bankruptcy proceedings were underway, and there was evidence in the record indicating that Philips agreed to purchase the maquila assets while acknowledging Elcoteq’s pending bankruptcy proceedings.

As Elcoteq’s property was located in Mexico, however, if the trustee prevails in the adversary proceeding, it is likely the ultimate outcome will depend on the assistance of the Mexican courts.