Chapter 15 of the Bankruptcy Code provides a procedure to obtain recognition of a foreign bankruptcy, insolvency or debt adjustment proceeding (a “foreign proceeding”) in the United States. Chapter 15 draws a distinction between a “foreign main proceeding” (i.e., a foreign proceeding pending in a country where the debtor has the center of its main interests) and a “foreign nonmain proceeding” (i.e., a foreign proceeding pending where the debtor has “an establishment”). Upon recognition of a foreign main proceeding, certain protections arise automatically in favor of the foreign debtor, including the imposition of an automatic stay. Recognition of a foreign nonmain proceeding does not trigger any automatic protections.
Upon recognition of either a foreign main or foreign nonmain proceeding, a court may grant “additional assistance” under section 1507 and/or “appropriate relief” under section 1521. Such relief is discretionary and subject to the public policy exception set forth in section 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.” Thus, a United States court may, for public policy reasons, refuse to extend comity to a foreign court’s order or grant relief that would seemingly aid the administration of a foreign estate.
Courts have regularly noted that the public policy exception should be narrowly construed and limited to the most fundamental policies of the United States. In one of the early Chapter 15 decisions, for example, a court concluded that the lack of a right to a jury trial in a foreign proceeding did not trigger the public policy exception. Additionally and, as discussed in our February issue, see “Important 2011 Rulings on Foreign Proceedings,” several courts in more recent decisions have refused to grant recognition to foreign proceedings or foreign orders that implicated privacy concerns or due process rights. In a separate instance, a court applied section 365(n) of the Bankruptcy Code, which permits a licensee to continue to use intellectual property notwithstanding the licensor’s rejection, to a Chapter 15 case where the court was convinced that the absence of the 365(n) protection would create uncertainty in the intellectual property markets and “undermine a fundamental U.S. public policy promoting technological innovation.” Despite these decisions, the scope of the pubic policy exception limitation remains unclear.
A case that may ultimately result in some clarity on the public policy exception is the recent decision by the United States Bankruptcy Court for the Northern District of Texas denying the request of Vitro, S.A.B. de C.V for an order enforcing its Mexican concurso in the United States. The decision is currently on appeal to the Court of Appeals for the Fifth Circuit.
The bankruptcy court in Vitro concluded that the United States has a policy against the discharge of claims against a non-debtor. In denying Vitro’s request for an order enforcing its Mexican concurso in the United States, the bankruptcy court determined that the concurso would extinguish creditors’ claims against non-debtors. According to the court, such a discharge would be manifestly contrary to United States public policy and should not be countenanced. The bankruptcy court was seemingly less troubled by other features of Vitro’s concurso, including insider voting and retention of value by equity. Nevertheless, the court noted these “two other strong objections” for the appellate court.
A concurso is a tool commonly used by Mexican companies to restructure their debt. Given the unique aspects of Vitro’s concurso, the Vitro decision would not necessarily support the denial of recognition of other Mexican concursos.
However, the bankruptcy court’s public policy analysis (and that of the appellate court) may have repercussions beyond this case.
Vitro, the largest manufacturer of glass containers and flat glass in Mexico, suffered a dramatic decline in operating income as a result of the global economic and financial crisis that began in 2008. The decline in its operating income caused Vitro to default on certain financial obligations, including $1.216 billion in outstanding notes. Those notes were unsecured, but guaranteed by certain subsidiaries of Vitro, including some located in the United States.
In an effort to restructure its financial obligations, Vitro filed a voluntary judicial reorganization proceeding in Mexico and proposed a pre-packaged restructuring plan under Mexican law (i.e., a concurso). Vitro’s concurso provided for, among other things, a reduction of principal and interest payments and an extension of the maturity dates of the notes. In connection with the voluntary judicial reorganization proceeding, Vitro filed a petition under Chapter 15 with the bankruptcy court. The bankruptcy court granted recognition to Vitro’s voluntary judicial reorganization proceeding on July 21, 2011. At that time, the bankruptcy court did not consider recognition of the concurso, as it had not yet been approved in Mexico, or issue an injunction for the benefit Vitro’s subsidiaries.
A group of noteholders opposed approval of the concurso in Mexico. In addition, they sued certain non-debtor subsidiaries of Vitro that had guaranteed repayment of the notes in New York state court. Months of contested litigation followed in multiple venues. On February 3, 2012, the Mexican federal district court issued an order approving Vitro’s concurso. In addition to restructuring Vitro’s obligations, including those owed to the noteholders, the order approving the concurso extinguished the non-debtor subsidiary guarantees. Despite the terms of the Mexican court’s order approving the concurso, the noteholders continued to attempt to recover from the guarantors in the United States. In response, Vitro requested an order from the bankruptcy court under sections 1507 and 1521 enforcing the Mexican court’s order approving the concurso in the United States and enjoining certain actions against Vitro and its non-debtor subsidiary guarantors.
The noteholders objected to Vitro’s request for several reasons. First, according to the noteholders, the concurso was the result of an unfair and corrupt Mexican judicial system. Second, they argued that the concurso would have an adverse effect on the financial markets. Finally, the noteholders argued that the concurso was manifestly contrary to United States public policy and therefore should not be enforced by the bankruptcy court.
Bankruptcy Court’s Analysis
After a four-day trial, the bankruptcy court summarily dispensed with the majority of the noteholders’ objections. According to the bankruptcy court, there was no evidence of corruption in the Mexican judicial system. Moreover, any objection concerning the Mexican court’s unfairness or the legal process should be addressed in Mexico and not in the United States. In addition, the noteholders’ evidence, although credible, did not sufficiently quantify the adverse effect that enforcement of the concurso would have on the United States financial markets. Therefore, the bankruptcy court could not confirm that enforcement would have an adverse effect in the United States. Nevertheless, the bankruptcy court ultimately denied Vitro’s request for an order enforcing the concurso in the United States for three reasons, all of which related to the concurso’s restrictions on the noteholders’ ability to collect against the non-debtor guarantors.
First, according to the bankruptcy court, Vitro had failed to satisfy the requirements of section 1507, which governs a request for “additional assistance.” In particular, the concurso’s proposed distribution was not “substantially in accordance with the order prescribed” by the Bankruptcy Code. According to the bankruptcy court, under chapter 11, a creditor would be entitled to a distribution from Vitro’s estate and would “be free” to assert its rights against any other obligor, including a non-debtor guarantor. The concurso, however, eliminated a creditor’s recourse against Vitro’s non-debtor affiliate guarantors. Second, the concurso arguably did not sufficiently protect the interests of creditors to grant relief under section 1521, which governs a request for “appropriate relief.” According to the court, the concurso entrusted the distribution of the assets of the non-debtor subsidiary guarantors to Vitro without sufficiently protecting creditors. Finally, the concurso improperly extinguished the noteholders’ claims against the non-debtor subsidiary guarantors in violation of the United States’ policy against the discharge of claims against a non-debtor. According to the court, Congress expressed this policy in section 524. Combining its statutory interpretation with the Fifth Circuit case law that “has largely foreclosed non-consensual non-debtor releases,” the court concluded that this policy is a fundamental one. Thus, according to the bankruptcy court, enforcement of Vitro’s concurso would violate section 1506 in that the concurso was manifestly contrary to the United States public policy of preserving a creditor’s rights and claims against a non-debtor.
Other Unresolved Issues
In denying Vitro’s request, the bankruptcy court stressed that it was most troubled by the unique aspects of Vitro’s concurso and, in particular, the elimination of claims against the non-debtor guarantors. As such, the bankruptcy court’s decision should not be interpreted as barring recognition of other Mexican concursos in the United States. Indeed, according to the bankruptcy court, it “would expect that [future] Concurso decisions would be enforced in this country.” Having concluded that it would not enforce Vitro’s concurso because it impermissibly discharged claims against the non-debtor guarantors, the bankruptcy court noted, but refused to address the merits of, the noteholders’ contention that enforcement of the concurso would be manifestly contrary to United States public policy because the concurso violated the United States prohibition against insider voting and the retention of value by equity unless creditors are paid in full (i.e., the absolute priority rule). It nevertheless highlighted these issues for the appellate court.
Third party releases are not uncommon in the United States. Nevertheless, relying on its statutory interpretation and existing Fifth Circuit case law, the bankruptcy court in Vitro concluded that the United States has a fundamental policy against the discharge of claims against a non-debtor. Thus, the bankruptcy court refused to enforce Vitro’s concurso, because the release contained therein was, in its view, manifestly contrary to United States public policy.
In its analysis, the Fifth Circuit will presumably comment on the scope of the public policy exception and the ability to grant recognition to a foreign proceeding that effectuates a discharge of claims against a non-debtor. It may compare the lower court’s decision to the decision by the Bankruptcy Court for the Southern District of New York in In re Metcalfe & Mansfield Alt. Invs., 421 B.R. 685 (Bankr. S.D.N.Y. 2010).
There, the court granted recognition to a Canadian order that contained a third party release. According to the bankruptcy court, Vitro differs from Metcalfe in that non-insider creditors overwhelmingly supported Metcalfe’s plan, there was no timely objection to Metcalfe’s plan and the release contained in Metcalfe’s plan was more limited. Regardless of the outcome of the appeal, the Fifth Circuit’s public policy analysis and its determination on whether the policy against the discharge of claims against a non-debtor is a fundamental one will likely have significant influence on future requests for recognition in the United States, and in particular the ability to recognize non-debtor releases approved by foreign courts.
The bankruptcy court’s decision has been “certified” for direct appeal to the Court of Appeals for the Fifth Circuit, thereby bypassing the District Court. Oral argument was held on October 3, 2012 before the Fifth Circuit. As of the date of this publication, the Fifth Circuit had not yet ruled.