Recognition Under Chapter 15

In Bear Stearns, the joint provisional liquidators (JPLs) appointed in Cayman liquidation proceedings involving the two funds ' each organized under Cayman Islands law with its registered office there ' filed Chapter 15 petitions seeking recognition of the Cayman liquidation proceedings as main proceedings or, in the alternative, nonmain. This 'main' or 'nonmain' distinction determines if certain relief, such as the imposition of the automatic stay to protect property of the debtor located in the U.S., applies automatically upon recognition, or might otherwise be available based on the court's discretionary powers to order appropriate relief. At least one legal commentator has stated that coding a foreign proceeding as either main or nonmain is now a prerequisite to obtaining relief under Chapter 15 ' a view cited and adopted by the Court in Bear Stearns. However, in In re Schefenacker plc, (Bankr. S.D.N.Y., June 14, 2007) (Case No. 07-11482), we acted as counsel for the foreign representatives seeking recognition of a UK company voluntary arrangement (CVA) and enforcement of the CVA in the U.S. Chief Judge Bernstein agreed with our arguments that the CVA clearly qualified as either a main or nonmain and the injunctive relief requested would be available in either case, so the Court entered an order recognizing the foreign proceeding, as either main or nonmain, and enforcing the CVA in the U.S.

To obtain recognition of a foreign proceeding as 'main,' a foreign representative must demonstrate that the foreign proceeding is pending in the foreign debtor's center of main interests (COMI). COMI is not defined in the U.S. Bankruptcy Code, but Chapter 15 (like the Model Law) affords a presumption that, in the absence of evidence to the contrary, a debtor's registered office is the location of its COMI. In Bear Stearns, Judge Lifland found sua sponte that this presumption had been rebutted because the following evidence (taken directly from the debtors' Chapter 15 petitions) suggested the debtors' COMI was located outside the Cayman Islands: 1) the debtors had no managers or employees in the Cayman Islands; 2) the debtors' investment manager was located in the U.S.; 3) the debtors' back office operations and books and records were located in the U.S.; and 4) the debtors' liquid assets were located in the U.S. Furthermore, Judge Lifland found that the debtors' investor registries were maintained in the Republic of Ireland, their accounts receivables were located in the U.S. and throughout Europe, and their counterparties to financial contracts were based inside and outside the U.S., but none was located in the Cayman Islands. Finally, Judge Lifland noted the possibility that certain pre-petition transactions conducted by the debtors in the U.S. might be avoidable under U.S. law. Thus, Judge Lifland found that the debtors' COMI was the U.S., 'the place where [the debtors] conduct the administration of their interests on a regular basis and is therefore ascertainable by third parties, and, more specifically, is located in [the Southern District of New York] where principal interests, assets, and management are located.' Judge Lifland rejected the notion (based on Sphinx) that the court had some pragmatic authority to recognize the Cayman proceedings as main proceedings because no party had objected to such recognition ' a result that would reduce the recognition process to 'a rubber stamp exercise.'

The JPLs argued alternatively that if recognition could not be accorded as main, then the Cayman proceedings should be recognized as nonmain. Here, the threshold determination would turn on whether the debtors have an 'establishment' in the Cayman Islands. Judge Lifland reviewed the definition of 'establishment,' which means 'any place of operations where the debtor carries out nontransitory economic activity.' Judge Lifland noted the debtors
are 'exempted companies' under Cayman law, and as such the debtors are precluded from engaging in business in the Cayman Islands, except in furtherance of their business activities carried on outside the Cayman Islands. This distinction is perhaps a red-herring because the Cayman exempted companies law limits the business activities that exempted companies can engage in with residents of the Cayman Islands, but it does not otherwise limit the scope of operations such company can conduct from the Cayman Islands to support offshore activities. In any event, Judge Lifland found that there was no pertinent nontransitory economic activity conducted locally in the Cayman Islands by the debtors. Judge Lifland held there could be no finding of a seat for local business activity or a proxy for having an establishment in the Cayman Islands.

Judge Lifland denied recognition under Chapter 15, but suggested the JPLs were not without a remedy because they could proceed with involuntary, plenary bankruptcy cases under Chapters 7 or 11. The JPLs recently announced their intention not to commence full-blown U.S. bankruptcy cases because doing so would be expensive and reduce recoveries for the debtors' creditors.

Commentary and Practice Points

While the Bear Stearns decision is on appeal, the decision may have only limited application to Chapter 15 cases that involve letterbox companies that do not carry out any business in the jurisdiction of their registration. Indeed, a similar threshold recognition issue is present in In re Basis Yield Alpha Fund (Bankr. S.D.N.Y.) (Case No. 07-12762 (REG)), a Chapter 15 case involving another failed hedge fund registered in the Cayman Islands and subject to insolvency proceedings there. In Basis Yield, Bankruptcy Judge Gerber stated in an initial scheduling conference that, regardless of whether there are any objections to recognition, the court would require the foreign representatives to provide direct evidence of the debtors' connection to the Cayman Islands before any recognition or relief could be granted.

Bear Stearns nevertheless suggests some pre-bankruptcy planning could avoid stumbling on the hurdles to relief under Chapter 15. In Bear Stearns, the court found recognition to be a formulaic determination, which is the intent of the Model Law and ensures greater predictability in cross-border insolvencies. Foreign debtors and their would-be foreign representatives therefore might take steps before commencing any Chapter 15 case to ensure the foreign representatives can demonstrate the debtor's connections to the foreign jurisdiction where their proceeding is pending. Such planning must be implemented subject to a careful review of the debtor's organizational documents and applicable law (including tax law). In addition to a registered office, potential Chapter 15 debtors can take steps to ensure they have material property located in such jurisdiction. Maintaining an actual office to conduct operations, maintain records or otherwise support foreign operations would also militate in favor of recognition. In effect, establishing that jurisdiction as the place from which the debtor conducts business on a regular basis so as to be ascertainable by third parties, and where the debtor's principal interests, assets, and management are located (if possible), particularly when the debtor seeks recognition as 'main'. If the debtor cannot overcome the threshold inquiry to establish COMI in the place of its registered office, such planning efforts should allow recognition as nonmain based on having an 'establishment' in that jurisdiction (i.e., something more than a letterbox).

The Bear Stearns decision may well withstand the appeal as a correct interpretation of Chapter 15. The statutory rigidity the decision suggests, however, is arguably improvident as a policy matter. The court suggested the JPLs had the alternative to file involuntary, plenary bankruptcy cases under Chapter 7 or 11, but this would have resulted in dual plenary proceedings in the U.S. and the Cayman Islands, which would at the very least result in increased administrative costs at the expense of the debtors and their creditors. There are Chapter 11 cases where U.S. jurisdiction is predicated on nothing more than a bank account in the US. It would be difficult to explain why, as a matter of policy, more is required in a foreign jurisdiction before it can be recognized in the U.S. Finally, requiring plenary U.S. cases in Bear Stearns would deny the Cayman Islands' courts primacy in determining how best to liquidate Cayman organized entities, a result that seems to disregard the robust insolvency process that applies in the Cayman Islands, a sister common law jurisdiction where parties in interest are subject to the same principles of fairness and due process that would apply in any U.S. court.

Ken Coleman ([email protected]) is a partner and co-head of the US restructuring group in the New York office of Allen & Overy LLP. Daniel Guyder ([email protected]) is an associate in the U.S. restructuring group.

The U.S. Bankruptcy Court for the Southern District of New York recently held in two related cases under Chapter 15 of the U.S. Bankruptcy Code involving failed hedge funds ' Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd. (Case No. 07-12383) and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund, Ltd. (Case No. 07-12384) ' that the mere presence of a registered office in the Cayman Islands, without 'pertinent' nontransitory economic activity in the Cayman Islands, was insufficient to recognize Cayman liquidation proceedings as 'main' or 'nonmain' and therefore the court denied relief under Chapter 15. In so holding, Bankruptcy Judge Burton Lifland parted with the more flexible approach to recognition, as noted in dicta in In re Sphinx, Ltd., 351 B.R. 103, 117 (Bankr. S.D.N.Y. 2006), providing that if no party objects, the bankruptcy court ' as a pragmatic matter ' could recognize a foreign proceeding as a nonmain proceeding despite the absence of any adhesive connection with the Cayman Islands beyond a registered office. The Bear Stearns decision highlights the rigid barriers to relief under Chapter 15. It is supported by the wording of the statute, but is the statute furthering the right policy? Should a statute intended to foster international cooperation in insolvency cases deny relief in support of well-established, common law foreign insolvency regimes?

The Bear Stearns decision is on appeal, but in the interim potential debtors (and their advisors) might be advised to undertake pre-bankruptcy planning to increase the likelihood the debtor will satisfy the formulaic determination of eligibility for relief under Chapter 15. In effect, the repealed ' 304 of the US Bankruptcy Code, Chapter 15 was added to the Code with the 2005 amendments to adopt the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law (the 'Model Law').

The Decision

In Bear Stearns, the joint provisional liquidators (JPLs) appointed in Cayman liquidation proceedings involving the two funds ' each organized under Cayman Islands law with its registered office there ' filed Chapter 15 petitions seeking recognition of the Cayman liquidation proceedings as main proceedings or, in the alternative, nonmain. This 'main' or 'nonmain' distinction determines if certain relief, such as the imposition of the automatic stay to protect property of the debtor located in the U.S., applies automatically upon recognition, or might otherwise be available based on the court's discretionary powers to order appropriate relief. At least one legal commentator has stated that coding a foreign proceeding as either main or nonmain is now a prerequisite to obtaining relief under Chapter 15 ' a view cited and adopted by the Court in Bear Stearns. However, in In re Schefenacker plc, (Bankr. S.D.N.Y., June 14, 2007) (Case No. 07-11482), we acted as counsel for the foreign representatives seeking recognition of a UK company voluntary arrangement (CVA) and enforcement of the CVA in the U.S. Chief Judge Bernstein agreed with our arguments that the CVA clearly qualified as either a main or nonmain and the injunctive relief requested would be available in either case, so the Court entered an order recognizing the foreign proceeding, as either main or nonmain, and enforcing the CVA in the U.S.

To obtain recognition of a foreign proceeding as 'main,' a foreign representative must demonstrate that the foreign proceeding is pending in the foreign debtor's center of main interests (COMI). COMI is not defined in the U.S. Bankruptcy Code, but Chapter 15 (like the Model Law) affords a presumption that, in the absence of evidence to the contrary, a debtor's registered office is the location of its COMI. In Bear Stearns, Judge Lifland found sua sponte that this presumption had been rebutted because the following evidence (taken directly from the debtors' Chapter 15 petitions) suggested the debtors' COMI was located outside the Cayman Islands: 1) the debtors had no managers or employees in the Cayman Islands; 2) the debtors' investment manager was located in the U.S.; 3) the debtors' back office operations and books and records were located in the U.S.; and 4) the debtors' liquid assets were located in the U.S. Furthermore, Judge Lifland found that the debtors' investor registries were maintained in the Republic of Ireland, their accounts receivables were located in the U.S. and throughout Europe, and their counterparties to financial contracts were based inside and outside the U.S., but none was located in the Cayman Islands. Finally, Judge Lifland noted the possibility that certain pre-petition transactions conducted by the debtors in the U.S. might be avoidable under U.S. law. Thus, Judge Lifland found that the debtors' COMI was the U.S., 'the place where [the debtors] conduct the administration of their interests on a regular basis and is therefore ascertainable by third parties, and, more specifically, is located in [the Southern District of New York] where principal interests, assets, and management are located.' Judge Lifland rejected the notion (based on Sphinx) that the court had some pragmatic authority to recognize the Cayman proceedings as main proceedings because no party had objected to such recognition ' a result that would reduce the recognition process to 'a rubber stamp exercise.'

The JPLs argued alternatively that if recognition could not be accorded as main, then the Cayman proceedings should be recognized as nonmain. Here, the threshold determination would turn on whether the debtors have an 'establishment' in the Cayman Islands. Judge Lifland reviewed the definition of 'establishment,' which means 'any place of operations where the debtor carries out nontransitory economic activity.' Judge Lifland noted the debtors
are 'exempted companies' under Cayman law, and as such the debtors are precluded from engaging in business in the Cayman Islands, except in furtherance of their business activities carried on outside the Cayman Islands. This distinction is perhaps a red-herring because the Cayman exempted companies law limits the business activities that exempted companies can engage in with residents of the Cayman Islands, but it does not otherwise limit the scope of operations such company can conduct from the Cayman Islands to support offshore activities. In any event, Judge Lifland found that there was no pertinent nontransitory economic activity conducted locally in the Cayman Islands by the debtors. Judge Lifland held there could be no finding of a seat for local business activity or a proxy for having an establishment in the Cayman Islands.

Judge Lifland denied recognition under Chapter 15, but suggested the JPLs were not without a remedy because they could proceed with involuntary, plenary bankruptcy cases under Chapters 7 or 11. The JPLs recently announced their intention not to commence full-blown U.S. bankruptcy cases because doing so would be expensive and reduce recoveries for the debtors' creditors.

Commentary and Practice Points

While the Bear Stearns decision is on appeal, the decision may have only limited application to Chapter 15 cases that involve letterbox companies that do not carry out any business in the jurisdiction of their registration. Indeed, a similar threshold recognition issue is present in In re Basis Yield Alpha Fund (Bankr. S.D.N.Y.) (Case No. 07-12762 (REG)), a Chapter 15 case involving another failed hedge fund registered in the Cayman Islands and subject to insolvency proceedings there. In Basis Yield, Bankruptcy Judge Gerber stated in an initial scheduling conference that, regardless of whether there are any objections to recognition, the court would require the foreign representatives to provide direct evidence of the debtors' connection to the Cayman Islands before any recognition or relief could be granted.

Bear Stearns nevertheless suggests some pre-bankruptcy planning could avoid stumbling on the hurdles to relief under Chapter 15. In Bear Stearns, the court found recognition to be a formulaic determination, which is the intent of the Model Law and ensures greater predictability in cross-border insolvencies. Foreign debtors and their would-be foreign representatives therefore might take steps before commencing any Chapter 15 case to ensure the foreign representatives can demonstrate the debtor's connections to the foreign jurisdiction where their proceeding is pending. Such planning must be implemented subject to a careful review of the debtor's organizational documents and applicable law (including tax law). In addition to a registered office, potential Chapter 15 debtors can take steps to ensure they have material property located in such jurisdiction. Maintaining an actual office to conduct operations, maintain records or otherwise support foreign operations would also militate in favor of recognition. In effect, establishing that jurisdiction as the place from which the debtor conducts business on a regular basis so as to be ascertainable by third parties, and where the debtor's principal interests, assets, and management are located (if possible), particularly when the debtor seeks recognition as 'main'. If the debtor cannot overcome the threshold inquiry to establish COMI in the place of its registered office, such planning efforts should allow recognition as nonmain based on having an 'establishment' in that jurisdiction (i.e., something more than a letterbox).

The Bear Stearns decision may well withstand the appeal as a correct interpretation of Chapter 15. The statutory rigidity the decision suggests, however, is arguably improvident as a policy matter. The court suggested the JPLs had the alternative to file involuntary, plenary bankruptcy cases under Chapter 7 or 11, but this would have resulted in dual plenary proceedings in the U.S. and the Cayman Islands, which would at the very least result in increased administrative costs at the expense of the debtors and their creditors. There are Chapter 11 cases where U.S. jurisdiction is predicated on nothing more than a bank account in the US. It would be difficult to explain why, as a matter of policy, more is required in a foreign jurisdiction before it can be recognized in the U.S. Finally, requiring plenary U.S. cases in Bear Stearns would deny the Cayman Islands' courts primacy in determining how best to liquidate Cayman organized entities, a result that seems to disregard the robust insolvency process that applies in the Cayman Islands, a sister common law jurisdiction where parties in interest are subject to the same principles of fairness and due process that would apply in any U.S. court.

Ken Coleman ([email protected]) is a partner and co-head of the US restructuring group in the New York office of Allen & Overy LLP. Daniel Guyder ([email protected]) is an associate in the U.S. restructuring group.