Tradex: Requirements and Limitations of Chapter 15's Nonmain Recognition

Statutory Hurdles to Recognition

Chapter 15 has been described as a flexible approach to cross-border insolvencies. See, e.g., In re SPhinX, LTD. (“In re SPhinX“), 351 B.R. 103, 114 (Bankr. S.D.N.Y. 2006) aff'd, In re SPhinX, LTD. (“In re SPhinX II“), 371 B.R. 10 (S.D.N.Y. 2006). The Chapter's recognition scheme, however, does not reflect that flexibility. In re Bear Stearns High-Grade Structured Credit Master Fund, Ltd. (“In re Bear Stearns“), No. 07-12383, 07-8730, 2008 WL 2198272 at *7 (S.D.N.Y. May 22, 2008) (“Recognition turns on the strict application of the objective criteria”). Recognition under Chapter 15 is not automatic. A foreign representative must file a Chapter 15 petition, accompanied by either: 1) a foreign decision authorizing the foreign proceeding and appointing a representative; or 2) other appropriate proof of the proceeding and the representative. 11 U.S.C. ' 1515. A United States bankruptcy court, in turn, must find that the foreign proceeding is a foreign main proceeding or a foreign nonmain proceeding, the foreign representative is a person or body and the application meets the filing requirements noted above. 11 U.S.C. ' 1517(a).

Strict recognition procedures begin with the definitions of foreign main proceeding and foreign nonmain proceeding. Chapter 15 defines a foreign main proceeding as a “foreign proceeding pending in the country where the debtor has the center of its main interests.” 11 U.S.C. ' 1502(4). By contrast, a foreign nonmain proceeding is a proceeding “pending in a country where the debtor has an establishment,” 11 U.S.C. ' 1502(5). The term “establishment” is defined as “any place of operations where the debtor carries out nontransitory economic activity.” 11 U.S.C. ' 1502(2).

The practical difference between main and nonmain recognition can be reduced to the difference between mandatory and discretionary relief. Section 1520 of the Bankruptcy Code provides that upon main proceeding recognition:

(a) the automatic stay under Bankruptcy Code section 362 (as well as the creditors' right to adequate protection and relief from the automatic stay under sections 361 and 362(a) of the Bankruptcy Code) applies with respect to the debtor and its property within the territorial jurisdiction of the United States, (b) sections 363, 549 and 552 of the Bankruptcy Code apply to restrict the ability to transfer such property absent court approval, and (c) unless the court orders otherwise, the foreign representative may operate the debtor's business and exercise the rights and powers of a trustee under Bankruptcy Code sections 363 and 552. In re SPhinX, 351 B.R. at 115.

By contrast, ' 1521 provides courts with the discretion to grant all foreign debtors relief, including ' 1520 relief, but only “to protect the assets of the debtor or the interests of the creditors.” 11 U.S.C. ' 1521.

Chapter 15 has as a goal increased cooperation and the fair and efficient administration of insolvency proceedings. Cooperation, however, does not mandate the consolidation of concurrent proceedings or grant foreign liquidators jurisdiction over domestic assets. Section 1521 enables a bankruptcy court to subject a debtor's assets to a foreign liquidator if creditors in the United States are sufficiently protected but, in a foreign nonmain proceeding, limits relief to “assets that, under the law of the United States, should be administered in the foreign nonmain proceeding or concerns information required in that proceeding.” 11 U.S.C. ” 1521(b)-(c). Under section 305(a)(2), a court may grant a foreign representative standing to seek the dismissal or suspension of an involuntary proceeding only if a petition under ' 1515 for recognition of a foreign proceeding has been granted and the purposes of Chapter 15 would best be served by such dismissal or suspension. 11 U.S.C. ” 305(a)(2).

Recent High-Profile Cases

Prior to the Tradex decision, Southern District of New York bankruptcy and district courts issued a series of high-profile rulings addressing recognition under Chapter 15. See, e.g., In re Basis Yield Alpha Fund (Master), No. 07-12762 (REG), 2007 WL 4723359 (Bankr. S.D.N.Y. Jan. 16, 2008), aff'd, 381 B.R. 37, 46 (Bankr. S.D.N.Y. 2008); In re Bear Stearns High-Grade Structured Credit Master Fund, Ltd. (“In re Bear Stearns II“), 374 B.R. 122 (Bankr. S.D.N.Y. 2007). Each case involved a hedge fund registered in the Cayman Islands and subject to corporate law limiting fund operations there. The following recognition principles arise out of the decisions:

• The ' 1516(c) presumption that the center of the debtor's main interests (the “COMI”) is its registered office is rebuttable and does not shift the burden of persuasion regarding the COMI's location away from the debtor.
• Factors that could be relevant to determination of the COMI include, but are not limited to, “the location of the debtor's headquarters; the location of those who actually manage the debtor (which, conceivably could be the headquarters of a holding company); the location of the debtor's primary assets; the location of the majority of the debtor's creditors or of a majority of the creditors who would be affected by the case; and/or the jurisdiction whose law would apply to most disputes.” In re Bear Stearns II, 374 B.R. at 128.
• Courts will evaluate if recognition is appropriate even absent an objection to the debtor's petition for Chapter 15 relief.
• Auditing services and the preparation of incorporation documents do not comprise sufficient economic activity to evidence the existence of an establishment for nonmain recognition.
• A failure to maintain assets in the country which is the site of the foreign proceeding limits the scope of available relief under ' 1521(c) and “supports the conclusion that nonmain recognition would be inappropriate.” In re Bear Stearns, 2008 WL 2198272 at *13.

The bankruptcy court and district court SPhinX decisions, which approved nonmain recognition, pre-dated the Bear Stearns and Basis Yield rulings. SPhinX, however, offers little guidance regarding nonmain recognition. The SPhinX courts apparently did not consider the extent of the debtor's nontransitory economic activity in its “home” jurisdiction, the Cayman Islands, and, instead, assumed that all foreign proceedings warranted either main or nonmain recognition. Accordingly, evidence that the debtor's COMI was outside the Cayman Islands supported nonmain recognition. In re SPhinX II, 371 B.R. at 17. Subsequent courts have required evidence of an “establishment” for nonmain recognition.

In re Tradex

On Nov. 1, 2007, the Swiss Federal Banking Commissioner issued a bankruptcy decree against Tradex. The decree followed a Massachusetts state court ruling directing the appointment of a receiver for Tradex if bankruptcy proceedings were not initiated by Nov. 12, 2007. On Nov. 7, certain of Tradex's creditors (the “Petitioning Creditors”) filed for involuntary relief under Chapter 7. Approximately three weeks later, Tradex filed a Chapter 15 petition, seeking recognition of the Swiss proceedings and consolidation of the Chapter 15 and Chapter 7 cases. Ultimately, Tradex sought to subject the “U.S. assets and claims ' [to] the auspices of the foreign representatives.” In re Tradex, 384 B.R. at 40.

Tradex does not resemble either the Basis Yield or Bear Stearns debtors. It is not a hedge fund registered in a foreign tax haven or subject to any law that limits the scope of its operations in its home jurisdiction. Instead, Tradex is a foreign exchange trading company built on an Internet trading platform. Tradex previously maintained its operations in Switzerland and is still registered there. Prior to its insolvency, however, Tradex moved its operations to Boston. At the petition date, only three people (including Tradex's owner) worked in Tradex's Switzerland office. Id. at 39.

Tradex sought recognition of the Swiss insolvency proceeding as either a main or nonmain proceeding. According to the court, the Swiss office with its three employees established sufficient presence to collapse the recognition analysis into a question of main versus nonmain recognition. Id. at 42. Main recognition, the court concluded, was unwarranted because most of Tradex's creditors, assets and operations resided in Boston. While Tradex may have maintained an establishment in Switzerland, its COMI was in Boston. Id. at 44.

Turning to Tradex's request that the court grant the foreign liquidators the right to distribute assets located in the United States, the court noted that the Petitioning Creditors sought Chapter 7 relief almost three weeks before Tradex's Chapter 15 petition date. Id. at 37. In fact, by the time of the recognition ruling, the Chapter 7 trustee had begun administering the debtor's domestic assets. As a result, despite the award of nonmain recognition, the Bankruptcy Court refused to halt the Chapter 7 proceedings or stop the Chapter 7 trustee from administering the domestic estate and determined that the Chapter 15 and Chapter 7 proceedings would proceed concurrently. Id. at 44.

Analysis

Naturally, few hedge fund managers anticipate their funds' failure and eventual liquidation. Despite best-laid plans, however, some investment strategies will fail and some funds will liquidate. Many such failing institutions will be registered in the Cayman Islands. The Bear Stearns and Basis Yield decisions indicate that United States bankruptcy courts will not recognize foreign insolvency proceedings where the debtor is registered in but maintains few other contacts with a foreign jurisdiction. The rulings do not address exactly what presence is necessary to warrant recognition.

Conclusion

Assuming the court considered only Tradex's operations at the petition date (and not the previous Swiss operations), the Tradex decision may outline the bare minimum necessary for nonmain recognition. At its petition date, Tradex maintained in Switzerland one office and three employees (one of whom was the owner). Yet, the office with its limited personnel constituted an establishment under ' 1502. Nonmain recognition did not require significant economic activity in Switzerland. Along similar lines, while no entity can rewrite its past dealings with its “home” jurisdiction or change laws that limit its activities there, a financial institution sensing an oncoming insolvency would be well advised to at least consider, to the extent possible, establishing a tangible presence in its home country in order to support nonmain recognition down the road.

Michael J. Sage is a partner of the law firm O'Melveny & Myers LLP. He specializes in the areas of bankruptcy, restructuring and reorganization and may be reached at 212-728-5942 or [email protected]. Joshua Weisser is an associate and specializes in the areas of bankruptcy, restructuring and reorganization and may be reached at 212-326-2176 or [email protected].

Entities that commence foreign insolvency proceedings often seek recognition of those proceedings in United States bankruptcy courts under Chapter 15 in order to administer assets located in the United States and stay United States creditors. The Chapter's objectives include cooperation, greater legal certainty, fair and efficient administration of cross-border insolvencies, the protection and maximization of the debtor's asset value, and facilitation of troubled entities' reorganization. 11 U.S.C. ” 1501(a)(1)-(5).

A series of high-profile decisions issued within the past year addressed Chapter 15's strict recognition procedures and denied recognition to proceedings involving hedge funds registered in the Cayman Islands. Their collective takeaway is clear. An entity registered in a foreign tax haven that maintains little contact with that foreign jurisdiction will not receive Chapter 15 recognition of any foreign insolvency proceeding commenced there.

Recently, a Massachusetts bankruptcy court in In re Tradex also considered Chapter 15's recognition procedures. In re Tradex Swiss AG (“In re Tradex“), 384 B.R. 34 (Bankr. D. Mass. 2008). The resulting decision did not question the previous rulings; it instead applied the precedent to different facts. In doing so, the court explored nonmain recognition's requirements and the interaction between Chapter 15 and other Bankruptcy Code Chapters. Ultimately, the Tradex decision outlines precautionary steps foreign entities may take prior to filing for Chapter 15 relief to help prove the existence of a foreign nonmain proceeding and limitations of any resulting award of recognition.

Statutory Hurdles to Recognition

Chapter 15 has been described as a flexible approach to cross-border insolvencies. See, e.g., In re SPhinX, LTD. (“In re SPhinX“), 351 B.R. 103, 114 (Bankr. S.D.N.Y. 2006) aff'd, In re SPhinX, LTD. (“In re SPhinX II“), 371 B.R. 10 (S.D.N.Y. 2006). The Chapter's recognition scheme, however, does not reflect that flexibility. In re Bear Stearns High-Grade Structured Credit Master Fund, Ltd. (“In re Bear Stearns“), No. 07-12383, 07-8730, 2008 WL 2198272 at *7 (S.D.N.Y. May 22, 2008) (“Recognition turns on the strict application of the objective criteria”). Recognition under Chapter 15 is not automatic. A foreign representative must file a Chapter 15 petition, accompanied by either: 1) a foreign decision authorizing the foreign proceeding and appointing a representative; or 2) other appropriate proof of the proceeding and the representative. 11 U.S.C. ' 1515. A United States bankruptcy court, in turn, must find that the foreign proceeding is a foreign main proceeding or a foreign nonmain proceeding, the foreign representative is a person or body and the application meets the filing requirements noted above. 11 U.S.C. ' 1517(a).

Strict recognition procedures begin with the definitions of foreign main proceeding and foreign nonmain proceeding. Chapter 15 defines a foreign main proceeding as a “foreign proceeding pending in the country where the debtor has the center of its main interests.” 11 U.S.C. ' 1502(4). By contrast, a foreign nonmain proceeding is a proceeding “pending in a country where the debtor has an establishment,” 11 U.S.C. ' 1502(5). The term “establishment” is defined as “any place of operations where the debtor carries out nontransitory economic activity.” 11 U.S.C. ' 1502(2).

The practical difference between main and nonmain recognition can be reduced to the difference between mandatory and discretionary relief. Section 1520 of the Bankruptcy Code provides that upon main proceeding recognition:

(a) the automatic stay under Bankruptcy Code section 362 (as well as the creditors' right to adequate protection and relief from the automatic stay under sections 361 and 362(a) of the Bankruptcy Code) applies with respect to the debtor and its property within the territorial jurisdiction of the United States, (b) sections 363, 549 and 552 of the Bankruptcy Code apply to restrict the ability to transfer such property absent court approval, and (c) unless the court orders otherwise, the foreign representative may operate the debtor's business and exercise the rights and powers of a trustee under Bankruptcy Code sections 363 and 552. In re SPhinX, 351 B.R. at 115.

By contrast, ' 1521 provides courts with the discretion to grant all foreign debtors relief, including ' 1520 relief, but only “to protect the assets of the debtor or the interests of the creditors.” 11 U.S.C. ' 1521.

Chapter 15 has as a goal increased cooperation and the fair and efficient administration of insolvency proceedings. Cooperation, however, does not mandate the consolidation of concurrent proceedings or grant foreign liquidators jurisdiction over domestic assets. Section 1521 enables a bankruptcy court to subject a debtor's assets to a foreign liquidator if creditors in the United States are sufficiently protected but, in a foreign nonmain proceeding, limits relief to “assets that, under the law of the United States, should be administered in the foreign nonmain proceeding or concerns information required in that proceeding.” 11 U.S.C. ” 1521(b)-(c). Under section 305(a)(2), a court may grant a foreign representative standing to seek the dismissal or suspension of an involuntary proceeding only if a petition under ' 1515 for recognition of a foreign proceeding has been granted and the purposes of Chapter 15 would best be served by such dismissal or suspension. 11 U.S.C. ” 305(a)(2).

Recent High-Profile Cases

Prior to the Tradex decision, Southern District of New York bankruptcy and district courts issued a series of high-profile rulings addressing recognition under Chapter 15. See, e.g., In re Basis Yield Alpha Fund (Master), No. 07-12762 (REG), 2007 WL 4723359 (Bankr. S.D.N.Y. Jan. 16, 2008), aff'd, 381 B.R. 37, 46 (Bankr. S.D.N.Y. 2008); In re Bear Stearns High-Grade Structured Credit Master Fund, Ltd. (“In re Bear Stearns II“), 374 B.R. 122 (Bankr. S.D.N.Y. 2007). Each case involved a hedge fund registered in the Cayman Islands and subject to corporate law limiting fund operations there. The following recognition principles arise out of the decisions:

• The ' 1516(c) presumption that the center of the debtor's main interests (the “COMI”) is its registered office is rebuttable and does not shift the burden of persuasion regarding the COMI's location away from the debtor.
• Factors that could be relevant to determination of the COMI include, but are not limited to, “the location of the debtor's headquarters; the location of those who actually manage the debtor (which, conceivably could be the headquarters of a holding company); the location of the debtor's primary assets; the location of the majority of the debtor's creditors or of a majority of the creditors who would be affected by the case; and/or the jurisdiction whose law would apply to most disputes.” In re Bear Stearns II, 374 B.R. at 128.
• Courts will evaluate if recognition is appropriate even absent an objection to the debtor's petition for Chapter 15 relief.
• Auditing services and the preparation of incorporation documents do not comprise sufficient economic activity to evidence the existence of an establishment for nonmain recognition.
• A failure to maintain assets in the country which is the site of the foreign proceeding limits the scope of available relief under ' 1521(c) and “supports the conclusion that nonmain recognition would be inappropriate.” In re Bear Stearns, 2008 WL 2198272 at *13.

The bankruptcy court and district court SPhinX decisions, which approved nonmain recognition, pre-dated the Bear Stearns and Basis Yield rulings. SPhinX, however, offers little guidance regarding nonmain recognition. The SPhinX courts apparently did not consider the extent of the debtor's nontransitory economic activity in its “home” jurisdiction, the Cayman Islands, and, instead, assumed that all foreign proceedings warranted either main or nonmain recognition. Accordingly, evidence that the debtor's COMI was outside the Cayman Islands supported nonmain recognition. In re SPhinX II, 371 B.R. at 17. Subsequent courts have required evidence of an “establishment” for nonmain recognition.

In re Tradex

On Nov. 1, 2007, the Swiss Federal Banking Commissioner issued a bankruptcy decree against Tradex. The decree followed a Massachusetts state court ruling directing the appointment of a receiver for Tradex if bankruptcy proceedings were not initiated by Nov. 12, 2007. On Nov. 7, certain of Tradex's creditors (the “Petitioning Creditors”) filed for involuntary relief under Chapter 7. Approximately three weeks later, Tradex filed a Chapter 15 petition, seeking recognition of the Swiss proceedings and consolidation of the Chapter 15 and Chapter 7 cases. Ultimately, Tradex sought to subject the “U.S. assets and claims ' [to] the auspices of the foreign representatives.” In re Tradex, 384 B.R. at 40.

Tradex does not resemble either the Basis Yield or Bear Stearns debtors. It is not a hedge fund registered in a foreign tax haven or subject to any law that limits the scope of its operations in its home jurisdiction. Instead, Tradex is a foreign exchange trading company built on an Internet trading platform. Tradex previously maintained its operations in Switzerland and is still registered there. Prior to its insolvency, however, Tradex moved its operations to Boston. At the petition date, only three people (including Tradex's owner) worked in Tradex's Switzerland office. Id. at 39.

Tradex sought recognition of the Swiss insolvency proceeding as either a main or nonmain proceeding. According to the court, the Swiss office with its three employees established sufficient presence to collapse the recognition analysis into a question of main versus nonmain recognition. Id. at 42. Main recognition, the court concluded, was unwarranted because most of Tradex's creditors, assets and operations resided in Boston. While Tradex may have maintained an establishment in Switzerland, its COMI was in Boston. Id. at 44.

Turning to Tradex's request that the court grant the foreign liquidators the right to distribute assets located in the United States, the court noted that the Petitioning Creditors sought Chapter 7 relief almost three weeks before Tradex's Chapter 15 petition date. Id. at 37. In fact, by the time of the recognition ruling, the Chapter 7 trustee had begun administering the debtor's domestic assets. As a result, despite the award of nonmain recognition, the Bankruptcy Court refused to halt the Chapter 7 proceedings or stop the Chapter 7 trustee from administering the domestic estate and determined that the Chapter 15 and Chapter 7 proceedings would proceed concurrently. Id. at 44.

Analysis

Naturally, few hedge fund managers anticipate their funds' failure and eventual liquidation. Despite best-laid plans, however, some investment strategies will fail and some funds will liquidate. Many such failing institutions will be registered in the Cayman Islands. The Bear Stearns and Basis Yield decisions indicate that United States bankruptcy courts will not recognize foreign insolvency proceedings where the debtor is registered in but maintains few other contacts with a foreign jurisdiction. The rulings do not address exactly what presence is necessary to warrant recognition.

Conclusion

Assuming the court considered only Tradex's operations at the petition date (and not the previous Swiss operations), the Tradex decision may outline the bare minimum necessary for nonmain recognition. At its petition date, Tradex maintained in Switzerland one office and three employees (one of whom was the owner). Yet, the office with its limited personnel constituted an establishment under ' 1502. Nonmain recognition did not require significant economic activity in Switzerland. Along similar lines, while no entity can rewrite its past dealings with its “home” jurisdiction or change laws that limit its activities there, a financial institution sensing an oncoming insolvency would be well advised to at least consider, to the extent possible, establishing a tangible presence in its home country in order to support nonmain recognition down the road.

Michael J. Sage is a partner of the law firm O'Melveny & Myers LLP. He specializes in the areas of bankruptcy, restructuring and reorganization and may be reached at 212-728-5942 or [email protected]. Joshua Weisser is an associate and specializes in the areas of bankruptcy, restructuring and reorganization and may be reached at 212-326-2176 or [email protected].