Why International Litigants Are Using Chapter 15 to Optimize Financial Recoveries in Foreign Insolvency Proceedings

By contrast, once in Chapter 15, a foreign officeholder from a common law jurisdiction such as the United Kingdom, Hong Kong, the Cayman Islands or the British Virgin Islands (BVI) may be free to pursue an expansive “fishing expedition”-style discovery that it may use to sue targets in a U.S. bankruptcy court without the fear of paying the costs of those targets if they are unsuccessful. This article discusses a few recent cross-border decisions that put these tactical advantages into context.

Application of Foreign Law to U.S.-Based Claims

A major advantage of commencing proceedings through the Chapter 15 gateway is the ability to litigate claims arising under the domestic bankruptcy laws of the foreign jurisdiction as opposed to U.S. bankruptcy law. A 2010 decision by the U.S. Court of Appeals for the Fifth Circuit in the Chapter 15 case of Condor Insurance Company (in liquidation in St. Kitts & Nevis) was the first major decision in the Chapter 15 era holding that foreign representatives could bring non-U.S. law claims in U.S. bankruptcy courts.

A more recent example stems from the ongoing Fairfield Sentry saga. The facts are well known. Following Chapter 15 recognition of the BVI winding-up proceedings of Fairfield Sentry and Fairfield Lambda, two offshore feeder funds that invested in Bernard Madoff's fraudulent Ponzi scheme, the BVI liquidators brought an action in the U.S. bankruptcy court against former investors in the offshore funds. The BVI liquidators asserted several BVI-based claims against the former investors in the action, including for the clawback of redemption payments made prior to the funds' insolvency. In response, many of the investors brought an application before the BVI court for an anti-suit injunction to restrain the BVI liquidators from proceeding with claw-back claims in the U.S. Chapter 15 court.

Earlier this year, the BVI court issued a decision refusing the application, determining that it was for the U.S. bankruptcy court to decide whether or not to allow the liquidators' BVI clawback claims to be pursued in the U.S. This creditor-friendly decision is likely to resonate with persuasive force in England and Wales and in other offshore jurisdictions that are founded on English law, such as the Cayman Islands. The message for foreign office holders is that pursuit of proceedings in the U.S., where potential defendants are located, should be a key consideration for a foreign office holder trying to maximize recoveries for creditors.

Also recently, in the case of In Re Hellas Telecommunications (Luxembourg) II SCA, 535 B.4. 543 (2015) (In Re Hellas), following Chapter 15 recognition of the debtor's Eglish liquidation proceeding, the English liquidators brought a claim in the New York bankruptcy court against various defendants concerning their historical interactions with the debtors. Many of the defendants challenged the bankruptcy court's jurisdiction over them, but the bankruptcy court rejected those challenges, determining that it would allow the liquidators to proceed with claims, which involved allegations of fraudulent transfers under section 423 of the English Insolvency Act 1986, and fraudulent trading under section 423 of the English Insolvency Act.

The U.S. bankruptcy court concluded that its decision was consistent with the cross-border insolvency regime in place in the United Kingdom. Success by the defendants would have resulted in the foreign office holders not being able to recover any damages against the defendants, due to the fact that the claims could not be pursued in the UK for jurisdictional reasons arising under English law. Indeed, the UNCITRAL Model Law on Cross-Border Insolvency was adopted in England and Wales precisely to prevent that unjust result. See In Re Hellas, at 569.

The New York bankruptcy court warned, however, that its decisions should not be mistaken for unfettered deference. Rather, the court recognized that such claims should not be dismissed on international comity grounds because: 1) permissive abstention was not available in the circumstances; and 2) the claims should not be dismissed under the forum non conveniens doctrine because the defendants had failed to establish that an adequate alternative forum existed to adjudicate the claims. Citing In re: Sphinx, Ltd., et al., 351 B.R. 103 (2006) and as noted in Underwood v. Hilliard (In re Rimsat, Ltd.), 98 F.3d 956, 963 (7th Cir.1996), “Comity is a doctrine of adjustment, not a mandate for inaction.” Further, the U.S. bankruptcy court held that, even if section 423(4) of the English Insolvency Act was an exclusive jurisdiction provision, it was not bound by it. See In Re Hellas, at 567.

Foreign Law, U.S. Procedure: Advantages for Litigants

As noted above, another advantage of Chapter 15 is the ability to access U.S. discovery and procedure in a foreign insolvency proceeding where the applicable foreign law may be much more restrictive. The underlying principle was recently recognized by the New York bankruptcy court in In Re Hellas. In that case, the bankruptcy court explained that, although it was bound to apply the substantive law of the UK to adjudicate the section 423 English Insolvency Act claim, it was not bound to follow English procedural law. Ibid at 566. Citing Bournias v. Atl. Mar. Co., 220 F.2d 152, 154 (2d Cir.1955), the court stated:

In actions where the rights of the parties are grounded upon the law of jurisdictions other than the forum, it is a well-settled conflict-of-laws rule that the forum will apply the foreign substantive law, but will follow its own rules of procedure.

This stance by the U.S. bankruptcy courts has pushed open the gate for foreign office holders to explore whether it is more advantageous to pursue potential claims through the U.S. bankruptcy courts, or within their home courts. This is particularly relevant where the target defendant is resident in the U.S. and has limited or no connections within another potential jurisdiction, such as the UK. The ability to obtain both pre- and post-action discovery, which is often broader in scope than what is available in originating jurisdictions such as the UK, remains a significant consideration when a foreign office holder decides the venue in which to bring his or her claims. Further, unlike proceedings in jurisdictions such as the UK, the Cayman Islands, the BVI and other English-derived common law jurisdictions, documents received through U.S. discovery are not treated as confidential unless the U.S. court expressly orders that such documents be sealed.

In ICP Strategic Credit Income Fund Ltd., et al. (a Cayman Islands involuntary bankruptcy known as “official liquidation”), the U.S. Bankruptcy Court of the S.D.N.Y. granted Chapter 15 recognition to the Cayman liquidators of ICP Strategic Credit Income Fund Ltd and ICP Strategic Credit Income Master Fund Ltd (the ICP Funds). The Cayman liquidators sought discovery against KPMG, the auditors for the ICP Funds, including the deposition of KPMG's corporate representatives and orders for broad disclosure. The Cayman liquidators had already sought such discovery against KPMG in the Cayman court and had been refused a disclosure order.

The U.S. bankruptcy court granted the relief sought and also granted permission for the foreign office holders to pursue additional discovery requests and subpoenas in the U.S. KPMG objected to the order on the grounds (among others), that the requests were too broad in their scope; an undue burden would be imposed on KPMG if it had to deal with such requests; the nature of a number of the requests was vague and ambiguous; and the need for confidentiality provisions to protect KPMG's proprietary information in the relevant discoverable documents. While the U.S. bankruptcy court was persuaded to make an order to protect certain proprietary information belonging to KPMG, it dismissed the other objections raised by KMPG. The practical effect is that the Cayman liquidators retained access to information beyond the scope of what would have been available to them under the law of Cayman Islands.

The position has been compounded by the Privy Council decision in Singularis Holdings Limited v PricewaterhouseCoopers [2014], UKPC 36; PricewaterhouseCoopers v Saad Investments Company Limited [2014] UKPC 35. In that case the Privy Council considered the ability of the Bermuda court to grant discovery orders against auditors in aid of bankruptcy proceedings commenced in the Cayman Islands, where the Cayman Islands' own bankruptcy legislation did not permit discovery against the auditors of a company that was the subject of bankruptcy proceedings. The Privy Council held that the Cayman Liquidator could not obtain a discovery order against the auditors, as Bermuda's bankruptcy legislation and procedural law dealing with discovery did not extend to a foreign office holder. This decision has broad application, as it binds numerous English law-derived jurisdictions including the Cayman Islands, Bermuda and the BVI.

The potential procedural advantages that follow recognition of foreign bankruptcy proceedings pursuant to Chapter 15 are not limited to discovery. In light of the decisions highlighted above, another reason for a foreign office holder to pursue Chapter 15 proceedings in the U.S. bankruptcy court is to establish personal jurisdiction over potential U.S. defendants who are unlikely to submit to the jurisdiction of the foreign office holder's home court. In addition, the automatic stay that is triggered by the recognition of foreign bankruptcy proceedings is often a powerful blow to competing creditors and stakeholders located in the U.S.

Another reason for a foreign office holder to elect to litigate in the U.S. through Chapter 15 is that, unlike many jurisdictions (e.g., the UK, Hong Kong, the Cayman Islands and the BVI), the U.S. is not a cost-shifting jurisdiction. Litigants in U.S. proceedings do not necessarily face the same financial risks and potential for adverse costs orders that arise in English law-derived jurisdictions.

Conclusion

Securing recoveries in large, complex cross-border bankruptcies typically requires a forum by which to extend both the search for hidden assets and the jurisdictional reach of the proceeding to pursue foreign claw-back targets. Often, Chapter 15 will provide a foreign office holder with both. The tactical advantages of pursuing recovery through Chapter 15, which include gaining access to expansive discovery powers, and avoiding jurisdictional challenges and the financial risks they entail in a costs-shifting jurisdiction, make it a powerful tool for a foreign office holder. For these reasons, Chapter 15 will continue to be key to unlocking recoveries for creditors in many foreign bankruptcies.

Authors Rebecca Hume, Jeremy Hollembeak and Anna Gilbert are lawyers at Kobre & Kim LLP.