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In Barnet the Second Circuit departs from precedent and sets the stage for potential circuit split

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Daniel Guyder

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13 February 2014

In Drawbridge Special Opportunities Fund LP v. Barnet (In re Barnet), 737 F.3d 238 (2d Cir. 2013) (“Barnet”), the United States Court of Appeals for the Second Circuit held that foreign entities seeking recognition under chapter 15 of the Bankruptcy Code must, in addition to satisfying the requirements for recognition set forth in that chapter, have a residence, domicile, place of business or assets in the United States pursuant to section 109(a) of the Bankruptcy Code. The Second Circuit reversed the bankruptcy court which had granted recognition under chapter 15 to an Australian company that had not introduced any evidence of assets or operations in the U.S. In granting recognition, the bankruptcy court had followed a long line of jurisprudence stretching back to former section 304 of the Bankruptcy Code – the precursor to chapter 15. By holding that a foreign debtor must comply with section 109, the Second Circuit has added an additional obstacle to chapter 15 recognition, and made it more difficult for foreign companies to benefit from the U.S. legal system. Moreover, within a week of the Barnet decision1, and fully briefed on its holding, the Bankruptcy Court for the District of Delaware issued a conflicting opinion in In re Bemarmara Consulting a.s., Case No. 13-13037 (KG) (Bankr. D. Del. Dec. 17, 2013) (“Bemarmara”). Thus, the Second Circuit has set the stage for a potential circuit split.

Chapter 15

Chapter 15 of the Bankruptcy Code largely incorporates the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law to provide an effective method for administering cross-border insolvencies.2 Congress’s stated objectives for chapter 15 include (i) promoting cooperation between the United States courts, foreign courts, and other competent authorities of foreign countries involved in cross-border insolvency cases, (ii) providing greater legal certainty for trade and investment, (iii) fair and efficient administration of cross-border insolvencies, (iv) protecting and maximizing foreign debtors’ assets, and (v) rescuing troubled companies to preserve investment and employment.3 Chapter 15 applies when a foreign representative seeks recognition of a foreign insolvency proceeding by a U.S. bankruptcy court. An important form of relief provided by chapter 15 is the ability to engage in court sanctioned discovery.4

The Barnet Case

In Barnet, the debtor was the subject of an Australian liquidation proceeding. The debtor did not transact business, or have any operations in the United States, and its foreign representatives were not aware of any U.S. based creditors at the petition filing date. However, the foreign representatives were investigating and prosecuting potentially valuable causes of action on behalf of the debtor’s estate. On the belief that the debtors may have assets in the United States in the form of claims or causes of action against entities located in the United States, the foreign representatives expected to rely on the discovery powers available under chapter 15.

Drawbridge Special Opportunities Fund LP (“Drawbridge”) objected to recognition of the foreign proceeding on the ground that the foreign debtor did not meet the criteria to be an eligible debtor pursuant to section 109(a) of the Bankruptcy Code and therefore was not eligible for relief under chapter 15. Under section 109(a) of the Bankruptcy Code “only a person that resides or has a domicile, a place of business, or property in the United States . . . may be a debtor under [the code].” The foreign representatives did not identify a residence, domicile, or place of business in the United States. With regard to property in the United States, Drawbridge argued that the foreign representatives only identified potential claims against unknown parties, and to the extent any claims materialized, such claims would be assets located in the domicile of the plaintiff rather than the defendant.

Ultimately, the bankruptcy court entered an order recognizing the Australian liquidation proceeding under chapter 15. In granting recognition, the bankruptcy court concluded, among other things, that there is no requirement that a foreign debtor be domiciled or have a residence, place of business or property in the United States for a foreign proceeding to be recognized under chapter 15. Drawbridge appealed from the recognition order, and the bankruptcy court certified for direct appeal to the Second Circuit the issue of whether the eligibility requirements of section 109(a) apply to a debtor under chapter 15 of the Bankruptcy Code. In its certification, the bankruptcy court noted that it was not aware of any controlling decision by the Second Circuit or the Supreme Court of the United States on the issue, and that it was persuaded by the decisions of the United States Bankruptcy Court in In re Toft, 453 B.R. 186 (Bankr. S.D.N.Y. 2011) and the United States District Court in In re Fairfield Litig., 458 B.R. 665 (S.D.N.Y. 2011)5 which explicitly held that compliance with the eligibility standards of section 109 of the Bankruptcy Code was not required to grant recognition for purposes of discovery under chapter 15. Moreover, the court noted that permitting foreign debtors that lack property in the United States to obtain chapter 15 relief is consistent with the law and practice under former section 304 of the Bankruptcy Code, the predecessor to chapter 15. In fact, the bankruptcy court cited a long line of cases where such relief was made available under former section 304 including Haarhuis v. Kunnan Enterprises,Ltd., 177 F.3d 1007, 1013 (D.C. Cir. 1999), In re Brierley, 145 B.R. 151, 159 (Bankr. S.D.N.Y. 1992), In re Kingscroft Ins. Co., 138 B.R. 121, 126 (Bankr. S.D. Fla. 1992), and In re Gee, 53 B.R. 891, 898 (Bankr. S.D.N.Y. 1985).

The bankruptcy court reasoned that requiring a foreign representative to identify U.S. assets prior to recognition would permit concealment of assets in the U.S. and defeat a fundamental purpose of chapter 15. The bankruptcy court further stated that the issue was a matter of public importance, the resolution of which would “dramatically impact the jurisdiction of the United States bankruptcy courts and the use of Chapter 15 to assist in the administration of cross-border insolvency cases and the legitimate investigation of claims and assets in the United States.” While the issue was on appeal, the bankruptcy court separately granted the foreign representatives leave to conduct discovery against various entities including Drawbridge.

The Second Circuit disagreed, vacating the bankruptcy court’s recognition order and remanding the case to the bankruptcy court for further consideration. Highlighting the “straightforward nature of [its] statutory interpretation,” the Second Circuit observed that section 103 of the Bankruptcy Code provides that chapter 1 of the Bankruptcy Code applies in a case under chapter 15. “Section 109, of course, is within Chapter 1 of Title 11 and so, by the plain terms of the statute, it applies in a case under chapter 15.” Despite the foreign representatives’ policy-oriented and textual arguments to the contrary, the Second Circuit reasoned that the plain meaning of sections 103 and 109(a) of the Bankruptcy Code controlled.

Implications

As explained by the bankruptcy court in its certification for direct appeal to the Second Circuit, the weight of authority favors granting recognition for purposes of discovery and other injunctive relief under chapter 15 even though the debtor does not have assets in the United States.

The broad discretionary relief authorized pursuant to section 1521 of the Bankruptcy Code reveals the commitment of the United States to cooperate and coordinate with foreign insolvency proceedings to, among other things, protect the value of the debtor’s assets. A key function of this discretionary relief includes the ability to examine witnesses, take evidence, and provide for the delivery of information concerning the debtor’s assets, affairs, rights, obligations, or liabilities. Because chapter 15 recognition is intended to be the exclusive door for a foreign representative’s access to U.S. courts6, the Barnet decision may, in certain circumstances, thwart the ability of a foreign representative to effectively investigate and pursue legitimate causes of action in the United States. This could be particularly problematic for insolvency proceedings arising from fraud or other malfeasance, where litigation claims may be the only significant source of recoveries for creditors.

While it remains to be seen whether courts in other jurisdictions will generally follow Barnet, the U.S. Bankruptcy Court for the District of Delaware issued a strongly worded opinion suggesting that at least one other circuit is not likely to follow suit. In Bemarmara, the Delaware bankruptcy court stated plainly “[t]he decision of the Second Circuit is not controlling on this Court.” It further explained that it did “not agree with the decision of the Second Circuit. And it is the Court’s belief that there is a strong likelihood that the Third Circuit, likewise, would not agree with that decision.”
The Bermarmara ruling was based on the finding that section 109(a) of the Bankruptcy Code applies to debtors, and in chapter 15 proceedings, foreign representatives petition the bankruptcy court for recognition, not debtors.7 The court also emphasized that section 1502 of the Bankruptcy Code is the definition section for chapter 15, and pursuant to section 1502, a debtor is an entity that is involved in a foreign proceeding, there is no requirement that the debtor have assets in the United States. This holding was in direct contrast to the Second Circuit, which found that “[g]iven its broadest reading, Section 1502 still could not affect the definitions contained in Chapter 1.”

Although the bankruptcy court in Barnet insisted that resolution of the issue “will dramatically impact the jurisdiction of the United States bankruptcy courts,” it is unlikely to impact the vast majority of foreign debtors. The eligibility requirements of section 109(a) have been construed liberally, particularly in determining whether a debtor has “property in the United States.” Courts have found that entities whose business operations and assets were overwhelmingly located abroad may be debtors in plenary chapter 11 cases upon a showing of a mere “peppercorn” of property interests located in the United States.8 Thus, this showing may not be such a burden for many foreign representatives.9 Further, to the extent entities do not have assets in the United States, the deficiency may potentially be remedied by obtaining a nominal amount of U.S. property, such as a U.S. bank account or perhaps by relying on the retainer of U.S. bankruptcy counsel. However, this type of strategic filing might be challenged and result in dismissal for bad faith.


 
1 Barnet was issued on December 11, 2013, and Judge Gross entered a ruling on the record in Bermarmara on December 17, 2013.
2 U.S.C. § 1501.
3 U.S.C. § 1501(a).
4 U.S.C. § 1521(a)(4).
5 It should be noted that Fairfield Sentry was originally decided by Judge Lifland, one of the draftspeople of chapter 15. See In re Faifield Sentry Ltd., 484 B.R. 615, 627 (Bankr. S.D.N.Y. 2013) (noting that Judge Lifland was a member of the United States delegation to UNCITRAL (Working Group V)).
6 See H.R. Rep. No. 109-31(l), at 110 (2005).
7 The Judge noted that “[c]ommenters have reflected on the possibility that it was a scrivener’s error and that the intent was that 109(a) not apply.”
8 In re McTague, 198 B.R. 428, 431 (Bankr. W.D.N.Y. 1996)
9 See e.g. In re Yukos Oil Co., 321 BR. 396 (S.D. Tex. 2005); In re Globo Comunicacoes E Participacoes S.A., 317 B.R. 235 (S.D.N.Y. 2004); In re Aerovias Nacionales de Colombia S.A., 303 B.R. 1 (Bankr. S.D.N.Y. 2003); and In re Global Ocean Carriers Ltd., 251 B.R. 31 (Bankr. D. Del.2000).
 

 

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