This article was published in slightly different form in the December 2006 issue of Financier Worldwide.

Through the Looking Glass — Cross-border Restructurings in Today's Global Credit Market
Dan Hamilton, Mark Glengarry

The idea of a company conducting business across geographic boundaries is as old as the concept of a company itself. Indeed some of the first companies, like the South Sea Company and East India Company, were formed and funded, at least ostensibly, for this very purpose. Today's global business environment has wrought massive changes in the way in which companies trade and compete. In turn this has altered the way in which credit to these companies is structured, provided, rated, priced, traded, repackaged, restructured and, in some situations, discharged. The cheap availability of credit in the current business cycle has also spawned many new participants in the market, from the myriad private equity and hedge funds to the seemingly infinite number of derivative counterparties. But one thing has not changed since the days of the South Sea Company and its investors, such as Isaac Newton: when international businesses fail, the consequences can be as confusing as they are dramatic.

Intermittent disasters such as the South Sea Company aside, it took until the late 1980s and early 1990s to witness business failure on a truly global scale. Historically, and perhaps not surprisingly, countries across the globe had sculpted their domestic insolvency rules to favour local creditors ahead of international creditors. This inevitably resulted in a feeding frenzy over assets located in each separate country with the interests of international creditors and insolvency practitioners often being circumvented or ignored. Conversely, debtors had for many years sought to benefit from favourable insolvency regimes (such as Chapter 11 bankruptcy in the US) when looking to restructure debts.

In 1992 the United Nations Commission on International Trade (UNCITRAL) determined that while the international alignment of insolvency laws was a bridge too far, it would attempt at least to set forth a procedure for the recognition and priority of different insolvency proceedings. In 1997 this resulted in the UNCITRAL Model Law on Cross Border Insolvency. Initially the take-up across the globe was poor but this has recently changed following the United States (in October 2005) and Great Britain (in May 2006) formally enacting the UNCITRAL Model Law itself.

Separately, for a number of decades the European Union had been working on its own legislation to deal with cross-border insolvency disputes between Member States. After its own unique bureaucratic machinations (including delaying the adoption on account of a dispute over British beef) it managed (with the exception of Denmark) to enact its own legislation in the form of the EC Regulation on Insolvency Proceedings 2000 (the EC Regulation).

While the Model Law and the EC Regulation differ substantially in detail and effect the key concepts are similar and include the following:

• A distinction between 'main' insolvency proceedings and a 'non-main' or 'secondary' proceeding. A 'main' proceeding is where the insolvent company's 'centre of main interests' resides. A non-main or secondary proceeding, can be used in a country where the debtor has an 'establishment';
• Recognition of foreign liquidators by the courts of a country; and
• Rights for the foreign liquidator to initiate local insolvency proceedings in relation to a debtor who is subject to foreign proceedings and to participate in local insolvency proceedings in respect of a debtor.

At a glance these concepts seem logical and rather uninspiring but the complexity and ingenuity of today's international business world has thrown these rules into sharp relief. The concept of 'centre of main interests' or COMI has been the focus of much attention. To many people the idea that there could be a dispute about where the centre of a company's main operations resides seems nonsensical but consider this; in 2005, a German nickel manufacturer and supplier successfully moved its COMI from Germany to England to benefit from English restructuring proceedings. The fluidity inherent in the concept of COMI allows for such a movement to occur and the innate differences in insolvency laws incentivises parties to seek to move to a more favourable jurisdiction. So, paradoxically, rather than clarifying cross- border insolvencies this new legislation will likely produce results which the framers of the legislation never anticipated.

The collapse of Parmalat resulted in the first European Court of Justice (ECJ) decision to examine the COMI concept and illustrated many of the usual issues seen in cross-border insolvencies. The case concerned Eurofood, an Irish subsidiary of Parmalat SpA, which was dedicated to providing financing for the Parmalat group of companies. The company's day-to-day operations were carried out by Bank of America's Dublin branch, but major policy decisions were effectively made in Italy. In December 2003, Parmalat SpA was discovered to be in deep financial crisis and it was placed into extraordinary administration in Italy. BoA, fearing that an attempt would be made to bring Eurofood within the Italian procedures, applied for the liquidation of Eurofood in Ireland. In turn administration proceedings were opened in Italy by the Italian administrator of Parmalat. A stand-off ensued with each country claiming that it had opened main proceedings (something not possible under the EC Regulation). The legal dispute was referred to the ECJ for resolution. The ECJ issued its ruling in May 2006 some two and a half years later. Sadly, this is not a very helpful timescale to operate in when trying to tie down the restructuring of a complex multi-billion dollar international group of companies. What the court decided was practical but seems to have left as many questions unanswered as answered.

The ECJ found in favour of the Irish Courts and stressed that if one country's courts disagree with a decision in another country, the solution is to appeal that decision in the country it was made, not just ignore it. The key question of where a company's COMI is located remained unanswered. Some clues were given, but not the clear statement that some had hoped for. The result is that the stated aim of the EC Regulation to prevent companies from forum shopping has not been achieved. In fact, the EC Regulation has allowed companies to file for bankruptcy in a country seen as helpful to their particular aims in restructuring — so the MG Rover Group subsidiaries in France and Germany were included in the English administration process, and the English parts of Eurotunnel have been put into the French 'procédure de sauvegarde' along with their French sister companies.

The US has always been a receptive ground for seeking bankruptcy protection and the availability of debtor-in-possession financing allows a business to seek working capital facilities while it restructures and reorganises its debts. But the attempted Chapter 11 filing by the Russian oil giant Yukos in 2005 stretched even its generous standards. In an attempt to stop the Russian government's sale of its major subsidiary to satisfy Russian tax claims, Yukos's CFO sought the protection of the bankruptcy court in Texas. Jurisdiction was based on his home there and a deposit of US dollars in his attorney's account. While the action was eventually dismissed by the Texas courts it is interesting to note that the court found that the minimal connection to the US did satisfy the minimum jurisdictional hurdle under the US Bankruptcy Code. It is also evident that the incentive for Yukos in filing was not so much to prohibit the Russian government from completing the sale (it knew nothing could be done to stop this) but to prevent international investment banks from taking part in the sale process and funding the acquisition vehicle.

In any distressed financing, therefore, stakeholders can never be quite sure where any restructuring is likely to start. For the debtors themselves, however, there are other uncertainties. Viewing any credit is now akin to peering, Alice style, through the looking glass. In a restructuring it is now no longer sufficient to just consider the principal banks, bondholders and trade creditors from whom the debtor originally borrowed funds. Thought also needs to be given to the matrix of distressed debt players who may be participating in the debt, the credit derivative holders who are essentially betting on the debt, the CDO fund which holds and has repacked the debt, and the private equity fund which, in turn, is leveraged by another level of lenders, credit derivative parties and CDO funds. Overlayed on top of this is the geographic spread of these players and the relevant legal systems in which they have transacted and where any applicable restructuring could occur. Some wonder how credit decisions are made at all by lenders in the current market; many feel that the sole criterion is the ability to pass-the-parcel of risk to someone else before the music stops. What is certain is that in a restructuring, it can be very hard to pin down who the debtor's creditors really are, and who will agree the terms. We have seen a remarkably long period of benign economic conditions across the globe, but there are already some who are gearing up for the next economic downturn. No one can predict when it will come, but when it does it is likely to see a whole raft of new problems to deal with. The key to solving these problems is understanding where the best place (and the worst) for dealing with them lies.

Dan Hamilton is a partner and the head of Financial Restructuring and Insolvency Group in White & Case's London office. Mark Glengarry is an associate in that group in London.