US Bankruptcy Court Denies Recognition of Cayman Insolvency Proceedings Concerning Bear Stearns Funds
November / December 2007
Insolvency Notes Newsletter, November / December 2007
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Can a United States bankruptcy court deny recognition of a foreign insolvency proceeding even if no one opposes such recognition? In a recent decision, Judge Burton Lifland, a highly respected bankruptcy judge and one of the authors of Chapter 15 of the Bankruptcy Code, says yes.
Liquidators of Bear Stearns Funds Seek Relief under Chapter 15
Suffering financial distress, two investment funds, the Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd. and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund, Ltd., which are exempted, open-investment limited liability companies chartered under Cayman law and registered in the Cayman Islands, filed petitions seeking orders to wind-up under provisions of the Cayman Islands Companies Law. On July 31, 2007, the Grand Court of the Cayman Islands entered orders appointing two joint provisional liquidators ("JPLs") and enjoining creditor actions against the Funds. The same day, the JPLs filed petitions for recognition of the Cayman proceedings under Chapter 15 of the United States Bankruptcy Code in the bankruptcy court for the Southern District of New York, where most of the Funds' assets are located.
The JPLs asserted that Chapter 15 protection was necessary to protect the assets of the Funds located in the United States (believed to be all or virtually all of the Funds' assets) and to aid the JPLs in the execution of their duties to protect and marshal the Funds' assets for liquidation and distribution to creditors under Cayman law. The JPLs reported that one party to a repurchase agreement with the Funds has claimed a shortfall in the amount owed it after selling the assets subject to its agreement. In addition, a class action suit has been commenced in New York (state) Supreme Court against the Funds' feeder funds and their corporate administrator. These and other contacts with creditors caused the JPLs to fear that the Funds' creditors might seek attachment of the Funds' unencumbered assets, frustrating the equitable and orderly distribution of assets that Cayman insolvency law seeks to impose.
After considering the JPLs' arguments, the bankruptcy court issued preliminary injunctions blocking most creditor actions against the Funds until after the hearing on the petitions for recognition.
Purpose of Chapter 15 of the Bankruptcy Code
The petitions filed in New York commenced cases under Chapter 15 of the Bankruptcy Code. Congress enacted Chapter 15, which came into force in October 2005, to facilitate "(1) cooperation between…courts of the United States…and courts and other competent authorities of foreign countries involved in cross-border insolvency cases; (2) greater legal certainty for trade and investment; (3) fair and efficient administration of cross-border insolvencies that protects the interests of all creditors and other interested entities, including the debtor; [and] (4) protection and maximization of the value of the debtor's assets..."1 Chapter 15 has its origins in a model statute promulgated by the United Nations Commission on International Trade Law (commonly referred to as "UNCITRAL"), that seeks to harmonize cross-border procedural insolvency law. It replaced less comprehensive provisions of the Bankruptcy Code governing cross-border insolvency cases.2
Under Chapter 15, in appropriate cases, American bankruptcy courts have wide latitude to aid foreign insolvency courts and their representatives in effecting reorganization of their debtors or the orderly liquidation of their debtors' assets. The kinds of relief available include "staying," or imposing a moratorium on, most actions respecting the debtor that is the subject of the foreign proceeding or its assets, rights, obligations or liabilities and suspending the debtor's right to transfer, encumber or dispose of the debtor's assets.
The American bankruptcy court may also grant the "foreign representative" (in these cases, the JPLs) many of the powers trustees enjoy in American bankruptcies to gather, administer, liquidate and distribute the assets and businesses of debtors. In the case of the Funds, for example, some of their assets consist of receivables from broker dealers and, under Chapter 15, the JPLs might obtain orders compelling those broker dealers to turn the receivables over to them.
Notably, Chapter 15 generally does not empower foreign representatives to use American bankruptcy law to avoid or recover value lost in pre-bankruptcy transactions that may have disadvantaged a debtor's creditors in general, although the foreign representatives may be able to do so under other law. Nor does Chapter 15 prevent counterparties to certain financial contracts, such as repurchase agreements, from exercising their rights and remedies under such contracts.
Scope of Recognition under Chapter 15
Under the law as it existed before the enactment of Chapter 15, bankruptcy courts enjoyed great flexibility in determining whether or not to grant "comity" by honoring the requests of representatives of foreign insolvency proceedings for relief in aid of their efforts to liquidate or reorganize insolvent entities. In enacting Chapter 15, however, Congress determined that relief should be available to representatives of a foreign bankruptcy proceeding only if the proceeding is pending in a country significantly connected to the assets and business activities of the debtor to be reorganized or liquidated. Thus, in order to obtain most of the relief available under Chapter 15, representatives of a foreign insolvency proceeding must first demonstrate that the debtor subject to such proceeding has connections to the country in which the foreign proceeding is occurring significant enough for a bankruptcy court to "recognize" the proceeding as either a "foreign main proceeding" or a "foreign nonmain proceeding."3 The requirement of "recognition" and the "main"/"nonmain" categorization of recognized foreign proceedings did not exist under former law. Under Chapter 15, however, recognition is a threshold determination essential for a foreign representative to obtain most forms of relief.
Recognition of a foreign proceeding as a foreign main proceeding, which entitles the representative of the proceeding to certain automatic relief and confers standing upon the representative to seek additional relief that may be granted at the bankruptcy court's discretion, is meant to apply to an insolvency proceeding pending in the country in which the debtor has the "center of its main interests." The thought is that the country in which the debtor has the center of its main interests should generally take charge of the liquidation or reorganization and that, if that country is not the United States, American courts should play a supporting role, albeit with appropriate safeguards for US creditors, policies and procedures.4
If recognition is sought for insolvency proceedings in a country in which the debtor does not have the center of its main interests but in which it does maintain an "establishment," defined as a "place of operations where the debtor carries out a nontransitory economic activity," recognition as a "foreign nonmain proceeding" may be granted. In that event, some relief may be granted — at the court's discretion rather than automatically — but it should be coordinated, and not interfere, with any main proceeding. Any such relief is subject to revision as events unfold.
If the debtor has no "establishment" in the country where the foreign insolvency proceeding is pending and if the center of the debtor's main interests is not located there, recognition of the proceeding should be denied.5
The Court Denies the Liquidators' Request for Recognition
According to the court, the process of recognition of a foreign proceeding is a simple single step process applying the definitions of "establishment," "foreign main proceeding," "foreign nonmain proceeding," "foreign proceeding," and "foreign representative" to the facts of a petition to determine whether recognition of a proceeding as either a main or nonmain proceeding is appropriate.6 Although it had no difficulty determining that the JPLs are "foreign representatives" as the Bankruptcy Code defines that term, the court denied recognition of the Cayman insolvency proceedings because it found the Funds have neither the centers of their main interests nor establishments in the Cayman Islands.
Notably, no objections were filed to the petitions for recognition. According to the court, "[t]he [JPLs] basically argue that because no objections have been filed and the Funds' registered offices are in the Cayman Islands," recognition of the Cayman liquidations as foreign main proceedings should follow.7 In the court's eyes, however, the lack of any real objection did not negate the need for it to "make an independent determination as to whether the foreign proceeding meets the definitional requirements of sections 1502 and 1517 of the Bankruptcy Code."8 Thus, if proper evidence appears that raises questions for the court about whether the center of main interest is in the place of registration, recognition should not be "rubber stamped."9
Unfortunately for the JPLs, the court found, based on evidence provided in their own pleadings, that the Funds were simply "letterbox" companies, doing no business in the Cayman Islands apart from that necessary to maintain registration. The court concluded that the center of the Funds' main interests is in the United States, "where the Funds conduct the administration of their interests on a regular basis and [which] is therefore ascertainable by third parties."10 It therefore concluded that it could not grant recognition to the Cayman proceedings as foreign main proceedings.
The court then turned to the question of whether the proceedings might be recognized as foreign nonmain proceedings. That question turned upon whether the Funds had an establishment in the Cayman Islands "for the conduct of nontransitory economic activity," which the court equated to "a local place of business."11 The court found no evidence of any such place of business in the Cayman Islands. Indeed, the Funds conducted no business there apart from activities necessary to further their business elsewhere.12
Other Avenues Available to the Funds
The court concluded its opinion by focusing on how the JPLs might still obtain relief from US courts. According to the court, "Section 303(b)(4) of the Bankruptcy Code specifically provides that an involuntary case may be commenced under Chapter 7 or 11...by a foreign representative of the estate in a foreign proceeding so that a foreign representative is not left remediless upon nonrecognition."13
The Funds, however, have chosen another route for now, viz, an appeal of the bankruptcy court's ruling to the district court.14 The appeal is unusual in that, as there was no objection to recognition, there is no appellee to contest the appeal. Given this posture, the district court has issued a scheduling order allowing amicus curie briefs to be filed either in favor of or against the position of the JPLs. The briefing is to be concluded by December 12, 2007.
White & Case will continue to monitor this and other high-profile cross-border insolvency cases. Look to future issues of Insolvency Notes for a discussion of important developments in this area as they arise.
1 11 U.S.C. § 1501(a); In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd., 374 B.R. 122, 124-26 (Bankr. S.D.N.Y. 2007).
2 See H.R. Rep. No. 109-31, at 118-19 (2005).
3 See generally 11 U.S.C. §§ 1509, 1515 and 1517.
4 See generally 11 U.S.C. §§ 1517, 1520-22, 1528-30.
5 See H.R. Rep. No. 109-31, at 113-15 (2005) ("The drafters of the Model Law understood that only a main proceeding or a non-main proceeding meeting the standards of section 1502 (that is, one brought where the debtor has an establishment) were entitled to recognition under this section [1517].").
6 Bear Stearns, 374 B.R. at 126.
7 Id. at 129.
8 Id. at 126.
9 Id. at 126, 129. The court also pointed out that the Guide to Enactment of the UNCITRAL Model Law on Cross Border Insolvency, U.N. Gen. Ass., UNCITRAL 30th Sess., U.N. Doc. A/CN.9/442 (1997), ¶ 122, "explains that the presumption does 'not prevent, in accordance with applicable procedural law, calling for or assessing other evidence if the conclusion suggested by the presumption is called into question by the court or an interested party." Bear Stearns, 374 B.R. at 129 (emphasis in original). With respect to the case before it, the court noted that "[t]here may be many reasons for the lack of objections [to the Cayman JPLs' petitions], including the fact that many members of the financial communities have their own similar relationships with offshore jurisdictions." Id. at 129 n. 7. In this connection, it interesting to consider that there are over 8,500 investment companies registered in the Cayman Islands, including an estimated 75 percent of all hedge funds. Lynnley Browning, Offshore Tax Breaks Lure Money Managers, July 1, 2007.
10 Bear Stearns, 374 B.R. at 130 and n.9.
11 Id. at 131.
12 Id. The "exempted" status of the Funds under Cayman law, the court observed, makes discovery of nontransitory economic activity unlikely, since exempted companies are prohibited from carrying on business except that necessary to further business outside the Cayman Islands. Id.
13 Id.
14 The bankruptcy court granted a motion to continue the injunctions pending the appeal.
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