The globalization of the world’s business activities and the nearly universal adoption of capitalism as the world’s economic system have led to two related phenomena. The first is the need for effective national economies to enact an effective bankruptcy law. Capitalism rewards the taking of risk, and the taking of risk leads to inevitable failures. The more efficiently the applicable bankruptcy system frees the assets trapped in a failed capital structure, the more economic growth can be generated from the asset. China, Mongolia, the Czech Republic are among the emerging economies that have realized this phenomenon and recently adopted a new bankruptcy law.
The second phenomenon is that differences between two nations’ bankruptcy laws lead courts to display anything from deference, coordination, cooperation, and/or rejection where there are assets domiciled in different jurisdictions. Recognition of this need to accommodate different commercial laws as applied to assets of a single global business entity has been present since 1967 when the United Nations first directed the establishment of a uniform commercial legal structure.[1] This effort was applied to bankruptcy laws leading to the enactment of UNCITRAL in 1994.[2] In 2005, the United States enacted the Bankruptcy Abuse Prevention and Consumer Protection Act which contained a new Chapter, Chapter 15, which adopted UNCITRAL.[3] It has been adopted by Mexico, Brazil, Argentina, Poland, Eritrea and the US, among many other nations.[4]
Chapter 15 is not materially different from previous US law in its attempt to balance territorialism (referred to as the “grab rule”), with universalism (complete cooperation among bankruptcy proceedings).[5] Whether two courts engage in a turf war or cooperation depends upon where the where the dominant center of business operations exists and whether the two bankruptcy laws are reconcilable. If that dominant center of business is in the U.S., American bankruptcy laws will be applied. If that that dominant center of business is in another country, American courts will defer to the other nation. If the dominant center of business is in more than one place, bankruptcy jurisdiction will be shared and the proceedings coordinated to the extent allowed by the different legal structures.
Understanding how these principles are reconciled can best be seen from their application in actual situations. Lessons can be learned that will be useful not only to businesses which are themselves suffering from financial distress but also their business partners. Most importantly, all international businesses can benefit from understanding what structure will most benefit them in international deals that, as with all deals, has the risk of foundering in the future.
An example of US courts’ deference to another country’s laws is In re Yukos Oil Co., 321 B.R. 396, 406 (Bankr. S.D. Tex. 2005). On December 15, 2004, before the enactment of Chapter 15 (although the law was similar), Yukos, a Russian oil conglomerate filed Chapter 11 in the US to avoid restrictions against a sale of an oil division to pay the Russian government various amounts. The US Bankruptcy Court dismissed the case to avoid interfering with the sovereignty of the Russian government which would not participate in the case. As a result, Yukos was required to resolve its business insolvency problems in Russia, under Russian law and procedure. The US Bankruptcy Court found there was not sufficient connection with the U.S., despite the US banks, employees and US world wide jurisdiction potentially involved, to provoke a potential controversy between the US and Russian government regarding a situation which involved a Russian business and internal Russian affairs.
At the opposite end of the spectrum was the result in a Grand Cayman hedge fund case where a US investment bank sought to commence Chapter 15 ancillary proceeding for a special investment vehicle ("SIV") in the Grand Cayman Islands holding a pool of sub-prime mortgages. After the hedge fund SIV collapsed, insolvency proceedings were commenced in the Caymans. An unhappy U.S. investor sued the SIV hedge fund and related parties, in New York, where the fund’s bank accounts, records and personnel were located. In re: Basis Yield Alpha Fund (Master); 381 B.R. 37 (Bankr. S.D. NY 2008). The Bankruptcy Court in New York declined to allow the commencement of an ancillary proceeding here in the US to give the Cayman insolvency proceedings any support as it held that the dominant center of the business operations for the SIV was here in New York. The Court specifically declined to protect the assets of the SIV from litigation in the US by disgruntled investor actions in court, unless the SIV was willing to fully subject itself to the full jurisdiction of the US Bankruptcy Court by filing a separate Chapter 11.
Where the businesses’ assets are located globally, multiple insolvency proceedings must be filed in the US and elsewhere. In the BCCI, Maxwell, and other well known major international insolvency cases, coordination of these different laws was the goal. Local law for local issues was respected. For issues transcending the borders, a coordinated approach was adopted.
The lessons to be gained by the new Chapter 15 is that any legal authority is only as powerful as it is enforceable by a willing and able local jurisdiction that can exert the power of financial or physical force. In essence, a foreign entity’s ability to access the US Bankruptcy Courts will depend upon how convinced the US judge is that the dispute is more important to U.S. business interests than to foreign interests. If the judge is not so convinced, the US Court will either abstain or coordinate the proceedings only to the extent necessary to protect the US interests that do not predominate.
In practical terms, the risk of conflicting insolvency standards means:
If the business is located overseas, the business needs to comply with the law applicable where it is operated.
If the business is superficially an offshore business, but is conducted in the US to minimize the impact of US regulatory or tax law, it needs to satisfy US law regardless of where the business is incorporated.
If the business exists everywhere, it needs to comply with the strictest standards potentially applicable.
As the globe continues to shrink, these concerns will abate as legal systems become more coordinated. However, for now, successful businesses are those which are are prepared for anything, particularly in a global international turf war.
Margaret Mann is a partner in the Finance and Bankruptcy Practice Group in the firm’s San Diego Office. Ms. Mann has been involved in commercial litigation and bankruptcy law since 1981. She has significant experience in large, complex domestic and international insolvency proceedings on behalf of creditors, fiduciaries, borrowers and other interested parties, with expertise in the franchise and tax credit syndication industries. Margaret can be reached at mmann@sheppardmullin.com
[1] Sandile Khumalo and Vrije Universiteit, International Response to UNCITRAL Model Law on Cross Border Insolvency 4 (2004), HTTP://www.iiglobal.org/organizations/UNCITRAL/insol_Response.pdf
[2] M. Cameron Gilreath, Note, Overview and Analysis of how the United Nations Model Law on Insolvency Would Affect United States Corporations Doing Business Abroad 19 BANKR.DEV.J. 399, 406 (2000)
[3] See Khumalo & Universiteit, supra, Note 1 at 4; See also Gilreath, supra, note 2 at 400-01.
[4] UN Commission on International Trade Law, status of 1997 Model Law on Cross Border Insolvency, 2005 www.uncitral.org/uncitral/en/uncitral_text/insolvency/1997Model_status.html
[5] Biery, Boland and Cornwell, Transnational Insolvencies in Chapter 15 at 23-30; Boston College Law Review Volume XLVII No. 1 December 2005.