Bankruptcy Judge Sean H. Lane declined an invitation for the bankruptcy court in New York to become a weapon designed to disrupt a reorganization in Brazil, where the U.S. court had already granted foreign main recognition under chapter 15.
Because the facts are so unique, Judge Lane’s Dec. 4 opinion probably does not undercut the ordinarily successful facet of so-called bankruptcy tourism, where a company located in a nation with unfavorable bankruptcy laws initiates insolvency proceedings in a more favorable forum where it is incorporated, such as Cayman Islands, and then obtains chapter 15 recognition in the U.S.
Judge Lane’s 120-page opinion is an exhaustive analysis of chapter 15 caselaw generally, with particular emphasis on the ability under Section 1517 to revoke or modify a previous ruling about a foreign company’s center of main interest, or COMI. If the opinion means anything, it means that a creditor must litigate the debtor’s COMI when the opportunity first arises, because a U.S. court will be disinclined to alter a previous ruling on COMI when proceedings are underway in the court that first received foreign main recognition.
The Brazilian Debtors
The case involved one of Brazil’s largest telecommunications providers, known as the Oi Group. The group included a wholly owned Dutch financing subsidiary whose sole business was to issue notes. In turn, the Dutch company would loan proceeds from the note issues to Brazilian affiliates to finance their activities. Of course, the Dutch company had receivables from the affiliates who received the proceeds, and the Brazilian parent guaranteed the notes.
Consequently, holders of the Dutch company’s notes theoretically had two means of collection: from the Dutch issuer and through the parent’s guarantee. Ultimately, however, the ability to recover on the Dutch-issued notes depends on the economic success of the Brazilian affiliates because the Dutch financing subsidiary has no substantial assets aside from the receivables owing by its affiliates.
Soon after four members of the Oi Group, including the Dutch financing subsidiary, initiated reorganization proceedings in Brazil, several holders of the Dutch-issued notes initiated an involuntary bankruptcy in the Netherlands against the Dutch financing subsidiary. As a defensive measure, Judge Lane said, the Dutch company commenced a suspension of proceedings in the Netherlands entailing a general moratorium on actions by unsecured creditors. The Dutch court appointed an independent individual to become the administrator.
Meanwhile, the four members of the group, including the Dutch financing subsidiary, sought recognition of the Brazilian proceedings as their foreign main proceeding.
Granting foreign main recognition to the four companies, Judge Lane had no difficulty finding that Brazil was the COMI for three of them. They were incorporated in Brazil and operated there. The Dutch company’s COMI was more problematic because, unlike its corporate cousins, it was incorporated in the Netherlands and thus could not benefit from the presumption in Section 1516(c) that the place of incorporation was also the COMI.
In his recognition decision in July 2016, Judge Lane found that Brazil was also the COMI of the Dutch company under caselaw allowing a financing subsidiary to have its COMI at the group’s nerve center in Brazil.
Although they were present in the recognition proceedings last year, U.S. hedge funds holding the Dutch-issued bonds did not object to the finding that the Dutch company’s COMI was Brazil.
Meanwhile, the hedge funds persuaded the administrator in the Dutch proceedings to move for conversion to bankruptcy. Although the lower court did not convert, the Dutch appellate court reversed and switched the proceedings to bankruptcy. The same individual who had been the administrator continued as the insolvency trustee for the Dutch company.
With support and financing from the hedge funds, the Dutch trustee filed pleadings in New York to modify last year’s recognition order by recognizing the Dutch bankruptcy as the foreign main proceeding for the Dutch subsidiary.
Writing an opinion that is must reading for anyone versed in cross-border insolvency law, Judge Lane refused to change last year’s recognition order.
Section 1517(a) or (d)?
The hedge funds, as holders of the Dutch-issued notes, argued that Judge Lane should rule on recognition under Section 1517(a), which lays out the criteria for granting foreign recognition.
The Brazilian parent disagreed, contending that Section 1517(d) controls. That subsection deals with the modification or termination of previously granted recognition. In addition, the parent argued that the court must impose the standards in Rule 60(b) of the Federal Rules of Civil Procedure to alter the prior recognition order.
Judge Lane made short shrift of the bondholders’ contention that Section 1517(a) governed. Were that the case, he said, it would read subsection (d) out of the statute.
However, Rule 60(b) does not apply, Judge Lane said, because Section 1517(d) contains a flexible discretionary standard that would be at odds with Rule 60(b).
The bondholders raised judicial estoppel arguments, contending that the Brazilian parent admitted that the Netherlands was the COMI for the Dutch subsidiary when initiating the Dutch suspension of proceedings.
The European Union regulations at play in the Dutch proceedings are not an implementation of the UNCITRAL Model Law from which chapter 15 was taken, Judge Lane said. Unlike the E.U. regulations, chapter 15 gives “limited weight” to the presumption of COMI as being the country of incorporation. For a variety of reasons, Judge Lane said that the Dutch court was not misled about the finance subsidiary’s COMI, thus making judicial estoppel inapplicable.
Abstention and Comity
According to the hedge funds, the U.S. court should grant comity to the Dutch court’s conclusion about the Dutch subsidiary’s COMI.
Unlike the European regulations where one nation’s decision on COMI is binding on other countries in the E.U., Judge Lane said that Section 1517 does not mention comity. He concluded that a U.S. court can “make its own determination on recognition in this case, rather than defer to the Dutch courts.”
Applying Section 1517(d) to the Facts
Having decided that Section 1517(d) governs, Judge Lane applied the law to the facts, concluding that he would not exercise discretion to modify his prior recognition order and change the Dutch subsidiary’s COMI to the Netherlands.
Section 1517(d) provides that chapter 15 does “not prevent modification or termination of recognition if it is shown that the grounds for granting it were fully or partially lacking or have ceased to exist . . . .” Analyzing an extensive trial record in detail, Judge Lane concluded there was no basis for exercising discretion to modify his COMI finding last year with regard to the Dutch subsidiary.
Then, Judge Lane announced another reason for declining to exercise discretion: the “behavior” of the hedge fund holders of the Dutch-issued bonds. He began by noting that the bondholders had not objected in the proceedings last year when he found that Brazil was the COMI of the Dutch subsidiary. He said that the bondholders’ silence was part of a strategy aimed at derailing the reorganization that might emerge in Brazil.
According to Judge Lane, the holders of the Dutch bonds are hoping for a so-called double dip. They aim to recover once on their guarantee issued by the Brazilian parent and a second time, on the same debt, by a recovery from the Dutch subsidiary’s claim against the parent. The bondholders are afraid, Judge Lane said, that the Brazilian proceeding would end with substantive consolidation, giving the bondholders only one dip.
If the Dutch proceedings were given foreign main recognition, Judge Lane said that the “credible evidence” indicated that the bondholders intended to use foreign main recognition of the Dutch proceedings “to block this court’s recognition of the Oi Group’s Brazilian plan.”
He said that “the evidence here presents a disturbing picture: a creditor unhappy with Brazilian insolvency proceedings decided to strategically remain silent through a chapter 15 recognition of those proceedings . . . while planning . . . a strategy designed to reverse that recognition and block any restructuring in the Brazilian proceeding.” The strategy, the judge said, is “at odds with many of the goals of chapter 15,” such as “promoting cooperation between U.S. and foreign courts, greater legal certainty . . . [and] fair and efficient administration of cross-border insolvencies . . . .”
Near the end of the opinion, Judge Lane said that the bondholders’ strategy “is a troubling one that the court refuses to countenance.” That conclusion, he said, influenced the exercise of his discretion under Section 1517(d).
Although Judge Lane refused to modify his prior grant of foreign main recognition to the Brazilian bankruptcy, he did not forever slam the door shut on the bondholders. He said that the bondholders can come back to the U.S. court later “and challenge the recognition of any plan approved in” the Brazilian reorganization.