Timing is everything:

Cross-border recognition and Bear Stearns reprised

Read the article in the Cayman Financial Review Magazine 

Endnotes 

When liquidators are appointed to wind up a Cayman or other off-shore registered company, when should they apply to a US or European court for recognition? Would delaying the request until some months after their appointment affect the outcome? Two different answers emerged from two authoritative sources at precisely the same time in mid-April 2013. The answer from an influential US court is quite at odds with the policy of cross-border insolvency administration, as confirmed by the answer from the relevant UNCITRAL Working Group.

 

In 2007, the Cayman liquidators for the Bear Stearns funds applied for recognition from the New York bankruptcy court immediately following their appointment, with well-known negative results1. More recently, in contrast, the British Virgin Islands liquidators of Fairfield Sentry, the largest feeder fund for the Madoff investment scheme, waited for nearly a year after their appointment to seek recognition from the same New York bankruptcy court. The two companies’ operational histories are essentially identical, both having been managed all but exclusively from New York, but Fairfield Sentry’s BVI liquidators were granted recognition.

The only significant difference between the two cases was timing. On 16 April 2013, the federal Second Circuit Court of Appeals in New York released its decision in Fairfield Sentry’s case, where time – in the rigid grammatical sense – once again trumped logic and legislative purpose. The upshot of the ruling is that a delay in seeking recognition from a New York bankruptcy court may well make all the difference.

The simple (simplistic?) explanation for why this is so lies in one word of the US Bankruptcy Code implementing the UNCITRAL Model Law on Cross-Border Insolvency. The relevant provision offers recognition and full cooperation from US courts only for foreign insolvency representatives from the country of the debtor-company’s centre of main interests. The concept of “centre of main interests” has been discussed at length here2 and elsewhere. The question for the Fairfield Sentry court was, as of what point should the analysis be made of the sufficiency of the company’s contacts with the liquidators’ country: when the foreign proceedings were commenced, or when the petition for US recognition was submitted?

The Model Law’s policy and purpose clearly support one answer, when the foreign proceeding was commenced. This is the point in time when creditors were engaging with the company and evaluating which laws might govern a liquidation. The purpose of COMI analysis is to assign primary control of a liquidation to the country having the strongest, clearest connection with the debtor-company at the moment of its collapse.

The Fairfield Sentry court took a different approach, based not on policy and purpose, but on grammar. The court focused on the “plain language” of the relevant provision of law, which called for an analysis of where the debtor-company “has” its COMI. The use of the present tense verb compelled the court to focus on the time of filing of the petition for recognition. By the time when Fairfield Sentry’s US recognition petition was filed, the only managers were the BVI liquidators, and their activities had been confined to winding up the company in the BVI, even though little or no activity had been undertaken in the BVI before the liquidation commenced.

The court left itself an “out” by allowing consideration of “bad faith” manipulation of COMI during the period before the recognition petition was filed. But a mere delay in seeking recognition of a foreign proceeding and allowing the foreign liquidators to become the company’s only managers undertaking the company’s activities did not constitute “bad faith” and likely never would. It did, however, entirely upend the investor expectations that lie at the heart of the COMI analysis and that led to the decision in the Bear Stearns case. If the Bear Stearns liquidators had waited for some months to lodge their request for recognition, the Fairfield Sentry approach would have all but required recognition.

At exactly the same time when the Fairfield Sentry decision was released, UNCITRAL Working Group V was meeting just across town in New York to adopt a clarification of the wording of the Model Law on Cross-Border Insolvency (UN Doc. A/CN.9/766, para 42; UN Doc. A/CN.9/WG.V/WP.112, paras 128A-128D).

Not constrained by grammar and the laws of unintended consequences, the Working Group took the opposite, more sensible approach. Contrary to the Fairfield Sentry court’s conclusion, the recognition provision was not meant to indicate the point in time at which the COMI determination should be made. Rather, the Working Group clarified the reference point for determining COMI should be when the foreign proceeding was commenced. It explained that the use of the present tense in the recognition provision was designed simply to require that a foreign proceeding be pending in the place where the debtor-company’s COMI “is” when the recognition petition is lodged.

Indeed, the Working Group specifically addressed the common problem presented in the Fairfield Sentry case. Debtor-companies often cease operations upon the commencement of an insolvency case. By the time when a foreign insolvency representative files a petition for recognition, the foreign proceeding itself and the insolvency representative’s activities in administering it may well be the debtor-company’s only activities and the only indicators of the debtor’s centre of main interests.

Such a boot-strap approach would undermine the very purposes of the Model Law and render the COMI analysis a mere tautology. To produce clearer and more sensible results, the Working Group confirmed that the COMI determination should be made as of the date of commencement of the foreign proceeding – immediately before liquidators took charge of the debtor’s assets and activities.

It is unlikely that either Congress or the Supreme Court will act to clarify US law as UNCITRAL Working Group V has done to the Model Law. As a result, at least in New York, several months’ delay in seeking US recognition will be the clever strategy for non-US insolvency representatives. 

Endnotes:

1 See Jason Kilborn, ‘Cayman hedge fund liquidators not welcome in US?’, Cayman Fin. Rev. issue 17, 4th Quarter 2009, at 56
2 See, eg, Jason Kilborn, ‘Cayman hedge fund liquidators welcome in Delaware, if not New York’, Cayman Fin. Rev. issue 20, 3rd Quarter 2010, at 74-75.

 

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Jason Kilborn

Professor Jason Kilborn teaches business and commercial law at John Marshall Law School in Chicago.  His primary focus is on the comparative analysis of insolvency systems for individuals, though his interest extends to international bankruptcy as well. He recently co-authored a book on international co-operation in cross-border insolvency cases, published by Oxford University Press.

Jason Kilborn
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