Five years on and is it working as intended?
An article in the Cayman Financial Review in October last year by Professor Jason Kilburn , suggested that Chapter 15 was working well in the US other than for Cayman Islands Hedge Funds.
In this article I want to examine why a distinction was drawn for hedge funds, I want to look at the split that has started to occur in jurisprudence between the US and the UK, look at some recent cases where the US courts have been more cooperative with overseas liquidators and then in conclusion look into a crystal ball to see how we think that the US courts will treat Cayman Islands Hedge Fund liquidators in the future.
Before getting into the detail I think it is worthwhile dealing with a few simple questions.
What is Chapter 15?
Chapter 15 is the US law that deals with the recognition of overseas liquidators.
Chapter 15 had its origins in an UNCITRAL (United Nations Commission on International Trade Law) model law that set out a blueprint for international cooperation between jurisdictions for the official conduct of cross-border liquidations.
Why is this important?
Clearly when a Cayman Islands liquidator gets appointed by the shareholders or the Cayman Islands Court, he has a number of duties. He has a duty to identify, take control and protect the assets of the company pending the identification and agreement of creditor claims prior to a distribution. In most Cayman Islands liquidations the assets are located in another jurisdiction. Accordingly, the liquidator needs to take steps in those other jurisdictions to take control of those assets.
Additionally, in a winding up by the Cayman Islands Court a stay of all proceedings against the company is automatically granted. This can be sometimes necessary for the protection of the company and to enable an orderly winding up, to ensure this stay is enforced overseas.
Therefore, the implementation of the model law or a similar recognition process is necessary for the efficient conduct of the case. This is clearly important to the appointed liquidator for a cost effective discharge of his duties. It is also important for the jurisdiction since when people set up vehicles in a certain country they need to have assurance that, in the unfortunate event that things go wrong, when the business model no longer works, there needs to be some sort of mechanism to facilitate the effective winding up of the company.
In today’s world most company’s affairs involve international and cross-border trade and therefore an effective and efficient cross-border system is required.
For any meaningful discussion on Ch 15 one needs to have a dictionary at hand. As an indication of the torturous recognition process the very terminology used in Ch 15 is complex and vague. There are a few basic definitions that demonstrate this.
- COMI – Centre of Main Interest. A term of art not defined in the US Bankruptcy code
- Establishment – defined in the US Bankruptcy code as any place of operations where the debtor carries out a non-transitory economic activity
- Foreign Main Proceeding – a foreign proceeding pending in a country where the debtor has the centre of its main interest.
- Foreign Non Main Proceeding – a foreign proceeding other than a foreign main proceeding, pending in a country where the debtor has an establishment.
In practical terms the main difference to an overseas liquidator between a foreign main proceeding and a non main proceeding is that in the former the relief is automatic.
What’s the big deal?
Chapter 15 came into effect in 2005. Prior to Chapter 15, Cayman Islands liquidators applied for assistance from the US under Section 304. There was a set of rules and procedures that had to be adhered to and the Cayman Islands liquidators and indeed the US court were familiar with these steps and by and large the recognition and international comity worked effectively.
Following the introduction of Chapter 15 there were a number of successful Chapter 15 applications up until a series of funds, including SPhinX, Basis Yield and Bear Stearns. We will deal with these three cases quickly, since they were discussed in Professor Kilburn’s article last year.
SPhinX involved the application for recognition by the Cayman Islands liquidator. The case was clouded by an association with the problems experienced on another case involving the same judge, Judge Drain. Essentially he refused to recognise the liquidator of SPhinX as a foreign main liquidator, because he felt that the application was being brought for an improper purpose. He did recognise the liquidator as a foreign non main proceeding but decided to not allow all of the relief.
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On the two Bear Stearns funds Judge Lifland, denied recognition as a foreign main proceeding since the judge found that the COMI of the funds was in the US, and that the presumption of the registered office being a COMI had been rebutted by the evidence to the contrary. In addition the judge found that the funds were denied recognition as a non main proceeding as the judge found that they did not even have an establishment in the Cayman Islands within the meaning of Chapter 15. It continues to baffle me how the registered office, in the country of incorporation, cannot be considered as an establishment.
Basis Yield Alpha Fund
Basis Yield was in a similar position to Bear Stearns, and given the decision of the judge in that case, the liquidators of Basis Capital put no evidence before the court, rather seeking to rely on the rebuttable presumption. In that case Judge Gerber once again refused recognition either as a main or non main and set out a 21 point list of factors that should be considered with regards to establishing COMI.
These three cases together set a very worrying precedent for overseas liquidators. Essentially it appeared that the US courts were being exceedingly intransigent in their interpretation of the complex definitions encapsulated in Chapter 15. A particular concern was the lack of a true presumption of the registered office being the centre of main interest in the event that there was no active opposition.
However, recent cases in the US and the UK have set a rather more optimistic precedent.
Stanford International Bank Limited (“Stanford”)
In Stanford the liquidator had been appointed by the Antiguan court and a receiver had been appointed by the US SEC. Both of these officeholders were seeking recognition in the UK. The UK court found that the presumption that COMI coincides with the location of the registered office was a true presumption and the burden lies upon the party seeking to rebut it with connecting factors that were objective and ascertainable by third parties. This is a key difference with the US decisions in Basis and Bear Stearns.
This distinction highlights the divergence between the US and the UK decisions in this area when applying substantially similar versions of the model law. Unfortunately under the preamble to the UNCITRAL model law, it says that one of the purposes of the law is to provide “greater legal certainty for trade and investment”. Obviously this split in jurisprudence is at odds with that original purpose.
However, the US courts have more recently had a number of cases where the US courts did recognise the overseas liquidator and provided quite exceptional assistance and relief. Thereby suggesting that Chapter 15 may be beginning to work as the model law intended.
Metcalfe and Mansfield Alternative Investments (“Metcalfe”)
Metcalfe involved the relatively straight-forward recognition application of a Canadian insolvency proceeding. The US court was asked to enter an order enforcing the US provision of a Canadian court order containing broad third parties releases.
The US court ruled that the releases would be enforceable in the US, not on the basis that such releases would have been available in the US bankruptcy and similar circumstances, but that “principle of enforcement of foreign judgments and comity in Chapter 15 cases strongly counsel approval of enforcement in the United States that the third party non-debtor release and injunction provisions included in the Canadian orders, even if various provisions could not be entered in a plenary Chapter 11 case”.
It was fairly remarkable that the US court was willing to approve the enforcement of the releases in the US even though the application of the substantive law of releases under Chapter 11 might have produced a different result.
Condor Insurance Company Limited (“Condor”)
The Fifth Circuit of the Court of Appeals reversed the findings of a Southern District of Mississippi Bankruptcy Court and the District Court, on the issue of whether a Chapter 15 proceeding could be used to pursue foreign law avoidance actions against defendants and assets in the US. The joint official liquidators of Condor, a Nevis company, were allowed to pursue fraudulent transfer actions governed by the law of Nevis to recover $313 million in transfers made by the foreign debtor.
The fifth circuit ruled that Condor was an eligible debtor under Chapter 15 and the pursuit of the fraudulent transfer action was appropriate under Chapter 15 because it was not a US law that was expressly excluded under Chapter.
Once again this is fairly exceptional law in the US given that the court allowed the JOL’s to pursue the foreign cause of action even when the equivalent US cause of action could not have been pursued under their various statues?
So does this mean that the concerns highlighted by Bear Stearns and Basis Yield in 2008 have been over-ruled and now foreign liquidators can expect greater flexibility and cooperation from the US Courts?
Unfortunately, I am not convinced that it is that straight forward. I feel that the US courts still have an issue with liquidators of vehicles such as hedge funds where the overseas liquidators have difficulty addressing the problem presented by satisfying the definitions in the Chapter 15 ambit?
This was successfully approached in the case of in re SAAD Investments Financial Company (No. 5) Ltd. (“SIFCO 5“) whereby the liquidators submitted the argument that following their appointment, they were the centre of main interest of the entity. The subtlety of the case hinged on the timing of when the Court looked at the question of COMI. In SIFCO 5 the attorneys (in my view quite correctly) had the judge focus on the COMI being considered at the time the application was being made rather than during its life. Prior to that time the JOL’s had been appointed by the Cayman court and therefore had taken control of the operations of the company.
In conclusion, the various cases discussed above have emphasised the fact that any Ch 15 application needs to focus on the timing of the COMI considerations as well as the importance of demonstrating establishment. With this in mind Cayman liquidators should be able to approach the US Courts with greater certainty of obtaining some form of recognition and assistance.