Cross-Border Bankruptcy Battleground: The Importance of Comity (Part I)
The process whereby U.S. courts recognize and enforce the judicial determinations and proceedings of courts abroad (commonly referred to as "comity") has been an integral part of U.S. jurisprudence for hundreds of years. Comity plays an important role in cross-border bankruptcy cases involving debtors that are subject to bankruptcy or insolvency proceedings outside the U.S. but have creditors or assets in the U.S. Comity is among the fundamental principles underpinning chapter 15 of the Bankruptcy Code, as well as provisions in U.S. bankruptcy law governing cross-border cases that preceded chapter 15's enactment in 2005.
The extent to which U.S. and foreign bankruptcy laws are inconsistent is an important component in a U.S. court's analysis in determining whether a foreign court's decrees should be enforced in the U.S. under principles of comity. Conflicts of law in the realm of cross-border bankruptcy cases were the subject of two rulings handed down by New York bankruptcy courts in early 2010. In In re Metcalfe & Mansfield Alternative Investments, bankruptcy judge Martin Glenn, by way of "additional assistance" in a chapter 15 case involving a Canadian debtor, enforced a Canadian court's order confirming a restructuring plan that contained nondebtor releases and injunctions, even though it was uncertain whether a U.S. court would have approved the releases and injunctions in a case under chapter 7 or 11 of the Bankruptcy Code. In In re Lehman Brothers Holdings, Inc., bankruptcy judge James M. Peck refused to recognize rulings by U.K. courts that validated a "flip clause" in a swap agreement that shifted the priority of claims between a noteholder and its swap counterparty, a Lehman Brothers affiliate, due to the U.S. bankruptcy filing of the parent company. Even though the priority shift was valid under U.K. law, the court declined to recognize the rulings notwithstanding principles of comity because it concluded that the flip clause, a common risk mitigation technique in swap transactions, was an ipso facto clause that is unenforceable under U.S. law. These rulings indicate that comity continues to be a significant consideration in cross-border bankruptcy cases involving the conflicting laws of different nations, both within and outside chapter 15. In Part I of this article, we address the court's ruling in Metcalfe & Mansfield.
As noted, U.S. courts apply general principles of comity in determining whether to recognize and enforce foreign judgments. In its 1895 ruling in Hilton v. Guyot, the U.S. Supreme Court held that a U.S. court should enforce the judgment and that the issue should not be "tried afresh" if a foreign forum provides
a full and fair trial abroad before a court of competent jurisdiction, conducting the trial upon regular proceedings, after due citation or voluntary appearance of the defendant, and under a system of jurisprudence likely to secure an impartial administration of justice between the citizens of its own country and those of other countries, and there is nothing to show either prejudice in the court, or in the system of laws under which it was sitting.
Comity has long been an important consideration in cross-border bankruptcy and insolvency cases. Prior to the enactment of chapter 15 in 2005, section 304 of the Bankruptcy Code governed proceedings commenced by the accredited representatives of foreign debtors in the U.S. that were "ancillary" to bankruptcy or insolvency cases filed abroad. Ancillary proceedings were typically commenced under section 304 for the limited purpose of protecting a foreign debtor's U.S. assets from creditor collection efforts by means of injunctive relief granted by a U.S. bankruptcy court and, in some cases, for the purpose of repatriating such assets or their proceeds abroad for administration in the debtor's foreign bankruptcy case. In deciding whether to grant injunctive, turnover, or other appropriate relief under former section 304, a U.S. bankruptcy court was obliged to consider "what will best assure an economical and expeditious administration" of the foreign debtor's estate, consistent with a number of factors, including comity.
Comity continues to play a prominent role in chapter 15, which is patterned on the Model Law on Cross-Border Insolvency. The Model Law is a framework of legal principles formulated by the United Nations Commission on International Trade Law in 1997 to deal with the rapidly expanding volume of international insolvency cases. To date, it has been adopted in 17 nations or territories. The stated purpose of chapter 15 is "to incorporate the Model Law on Cross-Border Insolvency so as to provide effective mechanisms for dealing with cases of cross-border insolvency" consistent with objectives that include cooperation between U.S. and non-U.S. courts and related functionaries.
To effectuate that goal, if a U.S. court "recognizes" a foreign "main" or "nonmain" proceeding under chapter 15, it is authorized under section 1507 to provide "additional assistance" to a foreign representative. This can include injunctive relief or authority to distribute the proceeds of all or part of the debtor's U.S. assets, provided, however, that the court concludes, "consistent with the principles of comity," that such assistance will reasonably ensure, among other things, the just treatment of creditors and other stakeholders, the protection of U.S. creditors against prejudice in pursuing their claims in the foreign proceeding, and the prevention of fraudulent or preferential disposition of property. In addition, if the bankruptcy court enters an order of recognition under chapter 15, section 1509 provides that any other U.S. court "shall grant comity or cooperation to the foreign representative."
Applying principles of comity to strike a fair balance between the competing interests of creditors under conflicting laws is a difficult undertaking. The bankruptcy court in Metcalfe & Mansfield was recently called upon to do so.
Metcalfe & Mansfield
Metcalfe & Mansfield Alternative Investments II Corp. and certain affiliated entities (collectively, "Metcalfe") are investment vehicles formed to participate in Canada's multibillion-dollar asset-backed commercial paper ("ABCP") market. ABCP is a sophisticated financial instrument consisting principally of short-term investments, typically with a low interest yield marginally better than that available from other short-term paper issued by a government or bank. ABCP is "asset-backed" because the cash that is used to purchase an ABCP note or trust certificate is converted into a portfolio of financial assets or other asset interests that in turn provide security for the repayment of the notes. The assets generally consist of "traditional" securitized assets, such as residential and commercial mortgages, credit card receivables, and auto loans, as well as collateralized debt obligations ("CDOs"), which are not specific to one type of debt but are a type of asset-backed security and structured credit product. Most of the CDOs are synthetic, thus gaining credit exposure to a portfolio of fixed income assets (without actually owning those assets) through the use of credit default swaps.
The ABCP market froze during the week of August 13, 2007. The crisis was triggered by market sentiment, as news spread of defaults on U.S. subprime mortgages. A perceived lack of transparency in the Canadian ABCP market caused investors to lose confidence, fearing that the assets backing ABCP might include substantial exposure to subprime mortgages or other overvalued assets. The entire system ground to a halt as margin calls, rejection of new funding requests, and defaults multiplied.
Various key participants in the market signed an agreement on August 14, 2007, establishing a 60-day standstill period to prevent the destruction of value that a forced liquidation of the underlying assets would have caused. During the standstill period, key participants and other parties negotiated a plan to restructure the entire ABCP market to provide for marketwide transparency in the assets underlying restructured ABCP notes and a greater opportunity for investors to recover on their claims.
The Canadian Restructuring Proceeding
An investors' committee filed a petition for relief on behalf of Metcalfe under Canada's Companies' Creditors Arrangement Act (the "CCAA") on March 17, 2008, in the Ontario Superior Court of Justice (Commercial List) (the "Ontario Court"). The case (the "Canadian Proceeding") was commenced to effect the restructuring of all outstanding non-bank-sponsored ABCP obligations, which were estimated to have a face value on the filing date of approximately CAN$32 billion. The ABCP restructuring was the largest restructuring in Canadian history.
A creditor-initiated Plan of Compromise and Arrangement restructuring Metcalfe as well as the ABCP market generally was approved by an overwhelming vote of ABCP noteholders (96 percent in number and dollar amount). The Ontario Court entered an order approving and implementing the plan on June 5, 2008 (the "Plan Order"). That order was upheld on appeal by more than 30 parties by the Ontario Court of Appeal on August 18, 2008. Canada's Supreme Court later denied a petition for review of the Plan Order, which became effective in January 2009.
The Nondebtor Releases and Injunctions
Among other things, the Plan Order provided each participant (debtor or nondebtor) in the Canadian ABCP market with a release from substantially all liabilities in any way related to the market. It also enjoined substantially all litigation against market participants involving market-based claims and causes of action. The jurisdiction of the Ontario Court to grant the third-party release and injunction provisions was the central issue before both the Ontario Court and the Ontario Court of Appeal, both of which decided in "lengthy, reasoned written decisions" that, under the CCAA, the Ontario Court had jurisdiction and properly exercised its power and discretion in approving the provisions. As noted, the Canadian Supreme Court denied review.
The Chapter 15 Petition
A monitor appointed by the Ontario Court for Metcalfe filed a chapter 15 petition in New York on November 10, 2009, seeking an order under section 1517 of the Bankruptcy Code recognizing Metcalfe's Canadian Proceeding as a foreign main proceeding. The monitor also sought, by way of "additional assistance" under section 1507, an order enforcing the global releases and injunctions contained in the Plan Order.
The bankruptcy court had no difficulty concluding that the Canadian Proceeding was entitled to recognition under chapter 15 as a foreign main proceeding. The only remaining issue, the court explained, "arises from the inclusion in the Canadian Orders of a very broad third-party non-debtor release and injunction."
Metcalfe's monitor argued that the third-party nondebtor release and injunction provisions should be enforced in the U.S. because such provisions would pass muster, if Metcalfe were a debtor in a plenary bankruptcy case (i.e., a chapter 7 or 11 case), under the rigorous standards established by the Second Circuit Court of Appeals in In re Drexel Burnham Lambert Group, Inc.; In re Metromedia Fiber Network, Inc.; and In re Johns-Manville Corp. In addition, the monitor asserted that, even if a bankruptcy court within the Second Circuit would not have issued the nondebtor release and injunction in a plenary case, the provisions of the Plan Order should be enforced in the U.S. "pursuant to law applicable to enforcement of foreign judgments, the principles of international comity, and the public policy embodied in chapter 15 of the Bankruptcy Code."
The New York bankruptcy court emphasized that Second Circuit precedent places "significant limitations on bankruptcy courts ordering non-debtor releases and injunctions in confirmed chapter 11 plans." However, the court explained, the U.S. Supreme Court's reversal in 2009 of the Second Circuit's 2008 Manville decision, where the court of appeals had ruled that a bankruptcy court has jurisdiction to issue a nondebtor release only where the released claims "directly affect the res of the bankruptcy estate," rendered Second Circuit law on approval of such provisions "uncertain."
Even so, the bankruptcy court reasoned that such uncertainty was of little consequence in the case before it, which did not involve the propriety of nondebtor injunctions and releases in a plenary bankruptcy case, but rather a request to enforce a foreign judgment in a chapter 15 case. The court concluded that "principles of enforcement of foreign judgments and comity in chapter 15 cases strongly counsel approval of enforcement in the United States of the third-party non-debtor release and injunction provisions included in the Canadian Orders, even if those provisions could not be entered in a plenary bankruptcy case."
According to the bankruptcy court, (i) the nondebtor release and injunction provisions at issue treated all claimants in the Canadian Proceeding similarly; (ii) relief granted in a foreign proceeding and the relief available in a U.S. bankruptcy case need not be identical, so long as the foreign procedures meet "fundamental standards of fairness" in the U.S.; (iii) although recognition of a foreign proceeding turns on the objective criteria set forth in section 1517 of the Bankruptcy Code, post-recognition relief "is largely discretionary and turns on subjective factors that embody principles of comity"; (iv) the "public policy exception" contained in section 1506 is narrowly construed; (v) both Second Circuit precedent and the rulings of the Canadian courts "reflect similar sensitivity to the circumstances justifying approving" nondebtor release and injunction provisions; and (vi) although Manville may be interpreted as identifying additional jurisdictional limits placed by Congress on the power of U.S. bankruptcy courts to approve nondebtor releases and injunctions, the Canadian courts have interpreted the CCAA as creating no such jurisdictional impediments.
Given the similarities between Canadian and U.S. law, the fact that "Canadian courts afford creditors a full and fair opportunity to be heard in a manner consistent with standards of U.S. due process," and the absence of any challenge to the jurisdiction asserted over the matter by the Canadian courts, the bankruptcy court concluded that both principles for recognition of foreign judgments and comity supported the exercise of its discretion to give res judicata effect to the Plan Order:
The Canadian Proceedings were the result of near-cataclysmic turmoil in the Canadian commercial paper market following the onset of the global financial crisis. The far-reaching Plan was adopted with near-unanimous creditor support, approved by the Ontario Court, and then affirmed on appeal by the Ontario Court of Appeal in the face of a jurisdictional challenge to the inclusion of third-party non-debtor release and injunction provisions. There is no basis for this Court to second-guess the decisions of the Canadian courts. Principles of comity in chapter 15 cases support enforcement of the Canadian Orders in the United States whether or not the same relief could be ordered in a plenary case under chapter 11. Therefore, the Court will enter an order recognizing this case as a foreign main proceeding and enforcing the Canadian Orders.
Metcalfe & Mansfield is an interesting case study on comity in cross-border bankruptcy cases involving significant differences in law between nations that are otherwise generally perceived as having a common legal heritage. Where such conflicts of law are manifest, the U.S. bankruptcy court is obligated to balance the strong interests in applying local law to a given dispute against the important international principle of deference to the duly sanctioned resolutions of foreign states and their judicial institutions. Given the present state of uncertainty in U.S. law concerning the circumstance under which third-party releases and injunctions are valid and enforceable on jurisdictional grounds, Judge Glenn's decision to enforce the Canadian courts' orders is not surprising.
In Part II of this article, we will discuss bankruptcy judge Peck's ruling in Lehman Brothers, where he reached a different conclusion based upon what he perceived to be an overriding interest in applying U.S. law.
In re Metcalfe & Mansfield Alternative Investments, 421 B.R. 685 (Bankr. S.D.N.Y. 2010).
Lehman Brothers Special Financing, Inc. v. BNY Corporate Trustee Services, Ltd. (In re Lehman Brothers Holdings, Inc.), 422 B.R. 407 (Bankr. S.D.N.Y. 2010).
Hilton v. Guyot, 159 U.S. 113 (1895).
SEC v. Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert Group, Inc.), 960 F.2d 285 (2d Cir. 1992).
In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005).
In re Johns-Manville Corp., 517 F.3d 52 (2d Cir. 2008), rev'd on other grounds sub nom. Travelers Indemnity Co. v. Bailey, 129 S. Ct. 2195 (2009).