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Bankruptcy Court in Chapter 15 Case Refuses to Extend Comity to Gibbs Rule in Enforcing Croatian Settlement Modifying English-Law Debt

For more than a century, courts in England and Wales have refused to recognize or enforce foreign court judgments or proceedings that discharge or compromise debts governed by English law. In accordance with a rule (the "Gibbs Rule") stated in an 1890 decision by the English Court of Appeal, creditors holding debt governed by English law may still sue to recover the full amount of their debts in England even if such debts have been discharged or modified in connection with a non-U.K. bankruptcy or insolvency proceeding.

Such territorialism flies in the face of the "modified universalist" framework governing cross-border insolvencies that has been sanctioned by the more than 40 countries, including the U.K. and the U.S., that have enacted some form of the 1997 UNCITRAL Model Law on Cross-Border Insolvency (the "CBI Model Law").

Judge Martin Glenn of the U.S. Bankruptcy Court for the Southern District of New York recently addressed this inconsistency in In re Agrokor d.d., 591 B.R. 163 (Bankr. S.D.N.Y. 2018). Having previously entered an order recognizing a Croatian company’s restructuring proceeding under chapter 15 of the Bankruptcy Code, the court recognized and enforced a settlement agreement that restructured English-law debt. It concluded that, under principles of comity, it would be appropriate to enforce the settlement agreement in the U.S., even though enforcement of the agreement would represent a refusal to extend comity to the Gibbs Rule.

Comity

"Comity" is "the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protection of its laws." Hilton v. Guyot, 159 U.S. 113, 164 (1895). International comity has been interpreted to include two distinct doctrines: (i) "legislative," or "prescriptive," comity; and (ii) "adjudicative" comity. Maxwell Comm’n Corp. v. Societe Generale (In re Maxwell Comm’n Corp.), 93 F.3d 1036, 1047 (2d Cir. 1996).

The former "shorten[s] the reach of a statute"—one nation will normally "refrain from prescribing laws that govern activities connected with another state when the exercise of such jurisdiction is unreasonable." Official Comm. of Unsecured Creditors of Arcapita Bank B.S.C.(c) v. Bahrain Islamic Bank (In re Arcapita Bank B.S.C.(c)), 575 B.R. 229, 237 (Bankr. S.D.N.Y. 2017).

"Adjudicative" comity, or "comity among courts," is an act of deference whereby the court of one nation declines to exercise jurisdiction in a case that is properly adjudicated in a foreign court. Id. at 238. U.S. courts generally extend comity whenever a foreign court has proper jurisdiction and "enforcement does not prejudice the rights of United States citizens or violate domestic public policy." CT Inv. Mgmt. Co., LLC v. Cozumel Caribe, S.A. de C.V. (In re Cozumel Caribe, S.A. de C.V.), 482 B.R. 96, 114 (Bankr. S.D.N.Y. 2012).

Because a foreign nation’s interest in the equitable and orderly distribution of a foreign debtor’s assets is an interest deserving respect and deference, U.S. courts generally defer to foreign bankruptcy proceedings and decline to adjudicate creditor claims that are the subject of such proceedings. See Canada Southern Railway Co. v. Gebhard, 109 U.S. 527, 548 (1883) ("the true spirit of international comity requires that [foreign schemes of arrangement], legalized at home, should be recognized in other countries"); accord JP Morgan Chase Bank v. Altos Hornos de Mexico S.A. de C.V., 412 F.3d 418 (2d Cir. 2005) (applying principles of comity in an ancillary proceeding under section 304 of the Bankruptcy Code, the precursor to chapter 15 of the Bankruptcy Code); In re Int’l Banking Corp. B.S.C., 439 B.R. 614, 624 (Bankr. S.D.N.Y. 2010) (citing cases).

In this context, deference to a foreign proceeding is warranted "so long as the foreign proceedings are procedurally fair and . . . do not contravene the laws or public policy of the United States." Cozumel Caribe, 482 B.R. at 114. Courts examine a number of factors in assessing procedural fairness, including:

(1) whether creditors of the same class are treated equally in the distribution of assets; (2) whether the liquidators are considered fiduciaries and are held accountable to the court; (3) whether creditors have the right to submit claims which, if denied, can be submitted to a bankruptcy court for adjudication; (4) whether the liquidators are required to give notice to the debtor’s potential claimants; (5) whether there are provisions for creditors meetings; (6) whether a foreign country’s insolvency laws favor its own citizens; (7) whether all assets are marshalled before one body for centralized distribution; and (8) whether there are provisions for an automatic stay and for the lifting of such stays to facilitate the centralization of claims.

Finanz AG Zurich v. Banco Economico S.A., 192 F.3d 240, 249 (2d Cir. 1999).

Role of Comity in Cases Under Chapter 15 of the Bankruptcy Code

As with the CBI Model Law, comity is a pillar of chapter 15 of the Bankruptcy Code. Cozumel Caribe, 482 B.R. at 114–15 (a central tenet of chapter 15 is the importance of comity in cross-border insolvency proceedings).

Under section 1515 of the Bankruptcy Code, the representative of a foreign debtor may file a petition in a U.S. bankruptcy court seeking "recognition" of a "foreign proceeding." Section 101(24) of the Bankruptcy Code defines "foreign representative" as "a person or body, including a person or body appointed on an interim basis, authorized in a foreign proceeding to administer the reorganization or the liquidation of the debtor’s assets or affairs or to act as a representative of such foreign proceeding."

"Foreign proceeding" is defined in section 101(23) of the Bankruptcy Code as:

a collective judicial or administrative proceeding in a foreign country, including an interim proceeding, under a law relating to insolvency or adjustment of debt in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganization or liquidation.

More than one bankruptcy or insolvency proceeding may be pending with respect to the same foreign debtor in different countries. Chapter 15 therefore contemplates recognition in the U.S. of both a "foreign main proceeding"—a case pending in the country where the debtor’s center of main interest (COMI) is located (see 11 U.S.C. § 1502(4))—and "foreign nonmain proceedings," which may have been commenced in countries where the debtor merely has an "establishment" (see 11 U.S.C. § 1502(5)).

Section 1509(b) provides that, if the U.S. bankruptcy court recognizes a foreign proceeding, the foreign representative may apply directly to another U.S. court for appropriate relief, and a U.S. court "shall grant comity or cooperation to the foreign representative."

In addition, after recognition of a foreign proceeding, section 1521(a) authorizes the court, upon the request of the foreign representative, to grant a broad range of relief designed to preserve the foreign debtor’s assets or otherwise provide assistance to the court or other entity presiding over the debtor’s foreign proceeding. Such post-recognition relief "is largely discretionary and turns on subjective factors that embody principles of comity." In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd., 329 B.R. 325, 333 (S.D.N.Y. 2008).

Section 1507 of the Bankruptcy Code similarly states that, post-recognition, the court may provide "additional assistance" to a foreign representative under the Bankruptcy Code "or under other laws of the United States." In determining whether to provide such relief, the court must consider whether such assistance, "consistent with the principles of comity," will reasonably ensure, among other things: (i) the just treatment of all creditors and interest holders; (ii) protection of U.S. creditors "against prejudice and inconvenience in the processing of claims in such foreign proceeding"; and (iii) "distribution of proceeds of the debtor’s property substantially in accordance with the order prescribed" in the Bankruptcy Code.

Discretionary relief under sections 1507 and 1521 can include recognition and enforcement of a restructuring plan or scheme approved by a foreign court. See In re Avanti Comm’ns Grp. PLC, 582 B.R. 603 (Bankr. S.D.N.Y. 2018); In re Rede Energia S.A., 515 B.R. 69 (Bankr. S.D.N.Y. 2014); In re Metcalfe & Mansfield Alternative Investments, 421 B.R. 685 (Bankr. S.D.N.Y. 2010).

However, section 1522 provides that the bankruptcy court may grant relief under section 1521 "only if the interests of the creditors and other interested entities, including the debtor, are sufficiently protected."

In addition, section 1506 of the Bankruptcy Code sets forth a public policy exception to the relief otherwise authorized in chapter 15, providing that "[n]othing in this chapter prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States."

The Gibbs Rule and the New Model Law on the Enforcement of Insolvency Judgments

In Antony Gibbs & Sons v. La Société Industrielle et Commerciale des Métaux [1890] LR 25 QBD 399, a Parisian company entered into a contract to purchase copper from a London merchant. Delivery of the copper was to take place in England. The buyer was placed into a judicial liquidation proceeding in France and refused to take delivery of some of the copper. The seller filed a claim in the liquidation proceeding for damages but reserved its right to continue prosecuting an action against the buyer in an English court. The French liquidator disallowed the claim for damages, and a French court upheld that determination. Thus, the claim was effectively discharged in the French liquidation proceeding.

In the pending English litigation, the Court of Appeal concluded that the contract was governed by English law and that discharge of the claim in the French liquidation proceeding did not prevent the seller from attempting to collect on it in England. The Court reasoned:

Why should the plaintiffs be bound by the law of a country to which they do not belong, and by which they have not contracted to be bound? Therefore, if it were true that in any of the modes suggested the defendants were by the law of France discharged from liability, I should say that such law did not bind the plaintiffs, and that they were nevertheless entitled, according to English law, to maintain their action upon an English contract.

The Gibbs Rule has been applied in many subsequent U.K. court rulings, even after the U.K. adopted its version of the CBI Model Law in 2006 (the Cross-Border Insolvency Regulations (the "CBIR")). See, e.g., Bakhshiyeva v Sberbank of Russia [2018] EWHC 59 (Ch) (ruling that, under the Gibbs Rule, the court would refuse to grant the application of the foreign representative of an Azerbaijan bank debtor for a permanent stay of creditors’ enforcement of claims in England under an English law-governed contract, contrary to the terms of the bank’s Azeri insolvency proceeding, even though the proceeding had been recognized in England under the CBIR), aff’d, [2018] EWCA Civ 2802, 2018 WL 06605589 (Dec. 18, 2018) (holding that the CBI Model Law is merely procedural and cannot impair substantive English-law contract rights protected by the Gibbs Rule); accord Goldman Sachs International v Novo Banco SA [2018] UKSC 34, [2018] 1 WLR 3683.

Because it is inconsistent with the modified universalist approach underpinning modern cross-border bankruptcy legislation, the Gibbs Rule has frequently been criticized as an anachronism that should be consigned to the dregs of history. See, e.g., Pacific Andes Resources Development Ltd. [2016] SGHC 210 (discussing various academic criticisms of the Gibbs Rule’s continued application and explaining that a fundamental problem with the rule in international insolvency cases is that it mischaracterizes the discharge of debt as a contractual issue rather than an issue of bankruptcy law, which gives primacy to policy over contractual rights).

On September 18, 2018, the United Nations Commission on International Trade Law published its final version of the new Model Law on the Recognition and Enforcement of Insolvency-Related Judgments (the "IRJ Model Law"). The IRJ Model Law creates a framework for the recognition and enforcement of judgments in foreign bankruptcy and insolvency proceedings. It is intended to supplement and complement the CBI Model Law. If adopted by the U.K., the IRJ Model Law would presumably abrogate the Gibbs Rule. Until then, however, it persists as an impediment to the enforcement of non-U.K. insolvency judgments impairing English-law contract rights.

In Agrokor, the U.S. bankruptcy court was confronted with a dilemma: under principles of comity, should it recognize and enforce a Croatian settlement agreement that restructured English-law debt, even though a U.K. court applying the Gibbs Rule would likely refuse to do so?

Agrokor

The Agrokor Group ("AG") is the largest private company by revenue in the Republic of Croatia, with more than 60,000 employees. Seventy-seven AG companies are based in Croatia and established under Croatian law, but they operate both within and outside the country. These entities are part of a group of 155 AG companies, the remainder of which are not based in Croatia and operate outside the country (principally in Slovenia, Serbia, and Bosnia-Herzegovina).

AG’s financial difficulties and its importance to the Croatian economy spurred the enactment in April 2017 of Croatia’s Act on the Extraordinary Administrative Proceedings in Companies of Systemic Importance for the Republic of Croatia (the "EA Law"). As stated in its preamble, the purpose of the legislation, which does not apply solely to the Agrokor Group, is the "protection of sustainability of operations of the companies of systemic importance for the Republic of Croatia which with its operations individually or together with its controlled or affiliated companies affect the entire economic, social and financial stability of the Republic of Croatia." The law applies to enterprise groups of Croatian companies that have a principal place of business in Croatia, even though they may operate both within and outside the country.

The EA Law includes provisions for the reorganization and adjustment of debts of systemically important companies. Those provisions contemplate the negotiation, acceptance by creditors, and court approval of a settlement agreement—essentially a plan of reorganization that adjusts the debt and ownership interests of distressed companies.

The 77 Croatia-based AG companies (the "AG Debtors") commenced a proceeding under the EA Law (the "EA Proceeding") shortly after it was enacted in April 2017. At the time of the filing, these companies had approximately €625 million in New York law-governed debt and €1.6 billion in English law-governed debt.

The settlement agreement proposed in the EA Proceeding (the "Settlement Agreement") classified and treated various categories of priority, unsecured, and secured claims, as well as equity interests. The agreement provided for a projected recovery of not more than 51 percent on the English and New York law-governed debt and incorporated certain third-party releases, including releases of guarantees of the English and New York law-governed debt.

On July 4, 2018, the required majority of AG’s creditors (including insider creditors) voted to accept the Settlement Agreement, which was later approved by the Commercial Court of Zagreb in Croatia. The High Commercial Court denied more than 90 appeals of the approval order on October 26, 2018, making the Settlement Agreement final.

In 2017 and 2018, the foreign representative of the AG Debtors sought recognition of the EA Proceeding in seven foreign jurisdictions, including the U.K. and the U.S. As of November 2018, only a Swiss court had issued a final decision recognizing the proceeding under its insolvency law. In September 2017, the High Court of England and Wales had recognized the EA Proceeding under the CBIR, finding that the proceeding did not manifestly violate English public policy. However, that decision is on appeal and did not include recognition of the Settlement Agreement, which was approved by the Croatian court after the English court entered its recognition order.

Courts in Slovenia, Serbia, Bosnia-Herzegovina, and Montenegro refused to recognize the EA Proceeding, although those rulings have also been appealed. Among other things, those courts expressed concern that the EA Law was enacted not for the collective benefit of creditors, but on an ad hoc basis to benefit AG and to protect the economic, social, and financial stability of Croatia.

In July 2018, the Recast Insolvency Regulation (EU) 2015/848 became effective in the European Union. Thus, enactment of the EA Law by Croatia ostensibly afforded the EA Proceeding automatic recognition as an insolvency proceeding in all European Union member states.

On July 12, 2018, the foreign representative filed a petition on behalf of nine AG Debtors in the U.S. Bankruptcy Court for the Southern District of New York, seeking recognition of the EA Proceeding under chapter 15 as well as recognition and enforcement of the Settlement Agreement in the U.S. The bankruptcy court entered an order recognizing the EA Proceeding on September 21, 2018. However, the court reserved decision at that time on the request to recognize and enforce the Settlement Agreement.

The Bankruptcy Court’s Ruling

On October 24, 2018, the bankruptcy court issued an order provisionally recognizing and enforcing the Settlement Agreement, subject to its finalization.

The court began its analysis by examining various aspects of the EA Law in an effort to determine whether its rules are procedurally fair in accordance with the factors stated in Finanz AG Zurich. The court noted, among other things, that under the EA Law: (i) a proceeding is presided over by a Croatian court; (ii) the debtor is represented by a court-appointed "extraordinary commissioner" with the statutory duties of a bankruptcy receiver; (iii) creditors are represented in the proceeding by a creditors’ committee; (iv) procedures exist for notice to creditors of the proceedings and the resolution of creditor claims; (v) procedures are provided for the negotiation, acceptance by creditors, and court approval of a settlement agreement providing for the treatment of claims and interests; (vi) creditors are deemed to accept a settlement agreement if the requisite majority of creditors vote in favor of it; and (vii) all creditors are bound by a settlement agreement, whether or not they vote.

Concluding that the EA Law "tracks closely to the structure" of the U.S. Bankruptcy Code and many other foreign insolvency laws, the court accordingly held that the EA Proceeding "was procedurally fair, provided proper notice to all creditors and, through the Settlement Agreement, determined the rights of all creditors to property that was subject to the jurisdiction of the Croatian Court."

Having concluded that the EA Law’s structure is procedurally fair—a finding that it had previously made in granting the petition for recognition of the EA Proceeding—the bankruptcy court next examined whether there was any reason that it should refuse to recognize and enforce the Settlement Agreement in the U.S. It found none, on the basis of the terms of the Settlement Agreement itself, notwithstanding the fact that several other courts had refused to recognize the EA Proceeding or the possibility that the English courts might refuse to recognize the Settlement Agreement in whole or in part under the Gibbs Rule.

The court explained that, although the Settlement Agreement released and discharged guarantees by nondebtor affiliates of both the English law and New York law-governed debt, "this Court has recognized and enforced such releases" under appropriate circumstances (citing Avanti, 582 B.R. at 617–18, and Metcalfe & Mansfield, 421 B.R. at 688).

Nor was the court troubled that votes cast by "insiders" might have tainted acceptance of the Settlement Agreement. It explained that, in In re Vitro S.A.B. de C.V., 701 F.3d 1031 (5th Cir. 2012), the Fifth Circuit affirmed a bankruptcy court’s refusal in a chapter 15 case to recognize a Mexican court’s order approving a Mexican debtor’s reorganization plan containing guarantor releases because acceptance of the plan was possible only by counting the votes of insiders, which is contrary to U.S. bankruptcy law (see 11 U.S.C. § 1129(a)(10)). Unlike in Vitro, the Agrokor court noted, the requisite majority of creditors accepted the Settlement Agreement without counting insider votes.

Given the procedural fairness of the EA Law, its previous recognition of the EA Proceeding, the terms of the Settlement Agreement (including the fact that creditor distributions "closely follow the waterfall provisions of the U.S. Bankruptcy Code"), and the agreement’s overwhelming acceptance by creditors, the court concluded that the Settlement Agreement, including the third-party releases, should be "recognized and enforced in these Chapter 15 cases with respect to the nine Foreign Debtors that filed these Chapter 15 cases." Under the circumstances, the court emphasized, its broad discretion to grant post-recognition relief under sections 1507 and 1521 encompasses recognition and enforcement of the Settlement Agreement.

Decisions of other foreign courts denying recognition of the EA Proceeding, the bankruptcy court wrote, "have no direct impact upon the decision to recognize and enforce the [EA] Proceeding and Settlement Agreement in the U.S."

Finally, the court concluded that the Gibbs Rule was not an impediment to recognition and enforcement of the Settlement Agreement in the U.S. The court agreed with other foreign courts and commentators that the Gibbs Rule mischaracterizes the discharge of debt in international insolvency cases as a contractual issue rather than as a bankruptcy or insolvency-law issue. The court noted that "England, of course, is free to continue to adhere to the Gibbs rule, but that does not mean that a U.S. bankruptcy court must follow the rule in deciding whether to recognize and enforce the decision of a court of another jurisdiction."

As noted, the Settlement Agreement became final on October 26, 2018. The bankruptcy court entered an order unprovisionally recognizing and enforcing the agreement on December 14, 2018.

Outlook

Cases like Agrokor are emblematic of the increasing incidence of cross-border bankruptcy cases involving enterprise groups of companies based or operating in, or having debt instruments governed by, multiple countries. Many nations have recently enacted legislation designed to address the proliferation of such cases, which sometimes present difficult issues that may not be adequately addressed by existing cross-border bankruptcy laws, including the CBI Model Law and chapter 15. In Agrokor, because each of the debtors involved in the case had a common COMI in Croatia, the court concluded that, although the enterprise group aspects of the EA Law were "novel," the chapter 15 cases "do not push the boundaries of cross-border insolvency law."

The Gibbs Rule is a throwback to the older era of territorialism, during which the courts and laws of individual countries protected the interest of local creditors. The CBI Model Law, chapter 15, and the IRJ Model Law embrace a more universalist approach. Subject to certain exceptions—such as the "public policy" exception—this approach embraces the extension of comity to foreign bankruptcy regimes, even if they are not identical to the regime of the recognizing court’s country, so long as foreign proceedings are procedurally fair.

Comity is a central element of chapter 15. If a U.S. bankruptcy court determines that a foreign proceeding meets the requirements for recognition under chapter 15, that court and other U.S. courts are obligated to extend comity to the foreign representative. Moreover, as illustrated in Agrokor, the bankruptcy court has broad discretion to grant appropriate post-recognition relief, including the recognition and enforcement of a foreign debtor’s restructuring plan.

Finally, in recognizing and enforcing in the U.S. an agreement modifying or discharging English law-governed debt, regardless of whether U.K. courts ultimately determine to do so in the U.K., the U.S. bankruptcy court’s ruling in Agrokor may be viewed as a further evolution of chapter 15 precedent applying international comity.

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