Chapter 15 Filing as a Litigation Tactic Not Bad Faith Justifying Automatic Stay Relief
Debtors in non-U.S. bankruptcy or restructuring proceedings commonly seek to shield their U.S. assets from creditor collection efforts by seeking "recognition" of those proceedings in the United States in a case under chapter 15 of the Bankruptcy Code. If a U.S. bankruptcy court recognizes the debtor's foreign proceeding, the Bankruptcy Code's automatic stay prevents creditor collection efforts, including the commencement or continuation of any U.S. litigation involving the debtor or its U.S. assets. A U.S. bankruptcy court can lift the automatic stay triggered by chapter 15 recognition upon a showing of "cause."
In In re Culligan Ltd., 2023 WL 5942498 (Bankr. S.D.N.Y. Sept. 12, 2023) ("Culligan II"), the U.S. Bankruptcy Court for the Southern District of New York considered a motion for relief from the automatic stay filed by the plaintiffs in New York state court litigation against a Bermuda-based debtor's directors, its controlling shareholders and certain other defendants (including the debtor as a nominal defendant) asserting derivative claims challenging the legality of payments made and obligations incurred by the debtor as part of a 2006 restructuring.
In an unpublished ruling, the court denied stay relief as well as a related motion seeking an order directing the debtor's foreign representatives to abandon the state court litigation as having inconsequential value. In so ruling, the bankruptcy court rejected the plaintiffs' argument that stay relief was warranted because the debtor's foreign representatives filed the chapter 15 case in bad faith as a litigation tactic to gain the upper hand in the state court litigation. According to the court, even if there were a good-faith filing requirement in chapter 15, "a bankruptcy filing cannot be said to be in bad faith where the debtor reasonably seeks the benefit of the automatic stay to effectuate an orderly liquidation."
Recognition of Foreign Bankruptcy Cases under Chapter 15
Chapter 15 was enacted in 2005 to govern cross-border bankruptcy and insolvency proceedings. It is patterned on the 1997 UNCITRAL Model Law on Cross-Border Insolvency (the "Model Law"), which has been enacted in some form by more than 50 countries.
Both chapter 15 and the Model Law are premised upon the principle of international comity, or "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). Chapter 15's stated purpose is "to provide effective mechanisms for dealing with cases of cross-border insolvency" with the objective of, among other things, cooperation between U.S. and non-U.S. courts.
Under section 1515(a) 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 United States of both a foreign "main" proceeding—a case pending in the country where the debtor's center of main interests ("COMI") is located (see 11 U.S.C. § 1502(4))—and foreign "nonmain" proceedings, which may be pending in countries where the debtor merely has an "establishment" (see 11 U.S.C. § 1502(5)). A debtor's COMI is presumed to be the location of the debtor's registered office, or habitual residence in the case of an individual. See 11 U.S.C. § 1516(c).
An "establishment" is defined by section 1502(2) as "any place of operations where the debtor carries out a nontransitory economic activity." Unlike with the determination of COMI, there is no statutory presumption regarding the determination of whether a foreign debtor has an establishment in any particular location.
Upon recognition of a foreign "main" proceeding, section 1520(a) of the Bankruptcy Code provides that certain provisions of the Bankruptcy Code automatically come into force, including: (i) the automatic stay preventing creditor collection efforts with respect to the debtor or its U.S. assets (section 362, subject to certain enumerated exceptions); (ii) the right of any entity asserting an interest in the debtor's U.S. assets to "adequate protection" of that interest (section 361); and (iii) restrictions on use, sale, lease, transfer, or encumbrance of the debtor's U.S. assets (sections 363, 549, and 552).
Following recognition of a foreign main or nonmain proceeding, section 1521(a) provides that, to the extent not already in effect, and "where necessary to effectuate the purpose of [chapter 15] and to protect the assets of the debtor or the interests of the creditors," the bankruptcy court may grant "any appropriate relief," including a stay of any action against the debtor or its U.S. assets not covered by the automatic stay, an order suspending the debtor's right to transfer or encumber its U.S. assets, and, under section 1521(a)(7), "any additional relief that may be available to a trustee," with certain exceptions.
Section 1522(a) provides that the bankruptcy court may exercise its discretion to order the relief authorized by sections 1519 and 1521 upon the commencement of a case or recognition of a foreign proceeding "only if the interests of the creditors and other interested entities, including the debtor, are sufficiently protected."
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."
Culligan Ltd. (the "debtor") was a Bermuda-incorporated holding company for direct and indirect subsidiaries that distributed water purification and filtration units through franchise dealers located exclusively in North America.
In a 2006 restructuring, the debtor borrowed $850 million to refinance existing debt, repay $200 million to an investor, and pay a $375 million dividend to shareholders. The debtor restructured again in early 2012.
In May 2012, certain of the debtor's minority shareholders, consisting of 71 of the 262 Culligan water dealers (collectively, the "plaintiffs"), commenced a derivative action (the "NY litigation") against the debtor's directors, its controlling shareholders, and certain other defendants in New York state court alleging that the consolidated Culligan System entities, including the debtor, violated New York law in assuming debt and paying shareholders and investors as part of the 2006 restructuring because the entities had insufficient capital.
The state court dismissed the complaint in March 2013, ruling that Bermuda law, rather than New York law, applied. The plaintiffs appealed.
On April 29, 2013, the debtor's majority shareholders authorized it to commence a members' voluntary liquidation ("MVL") under the Bermuda Companies Act of 1981. That same day, the Bermuda court appointed joint liquidators for the debtor for the purpose of winding up the company. The liquidators notified the plaintiffs of the filing and expressed their view that the NY litigation should not proceed because they had assumed control of the debtor.
The plaintiffs refused and in 2014 obtained a reversal on appeal of the state court's dismissal ruling. However, during the ensuing six years, the state court dismissed no fewer than four amended complaints on various grounds. Its decision on a motion to dismiss a fifth amended complaint was pending as of July 2021.
In June 2017, one of the debtor's affiliates paid it $11.67 million in connection with the winding-up proceeding, bringing the debtor's total cash holdings to $11.87 million. The liquidators accordingly determined that a distribution should be made to shareholders under the MVL in the amount of approximately $11.34 million. After reserving $500,000 to pay liquidation fees and expenses, as well as fees related to the NY litigation, they distributed $11.1 million to the debtor's shareholders, nearly $400,000 of which they disbursed to 56 of the 71 plaintiffs.
As of June 2019, the debtor had approximately $240,000 remaining in payment obligations to multiple shareholders, including nearly $38,000 to the 15 remaining plaintiffs, and had $288,000 in cash. However, due to expected liabilities arising from anticipated fees in the NY litigation, the liquidators determined that the debtor had become insolvent. In July 2019, they accordingly petitioned the Bermuda court to convert the MVL to a court-supervised liquidation. The court granted that relief and confirmed the liquidators in that role for purposes of the liquidation.
In June 2020, the liquidators sought an order from the Bermuda court restraining the plaintiffs from suing the debtor or commencing litigation in its name anywhere in the world. That proceeding was suspended, however, after the liquidators, as the debtor's foreign representatives, filed a chapter 15 petition on September 17, 2020, in the U.S. Bankruptcy Court for the Southern District of New York seeking recognition of the debtor's Bermuda liquidation as a "foreign main proceeding." They also sought an order confirming that the automatic stay precluded continuation of the NY litigation, due to the risk that the suit "may further deplete the dwindling assets of the Debtor and frustrate the Bermuda Liquidation."
The plaintiffs opposed the recognition petition, arguing that: (i) the foreign representatives were forum shopping and commenced the case to enjoin the NY litigation and thereby circumvent the adverse rulings of the state court; and (ii) the foreign representatives filed the chapter 15 petition in bad faith and for the improper purpose of barring the plaintiffs from prosecuting the NY litigation by application of the automatic stay. According to the plaintiffs, the foreign representatives filed the chapter 15 case in bad faith because the debtor was merely a nominal defendant in the NY litigation, it would not incur any liability, and its litigation costs were covered by insurance. They also asserted that the foreign representatives were not seeking a stay to provide breathing room to conduct good-faith liquidation efforts but, rather, improperly seeking chapter 15 recognition and application of the stay to permanently enjoin—as distinguished from merely to pause—the NY litigation.
In In re Culligan Ltd., 2021 WL 2787926 (Bankr. S.D.N.Y. July 2, 2021) ("Culligan I"), the court granted recognition under chapter 15 to the debtor's liquidation proceeding. Among other things, U.S. Bankruptcy Judge James L. Garrity, Jr. ruled that the narrow and rarely invoked public policy exception in section 1506 did not warrant denial of chapter 15 recognition. He wrote that "courts have generally found that section 1506 does not prohibit recognition in situations where the debtor has engaged in bad faith." Id. at *15 (citing In re Manley Toys Ltd., 580 B.R. 632, 648 (Bankr. D.N.J. 2018), aff'd, 597 B.R. 578 (D.N.J. 2019); In re Creative Fin. Ltd., 543 B.R. 498, 515 (Bankr. S.D.N.Y. 2016)). Instead, Judge Garrity explained, the question under section 1506 is not whether the debtor's actions violate public policy, but whether the foreign court's procedures and safeguards fail to comport with U.S. public policy.
Judge Garrity acknowledged that there was evidence to show that the foreign representatives filed the chapter 15 petition as part of their "litigation strategy" to bring an end to the NY litigation and that "the admitted, and apparently entire, purpose of the present chapter 15 filing" was to prevent the plaintiffs from continuing the lawsuit. Id. at *15. However, he faulted the plaintiffs' reliance on case law finding bad faith as "cause" for dismissing chapter 11 cases under section 1112(b) of the Bankruptcy Code. Unlike in chapter 11, Judge Garrity reiterated, recognition under chapter 15 is subject to the public policy exception of section 1506, which considers not whether the actions of the debtor violate public policy, but whether the foreign court's procedures and safeguards fail to comport with U.S. public policy. In the absence of any such allegations, Judge Garrity held that the alleged bad faith was not a basis to deny chapter 15 recognition.
Judge Garrity accordingly granted the petition for recognition of the Bermuda liquidation proceeding under chapter 15 as a foreign main proceeding. Upon recognition, the automatic stay precluded continuation of the NY litigation (including the issuance of any decision on the debtor's motion to dismiss the fifth amended complaint as well as the plaintiffs' anticipated filing of a sixth amended complaint). In so ruling, Judge Garrity declined to address whether the foreign representatives were entitled to supplementary injunctive relief under section 1521 (in addition to the automatic stay arising upon recognition under section 1520(a)) and stated that any request by the plaintiffs for relief from the automatic stay to continue the NY litigation was premature because it was not procedurally proper.
On July 30, 2021, the plaintiffs filed a motion for an order: (i) modifying the automatic stay to continue the NY litigation; and (ii) directing the foreign representatives to abandon the NY litigation.
According to the plaintiffs, relief from the stay was warranted in accordance with the 12-factor test set forth in In re Sonnax Indus., Inc., 907 F.2d 1280 (2d Cir. 1990), because, among other things:
- The vast majority of the debtor's assets had already been distributed, such that continuation of the NY litigation would not interfere with the Bermuda liquidation;
- The debtor's legal fees in the NY litigation were mostly covered by insurance;
- The debtor was only a nominal defendant in the NY litigation;
- The debtor had few, if any, creditors, and they would not be prejudiced by continuation of the litigation;
- Success in the NY litigation by the plaintiffs would not result in an avoidable judicial lien; and
- The balance of equities favored stay relief because the successful prosecution of the NY litigation would benefit the debtor's stakeholders, whereas denial of stay relief would sanction the foreign representatives' bad-faith litigation tactic in filing the chapter 15 petition for the purpose of preventing prosecution of the NY litigation.
In addition, the plaintiffs argued that the court should compel the foreign representatives to abandon the NY litigation under section 554(b) of the Bankruptcy Code because the action was of "inconsequential value," and the foreign representatives had a conflict of interest because they were employed by one of the other defendants in the NY litigation.
The foreign representatives opposed the motion. Among other things, they argued that the plaintiffs were effectively asking the court to reconsider its recognition decision, including the court's ruling that the chapter 15 petition was not filed in bad faith. They also claimed that relief from the stay was not justified under the Sonnax factors because, among other things: (i) continuation of the NY litigation would burden the debtor because it (rather than its insurer) was responsible for any fees arising from the foreign representatives' participation in the litigation; (ii) stay relief would not lead to resolution of the already protracted action, which was still only in the pleading stage; (iii) the claims in the NY litigation were derivative and belonged to the debtor; and (iv) denial of stay relief would not prejudice the plaintiffs because they would have an opportunity to be heard in the Bermuda court.
The foreign representatives opposed abandonment because section 554 of the Bankruptcy Code is not among the provisions that section 103(a) makes applicable to chapter 15 cases. In addition, the foreign representatives contended that abandonment is not warranted because, among other things, if allowed to proceed, the NY litigation would continue to burden the debtor because it would be responsible for any fees arising from the foreign representatives' participation in the litigation.
The Bankruptcy Court's Ruling
The bankruptcy court denied the motion.
Addressing the motion for abandonment first, Judge Garrity explained that sections 103(a) and 1520(a) of the Bankruptcy Code catalogue the provisions of the Bankruptcy Code that apply in a chapter 15 case, but the Bankruptcy Code's abandonment provision—section 554(b)—is not among them. However, he explained, some courts have reasoned that a foreign representative may be permitted to abandon a debtor's property under appropriate circumstances pursuant to section 1521(a)(7), which, as noted previously, authorizes a bankruptcy court, "at the request of the foreign representative," to grant "any additional relief available to a trustee," with certain exceptions not relevant here. Culligan II, 2023 WL 5942498, at *13 (citing unpublished orders entered in In re Motorcycle Tires & Accessories LLC, No. 19-12706 (Bankr D. Del.) (orders dated Mar. 31, 2020), and In re Strata Energy Servs. Inc., No. 15-20821 (Bankr. D. Wyo.) (order dated Sept. 7, 2016)).
According to Judge Garrity, these cases are distinguishable because a foreign representative (rather than a creditor) moved to abandon the debtor's property and the motions were not contested. Moreover, he noted, even if section 1521(a)(7) can provide authority to grant section 554(b) relief in a chapter 15 case, abandonment was not appropriate in the case before him. Judge Garrity explained that abandonment of property is justified only if the property "is burdensome to the estate or … is of inconsequential value and benefit to the estate." Here, the foreign representatives demonstrated that they would be adversely impacted by abandonment of the NY litigation to the plaintiffs because, among other things, the foreign representatives would incur even more expense litigating any appeal from the motion to dismiss the complaint. In addition, Judge Garrity was "not convinced" that there was any conflict of interest sufficient for him to mandate abandonment of the action to the plaintiffs. Id. at *15.
Judge Garrity also rejected the plaintiffs' argument that allowing the foreign representatives to "control and dismiss" the NY litigation would be "manifestly contrary" to U.S. public policy within the meaning of section 1506 of the Bankruptcy Code because it would impinge on the plaintiffs' due process rights. Those rights were protected, he explained, because: (i) the foreign representatives were obligated to obtain the Bermuda court's permission (on notice to the plaintiffs) to seek dismissal or other disposition of the NY litigation, and the plaintiffs had the right to be heard by the Bermuda court in connection with any such request; (ii) if the Bermuda court authorized dismissal or other disposition of the NY litigation, the foreign representatives would have to seek recognition and enforcement of that authority from the U.S. bankruptcy court, where the plaintiffs also had the right to be heard; and (iii) the plaintiffs had the right to oppose dismissal or other disposition of the NY litigation in the NY court.
Judge Garrity concluded that there was no "cause" for relief from the automatic stay to continue with the NY litigation under the Sonnax factors. Factors dealing with judicial economy, resolution of the issues in the litigation, and trial readiness all "weigh[ed] heavily against granting relief from the stay given the already protracted nature of the litigation, serious questions regarding the plaintiffs' derivative standing to bring the litigation, and the pending (and anticipated) motions to dismiss. Factors addressing interference with the debtor's bankruptcy case and the unavailability of insurance to cover the debtor's costs also weighed against granting stay relief. In addition, the delay and asset drain attendant to continuation of the NY litigation outweighed any prejudice to the plaintiffs by having to participate in the Bermuda liquidation.
Finally, Judge Garrity rejected the plaintiffs' argument that the stay should be lifted because the foreign representatives filed the debtor's chapter 15 case in bad faith as a litigation tactic:
[A] bankruptcy filing cannot be said to be in bad faith where the debtor reasonably seeks the benefit of the automatic stay to effectuate an orderly liquidation…. In this case, the Foreign Representatives readily admit that the chapter 15 filing is part of their strategy to enjoin, control, and eventually dismiss, an action that they view as meritless, which is draining the Debtor's limited assets and preventing the orderly completion of the Bermuda Liquidation. This strategy is not so much a tactic to combat a negative outcome in the [NY litigation] as it is a tactic to bring the [NY litigation] to a conclusion in furtherance of the Debtor's wind-down. In the end, the Foreign Representatives "may or may not be correct" that dismissal of the [NY litigation] is the best course of action, … but for the reasons outlined herein, their view is not unreasonable.
Id. at *20 (citations omitted).
Culligan II is an important ruling, even though the decision is unpublished and therefore of limited precedential value. In its previous decision recognizing the debtor's Bermuda liquidation proceeding—Culligan I—the bankruptcy court granted chapter 15 recognition despite allegations that the company's court-appointed foreign representatives filed the chapter 15 petition solely to enjoin the pending state court litigation. According to the bankruptcy court, although the Bankruptcy Code gives a U.S. court the discretion to deny any chapter 15 relief that is "manifestly contrary" to U.S. public policy, "this exception is not met by a simple finding that the Chapter 15 Petition has been filed as a litigation tactic." See Culligan I,2021 WL 2787926, at *16.
The bankruptcy court doubled down on that message in its most recent ruling, albeit in the context of a motion for relief from the automatic stay to continue the litigation and a motion to compel abandonment of the lawsuit. In denying that relief, the court recognized that the plaintiffs were effectively attempting to relitigate the recognition dispute. The court accordingly rejected their challenge to the debtor's chapter 15 case as a bad-faith litigation tactic for the same reasons stated in Culligan I, thereby reinforcing the utility of chapter 15 as a means of providing U.S. court assistance to a debtor's foreign bankruptcy or restructuring proceedings and foreign courts overseeing such proceedings.