Restructuring

Contributed by Alexander Woolverton
A debtor in a foreign insolvency proceeding may petition a United States bankruptcy court for recognition of the foreign proceeding under chapter  15 of the Bankruptcy Code, which provides certain relief similar to that provided to debtors in bankruptcy cases pending in the United States and its territories.  When a foreign debtor seeks such recognition of its bankruptcy proceeding, a U.S. court must determine the location of the foreign debtor’s “center of main interests” (COMI).  If the debtor’s COMI is located in the same jurisdiction where the insolvency proceeding is taking place, the proceeding is recognized as a “foreign main proceeding,” and certain sections of the Bankruptcy Code (such as the automatic stay set forth in section 362) will apply to the debtor and any of its property located in the United States.  If the debtor’s COMI is located in a different jurisdiction than where the insolvency proceeding is pending, the proceeding may be recognized as a “foreign nonmain proceeding.”  Under such circumstances, the bankruptcy court has discretion to grant the foreign debtor the protection of the automatic stay.
But what if a debtor’s COMI changes? What is the appropriate time period to analyze in determining the location of a debtor’s COMI?  Is it when the foreign proceeding was filed, or when the foreign representative files a chapter 15 petition for recognition?  This was precisely the question that the United States Court of Appeals for the Second Circuit considered in Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.).  The answer: the time of the filing of the chapter 15 petition, with an opportunity to look back in time, but only to ensure that a foreign debtor’s COMI is not being manipulated.  In reaching its conclusion, the Second Circuit embraced the Fifth Circuit’s reasoning from Lavie v. Ran (In re Ran), and rejected the reasoning of a decision from the Bankruptcy Court for the Southern District of New York—In re Millennium Global Emerging Credit Master Fund.  But because the bankruptcy court clearly found—and the Second Circuit agreed—Sentry’s COMI was located in the BVI when its liquidation commenced and when it filed its petition for recognition, the distinction between Ran and Millennium Global appears to be—in this case—of no consequence.
Background
Fairfield Sentry Limited was the largest of the so-called “feeder funds” of Bernard L. Madoff Investment Securities LLC.  Formed in 1990, Sentry was incorporated under the laws of the BVI, where it also had its registered office, agent, secretary, and corporate documents.  After the discovery of Madoff’s massive Ponzi scheme and his arrest in December 2008, Sentry’s independent directors began winding down its business and preserving its assets in anticipation of litigation and bankruptcy.  While the directors were located across the globe, much of the winding down process was centered in the BVI.  Sentry subsequently became “engulfed in lawsuits.”  One such lawsuit was filed by Morning Mist Holdings Ltd., a Sentry shareholder that filed a derivative suit against Sentry in New York state court in May 2009.
On July 21, 2009, the High Court of Justice of the Eastern Caribbean Supreme Court (the BVI Court) entered an order commencing liquidation proceedings of Sentry and appointing a BVI-based liquidator.  On June 14, 2010, almost a year after the commencement of the BVI-based liquidation proceeding, the liquidator petitioned the bankruptcy court for recognition of the BVI liquidation as a foreign main proceeding under chapter 15 of the Bankruptcy Code.  The liquidator asserted that Sentry’s COMI was located in the BVI.
Recognition of the BVI liquidation as a foreign main proceeding stayed, among others, Morning Mist’s derivative action in the US.  Consequently, Morning Mist appealed, arguing that determining COMI required consideration of the foreign debtor’s entire operational history.
The Lower Courts’ Analysis
In determining Sentry’s COMI, the bankruptcy court examined the period between December 2008 (when Sentry stopped doing business), and June 2010 (when the liquidator filed the chapter 15 petition).  Concluding that Sentry’s COMI was in the BVI between December 2008 and the date the Sentry’s foreign representative sought recognition under Chapter 15, the bankruptcy court entered an order recognizing the BVI liquidation as a foreign main proceeding.  Citing and implicitly rejecting Ran, the bankruptcy court wrote, treating COMI “like a migrating concept that—roulette wheel-like—gets measured at the moment . . . the wheel stops . . . leaves the door open for an untoward gaming of the proceedings.”
Morning Mist appealed. On September 16, 2011, the United States District Court for the Southern District of New York affirmed the bankruptcy court’s order recognizing the BVI liquidation as a foreign main proceeding.  Again, Morning Mist appealed, arguing that “the bankruptcy court should have looked at Sentry’s entire operational history.”  The liquidator argued in favor of the lower courts’ determination of COMI with reference to the period between the commencement of Sentry’s liquidation and the date Sentry filed its chapter 15 petition.
In favor of its doomed “operational history” argument, Morning Mist argued in favor of applying the Millennium Global decision’s flexible approach to determining COMI, discussed below.  Morning Mist argued such an approach would warrant consideration of Sentry’s entire operational history.  The Second Circuit disagreed and held that the so-called “wheel” stops when a debtor files its chapter 15 petition for recognition.
The Second Circuit’s Decision
In identifying the relevant time period, the court implicitly rejected Morning Mist’s argument that the debtor’s “entire operational history” should be considered for purposes of a COMI determination, narrowing the analysis to a choice between the date of the filing of the foreign insolvency proceeding and the date on which chapter 15 recognition is sought.  In rendering its decision, the court considered the text of section 1517 of the Bankruptcy Code, the decisions of other courts—most notably Ran (decided by the Fifth Circuit Court of Appeals) and Millennium Global (previously decided by the bankruptcy court), and the decisions of foreign courts interpreting chapter 15.
The court began its analysis by stating that the Bankruptcy Code’s use of the present tense in section 1517(b) of the Bankruptcy Code strongly suggested that the relevant date for determining COMI was the date the petition for recognition is filed.  The Bankruptcy Code allows a court to recognize a foreign proceeding as a foreign main proceeding “if it is pending in the country where the debtor has the center of its main interests.  11 U.S.C. § 1517(b) (emphasis added).  This factor eventually proved decisive.
Ran involved an individual who accumulated debt in Israel, where an insolvency proceeding was initiated, who later established residence in Texas.  When the foreign representative filed a petition for recognition—some ten years after the debtor relocated—the court concluded that the debtor’s COMI was in the United States.  The Fifth Circuit in Ran held that section 1517 requires courts to determine COMI as of “the time the petition for recognition was filed.”  As a consequence, the foreign representative was barred “from obtaining any relief before any court in the United States, no matter what the nature of Ran’s derelictions in Israel.”
In Millennium Global, two Bermuda investment funds were liquidated after they encountered financial difficulty.  Approximately three years after the commencement of foreign liquidation, the liquidator filed a chapter 15 petition in the United States Bankruptcy Court for the Southern District of New York.  The bankruptcy court in Millennium – specifically disagreeing with Ran—held that COMI should be determined as of the commencement of the liquidation.  In support of its conclusion, the bankruptcy court wrote that “reference to the commencement date of the insolvency proceeding for which recognition is sought does not invite a ‘meandering’ inquiry” as the Ran court suggested.  Rather, using the date of the commencement of the liquidation of the foreign debtor “avoids the use of chapter 15 as a shield by absconding debtors,” and such a date will ensure that a debtor’s COMI is truly ascertainable by third parties.
The Second Circuit disagreed with the Millennium Global court’s reasoning.  It held that “a debtor’s COMI should be determined based on its activities at or around the time the Chapter 15 petition is filed, as the statutory text suggests.”  The court did qualify its holding, however, by writing that “a court may consider the period between the commencement of the foreign insolvency proceeding and the filing of the Chapter 15 petition to ensure that a debtor has not manipulated its COMI in bad faith.”
Recognition is Not Contrary to U.S. Public Policy
The court also quickly dismissed the argument made by Morning Mist that the, because the proceedings in the BVI liquidation were sealed, recognition of the proceeding would be contrary to U.S. public policy.  “Important as public access to court documents may be, it is not an exceptional and fundamental value.”  Accordingly, the court found “no basis on which to hold that recognition of the BVI liquidation is manifestly contrary to U.S. public policy.”
Conclusion
The Second Circuit’s decision provides guidance to courts that need to determine the location of a foreign debtor’s COMI.  In this particular case, the rules advocated by either the Ran or the Millennium Global courts would have led to the same result.  While not outcome determinative in this case, in other cases, the Second Circuit’s decision may ultimately affect the scope of relief available under the Bankruptcy Code to a foreign debtor.