Restructuring

Contributed by Alexander Woolverton
The ability of a foreign debtor to avail itself of the protections of the Bankruptcy Code, such as the automatic stay, with respect to its property located within the United States is one of the most fundamental and valuable tools available to foreign debtors with domestically located property. When a foreign debtor obtains “recognition” of its principal insolvency proceeding by U.S. courts, section 1520 of the Bankruptcy Code does not only provide the foreign debtor the protections of the automatic stay, but also requires the foreign debtor to obtain approval under section 363 of the Bankruptcy Code with respect to any transfer of an interest in property within the territorial jurisdiction of the United States.
It is easier to say with certainty that certain types of property are “within the territorial jurisdiction of the United States” than other types. But what about a foreign debtor’s claim against a domestic debtor? About a year and a half ago, we blogged about a decision in which the United States Bankruptcy Court for the Southern District of New York ruled that a foreign debtor’s claim against a domestic debtor was not “located” in the United States. Since then, the decision was appealed to the United States District Court to the Southern District of New York, which agreed with the bankruptcy court.
Recently, the Second Circuit overruled both the bankruptcy and district courts and held that such a claim did indeed constitute “property within the territorial jurisdiction of the United States under section 1520(a)(2), and the transfer of such property was subject to a section 363 review by the bankruptcy court.
Background
As you might remember, Fairfield Sentry was one of the main “feeder funds” into Bernard L. Madoff Investment Securities (BLMIS). After BLMIS was placed into liquidation under the Securities Investor Protection Act, Sentry was placed into its own insolvency proceeding in the British Virgin Islands. Later, Sentry held an auction in which it sold its SIPA claim against BLMIS to Farnum Place, LLC for 32.125% of the claim’s allowed amount.
Shortly after the completion of the auction, Sentry and Farnum executed a trade confirmation that was expressly subject to the approval of both the BVI and U.S. courts. Shortly after that, the trustee of the BLMIS liquidation entered into a settlement that increased the value of the SIPA Claim from about 32% to more than 50% of the allowed amount, which translated into an increase in value of about $40 million. Sentry then did everything within its power to avoid being bound by the trade confirmation.
When Sentry refused to seek approval of the sale from the BVI court, Farnum sued to compel. Although the BVI court ruled in Farnum’s favor, it expressly declined to express any views on whether the bankruptcy court would – or should – approve the sale. Then, Sentry sought an order from the bankruptcy court, pursuant to section 363(b) of the Bankruptcy Code, denying approval of the sale.
The Bankruptcy Court Decision
The bankruptcy court denied Sentry’s motion, holding that its review of the sale was not governed by section 363 of the Bankruptcy Code, as Sentry contended, because it was not a transfer of property within the United States. Relying on a New York Court of Appeals decision, the bankruptcy court held that justice, convenience and common sense all led to the conclusion that the claim was located with Sentry in the BVI, not with BLMIS. Farnum appealed the bankruptcy court’s decision to the district court, lost, and appealed again to the Second Circuit.
The Second Circuit’s Decision
The Second Circuit began by characterizing the interest that Sentry had tentatively transferred to Farnum. Disagreeing with Sentry, the court reasoned that the property at issue was the SIPA Claim itself, not the funds in the BLMIS estate. The question, then, was the location of such an intangible interest. Section 1502(8) of the Bankruptcy Code defines “within the territorial jurisdiction of the United States” as (1) tangible property located in the United States, and (2) “intangible property deemed under applicable nonbankruptcy law to be located within that territory, including any property subject to attachment or garnishment that may properly be seized or garnished by an action in a Federal or State court in the United States.”
The Second Circuit, overruling the holding the SIPA Claim is “located” in the BVI, found fault with the bankruptcy court’s “incomplete” analysis – namely its failure to analyze whether the SIPA Claim was subject to attachment or garnishment within the meaning of section 1520.
Under New York law, property that can be assigned or transferred is subject to garnishment. With “respect to intangible property that has as its subject a legal obligation to perform, the situs is the location of the party of whom that performance is required pursuant to that obligation.” Because the BLMIS trustee “is obligated to distribute to Sentry its pro rata share of the recovered assets . . . the situs of the SIPA Claim is the location of the [BLMIS trustee], which is New York.” Accordingly, the Second Circuit concluded that because the sale of the SIPA claim constituted a transfer of property within the United States, the sale was subject to review under section 363 of the Bankruptcy Code by the bankruptcy court.
The Second Circuit further ruled that comity did not require approval of the sale. The court found that section 1520(a)(2)’s application of section 363 is a requirement that acts “as a brake or limitation on comity.” That is, notwithstanding principles of comity, a bankruptcy court must analyze a transfer of property within the United States pursuant to the standard applicable under section 363. Furthermore, the court noted that it was “not apparent at all that the BVI [c]ourt even expects or desires deference in this instance,” particularly because the BVI court specifically declined to express a view on whether the sale would be approved by the bankruptcy court. Accordingly, in light of the requirements of section 1520, the Second Circuit found that the bankruptcy court had erred in concluding that the SIPA claim was not “located” in the United States.
Conclusion: A Reverse and Remand With Helpful Dicta
The Second Circuit reversed the decisions below, ruling that the bankruptcy court would have to determine whether the sale of the SIPA Claim was permissible under section 363. While the Second Circuit “intimate[d] no view on the merits of the section 363 review on remand,” the court kindly provided “some guiding principles” for the bankruptcy court. Specifically, the Second Circuit noted bankruptcy courts often consider whether the asset is increasing or decreasing in value and that bankruptcy courts have broad discretion and flexibility to enhance the value of the estate for the benefit of all creditors. Last, the Second Circuit clarified that the bankruptcy court would be obligated to consider any fluctuation in value of the SIPA claim between the sale of the claim and approval by the bankruptcy court. Even though the Second Circuit did not rule on the sale, it seems Sentry’s chances of overturning it have dramatically improved.