Restructuring

Contributed by Katherine Doorley
Should a foreign restructuring process that allows secured creditors to liquidate the debtor’s fully-encumbered assets in a separate proceeding from unsecured creditors be granted recognition in the United States?  In In re ABC Learning Centres Ltd., No. 12-2808 (3rd Cir. Aug. 27, 2013), the United States Court of Appeals for the Third Circuit determined whether an Australian insolvency proceeding should be accorded recognition under chapter 15 of the Bankruptcy Code and whether the debtor’s fully-encumbered property in the United States was protected by the automatic stay.
Background
ABC Learning Centres Ltd. was an Australian corporation providing child care and educational services around the world.  ABC conducted business in the United States primarily through subsidiaries, including ABC Developmental Learning Centres (USA) Inc.  RCS Capital Development, LLC contracted with ABC Developmental to build child care facilities in the United States.  Litigation between the parties ensued, and RCS won a $47 million verdict against ABC Developmental in Arizona state court.  RCS, separately, was a defendant in an action brought by ABC Learning against it in Nevada.
In November 2008, ABC Learning’s directors entered into Voluntary Administration under Australian law to examine reorganization options, which breached ABC Learning’s loan agreements with its secured creditors and triggered the creditors’ rights to realize their assets through a receivership process under the Australian Corporations Act.  The secured creditors exercised their rights and appointed a receiver.  All of ABC’s assets were encumbered by the liens of the secured creditors.
In June 2010, ABC’s directors voted to commence liquidation proceedings.  Under Australian law, the receivership continued during the liquidation.  The liquidators, as foreign representatives, petitioned the United States Bankruptcy Court for the District of Delaware for recognition of the insolvency proceedings.  The petition for recognition was filed prior to entry of a final judgment in the Arizona matter, and the immediate focus of the stay was ABC’s suit against RCS in Nevada.  The bankruptcy court found that the Australian liquidation was a foreign main proceeding which met the requirements for recognition under chapter 15 and did not manifestly contravene public policy.  The bankruptcy court also stayed all actions against ABC and ABC’s property in the United States and granted RCS’s motion to lift the automatic stay for the sole purpose of converting the Arizona verdict to a final judgment and applying the judgment against the Nevada action.  On appeal, the United States District Court for the District of Delaware upheld the bankruptcy court’s orders.  Nevertheless, RCS appealed to the Third Circuit because RCS wanted relief from the stay to enforce its judgment against ABC.
Liquidation and Receivership Proceedings Under Australian Law
Under Australian law, a company’s directors may determine whether the company is insolvent and initiate liquidation proceeds.  Once a liquidation has commenced, unsecured creditors are prevented from initiating or continuing legal proceedings.  Secured creditors participate in separate receivership proceedings in which a receiver realizes secured assets and distributes the proceeds.  The receiver only represents the interests of the secured creditors.
Receiverships can proceed in parallel with liquidations, and secured creditors may elect to surrender the secured assets to the liquidator and receive a distribution through the liquidation.  Whereas a receiver represents only the secured creditors, a liquidator represents all creditors.  The receiver does not operate independently.  It has authority to review the appointment of the receiver, and investigate and challenge the liens asserted by secured creditors.
Was the Australian Insolvency Proceeding Entitled to Recognition?
Section 1517 of the Bankruptcy Code provides that “an order recognizing a foreign proceeding shall be entered if . . . such foreign proceeding for which recognition is sought is a foreign main proceeding” and the petition meets the administrative requirements of section 1515 of the Bankruptcy Code.  Section 101(23) of the Bankruptcy Code defines the term “foreign proceeding” as a collective judicial or administrative proceeding in a foreign country under an insolvency law.
Even though RCS recognized the liquidation was a foreign main proceeding, RCS contended that only the receivership, a non-collective proceeding, benefitted from recognition.  Effectively only the receivership was recognized, and recognition was granted in error.  In dismissing RCS’s argument, the Third Circuit noted that the fact that ABC’s assets were entirely leveraged did not determine whether the Australian proceedings were collective, and that chapter 15 does not forbid recognition where a debtor’s assets are fully encumbered.
RCS further argued that because the receivership was a non-collective proceeding, recognition would contravene the public policy in favor of collective insolvency proceedings.  The collective proceeding requirement reflects United States policy “to provide an orderly liquidation procedure under which all creditors are treated equally.”  The Third Circuit found that it was “undisputed” that the Australian liquidation was a collective proceeding because the liquidator was required to distribute assets on a pro rata basis to creditors of the same priority, and secured creditors were entitled to recover the full value of their debts by realizing the value of the assets securing those debts and submitting an accounting to the liquidator.  In fact, the Third Circuit found that recognition would advance the collective proceeding policy, because RCS had sought to attach assets before the secured creditors could realize them.
Are ABC’s Assets Protected by the Automatic Stay?
Section 1520 of the Bankruptcy Code provides that, upon recognition of a foreign main proceeding, the automatic stay under section 362 of the Bankruptcy Code applies with respect to the debtor and the debtor’s property within the United States.
RCS argued that the secured creditors effectively owned ABC’s property because all of ABC’s assets were encumbered and because the receiver had the right to use and dispose of the property at its discretion.  According to RCS, ABC held only bare legal title to those assets rather than an equitable interest, and therefore, pursuant to section 541(d) of the Bankruptcy Code, ABC’s estate would also hold only bare legal title to the assets, and those assets should not be considered property of the estate.
The Third Circuit disagreed, finding that ABC retained an equitable interest in the property because (i) the receiver must turn over any realized funds in excess of the value of the liens, (ii) ABC retained the right to redeem the encumbered property, and (iii) the liquidator had the right to challenge the liens.  According to the Third Circuit, because ABC retained an equitable interest in its property, the property was property of the debtor and was protected by the automatic stay.
In so finding, the Third Circuit noted that chapter 15 does not create a separate bankruptcy estate and that in general, section 541 of the Bankruptcy Code is not applicable in chapter 15 cases.  Even if the court applied section 541(d), however, which provides that if the debtor holds only bare legal title in particular assets, the estate will also hold only bare legal title, the property in the United States would still be property of the estate, because ABC has an equitable interest in those assets.  Because the United States property was property of ABC’s estate, RCS was stayed from enforcing its judgment.
RCS had argued that ABC’s Australian insolvency proceedings should not be recognized in the United States because the estate was not being administered for the benefit of all creditors.  While the Third Circuit found that the Australian insolvency proceedings were entitled to recognition, despite the fact that secured creditors were allowed to participate in a process separate from unsecured creditors, the Third Circuit’s decision was based, at least in part, on the fact that Australian law provided for a priority scheme, albeit a different priority scheme from the Bankruptcy Code.  Whether the Third Circuit would have reached the same conclusion if the foreign representatives had only sought recognition for the receivership proceeding is an interesting question perhaps left for another case and, another day.