Foreign Debtor Eligibility for Chapter 15: The Second Circuit’s Gateway Requirements May Not Limit Access After All

On June 19, 2014, the Bankruptcy Court for the Southern District of New York once again granted Australia-based Octaviar Administration Pty Ltd. chapter 15 recognition as a foreign main proceeding, six months after the Second Circuit overturned an earlier order granting the same relief. The bankruptcy court overruled objections to the petition for recognition from Drawbridge Special Opportunities Fund LP, a defendant in litigation that the Octaviar court-appointed liquidators are pursuing in the U.S., finding that Octaviar has property in the U.S. to satisfy the eligibility requirements of section 109(a) of the Bankruptcy Code, as required by the Second Circuit for granting chapter 15 relief. The decision may indicate that the gateway requirements imposed by the Second Circuit are not such an impediment to foreign debtors seeking chapter 15 relief.
Octaviar’s directors placed Octaviar into voluntary administration in Australia in October 2008; the Supreme Court of Queensland, Australia, appointed Katherine Elizabeth Barnet and William John Fletcher as liquidators of Octaviar in July 2009. Octaviar first filed its chapter 15 petition seeking recognition of the Australian proceeding in August 2012.
Drawbridge, which was already a defendant in litigation the court-appointed liquidators had commenced in Australia, objected to Octaviar’s chapter 15 petition on the basis that (i) Octaviar did not have a domicile, place of business or property in the U.S., as required by section 109(a), and (ii) that chapter 15 could not be used solely for discovery in aid of a litigation pending in a foreign proceeding. In initially granting chapter 15 recognition in September 2012, the bankruptcy court held that there was no requirement that an entity that is the subject of a foreign proceeding be domiciled or have a residence, place of business, or property in the United States in order for the foreign proceeding to be recognized under chapter 15. However, at the request of the liquidators and Drawbridge, the bankruptcy court certified its recognition order for direct appeal to the U.S. Court of Appeals for the Second Circuit to consider, among other things, whether the debtor eligibility requirements of Bankruptcy Code section 109(a) applied to petitions for recognition of a foreign main proceeding under chapter 15 of the Bankruptcy Code.
The Second Circuit vacated the bankruptcy court’s decision in December 2013, unanimously holding for the first time that bankruptcy courts may not grant recognition to a foreign insolvency proceeding under chapter 15 unless the debtor that is the subject of the foreign proceeding has a domicile, residence, business or property in the U.S., as required by section 109(a).
After the Second Circuit issued its decision, Octaviar’s liquidators filed a second chapter 15 petition in February 2014 and renewed their request for recognition of the Australian proceeding as a foreign main proceeding, this time asserting that Octaviar had property in the U.S. in the form of claims and causes of action against Drawbridge and other U.S. entities and an undrawn retainer with U.S. counsel. The bankruptcy court once again found that the Australian proceeding qualified for recognition as a foreign main proceeding because (i) the causes of action, although related to other causes of action proceeding in Australia, were located in the U.S. and (ii) the foreign representatives had not manufactured eligibility by transferring the funds to their U.S. attorneys.
The Intangible Property Was Sufficient
The bankruptcy court noted that, even in their first chapter 15 petition, the liquidators made clear that, in furtherance of their primary goal of marshaling Octaviar’s assets and making distributions to creditors, they were seeking chapter 15 recognition to investigate potential causes of action against entities in the U.S. and to prosecute those claims in the U.S. In their second chapter 15 petition, the liquidators more clearly identified those causes of action, and had actually commenced litigation against Drawbridge and other related entities in both the District Court for the Southern District of New York and in the New York Supreme Court. Thus, the liquidators met their burden of demonstrating that Octaviar had property in the U.S. to satisfy the eligibility requirements of section 109(a).
In determining that the causes of action were located in the U.S. rather than Australia, where Octaviar was domiciled, the court found that the liquidators’ claims were brought under U.S. law and involved defendants located in the U.S. (that were different from those in related actions pending in Australia) and allegations that funds were wrongfully transferred to the U.S. The U.S. courts had both subject matter and personal jurisdiction, and so the bankruptcy court concluded the claims were present in the U.S.
The Undrawn Retainer
The bankruptcy court also found that the $100,000 that the liquidators had transferred to their U.S. counsel prior to the filing of the second chapter 15 petition was sufficient to meet the requirements of section 109(a). Drawbridge did not dispute that the funds were property in the U.S. that existed by the time the liquidators renewed their request for recognition, but instead argued that the transfer of funds was a bad faith attempt to manufacture chapter 15 eligibility and to evade the consequences of the Second Circuit’s ruling.
The bankruptcy court found that the liquidators acted in good faith in transferring the funds to their counsel’s client trust account. The court noted that retainers can serve as a basis for section 109(a) compliance, and serve an “obvious legitimate economic function, understood by every practicing attorney.” In addition, the court noted that section 109(a) is silent regarding the amount of such property in the U.S. and does not require an inquiry into the circumstances surrounding the debtor’s acquisition of such property. Therefore, the court reasoned that to impose a requirement that the property in the U.S. be “substantial” would circumvent the plain meaning of the statute, which the Second Circuit had characterized as straightforward when it considered the eligibility issues on appeal.
Policy Implications
In granting recognition the second time around, the bankruptcy court emphasized that the relief was consistent with the goals of chapter 15 (promoting cooperation among courts), and that denial of recognition would deprive the liquidators of the opportunity to bring causes of action on behalf of Octaviar in the United States. The court also noted that Drawbridge was not without recourse – its arguments were akin to a forum non conveniens defense, and it could bring such a motion, provided that it consented to jurisdiction in Australia (which Drawbridge apparently was not subject to and did not at that point consent to), or it could seek to stay the federal and state court proceedings as duplicative or derivative of the Australian litigation. In this respect, the bankruptcy court did not see its order granting chapter 15 recognition to Octaviar’s Australian proceeding as prejudicing Drawbridge or abridging its rights to assert all available defenses in the federal and state court actions.
Many commentators have expressed concern that the new requirements for chapter 15 recognition imposed by the Second Circuit in the 2013 decision would create a material obstacle to chapter 15 relief for foreign debtors and drive foreign debtors to seek recognition in courts outside the Second Circuit. The decision on remand in Octaviar, however, shows that courts in the Southern District of New York, at least, still view themselves as having considerable flexibility in interpreting the eligibility requirements for foreign debtors to avail themselves of the benefits of recognition under chapter 15. It remains to be seen whether Drawbridge will appeal again, but we will follow this interesting case and update our readers if there are any significant developments.