Narrow Straits: The Limitations of Section 1506 of the Bankruptcy Code

Contributed by Dana Hall
The United States Bankruptcy Court for the Southern District of New York recently provided practitioners with a reminder that bankruptcy courts will construe the “public policy” exception of section 1506 of the Bankruptcy Code very narrowly.  In In re Gerova Financial Group, Ltd., Judge Gropper granted recognition of the chapter 15 debtors’ involuntary liquidation proceedings before the Supreme Court of Bermuda as “foreign main proceedings” despite the objection of certain of the debtors’ creditors on public policy grounds.
The debtor entities, collectively referred to as Gerova, operated as an investment company, incorporated and operating, until its demise, primarily out of Bermuda.  Upon the general public’s discovery that Gerova had been operating a Ponzi scheme, the business ceased operating and three of its creditors petitioned the Supreme Court of Bermuda to appoint liquidators and commence “winding-up proceedings.”  Because Gerova was able to dispute or resolve certain of the creditors’ claims, only one creditor, Maxim, remained as a petitioning creditor, and the Bermuda court offered Gerova the ability to avoid the appointment of liquidators by satisfying Maxim’s claim in full.  When Gerova failed to pay Maxim’s claim, the court ordered the appointment of liquidators.  The liquidators subsequently filed a chapter 15 petition in the United States Bankruptcy Court for the Southern District of New York and sought recognition of the Bermuda proceedings as “foreign main proceedings” to obtain discovery related to Gerova’s financial affairs and to recover on claims against assets located within the territorial jurisdiction of the United States.  Three of Gerova’s creditors objected to recognition on the bases that the relief sought was opposed by a significant percentage of Gerova’s creditors, the involuntary Bermuda proceedings had been commenced at the behest of a single creditor, and that, accordingly, recognition of the Bermuda proceedings was “manifestly contrary to the public policy of the United States” under section 1506 of the Bankruptcy Code.
Section 1517(b) of the Bankruptcy Code provides that a foreign proceeding “shall be recognized” as a “foreign main proceeding” if “it is pending in the country where the debtor has the center of its main interests.”  Section 1506 of the Bankruptcy Code provides a public policy exception and permits a bankruptcy court to refuse to take any action under chapter 15 of the Bankruptcy Code “if the action would be manifestly contrary to the public policy of the United States.”
Before addressing the objectors’ public policy arguments, the bankruptcy court first determined that Bermuda was, in fact, Gerova’s “center of main interests” and that recognition as a foreign main proceeding was, therefore, warranted pursuant to section 1517(b).  Significant to the court’s determination were the facts that Bermuda “was the location of Gerova’s only known physical office, the location of its only known employee, the place of at least some of its board members and meetings, the location of its corporate books and records, and the place where litigation adversaries served or attempted to serve process.”
After determining that Bermuda was Gerova’s “center of main interests,” Judge Gropper went on to determine that recognition of the foreign main proceeding was not “manifestly contrary to the public policy of the United States.”  The bankruptcy court found that the objectors had failed to provide any support for their proposition that the court should deny recognition if the majority of Gerova’s creditors did not support the liquidation, the involuntary petition was filed by a single creditor, and the debtors had an opportunity to pay the claim of that creditor to avoid liquidation.  The bankruptcy court, relying on In re Ephedra Prods. Liab. Litig., stated that section 1506’s public policy exception is to be “narrowly construed.”  In Ephedra, the United States District Court for the Southern District of New Yorkhad determined that certain claims resolution procedures in a Canadian insolvency proceeding were not manifestly contrary to public policy despite the fact that they denied claimants the right to a jury trial.  The Ephedra court had stated that section 1506 should be invoked only under “exceptional circumstances concerning matters of fundamental importance” and that foreign judgments are generally granted comity so long as they “are according to the course of a civilized jurisprudence, i.e. fair and impartial” (internal quotation and citation omitted).  The Gerova court determined that although section 303(b)(1) of the Bankruptcy Code requires an involuntary petition to be supported by three or more creditors where a debtor has more than 12 creditors in total, many other countries, including England and Canada, permit the commencement of involuntary insolvency proceedings based on the petition of a single creditor and such a policy is not outside “the course of civilized jurisprudence” and does not violate a matter of “fundamental importance.”
The bankruptcy court also determined that section 305 of the Bankruptcy Code, which permits a bankruptcy court to dismiss a chapter 15 case if “the purposes of chapter 15 . . . would best be served by such dismissal or suspension,” did not apply to Gerova’s foreign proceeding.  Specifically, the court found that the purpose of chapter 15 – the promotion of cooperation with foreign courts – would not be best served by making an order of recognition conditioned on a reexamination of the “need for” the underlying insolvency proceedings.
The Gerova court’s decision, a decision squarely in line with existing precedent in the Southern District of New York, serves as a firm reminder that where a bankruptcy court establishes that the jurisdiction of a foreign proceeding is the debtor’s “center of main interest,” the court will not easily upset that determination on public policy grounds.