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Cross-Border Insolvencies: Defection Isn’t the Only Problem

March 17, 2016

A recent paper by Andrew Dawson, a law professor of the University of Miami, looks at the current cross-border insolvency framework from the point of view of the cultural differences that may be expressing themselves through the distinct systems on the opposite sides of many an international border.  His discussion employs litigation arising from the Madoff scam as one of its case studies of this problem.

The U.S. – some American readers may be surprised to read this – has a culture of textual fidelity, and this is a problem.

The United States adopted the Model Code on Cross-Border Insolvency in 2012, thus creating Chapter 15.  The gist of it is that a debtor in a foreign insolvency proceeding may petition a bankruptcy court in the United States for recognition of the foreign proceedings. When the debtor seeks such recognition, the court in the U.S. is to decide the location of the foreign debtor’s “center of main interests.” If the COMI is where the foreign proceeding is taking place, then that proceeding is to be recognized as the “foreign main proceeding.”

Forum Shopping and Defection

This COMI inquiry is part of a broader system designed to produce cooperation among courts, predictability for debtors and creditors alike, and a minimum of that head-banging sense of futility that debt-collecting gone awry can incite. But skeptics immediately raised concerns that this would instigate forum shopping. There has certainly been some of that. Dawson’s paper cites for example the case of China Medical Technologies, a group of Chinese operating entities that filed bankruptcy in the Cayman Islands based solely on their place of incorporation, and filed for Chapter 15 protection in New York.

Such instances explain why some courts, as Dawson says, have “defected” from the Model Law’s scheme out of concern over the protection of local interests, the traditional concern of sovereigns and their courts.

But, Dawson adds, there is a distinct issue, which is that at the international level, when cooperation is required from courts in different countries under the Model Code’s system, sand will get into the gears of that cooperation as a consequence of the different countries’ “different approaches to statutory interpretation” exacerbated by the “lack [of] a shared legal tradition.”

The Madoff Scam, Revisited

It is in this context that Dawson looks at the litigation referenced above, In re Fairfield Sentry, which was part of the fall-out from Bernard Madoff’s infamous Ponzi scheme.   The named company, Fairfield Sentry, was a British Virgin Islands chartered feeder fund.

In this case, the question arose: can’t a “center of main interests” change over time?  What if the COMI of Fairfield Sentry was New York when it filed bankruptcy in the BVI, but that by the time (nearly a year later in this case) when the filing took place in New York, the COMI had shifted to the BVI?  By that time, after all, (in Dawson’s words), “the debtor had … ceased all activities in the United States and its only activities were its liquidation proceedings” [emphasis added]. Should the US courts recognize the BVI proceeding as the foreign main proceeding under chapter 15 or not?

The Second Circuit held that the relevant time for the COMI determination was the time of the Chapter 15 filing, subject yes to a look-back but the only purpose of the look back is to ensure that the debtor has not been manipulating the COMI for purposes of court shopping.

Dawson sees this as an example of “those darn Americans and their intent-blind textualism.” [Okay, those aren’t precisely his words]. The U.S. courts were overly impressed in this instance by the use of the present tense verbs in the language of Chapter. Under section 1517, “an order recognizing a foreign proceeding shall be entered if (1) such foreign proceeding … is a foreign main proceeding” and under section 1502 that means a proceeding “where the debtor has the center of its main interests.” Both “is” in the former and “has” in the latter language are present tense.

Dawson regards this ruling as plainly wrong, and he hopes that as courts become “familiar with the Model Law,” they’ll get more into the spirit of it, and they’ll stop letting local cultural issues, such as the fad for textualism in the U.S., interfere with the spirit of the thing.  Since cross-border proceedings “are still relatively novel,” he is inclined to be forgiving.