United States: Pushing The Borders Of Chapter 15: When A Foreign Representative "Flouts" The Purposes Of Cross-Border Insolvency In The United States

The case law interpreting Chapter 15 of the US Bankruptcy Code continues to demonstrate that there are rarely simple answers to the complex issues presented by cross-border insolvency cases. In the recent case of In re Cozumel Caribe, S.A. de C.V.,1 the US Bankruptcy Court for the Southern District of New York held that the legal standard for obtaining access to US bankruptcy courts through Chapter 15 is less exacting than the standard for granting comity in Chapter 15 to specific orders of foreign courts. But, in deciding the case, the court had to grapple with a thornier question that arises in some cross-border insolvency cases: What should a court do "when, after granting recognition to a foreign proceeding, the conduct of the foreign representative, or other parties in interest, flout[s] the purposes of chapter 15"?2 

In Cozumel Caribe, the US court found "very serious questions"3 about the conduct of the foreign representative in the Chapter 15 and the Mexican concurso mercantil (commercial bankruptcy) proceedings. But the court nevertheless concluded that Chapter 15 does not permit it to review anew the rulings and conduct of the concurso proceeding. Rather, it found that the proper role for the US court is to decide whether to extend comity to the ultimate results of the Mexican bankruptcy in the United States, if and when such a request is made by the debtor's foreign representative. As a result, the case serves as a stark reminder that, if a foreign debtor seeks no more than an order granting recognition under section 1517 and the automatic effects of recognition under section 1520 of Chapter 15 with respect to US assets, creditors may have to live with the processes and results of a foreign proceeding, no matter how contrary they may be to US interests, law or public policy.  

Background

Cozumel Caribe and its affiliates are organized under Mexican law and own resort properties in Mexico. CT Investment Management Co, LLC (CTIM) lent Cozumel Caribe $103 million, secured by Cozumel Caribe's hotel revenues, which were to be deposited into lockbox accounts, one of which is in New York under CTIM's control. Certain of Cozumel Caribe's affiliates also guaranteed Cozumel Caribe's debt under New York law governed guarantees.4

In 2010, Cozumel Caribe (but not its affiliates) filed a concurso in Mexico. Upon the request of Cozumel Caribe, the US bankruptcy court granted Chapter 15 recognition of the Mexican proceeding.5 At the time, the New York lockbox account held about $8 million. Once Cozumel Caribe filed its concurso, both Cozumel Caribe and its guarantors stopped making payments on the debt to CTIM and started to withhold hotel revenues from the lockbox accounts.6 

CTIM attempted to recover on its debt, both from the guarantors and from the New York lockbox, in Mexican and US courts. In Mexico, the concurso court stayed any collections from Cozumel Caribe's lockbox accounts or from its guarantors (the May 27 Order).7 In the United States, the bankruptcy court granted comity to stay CTIM's efforts to collect from the New York lockbox,8 while a federal district court granted comity to stay CTIM's efforts to collect from the guarantors.9 

The Bankruptcy Court's Decision

Following what CTIM viewed as repeated and unacceptable delays and unfair treatment in the concurso, and having been prevented from pursuing remedies by the comity extended to the May 27 Order by US courts, CTIM asked the bankruptcy court to revoke the recognition of Cozumel Caribe's foreign bankruptcy. Legally, the hook for CTIM's request was section 1506 of the Bankruptcy Code,10 which allows a court to refuse (and by extension revoke) recognition on the grounds that the foreign proceedings were "manifestly contrary" to US public policy.11 CTIM's argument was that the US courts should not abide the misbehavior of the debtor's foreign representative.12 

CTIM alleged five such items of misconduct. First, the debtor's foreign representative had taken inconsistent positions in the value of CTIM's claim—a "key issue" in Cozumel Caribe's proceedings.13 Second, the foreign representative failed to inform the US courts of major developments in Mexico involving the non-debtor guarantors.14 Additionally, CTIM alleged that (1) the guarantors had taken advantage of the US stay to try to cancel their guarantees in Mexican courts;15 (2) one guarantor had spun off its assets fraudulently; and (3) the foreign representative had engaged in dilatory tactics in Mexico.16

The foreign representative's actions clearly disturbed the US bankruptcy court, which held out the possibilities of sanctions17 or denial of enforcement of a future Mexican judgment.18 Nevertheless, the court held that CTIM's proposed remedy—total revocation of US recognition—would be too much, too soon, at least as long as "the current status quo (with approximately $8 million held in a CTIM-controlled bank account in New York) sufficiently protects CTIM's interests."19 

CTIM's complaints came too soon because "at least until the Foreign Representative seeks an order extending comity to a final Mexican court order or judgment, this Court need not decide whether to give effect to the ruling."20 Chapter 15 generally encourages US courts to respect the processes and decisions of foreign courts. US judges will therefore be hesitant to condemn foreign proceedings pursuant to Chapter 15 until the litigants have exhausted their remedies overseas.21 

The relief CTIM sought was also too broad because "comity . . . is not an all or nothing exercise—some orders or judgments in the same case or proceeding may merit comity while others may not."22 Total non-recognition will therefore rarely be the appropriate remedy, even for serious misconduct. As long as a US court is confident that it will be able to protect US creditors' interests on an order-by-order basis,23 it will prefer to keep a case within the structure of Chapter 15.24 

In rendering its decision, the bankruptcy court construed the public policy exception of section 1506 "narrowly,"25 insisting that section 1506 is not a license for a US court to make "an independent determination about the propriety of individual acts of a foreign court."26 In essence, a foreign order is not "manifestly contrary"27 to US policy just because the result would be different in a domestic bankruptcy or would harm some US creditors.

In this respect, the result contrasts with the Fourth Circuit's approach in Jaffé v. Samsung Electronics Co. (Qimonda).28 In Qimonda, the foreign representative of Qimonda, acting under German law, rejected Qimonda's patent license agreements with various US companies. The US companies had incurred major fixed costs to develop products in reliance on those licenses, but the foreign representative's rejection meant that the US licensees could no longer use the debtor's patented technology until they agreed to new license agreements, at least under German bankruptcy law. Under the US Bankruptcy Code, applicable to a native US case, similar licensees could have kept their license rights under section 365(n). The foreign representative sought recognition of the foreign proceeding pursuant to Chapter 15, apparently with the goal of obtaining an order that would apply the German result to the US licensees. Before the foreign representative explicitly requested such relief, however, creditors requested that the bankruptcy court extend the effects of section 365(n) as a condition to entering any order recognizing the German proceeding pursuant to section 1517. In response, the US bankruptcy court issued an order under sections 1521(a) and 1522 of the Bankruptcy Code, making section 365, including 365(n), applicable to the Chapter 15 proceeding. The Fourth Circuit affirmed, in part, the holding of the bankruptcy court that the "interests of the creditors" in their license rights would not be "sufficiently protected" if the US courts declined to extend the protections of section 365(n).29 In dicta, the Circuit further suggested that section 365(n)'s treatment of patent licenses is the sort of "public policy" that US courts must apply under section 1506.30

The different procedural postures of Cozumel Caribe and Qimonda explain, in part, the different results. In Qimonda, creditors requested that the court extend section 365(n) protections as a condition to granting the recognition order because the foreign representative's primary purpose in seeking recognition was apparently to extend the effects of the rejection of the contracts under German law in the United States. In Cozumel Caribe, the foreign debtor had not yet asked the bankruptcy court to do anything except to maintain the status quo during the Mexican proceedings, so the court could postpone a rigorous comity analysis. The Qimonda court could have denied recognition. Instead, it extended the protections under section 365(n) to rejections under German law. But, the Cozumel Caribe decision arguably stands for the proposition that Chapter 15 powers should be more limited. In contrast to the Qimonda court, the Cozumel Caribe court found that Chapter 15 is not a tool to extend US legal principles into foreign proceedings. 

The Bottom Line

Creditors should not expect a Chapter 15 bankruptcy court to rescue them from the vagaries of a foreign bankruptcy. When a foreign debtor enters bankruptcy abroad, creditors should expect that a foreign court will generally resolve their claims. While there is certainly precedent for creditors being protected under Chapter 15, the powers of Chapter 15 may only be available to help creditors once the foreign debtor seeks recognition under Chapter 15 and then requests either (i) the extension of bankruptcy powers to US assets through Chapter 15 or (ii) that the US bankruptcy court grant comity to foreign judgments. The foreign representative's mishandling of the Chapter 15 case, or even the foreign representative's bad faith, may not be enough to alter these fundamental hurdles to creditor protection under Chapter 15.


— B.R. —, 2014 WL 1569238, No. 10-13913 (Bankr. S.D.N.Y. Apr. 21, 2014).

2 Id. at *1.

3 Id.

4 See id. at *2.

5 Id. at *1.

6 Id. at *3.

7 See CT Inv. Mgmt. Co. v. Carbonell, 2012 WL 92359, No. 10-6872 at *4 (S.D.N.Y. Jan. 11, 2012); CT Inv. Mgmt. Co. v. Cozumel Caribe, S.A. de C.V., 482 B.R. 96, 102–03 (Bankr. S.D.N.Y. 2012).

8 CT Inv. Mgmt. v. Cozumel Caribe, 482 B.R. at 115–16.

9 Carbonell, at *5–6.

10 11 U.S.C. § 1506.

11 See also § 1517(d) (allowing termination of recognition when "the grounds for granting it were fully or partially lacking or have ceased to exist").

12 See Cozumel Caribe at *3.

13 Id. at *3-4. In Mexico, the foreign representative valued CTIM's claim at $27 million; in the United States, the foreign representative acknowledged the claim's value of $103 million.

14 See id. at *5. In defense, the foreign representative disclaimed any involvement with the guarantors' proceedings. The US bankruptcy court found this implausible, given that the foreign representative did inform the concurso court of favorable developments in those same cases.

15 Cf. In re Vitro S.A.B. de CV, 701 F.3d 1031 (5th Cir. 2012) (declining to enforce discharge of non-debtor guarantors under a Mexican reorganization plan); WilmerHale, Jurisdictional Mix-and-Match: Vitro, Elpida and Fairfield Demonstrate the Uncertainties of Cross-Border Bankruptcy for US Bondholders and Buyers (Feb. 15, 2013), available here.

16 See id. at *3–5. The Court gave short shrift to these last three complaints. The guarantors' behavior "d[id] not implicate the Court's Recognition Order," while the delay in Mexico was not serious enough for a US court to withhold comity. Id. at *5 (citing a six-year delay in JP Morgan Chase Bank v. Altos Hornos de Mexico, S.A. de C.V., 412 F.3d 418, 428–29 (2d Cir. 2005)).

17 Id. at *5.

18 Id. at *3, *10.

19 Id. at *1.

20 Id. at *4.

21 See id. at *5 (observing that the local Mexican court's decisions "may be subject to further proceedings in the Mexican courts," and citing Altos Hornos, 412 F.3d at 421 n.1, as an example of a functioning Mexican appellate process).

22 Id.

23 As was the case here, given that Cozumel Caribe's US bank account remained frozen.

24 See id.; In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd., 389 B.R. 325, 333 (S.D.N.Y. 2008) ("Recognition turns on the strict application of objective criteria. Conversely, relief is largely discretionary and turns on subjective factors that embody principles of comity.").

25 Id. (quoting In re Ephedra Prods. Liab. Litig., 349 B.R. 333, 336 (S.D.N.Y. 2006)).

26 Id. (quoting In re Metcalfe & Mansfield Alt. Invs., 421 B.R. 685, 697 (Bankr. S.D.N.Y. 2010)).

27 11 U.S.C. § 1506.

28 737 F.3d 14 (4th Cir. 2013), petition for cert. filed, No. 13-1324 (Apr. 30, 2014). WilmerHale has followed doctrinal developments in Chapter 15 closely, and has written about Qimonda and the Qimonda bankruptcy in three previous alerts: Cross-Border Bankruptcy in 2013: 10 Decisions Shaping Chapter 15, (Jan. 30, 2014) (discussing Qimonda in the context of several recent cases concerning the extent of Chapter 15 relief), available here; Fourth Circuit Upholds US Patent Licensee Protections in Chapter 15 Cross-Border Bankruptcy Case (Dec. 19, 2013) (analyzing the Qimonda decision), available here; and Protections for Intellectual Property Licensees in Cross-Border Insolvencies (Nov. 4, 2011) (analyzing the bankruptcy court opinion that Qimonda affirmed) available here.

29 Qimonda, 737 F.3d at 31 (applying the "interests of creditors" test of § 1522(b)).

30 Id. at 32.

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