The US District Court for the Southern District of New York has upheld the rejection of a petition by liquidators of the Bear Stearns High Grade Structured Credit funds for recognition of their liquidation proceedings in the Cayman Islands. This decision comes as no surprise to observers of this case, and some might paint a gloomy picture when discussing the future of Chapter 15 bankruptcies for hedge funds in the future. However, a close reading of the Court's ruling suggests that there is still hope for the well-advised.
The Cayman liquidation did not qualify as a "foreign main proceeding": the statutory presumption that Cayman as a place of incorporation of the funds was its Centre of Main Interests (COMI) was rebutted by contrary evidence. But the ruling went on to record that the funds did not qualify in part because of a failure or omission to show (a) that the fund directors had any substantial involvement in the business of the funds, or (b) that outside investors knew these were Cayman funds.
The Cayman liquidation also did not qualify as a "foreign non-main proceeding", due to a failure to show that the funds had any place of operations in Cayman where they carried out "non-transitory economic activity": this was based on the same evidentiary failings referred to above, and also on the lack of assets held by the funds in the Cayman Islands (a factor of doubtful relevance to this statutory test).
Significantly, there was no reference to the comments made by the Judge in the court below that an "exempted" company (being the type of company routinely used for incorporation of hedge funds) was prohibited by statute from conducting any business in Cayman. This was perhaps because the Judge had heard no expert evidence on Cayman law before making these remarks, and the liquidators' subsequent filings in the appeal showed such a conclusion to be untenable as a matter of Cayman law. It is hoped that we have seen the last of this argument from a US court.
At the same time, some general propositions were stated which might be surprising to some practitioners in the field of cross-border insolvency:
- First, it was said that the shift from a "subjective
comity-based process [under earlier bankruptcy law] to
Chapter 15's more rigid recognition standard is
consistent with the general goals of the Model Law".
Supporters of the Model Law may argue that principles of
comity should inform a court's interpretation of its
recognition standards as well as its subsequent grant of
relief to aid a foreign liquidation.
- Second, it was held that "Principles of comity do
not figure in the recognition analysis", whereas
post-recognition "conversely the relief is largely
discretionary and turns on subjective factors that embody
principles of comity". However, this statement ignores
the fact that the recognition of a foreign main proceeding
leads automatically to the grant of a list of mandatory items
What does the future hold for Chapter 15 and possible filings by insolvent hedge funds or other offshore vehicles with substantial onshore dealings, in light of this ruling?
- This appeal ruling may effectively be confined to its
facts, and can readily be distinguished in another case which
does not have such problematic circumstances.
- The ruling also provides important lessons to be learned
in terms of the evidence that should be submitted (or even
generated) for successful recognition. The next Chapter 15
fund case will be presented quite differently.
- The statutory term "non-transitory economic
activity" remains undefined and unexplained, save to say
that certain ancillary functions (such as auditing work) will
not qualify. In a case with better facts, foreign liquidators
may still persuade the US Bankruptcy Court that an
appropriately-structured fund comes within that term.
- In particular, it would seem that substantial business
activities by Cayman-resident directors and administrators of
hedge funds (as long as it is adequately documented and
evidenced) should qualify those funds for at least non-main
recognition under Chapter 15.
In conclusion, while this ruling confirms the challenges for many distressed hedge funds which are considering bankruptcy, there may still be solutions which allow for a successful Chapter 15 filing.
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