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
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
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
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.
The content of this article is intended to provide a
general guide to the subject matter. Specialist advice should
be sought about your specific circumstances.
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