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The Second Circuit Clarifies Standard for Obtaining Chapter 15 Recognition

Pachulski Bulletin No. 13
April 2013

OVERVIEW

In In re Fairfield Sentry Limited, the Second Circuit federal appeals court clarified certain important issues relating to whether United States courts should recognize foreign insolvency proceedings under chapter 15 of the Bankruptcy Code. In particular, the Second Circuit resolved a dispute among lower courts by holding that the determination of whether to grant recognition should take place as of the time the chapter 15 petition is filed rather than the time the foreign insolvency proceedings are commenced. Consistent with that holding, the Second Circuit also ruled that “any relevant activities, including liquidation activities and administrative functions,” may be considered in deciding whether to grant recognition under chapter 15. Fairfield Sentry will likely make it easier for foreign representatives to obtain recognition under chapter 15, although the Second Circuit cautioned that the analysis would be “subject to an inquiry into whether the process has been manipulated.”

BACKGROUND

In order to commence a chapter 15 case, a foreign representative of a debtor that is the subject of a foreign proceeding must file a petition for recognition. 11 U.S.C. §§ 1504, 1509, and 1515. A foreign proceeding can be either a main proceeding (i.e., located in a country where the debtor has its center of main interests (“COMI”)) or a nonmain proceeding (i.e., located in a country where the debtor has an “establishment,” that is, “any place of operations where the debtor carries out a nontransitory economic activity”). 11 U.S.C. § 1502(2).

The distinction between “main” proceedings and “nonmain” proceeding is significant because once a foreign main proceeding has been recognized, certain provisions of the Bankruptcy Code (such as the automatic stay) will automatically apply to the debtor and its property located within the United States. If, on the other hand, the foreign proceeding is a nonmain proceeding, the foreign representative must request specific “appropriate relief” under section 1521 (e.g., it must demonstrate that it is entitled to the imposition of the stay).

Prior to Fairfield Sentry, courts in the Southern District of New York imposed an affirmative duty on the bankruptcy court to inquire as to the factual circumstances relevant to determining a debtor’s COMI, focusing on the following factors:

the location of the debtor’s headquarters; the location of those who actually manage the debtor (which, conceivably could be the headquarters of a holding company); the location of the debtor’s primary assets; the location of the majority of the debtor’s creditors or of a majority of the creditors who would be affected by the case; and/or the jurisdiction whose law would apply to most disputes.

In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, 389 B.R. 325, 326 (S.D.N.Y. 2008) (quoting lower court’s opinion, 374 B.R. 122, 128 (Bankr. S.D.N.Y. 2007)).

In reviewing these factors, some courts held that the relevant time was the date of the commencement of the foreign proceeding, while others held that the relevant time was the date of the filing of the chapter 15 petition. Compare In re Gerova Fin. Group, 482 B.R. 86, 92 (Bankr. S.D.N.Y. 2012) (citing In re Millennium Global Emerging Credit Master Fund, 458, B.R. 63, 72-76 (Bankr. S.D.N.Y. 2012)) (noting split of authority), with Fairfield Sentry, 2011 WL 4357421 at *6 (2d Cir. April 16, 2013). Fairfield Sentry resolved the dispute among the lower federal courts in New York.

FAIRFIELD SENTRY AND ITS IMPACT

Fairfield Sentry was organized under the laws of the British Virgin Islands (“BVI”) and was one of the largest feeder funds to Bernard L. Madoff Investment Securities. Fairfield Sentry ceased operations in December 2008 following Madoff’s arrest and was placed into liquidation in the BVI in July 2009.

Prior to the commencement of Fairfield Sentry’s liquidation, a Fairfield Sentry shareholder had instituted a derivation action in New York state court. In June 2010, the liquidators appointed by the BVI court petitioned the United States Bankruptcy Court in the Southern District of New York for recognition as a foreign “main” proceeding, thus automatically staying the state court litigation. One month later, the bankruptcy court granted the liquidator’s chapter 15 recognition petition.

On appeal, the shareholder contended that the bankruptcy court (and the district court, on its initial appeal) erred in ruling that the factual analysis concerning COMI was to be determined as of the date of the filing of the chapter 15 petition. The Second Circuit disagreed, upheld the lower courts’ rulings, and held — based on its reading of the text of the statute, other federal court decisions, and international sources — that a “debtor’s COMI is determined as of the time of the filing of the chapter 15 petition.” In so doing, the Second Circuit expressly added the liquidation activities to those factors that should be considered in the COMI determination.

Fairfield Sentry is significant because prior to its liquidation (like many offshore investment funds), Fairfield Sentry’s operations were carried out beyond the BVI’s borders and it would have been difficult to meet the COMI test under those circumstances. In contrast, by utilizing the date of the commencement of the chapter 15 proceedings, and the activities occurring after the commencement of the foreign insolvency proceedings, the BVI liquidators were able to establish that Fairfield Sentry’s COMI was in the BVI at that time and third parties were aware of or could ascertain that fact.

By fixing the relevant time period to the date of the chapter 15 filing, and by allowing lower courts to rely on business activities (including liquidation activities) conducted up to that time, the Second Circuit in Fairfield Sentry has made it easier for foreign representatives to obtain recognition (whether as “main” or “nonmain”) of foreign insolvency proceedings. Foreign representatives should be aware, however, that the court will also review business activities with an eye towards determining whether COMI has been subject to manipulation or gerrymandering.

Please contact Rob Feinstein or John Morris at Pachulski Stang Ziehl & Jones LLP with any questions regarding Fairfield Sentry.