The ABCs of Chapter 15 -- Third Circuit Upholds Broad Scope of Recognition in Cross-Border Cases

The Bottom Line:

Looking at global economics, cross-border restructurings are predicted to be a larger focus in the United States in 2014 as U.S. affiliates or assets are addressed in connection with foreign-based insolvencies. Chapter 15 of the Bankruptcy Code -- established in 2005 -- allows an ancillary proceeding to be commenced in the United States, rather than requiring a separate full bankruptcy action to be filed here, when the “main” proceeding is brought in another country. In ABC Learning Centres, No. 12-2808, 2013 U.S. App. LEXIS 17844 (3d Cir. Aug. 27, 2013), the Third Circuit affirmed the recognition of an Australian liquidation proceeding as a “foreign main proceeding” within the ambit of Chapter 15, even though the debtor’s assets were fully encumbered, leaving no value anticipated to be distributed to unsecured creditors. This case involved separate receivership and liquidation proceedings in Australia and a competing U.S. creditor seeking to obtain judgment liens over U.S. assets. In its ruling, the Court overruled arguments by the U.S. unsecured creditor that the Australian liquidation proceedings were essentially for the sole benefit of the secured creditors and did not warrant judicial recognition by U.S. courts. The Third Circuit’s decision provides a nice summary of the purposes of Chapter 15 and the recognition (no pun intended…) that unsecured creditors should not force a race to U.S. courthouses to enhance their position over U.S. assets and disregard foreign insolvency proceedings. Such behavior ignores basic principles of international comity.

What Happened:

ABC Learning Centres Ltd. (“ABC”) was an Australian company that also operated in other countries, including the United States. In November 2008, ABC went into Voluntary Administration in Australia, where administrators were appointed to determine whether the company should be restructured or liquidated. The administrators ultimately opted for liquidation and two of the administrators were appointed as liquidators. However, because the Voluntary Administration breached ABC’s secured loan agreements, the secured creditors exercised their rights to appoint a separate receiver to obtain control over the collateral and sell it on behalf of the secured creditors. In Australia, receivership and liquidation are separate proceedings that can operate in tandem, with a “receiver” representing the interest of secured creditors, while the “liquidator” represents the interests of all creditors, including unsecured creditors. The liquidator coordinates with the receiver, who has primary responsibility for selling the collateral. After repayment of the secured creditor, the receiver turns any excess proceeds over to the liquidator for distribution to other creditors. The key to ABC was the argument that the secured creditors were undersecured and there was no equity in the collateral for unsecured creditors – in essence, arguing that the “true” foreign proceeding was the limited purpose receivership and not the broader purpose liquidation proceeding. More on this below.

In May 2010, the liquidators petitioned the Bankruptcy Court of Delaware under Chapter 15 for recognition of the Australian proceedings. At the time, RCS Capital Development LLC (“RCS”), a U.S. unsecured creditor, was pursuing a substantial litigation claim against ABC in the United States, hoping to obtain a judgment and judgment lien against ABC’s U.S. assets. The Chapter 15 case would have stayed RCS’s efforts. The Bankruptcy Court held that the liquidation proceeding met the recognition requirements of a “foreign main proceeding”, thereby imposing an automatic stay upon RCS’s actions against ABC and its property within the United States’ jurisdiction. The District Court of Delaware affirmed the Bankruptcy Court’s orders.

The Third Circuit decision provides an overview of the purpose and intent of Congress’ enactment of Chapter 15, including efforts to expand judicial recognition of cross-border insolvencies globally by closely following the UNCITRAL Model Law as a template for other countries to likewise adopt. Under Chapter 15, U.S. bankruptcy courts must recognize a foreign proceeding when the recognition requirements are met, in contrast to the flexibility that was allowed under former Section 304 of the Bankruptcy Code, where recognition was discretionary under principles of comity. In ABC, the Third Circuit affirmed that all of the required elements of a “foreign proceeding” were met for the liquidation proceeding, rejecting RCS’s arguments that the liquidation proceeding was not “collective” in nature – one of the requirements for recognition – simply because ABC’s assets were entirely leveraged (with nothing for the liquidator to distribute in its separate proceeding to unsecured creditors following completion of the receivership proceeding); in essence, RCS argued that the receivership dominated the liquidation proceedings.

In rejecting the limitation of Chapter 15 to ABC, the Third Circuit reasoned that the debtor’s debt to value ratio “does not affect the collective nature of the Australian liquidation proceeding.” The Third Circuit further explained that “Chapter 15 makes no exceptions when a debtor’s assets are fully leveraged,” as such an exception would contravene the purposes of Chapter 15 and its mandatory language regarding recognition.

The Third Circuit further held that the public policy exception to recognition of a Chapter 15 case was not met. Section 1506 states that “Nothing in [Chapter 15] prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States.” The Third Circuit emphasized that the use of the word “manifestly” supports construing the public policy exception narrowly, and determined the public policy exception does not apply in this case. To the contrary, the Third Circuit explained that recognition in this case serves the policies of the collective proceeding requirement – namely that without Chapter 15 recognition, RCS could unfairly jump ahead of the priorities of secured creditors; RCS’s desired approach “would eviscerate the orderly liquidation proceeding, and ignores all priority of debts.” The Third Circuit noted that the principles of Australian insolvency proceedings as applicable in this case do not conflict with U.S. bankruptcy principles, as both prioritize secured creditors. The slight differences in process between Australian and U.S. proceedings relevant to this case are merely a “different way to achieve similar goals.”

The next issue on which the Third Circuit ruled, which followed from recognizing the foreign proceeding, is that the automatic stay applies to property of the debtor within the United States’ jurisdiction. RCS contended that ABC’s assets in the United States are not “property of the debtor” because ABC only holds legal title and no equitable interest in those assets given that the property is entirely leveraged. However, the Third Circuit affirmed that ABC does retain equitable interest in its encumbered property, even though the assets are leveraged. The Third Circuit found that ABC held “several important equitable interests in its property” including (i) the right to surplus proceeds from the sale of the encumbered assets (even if any surplus is unlikely) and (ii) the right of redemption. The Third Circuit concluded that ABC’s assets in the U.S. were “property of the debtor” and thus subject to the automatic stay under Section 1520.

Why the Case is Interesting:

This case is notable for a couple of reasons. On a broad level, it illustrates how U.S. courts apply Chapter 15 to support cross-border comity/recognition and promote a more effective handling of multinational bankruptcies. On a more granular level, it is notable that the Third Circuit acknowledged that Chapter 15 mandates recognition when the recognition requirements of Section 1517 are met – here, a “liquidation proceeding” was recognized to obtain a stay of a U.S. creditor’s actions against the debtor’s assets, even though those assets would be sold by a receiver for the benefit of the secured creditor. Perhaps it is a case of “forum” over substance….