Even if foreign law might not allow discovery, District Judge Denise Cote of Manhattan upheld Bankruptcy Judge Shelley C. Chapman by permitting foreign liquidators to demand production of accountants’ work papers in a chapter 15 case.

Hedge funds in liquidation in the Cayman Islands had been managed in New York. Shortly after commencement of the liquidation, the liquidators prevailed on Judge Chapman to grant recognition of the proceedings in the Caymans as the foreign main proceeding under chapter 15. The recognition order authorized the liquidators to take discovery in the U.S.

Two months after recognition, the U.S. Attorney indicted the funds’ managers for investment advisor fraud.

Discharging their duties under law of the Cayman Islands, the liquidators sought informal discovery from the funds’ New York-based outside auditors, who turned over documents admitted to be the funds’ property. The accountants, however, refused to produce their work papers, arguing that the work papers were their property and not subject to discovery under law of the Cayman Islands. The accountants also contended that an arbitration clause in the engagement agreement precluded discovery.

In an opinion on April 17, Judge Chapman granted the liquidators’ motion to compel discovery of the work papers. To read ABI’s discussion of Judge Chapman’s opinion, click here. The accountants immediately appealed.

In Judge Cote’s district court, the appellants accelerated the appeal and again sought a stay. Characterizing Judge Chapman’s opinion as “thorough and well-reasoned,” Judge Cote denied a stay and upheld the discovery order on the merits in an opinion and separate order, both on June 29. She said that Judge Chapman “acted well within [her] authority in granting the Liquidators’ motion to compel production” of the work papers.

Judge Cote explained that authority to compel discovery in a chapter 15 case emanates from Section 1521(a)(4), which permits a foreign representative to examine witnesses and take evidence “or the delivery of information” regarding the debtor’s affairs, and from Section 1521(a)(7), which gives the bankruptcy court authority to grant “any additional relief.” Those provisions in chapter 15 are coupled with Section 524(e) and Bankruptcy Rule 2004, the general discovery authority for bankruptcy cases, Judge Cote said.

Judge Chapman’s order compelling discovery “fits comfortably within this broad grant of powers,” Judge Cote said. “After all,” work papers created in the last two years before liquidation “would be highly relevant” in the wake of “a massive business failure,” she said.

Next, Judge Cote rejected the accountants’ defenses.

The arbitration agreement did not bar discovery because the liquidators had brought no claims against the accountants. Judge Cote cited Judge Chapman for saying that the discovery order did nothing to take away the accountants’ right for a claim to be determined in arbitration.

Significantly, Judge Cote said that the accountants’ argument, taken to “its logical conclusion,” would prevent work papers from being discoverable whenever there was an arbitration agreement. She said the accountants cited “no support for that sweeping proposition.”

Judge Cote also rejected the accountant’s argument based on the notion that the liquidators could not obtain the work papers under Cayman Islands law.

Judge Cote said that the “foreign discoverability rule has been roundly rejected” in the “analogous context of 28 U.S.C. § 1782,” which enables federal courts to provide discovery in connection with legal proceedings abroad.

Judge Cote declined “to impose such a rule for chapter 15 proceedings.”

The accountants have already appealed and filed a motion in the Second Circuit for a stay pending appeal.