The Benefits and Risks of Manufactured Eligibility

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Sep 2004

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As the world becomes more
globally interconnected and the borders and barriers between countries have
broken down, there has been a rapid increase in the existence of domestic
companies with foreign affiliates and vice-versa. When these companies
enter financial distress, a decision must be made regarding the best forum
in which to file for bankruptcy.

There are several fundamental benefits to the filing
by a foreign company in the United States or for the joint administration
of a bankruptcy of foreign and domestic affiliated companies in the United
States. The most persuasive of these is the increased certainty of how the
bankruptcy process will play out and the cost-effectiveness of
administering the bankruptcy cases of all of the entities of a
multinational in one place. Additionally, U.S. bankruptcy law is much more
accepting of the reorganization process than the laws of other countries,
especially those in Europe. Many countries still view bankruptcy simply as
a means of liquidation rather than reorganization.

However, it is important to note that a
U.S.-administered bankruptcy may not be a panacea for every foreign company
in need of some form of debt reorganization. A U.S. Bankruptcy Court can
only take enforcement action for violations of the automatic stay by
creditors over which the court has personal jurisdiction. See, e.g., In re Lykes Bros. S.S. Co. Inc., 207 B.R. 282 (Bankr. M.D. Fla. 1997). Additionally, while
the orders of a bankruptcy court have "extraterritorial
effect," those orders are only enforceable where a foreign nation
gives "full faith and credit" to those orders due to
"comity, treaty or convention." In
re McTague, 198 B.R. 428, 430 (Bankr.
W.D.N.Y. 1996). Regardless, the potential situations in which a company
could benefit from an American bankruptcy filing rather than a foreign one
are numerous. For example, where a domestic parent has a substantial bond
debt and one of its foreign affiliates serves as a guarantor of that debt,
it would be worthwhile to jointly administer the bankruptcies in the United
States, especially where the affiliate is otherwise completely solvent
absent the problematic bond debt.

<h4>Eligibility Under §109</h4>

There are four potential means for a company to
establish its eligibility as a debtor under §109 of the Bankruptcy
Code: (1) residence in the United States, (2) domicile in the United
States, (3) a place of business in the United States or (4) property
located in the United States. Accordingly, "a foreign entity or
individual domiciled abroad but owning property or doing business in the
United States is eligible to be a debtor under 11 U.S.C. §109." In re Xacur, 219 B.R. 956, 966
(Bankr. S.D. Tex. 1998); Israel-British Bank
(London) Ltd. v. Federal Deposit Insurance Corp., 536 F.2d 509, 513 (2d Cir. 1976). Additionally, the presence of
one of these criteria has been found to warrant U.S. debtor eligibility
even where there are other forums where a company has significantly greater
number and breadth of contacts. In re Aerovias
Nacionales de Colombia S.A., 303 B.R. 1
(Bankr. S.D.N.Y. 2003).

<blockquote><blockquote>
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[I]f no assets in any form are currently located in
the United States, eligibility could be manufactured via a U.S. bank
account with a small amount of money and/or via the payment of a retainer
to bankruptcy counsel.
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Each individual debtor must meet one of the criterion
under §109, and the determination must be made on the date the
debtor's bankruptcy petition is filed. In
re Global Ocean Carriers Ltd., 251 B.R. 31,
37-39 (Bankr. D. Del. 2000); Bank of America
N.T. & S.A. v. World of English N.V., 23
B.R. 1015, 1019-20 (N.D. Ga. 1982). The sheer fact that a company's
affiliate or parent company is eligible to file for bankruptcy in the
United States does not automatically ensure that company's status as
a U.S. debtor. Instead, a subsidiary of an eligible debtor must separately
meet the criteria to be eligible. Bank of
America, 23 B.R. 1015.

The first three criteria (residence, domicile or
place of business) are generally straightforward and easily determinable.
In fact, in the case of a company, the first two criteria are almost
rendered superfluous by courts' interpretation of the third, the
"place of business" criterion. This criterion has been
interpreted to mean any place of business rather than a company's
principal place of business. However, the mere fact that a company does
business in the United States has been found by courts to fall short of
either having a place of business or having property here. Global Ocean, 251 B.R. at
37.

<h4>The Property Path</h4>

The broadest eligibility criterion, and the one that
requires the most minimal of contact with the United States, is the
property requirement. In order to meet the property requirement under
§109, the potential debtor must demonstrate that it has actual
property in the United States, rather than "some type of remote or
inchoate claim against property that is in the United States." See, e.g., In re Head, 223 B.R.
648, 652 (Bankr. W.D.N.Y. 1998). However, absent this restriction, the
property requirement for debtor eligibility is extremely broad. There is no
statutory requirement as to the property's minimum value. See, e.g., In re Paper I Partners L.P., 283 B.R. 661 (Bankr. S.D.N.Y. 2002); In
re McTague, 198 B.R. at 432. As noted by the
court in In re McTague, §109 "does not appear to be vague or ambiguous, and it
seems to have such a plain meaning as to leave the court no discretion to
consider whether it was the intent of Congress to permit someone to obtain
a bankruptcy discharge solely on the basis of having a dollar, a dime or a
peppercorn located in the United States." 198 B.R. at 432.
Accordingly, if a potential debtor has property of any value in the United
States, it should qualify as a debtor under §109. In re McTague, 198 B.R. at 432; In re Global Ocean, 251
B.R. at 39.

The most straightforward means of meeting this
requirement is via the ownership of a U.S. bank account by the potential
debtor. Courts have held that this property requirement has been met via
the presence of a minimal amount of money in a U.S. bank account. See, e.g., In re Iglesias, 226
B.R. 721, 722-23 (Bankr. S.D. Fla. 1998).

However, the breadth of the property requirement can
be seen by the relatively atypical "property" through which
courts have found the requirement satisfied. Of particular note to a
discussion of parent and subsidiaries is the finding that the location of a
company's original business documents in the United States satisfies
the §109 property requirement. Accordingly, where the books and
records or other original business documents of a foreign affiliate are
kept in the United States by the domestic parent, the affiliate will be
eligible to file in the United States as a debtor. In re Paper I Partners, 283 B.R. at
674; In re Global Ocean, 251 B.R. at 38.

Additionally, courts have found that the unused
retainer paid to bankruptcy counsel in anticipation of filing for
bankruptcy constitutes sufficient property to meet the criteria under
§109. In re Global Ocean, 251 B.R. at 39. This is due to the fact that the debtor
retains a property interest in such unearned portion of that retainer. See, e.g., In re Independent Engineering Co. Inc., 232 B.R. 529, 533 (1st. Cir. BAP 1999). Moreover, it is
not relevant who paid this retainer, so long as the retainer was paid on
behalf of the foreign entity and meant to cover the fees for its attorneys.
In re Global Ocean, 251 B.R. at 39; In re Independent
Engineering, 232 B.R. at 533. In essence,
the payment of the retainer on behalf of the affiliate gives it a property
interest in the retainer. Accordingly, it is possible for the parent or
holding company to pay an overarching retainer for itself and its
affiliates that would serve to satisfy the §109 eligibility
requirement. However, in order to meet the property requirement this way,
some portion of the retainer would need to have been unearned by the
attorneys at the time the petition is filed. Nonetheless, relying on this
"property" for eligibility purposes could be risky, as a court
could rule that such an interpretation of the property requirement would
render any company eligible to meet the requirement.

Another somewhat atypical means of meeting the
property requirement may occur in a parent/subsidiary relationship where
the parent was located outside the United States with a subsidiary in the
United States. The parent would have property in the United States by
virtue of its ownership of the stock of a U.S. corporation and could thus
qualify as a debtor under §109. In re
Global Ocean, 251 B.R. 31. On the other
hand, where the parent and subsidiary are in inverse positions, this would
not be true.

<h4>Manufactured Eligibility</h4>

Some courts have indicated that a debtor may not
"manufacture" eligibility by taking such actions as opening
small bank accounts in the United States or acquiring U.S. mailing
addresses exclusively for bankruptcy jurisdiction purposes. In re McTague, 198 B.R. 428; In re Head, 223 B.R. at 652; Bank of America, 23 B.R. 1015.
Moreover, reliance on an unused retainer could be viewed as
"manufactured" eligibility. The breadth of this prohibition on
manufactured eligibility is unclear; however, one court made its
determination of whether eligibility had been manufactured by examining the
"totality of the circumstances." In
re McTague, 198 B.R. at 432-33.
Regardless, the manufacturing of eligibility would likely only be a problem
if that manufacturing were challenged by a party that did not want the
foreign company to file in the United States. It is possible in a
bankruptcy that there may only be a few creditors who have the motivation
to justify expending the time and money to challenge the debtor's
eligibility. Such a challenge could potentially come from a foreign
creditor or labor union objecting to the bankruptcy's venue in the
United States. However, any problem creditor, labor union or similar
entities could potentially be identified and dealt with prior to filing or
via the first-day motions.

<h4>Conclusion</h4>

When faced with imminent bankruptcy, a foreign
company should first determine if it meets any of the broader eligibility
criteria for debtor status; namely, residence, domicile or a place of
business in the United States. Where the company lacks those contacts, it
must determine whether it has any property located in the United States. As
previously indicated, even a de minimus amount of property should be sufficient to meet the
criteria under §109. Accordingly, a company should think as broadly as
possible in determining if it maintains any property interest of any kind
in the United States. However, if no assets in any form are currently
located in the United States, eligibility could be manufactured via a U.S.
bank account with a small amount of money and/or via the payment of a
retainer to bankruptcy counsel. This is technically a feasible way to
achieve eligibility as a debtor since the eligibility determination is made
on the date of the filing of the petition and not at some prior date.
Nonetheless, as previously noted, there is a potential that some courts may
find that a foreign company is not an appropriate debtor in that case due
to its "manufactured" eligibility. Thus, whenever eligibility
under §109 is manufactured, a debtor should anticipate the possibility
that the eligibility will be deemed invalid and act accordingly.

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Journal Authors

Marc P. Solomon

Journal Date

Wednesday, September 1, 2004 - 12:00

Bankruptcy Rule

2004