Ionica PLC Comity Taken Seriously

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Jun 2000

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Recently, in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Ionica PLC, 241 B.R. 829 (Bankr. S.D.N.Y. 1999)</a>, the U.S. Bankruptcy Court for the
Southern District of New York (Chief Bankruptcy Judge Stuart M. Bernstein) dismissed a chapter 11 case
under the doctrine of comity, in deference to a pending proceeding commenced by the debtor in the United
Kingdom. The case is significant from an international perspective because the principal purpose of the
chapter 11 filing was an attempt by the Joint Administrators in the U.K. proceeding to utilize the chapter
11 case and the bankruptcy court as a "friendly forum" to pursue equitable subordination and substantive
consolidation claims that they believed could not be successfully prosecuted under English law. In essence,
the commencement of the chapter 11 case constituted "forum shopping" on an international scale, which
was rejected by the bankruptcy court.

Ionica plc, a British company, operated a telecommunications business in the U.K. It had no contact
or other relationships with, or business in, the United States. The only "property" of Ionica located in the
United States was certain securities that had been pledged to an indenture trustee to collateralize debt
offered by Ionica in the United States in 1996.

In 1997, Ionica Group plc (Group) was formed at the request of Ionica's lenders to facilitate additional
financing for Ionica's startup business. Ionica became a wholly owned subsidiary of Group, and Group
consummated an initial public offering, the proceeds of which allegedly were to be used to fund Ionica's
expansion and development. According to Ionica, Group was to act as a conduit, with the IPO proceeds
to be funded by Group to Ionica as needed. Initially, this took place, but as Ionica's business and financial
situation soured, Group allegedly balked at advancing additional funds, acted to protect its position and
eventually agreed to advance funds to Ionica only on a secured basis.

By October 1998, Ionica was in extremis and had no ability to obtain additional financing. Accordingly,
on Oct. 29, 1998, it presented a petition to the High Court of Justice in London for the administration of
Ionica under the Insolvency Act of 1986. On Dec. 8, the Joint Administrators appointed by the high court
in the proceeding submitted an ex parte application to the high court for "liberty" to file a chapter 11
petition for Ionica in the United States. Notably, as the bankruptcy court recognized, the intent of the
chapter 11 filing "was not the reorganization of Ionica's business, which was admittedly defunct. Rather,
[the joint administrators] wanted to take advantage of favorable U.S. bankruptcy law to challenge the
secured and unsecured claims of Group either through equitable subordination or substantive
consolidation." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. at 833</a>. Further, the sole basis for eligibility for Ionica to seek relief under chapter
11 was the pledged securities held by the indenture trustee, which Ionica, shortly after the chapter 11 filing,
agreed to turn over to the indenture trustee for application to the notes. Group filed a motion to dismiss
Ionica's chapter 11 case on the following grounds:

<blockquote>
(a) Ionica was ineligible to be a debtor under §109(a) of the Bankruptcy Code because it had no
domicile, place of business or property in the United States; 
(b) Ionica had no business to reorganize and the chapter 11 case was commenced solely as a forum
shopping scheme to pursue equitable subordination and substantive consolidation claims unique
to U.S. bankruptcy law; and 
(c) The chapter 11 case should be dismissed under Bankruptcy Code §305(a)(2) because of the
pending U.K. proceeding—more specifically, there was a pending foreign proceeding, and the
factors set forth in §304(c) (such as comity) mandated a dismissal.
</blockquote>
In granting the motion to dismiss, the bankruptcy court focused on the §304(c) factors,<a href="#2" name="2a">2</a> primarily relying on comity and established Second Circuit precedent regarding such doctrine:

<blockquote>
We begin the analysis with comity. "Comity is a doctrine that encourages deference to foreign laws
and judgments if macro systemic concepts, such as due process and impartiality, are present in the
foreign proceedings." The Second Circuit has often underscored the importance of extending comity
in foreign bankruptcy proceedings. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… AG Zurich v. Banco Economico S.A., 192 F.3d
240, 246 (2d Cir. 1999)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Communication Corp. v. Societe Generale (In re Maxwell
Communication Corp.), 93 F.3d 1036, 1048 (2d Cir. 1996)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Life Ins. Co. v. Linter Group Ltd., 994 F.2d at 999</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… S.S. Co. v. Salen Reefer Servs., AB, 773 F.2d 452, 458 (2d Cir. 1985)</a>

(emphasizing that "deference to foreign insolvency proceedings will, in many cases, facilitate
'equitable, orderly and systematic' distribution of the debtor's assets."); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Maxwell
Communication Corp., 93 F.3d at 1048</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… S.S. Co. v. Salen Reefer Servs., AB, 773 F.2d at
458</a> ("American courts have consistently recognized the interest of foreign courts in liquidating or
winding up the affairs of their own domestic business entities.")
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. at 835</a>. In concluding that the pending U.K. proceeding met the requisite standard for comity, the
bankruptcy court relied on the fact that English law is consistent with concepts of due process and
impartiality in the United States and, more specifically, that English insolvency laws are generally afforded
comity.

In addressing the other §304(c) factors, the bankruptcy court noted that 1) English law treats all
creditors, whether domestic or from the United States, fairly (§304(c)(1)); 2) the U.K. procedures do not
prejudice or inconvenience U.S. creditors (§304(c)(2)); and 3) English law does not foster preferential or
fraudulent transfers of a debtor's property (§304(c)(3)).

The joint administrators, however, focused on §304(c)(4) and contended that the U.K. proceeding would
not distribute the debtor's assets in accordance with U.S. law. They argued that because allegedly valid
claims for equitable subordination and substantive consolidation with respect to Group would not be
recognized in the U.K., Group would receive a greater distribution in the U.K. administration proceeding.

In rejecting the joint administrators' argument, Judge Bernstein stated:

<blockquote>
Section 304(c)(4) only requires that the foreign distribution scheme be "substantially in accordance"
with United States bankruptcy law; it does not have to mirror the United States distribution rules.
Consequently, this factor does not preclude deference merely because the foreign distributive
scheme subordinates or accords a lower priority to the United States creditor's claim. Rather, the
distribution scheme must be repugnant to a fundamental principle of American law, or render the
claim unenforceable.
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. at 836-37</a> (emphasis supplied, citations omitted). In finding that the refusal of English law to
recognize claims premised on equitable subordination and substantive consolidation does not make it
repugnant to U.S. law, the bankruptcy court noted that American non-bankruptcy law also does not
recognize these claims and, accordingly, these claims "are not fundamental to our basic notions of fairness
and justice." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. at 837</a>.

In conclusion, Judge Bernstein held that consideration of all the circumstances compelled deference to
the proceeding pending in the U.K., even assuming that "English law will deprive Ionica's creditors of the
remedies of equitable subordination and substantive consolidation based upon the inequitable conduct
alleged" by Ionica. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. at 839</a>.

A number of factors support the bankruptcy court's decision in Ionica and its goal of maintaining the
integrity of the relationship of the U.S. Bankruptcy Code with foreign insolvency schemes. For example:

<li>Ionica had no connection or nexus with the United States other than pledged securities in a
collateral account in which Ionica acknowledged it had no economic interest.
</li><li>Ionica had no assets to administer in a U.S. chapter 11 case.
</li><li>Ionica had no ability and no intent to reorganize under chapter 11 of the U.S. Bankruptcy Code.
</li><li>The joint administrators admitted that the chapter 11 filing was a forum-shopping exercise in an
attempt to pursue equitable subordination and substantive consolidation claims against Group in
what they perceived to be a more friendly jurisdiction, and
</li><li>Creditors of Ionica had no reason to believe that any potential insolvency proceeding would be
administered anywhere other than in the U.K. with English law applying.</li></ul>
</blockquote>

Indeed, under the circumstances, it would have been totally inappropriate for the U.S. bankruptcy court
to usurp the authority of the high court in the U.K., particularly where there was every reason to believe
that U.S. creditors would be treated fairly and equally in the U.K. proceeding.

In this era of the globalization of financial transactions, the Ionica decision represents a sound and
proper application of the doctrine of comity that should foster the integrity of judicial systems and the
expectations of creditors dealing in foreign jurisdictions.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Mr. Karotkin is a partner and Mr. Puntus is an associate in the New York office of Weil Gotshal & Manges LLP, specializing in debt
restructurings and reorganization cases. They have been involved in several cross-border insolvency matters. <a href="#1a">Return to article</a>

<a name="2">2</a> Section 304(c) of the Bankruptcy Code provides:
<blockquote>
(c) In determining whether to grant relief under subsection (b) of this section, the court shall be guided by what will best assure an economical and expeditious administration of such estate, consistent with—
<blockquote>
(1) just treatment of all holders of claims against or interests in such estate; 
(2) protection of claim holders in the United States against prejudice and inconvenience in the processing of claims in such foreign proceeding;

(3) prevention of preferential or fraudulent dispositions of property of such estate; 
(4) distribution of proceeds of such estate substantially in accordance with the order prescribed by this title; 
(5) comity; and 
(6) if appropriate, the provision of an opportunity for a fresh start for the individual that such foreign proceeding concerns. <a href="#2a">Return to article</a>

Journal Authors

Marc D. Puntus

Stephen Karotkin

Journal Date

Thursday, June 1, 2000 - 12:00