Second Circuit Explores Parameters of Ancillary Jurisdiction

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May 2001

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ust a few weeks ago the Second Circuit issued an opinion in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of New York v.
Treco (In re Treco), 240 F.3d 148 (2nd Cir. 2001)</a>, that promises
to have a significant impact on the deference afforded foreign bankruptcy proceedings.
In Treco, Bahamian liquidators sought to have assets held in an account at the Bank
of New York (BNY) turned over pursuant to §304 of the Bankruptcy Code.<a href="#2" name="2a">2</a> The
liquidators represented Meridien International Bank Ltd., a bank incorporated in the
Bahamas and undergoing bankruptcy proceedings there. BNY had certain claims against
Meridien that BNY believed to be secured by assets held in accounts at BNY.<a href="#3" name="3a">3</a>

The liquidators moved pursuant to §304 to have the assets held by BNY turned over
to them to be administered in accordance with Bahamian law. Under Bahamian law,
administrative expenses are paid ahead of secured creditors, and BNY stood to recover
only a small fraction, if any, of the money currently held by it despite its
purported secured status. The bankruptcy court ruled in favor of the liquidators and
ordered the turnover of the account held by BNY. The bankruptcy court's decision was
affirmed by the district court and subsequently appealed to the Second Circuit. On
appeal, the Second Circuit overruled the lower courts and rejected the liquidators'
request. The Second Circuit ruled that due to the substantial differences between
Bahamian and U.S. bankruptcy law, the lower courts abused their discretion by
ordering the turnover.

<h3>U.S. Approach to Foreign Insolvency Proceedings Generally</h3>

In order properly to place the decision in context, it is useful to engage in a
brief look at the two main approaches to the problem of asset distribution in a
cross-border insolvency, namely territorialism and universalism. The territorial approach
provides that each court should be allowed to distribute the assets present within its
jurisdiction according to local laws. This approach places the greatest amount of
importance on the distribution of local assets to local creditors. The territorial approach
is problematic, however, because it can lead to the piecemeal liquidation of corporate
assets and makes it difficult, if not impossible, to accomplish a global reorganization
of a bankrupt debtor.

The alternative approach to the distribution of assets in cross-border insolvencies
is often labeled the universal approach. Universalism prefers a main proceeding to be
brought in one country, possibly the nation of domicile, while other ancillary
proceedings may be brought in other countries where the debtor's property is located.
The courts where ancillary proceedings are brought may serve as facilitators in the
recovery and distribution of the debtor's assets in accordance with the rules of the
nation having jurisdiction in the main case.

The United States has adopted a modified universal approach that is embodied in
§304 of the Bankruptcy Code. Section 304 accepts the central premise of
universalism, namely that assets should be collected and distributed globally, but
maintains the discretion of bankruptcy courts in the United States to evaluate the
fairness of home country proceedings and to protect the interests of American claim
holders. Section 304 gives bankruptcy courts broad discretion and states in pertinent
part:
<blockquote>
(c) In determining whether to grant relief...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) distributions 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.
</blockquote>

</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §304(c)</a>.

<h3>Specific Requirement That Foreign Distribution Be Substantially in Accordance with
Bankruptcy Code</h3>

In Treco, the Second Circuit focused on §304(c)(4) of the Bankruptcy
Code, which provides that the distribution of funds in the primary proceeding should
be "substantially in accordance with the order prescribed by this title." Though the
Second Circuit acknowledged that the Bahamian proceedings in general provided a fair,
non-prejudicial forum for the payment of claims, it was troubled by the treatment
afforded secured creditors as compared with their treatment under the Bankruptcy Code.
The court noted that unlike U.S. law, Bahamian law provides for the payment of
administrative claims ahead of secured creditors. The court noted, "[t]he importance of
the difference in prioritization under U.S. and Bahamian law is particularly acute
in this case because of the strong possibility that [Meridien's] estate will have little
or no funds after payment of administrative expenses...the liquidators testified [that]
they had collected approximately $10 million in receivables, but...nearly $8
million had been used to pay administrative expenses." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 2001 WL 124938</a>
at *8. The court believed that the markedly different treatment of administrative
expenses under Bahamian law and its impact on expected recoveries precluded the
distribution of proceeds in "substantial accordance" with the order prescribed by the
Bankruptcy Code and found that turnover was improper.

<h3>Second Circuit Emphasizes Fact-specific Analysis</h3>

In its opinion, the Second Circuit emphasized the importance of doing a
case-by-case analysis under §304 and focusing on the specific circumstances at issue.
"[A] comparison of the priority rules cannot be conducted in the abstract. A court
must consider the effect of the difference in the law on the creditor in light of the
particular facts presented." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at *8</a>. The court specifically rejected two prior
decisions by bankruptcy courts that found that Bahamian law should be afforded deference.
Beyond the obvious point that it was not bound by lower court precedent, the Second
Circuit's analysis went further to reiterate that any analysis under §304 must be on
a case-specific basis and that the nature of the current proceeding and the effect of
Bahamian law on the parties before it counseled for a different approach. The Second
Circuit specifically rejected the district court's general observation that Bahamian
law recognizes a distinction between secured and unsecured creditors as a primary
factor. The court focused more particularly on the ultimate outcome of the proceeding
pending in the Bahamas rather than more abstract considerations. Contrary to the
results under the Bankruptcy Code, if BNY were forced to turn over the accounts
in its possession to the Bahamian liquidator, it would only receive a small fraction
of the amount it turned over despite its status as a secured creditor. "The
Bahamian rule...threatens to destroy BNY's claim." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at *10</a>.

<h3>Conclusion</h3>

The Second Circuit's decision reaffirms the status of secured creditors under the
Bankruptcy Code and provides them with further protections against proceedings instituted
abroad that would alter their status. It also places increased importance on the
nature of foreign proceedings and gives bankruptcy courts greater discretion to protect
creditors from treatment that is not in accordance with the scheme set forth in the
Bankruptcy Code. The Second Circuit was careful to point out that comity was still
an important factor to consider: "We are not creating a presumption against affording
comity to Bahamian bankruptcy proceedings. We expect that the case-specific analysis
required by §304 will in many or most cases support the granting of the requested
relief." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at *10</a>. The Second Circuit's decision does, however, open up more
of a gray area determining whether relief may be granted to ancillary proceedings
brought in the United States. How much disparate treatment of creditors will be
tolerated, and when will courts intervene to protect creditors that face lesser
recoveries under a foreign insolvency regime? Past cases cited by the Second Circuit
involved foreign laws that failed to distinguish between secured and unsecured claims or
failed to recognize a secured claim. Treco takes that analysis one step further and
indicates that any significant difference in ordering is susceptible to attack in an
ancillary proceeding. The court's broad language might also allow for the application
of the principles enunciated in Treco to unsecured creditors as well. Seemingly, any
significant departure from the ordering scheme set forth in the Bankruptcy Code may
now be vulnerable to attack in an ancillary proceeding brought in the United States.

Despite the recent approval by the House and Senate of a new chapter 15 to the
Bankruptcy Code, which covers ancillary and other cross-border cases, the Second
Circuit's decision in Treco should have continued vitality going forward.<a href="#4" name="4a">4</a> The new
version of §304(c) is embodied in proposed §1507(b).<a href="#5" name="5a">5</a> Section 1507(b)
is substantially modeled on §304(c), and though it may arguably place a greater
emphasis on comity, it is still clear from the statute that creditors will continue
to have the benefit of receiving distributions substantially in accordance with the order
prescribed by the Bankruptcy Code.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Mr. Silverman is a partner with Bingham Dana LLP, where his practice focuses on both U.S. and international restructurings.
Mr. Pereira is an associate with Bingham Dana LLP. <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §101</a>, et seq. <a href="#2a">Return to article</a>

<a name="3">3</a> The Second Circuit did not rule specifically on the validity of the security interest in question, but instead assumed for the
purposes of its opinion that BNY was secured. The determination of whether BNY was actually secured was left for the lower courts to determine
on remand. <a href="#3a">Return to article</a>

<a name="4">4</a> A version of the Bankruptcy Reform Act of 2001 has been approved by both the House and Senate and (as of this writing)
currently awaits reconciliation. <a href="#4a">Return to article</a>

<a name="5">5</a> The text of the House and Senate versions of §1507(b) are identical and read as follows:
<blockquote>
(b) In determining whether to provide additional assistance under this title or under other laws of the United States, the court shall
consider whether such additional assistance, consistent with the principles of comity, will reasonably assure—
<blockquote>
(1) just treatment of all holders of claims against or interests in the debtor's property;

(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 the debtor;

(4) distribution of proceeds of the debtor's property substantially in accordance with the order prescribed by this title; and

(5) if appropriate, the provision of an opportunity for a fresh start for the individual that such foreign proceeding concerns. <a href="#5a">Return to article</a>

Journal Authors

Helder P. Pereira

Ronald J. Silverman

Journal Date

Tuesday, May 1, 2001 - 12:00

Bankruptcy Rule

2001