The U.S. Court of Appeals for the Second Circuit recently held that a bankruptcy court must conduct a § 363 review of a chapter 15 debtor’s sale of U.S. assets, even if the sale was previously approved by a foreign court.[1] Although it acknowledged that comity is an important consideration in a chapter 15 proceedings, the Second Circuit determined that § 1520(a)(2)[2] “acts as a brake or limitation on comity” by requiring bankruptcy courts to conduct the § 363[3] review.[4]
In Krys v. Farnum Place LLC (In re Fairfield Sentry Ltd.), Fairfield Sentry Ltd., a British Virgin Islands (BVI) investment fund, invested approximately 95 percent of its assets with Bernard L. Madoff Investment Securities LLC (BLMIS).[5] After Bernard L. Madoff confessed to using BLMIS’s customer funds in furtherance of a massive Ponzi scheme, the U.S. bankruptcy court placed BLMIS into a Securities Investor Protection Act of 1970 (SIPA) liquidation.[6] Shortly thereafter, the High Court of Justice of the Eastern Caribbean Supreme Court (the “BVI court”) placed Fairfield Sentry into liquidation and appointed Kenneth M. Krys as liquidator.[7] In June of 2010, Krys sought the U.S. bankruptcy court’s recognition of the BVI liquidation under chapter 15, which was granted.[8]
Fairfield Sentry filed three claims in BLMIS’s SIPA liquidation and eventually reached a settlement with the BLMIS trustee for an allowed claim in the amount of $230 million (the “SIPA claim”).[9] During the summer of 2010, Krys conducted an auction for the sale of the SIPA claim.[10] Farnum Place LLC was the highest bidder with an offer to purchase the SIPA claim for 32.125 percent of the allowed amount.[11] Later, Krys and Farnum executed a trade confirmation for the sale of the SIPA claim, which required the approval of both the U.S. bankruptcy court and the BVI court.[12] As luck would have it, only three days after the signing of the trade confirmation, the BLMIS trustee announced a settlement that would result in the value of the SIPA claim increasing from approximately 32 percent to more than 50 percent of the allowed portion.[13]
Due to the increased value of the SIPA claim, Krys requested that the BVI court disapprove the sale to Farnum because it was no longer in the best interests of Fairfield Sentry’s estate.[14] Although it approved the trade confirmation, the BVI court ordered Krys to bring the trade confirmation before the U.S. bankruptcy court for review.[15]
After applying the test of “common-sense appraisal of the requirements of justice and convenience,” as set forth in Severnoe Sec. Corp. v. London and Lancashire Insurance Co.,[16] to determine the location of the SIPA claim, the U.S. Bankruptcy Court for the Southern District of New York held that the SIPA claim was not “within the territorial jurisdiction” of the U.S. as required by § 1520(a)(2) for a § 363 review.[17] The bankruptcy court further held that under comity principles, it had to defer to the BVI court’s ruling because failing to do so “necessarily undermines the equitable and orderly domestic court into a foreign appellate court where creditors are always afforded the proverbial ‘second bite at the apple.’”[18] The district court affirmed the bankruptcy court’s ruling and noted that “[c]ourts should be loath to interfere with corporate decisions absent a showing of bad faith, self-interest, or gross negligence.”[19]
On appeal, the Second Circuit disagreed with the bankruptcy court’s determination that the SIPA claim was not “a transfer of an interest of the debtor in property that is within the territorial jurisdiction” of the U.S. under § 1520(a)(2).[20] The Second Circuit determined that the bankruptcy court’s analysis was incomplete because it did not take into account the § 1502(8) definition of “[w]ithin the territorial jurisdiction” which includes “any property [that is] subject to attachment or garnishment that may properly be seized or garnished by an action in a Federal or State court in the United States.”[21] As applicable New York law provided that the SIPA claim was subject to attachment and garnishment by state and federal courts, the Second Circuit held that the situs of the SIPA Claim was New York, and thus, a § 363 review was required under § 1520(a)(2).[22]
The Second Circuit further disagreed that comity principles required deference to the BVI court’s approval of the sale of the SIPA claim.[23] While the Second Circuit recognized the importance of comity in chapter 15 proceedings, it held that the express language of § 1502(a) (requiring § 363 review of transfers of property within the U.S.) was a limitation on comity.[24]
Fairfield Sentry reflects a similar interpretation of chapter 15 as evidenced by the Second Circuit in Drawbridge Special Opportunities Fund LP v. Barnet (In re Barnet).[25] In Barnet, the Second Circuit held that § 109(a)[26] applies to cases brought under chapter 15 and thus, the bankruptcy court should not have granted recognition to a foreign proceeding when there was no showing that an Australian debtor had a domicile, place of business or property in the U.S.[27] To that end, the Second Circuit noted that “if Congress wished to exclude chapter 15 from the reach of § 109(a),” it would have expressly stated the same.[28] Both the Fairfield Sentry and Barnet cases indicate that while the Second Circuit acknowledges the grander comity considerations of chapter 15, there is a trend toward interpreting the Bankruptcy Code as a “brake or limitation” on comity principles.
[1] 768 F.3d 239 (2d Cir. 2014).
[2] Section 1520(a)(2) provides that “[u]pon recognition of a foreign proceeding that is a foreign main proceeding … sections 363, 549, and 552 apply to a transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States to the same extent that the sections would apply to property of the estate.”
[3] Section 363 governs the “use, sale, or lease” of estate property.
[4] Id. at 245-246 (quoting In re Vitro S.A.B. de CV, 701 F.3d 1031, 1054 (5th Cir. 2012)).
[5] Id. at 241.
[6] Id.
[7] Id.
[8] Id.
[9] Id.
[10] Id. at 242.
[11] Id.
[12] Id.
[13] Id.
[14] Id.
[15] Id.
[16] 174 N.E. 299 (1931).
[17] Fairfield Sentry, 768 F.3d at 244.
[18] Id. at 243 (quoting In re Fairfield Sentry Ltd., 484 B.R. 615, 628 (Bankr. S.D.N.Y. 2013)).
[19] Krys v. Farnum Place LLC (In re Fairfield Sentry Ltd.), No. 13 Civ. 1524 (AKH) at *1, 2 (S.D.N.Y. Jul. 3, 2013).
[20] Fairfield Sentry, 768 F.3d at 244.
[21] Id.
[22] Id. at 244-245.
[23] Id. at 245.
[24] Id. at 245-246.
[25] 737 F.3d 238 (2d Cir. 2013).
[26] Section 109(a) provides that “only a person that resides or has a domicile, a place of business, or property in the United States, or a municipality, may be a debtor under this title.”
[27] Barnet, 737 F.3d at 247.
[28] Id. at 249.