Making Sense of Jurisdictional Chaos: Chapter 15 Protects the Corporate Group

Jurisdictional battles are not inevitable when assets and liabilities span borders. Notwithstanding some criticism of the rigid application of standards, chapter 15 of the U.S. Bankruptcy Code has proved to be a flexible and effective tool for cross-border restructuring since its enactment in 2005.[1] A popular misconception is that a chapter 15 ancillary case is not a realistic option for a corporate group with a material U.S. presence and that recognition, if obtained, leaves the group exposed during the critical period between filing and recognition. In fact, corporate groups with significant U.S. operations have used the plenary-ancillary model to obtain recognition in a single jurisdiction (despite varying places of incorporation, operation and asset location) and a great deal of the relief available under chapter 11.

Establishing COMI for Multi-jurisdictional Corporate Groups
In a “foreign main proceeding” under chapter 15,[2] the debtor's registered office is presumed to be its center of main interest (COMI) for the purposes of recognition. The COMI presumption is derived from EC Regulation 1346/2000 on insolvency proceedings and potentially poses an impediment to corporate groups with registered offices in various jurisdictions. The European Court of Justice (ECJ) has interpreted the presumption to require the application of the COMI analysis to each member of a corporate group, thus hindering the possibility of a centralized proceeding.[3] The legislative history of chapter 15 offers U.S. bankruptcy courts little guidance on applying the COMI analysis to corporate groups. However, it does make it clear that the presumption is there for speed and convenience only, and that “the ultimate burden as to each element [of recognition] is on the foreign representative.”[4] Accordingly, lawyers can rebut the presumption and avoid the inefficient, and arguably unintended, debtor-by-debtor approach.[5]

In recent chapter 15 cases, petitioners have demonstrated that the COMI presumption can be refuted by evidence that the debtor's COMI is other than its place of incorporation.[6] In In re Destinator Technologies Inc., et al.,[7] an international group of software development companies petitioned a U.S. bankruptcy court to establish the group's COMI in Canada and have the Canadian proceeding recognized as the foreign main proceeding. Operations were principally directed from a Canadian subsidiary, but programming was based in China and research and development was based in Israel. The group’s intellectual property assets and the parent company were in the U.S. Of the group, the U.S. and Canadian entities went into proceedings under the Companies’ Creditor Arrangement Act (CCAA) in Canada and chapter 15 proceedings in Delaware. Notwithstanding the presence of the U.S. holding company, the Canadian monitor, acting as foreign representative, demonstrated to the court that all decision-making, record-keeping and major administrative functions were conducted from Canada, and therefore that the CCAA proceeding should be recognized as a foreign main proceeding.

Similarly, in In re MAAX Corp., et al., [8] the corporate group manufactured kitchen and bathroom fixtures in the U.S. and Canada. Operating subsidiaries with both factories and employees were located in seven U.S. states. Despite a significant U.S. presence, the primary proceeding for the group, including the U.S. subsidiaries, was the proceeding in Montreal, Quebec, which was recognized as the “foreign main proceeding” by the U.S. Bankruptcy Court for the District of Delaware. The Canadian monitor acting as foreign representative in the chapter 15 was able to prove that the MAAX group’s COMI was in Canada by demonstrating that all senior-level management decision-making, administrative functions and financing decisions took place there.

More recently, in Biltrite Rubber (1984) Inc., et al.,[9] a corporate group in the custom rubber mixing and manufacturing business included two operating companies, a Canadian parent and a U.S subsidiary. The Canadian monitor, acting as foreign representative in the chapter 15, was able to prove to the bankruptcy court that Biltrite was managed and operated on a consolidated basis from Toronto with essentially all of its strategic decision-making and corporate management functions occurring there. The monitor also emphasized that its most significant creditor and senior lender were located in Canada. The U.S. bankruptcy court recognized the Canadian proceedings as foreign main proceedings, notwithstanding that the U.S. facility employs more than 100 people.

In these cases, the foreign representative succeeded in establishing a chapter 15 ancillary proceeding, notwithstanding each group’s significant U.S. presence. By presenting the COMI analysis in a way that reflects how a business is actually managed, U.S. bankruptcy courts can be persuaded to recognize one centralized insolvency proceeding, thereby not only avoiding the risk of competing insolvency proceedings, but also providing a cost-effective and efficient way to replicate chapter 11 protections without the need for more cumbersome and expensive dual plenary proceedings. However, the critical period for the multinational company is often the time between commencement of a chapter 15 and recognition. The next section will demonstrate that chapter 11 protections can be obtained on a provisional basis during this interim period.

Wide Variety of Provisional Relief Available to Foreign Debtors
Critics have cautioned against chapter 15 because of preconceived notions of the range of relief (interim or otherwise) offered, when in fact the substantive relief (with the exception of avoidance actions) of a plenary chapter 11 is also available under chapter 15 at the discretion of a U.S. bankruptcy court.[10] The need for interim relief arises from U.S. due process rules that specify 20 days’ notice to certain parties in interest before a court will consider a motion for recognition. Interim relief is often crucial for the survival of the company during the pendency of the proceedings. Since its inception, many of the key debtor protections of the Bankruptcy Code, including the automatic stay, prohibition on contract termination, debtor-in-possession financing and approval of a sale of assets, have been provisionally applied in chapter 15.[11]

In MAAX, the foreign representative successfully petitioned for the provisional application of §365(e) of the Bankruptcy Code to ensure that U.S. landlords would be prohibited from terminating their leases with the U.S. subsidiaries that were debtors in the Canadian proceeding. Section 365(e) protects a debtor against contract termination that is based solely on its insolvency and is of critical importance to debtors in chapter 11.[12] In Destinator, the U.S. bankruptcy court approved the provisional application of §§363 and 364 of the Code. This allowed for the sale of the company’s assets free and clear of liens, and for needed financing during the interim period. In In re Madill Equipment Canada, the monitor successfully moved for the application of §§61 and 363 on a provisional basis, which allowed for interim use of cash collateral by the foreign debtor during the pendency of its chapter 15 cases.[13] Finally, in Biltrite, the bankruptcy court permitted provisional application of §362 to stay creditors from taking action against the foreign debtors or their property in the U.S.

While U.S. bankruptcy courts have repeatedly granted provisional relief, there is some disagreement as to whether it is necessary to satisfy the standards and procedures applicable to an injunction (making a showing of likelihood of success on the merits and irreparable harm) as required under §1519(e) of the Code. Bankruptcy courts have dispensed with the need for an adversary proceeding, but have, until recently, generally continued to require that parties demonstrate irreparable harm absent such relief. In In re KPMG Inc., Foreign Representative of Redcorp Ventures Ltd. and Redfern Resources Ltd., the court was satisfied with a showing that the relief was needed to protect the assets of the debtor and the interests of creditors without showing irreparable harm.[14] The Redcorp court relied on the arguably cavalier approach to provisional relief of a California bankruptcy court in In re Pro-Fit International Limited.[15] In that case, the court held that the automatic stay was “quite different from an injunction” in that “its purpose is to protect property.” The in rem nature of the stay, as well as its application on an interim basis, led to a finding that the standards in §1519 need not be met.

Provisional relief has not always been so seamlessly obtained, and most courts still require a showing of irreparable harm. In Biltrite, the bankruptcy court concluded that the provisional application of the stay was, in fact, akin to a temporary restraining order. While the court did not require an adversary proceeding, the foreign representative had to make a strong showing of irreparable harm. The court emphasized not only the requirements of §1519(e) but also Congress’s intention not to make the stay automatically applicable upon filing a petition under chapter 15.

Conclusion
The Pro-Fit/Biltrite split provides a useful illustration of the ongoing dialogue between bankruptcy practitioners and the courts. Lawyers will continue to push the boundaries of chapter 15 looking for ways to streamline and simplify the procedures. Chapter 15, although still developing and likely to be tested more in the current environment, has proven to be flexible and efficient. The criticism and concerns based on the seemingly rigid application of the statute should now be allowed to fade.