The Failing Quest for Gold & Honey - New Barriers to Recognition under Chapter 15 and an Impasse for Foreign Receivers

On Aug. 21, 2009, the U.S. Bankruptcy Court for the Eastern District of New York issued a memorandum opinion in In re Gold and Honey, Ltd.[1]denying recognition of petitions filed by receivers appointed by the Tel-Aviv-Jaffa District Court for the State of Israel. The court found that the receivers failed to meet their burden in showing that the Israeli receivership proceeding was a “foreign proceeding” within the Bankruptcy Code’s definition. In addition, the court concluded that granting recognition would be manifestly contrary to the public policy of the United States. The ruling is of broad instructive value on the process of recognition under chapter 15 of the U.S. Bankruptcy Code, and further refines the existing body of jurisprudence regarding transnational insolvency law.

Background of In re Gold & Honey
Debtor Almond Jewelers is a New York-based designer, manufacturer and marketer of jewelry made from gold and other precious metals. Having encountered various manufacturing difficulties in the United States, Almond moved its manufacturing facility to Israel, where it could enjoy substantial government financial incentives to build factories for mass production of metal components. Debtor GH LP is a New York limited partnership through which operations in Israel began. Debtor GH Ltd. is an Israeli corporation with 49.5 percent ownership of GH LP, and the recipient of funds provided to the debtors by the Israeli government. First International Bank of Israel (FIBI) is a prepetition lender to GH Ltd. that extended credit based on guarantees by GH LP.

In late July 2008, after increasing its secured working-capital credit line, FIBI seized substantially all of GH Ltd. and GH LP’s assets and accounts, and commenced the Israeli receivership proceeding. On Sept. 23, 2008, the debtors filed chapter 11 cases that were jointly administered in New York. Notwithstanding the filing of the chapter 11 petitions and the corresponding automatic stay, FIBI continued its application for temporary receivers before the Israeli court. Over FIBI’s objection at an expedited hearing, the court determined that the automatic stay did apply to the debtor’s property wherever located and by whomever held, and issued a stay order to the same effect.

The Israeli court found that GH Ltd. and GH LP had failed to properly register the stay order in the receivership proceeding and declined to respect imposition of the automatic stay. Thus, on Nov. 30, 2008, the Israeli court appointed an Israeli attorney for FIBI and an accountant as permanent receivers for GH LP and GH Ltd. On Jan. 28, 2009, the receivers filed petitions seeking recognition of the Israeli receivership proceedings as foreign main proceedings of GH LP and GH Ltd. under chapter 15.

Denial of the Israeli Receivers’ Petitions for Recognition
In rendering his decision on the merits, Hon. Alan Trust was careful to acknowledge that “[r]ecognition…is not a ‘rubber stamp exercise,’” and that the court is free to “consider any and all relevant facts,” with the ultimate burden of proof on the foreign representative.[2] Noting that §§1517(a)(1) and 1502 require that the foreign proceeding for which recognition is sought must be a foreign main or foreign non-main proceeding, Judge Trust called to the Code’s statutory definition of “foreign proceeding.” Paraphrasing the text of §101(23), Judge Trust explained:

The term “foreign proceeding” means a collective judicial or administrative proceeding in a foreign country, including an interim proceeding, under a law relating to insolvency or adjustment of debt in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganization or liquidation.[3]

Judge Trust was satisfied with the receivers’ showing on all but two elements of the definition. The court first found that the Israeli receivership did not qualify as a proceeding that was “collective in nature.” Relying on In re Betcorp, Judge Trust iterated that “a proceeding that is ‘collective in nature’ is one that ‘considers the rights and obligations of all creditors.’”[4] In Betcorp, the court held that a voluntary Australian wind-up proceeding was collective in nature because attempts by creditors to undermine the orderly process was outlawed. For Judge Trust, dicta within the Betcorp decision carried particular import: “[The Australian wind-up] is in contrast, for example, to a receivership remedy instigated at the request, and for the benefit of, a single secured creditor.”[5] Since the Israeli receivership was primarily designed to allow FIBI to collect its debts, Judge Trust found that it did not comport with the Code’s understanding of a proceeding that is “collective in nature.”

Second, Judge Trust found that the Israeli receivership did not involve the “assets and affairs” of GH LP. Emphasizing the conjunctive nature of the statutory phrase, Judge Trust explained that “a debtor’s assets and affairs must be subject to the jurisdiction of a foreign court.”[6] Although the receivers proved that all of GH LP’s assets in Israel were under the control of the Israeli court, they failed to carry their burden of showing that its affairs were subject to that court’s jurisdiction.

Specifically, the receivers adduced no proof that they had been given authority over GH LP’s business affairs; moreover, FIBI itself had conceded that the receivers were never vested with such authority by the Israeli court.

For the two aforementioned reasons, Judge Trust held that the Israeli receivership did not fit the Bankruptcy Code’s definition of “foreign proceeding.” Accordingly, the action pending in Israel was disqualified from designation as a foreign main or non-main proceeding for the purposes of recognition under chapter 15.

Judge Trust looked to the dictates of public policy that are codified in chapter 15 as additional grounds for denying the receivers’ petitions for recognition. Echoing the language of §1506,[7] Judge Trust found that “[r]ecognition of the Israeli receivership proceeding as a foreign proceeding would be manifestly contrary to the public policy of the United States because such recognition would reward and legitimize FIBI’s violation of both the automatic stay and this Court’s Orders regarding the stay.”[8] Since the Israeli receivers were appointed in violation of the automatic stay, the court refused to legitimize the action and struck it down as void.

Among the other “serious ramifications” of granting recognition to the Israeli petitioners, the court predicted that condoning FIBI’s conduct regarding the stay “would limit a federal court’s jurisdiction over all of the debtors’ property…as any future creditor could follow FIBI’s lead and violate the stay in order to procure assets that were outside the United States, yet still under the United States court’s jurisdiction.”[9]

Significance of the Gold & Honey Decision
The Gold & Honey decision provides useful guidance on the meaning of “foreign proceeding,” which is a term relevant not only to applications under chapter 15, but also to applications under other versions of the Model Law enacted by other nations. Judge Trust’s analysis illustrates the elemental nature of the definition contained in §101(23) and the necessity of a foreign petitioner’s attention to each component part. On the issue of collective action, Gold & Honey establishes a rule, lifted from dicta in Betcorp, that foreign receiverships benefitting a single creditor may not be recognized as foreign proceedings under chapter 15.

Furthermore, Gold & Honey demonstrates that the public policy mandate of §1506 is neither meek nor hollow. For Judge Trust and jurists bound to follow, §1506 is a powerful tool by which the tenets of American bankruptcy law will be upheld beyond the borders of the United States.