Disagreeing with the Sixth Circuit, the First Circuit Bankruptcy Appellate Panel and several lower courts, Bankruptcy Judge Christopher S. Sontchi of Delaware applied the law of Singapore — not federal common law — to decide whether an offshore real estate investment trust was a “business trust” eligible for chapter 11.
In his June 1 opinion, Judge Sontchi based his conclusion on “the bedrock principle of Butner v. U.S. that bankruptcy judges should not unsettle non-bankruptcy rights in the absence of a clear directive from Congress.”
Judge Sontchi’s decision to reject federal common law is consistent with — if not mandated by — an opinion last year from the U.S. Supreme Court.
The Singapore REITs
Three real estate investment trusts organized under the laws of Singapore filed chapter 11 petitions in Delaware. One was the ultimate parent, and the other two were intermediate holding companies. Downstream, the REITs owned hotels in the U.S.
The highly complex corporate structure was designed so the ultimate non-U.S. equity holders would not be subject to U.S. withholding taxes. As a result, the REITs themselves had no employees and no operations of their own. Indeed, non-debtor managers made decisions for the REITs. However, the REITs were liable for substantial debts related to the hotels.
The largest creditor filed a motion asking Judge Sontchi to dismiss the petitions, alleging that the REITs were not business trusts and were thus ineligible to be chapter 11 debtors. Judge Sontchi applied the law of Singapore and concluded that the REITs were business trusts. Finding that the REITs were eligible to be debtors, he denied the motion to dismiss.
Butner Governs
Under Section 109(d), only a “person” may be a chapter 11 debtor. A “person” is defined in Section 101(41) to include a “corporation” which, in turn, is defined in Section 101(9)(A)(v) to include a “business trust.”
Does federal common law or the law of the state of incorporation determine whether an entity is a business trust? Judge Sontchi said there is “a split of authority as to whether the law of the jurisdiction in which the trust resides or federal common law governs.”
Recently, the First Circuit BAP cited the Sixth Circuit approvingly and invoked federal common law. See In re Catholic School Employees Pension Trust, 599 B.R. 634 (B.A.P. 1st Cir. 2019); and Brady-Morris v. Schilling (In re Kenneth Allen Knight Trust), 303 F.3d 671 (6th Cir. 2002).
Judge Sontchi explained that those courts based their conclusions on the uniformity aspect of the Bankruptcy Clause of the Constitution, to foster results that would be uniform throughout the U.S. Those courts created federal common law because, as Judge Sontchi said, “There is no federal [statutory] law that creates business entities.”
Judge Sontchi said he disagreed with “the weight of authority.” The argument about uniformity, he said, “is the exact argument that was rejected by the Supreme Court in” Butner v. U.S., 440 U.S. 48 (1979).
Butner dealt with the ownership of rents following default. Did the rents belong to the lender or to the debtor? State laws differed. In some states, rent would be estate property, and in others, it wouldn’t. The courts that adopted federal common law sought uniformity.
The Supreme Court rejected the quest for uniformity, holding that “[p]roperty interests are created and defined by state law.” Id. at 55. The high court said that employing state law reduces uncertainty.
Similarly, Judge Sontchi said that following the law of the state of incorporation would foster uniformity. Even though results may be different in different states, the definition of a business trust will be uniform “based on the law of the jurisdiction under which the trust exists.” For instance, people “will know when they form a trust in Delaware . . . that Delaware law will uniformly govern whether it is a business trust even if the trust files bankruptcy in California,” he said.
Furthermore, no uniform definition of a business trust has been developed under federal common law. The First Circuit BAP, for example, said there is “no uniform standard . . . to define what constitutes a ‘business trust.’” Catholic School, id., 599 B.R. at 653.
Judge Sontchi added his own take when he said there is “a striking inconsistency between bankruptcy courts on this issue with at least three different legal tests having been developed.”
Judge Sontchi held that “federal common law should not determine whether a trust is a ‘business trust’ under the Bankruptcy Code. Rather, the law of the jurisdiction in which the trust is organized, in this case the Republic of Singapore, shall govern.”
Hearing from experts on Singapore law, Judge Sontchi decided that the REITs were business trusts eligible to be chapter 11 debtors. He also denied the creditor’s motion to dismiss based on arguments that the petitions were bad faith filings. The petitions, he said, were filed in good faith and for a legitimate bankruptcy purpose.
Observations
Judge Sontchi’s conclusion finds support in recent Supreme Court authority, Rodriguez v. F.D.I.C., 140 S. Ct. 713, 206 L. Ed. 2d 62 (Feb. 25, 2020).
In Rodriguez, the high court used a bankruptcy case to limit the use of federal common law. More particularly, the Supreme Court held that federal courts may not employ federal common law to decide who owns a tax refund when a parent holding company files the tax return but a subsidiary generated the losses giving rise to the refund. Rather, state law governs.
The unanimous opinion said that “cases in which federal courts may engage in common lawmaking are few and far between.” Id., 140 S. Ct. at 716.
Almost on point, the Supreme Court said that state law — such as “rules for interpreting contracts, creating equitable trusts, avoiding unjust enrichment” — are “readymade” for deciding an ownership dispute. Id. The opinion went on to say that “only limited areas exist in which federal judges may appropriately craft the rule of decision.” Appropriate areas, the Court said, are in admiralty law and disputes among states. Id. at 717.
Disagreeing with the Sixth Circuit, the First Circuit Bankruptcy Appellate Panel and several lower courts, Bankruptcy Judge Christopher S. Sontchi of Delaware applied the law of Singapore — not federal common law — to decide whether an offshore real estate investment trust was a “business trust” eligible for chapter 11.
In his June 1 opinion, Judge Sontchi based his conclusion on “the bedrock principle of Butner v. U.S. that bankruptcy judges should not unsettle non-bankruptcy rights in the absence of a clear directive from Congress.”
Judge Sontchi’s decision to reject federal common law is consistent with — if not mandated by — an opinion last year from the U.S. Supreme Court.