British Virgin Islands: Application Of Chapter 15 Of The US Bankruptcy Code To Non-US Insolvency Proceedings

Two recent US cases in New York have provided some useful insights into the treatment by the US Courts in New York of applications made under Chapter 15 of the US Bankruptcy Code for non-US insolvency proceedings to be treated by the US Courts as the main proceedings for the liquidation of non-US entities.

By way of background, Chapter 15 of the US Bankruptcy Code enables a liquidator of non-US insolvency proceedings to make an application to the US Courts for recognition of those non-US insolvency proceedings as the main proceedings for the liquidation of non-US entities. In such instances, Chapter 15 recognition will be granted where the liquidator can demonstrate that the proceedings are being pursued in the jurisdiction which represents the "centre of main interest" of that entity.

Within Chapter 15, there is a positive presumption that the "centre of main interest" is the jurisdiction in which the entity's registered office is located (i.e. for an offshore company, the jurisdiction of that company's registered office). However, the recent US cases of SPhinX, Ltd et al (2006) and Bear Stearns High-Grade Structured Credit Strategies Master Fund (in Provisional Liquidation) (2007) have provided an indication of the considerations made by the US Courts when presented with an application for Chapter 15 recognition.

The significance of Chapter 15 recognition is that, once granted, the US Courts will treat the non-US insolvency proceedings as the "foreign main proceedings" of the liquidation, the practical effect of this being to stay all actions brought in the United States in relation to the assets of the entity in liquidation, so guaranteeing the liquidator the co-operation of the US Courts and avoiding competing actions across international borders. Consequently, Chapter 15 recognition serves to protect the interests of the entity in liquidation and its liquidator, as well as its creditors and members, by enabling the liquidator to wind-up the entity quickly and efficiently by avoiding full blown Chapter 11 proceedings in the United States. As Chapter 11 is a restructuring and reorganisation procedure, there are significant additional cost implications associated with entering into Chapter 11.

Where the US Courts are unwilling to recognise the non-US proceedings as "foreign main proceedings" (i.e. where the US Courts determine that the non-US jurisdiction is not the "centre of main interest"), it is still open to the US Courts to give partial recognition to the non-US proceedings and to grant certain relief, such as partial stays of US actions, increased discovery powers for the liquidator with respect to US based assets and rights of audience for the liquidator to participate in the US insolvency proceedings.

The implication Chapter 15 recognition not being granted is that the non-US insolvency proceedings would need to run in parallel with the US insolvency proceedings.

The first case, SPhinX, Ltd et al (2006), which involved a Cayman Islands domiciled fund pursuing a global equities strategy (and so whose assets were scattered across the world in various brokerage and custody accounts), the investment manager of the fund was domiciled in Delaware, the administrator was based in New Jersey and all of its directors were based in the United States. As a consequence, the only aspect which tied SPhinX to the Cayman Islands was that its registered office was located in the Cayman Islands. Therefore, prima facie, the positive presumption in Chapter 15 that the jurisdiction of the registered office is the determinate for its "centre of main interest" would seem to have favored Chapter 15 recognition being granted.

Accordingly, the liquidator of SPhinX applied to the US Courts for Chapter 15 recognition (and seemingly, significantly, none of the creditors or members, the majority of whom were based in Europe, objected to this application being made).

However, Refco objected to this application. Their interest in the application by the liquidator of SPhinX for Chapter 15 recognition being on the basis that Refco had previously entered into a settlement agreement with SPhinX in relation to some US proceedings and, had the US Court granted Chapter 15 recognition, one of the implications of Chapter 15 recognition being granted would have been that the consequent automatic stay would have frustrated the Refco settlement.

In considering the Chapter 15 recognition application, the US Court determined that, but for the Refco settlement agreement and the effect which Chapter 15 recognition would have had on it, it would have accepted the positive presumption of the Cayman Islands as the "centre of main interest", notwithstanding that no other activity, aside from it being the location of SPhinX's registered office, took place there.

However, the more recent case of Bear Stearns High-Grade Structured Credit Strategies Master Fund (in Provisional Liquidation) (2007) has had an important impact upon the likely interpretation of the US Courts to the positive presumption in Chapter 15 about the centre of main interest being the jurisdiction in which its registered office is located.

In Bear Stearns High-Grade Structured Credit Strategies Master Fund (in Provisional Liquidation) (2007), the facts were very similar to those in SPhinX et al (2006), with exception that the Bear Stearns entity did have directors based outside the United States (some of its directors were based in the Cayman Islands) and therefore, prima facie, it appeared to have an even greater nexus to the Cayman Islands as a result.

However, the US Court determined there that even in the absence of any objection by investors or creditors to the application for Chapter 15 recognition, it was duty bound to consider the facts and circumstances to determine whether the evidence indicated that the "centre of main interest" was located somewhere other than the Cayman Islands.

Upon review of the location of the day to day activities of the entity, such as the provision of investment management and administration services to the fund and the maintenance of the fund's statutory records, the US Court concluded that there was no "establishment" in the Cayman Islands for the conduct of "non-transitory economic activity" (as defined in the US Bankruptcy Code) and, as a consequence, the US Court, in express contradiction of the comments made in SPhinX et al (2006), determined that there was no nexus to the Cayman Islands and that, therefore, the "centre of main interest" was not in the Cayman Islands, such that Chapter 15 recognition could not be granted.

This decision in Bear Stearns High-Grade Structured Credit Strategies Master Fund (in Provisional Liquidation) (2007) was recently unsuccessfully appealed and therefore this decision provides fairly good authority as to the likely stance taken by the US Courts in New York when considering applications for Chapter 15 recognition.

As well as providing useful guidance as to the likely stance taken by the US Courts in New York when considering an application for Chapter 15 recognition, the case law in SPhinX, Ltd et al (2006) and Bear Stearns High-Grade Structured Credit Strategies Master Fund (in Provisional Liquidation) (2007) also provides important structuring considerations which can be utilised by hedge fund managers when considering where to locate the service providers for new funds, which may be significant if a substantial number of the likely investors and creditors are not going to be US based.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.