New York Bankruptcy Court Rules that Good Faith Is Not the Gatekeeper to Chapter 15
Despite the absence of any explicit directive in the Bankruptcy Code, it is well understood that a debtor must file a chapter 11 petition in good faith. The bankruptcy court can dismiss a bad faith filing "for cause," which has commonly been found to exist in cases where the debtor seeks chapter 11 protection as a tactic to gain an advantage in pending litigation. A ruling recently handed down by the U.S. Bankruptcy Court for the Southern District of New York suggests that no such good faith filing requirement applies to a petition seeking recognition under chapter 15 of the Bankruptcy Code of a foreign bankruptcy. In In re Culligan Ltd., 2021 WL 2787926 (Bankr. S.D.N.Y. July 2, 2021), the court granted recognition under chapter 15 to the liquidation proceeding of a Bermuda company despite allegations that the company's court-appointed liquidators filed the chapter 15 petition solely to enjoin shareholder litigation pending in a New York State court. According to the bankruptcy court, although the Bankruptcy Code gives a U.S. court the discretion to deny any chapter 15 relief that is "manifestly contrary" to U.S. public policy, "this exception is not met by a simple finding that the Chapter 15 Petition has been filed as a litigation tactic."
Procedures, Recognition, and Relief Under Chapter 15
Chapter 15 was enacted in 2005 to govern cross-border bankruptcy and insolvency proceedings. It is patterned on the 1997 UNCITRAL Model Law on Cross-Border Insolvency ("Model Law"), which has been enacted in some form by more than 50 countries.
Both chapter 15 and the Model Law are premised upon the principle of international comity, or "the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protection of its laws." Hilton v. Guyot, 159 U.S. 113, 164 (1895). Chapter 15's stated purpose is "to provide effective mechanisms for dealing with cases of cross-border insolvency" with the objective of, among other things, cooperation between U.S. and non-U.S. courts.
Under section 1515 of the Bankruptcy Code, the representative of a foreign debtor may file a petition in a U.S. bankruptcy court seeking "recognition" of a "foreign proceeding." Section 101(24) of the Bankruptcy Code defines "foreign representative" as "a person or body, including a person or body appointed on an interim basis, authorized in a foreign proceeding to administer the reorganization or the liquidation of the debtor's assets or affairs or to act as a representative of such foreign proceeding."
Section 109(a) of the Bankruptcy Code provides that, "[n]otwithstanding any other provision of this section, 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 [the Bankruptcy Code]." In Drawbridge Special Opportunities Fund LP v. Barnet (In re Barnet), 737 F.3d 238 (2d Cir. 2013), the Second Circuit ruled that section 109(a) applies in cases under chapter 15 of the Bankruptcy Code. For purposes of section 109(a), "property in the United States" has been held to include an attorney retainer in a U.S. bank account, causes of action under U.S. law against parties in the United States, and contract rights governed by U.S. law, including U.S. dollar-denominated debt issued under an indenture governed by New York law with a New York choice-of-forum clause. See In re Cell C Proprietary Ltd., 571 B.R. 542 (Bankr. S.D.N.Y. 2017); In re Berau Capital Resources Pte Ltd, 540 B.R. 80 (Bankr. S.D.N.Y. 2015); In re Octaviar Administration Pty Ltd., 511 B.R. 361 (Bankr. S.D.N.Y. 2014).
"Foreign proceeding" is defined in section 101(23) of the Bankruptcy Code as:
[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.
More than one bankruptcy or insolvency proceeding may be pending with respect to the same foreign debtor in different countries. Chapter 15 therefore contemplates recognition in the United States of both a foreign "main" proceeding—a case pending in the country where the debtor's center of main interests ("COMI") is located (see 11 U.S.C. § 1502(4))—and foreign "nonmain" proceedings, which may be pending in countries where the debtor merely has an "establishment" (see 11 U.S.C. § 1502(5)). A debtor's COMI is presumed to be the location of the debtor's registered office, or habitual residence in the case of an individual. See 11 U.S.C. § 1516(c). An "establishment" is defined by section 1502(2) as "any place of operations where the debtor carries out a nontransitory economic activity."
Upon recognition of a foreign "main" proceeding, section 1520(a) of the Bankruptcy Code provides that certain provisions of the Bankruptcy Code automatically come into force, including: (i) the automatic stay preventing creditor collection efforts with respect to the debtor or its U.S. assets (section 362, subject to certain enumerated exceptions); (ii) the right of any entity asserting an interest in the debtor's U.S. assets to "adequate protection" of that interest (section 361); and (iii) restrictions on use, sale, lease, transfer, or encumbrance of the debtor's U.S. assets (sections 363, 549, and 552).
Following recognition of a foreign main or nonmain proceeding, section 1521(a) provides that, to the extent not already in effect, and "where necessary to effectuate the purpose of [chapter 15] and to protect the assets of the debtor or the interests of the creditors," the bankruptcy court may grant "any appropriate relief," including a stay of any action against the debtor or its U.S. assets not covered by the automatic stay, an order suspending the debtor's right to transfer or encumber its U.S. assets, and "any additional relief that may be available to a trustee," with certain exceptions. Under section 1521(b), the court may entrust the distribution of the debtor's U.S. assets to the foreign representative or another person, provided the court is satisfied that the interests of U.S. creditors are "sufficiently protected."
Section 1507(a) of the Bankruptcy Code provides that, upon recognition of a main or nonmain proceeding, the bankruptcy court may provide "additional assistance" to a foreign representative "under [the Bankruptcy Code] or under other laws of the United States." However, the court must consider whether any such assistance, "consistent with principles of comity," will reasonably ensure that: (i) all stakeholders are treated fairly; (ii) U.S. creditors are not prejudiced or inconvenienced by asserting their claims in the foreign proceeding; (iii) the debtor's assets are not preferentially or fraudulently transferred; (iv) proceeds of the debtor's assets are distributed substantially in accordance with the order prescribed by the Bankruptcy Code; and (v) if appropriate, an individual foreign debtor is given the opportunity for a fresh start. See 11 U.S.C. § 1507(b).
Section 1522(a) provides that the bankruptcy court may exercise its discretion to order the relief authorized by sections 1519 and 1521 upon the commencement of a case or recognition of a foreign proceeding "only if the interests of the creditors and other interested entities, including the debtor, are sufficiently protected."
Finally, section 1506 sets forth a public policy exception to the relief otherwise authorized in chapter 15, providing that "[n]othing in this chapter prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States." However, section 1506 requires a "narrow reading" and "does not create an exception for any action under Chapter 15 that may conflict with public policy, but only an action that is 'manifestly contrary.'" In re Fairfield Sentry Ltd., 714 F.3d 127, 139 (2d Cir. 2013).
Culligan
Culligan Ltd. ("debtor") was a Bermuda-incorporated holding company for direct and indirect subsidiaries that distributed water purification and filtration units through franchise dealers located exclusively in North America.
In a 2006 restructuring, the debtor borrowed $850 million to refinance existing debt, repay $200 million to an investor, and pay a $375 million dividend to shareholders. The debtor restructured again in early 2012.
In May 2012, certain of the debtor's minority shareholders, consisting of 71 of the 262 Culligan water dealers (collectively, "plaintiffs"), commenced a derivative action ("NY litigation") against the debtor's directors, its controlling shareholders, and certain other defendants in New York State court. The action alleged that the consolidated Culligan System entities, including the debtor, violated New York law in assuming debt and paying shareholders and investors as part of the 2006 restructuring because they had insufficient capital.
The state court dismissed the complaint in in March 2013, ruling that Bermuda law, rather than New York law, applied. The plaintiffs appealed.
On April 29, 2013, the debtor's majority shareholders authorized it to commence a members' voluntary liquidation ("MVL") under the Bermuda Companies Act of 1981. That same day, the Bermuda court appointed joint liquidators for the debtor for the purpose of winding up the company. The liquidators notified the plaintiffs of the filing and expressed their view that the NY litigation should not proceed because they had assumed control of the debtor.
The plaintiffs refused and in 2014 obtained a reversal on appeal of the state court's dismissal ruling. However, during the ensuing six years, the state court dismissed no fewer than four amended complaints on various grounds. Its decision on a motion to dismiss a fifth amended complaint was pending as of July 2021.
In June 2017, one of the debtor's affiliates paid it $11.67 million in connection with the winding-up proceeding, bringing the debtor's total cash holdings to $11.87 million. The liquidators accordingly determined that a distribution should be made to shareholders under the MVL in the amount of approximately $11.34 million. After reserving $500,000 to pay liquidation fees and expenses, as well as fees related to the NY litigation, they distributed $11.1 million to the debtor's shareholders, nearly $400,000 of which they disbursed to 56 of the 71 plaintiffs.
As of June 2019, the debtor had approximately $240,000 remaining in payment obligations to multiple shareholders, including nearly $38,000 to the 15 remaining plaintiffs, and had $288,000 in cash. However, due to expected liabilities arising from anticipated fees in the NY litigation, the liquidators determined that the debtor had become insolvent. In July 2019, they accordingly petitioned the Bermuda court to convert the MVL to a court-supervised liquidation. The court granted that relief and confirmed the liquidators in that role for purposes of the liquidation.
In June 2020, the liquidators sought an order from the Bermuda court restraining the plaintiffs from suing the debtor or commencing litigation in its name anywhere in the world. That proceeding was suspended, however, after the liquidators, as the debtor's foreign representatives, filed a chapter 15 petition in the U.S. Bankruptcy Court for the Southern District of New York on September 17, 2020, seeking recognition of the debtor's Bermuda liquidation as a "foreign main proceeding." They also sought an order confirming that the automatic stay precluded continuation of the NY litigation, due to the risk that the suit "may further deplete the dwindling assets of the Debtor and frustrate the Bermuda Liquidation."
The plaintiffs opposed the recognition petition, arguing that: (i) the foreign representatives were forum shopping and commenced the case to enjoin the NY litigation and thereby circumvent the adverse rulings of the state court; and (ii) the foreign representatives filed the chapter 15 petition in bad faith and for the improper purpose of barring the plaintiffs from prosecuting the NY litigation by application of the automatic stay. According to the plaintiffs, the foreign representatives' bad faith was evidenced by the facts that the debtor was merely a nominal defendant in the NY litigation, it would not incur any liability, and its litigation costs were covered by insurance. They also asserted that the foreign representatives were not seeking a stay to provide breathing room to conduct good faith liquidation efforts but, rather, improperly seeking chapter 15 recognition and application of the stay to permanently enjoin—as distinguished from merely to pause—the NY litigation.
The Bankruptcy Court's Ruling
Eligibility for Chapter 15 Relief. First, U.S. Bankruptcy Judge James L. Garrity, Jr. found that the debtor was eligible for relief under chapter 15 even though it did not have a domicile or place of business in the United States because the debtor had an interest in funds deposited with its U.S. lawyers as a retainer in a client trust account in New York.
Next, Judge Garrity concluded that the liquidators qualified as foreign representatives of the debtor in accordance with section 101(24) of the Bankruptcy Code. He also determined that the debtor and the petition for recognition satisfied all of the remaining eligibility requirements for relief under chapter 15.
Judge Garrity then considered whether the debtor's COMI was located in Bermuda—a prerequisite for finding that the Bermuda liquidation could be recognized as a "foreign main proceeding." He concluded that the relevant date for determining the debtor's COMI was the date the liquidators were initially appointed by the Bermuda court—in 2013—and that the debtor's activities prior to that date had no bearing on the determination. Judge Garrity found that, both in 2013 and on the chapter 15 petition date in 2020, the debtor's COMI was in Bermuda, where it was incorporated and headquartered; most of its cash was on deposit; the debtor's shareholders voted to commence the MVL; and the liquidators resided and were overseeing all liquidation activities, which were governed by Bermuda law. According to Judge Garrity, the contingent and disputed litigation claims asserted in the NY litigation did not support a finding that the debtor's COMI was in New York, even though the state court had determined that New York law governed the dispute and much of the documentary evidence was located in New York.
Alleged Bad Faith Did Not Preclude Recognition. Judge Garrity also ruled that the narrow and rarely invoked public policy exception in section 1506 did not warrant denial of chapter 15 recognition. He wrote that "courts have generally found that section 1506 does not prohibit recognition in situations where the debtor has engaged in bad faith." Culligan, 2021 WL 2787926 , at *15 (citing In re Manley Toys Ltd., 580 B.R. 632, 648 (Bankr. D.N.J. 2018), aff'd, 597 B.R. 578 (D.N.J. 2019); In re Creative Fin. Ltd., 543 B.R. 498, 515 (Bankr. S.D.N.Y. 2016)). Instead, Judge Garrity explained, the question under section 1506 is not whether the debtor's actions violate public policy, but whether the foreign court's procedures and safeguards fail to comport with U.S. public policy.
Judge Garrity acknowledged that there was evidence to show that the foreign representatives filed the chapter 15 petition as part of their "litigation strategy" to bring an end to the NY litigation and that "the admitted, and apparently entire, purpose of the present chapter 15 filing" was to prevent the plaintiffs from continuing the lawsuit. Id. at *15. However, he faulted the plaintiffs' reliance on case law finding bad faith as "cause" for dismissing chapter 11 cases under section 1112(b) of the Bankruptcy Code. Unlike in chapter 11, Judge Garrity reiterated, recognition under chapter 15 is subject to the public policy exception of section 1506, which considers not whether the actions of the debtor violate public policy, but whether the foreign court's procedures and safeguards fail to comport with U.S. public policy. In the absence of any such allegations, Judge Garrity held that the alleged bad faith was not a basis to deny chapter 15 recognition.
Judge Garrity accordingly granted the petition for recognition of the Bermuda liquidation proceeding under chapter 15 as a foreign main proceeding. In so ruling, he declined to address whether the foreign representatives were entitled to supplementary injunctive relief under section 1521 (in addition to the automatic stay arising upon recognition under section 1520(a)) and stated that any request by the plaintiffs for relief from the automatic stay to continue the NY litigation was premature because it was not procedurally proper.
Outlook
Culligan highlights important distinctions between cases under chapter 11 and chapter 15 of the Bankruptcy Code. Good faith acts as a gatekeeper to chapter 11 because access to chapter 11 is premised on the legitimacy of the debtor's need to reorganize or effect an orderly liquidation in response to genuine financial distress. Thus, the good faith inquiry focuses on the debtor's motives for seeking chapter 11 protection. And, as articulated in In re National Rifle Association of America, 628 B.R. 262 (Bankr. N.D. Tex. 2021), a chapter 11 case filed to gain an unfair advantage in litigation or avoid a regulatory scheme generally will be dismissed because the bankruptcy was not commenced in good faith.
By contrast, the public policy exception in chapter 15 focuses on the foreign country's insolvency process, rather than the debtor or its conduct. Chapter 15 was designed to provide a mechanism for U.S. bankruptcy courts to assist foreign tribunals and functionaries in the process of overseeing a foreign debtor's bankruptcy or insolvency. Provided the foreign bankruptcy or insolvency process roughly comports with U.S. public policy, the foreign debtor's (or foreign representative's) intent behind seeking recognition through chapter 15 is largely irrelevant.
