Ch. 6 The Role of Comity

1. Practice Tip: In addition to traditional comity analysis, Congress has codified a “recognition” procedure under the bankruptcy law, therefore Section 304 of the U.S. Bankruptcy Code no longer exists and has been replaced by a new regime called “Chapter 15”.
2. U.S. courts customarily decline to adjudicate creditor claims that are the subject of a non-U.S. bankruptcy proceeding.
   1. As a general rule, cross-border bankruptcy proceedings present exceptional circumstances and are afforded special deference due to the unique interest in the orderly and equitable distribution of debtor-assets. Royal and Sun Alliance Ins. Co. of Canada v. Century Int’l Arms, Inc., 466 F.3d 88, 92 (2d Cir. 2006).
   2. Moreover, “[s]ince ‘[t]he equitable and orderly distribution of a debtor’s property requires assembling all claims against the limited assets in a single proceeding,’ American courts regularly defer to such actions.” Finanz AG Zurich v. Banco Economico S.A., 192 F.3d 240, 246 (2d Cir. 1999) (quoting Victrix S.S. Co., S.A. v. Salen Dry Cargo A.B., 825 F.2d 709, 713-14 (2d Cir. 1987)).
      1. Practice Tip: In such cases, deference to the foreign court is appropriate so long as the foreign proceedings are procedurally fair and do not contravene the laws or public policy of the U.S.
3. Three recent decisions have greatly enhanced the growing body of law addressing the relationship between the U.S. and non-U.S. legal regimes². Note, that these cases were decided under the recognition rules of section 304, which recently were changed with the implementation of Chapter 15.
   1. The Second Circuit, in exercise of comity and procedural fairness, issued its ruling averring that it will stay a U.S. lawsuit if it is contrary to foreign law and principles and permit the lawsuit if it is supported by that law and principles. Compañia Embotelladora del Pacifico, S.A. v. Pepsi Cola Company, 114 Fed. Appx. 423 (2d Cir. 2004).
      1. Practice Tip: Assertion of non-U.S. law may lead to dismissal of U.S. proceedings. In the above Pepsi case, the District Court dismissed the plaintiff’s case based on the Court’s determinations of Peruvian law, which was premised upon defendant’s motions coupled with affidavits of Peruvian law and rulings of administrative bankruptcy tribunals in Peru as well as a hearing to determine Peruvian law.
      2. As a practical point, the defendant in Pepsi, was able to demonstrate to the Court that the plaintiff was not authorized to bring the action in the U.S. since a Special Creditors Committee in Peru had disapproved of the lawsuit’s continuation. By invoking Fed. R. Civ. P. 44.1 (which permits matters of foreign law to be adjudicated as questions of law based even on otherwise inadmissible hearsay), defendant avoided the conventional strictures of a motion to dismiss under Fed. R. Civ. P. 12(b)(6).
      3. Consequently, a similarly situated litigant, should be able to obtain a determination of the non-U.S. law issues on a pre-discovery motion to dismiss, rather than having to go through extensive and costly discovery before a motion for summary judgment is ripe in a U.S. court.
      4. On appeal, while the Second Circuit disagreed with the District Court’s legal determination, it fully supported the practical approach defendant had urged. Following the precedent set forth in Finanz A.G. Zurich v. Banco Economico S.A., 192 F.3d 240, 246 (2d Cir. 1999), the Second Circuit gave comity to the proceedings in Peru, requiring plaintiff first to obtain a determination whether in fact the lawsuit was authorized, staying all U.S. proceedings in the interim, and directing dismissal of the U.S. action if the authorization is not obtained.
      5. On a tangential issue—whether a partial assignment of plaintiff’s claims was valid—the Court of Appeals similarly expressed its willingness to defer to Peruvian courts on the subject of validity.
      6. Practice Tip: In the above litigation there were no U.S. federal rights at stake in the matters presented for determination. There was, however, the specter of abuse by a non-U.S. company coming to the U.S. without authority and pursuing major litigation against a U.S. entity.
   2. The Multicanal cases: two decisions which together extend a line of Bankruptcy Court decisions approving non-U.S. restructurings notwithstanding their ever-increasing deviations from the U.S. creditor protections that bondholders might be said to have bargained for when they loaned money to an issuer outside the U.S.. Public policy concerns lurked behind the court’s analysis.
      1. Practice Tip: The post-trial decision also, however, shows how a prejudiced minority group of U.S. creditors might get a U.S. court to draw the line between permissible and impermissible foreign restructuring regimes, for the decision withholds recognition in the face of clear and unexplained discrimination against a subset of U.S. creditors (retail investors). That decision also signals a warning to non-U.S. issuers against utilizing threats and intimidation tactics against U.S. creditors to secure their majorities.
      2. Multicanal turned to the U.S. Bankruptcy Court for “recognition” of its Argentine restructuring mechanism, know as “Acuerdo Preventivo Extrajudicial” or “APE”. The mechanism was largely untested.
      3. The Court interpreted § 304 and the prior case law as entailing a narrower scope of review than that urged by the objecting creditors. The Court stated that its primary function was to determine the most “economical and expeditious administration of the estate” – not whether U.S. bondholders’ reasonable expectations were being frustrated by Multicanal’s post-hoc refusal to accord creditors the protections it promised when it borrowed the money.
      4. Finding “comity” to the Argentine regime to be an overriding factor, the Court believed that it was sufficient that, in satisfying the § 304 factors, certain aspects of the APE were, in the Court’s view, similar to U.S. pre-packaged bankruptcies.
      5. The Court found it important that many creditors voted in favor of the APE, although the Court acknowledged that there were voting irregularities in the APE (irregularities that would not have been tolerated in a U.S. proceeding).
      6. Even the Court’s finding that there was indeed disparity in the procedures for obtaining “yes” and “no” votes was insufficient to withhold recognition. The court noted, “the question here is not whether the APE should be confirmed as a U.S. Chapter 11 plan, but whether it is entitled to recognition under § 304 and fundamental principles of due process”.
      7. Despite the foregoing, the Bankruptcy Court nonetheless agreed with defendant’s arguments and withheld § 304 “recognition” on two grounds: (i) it agreed with the presented proof that Multicanal discriminated against U.S. retail creditors, who were not able to exercise the vote that other creditors were and were being forced to accept a type of consideration (cash) that the Court found was worth substantially less than the other consideration (new notes and equity); and, (ii) the Court reacted to the fact that, in Argentina, Multicanal had caused criminal accusations to be initiated against individual employees of our client – which we showed to be rank efforts to intimidate a vocal dissenting U.S. creditor.
      8. The Court gave no weight to the incredible testimony of the Multicanal director who portrayed the incident as one he pursued in his personal capacity rather than as a director and officer of Multicanal. The Court has required Multicanal to prove the “substantial justification” for its conduct and is withholding § 304 recognition absent such a showing.
      9. Distilling several decisions in the case, the Court made at least four comity-dependent rulings: (i) On the basis of comity, it affirmed a prior ruling of the federal bankruptcy court that rejected the investors’ claim that the law governing their investments, because protected by a specific federal law (the Trust Indenture Act), should not be subject to the same deferential attitude as courts have expressed with respect to claims that are not based on specific federal law; (ii) On the basis of comity, it rejected the investors’ claim that the voting irregularities that they proved to have existed in the Argentine proceeding should give rise to a revote before the U.S. recognized the Argentine approval; but (iii) the Court was unwilling to grant comity unless the prejudicial discrimination of U.S. retail investors proved to have occurred in the economics of the deal was eliminated; and (iv) the Court was unwilling to accord comity unless and until the company proved that its restructuring proposal complied with the U.S. securities laws.
   3. Creditors are entitled to an Article III Court, rather than a bankruptcy court, to decide the issues of the prioritization or interplay between both the Federal tender offer rules and the TIA on the one hand and § 304 (granting “comity” to non-U.S. restructuring proceedings) on the other. SHL v. Cablevision, 04-CV-6720 (S.D.N.Y. 2004).
      1. The grounds for withdrawal arose under the mandatory and permissive withdrawal statute, 28 U.S.C. § 157(d), which provides: “The district court shall on timely motion of a party, so withdraw a proceeding if the court determines that resolution of the proceeding requires consideration of both title 11 and other laws of the United states regulating organizations or activities affecting interstate commerce.”
      2. Under settled principles, withdrawal is mandatory under § 157(d) in cases “where substantial and material consideration of non-Bankruptcy Code federal statutes is necessary for the resolution of the proceeding.” In re Ionosphere Clubs, Inc., 922 F.2d 984, 995 (2d Cir. 1990). Withdrawal is also mandatory where matters to be decided “require the bankruptcy court to substantially interpret federal statutes which affect interstate commerce.” City of New York v. Exxon Corp., 932 F.2d 1020, 1026 (2d Cir. 1991).
      3. Practice Tip: The Court in Cablevision reasoned that a federal issue was at stake because the creditors claimed that the foreign restructuring violated the federal tender offer rules and the federal Trust Indenture Act (“TIA”). Unlike the decision in Multicanal, where the Bankruptcy Court determined as a matter of law that no conflict existed, the District Court in Cablevision ruled: “The very existence of a dispute as to whether the rights of [the creditor] under the TIA and Williams Act supersedes § 304 or whether the Bankruptcy Code overrides the TIA, regardless of the ultimate resolution of such dispute, mandates withdrawal.” 2004 WL 2274793 at * 3 (S.D.N.Y. Oct. 6, 2004).
      4. Practice Tip: Prior to the decision in Cablevision, a § 304 case has never been withdrawn from the bankruptcy court. In the context of this discussion of comity, the question is whether Multicanal and Cablevision are reconcilable. Multicanal, as a matter of law, held that the existence of U.S. federal rights did not change the analysis under § 304 at all. Cablevision, on the other hand, felt the need to determine the prioritization of the TIA or the federal tender offer rules and § 304.
   4. Comments on the Trilogy of Recent Cases.
      1. These three recent cases give some indication of how courts are considering the issue of deference or comity to non-U.S. “proceedings”, in particular non-U.S. restructurings.
      2. Multicanal is based on a reading of § 304 that gives no additional weight to the federal rights embodied in the federal TIA and requires U.S. recognition of a non-U.S. restructuring providing far fewer substantive and procedural creditor protections than a U.S. company would have to provide. Yet the decision also stands for the propositions that there are limits to what a non-U.S. company can do and that there remain some protections that U.S. creditors can insist on.
      3. Cablevision determined that the issue of priority between the federal TIA and tender offer rules on the one hand and the comity inherent in § 304 on the other do in fact present significant and unanswered questions of federal law.
      4. As the law develops further, important policy questions will have to be answered. If it is easier for a non-U.S. company having issued U.S. debt to U.S. creditors to restructure its obligations by using non-U.S. regimes, and if U.S. creditors cannot rely on the promises made in the indentures and notes issued by non-U.S. companies, the market for U.S. securities issued by companies based outside the U.S. will undoubtedly be affected.

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2 Proskauer Rose LLP represented the defendants/respondents in the three recent cases discussed in this section. The decisions address significant issues of first impression of particular importance to domestic as well as international business transactions.