Blockchain law: Laying down the law for digital assets
Robert Schwinger describes some of the recent developments in the regulation of digital assets built on blockchain technologies.
In 2017, more than eighty-five Chapter 15 cases were filed in more than a dozen different judicial districts. The Southern District of New York was the preferred Chapter 15 venue with fifty-four cases filed there. Delaware and the Southern District of Florida were second, each with nine new Chapter 15 filings. The Chapter 15 cases filed in 2017 were related to foreign proceedings pending in the following countries: Australia, Austria, Azerbaijan, Bermuda, Brazil, the British Virgin Islands, Canada, the Cayman Islands, Chile, Colombia, France, Germany, Indonesia, Italy, the Netherlands, the Republic of Korea, Romania, Russia, and South Africa.
There were several interesting decisions issued in 2017, including some that contrasted with prior rulings. For example, the United States Bankruptcy Court for the Southern District of Florida held that a Brazilian liquidator had standing to pursue fraudulent transfer claims under New York law. This was in contrast to a prior decision of the United States Bankruptcy Court for the Southern District of New York dismissing New York law-based fraudulent transfer claims asserted by English liquidators. See Chapter 15: Pursuing “Avoidance Actions” Under Nonbankruptcy Law, Zone of Insolvency Blog (April 27, 2017). Other decisions in 2017 reinforced prior rulings. As discussed in our Fall 2017 issue, the United States Bankruptcy Court for the Southern District of New York continued to recognize Canadian proceedings and restructuring plans this year. See Chapter 15 Developments: United States Courts Enforce Canadian Restructuring Plans, US Financial Restructuring Newswire at 17 (Fall 2017). In several other cases, New York bankruptcy courts highlighted the ease with which a foreign debtor can satisfy the debtor-eligibility requirements as mandated by the Court of Appeals for the Second Circuit. See In re Cell C Proprietary Limited, 571 B.R. 542 (Bankr. S.D.N.Y. 2017) (noting in a case in which Norton Rose Fulbright represented the foreign representative of a South African proceeding that a foreign entity is eligible to be a debtor if it has property in the US, such as retainer or bank account, or debt that is subject to New York governing law and a New York forum selection clause).
This article focuses on two of the more interesting 2017 decisions from the United States Bankruptcy Court for the Southern District of New York addressing Chapter 15 petitions for recognition of foreign main proceedings. Before discussing the two cases, the article summarizes the standard for recognition of a foreign main proceeding.
Under section 1517(a) of the Bankruptcy Code, a foreign proceeding, such as a foreign insolvency, bankruptcy, liquidation, or debt adjustment proceeding, shall be recognized, if (1) the foreign proceeding is a foreign main or foreign nonmain proceeding, (2) the petition for recognition was filed by a foreign representative, and (3) the petition satisfies certain procedural requirements. If all three criteria are satisfied, the petition for recognition must be granted, unless recognition would be “manifestly contrary” to US public policy.
Upon recognition of a foreign proceeding, a foreign representative, such as a trustee, liquidator, or debtor in possession, will have access to the United States courts and can sue or be sued in the United States. Further, upon recognition of a foreign main proceeding, certain protections arise automatically in favor of the foreign debtor and the foreign representative. In particular, creditors will be enjoined from taking most actions against the foreign debtor or its assets in the US. Recognition of a foreign nonmain proceeding does not have the same automatic effect as recognition of a foreign main proceeding. However, a bankruptcy court may grant the same relief in connection with a foreign nonmain proceeding on a discretionary basis. Thus, the type of foreign proceeding being recognized ultimately may have little consequence beyond timing and procedural issues.
If the foreign proceeding is not a foreign main proceeding or a foreign nonmain proceeding, a court should not grant recognition. A foreign main proceeding is a foreign proceeding pending in the country where the debtor has the center of its main interest or “COMI.” Chapter 15 does not define COMI, but a debtor’s registered office is presumed to be its COMI. In determining a debtor’s COMI, United States courts have considered, among other things: the location of the debtor's headquarters; the location of those who manage the debtor; and the location of the debtor's assets. Several United States courts, including the Court of Appeals for the Second Circuit (whose precedent is binding on New York bankruptcy courts), have concluded that COMI should be determined at the time of the filing of the Chapter 15 petition without regard to the debtor’s operational history. A court may thus consider activities following the commencement of the foreign proceeding, which may result in a shift of a debtor’s COMI from its historical location to another jurisdiction.
In one of the more interesting cases decided this year, the United States Bankruptcy Court for the Southern District of New York was faced with competing foreign insolvency proceedings and competing Chapter 15 cases. Following recognition of a Brazilian proceeding as a foreign main proceeding, certain noteholders initiated a competing proceeding in the Netherlands. The court-appointed Dutch trustee thereafter filed a Chapter 15 petition for recognition of the Dutch proceeding. A debtor, however, may only be subject to one foreign main proceeding at any given time. Accordingly, the bankruptcy court had to choose between granting recognition to the Dutch proceeding and terminating recognition of the Brazilian proceeding, or maintaining the status quo and denying recognition of the Dutch proceeding. As discussed below, the case raised several issues, including the applicable standard to apply when considering recognition of a competing Chapter 15 filing and the significance of creditor motivation.
Oi S.A. and its affiliates form one of the largest groups of telecommunications service providers in Brazil. Facing financial distress, certain members of the Oi Group, including Oi Brasil Holdings Coöperatief U.A., a Dutch subsidiary of Oi S.A., commenced reorganization proceedings in Brazil. Thereafter, the Southern District of New York Bankruptcy Court granted recognition to the Brazilian proceedings of the Oi debtors, including Dutch Oi, as foreign main proceedings, finding that the COMI of each of the debtors was Brazil. Although recognition of the Brazilian proceedings was not opposed, the court expressly found that Brazil was the COMI of Dutch Oi. According to the court, Dutch Oi was a special purpose vehicle created to obtain financing for the Oi Group, and the COMI of a special purpose vehicle, such as Dutch Oi, “turns at a location of the corporate nerve center and the expectation of creditors,” which, in this instance, was Brazil.
Prior to the bankruptcy court’s hearing on the petition for recognition of the Brazilian proceedings, certain US holders of notes issued by Dutch Oi filed involuntary bankruptcy petitions against Dutch Oi in the Netherlands. Following recognition of the Brazilian proceedings, Dutch Oi filed a petition for a “suspension of payments” in the Netherlands that generally resulted in a stay of actions against the debtor. Ultimately, the suspension of payments proceeding was converted to a bankruptcy case and a trustee was appointed.
The Dutch trustee, with support from certain noteholders, filed a petition with the New York bankruptcy court for recognition of the Dutch bankruptcy case as a foreign main proceeding under Chapter 15. A debtor may only have one COMI at any particular time and therefore can only be subject to one foreign main proceeding at a time. Consequently, in deciding whether to grant recognition to Dutch Oi’s Dutch proceeding, the bankruptcy court had to address its prior order granting recognition to Dutch Oi’s Brazilian proceeding.
As a threshold matter, the bankruptcy court needed to determine the standard that governed the petition for recognition of the Dutch proceeding. The Dutch trustee (and supporting noteholders) argued that the bankruptcy court should apply the formulaic approach set forth in section 1517(a). According to the trustee, if the bankruptcy court determined that Dutch Oi’s COMI was the Netherlands as of the date of the new Chapter 15 filing, then the court was required to recognize the Dutch proceeding as a foreign main proceeding and terminate recognition of Dutch Oi’s Brazilian proceeding.
In contrast, Oi argued that the court could recognize the Dutch proceeding only if the court first terminated recognition of the Brazilian proceeding under section 1517(d) of the Bankruptcy Code. Under section 1517(d), a court may terminate or modify a prior recognition order if the grounds for recognition “were fully or partially lacking,” or “have ceased to exist.”
The bankruptcy court agreed with Oi, finding that section 1517(d) “specifically contemplates the question currently before this Court: a request to terminate or modify a prior recognition.” The bankruptcy court noted that, unlike the decision to recognize a foreign proceeding in a typical case, which is governed by section 1517(a), the decision to terminate a prior recognition is discretionary and not mandatory. Moreover, the court noted that two prongs of section 1517(d) required the court to evaluate recognition at different times. The first requires the court to analyze “whether the basis for recognition previously presented to the Court was flawed in some way.” The second prong requires the court to analyze “whether something has changed since recognition.”
The Dutch trustee and supporting noteholders argued that the evidence supported termination of recognition of the Brazilian proceeding under both prongs of section 1517(d). First, the trustee asserted that the basis for recognition of the Brazilian proceeding was flawed. According to the trustee, the bankruptcy court was not aware of certain facts that would have supported a finding of COMI in the Netherlands when it recognized the Brazilian proceeding. In particular, according to the trustee, the bankruptcy court did not know that (1) Dutch Oi’s registered office was in the Netherlands, (2) Dutch Oi’s board had issued resolutions and obtained an opinion letter stating that Dutch Oi’s COMI was in the Netherlands, (3) Dutch Oi fraudulently transferred assets to Brazilian affiliates before commencing the Brazilian proceeding, (4) Dutch Oi was planning on filing a Dutch proceeding during the Brazilian Chapter 15 case, and (5) Dutch Oi engaged in financing and hedging activities beyond its purported special purpose of issuing notes.
The bankruptcy court dismissed each of the trustee’s allegations, finding that evidence refuted the trustee’s position or that the trustee’s assertions were not relevant to the COMI analysis. The bankruptcy court began by noting that Oi previously disclosed and the court was aware of Oi Dutch’s connections to the Netherlands — including that it was incorporated and maintained its registered office in the Netherlands and that its directors, one of whom lived in the Netherlands, met in the Netherlands — when the court recognized the Brazilian proceeding. Moreover, these facts did not support a finding of COMI in the Netherlands.
The bankruptcy court also found that statements made by Oi (and its board) in the Dutch proceeding regarding COMI were not relevant to the bankruptcy court’s determination because the standards under applicable law (i.e., the European Union Convention on Insolvency and/or Dutch law versus US law) were different. For similar reasons, the bankruptcy court concluded that the Dutch court’s determination that Dutch Oi’s COMI was the Netherlands was not entitled to comity, and Oi was not estopped from challenging the assertion that the Netherlands was Dutch Oi’s COMI. Moreover, the fact that Dutch Oi may have fraudulently transferred assets or was planning on filing a Dutch proceeding when the Brazilian proceeding was being recognized was irrelevant to the COMI analysis. The bankruptcy court concluded that the evidence demonstrated that Dutch Oi was a special purpose financing vehicle that did not engage in activities beyond serving the financing needs of the Oi Group. Consequently, the nerve center of Dutch Oi was found to be in Brazil, where the Oi Group conducted its operations and managed Dutch Oi.
Second, the Dutch trustee argued that his appointment was a significant development that would support termination of recognition of the Brazilian proceeding. Specifically, the trustee asserted that his conduct in the Netherlands following recognition of the Brazilian proceeding resulted in a shift of Dutch Oi’s COMI from Brazil to the Netherlands. Consequently, according to the trustee, the Dutch proceeding (and not the Brazilian proceeding) was the foreign main proceeding for Dutch Oi as of the date of the new Chapter 15 filing.
The bankruptcy court acknowledged that the actions of a foreign trustee prior to a Chapter 15 filing can be relevant to the COMI analysis. The activities, however, must be sufficiently significant or material to result in a COMI shift. In this instance, the bankruptcy court concluded that the trustee’s activities in the Netherlands were insufficient to shift Dutch Oi’s COMI “for two reasons: 1) his actions do little to change the economic realities associated with [Dutch Oi’s] status as a special purpose financing vehicle and the related expectations of creditors; and 2) there are significant legal and pragmatic limitations on the [Dutch trustee].” In particular, the trustee had no ability to restructure Dutch Oi. Under Dutch law, the board of Dutch Oi had the exclusive authority to propose a restructuring plan. Moreover, as conceded by the Dutch trustee, it was unlikely that Dutch Oi would restructure its debts separate from the Brazilian proceeding. The court therefore found that the evidence did not reflect that Dutch Oi’s COMI had shifted to the Netherlands after recognition of the Brazilian proceeding and so, the court refrained from terminating the prior recognition.
In denying the Chapter 15 petition for recognition of the Dutch proceeding, the bankruptcy court emphasized that it was troubled by the actions taken by a certain noteholder, describing how the noteholder “weaponized” Chapter 15 by “strategically” not opposing recognition of the Brazilian proceeding and then later initiating (and supporting recognition of) the Dutch proceeding with the ultimate goal of gaining leverage over the Oi Group in the restructuring negotiations. According to the court, the noteholder “kept silent at the Prior Recognition Hearing while pursuing bankruptcy proceedings for [Dutch Oi] in the Netherlands with the intent of overturning this Court’s Prior Recognition Order, and undermining the Brazilian RJ Proceeding.”
The Dutch trustee and the noteholder tried to minimize the import of the noteholder’s actions by stressing that the noteholder acted on its own behalf and did not control the trustee or the debtor. The court acknowledged that the noteholder did not have fiduciary obligations to other creditors, and did not control the debtor or the trustee. Nevertheless, the court concluded that it would consider the noteholder’s actions in determining whether to terminate or modify the prior recognition under section 1517(d) given the noteholder’s “unique and central role in creating the factual record.” The court found the noteholder’s strategy of remaining silent through recognition of the Brazilian proceeding while planning to eventually terminate recognition to thwart the restructuring to be “troubling” and inconsistent with the aims of Chapter 15, including promoting cooperation between US and foreign courts. According to the court, the noteholder’s conduct, including lack of candor with the court, was an independent basis for the court to refrain from terminating recognition of the Brazilian proceeding.
Following the bankruptcy court’s decision, that noteholder released a statement declaring that it had acted “with utmost candor and good faith” and ultimately filed a motion requesting that the bankruptcy court reconsider and vacate that portion of the decision critical of the noteholder. In addition, the noteholder was part of a group of noteholders that appealed the bankruptcy court’s decision. The Dutch trustee also appealed the bankruptcy court’s decision. As of the date of this article, the appeals and the motion for reconsideration have not been decided. It remains unclear what effect, if any, the appeals will have on the Oi Group’s restructuring plan that was approved by creditors in Brazil, including the noteholders that advocated for the recognition of the Dutch proceeding, and the Brazilian court.
In a decision issued prior to Oi, the Southern District of New York Bankruptcy Court was presented with a case involving a COMI shift by a debtor in anticipation of a debt restructuring. There, the court was not troubled by the COMI shift, finding it to be motivated by a “legitimate, good faith purpose.”
Ocean Rig UDW Inc. and certain affiliates form a group that operates as an international offshore oil drilling contractor, owner, and operator. Ocean Rig is a holding company and the parent of three other holding companies, each of which owns non-debtor companies that directly or indirectly own a fleet of deepwater oil drilling rigs. The principal assets of the four debtor holding companies were the equity interests in their subsidiaries. Facing significant payment obligations due in 2017, the four holding companies filed winding-up petitions with the Grand Court of the Cayman Islands on March 24, 2017. Thereafter, the Cayman Islands court appointed joint provisional liquidators to promote “schemes of arrangement” for the debtors.
Many countries, including the United Kingdom and the Cayman Islands, permit a company to restructure its debt under a scheme of arrangement, much like a company can restructure its debts in the US under a plan under Chapter 11 of the Bankruptcy Code. A scheme is generally binding on creditors after it has been approved by the requisite majorities of creditors and sanctioned by the appropriate foreign court. A debtor or its foreign representative will often seek an order enforcing a scheme of arrangement in the US after the related foreign proceeding has been recognized under Chapter 15.
In accordance with their powers, the provisional liquidators filed Chapter 15 petitions for recognition of the Cayman Islands proceedings with the New York bankruptcy court. A purported shareholder of Ocean Rig objected to recognition, arguing that the debtors’ COMI was not the Cayman Islands. The court found that the shareholder failed to demonstrate she had standing to contest recognition. Nevertheless, the court concluded that it would address the merits of the shareholder’s objection because the court was required to determine whether the provisional liquidators had satisfied the requirements for recognition under Chapter 15 and, in particular, demonstrated that the debtors’ COMI was the Cayman Islands.
The court found that, prior to filing the winding-up petitions in the Cayman Islands, the debtors’ COMI was located in the Republic of the Marshall Islands. Unlike the Cayman Islands, however, the Marshall Islands does not provide for debt restructuring. Accordingly, a financially distressed company would likely be liquidated in the Marshall Islands. In contemplation of restructuring their debt under a Cayman Islands scheme, the debtors began shifting their COMI from the Marshall Islands to the Cayman Islands in April 2016. Initially, Ocean Rig, which was registered as a non-resident corporation in the Marshall Islands, registered as an exempted company in the Cayman Islands. Thereafter, the subsidiary holding companies, which were registered as non-resident corporations in the Marshall Islands, registered as foreign companies in the Cayman Islands.
According to the court, the evidence demonstrated that the debtors’ COMI as of the date of the Chapter 15 filing was the Cayman Islands. As of that particular date, the debtors’ head office and administrative service functions were performed by a non-debtor affiliate located in the Cayman Islands. All of the employees of the affiliate had residences in the Cayman Islands, and the services agreement between the affiliate and the debtors was governed by Cayman Islands. Further, the debtors’ restructuring activities, which included meetings with creditors and the debtors’ legal and financial advisers, were conducted from the Cayman Islands. In addition, each of the debtors’ board of directors met and had a director that resided in the Cayman Islands. The debtors’ books and records were also located in Cayman Islands. Moreover, the debtors notified key parties in interest, including paying agents, indenture trustees, and administrative and collateral agents, and published notice of their relocation. Significantly, according to the court, there was no evidence supporting an alternative COMI for the debtors as of the Chapter 15 filing date.
The court acknowledged that a court may disregard a COMI shift where there is evidence of “mischief” or improper manipulation. In this instance, the court found that the motivation for the COMI shift was legitimate and valid. Under the laws of the Marshall Islands, a financially distressed company can be dissolved and liquidated. However, there is no provision that would have allowed the debtors to restructure their debt in the Marshall Islands. The court noted that a restructuring under a Cayman Islands scheme would yield a greater recovery for creditors than a liquidation under the laws of the Marshall Islands. Consequently, “the Foreign Debtors’ COMI shift to the Cayman Islands was done for legitimate reasons, motivated by the intent to maximize value for their creditors and preserve their assets.” The court thus recognized the Cayman Islands proceedings as foreign main proceedings.
The purported shareholder and a creditor appealed the bankruptcy court’s order granting recognition to the Cayman Islands proceedings as a foreign main proceeding. The creditor subsequently withdrew its appeal. The shareholder’s appeal is still pending. In the interim, the bankruptcy court entered an order enforcing the scheme of arrangement in the United States. According to a status report filed by the provisional liquidators with the bankruptcy court, the restructuring has been effectuated. Consequently, the appeal may now be moot and indeed, the debtors have filed a motion to dismiss the appeal on that basis. Please stay tuned to zoneofinsolvencyblog.com for further updates on this Chapter 15 case and others.
In New York, a debtor’s COMI will be determined as of the Chapter 15 filing date. In determining a debtor’s COMI, a court may consider the actions following the commencement of the foreign proceeding. Consequently, bankruptcy courts have granted recognition to foreign main proceedings upon finding that the debtor or a foreign representative shifted the debtor’s historical COMI to the jurisdiction where the foreign proceeding is pending. The Oi decision should not be interpreted as a bar to a COMI shift. Instead, it reinforces a court’s ability to consider the motivation for the shift. If the COMI shift is driven by a valid reason, as occurred in Ocean Rig, a court would likely not be concerned with the shift and grant recognition to the foreign proceeding pending in the debtor’s new COMI as a foreign main proceeding.
Robert Schwinger describes some of the recent developments in the regulation of digital assets built on blockchain technologies.
On January 20, 2020, the Financial Reporting Laboratory (Lab) of the Financial Reporting Council published a report setting out the results of a project the Lab undertook to test whether the principles of good reporting in the Lab’s earlier reports on business models, risk and viability reporting and performance metrics could be applied in the context of reporting on the workforce.