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Focus: Insolvency – October 2007

Cross-border insolvency – COMI and the Bear Stearns decision

In brief: The recent decision of the United States Bankruptcy Court in Bear Stearns provides a clear and useful guide to the interpretation of the concept of centre of main interests (COMI) in the US. This concept is central to the recognition procedures in the UNCITRAL Model Law on Cross-Border Insolvency, which has been enacted in the US by Chapter 15 of the US Bankruptcy Code. Legislation introduced into the Australian Parliament on 20 September 2007 would enact the Model Law into domestic Australian law. This decision is important because it is likely to be followed by Australian courts when interpreting and applying the concept of COMI in Australia. Partner Paul Nicols (view CV) and Lawyer Pouyan Afshar analyse this decision and its implications.

How does it affect you?

  • The location of a debtor's COMI will be of strategic significance for financiers, creditors and insolvency practitioners in cross-border insolvencies.
  • Bear Stearns1 clarifies the strength and operation of the presumption in the Model Law that the debtor's COMI is where its registered office is located. The decision stands for three propositions:
    • that courts will not merely rubber stamp applications for recognition;
    • that the presumption will operate only in a case where there is no dispute as to the location of the debtor's COMI. Where there is a dispute, the location of the debtor's registered office is simply evidence of the location of its COMI, which can be outweighed by evidence supporting an alternative location; and
    • the foreign representative bears the burden of proving where the debtor's COMI is.
  • If this decision is followed in Australia, financiers, creditors and insolvency practitioners may be able to defeat applications for recognition of a foreign proceeding as a 'foreign main proceeding' or 'foreign non-main proceeding' more easily, provided that they can point to some evidence to rebut the presumption.

The facts

In early 2007, joint provisional liquidators (JPLs) were appointed to two Bear Stearns hedge funds (the funds).2 The funds were registered in the Cayman Islands and a bankruptcy proceeding was instituted in the Grand Court of the Cayman Islands to liquidate both funds. The JPLs filed petitions under Chapter 15 of the US Bankruptcy Code to have the proceeding in the Cayman Islands recognised as a 'foreign main proceeding' and to be granted relief flowing from that recognition, namely a stay of proceedings in all other jurisdictions, or in the alternative to have the proceeding recognised as a 'foreign non-main proceeding' in order to take advantage of the court's discretion to order a stay on all other proceedings.

There were no objections to these petitions from other interested parties.

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The context

Chapter 15 of the Bankruptcy Code enacts the UNCITRAL Model Law on Cross-Border Insolvency (the Model Law) into US domestic law. Under the Model Law, a foreign proceeding can be recognised as either a 'foreign main proceeding' or 'foreign non-main proceeding'. This determination is based on the location of the debtor's COMI. COMI is not defined in the Model Law or in the Bankruptcy Code. In determining its meaning, courts have had regard to the Guide to Enactment of the Model Law, EU insolvency conventions and regulations, and decisions of foreign courts. For a discussion of the meaning of COMI, see International Insolvency: The latest developments on the global stage.  

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The decision

The central question before the Bankruptcy Court was whether the Cayman Islands was the location of the debtors' COMI. The JPLs raised two arguments in support of such a finding, namely that:

  1. none of the other interested parties had objected to the Cayman Islands proceeding being recognised as the 'foreign main proceeding'; and
  2. because the Cayman Islands was where the funds' registered offices were located, there was a presumption that their COMI was the Cayman Islands.

Judge Lifland rejected both arguments and found that the debtors' COMI was the US. Consequently, the JPLs were denied the automatic stay on all US proceedings, which would have resulted from recognition of the Cayman Islands proceeding as a 'foreign main proceeding'.

Rejecting the JPLs' first argument, Judge Lifland stated that the court is not a rubber stamp for an application for recognition. The court could question the merits of an application on its own motion and test its basis. Judge Lifland disagreed with the decision in SPhinX3 insofar as that decision indicated that non-objection by interested parties would make the process a rubber stamp exercise.

On the basis of statements in the JPLs' own application, the court found that there was ample evidence that the funds' COMI was the US:

  • there were no employees or managers in the Cayman Islands;
  • the funds' investment manager was located in New York;
  • the administrator that ran the funds' back-office operations was in the US, along with the funds' books and records;
  • prior to the commencement of the proceedings, all of the funds' liquid assets were located in the US;
  • the majority of the funds' investors were registered in the Cayman Islands, but they had the same minimum profile in the Cayman Islands as did the funds; and
  • the funds' investor registries were located in Ireland and their accounts receivables were located throughout Europe and the US.

The Model Law states that in the absence of 'proof' to the contrary, the location of the debtor's registered office would be its COMI. By contrast, Chapter 15 of the Bankruptcy Code uses the word 'evidence'. The drafters had made this change, the judge noted, in order to make it clearer that the burden of proving the location of the debtor's COMI falls squarely on the foreign representative. The Australian proposed enacting legislation, the Cross-Border Insolvency Bill 2007, retains 'proof' as its preferred terminology. Whether an Australian court will consider this distinction important remains to be seen.

The decision in Bear Stearns also deals with the operation of the presumption. Its purpose, the judge noted, is to permit speedy action when there is no dispute about the location of the debtor's COMI. It would cease to operate if there is such a dispute. In that case, a court must be satisfied on the evidence as to the location of the debtor's COMI; the location of the debtor's registered office would simply be one piece of evidence in relation to the location of its COMI.

This finding is significant because it departs from the approach in SPhinX, where it was suggested that courts should not overturn the presumption in the absence of objection by interested parties, even in the face of compelling evidence supporting a finding that the debtor's COMI was somewhere other than where its registered office was located.

Accordingly, the court held that the proceeding in the Cayman Islands could not be recognised as a 'foreign main proceeding'.

Judge Lifland similarly rejected the JPLs' application to have the proceeding recognised as a 'foreign non-main proceeding' and, thus, denied them the opportunity to apply for a discretionary stay. The judge found that the nature of the funds, as tax-exempt companies, precluded them from carrying out any business or economic activities other than that which was necessary for the furtherance of their off-shore business. Therefore, the funds' activities could not constitute an 'establishment in the Cayman Islands for the conduct of non-transitory economic activity'.

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Effect of the decision in Australia

Decisions in the US will certainly affect the way Australian courts interpret and apply the concept of COMI under the proposed Australian enacting legislation. An Australian court would need to consider the enacting legislation, the Model Law, enacting legislation in other Model Law jurisdictions and foreign decisions in interpreting and applying the concept of COMI. Indeed, the Model Law and the Explanatory Memorandum to the Cross-Border Insolvency Bill 2007 expressly envisage such an approach by Australian courts in interpreting the enacting legislation. For a discussion of the Bill, see AAR Focus: Insolvency – September 2007.

We expect that this decision would be followed in Australia and note that it is consistent with the decision of the European Court of Justice in Eurofood.4  

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Conclusion

Clearly, this is an important decision for financiers, creditors and insolvency practitioners in Australia. It provides a useful guide to the interpretation of the COMI concept and propounds a substantive, rather than formulaic, approach to the issue. It remains to be seen whether Australian courts will follow its interpretation and application of the COMI concept. However, we expect that they will do so.

The JPLs have now appealed this decision. We will continue to monitor this appeal and will report on any interesting developments.

Footnotes
  1. In re Bear Stearns High-Grade Structured Credit Strategies Master Fund (In Prov Liq) and in re Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund No. 07-12383 and No. 07-12384 (Bankr. S.D.N.Y. Aug 30, 2007).
  2. Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd (In Provisional Liquidation) and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd.
  3. In re SPhinX Ltd, 351 B.R. 103 (Bankr. S.D.N.Y. 2006).
  4. Eurofood IFSC Ltd Case C-341/04.

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