Bear Stearns Hedge Funds File Cayman Insolvency Proceedings and U.S. Chapter 15 Cases

On July 31, 2007, two Bear Stearn’s hedge funds filed insolvency petitions in the Grand Court of the Cayman Islands. The two funds, which were limited liability companies organized and incorporated in the Cayman Islands, were the Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd. (“High-Grade Fund”) and the Bear Sterns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. (“Enhanced Fund”). In their petitions to the court, they pled that they were insolvent and unable to pay their debts as they fell due. They requested that they be “wound up” by the court under the provisions of the Cayman Island’s Companies Law. The court appointed Joint Provisional Liquidators (“JPLs”) with various powers, including to take control of the funds’ assets and books and records. Some commentators have expressed concern that the proceedings of the Cayman Court will prove less transparent than would a proceeding in a U.S. Court and that the Cayman Judges have a track record highly favorable to incumbent management.

The hedge funds were open-ended investment companies and intended to invest in various investments, including asset-backed securities, synthetic asset-backed securities, mortgage-backed securities, derivatives, options, swaps, and futures. Bear Stearns Asset Management, Inc. (“BSAM”) was the investment manager of the funds. Following volatility in the U.S. subprime lending market in early 2007, the funds began to suffer a significant devaluation of their asset portfolios which led to margin calls from many of its trading counterparties which the funds were unable to meet. This led to default notices by these counterparties and their exercise of rights to seize and/or sell assets that were subject of repurchase agreement or over which they held security agreements. Subsequent events led to further downward pressures and deterioration.

On July 25, 2007, the JPLs of the High-Grade Fund and Enhanced Fund filed Chapter 15 petitions pursuant to section 1504 and 1515 commencing Chapter 15 cases in the U.S. Bankruptcy Court for the Southern District of New York in cases 07-12383 and 07-12384 respectively. These Chapter 15 cases were ancillary to the Cayman Island’s proceedings and sought recognition of the Cayman proceedings as a “foreign main proceeding” pursuant to section 1502(4). The effect of the Chapter 15 cases will be based on whether the Cayman foreign proceedings are each determined to be a “foreign main proceeding” or a “foreign nonmain proceeding.” This is based on a determination by the court whether the debtor’s “center of main interests” (“COMI”) is in the jurisdiction where the foreign proceeding was commenced. There is a presumption that a debtor’s COMI is its place of incorporation, but this presumption can be rebutted.

Chapter 15 is the U.S. adoption of the model law on cross-border bankruptcies proposed by the United Nations Commission on International Trade Law. The law generally mandates the cooperation of the U.S. bankruptcy courts with those of foreign jurisdictions.

The funds both filed motions for a temporary restraining orders and preliminary injunctions staying execution and litigation against the funds and further sought to entrust the funds assets to the JPLs. The funds pled to the court that the relief sought would avoid piecemeal distribution of its assets and provide “breathing-room” necessary to conduct an orderly review and wind-up of the funds’ affairs so that their creditors would receive equitable treatment.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983

Foreign Creditor May Be Sanctioned for Violating Court Injunction

The issue before the court in the pre-BAPCPA case of In re Simon, 153 F.3d 991 (9th Cir.1998), cert. denied 525 U.S. 114 (US 1999) was whether a foreign creditor is subject to U.S. bankruptcy court sanction for pursuing foreign collection of a debt discharged in a U.S. bankruptcy case in which the foreign creditor participated. The court concluded that the bankruptcy court may sanction the foreign creditor for violating a court injunction.

The Debtor William N. Simon filed for chapter 7 relief in the U.S. and obtained his discharge of debt. Pursuant to section 524, the discharge order operates as an injunction against the collection of certain debt against the debtor. Simon scheduled Hong Kong and Shanghai Banking Corp., Ltd. (“HSBC”) as a creditor in his case and HSBC filed a proof of claim in the bankruptcy case. HSBC filed a complaint seeking declaratory relief from the bankruptcy court that the bankruptcy discharge injunction was not effective outside of the U.S.

The court found that Congress has the unquestioned authority to enforce its laws beyond the territorial boundaries of the U.S., but whether Congress has exercised that authority in a particular case is a matter of statutory construction. Unless a contrary intent appears, there is a presumption that the legislation of Congress is meant to apply only within the territorial jurisdiction of the U.S.

The court concluded that as to actions against the bankruptcy estate, Congress clearly intended extraterritorial application of the Bankruptcy Code. The bankruptcy court obtains exclusive in rem jurisdiction over all of the property of the estate including property located outside of the territorial jurisdiction of the U.S. The court concluded that Congress intended extraterritorial application of the Bankruptcy Code as its applies to property of the estate. The court further noted that as a matter of general principle, protection of in rem or quasi in rem jurisdiction is a sufficient basis for a court to restrain another court’s proceedings and that this rationale extends to foreign proceedings.

The court noted that the more difficult question was whether a bankruptcy court may enjoin a foreign collection action against the debtor personally or as to non-estate assets if the creditor was not a party to the U.S. bankruptcy proceedings. But the court was not required to reach this question as HSBC fully participated in Simon’s U.S. bankruptcy case and thereby surrendered to U.S. jurisdiction. In this instance, the presumption against the extraterritorial effect of a statute would not apply. Therefore, Simon’s chapter 7 discharge injunction enjoins HSBC, but not the courts in Hong Kong. If HSBC chooses to commence collection proceedings in Hong Kong against Simon, it does so at the risk of U.S. bankruptcy court sanction.

The court rejected HSBC’s argument that it only submitted itself to limited bankruptcy court jurisdiction as the proof of claim it submitted in Simon’s case was for a different debt than the one it sought to pursue in Hong Kong. The court noted that HSBC failed to assert its position in the bankruptcy court by requesting abstention, to move to lift the automatic stay, to move for adequate protection, or to file an objection to discharge of Simon’s debts.

The court noted that it did not decide whether discharge injunction of section 524 itself applies extraterritorially in all cases either as to non-estate assets or as to the debtor’s personal liability.

The court also rejected HSBC’s arguement that international comity requires the court to vacate the bankruptcy court’s injunction forbidding debt collection against Simon for pre-petition debt. The court noted that the international comity concerns underlying Maxwell Communications Corp., 93 F.3d 1036, 1050 (2d Cir. 1996) were not present in this case.

The court noted that the Bankruptcy Code does not codify either the “territorial theory” or the “universalist philosphy” but provides for a flexible approach to international insolvencies dependent upon the circumstances of the particular case. Under the territorial theory or “grab” rule, courts in each national jurisdiction are responsible for seizing and controlling assets within their geographic reach. The universalist philosophy contemplates one plenary transnational proceeding governing the administration of assets world-wide. The court noted in this pre-BAPCPA case, that if the Bankruptcy Code contains any philosophy it is of deference to the country where the primary insolvency proceeding is located and flexible cooperation in administration of assets. e.g. Sections 304 and 305.

In summary, the court held that the lower court’s order did not involve an improper extrterritorial application of the discharge injunction as to estate property becaus section 541 expressly includes all of the debtor’s property regardless of geographic location. The discharge injunction was also validly applied to HSBC as to Simon’s non-estate property because HSBC participated in Simon’s bankruptcy case and thereby subjected itself to the otherwise valid orders of the bankruptcy court. Finally, international comity did not compel a contrary result because there was no conflicting proceeding in a foreign nation.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983