Foreign companies seeking to protect their overseas assets from their creditors have often turned to the United States for immediate relief under Chapter 11 of the Bankruptcy Code. Establishing jurisdiction in the US for purposes of a bankruptcy filing has proved easy – the establishment of a nominal professional fees retainer with a local law firm on the eve of a bankruptcy filing will suffice. Upon such a filing, the automatic stay under Section 362 of the Bankruptcy Code goes into global effect, shielding a foreign debtor’s assets, wherever they may be located, from creditors’ recovery actions and litigation. At times, that relief may be short-lived. An aggrieved creditor may challenge a bankruptcy filing as having been made in “bad faith”, seeking to dismiss a pending bankruptcy proceeding that it believes was designed for the sole purpose of frustrating the exercise of its creditor rights and remedies and for which US jurisdiction was manufactured.
The Bankruptcy Court in In re JPA No. 111 Co., Ltd. and JPA No. 48 Co., Ltd., Case No. 21-12075 (DSJ) recently addressed such a challenge in cases filed by two Japanese single purpose entities (the “Debtors”). Each of the Debtors owned a single aircraft that was leased, indirectly, to an airline. Like many in their industry, the Debtors were in financial distress due to the global decline in travel caused by the pandemic. FitzWalter Capital Partners (Financial Trading) Limited (“FitzWalter”) acquired a substantial portion of the Debtors’ secured debt in late 2021, appointed itself “security agent” under the relevant loan documents and commenced foreclosure proceedings in England with regard to the “lease assets.” FitzWalter fixed December 17, 2021 as the deadline for bids. On or about December 13, the Debtors became aware of the foreclosure action and on December 17 commenced their chapter 11 cases in the Bankruptcy Court for the Southern District of New York. Days later, the Debtors filed pleadings seeking the approval of bid procedures for the aircraft and identified a stalking-horse bidder for its assets pursuant to Section 363 of the Bankruptcy Code (a “363 Sale”). The Debtors argued that a 363 Sale would maximize value and create an opportunity to achieve a recovery for equity, which the English foreclosure would likely not afford.
FitzWalter moved to dismiss the Debtors’ cases on three grounds: (1) the Debtors did not meet the standards for jurisdiction and were not eligible to be a “debtor” under the Bankruptcy Code; (2) the cases were commenced in “bad faith” as efforts to frustrate the legitimate exercise of FitzWalter’s contractual remedies; and (3) the Court should abstain under Section 305(a)(1) of the Bankruptcy Code because, among other things, an alternative means exist for distributing the Debtors’ assets. The Debtors, supported by a few of their other secured creditors, argued that FitzWalter’s enforcement actions would serve only FitzWalter’s interests and impair recoveries to other creditors and equityholders.
The Court denied FitzWalter’s dismissal motion. The Court dispensed with the first argument quickly, holding that the Debtors owned property in the US in the form of unapplied retainers deposited with their US counsel, thus satisfying the requirements of Section 109 of the Bankruptcy Code. Section 109 provides that “only a person that resides or has a domicile, a place of business, or property in the United States” may be a debtor. 11 U.S.C. § 109 (emphasis added). It was irrelevant that the Debtors were foreign companies, that they had no offices, employees, or operations, in the US, and may otherwise have had no contact with the US. Further, it did not matter that the retainers were paid on their behalf by a non-Debtor parent – the Debtors were entitled to any unpaid amounts and therefore, they owned property in the US.
With regard to “bad faith”, Section 1112(b) of the Bankruptcy Code provides that a court shall, for cause, either dismiss a chapter 11 case or convert it to chapter 7, whichever is in the best interests of creditors and the estate. See 11 U.S.C. § 1112(b). The factors that courts often consider when determining whether “bad faith” exists include: “(1) the debtor has only one asset; (2) the debtor has few unsecured creditors whose claims are small in relation to those of the secured creditors; (3) the debtor’s one asset is the subject of a foreclosure action as a result of arrearages or default on the debt; (4) the debtor’s financial condition is, in essence, a two party dispute between the debtor and secured creditors which can be resolved in the pending state foreclosure action; (5) the timing of the debtor’s filing evidences an intent to delay or frustrate the legitimate efforts of the debtor’s secured creditors to enforce their rights; (6) the debtor has little or no cash flow; (7) the debtor can’t meet current expenses including the payment of personal property and real estate taxes; and (8) the debtor has no employees.” In re C-TC 9th Ave. Partnership, 113 F.3d 1304, 1311 (2d Cir. 1997) (citations omitted). These factors, however, are not applied equally and courts will consider the facts and circumstances as they are presented in any case.
Although the Court acknowledged that many of the “C-TC factors” were satisfied, it gave considerable weight to the Debtors’ assertions that a 363 Sale was most likely to maximize recoveries for all stakeholders and that the foreclosure would likely realize lower value. FitzWalter presented no evidence on the likely price to be achieved in foreclosure. That the Debtors had proceeded so quickly to a 363 Sale with a stalking-horse bidder was compelling evidence that they were pursuing a viable strategy and had a bankruptcy purpose. Upon consideration of all evidence, the Court determined that the cases were commenced in a “subjectively good-faith effort to maximize recoveries of all stakeholders by making the best of a difficult commercial situation.” JPA at 19.
Section 305(a)(1) of the Bankruptcy Code permits a court to dismiss or suspend a case if “the interests of creditors and the debtor would be better served by such dismissal or suspension.” 11 U.S.C. § 305(a)(1) (emphasis added). Courts have considered the following in connection with abstention: “(1) the economy and efficiency of administration; (2) whether another forum is available to protect the interests of both parties or there is already a pending proceeding in state court; (3) whether federal proceedings are necessary to reach a just and equitable solution; (4) whether there is an alternative means of achieving an equitable distribution of assets; (5) whether the debtor and the creditors are able to work out a less expensive out-of-court arrangement which better serves all interests in the case; (6) whether a non-federal insolvency has proceeded so far in those proceedings that it would be costly and time consuming to start afresh with the federal bankruptcy process; and (7) the purpose for which bankruptcy jurisdiction has been sought.” JPA at 29-30 (citations omitted). For many of the same reasons that prevented the Court from dismissing the case under Section 1112(b), the Court denied this request as well.
The outcome in JPA hay have been very different had the Debtors been unable to find a stalking-horse bidder in such a short period of time. Absent a feasible path forward, and the support from other secured creditors, an analysis of the C-TC factors may have led to a different conclusion.
Notably, the Debtors commenced their insolvency proceedings under Chapter 11 in the US rather than seek protection in the English courts under the new moratorium and restructuring plan procedures introduced in England by the Corporate Insolvency and Governance Act 2020. Certainly, Chapter 11 protection offers long standing precedent allowing access to foreign debtors, an immediate stay of recovery actions, a well-defined process for the sale of assets outside and a mechanic for the distribution of proceeds to creditors and, in some instances, equity holders. On these matters precedent in the English courts remains limited and their approach to similar circumstances is largely unknown.
Of course, foreign debtors must remain cautious when considering a filing in the US, particularly when doing so on an emergency basis with the purpose of halting foreign collection actions. For all of its many benefits, Chapter 11 brings with it many burdens that foreign debtors are not always aware. A careful weighing of these benefits and burdens (with the support of experienced counsel in the US and England) is critical for ensuring a successful journey through Chapter 11 in the US.