On September 26, 2014, the U.S. Court of Appeals for the Second Circuit, in Krys v. Farnum Place, LLC (In re Fairfield Sentry Ltd.), No. 13-3000, 2014 WL 4783370 (2d Cir. Sept. 26, 2014) (Fairfield), vacated orders of the District Court for the Southern District of New York and the U.S. Bankruptcy Court for the Southern District of New York, which had both denied to conduct, in the context of a Chapter 15 ancillary bankruptcy proceeding, a Section 363 review of a sale of a claim by the Liquidator of Fairfield Sentry Limited (Sentry).
Notably, the Second Circuit disagreed – correctly – with the determination that a claim against a bankruptcy estate in a proceeding under the Securities Investor Protection Act (SIPA)1 is not within the territorial jurisdiction of the United States; the court ruled that the SIPA claim is within that territorial jurisdiction because it is subject to attachment or garnishment in the United States. The court also held that a Section 363 review (as defined by Second Circuit precedent) of the claim sale is a mandatory prerequisite to any “transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States.”2
While the Second Circuit recognized that in Chapter 15 ancillary proceedings, principles of comity often dictate whether a Bankruptcy Court may take certain actions, it also noted that it is not a per se rule – “Chapter 15 does impose certain requirements and considerations that act as a brake or limitation on comity.” However, the Second Circuit’s decision in Fairfield to decline to afford any comity to the foreign court’s approval of the sale must be cabined by the unusual fact that the foreign court essentially declined such deference.
Sentry, a British Virgin Islands (BVI) investment fund, had invested approximately 95% of its assets with Bernard L. Madoff Investment Securities LLC (BLMIS). After the Ponzi scheme was discovered and BLMIS was placed into a SIPA liquidation, Sentry filed three customer claims for net losses of approximately $960 million. The BLMIS trustee (the Trustee) and Sentry reached an agreement whereby Sentry received an allowed SIPA claim of $230 million (the SIPA Claim).
By June 2009, Sentry was in liquidation in the BVI (the BVI Liquidation), Kenneth Krys was appointed as liquidator and he sought and obtained recognition of the BVI Liquidation as a foreign main proceeding. Krys marketed the SIPA Claim through an auction process and an offer by Farnum Place, LLC (Farnum) for 32.125% of the amount of the SIPA Claim was selected as the highest and best bid. The parties negotiated a trade confirmation, setting forth the terms and conditions of the sale of the SIPA Claim from Sentry to Farnum. The trade confirmation specifically provided that the sale was conditioned upon approval by both the BVI court and the Bankruptcy Court.
A few days after the parties executed the trade confirmation, the Trustee announced a massive settlement that would bring approximately $7.2 billion into the BLMIS estate, increasing the value of the SIPA Claim by approximately $40 million. As a result, Krys asked the BVI court to disapprove the sale of the SIPA Claim to Farnum on the basis that it was no longer in the best interest of the Sentry estate.
The BVI court ultimately approved the terms and conditions of the sale of the SIPA Claim to Farnum, but did not opine as to whether the Bankruptcy Court in the Chapter 15 ancillary proceeding would approve the sale under Section 363: “it would be unwise for [it] to express views on the issues that will arise for determination by the U.S. Bankruptcy Court” and the Bankruptcy Court must be “presented with a choice whether or not to approve [the sale].”
Bankruptcy Court and District Court Decline to Perform Section 363 Review
Krys filed an application with the Bankruptcy Court on April 18, 2012 seeking review of the trade confirmation under 11 U.S.C. § 363(b) and an order disapproving the trade. The Bankruptcy Court denied Krys’s application, holding that a Section 363 review was not warranted under Section 1520(a)(2) of the Bankruptcy Code because the sale did “not involve the transfer of an interest in property within the United States . . . .” In so holding, the Bankruptcy Court relied upon applicable nonbankruptcy law which, under the test articulated in Severnoe Sec. Corp. v. London and Lancashire Ins. Co., 255 N.Y. 120, 123-24 (1931), required a “common sense appraisal of the requirements of justice and convenience[.]” According to the Bankruptcy Court, “justice, convenience and common sense dictate . . . that the SIPA Claim is located with the debtor in the BVI.”
The Bankruptcy Court also held that, in any event, “comity dictates that this [c]ourt defer to the BVI Judgment” because “[f]ailing to grant such comity . . . under these circumstances [would] ‘necessarily undermine the equitable and orderly distribution of a debtor’s property by transforming a domestic court into a foreign appellate court where creditors are always afforded the proverbial “second bite at the apple.”’” In other words, the Bankruptcy Court held that principles of comity required it to decline Section 363 review. In so holding, the Bankruptcy Court expressly disagreed with a recent decision by the Bankruptcy Court for the District of Delaware,3 which held that “Section 1520 is mandatory” and that, with respect to Section 363 review as provided for under that section, “principles of comity either do not apply or must defer to the plain meaning and legislative history” of the statute.4
The District Court for the Southern District of New York, on appeal, affirmed the Bankruptcy Court’s decision, holding that it was “not clear that Section 363 . . . applies” but that, even if it did, the Bankruptcy Court’s decision was appropriate when considering principles of comity.5
Second Circuit Vacates Lower Courts’ Orders
On appeal, the Second Circuit vacated the District Court’s order affirming the Bankruptcy Court’s decision to deny Section 363 review, basing its decision on two key rulings: (i) the sale of the SIPA Claim at issue was a “transfer of an interest of the debtor in property within the territorial jurisdiction of the United States”; and (ii) as a result, Section 363 review was required.
SIPA Claim Qualifies as Property Within Territorial Jurisdiction of the United States
In Fairfield, the Second Circuit departed with the Bankruptcy Court on the issue of whether the sale of the SIPA Claim was a transfer of an interest of the debtor in property within the territorial jurisdiction of the United States. According to the Second Circuit, it was.
The phrase “within the territorial jurisdiction of the United States” is defined in section 1502(8) as “. . . intangible property deemed under nonbankruptcy law to be located within [the territory of the United States], including any property subject to attachment or garnishment that may properly be seized or garnished by an action in a Federal or State Court in the United States."6 In vacating the Bankruptcy Court’s decision, the Second Circuit focused on the last phrase in the definition in Section 1502(8), which provides that “any property subject to attachment or garnishment” qualifies as property within the territorial jurisdiction of the United States. Under applicable New York law, “‘any property which could be assigned or transferred’ is subject to attachment and garnishment”7 and, for attachment purposes, the relevant situs is the location of the party whose legal obligation it is to perform. Because the Trustee has the statutory obligation to “distribute to Sentry its pro rata share of the recovered assets[,]” the Second Circuit held that the situs of the SIPA Claim is the location of the Trustee – New York.
According to the Second Circuit, the Bankruptcy Court’s analysis of the situs of the SIPA Claim was incomplete because it failed to recognize that property subject to attachment or garnishment in the United States would fall under the purview of Section 1520(a)(2). Once that clause is taken into account, it is clear that the situs of the SIPA Claim is New York, and that the sale of the SIPA Claim qualifies as a “transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States” for purposes of Section 1520(a)(2) and, relatedly, Section 363.
Section 363 Review is Required
Under Section 1520(a)(2) of the Bankruptcy Code, Section 363 applies to a sale of assets in a Chapter 15 ancillary proceeding to the same extent as it would in a Chapter 11 proceeding if the sale is a “transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States . . . .”8 In Chapter 11 proceedings, Section 363 review of a sale is only required when such sale is outside the ordinary course of business. While the Bankruptcy Court is generally not in the business of approving the transfers of claims in a Chapter 11 case,9 such transfers are usually between parties which are not themselves in proceedings under the Bankruptcy Code. If the transfer by a party subject to the Code were considered in the “ordinary course,” it would not require review under Section 363. Whether or not the transfer in Fairfield would have required Section 363 review in a Chapter 11 case, the trade confirmation specifically required Bankruptcy Court approval. As a result, the Second Circuit (and the lower courts before it) had to determine whether Section 363 review was required in the circumstances, considering both the language of the statute and the actions (or inactions) of the BVI court in the foreign main proceeding.
Ultimately, the Second Circuit in Fairfield held that, based upon a reading of the statute and the terms of the trade confirmation, the sale must be reviewed under Section 363 and, notably, that interests of comity did not change that result. According to the court, where Section 363 review is required, it is “a statutory command” that operates as a “brake or limitation on comity.” This is especially true where, as in Fairfield, the BVI court “expressly declined to rule on whether the Trade Confirmation required approval under section 363” and “it is not apparent at all that the BVI Court even expects or desires deference . . . .”
No Clarity on Whether Express Language Of Section 1520(a) Limited By Comity
The Second Circuit somewhat infectiously used the phrase “Section 363 review” as requiring an independent business judgment analysis under its non-Chapter 15 precedent. It missed the point that applying Section 363 to the same extent that it would apply to property of an estate does not eliminate the principles of comity that infuse Chapter 15.10 In other words, if the decision of the foreign court would otherwise satisfy the requirements to be afforded comity, it should be considered and accepted by the Bankruptcy Court as satisfying Section 363 to the extent it specifically addresses the sale.
The strength of comity in Chapter 15 has been articulated by courts in different Circuits in starkly different ways.11 The Second Circuit’s decision in Fairfield – that a bankruptcy court in a Chapter 15 proceeding may not ignore the plain meaning of Section 1520(a) – is more closely aligned with the reasoning expressed by the Bankruptcy Court for the District of Delaware in Elpida Memory. There can be no dispute that Section 1520 says that Section 363 applies to a sale of property within the territorial jurisdiction of the United States. But both the Elpida and Fairfield courts appear to fall victim to the conclusion that this statement precludes affording any comity to a decision by a court in the foreign main proceeding. That conclusion is belied by Section 1508 and the need to interpret Chapter 15 with a view to its international origin and to harmony with foreign proceedings.12
But what would have happened in Fairfield if the BVI court had not specifically deferred to the U.S. Bankruptcy Court on the issue of whether the sale could be approved? Notably, in reaching its conclusion that Section 363 review was required, the Second Circuit in Fairfield did not expressly hold that Section 1520 was impervious to comity. To that end, the court emphasized the fact that the BVI court did not completely decide the sale approval issue; it left for the Bankruptcy Court to decide whether the sale could be approved.
The Second Circuit’s decision in Fairfield gets it right with respect to the scope of property that is within the territorial jurisdiction of the United States. To the extent that it can be read to entirely preclude comity to the approval of a sale by a court in a foreign main proceeding when that court has not specifically deferred, it goes too far. While Bankruptcy Code Section 1520(a)(2), on its face, clearly applies Section 363 to any sale of assets within the United States, it does not prohibit application of the principles of comity which are at the core of Chapter 15.
1 SIPA applies the Bankruptcy Code and rules to the extent not inconsistent with SIPA.
2 Second Circuit precedent provides that a review under § 363 “‘requires that a judge … expressly find from the evidence presented before him at the hearing a good business reason’ to approve the sale.” Fairfield, 2014 WL 4783370 at *3 (quoting In re Lionel Corp., 722 F.2d 1063, 1071 (2d Cir. 2004)).
3 In re Fairfield Sentry Ltd., 484 B.R. 615, 626 (Bankr. S.D.N.Y. 2013) (citing In re Elpida Memory, Inc., No. 12-10947, 2012 WL 6090194 (Bankr. D. Del. Nov. 20, 2012)).
4 Elpida Memory, 2012 WL 6090194 at *8-9.
5 Krys v. Farnum Place, LLC (In re Fairfield Sentry Ltd.), No. 13 Civ. 1524 (AKH) at 1, 2 (S.D.N.Y. July 3, 2013) [ECF No. 15] (holding that the Bankruptcy Court’s denial to perform Section 363 was proper, even if Section 363 applies, because the BVI court, “with primary jurisdiction over the debtor’s bankruptcy—observed that the deal ‘was negotiated at arms [sic] length by sophisticated parties with full awareness of the market’ and . . . concluded that ‘the fact . . . that the market has risen since the transaction closed is irrelevant.’”).
6 11 U.S.C. § 1502(8).
7 See N.Y. C.P.L.R. §§ 5201(b), 6202.
8 11 U.S.C. § 1520(a)(2) (“[u]pon recognition of a foreign proceeding that is a foreign main proceeding -- . . . (2) section 363 . . . appl[ies] to a transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States to the same extent that the section would apply to property of an estate . . .”).
9 See Bankruptcy Rule 3001(e).
10 “The Second Circuit has ‘repeatedly noted the importance of extending comity to foreign bankruptcy proceedings.’” Duff & Phelps, LLC v. Vitro S.A.B. de C.V., No. 13 Civ. 3242 (PAE), 2014 WL 239802, at *6 (S.D.N.Y Jan. 21, 2014) (quoting Finanz AG Zurich v. Banco Economico S.A., 192 F.3d 240, 246 (2d Cir. 1999)).
11 Compare In re Vitro S.A.B. de C.V., 701 F.3d 1031, 1064 (5th Cir. 2012) (holding that comity is the “principle objective” in Chapter 15 ancillary proceedings; it is “the rule . . . not the exception”) with Elpida Memory, 2012 WL 6090194 at *8-9 (while recognizing “the importance of comity, especially in the context of Chapter 15,” holding that it must review a “motion de novo as it relates to assets in the United States and, in so doing, must apply the well-settled standard governing a sale of assets under section 363 of the Bankruptcy Code.”).
12 “In interpreting this chapter , the court shall consider its international origin, and the need to promote an application of this chapter that is consistent with the application of similar statutes adopted by foreign jurisdictions.” 11 U.S.C. § 1508.