Alert May 06, 2014

Misconduct Not Grounds to Terminate Chapter 15 Recognition


A recent ruling from the U.S. Bankruptcy Court for the Southern District of New York illustrates the limited, specific grounds for changing or terminating chapter 15 recognition. The ruling demonstrates that recognition may not be terminated as a sanction for misconduct and emphasizes the limited grounds for modifying or terminating recognition under chapter 15, specifically that recognition may only be revoked where the facts which supported recognition no longer hold.

The Issue

The latest round in the ongoing struggle between Cozumel Caribe, S.A. de C.V. (“Cozumel Caribe” or “Debtor”) and its secured creditor CT Investment Management, LLC (“CTIM”),[1] involved CTIM’s motion to terminate the order recognizing Cozumel Caribe’s Mexican reorganization case as a foreign main proceeding under chapter 15 of the Bankruptcy Code.[2]

CTIM alleged delay by the Mexican court and a pattern of misconduct by the Foreign Representative, the Debtor and its affiliates as grounds to terminate recognition. In an April 21, 2014 decision,  the U.S. Bankruptcy Court for the Southern District of New York denied the motion but scolded the Foreign Representative.  The ruling illustrates the limited, specific grounds for modifying or terminating recognition under chapter 15.[3]

The Fight Over the Lockbox

Cozumel Caribe is a Mexican corporation that owns and operates a resort hotel in Cozumel, Mexico; its non-debtor Mexican affiliates (the “Affiliates”) also own and operate resort properties throughout Mexico. The Debtor and eight of its Affiliates are obligors under two promissory notes totaling $103 million. The joint obligations of the Debtor and the Affiliates were guaranteed by the groups’ parent and its principal (the “Guarantors”) through instruments governed by New York law that included consent to New York jurisdiction.

While only Cozumel Caribe commenced insolvency proceedings in Mexico (the “concurso”), on May 27, 2010 it obtained an ex parte order from the Mexican court granting so-called “Precautionary Measures” that barred any action to collect the debt from the property of the Debtor and its non-debtor Affiliates, specifically including $8 million held in a CTIM lock box account in New York.

Since the commencement of the concurso , CTIM has been trying to sue the Guarantors and to recover the non-debtor Affiliates’ share of the lock box funds. CTIM first challenged the Precautionary Measures in the Mexican courts, without success. Next, in September 2010, it tried suing the Guarantors in the Southern District of New York. However, in the interim, in July of 2010, the Foreign Representative sought recognition of the concurso and, on Oct. 20, 2010, the bankruptcy court granted recognition as a foreign main proceeding.

The Foreign Representative then appeared in the SDNY action and moved successfully for an extension of comity to the Precautionary Measures. In round three, CTIM filed an adversary complaint seeking a declaratory judgment that the funds in the lock box were not property of Cozumel Caribe and, consequently, not subject to the automatic stay that entered upon recognition of the foreign main proceeding under section 1520.[4] The Foreign Representative countered with a motion to stay the adversary proceeding on grounds of international comity.

Round three was decided in favor of the Foreign Representative in November 2012 when the bankruptcy court found that the interests of CTIM were sufficiently protected so long as the lock box funds remained in the U.S. and stayed the adversary proceeding. The court went on to say that CTIM deserved a determination of whether any of the funds were not subject to the Precautionary Measures – a determination that should be made by the Mexican court.

The Alleged Misconduct

A year later, with no allocation of the funds by the Mexican court, CTIM filed the Motion to Terminate alleging a pattern of misconduct: the Foreign Representative knowingly misstated the amount of CTIM’s claim in the concurso proceedings (in Mexico, the Debtor scheduled the CTIM claim as $23 million after stating to the U.S. bankruptcy court that the claim was in fact $103 million); the foreign representative “engaged in dilatory conduct” in the concurso proceedings to hinder and delay CTIM’s enforcement of its rights; the Guarantors sought to void the guarantees in the Mexican court; the parent-Guarantor sought to spin off assets for no consideration; and the Foreign Representative failed to comply with reporting requirements previously ordered by the bankruptcy court.

Because the Motion to Terminate raised serious questions about the conduct of the Foreign Representative and the Debtor’s principals, the court cautioned that “[t]he Foreign Representative should take little comfort from the Court’s ruling” denying the Motion. Denial was premised on the nature of recognition under chapter 15 and the limited circumstances in which recognition can be modified or terminated, not on the behavior of the parties.

The Nature of Recognition

For reasons of accord with concepts of recognition in civil law jurisdictions that adopt the UNCITRAL Model Law on Cross-Border Insolvency (on which chapter 15 is based), a grant of recognition under chapter 15 is not a typical court order that can be modified for cause. Instead, recognition confers a “status” that can only be modified or terminated under the specific circumstances identified in section 1517(d): that the grounds for granting it were fully or partially lacking or have ceased to exist.[5]

The limited grounds for modifying or terminating recognition are in keeping with the nature of recognition itself. In chapter 15, recognition of foreign proceedings is a rigid, objective inquiry. After notice and a hearing, if the foreign proceedings and foreign representative meet the definitional requirements of sections 101(23) and (24), respectively, the proceeding qualifies as a “foreign main” or “foreign nonmain”[6] proceeding under sections 1502(4) or 1502(5), and the petition satisfies the procedural requirements of section 1515, the court is obligated to grant recognition.[7] Section 1517(d) is the only avenue for vacating recognition, and, based on chapter 15’s rigid approach to recognition, is limited to situations where it is shown that the basic facts which supported the initial grant of recognition either did not exist or no longer do so.

CTIM argued for retrospective application of the section 1506 mandate that recognition not be granted where doing so would be “manifestly contrary” to U.S. public policy because orders of the Mexican court allegedly violated public policy.  The bankruptcy court demurred:  among other reasons, the public policy exception should be narrowly construed and the U.S. court will not inquire into specific acts of the foreign court.

The Court’s Right Answer

The court’s ruling correctly interpreted chapter 15. The concurso remained a foreign main proceeding within the definitional requirements of sections 101(23) and 1502(4), the Foreign Representative satisfied the definitional requirements of section 102(24) and, consequently recognition remained proper under section 1517(a) and (b). While the court took care to distinguish its ruling denying CTIM’s motion from its view of the alleged misconduct by the foreign representative, vacating the recognition order was not an appropriate remedy even if sanctions were warranted.  Despite the serious nature of CTIM’s allegations, because those allegations did not implicate the factual basis for the original grant of recognition, they were not proper grounds for terminating recognition under 1517(d):

But CTIM has not shown that the Court’s grounds for granting recognition have ceased to exist or that continued recognition would be manifestly contrary to U.S. public policy. It may be that the Foreign Representative or his counsel should be subject to sanctions, but that is not presently before the Court, and vacating the Recognition Order at this stage of this case is not the appropriate sanction.

[1] The loans had been securitized and CTIM was the Special Servicer.  Additional background for the recent decision and for this report can be found in decisions in two prior rounds of this struggle, CT Investment Management Co., LLC v. Carbonell, 2012 WL 92359 (S.D.N.Y. 2012) and CT Investment Management Co., LLC v. Cozumel Caribe, S.A. de C.V., 482 B.R. 96 (Bankr. S.D.N.Y. 2012).

[2] Under section 1502(4) a “foreign main proceeding” is a foreign proceeding pending in the country where the debtor has its “center of main interests,” which in Cozumel Caribe the court determined to be Mexico.

[3] In re Cozumel Caribe, S.A. de C.V, 2104 WL 1569238 (Bankr. S.D.N.Y. April 21, 2014); Case No. 10-13913(MG).

[4] Recognition of a foreign main proceeding has several “effects” under section 1520, including application of the automatic stay of section 362 “with respect to the debtor and the property of the debtor that is within the territorial jurisdiction of the United States.”

[5] The legislative history to the Bankruptcy Reform and Consumer Protection Act of 2005, which added chapter 15 to the bankruptcy code, reflects this subtle but important distinction: “Consistent with the position of various civil law representatives in drafting the [UNCITRAL] Model Law, recognition creates a status with the effects set forth in section 1520, so those effects are not viewed as orders to be modified, as are orders granting relief under sections 1519 and 1521.”  H. Rep. 109-31, p. 113 (emphasis added).

[6] Section 101(23) defines a “foreign proceeding” as a “collective judicial proceeding or administrative proceeding in a foreign country, including an interim proceeding, under a law relating to insolvency or adjustment of debt in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganization or liquidation.”  For purposes of section 101(24), an eligible “foreign representative” is a “person or body, including a person or body appointed on an interim basis, authorized in a foreign proceeding to administer the reorganization or the liquidation of the debtor’s assets or affairs or to act as a representative of such proceeding.”  Under section 1502(4) a “foreign main proceeding” is a foreign proceeding pending in the country where the debtor has its “center of main interests.” Under section1502(5) a foreign nonmain proceeding is a foreign proceeding, other than a foreign main proceeding, pending in a country where the debtor has an “establishment.”

[7] See, e.g. In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd., 374 B.R. 122, 132 (Bankr. S.D.N.Y 2007), aff’d, 389 B.R. 325 (S.D.N.Y. 2008)); H.R. Rep. No. 109-31, at 110.  Section 1517(a) provides that subject to section 1506, after notice and a hearing, an order recognizing a foreign proceeding shall be entered if (1) such foreign proceeding for which recognition is sought is a foreign main proceeding or foreign nonmain proceeding within the meaning of section 1502; (2) the foreign representative applying for recognition is a person or body; and (3) the petition meets the requirements of section 1515.