This chapter will address the questionnaire from the perspective of US law, with particular focus on Title 11 of the US Code (the Bankruptcy Code) and the Federal Rules of Bankruptcy Procedure (the Bankruptcy Rules). The US is a federal system that uses the common law, with some laws falling under the purview of each state and some that are federal in nature, applying across the country. Even for federal laws, however, the US courts are divided into twelve regional circuits, each of which is not bound by the interpretation of other federal circuits. Accordingly, whether a particular rule will apply to a matter will depend on whether the matter is subject to state or federal law and if federal, the circuit in which the case is pending.
A. DOMESTIC FAMILY OF COMPANIES
1. If insolvency proceedings must be commenced for the family of companies, does your law permit a joint proceeding, ie, a single court file, a single judge, a single list of creditors, single notice list, or must the case for each member of the family proceed separately with no practical acknowledgment of the related proceedings?
The Bankruptcy Rules specifically contemplate the procedural consolidation of related cases to allow for efficient administration. Bankruptcy Rule 1015 allows procedural consolidation of cases involving two or more related debtors. It is also common to have a consolidated notice list for procedurally consolidated cases.
(a) What if the members of the family are organised under, or operate in, different locations within your country? Can a company from a distant location in your country commence its bankruptcy proceeding where its affiliate is located, if the affiliate has already commenced its bankruptcy proceeding?
Venue for bankruptcy cases is governed by 28 USC ss 1408–1410. In summary, a bankruptcy proceeding may be commenced in the jurisdiction ‘in which there is pending a case under title 11 concerning such person’s affiliate, general partner or partnership’ (28 USC s 1408(2)). As a result, a California company can file a proceeding in New York if an affiliate has a case pending there.
(b) To the extent your country has different types of insolvency proceedings (such as Chapter 11 reorganisation and Chapter 7 liquidation in the US), do the members of the corporate family all have to proceed under the same type of proceeding?
Technically the answer is ‘No’. However, if for example a company is in a Chapter 11 proceeding and a wholly-owned subsidiary is in a Chapter 7 proceeding, the Chapter 11 company will not have any control over the Chapter 7 proceeding for the subsidiary. A trustee is automatically appointed in a Chapter 7 case and controls the debtor’s property and operations, while in a Chapter 11 case, the debtor, at least initially, controls its property and operations as a debtor in possession. (See 11 USC ss 701–704, 1107.)
2. Does your law permit, or prohibit, a single administrator/trustee /receiver to administer the assets and the liabilities of the entire corporate family?
Generally in US bankruptcy cases, a single party acts as either trustee or as presiding officer for the corporate family members (Re Ben Franklin Retail Stores Inc 214 BR 852 (Bankr ND Ill 1997)). This is so even if members of the corporate group have claims against each other or guaranteed each other’s debt (Re Intl Oil Co 427 F 2d 186 (2d Cir 1970)). A single trustee or manager should, however, publicly disclose in court filings any potential conflicts among the members of the corporate group as he discovers them. If there is sufficient disclosure, then a court will likely continue the joint management unless an actual conflict arises. (See, eg, Re O.pm. Leasing Servs Inc 16 BR 932, 938 (Bankr SDNY 1982): ‘The realities and practicalities of bankruptcy administration in large, complex cases ... makes it doubtful that a court will sever an established trusteeship over multiple related corporations in cases that are well progressed unless there is a showing of actual, present conflict incapable of any other equitable resolution, especially where, as here, full disclosure of the potential for conflict was made at the outset of appointment.’)
(a) If so, is there a hearing for the court to determine whether the administration by a single party is appropriate? Are secured and unsecured creditors or other parties in interest allowed to object or be heard at such hearing?
As noted above, generally a single party will serve as trustee or manager for the entire corporate family in bankruptcy. If a party in interest does not support the joint management, it must file a motion with the Bankruptcy Court seeking appropriate relief. Under the Bankruptcy Code, a party in interest includes creditors, creditors’ committees, stockholders, or the US Trustee (a government official that monitors bankruptcy cases). Any such party may file a motion with the Bankruptcy Court requesting the appointment of an independent fiduciary for one or more members of a corporate family in bankruptcy (11 USC s 1104). The party requesting the appointment of an independent fiduciary has the burden of proving there is an actual conflict among the members of the corporate family, or wrongdoing such as fraud, dishonesty or other good cause to appoint an independent trustee for one or more members of the corporate group. (See 11 USC ss 1104(a)(1)–(3).) In addition, if a party suspects wrongdoing or other grounds to appoint a trustee, but lacks proof, it may request that the Bankruptcy Court appoint an independent examiner. An examiner does not operate any of the companies, but will investigate designated issues and prepare a report for the Bankruptcy Court and creditors to act upon. (See 11 USC ss 1104(d), 1106(b).) Section 1104(c) permits the Bankruptcy Court to appoint an examiner in its discretion, but also requires the appointment of an examiner in any case in which the debtor’s fixed, liquidated unsecured debts (other insider debts or debts for goods, services or taxes) exceed $5m (Loral Stockholders Protective Comm v Loral Space & Commcns Ltd (Re Loral Space & Commcns Ltd) 2004 US Dist LEXIS 25681 (SDNY 2004)). Regardless of whether a trustee or examiner is sought, a party in interest must request relief from the Bankruptcy Court as soon as it believes an independent party may be needed. The right to request this relief is waived if the party in interest stands by as the case progresses with joint management (Re Nat’l Pub. Serv. Corp 68 F 2d 859 (2d Cir 1934); Re Adelphia Commcns. Corp 2006 Bankr LEXIS 75, at *183–84 (Bankr SDNY 2006)). Once a party in interest files a motion to appoint a trustee or examiner, all other parties in interest in the case may support or oppose the motion (11 USC s 1109).
(b) What about joint representation by other professionals, such as law firms or accounting or auditing firms?
As with the answer above, in most cases a professional firm may provide services to all members of a corporate group in bankruptcy. However, when there are material conflicts among members of the corporate group, joint representation is not allowed. There is not, however, a uniform rule on whether the conflicts of interest must be actual or potential to require separate professionals for each member of a corporate group. For instance, in Interwest Business Equipment v US Trustee (Re Interwest Business Equipment) 23 F 3d 311 (10th Cir 1994), affiliated debtors had an arrangement whereby one member of the group would pay another a percentage of its revenue; this relationship continued even though other unaffiliated creditors went unpaid. Although there may have been an innocent explanation for these arrangements, the court required separate counsel for each bankruptcy estate. Other cases are less stringent, however, requiring an actual conflict between members of the corporate group before requiring different professional firms. (See Re BH & P Inc 949 F 3d 1300, 1314–15 (3d Cir 1991) (holding ‘[t]he existence of interdebtor claims is ... no longer an automatic ground for disqualification of counsel for the trustee,’ and there must be an actual conflict of interest to disqualify counsel from joint representation); see also Re Adelphia Commcns Corp 2006 Bankr LEXIS 75, at *169 (Bankr SDNY 2006) (same); Re Gilbertson Restaurants LLC 2004 Bankr LEXIS 987 (Bankr ND Iowa 2004) (same).)
3. Does your law encourage or discourage overlapping boards or management teams for separate members of a corporate family?
US corporate laws (which vary according to the state of incorporation of the company) permit overlapping boards. (See, eg, 8 Del C s 144(a)(3).) In addition, there is no requirement in US corporate laws that directors or managers be residents of the jurisdiction where the company operates. Accordingly, a corporate family featuring a parent company incorporated in New York, with subsidiaries located in California and Florida, may have similar or identical boards and management teams. As a matter of convenience and to ensure enterprise control remains with the same parties, most US corporate families use overlapping boards and management teams. In such a case, however, those directors must understand that ‘a person who is a director of a parent and of a subsidiary owes the same duty of good management to both.’ (Levien v Sinclair Oil Corp 261 A.2d 911, 915 (Del Ch 1969)). Accordingly, when two members of a corporate group have dealings with each other, or must allocate costs or assets among themselves, common directors must be careful to ensure the dealings or allocations are fair. A director of two related companies who permits transactions favouring one company to the detriment of the other may be personally liable to shareholders or creditors of the wronged company. (See, eg, Mills v Withers 483 SW 2d 339 (Tex Ct App 1972).)
(a) If the directors of a parent company are not directors of the subsidiary, but they either directly or indirectly manage the affairs of the subsidiary anyway, do your country’s laws render such people de facto or ‘shadow’ directors of the subsidiary?
If a parent corporation exercises undue control over a subsidiary, then that parent corporation could be held liable for such control. (See, eg, Odyssey Partners LP v Fleming Cos 735 A2d 386 (Del Ch 1999).) This liability could extend to the parent company’s officers and directors, even if they are not officers or directors of the subsidiary, provided they exercise actual control over the subsidiary’s actions. (See, eg, Lazenby v Henderson 135 NE 302, 303–04 (Mass Sup Ct 1922).) In addition, there are other theories under which third parties (such as directors of a parent company) could be liable for their direct or indirect management of an affiliate. For instance, some US states recognise the cause of action of ‘aiding and abetting’ a fraud or a breach of fiduciary duty by third parties. To sustain such an action, an injured party would have to prove (1) the third party’s conduct was wrongful, (2) the defendant had knowledge that the third party’s wrongful conduct was occurring, and (3) the defendant’s conduct gave substantial assistance or encouragement to the third party’s wrongful conduct (Crowthers McCall Pattern Inc v Lewis 129 BR 992, 999 (SDNY 1991)). Thus, if a parent company’s officers or directors knowingly and substantially assisted the subsidiary in committing a wrong, the parent company’s officers and directors could be directly liable to the injured party.
(b) Do the duties or responsibilities of officers or directors of a family of companies change when the companies become insolvent? For example does their duty shift from a responsibility to the shareholders to a responsibility to the creditors. What if only one of the companies is insolvent?
The law in this area is evolving. A recent decision from the Delaware Chancery Court, a leading court on corporate law matters, held that when a company becomes insolvent, its officers and directors owe the same duties to the company that they owed when it was solvent (Prod Resources Group LLC v NCT Group 863 A2d 772, 792 (Del Ch 2004)). Those duties require the officers and directors to act with good faith and loyalty, and Delaware law protects the decisions of such parties through the ‘business judgment rule’ as long as such decisions are independently made and do not favour the personal interests of the officers and directors over creditors (ibid at 788). Finally, exculpatory provisions in a company’s corporate charter that protect officers and directors from lawsuits alleging breaches of the duty of care apply equally to lawsuits brought by creditors or stockholders (ibid at 793).
However, because the duties owed to creditors of an insolvent company are matters of state law, not federal law, there is no uniform rule in the US on this matter. For example, some cases impose a duty on directors of an insolvent company to maximise the value of the company; to the extent they negligently fail to do so, they are liable to creditors. (See NY Credit Men’s Adjustment Bureau v Weiss 110 NE 2d 397, 400 (NY Ct App 1953).) This is very different from the rule governing a solvent company; as noted above, under the business judgment rule, directors of a solvent company cannot be sued for poor decisions, as long as they did not act in bad faith. To illustrate other differences among state laws, another case has held that exculpatory provisions in a company’s charter did not apply to lawsuits brought by creditors, only to lawsuits brought by shareholders (Re Ben Franklin Retail Stores Inc 225 BR 646, 652 (Bankr ND Ill 1998)). Accordingly, the nature of the duties owed by directors of an insolvent company is unsettled, and will vary according to the circumstances and governing state law.
4. Are there rules and do they change regarding members of the corporate family transferring assets among one another (such as by way of loans, capitalisation, other transactions) when the members are insolvent?
It is not uncommon for members of a corporate group to have claims against, or equity investments in, one another. Outside bankruptcy, these relationships are governed by the law of the entity’s state of formation, and those state laws respect the nature of the interest that one affiliate has in another. For instance, Delaware partnership law provides that ‘a partner may lend money to, borrow money from, act as a surety, guarantor or endorser for, guarantee or assume one or more specific obligations of, provide collateral for and transact other business with, the limited partnership’ (Del Genl Corp Law s 17–107). That statute also provides that a partner transacting business with a partnership ‘has the same rights and obligations with respect thereto as a person who is not a partner’ (ibid). The same is true under other state’s laws. (See, eg, Cal Corp Code s 15617: ‘A partner may lend money to and transact other business with the limited partnership and, subject to other applicable law, has the same rights and obligations with respect thereto as a person who is not a partner.’)
Creditors or other parties in interest may seek to recharacterise affiliate dealings once a bankruptcy case has been filed. For instance, if a transaction between one affiliate and another is characterised as debt but actually has the qualities of equity, the Bankruptcy Court may recharacterise the debt as equity. (See, eg, Re Cold Harbor Assocs LP 204 BR 904, 915 (Bankr ED Va 1997: the central inquiry under the recharacterisation theory is ‘whether the transaction bears the earmarks of an arm’s length negotiation. ... The more such an exchange appears to reflect the characteristics of such an arm’s length negotiation, the more likely such a transaction is to be treated as debt.’) Accordingly, even though affiliates may make loans or investments or transact business with each other freely outside of bankruptcy, a Bankruptcy Court may recharacterise those transactions once a bankruptcy case is filed. The Bankruptcy Court may also impose other remedies, such as ‘equitably subordinating’ affiliate debts to the debts of third party creditors. (See, eg, Herzog v Leighton Holdings Ltd (Re Kids Creek Partners LP) 212 BR 898, 931 (Bankr ND Ill 1997), affd 239 BR 497 (ND Ill 1999: ‘With equitable subordination, the court generally looks at the misconduct of a creditor as a basis to subordinate its debt where incurring of the debt was inequitable toward the other creditors.’) These theories are discussed in more detail in question 5(b), below. US counsel should review affiliated transactions to determine the risks of recharacterisation or whether other safeguards are needed to protect the intent of the parties to the transaction.
(a) Are cash sweep procedures allowed, that is, all cash from all subsidiaries is swept out to one account controlled by one of the family entities and then redistributed among the family members to pay bills?
Once members of a corporate group enter bankruptcy, they are allowed to continue to transact business among each other without Bankruptcy Court approval if such matters are ‘in the ordinary course of business’ (11 USC s 363(b)(1)). This could include ‘cash sweeps,’ which likely would be considered short-term loans from one member of a corporate group to another, if those ‘cash sweeps’ were customary before the bankruptcy case (11 USC s 364(a)) (allowing a debtor to incur unsecured debt in the ordinary course of business). However, determining whether a given transaction is in the ‘ordinary course of business’ is subjective, and depends on what a ‘hypothetical creditor’ would expect and what a ‘similar business’ would do. (See, eg, Med Malpractice Ins Assn v Hirsch (Re Lavigne) 114 F 3d 379 (2d Cir 1997).) Accordingly, a member of a corporate group that wishes to loan funds to or transact business with another bankrupt affiliate (including through a cash sweep) should provide disclosure to the court, and perhaps also seek Bankruptcy Court approval before doing so, in case it is later determined that such transaction was not in the ordinary course of business.
(b) What if the redistribution results in a healthy subsidiary funding the shortfalls in another subsidiary that is losing money?
If this appears to be taking place, creditors or other parties in interest harmed by this redistribution have at least two options. First, they can file a motion to discontinue such cash transfers, as unduly harmful to the healthy subsidiary. Bankruptcy Courts have the general equitable power to ‘issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title’ (11 USC s 105(a)). This equitable power would include the power to prohibit affiliate transactions harmful to creditors of the other members of the corporate group. Second, parties in interest may seek to appoint an independent examiner to determine whether such transactions should continue. (The standards to appoint an examiner were discussed question 2(b), above.) The examiner, after an investigation, might recommend additional safeguards to ensure the healthy subsidiary’s funds are protected or will be returned later in the case. This approach was taken in the Enron bankruptcy cases, as creditors alleged that an independent party needed to review the post-bankruptcy cash management procedures between two large Enron affiliates (Re Enron Corp 279 BR 671, 678–79 (Bankr SDNY 2002)).
5. How does your law treat claims of one member of a corporate family against other members of the corporate family?
(a) Are such claims invalid or unenforceable?
The Bankruptcy Code does not discriminate between claims of one member of a corporate family against other members of the corporate family (‘intercompany claims’) and claims of third parties. All claims that are properly and timely filed are presumptively ‘allowed’ (the term used in the Bankruptcy Code for valid, enforceable claims), unless objected to by the debtor, a creditors’ committee, or another party in interest. (See 11 USC s 502(a).) The fact that a claim is an intercompany claim is not, by itself, grounds for objection.
(b) If not, are such claims on equal footing with those of third party creditors, or are they subordinated, or is there other treatment required or permitted under your law?
Although intercompany claims are presumptively allowed, such claims will be subject to scrutiny by parties in interest. In appropriate circumstances, intercompany claims may be subordinated to claims of outside creditors. The two primary means to subordinate intercompany (or other) claims are (1) equitable subordination and (2) recharacterisating the claim.
Equitable subordination and recharacterisation accomplish the same functional goal – the subordinated or recharacterised creditor can only be paid after non-subordinated or nonrecharacterised creditors are paid in full. However, the two theories work differently. Equitable subordination, as the name suggests, subordinates one creditor’s claims to other creditors’ claims. Recharacterisation, on the other hand, changes the debt claim to an equity interest and therefore the recharacterised claim shares pari passu with equity.
The Bankruptcy Code specifically authorises equitable subordination. Section 510(c) provides that the Bankruptcy Court may ‘under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest’ (11 USC s 510(c)). A party seeking subordination of a claim must bring an adversary proceeding (a civil lawsuit before the Bankruptcy Court) or provide for subordination through a plan of reorganisation (Fed R Bankr p 7001(8)).
While equitable subordination has a statutory predicate, the statute’s parameters are a matter of common law. Most courts use the Mobile Steel test, which requires that: (1) the creditor to be subordinated has engaged in inequitable conduct, (2) the inequitable conduct resulted in harm to other creditors of the debtor, and (3) subordination would not otherwise be inconsistent with the bankruptcy laws (Benjamin v Diamond (Re Mobil Steel Co) 563 F 2d 692, 702 (5th Cir 1977)). As the law following Mobile Steel has developed, courts have distinguished between insider claims and non-insider claims – claims of non-insiders are far less likely to be subordinated. To subordinate a non-insider, substantial ‘egregious and unfair’ misconduct must be proven (Sunbeam Corp v Morgan Stanley & Co (Re Sunbeam Corp) 284 BR 355, 364 (Bankr SDNY 2002)). Such conduct must be tantamount to fraud, overreaching, or spoliation (ibid at 364). That said, some courts have recognised that subordination of a non-insider may be appropriate even when the conduct does not amount to actual fraud (Capitol Bank & Trust Co v 604 Columbus Ave Realty Trust (Re 604 Columbus Ave Realty Trust) 968 F 2d 1332, 1361 (1st Cir 1992)). The standard is nonetheless very high to subordinate a non-insider and courts rarely do so (Re Sunbeam Corp 284 BR at 364).
In contrast, courts are far more liberal in subordinating an insider’s claim. When a creditor is an insider, ‘his dealings are subject to rigorous scrutiny and the burden is on him to prove the good faith of the transaction and also to show its intrinsic fairness to the debtor’ (Mishkin v Siclari (Re Adler, Coleman Clearing Corp) 277 BR 520, 564 (Bankr SDNY 2002)). When the party to be subordinated is an insider, the proponent of subordination must show a substantial basis to warrant subordination, then the burden shifts to the insider to prove the fairness of his claim (Re 80 Nassau Assocs 169 BR 832, 840 (Bankr SDNY 1994) (citing Pepper v Litton 308 US 295, 306 (1939)).
As noted above, recharacterisation accomplishes the same economic objective as equitable subordination, but through a different means. Recharacterisation is a judicial inquiry into whether a debt transaction bears the rudiments of an arm’s length transaction. If it does not, the Bankruptcy Court may recharacterise the debt claim as an equity interest. Ultimately the court will not ‘accept the label of ‘debt’ or ‘equity’ placed by the debtor upon a particular transaction, but ... inquire into the actual nature of a transaction to determine how best to characterise it’ (Re Cold Harbor Assocs LP 204 BR 904, 915 (Bankr ED Va 1997)).
Unlike equitable subordination, recharacterisation has no express statutory basis. Instead, courts rely on their equitable powers under section 105(a) of the Bankruptcy Code to ‘issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]’ (11 USC s 105(a)).
6. Does your law allow for the pooling of assets and liabilities of all members of the corporate family, so that a creditor of one member becomes, in essence, a creditor of all members?
In certain cases, US Bankruptcy Courts will order the ‘substantive consolidation’ of the assets and liabilities of one member of a corporate family with the assets and liabilities of another member of the corporate family. When a court orders substantive consolidation, all assets of the consolidated entities will be available to satisfy all claims against the consolidated entities. Additionally, substantive consolidation cancels intercompany claims among the consolidated entities.
(a) If so, is such pooling automatic or does it require a factual showing and court involvement?
Substantive consolidation is not automatic or routine; the debtor or creditors must make a proper factual showing to the Bankruptcy Court to consolidate multiple companies. Courts have approved substantive consolidation of a debtor corporation with other corporations, partnerships, and individuals. Furthermore, some (but not all) Bankruptcy Courts will order the consolidation of a debtor with a non-debtor who is not even before the court, if the standards discussed below are satisfied.
The Bankruptcy Code has no express statutory support for substantive consolidation, and, like the concept of recharacterisation, authority for consolidation arises from the Bankruptcy Court’s equitable powers under Bankruptcy Code Section 105. Because of this lack of express statutory support and because substantive consolidation will necessarily harm certain creditors (ie, the creditors of the more solvent entities being consolidated), most courts will order consolidation only upon consent, or if there is not consent, sparingly upon a proper factual basis. (See, eg, R2 Invs LDC v World Access Inc (Re World Access Inc) 301 BR 217, 272 (Bankr ND Ill 2003).)
Historically, courts have analogised substantive consolidation to the concept of ‘piercing the corporate veil’ to defeat a corporation’s limited liability so as to make shareholders liable for corporate debts. Piercing the corporate veil, however, is a limited common law remedy, and does not result in the combination of the assets and liabilities of all members of a corporate family, as substantive consolidation does. (See Re Tureaud 45 BR 658, 662 (Bankr ND Okla 1985).) Nevertheless, veil-piercing factors are useful in a substantive consolidation analysis; these factors include whether the companies had common directors, whether one affiliate finances the other affiliate, or whether one affiliate is grossly undercapitalised, among other factors (ibid). The case of Augie/Restivo has reduced this multifactor test to two ‘critical factors’ for substantive consolidation (Union Sav Bank v Augie/Restivo Baking Co (Re Augie/Restivo Baking Co) 860 F 2d 515, 518 (2d Cir 1988)). Under Augie/Restivo, consolidation will be granted if it can be proven that (1) creditors dealt with the separate companies as a single economic entity and did not rely on the separate credit of the companies or (2) consolidation will benefit all creditors by eliminating the costs of untangling their finances, claims and assets (ibid).
The Augie/Restivo test is restrictive; it disfavours consolidation (absent creditor consent). Other courts have set a lower threshold to permit consolidation. For example, some courts require a proponent of consolidation first show a substantial identity between the entities to be consolidated and that consolidation will avoid some harm or grant some benefit. (See Eastgroup Props v S Motel Assn Ltd 935 F 2d 245, 249 (11th Cir 1991).) Once the proponent has proven this, the burden shifts to parties opposing consolidation, who must prove they relied on the separateness of the entities to be consolidated (ibid). Even if the parties opposing consolidation prove they relied on the separateness of the entities, the court may still order consolidation unless the harm from consolidation greatly outweighs the benefit (ibid).
The most recent ruling on substantive consolidation is Re Owens-Corning 419 F 3d 195 (3d Cir 2005). Owens-Corning makes substantive consolidation more difficult than Augie/Restivo. Under Owens-Corning, a proponent of consolidation must prove that (1) prior to the bankruptcy, the debtors to be consolidated disregarded their corporate separateness so significantly that creditors treated the different companies as a single legal entity, or (2) the entities’ assets and liabilities are so scrambled that consolidation helps all creditors (ibid at 211). Thus, a proponent of consolidation must show corporate breakdown so significant that creditors had contractual expectations that the entities were unified and that their expectation was reasonable (ibid at 212). Even when such proof is established, a creditor may still prevent consolidation if it proves it is adversely affected by the consolidation and it actually relied upon the separateness of the entities (ibid).
Accordingly, the law of substantive consolidation is different in the various courts of the US, and remains an evolving theory.
(b) What proceedings (motion, request, trial, etc) are required for the court to order the pooling of assets and liabilities?
Substantive consolidation may be accomplished through a motion to the Bankruptcy Court, by an adversary proceeding, or through a plan of reorganisation or liquidation. Regardless of how consolidation is sought, if a party objects to consolidation, a trial is required (often after significant pre-trial discovery by all sides). Also, whatever procedure is selected, ample advance notice must be given to creditors.
(c) Does your country’s law contemplate any partial pooling of assets and liabilities?
As discussed above, the power to consolidate derives from the inherent equitable powers of the Bankruptcy Court. As such, consolidation is a flexible remedy that may be tailored to the needs of the particular case. Therefore, there is nothing in US bankruptcy laws preventing ‘partial’ pooling of assets and liabilities, and there are limited examples under US law in which a court has determined a partial consolidation is warranted. For example, a court might authorise partial consolidation when a bank lender can prove it relied on the separate credit of one debtor entity, but all other creditors did not rely on the separateness among the various entities. In such a case, a court might permit the bank to satisfy its claim from the assets of the entity upon which it relied, and thereafter consolidate the entities to satisfy other creditor claims. Partial substantive consolidation is rare, however, and only used when the unique facts of the case warrant it.
(d) If the pooling of assets and liabilities is called for, are there any protections for certain types of creditors, such as creditors with a lien or other security interest in particular assets?
While there are no specific statutory protections for a properly secured and perfected creditor, such a creditor should ordinarily be protected from consolidation. A secured creditor has a separate and distinct property interest in the collateral securing the debt. This separate property interest means that, even though the collateral may be property of the estate, to the extent the secured claim is fully collateralised it will be treated outside of the general priority scheme existing under section 507 of the Bankruptcy Code. Indeed, the claim is against the debtor’s property and only derivatively against the debtor himself.
There are other systemic protections for secured creditors, protecting them from harm by consolidation. Most significantly, for a debtor to use collateral subject to a secured lender’s lien, the debtor must provide the secured party ‘adequate protection’ of the secured lender’s interest in its collateral (11 USC s 363(e)). Adequate protection is meant to protect the secured lender, through periodic cash payments, replacement liens, or some other equivalent mechanism, from a diminution in its collateral value by the debtor’s continued use of the collateral (11 USC s 361). Finally, if a secured party’s adequate protection fails (ie, the value of the collateral plus any adequate protection is less than its value when the bankruptcy case was filed) the court shall grant the secured lender a ‘super priority’ claim senior to all other claims in the case (11 USC s 507(b)).
7. How are secured creditors treated with respect to a family of companies? For instance, if a creditor has a security interest in the assets of one member of the family, and a guarantee from another member of the family, are both such claims valid in insolvency proceedings of the entire family?
The answer depends upon whether the two companies have been substantively consolidated as discussed in question 6. If not, then the claims against each company remain. The only caveat is that any payment from one creditor will mitigate the claims against the other. For example, if the creditor collects 80 per cent of its claim from the primary obligor, it can only collect 20 per cent from the guarantor. Of course, the guarantor may then have a claim against its affiliate, the primary obligor. (See 11 USC s 509(a).) That would be an intercompany claim, the treatment of which is discussed in question 5, above.
8. Do your laws or courts provide for post-insolvency commencement of new financing that allows continued operation of the business and provides adequate protection to the lender who made the loan? Explain.
Section 364 of the Bankruptcy Code governs a debtor’s ability to obtain credit in an insolvency case, and the corresponding protections provided to creditors providing post-bankruptcy credit. In particular, section 364 provides that if a debtor is unable to obtain unsecured credit, it may obtain secured financing ‘with priority over any and all administrative expenses ...’ (11 USC s 364(c)(1)). Furthermore, a debtor may incur debt secured by a senior or equal lien on property that is already subject to an existing lien if the debtor is unable to obtain financing and the existing lien holder is adequately protected (11 USC s 364(d)). (The concept of ‘adequate protection’ is discussed in question 6(d), above.) In any event, before a debtor can obtain any secured credit, it must seek court permission after proper notice to creditors and opportunity for a hearing. (See Fed R Bankr p 4001(c).)
9. Are directors and officers subject to civil or criminal sanctions if:
US law tends to be substantially less punitive than European countries regarding holding officers and directors criminally liable for their company’s insolvency. Accordingly, while officers and directors may be held liable for theft, fraud, securities fraud and similar crimes when they have an actual intent to do harm to a particular creditor or stockholder, none of these are bankruptcy crimes and are rarely seen (notable exceptions like Enron, Adelphia and WorldCom exist, of course). As to questions 9(b) and (c), no such crimes exist under US law, which allows US companies to continue to transact business even though they may be ‘in the zone of insolvency.’ As long as continuing to operate is a reasonable decision, such as where officers and directors believe the company’s fortunes may turn around, those continued operations will likely not lead to personal liability for the officers and directors. If the continued operations allow officers and directors to personally benefit at the expense of creditors, however, they may be liable to creditors for breach of fiduciary duty, as discussed in question 3(b) above.
B. INTERNATIONAL FAMILY OF COMPANIES
1. If one or more members of the corporate family is incorporated under or governed by the laws of another country, does that change your answers to any of the questions set forth above?
Other than in Chapter 15 of the Bankruptcy Code, the Bankruptcy Code purports to assert jurisdiction over all assets of the debtor ‘wherever located’ (11 USC s 541(a); Re Globo Comunicacoes E Participacoes SA, 317 BR 235 (SDNY 2004)). Therefore, the Bankruptcy Code does not restrict the relief discussed above only to assets in the US, and all such relief should (in theory) be available to a court or a creditor for all the debtor’s assets ‘wherever located.’ Practically speaking, and as further discussed below in question B.2(a), the ability of a US Bankruptcy Court to exercise jurisdiction over assets located outside of the US may be limited and therefore a court may decline to grant some or all of the relief over those foreign assets.
2. If insolvency/restructuring proceedings are instituted for corporate family members in different countries:
(a) What controls as to where the case must be filed (eg, centre of main interests, principal place of business, location of parent, etc)?
It is common for a US company to file a domestic bankruptcy case, while its foreign affiliate files a concurrent case in another country. In that circumstance, the debtor will develop protocols for cooperation among the courts, including procedures for international creditor notices, communications between courts, and joint hearings. See www.iiiglobal.org/ international/protocols.html for examples of these protocols. The US Bankruptcy Code was recently amended to provide specific authority for cooperation among US and foreign courts. (See 11 USC ss 1525–1532.)
(b) Do the courts attempt to exercise jurisdiction over the assets of the company filing domestically no matter where located (for example, overseas), or do they limit their jurisdiction to only those assets located in your country?
Section 109(a) of the Bankruptcy Code requires a debtor to be ‘a person that resides or has a domicile, a place of business, or property in the US…’ (11 USC s 109(a)). As discussed above, if a company is a proper debtor under Bankruptcy Code section 109, section 541(a) of the Bankruptcy Code extends the jurisdictional reach of the Bankruptcy Code to all the debtor’s assets ‘wherever located.’ This is a breathtaking scope of jurisdiction. If a company has any property in the US, it may be a proper debtor and once properly before the Bankruptcy Court, the court’s jurisdiction extends to all the debtor’s assets, even those in foreign jurisdictions.
The furthest reaches of this jurisdictional scope were probed in the recent bankruptcy case of the Russian oil company, Yukos (Case No 04–47742, SD Tex). Yukos was the largest oil producer in Russia and had approximately 200 subsidiary companies in Russia and other countries, but none in the US. In its bankruptcy petition, it reported having assets of over $12bn. It did not, however, have any operating assets in the US. Instead, its only claims to proper jurisdiction in the US were that its chief financial officer maintained an office in his home in Texas and that on the very date of the bankruptcy, Yukos had incorporated a subsidiary in the US and transferred to that subsidiary $2m from various sources. (See Re Yukos Oil Co 321 BR 396, 402, 406 (Bankr SD Tex 2005).) The court held that the assets located in the bank account alone were sufficient for the court to assert jurisdiction over all of Yukos’ assets, including its foreign assets (ibid at 407). Ultimately, however, the court dismissed the US bankruptcy case because it could not assure that Yukos’ principal creditor, the Russian government, would participate in the proceedings or be bound by the US Bankruptcy Court rulings (ibid at 411). Without such participation or binding effect, any restructuring would have been futile.
The Yukos bankruptcy is emblematic of how US Bankruptcy Courts handle the extraterritorial application of the Bankruptcy Code. So long as there is any property of the debtor, no matter how trivial, there is a sufficient statutory basis for the debtor to file a US bankruptcy case. However, once the slim statutory predicates are satisfied, the court will engage in a more practical analysis to determine whether, in its discretion, it should assert extraterritorial jurisdiction. This includes analysing whether the US court can properly effect a reorganisation of the debtor’s assets and liabilities, whether the creditors in the case will participate and be bound by a US proceeding, whether the US court is a convenient forum for the parties, the US’s interests in seeing the assets in question reorganised under the Bankruptcy Code, and general concerns of respect for foreign jurisdictions and comity.
(c) Would your courts enforce a court order from a foreign country that attempted to exercise jurisdiction over assets located in your country but owned by the company that is subject to the foreign insolvency proceedings?
Under new Chapter 15 of the Bankruptcy Code, a US court will grant ‘recognition’ to a representative of a foreign bankruptcy case upon application to the US Bankruptcy Court. Provided the actions of the foreign court are not ‘manifestly contrary to the public policy of the US,’ those actions will be respected here (11 USC ss 1506, 1517). The foreign representative may dispose of US assets, as long as the interests of US creditors are protected (11 USC s 1521(b)).
(d) Has your country adopted any procedures (such as the Model Law on Cross-Border Insolvency) to address the various issues that arise in dealing with cases of cross-border insolvency?
Chapter 15 of the Bankruptcy Code became effective for cases filed after 17 October 2005. The purpose of Chapter 15 ‘is to incorporate the Model Law on Cross-Border Insolvency so as to provide effective mechanisms for dealing with cases of cross-border insolvency…’ (11 USC s 1501(a)).
