In an interesting decision with important implications for both Chapter 15 practice and financial institutions’ global credit risk analyses, a US Chapter 15 court (the “Court”) granted recognition of a number of Brazilian proceedings involving entities within the OAS Group. See In re OAS S.A. et al., Case No. 15-10937 (SMB) (Bankr. S.D.N.Y., July 13, 2015). Some aspects of the decision will be useful to cross-border insolvency practitioners for the views the Court provides on the appointment of foreign representatives (see our discussion in section 1, below) and on cross-border insolvency pitfalls (see sections 2-3, below). Global banks and financial institutions also should benefit from the reaffirmation of the tenet that Chapter 15 is the foreign representative’s “exclusive door” to the US court system, a notion that should streamline a bank’s contingency risk and global credit risk analyses (see section 3, below); on the other hand, they will also take note of certain complications that the decision introduces into their regulatory capital and counterparty’s credit risk review (see our discussion in section 4, below). In the following note, we share a few considerations mainly from a global credit risk management perspective.
1. Who is entitled to serve as Chapter 15 foreign representative?
Under US Chapter 15, the “foreign representative” is the person who applies to the US bankruptcy court for recognition of the foreign proceeding in which the foreign representative has been “appointed.” Much ado in the OAS Chapter 15 proceeding focused on the authorization and power of Mr. Tavares, the Brazilian representative appointed by the OAS boards of directors, to serve as Chapter 15 foreign representative. Relying on the Fifth Circuit's reasoning in Vitro,1 the Court concluded that a foreign representative does not need to be “specifically” authorized or appointed “by the foreign court” to act as the “foreign representative” in a Chapter 15 proceeding–instead, the Court held that a “foreign representative” can be appointed by the board of directors to represent the debtor and administer the reorganization, including for purposes of seeking Chapter 15 relief.
Although this approach on its face is consistent with Chapter 15 case precedents, in reality it goes one step further. Other Chapter 15 courts have in the past recognized a foreign representative even absent a specific foreign court approval. In this case, however, the Brazilian court had appointed a separate judicial administrator (Alvarez & Marsal) to supervise the reorganization. Relying on Brazilian law experts, Mr. Tavares was able to convince the Court that the Brazilian debtors were still running the companies’ business (and by the same token, that the role of the Brazilian judicial administrator was only of a supervisory nature), and that consequently the companies’ boards had the authority to appoint Mr. Tavares to his special role despite the parallel judicial appointment of an administrator.
While the recognition as Chapter 15 foreign representative of a person different than the judicially-appointed person may be appropriate in certain circumstances, it is a solution that should be carefully evaluated as it may impose a burden on the Chapter 15 court, create uncertainties for the parties involved, and ultimately open the door to abuses and manipulations.
2. Sophisticated coordination in cross-border insolvency matters is key to effective client representation
The Court precluded Aurelius Capital Management and Alden Global Capital, the two entities that opposed the Chapter 15 recognition of the Brazilian proceedings, from making arguments in the Chapter 15 case that were inconsistent with the position those same entities had taken before a British Virgin Island court where a related dispute was pending. Taking a holistic and genuinely cross-border approach, the Court concluded that principles of judicial estoppel and comity precluded Aurelius and Alden from arguing that the OAS debtors were not debtors in possession because those same objectors had made opposite arguments in submissions filed before the BVI court.
The restriction imposed by the Court is not unknown outside cross-border insolvency settings, but is nevertheless a welcome development in Chapter 15 settings because it should limit abusive litigation posturing.
The Court’s holistic approach is also a testament to the need for legal coordination in cross-border insolvency matters. Cross-border insolvency practice is highly complex because, by definition, it involves two or more proceedings pending in different countries. The realities of each cross-border insolvency proceeding are complex and can expose even sophisticated litigants to the risk of taking inconsistent positions across the various jurisdictions. The OAS decision carries the important implication that a well-calibrated case coordination across the multiple jurisdictions is key to effective client representation.
3. Chapter 15 provides the exclusive portal for a foreign representative to access the US court system—a tenet which should streamline contingency and credit risk analyses
The OAS decision restates a fundamental tenet in Chapter 15 that, regrettably, has been sometimes overlooked by US state and federal courts2—that Chapter 15 provides the “exclusive door” for the foreign representative to gain full access to state and federal court assistance in the United States. The tenet's rationale is far-reaching in its simplicity: “The goal is to concentrate control of these questions [of ancillary assistance to foreign proceedings] in one court …. [under] the expert scrutiny of the bankruptcy court.”3 The OAS decision represents a step towards more consistent US jurisprudence in this regard.
Financial institutions will appreciate this notion of concentration of all ancillary questions before the Chapter 15 court, because it improves the quality of and predictability in their contingency and credit risk analyses. For example, in a cross-border insolvency setting, the special protections of the contractual right to liquidate, terminate or accelerate a financial contract (e.g., securities contracts, commodity contracts, forward contracts, repurchase agreements, swap agreements, master netting agreements, etc.), known as the US Bankruptcy Code’s “safe harbors,” are imported into Chapter 15 but are only available and effective within a Chapter 15 case. If Chapter 15 were not the “exclusive door” to the US court system, a foreign debtor could strategically choose to sue a financial institution in a US state or federal court and, by obtaining a restraining order or injunction, restrict the financial institution’s ability to terminate or accelerate a repo or other financial contract. The Court’s reiteration of the principle that Chapter 15 constitutes the “exclusive door” makes such non-Chapter 15 strategy less likely to gain traction in the future.
4. Brazilian COMI for the OAS Austria entity creates a conundrum for financial institutions
One of the Brazilian debtors seeking Chapter 15 recognition was OAS Investments GmbH, an entity incorporated in Austria (OAS Austria). Under Chapter 15, the recognition of a foreign proceeding as a main proceeding involves the US court's review of whether the foreign proceeding is pending in the country where the foreign debtor has its center of main interest (COMI), and the COMI is presumed to be at the foreign debtor’s place of incorporation. OAS Austria had filed its proceeding in Brazil rather than in Austria, however, and as a result its Chapter 15 recognition became highly disputed. The Court concluded that in this case the COMI was not in the jurisdiction of incorporation (Austria), but in Brazil. This conclusion carries important implications also from a global credit risk management perspective, which are briefly touched upon in the following discussion.
OAS Austria is a special purpose vehicle (SPV) with (i) only a post office box in Vienna, Austria, (ii) no business, assets, a physical location, or employees in Austria, and (iii) creditors predominantly located worldwide. As to an SPV, the COMI analysis presents special challenges.
Echoing the approach adopted by the late Judge Lifland in the Bear Stearns Chapter 15 case,4 the Court proceeded to review the factors that, from a creditor’s standpoint, would lead an investor or purchaser of OAS Austria's notes to identify in what jurisdiction the investment was really “located” and the credit risk profile that would result from such “location.” The Court found that (a) OAS Austria's nerve center and headquarters being in Brazil, where the OAS parent entity had the power to elect executive officers and direct the business of OAS Austria, (b) OAS Austria's explanation in its Offering Memoranda that the executives and advisors of OAS Austria were located in Brazil, and, most importantly, (c) the creditors’ expectation (based on statements contained in the finance documentation regarding the notes being guaranteed by Brazilian entities, the company being an SPV, and risk disclosures including possible bankruptcy proceedings in Brazil) were all factors indicating that the purchasers of the notes understood that they were investing in Brazilian-based businesses, with no regard to the jurisdiction of incorporation.
In 2014, another Brazilian case, Lupatech S.A., also involved a scenario similar to the one in OAS. Lupatech Finance Limited, the Cayman Island financing arm of the Lupatech Group, filed its proceeding in Brazil as part of the Lupatech Group reorganization. In the US, where the Lupatech debtors sought Chapter 15 recognition, the same Court and judge granted recognition of the Cayman Islands entity's Brazilian case.5 Notably, in the Lupatech Chapter 15 proceeding no party objected to the relief. The OAS case may indicate a trend in favor of Brazilian COMI shifts.
COMI shifts. COMI disputes are not new in Chapter 15. Bear Stearns was the first Chapter 15 case where the COMI issue rattled the business community by introducing the possibility that the jurisdiction of the feeder fund, the manager, or other analogous nerve center and headquarters of the SPV could be the SPV’s COMI. What makes Bear Stearns a unique case, though, is that the COMI issue was raised by the court sua sponte. A different trend has emerged in Europe, where COMI shifts have been instrumental in the reorganizing company's pursuit of forum shopping strategies. Companies have migrated their COMI to England, relied on the fact that the creditors’ rights under the finance documents were governed by English law, or changed the governing law of their finance documents to English law, in each case for purposes of creating a “sufficient connection” to England thereby enabling the company to reorganize pursuant to UK schemes of arrangement.6 As in the OAS case, the change in COMI introduces a different jurisdiction in the picture, determining a shift in the laws of the forum that will apply to the reorganization proceeding. However, in all the non-Brazilian cases, the “new” COMI arguably represented an improvement from the general creditors’ perspective because it enabled the use of reorganization statutes or company law schemes that were otherwise not available in the jurisdiction of origin. Conversely, a shift to a Brazilian forum determines material changes in the global credit risk profile of a financial counterparty.
The Basel conundrum. The OAS decision in this respect has deep implications on the complex global credit risk analyses that financial institutions have to carry out when they calculate their risk exposures in all relevant jurisdictions. A financial institution that is subject to Basel III rules or other analogous regulatory capital requirements must analyze its risk exposures in all “relevant jurisdictions” and be able to conclude with a well-founded basis that any risk mitigation technique in relation to exposures, including netting, collateral and securitization, is legal, valid and enforceable upon an event of default, including any type of insolvency of the counterparty. The jurisdiction in which the insolvency proceeding regarding the counterparty is likely to occur is the most important “relevant jurisdiction” in the analysis. The OAS case complicates this analysis. Financial institutions will now be confronted with the catch-22 situation of having to dive into the complexities of the legal and economic position of the counterparty vis-à-vis its parent, its corporate group, and its creditors—because each one of those factors may implicate a new jurisdiction in which the insolvency proceeding may be filed. Similar considerations apply to financial institutions that are not subject to Basel III-type rules, although their situation may not always be a catch-22 one. As a result of the OAS decision, financial institutions may need to engage in much more due diligence of their clients than before, and failure to do so could reduce their return on equity.
In conclusion, although one could find the OAS decision to be driven by fairness considerations in light of the specific circumstances of the OAS Group, the decision carries the (probably unintended) effect of increasing the level of complexity of a financial institution’s review of its counterparty’s global credit risk, and may induce certain financial institutions to tweak their internal global credit risk management and client due-diligence policies. It is going to be interesting to see how financial market participants will react to the OAS decision once its implications have been fully digested.
Ad Hoc Grp. of Vitro Noteholders v. Vitro S.A.B. de C.V. (In re Vitro S.A.B. de C.V.), 701 F.3d 1031 (5th Cir. 2013), cert. dismissed, 133 S. Ct. 1862 (2013).
See, e.g., Drawbridge Special Opportunities Fund LP v. Barnet (In re Barnet), 737 F.3d 238, 251 (2d Cir. 2013), in which the court in dictum presumed that “other provisions of federal law provide the relief that the [UNCITRAL] Model Law [on Cross Border Insolvency] was intended to provide”—an indication, in the Barnet court’s view, that “Congress may have intended to limit the relief provided by Chapter 15 because it knew that additional relief was already available outside of Chapter 15.” The Barnet rationale would sanction parties seeking relief from multiple courts thereby avoiding the scrutiny of one bankruptcy court, with the risk of inconsistent application of comity by the numerous courts involved. This rationale would create procedural confusion and is inconsistent with the Chapter 15 architecture and legislative history.
House Rep. No. 109-31, Pt. 1, 109th Cong., 1st Sess. 100-111 (2005).
In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd., 347 B.R. 122 (Bankr. S.D.N.Y. 2007), aff'd, 389 B.R. 325 (S.D.N.Y. 2008).
See In re Lupatech, S.A. et al., Case No. 14-11559 (SMB) (Bankr. S.D.N.Y., filed May 22, 2014). The Brazilian cases of OGX Petróleo e Gás Participações S.A. and its affiliates also involved a scenario similar to the one in OAS, however Chapter 15 recognition was not sought in those cases.
See, e.g., Magyar Telecom B.V.  (Dutch company part of a Hungarian group migrated its COMI to the U.K.); Rodenstock GmbH  (German company used the English governing law of its finance documents as the required “sufficient connection” to England); PrimaCom Holdings GmbH  (ditto); Van Gansenwinkel Groep B.V. [22 July 2015] (Dutch company used the English governing law of its finance documents as the required “sufficient connection” to England); Apcoa Parking Holdings GmbH  (German company changed the governing law and jurisdiction clause in its finance documents to English law/England); DTEK Finance B.V.  (Dutch company changed the governing law in its finance documents to English law).