2nd Circuit Clarifies Center of Main Interests- Bankruptcy Law Resource Centre

By Diane Davis

The U.S. Court of Appeals for the Second Circuit April 16 held that a debtor’s center of main interests (COMI) is determined as of the time of filing of a Chapter 15 bankruptcy petition, and a court may consider the time period between the initiation of the foreign liquidation proceeding and the filing of the Chapter 15 petition to ensure that a debtor has not manipulated its COMI in bad faith (Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.), 2d Cir., No. 11-4376-cv, 4/16/13).

Affirming the decision of the district court, Chief Judge Dennis Jacobs concluded that the COMI of debtor Fairfield Sentry Limited, the largest “feeder fund” that invested with Bernard L. Madoff Investment Securities LLC, was in the British Virgin Islands (BVI) at the time of the Chapter 15 petition, and that Sentry did not manipulate its COMI in bad faith between the initiation of the BVI proceeding and the filing of the Chapter 15 petition.

Resolves Split Among Lower Courts in New York

“The Second Circuit’s decision resolves a split among lower courts in New York regarding an important question arising in Chapter 15 cases and offers guidance in interpreting the meaning of ‘center of main interest,’” Douglas P. Bartner and Robert A. Britton of Shearman & Sterling LLP, New York, N.Y., told BNA April 18. “The Second Circuit’s opinion is an accurate interpretation of the text of Chapter 15,” they said in an email.

“The Second Circuit acknowledged the differing view held by In re Millennium Global Emerging Credit Master Fund Ltd., 458 B.R. 63 (Bankr. S.D.N.Y. 2011), aff’d, 474 B.R. 88 (S.D.N.Y. 2012), but ultimately found that the present tense used in the statutory definition of ‘center of main interest’ must refer to the time that the Chapter 15 petition is filed rather than the time that the applicable foreign proceeding was commenced,” Bartner and Britton said. They recently discussed this issue and the Millennium and Sentry cases in an article in Bloomberg BNA’s Bankruptcy Law Reporter, “The Timing Is Off: The Definitional Gap Between Plain Language and Legislative Intent in the Recognition of Foreign Proceedings” (25 BBLR 501, 4/11/13).

“Importantly, the Second Circuit also recognized the potential for ‘center of main interest’  manipulation that arises from applying the plain language of Chapter 15, and stated that courts may consider whether a debtor has manipulated its ‘center of main interest’ in bad faith as part of the recognition analysis,” Bartner and Britton said. Thus, while “going a long way to better define COMI, the Second Circuit clearly is mindful of the tension between the strict statutory reading of when to examine ‘center of main interest’ and the inequity that may arise from not taking a close look at the facts surrounding the selection of the venue for the foreign proceeding,” they said.

Chapter 15 Doors ‘Open’ to Liquidators

“The Second Circuit’s decision provides clarity and certainty as to the Liquidator’s ability to use the tools of Chapter 15 to assist his cross-border recovery efforts for the stakeholders of Fairfield Sentry—all of which are victims of the Madoff fraud,” an April 16 press release from Brown Rudnick LLP, New York, N.Y., states. “More generally, the decision confirms that the doors to Chapter 15 relief and U.S. courts are not closed to off-shore funds in liquidation proceedings (like Fairfield Sentry).”

“Cross-border insolvency practitioners worldwide should be pleased that the Second Circuit has provided guidance to courts nationwide as to several critical and often hotly contested Chapter 15 gating issues, including the ‘center of main interests’ concept for foreign main proceeding recognition and the ‘public policy’ exception to recognition and assistance,” Brown Rudnick partner David Moulton, who argued the appeal before the Second Circuit, said in the press release. “Significantly, the opinion also makes it clear that liquidators of offshore funds will not be summarily precluded from access to and relief from US courts under Chapter 15, a fear that arose from some earlier lower court cases,” he added.

Robert A. Wallner of Milberg LLP, New York, N.Y., who argued the case for appellant Morning Mist Holdings Limited, declined to comment following the court’s decision.

Foreign Main Proceedings

For a foreign proceeding to be recognized as a “foreign main proceeding,” it must be “pending in the country where the debtor has the center of its main interests,” the court said, citing Bankruptcy Code Section 1517(b)(1). That determination is based on a debtor’s COMI at the time the Chapter 15 petition is filed, the court noted. A court may look at the period between the commencement of the foreign proceeding and the filing of the Chapter 15 petition, the court said, but there is no support for shareholder Morning Mist Holdings Limited’s contention that a debtor’s entire operational history should be considered.

According to the court, upon the revelation of the Madoff fraud in December 2008, the debtors discontinued the transfer of funds for investment with BLMIS in New York, which comprised 95 percent of Sentry’s investments. The board of representatives resigned shortly thereafter, and contracts were severed, the court said. Thus, the debtors have no place of business, no management, and no tangible assets located in the United States, and the debtors’ activities for an extended time period have been in connection with winding up the debtors’ business, the court said. Although Sentry had assets in other jurisdictions, the administration of its affairs in the relevant time was orchestrated from the BVI, the court said.

The court also found that the confidentiality of BVI bankruptcy proceedings does not offend U.S. public policy. According to the court, Morning Mist cannot establish that “unfettered public access to court records is so fundamental in the United States that recognition of the BVI liquidation constitutes one of those exceptional circumstances contemplated in Section 1506.” Public access to court documents is not an “exceptional and fundamental value,” the court opined. “It is a qualified right; and many proceedings move forward in U.S. courtrooms with some documents filed under seal,” the court said.

Winding Down After Madoff’s Arrest

Debtor Sentry was organized in 1990 as an International Business Company under the laws of BVI. From 1990 until Madoff’s arrest on Dec. 11, 2008, Sentry was invested with BLMIS. Sentry administered its business interests from the BVI, where its registered office, registered agent, registered secretary, and corporate documents were located. Day-to-day operations were handled by investment manager Fairfield Greenwich Group based in New York.

When Madoff was arrested, Sentry’s two independent directors, Jan Naess and Peter Schmid, suspended all share redemptions and began winding down Sentry’s business and preserving assets in anticipation of litigation and bankruptcy. In May 2009, shareholder Morning Mist filed a derivative action in New York state court, claiming that Sentry’s directors, management, and service providers breached duties to Sentry.

Liquidator Appointed

Subsequently, on July 21, 2009, the High Court of Justice of the Eastern Caribbean Supreme Court (the BVI court) entered an order which commenced Sentry’s liquidation proceedings under Virgin Islands Insolvency Act of 2003, and appointed Kenneth Krys and Christopher Stride—who later resigned—as liquidators. On June 14, 2010, the liquidator petitioned the U.S. Bankruptcy Court in the Bankruptcy Law Resource CenterSouthern District of New York for recognition of the BVI liquidation proceedings under Chapter 15.

As of that date, Sentry’s liquid assets consisted of approximately $73 million in Ireland, $22 million in the United Kingdom, and $17 million in the BVI. Sentry also had claims and causes of action, including claims for $6 billion in customer funds under the Securities Investor Protection Act, $3 billion from Madoff customers who profited from redemptions in New York, and $150 million in similar redemption claims in the BVI.

Foreign Main Proceeding Recognized in U.S

On July 22, 2010, the bankruptcy court granted the liquidator’s Chapter 15 recognition petition. To determine Sentry’s COMI, the court examined the period between December 2008, when Sentry stopped doing business, and June 2010, when the Chapter 15 petition was filed. The court concluded that Sentry’s COMI for the purpose of recognition as a main proceeding was in the BVI, not elsewhere and, thus, recognized the BVI liquidation as a “foreign main proceeding” under Section 1517(b)(1). Recognition of the BVI liquidation as a foreign main proceeding imposed an automatic stay under Section 1520 on any other proceedings against Sentry in the United States, including the derivative action brought by Morning Mist.

District Court Affirmed

Morning Mist appealed to the district court, which affirmed, holding that the bankruptcy court properly considered Sentry’s administrative activities in its COMI analysis, and correctly considered Sentry’s COMI as of the filing of the Chapter 15 petition and not over its 18-year operational history. Thus, the automatic stay was upheld.

Morning Mist appealed to the Second Circuit, arguing that the bankruptcy court should have looked at Sentry’s entire operational history. Citing Millennium, Morning Mist urged the appeals court to employ the American jurisdictional concept of “principal place of business” when considering COMI, which would require consideration of a debtor’s operational history.

Morning Mist also contended that the bankruptcy court should have applied the public policy exception available under Section 1506 because the BVI proceedings were “cloaked in secrecy.”

COMI Not Defined

Section 1502, the appeals court explained, defines a foreign main proceeding as a “foreign proceeding pending in the country where the debtor has the center of its main interests,” and defines a foreign nonmain proceeding as a “foreign proceeding, other than a foreign main proceeding, pending in a country where the debtor has an establishment.” The statute does not define COMI, the court noted, but Section 1516(c) establishes a presumption: “[i]n the absence of evidence to the contrary, the debtor’s registered office … is presumed to be the center of the debtor’s main interests.”

Focus on Present Tense

The appeals court concluded that a debtor’s COMI is determined as of the time of the filing of the Chapter 15 petition. To offset a debtor’s ability to manipulate its COMI, a court may look at the time period between the initiation of the foreign liquidation proceeding and the filing of the Chapter 15 petition. In making this determination, the appeals court looked to the present tense of Section 1517 (b), which states as follows: “a foreign proceeding shall be recognized … as a foreign main proceeding if it is pending in the country where the debtor has the center of its main interests.” The present tense suggests that a court should examine a debtor’s COMI at the time the Chapter 15 petition is filed, the court said.

The court also noted that nearly every federal court to address this question has determined that COMI should be considered as of the time the Chapter 15 petition is filed, the court said, citing In re Ran, 607 F.3d 1017 (5th Cir. 2010)(22 BBLR 785, 6/10/10). According to the Fifth Circuit, third parties (primarily creditors) should be able to ascertain a debtor’s COMI. The Second Circuit agreed with this approach.

The Second Circuit rejected the principal place of business approach under Millennium, concluding that Congress’s decision to use the term “COMI” instead of principal place of business” was intentional. According to the court, the concept was drawn from the European Union Convention on Insolvency Proceedings, which says that the “centre of main interests should correspond to the place where the debtor conducts the administration of  is interests on a regular basis and is therefore ascertainable by third parties.” Like the U.S. statute, the EU Regulation uses the present tense, the court noted.

Further, European case law interpreting COMI appears to generally focus on whether a debtor’s COMI is regular and ascertainable, the court said.

COMI Factors

The appeals court found that any relevant activities, including liquidation activities and administrative functions, may be considered in the COMI analysis. The court also found the nonexclusive list in In re SPhinX Ltd., 351 B.R. 103 (Bankr. S.D.N.Y. 2006), to provide a widely adopted list of COMI factors, such as: the location of the debtor’s headquarters, the location of those who actually manage the debtor, the location of the debtor’s primary assets, the location of the majority of the debtor’s creditors or of a majority of the creditors who would be affected by the case, and/or the jurisdiction whose law would apply to most disputes. The court warned against mechanical application of these factors, however.

No Public Policy Exception

Section 1506, the court explained, provides that “[N]othing in this chapter prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States.” According to the court, this statute should be read “restrictively”and invoked only “under exceptional circumstances concerning matters of fundamental importance for the enacting State.”

The confidentiality of BVI bankruptcy proceedings does not offend U.S. public policy, the Second Circuit concluded. Public summaries are available, the court noted, and Morning Mist could not establish that “unfettered public access to court records is so fundamental in the United States” that it qualifies as an exceptional circumstance, the court said. “The right to inspect and copy judicial records is not absolute,” the court noted. According to the court, public access to court documents is not an exceptional and fundamental value, but is a “qualified right.” Thus, there is no basis on which the court could conclude that recognition of the BVI liquidation is manifestly contrary to U.S. public policy, the court said.

Judge Ralph K. Winter and Judge Laura Taylor Swain of the U.S. District Court for the Southern District of New York, sitting by designation, joined the opinion.

Robert A. Wallner and Kent A. Bronson of Milberg LLP, New York, N.Y., and Stephen A. Weiss of Seeger Weiss LLP, New York, N.Y., represented the appellants Morning Mist Holdings Limited, and Miguel Lomeli. David J. Molton, Daniel J. Saval, May Orenstein, and Kerry L. Quinn of Brown Rudnick LLP, New York, N.Y., represented the appellees Kenneth Krys and Christopher Stride.