The United States Court of Appeals for the Second Circuit recently asserted its authority in addressing an asset sale in a cross-border bankruptcy case where the main insolvency proceeding was conducted in the British Virgin Islands in In re Fairfield Sentry Ltd., 768 F.3d 239 (2d Cir. 2014). Despite approval of a sale order by the court presiding over the British Virgin Islands insolvency proceeding, the Second Circuit Court of Appeals held that the sale must also be reviewed under the more stringent standards of Section 363 of the Bankruptcy Code – which did not bind the British Virgin Islands Court – to assure that the sale was in the best interest of the estate. Notwithstanding principles of comity, the Second Circuit held that, because the property sold in the foreign main proceeding was subject to attachment within the United States, it was “within the territorial jurisdiction of the United States” under Chapter 15, and the United States court was obligated to assure compliance with Section 363 of the Bankruptcy Code.

Fairfield Sentry Limited (Sentry) is a British Virgin Islands (BVI) investment fund that invested substantially all of its assets in a company owned by Bernard Madoff. Upon the collapse of Madoff’s empire, the company was put into a liquidation proceeding in the United States under the Securities Investor Protection Act (SIPA), and a trustee (SIPA Trustee) was appointed to oversee the liquidation of the fund.

Sentry filed multiple claims in the U.S. proceeding, which were contested by the SIPA Trustee and ultimately settled under a settlement agreement that provided Sentry with an allowed claim of $230 million against the U.S. estate.

Meanwhile, Sentry was also placed into a liquidation proceeding under the laws of the BVI and a liquidator was appointed. The BVI liquidator sought and obtained recognition of the BVI proceeding as “foreign main proceeding” under Chapter 15 of the Bankruptcy Code, which stayed proceedings against Sentry and certain of Sentry’s assets in the U.S.

In connection with the BVI liquidation, the liquidator conducted an auction of the $230 million claim, which was ultimately sold to Farnum Place, LLC (Farnum) for approximately 32% of its face value. To memorialize the transaction, the parties entered into a Trade Confirmation, which included provisions requiring the BVI trustee to seek approval of the sale from the BVI Court, as well as the U.S. court, and provided that New York law governed the agreement.

Three days after the Trade Confirmation was signed, the SIPA Trustee entered into a settlement agreement with a third party which brought $5 billion into the U.S. estate, causing the SIPA claim to nearly double in value.

Upon review of the sale, the BVI court approved the sale without expressing a view as to the issues that would be decided by the U.S. Court, including a review under Section 363 of the Bankruptcy Code. There is no equivalent of Section 363’s “good business reason” standard under applicable BVI law.

Subsequently, the BVI liquidator filed an application with the United States Bankruptcy Court for the Southern District of New York to review the sale under Section 363 of the Bankruptcy Code, requesting an order disapproving the transaction on the basis that it was not in the best interest of the estate and its creditors. That application was denied by the Bankruptcy Court, which characterized the effort as a case of seller’s remorse, holding that: (i) the U.S. court did not have authority to review the sale as the transaction did not involve property within the United States and (ii) comity required deference to the BVI court’s decision approving the sale. On appeal, the District Court affirmed the Bankruptcy Court’s holding.

The Second Circuit reversed the holding of the lower courts and held that the Trade Confirmation was subject to review under Bankruptcy Code Section 363. In so holding, the Second Circuit found that: (i) the SIPA claim was in fact property that was an interest of the debtor within the territorial jurisdiction of the U.S. and (ii) comity considerations did not require deference to the BVI court.

Under Section 1520 of the Bankruptcy Code, sales in a foreign proceeding are subject to review under Section 363 if the property involves the “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 sections would apply to property of an estate.” 11 U.S.C. § 1520(a)(2). The Second Circuit held that the SIPA claim was property within the territorial jurisdiction of the U.S. not because the fund against which the claim could be made was in the U.S., but because the claim was subject to garnishment or attachment within the U.S. meeting the requirements of section 1502(8) of the Code. Under New York law, any property that can be assigned or transferred is subject to attachment and garnishment, and the situs of that property is the location of the party of whom performance is required, in this instance, the SIPA Trustee. Therefore, the situs of the SIPA claim was the location of the SIPA Trustee: New York.

The Second Circuit further analyzed whether the concepts of comity found throughout Chapter 15 of the Bankruptcy Code required deference to the BVI court’s determination approving the sale. The Second Circuit concluded that deference was not required. First, the Court concluded that its obligation to review the sale under Section 363 was mandatory and not optional, an example of multiple limits on comity that are built into Chapter 15. Second, there was no evidence that the BVI court expected comity in the circumstances in light of the BVI court’s express reluctance to comment on Section 363 analysis to be performed by the U.S. court.

The Second Circuit remanded the case to the Bankruptcy Court with express guidance on the standard to be applied, which included a “subtle” direction to consider whether an asset is “increasing or decreasing in value” in order to “enhance the value of the estate.”

This opinion is significant for creditors with claims in cross-border proceedings. Even if a claim against property within the U.S. is held by a foreign estate and sold by the foreign estate, the sale will nonetheless be subject to scrutiny and review by U.S. courts under Section 363 of the Bankruptcy Code.