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This article was published in the August 9, 2004, edition of The National Law Journal.

How do foreigners perceive the American bankruptcy system? Do they think that all American judges have brush cuts, wear cowboy boots, chew tobacco and, with a "Don't Tread on Me" flag displayed behind them, refuse to assist those who hail from overseas? While foreigners likely do not see American judges as such caricatures, they do have cause for concern when, in connection with a foreign bankruptcy proceeding, the assistance of an American court is required.

There are two principles that create tension in the world of international bankruptcy. Under the principle of universalism, the orders of a foreign bankruptcy court should be recognized and enforced anywhere in the world regardless of where the debtor's assets are located. Under the principle of territorialism, courts in each country where the debtor's property is located have the right to administer the assets located in their country. Both principles promote valid objectives. Universalism promotes an efficient, coordinated and streamlined reorganization or liquidation. This should maximize the recovery of all stakeholders. Territorialism protects against unfair practices in other countries.

Section 304 of Title 11 of the U.S. Code (the Bankruptcy Code) is something of a hybrid combining elements of both universalism and territorialism. Section 304 is the means by which the representative of a foreign bankruptcy estate may obtain the assistance of an American court. Under § 304, a foreign representative may obtain an injunction against creditor activity in the United States, the turnover of property and other "appropriate relief." 11 U.S.C. 304 (b).

Before granting any relief under § 304, the U.S. court must determine that the relief is consistent with the just treatment of all stakeholders; protection against prejudice or inconvenience in processing claims in the foreign proceeding; preventing preferential or fraudulent dispositions of property of the estate; distribution of proceeds substantially in accordance with the distribution order under the Bankruptcy Code; comity; and a fresh start of the debtor (if applicable) (collectively known as the 304 factors). The touchstone of § 304 is flexibility. Principles of universalism are addressed by the comity factor. Principles of territorialism are addressed by the other factors.

Pros and cons

One of the attractive features of a § 304 proceeding is the potential for reduced administrative expenses. Because a § 304 case is ancillary to the foreign proceeding and not a separate plenary case with its own bankruptcy estate to be administered, the § 304 case should have substantially lower administrative expenses. The bulk of the administration will take place before the foreign court, with the American court merely recognizing and enforcing the orders of the foreign court. A § 304 proceeding is also appealing because it reduces the risk of inconsistent rulings concerning the same debtor. Only one court, the foreign court, will resolve claims and approve a distribution. Also, the bankruptcy process in many foreign courts works more quickly than the American process. An American Chapter 11 or 7 proceeding is more apt to interrupt the timetable of the foreign court.

One of the drawbacks of § 304 is that at times it can be unpredictable. The weight given to each of the 304 factors will depend in large part on the judge assigned to the case. Sometimes one appears before a judge who is a devotee of universalism. This judge will direct all substantive decisions to the foreign court. Other times, one may argue before a judge less willing to defer to the foreign court. This resistance is commendable on at least one level. The judges are very often not familiar with the bankruptcy laws of the foreign country. They want to make sure that the stakeholders are treated fairly, and what better way to accomplish this than to avoid the unfamiliar and keep control over the case?

There is a lively debate over the strengths and weaknesses of § 304. Regardless of who is right, § 304 is the card practitioners have been dealt. The case law contains many black and white examples in which § 304 relief is granted or denied appropriately. However, in the trenches, one sees a lot of gray areas where effective representation can sway a judge in favor of recognizing and enforcing orders of the foreign court. Here are a few of the strategies that can be used at key moments of a § 304 case.

Section 304 does not provide for an automatic stay. Hence, it is critical at the outset of a § 304 case that the foreign representative persuade the American court to issue an injunction against creditor activity. Usually, the court is willing to issue a temporary restraining order at the time the bankruptcy case is filed. The real fireworks start at the hearing for the preliminary injunction after all creditors have received notice.

The injunction application is no time to hold back. Filing a detailed affidavit from an expert on the law in the foreign jurisdiction can be essential. In that affidavit, practitioners should consider providing an overview of the foreign bankruptcy law, the choice of law rules, a description of the foreign court's supervision of the case, the fiduciary duties of the foreign representative, notice requirements and distribution priorities under the foreign law. Counsel should address all of the 304 factors. Then counsel should arrange for the foreign representative and its foreign counsel to appear for the preliminary injunction hearing to answer any questions of creditors or the court. The goal in all of this is to assure the court that the foreign jurisdiction has a fair system in place to administer the case.

Before the preliminary injunction hearing, counsel would do well to identify the administrative claimants such as landlords, warehousemen and key trade creditors. Counsel should also engage in private discussions with all of them so that they understand the plan going forward. These groups are often the squeaky wheels, which can rattle a court unnecessarily. It is a great benefit to educate them on the process beforehand. After this, they often turn from obstacles to supporters of the process.

Before the preliminary injunction hearing, it is important for the foreign representative to be able to explain to the American court with some data and appraisals how the foreign representative can maximize the return for stakeholders. Simply repeating the mantra that returns will be maximized if the reorganization or liquidation is coordinated in one court may be sufficient for a universalist-leaning judge, but likely will not satisfy a territorialist-leaning judge. True, this is a tall order; the foreign representatives are busy learning the debtor's business and commencing the bankruptcy case.

The situation is fluid, and it takes time to develop a fixed strategy. Nevertheless, certain creditors, such as warehousemen and statutory lien holders, will argue that they should be granted an exception from the injunction. They will argue that they can maximize the value of certain property better than the foreign representative can. They will back up their assertions with appraisals and other data. If the foreign representative responds with requests for more time to get organized, or makes vague representations on its ability to maximize returns, there is a great risk that the U.S. court will grant an exception to the injunction. The foreign representative needs to fight data with data, and appraisals with appraisals.

Another sensitive area is the turnover of property to the foreign jurisdiction. The 2d U.S. Circuit Court of Appeals in In re Koreag, 961 F.2d 341 (2d Cir. 1992), held that before property is turned over to the foreign court, the U.S. court should decide whether the foreign debtor has an ownership interest in the property. This seems benign on its face, but it can become a litigation quagmire. For example, if the foreign debtor is part of a corporate family tree of many companies, some of which are debtors in the foreign case, and some of which are not, determining ownership of assets can be a challenge (especially if there was poor record-keeping or corporate formalities.)

Americans as 'foreign debtors'

In the absence of other countervailing concerns, it might be useful if all the American companies were placed into bankruptcy in the foreign jurisdiction. The American entities will still qualify as foreign debtors as defined by § 304 so long as their principal place of business (the place from which they are managed by the board of directors and senior corporate officers) is in the foreign jurisdiction. The advantage with this approach is that the division of asset ownership among the entities is arguably no longer relevant. No matter which of the entities owns the property, one of them does. Therefore, the foreign court can assert jurisdiction over that property.

A final tip relates to asset sale and turnover motions. Asset sales are critical in a § 304 case. There are often a number of sales in each case. When counsel is seeking recognition of the order of the foreign court authorizing the sale of assets, it is wise to also seek an immediate turnover of the sale proceeds to the foreign court. A universalist judge will approve the sale and turnover of the property all at once. A territorialist judge is more of a challenge; obtaining turnover from him or her is the toughest challenge. Nearly all judges will grant a status-quo injunction, but when someone wants to start removing property from a U.S. jurisdiction, look out.

If things do not appear to be going well with a territorialist judge, counsel may want to request that the sale of property be approved with all liens and claims attaching to the proceeds in the same form and priority as they existed prior to the sale. Counsel then should offer to hold the sale proceeds in the United States pending further order of the U.S. court. Then counsel should wait until all the asset sales have been completed and make one turnover motion covering all the sales. This approach has proven to be quite successful. The turnover motion takes place later in the case when more details concerning anticipated distributions are known and can be presented to the U.S. court.

It is difficult to predict how a judge will weigh each of the 304 factors. This certainly makes § 304 practice an interesting challenge. The good news is that most of the time, even a territorialist-leaning judge will approve the § 304 relief that counsel request once he or she shows the court that creditors will be treated fairly in the foreign court. This article has offered practitioners some tips on how to present an effective § 304 case and deal with territorialist-leaning judges. Following the tips in this article will go a long way toward avoiding a comity of errors in anyone's § 304 case.