Imagine that an insolvent foreign company’s assets are fully encumbered (perhaps not so difficult to imagine). Also imagine that the foreign company is simultaneously subject to receivership at the behest of secured creditors and also liquidation. Then imagine that the foreign jurisdiction’s laws allow the company’s secured creditors, through the receiver, to retain possession of the company’s assets and to satisfy debts directly from those assets.

This differs from the approach taken under United States law in two ways: (1) receivership proceedings (creatures of state law) and bankruptcy proceedings (creatures of federal law) are separate, normally exclusive proceedings; and (2) the Bankruptcy Code generally requires that a debtor’s assets be turned over to the debtor’s bankruptcy estate, which liquidates the assets and distributes the proceeds according to the established priority scheme.

Does the different approach to the treatment of secured debt and encumbered assets violate fundamental principles of the Bankruptcy Code and provide a debtor’s unsecured creditors with a basis for denying recognition of the foreign insolvency proceeding? Is that difference in approach “manifestly contrary” to United States public policy?

The debtor in question was ABC Learning Centres Ltd., an Australian company that was subject to parallel receivership and liquidation proceedings in Australia. The debtor’s Australian liquidators filed a petition for recognition of those proceedings under Chapter 15 of the Bankruptcy Code with the United States Bankruptcy Court for the District of Delaware. The bankruptcy court granted recognition of the Australian liquidation proceeding as a foreign main proceeding.

Under Chapter 15, when a foreign insolvency proceeding is recognized as a foreign main proceeding, the foreign representative is entitled to certain specified relief, including the immediate effectiveness of the automatic stay with respect to actions against the debtor’s assets located within the United States.

RCS Capital Development LLC, a judgment creditor of one of ABC’s subsidiaries, objected to recognition, and appealed the bankruptcy court’s recognition order. The United States District Court for the District of Delaware affirmed the bankruptcy court’s decision. RCS renewed its objection in an appeal to the United States Court of Appeals for the Third Circuit.

In In re ABC Learning Centres Ltd.^[1], the Third Circuit considered RCS’s appeal of the recognition of

ABC’s Australian liquidation proceeding as a foreign main proceeding, with its attendant application of the automatic stay.

RCS argued that the Australian liquidation proceeding could not qualify for recognition as a foreign proceeding (either as a foreign main proceeding or as a foreign nonmain proceeding) because the liquidation proceeding was a combined liquidation/receivership which operated solely for the benefit of the secured creditors, and so was not truly a “collective judicial or administrative proceeding.”^[2] RCS insisted that the Australian liquidation proceeding could not qualify for recognition because Australia’s treatment of secured debt and encumbered assets was manifestly contrary to United States’ public policy.

Under Australian law, receiverships and liquidation proceedings can run parallel, and a secured creditor in such liquidation/receivership proceedings may retain assets and realize upon them instead of surrendering those assets to the debtor’s estate and receiving a distribution from the estate. The court noted that “RCS contends we should not recognize the liquidation proceeding or uphold the stay, because the receivership would gain all the benefits of the ordered relief, and because it is a non- collective proceeding which contravenes our public policy in favor of collective insolvency proceedings.”^[3]

RCS argued that a “liquidation proceeding operating parallel to a receivership could [only] be granted Chapter 15 recognition ‘in a case where the secured creditors only have a portion of the assets.’”^[4] But where, as in the case of ABC, a debtor’s assets were fully encumbered, leaving “little for the liquidator to administer, aside from investigating the charges claimed by the secured creditors,” recognition would be manifestly contrary to U.S. public policy.^[5]

Section 1506 of the Bankruptcy Code provides that “[n]othing in [Chapter 15] 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.”^[6] Courts construe this public policy exception narrowly. Rather, it is “intended to be invoked only under exceptional circumstances concerning matters of fundamental importance for the United States.”^[7] The “key determination required ... is whether the procedures used in [the foreign proceeding] meet our fundamental standards of fairness.”^[8]

The ABC court contrasted the circumstances of debtor and creditor in ABC with those in In re Gold & Honey Ltd.^[9], in which the debtors’ lender initiated receivership proceedings in Israel and seized all of the debtors’ assets. After the Israeli court denied appointment of a receiver, the debtors filed Chapter 11 petitions in the United States. Notwithstanding the pending Chapter 11 cases and the automatic stay, the lender continued its efforts to have receivers appointed through the Israeli court.

The debtors sought and received a declaratory order from the bankruptcy court stating that the automatic stay applied to all of the debtors’ property wherever located. The lender persisted in its receivership action in Israel and was ultimately successful in obtaining appointment of a receiver. The Israeli receiver then filed a Chapter 15 petition with the bankruptcy court, seeking recognition of the Israeli receivership as a foreign main proceeding.

The Gold & Honey court refused recognition of the Israeli receivership, finding that such recognition would be manifestly contrary to United States public policy. The Israeli receivership, the ABC court observed “hindered two fundamental policy objectives of the automatic stay: ‘preventing one creditor from obtaining an advantage over other creditors, and providing for the efficient and orderly distribution of a debtor’s assets to all creditors in accordance with their relative priorities.’”^[10]

The ABC court also looked to the analysis afforded by the court in In re Ephedra Prods. Liab. Litig.^[11], where “a Canadian insolvency proceeding was challenged under the public policy exception because it did not afford a right to a jury trial. ... Despite our constitutional right to a jury, Canada’s lack of a right to a jury trial did not contravene a fundamental policy because the Canada proceedings afforded substantive and procedural due process protections, and ‘nothing more in required by § 1506 or any other law.’”^[12]

Surveying the facts before it, the ABC court soundly rejected RCS’s position. “Rather than contravene public policy,” the court reasoned, “recognition advances the policies that animate the collective proceeding requirement. RCS seeks to attach assets before the secured creditors can realize them. Without Chapter 15 recognition, RCS could skip ahead of the priorities of the secured creditors. ... RCS’s approach would eviscerate the orderly liquidation proceeding, and ignores all priority of debts. Efficient, orderly and fair distribution are not only the policies behind the collective proceeding requirement, but are some of the ‘chief purpose[s] of the bankruptcy laws.’ [citation omitted] Without bankruptcy proceedings, creditors would race to the courthouse to collect from a troubled entity, depleting assets and enabling some creditors to collect fully on the debts and others not at all, and with no regard to priority. Accordingly, it would contravene our policy ‘to provide an orderly liquidation procedure under which all creditors are treated equally’ if RCS could evade collecting its debt through the Australian liquidation proceeding.”^[13]

The court concluded that while the Australian approach to secured creditors’ treatment differs from the approach taken under United States law, both methods served similar ends. “The sole difference here,” the court stated, “is that Australian law allows secured creditors to realize the full value of their debts and tender the excess to the company, whereas secured creditors in the United States must generally turn over assets and seek distribution from the bankruptcy estate. ... The Australian legislators selected a different method to prioritize secured creditors. Rather than manifestly contravene our policy, Australian law established a different way to achieve similar goals.”^[14] 

[1] In re ABC Learning Centres Ltd., Case No. 12-2808, 2013 WL 4516820 (3rd Cir. August 27, 2013).

[2] Id. at *16.

[3] Id.

[4] Id. at *14.

[5] Id.

[6] 11 U.S.C. § 1506.

[7] In re Ran, 607 F.3d 1017, 1021 (5th Cir. 2010).

[8] In re Metcalfe & Mansfield Alternative Investments, 421 B.R. 685, 697 (Bankr. SDNY 2010). [9] In re Gold & Honey, Ltd., 410 B.R. 357 (Bankr. E.D.N.Y. 2009).

[10] In re ABC Learning Centres Ltd., 2013 WL 4516820 at *17.

[11] In re Ephedra Prods. Liab. Litig., 349 B.R. 333 (S.D.N.Y. 2006).

[12] In re ABC Learning Centres Ltd., 2013 WL 4516820 at *17-18.

[13] Id. at *18-19.

[14] Id. at *19. 

This article was previously published in Law360.