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B U S I N E S S R E S T R U C T U R I N G

Recent Developments in Bankruptcy and Restructuring Vol. 2 No. 3 March 2003

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Beginning in 2003, three-ring binders will be available to readers of theBusiness Restructuring Review. To obtain a binder free of charge, send ane-mail message requesting one to mgdouglas@jonesday.com.

Expanding the Scope of theAutomatic Stay to Co-DefendantMark G. Douglas

A basic tenet of federal bankruptcy law is that the automatic stay suspends credi-tor collection efforts and litigation against a debtor that files for bankruptcy pro-tection, but does not apply to actions directed toward non-debtor third-parties.Still, there are exceptions to the rule. Under the right circumstances, the scopeof the stay may be expanded to prevent actions against a non-debtor. One suchcircumstance — namely, where the debtor and a company that is wholly ownedby him are co-defendants in litigation — was the subject of a decision recentlyhanded down by the United States Court of Appeals for the Second Circuit. InQueenie, Ltd. v. Nygaard Int’l, the Second Circuit held that the automatic stayapplied to preclude continued litigation against the debtor’s wholly owned cor-poration because adjudication of a claim against the corporation would have an“immediate adverse economic impact” on the debtor.

The Automatic StayWhen a petition for relief under the Bankruptcy Code (other than an ancillarypetition in furtherance of a qualified foreign insolvency proceeding) is filed byor against a debtor, a statutory injunction — or “automatic stay” — immedi-ately becomes effective to suspend creditor collection efforts and litigation againstthe debtor and property of its bankruptcy estate. Bankruptcy Code section362(a) stays, among other things, “the commencement or continuation, includ-ing the issuance or employment of process, of a judicial, administrative, or otheraction or proceeding against the debtor that was or could have been commencedbefore the commencement of the case . . . or to recover a claim against the debtorthat arose before the commencement of the case.” The “automatic stay” also pre-cludes the enforcement of a pre-bankruptcy judgment against the debtor or its

2 Expanding the Scope ofAutomatic Stay to Co-Defendant

The Second Circuit ruled that theautomatic stay prohibited continu-ation of litigation against a corpo-ration wholly owned by the debtordue to the immediate adverse eco-nomic impact on the debtor.

3 What’s New at Jones Day

4 Chapter 11 Plan DeprivingCreditor of Default Interest notProposed in Bad Faith

According to the Ninth Circuit,when a debtor reinstates a defaultedobligation under a plan, it need notpay interest on the creditor’s claimat the default rate to render theclaim unimpaired.

7 In Brief

9 Legislative Alert

10 Bankruptcy Filing to PreventAsset Sale Constitutes Bad Faith

The Eleventh Circuit held that thebusiness judgment rule does not in-sulate a company’s decision to filefor bankruptcy with an impropermotive.

13 Managing TransnationalInsolvencies

A recent Third Circuit ruling illus-trates the importance of comity incross-border litigation and thepressing need to enact long-stalledlegislation governing transnationalbankruptcies.

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property, “any act to obtain possession”of estate property, to exercise controlover estate property and a wide varietyof creditor enforcement actions, includ-ing perfecting a lien on the debtor’sproperty and “any act to collect, assessor recover a claim against the debtorthat arose before the commencement ofthe case.”

The automatic stay is broad inscope and applies to almost every formaland informal action against the debtoror its property. Its purpose is to give thedebtor a breathing spell from creditorsduring which either the debtor can de-vise a repayment or reorganization planor a bankruptcy trustee can effect an or-derly liquidation of the debtor’s assets.The automatic stay also protects credi-tors by averting a scramble for thedebtor’s assets and facilitating an orderlyliquidation procedure under which allsimilarly situated creditors are treatedequally.

Automatic Stay Exceptions and Relieffrom StayCertain actions are excepted from theautomatic stay. Most of these excep-tions are based upon important policyconsiderations developed over manyyears predicated upon the perceptionthat certain actions should not inter-rupted or foreclosed by a bankruptcy fil-ing because the prejudice suffered bynon-debtors outweighs the “breathingspell” policy underlying the automaticstay. Thus, Bankruptcy Code section362(b) provides that the stay does notpreclude, among other things, the com-mencement or continuation of criminal,paternity, child support, alimony ormaintenance actions, certain setoffs bystock and commodities brokers, forwardcontract merchants and securities clear-ing agencies, tax audits or the issuanceof a notice of tax liability and actions by

a commercial lessor to obtain possessionof leased property if the lease expiredprior to the bankruptcy filing.

While the stay in Bankruptcy Codesection 362(a) is automatic, it is not per-manent. As a general rule, the stay ofactions against a debtor’s property con-tinues until the asset is no longer part ofthe bankruptcy estate (i.e., when theproperty has been sold or abandoned orwhen the estate no longer exists becausethe case is dismissed). The stay of anyother act specified in the statute contin-ues until the earliest of closure or dis-missal of the bankruptcy case or thedenial or grant of a discharge to thedebtor. However, the automatic staymay be lifted earlier. Any entity seekingrelief from or modification or termina-tion of the stay may petition the bank-ruptcy court for this purpose. The courtwill grant the request if it finds “cause”to do so. “Cause” is typically foundwhere the debtor cannot adequately pro-tect a creditor’s interest in property, orwhere the debtor lacks “equity” in theasset (e.g., because it is encumbered bymortgages in excess of the value of theproperty) and the property is not neces-sary for the debtor, in a chapter 11, 12or 13 case, to reorganize effectively.

Application to Non-DebtorsThe automatic stay generally does notbar acts against non-debtors (such as aco-debtor who is liable on a debt withthe debtor). However, a bankruptcycourt may extend the stay or enjoin actsagainst non-debtors where such actionswould adversely affect the debtor’s es-tate, frustrate the statutory scheme em-bodied in the Bankruptcy Code orinterfere with the debtor’s efforts to re-organize. For example, if an act againsta non-debtor would detrimentally influ-ence the debtor and serve as an indirectmeans of collecting a claim against the

debtor, the court may enjoin such an actin order to ensure that a creditor maynot do indirectly that which the credi-tor is forbidden to do directly. The piv-otal question is whether the debtor willsuffer irreparable harm if the proceed-ings against the non-debtor go forward,since it is the debtor’s interest, and notthe interests of non-debtors, which theinjunctive powers are designed to pro-tect. It is an extraordinary exercise of abankruptcy court’s equitable discretionto stay acts against non-debtors. Thecourt may do so only if unusual circum-stances are present. In Queenie, Ltd. v.Nygaard Int’l, the Second Circuit foundthat the facts before it were sufficientlyunusual to warrant expansion of the au-tomatic stay to preclude continued liti-gation against the debtor’s co-defendantand wholly owned corporation.

BackgroundQueenie, Ltd. (“Queenie”) was a corpo-ration engaged in the distribution ofwomen’s garments. The company usedfabric designs acquired from variousthird-parties to create its clothing, whichwas manufactured by overseas fabricmills. Queenie’s sole shareholder wasMarc Gardner (“Gardner”). Queeniedid business for approximately eightyears with Heavenly Fabrics, Inc.(“Heavenly”). Heavenly was a textileimporter that contracted for the manu-facture of fabrics for women’s appareland provided designs for its clients, whoin turn purchased fabric from Heavenlyfor the purpose of creating garmentsthat used the designs.

In 1996, Queenie commenced liti-gation against a competitor, NygaardInternational (“Nygaard”), contendingthat Nygaard had appropriated variouscopyrighted designs. A flurry of coun-terclaims ensued, so that the copyrightinfringement litigation ultimately in-

B u s i n e s s R e s t r u c t u r i n g R e v i e w I 3

John J. Rapisardi’s (New York) bi-monthly bankruptcy column entitled“Thou Shalt Not Trade: Restrictions onTrading in Bankruptcy” appeared inthe March 14, 2003 edition of theNew York Law Journal. He coauthoredan article with Mark G. Douglas (NewYork) entitled “Lockup Lockout?” thatappeared in the January 7, 2003 edi-tion of The Daily Deal.

Richard M. Cieri (Cleveland) was rec-ognized in the December 15, 2002edition of Turnarounds & Workouts asone of the “Outstanding BankruptcyLawyers of 2002” for his outstandingachievements as counsel to the OfficialFinancial Institutions’ Committee ap-pointed in the Kmart Corp. chapter 11cases, debtor’s counsel in the LaidlawInc. and World Kitchen, Inc. chapter11 cases and counsel in the Excel/NRG restructuring. He and PaulD.Leake (New York) were includedamong the leading U.S. insolvencyand restructuring attorneys in the 2003edition of International Financial Re-view 1000. Mr. Cieri was also selectedfor listing in the 2003 edition ofthe K & A Restructuring Register:America’s Top 100.

Corinne Ball (New York) was amongthe faculty for the March 6-7, 2003“Corporate Mergers and Acquisitions”program in San Francisco jointly spon-sored by the American Law Instituteand the American Bar AssociationCommittee on Continuing ProfessionalEducation as part of their 18th AnnualAdvanced ALI-ABA Course of Study.A two-part article co-authored by herand John K. Kane (New York) entitled“A Practical Guide to Distress M&A”appeared in the January and February2003 editions of The M&A Lawyer.Ms. Ball and David G. Heiman (Cleve-land) were among the attorneysnamed in the January 15, 2003 edi-tion of Turnarounds and Workouts aslead counsel in “Successful Chapter11s - 2002.”

Erica M. Ryland (New York) spoke ata seminar on Telecommunications Re-structuring in New York City, spon-sored by Law Seminars International,on February 13-14, 2003.

On January 16, 2003, Carl M. Jenks(New York) presented a paper entitled“Filing for Bankruptcy: A Starter Kit forCorporate Tax Advisors” to the BNATax Management Advisory Board inNew York City that will ultimately bepart of the new BNA portfolio on Cor-porate Bankruptcy.

An article discussing recent develop-ments in the chapter 11 case of Na-tional Century Financial Enterprises,whose bankruptcy team is directed byCharles M. Oellermann (Columbus)and Paul E. Harner (Chicago), ap-peared in the “Weekly News andComment” section of the December24, 2002 edition of Bankruptcy CourtDecisions. Mr. Harner was quoted inthe February 28, 2003 issue of TheNew York Times in an article discuss-ing the confirmation of a plan of reor-ganization in Laidlaw, Inc.’s chapter11 cases.

What’s New at Jones Day?

Log on to www.jonesday.com for additional information concerning Jones Day’sRestructuring and Reorganization Practice as well as the firm’s other practicegroups throughout the world.

continued on page 8

volved Queenie, as plaintiff and coun-terclaim defendant, Nygaard as defen-dant and counterclaim plaintiff, andGardner, Heavenly and its principal, ascounterclaim defendants. A jury re-jected Queenie’s copyright infringementclaim. However, it found Queenie,Gardner, Heavenly and its principal li-able to Nygaard for tortuous interfer-ence with economic advantage andawarded punitive damages against all ofthem. After the district court refused tovacate the judgment on various grounds,

the counterclaim defendants appealed tothe Second Circuit. Gardner also fileda petition for relief under chapter 11 ofthe Bankruptcy Code. Queenie did notfile for bankruptcy.

Two issues were before the Court ofAppeals: the propriety of the judgmentbelow on the merits and whether theautomatic stay applied not only toGardner, but to Queenie and the othercounterclaim defendants as well. TheCourt rejected the appeal on the meritsin short order, finding that the record

below supported the district court’s rul-ing. Addressing the automatic stay is-sue, the Second Circuit remarked at theoutset that it is well established that asuit against a co-defendant is not auto-matically stayed by the debtor’s bank-ruptcy filing. However, the Courtobserved, the stay can apply to non-debtors, but “normally does so” onlywhen a claim against the non-debtorwill have an immediate adverse eco-nomic consequence for the debtor’s

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Chapter 11 Plan Depriving Creditor of DefaultRate Interest not Proposed in Bad FaithShana F. Klein and Mark G. Douglas

Among the important advantages af-forded to a chapter 11 debtor-in-posses-sion is the ability to leave a creditorunimpaired by reinstating a defaultedobligation according to its terms prior todefault. However, there is a disagree-ment among courts as to whether “cur-ing” outstanding defaults under abreached contract requires payment ofinterest at the default rate specified inthe contract as well as any related latecharges and fees. The Court of Appealsfor the Ninth Circuit recently took thelatest bite from an increasingly contro-versial apple in In re Sylmar Plaza, L.P.Addressing both the “cure” amount con-troversy and the Bankruptcy Code’s re-quirement that a chapter 11 plan ofreorganization be proposed in “goodfaith,” the Ninth Circuit held that aplan of reorganization “crafted solely” todeprive a secured creditor of its contrac-tual default rate of interest compliedwith all the requirements of section1129 of the Bankruptcy Code, includ-ing the requirement of “good faith.”

The Bankruptcy Code’s Good FaithRequirementAny chapter 11 plan of reorganizationsubmitted to a bankruptcy court for ap-proval, or “confirmation,” must satisfycertain basic requirements set forth inthe Bankruptcy Code. Among those re-quirements is the mandate in Bank-ruptcy Code section 1129(a)(3) thatevery plan be “proposed in good faithand not by any means forbidden bylaw.” This “good faith” requirement,which is derived from a long historypre-dating the enactment of the Bank-

ruptcy Code in 1978, is designed to en-sure that a bankruptcy court has the dis-cretion to prevent confirmation ofreorganization schemes that arguablycomply with the technical strictures ofthe statute, but are somehow at oddswith the fundamental objectives andpurposes of federal bankruptcy law.Thus, Bankruptcy Code section1129(a)(3) has been construed to re-quire that a plan be proposed with“honesty and good intentions” and with“a basis for expecting that a reorganiza-tion can be effected.” In keeping withthat mantra, bankruptcy courts are com-missioned with determining whetherevery plan, viewed in light of the “total-ity of the circumstances,” fairly achievesa result consistent with the BankruptcyCode. The scope of the court’s discre-tion in making that determination isconsiderable.

Reinstatement of DefaultedObligations in BankruptcyA chapter 11 debtor’s ability in a bank-ruptcy case to cure a default and rein-state the terms of a breachedpre-bankruptcy contract, lease or otherunexpired agreement is a cornerstone ofUnited States bankruptcy law. Withoutthis power, bankruptcy would not benearly as effective as a means of enablingfinancially troubled debtors to rehabili-tate operations and reorganize success-fully unburdened by limitingconsiderations that precipitated thebankruptcy filing. Under BankruptcyCode section 1123(a)(5)(G), a plan ofreorganization may provide adequatemeans for its implementation such as,

among other things “curing or waivingany default.” The provision allows a re-organized debtor to reinstate a breachedagreement after confirmation of a planas if the breach never occurred. Otherprovisions of the Bankruptcy Code alsopermit a debtor to reinstate defaultedcontracts by “assuming,” or reaffirming,certain kinds of “executory” (unexpired)contracts or leases notwithstanding theexistence of pre-bankruptcy defaults. Inall cases, however, the debtor must“cure,” or satisfy, outstanding defaults(except those relating to its financialcondition or the filing of its bankruptcycase) under an agreement before it canbe reinstated.

If the contract in question containsa clause providing for payment of post-breach interest at the default rate andother associated late charges or fees, it isunclear in one context whether theseamounts must also be paid as part of thedebtor’s “cure” obligations. Where anexecutory contract providing for defaultinterest is being assumed by a debtor,section 365(b)(2)(D) of the BankruptcyCode expressly provides that a defaultneed not be cured if it relates “to the sat-isfaction of any penalty rate or provisionrelating to a default arising from anyfailure by the debtor to perform non-monetary obligations under the execu-tory contract.” The answer is less clearif the debtor proposes in a plan of reor-ganization to reinstate, for example, adefaulted loan agreement that obligatesthe debtor to pay post-default interest ata significantly higher rate.

This is so notwithstanding the ar-guably clear dictates of Bankruptcy

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Code section 1123(d), which providesthat “if it is proposed in a plan to curea default the amount necessary to curethe default shall be determined in accor-dance with the underlying agreementand applicable nonbankruptcy law.”What is required to cure a reinstatedobligation in accordance with the termsof a chapter 11 plan is of great signifi-cance in the context of enfranchisementfor the purpose of plan approval or re-jection. Only creditors whose claims are“impaired” under a plan have the rightto vote. Unimpaired creditors are statu-torily deemed to have voted in favor ofa plan. Bankruptcy Code section1124(2) provides that a creditor’s claimis impaired unless the plan either “leavesunaltered the legal, equitable, and con-tractual rights to which such claim” en-titles its holder, or notwithstanding anycontractual provision or applicable lawthat entitles the holder of a claim to de-mand accelerated payment, the plan“cures any such default,” reinstates thematurity and terms of the claim andcompensates the holder for damages itincurred reasonably relying upon theacceleration clause. Despite the unam-biguous language of section 1123(d),many courts have refused to construethe language of the statute to requirepayment of default interest because it isperceived as being inconsistent with theidea that “[c]uring a default commonlymeans taking care of the triggering eventand returning to pre-default condi-tions.” The approach adopted by thesecourts has fueled a growing controversy.

Ninth Circuit Law and the 1994Bankruptcy AmendmentsIn a 1988 case before the Ninth CircuitCourt of Appeals, In re Entz-WhiteLumber and Supply, the debtor sought to“cure” a defaulted and matured loan bypaying off the entire principal due, to-gether with interest at the non-defaultrate. The creditor objected, arguing thatit was entitled to default interest. TheCourt cited the seminal case from theSecond Circuit on cure, In re Taddeo, forthe proposition that, while undefined bythe Bankruptcy Code itself, “[c]uring adefault commonly means taking care ofthe triggering event and returning topre-default conditions. The conse-quences are thus nullified. This is theconcept of ‘cure’ used throughout theBankruptcy Code.” Although Taddeowas a chapter 13 case, the strategy wasadopted in a series of chapter 11 cases inthe mid-1980s. The bankruptcy courtin those cases held that a debtor maycure a default, and “de-accelerate” aloan, by paying interest at the contractrate. The decisions have endured as thefoundation for much of the section1124(2) jurisprudence to date. TheEntz-White Court adopted the reason-ing of these cases.

The problem arises from Congress’amendment of the Bankruptcy Code in1994 to add section 1123(d), which ap-plies to contracts entered into after Oc-tober 22, 1994. Prior to section1123(d), the Bankruptcy Code did notcontain any statutory language relatingto the amount required to cure a defaultpursuant to a plan of reorganization;section 1123(a)(5)(G) permitted a cure

or waiver of a default pursuant to a planof reorganization but did not provideany definition of cure or any statutoryguidance as to the amount required tocure the default. Some commentatorsand courts have concluded that section1123(d) is unambiguous and concretelyrequires that default interest, if providedunder an agreement and not prohibitedby applicable law, must be paid as partof a section 1124(2) cure, notwithstand-ing prior judicial determinations to thecontrary. Commentators have also sug-gested that because Bankruptcy Codesection 365(b)(2)(D), which was alsoenacted in 1994, specifically relieves thedebtor from any obligation to pay de-fault-rate interest when it assumes a con-tract, the absence of express language tothat effect in section 1123(d), by “nega-tive implication,” means that Congressintended otherwise.

Illustrative of this view are decisionsrendered by a California district court inIn re Pacific Gas and Electric Co. and theNinth Circuit bankruptcy appellatepanel in Hassen Imports P’Ship v. KWPFinancial VI (In re Hassen ImportsP’Ship). Both of these courts found thatsection 1123(d) of the BankruptcyCode calls the specific holding of Entz-White into question. The Fifth Circuitalso called the continued vitality ofEntz-White into doubt in a 1998 deci-sion. In Matter of Southland Corp., theCourt of Appeals held that the debtorwas required to pay interest on a securedcreditors’ claim at the default rate speci-fied in its credit agreement where thedebtor’s plan of reorganization did not

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reinstate, but rather impaired, thecreditor’s claim. Rejecting the debtor’scontention that the Entz-White rationaleshould be applied in a context otherthan determining whether a claim isunimpaired under section 1124(2), theCourt of Appeals remarked that “[a]partfrom the doubtfulness of adopting Entz-White or extending its reasoning in thiscircuit, we note that Congress, in bank-ruptcy amendments enacted in 1994,arguably rejected the Entz-White denialof contractual default interest rates.”

On the other hand, In re PhoenixBusiness Park Ltd. P’ship, an Arizonabankruptcy court, after analyzing thelegislative history of sections 1123(d)and 365(b)(2)(D), held that Entz-Whitewas not legislatively overruled. Thecourt rejected the “negative implicationargument,” and held that the limitinglanguage of section 1123(d) does notapply to “cure” for purposes of impair-ment within the meaning of section1124(2) because if Congress had in-tended it to do so it would have in-cluded an express reference in the statuteto make clear that it was overrulingEntz-White. Judging by the Court ofAppeals’ decision in Sylmar Plaza, Entz-White continues to be good law in theNinth Circuit.

The Ninth Circuit’s OpinionThe Hornwoods, a family of successfulreal estate investors, obtained a loan ofapproximately $8 million in 1992 se-cured by a shopping center. The termsof the loan agreement entered into bythe Hornwoods and the lender relatingto interest payments provided, in rel-evant part, for a fixed rate of 8.87%and, should the Hornwoods default un-der the terms of the agreement, a defaultinterest rate of 13.87%.

Approximately five years after ob-taining the loan, the Hornwoods trans-ferred the shopping center to a newlycreated limited partnership without thelender’s consent and the balance of theirreal estate portfolio to four other newlycreated limited partnerships. Immedi-ately thereafter, the Hornwoods ceasedmaking payments, which, in effect, en-titled the lender to the 13.87% interestrate. As a result of the default, thelender filed a foreclosure action againstthe Hornwoods. The foreclosure wasstayed when the limited partnership thatowned the shopping center filed forchapter 11.

The bankruptcy court confirmedthe debtor’s plan of reorganization,which provided for full payment of thelender’s secured claim, which the plandesignated as unimpaired. Full pay-ment, however, did not include the13.87% interest rate, thereby deprivingthe lender of approximately $1 milliondollars to which it was entitled underthe contract as default interest. Thelender appealed, contending that,among other things, a plan intended tonullify the consequences of a default andavoid default interest payments was pro-posed in bad faith in derogation ofBankruptcy Code section 1129(a)(3).According to the lender, the plan was,

per se, a sham solely designed to deprivethe creditor of the benefit of the defaultrate of interest. After the bankruptcyappellate panel affirmed the bankruptcycourt’s confirmation order, the lenderappealed to the Ninth Circuit.

Applying the “totality of the cir-cumstances” test, the Court of Appealsrejected the lender’s “per se” argument.The Ninth Circuit noted that the Bank-ruptcy Code permits a debtor to cure itsdefaults and this power entails nullifica-tion of the consequences of a default,such as avoiding the higher interest pay-ment. According to the Court, merelybecause “a creditor’s contractual rightsare adversely affected does not by itselfwarrant a bad faith finding.” Remark-ing that “Congress made a determina-tion that an eligible debtor should havethe opportunity to avail itself of a num-ber of Code provisions which adverselyalter creditors’ contractual andnonbankruptcy rights,” the Court ruledthat the fact that the debtor’s sole pur-pose in proposing the plan was to avoidthe higher interest payment does notnecessitate a finding of bad faith sincethat purpose is authorized by the Bank-ruptcy Code.

The fact that the debtor’s sole purpose in proposing

the plan is to avoid the higher interest payment

does not necessitate a finding of bad faith since

that purpose is authorized by the Bankruptcy Code.

continued on page 16

B u s i n e s s R e s t r u c t u r i n g R e v i e w I 7

In BriefThe repercussions of the U.S. SupremeCourt’s ground-breaking decision earlythis year in FCC v. NextWave PersonalCommunications, Inc. have been swiftbut predictable. As reported in the Feb-ruary 2003 edition of the Business Re-structuring Review (vol. 2, no. 2), theHigh Court, by a margin of seven toone, ruled in NextWave that section 525of the Bankruptcy Code prohibited theFederal Communications Commissionfrom revoking broadband capacity li-censes auctioned to NextWave, a chapter11 debtor, due to the company’s inabil-ity to make timely payments owed tothe FCC for the purchase of the li-censes. The decision was a significantone for the telecommunications indus-try. It put an end to protracted litiga-tion that had for many years limitedaccess to the disputed broadband capac-ity. It was also viewed as having giventhe green light to technology developerseager to exploit the public airways by re-moving the shroud of controversy fromthese important broadband licenses.

NextWave was merely one of manycompanies who prevailed at auction andlater found that the capital market fortelecom development had dried up.These companies also discovered thatthey had vastly overpaid for broadbandlicenses auctioned by the FCC in 1996.Many of them filed for bankruptcy pro-tection in an effort to prevent the FCCfrom revoking and re-auctioning theirlicenses. One such company, KansasPersonal Communications Services,Ltd., was the subject of a ruling handeddown by the United States Court of

Appeals for the Tenth Circuit in the af-termath of the Supreme Court’s decisionin NextWave.

Kansas PCS was the winning bid-der of three licenses in the same block asthose auctioned to NextWave. Similarlyto NextWave, Kansas PCS failed tomake installment payments on licenses,which then cancelled automatically un-der FCC rules. After Kansas PCS filedfor bankruptcy, the bankruptcy courtruled that the Bankruptcy Code pre-cluded the FCC’s automatic cancellationregulation from being enforced. How-ever, the district court reversed this de-cision on appeal, ruling that the licensecancellation was automatic and was notcovered by section 362 of the Bank-ruptcy Code. Kansas PCS appealed thedecision to the Tenth Circuit, and com-mentators following developments inthe embattled telecom industry postu-lated that the Court of Appeals mighthand down a decision construing thescope of the FCC’s regulatory power inbankruptcy proceedings in a differentway than the other three circuits thathave weighed in on this issue.

The Supreme Court decidedNextWave before the Tenth Circuit hadan opportunity to do so. Then, onMarch 4, 2003, the Court of Appealsissued its decision in Kansas PersonalCommunications Services, Ltd. v. FederalCommunications Commission (In re Kan-sas Personal Communications Services,Ltd. In a brief unpublished opinion, theTenth Circuit reversed the districtcourt’s ruling, observing that in accor-dance with NextWave, “[t]he Chapter 11

filing barred the FCC from taking anyaction against the license of Kansas Per-sonal Communications Services, Ltd.without first obtaining authority to doso from the bankruptcy court.”

NextWave and its progeny provide aglimmer of hope for beleagueredtelecoms, but the prospects for the in-dustry are still far from rosy, judging byrecent statistics. One telecom researchfirm, Probe Research, recently issued areport entitled “Debt, Demographicsand Telecom,” which points to the pos-sibility of an even bigger telecommuni-cations crisis than the industry hassuffered in the last few years. Stay tunedfor further developments.

__________________________

Federal Communications Commission v.NextWave Personal Communications, et.al., 123 S. Ct. 832 (2003).

In re Kansas Personal CommunicationsServices Ltd., 252 BR 179 (Bankr. D.Kan. 2000).

United States of America v. Kansas Per-sonal Communications Services, Ltd., 256BR 807 (D. Kan. 2000).

Kansas Personal Communications Services,Ltd. v. Federal Communications Commis-sion (In re Kansas Personal Communica-tions Services, Ltd., 2003 WL 723952(10th Cir. Mar. 4, 2003).

8 I J o n e s D a y

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estate, such as a claim to establish an ob-ligation guaranteed by the debtor, aclaim against the debtor’s insurer or ac-tions involving “such identity of inter-est” between the debtor and thethird-party defendant that the debtormay be said to be the real party defen-dant.

The Second Circuit found that thecase before it warranted extension of theautomatic stay to include Queenie, butnot the other counterclaim defendants.According to the Court, “the stay ap-plies to Queenie because it is whollyowned by Gardner, and adjudication ofa claim against the corporation will havean immediate adverse economic impacton Gardner.” It rejected the argumentthat the stay should apply to the other

counterclaim defendants on the theorythat allowing the litigation to go for-ward without Gardner and Queeniemight deprive them of the ability tocontest certain issues by reason of thedoctrine of collateral estoppel. Thatthreat alone, the Court observed, hasnever been a sufficient basis for extend-ing the scope of the stay to interferewith enforcement of creditor rightsagainst non-debtor co-defendants.

AnalysisQueenie, Ltd. v. Nygaard Int’l does notrepresent a departure from the approachemployed by most courts when deter-mining whether the automatic stayshould preclude creditor enforcementactions against non-debtor entitiesclosely affiliated with a chapter 11debtor. However, while the outcome isnot controversial, the language of theSecond Circuit’s opinion leaves room fordoubt concerning the precise reason forextending the stay to the non-debtorwholly-owned corporation. As noted,the Court stated that the stay applied toQueenie because “it is wholly owned byGardner, and adjudication of a claimagainst” Queenie would have an imme-diate adverse economic impact onGardner.

The fact that the non-debtor waswholly-owned by the debtor shouldhave been irrelevant. As noted by an Il-linois district court in In re Winer,“[a]bsent a piercing-the-corporate veilsituation (and none is claimed to existhere), the debtor’s presence in the bank-ruptcy court cannot block actions impli-cating the nondebtor subsidiary.”Efforts to stay actions against non-debtor subsidiaries on the theory that

they might adversely affect property ofthe debtor’s bankruptcy estate by de-pressing the value of stock held by thedebtor have rarely been successful. In-deed, this has been the law in the Sec-ond Circuit for more than thirty years,although the Court of Appeals inQueenie, Ltd. v. Nygaard Int’l failed toeven mention its previous ruling directlyon this point in In re Beck Industries. Inthat case, the Second Circuit ruled thatthe immediate predecessor to the Bank-ruptcy Code “does not authorize the[bankruptcy] court to enjoin a suitagainst a solvent independent subsidiaryof the debtor merely because its stock isheld by the debtor in reorganization.”According to the Court, extension of thestay to preclude actions against a subsid-iary would require a showing that thesubsidiary is a mere sham or alter ego ofthe debtor. Queenie, Ltd. v. Nygaard Int’lseems to indicate that the standard hasbecome less stringent.

Standing alone, it would be rela-tively simple to ascribe the ambiguitylurking in the Second Circuit’s words toinadvertence, but the Court has failed tomake a distinction on this issue before.In B.F. Goodrich v. Betkoski, the Court ofAppeals, in a seemingly innocuous re-mark that had little to do with the mer-its and significance of its ruling, statedthat “[a]s the automatic stay protectingNorth Penn necessarily protects its sub-sidiary, Lombard Brothers, we believethat the claims against both entitiesshould be dismissed without prejudiceuntil the stay is lifted.” Given its clearmisstatement of the law in B.F. Goodrichon the scope of the stay, it is difficult todetermine whether Queenie, Ltd. v.Nygaard Int’l is meant to suggest that the

While the outcome is

not controversial, the

language of the Sec-

ond Circuit’s opinion

leaves room for doubt

concerning the precise

reason for extending

the stay to the non-

debtor wholly owned

corporation.

B u s i n e s s R e s t r u c t u r i n g R e v i e w I 9

L E G I S L A T I V EA L E R T

True to his pledge, House Judiciary Committee Chairman James

Sensenbrenner reintroduced long-stalled bankruptcy reform legislation in the

108th Congress shortly after lawmakers convened on January 7, 2003 with

a reconstituted Republican majority. The Committee held the year’s inaugu-

ral hearing on the pending bill on March 4, but left bill proponents and op-

ponents scratching their heads over how this year’s reform effort will eventually

play out. Congressman Sensenbrenner introduced new bankruptcy reform

legislation (H.R. 975) with 50 co-sponsors on February 27. It is an exact copy

of the version that failed to pass in the last Congress (H.R. 333), minus any

language relating to the controversial issue of how to treat debts incurred in

connection with abortion clinic protest activity. Dispute over the abortion issue

was primarily responsible for killing the legislation in 2002.

Apparently, the abortion issue is not the only hurdle that must be overcome.

Major opponents of the bill as it is currently written argue that the bill’s so-

called “means test” is inherently flawed. The means test, which is based on

a filer’s income level, is designed to determine who can qualify for chapter

13 bankruptcy, which requires some repayment of debts over time, and who

can file under chapter 7 liquidation. Critics claim the means test fails to tar-

get fraud and also fails to account for extraordinary events like the sudden

loss of a job or health care. The issue is an important one, given the fact

that individual bankruptcy filings accounted for the overwhelming majority

(97.6 percent) of all bankruptcy cases filed in calendar year 2002.

Signaling a desire to avoid last year’s legislative wrangling that doomed

efforts to reform bankruptcy law for the sixth straight year, Senate Judiciary

Committee Chairman Orrin Hatch has said he wants to bring bankruptcy re-

form legislation directly to the Senate floor and skip the customary commit-

tee mark-up process, but this approach has already drawn criticism from

Senate Democrats. Meanwhile, the controversial abortion language will likely

lie in wait again until the bill reaches conference or its sponsor, Senator

Charles Schumer, attempts to add the amendment either in committee or on

the Senate floor.

stay should apply to the non-debtor be-cause it is wholly-owned by the debtorand irrespective of whether adjudicatinga claim against it as a co-defendantwould have an immediate adverse im-pact on the debtor.

___________________________________________

Queenie, Ltd. v. Nygaard Int’l, 2003 WL462416 (2d Cir. Feb. 25, 2003).

Croyden Associates v. Alleco, Inc., 969F.2d 675 (8th Cir. 1992).

Teachers Insurance and Annuity Ass’n v.Butler, 803 F.2d 61 (2d Cir. 1986).

McCartney v. Integra National BankNorth, 106 F.3d 506 (3d Cir. 1997).

In re Johns-Manville Corp. v. AsbestosLitigation Group (In re Johns-ManvilleCorp.), 26 B.R. 420 (Bankr. S.D.N.Y.1983).

A.H. Robins Co. v. Piccinin, 788 F.2d994 (4th Cir. 1986).

In re Winer, 158 B.R. 736 (N.D. Ill.1993).

In re Hudgins, 153 B.R. 441 (Bankr.E.D. Va. 1993).

In re Beck Industries, Inc., 479 F.2d 410,415 (2d Cir.), cert. denied sub. nom.Trustees of Beck Industries, Inc. v.Feldman, 414 U.S. 858 (1973).

B.F. Goodrich v. Betkoski, 99 F.3d 505(2d Cir. 1996).

10 I J o n e s D a y

Bankruptcy Filing to Prevent AssetSale Constitutes Bad FaithAnn Marie Bredin and Mark G. Douglas

Record-setting business bankruptcy fil-ings in 2002 and headlines touting whatwould appear to be a headlong rush tothe bankruptcy courts by embattled cor-porate giants such as WorldCom,Conseco, United Airlines, Adelphia andKmart have brought renewed attentionto the propriety of bankruptcy relief asa panacea for a company’s financialtroubles. Highly publicized incidents ofbankruptcy abuse have contributed to agrowing perception that the bankruptcyprocess is rife with misconduct. In fact,abuse of the bankruptcy process by un-scrupulous corporate debtors is the ex-ception. For the vast majority ofbusinesses, the filing of a petition underchapter 11 is the result of a thoroughand, sometimes difficult, analysis of avariety of strategic options. However, incertain cases, the filing of a chapter 11case is found to be inappropriate as hav-ing been undertaken in “bad faith.”The Eleventh Circuit Court of Appealsrecently addressed the appropriate rem-edy for bankruptcy abuse amounting to“bad faith” in In re The Bal HarbourClub, Inc. Confronted with a debtorthat had invoked the bankruptcy processto prevent a purchaser from acquiringcertain property sold by the debtor be-fore a change in control of the debtor’sboard of directors, the Court of Appealsaffirmed a bankruptcy court’s dismissalof the debtor’s chapter 11 case as havingbeen failed in “bad faith.”

Business Judgment and Filing forBankruptcyGiven the significance of a bankruptcyfiling on a business, both in terms of its

practical effects on day-to-day opera-tions and its subtler impact on publicperception of the company, the determi-nation to enter chapter 11 is usuallywell-reasoned and well-supported. Likeother significant decisions made by acompany’s management, the determina-tion to file for bankruptcy must repre-sent an exercise of sound businessjudgment, as gauged by the “businessjudgment rule.” While not a bank-ruptcy-specific concept, the “businessjudgment rule” plays an important rolein the administration of many bank-ruptcy cases. The rule is essentially apresumption that, in making businessdecisions not involving direct self-inter-est or self-dealing, corporate directorsact on an informed basis, in good faithand in the honest belief that their ac-tions are in the corporation’s best inter-ests. This rule generally protectsdirectors from liability for detrimentalcorporation transactions if the transac-tions were effected in good faith andwith due care and the relevant decisionswere within the directors’ authority.

Two primary rationales support thebusiness judgment rule. First, it seemsunfair, and fundamentally counterpro-ductive, to permit shareholders tochoose directors through the electionprocess and then to collect from thosesame directors when their judgment —as opposed to their honesty or diligence— proves flawed. If directors were thevictims of potentially costly “Monday-morning quarterbacking” with respectto their business decisions, few peoplewould be willing to assume director po-sitions. The second primary underpin-

ning of the business judgment ruleis that, as a general matter, courtsare ill-equipped to take on the cor-porate decis ion-making process .Such responsibility, if even appro-priate, likely would prove to be pro-hibitively time-consuming.

In the bankruptcy context, courtsroutinely defer to the business judgmentof the directors of a chapter 11 debtor-in-possession with respect to decisionsinvolving the management of thedebtor’s property and the operation ofthe debtor’s business. For example, adebtor’s decision to assume or reject acontract or lease is deemed to be a mat-ter of business judgment. So too aredecisions regarding the debtor’s choiceof bankruptcy counsel and other profes-sionals, as well as determinations to sellassets outside the ordinary course of thedebtor’s business. The directors of chap-ter 11 debtor, however, are not empow-ered with carte blanche authority to runthe company. The business judgmentrule simply provides a presumption ofpropriety that ultimately may be re-futed. Where something as basic as thedebtor’s initial determination to file forreorganization under chapter 11 is calledinto question, the Bankruptcy Codecontains a mechanism to assess whetherthe debtor should be allowed to remainin chapter 11 and reap its benefits at theexpense of creditors,

Dismissal or Conversion for “Cause”Bankruptcy Code section 1112(b) al-lows the bankruptcy court, in its discre-tion, to convert a chapter 11 case tochapter 7 or to dismiss a chapter 11

B u s i n e s s R e s t r u c t u r i n g R e v i e w I 11

continued on page 12

case, whichever is in the best interests ofcreditors and the estate, for “cause.”The Bankruptcy Code does not define“cause.” Although section 1112(b) pro-vides 10 example of cause, the list ismerely illustrative, not exhaustive. Inother words, a court may convert or dis-miss a case for a reason that is not enu-merated in section 1112(b), providedthat the reason is sufficient to show theexistence of cause. Examples from theexplicit list in this statutory section in-clude: “continuing loss to and diminu-tion of the estate and absence of areasonable likelihood of rehabilitation,”“inability to effectuate a plan” and “un-reasonable delay by the debtor that isprejudicial to creditors.”

Courts consistently have found thatthe prosecution of a chapter 11 case in“bad faith” — not one of the 10 listedexamples — constitutes “cause” undersection 1112(b). A bad faith filing gen-erally refers to filing with the purpose ofabusing the judicial process. In someinstances, the filing is deemed improperbecause, despite the best intentions ofthe company, it appears improbable thatthe benefits of reorganization will beachieved at a reasonable cost or withina reasonable time period. In other cases,courts have found that the insiders ofthe company have acted in bad faith, at-tempting to abuse the judicial processand protections afforded by chapter 11.In these cases, despite the typical judi-cial deference to the business judgmentof the directors of a company, a courtwill convert the chapter 11 case to achapter 7 liquidation case or dismiss theproceeding altogether. As discussed in

the Bal Harbour decision, the analysis ofwhether a chapter 11 filing was in badfaith largely parallels the analysis under-taken by courts employing the businessjudgment rule.

BackgroundBal Harbour Club (the “Club”) was anot-for-profit Florida corporation thatowned and operated a private social andyacht club in Florida. In 1993, theClub’s Board of Governors (the“Board”) decided to sell its oceanfrontproperty, consisting of 5.5 acres. InJune 1995, the Board found a buyer,AVA Development, Inc. (“AVA”), andagreed to sell the property to AVA for$34 million, conditioned on a favorablemodification (for AVA) in the applicablezoning regulations. While AVA waspursuing such modification, JosephImbesi acquired control of the Club’sBoard and immediately took steps toprevent AVA from acquiring the ocean-front property. To this end, the Boardresolved that the Club file a chapter 11case in October 1998. Two weeks afterthe Club’s bankruptcy filing, AVAmoved to dismiss the Club’s petitionpursuant to Bankruptcy Code section1112(b). AVA asserted that the Club’slack of good faith constituted cause fordismissal.

After an evidentiary hearing, thebankruptcy court granted AVA’s motion,finding that “the bankruptcy filing inthis case was an improper use of thebankruptcy process and the Court.”The court found that evidence of suchimproper use included Imbesi’s “pur-chase of proxies to influence” the selec-

tion of Board members, and “the initia-tion of litigation to frustrate” AVA’s ac-quisition of the oceanfront property.Additional evidence included the“highjacking” of the Debtor by replac-ing the Board through the use of “phonyloans,” and the “borrowing of $1.145million, without agreeing to any termsof repayment or an interest rate from aperson holding the control of an insider[i.e. Imbesi or a company he controlled]in a last minute rush in order to gainstrategic advantage over another inter-ested party.” The Club appealed thebankruptcy court’s dismissal of its chap-ter 11 petition to the district court,which affirmed, finding no error in thebankruptcy court’s application of section1112(b) to the facts before it and con-cluding that dismissal of the case was adecision that fell well within the bank-ruptcy court’s discretion.

The Eleventh Circuit’s DecisionThe Club fared no better on appeal tothe Eleventh Circuit. According to theClub, the bankruptcy court erred byfailing to give the Club the benefit ofthe business judgment rule, which, ac-cording to the law in the Eleventh Cir-cuit, dictated a “policy of judicialrestraint born of the recognition thatdirectors are, in most cases, more quali-fied to make business decisions than arejudges.” Acknowledging that the Club“properly points out” that, under thebusiness judgment rule, courts “pre-sume” that directors have acted in goodfaith, the Court of Appeals further ob-served that a “court will not call upon a

12 I J o n e s D a y

As more companies consider bankruptcy as a strategic option,

and as governmental and public scrutiny of corporate gover-

nance decisions becomes increasingly intense, directors must

remain vigilant about their responsibilities and be aware of the

limitations on the protections afforded to corporate insiders.

director to account for his action in theabsence of a showing of abuse of discre-tion, fraud, bad faith, or illegality.”However, the Eleventh Circuit empha-sized, a presumption only goes so far toprotect the actions of a director. It canbe overcome.

At the outset, the Court of Appealsnoted that because AVA bore the burdenof proving “cause” for dismissal underBankruptcy Code section 1112(b), theClub did not need the benefit of a pre-sumption, particularly given the factthat, unlike in the traditional situation,the Board possessed all of the evidenceregarding its reasoning for filing thechapter 11 petition. Next, the EleventhCircuit noted that the use of the word“presumption” in articulating the busi-ness judgment rule was not intended tocreate a presumption in the classical pro-cedural sense: as a vehicle that puts theburden of going forward with the evi-dence on the party without the burdenof proof. Instead, the Court noted, theterm merely expresses the “substantiverule of director liability”: that “so longas due care was exercised, the [rule] pro-tects a ‘good director’ (one who did notact fraudulently, illegally, oppressively, orin bad faith) who made an honest error

or mistake in judgment, but not a ‘baddirector’ (one who acted fraudulently,illegally, oppressively, or in bad faith)who made a bad decision.”

The Eleventh Circuit then turnedto the merits, observing that the “ques-tion before the bankruptcy judge was aquestion the business judgment rule en-visions — whether the Board acted inbad faith when it filed the instant peti-tion.” Concluding that AVA had met itsburden of proof on that issue, the Courtof Appeals ruled that Bankruptcy Codesection 1112(b) authorized the bank-ruptcy court to dismiss the petition ona finding that it had been filed in badfaith, for the purpose of abusing the ju-dicial process and the reorganization af-forded by chapter 11.

AnalysisBal Harbour is indicative of the kind ofconduct that oversteps the bounds ofpropriety in the realm of corporate de-cision making when considering a solu-tion for a company’s financial problems.Because the Board’s misconduct in BalHarbour was egregious, other cases in-volving actions that more closely skirtthe limits of permissible bankruptcyplanning and strategy are probably more

instructive in defining the boundaries ofBankruptcy Code section 1112(b). TheEleventh Circuit’s decision, however, isan interesting articulation of the inter-section of the business judgment ruleand bad faith filing standard. As morecompanies consider bankruptcy as astrategic option, and as governmentaland public scrutiny of corporate gover-nance decisions becomes increasinglyintense, directors must remain vigilantabout their responsibilities and be awareof the limitations on the protections af-forded to corporate insiders.

______________________________________________________

In re The Bal Harbour Club, Inc, 316F.3d 1192(11th Cir. 2003).

In re Syndicom Corp., 268 B.R. 26(Bankr. S.D.N.Y. 2001).

In re Long Bay Dunes Homeowners Ass’n,Inc., 246 B.R. 801 (Bankr. D.S.C.1999).

FDIC v. Stahl, 89 F.3d 1510 (11th Cir.1996).

B u s i n e s s R e s t r u c t u r i n g R e v i e w I 13

continued on page 14

Managing Transnational InsolvenciesFedra Fateh

The unprecedented expansion of globalcommerce continues to test the ingenu-ity of lawmakers scrambling to devise aworkable framework of rules to governinternational transactions. Until a leg-islative framework governing cross-border insolvencies is established,parallel U.S. and foreign bankruptcyproceedings will continue to presentU.S. Courts with the potential of con-flicting insolvency regulatory regimes.In Stonington Partners, Inc. v. Lernout &Hauspie Speech Products N.V., the ThirdCircuit affirmed its policy of restraint inexercising its power to enjoin foreignproceedings in deference to the doctrineof international comity.

The Doctrine of International ComityComity is a doctrine that reconciles ju-risdictional conflict by encouraging def-erence to the judgment of a foreigncourt under the appropriate circum-stances. When compliance with theregulatory laws of both countries is im-possible, courts use the principle of co-mity as a canon of construction, to limitthe reach of a domestic statute, or todecline to exercise jurisdiction in a caseproperly adjudicated in a foreign court.In order to determine whether the for-eign court is the more appropriate fo-rum, the domestic court evaluates allrelevant factors (similar to a choice-of-law analysis), including (i) the link be-tween the regulating state and therelevant activity, (ii) the connection be-tween the state and the person respon-sible for the activity (or protected by theregulations), (iii) the effect of the regu-lation on the parties’ reasonable expec-tations, (iv) the significance of theregulation on the international system,

(v) the scope of the state’s regulations,and (vi) the likelihood of conflict withother states’ regulations.

Comity is especially important inthe bankruptcy context because coop-eration with the foreign insolvency re-gime will facilitate an equitable andorderly distribution of the debtor’s assets— the central aim of the U.S. Bank-ruptcy Code. Moreover, Congress ex-plicitly acknowledged the importance ofinternational comity in dealing withtransactional insolvencies. Section 304of the Bankruptcy Code allows an ac-credited representative of a companythat is the subject of a foreign insolvencyproceeding to file an “ancillary” bank-ruptcy proceeding in the U.S. to preventpiecemeal liquidation of its U.S. assets.The statute lists comity as one of severalfactors to be considered by a court whenconsidering whether to grant relief to aforeign debtor. Although section 304 isunclear as to the weight to be given toeach factor, the majority of courts givespreference to considerations of comity.Even though section 304 of the Bank-ruptcy Code only applies to ancillaryproceedings filed as a complement toforeign bankruptcy or insolvency cases,bankruptcy and other courts presidingover transnational litigation have beenmotivated by the language and legisla-tive history of section 304 to apply prin-ciples of comity in any insolvencyproceeding involving a foreign court.

The Standard for Anti-Suit InjunctionsFaced with a conflict between U.S. lawand that of a foreign state, bankruptcyand other federal courts are often askedto grant an anti-suit injunction, enjoin-ing one of the parties from resorting to

a foreign court or enjoining the foreigncourt itself. There is no uniform stan-dard for determining when such anti-suit injunctions are warranted. Thecircuits are split over the degree of def-erence owed to foreign courts in casesinvolving parallel bankruptcy proceed-ings or non-bankruptcy litigation.

The Fifth, Seventh and Ninth Cir-cuits have adopted a “liberal” standard.Courts ascribing to this standard will is-sue an anti-suit injunction under any ofthe following circumstances: (i) policy inthe enjoining forum would be frus-trated, (ii) the foreign proceeding wouldbe vexatious, (iii) the foreign proceedingwould threaten a domestic court’s in remor quasi in rem jurisdiction over assets orproperty, or (iv) allowing the foreignproceeding would delay the domesticproceeding.

Conversely, under the “restrictive”approach applied by the District of Co-lumbia, Second, Third and Sixth Cir-cuits, an injunction against a foreignproceeding is granted only (i) to protectthe jurisdiction of the domestic court, or(ii) to safeguard an important publicpolicy. For example, in Laker AirwaysLtd. v. Sabena, the Court of Appeals forthe District of Columbia Circuit upheldan anti-suit injunction where the foreigndebtor initiated the foreign proceedingsolely for the purpose of terminating theU.S. court’s adjudication of antitrustlitigation and the foreign court had en-joined the parties from pursuing thecase in the United States. Courts apply-ing the “restrictive approach” rarely relyon the public policy exception as justi-fication for issuing an anti-suit injunc-tion. As noted by the Sixth Circuit

14 I J o n e s D a y

continued from page 13

Court of Appeals in Gau Shan Co. v.Bankers Trust Co., “only the evasion ofthe most compelling public policies”warrants the issuance of an anti-suit in-junction, and the treble damages rem-edy at issue in the case did not rise tothat level. In sum, courts applying the“restrictive” standard are willing to grantanti-suit injunctions only under excep-tional circumstances. In StoningtonPartners, the Third Circuit upheld its“restrictive” approach in declining to af-firm the lower court’s injunction againa creditor pursuing its claim under themore favorable laws of a foreign court.

BackgroundLernout & Hauspie Speech ProductsN.V. (“Lernout”) was a Belgian com-pany with headquarters in the UnitedStates and Belgium that had initiatedparallel plenary bankruptcy proceedingsin both countries. Stonington Partners,Inc. (“Stonington”) asserted a claimagainst Lernout resulting from an alleg-edly fraudulent stock transaction. Un-der U.S. bankruptcy law, Stonington’sclaim was a pre-petition claim arisingfrom the rescission of a purchase of thedebtor’s securities, subject to mandatorysubordination under section 510(b) ofthe Bankruptcy Code. However, underBelgian law, the claim would be treatedas an unsecured claim, on parity withother unsecured claims. Lernout at-tempted to confirm a reorganizationplan in Belgium that would have subor-dinated Stonington’s claim, but the Bel-gian court rejected the plan because ofthe unequal treatment of creditors.

Presented with a true conflict oflaws, the U.S. bankruptcy court had todetermine whether principles of interna-

tional comity precluded it from givingeffect to the classification and treatmentof claims prescribed by the BankruptcyCode. This required a determination asto which sovereign had the most signifi-cant interest in the application of itslaws to the case. The court found thatthe United States was the “center ofgravity” and, therefore, its laws shouldprevail over the conflicting insolvencylaws of Belgium. As a result, it enjoinedthe Stonington from pursuing its claimin the Belgian bankruptcy proceeding.Notably, the bankruptcy court dis-claimed any intention of interferingwith the Belgian court’s application ofits law. Stonington appealed. The dis-trict court upheld the bankruptcycourt’s finding that the United Stateswas the “center of gravity” and thereforethe denial of comity and grant of in-junctive relief were appropriate.

The Third Circuit’s RulingOn appeal to the Third Circuit, theCourt of Appeals reiterated its “restric-tive” standard for issuing an anti-suitinjunction. As a preliminary matter, theCircuit Court clarified that it saw nodistinction between enjoining a partyfrom resorting to a foreign court andenjoining a foreign proceeding. Then,as a point of departure for its analysis,the Court emphasized its “serious con-cern for comity” as the motivation be-hind its “restrictive” approach.Principles of comity, the Third Circuitfound, had not been adequately consid-ered by the U.S. court when it decidedto enjoin foreign litigation.

The Third Circuit ultimately re-versed and remanded the district court’sinjunction on the ground that the appli-

cable case law unequivocally directscourts to exercise restraint in enjoiningforeign proceedings in light of comityconcerns that were not taken into con-sideration by the lower courts. TheCourt expressed skepticism as towhether an anti-suit injunction was ap-propriate under these circumstances.Nonetheless, finding that the bank-ruptcy court was better suited to engagein the qualitative analysis required, theCircuit Court directed the bankruptcycourt to apply the appropriate standardfor enjoining foreign proceedings whileconsidering the important comity con-cerns in order to determine whetherthese facts amount to the rare situationin which such relief is warranted.

AnalysisStonington Partners reiterates the well-established reluctance of certain circuitsto grant anti-suit injunctions in breachof the comity among the courts of sepa-rate sovereignties. The circumstancesunder which such relief is warrantedunder the “restrictive” approach arequite limited. No doubt, the willingnessof U.S. courts to uphold the doctrine ofinternational comity does promote co-operation with courts of other nations,which can be beneficial in the context ofcross-border insolvencies. However, acreditor based in the United States, en-tering in an agreement governed by U.S.law, with an entity with a significantpresence in the United States will inevi-tably be troubled by the uncertainty thatresults when a domestic court defers toa foreign court, even in a plenary bank-ruptcy proceeding conducted in theUnited States. For this reason, the more“liberal” approach of the other circuits

B u s i n e s s R e s t r u c t u r i n g R e v i e w I 15

When confronted with debtors with assets and creditors widely dis-

persed throughout numerous sovereign states, cooperation among do-

mestic and foreign legal regimes is essential in order to safeguard

international legal norms with important foreign policy implications.

may result in a more predictable out-come because those courts seem to bemore willing to entertain argumentssupporting U.S. control of paralleltransnational proceedings.

Ultimately, the rise in cross-borderbankruptcies and the need for both ju-ridical cooperation and commercial pre-dictability highlight the need foradoption of international insolvencyguidelines. Some progress in this direc-tion has been made. The EuropeanUnion has adopted a Regulation on In-solvency Proceedings, but it applies onlyto member states. In an ambitious ef-fort at furthering global cooperation, theUnited Nations Commission for Inter-national Trade Law has promulgated aModel Law on Cross-Border Insolvency.Bankruptcy reform legislation passed byboth the United States Senate andHouse of Representatives in 2000 and2001 include similar versions of theModel Law. The legislation provides forthe addition of a new chapter 15, incor-porating the Model Law. These provi-sions would govern (i) ancillaryproceedings, substituting section 304 ofthe Bankruptcy Code; (ii) situationswhere a domestic court seeks the assis-tance of a foreign court in connectionwith a case under the Bankruptcy Code;

(iii) parallel plenary bankruptcy pro-ceedings in a domestic and foreigncourt; and (iv) situations where creditorsor other interested persons in a foreigncountry have an interest in initiating orparticipating in a case under the Bank-ruptcy Code.

The adoption of a new chapter 15would homogenize the appellate courts’resolution of the competing demands ofthe domestic bankruptcy regime and theneed for respect for international co-mity. When confronted with debtorswith assets and creditors widely dis-persed throughout numerous sovereignstates, cooperation among domestic andforeign legal regimes is essential in orderto safeguard international legal normswith important foreign policy implica-tions. Moreover, the orderly and equi-table distribution of debtors’ assets,increasingly found all over the world, isa central goal of the Bankruptcy Code,which still requires legislative reform inorder to be achieved. Unfortunately,proposed chapter 15 and other amend-ments that would effect the most sweep-ing changes to U.S. bankruptcy lawssince 1994 have been mired in CapitolHill trenches due to partisan infightingregarding aspects of the legislation thathave nothing to do with international

insolvency law considerations. This maysoon change. The bankruptcy bill wasrecently re-introduced by lawmakers in-tent upon breaking the deadlock.

___________________________________________________

Stonington Partners, Inc. v. Lernout &Hauspie Speech Products N.V., 310 F.3d118 (3rd Cir. 2002).

Laker Airways Ltd. v. Sabena, 731 F.2d909 (D.C. Cir.1984).

Gau Shan Co. v. Bankers Trust Co., 956F. 2d 1349 (6th Cir. 1992).

Kaepa, Inc. v. Achilles Corp., 76 F.3d 624(5th Cir.), cert. denied, 519 U.S. 821(1996).

Allendale Mut. Ins. Co. v. Bull Data Sys.,Inc., 10 F.3d 425 (7th Cir. 1993).

Seattle Totems Hockey Club, Inc. v. Nat’lHockey League, 652 F.2d 852 (9th Cir.1981), cert. denied, 457 U.S. 1105.

16 I J o n e s D a y

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AnalysisThe Ninth Circuit in Sylmar Plaza didnot deviate from the general rule appliedby most courts in determining “goodfaith” by viewing the “totality of the cir-cumstances.” The crux of its reasoningis that a plan whose terms comply withthe provisions of the Bankruptcy Code— even those that alter a creditor’srights and remedies under applicablenon-bankruptcy law — is proposed ingood faith. However, curiously absentfrom Sylmar Plaza is any reference tosection 1123(d) and the effect, if any, ofthe 1994 amendments to the Bank-ruptcy Code. In Sylmar Plaza, theNinth Circuit merely relies on Entz-White as established precedent withoutdisposing of, or even discussing, thecontroversy clouding its continued vital-ity. This could be ascribed to the factthat the loan agreement in Sylmar pre-dated 1994, so that section 1123(d)does not apply, but we cannot be sure.

In any event, parties relying on SylmarPlaza should proceed with caution,given the split of authority within thecourts as to whether the 1994 amend-ments to the Bankruptcy Code legisla-tively overruled Entz-White and theopinion’s indifference to the existence ofthe controversy. _______________________________________Hornwood v. Sylmar Plaza, L.P., Inc. (Inre Sylmar Plaza, L.P.), 314 F.3d 1070(9th Cir. 2002).

Great Western Bank & Trust v. Entz-White Lumber and Supply, Inc. (In reEntz-White Lumber and Supply, Inc.),850 F.2d 1338 (9th Cir. 1988).

In re Taddeo, 685 F.2d 24 (2d Cir.1982).

Levy v. Forest Hills Assocs. (In re ForestHills Assocs.), 40 B.R. 410 (Bankr.S.D.N.Y. 1984).

In re Manville Forest Products Corp., 43B.R. 293 (Bankr. S.D.N.Y.1984), aff ’din part, rev’d in part, 60 B.R. 403(S.D.N.Y. 1986).

In re Kizzac Management Corp., 44 B.R.496 (Bankr. S.D.N.Y. 1984).

In re Hassen Imports P’ship v. KWP Fin.VI (In re Hassen Imports P’ship), 256B.R. 916 (B.A.P. 9th Cir. 2000).

In re Pacific Gas and Elec. Co., 283 B.R.41 (N.D. Cal. 2002).

In re Phoenix Business Park Ltd. Partner-ship, 257 B.R. 517 (Bankr. D. Ariz.2001).

Matter of Southland Corp., 160 F.3d1054 (5th Cir. 1998).