Cross-jurisdictional Filing An Alternative International Bankruptcy Strategy
Bankruptcy professionals are increasingly challenged to develop a successful reorganization strategy that crosses international borders. The complexity arises from the relationship between U.S. bankruptcy laws and local foreign bankruptcy laws. Filing for bankruptcy in the United States does not afford a foreign affiliate or subsidiary protection within its own borders and vice versa. Often, filing an entity in one country can constitute grounds for precipitous actions against its foreign affiliate within its respective jurisdiction. Therefore, bankruptcy professionals are forced to determine a bankruptcy strategy that protects the debtor entity throughout its geographic base.
Conventional wisdom suggests that the company files locally in each country where it seeks to protect assets. However, alternative strategies may emerge, provided the correct circumstances exist, whereby the company can achieve similar, if not better, results by filing foreign entities cross-jurisdictionally within the United States rather than locally.
This article focuses on the set of circumstances or "leverage points" that can determine whether filing a foreign entity within the United States can provide the stay sought locally and protect foreign-based operations. Although each bankruptcy situation has its own case-specific details, understanding the key leverage points can facilitate a quick assessment of whether a cross-jurisdictional filing provides the desired protection, and will often determine the success of the filing of a foreign entity within a U.S. bankruptcy court.
Leverage Point #1: Identification of Asset Jurisdiction
If the largest foreign creditors have U.S.-based assets or conduct material business in the United States, filing a foreign entity within the U.S. bankruptcy courts can create significant leverage. The degree of leverage is directly related to the size of creditor's assets in the United States (versus the size of its assets elsewhere), ease of identification and transferability. Small amounts of highly liquid assets will create less leverage than the existence of a complete operating division within U.S. borders.
The existence of creditor assets within the United States can create a pseudo-foreign automatic stay within the U.S. courts. The debtor's demonstrated knowledge of and preparation on these issues can materially impact negotiations. Once debtors disclose a clear knowledge of the facts of the filing, most creditors' counsel understand the dynamic that will allow the debtor the short-term protection needed to bring about the reorganization. If a creditor has business interests in the United States, violation of the stay could result in harsh penalties mandated by the court.
Leverage Point #2: Process Comparisons
A comparison of the underlying bankruptcy laws in the United States with foreign bankruptcy laws will present possible avenues for creating leverage. Two key factors to compare are (1) the general outcome of a local filing and (2) the relative strength and effectiveness of protection by the automatic stay provisions.
If the general outcome of a local filing is adverse compared to a U.S. bankruptcy filing, then this fact alone can help create leverage with local creditors. If the average bankruptcy within the foreign local jurisdiction is long, expensive and provides low recovery or results in liquidation, then these factors can be used to develop leverage for dialogue with the largest creditors. The dialogue should highlight how a cross-jurisdictional filing, workaround, or combination of both can produce better-than-average results, which can translate into either preserving the assets or increasing recovery.
In some countries, the equivalent of the automatic stay provision doesn't create similar levels of protection for the debtor entity as in the United States. Creditors may be able to continue collections on debt and may also be able to accelerate payment. In many countries, the local automatic stay is ineffective against standard default, acceleration and cancellation clauses. This is fundamentally the antithesis of bankruptcy law in the United States, where the intent of bankruptcy law is to allow the greatest opportunity for reorganization of the distressed debtor. Therefore, in the United States, the automatic stay overrides many precipitous contractual provisions.
For example, consider Brazil's bankruptcy process, concordata. Generally, concordata results in liquidation or extremely low recovery (factor #1). Therefore, the largest creditors of a Brazilian-based debtor are more likely to discuss a workaround that will avoid a local filing with the intent to develop a consensual strategy that will offer a more positive outcome.
At the same time, concordata does not stay secured debt collections or invalidate cancellation clauses in contracts (factor #2). Therefore, if a company should file locally, its suppliers have the ability to cancel services to the debtor. These factors present a tremendous disincentive to filing locally in Brazil. At the same time, the existence of cancellation clauses without stay protection may negatively affect a cross-jurisdictional filing. Therefore, a workaround can offer the most reasonable plan to address an insolvency situation in Brazil. Although a workaround is not a cross-jurisdictional filing, the opportunity to avoid a local liquidation and the lack of stay enforcement still produces the needed leverage for productive debtor-creditor discussions.
Leverage Point #3: Local Relief
U.S. critical vendor motions and other pre-petition relief motions are highly contested topics in today's bankruptcy courts. In cross-jurisdictional filings, the importance of vendor relief increases exponentially. Smaller local creditors without assets in the United States may find it in their interests to initiate local legal action. Such actions may gather local legal support due to the U.S. filing. For example, Argentinian courts can use the filing of a local entity in the United States as the basis to rule in favor of a local creditor seeking to place the debtor into liquidation. The most direct way to avoid such precipitous actions is to obtain court approval to continue payments in the ordinary course. However, creating leverage within the U.S. courts for the debtor to disburse relief is challenging.
One tool for establishing significant strategies to garner support for relief is a "creditor examination." A creditor examination is a detailed analysis of the nature of the debtor's ordinary course business versus the functionality of its creditors. It allows the professional team to develop strategies that offer the debtor the opportunity to operate the business without interruption and creditors relief for some—or all—of their outstanding debt.
Some of the possible examples of creditor categories that may develop from the creditor examination are:
- Customer: Some creditors may also comprise a substantial customer base for the debtor's business, creating a unique dynamic either to support a motion for relief or a workaround. Examining the net position between the two could prove that the debtor owns a net positive relationship with its creditor, helping to support a petition for relief.
- Supplier: Some cases involve debtors whose assets are most valuable while continually operating (rather than being liquidated), like telecommunications companies. If a group of creditors is essential to continuing the debtor's operations, and thus the valuable customer base, intact, then seeking relief is a benefit to the creditors as well.
- Tax Collector: In some cases, the creditor may be a vehicle for collection of taxes by the local government, effectively making the debtor a tax collector on behalf of the government—thereby supporting a motion for payment of third-party taxes.
Leverage Point #4: Communication
Communication with internal and external constituencies provides a vital link in cross-jurisdictional filings—particularly when the local equivalent of chapter 11 would result in liquidation. The need for increased levels of communication is exacerbated by the need to address medium-to-small creditor concerns rather than have them act precipitously.
- Internal communication: To launch and maintain a successful, consistent communication strategy, it is essential that management is educated on the laws that govern the jurisdiction of the filing. Senior management should provide local management with materials to develop an understanding of the U.S. process, as well as answer those questions that surface during the process. Preparing all employees will not only help to ensure that no legal violations of the law of the jurisdiction occur, but will also allow the debtor's employees to focus with confidence on a normal course of business.
- External communication: The need for external communication increases when a cross-jurisdictional filing occurs. Creditors and customers may know the laws within their local jurisdiction, but will generally have a very limited understanding of U.S. chapter 11 laws. Understanding the "fresh start" intent of the chapter 11 process, the impact on the normal course of business and the expected outcome will significantly enhance the relationship with cross-jurisdictional creditors and customers, and will aid in increasing the probability of a successful proceeding.
- Medium-to-small creditor communication: Typically in U.S. filings, conversations with medium-to-small creditors consist of informational discussions about the nature of post-petition practices between the debtors and creditors. Many creditor services are not exclusive. Most are familiar with the process, and as a result, the debtor may be in the position to dictate the tone of communication.
In a cross-jurisdictional filing, the debtor has less leverage to shape the discussion with creditors. Management must allocate extra attention to creditor concerns while educating them about the U.S. bankruptcy process. The debtor should extract the underlying issues regarding the creditors' willingness or unwillingness to cooperate. For example, the debtor's understanding of the initial objective of a creditor may be that they want to get paid on their pre-petition debts. However, through a broader dialogue, the debtor may come to understand that the real issue centers on the creditor's short-term cash-flow gap. By examining the post-petition payables, it may be possible to briefly modify post-petition payments and address the creditor's cash-flow issues.
Leverage Point #5: Notable Process Challenges
The emphasis in foreign countries on employees' and officers' liability may conflict with U.S. bankruptcy provisions and requires extensive discussions with creditors and advisors.
- Severance and Key Employee Retention Plans (KERP): Foreign governments may have set minimum payments for severance calculations based on employee years of service or rank, often exceeding those normally provided in a U.S. chapter 11 proceeding. Furthermore, in tight liquidity situations, the cost may limit the level and nature of the terminations. Other times, these costs alone may dictate the direction of the case and whether a filing is feasible or not. Communicating these requirements to key stakeholders early reduces the challenges faced in developing a KERP and provides an approach to implementing cost reductions.
- Director and Officer Liabilities: In many foreign countries, director and officer liabilities extend beyond the corporate boundaries and into personal liabilities, which can sometimes carry criminal charges. Certain corporate obligations incurred beyond the point when a company is deemed insolvent may become the personal obligations of senior managers. Therefore, when developing a strategy for reorganization, the laws addressing director and officer liabilities must receive detailed attention.
- Joint Administration: If a single jurisdiction is chosen, then a joint administration pleading can significantly reduce the cost and time needed to manage the debtor's cases within court. If successful, this pleading will minimize the time and cost for all participants: the court, trustee, all creditors and the debtors. It will contribute in maximizing the possible recovery within the case.
With the proper leverage points, a cross-jurisdictional bankruptcy filing—although challenging—can achieve a successful reorganization for a debtor with a more streamlined and controlled bankruptcy process than independent local filings. Below is a recap of leverage points:
- The existence of U.S.-based assets can create a pseudo-automatic stay with large international creditors.
- A comparison of anticipated recoveries in the U.S. process vs. a local foreign process opens a discussion and potential cooperation from creditors to maximize recovery.
- Local relief strategies can be developed through a creditor examination to assist in avoiding local precipitous legal actions.
- Communication will be vital to manage the additional complexities of a cross-jurisdictional filing.
- Concentration on employee and officer liabilities will determine and shape key bankruptcy negotiations.
- Joint administration can streamline the logistics of the filing.
As international bankruptcies continue to challenge the sometimes-arcane bankruptcy laws of individual countries, today's turnaround professional must assertively use creative measures to deliver effective international bankruptcy strategies with the most effective and efficient results for his or her clients.
1 Stacey Hightower is an associate with AlixPartners LLC in New York. He can be contacted at 9 West 57th St., Suite 3420, New York, N.Y., 10019, telephone: (212) 490-2500, fax: (212) 490-1344. Return to article