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Cross-Border Insolvency Forum Shopping Naivete

posted by John Pottow

by Ted Janger and John Pottow

Recently, two U.S. law professors and a third from Singapore offered unsolicited advice to the United Nations Commission on International Trade Law (“UNCITRAL”) regarding that organization’s ongoing efforts to harmonize and modernize the law of cross-border insolvencies.  They wrote an open letter (the “Letter”) to the Secretariat—joined by a number of other academic signatories—that calls upon UNCITRAL to abandon one of the core principles of its Model Law on Cross Border Insolvency (the “MLCBI,” adopted as chapter 15 of the U.S. Bankruptcy Code): that, other things being equal, a cross-border bankruptcy case should be based where the debtor is located. 

This principle is implemented by according special deference and comity to the insolvency case located at the debtor’s center of main interest (the “COMI”).  The debtor’s COMI is the jurisdiction where it carries out its activities and, hence, is the jurisdiction that is known and readily apparent to third parties.  It therefore is predictable.  The COMI principle thus has a lot to recommend it.  In most cases it will enhance the legitimacy of bankruptcy outcomes by simultaneously furthering administrative convenience, increasing transparency, vindicating creditor expectations, and respecting national sovereignty.  Like most rules of private international law, it is rooted in common sense.

Notwithstanding COMI’s many virtues, the Letter’s authors recommend jettisoning COMI in favor of a regime of unfettered forum choice and jurisdictional competition; the main proceeding entitled to deference in a multinational insolvency should be freely selected by the debtor.

The Letter starts by gesturing respectfully towards modified universalism as the preferred method to coordinate a global cross-border insolvency case through a main proceeding entitled to deference—one case, under one law, presumptively given global recognition. But the authors then attack modified universalism (and UNCITRAL’s) mechanism for identifying and the rationale for deferring to that main case—that it is the case opened at the debtor’s COMI.  According to the Letter, COMI-based deference has three flaws: (1) COMI limits debtors’ free reign to choose their bankruptcy venue, a restriction that they claim is intrinsically inefficient; (2) COMI is litigable; and (3) COMI can be changed “opportunistically” and thus frustrate the expectation of creditors.

The latter two arguments—COMI indeterminacy and COMI mobility—are makeweights.  Indeed, these complaints may well be more applicable to the authors’ free choice approach, but we can leave that debate for another day.  Consider first the Letter’s attack on COMI’s determinacy.  It is supported by pointing to the brave new world of cryptocurrency exchanges (and other virtual organizations) that purport to exist only in the ether; surely, the authors reason, those COMIs will be hard to detect.  We are less concerned, because even if everybody at a crypto intermediary works from home, their company is incorporated and has bank accounts.  Under the MLCBI, the COMI of a crypto exchange, ethereal though the entity may be, would presumptively be the jurisdiction of incorporation.  Anybody seeking to cast doubt would be hard-pressed to rebut that presumption.  But even if the COMI of cryptocurrency exchanges are debatable, they are a sideshow.  The advent of cryptocurrency has done little to unsettle the COMI of enterprises that participate in the real economy, such as General Motors or WeWork.  So, we just don’t get the fuss.  As for the complaint of COMI mobility, the authors’ argument is puzzling.  After all, their principal objection to COMI is that it is too constraining.  Under their logic—that debtors need the ability to choose venue so that they can gravitate toward efficiency—COMI mobility should be celebrated rather than feared by lenders. 

The authors’ real gripe is that the COMI regime restrains forum shopping.  This grievance rests on a faith-based argument that rational debtors will choose to “race to the top” toward an efficient bankruptcy regime and hence lower credit costs.  In their view, jurisdictional competition is necessarily good.  This retreads a well-worn argument on the U.S. domestic front advanced by one of the authors decades ago that businesses should be able to pre-specify their bankruptcy regimes in their corporate charters for all lenders to know and price.  (The idea died on the policy vine for lack of a first.) 

The problem with the Letter’s mantra that forum shopping is good is that forum shopping can also be bad.   It is theoretically and certainly empirically contestable whether the net outcome of more forum shopping will be positive or negative.   We don’t know whether more forum shopping will result in generally efficient or opportunistic forum choice.  Indeed, cynical and transparently contrived forum shopping has recently been all the rage in mass tort cases involving opioids and talc.  Using a technique known colloquially as the “Texas Two-Step,” Johnson & Johnson reincorporated its cosmetics subsidiary in Texas, split it into two separate corporations using Texas’ divisional merger statute, and then reincorporated the entity containing its talc liabilities in North Carolina, all within several days.  The filing entity had three separate corporate charters within the course of a week, all in an attempt to find a favorable bankruptcy forum.  Similarly, the Sackler family chose White Plains as the venue to file the bankruptcy of opioid producer Purdue Pharma (with nothing more than leased office space as a connection) because it was thought to be a forum that would allow them to bind dissenting tort claimants to releases of non-debtor members of the Sackler family.  Indeed, this was only possible because the United States does not have a COMI requirement.  We see no reason to take this embarrassment global.

Recognizing this “bad” aspect of forum shopping as the Achilles’ heel to their argument, the authors retreat to a suggestion that UNCITRAL could somehow force domestic jurisdictions to amend their insolvency laws to grant distributional priorities to vulnerable creditors likely to be on the short end of the debtor choice stick.  We are inclined to agree that a globally recognized priority for tort claimants, employees, and others might well make sense.  But this suggestion manifests a serious misunderstanding of what UNCITRAL does.  UNCITRAL cannot compel a jurisdiction to adopt its commercial law harmonizing instruments, let alone a priority scheme that embodies economically progressive values.  (Of course, the beauty of economists’ freedom from reality is that they can simply add that as another recommendation to their list of proposals, realistic or not.)  More importantly, UNCITRAL operates on consensus.  There is nothing close to consensus on the desirability of a “torts-first” priority, let alone whether forum shopping is on balance normatively desirable.  A proposed model law that incorporated either proposal would likely be dead on arrival.

UNCITRAL is not insensitive to the idea that forum shopping is sometimes good.  Entities “forced” to file in COMIs of liquidation-only regimes face the prospect of value destruction when reorganization would be better.  Such companies have at least two choices under the current MLCBI regime, and both strategies have been deployed in modern bankruptcy practice.  They can migrate their COMIs or they can simply file a nonmain proceeding in a more attractive venue and then seek discretionary relief in their home jurisdiction, which has the power under the MLCBI to grant recognition so long as local creditors are “adequately protected.”  And UNCITRAL has now promulgated an instrument that contains an even better solution, at least for the common situation when the debtor is a collection of entities constituting a corporate group: the Model Law for Enterprise Group Insolvencies (the “MLEGI”).  The MLEGI goes a step further in addressing the issues of group cases and the limitations of COMI for multi-jurisdictional enterprises in a way that is both pragmatic and straightforward.  It contemplates the opening of a “planning proceeding” at the COMI of an essential (“necessary and integral”) group member that would serve as a principal forum for crafting the group’s insolvency solution.  Group members and creditors of group members can participate in that proceeding, but as under the MLCBI, any relief ordered would have to be accepted by each group member’s home jurisdiction.  The goal is to capture the efficiencies of a jurisdiction with the capacity to coordinate a global solution—usually a restructuring—while respecting the local policies and sovereignty of the debtor’s home jurisdiction. 

We could go on.  So, we will!  We do not think offering every creditor a veto right on changing the debtor’s selected jurisdiction will lead to greater efficiency; that is simply a re-invention of the U.S. Trust Indenture Act, the holdout problems of which ground one of the justifications for the Bankruptcy Code.  We are similarly unpersuaded that a backup proposal premised upon debtors convincing a judge that their chosen jurisdiction is “more beneficial” than the COMI is likely to generate less litigation than one based upon the location of COMI.  Nor do we think the invitation to expand the scope of the public policy exception will be welcomed by UNCITRAL member states familiar with the MLCBI.

Our point is not to pick on the authors of the Letter—or the additional signatories, most of whom, in fairness, are academics who neither conduct research in the area of cross-border insolvency law nor have previously engaged with the work and working methods of UNCITRAL.  Rather, it is to underscore that the consensus-driven model of UNCITRAL makes the scrapping of COMI fanciful.  In our view, it is also ill-advised.  We believe a more thorough appreciation of the benefits of COMI and the broader regime of model laws, coupled with a frank reckoning with the constraints on how UNCITRAL operates, must necessarily ground further discussion of any future agenda.

Comments

The authors' analysis is right on. On the point of using nonmain fora when necessary, pls see Comity and Choice of Law in Global Insolvencies, 54 Texas Int. L.J. 259 (2019).

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