Earlier this year, the US Bankruptcy Court for the Northern District of Texas (Bankruptcy Court) handed down a decision that could have far-reaching consequences for cross-border insolvencies. The June 13 ruling, under chapter 15 of the US Bankruptcy Code (Code), was in Vitro SAB de CV v ACP Master Ltd (In re Vitro). The Bankruptcy Court's jurisdiction is not often considered a hot spot for bankruptcy filings. In 2011, for example, the district fielded a total of 18,328 bankruptcy filings, compared to 59,093 petitions filed in the Northern District of Illinois and 134,401 in the Central District of California. However, the Bankruptcy Court was among only a handful of US bankruptcy courts to host multiple chapter 15 proceedings last year.
One of those proceedings was initiated by foreign representatives of Vitro, a Mexican holding company that operated the country's largest manufacturer of glass containers and flat glass through subsidiaries and facilities spanning eleven countries across the Americas and Europe. They were seeking recognition in the US of the pre-packaged restructuring plan (Concurso plan) approved in its voluntary judicial reorganisation proceeding filed in Mexico (Mexican Proceeding) on December 13 2010 under the Mexican Business Reorganisation Law (Ley de Concursos Mercantiles).
Although US bankruptcy courts have given effect, via chapter 15 proceedings, to other plans approved under Ley de Concursos Mercantiles, a number of factors set In re Vitro apart. First, in order to procure sufficient votes to approve its Concurso plan, Vitro relied almost exclusively on debt held by its subsidiaries and affiliates. Secondly, the Concurso plan provided for the release of non-debtor guarantors from their guaranty obligations. Crucial to Vitro's strategy in approving its plan was the fact that – in stark contrast to the Code's prohibition of counting insiders' votes in a plan that does not provide for 100% recovery for all affected creditors – the Ley de Concursos Mercantiles does not expressly make such distinction. Taking advantage of this difference in law and obtaining approval of the Concurso plan in the Mexican Proceeding, Vitro next sought to enforce the plan through, inter alia, a permanent injunction in the US under its chapter 15 proceedings.
Comity considerations
Under chapter 15 of the Code (s1521(b)), a court may entrust a foreign debtor's US assets to a foreign representative if it is 'satisfied that the interests of creditors in the United States are sufficiently protected.' Section 1507(b) provides that the court may also 'provide additional assistance to a foreign representative' – including the enforcement of a foreign court's order – 'consistent with principles of comity,' if the court determined, after its review of the circumstances, that such assistance was warranted.
A number of significant holders of Vitro's notes, worth more than $1.2 billion in total, received less favourable treatment under the Concurso plan than they might have expected under a consensual plan approved by the vote of unaffiliated creditors. Not surprisingly, together with the respective indenture trustees, these noteholders objected to granting US recognition of the plan under chapter 15. They marshaled numerous objections to the Concurso plan, arguing on several grounds that it failed to satisfy section 1507(b) of the Code. These grounds included that the plan: unfairly discriminated between foreign and non-foreign creditors; failed to protect US creditors from prejudice or inconvenience in the processing of its claims in the Mexican Proceeding; failed to provide reasonable assurance against fraudulent transfers; and failed to distribute the proceeds of the estate in substantial accordance with the Code.
The noteholders asserted that the Concurso plan failed to satisfy the standard for assistance set out in s1507 of the Code. They also claimed that various aspects of the Concurso plan were manifestly contrary to a fundamental US public policy, and called on the Bankruptcy Court to exercise its discretion under s1506 of the Code – the so called public policy safety valve devised by Congress. As aptly described by the Bankruptcy Court, this section provides the "final hurdle" for any chapter 15 debtor, stating: 'nothing in this chapter 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.' Although the 2010 Fifth Circuit decision In re Ran ruled that it can only be invoked under 'exceptional circumstances concerning matters of fundamental importance for the United States,' s1506 provides chapter 15 courts with authority to stop recognition of foreign proceedings in their tracks.
Courts have often cautioned that comity, defined by the Supreme Court as 'recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation,' is of utmost importance in chapter 15 proceedings. However the Bankruptcy Court explained that 'granting comity to judgments in foreign bankruptcy proceedings is appropriate as long as US parties are provided the same fundamental protections that litigants in the US would receive.' Put another way, a foreign representative cannot force a US bankruptcy court to apply foreign laws by relying solely on, as stated in the 2011 case In re Toft, an 'impassioned appeal to comity.'
Based on its review of the limited existing case law, the Bankruptcy Court concluded that an exception to comity was warranted. In doing so, the court zeroed in on the blanket releases from liability granted under the Concurso plan to Vitro's non-debtor guarantor subsidiaries. In doing so, it noted: 'for the past year, this Court has expressed concerns regarding the most problematical part of the Mexican Proceeding, the extinguishment of claims held by the objecting parties against non-debtor subsidiaries, entities which did not avail themselves of protection in the Mexican proceeding.'
Reasons threefold
The Bankruptcy Court gave three primary reasons for its decision. First, it agreed with the objecting noteholders that the Concurso plan failed to satisfy section 1507(b) of the Code's assistance standard. This was because of the 'drastically different treatment' they would receive under the Concurso plan compared to in the US where they would be free to pursue their remedies against the non-debtor guarantors. Second the Bankruptcy Court also reasoned that this disparity did not 'provide an appropriate balance between the interests of creditors and Vitro SAB and its non-debtor subsidiaries,' and therefore, the US creditors were not adequately protected as required under s1521(b) of the Code. Finally, the court agreed with the objecting US creditors that the releases of the non-debtor guarantors contained in the Concurso plan constituted sufficient public policy grounds to deny comity under s1506.
Regarding this last point, one of the primary reasons a guaranty is sought from an additional party is to protect a creditor against the risk of the primary obligor being unable to meet its payment obligations. In practice in the US corporate bond market, it is basically a given that a corporate guarantor who does not avail itself of bankruptcy protection is not discharged from its guaranty obligations merely due to the fact that the primary obligor's debts have been discharged in bankruptcy.
This concept was expressly embodied in the indentures of the three tranches of notes at issue. They all contained identical guaranty language, governed under New York law, as follows:
Guaranty Unconditional. The obligations of each Guarantor hereunder are unconditional and absolute and, without limiting the generality of the foregoing, will not be released, discharged or otherwise affected by... any insolvency, bankruptcy, reorganization or other similar proceeding affecting the Company or its assets or any resulting release or discharge of any obligation of the Company contained in the Indenture or any Note.
In light of the above, observing that both Congress and US courts generally disapprove of non-consensual third party releases of the kind included in the Concurso plan, the Bankruptcy Court concluded that 'the protection of third party claims in a bankruptcy case is a fundamental policy of the United States.'
What is perhaps most interesting is that, although mentioned several times in the court's opinion, the underlying issue of a cramdown plan being supported by insider votes was not the deciding factor in rejecting comity. The Bankruptcy Court noted that 'allowing insiders to vote, including the subsidiaries who voted to extinguish their own guarantees to the Objecting Parties, gives the Court pause.' But it went on to say that such issue 'may be one of Mexican law, which should be decided by a court in Mexico.' This is consistent with the fact the same Bankruptcy Court had issued an order six months prior enjoining the noteholders from pursuing an injunction against the US non-debtor subsidiaries that would have prevented them from giving their consent to the Concurso plan.
Creditor warnings
Notwithstanding the Vitro court's and other courts' analysis of the public policy exception, what might or might not constitute a fundamental policy of the US for this purpose remains relatively murky. Moreover, the amount of litigation and wrangling involved in preventing the application of comity based upon a fairly new statute serves as a warning for creditors. They must be aware of, and do what they can to protect themselves against, the application of potentially adverse foreign insolvency laws on the front-end.
For example, creditors of Mexican debtors in default should monitor, control and be fully aware at all times of the amount of intercompany liabilities owing by such debtors. Had its noteholders initially required all Vitro's intercompany debt to be collaterally assigned, and all documentation evidencing the same duly endorsed and physically delivered to creditors, they might have been able to prevent creation of the intercompany debt scheme devised by Vitro to garner sufficient votes in support of its plan. Alternatively, they might have at least claimed the right to vote such intercompany claims in concurso mercantil, and thereby had the chance to block approval of the debtor's cramdown plan in the Mexican Proceeding.
Another key, and related, point for creditor consideration is timing. The Ley de Concursos Mercantiles provides that during the 270 days (or any longer lookback period fixed by the judge in a concurso proceeding) before the date of judgment that a debtor is insolvent, certain transactions (including those with subsidiaries) are subject to higher scrutiny for potential fraud. It's worth noting that this is similar to the preference period contained in the Code. Therefore, in the event a Mexican debtor is unwilling to disclose information regarding its intercompany claims, creditors should proceed with caution. Getting lulled into lengthy workout negotiations with a defaulting debtor could allow the lookback period to lapse, and increase the leverage of a Mexican debtor who may have surreptitiously entered into transactions that gave rise to intercompany debt. In this scenario creditors often have a natural aversion to commencing involuntary bankruptcy proceedings to preserve their rights, as the associated costs will consume part of the assets otherwise available for their recovery. However in light of In re Vitro, creditors may now more seriously weigh such cost against the risk of an unfavourable cramdown orchestrated by a wily debtor.
By Foley & Lardner of counsel John L Murphy in Miami and senior counsel Joanne Lee in Chicago