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US structured finance

Patton Boggs LLP

Dallas

May a creditor bring a legal action in the US against a foreign person when that person is subject to a bankruptcy proceeding in its country of domicile? With the steady globalization of business, this question is becoming increasingly relevant. In early October, the US Court of Appeals for the Second Circuit dismissed a case brought in federal court in New York on the grounds of international comity. The Second Circuit elected to defer the creditor's claim to a liquidation proceeding being conducted in Brazil - Finanz AG Zurich v Banco Economico SA (2nd Cir 1999).

The case involved a forfaiting transaction in which a Brazilian importer's notes were sold to Deutsche Morgan Grenfell Trade Finance (DMG). The notes bore the guarantee of the Cayman Island branch of Banco Economico (BESA), a Brazilian bank. Each note stated that it was payable at BESA's New York branch.

Finanz AG Zurich purchased several of the notes from DMG on a non-recourse basis. However, prior to the maturity of the notes, Brazil's central bank placed BESA and its various branches into "intervention", a form of pre-bankruptcy financial monitoring. The following year, the Central Bank converted the intervention into an extrajudicial liquidation of BESA which the US court found was similar to a liquidation proceeding under the US Bankruptcy Code. While these proceedings were in progress in Brazil, DMG, on behalf of itself and Finanz, presented all the notes for payment by BESA at its New York branch. Payment was refused by the branch. The general manager of the branch responded by indicating that Finanz could either pursue the Brazilian importer or assert a claim in the Brazilian liquidation proceeding. Instead, Finanz brought suit in New York, but the federal district court dismissed the case. On appeal, the Second Circuit has upheld the lower court.

The appellate court noted that for reasons of international comity US courts will ordinarily defer to proceedings taking place in foreign countries so long as the foreign proceeding "does not prejudice the rights of US citizens or violate domestic public policy". The court also noted that the doctrine of comity has been extended by US courts to foreign bankruptcy proceedings. Finanz argued that deferral to the Brazilian liquidation proceeding was not appropriate because:

  • such deferral would violate US public policy; and

  • the Brazilian proceeding lacked due process and was unfair to foreign creditors.

Finanz contended that since the aval was payable in New York (at BESA's New York branch), the US has an interest in ensuring that the guarantee is honoured. The Second Circuit rejected this argument since the aval was a liability of a foreign branch of the Brazilian bank. It was merely payable at the New York branch; it was not a liability of the New York branch. Therefore, deferral to the Brazilian liquidation proceeding would not violate US public policy interests.

Regarding the fairness issue, Finanz argued that the Brazilian liquidation proceeding lacked due process because:

  • Brazilian law does not require individualized notice to creditors (notice by publication is sufficient); and

  • Brazilian law requires Finanz to convert its claim from US dollars into Brazilian reals.

The Second Circuit rejected both arguments, pointing out that Finanz had actual notice of the Brazilian proceeding and that the US Bankruptcy Code also requires conversion of a claim denominated in a foreign currency. The Court, did note, however, that if the early conversion of a creditor's claims into foreign currency would render a debt unenforceable or valueless, the Court "might have cause to conclude that a conversion procedure was fundamentally unfair".

Thus, since the Brazilian liquidation proceeding was neither unfair nor in violation of US public policy, considerations of international comity justified the lower court's dismissal of Finanz's case in favour of the Brazilian proceeding.

Robert S Rendell

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