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United States

Status of participants in bankruptcy proceedings

What is the relationship between a participant in a secured loan and the debtor when the debtor becomes bankrupt? This question has troubled many participants concerned that they may not be able to assert rights in the collateral during the course of the bankruptcy proceeding.

A recent case, In re Felicity Associates, 1996 WL 339148 (Bankr. DRI) sheds some light on this question, in a manner disadvantageous to loan participants.

Citizens Trust Company had made a secured loan to Felicity Associates in the amount of US$500,000. The amount of the debt had been reduced to US$286,000 before Felicity filed for bankruptcy under Chapter 11 of the Bankruptcy Code. Marie Porcaro, the majority shareholder of Felicity, had guaranteed the loan, and Citizens made a demand under the guarantee. Porcaro agreed to pay Citizens US$200,000 in return for an equivalent interest in the loan made by Citizens. Under this settlement, Porcaro and Citizens entered into an 'Option Agreement to Purchase Participation Share' which provided that:

"(iii) [Citizens] shall have the sole and absolute right to manage, perform and enforce the terms of the Agreement, and to exercise and enforce all provisions, rights and remedies exercisable or enforceable by Bank in connection with the Debtor's bankruptcy proceeding in Bank's sole and absolute discretion ..."

When Felicity filed a Plan of Reorganization under Chapter 11, Porcaro was listed as a secured creditor of Felicity. Citizens objected to this classification on the basis of the Option Agreement referred to above.

The Bankruptcy Court for the District or Rhode Island found that the Option Agreement constituted a true participation agreement. The Court noted that there are two elements of a participation agreement:

  • the lead bank retains the collateral in its name; and
  • the lead bank services the loan.

The court concluded that, on the basis of paragraph (iii) quoted above, the Option Agreement was indeed a participation agreement.

The court then observed that under a participation agreement "the lead bank is charged with monitoring and collecting the debt, including the filing of a proof of claim in bankruptcy, and perfecting the claim against the borrower ... because the participant's relationship is with the bank and not with the debtor, the lead bank, and not the participant is considered the creditor".

Accordingly, the court ruled that Porcaro, as a participant in the Citizens loan to Felicity, was not a secured creditor in the bankruptcy case. In fact, it would seem to follow that Porcaro was not an unsecured creditor either as the only right a participant has to loan proceeds is the right to receive its percentage share from the lead bank. If a loan participant wishes to be treated as a secured creditor of the debtor, it may be possible to modify the wording of the participation agreement, but most lead banks would resist such a change in the relationship of the parties.

Enforcement of foreign judgments

The US has not entered into any international conventions providing for the reciprocal enforcement of foreign judgments. However, procedures exist under state law for the enforcement of foreign judgments without the necessity of retrying the case.

Dynamic Cassette International v Mike Lopez & Associates, 923 F Supp 8 (EDNY 1996), decided by a federal court in New York earlier this year, illustrates how a foreign judgment can be enforced in New York. Dynamic Cassette, a UK company, had shipped certain goods to Lopez, a US company with offices in New York and Dallas. After Lopez failed to honour invoices for the goods, Dynamic sued in England's High Court of Justice, Queen's Bench Division. The sales contract between Dynamic and Lopez provided that "the contract of sale ... shall be governed by English law in the jurisdiction of the High Court of Justice of England". Lopez failed to appear in the English proceeding and the court issued a default judgment in the amount of £156,935 (US$240,000) plus costs and interest.

Dynamic then sued in federal court in New York to enforce the English judgment. The New York Uniform Foreign Country Money Judgments Recognition Act governs suits to enforce foreign judgments in state or federal courts in New York. Under the New York Uniform Act, a foreign judgment will be recognized and enforced in New York unless "the judgment was rendered under a system which does not provide impartial tribunals or procedures compatible with the requirements of due process of law", or if "the foreign court did not have personal jurisdiction over the defendant".

Lopez did not challenge the suit in federal court in New York. Nevertheless, the New York court held that the High Court of Justice, Queen's Bench Division, is a fair and impartial tribunal whose judgments should be enforced in New York. While this holding may be dictum (in view of the failure of the defendant to contest the enforcement proceeding), it does indicate that courts in New York are prepared to accept English judgments under the standards of the Uniform Act.

The court also found that the English court had personal jurisdiction over Lopez even though it had failed to make an appearance. Under the sales contract, Lopez had agreed to submit to the jurisdiction of the High Court of Justice, and it had been served in the English action in accordance with Texas law.

The remaining question for the New York court was how to convert the English judgment, denominated in sterling, into US dollars. Section 27(b) of the New York Judiciary Law now instructs courts in New York to enforce a foreign judgment by converting the currency of the judgment into US dollars "at the rate of exchange prevailing on the date of entry of the judgment". The court found that the judgment referred to in the statute is the judgment of the enforcing jurisdiction, ie the New York court. However, the court did not specify how to determine the applicable exchange rate on that date and which rate to use if the exchange rate varies on that date.

The court's decision in the Dynamic Cassette case does not make any new law. But it does illustrate the manner in which English judgments will be enforced in New York and serves as a warning to US parties who choose to ignore foreign judicial proceedings.

Robert S Rendell

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