I. INTRODUCTION
Bankruptcy forum shopping, it appears, is a popular pastime in the United States particularly in reorganisation cases under Chapter 11 of the Bankruptcy Code. “Forum shopping” may be defined as a Chapter 11 filing in a court other than that which serves the location of the company's head office.Footnote 1 In the US, there are a number of jurisdictional hooks and a large company has more or less free rein in terms of the venue for filing a case under the Bankruptcy Code. Manhattan and Delaware have become popular as shopping venues. On the other hand, bankruptcy law in the US is federal law and there should not be any difference in substantive law depending on the court in which the case is filed.
In the European Community context there are greater incentives for forum shopping in that substantive bankruptcy law differs in each EC member States but the opportunities are superficially less given a more restricted basis for assuming jurisdiction. This paper asks whether the jurisdictional restraints can be overcome and whether bankruptcy forum shopping can become widespread in Europe in the wake of the European Insolvency Regulation (EIR) which allows for Europe-wide recognition of insolvency proceedings. It also looks at the desirability of the practice and whether safeguards can be put in place to mitigate any undesirable consequences and negative externalities. It concludes that the jurisdictional hooks are sufficiently fuzzy so as not to prevent forum shopping from potentially developing on a large scale and indeed there is evidence that the UK is becoming the restructuring capital of Europe. On to the other hand, there is little to prevent asset-grabbing by local creditors and rival jurisdictional claims by national courts. So the overall result is somewhat disappointing insofar as the efficient disposal of bankruptcy cases is concerned. A better approach may be to return to the practice whereby insolvencies are administered on a national territorial basis alongside cooperation with courts in other countries. The paper begins by examining the concepts of universalism and territorialism which are at the heart of international insolvency law and practice.
II. UNIVERSALISM AND TERRITORIALISM
Universalism implies that the assets of an insolvent company should be administered on a worldwide basis.Footnote 2 The administration of the insolvency estate should be conducted under the auspices of a single judicial authority which would normally be in the country of incorporation. Universalist notions of insolvency administration are compatible with the existence of secondary insolvency proceedings in jurisdictions where assets of the insolvent company are located but these secondary proceedings should be ancillary in nature.Footnote 3 They should serve merely as mechanisms for the more efficient collection of assets at a local level and the transmission of such assets to the liquidator in the main proceedings. Scott V.C. in Re Bank of Credit and Commerce International SA (No 10) attempted to explain the principles governing ancillary liquidations stating:
(1) Where a foreign company is in liquidation in its country of incorporation, a winding up order made in England will normally be regarded as giving rise to a winding up ancillary to that being conducted in the country of incorporation.
(2) The winding up in England will be ancillary in the sense that it will not be within the power of the English liquidators to get in and realise all the assets of the company worldwide. They will necessarily have to concentrate on getting in and realising the English assets.
(3) Since in order to achieve a pari passu distribution between all the company's creditors it will be necessary for there to be a pooling of the company's assets worldwide and for a dividend to be declared out of the assets comprised in that pool, the winding up in England will be ancillary in the sense, also, that it will be the liquidators in the principal liquidation who will be best placed to declare the dividend and to distribute the assets in the pool accordingly.Footnote 4
In theory at least, English insolvency law has long been committed to a universalist vision. Traditionally an English liquidation has universal effect and applies to all assets of the company irrespective of location,Footnote 5 though, of course, there can be practical difficulties in securing recognition of the winding up in the relevant foreign jurisdiction where the assets happen to be situated. As a general proposition, it was not possible to have a winding up confined to a company's domestic assets.Footnote 6 The Privy Council in Cambridge Gas Transport Corporation v. Official Committee of Unsecured Creditors (of Navigator Holdings Plc) Footnote 7 underscored the universal application of insolvency proceedings. Lord Hoffmann said:
There should be a single bankruptcy in which all creditors are entitled and required to prove. No one should have an advantage because he happens to live in a jurisdiction where more of the assets or fewer of the creditors are situated.Footnote 8
Lord Hoffmann used public choice theory to explain the universality doctrine suggesting that it
… may owe something to the fact that eighteenth and nineteenth century Britain was an imperial power, trading and financing development all over the world. It was often the case that the principal creditors were in Britain but many of the debtor's assets were in foreign jurisdictions. Universality of bankruptcy protected the position of British creditors. Not all countries took the same view. Countries less engaged in international commerce and finance did not always see it as being in their interest to allow foreign creditors to share equally with domestic creditors.Footnote 9
Lord Hoffmann also acknowledged that English law had not always fully realised the aspiration of universality citing s. 221 of the Insolvency Act which invested the English courts with a broad power to wind up companies incorporated in other jurisdictions notwithstanding the absence of foreign main insolvency proceedings.
Lord Hoffmann was prepared to give free rein to the principle of universalism in Re HIH Casualty and General Insurance Ltd Footnote 10 holding that “surplus” assets in an English ancillary liquidation could be transferred to a foreign main liquidator despite the fact that the basis of distribution in the foreign proceedings was different from that in the English proceedings. The remission of assets could be ordered at common law on the basis that foreign main proceedings in the country of incorporation should, prima facie, be allowed to have universal effect. Other members of the House of Lords were not prepared to go so far and decided the case on the basis that the request to transfer assets came from an Australian court pursuant to s. 426 of the Insolvency Act 1986.Footnote 11 This section allows an English court administering insolvency jurisdiction to provide assistance, upon request, to a court in a designated foreign country.Footnote 12 Australia was a designated country for s. 426 purposes and there was nothing unacceptably discriminatory or otherwise contrary to public policy in the Australian insolvency provisions.Footnote 13
The rival theory to universalism is “territorialism”, which implies that insolvency proceedings should have an exclusively territorial focus.Footnote 14 Adherents of territorialism see it as more realistic in its goals than universalism. If a State espouses universalism and purports to give its insolvency proceedings global effect this claim to extra-territorial effect is unlikely to be recognised in a State where corporate assets are located and whose national interests are at stake. National interests may take the shape of Revenue claims or employee creditors pressing for payment of unpaid wages. Universalism comes a cropper in the face of national interests, vital or otherwise. Territorialism therefore comes into its own wearing the clothes of realism and practicality. Professor Tung, for example, contends that universalism is simultaneously a bad deal for every country involved.Footnote 15 Courts and countries care more about what happens within their borders than what happens outside those borders. Yet, universalism asks each country to give up control over events within its own borders in some cases in return for control over events outside its own borders in other cases.
One of the practical downsides to universalism is that States are unlikely to be in unanimous agreement about the factor that founds the exercise of universal jurisdiction.Footnote 16 One state may assert that the country of incorporation should form the basis of universal jurisdiction whereas another State may look to the country's principal place of business as the exclusive connecting factor. If the connecting factor in is fact principal place of business or some variant such as centre of main interests, then this gives rise to the possibility of forum-hopping through last minute manipulation of the factual matrix so as to invest a favoured location with jurisdictional competence.
Proponents of universalism might however contend that the notion of location of assets is itself a highly contested and problematic concept. It may not be easy to determine the precise “locus” or “situs” of particular assets, especially highly movable or fungible assets. Tying debts and other intangible assets to a particular location appears an artificial exercise.
Universalism and territorialism are polar opposites and it is possible to formulate theories that attempt to bridge distance between these extreme paradigms. Indeed, most States probably adhere to intermediate positions of some shape or kind. For instance, it is probably best to view the European Insolvency RegulationFootnote 17 as embodying a notion of modified universalism and the UNCITRAL Model Law on Cross-Border Insolvency as representing a form of cooperative territorialism.Footnote 18
III. UNIVERSALISM AND TERRITORIALISM IN PRACTICE: THE EIR AND UNCITRAL MODEL LAW
Under the Regulation, a European jurisdiction which serves as the centre of main interests (COMI) of the debtor is given exclusive competence to open main insolvency proceedings and it is intended that the opening of such proceedings should have immediate and universal effect throughout the European Union.Footnote 19 The theory behind the Regulation is that insolvency proceedings with pan-European extra-territorial effects will produce better returns for creditors etc than an agglomeration of separate national proceedings.Footnote 20 Corporate rescue, or at least business rescue, is the more likely outcome if the main bulk of the insolvency proceedings are handled out of a single jurisdiction i.e. where the company has the centre of its main interests.
The Regulation sets out a number of matters which are specifically referred to the law governing the opening of the proceedings including:
(a) against which debtors insolvency proceedings may be brought;
(b) the assets which form part of the estate;
(c) the powers of the liquidator;
(d) the effects of insolvency on current contracts to which the debtor is a party;
(e) rules governing the lodging, verification and admission of claims;
(f) priority ranking of creditors.
The Regulation also assigns jurisdiction to open secondary insolvency proceedings based on the presence of an “establishment” within a particular country. The scope of such proceedings is limited to the assets situated within the Member State – an exclusively territorial, as distinct from universal, effect. Secondary proceedings safeguard the position of local preferential creditors whose claims are non-preferential under the law of the main proceedings.Footnote 21 A truly universal system would give all power to the liquidator in the main proceeding and provide that a secondary liquidator was a mere minion to collect assets and transfer them to the main proceedings for distribution according to the law governing those proceedings. But this is not what the Regulation does. It follows the general principle that the law of the forum governs proceedings instituted in that forum, whether main or secondary proceedings. The fact that proceedings may be started in two or more jurisdictions with the application of different laws means that the principle of universality has been partially abandoned and that conflicts between different priority rules will inevitably arise. There are a number of provisions to deal with this including the imposition of a duty on the primary and secondary liquidators to communicate with one another promptly.Footnote 22 Moreover, any “surplus” in a secondary liquidation must be passed to the main liquidator, but this may be a case of shutting the stable door after the horse has bolted. There may be little or nothing left in the secondary pot after the claims of local preferential creditors have been satisfied.
Under a second major exception to universalism, there are certain insolvency matters not regulated by the law of the forum. Article 5, for example, recognises the rights of secured creditors with a valid claim to assets under the law of the place where the assets are situated. Creditors can acquire security by fulfilling the relevant conditions under this law, safe in the knowledge that their secured status will not be disturbed by the commencement of insolvency proceedings in another EC State. Article 6 preserves certain set-off rights. Article 4(2)(d) states that the law of the insolvency forum shall govern the conditions under which set-offs may be invoked, but under Article 6 set-off rights can still be claimed if they are permitted by the law applicable to the insolvent debtor's claim. Article 7 preserves sellers' rights under reservation of title clauses where the assets are situated in a different Member State than the insolvency forum. Article 8 reiterates the well established norm of private international law that questions of title to immovable property are governed exclusively by the lex situs. Article 9 is designed to protect the integrity of payment systems and financial markets. It provides that the effects of insolvency proceedings on the rights and obligations of the parties to a payment or settlement system or to a financial market shall be governed solely by the law of the Member State applicable to that system or market.
Notwithstanding these major exceptions, the European Insolvency Regulation does subscribe to a general universalist vision based on the market integration ideals underpinning the EU. The Insolvency Regulation is an emanation from the European Union, whose member states have agreed to pool their sovereignty and agreed to work towards an ever closer Union. Europe is seen as a single market and in this context it makes sense to have a single set of main insolvency proceedings rather than a hodge podge of separate territorial proceedings that will have the effect of partitioning corporate assets along national lines.Footnote 23
The UNCITRAL Model Law on Cross-Border InsolvencyFootnote 24, on the other hand, is a much more limited and less ambitious undertaking – an exercise in realism and the art of the possible.Footnote 25 Descriptions differ however among both supporters and opponents of the measure with some suggesting that it embodies universalist ideals but others would see the Model Law as a form of co-operative territorialism. Harmonisation efforts were concentrated in certain key areas such as:
(1) co-operation between courts in countries where the debtor's assets were located;
(2) providing foreign creditors or foreign insolvency representatives with access to local courts;
(3) recognising certain orders issued by foreign courts.
The Model Law accords recognition to foreign insolvency proceedings but the degree of recognition varies depending on whether the proceedings are “main” or “non-main”. Foreign main proceedings are defined as proceedings taking place in the State where the debtor has its centre of main interests (COMI).Footnote 26 The COMI concept is the same as that in the EIR. Foreign non-main proceedings means foreign proceedings, other than foreign main proceedings, taking place in a State where the debtor has an “establishment”. “Establishment” is defined as “any place of operations where the debtor carries out a non-transitory economic activity with human means and goods or services.”Footnote 27 Again this is the same definition of “establishment” as that found in the EU Insolvency Regulation but with the addition of “services”.Footnote 28 An enacting State is however allowed to use “assets” as the basis for opening insolvency proceedings where foreign main proceedings have been recognized, but such local proceedings have exclusively territorial effects.Footnote 29 In the UK, however, the Cross-Border Insolvency Regulations 2006 depart somewhat from this regime. While local proceedings opened up after foreign main proceedings have been recognised are limited to assets in the UK, there is no restriction on the jurisdictional base for opening such proceedings.Footnote 30 Effectively, the position under existing law is preserved and this allows a foreign company to be wound up in the UK where there is “sufficient nexus” with the UK.
While there are undoubted similarities between the Model Law and the Insolvency Regulation; in particular through the use of the COMI concept, there are also significant differences. The Model Law does not go nearly as far as the Insolvency Regulation. Firstly, recognition of insolvency proceedings opened in another EU Member State is automatic under the Regulation whereas, under the Model Law, it is dependent upon an application to the court. Secondly, under the regulation, insolvency proceedings have the same effect in other EC states as they have in the law of the insolvency forum whereas under the Model Law the consequences of recognition depend on the law of the recognizing State. Thirdly, the Model Law does not purport to say which law should govern insolvency proceedings that are opened in a particular jurisdiction whereas the Regulation fixes this as the law of the forum. Finally, and more generally, the Model Law is much looser and more exhortatory in tone than the Regulation.
IV. FREEDOM OF CHOICE AND JURISDICTIONAL COMPETITION
On a theoretical level it might be argued that companies in Europe should have a relatively free hand in opting into a particular national bankruptcy and restructuring regime. Freedom of choice has long been advocated in the context of debates over the US bankruptcy regime. Under the menu approach, a company on its formation may select one alternative from a list of available bankruptcy options.Footnote 31 All potential consensual creditors would be governed by the same chosen bankruptcy regime and the rights of non-consensual creditors such as tort victims should be set by mandatory rules unless the regime chosen provides them with better protections. Others have gone further and advocated a pure contract approach.Footnote 32 Simply stated, creditors would opt in to a particular bankruptcy regime when making their contracts with the company and only where their contractual choices were incomplete would they be subjected to default rules. The rights of non-consensual creditors, on the other hand, should be set by mandatory rules. In matters outside the reach of private contracts, mandatory rules of bankruptcy law govern.
The “menu” and “pure contract” approaches suffer from complexity and a lack of flexibility. Just as one bankruptcy procedure does not suit all types of company well, the same bankruptcy procedure might not be suitable at all times for the same company throughout its existence. “[C]hoosing an insolvency capital structure in advance requires the parties to predict the future. If the firm guessed wrong about the likely source of financial difficulties, changed significantly between its inception and the time it encountered trouble, or both, the special insolvency structure could prove wholly ineffective. To be sure, the parties could attempt to adjust their prearranged structure midstream in an effort to address changed conditions, but negotiations of this sort would be costly and frequently unsuccessful.”Footnote 33
Flexibility calls for a mechanism by which a company can change its original bankruptcy option to an alternative and more suitable one. But there is considerable difficulty in devising such a mechanism. If the unanimous consent of creditors is required there is the risk of “hold-out” behaviour by certain creditors; but anything less than a unanimity requirement opens up the possibility of advantage gaining by the company at the expense of creditors.
On the complexity point, there may be considerable costs for a company in weighing up the available alternatives and choosing an appropriate bankruptcy structure in advance. Transaction costs are high but these costs become more manageable if parties can only opt into a particular national insolvency regime. If the choice is confined to the national laws of States within the EU then there is considerable scope for party autonomy but, at the same time, the risks generated by judicial interpretations of the unknown become more quantifiable.Footnote 34
This prospect means the creation of opportunities for competition between national legal orders.Footnote 35 There is scope for innovative insolvency lawmaking at the local national level implying more chance for initially unpromising, but ultimately beneficial, ideas to win through and gain general acceptance. These seeds of ingenuity can be tested and put into play at the local level and then reproduced across national frontiers if they turn out to be generally beneficial. Competition among national legal orders for bankruptcy business may foster the emergence of seed beds for dynamism and innovation. The American Law and Economics Scholar and leading bankruptcy judge, Frank Easterbrook has made the point that:Footnote 36 “When governments become sufficiently plentiful, and when the scope of laws matches the domain of their costs and benefits (that is, when costs and benefits are all felt within the jurisdiction enacting the laws), competitive forces should be as effective with governments as they are with private markets.”
In short, States can try out different types of bankruptcy laws and gauge the impact of such laws on levels of bankruptcy business as well as on the cost and availability of credit.Footnote 37 The scope for competition and innovation at a national level may lead to a great release of energy and creativity.Footnote 38
Certain commentators have argued, however, that EC countries have little incentive to compete among themselves to attract large bankruptcy cases and that competitive pressures are unlikely to stimulate national legislatures to make responsive changes in their bankruptcy regimes.Footnote 39 Any possible gains are limited by the fact that secondary insolvency proceedings can be opened in different jurisdictions. Moreover, the COMI jurisdictional standard grants confines forum shopping opportunities to companies with an appreciably international scope of activities. The presumption that the COMI is in the State of incorporation also limits such opportunities to “pseudo-foreign” companies. In short, the COMI standard allows case placers a narrow selection of venues while in the US large public companies are free to file their bankruptcies pretty much everywhere they choose.
But, overall, this argument seems seriously to underestimate forum-shopping opportunities presented by the EIR and the inducements that States have to enter the jurisdictional market place. For a start, attracting a greater share of European bankruptcy business may lead to an increase in prestige and respectability for national courts. At the very least, this means more court filing fees and funding for judicial programmes but above all it means more business for insolvency practitioners, lawyers, accountants and other professionals in the jurisdiction. In the UK, the financial services industry is an important part of the economy as are law-related revenues. Large law firms can act as a great spur to regulatory competition in the insolvency sphere. Certainly, they can be an influential interest group in pressing for the necessary legislative and other measures to accommodate pan-European legal business. Given the prominent position of London, one might expect that a large proportion of the legal services revenue generated by UK insolvency law would be captured in the UK. As Professor Armour remarks,Footnote 40 “Having so much at stake, the UK-oriented pan-European law firms constitute a powerful interest group in lobbying for or against legal change that is likely to affect the competitiveness of English law.”
There are suggestions that the UK has already become the restructuring capital of European with many ostensibly European companies shifting certain operations to the UK immediately prior to insolvency with a view to claiming a UK centre of main interests and the consequent application of UK law. This is particularly the case with German companies, highlighted by the Deutsche Nickel, Schefenacker and Hans Brochier cases.Footnote 41 The UK administration and company voluntary arrangement (CVA) procedures are seen as more flexible and familiar by key stakeholders, including in particular, US banks and bond holders. A debt for equity swap under German law encounters “holdout” problems which can be overcome in the UK restructuring environment through making use of a CVA which allows a 75% majority of creditors to bind the minority. German law also imposes stricter time limits for achieving acceptance of a debt restructuring plan and/filing for bankruptcy.
But will competition among national insolvency law makers in Europe lead to a “race to the bottom” so that companies incorporate in jurisdictions with weak insolvency laws, giving managers or other groups “rent seeking” opportunities?Footnote 42 It has been suggested that involuntary or poorly adjusting creditors can be protected by secondary and territorial insolvency proceedings and that this truncates the possibility for a “race to the bottom” leaving only opportunities for a “race to the top”.Footnote 43 Also, vulnerable creditors can be protected more effectively and precisely by mechanisms such as credit insurance. It may be that this assessment is too sanguine and places a somewhat unrealistic faith in market solutions. For instance, creditors who are not in a position effectively to bargain for security may not be in a strong position to take out credit insurance. There is extensive evidence about the effects of forum shopping in the US as well as a rich theoretical literature. While opinions are divided, the evidence at the very least suggests that the practice carries certain dangers which must be guarded against. The American experience will now be considered.
V. BANKRUPTCY FORUM SHOPPING IN THE US
It has been noted already that bankruptcy law in the US is federal law and the substantive provisions are the same across the US. Nevertheless, there are separate bankruptcy courts and the manner of application of the substantive law may be different in the different courts. Many restructuring cases are filed in Delaware, for instance, even though the bulk, if not all, of the company's business is carried on outside Delaware.Footnote 44 It is enough to give the Delaware court jurisdiction that the company, or an associated company, was incorporated in Delaware. Effectively, Delaware is the shopping venue of choice for so-called “case placers”, though other venues such as Manhattan (Southern District of New York) have been popular from time to time. Few commentators doubt that the rise of Delaware in this regard was the result of conscious forum shopping. Instead the focus of the debate has been on whether the “Delawarisation” of US bankruptcy law has been good or bad for the bankruptcy system and for the economy as whole.Footnote 45
As far as some commentators are concerned, “forum-shopping” is an overall social good with courts striving amongst themselves to develop best practice. Delaware enthusiasts argue its dominance has been the result of a largely beneficial competitive process where Delaware's superior expertise, professionalism and speed has made bankruptcy law more efficient in dealing with large, complex cases.Footnote 46 Others see the practice in a much more jaundiced light, basically as the rise of bankruptcy lawlessness and pandering to narrow special interests. Courts, it is argued, wastefully compete among themselves for bankruptcy business through offering inducements to case players – incumbent managers and bankruptcy professionals who choose to file in courts that are most friendly to them.Footnote 47 Delaware critics suggest that the rise of Delaware has been a negative consequence of forum shopping and represents an unconscionable sellout to the case placer.Footnote 48
Courts may be sympathetic towards those that are responsible for the placing of a bankruptcy case in a particular court. For instance, the willingness of a bankruptcy court to grant first day orders enhances its attractiveness to “case-players” and increases the likelihood of the court attracting bankruptcy business. Once a Chapter 11 case begins, it is common for the company to seek judicial authority – so-called “first day” orders – to pay the outstanding unsecured claims of “critical” vendors whose goodwill and continuity of supply is essential to the company remaining in business. The practice however, of paying off certain unsecured debts in priority to others seems to cut across the bankruptcy principle requiring equal treatment of similarly situated creditors.Footnote 49 A great deal of intellectual dexterity is needed to reconcile the practice of first day orders with the provisions of the Bankruptcy Code. But case players may now want something more. Professor LoPucki, has commented that the initial round of court competition has come to a close: “In that round, the courts focused principally on procedural matters such as establishing omnibus hearings, assuring quick action on first-day motions, and paying professionals monthly. … The case placers no longer shop for these practices; they can find them in almost any big city court. Courts interested in improving their market share now must offer something more.”Footnote 50
This may include the application of less than rigorous standards for the confirmation of a reorganisation plan. Delaware has developed a particular expertise in handling “prepacks” or prepackaged Chapter 11s, i.e. where the main contours of the reorganisation plan are mapped out in advance of the Chapter 11 filing. It has been suggested however, that this may be due to a willingness to confirm prepacks on a “no questions asked” basis, though under s. 1129 of the US Bankruptcy Code judges are specifically required to consider the feasibility of a reorganisation plan. On the other hand, there is empirical evidence that the Delaware Bankruptcy Court does not handle prepackaged cases with any greater speed or certainty of outcome than other courts.Footnote 51 The research implies that the real reason why a company may prefer Deleware is to shop for judges:
Although bankruptcy law and procedure are uniform throughout the United States, the perception that case processing is different across cities induces forum shopping. Thus, the system's worst fears about the reasons for shopping are likely correct: debtors shopped to New York and now shop to Delaware in large part to secure particular judges or to avoid judges in their home districts.Footnote 52
Even more worrying is a perception that favourite shopping venues may display a general apathy in investigating and prosecuting cases of possible fraud. While Chapter 11 is founded on a debtor-in-possession norm an outside trustee can be appointed to take over the management of the business of the company in exceptional cases such as fraud.Footnote 53 But in none of the big ticket Chapter 11 cases at the turn of the century – Enron, Gobal Crosssing, Adelphi Communications and Worldcom – where fraud was suspected – was an outside trustee appointed. Professor LoPucki has remarked sarcastically that through its sympathetic approach to management exhibited in these cases the “New York bankruptcy court surpassed Delaware in 2002 to become the nation's most attractive bankruptcy court.”Footnote 54
Others argue however that the non-appointment of an outside trustee in Enron was merely a wrong decision and the other cases simply followed that incorrect path. Mistakes occur even in the best regulated systems. The important issue is whether a system has been designed in such a way as to minimise the risk of “mistakes” and inefficient decision making or whether such outcomes are an in inherent feature of the structure of the system.Footnote 55 The EIR will now be put under the spotlight in this connection.
VI. THE EUROPEAN INSOLVENCY REGULATION: UPSIDES AND DOWNSIDES
On its face, the Regulation is firmly in the pragmatic European tradition avoiding extremes and tying the exercise of universal jurisdiction to where the debtor has the centre of its main interests. It does not allow parties the freedom of choosing which national law should apply to a particular bankruptcy. One does not have the mixed blessings of jurisdictional competition, on the one hand, or rampant forum shopping, on the other.
Moreover, some of the dire warnings emanating from the US do not appear to have been borne out by the evidence thus far. For example, Professor LoPucki has suggested that the vagueness of the COMI test combined with pressure on courts to claim big cases will generate more destructive competition than that presently “corrupting” US bankruptcy courts. In his view, the ultimate beneficiaries will be “case placers” – favoured insiders such as corporate executives and professional advisers using the system to leverage benefits for themselves partly at the expense of the companies they ostensibly serve.Footnote 56 Courts are seen as powerless to impose restrictions on this rent-seeking behavior; if some courts try to do this, cases will simply go elsewhere. Undoubtedly, in the European context, there are information asymmetries creating moral hazard problems and this may lead to opportunistic insolvency filings in management friendly jurisdictions. In addition, the interests of tort creditors are likely to be adversely affected if managers and sophisticated creditors combine together to use forum-shopping opportunities to their own advantage. Large or important creditors are likely to be better informed than tort creditors about a company's financial health and also the preferences of its management. There may be cases where such a creditor forces a company into a particular insolvency law regime that is detrimental to position of tort creditors.Footnote 57
But the English courts have not been a safe haven for rent-seeking nor for corporate management suspected of fraud. Jurisdiction has also been declined on occasion. For instance, in the Hans Brochier case,Footnote 58 admittedly on promptings from the administrators, the English court declared that the COMI of a German incorporated company was not in the UK despite insolvency proceedings having earlier been instituted on that basis. Neither is there much evidence of the courts changing their practices to accommodate the desires of “foreign” case placers. The Enterprise Act 2002 reformed UK insolvency law and practice and pushed it in a Chapter 11 direction. The objective of the legislation was to borrow the best features of Chapter 11 but, at the same time, avoiding its perceived pitfalls. The Act however, responded to the perceived needs of the domestic economy rather than being the outcome of external pressure.Footnote 59
As far as the UK is concerned, the Regulation has brought some benefits. The position of London as a leading legal and financial services centre has been strengthened with at least a modest shift of European restructuring operations to the UK.Footnote 60 The world of global finance, in particular US bankers and bond holders, appear to be more comfortable and familiar with the UK restructuring environment. It is seen as more flexible than its continental counterparts in that holdouts by minority creditors can be overcome. Furthermore, the process can be activated without judicial intervention, by means of the non-court appointment of an administrator to displace existing management, if needs be.
But there are downsides to the Regulation. Firstly, the concept of “centre of main interests” is inherently problematic and certainly capable of varying judicial interpretations. There is fairly general agreement about the fuzziness and fact sensitivity of COMI.Footnote 61 “First, when the principal assets, operations, headquarters and place of incorporation are in different countries, which is the ‘home country’?” It is questionable whether any greater certainty is introduced by the statement in recital 13 of the preamble that the COMI “should correspond to the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties”.
Secondly, the application of the COMI concept becomes particularly problematic in the context of groups of companies. Thirdly, there is an issue about the extent to which a company's COMI can be affected by last minute moves of a company's operations. Fourthly, there is the issue of what exactly constitutes the opening of insolvency proceedings. Fifthly, the courts in a Member State that are first seised of an insolvency matter may well be inclined to assert jurisdiction. In cases of doubt, therefore, it behoves a party whose personal interests are best served by the opening of proceedings in a particular State to initiate insolvency proceedings in that State even though the COMI is debatable. Under the Regulation, there is a virtual race, with the first insolvency proceedings to be opened entitled to full and unquestioned recognition throughout the EC. He who hesitates is lost. There is an incentive to file first and to ask questions later – a point illustrated by the Hans Brochier litigation.Footnote 62 The ECJ has stressed that once the courts in a Member State have made the decision to open main insolvency proceedings that decision should be respected and recognised by courts in other Member States with immediate effect. If a party feels that the wrong decision was made then the appropriate course of action is to invoke rights of appeal in the State where the proceedings were begun and not to flit off to another Member State in search of a different order.Footnote 63 Finally, it may be that the provisions governing the relationship between the main and secondary insolvency proceedings work disharmoniously and impede the achievement of corporate rescue.
VII. COMI WITH PARTICULAR REFERENCE TO CORPORATE GROUPS
In general, UK courts have taken an expansive approach when applying the COMI concept and little weight has been placed on the fact of incorporation in a particular country (though greater weight has been placed on it by the ECJ). Re Daisytek-ISA Ltd Footnote 64 serves as a leading example.Footnote 65 The company was the holding company of a group of trading companies – including French and German-incorporated subsidiaries – and it was held that an English court had jurisdiction to make an administration order in respect of each of the companies on the basis that their COMI was in England, notwithstanding the foreign incorporation. The court considered the scale and importance of the interests administered at the various locations that might be regarded as the COMI. The evidence indicated that the majority of the group's administration was conducted from its UK head office. Consequently, it was held that the UK was the COMI for each subsidiary within the group. The most important “third parties” referred to in recital 13 were considered to be the potential creditors (by value) and in the case of a trading company this was likely to be financiers and its trade suppliers.
One may criticise this approach for being too subjective and inscrutable to third parties in that considerable emphasis is placed on where the management decisions of a particular company are controlled.Footnote 66 Creditors when extending credit are not in a position easily to ascertain what insolvency law regime will apply and in addition, they cannot rely on this regime remaining constant during the period of credit. Risk sensitive creditors may increase the cost of credit to compensate for the increased risk.
COMI deficiencies are particularly stark in the context of groups of companies. The COMI of different members of a corporate group are not necessarily identical and depending on how the standard is applied in a concrete case, insolvency proceedings in relation to different group companies may, or may not, be handled in a single jurisdiction by the same court. There is a strong argument that one should acknowledge the reality of multinational corporate groups. With the recognition of only one COMI, a corporate group could be subject to a single main insolvency proceeding and this would have the effect of improving the coordination and administration of the global estate and the net recoveries for creditors. The ability to file insolvency proceedings in respect of all group companies in the same jurisdiction brings with it significant strategic advantage. A coordinated sale or restructuring plan can be developed for the entire group while maintaining the flexibility to deal with specific local problems where appropriate. The value of this is illustrated by Re Collins & Aikman Footnote 67 where administrators were alive to the potential disruption that could be caused if creditors opened secondary proceedings in different countries. It was held that the administrator should honour promises made to creditors that, in return for not opening secondary proceedings in other jurisdictions, local priorities would be respected.
The main guidance from the ECJ on COMI has come in the Eurofood caseFootnote 68 arising out of the collapse of the multinational Parmalat group. The court said that the concept had an autonomous meaning for the purpose of the Regulation and must be interpreted independently of national legislation. There was a presumption that the COMI of a company was in the State where its registered office was located and this presumption applied even if the company had a parent company with a registered office in a different State. The presumption could only be rebutted “if factors which are both objective and ascertainable by third parties enable it to be established that an actual situation exists which is different from that which locating it at that registered office is deemed to reflect. That could be so in particular in the case of a company not carrying out any business in the territory of the Member State in which its registered office is situated. By contrast, where a company carries on its business in the territory of the Member State where its registered office is situated, the mere fact that its economic choices are or can be controlled by a parent company in another Member State is not enough to rebut the presumption laid down by the Regulation.”Footnote 69
The court gave the example of letter box countries not carrying on any business in the countries of their registered offices.Footnote 70 In these circumstances, the presumption of concordance between registered office and COMI is easily rebutted but not so more generally unless there were factors that were both “objective and ascertainable by third parties”. What if the company carries on some business in the State where its registered office is situated but the bulk of its economic activities are carried on elsewhere? Is the presumption rebutted in this scenario? There is no explicit guidance from the court.
Eurofood concerned an Irish-incorporated, wholly-owned, subsidiary of Parmalat, a major global food company incorporated in Italy, and whose principal business activity consisted of providing financing facilities for companies in the Parmalat group. The company enjoyed tax benefits that were conditional on it being managed and operated in Ireland. Moreover, the day-to-day administration of Eurofood was conducted in Ireland in accordance with the terms of an agreement which was governed by Irish law and which contained an Irish jurisdiction clause. The Irish Supreme Court held that the COMI was in Ireland and the ECJ did not indicate any dissent from this conclusion although not having to answer the precise question.
The ECJ approach seems somewhat different however, from the “integrated economic unit” approach which UK courts have followed. The UK courts have tended to look at the affairs of the group of companies as a whole. The ECJ has concentrated the inquiry onto each individual company stating that the fact that the economic purse strings of a subsidiary are pulled from Group Headquarters does not, of itself, alter the COMI.
The UK courts have not been alone in facilitating a coordinated approach towards group insolvencies. In the Eurotunnel case, for example, the French commercial court asserted jurisdiction over 17 companies in the Eurotunnel group including many incorporated in other EC countries including the UK.Footnote 71 The basis for the exercise of jurisdiction was that the joint committee managing the group sat in France; group financial management and accounting as well as debt restructuring negotiations were carried out in France, and the chairman of most companies in the group was a French citizen and resident. The court applied the COMI concept in a manner that was functionally equivalent to consolidated group insolvency proceedings. Effectively, the Court disregarded the presumption that the COMI of subsidiary companies should be tied to the location of their registered office.
But again this approach is difficult to reconcile with that of the ECJ in Eurofood. Eurofood is not to all tastes, for it implies that the presumption of concordance between COMI and the State where the registered office is located cannot be rebutted if the company carries on some activity in that State. The decision makes an integrated approach towards group insolvencies difficult to achieve. This result is more readily attainable had the ECJ taken up the suggestion of Advocate General Jacobs in apparently endorsing a “head office functions” test for ascertaining COMI. Advocate General Jacobs added howeverFootnote 72 that the focus must be on “head office functions rather than simply on the location of the head office because a ‘head office’ can be just as nominal as a registered office if head office functions are not carried out there”. He pointed out that the registered office is often chosen for tax or regulatory reasons and has no real connection with the place where head office functions are performed.
The “head office functions” test was used in Re Enron Directo SA,Footnote 73 where it was held that an “Enron” company incorporated and trading in Spain had its COMI in England since its head office functions were carried out in London. Accordingly, a UK administration order was made in respect of the company. The “head office functions” test was also used by a French court in MPOTEC Gmbh Footnote 74 where it was stated that the notion of head-office functions was founded upon the following elements:
(a) the place of meetings of the board of directors;
(b) the law governing the main contracts;
(c) the location of business relations with clients;
(d) the place where the commercial policy of the group is defined;
(e) the existence of a prior authorisation from the parent company to enter into certain financial arrangements;
(f) the location of bank creditors; and
(g) the centralised management of purchasing policy, staff, accounts and computing systems.
Applying this guidance, the court decided that a German incorporated member of a French group of companies had its COMI in France. More generally, the court stressed the importance of centralizing proceedings under the supervision of a single court so as to allow the implementation of a global restructuring plan. It commended the virtues of a pragmatic approach saying,Footnote 75 “the centralisation of proceedings permits the avoidance of the partitioning effects linked to the opening of several main proceedings in different Member States.”
Recognising the problems caused by the present approach, the American bankruptcy Judge Samuel Bufford has proposed a split solution.Footnote 76 He suggests that the insolvency of economically integrated group members should be administered in the home country of the integrated group and the insolvency of economically independent group members separately in their own home countries. This solution however complicates venue decision and there is an element of subjectivity in determining whether corporate groups are economically integrated. Application of the test will be complex adding more uncertainty. The proposal also delays identification of the main proceeding pending notice to potentially affected parties and a court hearing.Footnote 77
VIII. MOVING COMI
The COMI notion is a movable feast. The fact that COMI has been established in a particular jurisdiction does not preclude a later alteration in its location subject to the caveat introduced by the ECJ in Re Staubitz-Schreiber Footnote 78 that the relevant time for determining the location of COMI is the lodging of the request to open insolvency proceedings. In particular, it was held that the national court where the COMI is situated, at the time of the request, retains competence to open those proceedings if the COMI is moved to another country after lodging the request, but before the proceedings are opened.Footnote 79 In the ECJ's opinion, this outcome ensured greater judicial certainty for creditors in that a transfer of jurisdiction would oblige creditors to be in continual pursuit of creditors from one country to another and might lead to the prolongation of proceedings.
The COMI can be shifted however before the institution of insolvency proceedings. The fact sensitivity of the COMI inquiry always leaves room for strategic manipulation of the relevant facts and also creates opportunities for forum shopping in the immediate vicinity of insolvency.Footnote 80 Companies have ample opportunities to move assets and operations around so as to maximise the opportunity of choosing their preferred bankruptcy venue.
The courts at least have been mindful of the possibility of cynical advantage gaining by certain debtors. An alleged change must have some element of permanence and must be based on substance and not on illusion. In Shierson v. Vlieland-Boddy Footnote 81 the Court of Appeal said that in making its determination the court must have regard to the need for the COMI to be ascertainable by third parties and “in particular, creditors and potential creditors. It is important, therefore, to have regard not only to what the debtor is doing but also to what he would be perceived to be doing by an objective observer. And it is important, also, to have regard to the need, if the centre of main interests is to be ascertainable by third parties, for an element of permanence. The court should be slow to accept that an established centre of main interests has been changed by activities which may turn out to be temporary or transitory”.
In Re Ci4net.com Inc Footnote 82 a distinction was drawn between cynical changes in the seat of a company's operations and a restructuring of the business which is carried out for sound commercial reasons long before the question of insolvency proceedings becomes live. In the latter situation the policy against forum shopping did not raise a bar to a change in COMI. But what if the case lies somewhere between these extremes e.g. an attempt is made to change COMI to avail of what is perceived to be a more advantageous insolvency and restructuring regime in a particular jurisdiction? This is what happened in the trilogy of unreported German restructuring cases referred to earlier – Deutsche Nickel, Schefenacker and Hans Brochier. In the first two, nobody disputed the proposition that the COMI had moved to the UK.
Basically in these cases, German industrial companies “migrated”, firstly using provisions of German law to convert into a limited partnership. A UK incorporated company entered the partnership and the other partners exited so that the “partnership” assets and liabilities accrued by operation of the law of universal succession to the UK company. The directors then began negotiations with its bond holders and put forward proposals for a CVA.
In Hans Brochier Footnote 83 there was a jurisdictional challenge and a virtual race to the courthouse involving the directors of the company and employee creditors. In a sense the directors won the race making an out of court appointment of administrators literally minutes before German insolvency proceedings were commenced at the instigation of the employee creditors. But the UK administrators later took the point that the COMI was in fact in Germany and their appointment was discharged. One might comment that the administrators were acting honorably as officers of the court – a status ascribed to them in the Insolvency Act.Footnote 84 But it should also be noted that the German Insolvency proceedings carried advantages for the parties that had no counterpart under the UK procedures and the administrators were no doubt conscious of this.
IX. WHAT CONSTITUTES THE OPENING OF INSOLVENCY PROCEEDINGS UNDER EIR?
Once insolvency proceedings are opened in a particular State they have to be recognised in all other Member States.Footnote 85 The mutual recognition mandate elevates the question of what constitutes the opening of insolvency proceedings to central importance. In Eurofood Footnote 86 the ECJ addressed this issue and looked to the definition of “insolvency proceedings” under Art. 1(1) of the Regulation, which refers to four characteristics of “insolvency proceedings”: (1) collective proceedings; (2) based on the debtor's insolvency; (3) entailing at least partial divestment of the debtor; and (4) involving the appointment of a liquidator.
The forms of proceedings were listed in Annex A to the Regulation and the list of liquidators appears in Annex C. “Provisional liquidators” appear in the entry for Ireland, although originally they were not included for the UK.Footnote 87 The court pointed out that only one main set of insolvency proceedings could legitimately be opened and, to avoid uncertainty, it was necessary to avoid a situation where two or more states claimed concurrent jurisdiction.Footnote 88 In the court's view this objective was best achieved if a decision to open insolvency proceedings was regarded as including a decision on an application, based on the debtor's insolvency, seeking the opening of proceedings referred to in Annex A, where the decision involves divestment of the debtor and the appointment of a liquidator referred to in Annex C. Such a divestment entailed the debtor losing powers of management over the assets.Footnote 89
Administration, including administration through the out-of-court route, is among the procedures referred to in Annex A of the Regulation and “administrators” appear in the list of “liquidators” in Annex C. This suggests that the commencement of a UK administration by means of out of court appointment should produce an immediate and universal effect throughout the EU. Nevertheless, it appears difficult to match the language of Article 3 of the Regulation – in particular the concept of the “opening” of insolvency proceedings “by the court” or some “other competent body of a Member State” – with the standard process by which administration is commenced. Blackburne J. in Re Salvage Association,Footnote 90 however, while accepting that the Regulation, and in particular Art. 3(1), appears to be premised on the assumption of court activation of insolvency proceedings, suggested that literalism should be avoided in favour of a broader, purposive interpretation.Footnote 91 The reference to “competent body of a Member State” should be understood as applying to any body recognised as competent in that Member State to resolve upon the insolvency proceedings in question. This interpretation accords with that put forward in the Virgos-Schmit ReportFootnote 92 where it was suggested that the expression “court” in this context was to be construed in a very broad sense to cover “ … a person or body empowered by national law to open proceedings or make decisions in the course of those proceedings”. Moreover, under the insolvency legislation, an administrator is deemed to be an officer of the court, whether or not actually appointed by the court.Footnote 93
X. RECOGNITION OF INSOLVENCY PROCEEDINGS
Main insolvency proceedings, once opened, are intended to have immediate and universal effect throughout the EU. Judicial or administrative authorities in other EU states are not supposed to second guess the competence of the first court to open insolvency proceedings subject to a limited exception on grounds of public policy. Article 26 permits the refusal of recognition where this would be manifestly contrary to a State's public policy, “in particular its fundamental principles or the constitutional rights and liberties of the individual.”
In Eurofood the ECJ referred to the equality of arms principle as being of particular importance. It suggested that a refusal to recognise was justified where the decision to open the proceedings was taken in flagrant breach of the fundamental right to be heard, enjoyed by a person affected by such proceedings. While specific detailed rules could be tailored to the circumstances and to deal with urgent cases restrictions on the exercise of that right should be fully justified and accompanied by procedural safeguards ensuring that affected parties had the opportunity to challenge measures adopted as a matter of urgency.Footnote 94
In the Daisytek litigation it was argued that the French courts should refuse to recognise the English insolvency proceedings for ignoring the right of the employees to be represented in court, thereby running counter to French public policy. The Cour de Cassation however, looked to Eurofood for guidance and suggested that Art. 26 should given a limited interpretation. The fact that employees' representatives were not heard before the decision to open insolvency proceedings did not, in itself, constitute a flagrant breach of the fundamental right to be heard.Footnote 95
XI. SECONDARY PROCEEDINGS AND IMPEDIMENTS TO THE RESCUE CULTURE
While main insolvency proceedings may be either liquidation or reorganisation proceedings, secondary proceedings can only be of a liquidation nature. In general, implementation of the Regulation should promote business or corporate rescue since both an administrator's powers and the stay on creditor enforcement actions will be recognised throughout the EC. On the other hand, the fact that secondary proceedings cannot include the debtor rehabilitation provisions of a particular jurisdiction may act as a significant impediment to the rescue culture.Footnote 96 For example, an administrator trying to formulate and implement a rescue plan could find the plans frustrated by creditors in a particular jurisdiction who take the view that a secondary liquidation in that jurisdiction would better serve their interests.
The liquidator in main proceedings has however, a number of powers to intervene in secondary proceedings.Footnote 97 First, independent territorial proceedings initiated before main insolvency proceedings have been commenced must be converted into winding-up proceedings on his request.Footnote 98 Secondly, a secondary liquidation can be stayed for up to three months at the request of the liquidator in the main proceedings, although the court granting the stay may require the liquidator in the main proceedings to take any suitable measure to guarantee the interests of the creditors in the secondary proceedings and of individual classes of creditors.Footnote 99 A request by the liquidator for a stay may be rejected only if it is manifestly of no interest to the creditors in the main proceedings. The stay may be extended for further three-month periods at a time but the stay may be lifted by the court where it no longer appears justified having regard to the interests of creditors. Thirdly, a composition in the secondary proceedings may not become final without the consent of the liquidator in the main proceeding. But such consent cannot be withheld if the financial interests of the creditors in the main proceeding are not affected by the composition.
XII. CONCLUSION
The European Insolvency Regulation embodies a general preference for a universal rather than a territorial approach towards insolvency proceedings. Territorialism is seen as skewing investment choices insofar as it entails a legal or factual privilege for local creditors. Universalism is considered the better approach in that multiplicity of proceedings are avoided; direct bankruptcy costs are lower and creditors face lower information costs in adjusting their credit terms to take account of perceived risks. Value maximising reorganisation or liquidation strategies can also be implemented much more easily.
The Regulation also furthers the goal of market integration underlying the EU. Professor Westbrook has remarked that it is
… unsurprising that virtually every country has established a national bankruptcy regime coextensive with its national market – virtually all federated countries including those like the US that give considerable autonomy to regions in business and commercial matters, nonetheless insist that the bankruptcy regime be national, to fit the national dimensions of the market.Footnote 100
But the EU is not a country and also the Regulation suffers from many deficiencies. These have been highlighted already. The COMI standard is inherently fuzzy and manipulable. The Regulation assumes that the area of greatest economic activity will be in the State where the bulk of assets and liabilities exist, but this may not be the case. COMI is a poor performer whatever standard of efficiency one uses. It makes decisions on venue difficult to predict creating uncertainties in the market place. In response to the uncertainty, creditors may tighten credit terms. The COMI can be shifted even in the general vicinity of insolvency upsetting the expectations of those who advanced credit to the company on the assumption that the COMI was in a particular jurisdiction. Parties have an incentive to “forum shop” and also to institute insolvency proceedings as promptly as possible in their favoured location lest another interested party file first in another location. The COMI standard is particularly unsatisfactory in relation to groups of companies because it narrows the focus onto the affairs of a single company whereas with integrated corporate groups, the focus arguably should be on the group as a whole.
Can these deficiencies be cured? COMI is at the heart of the Regulation and where the main deficiencies lie. One can tamper with COMI, trying to give it more shape and predictability particularly in the context of the groups of companies. But this “mend and make do” approach is not a cure-all. A more radical solution is to scrap the concept of COMI altogether and to go for a more certain method of determining bankruptcy venue and, by extension, applicable bankruptcy law. The most certain choice in this regard is the state of incorporation. Under EC freedom of establishment rules entrepreneurs are free to incorporate in one EC State and then carry on business in another. There is a mismatch however between the company law applicable to a business entity and the insolvency law. The former is dictated by the State of incorporation but the latter by COMI. Alignment of the two would bring about greater predictability. Moreover, it would end the anomaly whereby certain provisions are considered to be part of Company law in one country and Insolvency law in another.
At the political level however, extending “charter competition” to insolvency law may be unacceptable. Furthermore, the bulk of insolvency law has nothing to do with the internal affairs of a company but is concerned with property law and the interests of third parties potentially affected by the fate of the company.Footnote 101 At its core, insolvency law contains a strong element of debt collection law as shaped by public interest considerations.Footnote 102 Also under the EC freedom of establishment regime, there are general interest requirements conceived by States that may justify measures restricting freedom of establishment.Footnote 103 The protection of third parties such as creditors and employees as well as workforce regulation can be seen as imperative requirements in the general interest.
In addition, tying insolvency law to the state of incorporation does not necessarily work very well in the corporate group context. Different countries in the same group may be incorporated in different countries depending on the area of operations and tax considerations in a particular jurisdiction. In this scenario, giving the state of incorporation power to determine the insolvency law applicable to each company is likely to block, or seriously obstruct, a group workout or restructuring. Co-operation between individual courts and countries administering assets on a territorial basis may be the only sensible way forward.
