MYSTERY OF THE SPHINX-COMIIN THE US...there was no evidence of any board meeting taking place there....

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practicalsolutionsto avoidthem.The decisionsinMcKayand Re SE Servicesshow a continued commitment by thecourts to the rescue culture and a realistic attitude tostriving to ensure that professionals involved incorporate recovery are dealt with even-handedly. Giventhat it appears accepted that the insolvent companyshould be responsible for payingfor professional advicereceived by it, it difficultto see how such advice couldnot come within the definition of "costs and expenses ofthe appointor" for the purposes of r.2.67(I)(c) in the

case of a company or directors' appointment. Until suchtime, however, as a clear court or legislativestatement ismade to that effect, practitioners will need to continuerelyingon other means-such as the discretioncontained in para.13-to secure payment of their fees.

-

I [2006] All E.R. (D) 2662 [2005] EWCA Civ 1153 Re A Company No.005174 of 1999 [2000] B.C.C. 698 at 708

A/istair Bacon is a partner with Hammonds, London

MYSTERY OF THESPHINX-COMIIN THE US

Gabrie/ Moss Q.c.

e!/ Allocation of jurisdiction; Centre of main interests;Cross-border insolvency;Groups of companies;United States

Introduction

The judgment of Judge Drain in Re Sphinx Ltd, a case in theSouthern District Court of New York on September 6,2006 appears to be the first in relation to a contestover the location of the "centre of main interests" ofa debtor in the context of Ch.15 of the USBankruptcyCode, the US enactment of the UNCITRALModel Law.

The case concerned a Cayman registered group ofcompanies in liquidation in the Cayman Islands.Theoutcome was that the US court declined to recognisethe Cayman liquidationsas "main" proceedings andrecognised them as "non-main'" proceedings.

The Cayman companies operated hedge funds,tracking certain indices.The companies were establishedoffshore to take advantage of Cayman tax and regulatorybenefits. However, the companies did not conduct anytrade or business in the Cayman Islands,had noemployees and no physicaloffices in the Cayman Islands.The only "assets" in the Cayman Islandswere thecorporate books and records required to be maintainedunder Cayman law. The real assets and the conduct ofthe business were in the United States. Approximately$500 millionof assets were located in the United States.

The hedge fund business of the companies wasactually conducted under a fullydiscretionary investmentmanagement contract by a Delaware company carryingon business in New York. The companies' auditors werePWC at their Cayman office,a requirement of Caymanlaw. It is not clear, however, how much of the actualauditing work was performed in the Cayman Islands.None of the directors resided in the Cayman Islandsandthere was no evidence of any board meeting taking placethere. The directors were Irish,Bahamianand USresidents. The investors were located throughout theworld, with only about 14per cent in the United States.The investors apparently qualifiedas creditors for thepurposes of Cayman Islands'winding up proceedings.

The Cayman companies had been Defendants toproceedings relating to the Refco collapse, seeking therepayment of an alleged preference. The preference

claimwas settled and the settlement funds put in escrowpending the claimantsgetting court approval in their owninsolvencyproceedings for the settlement. Certaininvestors in the Cayman companies' hedge fundsobjected in the insolvencyproceedings of the claimanton the basis that the settlement was too favourable tothe claimant.This was obviously not a good objection inthe estate of the claimantand the objection wasdisallowed but the investors appealed, thereby holdingup both the settlement and the resolution of theclaimants' insolvencyproceedings.

The Cayman companies went into liquidationandthe liquidators tried to hold up the appeal relating to thesettlement on the grounds that they needed to investigatewhether the settlement was proper from the Caymancompanies' perspective. This applicationwas rejected.

The proceedings, the subject of the judgment beingconsidered, were applications for recognition by theliquidators of the Cayman companies of the Caymanproceedings as main proceedings, thereby creating anautomatic stay under Ch. 15the US Bankruptcy Code,with the goal of stayingthe appeals in relation to thesettlement agreement. It seems there was no otherreason for applyingfor recognition.

One would have thought the short answer on thesefacts was that since the companies carried on nobusiness in the Cayman Islandsand since everythingwasrun from the United States, the presumption as to thecentre of main interests being in the place of registrationwas plainlyrebutted and, using the "head officefunctions" test, 2 the centre of main interests was plainlyin the United States. That in turn would mean that theCayman proceedings could not be recognised as mainproceedings. Moreover, there was no "establishment" inthe Cayman Islandsas defined by s.IS02 of the USBankruptcy Code, i.e. "any place of operations wherethe debtor carries out a non transitory economicactivity", since there was no such place of operations inthe Cayman Islandsand no economic activitywas carriedon at the registered office in Cayman.Thus recognitionas a non-main proceeding was not possible either.

The actual result of the case was a refusal to recognisethe Cayman proceedings as main proceedings, but noton the basis that the COMI was not there. Moreover,there was recognition of the Cayman proceedings asnon-main proceedings but with no attempt to deal withthe need to show an "establishment" or any recognitionthat the facts failed to show any place of operations inCayman where economic activitywas carried out.

Whilst the decision of Judge Drain not to recognisethe Cayman proceedings as main proceedings must be

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entirely correct, his reasoning is, with all due respect,difficult to follow.

COMI

In considering the approach to the concept of "centre ofmain interests", Judge Drain considered that thestatutory presumption would be of "less weight" in theevent of a serious dispute, since the presumption wasincluded for speed and convenience of proof wherethere was no serious controversy.3

So far, so good. However, the nextprinciple mentioned byJudge Drain, that of deferring tothe creditors' acquiescence in or support of a proposedcentre of main interests cannot be right, sincethe locationof the centre of main interests must be an objectivejudgment by the court on the basis of the evidence.

JudgeDrainreferredto the Eurofooddecisionof theEuropean Court of Justice and observed, accurately, thatthe question put to the European Court of Justice by theIrish Supreme Court:

"assumedthat the only evidenceofferedto rebut theplace-o(-registered-o(ticepresumption was thatmanagement for the holding company that owned thedebtor made decisions on the debtor's behalf in the

alternative proposed COMI."

That situation was completely distinguishableon thefacts of the present case. Again,a good point.

Judge Drain concluded that there were importantobjective factors pointing to the centre of main interestsbeing located in the United States, since the only businessdone in the Cayman Islandswas limited to those stepsnecessary to maintain the companies in good standing asbeing registered Cayman Islands'companies. Pragmaticconsiderations also pointed to the United States sincethere were no assets in the Cayman Islandsandtherefore liquidators in the Cayman Islandswould haveto seek assistance from other courts. Moreover, most ifnot all of the creditors and investors were locatedoutside the Cayman Islandsand the Cayman court wouldhave to rely on orders of other courts to bind them.

Judge Drain commented that the Cayman courtsthemselves had not made a findingas to the centre ofmain interests and in any event he would not have beenbound by any such finding.

The only extant proceedingsAt this stage the judgment takes a peculiar turn. JudgeDrain considered and placed weight upon the fact thatthe Cayman Islandswinding up proceedings were theonly extant proceedings and that they were capable ofwinding up the affairsof the debtor, notwithstanding thefact that the relevant activities and assets were in theUnited States. He also referred to the fact that theCayman companies had held themselves out in theiroffering memorandum as offshore Cayman Islandentities. Judge Drain then considered that in principleand but for one additional consideration he would havebeen inclinedto find that the debtor companies' centreof main interests was in the Cayman Islandsand torecognise the Cayman proceedings as foreign mainproceedings. In doing so he took into account that these

were liquidationsana not reorgalll:.cnionswhich mightbetter take place at the place where the debtors'interests were administered-a reference to the"definition" (in reality, "description") of centre of maininterests in recital (13) to the EC RegulationonInsolvencyProceedings. He considered that theliquidators and the Cayman court were the only partiesready to perform the winding up function and the vastmajority of the parties with a relevant interest tacitlysupported that approach.

With the greatest of respect to Judge Drain, this is anextraordinary dictum. The centre of main interests isplainlyan objective concept which is unrelated to thequestion of which jurisdiction is ready, willingand able toperform the winding up function and to the tacit (orindeed express) support of interested parties. Moreover,on the facts of this case, the choice, in principle,of theCayman Islandswent directly against the evidence, whichplainlyshowed that the presumption based on the placeof the registered officewas rebutted by the evidence thatthe companies' affairswere run and managed outside theCayman Islandsand in particular in the United States.The United States plainlyhad the strongest claim to bethe centre of main interests, since the companies did nobusiness in the Cayman Islandsand were simplyregistered there for tax and regulatory purposes.

Fortunately, the reasoning as to where the centre ofmain interests might have been found to be was only adictum, because the choice "in principle" was overriddenbyJudge Drain's view that the applicationwas abusive,because it was for an improper collateral purpose. Theonly reason for the applicationfor recognition as a mainproceeding was to get an automatic stay of the appealfrom the order sanctioning the settlement agreementand the applicationwas thus a mere tactic to try andsabotage the settlement and obtain a better payment forthe investors of the Cayman companies. These tacticswere described byJudge Drain as "improper forumshopping". It is respectfully suggested that a betterdescription would be an "abuse of process", on thegrounds that the applicationwas being made for acollateral and improper purpose--the proper purpose ofseeking recognition would be to protect the assets orother proper interests of the creditors and not in orderto extort a better settlement.

Recognition by the US Bankruptcy courtThe next stage in the reasoning is also very odd. JudgeDrain considered that the US legislature had separatedthe concept of "recognition" under the BankruptcyCode from the concept of "recognition as a foreignnon-main proceeding". With respect, this does notseem to be correct the UNCITRALModel Lawprovidesfor recognition either as a foreign main or nonmainproceeding but not recognition inthe abstract. Moreover,the wording of s.1517 of the US Bankruptcy Code,4enacting the Model Law,gives the same limited choice.

Judge Drain then went on to recognisethe Cayman proceedings as non-main proceedings. Hereferred back to the "main objective factors" pointingto the Cayman Islandsnot being the debtors' centreof main interests and therefore considered that, since"no negative consequences would appear to result fromrecognisingthe Cayman Islandsproceedings as non-main

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proceedings, that is the better choice". With the greatestrespect to Judge Drain, this is not reallya question of"choice" but of whether the proceeding being consideredfallswithin the concept of main or non-main proceeding.In particular, to be able to recognise a proceeding asa non-main proceeding, the definition in s.IS02 of the USBankruptcy Code requires the proceeding to be "pendingin a country where the debtor has an establishment".5The same section defines "establishment" as "any place ofoperations where the debtor carries out a non-transitoryeconomic activity".6The difficultywith Judge Drain'srecognition of the Cayman proceedings as non-main pro-ceedings is that, on the evidence set out byJudge Drain,there was no "place of operations" in the Cayman Islandsand no "economic" activitybeing carried out there.

Judge Drain did hold that one can have a foreignnon-main proceeding even though there is no otherpending proceeding-a concept which, of course, is veryfamiliarunder the EC Regulation,which expressly refersto the abilityto open independent territorialproceedings prior to the opening of any mainproceedings in certain conditions: see Art.3.

Conclusions

Whilst it was plainlyright for Judge Drain to reject theapplication for recognition of the Cayman proceedings asmain proceedings, the reasoning, with all due respect tohim, is wholly unsatisfactory.The only European casethat he mentions,the Euro(ooddecision,wasof littleassistance and was distinguishedby him. However, hedoes not refer to and perhaps was not referred to thewealth of national case law in Europe on this subject.Nor does he mention any of the writings of numerouscommentators who have dealt with this subject in theEuropean context? It was plainon the facts as recited byJudge Drain that on an objective basis the Cayman Islandshad no real claim to be the centre of main interests,since no "head office functions"Bwere being carried onthere and the registration in Caymanwas purely for taxand regulatory purposes. Since no business was carriedon in Cayman, the dicta of the European Court of Justicedecision in Euro(ood9provided an additional basis forholding that the presumption based on registered officewas rebutted and the COMI was in the United States.

Since the presumption of the place of the registeredofficewas plainlyrebutted on the facts, the remainingquestion was: which other jurisdiction had the best claimto be the centre of main interests? Given that thebusiness of the company was controlled and directed inthe United States under contract, the best candidate wasplainlythe United States. The fact that the majority ofinterested parties either wanted or acquiesced in theCayman Islandsbeing treated as the centre of maininterests should not have been of any relevance. Sincethe application for recognition as a main proceeding wasabusive, it could and should have been dismissed on thatground alone in any event. Although s.ISI7 of the USBankruptcy Code is in mandatory terms 10requiringrecognition, this must be read subject to universallyaccepted principles, for example that the court'sjurisdiction may not be abused. Alternatively,the publicpolicy exception in s.IS0611can be used to prevent anabuse of process, since an abuse would violatefundamental procedural norms of any jurisdiction and

lead to an unfair process: see the principle set out at [65]of the Euro(oodjudgment.

As far as recognising the Cayman proceedings asnon-main proceedings is concerned, this is not inaccordance with Ch. 15or the UNCITRALModel Lawand cannot be justified in terms of the facts, since therewas no "establishment", as defined by Ch. 15,in theCayman Islands.

As a matter of speculation, the difficultyfelt by JudgeDrain in this case may stem from the thought in theUnited States, arisingfrom the legislativehistory, thatCh. 15 is the onlymode of seekingassistance for foreignproceedings. Unfortunately, this view, if correct, createsa serious gap in a case where there is a proceeding in theplace of registration (and therefore recognised in mostparts of the World) but where the centre of maininterests is elsewhere and there is no "establishment" inthe place of registration. If,perhaps for reasons ofinconvenience and expense, no main proceedings arestarted in the place where the centre of main interests islocated, there is a serious difficultyrecognisingtheproceedings in the United States, if the view is taken thatCh.15 is the only route.

It is possible that this type of problem lies behind theawkward reasoning in the Sphinxcase, with its attemptto find a practical solution that unfortunately does not fitthe languageor provisions of the statute or indeed thecase law in Europe. It is respectfully suggested that abetter route, that does not do violence to the languageof the statute would be to hold that Ch.15 is notexclusive,since it does not expressly purport to be, andthat the US courts can in cases such as Sphinxfollow thelead of the PrivyCouncil in the CambridgeGasandNavigatorcase [2006] 3 All E.R.829 in applyingcommonlaw judicialassistance to foreign proceedings irrespectiveof the location of the centre of main interests. JudgeDrain refers to the Cambridgedecision at fn.21 of hisjudgment and it is a great pity that he did not hold thathe could use the common law jurisdiction instead ofCh. 15to assist the Cayman proceedings, since thatwould have provided both a principled and practicalsolution. His reasoning, with all due respect to him,leaves the interpretation of Ch. I5 in a mess, leavingituncertain what the correct approach in the UnitedStates is to both the centre of main interests and theconcept of establishment.

I "Non-main" is the US version of secondary proceedings: once againGreat Britain and the US are tWo countries divided by a commonlanguage.2 As approved by the Advocate General at [Ill] and [112] of hisOpinion In Eurofood [2005] B.C.C. 10213 This is consistent with the approach in the English case of Ci4net[2005] B.C.C. 2774 In Great Britain. Art. 17 of Sch.1 to the Cross-Border InsolvencyRegulations 2006 is to the same effect.5 Art.2(h) of Sch.1 to the The Cross-Border Insolvency Regulationsalso defines "non-main" proceedings so as to require requires an"establishment" to exist in the relevant country.6 Compare Art.2(e) of the Regulations which add: ". . .wlth humanmeans and assets or services."

7 For example. the leading work in English. Moss Fletcher and Isaacs.The EC Regulation on Insolvency Proceedings (OUP. 2002).8 The "head office functions" test pioneered In the case law in the UKand subsequently followed in Germany. Italy. Hungary and France wasapproved by the Advocate General In Eurofood, reported at [2005]BCC 1021 at [Ill] and [112].9 Paras 34 and 35 of the judgment of the ECJ reported at [2006]B.C.C. 397 cites as a typical example of the rebuttal of the presumption

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a case where the company does not carry on business in thejurisdiction where it is registered.10 As is Art.17 of 5ch.1 to The Cross-Border Insolvency Regulations GabrielMossQ.c.is Chairmanof theE.ditorialBoardof

InsolvencyIntelligence

ADDRESSING THE REFORM OFTHE INSOLVENCYREGULATION: WISH LISTS ORFANCIES?

PaulJ.Omor

(!Y. Centre of main interests; Creditors; Cross-borderinsolvency; EC law; Jurisdiction; Priorities

Introduction

The European Regulation on Insolvency Proceedings20001 is the successor text to the European InsolvencyConvention 1995. It is the result of a project nearly fourdecades long in the making and forms part of an overalljurisdiction, recognition and enforcement allocationinitiative that also brought into being the BrusselsConvention 1968.2The history of the project included anumber of drafts whose remit moved graduallyawayfrom including elements of substantive harmonisationtowards simple procedural harmonisation and choice oflaws. There were a number of false starts, including thesuspensionof work after a failure to reach a consensuson a second draft in 1985. reversed following theinitiation of a rival project by the Council of Europewhich saw the conclusion of the Istanbul Convention1990.3 Although the Council of Ministers approved thetext that becamethe European Insolvency Convention1995, it did not enter into force because the UnitedKingdom failed to adhere within the time period openfor signature.4 Following a proposal co-authored byGermany and Finlandin 1999, the Insolvency Regulationrevived this project without major amendment to itsprovisions and the text entered directly into force onMay 31, 2002 in all of the member states in the EuropeanUnion subject to Title IV of the EC Treaty. then 14 innumber (Denmark being excluded as it had securedopt-out provisions during negotiations for the Treaty ofMaastricht). As part of preparations for the EuropeanUnion being joined by 10 new Member Stateson May I,2004, the Insolvency Regulationwas amended by therelevant Act of Accession, signed on September 23.2003. with effect from the date of accession. There have

also been some updating amendments to the lists ofinsolvency proceedings and officials in the annexes to theInsolvency Regulation.s It is likely there will be furtheramendments consequent on the Act of Accession, signedon April 25, 2005, providing for the accession of Romaniaand Bulgaria to the European Union on January I, 2007.

Reform Challenges

Since the enactment of the InsolvencyRegulation, therehavebeencallsfor reformsto the text. Someoftherelevant issues were raised in a 2005 conference paper

authored by Gabriel Moss Q.c. and ProfessorChristophPaulusand publishedinthis journalin early2006.6Thispaper dealt with concerns surrounding the definition ofthe "centre of main interests", the phenomenon offorumshoppingthroughdebtors movingprior to theinitiation of proceedings as well as the race to courthighlightedbydecisionssuchas E.urofood.7It also notedother related issues such as a possible framework forcourt-to-court communications, whether there shouldbe a central register of insolvencyjudgments. perhapstogether with publication through an officialwebsite. aswell as difficultiesattendant on the amendment process.The paper also questioned whether a special regime ordefault presumption for corporate groups should becreated and the consequent impact on prospects forcorporate rescuethroughthe InsolvencyRegulationbythe maintenance of the limitationto winding upprocedures in the case of secondary proceedings. Anumber of cogent points were made in the article. someof whichhavealsobeenaddressedbyother authors,Sexplainingwhy reforms may be necessary. Manyof thesecould usefullybe taken on board during any amendmentsthat may be made as the InsolvencyRegulation isreviewed, a process to which the authors sayconsideration is already being given.9

More Reform Challenges

Although it is not the purpose of this piece to responddirectly to the Moss-Paulus paper, there are other issuesthat would merit consideration were reforms to beinitiated that are germane to concerns raised in thatpaper. These include the issue of priorities and thepossible interference of doctrines of public policy, theuse of avoidance strategies aimed at preventing theproliferation of proceedings as well as the overallrelationship of the Insolvency Regulation to otherinternational instruments regulating cross-borderinsolvency, in particular the UNCITRAL Model Law onCross-Border Insolvency 1997.10

(i) Priorities and Public Policy Issues I I

The basic principle in the InsolvencyRegulation is thatthe rules governing the admission and content of claims,the special position of debts arising after the institutionof insolvencyproceedings aswell as proof andverification of all these claimsare all matters for thesubstantive law of the jurisdiction where proceedings areopened (the lex concursusprinciple).12Similarly,the samesubstantive law also governs the distribution of proceedswhen assets are realised, the ranking of claims as well asthe rights of creditors who have obtained partialsatisfaction after insolvencyproceedings are opened (forexample through the use of quasi-security). Because theInsolvency Regulation paradigm allows for the possibilityof multiple proceedings subject to the threshold test ofan "establishment" existing in the case of secondary orterritorial proceedings,13 the possibility of multiple

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