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The Fifth Circuit’s Vitro Decision on Cross Border Insolvencies:

A Game Changer?

S e l e c t e d t o p i cBruce NathaN, esq. aNd richard corBi, esq.

Recently, the Fifth Circuit Court of Appeals, in In re Vitro S.A.B. DE CV, affirmed the decision by the Bank-ruptcy Court for the Northern District of Texas to refuse to enforce a controversial plan of reorganization proposed by Vitro S.A.B. de CV (Vitro) and approved in Vitro’s foreign insolvency proceeding in Mexico. The court took issue with Vitro’s court-approved plan in Vitro’s Mexico proceeding because the plan had dis-charged certain bondholders’ guarantee claims against Vitro’s subsidiaries who were not debtors in the pro-ceeding. The Fifth Circuit held that the plan’s release of third party claims against non-debtors (Vitro’s subsid-iaries) could only be approved in a Chapter 15 case based on proof of “exceptional circumstances,” even where the plan was not necessarily “manifestly con-trary” to U.S. public policy. Vitro failed to satisfy this high burden because its plan (i) did not appropriately balance the interests of Vitro’s creditors and the bond-holders holding Vitro’s subsidiaries’ guarantees that were subject to the plan’s release provision; (ii) violated the absolute priority rule, which is a cornerstone of U.S. bankruptcy law, by allowing Vitro’s equity to retain sub-stantial value, while not providing full payment of cred-itors’ claims; and (iii) improperly denied the bondhold-ers a distribution close to the full amount of their claims and prevented non-consenting bondholders any alter-native means to fully recover their claims.

The Fifth Circuit’s refusal to uphold the Mexico court order approving Vitro’s plan conflicts with the doctrine of comity that gives strong deference to a foreign court’s order or judgment. The Fifth Circuit’s decision shows

that U.S. courts will not necessarily rubberstamp a for-eign court’s decision that runs afoul of U.S. bankruptcy law. This could have significant implications upon and might undermine cross-border restructurings.

chapter 15 overviewChapter 15 contains the rules and procedures that a foreign debtor can utilize to facilitate a foreign insol-vency proceeding in the United States. Chapter 15 cases are filed to protect a foreign debtor’s assets and business in the U.S. from creditor enforcement actions and allow a foreign debtor to obtain relief from U.S. courts on most matters. Bankruptcy Code Section 101(23) defines a foreign proceeding as a “collective judicial or administrative proceeding in a foreign country, includ-ing an interim proceeding, under a law relating to insolvency or adjustment of debt in which proceeding

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the assets and affairs of the debtor are subject to control and supervision by a foreign court, for the purpose of reorganiza-tion or liquidation.” Vitro’s reorganization proceeding pend-ing in Mexico qualifies as a foreign proceeding.

A foreign representative in a foreign insolvency proceeding commences a Chapter 15 case by filing a petition for Chapter 15 relief with a U.S. bankruptcy court. Bankruptcy Code Sec-tion 101(24) defines a foreign representative as the agent appointed in a foreign proceeding to oversee the reorganiza-tion or liquidation of the foreign debtor and represent the debtor in any foreign court, such as a U.S. bankruptcy court.

A foreign representative must obtain recognition of a foreign proceeding in order to obtain the rights and benefits afforded by Chapter 15. That includes the specific categories of relief contained in Section 1521(a) of the Bankruptcy Code, as well as authorizing more general relief by allowing a bankruptcy court to “grant any appropriate relief ” in order to “effectuate the purpose of this chapter and to protect the assets of the debtors or the interests of the creditors.” According to Section 1521(b), that also includes entrusting “the distribution of all or part of the debtor’s assets located in the United States to the foreign representative or another person, including an exam-iner, authorized by the court, provided that the court is satisfied that the interests of creditors in the United States are sufficiently protected” (emphasis added).

In addition, Section 1507(a) of the Bankruptcy Code states that “the court, if recognition is granted, may provide addi-tional assistance to a foreign representative.” However, accord-ing to Section 1507(b), there must be reasonable assurance of the: “(1) just treatment of all holders of claims against or inter-ests in the debtor’s property; (2) protection of claim holders in the United States against prejudice and inconvenience in the processing of claims in such foreign proceeding; (3) preven-tion of preferential or fraudulent dispositions of property of the debtor; [and] (4) distribution of proceeds of the debtor’s property substantially in accordance with the order pre-scribed by this title...”

Section 1506 of the Bankruptcy Code further states that not-withstanding the comity doctrine that defers to a foreign court’s order on judgment, “[n]othing in [Chapter 15] prevents the court from refusing to take an action governed by [Chapter 15] if the action would be manifestly contrary to the public policy of the United States.” While the Bankruptcy Code does not define “manifestly contrary to the public policy of the United States,” the courts have focused on whether: (i) the for-eign proceeding is procedurally unfair; and (ii) the application of the foreign law would “severely impinge the value and import” of a U.S. statutory or constitutional right so that grant-ing comity would “severely hinder” a U.S. bankruptcy court’s ability to protect those rights.

FactsVitro S.A.B. de C.V. and its subsidiaries are the largest manu-facturers of glass containers and flat glass in Mexico. Vitro is a holding company organized in Mexico that conducts substan-

tially all of its multinational operations through its subsidiar-ies. Vitro and its subsidiaries have manufacturing facilities in 11 countries and distribution centers throughout the Ameri-cas and Europe.

Vitro issued unsecured notes in the aggregate principal amount of approximately $1.2 billion to numerous U.S bond-holders. Substantially all of Vitro’s indirect and direct subsid-iaries, who were not debtors in the Mexico proceeding, guar-anteed the full payment of the notes.

On December 13, 2010, Vitro filed a voluntary judicial reor-ganization proceeding (the Mexico proceeding) under the Ley de Concursos Mercantiles (Mexico’s Bankruptcy Reorganiza-tion Act) in Mexico’s Federal District Court for Civil and Labor Matters for the State of Nuevo León. When Vitro com-menced the Mexico proceeding, the total outstanding indebt-edness owed to Vitro’s creditors, excluding intercompany indebtedness, totaled approximately $1.7 billion, of which approximately $1.2 billion was owed on the Vitro notes. On January 7, 2011, the district court in Mexico denied Vitro’s request for a concurso mercantile to adjudicate Vitro as a debt-or in the Mexico proceeding. The district court’s decision was appealed and on April 8, 2011, an appellate court in Mexico reversed the district court’s ruling and issued a declaration of concurso mercantile adjudicating Vitro as a debtor in the Mex-ico proceeding.

Thereafter, Vitro’s foreign representatives (appointed by Vitro’s board of directors) filed a Chapter 15 petition in the United States and the case ended up in the United States Bankruptcy Court for the Northern District of Texas. Vitro ultimately obtained bankruptcy court approval recognizing the Mexico proceeding.

In August 2011, the U.S. bondholders holding Vitro notes guaranteed by Vitro’s subsidiaries commenced suit in the New York state court seeking a money judgment on their guaran-tees and a declaratory judgment that Vitro’s reorganization in the Mexico proceeding would not impact their ability to col-lect their guarantee claims against the subsidiaries. The New York state court ruled in favor of the bondholders, holding that the subsidiaries’ guarantees could not be modified in the Mexico proceeding.

Vitro sought approval of a prepackaged concurso restructuring plan of reorganization. On February 3, 2012, the district court approved the concurso reorganization plan in the Mexico pro-ceeding (the concurso plan approval order). That included approval of the plan’s provision releasing the bondholders’ guarantee claims against Vitro’s subsidiaries who were not debtors in the Mexico proceeding. Despite the issuance of the concurso approval order, the U.S. bondholders continued their U.S. lawsuit to collect their guarantee claims against the sub-sidiaries. On March 2, 2012, Vitro’s foreign representatives filed a motion in the bankruptcy court to enforce the plan in the U.S. and stay the bondholders’ pending litigation in New York to collect their guarantees against Vitro’s subsidiaries. The bondholders objected to the enforcement motion. After

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the bankruptcy court granted a temporary restraining order that temporarily stayed the New York State litigation, the court held a trial on the enforcement motion.

On June 13, 2012, the Bankruptcy Court for the Northern District of Texas refused to enforce Vitro’s plan of reorganiza-tion approved in the Mexico proceeding because the plan was “manifestly contrary” to U.S. public policy by improperly dis-charging the guarantee claims that Vitro’s bondholders held against Vitro’s subsidiaries, who were not debtors in the Mex-ico proceeding. The bankruptcy court also concluded that Vitro was improperly attempting to distribute its subsidiaries’ assets through Vitro’s reorganization plan approved in the Mexico proceeding, without sufficiently protecting the U.S. bondholders holding guaranty claims against the non-debtor subsidiaries, precisely the result Vitro could not achieve in a U.S. bankruptcy case.

The bankruptcy court’s order was appealed directly to the United States Court of Appeals for the Fifth Circuit.

the Fifth circuit court of appeals statutory FrameworkThe issue before the Fifth Circuit was whether the bankruptcy court erred in refusing to enforce the concurso plan approval order in Vitro’s Mexico proceeding that discharged the bond-holders’ guarantee claims against the non-debtor Vitro sub-sidiaries. The Fifth Circuit first examined the statutory back-ground of Chapter 15 that requires consideration of both Sections 1507 and 1521. The Fifth Circuit created a three-part framework because the statutory relationship between Sec-tions 1507 and 1521 is “not entirely clear.”

First, a court should consider whether the requested relief is included in Section 1521 of the Bankruptcy Code. Section 1521(a) lists seven specific forms of relief that a court could entertain following recognition of a foreign proceeding. The court should, therefore, consider whether the requested relief is within the scope of any one of these explicit provisions. Also, Section 1521(b), provides that “the court may, at the request of the foreign representative, entrust the distribution of all or part of the debtor’s assets located in the United States to the foreign representative…provided that the court is satis-fied that the interests of creditors in the United States are suf-ficiently protected.” Section 1522 of the Bankruptcy Code, however, limits section 1521 by providing that relief under Section 1521 may be granted only “if the interests of the cred-itors and other interested entities, including the debtor, are sufficiently protected.”

Second, if the requested relief is not set forth in Section 1521(a)(1)-(7) and (b), the court should decide whether it can be con-sidered “appropriate relief ” under Section 1521(a). This, in turn, requires consideration of whether the requested relief had been either previously provided under Chapter 15’s prede-cessor, former Section 304 of the Bankruptcy Code, or is oth-erwise available under U.S. bankruptcy or other applicable law. Third, a court should consider relief under Bankruptcy Code Section 1507 only if the requested relief was not previously available under either former Section 304 or under U.S. law.

The burden of satisfying Section 1507 is even more rigorous since the relief it provides is more “extraordinary” than the relief available under Section 1521. This is designed to prevent a foreign debtor from invoking section 1507 to seek relief that is not otherwise be available in other sections of Chapter 15 or other U.S. law.

Fifth circuit court of appeals analysisApplying this framework, the Fifth Circuit upheld the bank-ruptcy court’s refusal to enforce Vitro’s concurso plan. First, Section 1521(a)(1)-(7) and (b) do not permit a foreign debtor to discharge claims by third parties against non-debtor enti-ties. Section 1521(a)’s provision for “any appropriate relief ” also does not allow a non-consensual discharge of non-debtor obligations under a guaranty because former Bankruptcy Code Section 304 did not authorize such a release. In addition, the Fifth Circuit has rejected plans that approved a release of claims against non-debtor entities, such as guarantors.

Finally, the Fifth Circuit considered whether Section 1507 allows a release of guaranty claims against a non-debtor entity. While recognizing that a court could have relied upon the comity doctrine to theoretically approve a release of claims against non-debtor entities, the Fifth Circuit ultimately ruled that the bankruptcy court had correctly refused to enforce the concurso plan approval order that approved the release of the bondholders’ claims against the non-debtor Vitro subsidiar-ies. The Fifth Circuit relied on the fact that (i) the release of claims against the non-debtor Vitro subsidiaries did not sat-isfy Section 1507(b)(4) because Vitro’s concurso plan had failed to provide for a distribution in accordance with the pri-ority scheme mandated by the Bankruptcy Code and (ii) Vitro had also failed to prove the existence of an “extraordinary cir-cumstance” in the case that would have otherwise justified a release of guaranty claims against the non-debtor subsidiar-ies. The Fifth Circuit noted that Vitro’s concurso plan’s release of the bondholders’ guaranty claims against Vitro’s non-debt-or subsidiaries provided a substantially reduced recovery to the bondholders by cutting off their ability to recover from the non-debtor Vitro subsidiaries. This was not consistent with what the bondholders would have recovered in a U.S. bank-ruptcy case. The court also concluded that Vitro did not prove any “extraordinary circumstances” warranting approval of its concurso plan where (i) Vitro’s equity holders retained sub-stantial value in violation of the absolute priority rule (that requires full payment of creditors’ claims prior to any distri-bution to equity); (ii) the bondholders had opposed the plan, (iii) the plan had failed to provide for the full payment of the bondholders’ guaranty claims, and (iv) the plan was approved, over the bondholders’ objection, only after their claims were lumped together with the claims of insider creditors to create a class of creditors that accepted the plan.

takeawayThe Fifth Circuit’s decision in Vitro clearly points out that for-eign insolvency law cannot be used as a sword to circumvent U.S. bankruptcy law. The Fifth Circuit disregarded the over-arching principle of comity applicable to Chapter 15 and many cross border cases to uphold the bankruptcy court’s

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rejection of the concurso plan approval order in Vitro’s Mexico proceeding because the order and Vitro’s concurso plan con-flicted with this country’s bankruptcy law.

On December 28, 2012, the Fifth Circuit denied Vitro’s request to hear the matter en banc. As of the date of this pub-lication, Vitro’s foreign representatives have not filed a peti-tion for certiorari with the United States Supreme Court who will have the final say here.

Bruce Nathan, Esq. is a partner in the New York City office of the law firm of Lowenstein Sandler LLP. He is a member of NACM and is on the Board of Directors of the American Bankruptcy Institute and is a former co-chair of ABI’s Unsecured Trade Creditors Committee. Bruce is also the co-chair of the Avoiding Powers Advisory Committee working with ABI’s commission to study the reform of Chapter 11. He can be reached via email at bnathan@lowenstein.com.

Richard Corbi, Esq. is counsel in the law firm of Lowenstein Sandler LLP. He can be reached at rcorbi@lowenstein.com.

*This is reprinted from Business Credit magazine, a publication of the National Association of Credit Management. This article may not be forwarded electronically or reproduced in any way without written permission from the Editor of Business Credit magazine.

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