Volume 42 | Number 3 Summer 2007
Page 3 of 8
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II. Framing the Problem
A. Choice of Bankruptcy Law
The ancient law review article I mentioned above was devoted exclusively to the second determination, the choice of bankruptcy law. In that article, I surveyed the few existing cases concerning choice of law for avoidance actions and performed a detailed analysis as to the choice of the proper avoidance law in multinational cases. I refer the reader to that article for a more elaborate discussion.
Because all three of the recent cases have involved what Americans would call a “fraudulent conveyance,” I will focus on that aspect of the problem. We start with the fact that a court following a traditional territorial approach to multinational bankruptcies will have difficulty fashioning a defensible choice-of-law rule for avoidance of multinational transactions. Territorialists grab what local assets are available and apply local law to them.9 They then distribute any proceeds of an avoiding action under the local priority system.10 They would normally not seek to recover assets located in foreign jurisdictions, but they may control assets that have arguably been transferred in fraud of creditors. The literature does not reveal any coherent approach to the application of foreign avoidance law under a territorialist system.
However, courts in the United States and a number of other countries are moving in the direction of a modified universalism in multinational bankruptcies, seeking to cooperate with other courts in achieving a pragmatic result as close as possible to the ideal of a single worldwide proceeding.11 Those courts are forced to consider which country’s bankruptcy laws should be applied to a particular issue in a multinational bankruptcy system. For example, if a creditor subject to personal jurisdiction in two countries, such as a multinational bank, engages in behavior that violates the moratorium (stay) of the country where a bankruptcy proceeding is pending, yet the behavior takes place entirely in the second country where there is no proceeding, which law should apply to the creditor’s conduct?12
The most difficult choice-of-law issue is determining which avoidance law to apply to a given pre-bankruptcy transaction. The first step in fashioning a sound approach is to understand that the avoidance provisions in every country reflect a balance between two conflicting values:
a) the need to return to the estate certain property transferred prior to bankruptcy for redistribution according to the statutory scheme of priority;13
b) the need to avoid imposing too much uncertainty in the marketplace with regard to transactions that are normally unobjectionable.
Countries draw the balance quite differently at the margins. Almost all bankruptcy laws would permit avoidance of a gift given with the intent to evade creditors at a time when the transferor was insolvent and the transferee had the intent to cooperate in the evasion.14 However, jurisdictions are sharply divided as to the relevance of the transferee’s state of mind—some regarding it as a crucial element or defense, while others are prepared to avoid the transfer regardless of the transferee’s knowledge or intent.15 Where there is some consideration for a transfer by an insolvent, but what the transferor gets falls well short of equaling the value of the property, some laws would make avoidance dependent upon the state of mind and knowledge of the transferor, the transferee, or both.16 Other laws (for example, the Bankruptcy Code in the United States17) would for the most part ignore the state of mind of either party in determining avoidability.
The case for avoidance is often compelling. A pre-bankruptcy transfer by an insolvent debtor for little or no consideration may well impact the rights of creditors in a serious way and often will be ill-motivated in fact. On the other hand, fraudulent conveyance laws often reach far back in time, and avoidance of a transfer made to an innocent party years before bankruptcy may impose a serious and costly uncertainty on the market and be seen as quite unfair to the transferee.18
It will fairly often be true that one country with significant contacts with a payment or other transaction would hold it avoidable while a second relevant country would not. In this common situation, which law should be applied? I have argued that those courts following the approach of modified universalism should apply the avoidance law of the debtor’s home country.19 In broad and brutal summary of a complex analysis, there are two key reasons for this conclusion. The first reason is that no other rule can be predictable and transparent in its application.20 The modern conflicts literature has long since demonstrated that a rule depending on the “place” in which the transaction occurred is manipulable and unpredictable.21 In every difficult case, the transaction has elements in more than one jurisdiction; therefore, it is easy to choose either place as the relevant location and apply its law.
In reaction to this defect, modern conflicts analysis looks at significant conflicts and the interests of the states involved.22 However, modern analysis applied on a case by case basis can also raise serious problems of predictability,23 making it hard for parties to know if their transactions might run afoul of bankruptcy laws in another country. A home-country rule provides the best result we can currently hope to achieve in that it is relatively difficult to manipulate and produces reasonably predictable outcomes. 24 No other approach can produce as good results at an acceptable cost.25
The second reason for applying home-country law turns on the fact that the whole purpose of avoiding powers in a bankruptcy proceeding is to redistribute the debtor’s assets according to certain statutory priorities.26 Because of the link between avoidance and priority, an interests analysis supports a home-country rule. Let’s take the example of a transfer of personal property made by X, a citizen and resident of Country A, to Y, a citizen and resident of Country B. At all times the property is located in Country B. Shortly after the transfer, X files for bankruptcy in Country A. There is no bankruptcy filed as to X in Country B. The bankruptcy law of Country A provides that all bankruptcy distributions will go to Creditor Group 1, including all proceeds of avoidance actions. Country B’s bankruptcy law gives all such distributions to Creditor Group 2. The transfer is not avoidable under the laws of Country A, but is avoidable under the laws of Country B. We may also assume that there are creditors from each creditor group in each of the two countries.
In this situation, it seems obvious that the Country A court should refuse a request by X’s trustee in bankruptcy to avoid the transaction. It cannot be avoided under the local law in Country A. If the Country A bankruptcy court avoids the transfer by applying the law of Country B, the result would be a windfall for Creditor Group 1, even though neither country would avoid the transaction for the benefit of Group 1. Nothing would go to Creditor Group 2 because of the priority system in Country A. The lawmakers in Country A expressly decided that avoidance in such a case as this would impose excessive costs on the commercial community, even though the result would benefit their favored Creditor Group 1. On the other hand, the lawmakers in Country B overcame any concerns about commercial effects because of the perceived importance of protecting Creditor Group 2. They seem to have no concern for Creditor Group 1. Country B lawmakers might even protest imposing costs on their commercial community to produce proceeds for Group 1. Neither country’s interests would be served by applying Country B’s avoidance law in this case. If we make Creditor Group 1 secured creditors and Group 2 employees or taxing authorities, the example is not unrealistic, albeit greatly simplified.
This example illustrates that the best rule for choice of avoiding powers is the law of the country that will distribute the proceeds of any avoidance recovery.27 In an ideal universalist system, that court would be the home-country court for all creditors throughout the world. Thus the powers would be used when the recoveries would benefit those who were given priority under the home-country’s laws. But universalism is currently only an ideal. A pragmatic court committed to modified universalism, such as we find in the United States, should try to come as close to the universalist result as it practically can. 28 Thus, it should generally choose the avoiding power of the home-country court: the transaction is avoidable if, and only if, it is avoidable under home-country law. Only one of the three cases I discuss came to that result, although it has the most important precedential force under United States law.
B. Nonbankruptcy Law
Ordinarily, this part of the analysis follows the same path as in a nonbankruptcy context, using the choice-of-law rules generally applied in the jurisdiction to determine if local law or some other law should apply to the nonbankruptcy elements of the case. As noted above, in the instance of an ordinary contract claim filed in the bankruptcy case, the proper law of the contract determines the validity and amount of the claim, while bankruptcy law determines its priority.29
Occasionally, the problem becomes more complicated because the bankruptcy law reflects a policy different from nonbankruptcy law. For example, in a purely domestic case within the United States, nonbankruptcy law may give landlords a much bigger claim than United States bankruptcy law will permit.30 The bankruptcy law simply overrides the nonbankruptcy law in that case. But if the nonbankruptcy law is that of another country, the correct answer may not be so clear. The French case does not appear to raise such an instance, but it suggests how the problem can arise. I will address that point later in this article.
A second relevance of nonbankruptcy law is found in avoidance statutes that may be used without a pending bankruptcy proceeding. A well-known example is the Uniform Fraudulent Transfer Act31 in the United States. It is a uniform law adopted in most states that can be used by a single creditor to avoid a fraudulent conveyance and to reap the recovery for the payment of that creditor’s debt. I address that wrinkle in the discussion of Al Sabah below.