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Third Circuit Affirms Chapter 15 Recognition of Australian Liquidation Proceeding as Foreign Main Proceeding

August 29, 2013

Earlier this week, the Third Circuit Court of Appeals affirmed the recognition of an Australian liquidation proceeding as a foreign main proceeding in In re ABC Learning Centres Limited, n/k/a ZYX Learning Centres Limited, Case No. 12-2808 (3d Cir. Aug. 27, 2013). The opinion is noteworthy because it appears to be the Third Circuit’s first substantive ruling in a Chapter 15 case.

ABC Learning Centres was an Australian company which provided child care and educational services in Australia, the United States, and other countries. RCS Development Capital LLC contracted with ABC to develop child care facilities in the U.S. and guaranteed certain of ABC’s loan obligations. RCS won a $47 million breach of contract claim against ABC in Arizona state court, and ABC brought a suit against RCS in Nevada seeking $30 million in damages.

ABC entered into a Voluntary Administration under Australian law to determine whether ABC could be restructured or had to be liquidated. Following the initiation of the administration, ABC’s secured creditors exercised their right to commence an Australian receivership. ABC subsequently entered Australian liquidation proceedings. Under Australian law, the receivership and liquidation operate in tandem. The receiver, which managed and operated ABC with the permission and oversight of the liquidators, solely represented the interests of the secured creditors and was charged with satisfying the secured creditors’ claim by monetizing the assets of ABC. The liquidators, in contrast, represented the interests of all creditors and were responsible for investigating security interests, obtaining an accounting and payment of the value of assets realized by the receiver in excess of the secured debt, and distributing assets on a pro rata basis among creditors of the same priority.

ABC’s liquidators petitioned the Delaware Bankruptcy Court for recognition of the Australian liquidation proceeding as a foreign main proceeding under Chapter 15 of the Bankruptcy Code. The Bankruptcy Court found that the liquidation was a foreign main proceeding and ordered an automatic stay of actions against ABC and ABC’s property in the United States. RCS was granted limited relief from the automatic stay to render the Arizona verdict into a judgment and apply that judgment against the Nevada action. RCS appealed to the Delaware District Court, which affirmed the Bankruptcy Court’s orders, and then to the Third Circuit.

RCS did not dispute that the Australian liquidation proceeding met the administrative requirements under Section 1515 of the Bankruptcy Code to be recognized as a foreign proceeding. Instead, RCS argued that, because ABC’s assets were fully encumbered, in effect only the receivership -- the process being utilized by the secured lenders -- had the potential to benefit from Chapter 15 recognition. RCS noted that the receivership, unlike the liquidation proceeding (which is pursued on behalf of all creditors), is not a “collective proceeding” within the meaning of Chapter 15 because the receiver represents the interests only of secured creditors. Thus, it argued that Chapter 15 should not be utilized solely to benefit a non-collective proceeding. The Third Circuit rejected these arguments, holding that there was no “exception to recognition based on the debtor’s debt to value ratio at the time of insolvency” and that “such an exception could contravene the stated purpose of Chapter 15 and the mandatory language of Chapter 15 recognition.”

RCS further argued that recognition of the liquidation proceeding would contradict U.S. public policy in favor of collective insolvency proceedings because the receivership, which is a non-collective proceeding, would gain all of the benefits of recognition of ABC’s liquidation proceeding. Noting that the public policy exception has been narrowly construed to apply “where the procedural fairness of the foreign proceeding is in doubt or cannot be cured by the adoption of additional protections; or where recognition ‘would impinge severely a U.S. constitutional or statutory right,’” the Third Circuit held that recognition was not manifestly contrary to U.S. public policy merely because the secured creditor was entitled to liquidate its collateral and tender the excess to the company rather than turn over assets and seek a distribution from the bankruptcy estate, as in the United States. The Court noted that the liquidation was a collective proceeding that would allow for pro rata distribution among creditors of the same priority. Moreover, the Court noted that the Australian proceeding, rather than being manifestly contrary to U.S. public policy, simply “established a different way to achieve similar goals.”

Finally, RCS argued that Section 1520(a) did not stay actions against ABC’s assets located within the territorial jurisdiction of the United States because, according to RCS, ABC held only legal title and no equitable interest in its assets because they were fully encumbered. The Court held the ABC retained equitable interest in its encumbered property because, under Australian law, (1) the receiver is required to repay realized value in excess of the secured debt to ABC, (2) ABC retained a right of redemption with respect to the encumbered property, and (3) the liquidator had the right to challenge the charges claimed by the receiver. The equitable rights retained by ABC rendered its property “property of the debtor” subject to the automatic stay under Section 1520 of the Bankruptcy Code.

The Court held that allowing RCS, an unsecured creditor under both U.S. and Australian insolvency regimes, to recover on its judgment ahead of other creditors “would require a hodgepodge of United States and Australian bankruptcy law” and “is one of the outcomes that Chapter 15 was designed to prevent.” Thus, the Court affirmed the recognition of the Australian liquidation proceedings as foreign main proceedings. This exploration of the policy behind Chapter 15, in the very first Third Circuit opinion concerning Chapter 15, could provide guidance in future Chapter 15 cases that come before the Court.