Bankruptcy law has its own set of rules.
When a company files for Chapter 11 reorganization under the U.S. Bankruptcy Code, the filing triggers an automatic stay that prohibits any attempts by creditors to exercise control over any property of the bankruptcy estate.
The bankruptcy court then has jurisdiction over all property of the estate, which includes all property "wherever located and by whomever held."
As the recent U.S. Court of Appeals for the Seventh Circuit's ruling in Sheehan v. Breccia Unlimited Co. demonstrates however, in cases of foreign-held assets, the bankruptcy court must also have personal jurisdiction over a foreign lender for the automatic stay to apply to foreclosure proceedings in a foreign country.
As background, a debtor, Joseph C. Sheehan, lives in Illinois. Beginning in 2006, he borrowed money from an Irish bank to buy an interest in Irish medical company Blackrock Hospital Limited and real estate in Ireland.
He pledged the equity to secure the loans and the lender took a mortgage on the real estate. In 2010, Sheehan defaulted on the loans.
Breccia also owned an equity interest in the medical business and, when Sheehan defaulted, it bought Sheehan's loans from the original lender, then foreclosed on the collateral. Breccia is based in Dublin, so it sued in Ireland to collect on the loans.
An Irish appellate court ruled in Breccia's favor and authorized it to appoint a receiver to take possession of Sheehan's equity interest and real estate.
In response, Sheehan filed a petition for Chapter 11 reorganization in the U.S. Bankruptcy Court for the Northern District of Illinois. He then invoked the automatic stay provisions of Chapter 11 and filed an adversary claim — a separate lawsuit within the bankruptcy proceeding — in an attempt to halt the receivership proceedings in Ireland.
The bankruptcy court, affirmed by the federal district court, held, in part, that the bankruptcy court lacked personal jurisdiction over the Irish defendants because none of them conducted any activity related to the adversary claims in the U.S. The Seventh Circuit affirmed.
Although bankruptcy proceedings operate under the bankruptcy code, bankruptcy courts are still subject to constitutional standards. Due process requires that out-of-forum defendants must have "certain minimum contacts with [the forum] such that the maintenance of the suit does not offend traditional notions of fair play and substantial justice."
A bankruptcy court has in rem jurisdiction over all the property in the bankruptcy estate, including real estate located in a foreign country or shares of stock of foreign corporations.
Although the filing of a bankruptcy petition triggers the automatic stay prohibiting attempts to exercise control over property of the estate, prohibitions on attempts by creditors to reach such property, however, cannot be enforced if a court does not have personal jurisdiction over the party holding the property.
This ruling has major implications for individuals and businesses with foreign assets. To give substance by example, imagine three, fictional Wisconsin-based companies, each of which manufactures licensed athletic apparel.
One of these used a loan from a foreign investor to finance an addition to its Wisconsin factory. Another used domestic funding to finance its factory abroad. The third's debt from building its foreign factory was acquired by a foreign bank.
Working through each of these examples offers an insight into Sheehan's potential impact.
Green and Gold Company, which manufactures American football apparel, keeps its principal place of business in Appleton, Wisconsin.
Green and Gold has no international assets, but funded a recent addition to its Appleton factor with a loan — collateralized by the factory — from a foreign investor, an American football enthusiast living in Berlin, Germany.
Next, Red and Gold Company manufactures soccer apparel with licenses from both American and European teams. Red and Gold is based in Madison, Wisconsin, but has a factory near Madrid, Spain. Red and Gold's funded its factory through a Wisconsin bank.
Finally, Black and White Company manufactures rugby apparel. Like the others, Black and White's nerve center is in Wisconsin, on the southside of Milwaukee.
However, Black and White's factory is in New Zealand. And Black and Gold's debt to finance its factory was recently acquired by a bank in Wellington, New Zealand.
The following table lists each fictional company, the location of its collateralized assets — in this case, for simplicity, each company's loan is secured by its factory — and the affiliation of its creditor.
Next, imagine that each company is experiencing a decline in business due to a global pandemic. Each company has defaulted on its loan. Now what?
Green and Gold's investor files a foreclosure action in Outagamie County, Wisconsin. To halt the foreclosure and give itself a chance to reorganize, Green and Gold files for Chapter 11 bankruptcy relief.
Green and Gold's filing creates the automatic stay and pulls Green and Gold's assets into the bankruptcy court's jurisdiction. Is the foreclosure stayed?
Sheehan's reminder is clear: The bankruptcy court's jurisdiction over Green and Gold and its factory is not a nexus to personal jurisdiction over Green and Gold's football-loving creditor.
So, the court will need to determine whether the creditor has sufficient minimum contacts with Wisconsin. In this case, he does.
Green and Gold's investor is a football fanatic who frequently travels to Wisconsin to enjoy football games. He rents a small apartment in Wisconsin near his favorite team's stadium. And, unlike the defendants in Sheehan, Green and Gold's investor is taking action in Wisconsin to assert control and ownership over Green and Gold's domestic property.
Assuming that exercising personal jurisdiction would not violate traditional notions of fair play and substantial justice, the automatic stay freezes the foreclosure action. The situation plays out similarly for Red and Gold.
Unlike Green and Gold, Red and Gold's collateral is in a foreign jurisdiction: Spain. However, if Red and Gold files for bankruptcy after defaulting on its loan, that factory, for jurisdictional purposes, is brought under the bankruptcy court's res.
Further, Red and Gold's secured creditor is a domestic bank. The bankruptcy court has jurisdiction over the Spanish factory and, more importantly, over the bank. The automatic stay freezes the foreclosure action.
Finally, we turn to Black and White.
Black and White's bankruptcy creates the automatic stay and — like Red and Gold — pulls its foreign factory into the res of the bankruptcy court. But does the automatic stay stop the foreclosure of its factory? As was the case in Sheehan, likely no.
The Wellington bank's foreclosure action to take control of Black and White's collateral will occur in New Zealand, and the collateral, Black and Gold's factory, is also in New Zealand. Indeed, the Wellington Bank's action, though directed at Black and Gold, a Wisconsin company, is not enough to create personal jurisdiction.
So, unless the Wellington Bank otherwise has sufficient minimum contacts with Wisconsin, the bankruptcy court lacks jurisdiction to stay the New Zealand foreclosure action. Black and Gold's factory is foreclosed and unavailable to Black and Gold for the purposes of its reorganization.
As the world becomes more interconnected, domestic companies will undoubtedly do more and more business with foreign banks and financing arms.
However, after Sheehan, domestic companies engaged in international business — especially domestic companies with foreign assets — should consider the bankruptcy implications of entering into collateralized financing agreements with foreign entities. Certainly, Sheehan should not be read to say that domestic companies should never accept foreign financing.
It is, however, a reminder that bankruptcy law has its own set of rules — one that companies should be aware of and plan for before they need bankruptcy help.
One option for domestic companies to protect themselves is by negotiating forum selection and choice-of-law clauses, and jurisdictional waivers, in international financing agreements.
Forum selection clauses establish the agreed venue in which to resolve disputes and may waive objections to jurisdiction. Choice-of-law provisions specify that any dispute arising under the contract or agreement will be decided under the law of a particular jurisdiction.
Another recent Seventh Circuit case, Seafarers Pension Plan v. Bradway, confirmed the enforceability of this option.
Choice-of-law and forum-selection provisions in agreements between domestic and foreign businesses are "valid and should be enforced unless enforcement is shown by the resisting party to be unreasonable under the circumstances."
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