Choice of law in United States cross-border insolvencies.

• Author: Coulson, Richard E.

1. INTRODUCTION

   In a period marked by the development of numerous treaties, conventions, and statutes designed to regulate international business, the field of international bankruptcy remains disturbingly resistant to reform. Most of the major initiatives proposed in past decades have failed completely; others, though adopted, have had only moderate impact. As a result, the bankruptcy of a multinational enterprise typically triggers diverse and uncoordinated legal proceedings in various countries connected to the affairs of that enterprise. For instance, this lack of coordination imposes substantial costs both on the bankruptcy process itself, by multiplying administrative expenses, and on international commerce generally, by preventing lenders from predicting accurately the consequences of debtor insolvency. The need for a method of addressing international insolvencies that is fair, predictable, and consistent therefore remains pronounced.

   The movement to reform international bankruptcy law has been cast largely as a struggle between two opposing camps: universality and territoriality. For the past few decades, universalists who argue that international bankruptcies should be administered by a single forum, have been winning the battle. Universalists argue that the centralized administration of cross-border bankruptcies will provide: (1) equality of treatment for all creditors; (2) maximization of the value of the bankruptcy estate; (3) expeditious and efficient administration of the estate; and (4) predictability of outcome. Universalist principles have shaped the discourse as well as the goals of the bankruptcy reform movement.

   In the year 2000, however, the consensus that had long favored universality seemed to be weakening. Territoriality, which favors the simultaneous administration of multiple local bankruptcies, is gaining currency among commentators. On the legislative front, the international bankruptcy provisions of the proposed Bankruptcy Reform Act of 1999 (1) while purporting to foster universality, instead reveals only a partial commitment to the universality approach. Finally, recent cases evidence the increasing tendency of courts to abandon the battlefield altogether by handling cross-border bankruptcies in an extra-regulatory fashion. (2)

   Many recent large bankruptcies, including Swissair, WorldCom, Enron, and United Airlines, necessarily have multi-jurisdictional problems. But smaller enterprises also operate across international borders. What law to apply is traditionally a conflict of laws problem. Nevertheless, as Professor Buxbaum and others point out, (3) cross-border insolvencies have not generally been analyzed in terms of choice of law methodology.

   First, we need to identify the terminology used in this area of law. Professor Buxbaum mentioned "Universality" and "Territoriality." (4) Although neither describes the exact situation in the United States today, both are active elements in efforts to describe courts' efforts to apply the limited legislative guidance. "Universality maintains that a single forum should administer the bankruptcy of an insolvent corporation. The bankruptcy proceeding would reach all assets of the debtor, wherever located, and would distribute those assets to all creditors, wherever located." (5) Generally, it is assumed that this distribution of assets and determination of claims would be done according to the forum's own laws.

   Territoriality, in contrast, is the familiar state law collection technique of grabbing the local assets and distributing them to the local creditors according to its own laws. (6) The United States has a long history of trying to reconcile the needs and interests of local creditors in and to local assets (the race to the court house) and the desire for equitable distribution of an insolvent debtor's assets. (7) Naturally, if the debtor is not insolvent, a local creditor may be inconvenienced and taxed with added costs by participating in a foreign proceeding, in theory, however, that creditor will eventually be paid. It is where the assets are insufficient that equality of distribution and other bankruptcy protective tools are needed--such is the international conflict.

   As noted, the United States has seldom been purely one or the other. Indeed, the current regime under Bankruptcy Code section 304 has been characterized as "modified universality." (8) This characterization is accurate but a little odd. It would appear that the United States is truer to Universality than any other nation.

   In this piece I do not attempt to set out what choice of law principles should govern cross-border insolvencies in the United States. Rather i attempt to trace federal choice of law rules and show how those rules, such as they are, have had limited use thus far in bankruptcy cases. In Part II I discuss choice of law rules and identify what federal choice of law rules are in various contexts. In Part III I discuss the trend, if it can be called a trend, in cases decided prior to the Bankruptcy Reform Act of 1979 ("BRA" herein). Part IV examines the structure of the BRA dealing with cross-border issues and discusses selected cross-border cases decided under the BRA showing the limited application of federal choice of law analysis. In Part V I leave with a brief restatement of the problem facing courts in cross-border insolvency cases rather than a solution, other than to suggest that developed choice of law principles are designed to inform the choice and should not be overlooked in deciding whether to apply United States bankruptcy law.

2. WHOSE CHOICE OF LAW RULES?

   1. Choice of Choice of Law Rules

      For some time it has been settled that a federal court sitting in diversity jurisdiction shall apply the choice of law rules of the state in which it sits. (9) Klaxon was based on Erie Railroad Co. v. Tompkins (10) which relied in part on the Rules of Decision Act. (11) This Act provides that "[t]he laws of the several states ... shall be regarded as rules of decision in civil actions in the courts of the United States, in cases where they apply." (12) Thus the "laws of the several states" includes the forum state's choice of law rules. (13) Does this apply in Bankruptcy?

      The answer is curiously clouded. Vanston Bondholders Protective Committee v. Green (14) is a starting point. In Vanston, the issue was whether interest on interest should be paid in a Chapter 11 bankruptcy proceeding. (15) If it was payable, the first mortgage bondholders would be paid in full, but subordinate creditors would have a reduced share. (16) The Court said:

      What claims of creditors are valid and subsisting obligations against the bankrupt at the time a petition in bankruptcy is filed, is a question which, in the absence of overruling federal law, is to be determined by reference to state law.... Determination [of which state's law applies where, as here, other states have significant contacts] requires the exercise of an informed judgment in the balancing of all the interests of the states with the most significant contacts in order best to accommodate the equities among the parties to the policies of those states. (17) This quote was dicta, because the Court held that regardless of whether interest on interest was allowable under any or all of the potentially interested states' laws, the issue was determinable by reference to the policy of the Bankruptcy Act; (18) that is, there was "overruling federal law." (19) Nevertheless, this case has been the point of jumping off for much analysis. However, this analysis has not pointed in a clear direct line.

      It is to he noted that the Vanston Court, albeit in dicta, used a phrase to state the essential choice of law relation that has similarly become basic in the Restatement (Second) Conflict of Law ("Restatement of Conflicts"); they referred to the "states with the most significant contacts," (20) whereas the core concept of the Restatement of Conflicts is the "most significant relationship." (21) Because the latter, in some version, appears in most states, and because the federal courts have adopted the Restatement of Conflicts as the basis of federal common law choice of law, (22) it often happens that there is no essential difference in the choice of choice of law; thus, the issue is left unresolved. This result was reached by the Fifth Circuit in Woods Tucker Leasing Corporation v. Hutcheson-Ingram Development Co., (23) where it held that Texas and Mississippi would apply the choice of law provision of the Uniform Commercial Code, as would the federal court, in making its own choice to recognize a contractual choice of law provision. (24)

      The Second Circuit reached a finer judgment in In re Gaston & Snow. (25) The case was a bankruptcy adversary proceeding on an oral contract between a Chapter 11 law firm and its former clients. (26) At issue was the applicable statute of limitations. (27) The court, after noting the division in the courts of appeals, held that because federal choice of law rules are a creature of federal common law, and that because federal common law was only available where there was a significant federal interest, that where state law was the underlying dispositive law, the bankruptcy courts should apply the choice of law rules of the forum and not federal law. (28)

      Reaching a directly contrary view is In re Vortex Fishing Systems, Inc. (29) That case also involved a statute of limitations which lay at the basis of a claim on which a creditor predicated its standing as an involuntary bankruptcy petitioner. (30) The case does not carefully discuss our issue but, following earlier circuit law, (31) held that "[i]n a bankruptcy case, the court must apply federal choice of law rules." (32)

      Since most substantive rights in bankruptcy are based on state or nonbankruptcy law, and since those state issues are respected in bankruptcy absent federal bankruptcy statutes or strong, clear policies...