Greed and pride in international bankruptcy: the problems of and proposed solutions to "local interests".

• Author: Pottow, John A.E.

TABLE OF CONTENTS I. INTERNATIONAL BANKRUPTCY THEORY II. LOCAL INTERESTS: DEFINING THE PROBLEM A. Introduction B. The Interests of Local Creditors 1. Content-Neutral Interests: Asset Coverage Ratio ("ACR") 2. Content-Based Interests: The Content of Local Bankruptcy Law C. The Interests of Local Sovereigns 1. The Problem: Sovereignty and Territorialism's Allure 2. Semi-Solutions: Universalism's Olive Branch to Sovereignty 3. Pride in Action D. Summary III. PROPOSED SOLUTIONS TO PROTECT LOCAL INTERESTS UNDER UNIVERSALISM A. First-Best: Recharacterizing the Debate 1. Diffuse Reciprocity 2. Bankruptcy Meta-Norms B. Second-Bests: Current and New Pragmatic Proposals 1. Liens 2. Circumscription 3. Carve-Outs C. Could It Ever Happen? IV. SUMMARY, FURTHER COMMENT, AND CONCLUSION The collapses of Yukos, Parmalat, and other international juggernauts have focused scholarly attention on the failure of multinational enterprises. Even what one might consider "American" companies, such as Chicago-based United Airlines, have made clear in their restructuring plans that their operations have profound effects on the dozens of nations around the globe where they transact business. (1) Government and quasi-government reform efforts to regulate these cross-border insolvencies have abounded, including among others, the UNCITRAL Model Law on Cross-Border Insolvency. (2) UNCITRAL is also building on World Bank and INSOL (3) efforts at promulgating a Legislative Guide for "best practices" bankruptcy codes. (4)

Scholars vary in their enthusiasm toward these reform efforts, but most will agree that these initiatives should be grounded in a coherent theory of cross-border financial distress. (5) Debate to date in international bankruptcy theory has centered on two competing paradigms, universalism and territorialism. (6) This rich scholarly discussion is replete with complex overlays, such as the proper role of private ordering by parties within either proposal. (7) One of the principal sticking points of this debate, however, has been how best to protect what are often called "local interests." (8) While scholars and courts are not as precise in their use of this term as they might be, they express serious concern over the perils local creditors and small-country sovereigns face in trying to design a viable international bankruptcy system. (9)

The purpose of this Article is twofold. First, it explores what exactly we mean in cross-border insolvency law when we talk about "local" creditors and protecting "local interests." Because these local interests are crucial to the debate between universalists and territorialists (with the latter claiming that the former cannot protect these interests sufficiently), (10) rigorous analysis is imperative to permit meaningful critique. Second, this Article advances policy recommendations to address the problems of local interests (as properly understood) and suggests the next stage in designing a theoretically sound but pragmatically functional international bankruptcy system.

The Article proceeds as follows: Part I summarizes briefly the universalist-territorialist debate in international bankruptcy theory. Part II first looks at the concern of protecting "local creditors" and unpacks that concept into its constitutive parts. It argues that this construct is actually an amalgam of what is called the local asset-claims ratio (a legally neutral, unpredictable-before-bankruptcy happenstance) and the content of the local state's substantive bankruptcy laws (an arguably predictable factor ex ante to any given debtor's default). These components both affect the overriding motivation of the local creditor in a cross-border insolvency, which I characterize as "greed." Part II further explores the idea of protecting "local states" and argues that these are distinct concerns from the problems of local creditors. These state-specific interests present separate obstacles for international bankruptcy that operate on a parallel but distinct track from greed. The related vice of these local sovereign policymakers that matches their local constituents' greed is what I loosely call "pride."

Armed with a more accurate and honest understanding of the challenges local greed and local pride present in cross-border insolvencies, Part III turns to policy recommendations, focusing on the more intractable but at least more predictable problem of pride. It offers a first-best resolution from a theoretical standpoint, contending that recharacterization of the conflicts of laws presented by cross-border disputes--by focusing on diffuse reciprocity and the identification of bankruptcy meta-norms--provides the clearest path to taming the problem of sovereign pride. It suggests that the project of substantive harmonization, especially the reduction of priority payout provisions within domestic bankruptcy laws, begins this task. Because international bankruptcy is an inchoate and fluctuating field, however, Part III also offers some second-best, pragmatically oriented policy alternatives. It first critiques two of the dominant proposals, liens and circumscription. It then proposes a new and arguably better idea: a substantive carve-out in favor of the local territorial state within an overarching universalist framework. The carve-out proposal, while directed at pride, may have spillover potential that will help with greed; it thus takes aim at two birds with one stone.

1. INTERNATIONAL BANKRUPTCY THEORY

   In broad summary, international bankruptcy creates enormous problems for commercial actors because of a combination of at least three general attributes of insolvency law. First, insolvency laws have an expansive reach. That is, when an entity commits general default on its various financial obligations, the resolution of that failure requires that all participants be bound to the legal outcome. Accordingly, bankruptcy proceedings are in rem and bind all potential stakeholders in the debtor's property. (11) This broad-sweeping and compulsory law corrals those constituents who would prefer to defer collective resolution and deal with their debts on an individual in personam basis. All must join a group resolution. (12)

   In addition to this breadth, bankruptcy law intrudes upon another axis: it invades and displaces pre-existing legal relationships. What otherwise is a perfectly enforceable executory contractual obligation can find itself dishonored or modified by a debtor under the jurisdiction of a bankruptcy court, often to the dismay of the contractual counterparty. Some have termed bankruptcy a type of "meta-law" that swoops in and trumps baseline legal relationships in the unusual circumstance of general financial default. (13)

   In addition to being invasive along these two axes, bankruptcy law is also "prickly." That is, despite the protestations of many scholars who insist (with some merit) that the principal focus of a bankruptcy law should be the efficient resolution of financial distress, (14) the bankruptcy laws on the books in myriad jurisdictions around the globe unabashedly contain a panoply of redistributive provisions. (15) Among the most vivid of these are the priority payout rules of estate distribution. Although the baseline norm of bankruptcy distribution is "equality is equity," and therefore that limited assets should be distributed pro rata to share the burden of nonrecovery equally, the norm is most often honored in the breach. (16) For example, employee-creditors owed back wages for unpaid services are arguably no different from a bank owed back payments for unpaid loan invoices; yet many systems advance the employees to the front of the line, offering them special, preferred payment before the garden-variety creditors (or, as Professor White prefers, the "dross") (17) scrounge for the scraps. (18) While scholars differ in their views as to what these priority payout provisions represent--important normative policy preferences regarding conceptions of fairness, economic assessments of comparative bargaining ability, or simply the spoils of domestic rent-seeking contests--the point is that these provisions implicate prickly issues that reveal a legislator's redistributive values in a sensitive legal context in which insufficient assets guarantee that unhappiness and pain will abound. (19)

   Given this combination of attributes--broad-reaching scope, invasively displacing power, and normatively touchy legal rules--that characterize a typical bankruptcy code, it should not be surprising that international coordination engenders some difficulties. (20) And in an increasingly globalized economy, cross-border failures are becoming more and more common. When an international enterprise fails, several jurisdictions plausibly can lay claim to resolving the dispute. (21) Because bankruptcy laws tend to be broad-reaching, conflicting claims are likely. Because bankruptcy laws are invasive and prickly, these conflicts are likely to be thorny.

   To illustrate with a quick example, consider a Canadian-based manufacturer (incorporated in Ontario) with a plant, workforce, accounts, and sales force in Canada that also has a branch office and warehoused inventory in the United States (perhaps Michigan). Both Canada and the United States have colorable claims to regulate the resolution of that debtor's distress. The claims to jurisdiction are greatest regarding the assets located in the Michigan warehouse: Canada is presumably interested in governing the resolution of a "Canadian" debtor, and the United States in adjudicating property rights of assets located within her physical territory. This is a potential zone of conflict in which two sovereigns could both seek to exert regulatory control. (22)

   Bankruptcy scholars have coalesced around a discussion of two dominant forms of international regulation under such a scenario. ("Regulation" is being used loosely to refer to the systematic resolution of these situations...