The case for cooperative territoriality in international bankruptcy.

• Author: LoPucki, Lynn M.

"[It] seems unrealistic to think that universalism will be accepted absent roughly similar laws." -- Jay L. Westbrook (1991)(1)

INTRODUCTION

Universalism -- the idea that a multinational debtor's "home country" should have worldwide jurisdiction over its bankruptcy -- has long had tremendous appeal to bankruptcy professionals. Yet, the international community repeatedly has refused to adopt conventions that would make universalism a reality. In an article published last year, I proposed an explanation.(2) Universalism can work only in a world with essentially uniform laws governing bankruptcy and priority among creditors -- a world that does not yet exist.

Because it is impossible to fix the location of a multinational company in a global economy, the introduction of universalism in current world circumstances would give each multinational company a choice of countries in which to file. By its choice, the company could choose not only the procedure for its bankruptcy, but also the substantive rights its creditors would have. Universalism would require other nations to recognize the effects of that strategic choice. Given the huge amounts of money potentially at stake, governments rightly fear that opportunism would run rampant.(3)

Universalists insist that the requirement that bankruptcies occur in the "home country" of the multinational company would prevent forum shopping. They premise their defense of universalism on the assumption that each multinational company would have one home country and that everyone could know in advance which it was.(4) Yet, no universalist writer has been able to define "home country" with any specificity or to describe how their system reliably could determine it.

In this essay, I again raise the three specific questions regarding home countries that universalists seem unable to answer. First, when the principal assets, operations, headquarters, and place of incorporation are in different countries, which is the "home country"? Second, does "home country" refer to the home country of a corporate group or does each corporation in the group have its own "home country"? Third, what rules will govern the inevitable changes in the "home country" that occur after credit has been extended? The inability of the two prominent universalists writing in this symposium to answer these questions, suggests that they are, indeed, unanswerable.

I agree with Professor Westbrook(5) that it is likely that the globalization of business eventually will harmonize the now-divergent debt collection and insolvency systems of the countries of the world, making conditions ripe for universalism.(6) That may take decades, however, or even centuries. The issue is what to do while we are waiting for the "new world" society -- essentially, a world government -- to arrive.(7) I believe it is to continue to apply principles of sovereignty -- territoriality. Westbrook believes it is for countries -- and even individual judges -- to begin implementing universalist principles on a piecemeal basis today.(8)

Responding to the universalist ideal, some bankruptcy judges already surrender assets to "home country" courts that will distribute them differently. Westbrook applauds these surrenders as steps along the road to universalism,(9) and he attempts to excuse the injustice to the individual creditors involved by noting that, if the courts of other nations did the same, there might be a "Rough Wash" in which all nations received about as much value as they gave.(10) Westbrook's analysis ignores that it is creditors, not nations, that have entitlements in bankruptcy estates. The creditor that goes unpaid because its country surrenders the assets to a foreign court for distribution according to the foreign country's laws is not consoled by the fact that some other creditor of the same nationality received a windfall from that foreign court in another case.

Part I of this Essay describes the current, territorial system for international bankruptcy and the potential for international cooperation within it. Part II explains the significance of the universalists' inability to answer the three questions posed above, and adds a fourth. Part III responds to the attacks that Professors Guzman and Westbrook make on territoriality, and Part IV considers Professor Rasmussen's thought-provoking contractualist approach to international insolvency. Part V concludes that territoriality continues to provide the soundest basis for international cooperation in present world circumstances and for the reasonably foreseeable future.

1. TERRITORIALITY

   Territoriality -- the idea that each country has the exclusive right to govern within its borders(11) -- is such a basic principle of international law that it often goes unnoticed. It is the default rule in every substantive area of law, including constitutional law, taxation, trademarks, industrial regulation, debt collection, and bankruptcy.(12) When applied to the bankruptcy of a multinational company, territoriality means that the bankruptcy courts of a country have jurisdiction over those portions of the company that are within its borders and not those portions that are outside them. Some nations claim "extraterritorial effect" for their bankruptcy systems, but they recognize that -- absent treaties or conventions to the contrary -- they can enforce their laws only against assets or persons within their own borders.(13) With respect to bankruptcy, such treaties and conventions are virtually non-existent. Territoriality is currently the international law of bankruptcy.(14)

   Most multinational companies have responded to territoriality by placing their holdings in each country in a separate corporation, formed under local law. Some of these local subsidiaries are freestanding, self-sufficient businesses that the local country can reorganize or liquidate in accordance with local law. But other local subsidiaries may own only the local assets of an integrated, international business. And, in yet other cases, a foreign entity may own local assets directly. In these latter two circumstances, international cooperation may be needed to reorganize the business or liquidate its assets for the best price.

   In a territorial system, the necessary international cooperation takes place in each case. That is, "parallel" bankruptcy proceedings are initiated in each country in which the corporate group has substantial assets. Each court appoints a "representative" for the estate of each entity filing in its jurisdiction. Those representatives then negotiate a solution to the debtor's financial problems. If the estates are worth more in combination than they are separately, it will be in the interests of the representatives to combine them.

   Problems may arise because the bankruptcy laws of particular countries do not authorize cooperation, even when cooperation would increase the value of the local estate. But a country that will not authorize cooperation on a limited territorial basis will certainly not do so on the much more extensive basis of universalism. As a consequence, these deficiencies in authorization in no way bolster the case for universalism.(15)

   As the international bankruptcy system currently operates, the application of territorial principles to multinational cases presents no serious problems. When the debtor's financial problems are confined to the entities located in a single country, the distressed entity or entities reorganize or liquidate in that country, and the foreign entities are unaffected. When a multinational company's financial problems extend across borders, each financially distressed entity files for bankruptcy in each country where it has significant assets. The effect is to create at least one bankruptcy estate in each country. The representatives of those estates negotiate and obtain court approval of an agreement ("protocol") that provides the terms for cooperation in the particular case.(16) In theory, the representatives of a multinational company's estates might fail to agree on a protocol. But territoriality's detractors, as yet, offer no examples of cases in which that has occurred.

   The representatives negotiate in light of what would happen if they do not reach an agreement. Absent an agreement, the assets in each country would be reorganized or liquidated and the proceeds distributed in accord with the laws of that country. For example, assume that a financially distressed entity has assets in the United States and Canada. The entity would file in both countries, an estate would be created in each, and the courts of each country would appoint a representative of the estate in that country. Unless the representatives agreed otherwise, the U.S. assets would be distributed in accord with U.S. law and the Canadian assets would be distributed in accord with Canadian law. In this context, "U.S. law" would include U.S. conflicts rules, but bankruptcy conflict rules generally direct that the court look to local law in the distribution of a bankruptcy estate.(17) The result is that the priority rules of the country where an asset is located typically determine the key issue in any bankruptcy case -- who shares in the asset and in what proportion.

   The system of territoriality described here is not one that I propose. It is the system currently operating in the world. Thus, it is the system that should be compared to the form of modified universalism that Westbrook would implement without waiting for the adoption of an international convention.(18)

2. UNIVERSALISM

   "Universalism" is the term ordinarily used to refer to a world bankruptcy system in which a single court -- that of the debtor's "home country" -- would have jurisdiction over a debtor's assets, wherever located, and distribute them in accordance with the law of that country. The term "pure universalism" is used to refer to a universalist system in which law enforcement officers in all countries are...