Beyond UNCITRAL: alternatives to universality in transnational insolvency.

• Author: Kipnis, Alexander M.

The rapid growth of international economic activity in the recent decades has brought forth a unique and formidable policy challenge. The challenge consists of reconciling two goals which sometimes compete directly with one another: creating a regime that allows economic interaction between private actors to occur with the highest possible degree of efficiency, and allowing sovereigns to ensure that the regime does not thwart their public policy to induce those sovereigns' cooperation.

The tension between these competing goals is patently evident in transnational bankruptcies. On one hand, considerations of efficiency call for three things: ex ante predictability, elimination of wasteful duplication of work by the courts, and incentives for optimal ex ante allocation of resources. On the other hand, any proposed regime must be sufficiently attractive to sovereign actors for adoption, and actually become widely adopted, if it is to become a genuine international regime. To that end, it must allow sovereign actors to satisfy the needs of their own domestic public policy if they are to cooperate.

This paper discusses the need for a comprehensive system for the resolution of transnational bankruptcies. It then examines the various bankruptcy systems that are discussed in the scholarship or implemented in practice in the present day, including the various flavors of territoriality, universality, and contractualism, along with a solution predicated on the establishment of an international body for administering transnational insolvency proceedings. It further addresses the UNCITRAL Model Law on Transnational Bankruptcy and its implementation, in particular, in the United States. It discusses the advantages and disadvantages of each regime and offers thoughts on how each may be improved or tailored to suit various economic needs. The paper concludes by advocating a modified form of cooperative territoriality as an imperfect but most workable framework for an international bankruptcy regime.

1. OVERVIEW OF CROSS-BORDER BANKRUPTCY: THE NEED, THE EXPECTATIONS, AND THE REALITY OF TRANSNATIONAL REGIMES

   1. Why a Transnational Bankruptcy System?

      Transnational bankruptcy regimes have been the subject of a lively debate in recent literature. (2) But the need for such a regime is not necessarily obvious; after all, every country that has economic activity of any global significance already has its own domestic bankruptcy laws. (3) These laws already purport to govern situations where the bankruptcy has an international dimension; that is, when the debtor's assets or creditors are located outside the borders of the country in which the bankruptcy occurs. (4) Why then is a global regime needed?

      A global framework for bankruptcy law is necessary for largely the same reasons that domestic bankruptcy law is needed. In a world without bankruptcy law, considerable and unnecessary social costs would be imposed every time a troubled company is unable to pay its debts in full. In such a world, each creditor would have an incentive to be the first to file suit against the debtor, the first to reduce its claim to judgment, and the first to execute that judgment by seizing the debtor's assets. This race to the debtor's assets imposes two forms of social cost. First, the dismemberment of the debtor's estate may prevent the debtor's assets from being put to their highest value use. It is not uncommon that the debtor itself will already he the highest value user of the asset because the going-concern value of the debtor's business will frequently exceed the value of all the debtor's assets if sold piecemeal. Second, the "first-in-time" rule with respect to the creditors' ability to receive and execute a judgment is an inefficient way to ensure the optimal distribution of the debtor's assets. (5) Bankruptcy law solves both problems by (1) eliminating the forced liquidation of the debtor's assets (by giving the debtor the opportunity to reorganize, at least under certain circumstances); and, (2) when liquidation is indeed warranted, by imposing a system of priority on the competing claims that is deemed more socially optimal than a simple "first-in-time" rule.

      Bankruptcy on a transnational level works in a similar way. Without a comprehensive international regime, a similar problem would occur. When a debtor encounters trouble, its creditors (6) would first look to the debtor's assets in their own country to satisfy their claims. (7) This course of action is rational because the creditors' cost of seizing the debtor's domestic (8) assets will be significantly lower than their cost of pursuing assets abroad. (9) If domestic bankruptcy law operated without regard to an international regime, these creditors would then be able to force the debtor into bankruptcy in their own country (either by means of an involuntary petition or by a coercive placement into voluntary bankruptcy, such as by exercise of default and acceleration clauses) and then use the debtor's assets in that country to satisfy their claim. This is particularly true if the creditors believe that it is not worthwhile for them to participate in bankruptcy proceedings involving that debtor in foreign countries at all. Just as in the case of a domestic bankruptcy, creditors in various countries would then have an incentive to race to the assets in their home countries. This time, the incentive to rush to the assets is strengthened by the fact that the debtor's going-concern value (and its likelihood of repaying domestic debts) becomes increasingly threatened by foreign creditors' efforts to seize the debtor's assets elsewhere. This imposes the familiar social costs of unnecessary dismemberment of a going concern, which may already be putting its assets to their highest value use, and of poor ordering of distribution priorities among the competing creditors, this time on a worldwide scale.

      An international bankruptcy regime would minimize those costs. It would provide a means for preserving the debtor's going concern value by instituting a mechanism that would authorize reorganization where it would maximize social benefit. It would also remove the incentives for creditors to rush to the debtor's assets in their own country by instituting a proceeding (or a set of concurrent proceedings) to authorize an orderly way for the debtor to reorganize or liquidate. It would finally provide for a distribution priority that maximizes social value, yet is mindful of disparate and, at times, mutually exclusive national policies that value certain kinds of creditors and claims over others.

   2. Brief Overview of Bankruptcy Systems in Scholarship and Practice

      Significant differences exist today between the substantive bankruptcy laws of various countries. Professor LoPucki (10) cites a wide array of differences in priority systems alone: for example, some countries allow tort creditors to share pro rata with contract creditors; others subordinate tort claims to contract claims; and still others do not allow any tort claims which have not yet been reduced to judgment. (11) Additionally, some countries treat creditors with setoff rights as secured (and therefore entitled to higher priority, at least in a reified sense), and others do not. (12) Also, some countries allow employees to assert high-priority claims for wages, others do not. (13)

      Beyond the differences in substantive bankruptcy laws, there are, more importantly, differences in the way that each country's bankruptcy regime approaches situations when some of the debtor's assets or debtors are located beyond its borders, and when a debtor that has assets within the country's borders seeks protection elsewhere. The differences between these regimes lie in two principal areas: the degree of cooperation that the country is willing to extend to another country when the debtor with assets in the first country has filed for bankruptcy in the second; and, the degree of access that the country allows to foreign creditors when a multinational debtor files domestically. (14) Five broad types of regimes of international bankruptcy are generally discussed in the literature today: territoriality, universality, contractualism, international organization, and secondary bankruptcy. Each is discussed in turn.

      Under territoriality, each country in which the debtor's assets are located has jurisdiction over the distribution of only the portion of the estate that consists of the assets located in that country. (15) Accordingly, in a typical multinational bankruptcy, a multitude of concurrent proceedings in the various countries in which the debtor has assets is necessary for the resolution of the case. (16)

      The second regime is universality. Under universality, only one country would have jurisdiction over the entire bankruptcy. (17) The courts of that country would apply that country's substantive bankruptcy law, such as rules governing automatic stay, avoiding powers, and distribution preferences. (18) All other countries in which the debtor has assets would then cooperate with the forum country, for example, by surrendering the control over the debtor's assets to the forum country. (19) In such a bankruptcy, there would only be one main proceeding, complemented as necessary by ancillary proceedings in countries in which the debtor owns assets. (20)

      The third regime is that of corporate-charter contractualism, which is actually a form of universality. In that regime, each firm is free to choose the bankruptcy forum country and laws to which it wishes to be subject. (21) The choice would be made when the entity is incorporated. (22) The selection would be specified in the corporation's charter, which would in turn provide public notice of the corporation's choice. (23) Prospective creditors would thus receive information about the firm's bankruptcy options ex ante. Once made, the corporation's choice of bankruptcy regime cannot be revoked without...