Citation(2008) 20 SAcLJ 343
Date01 December 2008
Published date01 December 2008

The proliferation of rules aimed at the management of cross-border insolvencies has not been coupled with sufficient attention to the choice of law rules relating to the avoidance of antecedent transactions as legal acts detrimental to all the creditors. This article is the first of its kind in considering the current state of play under English choice of law rules in insolvency transaction avoidance and proposes the path forward. The proposals seek to reorient the jurisprudence on extraterritorial application of domestic statutes, reflect the philosophical underpinnings of universalism and draw on the US conflicts experience.

I. Introduction

1 A key feature of insolvency law is its ability to unwind antecedent transactions, namely transactions entered into by the debtor in the twilight period prior to the commencement of insolvency proceedings. Where the transactions contain one or more foreign elements, a choice of law issue surfaces. For example, what law determines the voidability of an alleged fraudulent conveyance by the debtor of a foreign property? Choice of law issues can become acute in cross-border insolvencies which may involve multiple proceedings, subsidiaries, affiliated entities, assets, operations and creditors in dozens of nations. However, English choice of law rules in insolvency transaction avoidance are primitive.2 Judicial authorities are scarce and not exactly on point,3 while academic analysis is almost non-existent.4

2 This article reviews the contexts in which such choice of law issues are most likely to arise, suggests how existing cases on extraterritoriality should be rationalised, and proposes the proper choice of law approach going forward.

II. Overview of English insolvency avoidance rules and the conflicts perspectives of insolvency

3 The corpus of insolvency law concerns in essence how an asset deficit is to be managed in a way fair to all participants. An essential limb of that corpus is the distribution of assets among the claimants, while respecting as much as possible the claimants’ pre-insolvency entitlements. As the US Supreme Court has repeatedly held, “[c]reditors’ entitlements in bankruptcy arise in the first instance from the underlying substantive law creating the debtor’s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code”.5 Once the pre-insolvency entitlements are established, the claimants’ rights to payment from the insolvent estate are solely a matter of insolvency law, primarily a matter of legislative policy informed by such normative standards as equality, fairness, liberty and efficiency. As Mummery LJ pointed out in Re Polly Peck International (No 2),6 Parliament has sanctioned a scheme for distribution of assets designed to achieve a fair distribution of the insolvent company’s property among the unsecured creditors. The essential characteristic of the statutory scheme is that the insolvency officeholder is bound to deal with the assets of the company as directed by statute for the benefit of all creditors.

4 The statutory insolvency scheme is buttressed by provisions allowing reversal of antecedent transactions that are deemed to violate the policies underlying the statutory scheme. Chief among these avoidance provisions are s 238 of the Insolvency Act 19867 (“IA 1986”)

aimed at conserving the debtor’s estate and s 239 of IA 19868 aimed at preventing distortions of the distribution regime enshrined in insolvency law.9

5 Such avoidance rules are not unique in English insolvency law, but are ubiquitous in all bankruptcy systems. While the precise elements of each avoidance provision differ from jurisdiction to jurisdiction, the differences merely reflect the local insolvency and commercial policies. For example, local sensitivities to commercial uncertainty shape the defences to avoidance actions, such as the requirements of good faith, contemporaneous exchanges for new value, and payments made in the ordinary course of business.10

6 The conflicts perspectives of insolvency have traditionally tracked the above understanding of insolvency law. Savigny made the following timeless remarks:11

[B]ankruptcy appears to be in substance a mere process in execution as to a determinate mass of property, the function of the judge consisting in adjusting the claims of the individual creditors to this mass …

As the bankruptcy has in view an adjustment of the claims of a number of creditors, it is possible only at one place, namely, at the domicile of the debtor, so that the special forum of the obligation is here displaced by the general personal forum.

The functions of the judge in bankruptcy (Concurs) consists of two distinct portions — preparatory acts, and the division of the estate (competition, Concurs).

Among the preparatory acts are the determination of claims themselves (liquidation), then the formation and determination of the estate in bankruptcy (common fund, Concursmasse) by elimination of all portions not belonging to the estate of the debtor (Vindicanten, Separatisten), by collection of all portions really belonging to the estate, and by converting them into cash by sale.

7 Accordingly, even on the 19th-century conflicts understanding, each phase in the bankruptcy process (such as the ranking of creditors) could raise separate choice of law issues:

Bankruptcy concerns … not the rights themselves, but execution against a determinate estate existing at a particular time; for the purposes of this execution the priorities of the individual creditors have to be determined. What law is to be applied to these priorities? Here creditors who have hypothecs are to be distinguished from the other creditors.12

The matter will become clearer by being applied to the common law of bankruptcy founded on the rules of the latest Roman law, as it has been developed in the theory and practice of modern times.

The whole creditors are arranged in five classes: 1. absolutely privileged; 2. privileged hypothecs; 3. common hypothecs; 4. personally privileged; 5. all others … Among these five classes, the first, fourth, and fifth contain pure obligations, and are subject to the law in force at the place of the court of bankruptcy exclusively, without respect to the possibly different law of the place where the obligation has arises or the place of its fulfilment. There remain … the second and third classes, comprising the creditors holding hypothecs [who] are to be judged according to the law which existed at the time of the constitution of their real right …13

III. Cross-border insolvency and choice of law in transaction avoidance

8 English cross-border insolvency rules condition the context in which choice of law issues relating to transaction avoidance may arise. They are mainly as follows.

A. English insolvency proceedings within the EU Insolvency Regulation

9 The EU Insolvency Regulation establishes a common framework for co-operation in cross-border insolvency among the member states of the EU (other than Denmark), based on the principles of mutual recognition and co-operation. Its general aim is to make cross-border insolvency proceedings operate efficiently and effectively throughout the Community, thereby promoting the proper functioning of the internal market. Certain types of entity are specifically excluded from its operation (for example credit institutions, investment undertakings which provide services involving the holding of funds or

securities for third parties and collective investment undertakings (Art 1(2)).

10 Broadly, the EU Insolvency Regulation grants the courts of the member state within the territory of which the centre of main interests (“COMI”) of a debtor is located jurisdiction to open insolvency proceedings in respect of such debtor.14 These proceedings are, with regard to other member states, international in scope, are to be governed by the law of the member state where proceedings are opened and are to be effective in all member states, unless secondary proceedings are opened in another member state.

11 In short, if the debtor has its COMI in a member state other than Denmark,15 the EU Insolvency Regulation prescribes the jurisdiction in which insolvency proceedings may be opened and the applicable lex concursus.

12 Consider the following scenario. A debtor incorporated in Slovakia (with its COMI in England) has placed a deposit with the London branch of a French bank in order to secure the debtor’s guarantee in respect of a loan facility granted by the bank to the debtor’s parent in France. The guarantee is governed by French law and provides that if the debtor defaults under the guarantee, the bank could set off the deposit against the debtor’s guarantee obligations. Both the debtor and its parent become insolvent. The debtor goes to English liquidation and the liquidator argues that the bank is not entitled to set off the deposit because the upstream guarantee is a transaction at an undervalue pursuant to s 238 of IA 1986. An immediate choice of law question arises as to what law should determine the voidability of a French law-governed guarantee between a Slovak debtor and a French bank.

13 Article 4(2) of the EU Insolvency Regulation would appear to supply the answer in the following way. It provides that the law of the State of the opening of proceedings shall be the lex concursus,

determining, inter alia, the scope of the estate’s assets and the rules relating to the voidness, voidability or unenforceability of legal acts detrimental to all the creditors (Art 4(2)(m)).16

B. English insolvency proceedings outside the EU Insolvency Regulation

14 Consider the following scenario. A debtor incorporated in Jersey (with its COMI in Jersey)17 has placed a deposit with the London branch of a French bank in order to secure the debtor’s guarantee in respect of a loan facility granted by the bank to the debtor’s parent in France. The guarantee is governed...

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