by Amber M. Carson
Gray Reed & McGraw LLP

The protection afforded by the automatic stay is arguably the most powerful instrument in a debtor’s toolbox. As globalization of businesses and economies increase, more and more commercial enterprises are forced to examine the impact, if any, of a domestic bankruptcy case on their foreign creditors and assets. For instance, if foreign creditors are permitted to seize a debtor’s international assets notwithstanding the debtor’s U.S. bankruptcy proceeding, such seizure can result in significant adverse consequences, including, but not limited to: a loss of value to the debtor’s bankruptcy estate (and, in turn, its creditors as a whole), confusion and chaos when administering the debtor’s assets, and depending on what percentage of the debtor’s assets are located internationally, ultimately negate the debtor’s entire purpose for filing for bankruptcy protection.

Pursuant to section 362 of the Bankruptcy Code, the commencement of a bankruptcy case operates as a stay of various actions, including the commencement or continuation of judicial proceedings, the enforcement of judgments, collection activities, perfection of liens, and the setoff of debts against the debtor or its property. This is known as the “automatic stay” and is applicable to all persons. The purpose of the automatic stay is to allow a debtor a “breathing spell” from litigation and collection activities, thereby enabling the debtor time to repay its debts (to the best of its ability) or reorganize. It also provides a court the sole authority to control and marshal the debtor’s assets over which it has in rem jurisdiction. This ameliorates the chaos, delays, and added expense that ensue as a result of creditors pursuing remedies against the debtor in several different courts.

The automatic stay applies to a debtor’s property “wherever located.” 11 U.S.C. § 541(a). Based upon this language, many courts have held that the automatic stay applies extraterritorially by way of in personam jurisdiction, thereby applying with equal force to actions taken outside of the United States. Such an interpretation means that, for example, once a debtor files for bankruptcy in the United States, foreign involuntary bankruptcy proceedings against the debtor, foreign proceedings seeking a judgment against the debtor, and seizure of the debtor’s foreign assets are all violations of the automatic stay.

Policy reasons justify extending the reach of the automatic stay extraterritorially. When several insolvency proceedings by or against the same debtor are initiated in different countries, each applying different laws, there is no uniformity. Besides adding significant additional cost and delay to already complicated proceedings, creditors receive widely differing distributions of benefits depending upon where the debtor’s assets are located at the initiation of each proceeding. Furthermore, in such a case, reorganization is largely impossible, thereby depriving the community and company from the entity’s going concern value. These policy concerns drove the creation of the UNCITRAL Model Law on Cross-Border Insolvency (the “Model Law”), which has now been enacted in some form by over forty countries around the globe, including the United States, Great Britain, Canada, and Mexico. The Model Law sets out guidelines for recognition of foreign insolvency proceedings and allows debtors the ability to seek recognition of the automatic stay in foreign countries that have adopted the Model Law.

Courts have found additional justification for extraterritorial application of the automatic stay when foreign creditors actively participate in a debtor’s bankruptcy proceeding. Certain activities, such as seeking relief or filing a proof of claim in a United States bankruptcy court, can result in an inferred submission of the creditor to the court’s jurisdiction. In such a case, courts have justified the application of United States bankruptcy laws to a foreign transaction or occurrence.

Domestic courts applying the automatic stay extraterritorially can be incredibly defensive over its protections. Courts that have perceived violations of the automatic stay by foreign creditors have issued orders holding foreign creditors in contempt, imposing sanctions, and even threatening to issue bench warrants. Whether such punishments are effective against a foreign creditor, however, is an issue for another day.

In sum, both domestic debtors and foreign creditors need to be aware of the potential impact of the automatic stay on operations, proceedings, and property outside the borders of the United States. Until the Supreme Court of the United States makes a definitive ruling regarding the extraterritorial reach of the automatic stay, foreign creditors should exercise caution before taking any actions in their home countries that could violate this all-important and protected provision of the Bankruptcy Code.

Amber M. Carson is an associate at Gray Reed & McGraw LLP.  She may be reached at acarson@grayreed.com.

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