What Happens to a Claims Trade If a U.S. Bankruptcy Court and a Foreign Court Disagree on the Validity of the Trade?

Hedge funds that purchase bankruptcy claims assume numerous risks, including uncertainty relating to the timing and amount of distributions to be received in bankruptcy proceedings.  In particular, claims purchasers run the risk that the purchased claim will be disallowed, reduced, or subordinated altogether.  See “Five Steps Hedge Fund Managers Should Take to Mitigate Avoidance and Disallowance Risks After Delaware Court Finds that Avoidance and Disallowance Risks Travel with Trade Claims,” Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).  A recent bankruptcy court opinion highlights another risk associated with bankruptcy claims trading – a risk relating to seller’s remorse where a seller “forum shops” among courts in different jurisdictions in an attempt to undo a trade.  In this case, the seller’s representative brought the matter to the U.S. Bankruptcy Court (U.S. Court) following an adverse decision in a “foreign main proceeding” in which a foreign court upheld a bankruptcy claim transaction entered into with a hedge fund purchaser.  In evaluating whether it would contravene the foreign court’s judgment, the U.S. Court considered: whether it was appropriate for the U.S. Court to conduct a plenary review under Section 363 of the U.S Bankruptcy Code (Code) to determine whether the transaction involved a transfer of property in the U.S., as mandated by Chapter 15 of the Code; and whether undoing the foreign court’s ruling would offend the principle of comity integral to Chapter 15 of the Code.  This article summarizes the factual background, legal analysis and decision in the case, including a discussion of the mechanics of Section 363; the requirement under Chapter 15 of a transfer of interest in property within the U.S.; and the doctrine of comity as applied in bankruptcy situations.

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