Vol 4 (2007) - Issue 6

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Changing COMI Prior to Insolvency is Fair Game!

Investors and lenders have increasingly taken into account domestic and cross-border insolvency laws and their judicial implementation in their investment decision making process. Since trade and capital flows are multi-jurisdictional, in 1997, the UNCITRAL Model Law on Cross-Border Insolvency was created as a means to establish the underlying principals of international insolvency. The UNCITRAL Model Law attempted to resolve the issues surrounding recognition of foreign main or non-main proceedings, treatment of foreign creditors, territorial limitations of jurisdictions, and enforcement of foreign judgments. In the United States, key elements of the UNCITRAL Model Law were adopted through the addition of chapter 15 of the Bankruptcy Code included in the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005.

The UNCITRAL Model Law has arguably led investors to consider more foreign jurisdictions for investment purposes, as more countries begin to allow for the rehabilitation, rather than only the liquidation option of insolvent businesses. This has, in turn, led to more opportunities for capital flows around the world flowing to their greatest economic return. That said, when these investments underperform it has also made the task of resolving multi-jurisdictional insolvencies far more complicated.

In this article, we explore one element of cross-border insolvency judicial proceedings, namely, the establishment of a company’s centre of main interest (COMI). A strategically selected and properly established COMI can be beneficial to certain stakeholders given the specific circumstances of the distressed company, and create value for some stakeholders largely driven by the judicial process governing any potential insolvency proceeding.

Jurisdiction risk

In the past few years, investors, banks, legislators and other stakeholders have worked hard to implement preventative measures that attempt to ensure transparency in financial reporting enabling better investment decisions whilst maintaining confidence in the financial marketplace through, for example, the Basel II Capital Adequacy Accord (2004) mandating stricter minimum capital adequacy requirements on banks in the G10 countries. These lenders, based in an ever increasing variety of locations, are willing to take into consideration wider geographic investment risks than ever before and in doing so are pricing these risks into their investment decisions.

Lenders generally believe that when they are dealing with a company they are exposed to the particular insolvency jurisdiction in which it resides. As such they will price their credit risk against the legal environment that would apply to them if the deal underperformed and they needed to exercise their judicial rights to recover value. Assuming a company or corporate group’s ‘home’, or ‘centre of main interests’ is readily apparent and unambiguous, lenders are able to factor into their risk models the probability of a net result given the relevant bankruptcy laws that they would be dealing with. However, with more and more cross-border activity, determining a company’s COMI is not always easily done.

The insolvency regime that may be applicable to a particular debtor will often be a pivotal issue in a workout or restructuring transaction, even where a transaction is intended to be out-of-court. The applicable laws will determine:

– When, for example, the directors’ duties might change from being owed to shareholders to a general body of creditors.

– When a director is under a statutory duty to file for the insolvency of a distressed entity thus potentially diminishing the value of the assets significantly.

– The point at which insolvency practitioners can look back at the antecedent transactions in an attempt to unwind them under the applicable insolvency laws.

– The benchmark for any negotiations as stakeholders will measure any proposed recovery against the possible results from a formal insolvency proceeding.