A Foreign Entity May be Subject to U.S. Bankruptcy Court Jurisdiction Simply by Utilizing a U.S. Bank Account in a Transaction with Another Foreign Entity
A foreign (non-U.S.) company can be dragged unwillingly into a U.S. bankruptcy case if the bankruptcy court has “personal jurisdiction” over the company. The chapter 11 case of In re Arcapita Bank B.S.C.(C) provides a reminder that the bar is fairly low to find that such jurisdiction exists.1 Although the bankruptcy court and district court initially expressed different views as to where the line is – with back and forth opinions spanning years – the District Court for the Southern District of New York (the “District Court”) recently held that a foreign entity does not need to do business in the United States to find itself within the jurisdiction of a U.S. bankruptcy court. Rather, a simple transaction involving U.S. currency flowing through a U.S.-based correspondent bank – with funds originating from and ending up outside the United States – is enough to allow the bankruptcy court to exercise jurisdiction over a foreign entity.
Specifically, the District Court held that a Bahraini Islamic wholesale bank, Bahrain Islamic Bank (“BisB”), which attempted to offset a prepetition debt with chapter 11 debtor, Arcapita Bank B.S.C.(C). (“Arcapita”), also a Bahraini entity, was subject to the bankruptcy court’s jurisdiction simply because BisB utilized New York correspondent bank accounts to effectuate the Shari’ah-compliant Murabaha investment transaction at issue. Furthermore, the District Court held that international comity did not require the bankruptcy court to abstain because, among other things, the Central Bank of Bahrain (“CBB”) – a Bahraini government agency – issued a regulatory direction letter (“Formal Direction Letter”) demanding BisB to return the funds to Arcapita or to appeal to the U.S. bankruptcy court to seek relief from the automatic stay in order to effectuate a setoff transaction.
Headquartered in Bahrain, Arcapita was licensed as an Islamic wholesale bank by the CBB and a global manager of Shari‘ah-compliant alternative investments. It filed for chapter 11 in the Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) on March 19, 2012. Defendant BisB is an Islamic commercial bank also headquartered in Bahrain. BisB maintains and uses correspondent bank accounts in New York.
A few days prior to its bankruptcy filing, Arcapita made several discrete short-term Shari’ah-compliant debt investments through BisB (the “Placement”) pursuant to an investment agreement between the two banks (the “Placement Agreement”).2 The Placement Agreement was negotiated and signed in Bahrain and provided that the laws of the Kingdom of Bahrain govern, except to the extent that such laws conflicted with the principles of Islamic Shari’ah, in which case Shari’ah law would prevail. BisB directed Arcapita to transfer the Placement funds to BisB’s New York correspondent bank account, and BisB wired the money out of the account (and out of the United States) the same day. Although the Placement matured shortly after Arcapita’s bankruptcy filing, BisB failed to deliver the Placement’s proceeds to Arcapita as required under the Placement Agreement. Instead, BisB only returned the amount of proceeds that exceeded Arcapita’s outstanding balance owing to it, which was approximately $10 million, and argued that it was entitled to set off the rest of the debts under Bahraini law against amounts Arcapita owed to it.
In 2013, the Bankruptcy Court confirmed Arcapita’s plan of reorganization and granted standing to the official committee of unsecured creditors (the “Committee”) to pursue claims against BisB. The Committee subsequently brought claims against BisB for violation of the automatic stay, turnover, breach of contract, avoidance of a preferential transfer, and claims disallowance. BisB moved to dismiss on the basis of lack of personal jurisdiction and international comity.
Personal Jurisdiction Generally
Determining whether a bankruptcy court may exercise personal jurisdiction over a foreign defendant is a two-prong inquiry. First, the court must examine whether the defendant has “the requisite minimum contacts with the United States at large” to satisfy the Due Process Clause. In so doing, courts differentiate between “specific” and “general” personal jurisdiction, either of which is adequate. Specific jurisdiction is established when a foreign defendant “purposefully directs his activities at residents of the forum” and the underlying cause of action “arises out of or relates to” those activities. In contrast, general jurisdiction “is based on the defendant’s general business contacts with the forum” and permits a court to exercise its power in a case where the subject matter of the suit is unrelated to those contacts. If minimum contacts are present, the court must then turn to the second inquiry of whether the exercise of jurisdiction is reasonable and whether it would offend “traditional notions of fair play and substantial justice.” In determining whether the assertion of jurisdiction is reasonable in a given case, bankruptcy courts will consider the following factors: (1) the burden that the exercise of jurisdiction will impose on the defendant; (2) the interests of the forum state in adjudicating the case; (3) the plaintiff’s interest in obtaining convenient and effective relief; (4) the interstate judicial system’s interest in obtaining the most efficient resolution of the controversy; and (5) the shared interest of the states in furthering substantive social policies.
2015 Bankruptcy Court Decision Held No Personal Jurisdiction Existed
In 2015, the Bankruptcy Court held that it did not have specific jurisdiction over BisB. The Bankruptcy Court rejected the Committee’s argument that BisB purposely availed itself of the benefits of the U.S. banking system simply by using New York correspondent bank accounts. The Bankruptcy Court recognized that although BisB’s funds were transferred to BisB’s own correspondent bank account in New York, the use of the New York account was a transitory intermediate step – with the funds being transferred out of the United States the same day for investment – while the overall transaction took place in Bahrain between Bahraini parties under an agreement governed by Bahraini law. Ultimately, the Bankruptcy Court held that while the use of the account is admittedly a contact, it was too weak to satisfy due process requirements and BisB would not have reasonably foreseen being hauled into court in the United States. Rather, the Bankruptcy Court found that BisB would reasonably assume that any suit relating to the Placement Agreement would be in Bahrain under Bahraini law.
The Bankruptcy Court also highlighted that the use of the New York correspondent account was not central to the alleged wrong – the subsequent refusal to return money to Arcapita. Thus, the Bankruptcy Court held that “the one-off use of the correspondent account by BisB [was] unrelated to the setoff issue, let alone central to its adjudication.”
2016 District Court Decision Reversed Bankruptcy Court – Held Personal Jurisdiction Satisfied
On appeal by the Committee, the District Court held in 2016 that (i) the Bankruptcy Court erred in holding that it lacked personal jurisdiction over BisB; (ii) BisB’s selection of the New York correspondent account constituted sufficient “minimum contacts” on which to assert personal jurisdiction; and (iii) the assertion of personal jurisdiction was “reasonable.” Accordingly, the District Court vacated and remanded the case to the Bankruptcy Court.
As to the question of “minimum contacts,” the District Court found that the purposeful use of correspondent bank accounts in New York constitutes a “transaction of business” within New York. It noted that BisB, not Arcapita, set the terms of each Placement transaction and then presented those terms in an offer to Arcapita. The District Court found that BisB’s designation and use of New York correspondent bank accounts to receive the Placement funds were sufficiently deliberate and were undoubtedly “contacts” with the United States. Furthermore, the District Court found that the preferential transfer actions brought by the Committee arose from or were related to the use of the New York correspondent bank accounts.
The District Court stated that asserting jurisdiction over BisB did not somehow render “mere maintenance” of a correspondent account in the United States sufficient to support personal jurisdiction over the accountholder in connection with any controversy. Of note, the District Court stated that, “[h]ad the record demonstrated that Arcapita, as opposed to [BisB], selected the U.S. dollar and the New York accounts to effectuate the Placements, [BisB’s] contacts with the United States would have been adventitious, and jurisdiction would not have lied.” The District Court noted that BisB’s in-forum activity reflected its “purposeful availment” of the privilege of carrying on its activities in the United States, and that BisB established minimum contacts sufficient to confer a court with jurisdiction over it, even if the effects of BisB’s conduct were felt entirely outside of the United States.
Next, the District Court held that the assertion of personal jurisdiction was reasonable. Specifically, the District Court found that (i) the burden imposed on forcing the foreign entity to litigate far from home was mitigated by the conveniences of modern communication and transportation; (ii) the United States has a strong interest in adjudicating claims that arise under the Bankruptcy Code so that both creditors and debtors can obtain remedies and relief that Congress has determined to be fair and equitable – and it would not seem prudent to allow foreign creditors to obtain priority over domestic creditors based simply on foreign status; and (iii) the Committee has a strong interest in obtaining convenient and effective relief, and it is unclear whether it would be able to bring similar causes of action in a non-U.S. forum.
Accordingly, the District Court held that BisB’s selection and use of correspondent bank accounts in New York provided a sufficient basis for a court to assert personal jurisdiction over them and remanded the case back to the Bankruptcy Court.
Post-Remand Bankruptcy Court Decision
Shortly thereafter, BisB moved to dismiss on grounds of international comity in the Bankruptcy Court. The Bankruptcy Court denied BisB’s motion and BisB’s subsequent request for reconsideration. The parties then cross-moved for summary judgment. The Bankruptcy Court granted the Committee’s motion and denied BisB’s motion, entered judgment in favor of the Committee, and awarded prejudgment interest at New York’s statutory rate of 9 percent.
2022 District Court Decision
BisB appealed five orders of the Bankruptcy Court, challenging (i) the Bankruptcy Court’s refusal to revisit the issue of personal jurisdiction after the discovery of new evidence; (ii) the Bankruptcy Court’s failure to dismiss on international comity grounds; (iii) the Bankruptcy Court’s ruling that BisB was not entitled to setoff, as a matter of Bahraini law or under the safe harbor provisions of the Bankruptcy Code and, therefore, (iv) its holding that BisB was in violation of the automatic stay; and (v) the Bankruptcy Court’s award of prejudgment interest and use of the New York statutory rate. On May 23, 2022, the District Court (via a different judge than the 2016 decision) found all five of BisB’s arguments without merit, affirmed the challenged orders of the Bankruptcy Court, and dismissed the appeal.
On remand, BisB unsuccessfully renewed its personal jurisdiction challenge at the Bankruptcy Court, arguing that new evidence unearthed in discovery showed it was actually Arcapita that chose to use U.S. dollars to effectuate the investments – upending one of the premises of the District Court’s ruling that BisB purposely availed itself of New York by choosing U.S. dollars.
The District Court held that the Bankruptcy Court did not err in rejecting BisB’s request for reconsideration, noting, among other things, its prior ruling that the Bankruptcy Court could exercise personal jurisdiction based on BisB’s use of New York correspondent accounts. Despite statements in its 2016 decision that had Arcapita – not BisB – chosen to transact in U.S. dollars, jurisdiction may not have existed, the District Court now held that this new evidence did not upend the premise of its previous ruling. Rather, “BisB chose to accept the terms [of Arcapita’s desire to invest in U.S. dollars] and then designated correspondent bank accounts in New York to receive the fund transfers.”
Most instructively, the District Court underscored its previous ruling’s explicit statement that BisB could have avoided the United States entirely by routing the Placements though different correspondent accounts anywhere in the world other than the United States.
Next, the District Court held that the Bankruptcy Court did not abuse its discretion in declining to abstain on grounds of international comity. It is generally accepted that under international comity, “states normally refrain from prescribing laws that govern activities connected with another state when the exercise of such jurisdiction is unreasonable.”3 The District Court noted that although international comity is an “often invoked doctrine,” it only comes into play when there is a “true conflict” between the two countries’ laws such that compliance with both would be “impossible.” If a “true conflict” exists, bankruptcy courts apply the following factors to consider whether abstention is appropriate: (i) the link of the activity to the territory of the regulating state; (ii) the connections between the regulating state and the person principally responsible for the activity; (iii) the character of the activity to be regulated and the importance of regulation to the regulating state; and (iv) the likelihood of conflict with the regulation by another state.
The District Court rejected BisB’s argument that the breach of contract claim under Bahraini law compelled a different conclusion as to which country has a stronger regulatory interest. The court noted that the conduct at the heart of the Committee’s action were the wire transfers routed through the New York correspondent banks – which the District Court found gave rise to all of the Committee’s claims. Furthermore, the District Court pointed to the CBB’s Formal Direction Letter – which the District Court found to be binding Bahraini law – instructing BisB to return the funds to Arcapita or to appeal to the Bankruptcy Court to seek relief from the automatic stay. The District Court noted that, “[i]f the Bahraini government had an interest in regulating the conduct itself, one might expect that it would only have instructed that BisB return the funds and not mentioned possible avenues of relief in the Bankruptcy Court.” In light of the Formal Direction Letter, the District Court found that there was no abuse of discretion because there “appears to be no true conflict of law…and…principles of international comity are simply not implicated.”
Lastly, the District Court held BisB did not have a right to offset the Shari’ah-compliant transaction as any setoff “was abrogated” by directions from a Bahraini regulator, and regardless, the setoff would be unenforceable under section 353(a)(3)(C) of the Bankruptcy Code because BisB incurred the debt for purposes of the setoff right. Furthermore, the District Court held that the Shar’iah-compliant Murabaha transaction under Islamic law did not qualify for safe harbor protections. The District Court also held that the Committee was entitled to statutory prejudgment interest at 9% New York rate, despite Shari’ah and Bahrain law. These holdings are beyond the scope of this article, but are also interesting.
The Arcapita decision is insightful as to how easily a foreign entity can find itself subject to the personal jurisdiction of a Bankruptcy Court, even without intending to do so. It shows that a foreign entity does not necessarily need to do business, have a presence, advertise, or regularly transact within the United States to be subject to the U.S bankruptcy court jurisdiction. One simple flow-through transaction through a U.S.-based correspondent account may be enough. The District Court gave blunt guidance: if you want to stay out of U.S. bankruptcy court, do not use U.S. bank accounts.
While this decision may serve as a stark warning that foreign entities do not need to do much in the United States to be hauled into U.S. bankruptcy court, it also highlights the attractiveness of chapter 11 as a forum for distressed foreign entities to address their debts. In addition to the numerous benefits afforded by chapter 11’s substantive provisions, the powerful reach of a U.S. bankruptcy court’s jurisdiction over other foreign counterparties is also valuable in enabling a worldwide restructuring. This is one of the many reasons chapter 11 has become a popular tool for numerous non-U.S. companies to restructure their debts.