On April 21, 2014, the US Bankruptcy Court for the Southern District of New York, in In re Cozumel Caribe, S.A. de C.V., held that US courts cannot withdraw recognition of a Chapter 15 proceeding as a sanction for misconduct, because they can do this only when the grounds for granting recognition no longer hold or when continued recognition would be "manifestly contrary to US public policy" (508 B.R. 330 (Bankr. S.D.N.Y. 2014)).

Cozumel Caribe and its affiliates are entities organized under Mexican law which own resort properties in Mexico. CT Investment Management Co., LLC (CTIM) lent $103 million to Cozumel Caribe, secured in part by hotel revenues that were to be deposited into various lockbox accounts, including one in New York containing about $8 million, controlled by CTIM. Cozumel Caribe's principal and certain of its affiliates (Guarantors) guaranteed its obligations and consented to New York jurisdiction under a guarantee agreement governed by New York law.

In 2010, Cozumel Caribe, without its affiliates, filed a concurso mercantile (commercial bankruptcy) proceeding in Mexico. Cozumel Caribe and its affiliates stopped making payments to CTIM and ceased depositing hotel revenues into the lockbox. CTIM attempted, unsuccessfully, to sue the Guarantors and affiliates in both the Mexican and New York courts to recover on its debt. On May 27, 2010, the Mexican court entered an ex parte order barring any party from taking any action to collect any of the debt from the property of Cozumel Caribe and its affiliates, specifically including any funds in the CTIM lockbox account (May 27 Order). The US District Court for the Southern District of New York (District Court) granted comity to stay CTIM's actions to collect from the Guarantors.

Cozamel Caribe commenced a Chapter 15 case in the US Bankruptcy Court for the Southern District of New York (Court), which recognized its concurso proceeding as a foreign main proceeding on October 20, 2010. CTIM then filed an adversary proceeding in the Court seeking to recover the funds in the lockbox. The Court granted comity to stay this action.

A year later, CTIM requested that the Court terminate the recognition of Cozumel Caribe's foreign proceeding on the basis that section 1506 of the Bankruptcy Code, which allows a court to refuse to grant recognition of a foreign proceeding if doing so would be "manifestly contrary to US public policy," also allows a court to terminate recognition on that basis. CTIM alleged that continued recognition of the concurso proceeding would be manifestly contrary to US public policy because Cozumel Caribe:

Also, under section 1517(d) of the Bankruptcy Code, recognition of a foreign proceeding can be modified or terminated "if it is shown that the grounds for granting it were fully or partially lacking or have ceased to exist."

The Court denied CTIM's motion to terminate recognition of the concurso proceeding, explaining that CTIM has not shown that the grounds for the original grant of recognition have ceased to exist under section 1517(d), or that continued recognition would be manifestly contrary to US public policy under section 1506.

The Court rejected each of CTIM's arguments. First, while the Court was "concerned" about the foreign representative taking inconsistent positions on the amount of CTIM's claim, CTIM could not use the Court to "invalidate or circumvent proceedings in the Mexican courts" and instead should seek relief there. However, the Court suggested the possibility of sanctions against the foreign representative as an appropriate remedy. The Court held that:

Second, the Court held that the attempts to invalidate or evade the guarantee agreement "do not implicate" the recognition order and were not properly brought before the Court. The Court explained that the District Court's decision to extend comity to any decision or order in the concurso proceedings, including the May 27 Order as it related to the Guarantors, should not depend on the status of recognition in the Chapter 15 case.

Third, the Court held that the Spinoff issue was irrelevant, as it involved a non-debtor.

Next, the Court held that the "dilatory conduct" in the concurso proceeding, causing delays in the enforcement of CTIM's rights, did not justify terminating recognition.

Finally, the Court held that terminating recognition was not an appropriate remedy for the foreign representative's failure to inform the Court of significant developments in the various Mexican courts. Instead, the Court ordered imposed a stricter reporting requirement in the Chapter 15 case.

This case illustrates that bankruptcy courts apply a high standard to terminate recognition of a foreign main proceeding under Chapter 15. While misconduct by a foreign representative or other interested party is not sufficient cause to terminate recognition, a court must balance the parties' competing interests and design other remedies. For example, in this case, the Court suggested sanctions against the foreign representative and imposed stricter reporting requirements.

While it is difficult to revoke recognition, US bankruptcy courts will not grant comity to specific orders of foreign courts unless these orders generally comply with US public policy. However, once a US bankruptcy court extends comity to a foreign court order, US creditors may need to wait until that order is final before challenging its validity in Chapter 15.

For more information on Chapter 15, see Practice Note, Chapter 15 Overview: US Bankruptcy Cases Ancillary to Foreign Proceedings.