Towards a New Approach for the Choice of Insolvency Forum

By Anthony J. Casey (University of Chicago Law School), Aurelio Gurrea-Martinez (Singapore Management University) and Robert K. Rasmussen (USC Gould School of Law)

(*) Letter sent to the Secretariat of UNCITRAL Working Group V (Insolvency) on 14 September 2023

1. Introduction

The UNCITRAL Model Law on Cross-Border Insolvency (“MLCBI”) turned 26 years in 2023. During this period, it has been adopted in more than 60 jurisdictions around the world and it has significantly contributed to successful management of insolvency proceedings with a cross-border element. Therefore, the MLCBI is an achievement that the international insolvency community needs to celebrate.

The MLCBI is built on the idea of “modified universalism”. Therefore, it envisions the commencement of a main procedure in a single jurisdiction even if non-main proceedings can also be opened and the laws of other jurisdictions can still be relevant for certain aspects of the procedure. Once the procedures are opened, the MLCBI establishes a set of rules to facilitate cooperation and assistance for the successful management of the procedures.   

In our view, the adoption of modified universalism as a regulatory model to deal with cross-border insolvency is a sensible one. Indeed, against those favoring the adoption of a more fragmented (or “territorialist”) approach, we believe that the existence of a centralized procedure is a superior option.[1] We also believe that the type of cooperation and assistance facilitated by the MLCBI significantly improves the efficiency and effectiveness of insolvency proceedings in cases where the debtor has assets, creditors and operations in various jurisdictions. Therefore, any future reforms and developments in the area of cross-border insolvency promoted by UNCITRAL should keep moving in that direction.

2. Harmful economic effects generated by the concept of COMI

Despite our positive views about the content and impact of the MLCBI, we believe that the MLCBI errs in the policy option chosen to determine the initiation of the foreign main proceeding. Under the MLCBI, a procedure qualifies as a foreign main procedure if it takes place in the jurisdiction where the debtor has its centre of main interests (“COMI”), which is generally the place of the debtor’s registered office unless it is shown that the central administration of the debtor is in a different location which is ascertainable by creditors.[2] In our view, this policy option presents various flaws that can undermine the ability of insolvency law to facilitate the maximization of the returns to creditors, the effective reorganization of viable but financially distressed businesses, and the promotion of entrepreneurship, access to finance and economic growth.[3]

First, the MLCBI encourages debtors to initiate insolvency proceedings in the place where they have their COMI. Otherwise, even if a jurisdiction eventually allows foreign debtors to initiate insolvency proceedings, as it is indeed permitted in various countries,[4] the debtor faces the risk that the procedure or some aspects triggered by the procedure - such as a moratorium or a discharge or modification of the terms of a debt - might not be recognized overseas.[5] As a result, this aspect may encourage debtors to initiate insolvency proceedings in the place of their COMI, even if their local jurisdictions have an inefficient insolvency system or other jurisdictions simply provide a more attractive legal, market or institutional environment to deal with financial distress. Therefore, the initiation of an insolvency proceeding in a less efficient insolvency forum not only may hamper the maximization of the returns to creditors and the effective reorganization of viable but financially distressed businesses but it can also lead to an ex ante increase in the cost of credit that will reduce firms’ access to finance and the promotion of economic growth. Furthermore, given that countries with inefficient insolvency frameworks often include emerging economies, the preservation of the concept of COMI will be particularly harmful in countries where the adoption of active policies to reduce poverty and foster growth are more urgently needed.[6]

Second, the concept of COMI is far from clear, especially in a world that has become increasingly global, internationally connected and technology driven. Indeed, many companies nowadays have assets, creditors, subsidiaries, offices, employees and clients in many jurisdictions. In this context, determining the debtor’s COMI is not an easy task. Additionally, due to the nature of certain businesses, such as cryptoexchanges and decentralized finance applications, the concept of COMI becomes even less clear.[7] In such a world, a market participant can never be entirely sure about the place of debtor’s COMI. As a response, lenders will rationally price their loans assuming the worse scenario – that is, the place with the most inefficient insolvency forum where the debtor could potentially initiate an insolvency proceeding– leading to an undesirable increase in the cost of credit. Additionally, many market participants might also be discouraged from doing business with a company if they do not know where a potential insolvency proceeding will be initiated. Thus, the current concept of COMI may discourage transactions that could potentially create jobs, wealth and growth. As a result, the uncertainty created by the concept of COMI can also be detrimental for society from an ex ante perspective, that is, before a situation of insolvency arises. Put differently, the current concept of COMI hampers economic growth even if a company never becomes insolvent.

Third, due to the controversies surrounding the concept of COMI, different stakeholders may have different views about the place of the debtor’ COMI. Under the current system, these controversies will need to be handled in court, and very often with the involvement of different courts. As a result, the current concept of COMI will inevitably result in litigation costs that will destroy value at the expense of debtors, creditors and society as a whole.

Finally, the concept of COMI can lead to opportunistic behaviour by debtors. Indeed, given that the concept of COMI can be moved without obtaining prior consent from the creditors, debtors can opportunistically change their COMI once they have obtained credit. Therefore, this risk of opportunistic behavior can be priced by lenders in the form of higher interest rates, requiring more collateral, or not extending credit at all. Thus, the concept of COMI ultimately reduces firms’ access to finance and the promotion of economic growth. 

3. Alternative approaches to determine the insolvency forum 

As a result of the factors mentioned in Section 2, we respectfully urge UNCITRAL to reconsider the concept of COMI. In our view, the concept of COMI should be abolished and replaced by the approach suggested in Section 3.1. Alternatively, UNCITRAL should consider the adoption of the second-best solution suggested in Section 3.2.

3.1. Preferred approach: the ex ante choice of the insolvency forum in the company’s constitution[8]

As one of us suggested in the 1990s, an alternative approach to determine the place where an insolvency proceeding will be initiated (should the need arise) may consist of allowing debtors to choose the insolvency forum in the company’s constitution.[9] This approach presents several advantages. First, it provides more predictability about the place where an insolvency proceeding will take place. Indeed, as the debtor’s insolvency forum would be mentioned in the company’s constitution, every market participant would have the ability to know where a future insolvency proceeding will be initiated. Second, this solution would also reduce litigation costs once a debtor initiates an insolvency proceeding. Finally, the choice of insolvency forum in the company’s constitution would allow debtors and creditors to have access to more attractive insolvency frameworks. Therefore, this approach would encourage lenders to extend credit at a lower cost, facilitating firms’ access to finance and the promotion of economic growth. By allowing debtors to choose more efficient insolvency systems, this solution would also contribute to the maximization of the returns to creditors and the effective reorganization of viable but financially distressed businesses.

It can be argued that this solution can lead to opportunistic behaviour by debtors. For example, a potential concern is that debtors may want to opportunistically choose a forum that can be attractive to them but detrimental to the creditors. It can also be argued that this system may allow debtors to opportunistically change the insolvency forum once they have obtained credit. Thus, by choosing a more debtor-friendly and less creditor-friendly regime, they can benefit themselves at the expense of the creditors. Finally, another potential criticism of the proposed approach is that it may hamper the change of insolvency forum even if debtors and creditors realize that a jurisdiction not initially chosen by the debtor can serve as a more attractive insolvency forum. However, these arguments are not persuasive if, as we urge UNCITRAL, our proposed approach is adopted with the safeguards and conditions suggested below.

First, it is important to start our analysis by highlighting that debtors should not have incentives to choose an insolvency forum that is not attractive for sophisticated lenders. Otherwise, they will be exposed to an increase in the cost of debt or, in certain scenarios, they may even restrict themselves from having access to credit. Therefore, the real risk of opportunistic behavior when initially choosing the insolvency forum only exists in the context of vulnerable creditors such as tort claimants and employees, that do not have the ability, information or bargaining power to adjust the conditions of their claims.

Second, the risk of having debtors choosing an insolvency forum that can be detrimental for vulnerable creditors, however, is a concern that can be addressed through several mechanisms. For example, if countries seriously want to protect these creditors, a defined group of vulnerable creditors such as tort claimants and employees can be given a preferential treatment in the ranking of claims,[10] and the lack of respect of this priority may serve as a cause for denying recognition, even on the basis of “public policy”, of any insolvency proceeding initiated by the debtor in a foreign jurisdiction.[11] Alternatively, countries can just impose that those vulnerable creditors should not be worse off, in terms of expected returns, compared to what they would receive if the procedure would have been initiated in the debtor’s local jurisdiction.[12]  

Third, as mentioned above, another risk associated with our proposal –if adopted without any safeguards– is that, given that the company’s constitution can be changed by the shareholders and not by the creditors, the debtor may opportunistically change the insolvency forum once it has obtained credit. To address this problem, UNCITRAL may adopt different solutions. For instance, it can require debtors to provide notice to all the pre-existing creditors, except for those vulnerable creditors identified by the insolvency legislation.[13] Then, if no creditor objects within a reasonable period of time  (e.g., 3-4 weeks), the change of the insolvency forum approved by the company would be deemed to be blessed by the creditors.[14] By adopting this approach, none of the company’s pre-existing creditors would be required to accept an insolvency forum that was not accepted at the moment of extending credit. Therefore, this approach can be considered the most protective one.[15]

A more flexible approach may consist of requiring approval of a majority or super-majority of the creditors.[16] While this approach may avoid some holdout problems eventually existing in the previous approach, it can create certain costs. On the one hand, obtaining consent from the majority or super-majority of creditors can be costly, especially in the context of companies with dispersed debt structures. On the other hand, since certain creditors might be required to accept an insolvency forum that was not foreseen at the moment of extending credit, it can encourage lenders to assume the worst scenario when drafting their debt contracts. Therefore, this approach can lead to an increase in the cost of credit.

A third approach eventually adopted by UNCITRAL may consist of subjecting the change of the insolvency forum to any conditions eventually imposed in the company’s constitution.[17] Sophisticated lenders will price their loans taking into account the approach adopted by the debtor. Therefore, debtors seeking to obtain credit at a lower cost will have incentives to choose a system that can be attractive to creditors. And vulnerable creditors will be fully protected given that they would always get priority.  

3.2. The second-best approach: ex post choice of insolvency forum

If UNCITRAL decides to keep the concept of COMI, debtors should be allowed to initiate an insolvency proceeding in any jurisdiction that permits the initiation of insolvency proceedings by foreign companies.[18] Additionally, and more importantly, the MLCBI should establish that the place where the insolvency proceeding is initiated will be considered functionally equivalent to the debtor’s COMI for the purpose of the MLCBI. Put differently, initiating an insolvency proceeding in the place of debtor’s COMI or in any other forum chosen by the debtor would trigger similar effects under the MLCBI. To grant these functionally equivalent effects, however, the debtor needs to show that the place of filing is beneficial for the creditors as a whole. In the absence of clear evidence showing the beneficial effects of choosing a different insolvency forum, the debtor would still be allowed to initiate an insolvency proceeding if it is permitted by the laws of that jurisdiction (as it happens nowadays) but it would be subject to the legal risks currently associated with initiating an insolvency proceeding in a place that it is not the debtor’s COMI.

This second-best solution improves the current regulatory framework for cross-border insolvency in several ways. First, it allows debtors and creditors to benefit from the choice of a more efficient insolvency forum.[19] And while this practice is already observed in the market,[20] the adoption of the proposed solution in the MLCBI would provide more certainty. Second, if the debtor shows that the place of filing can be beneficial for the creditors as a whole, this solution may avoid many of the legal risks associated with choosing an insolvency forum that is not the debtor’s COMI.

Yet, it should be noted that this solution is inferior to the preferred approach suggested in Section 3.1. On the one hand, this solution can lead to litigation costs if, for example, there are some disagreements about the ability of the place of filing to benefit the creditors as a whole. On the other hand, even if the new place chosen by the debtor has functionally equivalent effects to the debtor's COMI provided that it can be beneficial for the creditors, nothing would prevent the debtor from initiating the procedure in the place of the debtor's COMI even if this solution is not the most desirable one for the creditors. Thus, from an ex ante perspective, this scenario will be priced by sophisticated lenders, leading to an undesirable increase in the cost of credit. Hence, while this second-best solution can still improve the current regulatory framework for cross-border insolvency, it would provide a less desirable solution than the preferred approach suggested in Section 3.1.

4. Conclusion

The MLCBI has played a major role in the improvement and efficient management of cross-border insolvency cases. In our view, the principle of modified universalism and the cooperation and assistance promoted by the MLCBI have contributed to the success of this instrument enacted by UNCITRAL. Therefore, any future reforms and developments in the space of cross-border insolvency should keep embracing these principles. Nonetheless, we believe that the MLCBI presents a major flaw: the adoption of the concept of COMI as the policy option to determine the place where a main foreign proceeding should take place. We believe that embracing the concept of COMI can undermine the ability of insolvency law to promote the maximization of the returns to creditors, the effective reorganization of viable but financially distressed businesses and the promotion of entrepreneurship, access to finance and economic growth. Therefore, we respectfully urge UNCITRAL to reconsider the concept of COMI and adopt one of the approaches suggested in this article. To support our views, Annex 1 includes a list of prominent scholars and leading practitioners that endorse our proposal.

We will be honored and delighted to discuss the details and possible implementation of this proposal and provide any assistance eventually needed by the Secretariat of UNCITRAL Working Group V.    

Anthony J. Casey               Aurelio Gurrea-Martínez               Robert K. Rasmussen

ANNEX 1: Signatories

Scott A. Atkins

President, INSOL International

Global Chair & Global Head of Restructuring, Norton Rose Fulbright

Kenneth Ayotte

Robert L. Bridges Professor of Law

UC Berkeley School of Law

Sumant Batra

President, Insolvency Law Academy

Past President, INSOL International 

Vincent Buccola

Associate Professor of Legal Studies & Business Ethics

The Wharton School of the University of Pennsylvania

Juanitta Calitz

Associate Professor of Law and Vice Dean for Research & Internationalization

Faculty of Law

University of Johannesburg

Anthony J. Casey

Donald M. Ephraim Professor of Law and Economics and Faculty Director of the Center on Law and Finance

University of Chicago Law School

Jared Ellias

Scott C. Collins Professor of Law

Harvard Law School

Brook E. Gotberg

Francis R. Kirkham Professor of Law

BYU Law School

Aurelio Gurrea-Martínez

Associate Professor of Law and Head of the Singapore Global Restructuring Initiative

Singapore Management University Yong Pung How School of Law

Thomas H. Jackson

President Emeritus and Distinguished University Professor Emeritus

University of Rochester

Joshua C. Macey

Assistant Professor of Law

University of Chicago Law School

Soogeun Oh

Professor Emeritus

Ehwa Womans University

Samir Parikh

Robert E. Jones Professor of Advocacy and Ethics

Lewis & Clark Law School

Robert K. Rasmussen

Professor of Law and J. Thomas McCarthy Trustee Chair in Law and Political Science

USC Gould School of Law

Wolf-Georg Ringe

Professor of Law and Finance and Director of the Institute of Law & Economics

University of Hamburg

David Skeel

S. Samuel Arsht Professor

University of Pennsylvania Carey Law

Richard Squire

Professor of Law & Alpin J. Cameron Chair in Law

Director, Fordham Corporate Law Center

Fordham Law School

Alan Schwartz

Sterling Professor of Law

Yale University

Felix Steffek

Professor of Law and J M Keynes Fellow in Financial Economics

Director of the Centre for Corporate and Commercial Law

University of Cambridge

Wataru Tanaka

Professor of Commercial Law

Institute of Social Science

University of Tokyo

Winifred Tarinyeba Kiryabwire

Associate Professor of Law

School of Law

Makerere University, Uganda

Randall Thomas

John S. Beasley II Chair in Law and Business

Vanderbilt Law School

Sophie Vermeille

Founder

Rules for Growth Institute (Droit & Croissance)

Yesha Yadav

Professor of Law and Milton R. Underwood Chair

Vanderbilt Law School