A Commitment Rule for Insolvency Forum: A Response to Critics

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

I. Introduction 

On 14 September 2023, we sent a letter to the Secretariat of the United Nations Commission on International Trade Law (UNCITRAL) Working Group V (Insolvency) expressing our concern about the concept of Centre of Main Interest (“COMI”) adopted in the Model Law on Cross-Border Insolvency (“The Model Law”). We noted that the concept of COMI presents various weaknesses. Among others, (i) it creates uncertainty and litigation costs, especially in the context of multinational companies with offices, creditors, operations and employees in several jurisdictions; (ii) it can lead to opportunistic behaviour given that, without providing any safeguards to its pre-existing creditors, a debtor can move its COMI to a jurisdiction that may be detrimental for creditors; (iii) it can increase a firm’s cost of credit because sophisticated lenders will price in the risk of being subject to an undesirable insolvency forum; and (iv) it can hamper the effective reorganization of viable but financially distressed businesses and reduce returns to creditors, especially for companies based in countries without efficient insolvency systems. 

As a result, we proposed a better approach—the “Commitment Rule”—for determining the place where a foreign main insolvency proceeding will be initiated. The arguments for the Commitment Rule are laid out in detail in a journal article we posted in January 2014. In short, the Commitment Rule allows debtors to commit, in advance, to a particular insolvency forum. To make this commitment public and binding, the debtor must put it in their company’s constitution. This upfront and observable commitment eliminates uncertainty and opportunistic manipulation. With the adoption of various safeguards that we suggest in our proposal, the Commitment Rule also allows the modification of insolvency forum if circumstances change and debtors and creditors realize they are better off in another insolvency forum. 

Despite the desirability of the Commitment Rule, we are aware that such a disruptive change to the Model Law will not be easy. In fact, for various reasons, such as status quo and other biases among lawmakers (and academics), it faces significant obstacles. Yet, as academics, we must do more than simply describe current law. We have a moral and professional obligation to examine legal changes that will make society better off. In our field, that obligation includes recommending regulatory and policy change that can improve financial markets and benefit businesses (especially those in emerging markets), even if those ideas are considered “naïve” (using the term employed by two US academics who criticize our proposal). To ignore policy changes that can improve people’s welfare would be contrary to our fundamental obligations as academics. After all, the success in the move from a territorial system of insolvency laws to today’s modified universalism was driven in large part by similarly ambitious academics striving to improve a system they viewed as less than ideal. 

The adoption of the Commitment Rule adds predictability, improves access to finance and economic growth, and facilitates efficient insolvency proceedings while also reducing litigation costs and opportunistic behaviour by debtors. Therefore, it represents a significant improvement of the Model Law. 

In the alternative, if UNCITRAL is committed to the concept of COMI, we have also proposed an alternative (“second-best”) approach to deal with insolvency forum. This alternative would revise the COMI rule to facilitate ex post choice of insolvency forum. Namely, a debtor would be allowed to initiate an insolvency proceeding in any jurisdiction that permits the initiation of insolvency proceedings by foreign companies if doing so would collectively benefit its collective. While this practice is common today, debtors face several issues and limitations (including lack of recognition, or lack of automatic relief) if the debtor does not initiate the procedure in the place of the debtor's COMI. Therefore, the Model Law should provide that the place where the insolvency proceeding is initiated is functionally equivalent to the debtor’s COMI. Put differently, initiating a proceeding in the debtor’s COMI or in any other forum would trigger similar effects under the Model Law. The debtor would, however, need to show that the place of filing is beneficial for the collective interests of its creditors as a whole.[1] 

This second-best approach improves the current regulatory framework for cross-border insolvency by allowing debtors and creditors to benefit from the choice of a more efficient insolvency forum without being worried about the limitations and legal risks associated with initiating an insolvency proceeding in a forum that some creditors could argue (and litigate) is not the debtor’s COMI. 

The annex of our letter to UNCITRAL shows that our proposal has been endorsed by some of the most prominent insolvency experts around the world, including scholars from the University of Cambridge, the University of Hamburg, the University of Tokyo, Harvard University, UC Berkeley, the University of Chicago, the University of Pennsylvania, and Yale University, among other leading institutions. Signatories of the proposal also include the (then) president of the largest association of insolvency professionals (INSOL International), Mr. Scott Atkins; the former chairman of UNCITRAL, Mr. Oh Soo-geun; and the former president of INSOL International, Mr. Sumant Batra. Moreover, the group of prominent insolvency experts endorsing our proposal includes diverse experts and practitioners from advanced economies and emerging markets, as well as from civil law and common law jurisdictions. It is a proposal without borders. We all believe it can improve the current approach to deal with cross-border insolvency while serving as a valuable tool to foster entrepreneurship, access to finance and economic growth. 

II. The Commitment Rule after a year of debates 

Our proposal has captured the attention of many academics and practitioners working in cross-border insolvency. Various organizations of insolvency professionals, including INSOL International, the American Bankruptcy Institute and the International Insolvency Institute, have created panels or specific seminars to discuss our proposal. Several scholars and practitioners have also commented on the proposal. While many experts in the legal, financial and insolvency industry have been supportive, a few academics and practitioners have been critical. It is useful, at this time, to respond to the concerns and misunderstandings of the critics. The following section, therefore, reviews the main arguments that have been raised against our proposal —and explains why many of them reflect a lack of understanding and none of them undermines the ultimate desirability of the Commitment Rule as compared with current practice.   

III. Arguments and concerns against our proposal (and why they are not convincing)  

1. The Commitment Rule can encourage debtors to opportunistically choose a forum that can be detrimental for creditors 

This argument, which was initially suggested by some critics the day after our letter was sent, fails to recognize the core features of the Commitment Rule. If debtors commit to initiate an insolvency proceeding in a particular forum that is detrimental to creditors, nobody—at least not any sophisticated lender—will ignore that choice. These lenders will refuse to lend or significantly increase the debtor’s cost of credit. Of all the theories in finance, this is the most obvious and empirically supported. Lenders are self-interested and behave accordingly. And a debtor who chooses a creditor-unfriendly forum will pay for doing so. That is how credit markets work. As a result, the choice of an undesirable insolvency forum for creditors will be undesirable for debtors. If anything, the Commitment Rule will encourage debtors to choose a more creditor-friendly forum than they do under the current regime. 

2. The Commitment Rule can encourage debtors to choose a forum that is good for sophisticated lenders but it is bad for vulnerable creditors 

This argument (raised by a former judge) is more sophisticated. We considered it extensively in formulating and evaluating our proposal. At the outset, it is worth noting that this concern exists with the current regime. Indeed, the problem is more acute under the status quo than it would be with the Commitment Rule. 

The dynamic relationships between sophisticated and vulnerable creditors arises in any system where debtors have the potential to forum shop, and every system other than pure territorialism, including the status quo, provides that potential. The key, therefore, is to minimize the problem. The Commitment Rule does this by pushing the choice to an earlier time so that it is made ex ante (long before insolvency) rather than ex post (on the eve of the insolvency or restructuring proceedings).  

Under the current regime, debtors can generally choose their forum—with or without shifting their COMI. This choice of insolvency forum (often referred to as “forum shopping”) is pervasive. Sometimes the shopping is done for good reasons. Sometimes for bad reasons. Good, or value-enhancing, forum shopping results in an insolvency forum that makes the entire group of creditors better off. Bad, or opportunistic, forum shopping results in a forum that is detrimental to the creditors as a whole or shifts value from one group to another. From a policy perspective, value-enhancing forum shopping should be allowed (even promoted) and opportunistic forum shopping should be minimized. 

Unfortunately, the current approach to cross-border insolvency does not prevent opportunistic forum shopping. It is widely recognized—especially by those criticizing the Commitment Rule—that COMI shifting is easy to do. Moreover, changing the COMI might not even be needed for the initiation of an insolvency proceeding in other jurisdictions—even if, in these circumstances, the proceeding would not be recognized as a foreign main proceeding. As such, the status quo creates a particular risk for vulnerable creditors. Under the current system, sophisticated lenders can pressure a debtor to shift its COMI and choose a forum that transfers value to them from the vulnerable creditors. 

The Commitment Rule cannot perfectly solve this problem. But it does shift the dynamic in favor of vulnerable creditors. Ex ante commitment favors efficient insolvency forums that benefit all creditors. Before insolvency arises, the interest of creditors of all types are generally aligned—certainly more so than on the eve of insolvency proceedings. Additionally, as noted above, when the debtor commits ahead of time to the efficient forum, that reduces the cost of credit. Cheaper credit leads to fewer insolvencies, and all creditors do best when a company succeeds.  

Put simply, with the COMI rule there is unfettered time-of-filing forum shopping. With the Commitment Rule there is market-constrained advance forum shopping. Vulnerable creditors face some risk under each system, but the COMI rule exacerbates the risk and it certainly doesn’t reduce it. As such, one cannot point to COMI as a commitment to protect the vulnerable. 

Finally, there are other ways to protect vulnerable creditors. These creditors can face risk with any insolvency system that embraces some degree of universalism. We believe in the value of universalism, and oppose a pure territorialist approach, which is considered in some countries as a protection to vulnerable creditors. And so, our proposal notes that vulnerable creditors (or at least some of them, such as tort claimants and employees) could be protected by giving them a priority in the ranking of claims. With that priority established, any proceedings that failed to respect it should lead to the lack of recognition of a foreign insolvency proceeding and could even trigger the public policy exception currently provided in the Model Law. 

Therefore, the Commitment Rule implicates no risk for vulnerable creditors. If countries are concerned about the protection of vulnerable creditors, they should make sure that those creditors enjoy a priority in the ranking of claims in their jurisdiction as a first step. Then, whether it is with a COMI rule or the Commitment Rule, they need to make sure that the underlying priority rules are respected.  

3. The Commitment Rule is not needed because companies can currently choose the insolvency forum 

It is true that, under the current rules, companies can generally choose the insolvency forum provided that certain conditions are met (typically showing a connection with the foreign insolvency forum). This observation, however, ignores the benefits of a choice that is made in advance. That precommitment is superior to the current rule, which allows for eve-of-filing choice. 

Without precommitment, a business based in a country with an inefficient insolvency forum pays a penalty when it obtains a loan. That penalty is based on the option of filing in that forum.  Given the risk associated with the initiation of an insolvency proceeding in an inefficient insolvency forum, lenders will increase the cost of debt or not extend credit at all. The ex post choice to file in an efficient forum cannot undo those penalties. These businesses are penalized  long before the choice is made. Precommitment solves this problem, by allowing the business to make a binding promise to choose an efficient forum. 

4. The concept of COMI provides certainty and is not litigated 

Some commentators and COMI supporters have argued that COMI is a clear and predictable concept that is not generally litigated. Interestingly, in addition to being in tension with the previous criticism, the evidence shows otherwise. Just in the past few months, the concept of COMI has been litigated in various cases, such as In re Black Press Ltd. (United States) and In Re Fullerton Capital Limited (Singapore). This uncertainty and resulting litigation is not surprising. In today’s world, businesses have assets, employees, and offices in many jurisdictions, or they are organized through corporate-group structures with subsidiaries and affiliates incorporated in various jurisdictions. Determining the “proper” COMI of such businesses (and needless to say cryptoexchanges and decentralized finance applications) can be challenging and often results in complex disputes. Indeed, the concept of COMI is only “clear” in the context of companies exclusively based in one jurisdiction. It is not surprising, then, that a former judge of the SDNY bankruptcy court observed, “[I]ssues relating to the debtor’s centre of main interests have been litigated repeatedly in Chapter 15 cases”.[2] 

The adoption of the Commitment Rule will necessarily lead to less litigation over COMI. The insolvency forum will be chosen ex ante, in an easily verifiable manner, and will be binding. The proper forum will be clear and predictable and there will be nothing to litigate. And so there will be considerably fewer controversies.

5. The choice of an insolvency forum that can be beneficial for the creditors [as is suggested in our second-best approach] can also create litigation costs 

We agree. For that reason, our second-best approach is just that: a second-best approach, and not our preferred approach. Yet, while our second-best approach may be less desirable than the Commitment Rule, it is still an improvement over the current framework. First, it allows debtors and creditors to benefit from the choice of a more efficient insolvency forum. While this practice is currently observed in the market, the adoption of our proposed second-best approach would formally recognize the type of value-enhancing forum shopping that should be allowed and even promoted. Second, there would be no more wasteful litigation over what is the “real” COMI. Rather, if there is litigation, it would be over something that matters: Whether creditors as a whole are better off? Third, if a debtor shows that the place of filing is beneficial for the creditors as a whole, this solution may avoid some of the legal risks (in terms of lack of recognition)) associated with choosing an insolvency forum that is not the debtor’s COMI. The key is that this issue will be resolved at the outset of the initial proceeding rather than down the road when someone challenges recognition in another jurisdiction. 

6. The COMI rule provides more flexibility to debtors than the Commitment Rule 

This is an odd argument coming from the same critics who argue that the COMI rule prevents manipulation by binding debtors. Here they argue that COMI actually allows the debtors with broad flexibility. It is not clear how they reconcile these positions. If by “flexibility” the critics mean that COMI provides the debtor the ability to be manipulate creditors without providing safeguards, then we agree. The current COMI rule is more flexible on that dimension. But such flexibility is undesirable. 

The Commitment Rule is more carefully designed to retain flexibility when it is beneficial and constrain it when it can be manipulated. It facilitates the change of insolvency forum when appropriate while simultaneously protecting creditors from opportunistic changes. 

The Commitment Rule can also be designed to allow different amounts of flexibility. A rigid version  might require that debtors  provide notice to all the pre-existing creditors and give those creditors a veto right before amending their forum choice. Thus, only if no creditor (or if fewer than a certain percentage of creditors) objects within a reasonable period of time (perhaps 3-4 weeks), would the forum change become effective. 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. As a result, this would be the most creditor-protective approach as well as the less flexible one.  

A more flexible approach could require approval of a majority or super-majority of the creditors. While this approach may avoid some holdout problems inherent in the previous approach, it might create other costs. Obtaining consent from the majority or super-majority of creditors can be costly. Additionally, some creditors may price their loans on the basis that they might eventually be required to be subject to an unwanted insolvency forum. Therefore, this approach can encourage sophisticated lenders to increase the cost of debt. 

For that reason, perhaps the most desirable approach in terms of flexibility would  allow a debtor to adopt specific amendment rules in its constitution,, which is the solution that one of us suggested in a previous article co-authored with Joshua Macey. For example, the amendment rule might: (i) require consent by  a minimum number or percentage of creditors; (ii) put a delay on the effective date of a change in the constitution; (iii) allow the change of the insolvency forum provided that it is approved by a particular individual (for example, an arbitrator, advisor, or designated independent director) or group of people (e.g., board of directors, company’s independent directors, external committee of legal and financial advisors). A debtor would write its amendment rules considering the demands and expectations of the credit markets. Again, sophisticated lenders will take the adopted rules into account when they price loans. Debtors, knowing this, will have incentives to choose a method that is trustworthy, value-enhancing and protective of the interests of the creditors. And as discussed above, vulnerable creditors will be protected separately through the combination of a priority and the lack of recognition of a procedure (on the basis of a public policy violation) if that priority is not respected. 

7. The choice of insolvency forum may undermine the legitimacy of the insolvency system if debtors can choose a place where they do not have any connection 

If a foreign jurisdiction provides a more efficient insolvency forum that can save viable firms and contribute to the preservation of jobs and wealth in the company’s local jurisdiction, that alone legitimizes the  use of the foreign insolvency system. Indeed, we expect  that some jurisdictions will embrace local companies committing to the most efficient insolvency regime available, regardless of connections. Constructing and maintaining a vibrant and efficiency insolvency system is not easy or inexpensive matter. The economies of countries with inefficient insolvency systems would benefit from the proceedings available elsewhere given that their local companies would be in a better position to obtain financing and create jobs and wealth. In any case, if any jurisdiction is itself concerned with the  “legitimacy” of their local courts when admitting the insolvency proceeding of a foreign company, they can certainly impose more stringent filing requirements. Nothing about the Commitment Rule requires a jurisdiction to accept foreign cases. Indeed, those jurisdictions might reject such cases merely because their courts are overburdened. But markets can be trusted to avoid the choice of jurisdictions adopting such policies. 

8. If COMI is abolished, a solution needs to be provided for individuals 

We agree. Our proposal to replace the COMI rule focuses on corporations, where the COMI rule does more harm than good. Nonetheless, if UNCITRAL abolishes the COMI rule, it would need to come up with a rule for individuals. To that end, it should be kept in mind that corporations and individuals enter insolvency proceedings under distinct circumstances, and the goals and policy justifications of insolvency law are quite different for corporations and individuals. For instance, while many insolvency laws seek to provide a discharge of debts to honest but unfortunate individual debtors, this “fresh start policy” does not exist in many jurisdictions around the world – particularly in many emerging economies. The goal of corporate insolvency law, on the other hand, is more consistent across jurisdictions. Even though certain insolvency laws might be more attractive to debtors or creditors, most insolvency regimes seek to minimize the destruction of value, maximize returns to creditors, and achieve the reorganization of viable but financially distressed firms. Allowing the choice of insolvency forum in the context of individuals can, therefore, more easily contravene the “public policy” of a country.  Thus, a rule based on the debtor’s habitual residence, as currently exists under the Model Law, would be more desirable and respectful of a country’s public policy. For that reason, if the COMI rule is abolished, the Model Law should—for individual debtors—adopt the debtor’s place of habitual residence as a non-rebuttable presumption in determining proper insolvency forum. 

9. The solution is not allowing companies to choose a foreign insolvency proceeding but improving a country’s local insolvency system 

Improving a country’s legal and institutional environment to deal with financial distress is the Utopian ideal. Unfortunately, due to a variety of factors, including lack of resources or political will, or lack of awareness about the importance of insolvency law for the promotion of economic growth, many countries do not embark on the legal and institutional reforms needed to improve the insolvency system. And even if these reforms are implemented, other jurisdictions can still provide a more attractive restructuring environment. Therefore, facilitating the choice of insolvency forum will always be more desirable than forcing companies to be subject to an insolvency proceeding that is not optimal. 

Any insolvency reform facilitating economic growth is desirable regardless of whether the infrastructure or insolvency system facilitating that outcome is provided locally or internationally. Of course, accessing an efficient insolvency framework provided by a foreign jurisdiction can be more costly. Still, given the underdevelopment of many insolvency systems, the benefits of foreign access  often exceed the extra costs. In those scenarios, debtors and creditors will prefer to initiate the procedure overseas, and allowing companies to do so can benefit a local economy by providing greater access to finance and more chances to keep viable businesses alive. Additionally,  governments have limited resources and other legal and institutional reforms (e.g., improvement of the judiciary or adoption of an efficient corporate law or secured transactions regime) may be more urgently needed. 

10. COMI needs to be revisited, but not as the authors of the Commitment Rule suggest 

The concept of COMI needs to be revisited. But how? Some critics of our proposal have advocated for more modest reforms. For example, some have suggested using the registered office for conclusively determining the insolvency forum. Others have suggested using the place of incorporation. In a lecture delivered by Professor Jay Westbrook, he suggested getting rid of the registered office as a presumption of COMI and favoring the choice of a forum that can provide an efficient resolution of financial distress. These proposals are flawed. On the one hand, choosing the place of incorporation or the registered office can be reasonable options to provide predictability. However, it would make things more rigid and limit all forum choice—good and bad. On the one other hand, keeping COMI but getting rid of the rebuttable presumption for registered office would increase uncertainty and litigation costs. Nonetheless, Professor Westbrook’s second observation, which is very much aligned with our second-best approach, can be a more sensible approach. 

IV. Conclusion 

After a year of academic and policy debates since we submitted our letter to UNCITRAL, we can draw several lessons and conclusions. First, none of the arguments provided by the critics of the Commitment Rule are convincing. Second, many of the arguments against the Commitment Rule reflect a lack of understanding of our proposal. Indeed, many of the criticisms are inconsistent with each other. Third, even some of the most enthusiastic supporters of COMI have suggested that COMI needs to be revisited. Regardless of which reform proposal eventually gets adopted, something is plainly wrong with the COMI Rule as it currently stands. In our letter, we suggested the approach that, in our view, is most desirable. Still, there might be many other ways to improve the current system. We, therefore, look forward to a broad debate on how the system can be improved.

* This post includes the content of a working paper available on SSRN.