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A federal judge has pulled the plug on creditors of foreign banks. In harsh terms and curt orders, Judge Jed Rakoff of the Southern District of New York, on an appeal from a bankruptcy case in that district, Beogradska Banka A.D. v. Superintendent of Banks, summarily changed the landscape for creditors of foreign banks doing business in the United States. The ruling increases significantly the risk that creditors will not have access to assets when the parent institution is in bankruptcy proceedings in its home country. Though a local case, it bears watching by bankers and regulators nationwide-with nearly 500 foreign banking organizations having more than $1.3 trillion in assets in 21 states. The U.S. offices of two foreign banks were placed in bankruptcy in Yugoslavia. Those U.S. offices had been licensed to do business by the New York State Banking Department. As required by New York law governing liquidations of foreign banks, the department seized the banks’ assets in New York to protect all creditors of the offices, whether or not the creditors are located in New York. The government agency conducting the bankruptcy in Yugoslavia (known as the B.R.A.) filed a number of lawsuits to compel the department to turn over the seized assets. After much legal wrangling-and losses-the B.R.A. filed an action in U.S. Bankruptcy Court to open an ancillary proceeding. The court declined to exercise its jurisdiction, noting that the department “is the very type of regulatory agency, and its liquidation scheme the very type of scheme,” to which the Federal Bankruptcy Code defers. The B.R.A. appealed to federal district court, which overruled the bankruptcy court. At issue is the interaction of two separate provisions of the code: Sec. 109, which excludes foreign banks from the definition of debtor, and Sec. 304, which allows a representative of a foreign bankruptcy proceeding to petition the U.S. Bankruptcy Court to order the turnover of assets to the foreign representative. Under Sec. 109, foreign banks are excluded from the definition of debtor. For more than 100 years, banks have been excluded from the subject-matter jurisdiction of U.S. bankruptcy courts, and for good reason. As Congress observed: “[A]n alternative provision is made for their liquidation under various state and federal regulatory laws.” If banks are excluded from the bankruptcy court’s primary subject-matter jurisdiction-over bank assets-then it must follow that banks also are excluded from its secondary, ancillary Sec. 304 proceedings. Otherwise, Sec. 304 would allow access “through the back door where the front door is most decidedly barred” as aptly put by the bankruptcy court. Neither Sec. 304 nor its legislative history suggests otherwise. Section 304 was enacted in 1978 with the creation of the Bankruptcy Code, the same legislation in which Sec. 109 excluded banks as debtors. Therefore, Sec. 304 cannot be read in isolation, but that is what Rakoff has done. The legislative history actually reinforces the conclusion that 304 does not confer back-door jurisdiction over bank assets. Congress clearly stated that 304 applies to a “debtor” in U.S. bankruptcy proceedings. But foreign banks are not “debtors” under Sec. 109 of the code. Simply put, Sec. 304 does not apply to foreign banks. Consequently, a foreign representative cannot use Sec. 304 to go after foreign banks’ assets. Any other reading creates an impossible “catch-22″ for creditors: They are denied access to federal bankruptcy proceedings because alternate state and federal liquidation schemes exist here, yet they are also denied relief under those very schemes because a foreign representative of a bankruptcy proceeding abroad files a petition for an ancillary proceeding and removes the assets from the creditors’ reach. It is inconceivable that Sec. 304 cedes sovereignty-both state and federal-to a foreign government without any record to substantiate such an intent. Given the lack of specific direction under Sec. 304 and the rich fabric of authority under Sec. 109, the judge’s ruling is simply wrong. A ripple effect While this is one ruling of a district court, the implications are still major. The ruling incorrectly and unnecessarily interferes with a fundamental element of foreign-bank supervision nationwide, affecting all foreign banks and their creditors. Current U.S. supervisory strategy is to “ringfence” assets of the U.S. offices-that is, wall them off from the parent’s assets. Creditors and customers of a foreign bank’s U.S. offices rely on U.S. supervisory tools such as asset-pledge and asset-maintenance requirements to protect their interests. If supervisors cannot conduct liquidations, these tools are useless. This ruling undermines the U.S. system of foreign-bank supervision by rendering this protection futile. The decision increases risks for creditors and supervisors of foreign banks. As risks increase, so do prices. Foreign banks doing business here and their parent institutions will end up bearing the cost of the increased risk. Customers will lose confidence in the U.S. offices. Creditors will devise legal and market responses. Rest assured that supervisors will carry out their sworn oaths to ensure the safety and soundness of the institutions they license and to protect all bank creditors. They will employ supervisory strategies, such as an “exit strategy” to require even healthy U.S. offices to satisfy all of their liabilities and/or cease operations when a parent is in trouble or bankruptcy in another country. The consequences could be extreme; supervisors, creditors and foreign banks all have a vested interest in correcting the ruling. Timothy N. Bergan is senior vice president, international, of the Conference of State Bank Supervisors. After Nov. 1, he can be reached at Holland & Knight ([email protected]).

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