On June 13, 2012, the United States Bankruptcy Court for the Northern District of Texas (the “Bankruptcy Court”) published an opinion ruling on whether the Mexican Plan of Reorganization (the “Concurso Plan”) of the Mexican glass-manufacturing company, Vitro, S.A.B. de C.V., approved by the Federal District Court in Mexico, should be enforced under Chapter 15 of United States Bankruptcy Code.¹ The Bankruptcy Court concluded that the Concurso Plan should not be accorded comity to the extent that it extinguishes the guaranties held by the debtor’s non-debtor subsidiaries in favor of third-party noteholders. In the Bankruptcy Court’s view, such an order would be manifestly contrary to the public policy of the United States. The Bankruptcy Court’s opinion joins a very short list of cases that address the public policy exception under § 1506 of the Bankruptcy Code.

Chapter 15 Primer

Chapter 15 provides for recognition and assistance where insolvency proceedings are pending in more than one country and establishes guidelines for the protection of assets internationally, while being sensitive to the political issues and differing legal systems of the countries involved. Any determination of a request for assistance under Chapter 15 must be “consistent with the principles of comity.”²

“Comity,” in the legal sense, is neither a matter of absolute obligation, on the one hand, nor of mere courtesy and good will, upon the other. But it is the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protection of its laws.³

The determination to grant comity is balanced by the language of § 1506, which provides that “[n]othing in this chapter prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States.”⁴

Case Background

The Vitro Concurso Plan, as originally proposed and ultimately approved in Mexico, eliminated any recourse certain noteholders held against Vitro’s non-debtor subsidiaries. The noteholders were not pleased. Vitro then filed a petition in the United States seeking recognition of the Mexican reorganization case as a foreign main proceeding under Chapter 15 of the Bankruptcy Code. Recognition was granted on July 21, 2011.

In August 2011, a group of noteholders filed suit in New York state court against the subsidiaries. The New York court ruled in favor of the noteholders, finding that the indentures prevented non consensual modification of the subsidiaries’ guaranties because the subsidiaries expressly waived any rights under Mexican law.

The Mexican court approved the Concurso plan on February 3, 2012, and Vitro proceeded to consummate the plan, issuing new notes and debentures, effectively discharging the obligations of Vitro’s non-debtor subsidiaries, and funding trusts for the payment of claims. Approval of the Concurso plan discharged Vitro’s obligations to the noteholders under the original notes and released claims against the subsidiaries under the guaranties. Vitro then filed its motion to enforce the Concurso Plan in the United States and sought a permanent injunction of collection efforts against its subsidiaries pursuant to §§ 105, 1507, and 1521 of the Bankruptcy Code. Certain noteholders filed objections to the enforcement motion (the “Objecting Parties”).

The Bankruptcy Court’s Conclusions

The Bankruptcy Code does not define “manifestly contrary to public policy” but the public policy exception of § 1506 is meant to be narrowly construed and used only to defend the most fundamental policies of the United States. The courts primarily focus on two factors:

(1) whether the foreign proceeding was procedurally unfair; and (2) whether the application of foreign law or the recognition of a foreign main proceeding under Chapter 15 would “severely impinge the value and import” of a U.S. statutory or constitutional right, such that granting comity would “severely hinder United States bankruptcy courts’ abilities to carry out . . . the most fundamental policies and purposes of these rights.⁵

The Bankruptcy Court rejected the arguments of the noteholders regarding corruption of the Mexican judiciary, impact on the credit markets from approval of the Concurso Plan, and general unfairness of the Mexican proceedings and noted that these objections would more appropriately be handled by the Mexican courts, noting that an appeal of the Concurso had already been filed in Mexico.

The Bankruptcy Court recognized that the United States has a general policy against the discharge of entities other than a debtor in an insolvency proceeding and denied the enforcement motion for three reasons. First, the Concurso Plan does not substantially comply with the distribution scheme prescribed by the Bankruptcy Code. Under the Bankruptcy Code, the Objecting Parties would receive distributions from Vitro and also be able to recover any deficiencies from the non-debtor subsidiary guarantors. The Concurso Plan, however, provides for drastically smaller recoveries and extinguishes guarantor liability. Second, the Concurso Plan does not sufficiently protect creditors’ interests as required by § 1521(a) in a manner that is balanced with the interests of Vitro. Third, protection of third party claims in a bankruptcy case is a fundamental policy of the United States, and because the Concurso Plan extinguishes these claims, it is manifestly contrary to that public policy and is unenforceable.

The Bankruptcy Court also noted, but did not rule on, two other “meritorious” arguments of the Objecting Parties. Insiders, including intercompany claims, were allowed to vote on the Concurso Plan even though bonds were issued shortly before the Concurso proceeding under questionable circumstances. Also, the Concurso plan arguably violated the absolute priority rule because the holders of equity in Vitro retained significant value when the creditors were not paid in full.

The Bankruptcy Court stated that generally, Concurso plans would be enforced in the United States; however, the Vitro plan was unenforceable. The Bankruptcy Court stayed its decision until June 29th to allow Vitro an opportunity to appeal the Bankruptcy Court’s decision and seek a stay on appeal.

Continued Uncertainty

Case law regarding § 1506’s public policy exception is sparse; however, the drastic departure of the Vitro Concurso Plan from confirmable Chapter 11 plans may prove to be enough to establish a fundamental public policy regarding the dischargability of third-party claims.

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