The Long Arm of Canadian Insolvency Law and a Tale of Three Jurisdictions

The Long Arm of Canadian Insolvency Law and a Tale of Three Jurisdictions

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Bankruptcy courts have an uncanny propensity to exercise worldwide jurisdiction over a debtor's assets and creditors even though they have no ability to enforce their orders beyond jurisdictional and territorial boundaries. Conversely, courts and tribunals that do have jurisdiction and enforcement powers over a debtor's far-flung assets as well as creditors are frequently loathe to recognize and give extra territorial effect to the orders and decrees of a foreign bankruptcy court. Compounding the problems created by these tensions is the fact that, in today's increasingly technological and global economy, the location of creditors and assets is often difficult to pinpoint and may itself encompass more than one jurisdiction.

The entertainment industry offers a classic example of cross-border creditor and debtor relationships involving intangible assets whose exact location may be uncertain and whose scope may be global. When a producer licenses world-wide distribution rights to an overseas distributor and either the producer or the distributor finds itself in an insolvency proceeding, the ultimate determination of who owns distribution rights may be very delicate, especially when both the producer and the distributor claim to have rights in the licensed intellectual property. The Canadian insolvency proceeding of Paragon Entertainment, a Canadian corporation, and one of its subsidiaries, Handmade Films, a U.K. corporation, offers interesting insight into just how complicated the quagmire may become.

Prior to its insolvency, U.K.-based Handmade entered into a license (the "License") with SKA Productions, also a U.K. company. Pursuant to the License, SKA licensed to Handmade worldwide theatrical distribution rights (the "Licensed Rights") in and to a motion picture entitled "Lock Stock and Two Smoking Barrels" (the "Film"), provided Handmade would make two installment payments (individually, an "Installment"; collectively, the "Installments") to SKA. Paragon entered into a guaranty (the "Guaranty") in favor of SKA, guaranteeing payment of the Installments. The License was governed by English law, was entered into in England and was to be performed exclusively within England.

Before paying the first Installment to SKA, Handmade's parent, Paragon, filed a proceeding (the "CCAA Proceeding") under the Canadian Company's Creditors Arrangement Act (CCAA) in Toronto, on behalf of itself and its subsidiaries, including Handmade. After the filing, Paragon and Handmade obtained an injunction (the "Canadian Injunction") that, among other things, restrained and enjoined all persons everywhere in the world and specifically in the United Kingdom and the United States from terminating, amending or modifying any contract or license with Paragon and Handmade. The Canadian Injunction also required such third parties to continue to perform all obligations under any contract or license with the debtor entities, including Paragon and Handmade.

The Canadian Injunction appointed a monitor (the "Monitor") in the CCAA Proceeding. Under the CCAA, the powers and the responsibilities of a monitor are quite extensive, and include the responsibility to report to the court on the status of a debtor's bankruptcy proceeding and the power to participate in the negotiation of a plan of arrangement.

Although the CCAA Injunction specifically purported to affect and control assets and creditors located in the United Kingdom, the Monitor never applied under §426(4) of the U.K. Insolvency Act of 1986 for recognition and enforcement of the Canadian Injunction. Section 426(4) provides, in relevant part, that: "[t]he courts having jurisdiction in relation to insolvency law in any part of the United Kingdom shall assist the courts having the corresponding jurisdiction in any other part of the United Kingdom or any other relevant country or territory." Canada is a relevant country for the purposes of §426(4).

With notice of the commencement of the CCAA Proceeding and the issuance of the Canadian Injunction, SKA wrote several letters to Handmade threatening to terminate the License on the basis of "anticipatory repudiation," claiming that Handmade was unable to make the first Installment payment under the License and that its guarantor, Paragon, was neither willing nor able to perform on the Guaranty. Handmade informed SKA that it could not terminate the License because of the Canadian Injunction. Undeterred, SKA terminated the License for anticipatory repudiation and thereafter sought to find a third party to buy the Licensed Rights.

A U.S.-based motion picture distributor (the "Purchaser") wished to buy the Licensed Rights from SKA but was concerned about the "cloud on title" created by the Canadian Injunction. On the one hand, it appeared that because the Monitor had not obtained recognition of the Canadian Injunction in the United Kingdom under §426(4) of the Insolvency Act, as a matter of British law, SKA—a U.K.-domiciled company—was not bound by the Canadian Injunction and would be free to conduct itself as if the injunction did not exist. It also appeared that even if the Monitor subsequently successfully moved a U.K. court for recognition of the Canadian Injunction, such recognition would not be given retroactive effect and the termination of the License would continue to be valid.

On the other hand, the Licensed Rights were worldwide rights in and to the Film, and a large portion of their value would be obtained from exploitation in North America. Clearly, a Canadian court would view the License termination as invalid in light of the Canadian Injunction. Furthermore, whether a U.S. court would regard the License as having been validly terminated by SKA is a matter of some uncertainty. The Canadian Injunction was certainly not self-executing within the United States and, like the U.K. courts, a U.S. court would probably not recognize and enforce the Canadian Injunction unless the Monitor took affirmative steps to seek such recognition within the United States. At least three avenues were available to the Monitor to obtain such recognition of the Canadian Injunction: application to a U.S. court for recognition of the order under principals of international comity; the commencement of an ancillary proceeding under §304 of the U.S. Bankruptcy Code for Paragon and its subsidiaries; or the commencement of a full voluntary or involuntary chapter 11 or chapter 7 proceeding for Paragon and its subsidiaries under the U.S. Bankruptcy Code. The Monitor pursued none of these remedies.

However, even if the Monitor had taken one or more of the foregoing steps to obtain recognition of the Canadian Injunction in the United States, would such recognition, whether obtained before or after SKA terminated the License with Handmade, affect a U.S. court's view as to the validity of that termination? After all, the License was entered into in England between two English companies domiciled in England, was subject to English law and was to be performed exclusively within England. Under conflict of law principles, a U.S. court may still have found that the termination of the License by SKA was valid because the Monitor had not sought recognition of the Canadian Injunction in the U.K. Nonetheless, given the uncertainty of the law in this area and the paucity of relevant authority, the Purchaser faced a distinct and real risk that a U.S. court might give Handmade's rights in the License priority over those of SKA or any assignee of SKA.

Fortunately, the Purchaser was aware of the existence of the CCAA Proceeding and the Canadian Injunction and had the foresight to realize that their existence significantly impaired the quality of any rights SKA might purport to sell in the Film. While the Purchaser ultimately acquired the Licensed Rights from SKA, it did not do so without first settling with the Monitor and purchasing whatever rights Handmade still had in the Film.

A less cautious buyer, unaware of Handmade's insolvency proceeding, might have purchased the Licensed Rights without realizing the dangers and complications the purchase entailed. As that unwitting purchaser sublicensed its rights to third parties, who in turn may have sublicensed to other third parties, a whole host of new parties might have become embroiled in the insolvency proceeding of a debtor with whom they had never done business and had no privity of contract.

Absent uniform globally recognized rules on the jurisdiction of insolvency courts and the recognition of judgments and orders issued by those courts, the foregoing fact pattern and the problems it creates for international commerce are likely to become increasingly common. The only sound advice one can give a client should be given in a language which itself was recognized throughout the world: "caveat emptor"!

Journal Date: 
Tuesday, September 1, 1998