Legal Issues in Maritime Bankruptcies [PART 2]

Read Part 1 

III.      Automatic Stay

The automatic stay in U.S. bankruptcy stops all proceedings during the pendency of a bankruptcy procedure. Its broad reach extends to all other litigation, lien enforcements, attempts to collect on judgments and any other conduct that would interfere with the estate or property of the debtor.

The purpose of the stay is two-fold: First, it allows the debtor to focus its time, energy and resources on reorganization, and prevents the debtor from having to deal with lawsuits throughout the country (or world); and second, it promotes a fair distribution of the debtor’s assets to all creditors, as all creditors must bring their claims to the bankruptcy court for a fair distribution among creditors. The absence of a stay would cause a race to the courthouse, and allow creditors to file claims in various courts in various jurisdictions to “get a piece of the pie” in front of other creditors with equal or greater claims.

Due to the Supremacy Clause of the U.S. Constitution, all pending State Court actions are immediately stayed; similarly, non-maritime federal actions are also stayed.

IV.   Tension Between the Courts

The rise in bankruptcy petitions among maritime companies has exposed a tension inadvertently created by the structuring of the U.S. judicial system under the U.S. Constitution: the respective authority of the Bankruptcy Court and the District (i.e. federal) Court. This tension has left three parties susceptible to uncertainty: (1) maritime debtors; (2) creditors of maritime debtors; and (3) purchasers of maritime assets through judicial foreclosure, e.g., vessels.[1] The net effect could change the way maritime companies conduct business in the industry.

The U.S. Constitution gives exclusive jurisdiction over Admiralty cases to “Article III judges,” who are appointed by the President, confirmed by the U.S. Senate, and preside over District Courts, whereas Bankruptcy Courts are created under Article I of the U.S. Constitution. Further, Bankruptcy Courts (while a unit of the District Courts) have original and exclusive jurisdiction over all bankruptcy proceedings and a debtor’s property, wherever located, and over the estate.

V.                 Maritime Liens

Under U.S. maritime law, a lien is automatically created by operation of law when a vendor provides “necessaries” to a vessel to “keep it going.” What constitutes a “necessary” is subject to broad interpretation, tends to be expansive, and need not be recorded to be effective. Such liens can only be discharged by a District Court under Admiralty Jurisdiction by an Article III judge. So if a District Court sells a vessel by judicial auction via an action brought by a creditor, the vessel is sold “free and clear of all liens and encumbrances.”

VI.               Dueling Authority under Current U.S. Law

Various groups (courts, legislature, debtors and creditors) have engaged in a struggle to reconcile the conflict between the dueling authority of the Bankruptcy Court and the District Court. One side argues that the broad power of the Bankruptcy Court and common sense principles of jurisprudence provide jurisdiction over maritime assets. The other side contends that the U.S. Constitution has given original and exclusive jurisdiction over maritime issues to Level III District Courts, leaving the Bankruptcy Court without jurisdiction over maritime matters.

Who will win? The current state of the law is unclear. In a 2^nd Circuit decision (Aug 2005), In Re Millennium Seacarriers, Ltd., the Court held that as the lienors voluntarily submitted to the jurisdiction of the Bankruptcy Court, that court had jurisdiction over the maritime assets. The determining factor appeared to be that lienors voluntarily agreed to the jurisdiction of the Bankruptcy Court.

But Millennium is not the end of the discussion. Then-Judge Sotomayor (now U.S. Supreme Court Justice) stated that “only a federal admiralty court acting in rem” can “conclusively” extinguish maritime liens.

VII.       Going Forward

How will the law reconcile the Bankruptcy Court vs. District Court issue?

One view is that a rational, pragmatic approach suggests Bankruptcy Courts will eventually have authority to not only stay pending maritime proceedings in District Court but also exercise authority over a debtor’s maritime assets and remove maritime liens on the disposal of a vessel by judicial sale.

But at least one commentator has suggested that the only way to resolve this issue is by congressional act, giving exclusive jurisdiction to the District Court over pre-petition on foreclosure proceedings and, where applicable, jurisdiction over maritime bankruptcy proceedings. Theoretically, this would mean that a District Court would handle maritime bankruptcies (a novel approach but likely not effective)! U.S. Bankruptcy proceedings are very much their own “animal,” and few outside the bankruptcy field have a sophisticated understanding of laws and procedures sufficient to effectively apply them.

A solution may be based on a “logical, balanced” approach granting Bankruptcy Courts jurisdiction over maritime proceedings and assets to avoid conflicting rulings. Arguably, Bankruptcy Courts would be better able to enforce maritime foreclosure proceedings than a District Court would be to administer bankruptcy law.

So what should you do if asked by a client whether to purchase a vessel without a release from a U.S. District Court? Tread lightly – the vessel may still be subject to maritime liens, and the most conservative approach would be to avoid such a purchase no matter how tempting the bargain.[2] – MarEx

 

In case you missed it, read Part 1 of this feature editorial HERE.