No Double Dipping – Avianca Bankruptcy Court Demands that Foreign Creditors Drop Foreign Enforcement Proceedings at Risk of Having Bankruptcy Claims Disallowed

Other Author      Lauren Wray, Associate, New York

In a January 2023 opinion,1 the Southern District of New York Bankruptcy Court overseeing the bankruptcy case of Latin American airline Avianca and certain of its affiliates sanctioned over 150 of the airline’s Brazilian and Columbian creditors who had filed proofs of claim in the bankruptcy case finding that those creditors’ failure to drop their similar claims in foreign jurisdictions violated the discharge awarded to Avianca in connection with its approved reorganization plan.  In requesting such sanctions from the Bankruptcy Court, Avianca requested unique relief – arguing that such creditors should be given 30 days to discontinue their foreign lawsuits on the threat of otherwise seeing their claims in the bankruptcy case disallowed – noting that otherwise Avianca faced the risk of inequitable “double dipping” by such creditors who could seek to recover both in foreign enforcement actions and in the bankruptcy case.  While noting that Avianca had “cited no case” that allowed such unique sanctions, and that it was “not aware” of any such case, the Bankruptcy Court nonetheless found Avianca’s request to be “proper” finding that “the injustice that would result from the Foreign Plaintiffs’ double recovery, and the Foreign Plaintiffs’ clear contempt for this Court’s order” justified the proposed approach.  The Bankruptcy Court presented a stark and novel choice to the breaching creditors: discontinue their foreign claims within 30 days or have their claims in the bankruptcy case disallowed.

The decision is a stark reminder of the conflicts that can sometimes arise based on the Bankruptcy Code’s international reach, and the impact that US bankruptcy proceedings can have even outside of the United States.  At times, foreign creditors are surprised to learn of the Bankruptcy Code’s purported scope and, presumably believing they are beyond the court’s reach, refuse to act (or to cease acting) regardless of what a Bankruptcy Court might otherwise order – indeed counsel to a significant number of the creditors at issue in Avianca expressly admitted as such noting that he “did not believe his clients” had an obligation “to choose between prosecuting their claims in the Bankruptcy Court “or in the Colombian courts.”  The Avianca court issued a stark rebuke of that view holding that it represented “clear and convincing” evidence that the foregoing creditors had “flouted” the Bankruptcy Code’s scheme reminding even purely foreign creditors of the risks posed by refusing to comply with US bankruptcy court orders.

The Bankruptcy Code’s Automatic Stay & Discharge/Injunction Provisions

The automatic stay provisions, under Section 362 of the Bankruptcy Code, and the discharge and injunction provisions, under Sections 1141 and 524 of the Bankruptcy Code, are hallmarks of the US insolvency regime.  Each prevent individual creditors from taking action to collect on prepetition debts outside of the bankruptcy process – the automatic stay upon a case’s filing through plan confirmation and the discharge/injunction provisions once a plan has been confirmed.  Collectively, these provisions bar nearly all actions against a debtor and its prepetition assets, applying to all creditors, whether secured or unsecured, and all assets, whether inside or outside of the United States.

If a creditor is found to have acted, or not acted, in violation of these provisions, its actions are likely to be deemed void and it may also be subject to further sanctions.  Specifically, to the extent a creditor’s actions are determined to have “wilful” or “an intentional act done with knowledge that the act” is not permitted,2 under Section 105(a) of Bankruptcy Code, Courts are permitted to impose coercive sanctions to encourage compliance (e.g., continuing monetary penalties for so long as an offending party does not comply) or monetary sanctions to address financial harm (e.g., reimbursement of legal fees spent enforcing automatic stay or discharge provisions).3

Avianca Decision

Avianca, one of Latin America’s largest airlines, filed for bankruptcy in May 2020 citing a need to preserve and reorganize its businesses as it navigated the impact of the COVID-19 pandemic on global passenger traffic and reduced industry revenues worldwide.  In November 2021, the Bankruptcy Court approved Avianca’s Chapter 11 reorganization plan which went effective a month later.  Giving effect to the Bankruptcy Code’s discharge and injunction provisions, the plan included a “discharge provision” under which creditor recoveries under the plan would be deemed “in exchange for and in complete satisfaction, discharge, and release of all claims and interests of any nature whatsoever” and an “injunction provision” which enjoined all claimholders from “commencing or continuing in any manner any action or other proceeding of any kind on account of or in connection with or with respect to” any prepetition claims.   

Nearly a year later, however, certain foreign creditors with claims purportedly settled by the Avianca plan impermissibly continued to pursue over 160 pre-bankruptcy claims against Avianca in Brazil and in Colombia.  Avianca repeatedly notified counsel to the foreign creditors that such proceedings violated the discharge and injunction provisions in its plan but to no avail.  After receiving no meaningful response, Avianca filed a motion with the Bankruptcy Court seeking to sanction the “double-dipping” foreign creditors unless and until they discontinued the foreign actions.

Motion for Sanctions

Avianca began its motion by noting that the Bankruptcy Court had authority to sanction the foreign creditors, who had filed claims in the US bankruptcy proceedings but had nonetheless failed to drop their foreign enforcement proceedings, pursuant to the broad enforcement powers granted to it under section 105(a) of the Bankruptcy Code.  Avianca then asserted that the foreign creditors had subjected themselves to the equitable jurisdiction of the Bankruptcy Court by filing their proofs of claim, and that the foreign creditors had violated the discharge and injunction provisions of the Bankruptcy Code, the terms of Avianca’s confirmed plan of reorganization, and the Bankruptcy Court’s order confirming that plan given that they were subject to that equitable jurisdiction and nonetheless failed to discontinue their pursuit of foreign litigation.

In moving for the unique relief of disallowing the creditors’ claims if they did not drop the foreign proceedings within 30 days, Avianca argued that the foreign creditors would be undeterred by an injunction merely directing them to drop that litigation, emphasizing that the creditors had already flouted the Avianca plan injunctions and “demonstrated their contempt” for prior orders of the Bankruptcy Court in the case and the “jurisdictional reach of the Bankruptcy Code” in general.  Indeed, absent a Bankruptcy Court order, Avianca was resigned to litigating the foreign claims abroad, but beseeched the Bankruptcy Court to craft an equitable solution in the chapter 11 case to prevent an unfair double recovery by the foreign creditors and to preserve Avianca’s “fresh start” by disallowing the foreign creditor’s claims as a method of sanction. 

Avianca therefore asked the bankruptcy court to enter an order either (i) imposing sanctions disallowing the claims of the foreign creditors (allowing claims to be reinstated only if the foreign actions were discontinued within 30 days) or (ii) equitably subordinating the foreign creditors’ claims to all other claims.

At a hearing on January 19, 2023, chief bankruptcy Judge Martin Glenn said it was “clear and unambiguous” that the foreign creditors had failed to comply with the Avianca plan of reorganization that he had approved in November 2021.  However, Judge Glenn also appeared to be conflicted regarding how to proceed noting, at the hearing, that he was not aware of any other decisions granting the specific relief requested by Avianca.  

Order Granting Motion for Sanctions           

Shortly after the hearing, on January 27, 2023, the Bankruptcy Court granted Avianca’s motion for sanctions.  The order provided that, each claim of the foreign creditors was provisionally disallowed and would be permanently disallowed, unless the respective foreign creditor discontinued its foreign action and filed an affirmation regarding that discontinuance with the Bankruptcy Court within 30 days.  The Bankruptcy Court also gave Avianca 60 days to object to a claim reinstated pursuant to a discontinuation affirmation.  As of the date hereof, it appears that no foreign creditors have filed a discontinuation affirmation.

In a memorandum opinion filed on same day as the order, Judge Glenn agreed with Avianca that sanctions were appropriate because the foreign creditors subjected themselves to bankruptcy court jurisdiction by filing proofs of claim in the chapter 11 case and, despite the foreign creditors having had notice of the Bankruptcy Court’s orders, they refused to comply and “flouted the provisions” of the discharge and injunction provisions included in Avianca’s plan.  Further, Judge Glenn found coercive sanctions reasonable and effective to prevent the harm and injustice of a double recovery by the foreign creditors.  If the foreign creditors were to discontinue their foreign actions, they could “pursue their claims in the bankruptcy court.”  If, on the other hand, they did not comply with the court’s order their claims would “be disallowed, as any double recovery” would be “obtained at the expense of Avianca’s other unsecured creditors would be unfairly diluted.”  The sanction of disallowing the claims, subject to the foreign creditors agreeing to drop their foreign enforcement actions was “reasonable in relation to the facts.”

The efficacy of the unique sanctions in Avianca remains uncertain—i.e. whether any of the foreign creditors will discontinue their foreign claims to avoid the disallowance of their claims in the chapter 11 case—but the sanctions themselves again emphasize the international reach of the US Bankruptcy Code.