Academic

Chung on Chapter 15 & Foreign Exchange Markets

By Lawrence Solum

John J. Chung (Roger Williams University - School of Law) has posted Chapter 15 of the Bankruptcy Code and its Implicit Assumptions Regarding the Foreign Exchange Market (Tennessee Law Review, Vol. 76, 2008) on SSRN. Here is the abstract:

The goal of Chapter 15 of the Bankruptcy Code is to require all the creditors from around the world to seek repayment in the court of the debtor's home country. In the typical case, they will be paid in the currency of the home country. But creditors are not indifferent to the currency of payment. Currencies fluctuate in value against each other. The fluctuations are potentially prejudicial because creditor claims are valued, and converted into the currency of the forum, at one point in time, but are paid out later in that same currency. Years may separate these two events. What happens if the currency of the forum falls in value against the currency of the creditor's home currency? The answer is simple: The foreign creditor receives less, when measured in its home currency. The reality of the foreign exchange market means that Chapter 15 imposes unavoidable and involuntary foreign exchange risk on creditors.

Given the nature of the foreign exchange market, the viability of Chapter 15 is based on two implicit assumptions. The first assumption is that the currency of the foreign proceeding is convertible. After all, a distribution in a foreign currency that cannot be converted into a creditor's local currency is practically worthless. The second assumption is that foreign exchange rates are stable over time. Chapter 15 implicitly assumes that a distribution in the currency of the home country to a foreign creditor in Year 4 (to pick a random year) will constitute fair compensation for a claim valued and allowed in Year 1 of the bankruptcy proceeding.

These assumptions are fragile. Currency instability (rather than stability) prevails in the foreign exchange market. Therefore, this article contends that the courts should resort to the public policy exception in Chapter 15 to protect creditors from the unavoidable risks and losses resulting from foreign exchange fluctuations. In sum, this article may be viewed as a challenge to Chapter 15's assumptions regarding the fixed nature and meaning of the value of currency. The foundation of bankruptcy law, which is the orderly repayment of debts, depends on the value of the thing (in this case, money) used as repayment. Chapter 15 assumes that the currency of one country has some fixed or stable meaning or value in relation to another currency, and that repayment in one currency has meaning or value in another currency. This article exposes the problems with these assumptions.

Full post as published by Legal Theory Blog on April 03, 2009 (boomark / email).