In Re: Arcapita Bank B.S.C.

Background

Arcapita Bank B.S.C.(C), a Bahrain-licensed Islamic wholesale bank, filed for Chapter 11 protection on March 19, 2012. Before the filing, Arcapita and Bahrain Islamic Bank (BisB) made short-term, Shari’a-compliant investments with each other. These transactions used commodity murabahas: arrangements in which one party transferred funds, the other party bought commodities as an intermediary, and then agreed to repurchase them later for the original cost plus a fixed profit amount.

BisB had placed approximately $9.8 million with Arcapita, and Arcapita owed that amount when it entered bankruptcy. Shortly before the filing, Arcapita made three $10 million placements with BisB. BisB paid the proceeds from two placements but retained $10 million from the third. BisB later claimed that it had exercised a right of setoff under Bahraini law, meaning it subtracted Arcapita’s debt from the money it owed Arcapita. The Central Bank of Bahrain then issued a Formal Direction instructing BisB to return the funds or seek permission from the Bankruptcy Court before exercising a setoff.

The official committee of unsecured creditors brought adversary proceedings against BisB for breach of contract under Bahraini law, violation of the Bankruptcy Code’s automatic stay, and turnover of property belonging to the bankruptcy estate. The Bankruptcy Court ultimately granted the committee’s motion for summary judgment, denied BisB’s cross-motion, ordered turnover, awarded prejudgment interest, and entered judgment for the committee. BisB appealed five Bankruptcy Court orders.

Personal Jurisdiction and International Comity

The court affirmed the Bankruptcy Court’s refusal to reconsider personal jurisdiction. An earlier District Court ruling had held that BisB purposefully connected itself to New York by choosing to route the placements through its New York correspondent bank accounts. Because BisB did not appeal that ruling, it became binding law for the later stages of the case. The later-discovered evidence that Arcapita had requested transactions in U.S. dollars did not change the result because BisB accepted those terms and selected the New York accounts.

The court also affirmed the Bankruptcy Court’s refusal to abstain based on international comity, a doctrine under which a court may decline to apply its law when doing so would improperly interfere with another country’s interests. The court held that BisB had not shown a true conflict between U.S. and Bahraini law. The Central Bank of Bahrain’s Formal Direction instructed BisB either to return the funds or seek relief from the U.S. Bankruptcy Court, which supported the conclusion that the two legal systems did not require incompatible actions. The court also affirmed the denial of BisB’s reconsideration motion because BisB had not adequately argued that ruling on appeal.

Setoff and Safe Harbors

The court affirmed the finding that BisB lacked a valid right of setoff under Bahraini law or Shari’a principles. Even if BisB had a setoff right when it asserted it on June 28, 2012, the court held that the Central Bank’s later Formal Direction controlled and required BisB to return the funds or seek permission from the Bankruptcy Court. Under Bahraini law, the court explained, a special law addressing a specific issue takes precedence over general provisions of the Bahraini Civil Code.

The court also affirmed the conclusion that the murabaha transactions were not protected by the Bankruptcy Code’s safe-harbor provisions. The transactions were not securities because they were loan-like, were not publicly traded or liquid, and lacked typical shareholder features. They were not forward contracts or swap agreements because the commodities were used as a vehicle for financing, neither party retained them long enough to face meaningful price risk, and the transactions did not have the required relationship to financial markets. BisB also waived its argument that the transactions were protected as contractual rights under the law merchant or normal business practice by failing to develop that argument on appeal.

The court further affirmed the finding that BisB incurred the relevant debt for the purpose of obtaining a setoff, which would independently disallow the setoff under Section 553(a)(3)(C) of the Bankruptcy Code. The court relied on the unusual timing and size of the placements, BisB’s knowledge of Arcapita’s financial difficulties, BisB’s request for an amount just above Arcapita’s debt, and the parties’ communications before and after the bankruptcy filing. The court found no clear error in the Bankruptcy Court’s conclusion that the evidence showed an effort to create a debt that could later be used for setoff.

Automatic Stay

The court affirmed the ruling that BisB violated the automatic stay under Sections 362(a)(3) and 362(a)(7) by retaining the funds. Because BisB had no valid setoff right and no applicable safe-harbor protection, it was not entitled to keep property belonging to the bankruptcy estate without obtaining relief from the stay.

Prejudgment Interest

The court affirmed the award of prejudgment interest. Although BisB argued that interest was inconsistent with Shari’a and Bahraini law, the court agreed with the Bankruptcy Court that Bahraini law allowed recovery for losses, lost profits, damages for breach of contract, and certain gains wrongfully retained. The interest award served to compensate the estate for being deprived of the funds and was not treated as a penalty.

The court also affirmed the 9 percent New York statutory rate. The Bankruptcy Court had considered the investment returns available in Bahrain, the cost of financing the bankruptcy case, possible investment returns elsewhere, and the case’s connections to New York. The court held that the Bankruptcy Court adequately explained its decision and did not abuse its discretion by rejecting BisB’s proposed federal rate.

Disposition

The court affirmed the challenged Bankruptcy Court orders and dismissed the appeal. It directed the Clerk to enter judgment in favor of the official committee of unsecured creditors and close the case.