US law - Rule B FAQ

Rule B actions have been on the rise, so Gard News has asked James Power, Senior Counsel at Holland & Knight, New York, to clarify some aspects of this attachment procedure.

The New York maritime community anxiously and somberly anticipated the long-awaited decision in Consub Delaware LLC v. Schahin Enganharia Ltda.¹ Many predicted that the Second Circuit would severely restrict the current use of Rule B attachments in New York by disallowing the attachment of Electronic Fund Transfers (EFTs) remitted to the defendant. However, if this was the fear, the danger has been averted for the time being. In fact, the court reaffirmed Winter Storm,² which held that “EFT funds in the hands of an intermediary bank may be attached pursuant to Admiralty Rule B (1)(a).”;³ and so Rule B remains a frenzied free-for-all.

Although it agreed with Winter Storm, the Consub court specifically mentioned in a footnote that they did not consider the question of “whether funds involved in an EFT en route to a defendant are subject to a Rule B attachment”. Both matters considered EFTs that originated with the defendant. Therefore a future appeal on the issue of funds destined for the defendant remains a possibility.

In the meantime, the maritime community has been experiencing its share of the global financial turmoil and Rule B actions have been on the rise. The New York maritime bar has been busy both seeking and defending Rule B actions on behalf of their clients. Attorneys have been creative and aggressive in their representation. As a consequence, less heralded cases have been quietly but rapidly shaping the framework of the practice.

To help readers make sense of the current issues and trends, Gard News sought the insight of someone on the Rule B front-line: James Power, who is Senior Counsel at Holland & Knight. Below are Gard News’ questions and his answers:

GN: Rule B actions can impede a company’s ability to do business. What can a company do to avoid being the target of a Rule B action?

JP: There are several actions a company can take to increase the chances of avoiding Rule B attachment in the first instance, and to increase the chance of successfully vacating an attachment if a company's funds are attached. A very popular course of action that has seemed to achieve a certain degree of effectiveness in avoiding Rule B attachment has been to register as a foreign business corporation under Section 1304 of the New York State Business Corporation Law and to appoint an agent for service of process.

The premise underlying registration and designation of an agent for service of process in NY is found in the language of Rule B itself.  Essentially, Rule B states that if a defendant is not found within the district when a verified complaint is filed, a plaintiff may obtain a process (or writ) to attach the defendant's tangible or intangible property located within the district up to the amount of the claim.  Simply put, a plaintiff may attach the property of a defendant who is not "found" within the district.  Hence, if a defendant is "found" within the district, Rule B is not available and a plaintiff would be precluded from attaching property of the defendant including any EFTs passing through New York clearing house banks.  The primary issue has been the interpretation of the term "found" within the language of Rule B.  Historically it has been interpreted to mean that the defendant was engaged in a continuous course of doing business in the district such that a finding that the defendant was present in the jurisdiction would be warranted.

The legal foundation in support of registering as a foreign business corporation in New York and appointing an agent for service of process has undergone a fairly significant transformation in the last year and especially in the last several months.  Although there are some cases that have clearly found a defendant who has registered as a New York foreign business corporation and appointed an agent for service of process in New York to be subject to Rule B attachment, there has been a wave of recent decisions finding that registration and appointment of an agent for service of process is sufficient to enable a company to avoid Rule B attachment.  Some companies have been successful in staving off Rule B attachments merely because they have registered and appointed an agent for process in New York.  However, there is a line of cases against a particular bankrupt charterer working their way through the Southern District Court that has shown, short of establishing a full-time operation in New York, that no measure is fool-proof in avoiding Rule B attachment.  In this case the overwhelming majority of plaintiffs was denied a writ of attachment because the defendant registered as a foreign business corporation in New York and had appointed an agent for service of process.  But there are a handful of claimants who have obtained writs.  So the lesson learned is that nothing is certain – not even when faced with similar claims by different claimants against the same defendant.  There are approximately 45 judges in the Southern District of New York, each potentially having a different view. 

GN: Several international maritime companies have offices in Connecticut or New Jersey. Is this sufficient to comply with the “adjacent jurisdiction” requirement to avoid or vacate a Rule B attachment?

JP: An important and often cited phrase from the Second Circuit Court of Appeals decision in Aqua Stoli⁴ is that a writ of attachment may be vacated if the defendant is "present in a convenient adjacent jurisdiction".  Based on this particular phrase, an important but limited body of law has developed in the last two years which can have a profound effect on whether or not a company is immune from Rule B attachment.  Based on several Southern District Court decisions, a clear but somewhat contradictory rule has emerged concerning the meaning or situs of a "convenient adjacent" jurisdiction.  Originally, the rule was interpreted to include adjacent judicial districts within New York.  New York state is divided into four federal judicial districts: Eastern, Western, Northern and Southern.  Most Rule B cases are filed in the Southern District of New York, which includes not only Manhattan (i.e., New York County) but also the counties of Bronx, Dutchess, Orange, Putnam, Rockland, Sullivan and Westchester.  It is noteworthy that some parts of Dutchess and Sullivan counties are located more than 50 miles from Manhattan.  An adjacent jurisdiction was initially considered to be for example, the Eastern District which includes Brooklyn (Kings County) and Long Island (Suffolk, Nassau and Queens Counties).

Thus, a shipping company with an office on Long Island would be located in a "convenient adjacent jurisdiction" such that a maritime claimant would be precluded from attaching that company's property, including bank accounts located in either the Eastern District of New York or the Southern District of New York. 

Recent cases have expanded the definition of convenient adjacent jurisdiction to include not only districts in New York, but adjacent state jurisdictions.  The current state of the law instructs that New Jersey is considered a "convenient adjacent jurisdiction".  Therefore, a maritime claimant would be precluded from attaching wire transfers passing through New York banks if a defendant shipping company has an office in New Jersey. 

However, Connecticut, which seems to be the preferred home port for many US-based shipping companies, has been the subject of conflicting Southern District Court decisions on whether it is considered to be a "convenient adjacent" jurisdiction for the purpose of avoiding Rule B attachment.  Up until 17th November 2008 Connecticut was not considered to be a "convenient adjacent" jurisdiction.  However, on 17th November 2008 Judge Sand held that Connecticut, like New Jersey, is a "convenient jurisdiction".⁵  Although this recent decision gives some promise to those shipping companies based in Connecticut, there still remains a conflicting District Court decision on the same issue.  Therefore, companies based in Connecticut that have registered as foreign business corporations in New York should use caution in making any immediate withdrawals of their New York presence as the law on whether Connecticut is a "convenient adjacent" jurisdiction remains dangerously unsettled. 

GN: In recent weeks we have seen several operators encounter financial difficulty and some have entered into bankruptcy proceedings. How does the dissolution of a company affect Rule B proceedings?

JP: A few months ago it would have been difficult to imagine our thoughts turning to questions about bankruptcy and dissolution.  However, this issue will probably gain greater significance in the months to come.  I have seen reports of two major bankruptcy-related proceedings initiated in London and Greece in the last two weeks.  A review of the Southern District electronic docket shows that Rule B activity against these companies increased significantly just prior to the respective filings and Rule B actions continue to be filed against these entities.  As many Gard members may already know, Rule B attachment, whether valid or invalid, can and often does cause harm to a company's normal operations.  Crucial funds are often attached at the most inopportune times.  One can appreciate that interruption in cash flow can have a profound effect on one's ability to pay others. 

While rules and procedures in bankruptcy or other related dissolution proceedings vary from jurisdiction to jurisdiction, in the simplest form, they are often used to rehabilitate the company so that it can emerge from the proceedings as a stronger operational entity.  In this situation, the legal proceedings provide legal safeguards that prevent creditors from further disrupting the operations of the company.  On the other hand, if a company is intending to dissolve, then the legal proceedings provide a mechanism for the orderly dissolution and distribution of assets.  However, the ability of a bankruptcy court to enforce its laws in other jurisdictions around the world is somewhat limited. For example, it should not be assumed that a company can protect itself from Rule B attachment of EFTs passing through New York by initiating bankruptcy proceedings in Greece or London.

If an owner or charterer that has filed for bankruptcy or administrative proceedings in a foreign jurisdiction wishes to prevent post-filing of Rule B attachment, there appears to be a procedural mechanism for recognition of the foreign proceedings in Chapter 15 of the US Bankruptcy Code.  The intended purpose of Chapter 15 is to provide recognition to foreign bankruptcy proceedings.  Therefore, in order to potentially stay any Rule B attachments of EFTs during the pendency of a foreign bankruptcy-related proceeding, a debtor (or administrator or liquidator) might seek to have the foreign bankruptcy court appoint a foreign representative in the US.  Once a Chapter 15 proceeding is initiated in the US Bankruptcy Court, most likely in the Southern District of New York, the foreign representative may seek to obtain a stay of execution against the debtor's assets.  This includes Rule B attachments.  Chapter 15 is relatively new and has not been used in the Rule B context but its predecessor statute was, and its use suggests that there may even be the potential of "reclaiming" for the benefit of the debtor any Rule B attachments filed after the foreign bankruptcy proceeding was initiated and perhaps even earlier.

GN: If a company finds itself the target of a Rule B action, can the plaintiff be forced to accept alternative security to avoid the further obstruction of the defendant’s business?

JP: A maritime claimant has the right to accept certain approved forms of security, but if the substitute security offered by a defendant in a Rule B action is not one of the approved forms then there is no requirement that it be accepted by the plaintiff.

Local Rule 65.1.1 of the Local Rules of the Southern District of New York provides a firm guideline for what constitutes adequate security.  Under Local Rule 65.1.1 sufficient substitute security includes:  1) cash or government bonds in the amount of the claim; 2) an undertaking or guarantee of a corporate surety holding a certificate of authority from the Secretary of Treasury; or 3) the undertaking or guarantee of two individual residents of the district in which the case is pending, each of whom owns real or personal property within the district worth double the amount of the bond.

While the exchange of P&I Club Letters of Undertaking (LOUs) is common in the global maritime community as security for maritime claims, there is absolutely no requirement that a maritime Rule B claimant accept a Club LOU as substitute security.  Similarly, it is often assumed that a bank guarantee is adequate substitute security.  Not so.  There have been specific instances where courts have refused to require a Rule B claimant to accept a foreign bank guarantee as substitute security. 

That being said, there are always exceptions. Obviously the parties can agree to a Club LOU as substitute security.  Also, a point to consider by any owner or charterer in this precarious environment is including a clause in the applicable charterparty designating a particular form of substitute security and perhaps setting the parameters for the security. For example, a charter could specify, or even require, that before a Rule B is filed, a demand for security must be made.  If the other party offers a Club LOU or bank guarantee within the set parameters, then a Rule B can be avoided.

GN: We have seen government-owned companies fail to pay their debts and then claim immunity under the Foreign Sovereign Immunities Act when an action is commenced against them. How can companies that enter into charterparties with government entities protect themselves?

JP: Any time a shipowner or charterer enters into a contract with a government-owned company, or a company believed to be government owned, great care should be taken to assess the risk involved. Severe limitations are imposed on one's ability to obtain pre-judgment security.  As far as Rule B attachment is concerned, the Foreign

Sovereign Immunities Act (FSIA) greatly limits a party's ability to obtain security by attaching property of a state-owned entity in the US, including EFTs. In the Rule B context, the party claiming immunity must make out a prima facie showing that it is an "instrumentality" or an "organ" of a "foreign state.”⁶  Generally, the entity claiming immunity must show that it is directly owned by the State and not a subsidiary of another entity.⁷  Furthermore, the entity must show it was created for a national purpose.⁸  If that burden is met it is then up to the Rule B claimant to show that an exception to immunity applies. 

Under the FSIA, "foreign states shall be immune from attachment”.  However, there are a few limited exceptions to this general rule.  The exception most relevant to Gard News readers involves an "express waiver".  What constitutes an express waiver of immunity under the FSIA is open to debate and is often fact-specific.  However, we can be sure that an explicit, not an implicit,  waiver is required.  Some courts have found that if the charterparty contains language evidencing a right to attach funds of the state-owned entity, as opposed to merely obtaining a lien, that can be considered an express waiver of sovereign immunity.  Other courts have found that the phrase "secure payment of money" was clearly intended to grant a security interest in certain property which includes the right to attach property.

Therefore, without requiring certain express waivers from the state-owned entity, a party in contractual privity with a state-owned entity may unwittingly find themselves in a most undesirable position.  For example, in the bulk trades we often see many sub-charter arrangements whereby the last charterer in line has contracted directly with a state-owned entity.  Should the state-owned entity refuse to provide cargo for shipment or perhaps decrease the imports of iron ore for steel mills, the charterer last in line may find itself in a position whereby it is unable to make the required hire payments to the time-chartered owner.  In this situation, the party in contract with the state-owned entity would generally be precluded from obtaining a Rule B attachment of the state-owned entity's funds, but the party from whom it chartered the vessel could attach funds pursuant to Rule B.  Thus, the financial hardship of not receiving the expected hire payments from the state-owned entity is exacerbated when your wire transfers are attached by the time-chartered owner. At the time of contracting, it may be nearly impossible to ascertain the exact state ownership interest of an entity.  Nevertheless, a party that has any doubt should perform some initial due diligence to determine the likelihood that the other party to the contract may have a valid claim for immunity to Rule B attachment under the FSIA. 

GN: Often Rule B actions will claim (rightly or wrongly) that related entities are alter-egos for the offending company. As a result, sometimes innocent companies are unjustly targeted and their business ravaged by Rule B. Is anyone safe?

JP: This practice of naming as many related (and sometimes unrelated) entities as possible in order to expand the net for attaching electronic wire transfers has been gaining in popularity by aggressive maritime claimants.  In the US corporations have safeguards provided they follow certain corporate formalities.  If these corporate formalities are followed, the acts and liabilities of a corporation are typically limited to that corporation alone – and are not attributable to the parent corporation or other related companies.  While there are clear standards in place regarding what constitutes an alter-ego company for the purpose of piercing the corporate veil, the temporary nature of Rule B attachments has created a "grey area" in which many maritime claimants operate. 

Rule B requires that a plaintiff meets minimum standards for pleading alter-ego.  Many Rule B complaints filed in the Southern District of New York merely allege that "upon information and belief" company X is the alter-ego of company Y.  Though many judges find these bare allegations insufficient to support an alter-ego allegation, there have been instances where writs of attachment have been issued.

Somewhat related to an alter-ego allegation is an allegation that the defendant or co-defendant is a paying agent.  This allegation has gained some traction recently.  Essentially, a maritime plaintiff makes combined allegations that the several named defendants are somehow alter-egos and/or paying agents for each other.  Typically, there is some evidence that one of the defendants made one or more payments on behalf of the other.  It does not necessarily have to be hire payments.  This practice is not uncommon as ship managers often make payments from time to time on behalf of, and as instructed by, an owner or charterer.  However, in today's Rule B legal environment these seemingly harmless acts can cause hardship in the event a Rule B complaint is filed.  Companies should take care to make clear to any third parties that they are not acting as a "paying agent".  If a payment is made on behalf of a principal some statement should be made that it is a one-time payment. 

Once a plaintiff in a Rule B action makes out a prima facie case, the defendant must then come forward to rebut the alter-ego allegations made in the complaint.  However, by this time funds may have already been attached.  Because Rule B is used by many maritime claimants as a means to obtain pre-judgment security, the mere attachment of funds, even if only temporary, may serve the interests of the plaintiff.  In the majority of cases, substitute security in the form of a LOU or a bank guarantee is obtained, even if the defendant has a valid defence to the alter-ego or paying agent claim.  However, some defendants choose to stand and fight the alter-ego allegations based on principle.  Under the strict letter of the law, there are indeed safeguards in place to protect against baseless alter-ego allegations.  Companies should be prepared, however, to demonstrate that they have in fact followed certain guidelines required to defeat an alter-ego claim by an aggressive maritime Rule B claimant.

Companies seeking to protect themselves from Rule B attachment should be extra-vigilant in dealing with corporate parents, subsidiaries and related entities.  Courts look to a host of factors in considering whether or not an alter-ego claim for liability has been sufficiently alleged.  These factors include:
1) disregard of corporate formalities;
2) inadequate capitalisation;
3) intermingling of funds;
4) overlap of ownership, officers, directors and personnel;
5) common office space, address and telephone numbers of corporate entities;
6) the degree of discretion shown by the allegedly dominated corporation;
7) whether the dealings between the entities are at arms length;
8) whether the corporations are treated as independent profit centres;
9) payment or guarantee of the corporation's debts by the dominating entity; and,
10) intermingling of property between the entities. These factors are not mutually exclusive and over the years courts have added other factors to consider in determining whether to pierce the corporate veil. 

Overall, if companies take certain minimum precautions when dealing with other companies within an umbrella organisation, they should be on solid ground for defending against alter-ego or paying agent allegations.  

Conclusion
The incidence of Rule B attachments has increased of late and the current financial climate has many companies looking for protection lest they find themselves trying to do business without a cash-flow. Be reminded that the solution that works for one company may actually create greater problems for another. It is possible that an unwitting company, in attempting to avoid becoming the target of a Rule B proceeding, may find itself subject to personal jurisdiction and unlimited liability. Therefore, the consequences to an individual company of registering to do business in New York must be vetted thoroughly with competent counsel based on the relevant factual circumstances.

Footnotes
1 2d Cir., Docket No. 07-0833-cv (23rd September 2008).
2 310 F.3d 263 (2d Cir. 2002).
3 310 F3d. at 278.
4 Aqua Stoli Shipping Ltd. v. Gardner Smith Pty Ltd., 460 F.3d 434 (2d Cir. 2006).
5 Swiss Marine Services S.A. v. Louis Dreyfus Energy Services L.P., No. 08 Civ. 7981 (S.D.N.Y. 17th November 2008).
6 The FSIA defines, in general, a "foreign state" as a "political subdivision of a foreign state or an agency or instrumentality of a foreign state". 28 U.S.C. Section 1603(a).
7 To be deemed an instrumentality of the state, investment in the company must be directly from the state, not through a corporate intermediary, even if the intermediary is owned entirely by the state.  The FSIA requires direct ownership of a majority of shares by the "foreign state".
8 A recent Southern District of New York case held that a Chinese shipping company was not an "organ" of the State because it was not formed to perform governmental functions, but rather to "engage in the shipping industry as agents, charterers, managers and operators of ocean going vessels and other functions related to the industry generally." Ocean Line Holdings Limited v. China National Chartering Corp. a/k/a Sinochart, S.D.N.Y. Docket No 07-8123 cv (Memorandum Decision issued September 26th, 2008); 2008 A.M.C. 2319 (S.D.N.Y. 2008).