On April 21, the White House released a memorandum placing a reconsideration of the Dodd-Frank Act’s Orderly Liquidation Authority (OLA) on the administration’s agenda. The memorandum directs the Secretary of the Treasury, Steven Mnuchin, to review and report on the OLA within 180 days, focusing on whether the OLA might lead to excessive risk-taking by financial institutions, counterparties, and creditors; whether invoking the OLA could lead to losses for the U.S. Treasury; and whether the OLA comports with a February 3 executive order outlining the president’s principles for financial regulation. Additionally, the memorandum calls for an assessment of whether bankruptcy, under a Bankruptcy Code amended to accommodate financial institutions, would be a more effective method of resolving failed financial companies than the OLA.
President Trump’s memorandum parallels congressional efforts to amend the Bankruptcy Code, but it is not structurally identical. Earlier in April, the House passed H.R. 1667, the Financial Institution Bankruptcy Act (FIBA), which would amend the Code to facilitate a single-point-of-entry (SPOE) resolution in which only the top-tier holding company of a financial institution enters bankruptcy, while the operating subsidiaries continue running as normal and receive support from the top-tier holding company. Nearly identical versions of FIBA passed the House in 2016 and 2015. FIBA, as passed by the House, would not repeal title II of the Dodd-Frank Act. It would thus make two resolution systems available for financial institutions.
Representative Jeb Hensarling’s CHOICE Act, a sweeping package of proposed financial reforms, also incorporates the text of FIBA as it currently stands. The CHOICE Act, however, would also repeal title II, leaving FIBA as the single formal structure for resolving financial institutions.
(By Rebecca Green, Harvard Law School, J.D. 2017.)
For previous Roundtable posts on the resolution of financial institutions, see Jackson & Massman, “The Resolution of Distressed Financial Conglomerates“; Lubben & Wilmarth, “Too Big and Unable to Fail“; and “Senator Reed Introduces Bill to Assess Systemic Risk Impact of ‘Bankruptcy-for-Banks’ Reforms.”
On March 22, the Supreme Court decided Czyzewski v. Jevic Holding Corp., holding that bankruptcy courts may not approve structured dismissals that provide for distributions that deviate from ordinary priority rules without the affected creditors’ consent. According to the Court, Chapter 11 contemplates three possibilities: (1) a confirmed plan; (2) conversion to Chapter 7; or (3) dismissal. Absent an affirmative indication of congressional intent, the Court was unwilling to endorse a departure from the Code’s priority scheme; thus, it rejected the Third Circuit’s “rare cases” exception allowing courts to disregard priority in structured dismissals for “sufficient reasons.”
Dechert warns the decision could short-circuit “creative solutions to difficult and unique issues” and impose a “real economic cost” on debtors, creditors, and the courts. PretiFlaherty speculates that Jevic might give additional leverage to priority claimholders who know that debtors and secured creditors now “have one less arrow in their quiver.” More generally, Winston & Strawn predicts bankruptcy professionals will “look to Jevic for insight” when developing exit strategies in difficult cases.
Foley & Lardner highlights the Court’s basic commitment to absolute priority, while noting the Court’s careful distinction between final distributions, which must follow absolute priority, and interim distributions, which may break from priority to serve the Code’s ultimate objectives.
DrinkerBiddle emphasizes that Jevic provides “support for employee wage orders, critical vendor orders, and roll-ups,” a “shot in the arm for the sub rosa plan doctrine,” and “fodder for objections to class-skipping gift plans.” Duane Morris agrees, noting that Jevic may be “cited in unexpected ways” in battles about gift plans, critical vendor payments, and the like.
Sheppard Mullin wonders how consent will be determined in structured dismissals and whether features of plan confirmation other than absolute priority — for instance, cramdown, the bests interest test, and bad faith — will be imported into the structured dismissal context as well.
(By David Beylik, Harvard Law School, J.D. 2018.)
The roundtable has posted previously on Jevic, including a report of the case by Melissa Jacoby & Jonathan Lipson. For opposing views on the case leading up to oral argument, see Melissa Jacoby & Jonathan Lipson on their amicus brief and Bruce Grohsgal making the case for structured dismissals. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article that the Jevic opinion referenced.
By Benjamin Liu (University of Auckland Business School)
The exit consent technique refers to an offer by a bond issuer to all the bondholders to exchange the existing bonds for new bonds or other types of securities, on the condition that the tendering bondholders consent to a resolution to amend the terms of the existing bonds to make them less valuable.
In Marblegate and Caesars, the U.S. District Court for the Southern District of New York held that the relevant exit consent in each case violated Section 316(b) of the Trust Indenture Act of 1939, reasoning that Section 316(b) prohibits not only impairment of a dissenting bondholder’s formal right to payment, but also “practical impairment” of such right. This article argues that there is no sufficient justification for giving Section 316(b) a broader interpretation than its plain language suggests. Such an interpretation is inconsistent with the legislative history of Section 316(b) and how the term “impairment of a right” is used in other contexts. In January 2017, in a 2–1 decision, the Second Circuit reversed the district court’s ruling in Marblegate, holding that Section 316(b) prohibits only non-consensual amendments to an indenture’s core payment terms.
In Assenagon, the U.K. High Court held that the exit consent arrangement in that case was unlawful because it breached the abuse principle under English law. This article argues that the application of the abuse principle in exit consent cases should be considered in light of the facts and the parties’ presumed intention. A consenting bondholder does not abuse its power when it is simply making a rational choice. Furthermore, it cannot possibly be the parties’ presumed intention that, when the issuer has made an exchange offer coupled with an exit consent, the consenting bondholder is required to prioritize the interests of the dissenting bondholders over its own interest.
The full article is available here.
For past Roundtable posts on exit consents and related issues, see the Roundtable’s round up of reactions to the recent Marblegate decision; our post covering a white paper by twenty-eight law firms on debt restructurings and the TIA; and Roe, “Fixing the Trust Indenture Act to Allow Restructuring Votes.”
By Adrian Walters (Chicago-Kent College of Law, Illinois Institute of Technology)
As Oscar Couwenberg and Stephen Lubben have demonstrated, foreign firms commonly file for bankruptcy in the United States in order to take advantage of chapter 11 of the Bankruptcy Code. But overseas critics tend to balk at the ease with which global bankruptcy jurisdiction can be engineered in the United States through a combination of the Bankruptcy Code’s low bar to entry and the worldwide effects of a bankruptcy case. They complain that the formal structure of U.S. eligibility and jurisdictional rules promote abusive bankruptcy forum shopping and the harmful imposition of U.S. norms on non-U.S. stakeholders.
This article advances a revised account of U.S. bankruptcy jurisdiction over non-U.S. debtors from a distinctively Anglo-American standpoint. The article’s thesis is that critics overemphasize formal jurisdictional rules and pay insufficient attention to how U.S. courts actually exercise jurisdiction in practice. It compares the formal law “on the books” in the U.S. and U.K. for determining whether or not a domestic insolvency or restructuring proceeding relating to a foreign debtor can be maintained in each jurisdiction and provides a functional account of how U.S. bankruptcy jurisdiction over foreign entities is exercised in practice, using the concept of jurisdictional congruence as a benchmark. While the American and British approaches to abusive forum shopping are developing on different legal cultural paths, the article also identifies reasons for thinking that they are trending towards a rough functional equivalence influenced, at least in part, by the U.S.’s commitment to the UNCITRAL Model Law through chapter 15 of the Bankruptcy Code.
In sum, the article lays foundations for further critical reflection on the roles that judges, practitioners, and the “center of main interests” standard play in configuring the market for international bankruptcy case filings and in facilitating and regulating forum shopping in that market. Through the lens of legal development, it also presents some practical and policy challenges for universalism, international insolvency law’s dominant theory.
The full article is available here.
By Debra A. Dandeneau (Baker & McKenzie)
Elliott v. General Motors LLC (In re Motors Liquidation Co.), 829 F.3d 135 (2d Cir. 2016), addresses General Motors’ attempt to sell substantially all of its assets to “New GM” free and clear of certain claims of vehicle owners under the Bankruptcy Code.
“New GM” acquired GM’s assets in a bankruptcy court-approved sale. New GM assumed liability for claims arising from any accidents occurring after the closing date and for any express vehicle warranties. Three classes of vehicle purchasers were not covered:
– prepetition purchasers with prepetition injuries from the “ignition switch defect,”
– prepetition purchasers with economic damages as a result of defects not covered by an express warranty, and
– postpetition purchasers of used GM vehicles who claimed economic damages as a result of defects.
The Second Circuit held that a debtor may sell free and clear of successor liability claims, but independent claims against New GM were not covered by the “free and clear” sale.
The court applied a variation of the “relationship test,” which requires prepetition conduct by the debtor plus some minimum contact or relationship with the claimant, to determine whether the purchasers held “claims.” Both pre-closing accident claims and economic loss claims by prepetition purchasers constituted “claims,” but postpetition purchasers of used vehicles did not have “claims.”
To determine whether the holders of prepetition claims received sufficient notice, the Second Circuit focused on GM’s knowledge of the claims instead of its knowledge of the identity of the creditors.
The full client alert is available here.
By Jonathan C. Lipson (Temple University-Beasley School of Law) and Melissa B. Jacoby (University of North Carolina – Chapel Hill School of Law)
The U.S. Supreme Court decided Czyzewski v. Jevic Holding Corp., in which we coauthored a brief for amici curiae law professors in support of Petitioners, truck drivers whom Jevic terminated shortly before it filed for bankruptcy. Holding about $8.3 million in priority wage claims, these workers objected to a settlement that Jevic’s shareholders and senior lenders reached with the creditors’ committee. The settlement denied the workers their priority payment, dismissed the bankruptcy, and foreclosed the workers’ rights to challenge under state law the leveraged buyout that led to the bankruptcy. The Third Circuit concluded that such a settlement was permissible in “rare” circumstances. The Supreme Court disagreed, holding that structured dismissals must comply with priority rules absent consent of the affected parties.
Justice Breyer’s majority opinion is notable for at least two reasons. First, it recognizes what was ultimately at stake: the integrity and efficiency of the chapter 11 process. The consequences of failing to reverse, the Court explains, “are potentially serious,” and include “risks of collusion,” “making settlement more difficult to achieve,” and eroding procedural protections that “Congress granted particular classes of creditors,” such as unpaid workers. The Court found no basis in bankruptcy law to allow for exceptions to priority rules in “rare” cases, and seemed to doubt that Jevic was such a case in any event.
Second, consider what Justice Breyer’s decision does not do. It does not, contrary to some reports, prohibit all structured dismissals: “We express no view about the legality of structured dismissals in general,” Justice Breyer noted. The decision also distinguishes the impermissible final distribution in Jevic from interim distributions, such as critical vendor orders, which might deviate from bankruptcy’s priority rules temporarily, but serve other fundamental objectives. By contrast, the Court in Jevic could not find “any significant offsetting bankruptcy-related justification.” The opinion also avoided related issues, such as the propriety of “gift plans” or third-party releases. It shows, however, that Justice Breyer may be the best Justice for the job, if or when the Court chooses to tackle those questions.
The Roundtable posted opposing views on Jevic leading up to oral argument in the case see. See Melissa Jacoby & Jonathan Lipson on their amicus brief and Bruce Grohsgal making the case for structured dismissals. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article that was referenced in the Jevic opinion.
By Jennifer Payne (Oxford University)
This paper examines the intervention of the law, and the role of the court, in debt restructuring, both in terms of imposing constraints on creditors and in seeking to ameliorate the potential abuses that can arise from such constraints. Three potential forms of abuse are examined: the imposition of a restructuring on dissenting creditors, which introduces the potential for wealth transfers between creditors; the imposition of a moratorium while a restructuring is negotiated, which might lead to misuse of the process by managers wishing to prop up companies that are not viable or may allow the managers of a viable business to “shake off” liabilities that the business is capable of servicing; and the imposition of debtor-in-possession arrangements, which raise the potential for new creditors to be preferred at the expense of existing creditors. It is argued that the court’s role in protecting creditors from these three forms of potential abuse is vital, although the nature of that role differs according to the form of abuse. Recent debt restructuring reform proposals in both the UK and the EU, which adopt quite different approaches to the role of the court in this process, are examined in the light of this discussion.
The full paper is available here.
By Aurelio Gurrea-Martínez (Harvard Law School and Ibero-American Institute for Law and Finance)
Most insolvency jurisdictions provide several mechanisms to reverse transactions entered into by a debtor prior to the commencement of the bankruptcy procedure. These mechanisms, generally known as claw-back actions or avoiding powers, fulfill several economic goals. First, they act as an ex post alignment of incentives between factually insolvent debtors and their creditors, since the latter become the residual claimants of an insolvent firm but do not have any formal control over the debtor´s assets while the company is not yet subject to a bankruptcy procedure. Therefore, the existence of these mechanisms allows the prevention or, at least, reversal of opportunistic behaviors by factually insolvent debtors. Second, the existence of avoidance actions may also prevent, at an early stage, a destructive race to collect. Third, these legal devices also minimize the overinvestment problems potentially faced by insolvent debtors. Fourth, the existence of avoidance powers may encourage managers to take corrective actions in a timely manner. Finally, the existence of avoidance actions may also protect the interests of both the debtor and its creditors as a whole when some market participants want to take advantage of a distressed debtor.
However, the use—and even existence—of avoidance actions is not costless. On one hand, such actions bring litigation costs. On the other hand, the existence of these provisions may be harmful for legal certainty, especially in those countries in which bad faith is not required to avoid a transaction and the “twilight period” may be too long.
In a recent paper, I discuss how insolvency legislators should deal with this trade-off. Namely, by providing an economic and comparative analysis of avoidance actions, I discuss the optimal way to design claw-back actions across jurisdictions, taking into account the costs and benefits potentially generated by these provisions.
The full paper is available here.
By Michael Friedman, Simone Tatsch, and Nicholas Whitney (Chapman and Cutler LLP)
As more Companies face liquidity issues and near term debt maturities, they are looking closely to exceptions contained within their indenture/credit agreement covenants in order to achieve an overall or partial restructuring of their capital structure. Investments in “Unrestricted Subsidiaries” are an exception to investment covenants, which have been used in an attempt to provide flexibility in restructuring a Company’s capital structure. Before purchasing debt, distressed investors need to be mindful of what Unrestricted Subsidiaries are and how they impact the overall credit of a Company or debt recovery.
Companies may use Unrestricted Subsidiaries in order to transfer a valuable asset outside of the purview of a Financing Agreement’s covenants. A Company can use the Unrestricted Subsidiary to exchange near term maturing debt junior in the Company’s capital structure for debt issued by the Unrestricted Subsidiary – an exchange that would otherwise not be permitted by the covenants. The exchanged indebtedness could then be supported by the asset which has been transferred to the Unrestricted Subsidiary.
Two recent and well publicized examples of moving value into an Unrestricted Subsidiary are iHeartCommunications (“iHeart”) and J.Crew Group, Inc. (“J.Crew”). In iHeart, the stock of an iHeart subsidiary was moved to an Unrestricted Subsidiary in order to effect a debt exchange, while in J.Crew valuable intellectual property was moved into an Unrestricted Subsidiary for likely the same purpose. Investors must be prepared to determine if there is a way for a Company to utilize its covenants to transfer value to an Unrestricted Subsidiary.
The full client alert is available here.
By Mark J. Roe (Harvard Law School)
During the past century, three decisionmaking systems have arisen to accomplish a bankruptcy restructuring — judicial administration, a deal among the firm’s dominant players, and a sale of the firm’s operations in their entirety. Each is embedded in the Bankruptcy Code today, with all having been in play for more than a century and with each having had its heyday — its dominant age. The shifts, rises, and falls among decisionmaking systems have previously been explained by successful evolution in bankruptcy thinking, by the happenstance of the interests and views of lawyers that designed bankruptcy changes, and by the interests of those who influenced decisionmakers. Here I argue that these broad changes also stem from baseline market capacities, which shifted greatly over the past century; I build the case for shifts underlying market conditions being a major explanation for the shifts in decisionmaking modes. Keeping these three alternative decisionmaking types clearly in mind not only leads to better understanding of what bankruptcy can and cannot do, but also facilitates stronger policy decisions today here and in the world’s differing bankruptcy systems, as some tasks are best left to the market, others are best handled by the courts, and still others can be left to the inside parties to resolve.
The full article is available here.