Fair and Unfair Discrimination in Municipal Bankruptcy

posted in: Municipal Bankruptcy | 0

By Richard M. Hynes and Steven D. Walt, University of Virginia School of Law

hynes_0915 walt_lowresSome bankrupt municipalities have proposed plans of reorganization that offer substantially greater recoveries to their active workers and retirees than those offered to other creditors.  Because these greater recoveries are not mandated by a priority enjoyed by the active workers and retirees, a judge can only approve such a plan if it does not “discriminate unfairly” against a class of disfavored creditors that votes against the plan.  This Article describes the law defining the unfair discrimination standard, identifies the categories of circumstances in which discrimination between co-equal classes is permitted, and argues that the claims of retirees and active workers do not fall into any of these categories.  The Article concludes that current law does not allow a judge to approve a reorganization plan that provides retirees and active workers with a greater recovery.

The full version of the article can be found here.

Court of Appeals Vacates DIP Financing Order for Lender’s Lack of Good Faith

By Michael L. Cook, Schulte Roth & Zabel LLP

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The Bankruptcy Code encourages lenders to make debtor-in-possession (“DIP”) loans to Chapter 11 debtors. Because of Bankruptcy Code § 364(e), an appeal from a financing order will ordinarily be moot when the lender acted “in good faith” unless the appellant obtains a stay pending appeal.  It is hence noteworthy when appellate courts overturn DIP financing orders that were not stayed pending the appeal.

The Fifth Circuit, on September 3, 2014, vacated five bankruptcy court and district court DIP financing orders due to (1) the lender’s lack of good faith in relying on a third party’s shares of stock as collateral; and (2) the bankruptcy court’s lack of subject matter jurisdiction to authorize a lien on third party collateral subject to disputed ownership claims.   In re TMT Procurement Corp., 2014 WL 4364894 (5th Cir. Sept. 3, 2014).  On October 23, 2014 the Fifth Circuit denied the petition for panel rehearing.

The Fifth Circuit rejected the debtors’ argument that the appeals were moot because of the lower courts’ repeated findings that the lender had made the loan in good faith.  TMT provides a new test regarding the Code’s “good faith” requirement for lenders, based on the lender’s knowledge of possible insider manipulation of the bankruptcy process.  The court also found a lack of subject matter jurisdiction because the debtors’ insiders used the bankruptcy financing process to “interfere with” unrelated state court litigation against the debtors’ controlling shareholder.

The full version of the article was recently published in The Bankruptcy Strategist. It is available online here.

Chapter 22 Roundtable in the WSJ Bankruptcy Beat

Last week, the Wall Street Journal’s Bankruptcy Beat posted several pieces on the causes and consequences of so-called “Chapter 22” repeat bankruptcy filings. In the first three posts of the series, bankruptcy experts offered a range of views on the topic.

In the first post, Harvey Miller, of Weil, Gotshal & Manges, said that increased recidivism in Chapter 11 filings was largely due to distressed debt and securities investors, who effectively gain control of the debtor and its plan formulation process and do all that is necessary to expedite the plan confirmation. Because nobody in this coordinated effort will challenge the plan’s feasibility and because the judge is not well placed to independently investigate, feasibility issues may go unaddressed.

Marshall Huebner, of Davis Polk & Wardwell LLP, in the second post, noted other factors that could trigger subsequent Chapter 11 filings, including a company’s underestimation of the broader industry’s decline, creditor pressure on the debtor to remain overleveraged, and a debtor’s inability to shed legacy liabilities.

In the third post, Mark Roe, professor at Harvard Law School reasoned that, regardless of the cause, recidivism is both not that common—less than 20% of Chapter 11 debtors—and not that bad of a trade-off if it stems from getting companies through the bankruptcy process quickly, as long as most of them recover and grow. Enforcing a strict zero-tolerance feasibility standard could do more damage to debtors by keeping them in bankruptcy longer.

Visit the Bankruptcy Beat website to see the rest of the experts’ views on Chapter 22 filings.

Visit the HLS Bankruptcy Roundtable’s prior coverage of Ed Altman’s study of the frequency and nature of Chapter 22 filings, posted in June, here.

This summary was drafted by Stephanie Massman (J.D. 2015)

Derivatives and Collateral: Balancing Remedies and Systemic Risk

By Steven L. Schwarcz, Duke University School of Law

schwarczProfessor Schwarcz examines whether the bankruptcy “safe harbor” for derivatives is necessary or even appropriate to protect against systemic risk—such protection being the safe harbor’s articulated justification. The article examines the most important function of the safe harbor: allowing derivatives counterparties to exercise their contractual enforcement remedies against a debtor or its property notwithstanding bankruptcy law’s stay of enforcement actions. A threshold question is whether there is anything inherently risky about derivatives that might cause a systemic failure.

The standard answer is volatility. But, the article observes, regulation could reduce that potential for systemic risk in a more limited fashion. The article next addresses the safe harbor from the standpoint of its impact on avoiding contagion. The safe harbor is supposed to enable large derivatives dealers to enforce their remedies against a failed counterparty, thereby minimizing the dealer’s losses and reducing its chance of collapse. There are, however, several flaws in the safe harbor’s design to accomplish that. First, the safe harbor incentivizes systemically risky market concentration by enabling dealers and other parties to virtually ignore counterparty risk. Second, the safe harbor operates independently of the size of the counterparty or its portfolio. The article then examines how the Lehman bankruptcy might inform the safe harbor debate. The article offers a final caution: To the extent the safe harbor might amplify, rather than protect against, systemic risk, its negative impact would transcend the traditional derivatives market.

The full version of this article is forthcoming from the University of Illinois Law Review and is available in draft form here.