Puerto Rico Update: White House Weighs in with a Proposal

posted in: Municipal Bankruptcy | 0

With over $70 billion in debt and little cash to fund its ongoing operations, Puerto Rico remains in a state of fiscal crisis. After this summer’s decision by the First Circuit affirming that Puerto Rico’s attempt at legislative self-help, the so-called “Recovery Act,” was unconstitutional, the Commonwealth was left to negotiate with its many creditors or else seek relief from the federal government.

On October 21, the White House introduced a plan urging Congress to address the situation in Puerto Rico, claiming that it “could become a humanitarian crisis” absent federal intervention.

The heart of the Obama administration’s plan is a robust legislative framework for extending bankruptcy protection to Puerto Rico’s public organs. In addition to supporting currently pending legislation that would extend Chapter 9 to Puerto Rico – allowing Puerto Rico’s municipalities to file for bankruptcy – the plan also proposes “a broader legal framework that goes beyond Chapter 9 to allow for a comprehensive restructuring of Puerto Rico’s liabilities.” The plan conditions access to this new territorial bankruptcy regime on the establishment of a fiscal oversight body to ensure that Puerto Rico “adheres to its recovery plan and fully implements proposed reforms.” The plan also encouraged Congress to reform Puerto Rico’s Medicaid program and to provide Puerto Ricans with access to the Earned Income Tax Credit.

The plan, described by the White House as A Roadmap for Congressional Action, received a “chilly” reception at a Senate committee hearing on Thursday, largely due to its lack of detail and the limited amount of information available.

For our previous posts on the situation in Puerto Rico, see here and here.

(This post was drafted by Bankruptcy Roundtable Managing Editor Robert Niles, J.D./M.B.A. ’16.)

Organized Labor and the Cost of Debt: Evidence from Union Votes

posted in: Cramdown and Priority | 0

Murillo Campello, Cornell University, National Bureau of Economic Research (NBER); Janet Gao, Indiana University – Kelley School of Business; Jiaping Qiu, McMaster University – Michael G. DeGroote School of Business; Yue Zhang, McMaster University

Despite their declining prominence, unions still shape human capital participation in corporate activity. Of the largest 100 industrial firms in the U.S. today, 33 have a unionized labor force, with most of their unions formed in the last 20 years. Unions are meant to enhance workers’ bargaining power in negotiating contracts governing benefits such as wages, health care, and pension funding. Arguably, these pecuniary benefits are less important than concerns such as job security and career development. Those non-contractual interests are most endangered when firms go bankrupt. To protect their members, unions have become active parties in legal proceedings under Chapter 11. Not surprisingly, their overriding goal in those proceedings has been that of securing job preservation.

Unionization assigns extraordinary rights to workers in bankruptcy. Critically, the shift to workers’ bargaining power can be detrimental to other corporate creditors. Building on these insights, our paper examines the effect of unionization on unsecured creditors by studying the price reactions of publicly-traded bonds to labor union elections. We do so using detailed election data from the National Labor Relations Board. Comparing closely-won and closely-lost union elections, we find that union wins lead to significant losses in bond values. Interestingly enough, they do not lead to poorer firm performance or higher default risk. We show that unionization is associated with longer proceedings in bankruptcy court, more bankruptcy emergences and refilings, and higher bankruptcy fees and expenses, all of which aggravate bondholders’ losses. Simply put, unionization bring losses to corporate creditors by way of increasing bankruptcy costs, but without increasing the likelihood that firms go into bankruptcy in the first place.

For the full article see here.

Bankruptcy in Groups

By William H. Beaver, Stanford University; Stefano Cascino, London School of Economics; Maria Correia, London Business School; and Maureen F. McNichols, Stanford University

Group bankruptcies tend to be large and affect a significant number of stakeholders. Business groups constitute a common way for ultimate owners to exercise control over a large number of companies while containing their risk exposure to different parts of the business through limited liability. In countries with underdeveloped financial infrastructures, business groups overcome difficulties in accessing external finance by reshuffling funds within the corporate structure.

In our study, we seek to understand how financial distress takes place within a business group. Using a large cross-country sample of group-affiliated firms, we show that group structure matters for parent and subsidiary bankruptcy prediction. Moreover, we show that the re-allocation of resources among group firms is likely to be a channel through which parent firms manage intra-group credit risk. Parents may be required to support financially distressed subsidiaries as a result of explicit or implicit agreements. Absent these agreements, parents might also have an incentive to support financially distressed subsidiaries as the bankruptcy of a subsidiary may impose severe costs (e.g., reputational damage, cross-default, direct liability under veil piercing). Intra-group support can also flow in the opposite direction as distressed parents may seek financial aid from healthy subsidiaries. The results of our study show that the association between parent and subsidiary default probabilities varies with the level of subsidiary integration within the group and country-level institutional quality. A shock to the parent probability of default is less likely to propagate to subsidiaries in countries with strong anti-self-dealing, investor protection, director liability and related-party transaction regulations.

Our findings are relevant for financial reporting regulators, auditors, investors and credit rating agencies, and speak to the regulatory debate on cross-border insolvencies.

The full article is available here.

WSJ The Examiners — Trust Indenture Act

posted in: Workouts and Pre-Packs | 0

In light of recent court developments in Marblegate and Caesars, in which courts interpreted Section 316(b) of the Trust Indenture Act (“TIA”) as barring bond exchange offers at issue, the Wall Street Journal’s Bankruptcy Beat this month posted responses to this question: how does bondholders’ use of the Trust Indenture Act affect companies’ ability to complete out-of-court restructurings?

Mark Roe sees the recent decisions as properly interpreting the TIA (see The Voting Prohibition in Bond Workouts for further analysis). But he sees the TIA to be a poor statute for today’s institutionalized market and urges the SEC to use its power to exempt transactions from the TIA, so as to allow binding votes in non-coercive out-of-court restructurings.

Adam Levitin and Sharon Levine predict that more companies will hesitate to register their debts to keep them out from the TIA. Levitin also sees the TIA’s voting ban as outmoded.

Jay Goffman discusses negative consequences of broad minority bondholder power and predicts that companies will limit their use of out-of-court exchange offers. J. Scott Victor also predicts that more companies will file for Chapter 11 bankruptcy when minority bondholders hold out and prevent out-of-court restructurings.

Jack Butler concludes that the TIA’s legislative intent was not to grant bondholders more than the legal right to sue the debtor, even if an exit consent transaction ousted them of the practical capacity to be paid.

On the other hand, Richard Chesley argues that recent decisions should not affect the use of out-of-court restructurings, while Brett Miller expects further judicial opinions on the scope and reach of the Trust Indenture Act.

For previous Bankruptcy Roundtable posts discussing the Trust Indenture Act’s scope, see herehere, and here.

(This post was drafted by Jenny Choi, J.D. ’16.)