28 Law Firms Publish White Paper Addressing Trust Indenture Act Complications In Debt Restructurings

posted in: Workouts and Pre-Packs | 0

By David A. Brittenham, Matthew E. Kaplan, M. Natasha Labovitz, Peter J. Loughran, Jeffrey E. Ross, and My Chi To of Debevoise & Plimpton LLP

On April 25, 2016, 28 leading U.S. law firms published a legal opinion white paper (the “Opinion White Paper”) addressing recent decisions of the United States District Court for the Southern District of New York interpreting Section 316(b) of the Trust Indenture Act of 1939 (the “TIA”) in the Marblegate and Caesars Entertainment cases. These decisions contain language that suggests a significant departure from the widely understood meaning of TIA § 316(b) that had prevailed for decades among practitioners. They have introduced interpretive issues that have disrupted established legal opinion practice and created new obstacles for out-of-court debt restructurings.

Section 316(b) of the TIA generally provides that the right of any holder of an indenture security to receive payment of principal and interest when due may not be impaired or affected without the consent of that holder. These recent decisions suggest that TIA § 316(b) protects more than the legal right to receive payment of principal and interest in the context of a debt restructuring.

The Opinion White Paper presents general principles that can guide opinion givers until the interpretive questions raised by these recent cases are resolved through future judicial opinions or legislative action.

The Opinion White Paper and further discussion of these cases are available here: Opinion White Paper.

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The Bankruptcy Roundtable has previously posted on the Trust Indenture Act as well as the Marblegate and Caesars Entertainment cases. Most recently, Mark Roe posted an article on the underlying policy behind 316(b) and suggested regulatory and legislative changes to address the problems of bondholder holdouts and coercive exit consents: The Trust Indenture Act of 1939 in Congress and the Courts in 2016: Bringing the SEC to the Table. Additionally, the Roundtable posted the National Bankruptcy Conference Proposed Amendments to Bankruptcy Code to Facilitate Restructuring of Bond and Credit Agreement Debt.

 

Texas Supreme Court Resolves Good Faith Value Defense Issue For Fifth Circuit

posted in: Avoidance | 0

By Michael L. Cook, Schulte Roth & Zabel LLP

The Uniform Fraudulent Transfer Act (“UFTA”) (§ 8(a)), like Bankruptcy Code 548(c), provides a complete defense for a “good faith” transferee who gives “reasonably equivalent value” when receiving cash from a fraudulent debtor. Courts have been split as to whether the good faith defense is available to transferees of Ponzi scheme debtors in the fraudulent transfer context. Thus, the Fifth Circuit held an advertising firm in an SEC receiver’s Texas fraudulent transfer suit liable for $5.9 million it had received in good faith from a Ponzi scheme debtor. Janvey v. Golf Channel Inc., 780 F.3d 641, 646-47 (5th Cir. 2015 (advertising services had “no value” to Ponzi scheme creditors although services might be “quite valuable” to creditors of a legitimate business; reversed district court’s holding that defendant “looks more like an innocent trade creditor than a salesman…extending [debtor’s] Ponzi scheme.”)

The Fifth Circuit vacated its decision three months later and certified the question of “what showing of ‘value’ under [the Texas version of the [UFTA]] is sufficient for a transferee to prove…the [good-faith] affirmative defense….” 2016 WL 1268188, at *2. The Texas Supreme Court answered the question on April 1, 2016, after discussing the statutory purpose and reviewing what other federal and state courts have done. According to the court, the UFTA “does not contain separate standards for accessing ‘value’ and ‘reasonably equivalent value’ based on whether the debtor was operating a Ponzi scheme…. Value must be determined objectively at the time of the transfer and in relation to the individual exchange at hand rather than viewed in the context of the debtor’s enterprise.”

The full memo is available here: Texas Supreme Court Resolves Good Faith Defense Issue for Fifth Circuit

Failure of the Clearinghouse: Dodd-Frank’s Fatal Flaw?

Stephen J. Lubben

Harvey Washington Wiley Chair in Corporate Governance & Business Ethics, Seton Hall University School of Law.

Clearinghouses reduce risk by acting as a central hub for trades. Each party to a trade faces only the risk of the clearinghouse’s non-performance, rather than the doubtlessly greater risk that the counterparty to the trade will fail to perform.

But the concentration of derivatives trades into a very small number of clearinghouses or central counterparties (CCPs) makes the clearinghouse’s own failure a matter of systemic concern. As such, the recovery and resolution of CCPs becomes vital in the post-crisis financial system.

Given that important context, I argue in my paper—recently published in the Virginia Law & Business Review—that the lack of any obvious resolution mechanism for clearinghouses represents a major flaw in the Dodd-Frank regulatory fabric.

I explain why Dodd-Frank’s new orderly liquidation authority was probably not intended to apply to clearinghouses and would provide little help in the case of a distressed CCP in any event. The Bankruptcy Code is equally unhelpful, in that clearinghouses are forced into Chapter 7 liquidation proceedings, and the “safe harbors” for derivative contracts would make such a filing an exercise in futility.

I also argue that the CCP’s own, internal resolution mechanisms will be unworkable in times of systemic crisis. Most clearinghouse rules state that upon exhaustion of their default fund and any assessment rights they have against members, all contracts will be closed and member positions netted. Given the concentration of certain trades in one or two clearinghouses, the sudden termination of more than half of the index CDS trades—to take but one example—could not help but have systemic effects.

In the paper, I propose that the government should nationalize the clearinghouses upon failure, and that the intention to do so should be made clear ex ante. That is, the government should expressly state clearinghouses that ultimately fail will be nationalized, with specific consequences to investors, and an expectation of member participation in the recapitalization of the clearinghouse, once that becomes systemically viable. This should provide stakeholders in the clearinghouses with stronger incentives to oversee the clearinghouse’s management, and avoid such a fate.

In essence, what I propose is a system of precommitment or “structured bailouts.” Bailouts of clearinghouses seem inevitable. We must specify what would happen today, both to discourage an avoidable situation, and to facilitate an organized response in the event of an essential bailout.

The Crude Downturn for Oil Companies

By John England, Andrew Slaughter, and Anshu Mittal of Deloitte LLP

The ups and downs in the crude oil and natural gas (O&G) industry over the past two years or so boil down to a 65 percent fall in oil prices, a $2.5 trillion loss in market value and a debt overhang of about $3 trillion. With persisting uncertainty about the timing of stabilization and recovery of oil prices, the financial stress in the industry is immediate and deteriorating.

In the United States alone, 35 crude oil and natural gas producers with cumulative debt of $18 billion filed for bankruptcy protection between mid-2014 and end-2015, and an additional eight have done so this year. The majority, however, are in Chapter 11 bankruptcy and continue to operate to maintain their production- and reserve-linked loans.

But stricter loan review guidelines by the Office of the Comptroller of the Currency (OCC), the banking regulator—for instance a borrower with debt/EBITDA ratio of more than four is now flagged as doubtful— and, could prompt banks to classify more and bigger O&G loans as “substandard and worse.” In fact, using similar financial and debt repayment metrics on 500 O&G producers globally, our analysis suggests a third of them are at a high risk of debt default and may file for bankruptcy protection, unless things take a dramatic turn for the better.

These stricter guidelines, along with the continued weakness in oil prices and expiration of hedges at favorable prices are choking the much-required cash supplies. U.S. shale producers are particularly vulnerable to the squeeze, as reduced funding immediately impacts their production due to the short investment cycle and high decline rates associated with shales. This impact has been evident in the past three months, with U.S. tight oil production having declined by about five percent this year.

In conclusion, 2016 will be a period of tough, new financial choices for the O&G industry, including the oilfield service providers and drillers. Staying solvent and navigating this downturn successfully will require technology-driven optimization solutions and tailoring of the operating model and, most importantly, innovative, flexible, and adaptive thinking in sourcing, managing, and deploying scarce capital. However, these conditions lay the foundation for a price rally and better years to come for those who can navigate these rocky waters.

The full article is available here: The Crude Downturn.

Fifth Circuit Affirms Secured Lender Surcharge

posted in: Cramdown and Priority | 0

By Michael L. Cook, Schulte Roth & Zabel LLP

The cost of maintaining a secured lender’s collateral is usually borne by the unencumbered assets of the debtor’s bankruptcy estate.  In other words, administrative expenses of the debtor’s estate (e.g., professional fees) cannot be recovered from the secured lender’s collateral because the trustee or Chapter 11 debtor-in-possession acts for the benefit of unsecured creditors, not the secured creditor.  Bankruptcy Code §506(c) provides an exception to the general rule, however, when the trustee incurs properly identified preservation expenses that primarily benefit the secured lender if the lender has either caused or consented to the accrual of these expenses.

The Fifth Circuit, on December 29, 2015, required a secured lender to “pay the [encumbered] property’s maintenance expenses incurred while the [bankruptcy] trustee was trying to sell the property.”  In re Domistyle, Inc., 811 F.3d 691 (5th Cir. 2015).  Explaining the Code’s “narrow” and “extraordinary” exception to the general rule meant to prevent a windfall to a secured creditor at the expense of unsecured creditors, the court rejected the lender’s argument that it had not benefited from the expenses paid by the trustee to preserve the property.  On the facts of the case, the court found that all of the surcharged expenses related only to preserving the property’s value and preparing it for sale – e.g., security expenses, lawn mowing and roof repairs.

This article briefly summarizes those appellate decisions explaining why courts usually deny surcharge requests.  It also describes the few cases permitting surcharge.

The full article can be found here.