The Secret Life of Priority: Corporate Reorganization After Jevic, 93 WASH L. REV. 631 (2018)

By Jonathan C. Lipson (Temple University – James E. Beasley School of Law)

The Supreme Court’s 2017 decision in Czyzewski v. Jevic Holding Corp. (In re Jevic) reaffirms that final distributions in chapter 11 cases must follow “absolute” priority absent the “consent” of priority creditors. The Court did not, however, define “consent” for this purpose, which is a problem, because consent can be hard to pinpoint in corporate reorganizations that involve hundreds or thousands of creditors and shareholders.

In this paper, I argue that, although the Jevic majority does not define consent, its reasoning reflects concerns about aspects of the reorganization process that may serve as proxies for it: stakeholder participation, outcome predictability, and procedural integrity.

First, I explain why “consent” is indeterminate in this context, inviting an inspection of process quality. Second, I assess Jevic’s process-value framework. Implementing Jevic’s values is not costless, so the Court’s commitment to them suggests that efficiency — the mantra of many scholars — is not the only or necessarily the most important value in reorganization. Third, I argue that these values conflict with the power that senior secured creditors have gained in recent years to control corporate reorganizations. Many worry that this power is the leading problem in corporate bankruptcy, producing needless expropriation and error. I also sketch opportunities that Jevic creates for scholars and practitioners who share these concerns.

Jevic reveals a secret: “priority” is not only about the order in which a corporate debtor pays its creditors, but also about the process by which it does so.

The full article is available here.

Non-Debtor Substantive Consolidation: Do Recent Cases Signal a Judicial Preference for State Law Claims?

By Charles W. Azano (Mintz Levin).

Jurisprudence varies on whether bankruptcy courts have the power to consolidate a bankruptcy debtor with a non-debtor. Even those courts that have permitted consolidation have done so with trepidation, calling the remedy “extreme” or “extraordinary,” and that the power is to be used “cautiously” or “sparingly.”

Two courts recently addressed whether it is possible for a non-debtor to be consolidated into the bankruptcy of an affiliated debtor, or whether such attempts are dead-on-arrival. First, the Eighth Circuit Court of Appeals in Official Committee of Unsecured Creditors v. Archdiocese of Saint Paul & Minneapolis (In re Archdiocese of Saint Paul & Minneapolis), held that because Section 303(a) of the Bankruptcy Code protected non-profit entities from involuntary bankruptcy filings, non-profit non-debtors could not be substantively consolidated into a debtor’s bankruptcy. Second, the United States Bankruptcy Court of the Northern District of Illinois, in Audette v. Jasemir (In re Concepts Am., Inc.), went even further and held that substantive consolidation of a non-debtor was barred under all circumstances in the Seventh Circuit. While both cases determined that the remedy of substantive consolidation was not available, they also each suggested that state law alter ego or piercing claims may provide the creditor an alternative remedy. This may just be a coincidence, or it may be a trend. In either event, it is fair to ask if there is a growing judicial preference for state law claims when a non-debtor is involved.

The full article is available here.

The Ninth Circuit Affirms Creditors’ Ability to Block ‘Cramdown’ by Purchasing Claims

By George P. Angelich and Annie Y. Stoops (Arent Fox).

The Ninth Circuit affirmed the creditor’s ability to block “cramdown” by purchasing junior debt for the purpose of protecting its own existing claim.  In re Fagerdala USA-Lompoc, Inc., 891 F.3d 848 (9th Cir. 2018).  In reversing the bankruptcy court’s decision to designate claims for bad faith under 11 U.S.C. § 1126(e), the Ninth Circuit held that the creditor acting in its self-interest by purchasing unsecured claims to block “cramdown” did not constitute bad faith unless evidence showed the creditor acted with a motive ulterior to the purpose of protecting its economic interest in a bankruptcy proceeding.  Examples of “ulterior motive” included a creditor purchasing claims for the purpose of blocking litigation against it or a debtor arranging to have an insider purchase claims.

Fagerdala clarifies that creditors may purchase claims in defense of their economic interests in bankruptcy proceedings.  In holding that the bad faith inquiry under 11 U.S.C.  § 1126(e) requires evidence of an “ulterior motive,” the Ninth Circuit sets the stage for designation where a non-creditor or strategic investor purchases claims as an offensive move to gain an advantage over the Chapter 11 debtor.

The full article is available here.

Bankruptcy Claims Trading

By Jared A. Ellias (University of California, Hastings)

Over the past twenty years, a robust secondary market has emerged in the debt of Chapter 11 firms. Critics worry that the trading associated with this market has undermined bankruptcy governance, by forcing managers to negotiate with shifting groups of activist investors in the Chapter 11 bargaining process. In my new Article, “Bankruptcy Claims Trading” I perform the first empirical study of trading in the financial claims of Chapter 11 debtors to learn more about how claims trading impacts the average Chapter 11 case. Using the entire record of trading in bond debt for all Chapter 11 debtors that filed for bankruptcy between 2002 and 2012, I find that nearly all Chapter 11 bonds trade very heavily throughout the bankruptcy process. However, I find that claims trading appears to be less important for bankruptcy governance than many critics fear. The activist groups that tend to participate in negotiations usually enter cases early and rarely change significantly. This suggests that bankruptcy claims trading is, on average, much more about passive investment and much less about activist entrance and exit.

The full article is available here.