A Cautionary Tale for Claims Traders and Other Contract Counterparties

posted in: Claims Trading | 0

By David Griffiths and Leonard Yoo (Weil, Gotshal & Manges LLP).

During a negotiation over a sale of claims, when parties agree to a price and preliminarily agree to enter into a final agreement, is there a binding agreement to negotiate in good faith towards a final agreement? 

The bankruptcy court in Westinghouse addressed this very issue.  In Westinghouse, Seaport, on behalf of its client, reached out to Landstar to purchase its claims against Westinghouse Electric Company LLC.  An employee of Landstar negotiated with Seaport to sell the claims but explained to Seaport that, while she was authorized to negotiate a price, all other terms would need to be approved by Landstar’s legal counsel.  Seaport and Landstar’s employee eventually agreed to a price for the claims that was “subject to” executed documentation.  Two days after this agreement, Landstar informed Seaport that it decided to not go through with the sale.  Seaport and its client litigated this matter arguing that there was a binding obligation to negotiate in good faith because it was customary in the claims trading industry for parties to agree on the price over email and negotiate the other terms towards a final agreement. 

The bankruptcy court disagreed and held that a preliminary agreement to negotiate in good faith was not formed because, among other reasons, (i) Landstar reserved its right to not enter into a binding agreement and (ii) Seaport did not explicitly confirm with Landstar that there was an enforceable agreement as to the obligation to negotiate in good faith nor the purchase price.

The full article is available here.

Junior Creditors Could Share In 363 Bankruptcy Sales

posted in: 363 Sale, Priority, Valuation | 0

By Charles Tabb and Tamar Dolcourt (Foley & Lardner LLP).

In July, the Seventh Circuit Court of Appeals issued a decision that appeared to upend the long-held understanding that an underwater secured creditor was entitled to all of the proceeds of a sale under Section 363 of the Bankruptcy Code. In our new article, we analyzed the decision in Illinois Department of Revenue v. Hanmi Bank in which the Seventh Circuit opened the door to a potential recovery for out-of-the-money junior creditors based on the theory that a free and clear sale under the Bankruptcy Code created a premium for the assets that the junior creditor may be entitled to share. Though Hanmi dealt explicitly with a state taxing authority and its particular rights under Illinois state law, there is nothing in the opinion which limits it to those facts or that type of creditor. Furthermore, even though the court ultimately valued the interest that the Illinois Department of Revenue was forced to give up through the free and clear sale at zero, that was simply a failure of proof in the particular case. We also consider the long-term ramifications of this opinion and its likely effect on future sales under Section 363, including the possibility of increased costs and delays of negotiating these sales with recalcitrant junior creditors.

The article may be found at Law 360:  the original publication.

A New Approach to Executory Contracts

By John A. E. Pottow (University of Michigan Law School)

Few bankruptcy topics have bedeviled courts—and busied commentators—as much as executory contracts. Perhaps the most nettlesome challenge is the problem of defining “executoriness,” which serves as the statutory gatekeeper to Section 365 of the Bankruptcy Code and its extraordinary powers. Elite lawyers, who are the closest approximation to chapter 11 repeat players, have no ex ante incentive to fix a definition; in part succumbing to a vividness bias, they want to exploit executoriness’s inherent ambiguity to select the definition perceived to be most advantageous in any given case ad hoc. From Westbrook to Countryman before, authors have struggled to find a coherent and normatively defensible definition of executoriness (including Westbrook’s call for its abolition) that would stop this gamesmanship, and even the American Bankruptcy Institute’s Review Commission has now entered the debate.

This article takes a new approach. It suggests abandoning the bootless task of finding the right test and concedes that executoriness is here to stay. This new approach focuses on the residuum of the “non-executory contract.” Using the policies, structure, and text of the Code, it argues that many of Section 365’s provisions can be synthetically replicated elsewhere. Doing so will blunt the strategic incentive to invest resources fighting the absence or presence of executoriness ab initio by scuttling the payoff. Concomitant gains will accrue to all.

The full article is available here.

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.

Three Provocative Business Bankruptcy Decisions of 2018

By Michael L. Cook (Schulte, Roth & Zabel LLP).

The appellate courts have issued at least three provocative, if not questionable, business bankruptcy decisions in the past six months.

Lakeridge:  In March, 2018, the U.S. Supreme Court avoided the substantive merits of a 2016 split decision by the Ninth Circuit that had permitted a Chapter 11 debtor to manipulate the reorganization plan process.  Despite the Court’s narrow holding approving the Ninth Circuit’s “clear error” standard for reviewing a bankruptcy court’s fact findings, four Justices wrote two separate opinions challenging the Court’s limited review of the Ninth Circuit’s stunning decision in the face of a powerful dissent.

In re Anderson:  The Second Circuit, on March 7, 2018, held that an asserted bankruptcy discharge violation was not arbitrable due to a conflict between the Federal Arbitration Act and the Bankruptcy Code.  Two months later, though, the Supreme Court stressed that it had rejected every effort to “conjure” conflicts between the Arbitration Act and a raft of other Federal statutes.

In re Temptnology:  the First Circuit, on January 12, 2018, in a split decision, wiped out the rights of a trademark licensee, explicitly rejecting a 2012 decision by the Seventh Circuit.  The First Circuit’s majority opinion relied on a heavily criticized 1985 Fourth Circuit decision, premising its  holding on the primacy of Federal bankruptcy law over Federal trademark law and distinguishing between a statutory breach and a common law breach.

The losing parties in the First and Second Circuit cases filed petitions for certiorari in June, 2018.  Given the Circuit split in one case and the later Supreme Court arbitration ruling in the other, both cases warrant Supreme Court review.

The full article is available here.


We at the Bankruptcy Roundtable will take a break from posting this August and hope that you too will be able to get away from your desk at work. We’ll be back after Labor Day.

Repo Markets Across the Atlantic: Similar but Unalike

By Songjiwen Wu (University of Heidelberg) and Hossein Nabilou (Universite du Luxembourg – Faculty of Law, Economics and Finance)

The vulnerabilities in the wholesale funding and in particular short-term (overnight) repurchase agreement (repo) markets were significant sources of systemic risk in the Global Financial Crisis. Numerous studies have investigated the role of repos in the crisis, but only a few scholars have explored why the European repo markets have weathered the crisis better than their US counterparts. With a focus on the underlying legal and structural features of repo markets across the Atlantic, our paper sets out to explain such a different outcome. In doing so, it sketches the key differences in the EU and the US repos by focusing on three main aspects of repo markets that are pivotal to highlighting potential vulnerabilities. First, it highlights the differences in the legal framework governing repos, such as legal construction of repo contracts, special bankruptcy treatment—the reform of which has been a key controversial issue across the Atlantic—and legal treatment of the reuse of collateral. Second, it discusses the composition, structure, and organization of the repo markets, such as differences in the composition of repo participants, maturity of repos, and the composition of the underlying collateral in repo contracts. Finally, it investigates the differences in the issues related to the market infrastructure of repo markets such as differences in the clearing and collateral management stages. The findings of our paper suggest that multiple legal and regulatory divergences, which could still pose challenges to the short-term funding markets, exist in repo markets across the Atlantic.

The full article is available here.


For previous Roundtable posts on repo markets, see Ganduri, “Repo Regret?“, and Morrison, Roe & Sontchi, “Rolling Back the Repo Safe Harbors“.

Bankruptcy Law as a Balancing System – Lessons from a Comparative Analysis of the Interaction Between Labor and Bankruptcy Laws

By Omer Kimhi (Haifa University Faculty of Law) and Arno Doebert (Independent)

The rehabilitation of distressed corporations often requires the reduction of labor costs. In order to regain economic stability, distressed firms need to terminate employees or modify their employment conditions. When employees are protected by statutes or by collective bargaining agreements, however, such measures are not always possible. The employer’s freedom to manage its work force is limited, and it may fail to implement labor reforms necessary for the firm’s recovery.

In the paper, we examine the intersection between bankruptcy and labor laws from a comparative perspective. We study the labor and bankruptcy laws of three different jurisdictions, the Netherlands, France, and Germany, and find a so far unexplored trend. Jurisdictions with high employment protection levels relax their otherwise rigid labor rules through their bankruptcy system. Within bankruptcy, employers enjoy greater flexibility and thus are better situated to decrease their labor costs and to reorganize.

The paper explores this trend vis-à-vis the arguments brought up by the procedural approach to bankruptcy. It looks at the rationale of the bankruptcy-induced modifications to the labor laws, and the effects these changes have on the bankruptcy process. We show that although the modifications are designed to promote the preservation of firms as going concerns, forum-shopping problems may lead to the opposite outcome. The analysis contributes to the ongoing debate between the traditional and procedural approaches, and sheds light on the interpretation of section 1113 of the Bankruptcy Code as well.

The full article is available here.

 

 

 

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