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.

Update on Directors’ and Officers’ Insurance in Bankruptcy

By Douglas K. Mayer, Martin J.E. Arms, and Emil A. Kleinhaus of Wachtell, Lipton, Rosen & Katz
110915.wlrk.dMayer.3477.web 110913.wlrk.mArms.1503.web120221.wlrk.kleinhaus-1009.webD&O insurance policies typically combine coverage for certain liabilities and defense costs of individual directors and officers (“A” coverage) and of their companies (“B” and “C” coverage). In recent years D&O policies also typically state that payments to insured individuals under their A coverage take priority over payments of B or C coverage to the insured company.

After commodities broker MF Global filed for bankruptcy in 2011, insured individual directors and officers asked the bankruptcy court to allow them to request payment of their A coverage for their defense costs in ongoing litigation, but were opposed by the contention that all access to the D&O insurance policy, including the individuals’ A coverage, was subject to the automatic bankruptcy stay due to the policy’s B and C coverages. [The B and C coverage of the company was directly subject to the stay; the personal A coverage was argued to be sufficiently related to the B and C coverage that it was also stayed.]

The bankruptcy court ultimately allowed the individuals to access their A coverage by honoring the policy’s priority of payment language, but in the interim granted the individuals only limited access to insurance money while the coverage litigation was ongoing. The MF Global D&O insurance dispute illustrates the significant risk that individuals may be barred, or at least significantly delayed, in gaining access to their personal A coverage under a typical directors and officers insurance policy issued to a company that subsequently enters bankruptcy, and highlights the usefulness of separate A-only or Difference in Condition coverage for individual directors and officers.

For the full memo, navigate here.

The Evolution of European Insolvency Law Part 3: The EU Parliament’s Report on the Amendment of the European Insolvency Regulation (EIR)

By Robert Arts and Dr. Björn Laukemann (Maîtr. en droit)

Robert Arts Laukemann PicAfter the external evaluation of European Insolvency Law (Part 1) and the European Commission’s proposal for the amendment of the EIR (Part 2), the report of the European Parliament (EP) on this proposal marked the latest stage of the reform process.

While the Parliament generally supports the changes proposed by the Commission and many of its amendments simply clarify wording or align the text with the existing legislation, the draft report made some noteworthy revisions:

  1. To prevent abusive venue-shopping, the draft requires the factual circumstances of the debtor’s centre of main interests to be established three months prior to the opening of insolvency proceedings.
  2. While welcoming the introduction of synthetic proceedings (i.e. the granting of special rights to groups of local creditors in order to avoid the opening of secondary insolvency proceedings) the EP strengthens the procedural standing of the local creditors by:

(i) granting them the power to challenge any decision to postpone or refuse the opening of secondary proceedings;

(ii) allowing them to petition the court conducting the main proceeding to take protective measures, e.g. by prohibiting the removal of assets or the distribution of proceeds, or by ordering the administrator to provide security; and

(iii) empowering the court to appoint a trustee to safeguard their interests.

  1. The coordination and cooperation between administrators appointed in different proceedings within a group of companies is further enhanced by the implementation of an independent coordinator who, for instance, is empowered to present a non-binding, court-approved group coordination plan, to mediate in disputes between insolvency representatives of group members, or to request a stay of proceedings with respect to any member of the group.

As a result, the Parliament report  aims to strengthen the role of main insolvency proceedings while still sufficiently considering interests of local creditors and to improve coordination within groups of companies. The draft is expected to pass the European Council by the end of this year.

See the full report here.

The Article III Problem in Bankruptcy

By Anthony J. Casey and Aziz Z. Huq, University of Chicago Law School

Casey, Anthony_0Huq Aziz 2009-06-18

The Supreme Court has struggled for the last three decades in defining the permissible scope of bankruptcy courts’ power. This question poses difficult federalism and separations-of-powers problems under Article III of the Constitution. Divided opinions in Northern Pipeline Construction v. Marathon Pipe Line, and more recently, in Stern v. Marshall, have produced confusion and litigation for practitioners and lower courts. This is true in large part because the Court’s Article III decisions lack any foundational account of why bankruptcy judges implicate a constitutional problem. As the Court prepares to confront the issue once again later this term, Aziz Huq and I provide such an account in a new article. This account more concretely identifies the precise stakes in this debate. We argue that a tractable, economically sophisticated constraint on delegations to the bankruptcy courts can be derived from what should be an obvious source: the well-tested creditors’ bargain theory of bankruptcy. Working from this account of bankruptcy’s necessary domain minimizes Article III and federalism harms while also enabling bankruptcy’s core operations to continue unhindered. To illustrate its utility, we then apply our framework to a range of common bankruptcy disputes, demonstrating that many of the Court’s existing jurisprudence is sound in result, if not in reasoning.

The article is forthcoming in the University of Chicago Law Review, and is available here.

Single Point of Entry and the Bankruptcy Alternative

Author: David A. Skeel, Jr., University of Pennsylvania Law School

dskeel

The Dodd-Frank Act requires systemically important financial institutions to prepare living wills explaining how they could be smoothly resolved in bankruptcy.  Yet Dodd-Frank itself did not do anything to ensure that the bankruptcy laws actually are adequate to the task of handling a major financial institution.  Earlier this month, the House Judiciary committee unanimously approved proposed legislation (known colloquially as “Subchapter V”) that is designed to finish the job.  Subchapter V would mimic the single point of entry strategy that the FDIC has devised for resolution under the Dodd-Frank Act by facilitating a quick sale of the assets and some of the liabilities of the financial institution’s holding company in bankruptcy.

In this Essay (which pre-dates Subchapter V), I consider the risks and benefits of single of entry and the bankruptcy alternative.  The Essay begins with a brief overview of concerns raised by the Lehman Brothers bankruptcy, and points out that the Dodd-Frank Act as enacted left nearly all of them unaddressed.   By contrast, the FDIC’s new single point of entry strategy, which is introduced in the second section, can be seen as addressing nearly all of them.  The third and fourth sections point out some of the limitations of single point of entry, first by highlighting potential pitfalls and distortions and then by explaining that single point of entry does not end the too-big-to-fail problem and would not reduce worrisome concentration in the financial services industry.  The final section turns to bankruptcy, and shows that the single-entry-style strategy can easily be replicated in bankruptcy.  Indeed, the strategy harkens back to the original procedure used to reorganize American railroads well over a century ago.

The full version of the article can be found here.

Post-Petition Interest: Not Very Predictable

posted in: Cramdown and Priority | 0

By Vicki Harding, Pepper Hamilton, LLP

hardingvIn a recent case a mortgagee battled the debtor over post-petition interest:  When did the lender become oversecured and thus entitled to interest?  Was it entitled to the default rate?  Should interest be compounded?

Some may be surprised to learn that a lender must do more than simply show that it is oversecured to receive its contract rate for the period between the petition date and confirmation.  Most courts hold that a bankruptcy court has at least limited discretion to use another rate.

Here the debtor filed a plan of reorganization that proposed to pay its senior lender in full with interest at 4.25% from the effective date of the plan, but did not include any post-petition, pre-effective date interest.

The lender argued that it was entitled to post-petition interest at the 14.5% contract default rate accruing from the petition date.  The debtor responded that the lender became oversecured only after a sale of its collateral and the default rate was unenforceable and inequitable.

Generally post-petition interest is not allowed, but there is an exception for oversecured creditors.  The 1st Circuit concluded that a bankruptcy court is not required to accept the contract rate, although there is a presumption that the contract rate (including default rate) applies if it is enforceable under state law and there are no equitable considerations leading to a different result. See here for a more detailed discussion of Prudential Ins. Co. of Am. v. SW Boston Hotel Venture, LLC (In re SW Boston Hotel Venture, LLC), 748 F.3d. 393 (1st Cir. 2014).

1 14 15 16 17