WSJ Examiners — Insider Pay in Bankruptcy

The Wall Street Journal’s Bankruptcy Beat recently focused on the ever-controversial topic of executive pay. Reflecting on a number of recent bankruptcy cases that involved the “redaction” of key employee names or compensation figures, the question for the Examiners was this: when it comes to pre-bankruptcy insider pay, how much disclosure is enough?

As Brett Miller points out, the answer to this question will depend on who you are in relation to the bankruptcy process. He advocates balancing competing interests on a case-by-case basis.

Practitioners Sharon Levine, Shaunna Jones, and Richard Chesley point out the quid pro quo nature of enhanced disclosure, describing it as a cost that firms must pay in order to access the benefits of bankruptcy protection. As Ms. Jones puts it, the benefits of the bankruptcy process “are not without a price, and one cost is the requirement that the debtor be transparent about how it uses its assets”.

Ms. Levine, along with Lisa Donohue, voiced concerns that a lack of transparency breeds mistrust and will make negotiations more difficult, conflicting with the consensual objectives inherent in the Chapter 11 procedure. Anders Maxwell makes the analogous point that disclosures are needed to “more adequately inform an ongoing debate” on executive pay generally which, if “left unaddressed, has the potential to sap public confidence in business and markets.”

Mark Roe also considers the wider context of Chapter 11 practice and history, particularly in relation to Key Employee Retention Plans (“KERPs”) and fraudulent conveyances. Ultimately, he says, disclosure is “a matter for judicial decision, not executive discretion.” J. Scott Victor makes the further point that unilateral redaction “unfairly benefits large debtors while requiring other debtors to follow the rules.”

Businesspeople who commented—Jack Butler and Marc Leder—sounded a contrary note, pointing out that the debate focuses only on public disclosure, as parties in the case generally have access to the business’ financial information. Mr. Butler highlights the risk of harassment that executives might face, while Mr. Leder states, in concurrence with Perry Mandarino, that “compensation data without any context can cause outside observers . . . to leap to uninformed and incorrect assumptions”.

(This post was drafted by Samuel Parsons, L.L.M. ’16.)

Restructuring the European Business Enterprise: The EU Commission Recommendation on a New Approach to Business Failure and Insolvency

By Horst Eidenmueller and Kristin van Zwieten, University of Oxford

In 2014, the European Commission issued a recommendation on the design of restructuring laws in EU Member States (the “Restructuring Recommendation,” or RR). It was followed in 2015 by the enactment of a recast version of the European Insolvency Regulation (EIR). These initiatives were intended to be complementary: the former was designed to improve the procedures available under national law for the restructuring of business debtor liabilities; the latter to improve the efficacy of these procedures in cross-border cases. Both initiatives have been driven by the view that the existing legal infrastructure for (cross-border) business restructurings in Europe is inadequate.

In this paper, we critically review the RR and put it into the context of the reform of the EIR. We find that although the two initiatives were intended to be complementary, they do not dovetail perfectly: procedures of the kind contemplated in the RR will not necessarily be eligible to fall within the scope of the recast EIR, so as to benefit from its rules on recognition and enforcement in cross-border cases.

In relation to the RR, we find that the Commission is right to push towards some level of harmonisation in Member States’ restructuring laws – regulatory competition is not a sensible regulatory alternative. However, we criticise both the methodology and scope of the RR, which leaves significant room for residual diversity in Member States’ laws, and ignores the complicated interaction between Member States’ existing insolvency laws and the restructuring procedures contemplated by the Commission.

We also take issue with some of the substantive recommendations made for the design of such procedures, arguing that the Commission wrongly requires evidence of financial difficulties or a likelihood of insolvency as the entry test, and that the process it contemplates is susceptible to abuse by sophisticated financial creditors at the expense of outside creditors and/or the debtor. We propose an efficient debtor-in-possession (DIP) regime as an alternative that could be initiated regardless of a firm’s solvency provided that it is economically viable and that the filing is not abusive.

For the full article see here.

The Trouble with Unneeded Bankruptcy Reform: The LSTA’s Response to the ABI Chapter 11 Commission Report

[Editors’ Note: The post below from the Loan Syndications and Trading Association (LSTA), summarizes their Report responding to the ABI Commission Report and Recommendation on the Reform of Chapter 11, released in December of 2014; for our previous post on the ABI report see here.]

The LSTA Report argues that:

  • The Commission Report is based on the “perception” that the system has failed. But that perception is not supported by reliable empirical evidence. The data that do exist generally support the conclusion that the system is functioning well.
  • The principal objective of current bankruptcy law is the maximization of value for all stakeholders. With few exceptions, it respects principles of non-bankruptcy law regarding the distribution of that value, as reflected in bankruptcy’s “absolute-priority” rule. The Commission Report breaks from those principles, arguing that market changes have led to distributions of value in bankruptcy that are “subjectively unfair,” and seeks to achieve results that it believes are fairer. But a clear, objective process that respects non-bankruptcy entitlements wherever possible is fair.
  • Many of the changes proposed by the Commission would reduce recoveries by secured lenders in the event of default. That would necessarily result in the increased cost, and reduced supply, of secured credit.

The LSTA Report reviews a number of specific proposals in the ABI Commission Report, including (i) calculating adequate protection based on a hypothetical foreclosure value; (ii) limitations on 363 sales and DIP loan provisions; (iii) “redemption option value”—which would require senior creditors in large bankruptcy cases to pay junior creditors even when the senior creditors have not been paid in full; and (iv) proposals for small and medium size enterprises. The LSTA concludes that these and other proposals would add cost and complexity to, and lengthen Chapter 11 cases.

For the full report, see here.

TCEH Bankruptcy: SDNY Transfers Delaware Trust Company v. Wilmington Trust N.A. Intercreditor Dispute to Delaware Bankruptcy Court, Reaffirming Broad View of Bankruptcy Jurisdiction

By Mark Ellenberg, Howard Hawkins, Ivan Loncar, Ellen Halstead, Michele Maman and Tom Curtin of Cadwalader Wickersham & Taft LLP

In Delaware Trust Company v. Wilmington Trust N.A. the United States District Court for the Southern District of New York found that a complaint based on an intercreditor agreement among secured creditors of Texas Competitive Electric Holdings LLC constituted a core proceeding.  Accordingly, the court denied a motion to remand the case to New York state court, where it had originally been filed, and also transferred the case to the US District Court for the District of Delaware.  The case was subsequently referred to the bankruptcy court presiding over the TCEH bankruptcy cases.  Plaintiff had alleged that the dispute, which involved allocation of adequate protection payments ordered by the Delaware Bankruptcy Court, was an intercreditor dispute that turned solely on the interpretation of a prepetition intercreditor agreement and, accordingly, should be decided in state court.  As such, the issue before the District Court was whether a New York court or the Delaware Bankruptcy Court should resolve the intercreditor dispute.

The District Court ruled that the dispute was core because the dispute would have no meaningful existence but for TCEH’s bankruptcy filing, as the ability to receive adequate protection derives solely from the Bankruptcy Code.  In addition, the Court found that the dispute was core because the intercreditor issue would likely arise again in the context of plan confirmation.   The decision is important because it reaffirms the often-challenged principle that contractual disputes solely among creditors may nonetheless qualify as “core” proceedings where, as here, the underlying dispute could only arise in the context of a bankruptcy proceeding.

For our full memo, please click here.

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.)

Chapter 11 Duration, Pre-Planned Cases, and Refiling Rates: An Empirical Analysis in the Post-BAPCPA Era

By Foteini Teloni, Fordham University School of Law

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) enacted and amended several business bankruptcy provisions that triggered a heated debate over their effects on the chapter 11 landscape and the debtor’s reorganization chances.

In this article, I use multivariate regression models to examine empirically and quantify, for the first time, BAPCPA’s effect on three distinct aspects of the chapter 11 process: (a) the duration of traditional chapter 11 cases; (b) the use of preplanned bankruptcies; and (c) debtor refiling rates.

My study indicates that BAPCPA fulfilled, on the one hand, a long-standing desire of having shorter business reorganization cases. Indeed, the average duration of chapter 11 dropped from 480 days to 261 days in the post-2005 era, while the proportion of companies undergoing preplanned bankruptcies rose 23% in that same period. Even after controlling for various factors, including the companies’ pre-filing financial profile, BAPCPA remained correlated at a statistically significant level with shorter chapter 11 duration and more preplanned cases.

On the other hand, however, the proportion of debtors that had to refile for bankruptcy soon after exiting their previous filing increased 30% in the post-2005 era. BAPCPA’s effect on recidivism remained statistically significant even after controlling for a number of factors, including the companies’ post-emergence profitability and leverage.

It seems that the 2005 amendments force the debtor to emerge hastily from its chapter 11 proceedings, ignoring operational and structural problems and, therefore, not achieving true rehabilitation. And if one measure for successful bankruptcies is refiling rates, then BAPCPA seems to have failed in this respect.

The full article is published in 23 Am. Bankr. Inst. L. Rev. 571 (2015), and is available here.

Curbing the Exploitation of Passive Creditors in Chapter 11 Reorganization by Leveraging the Oversight Role of the United States Trustee

By Addison F. Pierce, American University – Washington College of Law

The Bankruptcy Reform Act of 1978 is beginning to show its age in ways similar to the forty-year-old code it replaced. In addition to being ill-suited to address changes in the underlying credit market, the current code is confronting the development of an entirely new marketplace — a market in claims trading. While some praise the enhanced liquidity, others take issue with the strains placed on the efficacy of bankruptcy.

Rather than engaging in the normative debate, this Comment seeks to redress a clear drawback to the current system: the harm endured by passive creditors. Unlike those economically empowered to participate in the reorganization process, the passive creditor lacks the economic ability and incentive to play an active role. This position leaves the passive creditor’s ability to collect on its claim solely in the hands of another: the creditors’ committee. While this committee may have provided adequate protection in 1978, the credit market and its participants are very different today. Some argue that this issue is systemic and can only be addressed by replacing the current code; however, this Comment argues that something can be done short of this massive task. The challenge is as follows: if too little is done, passive creditors will continue to be exploited and if too much is done the whole market could be damaged. Recognizing this challenge, this Comment proposes that passive creditors can be afforded adequate protection by leveraging the oversight power of the US Trustee to ensure the proper functioning of creditors’ committees. Moreover, the recommendation of this Comment would enhance protection for passive creditor while remaining market neutral.

For the full article, see 4 Am. U. Bus. L. Rev. 95 (2015), available here.


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