As originally enacted, the Act allowed certain small businesses with no more than approximately $2.7 million of debt to file for bankruptcy under a new subchapter V of chapter 11 of the Bankruptcy Code.
By Shane G. Ramsey and John T. Baxter (Nelson Mullins)
The U.S. Supreme Court in Czyzewski v. Jevic Holding Corp., 137 S.Ct. 973 (2017), addressed the issue of chapter 11 debtors using structured dismissals to end-run the statutory priority rules. The Court’s ruling preserved the priority system, holding that the bankruptcy court could not approve a structured dismissal of a chapter 11 case that provided for distributions that failed to follow the standard priority rules unless the affected creditors consented to such treatment. Although the Bankruptcy Code does not expressly apply its priority distribution scheme to a structured dismissal, the Court clarified that courts should do so.
As a way to track how bankruptcy courts across the country are applying the ruling in Jevic, the Nelson Mullins Bankruptcy Protector has introduced a new periodic series: the Jevic Files. As of December 31, 2019, the Jevic Files has collected and summarized twenty-one cases across nineteen jurisdictions. While the majority of the cases involved structured dismissals in the context of a chapter 11 case, courts have also applied the ruling in Jevic to the dismissal of chapter 13 plans; the priority of trustee payments in a chapter 7 case; and even a state court foreclosure hearing that came on the heels of a dismissed chapter 11 case. As Jevic continues to be interpreted and applied in bankruptcy (and other) courts throughout the country, we will continue to keep an updated summary of cases through the Jevic Files.
By Jay Rao (University of California, Berkeley, School of Law)
This Article examines the application of equitable subordination under Title 11 of the United States Code to bankruptcy claims purchasing transactions that transpire after the occurrence of inequitable conduct by a third party. Although a significant issue with practical consequences, it has drawn relatively scant commentary. To the author’s knowledge, no scholarship to date has attempted to comprehensively discuss the issue or describe the indirect cleansing and washing of tainted claims resulting therefrom. While analyzing and criticizing the current state of the law, this Article introduces the concepts of the “subordination benefit,” “subordination benefit elimination theory,” and “limited subordination benefit theory” to facilitate and further conversations related to the intersection of equitable subordination and bankruptcy claims trading.
This Article primarily aims to promote an active, fluid bankruptcy claims trading market to, on an ex post basis, benefit creditors and, on an ex ante basis, reduce the cost, and induce the extension, of credit in the primary capital markets, thereby supporting the broader economy. Additionally, this Article seeks to reduce indirect cleansing of tainted claims and indirect claims washing through the bankruptcy claims market.
The subject matter is particularly timely and relevant, given the recent publication of the Final Report and Recommendations of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11, the significant growth of the claims trading market and increasing activity and sophistication of distressed investors, and the recent formation of the American Bankruptcy Institute’s Claims Trading Committee.
This Article argues that subordination benefit elimination theory, which represents the dominant theory propagated by courts and commentators, finds support in a misguided reading of caselaw and conflicts with sound economic policy and logic. Further, while acknowledging limited subordination benefit theory is a superior approach to subordination benefit elimination theory, this Article argues that limited subordination benefit theory also runs contrary to sound economic policy and logic. This Article requests commentators and courts halt and reverse the propagation of subordination benefit elimination theory and avoid disseminating limited subordination benefit theory. Instead, this Article proposes post-misconduct discounted claims purchasers be entitled to participate in the subordination benefit to the same extent as pre-misconduct claimholders.
If commentators and courts are unready to abandon both theories and if required to make a suboptimal binary choice, this Article suggests limited subordination benefit theory be propagated and utilized in lieu of subordination benefit elimination theory.
By Sara L. Chenetz and Tina N. Moss (Perkins Coie)
Reward Science and Technology Industry Group Co., Ltd. (“Reward”) joins a growing list of Chinese companies that have chosen to file a case in U.S. Bankruptcy Court in connection with their restructuring efforts under the People’s Republic of China’s Enterprise Bankruptcy Law (“EBL”). These U.S. cases are known as “Chapter 15” cases, in which the foreign representative of the debtor files a petition in a U.S. bankruptcy court seeking “recognition” of a foreign proceeding. Relief granted to Reward in its Chapter 15 proceedings included a stay of all efforts by Reward’s U.S. creditors to continue litigation and to commence any new lawsuits or other efforts to collect on claims in the United States. Additionally, the Reward foreign representative was granted the power to administer Reward’s U.S.-based assets for the benefit of its creditors and to gather evidence within the United States concerning Reward’s liabilities, assets, business affairs, and operations, including through examining witnesses under oath and issuing subpoenas to obtain documents. Reward’s Chapter 15 case demonstrates that companies that are the subject of EBL cases or are considering whether they could benefit from filing an EBL case may also be able to obtain protections from creditor action in the United States by commencing a Chapter 15 case. As part of a Chapter 15 case, U.S. bankruptcy courts may halt litigation and other collection efforts against the Chinese business (temporarily or permanently), limit the enforceability of certain contract provisions, and simultaneously facilitate the Chinese’s business’ efforts to reorganize or liquidate.
By Jonathan Seymour, Steven L. Schwarcz (Duke University School of Law)
The European Union recently adopted a Restructuring Directive intended to facilitate the reorganization of insolvent and other financially troubled firms. Although the central goal of the Directive parallels that of Chapter 11 of U.S. bankruptcy law—to protect and maximize the value of financially distressed but economically viable enterprises by consensually reorganizing their capital structure—the Directive introduces an innovative but controversial option: that EU Member States can decree that reorganization negotiations should be subject to a relative priority default rule, as opposed to the type of absolute priority default rule used by Chapter 11.
The purpose of the default rule—whether relative or absolute priority—is to provide a mechanism whereby a plan of reorganization may be approved notwithstanding failure of the parties to reach a consensus. Such a “cram down” plan reflects that one or more classes of impaired creditors or shareholders dissents. In that case, the EU’s relative priority default rule would allow confirmation of the cram down plan so long as senior classes are treated more favorably than junior classes. In contrast, Chapter 11’s absolute priority default rule would require senior classes to be paid in full before junior classes receive any distribution under the cram down plan.
EU officials argue that relative priority would provide a fairer and more pragmatic default rule than absolute priority. We disagree. As explained below, we believe that a relative priority default rule would, perversely, make consensual reorganization plans less likely. We also illustrate why a relative priority default rule could produce unfair and economically undesirable outcomes.
A relative priority default rule would make consensual reorganization plans less likely because, unlike an absolute priority default rule, it would not function as a penalty default. Absolute priority functions as a penalty default because it would require a costly and contentious going-concern valuation of the debtor, in order to determine what share of the equity in the reorganized debtor is necessary to pay the claims of senior classes in full before any remaining value may be paid to junior classes. To avoid that cost and contention, the parties are motivated to negotiate a consensual plan, even if they would have to give up some value.
Relative priority, in contrast, would not operate effectively as a penalty default rule. A debtor could gain approval of a nonconsensual (i.e., cram down) plan without any valuation of the reorganized business. Even if a valuation is required, a simple and relatively inexpensive floor or ceiling valuation should suffice, rather than the precise valuation required under absolute priority. Parties therefore would have little incentive to compromise.
A relative priority default rule also would permit unfair outcomes. Our article shows how such a default rule would permit shareholders to retain much of the value in a reorganized business, while forcing creditors to accept significantly less than full payment. That could make debt investments less attractive in EU Member States that adopt a relative priority default rule. At the same time, relative priority would create incentives, as was the case in the early years of the U.S. bankruptcy laws, for senior and junior classes to collude to “squeeze” intermediate classes. Additionally, by reducing the risk of insolvency for shareholders and management, relative priority could operate as a subsidy for overleveraged businesses and encourage risky behavior.
For all of these reasons, we believe that EU Members States should avoid adopting a relative priority default rule. Our article also responds to potential defenses of that option. We demonstrate that relative priority is unnecessary to deter holdout creditors from obstructing the plan negotiation process. We additionally explain why relative priority is not needed to promote successful reorganizations of small and medium sized businesses. To the extent that traditional Chapter 11-style reorganization has not worked well for small businesses in the US, we suggest that the recent Small Business Reorganization Act provides a better restructuring model by permitting such businesses to reorganize on a “best efforts” basis.
By Jonathan C. Lipson (Temple University Beasley School of Law), Adam J. Levitin (Georgetown Law Center), Stephen J. Lubben (Seton Hall University School of Law)
Recently, we (along with colleagues at other law schools) asked that an examiner be appointed in the Purdue Pharma chapter 11 bankruptcy case, pending in the Southern District of New York. Although the Bankruptcy Court has not yet acted on that request (technically, it was in the form of a letter to the United States Trustee), it has generated controversy and media attention (e.g., WSJ, WaPo, Rachel Maddow), which will likely persist until there are credible answers to the questions that motivated our request:
What was the role of the Sackler family (the owners of Purdue) in Purdue’s role in the opioid crisis? and
To what extent did the Sacklers or other insiders strip assets out of Purdue in anticipation of bankruptcy?
Chapter 11 of the Bankruptcy Code governs corporate reorganizations, such as Purdue Pharma’s, and provides that an examiner can be appointed if, among other things, it is in the interests of creditors and the debtor’s bankruptcy estate. Here, we argued that there is an overwhelming public interest which overlaps with the estate’s interest. This makes the need for an independent report on these two questions compelling.
As is well known, Purdue Pharma is at the center of the opioid crisis in America, having developed and marketed Oxycontin (among other drugs). This crisis has generated more than 2600 lawsuits against Purdue and the Sacklers, many brought by state and local governments that have had to bear the costs of drug addiction. The debtors and the Sacklers have proposed a settlement under which the Sacklers would cede the company to a “public trust” and make additional contributions, in exchange for releases. The settlement is alleged to be between $10 and $12 billion, with $3 billion of that coming from the Sacklers directly. While some plaintiffs have agreed to the settlement, others have not, and are fighting the bankruptcy process.
Like many mass tort debtors—from Johns-Manville to PG&E—Purdue seeks to channel and control its liability through bankruptcy reorganization. Bankruptcy Judge Robert Drain, of the Southern District of New York, has stayed the lawsuits, not just against Purdue, but also against the Sacklers, even though they are not debtors in bankruptcy—in order to permit the debtors to negotiate a plan of reorganization that would embody the proposed settlement.
We argued that an independent examination would answer the two key questions more credibly and efficiently than other mechanisms in bankruptcy for three reasons.
First, unlike many mass-tort bankruptcies, these cases appear to shield non-debtors (the Sacklers) from discovery and potential liability, even though there are credible allegations that they may have actively contributed to the opioid crisis and/or stripped assets from the debtors. The important question is not whether the Sacklers are making a contribution to a bankruptcy plan in exchange for a release from future liability, but whether their contribution is appropriate in light of the answers to our two questions. It will be very difficult to assess that without an independent examiner’s report.
Second, because Purdue Pharma is privately held, it is hard to know what happened at the company before bankruptcy. The debtors have appointed a special committee of the board to look into the pre-bankruptcy transfers, but because the Sacklers apparently still control the debtors, it is hard to know how independent this committee was, or can be. The committee is, for example, represented by the same counsel as Purdue Pharma, which may hamper the committee’s independence. In any case, even where other high profile debtors, such as Enron, have used independent committees to investigate allegations of wrongdoing, courts have nevertheless appointed bankruptcy examiners to assess, verify, and supplement the work of those committees. It is hard to see why Purdue should be different.
Third, and perhaps most important, the opioid crisis is not like other mass torts because it has generated extraordinary public interest. Victims of the opioid crisis understandably want their day in court—which is something that bankruptcy tends to eliminate. While thousands of lawsuits would be wasteful, failing to take seriously the dignitary interests of victims of the opioid crisis could threaten the legitimacy and integrity of the bankruptcy system. At the same time, if an independent examiner exonerates the Sacklers, this may help provide the redemption that they presumably want.
Although the United States Trustee has not yet sought an examiner, there have been three interesting developments since we sent the letter:
On November 6, 2019 Marshall Huebner, counsel to the debtor in possession, emailed us to say that “the Debtors (likely along with other core stakeholders) intend to strongly oppose the request, which, with apologies to its authors, contains many misstatements of fact.” However, Huebner identified no “misstatements of fact” (much less “many”).
On November 15, 2019, ten days after we sent the letter, the debtors filed a stipulation with counsel to the creditors committee and certain members of the Sackler family. The debtors and the Sacklers agreed to produce certain information to the committee (on a “professional eyes’ only basis”) that may respond to certain of the questions we asked, but in exchange the committee relinquished its right to seek an examiner until mid-April 2020. It is not clear how estate fiduciaries can properly cede such rights.
On December 16, 2019, the debtors filed a redacted version of the “independent” report noted above. It indicates that the Sacklers took about $10 billion in cash out of the debtors since 2008. This is not surprising, since the total value of the proposed settlement would have a face amount of about $10 billion (but a substantially lower present value given its payment schedule, and would not cover interest on the $10 billion).
The takeaway seems to be that, even though no examiner has been appointed, the Sacklers and the debtors in possession have begun to produce some information that may help to answer the questions we believe are central to this case. In this regard, the mere threat of an examiner might be having an effect. However, the ability to assess and verify this information is limited, at least for the time being.
That no one has actually requested an examiner is, at one level, not surprising. It is easy to imagine that managing this case is exceedingly difficult. The insiders in the case—especially counsel to the debtors and the official committee, and Judge Drain—may view an examiner as a wrench in the delicate machinery of the proposed settlement. Parties might therefore prefer to maintain the threat of an examiner, even as they are reluctant to pull the trigger on a motion.
The Purdue bankruptcy is, however, bigger than the financial claims of any of Purdue’s creditors. Purdue is a not a case that can be run like a standard chapter 11 because there is a strong public interest in establishing a clear and independent record of what Purdue and the Sacklers knew and did about the dangers of opioids, and the extent of the Sacklers’ transactions with Purdue. Establishing these facts credibly is important not just for the dignitary interests of opioid victims and their families, but also so that creditors can properly evaluate any settlement that emerges as part of the reorganization process.
Without credible answers to the questions we asked, there will be a shadow over these cases, one that may ultimately threaten the integrity of the reorganization process.
In In re Energy Future Holdings Corp., 773 Fed. Appx. 89, 2019 WL 2535700 (3d Cir. June 19, 2019), a panel of the U.S. Court of Appeals for the Third Circuit ruled that adequate protection payments made during a bankruptcy case and distributions under a chapter 11 plan are not distributions of collateral for purposes of a “waterfall” provision in an intercreditor agreement. The ruling is a reminder that intercreditor agreements will apply only in accordance with their terms.Although the parties could have drafted the intercreditor agreement to apply to any consideration received from the debtor by the noteholders, they did not. Therefore, the intercreditor agreement did not apply to the adequate protection payments and plan distributions made to the noteholders.Creditors have recently learned similar lessons in other cases. Because the ruling was unpublished, the decision is not binding on courts in the Third Circuit.
The Dubai International Financial Centre (the “DIFC”), one of the leading international financial hubs in the Middle East, Africa and South Asia (the “MEASA”) region, has recently announced the enactment of the new DIFC Insolvency Law, Law No. 1 of 2019 (the “New DIFC Insolvency Law”), which became effective in June 2019. Importantly, the New DIFC Insolvency Law which will repeal and replace the Insolvency Law of 2009 and was the subject of substantial research and global benchmarking introduces a completely new rehabilitation provision for distressed companies in the DIFC in addition to the previously existing procedures such as company voluntary arrangements, receiverships and liquidations. With the goal of promoting the rehabilitation of viable businesses that are part of the DIFC while addressing the continuing needs of the various stakeholders involved, the DIFC made several key changes as part of its enactment of the New DIFC Insolvency Law including: (1) the introduction of a debtor in possession procedure known as rehabilitation; (2) the introduction of a procedure that allows the management of a company to be replaced by a court-appointed administrator when there has been mismanagement of or misconduct by the company or management; (3) enhancing and modernizing existing rules and procedures; and (4) the incorporation of the UNCITRAL Model Law on Cross-Border Insolvency.
By Samuel Antill (Stanford Graduate School of Business)
In Chapter 11 bankruptcies, a court-supervised negotiation among creditors leads to one of two possible forms of exit, liquidation or emergence. In a liquidation, the bankrupt firm’s assets are sold (piecemeal or in a going-concern sale). Alternatively, if creditors agree to restructure the firm’s liabilities, the firm emerges and continues operating. I estimate a structural model of the choice between emergence and liquidation. In my sample of large-firm bankruptcies, I estimate that creditor recovery was substantially reduced by inefficient decisions to liquidate.
According to the “creditor’s bargain” theory of bankruptcy, the efficient form of exit (liquidation or emergence) from Chapter 11 is that which optimizes total expected creditor recovery. Beyond the importance to creditor recovery, an efficient approach to choosing between liquidation and emergence benefits pre-bankruptcy equity holders through lower costs of credit. The efficient form of exit from bankruptcy should be achieved, under the conditions of the Coase Theorem, by the bargaining among creditors that Chapter 11 is supposed to promote. Without this bargaining, potential coordination failures arise when each creditor pursues the form of exit that maximizes its own payoff.
In contrast to the view that Coasian bargaining in Chapter 11 successfully preserves viable firms, I estimate that inefficient decisions to liquidate are frequent. However, very few of the firms in my sample were inefficiently selected to emerge. I provide an explanation for this asymmetry. Exiting Chapter 11 through a confirmed plan of reorganization requires creditor consent under established voting rules. In contrast, Section 363(b) of the bankruptcy code allows managers to sell assets, or entire firms, without creditor approval. This procedure circumvents the bargaining among creditors that Chapter 11 supposedly promotes. I show that inefficient liquidations are concentrated in cases involving “363 sales.” This statistical association suggests that Section 363(b) enables the sort of coordination failure that Chapter 11 was designed to prevent. For example, these results are consistent with a view that managers may be inefficiently liquidating firms in order to benefit senior lenders or to obtain a job for themselves at a purchasing company.
Finally, I find that inefficient liquidations are largely avoidable. Using my estimated model, I consider the following counterfactual: how would expected creditor recovery change if form-of-exit decisions had been made by a statistical model? In this counterfactual scenario, the courts would hire a statistician to compare the expected potential recovery rates implied by my fitted model and recommend either liquidation or emergence. Each recommendation depends only on data available at the start of a given bankruptcy. I find that such a court statistician could dramatically improve average recovery.
Happily, ultimate resolution of the Blackjewel case later in autumn saw the employees made whole and the company investigated for fraud. But this solution was anything but assured before it was reached, and employees in any event suffered substantial harm in the form of disrupted family budgets and substantial uncertainty as to ultimate recovery for months – including, critically, just as a new school year was commencing for employee families’ children.
It would seem well advised, then, to put in place a more permanent and reliable process for cases like that of Blackjewel and its employees. What is needed is a solution that is uniformly applicable, reliable, and known in advance such that all concerned parties can bargain and plan ‘in the shadow’ of the regime. Our present arrangements are subject to vagaries of state law and state budgets that vary across state jurisdictional space and fiscal time. The obvious solution to the difficulties raised by such variance is to subject this realm, like that of bankruptcy itself, to federal legislation.
A bill I have recently drafted and advocated aims to ‘fit the bill’ in effect called-for by the Blackjewel affair. It does so by (a) assigning the Department of Labor (‘DOL’) a permanent representation role in future employer insolvencies; (b) federalizing the employer bonding requirements now found only in inconsistently administered state laws; (c) establishing an Employee Liquidity Support Fund to tide employees over while bankruptcy proceedings are pending; and (d) holding employing-firms’ executive officers personally liable for violations of the Act’s requirements.
The reason for DOL representation and oversight is to ensure that employees have a coherent and powerful representative ‘at the table’ during insolvency proceedings – one that is endowed with oversight authority not only during, but in advance of insolvencies.
The reason for federalizing employer bonding requirements is that states often vary over time in respect of the seriousness with which they administer such requirements, presumably in part for reasons sounding in lobbying pressures and ideology but also for reasons of basic capacity – large employers, after all, often are ‘bigger’ than the states that would supervise them.
The reason for establishing an Employee Liquidity Support Fund is presumably obvious. What made Blackjewel’s travails so hard on employees was precisely the fact that ultimate resolution was long in coming, while employee families’ daily living expenses couldn’t ‘wait.’ Against such a backdrop it makes sense for DOL to do for employees what our Federal Reserve does for financial institutions while insolvency and consolidation proceedings are underway – viz., provide tide-over funding.
Finally, the reason for holding executive officers personally liable for compliance with the Act’s requirements should be obvious as well. For again as in the case of financial institutions, so here the only surefire way of ‘incentivizing’ firms to comply is to incentivize those through whom all firms act – their executives, as the term ‘executive’ (derived from ‘execute’) itself suggests. Diffuse shareholders, who often lack power over corporate officers, and insider shareholders, who often have interests at odds with the interests of non-executive employees in any event, simply aren’t up to the task.
Employing firms, their executives and their owners have enjoyed multiple forms of state patronage for decades in our nation, while employees have in general enjoyed only sporadic assistance from public sector institutions and, less now than any time since the early 20th century, labor unions. This Act will help further a cause that’s increasingly now recognized once again to be both morally and economically compelling: That is the task of protecting the interests of our own productive citizenry – our labor force.