Bankruptcy Survival

By Lynn M. LoPucki and Joseph W. Doherty, UCLA School of Law

lopuckidoherty Of the large, public companies that seek to remain in business through bankruptcy reorganization, only 70% succeed.  The assets of the other 30% are absorbed into other businesses.  Survival is important both because it is efficient and because it preserves jobs, communities, supplier and customer relationships, and tax revenues.  This Article reports the findings of the first comprehensive study of who survives.  Eleven conditions best predict survival.  All are concurrently statistically significant in our best regression model. 1. A company that even hints in the press release announcing its bankruptcy that it intends to sell its business is much more likely to fail. 2. Companies whose cases are assigned to more experienced judges are more likely to survive. 3. Companies headquartered in isolated geographical areas are more likely to fail. 4. Companies that file with higher leverage are more likely to survive. 5. If a creditor’s committee is routinely appointed, the company is more likely to fail. 6. Companies with DIP loans are more likely to survive. 7. Companies that prepackage or prenegotiate their plans are more likely to survive. 8. Companies are more likely to survive if pre-filing interest rates are low. 9. Larger companies are more likely to succeed if they are larger. 10. Manufacturers are more likely to survive. 11. Companies with positive pre-filing operating income are more likely to survive. System participants can improve survival rates by shifting cases to more experienced judges and perhaps also by greater attention to the decisions to appoint committees, prenegotiate plans, obtain DIP loans, and publicly seek alliances. The article is forthcoming in the UCLA Law Review, May, 2015. Click here to read further.

Seventh Circuit Warns Intervenors Not to Sleep on Their Rights

By Eric G. Pearson, Foley & Lardner LLP
09794It’s an ancient principle of equity, drawn from Roman law: Equity relieves the vigilant, not those who sleep upon their rights. And it sums up quite well the Seventh Circuit’s recent decision in SEC v. First Choice Management Services, Nos. 14-1270 & 14-2284 (Sept. 11, 2014). First Choice did not involve equity (or even cite the maxim); it concerned an untimely motion to intervene. But the principle was the same, and it’s a good lesson for potential intervenors.

The court, in an opinion written by Judge Posner, affirmed the district court’s denial of a motion to intervene as untimely in a receivership proceeding. The intervenor knew that the receiver proposed to sell the property to which the intervenor had an adverse claim six months before seeking to intervene and had even been involved for over a decade in what the court described as “protracted negotiations” with the receiver to reclaim the property. But the intervenor never was a litigant and, the court held, “had no possible excuse for waiting for six months after [learning of the receiver’s adverse claim] before moving to intervene.” Instead, it had “wait[ed] till the last minute to try to throw a monkey wrench into the deal.”

The Seventh Circuit was unwilling to brook that sort of “dawdling,” which created only more work for the receiver, purchaser, and district court. It affirmed the denial of the motion and dismissed an independent appeal challenging the sale order. Please see a full copy of this article here.

The Agglomeration of Bankruptcy

By Efraim Benmelech, Nittai Bergman, Anna Milanez, & Vladimir Mukharlyamov

In “The Agglomeration of Bankruptcy,” Professor Benmelech and his coauthors examine the spread of bankruptcy by analyzing the ways in which bankrupt firms impose costs on nearby non-bankrupt competitors. The authors argue that the normally positive economies of agglomeration created by stores in close proximity to one another can become detrimental during downturns. When a store is in distress, proximity works to amplify the negative effects of distress. The result is that retail stores in distress impose costs, such as decreasing sales, on nearby peers, which can ultimately lead to store closures and ultimately bankruptcy.

The authors use a novel and detailed dataset of all national chain store locations and closures across the United States from 2005 to 2010. The authors show that stores located in proximity to those of national chains that are liquidated are more likely to close themselves. Importantly, this effect is stronger for stores in the same industry as the liquidating national chain as compared to stores in industries different from that of the liquidating chain. Further, the geographical effect of store closures on neighboring stores is more pronounced in financially weaker firms.

For the full article, navigate here.

This summary was drafted by Robert Niles (J.D./M.B.A. ’16)

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The HLS Bankruptcy Roundtable will be off-line for the holidays. We will be back in January.

The Duty to Maximize Value of an Insolvent Enterprise

By Brad Eric Scheler, Steven Epstein, Robert C. Schwenkel, and Gail Weinsten of Fried, Frank, Harris, Shriver & Jacobson LLP

In the recent Delaware Chancery Court decision of Quadrant Structured Products Company, Ltd. v. Vertin (October 1, 2014), the Court clarified its approach to breach of fiduciary duty derivative actions brought by creditors against the directors of an insolvent corporation. Importantly, the Court applied business judgment rule deference to the non-independent directors’ decision to try to increase the value of the insolvent corporation by adopting a highly risky investment strategy—even though the creditors bore the full risk of the strategy’s failing, while the corporation’s sole stockholder would benefit if the strategy succeeded. By contrast, the court viewed the directors’ decisions not to exercise their right to defer interest on the notes held by the controller and to pay above-market fees to an affiliate of the controller as having been “transfers of value” from the insolvent corporation to the controller, which were subject to entire fairness review.

This decision appears to stand for the proposition that, under all but the most egregious circumstances, the business judgment rule will apply to directors’ decisions that relate to efforts to maximize the value of an insolvent corporation. Thus, even decisions made by a non-independent board for a high-risk business plan that favors the sole equity holder over the creditors, as in Quadrant, will be subject to business judgment deference. The court also distinguished decisions involving direct transfers of value from the insolvent corporation to the controller, holding that these decisions would be subject to entire fairness review because the controller stood on both sides of such transactions.

See here for a more detailed discussion of this case.

Court of Appeals Vacates DIP Financing Order for Lender’s Lack of Good Faith

By Michael L. Cook, Schulte Roth & Zabel LLP

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The Bankruptcy Code encourages lenders to make debtor-in-possession (“DIP”) loans to Chapter 11 debtors. Because of Bankruptcy Code § 364(e), an appeal from a financing order will ordinarily be moot when the lender acted “in good faith” unless the appellant obtains a stay pending appeal.  It is hence noteworthy when appellate courts overturn DIP financing orders that were not stayed pending the appeal.

The Fifth Circuit, on September 3, 2014, vacated five bankruptcy court and district court DIP financing orders due to (1) the lender’s lack of good faith in relying on a third party’s shares of stock as collateral; and (2) the bankruptcy court’s lack of subject matter jurisdiction to authorize a lien on third party collateral subject to disputed ownership claims.   In re TMT Procurement Corp., 2014 WL 4364894 (5th Cir. Sept. 3, 2014).  On October 23, 2014 the Fifth Circuit denied the petition for panel rehearing.

The Fifth Circuit rejected the debtors’ argument that the appeals were moot because of the lower courts’ repeated findings that the lender had made the loan in good faith.  TMT provides a new test regarding the Code’s “good faith” requirement for lenders, based on the lender’s knowledge of possible insider manipulation of the bankruptcy process.  The court also found a lack of subject matter jurisdiction because the debtors’ insiders used the bankruptcy financing process to “interfere with” unrelated state court litigation against the debtors’ controlling shareholder.

The full version of the article was recently published in The Bankruptcy Strategist. It is available online here.

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)

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 Article III Problem in Bankruptcy

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

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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.

Federal Antitrust Laws: A New Tool to Prohibit Pre-Petition Coordination Among Creditors?

By Bradley Purcell, Justin Sabin, and Jamila Willis, Bryan Cave LLP

In today’s economic climate, restructuring activity is at a lull. Out-of-court solutions are attractive to financially distressed companies – they avoid the delay, the costs and the uncertainty of formal bankruptcy cases. Indeed, for these very reasons, cooperation between creditors and debtors is common and often encouraged by bankruptcy courts.

Though the Bankruptcy Code contemplates participation by committees of creditors and the goal of maximizing creditor recoveries, a string of recent opinions from the Eleventh Circuit casts doubt on the ability of creditors to lawfully coordinate in their pre-petition negotiations with debtors. In CompuCredit Holdings Corp. v. Akanthos Capital Mgmt., LLC, 916 F. Supp. 2d 1326 (N.D. Ga. 2011), a debtor brought suit against creditors who attempted collective negotiation, alleging violations of Section 1 of the Sherman Act, which prohibits anti-competitive behavior. The Eleventh Circuit’s en banc panel split evenly on whether CompuCredit had an antitrust claim under the Sherman Act based on the creditors’ collective conduct.

While this doesn’t change the bankruptcy landscape, it creates uncertainty in pre-petition negotiations and out-of-court workouts. An aggressive obligor may use the Eleventh Circuit’s en banc ruling and relevant antitrust laws to impede collective, pre-petition negotiation of creditors and quell negotiations and actions by pre-petition or informal committees of creditors.

The full discussion can be found here.

Mind the Gap: Supreme Court Partially Resolves Procedural Uncertainty Created by Stern v. Marshall

By Paul Hessler, Aaron Javian, and Robert Trust, Linklaters LLP

On June 9, 2014, in a highly anticipated decision Executive Benefits Ins. Agency v. Arkison, Chapter 7 Trustee of Estate of Bellingham Ins. Agency, Inc., the U.S. Supreme Court partially resolved the procedural uncertainty created by the Court’s decision in Stern v. Marshall. In Stern, the Supreme Court analyzed the constitutionality of 28 U.S.C. § 157, which in relevant part defines certain matters as “core” or “non-core,” and authorizes bankruptcy courts to finally adjudicate “core” matters, but only to issue findings and conclusions subject to de novo review in “non-core” matters. The Stern Court held that Article III of the U.S. Constitution prohibits Congress from vesting bankruptcy judges with the authority to finally adjudicate certain claims that it had statutorily designated as Javian, AaronLinklaters LLP“core,” such as state law avoidance claims. The Stern Court did not, however, address how bankruptcy courts should proceed in such cases. The Supreme Court considered that procedural question in Executive Benefits and held that with respect to “core” claims that a bankruptcy judge is statutorily authorized but prohibited from finally adjudicating as a constitutional matter, the courts should deal with such claims as they would in “non-core” proceedings; that is, by issuing findings and conclusions subject to de novo review by district courts.

The Supreme Court’s holding makes clear that a wide-range of bankruptcy-related disputes that were previously heard and decided by bankruptcy courts must now be submitted for de novo review by district Trust, RobertLinklaters LLPcourts. This additional layer of judicial involvement could make bankruptcy litigation more cumbersome and casts doubt on the well-established expectation of the bankruptcy court system as the single, consolidated venue for adjudication of all matters related to a debtor’s bankruptcy case. Importantly, the Supreme Court did not decide, and it remains to be seen, whether parties can consent to a bankruptcy court’s final adjudication of core matters that otherwise fall outside of a bankruptcy court’s constitutional authority under Stern. The full memo can be read here.

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