A Third Way: Examiners As Inquisitors

By Daniel J. Bussel, UCLA School of Law

BusselThere is a buzz concerning bankruptcy examiners. Recently in such cases as ResCap, Dynegy and Tribune, and perhaps now in Caesars, examiners have played a decisive role in resolving major Chapter 11 cases involving avoiding power claims.

“Litigate or settle” is the dispute resolution choice generally available in US bankruptcy courts. But there is another way: An inquisitorial model of justice in which an active and informed neutral investigates the facts and then assesses and applies the law to resolve a legal dispute. Chapter 11 examiners are peculiarly suited to introduce this inquisitorial process into a Chapter 11 case. In particular, Ken Klee, serving as examiner in the Tribune case, and a series of post-Tribune investigations show that inquisitorial methods make sense in certain large bankruptcy cases involving complex legal disputes (rather than financial or operational problems). Indeed Tribune and its progeny suggest that the inquisitorial experiment has already begun.

A Third Way: Examiners As Inquisitors looks at examiner methodologies in Tribune and the few post-Tribune examiner cases. It assesses the method’s comparative advantages (fact-finding accuracy, nonpartisan experts, freedom from artificial evidentiary constraints, transparency and legitimacy) and disadvantages (lack of finality, expense, delay, risks to reorganization efforts, risk of overzealousness, due process concerns) and suggests that in the absence of a countervailing business exigency demanding exclusive focus on reorganization, the Tribune model may offer a superior alternative for resolving contested avoidance claims. Indeed, large Chapter 11 cases may be an ideal proving ground for inquisitorial methods more broadly.

For more see A Third Way: Examiners As Inquisitors, 90 Am. Bankr. L. J. __ (forthcoming 2016), available here.

Bankruptcy Examiners in Chapter 11

By Jonathan C. Lipson, Temple University—Beasley School of Law, and Christopher Fiore Marotta, KPMG

Lipson MarottaBankruptcy examiners have long been a controversial feature of chapter 11—and remain so in recent cases such as Caesars Entertainment. Section 1104 of the Bankruptcy Code requires one if sought in large cases ($5 million+ in debt) or if “in the interests of creditors.” Congress created the position as a check on the reorganization process, since neither the SEC nor trustees typically provide oversight. Yet, system participants grouse about their costs and potential to disrupt negotiations. The ABI’s reform proposal would eliminate them.

In a recent paper, we study their use in a sample of 1225 chapter 11 cases from 1991-2010. We find that, despite the Code’s “mandatory” language, examiners are exceedingly rare, being sought in about 9% and appointed in 4% of cases. About half were very large cases, with far more than $5 million in debt, so most requests should have been granted—but they weren’t. The factors that Congress thought should matter most—such as fraud or incompetence—don’t.

What predicts whether an examiner will be appointed? Timing and location: an early request in a case outside Delaware is nearly twice as likely to be granted than otherwise. Yet, contrary to conventional wisdom, we also find that examiners correlate to better outcomes, including in post-bankruptcy earnings and headcounts.

We explain why examiners are so rare, and suggest a way to use them more frequently and economically.

For the full article see here.

Supreme Court Permits Bankruptcy Courts to Issue Final Judgments with Parties’ Consent

By Harold S. Novikoff, Douglas K. Mayer, Ian Boczko, Emil A. Kleinhaus, and Alexander B. Lees of Wachtell, Lipton, Rosen & Katz

The Supreme Court’s latest decision regarding the power of bankruptcy judges to resolve claims between bankruptcy estates and their creditors is Wellness International Network, Ltd. v. Sharif, handed down on May 26, 2015. In its landmark 2011 ruling in Stern v. Marshall, the Court held that bankruptcy judges have limited authority under Article III of the Constitution to determine claims asserted by an estate against creditors. However, Stern left open the question, which has split lower courts, whether parties can nonetheless consent to bankruptcy court adjudication. In Wellness, the Supreme Court held that bankruptcy litigants may waive Article III rights, and suggested that parties may forfeit untimely objections to a bankruptcy court’s lack of authority.

For a fuller analysis and summary, click here for our memo on Wellness.

Statutory Erosion of Secured Creditors’ Rights: Some Insights from the United Kingdom

By Adrian Walters, IIT Chicago-Kent School of Law

The prevailing wisdom is that Chapter 11 bankruptcy proceedings have been captured by secured creditors with the consequence that many Chapter 11s are little more than glorified nationwide federal foreclosures through which secured creditors exit by means of a section 363 sale.  Some scholars worry that secured creditor capture of Chapter 11 leads to asset deployment decisions that do not produce welfare-maximizing outcomes for creditors as a whole.

In an article forthcoming in the 2015 University of Illinois Law Review, I do not question this prevailing wisdom.  Instead, I seek to argue, by reference to experience in the United Kingdom, that if we are serious about curbing secured creditors’ control of bankruptcy proceedings through bankruptcy law reform, we have to acknowledge and understand the ways in which secured creditors respond to reforms that are adverse to their interests.

The article identifies four ways in which lenders may be expected to adjust to “adverse” bankruptcy reform: (i) meta bargaining; (ii) adjustments to pre-bankruptcy behaviour; (iii) transactional innovation; and (iv) shape shifting. The article then illustrates how lenders in England and Wales have successfully adjusted to sustained statutory attempts to undermine their bankruptcy priority by carving value out of their collateral, and to erode their control rights by abolishing their right to appoint an administrative receiver over floating charge collateral.

Click here to read more.

Overview of ABI Commission Report and Recommendation on the Reform of Chapter 11 of the Bankruptcy Code

By Jay M. Goffman, George N. Panagakis, Ken Ziman, Van C. Durrer II, John K. Lyons, Mark A. McDermott, and David M. Turetsky of Skadden, Arps Slate, Meagher & Flom LLP

The American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 recently released its Final Report recommending comprehensive reforms to Chapter 11 of the Bankruptcy Code. The report is the culmination of a three-year effort by over 200 restructuring professionals to evaluate Chapter 11 in light of the changing environment in which financially distressed companies operate. The Report is approximately 400 pages long. Skadden, Arps has prepared a comprehensive overview of the Report that condenses the salient points into a 30-page summary which can be found here. Selected recommendations for reform include:

  • DIP financing orders cannot impose milestones requiring the debtor to perform material tasks within the first 60 days (e.g., conduct a sale or file a plan).
  • No 363 sales of all or substantially all assets (“363x sales”) within the first 60 days unless the debtor demonstrates a high likelihood that the value of the debtor’s assets will decrease significantly.
  • 363 sales must satisfy requirements similar to plan confirmation requirements.
  • Junior, out-of-the-money stakeholders may be entitled to receive an allocation of value from senior creditors to reflect a possible upswing in the reorganized debtor’s value.
  • The cost of capital for similar debt issued to companies comparable to the debtor as a reorganized entity should be used when determining the appropriate discount rate for purposes of cram down.
  • Eliminating the requirement of at least one impaired accepting class of creditors for plan confirmation.
  • No appointment of an unsecured creditors’ committee if general unsecured creditors do not need representation in the case (e.g., if their claims are out-of-the-money).

Venue Roundtable in WSJ Bankruptcy Beat

Venue in Chapter 11 cases has been a hot topic, particularly after a recent venue battle in Caesar’s and the ABI Commission declined to recommend changing existing law, which gives debtors a broad choice for venue. Do current venue laws afford debtors, influential creditors, and their advisors too much leeway in electing where to file? And if so, should venue law be reformed? Last week, over a dozen bankruptcy professionals offered their views in the Wall Street Journal’s “Examiners” panel.

There was near-consensus among the WSJ’s Examiners that existing venue law—while perhaps imperfect—works well.

Anders Maxwell and Sharon Levine claimed, as did several others, that the large volume of filings in Delaware and the Southern District of New York renders those districts more efficient. Levine explained that “[t]he large volume of cases adjudicated within these two districts encourages further filings which in turn gives these courts even more of a track record, predictability and specialization.” Jack Butler argued that broad venue choice is a boon, since “[i]t creates opportunities for jointly-administered, cost-efficient filings, allowing fiduciaries to exercise their business judgment about what filing location might maximize enterprise value or reduce execution risk or both.” Moreover, “parties-in-interest actually seek to transfer venue in [only] a fraction of the cases filed.”

Companies also must consider “legal differences within the circuits” in deciding where to file, according to Richard Chesley. Differences in law, he explained, “can spell the difference between a confirmable plan of reorganization and liquidation.” Mark Roe judged that although the debtor might choose to file where it would be favored, that concern is offset by the expertise that courts hearing and deciding large, complex cases develop through repetition and experience. Venue restrictions that would disperse big firm filings would fail to capitalize on this expertise and experience. If more uniformity were needed, Roe argues, a nationwide intermediate appellate court would be the best approach.

The most vocal opponent of wide venue choice, Lynn LoPucki, wrote in his 2005 book, Courting Failure, that venue law degrades the bankruptcy courts, because the courts compete for large, prestigious cases by (i) advancing favorable precedent to attract debtors and (ii) tolerating high fees to curry favor with restructuring professionals, who influence where the case will be filed. This leads to a detrimental “race-to-the-bottom” style of “forum shopping,” which, he argues, facilitates the disproportionately large percentage of filings in Delaware and the Southern District of New York.

Visit the WSJ’s Bankruptcy Beat website to read the rest of the Examiners’ views on modern venue law.

This post was written by Aaron David (J.D. ’15).

Venue Reform Can Save Companies

By Lynn LoPucki, Security Pacific Bank Distinguished Professor of  Law at UCLA Law School
LoPucki imgOne side in litigation should not pick the court. That is exactly what happens, however, in big bankruptcies. A debtor, perhaps working together with its largest lender, can choose virtually any court in the country. The thousands of other stakeholders have no say.

The current system’s defenders argue that venue transfers will protect the stakeholders in appropriate cases. But in big case bankruptcy, venue transfer is illusory. Over the past ten years, 209 of the 317 large, public company Chapter 11s filed in the United States (66%) were filed in Wilmington, Delaware or New York City. One hundred eighty-six of the 209 (89%) were headquartered in some other district or division, but the Delaware and New York courts retained 206 of the 209 (99%).

Because cases have flowed to Delaware and New York since the 1990s, those courts’ judges now have high levels of big-case experience. In a recently completed study, Joseph Doherty and I found that significantly more companies survive under judges with greater big-case experience.

That doesn’t justify or necessitate letting corporate managers and DIP lenders pick their courts. The venue rules should require a big bankrupt to file with a big-case panel designated for its headquarters region. Within each of three or four regions, a chief judge could assign cases to maximize the development and utilization of big-case experience. That could eliminate forum shopping, level the playing field for stakeholders, reduce the pressure on judges to attract cases, and save more companies and jobs.

The Bankruptcy Clause, the Fifth Amendment, and the Limited Rights of Secured Creditors in Bankruptcy

By Charles J. Tabb, University of Illinois College of Law

2005-tabb The received wisdom in bankruptcy jurisprudence is that the Fifth Amendment Takings Clause independently limits the exercise of the bankruptcy power under the Bankruptcy Clause. Accordingly, secured creditors in bankruptcy are assumed to enjoy a constitutional right to receive the full value of their collateral in the bankruptcy case.

The thesis of this article is that the received wisdom is wrong. Professor Tabb argues that the Takings Clause of the Fifth Amendment does not and should not constrain the powers of Congress to modify the substantive rights of secured creditors under the Bankruptcy Clause. Instead, the only meaningful limits on the modification of substantive rights of stakeholders pursuant to the bankruptcy power are those that inhere in the Bankruptcy Clause itself.

The Bankruptcy Clause has only two limitations, both of which are extremely easy to satisfy regarding the treatment of secured creditors: that the law be “uniform,” and “on the subject of bankruptcies.”

The article first explains why it matters whether we continue to subscribe to the received wisdom that the Takings Clause limits what can be done to secured creditors in bankruptcy. Then it examines in considerable detail the historical evolution of bankruptcy jurisprudence in this area. Finally, the article assesses how we might best strike a prudential and meaningful constitutional balance.

To read the full article, click here.

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.

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