By Thomas J. Salerno, Gerald Weidner, Christopher Simpson, and Susan Ebner, (Stinson LLP)
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted into law. The CARES Act is reported to be “twice as large as any relief ever signed,” and will provide $2.2 trillion in relief to US businesses (with another $1 trillion being promised in the near future). While bankruptcy lawyers are aware that CARES expanded the debt limitations for eligibility for the Small Business Bankruptcy Reorganization Act, there could (and should) be another substantial implication for the brave new bankruptcy world—a new potential source of DIP financing. It is in this context that the CARES financing provisions become particularly interesting.
The authors recognize that there are established underwriting guidelines for SBA loans. Moreover, the existing regulations (and revisions in process) will come into play as to availability of these loans. Accordingly, while there is no express prohibition for some of the loans referenced herein from being accessed in a Chapter 11 proceeding, a de facto prohibition likely comes from existing underwriting guidelines. If the overarching purpose of the CARES Act is to assist businesses in weathering the economic storm while the COVID 19 virus ravages the economy, the authors argue that such underwriting guidelines can, and must, be loosened in order to allow application of some of these programs in Chapter 11 proceedings so that they can be most effectively implemented to stabilize businesses, preserve jobs, continue to keep employees and businesses on the tax rolls, etc.
In this way the stimulus funds will be used where they can be most effectively deployed. If not, those funds will be the equivalent of the federal government sending rubber rafts to a drought stricken area—a sign that the government cares, perhaps, but of certainly no real use to address the problem at hand. The full article is available here.
As originally enacted, the Act allowed certain small businesses with no more than approximately $2.7 million of debt to file for bankruptcy under a new subchapter V of chapter 11 of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.
On January 12, 2019, a new ‘Code of enterprise crisis and of insolvency’ was adopted in Italy.
The qualifying aspect of the new law is its emphasis on early intervention. The early warning system is based on enhanced internal monitoring and a ‘duty to scream’ imposed on public creditors, if the company is delinquent on VAT or social security contributions. All business entities must set up adequate ‘organisational, management and accounting’ systems that allow early detection of a crisis and timely dealing with it. The law also creates a public office that should help debtors to find an agreement with creditors or induce them to file for a proper reorganisation procedure.
There are incentives for debtors and directors who tackle the crisis early (and for auditors who take the appropriate steps). On the other hand, undue delay is addressed in various ways. Among them, a new presumption regarding the quantification of damages in case of directors’ trading after the moment when the company is deemed dissolved, that will make it easier for trustees to hold directors liable.
The reform also brings in updates on international jurisdiction, now entirely based on centre of main interest (COMI) (however, there is no general cooperation obligation with regard to cross-border insolvency), and a comprehensive set of rules on group crisis (seemingly compliant with the UNCITRAL principles).
Finally, the law makes relevant changes regarding two of the three available restructuring instruments, while there is nothing new with regard to the very peculiar reading of the absolute priority rule (APR) according to Italian insolvency law.
The law broadens the scope of the cramming down on dissenting creditors (subject to a 75% supermajority in the relevant class) in out-of-court, but court-confirmed debt restructuring agreements: once restricted to financial creditors only, they are now available with respect to all creditors. The confirmation of the plan, which envisages only intra-class cram down, is possible irrespective of compliance with any priority rule (absolute or relative), with the only backstop of a ‘best-interest test’, now based on a comparison with a liquidation scenario. This makes the Italian ‘scheme of arrangement’ a very flexible and effective tool (confirmation rates are also very high, in practice).
Regarding judicial composition with creditors (concordato preventivo), the law confirms the controversial requirement (introduced in 2015) that a minimum 20% payment of unsecured creditors is ensured when a liquidation plan is proposed, and adds the requirement of some form of ‘external’ financial input. By contrast, there is no such a threshold when the business is due to continue under the plan: however, ‘business continuation’ is now defined more narrowly than in the past – it is such only if creditors are paid mainly out of proceeds of the ongoing business, rather than from asset sales, or, under a statutory definition, if the continued business employs at least one-half of the previous workforce. This requirement may exceedingly restrict access to reorganisation or transfer wealth from creditors to employees.
As mentioned, the APR conundrum – the matter is domain of case law – is not solved by the new law. While the discussion regarding APR among creditors is confined mainly to what constitutes ‘new value’ (thus evading the APR waterfall), APR still seems not to apply to equity holders, in case of business continuation.
Finally, the new law introduces very minor tweaks to ‘plain’ insolvent liquidation proceedings, solving some interpretive issues but without an innovative approach, and makes the ‘certified reorganisation plan’, an out-of-court restructuring framework, somewhat more stable in case things don’t work out and the debtor ends up insolvent.
Certain new measures are already in force, but the whole new Code will come into force on 15 August 2020. It should be noted that the new law fully applies – as the law it supersedes – only to enterprises with less than 200 employees. Enterprises exceeding that threshold are deemed ‘large’ and, while being able to access ordinary restructuring tools, if insolvent they are subject to ‘extraordinary administration’, a special going-concern liquidation regime that provides for broad discretion for governmental authorities and the pursuit of business continuity even at the expenses of creditors’ rights.
The paper offers a comprehensive review of the main features of the new law, setting it in the context of the current Italian insolvency law framework.
Coupled with continued efforts in financial deleveraging and industrial reorganization, China delivered a number of changes to its bankruptcy law in 2019 in an effort to further accommodate smooth market exits for non-profitable businesses and to provide greater opportunities for viable businesses that experience temporary liquidity issues to be restructured as going concerns.
Currently, a lack of detailed rules and practical solutions to issues arising out of bankruptcies often deters parties from initiating such proceedings in China. The new rules will provide further clarification on extensively litigated/disputed issues and enhance transparency and consistency in the bankruptcy courts’ handling of cases. The developments encourage more usage of restructuring and compromise proceedings to find market solutions to address insolvency of Chinese companies.
“China’s bankruptcy laws and practices will be more and more market-driven,” said Xu Shengfeng, a Shenzhen-based bankruptcy and restructuring partner of Zhong Lun Law Firm, notwithstanding perceptions among foreign investors that “China’s bankruptcy regime is rather bureaucratic and administrative, with a certain level of involvement by local governments.”
“The goal is to build an institution in which the government’s role can be minimized, until its complete exit,” Xu said. “It cannot be done within a year or two, but this is certainly where things are headed.”
Market players, in particular financial institutions and asset management companies, are becoming more active and playing a greater role in leading restructuring and compromise proceedings. “Right now, many of the restructuring cases need capital injection from outside investors, and it is a great time for asset management companies,” Xu said. The recent U.S.-China Trade Deal promises to open doors for U.S. firms to obtain asset management licenses to acquire Chinese NPLs – see Article 4.5 of the US-China Economic and Trade Agreement.
Key changes to China’s restructuring regime in 2019 included:
establishment of specialized bankruptcy courts in Beijing, Shanghai, Shenzhen, Tianjin, Guangzhou, Wenzhou and Hangzhou;
Supreme People’s Court’s Judicial Interpretation III on the Enterprise Bankruptcy Law (EBL);
joint announcement of the Plan for Accelerating Improvement of the System for Market Entity Exits by 13 major state departments;
further establishment of regional bankruptcy administrator associations, including those in Beijing and Shanghai;
comment solicitation and final issuance of the Minutes of Conference on National Courts’ Civil and Commercial Trial Work, which devoted a section specifically for amendment of bankruptcy rules and restructuring regimes; and
“It was definitely a year of highlights,” said Xu. “The professionalism of bankruptcy trial teams, the establishment of online bankruptcy information disclosure platform, the promotion of pre-packaged restructurings and so on. The Supreme People’s Court is also making headways in the areas of personal bankruptcy and cross-border bankruptcy.”
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.
On July 25, 2019, the Judicial Insolvency Network announced its adoption of the Modalities of Court-to-Court Communication (the “Modalities”), which “apply to direct communications (written or oral) between courts in specific cases of cross-border proceedings relating to insolvency or adjustment of debt opened in more than one jurisdiction.” The Modalities are intended to facilitate implementation of the Guidelines for Communication and Cooperation Between Courts in Cross-Border Insolvency Matters, which since 2017 have been adopted by courts in several countries, including the Supreme Court of Singapore, the U.S. Bankruptcy Courts for the District of Delaware, the Southern District of New York and the Southern District of Florida, and courts in the United Kingdom, Australia, The Netherlands, South Korea, Canada, Bermuda, and the Eastern Caribbean. The U.S. Bankruptcy Court for the District of Delaware adopted the Modalities on an interim basis on July 25, 2019. It is anticipated that other courts will do so as well in the near term.
Mark G. Douglas (Jones Day) summarized key features of the Modalities and other developments since the Guidelines for Communication and Cooperation Between Courts in Cross-Border Insolvency Matters as developed and implemented by JIN (the judicial Insolvency Network) here.
In In re PT Bakrie Telecom Tbk, 601 B.R. 707 (Bankr. S.D.N.Y. 2019), the U.S. Bankruptcy Court for the Southern District of New York provided a primer on several important issues that a court may have to consider in ruling on a petition for recognition of a foreign bankruptcy proceeding under chapter 15 of the Bankruptcy Code. These include the requirement that a foreign debtor have property in the United States before being eligible for chapter 15, the rules regarding the appointment of a “foreign representative” for the debtor, what qualifies as a “collective proceeding” for the purpose of chapter 15 recognition, and the “public policy” exception to recognition. One notable conclusion by the court is that merely because a foreign proceeding has concluded does not prevent the later appointment of a foreign representative.
An examination of all of the issues highlighted by PT Bakrie entails a detailed factual analysis and careful application of the provisions of chapter 15 consistent with its underlying principles and purpose in providing assistance to foreign tribunals overseeing cross-border bankruptcy cases. Dan T. Moss and Mark G. Douglas (Jones Day) provided such a close examination and detailed analysis of the case here.
By Vincent S.J. Buccola (University of Pennsylvania – The Wharton School)
What good can a corporate bankruptcy regime do in the modern economy? The question bears asking because the environment in which distressed companies find themselves is so markedly different from the environment of just twenty years ago—to say nothing of the days of the equity receiverships, of sections 77 and 77B, of Chapters X and XI. The most important changes are well known: increased depth and liquidity of financial markets and, especially, increased capacity of financial contracting to say ex ante how distress will be resolved ex post. Recent efforts to take stock of contemporary bankruptcy practice, most notably the ABI’s Chapter 11 reform project, grapple implicitly with the significance of a changing environment. But by leaving the matter implicit, they underscore a lacuna about what the law’s marginal contribution to the economic order might be.
In a forthcoming article, Bankruptcy’s Cathedral, I hazard a general answer and elaborate its implications for a few prominent uses of bankruptcy in today’s practice.
The characteristic function of bankruptcy law, I say, is to recharacterize the mode in which an investor’s relationship to a distressed firm is governed. In particular, bankruptcy frequently toggles the protection of an investor’s economic interests from a property rule, in the Calabresi and Melamed sense, to a liability rule. It swaps out the investor’s unilateral right upon default to withdraw her investment, when such a right would ordinarily prevail, in favor of a judicially mediated procedure designed to give her the official value of her right. The automatic stay furnishes an example. It extinguishes a secured creditor’s power to repossess and sell collateral, and supplies instead a right only to what the bankruptcy judge determines to be “adequate protection” of its interest in the collateral.
This toggling function can be useful, Property rules are often more efficient during a company’s financial health than during distress. A state-contingent meta rule that switches between the two thus might be optimal. But what about financial contracting? Why can’t investors stipulate state-contingent meta rules if indeed they can maximize surplus by doing so? The short answer is that in some cases contract is sufficient, but in other cases legal or practical impediments are insuperable. The marginal contribution of bankruptcy law, then, is to supply toggling rules where investors cannot practically do so on their own.
One implication of my approach is to index the justifiable scope of bankruptcy to contingent facts about the efficacy of financial contracting. In environments where it is difficult for investors to specify state-contingent toggling rules, whether because of legal prohibition or practical impossibility, the compass for bankruptcy law is wider. As contract becomes more efficacious, bankruptcy’s brief grows correspondingly shorter.
This normative schema can be used to assess one-by-one the many actual interventions of bankruptcy laws. I scrutinize three uses of bankruptcy that are important in today’s practice: to confirm prepackaged plans, to effect going-concern sales, and to take advantage of the automatic stay. I find plausible justifications for a legal institution to bind holdout creditors and to extinguish in rem claims against a debtor’s assets. The automatic stay, on the other hand, is harder to justify. (The curious must read within to find out why.) More generally, though, my approach shows how one can weigh the contributions of a bankruptcy regime against its redundant or even counterproductive in light of contracting innovations.
The complete article is available for download here.
By Anthony J. Casey (University of Chicago Law School)
The prevailing theory of corporate bankruptcy law states that its purpose is to vindicate or mimic the agreement that creditors would have reached if they had bargained with each other to write their own rules. That idea – the Creditors’ Bargain theory – has held a central place in the minds of lawyers, judges, and scholars for almost forty years. At the same time, Creditors’ Bargain theorists have struggled to explain what actually prevents creditors from bargaining with each other and how efficient rules that interfere with creditors’ bargained-for rights fit into the theory.
Meanwhile, in other areas of the law, scholars have long recognized the limits of hypothetical contract theories. Notably, scholars have shown that when parties have limited or asymmetric information and incentives to bargain strategically, their contracts will be incomplete in ways that the law cannot remedy with a hypothetical contract. Bankruptcy scholars have never squarely addressed this challenge.
Taking aim at these issues, my article, The New Bargaining Theory of Corporate Bankruptcy and Chapter 11’s Renegotiation Framework, proposes a new law-and-economics theory of corporate bankruptcy. Financial distress routinely presents uncertainty that is not contractible. By its very nature – given the number of parties engaged in strategic bargaining and the number of contingencies – financial distress poses questions that are impossible to predict, define, and negotiate in an ex ante contract. As a result, relationships involving a distressed firm are governed by incomplete contracts that allow parties to hold each other up.
Corporate bankruptcy law’s purpose is to solve this hold-up problem. The problem is familiar in law, but its frequency in the distress context invites a special bankruptcy solution. The noncontractible uncertainty associated with financial distress is a recurring characteristic across all firms. Because every relationship of this type is incomplete and requires judicial intervention upon the occurrence of the same event, a uniform bankruptcy system that deals with those relationships will produce consistency, efficiency, and market predictability.
In Chapter 11 that uniform system takes the form of a structured renegotiation framework. Because of the high level of ex ante uncertainty, the system relies mostly on procedural protection rather than specific substantive prescriptions. The framework allows parties to renegotiate their relationships within a system that imposes prices and burdens on the bargaining process and then subjects the results to high-level judicial oversight. The specifics of this framework are targeted at reducing the worst and most likely instances of hold up that block renegotiation efforts.
Bankruptcy, then, is not about mimicking a hypothetical ex ante bargain. It is about facilitating an actual ex post bargain. The normative claim of my article is that bankruptcy law’s core purpose is to solve the hold-up problem. The descriptive claim is that the ex post renegotiation framework is the fundamental attribute of Chapter 11. The remaining normative question is whether Chapter 11 succeeds at its purpose. This New Bargaining Theory of corporate bankruptcy can help identify the metrics by which to answer that question.
By Laura Coordes (Sandra Day O’Connor College of Law)
Many health care providers are experiencing financial distress, and if the predicted wave of health care bankruptcies materializes, the entire U.S. economy could suffer. Unfortunately, health care providers are part of a growing group of “bankruptcy misfits,” in the sense that bankruptcy does not work for them the way it works for other businesses. This is so for two primary reasons. First, the Bankruptcy Code is insufficiently specific with respect to health care debtors. Second, the Code lacks an organizing principle to allow the court to reconcile the competing players and interests in a health care bankruptcy case.
Previous attempts to address these issues have not succeeded. Notably, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 scattered reforms across the Code, making bankruptcy more complicated for health care debtors. As a result, some have argued that these debtors are better off using bankruptcy alternatives such as state receiverships to address their debts.
In Reorganizing Health Care Bankruptcy, I assert that despite their bankruptcy misfit status, health care providers can realize distinct benefits from bankruptcy relief. To be effective, however, this relief must respond to health care providers’ unique needs. Creating separate Bankruptcy Code subchapters for health care business bankruptcies would allow Congress to clarify many aspects of health care bankruptcy and enable the development of specific procedures and a distinct organizing principle unique to health care provider bankruptcies. Although this proposal contemplates a significant structural change to the Bankruptcy Code, the Article explains why this change is warranted as part of the Code’s necessary evolution.
By Charles J. Tabb (University of Illinois College of Law)
The time has come to cast a discerning eye at chapter 11, the United States corporate bankruptcy reorganization statute, and examine how it is currently broken and what fixes can be made to improve it.
This Article first identifies five core normative goals that chapter 11 should promote: (1) maximize the value of the debtor firm; (2) distribute the maximized value of the firm fairly and equitably; (3) save jobs; (4) minimize the ripple effect of the firm’s failure; and (5) ensure that in pursuing those normative goals, the cure is not worse than the disease.
The Article then examines five critical ways in which chapter 11 in practice fails to achieve the normative ideals: (1) traditional chapter 11 restructurings are largely a thing of the past, and have given way to quick all-asset sales of the company; (2) secured lenders control everything and get a disproportionate share of the firm’s value; (3) a small number of other creditors are able to apply leverage to obtain unfair and inequitable payments on their claims compared to other creditors; (4) venue forum shopping has triggered a race to the bottom; and (5) bankruptcy judges routinely ignore the statute as written and legislate judicially.
The Article concludes by identifying seven possible reforms that could help transform chapter 11 from the current nightmare to the normative ideal dream: (1) making sales once again just sales; (2) resurrecting the “perishability” or “emergency” test for sales; (3) limiting secured creditors to foreclosure value; (4) opening up DIP financing terms and eliminating draconian terms; (5) eliminating all preferential priority-altering payments; (6) curtailing venue choice and forum shopping; and (7) eradicating judicial legislation.