The Secret Life of Priority: Corporate Reorganization After Jevic, 93 WASH L. REV. 631 (2018)

By Jonathan C. Lipson (Temple University – James E. Beasley School of Law)

The Supreme Court’s 2017 decision in Czyzewski v. Jevic Holding Corp. (In re Jevic) reaffirms that final distributions in chapter 11 cases must follow “absolute” priority absent the “consent” of priority creditors. The Court did not, however, define “consent” for this purpose, which is a problem, because consent can be hard to pinpoint in corporate reorganizations that involve hundreds or thousands of creditors and shareholders.

In this paper, I argue that, although the Jevic majority does not define consent, its reasoning reflects concerns about aspects of the reorganization process that may serve as proxies for it: stakeholder participation, outcome predictability, and procedural integrity.

First, I explain why “consent” is indeterminate in this context, inviting an inspection of process quality. Second, I assess Jevic’s process-value framework. Implementing Jevic’s values is not costless, so the Court’s commitment to them suggests that efficiency — the mantra of many scholars — is not the only or necessarily the most important value in reorganization. Third, I argue that these values conflict with the power that senior secured creditors have gained in recent years to control corporate reorganizations. Many worry that this power is the leading problem in corporate bankruptcy, producing needless expropriation and error. I also sketch opportunities that Jevic creates for scholars and practitioners who share these concerns.

Jevic reveals a secret: “priority” is not only about the order in which a corporate debtor pays its creditors, but also about the process by which it does so.

The full article is available here.

The Ninth Circuit Affirms Creditors’ Ability to Block ‘Cramdown’ by Purchasing Claims

By George P. Angelich and Annie Y. Stoops (Arent Fox).

The Ninth Circuit affirmed the creditor’s ability to block “cramdown” by purchasing junior debt for the purpose of protecting its own existing claim.  In re Fagerdala USA-Lompoc, Inc., 891 F.3d 848 (9th Cir. 2018).  In reversing the bankruptcy court’s decision to designate claims for bad faith under 11 U.S.C. § 1126(e), the Ninth Circuit held that the creditor acting in its self-interest by purchasing unsecured claims to block “cramdown” did not constitute bad faith unless evidence showed the creditor acted with a motive ulterior to the purpose of protecting its economic interest in a bankruptcy proceeding.  Examples of “ulterior motive” included a creditor purchasing claims for the purpose of blocking litigation against it or a debtor arranging to have an insider purchase claims.

Fagerdala clarifies that creditors may purchase claims in defense of their economic interests in bankruptcy proceedings.  In holding that the bad faith inquiry under 11 U.S.C.  § 1126(e) requires evidence of an “ulterior motive,” the Ninth Circuit sets the stage for designation where a non-creditor or strategic investor purchases claims as an offensive move to gain an advantage over the Chapter 11 debtor.

The full article is available here.

Inequality and Equity in Bankruptcy Reorganization

Richard M. Hynes and Steven D. Walt (University of Virginia School of Law).

Courts have developed a series of controversial doctrines that allow a debtor to depart from bankruptcy’s standard priority rules.  In a recent decision, the Supreme Court signaled tolerance of one type of departure, the critical vendor payment, as long as it occurs early in the case and is what an economist would call a strict Pareto improvement: a payment that makes all creditors better off.  This essay demonstrates that Pareto improvements appear in the stated tests governing other departures, including roll-ups and substantive consolidations.  Some scholars, and a few courts, would apply much more permissive tests similar to economists’ Kaldor-Hicks standard and allow deviations as long as the winners gain more than the losers lose.  Still other courts would do away with these doctrines entirely and allow departures only with the consent of the disfavored.  Defending the judicial use of the Pareto standard in reorganizations, the essay further discusses some of the normative considerations in the choice between a Pareto standard, a Kaldor-Hicks standard, and an absolute prohibition.

The full article can be found here.

The Pari Passu Fallacy – Requiescat in Pace

Lee C. Buchheit (Cleary Gottlieb Steen & Hamilton LLP)

The pari passu fallacy, first uncloaked in 2000, posits that when a sovereign borrower promises to maintain the equal ranking of a debt with the borrower’s other senior indebtedness, it thereby implicitly promises to pay all of those debts on a ratable basis.  In its 18-year life span, the fallacy has caused considerable mischief in the sovereign debt market.  It even prompted a wholesale change in the drafting of the pari passu clause in sovereign bonds expressly to disavow the ratable payment interpretation of the provision.  Recent decisions of the US federal courts in New York have clarified the circumstances in which a sovereign borrower will be held to breach, and just as importantly when it will be held not to breach, a contractual pari passu undertaking.  These cases confirm that a sovereign borrower will not breach a pari passu covenant merely by paying one creditor while not paying another, equally ranking, lender.

The full paper can be found here.

The Year in Bankruptcy: 2017

by Charles M. Oellermann and Mark G. Douglas (Jones Day).

In their annual chronicle of business bankruptcy, financial, economic, and related developments in the U.S., Charles M. Oellermann and Mark G. Douglas of Jones Day review the most significant events of 2017, including business bankruptcy filing statistics and industry trends; newsworthy developments regarding sovereign and commonwealth debt; the top 10 public-company bankruptcies of the year; notable private and cross-border bankruptcy cases; significant business bankruptcy and U.S. Supreme Court bankruptcy rulings; bankruptcy-related legislative and regulatory developments; noteworthy chapter 11 plan confirmations and exits from bankruptcy; and more.

The article is available here.

Insider Status and U.S. Bank v. Village at Lakeridge

By Ronit J. Berkovich and David Li (Weil, Gotshal & Manges LLP).

The U.S. Supreme Court, in U.S. Bank Nat’l Ass’n v. Village at Lakeridge, LLC, 583 U.S. ___ (2018), offered plenty of hints on an important topic while simultaneously ruling very little about it.  In chapter 11, whether a creditor qualifies as an “insider” can have enormous implications on a range of issues, including plan confirmation, fraudulent transfer and preference analyses, and severance payment and employee incentive/retention plan (KEIP/KERP) approvals.  Lakeridge involved a dispute as to whether the bankruptcy court properly determined in confirming a plan that the sole impaired accepting creditor (the romantic partner of one of the debtor’s officers) was not a “non-statutory” insider.  If the creditor actually were such an insider, then the chapter 11 plan should not have been confirmed.

In granting cert to hear the case, the Supreme Court expressly declined the opportunity to address whether the Ninth Circuit articulated the correct legal test to determine if a person qualifies as a non-statutory insider.  Instead, the Supreme Court granted cert only to answer the narrow question of whether the Ninth Circuit applied the correct standard of review to the lower court’s determination.  Justice Kagan, writing for the Court, kept to that script by simply affirming the Ninth Circuit’s decision to apply a clear error standard of review.  Concurrences by Justices Kennedy and Sotomayor, however, each acknowledged shortcomings in the legal test the Ninth Circuit applied and each appeared to invite lower courts to consider alternative approaches.  As a whole, Lakeridge provides little binding guidance, and practitioners can expect further development in non-statutory insider law by the Courts of Appeals.

The article is available here.

Ninth Circuit Holds That Impaired Accepting Class Requirement Applies to Plan Confirmation on a “Per-Plan” Rather Than a “Per Debtor” Basis

By James L. Bromley, Lisa M. Schweitzer, Sean A. O’Neal, Luka A. Barefoot, and Daniel K. Soltman (Cleary Gottlieb).

On January 25, 2018, the United States Court of Appeals of the Ninth Circuit held that section 1129(a)(10) of the Bankruptcy Code, which requires cramdown plans to have at least one impaired accepting class, applies on a “per-plan” basis, rather than a “per-debtor” basis. In re Transwest Resort Properties Inc., Case No. 16-16221 (9th Cir. Jan. 25, 2018). Under the “per-plan” rule, multiple debtors with a single plan of reorganization may cram down a plan on any creditor class with the support of only one impaired accepting class, even where the impaired accepting class has claims against a different debtor than the crammed down class that has rejected the plan. The Ninth Circuit is the first circuit court to address the “per-debtor” versus “per-plan” issue, and previous decisions were split between the Southern District of New York (adopting the “per-plan” approach) and the District of Delaware (adopting the “per-debtor” approach). Transwest will likely have a significant impact on how debtors and creditors within the Ninth Circuit and elsewhere consider their relative options prior to and during bankruptcy.

The remainder of this article will discuss the Transwest case background and the Ninth Circuit’s decision, and the expected impact of the decision, both inside and outside of the Ninth Circuit. The article is available here.

For earlier Roundtable coverage of 1129(a)(10), please see our recent post on strategic impairment in cramdowns.

Applying Jevic: How Courts Are Interpreting and Applying the Supreme Court’s Ruling on Structured Dismissals and Priority Skipping

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 February 19, 2018, the Jevic Files has collected and summarized thirteen cases across twelve 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.

The article is available here.

The Roundtable has posted on Jevic before, including a report of the case by Melissa Jacoby & Jonathan Lipson and a roundup of law firm perspectives on the Court’s decision and an initial scholarly take on the opinion from Nicholas L. Georgakopoulos. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article that the Jevic opinion referred to.

The Janus Faces of Reorganization Law

By Vincent S. J. Buccola (University of Pennsylvania – The Wharton School – Legal Studies & Business Ethics Department).

In Czyzewski v. Jevic Holding Corporation, 137 S. Ct. 973 (2017), the Supreme Court held that bankruptcy courts lack authority to implement structured dismissals that sidestep the absolute priority rule. The bankruptcy judge’s power to resolve cases by dismissal, a power the Bankruptcy Code grants explicitly, is implicitly limited by the norm of waterfall distribution—or so in any case the majority reasoned. The Court’s decision rested on an interpretive default rule. Because distributional priorities are so important to bankruptcy, the Code will be understood to bar departures absent a clear statement. At the same time, however, the Jevic majority went out of its way to distinguish (and seemingly bless) what it called “interim distributions” such as critical vendor orders, notwithstanding their capacity to undermine priorities and their dubious textual basis.

This article argues that this seeming inconsistency in Jevic is no misstep, but that there might be some sense to the conflicting interpretive approaches after all. Two distinctive paradigms now color interpretation of the Bankruptcy Code. One paradigm governs during the early stages of a case and is oriented toward the importance of debtor and judicial discretion to use estate assets for the general welfare. The other paradigm governs a bankruptcy’s conclusion and is oriented toward the sanctity of creditors’ bargained-for distributional entitlements. In combination, they produce what appears to be policy incoherence. But, at least in a world of robust senior creditor influence, a rule under which judicial discretion diminishes over the course of a case—discretion giving way to entitlements—may in fact tend to maximize creditor recoveries.

The full article is available here.

Debt Priority Structure, Market Discipline and Bank Conduct

By Piotr Danisewicz (University of Bristol), Danny McGowan (University of Nottingham), Enrico Onali (Aston University; University of Wales System – Bangor University), and Klaus Schaeck (University of Bristol).

This article explores how changes in debt priority structure affect banks’ funding costs and soundness. We exploit the staggered introduction of depositor preference laws across 15 U.S. states between 1983 and 1993 which confer priority to deposit claims in case of bank liquidation. The laws are exogenous with respect to the outcomes of interest and apply to state-chartered banks but not to nationally-chartered banks, allowing us to isolate causality using difference-in-difference methods.

We document changes in monitoring intensity by various creditors depending on whether creditors move up or down the priority ladder. Enactment of depositor preference reduces deposit interest rates, consistent with the fact that deposit claims are protected in case of bankruptcy thereby reducing depositors’ monitoring incentives. However, non-deposit interest rates increase as these creditors are exposed to greater losses in bankruptcy which leads them to more intensively monitor banks’ conditions.

Subordinating non-depositor claims also reduces banks’ risk-taking and leverage, consistent with market discipline. For example, non-depositors who receive negative signals about project returns may refuse to roll over funds which motivates banks to improve soundness to maintain access to key funding sources such as Fed Funds.

These insights highlight a role for debt priority structure in the regulatory framework, and support recent innovations in banking regulation that reallocate monitoring incentives towards non-depositors.

The full paper can be found here.

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