Fair Equivalents and Market Prices: Bankruptcy Cramdown Interest Rates

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By Bruce A. Markell (Northwestern University Law School)

Cramdown is the confirmation of a plan of reorganization over the dissent of an entire class of creditors. Bankruptcy’s absolute priority rule permits such confirmation only if the dissenting class is paid in full, or if no junior class receives anything. “Paid in full,” however, does not require payment in cash. It can consist of intangible promises to pay money that banks, investors, and markets regularly value.

Whether this market value can precisely be transferred to cramdown has vexed many. This Article, “Fair Equivalents and Market Prices,” surveys the doctrinal background of such valuations and devises three short apothegms that can synthesize the history and doctrine under these phrases: “don’t pay too little”; “don’t pay too much”; and “don’t expect precision.”

Against this background, debates arose recently when a New York bankruptcy court applied a chapter 13 case, Till v. SCS Credit Corp., to a large corporate cramdown in In re MPM Silicones, LLC (“Momentive”). Given the legislative history and precedents in the cramdown area, the Article takes the position that Momentive was correct, that it is compatible with the doctrinal roots of cramdown, and that in the future, courts should resist using pure market-based valuations in cramdown calculations.


This article recently appeared in the Emory Bankruptcy Developments Journal (2016). The Roundtable has also recently posted Anthony Casey’s related article from the same issue, “Bankruptcy’s Endowment Effect.”

Bankruptcy’s Endowment Effect

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By Anthony J. Casey (University of Chicago Law School)

The notion of endowments and entitlements has a powerful effect on corporate bankruptcy policy. Scholars and lawyers generally assume a creditor endowed with a right outside the bankruptcy system must receive the equivalent of that right when its debtor is within the bankruptcy system. Proponents of this idea often assert that the result is required by the foundational theory of bankruptcy.

In a forthcoming essay, “Bankruptcy’s Endowment Effect,” I demonstrate that this is false. The idea of sacred creditor endowments is an untenable position that misunderstands the fundamental principles of bankruptcy. Corporate bankruptcy is, at its core, a system that alters nonbankruptcy endowments according to a hypothetical bargain that all creditors of a firm would have entered if bargaining were costless. The entire point of that hypothetical bargain is to suspend and alter some nonbankruptcy endowments to maximize the value of the bankruptcy estate and the firm as a whole. Indeed, if every stakeholder retained all of its nonbankruptcy endowments, the Bankruptcy Code would have no provisions at all.

Of course, altering nonbankruptcy endowments can impose costs. Foremost among those costs is the risk of opportunistic behavior that is costly for the estate as a whole. Bankruptcy policy will, therefore, be designed to maximize estate value while minimizing opportunistic bankruptcy behavior. Thus, the guiding principle for optimal bankruptcy design should be not the preservation of nonbankruptcy rights but rather the minimization of opportunistic behavior that reduces the net value of a firm.

With that principle in hand, we can resolve many difficult questions of bankruptcy policy. In the essay, I focus on applying the principle to the debate over what interest rate a senior creditor should get in a chapter 11 cramdown. In particular, I analyze the dispute in In re MPM Silicones, LLC (“Momentive”), where the bankruptcy court mistakenly reached its final decision by importing a creditor-endowment framework from consumer bankruptcy law (where the framework might make more sense). I show that an optimal rule for corporate bankruptcy supports a cramdown interest rate based on the prevailing market rates for similar loans, which reduces the risk of opportunistic behavior by both debtor and creditor.

Recharacterization of Debt as Equity in the Fourth Circuit

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By Gabrielle Glemann (Hughes Hubbard & Reed)

In an unpublished opinion in August, In re Province Grande Old Liberty, LLC, Case No. 15-1669, 2016 WL 4254917 (4th Cir. Aug. 12, 2016), the Fourth Circuit Court of Appeals shed some light on the circumstances under which a court may recharacterize debt as an equity investment, effectively subordinating the claim.  The issue before the Fourth Circuit was not one of first impression — the Fourth Circuit had long recognized that a bankruptcy court’s equitable powers include “the ability to look beyond form to substance,” and had previously articulated the factors to consider in evaluating a request for recharacterization. See Fairchild Dornier GMBH v. Official Comm. of Unsecured Creditors (In re Official Committee of Unsecured Creditors for Dornier Aviation (North America), Inc.), 453 F.3d 225 (4th Cir. 2006). The Fourth Circuit decision is notable however, because the court looked beyond the facts giving rise to the underlying claim at issue and ultimately to the economic substance of the entire context of the transaction.  In Province, the creditor whose claim was at issue was a company owned by insiders of the debtor.  The creditors’ claim was based on a loan that was used by the debtor to settle other obligations.  The court held that the settlement agreement was the “substance of the transaction” and a basis for recharacterization, notwithstanding the fact that the creditor was not a party to the settlement agreement.

The full memo is available here.

Beyond Options

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By Anthony J. Casey (University of Chicago Law School) and Edward R. Morrison (Columbia Law School)

Scholars and policymakers now debate reforms that would prevent a bankruptcy filing from being a moment that forces valuation of the firm, crystallization of claims against it, and elimination of junior stakeholders’ interest in future appreciation in firm value. These reforms have many names, ranging from Relative Priority to Redemption Option Value. Much of the debate centers on the extent to which reform would protect the non-bankruptcy options of junior stakeholders or harm the non-bankruptcy options of senior lenders. In a new paper, “Beyond Options,” we argue that this focus on options is misplaced. Protecting options is neither necessary nor sufficient for advancing the goal of a well-functioning bankruptcy system. What is needed is a regime that cashes out the rights of junior stakeholders with minimal judicial involvement. To illustrate, we propose an “automatic bankruptcy procedure” that gives senior creditors an option to restructure the firm’s debt or sell its assets at any time after a contractual default. Under this procedure, restructuring occurs in bankruptcy, but sales do not. Sales are either subject to warrants (which give junior stakeholders a claim on future appreciation) or are subject to judicial appraisal (which forces senior lenders to compensate junior stakeholders if the sale price was too low). Our proposal can be seen as an effort to design a formalized restructuring procedure that borrows from traditional state law governing corporate-control transactions. We show that this procedure minimizes core problems of current law—fire sales that harm junior stakeholders, delay that harms senior lenders, and the uncertainties generated by judicial valuation, which are exploited by all parties.

The full paper is available here.

Do Economic Conditions Drive DIP Lending?: Evidence from the Financial Crisis

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By Colleen Honigsberg (Stanford Law School) and Frederick Tung (Boston University School of Law)

For many firms, obtaining debtor-in-possession (DIP) financing is crucial for a successful reorganization. Such financing can be hard to find, however, as lenders are understandably hesitant to lend to firms in severe financial distress. The Bankruptcy Code solves this potential dilemma by authorizing debtors to provide DIP lenders with various sweeteners to induce lending. But because these sweeteners are thought to come at the expense of other stakeholders, the Code permits these inducements only if the judge determines that no less generous a package would have been sufficient to obtain the loan.

Certain types of lending inducements, frequently described as “extraordinary provisions,” have become the subject of growing concern. Anecdotal evidence suggests the use of these provisions has skyrocketed in recent years, leading important bankruptcy courts and the American Bankruptcy Institute to question whether these provisions are really necessary for a robust DIP market—or whether DIP lenders are extracting excessively generous terms. Defenders of DIP lenders, however, have pointed to a plausible external explanation for the popularity of extraordinary provisions in recent years: The Financial Crisis. When credit is tight, lenders demand more inducements. Indeed, judges have explicitly cited credit conditions in approving controversial inducement packages.

In this article, we provide the first evidence on the relationship between credit availability and DIP loan terms. Using a hand-collected dataset reflecting contract terms from DIP loans issued between 2004 and 2012, we study the relationship between DIP loan terms and broader market conditions. As predicted, we find a statistically significant relationship between credit availability and ordinary loan provisions like pricing and reporting covenants. By contrast, we find no evidence that “extraordinary” provisions like roll-ups and case milestones are related to credit availability. We hope that our findings will inform judges and policymakers struggling to evaluate whether the sweeteners extracted by DIP lenders are really necessary to induce lending.

The full article is available here.

Supreme Court to Hear Arguments in Jevic on November 28

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The Supreme Court is scheduled to hear oral arguments in Czyzewski v. Jevic Holding Corp. on November 28. In this week’s posts, Bruce Grohsgal argues in favor of structured dismissals in his forthcoming article, and Melissa Jacoby and Jonathan Lipson, in an amicus brief signed by several law professors, argue that the Court should reject the structured dismissal in this case as a violation of absolute priority.

How Absolute is the Absolute Priority Rule in Bankruptcy? The Case for Structured Dismissals

By Bruce Grohsgal (Widener University School of Law)

A structured dismissal in a chapter 11 bankruptcy case is a court-approved settlement of certain claims by or against the debtor followed by the dismissal of the case. Courts have held that a bankruptcy court cannot approve a settlement unless it complies with the absolute priority rule, paying senior claims in full before any distribution to junior stakeholders.

The Supreme Court will consider structured dismissals this fall in In re Jevic Holding Corp. The question before the Court is: “Whether a bankruptcy court may authorize the distribution of settlement proceeds in a manner that violates the statutory priority scheme.”

The argument that a structured dismissal always must follow the absolute priority rule, even when a chapter 11 plan is not confirmable, overstates the current statutory reach of the rule. The rule reached its zenith by judicial launch in 1939 in Case v. Los Angeles Lumber, when the Supreme Court construed the statutory term “fair and equitable” to be synonymous with “absolute priority.” Congress has circumscribed the rule repeatedly since: in 1952 under the Bankruptcy Act, in 1978 with enactment of the Code, and in 1986 and 2005.

As a result of these enactments, the absolute priority rule is a special, limited rule that does not pervade the current Code. Indeed, the very reorganization plan—a consensual chapter 11 plan—that the Supreme Court held was not confirmable in Los Angeles Lumber would be confirmable under the current Code.

My article, forthcoming and available here, concludes that Congress has authorized the bankruptcy court to approve a structured dismissal in chapter 11 when it is in the best interest of creditors—such as when a plan is not confirmable—even if distributions do not follow the absolute priority rule. Accordingly, the Supreme Court should resolve the current circuit split by affirming Jevic.

Brief for Amici Curiae Law Professors in Support of Petitioners, In re Jevic

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By Jonathan C. Lipson (Temple University Beasley School of Law) and Melissa B. Jacoby (University of North Carolina – Chapel Hill School of Law)

Fair treatment of creditors is one of the first lessons of a law school bankruptcy course. Congress created detailed and deliberate rules governing the payment of creditors to resolve a bankruptcy case. When a creditor has a priority claim under the Bankruptcy Code, it must be paid in full before any more junior creditors receive anything at all. This principle is one of the elements of bankruptcy that also fosters predictability.

On the facts of Czyzewski v. Jevic Holding Corp., to be heard this term by the United States Supreme Court, the Bankruptcy Code’s priority structure entitled workers, whose jobs had been abruptly terminated, to an estimated $8.3 million. Instead, they received nothing. An agreement and dismissal order (known collectively as a “structured dismissal”) resolving litigation over a leveraged buyout that contributed to the company’s demise skipped the workers and provided payment to junior creditors because the LBO defendants so insisted. A divided panel of the U.S. Court of Appeals for the Third Circuit approved this arrangement.

Our amicus brief illustrates that nothing in the Bankruptcy Code permits this kind of priority-skipping settlement in the absence of creditor consent. By blessing this arrangement, the Third Circuit majority opinion undercut the Bankruptcy Code’s priority rules and longstanding norms. Although the majority suggested it was limiting this result to rare cases, that majority decision contained neither a workable standard for determining what makes Jevic itself rare, nor guidance on what should trigger deviations in future cases—or how far such deviations may go. Left standing, the holding erodes the predictability and fairness of bankruptcy law and produces perverse incentives: powerful parties regularly will seek to write their own distribution rules through structured dismissal orders or other means.

The full amicus brief may be found here.

Strategies for Purchasing and Selling Assets in Chapter 11

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By Jacqueline Marcus (Weil, Gotshal & Manges) and Doron Kenter (Robins Kaplan)

Sales of a debtor’s assets pursuant to section 363 of the Bankruptcy Code carry significant benefits for buyers and sellers alike. But pursuing a sale process with the overlay of the Bankruptcy Code can also pose challenges and pitfalls, particularly for participants who are unfamiliar with the intricacies of the bankruptcy process and the applicable statutes, rules, and procedures inherent in 363 sales.

Jacqueline Marcus, a partner with Weil, Gotshal & Manges, LLP, and Doron Kenter, Counsel with Robins Kaplan LLP, recently authored an article for Practical Law Bankruptcy, in which they outline the relative advantages and disadvantages of sales in bankruptcy, from both the buyer’s and the seller’s perspective, and offer a practical guide to participating in section 363 sales. The article discusses the various types of section 363 sales, as well as the forms of sale processes that debtors may choose to employ in selling some or substantially all of their assets.  The article discusses the benefits and drawbacks of finding, or being, a stalking horse bidder, and provides guidance for the marketing process, credit bidding, conducting auctions, and choosing a winning bid. It then discusses the competing views regarding the circumstances under which the bankruptcy court may call the debtor’s decision into question or reopen an auction that has otherwise been closed. Finally, the article discusses the considerations that should be taken into account in determining an exit strategy after a debtor completes a sale of substantially all of its assets.

The full text of the article is available here.

Bankruptcy Sales

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By Melissa B. Jacoby (University of North Carolina – Chapel Hill) and Edward J. Janger (Brooklyn Law School)

Bankruptcy courts have become fora for the sale of entire firms as going concerns, as well as for the liquidation of assets piecemeal. This book chapter teases out the advantages and disadvantages of conducting such sales under federal bankruptcy law as compared to state law. We first describe the forms that bankruptcy sales can take, and the contexts in which they occur. Next, we explore the concept of “bankruptcy created value,” identifying the ways in which the federal bankruptcy process can create value over and above what can be realized through compulsory state processes. We then identify several procedural and governance-based concerns about all-asset sales. We suggest that our recent proposal, the Ice Cube Bond, might address concerns about sales of substantially all assets by withholding a portion of the sale proceeds. To recover the withheld funds, claimants would have to establish that the sale did not harm the bankruptcy estate and that they would be legally entitled to the funds under the normal bankruptcy priority rules or pursuant to an agreement reached after the sale. To conclude, we explore the related issues of credit bidding and the permissible scope of sale orders that declare assets to be “free and clear” of various kinds of claims and property interests.

The full chapter may be found here.

This draft chapter has been accepted for publication by Edward Elgar Publishing in the forthcoming Corporate Bankruptcy Handbook, edited by Barry Adler, due to be published in 2017.

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