A Russian Sovereign Debt Default? No Longer Improbable

By Dennis Hranitzky, Richard East, Liesl Fichardt, Epaminontas Triantafilou, Yasseen Gailani, and Rupert Goodway (Quinn Emmanuel Urquhart & Sullivan, LLP)

The article summarizes the likelihood and implications of a sovereign bond default by the Russian Federation. It first discusses the economic sanctions imposed on the Russian Federation, their impact on Russia’s ability to access gold and foreign currency reserves and the consequences of sanctions on Russia’s ability to satisfy its obligations under the approximately $40 billion in UK law bonds. Noting that a payment default will likely lead to litigation arbitration, the article analyzes key provisions of the bonds, noting that atypical of sovereign bonds, they include no choice of law or venue provisions or waiver of sovereign immunity. The article explores anticipated litigation hurdles in both the US and the UK, with a focus on sovereign immunity and forum non conveniens defenses that may be available to Russia, including the particular difficulties that may be faced by litigants in enforcing a judgment from a US or UK court in the absence of a sovereign immunity waiver. The analysis of sovereign immunity necessarily includes consideration of the commercial activity exception and the article analyzes the US and UK interpretation of this exception. The availability of judgment enforcement discovery is also addressed, noting that broad written and sworn deposition discovery of both the debtor and third parties is the norm in the US and also potentially available in the UK. The article concludes with a recommendation that holders of Russian bonds organize themselves and seek advice on their options prior to the occurrence of a default.

The full article is available here.

The Importance of Being Bound: Bondholders’ Vote and Workouts in the U.S. and in Italy

By Francesca Prenestini (Bocconi University, Milan)

Francesca Prenestini

Most legal systems follow one of two rules for regulating the capacity of an issuer to renegotiate the terms of the bond loan to avoid insolvency or to accommodate changing capital needs. The first rule requires the individual consent of every bondholder while the second one permits the proposed agreement to be approved upon a majority decision which also binds dissenting bondholders.

This article analyzes the desirability of adopting a regulatory approach that allows a binding vote of bondholders on amendments of the core terms of the loan and other restructuring measures, including the conversion of bonds into shares. In doing so, this article examines the drawbacks of the prohibitive approach, which requires consent from all bondholders, with particular regard to the judicial cases and business practices of two major legal systems (the U.S. and Italy).

In the U.S., the Marblegate and Caesars cases have reignited the debate on out-of-bankruptcy restructurings of bond issues. In 2015, the U.S. District Court for the Southern District of New York reaffirmed that coercive exit consent transactions which force bondholders into questionable restructurings are prohibited by § 316(b) of the Trust Indenture Act of 1939 (“TIA”). Then, in January 2017, the U.S. Court of Appeal for the Second Circuit adopted a narrower interpretation, holding that § 316(b) only prohibits formal non-consensual modifications of an indenture’s core payment terms.
The district court’s interpretation, though broad, is more coherent with the text, the legislative history, and the purpose of the TIA. Section 316(b) provides that the individual right of each bondholder to receive payment of the principal of and interest on their indenture security on the due dates cannot (with a few minor exceptions) be impaired without the bondholder’s consent. This section was enacted to protect bondholders from insider abuses by giving individual bondholders the power to veto proposed amendments in an out-of-court restructuring. However, this individual veto power often precludes even fair renegotiation agreements between the issuer and the bondholders.

Under Italian law, the meeting of bondholders may approve “amendments of the terms of the loan” by majority vote. Nevertheless, in the light of quite restrictive interpretations of such a rule, those modifications may not change the structural characteristics of the bond loan.

This article suggests that governments should adopt rules that allow a majority bondholders’ vote to accept out-of-bankruptcy restructurings of bond issues. Currently two different solutions may be implemented in the U.S. and Italy: in the U.S., until § 316(b) can be reformed, the Securities and Exchange Commission could exercise its power to grant exemptions to authorize transactions and agreements otherwise banned; and in Italy, in the absence of a statutory prohibition, the contract governing the loan could include a provision allowing the meeting of bondholders to vote upon amendments of the core terms of the loan and other restructuring measures, such as the conversion of bonds into shares.

This article first examines the two different approaches to bond loans restructuring in various legal systems and in the context of sovereign debt, and considers why allowing a binding vote of the bondholders in workouts is so important given the rationales for and against this rule. Then it focuses on the U.S. legal system, and discusses the statutory provision that bans the majority rule, how the jurisprudence and business practices have evolved, and recent proposals for reform. The article also considers the Italian system, its rules and business practices, and how to overcome its limits. In the end, this article suggests an alternative rule and proposes interim solutions to the problem while awaiting statutory reform.

The full article is available here.

For previous Roundtable posts on § 316(b) of the TIA and Marblegate, see William W. Bratton, The New Bond Workouts; Out-of-Court Restructurings After Marblegate: Trust Indenture Act Section 316(b) and Beyond; Benjamin Liu, Exit Consents in Debt Restructurings; Second Circuit Rules on § 316(b) in Marblegate; Mark Roe, The Trust Indenture Act of 1939 in Congress and the Courts in 2016: Bringing the SEC to the Table; National Bankruptcy Conference Proposed Amendments to Bankruptcy Code to Facilitate Restructuring of Bond and Credit Agreement Debt; David A. Brittenham, Matthew E. Kaplan, M. Natasha Labovitz, Peter J. Loughran, Jeffrey E. Ross, and My Chi To, 28 Law Firms Publish White Paper Addressing Trust Indenture Act Complications In Debt Restructurings; Carlos Berdejó, Revisiting the Voting Prohibition in Bond Workouts (providing evidence related to argument made in Mark Roe, The Voting Prohibition in Bond Workouts, 97 Yale L.J. 232 (1987)).

Creditor Rights, Corporate Leverage and Investments, and the Firm Type

By Aras Canipek (University of Konstanz), Axel H. Kind (University of Konstanz), and Sabine Wende (University of Cologne – Faculty of Management, Economics and Social Sciences)

Aras Canipek
Axel Kind
Sabine Wende

Stronger creditor rights reduce credit costs and thus may allow firms to increase leverage and investments, but also increase distress costs and thus may prompt firms to lower leverage and undertake risk-reducing but unprofitable investments. Using a German bankruptcy reform, we find evidence on average consistent with the latter hypothesis. We also hypothesize and find evidence that the effect of creditor rights on corporate leverage and investments depends on the firm type, as it influences the effect creditor rights have on credit costs and distress costs and thus which effect dominates. For example, our findings suggest that stronger creditor rights are costly for large firms, for which the effect of creditor rights on distress costs should outweigh the effect on credit costs, but beneficial for small firms, for which the effect on credit costs should outweigh the effect on distress costs. Our understanding not only reconciles the mixed empirical evidence of existing studies, but also has important implications for optimal bankruptcy design. In particular, our findings are contrary to a widely held opinion that bankruptcy law should be uniform and balance the effect of creditor rights on credit costs and distress costs. Rather, they point to a menu of procedures in which a debtor-friendly and creditor-friendly procedure co-exist and thus allow different types of firms to utilize the procedure that suits them best. If such a menu is not possible, our analysis suggests that countries should choose a debtor-friendly or creditor-friendly procedure, depending on the most important firm type in the country.

The full article is available here.

Viability Assessment in Corporate Debt Restructuring: Optimizing the Filtration Effect of the European Directive on Restructuring and Insolvency

By Lydia Tsioli (King’s College London)

Lydia Tsioli

Despite being pivotal in corporate debt restructuring, viability, an intricate notion with double meaning and double role, has not been systematically examined in Europe. Against this background, and especially given that the new European directive on restructuring and insolvency (the “Directive”) is currently under transposition and restructuring law is making its first steps as a harmonized field across Europe, my recent paper, published in Norton Journal of Bankruptcy Law and Practice, undertakes a doctrinal, comparative [USA, UK] and economic analysis of law examination of viability with the aim of putting forward suggestions that will make viability the linchpin of the Directive, thus optimizing its filtration effect as defined below. 

In doing so, the paper first analyses and distinguishes the two different meanings of viability, namely financial viability and economic viability, and clarifies what the precise role of law is within the viability-related discourse. Such role consists in providing indicators of viability and incorporating appropriate “filtering mechanisms”, a term of art introduced by the paper, which refers to mechanisms filtering non-viable debtors out of the restructuring procedure, hence contributing towards satisfaction of restructuring’s overall goal of saving viable debtors only. 

The way in which such filtering mechanisms are triggered depends on who plays the role of the “ultimate viability assessor” within a restructuring framework, for example an Insolvency Practitioner (“IP”) or a court. Depending on this, the paper distinguishes between IP-centered and Non-IP – centered models of viability assessment and identifies the Directive as standing closer to the Non-IP – centered one. 

What the paper suggests though, is that, what ultimately matters is the appropriateness of filtering mechanisms in any chosen model of viability assessment. Such mechanisms can be most characteristically found under Chapter 11, Title 11 of US Bankruptcy Code and are the conversion/dismissal of a Chapter 11 case and stay relief under section 362. The paper examines them extensively and demonstrates how the existence or inexistence of viability in its double meaning, constitutes the “litmus test” for the triggering of Chapter 11’s filtering mechanisms. 

In light of these comparative findings, the paper finally turns to the European directive and identifies its filtering mechanisms. The paper subsequently, and most importantly, makes suggestions on how the filtration effect of the Directive’s existing mechanisms can be optimized through appropriate interpretation, transposition, judicial practice or future reform. Through these suggestions, it is aspired that first, the Directive will properly reflect the notion of viability and consequently achieve an effective filtering of viable debtors from non-viable ones, and second, viability will ultimately become the primary point of focus and linchpin of European corporate debt restructuring overall.

The paper, entitled “Viability Assessment in Corporate Debt Restructuring: Optimizing the Filtration Effect of the European Directive on Restructuring and Insolvency” is available here.

Reprinted from Norton Journal of Bankruptcy Law and Practice, Vol. 30 No. 5 (October 2021), with permission of Thomson Reuters. Copyright © 2021. Further use without the permission of Thomson Reuters is prohibited. For further information about this publication, please visit https://legal.thomsonreuters.com/en/products/law-books or call 800.328.9352.

The paper has been awarded the 2021 Silver Medal in the International Insolvency Institute’s “Prize in International Insolvency Studies”.

The Case for Bankruptcy Court Discretion to Shift Attorney’s Fees

By Daniel J. Bussel (Professor of Law, UCLA School of Law)

Daniel J. Bussel

Neither the “American Rule” (each party pays its own attorney) nor the “English Rule” (loser pays both parties’ attorneys) is the baseline principle in insolvency cases.  Most major parties do not bear their own attorney’s fees, win or lose.  Fee-shifting is pervasive; the bankruptcy court is directly involved in reviewing the fees; sometimes it’s almost impossible to figure who actually foots the bills.  This is true in US courts, which still generally purport to follow the “American Rule,” and courts in the UK, which generally purport to follow the “English Rule.”  In both countries, theory notwithstanding, equitable principles, born in England’s ancient chancery courts, permit discretionary fee-shifting in light of the collective nature of insolvency proceedings.

Unfortunately, some US courts, including the Supreme Court, disregarding this history and practice, anomalously cling to the American Rule, creating perverse incentives that disrupt the efficient functioning of the reorganization process.  Two leading examples are the Supreme Court’s decisions in Baker & Botts and Midland Funding, both critiqued in my paper, Fee-Shifting in Bankruptcy.  In Baker & Botts, the American Rule denies full compensation to the prevailing debtor’s attorney from any source, disincentivizing the pursuit of meritorious estate claims.  In Midland Funding, the American Rule rewards strategic manipulation by the holder of meritless claims, disincentivizing clearly valid objections.         

Abandoning the American Rule and authorizing a discretionary version of the English Rule as the default rule in bankruptcy for recovery of attorney’s fees is no radical step.  Empirical work is limited, but supports the conclusion that shifting from the American Rule to a discretionary version of the English Rule will have only a modest impact. In bankruptcy cases, an enormous amount of explicit and implicit fee shifting already occurs.  The bankruptcy courts have a well-developed set of procedures for regulating and allowing reasonable attorney’s fees.  They are well-positioned to exercise discretion in awarding attorney’s fees to control bullying and holdout tactics calculated to confer leverage by pressing weak claims and imposing costs on others.  

Several factors can appropriately guide court discretion to award fees in insolvency cases, including: 

  1. Whether the prevailing party or its adversary has a right to recover fees in nonbankruptcy litigation over the same issues. 
  2. Whether the bankruptcy code expressly contemplates recovery of fees as a component of damages. 
  3. The amount of fees and whether the stakes justify them. 
  4. The strength of the prevailing party’s merits case.
  5. Whether the nonprevailing party played the part of bully, holdout, or squeaky wheel. 
  6. Whether a systemic asymmetry exists between the parties allowing one party to implicitly shift fees whether it prevails or not and regardless of the court’s fee award. 
  7. Whether the prevailing party’s success in litigation will economically benefit others similarly situated or creditors generally. 
  8. Whether a fee award will advance the public interest in equitable administration of bankruptcy cases. 
  9. The extent to which a given fee award may be so onerous to the non-prevailing party that it would unreasonably deter access to the courts.
  10. Vexatious and unreasonable conduct by either (or both) of the litigants. 
  11. The extent to which the prevailing party incurred fees for considerations apart from the case at bar because of its status as a repeat player. 
  12. The extent to which the party seeking recovery of fees practically prevailed in the litigation.
  13. Whether the prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity.
  14. Whether the non-prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity.
  15. Assessing the practical economic incidence of fees initially borne by the estate.

The UK, starting from the English Rule, has created a discretionary fee-shifting regime in insolvency cases resembling the discretionary approach advocated here.  The English cases exhibit a continuing push-pull among (i) the desire to socialize costs of reorganizations that benefit third parties; (ii) concern about unduly discouraging participation by all affected constituents; and (iii) the problems posed by hold-outs, bullies and excessive litigiousness. See Matter of Virgin Active Holdings Ltd (Snowden, J.).  The realities of insolvency practice are impelling both the English and American systems towards court-supervised discretionary fee-shifting.

The damage done by the American Rule is limited by how pervasive fee-shifting already is in bankruptcy.  Fully embracing discretionary fee-shifting in favor of prevailing parties, however, is low-hanging fruit we can promptly gather in to facilitate sound administration of insolvent estates.

The full paper is available here.

Restructuring Sovereign Debt and Rebuilding a National Economy for a Failing State: The Case of Venezuela

By Steven T. Kargman (Kargman Associates/International Restructuring Advisors)

Steven T. Kargman

Venezuela is facing a veritable perform storm: a major humanitarian crisis, a collapsing economy, a sovereign debt crisis, and a political stalemate between the ruling Maduro regime and the opposition.  Yet, if and when Venezuela tries to come to terms with these very serious challenges (probably under the auspices of a new Venezuelan government), Venezuela will first and foremost need to address the pressing social needs of the Venezuelan people, but it will also need to undertake the monumental task of rebuilding its national economy and restructuring its sovereign debt that has been estimated to be $150 billion or more.

In a new article entitled “Venezuela: Prospects for Restructuring Sovereign Debt and Rebuilding a National Economy Against the Backdrop of a Failing State,” I discuss the prospects for a sovereign debt restructuring as well as the major legal and policy challenges associated with a program of sovereign debt restructuring and national economic reconstruction.  For any future sovereign debt restructuring, Venezuela will need to consider employing a broad range of restructuring tools, both old and new.  Further, for any future economic reconstruction effort, Venezuela will need to consider strategies for rebuilding its national oil industry as well as strategies for diversification of its economy.

The article originally appeared in AIRA Journal, Vol. 34, No. 2 (May 2021) and is reprinted with the permission of its publisher, the Association of Insolvency & Restructuring Advisors (AIRA).  The article can be found here.  (The article was first posted on the CLS Blue Sky Blog of Columbia Law School (May 18, 2021) and is cross-posted here with the permission of the CLS Blue Sky Blog.)

Restructurings in Emerging Economies One Year into the COVID-19 Pandemic

By Steven T. Kargman (Kargman Associates/International Restructuring Advisors)

Steven T. Kargman

A new article entitled “The COVID-19 Pandemic and Emerging Market Restructurings: The View One Year Later” provides an overview of the challenging economic landscape that continues to face many emerging economies in the wake of the COVID-19 pandemic, and it also discusses current sovereign debt restructuring and corporate debt restructuring issues in the emerging economies.
The article provides an analysis of sovereign debt restructuring situations involving a serial defaulter (Argentina) and failing states (Venezuela and Lebanon). It also reviews the sovereign debt restructuring travails of an African state, Zambia, that may have implications for future sovereign debt restructurings in Sub-Saharan Africa in light of the intercreditor tensions that arose in the Zambian case between Chinese creditors and bondholders.

Even though corporate defaults in the emerging economies were fairly muted over the last year, many observers expect a surge of corporate defaults, restructurings, and non-performing loans (NPLs) in the emerging economies and developing countries in the coming years, particularly as the special COVID-related responses of governments come to an end. Nonetheless, if and when there is a sharp increase in insolvencies in emerging market jurisdictions, this could pose a major problem for the court systems in the emerging economies and developing economies given the limited capacity of many of these systems to deal with a large volume of cases. Thus, there may well be a need for greater reliance on out-of-court restructurings to address this expected surge in insolvency cases in the emerging economies and developing countries.

The article originally appeared in International Insolvency & Restructuring Report 2021/22 and is reprinted with the permission of its publisher, Capital Markets Intelligence. The article can be found here.

Reviewing Redwater: An Analysis of the U.S. and Canadian Approaches to Environmental Obligations in Bankruptcy

By Laura N. Coordes (Associate Professor of Law, Arizona State University – Sandra Day O’Connor College of Law)

Laura N. Coordes

The United States and Canada have both seen significant litigation over the treatment of environmental obligations in bankruptcy proceedings. Both countries also have robust regulatory and statutory frameworks with respect to bankruptcy and environmental law, making the two jurisdictions ripe for comparison.

Although the U.S. legal landscape differs somewhat from Canada’s, courts in both countries have struggled to sort out the treatment of environmental obligations in bankruptcy. However, in 2019, the Supreme Court of Canada decided Orphan Well Association v. Grant Thornton Limited (“Redwater”), which characterized environmental obligations, not as claims, but as duties owed to the public that could not be compromised in bankruptcy. Meanwhile, U.S. courts continue to grapple with the question of how to treat a company’s environmental obligations in bankruptcy.

This article analyzes the impact of Redwater and highlights issues that U.S. scholars and policymakers should consider as they press for changes. In particular, the article focuses on three questions: (1) What is the role of the legislature as compared to the judiciary? (2) What is the role of federal law, as compared to provincial or state law? and (3) What is the role of the public interest?

These three questions implicate debates that go beyond the immediate issue of the role of environmental law in bankruptcy proceedings. However, considering environmental and bankruptcy law in light of these universal issues illuminates unresolved tensions that both the U.S. and Canada will likely continue to face on a larger scale.

The full article is available here.

Reorganization of Corporate Groups in Brazil: Substantive Consolidation and the Limited Liability Tale

By Sheila C. Neder Cerezetti (Professor of Law, University of São Paulo Law School)

Sheila C. Neder Cerezetti

As argued by prominent Brazilian scholars, some of the most relevant attributes of the corporate form – limited liability and asset partitioning – might be considered just a tale in Brazil, as they have been consistently and subsequently weakened by a variety of reasons.

In light of this and of the large number of corporate reorganization cases involving groups of companies, which gave way to a series of unsubstantiated applications of substantive consolidation, the article raises the debate on the correct use of the mechanism in the country.

I question whether the lenient approach to substantive consolidation by Brazilian courts (i) is a natural consequence of the weakening of limited liability and asset partitioning, and (ii) represents a better way to recognize the Brazilian corporate reality, bringing more truth to reorganizations.

In the attempt to answer these questions, the article introduces the basic aspects of corporate reorganization in Brazil, offering a comprehensive overview of the Brazilian Bankruptcy Act (Law No. 11,101/2005). The description addresses the broad use of procedural and substantive consolidation even if, at the time, the Brazilian Bankruptcy Act lacked provisions for proceedings with multiple debtors. It shows that the permissive approach first directed to procedural consolidation slowly unraveled into a silent acceptance of substantive consolidation.

Next, the article explores some of the uses of substantive consolidation in the USA (where the mechanism started and gained traction) and in the UNCITRAL Legislative Guide on Insolvency Law (an important indicator of what might be adopted in other jurisdiction in the future), with a brief reference to the status of the matter in the European Union. In these cases, a set of prerequisites have been established to determine when the exceptional measure of the mechanism is appropriate.

In contrast, I call a misuse the often-unsubstantiated acceptance of substantive consolidation in Brazil, that fails to note its exceptionally. In the vast majority of cases, substantive consolidation actually happened in proceedings where none of the parties and not even the court expressly addressed the issue and implicitly just treated a single plan as something normal, although it mixed assets and liabilities of different debtors. And in those cases where the matter has been expressly addressed, the criteria for ordering the consolidation (i) varied greatly, to the point that it could not be rationalized in the form of a test, and (ii) failed to treat the remedy as an exceptional tool.

In light of the mentioned “tale of limited liability in Brazil”, one could wonder if such a misuse of substantive consolidation is in fact inappropriate. However, I argue that this tale is not so severe as to justify the lenient approach described, in view of the rules on corporate groups as well as of the fact that strictly commercial and civil relationships are, for the most part, protected from the exceptions to limited liability.

The article contends that there still is a compelling case for a stricter use of substantive consolidation, considering, among other reasons, that accepting the lenient criteria for ordering substantive consolidation would mean further weakening the attributes of the corporate form. It concludes by pointing to other tools in bankruptcy law that can better deal with the exceptions to the limitation of liability, and argues that substantive consolidation should remain a remedy for abuses of the corporate form that turn it dysfunctional.

Finally, it should be noted that a recently approved bill included provisions on procedural and substantive consolidation in the Brazilian Bankruptcy Law, ratifying the lenient approach described in the article. The article also serves as an explanatory description of the pathways that led the Brazilian legal system to such a discipline and as a warning about the perils of following this route.

The full article is available here.

Bankruptcy Shopping: Domestic Venue Races and Global Forum Wars

By Anthony J. Casey (Professor, The University of Chicago Law School) and Joshua Macey (Assistant Professor, The University of Chicago Law School)

Anthony J. Casey
Joshua Macey

The United States Bankruptcy Code gives debtors wide discretion to reorganize in the venue of their choice. These lenient venue selection rules long have allowed bankruptcy courts in the District of Delaware and the Southern District of New York to dominate the market for large Chapter 11 cases, though recently the Southern District of Texas has also begun to attract a large number of cases.

This state of affairs has produced a vigorous debate. Critics of liberal venue rules charge that bankruptcy districts are engaged in a “race to the bottom” as judges compete for blockbuster cases. Others counter that competition for cases improves efficiency and predictability as judges develop expertise in overseeing large Chapter 11 cases.

This Article cautions that developments in foreign jurisdictions may limit the effectiveness of these venue reform proposals. In recent years, foreign jurisdictions have emerged as convenient forums for distressed debtors. For instance, in many cases, the English scheme of arrangement now represents a viable alternative to the American bankruptcy system, and over the past decade, a number of companies have chosen to use an English scheme of arrangement to restructure their debt instead of chapter 11, with the first United States-headquartered business doing so in 2019. Other jurisdictions have also sought to entice foreign debtors, with insolvency specialists speculating that Singapore, in particular, could become a restructuring hub.

Because American bankruptcy courts freely recognize foreign insolvency proceedings, firms that are directed to file in less favored districts may instead choose to reorganize in a foreign jurisdiction. In this environment, attempts to limit venue selection within the United States will have the opposite of their intended effect, replacing domestic venue shopping with even worse global forum shopping. By ignoring the availability of global forums, current venue reform proposals could, perversely, drive opportunistic debtors and creditors to restructure in foreign jurisdictions.

To address this, we argue that, rather than limit domestic venue choice, lawmakers should: (1) support the development of ex ante commitment to mechanisms for choosing venue and forum; and (2) whenever possible, resolve inconsistencies in substantive law across venues and forums. These are general principles of reform, and the implementation will depend on context. For example, commitment mechanisms look different for venue than they do for forum. But, if designed properly, these measures can reduce the costs of venue and forum shopping without giving up the benefits that come from allowing some choice of venue and forum.

It is worth noting that the merits of our proposal are independent of one’s view on the current state of venue shopping. If venue shopping is a real problem, the principles we introduce address that problem. If venue shopping is not a problem, the principles do no harm and even expand the choice set for debtors. Similarly, while the principles address the problem of global forum shopping, the benefits with regard to venue shopping exist with or without global forums. The same cannot be said of the status quo or the reforms currently being considered.

The article can be found here.

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