[Crypto-Bankruptcy Series] The FTX Bankruptcy: First Week Motions, Jurisdictional Squabbling, and Other Unusual Developments
By Megan McDermott (University of Wisconsin-Madison School of Law)
Note: This post is the first post in a series of posts on bankruptcies of cryptocurrency companies and the emerging issues they pose. This series is being managed by the Bankruptcy Roundtable and Xiao Ma, SJD at Harvard Law School, xma [at] sjd [dot] law [dot] harvard [dot] edu.
Check the HLS Bankruptcy Roundtable periodically for additional contributing posts by academics and practitioners from institutions across the country.
The FTX bankruptcy isn’t just significant for its size and scope, but also for some extraordinary procedural wrinkles. Here are a few notable developments from the first six weeks of the FTX bankruptcy:
- Unusual delays. Most Chapter 11 bankruptcies are the products of weeks, if not months, of behind the scenes planning. As a result, the typical debtor is able to file a flurry of first day motions that ensure a high degree of debtor control – at least during the early stages of bankruptcy, while creditors are scrambling to find representation and determine strategy. Not so with FTX, due to the fact that current CEO John Ray took over from Sam Bankman-Fried immediately before the Chapter 11 filing. Ray has testified that FTX’s abysmal record-keeping and absence of corporate controls have made it extremely difficult to get an accurate picture of FTX’s assets and liabilities. As a result, the traditional first day motions were heard a week into proceedings, and second day motions were postponed to January 11. The delay makes it easier for individual creditors to organize push back to the debtors’ plans, which could in turn impact overall creditor recovery.
- Jurisdictional squabbling. Bahamian regulators are mounting a spirited fight to retain control over the liquidation of FTX Digital Markets, one of the many entities in FTX’s global web of related businesses. The Bahamian regulators backed off their initial strategy of asking the Southern District of New York to open a parallel Chapter 15 proceeding. Nonetheless, they are currently arguing that the Delaware Bankruptcy Court lacks authority to halt liquidation under Bahamanian law. Given the rumors that Bahamanian authorities encouraged (or possibly compelled) Bankman-Fried to give Bahamanian customers preferential treatment in withdrawing frozen funds, there is a lot at stake in this jurisdictional skirmish. In his testimony to Congress, Ray mentioned this “extraordinary pushback” but expressed confidence that these efforts would be rejected in favor of the transparency and clarity that Chapter 11 promises to all stakeholders.
- Sealed submissions. Despite this commitment to transparency, FTX has asked to file a variety of court submissions under seal, including creditor lists. FTX’s lawyers argue that revealing creditor names would make them a target for hacking or, at the very least, poaching by competitors of FTX. The U.S. Trustee has objected strenuously to sealing these records, on the grounds that these risks are the trade-offs of a public and transparent proceeding. In addition, Dow Jones, Bloomberg, and other media interests have moved to intervene in order to oppose the debtor’s efforts to avoid disclosing creditor identities. In the Celsius bankruptcy, the Southern District of New York decisively rejected efforts to keep parts of the docket under seal. Judge Dorsey hasn’t taken a clear position yet but has agreed to keep creditor lists under seal – for now.
- Preferential transfers. During Congressional questioning, Ray was asked about rumors of looting in the months preceding the Chapter 11 filing, as well as some dubious post-petition maneuvers. There are also likely to be a number of insider transfers, especially since at least one of Bankman’s Fried’s parents (Stanford Law Professor Joseph Bankman) has reportedly received payments from FTX. Transfers between FTX and Bankman-Fried and his family may be in the billions. Expect some bombshells as FTX seeks to use Chapter 11 to avoid these transfers.
- Property of the estate. Major stakeholders are already wrangling to have their assets returned on the ground that these assets should not be considered property of the estate. Of particular note are two motions filed by committees representing U.S. and non-U.S. exchange customers. The customers are arguing that they are entitled to have their crypto assets returned rather than having to wait in line for a pro rata recovery alongside other unsecured creditors. Although some commentators have suggested that FTX’s terms of service may support these arguments, the legal authority for how to treat these assets is far from clear. Another early mover is crypto lender BlockFi, which is staking its claim to 56 million Robinhood shares that Alameda Research had pledged as collateral shortly before FTX’s Chapter 11 filing. These shares have lost around 40% of their value since early November, which is part of the reason BlockFi has filed its own Chapter 11 bankruptcy in the District of New Jersey. Bankruptcy courts across the country will likely see many similar ripple effects before FTX’s creditors see any recovery.
- Executory contracts. Given FTX’s lavish public relations spending and celebrity co-branding, many FTX partners are undoubtedly eager to extricate themselves from the now-disgraced company. For example, the publisher of the League of Legends video game filed an early motion for relief from the automatic stay, asking the court’s permission to halt their contractual obligation to promote FTX at various events. Right before the new year, FTX granted their wishes, moving to reject that cobranding deal alongside a long list of other executory contracts. FTX’s motion details almost two dozen sponsorship deals, ranging from the Golden State Warriors to Berkeley Athletics to an international cricket competition. FTX also hopes to cast aside paid celebrity endorsements from the likes of Gisele Bundchen and Shohei Otani. In the motion, FTX explained that “the Contracts are not integral to the Debtors’ Chapter 11 efforts, are not otherwise beneficial to the Debtors’ estates and present burdensome liabilities.” Accordingly, FTX requested that the contracts be deemed terminated immediately. That means the Miami Heat Arena may soon be in the market for a new naming rights partner. (See photo.) [Editor’s Note: On January 11, 2023, the bankruptcy court approved the termination of FTX’s naming rights: https://www.nba.com/news/miami-dade-coun…]
Please Don’t Forget the Victims: Mass Torts, Third Party Releases and the U.S. Bankruptcy Code
By Marshall S. Huebner and Marc J. Tobak (Davis Polk & Wardwell LLP)
[Editor’s Note: The authors, along with other attorneys at Davis Polk & Wardwell LLP, represent Purdue Pharma L.P. and various affiliated debtors in connection with their ongoing bankruptcy proceedings.]
For decades, third party releases have been the cornerstone of mass tort bankruptcies that have resolved previously intractable litigation and provided meaningful compensation to victims who might well have otherwise recovered nothing. In cases such as Johns-Manville (asbestos), A.H. Robins (Dalkon Shield), Dow Corning (silicone breast implants), Mallinckrodt (opioids), and Boy Scouts of America, courts concluded, on a developed factual record informed by pre-bankruptcy litigation history, that value-maximizing settlements and plans of reorganization were viable only by providing settling parties paying into the estate third party releases of appropriate scope. The alternative to these broadly and deeply supported settlements, many in the billions of dollars, was years of costly and uncoordinated litigation in scores of fora and resulting in greatly diminished victim recoveries.
Critiques of third party releases often argue that these releases are in some way unfair to the parties subject to the release, or that third party release cases privilege monetary recoveries over nonmonetary goals. This article aims to address these issues and refocus the debate on the importance of third party releases in achieving and maximizing monetary and nonmonetary goals of victims in mass tort bankruptcies.
First, we canvass the overwhelming judicial consensus that the Bankruptcy Code (including sections 105 and 1123) authorizes third-party releases and channeling injunctions where important or essential to a value-maximizing reorganization, meet additional limiting tests, and are within the court’s jurisdiction. We highlight that a thorough examination of United States v. Energy Resources Co., 495 U.S. 545 (1990), demonstrates that the Supreme Court specifically affirmed the power of bankruptcy courts to confirm plans of reorganization that nonconsensually adjust rights and liabilities among third parties when such adjustments enable a successful reorganization.
Second, we examine how existing law—properly applied—appropriately limits third party releases to circumstances in which they maximize value for, and are broadly supported by, victims and other creditors. Proponents of a third party release plan must not only convince the court that it is objectively superior to the alternatives; in addition, the parties directly affected by the release must vote in favor of the plan by an “overwhelming” margin. Unsurprisingly, such plans are often crafted by creditors and debtors together, ensuring that they reflect victims’ monetary and nonmonetary goals.
Finally, we consider how mass tort resolutions would necessarily change if third party releases were to become unavailable. We note that recent legislative initiatives to categorically ban third party releases outside the asbestos context would make mass tort victims far worse off without achieving countervailing benefits. We recommend that legislative efforts directed at third party releases instead subject them to uniform procedures and standards. Such legislation would address valid critiques of overused third party releases while ensuring that they remain available, under uniform standards, in cases in which they are indispensable.
Click here to read the full article.
Note: This is the Harvard Law School Bankruptcy Roundtable’s last scheduled post for the fall of 2022. The BRT intends to resume posting around mid-January, 2023. The BRT wishes all its readers an enjoyable holiday season!
Balancing Debtor and Creditors’ Interests in Bankruptcy Reorganization Proceedings: Best Practices for the Procedural Design of Claims’ Classification
By Anaïs Alle (Harvard Law School, L.L.M. 2022)
Reorganization proceedings, in contrast to liquidation sales, constitute a rather recent development in insolvency law. Embodied by Chapter 11 in the US, this trend has been further brought to light by the European Directive 2019/1023 of 20 June, 2019 on restructuring and insolvency, that requires EU Member States to set up a preventive reorganization framework. Reorganization plans typically involve complex interplays between competing stakeholders’ interests, and the classification of claims for the purpose of voting on the reorganization plan is both an illustration of these tensions and a mechanism designed to address them. Choices of European policymakers, especially in France where the classification of claims represents a major change, can offer new perspectives on best practices for modern reorganization plans. The classification of claims is an important feature of reorganization proceedings. First, it appears as a countermeasure to the debtor-in-possession and other debtor-friendly rules. Second, it promotes the adoption of a plan against hold-out problems from hostile minority or out-of-the-money creditors. Third, it provides guarantees of fairness and viability of the plan, through the consent of a representative majority of creditors.
Given the importance of claims’ classification, the design of classes has drawn a lot of attention during the implementation of the EU Directive in France. Debtor-in-possession proceedings leave the debtor with significant power over classification, with the potential for abuse through “gerrymandering”, i.e., the strategic classification of claims to create an artificially accepting impaired class, ensuring the adoption of a potentially unfair plan. Bankruptcy statutes fail to provide clear and binding criteria to restrict such strategies. Similarly, Chapter 11 case law – although precedents, notably Matter of Greystone III Joint Venture out of the 5th Circuit, have suggested a ban on gerrymandering – has been reluctant to challenge debtors’ classifications. Instead, policymakers have set protective rules for creditors, mainly the best-interest-of-creditors test and the absolute priority rule. However, these protections may be circumvented and difficult to enforce.
In this context, procedural design is suggested as a means of reconciling debtor-friendly rules with effective protections for creditors, thus ensuring a balance of interests in reorganization proceedings. First, effective judicial review over the classification of claims appears desirable and is addressed under French law with (i) the appointment of a trustee, with limited powers, assisting the debtor in possession, and (ii) an early, dedicated and fast-tracked appeal against the classification of claims, allowing the judicial resolution of disputes over classification before the adoption of the plan. A similar result may be achieved through a reinforcement of classification hearings. Second, hostile classification strategies could be avoided through prepackaged plans, in which the debtor negotiates with its creditors prior to filing for Chapter 11. French law provides for a dedicated two-stage framework through conciliation proceedings – confidential negotiations under the supervision of a court-appointed professional – followed by fast-tracked reorganization proceedings, where the plan can be adopted through a vote in classes that have been designed within the conciliation negotiations. Such proceedings are consistent with the modern negotiated, deal-approach to reorganizations while making use of insolvency mechanisms against hold-out problems, thus favoring a preventive and pragmatic solution to distressed situations.
Click here to read the full article.
Second Circuit Rules that Bankruptcy Courts May Award Appellate Legal Fees as Sanction for Contempt
By Charles M. Oellermann and Mark G. Douglas (Jones Day)
Courts disagree whether a bankruptcy court, in exercising its broad equitable powers, has the authority to award appellate legal fees as a sanction for contempt. The U.S. Court of Appeals for the Second Circuit recently weighed in on this issue as an apparent matter of first impression. In Law Offices of Francis J. Reilly, Esq. v. Selene Finance, L.P. (In re DiBattista), 33 F.4th 698 (2d Cir. 2022), the Second Circuit held that a bankruptcy court erroneously concluded that it did not have the power to award attorney fees incurred on appeal by a debtor seeking to enforce a contempt order for violations of a bankruptcy discharge order.
The Second Circuit explained that it is well settled that a bankruptcy court, exercising its broad equitable powers under section 105(a), “may compensate a debtor for a creditor’s violation of [a] discharge order” entered under section 524(a). These provisions, the court wrote, which “‘bring with them the old soil that has long governed how courts enforce injunctions,’” authorize a court to impose civil contempt sanctions to coerce compliance with an injunction or to compensate a complainant for losses arising from noncompliance. “[I]n line with long-established practice,” the Ninth Circuit explained, a bankruptcy court’s contempt power includes the authority to compensate a party for damages arising from noncompliance with an injunction, “even if those losses take the form of appellate litigation fees.”
The Second Circuit rejected the argument that the “American Rule” precludes an award of appellate fees “absent explicit statutory authority.” According to the court, an exception to the American Rule has long been recognized that permits a court to award legal fees for willful disobedience of an order entered as part of a fine levied on a contemnor.
Click here to read the full article.
Roundup: Ultra Petroleum and Contractual Make-Wholes
The Fifth Circuit held in October of this year in In re Ultra Petroleum Corp., 51 F.4th 138 (5th Cir. 2022) that a contractual make-whole provision in the debt instruments of certain unsecured creditors was unmatured interest under Section 502(b)(2). In this unusual case, where the debtor became solvent after filing for bankruptcy, the Fifth Circuit also held that the Solvent Debtor-Exception applied to claims for unmatured interest. The Fifth Circuit then determined that the Make-Whole Amount was a valid contractual claim and held that Ultra must pay the contractual Make-Whole Amount under the Solvent Debtor-Exception. Lastly, the Fifth Circuit held that an unimpaired creditor of a solvent debtor is entitled to interest at the bargained-for rate rather than the Federal Judgment Rate. In reaching this conclusion, the Fifth Circuit interpreted Section 726(a)(5)’s interest at the legal rate provision (relevant to a plan under Chapter 11 through Section 1129(a)(7)(A)) as a floor, rather than a ceiling, for interest payable by a solvent debtor.
Several law firms have now written memos summarizing this impactful decision. Weil summarizes the history of the Ultra Petroleum series of cases. Davis Polk suggests that the decision may have far-reaching consequences on the market use of make-whole provisions given the popularity of the Southern District of Texas as a forum for bankruptcy petitions. Proskauer notes that the Fifth Circuit’s decision addressed only the rights of an unsecured creditor with respect to a make-whole provision and suggests that Section 506(b) provides a legal basis for recovery of a make-whole provision by an oversecured creditor.
(This post was authored by Wesley Sheker, J.D. ’23.)
Bankruptcy-Remote Structuring: Reallocating Risk Through Law
By Steven Schwarcz (Stanley A. Star Distinguished Professor of Law & Business, Duke University School of Law)
Bankruptcy-remote structuring, a legal strategy with potential public policy implications, is crucial both to a range of important financial transactions—including securitization, project finance, covered bonds, oil-and-gas and mineral production payments, and other forms of structured financing—and to the ring-fencing of utilities and other publicly essential firms. In finance, the goal is contractually to reallocate risk by structuring securities-issuing entities that, absent the bankruptcy risks inherent to operating businesses, can attract investments based on specified cash flows. In ring-fencing, the goal is contractually to structure firms to minimize bankruptcy risks, thereby assuring their continued business operations.
Parties engaging in bankruptcy-remote structuring usually seek to reallocate risk more optimally, including by reducing information asymmetry and assigning higher risk to yield-seeking investors, thereby enabling firms to diversify and lower their costs of capital. In reality, bankruptcy-remote structuring can sometimes create harmful externalities. Some blame bankruptcy-remote securitization transactions, for example, for triggering the 2007-08 global financial crisis by shifting risk from contracting parties to the public.
This Article undertakes a normative analysis of bankruptcy-remote structuring, examining the extent to which parties should have the right to reallocate bankruptcy risk. It is the first to do so both from the standpoint of public policy—examining how bankruptcy-law policy should limit freedom of contract; and also from the standpoint of cost-benefit analysis (“CBA”)—examining how externalities should limit freedom of contract.
Traditionally, CBA weighs overall costs and benefits regardless of who pays the costs and who receives the benefits. That model makes sense for a neutral governmental assessment of costs and benefits, such as deciding whether to enact new regulation. In bankruptcy-remote structuring, however, the contracting parties both advocate and significantly stand to gain from the project. From a public policy standpoint, an impartial assessment of these private actions should weigh the socially relevant costs and benefits.
In that weighing, the Article explains why the socially relevant benefits of project finance that is used to facilitate the construction of critical infrastructure projects like powerplants and toll roads, as well as the socially relevant benefits of ring-fencing that is used to protect critical utilities, should exceed the socially relevant costs. However, for more generic structured finance transactions, like securitization, the CBA weighing is more difficult. These types of bankruptcy-remote transactions have valuable public benefits that are difficult to quantify. Their social costs are also difficult to quantify. Given these difficulties, the Article merely categorizes the benefits and costs without purporting to conclude how they balance. This approach has important precedent, including for assessing the costs and benefits of the Volcker Rule.
Finally, the Article examines how to reform bankruptcy-remote structuring to reduce its externalities, thereby rebalancing the costs and benefits to try to achieve net positive benefits.
Among other things, it compares the European Union’s regulatory framework that creates incentives for simple, transparent, and standardized (“STS”) securitization transactions and urges U.S. lawmakers to consider similar securitization reforms.
The full article is available here.
Preference Due Diligence in the Crypto Winter
By Michael Rosella (Katten Muchin Rosenman LLP) and Dan McElhinney (Stretto)
The crypto winter has arrived! Among many other issues of first impression for bankruptcy courts is the question of how the increased due diligence standards for preference actions set forth in the Small Business Reorganization Act of 2019 (the “SBRA”) will play out in a crypto case. The SBRA raised the bar on the due diligence needed to pursue preference litigation, requiring the debtor or trustee to assess “known or reasonably knowable affirmative defenses” before moving forward.
This article first assesses lingering disagreements related to the “heightened” pleading standard as applied to preference causes of action set forth in In re Valley Media and its progeny. Next, we delve into the cases interpreting the new due diligence standard set forth in the SBRA, as there is already disagreement on how to interpret the SBRA. Certain courts suggest the new due diligence standard constitutes an element of a preference claim that must be specifically pled in a complaint in order to avoid dismissal; others do not. Yet courts in this latter group, while eschewing the idea of a new element, do consider any information regarding pre-complaint due diligence efforts in the complaint, nonetheless. We then consider the issues unique to the opaque world of a cryptocurrency debtor that may impact the debtor or trustee’s ability to satisfy a heightened due diligence standard. Questions relating to the potential differences in assessing cash vs. crypto transfers and whether debtors or trustees will have access to key demographic and transaction data are considered. For example, whereas a debtor dealing in cash transfers would likely have bank statements, canceled checks, and access to accounting systems with basic transferee information, debtors transferring cryptocurrency to the independent digital wallet of a customer or counterparty would be less likely to have access to basic information necessary to satisfy a heightened due diligence standard.
We also provide key takeaways that highlight measures that cryptocurrency debtors should take to comply with the pleading and due diligence requirements. For example, a debtor in a cryptocurrency case should include in the complaint a recitation of its efforts to conduct reasonable due diligence — including efforts to obtain information needed to consider affirmative defenses, as well as reference to demand letters sent inviting the transferee to assert such defenses—to minimize any dismissal risk.
Click here to read the full article.
[Texas Two-Step and the Future of Mass Tort Bankruptcy Series] A Different Look at Sec. 548 and Concluding Thoughts
Note: This is the eighth in a series of posts on the Texas Two-Step, the bankruptcy of LTL Management, and the future of mass tort bankruptcies. Styled as a coda of sorts, this double-post includes a new view on section 548 by Judge Judith Fitzgerald (ret.) and Adam Levitin, and some commentary on the other posts in the series by John Pottow.
Check the HLS Bankruptcy Roundtable periodically for additional contributing posts by academics and others from institutions across the country.
Earlier posts in this series can be found here (by Jin Lee and Amelia Ricketts), here (by Jonathan C. Lipson), here (by Jared A. Ellias), here (by Anthony Casey and Joshua Macey), here (by David Skeel), here (by Ralph Brubaker), and here (by Mark Roe and William Organek).
Post One: The Texas Two-Step: A Different Look at Bankruptcy Code Section 548
By Hon. Judith K. Fitzgerald (ret.) (Professor in the Practice of Law, University of Pittsburgh School of Law; Shareholder, Tucker Arensberg, P.C.) and Adam J. Levitin (Anne Fleming Research Professor & Professor of Law, Georgetown University Law Center; Principal, Gordian Crypto Advisors LLC)[^]
Is the divisive merger in a Texas Two-Step bankruptcy a fraudulent transfer? To date, much of the analysis has focused on the question of the “transfer” of assets. From this perspective, the application of fraudulent transfer law is an uncomfortable fit. In a divisive merger, OldCo disposes of assets and liabilities by assigning the valuable assets to GoodCo and dumping the disfavored liabilities on BadCo. Yet the Texas divisive merger statute provides that “all rights, title and interest” in property are allocated in a divisive merger without “any transfer or assignment having occurred.” If state law deems the divisive merger not to constitute any form of transfer, how can a fraudulent transfer have occurred?
As Roe and Organek rightly contend, the Supremacy Clause mandates use of the Bankruptcy Code (“Code”) definition of “transfer” to the exclusion of contrary state law. Likewise, the Uniform Fraudulent Transfer Act has its own definition of transfer and indicates that the definitions are “[a]s used in this [Act],” such that even under state law the divisive merger statute’s definition of transfer would not control in a fraudulent transfer, voidable transactions, or § 544(b) action.
The key problem with viewing a divisive merger through the “transfer” lens is that Code § 548 requires the transfer to be one made by the debtor—BadCo—of its property or an interest it held in property. BadCo, however, did not exist at the time of the transfer and had no property at all. The transfer of the assets to GoodCo was not from BadCo, but from OldCo, which no longer exists. These seem to create impediments to attacking a divisive merger as a fraudulent transfer.
In order to bring the divisive merger within the ambit of § 548, a complainant might have to take an additional step, such as establishing that BadCo was the alter ego of the entity that transferred the property (as Roe and Organek note), or substantively consolidating BadCo and GoodCo. Without consolidation of BadCo and GoodCo, or an unwinding of the divisive merger altogether, a court could conclude that BadCo did not transfer property or an interest in property.
There is another part of § 548, however, that is a better fit for attacking a divisive merger. Section 548 also permits the avoidance of an obligation incurred by the debtor, for which the debtor received less than reasonably equivalent value and/or was insolvent at the time or was made insolvent as the result of the obligation.
The Texas divisive merger statute presents no obstacle for this theory. That statute deals with allocation of assets and liabilities under separate provisions. The asset provision deems the allocation of assets not to be a transfer, but there is no equivalent language in the liabilities provision. That is, nothing in the Texas statute states that the allocation of liabilities is not the incurrence of an obligation.
Similarly, § 548 refers to incurrence of an obligation by the debtor, a concept that works much better than a focus on transferring property of the debtor. Whereas the transfer provision implicitly requires the debtor to have had property to transfer in the first instance, the incurrence provision has no similar implication. All that is required is that the debtor, BadCo, incur an obligation that left it insolvent or insufficiently capitalized, a description that fits the treatment of BadCo in a divisive merger to a tee.
For example, in the divisive merger that preceded the LTL Management LLC bankruptcy filing, the BadCo, LTL, was saddled with all of the talc liabilities of OldCo (Old JJCI), an unliquidated liability in the billions of dollars. As part of the same transaction, it was given royalty-producing assets worth enough to cover the anticipated professionals’ fees in the bankruptcy, and certain insurance policies. LTL was also allocated a funding agreement by which both GoodCo (New JJCI) and OldCo’s parent (J&J) were to cover talc liabilities inside or outside bankruptcy, up to the value of OldCo on the date of the divisive merger, provided that certain conditions to use are satisfied. All of OldCo’s other assets (valuable brands and the JJCI name) and other liabilities were allocated to New JJCI. If the talc claims against LTL exceed the value of OldCo, then LTL would be insolvent, and the incurrence of the talc liabilities would be avoidable under § 548.
The distinction between transfers and obligations may support a fresh look at § 548, but raises the question of the remedy. The Code’s remedial provision, § 550, deals solely with recovery for the benefit of the bankruptcy estate of any avoided transfers of property; it is not geared toward the incurrence of obligations. But § 550 may not be necessary as a remedial provision regarding incurrence of obligations. Section 548’s language that “[t]he trustee may avoid…any obligation incurred … by the debtor” may itself be all that is necessary.
So what does this mean in practical terms? The avoiding of the incurrence of an obligation does not mean that the obligation disappears. Instead, its allocation follows normal state law successor liability principles. In the case of LTL, successor liability would likely put the talc liability squarely back on GoodCo through its continuation of OldCo’s business.
Focusing on obligations does not itself answer the valuation question about BadCo’s solvency, but it is a far better fit with fraudulent transfer law than trying to shoe-horn a divisive merger transaction into the definition of a “transfer” by a company that did not exist at the time property was transferred.
[^] Professors Fitzgerald and Levitin are both retained as consultants by certain talc claimants in the LTL bankruptcy; their opinions are their own.
 Tex. Bus. Org. Code § 10.008(a)(2).
 The authors do not address whether the divisive merger could be attacked as an actual fraudulent transfer under Code §§ 544 or 548.
 Tex. Bus. Org. Code § 10.008(a)(2)
 Id., § 10.008(a)(3).
Post Two: Concluding Thoughts on the Series
By John A. E. Pottow (University of Michigan)
A series of excellent posts have probed the recent developments of the infamous Texas Two-Step, and so I have only three additional comments.
First, a threshold issue that hungers for resolution is the idiosyncrasy of Texas law. As Jonathan Lipson points out, vertical forum shopping has suitors flocking to the bankruptcy court system, but what they specifically want is application of Texas corporate law. Specifically, mass tort defendants must avail themselves of its Doublespeak divisional merger statute and its “non-transfer transfers.” The issue is whether a transfer ordinarily susceptible to fraudulent conveyance scrutiny can be statutorily immunized by legislative pronouncement that it is an “un-transfer.” While this might invite the sort of textualism disquisition that would enthrall some (can the legislature define the black, frequently granulated table spice as “salt” without offending well-socialized legal sensibilities?), I am thematically drawn to Mark Roe and William Organek’s supremacy argument mooting it all out: that the Bankruptcy Code’s definition of “transfer” may supersede Texas’s. But I don’t think they get all the way there. My hopefully congenial amendment to their position is that additional work must be done to get the ball over the finish line by making out a Butner argument—which ought not be heavy-lifting—that federal bankruptcy purposes (e.g., preserving all assets for collective creditor treatment) warrant overriding the presumptive deference to state law definitions of property entitlements.
Second, all substantive concern, e.g., expressed as upsetting bankruptcy’s “traditional bargain” in Jared Ellias’ words (and especially so if they are solvent, as Ralph Brubaker reminds), really boils down to this: Are they cheating? And as Anthony Casey and Joshua Macey have noted, what that really means is: Are there enough assets left for the claimants? And that, as the road-terminus Rome of so many bankruptcy matters, is ultimately a valuation question—of claims, assets, going-concern surplus…the whole nine yards. Forests of trees have died in service of bankruptcy scholarship on valuation, and, just to make you, Dear Likely Reader, feel old, recall that North LaSalle well-preceded the birth of most current law students. My two cents in these hyper-inflationary times is that whenever I distrust valuation, and Ken Ayotte notes elsewhere that we should be extra-distrustful with synthetic analogues to real assets, I revert to my instincts that it’s hard to beat having skin in the game. Indeed, the elegance of the Code’s section 524(g) is in requiring the backstopping by half the equity of the company. So a “funding agreement” is fine and dandy, as is an “extraordinarily large” contribution of capital, but it’s no pledging of cold, hard assets. Third-party releases on demand? Not so fast! If debtors want to reap the bankruptcy system efficiencies of speedy aggregate litigation, they should have to backstop that benefit with the internalized risk of real, teethy underwriting.
Finally, and this point segues from the prior observation, the role of the discretion accorded bankruptcy judges stands front and center with the Two-Step. As the presumable watchdogs of over-reaching-cum-under-endowing BadCo, the bankruptcy judges wield their power to dispatch for lack of good faith or for receiving lack of reasonably equivalent value. (For the efficacy of bankruptcy judges in valuation matters, see Forests, supra.) To feel comfortable with them, then, one requires a sense of attunement to the risks and issues at stake. Yet as David Skeel reminded us, the gushing endorsement of the bankruptcy system dripping in the LTL opinion (or, perhaps by corollary, angst about the state tort system) may augur poorly for a critical eye being cast on these un-mergers. Unless we see some pushback and demonstrated non-naivete, legislative intervention seems overdetermined, as Jin Lee and Amelia Ricketts have already flagged.
I am broadly sympathetic to modular usages of the bankruptcy system, but I have also been around enough blocks to know that one person’s more efficient resolution is another’s value-extracting cudgel. To cheerily assume the riskless benefit (low risk, high returns!) of this latest bankruptcy innovation is not just blinkered but is a Siren call for legislative intervention.
Changes and Convergence of Bankruptcy Law: Recent Experience in Brazil
By Joao Guilherme Thiesi da Silva (Cleary Gottlieb Steen & Hamilton LLP)
Bankruptcy regimes across the globe have been constantly changing in response to new market demands and the evolution of insolvency law principles and objectives. Part of the academic community argues that such changes may lead to a convergence of domestic bankruptcy laws, as a result of globalization and market integration. Scholars have reviewed the phenomena of changes and convergence of bankruptcy laws in Europe, East Asia and Africa. However, little attention has been given to Latin American countries, such as Brazil. This paper aims at contributing to the discussion on changes and convergence of bankruptcy law, by focusing on four recent experiences within the Brazilian legal system, namely (i) the recent adoption of the UNCITRAL Model Law on Cross-Border Insolvency, (ii) the ability of creditors to propose a competing plan of reorganization, (iii) the adoption of pre-insolvency procedures, and (iv) the recognition of bondholders’ right to vote on a plan of reorganization. This paper concludes that there are indicia of a continuous convergence of Brazilian bankruptcy law with foreign and international norms, as changes in Brazilian bankruptcy law have increasingly mirrored the law and practice of certain metropolitan nations, as well as global norms and soft laws developed by international organizations and standard setting bodies. This paper further discusses the diverse array of processes through which convergence has taken place in Brazilian bankruptcy law, as well as the main driving forces underlying this convergence, such as the increasing influence of cross-border investments and international market players.
The full article is available here.
Recent Developments at the Intersection of Bankruptcy and Environmental Law
By Thomas Goslin (Weil, Gotshal, & Manges LLP)
Retired U.S. Bankruptcy Judge Robert E. Gerber once observed that issues as to the interplay between environmental law and bankruptcy are among the thorniest on the litigation map. Difficulties navigating this interplay largely stem from the inherent conflict between the goals of bankruptcy and environmental laws, with the former aimed at providing debtors with a fresh start, while the latter cast a broad net to hold parties (even some innocent parties) responsible for past harm to the environment. Despite the fact that modern environmental laws have been on the books for over 40 years, and that bankruptcy laws were first enacted in the earliest days of the Republic, relatively few courts have had occasion to opine on the treatment of a bankrupt debtor’s environmental liabilities. As such, those stuck at the intersection of bankruptcy and environmental law often lack clarity as to how or whether a debtor’s environmental liabilities can be addressed through a restructuring. This is particularly true when the liabilities arise from contaminated property owned by a debtor, which generally cannot be discharged in a chapter 11 case.
Two recent bankruptcy cases, however, have provided debtors and their advisors with new options for managing environmental liabilities associated with contaminated land. As discussed in detail in the article, developments in the pending chapter 11 case of Exide Holdings Inc. have both expanded the universe of cases where an environmental trust may provide an avenue for relief, as well as provided much needed clarity on when and under what circumstances a debtor may abandon contaminated real property under section 554 of the bankruptcy code. In a separate case, involving defense contractor Wellman Dynamics Corporation, the debtor and one of its secured creditors were able to negotiate a novel settlement with state and federal environmental regulators, which facilitated the sale of the debtor’s operations, including heavily contaminated land, under an arrangement where the buyer would fund remediation efforts based on an ability-to-pay formula tied to revenues generated from the acquired operations. While dire circumstances in both cases no doubt contributed to the unique results, the outcomes suggest that there may be more options available for debtors seeking to address liabilities arising from contaminated real property than previously thought.
The full article is available here.