By Anthony J. Casey and Aziz Z. Huq, University of Chicago Law School
The Supreme Court has struggled for the last three decades in defining the permissible scope of bankruptcy courts’ power. This question poses difficult federalism and separations-of-powers problems under Article III of the Constitution. Divided opinions in Northern Pipeline Construction v. Marathon Pipe Line, and more recently, in Stern v. Marshall, have produced confusion and litigation for practitioners and lower courts. This is true in large part because the Court’s Article III decisions lack any foundational account of why bankruptcy judges implicate a constitutional problem. As the Court prepares to confront the issue once again later this term, Aziz Huq and I provide such an account in a new article. This account more concretely identifies the precise stakes in this debate. We argue that a tractable, economically sophisticated constraint on delegations to the bankruptcy courts can be derived from what should be an obvious source: the well-tested creditors’ bargain theory of bankruptcy. Working from this account of bankruptcy’s necessary domain minimizes Article III and federalism harms while also enabling bankruptcy’s core operations to continue unhindered. To illustrate its utility, we then apply our framework to a range of common bankruptcy disputes, demonstrating that many of the Court’s existing jurisprudence is sound in result, if not in reasoning.
The article is forthcoming in the University of Chicago Law Review, and is available here.
Authors: Lenard M. Parkins and Karl D. Burrer of Haynes and Boone, LLP
Recently, the Eleventh Circuit rendered its decision in the Wortley v. Chrispus Venture Capital, LLC case unwinding a four-year old sale order based on a finding that the underlying bankruptcy case was filed in bad faith. The decision injects a new risk for buyers of distressed assets – the potential reversal of a sale order years after the closing of the transaction.
While the Wortley opinion clearly provides that a finding of “bad faith” with respect to the filing of a bankruptcy case can result in its dismissal (even) years later, it is unclear whether the holding requires the unwinding of all sales that transpired prior to dismissal of a bankruptcy case subsequently deemed to have been filed in bad faith. As a general matter, a dismissal for a bad-faith filing is a matter of court discretion under section 1112(b) – not a matter of jurisdiction. Further, section 349 seems to provide that dismissals are not per se intended to unwind sales to good faith purchasers in a bankruptcy case. Accordingly, it can be argued that the Wortley holding should be limited to circumstances in which the purchaser is also the party found to have unclean hands with respect to the debtor’s bankruptcy filing. Notwithstanding this analysis, the decision will require a new (and potentially amorphous) aspect of diligence for bankruptcy purchasers: the original motivation for the bankruptcy filing.
See here for a more detailed discussion of the Wortley decision.
By Stephen D. Adams, Editor, HLS Bankruptcy Roundtable
On September 10, 2014, the House Judiciary Committee approved H.R. 5421, the Financial Institution Bankruptcy Act of 2014, in a voice vote with bipartisan support. The bill would amend Chapter 11 of the Bankruptcy Code by adding Subchapter V, targeting large financial institutions. Subchapter V reflects the principles of the Single Point of Entry framework developed for the Orderly Liquidation Authority, which include the following: 1) an expedited involuntary commencement process that may be initiated by a regulator (in addition to a voluntary process), 2) a special transfer of estate property, including an assignment of executory contracts, leases, swaps and the like, to a new holding company, and 3) a brief but broad automatic stay on a wide variety of instruments in order to enable the special transfer. As a result, the subsidiaries of the bank holding company are in and out of bankruptcy quickly, but the parent holding company remains. To enable this special transfer, Subchapter V transfers may assign licenses, permits, and registrations, and are exempt from most avoiding powers. In addition, the prospective statute empowers judges to consider the effects of their decisions on financial stability, a power strengthened by authorization of the Federal Reserve, the SEC, the OCC, and the FDIC (but not the CFTC, it seems), to be heard on any issue in the case or proceeding. Finally, the bill would create a special category of judges who would handle these cases.
The approval statement of the House Judiciary Committee is here. The text of the bill can be found here, and you may track the bill’s progress here. Previously, the Roundtable covered a draft of the bill in the Senate in connection with Bruce Grohsgal’s discussion of the limits of the proposal, then called Chapter 14. David Skeel’s post today provides a comparison of an earlier (though substantially similar) proposal with the Single Point of Entry plan for the OLA.
Author: David A. Skeel, Jr., University of Pennsylvania Law School
The Dodd-Frank Act requires systemically important financial institutions to prepare living wills explaining how they could be smoothly resolved in bankruptcy. Yet Dodd-Frank itself did not do anything to ensure that the bankruptcy laws actually are adequate to the task of handling a major financial institution. Earlier this month, the House Judiciary committee unanimously approved proposed legislation (known colloquially as “Subchapter V”) that is designed to finish the job. Subchapter V would mimic the single point of entry strategy that the FDIC has devised for resolution under the Dodd-Frank Act by facilitating a quick sale of the assets and some of the liabilities of the financial institution’s holding company in bankruptcy.
In this Essay (which pre-dates Subchapter V), I consider the risks and benefits of single of entry and the bankruptcy alternative. The Essay begins with a brief overview of concerns raised by the Lehman Brothers bankruptcy, and points out that the Dodd-Frank Act as enacted left nearly all of them unaddressed. By contrast, the FDIC’s new single point of entry strategy, which is introduced in the second section, can be seen as addressing nearly all of them. The third and fourth sections point out some of the limitations of single point of entry, first by highlighting potential pitfalls and distortions and then by explaining that single point of entry does not end the too-big-to-fail problem and would not reduce worrisome concentration in the financial services industry. The final section turns to bankruptcy, and shows that the single-entry-style strategy can easily be replicated in bankruptcy. Indeed, the strategy harkens back to the original procedure used to reorganize American railroads well over a century ago.
The full version of the article can be found here.
Authors: Edward R. Morrison, Mark J. Roe, and Hon. Christopher S. Sontchi
Recent decades have seen substantial expansion in exemptions from the Bankruptcy Code’s normal operation for repurchase agreements. These repos, which are equivalent to very short-term (often one-day) secured loans, are exempt from core bankruptcy rules such as the automatic stay that enjoins debt collection, rules against prebankruptcy fraudulent transfers, and rules against eve-of-bankruptcy preferential payment to some creditors over other creditors. While these exemptions can be justified for United States Treasury securities and similarly liquid obligations backed by the full faith and credit of the United States government, they are not justified for mortgage-backed securities and other securities that could prove illiquid or unable to fetch their expected long-run value in a panic. The exemptions from baseline bankruptcy rules facilitate this kind of panic selling and, according to many expert observers, characterized and exacerbated the financial crisis of 2007–2009, leading to a bailout of the repo market and the institutions supporting mortgage-backed securities. The exemptions from normal bankruptcy rules should be limited to United States Treasury and similarly liquid securities, as they once were. The more recent expansion of the exemption to mortgage-backed securities should be reversed.
This article is forthcoming in The Business Lawyer, and a draft is available here.
By Bradley Purcell, Justin Sabin, and Jamila Willis, Bryan Cave LLP
In today’s economic climate, restructuring activity is at a lull. Out-of-court solutions are attractive to financially distressed companies – they avoid the delay, the costs and the uncertainty of formal bankruptcy cases. Indeed, for these very reasons, cooperation between creditors and debtors is common and often encouraged by bankruptcy courts.
Though the Bankruptcy Code contemplates participation by committees of creditors and the goal of maximizing creditor recoveries, a string of recent opinions from the Eleventh Circuit casts doubt on the ability of creditors to lawfully coordinate in their pre-petition negotiations with debtors. In CompuCredit Holdings Corp. v. Akanthos Capital Mgmt., LLC, 916 F. Supp. 2d 1326 (N.D. Ga. 2011), a debtor brought suit against creditors who attempted collective negotiation, alleging violations of Section 1 of the Sherman Act, which prohibits anti-competitive behavior. The Eleventh Circuit’s en banc panel split evenly on whether CompuCredit had an antitrust claim under the Sherman Act based on the creditors’ collective conduct.
While this doesn’t change the bankruptcy landscape, it creates uncertainty in pre-petition negotiations and out-of-court workouts. An aggressive obligor may use the Eleventh Circuit’s en banc ruling and relevant antitrust laws to impede collective, pre-petition negotiation of creditors and quell negotiations and actions by pre-petition or informal committees of creditors.
The full discussion can be found here.
By Vicki Harding, Pepper Hamilton, LLP
In a recent case a mortgagee battled the debtor over post-petition interest: When did the lender become oversecured and thus entitled to interest? Was it entitled to the default rate? Should interest be compounded?
Some may be surprised to learn that a lender must do more than simply show that it is oversecured to receive its contract rate for the period between the petition date and confirmation. Most courts hold that a bankruptcy court has at least limited discretion to use another rate.
Here the debtor filed a plan of reorganization that proposed to pay its senior lender in full with interest at 4.25% from the effective date of the plan, but did not include any post-petition, pre-effective date interest.
The lender argued that it was entitled to post-petition interest at the 14.5% contract default rate accruing from the petition date. The debtor responded that the lender became oversecured only after a sale of its collateral and the default rate was unenforceable and inequitable.
Generally post-petition interest is not allowed, but there is an exception for oversecured creditors. The 1st Circuit concluded that a bankruptcy court is not required to accept the contract rate, although there is a presumption that the contract rate (including default rate) applies if it is enforceable under state law and there are no equitable considerations leading to a different result. See here for a more detailed discussion of Prudential Ins. Co. of Am. v. SW Boston Hotel Venture, LLC (In re SW Boston Hotel Venture, LLC), 748 F.3d. 393 (1st Cir. 2014).
The Bankruptcy Roundtable celebrates its six-month anniversary this week and would like to thank the 63 authors, including 36 attorneys from 14 law firms, 26 bankruptcy, finance, and economics academics, and a judge, who contributed 38 weekly posts in that time. We would also like to thank the hundreds of lawyers, academics, and interested non-lawyers who subscribe to our emails, from the United States and around the world.
The Roundtable’s purpose is to encourage the exchange of ideas between academics and professionals on critical corporate bankruptcy issues, and we couldn’t do that without this network. Thanks a lot to all.
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By Ken Ayotte, University of California at Berkeley Law School
This paper offers the first empirical analysis of the timing and disposition decisions large Chapter 11 debtors make with respect to their leases and executory contracts in bankruptcy. In particular, I analyze the effect of the revised 365(d)(4), which requires tenant-debtors to make decisions on their real estate leases within seven months unless the landlord grants an extension.
I find that the seven month deadline strongly accelerated real estate lease disposition decisions. This suggests the existence of renegotiation frictions that prevent debtors from buying more time from their landlords. The accelerated timeline, moreover, may have affected case outcomes. Using a difference-in-differences methodology, I find that the probability of reorganization fell significantly more for lease-intensive debtors than for non-lease-intensive debtors after BAPCPA.
The paper also offers many new stylized facts. For example, I find that most assignments occur in the context of a going-concern sale of the whole firm or business unit, rather than on an individual basis. I also find that many debtors assume contracts early, rather than maximizing the “option value” of waiting. Examining early assumptions in detail, I find evidence consistent with “implicit contracting” motives, whereby assuming early secures benefits for the debtor that the formal contract alone could not.
The full paper may be found here.
By Gabriel A. Morgan, Weil Gotshal LLP
Discounted cash flow analysis is a mainstay among the valuation methodologies used by restructuring professionals and bankruptcy courts to determine the enterprise value of a distressed business. Despite its prevalence, the United States Bankruptcy Court for the Southern District of New York recently concluded that the DCF method was inappropriate for the valuation of dry bulk shipping companies. In In re Genco Shipping & Trading Limited, Case No. 14-11108 (Bankr. S.D.N.Y. July 2, 2014), the bankruptcy court explained that the DCF method is of limited use when projections of future cash flows are unreliable or difficult to ascertain. The bankruptcy court then found that accurate cash flow projections did not exist for Genco because dry bulk shipping rates are difficult to forecast due to the volatile nature of the dry bulk shipping market. Interestingly, the bankruptcy court concluded not just that accurate projections were unobtainable in the case of Genco, specifically, but also for dry bulk shippers, generally. The bankruptcy court observed that the DCF method is inappropriate for the dry bulk shipping market because it is volatile and highly fragmented, has low barriers to entry, and little differentiation exists among competitors, causing charter rates to fluctuate with supply and demand and making revenues unpredictable. Although the bankruptcy court merely applied existing law to the facts of the case, the decision in Genco could serve as precedent for the valuation of companies in other segments of the shipping industry, and other industries, that experience significant volatility in rates.
The full discussion can be found here.