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.
By Steven T. Kargman, President, Kargman Associates
Many of the world’s major advanced economies are subject to some form of cross-border insolvency regime, such as Chapter 15 in the United States. However, despite this clear and important progress in the adoption of cross-border insolvency regimes among many advanced economies, there appears to be a glaring gap in the international insolvency architecture. Specifically, very few of the major emerging economies – and, in particular, none of the BRIC countries (Brazil, Russia, India and China) – have adopted the UNCITRAL Model Law on Cross-Border Insolvency or otherwise enacted effective alternative regimes for handling cross-border insolvencies.
With their growing integration into the global economy, these emerging economies may face a rising number of cross-border insolvencies at some point in the coming years. Nonetheless, while the current absence of cross-border insolvency regimes in major emerging economies may not represent an immediate problem in the next few years, it may pose challenges for the international insolvency framework over the longer term given that these economies are playing an increasingly important role in the global economy.
This two-part article, originally published in 2012-2013 in Insolvency and Restructuring International, reviewed the status of the adoption among major emerging economies of comprehensive insolvency regimes along the lines of the UNCITRAL Model Law and outlined possible pathways that emerging economies might pursue that could lead to the adoption of such cross-border insolvency regimes in these jurisdictions. The article also explored intermediate steps that emerging economies might adopt as a means of growing more comfortable with the concepts that are central to any meaningful cross-border insolvency regime. Such intermediate steps might serve to pave the way ultimately for the adoption by these emerging market jurisdictions of a more comprehensive cross-border insolvency regime.
Part I of the article (September 2012) can be found here and Part II (April 2013) can be found here. (This article was first published in Insolvency and Restructuring International, Vol. 6 No. 2, September 2012 and Vol. 7 No. 1, April 2013, and is reproduced with the kind permission of the International Bar Association, London, UK © International Bar Association.)
By Paul Hessler, Aaron Javian, and Robert Trust, Linklaters LLP
On June 9, 2014, in a highly anticipated decision Executive Benefits Ins. Agency v. Arkison, Chapter 7 Trustee of Estate of Bellingham Ins. Agency, Inc., the U.S. Supreme Court partially resolved the procedural uncertainty created by the Court’s decision in Stern v. Marshall. In Stern, the Supreme Court analyzed the constitutionality of 28 U.S.C. § 157, which in relevant part defines certain matters as “core” or “non-core,” and authorizes bankruptcy courts to finally adjudicate “core” matters, but only to issue findings and conclusions subject to de novo review in “non-core” matters. The Stern Court held that Article III of the U.S. Constitution prohibits Congress from vesting bankruptcy judges with the authority to finally adjudicate certain claims that it had statutorily designated as “core,” such as state law avoidance claims. The Stern Court did not, however, address how bankruptcy courts should proceed in such cases. The Supreme Court considered that procedural question in Executive Benefits and held that with respect to “core” claims that a bankruptcy judge is statutorily authorized but prohibited from finally adjudicating as a constitutional matter, the courts should deal with such claims as they would in “non-core” proceedings; that is, by issuing findings and conclusions subject to de novo review by district courts.
The Supreme Court’s holding makes clear that a wide-range of bankruptcy-related disputes that were previously heard and decided by bankruptcy courts must now be submitted for de novo review by district courts. This additional layer of judicial involvement could make bankruptcy litigation more cumbersome and casts doubt on the well-established expectation of the bankruptcy court system as the single, consolidated venue for adjudication of all matters related to a debtor’s bankruptcy case. Importantly, the Supreme Court did not decide, and it remains to be seen, whether parties can consent to a bankruptcy court’s final adjudication of core matters that otherwise fall outside of a bankruptcy court’s constitutional authority under Stern. The full memo can be read here.
Author: Carlos Berdejó, Loyola Law School, Los Angeles
Economic theory suggests that corporate law should enable parties to contract freely in order to promote their best interests, leading to socially optimal arrangements. This is particularly true for corporate bonds, which are governed by detailed indentures and held by large, sophisticated investors. However, the Trust Indenture Act, which for 75 years has regulated the terms of U.S. public corporate debt, contains numerous mandatory rules, including a prohibition on collective action clauses (CACs). A CAC allows a qualifying majority of bondholders to modify the interest rate, maturity and principal of an outstanding bond issue in a manner that binds all bondholders, including those who may prefer to hold-out to extract a larger payment. This longstanding prohibition limits the ability of firms to restructure their debt via private workouts and can exacerbate the costs of financial distress by unnecessarily forcing issuers into bankruptcy. Most countries other than the U.S. do not prohibit CACs and afford parties flexibility in choosing the qualifying majority that may amend the core terms of a bond issue.
My article, Revisiting the Voting Prohibition in Bond Workouts, examines contracting choices in Brazil, Chile and Germany, countries that have recently enacted reforms affecting their bond markets, including changes in restrictions on CACs. I find that not only do market participants embrace increased flexibility with respect to CACs, but that interest rates decrease as a result, lowering the cost of capital for issuers.
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[Related Work Note: The work in Revisiting the Voting Prohibition in Bond Workouts provides evidence relating to the argument made in Mark Roe, The Voting Prohibition in Bond Workouts, 97 Yale L.J. 232 (1987), that the prohibition unwisely impeded out-of-bankruptcy recapitalizations and channeled some parties’ incentives towards coercive restructurings that would not have been needed if straight-forward votes were allowed. That article can be found here. More generally, academic bankruptcy theory has focused on the extent to which contract terms should be respected by law, inside and outside of bankruptcy. See Alan Schwartz, Bankruptcy Workouts and Debt Contracts, 36 J. of L. & Econ. 595 (1993), available here. –Stephen Adams, Editor]
Author: Stephen J. Lubben, Seton Hall University School of Law
For almost as long as there have been bankruptcy laws, there have been complaints that the primary beneficiaries of these laws are insiders who administer the bankruptcy system. In recent decades, this line of criticism has carried with it an implicit criticism of bankruptcy courts, which are urged to more aggressively police the costs of bankruptcy. Indeed, at least one recent critic has unkindly suggested that the failure of the courts to control bankruptcy costs is the result of a corrupt bargain between bankruptcy courts and practitioners.
Rarely addressed is why bankruptcy courts regulate professional costs at all. In most areas of American law, a professional is accountable solely to its client. Complaints about excessive cost might result in a separate malpractice action, but a client who thinks they have been overcharged for the defense of their speeding ticket will find little relief in traffic court. Why is bankruptcy different?
This paper begins to look at this question with brief overview of the concept of bankruptcy costs, traditionally divided between direct and indirect costs. I next turn to a consideration of the process for overseeing bankruptcy costs. I briefly trace the history of court control of compensation in corporate bankruptcy, and then detail the current legal structure. The final part of the chapter then surveys the existing understanding of chapter 11 cost, and concludes with a some thoughts on the important questions that remain unanswered.
In short, we know a bit about direct costs, but very little about any other sort of costs. Moreover, what we know is almost entirely lacking in context. This makes it quite hard to understand if the existing system of cost regulation is either useful or justified.
This article is available here.
By Michelle Harner, University of Maryland Francis King Carey School of Law
When a company is worth more as a going concern than on a liquidation basis, what creates that additional value? Is it the people, management decisions, the simple synergies of the operating business, or some combination of these types of soft variables? And perhaps more importantly, who owns or has an interest in such soft variables? These questions are important in all contexts, but hold particular significance in corporate reorganizations where a company’s liabilities frequently exceed the value of its assets. The value available to satisfy creditors’ claims is limited, and determining the parties’ respective rights to that value is often hotly contested and critical to an effective resolution. My article, The Value of Soft Variables in Corporate Reorganizations, 2015 Ill. L. Rev. ___ (forthcoming), explores these questions under existing legal doctrine and practice norms.
The basic thesis of the article is that soft variables contribute meaningful value to the operation of a company as a going concern but are often overlooked or undervalued in corporate reorganizations. Ignoring soft variables not only does a disservice to those working hardest to save the company but also arguably steals value from the company and those constituencies. If a company’s soft variables do not hold such value, it may indicate that a chapter 7 liquidation is the more appropriate resolution for the company. But if the company invokes the chapter 11 process and the resolution generates value above liquidation or book value, the court and the parties should identify the relevant soft variables and allocate value accordingly.
By Mark Jenkins at University of Pennsylvania and David C. Smith at University of Virginia
While a rich set of theories make clear that incentive conflicts between senior and junior claimants in a company’s capital structure may lead to inefficient outcomes, empirical evidence on how often these conflicts do so has been limited. In this paper, we study the incentives of senior claimants to force inefficient liquidations, or liquidations in which a firm’s assets are sold for less than the firm’s value as a going concern. We develop a bargaining model that assumes senior creditors can exert strong control over whether a firm reorganizes or liquidates during the bankruptcy process. The estimable parameters of the model allow us to gauge the efficiency of bankruptcy outcomes using a large sample of U.S. corporate bankruptcy cases over the period 1989 to 2011.
The main result of the paper is an estimate of the value loss that results from inefficient liquidations in bankruptcy. We estimate these losses to be up to 0.28 percent of the going-concern value of the firm, on average, across all bankrupt firms in our sample. As predicted by theory, these losses are realized primarily by firms with asset values that are close to the face value of secured debt. Our estimate of efficiency losses is driven by several auxiliary findings, including estimates of the fraction of firms that are efficiently reorganized, the fraction of firms that are efficiently and inefficiently liquidated, and the average liquidation discount faced by firms in bankruptcy.
The full article can be found here.
Author: Mindy Mora of Billzin Sumberg Baena Price & Axelrod, LLP
In an unusual but practical decision, the U.S. District Court for the District of Delaware affirmed a bankruptcy court order which approved both a sale of the debtors’ assets and the establishment of an escrow account to provide a “gift” to fund a distribution to the debtors’ unsecured creditors. What is significant about this decision is that it approved the use of gifting in a chapter 11 bankruptcy case. LCI Holding Company, Inc., civ. no. 13-924 (D. Del. March 10, 2014).
The concept of gifting in a bankruptcy case allows a secured creditor or purchaser to overcome objections to a sale of assets interposed by the debtor’s unsecured creditors. Often, the gift consists of a pool of funds for distribution to the debtors’ unsecured creditors, and bypasses the claims of priority creditors with more senior claims. See In re SPM Mfg. Corp., 984 F.2d 1305 (1st Cir. 1993).
A distribution that bypasses priority claims raises the issue of whether gifting is permissible in a chapter 11 case, based upon the requirement that distributions under a plan of reorganization must comply with the Bankruptcy Code, including the priority scheme for distributions to creditors and the absolute priority rule set forth in Bankruptcy Code § 1129(b)(2)(B). This type of compliance is not mandated in chapter 7 cases, in which bankruptcy courts have authorized gifting more regularly. See id. Apparently in Delaware, gifting is permitted in a chapter 11 case, so long as the sale of assets is followed by a dismissal of the case without the confirmation of a plan.