By Hilary Till (J.P. Morgan Center for Commodities, University of Colorado Denver Business School)
In the fall of 2011, futures market participants were caught off-guard when MF Global filed for bankruptcy. Essentially, this episode educated industry participants that customer protections in the U.S. commodity futures markets had been more ambiguous than expected. That said, there are a number of reforms that have been undertaken to help prevent future MF Globals. This article takes the position that a number of red flags existed as far back as 2007, regarding the firm’s financial weakness, which could have served as a warning to those investors relying on MF Global as a fiduciary.
In discussing the MF Global debacle, this article will cover the following seven areas:
(1) a brief background on the firm will be outlined;
(2) warning signs will be identified;
(3) the firm’s final week will be recalled;
(4) the response of regulators and bankruptcy trustees will be noted;
(5) the shortfall in customer segregated funds will be described;
(6) the CFTC’s charges and settlement will be mentioned; and
(7) later reforms will be summarized.
The article concludes that while MF Global’s business model appears not to have been viable after 2007, this observation does not excuse unlawful practices. In particular, the firm effectively (and arguably unlawfully) used customer funds in large-scale proprietary trades that the firm ultimately could not fund, leading to its chaotic bankruptcy.
By Mark A. Walker (Millstein & Co.) and Richard J. Cooper (Cleary Gottlieb Steen & Hamilton, LLP).
Venezuela is confronting an economic and financial crisis of unprecedented proportions. Its economy remains on a precipitous downward trajectory, national income has more than halved, imports have collapsed, hyperinflation is about to set in, and the government continues to prioritize the payment of external debt over imports of food, medicine and inputs needed to allow production to resume. Bad policies are complemented by bad news as oil production and prices have declined dramatically from previous highs. Financially, the country is burdened with an unsustainable level of debt and has lost market access. Venezuela will be unable to attract the substantial new financing and investment required to reform its economy without a comprehensive restructuring of its external liabilities.
Given this array of problems, Venezuela and its national oil company, PDVSA, face what may be the most complex and challenging sovereign debt restructuring to date. This paper proposes a framework for restructuring and discusses the key issues that will arise during the restructuring process. These issues include the vulnerability of PDVSA assets outside Venezuela to actions by creditors (which affects, most importantly, receivables from petroleum sales and PDVSA’s interest in the U.S.-based CITGO); whether the restructuring should be implemented in one or two steps (an immediate restructuring versus the reprofiling of principal payments in the short term); the incentives and disincentives for would-be holdout creditors to join a restructuring; and the admissibility and treatment of various claims (such as PDVSA bonds that may have been originally issued at prices below their par value and claims against PDVSA for services billed at significant premiums to market prices).
The article is available here.
Mark A. Walker is Managing Director and Head of Sovereign Advisory at Millstein & Co. Richard J. Cooper is a Senior Partner in the Restructuring Group at Cleary Gottlieb Steen & Hamilton, LLP. The views expressed in the article are those of the authors only.
By Ralph Brubaker (University of Illinois College of Law)
This article explores the diverse and intriguing implications of the Supreme Court’s recent decision in Wellness International Network, Ltd. v. Sharif, both from an “internal” bankruptcy perspective and as a very important and revealing component of the Court’s still-evolving general jurisprudence of non-Article III adjudications.
In that larger jurisprudence, the contrast between Wellness and the Stern v. Marshall decision prominently highlights a seemingly schizophrenic admixture of formal (Stern) and functional (Wellness) analytical methods. This article maintains, however, that what Stern and Wellness reveal and confirm is a coherent and consistent jurisprudence of non-Article III adjudications with a bifurcated analytical methodology that is a logical corollary of (and that facilitates a complex interaction between) the dual interests protected by Article III, § 1 — both nonwaivable structural separation-of-powers values and the waivable personal right of individual litigants to an Article III adjudication.
In the bankruptcy context, Wellness provides further evidence that the Supreme Court is, over a long run of decisions, simply confirming the constitutional significance of its extensive summary-plenary jurisprudence (taken from established English bankruptcy practice prevailing at the time of the Founding) as the operative constitutional boundary for the adjudicatory powers of non-Article III bankruptcy judges. This article uses the Wellness litigation to demonstrate how that summary-plenary jurisprudence can directly inform the core-noncore distinction drawn by the current jurisdictional statute (which codifies constitutional constraints). The Court’s existing and extensive summary-plenary jurisprudence provides a highly developed analytical framework for resolving even the most nuanced and difficult core-noncore determinations.
The full article is available here.
By Garence Staraci (Yale University, School of Management) and Meradj Pouraghdam (Institut d’Etudes Politiques de Paris (Sciences Po))
In syndicated loan contracts, a borrower’s failure to comply with a covenant restriction triggers a default, and as such the lender’s right to terminate the loan (or foreclose on assets which are serving as collateral). The likelihood that such a covenant violation would occur depends on the loan covenant strictness, which measures how stringent covenant restrictions are on the borrower. Rationales for creditors to demand strict covenants include the pricing of default risk and the allocation of bargaining power in more frequently triggered renegotiations.
In this paper, we propose a new determinant of covenant strictness: the degree of creditor friendliness in Chapter 11 bankruptcy practices. This new determinant dictates that the more debtor(creditor)-friendly the bankruptcy practice is, the more creditors will seek to increase(decrease) their level of loan monitoring outside of bankruptcy through an adjustment in covenant strictness. Borrowers would agree on stricter covenants in exchange for a lower loan spread, and vice-versa. We demonstrate that covenants are not only included in order to shift the governance from debtors to creditors once they are breached, but to also potentially address the concern creditors might have about how the bankruptcy law is practiced if the borrowing firm goes bankrupt.
This paper finally relates to the recent recommendations of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11, which has investigated the creditor friendliness of the corporate bankruptcy practice. Our results imply that any amendment to the Code that would limit the creditors’ rights during bankruptcy would have an impact on the pricing of syndicated debt through a modification of the covenant structure of loan contracts.
The full paper is available here.
By Nicholas L. Georgakopoulos (McKinney School of Law, Indiana University)
This article takes the United States Supreme Court’s simple “no” to nonconsensual structured dismissals in Jevic as an opportunity to study its contours. The first issue is the pending clarification on whether the right to object to a structured dismissal is an individual or a class right. An individual right would leave little space for consensual structured dismissals, whereas a class right would fit with the anti-hold-out scheme of reorganization law. Second, Jevic implies increased scrutiny on first-day orders, especially in liquidating reorganizations, pushing for additional caution and negotiation before early payments. Third is the issue of fees—latent in Jevic but burning in the academy—the tension between race-to-the-bottom and race-to-the-top views of jurisdictional competition with the Court’s silence in the foreground. Fourth is the Court’s approval of settlements (via interim orders) that violate priorities provided they promote a bankruptcy goal, as Iridium’s approval did. Fifth, the juxtaposition of the settlements in Iridium and Jevic stresses the importance of the bankruptcy court’s role in approving settlements when the parties’ incentives are biased.
The full article is available here.
The roundtable has posted previously on Jevic, including a report of the case by Melissa Jacoby & Jonathan Lipson and a roundup of law firm perspectives on the Court’s decision. For opposing views on the case leading up to oral argument, see Melissa Jacoby & Jonathan Lipson on their amicus brief and Bruce Grohsgal making the case for structured dismissals. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article that the Jevic opinion referenced.
By Andrew C. Kassner and Joseph N. Argentina, Jr. (Drinker Biddle & Reath LLP)
In Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017), the Supreme Court held that structured dismissals that violate the distribution scheme set forth in the Bankruptcy Code are not permitted. The Court distinguished such situations from other, somewhat common bankruptcy practices that also violate the Code’s distribution scheme, such as critical vendor orders, employee wage orders, and lender “roll-ups.” Those practices, the Court noted, “enable a successful reorganization and make even the disfavored creditors better off.” The question remained, however, how subsequent bankruptcy courts would analyze such practices in light of the Supreme Court’s decision in Jevic.
This article summarizes two early post-Jevic decisions and concludes that at least some courts will read the Jevic holding expansively into areas of chapter 11 practice other than structured dismissals. In In re Fryar, 2017 Bankr. LEXIS 1123 (Apr. 25, 2017), the Bankruptcy Court for the Eastern District of Tennessee would not approve a settlement agreement and § 363 sale that provided payment to a lender on account of its prepetition claims. In In re Pioneer Health Servs., 2017 Bankr. LEXIS 939 (Apr. 4, 2017), the Bankruptcy Court for the Southern District of Mississippi would not permit a hospital debtor to pay three physicians as “critical vendors.” These courts concluded that Jevic required additional scrutiny of distribution-violating proposals other than structured dismissals.
The full article is available here.
Andrew C. Kassner is the chairman and chief executive officer of Drinker Biddle & Reath, and former chair of its corporate restructuring group. Joseph N. Argentina Jr. is an associate in the firm’s corporate restructuring practice group in the Philadelphia and Wilmington offices. The views expressed in the article are those of Mr. Kassner and Mr. Argentina, and not of Drinker Biddle & Reath.
The roundtable has posted previously on Jevic, including a report of the case by Melissa Jacoby & Jonathan Lipson and a roundup of law firm perspectives on the Court’s decision. For opposing views on the case leading up to oral argument, see Melissa Jacoby & Jonathan Lipson on their amicus brief and Bruce Grohsgal making the case for structured dismissals. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article referred to in the Jevic opinion.
By Ralph Brubaker (University of Illinois College of Law)
Bankruptcy Code § 546(e) contains a safe harbor that prevents avoidance of a securities settlement payment. To date, pleas for sane limits on the scope of the § 546(e) safe harbor have focused upon what kinds of transactions should be considered a “settlement payment.” That language, however, is not the primary means by which § 546(e) both reveals its manifest object and correspondingly limits its reach thereto. Section 546(e) rationally constrains its scope via the statutory specification (the meaning of which the Supreme Court will consider in the pending case of Merit Management Group v. FTI Consulting) that the safe harbor only applies (because it need only apply) if the “transfer” sought to be avoided was allegedly “made by or to (or for the benefit of)” a protected securities market intermediary, such as a stockbroker or a financial institution.
Ascertaining the meaning and function of that determinative scope language requires an understanding of (1) the concept of a “transfer” as the fundamental analytical transaction unit throughout the Code’s avoidance provisions, and (2) the relationship between that avoidable “transfer” concept and the inextricably interrelated concepts of who that “transfer” is “made by or to (or for the benefit of).” By its express terms, § 546(e) only shields a challenged “transfer” from avoidance if (1) that transfer was “made by” a debtor-transferor who was a qualifying intermediary, “or” (2) a party with potential liability—because the challenged transfer allegedly was made “to or for the benefit of” that party—was a protected intermediary.
The full article is available for download here.
The roundtable previously posted a roundup of law perspectives on the Seventh Circuit’s decision in FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016). The Supreme Court granted certiorari to review that decision on May 1, 2017. Petitioner Merit Management Group, LP has filed its opening brief, and amicus curiae briefs have been filed by Opportunity Partners, L.P. and Various Former Tribune and Lyondell Shareholders. Argument has been scheduled for November 6, 2017.
By Rohan Ganduri (Goizueta Business School, Emory University)
In April 2005 Congress expanded the range of bankruptcy safe-harbored repurchase agreements (repos) to include mortgage-related securities with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The rationale behind this provision was to prevent a chain of failures among financial institutions by granting derivative counterparties an exemption to the automatic stay, thereby allowing them to close out their positions.
In “Repo Regret?” I show that there were unanticipated adverse consequences of BAPCPA, which exacerbated the growth of risky mortgage credit in the U.S. economy. BAPCPA affected the funding of non-bank mortgage originators, which fund their mortgage origination business primarily through short-term revolving lines of credit, typically secured by the originated mortgages. However, after BAPCPA, short-term secured loans were cloaked in repurchase agreement (repo) terms consistent with the bankruptcy code. This was because a repo lender has greater protection in bankruptcy, although a secured loan and a repo are economically equivalent.
Furthermore, safe harboring eliminated any long-term risk associated with a drop in the collateral’s value at liquidation. Lower exposure to the collateral’s risk drove down funding costs for non-bank originators and also reduced the incentives of short-term funding intermediaries to screen the mortgages that the non-banks placed as collateral to obtain funding. This increase in funding and lax screening led to the growth of risky mortgage credit.
Conferring seniority on derivative counterparties does not eliminate risk, however; it transfers the risk to other investors. In the case of BAPCPA and the mortgage market, the seniority accorded to repo lenders transferred the long-term credit risk associated with the holding of mortgage-related collateral entirely to the end mortgage-backed security (MBS) investors.
To the extent that greater defaults, due to increased origination of riskier mortgages, have externalities and spillover effects that cannot be internalized by the MBS investors by demanding higher yields, the cost of awarding seniority to derivative counterparties may outweigh its expected benefits.
The full article is available here.
For previous Roundtable posts on the safe harbors, see Morrison, Roe & Sontchi, “Rolling Back the Repo Safe Harbors“; Janger & Pottow, “Implementing Symmetric Treatment of Financial Contracts in Bankruptcy and Bank Resolution“; and Lubben, “Lehman’s Derivatives Portfolio.”
We at the Bankruptcy Roundtable will take a break from posting this August and hope that you too will be able to get away from your desk at work. We’ll be back on September 5th.
By Yue Qiu, University of Minnesota (will join Temple University as Assistant Professor of Finance on August 1st, 2017)
In this paper, I study the strategic role of debt structure in improving the bargaining position of a firm’s management relative to its non-financial stakeholders. Debt structure is essential for strategic bargaining between management and non-financial stakeholders because it affects the ease of renegotiating debt contracts and thus the credibility of bankruptcy threats. Debt structure, not necessarily debt level, is shown to be adjusted as a response to an increase in non-financial stakeholders’ negotiation power.
Using NLRB labor union elections as a laboratory setting and employing a regression discontinuity design, I find that passing a labor union election leads to larger creditor dispersion in a firm’s outstanding debt. In particular, union certification leads to an increase in the ratio of public debt to total assets and a decrease in the ratio of bank debt to total assets in the following three years after elections, whereas there is no significant change in the level of total debt. Moreover, the syndication size of newly issued bank loans increases while creditor ownership concentration decreases once the vote share for unions passes the winning threshold.
Further analyses confirm that the debt structure adjustments after union certification are more likely driven by strategic concerns of management rather than more constrained access to bank loans. Finally, I also show that the degree of wage concessions is strongly related to a firm’s debt structure using the airline industry as an empirical setting.
The full paper is available here.
By Steven L. Schwarcz (Duke University School of Law)
This Roundtable post is based on the author’s forthcoming article, Sovereign Debt Restructuring and English Governing Law, scheduled for publication in a symposium issue of the Brooklyn Journal of Corporate, Financial and Commercial Law (available at http://ssrn.com/abstract=2952776).
Unsustainable sovereign debt is a serious problem for nations as well as their citizens and creditors. It also is a threat to global financial stability. The existing “collective action clause” contractual approach to restructuring that debt is inadequate. At the same time, a multilateral framework, such as a convention or treaty, is not currently politically feasible. Recent research shows a drastic rise in sovereign debt litigation by holdout creditors, suggesting the urgency of finding solutions.
This article proposes a novel legal framework, focusing on governing law, for restructuring unsustainable sovereign debt. Because a significant percentage of sovereign debt is governed by English law, the UK Parliament has a unique opportunity to modify that law to include the legislative equivalent of perfect aggregate-voting collective action clauses in all English-law governed sovereign debt contracts. That not only would facilitate the fair and equitable restructuring of unsustainable sovereign debt; it also should ensure the continuing legitimacy and attractiveness of English law as the governing law for future sovereign debt contracts.
The article also proposes and examines the text of a model law that Parliament could consider as a basis for its legislation. Additionally, the article explains why, even absent Parliamentary enactment, a model-law approach could contribute to the incremental development of sovereign-debt-restructuring norms.
The full paper is available here