Chapter 22 Roundtable in the WSJ Bankruptcy Beat

Last week, the Wall Street Journal’s Bankruptcy Beat posted several pieces on the causes and consequences of so-called “Chapter 22” repeat bankruptcy filings. In the first three posts of the series, bankruptcy experts offered a range of views on the topic.

In the first post, Harvey Miller, of Weil, Gotshal & Manges, said that increased recidivism in Chapter 11 filings was largely due to distressed debt and securities investors, who effectively gain control of the debtor and its plan formulation process and do all that is necessary to expedite the plan confirmation. Because nobody in this coordinated effort will challenge the plan’s feasibility and because the judge is not well placed to independently investigate, feasibility issues may go unaddressed.

Marshall Huebner, of Davis Polk & Wardwell LLP, in the second post, noted other factors that could trigger subsequent Chapter 11 filings, including a company’s underestimation of the broader industry’s decline, creditor pressure on the debtor to remain overleveraged, and a debtor’s inability to shed legacy liabilities.

In the third post, Mark Roe, professor at Harvard Law School reasoned that, regardless of the cause, recidivism is both not that common—less than 20% of Chapter 11 debtors—and not that bad of a trade-off if it stems from getting companies through the bankruptcy process quickly, as long as most of them recover and grow. Enforcing a strict zero-tolerance feasibility standard could do more damage to debtors by keeping them in bankruptcy longer.

Visit the Bankruptcy Beat website to see the rest of the experts’ views on Chapter 22 filings.

Visit the HLS Bankruptcy Roundtable’s prior coverage of Ed Altman’s study of the frequency and nature of Chapter 22 filings, posted in June, here.

This summary was drafted by Stephanie Massman (J.D. 2015)

Derivatives and Collateral: Balancing Remedies and Systemic Risk

By Steven L. Schwarcz, Duke University School of Law

schwarczProfessor Schwarcz examines whether the bankruptcy “safe harbor” for derivatives is necessary or even appropriate to protect against systemic risk—such protection being the safe harbor’s articulated justification. The article examines the most important function of the safe harbor: allowing derivatives counterparties to exercise their contractual enforcement remedies against a debtor or its property notwithstanding bankruptcy law’s stay of enforcement actions. A threshold question is whether there is anything inherently risky about derivatives that might cause a systemic failure.

The standard answer is volatility. But, the article observes, regulation could reduce that potential for systemic risk in a more limited fashion. The article next addresses the safe harbor from the standpoint of its impact on avoiding contagion. The safe harbor is supposed to enable large derivatives dealers to enforce their remedies against a failed counterparty, thereby minimizing the dealer’s losses and reducing its chance of collapse. There are, however, several flaws in the safe harbor’s design to accomplish that. First, the safe harbor incentivizes systemically risky market concentration by enabling dealers and other parties to virtually ignore counterparty risk. Second, the safe harbor operates independently of the size of the counterparty or its portfolio. The article then examines how the Lehman bankruptcy might inform the safe harbor debate. The article offers a final caution: To the extent the safe harbor might amplify, rather than protect against, systemic risk, its negative impact would transcend the traditional derivatives market.

The full version of this article is forthcoming from the University of Illinois Law Review and is available in draft form here.

Update on Directors’ and Officers’ Insurance in Bankruptcy

By Douglas K. Mayer, Martin J.E. Arms, and Emil A. Kleinhaus of Wachtell, Lipton, Rosen & Katz
110915.wlrk.dMayer.3477.web 110913.wlrk.mArms.1503.web120221.wlrk.kleinhaus-1009.webD&O insurance policies typically combine coverage for certain liabilities and defense costs of individual directors and officers (“A” coverage) and of their companies (“B” and “C” coverage). In recent years D&O policies also typically state that payments to insured individuals under their A coverage take priority over payments of B or C coverage to the insured company.

After commodities broker MF Global filed for bankruptcy in 2011, insured individual directors and officers asked the bankruptcy court to allow them to request payment of their A coverage for their defense costs in ongoing litigation, but were opposed by the contention that all access to the D&O insurance policy, including the individuals’ A coverage, was subject to the automatic bankruptcy stay due to the policy’s B and C coverages. [The B and C coverage of the company was directly subject to the stay; the personal A coverage was argued to be sufficiently related to the B and C coverage that it was also stayed.]

The bankruptcy court ultimately allowed the individuals to access their A coverage by honoring the policy’s priority of payment language, but in the interim granted the individuals only limited access to insurance money while the coverage litigation was ongoing. The MF Global D&O insurance dispute illustrates the significant risk that individuals may be barred, or at least significantly delayed, in gaining access to their personal A coverage under a typical directors and officers insurance policy issued to a company that subsequently enters bankruptcy, and highlights the usefulness of separate A-only or Difference in Condition coverage for individual directors and officers.

For the full memo, navigate here.

The Evolution of European Insolvency Law Part 3: The EU Parliament’s Report on the Amendment of the European Insolvency Regulation (EIR)

By Robert Arts and Dr. Björn Laukemann (Maîtr. en droit)

Robert Arts Laukemann PicAfter the external evaluation of European Insolvency Law (Part 1) and the European Commission’s proposal for the amendment of the EIR (Part 2), the report of the European Parliament (EP) on this proposal marked the latest stage of the reform process.

While the Parliament generally supports the changes proposed by the Commission and many of its amendments simply clarify wording or align the text with the existing legislation, the draft report made some noteworthy revisions:

  1. To prevent abusive venue-shopping, the draft requires the factual circumstances of the debtor’s centre of main interests to be established three months prior to the opening of insolvency proceedings.
  2. While welcoming the introduction of synthetic proceedings (i.e. the granting of special rights to groups of local creditors in order to avoid the opening of secondary insolvency proceedings) the EP strengthens the procedural standing of the local creditors by:

(i) granting them the power to challenge any decision to postpone or refuse the opening of secondary proceedings;

(ii) allowing them to petition the court conducting the main proceeding to take protective measures, e.g. by prohibiting the removal of assets or the distribution of proceeds, or by ordering the administrator to provide security; and

(iii) empowering the court to appoint a trustee to safeguard their interests.

  1. The coordination and cooperation between administrators appointed in different proceedings within a group of companies is further enhanced by the implementation of an independent coordinator who, for instance, is empowered to present a non-binding, court-approved group coordination plan, to mediate in disputes between insolvency representatives of group members, or to request a stay of proceedings with respect to any member of the group.

As a result, the Parliament report  aims to strengthen the role of main insolvency proceedings while still sufficiently considering interests of local creditors and to improve coordination within groups of companies. The draft is expected to pass the European Council by the end of this year.

See the full report here.

The Article III Problem in Bankruptcy

By Anthony J. Casey and Aziz Z. Huq, University of Chicago Law School

Casey, Anthony_0Huq Aziz 2009-06-18

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.

A New Risk to Bankruptcy Sales – Unwinding of the Sale Due to a Bad Faith Filing

posted in: Valuation | 0

Authors: Lenard M. Parkins and Karl D. Burrer of Haynes and Boone, LLP

Parkins_Lenny HeadshotBurrer_Karl headshotRecently, 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.

House Advances Bipartisan Financial Institution Bankruptcy Act

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.

Single Point of Entry and the Bankruptcy Alternative

Author: David A. Skeel, Jr., University of Pennsylvania Law School

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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.

Rolling Back the Repo Safe Harbors

Authors: Edward R. Morrison, Mark J. Roe, and Hon. Christopher S. Sontchi

Morrison PicMarkRoeSontchi, Christopher resized_1

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.

Federal Antitrust Laws: A New Tool to Prohibit Pre-Petition Coordination Among Creditors?

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.

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