Singapore Schemes of Arrangement: Empirical and Comparative Analysis

By Wai Yee Wan (City University of Hong Kong), Casey Watters (Bond University), and Gerard McCormack (University of Leeds)

Wai Yee Wan
Casey Watters
Gerard McCormack

The scheme of arrangement, brought to Singapore through a transplantation of English law, provides one of the most flexible debt restructuring tools for companies. In 2017, Singapore enacted substantial reforms to its insolvency laws, transplanting elements of US Chapter 11, including a moratorium, rescue financing, and cross-class cramdown, into the flexible Singapore restructuring regime. Our paper (published recently in the American Bankruptcy Law Journal) addresses the effectiveness of English-modelled schemes as debt-restructuring tools in Singapore, both pre-2017 reforms and as a hybrid with elements of Chapter 11.

The English scheme of arrangement has been spoken of as a model for ‘early stage’ restructuring procedures. Although the scheme functions as Singapore’s de facto debtor-in-possession restructuring regime, it does not have any bankruptcy or insolvency stigma since it is a procedure based on company law rather than insolvency law. It is activated by the filing of documents with the court and an application to the court to convene meetings of relevant creditors to approve the scheme. The meeting of creditors under schemes is substantially similar to those conducted in Chapter 11 cases under § 341 of the US Bankruptcy code. Creditors whose rights are altered by the scheme are grouped into classes with creditors holding similar legal rights.

This is the first empirical study to date that comprehensively examines schemes of arrangement, including non-reported schemes, over a period. To this end, it employs a mixture of quantitative and qualitative data. To assess the schemes framework in Singapore, we conducted a study of schemes in three parts based on data availability. First, we examine the filings in court-sanctioned schemes of arrangement for the period 1996–2004 (with reported judgments). This period covers the Asian financial crisis of 1997 and includes private and publicly traded companies. Second, similarly, we examine the filings for schemes of arrangement with reported judgments for the period 2006–2015. This period covers the global financial crisis of 2008. We extended the database by including filings in court-sanctioned schemes of arrangement for SGX-listed companies, including non-reported judgments. Third, we examined the filings in court-sanctioned schemes between January 1, 2016 and May 22, 2019. May 22, 2019 was selected as it is the second anniversary from the date that the 2017 reforms came into force. We are able to have a wider sample size because cases during the latter period were tracked by the Supreme Court Registry. On examining the filings, we coded a number of variables related to the schemes of arrangement, including financial information related to the companies, class composition and outcomes of the schemes. Such data were manually collected and coded from all the filings, which were provided by the Singapore Supreme Court.

From our analysis of the data, we identified multiple characteristics of successful schemes, the most significant of which are controlling shareholder support and availability of new financing, often provided by the controlling shareholder. When present, disputes have centred on insufficient disclosure, with informational asymmetry a substantial concern identified in the study. Liquidation values were often missing and, when present, lacked a detailed bases for the stated values.

The results of the empirical study demonstrate the effectiveness of schemes as a debt restructuring tool for large insolvent companies. The scheme reforms, along with other insolvency reforms in Singapore, including adoption of the UNCITRAL Model Law on Cross-Border Insolvency, recent common law developments, and removing a ring-fencing provision that protected domestic creditors at the expense of foreign creditors, provide additional tools and lower barriers to restructuring in Singapore. The flexibility of schemes coupled with Chapter 11 tools make schemes an attractive debt restructuring option for many insolvent companies.

The full article is available here.

For related Roundtable posts, see Gerard McCormack and Wai Yee Wan, Transplanting Chapter 11 of the US Bankruptcy Code into Singapore’s Restructuring and Insolvency Laws. 

Delaware Bankruptcy Court Rules That Midstream Gathering Agreements Failed to Create Covenants Running with the Land

By Duston K. McFaul & Juliana Hoffman (Sidley)

Duston K. McFaul
Juliana Hoffman

On October 14, 2020, the honorable Christopher Sontchi, Chief Judge of the Delaware Bankruptcy Court, issued an opinion in the Extraction Oil and Gas bankruptcy case finding that certain oil, gas and water gathering agreements (the “Agreements”) did not create covenants running with the land under Colorado law and are thus subject to rejection in Extraction’s chapter 11 proceedings. The Bankruptcy Court applied Colorado law, which requires that the following three elements be satisfied: (1) the parties must intend to create a covenant running with the land; (2) the covenant must touch and concern the land with which it runs; and (3) there must be privity of estate between the covenanting parties. The Bankruptcy Court analyzed these elements relative to the debtor’s leasehold interest.

The Extraction decision is the Delaware Bankruptcy Court’s first published foray into a recent thicket of gathering agreement litigation that was reignited in 2016 with the Bankruptcy Court for the Southern District of New York authorizing the rejection of certain gathering agreements in the Sabine Oil & Gas bankruptcy case. Following Sabine, various oil and gas producers in chapter 11 attempted to use Sabine as a basis for invalidating dedications and shedding minimum volume and other commitments in their own gathering agreements. Such efforts were rebuffed in 2019 by the Colorado Bankruptcy Court in Badlands and by the Bankruptcy Court for the Southern District of Texas in Alta Mesa, each of which analyzed the elements of the asserted covenants running with the land relative to the debtor’s leasehold interest.  The courts in Badlands and Alta Mesa each found that the agreements at issue created valid real property covenants under applicable state law and were thus not executory contracts that could be rejected in bankruptcy.

The Extraction case diverged from Badlands and Alta Mesa in its narrow holding, which analyzed the purported covenants in the context of only the debtor’s mineral estate, and ultimately concluded the midstream agreements did not contain an enforceable covenant running with the land.  The Extraction rulings are currently on appeal before the Delaware District Court.

The full article is available here.

The Development of Collateral Stripping by Distressed Borrowers

By Mitchell Mengden (Law Clerk, Delaware Court of Chancery)

Mitchell Mengden

In the past decade, private equity sponsors have taken a more aggressive stance against creditors of their portfolio companies, the most recent iteration of which has come in the form of collateral stripping. Sponsors have been using creative lawyering to transfer valuable collateral out of the reach of creditors. This Article delves deeper into the issue by examining the contract terms and litigation claims raised by these transactions.

The lack of protective covenants and ease of manipulating EBITDA and asset valuations are key conditions that permit collateral stripping. Each of these conditions were present in the past decade, primarily due to the protracted expansionary stage of the credit cycle. Lenders, however, can protect themselves from collateral stripping by negotiating stricter covenants and tighter EBITDA definitions, as well as pursuing ex post litigation for fraudulent transfers, illegal distributions, and claims for breach of fiduciary duty.

Contractual opportunism and creative lawyering will almost certainly continue to pervade credit markets. This Article provides a roadmap of ways that lenders can protect themselves from opportunism during contracting and throughout the course of the loan. As this Article concludes, ex post litigation claims are often an inadequate remedy, so lenders should seek to tighten EBITDA definitions and broaden protective covenants—even if to do so requires other concessions—to avoid litigation.

The full article is available here.

Towards an Optimal Model of Directors’ Duties in the Zone of Insolvency: An Economic and Comparative Approach

By Aurelio Gurrea-Martínez (Singapore Management University)

Aurelio Gurrea-Martínez

When a company becomes factually insolvent but it is not yet subject to a formal insolvency proceeding, the shareholders—or the directors acting on their behalf—may engage, even in good faith, in various forms of behaviour that can divert or destroy value at the expense of the creditors. For this reason, most jurisdictions around the world provide a variety of legal strategies to respond to this form of shareholder opportunism. One of these strategies is the imposition of special directors’ duties in the zone of insolvency.

In a recent article, I analyse the primary regulatory models of directors’ duties in the zone of insolvency observed internationally. From a sample of more than 20 countries from Asia, Australia, Europe, Latin America, Africa, and North America, I distinguish six primary regulatory models: (i) the imposition of a duty to initiate insolvency proceedings, generally found in Europe; (ii) the imposition of a duty to recapitalise or liquidate the company, typically existing in Europe and Latin America; (iii) the imposition of duties towards the company’s creditors, including the duty to minimise losses for the creditors existing in the United Kingdom; (iv) the imposition of a duty to prevent the company from incurring new debts, existing in countries like Australia and South Africa; (v) the imposition of a duty to prevent the company from incurring new debts that cannot be paid in full, existing in Singapore and New Zealand; and (vi) the imposition of a duty to keep maximising the interest of the corporation, as it exists in Canada and the United States.

After analysing the features, advantages, and weaknesses of these models, my paper argues that the desirability of each regulatory model of directors’ duties in the zone of insolvency depends on a variety of country-specific factors including divergences in corporate ownership structures, debt structures, level of financial development, efficiency of the insolvency framework, and sophistication of the judiciary. For instance, in small and medium-sized enterprises (SMEs) as well as large controlled firms, there is a greater alignment of incentives between directors and shareholders. Therefore, in the event of insolvency, the directors will have more incentives to engage in a series of opportunistic behaviour that will advance the shareholders’ interests even if it is at the expense of the creditors. As a result, a more interventionist approach to protect the creditors, such as the duty to initiate insolvency proceedings, may make more sense in countries with a significant presence of SMEs and large controlled firms, as it happens in most jurisdictions around the world. By contrast, in countries like the United Kingdom and the United States, where large companies usually have dispersed ownership structures and therefore the directors are less influenced by the shareholders, a more flexible approach for the regulation of directors’ duties in the zone of insolvency may be more justified. Therefore, a duty to keep maximising the interest of the company or a duty to take steps to minimise potential losses for the creditors may make sense.

Nonetheless, country-specific factors other than corporate ownership structures can also affect the desirability of each regulatory model of directors’ duties in the zone of insolvency. For example, in countries without sophisticated courts, the discretion of courts should be reduced. Therefore, the imposition of clear rules (e.g., duty to initiate insolvency proceedings) may be more desirable than the use of standards (e.g., duty to minimise losses for the creditors or duty to keep maximising the interest of the corporation). Similarly, in countries with inefficient insolvency frameworks, initiating an insolvency proceeding can do more harm than good for both debtors and creditors. Therefore, these countries should not impose a duty to initiate insolvency proceedings even if, as it happens in many jurisdictions with inefficient frameworks (e.g., emerging economies), this solution makes more sense from the perspective of the corporate ownership structure prevailing in the country.

Based on a comparative, interdisciplinary, and country-specific analysis, my articles provides various policy recommendations to enhance the regulatory framework of directors’ duties in the zone of insolvency across jurisdictions taking into account international divergences in corporate ownership structures, debt structures, level of financial development, efficiency of the insolvency framework, and sophistication of the judiciary.

The full article is available here.

A modified version of this post was published on the Singapore Global Restructuring Initiative Blog.

The Hertz Maneuver (and the Limits of Bankruptcy Law)

By Anthony J. Casey (Professor of Law, The University of Chicago Law School), Joshua C. Macey (Assistant Professor of Law, The University of Chicago Law School)

Anthony J. Casey
Joshua C. Macey

On June 11, 2020, the Hertz Corporation attempted to become the first corporate debtor to finance a bankruptcy proceeding by issuing new shares of common stock to the public. Though many thought Hertz’s equity was worthless, its stock was trading at a positive value on the secondary markets, and Hertz was attempting to tap into that market value. When the bankruptcy court blessed the plan, many observers responded with outrage on behalf of retail investors who, they argued, were being duped into a worthless investment. They suggested that the law should prevent retail investors from buying these shares. Ultimately, the Securities Exchange Commission signaled that it had similar concerns and effectively killed the proposal.

This essay explores the questions raised by this incident. It argues that commentators were focused on the wrong bankruptcy problem. Contrary to the view of the commentators, Hertz’s bankruptcy does not show that retail investors require bankruptcy-specific protections. The Hertz maneuver does, however, highlight distortions created by bankruptcy law’s distribution rule, known as the absolute priority rule. That rule cuts off future opportunities for those holding equity (or junior claims) in a debtor firm and makes it difficult for stockholders and unsecured creditors to make long-term investments in the firm’s future value. From this perspective, existing proposals to alter bankruptcy’s priority rules begin to look like a form of investor protection that could facilitate investment in a firm’s long-term value.

The full article is available here.

Lawyer Networks and Corporate Bankruptcies

By Vidhan K. Goyal (Hong Kong University of Science and Technology), Joshua Madsen (Carlson School of Management, University of Minnesota), and Wei Wang (Smith School of Business, Queen’s University)

Vidhan Goyal
Joshua Madsen
Wei Wang

Does having a lawyer who has previously interacted with the judge matter for bankruptcy outcomes? While knowledge obtained through past interactions about the judge’s views and preferences could improve the efficiency of court process, lawyer familiarity with the judge could also result in a capture of economic rents, leading to delays due to the difficulties in measuring lawyer efforts. Furthermore, connected lawyers could also exploit their connections to obtain biased outcomes in favor of their clients.

We examine these questions in the context of corporate bankruptcies by assembling a comprehensive dataset that contains detailed biographical information, professional experiences, and past in-court interactions of 162 bankruptcy judges overseeing 650 large Chapter 11 cases from 1996–2013, and 2,426 unique lawyers from 775 law firms representing those cases as debtor’s counsel. Our results show that cases with a lead counsel lawyer connected to the judge spend 16–21% less time in bankruptcy, a 2.6–3.5-month reduction in bankruptcy duration, translating into aggregated savings of $3.2–4.5 billion in professional fees for our sample firms.

Our empirical strategy exploits a setting where lead counsel lawyers are selected by the firm before the bankruptcy is filed and thus the assignment of a judge, minimizing concerns that connected lawyers are endogenously hired. The results are robust to the inclusion of controls for case complexity, industry effects, lawyer’s expertise, law firm quality, and judges’ fixed characteristics. Our specifications therefore ensure that any effect from having a connected lawyer is not due to unobserved heterogeneity that is specific to courts, judges, or lawyers.

We further document that the most effective lead counsel connections arise through previous clerkships and in-court interactions with the judge assigned to the case. The effects concentrate in cases with smaller legal teams where connected lawyers presumably have more influence. Having a connected non-lead counsel lawyers’ or connected lawyer representing the unsecured creditors committee only weakly affects case duration.

Lastly, we investigate other bankruptcy outcomes, including the probability of emergence, the bankruptcy refiling rate, operating performance post emergence, the likelihood of a Chapter 7 conversion, and the likelihood of loss of exclusivity extension. We find no evidence that the faster restructurings come at a cost of higher refiling rates or poorer operating performance after emergence. More importantly, there is no evidence that connections lead to judge favoritism or pro-debtor biases.

How do connected lawyers accelerate the bankruptcy process? The most likely explanation is connected lawyers’ knowledge of a judge’s preferences. Judges are extremely busy, and must devote enormous effort to keep straight all the facts and legal nuance under consideration. Connected lawyers are plausibly more familiar with the assigned judge’s preferences and expectations as well as the cases, legal precedents, and statutes that the judge will rely on. They can exploit this knowledge to help the “light shine through.” Idiosyncrasies across judges and their preferences imply that lawyers’ experience with other judges may not be as useful as a connection to the assigned judge and that there is likely no one “magic bullet” used by all connected lawyers. That is, lawyers’ knowledge of judges’ preferences are largely non-transferrable. These findings have implications for the design of bankruptcy institutions, where institutions that lead to lawyers’ increased awareness of a judge’s preferences could produce efficiency gains.

The full article is available here.

Puerto Rico; Act III

By Stephen J. Lubben (Seton Hall University School of Law)

Stephen J. Lubben

Since 2017, the Commonwealth of Puerto Rico (and certain of its affiliated entities) have been in “bankruptcy” under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”).  PROMESA is a bankruptcy law, with various other bells and whistles, although Congress purported to enact it under its Article IV territories powers.

These cases are pending in the United States District Court for the District of Puerto Rico; however, Judge Laura Taylor Swain, of the Southern District of New York, was appointed by the Chief Justice to preside over the cases.  My new paper – Puerto Rico; Act III – provides a concise overview of where things now stand in the PROMESA process, and where they might be heading.

In addition to its restructuring provisions, the law creates the Financial Oversight and Management Board for Puerto Rico.  The Board frequently states that “the purpose of the Oversight Board is to provide a method for Puerto Rico to achieve fiscal responsibility and access to the capital markets.”  In essence, the Board operates as a supra-governmental body for fiscal matters.

At present several members of the Board have stepped down, and President Trump bumped one member off the Board – former bankruptcy judge Arthur J. González – by appointing a new member to his slot.  Congress and the president will have to fill out the Board, or devise a new path for the Commonwealth.

In the face of hurricanes, earthquakes, and COVID-19, the Board has attempted to push forward with a reorganization under Title III.  The virus, however, might substantially delay the process and force a reconsideration of the present reorganization plan.  It thus represents the opening of a third act in Puerto Rico’s debt drama.

Even before recent events, I had argued that the Board was being far too timid in its efforts to revamp Puerto Rico’s economy, given that the PROMESA process was presumably a one-time opportunity.  In particular, the debt relief the Board was proposing was comparatively modest, and I worried that it might leave the Commonwealth with still too much debt to successfully restart its economy.

The problem is that the Board’s current plan has the support of almost nobody, making even “cramdown” of the plan extremely unlikely.  Pensioners might be the most likely ally with the Board, although the government of Puerto Rico, and presumably many of the pensioners, object to the current offer.  As Justice Sotomayor recently noted,

The Board’s decisions have affected the island’s entire population, particularly many of its most vulnerable citizens. The Board has ordered pensions to be reduced by as much as 8.5 percent… Other proposed cuts take aim at already depleted healthcare and educational services. It is under the yoke of such austerity measures that the island’s 3.2 million citizens now chafe.[1]

Indeed, Justice Sotomayor’s recent opinion also provides a kind of roadmap for a challenge to PROMESA.  She explains that she concurred in the Court’s result only because nobody had argued that Puerto Rico’s Commonwealth status was inconsistent with the creation of the Board.  As she sees it, Congress made certain commitments to Puerto Rico in the 1950s when it created the Commonwealth, and Congress may not “take back” those commitments.  Any litigation following her approach would presumably involve extensive appeals, but it looms as a threat to the PROMESA process.

At heart, the problem in Puerto Rico is not unlike the problem in many sovereign and municipal workouts.  The bondholders want to recover as much as possible, of course, and are leery of settling claims only to see the debtor rebound shortly thereafter.  The conundrum being that the rebound is unlikely to happen without serious debt reduction.  Debt reduction is often not the only requirement for a rebound, but it is fundamental.

Either the Board needs to lead Puerto Rico out of this feedback loop, or Puerto Rico needs to extract itself from the PROMESA process. If not, the drama will continue for many more acts.  Future acts could in theory include statehood for Puerto Rico, or some new restructuring process, or perhaps even both.  Or the parties may simply reach a deal on a plan.  At this point it is hard to say any particular outcome is more likely than another.

[1] Financial Oversight And Management Bd. For Puerto Rico v. Aurelius Investment, LLC, 590 U. S. ____ (2020), Sotomayor, J., concurring in judgment, slip opinion at page 7.

Germany Poised for Big Step Towards Corporate Restructuring Best Practice

By Sacha Luerken (Kirkland & Ellis)

Sacha Luerken

Germany’s insolvency law has only in very few cases – around 1% of filings – been used for a Chapter 11-style going concern restructuring of a debtor company. Initiatives to introduce processes like the scheme of arrangement, an English procedure that was also commonly used to restructure non-English companies and is capable of Chapter 15 recognition in the U.S., were not successful, even though recoveries for unsecured creditors in Germany are remarkably low compared to other jurisdictions.

A paradigm shift occurred when the EU in June 2019 passed its directive 2019/1023 on preventive restructuring frameworks, which requires all EU member states to introduce a restructuring process for companies in financial difficulties, but before an actual insolvency. On September 18, 2020, a draft law was presented to introduce a scheme-like procedure in Germany, which provides for a restructuring of selected liabilities with 75% majority by amount in class, a cross-class cram-down subject to tests similar as in a U.S. Chapter 11 proceeding, a court-approved stay on enforcement and collateral realization, and even a rejection of onerous contracts by the court.

The draft law has been welcomed as a big step towards a restructuring culture in Germany by many advisors and practitioners, and as a potential blueprint for the implementation of the EU directive in other European jurisdictions.

The full article is available here.

Reprinted with permission from the October 06, 2020 edition of the Law.com International 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.

Regulating Bankruptcy Bonuses and Protecting Workers in the Age of COVID-19

By Jessica Ljustina (Harvard Law School)

Since March, executives of 18 large companies received over $135 million total in bonuses prior to their companies filing under Chapter 11, while “[t]hose same companies laid off tens of thousands of workers,” according to a Washington Post report. These recent examples are illustrative of gaps left by the last major reform targeting bankruptcy bonuses. Further reforms have been introduced in Congress every few years since 2005. Referencing inequality and perceived abuses in the context of COVID-19, the House Judiciary Committee advanced the current House bill to the full chamber on September 29, 2020, marking the proposed legislation’s furthest progress thus far.

H.R. 7370, the Protecting Employees and Retirees in Business Bankruptcies Act of 2020 (PERBB) would present significant changes to the Bankruptcy Code aimed at protecting workers. The bill would expand from existing regulation of insider retention bonuses to include a broader set of payments to insiders, senior executive officers, the 20 highest compensated employees who are not insiders or senior executives, department and division managers, and any consultants providing services to the debtor.

Through expanding the scope of executive compensation subject to restrictions, PERBB may more effectively reduce management bonuses paid in bankruptcy. However, the House version of PERBB fails to address bonus payments prior to filing for bankruptcy, a key issue identified at the outset of the post. The related Senate bill has an additional provision which would designate any transfer made to management “made in anticipation of bankruptcy” as a §547 preference avoidable by the trustee.

The full post, including a summary of proposed changes to the Code, is available here.

The full text of the House bill can be accessed here. A redline of relevant 11 U.S.C. provisions reflecting amendments proposed in H.R. 7370 is available here. The full text of Senate bill can be accessed here.

For related Roundtable posts, see Jared Ellias, Regulating Bankruptcy Bonuses; James H. M. Sprayregen, Christopher T. Greco, and Neal Paul Donnelly (Kirkland & Ellis), Recent Lessons on Management Compensation at Various States of the Chapter 11.

Special Considerations for Protecting Interests under Water Agreements in Bankruptcy

By Rahul D. Vashi, Anna G. Rotman, Chris Heasley, Shubi Arora, Kenneth A. Young, Fraser F. Wayne, and John C. Elkins (Kirkland & Ellis)

Rahul D. Vashi
Anna G. Rotman
Chris Heasley
Shubi Arora
Kenneth A. Young
Fraser F. Wayne
John C. Elkins

Midstream service providers in the oil and gas space typically expend substantial upfront capital investment to build pipeline systems to gather and transport hydrocarbons and produced water for oil and gas producers, and rely on the fee structures in their service contracts to recoup their investments. One common method used by midstream companies to protect their investments is to create (or attempt to create) in their service contracts a dedication of production from the oil and gas producer structured as a covenant that runs with the land.

Beginning with Sabine Oil & Gas Corp. v. HPIP Gonzales Holdings, LLC (In re Sabine Oil & Gas Corp.), 567 B.R. 869 (S.D.N.Y. 2017), bankruptcy courts have delivered divided opinions on whether midstream gathering and transportation contracts can be rejected, resulting in substantial uncertainty about whether midstream service providers can rely on their contractual terms. The major decisions regarding the treatment of midstream contracts in bankruptcy have focused on contracts for the gathering and transportation of hydrocarbons, and whether the contracts should not be rejectable because the oil and gas producer properly granted to the midstream company a covenant running with the land in its oil and gas properties.

Providers of produced water gathering and transportation services have typically relied on the same contractual protections as those that provide hydrocarbon gathering and transportation services. However, to date, midstream water contracts purporting to contain covenants running with the land have not been tested, and there is reason to believe that such agreements may be treated differently than their oil and gas counterparts. This article discusses certain issues and considerations that are specific to midstream water agreements and may affect whether such agreements are determined to be rejectable under the Bankruptcy Code.

The full article is available here.

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