Bankruptcy’s Role in the COVID-19 Crisis

By Edward R. Morrison and Andrea C. Saavedra (Columbia Law School)

Edward R. Morrison
Andrea C. Saavedra

Current COVID-19 policies treat bankruptcy law as a last resort for stressed businesses and consumers. We think that’s a sensible approach for small businesses and consumers, but not for large corporations. What many small businesses and consumers need now is quick access to liquidity and other forms of forbearance or debt forgiveness, not the debt-discharge of bankruptcy. Even for those who need a debt-discharge, it makes sense to offer them liquidity now and thereby ease the burden on our bankruptcy system, which could be overwhelmed by a flood of filings. In our view, it’s better to stabilize households and small businesses immediately and worry about restructuring their balance sheets after the crisis ends.

For large corporations, however, bankruptcy should be a front-line policy tool. Many were financially fragile before the current crisis, due to high leverage or operational problems. For them, government-backed financing should be provided during a bankruptcy process that cures these problems and forces investors, not taxpayers, to bear the costs of cure. Government action should save businesses (and jobs), not investors. This is a crisis-tested policy response, as we saw in the 2008 Financial Crisis: Both Chrysler and General Motors received government-backed financing during their bankruptcy cases. To be sure, an increase in filings by large corporations would burden our bankruptcy courts but our courts, and the professional bar and consultant industry that supports them, are well prepared to assist these corporations (and fairly represent and protect all parties’ interests), as they have done in past crises.

The full article is available here, and a more detailed summary can be accessed here.

COVID-19 Impacts on Landlords of Retail Debtors

By Scott K. Charles, Amy R. Wolf, Michael H. Cassel (Wachtell)

Scott K. Charles
Amy R. Wolf
Michael H. Cassel

This memorandum addresses one of the impacts of COVID-19 on retail bankruptcies. Several retailers in chapter 11 have sought to suspend their cases given the inability to operate or conduct going out of business sales during the pandemic. Courts in some cases have granted requests for extraordinary relief, which have included excusing the payment of rent notwithstanding the requirements of the Bankruptcy Code that nonresidential leases of real property be paid on a current basis.

The full article is available here.

The Late Prof. Harvey R. Miller, A Man for All Seasons: A Student’s Tribute

By Jay Rao (University of California, Berkeley, School of Law)

Jay Rao

Prof. Harvey R. Miller passed away after his battle with amyotrophic lateral sclerosis, commonly called Lou Gehrig’s disease, in 2015.  Before and after his passing, his substantial contributions and legacy have been discussed at length.  An exceedingly rare individual, he had an extraordinary impact on the field of restructurings and bankruptcies, the large law firm community, the business landscape, academic institutions, and, perhaps most important, the younger generation, including his classroom students.  This brief article, written by his former student at Columbia Law School, is intended as a tribute to this gifted practitioner, scholar, leader, and teacher, focusing on the reason this particular individual was so unique and compelling to the young men and women he encountered and how he transcended the practice and, in many ways, his era.

The full tribute is available here.

This DIP Loan Brought to You by Someone Who CARES!

By Thomas J. Salerno, Gerald Weidner, Christopher Simpson, and Susan Ebner, (Stinson LLP)

Tom Salerno
Gerald Weidner
Chris Simpson
Susan Warshaw Ebner

 

 

 

 

 

 

 

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted into law. The CARES Act is reported to be “twice as large as any relief ever signed,” and will provide $2.2 trillion in relief to US businesses (with another $1 trillion being promised in the near future). While bankruptcy lawyers are aware that CARES expanded the debt limitations for eligibility for the Small Business Bankruptcy Reorganization Act, there could (and should) be another substantial implication for the brave new bankruptcy world—a new potential source of DIP financing. It is in this context that the CARES financing provisions become particularly interesting.

The authors recognize that there are established underwriting guidelines for SBA loans. Moreover, the existing regulations (and revisions in process) will come into play as to availability of these loans. Accordingly, while there is no express prohibition for some of the loans referenced herein from being accessed in a Chapter 11 proceeding, a de facto prohibition likely comes from existing underwriting guidelines. If the overarching purpose of the CARES Act is to assist businesses in weathering the economic storm while the COVID 19 virus ravages the economy, the authors argue that such underwriting guidelines can, and must, be loosened in order to allow application of some of these programs in Chapter 11 proceedings so that they can be most effectively implemented to stabilize businesses, preserve jobs, continue to keep employees and businesses on the tax rolls, etc.

In this way the stimulus funds will be used where they can be most effectively deployed. If not, those funds will be the equivalent of the federal government sending rubber rafts to a drought stricken area—a sign that the government cares, perhaps, but of certainly no real use to address the problem at hand. The full article is available here.

Coronavirus Aid, Relief, and Economic Security Act Expands the Scope of the Small Business Reorganization Act

By Jessica Ljustina (Harvard Law School)

Jessica Ljustina

Congress passed the Small Business Reorganization Act of 2019 (“SBRA”) to streamline and reduce the cost of bankruptcy for small businesses; it went into effect on February 19, 2020.

As originally enacted, the Act allowed certain small businesses with no more than approximately $2.7 million of debt to file for bankruptcy under a new subchapter V of chapter 11 of the Bankruptcy Code.

The recently enacted Coronavirus Aid, Relief, and Economic Security (“CARES”) Act has temporarily increased the debt limit to $7.5 million for cases commenced in the next year. That may greatly expand the SBRA’s scope, as Professor Robert Lawless has estimated that over 50% of businesses that filed under chapter 11 between 2013 and 2017 had debt below $7.5 million.

The full article is available here.

The Italian Insolvency Law Reform

By Andrea Zorzi (University of Florence)

Andrea Zorzi

On January 12, 2019, a new ‘Code of enterprise crisis and of insolvency’ was adopted in Italy.

The qualifying aspect of the new law is its emphasis on early intervention. The early warning system is based on enhanced internal monitoring and a ‘duty to scream’ imposed on public creditors, if the company is delinquent on VAT or social security contributions. All business entities must set up adequate ‘organisational, management and accounting’ systems that allow early detection of a crisis and timely dealing with it. The law also creates a public office that should help debtors to find an agreement with creditors or induce them to file for a proper reorganisation procedure.

There are incentives for debtors and directors who tackle the crisis early (and for auditors who take the appropriate steps). On the other hand, undue delay is addressed in various ways. Among them, a new presumption regarding the quantification of damages in case of directors’ trading after the moment when the company is deemed dissolved, that will make it easier for trustees to hold directors liable.

The reform also brings in updates on international jurisdiction, now entirely based on centre of main interest (COMI) (however, there is no general cooperation obligation with regard to cross-border insolvency), and a comprehensive set of rules on group crisis (seemingly compliant with the UNCITRAL principles).

Finally, the law makes relevant changes regarding two of the three available restructuring instruments, while there is nothing new with regard to the very peculiar reading of the absolute priority rule (APR) according to Italian insolvency law.

The law broadens the scope of the cramming down on dissenting creditors (subject to a 75% supermajority in the relevant class) in out-of-court, but court-confirmed debt restructuring agreements: once restricted to financial creditors only, they are now available with respect to all creditors. The confirmation of the plan, which envisages only intra-class cram down, is possible irrespective of compliance with any priority rule (absolute or relative), with the only backstop of a ‘best-interest test’, now based on a comparison with a liquidation scenario. This makes the Italian ‘scheme of arrangement’ a very flexible and effective tool (confirmation rates are also very high, in practice).

Regarding judicial composition with creditors (concordato preventivo), the law confirms the controversial requirement (introduced in 2015) that a minimum 20% payment of unsecured creditors is ensured when a liquidation plan is proposed, and adds the requirement of some form of ‘external’ financial input. By contrast, there is no such a threshold when the business is due to continue under the plan: however, ‘business continuation’ is now defined more narrowly than in the past – it is such only if creditors are paid mainly out of proceeds of the ongoing business, rather than from asset sales, or, under a statutory definition, if the continued business employs at least one-half of the previous workforce. This requirement may exceedingly restrict access to reorganisation or transfer wealth from creditors to employees.

As mentioned, the APR conundrum – the matter is domain of case law – is not solved by the new law. While the discussion regarding APR among creditors is confined mainly to what constitutes ‘new value’ (thus evading the APR waterfall), APR still seems not to apply to equity holders, in case of business continuation.

Finally, the new law introduces very minor tweaks to ‘plain’ insolvent liquidation proceedings, solving some interpretive issues but without an innovative approach, and makes the ‘certified reorganisation plan’, an out-of-court restructuring framework, somewhat more stable in case things don’t work out and the debtor ends up insolvent.

Certain new measures are already in force, but the whole new Code will come into force on 15 August 2020. It should be noted that the new law fully applies – as the law it supersedes – only to enterprises with less than 200 employees. Enterprises exceeding that threshold are deemed ‘large’ and, while being able to access ordinary restructuring tools, if insolvent they are subject to ‘extraordinary administration’, a special going-concern liquidation regime that provides for broad discretion for governmental authorities and the pursuit of business continuity even at the expenses of creditors’ rights.

The paper offers a comprehensive review of the main features of the new law, setting it in the context of the current Italian insolvency law framework.

The full article is available here.

For previous Roundtable posts on Relative and Absolute Priority Default Rules in EU, see Jonathan Seymour and Steven L. Schwarcz, Corporate Restructuring under Relative and Absolute Priority Default Rules: A Comparative Assessment.

Do Bankruptcy Courts Have Constitutional Authority to Approve Nonconsensual, Third-Party Releases?

By Shmuel Vasser and Cara Kaplan (Dechert)

Shmuel Vasser
Cara Kaplan

The Third Circuit, applying the Supreme Court’s decision in Stern v. Marshall, recently held that the Bankruptcy Court has the authority to confirm a chapter 11 plan containing nonconsensual, third-party releases when such releases are integral to the debtor’s successful reorganization.

In Stern, the Supreme Court examined the scope of the bankruptcy court’s constitutional authority and found, among other things, that the bankruptcy court can resolve a matter that is integral to the restructuring of the debtor-creditor relationship.  Analyzing Stern, the Third Circuit in In re Millennium held that the Bankruptcy Court could confirm a plan that included non-consensual, third party releases because the releases were the result of “highly adversarial” and “extremely complicated” negotiations and without the releases, the debtor would not have been able to successfully reorganize.

The full article is available here.

Updated Overview of the Jevic Files: How Courts Are Interpreting and Applying the Supreme Court’s Ruling on Structured Dismissals and Priority Skipping

By Shane G. Ramsey and John T. Baxter (Nelson Mullins)

Shane G. Ramsey
John T. Baxter

The U.S. Supreme Court in Czyzewski v. Jevic Holding Corp., 137 S.Ct. 973 (2017), addressed the issue of chapter 11 debtors using structured dismissals to end-run the statutory priority rules. The Court’s ruling preserved the priority system, holding that the bankruptcy court could not approve a structured dismissal of a chapter 11 case that provided for distributions that failed to follow the standard priority rules unless the affected creditors consented to such treatment. Although the Bankruptcy Code does not expressly apply its priority distribution scheme to a structured dismissal, the Court clarified that courts should do so.

As a way to track how bankruptcy courts across the country are applying the ruling in Jevic, the Nelson Mullins Bankruptcy Protector has introduced a new periodic series: the Jevic Files. As of December 31, 2019, the Jevic Files has collected and summarized twenty-one cases across nineteen jurisdictions. While the majority of the cases involved structured dismissals in the context of a chapter 11 case, courts have also applied the ruling in Jevic to the dismissal of chapter 13 plans; the priority of trustee payments in a chapter 7 case; and even a state court foreclosure hearing that came on the heels of a dismissed chapter 11 case. As Jevic continues to be interpreted and applied in bankruptcy (and other) courts throughout the country, we will continue to keep an updated summary of cases through the Jevic Files.

The article is available here.

Inequitable Subordination: Distressing Distressed Claims Purchasers by Propagating Subordination Benefit Elimination Theory

By Jay Rao (University of California, Berkeley, School of Law)

Jay Rao

This Article examines the application of equitable subordination under Title 11 of the United States Code to bankruptcy claims purchasing transactions that transpire after the occurrence of inequitable conduct by a third party. Although a significant issue with practical consequences, it has drawn relatively scant commentary. To the author’s knowledge, no scholarship to date has attempted to comprehensively discuss the issue or describe the indirect cleansing and washing of tainted claims resulting therefrom. While analyzing and criticizing the current state of the law, this Article introduces the concepts of the “subordination benefit,” “subordination benefit elimination theory,” and “limited subordination benefit theory” to facilitate and further conversations related to the intersection of equitable subordination and bankruptcy claims trading.

This Article primarily aims to promote an active, fluid bankruptcy claims trading market to, on an ex post basis, benefit creditors and, on an ex ante basis, reduce the cost, and induce the extension, of credit in the primary capital markets, thereby supporting the broader economy. Additionally, this Article seeks to reduce indirect cleansing of tainted claims and indirect claims washing through the bankruptcy claims market.

The subject matter is particularly timely and relevant, given the recent publication of the Final Report and Recommendations of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11, the significant growth of the claims trading market and increasing activity and sophistication of distressed investors, and the recent formation of the American Bankruptcy Institute’s Claims Trading Committee.

This Article argues that subordination benefit elimination theory, which represents the dominant theory propagated by courts and commentators, finds support in a misguided reading of caselaw and conflicts with sound economic policy and logic. Further, while acknowledging limited subordination benefit theory is a superior approach to subordination benefit elimination theory, this Article argues that limited subordination benefit theory also runs contrary to sound economic policy and logic. This Article requests commentators and courts halt and reverse the propagation of subordination benefit elimination theory and avoid disseminating limited subordination benefit theory. Instead, this Article proposes post-misconduct discounted claims purchasers be entitled to participate in the subordination benefit to the same extent as pre-misconduct claimholders.

If commentators and courts are unready to abandon both theories and if required to make a suboptimal binary choice, this Article suggests limited subordination benefit theory be propagated and utilized in lieu of subordination benefit elimination theory.

The full article is available here.

China Continues to Issue New Rules Promoting Corporate Rescue Culture, Facilitation of Bankruptcy Proceedings

By Xiao Ma (Reorg | Harvard Law School)

Xiao Ma

Coupled with continued efforts in financial deleveraging and industrial reorganization, China delivered a number of changes to its bankruptcy law in 2019 in an effort to further accommodate smooth market exits for non-profitable businesses and to provide greater opportunities for viable businesses that experience temporary liquidity issues to be restructured as going concerns.

Currently, a lack of detailed rules and practical solutions to issues arising out of bankruptcies often deters parties from initiating such proceedings in China. The new rules will provide further clarification on extensively litigated/disputed issues and enhance transparency and consistency in the bankruptcy courts’ handling of cases. The developments encourage more usage of restructuring and compromise proceedings to find market solutions to address insolvency of Chinese companies.

“China’s bankruptcy laws and practices will be more and more market-driven,” said Xu Shengfeng, a Shenzhen-based bankruptcy and restructuring partner of Zhong Lun Law Firm, notwithstanding perceptions among foreign investors that “China’s bankruptcy regime is rather bureaucratic and administrative, with a certain level of involvement by local governments.”

“The goal is to build an institution in which the government’s role can be minimized, until its complete exit,” Xu said. “It cannot be done within a year or two, but this is certainly where things are headed.”

Market players, in particular financial institutions and asset management companies, are becoming more active and playing a greater role in leading restructuring and compromise proceedings. “Right now, many of the restructuring cases need capital injection from outside investors, and it is a great time for asset management companies,” Xu said. The recent U.S.-China Trade Deal promises to open doors for U.S. firms to obtain asset management licenses to acquire Chinese NPLs – see Article 4.5 of the US-China Economic and Trade Agreement.

Key changes to China’s restructuring regime in 2019 included:

  • establishment of specialized bankruptcy courts in Beijing, Shanghai, Shenzhen, Tianjin, Guangzhou, Wenzhou and Hangzhou;
  • Supreme People’s Court’s Judicial Interpretation III on the Enterprise Bankruptcy Law (EBL);
  • joint announcement of the Plan for Accelerating Improvement of the System for Market Entity Exits by 13 major state departments;
  • further establishment of regional bankruptcy administrator associations, including those in Beijing and Shanghai;
  • comment solicitation and final issuance of the Minutes of Conference on National Courts’ Civil and Commercial Trial Work, which devoted a section specifically for amendment of bankruptcy rules and restructuring regimes; and
  • launch of National Enterprise Bankruptcy Information Disclosure Platform, a platform for the public to access information related to bankruptcy cases and facilitate bankruptcy proceedings in terms of claim registration, notices for creditors’ meeting, publication of announcements, etc.

“It was definitely a year of highlights,” said Xu. “The professionalism of bankruptcy trial teams, the establishment of online bankruptcy information disclosure platform, the promotion of pre-packaged restructurings and so on. The Supreme People’s Court is also making headways in the areas of personal bankruptcy and cross-border bankruptcy.”

The full article is available here.

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