The Problem With Preferences
By Daniel J. Bussel, UCLA School of Law
Brook Gotberg in Conflicting Preferences does a great service in lucidly identifying the problem with preference law as currently configured. But she errs in diagnosing the cause and prescribing the treatment. As to cause, preference law is not and should not be a single-minded pursuit of equality of distribution without consideration of complementary, and even countervailing policies. To the contrary, the recent arc of preference law is strongly driven by refocusing on culpable opt-out behavior, and the goal of ratable distribution has been sharply subordinated to other objectives.
Repealing preference law in Chapter 11 would be counterproductive. Blanket repeal of preference law in Chapter 11, while simultaneously enhancing preference recovery in Chapter 7, insulates, indeed rewards, affirmative pre-bankruptcy opt-out behavior by insiders and creditors with superior knowledge or leverage, while undermining the reorganization objectives of Chapter 11. It will encourage, and in some instances require, liquidations that would not otherwise be necessary or desirable. Raising (not abandoning) the floor on preference recovery, bolstering (not eliminating) trade creditors’ ordinary course and new value defenses, and limiting or eliminating the safe harbors for financial contracts, all without discriminating between Code chapters, would reduce arbitrariness and unfairness in preference law. These more modest reforms would enable preference law to continue to police the most extreme forms of opt-out behavior, while fostering reorganizations where such reorganizations remain viable and desirable notwithstanding eve-of-bankruptcy opt-out actions by creditors and insiders.
For the full article see The Problem With Preferences, 100 Iowa L. Rev. Bull. 11, available here.
Conflicting Preferences: Avoiding Proceedings in Bankruptcy Liquidation and Reorganization
By Brook Gotberg, J. Reuben Clark Law School, Brigham Young University
The law of preferential transfers permits the trustee of a bankruptcy estate to avoid transfers made by the debtor to a creditor on account of a prior debt in the 90 days leading up to the bankruptcy proceeding. The standard for avoiding these preferential transfers is one of strict liability, on the rationale that preference actions exist to ensure that all general creditors of the bankruptcy estate recover the same proportional amount, regardless of the debtor’s intent to favor any one creditor or the creditor’s intent to be so favored. But preference law also permits certain exceptions to strict preference liability and gives the estate trustee discretion in pursuing preference actions. This undermines the policy of equal distribution by permitting some creditors to fare better than others in the bankruptcy distribution. However, these practices are arguably necessary to promote the conflicting bankruptcy policies that seek to maximize the value of the estate for the benefit of creditors and also encourage the survival of struggling businesses.
As a result, the law of preferences is internally inconsistent and controversial, attempting unsuccessfully to serve multiple policy masters simultaneously. Much of the analysis on preferences up to now has proposed amending preference law generally in an attempt to satisfy these often conflicting demands. This article recommends a more dramatic approach; returning preference law to a mechanism of equal distribution in liquidation proceedings (Chapter 7) by eliminating true exceptions to the rule, and doing away with preference law in the context of bankruptcy reorganization (Chapter 11).
For the full article see here.
Next week we will be featuring another article on this topic, Professor Daniel J. Bussel’s The Problem with Preferences.
Statutory Erosion of Secured Creditors’ Rights: Some Insights from the United Kingdom
By Adrian Walters, IIT Chicago-Kent School of Law
The prevailing wisdom is that Chapter 11 bankruptcy proceedings have been captured by secured creditors with the consequence that many Chapter 11s are little more than glorified nationwide federal foreclosures through which secured creditors exit by means of a section 363 sale. Some scholars worry that secured creditor capture of Chapter 11 leads to asset deployment decisions that do not produce welfare-maximizing outcomes for creditors as a whole.
In an article forthcoming in the 2015 University of Illinois Law Review, I do not question this prevailing wisdom. Instead, I seek to argue, by reference to experience in the United Kingdom, that if we are serious about curbing secured creditors’ control of bankruptcy proceedings through bankruptcy law reform, we have to acknowledge and understand the ways in which secured creditors respond to reforms that are adverse to their interests.
The article identifies four ways in which lenders may be expected to adjust to “adverse” bankruptcy reform: (i) meta bargaining; (ii) adjustments to pre-bankruptcy behaviour; (iii) transactional innovation; and (iv) shape shifting. The article then illustrates how lenders in England and Wales have successfully adjusted to sustained statutory attempts to undermine their bankruptcy priority by carving value out of their collateral, and to erode their control rights by abolishing their right to appoint an administrative receiver over floating charge collateral.
Click here to read more.
Indenture Trustees in Out-of-Court Restructuring Transactions: Proceed with Caution
By Howard Seife and Marian Baldwin Fuerst of Chadbourne & Parke LLP
The recent decision of the United States District Court for the Southern District of New York (the “S.D.N.Y.”) concerning the restructuring efforts of Caesars Entertainment Operating Company, Inc. (“OpCo”), the large United States casino operator which is currently in bankruptcy, should be on all indenture trustees’ radars. See MeehanCombs Global Opportunity Funds, LP v. Caesars Entertainment Corp., 14- cv-7091, 2015 WL 221055 (S.D.N.Y. Jan. 15, 2015). The case arises from an August 2014 transaction, in which OpCo restructured certain of its unsecured obligations resulting in the elimination of guarantees by OpCo’s parent, Caesars Entertainment Corporation (the “Parent,” together with OpCo, “Caesars”). Caesars moved to dismiss a lawsuit brought forth by certain OpCo unsecured noteholders. After heavily scrutinizing the August 2014 transaction, US District Court Judge Scheindlin held that the noteholders could proceed with a majority of their claims for breaches of the Trust Indenture Act of 1939, as amended (the “TIA”), and state law. The court’s decision, entered right on the heels of a December S.D.N.Y. decision addressing a similar situation, establishes a clear precedent that out-of-court restructurings eliminating parent guarantees are disfavored in this influential District. The decision cautions indenture trustees to closely review any changes to core terms even when acting under the direction of noteholders.
To read more, click here.
For two related pieces discussing the Trust Indenture Act, see here and here.
Corporate Bankruptcy Tourists
By Oscar Couwenberg & Stephen J. Lubben
Insolvency procedures are not designed for corporate group, but for individual debtor corporations. This becomes an especially important issue when corporations have international operations.
When such a corporate group becomes financially distressed, then different national insolvency procedures will claim jurisdiction over assets and debts of the corporation, the consequence of which is an uncoordinated wealth-destroying piecemeal sale of assets. The obvious solution is to look for a single forum that can address an entire firm’s financial distress.
In this paper we argue that chapter 11 of the United States Bankruptcy Code, and to a lesser extent also the UK scheme of arrangement under the Companies Act 2006, can be considered such bankruptcy havens for corporate bankruptcy tourists.
We construct a database of foreign debtors initiating a chapter 11 case over the period 2005 to 2012. In total our dataset includes 316 corporate debtors, organized in 49 corporate groups.
What we find is that corporations with mobile assets, with subsidiaries in many jurisdictions, or both, are the most frequent tourists in chapter 11. We further discuss why chapter 11 and its competitor in the UK render a trans-national insolvency system superfluous. We expect these two jurisdictions to see increasing amounts of “tourist” activity as Europe moves from its traditional reliance on bank financing to more frequent use of North American style high yield bond markets.
The full version of this article is available here.
The New Corporate Web: Tailored Entity Partitions and Creditors’ Selective Enforcement
By Anthony J. Casey, University of Chicago Law School
Firms often separate assets into distinct entities that have their own legal identity but are commonly owned and together form a large corporate group. While the law-and-economics literature has viewed these legal partitions as either all or nothing, firms have developed sophisticated legal mechanisms to create precisely tailored partitions. The result is a complex corporate web of interconnected legal affiliates.
For example, an asset that is placed in one legal entity may serve as collateral guaranteeing the debts of another legal entity within the corporate group. The assets of the two entities are separate for some purposes but integrated for others. Conventional theories of corporate groups cannot explain the tailored partitions in this corporate web. This article develops a new theory of selective enforcement to fill that gap.
When a debtor defaults on a loan, that default may signal a failure across the entire firm or it may signal a project-specific failure. Tailored partitions provide monitoring creditors with a valuable option to choose between project-specific and firm-wide enforcement depending on the information signal provided. Thus, firm-wide risks and failures can be addressed globally while the effects of project-specific risks and failures can be locally contained when necessary.
These concepts of selective enforcement and tailored partitions reveal important implications for theory and practice. They provide a cohesive justification for the web of entity partitioning and cross liabilities that characterize much of corporate structure today and inform the analysis of holding-company equity guarantees, fraudulent transfers, and ipso facto clauses.
The full version of this article is available here.
From Chrysler and General Motors to Detroit
By David A. Skeel, Jr., University of Pennsylvania Law School
In the past five years, three of the most remarkable bankruptcy cases in American history have come out of Detroit: the bankruptcies of Chrysler and General Motors in 2009, and of Detroit itself in 2013. The principal objective of this Article is simply to show that the Grand Bargain at the heart of the Detroit bankruptcy is the direct offspring of the bankruptcy sale transactions that were used to restructure Chrysler and GM. The proponents of Detroit’s “Grand Bargain” never would have dreamed up the transaction were it not for the federal government-engineered carmaker bankruptcies. The Article’s second objective, based the comparison of the Detroit cases, is to make a very brief case for reform of bankruptcy sales.
Part I of the Article briefly surveys the increased use of bankruptcy sales and related shifts in Chapter 11 practice over the past several decades. Part II describes the Chrysler and General Motors bankruptcies, which built on but radically expanded the scope of a bankruptcy sale. Part III turns to the Detroit bankruptcy, focusing primarily on the “Grand Bargain,” while also exploring the city’s use of another recent bankruptcy strategy, known as “gifting.” The Article concludes, in a brief final part, that the Detroit cases have pushed recent bankruptcy innovations to their logical extremes — and beyond — exposing the need to update the oversight of bankruptcy sales.
The full version of this article is available here.
Overview of ABI Commission Report and Recommendation on the Reform of Chapter 11 of the Bankruptcy Code
By Jay M. Goffman, George N. Panagakis, Ken Ziman, Van C. Durrer II, John K. Lyons, Mark A. McDermott, and David M. Turetsky of Skadden, Arps Slate, Meagher & Flom LLP
The American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 recently released its Final Report recommending comprehensive reforms to Chapter 11 of the Bankruptcy Code. The report is the culmination of a three-year effort by over 200 restructuring professionals to evaluate Chapter 11 in light of the changing environment in which financially distressed companies operate. The Report is approximately 400 pages long. Skadden, Arps has prepared a comprehensive overview of the Report that condenses the salient points into a 30-page summary which can be found here. Selected recommendations for reform include:
- DIP financing orders cannot impose milestones requiring the debtor to perform material tasks within the first 60 days (e.g., conduct a sale or file a plan).
- No 363 sales of all or substantially all assets (“363x sales”) within the first 60 days unless the debtor demonstrates a high likelihood that the value of the debtor’s assets will decrease significantly.
- 363 sales must satisfy requirements similar to plan confirmation requirements.
- Junior, out-of-the-money stakeholders may be entitled to receive an allocation of value from senior creditors to reflect a possible upswing in the reorganized debtor’s value.
- The cost of capital for similar debt issued to companies comparable to the debtor as a reorganized entity should be used when determining the appropriate discount rate for purposes of cram down.
- Eliminating the requirement of at least one impaired accepting class of creditors for plan confirmation.
- No appointment of an unsecured creditors’ committee if general unsecured creditors do not need representation in the case (e.g., if their claims are out-of-the-money).
The Weakest Link in Intercreditor Agreements Breaks Again in Momentive
By Lawrence Safran, Mitchell A. Seider, Keith A. Simon, and Adam J. Goldberg of Latham & Watkins LLP
Intercreditor agreements among secured creditors with respect to common collateral are often limited to lien subordination, as opposed to claim subordination. The agreement governs each secured creditor’s rights over the common collateral, without imposing claim subordination, which would require junior creditors to subordinate their claims and turn over all of their recoveries, whether or not derived from proceeds of collateral. Intercreditor agreements that provide only for lien subordination typically include a reservation of rights for junior creditors to retain all of their rights as unsecured creditors; however, the formulation of this reservation varies from agreement to agreement, and the exact language used can be critical in a court’s analysis.
The recent decision in In re MPM Silicones, LLC, Case No. 14-22503 (RDD) (Bankr. S.D.N.Y. Sept. 30, 2014) (Momentive) reflects the emerging trend of courts to narrowly interpret restrictions on junior creditors in these intercreditor agreements, where the restrictions are ancillary to the distribution of the common collateral’s value. In Momentive, the Bankruptcy Court found that the general reservation of rights as unsecured creditors serves to “ameliorate obligations that [junior secured creditors have] undertaken elsewhere in the agreement.”
This article explores recent case law arising from disputes over intercreditor agreements before bankruptcy courts, the issues and rulings in Momentive, and lessons that market participants should draw from the decision.
To read more, click here.
Bankruptcy Court Approves Non-Market Cramdown Rate on Momentive Secured Creditors
By Adam C. Harris and Karen S. Park of Schulte Roth & Zabel LLP
A recent decision from the Bankruptcy Court for the Southern District of New York provides guidance on the “fair and equitable” requirement as it relates to secured creditors in a so-called “cramdown plan.” Section 1129(b) of the Bankruptcy Code provides the means by which a Chapter 11 debtor may obtain confirmation of a plan of reorganization over the objection of a dissenting class of creditors, including secured creditors. To cram down a plan on a class of secured creditors, the plan must be “fair and equitable” to that class. One way to meet the “fair and equitable” requirement is to provide that the secured creditors retain their liens and receive deferred cash payments having a present value equal to the allowed amount of their secured claims.
In In re MPM Silcones LLC, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014), the Bankruptcy Court held that the interest rates on secured claims in a “fair and equitable plan” should be derived using a formula that starts with a “risk free” Treasury rate for similar duration instruments, and adds a risk premium generally in the range of 1%-3%. Importantly, the Bankruptcy Court rejected the objecting secured credtiors’ arguments that the interest rates should be based on the market, i.e., the rates that would be charged to the same debtor entity for a loan having the same terms and duration by a third party lender.
The Bankruptcy Court’s ruling has been appealed. If upheld, the decision could have far-reaching implications for distressed debt investors as well as on the availability and pricing of capital for borrowers.
Please find a full-length version of the article here.