By Lydia Tsioli (King’s College London)
Despite being pivotal in corporate debt restructuring, viability, an intricate notion with double meaning and double role, has not been systematically examined in Europe. Against this background, and especially given that the new European directive on restructuring and insolvency (the “Directive”) is currently under transposition and restructuring law is making its first steps as a harmonized field across Europe, my recent paper, published in Norton Journal of Bankruptcy Law and Practice, undertakes a doctrinal, comparative [USA, UK] and economic analysis of law examination of viability with the aim of putting forward suggestions that will make viability the linchpin of the Directive, thus optimizing its filtration effect as defined below.
In doing so, the paper first analyses and distinguishes the two different meanings of viability, namely financial viability and economic viability, and clarifies what the precise role of law is within the viability-related discourse. Such role consists in providing indicators of viability and incorporating appropriate “filtering mechanisms”, a term of art introduced by the paper, which refers to mechanisms filtering non-viable debtors out of the restructuring procedure, hence contributing towards satisfaction of restructuring’s overall goal of saving viable debtors only.
The way in which such filtering mechanisms are triggered depends on who plays the role of the “ultimate viability assessor” within a restructuring framework, for example an Insolvency Practitioner (“IP”) or a court. Depending on this, the paper distinguishes between IP-centered and Non-IP – centered models of viability assessment and identifies the Directive as standing closer to the Non-IP – centered one.
What the paper suggests though, is that, what ultimately matters is the appropriateness of filtering mechanisms in any chosen model of viability assessment. Such mechanisms can be most characteristically found under Chapter 11, Title 11 of US Bankruptcy Code and are the conversion/dismissal of a Chapter 11 case and stay relief under section 362. The paper examines them extensively and demonstrates how the existence or inexistence of viability in its double meaning, constitutes the “litmus test” for the triggering of Chapter 11’s filtering mechanisms.
In light of these comparative findings, the paper finally turns to the European directive and identifies its filtering mechanisms. The paper subsequently, and most importantly, makes suggestions on how the filtration effect of the Directive’s existing mechanisms can be optimized through appropriate interpretation, transposition, judicial practice or future reform. Through these suggestions, it is aspired that first, the Directive will properly reflect the notion of viability and consequently achieve an effective filtering of viable debtors from non-viable ones, and second, viability will ultimately become the primary point of focus and linchpin of European corporate debt restructuring overall.
The paper, entitled “Viability Assessment in Corporate Debt Restructuring: Optimizing the Filtration Effect of the European Directive on Restructuring and Insolvency” is available here.
Reprinted from Norton Journal of Bankruptcy Law and Practice, Vol. 30 No. 5 (October 2021), with permission of Thomson Reuters. Copyright © 2021. Further use without the permission of Thomson Reuters is prohibited. For further information about this publication, please visit https://legal.thomsonreuters.com/en/products/law-books or call 800.328.9352.
The paper has been awarded the 2021 Silver Medal in the International Insolvency Institute’s “Prize in International Insolvency Studies”.
By Daniel J. Bussel (Professor of Law, UCLA School of Law)
Neither the “American Rule” (each party pays its own attorney) nor the “English Rule” (loser pays both parties’ attorneys) is the baseline principle in insolvency cases. Most major parties do not bear their own attorney’s fees, win or lose. Fee-shifting is pervasive; the bankruptcy court is directly involved in reviewing the fees; sometimes it’s almost impossible to figure who actually foots the bills. This is true in US courts, which still generally purport to follow the “American Rule,” and courts in the UK, which generally purport to follow the “English Rule.” In both countries, theory notwithstanding, equitable principles, born in England’s ancient chancery courts, permit discretionary fee-shifting in light of the collective nature of insolvency proceedings.
Unfortunately, some US courts, including the Supreme Court, disregarding this history and practice, anomalously cling to the American Rule, creating perverse incentives that disrupt the efficient functioning of the reorganization process. Two leading examples are the Supreme Court’s decisions in Baker & Botts and Midland Funding, both critiqued in my paper, Fee-Shifting in Bankruptcy. In Baker & Botts, the American Rule denies full compensation to the prevailing debtor’s attorney from any source, disincentivizing the pursuit of meritorious estate claims. In Midland Funding, the American Rule rewards strategic manipulation by the holder of meritless claims, disincentivizing clearly valid objections.
Abandoning the American Rule and authorizing a discretionary version of the English Rule as the default rule in bankruptcy for recovery of attorney’s fees is no radical step. Empirical work is limited, but supports the conclusion that shifting from the American Rule to a discretionary version of the English Rule will have only a modest impact. In bankruptcy cases, an enormous amount of explicit and implicit fee shifting already occurs. The bankruptcy courts have a well-developed set of procedures for regulating and allowing reasonable attorney’s fees. They are well-positioned to exercise discretion in awarding attorney’s fees to control bullying and holdout tactics calculated to confer leverage by pressing weak claims and imposing costs on others.
Several factors can appropriately guide court discretion to award fees in insolvency cases, including:
- Whether the prevailing party or its adversary has a right to recover fees in nonbankruptcy litigation over the same issues.
- Whether the bankruptcy code expressly contemplates recovery of fees as a component of damages.
- The amount of fees and whether the stakes justify them.
- The strength of the prevailing party’s merits case.
- Whether the nonprevailing party played the part of bully, holdout, or squeaky wheel.
- Whether a systemic asymmetry exists between the parties allowing one party to implicitly shift fees whether it prevails or not and regardless of the court’s fee award.
- Whether the prevailing party’s success in litigation will economically benefit others similarly situated or creditors generally.
- Whether a fee award will advance the public interest in equitable administration of bankruptcy cases.
- The extent to which a given fee award may be so onerous to the non-prevailing party that it would unreasonably deter access to the courts.
- Vexatious and unreasonable conduct by either (or both) of the litigants.
- The extent to which the prevailing party incurred fees for considerations apart from the case at bar because of its status as a repeat player.
- The extent to which the party seeking recovery of fees practically prevailed in the litigation.
- Whether the prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity.
- Whether the non-prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity.
- Assessing the practical economic incidence of fees initially borne by the estate.
The UK, starting from the English Rule, has created a discretionary fee-shifting regime in insolvency cases resembling the discretionary approach advocated here. The English cases exhibit a continuing push-pull among (i) the desire to socialize costs of reorganizations that benefit third parties; (ii) concern about unduly discouraging participation by all affected constituents; and (iii) the problems posed by hold-outs, bullies and excessive litigiousness. See Matter of Virgin Active Holdings Ltd (Snowden, J.). The realities of insolvency practice are impelling both the English and American systems towards court-supervised discretionary fee-shifting.
The damage done by the American Rule is limited by how pervasive fee-shifting already is in bankruptcy. Fully embracing discretionary fee-shifting in favor of prevailing parties, however, is low-hanging fruit we can promptly gather in to facilitate sound administration of insolvent estates.
The full paper is available here.
By Robert K. Rasmussen (USC Gould School of Law)
The COVID pandemic put unprecedented pressure on all economies around the world. Many predicted that this economic dislocation would lead to an unprecedented number of corporate bankruptcies. This did not happen. The American government and other governments responded with extraordinary measures. While these measures allowed companies to ride out the worst of the pandemic, they did have consequences. Many large companies were left with unprecedentedly large amounts of debt on their balance sheets.
Perhaps a robust economy will allow companies to grow their way out from under their debt burden. But perhaps not. To prepare for the possible future increase in large companies filing for bankruptcy, Congress should act now to build up a bankruptcy infrastructure sufficient to handle an influx in cases. Specifically, Congress should require that every circuit create a “business bankruptcy panel” designed to administer the Chapter 11 filing of large companies. As is well-known, three bankruptcy districts currently serve as dominant venues for large cases – the District of Delaware, the Southern District of New York and the Southern District of Texas. It is by no means clear that these three courts could handle a significant increase in caseloads. Creating expertise across the country would help prepare the system for any future rise in cases. A secondary benefit of this reform is that it may also ameliorate some of the concerns that have been raised over the years by the dominance of a small number of venues for large corporate cases.
The full article is available here.
By Andrew Dietderich (Sullivan & Cromwell LLP)
Part II of Andrew Dietderich’s treatment of the practical side of forum shopping addresses the use of Chapter 11 by non-U.S. corporations with only limited U.S. contacts. The logic of international bankruptcy law – as reflected in Chapter 15 of the U.S. Bankruptcy Code and the UNCITRAL Model Law – suggests that these types of Chapter 11 filings should not happen. Instead of filing for Chapter 11, non-U.S. companies should file for plenary proceedings only in their home country, i.e., where they are headquartered or otherwise have their “center of main interest.” The role of U.S. courts should be limited to recognition and assistance of the home country proceeding under Chapter 15.
The article explains why these Chapter 11 cases happen and why “forum shopping” against the grain of international insolvency conventions is necessary for certain types of cross-border cases. Chapter 11 is sometimes the best (or the only) way to reorganize companies headquartered outside of the U.S., and U.S. courts have been uniquely effective at supervising these reorganizations in a manner fair to all stakeholders.
The article also suggests that the U.S. has a national interest in making its bankruptcy courts available for these types of cases, that principles of international comity are as active in Chapter 11 as they are in Chapter 15, and that non-U.S. stakeholders have nothing to fear from this application of Chapter 11 in the coming years. Part II appears in the October issue of the ABI Journal, available here.
By Andrew Dietderich (Sullivan & Cromwell LLP)
Corporate debtors can decide if, when and how to file for chapter 11. Recently, there is a great deal of concern about their ability to decide where. In a series of two articles for the ABI Journal, I explain as debtor’s counsel the practice of responsible forum shopping and argues that it is, on balance, a social good.
Motivated by recently introduced legislation that would force domestic debtors to file chapter 11 only in the jurisdiction of their headquarters, Part I warns that mandating a single venue for a corporate debtor will impede legitimate restructurings and hurt companies and workers. There are important reasons why a distressed domestic corporation may need to file away from its headquarters: examples from my own experience include the need to preserve critical corporate contractual assets and to protect rank-and-file employee severance.
Since U.S. bankruptcy law necessarily varies from place to place around the country, someone has to decide what particular version of bankruptcy law should apply to each case given its unique factual context and reorganization purpose. As with many other chapter 11 decisions, the board of directors of the debtor is the least worst alternative.
Of course, there are some legitimate concerns with the current system of modified venue choice. But the venue reform legislation proposed in Congress is too blunt of an instrument. It is uninformed by experience in the trenches reorganizing distressed business and, if passed, would hurt some of the people it aims to help. Part I appears in the September issue of the ABI Journal, available here.
Part II of the series addresses international forum shopping—specifically the use of chapter 11 by non-U.S. debtors with minimal U.S. contracts—appears in the October issue of the ABI Journal.
By Paul, Weiss
On June 28, 2021, in the chapter 11 cases of Paragon Offshore plc and certain of its affiliates (“Paragon” or the “Debtors”), the United States Bankruptcy Court for the District of Delaware denied the U.S. Trustee’s motion to compel payment of $250,000 in statutory fees assessed against litigation trust distributions. In its opinion, the Bankruptcy Court concluded that the U.S. Trustee had already collected all statutory fees due: first, when Paragon transferred its litigation claims to the litigation trust (the “Trust”) under its plan, and second, when the defendant in the Trust litigation, itself a chapter 11 debtor, later paid statutory fees in its own chapter 11 case based on, among other things, the cash settlement payment it made to the Trust. Finding the U.S. Trustee’s “attempt to double, or triple collect” the statutory fees “offensive,” the Bankruptcy Court held that the Trust’s payments of settlement proceeds to its beneficiaries were not “disbursements” made by or on behalf of the Debtors within the meaning of the U.S. Trustee fee statute, and as a result, that no such fees were payable.
Read the full article here.
By Casey Watters (Bond University) and Wai Yee Wan (City University of Hong Kong)
Creditors often face significant information asymmetry when debtor companies seek to restructure their debts. In the United Kingdom, it is mandatory for debtor companies seeking to invoke a court’s jurisdiction to restructure their debts via schemes of arrangement (schemes) to disclose material information in the explanatory statement. This information enables creditors to make an informed decision as to how to exercise their votes in creditors’ meetings.
English schemes have been transplanted into common law jurisdictions in Asia, including Hong Kong and Singapore. However, due to the differences in the shareholding structures and the kinds of debts prevalent in restructurings in the UK as compared to those in Hong Kong and Singapore, this transplantation gives rise to the question of whether the English-based scheme process adequately addresses information asymmetry in the local context. Drawing from the experiences of Hong Kong and Singapore, our paper, supported by the Research Grants Council of the Hong Kong SAR, argues that there are three principal concerns in the current disclosure regimes: how debtors disclose the liquidation analysis or alternative to restructuring via schemes; how debtors disclose advisors’ fees; and the equality of provision of information in the scheme process.
The key objective of mandatory disclosure for schemes parallels the objective of disclosure requirements for shareholder meetings under English corporate and securities laws: reducing information asymmetry faced by the shareholders. Failure to make adequate disclosures to creditors can lead courts to refuse to approve the scheme. Mandatory information disclosure in the course of securing a vote on the restructuring plan also features prominently in Article 8 of the EU Directive on Preventive Restructuring Frameworks 2019/1023.
However, there are specific risks in Hong Kong and Singapore that are either not present in the UK or not present to the same extent under traditional English schemes. First, shareholdings in listed companies in Hong Kong and Singapore are generally much more concentrated than in the UK. As a result, management’s interests are aligned with the controlling shareholders even when the company is “out of money.” In addition, schemes resolve all debts in Hong King and Singapore, rather than financial debts alone, as in the UK. Finally, retail investors have a significantly higher presence in debt instruments falling under the court’s jurisdiction. These different circumstances raise the question of whether the current disclosure regime sufficiently addresses risks arising from information asymmetry and provides the right incentives for debtors to disclose relevant and high-quality information for the creditors to make an informed decision when voting.
While Hong Kong’s scheme framework has largely remained unchanged since its enactment, Singapore has amended its scheme framework to include several debtor-in-possession features of Chapter 11 of the US Bankruptcy Code (Chapter 11), such as the availability of super-priority, cross-class cramdowns, and pre-packs. However, Singapore’s disclosure requirements continue to be largely based on English case law.
Drawing from the US approach towards disclosure in Chapter 11, we argue that disclosure of sufficient information on the company’s valuation should be a central focus of the explanatory statement and that the restructuring support agreement (RSA) should be carefully reviewed. We also argue for an ex ante approach to disclosure statements under schemes of arrangement at the stage in which the court decides rather to grant permission to convene the scheme meetings. As both Hong Kong and Singapore have sophisticated and experienced judiciaries, earlier involvement of the courts may provide greater confidence in the process for investors by compelling the disclosure of key financial information.
In our analysis of the practice of schemes, we reviewed approved schemes involving listed companies in Hong Kong and Singapore for the five-year period covering 2015-2019. We obtained information on disclosures from announcements made by listed companies, explanatory statements from publicly available sources, stock exchange websites, and information agents for bond documentation. Where possible, we compare the disclosures to creditors with the separate disclosures to shareholders published in shareholder circulars. We conclude that the disclosure requirements under the traditional English scheme model are insufficient to adequately address risks to investors and creditors in Hong Kong and Singapore. In order to provide investors with greater confidence in the scheme process, additional disclosure in the explanatory statement regarding the value of the company, and ex ante review of explanatory statements and RSAs are needed.
The full paper can be accessed here.
A version of this post first appeared on the Oxford Business Law Blog.
By Jared Mayer (Law Clerk, Supreme Court of New Jersey)
The Bankruptcy Code constrains bankruptcy courts’ equitable powers, yet bankruptcy courts have often used those powers in ways that go beyond the Code’s text. This conflict creates tensions between various bankruptcy goals. The Code provides ex ante certainty and contains substantive policy choices, which equity threatens to compromise by allowing bankruptcy judges to override the text. Without equity, however, bankruptcy proceedings would provide parties with occasions to gain positional advantages in bankruptcy, thereby allowing them to unilaterally capture value at those other parties’ expense.
Drawing on insights from equity theory, this Essay identifies a role that equity can play to balance these interests. This Essay proposes an “equity canon” for bankruptcy courts to use when interpreting the Bankruptcy Code: judges should interpret unclear provisions by disregarding interpretations that would lead to inequitable outcomes. Equity theorists have illuminated equity’s role in combating opportunistic evasions of the law that cannot be identified and prevented ex ante. This is particularly important in bankruptcy. While bankruptcy proceedings are designed to maximize the estate’s value, parties nonetheless have incentives to capture value for themselves. Bankruptcy courts can use the equity canon to combat parties’ opportunistic exploitation of the Code while respecting the Code’s primacy.
The full Essay is available here.
Nothing herein reflects the views of the Supreme Court of New Jersey or the New Jersey Judiciary.
By Jassmine Girgis (University of Calgary, Faculty of Law)
This chapter explores the evolution of corporate rescue in both Canada and the U.S. The timing and specific circumstances surrounding the legislation’s enactment were different in each country, but the underlying concepts and goals within the broader context of bankruptcy legislation were the same. Both countries had experienced the profound effects of business failure on directly impacted stakeholders, as well as on surrounding communities, and they recognized that saving companies would protect investments, preserve jobs, maintain the supplier and customer base, and prevent the wider impact of bankruptcy on society. To that end, both countries devised proceedings to restructure and rehabilitate financially distressed companies, allowing them to re-emerge with new debt or equity structures and continue operating as going concerns.
Historically, traditional restructurings – that is, proceedings in which the debtor company engages in lengthy negotiations with its creditors to restructure its debt obligations and business operations, all under the supervision of the court – were used extensively, dissolving unsuccessful companies while allowing others to emerge and continue operating. But these proceedings were slow, expensive, and cumbersome, and as changes in technology, firm assets, the economy and financial instruments modified the ways companies operated, and globalization altered their business methods and interactions with the community, a different process emerged. Rather than rescuing companies, this new process liquidated or merged them with other companies, and though traditional restructurings continued to occur, they have largely given way to sales or liquidations. Importantly, these emerging liquidation proceedings did not occur under bankruptcy or receivership regimes, but under the statutes that governed restructurings. They also occurred without meaningful consideration as to how this shift affects the public interest goals of the legislation.
The first part of this chapter discusses what happened: the history of these statutes, the reasons traditional restructurings emerged, and the eventual move to liquidations. The second part explores the three broad reasons liquidation plans replaced restructuring. First, an increase in secured debt left secured creditors in control of the financially distressed debtor corporations, and secured creditors typically prefer liquidation over restructuring. Second, the decline in the manufacturing and industrial era and growth of a service-oriented economy impacted firm assets; assets became less firm-specific and more fungible. Finally, increasingly complex financial instruments altered the composition of creditors; creditors at the table now include hedge funds and other non-traditional lenders, and they may be motivated by factors beyond saving the distressed company or maximizing its asset value.
The third part of this chapter addresses the consequences of using rescue legislation to liquidate companies. First, the governing legislation was not meant to be used in this way, and stakeholders in these expedited sales do not have the benefit of the procedural and substantive safeguards that arise in restructuring proceedings. Second, it is arguable that these liquidation proceedings do not fulfil the public policy goals of restructuring legislation. Finally, embedded within public policy is the concept of value-maximization, but what ‘value’ means and how it can be maximized, is not static, and may have different connotations under traditional restructurings than under liquidations.
The last part considers the most feasible way forward for each country: where does corporate rescue go from here? This section examines whether the bankruptcy forum should be abandoned in favour of non-bankruptcy legislation or private contracts, or whether the answer lies in improving the current legislative schemes. Although many do not want to see restructuring legislation overhauled, they do recognize that this legislation was enacted under different circumstances, in a different market, when corporations looked vastly different than they do today, and that to remain relevant, it must come to reflect today’s society and corporations. Doing so requires reconceptualizing how liquidation fits into the public policy goals of the statute and reassessing the concept of value to determine what it should encompass.
The full chapter is available here.
By Jeffrey Cohen, Michael A. Kaplan, and Colleen M. Maker (Lowenstein Sandler)
In Loan Forgiveness as Basis for Fraudulent Transfer Claims, authors Jeffrey Cohen, Michael A. Kaplan, and Colleen M. Maker address fraudulent transfer litigation as a valuable weapon in the bankruptcy code arsenal, to target assets transferred or disposed of prior to bankruptcy with the potential to provide at least some recovery to creditors of the debtor’s estate. The article examines debt cancellation as an overlooked, but still potentially viable and valuable, basis for a fraudulent transfer cause of action.
Avoidance actions may include not only transfers with fraudulent intent, but also constructive fraud through loan forgiveness or debt cancellation. For example, if a company makes loans to subsidiaries and then formally or informally either writes off, forgives and cancels the loan prior to bankruptcy, that action has the same impact as a fraudulent transfer: creditors are left holding the bag while the beneficiary is unaffected and may even receive a windfall at the expense of the creditors.
Intercompany transfers are often considered within the ordinary course of business in a complex corporate structure, and loans to directors and officers are not rare. However, avoidance actions regarding forgiveness of debt are seldom brought due of issues of standing, resources, discovery, and cost weighed against the viability of the claim. Parties must assess whether the possibility of recovery outweighs the risks or if limited resources are better used elsewhere, perhaps through direct distribution to creditors.