By Andrew N. Goldman, George W. Shuster Jr., Benjamin W. Loveland, Lauren R. Lifland (Wilmerhale LLP)
Valuation is a critical and indispensable element of the Chapter 11 bankruptcy process. It drives many aspects of a Chapter 11 case, from petition to plan confirmation, in all circumstances. It may be obvious that the COVID-19 crisis has added a layer of complexity—and volatility—to bankruptcy valuation issues with respect to valuing assets, liabilities, and claims, both in and outside the Chapter 11 context. But the crisis may also change the way that courts look at valuation determinations in Chapter 11—both value itself, and the way that value is measured, may be transformed by the COVID-19 crisis. While the full extent of the pandemic’s effect on valuation issues in bankruptcy has yet to be seen, one certainty is that debtors and creditors with a nuanced and flexible approach to these issues will fare better than those who rigidly hold on to pre-crisis precedent.
The United States’ response to COVID-19 has led to record levels of unemployment and a severe contraction in real GDP. The economic shock has already pushed companies such as J.C. Penney and J.Crew into bankruptcy. And many more, such as AMC and Hertz, may quickly follow. If that happens, the nation’s bankruptcy courts could soon face unprecedented levels of stress. There are at least four ways to address a potential surge.
First, Congress could authorize more permanent bankruptcy judges. It has currently authorized the federal courts of appeals to appoint 316 permanent bankruptcy judges throughout the country. But three years ago, when the economy was much stronger, the Judicial Conference argued that more judges were still needed.
Second, Congress could authorize more temporary bankruptcy judges. It has currently authorized about three dozen of them. Temporary bankruptcy judgeships expire when the occupant dies, retires, resigns, or is removed from office 5 years after the seat was created or extended. The most recent extension was in 2017, so the current temporary bankruptcy judgeships will remain vacant once occupants begin to depart after 2022 if the seats are not extended.
Third, the judicial council of each federal court of appeals could recall retired bankruptcy judges to serve.
Fourth, the judicial councils for the federal courts of appeals could agree to temporarily transfer bankruptcy judges around the country. Although this would do little to alleviate stress from an absolute rise in bankruptcies, it could help manage bottlenecks in places with disproportionate bankruptcy filings—such as Delaware, New York, and Texas. Under 28 U.S.C. § 152(d), “[w]ith the approval of the Judicial Conference and of each of the judicial councils involved, a bankruptcy judge may be designated to serve in any district adjacent to or near the district for which such bankruptcy judge was appointed.” And, under 28 U.S.C. § 155(a), “[a] bankruptcy judge may be transferred to serve temporarily as a bankruptcy judge in any judicial district other than the judicial district for which such bankruptcy judge was appointed upon the approval of the judicial council of each of the circuits involved.”
By Ben Iverson (Brigham Young University), Mark Roe (Harvard Law School)
The COVID-19 pandemic looks likely to cause a surge in bankruptcies in the United States—conceivably a surge as rapid and as substantial as the U.S. court system has ever experienced. A significant and rapid increase in judicial capacity to manage the flood of cases is more than appropriate, we argued in a recent op-ed.
Bankruptcy filings in the United States have historically peaked several months after a surge in unemployment. And American unemployment is now rising at an unprecedented rate, with more than 30 million claims filed in the last six weeks. If historical patterns hold, the bankruptcy surge would be on track to be the largest the American bankruptcy system has experienced.
Bankruptcy works well enough and quickly enough in normal times, particularly for restructuring large public firms. But it cannot work as well, and the economy will suffer, if the bankruptcy system is overloaded. Delays in critical vendor orders, DIP loan approvals, pre-packaged bankruptcy confirmations and the like could all slow commerce unnecessarily.
By Franklin H. Top III, Stephen R. Tetro, Richard F. Klein, James M. Heiser (Chapman and Cutler LLP)
Hundreds of billions of dollars are invested in aircraft equipment in the United States. With the airline industry suffering devastating losses resulting from the COVID-19 pandemic, Chapman and Cutler LLP recently released its Bankruptcy and Aircraft Finance Handbook. The handbook aims to help aircraft investors navigate the numerous challenges typically faced in airline bankruptcies. The handbook seeks to provide an understanding of the unique aspects of § 1110 of the Bankruptcy Code and other related provisions that govern the treatment of claims in bankruptcy involving aircraft. It also outlines the state law remedies available to aircraft investors outside of bankruptcy.
In addition, the handbook seeks to demystify the complex structures behind these investments, including secured loans, sale/leasebacks, operating leases, pass-through certificates, leveraged leases and public debt, including equipment trust certificates or enhanced equipment trust certificates. Each structure can present its own unique challenges in bankruptcy.
We also provide a checklist of considerations for aircraft investors drawn from over 30 years of experience, and identify some of the common challenges that investors face in airline bankruptcies. We provide investors with an understanding of the legal protections available in the event an aircraft investment heads south, as well as share lessons learned from prior airline bankruptcies from the 1990s to the present
By Scott K. Charles, Amy R. Wolf, Michael H. Cassel (Wachtell)
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.
By Thomas J. Salerno, Gerald Weidner, Christopher Simpson, and Susan Ebner, (Stinson LLP)
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.
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.
By Sara L. Chenetz and Tina N. Moss (Perkins Coie)
Reward Science and Technology Industry Group Co., Ltd. (“Reward”) joins a growing list of Chinese companies that have chosen to file a case in U.S. Bankruptcy Court in connection with their restructuring efforts under the People’s Republic of China’s Enterprise Bankruptcy Law (“EBL”). These U.S. cases are known as “Chapter 15” cases, in which the foreign representative of the debtor files a petition in a U.S. bankruptcy court seeking “recognition” of a foreign proceeding. Relief granted to Reward in its Chapter 15 proceedings included a stay of all efforts by Reward’s U.S. creditors to continue litigation and to commence any new lawsuits or other efforts to collect on claims in the United States. Additionally, the Reward foreign representative was granted the power to administer Reward’s U.S.-based assets for the benefit of its creditors and to gather evidence within the United States concerning Reward’s liabilities, assets, business affairs, and operations, including through examining witnesses under oath and issuing subpoenas to obtain documents. Reward’s Chapter 15 case demonstrates that companies that are the subject of EBL cases or are considering whether they could benefit from filing an EBL case may also be able to obtain protections from creditor action in the United States by commencing a Chapter 15 case. As part of a Chapter 15 case, U.S. bankruptcy courts may halt litigation and other collection efforts against the Chinese business (temporarily or permanently), limit the enforceability of certain contract provisions, and simultaneously facilitate the Chinese’s business’ efforts to reorganize or liquidate.
By Samuel Antill (Stanford Graduate School of Business)
In Chapter 11 bankruptcies, a court-supervised negotiation among creditors leads to one of two possible forms of exit, liquidation or emergence. In a liquidation, the bankrupt firm’s assets are sold (piecemeal or in a going-concern sale). Alternatively, if creditors agree to restructure the firm’s liabilities, the firm emerges and continues operating. I estimate a structural model of the choice between emergence and liquidation. In my sample of large-firm bankruptcies, I estimate that creditor recovery was substantially reduced by inefficient decisions to liquidate.
According to the “creditor’s bargain” theory of bankruptcy, the efficient form of exit (liquidation or emergence) from Chapter 11 is that which optimizes total expected creditor recovery. Beyond the importance to creditor recovery, an efficient approach to choosing between liquidation and emergence benefits pre-bankruptcy equity holders through lower costs of credit. The efficient form of exit from bankruptcy should be achieved, under the conditions of the Coase Theorem, by the bargaining among creditors that Chapter 11 is supposed to promote. Without this bargaining, potential coordination failures arise when each creditor pursues the form of exit that maximizes its own payoff.
In contrast to the view that Coasian bargaining in Chapter 11 successfully preserves viable firms, I estimate that inefficient decisions to liquidate are frequent. However, very few of the firms in my sample were inefficiently selected to emerge. I provide an explanation for this asymmetry. Exiting Chapter 11 through a confirmed plan of reorganization requires creditor consent under established voting rules. In contrast, Section 363(b) of the bankruptcy code allows managers to sell assets, or entire firms, without creditor approval. This procedure circumvents the bargaining among creditors that Chapter 11 supposedly promotes. I show that inefficient liquidations are concentrated in cases involving “363 sales.” This statistical association suggests that Section 363(b) enables the sort of coordination failure that Chapter 11 was designed to prevent. For example, these results are consistent with a view that managers may be inefficiently liquidating firms in order to benefit senior lenders or to obtain a job for themselves at a purchasing company.
Finally, I find that inefficient liquidations are largely avoidable. Using my estimated model, I consider the following counterfactual: how would expected creditor recovery change if form-of-exit decisions had been made by a statistical model? In this counterfactual scenario, the courts would hire a statistician to compare the expected potential recovery rates implied by my fitted model and recommend either liquidation or emergence. Each recommendation depends only on data available at the start of a given bankruptcy. I find that such a court statistician could dramatically improve average recovery.
Happily, ultimate resolution of the Blackjewel case later in autumn saw the employees made whole and the company investigated for fraud. But this solution was anything but assured before it was reached, and employees in any event suffered substantial harm in the form of disrupted family budgets and substantial uncertainty as to ultimate recovery for months – including, critically, just as a new school year was commencing for employee families’ children.
It would seem well advised, then, to put in place a more permanent and reliable process for cases like that of Blackjewel and its employees. What is needed is a solution that is uniformly applicable, reliable, and known in advance such that all concerned parties can bargain and plan ‘in the shadow’ of the regime. Our present arrangements are subject to vagaries of state law and state budgets that vary across state jurisdictional space and fiscal time. The obvious solution to the difficulties raised by such variance is to subject this realm, like that of bankruptcy itself, to federal legislation.
A bill I have recently drafted and advocated aims to ‘fit the bill’ in effect called-for by the Blackjewel affair. It does so by (a) assigning the Department of Labor (‘DOL’) a permanent representation role in future employer insolvencies; (b) federalizing the employer bonding requirements now found only in inconsistently administered state laws; (c) establishing an Employee Liquidity Support Fund to tide employees over while bankruptcy proceedings are pending; and (d) holding employing-firms’ executive officers personally liable for violations of the Act’s requirements.
The reason for DOL representation and oversight is to ensure that employees have a coherent and powerful representative ‘at the table’ during insolvency proceedings – one that is endowed with oversight authority not only during, but in advance of insolvencies.
The reason for federalizing employer bonding requirements is that states often vary over time in respect of the seriousness with which they administer such requirements, presumably in part for reasons sounding in lobbying pressures and ideology but also for reasons of basic capacity – large employers, after all, often are ‘bigger’ than the states that would supervise them.
The reason for establishing an Employee Liquidity Support Fund is presumably obvious. What made Blackjewel’s travails so hard on employees was precisely the fact that ultimate resolution was long in coming, while employee families’ daily living expenses couldn’t ‘wait.’ Against such a backdrop it makes sense for DOL to do for employees what our Federal Reserve does for financial institutions while insolvency and consolidation proceedings are underway – viz., provide tide-over funding.
Finally, the reason for holding executive officers personally liable for compliance with the Act’s requirements should be obvious as well. For again as in the case of financial institutions, so here the only surefire way of ‘incentivizing’ firms to comply is to incentivize those through whom all firms act – their executives, as the term ‘executive’ (derived from ‘execute’) itself suggests. Diffuse shareholders, who often lack power over corporate officers, and insider shareholders, who often have interests at odds with the interests of non-executive employees in any event, simply aren’t up to the task.
Employing firms, their executives and their owners have enjoyed multiple forms of state patronage for decades in our nation, while employees have in general enjoyed only sporadic assistance from public sector institutions and, less now than any time since the early 20th century, labor unions. This Act will help further a cause that’s increasingly now recognized once again to be both morally and economically compelling: That is the task of protecting the interests of our own productive citizenry – our labor force.