COVID-19 Debt and Bankruptcy Infrastructure

By Robert K. Rasmussen (USC Gould School of Law)

Robert Rasmussen

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.

“Confessions” of a Forum Shopper, Part II – Debtors Without Borders

By Andrew Dietderich (Sullivan & Cromwell LLP)

Andrew Dietderich

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.

“Confessions” of a Forum Shopper – A Debtor’s View of Venue Choice

posted in: Bankruptcy, Bankruptcy Reform | 0

By Andrew Dietderich (Sullivan & Cromwell LLP)

Andrew Dietderich

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.

Bankruptcy’s Equity Canon

By Jared Mayer (Law Clerk, Supreme Court of New Jersey)

Jared Mayer

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.

Chapter 11’s Descent into Lawlessness

By Lynn M. LoPucki (Security Pacific Bank Distinguished Professor of Law, UCLA School of Law)

Lynn M. LoPucki

The bankruptcy courts that compete for big cases frequently ignore the Bankruptcy Code and Rules. This Article documents that lawlessness through a detailed examination of the court file in Belk, Inc.—a one-day Chapter 11—and a series of empirical studies.

Chapter 11’s lawlessness reached a new extreme in Belk. Belk filed in Houston on the evening of February 23, 2021. The court confirmed the plan at ten o’clock the next morning, and the parties consummated the plan that same afternoon. Almost none of Chapter 11’s procedural requirements were met. The court did not give creditors notice of the disclosure statement or plan confirmation hearings until after those hearings were held. Belk filed no list of creditors’ names and addresses, no schedules, no statement of financial affairs, and no monthly operating reports.  No creditors’ committee was appointed, no meeting of creditors was held, and none of the professionals filed fee applications. The ad hoc groups that negotiated the plan failed to file Rule 2019 disclosures. Because no schedules were filed, no proofs of claim were deemed filed. Only eighteen of Belk’s ninety-thousand creditors filed proofs of claim, and Belk apparently just made distributions to whomever Belk considered worthy. 

The procedural failures in Belk are just the tip of the iceberg.  The competing courts are ignoring impermissible retention bonuses, refusing to appoint mandatory examiners, failing to monitor venue or transfer cases, granting every request to reject collective bargaining agreements, and providing debtors with critical-vendor slush funds. The article is available here

Mass Exploitation

By Samir D. Parikh (Lewis & Clark Law School; Fulbright Schuman Scholar; Bloomberg Law; Fulbright Commission)

Samir D. Parikh

Modern mass tort defendants – including Johnson & Johnson, Purdue Pharma, USA Gymnastics, and Boy Scouts of America – have developed unprecedented techniques for resolving mass tort cases; innovation coupled with exploitation. Three weapons in this new arsenal are particularly noteworthy. Before a filing, divisive mergers allow corporate defendants to access bankruptcy on their terms. Once in bankruptcy, these mass restructuring debtors curate advantageous provisions in the Bankruptcy Code to craft their own ad hoc resolution mechanism implemented through plans of reorganization. This maneuver facilitates various questionable outcomes, including the third-party releases the Sackler family recently secured. Finally, in order to minimize its financial contribution to a victims’ settlement trust, a mass restructuring debtor can agree to convert its tainted business into a public benefit company after bankruptcy and devote future profits – no matter how speculative they may be – to victims.

The net effect of these legal innovations is difficult to assess because the intricacies are not fully understood. Debtors argue that these resolution devices provide accelerated and amplified distributions. And forum shopping has landed cases before accommodating jurists willing to tolerate unorthodoxy. The fear, however, is that mass tort victims are being exploited. The aggregation of these maneuvers may allow culpable parties to sequester funds outside of the bankruptcy court’s purview and then rely on statutory loopholes to suppress victim recoveries.  Mass restructuring debtors are also pursuing victim balkanization – an attempt to pit current victims against future victims in order to facilitate settlements that may actually create disparate treatment across victim classes.

This Essay is the first to identify and assess the new shadowed practices in mass restructuring cases, providing perspective on interdisciplinary dynamics that have eluded academics and policymakers. This is one of the most controversial legal issues in the country today, but there is scant scholarship exploring improvement of the flawed machinery. This Essay seeks to create a dialogue to explore whether a legislative or statutory response is necessary and what shape such a response could take.

The full article will be available at 170 U. Pa. L. Rev. Online ___ (forthcoming 2021) and can be accessed here.

Courts in Puerto Rico Case Adopts Alternative Test to Find Settlement Agreements Were Executory

By John Beck and Jennifer Lee (Hogan Lovells)

John Beck
Jennifer Lee

A debtor can elect to either assume or reject an executory contract under section 365 of the Bankruptcy Code. Because the Bankruptcy Code does not define “executory”, courts have historically overwhelmingly applied the “Countryman” test – which asks whether the contract parties have remaining unperformed obligations such that the failure of either party to complete performance would constitute a material breach of the agreement – to determine if a contract is executory.  In a recent decision, however, Judge Laura T. Swain, the district court judge presiding over the 2017 Puerto Rico Oversight, Management, and Economic Stability Act proceedings, declined to utilize the Countryman test and adopted the alternative “functional approach” to determine whether the agreements at issue were executory. The “functional approach” focuses on the post-petition benefit to the debtor from assumption or rejection of a contract instead of the pre-petition obligations under the contract.  The decision is the latest among a string of recent cases that have relied on non-Countryman tests to determine whether a contract is executory, with the “functional approach” emerging as the prevailing alternative. Read the full article here.

Voting Rights Assignment Unenforceable, but Subordinated Creditor Lacked Standing to Participate in Chapter 11 Plan Confirmation Process

By Dan B. Prieto (Jones Day) and Mark G. Douglas (Jones Day)

Dan B. Prieto
Mark G. Douglas

In In re Fencepost Productions Inc., 629 B.R. 289 (Bankr. D. Kan. 2021), the U.S. Bankruptcy Court for the District of Kansas recently addressed the enforceability of a provision in a pre-bankruptcy subordination agreement under which a subordinated creditor assigned to a senior creditor its right to vote on any chapter 11 plan proposed for the borrower. The bankruptcy court ruled that such a provision is not enforceable because it conflicts with the Bankruptcy Code. In a twist, however, the court concluded that the subordinated creditor lacked “prudential standing” to participate in the confirmation process because it was extremely out-of-the-money and therefore had no stake in the outcome of the case, but was attempting to assert the rights of third parties.

Courts disagree over whether an assignment of plan voting rights in an intercreditor or subordination agreement is enforceable. Regardless of the particular approach adopted by a court on this issue, the growing consensus is that agreements that seek to limit or waive junior creditors’ voting rights must contain express language to that effect. The ruling in Fencepost adds yet another chapter to the ongoing debate on this issue.

 The Fencepost court’s conclusion that the subordinated creditor lacked prudential standing would appear to be driven in part by the facts of the case, which involved a subordinated, clearly out-of-the-money creditor intent upon impeding an otherwise consensual reorganization.

The Bankruptcy Code, however, expressly provides to the contrary by, among other things, giving every “party in interest” (including creditors and interest holders, without making an exception in cases where there is no value available for distribution to them), the right to appear and be heard “on any issue” in a chapter 11 case, the right to vote on a chapter 11 plan, and the right to object to confirmation of a plan. These provisions arguably indicate that Congress intended to modify or abrogate prudential standing requirements when it enacted the Bankruptcy Code. Moreover, the “rights” any out-of-the-money creditor or shareholder would be seeking to enforce by participating in the confirmation process are arguably their own, rather than the rights of third parties.

A logical extension of the rationale articulated in Fencepost is that clearly out-of-the-money creditors or shareholders of an insolvent corporation would never have prudential standing to participate in the chapter 11 plan confirmation process. That approach would be contrary to court rulings and general practice in many chapter 11 cases.

The full article can be accessed here.

Structuring and Practice for Aircraft Leases to Prevent Lease Payments from Being Clawed Back in a Lessee Bankruptcy

By Stewart B. Herman (Katten) and Timothy J. Lynes (Katten)

Stewart B. Herman
Timothy J. Lynes

In King v. Bombardier Aerospace Corporation et al., the trustee sought under 11 U.S.C. §§ 547(b) and 550(a) to have the lessor disgorge rent that the debtor lessee had paid to the lessor under an English-law aircraft lease during the prepetition preference period using funds advanced to the debtor by its shareholder. Pursuant to §547(b), the trustee argued that the debtor had made the payment for an antecedent debt; the loan balance on what was alleged to be disguised secured financing rather than a true lease. The lessor asserted (i) the trustee had not sufficiently shown the nature and amount of the antecedent debt as required under § 547(b)(2), (ii) under § 547(c)(4) the lessor had provided the debtor subsequent new value after the debtor made the payment, (iii) under § 547(c)(2) that the debtor had made the payment in the ordinary course of business, and (iv) that under the earmarking doctrine the payment should not be clawed back because the payment had been funded by a loan from a third party (the debtor’s shareholder). The court found (i) the trustee had not satisfactorily shown the nature and amount of the antecedent debt, (ii) the lessor had sufficiently shown it added subsequent new value to the debtors, (iii) the lessor had not sufficiently shown the payment was in the ordinary course of business, under either the subjective test or the objective test, and (iv) the lessor had not sufficiently shown facts to support an earmarking defense. The article concludes by offering suggestions for structuring leases to survive preference claims. The full article is available here.

Another Court Adopts Majority View in Approving Bankruptcy Trustee’s Use of Tax Code: Look-Back Period in Avoidance Actions

By Daniel J. Merrett (Jones Day) and Mark G. Douglas (Jones Day)

Daniel J. Merrett
Mark G. Douglas

The ability of a bankruptcy trustee or chapter 11 debtor-in-possession (“DIP”) to avoid fraudulent transfers is an important tool promoting the bankruptcy policies of equality of distribution among creditors and maximizing the property included in the estate. One limitation on this avoidance power is the statutory “look-back” period during which an allegedly fraudulent transfer can be avoided—two years for fraudulent transfer avoidance actions under section 548 of the Bankruptcy Code and, as generally understood, three to six years if the trustee or DIP seeks to avoid a fraudulent transfer under section 544(b) and state law by stepping into the shoes of a “triggering” creditor plaintiff.

The longer look-back periods governing avoidance actions under various state laws significantly expand the universe of transactions that may be subject to fraudulent transfer avoidance. Indeed, under a ruling recently handed down by the U.S. Bankruptcy Court for the Western District of North Carolina, the look-back period in avoidance actions under section 544(b) may be much longer—10 years—in bankruptcy cases where the Internal Revenue Service (“IRS”) or another governmental entity is the triggering creditor. In Mitchell v. Zagaroli (In re Zagaroli), 2020 WL 6495156 (Bankr. W.D.N.C. Nov. 3, 2020), the court, adopting the majority approach, held that a chapter 7 trustee could effectively circumvent North Carolina’s four-year statute of limitations for fraudulent transfer actions by stepping into the shoes of the IRS, which is bound not by North Carolina law but by the 10-year statute of limitations for collecting taxes specified in the Internal Revenue Code.

Zagaroli does not break new ground on the power of a bankruptcy trustee or DIP to bring avoidance actions under section 544(b) of the Bankruptcy Code. Nevertheless, the court’s endorsement of the majority approach on the availability of a longer look-back period in cases in which the IRS is a creditor is notable. Widespread adoption of this approach could significantly augment estate avoidance action recoveries.

The full article is available here.

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