Courts As Institutional Reformers: Bankruptcy and Public Law Litigation

Kathleen G. Noonan (University of Pennsylvania), Jonathan C. Lipson (Temple University—Beasley School of Law), and William H. Simon (Columbia Law School)

Wags sometimes ask: What is chapter 11 good for?

In a new paper, we show that, among other things, it provides a template that both legitimates and explicates Public Law Litigation (PLL), civil class action suits against public agencies such as police departments and prison systems. These are among the most controversial disputes that courts face; often criticized, and widely misunderstood. Analogies to chapter 11 practice show how critics err, and how PLL works.

We make three basic points. First, we show that both bankruptcy and PLL, which share roots in the federal equity receivership, are judicial responses to collective action problems that other institutional mechanisms (e.g., markets or electoral politics) cannot or will not address.

Second, we show that courts in neither context “run” the organizations in question. In both types of case, management (of the debtor or agency) remains in possession and control, subject to judicial and stakeholder (e.g., creditor or plaintiff) oversight.

Third, chapter 11 and PLL both operate at the organizational level, through “restructuring.” For chapter 11, this will usually involve a plan of reorganization. The PLL analogue is a settlement agreement in a consent decree. Like plans, consent decrees typically reflect negotiated improvements in operations designed to increase the agency’s chances of success.

Critics of PLL sometimes claim that courts commandeer public instrumentalities, exceeding their expertise and authority. But this is no truer in PLL than it is in chapter 11 reorganization. Rather, judges in both spheres facilitate consensual resolutions that seek to balance stakeholder participation against managerial discretion.

This matters because the Trump Administration has vowed to “deconstruct the administrative state,” which implies a reduction in the amount and quality of public services. Increased PLL would be a plausible response.

If that happens, courts should focus not on whether they can supervise the restructuring of public agencies, but how to do so more effectively. We show that the chapter 11 system can provide helpful guidance.

The full article is available here.

The Year in Bankruptcy: 2017

by Charles M. Oellermann and Mark G. Douglas (Jones Day).

In their annual chronicle of business bankruptcy, financial, economic, and related developments in the U.S., Charles M. Oellermann and Mark G. Douglas of Jones Day review the most significant events of 2017, including business bankruptcy filing statistics and industry trends; newsworthy developments regarding sovereign and commonwealth debt; the top 10 public-company bankruptcies of the year; notable private and cross-border bankruptcy cases; significant business bankruptcy and U.S. Supreme Court bankruptcy rulings; bankruptcy-related legislative and regulatory developments; noteworthy chapter 11 plan confirmations and exits from bankruptcy; and more.

The article is available here.

Practice Makes Perfect: Judge Experience and Bankruptcy Outcomes

By Benjamin Charles Iverson (Brigham Young University), Joshua Madsen (University of Minnesota, Twin Cities, Carlson School of Management), Wei Wang (Queen’s School of Business), and Qiping Xu (University of Notre Dame, Department of Finance).

Prior studies document the influence of bankruptcy judges’ discretion on restructuring outcomes, yet we know little about how judicial experience affects the bankruptcy process. We study how the accumulation of job-specific human capital influences judges’ efficiency in handling large corporate bankruptcy filings, using 1,310 Chapter 11 filings by large U.S. public firms overseen by 309 unique bankruptcy judges in 75 bankruptcy courts between 1980 and 2012.

Using random assignment of judges to cases for empirical identification, we show that cases assigned to a judge with twice as much time on the bench realize a 5.5% decrease in time spent in reorganization. This reduced time in court translates into savings of approximately $2 million in legal fees alone for a typical case in our sample. Judges’ time on the bench is associated with higher probability of emergence but not higher recidivism. The combined evidence suggests that more experienced judges are overall more efficient. We also find that it takes up to four years for a new judge to become efficient and that judges who see a higher volume of business filings and a greater diversity of cases by size and industry early in their tenure become efficient faster than those who don’t. We find little evidence that judges’ general experience and personal attributes consistently affect case outcomes.

Our analyses highlight a potential benefit of allowing firms to file in courts with more experienced judges. Restricting this flexibility (e.g., through the proposed Bankruptcy Venue Reform Act of 2017) may impose a cost on firms by forcing them to file in courts with less experienced judges.

The full article is available here.


The Roundtable has previously posted on potential Bankruptcy venue reforms, including a summary of the Bankruptcy Venue Reform Act of 2018 introduced by Senators John Cornyn, R-TX, and Elizabeth Warren, D-MA. For a critique of current venue rules—and a possible solution—see Prof. Lynn LoPucki, “Venue Reform Can Save Companies.” For a defense of the current system, see the Roundtable’s summary of the Wall Street Journal’s “Examiners” Panel on venue reform.

Justice Scalia’s Bankruptcy Jurisprudence: The Right Judicial Philosophy for the Modern Bankruptcy Code?

By Megan McDermott (Lecturer, University of Wisconsin School of Law).

The late Justice Scalia is best known among mainstream audiences for his originalist approach to the Constitution, as well as his polarizing views on various civil rights issues. But anyone who has cracked open a bankruptcy casebook also knows Justice Scalia for his many contributions to the bankruptcy field — both through sturdy majority opinions in interpretive cases like Timbers, Nextwave, and Radlax, and through his biting dissents and concurrences in watershed decisions like Dewsnup and Stern.

My recent article, Justice Scalia’s Bankruptcy Jurisprudence: The Right Judicial Philosophy for the Modern Bankruptcy Code?, seeks to both quantify and qualify Justice Scalia’s contributions to bankruptcy law. I show that during his three decades on the Court, Justice Scalia wrote in more bankruptcy cases than any other justice (followed closely by Justices Stevens and Thomas).

I also identify four predominant themes that emerge from Justice Scalia’s bankruptcy oeuvre: (1) a holistic approach to the Bankruptcy Code; (2) a commitment to textualism, regardless of outcome; (3) disdain for legislative history; and (4) a desire for clear boundaries regarding the scope and authority of bankruptcy courts.

Finally, the article explores the impact of his jurisprudential legacy on the bankruptcy field. Of particular note are the ways in which Justice Scalia’s approach often favored ordinary consumers over creditor interests. I conclude that while Justice Scalia did not always live up to the ideals that he advocated, he nonetheless offered a unifying vision that fits well with both the purpose and the design of the Bankruptcy Code.

The full article is available here.

Selling Innovation in Bankruptcy

posted in: 363 Sale, Valuation | 0

By Song Ma (Yale School of Management), (Joy) Tianjiao Tong (Duke University, Fuqua School of Business), and Wei Wang (Queen’s School of Business).

The past decades have witnessed the emergence of patent sales in corporate bankruptcies. Yet we know little about the facts and rationales of these important economic transactions.

In this working paper, we assemble a comprehensive data set of US Chapter 11 filings, USPTO patent transaction documents, and court records on assets sales from the past three decades. We document three stylized facts on patent sales in bankruptcy. First, patent sales are pervasive — more than 40% of bankrupt firms sell at least one patent, and on average they sell 18% of their patent portfolios. Second, patent transactions occur immediately after bankruptcy filing — concentrating largely within the first two quarters after filing. Third, patents are frontloaded in general asset sales in bankruptcy — firms sell a disproportionately large quantity of patents in asset sales during the early period of reorganization.

Why do firms sell patents during bankruptcy? We design a set of empirical tests to study the economic decisions behind patent sales based on the two economic views on assets reallocation in bankruptcy, namely asset restructuring and financing through asset sales. Our results show that bankrupt firms reallocate patents that are more redeployable and trade in a more liquid market . We find no evidence that they sell underexploited or underperforming patents. This pattern of selling more liquid patents holds stronger in firms with financial distress, firms undergoing poor industry conditions, and firms lacking external financing. The combined evidence lends support to the view that firms sell innovation during bankruptcy for financing purposes rather than for asset restructuring. Additionally, we find that bankrupt firms try to retain the inventors of sold patents and continue to cite sold patents after their sale. The evidence overall suggests that a firm’s imminent financing needs interact with its intent to avoid bankruptcy costs in shaping a firm’s decision to sell patents in bankruptcy.

The full paper is available here.

 

The Roundtable will be off for the holidays. We’ll be back early after the New Year.

Fiduciary Duties in Bankruptcy and Insolvency

By John A. E. Pottow (University of Michigan Law School).

Although discussed nowhere in the U.S. Bankruptcy Code, fiduciary duties play a central role in guiding the administration of an insolvent debtor’s assets. Regulatory oversight of trustees is only loosely circumscribed by statute, but significant lacunae exist regarding specification of the duties of loyalty.  In assessing what fiduciary obligations are owed to secured creditors, unsecured creditors, and debtors, some courts build upon the general principle that the trustee’s fiduciary duty of loyalty flows to all creditors. Other courts, though, work from the premise that secured creditors are better situated to look after themselves and that a trustee’s primary obligation is to unsecured creditors, perhaps especially non-priority general creditors. The Supreme Court has also weighed in, stating that a DIP’s fiduciary duties run directly (if somewhat delphically) to “the corporation.” How then does a trustee choose between beneficiaries of the estate, and what remedies are there for losing parties disappointed with this allegiance decision?  This book chapter explores the fiduciary obligations of trustees (including DIPs) under both statute and common law. There is a special focus on the intrinsic conflicts that arise within the “menagerie of heterogeneous creditors” that constitute the claimants of a bankruptcy estate.  A single normative theory seems unlikely to explain the results (so much for the “residual fiduciary beneficiary”!).  What does seem clear is that trustees are “more fiduciary” for some constituencies than for others.  Fortunately, U.S. bankruptcy courts are accustomed to shifting allegiances and disalignments of interest. Thus, the bankruptcy system may be well-suited to handle the endemic conflicts of interest between corporate constituencies through various bankruptcy-specific mechanisms, such as the institution of the Creditors Committee and the norm of engaged judicial oversight.

The full article is available here.

Optimal Capital Structure and Bankruptcy Choice: Dynamic Bargaining vs. Liquidation

posted in: Valuation | 0

By Samuel Antill and Steven R. Grenadier (Stanford Graduate School of Business)

In this work, we develop and solve a continuous-time dynamic bargaining model of Chapter 11 reorganization. We include many features of the Chapter 11 process, such as the automatic stay, suspension of dividends, the exclusivity period, post-exclusivity proposals by creditors, and the potential for forced conversion to Chapter 7. The reorganized firm may issue new debt and continue operating. Moreover, both debtors and creditors face uncertainty over future asset values as they debate reorganization plans. We solve for the equilibrium and the corresponding expected payoffs to creditors and equityholders.

Using this equilibrium, we proceed to model a firm’s optimal capital structure decision in a framework in which the firm may later choose to enter either Chapter 11 reorganization or Chapter 7 liquidation. Creditors anticipate equityholders’ future reorganization incentives and price them into credit spreads when the debt is issued (ex ante). The implied capital structure results in both higher credit spreads and dramatically lower leverage than existing models suggest. Giving creditors more bargaining power in bankruptcy typically leads to higher leverage and ex ante firm value, consistent with empirical evidence. If reorganization is less efficient than liquidation, the added option of reorganization can actually make equityholders worse off ex ante, even if the firm is eventually liquidated.

The full article is available here.

Equitable Mootness Doctrine Persists in Bankruptcy Appeals

By Shana A. Elberg, Amy Van Gelder, and Jason M. Liberi (Skadden, Arps, Slate, Meagher & Flom LLP)

In recent years, some courts have become critical of the doctrine of equitable mootness, a judicially created abstention doctrine — unique to the corporate bankruptcy world — that allows appellate courts to dismiss appeals from a bankruptcy court’s confirmation order if the relief sought on appeal threatens to unwind a complex debtor reorganization previously approved by the bankruptcy court. The doctrine promotes finality of confirmation orders, encourages the global consensual resolutions often crucial to complex reorganizations, and protects third parties that have justifiably relied upon the bankruptcy court’s confirmation order or transactions effectuated pursuant to that order.

Despite significant concerns expressed by courts regarding the impact of the doctrine on parties’ fundamental appellate rights, equitable mootness persists in some form within every circuit that has jurisdiction over bankruptcy appeals. Thus, plan proponents and objectors alike must be aware of its implications on contested plan confirmation proceedings and prepared to act quickly to advance their interests following plan confirmation.

This article provides a brief overview of the doctrine of equitable mootness, its application by appellate courts, and key considerations for bankruptcy and non-bankruptcy practitioners faced with contested plan confirmations and subsequent appeals.

The article is available here.

Momentive: Law Firm Perspectives

On October 28, 2017, the United States Court of Appeals for the Second Circuit handed down its decision in In re MPM Silicones, L.L.C., holding that where an efficient market exists, the appropriate cram-down interest rate in Chapter 11 cases is the market rate, distinguishing the formula rate applied by the Supreme Court in Till v. SCS Credit Corp. in Chapter 13 cases. The Second Circuit wrote that “the market rate should be applied in Chapter 11 cases where there exists an efficient market. But where no efficient market exists for a Chapter 11 debtor, then the bankruptcy court should employ the formula approach endorsed by the Till plurality.” The Second Circuit also disallowed the senior creditors’ claim for a make-whole payment, although the Third Circuit had allowed such a claim in In re Energy Future Holdings Corp.

Law firms have so far reacted unanimously that this decision is a win for secured creditors as it ameliorates the risk that unsecured creditors could extract value from the debtor at the secured creditors’ expense. Weil writes that “it seems like the Bankruptcy Court, now freed from Till, will find that an efficient market exists, and will adjust the interest rate on the replacement notes accordingly.”

Nevertheless, some firms predict that there may still be areas future controversy. Davis Polk warns that this decision “could result in expensive litigations between debtors and secured creditors as to whether there exists an efficient market and, if so, what the efficient market rate should be.” Norton Rose Fulbright also emphasizes that the next step for secured creditors is to focus on when an efficient market exists.

Firms have also noticed the decision’s implication for debtor-side strategy. Baker McKenzie suggests the possibility that “a debtor may engage in forum shopping to file its case in a jurisdiction that applies the formula approach,” or “be even more sensitive to the potential for exit financing quotes to be used as evidence against [debtors] in establishing a market rate.”

On the issue of the make-whole premium, Davis Polk highlights that the circuit split may increase forum shopping for distressed issuers with potentially significant make-whole obligations. It expects future issuers to draft clearly around the issue of make-whole obligation to provide for future Chapter 11 cases.

(By Jianjian Ye, Harvard Law School, J.D. 2018.)

Through Jevic’s Mirror: Orders, Fees, and Settlements

posted in: Cramdown and Priority | 0

By Nicholas L. Georgakopoulos (McKinney School of Law, Indiana University)

This article takes the United States Supreme Court’s simple “no” to nonconsensual structured dismissals in Jevic as an opportunity to study its contours. The first issue is the pending clarification on whether the right to object to a structured dismissal is an individual or a class right. An individual right would leave little space for consensual structured dismissals, whereas a class right would fit with the anti-hold-out scheme of reorganization law. Second, Jevic implies increased scrutiny on first-day orders, especially in liquidating reorganizations, pushing for additional caution and negotiation before early payments. Third is the issue of fees—latent in Jevic but burning in the academy—the tension between race-to-the-bottom and race-to-the-top views of jurisdictional competition with the Court’s silence in the foreground. Fourth is the Court’s approval of settlements (via interim orders) that violate priorities provided they promote a bankruptcy goal, as Iridium’s approval did. Fifth, the juxtaposition of the settlements in Iridium and Jevic stresses the importance of the bankruptcy court’s role in approving settlements when the parties’ incentives are biased.

The full article is available here.


The roundtable has posted previously on Jevic, including a report of the case by Melissa Jacoby & Jonathan Lipson and a roundup of law firm perspectives on the Court’s decision. For opposing views on the case leading up to oral argument, see Melissa Jacoby & Jonathan Lipson on their amicus brief and Bruce Grohsgal making the case for structured dismissals. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article that the Jevic opinion referenced.

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