Value Tracing and Priority in Cross-Border Group Bankruptcies: Solving the Nortel Problem from the Bottom Up
by | posted in: Priority, Valuation | 0

By Edward J. Janger (Professor, Brooklyn Law School) and Stephan Madaus (Professor, Martin-Luther-University Halle-Wittenberg)

Edward J. Janger
Stephan Madaus

The Nortel bankruptcy case is simultaneously the biggest success and biggest failure in the recent history of cross-border restructuring practice. On the plus side, the coordinated sale of an insolvent telecom firm’s key assets created a pool of value worth $7 billion—much larger than could have been accomplished through piecemeal local liquidation of spectrum licenses and intellectual property rights.  On the minus side, the fights over value allocation swallowed up a gargantuan part of that value—an estimated $2.6 billion.

 This article suggests a simple, perhaps naïve, solution to this problem.  The fights centered on alleged entitlements to priority—upward deviations from equal treatment and pro rata distribution. These fights were complicated by Nortel’s structure as a global corporate group. The claims were based on, among other things: (1) liens; (2) corporate structure; (3) territorial jurisdiction; and (4) local statutory priorities. Interactions among these claims to priority made it virtually impossible to unscramble the egg.  In our view, a straightforward solution to this problem is to remember that a creditor asserting priority has the burden of establishing the realizable value of its claim to priority in excess of its pro rata distribution.

The article proceeds in three steps.

First, it describes the current architecture for dealing with the insolvency of corporate groups and the problem posed by cases like Nortel and Lehman.

Second, it details the various types of claims to priority that can exist within a corporate group and explores the nature of priority.  It then develops the concept of “homeless value” and the “rump estate.”  Claims to priority may be hierarchical or they may be plural. They may be traceable to assets, countries, or entities, or they may inhere in the group. Regardless, when a firm continues to operate in bankruptcy (or is sold as a going concern), the relative position of the claimants must be fixed at the outset. Thereafter, subject to respecting the priority of the newly fixed claims, governance should be situated with the variable claimants to this unsituated value—the “rump estate.” These claimants are the ones who will benefit from any increase in value and pay for any decrease.

Third, the article suggests an approach to value allocation that would vastly simplify cases like Nortel, but which also provides a mechanism to allocate value in rescue cases where the firm continues to operate. The simple point is that priority claimants should have the burden of establishing the realizable value of their priority. This requirement establishes an entitlement floor for, and limits the veto rights of, these priority claimants. As such, it provides a legal default for allocating value in going concern sale cases, and a cram-down standard for restructurings.

The full article is available here.

The Proceduralist Inversion – A Response to Skeel
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Workouts and Pre-Packs | 0

By Edward J. Janger (Professor, Brooklyn Law School) and Adam J. Levitin (Professor, Georgetown University Law Center)

Edward J. Janger
Adam J. Levitin

In Distorted Choice in Corporate Bankruptcy, David Skeel offers a nuanced description of restructuring support agreements (RSAs) and how they can help a debtor to achieve the necessary consensus around a proposed Chapter 11 plan of reorganization. We take issue, however, with Skeel’s permissive view toward RSAs that permits provisions that would short circuit the “process” protections contained in Chapter 11. Such provisions include pre-disclosure lock-ups, milestones, and coercive deathtraps.

Chapter 11 contemplates bargaining in the shadow of certain basic statutory “distributional” entitlements: equal treatment, best interests, full cash payment of administrative expenses, and a guaranteed minimum-cramdown distribution. As such, RSAs can either reinforce the link between entitlement and distribution, or they can sever it.

In our view, Skeel insufficiently appreciates the purpose of process—how procedural protections such as classification, disclosure, and solicitation surrounding the vote forge the crucial link between bankruptcy bargaining and core principles of corporate governance and pre-bankruptcy entitlement. We offer, instead, an approach which sorts between process-enhancing RSAs and those that facilitate end-runs.

The article can be found here.

Implementing Symmetric Treatment of Financial Contracts in Bankruptcy and Bank Resolution
by | posted in: Financial Firms and Safe Harbors | 0

By Edward J. Janger (Brooklyn Law School) and John A.E. Pottow (University of Michigan Law School)

Financial contracts, such as swaps, repos, and options, are excepted from the Bankruptcy Code’s automatic stay by so-called “derivative safe harbors.” The Lehman Brothers bankruptcy provides a graphic illustration of how this device makes it almost impossible for non-bank financial firms, or other firms with significant derivative exposure, to restructure in chapter 11. Without a stay, non-debtor counterparties may run for the exits by exercising early termination rights, demanding payment, and offsetting obligations, thereby draining assets from the struggling debtor in a destructive rush.

The resolution regime for banks takes a different approach. It imposes a short stay on financial contract termination to permit the orderly transfer of a failed bank’s derivative portfolio intact to a solvent bank. This approach has been used for decades to preserve the value of financial contracts and to minimize the systemic disruption occasioned by bank failures. It has been extended contractually to cover many non-bank SIFIs through the relatively recent ISDA Resolution Stay Protocol. There are, however, significant gaps in the contractual regime. Non-SIFI financial institutions are not covered, and neither are non-financial firms that may have significant derivatives exposure, and may also be systemically important.

Our article offers a road-map for translating and generalizing the “short-stay” regime used for banks into chapter 11. The key to this synthesis is the bankruptcy concept of “adequate assurance of future performance,” provided through a commonplace bankruptcy device—debtor-in-possession financing. This financing can backstop the debtor’s timely performance of its financial obligations. We note that our approach would facilitate use of the “Single Point of Entry” strategy for restructuring financial firms in bankruptcy. Our approach also would, we contend, bring greater stability to financial markets, preserve otherwise evaporating value for insolvent debtors with a significant book of derivatives, and ultimately make it possible for many more firms to restructure in bankruptcy.

The full article, published in 10 Brooklyn Journal of Corporate, Financial and Commercial Law 155 (2015), is available here.

 

This article was recently published in the Brooklyn Journal of Corporate, Financial and Commercial Law as part of a symposium volume entitled: The Treatment of Financial Contracts in Bankruptcy and Bank Resolution. The volume includes papers by Riz Mokal, Anna Gelpern and Eric Gerding, Adam Levitin, and Irit Mevorach.

The Roundtable has also posted on this topic previously. See Morrison, Roe, and Sontchi, “Rolling Back the Repo Safe Harbors” and Murphy and Smith, “Bankruptcy Code with No Repo Safe Harbor—An Evaluation.”

Bankruptcy Sales
by | posted in: Cramdown and Priority | 0

By Melissa B. Jacoby (University of North Carolina – Chapel Hill) and Edward J. Janger (Brooklyn Law School)

Bankruptcy courts have become fora for the sale of entire firms as going concerns, as well as for the liquidation of assets piecemeal. This book chapter teases out the advantages and disadvantages of conducting such sales under federal bankruptcy law as compared to state law. We first describe the forms that bankruptcy sales can take, and the contexts in which they occur. Next, we explore the concept of “bankruptcy created value,” identifying the ways in which the federal bankruptcy process can create value over and above what can be realized through compulsory state processes. We then identify several procedural and governance-based concerns about all-asset sales. We suggest that our recent proposal, the Ice Cube Bond, might address concerns about sales of substantially all assets by withholding a portion of the sale proceeds. To recover the withheld funds, claimants would have to establish that the sale did not harm the bankruptcy estate and that they would be legally entitled to the funds under the normal bankruptcy priority rules or pursuant to an agreement reached after the sale. To conclude, we explore the related issues of credit bidding and the permissible scope of sale orders that declare assets to be “free and clear” of various kinds of claims and property interests.

The full chapter may be found here.

This draft chapter has been accepted for publication by Edward Elgar Publishing in the forthcoming Corporate Bankruptcy Handbook, edited by Barry Adler, due to be published in 2017.