Presumption of Filed Claim’s Validity and Amount Does Not Apply in Proceeding to Determine Secured Amount of Claim

By Paul M. Green, Mark G. Douglas (Jones Day)

Paul M. Green
Mark G. Douglas

The Bankruptcy Code creates a rebuttable presumption that a proof of claim is prima facie evidence of the claim’s validity and amount. Courts disagree, however, over whether that presumption also applies in a proceeding to determine the secured amount of the creditor’s claim. The U.S. Bankruptcy Court for the Eastern District of California weighed in on this issue in In re Bassett, 2019 WL 993302 (Bankr. E.D. Cal. Feb. 26, 2019). The court broadened the divide in the debate by holding that the presumption that a filed claim is valid does not create a presumption that the claim is secured to the extent specified in a proof of claim.

Valuation is a critical and indispensable part of the bankruptcy process. How collateral and other estate assets are valued will determine a wide range of issues, from a secured creditor’s right to adequate protection, postpetition interest, or relief from the automatic stay to a proposed chapter 11 plan’s satisfaction of the “best interests” test or whether a “cram-down” plan can be confirmed despite the objections of dissenting creditors. Bassett and other court rulings addressing the valuation of secured claims illustrate the importance of developing an adequate evidentiary record to support or refute a proposed valuation.

The full article is available here.

Bankruptcy Sales: Is A Public Auction Required to Assure That Property Is Sold for The Highest and Best Price?

By Vicki R. Harding (Vicki R. Harding, PLLC)

A buyer negotiating acquisition of commercial real estate from a Chapter 7 trustee or a Chapter 11 debtor-in-possession will almost always hear the mantra: “I have a fiduciary duty to maximize value for the benefit of the bankruptcy estate” – which the seller insists means the property must be sold through a public auction. The potential buyer may be designated as the stalking horse (e.g. its offer will be treated as an opening bid), and it may have input on the bidding procedures (bidder qualifications, minimum overbid, purchase price payment terms, etc.). But at the end of the day it runs a risk that after investing time and money in pursuing the acquisition someone else may be selected as having made a “higher and better” offer.

However, that is not always the case.  In re 160 Royal Palm, LLC, 600 B.R. 119 (S.D. Fla. 2019) presents an interesting case study. As discussed in Bankruptcy Sales: Highest Is Not Always Best, the bankruptcy court allowed a debtor to withdraw property from a previously authorized public auction and to proceed with a private sale to a designated buyer, subject only to an overbid by the stalking horse from the public auction. The court approved the private sale over the objection of a third party that claimed that in a public auction it would bid at least $1 million more than the private sale purchase price.

The full article is available here.

How Much Value Was Destroyed by the Lehman Bankruptcy?

The Federal Reserve Bank of New York’s Liberty Street Economics Blog has run a series of five posts seeking to estimate the total value destroyed by the Lehman Brothers Holdings Inc.’s Chapter 11 and Lehman’s investment bank affiliate’s liquidation through separate Securities Investor Protection Act (SIPA) proceedings.

Erin Denison, Michael Fleming, and Asani Sarkar, of the Federal Reserve Bank of New York’s Research and Statistics Group, estimate the total value destruction for Lehman, its creditors, and stakeholders to be approximately between $46 billion to $63 billion (between 15 to 21 percent of Lehman’s pre-bankruptcy consolidated assets), excluding expenses from the SIPA proceedings (an additional $1.4 billion) and the costs of resolving Lehman’s foreign subsidiaries. These estimates also exclude boarder spillover effects on the economy caused by Lehman’s collapse.

Denison, Fleming, and Sarkar suggest the main drivers of value destruction include: professional fees and expenses ($5.9 billion for Chapter 11 proceedings with an additional $1.36 billion for SIPA proceedings); liquidity costs for creditors during the lengthy proceeding ($15 billion); and lost relationships between Lehman and its equity underwriting clients ($23 billion). They break down these estimates of the value destroyed through a series of four posts, analyzing the direct costs (expenses paid to third parties for services provided during bankruptcy) and the indirect costs (opportunity costs for the firm, its creditors, and its stakeholders).

The first post on Creditor Recovery in Lehman’s Bankruptcy can be found here. The second post on Lehman’s Bankruptcy Expenses can be found here.  The third post on Customer and Customer and Employee Losses in Lehman’s Bankruptcy can be found here.  The fourth post on Indirect Costs of Lehman’s Bankruptcy can be found here.  The final summary post can be found here.


 

For previous Roundtable posts on the valuation and resolution of Lehman, see Steven Lubben, “Lehman’s Derivative Portfolio”; Mark J. Roe, and Stephen D. Adams, “Restructuring Failed Financial Firms in Bankruptcy: Selling Lehman’s Derivatives Portfolio.”

(This post was authored by Ryan Rossner, J.D. ’19.)

Fifth Circuit Adopts Flexible Approach to Collateral Valuation in Cramdown Chapter 11 Cases

posted in: Cramdown and Priority, Valuation | 0

By Peter S. Saba (Jones Day).

In In re Houston Regional Sports Network, L.P., 886 F.3d 523 (5th Cir. 2018), the U.S. Court of Appeals for the Fifth Circuit held that bankruptcy courts have flexibility in selecting the date on which to value collateral, “so long as the bankruptcy court takes into account the purpose of the valuation and the proposed use or disposition of the collateral at issue.”  In so holding, the Fifth Circuit rejected the proposition that a bankruptcy court must value collateral as of either the bankruptcy petition date or the effective date of a cramdown chapter 11 plan.  However, because the bankruptcy court failed to consider the proposed use of the collateral in assigning it a value, the Fifth Circuit remanded the case below for additional findings.

In declining to establish a bright-line rule mandating the valuation date for a creditor’s collateral in cramdown chapter 11 cases, the Fifth Circuit’s ruling, informed by section 506(a), gives bankruptcy courts the flexibility to consider an appropriate valuation date based on the actual use or disposition of a creditor’s collateral and the purpose of the valuation.  The principal benefit of this approach is that it recognizes that any valuation in this context should consider developments in a chapter 11 case which may have an impact on value.  Even so, secured creditors should be aware that consideration of the proposed or actual use of collateral under a plan may in some cases mean that collateral may be assigned a lower value as of plan confirmation or effectiveness than as of the bankruptcy petition date.

The article is available here.

Junior Creditors Could Share In 363 Bankruptcy Sales

posted in: 363 Sale, Priority, Valuation | 0

By Charles Tabb and Tamar Dolcourt (Foley & Lardner LLP).

In July, the Seventh Circuit Court of Appeals issued a decision that appeared to upend the long-held understanding that an underwater secured creditor was entitled to all of the proceeds of a sale under Section 363 of the Bankruptcy Code. In our new article, we analyzed the decision in Illinois Department of Revenue v. Hanmi Bank in which the Seventh Circuit opened the door to a potential recovery for out-of-the-money junior creditors based on the theory that a free and clear sale under the Bankruptcy Code created a premium for the assets that the junior creditor may be entitled to share. Though Hanmi dealt explicitly with a state taxing authority and its particular rights under Illinois state law, there is nothing in the opinion which limits it to those facts or that type of creditor. Furthermore, even though the court ultimately valued the interest that the Illinois Department of Revenue was forced to give up through the free and clear sale at zero, that was simply a failure of proof in the particular case. We also consider the long-term ramifications of this opinion and its likely effect on future sales under Section 363, including the possibility of increased costs and delays of negotiating these sales with recalcitrant junior creditors.

The article may be found at Law 360:  the original publication.

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.

Beyond Options

posted in: Cramdown and Priority | 0

By Anthony J. Casey (University of Chicago Law School) and Edward R. Morrison (Columbia Law School)

Scholars and policymakers now debate reforms that would prevent a bankruptcy filing from being a moment that forces valuation of the firm, crystallization of claims against it, and elimination of junior stakeholders’ interest in future appreciation in firm value. These reforms have many names, ranging from Relative Priority to Redemption Option Value. Much of the debate centers on the extent to which reform would protect the non-bankruptcy options of junior stakeholders or harm the non-bankruptcy options of senior lenders. In a new paper, “Beyond Options,” we argue that this focus on options is misplaced. Protecting options is neither necessary nor sufficient for advancing the goal of a well-functioning bankruptcy system. What is needed is a regime that cashes out the rights of junior stakeholders with minimal judicial involvement. To illustrate, we propose an “automatic bankruptcy procedure” that gives senior creditors an option to restructure the firm’s debt or sell its assets at any time after a contractual default. Under this procedure, restructuring occurs in bankruptcy, but sales do not. Sales are either subject to warrants (which give junior stakeholders a claim on future appreciation) or are subject to judicial appraisal (which forces senior lenders to compensate junior stakeholders if the sale price was too low). Our proposal can be seen as an effort to design a formalized restructuring procedure that borrows from traditional state law governing corporate-control transactions. We show that this procedure minimizes core problems of current law—fire sales that harm junior stakeholders, delay that harms senior lenders, and the uncertainties generated by judicial valuation, which are exploited by all parties.

The full paper is available here.

The Future of Solvency and Adequate Capitalization Analysis

posted in: Valuation | 0

By Michael Simkovic, Seton Hall University School of Law

Valuation, solvency, and adequate capitalization analyses play a crucial role in corporate reorganization. Courts and bankruptcy professionals have often complained about the expense, delay, subjectivity, and unpredictability inherent in traditional approaches to valuation.

However, newer methods based on market prices for equity, debt, or options and derivatives are supplementing, and in some cases supplanting more established approaches. One proposal is that instead of looking to bond or equity prices, courts should look to credit spreads between corporate and treasury bonds. Because investors could eliminate almost all credit risk by selling a corporate bond and purchasing a treasury bond, the difference in yield between a corporate bond and a treasury bond must compensate investors for the additional risks of non-payment of corporate bonds.

Credit spreads offer a clear indicator of market actors’ expectations about the likelihood of default and the likely losses given default. With a single assumption about recovery rates—which can be grounded in historic data or sometimes backed out from contemporaneous market data—one can reconstruct a daily market estimate of a debtors’ probability of default.

Credit-spread based approaches are faster, less expensive, and more objective than current approaches. An example is provided below using data for Caesar’s Entertainment Operating Company:

 

Figure 1. Caesars risk-neutral market-implied probability of default from CDS and bond spreads (preliminary analysis).

 

The traditional financial analysis performed by the Examiner in Caesars required months of work and only looked at a few specific dates. The preliminary market-based analysis above was completed by a law professor in a few days, and indicates capital adequacy on a daily basis.

If market-based approaches to solvency analysis could be used with confidence in many large corporate bankruptcy cases, the collective savings to debtors’ estates over a decade could easily be in the tens of millions of dollars.

 

Earnings Management and Firm Value in Chapter 11

posted in: Valuation | 0

Timothy C.G. Fisher, University of Sydney

Ilanit Gavious, Ben-Gurion University of the Negev

Jocelyn Martel, ESSEC Business School & THEMA

 

Earnings management occurs when managers deliberately manipulate the company’s earnings either to mislead stakeholders about the underlying economic performance of the company or to influence contractual outcomes. We study the impact of earnings management prior to bankruptcy filing on the passage of firms through Chapter 11.

Using the UCLA-LoPucki Bankruptcy Research Database, we merge a sample of 261 U.S. public firms that filed for Chapter 11 between 1995 and 2009 with firm-level financial information. We construct three measures of earnings management, two of which are accounting (accrual) manipulation measures (discretionary accruals and abnormal working capital accruals) and one a real activities manipulation measure (abnormal operating cash flows).

We find that upward earnings management (more positive or less negative abnormal accruals/operating cash flows) prior to filing significantly reduces the likelihood of confirmation, while downward earnings management significantly increases the likelihood of confirmation. We also find that the likelihood of emerging from Chapter 11 is significantly lower with upward earnings management. The impacts on confirmation and emergence are primarily due to the influence of earnings management values that are one- and two-standard deviations above or below the mean. Thus, our findings are consistent with creditors rewarding unduly conservative earnings reports while punishing overly optimistic earnings reports. We also find that auditor choice (Big 4 vs. non-Big 4) directly affects the probability of confirmation and of emergence from bankruptcy.

Overall, we find that upward management of earnings destroys economic value by making the survival of the firm less likely, an effect that has not previously been uncovered in the literature.

To access the full article, please click here.

Genco: Dry Bulk Shipping Valuations No Longer Anchored to Discounted Cash Flow Method

posted in: Valuation | 0

By Gabriel A. Morgan, Weil Gotshal LLP

PITCH_Morgan_Gabriel_22091Discounted cash flow analysis is a mainstay among the valuation methodologies used by restructuring professionals and bankruptcy courts to determine the enterprise value of a distressed business. Despite its prevalence, the United States Bankruptcy Court for the Southern District of New York recently concluded that the DCF method was inappropriate for the valuation of dry bulk shipping companies. In In re Genco Shipping & Trading Limited, Case No. 14-11108 (Bankr. S.D.N.Y. July  2, 2014), the bankruptcy court explained that the DCF method is of limited use when projections of future cash flows are unreliable or difficult to ascertain.  The bankruptcy court then found that accurate cash flow projections did not exist for Genco because dry bulk shipping rates are difficult to forecast due to the volatile nature of the dry bulk shipping market.  Interestingly, the bankruptcy court concluded not just that accurate projections were unobtainable in the case of Genco, specifically, but also for dry bulk shippers, generally.  The bankruptcy court observed that the DCF method is inappropriate for the dry bulk shipping market because it is volatile and highly fragmented, has low barriers to entry, and little differentiation exists among competitors, causing charter rates to fluctuate with supply and demand and making revenues unpredictable.  Although the bankruptcy court merely applied existing law to the facts of the case, the decision in Genco could serve as precedent for the valuation of companies in other segments of the shipping industry, and other industries, that experience significant volatility in rates.

The full discussion can be found here.

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