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 Hertz Maneuver (and the Limits of Bankruptcy Law)
by | posted in: Bankruptcy Reform, Bankruptcy Roundtable Updates, Cramdown and Priority, Priority, Valuation | 0

By Anthony J. Casey (Professor of Law, The University of Chicago Law School), Joshua C. Macey (Assistant Professor of Law, The University of Chicago Law School)

Anthony J. Casey
Joshua C. Macey

On June 11, 2020, the Hertz Corporation attempted to become the first corporate debtor to finance a bankruptcy proceeding by issuing new shares of common stock to the public. Though many thought Hertz’s equity was worthless, its stock was trading at a positive value on the secondary markets, and Hertz was attempting to tap into that market value. When the bankruptcy court blessed the plan, many observers responded with outrage on behalf of retail investors who, they argued, were being duped into a worthless investment. They suggested that the law should prevent retail investors from buying these shares. Ultimately, the Securities Exchange Commission signaled that it had similar concerns and effectively killed the proposal.

This essay explores the questions raised by this incident. It argues that commentators were focused on the wrong bankruptcy problem. Contrary to the view of the commentators, Hertz’s bankruptcy does not show that retail investors require bankruptcy-specific protections. The Hertz maneuver does, however, highlight distortions created by bankruptcy law’s distribution rule, known as the absolute priority rule. That rule cuts off future opportunities for those holding equity (or junior claims) in a debtor firm and makes it difficult for stockholders and unsecured creditors to make long-term investments in the firm’s future value. From this perspective, existing proposals to alter bankruptcy’s priority rules begin to look like a form of investor protection that could facilitate investment in a firm’s long-term value.

The full article is available here.

Secured Creditor’s “Net Economic Damages” Estimate of Disputed Claims “Plainly Insufficient” to Establish Collateral Value
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Valuation | 0

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

Paul M. Green
Mark G. Douglas

Valuation is a critical and indispensable part of the bankruptcy process. How collateral and other estate assets (and even creditor claims) 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. Depending on the context, bankruptcy courts rely on a wide variety of standards to value estate assets, including retail, wholesale, liquidation, forced sale, going-concern, or reorganization value. Certain assets, however, may be especially difficult to value because valuation depends on factors that may be difficult to quantify, such as the likelihood of success in litigating estate causes of action.

The U.S. Court of Appeals for the First Circuit recently addressed this issue in In re Montreal, Maine & Atlantic Railway, Ltd., 956 F.3d 1 (1st Cir. 2020) (“MMA Railway”). The First Circuit affirmed a ruling that a secured creditor failed to satisfy its burden of establishing that collateral in the form of indemnification claims settled by the estate had any value entitled to adequate protection. According to the court, with respect to a disputed claim, a showing of possible damages is not enough. Instead, the creditor must establish the likely validity of the claim and the likelihood of recovery.

MMA Railway is a cautionary tale for secured creditors. Creditors bear the ultimate burden of proof in establishing the value of their collateral under section 506(a) of the Bankruptcy Code—a determination that has important consequences in many contexts in a bankruptcy case. The First Circuit’s ruling highlights the importance of building a strong evidentiary record to support valuation. It also indicates that certain types of collateral (e.g., disputed litigation claims) are more difficult to value than others.

The full article is available here.

COVID-19: Rethinking Chapter 11 Bankruptcy Valuation Issues in the Crisis
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Valuation | 0

By Andrew N. Goldman, George W. Shuster Jr., Benjamin W. Loveland, Lauren R. Lifland (Wilmerhale LLP)

Andrew N. Goldman
George W. Shuster Jr.
Benjamin W. Loveland
Lauren R. Lifland

 

 

 

 

 

 

 

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 full article is available here.

Presumption of Filed Claim’s Validity and Amount Does Not Apply in Proceeding to Determine Secured Amount of Claim
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Valuation | 0

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 | posted in: 363 Sale, Bankruptcy Roundtable Updates, Fiduciary Duties, Valuation | 0

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?
by | posted in: Bankruptcy Administration and Jurisdiction, Financial Firms and Safe Harbors, Valuation | 0

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
by | 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
by | 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
by | 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.

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