By Laura Smith (Norton Rose Fulbright)
The Dubai International Financial Centre (the “DIFC”), one of the leading international financial hubs in the Middle East, Africa and South Asia (the “MEASA”) region, has recently announced the enactment of the new DIFC Insolvency Law, Law No. 1 of 2019 (the “New DIFC Insolvency Law”), which became effective in June 2019. Importantly, the New DIFC Insolvency Law which will repeal and replace the Insolvency Law of 2009 and was the subject of substantial research and global benchmarking introduces a completely new rehabilitation provision for distressed companies in the DIFC in addition to the previously existing procedures such as company voluntary arrangements, receiverships and liquidations. With the goal of promoting the rehabilitation of viable businesses that are part of the DIFC while addressing the continuing needs of the various stakeholders involved, the DIFC made several key changes as part of its enactment of the New DIFC Insolvency Law including: (1) the introduction of a debtor in possession procedure known as rehabilitation; (2) the introduction of a procedure that allows the management of a company to be replaced by a court-appointed administrator when there has been mismanagement of or misconduct by the company or management; (3) enhancing and modernizing existing rules and procedures; and (4) the incorporation of the UNCITRAL Model Law on Cross-Border Insolvency.
The full article is available here.
By Daniel J. Bussel (UCLA School of Law)
The Second Circuit recently issued its revised opinion in Tribune Company Fraudulent Conveyance Litigation, determining that a debtor-transferor that effectuates a transfer involving a securities contract in its capacity as the customer of a commercial bank is itself a “financial institution” within the meaning of the Bankruptcy Code section 101(22)(A) and therefore the transfer is protected under section 546(e).
This ruling has critically important implications for the avoiding powers of the bankruptcy trustee. Section 546(e) insulates all transfers involving securities by or to a financial institution from avoidance except as an “actual fraud” under section 548(a)(1)(A). Virtually all transferors are customers of commercial banks and almost any transfer can be effectuated with funds transferred through the agency or in the possession of a commercial bank. The result is the virtual repeal of the avoiding powers as to any transfer involving securities that is not an actual fraud on creditors, undoing centuries of fraudulent transfer and preference law.
These considerations are powerful enough that the Second Circuit, if necessary in light of the statute’s plain language, should have striven mightily to avoid interpreting the term “financial institution” so as to include the customers of commercial banks. The Code’s avoiding power sections read as a whole make no sense if limited only to cases involving transfers by entities that are not customers of commercial banks. Moreover, such a reading of section 101(22) flies in the face of Merit Management, the recent, directly applicable, Supreme Court precedent.
The full article is available here.
For more posts on the scope of section 546(e), see Ralph Brubaker, Understanding the Scope of the § 546(e) Securities Safe Harbor Through the Concept of the “Transfer” Sought to Be Avoided.
By Samuel Antill (Stanford Graduate School of Business)
In Chapter 11 bankruptcies, a court-supervised negotiation among creditors leads to one of two possible forms of exit, liquidation or emergence. In a liquidation, the bankrupt firm’s assets are sold (piecemeal or in a going-concern sale). Alternatively, if creditors agree to restructure the firm’s liabilities, the firm emerges and continues operating. I estimate a structural model of the choice between emergence and liquidation. In my sample of large-firm bankruptcies, I estimate that creditor recovery was substantially reduced by inefficient decisions to liquidate.
According to the “creditor’s bargain” theory of bankruptcy, the efficient form of exit (liquidation or emergence) from Chapter 11 is that which optimizes total expected creditor recovery. Beyond the importance to creditor recovery, an efficient approach to choosing between liquidation and emergence benefits pre-bankruptcy equity holders through lower costs of credit. The efficient form of exit from bankruptcy should be achieved, under the conditions of the Coase Theorem, by the bargaining among creditors that Chapter 11 is supposed to promote. Without this bargaining, potential coordination failures arise when each creditor pursues the form of exit that maximizes its own payoff.
In contrast to the view that Coasian bargaining in Chapter 11 successfully preserves viable firms, I estimate that inefficient decisions to liquidate are frequent. However, very few of the firms in my sample were inefficiently selected to emerge. I provide an explanation for this asymmetry. Exiting Chapter 11 through a confirmed plan of reorganization requires creditor consent under established voting rules. In contrast, Section 363(b) of the bankruptcy code allows managers to sell assets, or entire firms, without creditor approval. This procedure circumvents the bargaining among creditors that Chapter 11 supposedly promotes. I show that inefficient liquidations are concentrated in cases involving “363 sales.” This statistical association suggests that Section 363(b) enables the sort of coordination failure that Chapter 11 was designed to prevent. For example, these results are consistent with a view that managers may be inefficiently liquidating firms in order to benefit senior lenders or to obtain a job for themselves at a purchasing company.
Finally, I find that inefficient liquidations are largely avoidable. Using my estimated model, I consider the following counterfactual: how would expected creditor recovery change if form-of-exit decisions had been made by a statistical model? In this counterfactual scenario, the courts would hire a statistician to compare the expected potential recovery rates implied by my fitted model and recommend either liquidation or emergence. Each recommendation depends only on data available at the start of a given bankruptcy. I find that such a court statistician could dramatically improve average recovery.
The full article is available here.
By Robert Hockett (Cornell Law School)
The Blackjewel Coal bankruptcy of summer 2019 exposed critical weaknesses in our state-based system of employee creditor protection. Notwithstanding employees’ priority over other unsecured creditors in bankruptcy, and notwithstanding a bonding requirement imposed by the State of Kentucky, Blackjewel’s final round of paychecks paid to employees ‘bounced,’ confronting employees with imminent personal bankruptcies, forgone medical and other services, and even mortgage foreclosure and homelessness.
Happily, ultimate resolution of the Blackjewel case later in autumn saw the employees made whole and the company investigated for fraud. But this solution was anything but assured before it was reached, and employees in any event suffered substantial harm in the form of disrupted family budgets and substantial uncertainty as to ultimate recovery for months – including, critically, just as a new school year was commencing for employee families’ children.
It would seem well advised, then, to put in place a more permanent and reliable process for cases like that of Blackjewel and its employees. What is needed is a solution that is uniformly applicable, reliable, and known in advance such that all concerned parties can bargain and plan ‘in the shadow’ of the regime. Our present arrangements are subject to vagaries of state law and state budgets that vary across state jurisdictional space and fiscal time. The obvious solution to the difficulties raised by such variance is to subject this realm, like that of bankruptcy itself, to federal legislation.
A bill I have recently drafted and advocated aims to ‘fit the bill’ in effect called-for by the Blackjewel affair. It does so by (a) assigning the Department of Labor (‘DOL’) a permanent representation role in future employer insolvencies; (b) federalizing the employer bonding requirements now found only in inconsistently administered state laws; (c) establishing an Employee Liquidity Support Fund to tide employees over while bankruptcy proceedings are pending; and (d) holding employing-firms’ executive officers personally liable for violations of the Act’s requirements.
The reason for DOL representation and oversight is to ensure that employees have a coherent and powerful representative ‘at the table’ during insolvency proceedings – one that is endowed with oversight authority not only during, but in advance of insolvencies.
The reason for federalizing employer bonding requirements is that states often vary over time in respect of the seriousness with which they administer such requirements, presumably in part for reasons sounding in lobbying pressures and ideology but also for reasons of basic capacity – large employers, after all, often are ‘bigger’ than the states that would supervise them.
The reason for establishing an Employee Liquidity Support Fund is presumably obvious. What made Blackjewel’s travails so hard on employees was precisely the fact that ultimate resolution was long in coming, while employee families’ daily living expenses couldn’t ‘wait.’ Against such a backdrop it makes sense for DOL to do for employees what our Federal Reserve does for financial institutions while insolvency and consolidation proceedings are underway – viz., provide tide-over funding.
Finally, the reason for holding executive officers personally liable for compliance with the Act’s requirements should be obvious as well. For again as in the case of financial institutions, so here the only surefire way of ‘incentivizing’ firms to comply is to incentivize those through whom all firms act – their executives, as the term ‘executive’ (derived from ‘execute’) itself suggests. Diffuse shareholders, who often lack power over corporate officers, and insider shareholders, who often have interests at odds with the interests of non-executive employees in any event, simply aren’t up to the task.
Employing firms, their executives and their owners have enjoyed multiple forms of state patronage for decades in our nation, while employees have in general enjoyed only sporadic assistance from public sector institutions and, less now than any time since the early 20th century, labor unions. This Act will help further a cause that’s increasingly now recognized once again to be both morally and economically compelling: That is the task of protecting the interests of our own productive citizenry – our labor force.
The full article is available here.
By Mark G. Douglas and Dan T. Moss (Jones Day)
On July 25, 2019, the Judicial Insolvency Network announced its adoption of the Modalities of Court-to-Court Communication (the “Modalities”), which “apply to direct communications (written or oral) between courts in specific cases of cross-border proceedings relating to insolvency or adjustment of debt opened in more than one jurisdiction.” The Modalities are intended to facilitate implementation of the Guidelines for Communication and Cooperation Between Courts in Cross-Border Insolvency Matters, which since 2017 have been adopted by courts in several countries, including the Supreme Court of Singapore, the U.S. Bankruptcy Courts for the District of Delaware, the Southern District of New York and the Southern District of Florida, and courts in the United Kingdom, Australia, The Netherlands, South Korea, Canada, Bermuda, and the Eastern Caribbean. The U.S. Bankruptcy Court for the District of Delaware adopted the Modalities on an interim basis on July 25, 2019. It is anticipated that other courts will do so as well in the near term.
Mark G. Douglas (Jones Day) summarized key features of the Modalities and other developments since the Guidelines for Communication and Cooperation Between Courts in Cross-Border Insolvency Matters as developed and implemented by JIN (the judicial Insolvency Network) here.
In In re PT Bakrie Telecom Tbk, 601 B.R. 707 (Bankr. S.D.N.Y. 2019), the U.S. Bankruptcy Court for the Southern District of New York provided a primer on several important issues that a court may have to consider in ruling on a petition for recognition of a foreign bankruptcy proceeding under chapter 15 of the Bankruptcy Code. These include the requirement that a foreign debtor have property in the United States before being eligible for chapter 15, the rules regarding the appointment of a “foreign representative” for the debtor, what qualifies as a “collective proceeding” for the purpose of chapter 15 recognition, and the “public policy” exception to recognition. One notable conclusion by the court is that merely because a foreign proceeding has concluded does not prevent the later appointment of a foreign representative.
An examination of all of the issues highlighted by PT Bakrie entails a detailed factual analysis and careful application of the provisions of chapter 15 consistent with its underlying principles and purpose in providing assistance to foreign tribunals overseeing cross-border bankruptcy cases. Dan T. Moss and Mark G. Douglas (Jones Day) provided such a close examination and detailed analysis of the case here.
By David Skeel (University of Pennsylvania Law School)
On June 30, 2016, Congress passed the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”) in response to the economic crisis in Puerto Rico, which was already a decade old at that point and had left Puerto Rico with roughly $70 billion in overall debt and $50 billion of unfunded pension liabilities. PROMESA created a seven-member oversight board (the “Oversight Board”), and authorized the Oversight Board both to certify five (or more) year fiscal plans for Puerto Rico and its public corporations, and to initiate bankruptcy-like proceedings if necessary.
For over three years now, I’ve had the privilege of serving as one of the seven initial members of the Oversight Board. It has been a rocky ride at times, and we have been criticized both from the right (by creditors unhappy with our conclusion the debt needs to be significantly restructured) and from the left (for our conclusion that government reform and right-sizing are needed). The past year has finally brought at least some evidence of progress, although significant obstacles remain before anyone will be able to declare victory.
In this essay, I chronicle the Board’s efforts up to the beginning of last summer, shortly before widespread protests of the former governor led to his resignation. I begin with a brief sketch of the depth of Puerto Rico’s economic distress, which was made far worse by Hurricanes Irma and Maria in 2017, and of the principal responsibilities vested in the Oversight Board by PROMESA. I then survey the major decisions the Oversight Board has made—or in some cases, unsuccessfully tried to make—and the challenges that remain as the current Board members come to the end of our terms (which theoretically ended on August 31, three years after we were appointed, but continue until we are replaced with new members by the President and Congress).
The full article is available here.
By Paul M. Green, Mark G. Douglas (Jones Day)
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.
Vasile Rotaru (Droit & Croissance / The Rules for Growth Institute)
From a functional law and economics perspective, the recent European restructuring directive (the ‘Directive’) brings both welcome innovations and multiple pitfalls. Its final text bears the traces of the divergent objectives and inspirations of its drafters. In a recent paper, I attempt to provide a thorough analysis of the different hidden ‘models’ and important measures of the Directive, as well as its unfortunate oversights.
The first part of the paper lays the theoretical foundations of the subsequent analysis. It has long been argued that insolvency law should pursue two objectives: (i) facilitating debtor’s ex ante access to finance; and (ii) ensuring an efficient ex post distribution of resources in the economy, by restructuring economically viable companies with bad capital structures and swiftly liquidating companies with an unsustainable business. Together, the two should result in wealth maximization, the default (but by no means only) criterion for assessing business law’s merits.
The paper takes a ‘functional’ approach, which is fueled by a deep skepticism towards any extensive cost-benefit analysis. It suggests that the ex ante focus should be on ensuring that a suitable epistemic framework is in place when the decision as to the redistribution of resources has to be taken. This implies incentivizing decision-makers to reliably reveal their preferences and bear the costs of their actions while diminishing coordination failures and potential conflicts of interests. Starting with this intuition, I attempt to reformulate the classical creditors’ bargain theory, underlining that so called ‘preventive’ proceedings are no exception.
In the second part of the paper, I rely on this theoretical framework to provide a critical analysis of the main measures of the Directive. I show that the apparent complexity of its final text (the contemplated proceedings could potentially take more than 70 forms) is owed to its drafters pursuing divergent objectives: economic efficiency or short-term preservation of businesses and jobs at all costs, with an unfortunate bias in favor of the latter (especially concerning SMEs).
Moreover, two coherent formal ‘models’ of proceedings are offered. The first is a unitary, public proceeding, with a potential general moratorium for up to four months. The second is a two-step proceeding—partially inspired by the current French model—that would start with an amicable phase devoid of wide publicity and would be accompanied by individual moratoria granted on a casuistic basis where they seem justified. The second, short and public ‘closing’ phase would be triggered in the specific circumstances where the restructuring plan has to be forced upon dissenting stakeholders. Once a decision has been made as to the objectives and formal model, most of the subsequent transposition options follow.
The Directive implies a devolution of decision-making powers to classes of affected stakeholders, although the court preserves a far too important role. Indeed, stakeholders are in the best position to identify and exploit any restructuring gain. It remains to be seen which criteria will be used to ensure that the interests of members of a class are aligned and no abusive behavior takes place. Where a plan is not approved by all classes of stakeholders, the Directive provides for a cross-class cram-down, where a majority of classes or at least one class of stakeholders who are ‘in the money’ must approve the plan. The latter option could potentially lead to abuses and uncertainties, given the meagre experience of European practitioners with valuations as a going concern. The cram-down can involve a debt-equity swap imposed both on shareholders, who should be treated as any other class of stakeholders and dissenting creditors. This possibility is not trivial, as it forces creditors to continue financing the business, and should be duly justified.
Unfortunately, the contemplated protections of stakeholders’ interests are somewhat underwhelming. For instance, instead of ensuring that all stakeholders share the restructuring gain in accordance with their respective ranks in the capital structure, the Directive provides for a confusing and dangerous ‘relative’ priority rule, which will likely render the negotiations unpredictable, or, alternatively, for an incomplete ‘absolute’ priority rule. Moreover, no protection is provided against debtor’s potentially abusive behavior before the opening of proceedings.
Finally, the paper offers some insights into the expected impact of its transposition into French law. In particular, its last part suggests that any transposition needs to aim at increasing the transparency and predictability of restructuring proceedings in order to foster secondary debt markets, and therefore to ensure that impatient creditors can easily be replaced by those interested in the restructuring gain.
The full article is available here.
Ramin Baghai (Stockholm School of Economics), Rui Silva (London Business School), Luofu Ye (London Business School)
Corporate bankruptcies constitute an important mechanism through which the economy rids itself of obsolete firms and allocates their constituent parts to alternative and potentially more productive uses. This process of reallocation of human and physical capital is an “essential fact about capitalism” (Schumpeter 1942).
While resources may on average be used more productively following a bankruptcy, this process is not deterministic and likely involves various imperfections. In addition to the potential loss in value to the firm’s redeployable physical capital stock (e.g., due to asset fire sales), bankruptcy may involve some deterioration of organizational and human capital. Moreover, frictions in the post-bankruptcy re-allocation of resources across firms may lead capital and labor to be idle for some time or even result in protracted sub-optimal uses. In the case of workers, unemployment spells could also accelerate the depreciation of skills. While prior studies have focused primarily on the reallocation of physical capital and individual workers, we are the first to systematically study how the human capital embedded in teams is affected by corporate bankruptcies.
Teamwork has become a prevalent way of organizing production in science, in patenting, and, more broadly, in the corporate sector. It has been documented, in a variety of settings, that teamwork has substantial benefits compared to work in hierarchical environments, in particular when complex tasks are involved. Despite the importance of teamwork, there is little systematic evidence on the economic drivers affecting the creation, stability, and dissolution of productive team configurations. Understanding these forces is crucial for the design of corporate and public policies that maximize productivity.
In our working paper, we use employer-employee matched data on U.S. inventors to study how the human capital embedded in teams is reallocated in corporate bankruptcies; our data span the period 1980 to 2010. Our results paint a nuanced picture of the reallocation of human capital through bankruptcy. Team dissolution increases around bankruptcy and team inventors subsequently become less productive than their less team-dependent colleagues. However, the labor market and the market for corporate control promote the preservation of team-specific human capital. Therefore, on balance, the productivity losses associated with bankruptcy are modest for team-dependent inventors. In addition, inventors who do not work in teams may even experience an increase in their post-bankruptcy productivity (although these effects have limited statistical significance). This suggests that bankruptcies have the capacity to release resources to more productive uses. Overall, we conclude that frictions that limit the efficiency of asset reallocation through bankruptcy may be limited in the case of highly skilled labor.
The full article is available here.
By Francis J. Lawall and John Henry Schanne II (Pepper Hamilton LLP)
In Ad Hoc Committee of Non-Consenting Creditors v. Peabody Energy Corp., (In re Peabody Energy Corp.), 933 F.3d 918 (8th Cir. 2019), the Eighth Circuit held that a debtors’ Chapter 11 plan complied with Bankruptcy Code Section 1123(a)(4) (which mandates that a plan provide the same treatment to all members of a particular class), despite providing more favorable treatment to creditors that agreed to backstop a rights offering by paying the participating creditors significant premiums and allowing them to purchase preferred stock at a deep discount.
The Eighth Circuit’s decision in Peabody joins decisions from the Second, Fifth and Ninth circuits in ruling that a plan may treat one set of claim holders within a single class more favorably than another so long as the treatment is not for the claim but for distinct, legitimate rights or contributions from the favored group separate from the claim. As bankruptcy cases continue to grow in size and complexity, creative approaches such as that employed in Peabody are certain to be utilized in efforts to salvage businesses in troubled industries.