In Insys Liquidation Trust v. MeKesson Corporation (In re Insys Therapeutics, Inc.), No. 21-50176 (JTD), No. 21-50176, 2021 WL 3083325 (Bankr. D. Del. July 21, 2021), the United States Bankruptcy Court for the District of Delaware reminded practitioners to exercise caution when analyzing the scope of protections offered by critical vendor orders. The order at issue in Insys Therapeutics provided that “[t]he Debtors are authorized, but not directed . . . to maintain and administer the Customer Programs” and that “[n]othing contained . . . in this Final Order is intended to be or shall be construed as . . . (c) a waiver of any claims or causes of action that may exist against any creditor or interest holder.” These common provisions proved critical in the Court’s holding that “something more is required” to insulate critical vendors from preference liability.
In the opinion, the Court denied a motion to dismiss the complaint brought by a group of critical vendors for three reasons. First, the Court held that preferential payments that occur before the entry of a critical vendor order cannot be protected by a subsequent authorization to pay outstanding prepetition claims unless specifically provided in the order. Second, the permissive language of the critical vendor order did not support the vendors’ claim that the prepetition payments would necessarily have been authorized had they been made postpetition. Third, the critical vendor order expressly preserved the estates’ claims against critical vendors. Additionally, the Court analyzed and rejected application of the limited “critical vendor defense.”
The article discusses the Court’s holding in greater detail and offers practical considerations for practitioners. The full article is available here.
By Diana Bonfim (Banco de Portugal; Catholic University of Portugal – Catolica Lisbon School of Business and Economics) and Gil Nogueira (Bank of Portugal – Research Department)
How does corporate reorganization affect labor outcomes in bankruptcy? The existing literature argues that corporate reorganization affects the reallocation of labor because it retains workers in bankrupt firms. In some cases, bankrupt firms remain alive for too long and retain workers inefficiently. In other cases, reorganization reduces the probability of inefficient liquidation.
In this paper we show that resource retention is not the only determinant of labor outcomes in bankruptcy. The decision process in bankruptcy creates a principal-agent problem between firms’ claimholders and other stakeholders (e.g., workers, suppliers). Claimholders decide bankruptcy outcomes but other stakeholders with limited say in the bankruptcy process are also affected by these outcomes.
Workers are among these stakeholders. They use job contracts with firms as a form of insurance in times of adversity. In the absence of corporate reorganization, workers lose these job contracts and experience persistent costs of job loss. Reorganization improves labor outcomes because it reduces the probability that workers lose the insurance provided by job contracts when the costs of job loss are high.
We test this hypothesis empirically using data from Portuguese reorganization cases. The institutional setting has several features that help design an adequate empirical strategy. First, reorganization cases are randomly allocated across judges. We use this random assignment as a source of variation in the probability of reorganization that is not affected by other factors that also influence workers’ careers. Second, Portuguese firms report financial statements annually, which we use to check whether reorganization affects labor reallocation to more productive or profitable firms. Finally, we link this data to a rich administrative employer-employee matched dataset, which allows us to track workers who eventually change jobs. This dataset is unique because it contains rich job descriptors. We use this data to establish a relationship between corporate reorganization and the scarring effect of bankruptcy on workers’ job functions.
We uncover three main findings. First, we measure the effect of corporate reorganization on the sorting of workers to productive and profitable firms. In five years, only about 20% of the workforce remains in reorganized firms. Many workers from reorganized firms find jobs with new employers. We find no evidence that reorganization affects the reallocation of labor to efficient or profitable firms.
Second, reorganization is an important source of labor insurance against negative productions shocks. In the short term, reorganization increases the probability that workers are employed. In the long term, reorganization increases wages and reduces the scarring effect of job downgrading that is often observed in recessions. Reorganization reduces the probability that workers move to less skill-intensive occupations and increases occupation wage premia.
Third, we show that reorganization improves job transitions to new employers. Reorganization increases the average time it takes to leave a firm that files for bankruptcy by one year. Reorganization reduces the probability that workers move to low-paying jobs and increases the probability that workers find high-paying jobs with new employers.
Overall, our results show that corporate reorganization is an important source of labor insurance in bankruptcy, thereby mitigating the scarring effect of job loss. The full article is available here.
A debtor can elect to either assume or reject an executory contract under section 365 of the Bankruptcy Code. Because the Bankruptcy Code does not define “executory”, courts have historically overwhelmingly applied the “Countryman” test – which asks whether the contract parties have remaining unperformed obligations such that the failure of either party to complete performance would constitute a material breach of the agreement – to determine if a contract is executory. In a recent decision, however, Judge Laura T. Swain, the district court judge presiding over the 2017 Puerto Rico Oversight, Management, and Economic Stability Act proceedings, declined to utilize the Countryman test and adopted the alternative “functional approach” to determine whether the agreements at issue were executory. The “functional approach” focuses on the post-petition benefit to the debtor from assumption or rejection of a contract instead of the pre-petition obligations under the contract. The decision is the latest among a string of recent cases that have relied on non-Countryman tests to determine whether a contract is executory, with the “functional approach” emerging as the prevailing alternative. Read the full article here.
By Dan B. Prieto (Jones Day) and Mark G. Douglas (Jones Day)
In In re Fencepost Productions Inc., 629 B.R. 289 (Bankr. D. Kan. 2021), the U.S. Bankruptcy Court for the District of Kansas recently addressed the enforceability of a provision in a pre-bankruptcy subordination agreement under which a subordinated creditor assigned to a senior creditor its right to vote on any chapter 11 plan proposed for the borrower. The bankruptcy court ruled that such a provision is not enforceable because it conflicts with the Bankruptcy Code. In a twist, however, the court concluded that the subordinated creditor lacked “prudential standing” to participate in the confirmation process because it was extremely out-of-the-money and therefore had no stake in the outcome of the case, but was attempting to assert the rights of third parties.
Courts disagree over whether an assignment of plan voting rights in an intercreditor or subordination agreement is enforceable. Regardless of the particular approach adopted by a court on this issue, the growing consensus is that agreements that seek to limit or waive junior creditors’ voting rights must contain express language to that effect. The ruling in Fencepost adds yet another chapter to the ongoing debate on this issue.
The Fencepost court’s conclusion that the subordinated creditor lacked prudential standing would appear to be driven in part by the facts of the case, which involved a subordinated, clearly out-of-the-money creditor intent upon impeding an otherwise consensual reorganization.
The Bankruptcy Code, however, expressly provides to the contrary by, among other things, giving every “party in interest” (including creditors and interest holders, without making an exception in cases where there is no value available for distribution to them), the right to appear and be heard “on any issue” in a chapter 11 case, the right to vote on a chapter 11 plan, and the right to object to confirmation of a plan. These provisions arguably indicate that Congress intended to modify or abrogate prudential standing requirements when it enacted the Bankruptcy Code. Moreover, the “rights” any out-of-the-money creditor or shareholder would be seeking to enforce by participating in the confirmation process are arguably their own, rather than the rights of third parties.
A logical extension of the rationale articulated in Fencepost is that clearly out-of-the-money creditors or shareholders of an insolvent corporation would never have prudential standing to participate in the chapter 11 plan confirmation process. That approach would be contrary to court rulings and general practice in many chapter 11 cases.
The ongoing economic crisis caused by the COVID-19 pandemic has generated important proposals for addressing countries’ financial distress in the short to medium term. However, it has also made even more apparent the existing gaps in the global financial architecture writ large and highlighted the extent to which key actors pay closest attention to this infrastructure in situations of crisis. By then, of course, it is already too late.
This essay argues that the international community should use the energy generated in the current context to move toward ‘disaggregated sovereign bankruptcy’—which can be understood as a framework by which multiple processes at varying levels simultaneously support or instantiate a shared set of sovereign debt resolution principles and commitments. Such an approach moves beyond overly simplistic and binary framings of market-based versus statutory options, and instead conceives of improvements in the contractual realm, in the multilateral arena, and at the level of domestic legislation as complementary rather than competitive. The essay also clarifies that the explicit embrace of a more disaggregated framework for implementing debt resolution principles need not be disorganized. It argues in favor of establishing an international body purpose-built to recommend, coordinate, and facilitate steady, incremental progress in the architecture for dealing with sovereign debt across multiple vectors. Advocates of more rational debt restructuring should take steps now to adopt an infrastructure that would make future debt crises less severe and perhaps less likely—even when the spotlights are directed elsewhere.
By Steven T. Kargman (Kargman Associates/International Restructuring Advisors)
Venezuela is facing a veritable perform storm: a major humanitarian crisis, a collapsing economy, a sovereign debt crisis, and a political stalemate between the ruling Maduro regime and the opposition. Yet, if and when Venezuela tries to come to terms with these very serious challenges (probably under the auspices of a new Venezuelan government), Venezuela will first and foremost need to address the pressing social needs of the Venezuelan people, but it will also need to undertake the monumental task of rebuilding its national economy and restructuring its sovereign debt that has been estimated to be $150 billion or more.
In a new article entitled “Venezuela: Prospects for Restructuring Sovereign Debt and Rebuilding a National Economy Against the Backdrop of a Failing State,” I discuss the prospects for a sovereign debt restructuring as well as the major legal and policy challenges associated with a program of sovereign debt restructuring and national economic reconstruction. For any future sovereign debt restructuring, Venezuela will need to consider employing a broad range of restructuring tools, both old and new. Further, for any future economic reconstruction effort, Venezuela will need to consider strategies for rebuilding its national oil industry as well as strategies for diversification of its economy.
The article originally appeared in AIRA Journal, Vol. 34, No. 2 (May 2021) and is reprinted with the permission of its publisher, the Association of Insolvency & Restructuring Advisors (AIRA). The article can be found here. (The article was first posted on the CLS Blue Sky Blog of Columbia Law School (May 18, 2021) and is cross-posted here with the permission of the CLS Blue Sky Blog.)
By Steven T. Kargman (Kargman Associates/International Restructuring Advisors)
A new article entitled “The COVID-19 Pandemic and Emerging Market Restructurings: The View One Year Later” provides an overview of the challenging economic landscape that continues to face many emerging economies in the wake of the COVID-19 pandemic, and it also discusses current sovereign debt restructuring and corporate debt restructuring issues in the emerging economies.
The article provides an analysis of sovereign debt restructuring situations involving a serial defaulter (Argentina) and failing states (Venezuela and Lebanon). It also reviews the sovereign debt restructuring travails of an African state, Zambia, that may have implications for future sovereign debt restructurings in Sub-Saharan Africa in light of the intercreditor tensions that arose in the Zambian case between Chinese creditors and bondholders.
Even though corporate defaults in the emerging economies were fairly muted over the last year, many observers expect a surge of corporate defaults, restructurings, and non-performing loans (NPLs) in the emerging economies and developing countries in the coming years, particularly as the special COVID-related responses of governments come to an end. Nonetheless, if and when there is a sharp increase in insolvencies in emerging market jurisdictions, this could pose a major problem for the court systems in the emerging economies and developing economies given the limited capacity of many of these systems to deal with a large volume of cases. Thus, there may well be a need for greater reliance on out-of-court restructurings to address this expected surge in insolvency cases in the emerging economies and developing countries.
The article originally appeared in International Insolvency & Restructuring Report 2021/22 and is reprinted with the permission of its publisher, Capital Markets Intelligence. The article can be found here.
By Stewart B. Herman (Katten) and Timothy J. Lynes (Katten)
In King v. Bombardier Aerospace Corporation et al., the trustee sought under 11 U.S.C. §§ 547(b) and 550(a) to have the lessor disgorge rent that the debtor lessee had paid to the lessor under an English-law aircraft lease during the prepetition preference period using funds advanced to the debtor by its shareholder. Pursuant to §547(b), the trustee argued that the debtor had made the payment for an antecedent debt; the loan balance on what was alleged to be disguised secured financing rather than a true lease. The lessor asserted (i) the trustee had not sufficiently shown the nature and amount of the antecedent debt as required under § 547(b)(2), (ii) under § 547(c)(4) the lessor had provided the debtor subsequent new value after the debtor made the payment, (iii) under § 547(c)(2) that the debtor had made the payment in the ordinary course of business, and (iv) that under the earmarking doctrine the payment should not be clawed back because the payment had been funded by a loan from a third party (the debtor’s shareholder). The court found (i) the trustee had not satisfactorily shown the nature and amount of the antecedent debt, (ii) the lessor had sufficiently shown it added subsequent new value to the debtors, (iii) the lessor had not sufficiently shown the payment was in the ordinary course of business, under either the subjective test or the objective test, and (iv) the lessor had not sufficiently shown facts to support an earmarking defense. The article concludes by offering suggestions for structuring leases to survive preference claims. The full article is available here.
By Laura N. Coordes (Associate Professor of Law, Arizona State University – Sandra Day O’Connor College of Law)
The United States and Canada have both seen significant litigation over the treatment of environmental obligations in bankruptcy proceedings. Both countries also have robust regulatory and statutory frameworks with respect to bankruptcy and environmental law, making the two jurisdictions ripe for comparison.
Although the U.S. legal landscape differs somewhat from Canada’s, courts in both countries have struggled to sort out the treatment of environmental obligations in bankruptcy. However, in 2019, the Supreme Court of Canada decided Orphan Well Association v. Grant Thornton Limited (“Redwater”), which characterized environmental obligations, not as claims, but as duties owed to the public that could not be compromised in bankruptcy. Meanwhile, U.S. courts continue to grapple with the question of how to treat a company’s environmental obligations in bankruptcy.
This article analyzes the impact of Redwater and highlights issues that U.S. scholars and policymakers should consider as they press for changes. In particular, the article focuses on three questions: (1) What is the role of the legislature as compared to the judiciary? (2) What is the role of federal law, as compared to provincial or state law? and (3) What is the role of the public interest?
These three questions implicate debates that go beyond the immediate issue of the role of environmental law in bankruptcy proceedings. However, considering environmental and bankruptcy law in light of these universal issues illuminates unresolved tensions that both the U.S. and Canada will likely continue to face on a larger scale.
By Sheila C. Neder Cerezetti (Professor of Law, University of São Paulo Law School)
As argued by prominent Brazilian scholars, some of the most relevant attributes of the corporate form – limited liability and asset partitioning – might be considered just a tale in Brazil, as they have been consistently and subsequently weakened by a variety of reasons.
In light of this and of the large number of corporate reorganization cases involving groups of companies, which gave way to a series of unsubstantiated applications of substantive consolidation, the article raises the debate on the correct use of the mechanism in the country.
I question whether the lenient approach to substantive consolidation by Brazilian courts (i) is a natural consequence of the weakening of limited liability and asset partitioning, and (ii) represents a better way to recognize the Brazilian corporate reality, bringing more truth to reorganizations.
In the attempt to answer these questions, the article introduces the basic aspects of corporate reorganization in Brazil, offering a comprehensive overview of the Brazilian Bankruptcy Act (Law No. 11,101/2005). The description addresses the broad use of procedural and substantive consolidation even if, at the time, the Brazilian Bankruptcy Act lacked provisions for proceedings with multiple debtors. It shows that the permissive approach first directed to procedural consolidation slowly unraveled into a silent acceptance of substantive consolidation.
Next, the article explores some of the uses of substantive consolidation in the USA (where the mechanism started and gained traction) and in the UNCITRAL Legislative Guide on Insolvency Law (an important indicator of what might be adopted in other jurisdiction in the future), with a brief reference to the status of the matter in the European Union. In these cases, a set of prerequisites have been established to determine when the exceptional measure of the mechanism is appropriate.
In contrast, I call a misuse the often-unsubstantiated acceptance of substantive consolidation in Brazil, that fails to note its exceptionally. In the vast majority of cases, substantive consolidation actually happened in proceedings where none of the parties and not even the court expressly addressed the issue and implicitly just treated a single plan as something normal, although it mixed assets and liabilities of different debtors. And in those cases where the matter has been expressly addressed, the criteria for ordering the consolidation (i) varied greatly, to the point that it could not be rationalized in the form of a test, and (ii) failed to treat the remedy as an exceptional tool.
In light of the mentioned “tale of limited liability in Brazil”, one could wonder if such a misuse of substantive consolidation is in fact inappropriate. However, I argue that this tale is not so severe as to justify the lenient approach described, in view of the rules on corporate groups as well as of the fact that strictly commercial and civil relationships are, for the most part, protected from the exceptions to limited liability.
The article contends that there still is a compelling case for a stricter use of substantive consolidation, considering, among other reasons, that accepting the lenient criteria for ordering substantive consolidation would mean further weakening the attributes of the corporate form. It concludes by pointing to other tools in bankruptcy law that can better deal with the exceptions to the limitation of liability, and argues that substantive consolidation should remain a remedy for abuses of the corporate form that turn it dysfunctional.
Finally, it should be noted that a recently approved bill included provisions on procedural and substantive consolidation in the Brazilian Bankruptcy Law, ratifying the lenient approach described in the article. The article also serves as an explanatory description of the pathways that led the Brazilian legal system to such a discipline and as a warning about the perils of following this route.