Bankruptcy Shopping: Domestic Venue Races and Global Forum Wars

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

Anthony J. Casey
Joshua Macey

The United States Bankruptcy Code gives debtors wide discretion to reorganize in the venue of their choice. These lenient venue selection rules long have allowed bankruptcy courts in the District of Delaware and the Southern District of New York to dominate the market for large Chapter 11 cases, though recently the Southern District of Texas has also begun to attract a large number of cases.

This state of affairs has produced a vigorous debate. Critics of liberal venue rules charge that bankruptcy districts are engaged in a “race to the bottom” as judges compete for blockbuster cases. Others counter that competition for cases improves efficiency and predictability as judges develop expertise in overseeing large Chapter 11 cases.

This Article cautions that developments in foreign jurisdictions may limit the effectiveness of these venue reform proposals. In recent years, foreign jurisdictions have emerged as convenient forums for distressed debtors. For instance, in many cases, the English scheme of arrangement now represents a viable alternative to the American bankruptcy system, and over the past decade, a number of companies have chosen to use an English scheme of arrangement to restructure their debt instead of chapter 11, with the first United States-headquartered business doing so in 2019. Other jurisdictions have also sought to entice foreign debtors, with insolvency specialists speculating that Singapore, in particular, could become a restructuring hub.

Because American bankruptcy courts freely recognize foreign insolvency proceedings, firms that are directed to file in less favored districts may instead choose to reorganize in a foreign jurisdiction. In this environment, attempts to limit venue selection within the United States will have the opposite of their intended effect, replacing domestic venue shopping with even worse global forum shopping. By ignoring the availability of global forums, current venue reform proposals could, perversely, drive opportunistic debtors and creditors to restructure in foreign jurisdictions.

To address this, we argue that, rather than limit domestic venue choice, lawmakers should: (1) support the development of ex ante commitment to mechanisms for choosing venue and forum; and (2) whenever possible, resolve inconsistencies in substantive law across venues and forums. These are general principles of reform, and the implementation will depend on context. For example, commitment mechanisms look different for venue than they do for forum. But, if designed properly, these measures can reduce the costs of venue and forum shopping without giving up the benefits that come from allowing some choice of venue and forum.

It is worth noting that the merits of our proposal are independent of one’s view on the current state of venue shopping. If venue shopping is a real problem, the principles we introduce address that problem. If venue shopping is not a problem, the principles do no harm and even expand the choice set for debtors. Similarly, while the principles address the problem of global forum shopping, the benefits with regard to venue shopping exist with or without global forums. The same cannot be said of the status quo or the reforms currently being considered.

The article can be found here.

The Proceduralist Inversion – A Response to Skeel

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.

My Creditor’s Keeper: Escalation of Commitment and Custodial Fiduciary Duties in the Vicinity of Insolvency

By Amir Licht (Professor, Interdisciplinary Center Herzliya, Israel)

Amir Licht

In several common law jurisdictions, creditors of corporate debtors enjoy legal protections through vicinity-of-insolvency fiduciary duties, beyond what their contracts with those companies afford them.  These duties form a notoriously murky area, where legal space warps.  The contours of this area are fuzzy.  Courts openly acknowledge that it is difficult to identify clear guideposts for its threshold—as to when exactly these duties are enlivened.  In a forthcoming article, I purport to make two main contributions.  First, the article expands the theoretical basis for a special legal regime in virtually insolvent firms by pointing out escalation of commitment as a potent and relevant factor that has been largely overlooked by insolvency scholars.  Second, this article addresses the substantive content of the duty to protect creditors where such duties are recognized.

The standard account that is usually invoked to explain and justify special fiduciary duties to consider creditors’ interest points to the danger of opportunistic high-risk behavior by managers on behalf of shareholders.  I argue that this account may be sound but is nonetheless lacking.  In addition to such risk-shifting opportunism, lawmakers should also be mindful of managers’ tendency to unjustifiably continue failing projects, known as escalation of commitment.  Escalation of commitment refers to a phenomenon, in which people tend to remain married to their original choices and to commit resources to them even when it is no longer rational to do so.  Escalation of commitment is ubiquitous.  It has been observed in organizations large and small, in business corporations and in the public sector.  Escalation of commitment is not only an irrational and emotional personal behavior.  More often than not, it takes place in a broader social context of one’s ingroup—in particular, the board of directors, the organization, and one’s community and culture.

Escalation of commitment poses an equal, if not greater, challenge than risk shifting does to optimal regulation of companies in looming or virtual insolvency.  Being largely detached from rational calculations, escalation of commitment presents a more compelling justification for legal regulation, and a more interventionist one at that.  In this view, managers—especially owner-managers—of virtually insolvent firms may not enjoy the usual level of deference that the law affords to their business judgment in regular times, as their discretion at that point is prone to be clouded by a misplaced motivation to stay the course, weather the storm, and similarly-spirited no-quitting notions.  

Factors that could facilitate de-escalation include better information on costs and benefits of the project, regular evaluation and monitoring of projects, clear criteria for success and minimum target performance levels, and clear feedback about underperforming projects.  Such measures will have limited efficacy, however, if the information they generate is interpreted and acted on by decision-makers who have initiated the failing project and even by different persons who are nonetheless related to those decision-makers.  Change in management is thus essential.

While Delaware law rejects the idea of a pre-insolvency creditor-focused fiduciary duty, several jurisdictions do recognize duties to protect creditors, either as a duty to consider creditors’ interests or as the rule against wrongful (or insolvent, or reckless) trading.  I argue that these duties should be enlivened at the very edge of the zone of insolvency, close to the latter.  At that point, the mission of directors should transform from entrepreneurial to custodial.  That is, they should implement strategies that aim to preserve the firm—in working condition, to the extent possible, with a view to resuming regular business—but avoid seeking new projects with a view to maximizing profits.  This could mean that the shield of the business judgment rule may not be available to the same extent as in regular circumstances.  The Covid-19 pandemic that swept the globe in 2020 provides a fresh context for this approach and underscores the need to implement such a regime sensibly, with high deference to business decisions even if outside the scope of the business judgment rule.  The article concludes with a comparative analysis of creditor-oriented duties in several common law jurisdictions and examines how they could implement a custodial approach.

Chapter 15 and Bankruptcy Credit Events under Credit Default Swaps

By Corinne Ball, George Cahill, Kay Morley, Jay Tambe, Bruce Bennett, & Heather Lennox (Jones Day)

Corinne Ball
George Cahill
Kay Morley
Jay Tambe
Bruce Bennett
Heather Lennox

A recent spate of decisions by the EMEA Determinations Committee (“DC”) has provided clarity on when a chapter 15 filing will trigger a “Bankruptcy” credit event under credit default swaps.  Each of the relevant chapter 15 petitions sought recognition of an English scheme of arrangement, which is not a product of insolvency law and does not necessarily constitute a Bankruptcy, and each underlying scheme was considered narrow enough in scope to not be “with or for the benefit of its creditors generally” (triggering limb (c) of Bankruptcy).  As such, the primary issue in each determination was whether the relief sought in the chapter 15 was similar to a “judgment of insolvency or bankruptcy” and independently triggered limb (d) of Bankruptcy.

The DC found that Thomas Cook’s 2019 petition for recognition of its scheme as a foreign nonmain proceeding, which expressly waived the benefit of the stay courts can impose in such cases, was not similar to an insolvency judgement and did not constitute a Bankruptcy.  On the contrary, it held that Matalan’s August petition seeking recognition of a foreign main proceeding (involving an automatic stay) was similar and triggered a Bankruptcy.  In its October determination regarding Selecta, the DC addressed the intermediate scenario, a petition seeking a stay in connection with a foreign main proceeding, finding that this also triggered a Bankruptcy.  While every situation must be considered on its own facts, these determinations should prove instructive on when a chapter 15 filing will trigger a Bankruptcy credit event.

Disclaimer Statement: “The views and opinions set forth herein are the personal views or opinions of the authors; they do not necessarily reflect views or opinions of the law firm with which they are associated.”

The full article is available here.

Delaware Bankruptcy Court Rules That Midstream Gathering Agreements Failed to Create Covenants Running with the Land

By Duston K. McFaul & Juliana Hoffman (Sidley)

Duston K. McFaul
Juliana Hoffman

On October 14, 2020, the honorable Christopher Sontchi, Chief Judge of the Delaware Bankruptcy Court, issued an opinion in the Extraction Oil and Gas bankruptcy case finding that certain oil, gas and water gathering agreements (the “Agreements”) did not create covenants running with the land under Colorado law and are thus subject to rejection in Extraction’s chapter 11 proceedings. The Bankruptcy Court applied Colorado law, which requires that the following three elements be satisfied: (1) the parties must intend to create a covenant running with the land; (2) the covenant must touch and concern the land with which it runs; and (3) there must be privity of estate between the covenanting parties. The Bankruptcy Court analyzed these elements relative to the debtor’s leasehold interest.

The Extraction decision is the Delaware Bankruptcy Court’s first published foray into a recent thicket of gathering agreement litigation that was reignited in 2016 with the Bankruptcy Court for the Southern District of New York authorizing the rejection of certain gathering agreements in the Sabine Oil & Gas bankruptcy case. Following Sabine, various oil and gas producers in chapter 11 attempted to use Sabine as a basis for invalidating dedications and shedding minimum volume and other commitments in their own gathering agreements. Such efforts were rebuffed in 2019 by the Colorado Bankruptcy Court in Badlands and by the Bankruptcy Court for the Southern District of Texas in Alta Mesa, each of which analyzed the elements of the asserted covenants running with the land relative to the debtor’s leasehold interest.  The courts in Badlands and Alta Mesa each found that the agreements at issue created valid real property covenants under applicable state law and were thus not executory contracts that could be rejected in bankruptcy.

The Extraction case diverged from Badlands and Alta Mesa in its narrow holding, which analyzed the purported covenants in the context of only the debtor’s mineral estate, and ultimately concluded the midstream agreements did not contain an enforceable covenant running with the land.  The Extraction rulings are currently on appeal before the Delaware District Court.

The full article is available here.

Lawyer Networks and Corporate Bankruptcies

By Vidhan K. Goyal (Hong Kong University of Science and Technology), Joshua Madsen (Carlson School of Management, University of Minnesota), and Wei Wang (Smith School of Business, Queen’s University)

Vidhan Goyal
Joshua Madsen
Wei Wang

Does having a lawyer who has previously interacted with the judge matter for bankruptcy outcomes? While knowledge obtained through past interactions about the judge’s views and preferences could improve the efficiency of court process, lawyer familiarity with the judge could also result in a capture of economic rents, leading to delays due to the difficulties in measuring lawyer efforts. Furthermore, connected lawyers could also exploit their connections to obtain biased outcomes in favor of their clients.

We examine these questions in the context of corporate bankruptcies by assembling a comprehensive dataset that contains detailed biographical information, professional experiences, and past in-court interactions of 162 bankruptcy judges overseeing 650 large Chapter 11 cases from 1996–2013, and 2,426 unique lawyers from 775 law firms representing those cases as debtor’s counsel. Our results show that cases with a lead counsel lawyer connected to the judge spend 16–21% less time in bankruptcy, a 2.6–3.5-month reduction in bankruptcy duration, translating into aggregated savings of $3.2–4.5 billion in professional fees for our sample firms.

Our empirical strategy exploits a setting where lead counsel lawyers are selected by the firm before the bankruptcy is filed and thus the assignment of a judge, minimizing concerns that connected lawyers are endogenously hired. The results are robust to the inclusion of controls for case complexity, industry effects, lawyer’s expertise, law firm quality, and judges’ fixed characteristics. Our specifications therefore ensure that any effect from having a connected lawyer is not due to unobserved heterogeneity that is specific to courts, judges, or lawyers.

We further document that the most effective lead counsel connections arise through previous clerkships and in-court interactions with the judge assigned to the case. The effects concentrate in cases with smaller legal teams where connected lawyers presumably have more influence. Having a connected non-lead counsel lawyers’ or connected lawyer representing the unsecured creditors committee only weakly affects case duration.

Lastly, we investigate other bankruptcy outcomes, including the probability of emergence, the bankruptcy refiling rate, operating performance post emergence, the likelihood of a Chapter 7 conversion, and the likelihood of loss of exclusivity extension. We find no evidence that the faster restructurings come at a cost of higher refiling rates or poorer operating performance after emergence. More importantly, there is no evidence that connections lead to judge favoritism or pro-debtor biases.

How do connected lawyers accelerate the bankruptcy process? The most likely explanation is connected lawyers’ knowledge of a judge’s preferences. Judges are extremely busy, and must devote enormous effort to keep straight all the facts and legal nuance under consideration. Connected lawyers are plausibly more familiar with the assigned judge’s preferences and expectations as well as the cases, legal precedents, and statutes that the judge will rely on. They can exploit this knowledge to help the “light shine through.” Idiosyncrasies across judges and their preferences imply that lawyers’ experience with other judges may not be as useful as a connection to the assigned judge and that there is likely no one “magic bullet” used by all connected lawyers. That is, lawyers’ knowledge of judges’ preferences are largely non-transferrable. These findings have implications for the design of bankruptcy institutions, where institutions that lead to lawyers’ increased awareness of a judge’s preferences could produce efficiency gains.

The full article is available here.

Germany Poised for Big Step Towards Corporate Restructuring Best Practice

By Sacha Luerken (Kirkland & Ellis)

Sacha Luerken

Germany’s insolvency law has only in very few cases – around 1% of filings – been used for a Chapter 11-style going concern restructuring of a debtor company. Initiatives to introduce processes like the scheme of arrangement, an English procedure that was also commonly used to restructure non-English companies and is capable of Chapter 15 recognition in the U.S., were not successful, even though recoveries for unsecured creditors in Germany are remarkably low compared to other jurisdictions.

A paradigm shift occurred when the EU in June 2019 passed its directive 2019/1023 on preventive restructuring frameworks, which requires all EU member states to introduce a restructuring process for companies in financial difficulties, but before an actual insolvency. On September 18, 2020, a draft law was presented to introduce a scheme-like procedure in Germany, which provides for a restructuring of selected liabilities with 75% majority by amount in class, a cross-class cram-down subject to tests similar as in a U.S. Chapter 11 proceeding, a court-approved stay on enforcement and collateral realization, and even a rejection of onerous contracts by the court.

The draft law has been welcomed as a big step towards a restructuring culture in Germany by many advisors and practitioners, and as a potential blueprint for the implementation of the EU directive in other European jurisdictions.

The full article is available here.

Reprinted with permission from the October 06, 2020 edition of the Law.com International 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.

Special Considerations for Protecting Interests under Water Agreements in Bankruptcy

By Rahul D. Vashi, Anna G. Rotman, Chris Heasley, Shubi Arora, Kenneth A. Young, Fraser F. Wayne, and John C. Elkins (Kirkland & Ellis)

Rahul D. Vashi
Anna G. Rotman
Chris Heasley
Shubi Arora
Kenneth A. Young
Fraser F. Wayne
John C. Elkins

Midstream service providers in the oil and gas space typically expend substantial upfront capital investment to build pipeline systems to gather and transport hydrocarbons and produced water for oil and gas producers, and rely on the fee structures in their service contracts to recoup their investments. One common method used by midstream companies to protect their investments is to create (or attempt to create) in their service contracts a dedication of production from the oil and gas producer structured as a covenant that runs with the land.

Beginning with Sabine Oil & Gas Corp. v. HPIP Gonzales Holdings, LLC (In re Sabine Oil & Gas Corp.), 567 B.R. 869 (S.D.N.Y. 2017), bankruptcy courts have delivered divided opinions on whether midstream gathering and transportation contracts can be rejected, resulting in substantial uncertainty about whether midstream service providers can rely on their contractual terms. The major decisions regarding the treatment of midstream contracts in bankruptcy have focused on contracts for the gathering and transportation of hydrocarbons, and whether the contracts should not be rejectable because the oil and gas producer properly granted to the midstream company a covenant running with the land in its oil and gas properties.

Providers of produced water gathering and transportation services have typically relied on the same contractual protections as those that provide hydrocarbon gathering and transportation services. However, to date, midstream water contracts purporting to contain covenants running with the land have not been tested, and there is reason to believe that such agreements may be treated differently than their oil and gas counterparts. This article discusses certain issues and considerations that are specific to midstream water agreements and may affect whether such agreements are determined to be rejectable under the Bankruptcy Code.

The full article is available here.

When Arbitration Meets Bankruptcy: Considering Arbitration Options in the Wake of a Growing Rise in Corporate Insolvencies

By Shana A. Elberg, Christine A. Okike, & Jennifer Permesly (Skadden)

Shana A. Elberg
Christine A. Okike
Jennifer Permesly

The economic hardships brought about by the COVID-19 pandemic have impacted companies globally, leading many to consider both in-court and out-of-court restructurings. This trend will likely continue as the long-term effects of COVID-19 play out, and companies with arbitration clauses in their commercial agreements may wish to consider the impact of insolvency on their options for pursuing pending or future arbitrations. Under bankruptcy law, the initiation of insolvency proceedings results in an automatic stay of all civil proceedings brought against the debtor, including claims brought in arbitration. An arbitration counterparty may ask a bankruptcy court to lift the stay, which the court is permitted to do under the Bankruptcy Code “for cause.” The decision to lift the stay is ultimately a matter of the bankruptcy court’s discretion, though federal circuit courts have held that a stay of an arbitration involving a noncore matter generally must be lifted. The balance is particularly weighted in favor of arbitration in the international context.   Although the stay of arbitration is intended to apply extraterritorially, it is not always clear that arbitration tribunals seated outside the US, or counterparties located outside the US and not subject to the bankruptcy court’s jurisdiction, will consider themselves bound by the stay.  Companies considering their options for pursuing cross-border arbitrations against an insolvent debtor must therefore consider the relevant laws in at least three regimes: the seat of the arbitration, the place in which the debtor has declared insolvency and any countries in which enforcement of the award may ultimately be sought.

The full article is available here.

The New Mass Torts Bargain

By Samir D. Parikh (Lewis & Clark Law School)

Samir D. Parikh

Mass torts create a unique scale of harm and liabilities. Corporate tortfeasors are desperate to settle claims but condition settlement upon resolution of substantially all claims at a known price—commonly referred to as a global settlement. Without this, corporate tortfeasors are willing to continue with protracted and fragmented litigation across jurisdictions. Global settlements can be elusive in these cases. Mass torts are oftentimes characterized by non-homogenous victim groups that include both current victims and unknown, future victims—individuals whose harm has not yet manifested and may not do so for years. Despite this incongruence, the claims of these future victims must be aggregated as part of any global settlement. This is the tragedy of the mass tort anticommons: without unanimity, victim groups are unable to access settlement resources in a timely or meaningful way, but actual coordination across the group can be impossible.

Current resolution structures have proven ill-equipped to efficiently and equitably address the novel challenges posed by mass torts. Many cases cannot satisfy Rule 23’s requirements for class action certification. Multidistrict litigation is the most frequently invoked resolution structure, but the MDL process is distorted. The process was initially designed for one district court to streamline pretrial procedures before remanding cases for adjudication. Instead, MDL courts have turned into captive settlement negotiations. In response, a new strategy for resolving modern mass torts has emerged. Corporate tortfeasors—including Purdue Pharma, Boy Scouts of America, and USA Gymnastics—have started filing for bankruptcy. These mass restructurings automatically halt the affected MDL cases and transfer proceedings to a bankruptcy court—a process I describe as bankruptcy preemption. Unfortunately, bankruptcy preemption replaces one deficient structure with another. Mass restructuring debtors are exploiting statutory gaps in the bankruptcy code in order to bind victims through an unpredictable, ad hoc structure. The new bargain creates myriad risks, including insolvent settlement trusts and disparate treatment across victim classes.

This Article is the first to attempt a reconceptualization of how modern mass torts should be resolved and delivers an unprecedented normative construct focused on addressing anticommons dynamics through statutory amendments to the Bankruptcy Code. These changes, coupled with an evolved perspective on fundamental structural anomalies, are designed to improve predictability, efficiency, and victim recoveries. More broadly, this Article attempts to animate scholarly debate of this new, non-class aggregate litigation strategy that will reshape the field.

The full article is available here.

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