Federal Antitrust Laws: A New Tool to Prohibit Pre-Petition Coordination Among Creditors?

By Bradley Purcell, Justin Sabin, and Jamila Willis, Bryan Cave LLP

In today’s economic climate, restructuring activity is at a lull. Out-of-court solutions are attractive to financially distressed companies – they avoid the delay, the costs and the uncertainty of formal bankruptcy cases. Indeed, for these very reasons, cooperation between creditors and debtors is common and often encouraged by bankruptcy courts.

Though the Bankruptcy Code contemplates participation by committees of creditors and the goal of maximizing creditor recoveries, a string of recent opinions from the Eleventh Circuit casts doubt on the ability of creditors to lawfully coordinate in their pre-petition negotiations with debtors. In CompuCredit Holdings Corp. v. Akanthos Capital Mgmt., LLC, 916 F. Supp. 2d 1326 (N.D. Ga. 2011), a debtor brought suit against creditors who attempted collective negotiation, alleging violations of Section 1 of the Sherman Act, which prohibits anti-competitive behavior. The Eleventh Circuit’s en banc panel split evenly on whether CompuCredit had an antitrust claim under the Sherman Act based on the creditors’ collective conduct.

While this doesn’t change the bankruptcy landscape, it creates uncertainty in pre-petition negotiations and out-of-court workouts. An aggressive obligor may use the Eleventh Circuit’s en banc ruling and relevant antitrust laws to impede collective, pre-petition negotiation of creditors and quell negotiations and actions by pre-petition or informal committees of creditors.

The full discussion can be found here.

Mind the Gap: Supreme Court Partially Resolves Procedural Uncertainty Created by Stern v. Marshall

By Paul Hessler, Aaron Javian, and Robert Trust, Linklaters LLP

On June 9, 2014, in a highly anticipated decision Executive Benefits Ins. Agency v. Arkison, Chapter 7 Trustee of Estate of Bellingham Ins. Agency, Inc., the U.S. Supreme Court partially resolved the procedural uncertainty created by the Court’s decision in Stern v. Marshall. In Stern, the Supreme Court analyzed the constitutionality of 28 U.S.C. § 157, which in relevant part defines certain matters as “core” or “non-core,” and authorizes bankruptcy courts to finally adjudicate “core” matters, but only to issue findings and conclusions subject to de novo review in “non-core” matters. The Stern Court held that Article III of the U.S. Constitution prohibits Congress from vesting bankruptcy judges with the authority to finally adjudicate certain claims that it had statutorily designated as Javian, AaronLinklaters LLP“core,” such as state law avoidance claims. The Stern Court did not, however, address how bankruptcy courts should proceed in such cases. The Supreme Court considered that procedural question in Executive Benefits and held that with respect to “core” claims that a bankruptcy judge is statutorily authorized but prohibited from finally adjudicating as a constitutional matter, the courts should deal with such claims as they would in “non-core” proceedings; that is, by issuing findings and conclusions subject to de novo review by district courts.

The Supreme Court’s holding makes clear that a wide-range of bankruptcy-related disputes that were previously heard and decided by bankruptcy courts must now be submitted for de novo review by district Trust, RobertLinklaters LLPcourts. This additional layer of judicial involvement could make bankruptcy litigation more cumbersome and casts doubt on the well-established expectation of the bankruptcy court system as the single, consolidated venue for adjudication of all matters related to a debtor’s bankruptcy case. Importantly, the Supreme Court did not decide, and it remains to be seen, whether parties can consent to a bankruptcy court’s final adjudication of core matters that otherwise fall outside of a bankruptcy court’s constitutional authority under Stern. The full memo can be read here.

The Costs of Corporate Bankruptcy: How Little We Know

Author: Stephen J. Lubben, Seton Hall University School of Law

lubben-176x220_1 For almost as long as there have been bankruptcy laws, there have been complaints that the primary beneficiaries of these laws are insiders who administer the bankruptcy system. In recent decades, this line of criticism has carried with it an implicit criticism of bankruptcy courts, which are urged to more aggressively police the costs of bankruptcy. Indeed, at least one recent critic has unkindly suggested that the failure of the courts to control bankruptcy costs is the result of a corrupt bargain between bankruptcy courts and practitioners.

Rarely addressed is why bankruptcy courts regulate professional costs at all. In most areas of American law, a professional is accountable solely to its client. Complaints about excessive cost might result in a separate malpractice action, but a client who thinks they have been overcharged for the defense of their speeding ticket will find little relief in traffic court. Why is bankruptcy different?

This paper begins to look at this question with brief overview of the concept of bankruptcy costs, traditionally divided between direct and indirect costs. I next turn to a consideration of the process for overseeing bankruptcy costs. I briefly trace the history of court control of compensation in corporate bankruptcy, and then detail the current legal structure. The final part of the chapter then surveys the existing understanding of chapter 11 cost, and concludes with a some thoughts on the important questions that remain unanswered.

In short, we know a bit about direct costs, but very little about any other sort of costs. Moreover, what we know is almost entirely lacking in context. This makes it quite hard to understand if the existing system of cost regulation is either useful or justified.

This article is available here.

 

The Value of Soft Variables in Corporate Reorganizations

By Michelle Harner, University of Maryland Francis King Carey School of Law

When a company is worth more as a going concern than on a liquidation basis, what creates that additional value?  Is it the people, management decisions, the simple synergies of the operating business, or some combination of these types of soft variables?  And perhaps more importantly, who owns or has an interest in such soft variables?  These questions are important in all contexts, but hold particular significance in corporate reorganizations where a company’s liabilities frequently exceed the value of its assets.  The value available to satisfy creditors’ claims is limited, and determining the parties’ respective rights to that value is often hotly contested and critical to an effective resolution.  My article, The Value of Soft Variables in Corporate Reorganizations, 2015 Ill. L. Rev. ___ (forthcoming), explores these questions under existing legal doctrine and practice norms.

The basic thesis of the article is that soft variables contribute meaningful value to the operation of a company as a going concern but are often overlooked or undervalued in corporate reorganizations.  Ignoring soft variables not only does a disservice to those working hardest to save the company but also arguably steals value from the company and those constituencies.  If a company’s soft variables do not hold such value, it may indicate that a chapter 7 liquidation is the more appropriate resolution for the company.  But if the company invokes the chapter 11 process and the resolution generates value above liquidation or book value, the court and the parties should identify the relevant soft variables and allocate value accordingly.

A longer summary of the article can be found here, and the full article can be found here.

Bankruptcy’s Corporate Tax Loophole

By Diane Lourdes Dick, Seattle University School of Law

AvvoPhotoMy recent article, Bankruptcy’s Corporate Tax Loophole, 82 Fordham L. Rev. 2273 (2014), explains how corporate debtors use Chapter 11 to divert the value of tax losses and credits to a select group of stakeholders in contravention of bankruptcy’s distributional norms.

The problem stems from an ambiguity at the intersection of federal tax and bankruptcy law. Bankruptcy-specific exceptions in the tax laws transform a corporate debtor’s tax attributes into marketable property that, in many cases, gives the bankruptcy estate its intrinsic value. Yet bankruptcy law’s most vital safeguards neglect to fully take into account these tax assets, leaving them vulnerable to siphoning by dominant stakeholders who are in a position to extract excess returns.

Most notably, the debtor’s valuable tax attributes slip through the cracks of the “fair and equitable” test for contested Chapter 11 plans. The analysis requires, in pertinent part, that the court evaluate whether the plan provides each impaired and dissenting creditor with at least as much as it would have received in a hypothetical Chapter 7 liquidation. But testing a Chapter 11 plan against a hypothetical liquidation naturally omits the debtor’s tax attributes from consideration, as they would be extinguished when the liquidated debtor is subsequently dissolved. This means that the “fair and equitable” analysis ignores the very existence of what may be the debtor’s most valuable asset.

This extraordinary gap not only facilitates inequitable allocations of economic benefits and burdens in Chapter 11 but also causes a much broader, systematic misallocation of resources. I recommend statutory revisions to the federal tax and bankruptcy laws to neutralize the tax consequences of corporate restructuring decisions.

The full-length article can be found here and here. 

Revisiting the Recidivism-Chapter 22 Phenomenon in the U.S. Bankruptcy System

Author: Edward I. Altman, NYU Stern School of Business

Altman bio picThis study finds that about 15% of all debtors, who emerge as continuing entities from reorganization under Chapter 11 bankruptcy, or are acquired as part of the bankruptcy process, ultimately file for bankruptcy protection again. This recidivism rate spikes to 18.25% when considering only those firms which emerge as a continuing, independent entity. This highlights what appears to be a significant recidivism problem of our Chapter 11 system.

This article argues that the so-called “Chapter 22” issue should not be dismissed by the bankruptcy community as acceptable just because no interested party objected to the plan of reorganization during the confirmation hearing. Indeed, by applying the Z-Score model to large samples of Chapter 11 and Chapters 22, 33, and 44 firms, highly different and significant expected survival profiles are shown at the time of emergence. The bond-rating-equivalent of the multi-filing sample was CCC versus a BB-profile for the single-filing Chapter 11 sample. I believe that credible distress prediction techniques can be important indicators of the future success of firms emerging from bankruptcy and could even be used by the bankruptcy court in assessing the feasibility of the plan of reorganization – a responsibility that is embedded in the Bankruptcy Code.

The full article is available here.

 

Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts

By Benjamin Iverson, Kellogg School of Management at Northwestern University

On average, total bankruptcy filings rise by 32% during economic recessions, leaving bankruptcy judges with far less time per case exactly when financial distress is worst.  The inflexible nature of the bankruptcy system coupled with the varying demands placed upon it, leads to the concern that time constraints might limit the effectiveness of bankruptcy when economic conditions deteriorate.

In my paper, “Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts,” I test whether Chapter 11 restructuring outcomes are affected by time constraints in busy bankruptcy courts.  Using the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005 as a shock that decreased caseloads dramatically, I show that as bankruptcy judges become busier they tend to allow more firms to reorganize and liquidate fewer firms.  I interpret this as evidence that busy bankruptcy judges defer to the debtor in possession more often, scrutinizing each case less and thereby allowing reorganization more often.  In addition, I find that firms that reorganize in busy courts tend to spend longer in bankruptcy, while firms that are dismissed from busy courts are more likely to re-file for bankruptcy within three years of their original filing.

Perhaps most striking, I also show that busy courts impose costs on local banks, which report higher charge-offs on business lending when caseload increases.  If time constraints create higher costs of financial distress, it appears that these costs are typically passed on to the creditors of the bankrupt firms in the form of higher losses on distressed loans.

The full-length article can be found here.

 

Essential Corporate Bankruptcy Law

Authors:  Oscar Couwenberg & Stephen J. Lubben

In every economy, the question of what to do with financially distressed businesses is a matter of concern.   The United States has a long history of corporate restructuring law, starting with the reorganization of railroads in the nineteenth century and continuing through chapter 11 in its current form.   This naturally leads to a tendency to adopt chapter 11, or something like it.

But why?  In particular, chapter 11 is a rather ornate system of corporate reorganization, and it has been adorned with elements that reflect little more than particular creditors’ ability to lobby Congress.

We reexamine chapter 11 to understand its core.  In short, what, if any, are the essential elements of corporate bankruptcy law?

We point to two facets of chapter 11:  asset stabilization and asset separation.  These two aspects of chapter 11 could not be established other than by statute, and jurisdictions looking to reform their corporate bankruptcy processes should focus there.

Asset stabilization is the ability to temporarily protect assets as a coherent whole.  It includes obvious things like the stay on individual creditor collection, provision of post-bankruptcy liquidity and delays on termination of contracts with the debtor.

Asset separation captures the ability to separate assets from their concomitant liabilities.  This might take the form of a discharge, but is not necessary.  Essential is that the system provides clean title to a new owner of the assets, which may or may not be the post-bankruptcy firm.

As this is the core of any sensible corporate insolvency system, features beyond that are a matter of policy, and politics.

The full article can be found here.

Recent Lessons on Management Compensation at Various States of the Chapter 11

By James H. M. Sprayregen, Christopher T. Greco, and Neal Paul Donnelly, Kirkland & Ellis

Setting compensation for senior management can be among the most contentious issues facing companies reorganizing under Chapter 11 of the US Bankruptcy Code. Corporate debtors argue that such compensation—often in the form of base salary, bonuses, or stock of the reorganized company—helps retain and incentivize management, whose services are believed necessary to achieve a successful reorganization. Creditors, by contrast, may be loath to support compensation packages that they perceive as enriching the very managers who led the company into bankruptcy.

This tension over management compensation, though long present in corporate bankruptcy cases, has been more pronounced since 2005, when the US Congress added Section 503(c) to the Bankruptcy Code. Section 503(c) limits bankrupt companies’ freedom to give management retention bonuses, severance payments, or other ancillary compensation. For instance, under the current regime, a company cannot pay managers retention bonuses unless it proves to a bankruptcy court that the managers both provide essential services to the reorganizing business and that they have alternative job offers in hand. Even then, the Bankruptcy Code caps the amount of the retention bonuses. Severance payments to managers are similarly restricted by Section 503(c).…Read more here.

[This article first appeared in the March 2013 issue of Financier Worldwide magazine. Copyright Financier Worldwide 2014 all rights reserved. Reprinted with publishers permission. www.financierworldwide.com]

Capmark Decision Clarifies Insider Status for Market Participants

Authors: Marshall S. Huebner and Hilary A.E. Dengel, Davis Polk

Being deemed an “insider” has important ramifications for creditors in bankruptcy and can materially impact a creditor’s risk and recovery profile in any case.

In Capmark Financial Group Inc. v. Goldman Sachs Credit Partners L.P. (Capmark), the U.S. District Court for the Southern District of New York made several positive rulings on key insider status issues favorable to market participants who regularly find themselves, sometimes through affiliated entities, playing multiple roles with respect to a borrower counterparty.  Embracing the arguments advanced by the Goldman Sachs lending entities, the court rejected Capmark’s attempts to cast the lenders as “insiders” of Capmark based on an indirect equity interest in Capmark held by funds managed by certain of their affiliates – holding that Capmark failed to allege facts that would show the “extraordinary circumstances” required for veil piercing and stating that participation in an arm’s length transaction as an ordinary commercial lender will not give rise to non-statutory insider status.

The Capmark decision provides comfort and greater certainty to market participants that, absent falling into one of the expressly enumerated categories of insiders under the Bankruptcy Code, insider status should not attach to creditors who neither control a company nor deal with it at less than arm’s length.  The case is further discussed here in Capmark:  Clarifying Insider Status for Market Participants (ABI Journal, January 2014).

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