The New Bond Workouts

By William W. Bratton (University of Pennsylvania Law School)

Bond workouts are a dysfunctional method of debt restructuring, ridden with opportunistic and coercive behavior by bondholders and bond issuers. Yet since 2008 bond workouts have quietly started to work. A cognizable portion of the restructuring market has shifted from bankruptcy courts to out-of-court workouts by way of exchange offers made only to large institutional investors. The new workouts feature a battery of strong-arm tactics by bond issuers, and aggrieved bondholders have complained in court. A fracas followed in courts of the Second Circuit, where a new, broad reading of the primary law governing workouts, section 316(b) of the Trust Indenture Act of 1939 (“TIA”), was mooted in the Southern District of New York, only to be rejected by a Second Circuit panel.

In “The New Bond Workouts,” Adam Levitin and I exploit the bond market’s reaction to the recent volatility in the law to reassess the desirability of section 316(b). Section 316(b), which prohibits majority-vote amendments of bond payment terms and forces bond issuers seeking to restructure to resort to untoward exchange offers, has attracted intense criticism, with calls for its amendment or repeal. Yet section 316(b)’s staunch defenders argue that mom-and-pop bondholders need protection against sharp-elbowed issuer tactics.

Many of the empirical assumptions made in the debate no longer hold true. Markets have learned to live with section 316(b)’s limitations. Workouts generally succeed, so there is no serious transaction cost problem stemming from the TIA; when a company goes straight into bankruptcy, there tend to be independent motivations. But workout by majority amendment will not systematically disadvantage bondholders.  Indeed, the recent turn to secured creditor control of bankruptcy proceedings makes workouts all the more attractive to them, as their claims tend to be unsecured. Accordingly, we cautiously argue for the repeal of section 316(b). Section 316(b) no longer does much work, even as it prevents bondholders and bond issuers from realizing their preferences regarding modes of restructuring and voting rules. The contractual particulars are best left to the market. Still, markets are imperfect, and a free-contracting regime may result in abuses. Accordingly, repeal of section 316(b) should be accompanied by the resuscitation of the long forgotten intercreditor good faith duties, which present a more fact-sensitive way to police overreaching in bond workouts than section 316(b).

The full paper is available here.


For previous Roundtable posts on Marblegate, section 316(b), and bond workouts, see “Second Circuit Rules on § 316(b) in Marblegate“; Liu, “Exit Consents in Debt Restructurings“; Roe, “The Trust Indenture Act of 1939 in Congress and the Courts in 2016: Bringing the SEC to the Table.”

Bankruptcy Jurisdiction Over Foreign Entities: Exorbitant or Congruent?

By Adrian Walters (Chicago-Kent College of Law, Illinois Institute of Technology)

As Oscar Couwenberg and Stephen Lubben have demonstrated, foreign firms commonly file for bankruptcy in the United States in order to take advantage of chapter 11 of the Bankruptcy Code. But overseas critics tend to balk at the ease with which global bankruptcy jurisdiction can be engineered in the United States through a combination of the Bankruptcy Code’s low bar to entry and the worldwide effects of a bankruptcy case. They complain that the formal structure of U.S. eligibility and jurisdictional rules promote abusive bankruptcy forum shopping and the harmful imposition of U.S. norms on non-U.S. stakeholders.

This article advances a revised account of U.S. bankruptcy jurisdiction over non-U.S. debtors from a distinctively Anglo-American standpoint. The article’s thesis is that critics overemphasize formal jurisdictional rules and pay insufficient attention to how U.S. courts actually exercise jurisdiction in practice. It compares the formal law “on the books” in the U.S. and U.K. for determining whether or not a domestic insolvency or restructuring proceeding relating to a foreign debtor can be maintained in each jurisdiction and provides a functional account of how U.S. bankruptcy jurisdiction over foreign entities is exercised in practice, using the concept of jurisdictional congruence as a benchmark. While the American and British approaches to abusive forum shopping are developing on different legal cultural paths, the article also identifies reasons for thinking that they are trending towards a rough functional equivalence influenced, at least in part, by the U.S.’s commitment to the UNCITRAL Model Law through chapter 15 of the Bankruptcy Code.

In sum, the article lays foundations for further critical reflection on the roles that judges, practitioners, and the “center of main interests” standard play in configuring the market for international bankruptcy case filings and in facilitating and regulating forum shopping in that market. Through the lens of legal development, it also presents some practical and policy challenges for universalism, international insolvency law’s dominant theory.

The full article is available here.

Bankruptcy and the U.S. Supreme Court

By Ronald J. Mann (Columbia Law School)

The continuing struggle of the United States to emerge from the Great Recession gives policy responses to financial distress an immediacy they have lacked for 75 years. The Constitution directly grants Congress a broadly worded Bankruptcy Power, which Congress exercised with vigor in its 1978 enactment of the Bankruptcy Code. But the Code has played little or no role in mitigating the dislocation of the Great Recession. The slight rise in filings under the Code during the early years of financial distress contrasts markedly with the unprecedented rise in foreclosures, to say nothing of the more general social and economic turmoil of the last decade.

My forthcoming book, Bankruptcy and the U.S. Supreme Court, considers the role that the Supreme Court has played in the relatively anemic bankruptcy regime of the 21st century. The book’s main point is that the Supreme Court’s 82 decisions evaluating the Code systematically have taken a narrow interpretive approach that has left the Code much less effective than it might have been. The book includes some quantitative analysis. It is interesting, for example, that only 32 of the 82 decisions (39%) have come down in favor of a broad application of the Code. If you look at close cases (those with three or more dissenting votes), the results are even more stark, with only 5 of the 19 decisions (26%) applying the Code expansively.

But the bulk of the book is a series of case studies of nine of the close cases in the early days of the Code. Because the case studies focus much more on the process of the Court’s decision making than on the doctrinal results, they rely heavily on the internal papers of the Justices. Probably the single most important thing that the case studies demonstrate is the Justices’ attention to these cases. Many readers doubtless think of the bankruptcy cases as the “dogs” that the Justices turn to only after they’ve devoted their attention to the exciting constitutional and civil rights cases. But what you find when you go back to look the Justices’ papers is a great deal of back and forth in the crafting of opinions. In one case (Midlantic v. New Jersey Dep’t of Environmental Protection), Justice Powell’s majority opinion originally was crafted as a dissent; it became a majority when Justice Stevens switched his vote. Similarly, in Bildisco v. NLRB, Justice Rehnquist managed to get a court for his opinion only after months of negotiation that eventually led to the removal and rewriting of a large portion of the original opinion.

If you want to know more about how the Court goes about deciding these cases, then I encourage you to look at the book when it comes out from Cambridge University Press this spring.

Language Matters: Third Circuit Finds Make-Whole Provision Enforceable After Bankruptcy Filing

By Craig A. Barbarosh, Karen B. Dine, Jerry L. Hall, and Margaret J. McQuade (Katten Muchin Rosenman LLP)

In November 2016, the Third Circuit rendered a decision in Delaware Trust Co. v. Energy Future Intermediate Holding Co., LLC, finding that the defendants, who voluntarily filed for bankruptcy, were still obligated to pay over $800M in expected interest owed to lenders. The case stemmed from the defendants’ attempt to refinance, during bankruptcy, certain first lien and second lien notes in the wake of declining interest rates. The defendants filed for bankruptcy to render the notes immediately due and payable pursuant to the indentures’ acceleration provision. The defendants assumed acceleration would allow them to avoid the “make-whole” obligation to noteholders that otherwise would be due upon an optional redemption (i.e., the net present value of future payments not yet accrued at the time of prepayment).

In holding that the defendants’ actions effectively constituted an “optional redemption” triggering their obligation to pay future interest to noteholders under the make-whole provision, the Third Circuit clarified the often-muddy interplay between indenture acceleration provisions and “make-whole” redemption provisions. Specifically, the Third Circuit held that: (1) an acceleration provision that is silent as to “make-whole” does not annul a make-whole provision; (2) in order to sever “make-whole” obligations, acceleration provisions must specifically reference “make-whole” obligations; (3) “redemption” does not equal “prepayment;” and (4) issuers have the burden to insist on clear language if they intend to sever make-whole obligations through acceleration.

The full article is available here.

Bankruptcy on the Side

By Kenneth Ayotte (University of California – Berkeley School of Law), Anthony J. Casey (University of Chicago Law School), David A. Skeel, Jr. (University of Pennsylvania Law School)

 

Side agreements—such as intercreditor and “bad boy” agreements—are increasingly at the center of major bankruptcy disputes. Litigation around these disputes can be costly and the results of that litigation can dramatically alter the landscape within which the stakeholders bargain over reorganization.

These agreements commonly include a promise by one party to remain silent by waiving some procedural right they would otherwise have under the Bankruptcy Code. Those waivers are invoked at crucial points in the reorganization process, including the approval of debtor-in-possession financing and plan confirmation.

In our new paper, Bankruptcy on the Side, we show that while side agreements have beneficial potential, the parties entering them often impose negative externalities on outsiders. A promise not to extend new financing, for example, can affect the debtor’s reorganization prospects. Similarly, a promise not to object to a reorganization plan can rob the court of information that might benefit the other classes of creditors.

The paper presents a simple model to derive a proposal that is consistent with the intent of the parties to the side agreement but also limits negative externalities. The core of the proposal is that where there is a nontrivial potential for value-destroying externalities, the court should limit a nonbreaching party’s remedy to its expectation damages. On the other hand, if the agreement is unlikely to cause externalities, a court should enforce the agreement according to its terms. Our proposal is different and superior to the approach taken by most courts, which invokes a narrow interpretative standard to invalidate side agreements. We focus instead on enforcing the provisions under normal interpretative doctrines while limiting the use of special remedies like specific performance and stipulated damages.

The insights of our paper also provide a new answer to thorny questions involved in choosing which courts should resolve disputes over intercreditor agreements, and in deciding whether forum selection clauses should be enforced. Specifically, the bankruptcy courts have no specialized expertise for cases where the plaintiff seeks expectation damages. In those cases, the court should defer to default venue rules and forum selection clauses. Where specific performance or stipulated damages are at issue, by contrast, our model suggests that the dispute should be resolved exclusively in bankruptcy proceedings.

 

Successor Liability in § 363 Sales

By Michael L. Cook of Schulte, Roth & Zabel LLP

Bankruptcy Code §363(f)(1) empowers a bankruptcy court to order a debtor’s assets sold “free and clear of any interest in such property.” Courts in the business bankruptcy context have been wrestling with successor liability, i.e., whether an asset buyer can be held liable for the debtor-seller’s liabilities. In 2009, the Second Circuit affirmed a bankruptcy court order barring creditors of the selling debtor from pursuing the asset buyer “for product defects in vehicles produced by” the debtor. In re Chrysler LLC, 576 F.3d 108, 123-24 (2d Cir. 2009), vacated as moot, 558 U.S. 1087 (2009) (held, successor liability claims are interests covered by a sale order under Code § 363(f)(1)).

Most recently, on July 13, 2016, the Second Circuit held that the bankruptcy court’s asset sale order in the General Motors reorganization case limiting specific pre-bankruptcy product liability claims required prior “actual or direct mail notice” to claimants when the debtor “knew or reasonably should have known about the claims.” In re Motors Liquidation Co., 2016 U.S. App. LEXIS 12848, *46-47 (2d Cir. July 13, 2016). Although the substance of the sale order may have been enforceable otherwise, “mere publication notice” to known or knowable claimants was insufficient. Had the complaining product liability claimants received adequate notice, reasoned the court, they “could have had some negotiating leverage [regarding the terms of any sale order] . . . and [a meaningful] opportunity to participate in the proceedings.” Id. at *61. The court noted a “trend…toward a more expansive reading of ‘interests in property’ which encompasses other obligations that may flow from ownership of the property.” Id., at 124, citing In re Trans World Airlines, Inc., 322 F. 3d 283, 285-90 (3d Cir. 2003).

The full memo is available here.

Bankruptcy Advisory: What Can Oil Pipelines Do As Shipper Bankruptcy Risk Increases?

By Filiberto Agusti, Caroline H.B. Gaudet, and Steven Reed, Steptoe & Johnson LLP

The expansion of North American petroleum production in the past 15 years triggered the construction of many pipelines. Construction was financed largely through long-term Transportation Services Agreements (TSAs) whereby shippers committed to transport minimum volumes on the pipelines at specified tariff rates or make shortfall payments. The recent sharp drop in the world price of crude oil has led to bankruptcies. This article reviews whether, in shipper reorganizations, bankruptcy courts have jurisdiction to approve the rejection of TSAs for which the Federal Energy Regulatory Commission (“FERC”) has approved the tariff rate structure.

No court has yet addressed this question, but there is guidance from cases addressing rejection of FERC-jurisdictional electric power agreements. The Fifth Circuit found that bankruptcy courts have jurisdiction to approve rejection where the reorganized debtor’s business purpose is to abandon the FERC-approved service altogether. In dicta, however, the Court noted that the bankruptcy court would have lacked jurisdiction to approve assumption of a modified contract without prior FERC approval of the modification. And in In re Calpine, the Bankruptcy Court for the Southern District of New York held that it lacked jurisdiction to approve rejection of a FERC-jurisdictional electric power agreement if the business purpose of the rejection was to obtain more favorable pricing for the estate. From a FERC standpoint, it is unclear whether a pipeline and a debtor shipper can modify a TSA to reduce pricing as a requirement for assumption.

The linchpin of FERC’s acceptance of specified TSA rates is that those rates must be offered through an “open season” to all potential shippers. A FERC proceeding may be necessary to clarify whether a pipeline has discretion to modify the TSA of a debtor shipper or if a post-open season modification reducing the shipper’s specified TSA rates would violate FERC’s non-discrimination requirements.

The full article is available here.

The Crude Downturn for Oil Companies

By John England, Andrew Slaughter, and Anshu Mittal of Deloitte LLP

The ups and downs in the crude oil and natural gas (O&G) industry over the past two years or so boil down to a 65 percent fall in oil prices, a $2.5 trillion loss in market value and a debt overhang of about $3 trillion. With persisting uncertainty about the timing of stabilization and recovery of oil prices, the financial stress in the industry is immediate and deteriorating.

In the United States alone, 35 crude oil and natural gas producers with cumulative debt of $18 billion filed for bankruptcy protection between mid-2014 and end-2015, and an additional eight have done so this year. The majority, however, are in Chapter 11 bankruptcy and continue to operate to maintain their production- and reserve-linked loans.

But stricter loan review guidelines by the Office of the Comptroller of the Currency (OCC), the banking regulator—for instance a borrower with debt/EBITDA ratio of more than four is now flagged as doubtful— and, could prompt banks to classify more and bigger O&G loans as “substandard and worse.” In fact, using similar financial and debt repayment metrics on 500 O&G producers globally, our analysis suggests a third of them are at a high risk of debt default and may file for bankruptcy protection, unless things take a dramatic turn for the better.

These stricter guidelines, along with the continued weakness in oil prices and expiration of hedges at favorable prices are choking the much-required cash supplies. U.S. shale producers are particularly vulnerable to the squeeze, as reduced funding immediately impacts their production due to the short investment cycle and high decline rates associated with shales. This impact has been evident in the past three months, with U.S. tight oil production having declined by about five percent this year.

In conclusion, 2016 will be a period of tough, new financial choices for the O&G industry, including the oilfield service providers and drillers. Staying solvent and navigating this downturn successfully will require technology-driven optimization solutions and tailoring of the operating model and, most importantly, innovative, flexible, and adaptive thinking in sourcing, managing, and deploying scarce capital. However, these conditions lay the foundation for a price rally and better years to come for those who can navigate these rocky waters.

The full article is available here: The Crude Downturn.

External and Internal Asset Partitioning: Corporations and Their Subsidiaries

By Henry Hansmann, Yale Law School, and Richard Squire, Fordham University School of Law

In our book chapter “External and Internal Asset Partitioning: Corporations and Their Subsidiaries,” forthcoming in The Oxford Handbook of Corporate Law and Governance, we analyze the economic consequences of external and internal asset partitioning, and we consider implications of our analysis for creditor remedies that disregard partitions between corporate entities. “Asset partitioning” is the use of standard-form legal entities, such as the business corporation, to set boundaries on creditor recovery rights. “External” partitioning refers to the legal boundaries between business firms and their equity investors, while “internal” partitioning refers to the legal boundaries among the constituent entities (parents and subsidiaries) within corporate groups.

The chapter begins by cataloguing the economic benefits and costs of corporate partitioning. The benefits identified include reduced equityholder monitoring costs, liquid shares, shareholder diversification, reduced creditor information costs, correction of debt overhang, liquidation protection, and bankruptcy simplification. The costs of corporate partitioning are accounting costs and the agency costs of debt. We compare the economics of external and internal partitioning, and we find that internal partitioning provides fewer potential benefits while often generating higher costs. Corporate subsidiaries do, however, also provide non-partitioning benefits such as tax advantages, regulatory compliance, and the preservation of transferable bundles of contracts.

The final part of the chapter considers whether cost-benefit analysis predicts how courts actually apply de-partitioning remedies, with particular emphasis on veil piercing and enterprise liability. We conclude that courts should employ the distinction between external and internal partitioning when applying creditor remedies that disregard corporate partitions, and we identify factors — in addition to whether a partition is internal or external — that courts should consider when deciding whether to de-partition. For example, we argue that the presence of guarantees which pierce corporate partitions on behalf of select creditors militates in favor of the use of de-partitioning remedies for general creditors.

The full chapter is available here: External and Internal Asset Partitioning: Corporations and Their Subsidiaries.

Business Bankruptcy and Restructuring: 2015/2016

By Harold S. Novikoff, et al., Wachtell, Lipton, Rosen & Katz

Prior to 2015, corporate defaults and bankruptcy filings were at relatively low levels, amid continuing low interest rates and well-performing credit markets.

In 2015, those trends began to reverse.  There were 75 chapter 11 filings in 2015 involving debt of $100 million or more, the highest number since 2010.  During the second half of the year, credit and commodity markets proved increasingly volatile.  In addition, near the end of the year, several investment funds specializing in high-yield debt suspended redemptions or announced liquidations or closings.

Looking forward, we expect many of the trends from 2015 to continue.  In particular, low commodity prices will continue to create a challenging environment in the oil and gas and related sectors.  Retailers will also face pressure, including from internet shopping.  Faced with market volatility and the high costs of bankruptcy, we expect distressed borrowers to continue pursuing out-of-court strategies, including exchange offers, bespoke financing arrangements and equity capital infusions.

In this memo, we discuss several important developments and themes from 2015, as well as expectations for the year ahead.  Among other things, the memo discusses issues regarding secured creditor cramdown, the Trust Indenture Act, Puerto Rico and extraterritorial reach of the Bankruptcy Code.

The full memo is available here.

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