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.

WSJ Examiners — Insider Pay in Bankruptcy

The Wall Street Journal’s Bankruptcy Beat recently focused on the ever-controversial topic of executive pay. Reflecting on a number of recent bankruptcy cases that involved the “redaction” of key employee names or compensation figures, the question for the Examiners was this: when it comes to pre-bankruptcy insider pay, how much disclosure is enough?

As Brett Miller points out, the answer to this question will depend on who you are in relation to the bankruptcy process. He advocates balancing competing interests on a case-by-case basis.

Practitioners Sharon Levine, Shaunna Jones, and Richard Chesley point out the quid pro quo nature of enhanced disclosure, describing it as a cost that firms must pay in order to access the benefits of bankruptcy protection. As Ms. Jones puts it, the benefits of the bankruptcy process “are not without a price, and one cost is the requirement that the debtor be transparent about how it uses its assets”.

Ms. Levine, along with Lisa Donohue, voiced concerns that a lack of transparency breeds mistrust and will make negotiations more difficult, conflicting with the consensual objectives inherent in the Chapter 11 procedure. Anders Maxwell makes the analogous point that disclosures are needed to “more adequately inform an ongoing debate” on executive pay generally which, if “left unaddressed, has the potential to sap public confidence in business and markets.”

Mark Roe also considers the wider context of Chapter 11 practice and history, particularly in relation to Key Employee Retention Plans (“KERPs”) and fraudulent conveyances. Ultimately, he says, disclosure is “a matter for judicial decision, not executive discretion.” J. Scott Victor makes the further point that unilateral redaction “unfairly benefits large debtors while requiring other debtors to follow the rules.”

Businesspeople who commented—Jack Butler and Marc Leder—sounded a contrary note, pointing out that the debate focuses only on public disclosure, as parties in the case generally have access to the business’ financial information. Mr. Butler highlights the risk of harassment that executives might face, while Mr. Leder states, in concurrence with Perry Mandarino, that “compensation data without any context can cause outside observers . . . to leap to uninformed and incorrect assumptions”.

(This post was drafted by Samuel Parsons, L.L.M. ’16.)

The Trouble with Unneeded Bankruptcy Reform: The LSTA’s Response to the ABI Chapter 11 Commission Report

[Editors’ Note: The post below from the Loan Syndications and Trading Association (LSTA), summarizes their Report responding to the ABI Commission Report and Recommendation on the Reform of Chapter 11, released in December of 2014; for our previous post on the ABI report see here.]

The LSTA Report argues that:

  • The Commission Report is based on the “perception” that the system has failed. But that perception is not supported by reliable empirical evidence. The data that do exist generally support the conclusion that the system is functioning well.
  • The principal objective of current bankruptcy law is the maximization of value for all stakeholders. With few exceptions, it respects principles of non-bankruptcy law regarding the distribution of that value, as reflected in bankruptcy’s “absolute-priority” rule. The Commission Report breaks from those principles, arguing that market changes have led to distributions of value in bankruptcy that are “subjectively unfair,” and seeks to achieve results that it believes are fairer. But a clear, objective process that respects non-bankruptcy entitlements wherever possible is fair.
  • Many of the changes proposed by the Commission would reduce recoveries by secured lenders in the event of default. That would necessarily result in the increased cost, and reduced supply, of secured credit.

The LSTA Report reviews a number of specific proposals in the ABI Commission Report, including (i) calculating adequate protection based on a hypothetical foreclosure value; (ii) limitations on 363 sales and DIP loan provisions; (iii) “redemption option value”—which would require senior creditors in large bankruptcy cases to pay junior creditors even when the senior creditors have not been paid in full; and (iv) proposals for small and medium size enterprises. The LSTA concludes that these and other proposals would add cost and complexity to, and lengthen Chapter 11 cases.

For the full report, see here.

TCEH Bankruptcy: SDNY Transfers Delaware Trust Company v. Wilmington Trust N.A. Intercreditor Dispute to Delaware Bankruptcy Court, Reaffirming Broad View of Bankruptcy Jurisdiction

By Mark Ellenberg, Howard Hawkins, Ivan Loncar, Ellen Halstead, Michele Maman and Tom Curtin of Cadwalader Wickersham & Taft LLP

In Delaware Trust Company v. Wilmington Trust N.A. the United States District Court for the Southern District of New York found that a complaint based on an intercreditor agreement among secured creditors of Texas Competitive Electric Holdings LLC constituted a core proceeding.  Accordingly, the court denied a motion to remand the case to New York state court, where it had originally been filed, and also transferred the case to the US District Court for the District of Delaware.  The case was subsequently referred to the bankruptcy court presiding over the TCEH bankruptcy cases.  Plaintiff had alleged that the dispute, which involved allocation of adequate protection payments ordered by the Delaware Bankruptcy Court, was an intercreditor dispute that turned solely on the interpretation of a prepetition intercreditor agreement and, accordingly, should be decided in state court.  As such, the issue before the District Court was whether a New York court or the Delaware Bankruptcy Court should resolve the intercreditor dispute.

The District Court ruled that the dispute was core because the dispute would have no meaningful existence but for TCEH’s bankruptcy filing, as the ability to receive adequate protection derives solely from the Bankruptcy Code.  In addition, the Court found that the dispute was core because the intercreditor issue would likely arise again in the context of plan confirmation.   The decision is important because it reaffirms the often-challenged principle that contractual disputes solely among creditors may nonetheless qualify as “core” proceedings where, as here, the underlying dispute could only arise in the context of a bankruptcy proceeding.

For our full memo, please click here.

Bankruptcy in Groups

By William H. Beaver, Stanford University; Stefano Cascino, London School of Economics; Maria Correia, London Business School; and Maureen F. McNichols, Stanford University

Group bankruptcies tend to be large and affect a significant number of stakeholders. Business groups constitute a common way for ultimate owners to exercise control over a large number of companies while containing their risk exposure to different parts of the business through limited liability. In countries with underdeveloped financial infrastructures, business groups overcome difficulties in accessing external finance by reshuffling funds within the corporate structure.

In our study, we seek to understand how financial distress takes place within a business group. Using a large cross-country sample of group-affiliated firms, we show that group structure matters for parent and subsidiary bankruptcy prediction. Moreover, we show that the re-allocation of resources among group firms is likely to be a channel through which parent firms manage intra-group credit risk. Parents may be required to support financially distressed subsidiaries as a result of explicit or implicit agreements. Absent these agreements, parents might also have an incentive to support financially distressed subsidiaries as the bankruptcy of a subsidiary may impose severe costs (e.g., reputational damage, cross-default, direct liability under veil piercing). Intra-group support can also flow in the opposite direction as distressed parents may seek financial aid from healthy subsidiaries. The results of our study show that the association between parent and subsidiary default probabilities varies with the level of subsidiary integration within the group and country-level institutional quality. A shock to the parent probability of default is less likely to propagate to subsidiaries in countries with strong anti-self-dealing, investor protection, director liability and related-party transaction regulations.

Our findings are relevant for financial reporting regulators, auditors, investors and credit rating agencies, and speak to the regulatory debate on cross-border insolvencies.

The full article is available here.

Chapter 11 Duration, Pre-Planned Cases, and Refiling Rates: An Empirical Analysis in the Post-BAPCPA Era

By Foteini Teloni, Fordham University School of Law

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) enacted and amended several business bankruptcy provisions that triggered a heated debate over their effects on the chapter 11 landscape and the debtor’s reorganization chances.

In this article, I use multivariate regression models to examine empirically and quantify, for the first time, BAPCPA’s effect on three distinct aspects of the chapter 11 process: (a) the duration of traditional chapter 11 cases; (b) the use of preplanned bankruptcies; and (c) debtor refiling rates.

My study indicates that BAPCPA fulfilled, on the one hand, a long-standing desire of having shorter business reorganization cases. Indeed, the average duration of chapter 11 dropped from 480 days to 261 days in the post-2005 era, while the proportion of companies undergoing preplanned bankruptcies rose 23% in that same period. Even after controlling for various factors, including the companies’ pre-filing financial profile, BAPCPA remained correlated at a statistically significant level with shorter chapter 11 duration and more preplanned cases.

On the other hand, however, the proportion of debtors that had to refile for bankruptcy soon after exiting their previous filing increased 30% in the post-2005 era. BAPCPA’s effect on recidivism remained statistically significant even after controlling for a number of factors, including the companies’ post-emergence profitability and leverage.

It seems that the 2005 amendments force the debtor to emerge hastily from its chapter 11 proceedings, ignoring operational and structural problems and, therefore, not achieving true rehabilitation. And if one measure for successful bankruptcies is refiling rates, then BAPCPA seems to have failed in this respect.

The full article is published in 23 Am. Bankr. Inst. L. Rev. 571 (2015), and is available here.

Curbing the Exploitation of Passive Creditors in Chapter 11 Reorganization by Leveraging the Oversight Role of the United States Trustee

By Addison F. Pierce, American University – Washington College of Law

The Bankruptcy Reform Act of 1978 is beginning to show its age in ways similar to the forty-year-old code it replaced. In addition to being ill-suited to address changes in the underlying credit market, the current code is confronting the development of an entirely new marketplace — a market in claims trading. While some praise the enhanced liquidity, others take issue with the strains placed on the efficacy of bankruptcy.

Rather than engaging in the normative debate, this Comment seeks to redress a clear drawback to the current system: the harm endured by passive creditors. Unlike those economically empowered to participate in the reorganization process, the passive creditor lacks the economic ability and incentive to play an active role. This position leaves the passive creditor’s ability to collect on its claim solely in the hands of another: the creditors’ committee. While this committee may have provided adequate protection in 1978, the credit market and its participants are very different today. Some argue that this issue is systemic and can only be addressed by replacing the current code; however, this Comment argues that something can be done short of this massive task. The challenge is as follows: if too little is done, passive creditors will continue to be exploited and if too much is done the whole market could be damaged. Recognizing this challenge, this Comment proposes that passive creditors can be afforded adequate protection by leveraging the oversight power of the US Trustee to ensure the proper functioning of creditors’ committees. Moreover, the recommendation of this Comment would enhance protection for passive creditor while remaining market neutral.

For the full article, see 4 Am. U. Bus. L. Rev. 95 (2015), available here.

 

A Third Way: Examiners As Inquisitors

By Daniel J. Bussel, UCLA School of Law

BusselThere is a buzz concerning bankruptcy examiners. Recently in such cases as ResCap, Dynegy and Tribune, and perhaps now in Caesars, examiners have played a decisive role in resolving major Chapter 11 cases involving avoiding power claims.

“Litigate or settle” is the dispute resolution choice generally available in US bankruptcy courts. But there is another way: An inquisitorial model of justice in which an active and informed neutral investigates the facts and then assesses and applies the law to resolve a legal dispute. Chapter 11 examiners are peculiarly suited to introduce this inquisitorial process into a Chapter 11 case. In particular, Ken Klee, serving as examiner in the Tribune case, and a series of post-Tribune investigations show that inquisitorial methods make sense in certain large bankruptcy cases involving complex legal disputes (rather than financial or operational problems). Indeed Tribune and its progeny suggest that the inquisitorial experiment has already begun.

A Third Way: Examiners As Inquisitors looks at examiner methodologies in Tribune and the few post-Tribune examiner cases. It assesses the method’s comparative advantages (fact-finding accuracy, nonpartisan experts, freedom from artificial evidentiary constraints, transparency and legitimacy) and disadvantages (lack of finality, expense, delay, risks to reorganization efforts, risk of overzealousness, due process concerns) and suggests that in the absence of a countervailing business exigency demanding exclusive focus on reorganization, the Tribune model may offer a superior alternative for resolving contested avoidance claims. Indeed, large Chapter 11 cases may be an ideal proving ground for inquisitorial methods more broadly.

For more see A Third Way: Examiners As Inquisitors, 90 Am. Bankr. L. J. __ (forthcoming 2016), available here.

Bankruptcy Examiners in Chapter 11

By Jonathan C. Lipson, Temple University—Beasley School of Law, and Christopher Fiore Marotta, KPMG

Lipson MarottaBankruptcy examiners have long been a controversial feature of chapter 11—and remain so in recent cases such as Caesars Entertainment. Section 1104 of the Bankruptcy Code requires one if sought in large cases ($5 million+ in debt) or if “in the interests of creditors.” Congress created the position as a check on the reorganization process, since neither the SEC nor trustees typically provide oversight. Yet, system participants grouse about their costs and potential to disrupt negotiations. The ABI’s reform proposal would eliminate them.

In a recent paper, we study their use in a sample of 1225 chapter 11 cases from 1991-2010. We find that, despite the Code’s “mandatory” language, examiners are exceedingly rare, being sought in about 9% and appointed in 4% of cases. About half were very large cases, with far more than $5 million in debt, so most requests should have been granted—but they weren’t. The factors that Congress thought should matter most—such as fraud or incompetence—don’t.

What predicts whether an examiner will be appointed? Timing and location: an early request in a case outside Delaware is nearly twice as likely to be granted than otherwise. Yet, contrary to conventional wisdom, we also find that examiners correlate to better outcomes, including in post-bankruptcy earnings and headcounts.

We explain why examiners are so rare, and suggest a way to use them more frequently and economically.

For the full article see here.

Supreme Court Permits Bankruptcy Courts to Issue Final Judgments with Parties’ Consent

By Harold S. Novikoff, Douglas K. Mayer, Ian Boczko, Emil A. Kleinhaus, and Alexander B. Lees of Wachtell, Lipton, Rosen & Katz

The Supreme Court’s latest decision regarding the power of bankruptcy judges to resolve claims between bankruptcy estates and their creditors is Wellness International Network, Ltd. v. Sharif, handed down on May 26, 2015. In its landmark 2011 ruling in Stern v. Marshall, the Court held that bankruptcy judges have limited authority under Article III of the Constitution to determine claims asserted by an estate against creditors. However, Stern left open the question, which has split lower courts, whether parties can nonetheless consent to bankruptcy court adjudication. In Wellness, the Supreme Court held that bankruptcy litigants may waive Article III rights, and suggested that parties may forfeit untimely objections to a bankruptcy court’s lack of authority.

For a fuller analysis and summary, click here for our memo on Wellness.

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