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.

Regulating Bankruptcy Bonuses and Protecting Workers in the Age of COVID-19

By Jessica Ljustina (Harvard Law School)

Since March, executives of 18 large companies received over $135 million total in bonuses prior to their companies filing under Chapter 11, while “[t]hose same companies laid off tens of thousands of workers,” according to a Washington Post report. These recent examples are illustrative of gaps left by the last major reform targeting bankruptcy bonuses. Further reforms have been introduced in Congress every few years since 2005. Referencing inequality and perceived abuses in the context of COVID-19, the House Judiciary Committee advanced the current House bill to the full chamber on September 29, 2020, marking the proposed legislation’s furthest progress thus far.

H.R. 7370, the Protecting Employees and Retirees in Business Bankruptcies Act of 2020 (PERBB) would present significant changes to the Bankruptcy Code aimed at protecting workers. The bill would expand from existing regulation of insider retention bonuses to include a broader set of payments to insiders, senior executive officers, the 20 highest compensated employees who are not insiders or senior executives, department and division managers, and any consultants providing services to the debtor.

Through expanding the scope of executive compensation subject to restrictions, PERBB may more effectively reduce management bonuses paid in bankruptcy. However, the House version of PERBB fails to address bonus payments prior to filing for bankruptcy, a key issue identified at the outset of the post. The related Senate bill has an additional provision which would designate any transfer made to management “made in anticipation of bankruptcy” as a §547 preference avoidable by the trustee.

The full post, including a summary of proposed changes to the Code, is available here.

The full text of the House bill can be accessed here. A redline of relevant 11 U.S.C. provisions reflecting amendments proposed in H.R. 7370 is available here. The full text of Senate bill can be accessed here.

For related Roundtable posts, see Jared Ellias, Regulating Bankruptcy Bonuses; James H. M. Sprayregen, Christopher T. Greco, and Neal Paul Donnelly (Kirkland & Ellis), Recent Lessons on Management Compensation at Various States of the Chapter 11.

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.

Insolvency of Significant Non-Financial Enterprises: What Can We Learn from Bank Failures and Bank Resolution?

By Ilya Kokorin, Leiden Law School (The Netherlands)

Ilya Kokorin

The current economic downturn triggered by the spread of COVID-19 demonstrates that the role of insolvency law should not be restricted to resolving conflicts between private parties (i.e. creditors and debtors). Nevertheless, the very framework of insolvency law remains primarily: (i) microprudential – single entity focused and designed to protect individual debtors and their creditors, (ii) contractarian – implementing the idea of creditors’ bargain and solving coordination problems between creditors of a single entity, and (iii) reactive – centred around post-crisis liquidation of assets and allocation of proceeds among creditors. It may therefore be ill-fitted to serve the public interest in mitigating the negative externalities of large-scale (systemic) corporate debacles (e.g. Chrysler, GM, British Steel, Carillion) or handling the economy-wide instability experienced nowadays.

In contrast to corporate insolvency, in the aftermath of the global financial crisis of 2008 (GFC), bank resolution in the European Union (EU) and the USA went through fundamental changes that seek to preserve financial stability and ensure continuity of critical functions. Bank resolution has increasingly embraced the macroprudential vision, recognizing the need for an advanced preparation and a speedy intervention to ensure continuity of critical functions, preservation of financial stability and avoidance of bailouts. This vision has resulted in the specific proactive and reactive recovery and resolution strategies. In the recent paper Insolvency of Significant Non-Financial Enterprises: Lessons from Bank Failures and Bank Resolution, I explore whether the modern approaches to bank crises can be extended to non-financial enterprises. I discuss how insolvency law might help minimize social harm stemming from wide-ranging shocks and grand-scale business failures and suggest what we can learn from bank failures and bank resolution.

The failure of Carillion, once the UK’s second-largest construction company, has shown that the reactive approach to crisis resolution, centred around post-crisis intervention, posed significant risks not only for creditors but also for other stakeholders and communities at large. Carillion had around 43,000 workers, of whom 19,000 were based in the UK. It owed around GBP 2 billion to the extensive network of 30,000 suppliers, sub-contractors and other creditors and left the pension liability exceeding GBP 2.5 billion. Even though the signs of financial distress appeared long before Carillion filed for liquidation in January 2018, these warning signals were largely ignored. The failure of Carillion had substantial implications for the provision of public services, raising environmental, health and safety concerns. It ultimately led to a state intervention backed by taxpayers’ money. However, the actual economic and social cost of Carillion’s insolvency are hard to quantify. Financial distress of such a significant enterprise (significant non-financial enterprise or SNFE) required timely state intervention. Nevertheless, its multiple profit warnings came as a surprise to the Cabinet Office.

Insolvency of Carillion was characterized by the absence of timely reaction to prevent crisis escalation, a genuine threat of public disruption and a vast complexity determined by both the debtor’s organizational structure, consisting of more than 320 group members, and the nature of its activities. Many of the same features were observed in the failure of banks and banking groups during the GFC. As a response, both the EU (BRRD) and the USA (Title II of the Dodd-Frank Act) have embraced a proactive and precautionary approach focused on preparation and early response. In my paper, I use the case of Carillion to inquire whether selected bank recovery and resolution tools could have been adopted to prevent the collapse of Carillion, or to mitigate its negative consequences.

In particular, I analyse three such tools, namely: (i) intervention powers granted to state authorities for early (preventive) reaction to the escalation of financial problems before the actual insolvency, (ii) entity and group recovery and resolution planning, and (iii) administrative-led insolvency process. I conclude that while the first two mechanisms may prove beneficial, the last one is rather controversial. While an administrative-led process has certain advantages and prevails in bank resolution, it may be difficult and unnecessary to replicate or transpose to non-financial enterprises. Instead, a transparent court-supervised process with active involvement of creditors and debtors, as well as a limited and targeted engagement of public authorities on matters of public interest should be encouraged.

The full paper is available here.

Oversecured Creditor’s Right to Contractual Default-Rate Interest Allowed Under State Law

By Stacey L. Corr-Irvine and Mark G. Douglas (Jones Day)

Stacey L. Corr-Irvine
Mark G. Douglas

It is generally well understood that an “oversecured” creditor is entitled to interest and, to the extent provided for under a loan agreement, related fees and charges as part of its secured claim in a bankruptcy case. Although section 506(b) of the Bankruptcy Code provides that fees, costs or charges allowed as part of a secured claim must be “reasonable,” the provision does not expressly impose any restrictions on the amount or nature of interest allowable as part of a secured claim. A Bankruptcy Appellate Panel for the Eighth Circuit recently considered whether a secured creditor is entitled to contractual default-rate interest under section 506(b).

In In re Family Pharmacy, Inc., 614 B.R. 58 (B.A.P. 8th Cir. 2020), the panel reversed a bankruptcy court’s order disallowing a secured creditor’s claim for interest at the default rate under the parties’ contract using a penalty-type analysis generally applied to liquidated damages provisions. According to the panel, such an analysis cannot be applied to default interest provisions. The panel also held that the bankruptcy court erred when it held that the default interest rate was unenforceable based on “equitable considerations.”

The full article is available here.

Insolvency Law in Emerging Markets

By Aurelio Gurrea-Martínez (Singapore Management University)

Aurelio Gurrea-Martínez

Corporate insolvency law can serve as a powerful mechanism to promote economic growth. Ex ante, a well-functioning insolvency framework can facilitate entrepreneurship, innovation and access to finance. Ex post, corporate insolvency law can perform several functions, including the reorganization of viable companies in financial distress, the liquidation of non-viable businesses in a fair and efficient manner, and the maximization of the returns to creditors. Therefore, if having an efficient corporate insolvency framework is essential for any country, it becomes even more important for emerging economies due to their potential for growth and their greater financial needs.

Unfortunately, the academic literature has generally paid more attention to the regulation of corporate insolvency in developed countries. Thus, it has largely omitted the debate about the optimal design of insolvency law in jurisdictions that, in addition to requiring a more active policy debate, amount to 85% of the world’s population and 59% of the global GDP, since they include some of the world’s largest economies such as China, India, Brazil, Russia and Indonesia.

In my new article, ‘Insolvency Law in Emerging Markets’, I seek to fill this gap in the academic literature by analyzing the problems and features of insolvency law in emerging economies and suggesting a new framework for financially distressed companies in these countries. My paper argues that, even though, in an ideal scenario, any improvement of the insolvency framework in these countries should start by enhancing the judicial system and the sophistication of the insolvency profession, these reforms usually take time, resources and political will. In fact, due to a variety of factors, including corruption, lack of awareness about the importance of the insolvency system for the real economy, or lack of political incentives to engage in such complex reforms whose benefits will only be shown in the long run, they might never occur. For this reason, my paper suggests an insolvency framework for emerging economies taking into account the current market and institutional features of these countries. If these conditions change over time, or they do not exist in some particular emerging economies, my proposal would need to be adjusted accordingly.

My proposed corporate insolvency framework for emerging markets is based on three fundamental pillars. First, pre-insolvency proceedings and out-of-court restructuring should be promoted as a way to avoid an insolvency system that is usually value-destroying for both debtors and creditors. Second, insolvency proceedings should be reformed to respond more effectively to the problems and features existing in emerging markets, which generally include the prevalence of small companies and large controlled firms, as well as the existence of inefficient courts and unsophisticated insolvency practitioners. Finally, emerging economies should adopt a more contractual approach to deal with a situation of cross-border insolvency. Thus, by facilitating the choice of insolvency forum, debtors, creditors and society as a whole will be able to enjoy the benefits associated with having access to more sophisticated insolvency frameworks. Besides, since many debtors and creditors would be using foreign insolvency proceedings, this value-creating forum shopping may incentivize many Governments in emerging economies to invest the resources needed to improve the market and institutional environment existing in these countries, hopefully making the insolvency framework suggested in this article no longer needed.

The full article is available here.

Another version of this post was previously published on the Oxford Business Law Blog and the Singapore Global Restructuring Initiative Blog.

For previous Roundtable posts on insolvency reforms in China and India, see Xiahong Chen, INSOL Europe/LexisNexis coronavirus (COVID-19) Tracker of Insolvency Reforms—China; Xiao Ma, China Continues to Issue New Rules Promoting Corporate Rescue Culture, Facilitation of Bankruptcy Proceedings; and Himani Singh, Pre-packaged Insolvency in India: Lessons from USA and UK.

Secured Creditor’s “Net Economic Damages” Estimate of Disputed Claims “Plainly Insufficient” to Establish Collateral Value

By Paul M. Green and Mark G. Douglas (Jones Day)

Paul M. Green
Mark G. Douglas

Valuation is a critical and indispensable part of the bankruptcy process. How collateral and other estate assets (and even creditor claims) are valued will determine a wide range of issues, from a secured creditor’s right to adequate protection, postpetition interest, or relief from the automatic stay to a proposed chapter 11 plan’s satisfaction of the “best interests” test or whether a “cram-down” plan can be confirmed despite the objections of dissenting creditors. Depending on the context, bankruptcy courts rely on a wide variety of standards to value estate assets, including retail, wholesale, liquidation, forced sale, going-concern, or reorganization value. Certain assets, however, may be especially difficult to value because valuation depends on factors that may be difficult to quantify, such as the likelihood of success in litigating estate causes of action.

The U.S. Court of Appeals for the First Circuit recently addressed this issue in In re Montreal, Maine & Atlantic Railway, Ltd., 956 F.3d 1 (1st Cir. 2020) (“MMA Railway”). The First Circuit affirmed a ruling that a secured creditor failed to satisfy its burden of establishing that collateral in the form of indemnification claims settled by the estate had any value entitled to adequate protection. According to the court, with respect to a disputed claim, a showing of possible damages is not enough. Instead, the creditor must establish the likely validity of the claim and the likelihood of recovery.

MMA Railway is a cautionary tale for secured creditors. Creditors bear the ultimate burden of proof in establishing the value of their collateral under section 506(a) of the Bankruptcy Code—a determination that has important consequences in many contexts in a bankruptcy case. The First Circuit’s ruling highlights the importance of building a strong evidentiary record to support valuation. It also indicates that certain types of collateral (e.g., disputed litigation claims) are more difficult to value than others.

The full article is available here.

Claims, Classes, Voting, Confirmation and the Cross-Class Cram-Down

By Tomas Richter (Clifford Chance) and Adrian Thery (Garrigues)

Tomas Richter
Adrian Thery

Under EU Directive 2019/1023 promulgated in June 2019, the 27 Member States of the European Union must enact rules supporting preventive restructurings of businesses threatened by insolvency. The restructuring frameworks to be enacted are in a large part modelled after the U.S. Chapter 11 yet they are not carbon copies of it. Also, the 27 Member States have widely differing insolvency laws against whose background the preventive restructuring frameworks must operate, and significantly diverging institutions by which they will have to be applied. The implementation tasks will be both varied and formidable.

However, certain threshold questions are very similar across jurisdictions when it comes to particular topics relevant to corporate restructurings. In the context of agreeing to and adopting a restructuring plan, some of the key questions arise in relation to classification of investors’ claims and interests, grouping these claims and interests into classes, voting in the classes, and obtaining an official approval of the restructuring plan after investors have expressed their opinions on it via the voting mechanism.

The purpose of this first guidance note, published by INSOL Europe, is to flag some of the key issues that national legislators will want to consider in this particular context when implementing the restructuring frameworks prescribed by Title II of the Directive, and, at least at times, also to respectfully suggest which approaches, in the authors’ humble opinions, might perhaps be explored more productively than others.

The full article is available here.

Want to Take Control of Professional Fees in Large Chapter 11 Bankruptcy Cases? Talking with Your Client’s General Counsel is a Good First Step

By Professor Nancy Rapoport (William S. Boyd School of Law, University of Nevada, Las Vegas)

Nancy Rapoport

As someone who studies professional fees in large chapter 11 cases, I’ve thought a lot about how quickly those professional fees can escalate. Successful chapter 11 bankruptcies are expensive, though, in almost all cases, the end result—a successful reorganization—is a good result. But can the fees be controlled effectively?

I think that they can, although there are all sorts of reasons why, often, fees aren’t monitored very closely. There’s usually a disconnect between who’s paying those fees and who’s monitoring the work. In a non-bankruptcy context, a lawyer might bill a client on a monthly basis and get relatively fast feedback from the client regarding issues of reasonableness. The image that comes to mind is of a lawyer pushing a bill across a table and an experienced client pushing it back to request reductions for potentially unreasonable fees or expenses. But the process is different for fees paid to professionals in chapter 11 cases. Bankruptcy courts are charged with the responsibility of reviewing the fees and expenses for reasonableness, and the Office of the United States Trustee serves as another set of eyes, as would a fee examiner.

For estate-paid professionals, the bankruptcy court must first approve the fee applications, which then get paid either from a carveout of a secured creditor’s collateral or as administrative expenses. Imagine a typical list of estate-paid professionals: the debtor’s counsel (plus conflicts counsel and local counsel), the creditors’ committee counsel (plus conflicts counsel and local counsel), investment banks and financial advisors (often for both the debtor and the committee), along with other, more specialized counsel. All of those professionals are working at warp speed, because large chapter 11 cases are literally bet-the-company actions. The fee applications themselves can run into the thousands of pages, per professional, with the time entries showing who worked on what, and for how long, on a day-by-day basis. There’s also often a lag between the work done and the submission of the fee applications, and few actors—other than the professionals themselves and some large institutional creditors—are repeat players. If the client isn’t familiar with the rhythm of chapter 11 bankruptcies, then that client has to take the professionals’ word for whether the tasks were both reasonable and necessary. Parsing the fee applications is a complicated task.

Let me be clear: I’m not suggesting that bankruptcy professionals try to gouge the estate by performing unnecessary tasks. Far from it. The professionals whose fees I’ve reviewed have genuinely been trying to work within the reasonableness guidelines. But the staffing choices that get made—which level of professional works on which tasks, how long it takes to do the work, how many people review that work, how often all of the professionals touch base on the case’s progress, and how a professional must react to actions taken by a different professional—often don’t have the luxury, on the front end, of data-driven planning to eke out the most efficient workflows. Add to that the fact that all of these professionals worry about missing something important, and it’s not hard to see how fees can mount up.

I’ve written a lot about how to think about fees in chapter 11 cases, including these articles (here, here, and here). Most recently, I’ve been working with a co-author, Joe Tiano of Legal Decoder, to imagine a world in which big data can help professionals perform more efficiently (here and here). (Full disclosure: Legal Decoder helped me review the fees and expenses in the Toys R Us cases.) In a recent piece for the American Bankruptcy Institute Law Review, I’ve taken what we know about how a company’s general counsel works with outside professionals outside bankruptcy and suggested that, in a chapter 11 context, many of those behaviors can help to control the size of the professional fees and expenses: by paying closer attention to staffing and monthly budget-to-actual reconciliations, by using legal analytics to measure efficiency, and by using artificial intelligence for certain types of tasks. The point is that paying attention to efficient behavior on the front end benefits everyone, including the professionals themselves, who won’t have to negotiate reductions of their already billed work. The ABI Law Review article is available here.

For a previous Roundtable post discussing fees in another context, please see Through Jevic’s Mirror: Orders, Fees, and Settlements.

What Small Businesses Need Most Is A Little More Time

By Brook Gotberg (University of Missouri Law School; Chair, Small Business Committee of the Bankruptcy & COVID-19 Working Group)

Brook Gotberg

In the wake of the national shutdown of most commercial activity in response to the COVID-19 pandemic, many small businesses are struggling with financial disruption, restrictions on reopening, and uncertainty regarding future business prospects.  Small businesses make up the vast majority of private firms in the United States, and provide nearly two-thirds of all new jobs.  These businesses have been the most visible economic casualties of the global pandemic, with many already closing for good, and many others reevaluating their prospects.  Certain industries, particularly dining and entertainment, have been particularly hard-hit, and could face large-scale obliteration.

A group of interdisciplinary scholars, the Small Business Committee of the Bankruptcy & COVID-19 Working Group, has been meeting regularly since March to discuss policy proposals for bankruptcy that would best protect viable small businesses from unnecessary death.  Although bankruptcy serves as a method to discharge debt, it also operates to stop collection efforts, which may be essential even for companies with little to no debt.  We fear that many formerly profitable small businesses will unnecessarily fail in the face of the current constraints on bankruptcy protection – constraints which assume a functioning economy, not the current reality.  Moreover, a mass filing of bankruptcies could overwhelm the bankruptcy system itself, particularly in light of the accelerated time frames currently designated for small businesses under the Bankruptcy Code.

We therefore recommend that the Code be temporarily adjusted to put a six-month freeze on most typical deadlines, affording debtors additional time to propose a plan of reorganization.  Furthermore, we recommend that debtors be allowed an amortized schedule to repay past-due rent.

Our reasoning for this proposal is simple.  While bankruptcy law in normal times can distinguish viable companies from non-viable companies and recommend reorganization or liquidation accordingly, these are not normal times.  Baseline assumptions for the value of businesses depend on revenues, which are now artificially constrained.  Creditors, trustees, and judges cannot make informed decisions on the viability of a given enterprise based on the recent past, and that uncertainty is unlikely to be resolved in the near future.  It is therefore essential to allow bankrupt firms more time to take advantage of the automatic stay while reassessing options for reorganization.

Furthermore, the hit to revenues will likely create debt overhang for otherwise profitable businesses that could prove impossible to overcome in the short run. This is particularly true for rental obligations.  For many small businesses, past-due rent is likely to be the primary obligation, but the law does not permit debtors to repay past-due rent over time, as is permitted for other forms of debt.  Current bankruptcy rules require a debtor to commit to its outstanding rental agreements within 60 days of filing, and then to repay all past-due rental obligations “promptly” (see 11 U.S.C. § 365(b) and (d)(4)(A)).  Our policy recommendation would permit small business debtors to repay rental obligations over the life of the plan – three to five years, under the Small Business Reorganization Act (SBRA).

Similarly, we also recommend that interest accumulated on oversecured collateral after the date of the national emergency proclamation, March 13, 2020, be disallowed in an effort to preserve the respective positions of all creditors.

Recognizing the burden placed on landlords and secured creditors by these recommendations, our proposed changes to deadlines do not interfere with swift cash collateral motions and motions to obtain alternative financing.  We also recommend that, although most motions to lift the stay would not be permitted, creditors should be allowed to lift the stay in circumstances where it can be shown that the debtor is wasting or spoiling the collateral.

A simultaneous permanent closure of small businesses would be catastrophic for the American economy, as hinted at by the surge in unemployment that followed the temporary closures.  Beyond the loss of jobs, closure of businesses would mean fewer services offered within the community, and closed storefronts would likely invite blight, particularly in already vulnerable communities.  This could erase years of hard-won economic and social progress.

The goal of the Bankruptcy & COVID-19 Working Group is to make workable policy recommendations that will have a meaningful impact in mitigating the harm caused by COVID-19 to the American economy.  The group continues to meet, gather data, and review additional policy recommendations.  The goal is to minimize the long-term damage caused by the global pandemic by exploring how bankruptcy policy can do the most good.

The full letter can be found here.

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