INSOL Europe/LexisNexis coronavirus (COVID-19) Tracker of Insolvency Reforms—China

By Xiahong Chen (China University of Political Science and Law)

Xiahong Chen

The modification of Enterprise Bankruptcy Law of the People’s Republic of China in 2006 had been announced to be in legislative organ’s amendment procedure for years. As there is no further progress in 2020, the slow process must not catch the urgent needs of economic community for corporate rescue after breakout of coronavirus epidemic. Consequently, the Supreme People’s Court of P.R.China was playing an active role in policy-making from judicial perspective concerning civil disputes resolution. From April to June 2020, the Supreme People’s Court of P.R.China had issued 3 judicial guidance in series to direct judicial hearing of civil case in all level of courts during and after the epidemic, with purpose to guide judicial hearing of civil cases relating to disputes caused by coronavirus. Among them, the second one, published on 19 May 2020, contains 7 important guidelines for judicial hearing of bankruptcy cases relating to COVID-19, aiming to improve possibility of corporate rescue and enhance viability of those financial-distressed companies further.

Changes of bankruptcy policy in above-mentioned guidance include: (1) Court-supervised negotiation between the insolvent debtor and those creditors before the opening of bankruptcy proceeding; (2) Distinguishing real causes of insolvency when examining bankruptcy criteria; (3) Further promoting the link between civil execution proceedings and bankruptcy proceedings; (4) Extending the reorganization period from maximum of 9 months according to EBL 2006 by another 6 months; (5 ) Highlights of effective protection of creditors’ substantive rights and procedural rights in bankruptcy proceedings;(6) Maximizing the debtor’s ability to continue operations and the value of property disposal; (7) Promoting the efficient hearing of bankruptcy cases.

In this short note, the author Xiahong Chen, fellow of Bankruptcy Law and Enterprise Restructuring Research Center of CUPL, was invited by the INSOL Europe, introduces the main points of adjustments of bankruptcy policies relating to epidemic in detail. According to his observation, like the global legal and policy changing trends in bankruptcy area all over the world recently, the changes concerning judicial hearing of bankruptcy cases in China is expected to be helpful for survival of those financial struggling companies.

The full article is available here.

Venezuela’s Potential Debt Restructuring and Economic Recovery Efforts: Some Key Legal and Policy Challenges

By Steven T. Kargman (Kargman Associates/International Restructuring Advisors)

Steven T. Kargman

The article provides an overview of certain key legal and policy issues that are likely to arise in any eventual Venezuelan debt restructuring.  Specifically, the article focuses on what will likely be some of the central elements of any future debt restructuring, including the possibility of debt-for-equity swaps and oil warrants, and it also reviews various considerations in connection with a possible insolvency filing by Venezuela’s state-owned oil company, PDVSA.  Further, the article discusses legal and policy considerations related to economic recovery efforts that Venezuela may undertake in the future, including matters related to any efforts to revive Venezuela’s oil industry as well as any attempts to diversify Venezuela’s economy so that it is not so reliant on a single commodity, oil.  Finally, the article examines the issue of asset recovery and how a future Venezuelan regime might seek to recover assets that have been misappropriated from Venezuela.

This article recently appeared in the Venezuelan law journal, La Revista Venezolana de Legislación y Jurisprudencia (Venezuelan Journal of Legislation and Jurisprudence).  The full article can be found here.

Badges of Opportunism: Principles for Policing Restructuring Support Agreements

By Edward J. Janger (Brooklyn Law School) and Adam J. Levitin (Georgetown University Law Center)

Edward J. Janger
Adam J. Levitin

Business reorganizations are corporate control transactions. When a debtor is insolvent or nearly so, control is in play along two different axes. The first axis allocates control within the existing capital structure. The filing of bankruptcy effectuates a change of control from equity to debt. On the second axis, the company itself is on the auction block, meaning that its assets, or even the entire firm, may be transferred to a new owner. Outside investors may wish to buy the company, and the choice among offers implicates serious governance concerns. This article considers the dynamics of control through the lens of restructuring support agreements (“RSAs”)—contractual agreements among creditors, and sometimes the debtor, to support restructuring plans that have certain agreed-upon characteristics. We conclude that RSAs offer a salutary bridge between the efficiencies of a quick “all asset” sale and the procedural protections of a plan of reorganization. However, they also pose a potential avenue for opportunistic abuse. Specifically, we are concerned with provisions in an RSA that hold value maximization hostage to a reordered priority scheme. Thus, we argue that courts should scrutinize RSAs carefully, and prohibit those that lock in opportunistic value reallocation.

Opportunistic behavior can arise on all sides of restructuring negotiations. Insolvency creates opportunities for creditors (and the debtor) to use transactional leverage to influence the allocation of scarce assets: secured creditors may foreclose; banks may engage in setoff; key suppliers may threaten to stop supplying; landlords can threaten to evict; unsecured creditors may get judgments and start grabbing assets; and purchasers may seek to take advantage of a depressed valuation to purchase the company on the cheap. To the extent that the debtor has value as a going concern, individual creditors may have the power to extort value by threatening to force liquidation. Alternatively, fully secured creditors may prefer a quick realization on their collateral, because they do not benefit from increasing the value of the firm.

The Bankruptcy Code seeks to limit these uses of situational leverage in a number of ways: (1) it stays unilateral creditor action (the automatic stay); (2) it allows for the unwinding of certain prepetition transfers (avoidance); (3) it sets a baseline distribution if the firm liquidates, but promises more if the firm can restructure (best interests/adequate protection); (4) it creates a structured bargaining process that ensures adequate information and reduces the ability of a creditor to holdout in the face of a reorganization plan that is supported by key creditor constituencies (supermajority acceptance); and (5) it sets an entitlement baseline if the firm reorganizes (cramdown). Bargaining in bankruptcy is informed by these procedural requirements and substantive entitlements. If a deal is not reached, liquidation follows.

Recently, in Czyzewski v. Jevic Holding Corp., the Supreme Court raised concerns about procedural innovations that might be used to create “end-runs” around the plan process and these procedural protections. In this regard, RSAs can be a useful tool for aiding compliance with the plan process. However, they are also sometimes also referred to as “lockup” agreements. Once an RSA is proposed and supported by key constituencies, the costs of opposing the contemplated plan may be prohibitive for most creditors. The proposal may operate as a fait accompli. If the RSA freight train is being used to stop creditors from developing information or identifying bases for objection, the device becomes problematic.

The difficulty is distinguishing beneficial RSAs from harmful ones. In our view, a fundamental norm of chapter 11 should govern RSAs, all-asset sales, and a range of other transactions: the common interest in value maximization may not be held hostage by a creditor seeking to improve its own priority. The essay begins by describing the practice surrounding restructuring support agreements and identifies some of the anecdotal concerns raised. We then catalogue the good and bad in RSAs. Next, we illustrate how to distinguish the good from the bad by focusing on bargaining in the shadow of entitlements. Finally, we flesh out the concept of an end-run around the plan process in the context of an RSA and identify “badges of opportunism” that should raise an inference that the practice is being abused.

The full article can be found here.

A Bankruptcy History of Manias and Panics (in 80 pages)

By Mark Perelman (Yale School of Management)

Mark Perelman

Fraud and irrationality are often blamed for financial manias and panics. Investor euphoria can unleash social and technological breakthroughs, but the subsequent collapse can destroy value and radicalize the political sphere. Are these events random, idiosyncratic, or driven by some force? The ex-post answers—be they monetary, criminal, or international contagion—have a profound impact on the role of government in society, but have questionable predictive power.

The historical narrative in this article does not argue that overvaluation, changes in money market rates, and fraud play no part in financial panics. However, the instigating events that lead creditors to become sensitive to information which might impair contractual protections suggests that financial panics are reactive to changes in jurisdictional bankruptcy processes. The history of bankruptcy law is intertwined with that of crises and banking law, and—as argued using over 50 case studies spanning the Dutch Tulipomania of 1637 to the Great Recession of 2008—consistently causes and accelerates financial manias and panics.

This narrative can be illustrated by the most recent case study in this article: The Great Recession. Following the earlier Asian Financial Crisis, international investors demanded safe debt. Whereas home mortgages were sensitive to information regarding borrower bankruptcy, these mortgages could become safe debt if default risk were reduced. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) restricted access to bankruptcy in favor of insolvency debt management plans and gave home mortgage lenders priority over other creditors. BAPCPA—along with the Bankruptcy Amendments and Federal Judgeship Act of 1984’s safe harbor around negotiable derivatives, which gave counterparties priority over other creditors—purposely reduced incentives to monitor counterparties and gave markets a (false) sense of security about the mortgages underlying the repo market. The low default risk increased liquidity and allowed lenders to remove risky assets from their balance sheet and expand mortgage financing.

While it’s not possible to quantify the effect of the bankruptcy process relative to all of the other effects, the case studies in this article hope to illustrate how these mechanisms operate to develop more resilient economies. Without appropriate legal technology to solve collective action problems in the presence of asymmetric information, market failures arise in the form of systemic runs on credit extended to banks and other intermediaries. In the wake of financial panics, these technologies are developed by the government, courts, and the private market to improve access to financing, alleviate failures, and reset the cycle.

The full article can be found here.

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.

COVID-19 and the Bankruptcy Court Workload

By Taylor Custer (Harvard Law School)

Taylor Custer

The United States’ response to COVID-19 has led to record levels of unemployment and a severe contraction in real GDP. The economic shock has already pushed companies such as J.C. Penney and J.Crew into bankruptcy. And many more, such as AMC and Hertz, may quickly follow. If that happens, the nation’s bankruptcy courts could soon face unprecedented levels of stress. There are at least four ways to address a potential surge.

First, Congress could authorize more permanent bankruptcy judges. It has currently authorized the federal courts of appeals to appoint 316 permanent bankruptcy judges throughout the country. But three years ago, when the economy was much stronger, the Judicial Conference argued that more judges were still needed.

Second, Congress could authorize more temporary bankruptcy judges. It has currently authorized about three dozen of them. Temporary bankruptcy judgeships expire when the occupant dies, retires, resigns, or is removed from office 5 years after the seat was created or extended. The most recent extension was in 2017, so the current temporary bankruptcy judgeships will remain vacant once occupants begin to depart after 2022 if the seats are not extended.

Third, the judicial council of each federal court of appeals could recall retired bankruptcy judges to serve.

Fourth, the judicial councils for the federal courts of appeals could agree to temporarily transfer bankruptcy judges around the country. Although this would do little to alleviate stress from an absolute rise in bankruptcies, it could help manage bottlenecks in places with disproportionate bankruptcy filings—such as Delaware, New York, and Texas. Under 28 U.S.C. § 152(d), “[w]ith the approval of the Judicial Conference and of each of the judicial councils involved, a bankruptcy judge may be designated to serve in any district adjacent to or near the district for which such bankruptcy judge was appointed.” And, under 28 U.S.C. § 155(a), “[a] bankruptcy judge may be transferred to serve temporarily as a bankruptcy judge in any judicial district other than the judicial district for which such bankruptcy judge was appointed upon the approval of the judicial council of each of the circuits involved.”

Bankruptcy and COVID-19 Working Group

An interdisciplinary group of bankruptcy scholars from the “Large Corporations Committee of the Bankruptcy & COVID-19 Working Group” recently sent an open letter to the United States Senate/House of Representatives on the potential impact of a sharp rise in bankruptcies on the bankruptcy court system. In the letter, the bankruptcy scholars pointed to the deteriorating market for corporate debt and the rising unemployment rate as likely to induce increased bankruptcies in the next months. If the economy does not prepare, the level of demand on the bankruptcy court system could become overwhelming. Accordingly, the scholars urge Congress to start planning and create additional resources to support the existing court system, such as adding temporary bankruptcy judges, recalling of retired judges, and moving judges from less-busy districts to busier districts.

The full letter can be found here.