Leases and Executory Contracts in Chapter 11

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By Ken Ayotte, University of California at Berkeley Law School

Ayotte_Kenneth_medium_webThis paper offers the first empirical analysis of the timing and disposition decisions large Chapter 11 debtors make with respect to their leases and executory contracts in bankruptcy.  In particular, I analyze the effect of the revised 365(d)(4), which requires tenant-debtors to make decisions on their real estate leases within seven months unless the landlord grants an extension.

I find that the seven month deadline strongly accelerated real estate lease disposition decisions.  This suggests the existence of renegotiation frictions that prevent debtors from buying more time from their landlords.  The accelerated timeline, moreover, may have affected case outcomes.  Using a difference-in-differences methodology, I find that the probability of reorganization fell significantly more for lease-intensive debtors than for non-lease-intensive debtors after BAPCPA.

The paper also offers many new stylized facts.  For example, I find that most assignments occur in the context of a going-concern sale of the whole firm or business unit, rather than on an individual basis.  I also find that many debtors assume contracts early, rather than maximizing the “option value” of waiting.  Examining early assumptions in detail, I find evidence consistent with “implicit contracting” motives, whereby assuming early secures benefits for the debtor that the formal contract alone could not.

The full paper may be found here.

Creditor Conflict and the Efficiency of Corporate Reorganization

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By Mark Jenkins at University of Pennsylvania and David C. Smith at University of Virginia

While a rich set of theories make clear that incentive conflicts between senior and junior claimants in a company’s capital structure may lead to inefficient outcomes, empirical evidence on how often these conflicts do so has been limited. In this paper, we study the incentives of senior claimants to force inefficient liquidations, or liquidations in which a firm’s assets are sold for less than the firm’s value as a going concern. We develop a bargaining model that assumes senior creditors can exert strong control over whether a firm reorganizes or liquidates during the bankruptcy process. The estimable parameters of the model allow us to gauge the efficiency of bankruptcy outcomes using a large sample of U.S. corporate bankruptcy cases over the period 1989 to 2011.

The main result of the paper is an estimate of the value loss that results from inefficient liquidations in bankruptcy. We estimate these losses to be up to 0.28 percent of the going-concern value of the firm, on average, across all bankrupt firms in our sample. As predicted by theory, these losses are realized primarily by firms with asset values that are close to the face value of secured debt. Our estimate of efficiency losses is driven by several auxiliary findings, including estimates of the fraction of firms that are efficiently reorganized, the fraction of firms that are efficiently and inefficiently liquidated, and the average liquidation discount faced by firms in bankruptcy.

The full article can be found here.

Reports of Equity’s Death Have Been Greatly Exaggerated

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By Adam J. Levitin, Georgetown University Law Center

Mark Berman is veryLevitin Headshot kind to take notice of my article in his recent analysis of Law v. Siegel, posted on the HLS Bankruptcy Roundtable, here.  We agree on a great deal about the case and scope of equity practice.  A question persists about the scope of Law v. Siegel, though, and what it is proscribing when it reiterates the view that “whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code.”  The question, then, is which non-Code practices are properly characterized as “equity”.  My own view is that very little of modern bankruptcy practice is in fact “equity.”

Law v. Siegel, for example, should not affect such important non-Code practices as judicial interpretation of Bankruptcy Code statutory terms or judicially-created doctrines like substantial consolidation, which are sometimes mistakenly listed among the bankruptcy court’s “equitable powers”.  As I wrote earlier, though, because such practices are interstitial and formed as broad principles, they are, in my view, better understood as part of a federal common law of bankruptcy, and distinguished from equitable powers, which are based on case-by-case specifics, as in Law v. Siegel.  As interstitial powers, these lie outside any widening or narrowing of bankruptcy court’s equitable powers.

Moreover, the uncertainties about when actual equitable practices contradict statutes will continue.  In cases of clear contradiction, the interpretive result will be easy. But cases where it is unclear whether a conflict truly exists will continue to invite negotiation between and among the parties because of the cost and uncertainty of litigation.  Despite the Supreme Court’s best efforts, consideration of the equities will likely remain a part of our bankruptcy system.

For a fuller treatment of this subject, please continue here.

‘Wither’ the Equity Powers of the Bankruptcy Court

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Author: Mark N. Berman, Nixon Peabody LLP

The United StaMark Bermantes Supreme Court’s Law v. Siegel decision has been explained away as an understandable limitation of a bankruptcy court’s use of Bankruptcy Code Section 105(a)’s expansive authority based on conventional techniques of statutory construction. Bankruptcy courts will not be able to use Section 105(a) to authorize an order that is otherwise prohibited by another section of the Bankruptcy Code.  However, it is also possible to read the decision as yet another stop on the road to limiting the ability of the bankruptcy courts to ‘do equity.’

Revisiting Professor Levitin’s 2006 law review article entitled Toward a Federal Common Law of Bankruptcy: Judicial Lawmaking in a Statutory Regime, 80 Am. Bankr. L.J. 1-87 (2006), I posit that the equity jurisdiction of the bankruptcy courts has already been statutorily restricted and the United States Supreme Court has made it clear that everyone should be prepared for further limitation of what has historically been its power. The Supreme Court’s warning is repeated in this latest decision.

The full alert is available here.

[Editor: The full text of Professor Adam Levitin’s noted article, Toward a Federal Common Law of Bankruptcy: Judicial Lawmaking in a Statutory Regime, can be found here.]

Breaking Bankruptcy Priority: How Rent-Seeking Upends the Creditors’ Bargain

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Post by Frederick Tung, Professor at Boston University School of Law

In “Breaking Bankruptcy Priority:  How Rent-Seeking Upends the Creditors’ Bargain,” recently published in the Virginia Law Review, Mark Roe and I question the stability of bankruptcy’s priority structure and suggest a new conceptualization of bankruptcy reorganization that challenges the long-standing creditors’ bargain view. Bankruptcy scholarship has long conceptualized bankruptcy’s reallocation of value as a hypothetical bargain among creditors: creditors agree in advance that if the firm falters, value will be reallocated according to a fixed set of statutory and agreed-to contractual priorities.

In “Breaking Priority,” we propose an alternative view. No hypothetical bargain is ever fully fixed because creditors continually attempt to alter the priority rules, pursuing categorical rule changes to jump ahead of competing creditors. These moves are often successful, so creditors must continually adjust to other creditors’ successful jumps. Because priority is always up for grabs, bankruptcy should be reconceptualized as an ongoing rent-seeking contest, fought in a three-ring arena of transactional innovation, doctrinal change, and legislative trumps.

We highlight a number of recent and historical priority jumps. We explain how priority jumping interacts with finance theory and how it should lead us to view bankruptcy as a dynamic process. Breaking priority, reestablishing it, and adapting to new priorities is part of the normal science of Chapter 11 reorganization, where bankruptcy lawyers and judges expend a large part of their time and energy. While a given jump’s end-state (when a new priority is firmly established) may sometimes be efficient, bankruptcy rent-seeking overall has significant pathologies and inefficiencies.

The paper is available here.

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