Are Judges Randomly Assigned to Chapter 11 Bankruptcies? Not According to Hedge Funds
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Chapter 11, Insider Status, Legislation | 0

By Niklas Hüther (Indiana University) and Kristoph Kleiner (Indiana University)

Niklas Hüther
Kristoph Kleiner

”The bankruptcy system is supposed to work for everyone, but in many cases it works only for the powerful.”  – House Judiciary Committee Chairman Jerrold Nadler, July 28th, 2021

Researchers have long recognized that judicial outcomes are subject to the biases of the ruling judge. To alleviate concerns of fairness, courts in both the U.S. and abroad claim to assign judges to individual court cases randomly. From a policy perspective, randomization promotes public confidence in the judicial process by limiting forum shopping and the individual influence of any individual judge. From an academic perspective, recent empirical research in economics and finance exploits the random assignment of judges to causally identify of a wide range of legal outcomes.

This paper revisits the claim of randomized judicial assignment in the context of U.S. Bankruptcy Court. Our research is motivated by legal scholarship arguing that debtors in recent cases are influencing judicial assignments (Levitin, 2021), as well as renewed interest in these issues from policy makers and the public (Merle and Bernstein, 2019; Randles 2020). Despite these arguments, there are reasons to believe assignment is random. For instance, after contacting all U.S. Bankruptcy Courts, Iverson et al. (2017) found that only one court (the Eastern District of Wisconsin) reports assigning cases to judges non-randomly. In addition, a range of research including Bernstein et al. (2019) provides convincing evidence that debtor characteristics fail to predict judicial assignments. Missing from this literature is any large-scale empirical evidence of non-random assignment.

Analyzing U.S. corporate bankruptcy filings between 2010 and 2020, we provide new evidence that assignment is not random, but predicted by the lending decisions of hedge funds. By focusing on investments made before the assignment of a bankruptcy judge, our technique is not suspect to standard critiques that predictability is merely an outcome of ex-post data mining; instead, in order for investors to systemically invest in firms that are later assigned a preferred judge, it must be possible to infer future judicial assignments. In addition, we focus on hedge funds, as they routinely influence a wide range of bankruptcy outcomes including emergence and debt restructurings.  The prevalence of these investors allows us to explore a new channel of activism in the distress debt market: activist influence in judicial assignment process prior to filing.

In our setting, judges can decide whether to convert a Chapter 11 bankruptcy to a Chapter 7 liquidation; while secured creditors may have a preference for liquidation, unsecured creditors recover more under reorganization.  Exploiting this distinction, we confirm unsecured hedge fund creditors (relative to secured hedge funds) are significantly less likely to be assigned a judge with a tendency to convert Chapter 11 cases.  We also extend our analysis to an alternate bankruptcy outcome measure: the unsecured creditor recovery rate according to the confirmed plan. We find unsecured hedge funds are far more likely to be assigned a judge with a high past unsecured recovery rate.

We next test whether these estimates differ across the filings in our sample. First, we find that unsecured hedge fund claimants are assigned a preferable judge more commonly when the hedge fund invested shortly before the bankruptcy filing, suggesting hedge funds choose to invest explicitly to influence the filing. Second, we show the effects are greatest when the hedge fund is on the board of directors of the debtor at the time of filing, providing further support for the role of communication between debtor and creditor.

Finally, we conduct three robustness tests. First, we find no evidence that a judge’s future conversion rate (after controlling for the past conversion rate) is predicted by hedge fund investment, suggesting hedge funds are explicitly influencing judicial assignment based on information regarding past information. Second, focusing on the subset of districts that explicitly state random assignment within their district, we continue to find hedge fund investments predict assignment. Third, we include district-office-year fixed effects in our analysis and continue to find a relationship between hedge fund investments and assignment.

Moving forward, we believe there are two potential policies that can alleviate these issues. The first, and simplest, is for policy makers to develop a truly randomized process. Alternatively, policy makers can instead increase the number of bankruptcy judges, leading to lower predictability even if assignment is not fully randomized. Policy makers intent on a fairer judicial system should consider both proposals.

The full article is available here.

This piece previously appeared on the Oxford Business Law Blog.

COVID-19 Debt and Bankruptcy Infrastructure
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Legislation | 0

By Robert K. Rasmussen (USC Gould School of Law)

Robert Rasmussen

The COVID pandemic put unprecedented pressure on all economies around the world. Many predicted that this economic dislocation would lead to an unprecedented number of corporate bankruptcies. This did not happen. The American government and other governments responded with extraordinary measures. While these measures allowed companies to ride out the worst of the pandemic, they did have consequences. Many large companies were left with unprecedentedly large amounts of debt on their balance sheets.

 Perhaps a robust economy will allow companies to grow their way out from under their debt burden. But perhaps not. To prepare for the possible future increase in large companies filing for bankruptcy, Congress should act now to build up a bankruptcy infrastructure sufficient to handle an influx in cases. Specifically, Congress should require that every circuit create a “business bankruptcy panel” designed to administer the Chapter 11 filing of large companies. As is well-known, three bankruptcy districts currently serve as dominant venues for large cases – the District of Delaware, the Southern District of New York and the Southern District of Texas. It is by no means clear that these three courts could handle a significant increase in caseloads. Creating expertise across the country would help prepare the system for any future rise in cases. A secondary benefit of this reform is that it may also ameliorate some of the concerns that have been raised over the years by the dominance of a small number of venues for large corporate cases.

The full article is available here.

Chapter 11’s Descent into Lawlessness
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Jurisprudence, Workouts and Pre-Packs | 0

By Lynn M. LoPucki (Security Pacific Bank Distinguished Professor of Law, UCLA School of Law)

Lynn M. LoPucki

The bankruptcy courts that compete for big cases frequently ignore the Bankruptcy Code and Rules. This Article documents that lawlessness through a detailed examination of the court file in Belk, Inc.—a one-day Chapter 11—and a series of empirical studies.

Chapter 11’s lawlessness reached a new extreme in Belk. Belk filed in Houston on the evening of February 23, 2021. The court confirmed the plan at ten o’clock the next morning, and the parties consummated the plan that same afternoon. Almost none of Chapter 11’s procedural requirements were met. The court did not give creditors notice of the disclosure statement or plan confirmation hearings until after those hearings were held. Belk filed no list of creditors’ names and addresses, no schedules, no statement of financial affairs, and no monthly operating reports.  No creditors’ committee was appointed, no meeting of creditors was held, and none of the professionals filed fee applications. The ad hoc groups that negotiated the plan failed to file Rule 2019 disclosures. Because no schedules were filed, no proofs of claim were deemed filed. Only eighteen of Belk’s ninety-thousand creditors filed proofs of claim, and Belk apparently just made distributions to whomever Belk considered worthy. 

The procedural failures in Belk are just the tip of the iceberg.  The competing courts are ignoring impermissible retention bonuses, refusing to appoint mandatory examiners, failing to monitor venue or transfer cases, granting every request to reject collective bargaining agreements, and providing debtors with critical-vendor slush funds. The article is available here. 

COVID-19 and the Bankruptcy Court Workload
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates | 0

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.”