By Edward J. Janger (Professor, Brooklyn Law School) and Adam J. Levitin (Professor, Georgetown University Law Center)
In Distorted Choice in Corporate Bankruptcy, David Skeel offers a nuanced description of restructuring support agreements (RSAs) and how they can help a debtor to achieve the necessary consensus around a proposed Chapter 11 plan of reorganization. We take issue, however, with Skeel’s permissive view toward RSAs that permits provisions that would short circuit the “process” protections contained in Chapter 11. Such provisions include pre-disclosure lock-ups, milestones, and coercive deathtraps.
Chapter 11 contemplates bargaining in the shadow of certain basic statutory “distributional” entitlements: equal treatment, best interests, full cash payment of administrative expenses, and a guaranteed minimum-cramdown distribution. As such, RSAs can either reinforce the link between entitlement and distribution, or they can sever it.
In our view, Skeel insufficiently appreciates the purpose of process—how procedural protections such as classification, disclosure, and solicitation surrounding the vote forge the crucial link between bankruptcy bargaining and core principles of corporate governance and pre-bankruptcy entitlement. We offer, instead, an approach which sorts between process-enhancing RSAs and those that facilitate end-runs.
By Amir Licht (Professor, Interdisciplinary Center Herzliya, Israel)
In several common law jurisdictions, creditors of corporate debtors enjoy legal protections through vicinity-of-insolvency fiduciary duties, beyond what their contracts with those companies afford them. These duties form a notoriously murky area, where legal space warps. The contours of this area are fuzzy. Courts openly acknowledge that it is difficult to identify clear guideposts for its threshold—as to when exactly these duties are enlivened. In a forthcoming article, I purport to make two main contributions. First, the article expands the theoretical basis for a special legal regime in virtually insolvent firms by pointing out escalation of commitment as a potent and relevant factor that has been largely overlooked by insolvency scholars. Second, this article addresses the substantive content of the duty to protect creditors where such duties are recognized.
The standard account that is usually invoked to explain and justify special fiduciary duties to consider creditors’ interest points to the danger of opportunistic high-risk behavior by managers on behalf of shareholders. I argue that this account may be sound but is nonetheless lacking. In addition to such risk-shifting opportunism, lawmakers should also be mindful of managers’ tendency to unjustifiably continue failing projects, known as escalation of commitment. Escalation of commitment refers to a phenomenon, in which people tend to remain married to their original choices and to commit resources to them even when it is no longer rational to do so. Escalation of commitment is ubiquitous. It has been observed in organizations large and small, in business corporations and in the public sector. Escalation of commitment is not only an irrational and emotional personal behavior. More often than not, it takes place in a broader social context of one’s ingroup—in particular, the board of directors, the organization, and one’s community and culture.
Escalation of commitment poses an equal, if not greater, challenge than risk shifting does to optimal regulation of companies in looming or virtual insolvency. Being largely detached from rational calculations, escalation of commitment presents a more compelling justification for legal regulation, and a more interventionist one at that. In this view, managers—especially owner-managers—of virtually insolvent firms may not enjoy the usual level of deference that the law affords to their business judgment in regular times, as their discretion at that point is prone to be clouded by a misplaced motivation to stay the course, weather the storm, and similarly-spirited no-quitting notions.
Factors that could facilitate de-escalation include better information on costs and benefits of the project, regular evaluation and monitoring of projects, clear criteria for success and minimum target performance levels, and clear feedback about underperforming projects. Such measures will have limited efficacy, however, if the information they generate is interpreted and acted on by decision-makers who have initiated the failing project and even by different persons who are nonetheless related to those decision-makers. Change in management is thus essential.
While Delaware law rejects the idea of a pre-insolvency creditor-focused fiduciary duty, several jurisdictions do recognize duties to protect creditors, either as a duty to consider creditors’ interests or as the rule against wrongful (or insolvent, or reckless) trading. I argue that these duties should be enlivened at the very edge of the zone of insolvency, close to the latter. At that point, the mission of directors should transform from entrepreneurial to custodial. That is, they should implement strategies that aim to preserve the firm—in working condition, to the extent possible, with a view to resuming regular business—but avoid seeking new projects with a view to maximizing profits. This could mean that the shield of the business judgment rule may not be available to the same extent as in regular circumstances. The Covid-19 pandemic that swept the globe in 2020 provides a fresh context for this approach and underscores the need to implement such a regime sensibly, with high deference to business decisions even if outside the scope of the business judgment rule. The article concludes with a comparative analysis of creditor-oriented duties in several common law jurisdictions and examines how they could implement a custodial approach.
By Corinne Ball, George Cahill, Kay Morley, Jay Tambe, Bruce Bennett, & Heather Lennox (Jones Day)
A recent spate of decisions by the EMEA Determinations Committee (“DC”) has provided clarity on when a chapter 15 filing will trigger a “Bankruptcy” credit event under credit default swaps. Each of the relevant chapter 15 petitions sought recognition of an English scheme of arrangement, which is not a product of insolvency law and does not necessarily constitute a Bankruptcy, and each underlying scheme was considered narrow enough in scope to not be “with or for the benefit of its creditors generally” (triggering limb (c) of Bankruptcy). As such, the primary issue in each determination was whether the relief sought in the chapter 15 was similar to a “judgment of insolvency or bankruptcy” and independently triggered limb (d) of Bankruptcy.
The DC found that Thomas Cook’s 2019 petition for recognition of its scheme as a foreign nonmain proceeding, which expressly waived the benefit of the stay courts can impose in such cases, was not similar to an insolvency judgement and did not constitute a Bankruptcy. On the contrary, it held that Matalan’s August petition seeking recognition of a foreign main proceeding (involving an automatic stay) was similar and triggered a Bankruptcy. In its October determination regarding Selecta, the DC addressed the intermediate scenario, a petition seeking a stay in connection with a foreign main proceeding, finding that this also triggered a Bankruptcy. While every situation must be considered on its own facts, these determinations should prove instructive on when a chapter 15 filing will trigger a Bankruptcy credit event.
Disclaimer Statement: “The views and opinions set forth herein are the personal views or opinions of the authors; they do not necessarily reflect views or opinions of the law firm with which they are associated.”
By Rahul D. Vashi, Anna G. Rotman, Chris Heasley, Shubi Arora, Kenneth A. Young, Fraser F. Wayne, and John C. Elkins (Kirkland & Ellis)
Midstream service providers in the oil and gas space typically expend substantial upfront capital investment to build pipeline systems to gather and transport hydrocarbons and produced water for oil and gas producers, and rely on the fee structures in their service contracts to recoup their investments. One common method used by midstream companies to protect their investments is to create (or attempt to create) in their service contracts a dedication of production from the oil and gas producer structured as a covenant that runs with the land.
Beginning with Sabine Oil & Gas Corp. v. HPIP Gonzales Holdings, LLC (In re Sabine Oil & Gas Corp.), 567 B.R. 869 (S.D.N.Y. 2017), bankruptcy courts have delivered divided opinions on whether midstream gathering and transportation contracts can be rejected, resulting in substantial uncertainty about whether midstream service providers can rely on their contractual terms. The major decisions regarding the treatment of midstream contracts in bankruptcy have focused on contracts for the gathering and transportation of hydrocarbons, and whether the contracts should not be rejectable because the oil and gas producer properly granted to the midstream company a covenant running with the land in its oil and gas properties.
Providers of produced water gathering and transportation services have typically relied on the same contractual protections as those that provide hydrocarbon gathering and transportation services. However, to date, midstream water contracts purporting to contain covenants running with the land have not been tested, and there is reason to believe that such agreements may be treated differently than their oil and gas counterparts. This article discusses certain issues and considerations that are specific to midstream water agreements and may affect whether such agreements are determined to be rejectable under the Bankruptcy Code.
By Carl Wedoff (Jenner & Block), David P. Saunders (Jenner & Block)
For as long as there have been consumer businesses, they have collected consumer data. But in recent years, the volume and value of consumer data collection has increased exponentially, becoming a multibillion-dollar industry of its own. At the same time, consumer privacy laws are on the rise at the state level and are under consideration at the federal level. The value of data can create substantial friction for a business with respect to maintaining consumer interests and complying with privacy laws and regulations while maximizing the usefulness of consumer data to the business itself.
Bankruptcy courts routinely deal with the sale of consumer data, often in retail bankruptcies, but to date, “big data” issues have rarely, if ever, surfaced. However, this could change with the anticipated surge of corporate bankruptcy resulting from the recent COVID-19 pandemic.
As a result, bankruptcy judges and “consumer privacy ombudsmen,” or CPOs, need to evaluate more now than ever whether the transfer of consumer data is both permissible and in the best interests of all parties involved, including the consumers to whom the information relates.
This article explores the current framework for the sale of consumer data in bankruptcies and the potential changes in how bankruptcy courts may approach consumer data privacy issues in the future.
By Stacey L. Corr-Irvine and Mark G. Douglas (Jones Day)
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.”
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.
By Professor Nancy Rapoport (William S. Boyd School of Law, University of Nevada, Las Vegas)
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.
On January 13, 2020, the United States Bankruptcy Court for the District of Delaware issued an opinion in In re La Paloma Generating Company, LLC., Case No. 16-12700 [Adv. Pro. No.19-50110], which examined the implied covenant of good faith and fair dealing in the context of an intercreditor agreement (ICA) governing the relationship between the First Lien Lender (First Lien Lender) and the Second Lien Lenders (Second Lien Lenders) to the Debtors. The bankruptcy court held a party cannot be in breach of the covenant of good faith and fair dealing under New York law when merely enforcing a contractual right, in this case the First Lien Lender enforcing the ICA.
By Charles Tabb and Carly Everhardt (Foley & Lardner)
In Ritzen Group Inc. v. Jackson Masonry, LLC,the Supreme Court unanimously held that a bankruptcy court’s order denying relief from the automatic stay constituted a final order, and thus that order may—and must—immediately be appealed if so desired. The holding regarding finality is important, because parties normally only have an absolute right to appeal when an order is final, not when an order is interlocutory. In Ritzen, the Court announced a clear blueprint for gauging the finality of any bankruptcy order.
The opinion comes just a few years after the Supreme Court decided Bullard v. Blue Hills Bank, in which the Court held that an order denying confirmation of a plan was not final, because the plan confirmation process could continue notwithstanding the denial. In Ritzen, the Court distinguished Bullard, explaining that the stay relief proceeding constituted its own complete procedural unit, separate and apart from any claims resolution issues. Ritzen puts to rest the view that Bullard signaled relaxed finality in the context of bankruptcy.
The article analyzes Ritzen and how it will impact strategic decisions by creditors regarding stay relief and other forms of bankruptcy litigation. The article considers open questions left by the Court, including the impact on the finality of an order which states it was entered “without prejudice,” and whether res judicata may apply in cases where creditors make multiple requests for relief.