Bankruptcy Overload
by | posted in: Bankruptcy, Bankruptcy Reform, Chapter 11, Mass Torts, Reorganization, Third-Party Releases | 0

By Laura Coordes (Arizona State University Sandra Day O’Connor College of Law)

Laura Coordes

Over the past few years, a growing number of scholars have sought to diagnose what is wrong with the U.S. bankruptcy system. Congress has held hearings in search of an answer. And many answers have emerged, ranging from lack of balance to outright lawlessness. In my article, Bankruptcy Overload, I contend that these problems are part of a larger issue: the bankruptcy system is overloaded. Those who use it, whether debtors or non-debtors, frequently seek to extract more out of a bankruptcy than the process can, practically and legally, provide.

We have always asked the bankruptcy system to do a lot—indeed, the system’s flexibility and adaptability to new challenges and situations are often described as features rather than bugs. As our current system approaches its 45th birthday, however, it has become increasingly clear that users of the bankruptcy system are putting enormous pressure on it to do more, to resolve more issues, and to satisfy the needs and wants of a growing number of players. In the face of this increasing pressure, the system is beginning to buckle—and this buckling results in many of the problems scholars have identified with modern bankruptcy practice.

The goals and boundaries of bankruptcy law have always been subject to debate, making the system particularly susceptible to taking on more than it can bear. Over the years, many have embraced the resulting uncertainty of the limitations of bankruptcy as a necessary byproduct of bankruptcy’s built-in flexibility. However, even a system with significant capacity can be overloaded, and this Article’s core claim is that the bankruptcy system has reached that point.

This Article defines and explains the concept of bankruptcy overload, illustrating that many of the problems currently plaguing the bankruptcy system derive from overloading it. In addition, although overloading the system may create problems in individual cases, this Article shows that bankruptcy overload is systemically harmful, and that failure to recognize and address it will undermine the system’s long-term utility. Those seeking changes to bankruptcy law must be aware of the system’s capacity constraints. In addition to defining bankruptcy overload and identifying its harms, the Article illuminates ways to address many of the issues present in bankruptcy today while being cognizant of the effect of changes to bankruptcy law on the system as a whole.

The full article is available here.

Due Process Alignment in Mass Restructurings
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Chapter 11, Mass Torts | 0

By Sergio J. Campos (University of Miami School of Law) and Samir D. Parikh (Lewis & Clark Law School)

Sergio J. Campos
Samir D. Parikh

Mass tort defendants have recently begun exiting multi-district litigation (MDL) by filing for bankruptcy. This new strategy ushers defendants into a far more hospitable forum that offers accelerated resolution of all state and federal claims held by both current and future victims.

Bankruptcy’s resolution promise is alluring, but the process relies on a very large assumption: future claimants can be compelled to relinquish property rights – their cause of action against the corporate defendant – without consent or notice. Bankruptcy builds an entire resolution structure on the premise that the Bankruptcy Code’s untested interest representation scheme satisfies Due Process strictures. This Article questions that assumption, and identifies two compromised pillars. Primarily, the process for selecting the fiduciary that represents future victims’ interests (FCR) is broken. Further, the process by which courts estimate the value of thousands of mass tort claims places too much pressure on a jurist unfamiliar with personal injury claims. These compromised pillars raise the risk that the settlement trust will be underfunded and fail prematurely. In this outcome, future victims would have no recourse but to argue that the process did not satisfy Due Process, and the settlement should be unwound.

This Article proposes that the risk of a prematurely insolvent victims’ trust can be reduced considerably by making two adjustments. Our proposal seeks to (i) rebuild the FCR construct in order to ensure that future victims’ interests are effectively represented, and (ii) recalibrate the claim estimation process by facilitating coordination between the bankruptcy court and nonbankruptcy trial courts.

The full article is forthcoming in the Fordham Law Review and is available here.

 

Holdout Panic
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Insider Status | 0

By Stephen J. Lubben (Seton Hall Law School)

Stephen J. Lubben

It has been recognized that corporations themselves are designed to promote collective action, and thus “a primary function of corporate law is to coordinate and constrain individual behavior – even profit-motivated behavior.”  Given that corporate debt instruments largely serve a governance function amongst creditors, it is not surprising that they, like corporations themselves, tend to quash individual action in favor of the group.  But the divergence between individual and group interests comes to the fore in times of stress.

An individual creditor can be either an oppressed minority investor or a holdout.  Majority holders can be either the group seeking an efficient and beneficial restructuring, or effectively an insider group that collaborates with more formal insiders to extract value from minority creditors.  Which reality is genuine is highly dependent on the particular facts of the case at hand, and may be quite difficult for an outsider to discern.

Restructuring law attempts to balance this uncertainty by providing a series of checks and balances.  In general, restructuring law begins with a preference for the collective, but encircles the collective with a series of rules that protect individual creditors from abuse.  

Some of the balance comes from the agreements that create the creditor relationship or duties related to those agreements; however, other aspects of balance are external and come from outside structures like the Bankruptcy Code or the Trust Indenture Act.  In general, the basic challenge here is to find the point at which the illegitimate power of holdouts is reduced without trampling on the legitimate rights of minority creditors.  It is very easy to avoid holdouts if the majority always wins.

My paper explores the ways in which modern restructuring practice has moved toward that “majority always wins” extreme.  This change was not part of some grand plan, but rather the result of a series of incremental decisions, each reacting to perceived abuses by holdouts.  But in indulging our fears of holdouts, we have lost the essential balance of the system.

Take the example of the RSA – or restructuring support agreement – that, in a variety of ways, can represent a generalized assault on the requirement in section 1123(a)(4) that a chapter 11 plan must “provide the same treatment for each claim or interest of a particular class.”  RSAs achieve this end by providing for backstop fees paid to a select group that will never have to backstop anything or DIP loans that the debtor does not really need.

In one recent case, pre-bankruptcy the debtor contracted with a sub-group of its secured noteholders to have those noteholders make an interest payment on the notes.   That is, some of the secured noteholders paid the interest payment due to all the secured noteholders.

In exchange, these distinctive noteholders received new “super-priority secured notes” secured by a lien that surpassed the old secured notes’ liens, while also carrying a hefty 10% coupon.  When the debtor filed for chapter 11 later that same year, to implement its own RSA-driven plan, the new super-priority notes were paid in full, with interest and “make whole call” fees.  In short, the select lenders made a small, six-month loan for a very high return at low risk.  This opportunity was not available to everyone in the original class of noteholders.

In short, I conclude that the modern American restructuring system has evolved to favor the interests of the majority to the point where a debtor and a majority of its lenders can inflict serious harm on minority creditors.  At some point, this reality is bound to have consequences for both the debt markets and the utility of chapter 11.

The full article is available here.

Mitigating Rejection of Midstream Agreements in Bankruptcy
by | posted in: Bankruptcy, Bankruptcy Reform, Bankruptcy Roundtable Updates, Chapter 11 | 0

By David H. Sweeney, Jason P. Rubin, and Laura P. Warrick (Akin Gump Strauss Hauer & Feld, LLP), with Practical Law Oil & Gas

Producers of hydrocarbons generally require some level of gathering, processing, and other midstream services to monetize hydrocarbons. Midstream services are typically secured through contracts between the producers and the midstream providers. The fixed facilities that are required to perform those midstream services require significant investment by the midstream providers and have capacity constraints. To ensure producers’ performance and protect their investment, midstream providers often include in their contracts a dedication clause styled as a “covenant running with the land”. This clause purports to dedicate the land or reserves to the midstream infrastructure and is intended to bind third parties, including estates in bankruptcy, as an interest in real property. 

Decisions in recent Chapter 11 cases have challenged the notion that midstream services contracts containing purported covenants running with the land are not rejectable under section 365 of the Bankruptcy Code. The result is that a debtor may be able to reject a midstream contract containing a covenant running with the land, repudiate future performance of its duties, and a midstream service provider may find its claims reduced to a pre-petition unsecured claim for monetary damages. 

This article explores some recent case law regarding covenants running with the land in bankruptcy and offers practical suggestions for how producers and midstream providers might navigate the newly developing reality, including: 

  • Conducting diligence on midstream contracts to identify red flags and address potential issues before they become problems.
  • Addressing the shortcomings of covenants running with the land noted by bankruptcy courts.
  • Replacing covenants running with the land with a substitute, such as a presently possessory interest or a lien.

The full article is available here.

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.

The Judge Behind the Curtain
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates | 0

By Melissa B. Jacoby (Graham Kenan Professor of Law – University of North Carolina School of Law)

Melissa Jacoby

After a district court halted OxyContin maker and hawker Purdue Pharma’s exit from bankruptcy by finding its restructuring plan unlawful in late 2021, the yellow brick road of this high-profile case forked in two. One path is traditional: more appellate process. The United States Court of Appeals for the Second Circuit agreed to review Purdue’s restructuring plan on a fast track and oral argument is expected to be scheduled for late April 2022. The second path reflects a popular development in the federal judiciary: the presiding bankruptcy judge appointed another sitting judge as a mediator to oversee negotiations between representatives of the Sackler family and states whose appeal had prevailed in the district court. According to the judicial mediator’s most recent report, the Sackler family has offered more money to resolve the dispute; many, though not all, of the objecting states are on board to settle. Expectations that a deal can be brokered run high. 

Purdue Pharma is not the only big restructuring in which a judicial mediator has been tasked with managing a high-stakes matter. As another recent example, six judges from different federal courts served as mediators in the Puerto Rico bankruptcy for almost five years: from June 23, 2017 through January 22, 2022. 

The use of sitting judges for this behind-the-scenes work is the topic of my forthcoming article. Why are judges mediating other judges’ cases, particularly when Congress encouraged use of private neutrals for alternative dispute resolution? Are traditional judicial accountability measures effective when judicial mediators work with parties and lawyers in a process that lacks a citable record? Finding that the standard accountability measures are an awkward fit for judicial mediation, the article calls on the Judicial Conference of the United States, the policy-making body for the federal judiciary, to take steps to maximize the benefits and minimize the risks of these practices. Whatever your own experiences have been with bankruptcy-related mediations, I hope you find this project useful. 

The full article is available here.

Congressional Committees Propose Changes to Bankruptcy Code Prohibiting Non-Consensual Releases of Third Parties and Limiting Other Important Bankruptcy Tools
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Jurisprudence, Legislation, Third-Party Releases | 0

By Michael J. Cohen, Michael A. Rosenthal & Matthew J. Williams (Gibson Dunn)

The recent decision in In re Purdue Pharma did not uphold the third-party releases in the bankruptcy court’s approved plan. This post discuss the third-party releases issue.

— Harvard Law School Bankruptcy Roundtable Editors

Michael J. Cohen
Michael A. Rosenthal
Matthew J. Williams

On July 28, 2021, certain Democratic members of Congress, primarily in response to the $4.325 billion contribution made by the Sackler family to fund the settlement underpinning Purdue Pharma’s chapter 11 plan, introduced the Nondebtor Release Prohibition Act of 2021 (the “NRPA”), which proposes to amend the Bankruptcy Code to (i) prohibit the use of non-consensual third party releases in chapter 11 plans, (ii) limit so-called “Section 105” injunctions to stay lawsuits against third parties to a period no greater than 90 days after the commencement of a bankruptcy case, and (iii) provide a ground for dismissing a bankruptcy case commenced by a debtor that was formed within 10 years prior to such case via a divisional merger that separated material assets from liabilities.

When viewed against the backdrop of current complex chapter 11 practice, the NRPA is a flawed remedy for issues for which alternative means of redress already exist. First, the proposed elimination of the important bankruptcy tools of non-consensual third party releases and Section 105 injunctions – each of which is extraordinary in nature and only permitted in the rarest of circumstances – is a blunt force measure that threatens to vitiate the longstanding bankruptcy policy of favoring settlements over interminable value-destructive litigation.  Second, the loss of these tools may cause inequitable disruption in currently pending cases and stymie the implementation of critical creditor-supported strategies to resolve the most difficult cases going forward.  Moreover, a per se prohibition against non-debtor releases would contravene core bankruptcy principles by elevating the interests of a minority of creditors who would otherwise be bound to the terms of a chapter 11 plan containing such a release that is supported by the requisite majorities required under the Bankruptcy Code.  Third, while the disincentive against divisional mergers would affect a far more limited set of cases, it appears that the harm raised by some divisional mergers that are followed by bankruptcy may be adequately addressed through clarifying the applicability of fraudulent transfer law to challenge these transactions.

On November 3, 2021, the House Judiciary Committee sent the NRPA to the House floor for further consideration; the Senate Judiciary Committee has yet to act on the bill.  For more detail on the NRPA and our analysis of the bill, please find the full article here.

The Case for Bankruptcy Court Discretion to Shift Attorney’s Fees
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, International and Comparative | 0

By Daniel J. Bussel (Professor of Law, UCLA School of Law)

Daniel J. Bussel

Neither the “American Rule” (each party pays its own attorney) nor the “English Rule” (loser pays both parties’ attorneys) is the baseline principle in insolvency cases.  Most major parties do not bear their own attorney’s fees, win or lose.  Fee-shifting is pervasive; the bankruptcy court is directly involved in reviewing the fees; sometimes it’s almost impossible to figure who actually foots the bills.  This is true in US courts, which still generally purport to follow the “American Rule,” and courts in the UK, which generally purport to follow the “English Rule.”  In both countries, theory notwithstanding, equitable principles, born in England’s ancient chancery courts, permit discretionary fee-shifting in light of the collective nature of insolvency proceedings.

Unfortunately, some US courts, including the Supreme Court, disregarding this history and practice, anomalously cling to the American Rule, creating perverse incentives that disrupt the efficient functioning of the reorganization process.  Two leading examples are the Supreme Court’s decisions in Baker & Botts and Midland Funding, both critiqued in my paper, Fee-Shifting in Bankruptcy.  In Baker & Botts, the American Rule denies full compensation to the prevailing debtor’s attorney from any source, disincentivizing the pursuit of meritorious estate claims.  In Midland Funding, the American Rule rewards strategic manipulation by the holder of meritless claims, disincentivizing clearly valid objections.         

Abandoning the American Rule and authorizing a discretionary version of the English Rule as the default rule in bankruptcy for recovery of attorney’s fees is no radical step.  Empirical work is limited, but supports the conclusion that shifting from the American Rule to a discretionary version of the English Rule will have only a modest impact. In bankruptcy cases, an enormous amount of explicit and implicit fee shifting already occurs.  The bankruptcy courts have a well-developed set of procedures for regulating and allowing reasonable attorney’s fees.  They are well-positioned to exercise discretion in awarding attorney’s fees to control bullying and holdout tactics calculated to confer leverage by pressing weak claims and imposing costs on others.  

Several factors can appropriately guide court discretion to award fees in insolvency cases, including: 

  1. Whether the prevailing party or its adversary has a right to recover fees in nonbankruptcy litigation over the same issues. 
  2. Whether the bankruptcy code expressly contemplates recovery of fees as a component of damages. 
  3. The amount of fees and whether the stakes justify them. 
  4. The strength of the prevailing party’s merits case.
  5. Whether the nonprevailing party played the part of bully, holdout, or squeaky wheel. 
  6. Whether a systemic asymmetry exists between the parties allowing one party to implicitly shift fees whether it prevails or not and regardless of the court’s fee award. 
  7. Whether the prevailing party’s success in litigation will economically benefit others similarly situated or creditors generally. 
  8. Whether a fee award will advance the public interest in equitable administration of bankruptcy cases. 
  9. The extent to which a given fee award may be so onerous to the non-prevailing party that it would unreasonably deter access to the courts.
  10. Vexatious and unreasonable conduct by either (or both) of the litigants. 
  11. The extent to which the prevailing party incurred fees for considerations apart from the case at bar because of its status as a repeat player. 
  12. The extent to which the party seeking recovery of fees practically prevailed in the litigation.
  13. Whether the prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity.
  14. Whether the non-prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity.
  15. Assessing the practical economic incidence of fees initially borne by the estate.

The UK, starting from the English Rule, has created a discretionary fee-shifting regime in insolvency cases resembling the discretionary approach advocated here.  The English cases exhibit a continuing push-pull among (i) the desire to socialize costs of reorganizations that benefit third parties; (ii) concern about unduly discouraging participation by all affected constituents; and (iii) the problems posed by hold-outs, bullies and excessive litigiousness. See Matter of Virgin Active Holdings Ltd (Snowden, J.).  The realities of insolvency practice are impelling both the English and American systems towards court-supervised discretionary fee-shifting.

The damage done by the American Rule is limited by how pervasive fee-shifting already is in bankruptcy.  Fully embracing discretionary fee-shifting in favor of prevailing parties, however, is low-hanging fruit we can promptly gather in to facilitate sound administration of insolvent estates.

The full paper is available here.

“Confessions” of a Forum Shopper, Part II – Debtors Without Borders
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction | 0

By Andrew Dietderich (Sullivan & Cromwell LLP)

Andrew Dietderich

Part II of Andrew Dietderich’s treatment of the practical side of forum shopping addresses the use of Chapter 11 by non-U.S. corporations with only limited U.S. contacts.  The logic of international bankruptcy law – as reflected in Chapter 15 of the U.S. Bankruptcy Code and the UNCITRAL Model Law – suggests that these types of Chapter 11 filings should not happen.  Instead of filing for Chapter 11, non-U.S. companies should file for plenary proceedings only in their home country, i.e., where they are headquartered or otherwise have their “center of main interest.”  The role of U.S. courts should be limited to recognition and assistance of the home country proceeding under Chapter 15.

The article explains why these Chapter 11 cases happen and why “forum shopping” against the grain of international insolvency conventions is necessary for certain types of cross-border cases.  Chapter 11 is sometimes the best (or the only) way to reorganize companies headquartered outside of the U.S., and U.S. courts have been uniquely effective at supervising these reorganizations in a manner fair to all stakeholders. 

The article also suggests that the U.S. has a national interest in making its bankruptcy courts available for these types of cases, that principles of international comity are as active in Chapter 11 as they are in Chapter 15, and that non-U.S. stakeholders have nothing to fear from this application of Chapter 11 in the coming years. Part II appears in the October issue of the ABI Journal, available here.

“Confessions” of a Forum Shopper – A Debtor’s View of Venue Choice
by | posted in: Bankruptcy, Bankruptcy Reform | 0

By Andrew Dietderich (Sullivan & Cromwell LLP)

Andrew Dietderich

Corporate debtors can decide if, when and how to file for chapter 11. Recently, there is a great deal of concern about their ability to decide where. In a series of two articles for the ABI Journal, I explain as debtor’s counsel the practice of responsible forum shopping and argues that it is, on balance, a social good.

 Motivated by recently introduced legislation that would force domestic debtors to file chapter 11 only in the jurisdiction of their headquarters, Part I warns that mandating a single venue for a corporate debtor will impede legitimate restructurings and hurt companies and workers. There are important reasons why a distressed domestic corporation may need to file away from its headquarters: examples from my own experience include the need to preserve critical corporate contractual assets and to protect rank-and-file employee severance.  

 Since U.S. bankruptcy law necessarily varies from place to place around the country, someone has to decide what particular version of bankruptcy law should apply to each case given its unique factual context and reorganization purpose.  As with many other chapter 11 decisions, the board of directors of the debtor is the least worst alternative.   

Of course, there are some legitimate concerns with the current system of modified venue choice.  But the venue reform legislation proposed in Congress is too blunt of an instrument.  It is uninformed by experience in the trenches reorganizing distressed business and, if passed, would hurt some of the people it aims to help. Part I appears in the September issue of the ABI Journal, available here.

Part II of the series addresses international forum shopping—specifically the use of chapter 11 by non-U.S. debtors with minimal U.S. contracts—appears in the October issue of the ABI Journal.

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