Swaps, like other financial contracts (repurchase agreements, securities contracts, commodities contracts, forward agreements and master netting agreements), receive special treatment under the Bankruptcy Code. Their acceleration, liquidation and termination is not prohibited as an ipso facto clause and the exercise of setoff rights is not subject to the automatic stay. Transfers made in connection with these contracts are also exempt from avoidance as preferences and constructive fraudulent transfers as well as actual fraudulent transfer under state law. But their scope is not always free from doubt. Are provisions that modify the debtor’s priority of payment upon bankruptcy protected as well? Are provisions that the swap incorporates by reference protected? Must the swap counterparty itself exercise the right to liquidate, terminate and accelerate the swap? The Second Circuit just answered these questions.
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.
Federal courts regularly resolve consolidated corporate tax refund disputes in bankruptcy cases. In the current economic downturn, the ownership of a large tax refund paid to an affiliated group of corporate debtors can be significant. See, e.g., FDIC v. AmFin Corp., 757 F.3d 530, 532 (6th Cir. 2014) ($170 million refund). If a corporate debtor’s parent owns the refund, it is part of the parent’s bankruptcy estate, and the subsidiary may be an unsecured creditor for any claimed benefits. But if the debtor parent is an agent or trustee for its affiliates, the parent cannot use the refund to repay its creditors.
Corporate parents and their subsidiaries often file a consolidated tax return. That enables affiliates to offset their losses against each other so as to reduce the group’s overall tax liability. Because only the corporate parent may file a consolidated return, any refund is also paid to the parent, not to individual affiliates. Affiliated groups, therefore, usually enter into tax sharing or allocation agreements. These agreements – or their absence – have generated a spate of litigation.
The Circuit Courts of Appeals had been sharply split on how to resolve tax refund ownership issues until the U.S. Supreme Court resolved the issue this past February in Rodriguez v. FDIC (In re Western Bancorp, Inc.), 589 U.S. ___, 140 S. Ct. 713 (Feb. 25, 2020). Without deciding the merits, the Court remanded the case to the Tenth Circuit, directing it to apply state law to resolve the refund ownership dispute between the parent’s bankruptcy trustee and a subsidiary. The Supreme Court also rejected a purported federal default rule promulgated by the Ninth Circuit in 1973 that had been adopted by a few other Circuits, describing it as inappropriate federal “common lawmaking.” On May 26, 2020, following the Supreme Court’s remand, the Tenth Circuit, applied Colorado law, construed the relevant group tax sharing agreement, and held for the subsidiary bank, now in the hands of a FDIC receiver.
This article describes relevant issues litigated over the past fifty years. It also notes open issues that will continue to be litigated following the Rodriguez decision.
By Tomas Richter (Clifford Chance) and Adrian Thery (Garrigues)
Under EU Directive 2019/1023 promulgated in June 2019, the 27 Member States of the European Union must enact rules supporting preventive restructurings of businesses threatened by insolvency. The restructuring frameworks to be enacted are in a large part modelled after the U.S. Chapter 11 yet they are not carbon copies of it. Also, the 27 Member States have widely differing insolvency laws against whose background the preventive restructuring frameworks must operate, and significantly diverging institutions by which they will have to be applied. The implementation tasks will be both varied and formidable.
However, certain threshold questions are very similar across jurisdictions when it comes to particular topics relevant to corporate restructurings. In the context of agreeing to and adopting a restructuring plan, some of the key questions arise in relation to classification of investors’ claims and interests, grouping these claims and interests into classes, voting in the classes, and obtaining an official approval of the restructuring plan after investors have expressed their opinions on it via the voting mechanism.
The purpose of this first guidance note, published by INSOL Europe, is to flag some of the key issues that national legislators will want to consider in this particular context when implementing the restructuring frameworks prescribed by Title II of the Directive, and, at least at times, also to respectfully suggest which approaches, in the authors’ humble opinions, might perhaps be explored more productively than others.
By Shana A. Elberg, Seth E. Jacobson, & George R. Howard (Skadden)
Today, U.S. borrowers are more indebted than ever before. Borrowers have become increasingly aggressive in using secured leverage, and in taking advantage of “cov-lite” loan documents to engage in creative (and sometimes controversial) transactions to transfer assets beyond the reach of existing secured lenders by way of distributions to shareholders or contributions to unrestricted subsidiaries and then utilize those assets to raise additional secured financing. While the debt levels and cov-lite structures of leveraged loans may create risks for many stakeholders, lenders under asset-based loan facilities (“ABL facilities”) should be well-positioned to weather any storm. ABL facilities typically offer lenders greater protections in a liquidation scenario. In addition, ABL facilities often are a critical lynchpin of debtor-in-possession financing facilities when borrowers are looking to effectuate comprehensive restructurings through chapter 11. There are several tools available to ABL lenders to protect their credit position in the event that a borrower finds itself in a distressed situation. Lenders should position themselves to understand and use the chapter 11 process to ensure their debt claims retain, and even gain, protections in bankruptcy.
By Michael Ohlrogge (New York University School of Law)
In 2009, the Seventh Circuit ruled in U.S. v. Apex Oil that certain types of injunctions requiring firms to clean up previously released toxic chemicals were not dischargeable in bankruptcy. The result of this was to expose lenders, even those with security interests, to larger losses in the event a firm they extended credit to entered bankruptcy with significant outstanding environmental cleanup obligations. I document that lenders tightened the covenants on loans they extended to firms impacted the decision. In particular, lenders added new requirements that borrowers’ facilities and operations be inspected by outside environmental engineering firms in order to assess the safety with which they handle toxic chemicals.
Using an array of statistical tests and data from federal environmental agencies, I show that firms impacted by the decision responded to these new pressures from lenders by taking meaningful steps to reduce their risks of causing catastrophic pollution spills. In particular, firms reduced volume of toxic chemicals they release on-site by approximately 15%. In place of these releases, firms substituted off-site treatment by specialized facilities generally considered to be safer for the environment. These results point to important ways in which bankruptcy law and other legal rules that impact recovery for firms’ creditors can work to shape the positive or negative externalities those firms generate.
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.
By Jared A. Ellias (University of California Hastings College of the Law), George Triantis (Stanford Law School)
During the COVID-19 pandemic, Congress has moved quickly to get trillions of dollars of emergency relief to consumers, small businesses, and large firms. These efforts aim to rescue millions of American consumers and businesses from insolvency.
It is troubling, though, that the federal government is ignoring the law that already exists for cushioning the blows associated with financial distress: the bankruptcy system. In its strategy to provide relief and stimulus, the government is in effect offering roadside emergency assistance when the infrastructure and expertise of a hospital is easily accessible.
Because the bankruptcy system entails a detailed restructuring process, it forces companies to think hard about how they’ve been doing things and whether it makes sense to continue doing them that way. Cash infusions from programs like those in the CARES Act, on the other hand, are only designed to keep businesses’ heads above water. That’s all that some companies need, but for others that were already struggling before the crisis hit, such as J.Crew and Neiman Marcus, bankruptcy can encourage them to focus on their long-term health.
Our existing bankruptcy system isn’t only crucial for helping companies move past their immediate crisis of zero revenue and illiquidity, it will also be essential in helping entire industries adapt to a prolonged period of uncertainty created by the coronavirus pandemic.
By Andrew N. Goldman, George W. Shuster Jr., Benjamin W. Loveland, Lauren R. Lifland (Wilmerhale LLP)
Valuation is a critical and indispensable element of the Chapter 11 bankruptcy process. It drives many aspects of a Chapter 11 case, from petition to plan confirmation, in all circumstances. It may be obvious that the COVID-19 crisis has added a layer of complexity—and volatility—to bankruptcy valuation issues with respect to valuing assets, liabilities, and claims, both in and outside the Chapter 11 context. But the crisis may also change the way that courts look at valuation determinations in Chapter 11—both value itself, and the way that value is measured, may be transformed by the COVID-19 crisis. While the full extent of the pandemic’s effect on valuation issues in bankruptcy has yet to be seen, one certainty is that debtors and creditors with a nuanced and flexible approach to these issues will fare better than those who rigidly hold on to pre-crisis precedent.