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.
By Diane Lourdes Dick (Professor of Law, Seattle University School of Law)
Over the last year, publicly traded companies have provided thoughtful commentary in their public company disclosures regarding the financial decisions they have made in response to the COVID-19 crisis. Meanwhile, public and private companies have filed for bankruptcy protection, providing detailed narrative accounts of the events leading up to the filing and the various steps they have taken to stem losses and maintain the company as a going concern.
In a recent article, I use public disclosures and declarations of this sort to take a closer look at the firm-level decision-making process in response to the sudden liquidity crisis caused by the pandemic. Specifically, I analyze the recapitalization and restructuring decisions made by twelve large and mid-sized companies in the cruise, airline, health care, and consumer sectors in the spring and summer of 2020. Although the case studies are mere snapshots in time, they help to shed further light on the key factors that have influenced firm-level bankruptcy, bailout, and other recapitalization decisions.
The case studies reveal that, outside of bankruptcy, corporate managers of the profiled companies have followed a remarkably similar decision pathway. First, firms slashed costs and reduced employee headcount. Of course, many of these cuts are the natural consequence of voluntarily or involuntarily scaling back operations; in other cases, firms likely chose to make reductions of this sort because there are typically few if any legal impediments to doing so. But whether voluntary or involuntary, the choice to scale back operations generally means allocating economic burdens to employees, vendors, suppliers, and, in the case of firms that provide an essential service, the broader communities they serve.
A firm’s subsequent choices appear to be constrained by its overall financial condition and its new or existing legal commitments. For instance, companies with substantial open lines of credit were able to draw down available funds to shore up cash. Meanwhile, those with stronger balance sheets were able to obtain new debt and equity financing from the capital markets. Virtually all of the profiled companies that were eligible to receive governmental bailouts accepted the assistance—in both grant and loan form—with little apparent concern for the conditions and restrictions attached to such funds. Participation in bailout programs, in turn, constrained the firm’s choices regarding how to allocate economic burdens. For instance, the restrictions and limitations in the CARES Act were designed to delay or prevent companies from allocating economic burdens to employees and, in the case of airlines and health care facilities providing essential services, their broader communities.
The case studies suggest that to the extent these other liquidity options are available, corporate managers may view bankruptcy primarily as a legal or strategic tool rather than as a true financial restructuring option. Perhaps because of certain underlying assumptions about bankruptcy, no company seems to have weighed participation in a governmental bailout—with or without strings attached—against the option of filing for bankruptcy. Rather, these alternatives—like all of the major decisions firms make in response to a sudden liquidity crisis—appear to have been independently examined at very different points in the lifecycle of the distressed firm.
By Anthony J. Casey (The University of Chicago Law School)
In the spring of 2020, as the Covid-19 pandemic shut down economies around the world, pressure arose for governments to respond to the growing threat of pandemic-related market distress. In the United States, the initial proposals for government action varied in nature and focus. Some proposals targeted the financial system while others targeted small businesses and individuals. Others were intended to bail out large businesses and specific industries. Still other proposals took a more institutional focus. In the context of bankruptcy law, many imagined building up the bankruptcy system as a primary bulwark against a seemingly imminent wave of economic and financial distress.
With the exception of measures related to financial markets, the actual responses formed a chaotic mix of disconnected half-measures that neither stabilized the economy nor provided meaningful relief to those most affected. While that failure may be attributed in part to general government dysfunction and legislative gridlock, a large part of the problem arises from the lack of a clearly identified framework to guide government responses.
The main lesson here is that the appropriateness of tools deployed to alleviate a crisis depends on the nature of the specific problem at hand, and scattershot approaches are unlikely to work. As obvious as that principle may seem, it was largely ignored in 2020. Much of the confusion in the pandemic responses is attributable to using the wrong tools and implementing measures that lacked any clear purpose.
In particular, governments and commentators lost sight of two important distinctions in deciding how to act. The first is the distinction between tools appropriate for addressing economic distress and those appropriate for addressing financial distress. The second is the distinction between a systemic crisis where distress is spreading and an instance of firm-specific distress where the harm—though perhaps large—is contained.
These distinctions present four types of market distress: specific economic, systemic economic, specific financial, and systemic financial. Each type is distinct from the others, and for each there is a category of appropriate government responses (respectively): direct subsidies, general stimulus, bankruptcy proceedings, and financial bailouts. We thus have this matrix:
The importance of understanding these classifications is most evident in the flawed proposals for pandemic-related fixes to bankruptcy law and in the lack of a centralized economic plan to support failing small businesses around the country.
In a new article, I lay out this framework for identifying the right tools for responding to different forms of market distress. I describe the relationship between the category of tools and the type of distress. Having presented the framework, I then use it to closely examine the interaction between pandemic responses and bankruptcy law. This analysis is particularly important because efforts to understand the bankruptcy system’s role during the pandemic provide the starkest example of confused analysis of appropriate responses to systemic crises, and because a striking decline in bankruptcy filings in 2020 has puzzled many commentators.
By Mike Harmon (Gaviota Advisors, LLC) and Claudia Robles-Garcia (Stanford Graduate School of Business)
Corporate leveraged finance cycles have followed a predictable pattern in the forty years that have ensued since the invention of the junk bond in the late 1970s. They expand as investors’ risk appetites grow and recede as default rates rise. The recession of credit cycles has historically facilitated a healthy “creative destruction” in the form of restructuring transactions which have enabled over-leveraged companies to fix their burdened balance sheets. While the current credit cycle is positioned to share some of the characteristics of past cycles, it is also shaping up to differentiate itself in some meaningful ways. First, companies entered the current crisis with significantly more debt, and with that debt bearing a much higher blended risk profile, than in past cycles. Second, the restructuring “fix” has required much more additional financing than previous cycles, due to the economic nature of the crisis. Third, companies have had much more contractual leeway to avoid default, and to solve their liquidity problems with more leverage, than they have in previous cycles. Fourth, many investors have been aligned with borrowers on their desire to maintain elevated leverage levels. And finally, and probably most importantly, the Fed’s actions have facilitated, and even encouraged, the raising of more leverage. As a result of all of these factors, we believe that this restructuring cycle is more likely to see companies emerge with significantly more debt than we have seen in previous cycles. This will exacerbate the highly publicized “zombie” problem (where companies that are technically insolvent have no real catalyst to restructure), which could impact economic growth, and will increase the likelihood of a more protracted restructuring cycle in the years to come.
By Kristin van Zwieten (University of Oxford), Horst Eidenmüller (University of Oxford), and Oren Sussman (University of Oxford)
In a recent paper we argue that bail-outs or bail-ins are better than bankruptcy for the treatment of COVID-19 distress, even where there exists a reorganization procedure that functions well in normal conditions.
COVID-19 has severely disrupted the conduct of business around the globe. In jurisdictions that impose one or more “lockdowns,” multiple sectors of the real economy must endure prolonged periods of reduced trading or even total shutdowns. The associated revenue losses will push many businesses into bankruptcy. No public policy response can recover these losses. States can, however, act to reduce the amplification of the shock by the way in which they treat the cohort of newly bankrupt businesses.
In jurisdictions where a well-functioning reorganization procedure can produce value-maximizing outcomes in normal conditions, the temptation may be to subject this cohort to such procedures. This temptation should be resisted, not only because of the (significant) costs of these procedures, or because of concerns about institutional capacity to treat a high volume of cases, but also because such procedures are likely to be a poor “fit” for the treatment of COVID-19 distress. Distorting such procedures to accommodate the features of COVID-19 distress (or, in jurisdictions where there is not a reorganization procedure, introducing one designed with COVID-19 distress in mind) risks inhibiting the availability of credit for new projects in future, slowing the path to economic recovery.
The more attractive routes to relief are bail-ins (one-time orders to creditors or counterparties, or some class thereof, to forgive), bail-outs (offers to assume the debtor’s liabilities, or a class thereof), or some combination of the two.
In our paper, we explain why a public policy response is necessary to mitigate the amplification of the shock caused by trading shut-downs, and we compare treatment by the prevailing bankruptcy law with treatment by bail-ins or bail-outs along a range of dimensions. We conclude by developing principles to help guide the choice between bail-ins and bail-outs, and the design of either form of intervention.
We suggest that policymakers should intervene in ways that are proportionate, in the sense that they ought to confine themselves to that which is thought necessary to minimize the amplification of the economic shock caused by periods of trading shutdowns; that interventions should be designed to minimize distortions to efficient private bargains and private law rules; that transfers should be from the less financially constrained to the more financially constrained; that interventions should “fit” with the institutional apparatus responsible for administering them; and that the process of designing and delivering relief should be transparent.
We suggest these principles tentatively, mindful of the fact that policymakers may or may not be working with common conceptions of fairness and responsibility, and of the fact that some of our principles may only be able to be fully pursued at the partial expense of others. But we nevertheless hope that they offer a useful starting point for thinking about the design and delivery of novel forms of relief to debtors distressed by COVID-19 related revenue losses.
By Stephen J. Lubben (Seton Hall University School of Law)
Since 2017, the Commonwealth of Puerto Rico (and certain of its affiliated entities) have been in “bankruptcy” under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”). PROMESA is a bankruptcy law, with various other bells and whistles, although Congress purported to enact it under its Article IV territories powers.
These cases are pending in the United States District Court for the District of Puerto Rico; however, Judge Laura Taylor Swain, of the Southern District of New York, was appointed by the Chief Justice to preside over the cases. My new paper – Puerto Rico; Act III – provides a concise overview of where things now stand in the PROMESA process, and where they might be heading.
In addition to its restructuring provisions, the law creates the Financial Oversight and Management Board for Puerto Rico. The Board frequently states that “the purpose of the Oversight Board is to provide a method for Puerto Rico to achieve fiscal responsibility and access to the capital markets.” In essence, the Board operates as a supra-governmental body for fiscal matters.
At present several members of the Board have stepped down, and President Trump bumped one member off the Board – former bankruptcy judge Arthur J. González – by appointing a new member to his slot. Congress and the president will have to fill out the Board, or devise a new path for the Commonwealth.
In the face of hurricanes, earthquakes, and COVID-19, the Board has attempted to push forward with a reorganization under Title III. The virus, however, might substantially delay the process and force a reconsideration of the present reorganization plan. It thus represents the opening of a third act in Puerto Rico’s debt drama.
Even before recent events, I had argued that the Board was being far too timid in its efforts to revamp Puerto Rico’s economy, given that the PROMESA process was presumably a one-time opportunity. In particular, the debt relief the Board was proposing was comparatively modest, and I worried that it might leave the Commonwealth with still too much debt to successfully restart its economy.
The problem is that the Board’s current plan has the support of almost nobody, making even “cramdown” of the plan extremely unlikely. Pensioners might be the most likely ally with the Board, although the government of Puerto Rico, and presumably many of the pensioners, object to the current offer. As Justice Sotomayor recently noted,
The Board’s decisions have affected the island’s entire population, particularly many of its most vulnerable citizens. The Board has ordered pensions to be reduced by as much as 8.5 percent… Other proposed cuts take aim at already depleted healthcare and educational services. It is under the yoke of such austerity measures that the island’s 3.2 million citizens now chafe.
Indeed, Justice Sotomayor’s recent opinion also provides a kind of roadmap for a challenge to PROMESA. She explains that she concurred in the Court’s result only because nobody had argued that Puerto Rico’s Commonwealth status was inconsistent with the creation of the Board. As she sees it, Congress made certain commitments to Puerto Rico in the 1950s when it created the Commonwealth, and Congress may not “take back” those commitments. Any litigation following her approach would presumably involve extensive appeals, but it looms as a threat to the PROMESA process.
At heart, the problem in Puerto Rico is not unlike the problem in many sovereign and municipal workouts. The bondholders want to recover as much as possible, of course, and are leery of settling claims only to see the debtor rebound shortly thereafter. The conundrum being that the rebound is unlikely to happen without serious debt reduction. Debt reduction is often not the only requirement for a rebound, but it is fundamental.
Either the Board needs to lead Puerto Rico out of this feedback loop, or Puerto Rico needs to extract itself from the PROMESA process. If not, the drama will continue for many more acts. Future acts could in theory include statehood for Puerto Rico, or some new restructuring process, or perhaps even both. Or the parties may simply reach a deal on a plan. At this point it is hard to say any particular outcome is more likely than another.
 Financial Oversight And Management Bd. For Puerto Rico v. Aurelius Investment, LLC, 590 U. S. ____ (2020), Sotomayor, J., concurring in judgment, slip opinion at page 7.
Since March, executives of 18 large companies received over $135 million total in bonuses prior to their companies filing under Chapter 11, while “[t]hose same companies laid off tens of thousands of workers,” according to a Washington Post report. These recent examples are illustrative of gaps left by the last major reform targeting bankruptcy bonuses. Further reforms have been introduced in Congress every few years since 2005. Referencing inequality and perceived abuses in the context of COVID-19, the House Judiciary Committee advanced the current House bill to the full chamber on September 29, 2020, marking the proposed legislation’s furthest progress thus far.
H.R. 7370, the Protecting Employees and Retirees in Business Bankruptcies Act of 2020 (PERBB) would present significant changes to the Bankruptcy Code aimed at protecting workers. The bill would expand from existing regulation of insider retention bonuses to include a broader set of payments to insiders, senior executive officers, the 20 highest compensated employees who are not insiders or senior executives, department and division managers, and any consultants providing services to the debtor.
Through expanding the scope of executive compensation subject to restrictions, PERBB may more effectively reduce management bonuses paid in bankruptcy. However, the House version of PERBB fails to address bonus payments prior to filing for bankruptcy, a key issue identified at the outset of the post. The related Senate bill has an additional provision which would designate any transfer made to management “made in anticipation of bankruptcy” as a §547 preference avoidable by the trustee.
The full post, including a summary of proposed changes to the Code, is available here.
The full text of the House bill can be accessed here. A redline of relevant 11 U.S.C. provisions reflecting amendments proposed in H.R. 7370 is available here. The full text of Senate bill can be accessed here.
By Steven T. Kargman (Kargman Associates/International Restructuring Advisors)
Argentina’s new government under President Alberto Fernández recently completed a bond exchange which was approved overwhelmingly by its foreign bondholders. The final restructuring deal that Argentina reached with its foreign bondholders in early August was the product of a fraught and tortuous negotiating process that lasted several months and came after Argentina had defaulted on its sovereign debt in late May for the ninth time in its history.
A recent four-part article published in Global Restructuring Review examines the negotiating dynamics in the restructuring negotiations between Argentina and its foreign bondholders. The article focuses in particular on what I call the “three P’s”—namely, the pandemic, the professoriate, and the Pope—that I argue underpinned Argentina’s strategy in those negotiations.
Argentina sought to use each of the “three P’s” to its advantage. First, the pandemic likely made Argentina’s foreign creditors more accommodating in their stance vis-à-vis Argentina in light of the strains the pandemic placed on Argentina’s sovereign balance sheet. Second, Argentina benefited from the support of prominent professors from around the world who expressed their strong support for Argentina’s negotiating position. The professors weighed in on various matters such as whether Argentina’s debt sustainability would or would not be restored by debt restructuring proposals then under consideration and what type of collective action clauses (CACs) for binding dissenting creditors through a supermajority vote should be used in the new bonds issued pursuant to the restructuring. Third, Argentina sought to benefit from the Pope’s moral authority as reflected in a meeting the Pope held in late January with President Fernández as well as in the Pope’s participation a few days later in a Vatican conference on issues of debt and development.
In its final section, the article discusses the economic prospects for Argentina post-restructuring in view of the major economic challenges that Argentina will continue to face notwithstanding the outcome of the recently concluded sovereign debt restructuring. The article also provides an overview of certain factors that may be relevant to Argentina’s upcoming discussions with the International Monetary Fund (IMF) concerning the IMF’s outstanding loan of $44 billion to Argentina.
The full article can be found here. This four-part article was first published in Global Restructuring Review (GRR) and is reposted with the permission of the GRR.
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 Ilya Kokorin, Leiden Law School (The Netherlands)
The current economic downturn triggered by the spread of COVID-19 demonstrates that the role of insolvency law should not be restricted to resolving conflicts between private parties (i.e. creditors and debtors). Nevertheless, the very framework of insolvency law remains primarily: (i) microprudential – single entity focused and designed to protect individual debtors and their creditors, (ii) contractarian – implementing the idea of creditors’ bargain and solving coordination problems between creditors of a single entity, and (iii) reactive – centred around post-crisis liquidation of assets and allocation of proceeds among creditors. It may therefore be ill-fitted to serve the public interest in mitigating the negative externalities of large-scale (systemic) corporate debacles (e.g. Chrysler, GM, British Steel, Carillion) or handling the economy-wide instability experienced nowadays.
In contrast to corporate insolvency, in the aftermath of the global financial crisis of 2008 (GFC), bank resolution in the European Union (EU) and the USA went through fundamental changes that seek to preserve financial stability and ensure continuity of critical functions. Bank resolution has increasingly embraced the macroprudential vision, recognizing the need for an advanced preparation and a speedy intervention to ensure continuity of critical functions, preservation of financial stability and avoidance of bailouts. This vision has resulted in the specific proactive and reactive recovery and resolution strategies. In the recent paper Insolvency of Significant Non-Financial Enterprises: Lessons from Bank Failures and Bank Resolution, I explore whether the modern approaches to bank crises can be extended to non-financial enterprises. I discuss how insolvency law might help minimize social harm stemming from wide-ranging shocks and grand-scale business failures and suggest what we can learn from bank failures and bank resolution.
The failure of Carillion, once the UK’s second-largest construction company, has shown that the reactive approach to crisis resolution, centred around post-crisis intervention, posed significant risks not only for creditors but also for other stakeholders and communities at large. Carillion had around 43,000 workers, of whom 19,000 were based in the UK. It owed around GBP 2 billion to the extensive network of 30,000 suppliers, sub-contractors and other creditors and left the pension liability exceeding GBP 2.5 billion. Even though the signs of financial distress appeared long before Carillion filed for liquidation in January 2018, these warning signals were largely ignored. The failure of Carillion had substantial implications for the provision of public services, raising environmental, health and safety concerns. It ultimately led to a state intervention backed by taxpayers’ money. However, the actual economic and social cost of Carillion’s insolvency are hard to quantify. Financial distress of such a significant enterprise (significant non-financial enterprise or SNFE) required timely state intervention. Nevertheless, its multiple profit warnings came as a surprise to the Cabinet Office.
Insolvency of Carillion was characterized by the absence of timely reaction to prevent crisis escalation, a genuine threat of public disruption and a vast complexity determined by both the debtor’s organizational structure, consisting of more than 320 group members, and the nature of its activities. Many of the same features were observed in the failure of banks and banking groups during the GFC. As a response, both the EU (BRRD) and the USA (Title II of the Dodd-Frank Act) have embraced a proactive and precautionary approach focused on preparation and early response. In my paper, I use the case of Carillion to inquire whether selected bank recovery and resolution tools could have been adopted to prevent the collapse of Carillion, or to mitigate its negative consequences.
In particular, I analyse three such tools, namely: (i) intervention powers granted to state authorities for early (preventive) reaction to the escalation of financial problems before the actual insolvency, (ii) entity and group recovery and resolution planning, and (iii) administrative-led insolvency process. I conclude that while the first two mechanisms may prove beneficial, the last one is rather controversial. While an administrative-led process has certain advantages and prevails in bank resolution, it may be difficult and unnecessary to replicate or transpose to non-financial enterprises. Instead, a transparent court-supervised process with active involvement of creditors and debtors, as well as a limited and targeted engagement of public authorities on matters of public interest should be encouraged.