By Sergio J. Campos (University of Miami School of Law) and Samir D. Parikh (Lewis & Clark Law School)
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.
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.
By Aras Canipek (University of Konstanz), Axel H. Kind (University of Konstanz), and Sabine Wende (University of Cologne – Faculty of Management, Economics and Social Sciences)
Stronger creditor rights reduce credit costs and thus may allow firms to increase leverage and investments, but also increase distress costs and thus may prompt firms to lower leverage and undertake risk-reducing but unprofitable investments. Using a German bankruptcy reform, we find evidence on average consistent with the latter hypothesis. We also hypothesize and find evidence that the effect of creditor rights on corporate leverage and investments depends on the firm type, as it influences the effect creditor rights have on credit costs and distress costs and thus which effect dominates. For example, our findings suggest that stronger creditor rights are costly for large firms, for which the effect of creditor rights on distress costs should outweigh the effect on credit costs, but beneficial for small firms, for which the effect on credit costs should outweigh the effect on distress costs. Our understanding not only reconciles the mixed empirical evidence of existing studies, but also has important implications for optimal bankruptcy design. In particular, our findings are contrary to a widely held opinion that bankruptcy law should be uniform and balance the effect of creditor rights on credit costs and distress costs. Rather, they point to a menu of procedures in which a debtor-friendly and creditor-friendly procedure co-exist and thus allow different types of firms to utilize the procedure that suits them best. If such a menu is not possible, our analysis suggests that countries should choose a debtor-friendly or creditor-friendly procedure, depending on the most important firm type in the country.
By Lynn M. LoPucki (Security Pacific Bank Distinguished Professor of Law, UCLA School of Law)
The bankruptcy courts that compete for big cases frequently ignore the Bankruptcy Code and Rules. This Article documents that lawlessness through a detailed examination of the court file in Belk, Inc.—a one-day Chapter 11—and a series of empirical studies.
Chapter 11’s lawlessness reached a new extreme in Belk. Belk filed in Houston on the evening of February 23, 2021. The court confirmed the plan at ten o’clock the next morning, and the parties consummated the plan that same afternoon. Almost none of Chapter 11’s procedural requirements were met. The court did not give creditors notice of the disclosure statement or plan confirmation hearings until after those hearings were held. Belk filed no list of creditors’ names and addresses, no schedules, no statement of financial affairs, and no monthly operating reports. No creditors’ committee was appointed, no meeting of creditors was held, and none of the professionals filed fee applications. The ad hoc groups that negotiated the plan failed to file Rule 2019 disclosures. Because no schedules were filed, no proofs of claim were deemed filed. Only eighteen of Belk’s ninety-thousand creditors filed proofs of claim, and Belk apparently just made distributions to whomever Belk considered worthy.
The procedural failures in Belk are just the tip of the iceberg. The competing courts are ignoring impermissible retention bonuses, refusing to appoint mandatory examiners, failing to monitor venue or transfer cases, granting every request to reject collective bargaining agreements, and providing debtors with critical-vendor slush funds. The article is available here.