Bankruptcy & Bailouts; Subsidies & Stimulus: The Government Toolset for Responding to Market Distress
by | posted in: Bankruptcy, Bankruptcy Reform, Bankruptcy Roundtable Updates | 0

By Anthony J. Casey (The University of Chicago Law School)

Anthony J. Casey

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:

Systemic Specific
Economic General Stimulus Direct Subsidies
Financial Financial Bailouts Bankruptcy Proceedings

(Chapter 11)

 

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.

Where Past is Prologue: Applying Lessons from the Past to Protect ABL Lenders in a World of Future Distress
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Priority | 0

By Shana A. Elberg, Seth E. Jacobson, & George R. Howard (Skadden)

Shana A. Elberg
Seth E. Jacobson
George R. Howard

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.

The full article is available here.

COVID-19: Rethinking Chapter 11 Bankruptcy Valuation Issues in the Crisis
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Valuation | 0

By Andrew N. Goldman, George W. Shuster Jr., Benjamin W. Loveland, Lauren R. Lifland (Wilmerhale LLP)

Andrew N. Goldman
George W. Shuster Jr.
Benjamin W. Loveland
Lauren R. Lifland

 

 

 

 

 

 

 

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.

The full article is available here.

Bankruptcy and Aircraft Finance
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates | 0

By Franklin H. Top III, Stephen R. Tetro, Richard F. Klein, James M. Heiser (Chapman and Cutler LLP)

Franklin H. Top III
Stephen R. Tetro
Richard F. Klein
James M. Heiser

Hundreds of billions of dollars are invested in aircraft equipment in the United States. With the airline industry suffering devastating losses resulting from the COVID-19 pandemic, Chapman and Cutler LLP recently released its Bankruptcy and Aircraft Finance Handbook. The handbook aims to help aircraft investors navigate the numerous challenges typically faced in airline bankruptcies. The handbook seeks to provide an understanding of the unique aspects of § 1110 of the Bankruptcy Code and other related provisions that govern the treatment of claims in bankruptcy involving aircraft. It also outlines the state law remedies available to aircraft investors outside of bankruptcy.

In addition, the handbook seeks to demystify the complex structures behind these investments, including secured loans, sale/leasebacks, operating leases, pass-through certificates, leveraged leases and public debt, including equipment trust certificates or enhanced equipment trust certificates. Each structure can present its own unique challenges in bankruptcy.

We also provide a checklist of considerations for aircraft investors drawn from over 30 years of experience, and identify some of the common challenges that investors face in airline bankruptcies. We provide investors with an understanding of the legal protections available in the event an aircraft investment heads south, as well as share lessons learned from prior airline bankruptcies from the 1990s to the present

The full article is available here.

COVID-19 Impacts on Landlords of Retail Debtors
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates | 0

By Scott K. Charles, Amy R. Wolf, Michael H. Cassel (Wachtell)

Scott K. Charles
Amy R. Wolf
Michael H. Cassel

This memorandum addresses one of the impacts of COVID-19 on retail bankruptcies. Several retailers in chapter 11 have sought to suspend their cases given the inability to operate or conduct going out of business sales during the pandemic. Courts in some cases have granted requests for extraordinary relief, which have included excusing the payment of rent notwithstanding the requirements of the Bankruptcy Code that nonresidential leases of real property be paid on a current basis.

The full article is available here.

This DIP Loan Brought to You by Someone Who CARES!
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Corporate Governance, Legislation | 0

By Thomas J. Salerno, Gerald Weidner, Christopher Simpson, and Susan Ebner, (Stinson LLP)

Tom Salerno
Gerald Weidner
Chris Simpson
Susan Warshaw Ebner

 

 

 

 

 

 

 

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted into law. The CARES Act is reported to be “twice as large as any relief ever signed,” and will provide $2.2 trillion in relief to US businesses (with another $1 trillion being promised in the near future). While bankruptcy lawyers are aware that CARES expanded the debt limitations for eligibility for the Small Business Bankruptcy Reorganization Act, there could (and should) be another substantial implication for the brave new bankruptcy world—a new potential source of DIP financing. It is in this context that the CARES financing provisions become particularly interesting.

The authors recognize that there are established underwriting guidelines for SBA loans. Moreover, the existing regulations (and revisions in process) will come into play as to availability of these loans. Accordingly, while there is no express prohibition for some of the loans referenced herein from being accessed in a Chapter 11 proceeding, a de facto prohibition likely comes from existing underwriting guidelines. If the overarching purpose of the CARES Act is to assist businesses in weathering the economic storm while the COVID 19 virus ravages the economy, the authors argue that such underwriting guidelines can, and must, be loosened in order to allow application of some of these programs in Chapter 11 proceedings so that they can be most effectively implemented to stabilize businesses, preserve jobs, continue to keep employees and businesses on the tax rolls, etc.

In this way the stimulus funds will be used where they can be most effectively deployed. If not, those funds will be the equivalent of the federal government sending rubber rafts to a drought stricken area—a sign that the government cares, perhaps, but of certainly no real use to address the problem at hand. The full article is available here.

How Much Value Was Destroyed by the Lehman Bankruptcy?
by | posted in: Bankruptcy Administration and Jurisdiction, Financial Firms and Safe Harbors, Valuation | 0

The Federal Reserve Bank of New York’s Liberty Street Economics Blog has run a series of five posts seeking to estimate the total value destroyed by the Lehman Brothers Holdings Inc.’s Chapter 11 and Lehman’s investment bank affiliate’s liquidation through separate Securities Investor Protection Act (SIPA) proceedings.

Erin Denison, Michael Fleming, and Asani Sarkar, of the Federal Reserve Bank of New York’s Research and Statistics Group, estimate the total value destruction for Lehman, its creditors, and stakeholders to be approximately between $46 billion to $63 billion (between 15 to 21 percent of Lehman’s pre-bankruptcy consolidated assets), excluding expenses from the SIPA proceedings (an additional $1.4 billion) and the costs of resolving Lehman’s foreign subsidiaries. These estimates also exclude boarder spillover effects on the economy caused by Lehman’s collapse.

Denison, Fleming, and Sarkar suggest the main drivers of value destruction include: professional fees and expenses ($5.9 billion for Chapter 11 proceedings with an additional $1.36 billion for SIPA proceedings); liquidity costs for creditors during the lengthy proceeding ($15 billion); and lost relationships between Lehman and its equity underwriting clients ($23 billion). They break down these estimates of the value destroyed through a series of four posts, analyzing the direct costs (expenses paid to third parties for services provided during bankruptcy) and the indirect costs (opportunity costs for the firm, its creditors, and its stakeholders).

The first post on Creditor Recovery in Lehman’s Bankruptcy can be found here. The second post on Lehman’s Bankruptcy Expenses can be found here.  The third post on Customer and Customer and Employee Losses in Lehman’s Bankruptcy can be found here.  The fourth post on Indirect Costs of Lehman’s Bankruptcy can be found here.  The final summary post can be found here.

 

For previous Roundtable posts on the valuation and resolution of Lehman, see Steven Lubben, “Lehman’s Derivative Portfolio”; Mark J. Roe, and Stephen D. Adams, “Restructuring Failed Financial Firms in Bankruptcy: Selling Lehman’s Derivatives Portfolio.”

(This post was authored by Ryan Rossner, J.D. ’19.)

A Functional Analysis of SIFI Insolvency
by | posted in: Financial Firms and Safe Harbors | 0

By Stephen J. Lubben (Seton Hall University School of Law)

Since the disgrace of Lehman, the question of how to handle failing SIFIs has been quite vexed.   On the one hand, governmental rescue of shareholders and other investors is beyond annoying, and there is some intuitive sense that if management does a poor job, they and their investor backers should face the consequences, just like any other firm.   That bank managers would have the temerity to pay themselves large bonuses shortly after a taxpayer rescue only emphasizes the point.

On the other hand, there is a widespread understanding that a large bank, or a sufficiently interconnected one, is not quite like Kmart, Enron, or even American Airlines, in that when the bank fails, it tends to take a large chunk of the economy along with it.   Pre-failure regulation can mitigate some of the effects, but by the time we get to insolvency—or “financial distress”—the regulatory string has pretty much played out.   And in the end, we have trouble deciding if we really mean to treat large financial institutions like normal failed firms.

In A Functional Analysis of SIFI Insolvency, I argue that we need to consider what it is that we are trying to achieve in a bank insolvency case, and how that compares with bankruptcy law in general.  Bank insolvency, I submit, is all about special priorities: both ordinal and temporal.  The Bankruptcy Code, on the other hand, takes an “equality is equity” approach to priorities as a baseline, mostly using state law to draw the claim-asset border.

Financial insolvency law expressly rejects this model; it instead is all about protecting some favored group from the effects of insolvency.   There is no equality here, and it was never intended that there would be equality.   And thus it is time to stop pretending SIFI insolvency is “normal” corporate insolvency but bigger.

The full article is available here.

Could Problems at MF Global Have Been Anticipated?
by | posted in: Financial Firms and Safe Harbors | 0

By Hilary Till (J.P. Morgan Center for Commodities, University of Colorado Denver Business School)

In the fall of 2011, futures market participants were caught off-guard when MF Global filed for bankruptcy. Essentially, this episode educated industry participants that customer protections in the U.S. commodity futures markets had been more ambiguous than expected. That said, there are a number of reforms that have been undertaken to help prevent future MF Globals. This article takes the position that a number of red flags existed as far back as 2007, regarding the firm’s financial weakness, which could have served as a warning to those investors relying on MF Global as a fiduciary.

In discussing the MF Global debacle, this article will cover the following seven areas:

(1) a brief background on the firm will be outlined;

(2) warning signs will be identified;

(3) the firm’s final week will be recalled;

(4) the response of regulators and bankruptcy trustees will be noted;

(5) the shortfall in customer segregated funds will be described;

(6) the CFTC’s charges and settlement will be mentioned; and

(7) later reforms will be summarized.

The article concludes that while MF Global’s business model appears not to have been viable after 2007, this observation does not excuse unlawful practices. In particular, the firm effectively (and arguably unlawfully) used customer funds in large-scale proprietary trades that the firm ultimately could not fund, leading to its chaotic bankruptcy.

The article is available here, and is forthcoming in the Fall 2017 issue of the Global Commodities Applied Research Digest.

Do Economic Conditions Drive DIP Lending?: Evidence from the Financial Crisis
by | posted in: Cramdown and Priority | 0

By Colleen Honigsberg (Stanford Law School) and Frederick Tung (Boston University School of Law)

For many firms, obtaining debtor-in-possession (DIP) financing is crucial for a successful reorganization. Such financing can be hard to find, however, as lenders are understandably hesitant to lend to firms in severe financial distress. The Bankruptcy Code solves this potential dilemma by authorizing debtors to provide DIP lenders with various sweeteners to induce lending. But because these sweeteners are thought to come at the expense of other stakeholders, the Code permits these inducements only if the judge determines that no less generous a package would have been sufficient to obtain the loan.

Certain types of lending inducements, frequently described as “extraordinary provisions,” have become the subject of growing concern. Anecdotal evidence suggests the use of these provisions has skyrocketed in recent years, leading important bankruptcy courts and the American Bankruptcy Institute to question whether these provisions are really necessary for a robust DIP market—or whether DIP lenders are extracting excessively generous terms. Defenders of DIP lenders, however, have pointed to a plausible external explanation for the popularity of extraordinary provisions in recent years: The Financial Crisis. When credit is tight, lenders demand more inducements. Indeed, judges have explicitly cited credit conditions in approving controversial inducement packages.

In this article, we provide the first evidence on the relationship between credit availability and DIP loan terms. Using a hand-collected dataset reflecting contract terms from DIP loans issued between 2004 and 2012, we study the relationship between DIP loan terms and broader market conditions. As predicted, we find a statistically significant relationship between credit availability and ordinary loan provisions like pricing and reporting covenants. By contrast, we find no evidence that “extraordinary” provisions like roll-ups and case milestones are related to credit availability. We hope that our findings will inform judges and policymakers struggling to evaluate whether the sweeteners extracted by DIP lenders are really necessary to induce lending.

The full article is available here.

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