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.

Three Provocative Business Bankruptcy Decisions of 2018
by | posted in: Arbitration, Insider Status, Supreme Court, Trademarks | 0

By Michael L. Cook (Schulte, Roth & Zabel LLP).

The appellate courts have issued at least three provocative, if not questionable, business bankruptcy decisions in the past six months.

Lakeridge:  In March, 2018, the U.S. Supreme Court avoided the substantive merits of a 2016 split decision by the Ninth Circuit that had permitted a Chapter 11 debtor to manipulate the reorganization plan process.  Despite the Court’s narrow holding approving the Ninth Circuit’s “clear error” standard for reviewing a bankruptcy court’s fact findings, four Justices wrote two separate opinions challenging the Court’s limited review of the Ninth Circuit’s stunning decision in the face of a powerful dissent.

In re Anderson:  The Second Circuit, on March 7, 2018, held that an asserted bankruptcy discharge violation was not arbitrable due to a conflict between the Federal Arbitration Act and the Bankruptcy Code.  Two months later, though, the Supreme Court stressed that it had rejected every effort to “conjure” conflicts between the Arbitration Act and a raft of other Federal statutes.

In re Temptnology:  the First Circuit, on January 12, 2018, in a split decision, wiped out the rights of a trademark licensee, explicitly rejecting a 2012 decision by the Seventh Circuit.  The First Circuit’s majority opinion relied on a heavily criticized 1985 Fourth Circuit decision, premising its  holding on the primacy of Federal bankruptcy law over Federal trademark law and distinguishing between a statutory breach and a common law breach.

The losing parties in the First and Second Circuit cases filed petitions for certiorari in June, 2018.  Given the Circuit split in one case and the later Supreme Court arbitration ruling in the other, both cases warrant Supreme Court review.

The full article is available here.

We at the Bankruptcy Roundtable will take a break from posting this August and hope that you too will be able to get away from your desk at work. We’ll be back after Labor Day.

Insider Status and U.S. Bank v. Village at Lakeridge
by | posted in: Avoidance, Cramdown and Priority, fraudulent transfer, Insider Status | 0

By Ronit J. Berkovich and David Li (Weil, Gotshal & Manges LLP).

The U.S. Supreme Court, in U.S. Bank Nat’l Ass’n v. Village at Lakeridge, LLC, 583 U.S. ___ (2018), offered plenty of hints on an important topic while simultaneously ruling very little about it.  In chapter 11, whether a creditor qualifies as an “insider” can have enormous implications on a range of issues, including plan confirmation, fraudulent transfer and preference analyses, and severance payment and employee incentive/retention plan (KEIP/KERP) approvals.  Lakeridge involved a dispute as to whether the bankruptcy court properly determined in confirming a plan that the sole impaired accepting creditor (the romantic partner of one of the debtor’s officers) was not a “non-statutory” insider.  If the creditor actually were such an insider, then the chapter 11 plan should not have been confirmed.

In granting cert to hear the case, the Supreme Court expressly declined the opportunity to address whether the Ninth Circuit articulated the correct legal test to determine if a person qualifies as a non-statutory insider.  Instead, the Supreme Court granted cert only to answer the narrow question of whether the Ninth Circuit applied the correct standard of review to the lower court’s determination.  Justice Kagan, writing for the Court, kept to that script by simply affirming the Ninth Circuit’s decision to apply a clear error standard of review.  Concurrences by Justices Kennedy and Sotomayor, however, each acknowledged shortcomings in the legal test the Ninth Circuit applied and each appeared to invite lower courts to consider alternative approaches.  As a whole, Lakeridge provides little binding guidance, and practitioners can expect further development in non-statutory insider law by the Courts of Appeals.

The article is available here.

Capmark Decision Clarifies Insider Status for Market Participants
by | posted in: Bankruptcy Administration and Jurisdiction | 0

Authors: Marshall S. Huebner and Hilary A.E. Dengel, Davis Polk

Being deemed an “insider” has important ramifications for creditors in bankruptcy and can materially impact a creditor’s risk and recovery profile in any case.

In Capmark Financial Group Inc. v. Goldman Sachs Credit Partners L.P. (Capmark), the U.S. District Court for the Southern District of New York made several positive rulings on key insider status issues favorable to market participants who regularly find themselves, sometimes through affiliated entities, playing multiple roles with respect to a borrower counterparty.  Embracing the arguments advanced by the Goldman Sachs lending entities, the court rejected Capmark’s attempts to cast the lenders as “insiders” of Capmark based on an indirect equity interest in Capmark held by funds managed by certain of their affiliates – holding that Capmark failed to allege facts that would show the “extraordinary circumstances” required for veil piercing and stating that participation in an arm’s length transaction as an ordinary commercial lender will not give rise to non-statutory insider status.

The Capmark decision provides comfort and greater certainty to market participants that, absent falling into one of the expressly enumerated categories of insiders under the Bankruptcy Code, insider status should not attach to creditors who neither control a company nor deal with it at less than arm’s length.  The case is further discussed here in Capmark:  Clarifying Insider Status for Market Participants (ABI Journal, January 2014).