South Bay Law Firm will be back posting in 2011. In the meantime, have a safe and prosperous New Year!
What’s it worth to learn from prior mistakes or misdeeds?
For interested parties in most large Chapter 11 cases, apparently not much.
Bankruptcy “examiners” are private individuals appointed by the Office of the Unites States Trustee at the direction of a Bankruptcy Court to investigate and report on the causes of a company’s failure.
Chapter 11 of the Bankruptcy Code provides that examiners “shall” be appointed if requested in any case involving, among other things, more than $5 million in certain types of unsecured debt. In creating this position, Congress apparently expected examiners to be ubiquitous in the reorganization of large, public companies.
Nevertheless, it simply ain’t so. Anyone with restructuring experience can attest to the truisim that examiners are a rarity in Chapter 11 cases.
Earlier this month, Temple University Professor Jonathan Lipson posted statistical analysis on the appointment of bankruptcy examiners – and why, despite the mandatory language addressing their appointment in the Bankruptcy Code – so few are, in fact, actually appointed.
In ”Understanding Failure: Examiners and the Bankruptcy Reorganization of Large Public Companies,” Lipson – whose work will appear in a forthcoming edition of the American Bankruptcy Institute Law Journal – observes that examiners are rarely sought in Chapter 11 cases, and even less frequently appointed. Lipson’s docket-level analysis of 576 of the largest chapter 11 reorganizations from 1991 to 2007 shows they were requested in only 15% of cases. Despite the seemingly mandatory language of the Bankruptcy Code, examiners were appointed in fewer than half of the cases where sought, or less than 7% of the sample.
So what does it take to get an examiner appointed? Lipson summarizes the article’s findings as follows:
- Size matters. Cases in which examiners are sought are huge. The average case in which an examiner was sought was almost twice as large as the sample measured by median asset values and more than four times larger measured by mean asset values. Holding other things equal, a request for an examiner was three times more likely in a case with a debtor having at least $100 million in net assets. Cases in which examiners were appointed had mean liabilities twice the size of cases where the motions were not granted.
- Conflict matters. Cases in which examiners were sought or appointed were much more likely to be contentious, as measured by docket size and requests for chapter 11 trustees, than were cases without. Holding other things equal, a request for a chapter 11 trustee in a large case increases the odds of an examiner request by a factor of five.
- Venue matters. Examiners are much more likely to be sought—although not necessarily appointed—in the two districts that tend to have the largest cases, Delaware and the Southern District of New York (SDNY). Together, Delaware and the SDNY had forty-six (52%) of requests for an examiner, but actually appointed an examiner in only seventeen cases (about 43%). By contrast, examiners were appointed in twenty-two cases (about 57% of appointments) when requested in other districts.
- Fraud matters—somewhat. Although requests for an examiner correlated with allegations of pre-bankruptcy fraud—the paradigm grounds for an examiner—they were nevertheless rare even when a bankruptcy was precipitated by that form of wrongdoing: Of the thirty-one cases in the sample that allegedly involved fraud, examiners were sought in only nine and, of those, were appointed in only five.
- Strategy matters—somewhat. There is evidence that examiners will sometimes be sought for strategic, not information-seeking, reasons. Requests to appoint an examiner were withdrawn in fourteen cases (about 17% of requests in the sample) and rendered moot by subsequent events (e.g., plan confirmation) in sixteen cases (about 20% of requests). Judges and system participants interviewed for [Lipson's] paper indicated that they believed that, in many cases, the arguably “mandatory” language of the Bankruptcy Code produces gamesmanship,not enlightenment.
- Investors do not matter much. Notwithstanding a purported goal of protecting the “investing public,” individual investors made only eighteen requests for examiners. Far more likely to request an examiner (thirty-two cases) were individual creditors whose claims did not arise from investment securities (such as bonds) or fraud, but who apparently held claims for unpaid goods or services.
Lipson’s work provides empirically grounded insight on this little-used feature of Chapter 11, and is well worth a read.
Two prior posts on this blog (here and here) have traced the progress of an obscure – but potentially important – piece of California legislation designed to regulate the ability of local California governments to seek relief through the municipal debt adjustment process of Chapter 9.
Relatively little-known California State Assembly Bill 155 would, if voted and signed into law, require local public entities to first seek approval from the California Debt and Investment Advisory Commission (which operates under the auspices of the State Treasurer’s Office) prior to seeking the federal debt adjustment relief presently available to them by local government decision.
Though ostensibly addressing the “debt” and “investments” of local governments, the bill is in fact aimed squarely at protecting public employee unions who – unnerved by the 2008 Chapter 9 filing commenced by the City of Vallejo, California – have backed the legislation since its introduction into the California legislature nearly 18 months ago. According to analysis produced last July by the State Senate’s Local Government Committee, “labor unions and others want to require state oversight of local governments’ bankruptcy petitions.”
The reason? Public employee pensions and other employee benefits.
The details of public employees’ hiring and retention arrangements are typically governed by collective bargaining agreements (or “Memoranda of Understanding” in the context of public labor relations), brokered by the employees’ unions and their public employers. As presicently noted in an article on municipal collective bargaining agreements authored 3 years ago, “Public sector unions have successfully obtained comparatively generous compensation and benefits packages even as the fortunes of American labor have continued to decline. In particular, municipal pensions may jeopardize the fiscal survival of many public sector employers.”
With perrenial state and local budget deficits, declining property values and a shrinking tax base, and significantly reduced revenues, many local governments are now in precisely the sort of “survival mode” suggested by this article . . . and the unions know it. As a result, AB 155 has quietly made its way through the State Assembly and now appears poised to go to the State Senate floor.
Is “bankruptcy by committee” an appropriate balance between state interests and local government control? Does it hamstring local govrenment officials from responding effectively to a local fiscal crisis? Because municipal bankruptcies have always been used very sparingly, and only 2 such proceedings (including Vallejo’s) have filed statewide since 2008, is committee approval truly necessary? Or is it merely a means by which public employee unions can improve their bargaining position outside of bankruptcy? And what happens if a local government in financial crisis can’t get committee approval?
These questions appear, to date, unanswered.
But last week, AB 155 took a step forward, clearing the Senate’s Local Government Committee. The bill will now go to the Senate Appropriations Committee for review.
Many readers of this blog will be well aware that “venue shopping” – usually to a known, “debtor-friendly” jurisdiction such as Delaware or the Southern District of New York – is a common feature of Chapter 11 practice. For those who may not be, the primary idea is that the debtor’s management, looking to increase the likelihood of a successful reorganization, often identifies a “debtor-friendly” jurisdiction and seeks to fit within the venue provisions for commencing a reorganization case there.
But though the federal venue provisions (at least as interpreted by these courts) generally make it easy to obtain access to file a Chapter 11 case, not every such case filed in New York or Delaware stays there without a fight from one or more creditors who disagree with the debtor’s choice of forum.
Last week, another example of creditors disagreeing with the debtor’s choice of forum - in the strongest possible terms – presented itself in the recently-filed Chapter 11 bankruptcies of Rock & Republic Enterprises, Inc. and Triple R, Inc.
The purveyors of high-end jeans sought Chapter 11 protection on April 1 in Manhattan. Though the bulk of their management and facilities – and their creditors – are located in the Los Angeles metropolitan area, the companies opted for an East Coast venue, each citing a single office – and a showroom – as the basis for their request to reorganize in New York’s Southern District.
The companies’ primary secured creditor, RKF, LLC, wasn’t pleased. It immediately filed an “Emergency Motion to Transfer Venue” to the Central District of California, alleging:
- The companies’ status as California corporations;
- The companies’ management offices, books and records, and address for service of process are in the Los Angeles area;
- All but 2 of 10 of the companies’ leased premises are in the Los Angeles area;
- 16 of the companies’ top 25 creditors are based in Los Angeles (only 2 are in New York); and
- 9 of 14 litigation matters involving the companies are being heard in California.
On Friday, RKF was joined by Zabin Industries, Inc. Zabin is one of the companies’ self-described “larger unsecured creditors” and is also based in Southern California.
No word yet on a date for the hearing on RKF’s “Emergency Motion” – as of this writing, presiding Judge Arthur Gonzales hadn’t set one. Meanwhile, the Judge has set an accelerated hearing date on the companies’ request to reject an exclusive distribution agreement with Richard I Koral, Inc. (dba “Jessica’s”), the companies’ present off-price distributor.
Unfortunately, life is full of them . . . and so is the 2005 Bankruptcy Code. Today’s post will discuss just one: The expanded protection afforded trade creditors under Section 503(b)(9).
What does this section do? And just how much protection does it provide? As amended, Section 503(b)(9) was intended by Congress to protect vendors who supplied goods to a debtor within 20 days of a debtor’s bankruptcy filing by extending “administrative” (i.e., 100% payment) status to their claims. Along with amendments to Section 546(c), the idea was to protect vendors who extended credit to a debtor immediately before the debtor filed a case. But in fact, Section 503(b)(9)’s application may now be leaving many such vendors at greater risk.
How so? A recent Daily Deal piece by Natixis’ Christophe Razaire briefly outlines three general problem areas.
- Goods? Or services? Section 503(b)(9) protects suppliers of goods well enough, and understandably so: Along with Section 546(c), it is designed to preserve and augment the protections extended to the same vendors under the Uniform Commercial Code. But what about suppliers of services? Unfortunately, as a number of creative service providers have discovered, the Code offers no such similar protection. Moreover, where a company relies primarily on services for its activity, it appears doubtful that the Code’s amendment does anything to alleviate the risk of a debtor’s default and eventual bankruptcy.
- Payment? Or post-petition payables? Though Section 503(b)(9) provides administrative priority for “20-day” vendor claims and Section 546(c) likewise permits vendors to assert reclamation demands for goods supplied immediately prior to the debtor’s filing, in practice, vendors rarely see any early compensation in the case.
Instead, a bankruptcy court is far more likely to simply afford such claims their entitled administrative status, then require the vendors holding them to wait until the conclusion of the case for payment. Economically, this means that vendors who should be enjoying administrative protection and receiving cash are, in fact, merely exchanging one “IOU” for another – and, in the meantime, suffering as much liquidity distress as any other general unsecured creditor.
Needless to say, this liquidity distress has to be dealt with in some fashion. And it is often addressed through a refusal to further supply the debtor-in-possession except on “COD” or similarly restrictive terms. Alternatively, other customers of a cash-strapped vendor may feel the squeeze through tightened terms as the vendor struggles to compensate for large – but unsatisfied – administrative obligations owed by the debtor.
- Administrative protection? Or administrative insolvency? Perhaps the most unintended consequence of Section 503(b)(9)’s amendment is that business reorganizations involving large numbers of “20-day” claims may, in fact, be threatened by its application.
“20-day vendors” can, if they so choose, accept payments on their administrative claims at a discount – and, in fact, it is not uncommon for debtors to attempt to cut such deals. But where there are numerous “20-day” claimants, the debtor often faces very slow, arduous negotiations. Many vendors are reluctant to negotiate with the debtor for fear of “selling out” too low; others may try their hand at brinksmanship, betting that the debtor’s need to satisfy such claims prior to emerging from bankruptcy will reward their willingness to “hold out.”
Often, the “reward” for such bargaining is something less than creditors may have hoped for. The debtor concludes it cannot negotiate and must instead incur the [additional] administrative expense of contesting such claims directly in an effort to reduce their aggregate amount. If these claims disputes do not go the debtor’s way, or if the debtor is already struggling to emerge with sufficient cash, the debtor may be forced to liquidate – thereby leaving all creditors, from secured debt to general unsecured claims, with far less than might otherwise be the case.
How big can these problems get? A recent “Dealscape” blog post by Ben Fidler illustrates how the section is playing out in the troubled retail and auto parts sectors, where vendors of goods often play a significant role in a company’s operations. Fidler points to larger Chapter 11 filings, such as Empire Beef Co., Blackhawk Automotive Plastics, Inc., and Plastech Engineered Products, Inc., which have been left administratively insolvent or have been threatened with such insolvency, as a result of section 503(b)(9)’s amendments.
Though not every case is as large as the ones cited by Fidler – and not every case results in administrative insolvency – similar dynamics with similar results can just as easily arise in smaller Chapter 11’s.
In sum, this anecdotal data suggests that Congress’ well-intended efforts to afford some creditors with more options in a debtor’s reorganization may, in fact, have left all creditors with far less options.
Surely, this cannot have been Congress’ intended consequence.