Some of the week’s top bankruptcy and restructuring headlines:
And Still More:
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Posts Tagged ‘Bankruptcy Code”’
Some of the week’s top bankruptcy and restructuring headlines:
And Still More:
After a brief hiatus, we’re back – and just in time to discuss a recent decision of some import to trademark owners and licensors.
For many years, insolvency practitioners have recognized the value of the Bankruptcy Code in permitting a reorganizing firm to assign contractual rights to a third party, even where the contract itself prohibits assignment. That power is limited, however, where “applicable [non-bankruptcy] law” prohibits the assignment without the non-bankrupt party’s consent.
In recent years, the “anti-assignment” provisions of federal copyright and patent law have limited the transfer of patent and copyright licenses through bankruptcy. Whether the transfer of trademark licenses is likewise limited has been an open question, at least amongst the Circuit Courts of Appeal.
In late July, the Seventh Circuit Court of Appeals found in In re XMH Corp. that trademarks were not assignable.
XMH Corp. involved the former Hartmarx clothing company’s Chapter 11, along with the related filings of several subsidiaries. XMH ultimately sold its assets and assigned contracts to a group of third-party purchasers. Those assets included certain trademark licenses for jeans held by one of the XMH subsidiaries. The trademarks were owned by a Canadian firm.
The Canadian firm objected to the trademark assignment, and the bankruptcy court agreed. The District Court reversed, and the licensor appealed to the Seventh Circuit.
In a succinct, 15-page decision, Judge Posner found that where “applicable law” prohibits the assignment of a trademark, it cannot be assigned through a bankruptcy proceeding absent the trademark owner’s consent.
Judge Posner apparently reached this decision despite a lack of either party to articulate which “applicable law” actually prohibited the assignment:
But the Seventh Circuit then turned to the question of whether the contract actually contained a valid trademark license – and found that though the agreement appeared to provide a relatively short-term license of the trademark, what remained at the time of the proposed assignment was merely a contract for services.
Despite its brevity, XMH Corp. is instructive in two respects:
From the Fifth Circuit Court of Appeals, a recent decision regarding the curious (and well-aged) bankruptcy of Yuval Ran offers a thought-provoking consideration of what is required to obtain US recognition of a foreign individual’s bankruptcy case.
The Curious Case of Mr. Ran
Mr. Ran, an Israeli citizen, was at one point a director or shareholder in almost one hundred Israeli companies – some publicly-traded, and the largest of which was Israel Credit Lines Supplementary Financial Services Ltd. (“Credit Lines”), a public company co-founded and run by Ran, who served as CEO.
After raising millions of dollars from investors and acquiring interests in numerous other companies, Credit Lines ultimately found itself in liquidation through an Israeli bankruptcy proceeding. Credit Lines’ bankruptcy receiver asserted claims against Ran for millions of dollars in damages.
In June 1997, an involuntary bankruptcy proceeding was commenced against Ran in the Israeli District Court of Tel Aviv-Jaffa – but not before Ran and his family had departed Israel for Houston, Texas. Since their departure, Ran and his wife purchased a home and went to work for a local furniture company. Ran’s wife and five children are US citizens, and Ran himself is a permanent resident seeking US citizenship. With the exception of some minimal collection work on Credit Lines’ behalf shortly after he arrived in the US, Ran did no further business in Israel.
In December 2006 – nearly a decade after Ran and his family emigrated, and more than eight years after being appointed receiver of Ran’s estate – Zuriel Lavie, the receiver appointed for Ran’s Israeli assets, sought recognition of the Israeli bankruptcy proceeding as a foreign main or non-main proceeding under Chapter 15 of the Bankruptcy Code in the Southern District of Texas’ Bankruptcy Court.
Levie’s petition was denied the following May. After two rounds of appeals to the District Court, the parties finally found themselves before the Fifth Circuit Court of Appeals.
In affirming the District Court and the Bankruptcy Court’s denials, the Fifth Circuit briefly reviewed the procedural requirements for recognition set forth in Section 1517 of the Bankruptcy Code, then turned its attention to the one item of substance – whether the debtor’s bankruptcy proceeding qualified either as a foreign “main” or “non-main” proceeding as contemplated by Chapter 15.
“Main Proceeding” – Where is COMI?
Under US law – as under the UNCITRAL Model Law upon which it is based – a foreign “main proceeding” qualifies as such if the jurisdiction where it is pending is the debtor’s “center of main interests” (COMI). In the case of an individual such as Ran, COMI is presumptively the debtor’s “place of habitual residence” – a concept roughly equivalent to the debtor’s “domicile,” or physical presence coupled with an intent to remain there. One acquires a “domicile of origin” at birth, and that domicile continues until a new one (a “domicile of choice”) is acquired.
A similar concept – that of “habitual residence” – likewise applies under foreign law when the individual intends to stay in a specified location permanently. Factors pertinent to establishing an individual’s “habitual residence” include: (1) the length of time spent in the location; (2) the occupational or familial ties to the area; and (3) the location of the individual’s regular activities, jobs, assets, investments, clubs, unions, and institutions of which he is a member.
Under these facts, Ran’s COMI was presumptively in the US – and not in Israel. However, the presumption of COMI may be rebutted. Levie sought to do so by introducing evidence at the District Court that: (1) Ran’s creditors are located in Israel; (2) Ran’s principal assets are being administered in bankruptcy pending in Israel; and (3) Ran’s bankruptcy proceedings initiated in Israel and would be governed by Israeli law.
Ran countered by pointing out that: (1) Ran along with his family left Israel nearly a decade prior to the filing of the Chapter 15 petition; (2) Ran has no intent to return to Israel; (3) Ran has established employment and a residence in Houston, Texas; (4) Ran is a permanent legal resident of the United States and his children are United States citizens; and (5) Ran maintains his finances exclusively in Texas.
In weighing this evidence, the Fifth Circuit relied on earlier analysis in In re SPhinX, Ltd., 351 B.R. 103 (Bankr. S.D.N.Y. 2006), aff’d, 371 B.R. 10 (S.D.N.Y. 2007) – and more specifically, on analysis in In re Loy, 380 B.R. 154. 162 (Bankr. E.D. Va. 2007) (the only case to address the concept of COMI with respect to an individual debtor) – in which the Bankruptcy Court noted that factors such as (1) the location of a debtor’s primary assets; (2) the location of the majority of the debtor’s creditors; and (3) the jurisdiction whose law would apply to most disputes, may be used to determine an individual debtor’s COMI when there exists a serious dispute. The Fifth Circuit found that, unlike the Loy decision, the initial presumption (and the ultimate preponderance of evidence) under these factors weighed in Ran’s favor.
Undeterred, Lavie argued that the Fifth Circuit ought not to confine its COMI inquiry to the “snapshot” of Ran’s domicile that existed at the time the Chapter 15 petition was filed. Instead, he argued that the Fifth Circuit ought to look back to Ran’s “operational history” in Israel for a more comprehensive determination of COMI.
The Fifth Circuit panel was not persuaded. Instead, it looked to the statute’s use of present tense (i.e., a “main proceeding” is a “foreign proceeding pending in the country where the debtor has the center of its main interests”) to determine the COMI inquiry as dispositive of what evidence was relevant, and what evidence was not.
The panel then went on to provide policy bases for the “snapshot” approach to COMI, explaining that locating COMI as of the date the petition is filed aids international harmonization and promotes predictability. Perhaps most significantly the panel noted “it is important that the debtor’s COMI be ascertainable by third parties . . . . The presumption is that creditors will look to the law of the jurisdiction in which they perceive the debtor to be operating to resolve any difficulties they have with that debtor, regardless of whether such resolution is informal, administrative or judicial.”
On the question of whether Ran’s proceeding was a foreign “non-main” proceeding, the Fifth Circuit panel pondered its definition, i.e., “a foreign proceeding, other than a foreign main proceeding, pending in a country where the debtor has an establishment.” Lavie argued that Ran’s involuntary proceeding in Israel was, in itself, an “establishment.” Section 1502(2), however, defines an “establishment” as “any place of operations where the debtor carries out a nontransitory economic activity.”
Unlike COMI, the existence of an “establishment” is a simple factual determination with no presumptions in anyone’s favor. However, one court has noted that “the bar is rather high” to prove the debtor maintains an “establishment” in a foreign jurisdiction.
In essence, the Fifth Circuit found that in order to have an “establishment,” Ran must have had “a place from which economic activities are exercised on the market (i.e. externally), whether the said activities are commercial, industrial or professional” at the time that Lavie filed the petition for recognition.
For the same reasons that gave rise to the Fifth Circuit’s weight of the evidence in Ran’s favor regarding the “main proceeding,” the Israeli proceeding was determined not to be a “non-main” proceeding – and, therefore, not entitled to any recognition within the US.
In addition to being the first appellate decision addressing an individual’s COMI, the Ran case is noteworthy for the proposition that the mere existence of an individual’s insolvency proceeding, pending in another jurisdiction, is insufficient to qualify for recognition under US law. Instead, there must be a demonstration of ongoing activity – either through a showing of COMI, or through the “establishment” of ongoing activity – to qualify.
Further, though it is specifically limited to its own facts, the Ran decision offers a glimpse into the Fifth Circuit’s general approach to COMI – in particular, its observance that the debtor’s COMI should be ascertainable by third parties. This observance may prove significant in the event that similar disputes over the much larger and more contentious Stanford proceedings (see prior posts about Stanford here) ever make their way to the Circuit Court.
The esoteric world of credit default swaps and other derivative securities often appears far removed from the everyday practice of Chapter 11. But the impact of this little-known (and often less-understood) corner of the securities market upon the bankruptcy world has recently garnered considerable academic interest – and is now attracting some legislators’ attention as well.
Several posts on this blog (beginning here) have summarized the intersection between credit default swaps and bankruptcy. Some academics have explored the potential indirect effect of these securities upon out-of-court netogiations – focusing primariliy on the potential problems of “holdout” creditors and the “empty creditor hypothesis.” Others (here and here) have offered their preliminary thoughts on the continued usefulness of the Bankruptcy Code’s “securities safe harbors,” originally included to shield financial markets from the effects of large bankruptcy filings – but now perceived as distorting creditor priorities and possibly exacerbating the financial risk created by such events.
Some portions of this debate (such as the true impact of CDS’s on corporate insolvency) continue to play out in the realities of Chapter 11 economics. Other portions (such as the continued viability of the Bankruptcy Code’s “safe harbor” rules) are beginning to work themselves – albeit slowly – into legislative proposals.
Within the last 30 days, Florida’s Sen. Bill Nelson has offered a brief, 2-page amendment to the proposed financial reform legislation now working its way through the US Senate. In essence, the amendment would strip the “safe harbors” out of the Bankruptcy Code, ostensibly “leveling the playing field” for all creditors.
For its simplicity, the amendment – which has no co-sponsors – has provoked still further discussion amongst academics. Seton Hall’s Steve Lubben commends it as a good “first step” toward amending the Bankruptcy Code, but believes further compromise is necessary (his proposed compromises are outlined here). Harvard’s Mark Roe says, in an updated research paper, that the amendment deserves “central consideration” in connection with financial reform legislation.
A number of advanced commercial jurisdictions – such as the US, the UK, Germany, and Japan – permit a debtor’s bankruptcy administrator or trustee to pursue and recover preferential or fraudulent transfers. Unwinding such transfers, typically made from the debtor to a third party located in the same country, is often an important source of recovery for creditors.
But what happens when the transfer crosses international borders? More specifically, which country’s avoidance law applies: The law of the jurisdiction where the transfer was initiated? Or the law of the “destination” jurisdiction?
An important decision issued last Thursday by the Fifth Circuit Court of Appeals provides a preliminary answer for at least a portion of this question.
“Before” Chapter 15.
Prior to the enactment of Chapter 15, US bankruptcy courts disagreed on whether – and how – the administrator of a foreign insolvency proceeding could pursue such transfers in the US. Some courts permitted non-US administrators to pursue such recovery efforts directly (through an ancillary proceeding), under the fraudulent transfer law of the debtor’s home jurisdiction. Others permitted such recoveries only under US law, and only through a separately filed (and far more expensive and time-consuming) Chapter 11 or 7 bankruptcy case.
“After” Chapter 15.
Chapter 15 resolved at least a portion of this debate. Section 1521(a)(7) provides that upon recognition of a foreign proceeding, the court may grant “any appropriate relief” including “additional relief that may be available to a trustee, except for relief available under [the avoidance sections of the US Bankruptcy Code].” Section 1523(b) authorizes the bankruptcy court to order relief necessary to avoid acts that are “detrimental to creditors,” providing that, upon recognition of a foreign proceeding, a foreign representative has “standing in [the debtor’s US bankruptcy] case . . . to initiate [avoidance] actions.” In other words, Congress appeared to clear up the question where recovery efforts are initiated under US law: A full Chapter 11 (or 7) case is required.
But what about recovery efforts commenced under non-US law?
Courts visiting this issue under Chapter 15 appear almost as divided as those who looked at it prior to the Bankruptcy Code’s 2005 amendments.
Two cases, both addressing the question in dicta, have gone in opposite directions. In one, the Bankruptcy Court forbade a sale “free and clear” of an avoidable English lien on procedural grounds – but along the way, acknowledged that avoidance actions under the US Bankruptcy Code are cognizable only if the debtor is the subject of a case under another chapter of the Bankruptcy Code. In another, the Bankruptcy Court denied a request by the administrator of a Danish insolvency proceeding for turnover of previously-garnished funds on the grounds that such turnover provisions were not applicable in Chapter 15 – but nevertheless went out of its way to note that nothing in Chapter 15’s legislative history – or in prior US cross-border law – prohibited avoidance actions commenced under the law of the debtor’s home jurisdiction.
To date, however, only one case has addressed the issue directly.
Condor Insurance and the Bankruptcy Code’s Deafening Silence.
Condor Insurance, Limited (“Condor”), a Nevis-incorporated insurer and surety bond issuer, was placed into a winding-up proceeding in its home jurisdiction in 2007. The following year, Condor’s liquidators sought recognition in Mississippi – in part, to pursue alleged fraudulent transfers aggregating more than $313 million to Condor affiliates and principals.
The Bankruptcy Court and District Court Decisions.
The Condor defendants moved to dismiss, claiming the Bankruptcy Court lacked jurisdiction to grant the relief requested. The Bankruptcy Court agreed, and – on appeal, and in a published decision – the District Court affirmed. Central to the District Court’s reasoning was the idea that, in US courts, “the choice of law that is to be applied to a lawsuit is determined by a court having jurisdiction over the case, and the parties are not permitted to choose whatever law they wish when filing a lawsuit.” As a result, the District Court found it lacked jurisdiction to hear the avoidance action. Instead, it suggested that the liquidators commence and resolve the avoidance claims in Nevis – and then, upon procurement of a judgment, seek enforcement under principles of international comity.
The Fifth Circuit Decision.
In a decision issued last week, the Fifth Circuit Court of Appeals respectfully disagreed. Writing for a 3-judge panel, Judge Patrick Higgenbotham observed Chapter 15’s “international origins” to encompass “international law.” For the panel, Chapter 15 is not merely a procedural vehicle by which foreign administrators may cost-effectively protect assets domiciled, or control litigation originating, in the US. Instead, foreign administrators may import the substantive insolvency law of foreign jurisdictions into US courts, which have jurisdiction to apply such law to disputes pending in the US. See pp. 8-9 (“Whatever its full reach, Chapter 15 does not constrain the federal court’s exercise of the powers of foreign law it is to apply.”).
As a result, the statute’s silence speaks volumes. Once recognized in the US court system through Chapter 15, foreign administrators have direct access to the panoply of federal judicial powers available to assist their administration of insolvency-related matters in the US, limited only by the specific “carve-outs” for US avoidance actions reserved in Section 1521:
– What About “Section Shopping?”
The Fifth Circuit recognized the appellees’ concern over “section shopping” – i.e., the strategic use of Chapter 15 (rather than Chapter 11 or Chapter 7) by foreign administrators to leverage the benefits of foreign avoidance law in US forums. But where Congress had not taken further steps to guard against this threat, the Fifth Circuit overruled the District Court’s own efforts to do so. In fact, Judge Higgenbotham and his colleagues did not appear bothered by the spectre of “section shopping,” noting that in the case before it – that of a foreign insurance company – Chapters 7 and 11 were not eligible relief. Moreover, the District Court’s suggestion that the foreign administrator should simply obtain an avoidance judgment in Nevis, then seek enforcement of that judgment in the US, was “no answer. Not all defendants are necessarily within the jurisdictional reach of the Nevis court.” Decision at p.14.
– What Of “Mixing and Matching?”
Instead of “section shopping,” Judge Higgenbotham saw the danger of “mixing and matching” foreign insolvency proceedings with US avoidance law, arising in connection with a Chapter 11 or Chapter 7 case. See p. 11 (“When courts mix and match different aspects of bankruptcy law, the goals of any particular bankruptcy regime may be thwarted and the end result may be that the final distribution is contrary to the result that either system applied alone would have reached.”). The Fifth Circuit traced the development of the UNCITRAL’s efforts to address choice of law in avoidance actions while drafting the model law that forms the basis for Chapter 15, concluding:
The Fifth Circuit panel also found its own approach more consistent with that of US cross-border law that pre-dated Chapter 15, noting Bankruptcy Courts could – and sometimes did – apply either US avoidance law or foreign avoidance law to an action pending in an ancillary case under former Section 304. At least one court, however, had criticized this approach for the same “mixing and matching” of foreign and domestic insolvency law noted by the Fifth Circuit. See p.16 (citing and discussing In re Metzeler, 78 B.R. 674, 677 (Bankr. S.D.N.Y. 1987)):
– Wholesale Importation of Foreign Avoidance Actions?
As for concerns that US insolvency courts – and US businesses – might find themselves awash in avoidance claims arising under non-US law, the Fifth Circuit again reverted to the international policies undergirding the legislation:
The Unanswered Question.
The Fifth Circuit’s Condor decision leaves unanswered the question of whether avoidance actions commenced under Section 544 of the Bankruptcy Code – which itself references “applicable [non-bankruptcy] law” – includes foreign law. Section 1521, by its terms, excludes avoidance actions predicated on this section. But the Bankruptcy Court, the District Court, and the Fifth Circuit all ducked this issue.
One Manhattan bankruptcy judge recently observed, in dicta, that Section 544(b) gives the trustee the standing of a judgment lien creditor. Because a preference action under foreign law would not appear to depend on status as a judgment lien creditor, this section would appear inapplicable to preference claims. A preference action under foreign law might therefore be available as “additional assistance” under § 1507. See In re Atlas Shipping A/S, 404 B.R. 726, 744 at n.16 (Bankr. S.D.N.Y. 2009).
But Condor’s brief analysis didn’t address preference claims. It addressed avoidance actions, which – at least in the US – do depend upon judgment lien creditor status. As a result, the availability of foreign avoidance actions, while resolved in the Fifth Circuit – remains likely unanswered elsewhere.
In light of the tumultuous economic events of 2008 and 2009, a number of proposals for significant bankruptcy reform have surfaced – many of which have been summarized on this blog.
One of last year’s posts focused on the ongoing debate over the impact of credit derivatives on failing companies, and on the continued usefulness of Bankruptcy Code provisions designed to insulate the financial markets from the bankruptcy process.
Last week, Harvard’s Mark Roe added to that discussion with a paper entitled “Bankruptcy’s Financial Crisis Accelerator: The Derivatives Players’ Priorities in Chapter 11”
The essence of Professor Roe’s proposal is set forth at p. 3:
Professor Roe’s thoughtful analysis is a worthwhile read.
With both the global and regional Southern California economies showing early signs of life – but still lacking the broad-based demand for goods and services required for robust growth – opportunities abound for strong industry players to make strategic acquisitions of troubled competitors or their distressed assets.
Ray Clark, CFA, ASA and Senior Managing Director of VALCOR Consulting, LLC, is no stranger to middle-market deals. His advisory firm provides middle market restructuring, transactional and valuation services throughout the Southwestern United States from offices in Orange County, San Francisco, and Phoenix.
As most readers are likely aware, distressed mergers and acquisitions can be handled through a variety of deal structures. Last week, Ray dropped by South Bay Law Firm to offer his thoughts on a process commonly known in bankruptcy parlance as a “Section 363 sale.”
In particular, Ray covers the “pros and cons” of this approach.
The floor is yours, Ray.
Meanwhile, happy hunting.
The market collapse of 2008 and resulting financial crisis have led to significant reflection on a number of systemic features of our financial markets and on the stability of institutions that play significant roles in their function.
That reflection has produced a fresh round of legal scholarship on what role – if any – the federal Bankruptcy Code should play in addressing the financial difficulties of these institutions. In a recent paper, Columbia’s Harvey R. Miller Professor of Law Edward R. Morrison asks, “Is the Bankruptcy Code an Adequate Mechanism for Resolving the Distress of Systemically Important Institutions?”
The issue, at least as put by Professor Morrison in the opening paragraphs of his paper, is framed as follows:
Morrison’s paper sets out to assess this debate, and concludes by advocating [again, in his words] “an approach modeled on the current regime governing commercial banks. That regime includes both close monitoring when a bank is healthy and aggressive intervention when it is distressed. The two tasks – monitoring and intervention – are closely tied, ensuring that intervention occurs only when there is a well-established need for it.” As a result of the close relationship between the power to intervene and the duty to monitor, however, any proposed legislation “is unwise if it gives the government power to seize an institution regardless of whether it was previously subject to monitoring and other regulations.”
Elsewhere in the Empire State, at the University of Rochester, Distinguished Professor Thomas H. Jackson proposes “Chapter 11F: A Proposal for the Use of Bankruptcy to Resolve (Restructure, Sell, or Liquidate) Financial Institutions.” According to Jackson:
Jackson’s response to this growing chorus of objections is to propose amending existing Chapter 11 legislation. Again, in his words:
With views as divergent as these, one might be tempted to look for a fundamental assessment of the differences between the banking regulatory system and the Chapter 11 process. And that assessment is, in fact, available from the Congressional Research Service – which last April provided its own comparison of “Insolvency of Systemically Significant Financial Companies: Bankruptcy v. Conservatorship / Receivership.” As summarized by its author, Legislative Attorney David H. Carpenter:
Fascinating reading . . . and an awful lot of it.
Recent federal assistance to the banking sector has focused attention on how failing banks are regulated – and why. From the University of Virginia School of Law, professors Richard M. Hynes and Steven D. Walt visit this issue in their recent article entitled “Why Banks Are Not Allowed in Bankruptcy.”
Here’s the article – and the authors’ abstract:
The bankruptcy blogosphere is replete with commentary on Chrysler LLC’s sale, through Section 363 of the Bankruptcy Code, to a newly-formed entity. The sale, of substantially all of Chrysler’s assets for $2 billion, gave secured creditors an estimated $0.29 on the dollar. Other, unsecured creditors received more. Though challenged, the sale ultimately received the 2d Circuit’s approval in a decision issued August 5.
Was the Chrysler sale proper? Or did it constitute an inappropriate “end run” around the reorganization provisions that ordinarily apply in a confirmed Chapter 11 plan?
Harvard Law’s Mark Roe and Penn Law’s David Skeel tackle this question in a paper released earlier this month entitled “Assessing the Chrysler Bankruptcy.” Roe and Skeel argue, in essence, that there was no way to tell whether or not the sale was proper because the sale lacked valuation, an arm’s length settlement, or a genuine market test (i.e., an auction) – all traditional measures of whether or not secured creditors received appropriate value for their collateral. They then suggest that the Chrysler transaction may portend a return of sorts to the equitable receiverships used to reorganize the nation’s railroads at the end of the ninenteenth century.
Roe and Skeel follow two fundamental strands of thought.
First, they review the basic facts of the Chrysler sale against the context of other so-called “363 sales” and ask where Chrysler fits within this context.
Their answer is that it really doesn’t fit.
Most complex bankruptcy sales (i.e., sales that effectively determine priorities and terms that the Code is structured to determine under Section 1129) are insulated from running afoul of the Code’s reorganization provisions through judicial innovations such as expert valuations or priority determinations, creditor consents, or competitive auctions. According to Roe and Skeel, the Chrysler sale had none of these. Instead,
How was the Chrysler sale deficient in these respects?
Though it involved a valuation presented by Chrysler, “the court did not give the objecting creditors time to present an alternative valuation from their experts . . . . Here, the judge saw evidence from only one side’s experts.”
For those who may protest that the Chrysler sale did, indeed, enjoy the consent of Chrysler’s secured lenders, Roe and Skeel argue that the largest of these lenders were beholden to the U.S. Treasury and to the Federal Reserve – not only as regulators, but as key patrons via the federal government’s rescue program. They were, therefore, willing to “go along with the program” – and the Bankruptcy Court was inclined to use their consent to overrule other objections from lenders not so well situtated. On this basis, Roe and Skeel contend that the secured lenders’ “consent” – such as it may have been – wasn’t independent “consent” at all.
Roe and Skeel also point out that the “market test” proposed as a means of validating the sale was, in fact, not a test of Chrysler’s assets, but of the proposed sale: “There was a market test of the Chrysler [sale], but unfortunately, it was a test that no one could believe adequately revealed Chrysler’s underlying value, as what was put to market was the . . . [sale] itself.”
The authors then go on to argue that the sale was mere pretense – and that, in fact, “there was no real sale [of Chrysler], . . . at its core Chrysler was a reorganization”:
Was the Chrysler transaction – however it may be called – simply a necessary expedient, borne of the unique economic circumtsances and policy concerns confronting the federal government during the summer of 2009?
Roe and Skeel argue that, in fact, the government could have acted differently: It could have picked up some of Chrysler’s unsecured obligations (i.e., its retiree obligations) separately. It could have offered the significant subsidies contemplated by the deal to qualified bidders rather than to Chrysler. It could even have paid off all of Chrysler’s creditors in full. But it did none of this.
Second, Roe and Skeel consider that “[t]he deal structure Chrysler used does not need the government’s involvement or a national industry in economic crisis.” Indeed, it has already been offered as precedent for proposed sales in the Delphi and Phoenix Coyotes NHL team bankruptcies – and, of course, in the subsequent GM case.
One very recent case in which South Bay Law Firm represented a significant trade creditor involved a similar acquisition structure, with an insider- and management-affiliated acquirer purchasing secured debt at a significant discount, advancing modest cash through a DIP facility to a struggling retailer, and proposing to transition significant trade debt to the purchasing entity as partial consideration for the purchase.
The deal got done.
What’s to become of this new acquisition dynamic? Employing a uniquely historical perspective, Roe and Skeel travel back in time to observe:
They trace the treatment of equity receiverships, noting their curtailment in the US Supreme Court’s Boyd decision, the legislative reforms embodied in the Chandler Act of 1938, and the 1939 Case v. Los Angeles Lumber Products decision which articulated the subsequently-enacted “absolute priority rule” (but preserved the “new value exception”). Against this historical background, “Chrysler, in effect, overturned Boyd.”
But with a twist.
“One feature of Chrysler that differed from Boyd may portend future problems. Major creditors in Chrysler were were not pure financiers, but were deeply involved in the automaker’s production.” In cases where the value of the assets is enhanced by the continued involvement of key non-financial creditors, “players with similar [legal] priorities will not . . . be treated similarly.”
Translation: When non-financial creditors are driving enterprise value, a Chrysler-style sale suggests that some will make out, and some creditors – even, on occasion, some secured lenders – will get the shaft.
If accurate, Roe’s and Skeel’s Chrysler analysis raises some significant considerations about access to and pricing of business credit. It raises new concerns for trade creditors. It likewise presents the possibility that the Chapter 11 process – which has, in recent years, tilted heavily in favor of secured lenders – may not be quite as predictable or uniformly favorable as in the past.
Meanwhile . . . it’s back to the future.