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    Posts Tagged ‘Credit Slips’

    The Dodd-Frank Financial Reform Act: A Reader’s Digest Version

    Monday, July 26th, 2010

    A couple of prior posts on this blog (here and here) have explored the economic and regulatory reasons behind 2008’s financial meltdown, while others (here and here) have explored proposed means of handling distressed financial institutions deeemed systemically important to the nation’s financial markets.

    Economic Fears Reignite Market Slump
    Image by YoTuT via Flickr

     

    History and propositions are now overtaken by reform.  Last Wednesday, the Financial Reform Act (aka the Dodd Frank Act) became law.

    Over at Credit Slips, Seton Hall Law Professor Stephen Lubben has offered a very succinct, immediately accessible summary of the Act’s intersection with the US Bankruptcy Code – as well as some helpful links to other, useful material.

    Very important reading for those who want the “bullet points” without wading through the nearly 2,300 pages of legislation.

    Happy reading.

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    2009: Year of the Mega-Case?

    Monday, June 22nd, 2009

    Last Monday’s “Credit Slips” blog features a brief piece by Seton Hall’s Steve Lubben, who cites bankruptcydata.com for what by any measure is a remarkable statistic: Year-to-date, US Bankruptcy Courts have seen no less than 35 Chapter 11 cases involving debtors with assets of $1B or more.

    That’s nearly six billion-dollar filings per month.

    According to Lubben, it’s also more than all of 2008’s “mega-cases” combined.  Just as interesting, however, is Lubben’s comment on the “ripple effect” created by these cases:

    I think we can expect that the collective, collateral effect of these cases on trade creditors, landlords, and employees will equal, if not exceed, the effects of the better-known cases.  This will in turn create a ripple of small business bankruptcy cases . . . .

    Here at South Bay Law Firm, we couldn’t agree more.

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    Chrysler and Successor Liability

    Monday, June 1st, 2009

    Readers of this blog will be familiar with Seton Hall Professor Stephen Lubben’s prior work on credit default swaps and their impact on business bankruptcies.  In a post on last week’s Credit Slips, Professor Lubben weighed in on another timely topic: Chrysler’s proposed asset sale to Fiat.

    Of interest is a recent objection to the pending sale order filed by the State of Connecticut – the relevant portions of which are quoted in Lubben’s post – where the State argues:

    Neither the Supremacy Clause of the United States Constitution nor the doctrine of preemption obligate state courts to enforce an otherwise valid order of any United States Bankruptcy Court where such order is challenged under the successor liability law of the states. See e.g. MPI Acquisition, LLC v. Northcutt, 2009 Ala. LEXIS 14 at * 10 (Ala. 2009); Lefever v. K.P. Hovnanian Enterprises, Inc., 160 N.J. 307 (1999) (bankruptcy sale order did not preclude application of product-line successor liability); Gross v. Trustees of Columbia Univ., 816 N.Y.S. 2d 695 (2006) (successor liability imposed against purchaser of assets free and clear of claims in bankruptcy proceeding); Simmons v. Mark Lift Industries, Inc., 366 S.C. 308, 313 (2005) (“a plaintiff may maintain a state-based product liability claim under a successor liability theory against a successor corporation which purchased the predecessor’s assets in a voluntary sale approved by the federal bankruptcy court”). 

     According to Lubben:

    the State agues that the [Chrysler] sale order can’t release Chrysler from successor liability. This is a key issue, especially since the sale order in Lehman Brothers[' bankruptcy case] expressly included just such a release. Obviously the market for distressed assets would become even more illiquid if bankruptcy courts were unable to “cleanse” the assets as part of the sale process.

    The professor points out a number of problems with Connecticut’s argument and the authorities supporting it, including (i) the State’s misstatement of the Alabama court’s holding; (ii) the absence of any mention by the South Carolina court of section 363; and (iii) the New Jersey court’s own misstatement of federal bankruptcy law.  Of greater interest, however, is the New York decision cited by the State of Connecticut, which – according to the analysis offered on Credit Slips – relies on the Piper Aircraft decisions to find that successor liability under state law cannot be entirely eliminated by a federal bankruptcy sale order.

    For Lubben, the New York trial court has a point about successor liability, though not for the reasons given by State of Connecticut.  Instead, the bankruptcy court’s inability to “cleanse” the sale of distressed assets through a “Section 363 sale” has more to do with due process: In essence, those future claimants who may hereafter be injured by defective Chrysler vehicles should not be bound by a present bankruptcy order of which they had no notice.  Lubben asks for comments on whether “[a] limited group of claimants might nonetheless be able to bring such [successor liability] claims, if they have good arguments that due process so requires.”

    Great question, Professor Lubben.  I have only one observation. 

    Successor liability to future claimants has long been a thorny issue where bankruptcy sales are concerned.  It has received serious academic attention for well over a decade.  However, such sales are not the only context in which bankruptcy courts have had to wrestle with successor liability.  The Owens-Corning cases, which concerned the ability of an operating company to address future claims arising from asbestos-related product liability, resolved this problem and effectuated a successful reorganization through the appointment of a “future claims representative” – i.e., a representative appointed by the court and charged specifically with representing the interests of future claimants whose asbestos-related injuries had not yet manifested themselves in the company’s present reorganization.  The Owens-Corning decision was of such creativity that its approach was implemented by Congress for all asbestos-related reorganizations in subsequent amendments to the Bankruptcy Code.  See 11 U.S.C. 524(g) and its legislative history, which – incredibly – actually make for some interesting reading.

    Where Chrysler’s asset sale will likely result in a liquidating plan, could the bankruptcy court follow a similar approach – i.e., appoint a claims representative to bargain with existing creditors on behalf of those future plaintiffs not yet injured by already-manufactured Chrysler vehicles for an appropriate share of the Chrysler sale proceeds, to be distributed through a claims trust and enforced by a channeling injunction similar to that prescribed for asbestos-related liabilities under Section 524(g)?

    Comments, Professor Lubben?  Anyone else?  I’d love to hear from you at mgood@southbaylawfirm.com.

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    Credit Default Swaps and Bankruptcy

    Sunday, April 5th, 2009

    In a series of papers – the most recent a chapter in Greg N. Gregoriou’s and Paul U. Ali’s Credit Derivatives Handbook: Global Perspectives, Innovations, and Market Drivers (McGraw-Hill 2008) – Seton Hall Professor Stephen J. Lubben has argued over the past year or so that credit default swaps (CDS’s) will change the negotiation dynamic of large Chapter 11 cases.

    How so?

    An understanding of Lubben’s argument requires at least a rudimentary understanding of what CDS’s are and the purpose they serve.  As discussed by a brief article appearing in the March 5, 2009 edition of The Economist, “[a] CDS works like a fire-insurance policy: the holder pays a regular premium, but if the house burns down there is a big payoff. With CDSs, the payoff is triggered by a default – and filing for Chapter 11 [does] indeed trigger some CDSs.”

    Against this conceptual background, Lubben argues that where the holder of a CDS is better off with with a default on the debt underlying the swap than it is waiting for the debt to pay out, the dynamics of debtor-creditor negotiation before and during Chapter 11 will change.  In particular:

    – CDS’s could impede the negotiation of workouts, pre-arranged or pre-negotiated Chapter 11 plans, as creditors with a vested interest in the debtor’s failure either refuse to negotiate or – worse yet – actively seek the company’s demise.

    – CDS’s may shorten the timeframe for workout negotiations or promote the increased use of involuntary bankruptcy filings. 

    In a helpful post offered last month on the academically-oriented bankruptcy blog “Credit Slips,” John Marshall Law School Professor (and fellow “Credit Slips” blogger) Jason Kilborn points readers to the March 5 Economist article and suggests further that the CDS market may incentivize claims trading amongst speculators betting on the debtor’s failure:

    [W]hat if high-risk investors (speculators?) buy CDS['s], banking on a corporation’s default (akin to “naked short selling” of a company’s stock) [?]  This explosive situation comes to a head if the borrower company attempts a reorganization.  Now you’ve got very dedicated and often aggressive investors hoping for your failure!  [With] enough riding on the CDS paying out, one can easily imagine a CDS holder offering to buy a blocking position (34%) of the unsecured debt of a company attempting reorganization – which the CDS holder can probably do for a song in light of the pending reorganization (and the payout on the CDS will almost inevitably be more than a plan promises to unsecureds).  I’ve heard lots of grousing among judges wanting to know how certain “creditors” voting unsecured claims came to own those claims – now I understand why these judges want that info and what scary info they might find if the question is answered.  I presume the “not in good faith” votes of CDS holders voting down a reasonable reorg plan could be equitably subordinated or classified (rejected).  What a nightmare for debtor’s counsel!  All that work to then have your plan fail because investors with no real skin in your game tank your deal so they can collect the equivalent of hazard insurance on your failure.

    Precisely how – and under just what circumstances – CDS’s will affect the negotiation dynamics that for years have been a staple of reorganizations remains to be seen.  Lubben suggests that under some circumstances, the holders of CDSs may, in fact, still retain an interest in seeing the debtor succeed.  Kilborn himself points to recent developments in the case of LyondellBasell, the Dutch petrochemicals giant whose American unit, Lyondell Chemicals, commenced Chapter 11 proceedings in January: According to the March 7 Economist article, “some CDS holders want to force the debtor’s European parent to default, bringing in the complications of a cross-border reorganization.  That would so complicate the case that the chance of a total meltdown – and a payout on the CDS – would spike, so DIP lenders have ponied up just to avoid that eventuality.”

    Regardless of the ultimate outcome, this formerly esoteric and little-understood corner of the bond market appears to be having a very practical, real-world effect on larger Chapter 11 cases.

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