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posted by Stephen Lubben

In this morning's email:

Moody's Investors Service downgraded its Probability of Default Rating (PDR) for American Tire Distributors, Inc. ... following the company's announcement that it had initiated Chapter 11 bankruptcy proceedings...

ISDA Promotes a Race to the Bottom

posted by Stephen Lubben

Frustrated that Congress did not decide to collapse the CFTC and SEC as part of Dodd-Frank, and facing the reality that the SEC is still working on its rules under Title VII of Dodd-Frank, ISDA, the swaps industry trade group, is out with a white paper that urges the adoption of a "safe harbor."

This is not the infamous bankruptcy safe harbors, but rather a rule that would be adopted by both regulators. The basic idea is that compliance with one regulator's rule is "good enough." That is, swaps traders could choose which regulator they want.

What could possibly go wrong?

Excuse Me?

posted by Stephen Lubben

Barry Ritholtz has a generally sensible column about the ten-year anniversary of the financial crisis, but the bankruptcy stuff really makes no sense at all. Start with this proposition:

I believed then (and still believe) that the best course of action would have been prepackaged bankruptcies for all the insolvent institutions instead of bailouts.

How precisely would that work? A prepack involves pre-bankruptcy solicitation of votes from creditors – largely bondholders if we are talking about a SIFI's holding company. Under the securities laws, the solicitation will take at least 20 days. That is about 19 days more than will be required for the run on the SIFI to be fully commenced.

And then we have:

I would have had the federal government provide debtor-in-possession financing, allowed qualified private institutional investors to bid on the assets thereby letting markets set the valuations, with the government picking up the rest.

So this is not a prepack at all. If we are bidding on assets post-bankruptcy, there is no pre-bankruptcy plan for creditors to vote on. Indeed, until we see how the sale goes, there is no plan at all.

In short, we are just doing chapter 11, Lehman style. Maybe with a bit more pre-planning, which could not hurt. But if you assume better facts, you are bound to think you have found a better way

I continue to doubt that bankruptcy has much to offer with regard to a SIFI failure – which is really much more a question of ex ante regulation, and post default politics.

Available at finer booksellers everywhere (and Amazon too!)

posted by Stephen Lubben

CoverMy new book is out – the Law of Failure.

The sub-title is "A Tour Through the Wilds of American Business Insolvency Law," which pretty much tells the whole story. I try to cover all business insolvency law – not just the Bankruptcy Code. State laws, and federal laws like Dodd-Frank's OLA are covered too. All in a concise little volume.

In my research I discovered that many states have specialized receivership and other insolvency laws for specific types of businesses. And some states – I'm looking at you New Hampshire – still have corporate "bankruptcy" statutes on the books from the days when there was no federal bankruptcy law, or (as was the case with the early Bankruptcy Act) the law did not extend to all types of businesses. Can any of these laws really work? It is hard to say, since the Supreme Court has not dealt with a bankruptcy preemption issue in a very long time.

I welcome discussion on this question, or the book in general, from Slips readers, either below or via email.

Jay Alix v. McKinsey Update

posted by Stephen Lubben

As my summer of poutine, donairs, and nippy waters winds down, a quick post to note that the long-expected motion to dismiss has been filed in the battle between the chapter 11 financial advisors. A McKinsey spokesperson also provided the following statement, which gives some insight into how they intend to respond to this case:

“Jay Alix has waged a years-long crusade against McKinsey & Company to stifle competition in the bankruptcy advisory market. His attempt to bootstrap a disclosure dispute into a RICO action is devoid of any legal basis and obviously intended to do nothing but inflict reputational damage. Courts have previously upheld the appropriateness of McKinsey’s disclosures. This lawsuit is just one more part of Mr. Alix’s anticompetitive campaign to push out of the market a competitor whose deep expertise and unmatched scale deliver superior bankruptcy outcomes.”

Thoughts: initial thoughts on the Alix-McKinsey lawsuit

posted by Stephen Lubben

The compliant alleges some damming stuff. McKinsey brushes it all off as an anti-competitive ploy. It seems to me that the biggest risk to McKinsey is that the failure to disclose can itself be the basis for an order to disgorge fees.

McKinsey 2Even if McKinsey might have been retained in these cases if it had made disclosure up front – I don't necessarily agree with the Alix complaint that the alleged connections would have been, in all cases, fatal to their retention – failure to disclose is itself a serious problem. Bankruptcy professionals always have to disclose more than what is required by section 327's adverse interest/disinterested standard, because ultimately what counts as a problem for section 327 purposes is a question for the court, not the professional, to decide.

And I wonder why the courts approved McKinsey's retention applications in the first place. And where was the US Trustee? It is alleged that many of their retention applications stated that McKinsey had no relevant conflicts to disclose.  As in none. For a company of the size and importance of McKinsey, that frankly is not plausible. 

The allegations in paragraphs 120 to 122, which I have cut out in the image, are deeply troubling. In short, Jay Alix alleges that McKinsey recommended law firms to clients, and the law firms in turn recommended McKinsey for retention in the case. Not only might this be illegal, as Alix says, but this sort of relationship would have to be disclosed in the McKinsey (and law firms) retention applications even if not illegal.

Battle of Giants

posted by Stephen Lubben

I have been studying chapter 11 professionals since before the turn of the century, but today we have a first. Jay Alix, as assignee of AlixPartners LLP, has filed a 150 page complaint against McKinsey & Co., Inc. and others, alleging RICO violations in connection with McKinsey's alleged violations of section 327 and rule 2014.  This apparently comes out of the Wall Street Journal's report last week that McKinsey was suspiciously light and vague in its disclosures in bankruptcy court, as compared with other, similar professionals.

The alleged conspiracy goes back to cases during my time in practice – that is, long, long ago. It will be interesting to watch this develop.

Coming Soonish to a Bookstore Near You

posted by Stephen Lubben

Assuming you still have those in your town. If not, also available for preorder now is my forthcoming book, entitled The Law of Failure.  It is my attempt to consider all of American business insolvency law as a whole. Not just bankruptcy but also assignments, receiverships, and even oddball things like Nevada's campground receivership provisions.

The Economic Growth, Regulatory Relief, and Consumer Protection Act

posted by Stephen Lubben

Or EGRRCPA, for short. That is the official name of S. 2155, a bill which seems to be tearing Senate Democrats apart. Republicans are uniformly in favor of the bill, which Bloomberg describes as "another faulty bank-reform bill." Some Democrats see it as needed regulatory relief for small banks, while others, including the one who used to blog here, see S. 2155 as a rollback of keys parts of Dodd-Frank for big banks that remain too big to fail.

It is both. Indeed, if the bill were stripped of its title IV, I think most people could live with it. But title IV is a doozy.  

Most notably, it raises the threshold for additional regulation under Dodd-Frank from $50 billion in assets to $250 billion. Banks with more than $50 billion in assets are not community banks.

The banks in the zone of deregulation include State Street, SunTrust, Fifth Third, Citizens, and other banks of this ilk. In short, with the possible exception of State Street, this is not a deregulatory gift to "Wall Street," but rather to the next rung of banks, all of which experienced extreme troubles in 2008-2009, and all of which participated in TARP.

My prime concern – given my area of study – is that these banks will no longer be required to prepare "living wills." That is, they will not have to work with regulators on resolution plans.

How then do we expect to use Dodd-Frank's orderly liquidation authority if they fail? It would be impossible without advanced planning. Same for the misguided attempts at "chapter 14." I have real doubts about the wisdom of "bankruptcy for banks," but if it is ever to work, it will require lots of advanced planning (and luck).

And we can't use the normal FDIC approach of finding another, bigger bank to take them over, because that would simply create another colossus, like Wells Fargo. Certainly we don't want that.

Maybe a bailout then? Is that the "new" plan?

Chapter 11 Locale

posted by Stephen Lubben

For nearly two decades, the fact that many really large chapter 11 cases file in two districts has been a point of controversy.  On the one hand, the present system makes some sense from the perspective of debtor’s attorneys, and many DIP lenders, who value the experience and wisdom of the judges in these jurisdictions and the predictability that filing therein brings.  On the other hand, for those not at the core of the present system, it reeks of an inside game that is opaque to those on the outside.  And it is not clear the judges outside the two districts could not handle a big case; indeed, most could.

Where big chapter 11 cases should file is an issue again, at least among bankruptcy folks, given the possibility that the pending Cornyn-Warren venue bill might pass as part of some bigger piece of legislation, perhaps the pending S. 2155 (whose Title IV is so misguided it certainly warrants a separate post).

I have long been frustrated by the discussion of chapter 11 venue.  On the one hand, the present system has developed largely by accident, with little thought for the broader policy implications.  On the other, there is certainly some merit in concentrating economically important cases before judges who are well-versed in the issues such cases present.  The issue calls for careful study, but, as with most political issues these days, we are instead presented with a binary choice.

I have often contemplated concentrating the biggest chapter 11 cases among a group of bankruptcy judges, trained in complexities of multi-state or even global businesses.  A small panel of such judges could be formed in various regions around the country, such that the parties would never have to travel further than to a neighboring state for proceedings.  Geographically larger states – i.e., California and Texas – might comprise regions all by themselves.

Such an approach would ensure that cases would capture some of the benefits of the present system, without the drawbacks of having a Seattle-based company file its bankruptcy case on the East Coast.  Comments are open, what do readers think about developing a nationwide group of "big case" judges?

Tax "Reform"

posted by Stephen Lubben

Key takeaways for Slips readers from a Moody's report, dated today:

The legislation is credit negative to the US sovereign, owing to the reality that the cuts do not pay for themselves, and Moody's estimates the cuts will add $1.5 trillion to the national deficit over ten years. Higher deficits will put further pressure on the federal government's finances, which are already facing prospects of increased costs of entitlements. Unless fiscal policy reverses course, Moody's estimates that the federal government's debt-to-GDP ratio will rise by over 25 percentage points over the next decade, to above 100%. Combined with rising interest rates, debt affordability for the US will weaken significantly.

The net impact to state and local governments is negative. While the new $10,000 limit on state and local tax (SALT) deductions does not directly impact state or local tax receipts, it will blunt the effect of lower federal rates for many taxpayers. Because the state and local provisions raise the effective tax cost for many taxpayers, public resistance to tax increases will likely rise, and that in turn will constrain local governments' future revenue flexibility. In addition, if larger federal deficits caused by the tax cuts result in attempts to cut entitlement spending, states will be pressured to backfill cuts to federal funds from their own budgets.

The SALT change, combined with the higher standard deduction and tighter limit on the mortgage interest deduction, also reduces the tax incentive for home ownership, which is likely to slow home construction and sales, and moderately suppress home values and property tax growth in higher-price markets.

 

So, Is the High Yield Market Efficient?

posted by Stephen Lubben

My inbox is being bombarded with law firm commentary on the Court of Appeals for the Second Circuit's decision that cramdown interest rates should be determined by "market rates," rather than by formula, when the relevant debt market is efficient. A good summary of the commentary can be found over at the Harvard Bankruptcy Roundtable.

And then we have a Bloomberg story this morning, filled with hand wringing about what might happen if a particular mutual fund were to sell a particular bond position – where the fund owns less than 20% of the issue. Nevertheless, the suggestion is that such a sale could have big, market moving effects. That does not sound like a very efficient market.

Given that the high yield market is apt to be the most relevant market to a chapter 11 case, what precisely, then, has the Court of Appeals achieved?

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