postings Jay L. Westbrook

Nortel: The CBI Case of the Century (So Far)

posted by Jay Lawrence Westbrook

There can be little doubt Nortel wins the title for the cross-border insolvency case of the young century. Not only is it a huge case (US$7B or so), but as I noted in my last post it has established several milestones, including a joint televised trial in Toronto and New York and a common result in the two courts. Even more important are the substantive results in the universalist mode: the initial agreement on a global sale of assets without reference to territorial or corporate boundaries and the new ruling that orders global distribution on a quasi pro rata basis. The ruling is also notable for what it is not. It is not an acceptance of substantive consolidation. It is not territorialist; the result was unrelated to the situs of assets or creditors. It is also not fully universalist, although it does represent a species of modified universalism.

The key to the global distribution ruling, discussed below, is a finding that ownership of the sold assets could not be attributed to any one corporation in the corporate group and thus the proceeds should be distributed globally. I refer the reader to the opinions for the details, especially paragraph 250 of Judge Newburgh’s opinion. In summary, the proceeds of the sales are distributed pro rata among the estates. That result differs from a pure pro rata among all creditors of the corporate group primarily for three reasons. First, some cash stays in place. Second, intra-group claims share in the distribution from each estate, including an established $2B claim by the US sub against the Canadian parent. Third, an intra-group guarantee is potentially recognized.

The fundamental issue presented was entitlement to the proceeds of the sale of various assets. The first step necessarily was to determine ownership of those assets, primarily IP. The two judges agreed that the highly integrated nature of Nortel made it impossible to arrive at a fair and accurate determination of ownership within the Nortel group. By contrast, they obviously felt that the intra-group claim ($2B) against the parent and the parent’s guarantees were firmly attached to the US sub. No doubt they were also keenly aware of the Third Circuit precedent limiting substantive consolidation. Given a decision to avoid a result equivalent to substantive consolidation, and therefore to honor the corporate form as to claims, they were stuck with the problem of allocating the sale proceeds, a problem that substantive consolidation would have enabled them to avoid as discussed below.

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Nortel: More Universalist Than Not

posted by Jay Lawrence Westbrook

Shutterstock_108750656The Canadian and US courts have now ruled in the Nortel case. (Disclosure: I served as an expert for the UK pension interests in the case.) The case was already incredibly important because of an agreement among the parties to sell the worldwide assets of the corporate group without regard to territory or corporate ownership, creating a global pool of proceeds (about $7B) for distribution in such manner as agreed by the parties or as mandated by the two courts. (The UK court was not involved at this stage, which is an interesting point for another day.) A unified worldwide sale is a central advantage of universalism, enabling the parties here to achieve much higher values than had been predicted.

However, when the parties could not agree as to distribution, the two courts were forced to decide. Ignoring many significant aspects of that process, after a joint on-line trial the two courts reached a common result. The joint trial and common result were two more extraordinary accomplishments. The common resolution is a special triumph for universalism.

The result is a pro rata distribution of the sale proceeds by estate based upon the percentage of claims allowed in each case. In other words, the allocation of the $7B in proceeds was global, but global by estate, not pro rata as to each creditor of the group. The formula produces a global distribution overall, a universalist result, but one that favors the creditors of the US company in several ways, including giving effect to an inter-company claim by the US estate against the Canadian parent and to the guarantees that certain US bondholders had from the Canadian parent. While the result falls between the positions of the parties, it is reasonably defensible in principle rather than merely being a compromise. I look forward to making a further post analyzing the result. 

Graph image from Shutterstock

Dysfunctional Analysis Part 2

posted by Jay Lawrence Westbrook

Shutterstock_112522430Per Part 1 of this post, the word “executory” under section 365 of the Bankruptcy Code should be defined by its original, common law meaning per Williston: a contract in which some obligations remain. That common law definition was the one on the table when Congress originally adopted this ancient provision and there is no longer any justification for imposing the labyrinthine elements of executoriness on top of it. These additional executoriness requirements were developed by the courts in the olden days when court approval of AorR was not required and executoriness was a way to protect estates from trustee foolishness or carelessness. (See my old article for details at A Functional Analysis of Executory Contracts, 74 Minn. L. Rev. 227 (1989).)  During that time, the Countryman test did a brilliant job in greatly improving the policing of those failures. However, the Countryman test is not needed for that purpose now that court approval is required for AorR. It also does not solve the underlying problem, which is manipulation of the label “executory” in lieu of applying the statute as written to cover modern problems like options and licenses. The result is confusion and unpredictable injustice to estate and counterparty alike.

Under the form of Functional Analysis that I have suggested, the basic approach to AorR is taken from the words of the statute and is simplicity itself:

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Dysfunctional Analysis Part 1

posted by Jay Lawrence Westbrook

Warning: Grumpy Alert. I am grumpy because the ABI Commission’s recent report rejected any reform of the bizarre American approach to executory contracts, which requires a quality of “executoriness” in a contract before it can be assumed or rejected. (Think of Stephen Colbert and “truthiness.”) Worse still, it recommended codifying the Countryman test, which was a great advance in its day but has been rendered hopelessly outdated by statutory changes and modern contract practices—e.g. in options and LLC memberships. Shutterstock_112522430

One reason for the Commission’s recommendation was “the perceived value in maintaining some type of gating feature to vet those contracts that a debtor in possession could assume, assign, or reject in the chapter 11 case.” A reasonable conclusion from that would be that the reason for retaining the old test was that continued confusion and inconsistency would help counterparties to maneuver in the fog. But no. The Report explains that the case law is so predictable that eliminating executoriness would just create more litigation. For those who have recently reviewed that case law, I can only assure you I am not making this up. (Please note I don’t for a moment blame this error of the Commission majority on its excellent reporter.)

Some twenty-five years ago I was guilty of an article on this subject called A Functional Analysis of Executory Contracts. Unfortunately, some cases used the phrase to mean that executoriness should depend on benefit to the debtor, while my pitch was to abolish the executoriness requirement altogether. Herewith a brief reprise of that old article and perhaps an intimation of a new one.

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TBTF and The Single Point of Entry (SPOE): Part Two

posted by Jay Lawrence Westbrook

In an earlier post I described the FDIC’s proposed SPOE approach to resolution of SIFI banks and other financial institutions under Title II of Dodd-Frank. That post discussed two of the three components of SPOE: control of the process by the regulator and no bailout for management or owners. This post lays out the role of the third component, the “forlorn hope” debt. Shutterstock_95970961

That debt is unsecured debt owed to a bank holding company (BHC) and predestined to get little or nothing in case of the failure of the BHC. It serves in effect as a debt reserve to buffer the financial distress of the bank group. By being dumped, it would make the group as a whole solvent. By contrast, legislation already passed by the House would ignore the need for the reserve, thus setting up another bank bailout. The reserve debt component of SPOE awaits a strong rule from the Fed to make it a reality. This post discusses what the rule must do.

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Busted Banks: TBTF and the Single Point of Entry

posted by Jay Lawrence Westbrook

Shutterstock_95970961A Single Point of Entry (SPOE) sounds like the route of a returning astronaut or perhaps a building’s security plan or even a sex guide, but actually it is the FDIC’s proposal for saving the financial system when a giant financial institution strikes out on the derivatives market or discovers it has a school of London Whales. SPOE is important because the FDIC and the Bank of England have agreed on it as the best approach to a global resolution of a failing SIFI, the polite term for a TBTF bank. That agreement is crucial, because the largest banks can only be resolved on a global basis.

SPOE is a method of resolution of a SIFI in financial distress without having to choose between a government bailout or the collapse of the global financial system. By contrast, legislation passed by the House would privatize the SPOE process and likely result in future bailouts. The legislation is being marketed under the term SPOE, but bears little relationship to the FDIC proposal. The three key aspects of the FDIC plan are that a) the resolution process will be controlled by the regulator; b) there will be no bailout of the SIFI’s owners and management; and c) the creditors of the parent holding company will be tossed overboard, returning the bank group to solvency by erasing debt and lessening the need for government money to make the process work. This post discusses the first two points, control and no bailout, while a second post will talk about the debt dump. 

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