Private Equity Debt Shenanigans Conference

I'm obsessed with debt shenanigans and, in particular, the emergence of an entire industry (or so it seems) of lawyers who specialize in finding and exploiting contract loopholes in places where the parties to the transaction had no idea there were gaps.  And there are others who defend against this.  (Anyone remember J.Screwed or Windstream?). 

One area where the payouts of successful loophole detection and exploitation has shown big returns is the world of Private Equity. 

And now the Penn Law Review is hosting a conference on this topic. (Okay -- Their description of the topic is slightly different than mine).  Yay!

Call for papers is below:

The University of Pennsylvania Law Review will host its annual symposium on Friday, October 7, 2022, in-person. This year’s topic, “Debt Market Complexity: Shadowed Practices and Financial Injustice”, will explore the rise of increasingly complicated debt structures associated with private equity. We are issuing a call for papers for publication in the Law Review’s corresponding symposium issue.

To submit a paper for consideration, please provide an abstract no longer than 750 words to symposium@pennlawreview.com by July 31st, 2022. If selected for publication, completed drafts will be due January 1st, 2023. 

The complete call for papers, which includes more detail, is available here. 

Yehuda Adar on Contract Damages -- In a Bond Default

Figuring out the right damages measure for default on an actively traded financial asset such as a government bond is, at first, obvious -- just pay what you promised on the bond.  But then, when one thinks about features of damages law such as the option to substitute performance or mitigation, things get murkier.

Yehuda Adar, a guru of the messy law of damages at Haifa, has a super new paper on ssrn.com (here).  How he manages to be so very clear and coherent about a topic that is so messy is beyond me. 

Here is the abstract:

What are the damages to which an investor facing a repudiation or a material breach by a government issuer is entitled? The conventional answer that most investors would probably give is that, in the face of such a default on the bond indenture, damages should include both the repayment of the principal (‘par’) and the payment of any remaining (i.e., unpaid) coupons (discounted to present value). Is this conventional understanding warranted? For at least some sovereign bond experts, the answer is not at all obvious and straightforward at it might seem at first blush. Aren’t such damages over-compensatory? Indeed, by obtaining – prior to maturity – both the par and every remaining coupon payment, isn’t the bondholder being put in a better position than if the contract had been performed? Indeed, if there had been no breach, wouldn’t the bondholder have to wait for those payments to be made until maturity date? Secondly, if damages are to be calculated this way, isn’t the bondholder going to receive something more valuable than what he had before the breach? More concretely, whereas prior to breach the bond’s market value reflected the issuer’s credit ranking, the conventional measure of damages seems to treat the bondholder as if he owned a U.S. treasury bond. Third, shouldn’t the investor be expected to purchase a substitute on either the primary or secondary market to eliminate or at least minimize his damages? Shouldn’t this option significantly reduce the scope of the issuer’s liability?

As basic as these questions sound, they have managed to escape rigorous analysis in the sovereign bonds literature. One can hardly find a comprehensive analysis of remedial issues within this vast body of scholarship. What, then, is the correct measure of damages for the breach of a government bond? By closely inspecting this deceptively simple question, this Article highlights the availability, under the general law of contract damages, of no less than four different methods for measuring a bondholder’s expectation damages. The Article presents to the reader each of these alternative measures and illustrates how to implement each of them in a hypothetical case described at the outset of the Article. Then, the Article addresses two analytical challenges facing a court (or an arbitrator) wishing to reach the correct decision on the damages issue. The first involves a choice between two ways of conceptualizing the bondholder’s loss; namely, the loss of the promised performance of the indenture on the one hand, and the market value of the bond on the other hand. The next challenge is that of applying the mitigation of damages doctrine. Considering the normative and practical considerations pertinent to each of these challenges, the Article ultimately concludes that in most cases courts will tend to implement the ‘Gross Lost Profit’ measure of damages, which is the most generous of the four expectation damage measures. Surprisingly or not (depending on one’s intuitions), this measure coincides with the wisdom of the crowd.

 

 

Co Authoring in Legal Academia

Co authoring saved me. Literally.  But for the fact that my senior colleagues at UCLA did not care whether I ever wrote anything sole authored, I don't think I would have written anything. I was (and am) just too racked with insecurities.  And then I'd probably have had to get a real job. Aiyiyiyi.  I owe an ever lasting debt to those colleagues -- thank you to Bill Klein, Devon Carbado, Steve Bainbridge, Rick Sander and more.

But I had heard, at the time (a long long time ago) that other schools were not so encouraging. Some of them, the rumor was, discounted co authored work or refused to count it at all in the tenure file.  The model of the worthy scholar was the solo romantic creator toiling away on the magnum opus in solitude.  

Things have changed since then though, as this brilliant piece, The Evolving Network of Legal Scholars,  by Andrew Hayashi shows (although, I have to ask Andrew: Why is the article on co authorship not co authored?).  Even putting aside the fact that I find the topic fascinating (of course, I'd like anything about co authorship), it is beautifully written and has the coolest graphs.  Every section says something new and insightful and one is left wanting more at the end. That is not how I feel at the end of most law journal articles -- actually, I don't even reach the end of most law journal articles because they are such torture to read (especially mine).

Abstract is here:

The law professoriate is a network connected by scholarly interactions of various kinds, including co-authorship. I study the evolution of the co-authorship network from 1980-2020 and document a sharp increase in the number of scholars, the amount of scholarship, and explosive growth in the network of legal scholars during this period. Despite this growth, however, the distance between legal scholars has shrunk such that legal academia can be characterized as a “small world.” I describe the increase in the number and scholarly contributions of women, minorities, and lesbian, gay and bisexual (LGB) scholars and the rise of co-authorship, including “mixed” co-authorship. I find that members of the same gender or minority groups tend to coauthor with each other, but that this correlation has declined over time resulting in more co-authorship across identity categories. Finally, examining the ordering of author names on coauthored articles, I find that racial minority scholars make up a greater share of first authors than their share of authors in general, while women and LGB scholars make up a smaller share of first authors than one might expect if authorship were randomly assigned.

Just a few questions for Andrew, for his next article on this topic:

1. The article focuses on co authorship in law journals. But what about peer review journals.  Might it be the case that the types of folks who migrate towards the co authorship model tend to publish more in peer review journals? Especially in fields like health law? Does that create an under count?

2. Do things change over the life cycle of a scholar?  Does co authoring at some stage lead to working on larger and larger teams over time? (as one sees the benefits - I'm thinking of Eric Posner's podcast  conversation with Orin Kerr about this topic (here))

3. Can you tell us more about the schools where co authorship thrives more than others?  Are they more collaborative? Do they produce better (more creative) or worse ideas?

4. What about co teaching?  Some schools encourage co teaching in the way they give credit.  Does that result in more co authorship?

Confiscating Russian Assets (Now?)

As the Russia-Ukraine conflict continues and the amount of destruction to lives and property grows exponentially, a question that has come up is whether Russian assets overseas should be confiscated and made available to those who the Russian invasion has harmed  (e.g., here).  The list of those is growing larger minute by minute:  refugees, families of those who have died, people whose homes and livelihoods have been blown apart and on and on and on.

The amount of harm that Mr. Putin's craziness has caused is already far greater than the value of the frozen assets -- in the many trillions whereas the frozen assets (even if one adds in the oligarch properties) is in the hundreds of billions.  But should we wait until Mr. Putin has taken whatever portion of Ukraine he wants (e.g., 20-30%), installed some puppet government, and is finally willing to negotiate for peace?  At that point, as part of the negotiation, he is going to want to ask for his frozen assets back.  And the leaders of the countries where the frozen assets are located, who will be desperate for peace, might be tempted to give the assets back.  Let us not kid ourselves.  The political flesh is weak.  If those politicians see themselves garnering advantage at the ballot box by negotiating a quick peace (to the detriment of the claims or refugees and others), they will do that.  So, maybe there is an argument to confiscating the assets now while there is political will to do so.

On the other hand, there is the small matter of the law.  Due process before taking people's property and all that.  Does it allow for the confiscation of the property of a sovereign engaging in an egregious violation of international law by invading a neighbor?  There is the proverbial slippery slope of countries confiscating the property of other sovereigns whose behavior has displeased them without first ensuring that they are legally entitled to.

To my mind, these are fascinating questions to which there are not clear answers.

Two giants of the legal academy, Larry Tribe and Paul Stephan have been debating this in the context of what Mr. Biden is allowed to do.  The assets can be frozen. But can they be confiscated?

Here is the abstract of Paul's superb new paper that describes the issues:

This article addresses the legal issues that the United States would confront were it to move from freezing to seizing. It looks first at the executive branch’s existing legal authority to confiscate foreign property. It considers legislative proposals to extend that authority. Both existing law and possible future legislation face constraints under constitutional law. These constraints are unique to the United States but reflect principles of legality and due process that western states generally embrace. Finally, it provides a snapshot of the international legal issues that seizure of Russian state assets might present.

First and foremost, existing law does not permit the executive branch to dispose of Russian state assets in advance of a settlement with that state. A civil process exists to forfeit assets to the state, including those of state-owned entities, but that entails resort to the courts and requires some evidence of criminality. Legislation currently under consideration in the United States would enhance that process but not abandon it. It would not apply to the largest portion of assets, the deposits of the Russian Central Bank in US financial institutions, absent some proof that those deposits can be traced to criminal activity. US constitutional guarantees against expropriation in the absence of compensation and of civil forfeiture in the absence of due process almost certainly apply.

Finally, the seizure of assets belonging to the Russian state outside of normal criminal and regulatory processes would violate international law. What international law probably would permit, however, is the use of these assets to satisfy legal judgments rendered against the Russian Federation by duly constituted international investment tribunals established under treaties to which Russia is a party. The United States and other countries in the West might explore ways of encouraging the beneficiaries of these awards, both present and future, to devote their recoveries to Ukrainian reconstruction.

Tort Law, Social Policy... and Bankruptcy

I cannot tell you what to think about the fact that the long-running Clifford Symposium on Tort Law and Social Policy, at DePaul University College of Law in Chicago, kicks off with a bankruptcy panel this year.  The official title of the conference this year is Litigating the Public Good: Punishing Serious Corporate Misconduct. Much of the June 2-3 conference is scheduled to occur in person but online observation is available and free: register here. 

A Tournament of Lawyers: Who Should Sri Lanka Hire to Manage its Debt Restructuring?

Rumor is that close to thirty leading international law firms have put in bids to assist Sri Lanka in its upcoming debt restructuring.  Makes sense -- there is a fat paycheck for whoever gets the mandate.  Given the stakes, my guess is that these firms -- and I'm just guessing -- are busy trying to "influence" whomsoever they can in both the current government and in the opposition (after all, the current government might fall any day now) to get ahead in the competition.  Yuck.

Having a good adviser can make a huge difference in terms of how well one's debt restructuring goes.  Hopefully, the decision will made as a function of which adviser will give Sri Lanka the best restructuring design and not made as a function of who is best buddies with the President's closest flunky.  I'm not optimistic though.

I have a suggestion.  I know it has zero chance, but I'm going to make it anyway.  We should have a competition, a tournament of lawyers. Each of these firms should have to put up on  ssrn.com a ten page plan as to how it plans to solve the likely holdout problem with Sri Lanka's restructuring.  Then, Sri Lanka could have a neutral panel of respected restructuring experts pick the firm with the best plan. Or the experts could pick four semi finalists and those semi finalists could be given the opportunity to present their plans and answer questions in an open setting. 

Wouldn't it be a lot better for these firms to be spending their resources competing to design the best possible plan for Sri Lanka than competing to please the president's best friend or the cousin of the leader of the opposition?

These foreign advisers are expensive. And perhaps rightly so, given what they provide.  But they should have to earn every penny they charge a country in deep distress.  Maybe some of them with a really good plan might even offer to work pro bono?  After all, fame and fortune can come alongside a beautifully conducted restructuring.

Let the games begin.

 

Venmo's Unfair and Abusive Arbitration Opt-Out Provision

Venmo's changing the terms of its arbitration agreement, and the manner in which it is doing so is unfair and abusive to consumers. The CFPB and state attorneys general need to take action here to protect consumers.

Here's the story.  Last night I got an email from Venmo entitled "Upcoming Changes to Venmo." Nothing in the email's title (which is all I see on my devices) signals that there is a change in contractual terms, and I would have just deleted it without reading but for seeing consumer finance list-serv traffic light up about it.  So I looked at the email, and in the body it does explain that there are changes to the Venmo arbitration clause. It also tells me that I can opt-out of the Agreement to Arbitrate "by following the directions in the Venmo User Agreement by June 22, 2022".  The Venmo User Agreement is hyperlinked.  It is a 95 page document. The hyperlink takes me to the very top of the agreement, but the arbitration agreement starts on page 70.  It takes a lot of scrolling to get there, and nothing is particularly prominent about the arbitration agreement's text.

The arbitration agreement itself has a summary at the top that includes a few bullet points, one of which is "Requires you to follow the Opt-Out Procedure to opt-out of the Agreement to Arbitrate by mailing us a written notice." The term Opt-Out Procedure is a hyperlink to a form that can be printed (but not completed on-line).

What's so ridiculous about requiring a hand-written form to be sent through the mail is that Venmo will surely digitize the form. That means someone's gotta open the mail and do the data entry. Why not have the customer do that himself? Or for that matter, just have a check box on my Venmo account for opting out of the arbitration agreement? The only reason to use the paper form and posts is to make it harder for consumers to opt-out of the arbitration provision.

What Venmo's doing is unfair and abusive and therefore illegal under the Consumer Financial Protection Act. It's perfectly legal for Venmo to have an arbitration clause, and there is no requirement that consumers have a right to opt-out of arbitration, although a change in terms on an existing contract is a bit more complicated. Be that as it may, Venmo is the master of its offer, and by giving consumers a right to opt-out, but raising barriers to the exercise of that right, Venmo is engaging in an unfair or abusive act or practice. Venmo is trying to have its cake and eat it too, but pretending that consumers have a choice about arbitration, but not actually giving them one.

That's "unfair" under the Consumer Financial Protection Act because the practice makes it likely that consumers will lose their right to proceed as part of a class action. That is a substantial injury to consumers in aggregate. The ridiculous opt-out procedure makes this injury "not reasonably avoidable by consumers." The consumer would have to click on no less than two hypertext links, starting with an email the title of which gives no indication what is at stake, and then navigating through a 95 page agreement to find the second link. After that, the consumer must print, fill out, and mail a form. Whatever one thinks of the benefits of arbitration, there's no benefit to consumers or competition from making the opt-out difficult. To my mind, this is a very clearly unfair act or practice. It's also an "abusive" act or practice under the Consumer Financial Protection Act. Because the terms of the opt-out make it so difficult for a consumer to actually exercise the opt-out, the terms of the opt-out "take unreasonable advantage of —the inability of the consumer to protect the interests of the consumer in...using a consumer financial product or service."  (One might also even be able to argue that it is a deceptive practice--the opt-out right has been buried in fine print and hypertext links.) 

Both the CFPB and state attorneys general have the ability to enforce the UDAAP provisions of the CFPA against nonbanks like Venmo. I hope the CFPB and state AGs get on Venmo about this. It presents a good opportunity for the Bureau to make clear what it expects in terms of fairness for contract term modification and opt-out rights.

Can Russia Pay its 2022 Dollar Bond Obligation in Rubles? (More dodgy Russian bond clauses?)

I didn't think so. But one of my students has me questioning myself.

As of this writing, in April 2022, the press is reporting that Russia is on the brink of default because its foreign currency funds are frozen (here). Russia says that it is not in default because it is unable to make the dollar or euro payments as a result of the sanctions and is entitled to make its payments in rubles.  Investors have dismissed this idea – saying that it is “crystal clear” that payments on the bonds with payments due April 2022 have to be paid in foreign currency (here).

Yes, there are some bonds, containing an “Alternate Payments Currency” clause issued in the post-2014 period, where Russia is arguably entitled to make payments in rubles if, for reasons out of its control, it is unable to pay in the primary currency specified in the bond (here).  But the bonds that have come due in April 2022 do not contain that Alternate Payment Currency clause. And hence the assumption seems to be that the ruble payment constitutes a default.  And I confess that that was my assumption until a student, Doug Mulliken, pointed out a clause that I had previously missed.

It is clause number 15, titled “Currency Indemnity.”  The first sentence of the clause says:

The U.S. dollar is the sole currency of account and payment for all sums payable by the Russian Federation . . . in connection with the Bonds, including damages.

That’s well and good.  The US dollar is the currency of payment.  But then the clause goes on to say:

Any amount received . . . in a currency other than the U.S. dollar . . . by any Bondholder in respect of any sum . . . due to it from the Russian Federation shall only constitute a discharge to the Russian Federation to the extent of the U.S. dollar amount which the recipient is able to purchase with the amount so received or recovered in that other currency on the date of that receipt or recovery . . . If that U.S. dollar amount is less than the U.S. dollar amount expressed to be due to the recipient under any Bond, the Russian Federation shall indemnify such recipient against any loss sustained by it as a result. In any event, the Russian Federation shall indemnify the recipient against the cost of making any such purchase.

To my reading, Doug is right. Boiled down, the clause seems to say that payment in a different currency (e.g., rubles) can constitute a “discharge”, so long as the recipient can use those rubles to buy a sufficient number of dollars.  That seems to mean that Russia, can discharge its obligations by paying in rubles.

Now, maybe I have missed some other clause in the document that negates this.  It would not be the first time that that’s happened.  But I do remember reading a chapter in Lee Buchheit’s, How to Negotiate Eurocurrency Loan Agreements, (Chapter 20, if memory serves) that not only describes clauses like this, but also explains how they are a potential source of mischief if the clause was not written tightly enough to protect against the debtor using capital controls in a sneaky fashion.

The sneaky thing for Mr. Putin to do would be to make the payments in rubles into an account in Russia, immediately convert the rubles to dollars and then say that the dollars are frozen in place under capital controls.  Pay enough rubles and, according to the strict terms of the contract, that would be a discharge.  And Mr. Putin could say that those dollars would be frozen until his foreign assets in the west were unfrozen.

One might ask here: Doesn't the bond require payments to be made in NY?  Yes, but Section 15, the Currency Indemnity clause, describes what happens if the holder “recovers OR RECEIVES” a payment in another currency, presumably in another place.

And it says that the USD payment is “discharged” if the holder receives a sufficient amount of that other currency to buy $$$ in the amount originally due on the date the other currency is received or recovered.

All of that will have happened.

Would a court buy any of this? Probably depends on where the court is located.  London, NY or Moscow.

The problem probably could have been obviated had the Currency Indemnity clause specified that the dollars acquired with the other currency (rubles, in our hypothetical) be "freely transferrable dollars". But it doesn't say that.

Aiyiyiyi

Credit to Doug Mulliken. Errors are mine.

That Odd Sri Lankan Airline Guaranteed Bond

Mitu Gulati & Mark Weidemaier

After months of waffling, Sri Lanka’s head-in-sand government has finally acknowledged that it cannot pay its debts. The cavalry (IMF) has been called in and we guess that hordes of potential restructuring advisers are flying to Colombo to offer their services. Assuming they have done their homework, their proposals surely will consider both the government’s own debt and a Sri Lankan airline bond that the government has guaranteed.

Sri Lankan airlines used to be profitable. From 1998-2008, it was partially owned and run by Emirates. One of us recalls it being a special treat to fly on. But the government decided in 2008 to run the airline itself and, since then, it has performed terribly.  There have been corruption scandals, accusations that Emirates was pushed out after the airline refused to bump paying passengers to make room for the royal family, and reports that local banks have been strong-armed into lending and will be in trouble if the airline collapses. Perhaps it’s no surprise that it needed a government guarantee to borrow money.

Sovereign guaranteed bonds often carry a higher coupon than a bond issued by the sovereign, perhaps because the sovereign is viewed as the safest credit. But this logic seems upside down. Unlike a pure sovereign bond, a guaranteed corporate bond is backed both by the sovereign’s credit and by a separate pool of assets (e.g., airplanes). Even if the company is literally worthless, there is still the full sovereign guarantee. Obviously there will be other factors that affect price, such as liquidity (the market for pure sovereign bonds may be much larger). But in crisis, when the bonds are sure to be restructured, there seems every reason to favor the guaranteed bond.

Another reason to favor a guaranteed bond is that these often have less effective restructuring mechanisms than are found in the sovereign’s own bonds. Oddly, then, a guaranteed bond that was viewed as riskier at issuance can end up being a safer bet. Greece’s 2012 restructuring imposed haircuts of over 50% on pure sovereign bonds but most holders of guaranteed bonds got paid in full. There is even some evidence suggesting that investors had figured this out towards the end game in Greece and favored guaranteed bonds. 

Here are some of the provisions in the airline guaranteed bond that could cause Sri Lanka’s restructuring advisors a giant headache.

How to Destroy the Collective Action Clause

Mark Weidemaier & Mitu Gulati

We almost hate to post this, because it is so simple, and so fundamental, that it seems almost surely wrong. But if it’s wrong, we can’t see why. Maybe a reader can explain? Here goes.

For at least 20 years, reform efforts in sovereign debt markets have promoted collective action clauses (CACs) (here and here). The current version of the clause was drafted by a super-committee of senior lawyers, investors, and finance ministers – many of them people for whom we have enormous respect. It lets the sovereign bond issuer hold a restructuring vote across multiple series of bonds in a so-called aggregated vote. Before, most CACs in the market required a vote for each series of bonds. The point of the reform was to make it impossible for litigious holdouts to exclude one or more individual series of bonds from a restructuring that had garnered the support of a creditor supermajority. But—and here’s the important point—outside of the euro area, these aggregated CACs are reserved for bonds issued under foreign law. They don’t have to be. But contract reform to solve the holdout problem hasn’t seemed important for bonds governed by local law, which the sovereign can already restructure just by changing its law.

Most sovereigns issue most debt under local law. So, here’s the CAC destroying idea:

Phase 1, the sovereign restructures its local law debt (either by passing legislation or by asking bondholders to tender). The restructured bonds might or might not include new financial terms. What they definitely will now include is a modification provision substantially similar to the one that appears in its foreign law debt. However, the restructured bonds are still governed by local law.

Phase 2, the sovereign proposes a restructuring of the entire debt stock, aggregating the vote of local and foreign law bonds together.

Ukraine versus Russia, English Supreme Court

Bailiffs for Gunboats is the title I have given to a short paper to be published in a Festschrift for the famous German scholar, Christoph Paulus, lately head of the law faculty at Humboldt, Berlin. It discusses a case remarkably overlooked despite its unusual facts, its major legal and political implications, and its role as a prelude to the horrors of the current war in Ukraine.

The case of Ukraine v. Russia (“Ukraine-Russia”), pending decision in the Supreme Court of England for more than three years, lies at the intersection of traditional public international law and private international law. It presents the question of court enforcement of a debt that is intertwined with sovereign political relationships. More broadly, it reflects the great power that private enforcement of a commercial instrument may nowadays give to a creditor that has goals beyond repayment. In the special context of a sovereign creditor of a sovereign debtor, the case reveals the potential role of privately enforceable debt in achieving the creditor’s political ends.

The decline and fall of commercial law

A listserv post this morning accentuated a troubling trend at the intersection of commercial law and bankruptcy practice: a marked decline in confident expertise in the former.

The scenario is simple and, I suspect, common: perfected security interest in collateral (say, a car), collateral destroyed (either before or after bankruptcy filing), insurance company sends check to bankruptcy trustee rather than to the debtor or secured creditor. Trustee then claims the insurance check is not subject to the security interest, which understandably takes the secured creditor's lawyer quite by unpleasant surprise. Is this check not obviously "substitute collateral" for the destroyed original collateral (the car), s/he asks?

Well, yes, but ... neither the trustee nor a judge is likely to accept the creditor's lawyer's correct answer without some compelling analysis as to why; that is, citation to governing law (i.e., statutory authority). The challenge, which I emphasize to my Secured Transactions students every year, is that the security agreement is unlikely to resolve this. Only a lawyer who is very familiar with secured transactions law could possibly know how this answer gets worked out (regardless of what the security agreement says or does not say about insurance "proceeds"). Analysis below the fold (you know you can't resist!) ...