There's Still Time to Register for NCBJ 2019

The National Conference of Bankruptcy Judges' annual conference is happening soon – Wednesday, October 30 through Saturday, November 2. I'm delighted to be part of this year's education committee. The 2019 conference features some panels that include Slipsters and touch on Slipsters' research. (If you're thinking of attending, "semi early bird" registration, with its lower costs, ends at the end of September.)

Particularly noteworthy is the American Bankruptcy Law Journal symposium, "Equitable Powers of the Bankruptcy Court 40 Years After the Enactment of the Bankruptcy Code," which will be framed as a mock-Senate Judiciary Committee hearing during which a panel of experts will discuss and debate bankruptcy courts' equitable powers. The symposium features Slipsters Jay Westbrook and Melissa Jacoby.

Also worthy of mention are two panels that deal with consumer bankruptcy hot topics, both of which happen to touch on issues that recent papers analyzing Consumer Bankruptcy Project data have considered in depth. First is a panel titled, "Porsches and Clunkers – A Road Trip Through Car Issues." The description for the panel asserts, "many consumers file chapter 13 petition to save their cars, which are essential to maintaining their jobs." In our latest article, Driven to Bankruptcy, Slipster Bob Lawless, past Slipster Debb Thorne, and I rely on Consumer Bankruptcy Project data to assess the veracity of that assertion (among other questions related to cars, car loans, and bankruptcy). As detailed in my recent post about that article, we find a subset of bankruptcy cases that may be labeled "car bankruptcies," in which the debtor owns a car (or cars) and little else. In these cases particularly, debtors may find themselves in chapter 13 to save their cars.

Amicus Brief on Valid-When-Made

I have filed an amicus brief regarding "valid-when-made" in Rent-Rite Super Kegs West, Ltd. v. World Business Lenders, LLC. The brief shows pretty conclusively that there was no such doctrine discernible in the law when either the National Bank Act of 1864 or the Depository Institutions Deregulation and Monetary Control Act of 1980 were enacted, and that subsequent cases consistent with the doctrine are based on a misreading of older law. 

The Sky Is Falling: Securitization, Chicken Little Edition

It's been quite a week for "valid-when-made (up)".  Not only did FDIC and OCC race to court to defend the doctrine in the context of a 120.86% small business loan, but there's a Bloomberg story out about a set of class action usury law suits (here and here) against the credit card securitization trusts used by Capital One and Chase. The story suggests that these suits threaten the $563 billion asset-securitization market and also the $11 trillion mortgage securitization market. That claim is so readily disprovable, it's laughable. 

Here's the background. New York has a 16% usury cap under Gen. Oblig. Law 5-501. The National Bank Act § 85 provides that that cap does not apply to national banks that are based in other states (such as Delaware), but the National Bank Act only covers banks. The securitization trusts are not banks, but are common law or Delaware statutory trusts. The class action suits argue that under the 2d Circuit's Madden v. Midland Funding, LLC precedent, it is clear that New York usury law applies to the trusts; they cannot shelter in National Bank Act preemption because they are not national banks. 

Obviously, the banks see it the other way, and have invoked valid-when-made as part of their defense. They're wrong, but what irks me is that financial services industry lawyers and trade associations are claiming that if these class action suits succeed the sky will fall for securitization and that the Bloomberg article didn't really question this claim: Bloomberg's headline is that the entire $563 billion ABS securitization market is at risk, and bank attorneys suggest in the article that the $11 trillion mortgage securitization market is at risk too. 

Let's be clear. This is utter nonsense on a Chicken Little scale. These class action law suits affect only part of the $123 billion credit card securitization and the very small $30 billion unsecured consumer loan securitization markets. Even then they do not threaten to kill off these markets, but merely limit what loans can be securitized to those that comply with the applicable state's usury laws. They do not affect mortgage securitization at all and are unlikely to have much, if any impact on auto loan securitization or student loan securitization. To suggest, as the Bloomberg article does, that these class action suits affect the securitization markets for cellphone receivables or time shares (where is there a usury claim even possible in those markets?) is embarrassingly ridiculous. The sky isn't falling, Turkey Lurkey. Full stop. 

FDIC and OCC Race to Court to Defend 120.86% Interest Rate Small Business Loan

FDIC and OCC filed an amicus brief in the district court in an obscure small business bankruptcy case to which a bank was not even a party in order to defend the validity of a 120.86% loan that was made by a tiny community bank in Wisconsin (with its own history of consumer protection compliance issues) and then transferred to a predatory small business lending outfit. Stay classy federal bank regulators. 

[Update: based on additional information--not in the record unfortunately--this is clearly a rent-a-bank case, with the loan purchaser having been involved in the loan from the get-go.]

FDIC and OCC filed the amicus to defend the valid-when-made doctrine that the bankruptcy court invoked in its opinion. FDIC and OCC claim it is "well-settled" law, but if so, what the heck are they doing filing an amicus in the district court in this case? They doth protest too much.

What really seems to be going on is that FDIC/OCC would like to get a circuit split with the Second Circuit's opinion in Madden v. Midland Funding in order to get the Supreme Court to grant certiorari on the valid-when-made question in order to reverse Madden. The lesson that should be learned here is that while Congress seriously chastised OCC for its aggressive preemption campaign by amending the preemption standards in the 2010 Dodd-Frank Act, that hasn't been enough, and going forward additional legislative changes to the National Bank Act are necessary. Indeed, the FDIC and OCC action underscores why FDIC and OCC cannot be trusted with a consumer protection mission, even for small banks (currently they enforce consumer protection laws for banks with less than $10 billion in assets). The FDIC and OCC are simply too conflicted with their interest in protecting bank solvency and profitability, even if it comes at the expense of consumer protection. Moving rulemaking and large bank enforcement to CFPB was an important improvement, but what we are seeing here is evidence that it simply wasn't enough. 

More on the background to the story from Ballard Spahr. Needless to say, I completely disagree with the historical claim by FDIC/OCC (and echoed by Ballard Spahr) about "valid-when-made". Valid-when-made-up is more like it.  

Purdue and the Sacklers and the Limits of Fraudulent Transfer Law

One of the major issues in the Purdue Pharma bankruptcy is how much the Sackler family, which (indirectly) controls Purdue will contribute in order to get releases from opioid liability. (Relatedly, are such non-debtor releases allowed outside of the asbestos context, where they are specifically authorized by statute? Second Circuit law says "sometimes.") 

The question I have is why the Sacklers would contribute anything? Do the Sacklers themselves really have any opioid liability?  As far as I'm aware, the only suits filed so far against the Sacklers or their non-Purdue entities are for fraudulent transfers or unjust enrichment.  

The former claim allege that the Sacklers received assets that were transferred from Purdue with actual intent to hinder, delay, or defraud creditors. It is not a "fraud" claim involving a misrepresentation, but a claim based on intentional evasion of creditors. It's sometimes also called fraudulent conveyance or voidable transfer.  (There are also constructive fraudulent transfer allegations, but that's just a bunch of valuation questions.) The later claim is really a Hail Mary sort of claim, but the fraudulent transfer suits have some legs, and given that they are alleging actual fraudulent transfers, the crime/fraud exception to attorney-client privilege shouldn't apply under the Supreme Court's recent Husky Electronics ruling. (Also some states have criminal fraudulent transfer statutes, although none of have used them vis-à-vis the Sacklers...the statutes are pretty weak.  Maybe there's an argument for a federal bankruptcy criminal under 18 USC 152(7) as well, but a lot more facts would need to be known.) Without attorney-client privilege, the actual fraudulent transfer case gets a lot easier. But what it does mean practically?  

It means that the Sacklers will probably keep some, but not all of the funds they received from Purdue during the statute of limitations period (and everything they got outside of the limitations period). The situation underscores two problems with  fraudulent transfer statutes and the need for legislative fixes.

A Drafting Error in Small Business Reorganization Act?

Is there a drafting error in the Small Business Reorganization Act? The other day I posted my estimate that 42% of chapter 11's would qualify, but my sharp-eyed colleague, Ralph Brubaker, noticed something wonky (in all senses of the word) in the new definition of a "small business debtor." (He also tells me that the next issue of the always-excellent Bankruptcy Law Letter will provide an in-depth look at the new law.)

Specifically, the problem is in the exclusionary clause. After defining a small-business debtor as a debtor with less than $2,725,625 in debts, at least 50% of which arose from business activities, the definition then excludes (among other things):

(ii) any debtor that is a corporation subject to the reporting requirements under section 13 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m, 78o(d)); or
(iii) any corporation that—

(I) is subject to the reporting requirements under section 13 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m, 78o(d)); and
(II) is an affiliate of a debtor.

Clause (iii)(I) excludes the same thing as subparagraph (ii) with only slightly different words. Obviously, an extra condition in clause (iii)(II) does not make paragraph (iii) exclude anything that clause (ii) does not already exclude.

Read literally, the definition would allow a small subsidiary of a public-traded company to take advantage of the new small-business debtor rules. The ABI Commission to Study the Reform of Chapter 11 recommended they be excluded. My guess is that the drafters of the new law intended to exclude them, but the language used did not quite get the job done. Is there a reason for this language that I have missed? If not, it would seem to be a prime candidate for a technical correction fix.

Driven to Bankruptcy — New Research from the Consumer Bankruptcy Project

In America, people drive — to work, to the doctor, to the grocery store, to their kids' daycare, to see their aging parents. Research shows that car ownership increases the probability of employment and number of hours worked; households without cars have lower incomes and are more likely to be in poverty. In short, cars are essential. Household financial distress can threaten people's cars, and with them, the day-to-day stability that car ownership brings. People thus may file bankruptcy, in part, to save their cars.

Although there is a substantial literature on financial distress and home ownership, the literature on car ownership, financial distress, and bankruptcy is thin. In Driven to Bankruptcy (available via SSRN, forthcoming in the Wake Forest Law Review), Slipster Bob Lawless, past Slipster Debb Thorne, and I document what happens to car owners and their car loans when they enter bankruptcy.

In brief, we find that people who file bankruptcy own automobiles at the same rate as the general population. This means that over the last ten years, 15.1 million people filed for bankruptcy owning 16.4 million cars. The majority of these cars, particularly a household's most valuable car, entered bankruptcy encumbered with a hefty loan. And most debtors want to keep their cars, particularly their most valuable and second most valuable cars.

How Many New Small Business Chapter 11s?

The Small Business Reorganization Act of 2019 adds a new subchapter V to chapter 11 for small businesses. The new subchapter gives small businesses the option of choosing a more streamlined -- and hence cheaper and quicker -- procedure than they would find in a regular chapter 11. Perhaps most significantly, the absolute priority rule, which requires creditors to be paid in full before owners retain their interests, does not apply. For those interested in more detail, the Bradley law firm has a good blog post summarizing the key points of the new law, which takes effect in February 2020 (and if I have the math correct -- February 19 to be exact).

A point of discussion has been how many cases will qualify to be a small-business chapter 11. Using the Federal Judicial Center's Integrated Bankruptcy Petition Database, my calculation is that around 42% of cases filed since October 1, 2007, would have qualified. The rest of this post will explain how I came to that estimate as well as discuss year-to-year variations and chapter 11 filings by individuals.

Two New Podcasts: Succession/Slate Money and The Business Scholarship Podcast

I loved the first season of HBO’s Succession.  Superb acting, great sets, and a story about a totally dysfunctional family (that makes me think that my own dysfunctional one is relatively functional).  Plus, the really really rich and despicable people in the show (modeled on actual really really rich people – see here) are miserable – and I can’t help but be entertained by that. All of that said, I did not realize, until I heard the wonderful and brilliant combination of Felix Salmon, Emily Peck and Anna Szymanski discuss the show on their Slate Money podcast a few weeks ago, how much of the show connected to interesting corporate law questions. Long story short, for those of you who love Succession and teach business law stuff, I think you will enjoy the combination of watching the show and listening to the special Slate Money podcasts about the show (this is just a season 2 thing).  Actually, you don’t need to give a rat’s ass about corporate law to enjoy the combination of watching Succession in the late evening and listening to Slate Money the next morning.  In fact, there have been occasions where I’ve enjoyed the podcast more than the particular episode of Succession.

And, while on the subject of podcasts, I recently came across an excellent podcast that discusses new financial law papers. It is run by Andrew Jennings at Stanford Law (here). Andrew is unfailingly polite, but he clearly has thought about the papers in question and asks tough questions.  I’ve only listened to a couple of episodes so far, but I plan to try and listen to them all.  I especially liked the podcast about Cathy Hwang’s 2019 paper on “Faux Contracts” and the roles that contracts can play even when there is no enforcement possibility (podcast is here; paper is here). I’m especially intrigued by Cathy’s concept of intra-deal reputation that constrains parties from acting opportunistically – something that she documents with detailed interviews. This intra-deal effect (it isn’t quite reputation; but something in the vein of reciprocal fairness) seems to operate on parties in individual deals even though the parties are not trying to preserve any sort of longer-term repeat-player reputation. Clearly a paper, I need to read.

Enough With the Old Chinese Debt Already

Mark Weidemaier and Mitu Gulati

We may be partly to blame for the fact that stories keep surfacing about whether the U.S. government might help holders of pre-revolutionary, defaulted Chinese debt monetize their claims. Here’s Tracy Alloway of Bloomberg, with a good assessment of the political and legal basis for this kind of intervention. The bonds have been in default since the 1930s. China won’t pay these pre-PRC debts. Taiwan sends its regrets. But a vocal contingent of American bondholders is lobbying for the U.S. government to intervene. The precise manner of intervention is not clearly defined, but the basic idea is that the bondholders could assign their rights to the U.S. government, which could then use the bonds to offset U.S. debts to China. As Alloway quotes the President of the American Bondholders Foundation (a bondholder group): “What’s wrong with paying China with their own paper?”

Look, we’re torn here. Expressed like that, the idea is bonkers. No, it’s worse. If you’ll forgive an obscure theater reference: compared to a bonkers idea, this idea is lying “in the gutter looking up in wide-eyed admiration.” Sure, the US government could try to “pay” China with defaulted Chinese bonds. It could also try to pay with toilet paper or chewing gum.* We have to assume this would be a credit event triggering CDS contracts issued on the U.S. And to be fair, from a certain armchair perspective, that would be…entertaining?

Small Borrowers Continue to Struggle Without Relief

Several recent stories remind us that many, many ordinary people around the world continue to struggle with crushing debt with no access to legal relief, and when relief is introduced, it is vehemently opposed by lenders and often limited to the most destitute of debtors.  These stories also reveal the dark underside of the much-heralded micro-finance industry.

In Cambodia, micro-finance debt has driven millions of borrowers to the the brink of family disaster, as micro-lenders have commonly taken homes and land as collateral for loans averaging only US$3370. When many of these loans inevitably tip into default, borrowers face deprivation of family land, at best, and homelessness at worst. Actually, in the absence of a personal bankruptcy law (which Cambodia still lacks), things can get much worse. If a firesale of the collateral leaves a deficiency, borrowers might be coerced into selling their children's labor or even migrating away to try to escape lender pursuit. In the past decade, the MFI loan portfolio in Cambodia has grown from US$300 million to US$8 billion, about one-third of the entire Cambodian GDP! People around the world have turned to micro-finance to sustain their lifestyles (or just to survive) in an era of increasing government austerity, with disastrous results for many borrowers.

In India, the government continues to delay the introduction of effective personal insolvency relief, and it seems concerned with the interests of only the lending sector in formulating a path to relief for "small distressed borrowers." In a story that fills only half a page, consideration of individual or national economic concerns is not mentioned, but it is noted four times that discussion/negotiation with the "microfinance industry" has occurred, whose satisfaction seems paramount to law reformers. Among the "safeguards" put in place to prevent "abuse" of this new relief are (1) the debtor's gross annual income must not exceed about US$450 ($70 per month), (2) the debtor's total debt must not exceed about US$500, and (3) the debtor's total assets must not exceed US$280. While this may well encompass many poor Indian borrowers in serious distress, it offers no relief to what are doubtless many, many "middle-class" Indians similarly pressed to the brink and straining to cope in a volatile economy.

In South Africa, a decades-long fight to implement effective discharge relief for individual debtors has culminated in a half-hearted revision of the National Credit Act (Bloomberg subscription likely required). The long-awaited revision still promises relief only to a small subset of severely distressed borrowers. The bill offers debt discharge only to "critically indebted" debtors with monthly income below US$500 and unsecured debts below US$3400. A step to be applauded, this still leaves many, many South Africans to contend with a complex web of insolvency-related laws that offers little or no relief to many if not most debtors. And still, banks engaged in the typical gnashing of teeth and shedding of crocodile tears, terribly worried that this new dispensation will "drive up the cost of loans for low-income earners, restrict lending and encourage bad behavior from borrowers." Where have we heard this before? To their credit, South African policymakers apparently "made no attempt to interact with the [lending] industry," though the compromise solution here still leaves much to be desired.

On a brighter note, the country of Georgia is on the verge of adopting major reforms to its laws on enforcement and business insolvency (story available only in the really neat Georgian language, check it out!). In an address to parliamentary committees, the Minister of Justice remarked that a new system of personal insolvency is also in development. Georgia suffers from many of the same problems of micro-finance as Cambodia, so perhaps Cambodia and other similarly situated countries will be able to learn from Georgia's example. We'll see what they come up with.

The Weinstein Company Bankruptcy: What She Said

Nearly a year has passed since my last Credit Slips post on The Weinstein Company bankruptcy. The case, filed March 2018, remains open. Contract disputes have dominated many if not most bankruptcy court hearings this past year. The issues have been interesting, the amounts at stake substantial, and, in litigated disputes, the buyer of TWC's assets typically has prevailed (some appeals are pending). Other contract disputes have settled, but often with key terms redacted, further complicating efforts to evaluate this bankruptcy on even the most accepted of metrics. In May 2019, parties informed the court they were still negotiating a deal with misconduct survivors, although TWC acknowledged that it had not conducted an investigation that would enable its board to sign off on any such deal, and its existing legal team was neither equipped nor priced to handle that work. That this acknowledgement should be astonishing is the subject for another day. In any event, updates on negotiations have yet to materialize in the form of a court hearing or status conference. In the past few months, the TWC docket has grown mainly with the reliable beat of monthly professional fee applications.

Tomorrow, Sept. 10, 2019, is the official release date of She Said, by Jodi Kantor and Megan Twohey, on their investigation of Harvey Weinstein leading up to their October 2017 reporting. I doubt She Said will contain new information about TWC's bankruptcy per se. In all likelihood, though, She Said will drive home just how much Harvey Weinstein's alleged predatory acts were intertwined with the operation and management of TWC. 

Trump, Denmark and Greenland: What Next?

(This post draws directly from ideas from co authored work with Joseph Blocher; and particularly the numerous discussions we have had about the incentives that a market for sovereign control might create for nations to take better care of their minority populations in outlying areas (e.g., the US and Puerto Rico).  Mistakes in the discussion below, however, are solely mine).

It seems like forever ago, but it has only been a few weeks since the news came out that our esteemed chief executive wanted the US to purchase Greenland.  The notion was widely ridiculed in the press and provided wonderful fodder for comics around the globe.  But as people looked beneath the surface, it quickly became apparent that there was nothing in international law that prohibited the purchase and sale of sovereign control over a territory.  Where Trump was wrong was in his assumption that he needed to purchase Greenland from the Danes.  Under post World War II international law, however, a former colony such as Greenland has the right of self determination.  To quote the Danish prime minister, responding to Trump, “Greenland is not Danish. Greenland belongs to Greenland.”

The Danish PM also said “I strongly hope that this is not meant seriously.”  And, from her perspective of apparently wanting to keep the status quo of Greenland being part of Denmark, it makes sense that that’s what she hopes.  But let us focus on the words “Greenland is not Danish. Greenland belongs to Greenland.” If one thinks about those words just a little, they mean that Trump’s purchase (and maybe he should start calling this a “merger”, since that seems more polite) is perhaps a lot easier to execute than he initially thought.

Trump and any other suitors that Greenland might have (Canada, China, Iceland, Russia, etc.) need to only focus their attention on making the Greenlanders happy; they don’t need to worry about the Danes. No need for Trump to do diplomatic trips to Copenhagen. Trips should be to Nuuk instead. After all, it is the approval of the 55,000 Greenlanders that he needs.

How many Greenlander votes, specifically? (assuming that there would need to be a referendum first). International law doesn’t clearly say; but surely more than a majority – and ideally with a voting mechanism designed in such a way that the rights of the minority that might not want to be part of the merger being appropriately protected.

The point is that if DJT and his supporters remain committed to the Greenland strategy – and it appears they do (see here) – the next step is will be to persuade the people of Greenland that this merger is in their interest. That way, the next time Trump offers a merger deal to the roughly 55,000 Greenlanders, they will react with enthusiasm rather than horror.  One would expect, therefore, to see the US taking steps to mount the charm offensive in Greenland. And, as it turns out, preliminary steps in this direction have already been announced with the US planning to open a consulate in Greenland and engage in various outreach programs as part of its broader arctic charm strategy (here).

Anderson and Nyarko's Cool New Papers on Contract Evolution

Two of the contracts papers I’ve been most looking forward to this fall have just been posted on ssrn. They are are Rob Anderson’s “An Evolutionary Perspective on Contracting: Evidence From Poison Pills” (here) and Julian Nyarko’s “Stickiness and Incomplete Contracts” (here).

Both papers aim at deepening our understanding of how contracts evolve and, in particular, why they evolve in ways so very different from the standard model used in law schools where parties are assumed to negotiate for an optimal set of terms for their relationships.

One would predict a very different set of contract terms for parties if one takes the contract production process seriously and thinks of contract provisions as products (ala Barak Richman, here) or product attributes (ala Doug Baird, here).  Specifically, Rob and Julian both use models of contract production where new contracts are constructed by building on pre-existing templates.

In this world, one should expect a high degree of path dependence in the data.  And that is precisely what Rob and Julian demonstrate, looking at two very different areas of commercial contracting – poison pill and choice-of-forum provisions. The implications of their papers, both of which are studying the most sophisticated and well-heeled of all contracting parties, for the one of the core exercises in contract law – how should judges interpret contracts – are considerable.  That said – and this is not meant to take away from the two papers at all -- these papers are more about empirically documenting and understanding the phenomena than normative questions of what judges should be doing.

There is an enormous amount of new material in both papers and I will not do more than scratch the surface in terms of their respective contributions.  Here, however, are a couple of things about each of the papers that stood out to me.

Do Judges Do Contract Interpretation Differently During Crisis Times?

Scholars of constitutional law and judicial behavior have long conjectured that judges behave differently during times of crisis. In particular, the frequently made claim is that judges “rally around the flag”.  The classic example is that of judges being less willing to recognize civil rights during times of war (for discussions of this literature, see here, from Oren Gross and Fionnuala Aolain; and here, for an empirical analysis of the topic from Lee Epstein and co authors).

But what about financial crises?  Are judges affected enough by big financial crises to change their behavior and, for example, rule more leniently for debtors who unexpectedly find themselves being foreclosed on? In a paper from a few years ago, Georg Vanberg and I hypothesized that a concern with needing to help save the US economy from the depression of the 1930s may have been part of the dynamic explaining the Supreme Court’s puzzling decision in the Gold Clause cases (here).

A fascinating new paper from my colleague, Emily Strauss (here), analyzes this question in the context of the 2007-08 financial crisis.  Emily finds that lower courts judges, in a series of mortgage portfolio contracts cases during the crisis and in the half dozen years after, made decisions squarely at odds with the explicit language of the contracts in question.  From a pragmatic perspective, it is arguable that they had to; the contracts were basically unworkable otherwise.  But, as mentioned, this conflicted with the explicit language of the contracts. And judges, especially in New York, like to follow the strict language of the contracts (or so they say).   Then, and I think this is the most interesting bit of the story, Emily finds that, starting in roughly 2015 (and after the crisis looked to have passed), the judges change their tune and go back to their strict reading of the contract language.

Here is Emily’s abstract that explains what happened better than I can:

Why might judges interpret a boilerplate contractual clause to reach a result clearly at odds with its plain language? Though courts don’t acknowledge it, one reason might be economic crisis. Boilerplate provisions are pervasive, and enforcing some clauses as written might cause additional upheaval during a panic. Under such circumstances, particularly where other government interventions to shore up the market are exhausted, one can make a compelling argument that courts should interpret an agreement to help stabilize a situation threatening to spin out of control.  

This Article argues that courts have in fact done this by engaging in “crisis construction.” Crisis construction refers to the act of interpreting contractual language in light of concurrent economic turmoil. In the aftermath of the financial crisis, trustees holding residential mortgage backed securities sued securities sponsors en masse on contracts warranting the quality of the mortgages sold to the trusts. These contracts almost universally contained provisions requiring sponsors to repurchase individual noncompliant loans on an individual basis. Nevertheless, court after court permitted trustees to prove their cases by sampling rather than forcing them to proceed on a loan by loan basis.

Ditech, Reverse Mortgages, Consumer Concerns, and Section 363(o)

A couple days ago, Judge Garrity Jr. of the Bankruptcy Court for the Southern District of New York issued a 132 page opinion denying confirmation of Ditech's proposed plan. Ditech, of course, is an originator and servicer of mortgages, including reverse mortgages. Its plan contemplated sales of both its forward and reverse mortgage businesses--free and clear of customers' claims and defenses. As reported at various times since Ditech filed in February 2019, homeowners have claims that Ditech did not credit mortgage payments properly, levied improper fees, failed to recognize tax payment plans, and wrongly foreclosed on homes.

Beyond its sheer length, the opinion is noteworthy for a couple reasons. First, the sales of mortgage businesses in the context of a plan raised the question of whether § 363(o) applied. Section 363(o) deals with consumer credit transactions subject to the Truth in Lending Act and provides that if any "interest" in such a transaction is purchased through a sale, then the buyer must take all the claims and defenses related to the consumer credit transaction. Ditech, of course, wanted to sell free and clear of those claims, through the plan. In holding that § 363(o) does not apply in the plan context, Judge Garrity Jr. provides a detailed analysis of the section's legislative history. This history includes removal of language about application to reorganization plans by an amendment proposed by Senator Phil Gramm (which was approved), and Senator Gramm's continued opposition to the addition of § 363(o) in its entirety because he claimed it would, among other things, encourage people to make up grievances against mortgage originators and servicers. (As many readers likely know, Senator Gramm spearheaded the Gramm-Leach-Bliley Act.)

My Favorite Contract Metaphors: Skeuomorphs, Sea Squirts, Barnacles and Black Holes

I love contract metaphors. I’m especially fond of metaphors for the phenomenon of antiquated and useless contract provisions that find a way to persist over the decades in boilerplate contracts.  Philip Wood, the legendary English lawyer, uses the metaphor of barnacles on a ship’s hull to describe how more and more of these useless provisions can accumulate over the years, eventually severely impacting the efficiency of the ship. If you like boats and hate barnacles (perhaps because one of your most hated chores in the summers was for you to attempt to scrape barnacles off the hull of your uncle’s fishing boat), this metaphor may work especially well for you (sorry, Uncle Marvin). Another favorite of mine, that does not bring up memories of unpleasant chores, is Doug Baird’s skeuomorph.  To quote Douglas, who in the course of his explaining why we should not be surprised that suboptimal contract terms both emerge and then persist, has some wonderful examples:

To take a[n] . . .  example, maple syrup is often sold in a glass bottle with a small handle that serves no discernable utilitarian purpose. This is a relic of the time when maple syrup came in jugs and the handles were large enough to be useful. This phenomenon—of a product feature persisting when incorporated in a new environment in which it no longer serves a function—is well known and has a name: skeuomorph.

Douglas goes on to explain that these skeuomorphs can bizarrely become desired features of the product in question (and remember he is drawing an analogy to contract drafting). He writes, while continuing with the maple syrup bottle example:

Buyers of maple syrup want to see a small handle on the bottle. It serves no purpose, but it is what consumers have come to expect. Blue jeans are no longer made for working men who carry pocket watches, but buyers of blue jeans want a watch pocket all the same, even though they have no idea of the purpose it serves and have no use for it. Everyone expects Worcestershire Sauce bottles to come wrapped in paper even though the reason for doing this has long disappeared. Tagines took a particular shape for functional reasons when they were made of clay, and they retained this shape when made of aluminum even though there was no longer a functional reason for doing so. Skeuomorphs can be found everywhere on the “desktops” of personal computers

In short, the idea that a clause could be added to a contract and remain there merely because everyone expected it to be there suggests nothing special about either pari passu clauses in particular or contract terms more generally. The same forces are at work as with ordinary product attributes. Crafting legal prose is hard, and few contracts are ever written from scratch. Lawyers almost always start with a template taken from someplace else. For this reason, those who draft contracts are likely to import features from earlier contracting environments, even when they serve no purpose, merely because they are familiar. To give another example involving financial instruments, the first railway bonds were based on real estate mortgages. They still bear some of the attributes of real estate mortgages, and not always for the better.

If you like this topic, I recommend Douglas’ piece “Pari Passu Clauses and the Skeuomorph Problem in Contract Law” (you should of course ignore all the bits of this brilliant piece that are critical of my paper with Bob Scott and Steve Choi on Contractual Black Holes (yes, another metaphor I’m very fond of) that Douglas’ piece was a comment on).

Last but not least is the Sea Squirt, a close cousin of the barnacle.  This one comes from M&A guru, Glenn West who was speaking on a panel at UT in 2018 on M&A Contracting.  The title of his presentation was: “Have Sea Squirts Invaded Your Contract?—Avoiding Mindless Use of So Called ‘Market’ Terms You May or May Not Understand”.  Below I’ve excerpted some priceless language from an August 2017 blog post by Glenn on MAC clauses in M&A agreements.  And yes, Glenn is talking about M&A contracts containing brainless bits of language; the contracts drafted by the most elite among all transactional lawyers.

As an aside, there are a number of excellent recent papers arguing over how brainless M&A contracts are; see here (Anderson & Manns) and here (Coates, Palia & Wu).

From Glenn’s blog post, here goes:

The sea squirt is an animal that begins life with a brain and a tail.  Immediately after it is born, it uses its brain and tail to propel itself through the water until it finds some rockto attach itself.  Once it attaches itself to that rock it consumes its brain, absorbs its tail, and thereafter never moves again; it lives out its remaining life as a brainless water filter.

Many of the standard terms of M&A agreements also began their existence with a brain—the brain of a smart lawyer who perceived an issue that needed to be addressed and drafted a clause to address it.  And then other smart lawyers recognized the value of that newly drafted clause, and adapted and improved it until it became a standard part of most M&A agreements.  But once that clause became attached to the “market” it became divorced from the brain or brains that created it, and soon everyone was using it regardless of whether they truly understood all the reasons that prompted its drafting.  Even worse, market attachment is so strong that even after a standard clause has been repeatedly interpreted by courts to have a meaning that differs from the meaning ascribed to that clause by those who purport to know but do not actual know its meaning (mindlessly using the now brainless clause), it continues to be used without modification.  Such is the case for many with the ubiquitous Material Adverse Change (“MAC”) or Material Adverse Effect (“MAE”) clause.

My friend at UNC Chapel Hill, John Coyle, has an article coming out soon on “Contract as Swag”.  I’m eager to see how that metaphor will work. I like swag and I want learn how to get more of it.

Private Equity's Abuse of Limited Liability

One of the central features of the Stop Wall Street Looting Act that was introduced by Senator Elizabeth Warren and a number of co-sponsors is a targeted rollback of limited liability.

This provision, more than any other, has gotten some commentators’ hackles up, even those who are willing to admit that there are real problems in the private equity industry and welcome some of the other reforms in the bill. (See also here and here, for example.)

The idea that limited liability is a sine qua non of the modern economy is practically Gospel to most business commentators.  These commentators assume that without limited liability, no one will ever assume risks, such that any curtailment of limited liability is a death sentence for the private equity industry.

They're wrong. Limited liability is a substantial, regressive cross-subsidy to capital at the expense of tort creditors, tax authorities, and small businesses. Limited liability is a relic of the underdeveloped financial markets of the Gilded Age and operates as an implicit form of leverage provided by law. But it’s hardly either economically efficient or necessary for modern business activity. It's a fairly recent development in the western world, there are numerous exceptions to it, and a number of notable firms have prospered without it (JPMorgan & Co., Lloyds of London, American Express, and many leading law law firms).

In any event the Stop Wall Street Looting Act rolls back limited liability solely for private equity general partners in a surgical manner such that doesn’t affect limited liability more broadly. All the Stop Wall Street Looting Act will do is reveal which private equity firms have real managerial expertise, and are thus able to thrive without limited liability, and those that don’t and require the legal subsidy to be profitable. Far from undermining the private equity industry, it is a restoration of a central tenet of honest American capitalism: reward should be commensurate with risk.