It makes a fine Halloween gift!

On sale now, my latest book:  American Business Bankruptcy, A Primer. Suitable for use as supplemental reading in all sorts of bankruptcy classes, and even some corporate finance classes that cover financial distress (especially those using a certain textbook).

I also think it would be a good read for junior attorneys who (shockingly) neglected to take bankruptcy in law school. And don't forget the international attorneys who want a quick way to learn about American law. It also stabilizes wobbly tables and kills flies.

In short, it makes a great gift for everyone on your shopping list! Buy several copies today. And tomorrow too.

Aurelius v. Puerto Rican Control Board (or "Do Activist Hedgies Add Value?")

This post draws considerably from research on Puerto Rico and its current constitutional status with Joseph Blocher (see here).

Tuesday was oral argument day at the Supreme Court in the battle between the Puerto Rican Control Board and a big bad hedge fund, Aurelius.  Aurelius, zealous defender of the constitution that it is, had brought a challenge to the constitutionality of the Control Board. The claim being that the failure of President Obama and the then Congress to follow the strictures of the Constitution for the appointment of principal officers of the federal government (nomination by the President, followed by Senate confirmation) made the Board and all its actions invalid.

I am not a constitutional scholar and don’t have any desire to be one.  Still, the basic issue here seems fairly simple:  Are the members of the Control Board principal federal officers?

Congratulations to Pamela Foohey!

Congratulations to Pamela Foohey on being named to the American Bankruptcy Institute's 40 Under 40 list for 2019!  Pamela joins Credit Slips own Dalié Jiménez (class of 2018) as an honoree. 

And it's been a great news day for our former co-blogger Katie Porter, who was not only the subject of an American Banker article, but was put on a SCOTUS short list. 

A Mini Q&A on Venezuela’s Possible Defense to Foreclosure on the PDVSA 2020

Mark Weidemaier & Mitu Gulati

Along with Ugo Panizza of the Graduate Institute in Geneva, we’ve put up a couple of posts in recent days asking whether Venezuela might have a legal basis for challenging its obligations on the PDVSA 2020 bond (here and here). A large payment of close to a billion dollars is due in a few weeks and there is no money to pay it.  Most important, the bond is collateralized by a pledge of a majority stake in CITGO Holding.

The possible basis for the legal defense is that the bonds, and especially the pledge of collateral, were not properly authorized under Article 150 of the Venezuelan constitution. (This matter has also received press attention over the past few days—e.g., here and here).

As background, provisions in the Venezuelan constitution (Art. 312) and related Venezuelan laws require the passage of a “special law” (our translation) to authorize public indebtedness, but exempt PDVSA from the requirement. However, a separate constitutional provision, Article 150, requires “approval” from the National Assembly for contracts of national interest. We don’t know of situations in which the provision has been invoked. With apologies for possible mistranslations here and elsewhere in this post, here is the text:

Article 150. The entering into of national public interest contracts will require the approval of the National Assembly in the cases determined by law. 

No municipal, state, or national public interest contract can be entered into with States or foreign official entities or with companies not domiciled in Venezuela, not being assigned to them without the approval of the National Assembly.

The law may require in public interest contracts certain conditions of nationality, domicile or any other kind, or require special guarantees

For a Caracas Chronicles piece on this, see here.

We have gotten numerous questions in response to our two pieces, one at Project Syndicate and one here. There were many excellent questions. And since we find this topic fascinating (we are working on an empirical paper on governing law provisions in sovereign debt contracts), we decided to go down the rabbit hole of trying to answer them. 

The caveat here is that while we know a good bit about sovereign bond contracts, we have no expertise in Venezuelan constitutional law. Here goes:

Can Creditors Seize CITGO? Enforcing the PDVSA 2020 Bond Collateral

Mark Weidemaier & Mitu Gulati

Writing with Ugo Panizza, we have a piece out today on Project Syndicate (Should Creditors Pay the Price for Dubious Bonds?) discussing the collateralized bond issued by Venezuelan state oil company PDVSA (the PDVSA 2020 bond). We have written here previously about the bond as well. In 2016, when PDVSA was near default, it conducted a debt swap in which investors exchanged short-maturity bonds for the longer-maturity PDVSA 2020. To sweeten the deal, the PDVSA 2020 bond was backed by collateral in the form of a 50.1% interest in CITGO Holding, the immediate parent company of U.S. oil refiner CITGO Petroleum.

A payment of nearly $1 billion is coming due in the next few weeks on the PDVSA 2020 bond. The Maduro regime—no longer recognized as the legitimate government of Venezuela—can’t pay it. And the government-in-exile led by Juan Guaidó—though it desperately wants to retain control of CITGO—presumably can’t afford to pay. If there is a default, and bondholders seize the collateral, the loss of CITGO may significantly disrupt Venezuela’s ability to recover from its current economic and humanitarian catastrophe. To be sure, the prospects of recovery are dim while Mr. Maduro remains in power, but if he leaves, the loss of CITGO will be a major blow.

The Project Syndicate article describes how, under Venezuelan law, the National Assembly must approve contracts of national interest. That didn’t happen here. Venezuela might therefore challenge the issuance of the PDVSA 2020 bond, and the grant of collateral, as lacking proper authorization under Venezuelan law. Ugo and we examine the potential justification for such a challenge at Project Syndicate.

Here, we focus on a more wonky question: Is the validity of the PDVSA 2020 bond and the pledge of collateral to be judged under Venezuelan law or New York law? And would the outcome change depending on which law governs? The answers turn out to be more complicated than one might think. But, given the court battle that we expect, rather important.

The Puzzling Pricing of Venezuelan Sovereign Bonds

by Mark Weidemaier & Mitu Gulati

Venezuela’s sovereign bonds differ in ways that should, in theory, be reflected in market prices. For example, depending on the bond, the vote required to modify payment terms through the collective action clause (CACs) varies from 100% (requiring each holder to assent), to 85%, to 75%. Bonds with higher voting thresholds are harder to restructure and one would think prices would reflect this. Two bonds issued by state oil company PDVSA also have legal features that one might expect to have pricing implications. One bond benefits from a pledge of collateral (the PDVSA 2020) and, in consequence, should be priced higher than otherwise-comparable bonds. A second was issued at a particularly large original issue discount (OID); this is a potential legal defect that should lower its price. This is the so-called “Hunger bond” (PDVSA 2022 —see here, here and here for more)).

Although these differences seem like they should matter, reports from the European markets (where the bonds can still be traded) indicate that bid prices for Venezuelan sovereign bonds range from around 13.0 to 13.5 cents on the dollar, while ask prices range from about 14.5 to 15.5. Moreover, prices on the bonds with different voting thresholds are identical. That is, the bonds that cannot be restructured except with each creditor’s assent are trading the same as bonds that allow a creditor majority of 85% or 75% to force restructuring terms on dissenters. But why? Venezuela is in full-fledged default, when legal protections should matter the most.  Shouldn’t these non-US investors (US investors can’t buy, given OFAC sanctions) be offering higher prices for bonds with better terms?

Badawi & de Fontenay Paper on EBITDA Definitions

I confess that, on its face, this did not strike me as the most exciting topic to read about (and that comes from someone who writes about the incredibly obscure world of sovereign debt contracts).  After all, who even knows what EBITDA definitions are?  Sounds like something from the tax or bankruptcy code.  But don’t let the topic be off putting.  This is a wonderfully interesting project; and elegantly executed (here).  By the way, EBITDA stands for earnings before interest, taxes, depreciation blah blah. Turns out it is especially important for young companies, where potential investors want to know about the cash flow being generated (Matt Levine has been writing about it recently in the context of the WeWork debacle - here). It is also very important because it generally ties into the covenants in the debt instrument and can impact whether or not the covenants are violated.

Using machine learning techniques, Adam and Elisabeth look at the EBITDA definitions in thousands of supposedly boilerplate debt contracts.  And they find a huge amount of variation in this supposedly boilerplate term; variation that can end up making a big difference to the parties involved. (For those interested, there is a nice prior study by Mark Weidemaier in the on how supposedly boilerplate dispute resolution terms in sovereign bonds are often not really all that close (here); and John Coyle’s recent work on choice-of-law provisions in corporate bonds is also along these lines (here))

The question that naturally arises here is whether the variation in these EBITDA definitions is the product of conscious and smart lawyering or just random variation that arises as contracts are copied and pasted over generations. (for more on this, see here (Anderson & Manns) and here (Anderson)). My understanding of the results is that these definitions are definitely not the product of random variation; instead, there seems to be a lot of sneaky lawyering to inflate the supposedly standard EBITDA measure.

The Clock Is Ticking for the Sacklers

It's funny how what goes on in one bankruptcy case can sometimes point to looming issues in another. The PG&E plan exclusivity fight suggests an interesting dynamic looming in Purdue:  Purdue's own plan exclusivity could expire, which would completely upend the dynamic of negotiations with the Sackler family for a plan contribution in exchange for a non-consensual release of creditors' claims against them.  

As I see it, the Sacklers have no more than 18 months (and perhaps as few as 4 months) to cut their deal. If the Sacklers fail to reach a deal before plan exclusivity lapses, a state AG (or anyone else) could easily propose a plan that assigns all of the bankruptcy estate's litigation claims against the Sacklers to a trust for opioid victims or sells off the claims to a litigation vehicle.  The trust (or litigation vehicle) will then go and litigate against the Sacklers, and any recoveries will go to opioid victims. Critically, if this happens, the Sacklers will not be able to get a third-party release from Purdue's creditors.  They can still settle the fraudulent transfer claims of the bankruptcy estate, but they won't be shielded from creditors' direct claims.  

Now, I'm not sure how strong those direct claims really are, and thus how important a third-party release is for the Sacklers. They might decide that the asking price isn't worth paying. And the AGs might prefer to get half a loaf, rather than nothing; if so, they don't want plan exclusivity to lapse either--it's a great threat until it actually has to be played. Again we see the standard bankruptcy dynamic of one party threatening to push the other out the window, and the other party threatening to jump. Mutual defenestration.   

More generally, though, I wonder if Purdue will be able to get a pro forma extension of exclusivity given the enormous conflict of interest of its Sackler-controlled management. This seems like exactly the sort of case where plan exclusivity should not be extended because its main effect is to give the conflicted equity owners time to play for a lower settlement figure for their own liability.  In other words, plan exclusivity is benefitting the Sacklers personally, not necessarily the estate. That's akin to letting out-of-the-money equity sit around in bankruptcy and gamble on resurrection while burning up estate assets on administrative expenses. Yes, it's a mess of a case, but letting Purdue maintain plan exclusivity hardly seems like the right way to deal with that problem. A better outcome might require letting someone else be in the drivers' seat.

[Update: It seems that there actually is someone else in the drivers' seat already. Purdue's board of directors has been transformed over the past year. It now has a majority of independent directors and they seem to have some degree of insulation from the Sacklers, who continue to be the majority shareholders. There's not a lot of visibility on this because it is a private company, but the "informational brief" filed by Purdue explains some of this--the two branches of the Sackler family each appoint up to two Class A or Class B directors, but that there are also four other directors chosen by jointly by Sackler family members. Critically, there is a Special Committee of the board (comprised of a star-studded cast of restructuring professionals). The Special Committee has no Class A or Class B directors on it, and the Special Committee handles all matters relating to the Sacklers. It seems from a Shareholder Agreement (which I do not believe is public) that the Sacklers lack the ability to get rid of the Special Committee or do things like bylaw amendments, etc. to keep control.

That said, what I cannot tell from the public documents is what sort of board vote would be needed to proceed with a bankruptcy plan. Is it a simple majority? Unanimous? Is it even a vote of the full board, or just the Special Committee? The Informational Brief does not indicate whether matters encompassing more than to the Sacklers are solely the purview of the Special Committee. All of which is to say that from the public documents I have seen, I can't tell if the Sacklers have been totally pushed out of any management influence or if it is just that their influence has been substantially diminished. In any event, to the extent there's new management in charge, the case for terminating exclusivity is much weaker. Additionally, the case for a creditors' committee bringing fraudulent transfer actions derivatively looks a lot weaker.]

Speaking of which, why haven't we seen a motion to dismiss for cause filed at this point?  My guess is because it doesn't obviously help any one.  

Puerto Rico (A Quick Take, Part II)

Coen, Andrew. The Bond Buyer; New York, N.Y., 30 Sep 2019:

Assured Guaranty, which insures a large amount of Puerto Rico debt, came out against the plan.

“Assured Guaranty does not support this plan of adjustment as it is premised on a number of terms that violate Puerto Rico law, its constitution and PROMESA," said Assured spokesperson Ashweeta Durani.

Are we sure the first and second "violations" are relevant for these purposes?

Puerto Rico (A Quick Take)

So the debt restructuring plan is out. The New York Times indicates that the Oversight Board aimed to put the Commonwealth's debt at "less than" the average of the ten most indebted states. Not exactly a "fresh start" there, is it? Why not peg the debt to that of the average state?

Nonetheless, we can expect the bondholders to complain about even the relatively modest haircut they are slated to take, and they will surely note that the pensioners are taking less of a cut. Of course, the pensioners are in some sense funding the bondholder's recovery, since they are a key factor in keeping the Commonwealth's economy alive.

Normally we say that the liquidation baseline does not work in chapter 9 cases, because there is no real way to "liquidate" a municipality. But if the bondholders push too hard, they may test that assumption with regard to Puerto Rico. Lightly populated Caribbean islands do not support large debt loads, or even 63% recoveries to bondholders.

Matt Levine, Insider Trading and Mr. Potato Chip

Matt Levine is my favorite financial journalist to read on a regular basis because he is so darn funny (yes, there is lots of substance too, but I'm shallow and want to be entertained). Today's piece though, especially to someone who used to teach the law on insider trading, was priceless.

I want to cut and paste the entire piece here, because it made me smile and laugh out loud at the same time.  But I worry that Bloomberg might get annoyed and chase after me for stealing their content.  The link is here -- hope you find it as funny I did.

 

Student Loan Crisis Driving Racial Wealth Gap

Twenty years after taking out student loans, white borrowers have paid 94% of their debt (at the median.)  Black borrowers, on the other hand, have paid 5%. While a disturbing 20% of white borrowers defaulted on student loans at some point during twenty years, a catastrophic 50% of Black borrowers defaulted.

Inst. on Assets & Soc. Policy

 A new report from the Institute on Assets and Social Policy at Brandeis collates NCES and other data on student borrowers beginning college in 1995-96 to paint a grim picture of student debt burden as a key contributor to the racial wealth gap. As today's students take on far greater debt than the 1990s cohorts, this pernicious effect can only magnify. Cancelling student loan debt could play an important role in closing the gap. Debt cancellation should be judged not by the dollar amounts of debt forgiven for various borrowers, but by the degree of debt burden relieved for borrowers at various income and asset levels, as explained by progressive economist Marshall Steinbaum.

Small Biz Reorg Act Sleeper Innovations

Two aspects of the Small Business Reorganization Act of 2019 intrigued me as I looked more closely at this important new twist on Chapter 11 for the other 99%.

First, I thought the new SBRA procedure might be a fairly snooze-worthy Chapter 13 on protein supplements (i.e., not even steroids) because the current Chapter 13 debt limit (aggregate) is $1,677,125, while the new SBRA aggregate debt limit is less than double this, at $2,725,625 [note to the ABI: please update the figures in your online Code for the April 2019 indexation]. A couple of obvious and another non-obvious point cut in opposite directions here, it seems to me. First, Chapter 13 is not available to entities (e.g., LLCs), and for individuals, the Chapter 13 debt limits are broken out into secured and unsecured, while the SBRA figure is not. So the SBRA is significantly more hospitable to any small business debtor with only $500,000 in unsecured debt or, say, $1.5 million in secured debt. Flexibility is a virtue, so maybe the SBRA is just a meaningfully more flexible Chapter 13? No, as Bob's post reminded me. In the "conforming amendments" section at the end of the new law is hidden an important modification to the definition of "small business debtor" in section 101(51D), which will now require that "not less than 50 percent of [the debt] arose from the commercial or business activities of the debtor." So no using the SBRA provisions to deal more flexibly with an individual debtor's $500,000 in unsecured debt or a $1.5 million mortgage or HELOC if it's not related to business activity.

Second, this last point is the really intriguing aspect of SBRA for me. For the first time in recent memory, we see a crack in the wall that has insulated home mortgages from modification in bankruptcy. Sections 1322(b)(2) and 1123(b)(5) still prohibit the modification of claims secured by the debtor's principal residence, but the SBRA at last provides an exception to this latter provision: An SBRA plan may modify the debtor's home mortgage (including bifurcation into secured and unsecured portions?!) if "the new value received in connection with the granting of the security interest" was not used to acquire the home, but was "used primarily in connection with the small business of the debtor." A small crack it may be, but this sleeper provision strikes me as an important opening for serious discussion of modification of other non-acquisition home mortgage modifications in Chapter 13, for example. This would be a game changer after the HEL and HELOC craze of the earlier 2000s. It will doubtless provide further evidence that the HELOC market will not evaporate or even change appreciably as small business debtors begin to modify their home-secured business loans. Of course, that depends on a robust uptake of the new procedure. We shall see in 2020.

The Purdue Pharma Bankruptcy

By filing a bankruptcy petition last week, Purdue Pharma is automatically protected against many types of collection and litigation by operation of federal law. Seeking to turn this already-potent shield into something more formidable, the company has asked a bankruptcy judge to enjoin state and local government actions that might qualify as police and regulatory, and to shield members of the Sackler family and other third parties from both government and private suits. The number of actions affected is long - the first request would affect 435 actions and the second 560 actions (see exhibits A and B to the law suit) - as is the proposed duration, 270 days. Purdue Pharma also has asked the court to impose a "voluntary injunction" on the company regarding its marketing practices and that the court waive the security requirement. The preliminary injunction hearing is scheduled for October 11, 2019, in White Plains, New York. The statutory authority for the requests is generic: section 105 of the Bankruptcy Code. The provision does not say they can do this for sure - it only opens the door for parties to ask for all sorts of things.

Although I am a generalist when it comes to federal courts/jurisdiction/civil procedure relative to colleagues like Elizabeth Gibson, Ralph Brubaker, Susan Block-Lieb, and Troy McKenzie, I am also a "senator" at an upcoming mock senate hearing on the equitable powers of the bankruptcy court at the annual meeting of the National Conference of Bankruptcy Judges.* Thus, I offer miscellaneous observations on the injunction questions below. The devastating subtext, the opioid crisis, already is well known.