Lead into Gold? Sears' Possible Post-Petition Sale of Intracompany Debt

Sears is supposedly considering trying to raise liquidity through the post-petition sale of intracompany debt. The details of the debt and the proposed transaction aren't clear, but as a general matter, the post-petition sale of intracompany debt (or Treasury stock) seems problematic to me as with any lead into gold transaction.  Here's the issue:  if the debt is sold, is it still intracompany debt or does it become general unsecured debt? 

The viability of Sears' strategy depends on the answer to this question.  If it is still intracompany debt post-sale, it's not going to sell for very much; if it is general unsecured debt, it's much more valuable.  (This is putting aside the weird arbitrage with the CDS settlement auction market that gets warped by the CDS volume exceeding the reference debt volume.) 

In most bankruptcies, intracompany obligations between affiliated debtors are either subordinated or cancelled outright.  Nothing in the Bankruptcy Code compels this, but it's pretty standard. It tends to follow from a separate classification of intracompany obligations (again, not compelled by the Code) and from the difficulty in determining net intracompany obligations--deemed consolidation for voting and distribution is standard operating procedure in large bankruptcies. If the leaden intracompany claims can be transformed into golden general unsecured claims, it's a huge siphoning of value away from other general unsecured creditors.  General unsecured creditors are paid pro rata on their claims, so an increase in the size of the general unsecured claim pool dilutes recoveries on the debt.  

So would a sale of intracompany obligations transform them into arms' length obligations?

Matthew Whitaker as a Mini-Trump?

It seems no surprise that President Trump has named Matthew Whitaker as Acting Attorney General:  it turns out that he's a Mini-Trump.  There are two rather remarkable parallels to Trump in Whitaker's history.  First, his involvement with the  operation known as World Patent Marketing closely parallels Donald Trump's involvement with the fraud known as Trump University. And second, both have used charities as their own personal piggybanks. Classy.  

Tempnology and Janger Too!

The Supreme Court granted cert today in the bankruptcy case of Mission Product Holdings v. Tempnology, LLC. It sounds like another one of those cases only bankruptcy nerds can love, but it has potentially broad implications. On its face, it is about trademark licenses, but the Supreme Court could fix some case law about all contracts in bankruptcy. Several Credit Slips bloggers (including me) signed a "law professors" amicus brief in support of certiorari. 

I asked the inimitable Professor Ted Janger of Brooklyn Law School (and former Credit Slips guest blogger) to write with his thoughts on the case. Ted had a lot to do with the professors' brief. Here is what he wrote:

The split in the lower courts arose when the First Circuit inexplicably resuscitated the questionable proposition, first articulated in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), that rejection of an intellectual property license rescinds that license and terminates the licensee’s rights. Congress reversed Lubrizol for copyright and patent by enacting section 365(n), and in 2012, the Seventh Circuit rejected the reasoning of Lubrizol for trademarks, in Sunbeam Prods., Inc. v. Chi. Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012). While there remained some question as to the continued vitality of Lubrizol outside the patent and copyright context, the holding was, at best moribund. At least, that is, until the First Circuit’s decision in Tempnology.

For-profit college chain files (for receivership)

Education Corporation of America filed a legal action in federal district court last week claiming financial distress, seeing to enjoin its creditors and restructure its debt. Sounds like Chapter 11, right? But no. ECA can't file a bankruptcy petition, because that would immediately cut off its main funding source, federal student grants and loans. ECA and its subsidiary Virginia College LLC were already facing disaster under the Obama administration's gainful employment rule, but Secretary DeVos suspended that rule giving poorly performing trade schools a new lease on life. At the same time ECA was facing loss of federal student aid because their accreditor, ACICS, was derecognized by the Education Department under the prior administration for its weak oversight of deeply flawed for-profit schools, like Corinthian College. Unsurprisingly, Secretary DeVos is reconsidering the ACICS decision as well. In a story that seems to be repeating for many for-profit colleges, and even law schools, enrollments are plummeting due to a combination of consumer information about poor student outcomes and reluctant but inevitable enforcement by accreditors and regulators. ECA's proposed plan is to close some of its schools and continue operating others. Its very creative complaint asks the court for a nationwide injunction against its landlords and creditors and appointment of a receiver, among other things. Here is the court's temporary restraining order enjoining all landlords and creditors nationwide for 10 days.

While I am generally not in favor of bankruptcy discrimination, the ineligibilty of bankrupt colleges for taxpayer funding is eminently sensible. Given the weakness of institutional gatekeeping and the political challenges to shutting down predatory schools, and the for-profit college business model in which taxpayer grants and loans are used to prepay tuitions for students who are frequently misled about career chances, we don't need bankruptcy to give these failing schools a new lease on life.

UPDATE: After hearing and briefing, the District Court on November 5 dismissed ECA's action, finding there is no justiciable case or controversy.

CLO Yawn

There's a big story in the NY Times about how the financial structures being used to finance many corporate loans—so-called Collateralized Loan Obligations or CLOs—look very similar to those used to finance mortgages during the housing bubble.  Yup.  That's true. CLOs are a securitization structure, like MBS.  (If you want to know more gory details, see here.)  But that's really where the similarities end.  While the financing transactions are similar, the asset class being securitized is fundamentally different in terms of the risk it presents, and that's what matters.  The financing channel might be more vulnerable to underpricing than other financing channels because of opacity and complexity, but is the underlying asset class that matters in terms of societal impact.  This is for (at least) four reasons. 

CFPB "Abusive" Rulemaking?

Acting BCFP CFPB Director Mick John Michael Mulvaney announced this week that the CFPB would be undertaking a rulemaking to define "abusive," the third part of the UDAAP triad. The CFPB's key organic power is to prohibit unfair, deceptive, and abusive acts and practices.  Unfair and abusive have statutory definitions, whereas deceptive does not, but "abusive" is a new addition to the traditional UDAP duo of unfair and deceptive.  Mr. Mulvaney suggests that a definitional rulemaking is necessary so that regulated entities will know what the law is. 

Actually, it's very clear what "abusive" means, at least as applied by the CFPB to date.

Trump socialism and housing finance

Various tax law scholars have commented on the tax fraud allegations in the recent New York Times story. Equally important is the story's reminder that our housing finance system, and the real estate fortunes it has spawned, have depended for nearly a century on the largess of government.

Fred Trump, the president's father, built the fortune that Donald Trump inherited after avoiding or evading millions in estate and gift taxes.  Fred's fortune was almost entirely due to his savvy exploitation of federal government housing subsidies. When Roosevelt's New Dealers struggled to put the economy back on its feet, they invented the FHA mortgage insurance program, and Fred Trump was one of FHA's first profiteers. As recounted in Gwenda Blair's wonderful book, Fred went from building one house at a time to building Huge middle-class apartment complexes when he was first able to tap into government-backed FHA loans. 

 In his fascinating 1954 testimony before the Senate Banking Committee (begins at p. 395), Fred Trump explains how he purchased the land for the Beach Haven apartments for roughly $200,000, put the land in trust for his children and paid gift taxes on a $260,000 land valuation, and then obtained a a $16 million FHA mortgage to build the apartments.  Fred's corporation owning the buildings netted $4 million from the loan proceeds above and beyond the construction costs, and the land belonging to the Trump childrens' trust was valued by the City tax assessors at $1.3 million as a result of the FHA mortgage transaction and apartment construction. In other words, Fred Trump parlayed his $200,000 investment into a $4 million cash profit for his business and a $1.3 million ground lease producing $60,000 annual income for his children. In his testimony he conceded that this would have been impossible without the FHA government loan guarantee.

Peter Dreier and Alex Schwartz have written a nice exposé of the irony in President Trump's proposals to slash the very government housing finance subsidies to which he owes his personal fortune.