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The Delaware Thing

posted by Stephen Lubben

I want to thank the Credit Slips folks for having me visit for the week.  I thought I'd start off with a short post, on an uncontroversial subject.

Next week I'll be flying off to Vienna (yes, academic life is rough) to present my paper on Delaware's role in corporate reorganization at a conference on financial distress at the Vienna Graduate School of Finance. Unless you’ve been living under the well known rock, you know that for the last couple of years the bankruptcy community has been riveted by Lynn LoPucki's controversial thesis that Delaware is the central part of a system where "competing bankruptcy courts offer high fees to bribe the lawyers to bring them cases." In particular, as I understand Lynn's argument, he contends that Delaware is so desirous of big corporate cases that it (a) bribes professionals to come to Delaware and (b) goes easy on the 1129(a)(11) feasibility analysis, leading to more refilings.

As I note in the paper, even would be defenders of Delaware seem to have accepted that that Delaware cases refile at an abnormally high rate, and debates then proceed from that point. I remain unconvinced.

I'll talk about chapter 11 professional fees in another post, what I want to talk about here is Delaware's alleged role in chapter 11 refiling rates. Again, as I understand the argument, it goes like this: attorneys and other professionals push cases into Delaware because they know they can get their fees approved, the Delaware courts have adopted a "hands off" approach to fees and reorganization plans to attract these cases, but this approach leads to superficial reorganization and increased refiling. This is the phenomena that Lynn describes as "corruption," an effect that he argues has spread from Delaware to other districts whose judges also wish to preside over large corporate bankruptcy cases.

Note that the argument, although superficially appealing, does not hang together perfectly.  Attorneys could bring cases to Delaware just for the higher fees – the role played by the Court’s superficial review of reorganization plans is unclear.  If attorneys are driven by fees, its not clear why they should care about how courts approach plans.

But I argue in the paper that we need to ask some even more fundamental questions before this discussion gets completely calcified into pro and anit-Delaware camps. I'll get this discussion started by highlighting three four:

1.  Are we sure Delaware is the cause of refilings?

Lynn shows that cases in Delaware, and to a lesser extent the S.D.N.Y., have higher refiling rates, but these districts also have the vast bulk of the large chapter 11 cases. On a district by district level, there are examples of cities with higher refiling rates than Delaware – we dismiss these as being small sample effects, but are we sure that Delaware and New York are the relevant factors or are the refiling issues simply more observable in these districts because they have so many cases.

In the paper I present a regression model that shows that economic conditions and whether the case is a  prepack seem to be more important than whether the case was filed in Delaware. And while the model is certainly not perfect, the fundamental point is the doubt that the model raises about Delaware's centrality to the analysis. Until it has been shown that that Delaware is the distinguishing factor among cases that refile, I argue that it is both unfair and imprudent to assume a Delaware effect and put the burden on those who argue otherwise.

2. Why does the attorney-client relationship play such a small role in this story?

In my experience, the relationship between the lead law firm partner and the client's representative (typically the general counsel, but sometimes the CFO) is often a tense one during the chapter 11 process. The executives are on edge, for obvious reasons, and the slightest setback in court often leads them to question the partner’s judgment and ability. In this environment, it hardly surprises me that partners would be risk adverse – why not stick with what has worked in the past?  Indeed, not filing in Delaware can itself sometimes be a cause of friction with the client:  I remember one client specifically saying, after an unfortunate ruling by the local bankruptcy judge, that we should have filed the case in Delaware. More importantly, being risk adverse does not clearly show "corruption."

3. Does it matter if the conspiracy was instead an accident?

I have repeatedly seen Lynn defend the use of the word "corruption" by arguing that the Delaware bankruptcy courts changed their approach to chapter 11 to compete for big cases; not out of any belief that the new approach was consist with the Code or otherwise more efficient.

Even if we assume that it has been shown that Delaware cases have a higher refiling rate, don't we need to show that the relevant parties knew this?  Without this essential link, the story is at best a case of "whoops."

4.  And perhaps it's time to examine the issues?

People are understandably in a lather about Lynn's unsubtle allegations, but maybe, just maybe, we should spend a bit of time considering the points he surfaces:  for example, whether or not Delaware is the cause, what do we make of all these repeated trips through chapter 11? 

I'd also make a little plea here to drop the old "Delaware cases are different in some unknown/unexplainable/secret way that makes them more likely to fail" argument.


Short and non-controversial . . . right??

 

Comments

Thanks to Steve Lubben for keeping the embers of the Delaware debate burning. George Kuney famously referred to the dramatic, dysfunctional change in the processing of large, public company bankruptcies since Delaware began attracting cases in 1990 as the “hijacking of Chapter 11.” A large majority of the bankruptcy community support the recommendations of the National Bankruptcy Review Commission and the Cornyn bill. Both would put an end to Delaware venue. But many believe Delaware venue is not worth discussing because there is no way to ban it while Joseph Biden remains in the Senate.

Steve misstates my position, however, in two respects:

1. “Superficial reorganization and increased refiling” are characteristics of Delaware bankruptcy in the period 1990-2000, but I do not consider them “corruption.” Nor has Steve “repeatedly seen [me] use the word ‘corruption’” with respect to the Delaware bankruptcy court. He will be unable to produce even one such statement. I have never asserted that any particular judge or court is corrupt. I reserve the word “corruption” for judges who in bad faith choose future case attraction over what they believe is right. As an empirical researcher, I have no way of knowing what was in any judge’s mind at the time of any decision. What I assert is that the overall pattern of decision making in large public company bankruptcies is one that could not exist without that kind of corruption.

2. Joe Doherty and I have shown that companies reorganized in Delaware during the period of Delaware’s ascendency, 1991-96, refiled at a rate seven times as high as the refiling rate in other courts. Neither Steve, nor anyone else, contests that finding. Joe and I do not asset that difference persisted in later years. To the contrary, I argue in Courting Failure at page 120 that when the other courts copied Delaware’s methods in the period 1997-2000, the other courts’ refiling rates rose to the refiling rates of Delaware.

When Steve says “there are examples of cities with higher refiling rates than Delaware” he is not talking about the period 1991-1996. For that period there is only one court in the U.S. with a higher refiling rate than Delaware. Corpus Christi had only a single case and that one case resulted in refiling. Aside from Dealware and New York, there were only three refilings in total nationally for the period 1991-96. I think Corpus Christi does warrant being called a “small sample effect.”

Steve pleads for me to “drop the old ‘Delaware cases are different in some unknown/unexplainable/secret way that makes them more likely to fail’ argument.” But the uncontested difference in refiling rates for Delaware and other court companies is statistically significant at the .001 level and no one has been able to identify any difference in the companies choosing to reorganize in Delaware. So Steve, how would you explain the difference? Did Delaware just have a spectacular run of bad luck?

Ah, at last a comment!

I want to clarify something with regard to my last point (and Lynn's last comment). I was not actually referring to Lynn when I wrote about the unknown/unexplainable/secret Delaware difference -- in fact, I was talking about many of Lynn's critics who seem to try to deflect his arguments by making this argument (see the ABI panel in New York a few years back). I find this move totally underwhelming.

As for the other points Lynn makes, I'll just say that Lynn and I disagree about the appropriateness of making further subdivisions in the data based on certain time periods. I urge others to put in their "two cents."

This might also be a good place to note that I do think Delaware had its problems in the early to mid 1990s, but the problems I'm concerned with are not the ones Lynn talks about. In particular, I think the Delaware court during that period had a rather limited conception of due process, and was probably all too willing to enter substantive orders with almost no real notice to the relevant parties.

I have no problem with DE being studied. I do not believe recent developments threaten mootness, nor do I believe we should be apologetic for the aesthetic value of research! What you guys do disagree on is, as Steve says, the propriety of carving chronologic subdivisions. If Lynn is being EVIL, then he is mining his own data for an arbitrary cut-off point to concoct a significant result. If Lynn is being GOOD, then he is testing a hypothesis regarding a specific time period of relevance (e.g., his intution of the period of "ascendency" based on, e.g, judicial appointments or other developments). I suppose something in between's possible too.

While I think that John has put his finger on the key issue, I would object to the use of "good" vs. "evil." One thing this debate would greatly benefit from is a reduction in the rhetorical "heat" from both sides. While I do question the theoretical basis for drawing a line at 1996/97, I would never suggest that Lynn's decision to do so is the result of "evil."

S-- Click on my name undersigning this post to be directed to a helpful link. (I'm computer-useless, so this message may be posted twice as 2 comments.)

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