11 posts from January 2019

Jay Alix, McKinsey Redux

posted by Stephen Lubben

A quick note on this ongoing issue, in which Jay Alix (the individual) claims that McKinsey has gained bankruptcy work and market share by flouting the requirements of the Code. Reports are out this morning that some judges have sent this matter to mediation. I don't get that.

The basic issue is that McKinsey, under the most charitable interpretation, was extremely aggressive in deciding what needed to be disclosed to the bankruptcy court. This is basically a legal or policy question as to how to interpret section 327 et al.  How is that a proper subject for mediation? Can the parties really agree on the scope of disclosure? 

I know mediation is all the rage these days in large chapter 11 cases, but there are some issues that simply need to be addressed by the court.

Is SB 901 Constitutional?

posted by Adam Levitin

PG&E filed a notice that it was preparing to file for bankruptcy in around 15 days.  Companies don't usually make this sort of announcement willingly; it's an invitation to a creditor run.  PG&E filed the notice because it's required to under a recently enacted California law, SB 901.  SB 901 requires public utilities to file notice of changes of control at least 15 days in advance, and "change of control" is defined to include filing a bankruptcy petition.  That strikes me as really problematic--it is a state law conditioning and interfering with the exercise of a federal right.  (Imagine how this would work with a financial institution bankruptcy process...)  I can't believe that the law would hold up if challenged.  Yet PG&E filed the notice.  Maybe there's just not a meaningful run possibility for a power utility.

Who Went to Caracas Last Week?

posted by Mark Weidemaier

Mitu Gulati & Mark Weidemaier

More and more creditors are filing lawsuits against Venezuela, and we had been planning to do a post on how the dominos were falling. 

But then we came across a piece by Ben Bartenstein of Bloomberg about how some investors appear to be pursuing an alternate strategy, allowing bondholders to be compensated from oil-related activities. One can understand why creditors would rather have a future claim to oil revenues than litigate over unpaid bond debt. After all, Venezuela has huge oil reserves, and the current Venezuelan government is sure to lose power eventually. Although it may take a while, a government will eventually be in place capable of resuming oil production, and in that event, investors could make a bundle.

Good for investors, but terrible for the future government and the people of Venezuela. Having finally rid themselves of Maduro, they would have to deal with the fact that he and his cronies had either stolen the country's assets or pledged them in exchange for a temporary reprieve from creditors. This is not a new issue. It implicates the problem of odious debts, for which Venezuela is quickly becoming a poster child. (Ugo Panizza and Ricardo Hausmann have a nice piece about the need for Odiousness Ratings in the Venezuelan context.)

Continue reading "Who Went to Caracas Last Week?" »

Credit Bidding and Sears

posted by Adam Levitin

The Sears' auction is a really valuable teaching moment, I think (and perfectly timed for the start of the semester)—does Sears have going concern value that merits a sale of substantially all assets as a going concern, or is an immediate liquidation the value maximizing move?  

I don't have an opinion on that issue, but something strikes me as rather strange about ESL's bid for a sale of substantially all assets.  Very little of the now $5B in consideration offered is cash, less than 20%.  Instead, a large chunk is in the form of debt assumption and another large chunk is in the form of a credit bid.  It's the credit bid that looks odd to me.  ESL seems to be trying to credit bid three different loan facilities, including a second lien facility.  Here's the thing--ESL should only be able to credit bid against its collateral and then only in the amount of its collateral. I don't know what exactly is covered by the liens on each of the facilities, but I suspect that the assets being sold include things that are not covered by the liens. That would seem to create a Free-Lance Star problem for ESL.  And then there's the problem of the valuation.  In order to know what ESL can credit bid, we need to know to what extent it is secured.  To wit, consider a second lien facility.  If the collateral is worth $100 and the first lien debt is for $80 and the second lien debt for $30, the second lien debt shouldn't be able to credit bid $30 because it would only recover $20 from the sale in foreclosure.  The second lien's credit bid should be capped at $20.

Continue reading "Credit Bidding and Sears" »

Federal Student Loans and the Shutdown

posted by Adam Levitin

Is the Department of Education doing anything to assist furloughed federal employees with federal student loan obligations?  Federal contractors with such obligations?  You'd think that ED might instruct its servicers to treat delinquencies for furloughed federal employees and contractors differently than regular delinquencies.  That would be the right thing to do.  

SCRA and the Coast Guard in the Shutdown

posted by Adam Levitin

The Coast Guard apparently briefly had some advice for furloughed guardsmen that included "Bankruptcy is a last option."  The leaped out at me as strange.  What about the Servicemembers Civil Relief Act, a special act that provides protection for active duty military members and their dependents against collection actions?  Shouldn't SCRA hold creditors at bay, such that they don't need to consider bankruptcy for the foreseeable future?

Continue reading "SCRA and the Coast Guard in the Shutdown" »

FDCPA Exclusion for Litigating Attorneys

posted by Jason Kilborn

On the heels of oral arguments in the latest Supreme Court case concerning application of the Fair Debt Collection Practices Act to lawyers, ABA President Bob Carlson has a comment in Bloomberg Law today {subscription maybe required} explaining succinctly why litigating lawyers should be excluded from the FDCPA. He carefully distinguishes lawyers collecting debts outside the litigation context (pre-filing)--whom the FDCPA might reasonably regulate--but he convincingly argues for exemption for those involved in active litigation (I would hope and presume this applies to both the pre-judgment and post-judgment stages, the latter being the subject of a little book on judgment enforcement I've just written, including a bit about the FDCPA). The courts provide adequate oversight and abuse prevention in this formal collection context, Carlson argues, and the "gotcha" pitfalls for otherwise innocuous behavior in the FDCPA (especially the required "mini-Miranda" and validation notices) are unjustifiable as applied to court-supervised litigating lawyers. We'll see how warm a reception HR 5082 receives in Congress. 

The Implication of Reasonable Consumers Not Reading Contracts of Adhesion

posted by Adam Levitin

A final installment to this evening's blog storm (you can tell that I'm procrastinating on exam grading...).

The Consumer Financial Protection Act prohibits "unfair" acts and practices.  "Unfair" is defined as an act or practice that causes or is likely to cause substantial injury to consumers, that is not reasonably avoidable by consumers, and the harm of which is not outweighed by benefits to consumers or competition.  

Now consider that the reasonable consumer does not read prolix contracts in detail.  The reasonable consumer might look at a top-level disclosure, say the Schumer Box for a credit card, or maybe the TRID for a mortgage, but I don't think it's controversial to say that the reasonable consumer isn't going to get into the fine print that follows.  The reasonable consumer isn't going to bother doing this because (1) the consumer might not understand the fine print, (2) the consumer can't negotiate the fine print, and (3) the consumer knows there's a good chance that all of the competitors have similar or worse fine print, so a search for better fine-print terms is might be futile (and might come at the expense of worse top-line terms).  Only a fanatic or a masochist reads every line of a cardholder agreement.

If I'm right that a reasonable consumer doesn't bother reading the details in contracts of adhesion, then notice what the "unfairness" prohibition is doing:  it is requiring that the terms of the contract be substantively fair.  Any hidden tricks or traps, like the double cycle grace period language I highlighted in my previous post, are going to be unfair.  Add in the prong of "abusive" that deals with taking unreasonable advantage of consumers' lack of understanding, and I think the Consumer Financial Protection Act is effectively requiring that consumer finance contracts must be "conscionable" or else have all of the tricks and traps made very clear to the consumer.

That's actually pretty remarkable. That's a light year beyond prohibiting "unconscionable" contracts.  It's an really affirmative fairness requirement for contract terms. It's also exactly what it should be.  Contracts should be a mechanism for mutual (subjective) welfare enhancement, not for one party to hoodwink the other. I wonder how many compliance lawyers are looking at consumer finance contracts in light of the fact that a reasonable consumer doesn't read fine print.  They should be.  

A final thought:  where does this leave arbitration agreements?  Arguably they fall into the problem unfair and abusive category (although there may be some argument about consumer benefit).  Yes, the CFPB's arbitration rulemaking was overturned by the Congressional Review Act.  But the rulemaking was undertaken under a specific power.  Query whether that prevents a rulemaking that is substantially the same under the UDAAP power.  No one really knows.  

UDAAP Violation in BofA Credit Cardholder Agreements?

posted by Adam Levitin

Heads up Kathy Kraninger:  you might want to look at whether Bank of America is engaged in an unfair or abusive act or practice in its credit cardholder agreements.  Here's the deal.  

The Credit CARD Act of 2009 prohibits so-called "double cycle billing" on credit cards:

Prohibition on double-cycle billing and penalties for on-time payments.  ...[A] creditor may not impose any finance charge on a credit card account under an open end consumer credit plan as a result of the loss of any time period provided by the creditor within which the obligor may repay any portion of the credit extended without incurring a finance charge, with respect to—

(A) any balances for days in billing cycles that precede the most recent billing cycle; or

(B) any balances or portions thereof in the current billing cycle that were repaid within such time period.

The prohibition in clause (A) is on calculating the average daily balance to which the APR is applied based on balances other than in the current billing cycle.  That was the practice of double cycle billing:  the average daily balance was the average of not just the current billing cycle but of the current and previous billing cycles.  So even if you had no charges this billing cycle and had paid off the balance, you'd still have a positive average daily balance because of the previous month and thus pay interest.  

The prohibition in clause (B) is supposed to get at "trailing interest"—no interest should accrue on balances to the extent they are paid off on time.  If you charged $100, but repaid $90 on time, you should only be paying interest on $10, not on $100.  But notice how it's drafted. It only applies if there is a loss of a grace period; there is no grace period required.   If there is no grace period, you can be charged interest on the $100, even if you repaid $90 on time.  

So consider, then, this term from Bank of America's current credit card holder agreements:

We will not charge you any interest on Purchases if you always pay your entire New Balance Total by the Payment Due Date. Specifically, you will not pay interest for an entire billing cycle on Purchases if you Paid in Full the two previous New Balance Totals on your account by their respective Payment Due Dates; otherwise, each Purchase begins to accrue interest on its transaction date or the first day of the billing cycle, whichever date is later.

Did you get that?  You only have a grace period allowing for interest-free repayment if you have paid in full the two previous billing cycles.  Otherwise, you're going to be charged interest even if you pay the current cycle's balance in full.

Continue reading "UDAAP Violation in BofA Credit Cardholder Agreements?" »

Are Convenience Check Loans Underwritten to Ability-to-Repay?

posted by Adam Levitin

In my previous post, I complained that convenience check loans weren't underwritten based on ability-to-repay.  That's not to say that there's no underwriting whatsoever.  But it's important to recognize that prescreening for direct mailing for convenience check loans is not the same as underwriting the loans based on ability-to-repay.  For example, Regional Management, on the companies that offers convenience check loans says in its 10-K that:

Each individual we solicit for a convenience check loan has been pre-screened through a major credit bureau or data aggregator against our underwriting criteria. In addition to screening each potential convenience check recipient’s credit score and bankruptcy history, we also use a proprietary model that assesses approximately 25 to 30 different attributes of potential recipients.

That's dandy, but a credit score is a retrospective measure of credit worthiness. It doesn't say anything about whether a borrower has current employment or income, and it doesn't generally capture material obligations like rent or health insurance.

Continue reading "Are Convenience Check Loans Underwritten to Ability-to-Repay?" »

Usury 2.0: Toward a Universal Ability-to-Repay Requirement

posted by Adam Levitin

There's bi-partisan legislation pending that would prohibit the practice of installment lenders sending out unsolicited live convenience check loan:  you get an unsolicited check in the mail.  If you cash it, you've entered into a loan agreement.  

The debate about check loans has turned on whether consumers understand what they're getting into.  The legislation's sponsors say consumers don't understand all the terms and conditions, while the installment lender trade association, the American Financial Services Association, argues that there's no problem with live check loans because all the terms are clearly disclosed in large type font.  

This debate about consumer understanding and clarity of disclosure totally misses the point.  The key problem with check loans is that they are being offered without regard for the consumer's ability to repay.  For some consumers, check loans might be beneficial.  But for other they're poison.  The problem is that check loans are not underwritten for ability-to-repay, which is a problem for a product that is potentially quite harmful.  Ability to repay is the issue that should be discussed regarding check loans, not questions about borrower understanding.  Indeed, this is not an issue limited to check loans.  Instead, it is an issue that cuts across all of consumer credit.  Rather than focus narrowly on check loans, Congress should consider adopting a national ability-to-repay requirement for all consumer credit (excluding federal student loans).  

Continue reading "Usury 2.0: Toward a Universal Ability-to-Repay Requirement" »

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