New Resource on Uniform Commercial Code Reform for Digital Assets including Crytocurrency

Earlier this fall I linked to a variety of resources, including webinars, on amendments to the Uniform Commercial Code to account for various types of digital assets. The scope includes but is not limited to commercial transactions involving cryptocurrency.

To add to these resources, a version of the amendments that includes official comments is now available.  

Because there will not be a uniform effective date, and some states have gotten an early start by implementing prior drafts of the amendments (see prior post), these could swiftly become relevant to transactions and disputes, including those that land in bankruptcy court. 

DOJ and DOE New Guidelines for Supporting Student Loan Discharge in Bankruptcy = More Student Loan Discharges?

The Department of Justice, in coordination with the Department of Education, has announced a new process for its handling of bankruptcy cases in which debtors seek an undue hardship student loan discharge. This new guidance has been a long time coming. In 2016, the DOE issued a request for information regarding evaluating undue hardship claims. Slipster Dalié Jiménez and I (along with co-authors) submitted a response that urged the DOE to establish clear, easy-to-verify circumstances under which it would support (or not object to) debtors' requests for student loan discharges. Subsequently we published articles expanding on and updating our proposals, always focusing on how the DOE could craft guidelines that would provide specific, objective criteria for when the DOE would not object to a requested discharge, thereby removing the guess work from discharge requests, and hopefully encouraging the filing of more student loan discharge adversary proceedings.

The new guidelines will go a long way in helping people obtain student loan discharges. They incorporate key aspects of what consumer advocates and academics have highlighted as important to promote discharges for people who will benefit from student debt relief. I predict that, over time, more consumer debtors will request and receive undue hardship discharges.

In short, the new process requires the debtor to submit an attestation form with information that will allow the DOJ and DOE to assess the three prongs of the Brunner test. At first glance, this may seem like a rehashing of the Brunner standard, thus providing the DOJ and DOE with significant wiggle-room to decide whether to support discharge. But upon digging into the requirements to meet each prong, it becomes more clear that the DOJ and DOE, overall, has adopted clear, objective criteria for its decision-making. This should provide debtors and attorneys with confidence in how the DOJ and DOE will respond to student loan discharge requests. Details about how the DOJ and DOE will handle assessing each of the prongs, plus some ruminations on how this guidance may play out, after the break.

Credit Slips Now on Mastodon

Nine years ago, Credit Slips announced its new Twitter feed. Credit Slips is now also on Mastondon, at @creditslips.mastodon.lawprofs.org. We'll put links to our posts on Mastodon as they are published, as well as boost Credit Slips authors. For now, we'll also continue adding posts to our Twitter feed. Come find us on Mastodon! 

Binance's Custodial Arrangements: Whose Keys? Whose Coins?

For months, cryptocurrency FTX (and its majority owner, Sam Bankman-Fried) have been the lender of last resort in crypto markets and pretty much the only distressed acquirer around. Now we learn that FTX has itself failed and is getting scooped up in a distressed acquisition by Binance. Does this remind anyone of Bank of America's purchase of Merrill Lynch and Countrywide in 2008? We'll see if the transaction closes, but at the very least it poses the question of whether Binance stands on any stronger ground than FTX? Binance's revenue has been way down this year, but who really knows its financial condition? It's not a public company, so there's limited visibility into its financial condition.

Here's what I do know about Binance, however, and it gives me real pause: Binance.us's Terms of Use disclose absolutely nothing about its custodial arrangement for crypto holdings. From the documents on Binance.us's website, it is impossible to determine the legal relationship between Binance.us and its customers and hence the type of counterparty risk they have from dealing with the exchange. That's scary.

The Texas Two-Step as Fraudulent Transfer

Judge Judith Fitzgerald (ret.) and I have a post about the Texas Two-Step bankruptcy process up at the Harvard Bankruptcy Law Blog, which has been running a series on the phenomenon.  And the Slips' own John A.E. Pottow has a capstone post on the same topic.    

The tl;dr read version of my post with Judge Fitzgerald is that the real fraudulent transfer vulnerability of the Texas Two-Step is the incurrence of an obligation by the BadCo in the divisive merger, not the transfer of assets to the GoodCo. Focusing on the the incurrence of an obligation not only avoids the problem of the Texas divisive merger statute deeming the merger not to be a transfer of assets (as there is a separate provision in the statute about liabilities that doesn't parallel the asset provision), but it also avoids the problem that there is no longer a transferor entity in existence.  If we're right (and we are), then it means that the liabilities follow normal state law successor liability principles, which should put the liability on GoodCo, which is continuing OldCo's enterprise.

Dual Insulation? The Fifth Circuit's Factual Misunderstanding of CFPB Funding

I know I’m carrying around some extra weight.  But I don’t think it’s quite double insulation.  That sounds like something you need if you’re going on a polar expedition or are really concerned about the heating bill.  But the concept of "dual insulation" plays a big role in the Fifth Circuit’s decision in Community Financial Services Association of America, Ltd. v. CFPB, which held the CFPB’s funding mechanism to be unconstitutional because it is not an annual appropriation from Treasury.   

In this post, I’ll discuss some of the background on the case, the poorly understood nature of the CFPB’s funding (factual mistakes about which loomed large in the Fifth Circuit’s decision), and the challenge the Fifth Circuit faced in trying to differentiate the CFPB’s funding from that of a host of other federal regulatory agencies (that’s where dual insulation comes in).

US Chamber of Commerce vs CFPB

One would have thought that after a dozen years the challenges to the CFPB’s constitutionality would have been over and that the Supreme Court’s decision in Seila Law would have put the matter to rest. But there are still a trio of suits pending that bring constitutional challenges to the Bureau, including one recently filed in the Eastern District of Texas by the US Chamber of Commerce and some banking and business associations. That’s the suit I’m going to focus on. 

The Chamber’s suit alleges that a recent change in the CFPB’s examination manual—guidance for CFPB examiners that the Bureau happens to make public as a courtesy—that indicates that examiners are to consider discrimination in non-credit services to be an unfair, deceptive, or abusive act or practice is a “legislative rule.” A legislative rule must comply with the Administrative Procedure Act, including adequate notice-and-comment, being based in law, and not being arbitrary and capricious. As a kicker, however, the Chamber’s suit adds in a count that the Bureau’s funding is unconstitutional. What's likely to happen?

 

Help us Brainstorm how the Bankruptcy System Could be Fairer to Low-income People and People of Color

This past month, Nathalie (Martin) and I gave a talk at the Tenth Circuit Bench and Bar Conference on Credit, Race, Class, and Bankruptcy. After recounting some of the historical reasons for persistent wealth, income, and debt gaps among different races and ethnicities, we shared these slides to show that wealth and debt inequalities persist to this day.

In one news story that was only a month or so old, one family’s home appraisal in Maryland jumped almost $300,000 when the family covered all evidence that a Black family lived in the house. This was just one of several articles in the last two years alone. We found similar examples from Florida, Colorado, California, and Ohio, all within the last two years.

After that, we began a conversation about how the bankruptcy system and rules might unintentionally have a disparate impact on all low-income people, including many persons of color. As one example, we displayed this form from the bankruptcy court in Connecticut, which essentially announces the dismissal of chapter 7 cases with little explanation of why, before a debtor can even respond:

After groups in our session shared about problems, they came up with a list of things we could do within the system to help make it fairer for low-income people and persons of color, even without amending the Bankruptcy Code. Several judges shared things they already do to help low-income persons, including creating alternative systems for communicating with the court and for filling documents, for pro se persons without PACER, as well as creating a fund for translators for pro se debtors.

We seek more input on this topic from our CreditSlips readers. What have you seen happen in bankruptcy court, by way of local practice or rule, that could have a disparate impact on low-income people, many of whom are persons of color? In what ways might we tweak the system, even a little, to help ameliorate this impact? We appreciate your thoughts in the chat or to either of us by email. We plan to gather everything we learn and write about it. As most of us know, the little things are often the big things when it comes to equity justice.

New Book Alert: Delinquent

The University of California Press has published Delinquent: Inside America's Debt Machine by Elena Botella. 

Botella used to be "a Senior Business Manager at Capital One, where she ran the company’s Secured Card credit card and taught credit risk management. Her writing has appeared in The New Republic, Slate, American Banker, and The Nation."

Here's the description from the publisher between the dotted lines below: 

------------------

A consumer credit industry insider-turned-outsider explains how banks lure Americans deep into debt, and how to break the cycle.

Delinquent takes readers on a journey from Capital One’s headquarters to street corners in Detroit, kitchen tables in Sacramento, and other places where debt affects people's everyday lives. Uncovering the true costs of consumer credit to American families in addition to the benefits, investigative journalist Elena Botella—formerly an industry insider who helped set credit policy at Capital One—reveals the underhanded and often predatory ways that banks induce American borrowers into debt they can’t pay back.

Combining Botella’s insights from the banking industry, quantitative data, and research findings as well as personal stories from interviews with indebted families around the country, Delinquent provides a relatable and humane entry into understanding debt. Botella exposes the ways that bank marketing, product design, and customer management strategies exploit our common weaknesses and fantasies in how we think about money, and she also demonstrates why competition between banks has failed to make life better for Americans in debt. Delinquent asks: How can we make credit available to those who need it, responsibly and without causing harm? Looking to the future, Botella presents a thorough and incisive plan for reckoning with and reforming the industry.

---------------------

Looking forward to reading this book! Also expecting to see more from the University of California Press of direct interest to Credit Slips readers in the years ahead. 

Chase's 50% Venmo Transaction Fee

I teach about the $40 latte--a $5 latte with a $35 overdraft fee--and think I know how to avoid that. But I was pretty shocked when I looked at my Chase credit card statement today and saw the card card equivalent of an outrageous overdraft fee:  $20 in cash advance fees and $0.25 in cash advance interest for two credit-card funded Venmo transactions totaling $40. A 50% fee?  WTF.

What made this even more shocking was that Chase has never previously charged me fees or interest for Venmo transactions. As recently as July, I have Venmo'd without paying anything more than Venmo's 3% fee for credit-card funded transactions, and my card issuer has not sent me any change of terms notices in the interim. Puzzled, I decided to figure out what was going on. 

Getting Ready for Uniform Commercial Code Reform?

IAs digital assets and emerging technologies become common in commercial transactions, state commercial law must rise to the challenge - that's the driving force behind a new set of amendments to the Uniform Commercial Code, including Article 9 governing secured transactions in personal property - such as in virtual currencies and nonfungible tokens.

No state has enacted the amendments yet,* but prior reforms to Article 9, at least, have been remarkably successful at achieving broad enactment. Consider, for example, the visual of the 2010 amendments to Article 9. Blue=enacted!

How to track developments? Here are some publicly available resources courtesy of the Uniform Law Commission:

First, here is where to find the actual amendments as finally approved by the Uniform Law Commission and the American Law Institute. 

Second, here is a summary. Note the mention at the bottom of transition rules for lenders who followed existing law in perfecting security interests, etc. (by the way, there is not a prospective uniform effective date for these amendments). 

Third, videos! Here's one highlighting the changes for digital assets. And here's another on other matters covered in the amendments. 

Fourth, here's where proposed bills and enactment information will be tracked.

*According to the digital assets video, some states adopted earlier versions of part or all of these amendments (New Hampshire, Iowa, Nebraska, Indiana, Arkansas, and Texas) but are expected to update those to conform with the final versions. Wyoming and Idaho went their own way on commercial transactions in digital assets.  

Fake and Real People in Bankruptcy

This draft essay, Fake and Real People in Bankruptcy, just posted on SSRN, is considerably less far along than Unbundling Business Bankruptcy Law, posted last week. Fake and Real starts with a Third Circuit case that tends to be less well known: it upheld the dismissal of an individual bankruptcy filer whose primary asset was a home he had built with his own hands. Perhaps you will find that story relevant to current debates about what is permissible in large chapter 11 cases. Like Unbundling Business Bankruptcy Law, Fake and Real reflects some of my in-depth research on The Weinstein Company.  

Here is the abstract: 

This draft essay explores how the bankruptcy system is structurally biased in favor of artificial persons - for-profit companies, non-profit enterprises, and municipalities given independent life by law - relative to humans. The favorable treatment extends to foundational issues such as the scope and timing of permissible debt relief, the conditions to receiving any bankruptcy protections, and the flexibility to depart from the Bankruptcy Code by asserting that doing so will maximize economic value. The system's bias contributes to the "bad-apple-ing" of serious policy problems, running counter to other areas of law have deemed harms like discrimination to be larger institutional phenomena. These features also make bankruptcy a less effective partner in the broader policy project of deterring, remedying, and punishing enterprise misconduct.

Unbundling Business Bankruptcy Law

A long-in-process draft article has just become available to be downloaded and read here. Comments remain welcome.  The Weinstein Company bankruptcy features prominently in this draft article. 

Every contract in America contains an invisible exception: different enforcement rules apply if a party files for bankruptcy. Overriding state contract law, chapter 11 of the federal Bankruptcy Code gives bankrupt companies enormous flexibility to decide what to do with its pending contracts. Congress provided this controversial tool to chapter 11 debtors to increase the odds that a company can reorganize. To promote this objective while also preventing abuse and protecting stakeholders, Congress embedded this tool and others in an integrated package deal, including creditor voting. The tool was not meant as a standalone benefit for solvent private parties to pluck from the process for their own benefit, like an apple from a tree.

In recent decades, the chapter 11 package deal has been unbundled in practice, typically on grounds of economic urgency. While scholars and policymakers have attended to the quick going-concern sales of companies featured in unbundled bankruptcies, they have not sufficiently explored the challenges associated with a contract-intensive business.

To help fill that gap, this draft article illustrates how the ad hoc procedures used to manage quick sales of contract-intensive businesses can undercut two major chapter 11 objectives: maximizing economic value and fair distribution. They amount to a wholesale delegation of a substantial federal bankruptcy entitlement to a solvent third party. In addition to the impact on economic value and distribution, this draft article also explores a Constitutional problem with this practice: it arguably exceeds the scope of the federal bankruptcy power.

 

Restructuring Conference Announcement

Announcement that slipsters might be interested in:

Financial Restructuring Roundtable

Call for Papers

The Financial Restructuring Roundtable (formerly the West Coast Bankruptcy Roundtable) will be held in person on April 6, 2023 in New York City. Spearheaded by Tony Casey, Samir Parikh, Robert Rasmussen, and Michael Simkovic, this invitation-only event brings together practitioners, jurists, scholars, and finance industry professionals to discuss important financial restructuring and business law issues. 

Let's Make Some Crypto Law!

One of the undiscussed consequences of the spate of recent crypto bankruptcies – domestically including Celsius and Voyager – combined with Congress' inability to legislate is that the bankruptcy courts, namely those in the SDNY, will have a chance to make a lot of law regarding crypto.

For example, is Tether a good? (the citation to the UCC is odd - that's not actually the law anywhere, right?).

 

3M's Aearo Technologies' Bankruptcy: the Hoosier Hop

3M's earphone subsidiary, Aearo Technologies, filed for bankruptcy today in the Southern District of Indiana. This is looking like a really interesting case: it looks like a new generation of the Texas Two-Step strategy. Let's call it the Hoosier Hop. Here's the story.

Do Investors Really Prefer Putin’s Booby Trapped Bonds?

Mark Weidemaier and Mitu Gulati

We have written before about the “Alternative Payment Currency” clause in some Russian bonds, the one that allows for payment in rubles if, for “reasons beyond its control,” the government can’t pay in dollars or euros (or a subset of alternative currencies). Our general take on the clause was that it is a bit odious. That’s because we viewed it as way for investors to subsidize bad behavior by the Russian government. If the Russian government gets sanctioned, investors will help it out by taking on the currency risk associated with being paid in rubles. And we were not the only ones. Jonathan Wheatley of the FT, writing in 2018, when these clauses were introduced, quoted an investor this way:

“I cannot understand why any foreigner would take the risk of being paid out in roubles,” said one London-based asset manager, adding that many foreigners were likely to buy the bonds without reading the prospectus thoroughly.

Gazprom, the Russian state-owned gas producing giant, also began using these ruble option clauses in its foreign currency bonds at roughly the same time (here). Importantly, for our purposes, it was clear to all involved at the outset that these clauses were put in place in anticipation of western sanctions in the event that Russia were to engage in misbehavior (e.g., invading neighbors).

From first principles, we would have assumed a bond with this APC clause would be viewed as relatively unattractive compared to a bond that required payment in dollars or euros. Bonds denominated in foreign currency protect investors from the risk of devaluation in the borrower’s currency. If investors are less willing to lend in domestic currency, that should make the cost of borrowing in foreign currency lower. If one looks at broad trends over time, that’s mostly what we see. Poorer and lower-rated countries do seem to pay more to borrow in local currency than in foreign currency (here). By contrast, rich, highly-rated sovereign issuers borrow pretty much only in their local currency.

Moreover, the APC clause could be invoked opportunistically by the Russian government in circumstances where it isn’t actually impossible to pay investors in hard currency. That risk is probably small for a country with a long-standing reputation for good behavior vis-à-vis its obligations to the rest of the world such as the Netherlands or Germany.  But would anyone put Russia in that category, especially Russia under Putin after its repeated and extreme violations of international obligations? A clause that allows misbehavior by a counterparty known for its willingness to misbehave should make these bonds less valuable. Indeed, we’ve seen just that with Argentina after it engages in shenanigans vis-à-vis bondholders (here).

Given these principles, here is what we would have predicted:

Private Equity Debt Shenanigans Conference

I'm obsessed with debt shenanigans and, in particular, the emergence of an entire industry (or so it seems) of lawyers who specialize in finding and exploiting contract loopholes in places where the parties to the transaction had no idea there were gaps.  And there are others who defend against this.  (Anyone remember J.Screwed or Windstream?). 

One area where the payouts of successful loophole detection and exploitation has shown big returns is the world of Private Equity. 

And now the Penn Law Review is hosting a conference on this topic. (Okay -- Their description of the topic is slightly different than mine).  Yay!

Call for papers is below:

The University of Pennsylvania Law Review will host its annual symposium on Friday, October 7, 2022, in-person. This year’s topic, “Debt Market Complexity: Shadowed Practices and Financial Injustice”, will explore the rise of increasingly complicated debt structures associated with private equity. We are issuing a call for papers for publication in the Law Review’s corresponding symposium issue.

To submit a paper for consideration, please provide an abstract no longer than 750 words to symposium@pennlawreview.com by July 31st, 2022. If selected for publication, completed drafts will be due January 1st, 2023. 

The complete call for papers, which includes more detail, is available here. 

Yehuda Adar on Contract Damages -- In a Bond Default

Figuring out the right damages measure for default on an actively traded financial asset such as a government bond is, at first, obvious -- just pay what you promised on the bond.  But then, when one thinks about features of damages law such as the option to substitute performance or mitigation, things get murkier.

Yehuda Adar, a guru of the messy law of damages at Haifa, has a super new paper on ssrn.com (here).  How he manages to be so very clear and coherent about a topic that is so messy is beyond me. 

Here is the abstract:

What are the damages to which an investor facing a repudiation or a material breach by a government issuer is entitled? The conventional answer that most investors would probably give is that, in the face of such a default on the bond indenture, damages should include both the repayment of the principal (‘par’) and the payment of any remaining (i.e., unpaid) coupons (discounted to present value). Is this conventional understanding warranted? For at least some sovereign bond experts, the answer is not at all obvious and straightforward at it might seem at first blush. Aren’t such damages over-compensatory? Indeed, by obtaining – prior to maturity – both the par and every remaining coupon payment, isn’t the bondholder being put in a better position than if the contract had been performed? Indeed, if there had been no breach, wouldn’t the bondholder have to wait for those payments to be made until maturity date? Secondly, if damages are to be calculated this way, isn’t the bondholder going to receive something more valuable than what he had before the breach? More concretely, whereas prior to breach the bond’s market value reflected the issuer’s credit ranking, the conventional measure of damages seems to treat the bondholder as if he owned a U.S. treasury bond. Third, shouldn’t the investor be expected to purchase a substitute on either the primary or secondary market to eliminate or at least minimize his damages? Shouldn’t this option significantly reduce the scope of the issuer’s liability?

As basic as these questions sound, they have managed to escape rigorous analysis in the sovereign bonds literature. One can hardly find a comprehensive analysis of remedial issues within this vast body of scholarship. What, then, is the correct measure of damages for the breach of a government bond? By closely inspecting this deceptively simple question, this Article highlights the availability, under the general law of contract damages, of no less than four different methods for measuring a bondholder’s expectation damages. The Article presents to the reader each of these alternative measures and illustrates how to implement each of them in a hypothetical case described at the outset of the Article. Then, the Article addresses two analytical challenges facing a court (or an arbitrator) wishing to reach the correct decision on the damages issue. The first involves a choice between two ways of conceptualizing the bondholder’s loss; namely, the loss of the promised performance of the indenture on the one hand, and the market value of the bond on the other hand. The next challenge is that of applying the mitigation of damages doctrine. Considering the normative and practical considerations pertinent to each of these challenges, the Article ultimately concludes that in most cases courts will tend to implement the ‘Gross Lost Profit’ measure of damages, which is the most generous of the four expectation damage measures. Surprisingly or not (depending on one’s intuitions), this measure coincides with the wisdom of the crowd.

 

 

Co Authoring in Legal Academia

Co authoring saved me. Literally.  But for the fact that my senior colleagues at UCLA did not care whether I ever wrote anything sole authored, I don't think I would have written anything. I was (and am) just too racked with insecurities.  And then I'd probably have had to get a real job. Aiyiyiyi.  I owe an ever lasting debt to those colleagues -- thank you to Bill Klein, Devon Carbado, Steve Bainbridge, Rick Sander and more.

But I had heard, at the time (a long long time ago) that other schools were not so encouraging. Some of them, the rumor was, discounted co authored work or refused to count it at all in the tenure file.  The model of the worthy scholar was the solo romantic creator toiling away on the magnum opus in solitude.  

Things have changed since then though, as this brilliant piece, The Evolving Network of Legal Scholars,  by Andrew Hayashi shows (although, I have to ask Andrew: Why is the article on co authorship not co authored?).  Even putting aside the fact that I find the topic fascinating (of course, I'd like anything about co authorship), it is beautifully written and has the coolest graphs.  Every section says something new and insightful and one is left wanting more at the end. That is not how I feel at the end of most law journal articles -- actually, I don't even reach the end of most law journal articles because they are such torture to read (especially mine).

Abstract is here:

The law professoriate is a network connected by scholarly interactions of various kinds, including co-authorship. I study the evolution of the co-authorship network from 1980-2020 and document a sharp increase in the number of scholars, the amount of scholarship, and explosive growth in the network of legal scholars during this period. Despite this growth, however, the distance between legal scholars has shrunk such that legal academia can be characterized as a “small world.” I describe the increase in the number and scholarly contributions of women, minorities, and lesbian, gay and bisexual (LGB) scholars and the rise of co-authorship, including “mixed” co-authorship. I find that members of the same gender or minority groups tend to coauthor with each other, but that this correlation has declined over time resulting in more co-authorship across identity categories. Finally, examining the ordering of author names on coauthored articles, I find that racial minority scholars make up a greater share of first authors than their share of authors in general, while women and LGB scholars make up a smaller share of first authors than one might expect if authorship were randomly assigned.

Just a few questions for Andrew, for his next article on this topic:

1. The article focuses on co authorship in law journals. But what about peer review journals.  Might it be the case that the types of folks who migrate towards the co authorship model tend to publish more in peer review journals? Especially in fields like health law? Does that create an under count?

2. Do things change over the life cycle of a scholar?  Does co authoring at some stage lead to working on larger and larger teams over time? (as one sees the benefits - I'm thinking of Eric Posner's podcast  conversation with Orin Kerr about this topic (here))

3. Can you tell us more about the schools where co authorship thrives more than others?  Are they more collaborative? Do they produce better (more creative) or worse ideas?

4. What about co teaching?  Some schools encourage co teaching in the way they give credit.  Does that result in more co authorship?

Confiscating Russian Assets (Now?)

As the Russia-Ukraine conflict continues and the amount of destruction to lives and property grows exponentially, a question that has come up is whether Russian assets overseas should be confiscated and made available to those who the Russian invasion has harmed  (e.g., here).  The list of those is growing larger minute by minute:  refugees, families of those who have died, people whose homes and livelihoods have been blown apart and on and on and on.

The amount of harm that Mr. Putin's craziness has caused is already far greater than the value of the frozen assets -- in the many trillions whereas the frozen assets (even if one adds in the oligarch properties) is in the hundreds of billions.  But should we wait until Mr. Putin has taken whatever portion of Ukraine he wants (e.g., 20-30%), installed some puppet government, and is finally willing to negotiate for peace?  At that point, as part of the negotiation, he is going to want to ask for his frozen assets back.  And the leaders of the countries where the frozen assets are located, who will be desperate for peace, might be tempted to give the assets back.  Let us not kid ourselves.  The political flesh is weak.  If those politicians see themselves garnering advantage at the ballot box by negotiating a quick peace (to the detriment of the claims or refugees and others), they will do that.  So, maybe there is an argument to confiscating the assets now while there is political will to do so.

On the other hand, there is the small matter of the law.  Due process before taking people's property and all that.  Does it allow for the confiscation of the property of a sovereign engaging in an egregious violation of international law by invading a neighbor?  There is the proverbial slippery slope of countries confiscating the property of other sovereigns whose behavior has displeased them without first ensuring that they are legally entitled to.

To my mind, these are fascinating questions to which there are not clear answers.

Two giants of the legal academy, Larry Tribe and Paul Stephan have been debating this in the context of what Mr. Biden is allowed to do.  The assets can be frozen. But can they be confiscated?

Here is the abstract of Paul's superb new paper that describes the issues:

This article addresses the legal issues that the United States would confront were it to move from freezing to seizing. It looks first at the executive branch’s existing legal authority to confiscate foreign property. It considers legislative proposals to extend that authority. Both existing law and possible future legislation face constraints under constitutional law. These constraints are unique to the United States but reflect principles of legality and due process that western states generally embrace. Finally, it provides a snapshot of the international legal issues that seizure of Russian state assets might present.

First and foremost, existing law does not permit the executive branch to dispose of Russian state assets in advance of a settlement with that state. A civil process exists to forfeit assets to the state, including those of state-owned entities, but that entails resort to the courts and requires some evidence of criminality. Legislation currently under consideration in the United States would enhance that process but not abandon it. It would not apply to the largest portion of assets, the deposits of the Russian Central Bank in US financial institutions, absent some proof that those deposits can be traced to criminal activity. US constitutional guarantees against expropriation in the absence of compensation and of civil forfeiture in the absence of due process almost certainly apply.

Finally, the seizure of assets belonging to the Russian state outside of normal criminal and regulatory processes would violate international law. What international law probably would permit, however, is the use of these assets to satisfy legal judgments rendered against the Russian Federation by duly constituted international investment tribunals established under treaties to which Russia is a party. The United States and other countries in the West might explore ways of encouraging the beneficiaries of these awards, both present and future, to devote their recoveries to Ukrainian reconstruction.

Tort Law, Social Policy... and Bankruptcy

I cannot tell you what to think about the fact that the long-running Clifford Symposium on Tort Law and Social Policy, at DePaul University College of Law in Chicago, kicks off with a bankruptcy panel this year.  The official title of the conference this year is Litigating the Public Good: Punishing Serious Corporate Misconduct. Much of the June 2-3 conference is scheduled to occur in person but online observation is available and free: register here. 

A Tournament of Lawyers: Who Should Sri Lanka Hire to Manage its Debt Restructuring?

Rumor is that close to thirty leading international law firms have put in bids to assist Sri Lanka in its upcoming debt restructuring.  Makes sense -- there is a fat paycheck for whoever gets the mandate.  Given the stakes, my guess is that these firms -- and I'm just guessing -- are busy trying to "influence" whomsoever they can in both the current government and in the opposition (after all, the current government might fall any day now) to get ahead in the competition.  Yuck.

Having a good adviser can make a huge difference in terms of how well one's debt restructuring goes.  Hopefully, the decision will made as a function of which adviser will give Sri Lanka the best restructuring design and not made as a function of who is best buddies with the President's closest flunky.  I'm not optimistic though.

I have a suggestion.  I know it has zero chance, but I'm going to make it anyway.  We should have a competition, a tournament of lawyers. Each of these firms should have to put up on  ssrn.com a ten page plan as to how it plans to solve the likely holdout problem with Sri Lanka's restructuring.  Then, Sri Lanka could have a neutral panel of respected restructuring experts pick the firm with the best plan. Or the experts could pick four semi finalists and those semi finalists could be given the opportunity to present their plans and answer questions in an open setting. 

Wouldn't it be a lot better for these firms to be spending their resources competing to design the best possible plan for Sri Lanka than competing to please the president's best friend or the cousin of the leader of the opposition?

These foreign advisers are expensive. And perhaps rightly so, given what they provide.  But they should have to earn every penny they charge a country in deep distress.  Maybe some of them with a really good plan might even offer to work pro bono?  After all, fame and fortune can come alongside a beautifully conducted restructuring.

Let the games begin.

 

Venmo's Unfair and Abusive Arbitration Opt-Out Provision

Venmo's changing the terms of its arbitration agreement, and the manner in which it is doing so is unfair and abusive to consumers. The CFPB and state attorneys general need to take action here to protect consumers.

Here's the story.  Last night I got an email from Venmo entitled "Upcoming Changes to Venmo." Nothing in the email's title (which is all I see on my devices) signals that there is a change in contractual terms, and I would have just deleted it without reading but for seeing consumer finance list-serv traffic light up about it.  So I looked at the email, and in the body it does explain that there are changes to the Venmo arbitration clause. It also tells me that I can opt-out of the Agreement to Arbitrate "by following the directions in the Venmo User Agreement by June 22, 2022".  The Venmo User Agreement is hyperlinked.  It is a 95 page document. The hyperlink takes me to the very top of the agreement, but the arbitration agreement starts on page 70.  It takes a lot of scrolling to get there, and nothing is particularly prominent about the arbitration agreement's text.

The arbitration agreement itself has a summary at the top that includes a few bullet points, one of which is "Requires you to follow the Opt-Out Procedure to opt-out of the Agreement to Arbitrate by mailing us a written notice." The term Opt-Out Procedure is a hyperlink to a form that can be printed (but not completed on-line).

What's so ridiculous about requiring a hand-written form to be sent through the mail is that Venmo will surely digitize the form. That means someone's gotta open the mail and do the data entry. Why not have the customer do that himself? Or for that matter, just have a check box on my Venmo account for opting out of the arbitration agreement? The only reason to use the paper form and posts is to make it harder for consumers to opt-out of the arbitration provision.

What Venmo's doing is unfair and abusive and therefore illegal under the Consumer Financial Protection Act. It's perfectly legal for Venmo to have an arbitration clause, and there is no requirement that consumers have a right to opt-out of arbitration, although a change in terms on an existing contract is a bit more complicated. Be that as it may, Venmo is the master of its offer, and by giving consumers a right to opt-out, but raising barriers to the exercise of that right, Venmo is engaging in an unfair or abusive act or practice. Venmo is trying to have its cake and eat it too, but pretending that consumers have a choice about arbitration, but not actually giving them one.

That's "unfair" under the Consumer Financial Protection Act because the practice makes it likely that consumers will lose their right to proceed as part of a class action. That is a substantial injury to consumers in aggregate. The ridiculous opt-out procedure makes this injury "not reasonably avoidable by consumers." The consumer would have to click on no less than two hypertext links, starting with an email the title of which gives no indication what is at stake, and then navigating through a 95 page agreement to find the second link. After that, the consumer must print, fill out, and mail a form. Whatever one thinks of the benefits of arbitration, there's no benefit to consumers or competition from making the opt-out difficult. To my mind, this is a very clearly unfair act or practice. It's also an "abusive" act or practice under the Consumer Financial Protection Act. Because the terms of the opt-out make it so difficult for a consumer to actually exercise the opt-out, the terms of the opt-out "take unreasonable advantage of —the inability of the consumer to protect the interests of the consumer in...using a consumer financial product or service."  (One might also even be able to argue that it is a deceptive practice--the opt-out right has been buried in fine print and hypertext links.) 

Both the CFPB and state attorneys general have the ability to enforce the UDAAP provisions of the CFPA against nonbanks like Venmo. I hope the CFPB and state AGs get on Venmo about this. It presents a good opportunity for the Bureau to make clear what it expects in terms of fairness for contract term modification and opt-out rights.

Can Russia Pay its 2022 Dollar Bond Obligation in Rubles? (More dodgy Russian bond clauses?)

I didn't think so. But one of my students has me questioning myself.

As of this writing, in April 2022, the press is reporting that Russia is on the brink of default because its foreign currency funds are frozen (here). Russia says that it is not in default because it is unable to make the dollar or euro payments as a result of the sanctions and is entitled to make its payments in rubles.  Investors have dismissed this idea – saying that it is “crystal clear” that payments on the bonds with payments due April 2022 have to be paid in foreign currency (here).

Yes, there are some bonds, containing an “Alternate Payments Currency” clause issued in the post-2014 period, where Russia is arguably entitled to make payments in rubles if, for reasons out of its control, it is unable to pay in the primary currency specified in the bond (here).  But the bonds that have come due in April 2022 do not contain that Alternate Payment Currency clause. And hence the assumption seems to be that the ruble payment constitutes a default.  And I confess that that was my assumption until a student, Doug Mulliken, pointed out a clause that I had previously missed.

It is clause number 15, titled “Currency Indemnity.”  The first sentence of the clause says:

The U.S. dollar is the sole currency of account and payment for all sums payable by the Russian Federation . . . in connection with the Bonds, including damages.

That’s well and good.  The US dollar is the currency of payment.  But then the clause goes on to say:

Any amount received . . . in a currency other than the U.S. dollar . . . by any Bondholder in respect of any sum . . . due to it from the Russian Federation shall only constitute a discharge to the Russian Federation to the extent of the U.S. dollar amount which the recipient is able to purchase with the amount so received or recovered in that other currency on the date of that receipt or recovery . . . If that U.S. dollar amount is less than the U.S. dollar amount expressed to be due to the recipient under any Bond, the Russian Federation shall indemnify such recipient against any loss sustained by it as a result. In any event, the Russian Federation shall indemnify the recipient against the cost of making any such purchase.

To my reading, Doug is right. Boiled down, the clause seems to say that payment in a different currency (e.g., rubles) can constitute a “discharge”, so long as the recipient can use those rubles to buy a sufficient number of dollars.  That seems to mean that Russia, can discharge its obligations by paying in rubles.

Now, maybe I have missed some other clause in the document that negates this.  It would not be the first time that that’s happened.  But I do remember reading a chapter in Lee Buchheit’s, How to Negotiate Eurocurrency Loan Agreements, (Chapter 20, if memory serves) that not only describes clauses like this, but also explains how they are a potential source of mischief if the clause was not written tightly enough to protect against the debtor using capital controls in a sneaky fashion.

The sneaky thing for Mr. Putin to do would be to make the payments in rubles into an account in Russia, immediately convert the rubles to dollars and then say that the dollars are frozen in place under capital controls.  Pay enough rubles and, according to the strict terms of the contract, that would be a discharge.  And Mr. Putin could say that those dollars would be frozen until his foreign assets in the west were unfrozen.

One might ask here: Doesn't the bond require payments to be made in NY?  Yes, but Section 15, the Currency Indemnity clause, describes what happens if the holder “recovers OR RECEIVES” a payment in another currency, presumably in another place.

And it says that the USD payment is “discharged” if the holder receives a sufficient amount of that other currency to buy $$$ in the amount originally due on the date the other currency is received or recovered.

All of that will have happened.

Would a court buy any of this? Probably depends on where the court is located.  London, NY or Moscow.

The problem probably could have been obviated had the Currency Indemnity clause specified that the dollars acquired with the other currency (rubles, in our hypothetical) be "freely transferrable dollars". But it doesn't say that.

Aiyiyiyi

Credit to Doug Mulliken. Errors are mine.

That Odd Sri Lankan Airline Guaranteed Bond

Mitu Gulati & Mark Weidemaier

After months of waffling, Sri Lanka’s head-in-sand government has finally acknowledged that it cannot pay its debts. The cavalry (IMF) has been called in and we guess that hordes of potential restructuring advisers are flying to Colombo to offer their services. Assuming they have done their homework, their proposals surely will consider both the government’s own debt and a Sri Lankan airline bond that the government has guaranteed.

Sri Lankan airlines used to be profitable. From 1998-2008, it was partially owned and run by Emirates. One of us recalls it being a special treat to fly on. But the government decided in 2008 to run the airline itself and, since then, it has performed terribly.  There have been corruption scandals, accusations that Emirates was pushed out after the airline refused to bump paying passengers to make room for the royal family, and reports that local banks have been strong-armed into lending and will be in trouble if the airline collapses. Perhaps it’s no surprise that it needed a government guarantee to borrow money.

Sovereign guaranteed bonds often carry a higher coupon than a bond issued by the sovereign, perhaps because the sovereign is viewed as the safest credit. But this logic seems upside down. Unlike a pure sovereign bond, a guaranteed corporate bond is backed both by the sovereign’s credit and by a separate pool of assets (e.g., airplanes). Even if the company is literally worthless, there is still the full sovereign guarantee. Obviously there will be other factors that affect price, such as liquidity (the market for pure sovereign bonds may be much larger). But in crisis, when the bonds are sure to be restructured, there seems every reason to favor the guaranteed bond.

Another reason to favor a guaranteed bond is that these often have less effective restructuring mechanisms than are found in the sovereign’s own bonds. Oddly, then, a guaranteed bond that was viewed as riskier at issuance can end up being a safer bet. Greece’s 2012 restructuring imposed haircuts of over 50% on pure sovereign bonds but most holders of guaranteed bonds got paid in full. There is even some evidence suggesting that investors had figured this out towards the end game in Greece and favored guaranteed bonds. 

Here are some of the provisions in the airline guaranteed bond that could cause Sri Lanka’s restructuring advisors a giant headache.

How to Destroy the Collective Action Clause

Mark Weidemaier & Mitu Gulati

We almost hate to post this, because it is so simple, and so fundamental, that it seems almost surely wrong. But if it’s wrong, we can’t see why. Maybe a reader can explain? Here goes.

For at least 20 years, reform efforts in sovereign debt markets have promoted collective action clauses (CACs) (here and here). The current version of the clause was drafted by a super-committee of senior lawyers, investors, and finance ministers – many of them people for whom we have enormous respect. It lets the sovereign bond issuer hold a restructuring vote across multiple series of bonds in a so-called aggregated vote. Before, most CACs in the market required a vote for each series of bonds. The point of the reform was to make it impossible for litigious holdouts to exclude one or more individual series of bonds from a restructuring that had garnered the support of a creditor supermajority. But—and here’s the important point—outside of the euro area, these aggregated CACs are reserved for bonds issued under foreign law. They don’t have to be. But contract reform to solve the holdout problem hasn’t seemed important for bonds governed by local law, which the sovereign can already restructure just by changing its law.

Most sovereigns issue most debt under local law. So, here’s the CAC destroying idea:

Phase 1, the sovereign restructures its local law debt (either by passing legislation or by asking bondholders to tender). The restructured bonds might or might not include new financial terms. What they definitely will now include is a modification provision substantially similar to the one that appears in its foreign law debt. However, the restructured bonds are still governed by local law.

Phase 2, the sovereign proposes a restructuring of the entire debt stock, aggregating the vote of local and foreign law bonds together.

Ukraine versus Russia, English Supreme Court

Bailiffs for Gunboats is the title I have given to a short paper to be published in a Festschrift for the famous German scholar, Christoph Paulus, lately head of the law faculty at Humboldt, Berlin. It discusses a case remarkably overlooked despite its unusual facts, its major legal and political implications, and its role as a prelude to the horrors of the current war in Ukraine.

The case of Ukraine v. Russia (“Ukraine-Russia”), pending decision in the Supreme Court of England for more than three years, lies at the intersection of traditional public international law and private international law. It presents the question of court enforcement of a debt that is intertwined with sovereign political relationships. More broadly, it reflects the great power that private enforcement of a commercial instrument may nowadays give to a creditor that has goals beyond repayment. In the special context of a sovereign creditor of a sovereign debtor, the case reveals the potential role of privately enforceable debt in achieving the creditor’s political ends.

The decline and fall of commercial law

A listserv post this morning accentuated a troubling trend at the intersection of commercial law and bankruptcy practice: a marked decline in confident expertise in the former.

The scenario is simple and, I suspect, common: perfected security interest in collateral (say, a car), collateral destroyed (either before or after bankruptcy filing), insurance company sends check to bankruptcy trustee rather than to the debtor or secured creditor. Trustee then claims the insurance check is not subject to the security interest, which understandably takes the secured creditor's lawyer quite by unpleasant surprise. Is this check not obviously "substitute collateral" for the destroyed original collateral (the car), s/he asks?

Well, yes, but ... neither the trustee nor a judge is likely to accept the creditor's lawyer's correct answer without some compelling analysis as to why; that is, citation to governing law (i.e., statutory authority). The challenge, which I emphasize to my Secured Transactions students every year, is that the security agreement is unlikely to resolve this. Only a lawyer who is very familiar with secured transactions law could possibly know how this answer gets worked out (regardless of what the security agreement says or does not say about insurance "proceeds"). Analysis below the fold (you know you can't resist!) ...  

Odd Lots Podcast: The Narrowly-Avoided Russian Debt Default

Mitu and I have posted a few times (here, here, and here) about some of the odd features in Russia's bond contracts. Perhaps the weirdest (and most odious) is the Alternative Payment Currency Event clause, in which investors effectively insure the Russian government against the risk of future sanctions. Anyway, we had a chance to discuss these clauses, and the general complications of a potential Russian default, with Bloomberg's Tracy Alloway and Joe Weisenthal on their fabulous Odd Lots podcast:

There’s a big question over whether Russia will be able (or willing) to make payments on billions of dollars it’s borrowed from investors given its current situation. Not only does the country have a history of previous major defaults, but some of its outstanding bonds are also structured kind of strangely. On this episode of the Odd Lots podcast, Tracy Alloway and Joe Weisenthal speak with University of Virginia law professor Mitu Gulati and University of North Carolina's Mark Weidemaier. They describe how odd some Russian bonds are and what might happen after default.

Spoils Don't go to the Aggressor

Mark Weidemaier & Mitu Gulati

Ukraine has suffered an unprovoked invasion by a militarily more powerful neighbor, Russia, that covets its territory. The weaker Ukraine, in danger of being overrun, desperately seeks external financing for defense and to support its population. What might we think the rules of international law would be regarding the responsibility to pay that debt?

The relevant law here is antiquated. There are a handful of precedents from the nineteenth and early twentieth centuries where, best we can tell, the law was whatever it was convenient for the victor to assert. But, if one were to try and extract a doctrine out of those precedents, it would be that, while a victorious invader inherits the debts of the nation it invaded, it does not necessarily inherit debts incurred to resist the invasion. The doctrine even has a name: the law of “war debts”. To quote a 1924 treatise, “A creditor who advances money to a belligerent during a war to some extent adventures his money on the faith of the borrower’s success”.

That’s nuts. That doctrine incentivizes potential lenders to invest in the debt of the more powerful actor, even if the less powerful actor has a legitimate right to self-defense. It is perhaps not surprising that such an upside-down rule existed in the colonial era, when great powers constructed the law to justify their acquisition of territory (the original articulation of this doctrine seems to come from Britain after the Boer War). But today? In the supposed post-colonial era when borders are supposed to be sacrosanct absent the most egregious violations of human rights and colonial acquisitions by force are not supposed to happen? When an aggressor launches an unprovoked attack (Mr. Putin has his own version, we recognize), it seems logical both that that the aggressor should bear the cost of the victim’s self-defense and those who funded it should be the ones at risk. This rule internalizes the cost of misbehavior and might help deter aggression. This rule seems to set the right incentives whether or not the aggressor nation winds up being victorious.

In the Russia-Ukraine context then, who should be responsible for the extra borrowing that Ukraine has to do to defend itself? If the goal is to cause the misbehaving actor to internalize the costs it is imposing, the answer is surely Russia. Furthermore, to the extent lenders helped finance the Russian invasion, they are the ones who should face a high risk of nonpayment, not those who funded the Ukrainian defense. If we were to imagine a situation, post-war, where the international community had to allocate a limited pool of assets (e.g., frozen Russian reserves), we’d probably say that claimants who funded Ukraine’s self-defense should have a higher priority than claimants who helped fund Russian misbehavior. That is especially so if the lenders to Russia had reason to expect misbehavior. Maybe Russia even told them in its risk disclosures whilst borrowing – “Hey, don’t be surprised if I get sanctioned in the future – because I tend to misbehave”. (see Tracy Alloway (here), Adam Tooze (here), and us (here) on this).

None of this is rocket science. One of the things that legal rules are supposed to do is to incentivize good behavior and disincentivize bad behavior. As of this writing, the World Bank has just announced an emergency financing package of $700 million for Ukraine. Maybe that lending will be repaid by Russia, in a post invasion scenario on the theory that multilateral institutions such as the World Bank are not allowed to finance military expenditures. We don’t remember seeing any multilateral organization exception in the law of war debts though.

More important though, Ukraine needs financial assistance to defend itself and is surely going to be trying to borrow from the private markets. And lenders are going to be reluctant to fund it (or, will charge more) if they think they face significant risk of non-payment if Russia wins. Whether one liked it or not, risk disclosures would probably have to be made in the prospectus regarding the doctrines of state succession and war debts.

But what if the rule instead were that those who provided financing to Ukraine during these dire times were to have first shot at those frozen Russian assets in the post war period? (in legal lingo, priority)? Those risk disclosures and the pricing of the financing of the Ukrainian resistance might be different.

Maybe, just maybe, the free nations of the world (including those former colonial powers who created these doctrines) should announce a new and improved doctrine of war debts for the modern era: Spoils don’t go to the aggressor.

Should Investors Who Care About ESG Buy Russian Sovereign Bonds?

Mark Weidemaier and Mitu Gulati

Umm... no?

We can think of two models of ESG investing. (At Bloomberg, Matt Levine has a more sophisticated take; also here.) One is normative, simple, and apparently held by very few investors. It goes something like, don’t invest in “bad” activities or borrowers. A second model, apparently more common, is that investors rely on ESG metrics to inform them about potential risks and economic implications of a borrower’s ESG-related practices. As Sustainalytics puts it, “Material ESG issues (MEIs) are business issues related to environmental, social, and governance factors that may have a measurable impact on financial performance.” We confess that we don’t really understand this second model, or how it differs from an investment approach that puts risk-adjusted returns above all else. But it seems to make people feel good.

Anyway, you probably were not wondering about the link between Russian sovereign debt and ESG investing. Neither were we, because, well, why would anyone wonder about that? It seems obvious that investors buy Russian sovereign debt specifically because they do not care about ESG goals, at least for purposes of that investment. The ESG part of the investor’s brain is off doing something else while the part that chases yield buys Russian bonds. But most investors claim to care about ESG goals. And some people seem to be wondering what it means that investors who make this claim sometimes hold Russian bonds too. One way to understand this fact is to posit a flaw in ESG metrics. As the Financial Times summarizes one expert in sustainable finance, “Russia’s invasion of Ukraine has exposed the failings of asset managers and data analytics firms in their assessment of environmental, social and governance risks.” An implication is that “ESG data firms need to look at [the war in Ukraine] and ask themselves what they have missed.”

Another way to put the problem is to say that what ESG data firms have missed is that investors do not care about ESG. Yet a third way to put it is to say that investors cannot be bothered to read contracts, so you can get them to agree to the most outrageous things if you just have the chutzpah to write it down and hope they don't notice. The Russian sovereign bonds nicely illustrate both of these latter possibilities.

The Alternative Payment Currency Event Clause in Russian Sovereign Bonds

Mark Weidemaier and Mitu Gulati

A clause in recent Russian dollar and euro currency bonds – presumably written in anticipation of the possibility of sanctions from the US or the European Union -- allows payments to be made in a currency other than Euros and US dollars under certain conditions. Russia’s 2019 bond issuances in US dollars and Euros says, for example, that the Russian Federation may, under conditions “beyond its control”, make payments in an “alternative payment currency."

“Alternative payment currency” in the US dollar issuance is defined as “Euros, Pound sterling or Swiss francs or, if for reasons beyond its control the Russian Federation is unable to make payments of principal or interest (in whole or in part) in respect of the Bonds in any of these currencies, Russian roubles."

What's unclear is what makes a reason “beyond the control” of the Russian Federation in case it finds itself "unable to pay" in the specified currency. Presumably the fact that Vladimir Putin has forbidden something does not make it beyond the control of the government; he can choose not to forbid it. But could Russia plausibly argue that it is unable to pay because of western sanctions, and these are beyond its control?

Are Russian Sovereign Bonds Now Worthless?

That is the question Mitu and I discuss in the latest Clauses and Controversies episode. We were prompted by a Bloomberg story quoting Jay Newman (formerly of Elliott Associates), who expects Russia to default and points out that its international bonds lack waivers of sovereign immunity. But this doesn't mean investors can't sue. To the contrary, investors probably can convince courts in New York and other places to accept jurisdiction and enter favorable judgments. It won't be quite as easy as in cases where the bond includes a waiver of jurisdictional immunity and related provisions, such as appointing an agent for service of process, that ease the path to the courthouse. But it's certainly do-able.

The harder problem is finding attachable assets. Having a waiver of the sovereign's immunity from attachment and execution makes things much easier, but it's possible to attach assets even without a waiver, and especially so when the foreign state lacks the support of the U.S. and most other governments.

It turns out that Russia's international bonds have all kinds of interesting clauses. Some are very investor-friendly, including a super-broad pari passu clause. Some aren't investor-friendly at all, such as a very short, three year prescription clause. And others are just weird, including a clause in a subset of bonds that potentially allows the Russian government to pay in roubles. We discuss all of these in the podcast.

Maybe investors won't line up to sue the Russian government. But if ever there was an opportunity for distressed debt funds to be on the side of the angels, this is it. So perhaps this will be the assignment we give students in our sovereign debt classes to work on for the rest of the semester:

Your client is Rick Blaine, manager of the New York based hedge fund Ilsa Capital.

A few things you should know about Rick.

He is rumored to have run guns for the anti-Franco side in the Spanish Civil War.  He never drinks Vichy mineral water. And he hates thugs of all types and nationalities.

Ilsa Capital owns positions in each of the Russian Federation foreign currency/ foreign law bonds that are outstanding as of March 1, 2022. 

Rick wants to join the fight in the Ukraine but his employees have persuaded him that he can do more for the cause by increasing the financial pressure on Mr. Putin. For this he needs your counsel.

Rick assumes that the Russian Federation, in light of the painful financial sanctions being imposed on it by the EU and USA, will stop paying interest on all of its US dollar and euro-denominated bonds.

His question to you is simple — “once they default, what can we do to cause trouble?” Rick is very popular in the hedge fund industry and has assured you that once you design a strategy, Rick is more than happy (in his words) to round up the usual suspects.

Rick does not like to read lengthy documents from lawyers. Hence, please keep your memorandum to under ten pages (double spaced).

The Texas Two-Step? Just Don't Go to the Dance

Suppose a company facing mass tort liability to U.S. citizens produced a piece of paper that read "Cook Islands Liability Extinguishment Corporation." The company then says to the tort victims, "We have formed this corporation under the law of the Cook Islands, which allows us to assign any liability we want there and extinguish it. And, that's exactly what we did with your tort claims." The legal response would surely be that the law of the Cook Islands does not govern the company's tort liability under U.S. law.

The "American Default" of 1933 and Some Possible Sanctions

Last week, my International Debt class was fortunate last week to have the opportunity to talk to Sebastian Edwards about his wonderful book “American Default”.  The book tells the astonishing (to me at least) story of the abrogation of gold clauses in US corporate and government bonds in 1933 and how that abrogation is then upheld by at 5-4 vote of the US Supreme Court in 1935.  Equally astonishing, as Sebastian’s book describes, the spillover effects in terms of costs to US future government borrowing, were near zero.  If anything, USG bonds were oversubscribed.

Our class session with Sebastian was last Wednesday and the world has witnessed some remarkable and disturbing events since then in Ukraine.  In the wake of our discussion of FDR’s 1933 abrogation of the gold clauses though, I found myself wondering about the following hypothetical for purposes of class discussion.

A large country, Bearland, brags that it has $630 billion of international reserves, the largest portion of which is held in the form of US Treasury bonds. 

Tomorrow afternoon the US Congress passes the following law:

Commencing at 12:00 noon EST on February 26, 2022, holders of US Government debt securities will be required, in order to redeem those instruments at maturity, to certify that neither they nor any predecessor in title to the securities has ever invaded the Republic of Ukraine.   Securities owned by any holder who cannot make this certification will be redeemed at maturity and the proceeds deposited in a blocked account at the Federal Reserve Bank of New York.  

Context: Acme Capital, a New York based hedge fund, has acquired $1 billion of US Treasury bonds previously owned by Bearland.  Acme sues to declare the law unconstitutional and unenforceable. You are a law clerk to Justice Gelpern on the US Supreme Court.   She has asked you this question:  Don’t the Gold Clause cases from 1935 control this issue?   After all, Acme is getting its money so they are not harmed in that sense.  Acme just doesn’t like the fact that the money is blocked at the Fed”.

The foregoing strikes me as example of a situation in which the justices (and law clerks) must not only consider the legal correctness of the advice, but also its real world consequences.  In other words, very much the situation in 1935.

In the Bearland example, the legal question is whether the Bearland legislation imposes an ex post interference with contract or unconstitutional taking of Acme’s property by requiring the no-invasion certification.   

Advising that the measure is kosher, however, potentially puts all USG debt at risk of political interference. To see this, just change the words “invade Ukraine” in the Bearland certification to “invade Taiwan”.  Would any foreign state be prepared to buy US Treasury bonds knowing that they could be weaponized at any moment?  How much would that add to the interest rate on those bonds? Anything?

I wonder whether folks at the UST are considering strategies along these lines.  Maybe?

Bye, Bye, ABI

I have been an American Bankruptcy Institute member since June 1999, but I have finally made the difficult decision to allow my membership to lapse after 22 years at the end of next month. 

I've been thinking about this for some time. Academic friends had been suggesting to me for years that they were uncomfortable with some of ABI's practices, and I was shocked when ABI sharply raised my membership dues for the first time in two decades a few years ago. I've been thinking since then about the value proposition of my membership, and I had begun to notice that I seemed to be getting very little value for my increased dues ... and then I received the first of several renewal notice emails.

When I reviewed the renewal webpage, I recalled my friends' concerns about ABI's objectionable practices as I saw what seemed to me to be a troublesome new practice. For years, I have simply renewed and paid electronically, with no "gotcha" commitments. This year, for the first time, I noticed that I had to select a box indicating that I agreed to have my membership auto-renewed and my credit card auto-charged for future dues. Perhaps it's irrational, but this really stuck in my craw. I envisioned one of those misleading commercials for leggings or bamboo socks that suck you into an auto-renewal scheme, and more importantly, I recalled the FTC's concerns about the abusive auto-renewal trend that seems to have popped up in recent years. States have begun to pass anti-auto-renewal laws to curb this abusive practice. I understand, of course, that auto-renewal is convenient and desirable for many people, and the checkbox on ABI's renewal page would be unobjectionable if it were optional. But forcing members to "agree"--again, for the first time ever--to auto-renew and auto-pay in the following years (or navigate back into the electronic membership labyrinth and manage to figure out how to cancel this auto-renewal in time to avoid it) is a shocking practice for an organization that purports to stand for (among other things) protecting consumers. Unseemly at the very least.

Harmony or Mismatch? A virtual event on mass torts and bankruptcy on February 28

Just wanted to make sure Credit Slips readers were aware of this virtual event at noon Eastern/3 Pacific on February 28. Bonus: a link to a masterful analysis of the topic by Professor Elizabeth Gibson that the Federal Judicial Center published in 2005. (click here for information and registration)

Annotated Bibliography of Histories of Debt and Bankruptcy

I just read a really fabulous annotated bibliography of books (alas, articles by such luminaries as Emily Kadens are excluded) on the history of credit, debt, and bankruptcy in the United States. Many of my favorites are on here, along with a few new entrants with which I was, embarrassingly, unfamiliar. This is a great resource for new lawyers and law professors, in particular, but also for anyone interested in this fascinating history and/or looking for something to help while away the cold, blizzard-bound winter hours. Enjoy! 

Law School Rankings: How Much do They Really Matter?

I've long assumed that law school rankings are very important to law student choices regarding where to attend school. After all, why else would law schools themselves care so much about the rankings -- sometimes even hiring and firing deans based on this single variable (my assumption here is the most in the academy don't see there to be much of substance in the rankings -- but I may be wrong).

A wonderful new study from Albert Yoon and Jesse Rothstein, "Choice as Revelation" two of my favorite empiricists in the academy (I loved their prior paper about mismatch), challenges the conventional wisdom.  As I understand the core finding, students don't attach much difference to small differences in rankings. They care about other things in these choices among close competitors.  Strikes me that this is an important finding.

This is not to say that students don't care at all about rankings; they do -- especially at the very top (Harvard, Stanford, Yale).  After that though, not so much.  

The abstract reads:

Education is a credence good. While the virtues of education are widely embraced, its qualities are difficult to discern, even among its consumers. The sizeable and increasing cost of tuition – as in the case of U.S. law schools – only add to the stakes. In response, law school rankings have emerged, with the purported goal to help students make more informed choices. While these rankings have generated both interest and debate, an important question has remained unanswered: how do prospective law students perceive these schools? Drawing upon data provided by the Law School Admissions Council (LSAC), we analyze the universe of law school applications for the period 1989 through 2017, creating a revealed preference ranking of law schools based solely on where applicants choose to matriculate given their offers of admission. We find that applicants strongly prefer Yale, Stanford, and Harvard, and to a lesser extent other schools in the top 20, but do not draw such sharp distinctions outside of these schools. For all but the very top schools, we cannot rule out that schools adjacent in the rankings are equally preferred by admitted students. We also separately analyze the application, admission, and matriculation stages of the law school matching process. Applicants apply broadly, we find, but that admissions and matriculation decisions hew closely to academic indicators. Our revealed preference rankings are similar those of the U.S. News law rankings at the top but bear little resemblance for the remaining schools. Our rankings offer a compelling alternative to commercial rankings, which are opaque and highly manipulatable. Our analyses also highlight the limitations of ordinal rankings, which by themselves can suggest meaningful differences amongst alternatives where they do not exist.

What Happens If a Cryptocurrency Exchange Files for Bankruptcy?

Exchanges play a key role in the cryptocurrency ecosystem, but no one seems to have given any consideration to so far is what happens when a cryptocurrency exchange that provides custodial services for its customers ends up in bankruptcy. We’ve never had such a crypto-exchange bankruptcy in the US—Mt. Gox, for example, filed in Japan—but it’s certainly a possibility.  These exchanges are not banks, so they are eligible for Chapter 11 if they have any US assets or incorporation, and they face substantial risks from hacking and their own proprietary trading in extreme volatile assets.

So what happens to a customer if an exchange files for bankruptcy?  I think it ends very badly for the customers, as explained below the break. I do not think customers understand the legal nature of the custodial relationships, and exchanges have no incentive to make the legal treatment clear to customers. In fact, the exchanges are lulling the consumers with language claiming that the consumer "owns" the coins, when in fact the legal treatment is quite likely to be different in bankruptcy. In bankruptcy, it is likely to be treated as a debtor-creditor relationship, not a custodial (bailment) relationship. That means that customers are taking on real credit risk with the exchanges, which is a particular problem because of the opacity of the exchanges and their lack of regulation.

Just posted: Other Judges' Cases

This article has been in the works a long time. During the Detroit bankruptcy, I wrestled with some of its topics on Credit Slips.  

The case studies involve bankruptcy. The mediators in those cases are life-tenured judges.

The footnotes make it long; the text is short.  

Other Judges' Cases remains in the edits stage and is scheduled to be published later this year.  

Please read it. Thank you!

The Miscalculations Underlying Miller & Zywicki's Payday Loan Paper

Earlier this month Professors Todd Zywicki and Thomas Miller, Jr. wrote an op-ed in the Wall Street Journal arguing against payday loan regulation, based on their new empirical paper. Miller & Zywicki wrote:

Our findings will startle the rule writers at the CFPB. Contrary to the research cited in the CFPB’s 2017 rule, which claimed that “loans are almost always made at the maximum rate permitted,” we found that neither fees paid nor loan amounts inexorably rose to maximum allowable levels when those allowable levels were reasonable.

The implication is that there must be price competition among payday lenders with supply and demand setting prices, vitiating the need for regulation.

The problem is that Miller and Zywicki have incorrectly calculated the maximum fees permitted in numerous states. They wrongly assume that the effective rate charged for the first $100 of credit also applies to higher amounts. In fact, in many states, there is either a tiered, decreasing rate or a rate plus a flat fee included in any loan. As a result, Miller & Zywicki calculate the maximum permitted fees as being substantially higher than they in fact are in every state in which they find lenders are not pricing up to the legal limit.

Once this error is corrected, Miller and Zywicki’s figures actually confirm a truth that has long been obvious to anyone who has ever looked at payday loan pricing: there is no price competition, as lenders virtually always price up to the legal limit.

If my (lengthy) analysis below the break is correct, Professors Miller and Zywicki ought to retract both their op-ed and their paper. This is the sort of error for which op-eds and research papers are properly retracted. While Professors Miller and Zywicki might be opposed to payday regulation on ideological grounds, they surely do not want to base their claims on erroneous calculations of state fee caps.

PSLF update

At last report, the US Education Department has discharged 38,000 student loans under the limited waiver program to increase Public Service Loan Forgiveness approvals. US ED does not report comprehensive data, but piecing together several reports, this looks to be out of perhaps 800,000 to 900,000 total applications since 2017. In November 2020 there had been 227,000 applications, of which fewer than 6,000 were approved. From November 2020 to September 2021, borrowers submitted 678,000 applications, and 11,600 were approved (PSLF and TEPSLF).  The waiver program began in October 2021, and the 38,000 figure was reported in mid-December 2021.

In short, the 2% approval rate has been boosted to 5% to 10% (the denominator is hard to determine.) According to the September 2021 report, the vast majority of denials before the new waiver program (80%) were people either in non-qualifying FFEL repayment or some other non-repayment status (forbearance or deferment) for part of the ten-year period. The waiver should permit most or all of those denials to be reversed. So if you were turned down for PSLF before October 2021, send in an application under the waiver program. It is currently set to expire in October 2022.

Professionals Must Now Disclose Their Interests in the PR Cases

President Biden has just signed the "Puerto Rico Recovery Accuracy in Disclosures Act of 2021’’ or ‘‘PRRADA’," which requires professionals to make chapter 11-style disclosures when they file fee applications in the PROMESA title III cases. Failure to comply not only can result in loss of fees in the Puerto Rico cases, but such failure to disclosure must also be disclosed in other chapter 11 cases going forward. Presumably the prior failure to comply with statutory disclosure requirements should factor into the decision to authorize retention in chapter 11.

The Blurring of Tech and Finance

I have an op-ed in ProMarkets about how Apple leverages control of the iPhone's NFC chip to push the dominance of its platform into new areas that let it hoover up more consumer data. The NFC (near field communication) chip is what lets the iPhone do contactless payments for ApplePay.  Apple strictly controls access to the NFC chip--it doesn't let AndroidPay use it, for example. But the NFC chip's uses extend beyond payments.  Apple is now using it to let the iPhone operate as a car key and a hotel room key. The catch? If you're a car manufacturer or hotel and you want this cool technology to work with your product, you're going to need to share some of the consumer data with Apple. 

What we're seeing here is an example of the increased blurring between tech companies and financial services companies, tied together by troves of consumer data.  This is a development that ultimately challenges the traditional regulatory boundaries of FTC and CFPB and is going to raise all sorts of issues for antitrust, consumer protection, and data privacy for years to come.

A Better Way to Deal with Student Loan Debt

My Georgetown colleague Jake Brooks and I have an op-ed in Politico about the best way to address the student loan debt problem. We argue that existing proposals for outright student debt relief, whether $10k, $50k, or everything, are problematic, at least standing on their own, particularly because they fail to address the student loan problem going forward. Instead, we see income-driven repayment (IDR) plans as a key part of addressing the problem. 

Clauses and Controveries: From Commercial Bank Loans to Blue Bonds

Mark Weidemaier and Mitu Gulati

After a short hiatus (we like to say we are between seasons), the Clauses and Controversies podcast has resumed. This week's episode, From Commercial Bank Loans to Blue Bonds, features Antonia Stolper from Shearman & Sterling:

Sovereign debt markets have evolved significantly over the years, from syndicated bank loans, to bonds, to the current infatuation with ESG lending. Antonia Stolper (Shearman & Sterling) joins us to talk about the evolution of sovereign debt practice over the course of her eminent career. We also talk about Belize's recent debt restructuring, where some say creditors agreed to significant additional reductions in exchange for promises by Belize to invest the savings in environmental conservation projects. Antonia helps us understand what actually happened in this deal and what its implications might be for future sovereign restructurings.

New Year, New Data in Your Credit Score

During 2021, reports from the CFPB and consumer advocates spotlighted the role of credit scoring in people's financial growth or stagnation and decline. These reports emphasized racial and ethnic disparities in credit scores and in complaints about errors in credit reports. Congressmembers introduced three draft bills aimed at improving credit reporting. Given the problems with traditional credit reports and scores, along with barriers to access to credit and other opportunities faced by the credit invisible, the idea of alternative credit scoring was raised repeatedly last year -- in reports, news stories, and in the draft bills. Seemingly in reaction, starting now, Experian is adding data about "buy now, pay later" loans to credit reports. Soon after Transunion announced that it was “well on [its] way” to including the same data.

Sara Greene and I have a new paper about credit reporting and scores, "Credit Scoring Duality," that focuses on the benefits and potential problems of adding alternative data to credit scoring models. Adding more data to credit scores, at first, may seem appealing. More data = better, more accurate scores? However, the use of this alternative data will not necessarily make the credit invisible or people with low credit scores more attractive. Much of the additional data proposed suffer from the same demographic disparities as the data already incorporated into credit scores. That is, in general, the people supposedly helped by inclusion of alternative data are likely to perform below-average on these inputs. Beyond replicating already present disparities, Greene and I worry that pointing to alternative credit scoring as a solution will distract from larger, systemic issues that are shown by disparities in credit scores. For more details, see our draft paper.

Bankruptcy Filing Rate Is Lowest Since Bankruptcy Code's Enactment--The Question Is Why

There will be around 400,000 total bankruptcy filings in 2021. That figure is historically low. The table to the right shows annual filing figures since 2010, which was the post-2005 peak. The 400,000 filings this year is a 75% reduction from 2010. 

The 400,000 filings in 2021 will be a rate of 1.21 bankruptcy filing per 1,000 persons (using the mid-year, July population estimate). That is the lowest annual rate since the enactment of the Bankruptcy Code. In 1980, the first full calendar year of filings under the new law, there were 1.22 filings per 1,000 persons. In absolute numbers, there were 122,000 more filings in 2021 than in 1980, but there also are over 100 million more people living in the U.S.

Every calendar year since 1980 has had a higher bankruptcy filing rate. Absent some surprisingly high number of filings in December, this year will put an end to that. Ed Flynn's numbers over at the American Bankruptcy Institute show that at least through December 12, the situation has not changed.

Why are bankruptcy filings so low in the midst of a pandemic that has caused so much economic upheaval? Anyone who claims to have an answer to that question is either lying or overconfident. I certainly don't have an answer, but I have some hypotheses suggested by the data, with emphasis on "hypotheses." Below the fold, I explain those hypotheses and conclude with some thoughts about how much lower the filing rate can get.