Oops. How the FDIC Guaranteed the Deposits of SVB Financial Group

When President Biden announced the rescue of Silicon Valley Bank depositors, he emphasized that "investors in the banks will not be protected.  They knowingly took a risk and when the risk didn’t pay off, investors lose their money.  That’s how capitalism works." Unfortunately, that's not how US law works. 

There seems to be a gap in the Federal Deposit Insurance Act that is going to protect some investors in Silicon Valley Bank’s holding company, SVB Financial Group. The holdco’s equity in the bank will be wiped out in the FDIC receivership, but the FDIC doesn’t have any automatic claim on the holdco. This is basic structural priority/limited liability:  creditors of a subsidiary have no claim on the assets of a parent.

What's worse is that the holdco, which filed for bankruptcy today, has substantial assets including around $2 billion on deposit with SVB. Almost all of that $2 billion deposit at SVB would have been uninsured, but by guarantying all the deposits, FDIC accidentally ensured that the holdco’s bondholders would be able to recover that from that full $2 billion deposit.

There any provision in the Federal Deposit Insurance Act that subordinates the claims of insiders—like corporate affiliates or executives—that exceed the insured deposit limit to other creditors. So once FDIC guaranteed all deposits, it necessarily guaranteed the deposits of the holdco and other insiders. 

Who Knew Silicon Valley Was in Manhattan?

Silicon Valley Bank's holding company, SVB Financial Group, filed for Chapter 11 bankruptcy this morning...in the Southern District of New York. Who knew that Park Avenue South was in the heart of Silicon Valley?

Seriously, the venue here looks problematic. SVB Financial Group's petition lists its principal place of business as 387 Park Avenue South, Manhattan. There's a SVB location there with about 20,000 square foot of space. That's sure doesn't seem like a corporate headquarters for the 16th largest bank holding company in the US. Instead, it seems to be more of a bank branch. But the petition does bear the signatures, under penalty of perjury, of SVB Financial Group's CRO and, not so clearly under penalty of perjury, of SVB Financial Group's attorney at Sullivan & Cromwell. 

Curiously, SVB Financial Group has been telling federal bank regulators a different story about where it's located. On its Bank Holding Company Report, Systemic Risk Report, Consolidated Financial Statement, and Parent Company Only Financial Statement for Large Bank Holding Companies—documents filed with the Federal Reserve Board—SVB Financial Group said its address is 3003 Tasman Drive, Santa Clara, California. Hmmm.

What's Going on with First Republic Bank?

Following the failure of Silicon Valley Bank, a lot of other regionals have experienced depositor runs and serious pressure on their stock prices. But there's actually a lot of variation among regionals, and the solutions to SVB's problems don't necessarily fit the other regionals' problems, as the case of First Republic Bank shows.

Was SVB's problem a lack of membership?

If the bank is a Fed member, doesn't it take its USTs to the discount window instead of selling them for big losses? Does this suggest that all large banks (however defined) should be Fed members, regardless of their charter status?

Why Weren't Silicon Valley Bank Depositors Using CDARS?

Silicon Valley Bank seems to have had large amounts of uninsured deposits from businesses and high net worth individuals. And those uninsured deposits are likely to be impaired in the receivership, meaning that they will not get paid 100 cents on the dollar whenever they do get paid.

But here's the thing:  there are turnkey products that enable depositors to insure much, much larger amounts than the FDIC-insurance cap of $250k/depositor/account type. For years and years there's been deposit brokerage services that spread out deposits at multiple banks, all in amounts under the FDIC insured cap. The best known service is called CDARS-Certificat of Deposit Account Registry Service. It's offered by IntraFi (formerly Promontory). I don't know if SVB participated in CDARS, but it's a pretty straightforward solution to the deposit insurance cap.

What Could Go Wrong When a DIP Maintains a Large, Uninsured Deposit Account at Silicon Valley Bank?

You gotta feel for BlockFi customers. First, they find themselves creditors in BlockFi's bankruptcy. And now they've found out that BlockFi had a large, uninsured deposit...at Silicon Valley Bank. Yup, it seems that BlockFi had $227 million in a money market deposit account at SVB. (The UST refers to it as a "money market mutual fund," but that cannot be right, or it wouldn't be at SVB or have any insurance. [See "Another update" below regarding possibility that it was a money market mutual fund sweep account, in which case the money would in fact be protected.]) That would mean there's a $226.75 million uninsured deposit. Given what we know about SVB, part of that $226.75 million in uninsured funds is likely lost if it's still at SVB.  

The US Trustee filed a motion today to force BlockFi to put the funds in insured accounts, but it sure looks as if the cow's out of the barn already. If the money's lost, then the question is who's going to pay for this screw up, and it's especially juicy because it's all tied up with venue competition. 

Wither Student Debt Cancellation? Conservative Justices Showed Determination but a Lack of Conviction

[by Dalié Jiménez and Jonathan Glater]

Yesterday, the Supreme Court heard two cases challenging the constitutionality of the Biden administration’s plan for student debt cancellation. Suing to block the plan are a group of states that argue they will lose revenue if student debt is canceled and two borrowers who claim they should have access to more cancellation than they would receive but are asking the Court to prevent the cancellation plan altogether. 

The cases present two fundamental questions. First, the justices must determine whether the plaintiffs have “standing” to sue: have they established that they will suffer a concrete and particularized injury that is caused by the cancellation plan and which can be redressed by preventing cancellation. Second–and only if the answer to the first question is yes–the justices must assess whether the administration has the statutory authority to cancel student debt.  Listening to the arguments, one message was clear: the conservative justices want to reach the merits of the case but understand the difficulties the Court's standing jurisprudence (primarily a feature of conservative justices) poses.

At stake is a signature initiative by the administration, which means that for conservatives on the Court, the cases offer a chance to deal a partisan setback to the president.  And in the long battle waged by conservative justices to weaken executive agencies, these cases also provide a chance to undermine federal agencies more generally.  These justices clearly recognize the opportunity to achieve multiple goals here.

The oral arguments focused roughly equally on the two questions, but even the conservative justices seemed to have difficulty agreeing with the plaintiffs on the question of standing. This is not that surprising, because neither case features a plaintiff who has clearly suffered an injury that would be cognizable under the Court’s well-established doctrine governing who can sue whom for what and when.  

In fact, some of the possible theories of standing asserted by the plaintiffs in lower court proceedings received hardly any airtime at all during the arguments.  The justices focused on the potential, indirect injury to the state of Missouri if debt cancellation reduces revenue earned by a state-created corporation, MOHELA, which services federal student loans as an Education Department contractor. That reduction in revenue could mean that MOHELA pays less money to the state at some future date–a harm that is pretty speculative and uncertain, rather than concrete and particularized.

The conservative justices know that if they allow these plaintiffs to proceed, they may open the door to future plaintiffs whose claims to harm are as thin and attenuated. A future Republican administration, for example, would face litigation risk from parties who currently would not be able to mount a viable legal challenge. That seems a pretty likely scenario and would force the justices either to allow the suit to proceed, which they will not want to do, or to erode their institutional credibility further by coming up with a way of distinguishing that future case from those of today.

Without resolving the matter of standing, the Court cannot move forward to where they clearly want to go: a holding that would permanently stop the plan to cancel student debt and weaken the executive agencies fundamental to the modern administrative state. And while the oral argument did not clearly reveal the doctrinal basis for the justices aversion to the Biden cancellation plan, their questions did make clear just how hostile members of that conservative wing are to the idea of cancellation.  

All of which is bad news for the 40 million-plus borrowers whose financial futures will be affected by what the Court decides, a reality that Attorney General Prelogar and Justice Sotomayor both took time to highlight but that seemed of little import to the conservative justices. They were more concerned about the “unfairness” of the administration’s focused cancellation program for those who already paid off their loans or didn’t take out loans in the first place.  

It will not bolster the legitimacy of the Court if the conservative majority votes to block this limited cancellation initiative because only forgiveness for all borrowers of all time would be fair, while asserting that cancellation is beyond the authority of the administration anyway.  

 

The Texas Two-Step's New Key

In the wake of the Third Circuit's LTL Management decision many commentators wrote off the Texas Two-Step as dead. Turns out it's not, it's just playing out in a different key with a new filing in SDTX.

Job Opportunity -- Executive Director of National Consumer Bankruptcy Rights Center

With Tara Twomey's selection as the new head of the Executive Office of U.S. Trustee, the National Consumer Bankruptcy Rights Center (NCBRC) is seeking a new director. The NCBRC helps shape consumer bankruptcy law, as it did for many years under Twomey's leadership. This is an opportunity for someone else to do the same. See the NCBRC's web site for the job posting and more details.

Debt-based driving restrictions: new resources

Professor Kate Elengold and UNC Law 2L Michael Leyendecker have just posted very useful reports for no charge on the Social Science Research Network.  In Professor Elengold's words, these reports "classify, catalog, and cite every state law restricting driving privilege based on debt owed to the state or pursuant to a state-controlled system." This includes criminal or civil fines and fees,child support, taxes, tolls, and more. The Twitter announcement of these resources indicates that they welcome additions and corrections, and that a related scholarly article from Professor Elengold will be available soon. 

Here is the driver's license suspension report. 

Here is the car registration suspension report.  

The New Usury

I have a new paper up on SSRN. It's called The New Usury: The Ability-to-Repay Revolution in Consumer Finance. It's a paper that's been percolating a while--some folks might remember seeing me present it (virtually) at the 2020 Consumer Law Scholars Conference, right as the pandemic was breaking out. Here's the abstract:

Consumer credit regulation is in the midst of a doctrinal revolution. Usury laws, for centuries the mainstay of consumer credit regulation, have been repealed, preempted, or otherwise undermined. At the same time, changes in the structure of the consumer credit marketplace have weakened the traditional alignment of lender and borrower interests. As a result, lenders cannot be relied upon not to make excessively risky loans out of their own self-interest.

Two new doctrinal approaches have emerged piecemeal to fill the regulatory gap created by the erosion of usury laws and lenders’ self-interested restraint: a revived unconscionability doctrine and ability-to-repay requirements. Some courts have held loan contracts unconscionable based on excessive price terms, even if the loan does not violate the applicable usury law. Separately, for many types of credit products, lenders are now required to evaluate the borrower’s repayment capacity and to lend only within such capacity. The nature of these ability-to-repay requirements varies considerably, however, by product and jurisdiction. This Article collectively terms these doctrinal developments the “New Usury.”

The New Usury represents a shift from traditional usury law’s bright-line rules to fuzzier standards like unconscionability and ability-to-repay. While there are benefits to this approach, it has developed in a fragmented and haphazard manner. Drawing on the lessons from the New Usury, this Article calls for a more comprehensive and coherent approach to consumer credit price regulation through a federal ability-to-repay requirement for all consumer credit products coupled with product-specific regulatory safe harbors, a combination that offers the greatest functional consumer protection and business certainty.

#PublicDebtIsPublic and #DebtCeilingIsStupid

What could possibly trigger me enough to break a two-year blogging hiatus? A sudden burning desire to consider the difference among budget accountability, debt accountability, and the inane, moronic, irrational, exploding human appendix ****show that is the debt ceiling.

Postpetition Asset Sales in Chapter 13s--Modification, Not Estate Property

Debtors selling houses during a chapter 13 continues to cause conceptual problems for the courts. A recent decision, In re Marsh, from Judge Fenimore in Kansas City is an example. (Hat tip to Bill Rochelle for flagging this decision in his DailyWire column from the American Bankruptcy Institute ($). If you are a bankruptcy lawyer and don't get this column in your inbox each morning, you are missing out.) Judge Fennimore's opinion is a good point of departure to discuss why I don't think these conceptual problems are as difficult as lawyers make it out to be.

In the case at hand, the debtors scheduled the value of their home at $140,000. Between the $125,000 mortgage and a $15,000 homestead exemption, there was no value for unsecured creditors. The debtor confirmed a plan that provided for payment of the mortgage through the trustee, known as a "conduit plan." Although the debtor was below-median income and qualified for a three-year plan, the debtor opted to do a five-year plan, presumably to make it easier to cure the mortgage arrearage. The plan specified that unsecured creditors were to receive no distribution.

Forty-three months into the case the debtors filed a motion to sell the home for $210,000, which the court approved and which generated about $78,000 in cash after payment of the mortgage and fees. The debtor filed a "motion to retain" the cash. The chapter 13 trustee resisted, noting the cash would pay unsecured creditors in full.

Biden DOJ's Excellent Pick to Head USTP

The Department of Justice has announced Tara Twomey as the next head of the U.S. Trustee Program (USTP). This is an outstanding selection. I will leave her impressive biographical details to the DOJ press release, which you really should read. We here at Credit Slips would have added that she is a former guest blogger for us (which is probably why we are not allowed to write DOJ press releases).

Having known Director-designate Twomey for quite a few years, I wanted to add a few things that are not in the release. She is universally respected by her colleagues. Twomey is innovative in her approaches to legal questions, both as an advocate and a scholar. She is giving of her time to help better the law and the profession. More than once, she has served as pro bono counsel to help with an amicus brief, including for me. In her current position, she has filed many amicus briefs herself in the courts of appeals and Supreme Court, with one of her most recent efforts being cited favorably in a Tenth Circuit opinion released just this morning.

Many congratulations to Director-designate Twomey. Also, many congratulations to Attorney General Merrick and the Biden Administration on their excellent decision. Along with the work of the USTP during the leadership of the interim director, Ramona Elliott, the profession's confidence in the USTP is being restored. My inbox this morning has been full of nothing but positive comments on the selection.

Impact of the Illinois Predatory Loan Prevention Act

In 2021 Illinois passed its Predatory Loan Prevention Act (PLPA), which imposes a 36% military APR (MAPR) cap on all loans made by non-bank or credit union or insurance company lenders. Not surprisingly, the law has not been popular with higher cost lenders who either have to change their offerings, cease doing business in Illinois, or figure out some way to team up with a bank that won't run afoul of the law's anti-evasion provision. 

Recently, opponents of the PLPA have been making some noise, pointing to a study by a trio of economists—J. Brandon Bollen, Gregory Elliehausen, and Thomas Miller—about the impact of the PLPA. (The latter two are familiar scholars whose work consistently takes a dour view of consumer finance regulations: readers might recall my debunking of another recent study by Professor Miller, co-authored with Todd Zywicki, that was fundamentally flawed because of the miscalculation of loan caps in various states.)

Using credit bureau data, the Bollen et al. paper finds that the PLPA resulted in a 30% decrease in the number of unsecured installment loans to Illinois subprime borrowers and a 37% increase in the average installment loan size to Illinois subprime borrowers, which they attribute to the difficulty in making smaller loans profitable at 36% MAPR. Additionally, based on a lender-administered survey of 699 online borrowers (not necessarily of installment loans), the Bolen paper also reports a decline in borrower financial well-being following passage of the PLPA. 

Unfortunately, the Bollen paper suffers from serious data and methodological problems such that it does not tell us anything meaningful about the wisdom of the PLPA. Here's why. 

The Texas Two-Step's Liquidation Problem

This post is a joint post by Hon. Judith K. Fitzgerald (ret.)[*] and Adam Levitin

The Texas Two-Step has been the latest fad in mass tort bankruptcies, used, among others, by Johnson & Johnson, Georgia-Pacific, and, in a variation, 3M. The essential elements of the Texas Two-Step are the segregation of the debtor's mass tort liabilities in a non-operating subsidiary, which then enters into a funding agreement with the parent company to cover the mass tort liabilities up to some level. The subsidiary then files for bankruptcy and seeks to have the court stay the mass tort litigation against the non-debtor parent. If this maneuver is successful, the non-debtor parent goes about its normal business,[1] as do all of its creditors ... other than the mass tort victims. Meanwhile, the non-operating debtor subsidiary—whose sole creditors are mass tort victims—just sits in bankruptcy indefinitely.

The basic strategy behind a Texas Two-Step is “delay to discount”: the extended delay of the bankruptcy process pressures tort victims and their counsel to accept discounted settlement offers. The non-debtor parent feels no urgency for the bankruptcy to end because litigation is stayed against it. Moreover, the parent is able to continue its normal operations without being subject to bankruptcy court oversight or even to the regular expenses of defending the mass tort litigation. And because the debtor is a non-operating entity, it is under no pressure to emerge from bankruptcy. The debtor and its parent are both happy to let the bankruptcy drag on as long as necessary. In other words, the Texas Two-Step is an underwater breath-holding contest where the debtor has a snorkel. 

The ultimate end-game in a Texas Two-Step bankruptcy, however, is obtaining releases for the non-debtor parent (and other affiliates), bolstered by a channeling injunction that precludes tort victims from bringing suit against the parent and affiliates after the bankruptcy. There’s a fly in the ointment, however. A channeling injunction under section 524(g) requires that the debtor receive a discharge, and the debtor entity in the traditional Texas Two-Step case is not eligible for a discharge because it is a non-operating corporate entity that will be liquidating.

Sorting Bugs and Features of Mass Tort Bankruptcy

I have posted a short draft article about mass tort bankruptcy. If you would like to send me comments on the draft, that would be lovely, but please keep two caveats in mind. First, I must submit the revisions by February 9. Second, the article must not exceed 10,000 words. For every addition, some other thing must be subtracted. The required brevity means the article does not and cannot canvas the large volume of scholarship about the topic, let alone the mini-explosion in recent years. 

For the Credit Slips audience I would like to particularly highlight Part I of the article, which contextualizes debates about current mass tort bankruptcy by reviewing two sets of sources from the 1990s and early 2000s. The first is the 1997 final report of the National Bankruptcy Review Commission. The second is scholarship, including two Federal Judicial Center books published in 2000 and 2005, of Professor Elizabeth Gibson, whose expertise lies at the intersection of civil procedure, federal courts, and bankruptcy.  If you are working on or talking a lot about mass bankruptcy but have not reviewed these materials in a while (or ever), then I hope you will be incentivized to check those out for yourselves. 

New Year, New Personal Bankruptcy Law--in Kazakhstan

The list of countries with new personal insolvency laws continues to grow. Bloomberg noted today that the President of Kazakhstan had signed a new law setting out several procedures for relieving the debts of non-entrepreneur individuals (sole proprietors remain relegated to the existing law on rehabilitation and bankruptcy). The text of this 30 December 2022 law is here (in Russian only), and most of its provisions will become effective in 60 days, around March 1, 2023. 

The structure of this law and its four pathways to relief are clearly inspired by the 2015 law of Kazakhstan's northern neighbor. This indicates a continuing trend, as new personal insolvency laws are generally based on a model from the law of a country the adopting country respects, and the model in this case is a fairly good one (the parent law is described here and here). The Kazakh law differs in some respects from this predecessor model, but the basic system is the same: (1) a no-asset procedure ("out-of-court bankruptcy") providing a simple discharge to debtors with debt below about $11,000 (i.e., 1600 "monthly calculation units," which for 2022 was KZ₸3063, just over US$7, so 1600 x $7 = $11,200), (2) a 5-year payment-plan procedure ("restoration of solvency") for debtors with regular income who choose to propose a 5-year plan for court (not creditor) approval, (3) a traditional liquidation-and-discharge procedure ("judicial bankruptcy") unfolding over six months and leaving the debtor with exempt property, including a sole residence, and (4) a settlement option ("amicable agreement") for debtors who manage to convince their creditors to agree to a private compromise (read: never!).

While the requirements for accessing the no-asset out-of-court bankruptcy procedure seem wildly unrealistic and uniquely austere (no property of any kind!?), the new Kazakh system is fairly well structured. Judging by the northern neighbor's recent experience with its very similar set of procedures, it seems most likely the payment-plan procedure will be selected by very few debtors, and the courts will reject the unviable plans of the few debtors who try to pursue this route. Judicial bankruptcy will become the main pathway to relief, which seems to be within reach for ordinary Kazakh citizens. Eventually, the extremely restrictive access requirements for out-of-court no-asset bankruptcy seem likely to be relaxed--either in practice or in a first round of law reform--and that procedure will become the workhorse for the personal bankruptcy system.

Yet another laboratory to observe the effects of the messy compromises that create personal insolvency procedures--and thank goodness, yet another large population of debtors who finally have access to legal relief from debts that would otherwise hound them and their families forever, with no hope of recovery. The new year brings new hope for such families in Kazakhstan!

The Financial Inclusion Trilemma

I have a new draft article up on SSRN. It's called The Financial Inclusion Trilemma. The abstract is below. 

The challenge of financial inclusion is among the most intractable policy problems in banking. Despite being the world’s wealthiest economy, many Americans are shut out of the financial system. Five percent of households lack a bank account, and an additional thirteen percent rely on expensive or predatory fringe financial services, such as check cashers or payday lenders.

Financial inclusion presents a policy trilemma. It is possible to simultaneously achieve only two of three goals: widespread availability of services to low-income consumers; fair terms of service; and profitability of service. It is possible to provide fair and profitable services, but only to a small, cherry-picked population of low-income consumers. Conversely, it is possible to provide profitable service to a large population, but only on exploitative terms. Or it is possible to provide fair services to a large population, but not at a profit.

The financial inclusion trilemma is not a market failure. Rather it is the result of the market working. The market result, however, does not accord with policy preferences. Rather than addressing that tension, American financial inclusion policy still leads with market-based solutions and soft government nudges and the vain hope that technology will somehow transform the fundamental economics of financial services for small balance deposit accounts and small dollar loans.

This Article argues that it is time to recognize the policy failure in financial inclusion and give more serious consideration to a menu of stronger regulatory interventions: hard service mandates that impose cross-subsidization among consumers; taxpayer subsidies; and public provision of financial services. In particular, this Article argues for following the approach taken in Canada, the EU, and the UK, namely the adoption of a mandate for the provision of free or low-cost basic banking services to all qualified applicants, as the simplest solution to the problem of the unbanked. Addressing small-dollar credit, however, remains an intractable problem, largely beyond the scope of financial regulation.

Karens for Hire

The Washington Post has an article about a new business, "Karens for Hire," that is basically a way to hire a customer service advocate. Having spent way too much time with customer service of late, the article really hit a nerve. It gets at the central problem of consumer law, namely that the dollar amounts at issue in almost every dispute are way too small to litigate. Instead, consumers have to work through customer service and hope that they receive some sort of resolution, but that's a process that imposes substantial transaction costs (wait times, e.g.) and in which the consumer has no guaranty of a positive resolution, even if the consumer is in the right. 

There's some level of reputational discipline on companies with bad customers service, but it's pretty weak and indirect: when was the last time you investigated a company's customer service reputation before making a purchase? 

There are a few attempts to regulate customer service of which I am aware—TILA/EFTA error resolution procedures and RESPA loss mitigation procedures—but there's no general system of public regulation. Figuring out exactly what, if anything, would work as a more general solution to ensuring fair and efficient resolution of customer service calls remains one of consumer law's great challenges. 

Alex Jones's Bankruptcy

Alex Jones filed for Chapter 11 bankruptcy himself today. So what is Mr. Jones hoping to accomplish with the bankruptcy filing? I see three possible goals, but I'm skeptical that he'll achieve more than one of them.

First, by filing for bankruptcy, Jones buys himself a bit of time and breathing space. The automatic stay stops all litigation and collection activity against him. It's not indefinite, but it takes the heat off for a bit. That might help him avoid any collection activities by the Sandy Hook victims' families while his motions for a new trial and remittur are pending.  (As far as I can tell, the Connecticut 20-day post-judgment window for appeal has run, but I guess these are not "appeals" since they are motions to the same court?)

Second, the bankruptcy filing moves the action from Connecticut to a Texas bankruptcy court. Jones might be hoping he finds the bankruptcy court more favorably inclined. I'm skeptical. If his behavior in the bankruptcy court matches how he's behaved in other courtrooms, he's not going to find the judge very sympathetic.

Third, Jones will be looking to get a discharge of his debts—including the Sandy Hook defamation judgment. If a debt is discharged, it cannot be collected after the bankruptcy; the creditor gets only what it is able to collect as part of the bankruptcy process. That would mean that Jones's future income would be free from the creditor's claim; only his present, non-exempt assets would be available for repaying creditors. While those present assets include (I presume) all of the IP of the Jones empire (by virtue of his ownership of the companies that hold them), Jones might have concluded that salvaging his current assets are a lost cause and that he'd do best to focus on freeing up his future income. 

The hitch here is that there is an exception to the bankruptcy discharge for "willful and malicious injury by the debtor to another or the property of another." If the behavior that produced the Sandy Hook judgment was "willful and malicious," then Jones will not be able to protect his future income through bankruptcy.  While the Sandy Hook judgment was for defamation, intentional infliction of emotional distress, and unfair trade practices—things that sound willful and malicious—it was a default judgment, meaning that there was never any actual hearing of the merits of the case; Jones just didn't respond to the suit. If there is a discharge objection raised (as there surely will be), then Jones will have a chance to litigate not the actual judgment, but the "willful and malicious" issue, but that effectively means he has an opportunity to litigate the case he previously forfeited. I'm skeptical that he'll prevail (he certainly loses on willful, but maybe he's got a shot at malicious?), but he at least gets another roll of the dice.

Now this extra dice roll isn't risk free. By filing for bankruptcy, Jones will have to come clean about all of his current assets. If he fails to do so, he risks federal prosecution for bankruptcy crimes.  Additionally, while Jones has filed for Chapter 11, where the default setting is that the debtor retains control of his assets as a debtor in possession, there is the possibility of the appointment of a trustee to take over his assets. There will surely be a motion made for the appointment of a trustee given allegations of Jones hiding assets. Jones will get to fight the motion, but I think a trustee being appointed is a real likelihood. If a trustee is appointed, the trustee will act to avoid various pre-bankruptcy transfers made by Jones in an attempt to shield his assets (and if there is no trustee appointed, then a creditors' committee will seek authorization to do so). Either way, I cannot imagine that Jones will be able to retain effective control of the case for very long. 

Bankruptcy offers Jones a glimmer of hope--maybe he can get a discharge for the Sandy Hook verdict, if the court finds his behavior wasn't willful and malicious--but if I were a betting man, I wouldn't put my money on Jones. Yet as long as he comes clean to the bankruptcy court about his assets, etc., there's little downside to him for trying this last Hail Mary move to stave off the Sandy Hook creditors.

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!) ...