Merit Mgmt. Group LP v. FTI Consulting Inc.

The Supreme Court weighed in today on one of the the most important circuit splits in the bankruptcy world, namely the scope of one of the section 546(e) safe harbors from avoidance actions in bankruptcy.  Section 546(e) has two safe harbors, one for "settlement payments" and the other for transfers "made by or to (or for the benefit of) a ... financial institution ... in connection with a securities contract … commodity contract… or forward contract…”. This latter safe harbor had been read (ridiculously) broadly by some of the courts of appeals, as every non-cash transaction has to go through some sort of financial institution.  Specifically, imagine a transaction in which funds are moving from A to D, but go through intermediary financial institutions B and C:  A-->B-->C-->D.  Can D shelter in the fact that the transfer went through financial institutions B and C?  

The Supreme Court unanimously said no, and I think they clearly got the right result, although I fear the methodology the court used may ultimately be unhelpful for those who think that fraudulent transfer law has an important role to play in policing the fairness of financial markets and preventing against excessively risky heads-I-win, tails-you-lose gambles.  

Catch Veinte Dos

A few days ago, Mark and I put up a post on the possibilities of using Chapter 15 bankruptcy for Venezuela's state-owned company, PDVSA.  In response, we received a number of terrific comments, both via email and in the comments section.

One of the particularly interesting points that was made to us (both in email and in one of the comments), that we had not raised was the following: 

PDVSA is not just a Venezuelan company; it is the Venezuelan company -- the company responsible for generating 95% of the foreign currency earnings of the entire country.  Placing the fate of PDVSA into the hands of a bankruptcy judge poses an existential risk to the economy and to the government as the sole owner of the company unless, of course, the government can control the outcome of the insolvency proceeding.  But insolvency proceedings in which the equity owner of the bankrupt enterprise can control the outcome are not proceedings likely to be recognized or enforced by foreign courts.

Catch Veinte Dos?

The foregoing also brings up a slightly different question that Bob Rasmussen asked when he was visiting us last week, which was whether the bankruptcy proceeding could be conducted in a manner such that the 100% equity holder (who would normally have to turn over control to the debt holders in an insolvency) could retain all or almost all of the equity.  After all, it does seem clear that Venezuela is not going to accept giving up full control of PDVSA.  Bob did have some very interesting thoughts as to how this might be done in a purely domestic context.  The question that remained though was whether something similar could be engineered for the foreign state-owned company context that wasn't going to give up any control of the process.  But more on this later

 

Aurelius Seeks a Do-Over; Puerto Rico and the Appointments Clause Litigation

The lives of Puerto Rico residents remain profoundly disrupted by the aftermath of Hurricane Maria measured by metrics such as electricity, clean water, and health care access, with death tolls mounting. This week, though, in a federal court hearing on January 10, 2018, Puerto Rico has the extra burden of confronting Hurricane Aurelius.

Tax "Reform"

Key takeaways for Slips readers from a Moody's report, dated today:

The legislation is credit negative to the US sovereign, owing to the reality that the cuts do not pay for themselves, and Moody's estimates the cuts will add $1.5 trillion to the national deficit over ten years. Higher deficits will put further pressure on the federal government's finances, which are already facing prospects of increased costs of entitlements. Unless fiscal policy reverses course, Moody's estimates that the federal government's debt-to-GDP ratio will rise by over 25 percentage points over the next decade, to above 100%. Combined with rising interest rates, debt affordability for the US will weaken significantly.

The net impact to state and local governments is negative. While the new $10,000 limit on state and local tax (SALT) deductions does not directly impact state or local tax receipts, it will blunt the effect of lower federal rates for many taxpayers. Because the state and local provisions raise the effective tax cost for many taxpayers, public resistance to tax increases will likely rise, and that in turn will constrain local governments' future revenue flexibility. In addition, if larger federal deficits caused by the tax cuts result in attempts to cut entitlement spending, states will be pressured to backfill cuts to federal funds from their own budgets.

The SALT change, combined with the higher standard deduction and tighter limit on the mortgage interest deduction, also reduces the tax incentive for home ownership, which is likely to slow home construction and sales, and moderately suppress home values and property tax growth in higher-price markets.

 

Audio Recordings of Bankruptcy Court: News from Delaware

Several Credit Slips posts from earlier this year (here and here) focused on the virtues of courts releasing digital audio recordings of hearings, and specified the Judicial Conference authority for doing so. Over the summer, I found about three dozen bankruptcy courts for which at least one audio recording had been posted on a court docket in the prior year, albeit with significant variation in frequency of posting. 

It is great to be able to report that the U.S. Bankruptcy Court for the District of Delaware has joined the group of bankruptcy courts using this technology  (announcement here with the details). Proceedings before Judge Carey are the first to be posted, with other judges' hearings potentially to follow. 

 

 

Puerto Rico, its Control Board and the "Two-Step Plan" Story

It is rare that the ideas in academic articles fundamentally change the world. A package of pieces by Clay Gillette and David Skeel (starting with "Governance Reform and the Judicial Role in Bankruptcy" in 2014, followed by a NY Times Op Ed in 2015,  and concluding with "A Two-Step Plan for Puerto Rico" in 2016) have arguably done just that though. The context, as many slipsters have written about, was the enormous financial crisis that Puerto Rico has been mired in for multiple years now. The three Gillette-Skeel articles were the foundation for the institution of a federal control board to displace the local elected authorities in the Commonwealth of Puerto Rico and, in their place, run Puerto Rico's debt restructuring.

Oversimplifying, the idea is that there are occasions when an electoral system becomes so dysfunctional in its running of the local government's operation that a more command-based system needs to be put in place temporarily. Clay has an aptly titled piece "Dictatorships for Democracy" that also explicates this idea. In political economy terms, the problem that Clay and David attack in their pieces is the one where the local competition among electoral candidates is, for whatever reason, consistently delivering severely sub-optimal local governance -- a consistently bad electoral equilibrium that eventually produces a severe government bankruptcy. And the way to get out of the bad equilibrium, they argue, is a temporary dictatorship (aka control board) that is not beholden to the kinds of political interests that were causing the dysfunction.

The question of why the local government system in Puerto Rico produced such immense fiscal mismanagement is a complicated one.  I am inclined to put a big portion of the blame for bad governance on the fact that Puerto Rico has not been allowed to meaningfully govern itself in the same fashion as the states for over a century ("foreign in a domestic sense" and all that). That said, it is hard to argue with the observation that, whatever the reason, Puerto Rico seems to be stuck in a bad governance equilibrium that it needs to be pushed out of. And Clay and David have provided one solution that might just work. (My preferred solution would be that Puerto Rico be allowed meaningful governance rights at the federal level, but no one in Washington DC seems to be willing to give them that).

Two things got me thinking about their idea over the past few days, and induced me to write this post.  First, the hearing on the legal challenge to the constitutionality of the control board is coming up soon (based on a challenge from a NY hedge fund).  Second, there was an interesting article Simon Davis-Cohen of The Nation (a lengthy piece about Clay and David and their ideas) that appeared about a week or so ago. Davis-Cohen's article, to my mind, manages to be both admiring of the ideas and goals that Clay and David have and also question the whether they are appropriate in the Puerto Rican context.

Venezuelan Debt: Call a Spade a Spade

Adam Lerrick, of the American Enterprise Institute, has offered an intriguing approach to the Republic of Venezuela/PDVSA debt problem. Call a spade a spade. The distinction in the market between Republic of Venezuela and PDVSA bonds has always been artificial and the market has normally perceived it as such. Only recently have market participants begun trying to figure out which bonds -- PDVSA or Republic of Venezuela -- will be more likely candidates for a debt restructuring and therefore which should trade higher in the market.

PDVSA accounts for 95 percent for the foreign currency earnings of the entire country. Without PDVSA, there is no credit standing behind Republic bonds.  At base, there is only one public sector credit risk in the country and Lerrick invites us to acknowledge this fact.

He proposes that the Republic assume the indebtedness of PDVSA and proceed to restructure that debt as part of a generalized Republic debt workout. As part of this process -- and to discourage potential holdouts from the Republic's offer to exchange PDVSA bonds and promissory notes -- he suggests that the Government take back PDVSA's concession to lift and sell Venezuelan oil. This risk has always been prominently disclosed in the PDVSA offering documents and should not come as a surprise to anyone.

Lerrick's proposal adds to the growing list of suggestions for how a future Venezuelan debt restructuring (and there almost certainly will be such a debt restructuring) may be accomplished without holdout creditors devouring the process. No one wants to repeat the experience of Argentina.

Recently, in the context of trying to work out the knotty problem of how to restructure Venezuela’s promissory notes, Lee Buchheit and I made a similar suggestion along these lines. (our friends, Bob Lawless and Bob Scott, two gurus of this world of secured financing and contracts, were invaluable in helping us figure this structure out -- all blame for errors is ours, of course).

The structure we suggest differs from the Lerrick proposal mainly on the question of what should happen to the PDVSA oil assets, including receivables for the sale of oil.  We suggest that PDVSA pledge those assets to the Republic in consideration for the Republic's assumption of PDVSA bond/promissory note liabilities (as opposed to transferring title to the assets back to the Republic).  Such a pledge is expressly permitted by the terms of the PDVSA bonds and promissory notes and should operate to shield the assets from attachment by holdout creditors.

Rights of Secured Creditors in Chapter 11: New Paper

Ted Janger and I have posted a paper of interest to Credit Slips readers called Tracing Equity. We still have time to integrate feedback, so please download it and let us know what you think.

As the image accompanying this post suggests, the project was inspired in part by recommendations of the American Bankruptcy Institute's Chapter 11 Commission. Discussion of those proposals starts on page 51 of the PDF.

One of the main insights of Tracing Equity is that both Article 9 of the Uniform Commercial Code and the Bankruptcy Code distinguish between (1) lien-based priority over specific assets and their identifiable proceeds, and (2) unsecured claims against the residual value of the firm. By our reasoning, even attempts to obtain blanket security interests do not give secured lenders an entitlement to the going-concern and other bankruptcy-created value of a company in chapter 11. We explain why our read of the law is normatively preferable and, indeed, is baked into corporate and commercial law more generally--part of a large family of rules that guard against undercapitalization and judgment proofing.

Looking forward to your thoughts.

 

 

Greatest Bankruptcy Case Name Ever?

This morning I saw a docket for a bankruptcy case captioned In re Kabbalah Taxi, Inc.  Look for the cab with the little red thread around its mirror. If you meditate properly on the Tetragrammaton you will be teleported to your destination, although there are special fees for bridges and tunnels. I suppose the company competes with the Magic School Bus and the Chariot of Fire. Or it might just be a yeshivah bukher with a side job.

Any other great case names out there? Comments are open. 

WARN Act Claims after Spokeo v. Robins

I'm musing out loud here, but does the Supreme Court's holding in Spokeo v. Robins—that a suit claiming statutory damages without alleging actual damages lacks Article III standing—impact WARN Act claims in bankruptcy? The WARN Act is a labor law that requires advance notice of certain plant closings--basically advance notice of mass layoffs. Failure to provide such notice results in statutory damages, even though there might not be any actual damages. For example, imagine that a debtor provided notice of a plant closing but not sufficiently in advance--it was one day too late. Where's the harm?  I think under Spokeo there wouldn't Article III standing for a suit seeking damages. If so, that's a nice boon to unsecured creditors because WARN Act claims are going to be priority claims that get paid ahead of them. Going foward, I would think that Official Committees of Unsecured Creditors should be challenging WARN Act claims. Thoughts?    

Old-Fashioned Insolvency Policy in India

It seems to me a sign of serious regulatory dysfunction when a government expressly uses bankruptcy law as a means of collection, rather than rescue or at least collective redress, with an aim to treating economic stagnation. I've seen several stories recently like this one, touting the new Indian insolvency law and government regulators' strategy of putting pressure on banks to use involuntary insolvency (creditors' petitions) to clean up the NPL problems of a series of major industrial firms. The notion that insolvency law is about collecting NPLs seems at best anachronistic, and likely at least a sign of major dysfunction in other law or policy.

The right way for one lender (including the government tax collector) to collect one defaulted loan is to engage an ordinary collections process (judgment enforcement)--which itself might well result in the sale of the company, as envisioned in the story linked above. Creditor-initiated bankruptcy/insolvency proceedings should be the nuclear option, engaged only when creditors are worried that the debtor's assets will be dissipated by other enforcing creditors before the later-in-time ones can reach the ordinary enforcement stage. Such cases should be rare. The primary users of modern insolvency law should be debtors responding to positive incentives to seek an orderly opportunity for a global renegotiation of their debts, or an orderly way for the governors of those companies to liquidate and redeploy the assets of their companies more effectively--avoiding in the process a protracted battle about their own liabilities as personal guarantors and/or as directors liable for "insolvent trading." 

The subtext of the stories I've seen about the new Indian insolvency law seem to be (1) it does not provide an adequate incentive for debtor-companies to seek either rehabilitation or orderly liquidation when they realize they're in obvious financial distress, (2) the ordinary collections apparatus in India must be totally dysfunctional if banks have no incentive to engage it to deal with their NPLs, (3) the new insolvency law also provides an inadequate incentive for creditors to engage it to seek collective redress, since the government has to put pressure on banks to do so, and (4) all of the work on proper, modern insolvency policy in recent years by UNCITRAL, the IMF and World Bank, and many, many others has been lost on Indian regulators. Especially in developing nations like India and South Africa, the battle over the appropriate, modern role of insolvency law as debtor-initiated rescue or exit, as opposed to old-fashioned creditor-initiated collections, continues to rage.

 

How to Get Involved with the ABI Consumer Commission

As Jason Kilborn noted last month, the American Bankruptcy Institute (ABI) has formed a Commission on Consumer Bankruptcy. More information about the Commission is available on its web site including the unfortunate news that it got saddled with me as the reporter. We very much invite input and suggestions about the Commission's work. Right now is an especially good time to get involved as the Commission sets its agenda.

The ABI has charged the Commission with "researching and recommending improvements to the consumer bankruptcy system that can be implemented within its existing structure. These changes might include amendments to the Bankruptcy Code, changes to the Federal Rules of Bankruptcy Procedure, administrative rules or actions, recommendations on proper interpretations of existing law and other best practices that judges, trustees and lawyers can implement."

$45 Million for Stay Violations

How much in punitive damages is enough to punish unlawful conduct and deter its repetition? $45 million was one bankruptcy court's opinion, in the case of a wrongful home foreclosure and eviction in knowing violation of the automatic stay.

The court described the plaintiff-debtors’ treatment by defendant Bank of America as Kafkaesque, and found their deeply emotional testimony (one of them attempted suicide during the ordeal) completely credible, awarding more than $1 million in actual damages for the loss of housing and emotional distress. The court also noted that Bank of America had repeatedly settled cases with federal and state regulators for hundreds of millions, and even billions, of dollars, in recognition of serious and repeated compliance failures, including some related directly to servicing home mortgages.  

The fascinating 107-page opinion grapples at length with the dilemma of awarding enough punitive damages to effectively deter the defendant while avoiding an unseemly windfall to the plaintiffs. The solution: the decision awards $40 of the $45 million punitive award to consumer advocacy organizations and the five public California law schools. Citing an Ohio case, state statutes and several law review articles, the court proposes this split award technique as an appropriate step forward in the federal common law of §362(k) punitive damages. An interesting appeal is sure to follow.

Bankruptcy Fees in the Trump Budget

Thanks a tweet to the sharp-eyed Drew Dawson at the University of Miami, I saw this article in Politico that among the surprises in Trump's budget is an increase in bankruptcy filing fees (see item 5). Well, this seemed important to those of us in the bankruptcy world so I thought I would check it out. It proved surprisingly more difficult in this day and age than one would think to get a PDF copy of the Trump budget outline, but I finally found one. I am not sure the characterization of an increase in "bankruptcy filing fees" is entirely accurate.

Above is a screenshot from p. 30 of the document (clicking on it should bring up a full-sized image in a popup window). Keep in mind this is an outline of the underlying budget document. What appears to be proposed in an increase in the quarterly U.S. Trustee fee for chapter 11 filers and not a general increase in all bankruptcy filing fees or even the chapter 11 filing fee. Of course, the paragraph does characterize it as an increase in bankruptcy filing fees so maybe there is such a broad increase in the budget itself.

Does anybody know for certain?

Arbitrating the Discharge

The Second Circuit currently has a pending case (Anderson v. Credit One Bank, No. 16-2496) that raises the question of whether an alleged violation of the bankruptcy discharge injunction is subject to a predispute arbitration agreement. Professors Ralph Brubaker and Bruce Markell have joined me on an amicus brief explaining why the answer has to be "no." You can download the brief from SSRN. (UPDATE 3/3: The link was broken but should be fixed now.)

Bankruptcy specialists know the "discharge" means the forgiveness of prebankruptcy debts. The "discharge injunction" comes from section 524 of the Bankruptcy Code, which states that the entry of a discharge shall operate as an injunction against attempts to collect prebankruptcy debts. Indeed, one of the things the brief tries to make clear is that the "discharge" and "discharge injunction" are different concepts. Historically, filing bankruptcy gave rise to a discharge, but there was no enforcement of that discharge in the federal court that issued it. Rather, the debtor could plead the discharge as an affirmative defense in a state-court collection action.

Swindlers and Crooks Doing Backflips: New Balleisen Book on Fraud

Not a moment too soon, Princeton University Press has just released Fraud: An American History from Barnum to Madoff by historian & Duke University Vice Provost Ed Balleisen. (Some readers might be familiar with his earlier book on bankruptcy in Antibellum America).

As I learned when reviewing an earlier draft, Fraud is meticulously researched and completely fascinating, with plenty of careful attention to law and regulatory structures. The book's other virtues are well encapsulated by Kirkus:

"Balleisen casts a gimlet eye on the passing parade of hucksters and charlatans, peppering a narrative long on theory with juicy asides that build toward a comprehensive catalog of ‘Old Swindles in New Jargon’. . . . Ranging among the disciplines of history, economics, and psychology, Balleisen constructs a sturdy narrative of the many ways in which we have fallen prey to the swindler, and continue to do so, as well as of how American society and its institutions have tried to build protections against the con. But these protections eventually run up against accusations of violating ‘longstanding principles of due process,’ since the bigger the con, the more lawyers arrayed behind it."--Kirkus

Although it starts in the 19th Century, the book's breadth includes our recent "deregulatory" decades and the impact of that approach on fraud containment.  A book for our life and times for sure.

 

In re Trump Entertainment Resorts, Inc. in Retrospect

Today in bankruptcy I taught In re Trump Entertainment Resorts, Inc. (Bankr. D. Del. Feb. 20, 2015).  The case isn't in my casebook (although some might notice that I presciently included in the problem sets a recurring character named Ronald Grump, a real estate developer with frequent bankruptcy dealings), but I added it to my syllabus this fall because of the election connection.  It was only today, however, that I realized what a hugely important decision it was in retrospect.  

The case involved an attempt by Donald and Ivanka Trump to terminate the debtor's license to use their trademark name, which had been pledged by the debtor as collateral for a loan, despite being nonassignable by its terms.  The Trumps sued in state court to terminated the trademark based on an alleged breach of the license agreement, but the debtor's bankruptcy filing stayed the suit. The Trumps moved to lift the stay.  The bankruptcy court said that the trademark license was an executory contract, and under the hypothetical test for assumption, said that the debtor could not assume the license, and therefore lifted the stay to allow the state court termination litigation to proceed (which I assume resulted in termination).  

Here's the thing.  Imagine if this case had come out differently.  What if the bankruptcy estate could have assumed and assigned the Trump trademark?  And what if it were happening during the election season or now?  One can only imagine the bidding war that might have developed.  

Join us for the "The NCBJ at 90"

Will you be in San Francisco for the National Conference of Bankruptcy Judges annual meeting and related events? Please mark your calendars now for Thursday October 27, 3:oo pm Pacific Time: a special educational session honoring the 90th anniversary of the NCBJ.^* We (Profs. Gebbia, Simkovic, Pottow, and me, with great guidance and input from Judge Colleen Brown and Judge Mel Hoffman) will be discussing original historical research on bankruptcy courts and bankruptcy law conducted for this occasion. Early abstracts can be found on the NCBJ blog. In the meantime, Prof. Gebbia has been posting quizzes; I suspect some Credit Slips readers would ace these tests, but you won't know until you try!

So please do join us on October 27 to be part of this commemoration and conversation.

* The mission of the NCBJ, according to its website, is:

The National Conference of Bankruptcy Judges is an association of the Bankruptcy Judges of the United States which has several purposes: to provide continuing legal education to judges, lawyers and other involved professionals, to promote cooperation among the Bankruptcy Judges, to secure a greater degree of quality and uniformity in the administration of the Bankruptcy system and to improve the practice of law in the Bankruptcy Courts of the United States.

 

Police Misconduct in Bankrupt Cities

Bankruptcy filings by major cities have reinvigorated attention to municipal bankruptcy. As chapter 9 and its application have become more like chapter 11, a wide range of creditors are being swept into the process. As written before, city cases now have classes of general unsecured creditors. Those classes also have been including plaintiffs in civil rights lawsuits alleging unconstitutional police conduct. The proposed payouts vary.  San Bernardino's bankruptcy plan, which seeks to release the liability of non-debtor officers as well as the debtor, has been proposing a 1% payout. The confirmation hearing is currently set for October 2016.  Some cities with systemic police practice problems - Ferguson, Chicago - also are known to have pervasive financial difficulties. I am not suggesting or predicting they will end up in bankruptcy, but it is another reminder that civil rights advocates need to be up to speed on the impact of chapter 9, if only to be able to bargain in its shadow as other types of creditors do.

I have just posted a paper on this topic (revised and updated from a version posted earlier this summer). It walks through the issues and gives three brief case studies. Feedback from the Credit Slips readership would be very welcome, and/but please also pass along the link to civil rights lawyers who do § 1983 litigation. Here is the brief abstract:

When a financially distressed city files for bankruptcy, recovery for civil rights violations is at risk. This article examines the impact of bankruptcy on civil rights claims, with an emphasis on allegations of police misconduct resulting in lawsuits under 42 U.S.C. § 1983. We walk through how a bankruptcy filing affects civil rights plaintiffs, starting with the immediate injunction against litigation and debt collection activity, and ending with the legal release of debt and a restructuring plan. Using primary source materials, we offer three brief case studies: Detroit, Vallejo, and San Bernardino. We conclude with suggestions on where to go from here in research and advocacy.

Can a Nonprofit Startup Fix the Pro Se Problem in Bankruptcy?

For the past four years, Jim Greiner, Lois Lupica, and I have been working on the Financial Distress Research Project (FDRP)*, a large randomized control trial trying to find out what works to help individuals in financial distress. As part of the project, a large number (70+ at last count) of student volunteers have created self-help materials aimed at these individuals, using the latest learnings in adult education, psychology, public health, and more. Part of our work has focused on creating a set of materials to help pro se filers through a no asset Chapter 7 bankruptcy (I blogged about the student loan AP materials here).

Thoughts on the GM Ignition Switch Opinion

The Second Circuit handed down its much-anticipated decision on the GM successor liability claims. Bottom line is that most, if not all, of the various claims against New GM are not barred by the Sale Order because of lack of procedural Due Process.  That said, there's a lot more in the ruling.  My thoughts below the break: 

The Bad CHOICE Act

I'm testifying before House Financial Services tomorrow regarding the "CHOICE Act," the Republican Dodd-Frank alternative.  My testimony is here.  It's lengthy, but it doesn't even cover everything in the CHOICE Act--there are just too many bad provisions, starting with the idea of letting megabanks out of Dodd-Frank's heightened prudential standards in exchange for more capital, then moving on to a total gutting of consumer financial protection, and ending with a very poorly conceived good bank/bad bank resolution system executed through a new bankruptcy subchapter.  The only good thing about the Bad CHOICE Act is that it has little chance of becoming law any time soon. 

Essential Resources on Burdens of Proof in Bankruptcy Litigation: Property Exemptions and Beyond

Deliberations of the Advisory Committee on Bankruptcy Rules have generated great materials relevant to burdens of proof in bankruptcy litigation that judges and lawyers should read and keep on their shelves, whether physical or virtual. Judge Christopher Klein's Suggestion 15-BK-E, submitted in July of 2015, posited that Rule 4003(c) (which gives the objecting party the burden of proof in property exemption disputes) exceeds the authority of the Rules Enabling Act "with respect to claims of exemption that are made under state law that does not allocate the burden of proof to the objector." The document includes a detailed court decision, In re Tallerico, setting forth the reasoning. In a memorandum starting on page 67 of the agenda book downloadable here,  Assistant Reporter/Professor/prior Credit Slips guest Michelle Harner takes a deep dive into the intersection of burdens of proof and the Rules Enabling Act. The Harner memo considers two key Supreme Court decisions that present different standards. The first is Raleigh v. Illinois Dept. of Revenue, 530 U.S. 15 (2000), which played a central role in Judge Klein's submission and court decision. The second is Hanna v. Plumer, 380 U.S. 460 (1965). Harner concludes that Hanna is more on point in the event of a conflict between a federal bankruptcy rule and state law. And, as Harner explains, the Supreme Court in Hanna "rejected the argument that a rule is either substantive or procedural for all purposes" (p78), walks through the questions to be considered, and seeks to apply them to the exemption issue at hand. It looks like the Bankruptcy Rules Committee will not be proposing changes to Rule 4003(c) at this time, but this memo should live on, alongside the case law, as an essential resource for judges and lawyers who encounter disputes over the propriety of burdens of proof in federal rules. 

Bookshelf image courtesy of Shutterstock.com

 

Puerto Rico Restructuring Options That Don't Rely on Congress

The revised draft PROMESA bill (available here) is now under debate in Congress. The bill appears to respond to some early criticisms, although its length and complexity obscures answers to some important questions. Under the circumstances, it seems sensible for the Commonwealth to consider all of its options, including those that do not require Congressional action. These include, as Mitu Gulati and I write in the Financial Times (here, subscription required), changing Puerto Rico's own law in ways that might facilitate a restructuring. 

We asked law students in a class we taught jointly at the University of North Carolina and Duke to consider ways the Commonwealth could restructure without Congressional authorization. Working in groups, they came up with some answers that are both creative and plausible. That doesn't necessarily mean easy or agreeable from the perspective of Commonwealth politicians. Some proposals envision amending Puerto Rico's constitution, while others rely on provisions of Puerto Rico law that authorize collectively binding debt modifications but that haven't been previously applied in this context. The important point, however, is that Puerto Rico may have a wider range of options than many think. The attractiveness of these options is relative. If Congress cannot provide an effective restructuring mechanism that respects the Commonwealth's right to democratic governance, other lawful options will begin to seem more attractive. Two of the student groups have made their work available on-line; their short papers can be found at the links above.

Puerto Rico: Debt Restructuring and Takings Law

Per the last words of my PROMESA post, click here for an interview with Professor Charles Tabb, who discusses the (limited) impact of the Takings Clause on debt restructuring and moratorium legislation. 

Constitution image courtesy of Shutterstock.com

Puerto Rico Symposium: Of Wills and Ways

Debt relief without Congress? No one promised it would be pretty.  

Our brainstorm (remember the ground rules) has included Levitin's MacGyver-inspired local currency, eminent domain, and liberally-interpreted exchange stabilization, Weidemaier's use of COFINA doubts to wedge open the door for a Executive Branch/Puerto Rico partnership, and, thanks to economist Arturo Estrella, a long menu of options with examples, summarized succinctly as "where there is a will, there is a way" (p. 1) (english report at bottom of this page). Could the federal government underwrite new bonds in an exchange offer, asks Pottow? Be the mediator with a big stick, asks Lubben?  Might a holdout creditor be liable to shareholders if it rebuffed a reasonable deal, asks Jiménez? (scroll to the comments). Marc Joffe notes the potential analogy of the City of Hercules tender offer (as well as the fact that Levitin's local currency suggestion has a history from the Depression). 

Lawless reminds us of the risks associated with discriminatory treatment of Puerto Rico's debt and access to legal tools. Of course, there is a long history here. Maria de los Angeles Trigo points to UT professor Bartholomew Sparrow's study of the Insular cases. And while most expect debt relief will be conditioned on some sort of fiscal oversight, it needs to be designed in a way to avoid the foibles of the past.

Returning to Lubben's mediation theme, let's push the brainstorming a step farther: could Treasury appoint a federal judge, such as Chief District Judge Gerald Rosen (E.D. Mich.), to oversee the mediation, and demand that all creditors participate in good faith until released? Even in the absence of legal authority for this move, would creditors formally object or fail to show up? 

Thanks to participants and readers for active involvement so far, and please keep your thoughts and reactions coming this way.  

Puzzle photo courtesy of Shutterstock.com

Puerto Rico And (Very) Soft Executive Power

Melissa's post asked what the executive branch could do to facilitate restructuring of Puerto Rico's debt. I'll get to that, but I first want to talk about Puerto Rico itself. At first glance, the Commonwealth seems to be in a uniquely terrible position. It has the disadvantages of a sovereign (e.g., no bankruptcy) but lacks the advantages (e.g., legal and/or practical immunity from legal enforcement). In fact, it lacks only most of the advantages. One advantage of sovereignty it does enjoy--and that many "true" sovereign borrowers are obliged to forego when they borrow--is that much of its debt is governed by its own law. That law can be changed (subject to constraints in the U.S. constitution) or interpreted in ways that give the Commonwealth needed restructuring flexibility. 

Credit Slips Presents: A Virtual Symposium on Puerto Rico

Puerto Rico debt restructuring legislation is flying fast and furious around Congress. But the air contains more than a whiff of defeatism regarding the prospects of passage. Bills vary greatly in substance and scope, and yet apparently the response of powerful creditors is consistent: they want to retain the right to be holdouts and are making that position perfectly clear to our elected representatives.

Credit Slips contributors are no strangers to anti-restructuring advocacy, whether framed as moral hazard or otherwise. To that end, we embark on a virtual symposium inspired by the following question: What could the Executive Branch do to facilitate the restructuring of government debt in Puerto Rico absent Congressional action? 

On tap to brainstorm around this theme in the next two weeks are (in alphabetical order): Anna Gelpern, Melissa Jacoby, Bob Lawless, Adam Levitin, Stephen Lubben, Katherine Porter, John Pottow, Mark Weidemaier, and Jay Westbrook.

Initial Attorney Reactions to the New Bankruptcy Forms

Yesterday I spoke at the Oklahoma Bar Association's annual advanced bankruptcy seminar. My talk focused on my research into chapter 11 cases filed by churches, a few of which are from Oklahoma. But the seminar's timing aligned perfectly with the roll out of the new bankruptcy forms. And unsurprisingly the first hour of the seminar was devoted to introducing and discussing the forms. A debtor attorney who handles chapter 7, 11, 12, and 13 cases -- Brian Huckabee -- parsed through some of the forms and added some initial comments. My take-away is that debtor attorneys' chief concern is that the readability and understandability of the forms will make it easier for debtors to file pro se, taking work away from attorneys ("this is self-service!"), a concern which was raised during the public-comment period. A related concern was voiced by a chapter 7 trustee: that chapter 7 (and 13) trustees will end up spending more time working through each case.

Three items during the discussion stood out to me. The first two relate to the "self-service" nature of the forms, particularly the new forms' instructions and white space. The last item goes to an attachment to the proof of claim form, Form 410A -- Mortgage Proof of Claim Attachment. 

Longest Running Catholic Archdiocese Chapter 11 Case Finally Ends

The Archdiocese of Milwaukee filed its chapter 11 petition on January 4, 2011. Yesterday, four years and ten months later, Bankruptcy Judge Susan Kelley confirmed the dioceses' reorganization plan. During those four plus years, the most contentious issue regarded a $55 million trust fund established rather suspiciously prior to filing to care for a cemetery. The parties were sent to mediation repeatedly, but the cemetery issue seemed to remain the hold up -- until the 7th Circuit ruled that the cemetery trust fund was not shielded from the Code's avoidance provisions by the Religious Freedom Restoration Act. After the 7th Circuit's ruling, the archdiocese revised its plan to distribute $21 million in total to sex abuse claimants. $16 million is coming from that cemetery trust fund. 

In comparison, the archdiocese's initial plan proposed to distribute $4 million in total to these claimants. The $21 million primarily will be split among 355 people. Though it is difficult to compare settlement amounts across diocese chapter 11 cases because of unknowns about abuse severity, state laws that apply to the underlying claims, and available insurance monies and other assets, the $21 million still makes Milwaukee's settlement one of the smallest based on the number of people to receive compensation.

Who "Presides" over Chapter 13 Plan Confirmation Hearings?

Temple Law Review will soon publish a volume honoring Bill Whitford, based on a conference from last fall. That event was particularly special for an additional reason: it turned out to be the last opportunity, for many of us, to spend time with another inspiring leader in our field, Jean Braucher. 

My own short contribution, on judicial oversight in chapter 13 bankruptcies, has just been posted here. We will share the word when the entire volume is available - including, I believe, a piece from Jean.

Gavel image courtesy of Shutterstock

Unhappy Birthday, BAPCPA

BAPCPA's been in effect for 10 years now. I still remember the day before it went into effect, seeing round the block lines at the Wilmington courthouse as consumers rushed to file. 

There's lots to say about BAPCPA, for both consumers and businesses, but it boils down to this: it's not a fine wine and hasn't improved with age. The vinegar only gets more sour. 

How Do You C It?

One of the great challenges to the bankruptcy system if not to the American way of life is those who insist on capitalizing the  letter c when discussing chapters of the Bankruptcy Code. If it is "section 1129," as the Bluebook dictates, then it is "chapter 11." Both are merely designations for a portion of a statute.  The defense that is given to me is that the capitalized c just looks better. Are we supposed to capitalize words now merely because the mood strikes us? Are there no rules left? The horror. The horror.

When confronted with the RaNdOm CaPiTaLiZeR CrOwd, weak-willed persons such as myself cave in a spirit of compromise and also because I am a heckuva guy. Someone stronger must oppose this tyranny.

Donald Trump Speaks the Truth

I never thought I'd write this, but Donald Trump speaks the truth, at least as far as bankruptcy is concerned. 

There's plenty to criticize regarding Donald Trump, but I really wish the media would back off the bankruptcy angle of his career, or at least be smarter about it.  

Picking a Judge to Preside over a Municipal Bankruptcy

Last week I introduced to Credit Slips readers my draft article on federal court oversight of Detroit's bankruptcy. An easily overlooked element of what I called The Detroit Blueprint is non-random judge selection, required by Congress for municipal bankruptcy cases.

Departing from the random assignment norm in the federal judiciary, section 921(b) of the Bankruptcy Code requires the chief judge of the applicable circuit court of appeals to select the judge who will preside over a municipal bankruptcy. In 1997, the National Bankruptcy Review Commission unanimously recommended eliminating section 921(b).  That Commission's Final Report observed that the fear prompting the provision - random draw of a judge unable to handle the case - was no longer salient. Congress did not take up this recommendation. What difference did section 921(b) make in Detroit?

Chapter 9 and Federal Courts: The Detroit Blueprint

Among its other effects, the Puerto Rico debt crisis has dramatically increased the number of public figures and politicians whose verbal repertoire includes the term "chapter 9." Bondholders' resistance to chapter 9 access for Puerto Rico municipalities is fueled in part by an earlier public debt crisis: Detroit. As suggested in my Credit Slips posts, Detroit made some new law but its major lasting legacy is procedural. I just posted a draft article, based on original empirical research, documenting that procedural blueprint, Federalism Form and Function in the Detroit Bankruptcy. It shows the paths by which the federal court became a major institutional actor throughout Detroit's restructuring.

After reading scholarship and case law on chapter 9, one might envision that, because of the Tenth Amendment to the U.S. Constitution and federalism principles, presiding judges are essentially locked in a closet for much of the duration, released only when the parties affirmatively seek an adjudicator. That's never entirely accurate, but to say it is inaccurate regarding Detroit is the understatement of the year.

Although The Detroit Blueprint will have broader ripple effects, I am dubious that its most significant elements could or would be implemented in, say, a PREPA bankruptcy. Detroit should not be an impediment to changing the Bankruptcy Code to cure the wrongful omission of Puerto Rico municipalities. More on that, and additional perspectives from the article, in future posts.  
 

Image courtesy of Shutterstock

Dodd-Frank's Constitutionality

I'm testifying tomorrow before Senate Judiciary Committee's Subcommittee on The Constitution (yes, that's the official capitalization), about the constitutionality of the Dodd-Frank Act.  

Short version: nothing to see here folks.

Slightly longer version: really nothing to see here.

Even longer version:  the plaintiffs in State National Bank of Big Spring v. Lew have a totally non-Originalist interpretation of the Bankruptcy Clause, namely that "uniform laws" apparently requires equal treatment of all similar creditors, so title II Orderly Liquidation Authority is unconstitutional.  Yes, that's the sound of me shaking my head.

My written testimony is available  here.  

Attorney Market for Discharging Student Loans

On Friday, Tara Siegel Bernard reported in the New York Times that some bankruptcy judges think that the onerous Brunner standard for discharging student loans should change. Commenting on the article, reader "alma" writes:

As someone who recently filed for bankruptcy and has more than $100,000 in student loan debt, I can tell you why I did not try to get relief from student loans: I did not know it was an option. My lawyer simply told me that it was not possible to have student loans discharged. This article is the first I have even heard there was any method to do so ....

From the rest of the comments, this poster is not alone. Some of this may be explained by clients misunderstanding what's said (where the attorney means they don't think that this particular client will succeed in obtaining a discharge). But especially pre-2005 when the law was murkier, I do wonder about the level of advice given to filers.

Attempting to discharge student loans costs extra money, something bankruptcy clients are unlikely to have. Given the low numbers of attempts, it's unlikely any given bankruptcy attorney has any experience filing such a case. Doing it is no simple matter either; it's literally a federal case. I've only found one book out there detailing how to file an adversary proceeding to discharge student loans in bankruptcy. 

My own limited experience is that this is (unsurprisingly) quite hard. As part of a larger study, Jim Greiner, Lois Lupica, a couple of dozen students, and I have been working to create a DIY guide to a no-asset Chapter 7 bankruptcy guide, complete with a module on representing yourself through an adversary proceeding to discharge student loans. We just posted a paper on the philosophy behind our materials (and why we include cartoons like the one above). If we succeed, we hope that the materials we create will be useful to attorneys as well as pro se individuals. But there has to be a market before attorneys will use them.

What say you, Credit Slips readers, are bankruptcy attorneys offering student loan discharge services? Do clients want them? Can they afford them?

The cartoon credit goes to Hallie Pope. Hallie is the creator of "Blob" and other cartoons featured in the self-help materials in the Financial Distress Research Study.

Puerto Rico Preemption Redux: Back to You, Congress

On February 6, 2015, a district court held Puerto Rico's Recovery Act to be expressly preempted by section 903 of the Bankruptcy Code.

On July 6, 2015, the U.S. Court of Appeals upheld the finding: The Recovery Act is preempted, on both express preemption and conflict preemption grounds. 

Judge Torruella wrote a separate concurrence starting on page 50 of the decision. One of his points bearing special mention here is that he finds unconstitutional the 1984 Bankruptcy Code amendment that stripped Puerto Rico's right to authorize chapter 9 for its municipalities, due to the lack of a rational basis. Had he secured another vote for that view...

Credit Slips contributors surely will weigh in more, in this space or elsewhere, on the decision and  next steps. For now, Congress needs to move on H.R. 870, which now has support in the Senate. H.R. 870 simply reinstates Puerto Rico's ability to authorize its municipalities to use chapter 9, akin to states. Others advocate for bankruptcy relief for the Commonwealth of Puerto Rico itself; that proposal is separate from, and considerably more controversial than, H.R. 870.

 

That New Song About Bills

You may have heard it. It was on the radio the last three mornings as I drove to work. It goes, "I got bills I gotta pay, so I'm gonn' work work work every day." It made me think about bankruptcy (naturally). And it is really catchy. The song's simply titled, "Bills," and is LunchMoney Lewis's debut single. The lyrics reference empty fridges, cars not starting, shoes without "soul," praying that cards won't be declined, and, of course, piles of bills. The music video features an adorable girl and her lemonade stand, complete with a credit card reader made out of cardboard.

When asked about the song, Lewis said: "I feel like people relate to 'Bills' no matter where you’re from. Whether you’re very middle class or you’re lower class or you’re in the projects or you’re upper middle class. We all get bills. . . . That’s why I wanted to turn it into something positive, like when you hear 'Bills' it kind of makes you feel happy, you know?" (full interview). The song made me smile, and apparently is rapidly climbing the pop charts.    

Check out the official video for some Friday fun.

Stale Debts in Bankruptcy

Should liability under the Fair Debt Collection Practices Act (FDCPA) lie against a creditor who submits a proof of claim past the statute of limitations in a consumer bankruptcy case?

That is the question the Supreme Court declined to review recently in LVNV Funding, LLC v. Crawford. In Crawford, the Eleventh Circuit applied the "least sophisticated consumer" standard to find liability for the debt buyer when it submitted a proof of claim in 2008 for a debt that was out of statute as of 2004. Other courts have held differently. In fact, just last month, district courts in Indiana and Pennsylvania dismissed FDCPA suits against debt buyers under essentially the same facts as Crawford. Other courts, including the Second Circuit, have seemingly held that FDCPA liability can never lie in a bankruptcy case.

Putting the merits of applying the FDCPA in a bankruptcy case aside, it seems to me that in this specific instance potential liability under the Act could serve very useful functions: namely efficiency and cost savings.

Archdiocese's Potential Fraudulent Transfer Not Protected by RFRA, First Amendment

The Archdiocese of Milwaukee’s Chapter 11 case remains the longest running Chapter 11 case filed by an Archdiocese or other Catholic entity. It filed in January 2011, and because of religious-based objections to the application of the Code's fraudulent and preferential transfer provisions, Bankruptcy Judge Susan Kelley has declined to rule on any reorganization plan until the objections are settled.

The main hang-up is an April 2007 pre-petition transfer of $55 million from the Archdiocese’s general accounts to a trust earmarked for maintaining cemeteries--generally known as the "Cemetery Trust Fund." Post-filing, the Archbishop, acting in his role as the trustee of the Cemetery Trust Fund, sought a declaratory judgment from the bankruptcy court that the $55 million would never be part of the Archdiocese's bankruptcy because the First Amendment and/or the Religious Freedom Restoration Act (RFRA) barred the application of the Code's avoidance provisions. The action was defended by the Unsecured Creditors' Committee -- because the DIP was just a tad conflicted given that it acts through its sole corporate member, the Archbishop.

The question made its way up to the 7th Circuit, which issued a long awaited opinion today. The rulings are: (1) RFRA is not applicable because it only applies to suits in which the government is a party, and the Creditors' Committee is not the government; and (2) the Archbishop's free exercise rights are not violated by application of the Code's generally neutral principles that are narrowly tailored to support a compelling government interest in protecting creditors. In short, the Archdiocese decided to file under Chapter 11 and now it cannot seek a religious exemption for purported fraud.

All Late-Filed Taxes Now Nondischargeable?!

Sometimes a tax return is not a tax return. As a result, bankruptcy is becoming a less effective response to back tax woes in the US. Yesterday, the 1st Circuit joined the 5th and 10th in holding that old income tax debts are nondischargeable if the taxpayer-debtor filed the related tax returns late. This is the latest negative impact of BAPCPA and an oddly worded statute with an even odder citation.

Section 523(a)(1)(A) of the Bankruptcy Code has long made nondischargeable recent income tax debts, for taxes for which the return was due within three years before the bankruptcy filing. But older tax debts might also survive the discharge thanks to section 523(A)(1)(B)(i). That section renders taxes nondischargeable if the taxpayer-debtor failed to file a return. Not surprising. What is surprising is a recent revision and its expansive interpretation, which have created a vast new category of nondischargeable tax debts.

Puerto Rico Preemption

Last summer, PREPA bondholders filed actions challenging the constitutionality of Puerto Rico's recently enacted, but as yet unused, Public Corporation Debt Enforcement and Recovery Act. Last night, the district court filed a seventy-five page opinion. It did not dispose of the actions in full (e.g., the contract clause challenges remain alive but not decided), but did hold the Recovery Act is preempted. Given that the judge's order permanently enjoins Puerto Rico from enforcing the Recovery Act, I believe it is immediately appealable under 28 USC 1292(a)(1).

Random Thoughts on Reform

I just finished discussing the “random walk” theory in my Corporate Finance class, so I thought I would close out my stint on Credit Slips with some “random thoughts” on reform.

First, two expressions of sincere gratitude: I want to thank Bob Lawless and everyone at Credit Slips for the opportunity to blog about reform these past two weeks. It has been great fun. I also would like to thank the many practitioners, judges, financial advisors, academics, and industry groups who participated in the ABI Commission reform study process. Everyone made a meaningful contribution to the project. 

Bankruptcy Valuations: A Pair of Modest Proposals

I want to take up Michelle Harner's call for "innovation and new approaches to valuation". Valuation may well be the most important issue in bankruptcy, and it is also the issue that is least subject to meaningful judicial review. Imagine a Court of Appeals trying to parse through discounted cash flow models or what are proper comparables. The lack of meaningful appellate review makes it all the more important that we get valuation right. 

The Art of Valuation

Anyone who has ever litigated a valuation issue knows that valuation is more art than science. Experts often arrive at widely divergent valuations. Yet, these valuations are of the same company, for the same time period, based on the same data, and often invoke the same model. How then can the valuations be so different and, more importantly, which expert is right? Valuations of course can vary for a number of reasons, including different assumptions and inputs, and sometimes because of the methodology itself. But as one of my very astute students in Corporate Finance recently pointed out, valuations also likely differ because of the legal position (he actually used the term "self-interest") of the party employing the expert and offering the particular valuation into evidence.

Deflate Gate and Bankruptcy Reform

People (and institutions) like rules that give them a competitive edge. You need only to look at the recent headlines and the media coverage of “Deflate Gate” to understand this basic concept. Reportedly, Tom Brady, Peyton Manning, and other quarterbacks lobbied the NFL to allow each team to supply its own set of footballs for use by that team’s quarterback during games. Note—I am not suggesting ill motive on the part of either Brady or Manning (or the others).  Although I never played quarterback, I can understand a quarterback’s desire to select personally his own game-day equipment. 

How does any of this relate to chapter 11 reform? To answer that question, ask yourself a different one: Do you like how chapter 11 currently resolves your client’s key issues in most instances? If you answered “yes,” you likely see no reason for reform. If you answered “no,” you likely would favor reform, but perhaps only those aspects of reform beneficial to your client. Therein lies the ever-present dilemma for policymakers:  implementing the best policy for the overall federal bankruptcy system in the midst of so much noise.

The Melting Ice Cube Fallacy

Can a company really melt? Putting aside a business with a perishable product or inventory, does management really wake up one morning and say, “Wow, if we do not sell this company in 30 days or less, we will lose significant value for our stakeholders.” I highly doubt it. Rather, I think a company “melts” because management leaves the freezer door open too long, or perhaps a particular stakeholder has its foot in the door. (For a thoughtful article on the melting ice cube issue, see here.) 

If the Code simply did not permit expedited sales, what would happen? Could it be that the possibility of an expedited sale with all of the bells and whistles of a confirmed plan enables management and senior creditors either to delay the chapter 11 filing or to manufacture urgency? From my perspective, this question is the central difficulty with section 363 going concern sales. A company should be able to reorganize through a value-maximizing sale in chapter 11. But those sales should not include quick fire sales that offer little opportunity for a robust auction or the need to use chapter 11 tools to enhance value in that auction. Chapter 7 is already well suited for such fire sales.

Rethinking “Small” Business Bankruptcies

It may surprise some, but approximately 90% of all chapter 11 debtors have less than $10 million in assets or liabilities, less than $10 million in annual revenues, and 50 or fewer employees (see data on small and medium-sized enterprises (SMEs) in the ABI Commission Report, here). These companies are the heart of chapter 11. Nevertheless, most of the media and caselaw coverage discusses only the megacases—e.g., Caesars, American Airlines, Tribune Company, etc.—representing approximately 2-3% of chapter 11 debtors. It is time to change the focus of the conversation.

When a small business closes its doors, an entire community feels the impact. Consider the following description of the ripple effects of the closing of a small mine in Lincoln County, Montana:

In addition to the workers and families directly impacted by the loss of jobs, the ripple effects of the loss of that income will impact local businesses at every level. Restaurants, stores and other shops depend upon local consumers to keep themselves afloat, the dollars that are paid to those employees find their way into the hands of a number of additional places, keeping a small local economy alive.  (Full story here.)

Similar stories occur most everyday in towns across America (see, e.g., here).