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. 

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.  

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.

 

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!) ...  

Shocking Business Bankruptcy Law

Another quick announcement that I have posted a draft essay on some under explored intersections between big business bankruptcy and big shocks here. The abstract is short, yes, but so is the essay. It also discusses ice cream. Thanks for reading! 

Are Mortgage Servicers Ready for the Loan Mod Rush?

On May 4, the CFPB issued a report sharing information the agency had gathered about mortgage forbearances and delinquencies. One notable takeaway is that Black and Brown homeowners, as well as low-income homeowners, are very prevalent among those in forbearance. A large portion of those in forbearance also have loan to value ratios north of 60%. All of this suggests that many who face chronic financial struggles and are most at risk of losing their homes, are also those currently benefiting from the forbearance programs.

This makes me immediately think: what happens when the forbearance periods are over? (which most believe will happen between September and November of this year) Specifically: what will their loan modifications look like?

Greensill "Secured" Lending

Slips readers will be interested in Matt Levine's column today, which takes a deep dive into the recently failed Greensill's lending against “prospective receivables,” which is kind of like lending against my prospective estate in Scotland. Both look a lot like unsecured lending.

Commercial and Contract Law: Questions, Ideas, Jargon

In the Spring I am teaching a research and writing seminar called Advanced Commercial Law and Contracts. Credit Slips readers have been important resources for project ideas in the past, and I'd appreciate hearing what you have seen out in the world on which you wish there was more research, and/or what you think might make a great exploration for an enterprising student. This course is not centered on bankruptcy, but things that happen in bankruptcy unearth puzzles from commercial and contract law more generally, so examples from bankruptcy cases are indeed welcome. You can share ideas through the comments below, by email to me, or direct message on Twitter.

Also, I am considering having the students build another wiki of jargon as I did a few years ago in another course. Please pass along your favorite (or least favorite) terms du jour in commercial finance and beyond.

Thank you as always for your input, especially during such chaotic times.

Do Judges Do Contract Interpretation Differently During Crisis Times?

Scholars of constitutional law and judicial behavior have long conjectured that judges behave differently during times of crisis. In particular, the frequently made claim is that judges “rally around the flag”.  The classic example is that of judges being less willing to recognize civil rights during times of war (for discussions of this literature, see here, from Oren Gross and Fionnuala Aolain; and here, for an empirical analysis of the topic from Lee Epstein and co authors).

But what about financial crises?  Are judges affected enough by big financial crises to change their behavior and, for example, rule more leniently for debtors who unexpectedly find themselves being foreclosed on? In a paper from a few years ago, Georg Vanberg and I hypothesized that a concern with needing to help save the US economy from the depression of the 1930s may have been part of the dynamic explaining the Supreme Court’s puzzling decision in the Gold Clause cases (here).

A fascinating new paper from my colleague, Emily Strauss (here), analyzes this question in the context of the 2007-08 financial crisis.  Emily finds that lower courts judges, in a series of mortgage portfolio contracts cases during the crisis and in the half dozen years after, made decisions squarely at odds with the explicit language of the contracts in question.  From a pragmatic perspective, it is arguable that they had to; the contracts were basically unworkable otherwise.  But, as mentioned, this conflicted with the explicit language of the contracts. And judges, especially in New York, like to follow the strict language of the contracts (or so they say).   Then, and I think this is the most interesting bit of the story, Emily finds that, starting in roughly 2015 (and after the crisis looked to have passed), the judges change their tune and go back to their strict reading of the contract language.

Here is Emily’s abstract that explains what happened better than I can:

Why might judges interpret a boilerplate contractual clause to reach a result clearly at odds with its plain language? Though courts don’t acknowledge it, one reason might be economic crisis. Boilerplate provisions are pervasive, and enforcing some clauses as written might cause additional upheaval during a panic. Under such circumstances, particularly where other government interventions to shore up the market are exhausted, one can make a compelling argument that courts should interpret an agreement to help stabilize a situation threatening to spin out of control.  

This Article argues that courts have in fact done this by engaging in “crisis construction.” Crisis construction refers to the act of interpreting contractual language in light of concurrent economic turmoil. In the aftermath of the financial crisis, trustees holding residential mortgage backed securities sued securities sponsors en masse on contracts warranting the quality of the mortgages sold to the trusts. These contracts almost universally contained provisions requiring sponsors to repurchase individual noncompliant loans on an individual basis. Nevertheless, court after court permitted trustees to prove their cases by sampling rather than forcing them to proceed on a loan by loan basis.

Lowdermilk on Family Farmers in Financial Trouble - new paper!

Jamey Mavis Lowdermilk has just posted an article of interest to Credit Slips readers -- lawyers, judges, journalists, policymakers, and more. The article uses a case study of a chapter 12 family farm bankruptcy in North Carolina to ask bigger questions about farming finances and how public policy on farming is set. Extending the early work of now-Representative Katie Porter, Lowdermilk brings her own perspective and expertise to this topic. Before law school, Lowdermilk obtained a masters degree in applied economics and statistics with a specific interest in agriculture as well as rural development, and held a variety of positions related to farms, forestry, and credit. During law school, she started this chapter 12 project in my advanced bankruptcy seminar. After law school, Lowdermilk continued to work on the project and revise the paper for publication as a law review article. Several wonderful bankruptcy judges graciously offered feedback as her first footnote documents. Please check it out!

New (From the Archives) Paper on Determinants of Personal Bankruptcy

This working paper is a longitudinal empirical study of lower-income homeowners, including a subset of bankruptcy filers, produced with an interdisciplinary team of cross-campus colleagues, including Professor Roberto Quercia, director of UNC's Center for Community Capital. We just posted this version on SSRN for the first time yesterday in light of continued interest in its questions and findings. The abstract does not give too much detail (see the paper for that), but here it is:

Personal Bankruptcy Decisions Before and After Bankruptcy Reform

Abstract

We examine the personal bankruptcy decisions of lower-income homeowners before and after the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Econometric studies suggest that personal bankruptcy is explained by financial gain rather than adverse events, but data constraints have hindered tests of the adverse events hypothesis. Using household level panel data and controlling for the financial benefit of filing, we find that stressors related to cash flow, unexpected expenses, unemployment, health insurance coverage, medical bills, and mortgage delinquencies predict bankruptcy filings a year later. At the federal level, the 2005 Bankruptcy Reform explains a decrease in filings over time in counties that experienced lower filing rates.

New Paper: Consumer Protection After the Global Financial Crisis

Historian Ed Balleisen and I have just posted a paper of interest to Credit Slips readers who are interested in consumer protection, financial crises, and inputs into post-crisis policymaking more generally. I will let the abstract speak for itself:

Consumer Protection After the Global Financial Crisis

Edward J. Balleisen & Melissa B. Jacoby

Abstract

Like other major events, the Global Financial Crisis generated a large and diffuse body of academic analysis. As part of a broader call for operationalizing the study of crises as policy shocks and resulting responses, which inevitably derail from elegant theories, we examine how regulatory protagonists approached consumer protection after the GFC, guided by six elements that should be considered in any policy shock context. After reviewing the introduction and philosophy of the Bureau of Consumer Financial Protection, created as part of the Dodd-Frank Act of 2010, we consider four examples of how consumer protection unfolded in the crises’ aftermath that have received less attention. Our case studies investigate a common set of queries. We sought to identify the parties who cared sufficiently about a given issue to engage with it and try to shape policy, as well as the evolving nature of the relevant policy agenda. We also looked for key changes in policy, which could be reflected in various forms—whether establishing an entirely new regulatory agency, formulating novel enforcement strategies, or deflecting policy reforms.

The first of our case studies focuses on operations of the Federal Trade Commission in the GFC’s aftermath. Although the Dodd-Frank Act shifted some obligations toward the CFPB, we find that the FTC continued to worry about and seek to address fraud against consumers. But it tended to focus on shady practices that arose in response to the GFC rather than those that facilitated it. Our second case study examines the Congressional adoption of a carveout from CFPB authority for auto dealers, which resulted from strong lobbying by car companies worried about a cratering sales environment, and the aftermath of the policy. Here, we observe that this carveout allowed a significant amount of troubling auto lending activity to continue and expand, with potentially systemic consequences. Loan servicer misbehavior, particularly in the form of robosigning, is the focus of our third case study. Although Dodd-Frank did not explicitly address robosigning, the new agency it created, the CFPB, was able to draw on its broad authority to address this newly arising problem. And, because the CFPB had authority over student loan servicers, the agency could pivot relatively quickly from the mortgage context to the student loan context. Our fourth and final case study is the rise and fall of Operation Choke Point, an understandably controversial interagency program, convened by the U.S. Department of Justice, which, with the GFC fresh in mind, attempted to curtail fraudulent activities by cutting off access to online payment mechanisms. Here, we see an anti-fraud effort that was particularly vulnerable to a change in presidential administration and political climate because its designers had invested little effort in building public awareness and support for the program.

The Article concludes with an overall assessment and suggestions for other focal points for which our approach would be useful. The examples span a range of other domestic and global policy contexts.

 

 

 

Seeking nominations for the Grant Gilmore Award

The American College of Commercial Finance Lawyers seeks nominations for scholarly articles to be considered for the Grant Gilmore Award. It is not awarded every year, but when it is, the main criteria is "superior writing in the field of commercial finance law."  I am chairing the award committee this year, so please email me or message me on Twitter before December 14 to ensure your suggestion is considered. Especially eager to get suggestions of articles written by newer members of the academy that might otherwise be missed.

What Skews the Public-Private Balance in Corporate Bankruptcy Cases?

In a prior Credit Slips post, I shared a paper, Corporate Bankruptcy Hybridity, positing that bankruptcy should be conceptualized as a public-private partnership. The second section of Corporate Bankruptcy Hybridity identifies factors that have skewed the Bankruptcy Code's ideal balance between public and private interests and values. Preemptively I'll note it is not new to observe the increased privatization of bankruptcy and the qualitatively different nature of the oversight and ethics (see, e.g., Mechele Dickerson). More novel, I hope, is the articulation of a broader set of factors contributing to the skew. The list is illustrative, not exhaustive.

In the Zone: The Weinstein Co. Chapter 11 Hearings #9-13

Since my last Credit Slips post about The Weinstein Co. chapter 11, there have been five public hearings/status conferences (some of which were telephonic). Disparate observations from those hearings below.

Timing and Process in Crystallex v. PDVSA

[Updated with Crystallex's brief opposing the stay.]

In an earlier post, I noted some open questions that had to be answered before Crystallex could execute on PDVSA’s 100% ownership stake in PDV Holding (PDV-H). To recap: The federal district judge in Delaware let Crystallex attach the PDV-H shares on the theory that PDVSA is the Venezuelan government’s alter ego. The open questions relate both to timing (e.g., should there be a stay of execution pending appeal?) and process (how should an execution sale proceed)? A lot turns on the answers to these questions, as I’ll discuss below. First, however, here’s a simplified figure showing PDVSA’s corporate structure for readers who haven’t been following the dispute closely.

Corporate Bankruptcy as a Public-Private Partnership

I have just posted on the Social Science Research Network a forthcoming article called Corporate Bankruptcy Hybridity. Although the article has several intersecting objectives, today's post focuses on the first aim: conceptualizing corporate bankruptcy as a public-private partnership.  A public-private partnership, most plainly stated is "a legal hybrid which possesses some characteristics of a purely private corporation and others of a purely government.... however it is structured, it is formed to accomplish a public purpose."* As writings of scholars outside of bankruptcy make clear, the fact that a system relies in part on private actors and private funds does not absolve the system of its obligation to the public's broader constitutional, democratic, and welfare aims. In other words, even if a system is driven by a particular public purpose, other public objectives remain salient.

Reframing the system in this fashion explicitly rejects the common assumption that bankruptcy is best understood as a species of private law, as well as the belief that a workable theory requires that the bankruptcy system have only one public purpose.

In addition to enhancing scholarly debates, considering corporate bankruptcy a public-private partnership has real-world implications - most notably, helping reformers (statutory and otherwise) think creatively about the institutional actors and structures that can respond to identified problems, such as the problems carefully documented in the ABI Commission to Study the Reform of Chapter 11. The range of interventions described and prescribed in administrative law and related privatization scholarship is considerably broader than in reform projects such as the National Bankruptcy Review Commission or the ABI Chapter 11 Commission Report.

Of course, the article elaborates on these points, and I hope to highlight other objectives of Corporate Bankruptcy Hybridity in future posts. But in the meantime, I'd love it if you downloaded and read the article.

* This definition comes from an article published in 1969 by Robert Amdursky.

MoviePass Bankruptcy Watch

The financial travails of MoviePass and its parent company Helios & Matheson caught my eye today. I almost never go to see movies in theaters, so MoviePass was an unfamiliar business to me, but the basic idea is that the consumer pays an upfront subscription fee and then MoviePass provides an unlimited number of tickets for the consumer (although one per show, and more recently with various additional restrictions):  basically an all-you-can-eat buffet model applied to movies.  The buffet model requires the Jack Sprats of the world to subsidize their wives:  those who go to the counter once and get low-cost foods are subsidizing those who make multiple trips for the foie gras, etc.  The buffet model can work for a few reasons. First, there is a limit to how much anyone (except Joey Chestnut) can eat.  Second, people often go to restaurants in groups, which means that there will be some Jack Sprat wives in the mix.  Third, there are sales of other items (drinks, liquor) that can offset the buffet to the extent it's a loss leader.  And fourth, the buffet can be priced high enough that it won't lose too much money.

MoviePass doesn't seem to have many of these factors working in its favor.  People can watch a lot more movies in a month than they can make trips to a buffet table in an evening. There's going to be an adverse selection of heavy users among subscribers, and they don't bring along Jack Sprat wives--the extra business of friends who come to the theater doesn't go to MoviePass, but to the theaters.  And MoviePass doesn't have much in the way of other sale items to offset losses on tickets.  OK, so we've got a really bad business model that will only work if lots of people sign up, but don't actually go to the movies.  This strikes me as different from other subscription models, like gyms.  People are likely to overestimate their likelihood of going to the gym. My guess is that they are much less likely to overestimate how often they'll go to the movies. 

Well, this is all very interesting, but what does it have to do with Credit Slips?  Three things, I think, one dealing with payment systems and secured lending, and the other two dealing with bankruptcy, which seems to be where this is all headed (assuming that MoviePass is not run out of a bankruptcy remote entity). 

Wacky Warehouse Lien Scam

The US Trustee's office just prevailed in a sanctions case against a law firm with a most creative fee scam.  To oversimplify (and leave out certain other issues of bad behavior), the law firm steered debtors who owned cars in which they had zero equity into an arrangement in which the debtor's car would be towed for an (unpaid) fee by an affiliated firm and then stored in Indiana. The existing auto lender would never be notified of any of this. The affiliate would then assert a warehouseman's lien for the unpaid fee and foreclose on the car, and use the sale proceeds to pay back the fee and pay the debtor's bankruptcy filing fee to the law firm, with the auto lender getting nothing. 

Call for Commercial Law Topics (and Jargon!)

For the spring semester, I am offering advanced commercial law and contracts seminar for UNC students, and have gathered resources to inspire students on paper topic selection as well as to guide what we otherwise will cover. But given the breadth of what might fit under the umbrella of the seminar's title, the students and I would greatly benefit from learning what Credit Slips readers see as the pressing issues in need of more examination in the Uniform Commercial Code, the payments world, and beyond. Some students have particular competencies and interests in intellectual-property and/or transnational issues, so specific suggestions in those realms would be terrific. Comments are welcome below or you can write us at bankruptcyprof <at> gmail <dot> com. 

We also are going to do a wiki of commercial law jargon/terminology. So please also toss some terms our way through the same channels as above (or Twitter might be especially useful here: @melissabjacoby).

Thank you in advance for the help!

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.

 

 

Jevic Commentary

Just a cross-posting note: Jonathan Lipson and I comment on the U.S. Supreme Court's Jevic decision at the Harvard Law School Corporate Bankruptcy Roundtable.

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: LoPucki's Virtual Bankruptcy Proposal

Hard to believe it has been over a year since a creditor representative opposing H.R. 870 characterized chapter 9 municipal bankruptcy as "the Wild West" in Congressional testimony. Whatever uncertainties bankruptcy law contains (and, sure, they are not trivial), our symposium reveals that the true legal wilderness in government debt restructuring lies beyond the boundaries of title 11. 

Enriching the collective brainstorm is a proposal by the always-innovative UCLA law professor Lynn M. LoPucki published in the Huffington Post. Here's the link, and here's a quote:  

 

 

 

 

 

The full story offers plenty of caveats and risks for creditors - including that this approach could be considerably less protective of creditors' interests than bankruptcy - so do read the whole thing. Although the piece does not expressly mention the Executive Branch, prior Credit Slips posts (such as here) have illustrated the potential combination of the Administration's use of soft powers to promote restructuring efforts formally initiated by Puerto Rico - again, potentially without the creditor protections normally associated with bankruptcy and without other pieces of financial reform that many have advocated. 

 

 

Secured Credit, Churches, and Reorganization

Chapter 11's ability to empower true reorganization has received much criticism of late in light of an increasingly held assumption that most Chapter 11 cases end in a 363 sale of the debtor's assets. Around this time last year, the American Bankruptcy Institute and the University of Illinois College of Law co-hosted a symposium dedicated to discussing secured creditors’ rights and role in modern Chapter 11. Papers from the symposium (including by Slips contributors) very recently became available here.

I was lucky enough to moderate a couple of the symposium panels. As I was listening to the discussion, I noticed that what I was hearing about secured creditors and 363 sales did not match  what I had observed in my study of how religious organizations (mainly smaller churches) currently use Chapter 11. To accompany the release of the symposium papers, I wrote a short piece describing how secured creditors influenced religious organizations' Chapter 11 cases in ways that did not lead to widespread sales, but rather, plans and settlements.

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.

Little Big Mistakes: The Second Circuit Rules on GM/JP Morgan

Culminating a two-year appeals process, the United States Court of Appeals for the Second Circuit just ruled that the statement filed to terminate a financing statement perfecting a security interest was effective. Yes, the parties intended to terminate a different financing statement, but that doesn't change the outcome under the facts of this dispute (these facts have been the subject of several prior Credit Slips posts; see here and here and here).

Today's per curiam decision cites the Restatement (Third) of Agency for the proposition that "Actual authority . . .  is created by a principal's manifestation to an agent that the agent take action on the principal's behalf."  And, says the panel, that's what happened. Again, full (and fairly brief) opinion is here.

Pencil image courtesy of Shutterstock

Why Troubled Law Schools May Remain Open

For years, pundits have declared that many law schools were on the verge of closing. In particular, low-ranked, stand-alone law schools operating in competitive marketplaces were repeatedly highlighted as being at the highest risk of closing. And with enrollment plummeting at law schools around the country, many were wondering which law school would be the first to keel over. Thomas Jefferson School of Law was often highlighted as a particularly likely candidate. But instead of closing, Thomas Jefferson recently restructured $127 million in bond debt, writing down $87 million and having the interest rate on its remaining $40 million reduced to 2%. In exchange, the school handed over the only significant asset it had on its balance sheet—its new law school building. But the building was promptly leased back to the school and Thomas Jefferson remains open for business. This ignited my curiousity and I decided to investigate.  

A look at Thomas Jefferson’s audited financial statements helps make sense of the school’s restructuring and what it implies for other law schools.

A Filing Means What It Says

Almost two weeks ago now, the Delaware Supreme Court handed down its decision over J.P. Morgan's mistaken termination statement in the General Motors bankruptcy. (Note to Google Chrome users like me -- the link may not work; try a different web browser.)  I think they got it right, but to understand why, one obviously needs to know the facts. Melissa Jacoby has blogged about the case (especially) here and here. As Melissa explains in more detail in the former post, the case revolves a mistaken Uniform Commercial Code (UCC) filing by JPMorgan Chase. 

To really stylize the facts, there were two loans from JPMorgan Chase to General Motors. Let's call them Loan A and Loan B. Both loans were secured. Loan A was being paid off. Acting on behalf of JPMorgan Chase, lawyers for General Motors were instructed to file a termination statement in the UCC records. Because of a slip-up in the paperwork, termination statements were filed for both Loan A and Loan B. At the time General Motors entered bankruptcy, Loan B was still outstanding in the amount of $1.5 billion, meaning that if the termination statement is effective JPMorgan Chase would be unsecured in the General Motors bankruptcy.

A Bubble in Deceptive, Abusive Subprime Auto Lending?

In a long story in today's edition, the New York Times is reporting a bubble in often deceptive and abusive subprime auto lending on unaffordable terms, including very high rates of interest.  Although not quite the threat to the overall economy that the subprime mortgage bubble created eight or nine years ago, this apparent new bubble in lending for used vehicles has some similar features (targeting vulnerable consumers, lax underwriting, securitization, investors seeking high returns) and is causing significant pain for low income and unsophisticated borrowers.  A few regulators are mentioned in the story, but oversight so far seems to have been lax.

Small Formalities, Big Consequences in Secured Credit Law - An Update

To what extent does secured credit law protect creditors from the consequences of mistaken actions made on their behalf? I wrote about this issue in March 2013. As discussed in that post, the bankruptcy court issued both a decision on the merits and a certification for a direct appeal to the U.S. Court of Appeals for the 2nd Circuit.

The 2nd Circuit has now certified the following question to the Delaware Supreme Court: 

Under UCC Article 9, as adopted into Delaware law by Del. Code Ann. tit. 6, art. 9, for a UCC-3 termination statement to effectively extinguish the perfected nature of a UCC-1 financing statement, is it enough that the secured lender review and knowingly approve for filing a UCC-3 purporting to extinguish the perfected security interest, or must the secured lender intend to terminate the particular security interest that is listed on the UCC-3? 

The 2nd Circuit decision is here.  (The date of oral argument on the cover page should say March 2014, not March 2013). 

File folder photo courtesy of Shutterstock

ABI/Illinois Symposium -- Now on Video!

The American Bankruptcy Institute (ABI) Commission on Chapter 11 Reform has been considering how to improve the chapter 11 process. Among the thorniest issues the ABI Commission has faced is how to fairly balance the interests of secured creditors with the rights of other stakeholders in the chapter 11 process. To better understand the issues and especially to illuminate whether secured creditors can assert constitutional limits on chapter 11 reform, the ABI and the University of Illinois College of Law co-sponsored a symposium in early April at the offices of Kirkland & Ellis. 

The presentations now are all available for streamning over the Internet at the low, low price of free. The papers will be published in the University of Illinois Law Review.

Is UCC Article 9 the Achilles Heel of Bitcoin?

Last week, Professor Lynn LoPucki called me up and asked a good question. Why hasn’t Bitcoin fallen apart because of the operation of Article 9 of the Uniform Commercial Code (UCC)? It is a really good question. With Lynn’s permission, I am writing up a blog post about our conversation, but it was Lynn who first identified the issue.

As many readers will know, all 50 states have enacted the UCC with only minor variations. Article 9 governs security interests in personal property – that is, movable and intangible property as opposed to land and buildings. The bank that gave you a car loan has an Article 9 security interest in the automobile serving as collateral for the loan, and the bank providing operating capital for your corner bakery similarly may have an Article 9 security interest in the inventory, equipment, and accounts at the store. Article 9 is one of those laws that only specialists tend to know, but it plays an important role in the flow of commerce.

CapitalOne Contract Not Just Creepy But Illegal?

CapOne's taken a lot of flack today over its apparent desire to check what's in your wallet by visiting you at home and at work.  The LA Times story got even bigger when it made it to Twitter and  great (and lots of bad, see previous sentence) puns started rolling in.

The company answer seems to be that language from a security agreement for snowmobiles got "mixed in" with the credit card language (and no one over there is reading their 6-page contracts). They are now "considering creating two separate agreements given this language doesn’t apply to our general cardholder base."  

I wonder if that means that they'll also revisit the part of the credit card agreements that takes a security interest in anything you buy from Best Buy, Big Lots, Jordan's Furniture, Neiman Marcus/Bergdorf Goodman, or Saks?  (I should note, your clothes are only in danger if you have a Saks "retail" card; if your card is a Platinum or World card not only is your interest rate likely lower but it seems your stuff is also safe).

This, I Don't Believe

My friend, Frank Venis, sent me a link to a Planet Money/NPR story that 42.1% of home purchases are now in cash. I have been meaning to write up a quick post on the story since the story appeared, but my day job kept interfering.

New Empirical Paper on Home Mortgage Foreclosure and Bankruptcy

Cross-campus colleagues and I have posted a paper that studies intersections between mortgage foreclosure, chapters of bankruptcy, and other variables, using the Center for Community Capital's unique panel dataset of lower-income homeowners. An excerpt from the abstract:

We analyze 4,280 lower-income homeowners in the United States who were more than 90 days late paying their 30-year fixed-rate mortgages. Two dozen organizations serviced these mortgages and initiated foreclosure between 2003 and 2012. We identify wide variation between mortgage servicers in their likelihood of bringing the property to auction. We also show that when homeowners in foreclosure filed for bankruptcy, foreclosure auctions were 70% less likely. Chapters 7 and 13 both reduce the hazard of auction, but the effect is five times greater for Chapter 13, which contains enhanced tools to preserve homeownership. Bankruptcy’s effects are strongest in states that permit power-of-sale foreclosure or withdraw homeowners’ right-of-redemption at the time of auction.

Bear in mind that most homeowners in foreclosure in this sample did not file for bankruptcy. Among the 8% or so who did, the majority filed chapter 13. For even more context, please read the paper - brevity is among its virtues, and exhibits take credit for page length. A later version will ultimately appear in Housing Policy Debate.

Ribbon house image courtesy of Shutterstock.

Ice Cube Bonds: New Paper on 363 Sales and Chapter 11

FAC UT ARDEAT, begins The Flamethrowers by Rachel Kushner. It means "made to burn," the narrator learns (from that "gasbag . . . Chesil Jones"). Whether your preferred hurry-up 363 sale metaphor involves flames, ice, or a wagon full of rotting salmon, Ted Janger and I have just posted a draft of an article reframing the problems with pre-plan going-concern sales, and reallocating the risk associated with such sales. The abstract:

Financially-distressed companies can melt like ice cubes. In Chrysler’s Chapter 11 bankruptcy, the finding that the debtor was losing $100,000,000 per day justified the hurry-up sale of the company to Fiat.  This assertion -- that the firm is a rapidly wasting asset -- is frequently offered, and accepted, in support of quick sales under section 363(b) of the Bankruptcy Code. This raises a policy question:  is this speed and streamlined process a “bug” or “feature?” Do these hurry-up going-concern sales create a speed premium and maximize value for the bankruptcy estate, or do they facilitate collusive deals between incumbent managers, senior creditors and potential purchasers? The answer is, “a little bit of both.” It is, therefore, crucial to distinguish between sales where the court and parties have good information about the value of the company and the costs of delay, from those in which melting ice cube leverage is used to exploit information asymmetries and to lock-in a favored deal. To accomplish this sorting and reduce transactional leverage, we seek to allocate the increased risks of foregone process to the beneficiaries of the sale. We propose that a reserve – the Ice Cube Bond – be set aside at the time of sale to preserve any potential disputes about valuation and priority for resolution after the sale has closed. This approach retains expedited section 363 sales as a useful way to quiet title in complex assets and preserve value, while preserving the opportunities for negotiation and adjudication contemplated by the Bankruptcy Code.

Perhaps Ice Cube Bonds is the long weekend reading material you were hoping would come your way? We'd value your feedback.

Match image courtesy of Shutterstock.

When a Billion Dollars has Eight Digits; Taking Authorization Seriously

Move over, two ships Peerless. Even in legal regimes that prioritize substance over form, errors in the execution of formalities can produce significant consequences and the risk of transactional failure. And even chapter 11 cases featuring quick asset sales can generate litigation over such formalities for years to come. A recent example illustrates both points.  

On March 1, 2013, the United States Bankruptcy Court for the Southern District of New York issued and certified a judgment for direct appeal to the United States Court of Appeals for the Second Circuit. The decision grants summary judgment in Official Committee of Unsecured Creditors of Motors Liquidation Company v. JPMorgan Chase Bank, N.A. et al, adversary proceeding 09-00504, in the GM bankruptcy. The decision already has received in-depth summaries, at least in some law firm bulletins. If the Second Circuit accepts a direct appeal, I aspire to watch the oral arguments, but hope it will be easier to find a seat in the courtroom than in NML v. Argentina.   

Stripping Down Bankruptcy Jargon

A Credit Slips commenter recently asked that blog posts explain (or at least spell out) acronyms and specialist terminology. This inspired me to report back on a corporate bankruptcy terminology set that University of North Carolina Law students collaboratively produced last year (technically, a wiki) in business bankruptcy, an advanced transition-to-the-profession seminar. In both comments and emails, Credit Slips readers helped me expand the list of terms (and also offered great ideas for practical writing projects). So thanks again for your contributions, and thanks also to the Spring 2012 seminar alumni - some of whom are practicing bankruptcy law or clerking for bankruptcy courts right now, or headed there soon - who tackled the collaborative vocabulary project, and the entire seminar and its experimental elements, with such great spirit and a 100% perfect attendance record! So, some observations. 

Except as Provided in the Syllabus, Students Shall Read the Statutory Section (i) Before Coming to Class or (ii) In Class Unless Provided Otherwise

The legal side of what we do requires comprehending dense statutory texts. Law students, however, arrive in our courses after a first year of law school heavily devoted to case law. When I was teaching corporate law, a student once came up after class with a question about  preparing for the final exam. She earnestly explained that she understood "the law" -- it was just the statute she could not understand. Could I recommend a book that explained the statute? The law apparently was what was in the cases in the textbook, with the statute being some sort of aid to understanding the law. No wonder they put those statutes in books called statutory supplements!

In reaction to what I see as an overemphasis on court decisions in many other law school courses, my courses unashamedly emphasize the statutes we cover. For example, is a spouse is an "insider" under the Bankruptcy Code? Here is a hint for my students this upcoming semester -- the answer does not depend on your gut instinct: "relative" is a defined term. Thus, I was initially appalled on Friday when I got an advertisement from Aspen, a law textbook publisher (including of my own textbook on empirical methods in law), asking if I felt guilty about the amount of statutory material I assigned. If so, the new LoPucki and Warren statutory supplement for Bankruptcy Law and Article 9 (of the Uniform Commercial Code) was now available as a VisiLaw marked version that would make "inaccessible statutes accessible." No, I did not feel guilty about assigning too much statutory material -- if anything I wanted to assign more. This new development just seemed like another sign of the pending zombie apocalypse.

My initial reaction, however, was more "ready, fire, aim" than considered judgment. As I learned more about the product, I've decided it is worth a try. At the least, I wanted to write something here to get reactions from practitioners.

Article 9 and Bankruptcy Judges

A prior post addressed a proposed amendment to Article 9's official comments stating that the date of an Article 9 filing relates back to the initial filing date even if the debtor did NOT authorize the filing at that time. This post returns to that topic for two reasons. First, although it is risky to generalize, I sense that bankruptcy judges may still be unaware of this proposed amendment. This is relevant because bankruptcy judges often are on the "front lines" of Article 9 interpretation. Second, I have heard, indirectly, that at least some people want this amendment to lend approval to some lenders' current practice to routinely file without authorization during the loan application process. In other words, the loan is likely to be given within a few days, so no harm no foul. Maybe I misheard or misunderstood?  

Storage Wars and the Credit Practices Rule

A few times I have caught Storage Wars, a television show on A&E. When storage units customers do not pay their fees, the contents are auctioned off by the storage unit company. The show follows professional treasure hunters who bid at these auctions. The catch is that the treasure hunters are purchasing the unit without full knowledge of the unit's contents. With all the drama of finding out what was behind door number three on Let's Make a Deal, viewers get to watch these treasure hunters paw through the storage unit's contents and try to profit by finding items of real value. Every now and then, an item of tremendous value might be uncovered. A few days ago, I started wondering how this was legal.

Recommended reading: Broome on Article 9 Financing Statements

A few weeks ago I wrote about the importance of giving priority to an Article 9 financing statement only from the date on which the debtor  actually authorizes the filing, and a proposed official comment contrary to this position. My colleague Lissa Broome has just posted on SSRN an article she has written about another dimension of the issue: when secured parties file financing statements with an indication of collateral that is far broader than what the debtor authorized in the security agreement. She discusses recent cases that do not deter this activity as well as potential implications, including the chilling effect on future lending transactions.

When the debtor's signature was eliminated as a requirement for a valid financing statement in Revised Article 9, the drafters justified the change by technology: medium neutrality and facilitating paperless filing. Functionally, though, the implications go far beyond technology when you combine this change with the opportunity to file all-asset financing statements AND the broadest possible reading of the first to file or perfect rule discussed a few weeks ago.

Promoting Integrity in the UCC Article 9 Recording System

On January 1, 2011, Larry files a UCC-1 financing statement against David indicating David's equipment as collateral. At this point, David doesn't even know Larry, has not given him a security interest, and has not authorized this filing. On February 1, 2012, David meets and borrows money from Larry and signs a security agreement listing equipment as collateral (which, under UCC 9-509, automatically authorizes the filing of a financing statement against equipment). What is the relevant date for determining Larry's priority? The language of Article 9 itself strongly implies that February 1, 2012 is the relevant date. UCC 9-509 makes clear that financing statements are not valid unless authorized by the debtor - a pretty minimal burden to cloud the debtor's title. But a little-discussed 2010 amendment to the official comments of Article 9 says otherwise: to the drafters, if the filing is later authorized, Larry gets the benefit of the 1/1/2011 filing date for purposes of the "first-to-file-or-perfect" rule and other priority rules or competitions. 

The most relevant portion of the new paragraph (an addition to comment 4 to 9-322) reads as follows:

Should the Government or the Market Set Mortgage Down Payments? A New Study

UNC's Center for Community Capital has posted a new analysis of 19.5 million mortgage loans originated between 2000 and 2008 finding that mandatory down payments of 10% would lock out nearly 40% of all creditworthy borrowers while a 20% down payment would exclude 60%. The study finds a significantly higher exclusion rate for African American and Latino borrowers. The authors (Roberto Quercia of UNC, Lei Ding of Wayne State University, & Carolina Reid from the Center for Responsible Lending) do find valuable default-reduction benefits of other forms of strong underwriting as the Dodd-Frank Act already requires (through the "QM" and "QRM" classifications), but signal caution about the significant access costs of government-mandated down payment levels that government regulators may be currently considering.

Your Favorite Business Bankruptcy/Restructuring Lingo: A Word of Thanks

Just a word of gratitude to readers for providing great responses to the prior call for corporate bankruptcy lingo. Thanks to your help, UNC Law's advanced business bankruptcy students are collaboratively examining such terms through a wiki and this will help them make an even smoother transition into the professional world. If any new lingo comes to mind, don't hesitate to pass it along! 

Foreclosure Timelines and Mortgage Delinquency: More Evidence from Bankruptcy

At the end of a lively session yesterday at Duke Law School featuring Professor Stephen Ware of University of Kansas Law School, there was a brief discussion of whether shorter foreclosure timelines and clearer rules would promote more workouts of delinquent mortgages. The aforementioned paper about bankrupt homeowners suggests that the opposite might actually be the case: among homeowners in bankruptcy, longer foreclosure timelines in their home states were associated with a lower probability of foreclosure initiation while shorter timelines were associated with a higher probability of foreclosure initiation.

What is the Relationship Between Credit Cards and Mortgage Delinquency?

Previously I mentioned this new paper on homeowners in bankruptcy in the American Bankruptcy Law Journal. The central goal of the paper was to investigate what makes homeowners more or less likely to have mortgage troubles as they head into bankruptcy. One of the notable findings is that, across all the models, credit access had a significant effect on keeping mortgages current and avoiding foreclosure initiation (specifics listed pp. 302-304). But why?

In or Out of Mortgage Trouble? A Study of Bankrupt Homeowners

This is a newly published paper  in the American Bankruptcy Law Journal that I was lucky to work on with Daniel McCue and Eric Belsky at the Joint Center for Housing Studies at Harvard University. Using previously unexamined data in the 2007 Consumer Bankruptcy Project, we study what makes homeowners more or less likely to have mortgage troubles as they head into bankruptcy. Although much can be said about the econometric analysis, for now I wanted to mention quickly that the paper includes descriptive details about bankrupt homeowners (debtor-reported) such as numbers of missed mortgage payments, use of adjustable rate mortgages, mortgage broker use, mobile homes, and refinancing or home equity lines of credit. So please check it out!