The Inequities of Equitable Subordination

Sitting as courts of equity, bankruptcy judges have embraced an exceptionalist role whereby they exercise widespread discretion in deciding cases. The doctrine of equitable subordination epitomizes bankruptcy exceptionalism and its potential for market distortion.

The doctrine originated as a remedial measure to give innocent creditors of insolvent debtors priority over creditors that engage in malicious misconduct. The Supreme Court introduced equitable subordination in a bankruptcy case in which a parent company virtually preyed upon its subsidiary, effectively driving it into insolvency. The Court ruled that the subsidiary’s preferred shareholders should have priority over the parent’s intercompany debt claims against the … Read more

Venezuela: Prospects for Restructuring Sovereign Debt and Rebuilding a National Economy

Venezuela is facing not only a grave humanitarian crisis, but an acute financial and economic one as well–including a massive debt burden.  Moreover, Venezuela is in the throes of an extended political stalemate between the forces aligned with the regime of Nicolás Maduro and those led by opposition leader and so-called “interim” Venezuelan president Juan Guaidó.  However, as long as the Maduro regime remains in power, it seems unlikely that Venezuela will be able to negotiate a restructuring deal with its foreign creditors, due in no small part to certain restrictions provided for in the current U.S. sanctions regime vis-à-vis … Read more

Bankruptcy Shopping: Domestic Venue Races and Global Forum Wars

The United States Bankruptcy Code gives debtors wide discretion to reorganize in the venue of their choice. These lenient venue selection rules long have allowed bankruptcy courts in the District of Delaware and the Southern District of New York to dominate the market for large Chapter 11 cases, though recently the Southern District of Texas has also begun to attract a large number of cases.

Critics of liberal venue rules charge that bankruptcy districts are engaged in a “race to the bottom” as judges compete for blockbuster cases. Others counter that competition for cases improves efficiency and predictability as judges … Read more

The Government Tools for Responding to Market Distress

In the spring of 2020, as the Covid-19 pandemic shut down economies around the world, pressure arose for governments to respond to the growing threat of pandemic-related market distress. In the United States, the initial proposals for government action varied in nature and focus. Some proposals targeted the financial system while a few targeted small businesses and individuals. Others were intended to bail out large businesses and specific industries. Still other proposals took a more institutional focus. In the context of bankruptcy law, many experts imagined building up the bankruptcy system as a primary bulwark against a seemingly imminent wave … Read more

How Principal Reduction Through Mortgage “Cramdown” Affects Household Distress

The U.S. experienced an unprecedented number of home foreclosures during the Great Recession of 2007-2009. To limit defaults and deadweight losses, the government implemented various policies that reduced monthly payments by homeowners (i.e., Home Affordable Modification Program) and facilitated mortgage refinancing (i.e., Home Affordable Refinancing Program). These initiatives had modest success. An alternative policy proposal that was not implemented during the Great Recession would have allowed mortgage “cramdown” by judges as part of the Chapter 13 bankruptcy process. The proposal passed the House of Representatives but failed in the Senate. In these restructurings, the underwater portion of the mortgage is … Read more

Bankruptcies and the Covid-19 Crisis

The COVID-19 pandemic has disrupted normal life and triggered massive economic slowdowns. In the United States, consumer spending has dropped dramatically and unemployment temporarily hit the highest levels since the Great Depression. As a result, many experts have projected a massive number of consumer and business bankruptcy filings in the coming months.

In our recent paper, “Bankruptcy and the COVID-19 Crisis,” we track bankruptcy filings in the U.S. using real-time data on the universe of filings. Historically, bankruptcy filings have closely tracked the business cycle and unemployment rates. However, we show that this relationship has reversed during the COVID-19 crisis … Read more

O’Melveny & Myers Discusses Predatory Priming

Priming transactions have been increasing in frequency during the current pandemic restructuring cycle.  Priming usually involves the debtor shifting collateral and assets away from their core lending group to support new tranches of debt that are structurally or directly senior to their existing lenders.  Holders who are not included in the priming tranche are left with their investments further underwater and their restructuring options more limited if the priming “fix” doesn’t turn the debtor’s business around.  Some priming transactions have recently become more aggressive and involve a subset of lenders rigging a majority to improve their positions over minority lenders.  … Read more

Puerto Rico; Act III

In 2017, Puerto Rico and certain of its affiliates filed “bankruptcy” petitions under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”).  These cases are pending in the U.S. District Court for  Puerto Rico; however, under the law Judge Laura Taylor Swain in New York was appointed to preside over the cases.  My new paper – Puerto Rico; Act III – provides an overview of where things stand  and where they might be heading.

PROMESA is a bankruptcy law, with various bells and whistles attached. In addition to its restructuring provisions, the law creates the Financial … Read more

Arnold & Porter Discusses Covid-19 and Antitrust, Bankruptcy, and Distressed Sales

The COVID-19 pandemic has created significant financial distress for many businesses and there have been a number of bankruptcy filings recently,[1] with more likely on the horizon. As a result, there is likely to be an increase in acquisitions of companies or assets out of bankruptcy.[2] Companies considering bankruptcy sale-transactions need to consider the structure that best suits their needs—e.g., a “363 sale”  offering a separate sale process and potentially speed, or a sale as part of the plan of reorganization or liquidation plan, which allows for the sale to be incorporated into the plan process. It also … Read more

Estimating the Need for Additional Bankruptcy Judges in Light of the COVID-19 Pandemic

We recently estimated the U.S. bankruptcy system’s ability to absorb an anticipated surge of financial distress among American consumers, businesses, and municipalities as a result of COVID-19.

An increase in the unemployment rate has historically been a leading indicator of the volume of bankruptcy filings that occur months later.  If prior trends repeat this time, the May 2020 unemployment rate of 13.3 percent will lead to a substantial increase in all types of bankruptcy filings.  Mitigation, governmental assistance, the unique features of the COVID-19 pandemic, and judicial triage should reduce the potential volume of bankruptcies to some extent, or make … Read more

Skadden Discusses UK Covid-19 Bill to Aid Business, Restructuring

On 20 May 2020, the U.K. government published the Corporate Insolvency and Governance Bill (the bill), which includes measures designed to help businesses through the COVID-19 pandemic and features important substantive reforms to U.K. restructuring law, whose introduction has been accelerated by the crisis.

COVID-19-Related Measures:

The key temporary measures introduced by the bill are:

Statutory Demands and Winding up Petitions

Creditors frequently press companies to pay debts by issuing statutory demands followed by winding up petitions. Most recently, some landlords have been pursuing this route because of the temporary ban on the forfeiture of leases introduced by the Coronavirus … Read more

Covid-19 and Bankruptcy: A Case For “Light-Touch” Reorganizations

Different countries have adopted various strategies to prevent or delay initiation of insolvency proceedings and protect businesses in the wake of the Covid-19 crisis. Global response has broadly been along the lines of providing direct financial aid (by way of loans or grants) or taking steps by way of emergency legislation to delay insolvency proceedings. Whether it is the United States or Europe, the overall aim of these strategies is to keep businesses afloat and provide them with protection, albeit temporary, from creditor action. The protection is based on the premise that, in a post-lockdown period, businesses will be able … Read more

The Case for Creditor Cooperation Duties in Corporate Workouts

The COVID-19 pandemic is causing financial distress to economically viable firms on an unprecedented scale.  In this post, we introduce the novel idea of creditor cooperation duties to stabilize corporate workouts.

The prospect of widespread defaults by viable firms triggered by the COVID-19 pandemic has prompted emergency legislation around the globe. To a significant degree, these measures aim to keep distressed firms out of formal bankruptcy proceedings.  For example, duties to initiate such proceedings have been suspended in Germany, Italy, and Spain; rules that govern the liability of directors of near-insolvent or insolvent companies have been relaxed in Australia, Singapore, … Read more

Large Corporations Did Not Need A Bailout

The CARES Act passed in response to the COVID-19 crisis provides billions of dollars in industry-specific loans that will go to large corporations like Boeing and the major airlines. These provisions are part of a larger compromise that also puts important funds into the hands of individuals and small businesses. But one should not be fooled into thinking the provisions benefiting large corporations and their shareholders were a necessary part of a coronavirus bailout. Instead they go against the core principles that should guide policymakers in responding to a crisis of this sort.

As Eric Posner and I explained in … Read more

Bankruptcy’s Role in the COVID-19 Crisis

Current policy discussions tend to minimize the role of bankruptcy law in mitigating the financial fallout from COVID-19. Scholars too are unsure about the merits of bankruptcy, especially Chapter 11, in resolving business distress. In this paper, we argue that bankruptcy should be a central part of policies targeting large corporations, but should be used only as a backup to other policies for consumers and small businesses.

With respect to large corporations, we begin with the observation that, although the current crisis has destabilized all businesses, many were likely to suffer distress regardless of a pandemic. The past decade saw … Read more

COVID-19: A Global Moratorium for Corporate Bonds

The alarming prospect of widespread defaults by viable firms caused by the COVID-19 pandemic has prompted various proposals for financial assistance from states. But firms might face financial distress before these measures become effective. Smaller firms with concentrated debt may be able to informally negotiate an extension of maturity with their lenders. Debtors with bonds outstanding may not be able to arrange workouts so easily. What they need is a novel form of relief.

More than half of European corporate bond issues are governed by UK or U.S. law. We suggest that emergency legislation be introduced to extend the maturity … Read more

Restructuring Argentina’s Sovereign Debt: Navigating the Legal Labyrinth

For almost two years, Argentina has been facing a severe economic recession and has not had the ability to access international capital markets. This has been due to several factors, including a general capital flight from emerging markets following the U.S. Federal Reserve’s interest rate hikes throughout 2018, and the country’s persistent fiscal deficits and macroeconomic imbalances. The crisis moreover comes at a time when the risk of a global economic slowdown has sharply increased.

All of this has left Argentina vulnerable to a sovereign debt crisis. The president elect, Alberto Fernandez, has stated that once he takes office … Read more

Household Debt Overhang and Unemployment

Personal bankruptcy is pervasive in the U.S.—about one in 10 Americans will declare bankruptcy in his lifetime.1 Under the U.S. bankruptcy code, households are protected by limited liability. That is, they can discharge their debt and still keep a substantial amount of their assets. Such limited-liability protection distorts the incentives of indebted households, just as it distorts the incentives of indebted firms in corporate finance. In our forthcoming paper,  we investigate how this distortion can affect the labor market. In particular, we ask the following questions. How does limited-liability debt distort household labor supply, and how does this affect aggregate … Read more

Bankruptcy Hardball

By many accounts, we have entered an era of unprecedented contentiousness in debtor-creditor relations.  For an example of the new status quo, consider the recent actions of PetSmart, a perfectly normal American corporation struggling with debt from a leveraged buy-out gone sour.  The textbook account of corporate governance would suggest that PetSmart’s board of directors would respond to this financial distress by seeking to improve the underlying business or, perhaps, by filing for Chapter 11 bankruptcy to maximize the value of the firm for the benefit of creditors.  Instead, PetSmart’s board authorized a transaction that seems shocking for a firm … Read more

Why Do Bankrupt Firms Have Such Complex Capital Structures?

Complex capital structures are prevalent in many recent high-profile Chapter 11 bankruptcy cases.  One recent example is Toys ‘R’ Us, whose debt structure was, as characterized by Bloomberg Businessweek, “as complex and precarious as a Jenga tower. [1]” It included dozens of subsidiary entities, with separate debt facilities against entities owning the intellectual property, the real estate, and international operations, among other asset groups.  Why do capital structures become fragmented and complex in this way, and what are the implications for bankruptcy law?

In my working paper, Disagreement and Capital Structure Complexity,  I suggest one reason why a firm’s … Read more