Renegotiation and the Choice of Covenants in Debt Contracts

Incomplete contracting theories build on the idea that it is either not feasible or too costly for contracting parties such as borrowers and lenders to write contracts that perfectly anticipate all future scenarios. As a result, transacting parties are left exposed to the risk that they might face a costly future renegotiation. This expectation can in turn lead to inefficiencies in terms of investment or other value-enhancing corporate decisions. Despite the widespread use of incomplete contracting theories, few if any empirical studies have directly examined the extent to which future renegotiation considerations affect debt contract structures. My paper contributes to … Read more

Could Solvency II Threaten the Financial Stability of European Insurance?

The European insurance sector has approximately 6.8 trillion euros of assets under management. It is the largest European institutional investor, a fundamental element of financial stability and provides support for the global economy. Additionally, the European insurance sector is a significant source of jobs, providing employment for more than one million people. The chart below illustrates the share of GDP represented by insurance premiums, generally defined as penetration ratios.[1]

Solvency II, Figure 1
What is Solvency II?

The Solvency II Directive[2] is a set of regulatory requirements for the European insurance industry. Adopted in 2009, the Directive was slated to take effect … Read more

Wachtell Lipton discusses Treasury Department Seeking to Curb “Cash-Rich” and REIT Spin-Offs

The Treasury Department and the Internal Revenue Service have announced (in Notice 2015-59) that they are studying issues related to the qualification of certain corporate distributions as tax-free under Section 355 of the Internal Revenue Code in situations involving substantial investment assets, reliance on relatively small active businesses, and REIT conversions. The IRS concurrently issued related guidance (Rev. Proc. 2015-43), adding such transactions to its ever-expanding list of areas on which it will not issue private letter rulings. While this expansion of the IRS’s “no-rule” areas is not a statement of substantive law, these announcements may have … Read more

The Financial Industry’s Plan for Resolving Failed Megabanks Will Ensure Future Bailouts for Wall Street

The high-risk business model of large financial conglomerates (frequently called “universal banks”) was an important cause of the financial crisis. Universal banks rely on cheap funding from deposits and shadow banking liabilities to finance their speculative activities in the capital markets. By combining deposit-taking and short-term borrowing with underwriting, market making, and trading in securities and derivatives, the universal banking model creates a strong likelihood that serious problems occurring in one sector of the financial industry will spread to other sectors. To prevent such contagion, federal regulators have powerful incentives to bail out universal banks and protect all of their … Read more

The Detroit Bankruptcy Blueprint

What unites Atlantic City, the Chicago Public School System, and Puerto Rico’s electric company? They are financially distressed government entities facing various legal and political barriers to using the United States bankruptcy system. Negotiations over those barriers are, in part, a referendum on the historic Detroit chapter 9 case – not just the substantive outcome, but the procedural pathway constructed by the court from the case’s inception to the finish line.

Detroit was a game changer in understanding the federal court’s influence through management decisions rather than landmark rulings after trials. According to the conventional wisdom, judges perform primarily gatekeeping … Read more

PwC discusses Resolution: Single point of entry strategy ascends

The release last week of public summaries of the resolution plans submitted by the 12 largest financial institutions operating in the US reveal more insight into the institutions’ resolution strategies than ever before, including the strategy for each of their most important subsidiaries (“material entities”).

The considerable additional detail of the 2015 releases displays the structural differences between these institutions – especially between the eight domestic banks and the four foreign banking organizations (“FBOs”). In particular, there is a notable shift toward a Title I single point of entry (“SPOE”) strategy among domestic institutions:1

  • Six of the eight domestic

Read more

Simpson Thacher discusses SDNY Decision Holding that the Termination of a Parent Guarantee Violates Section 316(b) of the Trust Indenture Act

On June 23, 2015, the District Court (the “Court”) for the Southern District of New York (the “SDNY”) held that an out-of-court restructuring that involved the elimination of a parent guarantee and a significant asset transfer was impermissible under Section 316(b) of the Trust Indenture Act of 1939, as amended (“TIA”). The Court held that the elimination of the guarantee and asset transfer impaired the nonconsenting noteholders’ right to receive payment, which was protected by the TIA. This decision, Marblegate Asset Management et al. v. Education Management Corp. et al., No. 14 Civ. … Read more

Law and Custom as Constraints on the FOMC

The Federal Open Market Committee, which controls the supply of money in the United States, may be the country’s most important agency. The chair of the committee is often dubbed the second most powerful person in Washington, only deferring to the President himself. Financial scholars and analysts obsess over the institution, leading to a rich tradition of FOMC Kremlinology, veneration, and second-guessing in business schools and economics departments.

But legal scholars have been less entranced by the committee, put off, perhaps, by the fact that the institution has never been checked by the courts or the Administrative Procedure Act. As … Read more

Sullivan & Cromwell discusses Bank Capital Plans and Stress Tests

On July 17, the Board of Governors of the Federal Reserve System (the “FRB”) released a notice of proposed rulemaking (the “NPR” and the rules set forth therein, the “Proposed Rule”) that would modify certain aspects of the FRB’s capital plan rule (the “Capital Plan Rule”)[1] and Dodd-Frank Act stress test rules (the “DFAST Stress Test Rules”)[2] applicable to large bank holding companies (“BHCs”)[3] and certain banking organizations with total consolidated assets of more than $10 billion. The NPR would also affect elements of the … Read more

Nominate Our Blog for the ABA 100

To the friends of the CLS Blue Sky Blog: The ABA journal is conducting a poll to identify the top 100 legal blogs.  We would be honored by your nomination.  In addition to reprinting commentary from practitioners and regulators on legal developments in corporate law, securities and other financial regulation, antitrust, restructuring and kindred topics, we feature explanations of recent scholarship in these fields and debates on policy issues.  We select our content to provide readers with a rich and broad view, and do not shy away from technical topics.  I believe there are few if any other forums serving … Read more

Chapter 11 Duration, Preplanned Cases, and Refiling Rates: An Empirical Analysis in the Post-BAPCPA Era

The Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”),[1] enacted in 2005, has been the subject of extensive commentary over the effects that the Act might have on the chapter 11 landscape and the debtor’s reorganization chances.

In my article, “Chapter 11 Duration, Preplanned Cases, and Refiling Rates: An Empirical Analysis in the Post-BAPCPA Era,” I use multivariate regression models to examine empirically and quantify, for the first time, BAPCPA’s effect on three distinct aspects of the chapter 11 process: (a) the duration of traditional chapter 11 cases; (b) the use of preplanned bankruptcies, that is, prepackaged … Read more

Sovereign Equity – A Way Forward on Sovereign Debt?

Sovereign debt markets have been on a rough ride recently. On the heels of Argentina’s 2014 default, a turbulent debt situation in Greece has threatened the integrity of the Eurozone. An ongoing debt crisis in Ukraine has stoked economic anxiety and raised geopolitical blood pressures. Meanwhile, Puerto Rico’s debt crisis poses unique challenges as a quasi-sovereign territory without access to bankruptcy.

These episodes highlight the broad and far-reaching effects of sovereign debt on the global financial system. While sovereignty limits the enforceability of their debt contracts, sovereigns lack a formal bankruptcy system. Nor is there a global sovereign debt regulator. … Read more

Shearman & Sterling discusses Third Circuit’s Affirmation of Structured Dismissal of Chapter 11 Case, Holding That a Structured Dismissal Can Deviate From the Bankruptcy Code’s Priority Scheme in Rare Circumstances

On May 21, 2015, the United States Court of Appeals for the Third Circuit affirmed a decision of the United States Bankruptcy Court for the District of Delaware, which had approved the structured dismissal of the chapter 11 cases of Jevic Holding Corp., et al. The Court of Appeals first held that structured dismissals are not prohibited by the Bankruptcy Code, and then upheld the structured dismissal in the Jevic case, despite the fact that the settlement embodied in the structured dismissal order deviated from the Bankruptcy Code’s priority scheme.

Background

Jevic Transportation, Inc. was acquired by a subsidiary of … Read more

A Market Approach to Regulating the Energy Revolution: Assurance Bonds, Insurance, and the Certain and Uncertain Risks of Hydraulic Fracturing

Despite the recent drop in oil and natural gas prices, fossil fuels continue to flow out of U.S. wells at astounding rates. In just a few years, the United States has transitioned from a position of substantial dependence on foreign fuels to the status of a leading producer of both oil and gas. This is due largely to the combination of horizontal drilling and hydraulic fracturing deployed in shale formations around the United States. This rapid transition has greatly benefited parts of the country economically but also shows the perils of resource booms and the busts that follow. The current … Read more

Governor Lael Brainard on Dodd-Frank at Five: Assessing Progress on Too Big to Fail

If there is one simple lesson from the crisis that we all can embrace, it is that no financial institution in America should be so big or complex that its failure would put the financial system at risk.1 Congress wrote that simple lesson into law as a core principle of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).

Consequently, a fundamental change in our framework of regulation as a result of the crisis is to impose tougher rules on banking organizations that are so big or complex that their risk taking and distress could … Read more

What’s the Value of a TBTF Guaranty? Evidence from the G-SII Designation for Insurance Companies

Since AIG’s bailout in September 2008, the role of large, complex insurance firms in the global financial system has received much attention. Concern about the global operations, interconnectedness, and non-traditional activities of these large firms prompted the Financial Stability Board to formally designate 9 life and full insurance firms in six countries as Global-Systemically Important Insurers (G-SII) in July 2013. In the US, where insurance industry assets equal roughly half the size of total assets held by all financial institutions covered by the Federal Deposit Insurance Corporation, the Financial Stability Oversight Council has confirmed the designation of AIG, MetLife and … Read more

Greece: What About the Banks?

A recent news story gives us a sobering anecdote about the Greek crisis: a merchant who must conduct all his business in cash because he can neither receive credit card payments nor pay vendors with electronic transfers. This means that the Greek banking system is failing to provide a payment system, a core function.   At first blush, this looks like another piece of the same crisis story we’ve heard for some time. But it is important to distinguish the banking system and its woes from the refusal of the “Troika” to extend a bailout program for the Greek government over … Read more

Morgan Lewis discusses N.Y. Court of Appeals Decision Resolving Statute of Limitations Accrual for Putback Claims

On June 11, New York State’s highest court, the Court of Appeals, rendered a highly anticipated decision in ACE Secs. Corp. v. DB Structured Prods., Inc., __ — __ (2015) (ACE Court of Appeals Decision). The decision resolves several issues related to the timeliness of claims for breaches of representations and warranties—or “putback” claims—in the context of residential mortgage-backed securities (RMBS) litigation. In rendering its decision, the court held that the statute of limitations for putback claims accrues at the time that the underlying representation or warranty regarding the loan was breached by the loan seller (in this … Read more

PwC discusses Asset Managers: The SEC’s road ahead

The debate over asset managers’ potential systemic risk has been ongoing for some years, with little agreement between the industry, US regulators, and global standard setting bodies. US regulators themselves have been divided – the SEC has in particular been skeptical that asset managers or individual funds can be the source of systemic risk of a magnitude akin to that posed by large banks.

Nevertheless, consensus is finally forming on the need to address specific risks of the industry. With the designation of asset managers as systemically important financial institutions (“nonbank SIFIs”) by the Financial Stability Oversight Council (“FSOC”) now … Read more

A Different Take on the AIG Case: The Dangers of Invoking 19th Century Principles to solve 21st Century Problems

Bagehot, as in Walter Bagehot, was mentioned no less than seven times in the decision splitting the baby in the AIG trial.[1]   A nineteenth century British commentator, Bagehot was among the first to recognize that too little liquidity could wreak havoc on a financial system. [2]  In a series of admonitions, known today as Bagehot’s dictum, he admonished central banks to lend freely to any solvent institution with good collateral, but at a penalty rate to minimize the attendant moral hazard.[3] In invoking Bagehot, Judge Wheeler was in good company.   Ben Bernanke and other leading policymakers regularly invoked … Read more