Bankruptcy Law Insights

Detroit Emergency Manager Posits Sale of Art Masterpieces as Bankruptcy Looms -Van Gogh(ing) Once, Twice, Sold?

Ben Feder — Thu, 30 May 2013 16:23:35 -0500

Kevyn Orr, the emergency manager appointed by Michigan Governor Rick Snyder to try to resolve the Detroit financial crisis, has effectively replaced the Detroit mayor, former NBA legend Dave Bing. However, it is Orr who in the upcoming weeks will need to hit the equivalent of a three-point shot at the buzzer if Detroit is to avoid becoming the largest municipal bankruptcy case in history.

The conundrum Orr faces is straight-forward. Detroit will succeed in emerging from the depths of its fiscal morass only if substantial concessions are made by the city’s bondholders and bond insurers, labor unions, pension funds, and other creditors. Moreover, the hope of being able to reach any agreement of a scope which could address Detroit’s long term problems almost certainly hinges on a substantial financial contribution from the State of Michigan. Such concessions and state financial support may only be obtainable if Detroit were to file for bankruptcy under Chapter 9 of the Bankruptcy Code. Unfortunately, as the recent examples of large Chapter 9 cases -- Jefferson County in Alabama, and the cities of Stockton and San Bernardino in California -- amply demonstrate, a Chapter 9 bankruptcy case can be an unwieldy and ruinously expensive proposition. Jefferson County has seen its legal costs run into the tens of millions. Stockton and San Bernardino are both grappling with complex issues regarding the relative priorities of bond debt and public pension obligations, which may ultimately need to be resolved by the Supreme Court. Detroit would dwarf all three in size and complexity. Given the likely expense and duration that a Detroit Chapter 9 case would entail, the cure could well be worse than the disease.

Orr’s Herculean task, then, is somehow to obtain the needed concessions and state financial support that would replicate the outcome of a Chapter 9 bankruptcy while avoiding an actual bankruptcy filing.

To that end, Orr’s suggestion last week that part of the collection of the Detroit Institute of Arts, widely considered one of the finest art museums in the country and home to famous masterpieces by Van Gogh, Matisse and Caravaggio, could be sold as part of a plan of adjustment in a Chapter 9 case, should probably be viewed as part of a broader strategic campaign. Just as Orr is trying to wrest concessions from bondholders and municipal employees by describing the potential parade of horribles that would befall them under Chapter 9, this shot across the bow of one of the cultural crown jewels of the entire State of Michigan is strongly redolent of a message to voters and elected state government officials that the collateral damage of a Detroit bankruptcy would not be contained.

Legally, it is highly questionable whether the DIA could ever be forced to sell an art masterpiece. Even if legal title to the paintings belong to the city (which owns the museum), one of the key differences between a Chapter 9 municipal bankruptcy and a Chapter 11 corporate bankruptcy is that a Chapter 9 does not give rise to the creation of a bankruptcy estate over which a bankruptcy court has jurisdiction. Put another way, a can be liquidated corporation in order to satisfy creditors. A municipality cannot.

Orr’s trial balloon regarding the sale of artistic masterworks has been widely criticized and ridiculed. If, however, the suggestion can in some way help pave the way towards a resolution of Detroit’s financial woes, it could be looked back upon as a master stroke.

"Girls Gone Wild" Chapter 11 Case - [Insert Joke Here]

Ben Feder — Wed, 01 May 2013 09:52:03 -0500

GGW LLC and its affiliates (“GGW”), which produce and distribute the soft core pornography videos known as “Girls Gone Wild”, recently filed for relief under chapter 11 of the Bankruptcy Code. The filing follows years of legal troubles for the company’s founder, Joe Francis, including criminal charges of racketeering and tax evasion, and civil litigation against Steve Wynn’s Mirage Resorts Casinos stemming from gambling debts owed by Francis. The bankruptcy filing of GGW was evidently precipitated by a slander judgment of $19 million obtained by Wynn against Francis.

The prurient nature of GGW’s business model aside, the case actually provides a cautionary tale for entrepreneurs who seek bankruptcy protection under chapter 11 in order to try to maintain control of the businesses that they have founded. Such owners are often ill-suited for the so-called “fishbowl” of chapter 11; they tend to ignore the advice they are given (or are unable to comprehend) that the filing of a petition for relief under chapter 11 both creates a distinct bankruptcy estate, and imposes substantial fiduciary obligations on company officers and directors to such estate and its creditors.

Although supposedly no longer an officer of the company at the time of the petition, Francis had clearly remained firmly in control of GGW. He likely believed that chapter 11 would provide him with respite from his legal pursuers, not grasping that the protective shield of the automatic stay under the Bankruptcy Code inheres to the benefit of the debtor entity only, and not its founder.

Far from being shielded, Francis’ legal woes are mounting. Wynn moved for the appointment of an independent trustee to oversee GGW’s chapter 11 case, which the judge granted after hearing evidence that GGW corporate assets were being used to pay substantially all of Francis’s personal expenses, including his mortgage, credit card bills and legal fees for matters not involving GGW. In opposing the motion for a trustee, GGW’s bankruptcy counsel asserted:

Francis' 'bad boy' lifestyle and image are inextricably identified with the Girls Gone Wild brand just as Hugh Hefner is identified with Playboy magazine. ... Since there are many free sources of adult entertainment available to consumers on the Internet, the principal thing that causes consumers to pay for the same adult entertainment services offered by the GGW entities is the desire by the consumer to identify with Francis and his lifestyle by being a paid subscription member of the brand he is responsible for starting[.]

Losing control of the company with which he is “inextricably identified” has evidently not sat well with Francis. The trustee has sought and obtained a restraining order against Francis, after alleging that Francis made “violent threats” against GGW employees who were not following his directions. Pending a May 8 hearing, Francis is barred from attempting to influence control over GGW or from coming within 100 feet of its premises.

Now It Gets Interesting - Stockton, CA Found Eligible to Remain in Chapter 9

Ben Feder — Tue, 09 Apr 2013 08:52:59 -0500

Nearly nine months after it filed for protection under Chapter 9 of the Bankruptcy Code, a federal bankruptcy judge last week determined that the city of Stockton, California has satisfied the requirements of Section 109(c) of the Bankruptcy Code and may proceed with its efforts to adjust its massive bond, pension and employee obligations. Section 109(c) of the Bankruptcy Code mandates, among other things, that a municipality seeking protection under Chapter 9 must show either that it has negotiated in good faith with its creditors, or that such negotiations were “impractical”. Stockton’s bondholders had contended that the city’s failure to engage in negotiations with Calpers, the California public employee pension system, prior to filing its petition required the dismissal of Stockton’s bankruptcy case under Section 109(c).

Judge Christopher Klein disagreed, and ruled that the fact that Stockton had sought major concessions from its bondholders but none from Calpers (even though Calpers is its single largest creditor) would not serve to disqualify Stockton from continuing its Chapter 9 case. He noted that that city was unequivocally insolvent, and determined that it had done everything it feasibly could to avoid resorting to Chapter 9 bankruptcy.

While this might appear on the surface to be a defeat for the bondholders, it could turn out to be a loss worth experiencing. Stockton contends that negotiations with Calpers were impractical, given the strong public employee pension liability protections under California law. Judge Klein agreed, but only for the immediate purpose of determining whether Stockton was eligible to enter bankruptcy. Exiting bankruptcy will entail a completely different analysis.

Judge Klein made clear that his ruling last week was only a first step. His comments suggest that Stockton will have difficulty obtaining approval of a plan of adjustment unless it confronts its Calpers obligations head on.

Plans of adjustment for municipal debtors, similar to plans of reorganization for corporate debtors, prohibit “unfair” discrimination among classes of similarly situated creditors. The bondholders now have the opportunity to have a fight for which they have been spoiling, and show that any preferential treatment afforded Calpers in a Chapter 9 case is precisely the type of “unfair” discrimination that the Bankruptcy Code forbids. Calpers, which has been equally eager for this battle, will rejoin that such discrimination is not “unfair” as the protections for public employee pension obligations under California law mandate such different treatment. The bondholders undoubtedly intend to respond that such state law preferential treatment is trumped by federal law under the Bankruptcy Code. Calpers will argue that the preference under California law for public employee pension obligations is protected under the Tenth Amendment.

The issues have now been squarely set out on the table by Judge Klein. If he in fact rules that Stockton cannot justify preferential treatment of public employee pension obligations and that the Tenth Amendment is inapplicable here, the bondholders will not regret last week’s defeat in the slightest.

DeX Games - SuperMedia and Dex One File Simultaneous Chapter 11 Cases to Effect Merger

Ben Feder — Mon, 25 Mar 2013 09:51:45 -0500

Distressed m&a is the “new normal” in Chapter 11 cases, as noted here and elsewhere. Two large media marketing and advertising companies, SuperMedia and Dex One, took the “new normal” to new extremes last week by filing simultaneous and coordinated “prepackaged” Chapter 11 cases in order to complete a merger of their businesses.

Both SuperMedia and Dex One are direct descendants of Yellow Pages publishers that have struggled to transition to the age of digital information. Each one has gone through a previous Chapter 11 case. SuperMedia, formerly known as Idearc, was spun off from Verizon in 2006 and emerged from its first bankruptcy in 2009. Dex One, the former R.H. Donnelly Corporation, also went through Chapter 11 during that same period and completed its reorganization in 2010. The new company, to be known as Dex Media, hopes to have the size and resources to better compete against Google and other companies that dominate the digital media landscape.

The companies agreed to merge last year, but both needed to make changes to their existing loan agreements which required 100% consent from their respective lenders. “Prepackaged” bankruptcy cases are often used in such situations. Companies seeking to do transactions which require unanimous or near-unanimous approval of lenders or bondholders can utilize the plan voting provisions of Chapter 11 if they fall short of obtaining the necessary support. A Chapter 11 plan must be supported by each class of impaired creditors (a plan class being a similarly situated group of creditors, such as secured lender claims or unsecured trade creditor claims) by a vote of half in number and two-thirds in claim amount. Accordingly, a restructuring company that falls short of what is needed under its applicable loan agreements or indentures can, by minimizing the number of impaired creditor classes (e.g., by continuing to pay all trade and vendor claims in the ordinary course of business), negotiate with the specific class of lenders whose approval is required in order to make sure that it will have the necessary votes for Chapter 11 purposes.

This is exactly what SuperMedia and Dex One have done. Each failed to get the necessary 100% approval of their senior lenders, but had far more than enough support to gain approval of Chapter 11 plans. In true “prepackaged” cases, as here, the plan of reorganization is voted upon and approved by the requisite number of creditors prior to the filing of the cases. Ideally, all that remains is the approval of the bankruptcy court.

The process obviously entails no small number of risks, beginning with the opportunity for disgruntled parties to appear in the Chapter 11 case and cause delays. Those risks are multiplied for SuperMedia and Dex One, because a snag in the expedited plan confirmation process in one case will invariably reverberate in the other. The two debtors’ respective professional advisors will need precision, coordination and some degree of luck to complete this transaction by the contemplated late April plan confirmation date.

Too Cool for School Specialty - Alternative DIP Financing Allows Educational Company to Avoid Immediate Sale

Ben Feder — Mon, 04 Mar 2013 11:54:40 -0500

The School Specialty chapter 11 case began in what has become all too typical fashion. The company, overleveraged and short of cash, had no choice but to accept a lifeline extended by its second lien secured lender, a private investment fund. The terms of the debtor in possession (“DIP”) financing required School Specialty to seek an immediate sale of substantially all of its assets, with the investment fund serving as the lead, or “stalking horse” bidder. The investment fund’s $95 million offer consisted mostly of a “credit bid” of its secured debt. The loan covenants required the sale to be approved by the bankruptcy court by March 27, 2013, less than two months after the commencement of the case.

Bankruptcy and restructuring professionals would immediately recognize this scenario as part of the “new normal”. These days the focus of a large portion of chapter 11 cases is not to rehabilitate companies, but rather to maintain going concern value through a sale of assets pursuant to section 363 of the Bankruptcy Code. Aggressive investment funds often extend funds to businesses in financial distress (or buy the existing debt at deep discount) with the clear intent of acquiring such companies if they fall into bankruptcy.

This practice, commonly known as “loan to own”, tends to work more often than not because the distressed borrower usually has no viable alternative. A company lacking unencumbered assets or positive cash flow can rarely access any other financing, and it is nearly impossible to loan new money to a chapter 11 debtor on a senior priority basis over the objection of an existing secured lender. The debtor must therefore accede to a debtor in possession (“DIP”) financing from its existing lender that mandates an expedited auction time frame. Although a competitive bidding process is required in nearly all section 363 sales, the hurried auction process strongly favors the investment fund and leaves other bidders unable to formulate meaningful competing bids. The “loan-to-own” investment fund wins the auction with a credit bid and unsecured bondholders and trade creditors are usually left with little or no recovery.

Protests in cases of this nature that the “loan-to-own” fund is “stealing” the company usually are ignored (because, as stated above, there is no real option), but School Specialty’s unsecured bondholders have bucked this trend. The bondholders agreed to back up their assertions that an expedited auction would undervalue School Specialty by funding an alternative DIP financing of $155 million that will pay off the existing loan of the investment fund, and provide School Specialty with an additional $50 million of new liquidity. The auction process will be extended out by nearly two months.

The School Specialty bondholders’ are making a substantial gamble that the additional time will either result in a higher sale price or permit the company to reorganize, and it will be interesting to see if it pays off. Many commentators and practitioners have lamented that chapter 11 has devolved into a little more than a glorified foreclosure process. Unsecured creditors, even bondholders, rarely have the capability to assume the level of risk that Specialty School’s bondholders have taken on. If it proves successful, School Specialty may prove to be a model for similar cases, which would help to once again make chapter 11 a fairer process for all creditors.

Absolute Priority Rule Absolutism? Strict Interpretation of Bankruptcy Code Cramdown Provisions Nearly Causes Hawker Beechcraft Plan Confirmation to Skid Along the Runway

Ben Feder — Fri, 08 Feb 2013 13:42:25 -0500

By nearly any measure, the Chapter 11 cases of Hawker Beechcraft and its affiliates (the “Debtors”) stand as a significant success. The cases began as a standalone reorganization predicated upon a restructuring support agreement (the “RSA”) among the Debtors’ senior lenders and noteholders, which soon thereafter gained the support of the creditors’ committee. The cases then switched over to a sale process, and when that bogged down the Debtors seamlessly restarted the standalone reorganization based on the RSA. The Debtors’ plan of reorganization (the “Plan”) provides for the cancellation of all existing equity of the existing corporate parent, Hawker Beechcraft, Inc. (“HBI”) and the issuance of equity in a new holding company to creditors, with 89% going to the Debtors’ senior bank lenders and the remaining 11% going to noteholders and other unsecured creditors. The Plan contemplates that the Hawker Beechcraft corporate structure will otherwise remain the same, with existing intercompany interests being unimpaired. (Kelley Drye & Warren LLP represents a major Hawker Beechcraft creditor.)

The Debtors went into the confirmation hearing for the Plan last week with almost no major objections and without any substantial litigation having taken place along the way, a remarkable achievement for Chapter 11 cases of the Debtors’ size and complexity. It therefore surprised nearly everyone in the courtroom when Judge Stuart Bernstein raised an objection on his own based on the alleged failure of one Debtor to satisfy the cramdown requirements of Section 1129(b) of the Bankruptcy Code.

The Plan required the approval of creditors of each of the separate Debtors. When the votes were tabulated, however, the unsecured creditors of one Debtor, Hawker Beechcraft Corporation (“HBC”), had voted to reject the plan. This in and of itself did not give rise to substantial concern, as the Debtors believed that they would readily be able to confirm the Plan over the HBC creditors’ rejection under the cramdown provisions of Section 1129(b). That section provides that a plan may be confirmed notwithstanding the rejection of one or more classes of creditors (i.e., “crammed down”), so long, among other things, as it is “fair and equitable.” With respect to unsecured creditors who are not paid in full, “fair and equitable” requires adherence to the “absolute priority rule”, which in turn means that

the holder of any claim or interest that is junior to the claims of the [rejecting] class will not receive or retain under the plan on account of such junior claim or interest any property . . .

Since all of the existing equity of HBI is being cancelled and new equity is being issued to creditors, the Debtors believed that they complied fully with Section 1129(b). Judge Bernstein, however, in a very strict reading of the rule, stated that while he would confirm the Plan for all of the other Debtors, he could not do so for HBC because of the provisions that left the Hawker Beechcraft corporate structure intact. In other words, Judge Bernstein saw a violation of the absolute priority rule with respect to HBC’s creditors because the equity of HBC itself was not being cancelled, and viewed that as an impermissible retention of “property” by the direct parent of HBC (itself a subsidiary of HBI) “under the plan on account of [a] junior claim or interest[.]”

An interesting colloquy followed, in which Debtors’ counsel contended that the HBC stock was remaining in place solely to maintain the Hawker Beechcraft corporate structure for the benefit of the new equity holders, and that the cancellation of HBI’s stock satisfied the dictates of the absolute priority rule. Judge Bernstein eventually agreed to allow the Debtors to brief the issue and to make technical changes to the Plan.

Judge Bernstein’s reading of Section 1129(b) can be justified as a “plain language” reading of the statute but, as with other recent instances of “plain language” interpretations of the Bankruptcy Code, it contravenes widely-accepted views regarding the purpose and intent of the absolute priority rule. Other judges who have ruled on cramdown in similar situations, such as Judge James Peck in the Ion Media case, have agreed that preserving intercompany interests in order to maintain an existing corporate structure does not have any economic substance, and that only the treatment of the equity of the ultimate corporate parent should be considered for purposes of determining whether the absolute priority rule has been satisfied.

After reviewing the Debtors’ submission and the proposed changes to the Plan, Judge Bernstein the following day confirmed the Plan for all of the Debtors, including HBC.

Bip . . . Bip . . . Bip . . . "Pong" Creator Atari Files for Chapter 11

Ben Feder — Tue, 22 Jan 2013 16:23:44 -0500

Atari, Inc., the creator of the primordial video game “Pong”, filed for Chapter 11 yesterday in the U.S. Bankruptcy Court for the Southern District of New York. Its parent company, Atari SA, simultaneously sought bankruptcy protection in France. The moves were precipitated by a cessation of funding from Atari SA’s largest shareholder and primary lender. According to issued statements, the Atari U.S. subsidiaries have remained profitable but need access to new capital, and are likely to be sold off in a sale under section 363 of the Bankruptcy Code, which will allow them to continue as a going concern.

Atari recently created an updated version of “Pong” for iPhones and Android devices. In keeping with the times, the paddles are now individual creatures - Shaggy, Chompers, Sir Bouncelot, Gnop, and Razzle - each “with their own unique power boosts and personalities”.

Steel Cage Match Between Calpers and Bond Investors Continues in San Bernardino Chapter 9 Case

Ben Feder — Tue, 08 Jan 2013 16:05:05 -0500

The battle in California municipal bankruptcies between bond investors and Calpers, the California public employee pension system, began in the Stockton Chapter 9 bankruptcy case and continues unabated in the bankruptcy case of San Bernardino. The issues at stake – whether California state laws protecting public employee pension obligations are pre-empted and superseded by Congress’s Article I, Section 8 authority to establish uniform laws regarding bankruptcy, or are protected under the Tenth Amendment -- implicate fundamental issues of federalism, and in all likelihood the Supreme Court will eventually need to resolve the questions being raised regarding the proper balance between state and federal power.

In San Bernardino, Calpers filed a motion asserting that public employee pension obligations have priority status under California law and that it is entitled to full and immediate payment of all such obligations owed by the city, notwithstanding the pendency of its Chapter 9 filing and the existence of the automatic stay under Section 362 of the U.S. Bankruptcy Code. Judge Meredith Jury of the U.S. Bankruptcy Court for the Central District of California rejected the motion. This ruling itself is not particularly controversial; even assuming that Calpers is correct in its argument that it is entitled to preferential treatment in the bankruptcy case, the exception to the automatic stay that it is seeking to invoke – pertaining to the exercise of a state’s “police and regulatory power” – does not extend as far as Calpers contends. (That exception has consistently been interpreted by courts as intended to allow governmental entities to maintain and protect public safety, and not, as Calpers is trying to do, to collect moneys owed to them.)

The far more complicated question is whether priorities for unsecured claims created under state law – particularly regarding obligors that are themselves governmental units – can trump the distribution mechanisms of the U.S. Bankruptcy Code, and the Code’s underlying purpose of providing similar treatment for similarly situated creditors. Numerous states in addition to California have varying degrees of protection for public employee pension obligations. (Rhode Island, on the other hand, recently took the opposite tack and enacted a law that gave priority to bondholders in the Central Falls Chapter 9 cases.)

Calpers will argue that the preference under California law for public employee pension obligations is protected under the Tenth Amendment. San Bernardino’s bond investors will argue that the Bankruptcy Code expressly sets forth the priority of certain types of unsecured claims, that no other unsecured claims are entitled to more favorable treatment, and that California law regarding public employee pension obligations is pre-empted by the Supremacy Clause of the Constitution.

This question will not be definitively answered in the near future. Assuming no consensual resolution in either the San Bernardino or Stockton cases (and neither side appears ready to concede an inch), a judicial decision will probably not be rendered until one of these cities seeks approval of a plan of adjustment, which is still probably months and possibly years away. Appeals thereafter will take even longer. The issues raised here will remain an overhang over municipal bankruptcies in California and in other states that have established specific creditor priorities for governmental entity obligors.

Panic in Detroit? Motor City Moves Closer to Possible Chapter 9 Filing

Ben Feder — Thu, 13 Dec 2012 14:51:01 -0500

Detroit has seen signs of revival in its urban core following the near-death experiences of GM and Chrysler. Unfortunately, its municipal finances remain beaten down by the city’s long and precipitous decline over the past several decades. Labor and legacy costs, incurred when the auto industry thrived and the population well exceeded a million citizens, are now heavy shackles on a city whose population has dropped to 700,000. Those costs, combined with a dysfunctional municipal government that has been unable to make necessary reforms, are leading Michigan’s governor Rick Snyder and Treasurer Andy Dillon to launch a process to appoint an emergency fiscal manager for the city, a step that could well lead to a Chapter 9 bankruptcy filing.

Bankruptcy filings by municipalities and governmental entities have, despite dire predictions, remained fairly rare. The few recent well-publicized filings that have occurred have been driven by unusual circumstances. Jefferson County, Alabama faced the double body blow of corruption, cost overruns and financing with complex derivatives in connection with the upgrade its sewer system that ultimately saddled the County with over $3 billion in debt, and the invalidation of an occupational tax that provided the primary source of its unrestricted general fund revenues. California municipalities Stockton and San Bernardino faced huge underfunded pension liabilities and the residual effects of the collapse of the residential housing market.

Those cases are already proving to be litigious and difficult, as the dearth of precedential law makes novel issues much tougher to resolve. However, a bankruptcy filing by Detroit would dwarf all of them in size and complexity.

It is possible that such a case could effectively be “pre-negotiated”, in a manner similar to that of the automobile companies. In this instance, the State of Michigan, rather than the U.S. Treasury, might promise to provide the necessary financial backing in exchange for concessions from Detroit’s bondholders, unions, and retirees. The new arrangements would then be implemented through a bankruptcy filing in order to take advantage of certain powers afforded to municipal debtors under the Bankruptcy Code, such as the ability to reject burdensome contracts.

Pre-negotiated cases, however, are difficult enough to achieve with business enterprises. With a city of the size of Detroit, a bankruptcy case could very easily devolve into a morass of litigation that could drag out for many months or even years. There is no question that a Chapter 9 filing for Detroit should be the absolutely last resort. Unfortunately, the time is fast approaching when there will indeed be no other options.

I Never Liked Twinkies

Ben Feder — Wed, 28 Nov 2012 16:32:41 -0500

Sno-Balls, on the other hand, and virtually every type of Drakes confection – Yodels, Yankee Doodles, Devil Dogs – I enjoyed to excess at every opportunity.

Fortunately, none of these famous snacks are going away, feverish news reports of Twinkie hoarding and e-Bay price gouging notwithstanding. Hostess Brands in its current corporate form is headed for liquidation, joining Pan-Am, Polaroid and many others in the graveyard of iconic companies whose demise would have at one point in their history seemed unfathomable. Whether blame lays more properly with its unions or management remains unclear. But its name and most of its individual brands will continue on. The intriguing question at this point is in what form?

Specifically, will Hostess’s infrastructure assets, including its employees, remain attached to its recipes, trademarks and logos? Will its distribution networks stay intact? Is the enterprise as a whole worth more than the individual pieces?

Sometime in the next several days, Hostess’s bankruptcy counsel will file a motion for the approval of bidding and auction procedures to begin a distressed m&a process that will look to answer that precise question. It is possible that Hostess will already have a lead bidder to serve as the “stalking horse” and provide a baseline against which to compare other bids, but the more likely scenario is that the company and its investment bankers will start the process without one, and look to line up prior to the auction either a single stalking horse for the entire enterprise, or several stalking horse bids for individual brands and related segments of the business.

The auction itself promises to be one for the ages, as bids for the entire enterprise and for the separate pieces will constantly be weighed against each other. Distressed m&a auctions in large and complex chapter 11 cases have been known to extend on well past twenty-four hours. Fortunately, it can readily be expected that there will be a large supply of carbohydrates on hand to fuel the participants and their professionals.

A Messy Break-Up But a Clean Divorce: Dewey LeBoeuf Avoids Litigation Morass of Most Law Firm Bankruptcy Cases

Ben Feder — Wed, 07 Nov 2012 16:02:04 -0500

Large law firm failures typically produce lengthy and litigious bankruptcy cases. A frustrated lawyer in one such case succinctly described the essential problem: “the assets walk, talk and, worst of all, have their own counsel.” To the inherent tensions and creditor demands of any large chapter 11 case are added the raw pain, similar to divorce, that many partners feel at the downfall of an institution to which many have devoted long years. Others genuinely believe that they were betrayed or misled by firm management, or that they have strong legal arguments for avoiding liability.

This makes the recently approved settlement in the Dewey LeBoeuf bankruptcy case all the more remarkable. Given the size of the firm, the complexity of the international partnership structure, and the alacrity with which it spiraled down into dissolution, it looked to be a natural candidate to follow the well-worn path of law firm flameouts, from Finley Kumble on through to more recent cases such as Coudert Brothers and Howrey. Instead, however, a vast majority of the former partners of the firm have agreed to contribute $71.5 million towards payment of claims against the firm in exchange for being released from further litigation. The settlement has the support of the firm's major secured creditors and the unsecured creditors’ committee. Individual former partners will make contributions ranging from $5,000 to $3.5 million.

Substantial credit likely goes to Al Togut, Dewey LeBoeuf’s bankruptcy counsel. As it happens, Mr. Togut represented the unsecured creditors’ committee in Finley Kumble, the first major professional partnership bankruptcy, and played an integral role in the tortuous negotiations that it took to reach a resolution that case. It appears that Mr. Togut was able to bring the lessons of Finley Kumble and its progeny to bear in Dewey LeBoeuf, and succeeded in leading former partners and creditors to a settlement in the span of a few months that will avoid what otherwise would have been a morass of litigation over several years.

While the facts of each law firm failure are unique, it is likely that the Dewey LeBoeuf case has provided a template that will be the starting point in such future cases.

We've Seen This Movie Before - The Return of Covenant Lite and PIK-Toggle Debt

Ben Feder — Tue, 16 Oct 2012 12:08:35 -0500

Even as the financial crisis of 2008-09 began to ebb, the so-called “wall of debt” loomed large. Hundreds of billions of dollars of leveraged and high yield debt issued during the irrational exuberance era was coming due by 2014, threatening to drive up default rates and posing an ongoing threat to the health of the international financial markets.

Those fears seem very distant today. First, the “wall” got pushed back, as lenders and debt investors engaged in an ongoing game of what came to be colloquially referred to as “amend, extend and pretend”, renegotiating maturity dates in an effort to delay the day of reckoning. Now, thanks in no small part to central bankers’ determination to keep interest rates as low as possible, a white-hot high yield debt market has broken the wall into pieces, with parts of it not to be reassembled for decades. High yield (aka “junk”) debt issuances have returned to levels not seen since 2007, and are allowing leveraged companies to refinance pending obligations with maturities in some instances of as long as 30 years.

Incredibly, the demand for lower quality / higher yielding debt securities in the current low interest rate environment is already leading to the return of two features that embody some of the worst excesses of the previous decade. S&P and Moody’s have both recently warned about “covenant lite” debt, i.e., issuances that lack standard covenant protections which serve as early warning signs and permit lenders and investors to intervene at an early stage of a borrower’s financial distress. Other commentators are taking note of the return of another feature that led to deep investor losses during the last downturn – notes with payment in kind, or “PIK” features, which permit a borrower to flip an invisible toggle and switch from paying interest in cash, and instead allow it to effect payment through the issuance of additional notes.

There is nothing inherently wrong with extending credit to lower rated borrowers. But lenders and investors astoundingly seem already to have forgotten that, along with the higher yields that compensate them for the incrementally greater risks they are taking by lending to such borrowers, such credits require stronger, not weaker protections against defaults. The constantly repeated excuse last time was that no one could have seen what was coming. What will it be next time?

Blink and You Missed It - Emergency Sale of Digital Domain Media Approved

Ben Feder — Thu, 04 Oct 2012 10:09:10 -0500

Judge Brendan Shannon of the U.S. Bankruptcy Court for the District of Delaware last week approved the sale of Digital Domain Media Group, the special effects company founded by James Cameron, following one of the fastest distressed m&a transactions ever in a Chapter 11 case. The auction, held only 10 days after the petition date, nevertheless resulted in robust bidding and resulted in a purchase price of $30.2 million, double the $15 million offer of the initial bidder.

Prior to this case, most corporate bankruptcy professionals probably were of the view that a fast sale of a company in Chapter 11 could take place only in the most unique circumstances, such as were seen in Lehman Brothers and General Motors. Because of the size and complexity of those enterprises, and the potential ramifications of their failure on the U.S. economy and global financial markets, the consensus for the past few years has been that those cases were outliers with fact patterns almost certain not to be repeated.

Digital Domain Media, on the other hand, its cutting edge technology notwithstanding, is a fairly standard business enterprise, and not a particularly large one at that. Judge Shannon unsurprisingly was highly skeptical of Digital Domain Media’s request, telling its counsel that they would need to present evidence “that I don’t know that I’ve ever seen”. However, Digital Domain Media succeeded in showing that the company faced an immediate shutdown (and the loss of nearly 700 jobs) if the expedited sale were not approved. Credible testimony was presented to the effect that the film studios for whom Digital Domain Media provided digital services were at risk of millions of dollars of losses from any production delays, and would immediately pull their work from Digital Domain Media if an immediate sale did not take place.

All Chapter 11 professionals are highly familiar with working to save “melting ice cube” companies. Digital Domain Media demonstrates that a sale of a business in a matter of days following the petition date need not be predicated upon national or global financial Armageddon, but rather can possibly take place with respect to an ordinary business enterprise upon a credible showing of loss of value and jobs.

Second Circuit Summarily Reverses Claims Trading Decision

Ben Feder — Wed, 19 Sep 2012 07:58:32 -0500

The Second Circuit Court of Appeals, acting with unusual alacrity (oral argument was heard only one month ago), summarily reversed the district court decision in Longacre Master Fund v. ATS Automation Tooling Systems. The decision did not break any significant new ground, and the court did not take the opportunity to consider the controversial claims trading case of Enron v. Springfield Associates. However, the Second Circuit’s broad reading of the repurchase provisions of the claim purchase agreement will likely strengthen the hand of specialized firms that look to buy claims in large Chapter 11 cases.

As recently noted here, Longacre bought a claim from ATS in the Delphi bankruptcy case. A provision in their agreement required ATS, as the seller, to take back the claim if Delphi objected to it. Delphi did in fact object to the ATS claim under Section 502(d) of the Bankruptcy Code on the basis that ATS had received potentially voidable preference payments prior to the bankruptcy case. When Longacre demanded that ATS take back the claim, ATS refused, and Longacre sued to enforce the agreement.

The district court refused to enforce the repurchase provisions. Instead, it examined the merits of the claim objection itself, and determined that under the holding of Enron v. Springfield Associates, which held that a claim objection under Section 502(d) of the Bankruptcy Code based on the receipt of a voidable preference payment was valid only against the recipient of such payment, and could not be used to object to such claim in the hands of a good faith purchaser, Delphi’s objection lacked merit and therefore ATS should not have been required to repurchase the claim.

The Second Circuit did not address the merits of Enron, but instead assumed that the district court was right in its assessment that the objection was baseless. “Contrary to the District Court’s reasoning, nothing in the language of [the claim purchase agreement] requires the objection to be meritorious.” Under the court’s straightforward analysis of New York contract law, the Delphi objection constituted an “Impairment” under the agreement, which in turn triggered ATS’s repurchase obligation in the event that the objection was not fully resolved by ATS within six months, or was not likely to be resolved within a reasonable time thereafter.

The court remanded the case to so that the lower court could rule on whether ATS had met its requirement to resolve the claim within “a reasonable time” after the end of the six month period.

Second Circuit To Weigh In On Trading of Bankruptcy Claims

Ben Feder — Wed, 05 Sep 2012 10:51:53 -0500

The Second Circuit Court of Appeals recently heard arguments in a case that could have substantial implications on the trading of bankruptcy claims. While the court could choose to resolve the case, Longacre Master Fund, Ltd. v. ATS Automation Tooling Systems Inc., based on a straightforward analysis of New York contract law, it may also take the opportunity to consider the controversial claims trading case of Enron v. Springfield Associates decided several years ago by the district court for the Southern District of New York. Enron held that a claim objection under Section 502(d) of the Bankruptcy Code based on the receipt of a voidable preference payment was valid only against the recipient of such payment, and could not be used to object to such claim in the hands of a good faith purchaser.

Longacre bought a claim from ATS in the Delphi bankruptcy case. Millions of dollars of trade claims are routinely bought and sold in large Chapter 11 cases; specialized firms look to buy claims at a discount and hold them for the many months (and not infrequently years) that it takes for a plan of reorganization to be confirmed and distributions to be made. The sellers are often small or medium sized businesses that need the cash and are willing to sell in order to monetize the claim quickly.

Claim buyers often look to protect themselves by requiring the seller to take back the claim if the debtor objects to it. Longacre and ATS had such a provision in their agreement; it provided that Longacre, the buyer, would be entitled to a refund of the purchase price in the event that the claim was objected to and not fully resolved by ATS within six months, or was not likely to be resolved within a reasonable time thereafter.

Delphi did in fact object to the ATS claim under Section 502(d) of the Bankruptcy Code on the basis that ATS had received potentially voidable preference payments prior to the bankruptcy case. The claim was not resolved within the six month period and Longacre demanded that ATS take back the claim. ATS refused, and Longacre sued to enforce the agreement. The claim was ultimately resolved eight months later.

The lower court judge did not rule on whether ATS had met its requirement to resolve the claim within six month period or “a reasonable time thereafter”. Instead, the judge examined the merits of the claim objection itself, and held, under the holding of Enron v. Springfield Associates, that the objection lacked merit and therefore ATS should not have been required to repurchase the claim.

Longacre contends on appeal that the district court improperly added new terms to the agreement, rather than applying the contract as written. ATS argues that the district court was correct to determine if any prejudice actually occurred to Longacre as a result of the objection.

The key question here is whether, in deciding this case, the Second Circuit weighs in on the merits of the Enron decision. A recent decision in a Delaware bankruptcy case rejected the analysis of Enron; a similar ruling by the Second Circuit could substantially alter the landscape for the buying and selling of claims in bankruptcy cases.

Game On in Stockton, CA Chapter 9 Case - Bond Insurer Sets Focus on Calpers

Ben Feder — Wed, 15 Aug 2012 10:08:54 -0500

The Olympics may be over, but a potential clash of titans is gearing up in the Chapter 9 bankruptcy case of Stockton, California. Municipal bond insurer National Public Finance Guarantee Corporation (“National”) has challenged Stockton’s eligibility to be a debtor under Chapter 9 of the Bankruptcy Code, and is focusing expressly on the city’s alleged failure to seek concessions of its pension liabilities from Calpers, the California public employee pension system. Section 109(c) of the Bankruptcy Code mandates that a municipality seeking protection under Chapter 9 must show either that it has negotiated in good faith with its creditors, or that such negotiations were “impractical”. National contends that Stockton’s failure to engage in negotiations with Calpers prior to filing its petition requires the dismissal of Stockton’s bankruptcy case under Section 109(c).

Stockton listed Calpers as its single largest unsecured creditor in its petition, with a claim of $147.5 million. California state law conditions a municipality’s ability to seek bankruptcy protection under Chapter 9 on its participation in a 60 day negotiation process with its major creditors. National asserts that during such process, Stockton sought major concessions from its bondholders, but none from Calpers. Stockton can be expected to argue in its response to National that public employee pension liability protections under California law rendered negotiations with Calpers “impractical”.

National’s challenge to Stockton’s eligibility aims directly at those protections for public employee pension liabilities, protections which Calpers seeks to enforce rigorously. To date no bankruptcy court has ruled on whether such protections can provide Calpers with a priority over other unsecured creditors. Employee pensions were not challenged in previous Chapter 9 cases of California municipalities, but bondholders did not suffer major losses in those cases either. Such will probably not be the case in Stockton. Moreover, numerous other California cities and towns are experiencing similar financial distress due at least in part to public employee pension liabilities, and are likely to seek bondholder concessions as well. A showdown between Calpers and bond insurers and investors clearly looms, and National has now fired the first salvo.

Now He Tells Us? Sandy Weill Calls for Return of Separation Between Commercial and Investment Banking

Ben Feder — Fri, 27 Jul 2012 13:26:45 -0500

Whether Glass-Steagall would have prevented the great financial meltdown of 2007 through 2009 remains debatable. Nevertheless, hearing Sandy Weill, who effectively served as the law's official undertaker, essentially call for its reinstatement is nothing short of remarkable (and perhaps more than a little frustrating). Going far beyond the proprietary trading limitations contemplated by the Volcker Rule, it would require the breaking up of the largest financial institutions into commercial banks accepting insured deposits and investment banks.

The arguments over the relatively modest reforms contemplated by Dodd-Frank continue virtually unabated. However, given the spate of recent events involving massive hedging losses and LIBOR manipulation, any law or regulation which could effectively mitigate at least the worst excesses of the financial system has to be strongly considered.

Stockton, California Chapter 9 Filing - Another Outlier, Or Harbinger?

Ben Feder — Fri, 29 Jun 2012 11:16:03 -0500

Meredith Whitney, one of the first financial analysts to foresee the collapse of the housing market, famously predicted in December 2010 that a wave of municipal bond defaults was on the way. The wave, however, has yet to materialize, and the bankruptcy filing of Stockton, California will likely not change this.

As with the chapter 9 filing of Jefferson County, Alabama last November, Stockton’s filing will probably not portend an upsurge of municipal bankruptcies. Stockton and Jefferson County are outliers, facing dire circumstances caused by extreme combinations of terrible decisions and bad luck. While a great number of cities and towns are facing rising pension costs and substantial bond debt, the ignominy and high costs of bankruptcy will continue to make it an absolute last resort for distressed municipalities.

In most instances, the mere threat of default, bankruptcy and fiscal collapse will help most of the distressed cities and counties throughout the United States to find the means and political will to address their issues outside of court. Far more likely to trigger a wave, for example, are the recent successful efforts of Providence, Rhode Island. There had been much talk about Providence possibly seeking bankruptcy protection, but it has recently obtained substantial pension concessions from its unions and retirees, and additional voluntary payments into city coffers from tax-exempt Brown University, deals that will go far towards restoring the city to fiscal health.

The sheer number of troubled municipalities facing extraordinary fiscal pressures will invariably lead to some increase in chapter 9 bankruptcies, but such cases will continue to be the exceptions rather than the rule.

Not Required, But Still Appropriate - Judge Glenn Appoints Examiner in ResCap

Ben Feder — Fri, 22 Jun 2012 09:07:50 -0500

The chapter 11 case of mortgage lender and servicer Residential Capital, LLC (“ResCap”) is fascinating on a number of levels. Its parent company, Ally Financial, Inc. (“AFI”), hopes to use ResCap’s bankruptcy to extricate itself from potential liabilities arising from the collapse of the residential housing market at the end of the last decade. To that end, AFI has welcomed a thorough investigation in the chapter 11 case of its relationship with ResCap and transactions between the two entities, in the hope that a showing of no impropriety can form the basis for a global settlement that can be approved by the bankruptcy court.

One question that has arisen in the early stages of the case is whether the investigation should be undertaken by ResCap’s official committee of unsecured creditors (the “Committee”), or by an independent examiner appointed by the bankruptcy court. A motion filed by Berkshire Hathaway, Inc. (“Berkshire”), a major ResCap creditor, asserted that the appointment of an examiner is mandatory in this case under the plain language of Section 1104(c) of the Bankruptcy Code. ResCap and the Committee responded that, notwithstanding the evident requirement, the bankruptcy court had discretion not to appoint an examiner, particularly in view of the investigation by the Committee that is already underway. Judge Martin Glenn of the U.S. Bankruptcy Court for the Southern District of New York ruled this week that the Bankruptcy Code does not mandate the appointment of an examiner, but nonetheless determined that the circumstances of this case warrant such an appointment.

(Kelley Drye & Warren LLP represents a significant party in interest in the ResCap chapter 11 case, but has taken no part in the matters discussed in this post.)

The language of Section 1104(c) states in relevant part:

[O]n request of a party in interest . . . the court shall order the appointment of an examiner to conduct such an investigation of the debtor as is appropriate . . . if –

(1) such appointment is in the interests of creditors, any equity security holders, and other interests of the estate; or

(2) the debtor’s fixed, liquidated, unsecured debts . . . exceed $5,000,000.

The issue of whether an examiner is mandatory upon request in cases where the fixed debts exceed $5,000,000 has sharply divided courts and flummoxed practitioners. Judge Glenn noted that several courts, including the only circuit court to consider Section 1104(c), have held that the word “shall” eliminates judicial discretion and requires the appointment of an examiner upon request in any case where “fixed, liquidated, unsecured debts . . . exceed $5,000,000.” Conversely, other courts have concluded that the qualifying words “as is appropriate” clearly give a court the authority to determine whether such an appointment is in fact “appropriate”, and thus the power to deny such an appointment in circumstances where it would be not be.

After considering the cases on both sides, Judge Glenn determined that the “as is appropriate” qualification conveys discretion on the bankruptcy court as to whether to appoint an examiner. He then concluded that because there were no facts or circumstances regarding ResCap’s chapter 11 case that would make the appointment of an examiner “inappropriate”, Berkshire’s motion should be granted.

ResCap and the Committee had largely focused in their objections on the investigation already commenced by the Committee, and that the appointment of an examiner would be duplicative. While Judge Glenn intimated that a completed investigation might warrant a different conclusion, he noted that in this case the Committee’s investigation is still in its early stages. “Notwithstanding the ability of any other party to effectively and expeditiously investigate the Debtors . . . [a]ll of [the] circumstances [requiring the appointment of an examiner] are present here.”

The scope, timing and budget for the examiner’s investigation remain to be determined. Judge Glenn indicated in remarks from the bench before he rendered the opinion that he was highly sensitive to concerns regarding delay and unnecessary expense, and that he fully expected coordination and cooperation among the parties. The manner in which the Committee’s and the to-be-appointed examiner’s investigations ultimately proceed and co-exist will be closely watched and could serve as a model in other large cases where this issue arises.

Chapter 11 Once Again Safe for Undersecured Lenders - Supreme Court Affirms Right to Credit Bid in RadLax

Ben Feder — Tue, 29 May 2012 14:25:52 -0500

The U.S. Supreme Court today in Radlax Gateway Hotel, LLC, et al. v. Amalgamated Bank unanimously upheld the right of secured creditors to credit bid their debt upon a sale of their collateral pursuant to a nonconsensual chapter 11 plan of reorganization. As described in numerous prior posts on this site, the ruling resolves a split between circuits and removes a cloud of ambiguity from chapter 11 cases.

The debtors in RadLax had strongly argued in favor of a “plain meaning” approach to the cramdown provisions of Section 1129(b) of the Bankruptcy Code. However, the debtors’ proposed construction of Section 1129(b) was too tenuous even for Justice Scalia, probably the Court’s strongest advocate of that mode of statutory interpretation. Justice Scalia, in authoring the Court’s short opinion, wrote that a reading of the statute permitting a sale “free and clear” to take place without allowing the lenders to credit bid would “be hyperliteral and contrary to common sense.” Relying on another well-established rule of statutory interpretation, that “the specific governs the general”, Justice Scalia held that in view of the express reference in subsection (ii) of Section 1129(b)(2)(A), the right to credit bid in connection with a sale “free and clear” of liens cannot be abrogated by reference to the amorphous concept of “indubitable equivalence” in subsection (iii).

The Court’s opinion today ends what had been an aggressive but highly creative effort on the part of certain debtors to overcome what most practitioners had long believed to be established law. Justice Scalia describes the Bankruptcy Code as “an expansive (and sometimes unruly) area of law”, and writes of the Court’s “obligation to interpret the Code clearly and predictably using well established rules of statutory construction.” While some may suggest that the Court has more often honored this obligation in the breach rather than the observance (e.g., Till v. SCS Credit Corp.), today the Court unquestionably spoke in a concise voice.