Bankruptcy litigation
July 2015 | ROUNDTABLE | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
July 2015 Issue
Bankruptcy litigation is a challenging and complex endeavour, requiring a variety of tactics and resolution mechanisms. For the parties involved, financial expectations can be at odds with the reality of the situation, and knowing when to compromise is essential. Recent months have seen a number of new developments emerge, and important new precedents evolve. Bankruptcy litigation is set to remain a popular tool for creditors in high-stakes bankruptcy cases, as a process which can provide a range of creative approaches and workable solutions for debtors, creditors and stakeholders alike.
FW: Could you provide an overview of the key trends arising in bankruptcy litigation in recent months? In your opinion, what have been the most significant developments?
Sprayregen: There have been several trends arising in bankruptcy litigation in recent months. There continues to be a significant amount of litigation involving examiners, cram-up under Till and make-wholes. In addition, you have continuing Stern litigation regarding the extent of jurisdiction and power of the bankruptcy court vis-à-vis the district courts. The recent US Supreme Court decision in Wellness will not change all of that overnight. Probably the most significant development has been the confirmation of the Momentive plan, and subsequent affirmance by the US District Court for the Southern District of New York. In that case, the use of Till to cram-up over secured creditors at an interest rate favourable to the debtor was employed. In addition, make-wholes were disallowed. While the make-whole rulings were in line with previous make-whole rulings and continued to make the point that, if a creditor wants a make-whole allowed, the creditor needs to pay attention to the drafting of the indenture at inception to have the right verbiage in it, the prominence of the Judge makes it more important. With respect to the Momentive cram-up, I personally don’t think this was much ‘new’ law; however, many practitioners and commentators have reported as if it is a significant extension of existing law. While I disagree with that take, perception being reality, Momentive, at least directionally, has shifted some negotiating leverage from senior creditors to a debtor and, also, possibly, to subordinated creditors.
Durrer: Complex bankruptcies in recent months have resulted in the deployment of many different litigation tactics and resolution mechanisms: for example, the Detroit bankruptcy involved an extensive mediation requiring a team of six mediators, including five current or former bankruptcy judges. Following the success of the Detroit mediation process, Atlantic City appointed a mediator in April to assist with its own out-of-court restructuring negotiations. By contrast, the contentious Caesars Entertainment Operating Company bankruptcy has resulted in the appointment of an examiner to evaluate contested prepetition transactions. The appointed examiner is undertaking his examination in parallel with discovery being conducted by two separate creditors committees – all at the debtor’s expense. Litigation has become a more popular tactic for creditors in high-stakes bankruptcy cases, and the recent Trust Indenture Act (TIA) opinions from the Southern District of New York may further motivate disgruntled bondholders in particular to pursue litigation designed to slow down or wholly derail out-of-court restructuring efforts by troubled companies.
Sherrill: The Wellness International decision out of the US Supreme Court is the most heralded development in recent months. That opinion was big news as much for what it didn’t do – drastically undercut bankruptcy judges and magistrates – as for what it actually did. The conventional wisdom is at least partially correct that Wellness International is important in what it clarifies. But it does leave some fairly significant issues unsettled as well. Therefore, while it seems the Court’s intention was for everyone to move on from the Stern-type issues and go back to litigating cases as we’ve done in the past, there will still be some fairly substantive jurisdictional struggles over the scope and meaning of Wellness. The notion that we’re now past all of the Stern troubles is mistaken.
Friedman: In the recent past, the capital markets have been so forgiving that generally only the weakest or most controversial of enterprises have been forced to seek refuge in Chapter 11. In such an environment, where parties are competing for finite resources and management’s practices are under attack, we are seeing a greater level of litigious behaviour. Parties are routinely fighting confirmation of plans, with important new precedents evolving. The cram-down decision in the Momentive case and the equitable subordination of Charlie Ergen’s debt purchases in LightsSquared will resonate for years to come.
Pasquale: A significant recent development is the use by noteholders of section 316(b) of the federal TIA as a means to seek remedies for alleged violations of indentures subject to the Act. In two separate decisions by New York district courts, Education Management Corp. and Meehancombs, the courts held that noteholders could raise claims alleging a violation of section 316(b) when an out of court debt restructuring occurs that impairs the rights of minority noteholders to receive payment of principal and interest on the notes. Neither decision determined the issue on its merits, and, as a result, there remains much uncertainty regarding the extent that the Act may be applied to certain out of court transactions that impact, directly or indirectly, the right of noteholders to payment.
Miller: One of the continuing trends in Canada is the high cost of restructuring generally, and most notably with regard to litigation. This has played an increasing role in negotiations between companies and their creditors, lenders and other stakeholders. Given the high costs involved, parties remain very motivated to find other solutions if at all possible, including avoiding the commencement of restructuring proceedings at all. Ironically – or perhaps not – one other notable trend in Canada has been the increasing frequency with which representative counsel for a stakeholder group has been appointed by the Court in a restructuring proceeding. This used to be relatively rare, and arose in situations involving vulnerable stakeholders such as employees or retirees who would otherwise be unable to participate, or where representative status was an efficient means of communicating and obtaining resolution of issues.
Russell: We have seen the continuation of a longer term trend in large Chapter 11 cases where the debtor’s existing secured lenders sell off their debt to distressed debt investors who do not have the same historic relationship with the company, and are often looking to simply capture the spread between their buy-in price and their exit trade. These new debt holders generally have no interest in the benefits of a continuing post-emergence lending relationship with the company. This all contributes to a more litigious environment in which parties lack the same traditional incentives to focus on long term lending relationships and the ultimate success of the company and in which the creditor constituencies do not hesitate to resort to litigation in order to achieve a short-term recovery and satisfy their investment objectives.
“Given the high costs involved, parties remain very motivated to find other solutions if at all possible, including avoiding the commencement of restructuring proceedings at all.”
FW: In what ways can bankruptcy litigation processes differ from other types of litigation? To what extent do issues of cost and speed impact on the process?
Dailey: Bankruptcy litigation differs from other types of litigation in two main respects. Firstly, it frequently involves multiple parties, and is not just a proceeding involving one plaintiff and one defendant. Often debtors, secured creditors, unsecured creditors and equity holders all take a different litigation position on the same issue. Secondly, in comparison to traditional litigation, hearings on contested matters and bankruptcy trials are heard on a compressed timeline. This is because the issue being litigated is often dispositive to the overall restructuring of the debtor and the consummation of a plan of reorganisation.
Miller: Bankruptcy litigation involving a company that has been liquidated – an increasingly common situation in Canada – involves a zero sum game. Costs incurred in litigating a particular outcome permanently diminish recoveries available to all creditors. Obviously that’s different than a non-liquidating bankruptcy or a non-bankruptcy situation, where there may be a ‘winner’ and a ‘loser’. In Canada, bankruptcy litigation differs from other types of litigation in that you usually have a Court officer playing a central role in the proceeding. Most often that role is as a court-appointed monitor, in restructuring proceedings under the Companies’ Creditors Arrangement Act, or as a receiver, interim receiver or trustee in bankruptcy, in proceedings under the Bankruptcy and Insolvency Act.
Russell: Because of the time exigencies present in many bankruptcy proceedings, bankruptcy litigation generally proceeds at a faster pace than litigation in other fora. The frequently compressed timeframes in bankruptcy cases prevent the parties from conducting the same amount and scope of discovery as they would normally undertake to resolve similar disputes outside of bankruptcy. The parties accordingly have to focus on the issues that really matter, which, in most cases, results in a cheaper and more efficient dispute resolution.
Pasquale: Much of bankruptcy litigation is expedited, often litigated within months or even weeks, including document discovery, depositions and an evidentiary hearing. The truncated discovery requires the litigants to gather and review information, especially electronic documents, on a schedule far faster than most other litigation. Although the limited discovery period sometimes results in more focused adversarial discovery, the costs to review and prepare document production on such a fast schedule can be expensive. Indeed, the costs can rival or sometimes exceed the costs in non-bankruptcy litigation.
Sprayregen: Bankruptcy litigation differs from other types of litigation in several respects. It is often undertaken at a much greater speed than non-bankruptcy litigation and, as a result, traditional litigators often have some trouble keeping up with the pace. Some – but by no means all – bankruptcy judges are a bit looser with the evidentiary standards than in the district courts; partially, this may result from the dearth of jury trials such that evidence can be taken more for weight than admissibility.
Sherrill: The condensed timeframe is certainly a big difference, but cost may be more noteworthy. In bankruptcy litigation, virtually every piece of litigation comes down to an economic decision. No one is there for an apology or a feeling of vindication. In part, because so much litigation involves trustees, the decision of whether to settle or litigate is usually dollar-driven. That leads to interesting results. We see many bigger debtors farm their litigation out to smaller law firms, which may do the work on contingency or flat fees.
Durrer: Bankruptcy litigation, just like non-bankruptcy litigation, can be an extremely costly and time-consuming process for a company. However, bankruptcy litigation is unique in two respects: first, a company going through a formal bankruptcy process demands tremendous focus and attention from its management team to undertake a financial or operational restructuring at a time when that same team is typically already operating in a stressed environment merely to continue operations. Second, bankruptcy litigation enhances speculation regarding whether the company will survive, and this speculation may further impede the overall progress of the restructuring. Therefore, even though bankruptcy litigation proceeds on an accelerated timetable relative to non-bankruptcy litigation, it is often more damaging and distracting for company management due to the contextual pressures imposed by the ongoing restructuring itself.
Friedman: The process often proceeds at a rapid pace, as the business exigencies of a debtor do not permit threshold issues to play out in the more gradual fashion of plenary litigation. Discovery is often done on the fly and critical documents are sometimes improperly withheld by litigants hoping to use the frenetic pace as an excuse to evade disclosure obligations. You need to be very thorough and methodical to make sure you get the information you’re entitled to.
“In bankruptcy litigation, virtually every piece of litigation comes down to an economic decision. No one is there for an apology or a feeling of vindication.”
FW: What are some of the common causes of dispute in today’s bankruptcy processes which often lead to litigation?
Pasquale: Although bankruptcy is often described as a process founded upon negotiation, often litigation is a necessary means to bring parties to the negotiating table. Given the various tranches of debt in mid-to-large Chapter 11 bankruptcy cases and the payment priorities of the respective debt, litigation is frequently necessary to establish the rights of those creditors between and among each other and with respect to the debtor company. Litigation concerning valuation issues is often required to conclusively establish the fulcrum debt security that will drive the reorganisation.
Russell: In almost every instance, the parties ultimately are arguing about money, so it’s not surprising that most disputes arise out of the efforts by parties in interest to maximise their recovery in bankruptcy. This can be a dispute that directly affects a party’s bottom line, such as a creditors committee objecting to a financial adviser’s fee request because it would reduce unsecured recoveries. It can also result from a party using litigation as a negotiation leverage tactic, for example by objecting to a particular form of relief requested by the debtor or another party in interest solely to obtain other concessions in the case. At the end of the day, however, it all usually comes down to efforts to maximise recovery.
Miller: One source of litigation in a Canadian bankruptcy process relates to disputed claims of a significant dollar value. Where the monetary claims are very large, or require experts such as on foreign law, foreign statutory rights or involve novel legal issues, the litigation process will necessarily be more extensive. The litigation of certain claims governed by UK law involving UK statutory rights and remedies in the Nortel Networks proceeding is a recent example. Where billions of dollars are at stake and complex issues involving foreign law are involved, extensive litigation is almost inevitable. Disputes with regulatory authorities in a bankruptcy proceeding often lead to litigation, because the issue is important in setting a precedent or reflecting a public position of the regulatory body.
Friedman: There are lots of causes of bankruptcy litigation. Some of the most common revolve around the interest rate to be used to satisfy secured creditors and the treatment of claims traders.
Durrer: Bankruptcy litigation is certainly on the rise as capital structures and therefore reorganisations become more complex, which has led to more contentious and adversarial cases. Issues of valuation are sometimes contested among constituents, particularly by constituents who may be at risks of great financial loss but whose advisers are required to be paid by the debtor. In addition, recent TIA opinions from the Southern District of New York may lead to increased litigation and incentivising minority bondholders to challenge out-of-court restructurings, making it more difficult for debtors to engage in out-of-court restructurings.
Sherrill: Make-whole premiums are a frequently litigated – and even more frequently threatened – issue in recent years. The courts do not seem to have quite reached a consensus on those issues yet, but it feels as if that may not be too far away. We have also seen a great deal of litigation concerning the eligibility of a supplier of goods to the administrative expense under section 503(b)(9). That statute is novel in the sense that it provides the ability to recover 100 percent distributions on a pre-petition claim. For debtors that purchase significant amounts of goods in their ordinary course of business, the requirement of paying for 20 days’ worth of goods in full can create a major disruption in post-petition finances and rehabilitation efforts.
Dailey: Differing views on valuation have historically led to extensive litigation in bankruptcy cases and this will likely continue to be the issue that drives significant bankruptcy litigation in the future. This is because bankruptcy is a plenary proceeding, and essentially there is only one pie to divide among the various creditor constituencies. A dispute usually arises when a junior class of creditors that is either receiving less than payment in full or no distribution at all under the plan of reorganisation contests the valuation methodology used by the debtors or the senior creditors. A dispute can also arise in connection with the sale of assets or motion for adequate protection. In the former scenario, it is generally accepted that the best indication of value is what a willing buyer would pay for an asset; however, the timing of the proposed sale, at a particular moment in time in the up or down cycle of a market, can greatly influence what a buyer is willing to pay.
Sprayregen: Intercreditor agreements, perfection, make-wholes, leveraged buyout, fraudulent conveyance and equitable subordination of claims are all potential causes of dispute. Tax issues also are very much in vogue. I wouldn’t say there is any particular ‘common cause’ of dispute in today’s bankruptcy processes. Each case very much stands on its own.
“Bankruptcy litigation is certainly on the rise as capital structures and therefore reorganisations become more complex, which has led to more contentious and adversarial cases.”
FW: What developments have you seen in litigation involving directors and officers, and their responsibilities related to insolvency?
Sherrill: There have been some interesting questions of bankruptcy court jurisdiction over officer and director litigation recently. For example, the Montcrest Energy case involved questions of abstention, but the court did not reach those issues because it determined that the dispute belonged in state court. Somewhat similarly, another interesting threshold issue arose in the Beach First National Bancshares case. There, the court dismissed the trustee’s FIRREA claims against officers and directors, concluding that the trustee lacked standing because only the Federal Depository Insurance Corporation can assert those derivative claims. On appeal, the Fourth Circuit affirmed the district court’s ruling, relying on a similar Eleventh Circuit case.
Durrer: Directors and officers face increasing scrutiny with respect to their independence and exercise of business judgment in decision-making with respect to major transactions. The timely formation of independent or special committees is a powerful technique to address such claims and allegations responsibly and efficiently. The use of this strategy also enables the company to evaluate proposed transactions involving arguably interested or affiliated parties while preserving, in most cases, business judgment review of director decision-making.
Dailey: Unlike in a number of jurisdictions around the world, in the US there is no trading while insolvent liability for directors or officers. Obviously, officers and directors need to make appropriate disclosures if they are a public company, however merely being insolvent without more is not a basis for a cause of action against directors in the US. The existence of a trading while insolvent liability can overshadow out of court restructuring efforts in those jurisdictions where such a liability exists.
Pasquale: Directors and officers continue to be litigation targets when their companies become insolvent because claimants, often with no other source of recovery, seek to tap the D&O insurance policy. D&O litigation is sometimes threatened or brought to assert pressure in order to reach a settlement or resolve the bankruptcy case as a whole. The Delaware Chancery Court recently ruled that a creditor plaintiff needs only establish that a corporation was insolvent at the time the suit was filed in order to establish standing to sue derivatively for, among other things, breach of fiduciary duty against directors and officers. The decision would seem to expand the situations in which creditors can assert derivative breach of fiduciary duty claims.
Sprayregen: Curiously, I believe directors and officers today have less risk of liability in insolvency and bankruptcy situations than they did several years ago. This results from several Delaware State Court decisions clarifying the obligations of directors and officers in the zone of insolvency. As a result, it has become more difficult for creditors to both assert claims against directors and officers and, more importantly, sustain such claims.
Friedman: The business judgment rule is alive and well and courts are reluctant to second guess the decisions of honest management. But insiders who favour themselves at the expense of outside creditors will find courts reluctant to give them the benefit of the doubt.
Russell: Despite the recent Delaware Supreme Court decision in In re Cornerstone Therapeutics S’holder Litig. and Leal v. Meeks holding that directors protected by exculpatory corporate charter provisions should be dismissed from cases seeking only money damages regardless of the standard of review unless the plaintiff has alleged a duty of loyalty claim, Delaware law regarding the duties of officers and directors is fairly well-defined. Accordingly, there may not be significant additional jurisprudence over the nature of their responsibilities or the standards by which their actions should be judged. There may be an increasing focus, however, on the actions of private equity sponsors – and the directors they appoint – with respect to their portfolio companies that end up in bankruptcy.
“D&O litigation is sometimes threatened or brought to assert pressure in order to reach a settlement or resolve the bankruptcy case as a whole.”
FW: What recent court rulings have proved significant in the bankruptcy litigation space? How are these likely to impact on debtors and stakeholders going forward?
Miller: The most significant recent court ruling in Canada – following a 21 day joint trial with the US Bankruptcy Court – was in the Nortel Networks proceeding. Separate decisions were issued simultaneously by the Canadian and US Courts directing the allocation of $7.3bn in proceeds among the various global Nortel estates. The two courts issued separate but consistent rulings providing for an unprecedented pro rata allocation of the funds by reference to the aggregate amount of creditor claims that exist against each of the Nortel entities in Canada, the US, Europe and the Middle East. At the same time, they rejected each of the more ‘traditional’ allocation theories advanced by the debtor estates.
Friedman: Momentive and LightSquared are two key decisions of the recent past. Momentive provides a platform to cram-down secured creditors that is likely to be replicated extensively. And LightSquared was the first serious decision in years in which a non-insider was subordinated, providing much for claims traders to think about.
Russell: Southern District of New York bankruptcy judge Robert Drain’s decisions in In re MPM Silicones, LLC last fall, and the subsequent affirmance by the District Court, will have a significant impact in a number of respects. His rulings addressed issues including the appropriate rate of interest on replacement notes in a cram-down, the enforceability of make-whole provisions in bankruptcy and the ability of different tranches of creditors to constrain each other’s actions in an intercreditor agreement. Until more jurisdictions address these issues, they will remain unsettled, so it is hard to predict the ultimate long term effect such as whether lenders’ concern about being stuck with a below-market rate of interest on replacement notes will lead to an increased cost of capital for distressed borrowers.
Sherrill: The credit bidding cases, such as Fisker Automotive, Free Lance-Star and others, are really creating a new dynamic in some cases. The Bankruptcy Code guarantees the right to credit bid, unless the court orders otherwise ‘for cause’. Historically, it has been quite rare for a court to find cause to restrict credit bidding rights, but recent years have seen a few such instances, particularly in instances where the secured creditor had acquired its claim at a discount.
Pasquale: The Momentive decision was particularly significant in addressing both make-whole premiums and, controversially, the cram-down of senior lenders in the context of a plan of reorganisation. The court’s decision was consistent with other cases in finding that the senior lenders were not entitled to a make-whole premium because the indenture did not specifically provide for its payment upon acceleration of the debt following a bankruptcy filing. But, with respect to the cram-down rate of interest, the court surprised the markets by holding that that a new debt instrument issued under a plan of reorganisation could be forced upon senior lenders at an interest rate based on the US Treasury rate plus a risk premium of 1 to 3 percent.
Durrer: Over the last year, two separate opinions issued from the Southern District of New York have far-reaching implications for out-of-court restructuring involving bond indentures qualified under the TIA. Historically, courts have interpreted the TIA to require unanimous consent by bondholders in order to effect any change to the payment terms of the governing indenture, contrasted with mere majority consent to effect changes to non-payment terms. However, in both of these recent cases, the district courts ruled – on different procedural grounds – that proposed out-of-court restructurings that allegedly involved changes to non-payment terms of governing bond indentures violated the TIA, on the theory that these changes affected the practical ability of a bondholder to recover payment on its bonds.
Dailey: One recent ruling from the Southern District of New York, Momentive, has proven significant on important bankruptcy issues – the issue of cram-down, or cram-up, of senior secured creditors and the allowance of make-whole claims. In this case the bankruptcy court agreed with the debtors that the interest rate on certain replacement notes to be issued to the senior secured creditors under the plan of reorganisation did not need to be market rate to satisfy the present value requirement and, instead, held that a risk free rate, such as prime or treasury plus a small margin, was sufficient. The bankruptcy court cited to a Supreme Court decision in a Chapter 13 case as support for its decisions. Many critics of the decision believe that a Chapter 13 decision is not relevant in the Chapter 11 context and it is expected that this issue will continue to be litigated until settled by a legislative change or a higher court decision.
Separately, Momentive is cited as a relevant decision in the context of make-whole. The court held that make-whole was not part of the secured creditors claim in that case. This is often incorrectly cited as an anti make-whole decision. Notably however, the court did not hold that make-whole in general was not permissible under the bankruptcy code, but rather that the language of the indenture in question did not require make-whole in connection with mandatory prepayments, such as payment following a bankruptcy filing.
FW: How would you characterise the evolving dynamic between various creditor committees and creditor classes in a modern bankruptcy process? To what extent are multiple parties collaborating to reach a viable solution?
Sprayregen: The evolving dynamic between creditors committees and creditor classes is quite interesting. The two biggest bankruptcy cases pending in the US – EFH and Caesars – both have two official committees, which is a highly unusual construct. In addition, many large sophisticated hedge fund creditors traditionally will not serve on creditors committees. However, in the Caesars bankruptcy, with respect to the second lien committee, you have some well-known large hedge funds serving on an official creditors committee for the first time in a long time. There are huge amounts of complexity these days because of the desire of hedge funds for liquidity – meaning if the hedge fund were to become restricted, trading would be constrained. As a result, there are lots of very tough negotiations over what used to be easy non-disclosure and confidentiality agreements and, in particular, the cleansing clauses. On the one hand, this provides facially greater transparency regarding compliance with the securities laws; on the other hand, it does make negotiations more difficult because of the reduced ability to maintain confidentiality of negotiation processes.
Pasquale: Ad hoc creditor groups are now routinely formed in bankruptcy cases and typically drive the resolution of the bankruptcy because they represent the major economic interests in the case. There are frequently multiple ad hoc creditor groups in a large bankruptcy case, and each ad hoc group seeks to maximise its investment without any fiduciary obligation to ensure similar treatment to others who may hold the same tranche of debt. Often the goal is to negotiate a debt for equity exchange pursuant to a plan of reorganisation, and members of the ad hoc group also bring with them the resources to invest new capital in the company, thus spurring the reorganisation. This differs significantly from the role of the official unsecured creditors committee, which has a fiduciary duty to advance the interests of all unsecured creditors.
Miller: Historically, formal creditor committees have not had a meaningful presence in the Canadian bankruptcy process and do not have statutory recognition as they do in the US, for example. However, informal stakeholder groups and creditor committees are becoming much more organised and visible in larger proceedings. The Canadian restructuring regime has historically been defined by its focus on negotiation, rather than litigation. The ‘three Cs’ of the Bankruptcy Court in Canada are cooperation, communication and common sense, and our judges enforce those principles.
Sherrill: In a typical case, the creditors committee begins as hostile to the debtor, but eventually makes peace for the sake of reorganisation efforts. That detente can create an uncomfortable dynamic, however, for creditors that retain positions that are aggressively adverse to the estate. The creditors committee is expected to speak for the unsecured creditor body, and generally it does so, but there can be instances in which an individual creditor feels betrayed by the committee. Perhaps for this reason, we see more efforts to have the court recognise more discrete committees. Courts often resist such efforts, which undeniably increase the cost to the estate and may yield duplicative work products. In some circumstances, they do make sense, though.
Durrer: Courts in the US may approve the formation of more than one creditors committee, and may also approve the formation of an equity committee, all at the expense of the company. In light of these increasing out-of-pocket expenses and opportunity costs, modern bankruptcy solutions favour a pre-negotiated consensual solution prior to commencing a formal insolvency process. Accordingly, companies are encouraged to be proactive in engaging various constituencies and allowing such constituencies sufficient time to engage in the negotiating process.
Friedman: Parties will always seek ways to avoid litigation. It’s so expensive and time consuming in bankruptcy. But often the bids and the asks are very far apart. And, increasingly, creditor committees are not populated with the key decision makers so the creditor fiduciary has little ability to influence the outcome.
Russell: The capital structures of many companies – and, accordingly, many Chapter 11 debtors – have gotten increasingly complex which has resulted in debtors with multiple tranches of debt with varying interests. In addition, the increased prevalence of distressed debt trading means that there are parties with positions in multiple tranches. All of this means that the standard dynamic is no longer a debtor, an agent representing secured creditors, an unsecured creditors committee and, potentially, an equity holders committee. It is much more common now to have creditors holding claims across tranches and multiple formal and ad hoc committees in a case all vying to maximise their recoveries.
“The evolving dynamic between creditors committees and creditor classes is quite interesting. The two biggest bankruptcy cases pending in the US – EFH and Caesars – both have two official committees, which is a highly unusual construct.”
FW: In your opinion, are mediators and arbitrators now playing a more active and meaningful role in the bankruptcy process?
Russell: Parties are increasingly turning to mediation, in particular, to resolve difficult, multiparty intercreditor disputes without the cost and delay associated with litigating the issues to a judicial resolution. Mediation also can reduce the risks of litigation in that the parties avoid an ‘all or nothing’ result and come up with a middle ground that preserves some value for all of the parties. In addition, bankruptcy courts are increasingly referring parties to mediation and often appoint or suggest a sitting bankruptcy judge as the mediator.
Durrer: The use of mediators and arbitrators has been on a steady rise in the bankruptcy and insolvency contexts, but the real growth has been in the utilisation of mediators and arbitrators to broker global solutions which can ultimately result in the development of a plan of reorganisation with the consent of major constituencies. Current and former judges as well as practitioners serve as mediators in many jurisdictions, bringing more parties to the table as participants, and helping to ensure that all parties participate in good faith. Mediators and arbitrators facilitate communications among the parties and therefore allow parties to share perspective in ways that the heat of litigation sometimes stymies. Such objective analysis helps parties to develop more pragmatic views of the potential range of outcomes and therefore achieve a negotiated, self-determined resolution.
Friedman: Mediators are often appointed in large and complex cases. The best ones are the sitting judges who are colleagues of the bankruptcy judge.
Sprayregen: While I don’t particularly believe it is a great trend, many parties these days will not be willing to compromise without the assistance of a mediator. Often, I see the counsel who has the most trouble getting his or her client to compromise, is the counsel most desiring the mediator. I have not seen arbitrators play as much of a role.
Sherrill: There are many experienced mediators and arbitrators out there. It is easy to be more favourably inclined toward arbitration, because it usually arises as a result of both parties’ choice. To the extent there are any drawbacks in the process, those parties can blame themselves and make a different decision in the future. With mediation, though, it is often forced upon one party, ostensibly as a measure to help the court deal with mass litigation. It probably does achieve that objective, but it also happens to serve ulterior motives for the debtor as well – for example, forestalling discovery and keeping evidence out of the public eye. One other advantage of either type of alternative dispute resolution is that the parties can select a neutral who has experience with the relevant industry, which may be more efficient than educating a judge.
Pasquale: Mediation is more frequently used today in large, complex bankruptcy cases than it was many years ago. Examples of this include Cengage, Lehman and EFH. Bankruptcy judges have been willing to refer issues or sometimes entire cases to other sitting bankruptcy judges who serve as mediator. We most recently experienced this practice in LightSquared, an extremely litigious and prolonged case in which mediation before a bankruptcy judge helped the multiple constituencies agree to terms and structure a confirmable plan of reorganisation. Mediation is unlikely to succeed unless the parties understand that the process is and will remain confidential. In LightSquared, for example, the bankruptcy court issued an order deeming all communications relating to the mediation as “absolutely privileged” and enforced that privilege during litigation over confirmation of the plan.
Miller: Mediators and arbitrators have played an important role in some of Canada’s largest restructuring proceedings. However, they are less often utilised in other cases. Even where they are utilised in the larger cases, their role is usually limited to issues that are corollary to the main ones. With increased pressure on the parties to control costs in a bankruptcy proceeding, we may see mediators and arbitrators playing a more significant role in future.
“It is much more common now to have creditors holding claims across tranches and multiple formal and ad hoc committees in a case all vying to maximise their recoveries.”
FW: With many parties emerging unsatisfied from a bankruptcy dispute, what are the most significant factors that need to be observed to reach an outcome that is the best interests of those involved?
Durrer: Advisers should periodically ‘check-in’ to ensure that they remain sensitive to the commercial interests of their client and the other parties involved in bankruptcy disputes, and to how those interests shift and evolve, particularly during the course of the reorganisation process. In addition, keeping lines of communication open with other parties, including parties not directly involved in the dispute, helps to garner support for proposed solutions and also ensures that there is an open channel for settlement discussions. Finally, knowing whether and when to propose alternative dispute resolution procedures could be critical in moving matters toward a satisfactory outcome.
Sprayregen: I subscribe to the old saw that a bad settlement is better than a good lawsuit. The players in bankruptcy cases, and in increasingly complex capital structures, and in increasingly expensive insolvency proceedings, need to recognise the value of compromise and giving the other side something to which he or she truly believes the other side is not entitled. When you add up the cost of delay and cost of professionals, it is often better to make a ‘bad’ quick settlement. However, there are many financial players these days that calculate the litigation costs – in terms of both professionals and delay – and are willing to bear those costs for the upside of not compromising whatever their particular point of view is.
Sherrill: All attorneys must be adept at managing client expectations, but that task is particularly important in bankruptcy. More sophisticated parties will establish a robust litigation reserve, or write down their bad debt immediately. Thereafter, in a sense, nearly everything is positive. If a client is not quite experienced enough to take such measures on its own, then it is incumbent on the bankruptcy lawyer to adjust expectations and counsel the client toward more prudent actions.
Miller: There seems to have been a shift away from negotiated compromises or arrangements in recent years, and an increase in liquidations or credit-bid led sales processes. Canada’s main restructuring statute is being used more often as a tool for realisation or foreclosure, and that can lead to certain parties feeling very unsatisfied with the process and the result. Broad stakeholder support for a particular result can’t always be achieved, but meaningful participation at least ensures that all interests are taken into account by the Court. In situations where a Plan of Compromise or Arrangement is put forward, which is not always the case, the Court conducts a separate assessment of whether the plan is ‘fair and reasonable’, notwithstanding the approval of the plan by the requisite level of creditors.
Pasquale: For sophisticated financial parties that have invested in the debtor’s capital structure with the goal of maximising their investment return, the most important factor in assuring a satisfactory outcome is to consider the particular issues arising in the bankruptcy case and the economic interests of the client in order to obtain a commercial result. In my experience, doing so minimises unsatisfactory client outcomes because the client’s expectations are appropriately understood and managed. Similarly, litigation results are always somewhat uncertain, and informed, sophisticated financial parties factor that uncertainty into their investment strategies.
Russell: The presence of ultimately unsatisfied parties does not necessarily mean that the process has been unsuccessful. Most bankruptcy cases end up with a largely, if not entirely, consensual plan of reorganisation and it is an old adage that the most equitable settlement is one in which both parties leave the negotiating table slightly unsatisfied. Accordingly, having most of the parties walk away from a case not completely happy might mean that the outcome actually was in the best interest of the parties collectively. That being said, my concern as a trial lawyer and advocate is not the collective best interest but rather the parochial interests of my client.
Friedman: Parties should never lose sight of the business itself. You often have to fight aggressively for your legal rights but this is not an academic exercise. You can’t let the patient die on the operating table.
“In December 2014, the American Bankruptcy Institute published a report on proposed amendments and modifications to the Bankruptcy Code.”
FW: What bankruptcy litigation issues do you feel will continue to remain in the spotlight, and, conversely, which are likely to decline in significance?
Miller: With the increasing complexity of corporate organisation models and the globalisation of businesses generally, the treatment of enterprise groups in insolvency proceedings will continue to be in the spotlight and will require careful consideration. There are difficult issues involving choice of law, comity, traditional concepts of liability and asset ownership as well as ‘enterprise value’ that will be brought to bear when multinational enterprise groups become insolvent.
Dailey: In December 2014, the American Bankruptcy Institute published a report on proposed amendments and modifications to the Bankruptcy Code. This report focused on, among other things, the balance of power and leverage between debtors, secured parties and unsecured parties and sought to shift some of the perceived secured creditor leverage back to the debtor for the benefit of all creditors. The recommendations in this report are not law, and likely will not be taken up by Congress until after the 2016 elections. However, the issues raised in the report are being watched closely by bankruptcy restructuring professionals and are even being cited by parties to the courts as support for their arguments.
Sherrill: There are a handful of issues that seem as if they still need further clarity from the appellate courts. Some of the scope of Chapter 15 is still coming into focus, for example, and so too with courts’ treatment of personal data in bankruptcy estates. Interest rate issues arising out of the Till opinion never seem to go out of style, either. On the other hand, we will likely see some decrease in the jurisdictional issues that arose after Stern. Moreover, there are some issues associated with real estate bankruptcies – such as enforceability of ‘bad boy’ guarantees – that will likely decrease simply because the number of real estate cases seems to be dwindling quickly.
Friedman: Cram-down of secured debt is hot and getting hotter, especially as interest rates rise.
Durrer: As creditors utilise broader and more aggressive strategies in attempts to recover value, we are likely to see a focus on pre-petition transactions, particularly transactions involving alleged insiders or affiliates. Preference and avoidance action will likely remain a focus in bankruptcy litigation. Furthermore, an increase in TIA litigation is likely to occur following the recent decisions in the Southern District of New York.
Pasquale: Avoidance actions will remain important litigation tools to augment the bankruptcy estate. Litigation over valuation will also continue to be prevalent for the obvious reason that valuation often drives recoveries through the various creditor, and sometimes equity, classes. Also, because there are fewer large bankruptcy cases, financial creditors will be looking to maximise their returns in the existing cases and that will drive valuation disputes. We will, finally, see less litigation over the extent of a bankruptcy court’s jurisdiction under Stern v. Marshall, now that the US Supreme Court has issued subsequent opinions clarifying that bankruptcy courts have jurisdiction to finally determine claims by express or implied consent of the parties and can otherwise issue findings of fact and conclusions of law on even ‘core’ bankruptcy claims. Make-whole issues, such as arose in Momentive and EFH, will also continue to be litigated.
Russell: While the confusion created by the Supreme Court’s Stern v. Marshall decision has received a lot of attention, those issues will receive less focus going forward, particularly in light of the subsequent clarifying decisions regarding the scope of bankruptcy courts’ authority including the recent decision in Wellness Int’l Network Ltd. v. Sharif. Issues that are likely to enjoy continued attention include the scope of the safe harbour for avoidance actions provided by Section 546(e), the ability of secured creditors to credit bid the face amount of their claim, the enforceability of make-whole provisions and the applicability of the Till standard for cram-down interest rates to Chapter 11 cases. These last two issues will be of particular interest given Judge Robert Drain’s decision in In re MPM Silicones, LLC last fall.
“Most good lawyers are such zealous advocates for their clients that parties reflexively assume, in a zero sum game environment, that what is good for one is bad for the other.”
FW: What particular strategies would you advise when dealing with cases involving multiparty bankruptcy litigation?
Friedman: Bankruptcy has often been compared to herding cats. Most good lawyers are such zealous advocates for their clients that parties reflexively assume, in a zero sum game environment, that what is good for one is bad for the other. So a large multiparty case needs to begin with a first principle that everyone is going to work together to maximise the pie. Once people are all rowing in that direction, it is possible to begin the more controversial discussion of who gets what.
Durrer: Initially, parties should engage in a targeted dialogue to narrow the issues to the truly core issues which impact the greatest number of litigants. Second, consider alternative dispute resolution mechanisms such as mediation and arbitration in order to narrow the scope of contested issues and attempt to make progress toward a resolution on those contested issues. Third, attempt to build consensus and informally resolve discovery and other relatively minor disputes whenever possible, in order to avoid monopolising the judge’s attention on small issues. Fourth, check in with your client frequently regarding their views and expectations – as in any litigation scenario, the commercial realities are often shifting real-time, and the impact of those realities upon the agendas of the litigating parties can be utilised to drive a resolution through at the right moment.
Russell: In order to obtain the best possible result for a particular party, it is important to understand where each party’s leverage points are and how you and your client can exploit them to your advantage. One of the unique aspects of bankruptcy litigation is that you may be aligned with particular constituencies on certain issues but on opposite sides of the table as to other issues. Because of this, you need to keep your focus on the issues that will have the greatest impact on your client and its ultimate recovery. This will prevent you from taking a position on other issues that may ultimately alienate a party whose support you need where it really matters.
Pasquale: In contested matter, as opposed to adversary proceeding litigation, any party to the bankruptcy case may participate in litigation that arises on any issue. It is therefore important in a litigious, multiparty bankruptcy case to carefully consider whether participating in a particular litigated matter will advance the interests of the client. Not only will participating in the litigation increase costs to the client or to the bankruptcy estate, but such participation may expose the client to otherwise unnecessary and undesirable discovery.
Dailey: While there may be a time in a particular matter to litigate a dispute to conclusion, generally a negotiated dispute preserves value and time and provides certainty to all interested parties. Negotiations that focus on business solutions that might be ‘out of the box’, but provide a benefit to all parties, are most successful. Business goals should drive the legal process and not the other way around. Too often, negotiations focus on whose legal position is right and whose is wrong, and which party must give in to the other. Those negotiations are rarely successful. A client once told me when all parties leave the negotiating table equally unhappy, that is the sign of a successful negotiation since it means that all parties compromised.
Sprayregen: I would advise treating multiparty bankruptcy court litigation as much like normal district court litigation as possible. Many bankruptcy practitioners take shortcuts in litigation, both in discovery, expert reports and general preparation. In multiparty complex bankruptcy litigation, it is most helpful to your client, the other side, the court and the ability to compromise to prepare for the litigation as if it is the so-called normal ‘life or death’ type of non-bankruptcy litigation.
Miller: It’s important that all professional advisers consider if an agreed statement of facts can be developed, which greatly assists the court. They should also aim to narrow the issues to the extent possible, attempt to establish alignment between parties who may have a common interest on some or all of the issues, be particularly realistic in communicating potential outcomes and considering options for resolution to clients, and fully understand the factors that are the key drivers for each party in litigation. The last point cannot be overstated. In multiparty bankruptcy litigation, each party may be constrained or empowered by entirely different factors. A party who is funded by the estate with limited or no risk of a cost award against it if unsuccessful, may feel empowered to take a more aggressive position in litigation and resist settlement. A party for whom the issue in question is a matter of significant importance within its industry or practice may, in some cases, be more inclined to settle to avoid a bad precedent, or in other cases be more inclined to pursue it more forcefully in the hopes of establishing the ‘right’ precedent. The economic interests of each stakeholder must also be clearly understood. A dispute among creditors can highlight those who strongly favour early resolution and distributions, even if at a reduced amount, while others may be ‘patient money’, prepared to wait it out with money committed at rates that could not be replicated in the current market.
Sherrill: Bankruptcy lawyers tend to get comfortable with multiparty litigation pretty quickly. The main bankruptcy case is obviously multilateral, and bankruptcy lawyers learn to be nimble in that setting. In adversary proceedings, too, it is not uncommon for the committee or various other players to get involved. The strategies are often unique to the circumstances, but there are a few general rules that always make sense. Determine early which party is best suited to lead the charge among those with interests that are generally aligned with your own. If that’s not you, then vigorously assert your interests behind the scenes, but stay out of the way in court.
FW: How do you expect the bankruptcy arena to unfold throughout 2015 and beyond? What issues and challenges will dominate processes?
Friedman: Some of the low cost debt issued in the past five years is going to start to reset. If, as expected, interest rates start to rise materially, we are going to see a return to the financial restructurings that were the bread and butter of the last bankruptcy boom. We’re not there yet, but it’s coming.
Pasquale: So long as interest rates remain historically low and maturities continue to be extended, it seems that 2015 will look much like the past few years, with major bankruptcy reorganisation filings relatively few in number. It seems that the Federal Reserve may raise rates later in 2015, but that increase is expected to be small and would likely not have much immediate impact on bankruptcy filings. That said, certain sectors are struggling and we expect to see more filings by retailers and by coal, oil and gas producers. We expect that those companies that do find their way into Chapter 11 will have litigious bankruptcy cases because the sophisticated parties involved in those cases will analyse every conceivable issue in order to exploit opportunities for value.
Sherrill: From a macro view, we do not expect 2015 or early 2016 to be much different from the past few years. So long as interest rates remain low, many troubled companies that otherwise would be forced into bankruptcy will generally be able to refinance their debt. Although the Federal Reserve is expected to raise its benchmark rates sometime this year, few expect the increases to be steep. Therefore, the most realistic expectation is that we will continue to have low rates – and relatively easy refinancing – for months to come.
Miller: One of the more exciting developments we’ve seen in Canada is the creative use of our restructuring statute to address situations, legal entities or entire industries that were previously exempted by statute or generally not considered eligible for formal restructuring proceedings. That has included railways, Canada’s asset backed commercial paper industry and a national accounting partnership, following 20 years of litigation involving numerous plaintiffs for auditor’s negligence. This trend is not unique to Canada, and we’ve seen situations such as the City of Detroit in the US being restructured, which would not have been foreseen 10 years ago.
Durrer: We expect the emphasis on cross-border restructurings to remain robust throughout 2015 and beyond, as companies continue to seek comprehensive restructuring solutions to their global issues and challenges. US courts are becoming increasingly sophisticated in the mechanisms of cross-border insolvency cases, and creditor constituencies are also becoming more sophisticated in the mechanisms for challenging global insolvency proceedings on a jurisdiction-by-jurisdiction basis. Companies in distress have an increasingly broad array of options to plan and execute a financial or operational restructuring, but given the increasing complexity of reorganisation processes, it is imperative that a would-be debtor begin its contingency planning process in advance, to maximise the potential for consensual resolutions with its major constituents.
Russell: The energy space will be a particularly significant area of activity in the coming months as a result of the decline in oil and gas prices. We are already seeing a ripple effect on companies that supply goods and services to oil and gas companies and on coal producers as well. One of the challenges will be coming up with solutions in situations where there is very little current value to satisfy claims.
Renée Dailey is a member of Bracewell & Giuliani’s Finance and Financial Restructuring teams. Described in Legal 500 as “a first-class restructuring lawyer with a strong work ethic” and as an attorney who is “especially adept at pursuing matters that require persistence and focus”, Ms Dailey frequently represents noteholder and bank groups in complex out-of-court restructurings and in-court proceedings in the US and internationally. She can be contacted on +1 (860) 256 8531 or by email: renee.dailey@bgllp.com.
David M. Friedman heads Kasowitz’s Creditors’ Rights and Bankruptcy Practice Group. Mr Friedman represents, among others, debtors-in-possession, commercial lenders in complex real estate and industrial bankruptcies and informal restructurings, committees of creditors and equity security holders, hedge funds, high-yield mutual funds and other distressed investors, trustees in bankruptcy and acquirers of distressed businesses. Mr Friedman has consistently been ranked in Chambers USA as one of the ‘Leading Individuals’ in Bankruptcy/Restructuring. He can be contacted on +1 (212) 506 1740 or by email: dfriedman@kasowitz.com.
James H.M. Sprayregen, P.C. is recognised as one of the outstanding restructuring lawyers in the US and around the world, and has led some of the most complex Chapter 11 filings in recent history. He has extensive experience representing major US and international companies in and out of court as well as buyers and sellers of assets in distressed situations. He has experience advising boards of directors, and representing domestic and international debtors and creditors in workout, insolvency, restructuring and bankruptcy matters. He can be contacted on +1 (312) 862 2481 or by email: james.sprayregen@kirkland.com.
William Russell is a partner at Simpson Thacher & Bartlett LLP in New York. He represents clients in a wide variety of commercial disputes including banking litigation, bankruptcy and reorganisation matters, securities litigation, and transactional disputes. He is a member of the American Law Institute, co-chair of the New York State Bar Association’s President’s Committee on Access to Justice and a panel chair on the Disciplinary Committee for the First Judicial Department. He can be contacted on +1 (212) 455 3979 or by email: wrussell@stblaw.com.
Van C. Durrer II leads Skadden, Arps’ corporate restructuring practice in the western United States and advises clients in restructuring matters around the Pacific Rim. He regularly represents public and private companies, major secured creditors, official and unofficial committees of unsecured creditors, investors and asset-purchasers in troubled company M&A and financing and restructuring transactions, including out-of-court workouts and formal insolvency proceedings. He can be contacted on +1 (213) 687 5200 or by email: van.durrer@skadden.com.
Ken Pasquale is a partner at Stroock & Stroock & Lavan LLP. He has a diverse bankruptcy and litigation practice where he frequently represents institutional creditors in reorganisation proceedings, including with respect to fraudulent transfer and other bankruptcy claims. One of Mr Pasquale’s strengths is the creation and execution of effective litigation strategies that often have a decisive impact on the overall restructuring. Mr Pasquale is a frequent author and lecturer on bankruptcy litigation and related topics. He can be contacted on +1 (212) 806 5562 or by email: kpasquale@stroock.com.
Mark Sherrill is a partner in the Washington, DC office of Sutherland Asbill & Brennan LLP. He is a member of the firm’s Bankruptcy and Energy groups, and leads its Energy Restructuring & Creditors’ Rights team. His practice is centred on bankruptcy issues affecting energy companies and derivatives traders. He can be contacted on +1 (202) 383 0360 or by email: mark.sherrill@sutherland.com.
D.J. Miller is a partner in the insolvency and restructuring group of Thornton Grout Finnigan LLP and has more than 20 years experience in representing various stakeholders in complex restructuring proceedings and bankruptcy litigation. She currently acts as lead Canadian insolvency counsel to the UK Pension Claimants in the Nortel Networks case, and successfully obtained a Decision allocating US$7.3bn of proceeds on a pro rata basis among the various global estates, following an unprecedented joint trial of the Canadian and US Courts. She can be contacted on +1 (416) 304 0559 or by email: djmiller@tgf.ca.
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THE PANELLISTS
Bracewell & Giuliani
Kasowitz Benson Torres & Friedman LLP
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Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates
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Thornton Grout Finnigan LLP