Google+ Followers

Wednesday, December 7, 2016

Synopsis of Oral Argument in Jevic

The Supreme Court heard oral argument today in Czyzewski v Jevic Holding Corp, which presents the question of the power of a bankruptcy court to approve a settlement that effects a distribution of proceeds of property of the estate that does not follow the absolute priority rule.  $1.7 million of distributions in this case skipped over the priority unsecured claims of the petitioners, and went to the general unsecureds.  The Third Circuit held that a court could approve such a settlement given extraordinary circumstance, which followed the lead of the Second Circuit (Iridium), but conflicted with the Fifth Circuit (Aweco), which is why the Court took the matter on.  

As an initial matter, there was some confusion about the relationship between the question presented, which covers a settlement that violated the absolute priority rule (a question on which there was a conflict in the circuits), and the emphasis on this case being a "structured dismissal" such that the distribution occurred only at the end (implying that there is no conflict in the circuits about the terms of a structured dismissal, and a dispute over that question might not have been granted cert).

Without resolving that, the argument moved on with a question by Justice Breyer - what forbids a distribution outside of a plan not adhering to absolute priority.  Counsel responded that the structure of the Code contemplates either a plan confirmation in which absolute priority is relevant (actually in the case of priority unsecured claims, it isn't it's 1129(a)(9).or a liquidation in which the priorities are also followed.

Justice Ginsburg points out, there is a third path, a dismissal in which everyone goes back to their pre-existing  position. Counsel said, that's right, in which case the bankruptcy estate ceases to exist and, in principle, makes no distribution of estate assets at all.

Justice Kennedy chimes in that section 349, governing dismissal, contains a clause that says "unless the court, for case, orders otherwise," which literally appears to allow the court to order something out of the ordinary in a dismissal order.  Counsel responds that the authorities which have analyzed that phrase show it was meant only to protect the interests of persons who changed their position irrevocably in reliance on the existence of the bankruptcy., not carte blanche for the bankruptcy court. Justice Kennedy makes some inconclusive remarks alluding to the tension between the broad "for cause" phrase and the "careful scheme" of priorities elsewhere in the Code.  The Chief Justice asks where the legislative history is found and counsel points him to the House Report.

Justice Kagan asks counsel to state the holding she would like the Court to reach.  Counsel says, the case does not turn on the fact of a "structured dismissal"; the disregard of absolute priority is unlawful at any stage of the case.

Justice Alito pounces: it can never be lawful? Counsel responds, only in section  510 has Congress authorized bankruptcy courts to change priorities.  Counsel then goes on, you don't ned to reach the issue of whether "critical vendor" payments are lawful.  Those payments were authorized by this Court over a century ago, under the Doctrine of Necessity.  The doctrine justifies them because they preserve reorganization prospects.  But here, given that it was a structured dismissal, there was no prospect of reorganization,.

The Solicitor General, supporting the petitioners, was up next.  the rule you should adopt is that "a bankruptcy court can never resolve a bankruptcy by ordering the distribution of estate assets in a manner that violates the Code's absolute priority system without the consent of the impaired priority claim holder."

Chief Justice Roberts:  you don't allow for the "extraordinary circumstances" exception that the Third Circuit endorsed?  SG:  no, that's too big a loophole, given how many cases are administratively insolvent,  and encourages self-serving posturing to make the desired record.  Justice Breyer clarifies that the SG is not proposing to ban critical vendor payments.

Justice Alito asks her to address the "for cause" language in section 349(b), and basically she reiterates her "not permitted" position. which is not,what I think Justice Alito was asking for.  I think he wanted an analysis of the scope of that clause.

Justice Kagan and counsel clarify whether the desired holding would overrule Iridium in the 2d Circuit, and counsel says, depends on whether you limit your holding to situations in which the case is resolved and dismissed or not.

Justice Kennedy asks what happens in practice in structured dismissals and the SG, who I assume does not know, responds  that deals are often reached but it is unlawful to shove an unconfirmable plan through the structured dismissal doorway.

Justice Sotomayor returns to the initial question  about the apparent distinction between the broad "all contexts" question presented for certiorari and the emphasis on the "structured dismissal" context.
She affirms that there is a difference between holding that no settlement proceeds can be distributed outside the absolute priority rules, and saying no dismissal can be entered that circumvents that rule.

After counsel responds, Justice Ginsburg responds, are you saying a settlement can never be carried out if it calls for a distribution?  the SG responds:  a settlement should be limited to just liquidating a claim, unless the proper consents are obtained to a distribution.

Justice Alito asks the SG to explain how 1129(a)(9) and 507 factor in to the analysis.  Counsel points out that 1129(a)(9) permits a claim holder to agree to some treatment other than cash.  But 507 does not contemplate any deviation.

After the SG summed up, counsel for the debtor -respondent took over.  The initial question came from Justice Sotomayor, who observes that the structured dismissal took away a legal right away from the priority unsecured claim holders, the right to sue third parties.   Counsel for some reason fails to address her question but continues with his argument.  When he gets to the point where he says "this is a rare case", she stops him and disagrees: "every structured settlement of this kind is trying to exclude one set of creditors".  Again, counsel fails to respond directly, but begins talking about the fact that the petitioners had received $6 million via the first day order   -- "far more" than the $1.7 million that bypassed them under the structured dismissal  -- on their pre-petition priority claims for wages and benefits.  Justice Breyer dismisses that as irrelevant.  He too focuses on the claims against third parties. If the transcript is correct, counsel concedes the structured dismissal did in fact kill off those claims.

Then, counsel asserts that there is nothing in the Bankruptcy Code for bankruptcy judges to approve settlements. The bankruptcy judge only needs to get involved if there is disposition of estate assets under 363(b).  But under 363(b), judges have discretion.  Justice Breyer asks if they can reverse the order of priority.  Counsel says, in general they can't, but as the Second Circuit held in Iridium, there are rare exceptions.  This case is one of them.

Justice Kennedy pipes up: this case is not rare at all. It's just a chapter 7 case in waiting.
Discussion occurs of the first day payments among Justice Ginsburg, Chief Justice Roberts and counsel.

Justice Breyer compliments counsel for the "very good point" that in a chapter 7 the secured creditors would have taken everything and petitioners would have been no better off.  But then he poses a hypothetical involving buried treasure and asks if the court has power to dispose of it in a wild deviation from the priority scheme.  Counsel distinguishes between cases where the disfavored creditor would have received a distribution and those where it would not, if the scheme was followed.

Justice Kagan distinguishes between a Code that requires rigid adherence to its priorities and a Code that allows a bankruptcy judge to enact a "pareto-superior" outcome, one in which no one is worse off, but someone is better off.  Then says the only question is which of these Codes did Congress enact?   Counsel says, anytime you're in 1129, rigid. Anytime you're in 363(b), there is room for the "pareto-superior"outcome.

Justice Sotomayor says, then bypassing creditors will become the ordinary situation, not the extraordinary.  Counsel responds, bypasses are only legitimate if the bypassed creditor is not losing anything by virtue of being bypassed, where they would have had no recovery.

Justice Kagan re-asks, where is this in the Code, and expresses skepticism that 349(b) brings it in.
Counsel re-states his 363(b) argument and says the question is whether there is 363(b) discretion or whether the absolute priority applies all the time (editorial note: it is absolute, after all).

Justice Breyer and counsel have a rather muddled exchange , at the end of which Justice Breyer says "then I'm back with Justice Kagan. I'm pretty worried about that provision. [363(b)].

Helpfully (in my view), Chief Justice Roberts steps in and says "the reasonableness of your position is directly related to how extraordinary the circumstances are.  I mean, you're suggesting that the main criteria in approving under 363(b) is pretty much what the priorities are under chapter 11." Counsel agrees.  The Chief Justice continues, observing that it matters how "tight"a hold the priority scheme has on 363(b) vs does it merely  "inform the discretion" of the bankruptcy judge.  In the latter case, these scenarios will cease to be extraordinary.  He asks counsel to address that, but counsel resorts to re-stating his argument more or less ab initio.   The Chief presses him, so he relies on the statement in Iridium that conformity to absolute priority is the most important criterion.

Justice Kagan returns to the question of whether all that is happening is the "confirmation" of an unconfirmable plan, by calling it something else and reviewing it under a different section of the code.  Counsel responds, again somewhat obliquely, by suggesting (in my words) that Petitioners could have been more helpful about ways to make the plan confirmable, as opposed to just insisting on their rights.

Justice Sotomayor follows up by saying there is a difference between a settlement of an individual claim and a settlement that works like a plan. And says the second type would not be an "extraordinary" circumstance.  Counsel responds rather broadly that 363(b) discretion varies based on the facts of the case and might vary based on whether  you are at the start or end of the case.

Counsel then reviews with Justice Sotomayor that the funds in the case came in as a global settlement from an outside third party that, fearing liability on an avoidance action, insisted that the estate release that cause of action; that, in turn, gave the unsecured creditors leverage to demand some of the settlement, because otherwise they would have logically been able to pursue the avoidance action under a plan.

Counsel restates his argument at a high level of generality. Justice Breyer comes back and asks, even if we agree that a judge can authorize a debtor to "sell" a lawsuit, where do we find the authority to vary from absolute priority in distributing the proceeds?  Counsel sums up by saying:  363(b) discretion is, as Iridium says, restricted, but not obliterated, by absolute priority, and at least here, where no one is harmed by the deviation from absolute priority, it is within the court's discretion to authorize such a deviation.

Counsel for petitioners was given two minutes to reply, but the justices did not interrupt her and the argument ended.

The questions are all over the lot.  I could envision the Court saying cert was improvidently granted if it takes too long to reach a consensus.  Justice Alito and Sotomayor both raised this question.   I think that is unlikely. I think some of the Justices are trying to analyze the question presented and not limit themselves to the "structured dismissal" context.  There seem to me to be at least two justices, Breyer and Kagan, who don't see the statutory authority for respondents' position, even though they both seem to think it generated a "pareto-superior" outcome in this particular case.  Justice Sotomayor seems quite distrustful of the respondents' position.  Justice Kennedy's lone substantive question suggest he shares her skepticism. The Chief seems open-minded but seems to me unlikely to fall on his sword if a consensus scan be forged in favor of a different result.  I suspect Justice Ginsburg is in the same place.  Justice Alito seems the most inclined to support the debtors' position.  Justice Thomas did not speak and I have no idea how he would view this, since the legislative history behind 349(b) would not seem likely to interest him.  The Code is silent on the specific question and I don't know how he, as a literalist, would tend to rule when that is the case.  My bottom line is I expect the petitioners to win, although my confidence in that conclusion is low.  















Saturday, December 3, 2016

Zacks Investments Having Trouble Making Up its Mind About Aramark

I went into Fidelity's website to research the stock of Aramark, the food services provider.  Under the "News and Events" tab, these were the four most recent items:


  • Zacks Investment Research, Inc. downgrades ARAMARK from HOLD to SELL.

    Investars Analyst Actions - private – 12/01/2016
  • Show article details.

    Zacks Investment Research, Inc. upgrades ARAMARK from SELL to HOLD.

    Investars Analyst Actions - private – 11/30/2016
  • Show article details.

    Zacks Investment Research, Inc. downgrades ARAMARK from HOLD to SELL.

    Investars Analyst Actions - private – 11/29/2016


  • Zacks Investment Research, Inc. upgrades ARAMARK from SELL to HOLD.

    Investars Analyst Actions - private – 11/25/2016 


    I understand algorithms are driving most of these sites' output, but this is one algorithm that needs some re-writing.  This would be absurd "analysis" for pretty much any equity in the US markets, but Aramark is a low-vol stock to begin with (beta 0.66) and, during the time Zacks was playing tug of war with itself, the stock only moved within a band of less than 5%.  Embarrassing.               
  • Thursday, September 1, 2016

    The Puerto Rico Oversight Board Has Been Appointed (Sell on the News).

    Yesterday, August 31, President Obama appointed the 7 voting members of the oversight board for Puerto Rico under the law colloquially known as Promesa.  The board has a broad charter and a ridiculously impossible task in front of it. 


    Back in June, in a moment of weakness, I told a friend of mine at a hedge fund, “Sure, you can try to put my name on one of the lists of nominees.”  Then came August and his liaison in D.C. with the office of the relevant Congressional figure emailed me and said “You’re on the list” from that leader to the Administration.  Lest I get too arrogant, he took pains to let me know that most of the initial proposed appointees from the GOP side had been vetoed by the Administration; clearly I was not an “A-list” candidate inside the Beltway.  So I began educating myself on the law and the island’s predicament, and as I did, I became more and more fearful: “God, what if I do get appointed?  This thing is a disaster!”  So, while I felt obligated to live up to my undertaking, I was deeply relieved last night when said friend and said liaison let me know I had been passed over.  They explained, as the Wall Street Journal reported today, that the Administration had insisted on at least two of the GOP nominees being natives of Puerto Rico or having close ties there, and also (not reported in the WSJ) that the “Anglos” on the GOP side, Biggs of AEI and Skeel of U. Penn, had been cleared in the first round, so ultimately my presence on the list was, in retrospect, some sort of a gesture to my friend and his liaison as opposed to something that had a realistic chance of coming to fruition.  For which I am grateful.


    Personal anecdotes aside, let’s look at the nominees’ backgrounds, keeping in mind that the underlying problem pits a consistently Democratic government debtor against a large number of institutional creditors.  As Mary Williams Walsh of the Times, whose reporting I think has been reasonably balanced, reports (my additions are in parenthesis):

    The Republicans named to the board are:

    ■ Andrew G. Biggs, a resident scholar at the American Enterprise Institute (Mr. Biggs was also deputy commissioner for Social Security in the 2nd Bush administration and appears to be also a resident scholar at the free-market-oriented think tank, The Mercatus Center).

    ■ José B. Carrión III, president of Hub International, an insurance brokerage in Puerto Rico (This is a little misleading.  Hub International is a worldwide insurance brokerage (owned by private-equity firm Hellman & Friedman and headquartered in Chicago); Mr. Carrion is head of the Caribbean region, not the global company).

    ■ Carlos M. García, founder and chief executive of BayBoston Managers, a private equity firm. (Per his LinkedIn page, I found this:” Previously, he was appointed by the Governor of Puerto Rico as Chairman, President and CEO of the Government Development Bank for PR, the fiscal agent, financial advisor and bank of the Government of Puerto Rico. Mr. Garcia also chaired the Fiscal Restructuring and Stabilization Board created by law to safeguard Puerto Rico's credit rating. During his public service tenure (2009-2011), the Government of Puerto Rico improved its credit ratings and coordinated with federal regulators the implementation of a financial rescue plan for its banking system.”   I note that the Development Bank is one of the institutions whose restructuring is under the aegis of the Oversight Board).

    ■ David A. Skeel Jr., a University of Pennsylvania law professor with expertise in bankruptcy (His bio page from Penn’s website).

    The Democrats are:

    ■ Arthur J. Gonzalez, a senior fellow at the New York University School of Law and a former chief judge of the United States Bankruptcy Court for the Southern District of New York (I assume Judge Gonzalez is well known to readers of this blog).

    ■ José Ramon González, president and chief executive of the Federal Home Loan Bank of New York.  (According to a press release from FHLBNY, like Mr. Garcia, he was also CEO of the Government Development Bank for Puerto Rico, one of the debtors whose restructuring he will now be overseeing.  The FHLBNY is a federally chartered cooperative whose members are mortgage lending banks in New York, New Jersey and Puerto Rico.  It is exempt from all taxation and its securities are given preferential regulatory treatment for risk-capital weightings under bank regulations.  These subsidies are stated to have been intended to assist it in its mission to support affordable housing (notwithstanding that prices have appreciated beyond many working families’ ability to purchase.))

    ■ Ana J. Matosantos, president of Matosantos Consulting and a former director of the California Department of Finance From a biography I found on the web: “Ana Matosantos has a number of firsts on her resume. She was the youngest, the first Latina and the first openly gay person to hold the position of Department of Finance director.

    “She was also the first finance director to serve two governors of different parties.

    “Matosantos grew up in Puerto Rico, the daughter of a businessman and a high school administrator, and received a bachelor's degree in political science and feminist studies from Stanford University in 1997. After graduating, she spent two years working at the San Francisco-based Equal Rights Advocates, a public interest law firm that focuses on women’s rights.

    “She considered law school, but instead began her state government career as a consultant to the Senate Committee on Health and Human Services and as the human services consultant to the Senate Committee on Budget and Fiscal Review. Matosantos moved to the executive branch in 2004 as a member of the Health and Human Services Agency, where she served as an assistant secretary for programs and fiscal affairs and associate secretary for legislative affairs. In 2007, she became deputy legislative secretary for Health and Human Services and Veterans Affairs in the office of Governor Arnold Schwarzenegger where she worked on the administration’s comprehensive health care reform proposal.

    “From April 2008 to December 2009, Matosantos was the chief deputy director for budgets.

    Republican Governor Arnold Schwarzenegger appointed Matosantos, a Democrat, finance director in 2009. She was reappointed director by Governor Jerry Brown in January 2011 and 10 months later was arrested on suspicion of driving under the influence, pleaded no contest to driving while over the legal limit for alcohol and was sentenced to three years’ probation.

    “She resigned her post in September 2013.” 

    I write this post to point out that none of the appointees has any private sector restructuring experience, with the exception of a couple of “estate neutral” assignments Judge Gonzalez handled since leaving the bench.  (With all due respect to Professor Skeel (whose academic work I am sure is first-rate) and any other academic out there, I’ve never seen a full-time academic who could survive in a practice in a given debt restructuring situation.  Totally different mindsets and, after a point, skill sets.)

    Indeed, with the exception of Mr. Carrion and Mr. J Gonzalez’s work at a government-subsidized lender, none of the appointees has any extended private sector experience of any kind.  

    Last, notwithstanding that two of them held an executive office at the local development bank, none of them has any successful experience in economic development.  Most of the total years of employment of the board members come in government, government-subsidized, or not-for-profit institutions.  Yet, I would submit, the two things the island needs are economic development not dependent on infusion of funds from outside sources, and debt restructuring.

    I point particularly to Ms. Matosantos.  Even though she appears to have been in office during the period California handed out IOUs to its suppliers, there is no comparison between what a giant economy like California can do to turn itself around and attract talented entrepreneurs and what a modest Caribbean island can do, especially when there is no restriction of emigration from the island to Florida, New York or other destinations on the mainland. 

    Although I am sure all of them are well-intentioned, most have some kind of relevant expertise, and a couple appear to have a generally attractive philosophical outlook, overall the appointments seem to be lacking in key respects. Having studied the challenge that confronts them, I was dubious before the appointments were announced that the board could pull a comprehensive, consensual restructuring together; I am even more pessimistic now. 

    I have not held and do not hold any positions in the debt of any of the debtors subject to PROMESA, including, as far as I know, mutual funds that might hold their debt. Nor do I have any business or real estate interests on the island.


    Monday, April 4, 2016

    Eleventh Circuit Panel Makes Cursory (and Erroneous) Ruling on "Till in Chapter 11"

    A few  weeks ago, a panel of the Eleventh Circuit issued an opinion, In re Seaside Engineering & Surveying, Inc., No. 14-11590, denying an appeal of a chapter 11 confirmation order, that includes, among several issues considered, a brief holding relying on [a misreading of]  Till v SCS Credit Corp.  The entire section of the opinion dealing with Till is only 7 sentences and 12 lines long. The case involved a tiny amount of money - the debtor's business was valued at only $200,000 -  and I suspect the court did not receive in-depth advocacy on the topic. 

    Here is the entire section of the opinion dealing with Till:

    "E.  Interest Rate on Promissory Notes Exchanged Pursuant to the Second Amended Restructuring Plan.  Vision did not receive an immediate cash payment for its interest in Seaside; rather, Vision received promissory notes accruing with an interest rate of 4.25%. Vision argues that this rate does not adequately compensate for the highly prospective nature of the notes. This Court reviews the adequacy of the interest rate for clear error. In re Brice Rd. Devs., 392 B.R. 274, 280 (B.A.P. 6th Cir .2008).The Supreme Court adopted the formula approach for determining the interest rate payable to creditors in bankruptcy proceedings. Till v. SCS Credit Corp., 541 U.S. 465, 478–79, 124 S.Ct. 1951, 1961, 158 L.Ed.2d 787 (2004). “Taking its cue from ordinary lending practices, the approach begins by looking to the national prime rate․ Because bankrupt debtors typically pose a greater risk of nonpayment than solvent commercial borrowers, the approach then requires a bankruptcy court to adjust the prime rate accordingly.” Id. Here, the bankruptcy court applied this formula, adding a 1% adjustment to the prime rate of 3.25%. The 1% adjustment is within the range suggested by the Supreme Court in Till, 124 S.Ct. at 1962, and therefore the bankruptcy court committed no clear error."

    On the face of the text excerpted, one can see clear error.  The Supreme Court did not, in Till, adopt "the formula approach for determining the interest rate payable to creditors in bankruptcy proceedings".  That statement is wrong in two ways.  First, Till had three opinions, none of which commanded a majority of the Justices.  Thus, the "formula approach" is not what the "Court adopted" because the divided Court adopted nothing. (read the syllabus of the case if you think I am wrong; you will note that the only thing identified as being "of the Court" is the judgment (vacating and remanding).  Everything else is merely an opinion of the various Justices.)  The "formula approach" was just what the four Justices in the middle of the spectrum of opinions happened to agree on,  nothing more or less.  The only holding that can be divined in Till is that the "forced loan" approach cannot be used to determine the value, as of the effective date, of deferred payments in a chapter 13 plan.

    Second, and more substantive, Till was a chapter 13 case and there is nothing in the opinion that purports to impose the plurality's "formula approach" in all other "bankruptcy proceedings" as the Seaside opinion says. As I have written before, and as anyone who looks at the text of the Bankruptcy Code with a fresh eye can see, cramdown in a chapter 11 case like Seaside is governed by a different standard than cramdown in a chapter 13 case like Till. The cramdown section of chapter 11 mandates scrutiny pursuant to the century-old "fair and equitable" standard, which does not appear in chapter 13.  Courts adjudicating chapter 11 cramdown battles need to follow the precedent interpreting "fair and equitable"; courts adjudicating chapter 13 cramdowns are not subject to that standard because that language is not found in chapter 13.  Moreover, as I recounted last year, when one looks at the briefs and argument before the Court in Till, one sees that the Tills, the Solicitor General and the Justices all rejected the idea that chapter 11 precedent had any bearing on the question before the Court in Till.  

    Courts should not be looking at Till at all in adjudicating chapter 11 cramdowns.




    Wednesday, February 17, 2016

    Disparity Between Law Firm Realization in Chapter 11 vs. Other Practice Areas -- Or Just Mismeasurement?

    Steven J. Harper, former Kirkland partner, now critic of law schools and the legal profession, makes an important point in the American Lawyer about the disparity between the collection percentage law firms attain on bills to chapter 11 debtors and law firms' collection rates from other large corporate clients. 


    Harper notes, correctly, that while listed hourly rates for the top lawyers have soared in recent years to as high as $1500, collection percentages for overall law firm billing have plunged at the same time,, with many firms realizing less than 90% of their inventory value and many scraping 80% realization. 


    Harper also contrasts the falling realization on the total book of business with the continued high realization experience of law firms who submit fee applications in large chapter 11 cases, where payment is often over 95% of the amount rung up in the given fee app period.


    Harper deduces that "If a firm’s average is 83 percent and its bankruptcy lawyers collect close to 100 percent, then firms with large bankruptcy practices have nonbankruptcy clients pushing some practice areas into deep concessions off standard rates". Stated another way, which perhaps out of deference to his former firm he does not, bankruptcy practices in those firms are compensating for a good portion of the discounts that their non-bankruptcy clients are receiving, which seems illogical.


    I think this is cause for concern about reflexive approval of fee applications in chapter 11 cases, but at the same time, the issue is more complex than simply saying, "let's find out what the firms' realization rates are and haircut their bills by that amount."  This is because of what is known as the "ecological fallacy", which is when someone mistakenly believes that every individual in a group under study acts the same way as a single statistical measure of the group.  In this context, law firm billing is much more heterogeneous than an average or bottom line percentage reveals. For example, a corporate finance practice may realize, on average, more than 100% on closed deals, and less than 70% on busted deals.  The average may fall in the ninth decile (i.e. between 81 and 90%), but that doesn't imply that the average is the relevant metric for evaluating the reasonableness of a single fee situation, especially a one-time representation. If the one-time deal closes, only the closed transaction realization is relevant.  If it fails, only the failed deal realization is relevant. Of course, how you apply that to chapter 11 is not a simple proposition: consider two cases - first, a 363 sale that pays secureds 60% of their claims, followed by a liquidating plan with nothing but a litigation trust for unsecureds, and second, a similar case that produces 100% for secureds and 15% for unsecureds after a spirited auction in the case.  In both cases, everything closed as a legal matter, but people walk away happier from the second.  There is an intuition that perhaps law firm realization should vary in the two cases, if it is the custom to vary realization based on result in the non-bankruptcy context.  The difficulty with this intuition is that, in bankruptcy, there are usually several constituencies with widely differing outcomes  and the analogy to closing a transaction for a solvent enterprise where only one constituency, the representatives of the shareholders, calls the shots, is clearly imperfect.


    Similarly, there are realization disparities within a firm based on a variety of factors.  Litigation departments may offer higher discounts than corporate because their matters tend to be more leveraged and also very long-lasting, providing annuity-like underpinning to the firms' net income over several years; such financial security may be worth an insurance-like premium, i.e., an extra discount  For similar reasons, clients with large books of repeat business can procure larger discounts than occasional ones.  Most relevant to chapter 11 billing, lawyers with national reputations in other specialized areas, such as patent law, are in such demand that they don't have to offer discounts. 


    I think that legal bills in chapter 11 are generally too high, not so much due to the hourly rates of the lawyers leading the representation or even the realization, but for four reasons, which are, in declining order of importance: (1) structural incentives in the chapter 11 system for unhappy constituencies to trigger costly litigation; (2) failure of judges to run cases efficiently, especially in terms of uncontested matters, which could be signed off on without a hearing as 95% of district judges do; (3) failure of all actors in the system to establish reasonable standards for the cost of recurrent, predictable tasks, like motions to assume contracts and leases; and (4) fear of institutional creditors to alienate the most powerful debtor firms for fear of reprisal in plan negotiations or being frozen out in future cases.


    I could envision judges and USTs asking firms submitting fee apps about realization rates on similar representations, but I think it is unlikely to make much difference in fee awards, except in the rare case where recoveries melt down during the case.

    Thursday, January 21, 2016

    A Modest Proposal for Protecting Consumer Debtors in the Poorest Jurisdictions

    I haven't posted in a while.  There is a lot of financial distress going on and a lot of other big issues as well, but I try not to post unless I can convince myself have something unique to contribute.  This is one of those topics, I think.

    A couple of years ago I was in San Juan, P.R., for an ABI conference.  At the lunch break, I found myself at a table with a long-time professional colleague, a Judge from another district that I had appeared in front of a few times, and certain personnel from the local Bankruptcy Court, all of whom shall remain nameless.  One of the topics that came up, which can, without a doubt, be considered part of my continuing professional education, pertained to the local consumer bankruptcy practice, which, not surprisingly, is rather bustling in what is one of the poorest jurisdictions in the United States of America. Yet, in the course of the discussion, I learned a very curious fact about consumer bankruptcy practice in Puerto Rico: it is one of the few jurisdictions that has a significantly higher proportion of chapter 13 petitions than chapter 7 petitions for consumer debtors.  Statistics on the website of the U.S. Bankruptcy Court for the District of Puerto Rico show that, last year, the district had 5,744 chapter 13 filings and 4,477 chapter 7 cases, a number of which were likely not consumer cases but small business petitions.

    Now that doesn't make a lot of sense.  Puerto Rico is, by a shockingly large margin, poorer than any State in the United States.  The Census Bureau estimates the median household income in Puerto Rico to be just $19,686.  For comparison purposes, data generated by the U.S. Census Bureau about median household income in different places in the US (specifically, the table "Income of Households by State Ranked from Highest to Lowest") reveal that the median household income in the US (in 2013 dollars) was $51,849.  And the 5 lowest ranked states are:

    West Virginia$42,581
    Kentucky41,707
    Arkansas40,760
    Louisiana40,462
    Mississippi40,194

    Thus, the median household income in Puerto Rico isn't even half that in the poorest States in the US.  Moreover, given the amount of its population receiving income assistance and other welfare support from the Federal government, their actual earned income is probably significantly less than even that sum.   So it's highly surprising that the sub-population that winds up seeking relief from consumer debts by filing bankruptcy tends to pursue the chapter that was generally designed for higher earners and therefore provides less of a write-down and burdens their subsequent earnings more.

    Unfortunately, the anomaly is not limited to Puerto Rico. As a recent summary on the U.S. Trustee  website states:

    "Chapter 13 filings vary greatly from state to state, ranging from 6 percent to 70 percent of filings. These extremes are even more pronounced at the district level, with some judicial districts having chapter 13 percentages as high as 80 percent. The top jurisdictions with a predominant concentration in chapter 13 filings, or more than half of total filings, are Louisiana, Puerto Rico, South Carolina, Tennessee, Texas, Georgia, Arkansas and Mississippi.  States with the fewest chapter 13 filings, or less than 10 percent of total filings, are Idaho, South Dakota, Iowa and New Mexico." 


    With the exception of Texas, which ranks 25th, the jurisdictions with disproportionately high chapter 13 filings are all jurisdictions in the bottom third of the median national household income ranking:  Georgia [34], South Carolina [41], Tennessee [43], Arkansas [48] Louisiana [49], Mississippi [50], and of course, Puerto Rico [51].

    I looked at filings last year in the three poorest states and confirmed the Executive Office of the U.S. Trustee's summary remained generally accurate:

    Arkansas: In this State, in 2015, filing statistics bore a remarkable resemblance to Puerto Rico's:  5,296 chapter 13 filings vs. 4,560 chapter 7 cases. (Those figures are the sum of the filings in the State's two federal judicial districts.)

    Louisiana:  Only the Eastern District published data on its website breaking down consumer bankruptcy filings by chapter for 2015.  The distribution of filings in their district is skewed toward chapter 13: 1,834 chapter 13 cases vs 1,469 chapter 7 cases

    Mississippi:  In 2015, curiously, the two districts had significantly different balances of consumer bankruptcy filings.  In S.D. Miss., there were 2,913 chapter 13 filings and 3,339 chapter 7 filings.  Conversely, in N.D. Miss., they had 2,727 chapter 13 filings, vs, only 1,952 chapter 7 filings.

    For comparison's sake, I looked at the filing patterns in the other States, West Virginia and Kentucky, in the bottom decile of the Census Bureau's rankings:

    West Virginia: In 2015, West Virginia saw 1,095 chapter 7 filings and only 189 chapter 13 filings, making it quite a standout vs its economic peers in delivering the benefit of the federal bankruptcy law.

    Kentucky:  Its Western District saw 4,883 chapter 7 filings and 2,261 chapter 13 filings. The Eastern District's bankruptcy court website does not seem to present statistics on the chapter 7 / chapter 13 breakdown.

    As further comparison, I looked at filing patterns in a couple of the highest ranked states.

    Maryland: In Maryland, the State said to have the highest median household income, in 2015, there were 5137 chapter 13 filings vs 12,583 chapter 7 filings, some of which again were probably business filings and thus not comparable

    New Hampshire:  In New Hampshire, the second highest ranked State, in 2015, there were 503 chapter 13 filings vs 1,367 chapter 7 filings, some of which again were probably business filings and thus not comparable. 

    New Jersey:  In New Jersey, the 5th highest ranked State, in 2015, there were 17,983 consumer chapter 7 cases and 7,473 chapter 13 cases. 

    So, in all of these higher-income States, chapter 13 filings consistently comprise between 25% and 30% of total consumer bankruptcies, a dramatic contrast to the collection of poor states where such filings are more than half of total consumer bankruptcies.

    Do Fee Practices Cause the Anomaly?

    Initially, when I was in San Juan, I thought that the explanation for its radical departure from national norms might lie in the fact that the District has a pre-approved, "no-look" fee for attorneys for chapter 13 debtors of $3,000, which, I thought at the time, might be serving to incentivize said attorneys to channel their clients into chapter 13 cases for personal enrichment.  That may be the case  -- in these poor jurisdictions, I imagine, a steady diet of $3,000 fees would give an attorney a much higher lifestyle than the $600 or so they might be able to charge for preparing "no asset" chapter 7 filings.

    But, when I researched the "no-look" practices of a number of other jurisdictions, I found no correlation between such fees and a preference for chapter 13 vs. chapter 7.  In part, I relied on an article by Bruce M. Price, "'No Look' Attorneys' Fees and the Attorneys Who Are Looking: An Empirical Analysis of Presumptively Approved Attorneys' Fees in Chapter 13 Bankruptcies and a Proposal for Reform", from Spring 2012, and in part I did my own research on bankruptcy court websites.  I found the States with low proportions of chapter 13 filings have similar fee schedules to those with high proportions. 

    For example, in Maryland, the chapter 13 debtor's attorney has a menu of fixed fee arrangements to select from (Local Rules, App. F): $2,000 for plan confirmation alone; $3,000 for all matters in main case, right reserved to apply for more; or $4,500 for all matters in main case, no right to seek more.
    In New Hampshire, there is a simple $2,500 fixed fee pre-confirmation and $1,000 for post-confirmation representation (Admin Order 2016-1).  In New Jersey, it's $3,500  (Local Bankruptcy Rule 2016-5).  Looking at the poorer States with a low proportion of chapter 13, West Virginia and Kentucky, they too have similar fee arrangements.  In West Virginia, according to the Price article, it's  $3,000, and in Kentucky, the Western District offers a sliding scale from $1,625 to $3,000 depending on the amount of post-confirmation earnings and other assets available for distribution to unsecured creditors.   Finally and most tellingly, the two Districts of Mississippi have an identical standing order providing chapter 13 attorneys a no-look fee of $3,200, yet have contrasting filing patterns.   So, the existence of a no-look fee in the prevailing range (generally $3,500 and below), in and of itself, cannot be scientifically proven to influence the choice of chapter under which debtors are proceeding.  Were I a social scientist, grad student or law professor trying to get tenure, I could investigate the causes more extensively. On the other hand, if there is a sufficiently easy way to correct the misguided preference in these poorest jurisdictions for the form of bankruptcy relief that is less useful to consumer debtors, then the cause of the problem becomes not just academic but moot.

    Suggested Solution

    I spent a good thought over the past two years to a way to eliminate the unnecessarily negative outcomes being inflicted upon the debtors in these poorest jurisdictions.  Optimally, it would be something that did not require legislative action, given the intensity of the battle of BACPA and the general deterioration in the lawmaking process even since then.

    But I believe I have come up with a simple solution that does not require legislation, which is to adopt a rule, either as a local rule on a court-by-court basis, or, more optimally, an amendment of the Federal Rules of Bankruptcy Procedure, that says three simple things.

    First, tracking language already found in Section 707(b)(6) and (7), which prevent dismissing a chapter 7 case if the debtor's income is below certain thresholds: the new Rule would provide:

    Section I:  "If the current monthly income of the debtor, or in a joint case, the debtor and the debtor’s spouse, as of the date of the order for relief, when multiplied by 12, is equal to or less than—

    (A)  in the case of a debtor in a household of 1 person, the median family income of the applicable State for 1 earner;

    (B)    in the case of a debtor in a household of 2, 3, or 4 individuals, the highest median family income of the applicable State for a family of the same number or fewer individuals; or
                         
    (C)    in the case of a debtor in a household exceeding 4 individuals, the highest median family income of the applicable State for a family of 4 or fewer individuals, plus $525 per month for each individual in excess of 4,

    the debtor may only commence a case under chapter 7 of this Code."

    Now the reader might react with some surprise that a Rule could be adopted that would bar a debtor from filing a chapter 13 petition, but I believe it is eminently defensible for three reasons.  First, the scope of permitted rules, per the Rules Enabling Act (28 U.S.C. sec. 2075), is that they may not "abridge, enlarge or modify any substantive right".  The proposed Rule does not do any such thing because the choice between chapters is not a "substantive" right.  It is purely a procedural  
    election.  Further, to the extent any right that arises from filing for bankruptcy is "substantive", such as the relief it provides from creditors, that relief is identical in 7 and 13. Thus, the Rule does not "abridge, modify or enlarge" any such right.  Second, a chapter 7 debtor has, per Section 706(a), a "one-time absolute right" (quoting legislative history) to convert a case filed under chapter 7 to one under another chapter, such as 13.  Thus, requiring consumer debtors to file initially under 7 does not abridge or modify their ability to get relief under chapter 13.   Last, I submit, such a Rule, far from conflicting with anything in the Bankruptcy Code, actually furthers the overall legislative purpose of the income-based differentiations throughout Section 707.  Those clearly intend that debtors who fall below the specified income thresholds will proceed under chapter 7, not 13, and the Rule would just ensure that this intent is fulfilled more broadly and uniformly throughout the land.

    Of course, this argument raises immediately the question, if the debtor has an absolute right to just convert to chapter 13, won't they just file such a motion a minute after they file the petition, and then their attorney will resume representing them in the 13 and earning the no-look fee, and the problem will just remain?  In response, I have two solutions.  One, more aggressive, is that, again, the right to convert is purely procedural, and thus can be limited by Rule. Two, regardless of the view one holds on that proposition, it seems beyond dispute that courts can provide how conversions are effected, and thus the second prong of the proposed Rule would be to specify that:

    Section II:  "Any debtor described in Section I that wishes to exercise his or her right under Section 706(a) of the Code to convert a case under chapter 7 to one under chapter 13 may only do so after notice and a hearing that the debtor attends in person and at which he or she explains to the court the basis for his or her decision."   

    This, while not purporting to bar or limit the "absolute" right of conversion in any way, will enable the Bankruptcy Judge presiding over the debtor's case to inquire whether the debtor understands the economic effect of doing so, and the resulting conversation could result  in the debtor -- of his or her own free will -- foregoing the conversion or postponing the decision to reflect on it further.

    Last, because I have this lingering belief that the anomalous filing patterns in those poor jurisdictions is due, at least in part, to suboptimal and conceivably bad faith legal representation, the final section of the proposed Rule would, I hope, counterbalance any incentives that the current fee structures may be providing chapter 13 attorneys in those jurisdictions:

    Section III:  "(a) Each bankruptcy court may establish reasonable fixed fees for debtors' attorneys in chapter 13 cases that have been filed (or converted from cases under another chapter of the Code) in such court in accordance with the Code and these Rules, to be awarded and paid without the need for review, in the absence of objection by a party in interest (including the U.S. Trustee), by the court under Section 330 of the Code, and may further establish such procedures and conditions for award of such fees as it deems reasonable.

    "(b) Without limiting the foregoing, and without limiting the power of such Courts to employ other disciplinary measures they may deem advisable under given circumstances, each Bankruptcy Court shall retain the power under Section 330 to reduce and disallow compensation to chapter 13 debtors' attorneys, whether or not an objection has been made by a party in interest (including the U.S. Trustee) in the event the court finds, after notice and a hearing, that the case was not filed (or converted from cases under another chapter of the Code) in such court in accordance with the Code and these Rules or that the attorney failed to advise the debtor adequately concerning the relative merits of proceeding under chapter 13 versus chapter 7."

    With the attorneys' fees now tied to making sure their clients start off in chapter 7 and don't convert out of it routinely, I would hope that any incentive to channel the clients into 13 for increased fees is removed or offset.  Cumulatively, I would hope that the three prongs of the proposed Rule would correct the anomalous pattern of financially burdened residents in the poorest jurisdictions being routed systematically into the less effective vehicle afforded by federal law for resolving their debts.









    Friday, December 18, 2015

    Well-Reasoned "True Sale" Opinion from Middle District of Pennsylvania Bankruptcy Court


    In the December 2015 ABI Journal, I read an article by James Gadsden discussing the recent decision of United States Bankruptcy Judge Mary France in the Middle District of Pennsylvania, In re Dryden Advisory Services LLC, 534 B.R. 612 (Bankr. M.D. Pa.  2015). upholding a factoring agreement governed by New York law against an argument by the debtor-in-possession that the arrangement was a disguised financing arrangement such that the factored receivables were property of the estate.  This having been an area that I often had to grapple with, in the sense of reviewing, negotiating and signing off on “true sale” opinions to support the securitization practice, and there being a dearth of modern opinions addressing the “true sale” question, I read the article with interest.  I had met Judge France on a case in Harrisburg when she was in charge of the local office of the U.S. Trustee for the Region, and she had impressed me as having greater than customary business sense and common sense for one in that position (would she had been in charge of the Wilmington office instead), so my interest in the opinion was enhanced because she wrote it.  This was a difficult case, and the result is debatable, but I think she analyzed it with precision and sophistication.

    The debtor was in the business of pursuing tax refunds and other reductions for businesses, and was paid on commission.  Cash flow was lumpy and frequently sluggish.  Among its liquidity strategies was a factoring arrangement governed by New York law.  The principal relevant terms of that agreement were:

    *   Factor was under no obligation to factor any particular account, but had discretion to accept and reject the ones Debtor proposed.

    *   Factor took an initial 3.5% discount on the face amount of each invoice.  If the account remained outstanding after 30 days, Factor applied an additional 1.75% of face discount. Factor repeated that discount every 15 days thereafter until collection.

    *   To cover the discounts and other risks, Factor only advanced 75% of the amount of the invoice.   The remaining 25% balance served as a “holdback” of the purchase price.  If the account debtor did not pay in full, Factor kept the holdback.  If payment was made in full, Factor rebated the holdback to the Debtor, after deducting therefrom whatever discounts and other items applied.  Factor was, however, also entitled to retain from such remittances any amount needed to make itself whole on other purchased receivables that might be in default.  The 25% level of recourse, coupled with the ability to cross-collateralize receivables, is unusually aggressive, compared to what we would have agreed to give “true sale” opinions on.  I will discuss the implications later in this post. 

    *   Last, and most critically for the decision, the Factoring Agreement provided that Factor assumed the risk of non-payment on purchased accounts only if non-payment was “due to the occurrence of an account debtor’s financial inability to pay, an `Insolvency Event.'”  Notwithstanding this provision, Factor also had the right to put back t the account seller any invoice that was more than 89 days old. 

    After reciting authorities that provide an overview of the “true sale / disguised financing” issue, Judge France cites relatively modern case law from SDNY for the proposition that, “To constitute a bona fide factoring agreement under New York law, the factor need only assume the risk that the seller’s account debtor will be unable to pay.”  In fact, every quotation she supplies on this point includes “only” or “merely” making the point very clearly that the analysis is a fairly straightforward one. “[A]ll other risks associated with the sale of the accounts receivable remain with the client (e.g., commercial disputes …).”

    After general observations that the language of the agreement is not dispositive, and courts look “beyond labels and into the details of the transaction”, Judge France’s analysis begins – oddly, I thought -- by noting that the agreement called for the Debtor to hold payments it received in trust in the exact form received and to forward them immediately to Factor.  What troubles me about this observation is not just that its exclusive focus on the language of the agreement seems at odds with the immediately preceding proposition that the language of the agreement should be de-emphasized, but also, in the factual recitals, the Judge had recited at least one instance in which Debtor received payment of a factored receivable directly and initially paid over only the amount advanced on a given receivable, and Factor had to follow up to receive the balance.  That seems to undercut the significance attached to the language of the agreement.  The opinion obliquely takes up the topic of deviating from the language of the agreement, not as something directly bearing on the ultimate issue, but as a subsidiary question of whether the parties’ conduct had effectively amended the terms of the agreement; pointing to merger clauses and the usual boilerplate, the Judge concludes it hadn’t.  I think this – which may have been how the debtor’s lawyer framed it – is a misguided perspective. The right focus is on how the property at issue was handled, as the initial lines of the Judge’s analysis state.  It is irrelevant whether the agreement was or wasn't amended by the parties’ conduct; the conduct itself is what matters. 

    Further, it is unclear from the opinion, which recites some confusion among the litigants about how many receivables were at issue, whether there had been receivables paid to Debtor that, at the petition date, Debtor had failed to pay over to Factor. It may be that the confusion resulted from the account debtors paying the Factor directly but some clarity on the details might provide more insight.

    Judge France goes on to state that:

    “The ability of a buyer to demand that it receive payment directly from account debtors supports the finding that the transaction is a sale. Here, § 4.4 of the Amended Factoring Agreement gives Durham that right. “Durham may notify any Customer [i.e., account debtor] to make payments directly to Durham for any Account.” Durham Ex. 3 §4.4. After payment of several invoices was delayed, Durham exercised this right and demanded payment directly from Dryden’s account debtors. Had Durham exercised this right at the inception of the agreement it would have been abundantly clear that the transfer of the accounts was a sale. Durham may have preferred not to exercise this right initially to avoid disrupting the business relationship between Dryden and its clients, but in any event, it was entitled to exercise that right at any time under the terms of the Amended Factoring Agreement.”

    Here too, I regretfully submit, the Judge over-emphasizes this provision.  The power to take over collection is not unique to factoring:  every “plain vanilla” security agreement made by a borrower in favor of a lender concerning accounts receivable contains language to this effect.  It should therefore have been given no weight here.

    The Judge also considers arguments that the pricing formula and the fact that the Debtor was responsible to “service” collection of the factored accounts support characterization of the arrangement as a financing and not a sale. Correctly, I think, the Judge rejects those arguments as well.  Servicing by the account seller is a garden-variety feature of all securitization and, absent some abnormal or especially pertinent evidence it affected the main issue of recourse, it should be given no weight, as the Judge concluded; else there would never be a successful securitization.  The provision for additional time-based charges, which definitely smack of a financing, concern me more, but, in and of themselves, they don’t tip the balance.  They could be rationalized as just a greedy buyer looking for arbitrary excuses to ratchet up the income it’s going to earn; but, more importantly, it wouldn’t take a lot to rewrite the fees so that all 90 days’ worth were charged upfront, but the Factor established incentive compensation for the debtor as servicer that just happened to mirror the timing and amount of the second-stage fees, so I think here, too, the Judge reached the right result. Those fees don’t affect the issue of recourse enough to drive a different result.

    So, turning to that, here is what the Judge has to say about the extent of recourse:

    “Courts have held that the most important single factor when determining whether a transaction is a true sale is the buyer’s right to recourse against the seller. One of the core attributes of owning a receivable is the risk that it will not be paid. If the buyer “sells” the receivable, but retains the risk of non-payment, it is more likely that the transaction will be recharacterized as a loan. An agreement “without recourse” means that the purchaser/factor agreed to assume the full risk of collecting the money owed to the seller, whereas an agreement “with recourse” means that the seller retains the risk of collection.” Filler v. Hanvit Bank, 339 F. Supp. 2d 553, 556 (S.D.N.Y. 2004), aff’d, 156 F. App’x 413 (2d Cir. 2005).  Generally, if there is a full right of recourse against the seller, this weighs in favor of the existence of a loan because there is no transfer of risk. Recourse can take many forms including an obligation to repurchase accounts, a guaranty of the collectibility of accounts, or a reserve which is released when the receivables are paid. See Aicher & Fellerhoff, supra at 186.


    “The Amended Factoring Agreement provided that Durham accepted the risk of “non-payment on Purchased Accounts, so long as the cause of non-payment is solely due to the occurrence of an account debtor’s financial inability to pay, an “Insolvency Event.” Durham Ex. 3 §4.10. As to this discrete event, Durham had no recourse against Dryden. The agreement does, however, specify some events which would afford Durham recourse for non-payment. For example, Dryden agreed to “accept back (repurchase) from Durham any Purchased Account subject to a dispute between Customer and Client of any kind whatsoever.” Id. at § 4.11. This included Durham’s right to require Dryden to repurchase disputed accounts, all Purchased Accounts if there was an event of default, and accounts unpaid after ninety days if an insolvency event had not previously occurred. Id. at §6.4.1. While the foregoing provisions limit Durham’s risk and provide some forms of recourse, they are insufficient to support recharacterization of the transaction as a loan.


    “Even the existence of a right of full recourse is not dispositive. Thus, for example, “the presence of recourse in a sale agreement without more will not automatically convert a sale into a security interest.” Major’s Furniture Mart, Inc., 602 F.2d at 544.  “The question for the court then is whether the nature of the recourse, and the true nature of the transaction, are such that the legal rights and economic consequences of the agreement bear a greater similarity to a financing transaction or to a sale.” Id. Put somewhat differently, if a seller conveys its entire interest in a receivable, the transfer is a true sale, even if the seller has a recourse obligation. See generally Harris & Mooney, supra (proposing that the more critical factor is whether the seller retains a significant interest in the property, not whether the seller has a recourse obligation). Here, Dryden transferred the full economic interest in the Purchased Accounts to Durham. Further, Dryden did not have a full recourse obligation, although it is misleading to characterize the transaction as “nonrecourse” when the agreement included a hold back provision (the “Reserve” in ¶ 4.9) and Durham could require Dryden to repurchase accounts “on demand” as set forth in ¶ 6.4.”


    This is the correct framework for analysis and the only issue for debate is the weight to attach to the recourse provisions.  I find this much closer call than the Judge.  I do agree with her conclusion regarding the insignificance of the chargebacks for disputes.  That is a standard provision and has little to do with the issue of who bears the credit risk of the account debtor, which doesn’t arise unless the account debtor is legally obligated in the first place.  But, the other provisions she cites are much harder calls.  The ability to put back an account merely for being 90 days outstanding is anomalous and in the absence of a legal dispute over the obligation, difficult to square with the proposition that the factor has taken on the account debtor’s credit risk. 


    Additionally, 25% recourse is at least double, and in some cases triple, anything I ever saw in a securitization.  Now, granted, the companies I was working with were ones for whom securitization was an option, a way to shave some basis points off the cost of financing their working capital, not, as was the case here, a last resort for the Debtor to stay afloat. But, that said, isn’t that evidence of a financing, that the amount of recourse demanded reflected the seller’s creditworthiness, not the account debtors’ creditworthiness?  In our practice, whether we were giving an opinion or advising on the strength of a bankruptcy-remote structure, it was a cardinal point that the amount of recourse either had to be explicitly tied to the creditworthiness of the account debtor(s), or, more commonly, where the deal was a securitization program that would operate for several years, had to reasonably resemble the historical loss experience of the debtor on similar accounts.  And, as a lesser-included point, the Factor's ability in Dryden to apply a rebate owed the Debtor on one account to a default under another is certainly not helpful to the proposition that the factor had acquired the credit risk of the account debtors, although not in and of itself fatal.


    In expressing these doubts, I do not go so far as to say the decision is wrong, for a couple of reasons. 

    First, in the background here, I note, although I left it out of my summary of the facts, the opinion mentions that the Factor was recommended to the Debtor by the Small Business Administration and that could have had at least an unconscious effect on the Judge’s approach; she may not have wanted to resolve a close issue in a manner that might disrupt small-business financing in general or any SBA practices in workout situations.  While not analytically satisfying, the impact on real-world financing practices is and should be a concern for judges at all levels in the judiciary, because bankruptcy is just a small part of a larger body of public policies. 


    Second, as I have suggested in passing a couple of times, in contrast with opinion-giving, where one can only opine on the terms of agreements as supplemented by assumptions about compliance therewith, the resolution of a litigation over “true sale” should be based on actual facts and conduct at least as much as the bare bones of the agreement.  Here, while there was some evidence of deviation from a perfectly pristine transfer of the accounts to the Factor, it wasn’t particularly material; the Factor jumped on top of the issue right away and implemented strict compliance with the procedures designed to conform to a purchase relationship.  It is hard on the record recited in the opinion to find conduct consistent with a lender-borrower relationship.  Certain provisions of the agreement, such as the size of the holdback and the right to put back accounts more than 90 days old deviate materially from what I consider to be safe "true sale" practice.  But, did they ever come into play as an economic matter?  To me, that is the critical question for adjudication, not the words on a page.  Did any invoice go past 90 days and, if so, did the Factor put that receivable back, or did it continue to hold the credit risk, consistent with a "true sale"?  Did the Factor ever dip into recourse to cover a payment default, or just for fees?  If the Debtor couldn't show an actual event in which the Factor shifted the loss upon default to the Debtor, it is hard for me to say this wasn't a "true sale" in fact.


    Finally, and most importantly, I wasn’t there at the hearing and didn’t see the testimony or hear the arguments of counsel. The Judge’s opinion reduces her analysis to writing but doesn’t capture the full record of the litigation before her.  It may well have been that the Debtor just didn’t make the case well enough to win.  I believe, by the way, that the Debtor had the ultimate burden of persuasion under 363(p) as it was the one asserting the interest in the factored receivables, for purposes of using the proceeds thereof as cash collateral.  Ultimately, from what I see in the opinion, I would have been pretty undecided about whom to rule in favor of here, and the burden of proof allocation might well have been the dispositive factor on this record, had I been the judge.


    Overall, I think the Judge did a very commendable job on a highly sophisticated issue, constructing the right framework for analysis weighing of the factors, perhaps a little glibly but certainly defensibly, and arriving at an outcome that, considering the burden of persuasion, is probably the right bottom-line result.