Google+ Followers

Saturday, October 21, 2017

Second Circuit Decision in Momentive: Half a Loaf is Better Than None, But Even the American HomePatient Approach Does Not Conform to the Fair and Equitable Standard

On Friday, the Second Circuit panel that heard the senior secured lenders’ appeal in MPM Silicones issued its opinion affirming the lower courts’ holdings in all but one respect, that being the interest rate applicable to a cramdown / cram-up of the senior secured claims under 11 U.S.C. § 1129(b)(2)(A)(I).  The court held that the lower courts’ application of the Till formula had been incorrect as a matter of law.  Unfortunately, the error was limited, in the court’s analysis, to a conclusion that market evidence was irrelevant to an evaluation of a proposed cramdown interest rate, given that capital providers in the market would be seeking to make a profit, which, the lower courts believed, was not permissible under Till and the 2d Circuit’s predecessor, Valenti.  “We therefore conclude that the lower courts erred in categorically dismissing the probative value of market rates of interest.”  Opinion at 22.  Rather, the panel reiterated (per the majority opinion in 203 N. LaSalle, (which logically supersedes the plurality in Till), that “the best way to determine value is exposure to a market.”    

However, the court unfortunately did not evict the Till formula from chapter 11 altogether, nor did it resolve the contradiction between the sub-par recoveries Till tends to generate and the century of case law interpreting the “fair and equitable” standard to require 100% recovery for secured claims protected thereby.  Instead, in cursory terms, the panel announced that the Sixth Circuit’s two-step approach set forth in American Homepatient, just months after Till itself was handed down, constituted the best approach to evaluating a proposed interest rate under § 1129(b)(2)(A)(I).  Thus, they remanded to the bankruptcy court “so that the bankruptcy court can ascertain if an efficient market rate exists and, if so, apply that rate, instead of the formula rate.”  This indicates a superficial grasp of the precedents, given that 203 N. LaSalle (in a similar sticking-it-to-a-secured-creditor scenario) did not say “the best way to determine value is exposure to an efficient market” it just said "a market."  

Half a Loaf Is Better Than None

We should be grateful, I guess, that the Circuit at least modestly diminished Till in the chapter 11 context.  It could have been worse; the court could have perpetuated the mistakes so many lower courts made, namely reaching the conclusions that (1) without briefing, argument or explanation, and  while interpreting a section of the code where the “fair and equitable” standard does not appear, a plurality of the Supreme Court meant to overrule more than 100 years of its own decisions interpreting that standard to require 100% recovery on claims protected thereby before anyone junior can receive any distribution from the estate, and (2) creditors are not permitted to recover any amount that might constitute a profit or even a contribution margin, compared to some formula developed on a “seat of the pants” basis in random consumer bankruptcy cases in complete disregard of actual arms’-length transactions by willing lenders and borrowers.

Further, although the court should have developed the following point to a fuller extent, it is heartening to see that the court implicitly treated a 100% valuation as at least a parallel focus for the lower court: citing its own Valenti opinion, they wrote: “the goal of the cramdown rate is to put the creditor in the same economic position that it would have been in had it received the value of its allowed claim immediately.”  So, it is conceivable that the court on remand and its brethren in the future will have to look not only at the first step in the American Homepatient approach, i.e., are the credit markets efficient, but, even if they conclude “no”, and turn to the Till formula, they may have to add a sufficiently high risk premium to produce a 100% valuation “immediately” in the words of the Valenti opinion. In which case, economically, if not conceptually, the “Till in chapter 11” case law will die a deserved if unofficial death.

The American Homepatient Approach is Impractical

It would be truly amazing if the very first appellate panel to consider the question whether Till should apply to chapter 11, without the benefit of any development of the issue by lower courts, professionals in the field, or academic analysis (and frankly without having had a steady stream of large chapter 11 cases flowing through its docket), managed to hit the nail on the head with its proposed solution.  But I guess the American Homepatient judges were just idiots savants in the field of business reorganization. That they failed to recognize that chapter 11 has this magic phrase “fair and equitable” that was not at issue in Till is something only pedants might notice.

I think the Second Circuit selected American Homepatient as the governing framework for no reason other than it was the only alternative to a full adoption of Till that was readily available, and it enabled them to get the opinion out the door, nearly one year after oral argument and two years since the case landed on their docket.

But however practical it may have been for the panel to paste American Homepatient into the opinion and hit “upload”, it is not a practical solution for chapter 11 cases generally.  First, the term “efficient market” is not a practical concept, nor is it something bankruptcy judges understand or are equipped to investigate.  It is an academic construction, and it literally means “perfect efficiency” --  perfect information, perfect rationality of participants, no limitations of any kind (including cash constraints or regulation), no barriers to entry, no economies of scale, no profits above marginal cost, frictionless transacting, and no arbitrage of any kind.  That is why it is an academic concept. In the real world, none of those conditions, let alone all of them, occur consistently.  And there does not seem to be any point in establishing a factual inquiry that can only come out one way.  That would be a rule of law. 

As I’ve written before, I believe the source of the reference to “efficient market” in Till was a colloquy between Justice Breyer and counsel for SCS Credit in which Justice Breyer inquired why the contract rate on the Tills’ debt did not change as the overall interest rate environment changed, and SCS Credit’s counsel said the rate had been fixed at the usury rate threshold, not floating.  As Breyer wound up in the plurality, it is likely this realization influenced his rejection of the “contract rate” theory proffered by SCS, but the footnote represents an effort to leave the door open to a third solution, the “efficient market” one.  But as the word “efficient” is not a realistic description of any relevant market, the footnote should have used “competitive” or “robust” or “normally functioning” or some other commercially attainable adjective, not one of the ultimate “ivory tower” constructions of the 20th century.

In addition, a conceptual problem not noticed by these appellate courts is that in the context of financial markets, the term “efficient market” relates to secondary trading, not primary issuance. It arose initially out of Eugene Fama’s summer job, when he was asked to use his bright mind to find a pattern in stock movements that would help brokers make money.  He couldn’t. Instead he inferred that, having found empirical evidence that there were no systematic arbitrage opportunities in the stock market, given that that is one characteristic of an efficient market, then therefore the stock market must be efficient. That in turn led to the creation of index funds and him getting the Nobel Prize for Economics, among other things. Of course, over time subsequent researchers have found persistent strategies for outperformace, among which are small-cap stocks outperforming large-caps and momentum strategies beating pure fundamentals, whereupon some really clever soul pointed out that capitalization-weighted index funds are the ultimate momentum strategy, but I digress.

Second, bankruptcy judges have demonstrated that they do not understand what an efficient market is or how to think about that question.  (Indeed, this is a problem shared by their Article III colleagues. Per Justice White: "The legal culture's remarkably rapid and broad acceptance of the ECMH [efficient capital markets hypothesis] has not been matched by an equally broad and deep understanding." and "Confusion and contradiction are inevitable when traditional legal analysis is replaced with economic theorization [sic] by the federal courts.").  See generally Geoffrey Christopher Rapp, Proving Markets Inefficient: The Variability of Federal Court Decisions on Market Efficiency in Cammer v.Bloom and Its Progeny, 10 U. Miami Bus. L. Rev. 303 (2014)
Available at:

Too many bankruptcy judges doing "Till in chapter 11 'analysis'"adopt what I have called elsewhere the “loan market as Santa Claus” paradigm.  The borrower comes in with a wish list in its chapter 11 plan.   It wants to stay highly leveraged while paying debt service in crumb-sized increments for a really long time.  Heads equity wins, tails lenders lose.   Every expert agrees: “there ain’t nobody in their right mind who would make that loan on a par basis.”  So, the bankruptcy judge sagely frowns and says, “well, that must mean the loan market is not efficient!  Borrower, there are no dissatisfied customers in my court!  Go ahead and give that lender prime plus 3 on your wildly overleveraged cash flow! That’s fair and equitable!”)

In my article, I analogized this to a person who says, “you know, I could really build up my nest egg if I could pick up some Facebook shares at half price. I’ll put in an order right now for 5,000 shares at that price."  Pause.  "Why, it didn’t clear!  There must be something wrong with this market!”

Less sarcastically, the point is, very simply, you cannot tell anything about “the market” by looking at one participant, one transaction or one set of terms.  Rather, you would look at the market-wide volume of transactions, the number of firms competing to offer capital, the cost of finding them, the bid-ask spreads and so forth.  But on as broad and deep a scale as one can reasonably encompass.  Then, if you concluded, “yeah, we have some well-functioning capital markets in this country,” you would go on to say, “OK, if someone wanted to raise money on the value of this collateral, given this cash flow, what are the best terms they could get from these well-functioning capital markets?” Which is what CFOs are paid to find out.  But I have yet to see a bankruptcy court do anything like that. The vast majority seem to fall for the “I’m not getting what I need, it must be the market’s fault” spiel, and wind up saying silly things like “I find as a fact that the credit market in the U.S. is not efficient”, when they have not the slightest clue what that means.  And systematically their decisions only serve to encourage debtors to propose deliberately off-market repayment terms, to elicit such a finding from an unsophisticated decisionmaker.

Third, it is indeed ironic (and the irony reinforces my belief that the Second Circuit just grabbed at American Homepatient because it was handy, not because it had any compelling analytic foundation) that we now have two circuits telling bankruptcy judges to figure out “market efficiency” as if they were the FTC or something, in order to accommodate a plurality opinion that elsewhere calls market analysis a task “far removed from the usual tasks of bankruptcy judges.”  Bankruptcy judges, even the ones who may be able to comprehend some of the thousands of research papers on market efficiency, don’t have the professional education and training or the staff to assess whether the United States credit markets are efficient.  It is unfortunate for judges in these circuits that such an impossible inquiry is left in their inboxes.  “Please handle. Thx.  2d Cir.  P.S. Let’s touch base at the retreat!”

In some cases, it may be moot, because the forces driving the reorganization may not want to hang around and wait for ivory tower concepts to be debated by economics Ph.D’s (note to self: get one!) while dozens of meters tick at $1000/hour. They may often just opt for the commercially reasonable solution of raising the money.  But the risk is that too many judges issue silly opinions saying “The U.S. capital markets are not efficient” and then it will be the lenders who wind up throwing in the towel until some appellate court realizes that …

Neither American Homepatient nor Till Conforms to the Fair and Equitable Standard.

As I’ve written before, and as any reader can verify, chapter 11 contains the “fair and equitable” standard and chapter 13 does not.  That standard has been black letter law for over 100 years. It means that a plan has to provide 100% recovery to anyone protected by it before anyone junior can receive or retain anything.  Whether it produces 100% or not is a question of fact, not of rule or formula.  Changing that standard is for Congress, not courts.  The Till court was free to adopt a formula for payouts because the fair and equitable standard did not appear in the statute there at issue.  When the standard appears, as it does in all chapter 11 cramdowns, courts must ignore Till completely, not just as the rule of decision, but also as the fallback.  All they should ask is whether the plan payout is worth 100 cents on the dollar.  It does not matter whether the capital markets are efficient.  That entire field of study was barely in existence when Congress enacted the Bankruptcy Code in 1978.  No reference to it appears in the cramdown sections of the Code or their legislative history. As the majority in 203 N. LaSalle interpreted the relevant statute , they did not say “the best way to determine value is exposure to an market” they did not say "an efficient market."

Whether a particular capital market is efficient or not is analytically irrelevant to the application of section 1129(b)(2) and courts should kick its ivory tower butt out of Code jurisprudence altogether, because such academic, costly and overwrought inquiries are inconsistent with the goal of efficiently administering bankruptcy cases themselves. A further irony: making bankruptcy judges investigate "credit market efficiency' makes them less efficient.

Monday, August 14, 2017

Academic Attempts to Revive the Corpse of Relative Priority

It being a rainy day and wishing to procrastinate some unappealing chores, I spent some time this afternoon looking to see whether the article I had published two years ago concerning the lack of statutory foundation for application of Till v SCS Credit Corp to chapter 11 reorganizations had been cited in the meantime. I know it was cited in the MPM Silicones  briefing to the Second Circuit (thank you counsel) but otherwise  I found four citations.  One, in a brief in the litigation at the Second Circuit between the Elliott hedge funds and Argentina puzzled me and doesn't really have much to do with the main thrust of the article so I won't mention it here.

Two of the rest are by students so I'll take first the article by Bruce Markell entitled, "Fair Equivalents and Market Prices: Bankruptcy Cramdown Interest Rates" published last year in the Emory Bankruptcy Developments Journal. To its credit, the article is the first piece I have seen, other than my own analysis, that explicitly recognizes that the payout to a dissenting class of creditors under a chapter 11 plan must be judged by the "fair and equitable" standard.  But, and this is a theme that runs throughout my criticism of his work, he fails to take on the full argument, namely that the term of art "fair and equitable" is missing from the plan confirmation standard of chapter 13 (unless some acknowledgment of this point is buried in one of the 240 footnotes).  Which I have always contended is the critical reason why Till does not translate to chapter 11. It wasn't analyzing the words found in chapter 11.

Second, and more disingenuously, Markell does not provide a full discussion of the cases and authorities relevant to assessing the significance of market comps to the valuation called for by the "fair and equitable " Rule, and omits other unfavorable sources.   For example, there is no mention of  RFC v. Denver & Rio Grande Western Railroad Co., 328 U.S. 495 (1946) and its companion case Insurance Group Committee v. Denver &Rio Grande Western Railroad Co., 329 U.S. 607 (1947) which explicitly held that a creditors was entitled to receive "full compensation" on its prepetition claim and if that meant large profits, so be it.   And consulted market prices while so holding. 

So when Markell sits there and claims it's a "fact" that  "rates for new loans have components not appropriate for a cramdown, such as initiation costs and profit components."  That's just nonsense based on the Supreme Court's precedents.  And his only citation is to Valenti, the Second Circuit case on chapter 13s which of course are not governed by the "fair and equitable" standard he purports to be interpreting.  Ignores the Supreme Court case on the relevant statutory term, cites a lower court on a different section of the Code. Nice.

Nor, is there any mention of the Supreme Court's holding in 203 N. LaSalle, that the fair and equitable rule required a market check before a debtor could cramdown a new equity capital plan on the secured creditor. Why should the rule be any different for debt?  Markell does not address these inconvenient challenges.  

Even his presentation of the precedent he does acknowledge is disingenuous.  He lays out a homey matrix.  The case law, he says, teaches three "apothegms":  don't pay too little; don't pay too much and don't expect precision.  Of course, these homey admonitions don't appear in the text of the Supreme Court's opinions.  You know what does? "Full compensation".  Which is a little more precise than "don't pay too much and don't pay too little".  Those seem like disingenuous borrowings from the old "relative priority" doctrine that  Case v Los Angeles Lumber, killed off in 1940..  That was the whole point of the Supreme Court forcefully re-stating the absolute priority rule back then, to create a rule of 100% payout to senior creditors before juniors got anything.  . There had been widespread complaints that reorganization cases in the wake of the 1929 crash had been slow and inefficient and favored insiders, because the courts and the main players had all been operating on the notion of "relative priority" in which payouts were negotiated based on norms that everybody gave up a little, everybody kept a little and the relative priorities of senior to junior are mostly maintained.  In Case, in his first opinion since joining the bench, and prompted by future Justice Robert Jackson, then acting as SG, Justice Douglas, threw fire and brimstone at the old norms and said in essence, absolute priority means absolute.  And that was carried forth into the current Code, quite explicitly in the legislative history as the Supreme Court has recognized on multiple occasions. Markell seems to be aiming to get courts to think, hey, less than full value is OK, and it helps even out the recovery disparity. Spread the wealth, you know.. It's not OK. The court must aim for 100 cents and, of course, there are no guarantees, but a court can't intentionally aim lower. 

Markell's article also propagates the fallacious argument that (my paraphrase) "there is no market for cramdown loans because they're, you know, nonconsensual." This is surpassingly superficial and sophomoric. You know what?  There is no market for inheritances, or gifts, or divorce settlements, but tax courts and family courts use market transactions and comparable companies to value illiquid interests in businesses transferred via bequest, gift or divorce.  There's no bargaining or consent in any of those contexts either.  There's no market in tax certiorari proceedings, which are pretty nonconsensual too, but the courts look at recent market transactions in comparable properties in figuring out the value of your property; they don't just go "well, it's $X per bedroom in this town." This is basic human reasoning: research; compare and contrast, reason by analogy.  It's not so hard that it needs to be replaced with a formula.

A loan has certain key terms.  And there are on any given day, numerous loans that have some or all of those key terms:  for some the rate, but also one needs to know  the maturity, the covenants, the collateral, the prepayment right, etc.  But the variations on each variable are small.  There are thousands of people in the financial markets with expert knowledge of thees matrices of these variables on outstanding loans.  The LSTA and market participants have worked to standardize heavily the forms of the credit documentation and have largely succeeded, except in certain financial definitions.  Rating agencies routinely rate loans routinely, and the thousands of variations wind up being subsumed into a handful of ratings:  BBB,  BB-,  B-, CCC+ etc.  Prices and yields can be mapped against those ratings.  In fact, outstanding loans are marked to market pretty much every day, with the exception of certain loans (typically revolvers and Term Loan As with low leverage that are not particularly relevant to this question) held by Federally regulated institutions. But Term Loan Bs, 1.5 lien loans, 2d lien loans, where the rubber meets the road for cramdown purpose are held by funds that per regulation or agreement with their investors and lenders, mark to market every day, typically relying on a service that disseminates the same valuation to all holders of a given loan.  And then one can deduce that, to the extent the proposed exit loan shares characteristics of a given class of outstanding loans, it will likely be priced similarly by the market.  Further, there are thousands of loans brought to the loan market as new issues every year and they are priced, quite simply, by reference to similar loans that have recently been issued.  An exit financing is just one more of those and the market has easily absorbed them over the past decades.  The fact that it's a "cramdown loan" is not relevant to its valuation by anybody at any time.  To argue to the contrary is a  naive and completely false argument.

So when Markell, out of thin air and, as far as I know, zero experience in the real world of holding and trading debt, says (without citation)  "the market for bonds or loans generally is not the same market as reorganization debt, given that reorganization debt has at least an implicit assumption that the debt will be held to term and not traded"  he is just blowing smoke, It's utter nonsense.

A reader might be interested in a roundtable discussion of Markell's article which can be found here, but I warn you, it's three academics, none of whom has a clue about the real world of arranging loans to companies emerging from chapter 11.  

The second article is by a student at Cardozo Law Schol, Emma Guido, entitled "Till v SCS Credit Corporation: A "Prime-Plus-Plus" Method  Tilling [sic] Courts to Consider Efficient Market Evidence."  Ms Guido essentially advocates a compromise which is use Till and also look at the market when there is an efficient market;  sensibly, she does not go all academic on what "efficiency" is. Rightly, she acknowledges that loans have risks and the Till formula does not adequately capture them.  The article has all the benefits and limitations of a compromise approach.   It does not display the striking errors and ball-hiding of Markell's piece. Of the three articles, I think this is the best. I think it still falls short of the simple approach. Ignore Till, get rid of the confusing word "efficient" and stick with tried and true chapter 11 practices that just say, courts should hear evidence from people who know what they 're doing in raising debt capital at the time of the confirmation hearing about how the loan will be valued, and why, and make the best estimate possible. As they do in every other litigated valuation they adjudicate. .

Another substantive discussion occurs in an article published by a then-student at Seton Hall Law School, Thomas Green, in an article entitled "An Analysis of the Advantages of Non-Market-Based Approaches for Determining Cramdown Rates: A Legal and Financial Perspective."    Perhaps this is because my co-author was a Seton Hall Law School alumna and both had studied with Professor Stephen Lubben there.  And this article quotes Lubben's textbooks often so presumably reflects some input from him.

The article is a fine product for a student note, albeit somewhat lengthy and fairly high-level. It is a lot like the article I thought I was going to write on Till, until I read the briefs and oral argument at the Supreme Court and realized that everyone who thought Till was meant to change chapter 11 practice was completely wrong. The article contains, for instance, a 16 page discussion of the Efficient Capital Markets Hypothesis, which links to the two words "efficient market" in the dicta in footnote 14 in the plurality opinion in Till.  The thrust is, federal courts have routinely used the "ECMH" in securities cases adjudicating "fraud on the market" claims (glib again:  this overlooks the enormous and costly disputes in those cases over every aspect of the evidence and the analysis), so let's compare the ECMH to "cramdown loans".  Oops, Doesn't work well.  Why not? Well, there's not as much liquidity and then is that whole "taint of bankruptcy" thing. and then also "fraud on the market" cases involve secondary market trading whereas.the debt being issued when a company comes out of a bankruptcy is more of a "primary" issuance.  So, the author concludes, a judicial formula is indeed the best way to go.

But as I've written before, and as Markell also forthrightly points out, there is a huge gap between what lay people mean by "efficient" and what Economics textbooks mean by "efficient".  This makes the use of the term "efficient markets" a potential source of confusion in courts. As the author writes, quoting Justice White, "The legal culture's remarkably rapid and broad acceptance of the ECMH is not matched by an equivalent degree of understanding." In economics, efficiency, is a state of perfection rarely encountered in transactions between humans and probably not very stable. It means no or imperceptible transaction costs,essentially liquidity, enormous transparency.  Even so, economists have had to admit that there is no real-world example of a capital market that is perfectly efficient. At most as the author notes, they have concluded that movements in large cap equities in the U.S are consistent with the "semi-strong" expression of the ECMH.

Furthermore, as the author observes on a couple of occasions, the ECMH is something that aspires only to characterize secondary market trading, not primary security issuance.  It's apples and oranges, or, more aptly, analyzing the trading of orange juice in the commodity markets vs buying an orange tree. Unfortunately, he does not make the leap  (which, I understand, would have ruined the article) to say "the ECMH has nothing to tell us about market efficiency in the context of exit financing, so let's look elsewhere."  Instead, he claims, it is the cornerstone of "footnote 14" and thus a court-imposed formula should set the price of "cramdown loans".

Personally, I think it's a obvious non sequitur to go from "Efficient Capital Markets Hypothesis" to "Judge sets the rate".  I think the entire approach to the ECMH confuses the question.  To me, the approach is simply what judges have been doing for decades: value the paper like any other economic asset -- a building, a patent, a business -- using the best evidence available. Often, that will be the market. Sometimes not.    

The author completely fails to discuss what I have pointed out are the two biggest errors that the courts applying Till in chapter 11 have committed.  First, the opportunity for gamesmanship, exacerbated by the fact that judges do not grasp the meaning of the word efficiency. I called this in the article "the loan market as Santa Claus" fallacy  It plays out in all of these cases and the author even holds one up as a shining example of "how an efficient market analysis should work".
I understand he is a student, so I fault his faculty advisor for not having the common sense to see the absurdity of the reasoning.

In 20 Bayard Views LLC, he writes, the judge deemed the criterion of efficiency to be whether "other creditors are willing to lend on terms similar to those of the replacement notes under the plan.".NO! That bears no relation to anything in the ECMH or common sense.  It's just backward reasoning,  The ECMH would say, the prices that clear the market are the ones that are efficiently determined.  Not one single individual's bid.  I analogized this in my article to someone saying "I want to buy Facebook stock for $35 / share" when it was trading at $50. The investor's personal bid tells you nothing about efficiency of the $50.   Also it leaves the debtor a loophole big enough to drive its whole business through. Obviously, if a debtor knows that is the standard, the first thing they do is propose off-market terms.  Then those terms are "not available" in the market.  As the judge here noted: relying on testimony from the creditors that no one in the market would make a 100% LTV loan, he intoned,. "the market is inefficient" NO! The market was efficient --  that's the sane result. Those loans lose money  --  that's inefficient.  It's insane to hold that case up as an example to be followed.

In contrast, the creditor gave the sensible explanation:  "Look, if you want to pay us off, you can raise some senior debt, some mezzanine and some equity, and your all-in cost is somewhere around 11.68%.  It's expensive but you can do it. The market will fill that order for an arms-length price."  This reality-based explanation was lost on deaf ears unfortunately.

The second giant error the article shares with many courts is that  there is no discussion of any of the century of Supreme Court cases interpreting the "fair and equitable" rule (none of which mentions the "Efficient Capital Markets Hypothesis" by the way).  That means no discussion of what those cases have consistently held, which is that senior secured creditors get paid in full up to the value of their collateral, period, and that one should look at the market to determine whether a proposed plan is "fair and equitable".  Which only makes sense. Think about it: if a debtor can not raise new equity capital for its reorganization without a market check, why is the market somehow forbidden territory for the debt it wants to issue coming out of bankruptcy?  It's absurd to have opposite rules for the two types of capital

The article also offers a "policy argument" for the formula rate that consists of three points:  (1) saves money on professionals; (2) it's predictable; (3) "hey, creditors knew they could get screwed in bankruptcy when they made the loan, so it's fair to screw them."  To be fair, his more scholarly language is: "In sum, a bankruptcy petition inherently triggers numerous uncertainties, and the Code expressly contemplates multiple scenarios where a creditor’s expectations may be undermined."

This is glib and mistaken. The Code contains provisions that undermine a creditor's state-law contractual expectations.  The Code does not contain any provisions that undermine the Constitutional protection of the value of a secured claim as of the petition date, or else those provisions would be un-Constitutional.  

As for "Saves money on professionals", true, but so does a lottery, a coin flip, etc.   Any and every rule that eliminates a trial will save money on professionals.  But then there is that pesky Fifth Amendment thing about due process and takings of property.

"Predictable"?  In my 30 years of practice, I had not noticed that the rule "you get paid in full if you're oversecured" was confusing anyone.. See Case v Los Angeles Lumber.

Anyway, regardless of the disagreement over the analyses, it was a privilege to be cited in the several articles.


Friday, July 28, 2017

Default interest is at least 4000 Years Old

From my favorite blog, Marginal Revolution, the terms of a debt instrument 4,000 years ago in Anatolia (Turkey):

Monday, June 19, 2017

Unanimous Supreme Court Delivers Direct Blow to "No Platform" Extremists on College Campuses

In today's opinion in Matal v Tam, the Supreme Court unanimously (with only Justice Gorsuch abstaining, as the case was briefed and argued during the Obama administration), invalidates the "anti-disparagement" clause of the Lanham Act on First Amendment grounds. Although the 8 justices split, 4-4, on one aspect of the reasoning, all 8 of them agree that the First amendment bars the federal government from conditioning registration of a trademark on a criterion that the mark not be offensive to a person or a group.  Given the current environment on college campuses and in similar once-lively fora for debate, this opinion is a welcome re-affirmation of the fundamental civil liberty of free speech in the face of so-called "political correctness" which has given primacy in debate to the offense-taking of countless self-proclaimed marginalized groups.  No longer can extremists stifle ideological opposition or scientific inquiry at a government-run educational institution by claiming it is hurtful or bully the institution into withholding a "platform" from a speaker they consider offensive, the so called "no platform" demand (you can read here an absurdly pro-extremist explanation of what "no-platforming" means:

The Lanham Act has, since its inception,, prohibited registration of trademarks that "may disparage persons, living or dead, institutions, beliefs or national symbols, or bring them into contempt or disrepute"  The language obviously begs for a "facial" First Amendment challenge, at least since the flag-burning cases.

A rock band named The Slants applied to register their band's name as a trademark, Consistent with the Act (the Court so finds, or holds), the examiner at the Patent and Trademark Office, having received various complaints, found that "there is ... a substantial composite of persons who find the term in the application for mark offensive" (emphasis added).  Justice Alito's opinion excerpts several further uses of the word "offensive" in the rejection of the application.

The government -- recall again that this was briefed and argued under the we're-so-woke-and-sensitive Obama administration --  advanced three arguments to defend the clause: that issuance of a trademark amounts to "government speech";  that  trademarks are a form of "government subsidy" and last that a "government program" should be judged by different standards than other infringements on civil liberties.

All Justices agree that the registration of a trademark is not "government speech".  Humorously, Justice Alito quotes numerous trademarks and asks rhetorically if each one of them is the government speaking, and then, if tartly observes, if they really are the government speaking, it is just babbling. He further notes, if registration of a mark is government speech, then is registration of a copyright government speech?  Given the universe of things that are said in books and plays and songs, the absurdity of the government's position becomes evident.

The Court next considers whether registration of a trademark is a government subsidy.  Previously, the Court had allowed the government to withhold funds from activities it does not want to promote, even where the Court had acknowledged the applicant for the funds had a constitutional right to conduct the activity -- for example, abortion funding.  The government's argument was overly broad, defining any economic benefit from the registration as a "subsidy".

Here, the justices split on their reasoning  -- and in curious ways.  Justice Kennedy, writing for himself and the three female (and most progressive Justices) disposes of all the government's remaining argument with a strongly worded opinion that the disparagement clause is a form of "viewpoint discrimination" that requires heightened scrutiny and fails plainly that test.  He closes with a heartening paragraph:  "A law that can be directed against speech found offensive to some portion of the public can be turned against minority and dissenting views to the detriment of all.  The First Amendment does not entrust that power to the government's benevolence.  Instead our reliance must be on the substantial safeguards of free and open discussion in a democratic society."

Frame that, college presidents! (Seriously-- it helpfully appears on its own page)

Justices Alito, Breyer, and Thomas and Chief Justice Roberts agree with their colleagues.  "the disparagement clause discriminates on the basis of viewpoint.... Giving offense is a viewpoint."

But, they also opine, that, quite simply, a trademark registration isn't a subsidy.  To the extent money changes hands, it is the applicant paying the government.  An economic benefit from a government registration is not a subsidy - look how many programs there are where governments hand out licenses, which are just a form of registration.  Someone can easily derive a benefit from having a license - for example to operate a business or to drive a commercial vehicle. That would not enable the government to control what that person could say in public.

Then they consider the "this is a special government program" argument and also find it lacking in precedent.  The only precedents mentioned involve the government as employer and the touchy issue of forced collection of union dues among its employees.  The opinion here is a little terse, but the basic message is, that context bears no resemblance to this one and even if it did, this one involves viewpoint discrimination, so, no.

Justice Alito's coalition goes on to consider whether the "disparagement clause" could stand muster as a light regulation of "commercial speech" and conclude it does not. Here, these Justices -- note the inclusion of Justice Breyer -- take on directly the "politically correct" justification for speech restriction:

"no matter how the point is phrased, its unmistakable thrust is this: the government has an interest in preventing speech expressing ideas that offend. And, as we have explained, that idea strikes at the heart of the First Amendment. Speech that demeans on the basis of race ethnicity, gender, religion, age, disability, or any other similar ground is hateful, but the proudest boast of our free speech jurisprudence is that we protect the freedom to express ' the thought that we hate' [quoting Holmes]"

More analytically, these Justices conclude that the "disparagement clause" is not "narrowly tailored" as even restrictions on commercial speech must be, because -- to the extent it is not enforced discriminatorily, -- it bars what I call "anti-bad guy" speech, such as "down with racists" and so forth.  Justice Alito says, so read, the law under examination is not even an anti-disparagement clause but a "happy talk" clause.  In addition, the line between commercial and non-commercial speech is "not always clear" and they are unwilling to risk that free speech be abridged merely by "affixing the commercial label" to "any speech that may lead to political or social 'volatility'."   Stuff that, no-platformers.

A good day for liberal values as the primacy of free and open exchange of ideas over political correctness and the claim of offense is reaffirmed by all 8 Supreme Court justices, and there is no reason to believe Justice Gorsuch would see it any other way.

Tuesday, January 31, 2017

Sally Yates Should be Disbarred

I/m no fan of President Trump or his immigration policy, bit I don't know if there has ever been as massive and blatant a departure from professional responsibility as Sally Yates' instruction to all DOJ lawyers this week not to defend their client in pending lawsuits because, while conceding that the client had taken an action that was "lawful on its face", she did not believe the "policy choice embodied in [the relevant] executive order is wise or just. "

Apparently Sally Yates not only considers herself superior to the duly elected President of the United States in determining what the right policy choice is, like "Super-President Sally Yates," but she also apparently considers herself superior to all of the thousands of attorneys in the DOJ regarding the scope of professional responsibility to their client.  And you thought Donald J Trump was the biggest narcissist in town.

Yates' letter to the attorneys tries to draw an "on its face /  as applied" distinction.  That's ridiculous. The order had been applied for less than 48  hours, and had already been tweaked to clarify its non-applicability to green card holders.  Any lawyer with more than a week of courtroom experience would know how to defend the order in general while indicating the possibility that the policy might wind up being further modified based on observations about what transpired when it was put into effect. Concerns about one day's worth of application does not justify letting a default judgment be entered on the policy in general. She also  claims that attorneys at the DOJ have a collective responsibility to do justice.  That's equally ridiculously overbroad. Such a responsibility to do justice is congruent with the parameters of the lawyer's professional responsibility, it doesn't mean the lawyer can breach his or her professional responsibility to the client. There is a world of difference between electing not to prosecute an individual for a low-level crime, or choosing not to go along with a questionable entrapment, and letting a default judgement be entered that binds the United States of America globally and indefinitely.  The DOJ is not a free-floating fourth branch of government whose policy preferences supersede the elected branches'.

Here we have a lawyer-client relationship; a fast-moving lawsuit against the client; and the legal position of the client is, by her own admission, defensible, and she orders all lawyers under her supervision to intentionally and knowingly default in their representation of the client.  That has to be unprecedented.  Although I can imagine that, in the hundreds of years of lawyer-client relationships in the Anglo-American legal system, on occasion a lawyer has experienced some personal conflict with carrying out his or her representation of a client, the only ethical action in that context would be to seek to resign the representation, which would be conditioned upon someone else being able to take over the representation without harm to the client's interests.  This is hornbook law as instructed in classes of professional responsibility and, even in matters of public policy, there are precedents for it. For example, after President Carter's failed invasion of Iran in 1980.  Cyrus Vance resigned as his Secretary of Sate (after, not before).  He acted on his conscience but only at a time that did not derogate from the interests of the United States of America.

But here, she goes light-years beyond resolving her own conflict with the position of the client and, incredibly, instructs every lawyer working under her supervision to stop representing the client as well.  This is a lawyer's version of a coup d'etat.  I can't even imagine what the lawyers handling those cases must have thought when they received her instructions.

"Hey, boss says stop working on the 7 nation immigration ban litigation."
"What? Has it been withdrawn or was there a settlement of some kind?"
"Has someone found a Supreme Court case that clearly says the order is unConstitutional?"
"Then, what for?"
"Boss says she doesn't feel like it's a good policy."
"And I'm supposed to go in there and tell the judge to just default the United States of America because that's just how my boss feels?"
"I guess."
"'Cause, you know, I've got cases, I've got precedents, I can make an argument here."
"Toss 'em. Boss says we're to stand down, not defend the client in this case."
"And that's not malpractice?"
"Hope not."
"Will I be protected from disbarment because I was following my boss' instructions?"
"Doubt it."

Honestly, I think, were I in such a position, I would have had no choice but to disregard her instruction, figuring she was deranged or something like that. The lawyer's duty is to the client. If your superior is blatantly telling me to commit malpractice, I don't think there is, either in the short-term or long-term, any alternative but to continue to do my job ethically and hope that somehow the deranged superior winds up removed from her position. If she instructed me to withhold material evidence, it wouldn't protect me were I to do so, I don't see how this is any different.

And what about the several judges around the nation who expect to walk into court and receive a robust presentation of the cases and authorities so they can render the best-informed decision? Obviously they would have to appoint someone from the private sector, a la what happened in the DOMA litigation, to represent the position of the United States of America appropriately, and until that appointment occurred and the person selected was able to prepare a case, the judges would have to place the cases on hold, which hardly does the interests of any person affected by them any good at all.

Imagine if you were a criminal defendant and you had a public defender assigned to you.  The weekend before your trial is about to start, your attorney meets you and says, "I just wanted to let you know that I'm not going to make any argument on your behalf next week, not going to put on any witnesses, cross-examine anybody, or offer any other proof."
"I just think you're a bad guy. and you deserve to go to jail."
"Well if that's the way you feel, I want a new lawyer."
"Nope, I 'm going to be your lawyer, I'm just not going to do anything."

I know lately it feels like we've entered a bizarro universe, but I would hope that the professionals among us would not lower standards in response. If she felt as she says she did, she should have resigned in protest.  But, for instructing other attorneys to breach their professional responsibility to the client, she deserves to be disbarred.

Friday, December 30, 2016

New York Times Article on Stanford Sexual Assault Procedures Displays Shocking Ignorance of Relevant Federal Law

Today's New York Times carries a front-page article entitled "A Majority Ruled It Was Rape.  That Isn't Enough at Stanford."  The article, which extends for two full pages inside the (ever-shrinking) front section, faults Stanford University for failing to discipline a student who was accused of sexual assault by another student, after two separate panes concluded, each by a 3-2 vote, that the accused had in fact committed a sexual assault upon the accused.

Stanford's procedures for evaluating charges of sexual assault against a student established, at the time, 5-person panels to examine the "evidence" (which I put in quotes because what they review would not be "admissible evidence"in a properly conducted trial in the United States, which is a matter for another day).  The university required that at least 4 of the 5 panel members find against the accused before discipline could be meted out.   In this case, the first panel found 3-2 against the accused.  The accuser appealed to some other body on campus which agreed in part with her complaints about the first proceeding, and then a second panel was convened, which delivered the same 3-2 result.  So the accused was not disciplined.

According to the article, Stanford currently requires panels of only three persons now but now requires unanimity of the three to find an accused culpable.

The thrust of the article, obviously, is that it is unfair to accusers (predominantly female) that their accusations have to convince more than a simple majority to redress their grievances. The article concludes with a quote from the accuser that sums up the reporters' sentiments: "I am certain that this is not how the Title IX process is meant to work."

The accuser's "certainty" -- which has evidently been adopted by the reporters who turned her grievance into a front-page article -- is completely erroneous.  Put simply, a requirement of a unanimous verdict is exactly how Title IX proceedings do work. Indeed, the title of the article, to have been accurate, ought to have read: "A Majority Ruled It Was Rape.  That Isn't Enough -- Anywhere." (Of course, that would not have made for a good front-page story.)

All Title IX claims are adjudicated as civil cases in federal court. In all such cases, a party can request a jury trial.  Pursuant to Federal Rule of Civil Procedure 48, a jury verdict in a civil case requires the jury -- which may not be less than six people, in contrast with Stanford's three-person panels -- to reach a unanimous result. Thus, the "Title IX process" to which the accuser refers is, in fact, "meant to work" by means of unanimous verdicts. Falling short of unanimous agreement leaves the status quo in place and the accuser's grievances uncompensated.

This, it is worth emphasizing, is not a special rule for Title IX cases reflective of some patriarchal bias to protect male perpetrators.  It is the rule applied to all federal claims of any nature whatsoever. It is utterly non-discriminatory, measured by any non-gendered standard,

Sadly for Times readers, the article shows no awareness of this unanimity requirement in adjudication of Title IX grievances in the courts. As a result, the article likely misleads many readers into believing that Stanford, and other universities alluded to in the article, are acting "wrongly" or being "unfair," toward (predominantly female) accusers when, in fact, their standards are as non-discriminatory as they could be, mirroring as they do, the general standards of federal civil litigation.  (Indeed, those who are accused may have a colorable claim that the use of three-person panels to mete out punishment violates due process or Title IX or both, because the risks of bias and error are believed to increase to impermissible levels when juries are less than six persons, as the comments to FRCP 48 bear out.)

It's grotesquely embarrassing that neither of the reporters, nor any editor who vetted the article before it was published, displays any awareness of the fact that the premise of their story is completely at odds with the way the law that the story is written about actually works in practice.  I have a good deal of sympathy / empathy for journalists in the competitive environment they must operate in, when the pressure to generate stories that hold on to the attention of the declining subscriber base is so overwhelming.  But those feelings are easily overcome when the journalists in question set out on a social justice crusade and cast aspersions at other members of our society who, it turns out, actually know more about what they are doing than the reporters sanctimoniously faulting them.

It's also worth considering, although the authors failed to, that the existence of a 4-vote minimum might influence how panelists decide to vote.  Knowing that a 3-2 vote has no consequences for the accused may cause a voter to vote differently than if that third vote determines the accused's fate. I think it is a faulty premise to think that the third voter was sure the accused had committed a sexual assault.

There are many, many more things one could fault about the way sexual assault allegations are handled on college campuses. I could write hundreds of blog posts about the problems, starting with, why does anyone familiar with the "hostile environment" case law think that one student's allegations against another regarding a brief sexual encounter are a Title IX issue in the first place?  What about that implicates the "interstate commerce" power whereby Title IX was enacted?  Considering how ultra-leftist campuses are, and how feminist voices dominate discourse concerning gender matters on campuses, how can anyone seriously contend that a college campus is a hostile environment for women?  I hope that the incoming administration will make clear early on that such incidents do not implicate Title IX at all, and universities need not do more than refer such matters to the local law enforcement authorities for investigation and prosecution as justified,.  Further, I would hope that the incoming Congress would resolve the issue for the foreseeable future by defining "hostile environment" to make clear that there must be repeated, persistent and substantial acts towards a group of persons before a "hostile environment" is created.

But, regardless of what the future holds, as of now, the notion that Title IX requires a simple majority to believe an accuser is wholly at odds with federal law and in truth amounts to no more than a case of special pleading by persons who are ignorant as to the law.

Saturday, December 17, 2016

Second Circuit Oral Argument in Momentive Performance Solutions - Synopsis and Commentary

I listened to the oral argument before the Second Circuit in Momentive Performance Solutions, the appeal taken by the first lien creditors from Judge Drain’s confirmation decision (1) denying their claim for a make-whole and (2) imposing a Till-justified formula rate of interest that left their claims with a market value of 82 cents on the dollar.  The argument was held the morning after the national election, which must have posed quite a distraction; nonetheless, unlike large numbers of students nationwide who were apparently reduced to sniffling and sobbing incapacity by the outcome, the lawyers showed up well prepared and the argument was brisk.  (Parenthetically, I was surprised that only 30 minutes was allotted to the entire argument, which is half of the lowest amount I ever experienced.  I speculate that this is one of the steps the circuit has had to take to address its ever-growing backlog of cases.)

The argument focused almost entirely on the Till issue.  The parties rested on their briefs regarding the make-whole issue. Tactically that was a wise choice because the Third Circuit came out with its game-changing opinion in EFII, upholding the contractual make-whole in that case and, in its extensive analysis of precedent, giving the back of its hand to Judge Drain’s make-whole reasoning in MPM.   As one of the appellants’ counsel in MPM was also the counsel who argued for the creditors in EFII, probably they had walked away from the argument before the Third Circuit with a sense that they would prevail, and in turn, that likely informed the strategy brought to the oral argument in MPM.  The parties have since submitted letter briefs to the Second Circuit on the relevance of the EFII decision. I would not be surprised to see the Circuit certify the question to the New York Court of Appeals if they have any doubts at all about Judge Ambro’s analysis of New York law.   

As a reminder, the cramdown interest rate holding in MPM was the most extreme statement of the Till-in-chapter-11 to date:  that bankruptcy courts are required in all chapter 11 confirmations to apply a formula rate.

The panel was Judges Barrington Parker, Rosemary Pooler and Jose Cabranes.

What follows is a lightly paraphrased transcription of the key exchanges between the panel and counsel, interspersed with my “color commentary”

At the 2:22 mark, after the usual formalities, Judge Parker invited appellant counsel to state the rule that should have been applied by the bankruptcy court. 

Counsel for appellants replied, it is the rule laid down by the Sixth Circuit in American Homepatient, that the market rate should be applied in chapter 11 cases where there exists an efficient market; where there is no efficient market, the formula rate endorsed by the Till plurality should be applied.

Turning on my color commentary microphone, I think this was a tactical and strategic mistake.  What counsel should have said was: “it is the rule that is encapsulated by the statutory term of art, ‘fair and equitable’, which the Supreme Court has consistently held to mean that secured creditors get paid in full, every dollar of their claim.   It has nothing to do with ‘efficient markets’, a concept which did not exist when the ‘fair and equitable’ rule was promulgated by the Supreme Court and is not mentioned in any legislative materials related to its codification in section 1129(b)(2).”

The problems with counsel’s invocation of American Homepatient and "efficient market" are manifold. On a substantive or strategic level, it concedes that Till applies in chapter 11 when, as I have pointed out in my article and in prior blog posts, Till should not be seen as applying to chapter 11 at all.  First, the operative statutory language of chapter 11 cramdown, “fair and equitable,” is not found in chapter 13 at all (nor was it discussed in Till; nor do any of the cases applying Till to chapter 11 contain a judicial endeavor to reconcile it to the Court’s prior precedents interpreting “fair and equitable”). Second, in the briefing and argument for Till, the prevailing party, the solicitor general and, most importantly, the justices all took the position that chapter 11 was not relevant to the task of defining the proper approach to chapter 13 cramdown (the only person who argued for looking at chapter 11 was the losing party). Logically, then, if chapter 11 cramdown law was not relevant to Till, Till is not relevant to chapter 11 cramdown.  Third, do you seriously think that the Supreme Court overthrows a century of precedents saying secured creditors get paid in full without any briefing or argument on the topic?  Last, the Court in Till was motivated by practical concerns unique to chapter 13 cases, in particular, the need to find an approach that would be cost-efficient for disputes over small sums of money, whereas in a chapter 11 case, the amounts at stake justify case-specific, non-formulaic inquiries.

Furthermore, arguing for courts to decide whether markets are efficient is a tactical error because it immediately generates concerns about how courts will do that competently. Indeed, as I pointed out in my article, it is counter-intuitive, to say the least, to conclude that the Till plurality -- which said that “the coerced loan approach requires bankruptcy courts to consider evidence about the market for comparable loans to similar (though nonbankrupt) debtors, an inquiry far removed from such courts usual task of evaluating debtors financial circumstances and the feasibility of their debt adjustment plans” nonetheless intended said judges to determine whether U.S lending markets are efficient, a task more typically associated with DOJ, the Federal Trade Commission or other financial regulators perhaps. 

And this concern is exactly what came to Judge Parker’s mind, for he asked:

Judge: How do you know there is an efficient market?   Both here and in general. 

Counsel: In general, that is a determination for the bankruptcy court to make.   

Judge:  What is an efficient market?

Counsel:  A market where there is a debtor that has market weight and market strength.  This was a multibillion dollar company advised by one of the best investment banks in the country, that undertook, with the aid of that advisor, a broad and competitive marketing campaign to refinance the secured lenders, that had offers to do so from the three of the largest lenders in the country and also had raised fresh capital from its equity sponsor, Apollo, which manages over $25 billion in capital.  Not every case will have facts like these.  This is an extraordinary case.  Whether there is or isn’t an efficient market in some future case is not something we need to decide today but can be left to the future. 

Turning my commentary mike on again: Now, maybe here we can see the appellants’ strategy is, understandably, just to win this case, which has unusual facts in their favor, even if it isn’t intellectually satisfying. In fact, one might say, they have a duty to focus exclusively on that, not on fixing the law nationwide.  The trouble with that is, as we shall see, appellate courts don’t have to think that way.  And they may actually think that it is their job to think about the rule that should be applied to all cases.

Which is why it is optimal for creditors’ counsel in a Till-in-chapter-11 litigation to stick to the statutory text and not start talking about “efficient markets.“  This way, if a judge asks about “efficient markets”, you can say “whether a market is efficient is not an inquiry a bankruptcy judge needs to undertake when applying the ‘fair and equitable’ test.“  When you say that, now the appellate judges like you, because you’re making a concern go away.  So you continue “For over a century, bankruptcy courts have adjudicated whether a plan confirmation is ‘fair and equitable’ without the need to figure out whether the lending markets of the day were efficient.  Often, but not always, they have looked at market evidence.  There is extensive precedent that guides them as to how to value companies, collateral, proposed debt securities.  The Supreme Court, when it chose to review the lower courts’ interpretation of the statutory standard has never felt the need to discuss the efficiency of any market.  These time-honored practices should continue.  Whether the U S lending markets are efficient need not be raised at all, but, if it is raised, at most it goes to the weight of any market evidence.  We should understand the reference to ‘efficient markets’ in Till footnote 14 not to state the minimum condition needed for application of a market rate, but rather an example given, for purposes of illustration, to contrast with the non-existent market for refinancing chapter 13 debts that was an obvious concern for the plurality. “

The argument continued. As I said, the panel was not bound to acquiesce in the appellant’s strategy of positioning their case as extraordinary. 

Judge: What concerns me is, let’s assume this is an outlier, where you have a powerful body of evidence for the existence of a market.  We haven’t spoken on this yet and judges in this circuit are going to be looking at this as a precedent for all of their chapter 11 cases. I remember in the antitrust context, the exercise of analyzing a market was expensive and extensive, with expert witnesses and so forth.  How are we going to spare the chaos that this might cause those judges?

Counsel – this is what bankruptcy judges do for a living.  Valuation.  I am not asking the court to set a rule for small cases. This is a rule that will apply where there are two parties with equal power and weight coming at each other.  I am not asking the court to formulate a rule for what is an efficient market.

Color commentary:  this appears to be a tactical move to minimize the judges’ concerns about cost and competence while preserving the position that their particular case is indisputably one where the market was efficient.  Understandable for people who have a mega-case practice, but intellectually indefensible for a statute that does not establish different rules for different-size cases.  The intellectually defensible approach is never to open the door to “efficient markets” in the first place, just say that the century of “fair and equitable” litigation shows bankruptcy courts know how to figure out the market value of a stream of payments.  The legal error here was in thinking that the stream of payments did not have to amount to 100 cents on the dollar.

Counsel: I’m running out of time. Final point: If you look at Till, look at section V of the opinion where the plurality takes on the dissent and says the market for subprime loans is anything but competitive.  Why, if the Supreme Court intended that a formula rate should always be applied in chapter 11, why did the court take on the dissent in that issue? 

I don’t understand this point or find it meaningful.  There are plenty of things to say about Till’s lack of relevance to chapter 11 but this would not make my top 10.   I think it would have been wiser to end on the textual difference between the cramdown sections of chapters 11 & 13: the former has the statutory term of art “fair and equitable” and the latter does not.

Counsel for other secured party / appellant:  1129(b)(2)(A) says a plan’s stream of payments must have a PV of at least 100 cents on dollar.  Their own financial statements carry our debt at 82 cents on the dollar, exactly what our witness testified to at trial.  That’s just math.

Judge again: Tell me the rule you are urging on us.

Counsel: It is the same as first counsel argued.

Color commentary: I guess this was prepared and pre-agreed, but in a perfect world, second counsel would have seen the judges weren’t exactly enamored of the rule proposed by first counsel and gone with “you don’t even need to get into market efficiency to decide this, judges.  Just say Till does not apply in chapter 11 and courts should continue using tried and true valuation approaches for determining whether a proposed steam of payments is worth 100 cents on the dollar.”

Judge: If it’s efficient let it set the rate; if not let the judge apply the formula and let the judge decide which it is.

Counsel 2: That’s right. What Judge Drain held was all the profit had to be extracted from the interest rate. No, what Till and Valenti meant by profit was not the rate that produces a market value of 100 cents on the dollar; they meant about the excess profits caused by an inefficient market.  In Till it was a usury rate. This case had competitive refinancing.

Color commentary:  You know, this sounds perfectly reasonable when you hear it uncritically, but it’s not accurate. In Till, it was clear that the creditor did not get 100 cents on the dollar.  WHY DO YOU THINK THEY APPEALED?  Plus, this has already been argued to the bankruptcy judge and to the district judge. Neither one bought it. So maybe try something else.

Judge:  How will it work? The Judge will hold a hearing and experts will testify there is an efficient market?

Counsel: We propose at least where the evidence is clear the was an efficient market and the market rate was easily identifiable, that is the rate that applies. This court set forth a categorical rule the other way [formula rate always].

Opposing Counsel (This is in a separate recording due to an intermission).
Counsel for Appellees:  On Till issue, appellants focus on what market demands.  But proper place to begin is with “present value” as enunciated in Till which “the Supreme Court” made clear should follow the same approach across the Code. 

Turning on my mike:  This argument embeds three fallacies: 1) that the plurality opinion in Till speaks for “The Supreme Court”; (2) that the highly generalized dictum at the very outset of the opinion – “essentially the same approach” --  is entitled to be given meaningful weight; and (3) of course, that Till has any bearing on chapter 11, which is governed by the “fair and equitable” standard, which is not present in chapter 13 and which the SG and the Justices all said was not relevant to Till.  Unfortunately, these fallacies go largely unchallenged in this oral argument and indeed, the last one appears to have been unwisely invited by appellants’ argument.

Judge:  Yes, but you have footnote 14.

Counsel: the proper way to interpret fn 14 is to make it consistent with the holding of Till and not the flawed premise that the Supreme Court was trying to interpret market rates.  They held that “present value” equals the time value of money plus a risk premium.  Those factors are meant to exclude profit and transaction costs that would show up in a market rate.  Bankruptcies are not like markets; they are court-administered plans.  In such plans, profits and costs are not included.  The language of “super profits” that appellants try to limit Till to is not in Till at all.  Valenti said any degree of profit is impermissible because a court administers the plan and not the market. 

Second point is, how do you know when you have efficient market? Will a bankruptcy court know it when it sees it. This court actually grappled with that here. It held 4-day hearing.  Experts etc.  Based on that evidence, the so called efficient market is not in the needed amount. Semi-confidential, opaque process. Not how an efficient market works.  Affirmed by District court.  Clear error question and should be affirmed. 

Commentator here again:  This is also fallacious in numerous ways and illustrates the appellants’ mistake of fighting on the “Till” and “efficient market” battlefields instead of the “fair and equitable” and “century of precedent saying secured creditors have to be paid in full” battlefields. 

First, as I wrote in 2014, if you look closely at footnote 14, you will see it says nothing about the “prime plus” formula at all.  It does not say “it might make sense first to ask what rate an efficient market might produce, and then adopt the formula approach.”  It just says, “it might make sense to look at what rate an efficient market might produce”.  Period. No reference to a formula fallback. Unlike the American Homepatient approach, I think the phrase “might make sense” was intended just to indicate the chapter 11 issue was being left open for future analysis, and not to impose an "efficient market" hurdle that had to be overleaped to get out of the "prime plus" formula. 

Also, notice how footnote 14 only contrasts chapters 11 and 13, rather than asserting resemblances between them: “the same is not true in the Chapter 11 context … In the Chapter 13 context, by contrast ….” (emphasis added).  I find it hard to discern any intention of the justices to signal in the footnote an endorsement of applying their chapter 13 approach to chapter 11 cases, when the footnote only works to distinguish them. If anything, footnote 14 is a caution not to apply the prime plus formula in chapter 11s.

Second, neither Judge Drain nor any other judge on record has demonstrated a sound understanding of what an efficient market is. They all seem to think that a market is not efficient if a debtor cannot get the amount of money it wants on the terms that make its plan feasible.  (And that was before we had negative interest rates!). As I said before, although there is not complete academic consensus of what an efficient market is, there is ZERO support for that definition, which I call “the loan market as Santa Claus”.  I used the example of someone who wants to buy Facebook stock at $25 when (back when) it was trading at $50.  By bankruptcy court logic, that would make the US stock market inefficient.  This is ridiculous.  The efficiency of a market has to be assessed as a whole, across all its transactions, not just on one would-be participant’s attempt to do one transaction.

Third, since the debtor controls the marketing process and has an incentive to make it look inefficient so that it can fall back to the more favorable formula rate, the bankruptcy judge ought not hold the deficiencies of that process against the creditors.  That is an obvious conflict of interest.

Fourth, as appellant counsel will point out later, the depiction of Judge Drain’s opinion as having been a factual assessment subject to clear error review is inaccurate. Judge Drain clearly set up a legal rule – no profit, no transaction costs – and then found facts only within the parameters set up by that rule. 

Mike off.

Counsel:  appellants rely on American Homepatient which they say would create a purported split if this court affirms Judge Drain.  American Homepatient is a strange case for them because even there the lenders lost.

Judge:  But there are SIGNIFICANT DIFFERENCES between chapter 11 and chapter 13, both in the in real world and in the CODE PROVISIONS. [Emphasis mine]. Why not have different tests at least for finely tuned chapter 11s.

Comment: YES!  This judge gets it!  Sadly, appellants’ counsel will not take this remark up when he makes his reply.  But this was the path to victory here.  Mike off.

Counsel:  The Supreme Court says you can’t do that.  “Essentially the same approach” remark.  Footnote to that remark cites 1129 B.  That is my doctrinal answer. 

Judge: yes, but then it put in fn 14. Your categorical approach is not quite faithful to a complicated case.
Counsel:  again fn 14 should be read to consistent with Till.

Comment:  if you have staked out the principle that Till is not a chapter 11 case because “the fair and equitable” standard does not appear in chapter 13 nor in Till and because the SG and the Justices all agreed that chapter 11 analogies were not pertinent to Till, then you can readily smack this contention down. However, if you have conceded Till is governing, as appellants here did, then you have much less ability to reply to this argument.  Mike off.

Judge:  you are being categorical but this case is more nuanced.

Counsel:  More nuanced is how counsel talked about fn 14 in proceedings below.  You can look to efficient market and that informs the formula rate. 

Judge: Are you suggesting that examination of market factors can be used in evaluating formula rate.

Counsel: Yes, that is something we agree with.  Bankruptcy Court is free to look at market evidence to define risk premium. 

Judge: Sounds like you are all getting pretty close.

Counsel: I think we are Your Honor.  The evidence below was evaluated on that basis and the judge made a decision after hearing it – in fact Judge Drain increased risk premium after hearing it -  and that is not clear error. It is the approach the 5th and 11th Circuits took. That is what we ask this court to do here. 

Comment:  I have written up both the Fifth and Eleventh Circuit opinions and this is a gross overstatement.  The Fifth Circuit case (Texas Grand Prairie) was, as MPM is apparently turning out to be, a case where creditors’ counsel conceded ab initio that Till governed.  The court made clear it was bound by that and left a dictum at the end suggesting that it was not itself wedded to it.  The 1th Circuit case (Seaside Engineering) was obviously a case in which the Till point was barely briefed, argued or discussed. The amount at stake in the entire case was a pittance and there were over a dozen other issues. That is not persuasive in the Second Circuit in a mega-case.

But this colloquy shows how conceding Till applies puts the creditor at a terrible disadvantage rhetorically. There is a large battlefield to fight cramdown on. And issues about how to apply Till are a small patch on that field.  The strategically minded creditor would force its opponent to fight on the entire field.  Start methodically with the statute – fair and equitable -- review the precedent thereunder holding that it means paying secured creditors in full, and then at the end say: (1) Till is not a chapter 11 case and did not construe the relevant term. (2) Nor did the parties or the Justices think they were making a ruling for chapter 11 cases, as their briefs, the oral argument transcript and fn 14 indicate. (3) Till did not attempt to reconcile itself to either (a)  the preceding century of precedent interpreting fair and equitable,  or (b) decades of perfectly satisfactory practice where bankruptcy judges determined whether secured creditors were paid in full without having to resort to notions of an efficient market, and it is an insult to the Supreme Court to think that they meant to overrule that body of precedent without any discussion of it and after having said at oral argument that it wasn’t relevant. Then sit down and now the adversary has to fight on that entire battlefield.
Mike off.

Judge: you are running low on time. Just so I am perfectly clear – your ideal approach is a slightly hybrid approach You take T-Bill rate and you make adjustments necessary and the adjustments can involve looking at market rate to be sure the bankruptcy judge gets it right.  Do I understand that your view is the market rate is in some circumstances appropriate?

Counsel:  No, our submission is the formula rate is the approach. In determining the risk premium, the judge should look at all evidence which could include exit financing.  Since Till, they do not cite a single case in which a judge has applied an efficient market rate”.  Every other court has applied the formula rate.  Lending has not come to a halt.

Judge: We generally don’t like to pick and choose among other circuits’ approaches. We have here a very sophisticated bankruptcy bar and we are trying to determine with the help of you all the best and most careful approach to addressing the complex cases here that the rest of the country doesn’t often see.  Last question: do you think bankruptcy courts are competent to address question of market efficiency?

Counsel: That’s very complicated.  The one thing that is clear is you can’t account for transaction costs and profits.  

Judge: You’re out of time but that is not the question I asked. Opposing counsel said he thought the courts in SDNY could handle it. 

Counsel: no one has found an efficient market rate.  Bankruptcy courts are capable of looking at all the evidence   And come up with a risk premium. 

Comment:  That is the end of the appellees’ argument but you can see how, if the creditor concedes Till governs, then the creditor is limited to fighting about issues like the last colloquy focused on – what is an efficient market; can a bankruptcy judge analyze that competently (not one of them has so far) and does the rate selected by the bankruptcy court exclude transaction costs and profit?  That’s a very favorable setting for the debtor but a very defensive position for the creditor.

Mike off.

Reply by appellant counsel:  this decision is not a clear error -- it turns on a rule of law. What the rule of should be is what American Homepatient said -- if there is an efficient market, that controls. This is an easy case.  The debtor went out and got multiple alternative offers of exit financing.  What Judge Drain said was not “there isn’t an efficient market”. He said “I don’t care if the market is efficient.  I care that it has yielded a rate which reflects profits and transactions costs, contrary to Till and Valenti.  Read Till again -- I agree its text controls. [Emphasis mine].   I urge court to look at 203 N LaSalle and Radlax in which it has said how you determine value is exposure to a market. That is how you get to the right answer. Our bankruptcy judges are sophisticated and can handle the task of determining efficient market.   They look at market evidence in valuations all the time.

Judge: Why were the findings below clearly erroneous?

Counsel: I don’t say they are.  He [Judge Drain] said the market rate does not matter, that the 6rh Cir had misread Till.  But all the other courts in this district, prior to Judge Drain, have said, where there is efficient market, that rate controls. His rejection of that is legal error.

Final comment:  Well, here, counsel (1) immediately after hearing the panel say, we generally don’t pick and choose among other circuits’ approaches, starts off by saying, you should pick the Sixth Circuit approach to this issue; (2) concedes explicitly Till controls; and (3) fails to pick up on the panel judge’s statement that there are significant differences between the worlds of chapter 11 and 13 and the text of their two cramdown statutes. This last point is especially odd because their brief does in fact make that argument and it ought not to have been left in the oral argument locker room. On the plus side, he did manage to squeeze in a sentence about pre-Till endorsement of market checks in cramdown and obliquely gave the best evidence that bankruptcy judges can assess market efficiency when he stated that the other bankruptcy judges in the Second Circuit were holding that they would apply market rates if there were an efficient market.

But overall, the oral argument strikes me as a missed opportunity for the secured creditors and on balance favorable for the debtor. It seems to me a majority of the panel arrived looking for a way to rule for the creditors (why else ask both of them what rule of law they wanted the court to promulgate?) and walked away without a lot of assistance in that endeavor.