Monday, December 8, 2014
The Slow Food Movement May Be Coming to Chapter 11
The ABI Commission's report on chapter 11 reforms was released today. It certainly is a lengthy document, as one might expect from a committee whose membership is dominated by lawyers. Much of it proposes not what I would call "reform" but simply "codification", which is generally welcome -- e.g., inserting the Countryman definition of an executory contract; selecting the "actual" as opposed to the "hypothetical" test for assumption; blessing use of estate property to pay critical vendors or prepetition employee claims; overruling all of the "Till in chapter 11" decisions; codifying the "new value" exception to absolute priority; and so on.
The major changes proposed consist generally of reducing the rights of secured creditors during the administration of the case, and to some extent at the end as well, although in the latter instance the impingement on secured creditor rights is not as dramatic as many of the commission members' statements from time to time over the past two years advocated.
Also, section 363 practice receives a good deal of attention. Some of this is in the nature of codification of procedural aspects such as length of time before a debtor can initiate a sale. Prevailing interpretations that confer on certain contract counterparties leverage to block 363 sales, like patent and copyright licensors, would vanish. 363 sales are recognized to be plan-like in some respects, for example, the cutting off of claims is recognized to be like a discharge, with various notice and due process implications that flow from that; and the proposal to impinge on secured creditor recoveries in the plan context is carried over to the 363 context.
Other proposals strive to lengthen the time companies spend in chapter 11 - explicitly , early milestones for plan or sale filings would be forbidden from cash collateral and DIP financing orders; time to assume nonresidential real property leases would be extended to one year, etc. Implicitly, certain other proposals with respect to distribution of value could produce longer cases, as it would take a long time to figure out how to bargain around them, or to the extent the proposals actually subvert bargaining, how to administer cases around them.
In this last respect, that of elongating restructurings, the report adopts one of the oddest perspectives I have seen emanate from any industry. In so many other sectors of the economy -- making a car or a computer chip; getting a new drug on the market; getting your first-round draft pick onto the field; delivering a product from warehouse to consumer -- achieving your objective sooner and cheaper would be considered a good thing and something that the sector should strive for. Here, the report (p. 221) includes a chart showing a general decline over time in the number of days companies spend in chapter 11 -- and portrays it as a problem that needs to be solved. I was going to write, "I cannot think of any other industry where slowing the process down is considered a process improvement", and then I thought of the "slow food" movement and realized there was at least one. I could not write what I was going to write, but it did suggest an entertaining title for the post. (Note to self: if these proposals go through, open up restaurant in Wilmington Delaware. More people will be spending more time there and will need places to eat.)
But the "slow food" approach to dining is an option, not a mandate. None of us likes to go into a restaurant and have no choice but to accept slow service at a higher price than we think we need to pay. Why should that be a characteristic of business reorganization?
I don't see any evidence in this report that increased efficiency of debt restructuring has had a negative effect on continuity of jobs or any other public interest implicated in reorganizations. It is argued that earlier exits lead to lower recoveries by junior constituencies, but it is also recognized that the asserted correlation cannot be distinguished from what might be caused by normal economic cyclicality. No one can pick the top of the economic cycle -- how many people even predicted the recent plunge in the price of a single commodity, oil? It's pretentious to suggest that bankruptcy law changes are going to systematically improve the timing of a company's exit relative to the economic cycle. It also needs to be recognized that these are purely distributional issues: there is no going concern value being lost by the economy as a whole. It's just a question of in whose hands it winds up.
Which brings me to a related point. Setting aside again involuntary creditors, the distinction between senior secured and junior unsecured classes that drives much of the report's most controversial recommendations seems to me to be largely fallacious and antiquated. In the modern restructuring era, the specific names who show up as senior secured creditor in one case may be junior unsecured creditors in the next. These claims are held by pools of capital - hedge funds being the most obvious example, but there are plenty of bank loan and high yield mutual funds too. Even corporate financial institutions, like commercial banks, investment banks or insurance companies, are just pools of other people's money. Many of these entities have diversified portfolios of investments, such that it's fallacious to think of them as systematically always senior or always junior - with an exception for commercial banks who are required to follow safe and sound banking practices that typically, as interpreted by regulators, include taking collateral. And even if there are less-diversified institutions that focus predominantly on one kind of investment, for example a fund that is purely a distressed debt fund, they tend to be doing so ultimately for the economic benefit of stakeholders who themselves have diversified portfolios. The distressed fund may be seeded by an investment bank or a larger multi-strategy fund that doesn't want to have a permanent infrastructure or to have its name associated with distressed situations. Or they may be pension funds or university or charitable endowments that have widely diversified portfolios. The point being, don't get all worked up about senior creditors winning too often - ultimately, the investor class holds portfolios of investments and no one is being systematically screwed or privileged. Focus on making the process efficient instead, which generally means clear and predictable rules, in this case the absolute priority rule that the financial markets have had a century to adjust to.
I will comment on the anti-secured-debt proposals in the following post.