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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.