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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 Marke;ll'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.