Time Magazine Still Working Out Kinks of New Censorship Initiative

One of the things Time Magazine recently chose to use its First-Amendment-protected freedom to accomplish was to find out from its readers "Which Word Should be Banned in 2015".   Promoting a speech ban seems like an incongruous agenda for an institution that is protected by the First Amendment, yet the article does not appear to have been conceived in a spirit of irony  -- although the exercise wound up as a kind of self-inflicted parody.

Time gave its readers a list of 14 candidates that included "kale", "disrupt", "influencer", "said no one ever" and ... "feminist".  I try to imagine the meeting at which the list was being drawn up and someone was proposing "feminist" and all I can think of is Ricky Gervais.  But it went on the list and a writer (named Katy Steinmetz -- imagine how this story goes if a man writes the article) generated the article summarizing the arguments to ban each offending word.   (To throw another log on the irony fire, Steinmetz wrote this article earlier in the year, snarking at other persons' efforts to ban words.)  Her campaign speech to ban "feminist" was:

"You have nothing against feminism itself, but when did it become a thing that every celebrity had to state their position [link in original]on whether this word applies to them, like some politician declaring a party? Let’s stick to the issues and quit throwing this label around like ticker tape at a Susan B. Anthony parade."

So the poll was launched and, of all things, which word jumps way ahead of all the others but "feminist." OOPS!  Who saw that coming (said no one ever, at least within Time Inc.).

And then Glenn Reynolds called attention to it in his USA Today column
and apparently a backlash grew about Ricky Gervais's brilliant parody
Time's lack of respect for the word "feminist", and Time's managing editor, Nancy Gibbs, wound up inserting the following apology at the top of the webpage with the poll (which seems to have been aborted -- I cannot check any of the boxes opposite the words):

TIME apologizes for the execution of this poll; the word ‘feminist’ should not have been included in a list of words to ban. While we meant to invite debate about some ways the word was used this year, that nuance was lost, and we regret that its inclusion has become a distraction from the important debate over equality and justice.

In other words, Time needs to do a better job of censoring its censorship proposals.  Among great moments of First Amendment expression, where does the phrase "the word 'feminist' should not have been included in a list of words to ban" rank?  Kind of way down there, real low?

I am not a big user of aphorisms, but one I came across years ago from management guru Peter Drucker always stuck with me for some reason, and it seems very applicable to the editor's apology.  It goes to the effect of: "There is no greater waste of time for a manager than working to improve that which should not be done at all."  American media organizations protected by the First Amendment should not be refining lists of words to ban, nor apologizing for inclusion of one particular word in such a list.  They should not be suggesting the banning of speech at all, even in jest. Like political candidates, they should stay on message, all the time, and that message is, freedom of speech. 

(h/t: Hot Air)

A Dozen Reforms the ABI’s Bankruptcy Reform Commission Report Should Endorse

The ABI’s self-created commission to explore alterations of chapter 11 of the Bankruptcy Code is scheduled to deliver its report next month.  To the extent the recent public statements of its co-chairs are representative, the commission appears to continue to be adhering to its initial agenda of weakening secured creditor’ rights on the premise that, as one of them told the Wall Street Journal, there has been an "'unmistakable’ progression of secured lenders’ power in bankruptcy.” 

As I have repeatedly written, the word “unmistakable” is about the last one any unbiased observer would apply to claims that secured creditors have increased their advantage or unsecured creditors’ recoveries have declined meaningfully in recent decades.   

1)  Large corporate reorganizations in earlier eras often generated recoveries only for secured creditors.  See my writeup of the Denver & Rio Grande railroad reorganization for instance. 

2)  Persons closely tied to the formulation of the current Bankruptcy Code in 1978 published articles at the time explaining that secured creditors would receive very strong protection under the new Code.  That was the quid pro quo for subjecting them to comprehensive bankruptcy laws for the first time in the nation's history.  

3)  Claims of some kind of adverse change in the relative outcomes of secured and unsecured creditors are premised on a woefully mistaken analysis prepared by a law student with no experience of any sort, which has been brandied about without critical examination solely only because it serves the agendas of a number of different constituencies.

Rather, far from going astray in the past two decades, chapter 11 has actually become modestly more efficient in fulfilling its public purpose of reorganizing operating businesses with minimal disruption of the debtor’s operations and the constituencies who flesh out those operations.  Part of this is due to the natural development of case law resolving statutory ambiguities and conflicts, fleshing out statutory standards or filling in statutory gaps, but a large part of it is due to the increased activity of distressed debt investors, which has led to more accurate and reliable valuations informed by secondary market liquidity and pricing, and that in turn has expedited plan negotiations and the resolution of the legal case.  In addition, the impact of bankruptcy on smaller creditors has been greatly lessened due to the widespread use of first-day orders and other efficiencies.  Although there are one or two substantive aspects of chapter 11 that I think could use a dose of reform, in general, I think the process of chapter 11 works far better today than it did during its first decade.  Much more debt is being restructured either per day in bankruptcy or dollar of professional expenses than in restructuring’s early years.  That's increased efficiency.  Thus, I see no genuine case for reform, although there may be political or economic agendas that lead to calls for it.  It's the classic question of public interest versus an industry's interest:  the public at large gains from a more efficient resolution process, whereas various constituencies would benefit from making the process more inefficient or expensive, and getting secured creditors to absorb the increased cost. 

In contrast, I think the most helpful thing the commission could accomplish would be to increase the  Code’s efficiency and make it a more efficient mechanism for sucking excess debt out of the real economy.  This would entail just two steps: first, to codify the best practices and ideas that have been developed in regard to those determinations that are most frequently litigated, thereby cutting down on uncertainty and variability and making cases more predictable and efficient;  second, drawing upon the commission members’ real-world experience to cut through the myths and incantatory rhetoric that shroud certain formalistic, inefficient and wasteful practices in chapter 11 to, again, make it more efficient.

But before one even gets to the Bankruptcy Code, there is one reform of a different law that would make a huge difference in bankruptcy dockets, and that is, in the fashion of recent practice in sovereign debt issuance, to revise the Trust Indenture Act of 1939 to eliminate the need for 100% consent to compromise principal and interest payments in favor of a lower, but still quite high, super-majority threshold.

Now, turning to the Code itself, there are several obvious areas where the efficiency of reorganizations could be increased nationwide by codifying what are now a patchwork of individual districts' practices.  

1.         Codify First–Day Practice

This is an obvious and, I expect, uncontroversial reform.  There are well-established procedures, forms and parameters for “first-day” and “second-day” orders that have been developed in Delaware and SDNY to pay numerous types of pre-petition claims generated in the ordinary course of business, and to insulate employees and other non-financial constituencies from the potential ill effects of a bankruptcy.  These are beneficial to society as a whole because they reduce the scope of disruption from a filing and also enhance going-concern prospects.  Obviously, any reform should ensure they remain subject to the consent of those who are called upon to foot the bill, i.e., the holders of cash collateral and the representatives of unsecured creditors.  Enacting these practices into law will also enhance the administration of chapter 11 cases in venues outside of Delaware and New York, where occasionally less experienced judges get bogged down by formalistic doubts about the statutory authority for these eminently sensible motions and applications.  It should be made unmistakably clear that pre-petition debts, secured or unsecured, can be paid post-petition in accordance with their terms, or consistent with the ordinary course of business pre-petition, without the need for motion practice or court approval, if the debtors’ business judgment is to do so, but subject to the consent of anyone whose cash collateral is being used to do so, and the unsecured creditors’ committee.

2.         Codify Section 363 Practice

Section 363 sales are, economically, a perfectly sound way to resolve a distressed situation, when they transfer the operating business to a new entity and leave the legalistic,  litigious bankruptcy process to deal only with disputes over the proceeds.  Formalistic objections that are sometimes raised (“it’s not a plan’; “there’s no disclosure statement”; “it’s just helping the secured creditors”) are just that: formalistic, non-economic, non-substantive, matters of taste.  There is nothing morally or inherently wrong with a resolution called a “sale” as opposed to a “plan”.  Disclosure is a red herring in the plan process anyway (see point 4 below) and thrusting disclosure statements and voting into a sale process would make for useless inefficiencies.  A case that removes the risk of insolvency from an operating business efficiently is a net positive for the economy at large, even if that produces no recovery for unsecureds, if that’s what the economics lead to. Value is what matters for recoveries, and concerns for “fairness,” whatever that means in the context of battles among different pools of capital, can be addressed by making sure junior constituencies get a fair chance to bid if they are at risk of being squeezed out. But this efficient method of resolution of financial difficulties should be cemented into the Code so that it can be implemented consistently and without confusion, in all districts. Issues like the ability of first lien lenders to credit bid post-Fisker, or the parameters of bidding protections, or whether a distressed company has to open its books to a competitor who may not be acting in good faith, should be codified so that the process becomes completely predictable in all districts. 

If optically helpful, a new chapter could be created to contain the rules for sales of all or substantially all of the debtor’s operating business. It could provide timelines that are safe harbors, codify the authority of the buyer to select which pre-petition liabilities to assume, etc.

3.         Codify third-party release terms.

This should be another non-controversial reform as the content of permissible third-party release terms is pretty well defined in the major districts and has received substantial judicial and U.S. Trustee attention.  Again, codifying the state of play would make the best practices nationwide and further the efficient administration of reorganizations in other districts. As with first-day practice codification, making third-party releases uniform across the nation will indirectly address venue concerns, by minimizing uncertainty of plan proponents and constituents.

4.         Codify 1129 Practice, but also Create A Few Clear Rules and 

Safe Harbors to Streamline Confirmation Proceedings

Issues like post-petition interest, the 100% cap on senior classes’ recovery, the need for competitive bidding on new value plans, deference to market evidence in fixing cramdown rates, and other like issues have had judicial development since the Code was enacted and best practices should be codified.  Further, clear rules should be enacted limiting the participation of out-of-the-money constituencies in confirmation litigation at the estate’s expense.  Safe harbors should be specified such that, if a plan contains them, it is presumed to satisfy the corresponding confirmation standard, much as the Code now does for priority tax claims.  For example, broadly accepted valuation methodologies could be safe-harbored, certain debt-service ratios could be presumed feasible.

More ambitiously, as opposed to the current treatment of out-of-the-money classes, which now have to be solicited if they are offered anything, and so are often given nothing and deemed to reject, a safe harbor could be created that deems the first out-of-the-money class to accept if they receive a standardized upside participation in the reorganized debtor, like warrants for X% of its equity with a strike price that implies full recovery for the senior classes).  Also consideration should be given to establishing a clear rule on debt at emergence to mitigate the risk of chapter 22 --  say, for example a plan is presumed not feasible if it provides for debt > 4X last 12 months EBITDA. 

5.         Codify Clear Criteria for Substantive Consolidation Under Plans.

Deemed substantive consolidation is a reasonable approach to classifying claims and defining distributions in large complex chapter 11 cases where multiple debtors are liable to the vast majority of creditors. It usually reflects the reality of how creditors have interacted with and evaluated the creditworthiness of the debtors as a whole. But there really is no substantive basis for it – nothing in the Code speaks to it in any explicit way, and the judicial criteria for true substantive consolidation are extremely expensive to investigate and litigate.  So a very efficient reform would be to write a clear, simple rule for when it is permissible (or required) for a plan to effectuate a consolidation just for purposes of the plan: just by way of illustration, such a rule might be that, when more than 75% of the assets of the debtors are held by debtors who are jointly and severally liable for more than 75% of the group’s funded debt, those debtors can be deemed to be one consolidated debtor for purposes of the plan. 

Those are the codification suggestions.  Now, more controversially, here are three suggested reforms that fall under the heading: "Scrape Away the Pieties and Dogmas and Look Reality in the Eye":

6.         Stop Pretending that the Disclosure Statement Matters.

Whatever the vision that informed the Bankruptcy Code at inception, in practice the disclosure and voting process in chapter 11 cases is a sideshow and a formality.  Far from being a failure, this is actually a testament to the effectiveness of other mechanisms for creditor involvement earlier in the process, such as official creditors' committees and cash collateral budgeting.  By the time a disclosure statement is filed, the major constituencies have seen the data and analyzed it, their deals are done and the outcome is not the least bit in doubt. So the truth is, what is in the disclosure statement or not has no effect on the reorganization.  The real decision-making and the concomitant disclosure happen well before the disclosure statement hearing, in emails among financial advisors, and in conference rooms and conference calls where presentations are made and analyzed by the key constituents and their advisors.  The disclosure statement is in fact, whatever legal weight may be assigned to it, merely a record for posterity of what the debtor and the supporters of its plan have come to a consensus on.  I doubt that anybody reads the disclosure statement except the professionals who create it.  I don’t think I have ever known a judge to read the whole thing.  Many of the sections are merely recitations of past events that are otherwise memorialized in one public repository or another.  The hearing on its adequacy is at best a status conference for the judge to learn who is not on board and what the issues at confirmation are going to be.  So let the judge hold whatever status conference s/he wants to, but cut the document that goes to creditors down to just a short plan summary, term sheet proxies for its exhibits, the financial projections and the going concern valuation.  That is all that anybody really reads and it will get rid of the silly process of people filing objections that are speaking briefs for confirmation.

7.         Recognize that Management is Biased – But Its Bias Is Consistent with Public Policy

The Code, and many pro-debtor judges, treat debtors in possession as if they were neutral fiduciaries.  But it’s an open secret that management has an incentive to come out of bankruptcy with the most conservative capital structure possible.  It makes their job easier and also makes any equity package they negotiate for themselves more valuable. This benefits senior creditors, to be sure, at the expense of potential upside for junior creditors.  Everyone in the process knows this. 

Two corollaries flow from it in regard to reform: 1) this is not necessarily a bad thing, because there is a public interest in seeing companies emerge with conservative balance sheets as opposed to having chapter 22’s due to insufficient de-leveraging in the first reorganization.  A conservative capital structure actually furthers that policy, as long as it is in good faith, even though some constituencies suffer. 

But the key is, are these plans and projections in good faith or is the debtor sandbagging revenue and expense reduction opportunities until post-emergence?  Is there a consolidation that might generate higher value?

So, 2) let’s recognize this bias exists, and stop giving non-disinterested debtors such a controlling role in plan promulgation.  Create a mechanism that, in an orderly fashion, previews recoveries to the court at an early stage and, if it appears that some significant constituency is going to be left out of the money, empowers the court to obtain an independent expert review of the projections, strategies and assumptions well prior to confirmation, and then -- if he or she is not satisfied with the conclusions of the review -- to authorize the pursuit of alternatives.  Some activist judges do this already but it should be formalized to supply best practices, rather than ad hoc.  Courts should encourage out-of-the-money constituencies to supply ideas and alternative perspectives to whomever the court appoints to perform the independent review.

8.         Conform the Law to the Reality of Real Estate Chapter 11’s

Most real estate chapter 11 cases are just changes in ownership, with no impact on unaffiliated constituencies such as employees or trade creditors, and there is no benefit from any kind of a plan process. Often, the plan process just delays and makes more expensive the inevitable outcome of the first lien taking the property back.  This reality should be faced up to and all real estate cases, save those with some appreciable proportion of trade debt, should be shuttled into orderly 363 sales to the highest bidder with the mortgagees being able to credit bid.  Not just single-asset real estate.  All real estate businesses – hotels, apartments, office complexes, malls, etc.  If they don’t have a sufficiently large component of operating creditors, run them as orderly sales.  This prospect will certainly reduce the number of bad faith, eve-of-foreclosure filings, gerrymandered voting plans, and absurd “Till in chapter 11” litigation.

The next three provisions can be loosely grouped under the theme of "cutting back on expense and bullshit".

9.         Let Judges Bring Common Sense to Examiner Provisions

This is another reform that should be noncontroversial. Often the examiner motion is made for ulterior motives related to the prospective terms of a plan and solely to delay.  Judges should have more discretion to squelch examiner motions late in the game.   On the other hand, judges often use “examiners’ as “deputy bankruptcy judges” or mediators and thought should be given as to whether this is a sound practice. It’s certainly an expensive one.  Last, perhaps more controversial because it would limit professional fee opportunities, examiner investigations are often duplicative of work either the unsecureds can do or have done (such as fraudulent transfer analysis), or the Justice Department or other governmental actor or the plaintiffs’ bar is contemporaneously doing, and the Code should inhibit such duplicative tasks.  The examiner’s report in the Lehman bankruptcy is an extreme example of this problem, in that the examiner, one presumes in all good faith, ran up a bill of over $50 million to investigate matters that were separately investigated by multiple other private and public sector actors and generated a report of absolutely no consequence to the reorganization at all.   That should not be allowed to happen again.

10.       Eliminate 544(b) in Favor of a Uniform Federal Substantive and Procedural Standard, Which Should Be Modified to Eliminate Financial Speculation on Costly Litigation

One of the biggest fee-generators in a large chapter 11 is the pursuit of constructive fraudulent transfers.  Of course, “constructive fraudulent transfer cases” have nothing to do with “fraud” – that is separately covered by laws voiding intentional fraudulent transfers.  Rather, they are just attacks -- incredibly expensive hindsight attacks -- on valuation or on affiliate guarantees or other structural or documentary matters that are staples of sound credit policy.  A case like the TOUSA fraudulent transfer litigation, for instance – it cost millions of dollars and many hundreds of hours of judicial branch resources and what real-world good did it accomplish? It just moved money around from one group of lenders to the enterprise to another group of lenders.  It was really just a giant, bloated preference action in effect, if not in name.   What federal policy would encourage investing tens of millions of dollars and hundreds of hours of judicial resources for nothing more than moving the recovery around between different sets of financial institutions, as opposed to the much less expensive option of living with the structure as it lay when the bankruptcy filing occurred?  None that I can see, although it did generate good income for the professionals involved.

Because of 544(b)’s incorporation of state law (without specification of a clear rule for ascertaining which state), those attacks frequently produce excessively complicated, fee-generating issues of choice of law, deliberations over differing statute of limitations, and debates over whether 544(b)’s requirement of an unsecured creditor with a valid avoidance action exists or not.  Those disputes are not consistent with the Constitution’s concept of  a “uniform” law on bankruptcy or with the need for economy in administering a bankruptcy case.  No cognizable federal purpose is served by these collateral procedural disputes.  They simply delay the resolution of the merits and increase the cost of getting to that point.  They should be eliminated by striking 544(b) and focusing instead on the federal counterpart, currently found in 548(a).

But even the federal substantive law needs refreshing.  First and foremost, the alternative remedy of avoidance of the transfer – which transfer often occurred several years before the judgment might be entered and may have involved a large diverse quantity of assets and people – is outdated, impractical, and needs to be eliminated in favor of a simple damages award.

Secondly, to eliminate unproductive and inequitable speculation in lawsuits of this type, that simple  damages award should be set by a fixed formula: the amount owed at the time of the chapter 11 filing to creditors on those claims that existed at the time of the transfer, and who did not finance the harmful transfer, plus interest and the plaintiff's costs of litigation.  That wlill make them whole, no more, no less. Further, the payments should be made directly to the damaged creditors or their assignees, so that their recoveries are not diluted by other claimants of the estate that suffered no harm and may have financed the transaction in the first place.

By "inequitable", I mean the Moore v Bay paradigm whereby the existence of one unsecured claim with an avoidance action, no matter how small, enables the estate to seek to go after the entire transfer, even amounts well in excess of that needed to make the injured creditor whole, whereupon investors who are strangers to the case go out and acquire other claims against the estate, which may have had no injury from the transfer and may in fact have financed it to profit from the lawsuit). On top of that, you sometimes get cases, like Mirant, where a plan provides a 100% payout to unsecured creditors and yet fraudulent transfers are still pursued because the Code has been formalistically construed to require only benefit to “the estate”. 

In other words, repeal Moore v Bay and have prosecution of avoidance actions be a creditors' remedy, not the estate's.  These simple changes would end the unproductive and inequitable exploitation of antiquated legal rules for financial speculation. 

11.  Pay Professionals out of their Constituencies’ Recoveries. 

Some of the Commission’s hearings have had to do with ways to control expenses in bankruptcy. Right now, unsecureds and equity committees consistently get paid out of cash collateral of senior secured creditors, and, in turn senior secured and DIP creditors get their professionals paid on top of principal and interest, which fees ultimately reduce unsecured recoveries.  The combined effect is that no constituency has the combined ability and incentive to limit any professionals' activities,  and thus expenses are essentially uncontrolled.  I think the best solution that  has been suggested, and even on rare occasions already implemented, is that, while all constituencies should have the right to appear and be heard through professionals, they should also have bear their own professional costs out of their own plan recoveries.  Internalizing professional expenses will give every constituency an incentive to present only plausible arguments and theories and refrain from fishing expedition discovery, and in turn that will serve to streamline the proceedings considerably.

This last idea can simply be filed under  "The Impossible Dream "

12.       Treat Every Single Legacy Employment Claim as General Unsecured.

Finally, a reform that I think would be appropriate given the patchwork nature of the Code and of the circuits’  interpretation of it would be to treat all legacy employment claims as pre-petition general unsecured claims.  By legacy, I mean pension, retiree medical, WARN, general employee litigation, indemnification of officers and directors for pre-petition litigation, and the like. . Right now, retiree medical claims are privileged as to priority for no sound policy reason given the existence of multiple Federal and State health insurance programs like Medicare, Medicaid, Obamacare, and so on; pension modification usually requires a separate non-bankruptcy litigation with the PBGC; the priority WARN claims receive varies based on facts and circumstances that may be litigated; indemnification claims are often upgraded under the plan because they can be, and no one wants to alienate the management.  All of them should be seen as what they are, relative to the purpose of chapter 11 to reorganize the business in the way that makes it the strongest contributor to the economic future of the nation and the local communities: they are legacy liabilities that should be separated from the going concern, not burden it going forward.  But politically, I would doubt very much that anything that put retirees behind reorganization would have much chance of success, so I left if off the list as a concession to that political reality.

.           

Maybe Janet Yellen Should Meet Next with Bankruptcy Lawyers Whose Business Has Dropped Off

Yesterday the New York Times ran a story about a meeting Janet Yellen, Stanley Fischer and some other  Fed colleagues took the day before with about 30 people who aren't making as much money as they would like.  The meeting was organized by an advocacy group based in Brooklyn and the reporter chose to focus on one attendee, a photographer resident in Queens, who cannot get steady work and finds that, when he does work, he now makes only $250-300 per day instead of $400 that he used to make.  Neither number was verified and the man's statements are the only quantitative data in the story (although the story says the attendees wore T-shirts with charts on the back).  I suppose if you think of the Times as a local paper it made sense to focus on that person, but $250-300 per day would not seem like a struggling income level in many other regions of the country outside of New York City. 

The meeting had some similarities to a meeting Dr. Yellen took earlier this year at a community center in Chicago, just before her first speech as Fed Chair, in which, as Bloomberg reported it, she "told the stories of three people who had trouble finding work to illustrate her concern about the unemployed -- omitting the fact that two had criminal records [felony theft and heroin possession] that might have influenced employers’ decisions on whether to hire them."

The Times reporter, Binyamin Applebaum, described the latest meeting as a "gesture of concern"  for Americans who are still struggling to make a living.  The advocacy groups that organized the meeting believe that the Fed should continue aggressively easy monetary policy on the belief it will help wages rise and minority employment rise as well.  The story says nothing about whether the advocates considered whether prolonged easy money would cause prices to rise as well, given that in a service economy, one person's wage is another person's price, and whether their constituencies' net purchasing power would really change that much.

Whatever the political value of symbolic gestures, about which I am incredibly cynical (I think they are either false and disingenuous, or, if tendered and received in good faith as I assume this one was, make for dangerous substitutes for the intellectual rigor that ought to be applied to policy questions, and can lead ultimately to a politics of demagoguery), I think meetings like this are just poor ways to make policy of a macro-economic nature. 

First of all, most obviously, only people who aren't working full-time can take the time to travel to Washington DC to vent.  People who are working hard and succeeding are just as "real" as the people who aren't, but they can't take time off to meet with the Fed.  So meetings like this are biased inputs that proffer a misleading sample and a myopic view of the economy as a whole.  If the Fed wants to sample the views of "real people" in formulating policy, polling firms have tried and true methods to generate demographically accurate samplings, as opposed to just listening to self-selected squeaky wheels. 

Second, macro-economic policies (and particularly monetary policy) really can't determine community or sector level outcomes, let alone individual outcomes, like whether a photographer in New York City makes $300 or $400 a day.  Macro policies and factors can only affect the macro-environment.   What happens within that environment is primarily driven by factors far beyond the purview of monetary authorities; technological change, demographics, consumers' tastes, infrastructure, education, incentives, red tape, cultural norms about work and success and what is good in life, to name just a few of those factors.

Taking the photographer as an example, since he is the lone data point in the article, there are all kinds of secular factors that might explain his drop in income.  As for still photos, there is the drop in circulation of print; the leap in quality of cameras in mobile telephones and the proliferation of social media channels of distribution of the images captured by amateurs.  As for film shoots, there are plenty of cities where films can be shot more cheaply than New York: the website  before the trailer.com lists, Albuquerque, Atlanta, Austin, Boston, New Orleans and Seattle ahead of Brooklyn in ranking best locations to film in the U.S.  Did the meeting include photographers from those other cities as well?   Local government rules on doing business can affect the costs of doing business and may impact positively or negatively where a film is shot, regardless of the macro environment.  Furthermore, the type of film being made today has changed significantly from 20-25 years ago, featuring much more CGI and much less photography of actual backgrounds.  Were CGI professionals included in the meeting?  None of those developments can be meaningfully affected by monetary policy -- obviously, we have the same monetary policy in each of the cities named in this paragraph.

Of course, there are a few sectors -- those closely tied to financial services -- that are affected by monetary policy.  For example,  bankruptcy lawyers are much less busy than they were 4 or 5 years ago.  By the logic of these advocacy groups, maybe the Fed chair should take a meeting with some bankruptcy lawyers whose work has dropped off to understand the harm easy money does to the bankruptcy business.  (Or maybe Congress should reform the bankruptcy laws to make bankruptcy cases take longer and be more expensive, as seems to be the aim of a some reform proposals that have been floated by bankruptcy lawyers in recent years).

Obviously that's absurd, since the activity level of bankruptcy lawyers moves in the opposite direction of the overall economy, but it does make the point that focusing on small, unrepresentative groups within the economy is not going to provide useful insights for macro policies.  The whole point of technocratic organizations like the Fed is to be at a remove from populist pressures.  The best thing is for macro policy makers to focus on macro-level data or other data that are known to be highly correlated with macro-level developments, but most of all to understand and explain the limits of macro-level policy in affecting disparate and diverse sectors, communities and individuals. 

The Takings Clause in Bankruptcy: Making Sense of the Different Outcomes for Secured and Unsecured Claims

In  a recent edition of the invaluable Daily Bankruptcy News, a link appeared to an article by one Professor Charles Jordan Tabb entitled "The Bankruptcy Clause, the Fifth Amendment and the Limited Rights of Secured Creditors in Bankruptcy" which dealt with subjects I find interesting and have written about, so I read it.  It turns out to be essentially the same as a paper he gave at an ABI panel earlier this year, and as that paper is more accessible, I link to it rather than the cumbersome SSRN site that DBN linked to.

The article is a good example of two things:  One, the traditional law-professor-approach of taking some appellate opinions, identifying alleged inconsistencies in them, and then concluding that they really don't mean what people think they mean, they mean what the professor wants them to mean.   The second thing the article exemplifies is the current vogue of making conclusory claims about deficiencies in corporate reorganization due to purported domination of those cases by secured creditors in some "unfair" way, leading to a cry to "reform" the process to restore a Edenic "balance" that actually never existed at all.

I think the article is wrong on both counts.  First, as I assume the reader has not read it, I must explain what it says in some detail.  But to save the busier readers among you some time, here is the punch line of my argument:  All claims, secured and unsecured, are entitled to be protected against government expropriation under the Takings clause; the reason the topic only comes up in the context of secured claims is that that is the only context, when dealing with an insolvent debtor, where there is value to litigate about.  The discharge of unsecured debt in bankruptcy is indeed a taking, but often the just compensation for the taking amounts to zero when the asset taken (the discharged claim) is worthless, and, to the extent there is value available for distribution on account of unsecured claims, the bankruptcy process does a fairly reasonable job of getting that value to the holders of those claims, mitigating any Takings claim. 

Tabb;s article focuses mainly on a close reading of the major 20th century Supreme Court opinions on the limits of the Bankruptcy Clause, which, he says, rest on a "property/contract" distinction, that is,  a secured creditor's property interest in collateral is protected by the Takings Clause to the extent of its value, while unsecured (for which he uses the word "contract: as a proxy) claims are not protected at all.  (I will not address what he says about older case law, which is largely irrelevant because that era did not purport to affect secured debts via bankruptcy; in many ways, including no concept of a going concern reorganization, and debtors' prisons, the legal norms of the age were so different than our own that the subject was not even dreamed of).   Tabb says the "property/contract" distinction is "false" and "with only the slightest of pushes ... collapses".

He says the distinction is "false" because contract claims in other, non-bankruptcy contexts, have been held at the Supreme Court level to be protected by the Takings Clause.  This is correct and I won't belabor it further. 

He then goes on to devote the bulk of his attention to the (rhetorical) question, how, then can this distinction between protecting secured creditors under the Fifth Amendment and not protecting unsecured creditors be sustained?  Obviously he concludes it can't, and therefore, he syllogizes, we can treat secured claims with the same back of the hand with which we treat unsecured claims, all "for the national good" [he actually says that]. 

This argument is wrong for two very obvious reasons: (1) unsecured claims against an insolvent are often worthless, while secured claims are often not.  So, yes, unsecured claims are "taken" when a discharge occurs, but the just compensation required by the Takings Clause winds up being zero, because those claims are worthless as a practical matter, and no one bothers to spend the money needed to pursue the point as a matter of principle.  (2) When unsecured claims do have value, the bankruptcy process does a fairly reasonable job of getting that value out to the holders of those claims, so, again, the discharge may be a "Taking" in principle, but the amount of the loss -- the difference between the claim amount and the value received on account of it in the case -- which determines the amount of "just compensation" amounts to very little in real-world dollars, and again, no one seems to want to spend the kind of money required to establish the principle in our legal system just as an academic matter.

So one can come up with a much more coherent explanation of the "property/contract" distinction Tabb finds untenable:  It isn't a distinction based on label, but based on value.  Both interests are protected by the Takings clause from government expropriation to the extent of their value, but, in the main, unsecured claims against an insolvent tend to have no value  outside of bankruptcy, whereas secured claims have value outside of bankruptcy to the extent of the collateral's value.  That is why secured creditors wind up receiving protection, not because they bear  a magic label "property" but because their legal rights have meaningful value under non-bankruptcy law , while unsecured claims usually don't when the debtor is bankrupt.

  

An unsecured creditor has to reduce its claim to judgment, which may be extremely difficult (for example, in the consumer debt context, the barring of hearsay testimony under the rules of evidence, as well as statutes of limitations, pose real hurdles for a holder of defaulted debt to obtain a judgment by any means other than default).  Even then, there are non-bankruptcy laws that restrict the amount that can be collected from an individual judgment debtor, and restrict the property that may be levied to satisfy the judgment.  There are practical obstacles to getting paid on any judgment, including finding the debtor, finding unencumbered property, and most fundamentally, the fact that the debtor may not make enough money to pay much of anything on the claim.  Finally, as in the business bankruptcy context, there are usually more than just one or two unsecured creditors and it would be difficult for any one claimant making a "Takings" argument to prove that it would have been the one to win the "race to the courthouse" as opposed to coming in too late to recover anything.

In the business bankruptcy context, similar hurdles exist to realizing value on unsecured claims outside of bankruptcy.  A tort claimant will need years to get to trial, at which s/he may lose; even a winner faces appellate risks.  As a practical matter, tort claimants need settlements to get paid in any reasonable time, in or outside of bankruptcy.  A pension deficiency claim is easy to guesstimate, but much harder to prove as a fact and, as a practical matter, the cooperation of the debtor is necessary to expedite resolution.  Trade claims are surprisingly easy to delay payment on, including by way of disputing quality or price, except for "critical vendors".  Even for those creditors who might get a judgment before the debtor's assets dissipated, enforcing that judgment against a business operating in multiple states is again a tedious and draining process requiring large legal expenses that may not be economically recoverable.  And the "race to the courthouse" is likely to be even more congested with a business debtor than a consumer. 

So this is the point Tabb just misses: there are a large number of non-bankruptcy reasons why unsecured claims have no value to be compensated when they are extinguished, even though they are technically the subject of a governmental "Taking" every time a discharge is granted.

And, when there is value available to distribute to holders of unsecured claims, the bankruptcy process does a fairly reasonable job of doing that.  In particular, it solves for all the unsecured creditors the collective action problem that each would face individually.  Thus, properly administered with a view toward protecting creditors' priorities, as opposed to indulging local business owners, it delivers a reasonable approximation of the value that a "Takings" and "Just Compensation" suit would wind up delivering years later.  In fact, just as every discharge can be understood as a taking, so too we can see that every bankruptcy case embeds a just compensation litigation, and the Bankruptcy Code is a template for specifying the manner in which just compensation is to be figured out and paid out. And once the parties accept their respective awards consensually, or litigate them to finality, they are bound by the results and precluded by both claim and issue preclusion doctrines from relitigating the taking in the Court of Claims. 

Although Tabb makes a list of arguments that might rationalize the "property/contract" distinction (and knocks them down one by one), this is one he just misses completely.  He approaches the issue briefly, but fails to think in terms of value and the lack thereof.  Instead, he contends that, if the unsecured creditor just gets its ratable share of distributable value from the debtor's estate, there is "no compensation at all" and a clear "Takings violation" -- but then, he notes, the Supreme Court has never been troubled by that, so it must not be a "Taking".  Again, if one ignores economic worthlessness of an unsecured claim against a no-asset estate, as he does, that is literally correct.  But when what is "Taken" as a matter of form has no value as a matter of economic substance, his insight becomes merely academic.   The lack of value to be compensated explains fully why no one debates the Constitutionality of the discharge of unsecured debt outside of the academy.

Obviously, it isn't his goal to conclude that the Fifth Amendment limits what the government can do to creditor claims that have value. He's quite upfront about that early on, before he even begins his argument.   Citing absolutely no empirical data, he contends that, in the new "millenium" there has been a dramatic expansion in the power of secured creditors." As I have shown in prior posts, that is not true - it was well understood at the time the Bankruptcy Reform Act of 1978 was passed that secured creditors would generally have to consent to the plan "or the business will not be able to be reorganized."   Then he contends, similarly bereft of empirical data, that "Financing has  experienced a sea change [such that] many debtors enter bankruptcy with their assets fully encumbered."  As I've shown before (see same link. and also read the posts from January of this year), that has been a common feature of reorganizations going back to the railroad reorganizations of our nation's past: in the reorganization of the Denver & Rio Grande Railroad that made multiple trips to the Supreme Court in the postwar years, all the reorganization value was allocated to secured creditors, while the unsecured creditors and equity were wiped out, yet neither the regulators, nor the judge presiding over the bankruptcy, nor 7 Justices of the Court, all of whom approved the reorganization plan, had any trouble with that fact.

He goes on in the usual horrified fashion -- continuing to eschew empirical evidence -- to say that secured lenders are "driving potentially viable debtors into bankruptcy" and "Controlling secured lenders are using chapter 11 as a vehicle to foreclose on their assets" - as if secured lenders had the ability to decide whether their debtor stayed out of bankruptcy!  Then he complains that, in these 363 sales, "important stakeholders, bondholders, trade creditors, tort victims, employees, and shareholders, to name but a few are excluded from any recovery but for the whims of the controlling secured creditor"  -- with no citation but to a 1996 law review article that itself contains no empirical data.

This is such utter nonsense: the vast majority of 363 sales pass the debtor as a going concern to the buyer; in them as in pretty much all prepackaged plans and even many "traditional" chapter 11s, most trade creditors and employees usually ride right through with little economic suffering at all.  Why the other constituencies he mentions -- bondholders and, of all things, shareholders --  should be able to invade the recovery of the secured creditor's collateral, Tabb conspicuously fails to even attempt to offer a rationale.  Instead, he resorts to that tired, minimal-effort debating tactic, the rhetorical question: "Outside of bankruptcy, the secured lender may have considerable difficulty capturing anything above liquidation value. If the bankruptcy process itself allows the recovery of more value, why should all of that excess go to the secured lender?"

This approach to arguing distributional matters -- rhetorically asking one recipient how its receipt is justified -- has become a sorry staple of debate.  If one objects to a relative distribution -- as between A & B -- as "unfair", analysis of "unfairness" requires more than just asking "what justifies A's receipt of the distribution?"  If it's a relative fairness issue, then you need to ask "What justifies B's receipt of the distribution?", and then compare the two justifications that get proffered.  One can't evaluate relative claims to a limited fund by looking at just one claim, anymore than you can understand a team's ranking in a league's standings by asking what is its record, and not find out the records of the other competition around it. 

So here is the simple retort to Tabb's rhetorical question:  Outside of bankruptcy, the unsecured creditor may have considerable difficulty capturing anything, period. If the bankruptcy process itself allows the recovery of more value, why should any of that excess go to the unsecured creditor?

 

The secured creditor has taken the appropriate steps under non-bankruptcy law to establish a right to take everything, and the unsecured creditor hasn't, for its own business reasons in the cases of all but the tort creditors (who often are paid through insurance outside of the bankruptcy). Further, in many cases the secured creditor will not act as the despotic tractor beam that Tabb supposes, sucking  up all the value in the estate, including the money earmarked for payroll and bouncing the checks that trade creditors try to cash.  In many cases, it will finance the debtor's operations out of either cash collateral or an interim DIP financing or both, enabling many of the "important stakeholders" Tabb worries about to remain economically unscathed by the bankruptcy.  Then compare what the secured creditor does to what the other constituencies do for the debtor during the case: what do the retirees do to generate value in a bankruptcy?  what do the bondholders do? Etc.  Tabb doesn't bother to try to look at the full picture of his distributional problem and for that reason, along with the utter dearth of empirical support for his laments, his policy advocacy falls well short of anything that ought to elicit anyone's concern.