Archive for the ‘Bankruptcy & Financial Distress’ Category

What It Takes for the FDIC SPOE Resolution Proposal to Work

Editor’s Note: The following post comes to us from Karen Petrou, co-founder and managing partner of Federal Financial Analytics, Inc., and is based on a letter and a FedFin white paper submitted to the FDIC by Ms. Petrou; the full texts are available here.

In a comment letter and supporting paper to the FDIC on its single-point-of-entry (SPOE) resolution concept release, Karen Shaw Petrou, managing partner of Federal Financial Analytics, argues that SPOE is conceptually sound and statutorily robust. However, progress to date on orderly liquidation has been so cautious as to cloud the credibility of assertions that the largest U.S. financial institutions, especially the biggest banks, are no longer too big to fail (“TBTF”). Crafting a new resolution regime is of course a complex undertaking that benefits from as much consensus as possible. However, if definitive action is not quickly taken on a policy construct for single-point-of-entry resolutions resolving high-level questions about its practicality and functionality under stress, markets will revert to TBTF expectations that renew market distortions, place undue competitive pressure on small firms, and stoke systemic risk. Even more dangerous, the FDIC may not be ready when systemic risk strikes again.

Questions addressed in detail in the paper and Ms. Petrou’s answers to them are summarized below:

…continue reading: What It Takes for the FDIC SPOE Resolution Proposal to Work

“SPOE” Resolution Strategy for SIFIs under Dodd-Frank

Editor’s Note: H. Rodgin Cohen is a partner and senior chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell publication by Mr. Cohen, Rebecca J. Simmons, Mark J. Welshimer, and Stephen T. Milligan.

On December 10, 2013, the Federal Deposit Insurance Corporation (the “FDIC”) proposed for public comment a notice (the “Notice”) describing its “Single Point of Entry” (“SPOE”) strategy for resolving systemically important financial institutions (“SIFIs”) in default or in danger of default under the orderly liquidation authority granted by Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). [1] The Notice follows the FDIC’s endorsement of the SPOE model in its joint paper issued with the Bank of England last year.

…continue reading: “SPOE” Resolution Strategy for SIFIs under Dodd-Frank

A Theory of Debt Maturity

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday January 14, 2014 at 9:23 am
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Editor’s Note: The following post comes to us from Douglas Diamond, Professor of Finance at the
 University of Chicago Booth School of Business, and Zhiguo He of the
 Department of Finance at the University of Chicago Booth School of Business.

In our paper, A Theory of Debt Maturity: The Long and Short of Debt Overhang, forthcoming in the Journal of Finance, we study the effects of the debt maturity on current and future real investment decisions of an owner of equity (or a manager who is compensated by equity). Our analysis is based on debt overhang first analyzed by Myers (1977), who points out that outstanding debt may distort the firm’s investment incentives downward. A reduced incentive to undertake profitable investments when decision makers seek to maximize equity value is referred to as a problem of “debt overhang,” because part of the return from a current new investment goes to make existing debt more valuable.

Myers (1977) suggests a possible solution of short-term debt to the debt overhang problem. In part, this extends the idea that if all debt matures before the investment opportunity, then the firm without debt in place can make the investment decision as if an all-equity firm. Hence, following this logic, debt that matures soon—although after relevant investment decisions, as opposed to before—should have reduced overhang.

…continue reading: A Theory of Debt Maturity

European Bank Recovery and Resolution Directive

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday December 18, 2013 at 8:58 am
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Editor’s Note: The following post comes to us from Valia SG Babis at University of Cambridge.

The present article, Bank Recovery and Resolution Directive: Recovery Proceedings for Cross-Border Banking Groups, examines recovery proceedings for cross-border banking groups under European Union law. Recovery (or “early intervention”) includes measures intended to stabilize a bank (or banking group) and enable its recovery from financial stress. Recovery is targeted at a stage before resolution, when the bank (or group) in question has not breached the triggers for resolution, and therefore its economic recovery is still possible. The focus of this paper is primarily on three group recovery mechanisms under EU law: group recovery plans, intra-group financial assistance and coordination of early intervention measures regarding groups.

…continue reading: European Bank Recovery and Resolution Directive

The Bankruptcy-Law Safe Harbor for Derivatives: A Path-Dependence Analysis

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday December 9, 2013 at 9:33 am
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Editor’s Note: The following post comes to us from Steven L. Schwarcz, Stanley A. Star Professor of Law & Business at Duke University School of Law. The post is based on a paper co-authored by Professor Schwarcz and Ori Sharon of Duke University School of Law.

Bankruptcy law in the United States, which serves as an important precedent for the treatment of derivatives under insolvency law worldwide, gives creditors in derivatives transactions special rights and immunities in the bankruptcy process, including virtually unlimited enforcement rights against the debtor (hereinafter, the “safe harbor”). The concern is that these special rights and immunities grew incrementally, primarily due to industry lobbying and without a systematic and rigorous vetting of their consequences.

Path Dependence

This type of legislative accretion process is a form of path dependence—a process in which the outcome is shaped by its historical path. To understand path dependence, consider Professor Mark Roe’s example of an 18th century fur trader who cuts a winding path through the woods to avoid dangers. Later travelers follow this path, and in time it becomes a paved road and houses and industry are erected alongside. Although the dangers that affected the fur trader are long gone, few question the road’s inefficiently winding route.

…continue reading: The Bankruptcy-Law Safe Harbor for Derivatives: A Path-Dependence Analysis

Bankruptcy Court Denies $20 Million Severance for American Airlines CEO, Again

Posted by Kobi Kastiel, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Sunday October 27, 2013 at 9:22 am
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Editor’s Note: The following post comes to us from Alan W. Kornberg, partner and chair of the Bankruptcy and Corporate Reorganization Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP, and is based on a Paul Weiss client memorandum.

For the second time in six months, Judge Sean H. Lane of the United States Bankruptcy Court for the Southern District of New York declined to approve a $20 million severance payment to Thomas Horton, Chief Executive Officer of AMR Corporation. Earlier this year, as described in our April 18, 2013 client alert (discussed here), Judge Lane reviewed and denied the Horton severance payment as part of the $11 billion merger of US Airways and AMR Corporation but he left open the possibility—without expressing a view—of pursuing such a payment under the chapter 11 plan. In a September 13, 2013 decision, Judge Lane reviewed the same $20 million severance payment, this time included as part of AMR Corporation’s plan of reorganization, and, while confirming the plan of reorganization, again denied the severance payment. [1]

…continue reading: Bankruptcy Court Denies $20 Million Severance for American Airlines CEO, Again

A Solution to the Collective Action Problem in Corporate Reorganization

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday October 23, 2013 at 9:08 am
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Editor’s Note: The following post comes to us from Eric Posner, Kirkland & Ellis Distinguished Service Professor of Law and Aaron Director Research Scholar at the University of Chicago, and E. Glen Weyl, Assistant Professor in Economics at the University of Chicago.

Chapter 11 bankruptcy is a dizzyingly complex and inefficient process. Voting on potential reorganization plans take place by class, rules are based on achieving majorities and super-majorities by different standards, and a judge must evaluate the plan to ensure it respects pre-bankruptcy entitlements appropriately. Plan proponents can gerrymander plans in order to isolate creditors; hedge funds can buy positions that pay off if plans fail while allowing them to exert influence over the negotiation process; and judges are often unable to stop such gaming. To cut through this morass, lawyers and economists have proposed reforms, such as holding an auction for the firm or offering options to junior creditors that enable them to buy out senior creditors.

While these reforms could make important steps towards improving Chapter 11, they neglect a crucial problem the current system is designed to address: that of collective action. The current owners of various claims on the firm are usually well-suited to play the particular roles they are playing within the capital structure. Because of sunk investments in learning about the firm or their risk-preferences they are the most valuable investors to hold the assets they hold. A reorganized firm that does not have their appropriate participation may not be nearly as valuable as one that does. In fact, it may be better to liquidate the firm, even if reorganization could be efficient, than to reorganize it with the wrong owners.

…continue reading: A Solution to the Collective Action Problem in Corporate Reorganization

Rollover Risk: Ideating a U.S. Debt Default

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday September 23, 2013 at 9:00 am
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Editor’s Note: The following post comes to us from Steven L. Schwarcz, Stanley A. Star Professor of Law & Business at Duke University School of Law.

In Rollover Risk: Ideating a U.S. Debt Default, forthcoming in the Boston College Law Review, I systematically examine how a U.S. debt default might occur, how it could be avoided, its potential consequences if not avoided, and how those consequences could be mitigated. The impending debt-ceiling showdown between Congress and the President makes these questions especially topical. The Republican majority in Congress is conditioning any raise in the federal debt ceiling on spending cuts and reforms. Yet without raising the debt ceiling, the government may end up defaulting, perhaps as early as mid-October.

Even without that showdown, however, these questions are important. As the article explains, certain types of U.S. debt defaults, due to rollover risk, are actually quite realistic. This is the risk that the government will be temporarily unable to borrow sufficient funds to repay—sometimes termed, to refinance—its maturing debt.

Because rollover risk is such a concern, one might ask why governments, including the United States, routinely depend on borrowing new money to repay their maturing debt. The answer is cost: using short-term debt to fund long-term projects is attractive because, if managed to avoid a default, it tends to lower the cost of borrowing. The interest rate on short-term debt is usually lower than that on long-term debt because, other things being equal, it is easier to assess a borrower’s ability to repay in the short term than in the long term, and long-term debt carries greater interest-rate risk. But this cost-saving does not come free of charge: it increases the threat of default.

…continue reading: Rollover Risk: Ideating a U.S. Debt Default

MD&A Disclosure and the Firm’s Ability to Continue as a Going Concern

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday August 22, 2013 at 8:54 am
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Editor’s Note: The following post comes to us from Bill Mayew, Mani Sethuraman, and Mohan Venkatachalam, all of the Accounting Area at Duke University.

In January 2012, the Financial Accounting Standards Board decided by a narrow margin of 4-3 not to require management to perform an assessment of the entity’s ability to continue as a going concern. By May 2012, the FASB reconsidered this requirement and in June 2013 issued an exposure draft that mandates going concern disclosures as part of the financial report. Proponents of this requirement contend that more information is needed from management to inform investors and creditors of impending firm failure, particularly given the spate of recent bankruptcies that have occurred seemingly without warning from either the management or the firm’s auditors. Opponents contend, among other reasons, that managers already disclose sufficient information in their MD&A voluntarily. As such, their view is that an additional disclosure mandate would be an unnecessary imposition on management. In our paper, MD&A Disclosure and the Firm’s Ability to Continue as a Going Concern, which was recently made publicly available on SSRN, we directly inform this debate by assessing whether, to what extent, and when existing disclosures in a firm’s MD&A inform about a firm’s ability to continue as a going concern.

…continue reading: MD&A Disclosure and the Firm’s Ability to Continue as a Going Concern

Central European Distribution Corporation’s Chapter 11 Plan Incorporates Dutch Auction

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday August 20, 2013 at 9:10 am
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Editor’s Note: The following post comes to us from Mark S. Chehi, a partner in the Corporate Restructuring Group of Skadden, Arps, Slate, Meagher & Flom LLP, and is based on a Skadden memorandum by Mr. Chehi, Glenn S. Walter, Jay M. Goffman, and Mark A. McDermott.

On May 13, 2013, the U.S. Bankruptcy Court for the District of Delaware confirmed a prepackaged Chapter 11 plan of reorganization in the case of Central European Distribution Corporation (CEDC) [1] that incorporated an unmodified reverse Dutch auction. A reverse Dutch auction is a type of auction employed when a single buyer accepts bids from numerous sellers, and lowest-priced seller bids are accepted as winning bids.

The CEDC plan is perhaps the first instance of a Dutch auction process being incorporated successfully into a Chapter 11 reorganization plan. This precedent provides guidance for the use of Dutch auctions that may offer creditors distribution alternatives and maximize the utility of limited cash (or other limited property) available for distribution under a plan.

…continue reading: Central European Distribution Corporation’s Chapter 11 Plan Incorporates Dutch Auction

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