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. 
Posts Tagged ‘Bankruptcy’
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.
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.
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)  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.
The U.S. Court of Appeals for the Second Circuit held today that the trustee for Bernard L. Madoff Investment Securities (BLMIS) lacks authority to pursue common-law claims for damages suffered by Madoff’s customers. Based on that ruling, the Court affirmed the dismissal of a variety of damages claims against JPMorgan, HSBC and other banks relating to Madoff’s historic Ponzi scheme. See Picard v. JPMorgan Chase & Co., No. 11-5044 (2d Cir. June 20, 2013). Our firm represented JPMorgan both in the district court and on appeal.
Since the Supreme Court’s landmark decision in Caplin v. Marine Midland, 406 U.S. 416 (1972), it has been well-established that a bankruptcy trustee — as the legal successor to the debtor — may not bring damages claims that belong to creditors. It is also well-established that, under the doctrine of in pari delicto, the bankruptcy trustee for a fraudulent debtor may not sue third parties for harms caused by the debtor’s own fraud.
The idea that some banks are “too big to fail” has emerged from the obscurity of regulatory and academic debate into the broader public discourse on finance. Bloomberg News started the most recent public discussion, criticizing the benefit that such banks receive — a benefit that a study released by the International Monetary Fund has shown to be quite large.
Bankers’ lobbyists and representatives dismissed the Bloomberg editorial for citing a single study, and for relying on rating agencies’ rankings for the big banks, which showed that several would have to pay more for their long-term funding if financial markets didn’t expect government support in case of trouble.
In fact, though, there are about ten recent studies, not just one, concerning the benefit that too-big-to-fail banks receive from the government. Nearly every study points in the same direction: a large boost in the too-big-to-fail subsidy during and after the financial crisis, making it cheaper for big banks to borrow.
But a recent research report released by Goldman Sachs argues the contrary — and deserves to be taken more seriously than the first dismissive views. The report concludes that, over time, big banks’ advantage in long-term funding costs relative to smaller banks has been one-third of one percentage point; that this advantage is small; that it narrowed recently (and may be reversing); that it comes from the big banks’ efficiency and their bonds’ liquidity; and that historically it has been mostly small banks, not big ones, that have failed.
On March 27, 2013, Judge Sean Lane of the United States Bankruptcy Court for the Southern District of New York approved the $11 billion merger of US Airways Group and AMR Corporation effective upon confirmation of the AMR debtors’ chapter 11 plan. Upon completion of the merger, a new entity – “Newco,” for present purposes – will survive. In his March 27 ruling, Judge Lane declined to approve a proposed $20 million severance payment by Newco to Thomas Horton, the current Chief Executive Officer of AMR Corporation. Shortly thereafter, Judge Lane issued a written opinion explaining his reasoning for denying the proposed severance payment and in it, foreclosed an attempt to approve a severance package free from the strict standards of Section 503(c) of the Bankruptcy Code.
In connection with the proposed merger, the AMR debtors sought Bankruptcy Court approval of employee compensation and benefit arrangements (the “Employee Arrangements”) falling into three categories (i) Ordinary Course Changes; (ii) Employee Protection Arrangements; and (iii) the CEO severance payment. Though the US Trustee initially objected to all three Employee Arrangements, she eventually withdrew her objections to all but the CEO severance payment.
Frederick Tung and I recently posted “Breaking Bankruptcy Priority: How Rent-Seeking Upends the Creditors’ Bargain,” to SSRN. It is scheduled to appear in Virginia Law Review later this year. In “Breaking Bankruptcy Priority,” we examine the stability of bankruptcy’s priority structure.
Overall, bankruptcy reallocates value in a faltering firm. The bankruptcy apparatus eliminates some claims and alters others, leaving a reduced set of claims to match the firm’s diminished capacity to pay. This restructuring is done according to statutory and agreed-to contractual priorities, so that lower-ranking claims are eliminated first and higher ranking ones are preserved to the extent possible. Bankruptcy scholarship has long conceptualized this reallocation as a hypothetical bargain among creditors: creditors agree in advance that if the firm falters, value will be reallocated according to a fixed set of predetermined rules and contracts.
Firms offering comprehensive financial services scored a significant victory on April 9, 2013, when Judge Robert Sweet of the United States District Court for the Southern District of New York dismissed Capmark Financial Group Inc.’s (“Capmark”) insider preference action against four lender affiliates of The Goldman Sachs Group, Inc. (“Goldman Sachs”), which arose out of Capmark’s 2009 bankruptcy.  Davis Polk represented the Goldman Sachs lender affiliates and advanced the arguments adopted by Judge Sweet. The court’s opinion rejected Capmark’s attempt to cast the lenders as “insiders” of Capmark based on an indirect equity interest in Capmark held by funds managed by affiliates of Goldman Sachs and Goldman Sachs’s service as an advisor to Capmark. In doing so, Judge Sweet reaffirmed that corporate veils separating a lender from an affiliated entity holding equity positions or serving as advisor to the debtor will not lightly be disregarded, and that participation in an arm’s-length transaction as an ordinary commercial lender will not give rise to insider status. Furthermore, Judge Sweet held that reorganized debtors are judicially estopped from making an about-face on key factual issues underlying relief secured in bankruptcy court. In sum, the Capmark decision should pose a substantial obstacle to claims alleging that a lender is an “insider” by virtue of affiliated entities’ contacts with a debtor in the absence of evidence that the lender actually used the affiliates’ contacts to influence the debtor’s decisions.
To what extent are CEOs filing for bankruptcy tainted by the bankruptcy event? On the one hand, the CEO bears a major responsibility for the firm going broke. After all, the filing might have been avoided if the CEO had managed to reduce firm leverage or otherwise reorganize debt claims in time to stay out of court. On the other hand, CEOs going through bankruptcy likely gain valuable experience from the crisis. The net impact of these two opposing effects on executive reputation is an open empirical question.
In the paper, How Costly is Corporate Bankruptcy for Top Executives?, which was recently made publicly available on SSRN, we provide some first systematic estimates of top executives’ personal costs of corporate bankruptcy. The estimates are based on 324 large public companies filing for Chapter 11 bankruptcy over the past two decades.
The study provides evidence on the following three questions. First, do top executives experience large personal losses (both income and wealth) when filing for bankruptcy? Second, do creditor control rights influence the probability of CEO departure and the income losses? Third, do ex ante predicted personal losses affect CEO’s decision to leave the firm and their compensation contract design?