July 2017 | ROUNDTABLE | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
July 2017 Issue
Bankruptcy litigation is a daunting experience for any individual or organisation caught up in the storm. Certainly, for debtors, creditors, committees and trustees, as well as other stakeholders, the processes and procedures involved in examining a debtor’s affairs and establishing the legitimacy of claims are formidable. Reaching an outcome often proves particularly costly for parties in terms of time, money and reputation. With bankruptcy an ever-present reality, litigation remains a key tactic for those seeking redress.
FW: Could you provide an overview of what you consider to be the most significant developments and trends in the bankruptcy litigation arena over the past 12 to 18 months?
Root: The Supreme Court’s March 2017 opinion in the Jevic case is certainly a significant development and undoubtedly will have a ripple effect beyond the relatively narrow question that was posed to the Court. The Court held that a “structured dismissal” – a dismissal of a Chapter 11 case that modifies the rights and liabilities of parties – should not be approved if it fails to follow the “fundamental” bankruptcy priority rules that are “a basic underpinning of business bankruptcy law”. In the less than three months since the Court’s decision, we have seen courts and litigators raise Jevic to question a number of other priority shifting mechanisms that were relatively commonplace and endorsed by bankruptcy courts pre-Jevic, including gifting and priority shifting settlement motions. This is definitely an area to watch.
Eggert: The US Supreme Court’s decision in Czyzewski v. Jevic Holding Corp. limits the ability of secured and unsecured creditors to reach a settlement that does not strictly adhere to the US Bankruptcy Code’s priority scheme. Unsecured creditors routinely assert claims of the estate against lenders and other secured creditors. Until recently, those claims oftentimes resulted in a carveout for the benefit of unsecured creditors, but the Jevic decision makes this more difficult to accomplish and will likely require the use of any settlement proceeds to follow the priorities provided in the Bankruptcy Code. Implementing these types of settlements will also be more challenging because the Jevic decision narrowed the potential uses of a structured dismissal, which is a valuable and cost effective method for effectuating a settlement between secured and unsecured creditors.
Sprayregen: The decision in Czyzewski v. Jevic Holding Corp. settled whether senior creditors, whose liens exhaust a bankruptcy estate, and junior creditors or equity holders with control over the proceeding, can join forces to consummate a division of value bypassing other intervening creditors. Professor Brubaker of the University of Illinois summed it up well: “Jevic is vitally important because the Supreme Court has now taken a stand in favor of preserving the integrity of bankruptcy’s formal limits on distributions from the assets of a debtor’s estate, which is an indispensable, defining feature of any bankruptcy system”. He went on to articulate, and I agree, that while Jevic is expressly limited to the ‘structured dismissal’ context, the methodology and reasoning of the opinion provide a clear roadmap to invalidating other controversial, highly questionable distribution practices.
Durrer: Litigation continues to be a popular tactic for creditors in high-stakes bankruptcy cases, although as the volume of mandates has increased, the fact that bankruptcy professionals are busier on an overall basis has caused people to choose their battles more efficiently. We predict that as interest rates continue to rise, presumably increasing the rate of filings in the US, that this trend will result in more negotiated than litigated cases.
Montgomery: Cheap money has meant we are in a quiet period for restructuring and the focus has largely been on cross-border situations or those where there is particular sectoral pressure or special circumstances, such as fraud. There has also been continuing activity in the long tail insolvencies from the global financial crisis, such as Lehman Brothers and Nortel.
FW: What types of bankruptcy litigation have been prevalent in the past year?
Eggert: While avoidance actions – such as preferential and fraudulent transfers – remain commonplace, there has been an increase in the pursuit of directors and officers for breach of fiduciary duty and similar claims. This increase may be due to the increasing number of liquidating Chapter 11 cases, wherein many creditors believe management’s conduct caused the company’s failure and eventual liquidation. Creditors are also incentivised to pursue these claims when there is a director and officer liability insurance policy in place, as the existence of these policies ensures that there will be funds available to satisfy a judgment if the claims are successful.
Durrer: The battleground that many stakeholders have elected to pursue aggressively over the past year or so is the debtor’s proposed debtor-in-possession (DIP) financing. Debtors and senior creditors have tried, as a tactic, to lock in key elements of a restructuring at the DIP financing phase, such as timing, exit financing, treatment of senior debt, and the like. Junior creditors see this moment as their prime opportunity to extract value or enhance their recoveries by slowing down or otherwise exposing weaknesses in the debtor’s proposed reorganisation approach. Stakeholders are well advised to pay close attention to how DIP financing relates to the overall case – it could devastate a distressed company to suffer a delay or uncertainty in approval of such financing. Bankruptcy litigation, just like non-bankruptcy litigation, can be an extremely costly and time-consuming process for a company. However, bankruptcy litigation is unique in two respects. First, a company going through a formal bankruptcy process demands tremendous focus and attention from its management team to undertake a financial or operational restructuring at a time when that same team is typically already operating in a stressed environment merely to continue operations. Second, bankruptcy litigation enhances speculation regarding whether the company will survive which speculation may further impede the overall progress of the restructuring. Therefore, even though bankruptcy litigation proceeds on an accelerated timetable relative to non-bankruptcy litigation, it is often more damaging and distracting for company management due to the contextual pressures imposed by the ongoing restructuring itself.
Sprayregen: Makewhole issues, priority disputes, ‘insider’ status and intercompany claims have dominated recent bankruptcy litigation. There has also been interesting litigation regarding a debtor’s ability to reject certain midstream pipeline agreements and perfection disputes with bank lenders over security interests in oil and gas reserves. On the makewhole front, the Third Circuit in EFH found that makewhole provisions were enforceable in bankruptcy and that the noteholders there were entitled to the applicable premiums, thus parting with judge Drain’s decision in Momentive. In reaching its conclusion, the Third Circuit distinguished “redemption” premiums from “prepayment” premiums, finding the acceleration of the notes did not cancel EFH’s obligation to pay the premiums triggered by early redemption from postpetition refinancing. We will be closely watching how the Second Circuit deals with these issues when a decision is reached in the long awaited Momentive appeal, pending since oral argument in November 2016.
Montgomery: In the UK, the Lehman ‘waterfall’ cases have provided some interesting decisions in the insolvency context, for example on currency conversion claims. This is of particular interest to those affected by recent large currency swings involving sterling, following the Brexit vote in 2016, and the Swiss franc, following its unpegging from the euro in 2015. Interesting new legislation and case law in Singapore is attracting a lot of attention, as that country seeks to set itself up as a restructuring hub with liberal jurisdictional rules.
Root: In the past year, we have seen continued litigation over a number of hot button issues – fraudulent transfers and safe harbours, section 105 injunctions, enforceability of makewholes and third-party releases. We are also continuing to see litigation trusts created as a part of plans of reorganisation where significant pieces of litigation are reserved for prosecution by a litigation trustee for the benefit of creditors. Kicking the can on costly and protracted litigation permits a faster exit from Chapter 11 while preserving potential recoveries for stakeholders.
FW: How have recent court rulings impacted on the bankruptcy litigation space? How, in your opinion, will the outcome of such cases influence the way in which parties conduct their affairs in future litigation cases?
Durrer: The reversal by the Second Circuit Court of Appeals in the recent line of cases arising under the Trust Indenture Act (TIA) has caused restructurings to go ‘back to normal’ in that companies are more readily able to restructure public debt outside of Chapter 11. Historically, courts have interpreted the TIA to require unanimous consent by bondholders in order to effect any change to the payment terms of the governing indenture, contrasted with mere majority consent to effect changes to non-payment terms. However, a few years ago, a couple of federal trial courts in New York ruled – on different procedural grounds – that proposed out-of-court restructurings that allegedly involved changes to non-payment terms of governing bond indentures violated the TIA, on the theory that these changes affected the practical ability of a bondholder to recover payment on its bonds. The appeals court, in reversing these rulings, held that prior practice was in fact the rule. This should quiet one aspect of recent litigation trends. However, separately, an appellate court arising from a bankruptcy case in Delaware has made so-called third-party releases more difficult to obtain. A third-party release is where participants in a Chapter 11 reorganisation are protected by the bankruptcy court from claims of third-party creditors. This goes beyond the normal ‘discharge’ from liability that the debtor itself receives. In Millenium Lab Holdings II, LLC, the bankruptcy court approved the releases, but the district court reversed on the basis of the Supreme Court’s 2011 ruling in Stern v. Marshall. In short, the district court found that the bankruptcy court had exceeded its jurisdictional power, absent additional procedures and findings that would be very difficult to achieve in ideal circumstances. Practitioners would be well-advised to monitor subsequent rulings on this issue.
Sprayregen: The landmark Sabine decision shook up the bankruptcy litigation world recently. Judge Chapman permitted debtors to reject a key gas‑gathering contract with their primary midstream service provider. Opining the relevant contracts did not contain covenants that “run with the land” under Texas law, the court concluded such contracts were subject to rejection under the Bankruptcy Code. The decision sent ripples throughout the oil and gas industry, whereby other debtors gained leverage and moved to reject similar contracts. In Magnum Hunter and Penn Virginia, the debtors benefited from the Sabine result. Specifically, midstream providers to those debtors negotiated resolution, rather than risk a potentially negative litigation outcome. The impact of these cases has largely promoted negotiation and settlement with midstream counterparties, who realise litigating the issue is expensive and risky and it may be better to do some business than no business at all, depending on the unique facts of each situation.
Montgomery: There has been a lot of activity in the US. Debtors continue to bring aggressive clawback claims, including against financial institutions and various investment funds. This in turn puts into question the correct scope of the safe harbours exempting certain financial contracts from clawback risks. The US Supreme Court has recently agreed to hear one such case, Merit Management. And, there are at least two additional cases where debtors have requested Supreme Court review. So we expect to see some clarity concerning these provisions of the Bankruptcy Code in 2017 or early 2018. We also see non-US debtors invoking the US foreign recognition rules to pursue claims against US defendants with the goal of obtaining a relatively favourable forum and broad US style discovery. There are two prominent cases on foot and, depending on how they develop, we may see this strategy deployed more often.
Root: In addition to Jevic and the potential repercussions it has for gifting, settlements and other bankruptcy court priority deviations, the Supreme Court’s 2015 Wellness International case continues to be a high impact case for bankruptcy litigators. While Wellness clarified that litigants asserting and defending Stern claims could consent to the bankruptcy court’s final adjudication of those claims, thereby making the question of consent a fundamental issue that many bankruptcy courts are directing litigants to answer at the outset of adversary proceedings or contested matters, we are continuing to see litigation over what constitutes a Stern claim in the first instance. That is, the types of claims which might be delineated by the Code as ‘core’, but nevertheless require consent for final adjudication. This issue is presently before a Delaware bankruptcy court in the Millennium Labs bankruptcy, where the court has questioned whether it has constitutional authority to grant non-debtor third-party releases. In addition, the Second Circuit’s decision in General Motors that the “free and clear” protections of Section 363 did not apply where the debtor failed to give actual notice of a bankruptcy sale to potential claimants, will certainly impact notice and due diligence for both debtors and sellers in Section 363 transactions.
Eggert: The Jevic decision will not only impact how settlements are structured, but also the duration of litigation. Jevic created additional challenges for unsecured creditors in connection with a settlement of claims against secured creditors because it found that, under certain circumstances, the proceeds of a settlement must be used strictly in accordance with the priority scheme provided in the US Bankruptcy Code. The parties were previously able to structure such settlements so that only unsecured creditors received the proceeds. This will likely reduce the recovery for unsecured creditors because administrative and priority claims must first be paid in full. This smaller recovery may deter unsecured creditors from settling litigation in hopes of a greater recovery if the case is pursued to judgment.
FW: Full-scale litigation tends to be an enormously expensive process. With this in mind, are you seeing parties take a more creative and consensual approach to finding workable solutions in bankruptcy scenarios?
Eggert: Bankruptcy litigation is slightly different from a typical litigation case because there is often more urgency based on the debtor’s precarious financial condition, among other factors. Additionally, parties in bankruptcy cases may have similar goals, such as maximising the value of the debtor’s assets and minimising costs to the estate. But it is becoming increasingly difficult to realise value from a debtor’s assets, as many companies are selling their most valuable assets prior to filing for bankruptcy and the remaining assets are fully collateralised. The cost of administering a bankruptcy case is also increasing. These factors make parties in bankruptcy cases willing to seek creative solutions to complex problems and I expect that trend to continue.
Root: A common expression is that parties in a bankruptcy case are fighting over a ‘melting ice cube’, and as a consequence, most bankruptcy attorneys are practical litigators with an eye toward the endgame. Following the successful mediations in large, complex bankruptcy cases, parties seem more willing to engage in forms of alternative dispute resolution, including mediations, to resolve particularly thorny or multi-party disputes.
Montgomery: The number of litigation funders in the market continues to increase, including specialist insolvency players who are also interested in acquiring claims from insolvency practitioners. Some firms of insolvency practitioners have been looking at portfolio finance across a number of estates, which could have advantages for the firm and funder.
Sprayregen: Negotiation and settlement are not new or creative approaches to avoiding extensive, costly litigation. But they are effective. Recent decisions have promoted just that. Decisions regarding contract rejection, makewhole provisions and reserve-based loan perfection have compelled most practical businesses to renegotiate or settle to avoid the costly uncertainty of court determination, along with a lengthy appeal process. Other creative alternatives, if available, include refinancing, junior lien debt, asset sales and exchange offers.
Durrer: The use of mediators and arbitrators has been on a steady rise in bankruptcies for years to address expense issues, but the real growth has been in the utilisation of mediators and arbitrators to broker global solutions which can ultimately result in the development of a plan of reorganisation with the consent of major constituencies. Current and former judges as well as practitioners serve as mediators in many jurisdictions, bringing more parties to the table as participants, and helping to ensure that all parties participate in good faith. Mediators and arbitrators facilitate communications among the parties and therefore allow parties to share perspective in ways that the heat of litigation sometimes stymies. Such objective analysis helps parties to develop more pragmatic views of the potential range of outcomes and therefore achieve a negotiated, self-determined resolution.
FW: How would you characterise the evolving dynamic between various creditor committees and creditor classes in a modern bankruptcy process? What impact is this dynamic having on bankruptcy-related litigation?
Root: We have seen an increase in the number of committees representing creditors in large cases. It is not unusual to have more than one creditors committee, an equity committee, and ad hoc committees. More committees means more parties at the bargaining table advocating for their constituents, which can make achieving a global resolution more difficult and protracted, even if the end result is a compromise that better serves the interests of all of the players, as opposed to one or two key groups or creditors.
Montgomery: There is some trend away from the traditional model of debtors negotiating a standstill and restructuring with a committee of senior lender banks established relatively early, once maintenance covenants are under threat. Newer forms of debt with fewer covenants and, particularly more tradeable instruments have changed this dynamic and creditors buying in will often see litigation as one of the tools available to be deployed in a restructuring context.
Sprayregen: The creation of creditor groups and committees reduces the amount and risk of litigation. Generally, when creditors operate as a group, the majority opinion rules and the majority of creditors think economically and prefer to avoid the time and expense of litigation. True, there have been several recent cases that involve hostile groups but one needs to guard against the risk of the lowest common denominator approach. Nevertheless, generally the formation of groups and committees reduces the risk of litigation. Creditors are more often than not economically rational and aware that litigation is a gamble.
Durrer: Courts in the US may approve the formation of more than one creditors’ committee, and may also approve the formation of an equity committee, all at the expense of the company. In light of these increasing out-of-pocket expenses and opportunity costs, modern bankruptcy solutions favour a prenegotiated consensual solution prior to commencing a formal insolvency process. Accordingly, companies are encouraged to be proactive in engaging various constituencies and allowing such constituencies sufficient time to engage in the negotiating process. Absent such engagement, debtors may find that they end up in litigation with committees that could have been avoided or mitigated.
Eggert: The natural tension between secured and unsecured creditors always creates the potential for litigation. There can, however, also be instances where unsecured creditors’ interests are not necessarily aligned, such as when different segments of unsecured creditors are members of a creditors’ committee. These segments of unsecured creditors may have different motivations, and the dynamic between the different types of unsecured creditors could impact the path a committee takes in a case, including the nature of claims that are asserted and the parties the committee seeks to pursue. In certain circumstances, there will be more than one committee appointed in a particular case, retiree and bondholder committees for example, to address the potential for competing interests.
FW: In your opinion, are mediators and arbitrators now playing a more active role in the bankruptcy process?
Montgomery: There has always been a role for alternative dispute resolution (ADR) where there are holdout creditors or reluctant debtors in an insolvency situation. However, it is most common in circumstances where the cost of litigation would be disproportionate to the sums involved.
Sprayregen: Judges, practitioners and parties are further promoting and requiring mediation, more so than arbitration. That said, I do not believe mediation is always in the best interest of the client due to the dynamic nature of each case and the ability of bankruptcy courts to expedite litigation where necessary. I have found that mediation is most often employed when counsel is unsuccessful in reaching negotiated consensual resolutions. The phenomenon of bankruptcy judges acting as mediators in some jurisdictions is noteworthy. The result is generally quite positive and they tend to have a little more cache than non-judge mediators.
Eggert: I personally feel that the role of mediators has increased over the last few years. The increasing cost and complexity of litigation is likely driving more parties to explore the possibility of a settlement through the mediation process. Additionally, mediations seem to be taking place during the earlier stages of cases in order to explore whether parties can reach a resolution before expending the significant time and resources that are associated with litigation. Parties must, however, be careful not to waste time by mediating when there is no real possibility of a settlement. A mediation is more likely to be successful if both parties have a strong handle on the strength and weaknesses of their case and are willing to approach the mediation process with an open mind.
Root: Sophisticated parties recognise that complex litigation involves significant risk and that the cost of protracted litigation creates a ‘lose lose’ scenario where the dollars the parties are fighting over are being used to fund the dispute. Particularly in multi-party disputes, mediators can help guide parties to a global settlement and bankruptcy judges seem increasingly more proactive appointing or suggesting mediators, including other sitting or retired bankruptcy judges. We have seen the success of this approach in recent large and complex cases, including in the City of Detroit bankruptcy, where Judge Rhoades opined that the settlement brokered with the assistance of mediators “borders on the miraculous”.
FW: What can parties do to control some of the common challenges – and related costs that arise in bankruptcy litigation?
Sprayregen: The best offence is a good defence. Parties should retain advisers as soon as distress is apparent. Early involvement of restructuring professionals can eliminate or substantially mitigate the adverse consequences that often arise in distressed situations. Put another way, early involvement by advisers is akin to a healthy diet and exercise regimen, whereas waiting too long can result in emergency open‑heart surgery. Additionally, I always use the phrase ‘process is substance’. A focus on process and documentation is an imperative way to maintain control in the context of a litigation scenario. Clear records of important decisions often prove critical when the decisions are challenged, sometimes years later.
Root: Complex bankruptcy litigation often requires an immense amount of discovery related work over a very short period of time. One way for parties to minimise both the practical difficulty of managing discovery and the associated costs is to reach agreements at the outset as to reasonable limitations on the scope and time period for document collections and the examination of witnesses. Additionally, in multi-party cases, streamlining discovery so that parties sharing productions and jointly depositing witnesses can cut down on the redundancy that lengthens litigation and increases costs.
Eggert: Many of the common challenges and costs of litigation can be minimised by completing a thorough analysis of the facts and law at the outset of a case. Too often parties delay a detailed review of the facts or law at issue in their case, which can result in multiple extensions of discovery and case deadlines, prevents a party from fully understanding the strengths and weaknesses of their case, and results in a party not focusing on key issues. Performing a front-end detailed analysis will often include retaining experts early on in the case.
Montgomery: Jurisdictional choice is an important consideration in a cross-border context. By way of example, litigation is increasing in the US in non-US situations, but costs, timing and the relief that can be obtained will vary from jurisdiction to jurisdiction. So it is important to consider all possible options. If you are the defendant, then there will be strategic decisions whether to take part in foreign proceedings or to keep your powder dry and defend recognition at home or wherever you have assets.
FW: Not everyone can emerge satisfied from a bankruptcy dispute. In your experience, what factors are required to reach a positive resolution for the benefit of most interested parties?
Eggert: I would define a positive resolution as a result with which the client is completely satisfied. This does not necessarily require a wholesale victory and may involve a settlement where loss is minimised. The professional must always advocate for its client, but must also be candid in explaining the likelihood of success and whether the client’s expectations are realistic. Similarly, the client can provide invaluable information, such as industry and market data, historical knowledge and strategic business considerations. A positive resolution requires constant and straightforward dialogue between a client and its professionals and then interfacing with the other parties on a regular basis so that the strategy can continually evolve.
Montgomery: If litigation is being brought by an insolvency practitioner, they will have a duty to pursue a course which is in the best interests of creditors generally. The costs risk for such actions can be managed in appropriate cases through litigation funding, while retaining flexibility to settle litigation where possible and in the interests of creditors.
Durrer: Advisers should periodically ‘check-in’ to ensure that they remain sensitive to the commercial interests of their client and the other parties involved in bankruptcy disputes, and to how those interests shift and evolve particularly during the course of the reorganisation process. One approach is to develop a timeline of critical deadlines where a client must pick between potential alternative pathways. Then, work backwards to develop the tasks with the client that will ultimately dictate which alternative is achievable. Most often, staying on track will also require keeping lines of communication open and scheduling meetings with other parties – including parties not directly involved in the dispute – to garner support for proposed solutions and also ensures that there is an open channel for settlement discussions. Finally, knowing whether and when to propose alternative dispute resolution procedures could be critical in breaking through barriers to an agreed outcome.
Root: In theory, a successful bankruptcy case ends in a grand compromise – the confirmed plan of reorganisation. In practice, this means that very few parties will ride through the bankruptcy case without taking some sort of hit to their prepetition position. Most sophisticated players recognise the commercial realities of a bankruptcy case, but it is important to manage expectations throughout the process and to identify what a successful outcome would look like, keeping those realities in mind. In addition, notwithstanding the trend of prepacks and lock-up agreements, we are seeing many cases where additional sources of recovery are identified after the filing. In particular, creditors who were not privy to pre-filing negotiations and settlement discussions should approach a filing creatively and with a critical eye to identify additional causes of action and sources of recovery.
Sprayregen: While every case involves particular hurdles requiring a variety of approaches, preparation and flexibility are always key factors in reaching a positive resolution. Even if it is not certain a Chapter 11 filing is necessary, parties should be informed and realistic regarding all potential avenues at the outset. As one example, there are advantages for most parties in prepackaged and prearranged cases. And, conversely, disadvantages abound in free fall cases. Reaching a positive resolution also requires creativity, proactivity and the ability to consider settlement. Restructuring is a contact sport and one needs to proactively drive the deal. I often use the phrase ‘compared to what’ in helping them understand that they are not comparing options to nirvana – they are weighing them against the best reasonable alternatives in their given situation. Plus, negotiations are never over and settlement is always possible.
FW: What bankruptcy litigation issues do you feel will continue to remain in the spotlight for the foreseeable future? Conversely, are any likely to decline in significance?
Montgomery: In the UK, there is a trend toward stricter interpretation of the insolvency rules, which govern the practicalities of dealing with and prioritising insolvency claims. Although the rules have recently been reformulated, there remain a number of areas of where the text of the rule is unclear and, following recent Supreme Court case law, the formerly accepted practice may be in doubt, for example in relation to administration expenses. This could prove fertile ground for litigation.
Durrer: Given the recent reversal at the Second Circuit Court of Appeals, we expect to see litigation over the TIA fade into the background. However, the recent Millenium Health decision will likely reinvigorate Stern v. Marshall litigation in the context of confirmation of plans of reorganisation. Preference and avoidance action will likely remain a staple in bankruptcy litigation.
Root: We have seen continued litigation over the safe harbour exception to a trustee’s avoidance powers under Section 546, which excepts “margin payments”, “settlement payments”, and other transfers arising “in connection with” a securities contract, commodity contract or certain other contracts from avoidance. As originally drafted, this “exception” was intended to protect against disruptions in the commodities market. But over the years, the statute itself was amended to broaden the reach, and courts’ interpretation of the statute have likewise expanded upon this once narrow exception. In 2016, the Second Circuit, in the Tribune appeal, held that Section 546 pre-empted state law constructive fraudulent transfer laws and prohibited individual creditors from asserting those claims. In the wake of these decisions, and in light of the recent Supreme Court decision in Husky expanding on what conduct constitutes actual fraud, we may see less litigation over constructively fraudulent transfers and more plaintiffs asserting claims of actual fraud, which are not protected by the safe harbour. Although Tribune and earlier decisions from the Madoff and Sentinel cases signal a broadening of the statute, 2016 also brought along one outlier, Merit Management. In that case, the Seventh Circuit bucked the majority view and held that payments made to a financial intermediary – where that financial intermediary is a mere conduit – are not protected under the safe harbour, thereby allowing the trustee to pursue claims against the ultimate recipient of the transfer. Merit Management is currently before the Supreme Court. Whatever the outcome, Section 546 will continue to be a hot button litigated issue.
Sprayregen: Every individual case poses numerous different potential litigation issues. I do not foresee litigation regarding intercreditor agreements and perfection issues going away anytime soon. Makewhole provisions will likely also continue to remain in the spotlight until courts are able to provide a more solid consensus on their enforceability. And, of course, Stern issues still arise from time to time.
Eggert: I expect that fraudulent transfer and director and officer claims will remain in the spotlight for the foreseeable future. With the large number of liquidating Chapter 11 cases in recent years, creditors and liquidating trustees are oftentimes focused on recovering questionable transfers made in the years prior to the bankruptcy filing, and are also pursuing former management for their actions in the time leading up to the company’s bankruptcy filing. However, recharacterisation claims – wherein a party seeks to recharacterise purported debt as equity – will decline in the upcoming years. The Fifth Circuit’s Lothian Oil decision changed the landscape of these claims by requiring a plaintiff to look to state law to support the recharacterisation of debt to equity, and courts across the country are adopting that approach.
FW: Going forward, to what extent do you expect to see directors & officers specifically targeted by creditors in bankruptcy related litigation?
Durrer: Creditor focus on the actions or inactions of directors and officers in insolvency situations will not likely change. Directors and officers will face scrutiny not only with respect to their independence but also with respect to their level of care and exercise of business judgment in decision-making with respect to major transactions. We continue to recommend the timely formation of independent or special committees plus the engagement of subject matter experts as powerful tools to mitigate such claims responsibly and effectively. The use of this strategy also enables the company to evaluate proposed transactions involving arguably interested or affiliated parties while preserving, in most cases, business judgment review of director decision-making.
Eggert: I expect directors and officers will be specifically targeted on a regular basis in bankruptcy cases. The rise of liquidating Chapter 11 cases has resulted in many creditors and trustees pursuing directors and officers on the basis that actions taken by management while the company was insolvent caused the company’s downfall. These claims typically take the form of breach of fiduciary duty or similar claims of mismanagement. Many companies also have director and officer liability insurance that covers the creditor and trustee claims, thus guaranteeing those parties a recovery if their claims are ultimately successful.
Sprayregen: Directors and officers are continuously targeted but their risk of liability has decreased in the US due to recent Delaware Supreme Court decisions. In fact, US directors and officers have a lot more free rein and less risk of liability, on a comparative basis, than in other countries, such as Australia, the UK or Germany. However, they must still always carefully follow good process and expert advice. A likely area of increased litigation is regarding statutory ‘insider’ status. In The Village at Lakeridge, a third party acquired a $2.76m claim from an insider for $5000. The court determined the assignee was not an insider and the assignment was not made in bad faith. Separately, in Avaya, the debtors and trustee litigated, but ultimately settled, whether certain officers were insiders for purposes of compensation plans. The trustee’s position was that any board-appointed officer was an insider, regardless of the amount of authority and control exercised.
Root: Although directors and officers will continue to benefit from the business judgement rule, we can expect that creditors looking for an additional pool of recovery will press for investigations and examiners in any circumstance where it appears that there was self-dealing or lack of appropriate diligence. In addition, parties who may be blocked from recovering against third parties by the ever expanding Section 546 safe harbour exception – for example, creditors in an insolvency caused by a leveraged buyout – may look to directors and officers as alternate sources of recovery.
Montgomery: Direct claims by creditors would generally require some special factor, such as fraud. However, claims against directors and officers by insolvent companies or insolvency practitioners are a continuing trend, especially given the rise of specialist litigation funders interested in acquiring such claims. Additionally, there is an increased focus of regulators on individual responsibility in regulated industries, notably financial services, and a general increase in regulation and guidance in the UK around what is expected of directors of companies. This is also an area of increased political focus for the media and parliamentary committees, where individual reputations can be at risk, whatever the legalities of the situation.
FW: How do you expect the bankruptcy litigation arena to unfold throughout the course of 2017 and beyond? Do you expect to see an uptick in activity?
Sprayregen: As energy and power sector restructuring activity decreases, distressed retail and healthcare-related entities will likely be at the forefront. It is also somewhat difficult to predict how the market will react to the effect of president Trump’s promised business-friendly policies.
Root: Although interest rates are expected to rise, it is unlikely they will do so at a rate that precludes refinancing for many would-be debtors. Nevertheless, we are expecting to see an uptick in Chapter 11 filings in particular industries, for example in the retail space, which will lead to an increase in bankruptcy litigation generally. Within the retail industry, we can expect active litigation between landlords and lessees. Indeed, the issue of whether a prepetition lease termination gives rise to a preference or fraudulent transfer claim was the subject of two recent decisions – Great Lakes Quick Lube and Prime Income. We should also be on the lookout for municipalities seeking relief under Chapter 9, which will drive complex bankruptcy litigation.
Montgomery: Brexit will be a focus, especially once it becomes clear what the post-exit arrangements will be. One area for new court rulings will be whether England can remain the restructuring capital of Europe, with other countries such as the Netherlands – and even jurisdictions like Singapore – hoping to attract a lot of that business. The legal bases for jurisdiction and recognition of schemes of arrangement and insolvency processes will change, not necessarily for the worse, and legal innovation is likely to be required to navigate the new landscape.
Eggert: Bankruptcy litigation has increased over the past several years and I expect that trend to continue. Many Chapter 11 cases today have an undersecured lender and a quick sale process. The result in many of these cases is an unsecured creditor body left with little chance of a meaningful recovery unless they decide to pursue litigation against lenders, management and other insiders, and even other unsecured creditors. The US Supreme Court’s decision in Jevic will make it more difficult to reach a settlement with lenders that is only for the benefit of unsecured creditors, thus prolonging the cases against secured creditors. Creditors, moreover, will continue to pursue former management based on their perceived fault in causing a company’s liquidation and the existence of liability insurance further incentivises creditors to pursue those claims.
Durrer: The Stern v. Marshall lines of cases will create opportunities for junior creditors to attempt to extract value in the context of contested confirmation hearings. At the core, however, we expect the emphasis on cross-border restructurings to remain robust throughout 2017 and beyond, as companies continue to seek comprehensive restructuring solutions to their global issues and challenges. US courts are becoming increasingly sophisticated in the mechanisms of cross-border insolvency cases, and creditor constituencies are also becoming more sophisticated in the mechanisms for challenging global insolvency proceedings on a jurisdiction-by-jurisdiction basis. Companies in distress have an increasingly broad array of options to plan and execute a financial or operational restructuring, but given the increasing complexity of reorganisation processes, it is imperative that a would-be debtor begin its contingency planning process in advance, to maximise the potential for consensual resolutions with its major constituents.
Devon Eggert is a partner and co-leader of the Bankruptcy and Financial Restructuring Practice Group at Freeborn & Peters. Mr Eggert has represented debtors, creditors’ committees, and secured and unsecured creditors in Chapter 11 proceedings, insolvency litigation, and out-of-court restructurings across the US and abroad. He can be contacted on +1 (312) 360 6305 or by email: email@example.com.
Craig Montgomery is a partner in Freshfields Bruckhaus Deringer LLP’s dispute resolution practice and restructuring and insolvency practice in London. Mr Montgomery has a broad practice, advising on a range of matters, including contentious restructuring and insolvency matters, especially complex matters in regulated industries or involving cross-border issues. He also advises on insurance restructuring and insolvency, including schemes of arrangement and Part VII transfers, commercial litigation, corporate investigations and contentious regulatory scenarios. He can be contacted on +44 (0)20 7716 4888 or by email: firstname.lastname@example.org.
Melissa M. Root is a bankruptcy attorney experienced in sizeable bankruptcy cases. She frequently represents parties in large complex bankruptcy litigation matters and also frequently represents committees, debtors and trustees in Chapter 11 cases. Ms Root also frequently represents clients in bankruptcy appeals, including representing the petitioner in the Supreme Court's recent Wellness International decision. Ms Root is a member of the firm’s restructuring and bankruptcy, bankruptcy litigation and ERISA litigation practices. She can be contacted on +1 (312) 840 7255 or by email: email@example.com.
James H.M. Sprayregen is a restructuring partner in the Chicago and New York offices of Kirkland & Ellis LLP and serves on Kirkland’s worldwide management committee. He is recognised as one of the outstanding restructuring lawyers in the US and around the world and has led some of the most complex Chapter 11 filings in recent history. Mr Sprayregen also has extensive experience representing major US and international companies in restructurings out of court and in court around the globe. He can be contacted on +1 (312) 862 2481 or by email: firstname.lastname@example.org.
Van C. Durrer II leads Skadden, Arps’ corporate restructuring practice in the US and advises clients in restructuring matters around the Pacific Rim. He regularly represents public and private companies, major secured creditors, official and unofficial committees of unsecured creditors, investors and asset-purchasers in troubled company M&A and financing and restructuring transactions, including out-of-court workouts and formal insolvency proceedings. He can be contacted on +1 (213) 687 5200 or by email: email@example.com.
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