Article/Intelligence
Academic Roundup 2023-2024 With the Harvard Law School Bankruptcy Roundtable
Reorg’s collaboration with the Harvard Law School Bankruptcy Roundtable continues with the first Reorg/BRT Academic Roundup. This is a selection of academic articles posted on the Harvard Law School Bankruptcy Roundtable during the 2023-2024 academic year that the editors of the BRT believe will be most interesting, useful or informative for Reorg’s subscribers.
This year’s Academic Roundup articles cover a wide range of topics, including broad, evolving trends in bankruptcy, controversies surrounding provisions found in transaction documents, analytical tools for predicting financial distress, doctrinal questions about international insolvency and more.
The Harvard Law School Bankruptcy Roundtable is a publication of Harvard Law School that aims to bridge the gap between academic study of bankruptcy and the on-the-ground practice of restructuring professionals. We’re excited to partner with the Roundtable and hope to continue this partnership to bring the views and insights of academics and practitioners together.
You can subscribe to the Harvard Law School Bankruptcy Roundtable here.
A Commitment Rule for Insolvency Forum
Professors Anthony Casey (University of Chicago), Aurelio Gurrea-Martinez (Singapore Management University) and Robert Rasmussen (USC Gould School of Law)
The prevailing United Nations Commission on International Trade Law (UNCITRAL) rule for determining the appropriate “foreign main insolvency proceeding” forum in cross-border insolvencies ought, the authors argue, to be replaced.
The authors favor a Commitment Rule, subject to conditions. That rule would require debtors to commit in their charters to an insolvency forum ex ante. Such a rule would mitigate opportunistic forum-shopping and provide greater certainty for creditors, reducing litigation costs and facilitating institutional development around the world.
The reason to replace is that the Model Law on Cross-Border Insolvency’s “center of main interest” rule results in opportunistic forum-shopping by debtors, increases litigation costs and fails to mitigate creditor uncertainty ex ante.
This article was featured on the Harvard Law School Bankruptcy Roundtable and is accessible here.
Bankruptcy’s Turn to Market Value
Professors Mark Roe (Harvard Law School) and Michael Simkovic (USC Gould School of Law)
Chapter 11 bankruptcy, introduced in 1978, faced much criticism in the 1980s for inefficiency and susceptibility to abuse, with cases often needing years to resolve. Modern bankruptcy proceedings take months instead of years. This success has been attributed to various factors: creditor learning, statutory reforms, improved legal and judicial practices. The authors add and emphasize the importance of bankruptcy’s turn to market value, which was not usually accepted when the Bankruptcy Code came into play. Accepting market value reduces conflict and speeds up proceedings. The authors bring forward four developments relevant to this shift: changes in judicial attitudes, the rise of market transactions such as 363 sales, the growth of distressed debt markets and the decreased range of dispute today when valuation is contested. The rise of market value has been pivotal in the success of chapter 11.
This article was featured on the Harvard Law School Bankruptcy Roundtable and is accessible here. It is forthcoming in the University of Chicago Law Review. A Reorg event in which one author presented the article’s analysis is available here.
Creditors Strike Back: The Return of the Cooperation Agreement
Professor Samir Parikh (Lewis & Clark Law School)
Low interest rates following the Great Recession fueled demand for high-yield investments. This phenomenon enabled private equity firms to exploit borrower leverage and craft agreements with provisions that could be used to undermine creditor interests. In recent years there has been a surge in coercive tactics by distressed borrowers, who utilized ambiguous contract terms to divert assets from creditors. Scholars have extensively documented these tactics but overlooked how creditors could respond.
This essay fills that gap by examining cooperation among creditors, weighing its benefits against risks such as free riding. It also investigates the structure of cooperation agreements on the basis of a first-hand review of actual agreements from recent disputes. Despite the clear advantages of coordination, obstacles remain, including the borrower’s ability to sow discord. Creditors face a dilemma: cooperate for potential gains or defect and align with the borrower. The specter of opportunistic behavior looms large, complicating these high-stakes negotiations.
This article was featured on the Harvard Law School Bankruptcy Roundtable and is accessible here.
Loan-to-Own 2.0
Professor Robert Miller (University of South Dakota, Knudson School of Law)
The recent rise of convertible debtor-in-possession financing is symptomatic of a shift in the control of large bankruptcy cases. This article examines the past and present eras of lender and sponsor control, and argues that newer convertible DIP financing provides a windfall for sponsors, locking up a discounted stake in reorganized equity early in the case, resulting in an unfair and inequitable allocation under a chapter 11 plan. Convertible DIP financing is situated within the new era of sponsor control, and the author contends that its distortion of valuation violates Supreme Court precedent. Ultimately, the article argues that in sponsor-driven convertible DIP financings, the valuation used to compute the conversion is a lowball guesstimate designed to augment the sponsor’s returns at the expense of other stakeholders. Absent an informed valuation, it concludes that convertible DIP financing should not be authorized.
This article was featured on the Harvard Law School Bankruptcy Roundtable and is accessible here.
Mass Tort Bankruptcy Goes Public
Professor William Organek (Zicklin School of Business, Baruch College, CUNY)
Bankruptcy has increasingly, and controversially, become the forum in which mass torts are resolved. Departing from standard discussions on the (im)propriety of this trend, this article reveals an underexamined aspect of this shift and its startling results: government intervention. Governments increasingly intervene in high-profile bankruptcies, forcing firms into insolvency and dictating outcomes in their proceedings. Indeed, governments often assume multiple incompatible roles in these cases, appearing simultaneously as representatives of injured citizens, creditors in their own right and sovereigns with broader social duties and regulatory powers. These overlapping identities create conflicts of interest that can encourage governments to coercively privilege their monetary recoveries over the monetary and dignitary claims of their citizens.
Using several case studies, this article argues that such governmental actions should be subject to greater scrutiny and procedural protections. Bankruptcy courts can achieve this by applying the aggregate litigation concepts of exit, voice and loyalty to reduce distortion resulting from governmental intervention. Reciprocally, if mass tort liability does not migrate entirely to bankruptcy, importing certain bankruptcy practices to other forms of aggregate litigation can improve these conventional forms of mass tort resolution.
This article was featured on the Harvard Law School Bankruptcy Roundtable and is accessible here.
Predicting Bankruptcy: Ask the Employees
Professors John Knopf (University of Connecticut School of Business) and Kristina Lalova
(Michigan State University – Eli Broad College of Business)
Is employee satisfaction useful in predicting bankruptcy? To test this, the authors construct a boosting machine learning model of employee feedback, reviews and ratings, and compare its predictive performance against four existing “financial and market information” bankruptcy models. In doing so, the authors find surprising results.
Employee satisfaction predicts bankruptcy earlier (two to three years prior to filing) and more accurately than the four models included in the analysis. Financial and market data do not overtake employee satisfaction as predictors until the year immediately preceding the bankruptcy filing. The authors also find that the predictive accuracy of financial and market information models marginally improves if employee satisfaction data is included (again, except in the year that immediately precedes bankruptcy filing). Finally, they find that greater employee satisfaction predicts emergence from bankruptcy proceedings.
Leveraging data from 2008 and 2020, the paper distills robust empirical modeling results into substantial support for the simple idea that “employees sense financial difficulties and problems in the companies they work for years before they show up on financial statements.” In other words, if curious about prospects of financial distress, ask the company’s employees.
The article was featured on the Harvard Law School Bankruptcy Roundtable and is accessible here.
Standardizing and Unbundling the Sub Rosa DIP Loan
Professor Kenneth Ayotte and Alex Zhicheng Huang (University of California, Berkeley School
of Law)
In recent high-profile cases, DIP loans include terms such as rights offerings and backstop fees, locking in terms normally found in plans of reorganization. This raises fears about short-circuiting the chapter 11 plan process. The authors argue that this “sub rosa DIP loan” problem is a common one affecting many types of pre-plan transactions that provide the estate with an asset but also fix the priority and/or payoff of liabilities. Courts and the Bankruptcy Code police these transactions in two ways: by standardizing the liability so its true cost is more transparent, and by unbundling liability-side consequences from asset-side transactions.
The article conducts a case study of the J.C. Penney bankruptcy to understand how a non-standard, bundled DIP loan transaction can be used strategically to distort priorities. Surprisingly, it finds that a standard DIP loan would have required an interest rate of at least 545% to give the majority group the same payoff it received in the case from the loan’s nonstandard, bundled terms. The article concludes that courts should revive and strengthen standardization and unbundling norms to better defend priorities.
This article was featured on the Harvard Law School Bankruptcy Roundtable and is accessible here.