ABI Commission to Study the Reform of Chapter 11
June 7, 2013 Field Hearing
Association of Insolvency & Restructuring Advisors
Chicago, IL
Robert Keach: Al and I have a rather lengthy prepared statement that we'll dispense with. It will
be posted as part of the record of this meeting, and if anybody would like a copy
of it, I'm happy to send it to them. Let me give the very abbreviated version. [*]
We are going to hear from witnesses today on a number of topics. First, members
of the leadership of the AIRA will address issues of concern to the organization,
and report on a survey of their membership on things they like about chapter 11
and areas that are ripe for reform as far as their membership is concerned.
Second, we will take testimony regarding the control and governance of chapter
11 cases, in particular the problem of identifying who is in control of, or
attempting to control, the case in light of lack of transparency and regulation of
the claims trading markets. That same witness will also address the issue of
mandatory examiners in chapter 11 cases of a certain size and the possible need
for reform of those provisions.
Then we will hear from a witness with respect to the continuing problem of
addressing retiree benefits issues in Chapter 11, including whether or not section
1114 or like solutions are effective, or even appropriate remedies, and what the
alternatives might be, as well as the consequences of such alternatives.
To put those topics in a bit of context let me frame today's hearing. As we have
said in other venues and in other articles, trading and claims and distressed debt
has changed the landscape within which chapter 11 functions. The acquisition of
claims can be purely financial, or arbitrage play; the claim's purchaser simply
wants to make money on the spread between the purchase price of the claim and
the value of the distribution made on the claim under a plan or otherwise.
Claims acquisition can also be a takeover mechanism, with the acquirer seeking to
acquire control of the process and, eventually, the reorganized debtor or its assets.
However, determining what entities are seeking to acquire such control, or have
already acquired the means to do so, can be difficult. Knowledge of these entities
and these factors may be critical to the fair and efficient administration of the
chapter 11 process in a way that protects the interests of all stakeholders.
While changes to Rule 2019, that we all know about, increased transparency
relating to ad hoc groups, the improved rule does not completely address these
concerns.
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Section 1104(c)(2), the so-called mandatory provision for the appointment of an
examiner in cases of a particular size has become controversial. Likely the
product of a political compromise at the time of the Code’s passage, given the
diminished role of the SEC under the new chapter 11, the provision is seldom
utilized. Moreover, despite its apparent plain meaning, some courts have found
the appointment of an examiner under that section not to be mandatory upon
request, even when the dollar threshold is met. Still others have acquiesced in
appointing the mandatory examiner only to handcuff the newly-appointed
examiner with a small budget, a lack of professionals, or unrealistic time limits.
The continuing efficacy, not to mention necessity, of the provision is questioned
by many, while others decry the fact that courts seem to be ignoring or endrunning the statute and failing to utilize a valuable tool for necessary fact-finding
in chapter 11 cases.
Finally, section 1114, introduced to provide the same protection to retiree health
benefits that section 1113 was intended to provide to rights under collective
bargaining agreements, may or may not have accomplished that limited goal,
depending on one’s view as to what protection was appropriate.
Critics, particularly those on the labor side, often contend that neither provision
succeeds in providing sufficient protection, and that even the intended protection,
whatever that was, is too easily avoided by resort to all asset sales under section
363. The original dilemma may remain: how to reasonably protect retiree
medical benefits whenever possible for a particularly vulnerable population
without dooming restructuring by imposing the sometimes massive cost of doing
so. The corollary question of “who pays such costs” follows inexorably, leading
to questions of competing priorities, both in the technical bankruptcy sense and
otherwise.
With that, by way of introduction, we turn to our first panel, and we welcome the
leadership of the AIRA and, gentlemen, we'll turn it over to you. Our general
approach is to let you do your prepared remarks, and we have had the benefit of
having your paper last night, and then we'll open it up for questions by the
Commissioners.
With that, Grant, take it away.
Grant Newton: Thank you very much. First of all, on behalf of the AIRA we want to thank ABI
for giving us the opportunity to make this presentation, we are delighted that you
joined us here as a part of our Annual Conference.
The process that we are going to go through is, we did a survey among the Board
Members asking them to fill out a survey [on] the good and the bad aspects of
chapter 11 and the areas where they recommended change. We summarized the
results and then we, at a Board Meeting this week reviewed these again, and made
some changes to them, and we circulated of a draft of the document.
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I think there are several issues that are good; there are some that are bad.
Obviously we believe in chapter 11. My first question is how much time do we
have? I noticed you have quite a busy agenda there, so home much time do we
have?
Keach:
We do. We are going to go until five o'clock, so I would suggest that if, between
the two of you, you can 10 or 15 minutes and then we'll have some questions, and
then we'll move on. Does that work?
Newton:
That will work, yeah. We are going to skip the issues related to the good aspects
and the bad aspects then, and move down to some recommendations. Okay?
Keach:
Thank you. I will add, just so you know, the paper will become part of the record
as we'll be posted.
[*]
Grant Stein:
I'm Grant Stein, with Alston & Bird in Atlanta. I wear two hats in the AIRA. I'm a
Former President and Chair, and I'm also licensed practicing attorney at Alston &
Bird, but my area of interest for years and years has been the financial area and
my comments are made less with a lawyer hat and more with an AIRA hat on.
The first change that the AIRA wanted to focus on was the change relating to the
lease assumption periods and giving the court more time in appropriate
circumstances, not on an automatic basis, to modify that [period] to make real
estate cases run more smoothly, particularly in the area of retailers. I'm sure
you’ve heard of that before, but that’s an area that the folks that we work with
sees creating problems.
The second area that we wanted to focus on and it's not necessarily a legal
provision, but it's the way time is recorded and the way professionals, particularly
in the financial area, other than investment bankers, have to record their time,
instead of doing it in tenths, to get that modified to be in 15 or 30-minute
increments, which is more in keeping with what, usually the financial professional
does in the way they keep up with their time.
Newton:
I'll make one comment, that we realize that’s not a provision that’s currently in
the Bankruptcy Code, but it's a practice that’s used by the U.S. Trustee's office,
and we are not sure whether that’s an issue that you would want to address or
something that should be take up with the Trustee, but it is a observation that we
made and a recommendation that we would make.
Stein:
The third area that we focused on, [*] is that the detailed, overly detailed and very
un-useful for that reason, nature of disclosure statements in large cases that don’t
cut to the chase, [They] don’t explain economically what's happening in a way
that is less technical and more common sense, [they are] more focused than our
prospectus in SEC requirements and less on what do you need to know if you're
going to be voting as a holder of a claim in a given class. Less is better, more is
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not better, and that the excruciating detail that goes into these is not productive,
it's not helpful to those that read in many instances, and those that are more
sophisticated don’t need all that information in disclosure statement anyway, and
that’s an area that the folks that the AIRA wanted us to focus on.
Newton:
I think one of the examples that was shared with us, dealing with this issue, and I
actually had an opportunity to see this plan as well was where the draft of the plan
is clearly laid in a term sheet showing exactly what each of the constituents was
going to get, it showed the percent of the value they would be receiving of the
reorganized entity. When the document came out they was sent with the plan for
the voting, that schedule was not there and everything was expressed in terms of
$1,000 of claim and no values were given.
In order to get to the essence of what you really were going to get, you had to
through and figure out what they thought the value was and then back into it and
determine what dollar amount they were going to get. [*] We've seen several of
these. I'm not sure if it was written to make it as confusing as you could to figure
out what it was.[*] It felt like that was needed from a legal perspective was to get
to the point as to what the consideration would be. I think, as Grant mentioned,
simple language would have served the readers of the disclosure statement much
better in that case.
Stein:
The next area that we focused on was the provision in section 1111, that basically
says: if your schedule is undisputed, non-contention and liquidated, then you
don’t have to file a proof of claim, that provision doesn’t apply in Chapter 7.The
thought was that that provision should be modified to apply to Chapter 7, that will
make those types of cases and liquidations easier to deal with and administer.
The next area that we focused on was the section 503(b)(9) administrative
expense claim for goods delivered in the 20 days preceding the bankruptcy filing
and the view there was that the allowance of that claim, the funding of that the
claim, [and] the question of when that claim has to be paid. The whole concept
has created a situation in chapter 11 that makes dealing with those folks and
dealing with that funding obligation in changing the relative amounts necessary to
be able to exit bankruptcy, such that it's reflective of the efforts of a particular
interest group to try and codify or modify the statute and it takes away from what
was the original structure which was a more balanced statute. It's not to say that
the law shouldn’t involve it, but that at least our constituency looks at that
particular provision in the law as an evolution in the law that was not constructive
[*].
You all may have questions I know some of you have lived through the disparate
treatment among circuits of critical vendor payments, but we don’t see that as a
substitute for judicial determination and the judgment of the debtor in an
appropriate case where it's necessary to benefit the debtor if allowed in that
circuit.
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The last area that we wanted to focus on is KERPs. We know the statute was
changed to get rid of KERPs and we know that folks have tried to figure out ways
to deal with that under various incentive plans, but [it’s important] at the end of
the day being able to keep appropriately qualified management in place,
motivated to carry through in the rigors of what happens in a chapter 11 case, be it
one that reorganizes or one that sells where there's a sale as a going concern.
However it is, the statute should get scaled back to again, give the bankruptcy
judge more authority, more leeway to, in an appropriate case, to recognize the
benefit of and allow, KERPs. That’s something that our Board, based on what
they heard from our constituency, thinks is something that should get scaled back
from the amendments that have occurred in the last few years.
Newton:
I think that some of the comments came from our members related to the fact that
while we spent considerable amount of effort in terms of top management, [*] of
being sure that we have independent management, when you apply that rule to
lower-level employees you have to develop an incentive plan to retain some of
those individuals, [and] it becomes very difficult and a process that takes
considerable time. Probably it would be much better if the lower level managers
and executives at certain divisions of the company, were not required to go
through this process of developing some form of incentive method to retaining
those executives once they're in chapter 11.
This was a concept that at least a half-a-dozen of our members made comments
about, and issues that they felt had made it more difficult for them to go in and
take over and run a company in chapter 11 and [*] the need to retain a lot of the
middle management type people that were necessary for operations yet, there
were some restrictions placed on them in terms of their ability to continue.
Stein:
My final comment, with respect to the materials that we submitted, [and] if you
go through the written materials, there's so much good about chapter 11 and the
rehabilitative nature of what you do. You all see it in your practice or in your
courts, as the case may be, the cases and what they accomplish in the environment
that we have. We are a model for the rest of the world in that regard, as you know.
[*] That’s what the AIRA is, it's primarily on the financial side, it's business folks
looking at the business aspects of what we do and what you're trying to
accomplish in chapter 11, including from a policy standpoint even though we
have absolute priority and other rules that apply that are purely economic focused.
Having said that, there's also in the materials comments that were received that
are not the official AIRA positions, but that we thought were worth passing along
to the group to reflect some concerns of the various members of the organization
but that didn’t necessarily carry a consensus behind them.
With that, thank you for your time. [*]
Newton:
I do have one comment I would like to make, that I know we are going through
the process of looking at chapter 11, [and] I think this is very important and I
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think it's important for some changes to be made to the Chapter 11 process, but I
think that we need to realize that chapter 11 as it has been developed and it has
grown and developed over time has a lot to offer to businesses, and I know there
are other aspects of the world that would like to have the opportunity to use
something like we have in chapter 11.
I recently had an opportunity to address the Insolvency Practitioners Association
of Australia, and at the time I was there they were in the process of looking at,
attempting to adopt some form of our chapter 11 process. I spent three days there
and at the end of the third day I was told that they had decided not to push
legislation this year to move toward chapter 11, but that it would be back in a
couple of years.
Again, trying to get their law changed to be more in line with some of the
provisions we had in chapter 11 and I described some of these good and bad
aspects of chapter 11 that we've put in this paper with them, and had a opportunity
to spend quite a bit of time with him, talking about chapter 11. I learned what a
scheme was, okay, so a scheme is nothing more than [*] basically a chapter 11
without calling it a chapter 11, where they put together a plan, ideas, and actually
put it in effect, and we had a case study, when they finished it, my comment was,
"This looks like a chapter 11 to me." They say, “No, it's a scheme.” I said, “It's a
scheme,” so that was the end of that session.
Do you have any questions?
Keach:
I'm sure we do. Thank you for your prepared remarks and for the paper, we
appreciate that, and let me just open it up to the Commissioners for questions.
Jack, you had a question.
John Butler:
Thank you very much for your testimony. Much of your recommendations, on the
face at least, go to the issue of how much discretion a bankruptcy judge ought to
have. I mean, the issues relating to professional compensation, issues relating to
the executive non-residential property contracts. Will it go to issue of discretion?
The Commission in one of our other field hearings, earlier this week actually in
New York, had compelling testimony from landlord representatives who said,
"Look, unfettered discretion has led, historically, to results that are just unfair to
landlords who are compelled by their nature to be one of the few and voluntary
lenders in a post petition environment.”
I guess what I'd like to ask you to reflect on for us is the discretionary elements of
this, both as it relates to your recommendation on leases, and also to your
recommendation [*] on management compensation. We understand that the
limitations that you speak are mostly related to insiders but again, I think you're
relating to [*] how discretion is exercised on behalf of the judge, or by the
judiciary. I think judges would like to have more discretion and believe that
they're capable of exercising it appropriately, but I think we all recognize that
some of the changes you complain about have occurred over the last number of
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years have been where stakeholders have been dissatisfied with how that
discretion has been exercised.
[*]
Stein:
Three points. Just so that you know, there's only three even though it may sound
like more, the first is: landlords as involuntary lenders, landlords under the statute
from the time it was enacted get paid for their post-petition occupancy and use of
their premises. That’s not an involuntary lender. [An] involuntary lender is
someone that is required, for example, to give trade credit to a debtor, that’s an
involuntary lender. Or of course a real lender that could be and they're not under
the stature required to loan. From the perspective of a landlord, it depends on how
you look at it.
If you're getting paid for the use of your property, which is what you're entitled to,
and that benefits the reorganization process, why do we have the structure and
statute that we have of adequate protection? I don’t see that and I don’t think that
our group sees that just because that one constituency has the issue they have, if
that makes them and involuntary lender, or unfairly treated any different than any
secured lender; again, that receives adequate protection and has their property
used. That’s been in the statute for a long time. The preferential treatment, if you
will, where there's no cram down on a lease, is an extraordinary protection for the
lessor if that lease is assumed.
The second point, and the third point, which are probably more important, go to
the issue of judicial discretion, [*] and I'm not going to tell you that I was
practicing back when this happened, but we all are students of how things have
developed, my understanding is that back when the 1978 law came together, that
there was a major dispute that had to get resolved, were bankruptcy judges going
to be administrators, or were bankruptcy judges going to judges?
I mean, they became judges by rule in 1973 and so the question was, how was that
going to change? Which way was it going to go? There was a strong leaning
toward having them be bankruptcy administrators as opposed to judges, and
ultimately, through the efforts of the National Conference of Bankruptcy Judges,
Judge Joe Lee, Judge Drake, a compromise was reached. As I understand what
happened back in the late 1970s leading to the 1978 Reform Act that had the
judges designated to be judges, they couldn’t get Article III status, so they got
Article I status, but the standard of having a judge that makes decisions, that may
not make everybody happy, but that are structured and based and allowed to
facilitate the reorganization process to resolve disputes. [*]
I don’t mean to sound like I'm on a soap box, Jack, but the idea is that you try to
build consensus, there's nobody better at that than you, and with regard to
consensus, if you can't get there someone has got to make the decision and having
the judge being able to make that decision with the policy issues involved as that
judge perceives it, that’s supposed to be statutory that’s supposed to be a judge. If
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it's going to be a judge let them be a judge, let them make that judgment based on
the record and based on the evidence that’s presented to them in individual cases.
Is that going to mean you'll have lack of uniformity, it's going to mean that
different cases get different results based on different facts? That brings me to the
last point with respect to management compensation. That’s what the judge is
there for, in our view, and why there should be reasonable amount of power in
that judge to make decisions, because they're not bankruptcy administrators, and
haven’t been, and that determination was made a long time ago. It doesn’t mean
they have to be Article III Judges to be able to make those determinations in the
context of their authority as an Article I Judge dealing with bankruptcy.
I said I wasn’t going to be a lawyer, sitting here.
Keach:
Following on that KERP point because I wrote an article a long time ago, called
“The Case Against KERPs” which focused on what I call top-heavy KERPs;
Senior Executive KERPs. I guess one of the things that I would want to ask you
about is, if we were to think about reinstating KERPs in some shape or form, to
whom should they apply?
Grant, you talked a little bit about [*] upper middle management, and they have to
be insiders, so we'd have to be pretty far up in middle management I guess. More
importantly, if we are talking about an issue of discretion, what would the
standard be? Because as we all know from recent cases from a labor standpoint,
and I won't pretend to be a spokesperson for labor, one of the reasons that there is
linkage in the current statute between the treatment of employees in general, and
whether or not you can have KERPs and whether or not you can have KEIPs, is
that from labor's standpoint it's a sensitive issue, obviously, for KERPs to be
handed out to senior management at a time when rank and file compensation and
benefits are being suspended, frozen, slashed, rejected.
William Brandt: Or pension plans being discontinued.
Keach:
Right. What would the standard be? Could, for example, the judge take into
account whether or not the rewarding of KERP would create labor unrest? Could
it take into account what set of factors in deciding to exercise that discretion,
because if we are going to get back to discretionary KERPs, I doubt judges just
want a blank slate, I'm assuming they would want a standard, and what would that
standard be if we were to do that?
Newton:
The first comment I will make is that AIRA has a position on this issue that we
drafted sometime ago and submitted to Congress when they debated the issue and
[*] I will send you a copy that you can attach to the record. I think that in that
statement that we stated that KERPs have been misused, at that point in time
there's no question about that, but at the same time we felt like the restrictions that
were placed with the proposed legislation, was just basically what became the
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actual legislation, was too burdensome on companies and was not a good way to
go.
Keach:
In the area of KERPs, [*] it’s virtually impossible to qualify a KERP, right?
Newton:
That’s right, that’s correct. Therefore, I guess if you’ve got something that you
qualify for, should we make changes in it? [*] I'm not saying we should do away
with it, that’s not our point at all. I will send you a copy of that, and I think that
will be better to explain it. [*]
Keach:
Well, we would appreciate that and we'll add that to the record. Thank you.
Newton:
Okay. I think that as Grant pointed out, I think that the entire process involves
certain decisions that have to be made, and it's impossible to set guidelines for
each of these decisions along the way so the judge can look at a code and say,
“hey, this is what you do here, this is what you do there.” Certain items involve
judgment. It's a critical issue to decide which do and which do not, and that’s one
of the jobs that you'll have in making your recommendation, is which way to go
with certain items.
On this issue, we felt that moving back to a system that we had previously
although there certainly could be some modifications to it that d[o] away [with]
the abuses, and establish some type of standards in it, that it might make it helpful
to the judges to have some issue to look at to decide which way to go with it
based on some principle laid out.
Certainly we would need a principle laid out in it, and I have not spent any time
trying to identify how that might be worded, but I think that would be one point
that you might want to do in this process.
Keach:
Okay. Thank you. Before I dominate this, let me ask if anybody else had any
questions. Bill?
Brandt:
Professor Newton, following up on that, having worked with, now Senator
Warren, to write the KERP language at the last minute in the Senate Judiciary
room one night, one of the issues that came [up] when we wrote the language was
that in an era when you have, as Judge Carey pointed out at a panel yesterday,
primarily 363 sales, the era of two and three-year reorganizations long being over
and that might be the norm for the future, is the issue of the basis of the rational of
KERPs. Why not let the buyer pay the KERP? I mean, if you were going to do a
363 sale, why make the creditors bear the cost of this, especially when, as I used
to tell Professor Warren, I'm old enough to remember when we paid people to go
away, rather than to stay.
That’s probably dating me back in that Act, but that was the case. Why not allow
the purchasers, or the bidders to put those packages together because [*] if they
choose to keep the management team together, it is to their benefit rather than the
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creditors. That’s just, you know, that’s my thought on that, but would that be
something that you'd allow to have along with bid protection and the rest of it?
Newton:
Well, I understand the point you're making and I guess my response to that is two
points. Number one is that if this is laid out as a sale of the business then certainly
the question is: do you need someone to operate the business while the sale is
taking place? If so, do you want that to be put on a potential buyer before the deal
has been put together, or do you want to let the business continue to deteriorate
while the party’s bid is on process and [the process] takes six days at most to go
through it. I think some judgment has to be used to decide, what steps do we need
to be taking in the process.
The second point I would make is that this is not uncommon in a non-bankruptcy
situation, or in any business acquisition for some peoples to be paid a fee to keep
this business running until the deal is put together. [*]
Brandt:
I don’t have a debate with that I guess I'm trying to remember the last time I saw a
six to eight-month 363 sale. I get the melting ice-cube line all the time from the
lenders, with drop-dead dates in the debt financing and if it's going to be as
quickly as it suggested, is it not something that, perhaps if you found the case that
was going to last six or eight months, or had some time threshold, and you could
revisit KERPs after that, that might be something that I could think about? Would
that make some sense to you?
Stein:
The question, or at least my view on the question is: what is the best way when
what's involved is preserving growing concern value. If it's a three-month
liquidation, and I've done three-month liquidations and I've had KERPs approved
back when they were allowed, if in fact [KERPs are] appropriate to do, to
maintain the value that going concern, and enhance the likelihood of its being
sold, and enhance the likelihood of it being sold to a buyer that’s going to
maximize the number of employees and its viability as a business going forward,
which happens.
Not all businesses are bad. Sometimes they’ve got to get rid of leases if it's retail.
Sometimes they’ve got to shrink a variety of other things, change their balance
sheet, [but] the core business may be good. So the ultimate question is, how much
lead time is there coming in, is this going help preserve going concerned value
and is it consistent with [*] [the unwritten] policy of rehabilitation and
revitalization of a business when it comes out of bankruptcy, which can be
through a confirmed plan or through a sale? That’s what I come back to, [it]
depends what the case is, [it] depends what the facts are, [and] it's not supposed to
be a rubber stamp, [*] that’s what the judge is there for, judges don’t rubber
stamp, someone has got to make a record to support the determination by that
court at that time.
[*]
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Brandt:
One last question, which gets Mr. Butler involved. I kind of like the American
Airlines problem here. I mean if you're going to do a bonus system, you put it in
where the plan is confirmed, so the creditors are essentially voting on this since
it's their money. Perhaps maybe that’s the way to approach this, if you have a
confirmation process and internal reorganization versus a fast sale.
Stein:
Well, it's an apple and orange, and again he's done a wonderful job there. What
you could do before the statute changed in the way that it has to be done now, we
are talking about different things.
Keach:
Speaking of Mr. Butler, hold your question for a second. Did you have a question,
Steve?
[*]
John Butler:
Commissioners aren't supposed to debate yet, but Mr. Brandt did say something,
and I'll just point out that some of us believe that if the buyers pay for it, the
creditors are still paying for it, because it's a zero-sum gain.
Keach:
It might be a pricing consideration.
Butler:
Right, it might be a pricing consideration.
Brandt:
Plus optics are important.
Butler:
I'm not talking about the political optics, and I don’t mean to underestimate, those
may be critical actually, but it does from a value perspective I think, I'm not sure
what the difference is. [*] Again, on this judicial discretion issue, and on
management comp, I'm thing to find a solution. Talk about your views if you have
any on whether insider definition is too imprecise here. It's been suggested that
maybe what we should do is say look, KERPs and KEIPs are ordinary course
except they are not ordinary course for anyone in the C-suite: CEO, CFO, COO,
CAOs, and anyone who directly reports to them. That group of people ought to
get judicial scrutiny, but that otherwise the debtor in possession ought to be able
to run its business in the ordinary course subject to Committee review and anyone
else's.
Keach:
Which was actually the point of the paper I wrote years ago.
Butler:
I asked whether you have a point of view on that because if we segregated out the
C-suite and their direct reports and that had some level of judicial and committee
other stakeholder scrutiny and everyone else was dealt with in the ordinary of
business, do you have a view as to whether that makes sense or doesn’t make
sense?
Stein:
I have a view but it's not an AIRA view because we didn’t focus on that.
Butler:
Okay, I'd love to hear your view then.
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Keach:
We'll acknowledge the disclaimer.
[*]
Stein:
That makes a lot of logical sense in that it's often the way I've seen it play out, the
way you're describing where the structure in the play retention issues are not at
the top but it's at the lower levels. So that makes a lot of sense to me.
Keach:
Steve, you had a question and then … we are about five minutes, and in fairness
to the other witnesses move on. Go ahead.
Steven Hedberg: I'm just curious, on your [section] 503(b)(9) comments and your paper. We had
a chat with the NACM at a hearing a few weeks ago and you probably wouldn’t
be surprised to learn that they really, really like [section] 503(b)(9), and in fact
that they think it's too narrowly drawn, they should get the drop-ship goods, and
all kinds of other things. I'm curious on your thoughts on revising it. [*] Where is
the right balance between where their view is, that they continue to extend credit
to would-be debtors and companies that are in trouble because they know they
can fall back on this provision.
They of course like to get paid early on in the case if they can, and as a corollary
to the arguments toward a lot of judicial discretion in the other parts of the
conversations, it sounds like to me you're proposing to take that away here. So I'm
just curious to try to get a clearer sense of what kind of amendments you would
propose or changes to the [section] 503(b)(9) process that would reach an
appropriate balance of the trade creditors, the DIP lenders, the debtor in
reorganization, that entire constituency across the board.
Newton:
I'll make one little comment then let me turn it over to Grant. My first comment
would be that the payment of administrative expenses, related to the [section]
503(b)(9) should be no different than the rules regarding the administrative
expenses. We have special rules for those administrative expenses that are
different from what other administrative expenses are in the process, so I'm not
sure there's justification for that difference.
Keach:
You mean it would have to be a post-petition event, right? This is the only
circumstance in which we've created a pre-petition event to give rise to the
administrator?
Newton:
No, no, no. The issue with the payment is the timing, other administrative
expenses that may be classified as administrative expenses do not have to be paid
in the short time period you have with the [section] 503(b)(9).
Keach:
So you're not quibbling with the creation of the expense, but the manner in which
it's satisfied?
Newton:
No. I'm just pointing out the second part of it. [*] I agree with AIRA's position
that I think this has been detrimental to some restructurings in some situations,
* Language clarified in transcription process.
12
and we have some examples that we've discussed among our members. I do not
agree that we should necessarily retain that part of it either.
Keach:
Okay.
Geoffrey Berman: Again, I think the concern in the field hearing that Mr. Hedberg referred to,
was a few weeks ago, and that it was the trade's opportunity to tell us how they
feel. They are at the backend of this process and they feel that they are the class of
creditor that has been taken from the most. If you take away the [section]
503(b)(9) concept, where reclamation doesn’t work, the larger extenders of
unsecured credit are going to just stop. They see a company get ready to go into
bankruptcy they just won't ship. They rely on the [section] 503(b)(9) claim.
Where is the line that says we are not going to keep taking from the unsecured
creditors?
Newton:
First of all, the question is: under what conditions do we need to consider
unsecured creditors different than any other creditor in the case? That distinction
you're making, is when that change was made in the covenant. That’s one issue
that has to be addressed. To the extent that they're entitled to different treatment
than an employee is, or others that make a commitment and then they end up
filing bankruptcy. This is a special rule designed for suppliers.
[*] The second point I make is, in some situations there may have been a chance
for this company to have restructured, but for the administrative expenses that had
to be paid [and] because [of section] 503(b)(9), they were not able to restructure.
In that case, what did the creditors get for that? Obviously they're getting almost
nothing.
If the company had been able to provide a foundation for restructuring they would
have gotten more; so it's not totally one way or the other, I think there's some
balance between that in terms of the benefit.
Berman:
Where is Chapter 11 debtor is going to get the inventory to sell if they can't get it
from wholesale credit? This is a tension that I haven’t heard how it gets
addressed.
Stein:
Where did it get it before the law was changed a few years ago? It worked, it
happened.
Brandt:
I think what Geoff is saying is recognizing that the commercial markets have
changed since the Code was enacted, and you now see all of these cases or most
of these cases winding up, in the bankruptcy court on a highly over-leveraged
basis, where there's virtually nothing for most of unsecured creditors in an
overwhelming majority of the time. How do you get vendors on the eve of
insolvency when the discussion is plain that the company is having problems to
continue to ship in, when they think they're just transferring value to the secured
lender at that point? That is what some of us saw [section] 503(b)(9) as the
counterweight to.
* Language clarified in transcription process.
13
It may be slightly excessive, but we are wrestling with the problem. Some of the
Commissioners here have talked about a surcharge. If the lenders want to use the
bankruptcy court then they have to leave an automatic carve out of a percentage
of the value for unsecured. That may be one of the ways to address it. We are
struggling with that up here.
Keach:
Also I mean, just a quick response to: how did it work before and I’ll weave this
into the question. Remember [a] reclamation [claim] was at one point in time a
meaningful remedy. [A] Reclamation [claim] actually worked as a remedy when
there were not second and third liens on the assets. [A] reclamation [claim]
doesn’t work as a remedy when the ABL loan fully encompasses all of the
inventory and is under water.
The reason it used to work was that the basic capital structure of debtors was
different. We've talked a lot about that externality driving a lot of what we are
trying to investigate now. I mean [section] 503(b)(9) became a surrogate for a
meaningful reclamation [claim] process, and I guess that’s where the tension is.
Brandt:
… and to provide some assurance that there was no wealth transfer in the last
month to the secured lender from the unsecured who felt like they'd already given
at the office, and didn’t need to give more.
Keach:
We've only got about a minute at most, and I'll ask you a quick question which
maybe has a quick answer. I was fascinated by the recommendation about
disclosure statements because the Code currently has a provision that literally
allows a different disclosure statement to be drafted and used for each class of
claims, and in fact I've used that in cases where there was a heavy consumer
constituency to [use a] one-page disclosure statement for that class.
That provision of course is not mandatory now, so there's no requirement that the
disclosure statement actually be tailored on a per-class basis, so that classes get a
more simplified disclosure statement when that would do. I guess my question is,
would you be in favor of that kind of a provision, or at a minimum to implement
your suggestion of a more detailed requirement, that the kind of summary you’ve
talked about be included? I mean, I know I spent a lot of time reading American
Airline's disclosure statement and I do know they had such a chart, and it was
actually pretty useful and that’s in an all-equity plan, so they were actually
translating what the values were going to be under certain scenarios which, I think
was very useful to the constituency in that case.
Would those kinds of simple fixes address the problem you're talking about?
Newton:
It would help the process, I believe. I think somehow we need to change the
wording that’s used in the disclosure statements to get a lot of the layering out of
it, to get more practical information in it, and business information so it can be
understood [*].
* Language clarified in transcription process.
14
I think it's unnecessary to put some of the detailed information that’s in it, like the
one I just referred to [*]. The meaning of a disclosure statement is to be such that
it can be understandable by the creditors, and I don’t think we have accomplished
that, and I'm not blaming attorneys [*] obviously other financial advisors have
been guilty of this in many cases as well, so I'm not trying to pick on any one part,
but just as a general observation.
The Code did make it clear that that creditor should be able to understand, that’s
part of the wording in the Bankruptcy Code in terms of what the disclosure
statement should accomplish. That was our observation about it. [*]
[*]
Newton:
One side, one sheet, I've been suggesting for years in terms [that for] a certain
classes of unsecured creditors that might be the best way to go with, they might
have a better understanding of what's taking place in the process if we did that.
Keach:
We thank you. We've got to move on to our other witnesses, but we thank you
very much. We would appreciate receiving the language you talked about that the
Congressional Submission [on KERPs] and any other written follow up you
would like would be fine.
Newton:
I want to thank you very much for giving us this opportunity and we are delighted
you came to be here while we are having our conference.
Keach:
We appreciate your hosting us. Thank you.
Stein:
Thank you.
Keach:
Our next witness is Professor Daniel L. Keating, from the Washington University
School of Law in St. Louis. Professor Keating is going to talk to us, among other
things, about Section 1114, I should say.
[*]
Dan Keating: First, I want to thank all of you for inviting me and for spending your time on this
project, which I think is a great and worthwhile project. I was unable to attend the
labor-specific hearing in D.C., but I did read the transcript from that hearing.
The testimony that I'll be giving today is more general than most of what was said
in March by those witnesses, many of whom I saw had very direct involvement in
specific bankruptcy cases involving labor issues.
It's been 25 years since I last practiced bankruptcy law and it was here in Chicago,
at the First National Bank of Chicago, so my testimony today is going to be more
from the 30,000-foot view of an academic, but I hope that it will add a possibly
useful perspective to the overall mix of testimony.
* Language clarified in transcription process.
15
I don’t represent anyone or any group today, so these views are strictly my own,
but I did want to mention by way of full disclosure, that I grew up in a union
household with both of my parents serving as members of the Chicago Teacher’s
Union. They are both retired now and in their late 70s, and they are waiting
anxiously to see when and how the State of Illinois will reduce their retiree
medical benefits; so I certainly have some direct connection with people who are
experiencing the kind of emotions that the union worker and retirees experience in
chapter 11 bankruptcy cases where they feel like they’ve kept their end of the
bargain, and why can't their employer keep their promises as well.
With that, sympathy for the injustice that’s occurring does not necessarily then
translate into my agreeing with all the solutions that are being proposed by
organized labor to try to remedy these injustices. Instead, what I'm going to do is
offer five big-picture lessons that I think we've learned since the last round of
Congressional action on labor employment retiree issues back in the mid-[19]80s.
I'm just going to run these quickly because I know you’ve all read the written
testimony, and then I'll try to answer any questions you have.
First, you cannot effectively fix a non-bankruptcy problem with a bankruptcy
specific solution, and here I would like to compare under-funded defined pension
plans with under-funded retiree medical benefits. I think both of these are nonbankruptcy problems that are a form of financial deferred maintenance. One of
them got a non-bankruptcy solution, and that was ERISA and the other got
Bankruptcy Code section 1114.
Now why is that? Why did one get the non-bankruptcy solution and one got the
bankruptcy specific solution, because I think the underlying problems are
essentially the same. Is it simply the happenstance that the Studebaker Company
failed and walked away from its defined benefit pension obligations without even
filing for bankruptcy but LTV Corporation filed chapter 11 as their way to avoid
the retiree medical benefit obligations?
Section 1114, I think, was better than nothing from the perspective of the retirees,
but it failed to solve the fundamental problem of the failure to pre-fund these
kinds of promises.
The second lesson, I think, we've learned in the last 25 or 30 years is that when
you create large priorities that apply in a certain type of reorganization process,
then employers will simply seek to avoid that process and I think this helps
explain at least part of the reason [*] why companies with large retiree medical
benefit liabilities will often try to reorganize with the section 363 sale rather than
a traditional chapter 11 reorganization plan process.
Third, if you make a particular type of employee benefit more expensive for an
employer, then fewer employer will give that benefit. [*] I think we see how two
of the employee benefits have been subject of so much of the high profile
litigation these days. I'm talking here about defined benefit pension plans and
* Language clarified in transcription process.
16
what I think of as the open-ended retiree medical benefit plans. Those will soon
be a thing of the past and in their place virtually all workers, including even
government workers, I think, ultimately, will have some form of 401(k) for
pensions and then some sort of retiree medical account rather than an open-ended
promise by the employer to pay retiree medical benefits for life.
The fourth lesson is that a piecemeal liquidation can destroy even the most
powerful priority that Congress might create. Employers can always walk away
and do a piecemeal liquidation if they believe that a reorganization that requires
having to honor all legacy obligations is simply not financially viable. One recent
example that comes to mind is the Hostess Brands Case, where the buyer of the
assets and liquidation is now planning to reopen those plants and to hire about
1,500 workers but not at the wage rates of the prior collective bargaining
agreement.
Then the final lesson we've learned is that a lender's willingness to lend can be
affected by the creation of new priorities. Even if we were to create a Fair Labor
Standards Act “hot goods” provision to protect labor claims beyond the minimum
wage in overtime claims that are not protected by that super-priority, then any
company that had a lot of those kinds of claims would have a really difficult time
in the credit and capital markets.
In conclusion I worry that the creation of more bankruptcy specific priorities for
labor claims will end up hindering the overall effectiveness of bankruptcy as a
corporate reorganization tool, and at the same time, I don’t believe that
approaching these problems through the Bankruptcy Code will cure the true
underlying disease which is the ability of employers to make long-term promises
to workers and retirees without having to provide adequate pre-funding of such
promises.
That’s all I have to say with my oral remarks, and I welcome your questions.
Keach:
[*] Let me just ask a sort of basic point and this goes to something we were
talking about before went live, and that is that retirees strikes me as sort of the
ultimate involuntary creditor. They are, generally speaking, not at the company
when the decisions are made to put the company in the position that it's in where
it can't honor its retiree medical benefits.
Does that fact alone make a difference, and there are others, obviously,
involuntary creditors who have higher and lower social priorities, but does that
make a difference in terms of how we should prioritize their claims? How we
should secure them? I appreciate your point that this is not a bankruptcy problem,
but the non-bankruptcy solution to this problem will probably have to be a
different Commission. With respect to what we are doing, does that fact suggest
that we should in fact treat retiree medical claims differently, than we treat other
claims?
* Language clarified in transcription process.
17
In other words, should we take into account those kinds of factors and
voluntariness, social priority, et cetera when we are resetting these priorities?
Keating:
Well, I guess I would say, in a perfect world if we think that they deserve a
special priority for that reason and I tend to think that they do, I'd want to give it
to them in a way that they had it outside of bankruptcy as well as inside. I guess if
all we've got is bankruptcy, that’s the form we are talking about, I would be more
inclined to give them a priority. I think, as I said, [that] I concede [section] 1114,
was better than nothing, and how much better than nothing is one issue.
Another issue is a cross benefit issue, which is from the retiree's perspective it as
clearly better than nothing, because [*] I think it put them in a position where they
were getting better recoveries than they would have gotten otherwise. I mean, I
think LTV is the perfect example [where] without [section] 1114, they're just
general unsecured creditors. They are just going to sit back and wait for a case
that might take a couple years, they are not in a position like a banker, a trade
creditor, they are [not] going to have a diversified portfolio.
In a case like that, it got them something. Then you sort of have to ask the
question [because] there's a lot of sympathetic groups, retirees are near the top of
the list. What about tort creditors, they are involuntary too? The other thing about
retiree benefits that makes it difficult in terms of the cost to the process, is that
unlike a number of the priorities, even like the basic priorities that you see in
section 507(a), these retiree benefits in certain cases, in certain industries, can
literally swallow up the company, and in that respect they are different than a lot
of the garden variety priorities, even the ones that consumer deposits.
Even in the [section] 507(a) priorities, you have a dollar cap, so they are not going
to skew a case. But we've certainly seen cases where the retiree benefits, the size
of the obligation, is worth more than the assets of the company, [like] in those
auto cases. I think what's started to happen, and I don’t think this is a bad result, is
sometimes, and I'm thinking the auto cases again, the retirees’ union deals with
the employer and says, “all right, we all see that there is no way in the world the
company with the current demographic of workers to retirees could every pay
what we originally promise, so what can we do?”
“We'll give you half the company, or we'll give you a third of the company, and
we'll create a VEBA”and then you do the best and then we'll leave that to you and
we'll administer and do the best that you can to try to give as much coverage as
you can to the folks that got the promise, who are not going to get the full benefit
of the promise as originally made.” In a way it does sort of become like the mass
tort cases where there is a channeling injunction, but in this case it's a negotiated
channeling injunction.
I guess, going back to your question, [*] shall we treat them differently because
they involuntary they are more sympathetic? I would say yes, versus someone
who went into a lending arrangement with their eyes open. I mean, you could say,
* Language clarified in transcription process.
18
I mean, if you were just a super-hardcore libertarian conservative type, you could
say, “well, you know, back when they were workers and they were made this
promise, they could’ve checked to make sure that the company pre-funded, and if
the company wasn’t pre-funding they would go and find a job with a company
that would give them a separate medical benefit account that they were funding
on a cash basis.”
You can always walk back and say, well, you know, they really weren't
completely involuntary, because at some point they made a choice even if by their
passivity. I'm not going to make that argument, but it isn't even when volunteering
and involuntary, I think my point is it's not always black and white, even when it
seems like it's black and white, it's often shades of gray.
Keach:
One quick follow-up and then I know Mr. Butler has a question and Mr. Togut
does too. This is a structural question and it goes to something you said when you
were talking about how the unions deal with this particular issue. [Section] 1114
was set up, essentially, with the presumption that if the retiree medical benefits
spring from a collective bargaining arrangement, that the union will be the
representatives of the retirees. They are obviously some concerns that have been
expressed that there's an inherent conflict there when there isn't enough money to
go around which is, of course, in every case.
I wondered if you have a view on that, whether or not the presumption should be
that the union continues to represent the retirees or should they have separate
representation of their interest once a bankruptcy is filed.
Keating:
Maybe it should be a rebuttable presumption. I do think increasingly we are
starting to see conflicts between the active union workers and the interest of the
retirees. Maybe historically, if we went back a few decades where union workers
almost like something in the family, and so even if you weren't a retiree maybe
your dad was a retiree in the union, and so I think it seemed like traditionally,
maybe there's been a greater alignment of interest naturally between the retirees in
the union and the active workers.
Lately there have been cases where retirees feel like they are being sold out by the
current union workers, and feel like they're not getting the best representation
because of the inherent conflict of interest.
Maybe those are still the exception and not the rule, so maybe we are still at a
point where we can start with the presumption that the unions will look out for
those that worked before them, but that retirees, individual retirees should be able
to make a case to the bankruptcy judge that, in fact, the union is not adequately
looking out for their interest.
Keach:
Thank you. Mr. Butler and then Al.
Butler:
Professor, I wonder if you could reflect on what you understand to be the
differences between qualified pension plans and non-qualified retiree benefits.
* Language clarified in transcription process.
19
The reason I make the distinction is that one comes with a contract and a promise,
the other, many times, comes in its initial form without a promise. Many, many
companies maintain retiree benefit programs that on the terms the programs say in
plain English in large type, "This program can be discontinued at any time at the
discretion of the Company. It can be modified, it can be changed, there are no
promises." Yet we, for social reasons, choose to ignore the face of that disclaimer.
Do you see a difference between the two? Because one concern I have is your
paper pointed out, or testimony points out, is that you're seeing is people because
of what's happened in some bankruptcy cases where there has been a conversion
of discretionary programs to something else, you're seeing these programs being
discontinued wholesale across the country.
Keating:
Visteon in particular to name one, right? Visteon has basically said that [section]
1114 overrides that whole modification.
Butler:
The discretionary language in the contract. So [*] if you see a distinction, I'd love
to hear your views of it.
Keating:
Well, I definitely gave a lot of thought to the Visteon case, and my problem with
the Visteon case is that my feeling is if something is a claim outside of bankruptcy
then it should be a claim inside of bankruptcy and if something is not really a
claim outside of bankruptcy, if it's not a contractual right to payment, bankruptcy
shouldn’t make it one.
I think I would say, [and] this goes back to the Supreme Court and Butner,
bankruptcy should take state law entitlement as it finds it, absent of some clear
federal bankruptcy policy to the contrary. I guess in Visteon maybe the judge was
claiming [section] 1114 was the federal policy to the contrary. It seems to me that
if you have a non-vested retiree medical benefit promise that in fact outside of
bankruptcy could be terminated by the employer, then the same should be true in
bankruptcy.
I have to say though, there's a matter of contracts doctrine, the notion of these
non-vested retiree medical benefit, promises or programs, have always been a
puzzle to me, because I've never understood the notion of, “okay, we don’t really
owe you this retiree medical benefit obligation for life, we can stop it at any time
we feel like it.” Yet, “yeah, we are paying it, we are paying it even though we
don’t actually have to, and even though we could stop it at anytime,” it's always
been a strange concept to me.
Yet if outside of bankruptcy that’s how courts are willing to construe it, that it is
something that the employer can, in fact, walk away from, if that’s how nonbankruptcy law treats it, then I think that’s how bankruptcy law should treat it as
well.
Keach:
Thank you. Mr. Togut.
* Language clarified in transcription process.
20
Al Togut:
Yes. By the way, I'm Al Togut, the co-Chair [of the Commission]. [*]
I wanted to ask you [*] a multi-part question, and just so you understand where
I'm coming from, I represented the official retiree committee in Nortel.
It seems to me, I'm asking if you share this view or you don’t, and if you don’t
why not, that there's two kinds of retiree benefits fundamentally. When Jack
Butler talks about terminating the plan, that can be viewed as terminating the
promise to employees in the future that for continued performance you will get
benefits [and] you can distinguish from that the employees who are truly retired,
who have fully performed, who took a lesser pay because factored into their
compensation were these benefits. I have a question about your feeling about
terminating the benefits for a fully performed employee versus the promise to
provide the benefits in the future for future performance. That’s one part of this.
The other part of this is taking a case like Nortel, the whole idea of terminating
retiree benefits and the whole idea of Visteon, is that there's a greater good, and
the greater good is we are trying to save a company, and so in the process of
saving the company you have to cut back on expenses, and trim it down so that it
can continue to survive. But, [then] there's a chapter 11 with no company being
saved, a straight out liquidation.
To exaggerate the facts a little more, you take a case like Nortel where they had a
windfall in generating $7 billion for the intellectual property, they never expected
they'd get anything close to that. At that point, in a straight out liquidation the
retiree benefits were sought to be terminated to enhance the return to other groups
of creditors. I'm asking is what the distinction between a fully-performed
employee and having the promised benefits terminated, and a distinction between
saving a company, so it can emerge from chapter 11 and operate versus a straight
our liquidation.
Your view on those four possibilities?
Keating:
Let me take the first one. I think the first issue comes down to the common law of
vesting, and there's an entire common law of vesting around retiree benefits, and
if it's possible for a court to find that even with a person who is fully retired, that
has started to received benefits, that those benefits aren't, in fact, vested. That’s
[*] what I was saying before this weird concept of, “gee, you’ve got these retirees
they are not even giving anything to the company, then you're not contractually
bound to pay them these benefits, and yet you’ve been doing it?” Oh, and now
you're going to stop.” It's possible that a court could determine, “Yeah, those were
or weren't vested because those retirees when they were workers, even then they
knew that even after they retired, the company could change or terminate the
benefits at any time, it was right in the contract.” I think that’s rotten, but as a
contracts matter, as I understand the vesting common law, I think it's possible.
* Language clarified in transcription process.
21
I certainly think if I were a judge I would have less trouble in finding lack of
vesting with a worker who was still working and had some options with respect to
the promise that I'd made to them about what's going to happen after they retire
versus taking away the benefit from someone who has already done all their
[work], put in 40 years and they’ve been retired and they’ve been getting the
benefit. I think if I were a judge and I had discretion I would be more inclined to
figure out a way to find that that one was vested, but I think it's possible that they
could find it's not.
Your second question I think raises a great issue that I've addressed in other
papers on this. I say I've addressed it, I haven’t resolved it, but here is the issue
which is frustrating. One of the problems I see with section 1114 is, ultimately,
section 1114 needs to define the relative priority of the retiree, because one of the
weird things about [section] 1114 is that it was modeled on section 1113, but it's
like apples and oranges.
I mean, [section] 1113 is an executory contract, both sides still have something to
give, it's a labor contract. [In] section 1114, you're talking about someone who
gave what they're going to give to the debtor, and now they're just trying to claim
it. As a claimant, they ought to have a relative priority attached to their claim, so
that we know where they stand. In your scenario, the language of section 1114 has
this, "Shall pay … shall pay unless, shall pay unless” [and] you can come to court
and show that if you did pay that that would make it impossible to a
reorganization. It's kind of a nebulous priority, and in your case, it shows how we
really need [*] this backup administrative expense priority for the retiree benefits
under [section] 1114.
You see, I think even that priority a bit unclear. I think the case that you raised
where you’ve got this chapter 11 liquidation, so there's not going to be a
reorganization, there's not going to be a continuing company who has regular cash
flow to paying retiree benefits. I think that highlights the fact that these retiree
medical benefit claims, they're just a claim and a mega-claim, and Congress, why
didn’t you tell us what priority, what relative priority you wanted to put on that
mega-claim when you did section 1114, instead of assuming that tall cases were
going to be like LTV where the company is clearly going and is going to have a
cash flow.
In answer to your question, I don’t think [section] 1114 really answers the
question very well. That is, the question of the relative priority of the retiree claim
as against, secured creditors, unsecured creditors with priority, unsecured
creditors without priority, I think it's a puzzle the way that it was written, because
again, Congress tends to write reactive legislation, and [section] 1114 was a very
reactive piece of legislation. It was written in the aftermath of the LTV case and it
addressed what was going on in that case, but these retiree medical benefit issues
come in a lot of different forms, and sometimes ones that we can't imagine very
well, like the one that you just talked about.
* Language clarified in transcription process.
22
Keach:
To pick up on that theme for just a second and then we'll have to wrap up. Isn't it
the case of both sections 1113 and 1114 suffer from the same problem?
Keating:
Absolutely.
Keach:
That is, that they were written for a presumed kind of reorganization that happens
very infrequently at the moment, and that is a sort of bootstrap reorganization
with the company continuing in place largely in its existing form with, one hoped,
a better balance sheet but even the language of the provisions don’t seem to
accommodate the idea that you have companies that are being sold in 363 sales or
liquidated.
In fact, looking at the problem you just expressed in terms of not being told about
the priority, in fact, we are told what the priority would be in chapter 7, which is
nothing like it would be in chapter 11, and so that in and of itself suggests the
kind of schizophrenia around this point, and maybe the point we can close with
isn't this just a problem of the externalities of the kinds of chapter 11s we see
having overwhelmed the language.
Keating:
Yeah, [*] I've also talked about the lack of priority for retiree benefits in [chapter]
7, and the kinds of best interest of creditors test conundrums that that can be
created when the unsecured creditors who aren't retiree creditors can say, “well,
gee, I'm getting a lot less in this [chapter] 11 because these retirees who are just
going to be the same as me in the [chapter] 7, are getting this special priority, and
the going concern surplus in this case isn't as big as the retiree claim, so I want to
ask you to deny confirmation on the basis that this plan doesn’t meet the best
interest of creditors test.”
As far as section 363 goes, I know in reading the transcript for the testimony in
March, there was a lot of talk about new provisions that would deal with [section
363 [sales] and particularly trying to, in effect, force any [section] 363 sale to
consider, if not require, that the buyer keeps collective bargaining agreement
obligations in place and retiree medical benefit obligations in place. Of course, if
you were to make that hard and fast, then you might just end up with more
piecemeal liquidations if that had to run with land as it were. It might stop the
[section] 363 sales and you might end up with just less value maximizing
transactions in bankruptcy.
Keach:
As Chris Levine, who is not here often says, we could have drafted the
Bankruptcy Code on an index card, or could just say, “we pay everybody,” but it
probably wouldn’t work very well.
Thank you very much.
Brandt:
Can I just correct one thing though on the record that you mentioned? I'm Chair of
the Illinois Finance Authority and so I deal with pension fund issues in Illinois on
a daily basis.
* Language clarified in transcription process.
23
As I read your statement, your parents are members of the Chicago Teachers’
Union, but their pension plan is not operated by the State of Illinois, it is in perfect
shape, will never be affected by any legislation in Springfield, and is terribly
solvent, thankfully, because the City of Chicago has it as a separate pension plan,
separately funded.
Keating:
They don’t seem to believe that, but I'll tell them that tonight.
Brandt:
I understand.
Keating:
I'll tell them they can rest easy.
Brandt:
The CTU's Pension Plan has been for almost 35 years divorced from any other
pension plan, there's no oversight from Springfield, it is run under the oversight of
the City of Chicago.
[*]
Keach:
We do have to move on to Professor Lipson, who has been waiting patiently.
Our next witness is Professor Jonathan Lipson, who's from the Temple University
School of Law. Professor Lipson is going to talk to us about controlled discovery
and examiners, among other things.
Professor, we have read you paper and we would appreciate it if you could
summarize and then we'll get to the same kind of questioning you’ve been
watching up till now. Thank you.
Jonathan Lipson: Thank you very much for inviting me to discuss this with you today.
I wanted to start by thanking all of you guys, the Commissioners and the
American Bankruptcy Institute for organizing this. I think it's an extremely
important project and in some ways it's unfortunate that Congress isn't doing this,
but we are very lucky to have you guys doing it instead. I also want to thank to
Michelle [Harner] and Sam [Gerdano], because it seems that they're doing a great
job of managing the whole process.
Most of my work as an academic has looked at the problem of information flow
dealing with troubled companies. Regardless of what your politics are about
bankruptcy, I think most people would agree that you need an effective flow of
information to restructure troubled companies. Then I want to talk about two [*]
proposals that I gave you in my written statement.
First, is the problem of controlled discovery, as you’ve described it Bob. I think
the problem is well understood by the Commission and I think most bankruptcy
practitioners and it's simply that, given claims trading, given private distressed
investors, given complex hedging strategies, given complex capital structures, it
appears to be the case that it is increasingly difficult to understand who, to quote
* Language clarified in transcription process.
24
Abbott and Costello, is on first, in many cases, whether before bankruptcy or in
chapter 11. Obviously that’s important for [*] at least two reasons.
One is economic and one really goes to the integrity of the system. The economic
issue has to do with the fact that if it is difficult to discover who is in a position to
control a case, it is probably going to be more costly to renegotiate the capital
structure of the company and therefore to reorganize it, whether outside of
bankruptcy or inside of bankruptcy. Fights in cases like American Airlines and so
on are in essence, [are] about controlled discovery and compliance with rules that
would in a sense, force people to disclose their ability to control some aspect of
the case.
There are other economic costs that the problem of control discovery creates that I
describe in the paper, I won't belabor them now, but we can talk about them in the
Q&A.
The other issue is systemic integrity. If you don’t understand who is in control of
a company or a case, you might start to worry that folks who are in the control of
the company or the case don’t necessarily have the interest of the process at heart.
Maybe they're not acting in some way and in accordance with whatever it was
Congress thought it was doing in 1977 and 1979. It also makes it more difficult
for people like me and Michelle [Harner] to study the system and understand
what's really going on, because the information that we need is simply not, in
many cases, available.
The proposal that I gave to you, [and] I've written about it elsewhere, is to create a
system of what I call positional disclosure, and the basic idea is that we would ask
distressed investors that obtain a material position in or affecting a distressed
company to disclose that position or set of positions in real time online electronic
registries.
Why does this not already happen? Well, there's a gap in the law that federal
securities laws require disclosure of the ability to obtain control of solvent
companies under Rule 13D of the Securities Exchange Act of 1934, but that only
applies to voting equity, and what do we know about insolvent companies when
they are in the slide into bankruptcy or in the vicinity of insolvency, equity is not
what really controls the case for the company, it's going to be the debt in some
way.
[Rule] 13D doesn’t apply to debt. Once a company is actually in bankruptcy, if it
ends up in bankruptcy, we have [Bankruptcy] Rules 3001 and 2019, as amended,
which certainly make an effort to produce information about the ability to control
a case, but they are either imperfect or costly in a variety of ways. Having
investors make this disclosure in real time on a electronic registry, I think
probably ends up being [*] better for investors as consumers of the information
because they can rely on it, and better or the producers of the information because
it's cheaper to comply.
* Language clarified in transcription process.
25
It sounds simple but, you know, I recognize that there are many, many
complicated subsidiary questions that system would create, and I've discussed
some of those questions in other work and I'm happy to discuss those questions
with you.
That’s the first proposal, how to deal with using positional disclosure to deal with
the problem of controlled discovery.
The second proposal in some ways, I think, is to many people more mundane but
in some ways I think more of a hot-button issue for lawyers especially in large
cases, and that is the question of what to do about bankruptcy examiners. As Bob
mentioned that the outset in [section] 1104(c) of the Bankruptcy Code speaks as if
bankruptcy examiners are going to be mandatory if either certain conditions exist,
if there was fraud or something of that sort, or you have a debtor with qualifying
unsecured debt in excess of $5 million.
You might think that that means we are going to have lots of bankruptcy
examiners, and there is certainly authority in the Congressional record for the idea
that bankruptcy examiners would be fairly common in very large cases. In fact
that’s not all what has happened, I've done fairly extensive study of the use of
examiners, in chapter 11 and my research shows that even the very largest cases,
you're not likely to find them requested in more than 15 percent of those cases,
and they're [only] going to be appointed, that is the request is going to be granted
in fewer than half of those.
Those are the largest cases, cases involving more than $100 million, virtually
certain to satisfy the qualifying language of the mandatory element of [section]
1104(c). People don’t want them very often and judges are very uncomfortable in
granting requests for them, even when it appears that they're statutorily required.
When you look [*] at smaller companies, [and I] haven’t published this yet, but I
can give you a preview.
We got a sample of about 570 small cases, mainly cases that are not publicly
traded or have $100 million in assets, and there, you go from an appointment rate
of 6.7 percent, which is what you see in the big cases, to an appointment rate of
about 1 percent. There were a total of 10 examiners in the sample of small cases
that I looked at from 1991 to 2007.
It's pretty clear that people either don’t want examiners or judges, are not
comfortable with giving them examiners or some combination. Why? Well, it's
obvious, I think people are very concerned about the costs and benefits associated
with having a bankruptcy examiner. The question then becomes, well, if you are
concerned that, for example, people might be using the mandatory language,
seemingly mandatory language of [section] 1104(c) strategically, which certainly
people suggest happens sometimes, then what do you do? Well, I proposed in
other work that you eliminate that mandatory feature and you replace the
mandatory $5 million number, which is problematic for a bunch of reasons,
* Language clarified in transcription process.
26
including that it doesn’t actually account for inflation since 1978 with a
presumption that an examiner should be appointed if in the interest of the estate,
and then set forth some criteria that would guide a judge in understanding whether
or not an examiner will be in fact, in the interest of the estate. It's a presumption
that could obviously be rebutted, and part of the goal of replacing mandatory shall
with a presumption, is that it would then deter parties who might attempt to use it
strategically from doing so.
In the event that there really is a request, force the information out. If somebody
really has a good reason for asking for one, put them to the test, and if they don’t,
put it to rest. I've provided some sample language that I'm sure can be radically
improved by folks on this Commission, but I think you all get the basic idea.
Those are two suggestions that I have, and [when] Michelle ]Harner] asked if I'd
be willing or able to do this, and I said, "Of course, what would you like me to
talk about?" She said “anything you want,” which is really dangerous. It's like
[how] the most expensive piece of medical equipment [is] the pen and the blank
prescription pad. I've tried to limit myself to these two things, and I'd be happy to
discuss those or, really, almost anything, except medicine, with you.
Keach:
Judge Carey?
Judge Carey: Professor, I was one of those judges who Mr. Keach referred to earlier who
refused to appoint an examiner when the statutory standard had been met, and I
failed to do that because there was nothing for the examiner to examine, I found.
Did I do something wrong?
[*]
Lipson:
Yeah, it's sort of a Donald Rumsfeld problem, right, "You don’t know what you
don’t know." Yet, I obviously wasn’t in your courtroom at the time, I couldn’t
begin to tell you. [*] One of the things the second step of this research project
finds is that even amongst large cases, we've looked at more large cases than in
the first study, the courts in Delaware are very, very unlikely to appoint examiners
and indeed there’s a statistically significant inverse relationship between a request
for an examiner and getting one appointed if you happen to be in Delaware.
I think examiners are in part about systemic integrity, so if you have confidence in
the lawyers, if you have confidence in the other professionals in the case, that
they're doing their job, it's not obvious to me why you would have really any good
reason to doubt them and therefore appoint an examiner simply for the sake of
doing so. The answer [*] is by and large trust judges, and by and large trust
professionals, so I think what my proposal is seeking to do, is in essence bring the
statute into line with reality, that the profession and the bench have voted with
their feet, and they voted in a way that was different from what Congress initially
anticipated.
* Language clarified in transcription process.
27
Given the sort of sausage-like history of the provision, as Bob suggested earlier,
it's not obvious to me that Congress really meant it and so maybe this is simply
coming back to some kind of equilibrium that in fact is more useful.
So, no, I don’t have any reason to believe you did anything wrong.
Brandt:
Professor, trust me, if it's in there they meant it, and that would be a good way to
approach it.
Keach:
Yeah, but it probably was a compromise. I wanted to ask you some questions
about controlled discovery, but let me just follow-up on this point, and one of the
things that always struck me about this provision in general, [section] 1104 as a
whole, is that it doesn’t get used very much to the frustration of a lot of people
because both of the instruments are sort of, [well] one is a very blunt instrument,
which causes all kinds of havoc like termination of exclusivity, displacement of
management et cetera, and so nobody really wants to go there except in the most
extreme circumstances. The examiner role is insufficiently defined so that it's not
clear that it has the sort of tools to be terribly useful, and so that’s why it doesn’t
get used very much. There was a flurry, I can remember, historically, of the beast
called “an examiner with expanded powers,” where we all got creative and started
to try to define useful examiners, diplomat examiners and mediator examiners and
the like, and then that flurry died. My personal theory is that the externalities
conspired to give other people control that was sufficient enough to not have to
worry about that problem anymore.
Looking at that history, and then looking at that thesis, wouldn’t it be better if we
just overhauled this section in ways that created useful individuals, so the courts
would want to appoint them, and they could do jobs efficiently, and at some
defined as opposed to undefined cost?
Lipson:
Well, I hate to sound like a law professor, but what do you mean by useful,
[because] it really depends, right? I think one could understand that [section] 1104
is what Congress thought it was doing at the time. These are obviously legacy
positions, in a sense. I mean, examiners have been around in one form or another
for many years, it's not something that, in fact, sprang into existence in 1978,
examiners were appointed in equity long before the Chandler Act enacted them.
Keach:
I mean, just to follow up, and I gave you a piece just from experience. I'm largely
the debtor side chapter 11 lawyer in my district, and I can tell you one of the first
things I learned from one of my mentors was if you think that somebody might try
to move for a trustee in your case and you think they might win, move for the
appointment of an examiner, because it was always seen as a defensive
mechanism because examiners don’t actually do anything that’s going to hurt the
case.
By the time the report comes out we'll have confirmed the plan and moved on, so
what I mean by useful is something other than drafting a report that may or may
* Language clarified in transcription process.
28
not see the light of day. Now, we've seen, I think, in Tribune and other cases,
probably the most recent example would be Judge Gonzales' report which may
never see the light of day, but we've see examiner's reports generate meaningful
settlements and drive cases, so it's not that they can't be useful, but I guess the
question is, should we think about just overhauling the statute in ways greater
than fixing [section] 1104(c)(2)?
Lipson:
It's an excellent question, and I don’t know that I have a ready answer to it. I
guess if I had to answer the question one way or the other at this point, I would
say probably not. I think the system by and large works. Again, that’s because I
by and large have confidence in judges and I by and large have confidence in
lawyers, and the fact that we are not using these folks much doesn’t mean we
don’t want their appointment and power out there on the books.
[*] I interviewed a bunch of lawyers for the first phase of [my] examiner study,
and the person who had been an examiner on several case said, "You know, they
are high bore instruments, they're very rare but when you need one, you really
need one," and you can really use them, and judges sometimes find them very
valuable because they are a mechanism through which the judge can exercise
discretion and influence the case or help the case along in ways, that the judge
couldn’t do personally, whether with expanded powers or not.
Yeah, it's certainly interesting to think about other kinds of things, you could
easily imagine an entirely reformulated chapter 11 system, as we were talking
earlier about, going back to the 1973 study that, would say, well maybe this
should all be done by a bankruptcy administration and not involve courts at all.
There are all sorts of different ways to re-conceptualize the system.
I think that the other reason I would be a little resistant to really radically reform
[section] 1104 is that it's, like anything else in the law, something that
professionals know pretty well, and I think that professional competence depends
in significant part on familiarity with the tools that you have. You may not want
to use those tools a lot, but it doesn’t mean you don’t want them. Unless you have
serious doubts about the integrity of the lawyers, or the integrity of the Bench, or
the process generally, I guess I probably wouldn’t radically change [section]
1104(c).
Whether you might do something different with trustees is a question I haven’t
thought specifically about, but you're correct, request for trustees are even less
common than request for examiners. More common than either will be requests to
convert a dismissed case. That’s true about the large cases and the small cases,
and I spend as much time thinking about exactly why that might be but, again, I
think my instinct at this point without having too much time to reflect on it would
be, no, I wouldn’t radically overhaul [section]1104, but I might work around the
margins of it.
Keach:
Mr. Brandt.
* Language clarified in transcription process.
29
Brandt:
Judge Houser and I had a discussion about this on a panel some years ago and one
of the issues we talked about, and not in the large cases such as Revcor or the
others, but the mid-sized smaller case,, was if there was a motion for a trustee,
often the cost and the hubbub to do the hearing was almost going to kill the case,
and the mid-range ground was to appoint an examiner because one of the
examiners primary duties was to respond quickly to the court [on] whether there
should be a trustee and in effect [*] maybe skirt the issue of some of the evidence
or needs and get the question called rather quickly.
The problem became that examiners then sought to prolong their appointments
and they never got quite around to saying there should be a trustee or shouldn’t,
and as Bob says, they were often doing reports until the confirmation, and that
always struck me. I mean, I remember Judge Houser, and I'm not putting words in
your mouth, suggesting to me that sometimes the judges wanted the examiner to
actually come back and do what the statute says and that is, offer a
recommendation as to whether the immediate need for a trustee exist or not.
Would something like that, if we put some teeth into that particular aspect of it
and solve some of the issues you raise?
Lipson:
Do you mean sort of a pre-examiner examiner?
Brandt:
No. I mean, if the examiner actually did the primary duty that the Code says the
examiner should do, first report to the court on whether there's a need for a
trustee.
Lipson:
I'm not sure I read the statute necessarily in quite the same way. I mean, I think
that the statute is a little more open-ended and flexible than that, but I think it is
true, as Bob suggested earlier, that the examiner is a fallback position in many
cases.
Brandt:
Or is a ROM Trustee at some point?
Lipson:
Yeah, the ROM Trustee is sort of the judge’s little helper. There are all sorts of
ways you can view it depending on your view of examiners, but I think that the
problem that you're articulating is a very important one, which is you give an
examiner some rope and they're going to keep clawing on the rope. You say,
“You’ve got a month, and here is a budget, go figure out the answer to this
question. Don’t come back to me with 10 more questions and the request for
another three months, and $8 million and more in your budget."
Sometimes examiners come back and ask for that anyway, and sometimes they
don’t. [*] If you go back and look at the older cases I think there was more of
what you described earlier; which is the examiner really stretching things out. In
the same way that debtors in possession stretch out exclusivity forever, and judges
got smart and figured out that that wasn’t really such a good thing. Congress also
got into that game.
* Language clarified in transcription process.
30
I think the system is capable of responding to those abuses, and indeed, I have just
been working with New York City Bar Association on a book that they're
publishing on the best practices for examiners and helping those folks who have
to appoint examiners or people who would be examiners or might request them, to
understand exactly how they keep that railroad running efficiently. As I said, I
don’t think I've ever encountered anybody who seriously thinks we should
eliminate the position entirely, but I think there are concerns about cost, and that
concern about cost can be expressed in many ways.
Certainly if the question in the first instance is,should a trustee be appointed or
should this case be converted or dismissed, I don’t see why that isn't a very simple
question. [*]
Brandt:
In response to Judge Houser's dialogue with me, we were trying to find some
research, whether we could find any examiner who, shortly after their
appointment, let's say, within 20 days, suggested to the court there needed to be a
trustee and their work here was done, and frankly, we couldn’t find one.
Lipson:
Yeah, and I don’t think I've ever seen that either. You can imagine that selfinterest might be part of that, but [*] there's nothing that would preclude an
examiner from being asked that question.
Keach:
Professor Lipson, I want to switch to the topic [*] of this whole issue of the
conduct of claims trading parties,[*][which] is interesting because it seems to me
it goes fundamentally to the question that’s been debated, particularly since DBSD
I guess, which is does creditor motive actually matter?
It seems to me somewhat obvious if we are talking about somebody who has a
completely external motivator, like a swap tied to an event or a short position in a
related case. The kinds of things where I hypothesize and I think it gets a little bit
more difficult [is] as we move away from those kinds of obviously conflicting
positions.
I guess the point I want to get to bluntly is, don’t we have to answer the question
about how much we care about creditor motivation before we answer the question
about how much discovery of positions that’s required?
Lipson:
Well, we don’t ask it now [and] we don’t ask it of equity investors under Rule
13D or 13F.
Keach:
We do ask it now if they vote for plans, or it potentially it can be asked if they're
voting for plans for their clients.
Lipson:
You can't solicit, you can't solicit a vote on a plan under the Code.
Keach:
Well then, you can designate a vote for bad faith and Adelphi and DBSA would
suggest that conflicting positions could be grounds for doing so.
* Language clarified in transcription process.
31
Lipson:
Absolutely, yeah. Good faith obviously matters, and it's mattered for a long time,
long before DBSD or anyone. [*] If I understood your question correctly and help
me out here if I'm not, it's really going to assume you don’t have outliers.
Keach:
Let me just flip and ask it even more directly. You’ve hypothesized that we
should develop a system for disclosure of positions, and I guess my question is,
why? In other words, what about that information makes it important to the
smooth administration of a chapter 11 case?
Lipson:
It's, as I say in the written testimony and as I've said in other papers, I think that I
believe lawyers when they say that the transformation of the chapter 11 process
over the last 20 years has just made it more costly to renegotiate. So if you
assume that chapter 11 is really kind of the tip of the iceberg, that when
companies are in trouble, they're going to try to renegotiate with their
stakeholders long before bankruptcy, or at least before bankruptcy, maybe not
long before bankruptcy, and that most of what happens in Chapter 11 as a judicial
matter, is really only the tip of the iceberg and an awful lot of what really matters
is going to happen outside of the courtroom in a conference room somewhere.
In the olden days, when nobody was really trading and plans were very limited,
and in the olden days when management was probably was going to stick with the
company and you were going to have turnaround specialists and you weren't
going to have [section] 363 and whatever, everybody was chained to the
negotiating table. That meant, among other things, that you didn’t really have to
spend a lot of time getting confident that people, other people in the room have
the positions they claimed to have. One person I interviewed a few years ago, a
banker, said, "You sit in these meetings and somebody says, "I'm from Citadel
and I have all of the bonds or something”, how would you know if she didn’t.”
You can verify it, there are probably ways you can do it, you can get people to
sign things, maybe they'll lie, maybe they won't. You could litigate it under
certain circumstances, see NorthWest, but it all adds costs and delay. I think if
negotiations require conditions of trust to be successful, there are a couple of
ways you can get that, and one is through disclosure.
The other thing is that I think that I'm only interested in material position and I
don’t think everybody's position should be disclosed. I think a much harder
question is, what's material? I think that if I'm correct that these are costs that the
parties amongst themselves bear, they ultimately probably would benefit from
having a system of improved disclosure, pre-bankruptcy as well as in chapter 11,
for the same reasons that we think that investors in the larger securities markets
benefit from something like Rule 13D.
There seems to be something about taking control, creeping through the process
of taking control that matters in both closed negotiations and the larger
marketplace. It really is more about the cost of negotiating than it is about the cost
of adjudicating.
* Language clarified in transcription process.
32
Brandt:
What would you suggest that be material, I mean 5 percent on the outside for the
SEC, but in a bond it's probably 20 or 25 to 30 percent before it really can give
you a controlling position.
Lipson:
I think that’s probably right. You have to sort of start from the end, which is, what
would a plan likely look like?
Keach:
33.1 percent.
Lipson:
Yes, 30, whatever blocking position in [section] 1106 would be kind of plausible.
As I say, defining material here is not easy.
Brandt:
I agree with Bob and I think blocking position, but I'm not sure the level of
materiality, it's some threshold below that because it's indicates intent on a runner
basis much like the SEC requires for stock.
Lipson:
That’s right, and 5 percent obviously isn't the majority of anything and yet that’s
what the SEC says.
Brandt:
Could you see somebody like SEC having their role expanded to cover disclosure
for this kind of stuff and run the compliance?
Lipson:
Maybe. [*]
Keach:
Do you mean for claims and equity, both? [01:50:00]
Brandt:
Yes. I mean, for that trading. [*] Because we have this phrase "loan to own" I
mean, [and] at some you are essentially trading in equity instruments, they just
aren't called that yet.
Lipson:
Exactly and that’s where the gap in law is. The SEC got out of the business of
bankruptcy in 1978, they didn’t like it, and nobody like them being in that
business.
Brandt:
[*] I mean, let's say it wasn’t outside the SEC or something like, how would you
see the cost being managed for that compliance?
Lipson:
That’s the question. I think the idea behind online registries is that it's not that
hard to submit something [electronically].
Brandt:
You'd still have to have some enforcement mechanism that will cost money.
Lipson:
That’s right. Well it depends, you can public enforcement and you can have
private enforcement. You could, for example, leave it to the parties to say, we do
already under the 1934 Act. I think you’ve not disclosed something materially,
and you should have, and maybe there's a private cause of action that private
individuals can bring. Maybe you also have a regulatory apparatus that supports
* Language clarified in transcription process.
33
it. There are great questions and I haven’t answered all of them, in part because I
don’t think we understand the extent of the problem.
[*]
Butler:
I just want to take a breath for a second and go back because your testimony
focuses on controlled discovery, but the fact is that [*] the secondary distress
markets we have now, that we didn’t have 20 or 25 years ago, have a lot of
benefits as well as costs. Those benefits include providing liquidity to thousands
of stakeholders in cases who are able to cash out and go away at some discount or
at some price that they agree to in the market. It's a marketplace transaction.
That has, I think, [*] saved a lot of businesses who've been able to cash out and
move on. Not that I'm talking to the target but other stakeholders who are able to
cash out their positions and move on. The distressed trading place has, first and
foremost, provided liquidity and it is unregulated. There are lots of day trades,
someone's on something today, that’s on something tomorrow, and I think many
of us who are involved in the system, live in a world where you negotiate with
somebody in the room one day and find out the next day that they're not in the
room anymore.
The deal you had yesterday, you’ve got to redo tomorrow, that’s troubling, but
that’s the flip side of providing liquidity to stakeholders. I guess what I'd like to
hear you comment on a little bit, is the balance of the two. I mean, it's not just an
information issue, it's a liquidity issue for stakeholders and when you balance
those things, you’ve got to provide, I think, a marketplace where people want to
play and where people want to believe they're being treated fairly.
At least if they were distressed trader sitting next to you, I think they would say to
you, "Hey, to do the kind of disclosure you're talking about is extraordinarily
prejudicial because it would disclose to other people out investment strategy
which is not something that is anyone's business but ours and why is that?” And
maybe at some point it is [our business]. [*] I'm just trying to get you to, if you
could, to sort of broaden your testimony in terms of how you see all these
[interact].
Keach:
Just to tweak that question, the conflicting point, as Jack and I would say, is the
point is, when you're enter chapter 11, maybe chapter 11 is different.
Lipson:
I think the question is: liquidity for whom? It’s not liquidity for the debtor, so it's
got to be liquidity for folks who are selling out of their positions. So you could
say, “well, the trade sells, and that then enables them to re-lend to that debtor?”
Probably not, but maybe it provides liquidity, maybe that’s beneficial.
Butler:
No, I'm sorry. I was talking liquidity to stakeholders. That’s not a bad part in the
bankruptcy system. [*]
Lipson:
Correct. That’s right, and so it provides liquidity to the trade creditors, right?
* Language clarified in transcription process.
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Butler:
Right.
Lipson:
I certainly don’t believe that claim shedding is evil or inherently problematic.
What I'm focusing on is how to make it a more smoothly-functioning market, and
I think, you know, you’ve phrased the problem in the right way, which is that any
change of the sorts creates cost and you have to ask yourself are the benefits
commensurate with the costs? Part of the problem is that we know that a lot of
this is going on, and we know that it creates problems, we don’t know how
significant the problems are so I don’t have a model statute, for example, to give
you, because I don’t know for sure exactly what should be required, but I'm pretty
confident this is a significant concern.
The goal here is to have a smoothly functioning market, it's not to impede the
market at all, it is to promote liquidity, provided that the creation the liquidity
doesn’t result in other collateral cost.
Berman:
Don’t you need integrity within that marketplace?
Lipson:
That’s right, and I think [that’s] part of the economic costs and their social cost.
The economic costs are the costs of the parties, maybe that’s great maybe it's
small, maybe you have a smaller group of people that all know each other, and
they trust each other and it's not a problem. But there is also the question of
systemic integrity and nobody wants to go back to the bankruptcy ring or
anything like that and [*] I don’t think that’s right.
I do think that other things equal a little more transparency is probably better than
a little less. [*]These were all the arguments that were made back in the 1960s
when [Rule] 13D was added, and it seems like the equity markets have managed
to survive, and adjust so I'm always a little suspicious of the claim that if we have
to tell people what we are doing, we can't do it anymore, we'll drive up the cost,
so much so that we can't do it. There's no evidence to support that.
Brandt:
You were talking about disclosure of majority positions, and I give Jack the
differences, but day traders, you're talking about at some point of the threshold [*]
where the disclosure triggers, and as to only those who have begun to accumulate
and for that purpose. The only other issue and the question I had was, who would
pay for that? I find it manifestly unfair, although I think the system needs to be
there for disclosure, as Geoff says, that the debtor would wind up paying for the
disclosure cost to some bureaucracy because other people are buying the debt?
Lipson:
Yeah, you hope not, right? They're already paying the cost of dealing with Rule
2019 fights, and so it doesn’t seem like adding to the debtor's burden is the way to
go here. I think it's like any other exchange. Folks want to participate in the
exchange, pay for the cost of the exchange, which [*] is what you would expect at
minimum in any well-functioning market.
Now as for day traders, I mean, maybe you make an exception if you're going to
be in and out in a day. There are lots of ways you can carve out special exceptions
* Language clarified in transcription process.
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to balance the stuff out. As I said, I don’t have model language to give you, but I
do think this is an important concept to focus on and account for both the benefits
and the cost, but I'm confident that there is a gap in the system now.
Keach:
You’ve largely focused, I think, on control positions, and I tried to make the
distinction in my opening remarks between arbitrage and control positions. Isn't
this part of sort of the bigger problem and the fact that the debt trading market is,
in fact, unregulated, which has led to this problem of the ad hoc committees, and
[Washington Mutual] decision about when it's insider information? Should we be
accommodating trading by having special disclosure purges in bankruptcy?
I've never yet been able to figure out why a chapter 11 debtor would ever want to
purge its information to let people trade, but isn't it actually just part of the larger
problem of, should the debt markets be more like the security markets?
Lipson:
I think that’s right, so when I say in my written testimony that I think much of
chapter 11 or the world of distressed companies generally, has become a
secondary market for the trading of debt in order to obtain control of the
distressed companies, that’s right. The key is, that I don’t think you need to create
the same regulatory apparatus that we have securities law. What do we know
about the federal securities laws? They are super-expensive to comply with and
they have some significant benefits but, boy, pretty costly too.
I think that it is not difficult to learn from the mistakes, if you will, of the Security
Exchange Regime, and take the better pieces of it, while still trying to avoid some
of the excessive cost at the margin. I think the answer is, and this goes back to the
question about would you have the SEC do this, I would not.
[*] I don’t feel like I have my arms around the problem long enough to know
whether, or to what extent you would want regulatory involvement. You could
imagine the U.S. Trustee’s Office might be perfectly adequate, maybe not.
Brandt:
The extension of what you're talking about, the definition of insider trading,
somebody accumulating 20 percent of the debt while they're on the Committee, I
mean, if you were going to have this kind of regulatory enforcement scheme
you’ve got very fertile ground. What happens in our business says what would be
prohibited in some extent or least frowned upon in the equity markets.
Lipson:
That’s right, and you don’t currently have private causes of action except at the
margins in these kinds of cases. There's no reason that you couldn’t have a much
narrower class of private cause of action as the enforcement mechanism, so you
create a much higher hurdle. In effect, you do what Congress did with the PSRLA
and the SLUSA and make it much more difficult to bring security fraud actions,
but you do that from the outset so that if you want private enforcement, you make
it clear it’s only going to be in anyone's interest to try to enforce it when there's a
really serious violation. That’s part of what the term "material" would go to.
* Language clarified in transcription process.
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Keach:
We do have to wrap this up because we are a little bit over. [*] I want to thank
you very much for your thoughtful paper not to mention your body of work in
general in this area, and I want to thank you for coming today.
Lipson:
Thank you very much for having me.
Keach:
Thank you.
* Language clarified in transcription process.
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