00:00:00.889 - 00:00:17.069

I say let's not start from the top. Let's just assume that you heard the rest. Particularly I wanna thank Susan Jensen who was instrumental in allowing us to use this space, and I, we, really appreciate it. The subject of the program is

00:00:17.069 - 00:00:37.450

the report of ABI's commission on chapter 11 reform. I think we've got a lively set of issues to discuss. I think folks have the agenda and so, in the interest of getting started, I will pause only to thank Denise

00:00:37.450 - 00:00:54.259

Neary. For those who don't know makes everything run as smoothly as possible and does a terrific job covering for the failures of the rest of us. So Denise, thank you for all you've done in putting this together. And with that, why

00:00:54.259 - 00:01:11.980

don't we kick off. So Michelle. Terrific. So good morning to everyone, and I want to also start by thanking the American College of Bankruptcy and Denise and Craig for putting this fantastic program together and for inviting me to participate. I'm honored to be here today, so

00:01:11.980 - 00:01:32.599

thank you. I'm going to take the next 10 minutes or so to try to synthesize for you 3 things. First, the commission's objectives in this project. Second, the process that the commission used to achieve those objectives. And finally, I want to discuss the conceptual framework through

00:01:32.599 - 00:01:55.220

which the commission deliberated and ultimately recommended the principles in the final report. Before I do that, I have 2 things to ask of this audience. First, as I look out, I know that many of you are practitioners who day in and day out, represent clients, industry

00:01:55.220 - 00:02:15.910

groups. You pursue particular interests and agendas, and you're fantastic advocates. I remember those days fondly. For the next 3.5 hours, I ask you to take off your advocate's hat, and I want you to think about the federal bankruptcy system and the integrity of the federal

00:02:15.910 - 00:02:38.880

bankruptcy system through a holistic prism. Ask yourself, is the federal bankruptcy system working as effectively as it could for most, if not all, distressed companies and most, if not all, of their creditors. The second thing I want to ask you to do is: I want you

00:02:38.880 - 00:02:52.119

to think about driving through your city or your town. I certainly can do this living in Baltimore. And I want you to think about looking around and seeing all of those boarded up storefronts. I want you to think about those going out of business sale signs

00:02:52.119 - 00:03:09.320

that you're seeing. I want you to think about the people you likely know who have lost their jobs in the past several years. And again, I want you to ask yourself, is the federal bankruptcy scheme working as effectively as it could for most, if not all,

00:03:09.389 - 00:03:29.789

distressed companies and most, if not all of their creditors? And I ask you to start with those two points, because that's exactly where the commission started. When the commission was appointed 3 years ago, each of the 22 commissioners was asked to approach the project from an

00:03:29.789 - 00:03:54.139

integrity of the system perspective. Check your advocate's hat at the door. And I will say each of the 22 commissioners did that religiously. Second, their objective was to think about the system and its effectiveness, to study its effectiveness. It had no predetermined outcomes or agendas, and

00:03:54.139 - 00:04:12.330

most of the 3 years on this project was spent studying Chapter 11. What's working, what's not? How are we doing? Can we do things differently? Could we do things better better? What are the unintended consequences if we do things differently? All of those were on the

00:04:12.330 - 00:04:38.000

table. And to help the commission study the effectiveness of reform, it had a very methodical approach. So the first thing the commission did was it asked for volunteers to serve on 13 separate topical advisory committees. 150 professionals stepped up to the plate. The 13 advisory committees

00:04:38.000 - 00:05:04.679

covered a broad range of topics that are involved in every Chapter 11 case we all deal with. The committees included practitioners, judges, academics, financial consultants, industry experts. It was really an inclusive process from both an ideological perspective. A client representative representative perspective and a geographical perspective.

00:05:05.519 - 00:05:23.070

In addition to the 13 topical advisory committees, we also were fortunate to have an international working group. It was comprised of academics and practitioners from over 13 countries and what they did for us was actually quite phenomenal. They took targeted questions from the committees and the

00:05:23.070 - 00:05:39.790

commission and produced fantastic white papers on issues such as: how do you monitor your cases? Tell us about your monitors, your administrators, your receivers. What do you do with trade disclaiming? What do you do about surcharges? Tell us how you handle secure creditors' rights. Tell us

00:05:39.790 - 00:05:55.970

how you handle committees. And we really were able to think about not only how the US exports ideas in the context of insolvency and restructuring, but perhaps think about importing some ideas as well that might make our own system more efficient. For 2 years, these committees

00:05:55.970 - 00:06:14.980

and the international working group worked tirelessly. I was on most, not all, but most of the committee calls and certainly the commission meetings and calls. Many committees met monthly, if not twice a month. They produced research papers, they had deliberations, they had debates, and

00:06:14.980 - 00:06:31.570

then at the end of two years in February of 2014, get my dates correct here. Each of the committees met with the commission in person and we had an executive retreat where the committees had an opportunity to interact with the commission, talk about the recommendations,

00:06:31.779 - 00:06:47.970

talk about things they thought the commission might want to consider as it deliberated. And then the commission took all of that information that the committees produced and went into almost a full year of deliberations and as part of that process, deliberation process that consumed most of

00:06:47.970 - 00:07:05.959

2014, the commission met regularly in person on the phone in subcommittees and subgroups. We continued to do research, we continued to look at all of the information out there. So we looked at the academic literature, we looked at the empirical studies. And we also reflected on

00:07:05.959 - 00:07:22.380

2 years of public field hearings. So during the two years of committee studies, we had public field hearings in 16 different cities and, 16 different times in 11 different cities, get all my stats here together. And we heard from over 90 witnesses. I reviewed

00:07:22.380 - 00:07:41.739

over 800 pages of oral and written testimony. And we also were fortunate to have a symposium on secured credit and bankruptcy co-hosted by the Illinois Law School and the ABI. I have volumes of data and volumes of literature and volumes of testimony, and I

00:07:41.739 - 00:07:57.750

want to thank everyone. Many of you are in this room who contributed. It was fantastic and it was really informative to the commission throughout the process. So back to the original study question. Is Chapter 11 working as effectively as it could? So I will tell

00:07:57.750 - 00:08:14.829

you that the field hearings and the committee reports were very helpful on solving that question, and we heard a variety of perspectives and for some constituents, Chapter 11 appears to be working OK. And if you look at some of the data, it says companies still

00:08:14.829 - 00:08:33.059

reorganize in Chapter 11. And I think that's true. And I attribute much of that to many of the professionals in this room. We're fortunate to have a profession with innovative lawyers, academics, and judges who can make even an imperfect system work good enough. But

00:08:33.059 - 00:08:49.659

is good enough? What we want is a system that works for 2% or maybe less of the distressed companies in this country. OK. And so what the testimony told us was that for many companies, particularly in the small and middle market space, Chapter 11 is not

00:08:49.659 - 00:09:08.719

working. Companies are running away from the bankruptcy code. Sounded very familiar to the testimony before the 1978 code was enacted where people were using equity receiverships and any mechanism they could under state law to address financial distress and that's what we were hearing. And so it

00:09:08.719 - 00:09:22.159

was interesting to put that testimony together with some of the data because if you look at the data, it speaks largely to the largest cases in this country. It excludes what the commission thought of as small middle market cases, those with $10 million or less in

00:09:22.159 - 00:09:38.969

assets or liabilities. And it also talks about companies that actually file for bankruptcy. So could it be that only companies who have professionals that figure out how to make the current system work, file for bankruptcy and that it actually works. And for all those companies that

00:09:38.969 - 00:09:54.659

the system no longer works, they just don't file. And we don't have data on those. So I point that out as just one example of why the commission had public field hearings and why we asked professionals in this industry to talk to us and to

00:09:54.659 - 00:10:11.229

study the issues for us because the data is phenomenal. I do empirical research myself. I find it not only interesting but hugely fun, but then I have a warped sense of fun, right? But it's limited. So the commission took this entire body of work,

00:10:11.309 - 00:10:41.530

empirical data, traditional theoretical literature, research testimony, and it thought about bankruptcy Chapter 11 first principles. What are those first principles it used to think about reform? Rehabilitating companies. Mitigating value depressing and value destructing conduct. Respecting state law rights to the extent possible for creditors. And maximizing

00:10:41.530 - 00:11:02.539

value. It was really those four principles that drove the commission's consideration of the recommendations that you see in the final report. And the commission struggled many times with many issues because so much of what federal bankruptcy policy is about is finding balance among those four objectives,

00:11:02.619 - 00:11:16.549

those 4 principles. And that's what the commission strove to achieve was balance in policy, not balance in the sense of, well, let's give secured creditors a little something here and let's give unsecured creditors a little something here and let's give the debtor something here that's not

00:11:16.549 - 00:11:32.929

the type of balance the commission was seeking to achieve. The commission was seeking to balance the objectives and policy goals of a federal bankruptcy scheme. If we're just gonna sell and liquidate companies, let's do that under state law or Chapter 7. If we're gonna rehabilitate companies,

00:11:33.880 - 00:11:55.500

let's do it right. And so ultimately, the commission put forth over 240 discrete recommendations for reform. Some issues the commission wasn't able to reach consensus on, and we talk about those. These are hard issues and most importantly, I hope people understand the commission thought about

00:11:55.500 - 00:12:13.969

this report as the beginning of the dialogue, which is why I was so excited when Craig and Denise thought about putting this program together because this is exactly what the commission project wanted to engender. Discussion, robust debate, and hopefully then meaningful reform. That helps us save

00:12:14.330 - 00:12:35.679

save companies, save jobs, and get returns to creditors. Thank you. So thanks, Michelle um. So, to begin I guess I should say sort of by way of disclosure, I want do want to take Michelle up on her invitation to put our partisan

00:12:35.679 - 00:12:52.840

hats aside, and we very much believe we're gonna try to do that. I should say our firm does represent a trade association, that represents the interests of secured creditors in connection with the report. So I do come at this with that perspective. That

00:12:52.840 - 00:13:07.750

said, I'm enough of a bankruptcy nerd who sort of wakes up thinking about the structure of the code and how it operates that I also have, and I hope will bring to bear today, the perspective of that. Michelle suggests of all of us sort

00:13:07.750 - 00:13:28.690

of trying to think hard about what's the best way to organize the bankruptcy code in order to accomplish the legitimate objectives of bankruptcy law. You know, as Michelle described, the commission is made up of the absolute leading lights of our profession.

00:13:28.719 - 00:13:44.760

People for whom I think all of us have to have the absolute greatest respect. They are the deans of the bankruptcy bar without question and the process that they undertook, these people spent, you know, these are busy people and they spent a lot of

00:13:44.760 - 00:14:02.580

time, doing a lot of work on this and the report that they generated is a substantial piece of scholarship. So there are, as we'll discuss things that they recommend that I genuinely believe would make bankruptcy law

00:14:02.580 - 00:14:21.840

worse rather than better. I say that, you know, against the backdrop of having enormous respect for both the intellect and the integrity of the people who did this and the hard work that they put into it. I guess I begin in

00:14:21.840 - 00:14:38.469

thinking about the proposals of the report, beginning with I think one's got to be with the question of OK what does bankruptcy law do? What is the proper role and scope and purpose of bankruptcy law in the scheme of

00:14:38.469 - 00:14:56.219

federal law? And the way I've traditionally understood it and I think that the conventional understanding is, that it solves essentially the problem of financial distress. And so the question, to answer Michelle's question: how well is bankruptcy law working? You've got to start that with an understanding

00:14:56.219 - 00:15:15.219

of how is it working at solving what? The bankruptcy code does not, cannot, and will not solve the problem of a business that fundamentally doesn't make sense. It's not a solution to economic problems. The company that makes a widget and loses $1 on

00:15:15.219 - 00:15:33.109

every widget, no bankruptcy system is going to turn that into a thriving enterprise. That is the source of jobs and the foundation of community redevelopment in order for the the problem that the code solves is somewhat more modest than that. It's essentially the problem

00:15:33.109 - 00:15:53.030

of financial distress, either too much debt, over leverage, or maybe a period of liquidity, and that's the universe of problems to which the code is directed at solving and I think that's the proper scope. And the way, as I understand it, the

00:15:53.039 - 00:16:13.559

code is today designed and I hear I think designed properly, is it says, OK, we have these problems of financial distress. You want to avoid a situation in which a company that can work through that financial distress is unable to do so

00:16:13.559 - 00:16:34.469

because the operation of state law will lead to its liquidation. And activity that prevents the maximization of the value of the enterprise, so in order to allow a reorganizable business to reorganize the code does a number of things to prevent the liquidation,

00:16:34.630 - 00:16:54.090

allow the company to emerge. But it does that against the I think the backdrop of really two core principles. One is that it seeks as it does so to maximize the value of the enterprise, a sort of a

00:16:54.090 - 00:17:14.930

value maximization as a fundamental premise of bankruptcy has long been a central premise and reorganization is viewed as a tool to maximize value rather than an end of itself. The theory is if we maximize the value of the enterprise that will serve as the

00:17:14.930 - 00:17:33.139

foundation for the ultimate economic success, but reorganization is a means towards value maximization, not an end in of itself. And 2, once the value is maximized, you have a set of distributional questions, right? We've tried once. You figured out, OK, this is the most the

00:17:33.139 - 00:17:51.180

entity can be worth. Where does the value go? The general premise of bankruptcy as it exists today and one can you know poke around the edges, but the basic principle is it's generally in accordance with your non-bankruptcy entitlements. Bankruptcy is essentially agnostic on the question

00:17:51.180 - 00:18:06.729

of who gets the value. It tries to maximize the value and then the the sort of scheme of priority more or less is intended not to pick winners and losers in bankruptcy. Um, the notion is whatever you have outside of bankruptcy, you more or less

00:18:06.729 - 00:18:21.939

bring into it, and the bankruptcy code doesn't try to alter that, which makes sense because if bankruptcy itself were picking winners and losers, you'd have a whole bunch of fights about who should come in and when and you'd have a scheme of sort of forum

00:18:21.939 - 00:18:42.380

shopping into and out of bankruptcy that would be sort of unhelpful noise in the system. There's plenty of that already. But notionally the code is built around the idea that it's otherwise. Otherwise agnostic as to value and I guess another sort of central

00:18:42.380 - 00:18:59.380

point is bankruptcy, the code, sort of reflective of the earlier points, is essentially brings a modesty to it in thinking about and maybe this is unfair to the hard work of the commission and to Michelle, but let me just take a

00:18:59.380 - 00:19:15.949

run at it. In thinking about the code, and the code as it exists now as opposed to the code as reimagined by the commission. I keep having recur in my head The sort of New Yorker covers that were like a New Yorker's view

00:19:15.949 - 00:19:28.569

of the world that have the Manhattan skyline in the foreground and everything else you know recedes off into the distance and becomes smaller and smaller and part of me thinks in looking at this report that it's sort of the bankruptcy lawyer's view of

00:19:28.569 - 00:19:46.260

the law in which bankruptcy is the central part and the rest of the law becomes interesting only insofar as it filters through bankruptcy. And I think the code now brings a modesty and minimalism to the role of bankruptcy as against the writ against

00:19:46.260 - 00:20:12.979

the the law more broadly. That is an appropriate role for bankruptcy law in how it respects non-bankruptcy law and disrupts non-bankruptcy law really only to the extent really necessary to achieve one of the core bankruptcy objectives. So look, the

00:20:13.050 - 00:20:35.560

commission is dealing with the real thing. It is true that as the commit, the commission's mission statement, begins by saying, there's been an increase in the amount of secured debt in the time since the code was enacted in 1978.

00:20:35.829 - 00:20:54.750

That's true. There have been, there has developed a quite robust market, in leverage lending and in secured lending in general that means that companies that come into bankruptcy today come into bankruptcy probably with less flexibility than they used to. If you came in with

00:20:54.750 - 00:21:14.130

a lot of unlevered assets, you had more ability to sort of take your time through the bankruptcy process, figure out what was the value maximizing approach and decide yourself as the debtor what the right post bankruptcy entity and capital structure would look like and it

00:21:14.130 - 00:21:31.780

is unquestionably true that today companies come into bankruptcy by and large with more secure debt. And the cost of that secured, they got a benefit for that, right? They, the these markets have meant that these companies got access to capital at

00:21:31.780 - 00:21:46.645

a lower price pre pre-bankruptcy than would have been available in the absence of these markets. The question is, is there a consequence to having made that decision and you know I believe the answer to that in view of the way the code does and ought

00:21:46.645 - 00:22:04.920

to operate is yes, if you come into bankruptcy fully liened up, then the asset essentially the assets essentially belong to the secured creditor and the secured creditor gets more say in the disposition of the assets because essentially if you come in fully liened up

00:22:04.920 - 00:22:22.410

with the secured debt underwater we were talking about essentially spending the secured what is the secured creditor's money, what the commission does is the report at bottom seeks to create greater flexibility and I guess there'll be a longer discussion on this and the

00:22:22.410 - 00:22:47.630

when we talk about the valuation and distribution issues by essentially between the way the redemption option works between the treatment of adequate protection pushes value downstream creating additional flexibility to for the debtor in a way that really recuts the pre-bankruptcy bargain. And

00:22:47.959 - 00:23:10.329

I guess just going back to first principles, it's not obvious to me that that's a good idea. That it might have the effect of increasing the number of reorganizations, but to me the question, really ought to be, if the owner

00:23:10.329 - 00:23:29.369

the holder of the secured credit whose money is being spent believes that a different choice is value maximizing, why is it necessarily better to reorganize traditionally in bankruptcy through a bankruptcy process rather than follow a process that the party whose money is at

00:23:29.369 - 00:23:45.819

issue would prefer to follow? So. Those are the questions. The work is, you know, obviously an important one, and there's a lot to talk about. In the interests of time and sticking to the schedule, I will stop

00:23:45.819 - 00:24:03.060

talking now and maybe invite up the participants in the first round table discussion. Judge Ambro and Danielle. And I should say I should have said this in the beginning, I hope in order for this to be

00:24:03.060 - 00:24:21.885

interesting for everyone that, you know, this isn't just a set of a program where people listen to folks give prepared talks but that we interact And I hope we get to respond Yes, certainly. So let's do that. OK. So why don't

00:24:21.885 - 00:24:36.380

you start? Well, I'll defer to Judge Ambro and see how he would like to proceed with this. That's also a good idea. I guess the question I would ask everyone when I first started getting involved in bankruptcies, I guess it was under the old act

00:24:36.380 - 00:24:58.079

that's how old I am, back in the 80s, However, after the code passed, there was a perception that the code was bank debtor friendly. And so the playing field was tilted toward the debtor. I think today at the time of this ABI report, and by

00:24:58.079 - 00:25:24.569

the way it is as comprehensive and as qualitative, great quality treatment of issues as I have ever seen. And I think thanks go to Michelle and Bob Bob Keach for that. The Code today is perceived as maybe not being as debtor friendly. The playing

00:25:24.569 - 00:25:49.089

field may be tilted toward creditors. More 363 sales, fewer actual reorganizations. One of the things that people have said, and I've asked this to others in in conversation before, is some think like Harvey Miller, that it's claims trading is one of the primary reasons why

00:25:49.089 - 00:26:07.209

this perception has changed. And yet this report doesn't deal with claims trading. It's an extremely difficult issue. Michelle, maybe I can just start with you. What were some of the thoughts as to how do we deal with it? And in the end we

00:26:07.209 - 00:26:23.130

didn't really have a consensus as to how to deal with it. No, thank you, Judge and I just wanna clarify my last comment so I should say that Craig and and Danielle both were extremely helpful throughout the the research project and I have

00:26:23.130 - 00:26:38.020

tremendous respect for their perspectives and I think really what divides us is our view of first principles which we can talk about and get back to so. But Judge, to your specific question, so claims trading actually was hotly debated both at the

00:26:38.020 - 00:26:57.140

advisory committee level that tackled the issue and at the commission level and the struggle is, I think for many, the potential benefit to claims trading right, having that availability of an exit for creditors who don't want to be captive or subject to the

00:26:57.140 - 00:27:16.800

bankruptcy process right? It does provide liquidity and an exit strategy for those types of creditors and also it often can provide some counterbalance to the secured lenders in a case when you're thinking about dynamics and trying to ensure all voices are heard during

00:27:16.800 - 00:27:37.839

a process on the flip side and the counterarguments we certainly I think are all aware of instances where there's questionable conduct if not abuse by traders as to how the claims are amassed and what's done with the claims once they are accumulated as well

00:27:37.839 - 00:27:55.920

as the potential disadvantage to those who sell when they're not truly informed. And so there's the manipulation in the pricing there but so balancing the pros and cons, we weren't able, the commission was not able to reach a consensus that they should be

00:27:55.920 - 00:28:13.660

either cabined in their influence in the Chapter 11 process or perhaps restrict restricted altogether. Interesting. What was, what were some of the proposals that were rejected with regard to how to deal with claims trading? Obviously everybody understands that when you have those who buy

00:28:13.660 - 00:28:28.260

claims for like let's say 50 cents on a dollar, what they're interested in perhaps in some cases is they want to return on the investment, pure and simple. They're not really interested in working with the debtor to try to get a reorganization unless they see a

00:28:28.260 - 00:28:43.479

significant amount of value at the end. But oftentimes not. How do you deal with that? First of all, is that a problem? Or is that just a false perception? So I think it varies by case to case. I

00:28:43.479 - 00:29:02.079

certainly think there are examples and we heard in the testimony of instances where claims trader traders were the obstacle to getting to confirmation and so that would perhaps suggest a sell alternative right to give them the liquidated return they want immediately as opposed to

00:29:02.079 - 00:29:16.760

equity in a reorganized company, which they may not really get their rate of return as quickly through. And so to your point about what recommendations were made and how did the commission think about it, you would not be surprised perhaps to know

00:29:16.760 - 00:29:33.449

that most of the recommendations on claims trading focused on enhanced disclosure, right? Taking what we've done with Rule 1919 and doing even more, right. Not thinking about groups, thinking about individual creditors, making anyone who files a motion be more forthcoming with all the aspects of their

00:29:33.449 - 00:29:50.619

interest in the case and how they purchased and achieved their status in the particular case. And I think many felt more disclosure might be helpful in some but certainly not most cases and what we really need to think about was

00:29:50.619 - 00:30:06.250

identifying abuses and how to address those. So although claims training per se is not addressed, there is a recommendation on vote designation. And so if you have a creditor who votes in a way that's materially adverse to the majority of interests in the class, that now

00:30:06.250 - 00:30:21.239

would be a grounds for vote designation. So getting to instances where you have that blocking creditor who's interested only in a return only through one mechanism of a reorganization or exit strategy, if it was shown that their conduct was motivated by that self-interest and adverse to

00:30:21.239 - 00:30:37.650

the other holders of that class, the claim could be designated. So, you know, not directly on point, but thinking about other ways to target the abuse and not perhaps stifle the potential value in the liquidity provided by claims traders was part of the balance. Judge,

00:30:37.729 - 00:30:57.170

it's probably worth noting that there is an awful lot of ways, there are many ways in which the evolution of the market and secondary debt has operated to benefit the bankruptcy system. There are, because there are people who will buy debt, someone who doesn't

00:30:57.170 - 00:31:11.209

want to participate in the bankruptcy process is now able to sell their debt and get out of the process and is replaced by someone who's now a voluntary participant in the bankruptcy. Quite often somebody wants to sell because they are, let's say, a supplier. They have

00:31:11.209 - 00:31:25.130

liquidity issues. They can't afford much as they want to stay in and deal with this particular debtor. They may not be able to do so because they have their own banks concerns. And you know, look, as much as you know hedge funds may not

00:31:25.130 - 00:31:43.339

be the most popular constituency in the world they do bring a certain expertise in the operation of the bankruptcy process and discipline to the bankruptcy process and there's actually some you know, empirical evidence that suggests that the discipline on management brought by distressed, you know,

00:31:44.000 - 00:32:02.000

people who are expert in distressed companies leads to improved results in the bankruptcy process. So to be sure, I agree that the questions of disclosure are critical. If you have someone coming in who is, you know, actually holds one tranche of security and makes

00:32:02.000 - 00:32:15.359

an argument because they hold a smaller one and the judge doesn't understand why they're saying what they're saying, the judge should know and the other party should know what your economic stake is and why it is you're making this argument as opposed to that. That seems

00:32:15.359 - 00:32:31.239

to me a real issue and I think the amendments to the rules, mostly but not entirely, they solved it in a backhanded sort of accidental way. About the rules, but it's about groups, not necessarily about your holdings, but by and large there's

00:32:31.239 - 00:32:47.219

progress there. But otherwise I guess, you know, the notion that, you know, some of the suggestions I was at some of the hearings where folks made suggestions that, you know, the recovery of someone who buys distressed debt should be capped at the amount

00:32:47.219 - 00:33:01.140

they paid for the debt and to me this may be an appropriate place to be having this discussion. That's a debate that's as old as the republic right. In the immediate wake of the revolution there were talk that the speculators who bought the

00:33:01.140 - 00:33:18.910

debt held by Revolutionary War veterans from the states should be cashed out at only the amount they paid for the debt and the great debate, you know, between Hamilton and Jefferson on that question was resolved in favor of the view that actually when you

00:33:18.910 - 00:33:32.060

buy a piece of debt, the buyer stands in the shoes of the seller and can exercise all of the rights that the seller had. And that seems to be a sensible rule and I guess I think the commission got it right and not, you know, retreating from

00:33:32.060 - 00:33:48.260

that principle. Yeah, agreed I think we're treading into very dangerous territory when we start saying that stakeholders aren't entitled to advance their own economic interests because of the way in which they acquired those interests and now I mean to be sure to the extent that

00:33:49.000 - 00:34:09.590

to the extent that stakeholder behavior interferes with the goal of maximizing value for everyone, we need to figure out how to deal with that, but no recommendation should be driven by, you know, animus toward a particular class of investors or the way in which they

00:34:09.590 - 00:34:26.469

acquired their claims and therefore, I, you know, I agree that what the commission did is appropriate here. I think that to some extent the perception, Danielle, is that, obviously Michelle mentioned there were 4 principles. One is reorganizing, the other is maximizing maximizing value to creditors.

00:34:27.639 - 00:34:45.719

Who are the creditors and persons who are perhaps jaundiced would say the way it is today is the creditors are secured creditors and not other creditors. What would your response be to that? Look, I think it's true, as Craig said that the capital structure of

00:34:45.719 - 00:35:05.429

firms entering bankruptcy has changed over time. It's much more likely now that a company is going to enter Chapter 11 fully liened up. That indeed does give the secured creditor more control. I don't think that's necessarily a bad thing. If that simply reflects the fact that

00:35:05.800 - 00:35:30.010

non-bankruptcy law gives the secured creditor priority and the value to be derived from the company's assets, there's not necessarily anything wrong with that. Now there is a potential problem if secured creditors are acting in their own interests in a way that prevents maximization of value for

00:35:30.010 - 00:35:51.560

everyone. So for instance, if you know, say a slightly over secured creditor pushes for an immediate sale so that that creditor can recoup., Melissa's yes, exactly. And yes, can recoup, you know, its own debt in a way that leaves nothing

00:35:51.560 - 00:36:10.570

left over for anyone else that is a potential problem. We'll talk about this a bit more later. I'm not sure there's firm evidence that problem actually exists, but beyond that I think I agree with Craig and perhaps disagree with some of

00:36:10.570 - 00:36:28.949

the underlying premises of the report and that I don't think that value redistribution in and of itself should be a goal of bankruptcy. I think the goal of bankruptcy should be to make the pie larger for everyone, but then to distribute it in accordance with non-bankruptcy

00:36:28.949 - 00:36:47.889

entitlements and priorities. Let me ask Michelle a question then. One of the nouns that's used throughout the report is balance, and there is I gathered a perception at least among a number of the commissioners that things were out of balance at least since 1978, uh, with

00:36:47.889 - 00:37:09.040

the changes. Is that true? And what particularly is out of balance in your view? So I appreciate the question and I'm actually going to use it to respond to the first principles point that Craig and Danielle have both now raised. So the perspective that Craig and

00:37:09.040 - 00:37:31.379

Danielle articulate, that the purpose of bankruptcy law is to maximize creditors' value and that shouldn't reallocate value and that reorganizations is a means to the end of maximization, is a debate we've had forever, right? It's the creditor's bargain model versus a social policy perspective

00:37:31.379 - 00:37:51.209

of bankruptcy. And you know if you go back to Justice Story's commentary on the Constitution and the bankruptcy clause he talks about the bankruptcy clause independent as and being separate from states and viewing it as a mechanism that was necessary because the states wouldn't

00:37:51.209 - 00:38:08.465

allocate value appropriately when you had a national interest such as rehabilitation. At that time it was you know distressed merchants that they were focused on but the laws since evolved so you know it depends on where you stand on this issue as to whether you

00:38:08.465 - 00:38:25.050

think the premise of the report is correct or not and so law and economics versus a more social policy. So if I can just for a moment take my commission reporter hat off and and speak as Professor Harner, you know, for me what it

00:38:25.050 - 00:38:43.590

comes down to, you know, should a federal bankruptcy system that's funded by federal taxpayers help a secured creditor liquidate its collateral? I, you know, if all we're doing in bankruptcy is maximizing value for the creditor and at this point in the evolution of distressed companies,

00:38:43.719 - 00:38:59.959

that creditor primarily is funded debt, typically secured creditors, should federal taxpayers pay for that or should it be done under state law or or should we perhaps just tweak Chapter 7 and do these things quick and efficient? So it sounds like what you're saying is that's

00:38:59.959 - 00:39:18.879

out of balance. That's out of balance and but that would be my perspective. I think from the commission's perspective what they saw is that from the evolution of the concept of reorganization as an objective and end of bankruptcy there's always been the dual policies stated that

00:39:19.129 - 00:39:35.169

it's reorganization and maximizing creditor value. Sometimes those objectives can be in conflict, and what the commission tried to do was find ways to balance those competing goals so we reduce conflict and can achieve both. And I do think we can have a system that does

00:39:35.169 - 00:39:56.330

that. Michelle if the company is fully liened up, but through a bankruptcy process, you can maximize the value in a way that you couldn't under state law and therefore preserve the going concern, preserve jobs, preserve the enterprise. Why isn't that as appropriate

00:39:56.330 - 00:40:09.699

a use of the federal court system as you would have in the same situation in which there was a single unsecured creditor? I mean I don't understand why as a matter of policy, it's, it's less appropriate to use the tools of bankruptcy to maximize value

00:40:09.949 - 00:40:26.500

based on who the ultimate holder is. I think it's appropriate to use the tools of bankruptcy to try to make the pie bigger, to maximize value. But if you're doing that in a federal bankruptcy case and you're going to use the resources of the courts

00:40:26.500 - 00:40:44.620

and you're going to take advantage of tools to streamline the business so you pointed out earlier that the code traditionally has been viewed to remedy financial distress and not perhaps failings of the business model or economic distress and that is true,

00:40:44.659 - 00:40:59.639

but you would agree also there are tools, right, that can help a business become more efficient so that you're maximizing value, right? We can get rid of burdensome contracts, we can renegotiate our labor agreement. There are ways to streamline the business and avoid costs that you

00:40:59.639 - 00:41:16.340

otherwise couldn't outside the bankruptcy. So all of this is creating value. And if the only party that's going to benefit because of the way the tools are being manipulated is the secured party, is that really we want as the objective...But why is that a bad

00:41:16.340 - 00:41:30.899

thing? If that's what the parties' entitlements are under non-bankruptcy law? Where does this principle come from that says no, it would be better to redistribute value down the capital structure. So, a couple of things, and I know we're gonna talk about this later. I

00:41:30.899 - 00:41:48.879

don't think the commission's proposals suggest to redistribute value, and so we can talk about why I view redemption option as preserving value. But so I just want to emphasize if we're talking about a reorganization sale that's going to return value to

00:41:48.879 - 00:42:07.639

the secured credit but do so in a way that gives the company an opportunity to truly save jobs, streamline its operations and come out healthier, I think that's terrific. Just one quick antidote, right? So you think about the Hostess case, right? Hostess

00:42:07.639 - 00:42:25.310

is still out there, right? It's still running, but you know, most of those employees never saw their jobs again. I mean I don't think that's a successful reorganization, you know. Likewise, RadioShack. The reason it went into bankruptcy fully leaned up after having 11

00:42:25.310 - 00:42:40.909

consecutive quarters of losses in September, it got rescue financing from the party that's not now going to bid for the majority of its stores. I mean, there's a reason companies are going in fully liened up and part of what the report tried to do was encourage

00:42:40.909 - 00:42:52.830

companies to file sooner so the secured creditor doesn't have that position. So we should certainly continue this debate. The one principle that we all agree on is that we should do what Denise says, and that suggestion is that this group should exit the

00:42:52.830 - 00:43:57.199

stage, especially when the next section deals with something very important: SMEs. All right, this section, is going to deal with the small and medium size enterprise provisions and recommendations. Professor

00:43:57.199 - 00:44:24.510

Jacoby and Ms. Judith Rich will be speaking initially to present their positions. I'm going to make myself a little taller over here. So good morning everyone. So then our next segment is really about us speaking for the 99%. And here I

00:44:24.510 - 00:44:42.459

mean the 99% of Chapter 11 cases, even though bankruptcy is usually talked about with the largest public companies, and then we have a footnote, a bracket for everybody else, the reality is, as the report points out, that most of the cases aren't public companies,

00:44:42.590 - 00:45:01.260

most of the cases have smaller amounts of debts, smaller amounts of assets, and the question that I see the commission report trying to answer is: shouldn't we think about ways to adjust that system so that it matches the vast majority of cases? So the standard

00:45:01.260 - 00:45:18.649

concern in this area is that Chapter 11 is built around the model of a large public company and the governance structure that creates the negotiation field, leading to hopefully consensual restructuring that's based on a model of how creditors interact with each other and their level

00:45:18.649 - 00:45:34.340

of engagement. That we do not have in many small business cases. The priority rules, therefore don't always make as much sense, such as the absolute priority rule and so the argument goes, the system is pretty costly and complex, and so let's

00:45:34.340 - 00:45:53.540

just assume some of what was just discussed in the first panel and say, let's assume we agree that it is appropriate that some businesses try and reorganize in bankruptcy, they're worth more alive than dead. Or create other values. Can Chapter 11 do better

00:45:53.540 - 00:46:11.189

at that goal? Now, the first hurdle that we have to get over is that in 2005, premised in part on that it was difficult for businesses to reorganize in Chapter 11, another layer of obstacles was imposed and that that in further makes things complicated for smaller

00:46:11.189 - 00:46:29.719

businesses. So I see the ABI report as reflecting some really important premises to identify elements that could usefully be reconsidered to maximize restructuring chances again, with the assumption that that's a valuable thing under the bankruptcy clause for federal government to

00:46:29.719 - 00:46:49.260

do. Now as to the exact fixes. I do to some extent part ways with the ABI commission's specific proposals so I I want to talk about some discrete groups of areas where I agree that something should be fixed and maybe think about ways

00:46:49.260 - 00:47:03.445

that that could be improved. Now, I am speaking from some of my own experience working on law reform in this area. I also consulted with some of the judges in my state, which is North Carolina, one of whom is Judge Tom Small.

00:47:03.725 - 00:47:20.449

He initiated a fast track in his own courts, well known in the Eastern District of North Carolina, and I worked with him on developing a small business bill that Senator Whitehouse introduced in the 111th Congress. 3675. On the other hand, we have

00:47:20.449 - 00:47:35.719

a brand new judge in the middle district, Judge Ben Kahn. He was a partner at Nexsen Pruet for a long time, representing predominantly secured creditors. He's a great addition to the bench, uh, and so I've been excited to hear from my various,

00:47:35.850 - 00:47:48.129

colleagues on the bench in the state. And I promised them that I would say, of course, this disclaimer that if you agree with what I say, they get the credit and if you hate it, it was all me. So I think that's fine.

00:47:48.570 - 00:48:02.219

That's what tenure is for. So here are the issues. Here are the issues. So let's start with governance, and I'm trying to watch the clock here to make sure I keep things running, but you can bring out a

00:48:02.219 - 00:48:21.489

a hook if you want. That's fine with me. So governance. The first piece of this is replacing a creditors committee concept with something else, another person. So it is definitely true that Chapter 11 is premised on unsecured creditors being sufficiently invested in

00:48:21.489 - 00:48:38.290

the case to participate in a creditors committee that is central to the negotiations among all of the parties. We cannot force creditors to sit on creditors committees, and I am not proposing that we change that. But the reality is that in most cases, there is

00:48:38.290 - 00:48:53.449

no creditors committee because the creditors do not want to serve. So the idea of saying let's take it out of the bankruptcy code, they shall put a creditors committee in place that makes sense to me. A creditors committee could be formed, but it does not have to

00:48:53.449 - 00:49:11.040

be. So that shift of perspective makes sense to me, but it does raise questions about what the substitute should be. And whether the substitute should be automatic or variable depending on what the parties or the court or the US trustee argues. So,

00:49:11.120 - 00:49:26.090

the commission report talks about the possibility of an estate neutral. Now I'm still and I'll look forward to more comments about this later, what the full scope of who the estate neutral is and what their duties are relative to name the various

00:49:26.090 - 00:49:43.479

other parties that we sometimes serve in bankruptcy, that we've talked about but one other model is say a Chapter 12 trustee. Now that that kind of trustee does not replace management, but it serves a lot of different functions, some of which

00:49:43.479 - 00:49:58.889

have been spelled out in the bankruptcy Code, and some of which have developed over time, such as facilitating the plan, being a little bit more of a mediator or a negotiator. Now, I understand that the commission felt that Chapter 12, which is for

00:49:58.889 - 00:50:13.810

family farmers and fishers, and chapter 13 which is for individuals, were not appropriate models to look at. I quibble with that a little bit. I actually think that if you look closely at chapter 13s, some of them are operating business.

00:50:14.375 - 00:50:27.504

Even though they're individuals. And so I don't, I was surprised a little bit to see how quickly, at least, the report suggests that those ideas were just put off the table. But I do think that those kind of trustee models do give

00:50:27.504 - 00:50:44.159

us some further thought. Some would say they worked pretty well. So I leave that as an open question. If we're gonna not have a creditors committee, who else is coming in? I also would prefer that we know whether that's a mandatory appointment subject

00:50:44.159 - 00:51:00.360

to dismissal or not. It becomes a litigation point, if it's potential and not mandatory. I see that in cases in North Carolina. Suggestions that maybe we have a court restructuring officer, that's a term I'm still wrapping my head around, and other

00:51:00.360 - 00:51:17.550

such things that become subject to litigation. OK, so that's the governance piece. Confirmation standards, everything that's happening in a negotiation is with the backdrop of what are the fundamental entitlements. And in a closely held business, the goal from the debtor's perspective is not to hand

00:51:17.550 - 00:51:35.850

over ownership of the business to someone else. We all know that, and the current bankruptcy code understandably encourages parties to work toward a consensual resolution so that that issue doesn't come up, but the downside is if most creditors are inactive and they don't vote

00:51:35.850 - 00:51:50.320

you're far more likely end up in a so-called cramdown with the absolute priority rule in place than otherwise, and the leverage really does get skewed. So it is more likely that even if there is a a broader creditor body, it becomes much more of

00:51:50.320 - 00:52:08.340

a two-party dispute, perhaps with the under secured portion of a secured creditor's claim being being what's at issue. So whatever proposal people are putting on the table for small business and medium sized business bankruptcies or the 99%, I'm gonna stick with that. I'm going to

00:52:08.340 - 00:52:31.139

have to contend with the so-called absolute priority rule. The idea that unsecured creditors get paid in full or equity retains nothing. The ABI proposal has a preferred stock with voting rights idea that creditors would share in the ownership of the company, but would

00:52:31.139 - 00:52:48.649

have the right to vote on various extraordinary actions is the term that's used. Now, we can't get them to the credits aren't even voting on the plan. So I'm not sure how we're gonna encourage the creditors to vote on the extraordinary actions. I think

00:52:48.649 - 00:53:04.969

it creates a problem of potential duties for the creditors that they do not want, or I'm presuming they do not want it's giving them a post hoc governance right that may raise lender liability issues, fiduciary duty issues and the like, um, so I

00:53:04.969 - 00:53:20.909

would encourage, I think the focus is in the right place to say let's do something different with the absolute priority rule, but abolishing it all together tilts too much the wrong direction. But I think there are some other options. Again, the Senator Whitehouse bill

00:53:21.429 - 00:53:37.500

has a combination of a disposable income requirement with the possibility of a trustee being released if a consensual plan is released. I'm not saying that's perfect. It's just another way to sort of think it through. The last two I wanted to mention are timing

00:53:37.500 - 00:53:54.949

and the scope of the definition of what even is a small or medium sized enterprise. So for timing, I completely agree with the ABI commission that the bankruptcy code has to clean up the timeline for small and medium sized business cases. It has created

00:53:54.949 - 00:54:10.820

some impossibilities, such as trying to confirm a plan within 40 days of filing it, which doesn't always correspond with the rest of the deadlines and causes trouble that really, it's just adding problems. It's not solving any, and I think that has to go. I

00:54:10.820 - 00:54:26.314

did, I wasn't sure what the thinking was behind giving a sixty-day period to even come up with the schedule of when the plan would be filed and the other deadlines. To me, that's an element of case management. I talk about in various other contexts

00:54:26.524 - 00:54:41.004

the way that case management has been used in Chapter 11. And I was a little concerned about that 60 days. I thought maybe instead there would be a presumptive 90 days to file the plan with discretion to the court.

00:54:41.205 - 00:54:59.270

Finally, scope of the definition. I'm reading the report to say you are, you are a small business or you're not, for some subset. And then beyond that, it's discretionary. I'd actually flip that around. I would want it to be optional. To say, here's

00:54:59.270 - 00:55:12.810

a set of carrot and sticks, especially if we're not sure that we've got it right, here's a bunch here are the set of carrot and sticks. Chapter 12, that's the way it is. Family farmers can file for 11. They choose which one works for them.

00:55:13.020 - 00:55:28.659

I also am concerned about putting too much pressure on the judge to be asked to sua sponte, try to decide whether a debtor should be in a category or not. So that's what concerns me about the more extended definition that's in there. So it's

00:55:28.659 - 00:55:45.189

basically $10 million assets or liabilities and then up to $50 million was optional. I would make it optional for the 10 million and then sort of cap it there. Those are some details. I'm really grateful that the ABI commission is looking at these questions.

00:55:45.320 - 00:56:06.739

Um, the hook is drawn. That is perfect. Thank you. Again, by way of full disclosure...Why is it the response always require a full disclosure? But I guess it does. I represent, well, probably everyone in the capital structure. I represent secured creditors. I

00:56:06.739 - 00:56:25.080

represent mezzanine lenders, including small business investment companies. I represent borrowers. I represent portfolio companies of private equity. I come at this a little bit from a different perspective and I should, should let you know also that I also am the

00:56:25.080 - 00:56:44.719

daughter of a debtor's debtor's lawyer who practiced bankruptcy. Who continues to practice bankruptcy law and I found his perspective particularly interesting because we agreed far more than I expected, given that I generally represent secured creditors and so didn't expect to agree with them and,

00:56:44.870 - 00:57:07.159

frankly. I've also agreed with you Professor Jacoby on many of your many of your points. I think I echo what Craig Goldblatt said regarding I don't know that the purpose necessarily of reorganization is something that we need to

00:57:07.159 - 00:57:25.889

that should be emphasized over maximization of value and I think especially in the small business context, there are a lot of numbers in the report and I'm not a numbers person. But the numbers talked about small businesses that

00:57:25.889 - 00:57:40.969

fail and they talked about small businesses that fail and they just they don't obviously we can't find out those reasons because that data is not available. We could talk about small businesses that went into bankruptcy and why the bankruptcy you know why they ended up

00:57:40.969 - 00:57:58.560

in a liquidation or just a dismissal, because maybe we can look at the records and figure that out. But a lot of small business fail for a lot of reasons that the bankruptcy code I don't think can correct and so presumably the goal of

00:57:58.560 - 00:58:18.219

the bankruptcy code is to make it possible for small businesses that can reorganize or make it possible for secured creditors and and creditors and equity owners to use the bankruptcy code to maximize the value in those businesses that are viable. And whether they

00:58:18.219 - 00:58:37.020

can use that also for sale purposes. I think that sale results in a maximization of value and shouldn't be discouraged. The parts of the proposal that related directly to SMEs, that concerned me. I think the elimination, not the elimination.

00:58:37.143 - 00:58:53.292

The elimination of the automatic appointment of a secured creditor, of an unsecured creditors committee, makes perfect sense to me and making that optional obviously makes a lot of sense and I think from all elements of the spectrum, all, you know, body parties

00:58:53.292 - 00:59:07.325

and interest, it makes sense if there's a creditor's body an unsecured creditor's body that's active in the case they should be able to go to the US trustee and say we want a creditors committee that makes sense. And of course in a lot of cases

00:59:07.325 - 00:59:22.639

there's no activity. Of course if there's no activity it doesn't result in any costs because forming a creditors committee when there's no people willing to participate, you know, is really a little bit of irrelevant and in terms of these, again the

00:59:22.639 - 00:59:40.370

estate neutral and the role of the estate neutral and how that's gonna be how the compensation for the estate neutral works. I think that's something that clearly needs to be thought about more and developed more. Clearly there are a lot of businesses that go into

00:59:40.370 - 00:59:58.729

bankruptcy because the business owners have certain amounts of trouble, whether it's liquidity problems, whether it's supplier problems. I mean they end up in bankruptcy and they're looking for a resolution. A lot of the business owners, the resolution is not going to

00:59:58.729 - 01:00:13.052

be seeking a third party to come and fix their business but and I think it is as you said it's a concern that you're gonna, we put a lot of pressure on the judge in these cases to make those determinations whether it you

01:00:13.052 - 01:00:26.696

know there's a lot of discussion in the report about a judge being able to early on in the process determine whether business is viable or not, determine whether there should be an a state neutral I mean that's a lot of

01:00:26.696 - 01:00:42.135

involvement for the judge in a process and makes their role change I think a little bit in regards to the SMEs as opposed to what I think of as a traditional role of the judge and I don't know that we've thought that out enough and

01:00:42.135 - 01:01:00.239

that we've, you know, that maybe that should be something that comes from somewhere else. So I think, I think we do need to think about that. I wouldn't eliminate the concept of having some type of professional professional available for SME debtors

01:01:00.239 - 01:01:18.530

to get involved in the case, but often these disputes, you know, the reason a company ends up in bankruptcy are two party disputes and, you know, the introduction of a third party, the estate neutral may or may not solve those problems. Finally,

01:01:18.570 - 01:01:37.969

with regard to this, the equity redemption plan, I agree the more dramatic response my father had, which was I'm not giving the unsecured creditors 85% of my client's company, I'm not gonna put that at risk. That's not what I

01:01:37.969 - 01:01:50.649

want out of the bankruptcy process. What I want out of the bankruptcy process is to be able to structure the company, make a deal with the secured creditor, make a deal with the unsecured creditors and do what I've, you know, what I've always done and

01:01:50.649 - 01:02:05.570

come out of the process you know, if everything works out I still own the company. I still control the company and business owners putting their company into Chapter 11 aren't gonna wanna put that company at risk. And on the other side, whether it's

01:02:05.570 - 01:02:22.889

the unsecured creditors or secured creditors, I think there's a a redistribution of value there that I think is gonna have a chilling effect. I think there's, the many of the statistics discuss the fact that these entities end up in bankruptcy in large part

01:02:22.889 - 01:02:42.949

because of the inability to obtain financing or difficulty with regard to the financing. I don't think the commission has addressed or answered the question of how what we're proposing in any way to help that problem. In fact, I think it exacerbates it if you're gonna

01:02:42.949 - 01:02:59.270

lend to a small and medium sized enterprise and you have this potential that you're going to as a secured creditor, you're gonna be compelled to continue with your lien and get the reorganization value of your secured claim and then you're gonna your under secured

01:02:59.270 - 01:03:16.155

piece, will be an under secured, part you're gonna get 85% of the preferred stock. It raises a huge host of issues for me and in terms of of financing and advising financing sources. I think it's gonna be very difficult. I think it makes it

01:03:16.155 - 01:03:36.149

more difficult to occur uh excuse me, attract financing for these enterprises which are already having problems attracting financing. So unfortunately to me the commission's proposal with regard to the equity plan and with regard nowhere else do I see it, but with regard to the

01:03:36.149 - 01:03:53.510

equity plan especially and as far as you know creditors are concerned, the abrogation of the absolute priority rule, I think that creates a huge amount of concern. Creditors can obviously, we're very creative. We address things and we figure out ways, but I think

01:03:53.510 - 01:04:11.370

in a lot of these businesses, in small and medium sized enterprises, when they're obtaining financing, they're also usually providing personal guarantees. So unfortunately I think there's a lot of pressures here at play that I don't think we've practically addressed and maybe I'm

01:04:11.370 - 01:04:25.530

a cynic, but I don't see how the proposals are really first of all, I don't see how how the business owner is gonna want to go into bankruptcy knowing they may lose their business. And I think that's the main concern, and that's what

01:04:25.530 - 01:04:42.489

what we, I don't think we've addressed that and I don't think the equity redemption plan actually creates a viable option for those owners that they're gonna find attractive and I think for secured creditors and unsecured creditors it's all it's also very unattractive and I think

01:04:42.489 - 01:04:58.379

there's gonna be lots of issues with feasibility in terms of these plans because I don't see where you get exit financing if you've already identified where the excess cash flow of the enterprise is going, so I think it's a very difficult problem,

01:04:58.590 - 01:05:17.090

and I don't think that the commission's report has addressed those, and I appreciate any effort to try to think about ways to reorganize the debtor, but I don't think we've achieved that here. One of the other aspects of this report is that

01:05:17.250 - 01:05:36.169

for the small business, was the expectation that it would reduce costs. Looking at it, I have some questions about that, especially when you're dealing with the very small operators who they don't really have and their attorneys don't necessarily have

01:05:36.169 - 01:05:53.370

the expertise in the corporate end and so you have a lot of documentation when you come out of this. If you're gonna have the preferred stock and common stock and all of the other creation of the corporate division, there's some additional costs. Have

01:05:53.370 - 01:06:07.580

either one of you contemplated whether or not you felt that the commission had met its obligations to try and make these a little bit more economical for the small business and and medium sized business? You want me to throw it out

01:06:07.580 - 01:06:26.189

to her first? I think that I think that's, that's a good point. In terms of the, you know, documentation and the exit plan if it were the equity redemption value I think that's a very difficult template and very complicated and

01:06:26.189 - 01:06:45.489

fact specific and there's a lot of references to not making anything one size fits all and I don't know how you know who bears the cost of that and that is a pretty expensive proposition to create new classes of stuff and new rights and

01:06:45.489 - 01:07:02.600

to protect everybody from fiduciary, you know, obligations that they may be conflicted with respect to those. I think it's very difficult. I don't know that we've addressed the concern. Obviously I think removing the automatic unsecured creditors committee, if it goes some of the way,

01:07:02.729 - 01:07:17.870

but I don't see in that we never see them so there's no real cost associated with that. It's very rare that we see a creditors committee, so that's practical in this in the sense here but in terms of real cost, do you have any

01:07:17.870 - 01:07:31.320

response? So I appreciate the fact that with every law reform project, the devil also is in the details. I appreciate that there was not time to draft all of these proposals in the time that's allotted, and I think that that makes

01:07:31.320 - 01:07:45.649

it hard for me to know, especially if someone is a step removed from the real world day to day, how the cost will vary. I do think there has to be a sensitivity to, sometimes a reaction to, wanting to reduce costs

01:07:46.260 - 01:08:01.260

is to impose more obligations on the judge, and I'm not, I don't know whether that was the thinking in some of these proposals, but it usually adds cost because once you come before the judge, then you've got legal fees. So the administrative costs are increased

01:08:01.260 - 01:08:14.800

every time you come to the judge. So being able to resolve it in the background. Yes, you have legal fees associated with that, but the prep is different when you're preparing a case, arguing before a judge, and the negotiation process that's involved in it. If you

01:08:14.800 - 01:08:31.939

get the judge out of it, then sometimes you do have some reduced costs. And that what Judge Li's point makes perfect sense to me. I would just say to add to that that what I worry about in terms of allocating more responsibility to

01:08:31.939 - 01:08:49.533

judges is whether they're also being given the tools to perform that obligation with competence and legitimacy for a court. And I think already in current law and current practice in bankruptcy courts as well as federal district courts there are very mixed messages being sent to judges

01:08:49.533 - 01:09:08.685

about what role they are supposed to be performing. Passive umpire versus inquisitor versus case manager and the like. And so when I see sua sponte in the report at various junctures, I understand, I am very supportive of giving Judges discretion

01:09:09.084 - 01:09:23.274

over certain matters. I think that's an important part of making the system work. But I feel a little bit differently when I see that judges are being invited to do something on their own initiative and the litigation that might entail as well as questions

01:09:23.274 - 01:09:44.350

about diversity of practices, which itself is a cost, it's just distributed differently. One of the other questions I had was with regard to the redemption value. There's a provision in there that would seem to encourage attorneys to

01:09:44.350 - 01:10:01.000

have their clients dispute claims so that the redemption value that they have to pay would be reduced. Again an additional cost of litigation that I would say I see it a lot in 13s now where people are objecting to claims, not necessarily

01:10:01.000 - 01:10:16.339

because they really believe that the claim is not valuable or valid, but rather because they don't think anybody's going to respond. So they raise these objections and all of a sudden you get multiple objections to claims. In this particular case, it looks

01:10:16.339 - 01:10:31.259

like it would be fraught with the opportunity to reduce that redemption value by arguing somehow that it's disputed and thinking that these creditors aren't going to respond because they don't participate in these small cases. Was there any thought given to that? I haven't thought about

01:10:31.259 - 01:10:48.790

that particular example, and I will. I do appreciate that as we go through these various examples, some ideas that seem like conceptually useful and I don't mean to give that one way or another, but ones that might on

01:10:48.790 - 01:11:00.950

paper sound like something that should be pursued, in real life do have these, these other implications. And I don't doubt that the members of the commission have a lot of experience to bring to bear on that, but ultimately, at the end of the

01:11:00.950 - 01:11:13.270

day, they had to agree on a lot of things which is, uh, I am in awe of 22 people agreeing on a report of this length. I can't even imagine how it was done. So you know, I wanna be careful of

01:11:14.750 - 01:11:27.950

how I put it, but that is going to happen. I mean some of the proposals will have, will be tweaked because of those things I'm sure. That's just the nature of it. Any thoughts? Yeah, I think that, well, I don't

01:11:27.950 - 01:11:44.330

know if that that changes any because there's always an incentive, I think, especially with an inactive creditor body to object to claims, you know, with the absolute priority rule, obviously the incentive is absolute because the smaller you make the creditor body, you know, the

01:11:44.339 - 01:11:57.839

less you have to have to deal with in a plan make sure they're paid in full so I don't necessarily think that cost has changed at all. We certainly haven't eliminated in any way and I

01:11:57.839 - 01:12:13.479

don't know that, obviously I don't think building in anything to protect those uninvolved creditors makes sense. I mean they're making an economic decision that they don't want to respond because you know whether they've written off the obligation or they don't have the ability

01:12:13.479 - 01:12:30.080

to to afford a lawyer to protect their claim don't know that anything has changed there and I don't see that as a particular problem. That I don't think it's either incentivized by the new plan by the SME proposals or

01:12:30.080 - 01:12:47.450

you know disincentivized under current law. I think the same incentives exist. One of the problems that I've experienced with the small business cases, is that early on the debtors do not have their documents, their documentation together. And as

01:12:47.450 - 01:13:01.450

a result, they're not filing the required documentation very early on. This proposal does require a profit and loss, which is one of the documents that are supposed to be provided with the small business cases. Now that they're not providing because they don't have it, but

01:13:01.450 - 01:13:15.379

this has to be filed with a petition which would then mean that either I'm going to be dismissing cases very quickly or issuing deciding that I'll do it, in the basis of an order to show cause and give them the opportunity to do so,

01:13:15.799 - 01:13:31.680

within a period of time. I was wondering why it was thought that it should be filed immediately with the petition, where unfortunately people don't necessarily have all of their, they file emergency petitions all the time and very quickly and don't always have their

01:13:31.680 - 01:13:44.629

documentation. Well, I'm tempted to throw that question open to certain people in the audience because I don't know what the thinking was. I will hazard a guess and can be told I'm maybe I should put Professor Harner back and make her

01:13:44.629 - 01:14:01.259

come back. You can answer it as if you're Professor Harner. We could try that. The last part of Judge Lipp's statement goes to where I was thinking next, to what extent are the 99% or a little bit less than that of

01:14:01.589 - 01:14:16.270

Chapter 11's precipitated by a very specific event where the money is literally running out, where a judgment is going to be collected and the like versus a little bit more of a runway to dealing with the problem. Certainly, I think that the

01:14:16.270 - 01:14:31.720

tradeoff, if I were starting from scratch, I think the tradeoff should be for extraordinary relief, and because it's supposed to be on an expedited timeline there are pieces of the puzzle that need to be shared right away, especially if there's

01:14:31.720 - 01:14:42.959

going to be a third party in there trying to facilitate. Now, I don't know why that's necessary if there's 60 days in which to come up with the timeline. I don't see those two things as quite dovetailing, but that's kind of the best shot

01:14:42.959 - 01:15:04.839

I can give it. Any thoughts? Oh, all right, I thought I had another 5 minutes. We started a little late, but that's fine. OK, thank you. OK, so, um, I should also say in addition to bugging Michelle with these questions, Sam Giordano

01:15:04.839 - 01:15:25.120

from the ABI has joined us and wanted to back him for all of his help, and people should also pepper Sam with questions about the hard work of the commission. Thanks, I guess we'll be back on in 10 minutes or 12. So, we

01:15:25.120 - 01:15:44.910

have, we're happy to have, lucky to have our panel. Mr. Ellenberg was on the advisory committee. I'm not also on the commission. No, the advisory committee, as was Mr. Bernstein, and of course, Professor Harner,

01:15:44.919 - 01:16:07.479

the reporter. So, we're going to talk first about 365, the executory contracts and what the commission tried to do in that regard, again a balancing as the professor mentioned at the outset, between the contractual rights and obligations of the debtor,

01:16:07.890 - 01:16:31.640

versus the impact on non-debtor contracting parties and of course those of you who have toiled in the area have come across the constant struggle about defining executory contract the basic concept, and of course many courts have relied

01:16:31.640 - 01:16:52.839

on the Vern Countryman definition, and that definition for those of you who are new to the area, for 365 purposes, is a contract under which the obligation of the bankrupt and the other party to the contract are so far unperformed that the

01:16:52.839 - 01:17:18.819

failure of either to complete performance would constitute a material breach excusing the performance of the other. So this is a difficult definition to apply. There are other kinds of definitional structures that have come forward, including a so-called functional

01:17:19.220 - 01:17:44.649

analysis that would look at the benefit to the debtor and to the non-debtor contracting party of the kinds of things that you can do under 365 assuming a contract is signing it, rejecting it. The commission chose to propose that

01:17:44.649 - 01:18:06.810

the Countrymen definition be adopted, be incorporated in the code, and we might have differing views on whether that is a good idea. Perhaps, Michael, you can start us off with your vision of that.So part of what I think is

01:18:06.810 - 01:18:21.819

if it ain't broke, don't fix it. And, you know, there are some things that aren't broke in the code and I think there's a you know a temptation when you get a lot of really talented people together in a room

01:18:21.819 - 01:18:35.459

and you tell them to spend the next 3 years changing stuff a lot of stuff gets changed. I think the definition of the executory contract in my view is one of those where it might be better to leave well enough alone.

01:18:35.779 - 01:18:57.080

The overwhelming number of judges in the country, bankruptcy judges in the country, use the Countrymen test and apply the Countrymen test. There are I think a very small number of circumstances under which the Countrymen test just doesn't work perfectly and in those cases the judges

01:18:57.080 - 01:19:14.040

have the ability to use some modified version of the Countrymen test or use the Countrymen test but consider some other factors and I think that's that's kind of worked quite well and I'm not sure I see any reason to modify

01:19:14.040 - 01:19:29.729

it. I also don't think that every issue that's disputed among courts in the country needs to be resolved by an amendment to the bankruptcy code. It's, the bankruptcy judges are pretty smart people and giving them some discretion to handle things on a case by

01:19:29.729 - 01:19:43.129

case basis seems like a good idea to me and it's worked pretty well here. I'll just say one thing quickly about the functional test, which is the sort of primary alternative. There is some other different tests and Michael Andrew has a test and so forth,

01:19:43.209 - 01:20:00.120

but the functional test is probably, you know, if you say sort of like 97% of the courts use the the Countrymen test and the other 3% is mostly the functional test, those percentages are made up, the functional test says, basically, if

01:20:00.120 - 01:20:12.379

it would be good for the debtor to call it an executive. contract then we'll call it an executory contract. I mean it doesn't use those words but that doesn't seem right to me. I mean we don't do that with anything else. We don't

01:20:12.379 - 01:20:23.299

say if it would be good for the debtor to call it a swap we'll call it a swap or if it would be good for the debtor to call it a consumer good we'll call it a consumer good and I like

01:20:23.299 - 01:20:38.540

reorganization but that seems to go too far so I think if it ain't broken we shouldn't fix it. Mark, what do you think? Well, first, let me say that I will follow Michelle's dictate and take off my advocate's hat. However, in the

01:20:38.540 - 01:21:00.270

interest of full disclosure, I think much more clearly when I'm getting paid. So any first year law student can tell you what executory means. Executory means a contract that is not fully performed. That's the Williston test, and that law student will get

01:21:00.270 - 01:21:23.259

an A in contracts. That same student will get an F in bankruptcy, OK, because we've decided that not fully performed isn't enough. It has to be not fully performed on both sides of the contract, which has led to endless amount of time being spent by

01:21:23.259 - 01:21:47.439

judges and expensive lawyers finding obligations hidden deep within the contract, that will make it mutual instead of simply unilaterally not executory. And apart from to me the inherent wastefulness of that, I, I don't get the point. If the debtor has a contract

01:21:47.799 - 01:22:08.379

under which it is to supply 100 widgets 6 months from now to Party B which was entered into prior to the bankruptcy case and if 3 months into that contract the debtor files bankruptcy and if half a month prior to the date for

01:22:08.379 - 01:22:26.140

performance, it turns out that the price of widgets has doubled, then the debtor will reject the contract, sell the the widgets to somebody else, get the benefit of that and pay an unsecured claim in bankruptcy dollars, and that's what rejection does, and I think it's

01:22:26.140 - 01:22:48.950

a great concept. By the way, I'm a little surprised we've gotten to this point without the term fresh start or breathing spell being used, so I'm gonna say them now. If we have exactly that same fact pattern, but Party B prepays

01:22:48.950 - 01:23:07.180

for the widgets prior to the bankruptcy commencing under the Countrymen test we don't have an executory contract. I don't get it. Why shouldn't the debtor similarly be able to either sell the the widgets elsewhere or assume and assign that contract to somebody who pay them part

01:23:07.180 - 01:23:26.169

of the difference between what the contract price is and what the market price was? Now I suspect that part of what Countrymen was worried about was the case where there's a prepayment. And the value of the widgets drops, in which case the debtor will want

01:23:26.169 - 01:23:46.209

to reject the contract, um, but in the non-repayment case, the party B will have an unsecured claim for the benefit of his bargain, but where he's prepaid, he now has not only lost the benefit of his bargain, he's lost the money

01:23:46.209 - 01:24:05.350

that he prepaid, and my reaction to that is, you know, tough. That party B really made two transactions. He entered into the contract and he made a loan to the debtor. And to me that's what reorganization is about, so I think the functional

01:24:05.350 - 01:24:26.220

test works just fine. Doesn't the functional test contemplate as well the harm to the non-debtor creditor? In other words, it's not just focused on the debtor's benefit, not necessarily and I wouldn't really advocate for that.

01:24:26.379 - 01:24:40.810

One of the things just about every court agrees on now is that you don't take the impact on the non-debtor into account. As someone who represents both creditors and debtors, I tend to think that's correct. And I guess I will just

01:24:40.810 - 01:24:55.919

add quickly so people have the benefit of the commission's perspective here. This was a difficult decision for the commission primarily because of Mark, I think the point you raised about the litigation cost incurred in deciding at the outset whether you have an executory contract or not. And

01:24:55.919 - 01:25:10.200

so why not just take that issue off the table and get to the merits of the dispute. Ultimately though, I think that it was Michael's perspective that won out that, you know, courts are comfortable with interpreting executory contract and perhaps from the creditor side of the

01:25:10.200 - 01:25:25.799

equation, having some gating feature before a debtor can unilaterally decide to assume or reject a contract was at least some minimal protection that creditors were entitled to. So that was where they ultimately decided, but they actually spent most of their time thinking about the consequences of

01:25:25.799 - 01:25:45.379

a contract being subject to assumption or rejection. And so that leads us to the next issue. What happens during the gap period. The period between the filing, the entry of the order for relief, and the assumption assignment or rejection of the

01:25:45.379 - 01:26:07.270

contract. There has been, um the code specifies what happens in certain limited situations, imposes obligations on the debtor in those limited situations, but when the debtor is buying goods and services and the like, there is no specificity

01:26:07.270 - 01:26:26.910

in the code, and I think the commission tried to fill that gap, excuse the expression, for that period of time before the debtor has to assume or reject, and their proposal was twofold. I think that the debtor, must pay

01:26:27.520 - 01:26:50.870

quite naturally for goods and services provided post petition according to the terms of the contract and the non-debtor must perform according to the terms of the contract. Secondly, that the debtor is not required to perform before assumption. But the non-debtor party can

01:26:50.870 - 01:27:16.479

seek to compel the debtor to perform certain post petition obligations if the court determines that the harm to the non-debtor party resulting from the debtor's non-performance significantly outweighs the benefits to the estate derived from such non-performance, and the burden is on the non-debtor party to

01:27:16.490 - 01:27:35.609

compel this performance from the debtor. What does this panel think about how that balance was struck? So I guess I'll just kick us off in the thinking on that balance. I think the commission throughout the report tries to clarify where there's ambiguity

01:27:35.609 - 01:27:50.339

in the existing law where we have circuit splits, so clarifying what the rights of the respective parties would be after the filing at least gave parties the ability to negotiate from firm ground. Second, throughout the deliberations, there was a discussion of a point that Craig

01:27:50.339 - 01:28:07.169

actually raised earlier when we were talking about claims trading. The consequence of the debtor's bankruptcy on the counterparties's business and we had a lot of discussion about franchisees and what a debtor's decision to do with that franchise contract does to the franchisee's business and part

01:28:07.169 - 01:28:22.924

of that plays into whether or not a debtor, for example, has to provide parts and components to the franchisee or the counterparty that they need to then produce their product and continue their business. So the last thing you want to do is protect one

01:28:23.165 - 01:28:40.080

distressed company to create another failed company. So that was part of the dialogue in that that principle. So, so here I think that my own view is that the commission got it exactly right with maybe one very minor addition I would suggest. This is one

01:28:40.080 - 01:28:53.450

of these areas I think where having said that you know the revision to the code doesn't need to resolve every ambiguity or every dispute among courts and the discretion should be allowed. There is a lot of value, as Professor Harner said, I think to resolving

01:28:53.939 - 01:29:08.930

definitively those issues that are creating the most ambiguity and therefore the sort of most tax on the system because you know kind of ambiguity is a tax on the system at some level and this is the question just like in the real world you

01:29:08.930 - 01:29:21.700

get all the time. This just comes up all the time with what is you know from the non debtor counterparty to a contract what I know I have to perform. The debtor doesn't, isn't performing or do they have to perform or what do they have

01:29:21.700 - 01:29:36.529

to do or their non-monetary obligations are actually more important than their monetary obligations sometimes, which is sometimes the case and I think that there's a lot of value to certainty here. I also think that it's appropriate for debtors to have to perform economic obligations,

01:29:36.779 - 01:29:52.169

As the commission suggested, post petition, if they don't like the economic obligations which are essentially administrative expenses, the only difference is you're not deferring them to the end of the case, but I think it's a fair trade-off for the debtor not only getting

01:29:52.169 - 01:30:06.339

the benefit of the goods and services but also is also controlling the timing of assumption or rejection and I think it's probably in the estate's benefit to force debtors to focus on those issues sooner rather than later when they have economic consequence so that

01:30:06.339 - 01:30:20.740

if the debtor decides that it doesn't want to pay under the executory contract post petition, it should just pay attention to that if it matters economically sooner and reject the contract and if it's not important to the debtor so that they have other things

01:30:20.740 - 01:30:33.819

to focus on, then they should just go ahead and pay because it doesn't matter to the estate and it probably matters to the counterparty. The one thing I would suggest that might be added to that is what's the consequence of the debtor's failure

01:30:33.819 - 01:30:45.379

to do this, which I think is not set forth in the proposal, and it's just a question in the, you know, again in the real world you get all the time, is it a motion to compel them to perform? Is it a motion

01:30:45.379 - 01:30:59.370

to for relief from the automatic stay to terminate the contract? Is it an automatic right to terminate the contract? Can you just go, it's a post-petition obligation? Do you not need relief from this day and you can just sue post petition. Is it

01:30:59.370 - 01:31:12.450

a motion to compel assumption or rejection? And I think it would be good to know the answer to that question one way or the other. And with respect to non-monetary obligations, again I think this leaves it to the court discretion, the proposal leaves the court

01:31:12.450 - 01:31:32.810

discretion to rule for the counterparty where, well, to balance the harms, I'll say. I mean I don't think the codes, I don't think the commission's recommendation is that different from the status quo and certainly if a

01:31:32.810 - 01:31:49.529

debtor is going to request post-petition performance, it should pay in accordance with the contract terms unless and until it assumes or reject you know, I would point out that the reason the debtor is given the option on a relatively unfettered time period in Chapter

01:31:49.529 - 01:32:05.689

11 is that you don't necessarily know on the first day of the case that it's gonna succeed and you don't want to assume a contract if you're gonna end up in a liquidation, and of course every counterparty wants the certainty, and I understand

01:32:05.689 - 01:32:22.680

that and I've been on both sides of that problem, but you know, to bombard a debtor early in the case with these requests, I don't think it's helpful. Either to the debtor in terms of managing its time or for the general interest of the

01:32:22.680 - 01:32:43.029

estate because again you don't want to be saddling the estate with these admin expenses if if the reorganization isn't gonna succeed. So another area which the commission sought to resolve a conflict in the courts, deals

01:32:43.029 - 01:33:05.890

with the debtor as the licensee of an intellectual property license. There has been, there's an innate tension between the bankruptcy code, which of course is focused or allows a debtor in possession to assume a sign or reject, and the

01:33:05.890 - 01:33:30.089

federal laws on intellectual property which focus on the control that the licensor must exercise or has the right to exercise regarding their intellectual property. There have been several approaches to a debtor's attempt to particularly assume and assign. The so-called

01:33:30.089 - 01:33:54.129

hypothetical approach has envisioned the debtor in possession as a different entity than the prepetition debtor and has rejected the opportunity of a debtor to assume and to assign such a contract. The commission chose the so-called actual approach which allows a debtor in

01:33:54.129 - 01:34:17.220

possession to assume and assign these contracts. Perhaps the most interesting part of this issue, and I'd welcome comments on any part of it from anyone here, is the caveat that was introduced regarding the concern that the debtor might assume an intellectual property

01:34:17.220 - 01:34:40.419

license and assign it to a competitor of the licensor and the commission determined that in that case there could be a showing that if substantial harm were coming to the licensor by the assumption and assignment that the court would not

01:34:40.419 - 01:34:56.859

allow it. What do you think about any of that? So go ahead. I was just gonna give the theory behind it. So with the embrace of the actual test, which is that if the debtor is going to keep the license, they should be able

01:34:56.859 - 01:35:13.779

to do so and not be prohibited by Section 365C, the bankruptcy Code, even in the First Circuit and jurisdictions following the actual test, that debtor still couldn't assign it to a third party. And so in thinking about that division and whether it would be appropriate in

01:35:13.779 - 01:35:31.310

a reconceptualized world of IP licenses and bankruptcy and how valuable most IP licenses are to a debtor and possession, the commission decided that a debtor not only should be able to assume and continue to use an intellectual property license, but you should have free free assignability

01:35:31.310 - 01:35:48.689

of your IP licenses, and that proposal stemmed in part from the literature we received from the international committee really and thinking about foreign treatment of intellectual property licenses. But it did raise, well, how do you balance that with the valid rights of the counterparty, the

01:35:48.689 - 01:36:06.540

licensor who owns and developed the IP and that's where the competitor restriction that you mentioned, Judge, came into play. I've never understood why a debtor who was licensed pre-petition cannot assume the contract. I mean, it just never made sense to me. I can't see

01:36:06.540 - 01:36:27.490

any legitimate interest in the counterparty. On that point, that the distinction in that circumstance between the debtor and the debtor in possession to me is so theoretical as not to exist, would you agree with that if the reorganized debtor was going to be

01:36:27.490 - 01:36:53.430

controlled by a direct competitor you know that raises other issues, but couldn't that happen through merger outside of bankruptcy? Sure, sure. So yeah I mean I never understood in the license and and have a preclusion and the question is

01:36:53.430 - 01:37:04.750

whether that would be respected by the court or not. Look, my view is the same as marks on the hypothetical test. My sense is that that even the judges who ruled in favor of the hypothetical test weren't doing so because they thought it made any

01:37:04.750 - 01:37:17.359

sense. They were just committed to a plain reading interpret, plain meaning interpretation of the code, and they thought that's what the code said and by the way, they may be right about that, I think the more difficult issue is with respect to this

01:37:17.359 - 01:37:34.959

with respect to assignment and and here I think maybe the commission got the idea right, but the restriction on a competitor may be too narrow because there are parties that have close relationships with competitors. There are parties that are prospective competitors including very likely competitors,

01:37:34.970 - 01:37:52.564

but not now competitors. There are entities that would be a competitor as soon as I got assignment of the intellectual property license and and so you know I might allow the court to balance the equities depending on all factors including the identity

01:37:52.564 - 01:38:12.859

of the proposed asinity without limiting it to competitor. So there are other 365 issues but we have to move on to safe harbors. So as many of you know, there are certain types of contracts, labeled qualified financial contracts including securities contracts, commodities contracts,

01:38:12.899 - 01:38:36.859

a repurchase agreements, swap agreements and the like, that are exempt from certain bankruptcy protections in particular we're discussing 546E. The debtors, the DIP's right or the trustee's right to pursue fraudulent and preferential transfers. These protections from these kinds of

01:38:36.859 - 01:39:01.080

transfers are called safe harbors, and they are designed to avoid well to encourage market stability to avoid, the avoidance of securities trading issue, you know, securities transfers that need to be protected in the general marketplace. We are privileged to have

01:39:01.080 - 01:39:23.500

Mark with us on this panel who participated in the subcommittee who looked at the issue of safe harbors. The issue comes up particularly in the context of abuses that have arisen, wouldn't you say. In terms of the application of

01:39:23.500 - 01:39:44.250

safe harbors, not to protect market stability, but to allow private parties to benefit from these protections without any impact on the general market. What were the issues in the subcommittee that concerned the subcommittee most and how did they resolve it? Sure, um,

01:39:44.580 - 01:40:02.180

so one thing that doesn't appear in our recommendations but which was hotly debated was whether there should be safe harbors at all. Safe harbors generate a lot of heated discussion and there's no question that safe harbors are not good for debtor.

01:40:02.339 - 01:40:25.830

They override very fundamental principles of the bankruptcy code; automatic stay, ipso facto clause, and avoidance, you know. So what counterbalance, that is a sense that there could be a cascading unintended consequence in the financial markets if contracts that trade

01:40:25.830 - 01:40:46.790

in those markets are subject to the automatic stay and the anti so for inso facto provisions or for example margin payments two years later could be clawed back. And in my own mind, and I'm only speaking for myself on on anything I

01:40:46.790 - 01:41:09.549

say about the subcommittee today, in my own mind, the justification with safe harbors was absolutely proven conclusively in the Lehman case, because you had every other investment bank in the world, not just the United States, having extraordinarily large provisions with Lehman.

01:41:10.040 - 01:41:29.850

And if I was representing Morgan Stanley for example where our close out claim, let alone the value of the positions, was, well over a billion dollars and so if you froze those positions for some indeterminate period of time subject to the

01:41:29.850 - 01:41:47.060

debtor's decision to assume or reject the capital impact on their balance sheet would have been devastating and they would have been, they all would have collapsed immediately, which means financial markets would have collapsed. There was a point of view on the committee

01:41:47.060 - 01:42:07.640

of so what? I tend not to agree with that, So well It was a seriously held view. I don't mean to diminish it. So I

01:42:07.640 - 01:42:23.589

think, and we did debate whether whether we should do something more broad ranging in terms of eliminating safe harbors, but the majority view was that in general they're OK. And that they serve their purpose, so we then started focusing on how could

01:42:23.589 - 01:42:41.470

we tweak the existing safe harbors to make them better and more in sync with what Congress intended, because clearly there were instances where based on the language, they were unintentionally applying to transactions that have nothing to do with markets at all and that should

01:42:41.470 - 01:43:05.200

not be protected and the Quebec case which you might be familiar with was one main example where a completely private securities transaction was given the benefit of the anti-avoidance safe harbor. And another example is a case called McMenamin's Grill where

01:43:05.520 - 01:43:23.379

a restaurant, closely owned corporation, there was a transaction between the principals, and the court holding its nose said, you know, I hate to do this, but I have to apply the safe harbors to a buyback of stock, and so our

01:43:23.430 - 01:43:41.680

and that was low hanging fruit and there was unanimous view on the committee that we should exclude completely private transactions. Even though they involve securities from the protection of safe harbors, now the devils in the details, how do you define what a private transaction is

01:43:41.680 - 01:43:55.569

a closely held transaction? We didn't do that. We thought about it for 10 seconds and realized that there was no way we're gonna get that done within our time frame. More that there's a sort of, the way I look at this and I was

01:43:55.569 - 01:44:11.779

on a different subcommittee, not this one, is that there's a sort of cat and mouse game that goes on where the legislators draft something with a particular intent but you know don't get the language absolutely perfect because it's impossible to do that and then really smart

01:44:11.779 - 01:44:28.725

lawyers figure out ways to fit their transaction into what's written. And so you know Congress passes these safe harbors intent because of a concern about the impact on the capital markets and then a really smart guy says well if you read the language literally my

01:44:28.725 - 01:44:49.390

bar and grill fits in there or Congress writes repo exceptions to the automatic stay and to avoidance actions and then people just document things and there's a legitimate purpose for that, but then, you know, one of these

01:44:49.390 - 01:45:05.979

days somebody is going to start documenting home mortgages as repos and or car loans as repos and people say, well, you read the language literally. And there are other areas like that and I wonder whether this isn't just destined

01:45:05.979 - 01:45:19.419

to go on forever. That's not a reason to just give up, but you know, the commission finds some loopholes and some ways to close loopholes and I think did an admirable job of that. And then it'll be just

01:45:19.419 - 01:45:36.750

up to the lawyers to continue to be creative. And yeah, unfortunately I think we have to leave it there. Time I think is up Denise, would you agree? Can I add just one quick point that will tie these two comments together? Exceptional

01:45:36.750 - 01:45:52.660

job, both of you, of explaining what the commission did and Mark, I think your summary of your committee was spot on. Mark's comment about thinking of pulling the safe harbors completely out of the code, I think one reason that it was discussed

01:45:52.660 - 01:46:07.270

not only because I think there are some who can passionately believe that, but to Mark's point, to mitigate the abuse and so maybe you pull it out for some but not other types of debtors, right? The fees and the larger debtors may need the

01:46:07.270 - 01:46:24.370

safe harbors, your SMEs may not. And so that's one thing as we continue to discuss reform to put out there. Yeah, and let me just add one thing which is that the commission's recommendation on repos was not the subcommittee's recommendation. That was actually a minority

01:46:24.370 - 01:47:06.270

position on the subcommittee which the commission adopted. Understood. Thank you. Thank you. We're moving on to, uh, other topics. What done on that? So you've met Professor Jacoby and David Hillman is with us as

01:47:06.270 - 01:47:27.759

well. We're going to first talk about 363 sales in particular what has been called by the commission 363X sales, that is sales of all or substantially all of the assets of a debtor. Of course most of you, all of you who

01:47:27.759 - 01:47:46.339

are in the area know that this is commonplace now and the commission discussed globally that it has become a part of the landscape and has to be dealt with, not eliminated if you will. That was a basic premise of the discussion

01:47:46.419 - 01:48:13.049

and all kinds of possibilities were discussed and proposed about how to limit, what how can the process be made to be more bankruptcy friendly to be more in line with the basic principles that you heard articulated at the

01:48:13.049 - 01:48:35.299

outset. One area that was discussed was the melting ice kind of case. The kind of case that came in and sought immediate action, a very prompt action as soon as the case was filed, the sale is

01:48:35.299 - 01:48:57.810

all ready to go. And the concerns about that kind of sale are many, including the lack of ability of stakeholders to participate in that process meaningfully. So one of the proposals of the commission was to impose a 60

01:48:57.810 - 01:49:19.859

day moratorium on such sales from the the date of the order for relief for the filing subject to an opportunity for the trustee or debtor in possession to demonstrate by clear and convincing evidence that the value of the assets would decrease substantially

01:49:20.350 - 01:49:43.759

during those 60 days. There would be a need to comply with all of the new proposals regarding 363X sales which we'll get into as well. So what do you think about the 60 day moratorium that the commission proposes? I will

01:49:43.759 - 01:50:02.339

be happy to start this now on this panel. David and I might occasionally disagree. We'll see how it goes. So, I think that these proposals are identifying a very important problem and on this one, we're talking about from

01:50:02.339 - 01:50:18.149

the smallest chapter 11 to the very, very, very largest, the full spectrum. That once upon a time the idea was if a business was going to continue as a going concern that was done through a plan today that is more often done through a sale without

01:50:18.149 - 01:50:38.040

the expected procedural protections as Judge Wizmur just mentioned. I think this puts the court and the stakeholders in a very difficult position. And the message that's often given right after the filing, the debtor comes in with with parties and says we

01:50:38.040 - 01:50:51.680

need to do this is whether you call it a melting ice cube, there's the truck of rotting salmon sometimes comes up, we could come up with all sorts of ways to put it, but the idea is, Judge, we need to do this

01:50:51.680 - 01:51:09.220

now or we will have nothing left to sell later. The problem here is that there are extreme informational disadvantages at that time for the court and for some of the stakeholders who have not been as privy to the information that's already happened. We don't always

01:51:09.220 - 01:51:26.740

know whether it's truly melting ice cube. It is easier to allege than to know for sure. We don't know if the price is adequate, and there are distributional issues and a little bit in distinction from the discussion this morning, I do think that

01:51:26.740 - 01:51:45.100

bankruptcy by design has something to say about distribution as well as about growing the pie as well. So I have concerns about sales that happen very quickly. And so I see that the sixty-day moratorium with exceptions is designed to address

01:51:45.100 - 01:52:02.549

that. My concern is this, I appreciate that the legal standard has just increased above what it was. The Lionel standard, which wasn't even ever meant to apply to this kind of situation, which applied a reasonable business decision sort of standard, isn't high enough.

01:52:02.620 - 01:52:18.379

I think that's right. But I don't think that standard by itself changes all of the informational problems and all of the pressures that are on the court to take the action and that, so therefore we have the still practical realities of the situation. So that's,

01:52:18.629 - 01:52:38.180

I completely agree with the problem and I'm worried about that's the solution doesn't overcome the basic difficulties. I take a different view. As a threshold observation, I think we should start with the question of should we be legislating or proposing

01:52:38.180 - 01:52:58.229

reform to deal with what may be a problem that exists in some cases but is not the norm. And are we legislating to address problems that stem from the Great Recession, the greatest recession since the Great Depression in 2008, we really shouldn't use Lehman as

01:52:58.229 - 01:53:18.109

the poster child for a fast sale, right? The clearly there are sales that are happening under 363 at a pace that is much more robust than has occurred in the past, but one question that I have is, is that a bad thing? And I

01:53:18.109 - 01:53:35.069

think when we evaluate a a sale that may happen on a more expedited time frame, there are and I heard Professor Harner earlier today say it, it's being run for the benefit solely of the benefit of the secured creditor when we were talking

01:53:35.069 - 01:53:54.770

about first principles. Not all cases. But not all cases. But when we're dealing with a going concern sale whether it's in the 1st 60 days or thereafter, I think we also need to take into account the other beneficiaries of that sale. It's not just the secured

01:53:54.770 - 01:54:10.129

creditor who may realize the value of its collateral, but it's the it's the employees whose jobs are preserved. It's the vendors and suppliers and other contract counterparties with the debtor who still have a trading partner. And so as a prince as a as an observation of

01:54:10.129 - 01:54:32.029

first principles, I would say that bankruptcy is in fact providing value to more than just the secured creditor but specifically to the 60 day issue clearly nobody wants to see a sale happen in the beginning part of the case unless there's justification and

01:54:32.029 - 01:54:49.020

we can debate whether or not there needs to be a standard that's different from existing law but certainly the courts, at least all the courts that I've appeared before do apply an exacting standard and will not allow a sale to happen absent extreme and exigent

01:54:49.020 - 01:55:09.310

circumstances. But it happens. I was just at the first day hearing for RadioShack where I represent a secured creditor. The company presented compelling reasons to start a sale process to close approximately 1700 stores. Among other things, if the sale didn't at least start early, right,

01:55:09.339 - 01:55:26.779

the sale's gonna happen within the 1st 60 days. But if the process didn't get underway immediately, the debtors were about to incur March rent and March payroll for the 1700 stores which they decided to close, which would exceed about $30 million. So we're talking about a

01:55:26.779 - 01:55:45.660

compelling reason to avoid the incurrence of additional expenses. The other thing that I think we need to bear in mind when we're dealing with expedited sales, many debtors come to a bankruptcy court and having done a significant amount of pre-bankruptcy marketing. So we're not talking

01:55:45.660 - 01:56:08.049

about a situation, at least in my experience, it is a fair amount pre-bankruptcy marketing with experienced professionals, the purpose of which is to be able to go into court and to reduce the uncertainty for suppliers, customers, employees about what the

01:56:08.049 - 01:56:24.049

exit strategy here is. So there are many instances in which the sale is quite appropriate and a 60 day moratorium is not an appropriate fix for all cases, and the judges today have the discretion to deal with it. So if

01:56:24.049 - 01:56:37.930

I can just very quickly, I think the two perspectives you just heard are important because they certainly represent much of the dialogue on the commission. We had perspectives on all sides and, uh, so taking my commissioner hat off and just me Professor Harner,

01:56:37.970 - 01:56:54.830

I actually think the 60 day period is too short, but putting my perspective aside, I'll tell you why. And it goes to Melissa, Professor Jacoby's point about the informational symmetry in these cases. Yes, there's a lot of marketing prepetition. There's a lot of discussion, but

01:56:54.830 - 01:57:10.509

it's a very closed group of parties that have access to that information. And if you think about it, it's part of an integrated discussion, right? So if you have a debtor who thinks the chapter 11 process doesn't work for them, they're going to do everything they

01:57:10.509 - 01:57:26.049

can to stay out of Chapter 11 as long as they can. So that means they're taking on rescue financing, they're leaning up the assets, they're thinking about sales, maybe not a sale of the entire business, but some sales just to get more time. So that they've

01:57:26.049 - 01:57:42.689

created the emergency that when they get to the bankruptcy court's door, yes, they need to sell in 14 days because they've wasted, you know, a huge amount of time pre-petition because they were fearful of the code. So many of these issues the commission tried to address

01:57:42.689 - 01:57:58.064

are very integrated. If you had a better set of tools of Chapter 11 that management would embrace sooner, perhaps, you know, there wouldn't be such emergent need to sell. Quickly to Mark's point about the 60 days and that some cases you do need

01:57:58.064 - 01:58:15.035

to move that quickly, I think that, um, professionals and managers are astute enough to adjust their timelines so that if you know you have to wait 60 days once you file, parties will figure out how to make that work and what that

01:58:15.035 - 01:58:31.450

does, it just gives everyone else, including the court, the United States trustee and a creditors committee the opportunity to look at the deal, look at the options and make sure this truly is the best way to maximize value for all creditors. And here I would just

01:58:31.450 - 01:58:46.589

know, I take David's point about, you know, it's not just the secured creditor or the party that will receive the primary bulk of the proceeds from the sale, but it's the employees that keep a job in a community that maintains a tax base,

01:58:46.879 - 01:59:03.194

but often in the going concern sale context, particularly when they're very quick sales, it's a very reduced subset of employees that stay on with the going concern. Even taking the RadioShack example, they have 4000 stores, there's employees at all of those 4000 stores. Many of

01:59:03.194 - 01:59:17.314

those stores are not part of the general standard sale. Many of those employees are losing their jobs. Many of those communities now have empty lease space and no longer have that tax revenue. So I agree it's broader than just the secured, but it's not perhaps everyone

01:59:17.314 - 01:59:36.330

we would think of as being a traditional unsecured creditor. Maybe in the ideal world, creating more time to do more marketing may create more value. No, but it may not create more value. May not be just about marketing. It's about information, but who's you're asking us

01:59:36.330 - 01:59:50.629

to trust your clients to have sorted these into different categories and really the question is how to promote the best sorting because some of these cases there may be reasons that something is a melting ice cube, but you've got to create the conditions that 11

01:59:50.629 - 02:00:08.290

can sort those and then the people will respond to the incentives, but who bears the cost of the additional time, the additional professional fees, the potential for reduction in value. Let's talk about costs. Moving on to the other as

02:00:08.290 - 02:00:28.600

a major aspect of this 363X question. And that is we know that this process is not going through a normal plan process. it is cutting that short and therefore cutting the all of the 1129 protections and the confirmation process off so the commission looked

02:00:28.600 - 02:00:52.930

at that and proposed to insert in 363X type sales certain protections 1 through 4 to comply with the code in good faith and so on other key aspects were requiring sale proceeds to be set aside to pay administrative expenses which I know there

02:00:52.930 - 02:01:13.200

might be some disagreement about and we can take that up, and a specification that there not be any extraordinary provisions that are, against, that are proscribed by the code like absolute priority violations, third party releases, deviations from the claims allowance process.

02:01:13.490 - 02:01:31.654

So, there is an attempt to sort put a framework around this kind of sale that would fit it perhaps better into the bankruptcy code structure. What do you think, David? I know you're against some of these. Let me focus on one.

02:01:31.654 - 02:01:44.535

One of them. I think we can spend the whole day talking about all of them, but I'll focus on the administrative claim reserve. I mean, if this proposal were to be enacted and there were a 60 day moratorium, the first question really is there's going to

02:01:44.535 - 02:02:01.399

be increased costs associated with the case, right? You're gonna run the case potentially longer, more professional fees, a larger dip. Uh, more interest on any over secured claims. So there are significant expenses that come with this proposal which either are going to and nor to

02:02:01.399 - 02:02:17.319

the detriment of whoever is the owner of this collateral, maybe it's the secured credit or maybe it's somebody else in the capital structure, but the admin claim issue is one that is fraught with problems. I mean, generally speaking, the current practices

02:02:17.319 - 02:02:34.080

to negotiate a dip order or a cash collateral order to pay for the reasonable and foreseeable expenses to run the process. No one expects to walk into bankruptcy court and to not pay for the what people think are the fees and expenses to get

02:02:34.080 - 02:02:53.959

to the sale, but what the proposal here is is to reserve from the cash proceeds all administrative expenses through the sale closing date so. I've had this example. This is a real life practical issue. You have a budget and professionals, the creditors committee

02:02:53.959 - 02:03:11.069

is limited to a line item in the budget, and they cannot use cash collateral or dip collateral to, among other things, investigate claims and they're subject to a cap. Sometimes creditors committees and their council blow through the cap. Those claims may

02:03:11.069 - 02:03:28.919

be allowed administrative expenses. So under this proposal, the secured creditor who provided the dip and allowed for use of cash collateral would have to fund expenses incurred by a creditors committee in excess of an approved budget. So it sounds like you, you're not opposed to the

02:03:28.919 - 02:03:45.270

concept just to the details of a reserve. You're accepting of a reserve but worried that it would create, allow for perverse incentives, for overspending of other professionals. That's one example. Another example is there are, it won't

02:03:45.270 - 02:04:02.029

be clear at the time the judge bangs the gavel on the sale order. This is supposed to cover all administrative claims through closing. There are many examples of what I consider to be hidden or delayed administrative expenses that won't be known and it's questionable

02:04:02.029 - 02:04:17.600

whether or not the secured creditor should actually have to pay for a number of these expenses which may be completely unrelated to preserving and maintaining the collateral. I mean, I have a quick list here. The buyer decides not to assume a pension plan and there's

02:04:17.600 - 02:04:36.069

withdrawal liability. Some of that withdrawal liability could be a post-petition expense, and we could be talking about, you know, millions of dollars in that example, claims for a post, post-sale, pre-closing breach of an assumed contract, retroactive premium adjustments, taxes from the gain on sale. Another issue

02:04:36.069 - 02:04:54.310

here in addition to these hidden expenses is who, who has to pay for for these expenses? Let's assume that there's some unencumbered collateral value. The commission's proposal doesn't say, you reserve from the sale proceeds, but how do you allocate who pays for these

02:04:54.310 - 02:05:12.959

expenses if there are unencumbered collateral, excuse me, unencumbered assets, I mean, it would be my view that those assets would be first used to satisfy those expenses, especially if they're unrelated to preservation. And maintaining the secured creditors collateral. So if I can just say I

02:05:12.970 - 02:05:27.689

appreciate your concerns, but again here this was a result of thinking about the right balance between the policy objectives because there's also a whole host of costs that are not covered by the framework what we typically think of as burial costs, right? The case doesn't

02:05:27.689 - 02:05:43.100

stop when the sale closes. So yes, you're saying a secured creditor is willing to pay to get the sale done. But that's not when the system stops. There are resources that need to be expended after the sale of a close after the close of a sale.

02:05:43.439 - 02:05:55.200

It's been a long morning already after the close of a sale, and I guess one response would be, well, why don't we just convert and then go into a chapter 7, and that way the secured creditor gets everything it wants and we reduce the

02:05:55.200 - 02:06:10.290

costs and tax on the system. But if you're going to take advantage of a going concerned sale that's supposed to be a viable exit for reorganization, that is increasing value to more than just a secured creditor, right? The employees you mentioned and others, which the

02:06:10.290 - 02:06:27.384

commission was all for, right? Using sale as exit in the right cases we're maximizing value, then you know there are other costs. So you're unencumbered asset point, that's why I started here, you know, there's other costs those unencumbered assets. I agree and and those and

02:06:27.384 - 02:06:43.700

those the typical negotiation is at the sale hearing. There's a negotiation that exists between the relevant stakeholders, and sometimes you can reach an agreement that a certain amount of dollars will be set aside to fund the wind down. Maybe agreement can't be reached and the case

02:06:43.700 - 02:06:56.930

converts. It used to be perhaps you would consider a structured dismissal, which I understand what is one of the proposals to remove that from the list of options, but there is currently in place a negotiation that takes place over those very issues. Can I jump

02:06:56.930 - 02:07:10.290

in and for those who are less steeped in this on a very day to day basis, just set the reminder that the existing status quo has somewhat turned the world upside down again, if you start with the premise that if there's going to be

02:07:10.290 - 02:07:27.000

a going concern business after bankruptcy, that that would be done even if it was going to be sold as a going concern through a plan after voting after disclosure and meeting certain requirements. So like, wait, so if you. You had your turn.

02:07:27.669 - 02:07:48.640

OK, so. We've now moved to a system where there, we have many more going concerns through this early sale process. And there is somehow become an assumption that the money has to be dispersed automatically right away. Where does that come from? It's not in the bankruptcy

02:07:48.640 - 02:08:02.950

code. So I just want to be clear that what Professor Harner and the commission or what the commission did was actually, I do see as a compromise. I don't have a strong view on sort of the details of the reserve, but I just wanted

02:08:02.950 - 02:08:16.549

it to be clear that it is not a radical notion to say you should hold back the money to figure some of these things out. That's just common sense. Federal courts do it all the time. Which leads us for the last two minutes to a

02:08:16.549 - 02:08:37.529

very complicated topic and that is DIP financing and the attempt by the commission to put a framework on, on this process. As you all know, those of you who are working in the trenches, when the debtor enters bankruptcy,

02:08:37.649 - 02:09:00.479

it is most common that that debtor needs uh financing to pursue the process and to continue its operations, and it has become quite common for lenders to impose all kinds of special provisions in the willingness to lend to

02:09:00.490 - 02:09:16.350

debtors post petition. And the commission took a look at many of these and I'm gonna just quickly go through them and ask you to comment on whichever ones you want, because we, you know, we have about a minute left. So roll ups

02:09:16.350 - 02:09:39.089

which allow the pre-petition debt to be paid with the post-petition financing have been restricted substantially. There cannot be liens on avoidance actions which would otherwise in order to the benefit of unsecured creditors. Milestones or benchmarks which require the debtor

02:09:39.089 - 02:10:10.339

to achieve certain results within specified time frames have been restricted. No waivers of 506C obligations. 0h, thank you. I thought we were at 12 o'clock. OK, we have plenty of time. So, yeah 506C of course is the opportunity of

02:10:10.419 - 02:10:34.290

the debtor in possession to surcharge what we've just spent some time talking about surcharge the proceeds of the collateral for the costs of preserving the collateral and the commission proposes to restrict

02:10:34.290 - 02:11:00.350

the opportunity of a lender to require the waiver of that provision as well the waiver of the opportunity under 552B, uh, to impose upon what otherwise would be the secured lenders opportunity to attach proceeds post petition to their

02:11:00.350 - 02:11:21.140

collateral. The opportunity of the court to look at the equities of the case to modify the position of the secured lender vis a vis their post-petition position. The commission proposed that that kind of waiver would be prescribed so these are all kinds of

02:11:21.140 - 02:11:45.140

attempts to curtail overreaching if you will, perhaps the commission saw some overreach reaching in these proposals, to curb those kinds of uh processes. What do you think? I'll start off. I'll focus first from a macro perspective when you

02:11:45.140 - 02:12:04.895

combine the changes, the proposals to the 363 sale process and to the dip financing process, you're left with the inescapable conclusion that, taken as a whole, these types of changes are create a significant amount of risk for secured creditors and realizing the value of

02:12:04.895 - 02:12:22.595

their collateral if you're going to impose more risk on secured creditors in that process, the natural consequence will be to increase the cost of financing for borrowers at the front end, especially at rescue financing and even with respect to dip financing. So I mean

02:12:22.595 - 02:12:38.950

I'll highlight a couple of what I think are the most significant and by eliminating others I'm not trying to suggest that they're not significant, but I'm just trying to focus on time. So, we talk about the 506C waiver when a debtor

02:12:39.649 - 02:12:58.799

and a secured creditor negotiate a cash collateral order or dip financing. There's a quid pro quo. There's a negotiation about a budget in exchange for agreeing to fund those items listed on a budget, the lender expects that the debtor will not subsequently sue it to seek

02:12:58.799 - 02:13:19.089

to surcharge the collateral for other expenses that maybe weren't reasonably anticipated. It's a bargain. The same thing goes for the waiver of section 552, so these provisions essentially strip the benefits that would inure to the senior creditor in negotiating pre-petition, excuse me, post-petition finance arrangements.

02:13:19.689 - 02:13:35.200

One of the things that Judge Wizmur did not highlight in the changes in the financing section, which I believe is gonna be the subject of another panel, is a change to the standard of adequate protection to link it to foreclosure value. And one

02:13:35.200 - 02:13:51.839

of the things that I hope is discussed in the subsequent panel is there's a clear consequence, at least in my opinion, of changing that standard. It means in the context of a company that operates as a going concern and is not going to liquidate

02:13:52.169 - 02:14:10.529

the going concern value is invariably higher than the foreclosure value. It means that there's an equity cushion the equity cushion that will be used by debtors to seek to provide or to seek to prime the existing secured creditor which will lead to a proliferation of

02:14:10.529 - 02:14:29.140

what I think are uh extraordinary priming dip loans. That's not mentioned in the report but I think that's the natural consequence of that particular change. Roll ups. Look, it's hard to argue that there should be roll ups on the interim. I mean that's,

02:14:29.220 - 02:14:46.229

that's extraordinary, and unless there's no other option available to the debtor, I think courts are already reluctant to approve that. I think what's challenging about the roll up is the report says that if the lenders are providing, I think

02:14:46.229 - 02:15:00.310

I'm quoting here, substantial new credit on better terms than the roll up would be permitted at the final. I don't know what that means. Um, I've been involved in cases where my clients have made an advance of $30 million which at least I consider to

02:15:00.310 - 02:15:15.140

be substantial, and they rolled up 2 for 1 for every $1 of new money they rolled up $2 of pre-petition debt, so it's not clear to me as someone who's sort of in the day to day on this

02:15:15.140 - 02:15:30.620

whether that would qualify as a permissible roll up. I guess I'll end with what I started with. These changes would have a significant impact on secured creditors which, um, at least from the discussions that I've been having with the clients that I

02:15:30.620 - 02:15:47.330

deal with regularly, the consequences here could be very significant and probably contrary to what the commission's objective is and would increase the cost of credit and perhaps decrease the availability of post petition financing. So one of the arguments that I think has been most common

02:15:47.330 - 02:16:04.740

on any legislation affecting bankruptcy is that it will increase the cost of credit and the decrease the availability of credit up and down the board. Now I understand why that argument is made, but it shouldn't be the conversation stopper that it often ends up being.

02:16:04.890 - 02:16:21.970

First of all, there the jury is still out on questions such as the efficiency of secured credit versus other kinds of investments. Finance professionals and economists and lawyers or at least law professors like to argue about that all the time.

02:16:22.049 - 02:16:37.410

There is no reason to, so we have to be careful with the idea of saying we want to preserve one kind of one kind of credit device over others. We have no reason to believe that that one is inherently preferable. I say that recognizing

02:16:37.790 - 02:16:53.969

that I don't actually again see these proposals as being very radical at all in the at least the ones we just talked about. I see them as restoring some of the distributional choices inherent in the 1978 bankruptcy Code premised on the idea that it

02:16:54.459 - 02:17:07.179

kind of takes a village for a business. It needs money, but it needs people and the people need to make that fancy wedding cake or, and their labor is not, is not property and I think that all the different inputs have to be considered.

02:17:07.628 - 02:17:24.009

And so some of the provisions that are not going to be permissible waivers, I think really, really go to that. So I hope the next panel talks about what, under state law, what is property and what actually belongs to the secured creditor

02:17:24.009 - 02:17:37.070

because I agree with the idea of starting with state law premises. I think that's very important, but I think too much has been assumed in that basket. I think we need to be more rigorous about defining the what

02:17:37.070 - 02:17:53.370

the boundaries are, what exactly is that property right entitlement of a secured creditor. And, I guess I will just add to both of those fantastic summaries on the different perspectives on financing in a bankruptcy case. So first, I want to be clear

02:17:53.370 - 02:18:11.809

about this, and we've tried to get this message out. The commission was not anti-secured credit. The commission was very mindful of the impact recommendations, even proposed recommendations, could have on credit markets and liquidity and the availability of secured credit. But to Judge Ambrose's point earlier,

02:18:11.900 - 02:18:33.429

where the 78 code was perceived as being pro-debtor, perhaps, and we've seen this shift where now some would say it's pro-creditor, even pro secured creditor, the commission's approach really was pro-restructuring. Let's think about restructuring and providing all parties that are constituents of a distressed company an

02:18:33.429 - 02:18:51.330

opportunity to help its reorganization and so here I think about the waiver issue that Mark talked about and I understand the change in the norm that would be caused by saying you can't waive 506C or 552B. But as he described it, the negotiation to

02:18:51.330 - 02:19:07.849

waive those provisions and that protection is done usually prior to the bankruptcy before others are involved in the conversation between a secured creditor that has all the money and a distressed company that just wants to save itself. And so I'm not sure allowing a waiver at

02:19:07.849 - 02:19:26.039

that point in time. It is appropriate when we're talking about a system intended to remedy a collection collective action problem and help more than just a a small subset of of constituents. So I want to underscore that we didn't, the commission did not take

02:19:26.039 - 02:19:42.419

away those rights, right? So 506C is still in the code in its current form. 552B is still in the the code in its current form with one modification. And the court wouldn't have to surcharge. The court wouldn't have to find equities of the case warrant

02:19:42.419 - 02:19:56.099

a limitation on the secured creditor's interest in in proceeds, but it was simply to recognize before that is waived or before it is given up. And I know that you say, well, it has to be approved as part of the financing order in order for

02:19:56.099 - 02:20:11.879

the waiver to be effective. Again, I don't think that's an appropriate point in the case for there to be a waiver. Can I make one observation, ask one question? Sure. The observation is, on the 506C waiver. That's usually deferred until the final order

02:20:11.879 - 02:20:29.709

after a creditors committee's been appointed. Let's put that to the side, but here's the question: if these proposals were enacted and we deferred executing on a sale transaction in the 1st 60 days and delayed the process, and there are additional costs and

02:20:29.709 - 02:20:53.910

expenses, and the sale does not, and there's not a better, higher transaction, who, what, what constituency suffers that loss? The secured creditor. And this isn't this just an option for the junior creditors to see if the potential for more time creates value? It may not.

02:20:54.860 - 02:21:07.299

So a couple things in there and I appreciate the question. I always welcome questions about the report. So I'm glad you raised the 60 day, right? Because that's really what we're talking about here is that that short moratorium and it actually was meant to

02:21:07.389 - 02:21:21.615

reinvigorate Mark's earlier point about the breathing spell. You know, it used to be companies got a true breathing spell to think about the economics, right? And whether or not a particular financing arrangement or sale made sense. So to your point about, you know, when would that

02:21:21.615 - 02:21:37.019

determination be made if we're in a sale situation, right? Where it's going to allow the auction to start or the sale proceeding to start on the 61st day, which is all the commission recommendation is, right? Um, it's not a very long moratorium in RadioShack. That would

02:21:37.019 - 02:21:53.860

be $60 million more of administrative expenses based on the timing of a case that was premised that I didn't have to file right away because I'm going to go into court. And there's just in this case, I'm just a secured creditor, and the

02:21:53.860 - 02:22:08.799

debtor is the one who's made this decision. If you were advising RadioShack as counsel to a retailer, knowing what happens to retail debtors under Chapter 11 in the current environment, would you have advised Radio Shack to file earlier? The good news is I'm not counsel to

02:22:08.799 - 02:22:20.429

RadioShack, but. I'll take that as a no. But I, don't have, all I know is that if the relief isn't granted, there will be a dilution in enterprise value. So and I take your part, David, about the costs, and we have

02:22:20.429 - 02:22:36.705

to think about who's bearing the cost through any revisions, but I also understand that we will find equilibrium, right? Once we know what the rules are and how the costs will affect credit, we'll find an equilibrium. It's having an openness to think about change in a

02:22:36.705 - 02:23:20.519

way that might create more value for your clients as well as others. That sounds like a good point to end. Thank you. That's fine. So we'll just keep it rolling because I know people are probably

02:23:20.519 - 02:23:35.700

getting to a point where, well, among other things, I'm almost out of time. I asked you to take off your advocate's hat for 3.5 hours, so I'm running up against my deadline, so I don't want to push it, but I just, Danielle

02:23:35.700 - 02:23:55.980

and I are going to talk a little bit about the evaluation and distributional issues proposed by the commission's report. And so I'll give an overview and try to help explain the concepts and underlying principles to what the commission recommended. So starting at the very

02:23:55.980 - 02:24:13.530

basic level on valuation itself, the advisory committee on valuation and the commission thought about, well, how should we do valuation? Right now, we do judicial valuation. There's no methodology established in the bankruptcy code about how you value an enterprise, we don't say you have to do discounted

02:24:13.530 - 02:24:27.160

cash flow. We don't say you have to use adjusted book value. We leave it open and we allow the parties to present valuation evidence to the court and the court then gets to decide. Both the commission and the advisory committee found great value in that approach

02:24:27.160 - 02:24:41.950

because among other things, it often encourages consensual resolution. Right. Oftentimes it's better to figure out the right evaluation in the negotiating room before you get to trial because you never quite know what the judge, although they're very esteemed and usually get to the right result,

02:24:42.030 - 02:24:56.695

you never quite know what they're going to do. So that little bit of uncertainty that the judges provide for us can be negotiation fuel that sometimes is needed. The one thing though the commission really felt was a good recommendation by the advisory committee is

02:24:56.695 - 02:25:11.769

endorsing the use by the court of court appointed experts. Now there's a cost to that, so in every case it would not be the right approach but having the court appoint a valuation expert in addition to the advocates valuation experts perhaps adds a neutral perspective on

02:25:11.769 - 02:25:30.959

evaluation that the commission thought would be beneficial. So those were the basic valuation recommendations, probably not controversial. The more interesting ones get to what David mentioned just moments ago, starting with adequate protection and how we think about adequate protection. And so here the commission

02:25:30.959 - 02:25:47.000

tried to think about what a secured creditor would be entitled to on the petition date, and they thought about, you know, the union central case and what does that tell us about secured creditor's rights and if you read that case and and subsequent cases we're

02:25:47.000 - 02:26:08.540

really focused on what's the value of the secured creditor's interest in the debtor's interest in property. And what would be the remedy for the secured creditor at that point in time? It would be foreclosure. And so you're thinking about foreclosure and allowing a secured creditor to

02:26:08.540 - 02:26:23.959

realize the value of its collateral or its interest in the debtor interest in property, right? It's kind of the long phrase that justice is always used. Now, starting from that premise, one thing I want to emphasize, the recommendation says early in the chapter 11 case, when

02:26:23.959 - 02:26:42.440

we're thinking about adequate protection issues, the court should value the secured creditor's collateral on a foreclosure value basis. But we, I cannot tell you how long we deliberated about what that meant, right? And how should we think about foreclosure value so that we're respecting the secured

02:26:42.440 - 02:27:00.280

lenders' rights under state law to the greatest extent possible, staying in line with Butner right that says unless a federal interest trumps state law interest should be respected. So what the commission decided to do with the definition of foreclosure value is come up with something completely

02:27:00.280 - 02:27:12.259

different. So if you go to the accountant manual, you won't see how to calculate foreclosure value and we talked about the cost associated with that, but we figured we'll give accountants some more work to do and they can come up with ways to think about foreclosure

02:27:12.259 - 02:27:27.870

value is now defined by the bankruptcy code, but it's intended to capture what the secured parties' rights really would be under state law, so let's think about what the secured party could do in foreclosure if it's a single asset company or a company that's residing in

02:27:27.870 - 02:27:47.040

one state, it could probably do a going concern like foreclosure sell. It may have rights where even if there's multiple states, it could sell peace and flip, right? And gain close to going concern value. So the commission did not want to impose an artificial foreclosure

02:27:47.040 - 02:28:02.339

value that would look like a forced liquidation sale. That's not what it wanted. It wanted to try to recreate the state law right as closely as possible and give the secured credit, the value of that protection. Now David also mentioned, or it may have been Craig

02:28:02.339 - 02:28:19.019

earlier that one of the things that could happen from using foreclosure value for adequate protection purposes is that the going concern value presented by the debtor showed what the code, the commission calls a value differential, right? The going concerned sale in bankruptcy would be higher than

02:28:19.019 - 02:28:37.559

the foreclosure sale even under a best case scenario for the secured creditor. And that difference between those two values could be an equity cushion. That could be allowed to substitute for cash payments or other more tangible forms of adequate protection. That poses a risk, right,

02:28:37.559 - 02:28:55.389

to secured creditors and the commission thought about that and what they tried to do to balance again first principles of reorganization as they viewed them with the objectives and state law rights of the secured creditor is they said, OK, here's how we're going

02:28:55.389 - 02:29:10.969

to handle that. First of all, on the back end of the case. We're talking about distributional issues. We're going to value the secured creditors collateral on a reorganization value basis. So we're going to give them enterprise value and all of the surplus generated from the reorganization

02:29:10.969 - 02:29:28.309

process itself when we're distributing assets on the back end. Second, if we got it wrong, if there's really not a value differential, or if at some point during the case, the foreclosure value under state law is now much higher than the going concern value in the

02:29:28.309 - 02:29:44.709

Chapter 11 case because I don't know when the debtor's products failed or there's some change in circumstance, secured creditor always has the right to go back to court and say, I am now no longer adequately protected, and the additional remedy the commission recommends is at that

02:29:44.709 - 02:29:59.169

point if that's the case, the secured creditor shouldn't have to move for relief from stay and take its collateral and go to state foreclose under state law. We should let the secured creditor ask the court to direct the trustee or debtor to sell under 363 and

02:29:59.169 - 02:30:16.969

give the secured lender the benefit of the 363 process. That's something not currently available because under the code only the trustee or debtor has the right to sell, and certainly secured creditors can't mandate or direct the court to order the trustee or debtor to sell. So

02:30:16.969 - 02:30:34.740

yes, that's a very different approach to adequate protection and, and yes, I think although it's not explicit, David, to your point in the report about permitting priming, it was viewed as permitting more liquidity and perhaps the option for priming or more competitive dip market. And so

02:30:34.740 - 02:30:49.485

coupled with that, we didn't talk about the recommendation and the financing provisions to allow junior creditors that would be precluded under support coordination agreement from proposing a dip, but part of that was just to create a competitive dip market. Um, and as you said, there's so

02:30:49.485 - 02:31:05.969

much we could talk about, but I will move on now to, distributional and allocation issues. So Danielle, can I have some time to respond? So foreclosure value on the front end, reorganization value on the back end. Easy to articulate the two definitions, right?

02:31:05.980 - 02:31:21.544

What the secured creditor would get in a hypothetical foreclosure under state law in the best possible light for that secured creditor versus the enterprise value of the company under Chapter 11, the bankruptcy Code and all of the avoided cost or going concern reorganization surplus that

02:31:21.544 - 02:31:40.950

we frequently hear the literature talk about, would be available to the secured creditor. Now, the one twist on the back end is the introduction of this concept called redemption option value. And so the way the commission thought about allocation issues on the back end was

02:31:40.950 - 02:32:02.070

to think about, OK, when you think about valuation generally there's timing issues, right? So it addressed the first timing issue as to early in the case versus end of the case, but the more troubling valuation timing issue from the commission perspective was the impact of the

02:32:02.070 - 02:32:17.480

timing of the value realization event on the value itself. Now, what the heck do I mean by that? It matters when you value a company. And let's face it, a company usually files for Chapter 11 at the lowest point in its life. It's not filing because

02:32:17.480 - 02:32:35.259

things are good, right? It's filing because it's at a low point. Think about the energy industry right now, right? If an oil or gas company files today, and we do a quick sell in 1420 days, does anyone really think that represents the true or intrinsic value

02:32:35.259 - 02:32:53.870

of that oil and gas gas company? No, I mean, the value is depressed because of the commodity prices, so that was the timing valuation issue that the commission was really struggling with and it's important because it dictates who wins and loses in a chapter 11 case,

02:32:54.280 - 02:33:09.250

perhaps not justifiably so. So what it came up with, and I don't like the term option because I really don't think it's an option. I think it's misleading and I think it got there because of the formula the commission suggested could be used to determine what

02:33:09.250 - 02:33:27.599

the value is I think a bit more as a broadened valuation time window. So rather than saying we're going to value this company on date X. We're gonna say, we're gonna value the company over a normal economic cycle. And we debated what the economic cycle should

02:33:27.599 - 02:33:42.794

be. The commission came down with 3 years from the petition date. So the longer the company is in bankruptcy, probably the less the redemption option value would be, the quicker the case moves, the more the redemption option value. But a 3-year period, let's look at

02:33:42.794 - 02:34:00.980

the intrinsic value, the true value of this company during a 3-year period, and then let's determine the allocation of that value according to the absolute priority rule. And here, the way it would work is a senior creditor would be entitled to the reorganization value, including under

02:34:00.980 - 02:34:14.820

the redemption option formula, the full face amount of its claim. So the senior creditor here is secured any deficiency claim would have to be paid in full. All interest would have to be paid in full. Now the commission debated whether that should be default or non-default

02:34:14.820 - 02:34:30.370

interest. It went with non-default, but that would be something because of time value money people could talk about. But you have to pay the senior in full completely under the formula before any value would be available to go to the immediately junior class. So again,

02:34:30.429 - 02:34:47.750

it's not a deviation in respect that we're skipping classes or we're discriminating within classes on distributions. It's a different approach to valuing the enterprise for purposes of allocation. And one way to think about it, and then I'm gonna defer to Danielle for the mic

02:34:47.750 - 02:35:05.459

and then we can talk more in the roundtable, you know, one thing the commission recommended and I think this surprised some people is to prohibit all gifting, right? No interclass, no inter, intra-class gifting, just no gifting. The redemption option value actually I think

02:35:05.459 - 02:35:22.400

is a substitute for where you need to get a plan done. Right now, gifting is just arbitrary. It's negotiated, some people win, some people lose. I actually think redemption option value could help secured creditors because you can't be blackmailed anymore, right? What you're entitled to under

02:35:22.400 - 02:35:37.679

the code is a redemption option value. And here's how you can think about it. And in fact, the commission's proposals say if a junior class objects to the redemption option value and the court finds that the secured creditor and debtor's proposal on valuation was in good

02:35:37.679 - 02:35:54.709

faith, the junior class gets nothing. Likewise, if we're talking about redemption option value in the sell context. If there's a good faith valuation, which in sales is pretty easy, it's what the purchaser's willing to pay the seller. If the junior class objects, they get no redemption

02:35:54.709 - 02:36:11.629

option value. So there was some attempt again, to think about valuation more holistically in a more accurate and fair manner but still recognize the rights of the party. So thanks Michelle. There's an enormous amount to say here and we have very little time. So I want

02:36:11.629 - 02:36:24.469

to just say a few words focusing primarily on the adequate protection proposal, and if I can say I apologize if I talk too much, having lived with this thing for 3 years, it's so nice to be able to talk about it. No go ahead. No,

02:36:24.549 - 02:36:39.259

that was incredibly helpful and laid it out far more clearly than I probably could have done. So I think that's great. So I do want to explain though why I think the adequate protection proposal is not a good idea and

02:36:39.259 - 02:36:55.660

not just from the perspective of secured creditors but from the perspective of the system as a whole and I think there are there are a few points to make here. One is that I think Michelle very accurately described the the premise underlying the adequate protection

02:36:55.660 - 02:37:16.820

proposal which is that secured creditors non-bankruptcy entitlement and therefore their bankruptcy entitlement is nothing more than whatever dollar value would be realized in a foreclosure sale to a third party on the petition date in which the secured creditor may not credit bid. I don't

02:37:16.820 - 02:37:34.459

think that's the best or most accurate way of conceptualizing the secured creditors entitlement. We don't typically when we think about constituencies entitlement in bankruptcy think about what dollar amount would they get if they exercised their state law remedy on the petition date. I mean, if that

02:37:34.459 - 02:37:58.384

were so, unsecured creditors would be entitled to nothing. What instead I think bankruptcy does is carry over not state law remedies, but the relative priorities established by state law and in the case of secured creditors, that is first priority in any value derived from the

02:37:58.384 - 02:38:14.144

assets on which they have a lien. Now there, there was a debate alluded to in the previous panel about what exactly secured creditors can have a lien on. I'm not going to get into that, you know, that's a pretty robust debate, but you

02:38:14.144 - 02:38:36.839

know, let's assume for purposes of this discussion that we have a senior secured creditor that has a valid blanket lien on the debtor's assets. Assuming that we have that, what happens with this adequate protection proposal? So what we have is a dichotomy between the

02:38:36.839 - 02:38:51.629

way that the secured creditors entitlement is valued on the petition date, which is foreclosure value, and the way it's valued on the effective date or the date of the sale, which is going concern value, which I think is the correct way to value it. What effect

02:38:51.629 - 02:39:09.349

does it have to value it at foreclosure value for purposes of adequate protection? Well, as, as David mentioned, one of the things that it does is it permits new lenders to come in and prime the existing prepetition lender get a senior lien to the

02:39:09.349 - 02:39:33.750

prepetition lenders on the theory that the disparity between foreclosure value and a hypothetical 363 sale value is sufficient to provide an equity cushion that will adequately protect the secured creditor's right to foreclosure value. Similarly, it also I think would mean that debtors could use

02:39:33.750 - 02:40:00.650

cash collateral say to pay administrative expenses. What that means is that the entitlement to reorganization value on the effective date in many cases will be illusory. Because once value has been given to a priming lender or dissipated by the debtor, it's gone. That's not

02:40:00.650 - 02:40:20.400

going to be recaptured at the end of the case. So in many cases this will result in secured creditors not getting the benefit of their non-bankruptcy bargain which is to receive the value from their collateral. So that's one thing. The other thing that I think

02:40:20.400 - 02:40:38.000

is interesting to think about because you know that that in and of itself may not be enough to say this is a bad idea. I think if you you know if you accept the basic principles that we talked about earlier maybe that's enough but let's

02:40:38.000 - 02:40:55.570

look at what the practical consequences are. One of the problems that also was alluded to in the previous panels and that Melissa has written a very very good and thought provoking paper on is, you know, what do we do to solve the problem of

02:40:56.179 - 02:41:21.120

perverse incentives when, for instance, a creditor that is a little bit over secured might push for a quick sale in order to realize what's due to that creditor without adequately considering the possibility of realizing additional value if the case were allowed to proceed. So

02:41:22.139 - 02:41:36.379

whether or not that's an actual problem is unclear. There's recent scholarship that suggests that it's not but again I won't, I don't want to spend too much time getting into that. What's interesting I think about the adequate protection solution here is that it creates

02:41:36.379 - 02:41:59.660

that exact same problem in reverse because what it does is it forces the secured creditor to finance the debtor's efforts at reorganization. Which means that the debtor gets the opportunity to try to hit a home run to preserve current management's jobs or to realize

02:41:59.660 - 02:42:22.700

money for equity or other junior stakeholders using the secured creditor's money. That's not typically something that we want to encourage because one doesn't normally make efficient investing decisions when one's using somebody else's money. So the person whose money was at stake were to be

02:42:22.700 - 02:42:40.299

asked, you know, should I spend 50 cents now in return for a 50% chance of getting 75 cents in a year? That person would say no. But if you're spending somebody else's money, you'd say, why not? And I, you know, that I think

02:42:40.299 - 02:43:03.219

creates a very significant problem. And then I also want to talk just a little bit about the other costs that these proposals entail. Now, you know, as Melissa said, I think that costs in and of themselves shouldn't end discussion. Significant costs may

02:43:03.219 - 02:43:21.285

very well be tolerable if they're going to achieve significant benefits. But here I think the benefits of this proposal are highly uncertain. I mean, presumably. The you know the idea is that debtors will have greater flexibility to try to reorganize, but we don't know whether that's

02:43:21.285 - 02:43:43.120

actually a good idea or not, whether that will actually end up increasing value for all constituencies or not and the costs of this are very clear. For instance, the valuation suddenly becomes much more complex and the case becomes much longer and more expensive.

02:43:43.330 - 02:44:00.969

Justice Stevens said at one point, and I think most judges and practitioners would agree, that no problem in bankruptcy is more perplexing than the problem of evaluation, and that problem under the report's proposal is now considerably more perplexing because not only does the bankruptcy court have

02:44:00.969 - 02:44:19.530

to value the going concern value of the enterprise on the effective date, which is already very difficult to do and very heavily contested in many cases, it also has to establish the value that a secured creditor would obtain in a state law foreclosure sale, which may

02:44:19.530 - 02:44:37.969

be something that doesn't happen very often in practice and you know, perhaps the difference between that value and the value that a creditor might realize in a hypothetical 363 sale and bankruptcy so we have three different valuations right there. And likewise the redemption option value

02:44:37.969 - 02:44:54.709

proposal, which is also very interesting and I wish we had more time to discuss, would require bankruptcy courts to determine the value of a hypothetical option to purchase the firm which involves, you know, not only figuring out the enterprise value but also the expected volatility over

02:44:54.709 - 02:45:15.565

the option period and it's quite complex. All of these new judicial evaluations I think run counter to the bankruptcy code's preference, which I think is in Chapter 11 as written for more efficient and typically more accurate market valuations. They're likely to lead

02:45:15.565 - 02:45:35.980

to battles of the experts that will lengthen the case that won't be in anybody's interest. And then I just want to say one word about something that's already been mentioned, which is reducing secured credit or recovery will increase the cost of credit. Again, that's not

02:45:35.980 - 02:45:54.900

necessarily a reason in itself to reject a proposal, but it's something that has to be considered and I don't believe, although I know the commission did consider it, I don't believe the report sets out exactly how that cost was weighed against along with these other costs

02:45:54.900 - 02:46:13.519

against the potential and I think very uncertain benefits of these proposals. There is a debate about whether secured credit is efficient. I think that's a debate that needs to be resolved outside of bankruptcy, but there's a reason why secured credit in

02:46:13.519 - 02:46:32.790

particular is important that if you talk to market participants, they'll explain which is non-investment grade companies, which are the companies that are more likely to go into bankruptcy, sometimes can only get secured credit that they need secured credit in order to make the investments in

02:46:32.790 - 02:46:53.669

their businesses that they need. Unsecured credit is not only more expensive but it may in certain circumstances not even be available to those entities and so there's a risk that you know in the interest of giving these companies more flexibility in bankruptcy what would end

02:46:53.669 - 02:47:13.160

up happening if these proposals were adopted is that the vast majority of these companies that don't go into bankruptcy would be deprived of flexibility and that the proposals would end up hurting the very people they're designed to help. So I'm sure Michelle has responses to that.

02:47:13.570 - 02:47:26.940

So just very quickly because I know it's time to start our roundtable. You know, I think Danielle raises all good points and she's right. They were all considered by the commission. You know, and part of the challenge is,

02:47:27.070 - 02:47:45.269

you have a constituent like the secured creditors who are comfortable with what they know, right, and they're comfortable with how the code currently works and so I understand the resistance to uncertainty and unintended consequences and any legislation has to factor in those

02:47:45.269 - 02:47:56.663

potentials. What I will say and what I wanted to really point out was I don't think the valuations are quite as complex as Danielle makes them out to be, but that we can discuss another day. Second, these are default rules, right? I mean, the hope

02:47:56.663 - 02:48:14.856

is these are against which companies, creditors, and secured creditors are bargaining. So that was my point about the gifting right now you have a floor as to what you would have to give your junior class, you can negotiate something better. Consensual solution is always preferred,

02:48:14.866 - 02:48:32.375

I think in Chapter 11 cases. So part of the shift in rules was meant to provide clearer, less one-sided default rules that would promote a more robust negotiations among all the constituents. And then finally your point about other people's money I love

02:48:32.375 - 02:48:47.700

and we actually have to have a conversation about that more generally, but that's always the issue correct for any company that's borrowing money and we have the discussion in corporate governance all the time outside of bankruptcy because it's the shareholder bondholder conflict and why do

02:48:47.700 - 02:49:13.790

we let management keep borrowing money because all they're going to do is swing for the fences so you know it's a larger conversation that we absolutely should have along with the the efficiency and secured credit. Terrific comments. So bring up the we're

02:49:13.790 - 02:49:31.969

doing so and coming up, Michelle, why don't you talk about redemption option value and how that works. OK, so you know, I gave a very high level overview of it and, and really what it's meant to do is again try to remedy any

02:49:31.969 - 02:49:50.330

deficiency in evaluation caused by the mere timing of the evaluation event. And so, Danielle was mentioning that you would have to value the enterprise at that point of the reorganization whenever you're doing the sell or the plan and I think the

02:49:50.330 - 02:50:02.769

commission thought about that as the normal valuation we would do in the plan context anyways and if it's a cell, it's an arm's length cell and and then they tried to suggest a formula and you wouldn't have to use Black-Scholes again, I think that's

02:50:02.769 - 02:50:19.264

somewhat confusing because it makes us look more like an option than it is, but trying to develop a formula where we would take the enterprise value on that particular day and think about the potential for accretion and value during the remainder of the three-year redemption period

02:50:19.264 - 02:50:37.424

and then how that value should be allocated. And for those who are curious about it, I would encourage you to look at the charts in the recommendations because they really do show, I think, how infrequently redemption option might actually be there. I think the

02:50:37.469 - 02:50:54.860

hope is it would be there more often. But to Danielle's point about the timing differential, so foreclosure value would be determined early in the case at the time of adequate protection request. That's when the reorganization value for that purpose would be determined as well. So

02:50:54.860 - 02:51:09.044

the reorganization value of a company on date X early in the case could be different than at the end. So there could be accretion so that the secured party actually is protected. And if there is an increase in reorganization value and the creditor hasn't moved for

02:51:09.044 - 02:51:23.325

relief from state to get the collateral sold through 363 for its benefit in that instance, I think under the redemption option concept, what happens is the secured creditor ends up being the fulcrum that's going to own the company. And so, you know, you get your

02:51:23.325 - 02:51:41.089

reorganization value through the ownership on the end. So, but the redemption option value is simply a a new valuation mechanism to try to more accurately allocate value in the enterprise. I tossup a question for anybody who wishes to jump in. We all think of bankruptcy

02:51:41.089 - 02:51:55.259

at least I was always taught when I was in practicing in the bankruptcy world that it's all about leverage. You try to do what you can to get leverage for purposes of negotiation if you can. How would the recommendations to use foreclosure value early in the

02:51:55.259 - 02:52:18.139

case? And reorganization value later in the case affect negotiations and consensual evaluations? Anybody? So I'll start and give you the commission perspective. As I suggested, the hope was the new default rules would create more dynamic negotiations among more than just the debtor and the

02:52:18.139 - 02:52:34.059

secured creditor. So I don't want to say, you know, rebalancing the playing field because I think that's an inaccurate perspective of what the commission was trying to do. But they were trying to create an opportunity and time in a case for more parties to come to

02:52:34.059 - 02:52:49.740

the bargaining table and actually have some statutory default rules from which they would have some leverage to add value to the discussion. I think some of the perception is right now not many parties have much if any leverage in the case other than the secured

02:52:49.740 - 02:53:04.900

creditors. Anyone else? Yeah, well, I've got, I mean, I think that what Michelle said is another way of saying we're gonna take people who are out of the money and invite them into a conversation, In a world in which under non-bankruptcy entitlements they're otherwise entitled

02:53:04.900 - 02:53:21.230

to nothing that does give them leverage that is true and I think it raises the question that you know Danielle identifies which is as a normative matter, why is, why is taking money and pushing it down the capital structure, which is essentially what this operates

02:53:21.230 - 02:53:40.889

to do an objective of bankruptcy law. Melissa raised sort of, you know, the interesting question of whether as a matter of bankruptcy law that type of redistribution should be a normative value of bankruptcy, and I think it's hard to have this discussion intelligently without

02:53:40.889 - 02:54:00.480

squarely engaging that question. Is taking value and spreading it around the capital structure something that the bankruptcy code should be affirmatively encouraging? Because I think there's no question this operates to do that and the sort of the the underlying normative judgment that's really the public policy

02:54:00.480 - 02:54:15.330

question is, is that a good idea and I guess Judge to go back to your earlier point about claims trading in a world in which in at least in large cases, people are buying and selling debt all over the capital structure where you've got

02:54:15.330 - 02:54:30.049

essentially the same, you know, distressed debt players and hedge funds who are buying this tranche and selling the other. Why, as a matter of public policy, moving money down the capital structure, where it's gonna end up largely in the hands of the same distressed players

02:54:30.049 - 02:54:48.730

in any event ought to be an objective of the bankruptcy code seems to me candidly not to make a great deal of sense. Taking from Melissa's point, I think particularly in the context of a sale perhaps it can be seen as

02:54:48.809 - 02:55:12.500

a tax on the use of the process, understanding, as someone said earlier that there are amazing tools that are available in the bankruptcy process. We talked about contracts, rejecting contracts, all kinds of opportunities to alter debt structure, and

02:55:12.500 - 02:55:30.490

the price of that might be to spread around the value a little bit more than can be done in the present context. I think that might be the greatest recommendation for doing that. And, and I guess Craig, to your point

02:55:30.490 - 02:55:41.730

on trades claiming, I also think we have to consider what type of case we're talking about. So I think for the top 2% that's probably true, but I think as you move down and get into the small middle market companies that's less true and we're actually

02:55:41.730 - 02:56:02.780

talking about real creditors who have an interest and maybe deserve an opportunity to see. Well, yeah, um, and I don't even know how to respond to that. No, they are absolutely real creditors and so creditors with a longer history with the debtor

02:56:02.780 - 02:56:14.690

than your trade claimers. But the other point I wanted to make, you know, you're out of the money point. It's something we always struggle with, right? I mean, even now we struggle with that with equity committees, right? And when they're out of the money and

02:56:14.690 - 02:56:26.370

should they get a seat at the table? And I think what we've seen in some cases, yes, they should, because again, it goes to this timing question. If an oil and gas company case files today, is everyone really out of the money? And, I

02:56:26.370 - 02:56:39.875

guess, it goes to your policy question, right? What's bankruptcy supposed to do? Because if it's simply, simply supposed to be a place where it's truly the last resort and the company has no other options, so rather than letting it die, we'll see it as a going concern

02:56:39.875 - 02:56:52.684

and we'll try to reorganize what's left and pay those creditors perhaps, but if it's meant to be a rehabilitation tool that companies can invoke at a point in time where value accretion is still a real possibility, then I think we may be too quick to jump

02:56:52.684 - 02:57:07.559

to who's out of the money and who's in the money if we do it upon the filing. Daniel, well, I mean, Michelle, I think that's absolutely the, I mean, I think we view Chapter 11 exactly that way as a mechanism, you know, in a very effective

02:57:07.559 - 02:57:27.190

mechanism for increasing value and rehabilitating companies. I think where we differ is is it appropriate to try to rehabilitate companies when that results in reducing value? Because if you're balancing those two objectives, there has to be a point at which you say, look, we want

02:57:27.190 - 02:57:43.209

to rehabilitate this company even though it reduces value. To the creditors that may be that may be beneficial to again looks it's to the constituency is in other words, it keeps jobs. There are other goals yes, and that, I think that's

02:57:43.209 - 02:57:55.679

exactly the question. And I you know, I happen to agree that unemployment and the loss of jobs is a huge social problem and a huge concern that needs to be addressed. I just I'm not sure it should be addressed through bankruptcy because any

02:57:55.679 - 02:58:14.360

time you change the entitlements of stakeholders in bankruptcy as opposed to out of bankruptcy, you run the risk of creating perverse incentives for people either to, you know, enter into to invoke the process or to evade the process that otherwise wouldn't exist and you know, in

02:58:14.360 - 02:58:34.410

addition I think Craig made this point earlier I think there's some value in having you know, simple principles that that govern the process as opposed to a balancing of policies where it's really impossible to know how that should come out. I mean I what I

02:58:34.410 - 02:58:48.610

couldn't, what I understood from the report that there's the view that there's a policy in favor of reorganization but what I don't understand is in what circumstances does that trump the policy of maximizing value and how do we know when that

02:58:48.610 - 02:59:03.089

is? So I just wanna add here I completely respect the difference of opinion in the underlying policies and I think where you start somewhat dictates where you end up where it's somewhat path dependent, but I don't want us to lose sight that right now in the

02:59:03.089 - 02:59:18.184

United States, the history of federal bankruptcy laws has been premised on it being something more than a national collection device intended to maximize value if you go back and you look at the history of the bankruptcy code it throughout talks about the need to be able

02:59:18.184 - 02:59:33.325

to modify state law entitlements when a federal interest trumps and that federal interests being the preservation of jobs and rehabilitation of distressed companies. So I agree we can debate about what the policy should be, but I think there's a long history in this company to there

02:59:33.325 - 02:59:48.860

being an underlying social policy to the bankruptcy code. Let me pick up on that. What does the state law entitle a secured creditor to receive as adequate protection? Right, well, I mean, I think I set out what I think. It entitles the secured creditor to

02:59:48.860 - 03:00:07.299

receive, which is, you know, adequate protection of assuming that the collateral is going to be used as part of a going concern, it entitles the creditor to adequate protection of that value. The creditors shouldn't end up at the end of the process receiving

03:00:07.299 - 03:00:26.120

less than all of the value of its collateral up to the amount of its debt. This is the only time I've heard Danielle answer that question without quoting Learned Hand. It was a throwaway in a 1935 case equivalence. Come on, folks. Well, I was only gonna

03:00:26.120 - 03:00:41.059

supplement Danielle's answer. I think it's important to remember two adequate protections intended to protect against diminution in value, right? And so if you read, you know, the ResCap decision where Judge Glenn actually invoked 552b in the equities of the case exception, part of the reason

03:00:41.059 - 03:00:56.080

there was based on the premise of what adequate protection is intended to provide and, and the fact that it's only intended to protect against diminution of whatever that state law entitlement is. Just as a digression, Judge Glenn was a former law clerk to Judge Friendly. So

03:00:56.080 - 03:01:19.540

you should know something, I think. Perhaps anybody else on that? Uh, what the state law entitled to secure credit to receive? OK. Would the recommended one of the things that's troubling to a lot of folks is that, for example, dip lending used to be thought of,

03:01:20.019 - 03:01:39.080

maybe still thought, the safest lending out there. If You are solvent and the bank's coming after you, you're probably getting what today? 4.5%? Or less. You go into bankruptcy and you're supposed to have the safest lending going even today, or at least as of

03:01:39.080 - 03:01:57.030

6 months ago when I asked somebody, it was 8 and 9%. Why? So that that's a really good question and maybe David can can help us answer it. But look, but here's the story. I mean, you know, it's these are it is, it

03:01:57.030 - 03:02:12.790

is true, right, as an empirical matter that dip lending that the number of defaults under dip loans is, is excruciatingly small, and that by and large, just the math of it historically speaking is, it's a good investment. It's also the case that you

03:02:12.790 - 03:02:28.309

know we're talking about lending to companies that are in bankruptcy companies that have lost that have a track record of having lost a lot of other people's money and so the notion that a lender when looking and and it is also true that there's for

03:02:28.309 - 03:02:44.150

the reasons I think that we've been talking about for much of the day you know, a host of risk around what's actually going to happen in the bankruptcy case. There's the, you know, very long litigation tail. There's the, you know, risk that cases

03:02:44.150 - 03:03:00.160

get protracted and you know, it's sort of a process that is rife with people suing each other and so the notion that a banker would say I'm going to expect a premium in order to enter that world is at some level

03:03:00.160 - 03:03:12.330

just as a common sense matter, not stunning to me. I don't know I mean others have as much perspective on this as I do. I expect there to be some additional costs associated with monitoring it as well. In other words, if you go

03:03:12.330 - 03:03:27.110

out into the normal market and you're just lending, you're expected to get your payment, you get it and you're not really watching their finances on a monthly basis. Once they're in bankruptcy you are, you really do have to do some additional due diligence. Even after

03:03:27.400 - 03:03:40.360

the loan is provided. So I, there's additional cost. But so those points I think are right on and great points and it raises in my mind two things. So part of the question then is if there's going to be an increased cost

03:03:40.360 - 03:03:55.030

to the financing because of the additional risk and the monitoring that needs to be by that lender on the distressed company. Don't we really need a robust market to make sure that the debtor is, is getting a fairly priced dip and you know,

03:03:55.070 - 03:04:11.269

how do you balance how much protection is warranted in the face of the risk, a premium to cover additional costs and the risk certainly, but do we need waivers? Do we need milestones? Do we need negative covenants? Do we need so and so? And I

03:04:11.269 - 03:04:24.370

and I know what your answer is going to be. Put it out there. And you know that you're persuaded. I would not go that far. And can I just add one last thing? So I wanted to get back on a related

03:04:24.379 - 03:04:41.985

topic about, you know, the increase in cost to lending and perhaps the constriction, that we would see in availability if changes were made to dip lending. A colleague of mine, actually one of the commissioners reminded me recently of something that happened very

03:04:41.985 - 03:04:56.230

early in my practice. So I started practicing in '95. I was with Jones Day, 1998, Judge Walsh in Delaware, some of you might know him, right? Sent a letter around to all of us about, you know, what he was gonna approve by way of

03:04:56.230 - 03:05:09.780

dip financing agreements and what he wasn't gonna approve and lo and behold, the next day there was still a dip market. Dips were still getting done. Companies were still going through the process of reorganizing and what he said he would and would not approve were not,

03:05:09.910 - 03:05:24.235

you know, trivial changes. They were definitely a shift in the financing landscape. So I throw that out there, but now I'll see. Well, and he did that obviously consistent with the existing code because the court always retains the discretion. It's not clear that

03:05:24.235 - 03:05:34.275

you need to rewrite the bankruptcy code. That letter was what he would approve and what he wouldn't approve, so don't start asking for what he wouldn't approve when you know he's not gonna approve it, right. I mean, I guess the other point, and

03:05:34.275 - 03:05:51.709

I, you know, I confess that I come at thinking about these problems, you know, against the backdrop of really believing that markets answer questions better than judges and lawyers do, certainly financial questions. If it were the case that dip loans were a cash

03:05:51.709 - 03:06:05.790

cow and that you could make money by doing it risk free, presumably people who have capital would come into this market and offer these terms. I mean what you're talking about doing, the reason you have these waivers, I mean this is sort of David's

03:06:05.790 - 03:06:21.650

earlier point, that someone, you know, particularly where it's the pre-petition lender, right? Someone comes to you having lost a lot of your money and says, I'd like some more. And you say to them. OK, I'll give you even more money that you'll use in

03:06:21.650 - 03:06:34.070

order to protect my collateral, but here's the thing, you're not gonna use it to sue me. And the idea that you're gonna say to that person, no. You can't stop them from suing you, you might just say in that case they're not getting any more of

03:06:34.070 - 03:06:46.959

my money and this isn't a complicated economic point, it's just sort of a common sense and I do think that just that common sense way of thinking about these proposals is a real reason to pause over. I mean, what we haven't talked enough about

03:06:46.959 - 03:07:03.382

is how actually how terrific the bankruptcy code works. How, you know, the remarkable role that the code played in helping the country come out of the financial crisis. The lawyers have some concerns, but the finance literature talks about how in the last 20 or

03:07:03.382 - 03:07:19.892

30 years the system has redeployed capital more efficiently and more effectively than ever before, and I think Danielle sort of touched on this, but before you decide that we're going to fundamentally alter it, one's got to ask the question, you know,

03:07:20.703 - 03:07:33.166

it's working pretty well if you know, to quote my friend Michael, if it ain't broke. And really think about whether, you know, comparing whether the game is worth the candle. But, some of the restrictions that are proposed by the commission

03:07:33.166 - 03:07:54.005

are not about, don't sue me, they're about letting the code work. Avoidance of liens meant for unsecured creditors 506C intact, 552b intact. These are not, you know, anti code these, these are simple common sense kinds of provisions potentially that have been usurped, if you

03:07:54.005 - 03:08:18.629

will, in the minds of some by lenders at the outset when the debtor has no negotiating power. We got about 3 minutes or less left. Big question, who should be entitled to the contingent upside of reorganized debtor? Shall you start? Um, so I'm gonna give you

03:08:18.629 - 03:08:33.669

what I always tell my students is the typical lawyer answer. It depends, right? And this is where I think the commission came out, right? It depends on the valuation of the enterprise and the potential for accretion, and I think the secured creditor should be

03:08:33.669 - 03:08:49.940

entitled to the potential upside up to the value of its full secured claim, which would be its state law entitlement. And if there's potential accretion beyond that, that contingent accretion should go to the junior class below it. Oh, I completely agree with that. I'm not

03:08:49.940 - 03:09:10.580

sure the commission's proposals get us there, but I agree, I agree with that principle. Anyone else? Come on, come on up, come on up. Have a seat. But you ask a very basic question and so here's where I

03:09:10.580 - 03:09:28.860

have a question about the report. Sure. Contingent upside in the plan context, the report says if the secured lender is receiving cash or debt and therefore no entitlement to the residual equity or contingent upside, it does not have to pay this ROV to the immediately

03:09:28.860 - 03:09:45.830

junior class. So if the secured creditor is not receiving the residual equity and has no possibility of contingent upside, you don't have to pay it. If the secured creditors receiving equity, then the proposal kicks in. In the sale context, where a secured creditor is

03:09:45.830 - 03:10:04.040

not receiving any residual equity. And may not even be paid in full. The report says that the secured creditor who's not getting paid in full with no contingent upside still has to pay ROV. So great question. So two quick responses in our short time. So

03:10:04.040 - 03:10:19.879

first, I don't want people to think the redemption option value kicks in only for secured versus unsecured creditors, right? It's senior. So part of the reason in David's example, his first example where a secured creditor gets paid cash and debt securities and gets the full

03:10:19.879 - 03:10:34.065

value of its claim, 1129B in its current form would be satisfied. So then we drop down to the next class of creditors. And if that's your fulcrum, then we're talking about redemption option and whether there's upside accretion that needs to be shared with the class below

03:10:34.065 - 03:10:51.379

them. So the redemption option concept in the plan context really deals with the fulcrum. I agree with you that the cell context is completely different and the commission heavily debated it. But one of the things they still recognized was that timing matters in the cell, and

03:10:51.379 - 03:11:08.160

we can negotiate about who pays the additional value that might be available under a formula to the juniors, but we should have some role to facilitate that discussion. We also don't want to create a world in which we're preserving accretion value for creditors, but we incentivize

03:11:08.160 - 03:11:24.780

them to do the sell because they they don't have 30 seconds to reply the entity paying this tax, the ROV has zero upside potential in the sale context of this. If the company is sold to a third party for cash, yet they still have to pay

03:11:24.780 - 03:11:44.570

an out of the money stakeholder. But you could...I think he gets the last word. OK, I don't agree with it. They, uh, actually the the one thing we can all agree on today, the consensus is the ABI commission report is a comprehensive and thoughtful

03:11:44.570 - 03:12:09.290

consideration of important and very difficult issues. This advances the ball of our thinking and may we continue on this path. Thank you all.