2017 Insolvency and Corporate Reorganisation Report: US
SECTION 1: Market overview
1.1 What have been the recent bankruptcy and reorganisation trends or developments in your jurisdiction?
Following several years of upheaval in the oil and gas sector, the most significant bankruptcy trend in 2017 is the deterioration of the traditional retail sector and the resulting impact on commercial real estate. The deterioration is driven by competition from online retailers and changes in consumer spending habits. Retailers are focusing on closing under-performing locations to avoid bankruptcy. Structural changes to the Bankruptcy Code in 2005 requiring retailers to make long term commitments to their landlords within 120 days of filing have made it more likely that retailers filing for Chapter 11 will be forced to liquidate. Commercial landlords are working to repurpose empty properties, focusing on restaurants, fitness and other alternative uses.
1.2 Please review some recent important cases and their impacts in terms of precedents or shaping current thinking.
In March 2017, the US Supreme Court issued Czyzewski v Jevic Holding Corp, a decision that upheld the importance of the absolute priority rule, which requires that senior creditors be paid before junior creditors. This decision struck down the ability to use a tool known as a structured dismissal as an alternative to a reorganisation plan where the absolute priority rule was not observed. The decision was unusual in its appreciation of the distressed investing community and its intent to provide certainty to that community.
In January 2017, the US Court of Appeals for the Second Circuit, issued Marblegate Asset Management, et al. v Education Management Corp, et al., a decision that settled a debate about the breadth of the Trust Indenture Act (TIA) of 1939 and has major implications for out-of-court restructurings of bond debt. In particular, the Court held that Section 316(b) of the TIA only prohibits non-consensual amendments to the core payment terms (the amount of principal and interest owed as well as the date of maturity) of an indenture, overturning a lower court decision that extended Section 316(b) to prohibit an amendment that removed a guarantee and allowed a material asset transfer.
SECTION 2: Processes and procedures
2.1 What reorganisation and bankruptcy processes are available for financially troubled debtors?
The United States Bankruptcy Code provides for two types of main proceedings for distressed companies.
A company may commence a bankruptcy case under Chapter 11 of the Bankruptcy Code. Chapter 11 is traditionally used for the reorganisation of the company; however the company also may sell its assets or wind down its business operations in its Chapter 11 proceeding. While a trustee may be appointed in limited circumstances such as in cases involving fraud, typically the company's management continues to oversee the business and the restructuring.
Alternatively, a company may commence a bankruptcy case under Chapter 7 of the Bankruptcy Code. In Chapter 7, a third party trustee is appointed to oversee the case. The company's business operations are wound down and its assets are liquidated and distributed to the company's creditors. Unpaid creditors holding requisite amounts of undisputed claims may commence an involuntary proceeding under Chapter 7 or 11.
Unlike most other jurisdictions, in the US a company need not be insolvent to file for bankruptcy, financial distress is sufficient.
2.2 Is a stay on creditor enforcement action available?
The Bankruptcy Code imposes a worldwide automatic stay immediately upon the commencement of a case. The stay prohibits creditors from taking action to obtain judgments, make collections and otherwise enforce claims against the debtor. Certain narrow exceptions exist, such as for a government's exercise of its police and regulatory powers and for the exercise of certain rights under financial and derivative contracts.
The automatic stay does not apply to non-debtor affiliates or to claims against third parties for which a debtor may be co-liable, although bankruptcy courts may grant injunctions over non-debtor assets in certain circumstances. Parties also may petition the bankruptcy court to lift the stay to permit enforcement actions to proceed in limited circumstances, such as if the party can demonstrate that the property is not necessary for a reorganisation.
2.3 What are the key features of a reorganisation plan and how is it approved?
In a Chapter 11 case, a debtor is given the opportunity to propose a reorganisation plan. The Bankruptcy Code provides the debtor a 120-day period of exclusivity, which may be extended to 18 months total, to propose a reorganisation plan. If the debtor files a plan within that period, the debtor is given additional time, up to 20 months from the commencement of the case, to obtain confirmation of the plan. If exclusivity terminates, any creditor, official committee appointed in the bankruptcy case or other party in interest may file a plan of reorganisation and request permission to solicit votes in favour of that plan. A party also may seek to terminate a debtor's exclusivity rights for cause shown.
A reorganisation plan provides for the comprehensive restructuring of the company and the resolution and payment of creditors' claims (and if sufficient value exists, for distributions to equity). Under a Chapter 11 plan, claims and interests are categorised into different classes according to their relative priority. Creditors holding claims that are impaired and entitled to receive plan distributions are entitled to vote. A plan must be accepted by at least one creditor class, determined by acceptance by a majority in number and two-thirds in amount of the total non-insider creditor claims that voted on the plan. Creditors must receive distributions at least as valuable as what they would receive under a Chapter 7 liquidation. The plan also must be fair and equitable and not unfairly discriminate against non-accepting creditor classes. Reorganisation plans also typically contain discharge, release and exculpation provisions.
2.4 Can a creditor or a class of creditors be crammed down?
A cram-down plan may be confirmed over individual creditors' objections or the rejection of the plan by a creditor class, if one impaired creditor class accepts the plan.
The plan must be fair and equitable and comply with the absolute priority rule. In essence, the plan must provide that a non-accepting class of creditors receives the full value of their claims before a more junior class of creditors or interest holders receives plan distributions. Secured creditors may also be 'crammed-up and reinstated' even if they are not paid in full as long as their treatment does not amount to impairment.
The plan also cannot unfairly discriminate against creditors. Separate classes of claims of the same priority may receive different forms of plan consideration as long as the value received is similar or better for non-consenting classes of claims as consenting classes.
2.5 Is there a process for facilitating the sale of a distressed debtor's assets or business?
The Bankruptcy Code allows a debtor to sell some or all of its assets. Ordinary course sales are permitted without court permission or notice to creditors. Non-ordinary course sales of material assets or business lines also may permitted provided the debtor complies with the Bankruptcy Code (section 363) in conducting the sale. The debtor must demonstrate the sale is in the best interest of creditors and the debtor has obtained the highest or best price for the assets or business.
The sales are often conducted through an auction process, which is typically open and transparent. If a sale agreement is proposed with a buyer upfront (stalking horse bidder), the agreement is disclosed and remains subject to higher or better offers. Typical auction and bidding procedures include procedures for qualifying as a competitive bidder, and a timeline and process for submitting and considering competing bids. A stalking horse bidder also may receive bid protections in the form of a break-up fee and expense reimbursement if a competing transaction is pursued.
Debtor assets are typically sold free and clear of liens, claims or encumbrances and creditors look to the proceeds of the sale for recoveries. Provided that certain requirements are met, assets subject to security interests can be transferred free of the security interests with the liens attaching to the proceeds.
2.6 What are the duties of directors of a company in financial difficulty?
The duties of such directors are governed by state law and are generally consistent with general director duties. Actions taken in good faith, on an informed basis and in the interest of the company are protected by the business judgement rule. In this context, the two main duties are the duty of care and the duty of loyalty.
Directors satisfy the duty of care by keeping themselves reasonably informed and following processes that are consistent with standards in their business or industry, as well as consulting with and relying on independent advice from legal, financial and accounting advisors. The duty of loyalty requires directors to not act in their own self-interest, usurp corporate opportunities or receive preferential treatment because of their status as directors. Transactions between directors and the company typically are subject to a higher entire fairness standard of review.
In cases of distress by multiple companies within a corporate group, directors should consider their duties to each company as well as the group. Additional protections and process are prudent for related party transactions.
2.7 How can any of a debtor's transactions be challenged on insolvency?
Where a company transfers value prior to a bankruptcy, it may be subject to challenge as a preference or a fraudulent transfer.
A preference is a payment or transfer to a creditor on an antecedent debt that favours the creditor over similarly situated creditors when the company is insolvent. Such a transfer may not be avoidable if made in the ordinary course, according to ordinary course terms or if the ultimate recovery of the creditor in bankruptcy would have been the same even if it had not received the payment. The lookback period for preferences under the Bankruptcy Code is 90 days prior to the filing date for non-insiders and one year for related parties. Similar claims arising under state law may have longer lookback periods.
Under the Bankruptcy Code, as well as state fraudulent transfer laws, if a company consummates an asset transfer either with the intention to defraud its creditors or at a time that it is insolvent, will be rendered insolvent or left with unreasonably small capital (and for less than reasonably equivalent value), an action can be brought against the purchaser of those assets to rescind the transaction; or more likely, to claim the difference between the fair value of those assets at the time of the transaction (as determined by the court) and the purchase price paid for those assets.
2.8 What priority claims are there and is protection available for post-petition credit?
The Bankruptcy Code provides priority treatment to certain unsecured claims. Claims entitled to priority include claims by individuals for wages, salaries and commissions as well as claims for contributions to employee benefits plans. In both circumstances, the priority attaches to obligations arising within 180 days of a filing and is subject to a cap. In 2017, the cap is a maximum amount of $12,850 per employee for wages and $12,850 for employee benefit plan contributions. Certain tax claims of government entities, referred to as governmental units under the Bankruptcy Code, are also entitled to priority. In general, priority claims are unsecured.
The Bankruptcy Code has long permitted post-petition lending on an unsecured or more frequently on a secured basis. It is referred to as debtor in possession or DIP financing. Unsecured post-petition lending that creates an administrative claim for repayment does not require bankruptcy court approval. Other forms of post-petition lending require bankruptcy court approval. First, a debtor may obtain post-petition unsecured lending that is supported by an administrative claim that is senior to all other administrative claims. Such claims are also known as a super-priority administrative claims. Second, a debtor may obtain lending post-petition that is secured by one or more of the following: first liens on unliened property; junior liens on property already subject to liens; or senior, priming, liens on property already subject to liens. Priming liens are rarely granted on a non-consensual basis.
2.9 Is there a different regime for credit institutions and investment firms?
Financial institutions, including banks, investment firms and insurance companies, are not eligible to reorganise under Chapter 11 of the Bankruptcy Code. Instead, they are subject to separate state and federal insolvency statutes. However, holding companies of financial institutions typically are eligible for Chapter 11 protection. The management of financial institutions do not control the business post filing. Instead, a trustee or government regulator will be appointed to wind-down the business. Since the 2008 financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act has been at the centre of financial institution resolution in the US.
SECTION 3: International/cross-border issues
3.1 Can bankruptcy or reorganisation proceedings be opened in respect of a foreign debtor?
Non-US companies may file for protection under the Bankruptcy Code if they have a residence, domicile, assets or property located in the US. The bankruptcy court has worldwide jurisdiction over the debtor's assets and property. As a practical matter, in order for a US bankruptcy case to be an effective restructuring tool for a foreign company, the foreign company should confirm that the orders of the US court will be respected and enforced by foreign courts where its other assets and creditors are located.
3.2 Can recognition and assistance be given to foreign bankruptcy or reorganisation proceedings?
Chapter 15 of the Bankruptcy Code, based on the Uncitral Model Law on Cross-Border Insolvency, permits foreign companies to commence a secondary proceeding in the US in support of their foreign proceeding. The foreign proceeding may include reorganisation or liquidation proceedings where the debtor's assets and affairs are subject to court supervision. Upon recognition of the foreign proceeding various relief is automatically granted, including a stay to protect the foreign debtor's US assets and property.
The foreign debtor representative also may seek further orders from the Bankruptcy Court recognising additional relief granted in the foreign proceeding and the terms of any foreign reorganisation or liquidation plan. While a Chapter 15 proceeding is designed to provide comity to foreign insolvency proceedings, a bankruptcy court can decline to grant recognition or relief if it would be manifestly contrary to US public policy. The US bankruptcy courts have substantial experience in overseeing such Chapter 15 proceedings.
SECTION 4: Other material considerations
4.1 What other major stakeholders could have a material impact on the outcome of the reorganisation?
The Bankruptcy Code requires the formation of an unsecured creditors' committee immediately after the filing. This committee is selected by the Office of the United States Trustee (US Trustee), a branch of the US Department of Justice, from a list of the debtor's largest unsecured creditors. The committee retains its own legal and financial advisors, the cost of which is paid by the debtor. The committee acts as a fiduciary for all unsecured creditors and has standing to participate fully in the case. In many situations, the committee acts as sort of shadow board of directors for the debtor, meeting with management, reviewing decisions relating to matters outside of the ordinary course of business and participating in the negotiation of a plan of reorganisation.
SECTION 5: Outlook 2017
5.1 What are your predictions for the next 12 months in the corporate reorganisation and insolvency space and how do you expect legal practice to respond?
Companies involved in the energy industry (particularly those involved in production, exploration, transportation and support) continue to suffer considerable distress in 2017. In addition, the impact of e-commerce and shifts in consumer spending have placed substantial pressure on the retail sector, with defaults are increasing and an expectation that this trend will continue throughout 2017. Outside of energy and retail, government entities at every level face substantial challenges from pension and other legacy obligations that have been exacerbated by the low interest rate environment.
Within existing proceedings, the use of examiners, who are appointed by courts to investigate pre-petition transactions, continues to grow. Examiners are different from trustees or receivers. They are appointed to review specific events and retain legal and financial advisors who are paid by the debtor. They typically prepare comprehensive reports that evaluate the likelihood of success of potential courses of action and often drive settlements with potential defendants.
About the author
Partner, Cleary Gottlieb Steen & Hamilton
New York, US
T: +1 212 225 2629
Lisa Schweitzer's practice focuses on bankruptcy and financial restructuring, as well as commercial litigation. She has extensive experience advising companies, individual creditors and strategic investors in both US Chapter 11 proceedings and restructurings in other jurisdictions in North America, Europe and Asia, and has particular expertise in distressed M&A transactions and intellectual property matters.
Her work repeatedly has been recognised by the business and legal press, including The American Lawyer, which previously named her a Dealmaker of the Year. Among her many highlights, she is lead US restructuring counsel to Nortel Networks and affiliates in their US Chapter 11 proceedings, and oversaw the auction of Nortel's $4.5 billion patent portfolio, as well as other transactional and litigation matters. Her other notable experience includes representing Barclays Capital in its acquisition of Lehman Brothers' North American investment banking and capital markets assets, Inversiones Alsacia and Express de Santiago Uno and their affiliates in their prepackaged Chapter 11 reorganisation, and a large ad hoc group of bondholders in connection with the successful restructuring of Maxcom Telecomunicaciones through a prepackaged Chapter 11 proceeding. She also played a major role in connection with the bankruptcies of Vitro, Calpine, Adelphia Communication and Refco.
About the author
Partner, Cleary Gottlieb Steen & Hamilton
New York, US
T: +1 212 225 2264
James Bromley's practice is focused on restructuring and related litigation advice to debtors, creditors, strategic investors and government actors. He has broad experience with the telecommunications, shipping, financial, automotive, manufacturing, energy, mining, aviation and retail industries and is an expert in cross-border situations.
He has played a leading role in many high-profile restructurings, and his work repeatedly has been recognised by the business and legal press, including The American Lawyer, which named him a Dealmaker of the Year and Benchmark Litigation, which named him Bankruptcy Lawyer of the Year. He led the firm's representation of ModSpace Corporation in their Chapter 11 proceedings and of Nortel Networks and affiliates in their Chapter 11 proceedings and related proceedings in Canada and Europe. He represented the Federal Reserve Bank of New York and the Securities and Exchange Commission in the failure of Lehman Brothers and the United Auto Workers in the GM and Chrysler bankruptcies. He is also an accomplished trial lawyer, in recent years representing Nortel US in its cross-border allocation trial, the UAW in a trial over retiree medical benefits, and pro bono plaintiffs in a landmark jury trial.