Ethics, Empiricists and International Insolvency at NCBJ

Saturday was the final day of the National Conference of Bankruptcy Judges.   The panels focused on ethics issues of the future, the role of empirical research and international insolvency.

Ethics

The first topic up on the ethics panel was reasonable investigation.    The hypothetical involved a lawyer who was unwittingly asked to facilitate money laundering and purchase of estate assets with hidden assets.   Recent cases to be aware of include In re Soare, 493 B.R. 158 (Bankr. D. Nev. 2013)(attorney who failed to investigate whether judgment was nondischargeable and then refused to represent debtor in nondischargeability action required to disgorge fees) and  In re Goodman, No. 12-1643 (9^th Cir. BAP 9/5/13)(sanctions against attorney for negligent representation affirmed)(unpublished opinion can be found here).   

We  learned that ABA opinion 465 says that there is not a per se prohibition on attorneys offering groupons.    (That doesn’t mean it’s a good idea, though).   

The Ethics 20/20 Commission is working on guidelines that would allow foreign lawyers to appear in U.S. proceedings on a pro hac vice basis.   However, a U.S. lawyer must reserve the absolute right to advice on American law.

Hunter v. Virginia State Bar, 744 S.E.2d 611 (Va. 2013) is an interesting case on the intersection between blogging and State Bar advertising requirements.   Hunter published a blog titled “This Week in Richmond Criminal Defense,” which was accessible from his firm’s website.    The overwhelming majority of posts were about cases in which he obtained favorable results for his clients.   The blog did not contain any disclaimers.   The Virginia Supreme Court found that Hunter’s blog constituted commercial speech subject to regulation by the Bar.    The Court found that the Bar could require Hunter to place disclaimers on his posts about his own cases to the effect that the results in the given case did not guarantee the same results for other people.    However, it found that the First Amendment allowed Hunter to discuss public details of his cases without the client’s permission.   A dissent would have found that the First Amendment prevented the Bar from regulating the blog.    

Muniz v. United Parcel Service, 2011 U.S. Dist. LEXIS 11219 (N.D. Cal. 2011) dealt with whether the defendant could subpoena the plaintiff’s lawyer’s postings to a listserv.    The Court quashed the subpoena.   The case illustrates the danger of revealing work product by posting on a listserv.

Empirical Research

The panel on empirical research features three academics:   Dean J. Richard Leonard of Campbell University School of Law, Prof. Theodore Eisenberg of Cornell Law School and Prof. Melissa Jacoby of UNC School of Law.   

Until recently, Dean Leonard was a bankruptcy judge.   He said that when he took the bench, he asked what he should read and was referred to Warren and Westbook’s empirical book, As We Forgive Our Debtors.   He pointed out that empirical studies published by just one law review, the American Bankruptcy Law Review, were cited in 32 opinions ranging from trial courts to the Supreme Court.   

Prof. Eisenberg said that empirical research can be used to disprove the conventional wisdom about bankruptcy.   He referred to the view that the American bankruptcy system is too pro-debtor and noted that the concept of a Debtor-in-Possession is shocking to other countries.   He pointed to empirical studies showing that U.S. reorganization cases paid 20% more to unsecured creditors than those in other countries.   Of twelve studies looking at payouts to unsecured creditors in different countries, the top five payouts were in American bankruptcies.   His conclusion was that the combination of the absolute priority and the Debtor-in-Possession led management to propose a higher dividend to unsecured creditors than plans in other countries.  

He also talked about the importance of studying fees.   He said, “From the day you graduate, (fees) will control your life.”    He said that big fees made news while small ones did not.   In this regard, he said that newspapers were just doing their jobs.   However, he said that the headlines did not reflect reality.  In smaller cases, the fees awarded average 17.6-21.6% of the assets of the debtor.  However, when the assets involved exceeded $100 million, the fees averaged 1-2% of assets.   He contended that fees charged by other professionals, such as investment bankers, charged more in fees.   

In an interesting study, courts denied requested fees at the following rates:

Delaware             0.74%

New York            4.50%

Everyone else      2.29%

While I did not catch his conclusion, mine would be that you can’t assume that judges in Delaware and New York always march in lockstep. 

Prof. Jacoby expressed the concern that empirical studies were too reactive.   She said that there were numerous studies framed in response to concerns that debtors were getting too much relief in bankruptcy.   She said that this approach was a limiting factor on the questions that academics ask and that academics should be more proactive in asking questions that others were not raising. 

Two random points that she made were that academics need more theory in empirical research and that empirical research meant observation and that academics should take the time to observe bankruptcy courts at work.

Prof. Eisenberg got on a soapbox about parties making unsubstantiated claims about the legal system.  He said:

You shouldn’t be able to stand in front of an audience and make nonsensical claims (with statistics).   The Chamber of Commerce does it every day.  

 He went on to say that we study areas that we care about, such as economic statistics.   He said:

You couldn’t say that the inflation rate is 20% (and get away with it).  However, you could say that plaintiffs are recovering multimillion dollar verdicts because of crazy juries. 

The learned professors also made two seemingly contradictory statements.   On the one hand, they stated that there is a lot of shoddy empirical research out there and that empirical studies should not be blindly accepted.   On the other hand, they said that the appeal of empirical research was the “ability of completely untrained people to get into it.”   I think that the point here was that anyone can pick a facet of the legal system to observe, but that it is helpful to partner with statistics geeks to help tell you the significance of what you observed.   (TBLB:  My words, not theirs).

International Insolvency:  The Good, the Bad and the Ugly

The international insolvency panel largely focused on three cases:  In re Lehman Brothers Holdings, Inc., No. 08-13555 (Bankr. S.D. N.Y.) (the good), In re Nortel Networks, Inc., No. 09-10138 (Bankr. D. Del.) (the bad) and Ad Hoc Group of Vitro Noteholders v. Vitro, SAB de CV (In re Vitro, SAB de CV), 701 F.3d 1031 (5^th Cir. 2012) (the ugly).   (The Clint Eastwood reference came from panelist Bruce Leonard).    The panelists were Judge James Peck from the Southern District of New York, Marc Adams of Wilkie Farr, Andrew Leblanc from Milbank Tweed and Bruce Leonard from the Ontario office of Cassels Brock.    In some cases, my notes do not indicate who said what so I will have to attribute comments generically to the panel. 

Before getting into the cases, Judge Peck provided an introduction to chapter 15.   Judge Peck noted that according to section 1501, the purpose of chapter 15 is to “incorporate the Model Law on Cross-Border Insolvency so as to provide effective mechanisms for dealing with cases of cross-border insolvency with the objectives of” increasing cooperation between courts of the United States and other countries.    However, as illustrated by the cases that followed, there are factors that get in the way of those purposes.

According to Mr. Abrams, chapter 15 is “the exclusive portal through which foreign representatives can seek assistance of the U.S. bankruptcy courts.”   Chapter 15 allows an American court to recognize and enforce orders and decrees from foreign courts.   It is not a reorganization chapter like chapter 11, but merely allows American courts to assist foreign courts with regard to assets of foreign entities in the United States.

Under Chapter 15, a foreign representative may seek recognition of a proceeding in another country as either a foreign main proceeding (Main Proceeding) or a foreign non-main proceeding (Non-Main Proceeding).    A Main Proceeding is one that is filed in the company’s center of main interest (COMI).    A Non-Main Proceeding is one filed anywhere else that the company has non-transitory economic activity.  A proceeding filed somewhere that is neither a COMI or has non-transitory economic activity is not entitled to recognition.    

Unlike the U.S. venue laws, the COMI determination pays little attention to the company’s domicile or state of incorporation.   Instead, it is more of a nerve center test.   While this may seem clear, Judge Peck commented that “what is written down is not necessarily clear until the circuit court tells you it is clear.”    In the recent case of Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.), 714 F.3d 127 (2d Cir. 2013), the Second Circuit held that COMI is determined as of the date of filing of the chapter 15 petition, so that activities of the foreign representative prior to the filing of the chapter 15 can change what would have otherwise been the COMI.  

   

The importance of being a Main Proceeding vs. a Non-Main Proceeding turns on sections 1520 and 1521.   Under section 1520, a Main Proceeding (which is a proceeding filed in the COMI) is entitled to automatic relief, including enforcement of the automatic stay and sales free and clear of liens for assets in the USA.    Under section 1521, there are various forms of discretionary relief that can be granted to either a Main Proceeding or a Non-Main Proceeding.

The panelists stated that Lehman Brothers and Nortel Networks shared many similarities.   Both were large entities with multi-national operations that took a major hit after the freeze of the credit markets in September 2008.   Nortel filed in September 2008, while Lehman Brothers held on until January 2009.   (TBLB:  The role of the U.S. government in orchestrating the filing of Lehman Brothers is well documented in the movie Too Big to Fail in which a committee of top economic advisors decides that Lehman Brothers should go ahead and file chapter 11 at which point someone asks whether the company should be informed).

In the Nortel case, the business operated in 140 countries through a series of five business lines as opposed to operating through subsidiaries.   It filed proceedings in the United States, Canada and the U.K.    The U.S. claimed priority based on the location of the assets, Canada claimed priority based on the company’s headquarters and the U.K. claimed dibs based on the location of the intellectual property.   The United States and Canadian proceedings recognized each other as contemplated by UNCITRAL.   The U.S. also recognized the U.K. proceeding as a Non-Main Proceeding.   However, the Canadian and U.K. administrators did not seek recognition of each other’s proceedings.  

Based on the view that the company’s assets were melting ice cubes, the three administrators quickly agreed upon a sale of the company’s assets for $7 billion.   However, four years later, the funds continue to sit in escrow because the parties could not agree upon a formula for allocating the sales proceeds.   After three failed mediations, a trial has been scheduled for 2014 with at least four competing formulas for distribution.   

Mr. Abrams commented that the Model Law was not well equipped to deal with the situation where there were three competing COMIs.

Judge Peck stated:

It is hard to design a law that gets to good results.   People have to get to good results.

The panel’s consensus was that because the Nortel assets were sold prior to obtaining an agreement for distribution of the proceeds that the parties lacked sufficient incentives to cooperate once the money was in the lockbox.   

According to Judge Peck, in Lehman Brothers, on the other hand, the assets were “not easily monetized” and “had to be cultivated.”   The only way to unlock the value was through a consensual plan, as opposed to Nortel where the creditors were in gridlock.    In Lehman Brothers, the parties negotiated a protocol for international cooperation and “based on the excuse given by the protocol, people talked to each other and developed a plan.” 

Vitro was a large Mexican glassmaker with U.S. debt.    It obtained approval of a concurso in Mexico and sought recognition in the United States.   In Mexico, all creditors vote together in a single class, including insiders and intercompany claims.   Furthermore, approval of a concurso constitutes a novation which releases all guarantors.   Finally, because a focus of the Mexican law is preserving jobs, a concurso must have the approval of equity.    

When Vitro sought recognition in the U.S., Judge Hale said no based primarily on section 1506, which states that relief need not be granted if it would be “manifestly contrary to the public policy of the United States.”     I have previously written about Judge Hale’s decision here.   The Fifth Circuit affirmed Judge Hale, but on different grounds.   You can find the Fifth Circuit opinion here.   The Fifth Circuit ruled that the granting of non-debtor releases is an issue that has divided the circuit courts.   Because federal courts do not agree upon this issue, allowing non-debtor releases could not be “manifestly contrary.”   Instead, the Fifth Circuit held that:

On the basis of the foregoing analysis, we hold that Vitro has not met its burden of showing that the relief requested under the Plan—a non-consensual discharge of non-debtor guarantors—is substantially in accordance with the circumstances that would warrant such relief in the United States. In so holding, we stress the deferential standard under which we review the bankruptcy court’s determination. It is not our role to determine whether the above-summarized evidence would lead us to the same conclusion. Our only task is to determine whether the bankruptcy court’s decision was reasonable.

Opinion, p. 58.  

The panel was critical of this opinion, asking whether it meant that the United States would be exporting its laws to other countries.    Judge Peck stated:

Recognition was intended to be a presumption to facilitate the reorganization goals of other jurisdictions.   Vitro seems to have changed that model.  

Mr. Abrams argued that:

The panel put blinders on when applying a plain meaning approach.

Abrams also said that he thought Judge Hale had the right approach in examining whether the result was manifestly contrary to the public policy of the United States, even though he did not agree with the Judge’s conclusion.  

 

The panel noted that the Fourth Circuit has opined that Courts should avoid reaching the section 1506 issue to avoid retaliation.   Judge Peck stated that:

I defer to a court that is at least civilized.

He gave the example of a case decided by a local court in India that he had deferred to.   

In the Fairfield Sentry case, the Second Circuit was asked to address the “manifestly contrary” issue in the context of a foreign proceeding in which the records had been sealed.   It held that open records were not a matter of such importance to US policy as to negate recognition.

Mr. Abrams concluded with the remark that

It is not time to trigger an Amber Alert for Chapter 15 and international cooperation yet.

Parting Thoughts:

This is a very good conference.   However, when I attend, I am usually pulling down long days and am mainlining coffee to stay awake.   I can’t help but notice that some very smart people are not very dynamic speakers.    If you are speaking at a conference as prestigious as the National Conference of Bankruptcy Judges, is it not too much to ask that you look up from your notes and speak loudly enough to be heard.    If you sound bored with your own presentation, you are probably putting your audience to sleep.   I would also like to put in a word for more diversity in program formats.     Four people on a one hour panel who don’t interact with each other is nothing more than a series of short monologues.   While brevity is much to be desired, fifteen minutes or less is not enough time to tell me something I don’t already know.   When it comes to putting together a panel, quality of content is to be desired over quantity of talking heads.    If you are going to put multiple people up there, make them interact with each other and preferably disagree on some things.   In the words of Robin Williams, “If you are going to go into the jungle, clash.”  The student loan debate was a good example of how to keep things lively.

Highlights from the National Conference of Bankruptcy Judges Day 2

I started my day with a jog through New Orleans at sunrise. The Bernstein Law Firm from Pittsburgh sponsored the run. I managed to complete the run, although I was not moving very fast. My time may have had something to do with last night’s entertainment. Still, it was invigorating to see the sun come up over the Mississippi River and to hear St. Louis Cathedral chime 7am.

Meltdown Mania

Today’s topic du jour was the financial meltdown and bailout. Unlike yesterday, the three presentations on this topic complemented each other rather than plowing the same ground.

SIGTARP

However, to properly address the topic, it is necessary t o start with yesterday’s lunch speaker. On Thursday, IWIRC sponsored Neil M. Barofsky, who is the Special Inspector General for the Troubled Asset Relief Program. His department is a combination of TARP cop (he has a badge but not a gun) and oversight panel.

Barofsky spoke about two different topics: how well TARP has accomplished its goals and efforts to keep TARP honest. I did not take good notes, so any inaccuracies are due to my memory and not to the speaker.

According to SIGTARP Barofsky, TARP was sold to the public on the basis that it would accomplish three goals: 1) avoid a financial meltdown; 2) protect jobs; and 3) keep people in their homes. In his opinion, TARP accomplished the first goal, but failed at the second and third. This has contributed to public perceptions that TARP was nothing more than a bailout of Wall Street rather than Main Street.

He also talked about his department’s efforts to keep TARP honest. He explained the concept that fraudsters go through three stages: they incur a loss; they use creative accounting to cover the hole; and 3) they look for a “whale” to plug the hole. In the case of the TARP program, this meant that financial institutions who had undisclosed losses would apply for government money to try to solve their problems while lying about their actual finances. He gave several examples of prosecutions for submitting false applications to TARP. He estimated that SIGTARP had saved the government $500 million in funds not paid out and had recovered over $100 million from bad guys.

The Banks Are Not Fixed

Friday opened with “Bailout and the Fallout,” featuring moderator William Derrough and panelists Damon A. Silvers, Deputy Chair of the Congressional Oversight Panel, and Matthew Feldman, who helped Treasury with the auto bankruptcies.

The panel spent quite a bit of their time talking about the events leading up to TARP. The story beings in early 2007 with the collapse of the subprime mortgage market. Two Bear Stearns hedge funds were seized by Merrill Lynch in June 2007. The year 2007 ended with Lehman Brothers reporting a profit.

In March 2008, JP Morgan Chase Bank acquired Bear Stearns for $2 a share with a federal guaranty attached. According to Silvers, this violated the rule that we don’t bail out stock brokerages. However, the government did not know what the consequences of not bailing out Bear Stearns would be. While much has been made of the pressure placed on JP Morgan Chase Bank to make the acquisition, even greater pressure was placed on the Board of Bear Stearns. They were told that they could accept $2 a share or they could explain their failure to do so to FBI agents and SEC personnel in the next room.

In September 2008, the government seized Fannie Mae and Freddie Mac. Their problem was that they had strict lending standards. However, they were competing with lenders who had no standards (i.e., no doc loans). To solve this problem, they began buying the junk that others were producing.

Over the period September 12-13, 2008, the Bush administration decided not to bail out Lehman Brothers. A decision was made to let a brokerage fail based on the belief that the damage to the economy could be contained. According to one of the panelists, it was an experiment to see what would happen if a major brokerage went over the cliff.

On September 14, 2008, Lehman Brothers filed for bankruptcy and Merrill Lynch sold itself to Bank of America.

On September 15, 2008, Timothy Geithner summoned JPMorgan and Goldman Sachs to a meeting. He informed them that they would bail out AIG with an $80 billion loan. He gave them a term sheet and left. At 2am the next morning, an attorney for the two called the Fed and said they would not do the deal. Undeterred, the Fed scratched out the names of JP Morgan and Goldman Sachs and wrote in the Federal Reserve Bank of New York. The Fed went so far as to employ the attorney who had drafted the term sheet on behalf of the private parties.

The conclusion was that in September 2008, the government, Republicans and Democrats alike, made a decision to take an activist role in avoiding a financial meltdown. That policy continued with the Obama administration.

In March 2009, the Obama administration made the decision to save Chrysler and GM. The government made a decision that a private equity firm would not have made for the reason that eliminating millions of jobs during a financial crisis was too great of a risk to take.

The take away was that TARP succeeded in calming the financial panic but failed to “fix” the banks.

The following is pretty close to a direct quote from Damon Silvers, which drew a sustained ovation. He was comparing the decision to “fix” the failing automakers with the financial sector:

The banks are not fixed. The corrupt nature of the way they are poisoning our
financial sector has not been fixed. We will eventually have to step in and fix
them.

Regulation Is Not Our Friend

Friday’s lunch speaker was Fox Business Channel correspondent Charles Gasparino. His thesis was that the problem was not too little regulation, but too little trust in the market. The problem, in his view, was that the government intervenes to protect the market from the consequences of its bad decisions. Compounding the problem is that government regulators fail to recognize what is in front of them.

He said that regulation provides a sense of comfort that some all-knowing body is watching out for us. However, he said that regulation itself could have caused the financial crisis and that the recent Dodd-Frank financial reform legislation could lead to another financial crisis.

One problem he said was that regulators are always looking at the wrong stuff. The government investigated Bernard Madoff six times, but failed to verify any of his trades. Had they looked, they would have seen that they were non-existent and caught the fraud.

Gasparino also blamed a partnership between business and the government. He said that Wall Street was spared the pain of its mistakes time and time again. The Fed turned on the spigot in 1987, 1994 and 1998 to protect Wall Street. Lehmann Brothers was bailed out in 1994 and 1998. It survived until it took on so much risk that it nearly took down the financial system in 2008. Dick Fold, Chairman of Lehman Brothers believed that his firm would be bailed out up until the signed the bankruptcy petition. What if they hadn’t bailed them out, he asked. Would that have saved us from 2008? He also gave the example of Bear Stearns. In 1998, it was the company with the best risk controls. By 2008, it was the first to fail. His point was that the lesson Bear Stearns learned from the bailout of 1998 was that traders could receive the upside of risk taking while the government would protect them from the downside.

Gaparino claims that we put too much faith in regulation and not enough in the markets. Playing to the audience, he said that without all the bailouts, there would be more work for bankruptcy lawyers.

He also took aim at the Dodd-Frank financial reform bill. He argued that it enacts Too Big to Fail into law by allowing the government to take over (i.e. bailout) huge entities. He said that the bill’s problem was that it added more regulation when the system needed to be rebuilt from ground zero.

However, he did not criticize the decision to bail out AIG. He said that there was so much systemic risk built in by 2008 that the system could not have survived AIG going under. “When that toilet starts flushing, it takes everyone down.”

He had an interesting take on Glass-Steagall. His market-based solution was to allow combinations of banks and investment banks with the caveat that their deposits would not be insured. That way, they would have to pay more for deposits and the public would have to decide whether the increased return was worth the risk. He returned to his point that subsidizing risk is a bad idea. “They will gamble if you give them the incentive.”

Gasparino also suggested that bond rating agencies were worthless. They provided a false sense of security at the time that they were being pressured to give AAA ratings in order to generate fees. He suggested that investors should have been doing their own due diligence rather than relying on a third party.

He also suggested that political correctness may explain why business journalists didn’t point out the problems at Fannie Mae and Freddie Mac much earlier. He said that they were prodded by President Clinton’s Department of HUD to guarantee riskier loans, which led to a housing bubble. However, because giving working class people access to housing was deemed a worthy cause, the warning was not given.

Foreclosure Crisis

I attended a breakout session on the foreclosure crisis led by Alane Beckett, Judge Susan Barrett, Dillon Jackson and former ABI President Ford Elsaesser. They sounded a similar theme of an industry in shambles. On the one hand, you have Jeffrey Steffen signing 10,000 affidavits a month (one every 78 seconds). On the other hand, you have paperwork that may be hopelessly lost. There used to be mortgage brokers in every strip mall. When the bubble burst, they went away, leaving file cabinets full of original documentation that had never been forwarded on. The original notes may now be in a landfill somewhere.

Lenders are reluctant to sign a lost note affidavit because it requires them to indemnify the title company; it also requires that they had the note in the first place (prompting one of the audience members to quip that was affidavits that got us into the problem in the first place).

The other side of the foreclosure crisis is that it gives homeowners false hope. One family broke back into their home after it was foreclosed and they were evicted in the belief that the foreclosure was bogus. The problems in the mortgage industry do not mean that everyone gets a free home. However, failure to correct the problem will result in thousands of pro se parties filing pleadings they downloaded from the internet and class actions being brought to “spank” lenders, but which primarily benefit the lawyers.

Ford Elsaesser offered a ten point program to fix the problem:

1. The mortgage companies must hire real lawyers.
2. The real lawyers must sign the pleadings themselves.
3. No affidavits unless drafted by an attorney who personally speaks to the witness.
4. Motions to lift stay should have to meet the pleading requirements of Iqbal. This should be enforced by local rules.
5. No robo-signing, including by Judges. In other words, judges should stop signing default orders on defective lift stay motions.
6. MERS should go away.
7. Prior to filing a motion to lift stay, the mortgage company should contact the debtor to try to work out a modification or short sale or deed in lieu. This would allow homeowners to stay in their homes when feasible.
8. If the debtor has vacated the property, the mortgage company should contact the trustee to offer to purchase the property free and clear of liens for a small amount. This would give them good title.
9. There should be a national pre-mediation program on foreclosures.
10. Title companies will need to develop a standard for insuring foreclosed homes.

All of these proposals would increase the costs to mortgage companies. However, his point was that Sears had to pay to comply with the law. “Bringing mortgages into compliance is simply a financial cost.”

Gaming Industry Bankruptcies

My take away from this panel was that secured creditors can’t receive a lien on all the debtor’s assets, giving unsecured creditors more leverage. Lenders can’t foreclose upon and operate gaming machines. They can’t take a lien on gaming licenses or liquor licenses. The money in the teller cages is subject to control of the casino regulators. What do they have a lien on? “A big room with beds upstairs.” The highly regulated nature of the gaming industry means that regulators can insist that trade creditors get paid.

Chapter 9

The take away here is that the unique structure of chapter 9 is a compromise based on federalism. The federal government cannot exercise control over a municipality through the bankruptcy system. As a result, municipal bankruptcy must be authorized by state law. There can be no trustee, no creditors’ plan, no conversion to chapter 7 and no interference with the political or governmental powers of the municipality. Interestingly enough, there is also no requirement that counsel be formally retained or seek approval for their compensation.