Distressed Debt and Restructuring

Supreme Court Permits Bankruptcy Court to Hear Adversary Proceeding; Bypasses Issues Regarding Party Consent

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On June 9, the Supreme Court held that a bankruptcy judge may submit proposed findings of fact and conclusions of law for review by a federal district court in otherwise “core” adversary proceedings where a non-debtor party has not consented to bankruptcy court jurisdiction.  While a federal district court does not need to conduct the initial hearing, the district court must review the matter de novo prior to entering a final judgment.  See Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency), ___ U.S. ___ (2014).

The Supreme Court, however, did not address whether a bankruptcy court may exercise the federal judicial power under Article III by entering a final judgment against a non-creditor based on its consent, and, if so, whether “implied consent” can also satisfy the requirements of Article III.  Many commentators anticipated that the Supreme Court would resolve this issue.  Instead, the Supreme Court found that it was unnecessary to address the consent issue because the district court’s de novo review of the bankruptcy court’s order cured any potential error in the bankruptcy court’s judgment.  As a result, litigants will face continued uncertainty regarding their ability to waive their right to have a final judgment entered by an Article III court to avoid increased expense and delay.

Puerto Rico Tees Up GO Financing

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The Commonwealth of Puerto Rico continues its efforts to maintain fiscal and financial stability.  This week, we expect the Commonwealth to move forward with an approximately US$3 billion General  Obligation bond financing.  This offering is expected to provide the Commonwealth with sufficient liquidity to enable the Commonwealth to analyze its options in a more methodical fashion.  The Commonwealth agreed to waive sovereign immunity with respect to state and federal courts in Manhattan and the Federal District Court in Puerto Rico (as well as Commonwealth courts).  However, the Commonwealth did not waive sovereign immunity with respect to assets located in Puerto Rico.  Moreover, as general obligation debt, lenders cannot accelerate on a default despite request from investors for a provision permitting that remedy.  Statement.

Detroit Moves Forward with Swap Settlement, Post-Petition Financing, Plan of Adjustment

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Last week, the City of Detroit Chapter 11 bankruptcy case saw a handful of developments.  First, the City filed a motion seeking approval of a further revised proposed settlement with       its swap counterparties.  The City now seeks to settle the approximately US$286 million in swap obligations for US$85 million, which amount will be funded on exit from bankruptcy (or as many as 180 days subsequently).  The City had previously tried to settle the swap obligations for as much as US$230 million; Judge Stephen Rhodes has twice rejected the City’s efforts to settle.  The Court subsequently scheduled a hearing to approve the settlement on April 3.

Second, the City filed notice of revised post-petition financing with Barclays as the proposed lender.  The City now requests funding of only US$120 million in “Quality of Life” financing and no longer seeks funds to repay the swap settlement with the banks.  With the reduction in principal, the parties modified the collateral, which no longer includes gaming proceeds       but is restricted now to sales tax revenues and the revenues of certain asset sales (excluding others such as art held by the Detroit Institute of Arts).

Finally, the Court slightly modified the hearing on confirmation of the City’s plan of adjustment, postponing the hearing until mid-July (rather than June).

City of Detroit Files Proposed Plan of Adjustment in Bankruptcy Proceedings

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On February 21, the City of Detroit filed a proposed plan of adjustment and disclosure statement in its Chapter 9 bankruptcy proceedings.  The proposed plan would provide general obligation bond claims with a 20 percent recovery.  It proposes to settle pending litigation with each holder of certificates of participation with a claim for 40 percent of face value.  Those reduced claims would then receive a 20 percent recovery.  Pension beneficiaries would receive a range of recoveries generally greater than 20 percent of their claim amount.  The plan also proposes to spin off the Detroit Water and Sewerage Department.  This proposed plan is likely the beginning of a highly controversial process.  Disclosure Statement.  Plan of Adjustment.

Lehman Court Finds Safe Harbors Protect Damage Calculation Provisions in Swap

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Judge James M. Peck issued a significant opinion in the Lehman Brothers bankruptcy late last month, which preserved important safe harbored rights.  The opinion protects a non-debtor counterparty’s right to rely on a contractually agreed methodology for calculating damages upon the liquidation of a safe harbored swap agreement—even if the debtor’s bankruptcy triggers the provision.  To read the complete Orrick alert, please click here.

Bankruptcy Court Rules Detroit Eligible for Chapter 9

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At a hearing on December 3, Judge Stephen Rhodes ruled that the City of Detroit was eligible to file for protection under Chapter 9 of the Bankruptcy Code.  While the City filed for bankruptcy back in July and has been conducting a number of bankruptcy-related activities, this ruling officially launches the bankruptcy process.  Later in the week, Judge Rhodes issued a 143-page opinion detailing his analysis.  The analysis was largely based on the facts at hand and a simple application of those facts to the standards for a chapter 9 filing.  Among the Judge’s most noteworthy rulings: because pension rights are contractual rights under the Michigan constitution, they are subject to impairment in a federal bankruptcy proceeding.  Opinion.

Orrick Alert: Following Chapter 9 Plan, Monoline Insurer Must Continue to Make Payments on Old Bonds

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Earlier this month, Judge Judith J. Gische of the Appellate Division of the Supreme Court of New York, First Judicial Department found that ACA Financial Guaranty Corporation, as bond insurer, must make future, post-confirmation principal and interest payments on municipal bonds issued pre-bankruptcy.  The Court required these payments despite the fact that the bonds were exchanged for new bonds and cancelled under the municipality’s chapter 9 plan.  This decision is an unequivocal win for holders of distressed municipal bonds wrapped by monoline insurance policies and makes clear that insurers must continue to extend coverage to bondholders after a municipal issuer files for chapter 9 and obtains a discharge of the bond debt in bankruptcy.  This outcome may impact negotiations and potential resolutions in Detroit’s chapter 9 case and other recent municipal bankruptcies and distressed scenarios, such as Puerto Rico.  To read the entire Orrick Alert, please click here.

Court Finds ACA Financial Guaranty Must Back Pre-Bankruptcy Bonds

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Earlier this month, Judge Judith J. Gische of the Appellate Division of the Supreme Court of New York, First Judicial Department found that ACA Financial Guaranty Corporation, as bond insurer, must make future, post-confirmation principal and interest payments on bonds issued pre-bankruptcy by a municipal issuer despite the fact that the bonds were exchanged for new bonds and cancelled under the municipality’s chapter 9 plan.  The Court required ACA to make these payments because “neither the plan of debt adjustment nor the discharge of the bond debt in the bankruptcy proceeding changed the obligations under the parties’ contracts of insurance.”  The insurance policies at issue were governed by New York law.  This decision makes clear that monoline insurers must continue to extend coverage to bondholders after a municipal issuer files for chapter 9 and obtains a discharge of the bond debt in bankruptcy.  See Oppenheimer Amt-Free Municipals v. ACA Fin. Guar. Corp., 2013 N.Y. App. Div. LEXIS 5688 (N.Y. App. Div. 1st Dep’t Sept. 3, 2013).

Bankruptcy Court Enforces “No Action” Clause and Rules that Bondholders Lack Standing in Chapter 11 Case

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On August 28, Judge Burton R. Lifland of the Bankruptcy Court for the Southern District of New York held that an ad hoc group of bondholders did not have standing to object American Roads LCC’s plan or otherwise participate in its chapter 11 proceedings because the bondholders had delegated their rights to pursue remedies and take certain other actions under the applicable agreements to Syncora as bond insurer.  In re American Roads LLC., Case No. 13-12412 (BRL) (Bankr. S.D.N.Y. August 28, 2013).  The case involved what Judge Lifland described as a “unique financing structure known as an ‘insured unitranche,'” whereby all the secured claims are secured by the same lien under the same agreement with Syncora Guarantee as insurer.  Judge Lifland reasoned that bankruptcy courts have routinely held that a party lacks standing to take action where, as here, the party is subject to a “no action” clause pursuant to which that party delegated its rights to a third party.  Therefore, because the Court found that the prepetition intercreditor agreement that contained the no action clause was enforceable, the Court held that the bondholders did not have standing to participate in the debtors’ chapter 11 cases and overruled the bondholders’ objections to the debtors’ plan and disclosure statement.  Judge Lifland’s decision demonstrates that courts will continue to enforce strictly prepetition no action clauses in bankruptcy, and that creditors cannot participate in bankruptcy cases solely on account of their status as a parties-in-interest where they are subject to a no action clause.  Opinion.

City of Detroit’s Bankruptcy Enters Courtroom

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In the last two weeks, the Honorable Steven W. Rhodes of the Bankruptcy Court for the Eastern District of Michigan held two important in hearings in the City of Detroit’s chapter 9 case, the largest in history.

On July 24, Judge Rhodes heard arguments on two specific motions to confirm and extend the protections of the automatic stays under sections 362 and 922 of the Bankruptcy Code.  The Court approved both motions over numerous objections.  These objections were based primarily on the argument that the City’s bankruptcy case was not properly before the bankruptcy court because the Governor’s authorization to file for bankruptcy under PA 436 was not consistent with the Michigan Constitution and other state laws.

The Court declined to address the merits of those arguments, and stated that the Court would address state authorization issues as a component of a future hearing on Detroit’s eligibility to file for chapter 9.  Judge Rhodes also found that there was no need for a state court to weigh in on these issues because (i) the statute does not require it and (ii) a bankruptcy court has determined the eligibility issues surrounding municipal debtors in every recent chapter 9 case.

The Court then granted the stay confirmation motion, concluding that the Emergency Manager is an officer subject to the protections of the automatic stay under section 922 of the Bankruptcy Code.  The Court also granted the stay extension motion and found that section 105 of the Bankruptcy Code empowers the Court to extend the automatic stay because: (i) the City’s interests are intertwined with the interests of the entities to whom the stay would extend; (ii) the creditors opposing the extension will not be harmed if the extension is granted; (iii) the City could suffer irreparable harm if the extension is not granted, as evidenced by the numerous state court lawsuits and the costs attendant thereto; and (iv) the extension motion serves the public interest by increasing the likelihood that the debtor can reorganize, reducing transaction costs and eliminating the risk of inconsistent judgments.

On August 2, Judge Rhodes then heard arguments on the Court’s proposed dates and deadlines regarding eligibility and the filing of a chapter 9 plan of debt adjustment.  Although the Court took the scheduling issues under advisement, the Court suggested October 23, 2013 as the date on which a trial on eligibility could be held.  The Court also suggested that it would set March 1, 2014 as the deadline by which the City must file its plan.  In response, the City stated that it hoped to file a plan before December 31, 2013.  Finally, the Court approved the creation of a committee of retirees and scheduled a hearing regarding the assumption of the City’s swap settlement agreement for August 28, 2013.  These time frames demonstrate that the Court and the City intend to resolve the City’s chapter 9 case relatively rapidly.