Spotlight: insolvency proceedings in USA
Insolvency law, policy and procedure
i Statutory framework and substantive law
Although individual states in the United States have laws that govern the relationship between debtors and their creditors, insolvency law in the United States is primarily dictated by federal law because Article 1, Section 8 of the United States Constitution grants Congress the power to enact ‘uniform Laws on the subject of Bankruptcies’. While over time several different bankruptcy statutes have been passed by Congress, the US bankruptcy regime is currently set forth in Title 11 of the United States Code (the Bankruptcy Code), which codified the Bankruptcy Reform Act of 1978 and subsequent amendments. The most recent significant amendment to the Bankruptcy Code was the 2005 Bankruptcy Abuse and Consumer Protection Act.
The Bankruptcy Code is composed of nine chapters. Chapters 1, 3 and 5 provide the structural components that generally apply to all bankruptcy cases. Chapters 7, 9, 11, 12, 13 and 15 lay out general procedures specific to certain types of bankruptcies. Generally speaking, these specific types of bankruptcies are:
- trustee-administered liquidation (Chapter 7);
- municipality bankruptcy (Chapter 9);
- debtor-in-possession (DIP) managed reorganisation or liquidation (Chapter 11);
- family farmer and fisherman bankruptcies (Chapter 12);
- individual bankruptcies (Chapter 13); and
- cross-border cases (Chapter 15).
Generally speaking, with respect to plenary corporate bankruptcies, US insolvency law provides for two distinct regimes: a trustee-controlled liquidation under Chapter 7 and a DIP-controlled reorganisation or structured liquidation under Chapter 11. This chapter focuses on Chapter 11 proceedings. Below are certain key provisions of US insolvency law:
The automatic stay
One of the most important provisions of the US insolvency regime is the ‘automatic stay’, which is codified in Section 362 of the Bankruptcy Code. The automatic stay is a statutory injunction that applies immediately upon the commencement of a bankruptcy proceeding. Generally, the automatic stay operates to enjoin most creditors from pursuing actions or exercising remedies to recover against a debtor’s property. There are limited exceptions to the automatic stay and it can be modified by a court upon a showing of cause. The automatic stay provides the breathing room necessary for the debtor or trustee to assess and assemble all of the property of the estate without creditors seeking remedies to protect their own self-interests. Accordingly, the automatic stay allows for the preservation of the debtor’s assets and the maximisation of their value and for an equitable distribution of those assets to creditors.
One important exception to the automatic stay is that it generally does not apply to contracts that are colloquially referred to as ‘financial contracts’. Specifically, the automatic stay does not apply to certain delineated counterparties’ ability to offset, net, liquidate, terminate, or accelerate ‘securities contracts’, ‘commodities contracts’, ‘forward contracts’, ‘repurchase agreements’, ‘swap agreements’, or ‘master netting agreements’ with a debtor, provided that the counterparty may be required to exercise its remedies promptly. In addition, a debtor may not avoid as a fraudulent transfer a transfer to such a counterparty under one of these contracts unless the transfer is intentionally fraudulent.
The absolute priority rule
Another key tenet of US insolvency law is the absolute priority rule. The absolute priority rule provides that creditors with higher priority must be paid in full before creditors of lower priority receive any distribution from the bankruptcy estate, and thereby ensures a ‘fair and equitable’ distribution of the debtor’s property consistent with the priorities under applicable non-bankruptcy law. As a result, in the absence of consent, secured claims must be paid in full before general unsecured creditors receive any recovery from the secured creditor’s collateral. Similarly, because equity holders have the lowest priority, in the absence of consent, they cannot receive any distribution until all creditors have received payment in full on account of their allowed claims. Consent to the payment of a junior class can be obtained through a vote of the senior class on a plan of reorganisation.
The Bankruptcy Code also provides a number of procedures that allow the debtor or trustee to avoid a pre-bankruptcy transfer of property from the bankruptcy estate. This allows the debtor to maximise the value of the bankruptcy estate and prevent a depletion of the estate prior to the commencement of the bankruptcy proceeding that may favour certain creditors over others. These protections are found in Chapter 5 of the Bankruptcy Code. The most commonly used of these actions are:
- avoidance of preferential transfers, which enables an insolvent debtor, subject to certain defences, to avoid and recover payments based on antecedent debt made to creditors within the 90 days prior to the debtor’s filing for bankruptcy – up to one year for payments made to insiders of the debtor;
- avoidance of fraudulent transfers, which enables the debtor to avoid and recover transfers of property that were actually fraudulent or were made while the debtor was insolvent and for less than reasonably equivalent value; and
- avoidance of unperfected security interests, which enables a debtor to avoid liens on property if such liens were not perfected under applicable non-bankruptcy law prior to the commencement of the bankruptcy case.
The goal of US insolvency law is to provide maximum return to creditors (and, if possible, equity holders) of the debtor and, in that context, to reorganise rather than liquidate business debtors to preserve employment and to realise the ‘going concern surplus’ of reorganisation value over liquidation value. This is accomplished by reorganising a debtor corporation under the provisions of Chapter 11 of the Bankruptcy Code. However, if a reorganisation is not possible – or if it would not result in a maximisation of value for creditors – the debtor company can be liquidated either under Chapter 11 or Chapter 7 of the Bankruptcy Code. Chapter 7 transfers the control of the liquidation process from the debtor’s management, who are likely to have greater familiarity with the assets and their value, to a trustee appointed by the United States Trustee or elected by the debtor’s creditors. Chapter 7 liquidations usually result in lower recoveries for creditors. Therefore, companies are more likely to be liquidated under Chapter 7 if there are not sufficient funds in the estate or available to the estate to run a Chapter 11 process.
iii Insolvency procedures
As discussed above, the Bankruptcy Code provides for two main types of insolvency proceedings available to businesses with assets in the United States: Chapter 7 and Chapter 11.
Chapter 7 is a trustee-controlled liquidation. The goal of Chapter 7 is to ensure the most efficient, expeditious and orderly liquidation of the debtor’s assets to be distributed to the creditors and equity holders. Companies cannot reorganise under Chapter 7. The Chapter 7 liquidation procedure is administered by a Chapter 7 trustee either selected by the United States trustee or by an election conducted by certain creditors. The Chapter 7 trustee is responsible for realising upon all of the property of the estate and coordinating the distribution of such property or proceeds of sales of such property.
Chapter 11 provides for an insolvency proceeding in which the directors and management of the debtor company remain in control (the DIP) unless a trustee is appointed for cause. Chapter 11 proceedings allow for the reorganisation of the debtor’s operations and capital structure in the hope that the company will emerge from the bankruptcy process as a healthier, reorganised company. Chapter 11 gives the debtor the exclusive right to propose a plan of reorganisation for the first 120 days after commencement of the bankruptcy proceedings, and this date may be extended until 18 months after the order for relief (the petition date of a voluntary case) in the case if the debtor is making progress on a plan of reorganisation and can show cause why the court should extend the exclusivity period. The plan of reorganisation provides for how the debtor’s assets will be distributed among the classes of creditors and equity holders. It is also possible for a debtor to liquidate its assets through Chapter 11, which is typically a more structured liquidation than one under Chapter 7.
The culmination of a Chapter 11 proceeding is the confirmation of the plan of reorganisation. The Chapter 11 plan provides how creditors’ claims will be treated by the estate. Under the Chapter 11 plan creditors and shareholders are divided into classes of holders sharing substantially similar claims or equity interests. Chapter 11 plans must meet certain standards to be confirmed. Even if a plan is accepted by the requisite vote of all impaired classes, it must be found by the court to be in ‘the best interests of creditors’ (providing each dissenting class member with at least what would have been recovered in a liquidation). As to a class that rejects the plan, the plan must satisfy the Bankruptcy Code’s ‘fair and equitable’ requirement (also known as the absolute priority rule, described above).
The plan of reorganisation is filed together with a disclosure statement and submitted to a vote of the various creditor and shareholder classes. If at least one class that stands to receive less than their asserted claim (an ‘impaired’ class) votes in support of confirmation of the plan, excluding insider yes votes, the plan can be confirmed over even if rejected by another impaired class. Dissenting classes can thus be ‘crammed down’ so long as the plan is fair and equitable with respect to such class (that is, satisfies the absolute priority rule with respect to such class) and does not discriminate among similarly situated creditors. Once the plan is approved by the necessary stakeholders, a court can confirm a plan so long as certain other prerequisites of Section 1129 of the Bankruptcy Code are satisfied.
Chapter 15 is the Bankruptcy Code’s codification of the United Nations Commission on International Trade Law (UNCITRAL) Model Law and allows a foreign debtor, through its ‘foreign representative’ to commence an ancillary proceeding in the United States to support its foreign insolvency proceeding.
iv Starting proceedings
As set forth above, the US Bankruptcy Code provides for different types of insolvency proceedings. Not all of these proceedings are available for all types of companies. Specifically, insurance companies and banking institutions cannot file for Chapter 7 or Chapter 11 bankruptcy; a railroad can be a debtor under Chapter 11 but not Chapter 7, and stockbrokers and commodity brokers can file for bankruptcy under Chapter 7 but not Chapter 11. Regardless of the type of bankruptcy case, under Section 301(a) of the Bankruptcy Code, a debtor voluntarily commences a plenary insolvency proceeding by filing a petition with the bankruptcy court.
A bankruptcy proceeding can also be commenced against a debtor company, which is known as an ‘involuntary’ bankruptcy case. An involuntary case is commenced upon the filing of a petition with the bankruptcy court by three or more holders of non-contingent, undisputed claims, and such claims aggregate at least US$15,775 more than the value of any lien on property of the debtor securing such claims. A bankruptcy court will order relief against the debtor in an involuntary case only if the debtor is generally not paying its debts as they become due, unless such debts are the subject of a bona fide dispute as to liability or amount, or if a custodian as described in Section 303(h)(2) of the Bankruptcy Code has been appointed.
A Chapter 15 case is commenced when the foreign representative of the debtor company files a petition for recognition of the foreign proceeding with the US bankruptcy court.
v Control of insolvency proceedings
Under Chapter 7, the insolvency proceeding is controlled by a trustee who is appointed by the United States Trustee or elected by the debtor’s creditors to administer the debtor’s assets. The ‘Chapter 7 trustee’ is responsible for, among other things, ‘collect[ing] and reduc[ing] to money the property of the estate for which such trustee serves, and closes such estate as expeditiously as is compatible with the best interests of parties in interest’. Although the Chapter 7 trustee can continue business operations for a short period if value is maximised by doing so, generally, once a Chapter 7 trustee has been appointed, the debtor company is expeditiously liquidated.
Chapter 11 proceedings allow for the debtor’s existing management and directors to stay in place and operate the business during the bankruptcy case. For this reason, a debtor in a Chapter 11 proceeding is referred to as the ‘DIP’. The board of directors’ primary duties in connection with an insolvency proceeding are the same as they are outside bankruptcy – to maximise the value of the company. The key distinction is that when a company is insolvent, the creditors, not the shareholders, are the residual beneficiaries of the board’s fiduciary duties to the corporation and are, thus, able to bring actions for breach of fiduciary duty. If it is in the best interests of the estate and its creditors, a trustee may be appointed to replace the DIP and administer a Chapter 11 case.
During a Chapter 7 or Chapter 11 case, the DIP or trustee may take actions that are in the ordinary course of the debtor’s business without approval of the bankruptcy court. Actions after entry of the order for relief outside the ordinary course of business are subject to bankruptcy court approval.
In the United States, bankruptcy courts are courts of limited jurisdiction. This is because, unlike federal district and circuit courts, bankruptcy courts were not created under Article III of the United States Constitution. Instead, Congress created the bankruptcy courts because they were ‘necessary and proper’ to effectuate Congress’s enumerated powers to enact bankruptcy law. For this reason, bankruptcy courts may only oversee matters that are ‘core’ to the bankruptcy case unless the parties knowingly and voluntarily consent to adjudication of a ‘non-core’ matter by the bankruptcy court. Without consent, matters that are not ‘core’ to the insolvency proceeding must be decided by a federal district court. Appeals of bankruptcy court decisions are generally heard, in the first instance, by the federal district court sitting in the same jurisdiction as the applicable bankruptcy court. Bankruptcy court jurisdiction is the subject of much debate under a line of recent Supreme Court cases.
Among other things, the bankruptcy court manages filing deadlines, hears evidence on contested issues and issues orders regarding requests for relief by the parties. Nevertheless, and despite the involvement of the court, many aspects of the bankruptcy process are negotiated by the parties outside the courtroom and the DIP or trustee is free to enter into settlement agreements, which are then subject to the approval of the bankruptcy court.
vi Special regimes
Securities broker-dealers are not eligible for relief under Chapter 11. Instead, insolvent broker-dealers may liquidate under Chapter 7 of the Bankruptcy Code, but are more likely to be resolved in a proceeding under the Securities Investor Protection Act of 1970 (SIPA). SIPA proceedings are liquidation proceedings, and upon commencement of the SIPA proceedings, the broker-dealer will cease to conduct business as a broker-dealer, subject to certain limited exceptions. In SIPA proceedings, a trustee (the SIPA Trustee) will take control of all property, premises, bank accounts, records, systems and other assets of the broker-dealer and displace management. The SIPA Trustee’s primary duties will be to marshal assets, recover and return customer property (including through effectuating bulk account transfers to a solvent broker-dealer) and liquidate the broker-dealer.
In SIPA proceedings, the provisions of Chapters 1, 3 and 5 and Subchapters I and II of Chapter 7 of the Bankruptcy Code will also apply, to the extent consistent with SIPA, and the SIPA Trustee will generally be subject to the same duties as a trustee under Chapter 7 of the Bankruptcy Code with certain limited exceptions regarding securities that are property of the customers of the broker-dealer. If the broker-dealer is a registered futures commission merchant under the Commodity Exchange Act of 1936, the SIPA Trustee will have additional obligations under the Part 190 regulations promulgated by the Commodity Futures Trading Commission, with respect to any commodity customer accounts that have not been transferred to another futures commission merchant prior to the filing date.
Although bank holding companies can file for Chapter 11 relief, their subsidiary depository institutions are not eligible for relief under the Bankruptcy Code, and are typically resolved by the Federal Deposit Insurance Corporation (FDIC) under the Federal Deposit Insurance Act. The FDIC has the authority to market a failed depository institution for sale to another depository institution, or the FDIC can insert itself as a receiver, close the bank and liquidate its assets to pay off creditors. The powers of the FDIC as receiver are very similar to those of a trustee in bankruptcy.
Additionally, the Dodd–Frank Wall Street Reform and Consumer Protection Act established the Orderly Liquidation Authority (OLA), which provides that the FDIC may be appointed as receiver for a top-tier holding company of a failing financial institution that poses a systemic risk to financial stability in the United States. OLA sets forth the procedures that the federal government can take to cause the wind-down of financial institutions that were once considered ‘too big to fail’. Pursuant to OLA, the FDIC can exercise many of the same powers it has as a bank receiver to liquidate systemically risky financial institutions. Moreover, under the Dodd–Frank Act, institutions that may be subject to OLA must provide the FDIC with resolution plans (commonly known as ‘living wills’), to serve as road maps in the event the financial institution requires resolution. However, despite the enactment of OLA, these resolution plans must demonstrate how the financial institution would be resolved under the Bankruptcy Code.
State law governs all regulation of insurance companies, including the resolution of insolvent insurance companies.
The Bankruptcy Code has mechanisms for dealing with the insolvency proceedings of corporate groups and there is no special regime to address these types of filings. If multiple affiliated companies in the same corporate group seek relief under the US Bankruptcy Code, they will file separate bankruptcy petitions but will often seek joint administration of the various bankruptcy proceedings, meaning that the bankruptcy cases of each member of the group will be overseen by the same judge, which provides for greater efficiency in the administration of the cases. Importantly, joint administration does not mean that the assets and liabilities of the group will be combined. Rather, corporate separateness will be observed despite the joint administration of the cases, unless there is cause to breach corporate separateness and ‘substantively consolidate’ the assets and liabilities of the debtor.
vii Cross-border issues
As part of the 2005 Bankruptcy Abuse and Consumer Protection Act, the United States enacted Chapter 15 of the Bankruptcy Code, which is based on the UNCITRAL Model Law on Cross-Border Insolvency (the Model Law). Chapter 15 governs how a US court should treat a foreign insolvency proceeding when no plenary proceedings have been commenced in the United States and provides a mechanism for cooperation between the US court and the foreign court overseeing a debtor’s plenary insolvency proceeding. Generally, Chapter 15 allows for the commencement of an ancillary proceeding upon recognition of the debtor’s foreign proceeding. Once the foreign proceeding is recognised by the US bankruptcy court, the automatic stay applies to the debtor and the property of the debtor that is within the territorial jurisdiction of the United States and the debtor’s foreign representative enjoys certain powers and privileges under the Bankruptcy Code, such as the right to intervene in any court proceeding in the United States in which the foreign debtor is a party, the right to sue and be sued in the United States on the foreign debtor’s behalf, the authority to operate the debtor’s business and the authority to initiate avoidance actions in a case pending under another chapter of the Bankruptcy Code.
The bar for accessing plenary proceedings in the US bankruptcy courts is relatively low. A company can be eligible to commence a Chapter 11 proceeding in a US bankruptcy court so long as it is incorporated or has any property or operations in the United States. Because of the perceived debtor-friendliness of US bankruptcy courts and the courts’ vast experience in restructuring large multinational companies, many multinational companies are filing for Chapter 11, even if their principal place of business, or centre of main interest, is located outside the United States. This trend has been particularly prevalent in the shipping industry. For example, the Taiwan-based TMT Group opened an office in Houston only a few days before filing for Chapter 11 protection in the United States Bankruptcy Court for the Southern District of Texas.
Since the global financial crisis of 2008, the US economy had been experiencing a period of slow growth. The trend continued in 2019, with real GDP increasing in the fourth quarter at an average annual rate of 2.1 per cent. Reported unemployment also remained low: the unemployment rate for February 2020 was 3.5 per cent, down slightly from 3.8 per cent in February of the previous year and from its October 2009 high of 10 per cent. However, the covid-19 crisis upended this period of relative economic prosperity. The first quarter of 2020 saw real GDP fall by 5.0 per cent while the second quarter of 2020 saw real GDP plummet by a staggering 32.9 per cent. Unemployment also skyrocketed to 14.7 per cent in April 2020, though this figure declined somewhat to 10.2 per cent as of July 2020.
The covid-19 pandemic has also had a significant effect on the credit markets. After the financial crisis, credit was readily available to US businesses. In 2019, US corporations issued more than US$1.75 trillion in bonds, an increase from the almost US$1.53 trillion issued in 2018, although slightly less than the US$1.81 trillion issued in 2017. In the first three months of 2020, more than US$600 billion worth of bonds had been issued. The 10-year Treasury rate has ranged between 1.88 per cent and 0.52 per cent in the current calendar year, while, in 2019, the rate ranged between 2.95 per cent and 1.76 per cent.
US equity markets on the other hand, experienced a downturn in 2019. Specifically, US equity and equity-related proceeds totalled US$207.5 billion on 805 deals in 2019, which represents a 2.0 per cent decrease in proceeds compared to the US$212.7 billion raised in 2018. Additionally, the number of deals declined by approximately 12.7 per cent from the 907 in 2018. While it is clear that the covid-19 pandemic has had a substantial negative effect on equity capital raising since the most recently available numbers were published, the exact extent of this effect remains to be seen.
US corporate default rates have fluctuated since 2018. Moody’s measured the US speculative-grade default rate in March 2020 at 4.7 per cent, compared to default rates of 4.2 per cent in the end of 2019 and 2.8 per cent in the end of 2018. However, Moody’s further estimated that this rate would rise to 14.4 per cent in April of 2021. Moody’s indicated that the leveraged loan default rate has held steady at 1.9 per cent from December 2018 to March 2019, compared with the March 2018 rate of 2.9 per cent and 2017 first quarter rate of 2.2 per cent.
The frequency of business bankruptcy filings has increased in the past year. In 2019, 63 public companies filed for Chapter 7 or Chapter 11 proceedings, up from 58 filings in 2018. Furthermore, the amount of assets going into bankruptcy in 2019 was 150 billion, the highest number since 2009. This upward trend will likely continue and possibly accelerate throughout 2020. The increase in business bankruptcy filings because of the covid-19 pandemic will become more evident as the year continues.
One hundred and forty-seven companies commenced Chapter 15 proceedings in the 12 months ending on 31 March 2020, compared with the 98 Chapter 15 cases that were initiated during the 12 months ending on 31 March 2019. As stated above, the true impact that the covid-19 pandemic will have on the bankruptcy filings for the current year remains to be seen.
Plenary insolvency proceedings
One of the first industries to feel the impacts of the covid-19 pandemic was the airline sector. Travel restrictions, mandatory flight grounding, and the general fear of flying caused airline ticket sales to plummet shortly following the onset of the crisis and led to the grounding of approximately 70 per cent of the world’s passenger airline fleet. While certain US airlines received governmental assistance in order to mitigate the effects of widespread industry distress, many non-US airlines were unable to obtain similar relief. Accordingly, these airlines looked for novel ways to address their newfound liquidity problems. One strategy that is being used with increasing prevalence is for international airlines to commence Chapter 11 proceedings. While the Chapter 11 process is generally designed for United States companies, the Bankruptcy Code contains no requirement that a Chapter 11 debtor must be a US resident. Rather, having a place of business or property in the United States, even if minimal, is sufficient to satisfy the threshold jurisdictional and statutory requirements.
One of the first major international airlines to take advantage of the Bankruptcy Code’s permissive eligibility threshold in response to the covid-19 crisis was Avianca Holdings S.A, (together with its debtor affiliates, Avianca). On 10 May 2020, Avianca filed for Chapter 11 in the United States Bankruptcy Court for the Southern District of New York. As of its petition date, Avianca was the second-largest airline group in Latin America, offering passenger services on more than 5,350 weekly flights to more than 76 destinations in 27 countries. Avianca has been a leading airline in Latin America since 1919, and employed 18,900 people and generated approximately US$3.9 billion in annual revenues by the time of its Chapter 11 filing.
As of the petition date, the debtors had approximately US$5.36 billion of outstanding indebtedness, of which approximately US$5.2 billion (or 98.42 per cent), was secured by certain assets of the debtors. The secured indebtedness consists of:
- US$3,925.9 million outstanding under various bank loans and eca guarantees (finance leases – aircraft debt);
- US$250 million Kingsland, United Stakeholder Loan;
- US$50 million additional secured convertible loans;
- US$50 million in Citadel notes;
- US$25 million LatAm bridge loan;
- US$487.1 million in additional secured debt; and
- US$484.4 million in 9 per cent senior secured notes due 2023.
Avianca was also already experiencing financial troubles before covid-19. The company had incurred significant debt to increase capacity, which outpaced demand in Colombia and other principal markets and resulted in an unsustainable level of debt service. Without government assistance, which was not forthcoming, Avianca was thus particularly vulnerable to the disruption caused by the pandemic. Indeed, Colombian operations were brought to a standstill when, on 20 March 2020, the Colombian government closed its airspace to stem the spread of the virus. As of the date of this submission, Avianca is not operating international flights.
On 13 August 2020, an ad hoc group of holders of Avianca’s 9 per cent senior secured notes put out a notice stating that Avianca was negotiating a restructuring support agreement with certain holders of such notes. In connection therewith, the company had been working with its advisers to put in place a financing structure under a DIP facility consisting of an approximately US$1.3 billion Tranche A facility (Tranche A) and a US$700 million Tranche B facility (Tranche B). Both tranches would be secured ratably by a lien on all available collateral, with Tranche B subordinated in right of repayment to Tranche A. Under the notice, the noteholders would have an opportunity to participate in up to US$250 million of Tranche A financing, with US$200 million being backstopped.
A key dispute that will have a major impact on the outcome of the Avianca case involves the assignment of its credit card receivables. Specifically, since late 2017, the debtors have been party to a series of intertwined agreements with USAVflow Limited (USAV) pursuant to which the debtors agreed to provide to USAV, on an ongoing basis, certain credit card receivables generated in the United States pursuant to credit card processing agreements. As consideration for the debtors’ credit card receivables, USAV remitted an initial purchase price of US$150 million plus certain continuing monthly payments. Contemporaneously, certain lenders advanced USAV US$150 million in order to finance the receivables acquisition. USAV uses the collections of the receivables to make amortization payments on the loan, and all surpluses in excess of this amount are remitted to the debtors. This financing structure is common in the airline sector; however, it can create a unique liquidity problem upon the rapid onset of financial distress. For example, in Avianca, the administrative agent issued a notice of retention event, pursuant to which Avianca was no longer entitled to collect the surplus of collected receivables.
In light of the above, on 23 June 2020, the debtors commenced an adversary proceeding seeking to recharacterise the USAV arrangement as a secured financing. Moreover, because USAV was not granted a security interest in the proceeds, offspring, or profits of its prepetition collateral, the debtors urged the court to enter an order holding that USAV does not have any security interest in the post-petition credit card receivables, pursuant to Section 552 of the Bankruptcy Code. In the alternative, the debtors sought to reject the USAV agreements under Section 365 of the Bankruptcy Code.
On 4 September 2020, the court issued an opinion granting the rejection motion. Among other things, the court concluded that the applicable receivables purchase agreement was an executory contract subject to rejection. In doing so, the court further concluded that, under United States Supreme Court precedent, the result of rejection is not rescission of the contract rights previously sold to USAV. Rather, rejection relieves the debtors of future performance under the applicable agreements, ‘including the unperformed obligation under Section 2.01(a)(ii) of the RSPA to sell to USAV the contract rights arising under new credit card processing agreements that the Debtors may seek to enter with new credit card processors’.
ii J.C. Penney
The retail sector, which was already experiencing substantial financial distress coming into 2020, has also been decimated by the covid-19 pandemic. Extensive lockdown orders have led to an unprecedented decline in customer activity. One of the most significant victims of the pandemic was iconic retailer J. C. Penney Company, Inc. (J.C. Penne). Founded in 1902, J.C. Penney is one of the largest department store retailers in the US, operating 84 locations across 49 states and Puerto Rico, employing nearly 85,000 associates and managing a supply chain network with nearly 3,000 vendors and 11 domestic shipping facilities. The company owns 387 stores, including 110 stores operating on ground leases, and its stores are located in lifestyle centers, shopping malls, power centres, street level shops and outlets.
Because of the pandemic, April year-over-year net sales tumbled by approximately 88 per cent, and in-store sales for J.C. Penney decreased to nearly zero. The severe sales decrease resulting from crucial but economically painful public safety measures led to the commencement of Chapter 11 cases in the United States Bankruptcy Court for the Southern District of Texas on 15 May 2020. As of the petition date, J.C. Penney’s capital structure was as follows:
- approximately US$1.179 billion outstanding under an ABL Credit Facility;
- approximately US$1.521 billion outstanding under a first lien term loan;
- US$500 million of first lien notes due 2023;
- US$400 million of second lien notes due 2025; and
- US$1,318 million of legacy unsecured notes with various maturity dates.
J.C. Penney commenced the Chapter 11 cases with a restructuring support agreement with certain of its existing lenders which contemplated, among other things, (1) the incurrence of debtor in possession financing in the aggregate principal amount of US$900 million; (2) that the reorganised ‘OpCo’ will enter into post-effective date financing consisting of a new money revolving ABL loan and take-back term debt; and (3) the creation of a real estate investment trust, or REIT, to hold certain of the debtors’ properties, which would subsequently be leased to ‘New JCP’ in a sale-and-leaseback transaction under a market rate master lease. The RSA also includes a market testing process seeking interest in and bids for, among other things, providing debt or equity financing to New JCP and/or purchasing some or all of the assets of the debtors, as well as a sale ‘toggle’ feature allowing for a potential sale of all or substantially all of the debtors’ assets to a third-party purchaser if certain plan-related milestones are unmet.
On 29 July 2020, J.C. Penney announced that it had determined to pursue a sale process, under Section 363(b) of the Bankruptcy Code, on an expedited basis. J.C. Penney further noted that it was in active negotiations with three bidders that have made stand-alone operating company bids and have received a credit bid from their first lien and DIP lenders for the OpCo/PropCo restructuring proposal contained in the RSA. However, as of 19 August 2020, Judge David Jones expressed concern over the lack of progress in the sale process, noting that both thousands of jobs and ‘the very essence of the country’s infrastructure’ are at risk. As of the date of this submission, it remains to be seen whether and in what form this iconic American retailer will emerge from Chapter 11. The dynamics of the bankruptcy case are complex and, at the current time, it is unclear what the future may hold.
iii J. Crew
A second high-profile retail company that was effected by the covid-19 pandemic is J. Crew Group Inc. (together with its debtor affiliates, J. Crew). Like many other American retailers, J. Crew had begun to experience financial distress prior to the pandemic, in part owing to its 2011 leveraged buyout by TPG Capital and Leonard Green & Partners. J. Crew had previously garnered the attention of the restructuring world in 2017 when, in an effort to address an upcoming maturity on its PIK toggle notes, the company transferred valuable intellectual property assets to an unrestricted subsidiary, IPCo. IPCo then issued new debt that was used to pay down the existing notes. Notwithstanding this and other liability management transactions designed to avoid a Chapter 11 filing, the company succumbed to the pressures of the covid-19 pandemic and commenced Chapter 11 cases in the United States Bankruptcy Court for the Eastern District of Virginia on 4 May 2020. J. Crew commenced its Chapter 11 cases with a transaction support agreement, or TSA, with lenders holding approximately 71 per cent of its term loan and approximately 78 per cent of its IPCo notes, as well as with its sponsors, through which the company would convert US$1.65 billion of debt into equity. As of the petition date, the debtors’ capital structure included:
- US$347.6 million of 13 per cent senior secured notes due 2021, issued at IPCo;
- US$311 million outstanding under an ABL Facility issued at J. Crew Group, Inc.;
- US$1.334 billion outstanding under a term loan facility issued at J. Crew Group, Inc.; and
- US$299.7 million of preferred shares.
The TSA effectively contemplated a plan that would provide for the debtors’ prepetition secured term loans and prepetition IPCo secured notes to be equitised into approximately 82 per cent of the reorganised debtors’ new shares.
A critical motion filed on the first day of the case was the Motion of Debtors for Entry of Order (I) Extending Time for Performance of Obligations Arising under Unexpired Nonresidential Real Property Leases, and (II) Granting Related Relief (the Rent Deferral Motion). Section 365(d)(3) of the Bankruptcy Code provides that notwithstanding a debtor’s obligation to timely perform all obligations under a lease of nonresidential real property, the court may, for cause, extend the grace period for performance of any such obligation that arises within 60 days after the petition date. Under the Rent Deferral Motion, the debtors requested that the court extend the time to perform their obligations arising within 60 days of the petition date under the debtors’ unexpired leases by 63 days, through and including 6 July. In the motion, the debtors noted that ‘quite simply, with limited revenue generating options during these unprecedented circumstances, immediately paying the debtors’ approximately US$23 million of monthly Lease Obligations … related to approximately 500 nonresidential real property leases … for the first 60 days of these Chapter 11 cases is not prudent or in the best interest of the debtors’ estates and creditors’. The debtors further emphasised that the requested extension would give the debtors ‘significant liquidity relief in the form of US$46 million of rent deferrals’ as well as an opportunity for the debtors to negotiate with landlords and ‘make an informed decision’ on rejection or assumption of the leases
On 26 May 2020, the court granted the Rent Deferral Motion over the objections of the official committee of unsecured creditors and various landlords. In relying on the fact that the covid-19 crisis presented an unprecedented disruption of liquidity, the court held that the debtors should be entitled to a breathing spell from their monthly rent obligations. In granting the relief, the court disagreed with the objecting parties’ contentions that J.Crew’s case is factually distinguishable from other cases in which courts granted the debtors rent relief in light of the covid-19 pandemic’s onset during the course of the bankruptcies. Although the objectors argued that J.Crew entered bankruptcy in the midst of the pandemic and therefore could account for the aggressive shutdowns imposed on virtually all aspects of daily life in structuring its financing and proposed path forward, the court ruled that it ‘finds little to distinguish between’ J.Crew’s hardship and the other cases aside from the case filing ‘further along in the pandemic’. Additionally, in rejecting the landlords’ argument that the rent deferral effectively constituted a non-consensual loan to fund the Chapter 11 cases, Judge Philips noted that the TSA provides for exit financing and the landlords are well positioned to ultimately receive payment on account of missed rent.
On 25 August 2020, the court confirmed J. Crew’s Chapter 11 plan of reorganisation.
Dine-in restaurants are yet another sector that bore the brunt of the covid-19 pandemic. One of the first major restaurant chains to file for Chapter 11 in 2020 was NPC International (together with its debtor affiliates, NPC). NPC, a franchisee of 1,227 Pizza Huts in 27 states and 393 Wendy’s restaurants in eight states, is the largest Wendy’s franchisee in the United States and the third-largest coop in the food service industry. Although Wendy’s historical operations had consistently performed well, the pandemic and its impact on the supply chain and market volatility is projected to hurt 2020 performance, with revised 2020 EBITDA projected to be approximately US$48.8 million, down from initial projections of US$55.2 million. With respect to Pizza Hut, the debtors estimated that negative profitability trends from the past several years would continue in 2020.
As of the petition date, the company’s capital structure included:
- US$40 million outstanding under a super-priority secured term loan;
- US$63 million outstanding under a revolving credit facility;
- US$640 million outstanding under a first lien term loan;
- US$37 million outstanding letters of credit; and
- US$160 million outstanding under a second lien term loan.
The debtors entered Chapter 11 with an RSA with holders of 92.26 per cent of priority first lien lenders, 85.03 per cent of first lien lenders and 17.13 per cent of second lien lenders. The company noted that the restructuring transactions contemplated in the RSA would result in ‘(i) a substantially deleveraged capital structure; (ii) a potential substantial exit capital infusion to revitalise the debtors’ Pizza Hut restaurants; (iii) the potential to realise a value-maximising sale of some or all of the debtors’ Wendy’s restaurants, and (iv) a smaller, more profitable footprint of restaurants’. Under the plan term sheet annexed to the RSA, votes would be solicited from holders of first lien claims and general unsecured claims. Holders of first lien claims would receive, among other things, new take back debt, 100 per cent of the equity of the reorganised debtors, and the right to participate in a new money rights offering, to be backstopped by the ad hoc priority/first lien group and any other parties agreed to by those backstop parties (if applicable). General unsecured claims would receive a treatment to be determined.
At the hearing to consider the relief requested on the first day of the Chapter 11 cases, an ad hoc group of second lien lenders raised concern over whether the debtors intended to run the case for the benefit of the first lien lenders (i.e., the RSA parties). The group further emphasised that it was left out of the prepetition RSA negotiations and disagreed with the notion that second lien lenders are ‘out of the money’.
On 17 August 2020, the company announced that it had reached an agreement with Pizza Hut on the organisation of its restaurant portfolio and noted that it would launch a sale process for its Pizza Hut restaurants. The agreement will allow the debtors to close up to 300 of its Pizza Hut locations, many of which are dine-in facilities that have experienced financial decline in recent years owing to increased demand for delivery pizza. The company noted that the agreement provides NPC with flexibility to explore options for achieving a value maximising outcome as it seeks to finalise the terms of a comprehensive financial restructuring and emerge from Chapter 11.
Ancillary insolvency proceedings
Ancillary insolvency proceeding
i Cirque du Soleil
While many industries experienced distress resulting from the covid-19 crisis because of reduced demand for their goods and services, some were forced to shut down their businesses entirely. One of these companies is CDS U.S. Holdings, Inc. (together with its debtor affiliates, Cirque du Soleil). Over the past 35 years, Cirque du Soleil has become the world’s premier live entertainment media company known for having reinvented circus arts and creating one of the industry’s most iconic creative brands. Based in Montreal, Quebec, Cirque du Soleil has conceptualised, produced and presented shows on a global scale to more than 180 million spectators, in approximately 450 cities spanning 60 countries across six continents. Cirque du Soleil performs its marvels in custom-built, partner-hosted resident venues and, through touring, in different cities around the world, or licences to third parties for performances.
On 28 June 2020, Cirque du Soleil executed a stalking horse asset purchase agreement with certain sponsors, which provided for, among other things, a US$416 million implied purchase price, a new capital infusion of US$250 million to provide funding through a restart of Cirque du Soleil’s businesses, and the establishment and funding of contractor and employee funds to provide financial assistance to independent contractors and employees. The stalking horse asset purchase agreement provides a floor for Cirque du Soleil’s continued marketing of their assets through a sale and investment solicitation process, to obtain the highest or otherwise best bid for their assets and maximise value for all stakeholders and parties in interest.
On 29 June 2020, Cirque du Soleil commenced proceedings under the Companies’ Creditors Arrangement Act in Superior Court of Québec in order to facilitate the sale process. Subsequently, the company commenced chapter 15 recognition proceedings in the United States Bankruptcy Court for the District of Delaware. As of the time of the filing, Cirque du Soleil’s capital structure included the following:
- US$935 million outstanding under a first lien credit agreement (including US$815 million in term loan commitments and US$120 million in revolving commitments);
- US$150 million plus US$3.9 million in accrued interest under a second lien credit agreement;
- US$30 million plus US$2 million in accrued interest under an unsecured loan agreement;
- US$30 million plus US$2 million in accrued interest under the Fonds Unsecured Loan Agreement; and
- US$50 million under the Trapeze Term Loan.
On 10 July 2020, Cirque du Soleil announced that it had abandoned the initial stalking horse purchase agreement with TPG, Fosun and Caisse de dépôt et placement du Québec and was now pursuing a ‘vastly superior’ proposal with the ad hoc committee of first lien and second lien lenders. Shortly thereafter, the Superior Court of Québec approved the new stalking horse asset purchase agreement, which provided, among other things, for total consideration of more than US$1.2 billion.
On 4 August 2020, an ad hoc group of lenders holding approximately 20 per cent of Cirque du Soleil’s second lien term loan filed an objection to the Petition for Recognition arguing, among other things, that ‘blanket’ approval of all prior Canadian court orders should be denied and that where the debtors need Canadian court orders enforced in the United States, the foreign representative should be required to seek enforcement for each, with proper notice and an opportunity to object and be heard for all parties-in-interest. The ad hoc group further asserted that the court should not grant full force and effect to the Canadian court’s order approving the stalking horse agreement because, among other things, the debtors propose to allocate nearly all value to the first lien lenders without any evidence or data to justify such an allocation. In its reply to the objection, the debtors noted that they did not intend to seek recognition of certain orders, thus mooting the first portion of the objection. With respect to the ad hoc group’s objection to recognising the approval of the asset purchase agreement, the company noted that the same arguments had already been rejected by the Canadian court and that the ad hoc group’s strategy simply constituted ‘a forthcoming effort to circumvent the Canadian Court’s authority with a collateral attack of the Canadian Court’ SISP Order in the United States’. Shortly thereafter, the objection was resolved, and the Bankruptcy Court entered the recognition order.
Digicel Group One Limited (DGL1), Digicel Group Two Limited, and Digicel Group Limited (together with their debtor affiliates, Digicel) are leading providers of communications services in the Caribbean and South Pacific regions. Digicel provides a comprehensive range of mobile communications, business solutions, cable television, broadband and other related products and services to retail, corporate (including small and mid-sized enterprises) and government customers. DGL1, the debtor in the Chapter 15 case discussed below, had funded indebtedness consisting of US$1 billion in aggregate principal amount of 8.250 per cent Senior Notes due 2022 (the ‘Existing Notes’).
In recent years, Digicel has seen significant reductions in voice revenues, which were largely owing to the industry-wide trend of voice services being substituted by data usage by mobile subscribers. To address their liquidity concerns, on 1 April 2020, Digicel and an ad hoc group of noteholders entered into a lockup and support agreement (as amended, restated, supplemented or otherwise modified, the Lockup and Support Agreement). Under the Lockup and Support Agreement, the members of the ad hoc group agreed to, among other things, tender all of their Existing Notes and certain other notes in the applicable tender offer, and Digicel agreed to meet certain milestones and grant the members of the ad hoc group certain consent rights. Concurrent with the signing of the Lockup and Support Agreement, Digicel announced the commencement of various tender offers for their existing notes. With respect to the Existing Notes, Digicel Group 0.5 Limited (DGL0.5) (a newly formed holding company that will own all of the company’s current subsidiaries and other assets upon consummation of the scheme described below) offered to exchange the Existing Notes held by eligible holders for up to an aggregate principal amount of US$941 million of newly issued secured notes due 2024 to be issued by DGL0.5 (the New DGL0.5 Secured Notes). While the company commenced various other tender offers at different levels of the capital structure, DGL1 initiated a scheme of arrangement (under section 99 of the Bermuda Companies Act) between DGL1 and the DGL1 Scheme Creditors (the Scheme), in the Bermuda Court, Civil Jurisdiction (Commercial Court), 2020 in order to implement the DGL1 tender offer.
Under the Scheme, in exchange for their Existing Notes, DGL1 Scheme Creditors were slated to receive the New DGL0.5 Secured Notes, with the New DGL0.5 Secured Notes being allocated pro rata to DGL1 Scheme Creditors based on the principal amount of their Existing Notes, but excluding any accrued interest and any other amounts payable under the indenture governing the Existing Notes. Additionally, the Scheme contemplated a restructuring of Digicel by transfer of DGL1’s interests in its current subsidiaries and all other assets and known liabilities to DGL0.5. Moreover, in the event that the other conditions precedent to the Scheme’s consummation are satisfied, the Scheme contemplated that Denis O’Brien, Digicel’s founder, will cause Digicel Investments Limited (an entity controlled by him) to contribute US$50 million in aggregate consideration comprised of US$25 million in cash as well as ordinary shares and shareholder loans of Onnut Ventures Limited, which represents all of Onnut Ventures Limited’s outstanding issued share capital and outstanding shareholder loans, in exchange for 50 million common shares issued by DGL0.5 on or around the same day that the above steps occur.
On 15 May 2020, DGL1 commenced a Chapter 15 case in the United States Bankruptcy Court for the Southern District of New York. The Chapter 15 case was commenced with the following objectives:
- ensuring that all of DGL1 Scheme Creditors affected by the Scheme are treated consistently, regardless of where in the world they are located;
- entrusting the administration or realisation of all or part of the Digicel’s assets within the territorial jurisdiction of the United States to the foreign representatives of the Scheme;
- protecting DGL1 and its property, as well as the Existing Notes indenture trustee, from seizure or any lawsuits in the United States from those who are bound by the terms of the Scheme;
- ensuring that the releases under the Scheme approved by the Bermuda Court through its sanction of the Scheme will be enforceable within the United States; and
- minimising the risk of litigation over any potential residual claims that might exist under the Existing Notes Indenture in respect of the Existing Notes issued thereunder, which is governed by New York law.
On 17 June 2020, the bankruptcy court entered the Order Granting (i) Recognition of Foreign Main Proceedings; (ii) Recognition of Foreign Representatives, (iii) Recognition of Sanction Order and Related Scheme; and (iv) Related Relief Under Chapter 15 of the Bankruptcy Code, thereby granting full force and effect to the Scheme in the United States. The order was entered notwithstanding an informal objection from a relative of Mr O’Brien, who, among other things, DGL1 alleged lacked standing to object to recognition of the Scheme as he failed to articulate any alleged injury therefrom.
Swissport Fueling Ltd and its affiliates comprise the world’s leading independent provider of ground and cargo-handling services to the aviation industry based on revenue and number of airports served. As of 31 December 2019, Swissport provided ground handling and cargo services at 300 airports in 47 countries across six continents. During 2019, Swissport served approximately 265 million passengers on behalf of its airline clients and handled approximately 4.6 million tons of cargo. As noted above, the covid-19 pandemic led to a significant reduction in the number of global flights. This has severely curtailed Swissport’s core business, with volumes down by approximately 90 per cent in ground handling and approximately 30 per cent for cargo by the end of March 2020 and in April 2020. As part of a broader plan to address its recent liquidity problems, Swissport sought to incur new money super-senior financing. However, because the debtors failed to receive the unanimous consent necessary under the applicable credit documents to implement such a deal, the debtors instead toggled to a UK scheme of arrangement.
As of the commencement of the scheme, Swissport’s capital structure was as follows:
- US$1 billion outstanding under a term facility;
- US$39.9 million – cash (drawn) and US$19.8 million – letters of credit under a revolving facility;
- US$57.1 million outstanding under a revolving facility;
- US$470.5 million outstanding in 5.25 per cent senior secured notes due 2024;
- US$288.2 million outstanding in 9 per cent senior unsecured notes due 2025;
- US$238.6 million outstanding in a 15.5 per cent PIK facility;
- US$42.4 million outstanding of 6.75 per cent senior secured stub notes due 2021;
- US$18.6 million outstanding of 9.75 per cent senior stub notes due 2022; and
- US$95.8 million in local loans.
As noted above, the terms of Swissport’s existing financial indebtedness did not allow the group to incur a super senior tranche of indebtedness. Because Swissport could not obtain the unanimous consent required to execute such amendments, it chose to implement the amendments through the scheme of arrangement. Unlike an out-of-court scenario, amendments to the credit documents can be achieved, under the scheme, if the scheme is supported by a simple majority (by number) of the creditors present and voting (in person or by proxy) and representing at least 75 per cent by value (i.e., amount of the claims) of voters of the relevant class of creditors.
As noted by Swissport, the scheme of arrangement itself did not reduce any of its financial debt. Rather, the purpose was to effectuate the amendments in order to allow Swissport to obtain the new money financing; and provide Swissport with flexibility to negotiate and implement a holistic restructuring of its balance sheet in due course.
To implement the financing, amendments were necessary to both the:
- intercreditor agreement, which governed the respective rights between:
- holders of Swissport’s senior secured notes;
- holders of Swissport’s senior unsecured notes; and
- lenders under Swissport’s credit agreement; and
- Swissport’s prepetition credit agreement.
Further, because the borrower under the credit agreement was a Swiss-incorporated entity (Swissport International AG), and recognition of foreign proceedings in Switzerland is a complex process, Swissport sought to effectuate certain amendments to lower the consent thresholds required to change the identity of the borrower. Further, if such future restructuring proceedings were to take place in England, it would aid such proceedings if the credit agreement were to be governed by English law rather than New York law. As a result, Swissport sought to lower the consent threshold required to amend the jurisdiction and governing law clauses of its relevant debt documents.
On 12 June 2020, Swissport Fuelling Ltd commenced a Chapter 15 case in the United States Bankruptcy Court for the District of Delaware in order to ensure that the scheme has the force of law within the US. Under the recognition motion, the debtor sought entry of an order: (1) recognising the UK proceeding as a foreign main proceeding; (2) recognising the petitioner as the ‘foreign representative’ in respect thereof; (3) granting full force and effect and comity to the scheme and the scheme sanction order; (4) immediately closing this Chapter 15 case; and (5) granting such other relief as the court deems just and proper.
On 24 June 2020, the English court sanctioned the scheme, which received unanimous support among the creditors who were present and had voted at the scheme meeting. Led by an ad hoc group of 34 members, 81.87 per cent of total scheme debt by value attended the scheme meeting. On 6 July 2020, the US bankruptcy court entered the recognition order and, on 7 July 2020, Swissport announced that the scheme had successfully been completed.
Trends and other recent developments
Bankruptcy filings in the United States saw a very slight uptick in 2019, which was generally driven by activity in distressed sectors (e.g., energy and retail). However, the covid-19 pandemic has precipitated a number of bankruptcy filings across a wide swath of the economy. The sections below highlight recent trends relating to the covid-19 pandemic and offer some detail on recent decisions and other developments that may be relevant in US bankruptcy practice in the coming years.
i Covid-19 pandemic
As noted above, the most significant driver of 2020 US bankruptcy activity will certainly be the covid-19 pandemic. One metric evidencing the potential magnitude of the crisis is the 2,042 business Chapter 11 cases commenced during the three-month period ended 30 June 2020. During the same three-month period ended 31 March 2020, 1,854 Chapter 11 cases were filed, compared with 1,498 during the three-month period ended 31 December 2019, and 1,318 in the preceding quarter. As mandatory lockdowns and individuals’ fears of going out in public became widespread in 2020, countless sectors experienced substantial declines in revenue stemming from the covid-19 pandemic. The duration, amount and form of governmental financial support for businesses affected the pandemic will also be a factor in the amount of bankruptcy activity.
As discussed in last year’s edition of this review, the retail sector continued to constitute a substantial percentage of Chapter 11 activity in the United States in recent years. The onset of the pandemic accelerated this trend. To date, at least 26 large American retailers have commenced Chapter 11 cases in 2020. Some of these debtors include, in addition to the cases discussed above, Stein Mart, Tailored Brands, Lord & Taylor, Muji USA, Brooks Brothers, Lucky Brand, GNC, Tuesday Morning, Aldo, Neiman Marcus, and Pier 1.
The oil and gas industry also experienced significant levels of distress stemming from 2020 economic environment. Perhaps the greatest indicator of this occurred on 20 April 2020 when an oversupply and minimal demand caused crude oil prices to hit a historic sub-zero low, with futures for West Texas Intermediate Crude hitting -$37.63. Not surprisingly, 18 producers commenced Chapter 11 cases in the second quarter of 2020, the highest such figure since 2016. With more than US$9 billion in debt, the largest oil and gas company to file for Chapter 11 in 2020 was Chesapeake Energy Corporation. Given the amount of leverage in this sector, certain analysts expect that the current wave of oil and gas bankruptcy filings will continue well into the future.
While low fuel prices led to a period of prolonged growth in the airline sector during periods corresponding with prior editions of this volume, this was not the case in 2020. While the airline industry has historically been no stranger to the US Bankruptcy Court, low fuel prices in recent years largely meant that global and domestic carriers were able to generate sufficient earnings to service their debt. As discussed above, however, the grounding of flights and diminished demand for travel relating to the pandemic had immediate and extremely adverse effects on the industry. Shortly after Avianca filed for Chapter 11, LATAM Airlines Group S.A., the largest South American airline group, commenced its own Chapter 11 cases on 26 May 2020 in the United States Bankruptcy Court for the Southern District of New York. Just one month later, Grupo Aeromèxico S.A.B. de C.V., the largest airline in Mexico, filed for Chapter 11. Whether the world’s other leading airlines will be able to survive the covid-19 crisis and starve off insolvency proceedings remains to be seen.
A recent trend in bankruptcy settlements over the past several years has been the increasing use of ‘gifting’, a consensual arrangement in which a senior creditor class gives a junior class or equity some of its share of recoveries otherwise due to it under a plan of reorganisation. The rationale underlying this practice, at first glance, seems benign, as sophisticated parties with bargaining power seemingly may opt to transfer their rights to junior parties in exchange for a more swift resolution to the bankruptcy proceedings. However, this analysis becomes more complicated when an intermediate creditor is involved and the priority regime outlined in Section 507 of the Bankruptcy Code is considered. Under Section 507, there is a hierarchy in resolving the claims of various creditors against the assets of the debtor. Viewed in this light, a creditor with intermediate priority can object that junior creditors are receiving distributions before senior claims are paid in full, in violation of the absolute priority rule under Section 1129(b) of the Bankruptcy Code.
In 2011, the United States Court of Appeals for the Second Circuit handed down a decision in In re DBSD North America, which limited the ability of senior creditors to gift their share of a distribution to more junior creditors. In DBSD, the court considered whether senior creditors’ decision to gift some of its cash distribution to equity holders, bypassing junior creditors with claims of higher priority relative to the equity holders, ran afoul of the absolute priority rule. The court invalidated the plan, holding that the senior creditors had no right to gift property of the debtor’s ‘estate’ in contravention of the statutorily contemplated hierarchy. The decision left unresolved the propriety of a senior creditor bypassing an intermediate creditor in gifting non-estate property to a junior creditor. In a decision that limited the scope of the DBSD holding, the United States Court of Appeals for the Third Circuit held that the DBSD holding was limited to gifting estate property. Senior creditors, however, remained free to gift non-estate property.
An arrangement known as a ‘structured dismissal’ has become an increasingly popular technique for parties seeking to implement a gifting arrangement without running afoul of the absolute priority rule. A structured dismissal is a dismissal of a Chapter 11 case combined with additional provisions in the dismissal order, which often include mutual releases, procedures for claims reconciliation, ‘gifting’ of funds to junior creditors and retention of jurisdiction by the bankruptcy court. Structured dismissals are often employed in situations where the debtors have insufficient unencumbered assets to finance a confirmable Chapter 11 plan (e.g., after a sale of all or substantially all of such debtors’ assets pursuant to Section 363 of the Bankruptcy Code). The Supreme Court’s decision in Czyzewski v. Jevic Holding Corp indicates, however, that priority deviations implemented through non-consensual structured dismissals may not be allowed. Commentators and courts are still grappling with the ultimate scope of Jevic; while certain courts have interpreted Jevic broadly to deny priority-skipping distributions that are not tied to ‘a significant Code-related objective’; other courts have read Jevic narrowly and approved priority-skipping distributions in connection with a Chapter 11 plan or a settlement.
iii Covenants/DIP loans
Many large corporate bankruptcies involve the debtor securing post-petition debtor-in-possession financing (a DIP loan). The DIP loan provides the debtor with the cash necessary to continue its operations throughout the bankruptcy and to cover the costs of the bankruptcy. The lender extending a DIP loan to the debtor, often a pre-petition creditor of the debtor interested in protecting its pre-petition position, will place covenants in the DIP loan, setting milestones that the debtor must meet under the terms of the loan. Such milestones can include, among others, deadlines to file disclosure statement and solicit votes on a plan of reorganisation and deadlines to obtain critical relief (e.g., the filing of a motion under Section 1113 of the Bankruptcy Code seeking to modify collective bargaining agreements, deadlines to file sale procedures and sale motions, if applicable, and deadlines to obtain confirmation of a plan).
There is an inherent tension in the restrictiveness of these milestones, which can be constraining and onerous for a debtor and the need for financing. On the one hand, debtors need DIP financing, and lenders need assurances as inducement to make these loans to a bankrupt company. On the other hand, strict covenants can tie the hands of debtors and add additional complexity and expense if other creditors contest the plan supported by the DIP lenders.
The recent trend has been towards more DIP lenders insisting on more restrictive milestones in DIP covenants (though there have been recent exceptions to this trend, notably Toys ‘R’ Us). However, striking the right balance on the restrictiveness of milestones in DIP loans is still an open question. For instance, in response to the trend towards more restrictive covenants, the ABI Commission to Study the Reform of Chapter 11 recommended adding to the bankruptcy code that no milestones can require actions within 60 days of the petition date. It will be interesting to see where the market settles on this issue.
iv Pre-packaged bankruptcies
In a pre-packaged bankruptcy, a debtor negotiates a plan with its key creditors prior to the commencement of a Chapter 11 case. Solicitation of votes on the plan commences before the actual bankruptcy filing. While the Bankruptcy Code expressly contemplates this type of proceeding, there has been a recent trend towards increasingly fast-paced cases in which the debtors spend minimal time in bankruptcy. For example, the 2017 cases of Roust Corporation and Global A&T Electronics Ltd. represented two of the shortest pre-packaged Chapter 11 cases since the enactment of the Bankruptcy Code. In fact, both of the foregoing cases involved Chapter 11 plans that were confirmed in less than one week.
The year 2019 saw debtors enter and emerge from Chapter 11 faster than ever before. FullBeauty Brands filed for Chapter 11 on 3 February 2019. Its plan was confirmed on the very next day, and the company emerged from bankruptcy on 7 February 2019. Two months later, Sungard Availability Services Capital, Inc filed its pre-packaged Chapter 11 case. Less than one day after the filing, the court confirmed the debtors’ pre-packaged plan of reorganisation. The debtors emerged from bankruptcy less than 40 hours after filing.
Although each of the four cases discussed above took place in front of Judge Robert Drain of the United States Bankruptcy Court for the Southern District of New York, this trend is not limited to this venue. On 4 February 2019, Arsenal Energy Holdings LLC and its debtor affiliates filed for Chapter 11 in the United States District Court for the District of Delaware. One week later, the court confirmed Arsenal’s pre-packaged plan.
Proponents of these expedited procedures argue that swifter pre-packaged bankruptcies minimise disruptions to a company and its trade creditors, critical vendors, and employees. However, critics assert that such cases short-circuit the bankruptcy process and undermine the notice requirements of the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure. As debtors continue to seek out more efficient methods of effectuating balance sheet restructurings, the trend toward faster pre-packaged bankruptcies is likely to continue in the near term, notwithstanding the increase in traditional ‘free fall’ Chapter 11 cases resulting from the covid-19 pandemic.