December 14, 2021 - by Elliot Ganz. In the wake of the 2020 elections, with control of the presidency and both houses of Congress passing to the Democrats, the LSTA anticipated an interesting and eventful year for political activity impacting the loan market and for the LSTA’s political engagement and advocacy. And eventful it was. Five bills that could potentially impact the loan market were introduced in 2021. While passing any legislation in the current Congress is very challenging, the LSTA will be following these bills closely as we head into 2022 given how much is at stake. Through the LSTA’s grassroots advocacy affiliate, the Business Loans Coalition, LSTA members can support the LSTA’s advocacy effort and receive up to the minute information on our advocacy efforts.
Below, we review this year’s most important loan-related legislation and consider what we might expect in 2022.
In late October, the “Stop Wall Street Looting Act of 2021” ( the “SWSLA”) was introduced in the House and Senate. The bill, which primarily targets the private equity market, would reimpose risk retention on managers of CLOs and make changes to the bankruptcy code that would negatively impact secured creditors. Title VI of the bill, “Restrictions on Securitizing Risky Corporate Debt” amends Section 15G of the Securities Exchange Act of 1934 (Section 941 of the Dodd-Frank Act) by defining managers of CDOs (which would include CLOs) as a specific category of “securitizers”. This would effectively re-impose risk retention on managers of CLOs, requiring them to purchase and hold 5% of the fair value of CLOs they manage.
The LSTA believes that reimposing risk retention would be a significant policy error for several reasons. First, the original statutory rationale for imposing risk retention was to require managers of “originate-to-distribute” securitizations to have “skin in the game”. While this may work for originate-to-distribute securitizations, it assuredly does not make sense for CLOs where managers do not originate loans but, instead, purchase them in the open market. Indeed, the Court of Appeals panel that ruled on statutory grounds that that risk retention does not apply to CLO managers agreed that CLOs already achieve the policy goals sought by Congress through the incentives and transparency built into their structure.
Second, the Court’s view has been affirmed by federal regulators and independent auditors and validated by decades of experience. CLOs have performed extremely well for over 30 years, including through the 2008 financial crisis and the Covid-19 pandemic and investors in CLOs have experienced barely any losses at all. Moreover, federal regulators and the Government Accountability Office (GAO) have all concluded that neither syndicated loans nor CLOs are systemically risky.
At bottom, CLOs have performed very well, do not impose systemic risk, and their interests are already aligned with those of their investors. Reimposing the risk retention mandate, as SWSLA proposes, would be a costly mistake.
This year, four significant pieces of bankruptcy legislation were introduced in Congress each of which could have a significant impact on the loan and CLO markets.
Venue Reform. The “Bankruptcy Venue Reform Act of 2021” is designed to address the issue of “venue shopping” whereby debtors file for bankruptcy in districts where they believe courts will be more sophisticated and sympathetic even though they are not located their primary places of business (indeed, in most cases, the districts have very tenuous connections to the company). The bill would require companies to file for bankruptcy in the district in which their principal place of business is located. This issue is germane to the loan market because in a very high percentage of recent complex restructurings debtors have chosen to file in a small handful of courts they view as favorable, such as Delaware, White Plains New York, Houston Texas, and Richmond Virginia. Bipartisan venue reform legislation has been introduced numerous times over the years and has never gotten much traction for several reasons. First, it is an esoteric issue that has not been viewed as a priority, and second, members of Congress from states that have traditionally benefited from venue shopping (mainly Delaware and New York, where most complex bankruptcy cases were traditionally filed), have stood in the way. This time, however, things might be different. A number of high visibility, emotionally-charged cases like Purdue Pharma, Boy Scouts of America, and the National Rifle Association involved debtors who filed for bankruptcy in jurisdictions that have little or no relationship to their principle places of business. Moreover, bankruptcy forum shopping has morphed into “judge shopping” as a few bankruptcy districts have set up complex case courts where debtors know their case will be adjudicated by one or two sympathetic judges.
Release of Non-debtors. The “Nondebtor Release Prohibition Act of 2021” would severely limit the ability of bankruptcy judges to approve “third-party releases” to parties that have not themselves filed for bankruptcy. The bill would also effectively prevent companies that reorganize through a so-called “Texas Two-Step“ transaction from taking advantage of Chapter 11 reorganization. In a Texas two-step, a company restructures into two companies and then files one of them in bankruptcy thereby isolating the “clean” company from the bankruptcy process. This bill was introduced at a House Judiciary Committee hearing that focused on perceived abuses relating to several “mass tort” cases such as Purdue Pharma and Boy Scouts of America. Members and witnesses expressed their opposition to the ability of non-debtor third parties to stay litigation against themselves and obtain far-reaching releases through the debtors’ bankruptcies even though they were not filing for bankruptcy themselves and were not disclosing their financial records. Although the impetus for this bill arises out of mass torts cases, their non-debtor release provisions are broadly written and would extend to corporate loans. Many syndicated loan restructurings rely on third-party releases so the impact of this bill would be significant. Similarly, Texas-two step transactions are commonly used in more traditional corporate bankruptcies and would be swept up in this bill.
Bonus Payments in Bankruptcy. The “No Bonuses in Bankruptcy Act of 2021”, would prohibit the payment of most bonus and retention payments to highly compensated employees and insiders of companies that file for bankruptcy. This bill is designed to address a perceived loophole to the 2005 bankruptcy reforms that prohibited bankruptcy bonuses. As the General Accountability Office (GAO) noted in a report, many debtors work around that restriction by paying bonuses just prior to a filing. This bill would close that loophole. It would prohibit retention bonuses from being paid, both during or prior to a bankruptcy, to executives making more than $250,000 per year. The GAO report found that in fiscal year 2020, $165 million in bonuses were paid to 223 executives across 42 companies shortly before they filed for bankruptcy. The report also found $207 million in incentive bonuses were authorized for 309 executives across 47 companies during their bankruptcies.
The bill also empowers the U.S. Trustee (the Department of Justice’s bankruptcy watchdog) to claw back bonuses paid in the six months prior to a bankruptcy filing if those payments would not have been allowed during the bankruptcy.
The issue of bankruptcy retention bonuses has always been controversial. Some argue that bonuses should not be paid to parties that are responsible for a company falling into bankruptcy in the first place while others believe that it is in the interest of the bankruptcy estate to keep the prior leaders in place to avoid the resulting disruption that might result from their leaving.
Worker Protection. The “Stop Wall Street Looting Act of 2021” (“SWSLA”), would radically reform the bankruptcy code much to the detriment of secured creditors, including lenders in the institutional syndicated and private debt markets. Title III of the bill, “Protecting Workers When Companies Go Bankrupt” would, among other things, increase the priority of certain unpaid wages, severance payments, contributions to employee benefit plans, and state and federal claims, to administrative claims, thereby diluting the priority and value of senior secured claims that collateralize loans. The bill would also impose a “surcharge” on the value of collateral held by secured creditors. Importantly, these changes would apply to all secured loans, not only those related to private equity sponsored funds (which is the ostensible target of the bill).
What is likely to happen? With Senate Democrats holding the barest of majorities (50/50 with the Vice President breaking ties) and given the Senate’s focus on reconciliation and many other matters, these bills are unlikely to get much immediate traction. Nevertheless, because the stakes are so high, it will be important for the LSTA to closely follow the bills and vigorously advocate where necessary.
Conclusion. As expected, 2021 was a very active year on Capitol Hill for issues impacting the loan market. We expect no less in 2022 and will be monitoring issues closely as they develop.