June 23, 2021 - The deterioration of market norms has received much attention during the past year. Most recently, we wrote about how increasingly long and complex loan documentation, coupled with court decisions, are leading to unexpected outcomes in loan workouts. Today we introduce two recently posted law review that focus on different trends that have allowed borrowers to weaponize the bankruptcy process. In an article titled “The Rise of Bankruptcy Directors”, Jared Ellias, Ehud Kamar and Kobi Katiel show that many distressed companies, especially those controlled by private equity sponsors, prepare for bankruptcy by appointing bankruptcy experts to their boards of directors and give them the power to make key bankruptcy decisions. These supposedly independent directors (who are usually appointed repeatedly) often seek to wrest control from creditors of self-dealing claims against shareholders. The authors find that unsecured creditors on average recover 21% less when a company appoints such directors. In a second paper, “Purdue’s Poison Pill: The Breakdown of Chapter 11’s Checks and Balances”, Adam Levitin argues that the procedural checks and balances structure of bankruptcy are breaking down because of three interconnected factors. First, coercive restructuring techniques (such as RSAs and DIP loan provisions) often lock in the determination of subsequent decisions in bankruptcy. Second, it is increasingly more difficult to appeal these decisions for several reasons, including the doctrine of “equitable mootness” (which forecloses the possibility of an appeal). Finally, the ability of borrowers to “judge shop”, combined with the other two trends, gives them an insurmountable home court advantage. While we will do a deep dive on those articles next week., LevFin’s Max Frumes (author of “The Caesars Palace Coup”, a compelling account of the Caesar’s bankruptcy), interviews one of the authors of the first paper (available here).
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