Although I teach, write and practiced predominantly in corporate and commercial law, I also have an LL.M. in Tax. Granted, my LL.M. coursework largely focused on business taxation, and therefore falls squarely within my interests. Nonetheless, given that tax and corporate/commercial law are treated as separate legal disciplines, I see tremendous opportunities for comparative and interdisciplinary analysis among tax, corporate and commercial law.

For instance, I find it intriguing that courts employ highly divergent decision-making approaches in these realms. In the tax realm, courts tend to focus on the actual economic arrangement of the parties, in an effort to identify economic substance rather than mere contractual form. Courts presiding over tax cases tend to utilize more expansive and contextual interpretive methodologies, and routinely scrutinize objective and subjective intent and other "facts and circumstances." These approaches stand in contrast to the dominant, textualist interpretive paradigm in corporate and commercial law, which relies almost exclusively upon strict interpretive norms (such as rules of contract interpretation) to construe written agreements.

To be sure, these divergent methodologies reflect the differing goals of tax, corporate and commercial law. While jurisprudence across all three disciplines emphasizes the need for certainty, uniformity and predictability in the law, tax law remains manifestly skeptical of the party autonomy that corporate and commercial law strive to protect. Courts presiding over tax cases are often called upon to examine possible crimes against the public fisc; in contrast, courts presiding over corporate and commercial law cases are generally called upon to manage disputes among sophisticated parties to voluntary, utility-maximizing arrangements.

Yet despite these distinctions, courts are increasingly importing tax doctrine into the corporate and commercial law context. A classic example is the "debt recharacterization doctrine." In the federal income tax realm, considerably high stakes turn on the proper classification as debt or equity of a person's interest in a corporation. Generally speaking, the characterization of the investment as a loan means that payments of interest will be includible in gross income. In contrast, to the extent the investment is deemed to be an equity capital contribution, then the principal amount of the investment must be capitalized into the investor's basis in the corporation's stock. The tax treatment of any repayment will be determined pursuant to rules governing corporate distributions, with any amounts deemed to be a dividend includible in gross income. In light of these differing tax consequences, courts have developed multi-factor, highly facts-intensive and contextual analyses to recharacterize a purported debt instrument into an equity investment, and to reassign tax consequences accordingly.

The debt recharacterization doctrine was subsequently imported into the bankruptcy realm. In that context, if a court determines that an investment is equity rather than debt, then the claim will be treated as an equity ownership interest in respect of which no distribution of corporate assets can be made unless creditor claims are satisfied. Even within the less formalistic realm of bankruptcy, the importation of the debt recharacterization doctrine is a major departure from dominant jurisprudential norms. As a general matter, bankruptcy courts look to state contract law when matters arise under private agreements and there is no statutory law on point. For this reason, although bankruptcy courts have wide latitude to exercise legal and equitable powers, most matters that arise in respect of contracts are construed in accordance with state contract law, including rules of contract interpretation.

Of course, the bankruptcy context, much like the tax realm, may provide inherent justifications for the application of more expansive judicial methodologies. In particular, courts applying the debt recharacterization doctrine in bankruptcy matters are frequently responding to the plight of third party creditors who may recover less due to the crafty maneuvers of shareholders.

More recent cases demonstrate a willingness to import tax doctrine into corporate and commercial law even where the justifications for doing so are less obvious. For instance, in Coughlan v NXP BV, C.A. No. 5110-VCG (Del. Ch. Nov. 4, 2011), the Delaware Court of Chancery applied tax law's "step transaction doctrine" to an action brought by a stockholder representative seeking to construe terms of a merger agreement. In tax law, the step transaction doctrine is applied where parties engage in multiple transfers to circumvent rules that would apply to a more direct transfer. In Coughlan, the merger agreement provided that, in the event of a change in control of NXP or of pertinent corporate assets, the person acquiring NXP or the assets would be required to accelerate certain contingent payments or assume the obligations. The stockholder representative argued that NXP's two-step transfer of assets to a joint venture amounted to a change in control. NXP argued that it engaged in two transfers that were each permitted under the merger agreement. The court applied the step transaction doctrine, finding that the two transfers should be analyzed as a single transaction that ultimately effectuated a change in control.

The court explained that the step transaction doctrine has been imported into the Delaware corporate and transactional context as well as the bankruptcy realm. It cited a 2007 case construing provisions in a partnership agreement, whereby the Court of Chancery defended application of the doctrine: "I see no reason as a matter of law or equity why the step transaction principle should not be applied here. Indeed, partnership agreements in Delaware are treated exactly as they are treated in tax law, as contracts between the parties." Twin Bridges Ltd. P’ship v. Draper, 2007 WL 2744609, at *10 (Del. Ch. Sept. 14, 2007).

To be sure, such a rationale denies fundamental differences in tax, corporate and commercial law. However, in terms of judicial decision-making methodologies, the increased application of tax doctrine to cases in the corporate and commercial law realm may signal a movement away from formalism, and a rising interest in identifying the actual economic arrangement of parties as opposed to merely construing contractual form. Indeed, the Court of Chancery articulates this point in Coughlan, issuing words of caution to parties who rely on the written word in their business planning and legal advocacy: "transactional formalities will not blind the court to what truly occurred." Coughlan, C.A. No. 5110-VCG at 23.

Permalink | Bankruptcy| Corporate Law| Taxation | Comments (0) | TrackBack (0) | Bookmark

• Why is Judge Rakoff suggesting that there might be constitutional problems with clawing back Madoff money from the Mets owners?  My guess is that he's thinking about Due Process issues (a lack of notice, and a switch in legal regimes based not on the conduct of the Wilpons, but on Madoff's conduct).  But bankruptcy has usually been able to get around these sorts of problems.
• If you missed it, the Times built a story around Bob Lawless's explanations for the decline in consumer bankruptcies.

Permalink | Bankruptcy | Comments (0) | TrackBack (0) | Bookmark

Cross-border resolution authority is a form of bankruptcy, and getting the sovereigns to agree on bankruptcy coordination rules is difficult, as Stephen Lubben explains in DealBook.  Chapter 15 was amended in 2005 to try to encourage more coordination in international bankruptcies.  Here's Lubben:

But Chapter 15 does nothing to address the crucial problem an international enterprise faces upon bankruptcy. Before a bankruptcy, the enterprise might operate seamlessly across borders, but after the filing,  each corporation that makes up the enterprise becomes a separate case. When all the constituent corporations are from the United States, for example, these cases are easily consolidated in a single forum with a motion for “joint administration.” Thus, all of MGM’s 160 bankruptcy cases are pending before a single court in New York.

But if the various corporate pieces of a debtor are spread across several countries, the problems of dueling bankruptcy cases are not easily addressed. Even after the passage of Chapter 15, and the enactment of similar laws in other developed economies, international corporate bankruptcy largely remains a country-by-country affair.

Similar concerns, of course, apply to resolution authority, which is one reason it has become a matter of international diplomacy for financial regulators, rather than merely a matter of extraterritorial application of the FDIC's resolution rules.  Hence the entrance of the Basel Committee, and I'll address that a bit tomorrow.

Permalink | Administrative Law| Bankruptcy | Comments (0) | TrackBack (0) | Bookmark

The General Accounting Office has released TROUBLED ASSET RELIEF PROGRAM:  Automaker Pension Funding and Multiple Federal Roles Pose Challenges for the Future, brought to my attention by my colleague, Anne Lawton.  The general subject is the impact of GM/Chrysler failure on the Pension Benefit Guaranty Corporation ("PGBC") and the conflict inherent in the government's role as shareholder.  Anne has looked over the executive summary and what follows is based on her report.

First point. Over the next 5 years, GM and Chrysler will need to make significant contributions in order to satisfy minimum funding requirements for their defined benefit plans. For example, GM projects that total to be $12.3 billion for 2013 and 2014, with the possibility of additional further contributions. That's fine if the firms are profitable enough to make those contributions. But, what happens if the pension funds fail? About a year ago, PBGC estimated that the losses from failure of GM's and Chrysler's defined benefit plans would be $14.5 billion.

Second point. The Treasury is a shareholder in the firms. But, PBGC is governed by a three-member board and the Treasury Secretary (along with Labor and Commerce Secretaries) are the board members (right now, the Assistant Secretary of the Treasury for Financial Institutions is the board rep.) So, the report asks, how is the government "dealing with the potential tensions between its multiple roles as pension regulator and insurer, and its new roles as shareholder and creditor?" 

That's a good question.  To remind you, the report is here.

Permalink | Bankruptcy| Current Affairs | Comments (0) | TrackBack (0) | Bookmark

Almost exactly one (short) month after a hearing on February 2, 2010, Bankruptcy Judge Burton Lifland has issued an opinion upholding Trustee Irving Picard's calculation of "Net Equity" in untangling Bernard Madoff's Ponzi scheme (referred to by the judge as the "Net Investment Method").  (Story here; opinion here; prior posts here and here.)Though many victims had argued that their claims were equal to the balances on their November 20, 2008 statements from Bernard L. Madoff Investment Securities LLC, the judge held that this "Last Statement Method" ignored the fictitious nature of the returns reflected there and any withdrawals made, which necessarily were paid out of victim principal.  Therefore, the judge upheld the Net Investment Method, which defines a valid claim as the principal paid in less withdrawals.  The judge acknowledges that this method will lessen or extinguish many victims' claims.  However, the court states that "[t]he Net Investment Method harmonizes the definition of Net Equity with these avoidance provisions [from the Bankruptcy Code] by similarly discrediting transfers of purely fictitious amounts and unwinding, rather than legitimizing, the fraudulent scheme."

In anticipation of this ruling, three "net winner" victims have filed a lawsuit in New Jersey against the President and Directors of SIPC for running a "fraudulent investment insurance scheme."  Two of the victims have lessened or extinguished claims under the ruling because of withdrawals, but one victim seems to run afoul of the definition of "customer" (she is a member of an LLC that was a customer).  As they say, we will stay tuned.

Permalink | Bankruptcy | TrackBack (0) | Bookmark

Don't miss the Faculty Lounge's series on Greek sovereign debt, curated by Kim Krawiec and featuring contributions by Lee Buchheit, Mitu Gulati, and Anna Gelpern so far ... it's just the sort of rare mini-symposium that you don't often see in the blogosphere that often, present company excepted (we'll speak no ill of the Conglomerate here).  The writing is pretty witty, too, as it so often is whenever the subject is sovereign debt.  Do give it a look.

Permalink | Bankruptcy | Comments (0) | TrackBack (0) | Bookmark

While in Vegas I attended a great session on the gaming industry and bankruptcy.  I took a lot of notes, but what's stuck with me are Frank Merola's remarks origins of the gaming industry and their effect on gaming regulation.

According to Merola’s account, when the gaming industry was born in the 1950s, no banks would lend money to casinos, and they lacked access to the public markets as well.  So casino operators financed each other’s operations by taking a minority interest in a competitor (Caveat: I’m not sure of the accuracy of this assertion—everything I know about the casino industry I learned from…well…Casino).  Given this background, there was a real emphasis on knowing with whom you’re doing business (insert mafia joke here).  When Nevada enacted its Gaming Control Act in the late 1950s, it also focused on who was investing money, i.e., the state’s strict licensing requirements took their cues from the underlying structure of casino financing. 

Of course, the modern financial landscape looks very different from the 1950s, and it took a while for Nevada to decide how to handle investors whose character could not be readily ascertained.  It introduced institutional investor waivers to allow mutual funds with no identifiable owners to invest in casinos.  And, eventually, it let private equity funds in as well, using a kind of blind trust. Sounds like the separation of ownership from ownership has hit even the insular world of Las Vegas, doesn't it?

Permalink | Bankruptcy | TrackBack (0) | Bookmark

Instructed to be provocative, the illustriously named former Sen. Gordon Smith’s opening remarks included the observation that "All great nations in history presaged their declines with massive debt" and a reference to the "awful arithmetic" of our national debt. He closed by asking whether there should be a bankruptcy remedy for states, as there is for municipalities or counties. David Skeel responded that he doubted whether Congress would allow this, but hypothesized that states could issue bonds with voting provisions in place that would allow the debt to be restructured midstream. Smith was skeptical of the market’s appetite for such debt.

Permalink | Bankruptcy | Comments (0) | TrackBack (1) | Bookmark

At least, so says Rick Chesley, head of Paul Hasting's bankruptcy practice, in today's WSJ.  The article describes a "heated auction" for the remains of Polaroid Corp, an exciting story about 28 bids and counter-bids, and victory snatched from the top bidder by the bankruptcy judge.   

I still remember the magic of the polaroids of my youth--click a button, hear a whirr, a odd-sized, thick piece of paper comes out, you wave it and maybe blow on it, and await an image snatched from just minutes ago.  Today's digital cameras offer more instant gratification, but polaroid anticipation was a large part of the fun.  The WSJ eschews such nostalgic indulgences in favor of couture-commentary worthy of People magazine, describing the auction as follows:

"The 49-year old Ms. Tilton, sporting a 13-karat yellow diamond ring and four-inch Alexander McQueen stiletto heels, hardly looked the part of a Wall Street vulture....And the 5-foot-5-inch Mr. Salter is no sartorial slouch either. Dressed in a Dolce & Gabbana suit, Ferragamo loafers and a Brioni necktie, he carried a Louis Vuitton briefcase."

But I digress from my topic:  What does it mean that bankruptcy is "the new M&A?"  According to the article, 67 deals in 2009 have come from bankrupcty courts.  At my old firm the M&A attorneys were Masters of the Universe, swooping into tense situations, taking stock and taking charge, subsisting on Diet Coke for weeks at a time as they leapfrogged from deal to deal.  One told a fellow associate, "When I walk into a room, I know I can dominate everyone else there, physically and mentally."  Bankruptcy lawyers generally had a more conciliatory personality, part-counselor, part-bulldog.  I wonder whether Chesley was trying to claim a little of that old M&A lustre for himself?  If bankruptcy really is the new M&A, there will be lots of M&A lawyers looking for a piece of the action.

Permalink | Bankruptcy | Comments (0) | TrackBack (0) | Bookmark

One of my favorite podcasts, in addition to banquet of delights contained the UChannel series (quite the array of luminaries there, and, uh, Jonah Goldberg), is EconTalk, which comes out once a week, takes about an hour, and gets a pretty good, if right leaning, set of guests.  If only they had more lawyers though!  Sunstein did one last year, and I'm happy to point you to Todd Zywicki in this week's episode.

Permalink | Bankruptcy | Comments (1) | TrackBack (0) | Bookmark

Every commercial law teacher and bankruptcy teacher should distribute this story on the first day of class.  About a year and half ago, BofA mistakenly terminated both its and Citibank's financing statements perfecting security interests against Heller Ehrman, the California law firm that is now in dissolution.  Basically, someone checked the wrong box on this form!  This could turn out to be something close to a $57 MM clerical error. 

The firm had already paid the banks $51 MM since the firm announced its dissolution in September.  The banks tried to file a "correction" in October; the firm's dissolution committee discovered the termination document in November; in December the firm filed for Chapter 11 and has asked the court to throw out the banks' attempted October correction.  Assuming a strict application of the UCC, the attempted October correction would be a preferential transfer of a security interest, which would be avoided.  That makes the $51 MM in payments to the banks (or whatever portion was paid within the 90 days before Heller's bankruptcy filing) preferential.  So they have to give it back.  And the remaining $6 MM owed by the firm would also be unsecured.  So the banks might end up with something close to a $57 MM unsecured claim, instead of the secured position they thought they had.  Ugh.  Everyone make sure your malpractice premiums are paid up!

Apologies if your eyes glazed over while reading that last paragraph.  Can you tell I've been grading bankruptcy exams?  I actually thought about saving this fact pattern for next year's exam, but it's just too good not to share!

Permalink | Bankruptcy| Law Schools/Lawyering| Transactional Law | Comments (2) | TrackBack (0) | Bookmark

As the Big Three automakers' pleas for emergency bailout money appear to have fallen on deaf ears on Capitol Hill, the blogosphere is awash with discussion of bankruptcy scenarios (see, e.g., here, here, and here).  "Prepackaged" bankruptcy in particular seems to be a popular solution (see here and here).  But I find it hard to see how a prepack would work here.  Unlike a standard Chapter 11 filing, a prepack is a bankruptcy filing where the debtor and its major constituents--in this case, bondholders, banks, employees, unions, management, dealers (have I left anyone out?)--already have a deal worked out before they file.  Instead of negotiating in Chapter 11 (i.e., after the Chapter 11 filing), management and the major constituents work out the company's financial restructuring, new financing, and anticipated operational changes beforehand, and when they file for bankruptcy, they include not just the bankruptcy petition, but also the plan of reorganization and all the creditor consents required to confirm the plan.

Just judging from what I read in the paper, it is not apparent that the Big Three have had any discussions with their banks or bondholders or dealers about how to share the pain of a restructuring, or who would provide financing in bankruptcy.  Now, this may be just posturing on the part of companies.  They seem to be playing chicken with Congress, on the "too-big-to-fail" theory.  Needless to say, that's a dangerous game.  Especially during the interregnum, the specter of political gridlock looms large.

There may just be some usage issues here:  when commentators say "prepackaged," they might instead mean some kind of bankruptcy filing with strong government involvement.  For example, the government could offer bankruptcy financing conditioned on specific operational and managerial changes.  Not a bad idea.  But that's not a prepack.

Permalink | Bankruptcy| Current Affairs| Employees| Financial Crisis | Comments (2) | TrackBack (0) | Bookmark

In April 2008, U.S. business bankruptcy filings were up over 49% from the previous April.  That percentage has continued to increase, peaking recently with several high-profile bankruptcy cases, including Lehman Brothers, Washington Mutual and Circuit City.  During the past 90 days alone, according to filings posted on PACER, 395 chapter 11 cases were filed in the District of Delaware and 107 such cases were filed in the Southern District of New York.  (These numbers do not reflect businesses that have filed for liquidation under chapter 7 of the U.S. Bankruptcy Code.)  A similar trend is emerging in the United Kingdom, where business bankruptcies are up 26%.

And based on October sales numbers, the trend most likely will continue.  Retail sales were down 2.8% (4.1% from one year ago).  The breakdown shows retail sales, excluding autos, down by 2.2% and auto sales down an estimated 5.5%.  So, how will this current wave of corporate bankruptcies affect the economy?  Certainly, consumers may benefit from lower prices.  Reports suggest that retailers already are offering discounts similar to those traditionally reserved for the Friday after Thanksgiving and the few days before Christmas.  Gasoline prices also have dropped precipitously.  Of course, corporate bankruptcies are not all good news for consumers.  As Lisa Fairfax noted in a pair of informative posts last week (see here and here), unemployment is on the rise.  Corporate bankruptcies typically pose some risk of layoffs for employees, but that risk appears to be especially acute in the current wave of bankruptcies.

Corporate rehabilitation and the attendant preservation of jobs are important goals underlying chapter 11 bankruptcy.  A debtor needs cash flow, however, to accomplish these goals.  This fact does not change in bankruptcy.  A debtor that lacks adequate financing during the bankruptcy case or a viable business model simply cannot continue in business.  Unfortunately, many corporations that have filed for bankruptcy recently could not secure adequate debtor-in-possession financing or cannot generate sufficient revenues to sustain their business models.  Both problems stem, in part, from the current credit crunch—banks are not lending and consumers and business customers are not spending.

The result is an increase in corporate liquidations and resulting job losses, particularly in the chapter 11 context.  (A recent article notes that Edward Altman has predicted not only an increase in corporate bankruptcies and bond defaults, but that “the unemployment rate could peak as high as 9.5 percent.”)  Just a few examples of recent chapter 11 liquidations include Lehman Brothers, Washington Mutual, Mervyns, Whitehall Jewelers and Steve & Barry’s.  For interesting and thoughtful discussions of the pros and cons of liquidating a business under chapter 11 versus chapter 7 of the U.S. Bankruptcy Code, see Stephen Lubben’s 2007 article and a recent article by Michael Cooley posted on the TMA website, which explores the issue from a strategic perspective.

The trend of corporate liquidations also may be good news for market competitors.  In fact, several observers are speculating that Best Buy will benefit from Circuit City’s bankruptcy filing because it allows Best Buy to gain market share.  (Even if Circuit City does not ultimately liquidate in chapter 11, it already has announced plans to close 155 stores.)  Likewise, Wal-Mart reported third-quarter earnings of $3.14 billion and an increase in sales.  This competitive edge is somewhat the inverse of what happened during the last bankruptcy cycle, where reorganized debtors emerged from bankruptcy with trimmed down balance sheets and an edge over their non-debtor, leveraged competitors.

Finally, more corporate bankruptcies mean more work for bankruptcy lawyers, financial advisers, investment bankers and other professionals that work in the bankruptcy field.  For an extensive and extremely well done exploration of professional fees in bankruptcy, see Stephen Lubben’s 2007 report.  By way of example, observers predict that professionals’ fees in the Lehman Brothers’ liquidation will top $1.4 billion, plus costs of hiring experts to assist in the winddown (estimated at $200 million).  These numbers certainly prove the old saying that you can’t be broke to file bankruptcy.

Permalink | Bankruptcy | Comments (2) | TrackBack (0) | Bookmark

If you take the way the Fed has used its discount window so far as legal, then you wouldn't think that Treasury and the Fed would need to go to the Hill for authority for a massive bailout of everyone else.  I guess the institutions are beginning to run out of money, though.  I'd like to see a few more collapses before there is a superbailout, but do admit that the way each rescue has been done so far hasn't really contributed to moral hazard too much; the shareholders at Bear and AIG, and management at Frannie, have essentially lost everything by going under government protection.  Anyway, more skepticism about the use of the authority so far from Eric Posner, and don't miss this post by Steven Davidoff.

If I were the Fed, I'd get a retroactive blessing for the AIG takeover and for Bear too, for that matter, along with prospective bailout legislation.  The retroactive blessing wouldn't make the takeovers okay when they were done, but it would probably moot any efforts to undo those arrangements (if a plaintiff could figure out a way to get standing, and noting that courts don't usually supervise bailouts, etc).

Permalink | Bankruptcy | Comments (1) | TrackBack (0) | Bookmark

AIG wants access to the Federal Reserve's so-called discount window, investment banks already get it, the Fed is planning to expand it dramatically, and other companies, like the automakers, are wondering whether they can also benefit from taxpayer largesse.  Who can access the Fed's discount window? 

The short, but surprising, answer is that any of these institutions could access that window if the Fed wished to permit it.  Congress created the discount window with 1932 amendments to the Federal Reserve Act, and those Great Depression agencies (the SEC is another one of them, so is the FCC and NLRB) were given very broad statutory mandates.  Section 13(3) of the act provides

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.

Section 14(d), referenced above, simply authorizes the Fed to set these rates, which "shall be fixed with a view of accommodating commerce and business."

It is, like I said, a lot of power, and it was invoked by the Fed when it extended the discount window to investment banks (which the Fed doesn't regulate) in the wake of the disappearance of Bear Stearns.  Here's what the Fed said in the minutes it released on that decision:

[in deciding whether to offer] an extension of credit to any individual, partnership, or corporation under section 13(3) of the Federal Reserve Act, all available Board members then in office unanimously determined, in connection with the authorization of the extension of credit, that (1) unusual and exigent circumstances existed; (2) Bear Stearns, and possibly other primary securities dealers, were unable to secure adequate credit accommodations elsewhere; (3) this action was necessary to prevent, correct, or mitigate serious harm to the economy or financial stability; ... and (6) any credit extended will be payable on demand.

(Also discussed here.)  So upon a finding of unusual and exigent circumstances, the Fed can lend at bargain rates to just about anyone - and take pretty worthless collateral in exchange for its government-guaranteed money.

No big conclusion here, we're just being descriptive.  But the next time someone tells you that bureaucrats inevitably expand their powers to the outer limits of their statutory authority, ask them the last time the Fed got involved in a personal bankruptcy.  Or ask them about Lehman.

Permalink | Bankruptcy | Comments (19) | TrackBack (0) | Bookmark