Archive for September, 2007
Sunday, September 30th, 2007
It's always gratifying to learn that bankruptcy legends read this blog. Lynn LoPucki is one of those people.
Last night I opened an email I received from Professor LoPucki letting me know that he and my (not-so-old) old law school professor, Doug Baird, would be duking it out at the University of Chicago Faculty Law Blog over issues raised in Professor LoPucki's recent paper (written with empiricist Joseph W. Doherty) entitled Bankruptcy Fire Sales, 106 Mich. L.R. 1 (2007). The article was posted on SSRN last April, accompanied by the following abstract:
For more than two decades, scholars working from an economic perspective have criticized the bankruptcy reorganization process and sought to replace it with market mechanisms. In 2002, Professors Douglas G. Baird and Robert K. Rasmussen asserted in The End of Bankruptcy (pdf), an article published in the Stanford Law Review, that improvements in the market for large, public companies had rendered reorganization obsolete. Going concern value could be captured through sale.
This article reports the results of an empirical study comparing the recoveries in bankruptcy sales of large public companies in the period 2000-2004 with the recoveries in bankruptcy reorganizations during the same period. We find that, controlling for company values reported at case commencement, pre-filing operating profits, and post-filing operating profits, the recoveries in reorganization cases are more than double the recoveries from going concern sales. We attribute the low recoveries in sale cases to continuing market illiquidity and the corruption of the bankruptcy process by competition among bankruptcy courts for large, public company cases.
We also find that bankruptcy recoveries are higher in years when merger and acquisition activity is higher for reasons other than high stock prices. Lastly, we find that bankruptcy recoveries are higher when debt capacity in the debtor's industry is lower – the opposite effect predicted by Professors Andrei Shleifer & Robert W. Vishny in their landmark article in 1992 [entitled Liquidation Values and Debt Capacity: A Market Equilibrium Approach, 47 J. Fin. 1343 (1992)].
This "H2H"--as the U of C Law Blog calls the "head to head" grudge match--is sure to be a classic, as Professors LoPucki and Baird have been sparring over bankruptcy's most fundamental questions since 1990, when Professor LoPucki first challenged Professor Baird's "faith" in the free market's ability to properly value a company's worth in chapter 11. See LoPucki, Bargaining Over Equity's Share in the Bankruptcy Reorganization of Large, Publicly Held Companies, 139 U. Penn. L. Rev. 125 (1990). Their ongoing debate remains central to bankruptcy jurisprudence, as noted in this last post, with recent opinions by the Seventh Circuit's Judge Cudahy (while sitting by designation as a Third Circuit judge in VFB LLC v. Campbell Soup Co.) and Judge James M. Peck (in the Iridium bankruptcy) suggesting that judges, by placing a heavy burden of proving market folly on the party challenging the market's indication of value, are beginning to share Professor Baird's faith in free market valuations.
Professor LoPucki also took issue early on with the idea that chapter 11 should be eliminated and companies forced instead to liquidate expeditiously in chapter 7, an idea he attributes first to a 1986 article by Professor Baird (and Professor Baird's former writing partner, Thomas H. Jackson). See LoPucki, Strange Visions in a Strange World: A Reply to Professor Bradley and Rosenzweig, 91 Mich L. Rev. 79 n.2 (1992); and LoPucki & Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 Univ. Pa. L. Rev. 669 (1993).
Professor LoPucki stepped up the rhetoric in the debate in 1994, paying Professor Baird this back-handed compliment at an interdisciplinary conference at Wash. U. Law School: "Without the unrealistic work done by Baird and Jackson during the 1980s, bankruptcy scholarship might not have gone beyond the relatively shallow analysis produced by doctrinalism in the 1970s." See LoPucki, Reorganization Realities, Methodological Realities, and the Paradigm Dominance Game, 72 Wash. U. L. Q. 1307, 1312 (1994).
Professor Baird (with my former classmate, USC Law School Dean Bob Rasmussen) in The End of Bankruptcy, 55 Stan. L. Rev. 751 (2002), extended his critique of chapter 11 by concluding that "[c]orporate reorganizations have all but disappeared" and that chapter 11 has been transformed of late into a "convenient auction block" or a site that "merely put[s] in place preexisting deals." Professor LoPucki challenged this conclusion, citing to his 20 years of empirical data in an article the next year entitled The Nature of the Bankruptcy Firm: A Response to Baird and Rasmussen's "The End of Bankruptcy," 56 Stan. L. Rev. 645 (2003). Professors Baird and Rasmussen were unmoved, though agreed that while "the end" may not yet be here, the "twilight" sure is, for creditors--not managers--control the process. See Baird & Rasmussen, Chapter 11 at Twilight, 56 Stan. L. Rev. 673, 675 (2003) ("Corporate reorganizations today are the legal vehicles by which creditors in control decide which course of action--sale, prearranged deal, or a conversion of debt to a controlling equity stake--will maximize their return.").
Professors Baird, Rasmussen, and LoPucki have continued to debate the utility or futility of chapter 11 as a reorganization process, and who does (or should) control that process: the "residual owners" (i.e., the creditors) or "the judges and fiduciaries." Compare LoPucki, The Myth of the Residual Owner: An Empirical Study, 82 Wash U. L. Q. 1341 (2004), with Rasmussen, Search for Hercules: Residual Owners, Directors and Corporate Governance in Chapter 11, 82 Wash. U. L. Q. 1445 (2004); see also, Baird & Rasmussen, Private Debt and the Missing Lever of Corporate Governance, 154 U. Penn. L. Rev. 1209 (2006) ("Today's creditors craft elaborate covenants that give them a large role in the affairs of the corporation.... When a business stumbles, creditors typically enjoy powers that public shareholders never have, such as the ability to replace the managers and install those more to their liking. The powers that modern lenders wield rival in importance the hostile takeover in disciplining poor or underperforming managers. This essay explores these powers and begins the task of integrating this lever of corporate governance into the modern account of corporate law.").
Professor LoPucki shifted the debate from the empirical to the theoretical by positing his "Team 57 Vand. L. Rev. 741 (2004), in which he described the fundamental differences between the two theories as follows:
The Team Production Theory of Bankruptcy Reorganization, like the Creditors' Bargain Theory it challenges, is contractarian. It attempts to identify economically efficient institutions by assuming they are the institutions contracting parties would choose. In contrast to the Creditors' Bargain Theory, which is based on a hypothetical contract derived by the theorist, the Team Production Theory is based on the actual contracts entered into by team members. Researchers can test the Team Production Theory empirically by determining whether the actual contracts match those asserted by the Team Production theorist. The theory is both positive in attempting to describe the actual contracts among the team members and normative in its assertion that the actual contracts should be enforced because they are efficient. Id. at 744.
With Professor LoPucki hitting the mainstream with his book, Courting Failure: How Competition for Big Cases Is Corrupting the Bankruptcy Courts (Univ. of Michigan Press, 2006), Professors Baird and LoPucki debated the merits of Professor LoPucki's thesis in these articles: Baird, Beyond Recidivism, 54 Buff. L. Rev. 343 (2006), and LoPucki, Where Do You Get Off? A Reply to Courting Failure's Critics, 54 Buff. L. Rev. 511 (2006). Professor LoPucki further defended the premise of his book in an article published last year in the University of Chicago Law Review entitled Delaware Bankruptcy: Failure in the Ascendancy, 73 Univ. of Chicago L. Rev. 1387 (2006).
With his latest article, Bankruptcy Fire Sales, Professor LoPucki shifts the debate with Professor Baird back to familiar ground: the utility or futility of chapter 11 reorganizations. This is the first time, however, that they are going head-to-head in a blog forum, thus sparing both the author and the reader from having to labor through footnotes! Also, with the blog format, we get their real-time thoughts and responses, and don't have to wait a year for the official academic response in a law review article.
Professor Baird will have his work cut out for him, though, as the LoPucki/Doherty team has packed the article densely with empirical supporting data. Still, unlike this recent crestfallen champion, I doubt Professor Baird will be rubbing any "clear" on his head or arms for extra strength and insight before responding. Regardless, LoPucki's and Doherty's charge that "bankruptcy courts [are not fulfilling their] obligation to ensure that debtors in possession and their professionals act in the best interests of the debtors' estates when choosing between going-concern sale and reorganization" won't win the authors many kudos from judges attending the National Conference of Bankruptcy Judges later this month in Orlando. They write in conclusion:
Bankruptcy going-concern sales can provide a substitute for bankruptcy reorganization only if, for a given company, the sale can realize at least as much value as a reorganization. Otherwise, reorganization should continue in order to maximize value.
We found that, on average, reorganizations yielded 80% or 91% of book value, while sales yielded only 35% of book value. Those findings warrant the conclusion that, on average, companies sell for less than would be realized in their reorganizations. To reach a contrary conclusion, one might suppose that the best and strongest companies were reorganized while the worst and weakest were sold. But if debtors could sell their companies for as much as they would bring in reorganization, the statistically significant difference in sale and reorganization recoveries would never have arisen. Sale or reorganization would have been equally likely for each company and the pattern of sale or reorganization choices random. That the difference arose demonstrates at minimum that reorganization was sufficiently preferable to sale in high-recovery cases to warrant the cost of sorting the cases. If the reorganized companies had to be sold in some new regime, whatever reorganization advantage caused them to sort themselves under the old regime would be lost.
Our finding that the choice between sale and reorganization remains highly significant, even when we control for the financial condition of the company, suggests considerably more. It is theoretically possible that large differences in value existed among the companies studied; that those differences were not reflected in either book values or EBITDA; and that, for some reason not yet explained, those differences were highly correlated with the choice between sale and reorganization, with the weaker companies choosing sale. But barring such unlikely, unidentified differences, our findings demonstrate that large public companies were sold in bankruptcy going-concern sales for less than half what they would have been worth in reorganization.
Possible explanations for this market failure are not in short supply. The managers who decided to sell these companies rather than reorganize them frequently had conflicts of interest. So did the investment bankers who advised the managers and solicited bids. The stalking-horse bidders received protections in the form of breakup fees and substantial minimum bid increments that discouraged other bidders. The costs of participating in the bidding were high because the companies' situations were complex and changed rapidly. Bidders other than the stalking horse had little chance of winning. As a result, only a single bidder appeared at most bankruptcy auctions. The process from the hiring of the financial advisor to the court's order approving the sale was generally leisurely, averaging just under a year. In only five of twenty-nine cases (17%) did it take less than 180 days. But once the stalking horse was selected, the cases were fast tracked. The average time from execution of the stalking horse contract to the auction was only 41 days, giving competing bidders little time to organize. Together, these findings demonstrate, and at least partially explain, the failure of going-concern sales as an alternative to reorganization.
The bankruptcy courts have an obligation to ensure that debtors in possession and their professionals act in the best interests of the debtors' estates when choosing between going-concern sale and reorganization. Our findings show that the bankruptcy courts are not fulfilling that obligation.
Thanks for reading!
[For those keeping track, still no twins...ETA, Tuesday night.]
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Wednesday, September 26th, 2007
Nova eikaiwa is the biggest foreign language school in Japan, teaching predominantly English through a network of over 600 branches across the county and employing over 7,000 foreign nationals.
After adverse rulings to a number of complaints regarding Nova's refund policy, the Japanese Government imposed a
6 month ban from July to prevent the company from selling large lesson packages to students. The company has experienced a severe
downturn in cashflow as a result and there are reports of late payment to Japanese staff and suppliers in the last two months. Foreign teachers were unaffected until salary payments for the 15th September were paid late, and more senior teachers have not yet been paid.
Despite not being paid, many staff face a
tough decision: quit, or continue to show up to work in the knowledge that if the company goes bankrupt they are eligible for
unemployment benefits.
Despite this, CEO Nozomu Sahashi declared last Friday "
The dark clouds that have been hanging heavily over us will be cast aside... I said previously 'the darkest time is before the dawn,' and finally the first light of dawn can be seen". Five days later and some teachers are
still waiting to be paid.
Posted in Uncategorized | Comments Off
Wednesday, September 26th, 2007
Nova eikaiwa is the biggest foreign language school in Japan, teaching predominantly English through a network of over 600 branches across the county and employing over 7,000 foreign nationals.
After adverse rulings to a number of complaints regarding Nova's refund policy, the Japanese Government imposed a
6 month ban from July to prevent the company from selling large lesson packages to students. The company has experienced a severe
downturn in cashflow as a result and there are reports of late payment to Japanese staff and suppliers in the last two months. Foreign teachers were unaffected until salary payments for the 15th September were paid late, and more senior teachers have not yet been paid.
Despite not being paid, many staff face a
tough decision: quit, or continue to show up to work in the knowledge that if the company goes bankrupt they are eligible for
unemployment benefits.
Despite this, CEO Nozomu Sahashi declared last Friday "
The dark clouds that have been hanging heavily over us will be cast aside... I said previously 'the darkest time is before the dawn,' and finally the first light of dawn can be seen". Five days later and some teachers are
still waiting to be paid.
Posted in Uncategorized | Comments Off
Wednesday, September 26th, 2007
Nova eikaiwa is the biggest foreign language school in Japan, teaching predominantly English through a network of over 600 branches across the county and employing over 7,000 foreign nationals.
After adverse rulings to a number of complaints regarding Nova's refund policy, the Japanese Government imposed a
6 month ban from July to prevent the company from selling large lesson packages to students. The company has experienced a severe
downturn in cashflow as a result and there are reports of late payment to Japanese staff and suppliers in the last two months. Foreign teachers were unaffected until salary payments for the 15th September were paid late, and more senior teachers have not yet been paid.
Despite not being paid, many staff face a
tough decision: quit, or continue to show up to work in the knowledge that if the company goes bankrupt they are eligible for
unemployment benefits.
Despite this, CEO Nozomu Sahashi declared last Friday "
The dark clouds that have been hanging heavily over us will be cast aside... I said previously 'the darkest time is before the dawn,' and finally the first light of dawn can be seen". Five days later and some teachers are
still waiting to be paid.
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Tuesday, September 25th, 2007
As every blogger will agree, "thank goodness for guest bloggers!" (especially with my wife now 37 weeks and counting--laboriously so--with twins).
Today's guest blog is from my colleague at The Coleman Law Firm, Elizabeth E. Richert, who has been at my side--for better or for worse--since her graduation from Duke Law School in 2001.
If you're wondering how I had the time to blog, it's in large measure because Elizabeth does a lot of the spade work for me. If you're also wondering why I'm not blogging as regularly, well, Elizabeth's starting to do that for me too. Unfortunately, I don't think she does diapers (but see training video here).
So thanks Elizabeth for stepping up to the plate, and congratulations on your first of what I hope will be many more excellent posts!
***
Once upon a time, the investment world was jazzed about the possibilities of a global telecommunications system based on radio contact with low earth-orbiting satellites. The pursuit of this dream resulted in the catastrophic business failure of Iridium, whose lightning collapse--in turn--raised the following central question in fraudulent transfer litigation filed against Motorola in Iridium's bankruptcy case:
Is evidence of value from the public markets the proper valuation tool in determining the market value of a business even when the market turns out to have been spectacularly wrong about that business’s prospects?
Here's the background to the case (see also WSJ Law Blog post): In the early 90’s, Motorola developed a global telecommunications concept called “the Iridium System.” In 1993, Motorola spun-off the Iridium System into a separate entity, Iridium, Inc. (later Iridium LLC), which was owned by private investors. Motorola contracted to serve as Iridium’s prime contractor for the development of the space-related portions of the Iridium System and for the development, licensing, and sale of certain handsets and gateway equipment systems. Under these contracts, Iridium paid Motorola between 1995 and 1999 the tidy sum of approximately $3.7 billion.
In November of 1998, Iridium activated its global satellite communications service with much fanfare. Some nine months and--as Judge James M. Peck described it in this opinion--a “business failure of epic proportions” later, Iridium landed in bankruptcy. (Op. at 5). On behalf of the Iridium bankruptcy estate, the Statutory Committee of Unsecured Creditors sued Motorola for fraudulent conveyance and preference claims seeking to avoid the $3.7 billion in transfers from Iridium to Motorola.
In a (not entirely successful) attempt to keep the litigation of this contentious case under control, Judge Peck, from the United States Bankruptcy Court for the Southern District of New York, bifurcated the trial—limiting the first phase to the questions of whether Iridium was insolvent or had unreasonably small capital. In a 111 page "Opinion Regarding Insolvency and Unreasonably Small Capital,” Judge Peck held that the Committee failed to prove that Iridium was insolvent at the time of the challenged transfers.
While the Court supports its ruling with over 50 pages of factual findings, its holding was essentially a foregone conclusion once the Court determined that it agreed with the reasoning of VFB LLC v. Campbell Soup Co., 482 F.3d 624 (3rd Cir. 2007) (pdf), that “the public markets constitute a better guide to fair value than the opinions of hired litigation experts whose valuation work is performed after the fact and from an advocate’s point of view.” (Op. at 4). Indeed, Judge Peck concluded, “[g]iven the overwhelming weight of th[e] market evidence, it may be that the burden of proving insolvency and unreasonably small capital simply could not be met under any circumstances, regardless of the evidence adduced, in the wake of the Third Circuit’s VFB decision . . .” (Op. at 110)
In VFB—which Steve Jakubowski reviewed early on here—the issue was whether VFB received reasonably equivalent value for the $500 million it provided to Campbell for Campbell’s Specialty Foods Division. The district court found that VFB had, based on the significantly positive market capitalization of the Specialty Foods Division after its spin-off from Campbell. VFB appealed, arguing that the market capitalization did not accurately measure the value of its assets because Campbell manipulated the Specialty Foods Division’s sales and earnings prior to the spin. The Third Circuit upheld the district court’s ruling, validated the district court’s use of market data for valuation purposes, and found that that “[a]bsent some reason to distrust it, the market price is ‘a more reliable measure of the stock’s value than the subjective estimates of one or two expert witnesses.’” VFB, 482 F.3d at 636 (quoting In re Prince, 85 F.3d 314, 320 (7th Cir. 1996)).
In Iridium, the Court was presented with two quite different approaches to the presentation of valuation evidence. Motorola, led by the veteran (non-bankruptcy) litigator, Garrett Johnson of Kirkland & Ellis, took the position—endorsed by Judge Peck—that market capitalization is the best indicator of value unless proven otherwise. Motorola presented multiple witnesses to support the theory of the case that the public trading market for Iridium’s securities was well-informed and that the collective judgment of market participants confirmed the enterprise's significant value.
The Committee, represented by another veteran (non-bankruptcy) litigator, Greg Danilow of Weil, Gotshal & Manges, espoused the view that “the market, in retrospect, could not have been a reliable reference point in light of subsequent events that proved the market to be so plainly wrong in measuring Iridium’s fair value.” (Op. at 25). The Committee asked the Court to disregard the historical market data entirely as manifestly unreliable, and to rely instead on the Committee’s expert valuations based on discounted cash flows and restated cash flow projections.
Unfortunately for the Committee, the Court started from the proposition that public market data was the best indicator of value, and concluded that “to justify disregarding values placed on [Iridium’s] securities in an efficient public trading market, the Court needs a substantial reason to depart from that standard and find that the value implied by an efficient market is not a trustworthy benchmark.” (Op. at 26). The fact that “the market was plainly wrong as an indicator of future value and badly misjudged the likelihood of Iridium’s success,” Judge Peck concluded, did not provide such a substantial reason. (Op. at 25).
The Court thoroughly analyzed Iridium’s market capitalization, management’s contemporaneous projections of future cash flows, the contemporaneous valuations prepared by various third-party analysts, investors, and lenders, and the expert testimony by both sides and found that the market was well-informed regarding Iridium’s business plan, financial situation, and system capabilities and limitations, and that market capitalization was a reliable benchmark for value.
Judge Peck’s opinion is especially notable for trial advocacy junkies because he provides interesting observations on witness and expert credibility in valuation disputes. The Committee’s failure to deal with the market evidence head-on and rebut its contradictory valuations, for example, hurt the credibility of the Committee's expert and rendered their valuations unreliable in the Court's eyes. Judge Peck stated in this regard:
A solvency analysis lacks credibility when an expert uses projections that “fly in the face of what everyone[] believed at that time.” VFB, 2005 WL 2234606 at *30 n. 71. Here, Messrs. Reiss and Spragg’s conclusions of insolvency and inadequate capital do not correlate with the market validation of Iridium’s business plans and the positive value attributed to the business during the relevant period. This failure of the Committee’s experts to reconcile their conclusions with the prevailing market judgment or to cast serious doubt on the reliability of that market judgment provides sufficient reason for this Court to seriously question the reliability of their opinions. (Op. at 109)
The Court also expressed frustration that neither party attempted to parse the four-year valuation period into smaller blocks of time or to concentrate on discrete smaller testing periods relevant to a preference and fraudulent conveyance analysis (such as the ninety-day or one-year period before bankruptcy). (Op. at 22). This failure too, the Court concluded, contributed to the Committee's failure to prove insolvency and rendered their conclusions “most obviously suspect.” (Op. at 24).
Another important practice pointer is found in a footnote, where Judge Peck noted that all the witnesses for the Committee, with the exception of four experts, "testified" through spliced video-taped segments drawn from their deposition testimony. (Op. at 10 n.3). In contrast, Judge Peck found, “Motorola contributed greatly to its defense by having live witnesses whose credibility could be assessed by the Court.” Id. The Court reminded readers that “there is no substitute for observing the demeanor of witnesses who are testifying in person in the courtroom.” Id. Amen!
Didn't someone once say that
stock market trading is a "fool's game"? Well, don't call him to testify in your next fraudulent transfer case.
(Ed. Note: The inset picture shows some phones still being offered by the now reorganized Iridium. You sure have to wonder how Motorola's projections that about half the world would own Iridium phones were ever taken seriously.)
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Monday, September 10th, 2007
I made $3,000 in payments on my student loan during my Chapter 13 bankruptcy, but they were not applied to my loan balance. What should I do? I just had a chapter 13 bankruptcy discharged successfully after 3 years. When I filed chapter 13, the trustee told me to continue making payments on my student loan. I had been paying about $100/month to Sallie Mae. On finding I could no longer access my Sallie Mae account online, I called them to find out what they wanted me to do. The representative told me they couldn't bill me since I was in bankruptcy, but gave me the address where I could send my payments, and told me to write my SS# on the checks so they'd know where to apply the payments. I made the payments every month by check, and they cashed them.
Last February I checked my credit reports and found they showed the loans had zero balance, with a claim filed with the government. I called Sallie Mae again to find out what my balance was. I spoke to a rep in India, and he told me it was paid in full. I sent a letter to Sallie Mae requesting an accounting of the activity on my account since the bankruptcy was filed, and stated that per their rep saying the loan was paid in full I would send no more payments until I received such documentation. I never received anything in return.
Last week I got a letter from Sallie Mae stating my payments were to resume now that the bankruptcy was over, as of October 5th. The total balance on the loan did not reflect any of the approximately $3,000 I had sent them during the bankruptcy! I called them, and after going through a guy in India, a rep in the US, and her supervisor, I was told they sold the loan to the guarantor (Connecticut Student Loan Foundation) as soon as the Ch. 13 was filed, and that I had been supposed to pay CSLF the whole time. She said they'd been forwarding the money on to CSLF. Now that the bankruptcy was over, CSLF had sold the loan back to Sallie Mae, but without reflecting any of the $3,000+ in payments I'd made. She said if I wanted to dispute the loan amount I would have to document the bankruptcy, all my payments, etc, and that if I didn't make payment by Oct. 5 the payment would be reported to the CRAs as late.
I tried in good faith to make the payments I owed, I contacted Sallie Mae twice via phone and once via letter and they never mentioned that I shouldn't be paying them, and I never received any communication from CSLF the whole time. She is supposed to mail me a summary of all the payments they received during the bankruptcy.
I don't want to end up being charged interest on the amounts I already paid. I can't afford an attorney. Was it legal for Sallie Mae to cash my checks during that time? Should I call or write CSLF? What should I do?
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Monday, September 10th, 2007
I made $3,000 in payments on my student loan during my Chapter 13 bankruptcy, but they were not applied to my loan balance. What should I do? I just had a chapter 13 bankruptcy discharged successfully after 3 years. When I filed chapter 13, the trustee told me to continue making payments on my student loan. I had been paying about $100/month to Sallie Mae. On finding I could no longer access my Sallie Mae account online, I called them to find out what they wanted me to do. The representative told me they couldn't bill me since I was in bankruptcy, but gave me the address where I could send my payments, and told me to write my SS# on the checks so they'd know where to apply the payments. I made the payments every month by check, and they cashed them.
Last February I checked my credit reports and found they showed the loans had zero balance, with a claim filed with the government. I called Sallie Mae again to find out what my balance was. I spoke to a rep in India, and he told me it was paid in full. I sent a letter to Sallie Mae requesting an accounting of the activity on my account since the bankruptcy was filed, and stated that per their rep saying the loan was paid in full I would send no more payments until I received such documentation. I never received anything in return.
Last week I got a letter from Sallie Mae stating my payments were to resume now that the bankruptcy was over, as of October 5th. The total balance on the loan did not reflect any of the approximately $3,000 I had sent them during the bankruptcy! I called them, and after going through a guy in India, a rep in the US, and her supervisor, I was told they sold the loan to the guarantor (Connecticut Student Loan Foundation) as soon as the Ch. 13 was filed, and that I had been supposed to pay CSLF the whole time. She said they'd been forwarding the money on to CSLF. Now that the bankruptcy was over, CSLF had sold the loan back to Sallie Mae, but without reflecting any of the $3,000+ in payments I'd made. She said if I wanted to dispute the loan amount I would have to document the bankruptcy, all my payments, etc, and that if I didn't make payment by Oct. 5 the payment would be reported to the CRAs as late.
I tried in good faith to make the payments I owed, I contacted Sallie Mae twice via phone and once via letter and they never mentioned that I shouldn't be paying them, and I never received any communication from CSLF the whole time. She is supposed to mail me a summary of all the payments they received during the bankruptcy.
I don't want to end up being charged interest on the amounts I already paid. I can't afford an attorney. Was it legal for Sallie Mae to cash my checks during that time? Should I call or write CSLF? What should I do?
Posted in Uncategorized | Comments Off
Monday, September 10th, 2007
I made $3,000 in payments on my student loan during my Chapter 13 bankruptcy, but they were not applied to my loan balance. What should I do? I just had a chapter 13 bankruptcy discharged successfully after 3 years. When I filed chapter 13, the trustee told me to continue making payments on my student loan. I had been paying about $100/month to Sallie Mae. On finding I could no longer access my Sallie Mae account online, I called them to find out what they wanted me to do. The representative told me they couldn't bill me since I was in bankruptcy, but gave me the address where I could send my payments, and told me to write my SS# on the checks so they'd know where to apply the payments. I made the payments every month by check, and they cashed them.
Last February I checked my credit reports and found they showed the loans had zero balance, with a claim filed with the government. I called Sallie Mae again to find out what my balance was. I spoke to a rep in India, and he told me it was paid in full. I sent a letter to Sallie Mae requesting an accounting of the activity on my account since the bankruptcy was filed, and stated that per their rep saying the loan was paid in full I would send no more payments until I received such documentation. I never received anything in return.
Last week I got a letter from Sallie Mae stating my payments were to resume now that the bankruptcy was over, as of October 5th. The total balance on the loan did not reflect any of the approximately $3,000 I had sent them during the bankruptcy! I called them, and after going through a guy in India, a rep in the US, and her supervisor, I was told they sold the loan to the guarantor (Connecticut Student Loan Foundation) as soon as the Ch. 13 was filed, and that I had been supposed to pay CSLF the whole time. She said they'd been forwarding the money on to CSLF. Now that the bankruptcy was over, CSLF had sold the loan back to Sallie Mae, but without reflecting any of the $3,000+ in payments I'd made. She said if I wanted to dispute the loan amount I would have to document the bankruptcy, all my payments, etc, and that if I didn't make payment by Oct. 5 the payment would be reported to the CRAs as late.
I tried in good faith to make the payments I owed, I contacted Sallie Mae twice via phone and once via letter and they never mentioned that I shouldn't be paying them, and I never received any communication from CSLF the whole time. She is supposed to mail me a summary of all the payments they received during the bankruptcy.
I don't want to end up being charged interest on the amounts I already paid. I can't afford an attorney. Was it legal for Sallie Mae to cash my checks during that time? Should I call or write CSLF? What should I do?
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Monday, September 3rd, 2007
Last year, then "Junior Scholar" -- and now Associate Professor of Law at Georgetown -- Adam Levitin (who is also a long-time reader of this blog!) wrote an excellent piece entitled Finding Nemo: Rediscovering the Virtues of Negotiability in the Wake of Enron, 2007 Colum. Bus. L. Rev. 83 (WL) / (pdf). In it, he strongly criticized a decision by Bankruptcy Judge Arthur Gonzalez denying a good faith bankruptcy claim purchaser's motion to dismiss the Enron estate's cause of action for equitable subordination based not on the purchaser's own misconduct, but on the conduct of previous owners of the claims purchased, regardless of whether the conduct related to the claims themselves. Enron Corp. v. Springfield Assocs., L.L.C. (In re Enron), 2005 WL 3873893 (Bankr. S.D.N.Y. 11/28/05) (pdf). Professor Levitin sums up his critique of Judge Gonzalez's ruling as follows (at pp. 90-91):
The problems in Enron speak to a fundamental commercial law question about choice of property transfer rules. Enron was based on the commercial law principle of nemo dat quod non habet -- you can only transfer what you have. Nemo dat means that defenses travel with property transfers, so if bankruptcy claims would be subject to equitable subordination in the hands of a transferor, they should remain so in the hands of a transferee.
Nemo dat is the default rule for property transfers, but there is a competing commercial law paradigm: negotiability [as in Articles 2, 3, 7, and 8 of the UCC], and the law of real estate mortgages and titles. The essential characteristic of negotiability is that only limited defenses travel with property, and thus a transferee can receive more than the transferor had--a property right free of certain defenses against its enforcement. This means that there is some level of negotiability in any area of law with a good faith purchaser defense....
Historically, the law has differentiated between whether it adopts a nemo dat regime or a negotiability regime based on whether transactions are commercial or consumer.... [T]his article argues in favor of applying a negotiability regime to bankruptcy claims trading and proposes a general reconsideration of the rules governing the defenses that travel with a property transfer in commercial contexts.
Last January, District Court Judge Shira A. Scheindlin (herself no stranger to high-stakes bankruptcy controversies) granted the disheartened claims purchasers' request for leave to file an interlocutory appeal of Judge Gonzalez's ruling. She also concurrently granted the request filed in connection with an analogous interlocutory ruling by Judge Gonzalez in Enron Corp. v. Avenue Special Situations Fund II, LP (In re Enron), 340 B.R. 180 (Bankr. S.D.N.Y. 2006) (pdf), in which he disallowed under Code section 502(d) the claim of an entity that purchased its claim from a party who had received a potentially avoidable prepetition transfer. Judge Scheindlin granted these interlocutory appeals, she said, so that she could consider the following question that "although fairly simply stated, is complex and of first impression in this Circuit, and will have serious ramifications well beyond the parties involved in this particular appeal":
Whether equitable subordination under 510(c) and disallowance under 502(d) can be applied, as a matter of law, to claims held by a transferee to the same extent they would be applied to the claims if they were still held by the transferor based on alleged acts or omissions on the part of the transferor.
Last week, Judge Scheindlin was again the toast of distressed debt industry based on her lengthy decision vacating Judge Gonzalez's decisions. See Springfield Assocs., L.L.C. v. Enron Corp. (In re Enron), 2007 WL 2446498 (S.D.N.Y. 8/27/07) (pdf). Though Judge Scheindlin never cites to Professor Levitin's article, she does note -- as does Professor Levitin -- that the central distinction to be made in analyzing the question presented is whether the "well-established doctrine of nemo dat qui non habet" applies. (Op. at 20-22.)
To Judge Scheindlin, if the claims are being asserted by good faith purchasers of bankruptcy debt, then the doctrine doesn't apply and the claims cannot be equitably subordinated under Code section 510(c) or disallowed (pending receipt of the avoidable transfer) under Code section 502(d). Conversely, Judge Scheindlin ruled, if the transferee obtained the claim by way of "assignment," then the nemo dat doctrine applies, the "personal disabilities" of the claimant "travel with the claim," and the assignee's claim is subject to possible subordination and disallowance. (Op. at 29-44.)
Notably, Judge Scheindlin emphasizes, her decision is not based on policy concerns, and in particular the impact that an affirmance would surely have on depressing values in an already depressed market for distressed debt. See, e.g., Levitin Article at 161-164 ("Developments in the Refco bankruptcy provide an early look at ... how seriously Enron has affected the claims trading market.... As soon as rumors surfaced of BAWAG's alleged misdeeds, all claims that had ever passed through BAWAG's hands became radioactive before the other Refco creditors filed suit against BAWAG. No one would purchase them for any price because of the fear of subordination or disallowance.") Still, she seemed relieved to be able to note not only that "[t]he unnecessary breadth of the Bankruptcy Court's decisions threatened to wreak havoc on the markets for distressed debt," but also that, with this decision, "[t]hat result has now been avoided." (Op. at 52.)
What then was the basis for Judge Scheindlin's reversal?
The issue is "a matter of statutory interpretation," she held. (Op. at 30.) And this is where things start to get interesting, for as everyone agreed, "there is no case directly on point." Id. Further, since Code section 510(c) only references vague "principles of equitable subordination," there is no "plain meaning" to guide us. Judge Scheindlin, therefore, appropriately (see Judge Waldron's outline referenced here) turned next to the legislative history "to determine whether the legislative intent was to create a characteristic of a claim or rather a personal disability of claimants." (Op. at 30-31.)
Judge Scheindlin found no support in the legislative history or in pre-Code case law for extending the personal disability of a claimant to the good-faith purchaser of a claim, and here's where Judge Scheindlin's opinion begins to fray a bit at the edges. The claims trading industry didn't exist in the pre-Code days, so it's not surprising that Congress didn't consider the phenomenon. Further, to focus--as Judge Scheindlin does--on a specific legislator's or court's use of the word "holder" or "claimant" versus the word "claim" in describing when equitable subordination is appropriate perhaps ascribes to legislators and previous courts a distinction they themselves may not have discerned when they imprecisely uttered those precise words. (Op. at 31-36.)
In my humble view, given the absence of legislative history or case law directly on point, principles of equitable subordination under Code section 510(c) and claims disallowance under Code section 502(d) are perhaps best analyzed first through the optics that the US Supreme Court has fashioned for us in cases like Howard Delivery Serv., Inc. v. Zurich Am. Ins. Co., 126 S. Ct. 2105 (2006) (pdf) (discussed at length here and again here), and Travelers Casualty v. Pacific Gas & Electric Co., 127 S. Ct. 1199 (2007) (pdf) (discussed at length here and again here).
In Howard Delivery, the Court stated that "any doubt concerning the appropriate characterization [of a claim] ... is best resolved in accord with the Bankruptcy Code's equal distribution aim." 126 S. Ct. at 2116. This policy approach would seemingly weigh against any approach that would enable a claimant to engage in "claims washing" because of the adverse effect such cleansing would have on other creditors. (Compare Op. at 47-48.)
On the other hand, we are reminded in Travelers of the bedrock principle from the 9-0 decision in Butner v. United States, 440 U.S. 48 (1979) that "[c]reditors' entitlements in bankruptcy arise in the first instance from the underlying substantive law creating the debtor's obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code." (Travelers at p.6.) This principle, it would seem, favors recognition in bankruptcy of a purchaser's state law rights to "negotiability" (to use Professor Levitin's shorthand), subject to subordination and disallowance only in "drastic and unusual" circumstances (presumably absent here). (Op. at 38.)
In the end, it seems impossible for a judge to avoid policy considerations when deciding whether to invoke "principles of equitable subordination," particularly where--as here--the tension between equality of distribution in bankruptcy and recognition of a good faith purchaser's state law rights cannot be easily reconciled. Judge Gonzalez's rulings favored equality of distribution based on the presumption that any purchaser of a bankruptcy claim is necessarily on notice of the claim's potential disability. Conversely, Judge Scheindlin's opinion favored the traditional enhanced rights of good faith purchasers for value, relying instead upon the trier of fact to determine whether the purchaser took in good faith without actual knowledge of the disability of--or the receipt of an avoidable transfer by--the original claimant. (Op. at 37, 44.)
My sources (to whom I'm grateful for passing along this decision once it was issued) don't yet know if an interlocutory appeal will be taken to the Second Circuit, but it's hard to imagine given what's at stake that such an appeal will not be attempted. Given the central importance of this decision to the distressed debt industry (which Professor Levitin states at p. 86 "was estimated to be in the hundreds of billions of dollars about a decade ago and has seen a prodigious growth in recent years"), we can only hope that the case is taken up by the Second Circuit, and then by the US Supreme Court. It's hard to imagine a better pedigree than this case would offer the High Court on this issue.
So while--for now--as Judge Scheindlin stated, no further havoc will be wreaked on the markets, it's unclear whether the havoc already wreaked by Judge Gonzalez's opinion has been avoided entirely. As is often the case in litigation, time will tell.
Steve Jakubowski
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