"Once in a generation" review
Shortly before the Christmas break, the much anticipated review of the United States "Chapter 11 bankruptcy" regime was published by the American Bankruptcy Institute (ABI). This is one of very few such major "root and branch" reviews of Chapter 11 since its enactment in 1978, and the first since the 1990s.
Having been conducted by a Commission of leading American bankruptcy experts over a period of several years, with the benefit of extensive public hearings and submission processes, the review is comprehensive and occasionally controversial in its recommendations.
Implementation of the Commission's recommendations, however, is probably not imminent. The present political dynamic between the Executive and Legislative branches of government in the US, coupled with the controversial nature of some of the recommendations and the historically low legislative priority that bankruptcy has had in the US, is not likely to produce legislation containing any of those recommendations quickly. The review is, however, a thought-provoking document for insolvency professionals everywhere.
Eleven recommendations for Australian practitioners to consider
Eleven recommendations for Australian practitioners to consider For Australian restructuring and insolvency professionals, the review makes a number of recommendations for reform that are highly relevant to the ongoing narrative in Australia around potential adoption of aspects of the a Chapter 11 regime.
Without exploring the considerable detail of the review's findings, eleven key recommendations made by the ABI Commission that are relevant to future Australian reforms and to current market practices in Australia may be summarised as follows.
- Retain "debtor in possession". As a matter of principle, the "debtor in possession" model, whereby a debtor's incumbent directors and management may retain control of the debtor during the bankruptcy process (subject to US Trustee Service oversight) should be maintained. This recommendation adds weight to continued calls for consideration of adoption of such a model as part of the Australian corporate restructuring and insolvency regime.
- Specialist SME procedures. Much like similar reform debate in Australia, the review recommended creation and implementation of specialist procedures for use of Chapter 11 in relation to small-to-medium enterprises (SMEs). The focus for the recommended SME procedures is speed, efficiency and cost-effectiveness, while maintaining access to the benefits of the Chapter 11 procedure for SMEs.
- Tighter regulation of 363 sales of whole business. With the substantial increase in use of the "363 sale" (Court-approved sale by the debtor of its whole business or part thereof during a Chapter 11 procedure, outside of the ordinary course of business) and the decreased time period during which such sales are being executed, a need for greater regulation of 363 sales was identified. The Commission identified, however, the valuable role that a 363 sale has in a Chapter 11 procedure. Balancing those factors, the Commission recommended that 363 sales be made subject to broadly similar standards of Court review and control as presently apply to Chapter 11 bankruptcy plans.
- Selling assets free and clear of claims. While 363 sales are to be more tightly regulated, the Commission recommended that the 363 sale procedure be made more powerful as a "cut through" mechanism. Significantly, the review recommends that the 363 sale procedure contain very strong language enabling a sale of some or all of a debtor's assets free and clear of all encumbrances and other claims (with limited exceptions) - this is intended to disable secured creditors and other claimants from interfering with a sale of a debtor's assets during bankruptcy. It is interesting to compare this to the more limited arrangements in the Australian voluntary administration regime for sale by an administrator of assets subject to a security interest.
- Credit-bidding for assets. Consistent with present US and Australian practice, the Commission recommends that credit-bidding by a secured creditor for assets to be sold or restructured as part of the Chapter 11 procedure be expressly permitted. An interesting further recommendation, however, is that the potentially chilling effect of a credit bid on the market for assets be required to be considered by the Court when approving the proposed sale process.
- Ipso facto clauses. Again relevant to a common point of debate in Australia, the review recommends that the debtor's ability to insist on continued performance by contract counterparties be further strengthened, with the debtor having an effectively broad right to either affirm or repudiate contracts. The solvent counterparty is recommended to have only a limited right to apply to a Court for performance of some post-bankruptcy obligations of a debtor. This prevention on use of "ipso facto clauses" by contract counterparties of a bankrupt debtor continues to be a mainstay of the Chapter 11 procedure, and a central point of distinction from the present Australian regime.
- Valuation methodologies for plan approvals. While the U.S. courts presently have very considerable case law and established practices dealing with the approach to be taken to valuation in a Chapter 11 context - when considering plan or 363 sale approvals - the legislation is not itself prescriptive as to matters to valuation methodology in Chapter 11. The Commission recommends that this remains the case - particular valuation methodologies, or a requirement for independent expert evidence on valuation should not be mandated. Instead, the Commission recommends that the Court have power to appoint its own expert to assist in valuation exercises. In the context of recent high profile cases in Australia like Nexus Energy and Mirabela Nickel, the approach by Courts to valuation in an insolvency context is an important subject - a note for clients comparing the U.S. and Australian approaches will be on our website shortly.
- Cram-down - impaired creditor class voting in favour of plan. Potentially the most controversial recommendation made by the Commission is its recommendation that the requirement of the bankruptcy plan be approved by at least one impaired class of creditors. The recommendation is intended to remove the ability of a particular creditor to "hold up" approval of a plan - including by purchasing claims across the junior creditor classes sufficient to defeat approval in each class - and leave protection of junior creditor classes to the Courts. This recommendation, if implemented, would create a very powerful "cram down" procedure for senior creditors - a similar regime in the Australian "scheme of arrangement" procedure would be similarly powerful in driving restructures. That said, the cost of such a procedure is the need for robust Court review and the risk of protracted litigation.
- Restrictions on voting rights unenforceable. In an interesting recommendation, the Commission recommended that pre-bankruptcy voting agreements amongst creditors - such as those contained in many standard Australian intercreditor or priority agreements - be unenforceable for the purposes of voting on a bankruptcy plan. Such a change, if adopted, would obviously disturb market practice in banking documents, and may not be suitable for the Australian market, where the powerful "cram down" available in the US is not presently available to Australian senior creditors.
- Claims trading to continue. In contrast to item 9 above, the Commission recommended that claims trading post-bankruptcy be left largely unregulated by the Chapter 11 legislation. Various submissions were made around requirements to disclose to the debtor prices paid for claims and other information relevant to trading, but those submissions were not accepted. This recommendation remains consistent with Australian practice, where claims trading is similarly unregulated by the corporate insolvency legislation (although other legislation like securities and consumer protection legislation may still be relevant in particular instances).
- Preference recoveries. Finally, the Commission rejected submissions calling for complete removal of the power to claw back unfair preferences. The Commission did recommend, however, that there be an express requirement that a claim to recover an unfair preference only be asserted in good faith and with reasonable grounds for believing that the claim had merit. Given the robustness of the Australian unfair preference recovery procedures, and the ready availability of litigation funding for such recovery claims, it would be worthwhile considering introduction of a similar requirement in Australia.
In conclusion, the "once in a generation" review by the ABI Commission, particularly the eleven recommendations set out above, leaves Australian practitioners and policy-makers with further food for thought.
Further reading - ABI and ARITA
Look out for our impending article on comparative approaches to valuation in the insolvency context by the Australian and US courts shortly. In the meantime, for further reading on the ABI review, the Commission's full report is available from the ABI website and some further discussion of the Australian reaction to the review is available from the ARITA website.