This article is an extract from The Restructuring Review, 14th Edition

Overview of restructuring and insolvency activity

i Economic overview

Over the past year, from 1 May 2020 to 1 May 2021, covid-19 continued to dominate the United States' economic landscape. Unprecedented government stimulus relief coupled with aggressive monetary policy from the US Federal Reserve (e.g., maintenance of near-zero interest rates, buybacks of US treasury bonds and creation of facilities for corporate financing) helped avoid a sustained recession and spurred a dramatic and accelerated economic turnaround. In the first and second quarters of 2020, with covid-19 restrictions in full effect, real gross domestic product (seasonally adjusted at annual rates) shrunk by 5 per cent and 31.4 per cent, respectively; but in the third and fourth quarters of 2020 and the first quarter of 2021 rebounded sharply by 33.4 per cent, 4.3 per cent, and 6.4 per cent, respectively.2 Congress passed numerous significant covid-19 relief bills, including direct stimulus payments sent to individuals, unemployment benefits and trillions of dollars of spending.3 The Federal Reserve also cut interest rates effectively to zero (specifically, cutting the target range for the federal funds rate to zero to 0.25 per cent), and launched extraordinary measures 'to support the flow of credit to households and businesses' including buying bonds and launching various financing facilities.4 As of April 2021, the overall civilian unemployment rate, seasonally adjusted, was 6.1 per cent, down dramatically from a high of 14.8 per cent in April 2020 when the economy went into lockdown, but 2.6 per cent worse than the extremely low level of 3.5 per cent in February 2020 immediately before the effects of the pandemic began to be felt.5 And while deficit spending and low interest rates have led to concerns over government debt and price inflation, long-term interest rates remain low.6 Inflation also remains relatively low, although there have been significant, perhaps temporary, upward pressures in goods including used cars (see discussion of Hertz below) and construction materials, and the Consumer Price Index (CPI) has also reflected an upward trend, rising 4.2 per cent over the 12 months through April 2021.7

At the onset of the pandemic, the United States saw a significant uptick in distressed debt (loans and bonds), the level of which has since precipitously dropped. For example, at the 23 March 2020 peak, 57 per cent of performing loans in the S&P/LSTA Loan Index were trading below 80 per cent of face value, and 15 per cent were trading below 70 per cent. By the end of February 2021, 1.53 per cent of loans were trading below 80 per cent and 0.43 per cent were trading below 70 per cent.8

Meanwhile, in the equity markets, one of the great surprises of the recent covid-19 recession was the brevity of a steep decline in stock prices, followed by an impressive bull market reacting to the aforementioned monetary and fiscal stimulus. The S&P 500 reached an all-time high of nearly 3,400 in February 2020. By late March 2020, it had dipped as low as around 2,200, a downswing of around 35 per cent. It then rallied to new record highs. By the end of April 2021, it stood around 4,200, an all-time high 24 per cent above its February 2020 level and a remarkable 92 per cent above its March 2020 low.9 This equity market activity saw the advent of retail investors taking strategically challenged stocks such as GameStop and AMC to unforeseen levels with access to online trading platforms. This retail investing phenomenon has had the effect of squeezing short sellers with large positions in such stocks.10

As a result of a plethora of capital, low interest rates, government stimulus, and Federal Reserve liquidity initiatives, in the second half of 2020 and the first half of 2021 both debt and equity have been easy to finance. M&A deal activity has also hit record levels.11 Prominent in capital markets and M&A activity have been special purpose acquisition companies (SPACs), also known as 'blank cheque companies'. A SPAC is a publicly traded corporate entity with no assets other than money raised from investors used to acquire a to-be-determined business to take the acquired entity public; they were rarely used acquisition vehicles until 2020 and 2021.12 With frenetic M&A activity stoked by frothy debt and equity markets, and low interest rates and discount rates, company valuations have been pushed to increasingly high levels. And while some of the aforementioned rumblings regarding future inflation may temper some valuation expectations, a bull market appears to be continuing to gain momentum as the United States looks to leave covid-19 in the rear-view mirror with a significant portion of the population having been vaccinated. With an anticipated return to 'normalcy' during the second half of 2021, the country's domestic economic focus will likely shift from weathering the covid-19 storm to the efforts of the narrow Democratic majority in Congress to implement the new Biden administration's agenda, which includes a US$2 trillion infrastructure and jobs plan, and a US$1.8 trillion plan for helping families via spending on education, childcare and paid family leave, as well as proposed tax increases including a corporate tax hike and increased taxes on capital gains.13

ii Restructuring trendsOverall filing and industry trends

Given the economic volatility accompanying the covid-19 pandemic, corporate restructuring practitioners have figuratively seen both flood and drought in the past year. Business cases filed under Chapter 11 of the Bankruptcy Code (the most common form of in-court reorganisation for a large, complex business, as discussed further below) totalled 7,786 in 2020, up 28.7 per cent from 6,052 in 2019. However, the overall number of bankruptcy filings, including for individuals and small businesses, fell 29.7 per cent from 774,940 to 544,463. The federal judiciary's statisticians noted in announcing these figures that (1) 'Filings fell sharply in the early months of the pandemic . . . when many courts offered limited access to the public', and furthermore that (2) 'bankruptcy filings can lag behind other economic indicators'.14 It is worth noting that the new subchapter V of Chapter 11 (discussed below) appears to be gaining traction; although government statistics do not break them out from other Chapter 11 cases, it appears that over 1,000 cases filed or converted in 2020.15

At the onset of the covid-19 pandemic, the United States saw companies already in distress pre-pandemic lead the way in bankruptcy filings, pushed over the edge by economic stress, government shut-down orders, and reluctance of consumers to leave their homes. Also, some of the major industries in distress in 2020 were the predictable victims of covid-related business shutdowns, such as restaurants and movie theatres. Department stores and other retailers are an example of an industry that took hits from both sides: first an excess of retail space and a pre-pandemic shift towards online shopping, and second the impact of the pandemic, which shut them down temporarily and also accelerated the shift to shopping online. On the other hand, many investors were willing to provide bridge financing to recapitalise businesses viewed as facing surmountable, temporary problems. For example, while movie theatre chain Alamo Drafthouse declared bankruptcy, larger movie theatre chains AMC and Regal avoided bankruptcy due to capital raises.16

In addition to retailers, the travel industry faced many challenges brought on by covid-19 restrictions; US companies, however, largely avoided bankruptcy filings, based on access to capital markets, creditors largely refraining from taking aggressive actions, and, in numerous cases, government support. Specific businesses exposed to tourism and business travel that were severely impacted by covid-19 included cruise lines, airlines, hotels and rental car companies. Among cruise lines, in many cases companies raised sufficient funds to withstand a period of significantly diminished bookings and operations.17 Meanwhile, government funds supported most US airlines sufficiently for them to avoid bankruptcy,18 whereas foreign airlines lacking similar government support were forced to restructure. Some filed for Chapter 11 (particularly Latin American carriers Avianca Holdings SA, Grupo Aeromexico and LATAM Airlines Group SA), and others for Chapter 15 (discussed below, a procedure for dealing with cases of cross-border insolvency19) (e.g., Virgin Atlantic20). In addition to these various types of consumer-facing businesses, numerous energy companies, particularly oil and gas companies, also filed for bankruptcy in the past year due to volatility and declines in oil and other commodity prices, in a continuation of trends that predated the pandemic and that the pandemic exacerbated.

Professional practice trends

Although 2020 business Chapter 11 filings were substantially higher than in 2019, they undoubtedly would have been even higher but for the fiscal and monetary stimulus mentioned above. For some small businesses, a significant source of money was received from the federal government through the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and its Paycheck Protection Program (PPP), which provided forgivable loans to small businesses.21 For larger companies, as mentioned, the capital markets largely remained a viable source of financing. Indeed, for many of their clients, restructuring lawyers were busy with negotiating financings and out-of-court restructurings, evaluating government programmes and avoiding bankruptcy, as opposed to preparing for and executing bankruptcy filings. Financial professionals prepared budgetary models and calculated companies' 'runway', that is, how long they could survive with cash on hand (including from revolving credit facilities) without profitability returning to pre-pandemic levels. Debtor and creditor professionals then negotiated loan amendments, forbearances (where worsening financial performance had tripped covenants) and maturity extensions.

One financing technique that became popular was 'up-tiering', where creditors with unsecured debt (possibly maturing in the short term) exchanged it for secured debt (possibly with a longer maturity and higher interest rate). If a company's offer to exchange debt favoured some creditors and not others, or harmed existing secured creditors, litigation often ensued, with different creditor groups seeking to unwind the exchange or fighting over collateral and fees. For example, in each of Serta Simmons, Boardriders and TriMark, minority lenders sued the borrower, participating lender and sponsor or sponsors over up-tiering transactions.22 A raft of loosely drafted credit documents in the pre-pandemic loan market allowed for these sorts of transactions to occur. Newer financing documents are tending to close these previous loopholes. Where PPP loans, other government stimulus money or funds from Federal Reserve financing facility programmes were available, these also became part of professionals' potential financing tools.

Venue statistics

Among business Chapter 11 cases, there has long been a tendency for cases to file in specific forums such as Delaware or New York, based on the filer's 'domicile, residence, principal place of business . . . or principal assets . . . or . . . in which there is pending a case . . . concerning such person's affiliate'.23 For example, many corporations (or their affiliates) are organised in Delaware or have their principal place of business or assets in New York. Under the affiliate filing rule, a group of affiliated companies can file for bankruptcy in a given jurisdiction based on one of their affiliates establishing venue in that jurisdiction. For example, under the affiliate filing rule, a group of corporate entities incorporated in Florida can file for bankruptcy in Delaware if one of their affiliates is incorporated in Delaware.

In 2020, of the 7,786 business Chapter 11 cases, a plurality of 1,665 were filed in Delaware (21.4 per cent). The Southern District of Texas was second with 1,361 cases (17.5 per cent); in 2019 it had seen 345 cases (5.7 per cent), making it the third-most-common venue that year. The other districts in Texas also saw significant activity in 2020. While the Southern District of Texas (which includes Houston) has seen numerous major oil and gas company filings in recent years, in 2020 it also saw retail and other cases (e.g., department stores JC Penney and Neiman Marcus). The Southern District of New York (which includes Manhattan) was the third-most-common venue in 2020, with 686 cases (8.8 per cent), more than its 617 cases (10.2 per cent) in 2019 (when it led the nation in filings), but fewer than in Delaware and Texas. This table summarises these filing trends, which also include an increased concentration of filings in these common venues.24

Chapter 11 business case filings by district20202019
Total7,786100.0% 6,052100.0%
S.D. Tex.1,36117.5%2nd3455.7%3rd
Subtotal3,71247.7% 1,57126.0% 

Recent legal developments

i Bankruptcy law revisions in relation to small businesses and covid-19 relief

In recent years, Congress has passed a number of laws aiming to streamline the bankruptcy process for small businesses that have suffered as a result of the costs and complexities of reorganising under Chapter 11.62 Most notably, in 2019, the Small Business Reorganization Act of 2019 (SBRA) added new subchapter V to Chapter 11,63 which was described in detail in last year's edition of this publication. However, subchapter V eligibility was restricted to debtors with debts not more than the puny amount of US$2,725,625.64 This trend towards debtor-friendly legislation (particularly small business debtors) picked up steam in 2020 on account of the covid-19 pandemic. For the sake of affordable and successful small business reorganisations, we hope that it continues, even after the pandemic passes.

The first notable further change was that in 2020 the CARES Act amended subchapter V by raising the eligible debt limit to US$7,500,000. However, this provision was designed to sunset after one year.65 The covid-19 Bankruptcy Relief Extension Act of 2021 provided an additional one-year extension.66 It remains to be seen whether Congress will allow subchapter V eligibility to revert to a lower level after the pandemic passes.

The Consolidated Appropriations Act 2021 (CAA) included a variety of 'bankruptcy relief' provisions generally providing relief to debtors in connection with covid-19, generally subject to sunset provisions.67 Two notable sets of provisions regarded commercial leases, and discrimination against debtors.

Treatment of commercial leases

As discussed above, Bankruptcy Code Section 365 provides for the debtor's assumption, assignment, or rejection of executory contracts and unexpired leases.68 In a case under Chapter 11, the debtor generally may assume or reject an executory contract or unexpired lease at any time before confirmation of a Chapter 11 plan. However, as to commercial real estate leases, a tenant debtor must decide whether or not to keep the lease within 210 days of filing for bankruptcy (120 days plus one 90-day extension). Also, tenant debtors must timely pay to commercial landlords rent that becomes payable during a bankruptcy case, subject to a potential 60-day grace period. The 210-day deadline was added as part of the 2005 amendments to the Bankruptcy Code69 and has been criticised as an overly stringent protection for commercial landlords that causes retailers to avoid Chapter 11 or to liquidate rather than reorganise.70

CAA Section 1001(f) provides various temporary modifications to this statutory scheme.

First, applicable to subchapter V debtors only, an additional 60-day grace period is available if the debtor is experiencing a material financial hardship due, directly or indirectly, to covid-19. This provision helps to address situations that were common in the summer of 2020 (and which were discussed in detail in the previous edition of this publication) where retailers (although in many cases larger retailers not eligible for subchapter V) were either ordered by the government to close their locations temporarily, or voluntarily did so in response to the spread of covid-19, filed for bankruptcy, and then argued that they should receive extraordinary rent relief while facing a lack of revenues.

Second, the 210-day lease assumption or rejection deadline was temporarily extended to 300 days (210 days plus one 90-day extension).

These two modifications expire after two years, on 27 December 2022.

Discrimination against debtors

As a general matter, Bankruptcy Code Section 525 prohibits the government and private employers from discriminating against people on account of bankruptcy.71 However, covid-19 has raised two novel situations.

First, the CARES Act contained provisions regarding mortgage foreclosure and tenant eviction moratoria and mortgage forbearance. Benefiting individual debtors, CAA Section 1001(c) adds a temporary section providing that a person may not be denied relief under those provisions because of bankruptcy.

Second, regarding corporate debtors, as mentioned above, the CARES Act created PPP loans to provide financial relief to distressed small businesses. As discussed in the prior edition of this Restructuring Review, PPP loans are administered by the Small Business Administration (SBA). While the original legislation authorising PPP loans contained no exclusion for bankrupt companies – which predictably could benefit from PPP loans during the pandemic, and potentially use them to reorganise, preserving jobs – the SBA indicated that bankrupt companies were ineligible. Jilted debtors litigated the issue with the SBA with some success, for example focusing on Bankruptcy Code Section 525.72

CAA Sections 320(a) and (f) helped to clarify this important and contentious topic,73 although by creating new uncertainty. The CAA temporarily amended Bankruptcy Code Section 364 (concerning the debtor's ability to obtain loans while in bankruptcy) by allowing a debtor (or trustee) proceeding under subchapter V (but not under regular Chapter 11), Chapter 12 (for family farmers and fishermen), or Chapter 13 (for individuals) to obtain PPP loans with court permission. However, this amendment contained an unusual effectiveness provision. This provision provided that the amendment of Section 364 would only come into effect if the SBA determined that it would. Thus, Congress punted the issue of PPP loan eligibility back to the SBA. The SBA has not yet changed (and may never change) its position on this issue. Indeed, its latest frequently asked questions section about PPP loans reiterated that to be eligible for a PPP loan, an applicant must certify that it is not presently in bankruptcy. However, it noted that a Chapter 11, 12 or 13 debtor is considered to be out of bankruptcy for SBA and PPP purposes once a plan has been confirmed (or the case has been dismissed); it did not distinguish between regular Chapter 11 and subchapter V.74 The date that a plan is confirmed is often earlier than the date that the plan becomes effective (also known as 'substantial consummation'),75 and earlier still than the date of case closure (also known as obtaining a 'final decree').76 So some commentators expected a rush among eligible debtors to confirm a plan and access PPP funds.77 However, in early May 2020 the PPP ran out of money, and in any event new loan eligibility was scheduled to expire after 31 May 2020, so eligibility in bankruptcy seems to have become an academic matter.78

ii Case law developmentsViolation of the automatic stay: action versus inaction

In the second half of 2020, and in 2021 so far, the most notable court case in the bankruptcy context has probably been the Supreme Court's decision in City of Chicago v. Fulton.79 The question presented was whether an entity that is passively retaining possession of property in which a bankruptcy estate has an interest has an affirmative obligation under the Bankruptcy Code's automatic stay, 11 United States Code Section 362, to return that property to the debtor or trustee immediately upon the filing of the bankruptcy petition. The bankruptcy petitioners had filed bankruptcy petitions and requested that the City of Chicago return their vehicles, which had been impounded for failure to pay fines. The court below had concluded that the City's refusal violated the automatic stay, because by retaining possession the City had acted 'to exercise control over' the bankrupts' property, in violation of Bankruptcy Code Section 362(a)(3).

The Supreme Court disagreed. It held that the mere retention of estate property did not violate Section 362(a)(3). Under that provision, the filing of a bankruptcy petition operates as a 'stay' of 'any act' to 'exercise control' over the property of the bankruptcy estate. It concluded that 'the most natural reading of these terms . . . is that [they] prohibit[] affirmative acts that would disturb the status quo'.80 It appears instead that the clear avenue for seeking return of property is via a turnover proceeding under Section 542.

The Supreme Court expressly did not reach the question of whether the City of Chicago had violated any other sections of 362, specifically (a)(4) or (a)(6), which stay creation, perfection, and enforcement of liens, and 'any act to collect, assess, or recover a claim'.81 Thus, where arguments that the City's conduct had violated other sections had been presented, the intermediate appellate court subsequently remanded to the relevant bankruptcy courts for consideration of these alternative arguments.82 Further interesting developments on this topic are likely.

Fiduciary duties in LBO situations

As discussed above, clawback actions are a prominent method for creditors to enhance recoveries in Chapter 11. Likewise, whether in or out of bankruptcy, aggrieved shareholders, or creditors if they have standing, may sue for breach of fiduciary duty. In December 2020, the District Court for the Southern District of New York laid down an important discussion of these topics in the context of a leveraged buy-out (LBO), in In re Nine West LBO Securities Litigation.83 It provides guidance and warning to directors and officers about the risks of approving (even indirectly) transactions to increase corporate leverage that could ultimately leave a company insolvent.

The key question was whether creditor representatives could sue successfully former directors for breach of fiduciary duty for approving an LBO that arguably led to a company's bankruptcy.84 The short answer is yes – the litigation survived a motion to dismiss.85

Factual and litigation background

The Jones Group, Inc (or the Company), later renamed Nine West, was a publicly traded shoe and clothing company that sold brands including Nine West. In 2012, the Company began to market itself, and its board was advised that the Company could support a 5x debt to EBITDA (earnings before interest, taxes, depreciation and amortisation) ratio. In 2013, the Company agreed to a merger with an affiliate of a private equity firm. The Company would be taken private, would borrow a significant amount of additional corporate debt, and the existing shareholders would be cashed out. A portion of the company (brands referred to by the Court as the 'crown jewels') would be carved out and sold to other affiliates of the sponsor for allegedly 'substantially less than their fair market value'. Ultimately, the transaction structure included approximately 7x to 8x debt to 'adjusted' EBITDA. The directors disclaimed responsibility for the Company taking on more debt and selling the 'crown jewels', planned before but implemented shortly after they left the board.

The transaction closed in 2014, and Nine West filed for bankruptcy in 2018. When Nine West emerged from bankruptcy in 2019, a litigation trustee was put in place to pursue claims relating to the 2014 transaction against former directors and officers in order to collect money to distribute to creditors. In 2020, the litigation trustee (the plaintiff in this litigation) sued former directors on multiple grounds including (1) breach of fiduciary duty, (2) aiding and abetting breach of fiduciary duty, and (3) fraudulent conveyance, accusing the directors of complicity in the bankruptcy because they approved the 2014 sale, which arguably precipitated the Company's insolvency.

Directors ignore post-acquisition capital structure at their peril

The Court's 4 December 2020 opinion and order focused on fiduciary duties.86 The Court ruled that the directors ignored 'red flags' regarding the post-merger components of the transaction, and could not 'take cover behind the business judgment rule' (i.e., their approval of the sale was not entitled to judicial deference, as discussed in the 'duties of directors' section above).87 The key takeaway is that directors should not ignore significant changes to the company planned before a sale but implemented after a sale,88 when they will no longer be on the board. Put another way, directors' fiduciary duties include considering the health of the company following a sale.

Directors would do well to carefully consider all information provided to them regarding the future plans for their company, and may wish to obtain representations and warranties regarding the purchaser's future intentions with regard to incurrence of additional debt, and other corporate transactions. A director who approves an LBO should use due care and be wary, because he or she may later be sued on account of the LBO failing. If it is alleged that the director was passive and inadequately informed, he or she may not be able to obtain a dismissal prior to the court authorising discovery, which significantly increases defence costs and affects settlement negotiations. While Nine West was decided primarily under Pennsylvania law, where the Company was incorporated,89 careful advisers will refer to it for best practices regardless of location.

Significant transactions, key developments and most active industries

i Major Chapter 11 filings

Section I above provides a broad perspective on bankruptcy trends from the past year. As discussed above, industries that saw particular distress included retail, tourism, and other consumer-facing businesses (restaurants, hotels, airlines, etc.), as well as oil and gas. The largest Chapter 11 filings in 2020 by asset size included the following, with between US$7 billion and US$26 billion in assets:90

  1. Consumer-facing companies: The Hertz Corporation (rental cars) (the largest case of the year, with US$26 billion in assets), LATAM Airlines Group SA (airline), Ascena Retail Group, Inc (clothing) (i.e., Ann Taylor, Loft, Lane Bryant, etc.), JC Penney Company, Inc (department store), Neiman Marcus Group LTD LLC (department store), and Avianca Holdings SA (airline).
  2. Oil and gas (including equipment and services): Chesapeake Energy Corporation, Valaris plc, McDermott International, Inc, Whiting Petroleum Corporation, and Oasis Petroleum Inc.
  3. Pharmaceuticals: Mallinckrodt plc (in relation to opioid litigation).
  4. Telecom: Frontier Communications Corporation and Intelsat SA.

Although the out-of-court financing markets are robust, as discussed above, some significant Chapter 11 cases have filed in 2021 to date, including continued retail and oil and gas activity, including Paper Source (retail), Belk (retail) and L'Occitane (retail), and Seadrill Limited (oil drilling).91 An unusual weather event also triggered some filings: a particularly harsh winter storm in Texas in February 2021 triggered a surge in demand for energy while freezing equipment that was not winterised.92 Notable bankruptcies of electrical companies affected by the dislocation in the provision and sale of electricity included Brazos Electric Power Cooperative, Inc, and Griddy Energy LLC.93

ii Hertz: a case study in the value of equity in a distressed company

As discussed above, the travel industry has been significantly impacted by covid-19. One example of a business in the travel industry that has seen the highs and lows of the recent volatile markets is rental car company Hertz, which filed the single largest case in 2020, with US$26 billion in assets.94

After its bankruptcy filing, Hertz common stock continued to trade actively at a meaningful market capitalisation. Financial experts call this phenomenon 'option value' – even though the stock appears to be 'out of the money' and the equity value zero or negative (i.e., debts exceed assets), there is a chance that the company will recover. Indeed, when significant swings are likely (i.e., volatility is high), option value can be substantial. Hertz was a case in point. In an attempt to raise funds and capitalise on the unexpectedly high value of its stock, Hertz took the highly unusual and unprecedented step of attempting to sell equity into the public markets during a bankruptcy case. The bankruptcy judge, whose mandate is to support corporate rehabilitation and recoveries to creditors, and generally to approve corporate actions taken using reasonable business judgement, approved the proposed stock sale. However, the US Securities and Exchange Commission (SEC), whose mandate is protection of retail investors, strongly discouraged the sale, notwithstanding that Hertz had warned in its disclosures that the stock was likely worthless. The sale did not go forward except for a small portion sold before the SEC objected.95

Indeed, equity rarely recovers any value in Chapter 11 cases, but Hertz's case demonstrates that in the right economic circumstances, the US bankruptcy system can preserve equity value.96 For a point of comparison, the stock price of competitor Avis Budget Group, which avoided bankruptcy, finished April 2021 at an all-time high. In May 2021, Hertz ran an auction to provide equity capital to fund the company going forward, and after an active bidding war is proposing a plan of reorganisation funded by the winning bidding group that would 'deliver significant value to the Company's existing shareholders' including cash, common stock and warrants.97