Bankruptcy and Disclosure

The bankruptcy case concerning WMI, the former holding company of WaMu, continues its slow-paced way through the pertinent court in Delaware, under the guidance of Judge Mary Walrath.

On August 30, the consortium of trust preferred security holders (the TPS consortium) filed a motion that the debtors be deemed to have made certain admissions.

The WMI litigation was at one time chiefly a dispute between the debtor estate itself, on the one hand, and JPMorgan on the other., Back in the chaotic autumn of 2008, the FDIC seized WaMu, ran a quick min-auction, and sold it to JPMorgan. Everything was done so quickly that there was no real sorting out of the assets -- what belonged to the holding company, which thereafter declared bankruptcy, and what belonged to the operating company, which was now part of JPM.

So those two sides fought out the allocation of assets in bankruptcy court. They have more recently kissed and made up. Their making up is known as the "global settlement." But ... not so fast! says the TPS Consortium. "We're not sure we want you guys to make up."

Go here and then go to page 12 of that PDF. That was a letter written July of this year.

In the money quote, TPS says that in the pre-settlement litigation, "Debtors made numerous claims of value purportedly owned by, or owed to, the Debtors, which claims, if successful, could have resulted in significant distribution to creditors in these cases, including members of Class 19. But, prior to entering into the 'global settlement' to compromise substantially all of those claims (including claims as to the ownership of the Trust Preferred Securities), the Debtors had conducted, in the view of the TPS Consortium, minimal (and in some cases, perhaps, no) discovery or analysis of such claims. Moreover, it appears the Debtors’ attorneys responsible for negotiating the 'global settlement' had potentially disabling conflicts of interest with certain parties who, under the settlement, would receive significant additional benefits, including, without limitation, JPMC."

Bottom line? TPS wants to derail the settlement.

Enough background. Now we're back up to this week. On Monday, TPS filed its "motion to deem all requests admitted." Why should the court "deem" this? Because the debtors have been evading requests for admissions where TPS is, according to its attorneys, entitled to a yes or no answer.

"Debtors’ response is wholly inadequate because it is riddled with boilerplate
objections that cannot be sustained. In particular, Debtors make fourteen general objections (the “General Objections”) to every request and further object to every request as “vague, ambiguous, overbroad and unduly burdensome.”

"Debtors further improperly assert the attorney-client
privilege and work-product doctrine claiming that general facts are privileged."

The requests are, for example, that: "Counsel for the Debtors, Weil, Gotshal & Manges LLP, et al., were the sole negotiators of the Proposed Global Settlement Agreement for the Debtors."

Presumably they are asking this because they want to argue that Weil Gotshal was conflicted, and its conflict of interests should void the settlement. If they were the "sole" negotiators, the route from point A to point B is straighter and narrower.

I'll keep an eye on this.

WaMu bankruptcy

The Delaware bankruptcy court has authorized a study of the circumstances that led to the bankruptcy of Washington Mutual by Joshua Hochberg of the law firm McKenna Long & Aldridge.

This was part of those overly dramatic days of the fall of 2008. The FDIC seized the operating company, i.e. the actual bank, and unceremoniously sold it to JP Morgan Chase. This was all done hurriedly. As Sorkin wrote, "The FDIC typically conducts seizures of troubled banks on Friday evenings, to allow regulators time over the following weekend to readsy the institution to open under government oversight on Monday. But WaMu was deteriorating so rapidly -- nearly $17 billion had been withdrawn in ten days -- that the regulators had no choice," but to run the auction on Wednesday and effectuate the seizure on Thursday.

That didn't involve a bankruptcy court at all. But immediately thereafter its holding company (WMI) filed for bankruptcy protection. All this happened so quickly that no one had a chance to work out which assets belonged to WaMu and which to WMI, so they proceeded to argue that out in court. In a development that may have helped generate some changes in the law, JPMC sought full disclosure of all information called for by Bankruptcy Rule 2019(a), not just the names of the members of the WMI Noteholders Group and the aggregate value of their interests. Following the 2005 decision of the United States District Court for the Southern District of New York in In Re Northwest Airlines Corp., the court granted JPMC's motion and ordered full compliance back in December 2009.

It appears, though that the issue of disclosure in other forms is still bedevilling this particular bankruptcy proceeding.

Anyway, I look forward to an enlightening report from Hochberg.

Three brief items

1. Auction for Genzyme?

Genzyme Corp., a biopharm company based in Cambridge, Mass., has rejected a takeover offer from Sanofi-Aventis, the largest drug manufacturer in France.

According to a Bloomberg story, the discussions thus far have been informal, but "Sanofi may send a formal letter to Genzyme detailing its interest in an acquisition as soon as this week."

Genzyme has had the pleasure of Carl Icahn's company for some time now. Icahn curently controls two seats on the board. Icahn will surely make his views on the subject known if this does play itself out over the weeks to come.

GlaxoSmithKline is also sometimes mentioned as an interested party, so a real auction for Genzyme is a possibility.

2. Higher cross-border bid.

Alimentation Couche-Tard, the Canadian convenience store concern that owns the Circle K brand, has increased its bid for Casey's General Stores. It was bidding $36 a share in April and has now raised that to $36.75.

This values Casey's at $1.9 million, including debt says DealBook.

The offer expires at 5 PM on August 6 -- which, it so happens, is my baby sister's birthday. (Hello, Beth!)

Oh, and perhaps I' naive, but this strikes me as odd.

3. GSI Group Emerges from Chapter 11.

GSI is a multi-national family of companies that supply parts ("precision technology") to the medical, electronics, and industrial markets. Parts that, so far as I can tell, involve lasers.

Three of the entities within this family filed for chapter 11 reorganization in November 2009, in Delaware: GSI Group Inc., the parent Canadian holding company; GSI Group Corp., of Massachusetts; and MES International, Inc., a non-operating subsidiary of GSI Group Corp.

But now they have returned from that legal world of the undead to that of the truly living.

The Boston Business Journal, in May, described the descent into bankruptcy as
"a slew of regulatory and accounting setbacks that stemmed from revenue-booking practices between 2004 and 2008."

That got me curious, so I went here. Seventeen months ago, and eight months before its bankruptcy filing, GSI announced the results of an internal accounting probe and admitted to material revenue-recognition errors.

Bankruptcy and Dodd-Frank

Does the new Dodd-Frank bill have anything to say about corporate bankruptcies?

Yes, and to say myself the trouble of paraphrasing, I'll simply link you to a fine listing of direct and indirect consequences.

None of it seems to address the core dysfunction of our corporate bankruptcy system, though.

Back in March 2008, Judge Posner, of the 7th circuit court of appeals, suggested the key dysfunction -- out-of-control bankruptcy trustees. Posner wrote, “While the management of a going concern has many other duties besides bringing lawsuits, the trustee of a defunct business has little to do besides filing claims that if resisted he may decide to sue to enforce.”

In particular, trustees had become very aggressive by that time (BEFORE the worst of the credit crunch that autumn) in pressing claims for fraudulent conveyance. The result was that counter-parties to any institution that might even have been close to bankruptcy, which may even be rumored to be close to bankruptcy, have got very jittery. Why set one’s self up to be the defendant in a lawsuit brought by the next aggressive trustee?

It was and still is a legal climate that encourages “runs on the bank,” and that is what we have gotten.

It is more than a pity that neither Dodd nor Frank nor any of the many cooks that shared the legislative kitchen creating this crazy soup saw fit to address that problem head on. It is more than a pity, it is a symptom.

Principal Place of Business

Recently, in Hertz Corp. v. Friend, the US Supreme Court has unanimously endorsed the so-called "nerve center" test for determining what is a corporation's "principal place of business."

This is an important question in terms of access to the federal courts on a "diversity" rationale. A natural person is deemed to have only one state of residence for purposes of diversity jurisdiction. A corporation is deemed to be a resident of any state in which it is chartered and of the state that is its principal place of business. What does this mean? There has been what the law firm Blank & Rome has called a "cacophony of approaches," circuit by circuit, and SCOTUS now wants to turn this into more of a melody.

In the instant dispute, Friend et al. sued Hertz in a California state court seeking damages for what they claimed were California's wages and hopurs laws. Hertz, presumably believing it would receive better treatment in federal court, sought to remove the issue to same on ground of diversity of citizenship. The federal district court in California refused to take the case. It said Hertz was a citizen of California, so there was no diversity.

SCOTUS has now reversed that, finding that Hertz' nerve center is in New Jersey, so it may get into federal court.

The meaning of the phrase "principal place of business" is also a contested one in the context of bankruptcy, as SCOTUS observed.

Here's a quite recent illustration of that fact.

To How Many Failures is Trump Entitled?

I just wish I understood Donald Trump's career path.

I guess that failing on a really big scale gets one a reality TV show, and success in that peculiar endeavor gets one another chance to fail on a really big scale again, as indicated in the article to which I've just linked you.

Am I missing anything?

The Mervyn's Deal from 2004 reverberates

Back in 2004, Target's sold the Mervyn's department-store chain to a group of PE investors led by Cerberus. (Faille's first law of finance: Cerberus has one of its many canine heads in everything!)

Mervyn's declared bankruptcy in 2008. (Didn't everybody?) But in Mervyn's case, ticked-off unpaid creditors decided it was all Target's fault. Target had structured the sale so as to strip to valuable real-estate holdings from the transaction, so that Mervyn's thereafter was required to make lease payments on land it had previously owned. Inflated lease payments, say the ticked-off creditors.

The estate trustee has apparently brought an adversary action against Target through the bankruptcy court. I say "apparently" because I haven't done a serious search via PACER for the actual papers yet, so I'm relying on news accounts. Said accounts tell me that Judge Kevin Gross of the U.S. Bankruptcy Court in Wilmington, Del., said the complex series of transactions should be viewed as a single deal, one that had "devastating" consequences on Mervyn's creditors, and he denied the motion to dismiss.

Last year, William Ackman tried to use a proxy fight to persuade Target to turn the land under its stores into a real-estate investment trust. His slate of nominees for the board was defeated, though. I wonder if Ackman has a cheering interest in this lawsuit one way or the other?

Fairpoint bankruptcy

After writing the last two entries regarding Lehman Brothers I'm still in a post-bankruptcy-power-struggle kind of mood.

Bankruptcy is usually seen as an end. It takes a certain usefully skewed angle of vision to see it as a beginning. In that spirit, I observe that FairPoint Communications Inc. has won approval of its amended disclosure statement with a judge's order letting the bankrupt telecommunications provider begin soliciting votes on its reorganization plan.

Fairpoint, which is headquartered in Charlotte, North Carolina, was long a rural local telecomm business -- the most old-fashioned sort of telecomm -- something from the days of "Watson, come quick, I need you!" The company leaders got ambitious in 2007 and bought Verizon’s land line service area in rural New Hampshire, Vermont, and Maine for $2.7 billion dollars, acquiring 1.48 million acces lines in the process.

That may have been over-reaching at a bad time. Fairpoint filed for bankruptcy court protection on October 26, 2009.

Even after that filing it was getting back news from those "down east" assets, as when regulators in Maine said it couldn't use its chapter 11 filing to shield itself from a mandatory rate drop.

Since then it has had to restate its numbers for the first three quarters of 2009, the pre-bankruptcy quarters, significantly.

But that's all background. Here is what I wanted to foreground. Some heavy hitters, including John Paulson and Angelo Gordon, bought large positions in Fairpoint's bank debt before its filing for chapter 11 protection.

Judge Burton Lifland, in Manhattan, Lifland recent approved the troubled service provider's reorganization plan and a $75 million loan to pay for its exit out of Chapter 11 protection. Under the plan, FairPoint will give holders of secured debt 92 percent of the shares when the company emerges from Chapter 11 protection, while unsecured creditors would get eight percent of the shares.

Lifland applied what sounds like a minimal standard for approval. "I cannot find this plan patently unconfirmable," Lifland said adding that objections could be addressed during the confirmation hearing in May.

I'll try to come to a fuller understanding of the issues involved until then. This is sound and fury, yet I think it signifies something.

Lehman's Problems, Continued

I'm still mining the Examiner's Report that I discussed yesterday, looking for the good nuggets.

I found this: On page 480 of the second pdf in the series, the Examiner is discussing Lehman's efforts to sell itself to Warren Buffett. Fuld and Buffett spoke on Friday, March 28, 2008.

"They discussed Buffett investing at least $2 billion in Lehman. Two items immediately concerned Buffett during his conversation with Fuld. First, Buffett wanted Lehman executives to buy under the same terms as Buffett. Fuld explained to the Examiner that he was reluctant to require a significant buy-in from Lehman executives, because they already received much of their compensation in stock. However, Buffett took it as a negative that Lehman executives were not willing to participate in a significant way. Second, Buffett did not like that Fuld complained about short sellers. Buffett thought that blaming short sellers was indicative of a failure to admit one's own problems."

Buffett was of course wise in this. And the short sellers were right to believe that Lehman was over-valued as Einhorn explained in May 2008.

The vulture doesn't kill. The vulture feeds on the flesh of the dead. And, in so doing, said vulture performs a service. Though he is led to perform that service by his regard for his own self-interest, it is a genuine service. Bring out your old Adam Smith neckties!

Lehman's Problem was ... Lehman???

You mean it wasn't a conspiracy of short sellers?

I see from Sorkin's book that back on April 2, 2008, Dick Fuld had a breakfast meeting with Jim Cramer and sold him on the theory that Lehman's real problem was "a cabal of shorts," and the abolition of the uptick rule in 2007, which had presumably empowered said cabal.

Many have echoed Fuld's views. Indeed, in September 2008 the SEC halted the short selling of stocks in the financial sector altogether. That didn't last long, and it didn't seem to have any impact while it lasted, but the geniuses in Washington thought they had to show that they could collectively be a tough sheriff coming into Dodge.

Now there is a bounty of new evidence for what those of us who were skeptical of the anti-shorting cause have suspected all along. The problem with Lehman according to a report by the bankruptcy court's examiner just released was Lehman's own management, compounded by overly creative accounting and its enablers at Ernst & Young.

The report is available in full here. It's more than 2,000 pages long, and accordingly each of the links on the Jenner & Block page to which I've just linked you represents a separate volume. (The examiner is J&B's chairman, Anton Valukas.) But let's just stick to the Executive Summary, which appears at pp. 58-70 of the first volume/PDF.

Lehman failed because it was unable to retain the confidence of its lenders and counterparties. Why was it unable to retain their confidence? Because "a series of business decisions had left it with heavy concentrations of illiquid assets with deteriorating value...." Those decisions, misguided though they were, were within the business judgment rule -- i.e. they were legal. What may not have been legal, though, was the use of accounting trickier to obscure them.

The short sellers, then, were right. They accurately perceived the rottenness that Lehman's accounting trickier was designed to hide. Short sellers are the heroes of this examination, not the villains. Of course, they are well-compensated heroes, so there is no need to cry over their underappreciated character., Still, the short sellers were doing a valuable job, doing it well, and were made the scapegoats by the real malfeasors.

Who'd a thought?

Last Friday morning

Last Friday I attended a hearing, in Manhattan, and listened to witnesses testify before the Committee on Rules of Practice and Procedure of the Judicial Conference of the United States, on a proposed re-write of Rule 2019.

As is my usual practice in these matters, I drove down to Stamford the previous evening, stayed at a hotel (by preference La Quinta, which is convenient to both the highway and the train station), then took MetroNorth into Grand Central early Friday morning. When I arrived at the hotel, around 9 PM Thursday, there were three police cars in front of the main entrance. Two more were to come by a couple of minutes later. Bravely pushing on despite my own desperado past, I went to the front desk to check in anyway.

Curiousity in its cat-killing way got the better of me, and I made discrete inquiries. It appears that a homeless man had been camping out in of the the supposedly unocuupied rooms of the hotel. I'm unsure how he had originally gotten there, but apparently housekeepiung discovered him. All the police were doing was trying to find out who he was -- deliver him to some relation if they could find one -- deliver him to one of the city's shelters otherwise. For this they needed five squad cars? I'm guessing conversational lulls were ruling the day at the coffee shops on Stamford where that city's Finest hang out, and they relished the diversion.

Anyway, my train ride went smoothly the next morning and I was soon in Grand Central. I elected to take a cab from there to the federal courthouse near Foley Square where the hearing was to be, and the cabbie elected the FDR.

There are no trash bins within about two blocks of that courthouse. I know this because a woman in line with me at the security checkpoint was complaining about this as she held an empty styrofoam cofee cup in her hand. She had purchased the coffee who-knows-where and had found no place wherein the discard the cup.

My hearing took place on the 23d floor. The room's window faced north, and there was an impressive view of the towers of midtown.

The hearing was actually of interest as these things go, though its unlikely any of the fifty or so non-testifying observers was there for fun. I suppose you know a good deal more about that evening and morning in my life now than you ever thought you would. The point? -- well, how about this: this is my blog, and I can be self-indulgent if I want to.

Two bankruptcy cases: what SCOTUS Won't Decide

The Supreme Court of the United States yesterday announced that it will not grant cert to bankrupt flatware maker Oneida, which sought to use its chapter 11 filing in 2006 to relieve itself of the obligation to make its payments to the Pension Benefit Guaranty Corp.

The ERISA says simply: "[T]here shall be payable to the corporation [PBGC], with respect to each applicable 12-month period, a premium at a rate equal to $1,250 multiplied by the number of individuals who were participants in the plan immediately before the termination date.” But the bankruptcy court agreed with Oneida that this was a pre-petition claim under chapter 11, subject to relief. This is a matter of enormous concern to many companies who find, as the population of the US (like that of much of the rest of the industrialized world) ages, that pension obligations are a significant burden.

It is a burden they have largely brought upon themselves. I don't know anything of Oneida's specific situation, but many US companies have used the prospect of juicy pensions as a way of easing otherwise difficult labor negotiations. The unions representing their workers were also complicit in this game, because they could present higher pension promises as a negotiating victory to their rank-and-file, without worrying much about whether those promises were funded or just hot air. So the bill comes due, and the restaurant's diners keep passing it around the table.

The 2d Circuit has since overturned the bankruptcy court's discharge, though, preserving the ERISA obligation. And it was the 2d Circuit decision whence the company sought a writ of certiorari. Now SCOTUS has let that ruling stand, leaving the other circuits free to go their own ways without guidance. Of course, if those other circuits follow the 2d Circuit's precedent, there will never be a need for SCOTUS to weigh in. This is one of a class of cases in which SCOTUS prefers to wait until a split among the circuits develops.

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Another decision-not-to-decide: the Chrysler bankruptcy. Yesterday the Justices dismissed an appeal brought by Indiana pension funds who objected to the ham-handed way in which the Obama administration pushed the old Chrysler through bankruptcy at their expense. The 2d Circuit in June had approved of the shotgun sale of most of Chrysler's assets to Fiat, but Justice Ginsberg stayed the sale soon thereafter. Now the Justices have sent the case back to the 2d Circuit with an order that the circuit dismiss the challenge to that sale as moot.

The state treasurer in Indiana says that he is happy with the high court's decision not to decide on mootness grounds. The manner in which it is done effectively erases the Second Court's decision as a precedent, and this means there is no precedent upholding the kind of emergency proceeding employed here. Its critics survive to fight another day.

Three brief items

1. What is the "ethernet"?

A couple of entries ago, I described MRV Communications as a "networking/ethernet company." What does that mean? Networking is the broader term. All computer operating systems nowadays are "networking," i.e. they all support internet protocol at a minimum. "Ethernet" is a more specific term, referring to a particular local-area network (LAN) architecture.

2. General Growth Properties

GGP, the mall operator and a Delaware chartered corporation, remains in bankruptcy court, where it has been since its filing in April, in the Manhattan bankruptcy court.

The case is shaking up ideas about special purpose entities and what is or isn't bankruptcy remote. Walter Kurtz writes that "structurers are quickly moving away from Delaware" as a result of developments in this litigation, and that the Caymans will be their new charterer of choice.

3. Dell offers $3.9 billion for Perot Systems.

Analysts who cover Dell have long said that it was too tightly focused on hardware and should diversify into the software side of the industry. This it now appears intent on doing, by purchasing a company founded by a former independent presidential candidate.

Perot, I'm told, is a juicy target because it has contracts with hospital groups, and any reform of the healthcare system that does come out of this or ensuing Congresses will almost surely include a push to digitize healthcare, which of course means work for Perot. I'll try not to wax conspiratorial here, or even to mutter about crony capitalism.

Reader's Digest

The Reader's Digest Association (RDA) filed for bankruptcy court protection yesterday with a pre-aranged restructuring deal with the majority of its senior secured lenders. [So this will be, fittingly enough, an abbreviated bankruptcy with the boring stuff ommitted.]

The filing includes only the RDA's US units. It also has divisions in Canada, Latin America, Europe, Africa, Asia, Australia, and New Zealand -- all of which are unaffected. Indeed, in a bit of "having/eating the cake" legerdemain, those unbankrupt units will have access to the debtor-in-possession financing that the bankruptcy filing will secure.

The bankruptcy appears to be a side-effect of the Ripplewood LBO of a couple of years ago. That and the fact that RDA is suffering from the malaise that affects all dead-tree operations these days.

RDA is represented in this bankruptcy by Kirkland & Ellis LLP. It has filed in the Manhattan bankruptcy court, case number 09-23529.

SCOTUS Weighs in on Bankruptcy Law, II

Continuing yesterday's discussion of TRAVELERS INDEMNITY CO v. BAILEY (June 18, 2009).

Stevens wrote the dissenting opinion, for himself and Ginsburg.

"Because the 1986 injunction has never meant what the Court today assumes, respondents' challenge is not an impermissible collateral attack. The Court of Appeals correctly concluded that the Bankruptcy Court's 2004 order improperly enjoined the state-law claims at issue in this proceeding."

He cited a 1995 decision, CELOTEX v. EDWARDS, 514 US 300 (1995) for the proposition that "bankruptcy courts have no jurisdiction over proceedings that have ne effect on the debtor." My attention was piqued by that, because Stevens was actually citing to a footnote in the CELOTEX decision -- n. 6. CELOTEX too was a case in which the high court struggled with the jurisdictional language of the bankruptcy statutes. District courts are said to refer "any and all proceedings arising under title 11 or arising in or related to a case under title 11 ... to the bankruptcy judges for the district." How much is encompassed in that "related to"?

So, the bottom line here, the dissenters notwithstanding, is that (a) a bankruptcy court -- and a crucial one, that in the Southern District of New York -- has taken a very wide view of what is related to its proceedings, and that (b) the very wide view has survived challenge, even if on principles of res judicata rather than on any affirmation of its rightness.

This may, in a Machiavellian sense, be a necessary decision given the severity of asbestos liabilities outstanding and the systemic threat they may pose given the present economic climate. Still, hard cases make bad law, and I have to report a visceral reaction to the cutting off of Bailey's claims.

As the dissent pointed out, Bailey couldn't have objected and appealed the 1986 order because nothing in that order on its face spoke to her. Bailey appealed as soon as the order was "clarified" into a bar onher ability to litigate her claim -- if this was collateral, the fault for that was hardly hers.

Circuit City RIP

It seems certain now that Circuit City's bankruptcy proceedings are coming to an end as a liquidation, that hope for a reorganization and survival is gone.

The House subcomittee on commercial and administrative law, a panel of the House Judiciary Committee, had planned to take testimony from CC executives with an eye to potential amendments of bankruptcy law but that hearing was cancelled yesterday morning, apparently due to weather.

It appears that the executives wanted to complain largely about the way in which leases are treated under the 2005 amendments. It appears that before that year it was easier than it is now for a debtor to string out an old lease at the expense of its landlord.

Personally, I can't work up any sympathy for CC on that point -- unless there is something to it that I don't yet understand (very possible). But why should debtors be assistesd at the expense of their commercial lessors? Amending the law one way or the other on that point sounds like a zero-sum game to me.

[Subsequent interpolation, 3-5-09: The hearing has been rescheduled for 3-11, Wednesday, at 2 PM].

This is pertinent to general subject of this blog, the use of proxy campaigns to exercise power in and over the corporate suite ... how?

Circuit City is an example of a proxy partisan unheeded. It now appears obvious that the activist investors of HBK Capital Management were in the right a year ago, when they tried to get CC to sell itself to Blockbusters. That would have been the best way to maximize the equity that was then rapidly vanishing.

Chapter 11 avoidance actions

The court of appeals for the fourth circuit has decided a potentially important case about the limits of avoidance actions in bankruptcy cases.

The decision, by a three judge panel of the 4th circuit, came down February 11, in Huston v. DuPont.

Named plaintiff Richard M. Huston is the trustee for Natural Gas Distributors LLC, a company that filed for bankruptcy more than three years ago: January 20, 2006 to be precise. He has filed complaints against more than 20 former customers of Natural Gas, including DuPont.

My astute readers have probably heard the expression "possession is 9/10ths of the law," and may have even wondered what is the other tenth. Well ... bankruptcy law is the other tenth. Avoidance actions brought by trustees present a case in which possession, even possession honestly obtained, doesn't necessarily give one title.

This is easy to understand in a simple case. Suppose an individual with a lot of debt gives me a very valuable antique car he has had sitting in his garage. I am one of his debtors, and he gives me this car as an in-kind payment to settle his account with me.

I say "thank you," and transfer the car to my garage.

The next day, this debtor declares bankruptcy.

I have taken possession of the car, and by stipulation I have done so honestly, but the trustee of the estate will file a lawsuit demanding that I return the car to the estate. He'll want to sell it, add the proceeds to the kitty with the rest of the assets of the state, and then I can stand in line with the other creditors to await liquidation and my proper share.

That is called an "avoidance" action, and that is the sort of action Huston brought against DuPont.

One of the defenses, though, to a action in avoidance is the claim that the transfer at issue was part of a "swap contract." The definition of a "swap contract" for this purpose is extraordinarily complicated, covering several dozen enumerated contracts and transactions, as well as combinations on them, options on them, and the catch-all inclusion of "similar" contracts and transactions.

The portion of the definition relevant to the NGS/DuPont transaction is that a swap includes an agreement on "a commodity index or a commodity swap, option, future, or forward agreement."

The NGS/DuPont transaction involved the sale of natural gas. There was a standard form contract, plus a series of telephone conversations and confirming e-mails between representative of the corporate parties in which they determined the price of future deliveries of natural gas to DuPont during specified time periods.

The natural gas contracts and their prices were independent of the day-to-day fluctuations of the spot markets, and indeed were intended to protect DuPontagainst the possibility of spikes on the spot markets. So was the delivery of the natural gas pursuant to these contracts in the period just prior to the bankruptcy filing anything like the delivery to me of a car by my hypothetical debtor in the situation above? Or was it in the language of the statute a "forward agreement" on a commodity, and thus a "swap"?

The bankruptcy court had originally struck down DuPont's use of the "swap agreement" defense, contending that the deal at issue wasn't a swap agreement because it was a physically settled contract, NOT something traded in the financial markets, and thus outside what Congress presumably intended to protect in the language quoted above. The district court agreed.

But the appellate court disagreed, remanding the matter for further proceedings. It has not determined as a matter of law that this was a swap agreement. But it has said that the courts below were wrong to treat the manner of settlement (physical delivery) as dispositive. In the further proceedings, the bankruptcy court is instructed to allow the customers "to attempt to demonstrate factually and legally that their natural gas supply contracts were swap agreeents...."

I think the general reasoning of the appellate decision is sound. I wish the court had gone further than it did, and had held that these WERE swap agreements, removing that issue from further consideratioon by the bankruptcy judge. IMHO the threat of avoidance claims creates a great deal of uncertainty at the micro level in the US economy at present, and may significantly worsen downturns. Avoidance claims, and the damage trustees can do with them, HAVE to be limited. And if expanding the notion of a swap agreement is what it takes to do that, let's do it.

Bankruptcy has macroeconomic consequences

Thank you, Mr. Icahn. But my gratitude has its limits.

The positive first. I've been seeking to make the point for some time now that bankruptcy laws have macroeconomic consequences, and that in particular the depth of this present bust has a lot to do with malfunctions in the corporate re-organization system. (Follow that link to an entry on my other blog where I made this point back in sunny July.)

Nobody has listened to me, and I've been hoping somnebody who can command a broader audience than lil' old Christopher Faille would come along and say the same thing.

Now Mr. Icahn has stepped forward as that somebody. See his op-ed piece in Friday's Wall Street Journal.

That's all for the positive side, though. On the negative side, Icahn's agenda for bankruptcy reform seems to me wrong. The spotlight is good (thanks again) the proposal is bad. Icahn wants to abolish the rule that gives incumbent management (the debtor in possession) an exclusive opportunity to prepare a re-organization plan for the first 18 months after a filing.

He asks: "Why should the same management that got the company in trouble have the right to lock up its assets for an extended period of time?"

The simple answer to that question is that the management of a corporation has to make the decision to file for bankruptcy in the first place. Legislators have decided it is better to give them some incentive to do so than to have them continue to preside over an empty shell of a company until creditors force bankruptcy on them. The 18 month period that riles Icahn is part of a package aimed at inducing voluntary filings while there is still enough fo a company left for the filing to be in the public interest.

Maybe the legislature has made the wrong call there, but it isn't an inherently irrational call.

The problem with bankruptcy law, Mr. Icahn, isn't with the managers. It is with the overly aggressive liquidation trustees who bring "avoidance" actions and their kin at the real or imagined drop of a hat.

As trustees have become more aggressive in pressing such actions, financial entities all along the spectrum have become more sensitive about ending up as defendants therein. Regardless of the eventual outcome, just being a party to such a dispute is a catastrophe. What does one do to stay clear of that? In the absense of a time machine, the only way to avoid "avoidance" lawsuits is to refuise to be the counter-party of any institution that seems weak, or is even rumored to be considering a bankruptcy filing.

The trustees, in other words, have collectively created a hairtrigger mentality. If a hedge fund manager hears a rumor that his prime broker may be in trouble, he may not be able to afford to wait for evidence that the rumor is true. He has an incentive to sever his ties with that prime broker (read: Bear Stearns) on the rumor.

As Judge Posner wrote in the matter of Maxwell v. KPMG, "While the management of a going concern has many other duties besides bringing lawsuits, the trustee of a defunct business has little to do besides filing claims that if resisted he may decide to sue to enforce."

Bankruptcy reform has to focus on the task of reining-in such trustees.

Napster faces proxy contest

Napster ... there's a name redolent of history.

In the speeded-up cyberspatial sense of the word "history" of course.

It began in 1999 as a cool idea in the head of Shawn Fanning. Fanning was 18 years old at the time, and I understand the term "napster" itself was first his hair-related nickname.

He sparked an intense debate over peer-to-peer networks and intellectual property, and redefined the market for music.

Ah, those were the days. Unfortunately, that Napster shut down in July 2001as the result of a court order. The company now known as Napster was formally Roxio Inc., having purchased the original firm's brand and logos at a bankruptcy auction.

Roxio/Napster launched its service, Napster 2.0 in October 2003.

The reborn company's stock price hit a high of $10 in December 2004. But for the subsequent three and a half year, it's been skidding. In early July of this year it was selling for less than $1.25 a share. It has since rebounded a bit. Not much.

Hence, the dissatisfaction of many of its investors, and the present proxy contest. The demands? This from a filing.

"We believe the current classified board structure, the board’s continued support of its poison pill takeover defense, the dilution of shareholder ownership through restricted stock grants for 'performance' and the new 'change of control' severance package awarded to the CEO/chairman have misaligned the interests of the board from those of stockholders. In fact, we believe Napster’s generous senior executive compensation practices overall have created incentives for management NOT to sell the company. It is time for stockholders to exercise owner oversight and force entrenched directors to step aside by casting your vote with us."


Now THERE's a song they've taken from their peers.

Dysfunctional bankruptcy courts

It is a truth universally acknowledged that a failed business must be in want of a lawsuit.

My own bias in such cases is that investors --especially the institutional sort -- have to be prepared to take their knocks. When they invest in a risky posititon, either they were aware of the risk or they were likely lacking in their due diligence. Either way, I can work up more sympathy for the failed managers than for their vengeful former investors.

The failed managers aren't the only targets of the lawsuits that follow from a typical early 21st century business debacle.

We have these darned "fraudulent conveyance" and "avoidance" lawsuits that help spread trouble. Even the possibility that X now teeters near bankruptcy makes it very risky for anyone to accept money from X, which has a variety of perverse consequences and may have helped lead Bear Stearns to slaughter earlier this year.

Bridgeport Holdings will likely worsen the problems that arise from such situations. All it seems likely to accomplish in the first round of consequence is to drive up D&O liability insurance rates. The second round? the impact of those higher rates? an arbitrary re-allocation of resources toward fields thought to be inherent lewss transparent, and thus less likely to draw lawsuits.