Corporate Governance, Bankruptcy Waivers, and Consolidation in Bankruptcy

• Publication year: 2020

Corporate Governance, Bankruptcy Waivers, and Consolidation in Bankruptcy

Daniel J. Bussel

CORPORATE GOVERNANCE, BANKRUPTCY WAIVERS, AND CONSOLIDATION IN BANKRUPTCY

Daniel J. Bussel^*

Abstract

Corporate law formalities that impede effective bankruptcy relief are properly overridden in bankruptcy. Those formalities generally count for little outside bankruptcy and should not hamstring a bankruptcy court's ability to afford effective relief consistent with the underlying policies of the Code. Nevertheless, recent scholarship and caselaw in bankruptcy, reflecting a contract uber alles Zeitgeist, has given too much credence to both entity partitions that are blind to the reality of how firms actually operate and contractual barriers to voluntary bankruptcy relief baked into corporate charters. Bankruptcy law should refocus on honoring substance over form. In doing so, corporate formalities will properly yield to underlying substantive bankruptcy policy. The limited role of corporate formalities in the event of insolvency should be factored into market expectations surrounding asset securitization, including the frailty of both entity partitions within corporate groups, and bargained-for restrictions on entities' access to bankruptcy relief.

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Introduction.............................................................................................101

I. Corporate Governance In and Out of Bankruptcy...............108
II. Waiving Access to Bankruptcy Through a Corporate Charter...........................................................................................115
III. Substantive Consolidation of Affiliated Corporate Entities............................................................................................121
IV. Securitizing Corporate Assets...................................................127

A. Securitization Today................................................................. 127
B. LTV and General Growth ......................................................... 131
C. Assessing Securitization of the Core Assets of a Non-Financial Operating Company ................................................................. 136

Conclusion.................................................................................................136

Appendix: Securitization Data and Trends Not Involving Core Operating Assets of Non-Financial Originators.............................. 138

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Introduction

Strangely, bankruptcy law—once the vanguard of enterprise liability¹ —increasingly kowtows to the formalities of corporate law that stand in the way of effective reorganization. Despite longstanding express exemptions under state corporate law, itself,² and even as bankruptcy lawyers and judges reach for workarounds and settlements that permit enterprise-wide reorganizations and liquidations, bankruptcy courts and scholars assume that bankruptcy law regularly defers to corporate law formalism at significant cost to the underlying policies animating the Bankruptcy Code.³

In two particular areas, corporate law is seen as imposing rigid and substantive limitations on bankruptcy rights. These perceived limitations sometimes preclude bankruptcy courts from crafting enterprise-wide insolvency relief consistent with the terms and objectives of the Bankruptcy Code:

First, although bankruptcy courts have long held that access to bankruptcy relief may not be waived in a contract,⁴ those same courts have generally deferred to corporate law's decision to defer to contractual governance arrangements baked into corporate charters that hinder or preclude an entity from filing for bankruptcy relief.⁵

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Second, bankruptcy courts generally respect the legal boundaries between affiliated entities within a corporate group for substantive insolvency law purposes, even as those boundaries are routinely ignored for operational, financial, tax, and regulatory purposes.⁶

The explosion in "securitization" over the last twenty-five years is a primary driver of both phenomena.⁷ "Securitization" is based upon segregation and transfer of certain assets of an "originator" into a "bankruptcy-remote" trust or corporate subsidiary that is intended to remove the securitized assets from a future bankruptcy estate of the originator. The technique was developed to permit financial institutions to tap into the public debt markets to fund home loans and later commercial real estate mortgages. Until the early 1990s, the market for securitized debt outside of mortgage-backed securities was of de minimis proportions.⁸ But beginning in the 1990s, the technique was increasingly employed as a form of corporate finance with non-financial originators purporting to segregate assets in securitization vehicles as an alternative to traditional secured working capital lending.⁹ The bankruptcy implications of this use of securitization—which may involve segregating assets, sometimes crucial operating assets, in corporate subsidiaries that are disabled by their charters from commencing bankruptcy proceedings without the consent of their secured lender—are quite distinct from securitizations sponsored by financial institutions to fund their lending operations. Financial institutions are regulated entities, raise highly specialized issues regarding

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systemic risk and public policy, and are ineligible for bankruptcy relief.¹⁰ Applying securitization techniques to a non-financial originator, however, particularly when core working capital assets are used as collateral, directly implicates the problem of bankruptcy opt-out by the originator's secured lenders. This upsets the nuanced statutory balance drawn in the Bankruptcy Code between the rights of secured lenders and other constituents in bankruptcy cases, and potentially undermines the rehabilitative and reorganization policies of the Bankruptcy Code. Securitizing core assets of non-financial companies raises the concern of bankruptcy opt-out and is the subject of this Article.

More than twenty years ago, my UCLA colleague Lynn LoPucki suggested "the death of liability," by which he meant a systemic inability of the holders of tort claims and statutory claims to collect judgments.¹¹ For large corporations, the coming death of liability would result from continued growth in the then nascent practice of hiving off assets and pledging them exclusively to particular investors or contractual counterparties.¹² LoPucki hypothesized at length that through a combination of complex parent-subsidiary structures, security interests, and modern asset securitization techniques, large wealthy corporate groups would render themselves judgment-proof.¹³ At a time when Exxon was the most valuable enterprise in the world, LoPucki imagined a "Zero-Asset Exxon."¹⁴ By aggressively employing these strategies, Exxon could render itself judgment-proof without adversely affecting or reducing the massive scale of its operations.¹⁵ When LoPucki forecast the death of liability, a judgment-proof "Zero-Asset Exxon" seemed far-fetched given the vast wealth of the actual Exxon Corporation and the massive liability it was dealing with arising out of the catastrophic Exxon Valdez shipwreck and oil spill in Prince William Sound.¹⁶

It seems less fanciful now.¹⁷

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Indeed, in 2013, prominent bankruptcy scholars Douglas Baird and Anthony Casey addressed the same phenomenon of "entity partitioning" that LoPucki had described seventeen years before in the context of what they described as "withdrawal rights" from insolvency proceedings.¹⁸ Their fundamental premise was that bankruptcy law operated on entities, not enterprises.¹⁹ They suggested that sophisticated parties had finally fully absorbed this lesson and created an opt-out regime whereby they could and did effectively exclude the operation of bankruptcy law on their interests by hiving off critical assets into separate legal entities.²⁰ Bankruptcy restructuring had become optional, not mandatory, for these parties.

Baird and Casey chose the Los Angeles Dodgers as their headline example,²¹ noting that the enterprise relied on three interdependent highly specialized assets: the Dodgers baseball team, Dodger Stadium which stands isolated from downtown Los Angeles in Elysian Park, and its adjacent parking lots.²² Dodger Stadium, the third oldest ballpark in the country, is perfectly suited for major league baseball and just about nothing else. In true Angelino fashion, most fans drive to Dodger games in their own cars. The sprawling parking lots adjacent to Dodger Stadium provide parking for them during the baseball season.

Notwithstanding the obvious economic integration of the parking lots, stadium, and team, all of which were held under common ownership and continuously operated together as part of a unified enterprise for fifty years pre-bankruptcy, by the time of the Dodgers' bankruptcy, each asset was held in a separate limited liability company.²³ The LLCs owning the team and the stadium filed for bankruptcy relief, but the parking lot LLC did not.²⁴ Moreover, there were serious questions regarding the nonconsensual retention of the team's franchise agreement with Major League Baseball.²⁵ Baird and Casey note: "the

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Dodgers' bankruptcy was emphatically not a world in which all stakeholders had to work together and no one had the right to leave the scene."²⁶

Playing Pollyanna to LoPucki's Cassandra, Baird and Casey conclude by suggesting:

By allowing a limited number of investors to opt out of bankruptcy in a particular, discrete, and visible way, investors as a group may be able to both limit the risk of bargaining failure and at the same time enjoy the disciplining effect that a withdrawal right brings with it. Whether this preliminary assessment is correct, however, is not nearly as important as understanding the role that withdrawal rights play under existing law and their part in the much larger challenge of integrating a theory of the

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