Chapter 5 Bankruptcy Trends and Developments in Applying Liquidation Trusts

• Jurisdiction: United States

Chapter 5 Bankruptcy Trends and Developments in Applying Liquidation Trusts

This chapter surveys the key trends affecting the use of liquidation and litigation trusts, including the application of prepackaged bankruptcies. We recommend that the reader consider additional ABI resources if more information is needed.¹³

Chapter 11of the U.S. Bankruptcy Code has traditionally been used by debtors to reorganize and rehabilitate their distressed companies while bringing them through a process that streamlines operations and sheds debt. Increasingly, however, debtors are filing for chapter 11 bankruptcy protection with no intention of restructuring their businesses along these traditional lines.

Today, alternatives such as prepackaged plans and pre-negotiated § 363 asset sales are enabling debtors to settle many of the key issues among stakeholders well outside of the court-supervised process. In essence, the constituents are dividing the pie and establishing protocols to sell the business operations while leaving the litigation behind. These alternatives are seen as faster, cheaper processes that use much less court time. Those debtors that do use chapter 11 to negotiate with their creditors also find that they can more quickly exit bankruptcy by leaving behind the litigation and claims resolution, which can take years to be handled through a post-confirmation liquidation vehicle. These vehicles may be litigation trusts or other post-confirmation entities that operate similarly to a trust.

A. Key Trends

A number of significant trends are driving the increasing use of post-confirmation trusts and other vehicles. These trends indicate that longer-term factors are at play, such as the growing sophistication of bankruptcy and investment professionals who are resolving matters outside of court without the need for a protracted legal battle and a judge's decision. Other factors, such as the impact of BAPCPA¹⁴ in 2005, are more recent. BAPCPA requirements for shorter case durations and its limitations on the plan-negotiation process have combined with the increasing questions about the costs and efficiency of the bankruptcy process to offer yet more reasons to seek alternative case resolutions. The precise extent and interplay among these influences continue to be debated.¹⁵ Nevertheless, while the total amount of time spent resuscitating a debtor might or might not have changed, the period of public court supervision has notably declined.

B. Large Company Filings

Businesses fail in good times and bad. The definitions and ways of counting bankruptcy cases will depend on the source and purpose of the statistics. The number of large public company bankruptcy filings offers one definition to consider.¹⁶ The annual number of large public company bankruptcy filings continues to reflect the long-term cyclical nature of the general economy. After peaking in 2009, the annual number of large company public filings has declined. The effects of BAPCPA and other more recent factors have also played a role in this cycle since 2005. The number of large public company bankruptcy cases filed in the U.S. from 1991 through 2013 is shown in the table on the following page:¹⁷

Although default rates on debt have fallen, a 2012 survey from Debtwire North America indicated that by 2012, U.S. default rates had been below their historical averages of 3-4 percent for the marketplace that transacts distressed debt. More recent experience has been along these lines and is being driven by continued low interest rates and available buyer-side liquidity. Notably, the prime rate,¹⁸ currently 3.25 percent, is at its lowest level since 1955.¹⁹ The emergence of hedge funds that acquire debt and/or equity positions in distressed companies has also changed the landscape by bringing significant liquidity into the marketplace for distressed companies.²⁰

Still, given the large number of over-leveraged debt issues that remain outstanding, debt-issuers will need to continue re-approaching the market to avoid a default, particularly as maturity dates loom. A debtor's willingness to renegotiate terms in order to "amend and extend" the terms of existing debt, along with the marketplace's or the lender's acceptance, should help these debt-issuers avoid defaults in the near-term.²¹ These trends exemplify some of the reasons underlying the shift toward using out-of-court negotiations or out-of-court restructurings.

Changing global economics, changing political landscapes, significant regulatory evolution and change, and general economic instability all affect the general financial and lending environment for investors and debt-holders. However, their selection of bankruptcy or other some other alternative strategy to deal with a distressed business will ultimately be de rmined by the facts and circumstances of the debtor's unique situation.

C. Case Mix

The mix of cases in the most recent "Great Recession"²² was heavily tipped toward chapter 7 liquidations, reflecting, in part, the disappearance of capital necessary to finance the time and the professionals needed to resolve major issues. The shift is also indicative of the debt amendments and maturity extensions being used to prop up marginal businesses. Covenant breaches and maturity extensions accounted for nearly 2/3 of all debt amendments in 2012, down from 76 percent in 2011, with asset sales accounting for an additional 7-10 percent of activity.²³ Unfortunately, by the time a company finds itself in court, the liquidation outcome may have already been determined. The total number of all bankruptcy cases filed by chapter of the U.S. Bankruptcy Code since 2007 is shown below:²⁴

U.S. Bankruptcy Courts
Bankruptcy Cases Filed by Chapter of the U.S. Bankruptcy Code
Year	Total	Ch. 7	Ch. 11	Ch. 12	Ch. 13	Other1
2007	801,269	484,162	5,888	361	310,802	56
2008	1,042,806	679,898	8,785	332	353,739	52
2009	1,402,816	989,227	14.745	487	398,210	147
2010	1,596,355	1,146,511	14,191	707	434,839	...