A Response to Professor Baird's Essay on Unwritten Law: Writing Some Unwritten Law

• Citation: Vol. 36 No. 2
• Publication year: 2020

A Response to Professor Baird's Essay on Unwritten Law: Writing Some Unwritten Law

Richard Levin

A RESPONSE TO PROFESSOR BAIRD'S ESSAY ON UNWRITTEN LAW: WRITING SOME UNWRITTEN LAW

Richard Levin^*

In his essay, "The Fraudulent Conveyance Origins of Chapter 11: An Essay on the Unwritten Law of Corporate Reorganization"¹ Professor Baird sets out his view of the core of the unwritten law the bankruptcy judge must enforce:

When the question is one of policing the behavior of creditors during the bankruptcy process, the judge is asking whether the overall negotiations were conducted in a fashion that could be trusted to maximize the value of the assets within the bankruptcy estate . . . . Protecting the bargaining environment rather than ensuring proper division of the assets is the task at hand. Ensuring that distributional rules are followed is necessary to do this and hence a necessary part of ensuring that the players follow the rules of the game, but it is hardly the only part.²

Moreover, "Distributional irregularities are usually a symptom, not the disease. The prime directive is ensuring the integrity of the process."³ By that, he appears to mean assuring "everyone had a chance to participate in the bargaining process on fair terms."⁴

Process has always had an important role in American jurisprudence and especially in reorganization-land. Both the Supreme Court and the Second Circuit have recently recognized the right to negotiate, almost as a separate due process right.⁵ But substance in this context is not just an indicator of process. The statutory distributional rule—the actual written rules—matter in and of themselves. Distributional outcomes may indeed show whether the process, as Professor Baird defines it, was proper. But distributions that do not strictly follow distributional rules can also be the result of an entirely proper process.

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Both must be proper, not just the process. The trick is distinguishing when both are proper and when one or both are not.

I suspect that by "unwritten rules," Professor Baird means the ways in which courts decide this question. But I am not sure the rules are wholly unwritten. As Professor Baird acknowledges, there is a substantial body of case law addressing this question.⁶ I do not consider case law "unwritten."⁷ By contrast, I would characterize as "unwritten" Professor Baird's "rule" that in the reorganization arena, players stab others only in the chest, not in the back.⁸ In any event, I believe the rules are clear enough from the case law and from the simple extension that in a bold (and perhaps foolish) step, it might be possible to synthesize those rules.

I start with the premise that a business buyer generally does not pay more than what it believes the target asset is worth, and a business generally does not make a true gift in connection with a transaction in which it is participating. It expects value in return.⁹ The value might be tangible—the acquisition of an asset—or it might be to obtain the services or goodwill of someone important to the transaction. A bankruptcy judge supervising a transaction in a reorganization case must be aware of this business principle in policing the negotiations toward a conclusion to the case and considering the deal the parties ultimately bring forward for approval.

How does this principle apply to a buyer¹⁰ in a reorganization transaction? A buyer has two principal categories of costs in acquiring a business. It pays for the value of the business itself, and it pays transaction costs. The transaction costs will be capitalized along with the purchase price. From the buyer's longer-term perspective, those costs are fungible. Ordinarily, transaction costs are small relative to business value, but they can mount in a contentious chapter 11 case. And cantankerous creditors can cause those costs to grow substantially.¹¹ A

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buyer would normally expect to budget transaction costs as part of planning the transaction, and anything that would reduce transaction costs would likely allow the buyer to bid more for the asset itself.

That principle can be illustrated with the hypothetical Professor Baird's Essay poses, which is loosely based on the facts in In re ICL Holding Co., Inc.¹² There, the buyer funded a settlement for the administrative priority professional fees and general unsecured creditors, leaving nothing for the government's administrative priority tax claim. The court agreed with the bankruptcy court's characterization that the funds "belong[ed] to the purchaser[] [and] not to the debtors' estate"¹³ and therefore were not subject to the Bankruptcy Code's (Code) distributional priorities.

Let us simplify the hypothetical. The estate's sole assets are a widget and $100 in cash, and it owes creditors $200, including $10 to the widget repair company. A buyer is willing to pay $150 for both the widget and the cash. It makes no difference whether the buyer is an unrelated purchaser or a secured creditor who is credit-bidding its claims. One might surmise the buyer values the widget at $50. But the buyer says it is going to add $10 of its own cash to establish a trust fund to pay the case professionals. Does anyone doubt the buyer values the widget at $60? But no, says the bankruptcy court. That extra $10 is not property of the estate or proceeds of property of the estate that is subject to the Code's distribution scheme; it is the buyer's property, which it can do with what it wants. Nonsense.

Suppose the buyer needs the repair company to be available to maintain the widget in the future, and the repair company will refuse unless its claim is paid, so the buyer agrees to pay the repair company's $10 claim in addition to the $150 it is paying for the cash and widget. It is still clear the buyer values the widget with the availability of future repair at $60. We do not know how the buyer values the widget without repair availability, but probably not at $60 or even $50, since the repair bill is unrelated to the widget's inherent value.

How should we view this situation? Here, the estate is better off with the repair company paid. So, the estate itself might even pay the repair company before the auction.¹⁴ This is not a process question, only a distributional question

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with a goal, as Professor Baird describes, to determine what maximizes the value of the estate. The same be can be said of payments to customers, such as honoring frequent flyer miles, customer deposits, or warranty claims, some of which might be entitled to priority in any event.¹⁵ These creditors have no control over or even a role in the chapter 11 process or the negotiations and voting over plan distributions that Professor Baird would protect. So, payment cannot be seen as corrupting the process or the distributions. Outside of distributional negotiations, we should be comfortable leaving the decision whether to pay them or honor their claims without regard to the statutory priorities to the trustee's or debtor in possession's...