Bankruptcy Cases Taking Center Stage At The Supreme Court On Tuesday

The Supreme Court will hold oral argument in two bankruptcy cases on Tuesday, December 1.

The first case is Milavetz, Gallop & Milavetz, P.A. v. United States. Milavetz is a small law firm in Pennsylvania that filed an action to declare that portions of the 2005 amendments to the Bankruptcy Code violate the First Amendment. Such provisions include the prohibition against counseling clients to incur additional debt before filing their bankruptcy petition. These issues are particularly important to consumer bankruptcy attorneys and their clients. The SCOTUS Wiki page on the Milavetz case is here.

The second case is United Student Aid Funds, Inc. v. Espinosa. This case poses the fairly technical question of the procedural requirements for discharging student loans. Francisco Espinosa took out over $13,000 in student loans that he later attempted to discharge in a chapter 13 bankruptcy. Absent "undue hardship," student loans ordinarily may not be discharged through a bankruptcy case. Mr. Espinosa did not file a declaratory relief action to determine that undue hardship existed but the bankruptcy court nevertheless entered an order confirming Mr. Espinosa's chapter 13 plan and ultimately discharging the loans. Mr. Espinosa later reopened his bankruptcy case to obtain an order prohibiting the further collection of the loan. The bankruptcy court granted the request but the district court reversed on appeal. The Ninth Circuit then reversed the district court and in light of an earlier holding that a discharge can be challenged only by direct appeal. The SCOTUS Wiki page on the Espinosa case is here.

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An Interesting Take on Dubai

Today's Financial Times features a column from Professor Willem Buiter, [Update: Named today as chief economist for Citigroup] who suggests that the effect of Dubai's default on the world economy might be overstated:

Take the worst-case scenario where the debt, all $60bn of it, is worthless. The wealth loss would, through the wealth effect on consumption, reduce consumer expenditure by no more than 5 % of $60 bn per year, or $3 bn. That’s spread out fifty-fifty between Dubai and the rest of the world. Nasty, but of no systemic significance.

There are lots of other interesting tidbits as well. Here is another:

It is clear that nations whose public debt is mainly denominated in domestic currency and whose central bank is either not very independent or can be make dependent by the government of the day are likely to choose inflation and exchange rate depreciation over default as a way out of fiscal-financial unsustainability. That category would include the USA and, to a lesser extent, the UK. Because the ECB faces 16 national governments and national ministries of finance, the power and independence of the ECB are much greater vis-a-vis any Euro Area member state than the power and independence of any central bank facing a single national government and Treasury. That is regardless of the formal independence criteria laid down in laws, treaties or constitutions.

Worth a read.

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The Federal Government as DIP Lender

At the American Bankruptcy Institute Legislative Symposium on November 16-17, one of the more interesting ideas came from Harvey Miller. Harvey suggested that the federal government become a leading provider of debtor-in-possession financing.

To get everyone up to speed, most chapter 11 bankruptcy cases feature debtor-in-possession ("DIP") financing wherein a lender provides liquidity to the debtor in possession during the bankruptcy case. Most debtors of course would be unable to obtain credit on the open market and therefore the Bankruptcy Code provides extra incentives to the DIP lender to facilitate the loans to the debtor. The DIP lender gets special priority under section 364 of the Bankruptcy Code to protect the DIP lender's investment.

There are at least a couple significant sources of controversy in the world of DIP financing. First, putting it bluntly, there is quite a bit of money to be made from DIP financing. The rates and fees that the DIP lenders command from the DIP process are quite attractive. Second, other terms of the DIP agreements can be quite onerous as well. For example, the DIP lender often happens to be the debtor's senior secure lender and negotiates to "roll up" the prepetition debt into the DIP facility. Thus negotiating the terms of the order approving the DIP financing is often a very contentious moment in the case.

At the ABI panel discussions, there was a fairly steady drone of complaints about the role that secured lenders in general and the DIP lender in particular plays in a bankruptcy case. At the end of each panel discussion, the moderator typically asked the panel members a question to the effect of, "If you were a one-person Congress, what would you change?" Harvey came up with the most interesting suggestion -- make the federal government a DIP lender.

Obviously, the idea of the federal government doing DIP lending is no longer new or novel. The first I heard talk about the federal government as a DIP lender was a couple years ago when the GM bankruptcy case was only being contemplated. Of course, the federal government ultimately filled the role to both GM and Chrysler in their bankruptcy cases earlier this year. Back when I heard the idea the first time, the concern was that a debtor the size of GM would need such a massive DIP facility that the federal government would be the only lender capable of fulfilling the need. So the government was essentially the DIP lender of last resort.

Harvey's idea presumably would extend the federal government from being the DIP lender of last resort to being the DIP lender for cases of any reasonable size. And the concept definitely has some advantages.

For example, having the government serve as DIP lender would provide competition in an arena where there does not appear to be much at the moment. Generally the only entity interested in being the DIP lender these days is the debtor's senior secured lender. The debtor generally has little leverage in negotiating with its existing lender and ends up agreeing to provisions that are not necessarily what would result if there were an open market for DIP lending. If the government provided an alternative source for DIP lending, the senior secured creditor would be in a weaker position and less likely to be able to extort concessions from the debtor.

Another benefit to the idea is fiscal. You might recall above that there is quite a bit of money to be made in DIP lending. The fees and interests rates that DIP lenders obtain often are pricey. Harvey noted that the government deifnitely could make "a few bucks" if it were in the business of lending. With deficits being what they are, adding a few dollars to the public fisc at the expense of banks and other lenders might be an attractive proposition.

I'm not so naive to say that I expect this proposal to go anywhere. And that isn't because there is anything inherently wrong or inefficient about having the government fill this role. No one at the conference this week challenged Harvey on the idea. And after a couple days thought thus far I haven't come up with the a good argument against it. But there would be serious political opposition to the government regularly becoming a DIP lender.

Existing lenders have a huge incentive to oppose the government's entry into regular DIP lending. Not to weigh into the health-care debates, but in much the same way that health insurance carriers are loathe to have a government health insurance company provide low-cost competition, current players in the secured financing field have an obvious interest in keeping the government out of their business. Harvey is essentially offering up a "public option" for DIP financing.

It probably faces longer odds than the health-care version

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So Maybe G.M. Will Pay The Government Back After All?

There were a lot of questions regarding the U.S. Government's involvement in General Motors earlier this year. And there were many grounds on which to question the government's actions and whether the facilitating the bankruptcy was a good idea. Most of us assumed however, that the government would not get much direct return on its investment.

How much would the calculus change if we knew that the government would get paid back? See the following from the New York Times here:

A government report released last week concluded that taxpayers were unlikely to receive full repayment of the more than $81 billion lent to rescue G.M. and Chrysler. But [G.M. Chairman Edward] Whitacre, speaking at a small college near his home in Texas, insisted that G.M. intended to repay its full debt to the Treasury Department, excluding the nearly $1 billion lent to the old part of G.M. that remains in bankruptcy, The New York Times’s Nick Bunkley reported.

Note the conflicting views. The government is less optimistic that it will get paid back than G.M. is. So perhaps we shouldn't credit the Obama Administration with being too clairvoyant. We might just be getting lucky on this investment if we do in fact get paid back. But if the government recovers the lion's share of value that it invested, that might add some justification for the government's actions.

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