Overview and Analysis of Select Provisions of the ABI Chapter 11 Reform Commission Final Report and Recommendations By Orrick's Group Table of Contents

In December 2014, the American Institute (ABI) issued its Final Report and Recommendations of the Commission to Study the Reform of Chapter 11. The Report is almost 400 pages long and contains more than 200 recommendations. Twenty-two Commissioners, including attorneys, academics, financial advisors and a former bankruptcy judge spent more than two years taking testimony from over 90 additional restructuring experts and considering the reports provided by 13 advisory committees, each comprised of 10-12 members from the bankruptcy bench, the bankruptcy bar, the financial community and academia. The Commission developed the report with goals including: reducing barriers to entry for , facilitating more efficient resolution of disputed matters, enhancing debtors’ restructuring options and creating an alternative restructuring scheme for smaller businesses.

The recommendations do not constitute proposed legislation. Rather, the Report represents the opinion of the Commissioners and will spur debate. It ultimately could help lead to comprehensive overhaul of the almost 40-year old Bankruptcy Code. Recognizing that major bankruptcy reform generally takes years to wind its way through Congress, the Report implicitly acknowledges that 2018 is an appropriate target date for reform.

That does not mean the Report should be taken lightly, as it represents the consensus view of many well-regarded bankruptcy practitioners, academics and judges. At minimum, the Report will mark the commencement of a conversation about what the Commissioners view as much-needed reforms to the Bankruptcy Code. We also expect the report to receive the attention of judges and litigants in upcoming matters. Parties may look to the Commission’s interpretations of open legal questions as support for their assertions that certain interpretations represent the “better” argument or the “intended” result.

The Report covers nearly every aspect of the chapter 11 process with a multitude of suggested modifications to the Bankruptcy Code and bankruptcy jurisprudence. Below is our analysis of a number of the Commission’s most critical recommendations and of the potential impact of the proposed recommendations on the bankruptcy process.

Issues Related to Confirmation of a Plan: Modifications to the Absolute Priority Rule...... 1 Prohibition on Nonconsensual Gifting ...... 3 Eliminating “Cram-down” Requirement that a Plan be Approved by an Impaired Class of Claims ...... 4 Basing Cram-down On Market-Based Approach...... 5 Financing Issues: Select Issues in Post-petition Financing: Roll-Up Post-Petition Financing and Milestones. . . 6 Calculating Collateral Value for Adequate Protection ...... 7 Asset Sales: 60 Day Moratorium on Sales of Substantially All Assets and Elimination of Potential Chilling Effect as “Cause” to Limit Credit Bidding ...... 8 Rolling Back, Limiting and Clarifying Safe Harbor Protections...... 10 Third-Party Releases...... 14 Formalizing Process Around Rejection of Collective Bargaining Agreements ...... 15 Executory Contracts Under Section 365 of the Bankruptcy Code ...... 16 Professional Compensation...... 19 Contact Us ...... 21

Orrick, Herrington and Sutcliffe LLP II Issues Related to Confirmation of a Plan Modifications to the Absolute Priority Rule

Current State of the Law . . . an immediately junior class might have been in the Under section 1129(a) of the Bankruptcy Code, a plan money or received a greater recovery if the firm had may be confirmed if under the plan, all classes either been valued at a later date.” Report at 208. Therefore, get paid in full or consent to the plan. If neither of these the redemption option allows junior to benefit criteria are satisfied, a may still confirm a plan from an increase the debtor’s value that takes place after under section 1129(b) of the Bankruptcy Code if, among plan confirmation or a section 363 sale. The Report notes other things, at least one impaired class votes to accept that possible methods of paying the redemption option the plan. Even if an impaired class votes in favor of the value include “pursuant to the plan or section 363 sale plan, the plan must, among other things, be fair and order in the form of cash, , stock warrants or other equitable and satisfy the “absolute priority” rule. Under consideration.” Report at 210. In the context of 363 sales, section 1129(b)(2), a court cannot confirm a plan unless, this recommendation will require senior creditors to set with respect to dissenting secured creditors, such aside a form of compensation for the immediately junior creditors retain their and receive deferred cash class in the event the debtor’s enterprise value surpasses payments totaling the allowed amount of their secured the allowed amount of senior claims during the three year claim or receive the indubitable equivalent of the value option period. It need not actually be in the form of an of the secured claim. With respect to unsecured claims, option, but merely need reflect that option value. no junior class of creditors may recover unless the While the Commission notes that the principles set claims of any dissenting senior class have been paid forth in this recommendation “provide a conceptual in full. framework for an adjustment to the current absolute Commission Recommendation priority rule,” it believes that sections 1129(b) and 363 of the Bankruptcy Code should be amended accordingly. The Commission’s recommendation would alter the Specifically, the Commission recommends that section absolute priority rule so that the class immediately 1129(b) of the Bankruptcy Code should be amended junior to an impaired senior class may receive to provide, among other things, that (i) a “chapter 11 distributions, even if such senior class has not been plan may be confirmed over the non-acceptance of the paid in full. This recommendation, which applies to both immediately junior class if and only if such immediate chapter 11 plans and 363 sales of all or substantially junior class receives not less than the redemption all of the debtor’s assets in large-scale cases, is based option value, if any, attributable to such class”; and on the Commission’s view that the “reallocation of (ii) a “chapter 11 plan may be confirmed over the non- the reorganized firm’s future value in favor of senior acceptance of a senior class of creditors, even if the stakeholders and away from junior stakeholders” senior class is not paid in full within the meaning of the under current law is “subjectively unfair.” Report at absolute priority rule, if the plan’s deviation from the 207. Specifically, the Commission is concerned that absolute priority rule treatment of the senior class is valuations for plan confirmation may not take into solely for the distribution to an immediately junior class account potential upside that occurs soon after exit from of the redemption option value, if any, attributable to bankruptcy, resulting in a potential windfall for senior such class.” Report at 208-09. creditors. The Commission recommends that Congress amend To remedy this perceived unfairness, the Commission section 363 of the Bankruptcy Code to provide, among proposes that junior creditors receive a value distribution other things, that “if members of an immediately based on a “redemption option.” The redemption option junior class do not object to the sale, the immediately is a three year option (starting on the petition date) to junior class should be entitled to receive from the “purchase” the debtor’s enterprise, with a strike price reorganization value attributable to such sale not less equal to the full amount of the senior ’s claim. than the redemption option value, if any, attributable The redemption option addresses “the possibility that

Orrick, Herrington and Sutcliffe LLP 1 to such immediately junior class.” Report at 209. If the Practically, we would expect parties to negotiate away immediately junior class objects to the sale, they will from a long-term option and instead exchange value at not be entitled to the redemption option value. the time of confirmation, a likelihood acknowledged in the Report. In essence, the option merely represents a The Commission’s recommendation fundamentally negotiating chip for junior creditors to extract value, and alters the Bankruptcy Code’s existing priority scheme possibly a significant windfall for junior creditors. and the expectations of senior creditors. Senior creditors typically receive less return on their investment This proposal, if enacted, could alter significantly the because they have bargained for greater certainty that economics of the various classes of debt, and could the principal amount of their loan will be repaid in full. In alter fundamentally the plan negotiation process. The contrast, junior creditors typically receive greater return redemption option could create a significant hurdle to on their investment but, at the same time, experience confirmation as the parties attempt to address the proper greater risk that their principal will not be repaid in full if redistribution of value. Moreover, it could cause significant the borrower defaults or enters bankruptcy. If Congress uncertainty in the pricing of distressed debt in the codifies this recommendation, senior creditors will be secondary market, which could affect strategy employed deprived, to some extent, of the benefit of their bargain. by secondary buyers seeking equity-like interests. Moreover, the redemption option will especially divert The current assumption, that investors looking for value away from senior creditors who receive equity in a equity returns would move to the fulcrum security based reorganized debtor – as opposed to cash or replacement on current valuations, could be undermined. Rather, notes – on account of their claims. In such “loan to own” the out of the money security may hold equity-upside bankruptcy cases, senior lenders agree to receive equity through the redemption value option. As a result, in the reorganized debtor in hopes that the reorganized investors may look further down the capital structure. debtor’s enterprise value will increase post-bankruptcy.

Orrick, Herrington and Sutcliffe LLP 2 Prohibition on Nonconsensual Gifting

Current State of the Law As noted in the prior section Modifications to the Absolute Priority Rule, the “absolute priority rule” governs distributions in non-consensual plan confirmation. Despite the absolute priority rule, some courts have permitted senior or secured creditors to voluntarily “gift” a portion of their recovery to junior or unsecured creditors to obtain such creditors’ support for the plan. These courts take the view that gifting facilitates consensual confirmation and promotes An absolute prohibition on gifting is inconsistent with efficient resolution of the bankruptcy case. Such courts the Commission’s emphasis on efficiency. Granted, the hold that once the amount of senior creditors’ allowed prohibition works in tandem with the Commission’s claims has been determined, this value belongs to the proposed elimination of the requirement that a plan secured creditors to distribute as they wish. be approved by at least one impaired class of claims, as gifting would then be unnecessary to win the class’s Other courts prohibit gifting, viewing it as circumventing support for the plan. (See section titled Eliminating the absolute priority rule, and expressing concern that “Cram-down” Requirement that a Plan be Approved creditors with disproportionate bargaining power – by an Impaired Class of Claims.) However, even if particularly insiders – will collude to unduly influence Congress does not eliminate the impaired consenting the plan process and extract more than their share class requirement, gifting would still serve as a carrot to of value from the estate. Some of these courts have persuade holdup creditors not to object to confirmation. invalidated the votes of creditors who attempt to distribute a portion of their recovery to junior classes. In addition to undermining efficient resolution of the case, a prohibition on nonconsensual gifting is also Commission Recommendation inconsistent with the Commission’s emphasis on The Commission recommends that gifting be prohibited distributing value further down the capital structure, in the nonconsensual context. The Commission as embodied in their recommendation to provide a determined that “the potential abuses of gifting” “redemption option” to junior classes (see section such as “senior creditors imposing their will or unduly titled Modifications to the Absolute Priority Rule) and influencing plan negotiations” outweigh the benefits, use of the value for adequate protection such as “lowering barriers to confirmation of feasible purposes (see section titled Calculating Collateral plans” and providing distributions to more creditors. Value for Adequate Protection). Report at 239.

Orrick, Herrington and Sutcliffe LLP 3 Eliminating “Cram-down” Requirement that a Plan be Approved by an Impaired Class of Claims

Current State of the Law Creditors holding large blocks of claims will likely Under section 1129(a)(10) of the Bankruptcy Code, if a be impacted if the Commission’s recommendations class of claims is impaired under the plan, the court can are enacted. Such creditors often hold a “blocking only confirm a plan, if “at least one class of claims that is position” (meaning greater than one-third the amount impaired under the plan has accepted the plan . . . .” As of all allowed claims in a particular class so they can noted in the prior section Modifications to the Absolute effectively control the class vote) which gives them Priority Rule, in the absence of an impaired accepting leverage in the plan negotiation process. Under the class of claims, the debtor or plan proponent cannot recommendation, creditors holding a blocking position confirm a “cram-down” plan under section 1129(b) of the would lose the ability to block a plan, shifting bargaining Bankruptcy Code. The logical interpretation of the intent power to the debtor. This recommendation could also of this provision is that a court cannot confirm a plan that depress the market for bankruptcy claims trading lacks any creditor support. because investment funds and other large creditors will have less incentive to acquire claims in an attempt to Commission Recommendation obtain a blocking position. The Commission has recommended eliminating section This could also lead to more aggressive 1129(a)(10) in its entirety so that confirmation of a gerrymandering of classes as courts will not need to be chapter 11 plan will no longer require acceptance of wary of an effort to create an impaired accepting class. the plan by an impaired class of claims. Contrary to Finally, if implemented, this recommendation will the assertions of some courts and commentators, have a profound impact in cases with only one creditor the Commission notes that there is no support – class – such as a single asset or special purpose entity. in legislative history or otherwise – for the view that Single asset debtors often struggle to reorganize non- section 1129(a)(10) was intended to ensure that a consensually because it is difficult for them to obtain plan must have some creditor support. Rather, the an impaired consenting class. Thus, creditors of such Commission believes that “the potential delay, cost, debtors hold overwhelming leverage, which could be gamesmanship, and value destruction attendant to reduced under this proposed change. section 1129(a)(10) in all cases significantly outweigh[s]” any potential benefit derived from having a plan supported by impaired creditors. Report at 261.

Orrick, Herrington and Sutcliffe LLP 4 Basing Cram-down Interest Rate On Market-Based Approach

Current State of the Law of the cram-down interest rate. Momentive is not As noted above, under section 1129(b)(2)(A)(i) of the binding outside Judge Drain’s courtroom and has Bankruptcy Code, a plan proponent can cram-down not been followed by other courts to date. Arguably, a plan if the retains its liens and is the Commissioners believe that Judge Drain ruled provided with deferred cash payments having a present incorrectly in Momentive. value equal to the allowed amount of the secured Commission Recommendation creditor’s allowed secured claim. These deferred cash payments are often paid under newly issued The Commission’s recommendation rejects applying post-plan notes. In many contested confirmation the Till formula to chapter 11 cases and adopts a general hearings, debtors and secured creditors argue over market-based approach. The Commission believes what is the appropriate discount rate (i.e., the this approach best satisfies the purpose of section cram-down interest rate) to ensure that the 1129(b)(2)(A)(i). Specifically, the Commission concluded requirements of section 1129(b)(2)(A)(i) are met. that a bankruptcy court should set the cram-down interest rate based on the cost of capital for similar debt In the context of a chapter 11 case, courts are issued to companies comparable to the debtor as a divided as to whether the cram-down interest rate reorganized entity. If, however, a market rate cannot be should be set based on a market rate, or some other determined for a particular debtor, the court should use formula-based approach. While the U.S. Supreme Court a risk-adjusted rate that reflects the actual risk posed in squarely rejected a market-based approach in chapter 13 the case of the reorganized debtor, considering factors cases in Till v. SCS Credit Corp., 541 U.S. 465 (2004), such as the debtor’s industry, projections, leverage, it has yet to opine on this issue in the context of chapter revised capital structure, and plan obligations. 11 cases. In Till, the Supreme Court endorsed the “prime plus” formula which calculates the cram-down The Commission’s recommendation is beneficial to interest rate by taking the sum of a “risk free” base secured creditors who, as a general matter, have rate (such as the prime rate) and a debtor specific risk suggested that the application of the “prime plus” premium (which typically ranges from 1-3%). Based on formula to chapter 11 cases could negatively impact dicta in Till suggesting that the analysis may be different distressed debt markets. If this recommendation is in the context of a chapter 11 case, some lower courts implemented, the plan negotiation process should have first looked to market-based evidence such as become more efficient because the expectations of rates offered for similar post-restructuring financing in debtors and secured creditors will be informed by the other cases – to establish a market-based cram-down Bankruptcy Code as opposed to non-uniform judge interest rate. made law. In addition, if Congress codified this recommendation, Interestingly, this Report comes just a few months after it might increase the willingness of financial institutions Judge Robert Drain issued a controversial ruling in the to lend to distressed (or stressed) entities. Interest rates Momentive bankruptcy. Judge Drain imported the Till on loans made to distressed entities could potentially “prime plus” formulaic standard into a chapter 11 in decrease because lenders would have greater certainty the Southern District of New York. There, Judge Drain (and thus less risk) that a bankruptcy court will not supported his decision on the grounds that, among confirm a chapter 11 plan containing replacement other things, the language and fundamental purpose notes that bear interest at a below-market rate. This of the cram-down provisions of chapters 11 and 13 were recommendation would provide much needed clarity to similar. See In re MPM Silicones, LLC, no. 14-22505-rdd, the market – especially in light of the recent Momentive 2014 Bankr. LEXIS 3926 (Bankr. S.D.N.Y. Sept. 9, 2014). decision. This stands in contrast to a number of other chapter 11 decisions that endorse a market-based determination

Orrick, Herrington and Sutcliffe LLP 5 Financing Issues Select Issues in Post-Petition Financing: Roll-Up Post-Petition Financing and Milestones

Current State of the Law to “milestones, benchmarks, or other provisions that A “roll-up” is a form of post-petition or debtor-in- require the trustee (e.g., the debtor) to perform certain possession financing where lenders (including pre- tasks or satisfy certain conditions” within 60 days petition lenders) provide DIP financing that first pays after the petition date or the date of the order for relief off all or part their existing debt before “new credit” (whichever is later), or (2) otherwise conflicts with is extended to a debtor. A roll-up has the effect of another section of the Bankruptcy Code. This proposed elevating the debt of pre-petition lenders who will have modification is intended to relate to “tasks or conditions their debt paid in full and ahead of other creditors. that relate in a material or significant way to the debtor’s For this reason, among others, courts are generally operations during the chapter 11 case or to the resolution reluctant to approve roll-ups absent circumstances of the case, including deadlines by which the debtor where the debtor has no other reasonable prospects for must conduct an auction, close a sale, or file a disclosure DIP financing or a lender is oversecured and the roll-up statement and a chapter 11 plan.” Report at 80. would be beneficial to the estate. Furthermore, the Commission recommends that a court DIP lenders also often make the effectiveness of their should not approve “permissible extraordinary financing DIP facility contingent on the debtor achieving certain provisions” in connection with any proposed DIP bankruptcy case “milestones” by specific dates, such financing in any interim order approving such financing. as the date when the debtor must file a plan or have the This recommendation is intended to principally cover bankruptcy court confirm the plan. A debtor’s failure (1) milestones, benchmarks, or other provisions that to achieve these milestones is often tied to events require the debtor to perform certain tasks or satisfy of in the DIP facility which can have various certain conditions, (2) representations regarding the consequences. For example, a debtor’s failure to file validity or extent of the lender’s liens, and (3) roll-ups. a plan by a particular date may obligate the debtor to If these recommendations are codified by Congress, abandon reorganization efforts and commence a sale we do not believe they will radically alter the landscape process. Moreover, as a condition to providing DIP of DIP financing. Most courts already apply a heightened financing, DIP lenders typically require the debtor to standard before they approve roll-ups, and as a stipulate to certain conditions or events, such as the result, they are generally permitted only in limited extent of the lender’s liens on property of the estate. circumstances.

Commission Recommendation While courts tend to approve DIP financing containing The Commission recommends amending the Bankruptcy milestones and other extraordinary financing provisions, Code to specify that a court may approve a DIP facility such relief is initially granted only on an interim basis that rolls-up pre-petition debt, but only to the extent and a subsequent hearing is necessary before DIP that (1) the DIP facility is either provided by lenders who financing is approved on a final basis. A hearing on a do not directly or indirectly through their affiliates hold debtor’s request to approve DIP financing on a final pre-petition debt affected by the DIP facility or such basis usually takes place after a statutory committee of facility repays the pre-petition facility in cash, extends unsecured creditors has been appointed and has had substantial new credit to the debtor, and provides an opportunity to review and respond to such request. additional financing on better terms than alternative Therefore, mechanisms are currently in place to provide facilities offered to the debtor; and (2) the bankruptcy stakeholder constituencies with the ability to object court finds that the DIP financing is in the best interests to the terms of the DIP facility before they become of the estate. effective on a final basis.

The Commission also recommends that a court should not approve DIP financing that (1) is subject

Orrick, Herrington and Sutcliffe LLP 6 Calculating Collateral Value for Adequate Protection

Current State of the Law Secured creditors are entitled to “adequate protection” against diminution in the value of their collateral – including cash collateral. For example, if a debtor depletes collateral during the pendency of the bankruptcy, secured lenders are entitled to compensation. Under section 361 of the Bankruptcy Code, secured lenders can receive cash payments or replacement liens, or otherwise receive the “indubitable equivalent” of the value of the collateral (which is for adequate protection would facilitate post-petition generally interpreted to include an equity cushion). financing for a debtor, enhance the prospects for the Under current law and practice, when determining debtor succeeding in non-consensual motions to use cash entitlement to adequate protection, a secured creditor collateral, ease the debtor’s burden of making adequate values its collateral at a going concern value or fair protection payments and make it more difficult for secured market value, especially in a chapter 11 case with high creditors to obtain relief from stay. prospects for a successful reorganization. Placing a However, the Report also recommends that a secured higher value on the collateral at the outset of the case creditor should ultimately receive the “reorganization could result in creditors receiving greater adequate value” of its collateral in any plan of reorganization or protection if they can demonstrate the case will cause section 363 asset sale. If the value of collateral over depletion of that value. and above the foreclosure value has been consumed Commission Recommendation in post-petition financing or in the debtor’s operations Under the Commission’s recommendation, at least at the during the chapter 11 case, the Commission provides no beginning of a chapter 11 case, the rights of a secured explanation as to how the secured creditor would realize creditor with respect to its collateral would be limited the full reorganization value of its collateral. to the hypothetical “foreclosure value” of the collateral. Secured creditors may well ask whether using That foreclosure value is the dollar amount that would foreclosure value could result in seemingly over-secured result from the commercially reasonable foreclosure of creditors (based upon a going concern valuation) losing the collateral outside of bankruptcy, presumably net of the right to post-petition interest and professional fees foreclosure fees, costs and expenses. This foreclosure (because under-secured creditors are not entitled to value is different from, and likely much lower than, the same). This could result in expensive and time- going concern value or reorganization value. It follows consuming valuation fights at the outset of chapter 11 that the debtor’s adeaquate protection obligations with cases to determine foreclosure value, a valuation metric respect to diminution in value would likely be lower or that is not currently part of the valuation landscape even eliminated in many cases. of valuation experts. While there is logic in applying This recommendation appears to be based on the different valuations at different times in the case, the Commission’s belief that secured creditors currently have use of “foreclosure value” could create significant too much leverage and control in the beginning stages uncertainty as bankruptcy professionals typically do not of chapter 11 cases and that the Bankruptcy Code should rely on this valuation today and the debtor could deplete be revised to tilt the scales more in favor of the chapter collateral during the pendency of the case more easily. 11 debtor and its unsecured creditors. The Commission determined that utilizing foreclosure value as the baseline

Orrick, Herrington and Sutcliffe LLP 7 Asset Sales 60 Day Moratorium on Sales of Substantially All Assets and Elimination of Potential Chilling Effect as “Cause” to Limit Credit Bidding

Current State of the Law Commission Recommendation Bankruptcy Code Section 363 permits a debtor to sell The Commission refers to a sale of all or substantially all substantially all of its assets outside the ordinary course of a debtor’s assets as a “363x sale.” The Commission of business upon approval of the court. There are two proposes the prohibition of 363x sales during the first points at issue. In recent years, parties have resolved a 60 days of the bankruptcy case, unless the debtor can number of cases through a quick asset sale at the case’s show “by clear and convincing evidence that there is outset rather than pursuant to a plan of reorganization a high likelihood that the value of debtors’ assets will voted on by creditors and shareholders. Critics have decrease significantly during the 60-day period.” Report argued that such a significant event will determine the at 83. This recommendation is based, in part, on the final outcome of the bankruptcy outside the scope of a view that the increasingly rapid sale processes of recent plan and thus hasten resolution of the case without the years provide insufficient time to market the assets protections and time built into the confirmation process. thoroughly so that interested bidders can participate and maximize value. This can depress purchase price. Second, where the debtor seeks to sell assets that are Under the proposal, there must be a bona fide post- subject to a secured or interest under section 363, the petition auction process in nearly all chapter 11 cases, Bankruptcy Code permits the lien-holder to “credit bid” regardless of the prepetition effort. the amount of such claim to purchase the property. The claim-holder may offset such claim against the purchase The report also posits that “the potential chilling effect price and need not use cash to make a bid, up to the of a credit bid alone should not constitute cause” to allowed amount of its claim. limit a secured creditor’s credit bid. Report at 146. This view is based, in part, on the fact that all credit bidding The Bankruptcy Code provides that the court may discourages outside purchase offers to some extent; restrict the ability to credit bid for “cause,” but does not it also serves to protect secured creditors. Instead, specify when cause exists. Courts have restricted credit the Commission recommends that courts address the bidding in certain circumstances, purportedly because potential chilling effect of credit bidding in the sale there is uncertainty over the validity or value of the procedures (e.g., by withholding approval of procedures allowed claim, but seemingly primarily to reduce the with short marketing periods and/or withholding chilling effect of a large credit bid on the willingness of approval of marketing materials that emphasize the others to participate in the auction. secured creditor’s right to credit bid).

The Commission’s recommendations may have unintended effects. In 2013, the mean and median number of days between the bankruptcy filing and sale order were 82 and 74 days, respectively. Given this statistic, the 60-day moratorium may not have a significant effect on the outcome of most cases. In fact, the moratorium could shorten the sale period, if it pushes parties toward a sale on the 61st day.

Orrick, Herrington and Sutcliffe LLP 8 In addition, while the Commission points to pressure Commission’s recommendations with respect to DIP from secured creditors and DIP financiers as a driving financing is that “milestones upon which extension of force behind the truncated sale processes of recent post-petition financing is conditioned should not be years, increasingly rapid 363 sale processes may also be permitted to take effect until at least 60 days after the the result of more extensive pre-petition negotiations. petition date.” Report at 82. Among these prohibited The moratorium may discourage such marketing. milestones is “a provision stating that it is an event of However, it may give the court time to resolve valuation default if the court does not enter an order approving and other disputes regarding the validity or amount bidding procedures for a sale of all or substantially all of of an allowed claim, obviating the need to limit credit a debtor’s assets by a certain date.” Report at 82, n. 311. bidding for those reasons. The Commission’s recommendation to prohibit the Moreover, to the extent the Commission’s 60-day limitation of credit bidding solely for its chilling effect moratorium regarding 363x sales is intended to adds needed clarity after recent decisions such as Fisker relieve debtors from pressure from lenders for quick Automotive Holdings and Free Lance-Star Publishing sales of all assets, it will have limited impact. In its have implied that promoting a competitive auction may recommendations regarding 363x sales, the only be sufficient cause to limit credit bidding. In re Fisker activities that the Commission has stated would be Auto. Holdings, Inc., 510 B.R. 55, 61 (Bankr. D. Del. prohibited are “an auction” or “final approval of a 2014); In re Free Lance-Star Publ'g Co., 512 B.R. 798, sale transaction.” Report at 83. By contrast, one of the 807-808 (Bankr. E.D. Va. 2014).

Orrick, Herrington and Sutcliffe LLP 9 Rolling Back, Limiting and Clarifying Safe Harbor Protections

Current State of the Law Commission Recommendations The Bankruptcy Code affords special treatment While the Commission did not propose eliminating for specified entities, such as stockbrokers, repo the safe harbor protections, the Commission made a participants, swap participants and financial institutions number of recommendations aimed at rolling back, with respect to “repurchase agreements,” “securities limiting and clarifying the safe harbor protections. contracts” “swap agreements” and certain other • The financial contracts. Under the Bankruptcy Code, if an Rolling Back Safe Harbor Protections. Commission recommends that the safe harbor agreement falls within the defined term “repurchase protections for repurchase agreements and securities agreement”, “swap agreement” or “securities contract”, contracts should revert to their respective pre-2005 then a non-debtor stockbroker, financial institution, repo definitions thereby eliminating the safe harbor participant or swap participant, as applicable, would not protections for mortgages and mortgaged-backed be enjoined (or stayed by the operation of Bankruptcy securities. Alternatively, the Commission recommends Code § 362(a)) from exercising its contractual right to that, at the very least, the safe harbor protections terminate, accelerate or liquidate such agreement or should exclude repurchase agreements and securities from offsetting or netting out any termination values contracts that have the “economic attributes of or payment amounts owed to it under such agreement traditional mortgage warehouse facilities”, that despite the counter-party’s bankruptcy or are more akin to committed secured financing or financial condition. These special protections arrangements than so-called “true repurchase essentially supersede the limitation in Section 365(e)(1) agreements”. Report at 99. of the Bankruptcy Code, which invalidates bankruptcy termination clauses (sometimes referred to as ipso facto While recognizing the importance of the repurchase clauses). These ipso facto clauses typically provide that agreements in both domestic and global portfolios, a contract can be terminated or modified based upon some of the Commissioners believed that “inclusion the bankruptcy, insolvency or financial condition of one of these repurchase agreements encouraged runs of the parties. on debtor originators and accelerated (rather than reduced) contagion.” Report at 101. The In 2005, the Bankruptcy Code was amended to Commissioners agreed that the safe harbors expand the type of investments protected by the safe should not protect disguised mortgage warehouse harbor provisions to include repurchase agreements arrangements. The Commission proposed that and securities contracts relating to mortgage loans, “committed repurchase agreement mortgage-backed securities or any interests in mortgage facilities that function as mortgage warehouse loans or mortgaged-backed securities or options on facilities” should be expressly excluded from the such mortgage loans or mortgaged-backed securities. definition of repurchase agreements and securities contracts. Report at 102.

Query: What is a “disguised mortgage warehouse arrangement” and how is it distinguished from a “true repurchase agreement”? The Commission noted that in order to obtain short-term financing until the mortgage loans be deposited into a securitization pool, the “the loan originator obtains short-term financing from a lender through a credit facility or similar arrangement secured by a pledge of mortgage

Orrick, Herrington and Sutcliffe LLP 10 or other assets owned by the originator.” Report at 100. If adopted, the Commission’s recommendation likely will impact the $4 trillion repurchase agreement market and, more particularly, mortgage loan financing and securitization.

• Limiting Safe Harbor Protections. The Commission recommends limiting the safe harbor protection of certain transfers from avoidance as a fraudulent transfer. Under Bankruptcy Code section 546(e), The Commission notes that it is “difficult to reconcile a trustee or debtor in possession cannot avoid the protections that courts were affording the prepetition settlement payments or margin payments beneficial owners of privately issued securities with except for transfers made with actual fraudulent the original purpose of the legislation [namely, to intent. The Commission recommends excluding insulate the securities transfer system from fraudulent settlement payments made to beneficiaries of conveyance and preference actions]”. Report at 97. leveraged buyouts and similar transactions (i.e., As the court stated in In re American Home Mortgage, prepetition transactions in which some or all of Inc., 379 B.R. 503, 516-17 (Bankr. D. Del. 2008, “if the debtor’s assets are being used to facilitate the the definition of ‘repurchase agreement’ is met, the transaction) if the securities were privately issued. section 559 safe harbor provisions apply, period. Some courts (Third, Sixth and Eighth Circuits1) Similarly, if the definitions of ‘securities contract’ and have held that settlement payments to beneficial ‘financial institution’ are met, the section 555 safe owners of publicly and privately held securities are harbor applies, period. This conclusion is compelled protected from avoidance except for actual fraud. by the plain meaning of the statute and is consistent Section 546(e) would continue to protect settlement with the policy and legislative history underlying the payments for publicly issued securities and security relevant provisions of the Bankruptcy Code.”). industry participants who act as mere conduits. The Commission recommends that conduits should be We expect debtors, creditor committees and litigation expressly covered by section 546(e) to avoid any trusts will continue to prosecute actions (particularly uncertainty that might implicate the financial markets. in cases pending outside of the Third, Sixth and Eighth Report at 97. Circuits) seeking to recover payments as fraudulent transfers made to beneficial holders of privately The Commission also recommends expanding issued securities under federal (Bankruptcy Code the actual fraud exception from the safe harbor section 548) and state law. The clawback period under protections of Section 546(e) to include applicable the Bankruptcy Code is two years, but is four or six state laws. The Commission years or longer under some state law provisions. noted that currently the courts are split on whether the safe harbor protections are limited to fraudulent • Clarifying Revisions. The Commission also transfer actions under Bankruptcy Code section 548 recommends a few changes that will clarify the or whether they extend to such actions under state scope of the safe harbor protections for derivative law that are avoidable by the trustee under section transactions. Specifically, the Commission proposes 544(b) or by a litigation trust or individual creditors the following: after confirmation of a chapter 11 plan. Report at 98.

1 See, e.g., Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009); QSI Holdings, Inc. v. Alford (In re QSI Holdings, Inc.), 571 F.3d 545 (6th CIR. 2009), cert. denied, 558 U.S. 1148 (2010); Brandt v. B.A. Capital Co. (In re Plassein Int’l Corp.) 590 F.3d 252 (3d Cir. 2009), cert. denied, 559 U.S. 1093 (2010).

Orrick, Herrington and Sutcliffe LLP 11 • Walkaway Clauses Unenforceable. The Commission a qualified financial contract entitled to the benefits recommends amending the safe harbor protections of the Bankruptcy Code safe harbor provisions. to make walkaway provisions unenforceable, which (See, e.g., In re Nat’l Gas Distribs, 556 F.3d 247, 259 would bring the Bankruptcy Code into conformity (4th Cir. 2009) (natural gas supply contract could with the Federal Deposit Insurance Act and the constitute a commodities forward contract and, Orderly Authority. Termination clauses as such, a swap agreement under the Bankruptcy in most derivative agreements generally call for one Code). of two options in the event of termination following default. The first is called a “one way settlement Some courts have narrowly interpreted the provision” where the non-defaulting party can application of these safe-harbor provisions to walk away even if “out of the money”. This is also cases in which the clearance and settlement of called the “first method” and “limited two-way these types of transactions (without the risk that payments method.” The other method called the they may be subsequently undone or avoided) is “second method” is where the defaulting party is necessary to the stability and smooth operation of credited for its “in the money” positions and the the financial markets. The Commissioners noted non-defaulting party must pay the defaulting pay that the legislative history of the safe harbors whatever the defaulting party is owed. “establishes a desire to protect the securities transfer system and promote market stability”. Congress expressly invalidated these provisions Subjecting a nondebtor party to an ordinary supply for qualified financial contracts involving insured contract to the automatic stay and other provisions depositary institutions where the FDIC is appointed of the Bankruptcy Code would be “highly unlikely” as conservator or receiver. However, such provisions to cause market instability. Report at 107-08. were not invalidated for cases under the Bankruptcy Code. It was left to the courts to apply applicable Query: What makes a long-term supply contract state law to determine if the termination clause an “ordinary supply agreement”? The Commission is enforceable. Some courts have held that the notes that distinguishing an “ordinary” supply provision is an unenforceable liquidated damage agreement from a “qualified financial contract” provision because the non-defaulting party is may be difficult. The court will not be bound by the getting the windfall of not having to pay back the form of the contract, but instead, will look to its defaulting party even if it is “out of the money”. substance. Courts will need to analyze: Report at 106-07. (i) does the contract involve a dealer, market maker or other party; In the absence of adoption of the Commission’s recommendations, we expect that debtors will (ii) does the contract provide for the physical continue to litigate the enforceability of these delivery of goods used, traded, or produced by walkaway clauses. the debtor in the ordinary course of business?

• Ordinary Supply Contracts Not Protected. The • Calculation of Damages. The Commission Commission recommends that the Bankruptcy recommends amending section 562(b) to define Code should be amended to prevent nondealer “commercially reasonable determinants of value” counterparties to physical supply contracts from as those specified in the contract that are not benefitting from the safe harbor protections, manifestly unreasonable or, in the absence of such including contracts for the supply of natural gas determinations of value, commercially reasonable and electricity. Some courts have held that, as market prices. Report at 104. written, ordinary supply agreements may constitute

Orrick, Herrington and Sutcliffe LLP 12 In 2005, the Bankruptcy Code was amended to add We expect non-debtor counterparties to use the a new section (Section 562) to the Bankruptcy Code Commission’s recommendations to assert that to fix the date on which damages will be measured the contract terms should be respected to govern if a debtor rejects, or a non-debtor counterparty damage calculations. In the absence of contract terminates, a swap agreement, repurchase terms or, if the contract terms are determined to be agreement or securities contract. Under section manifestly unreasonable, counter-parties will seek 562, damages will be measured as of the earlier of to use commercially reasonable market prices. (1) the date of such rejection or (2) the date or dates • The Commission considered, but of such liquidation, termination or acceleration. Other Changes. rejected at this time, a proposal to apply a short- If no commercially reasonable determinants of term stay that would have allowed the debtor to value exist on that date, section 562(b) provides assume and assign derivative agreements before that damages should be measured as soon as counterparties can terminate, liquidate or close them commercially reasonable determinants of value are out. The Commissioners note the existence of short available. stays under the FDIA and OLA, but did not believe The Commissioners note that issues have arisen that imposing such a stay would help the debtor’s as to the methodology to be used in calculating rehabilitation efforts. The Commissioners questioned damages. Mindful of the policies of promoting the debtor’s ability to review its derivative agreements “market stability and respecting prepetition in a meaningful and expeditious manner, and to bargains whenever possible”, the Commission structure and fund a transaction early in the chapter recommends that the contract terms should govern 11 case. the damages upon termination. Alternatively, The Commission noted that legislation is pending commercially reasonable market prices should be to impose a short stay for financial institutions used to calculate termination values if the contract determined to be systemically important. Report at is silent or the contract terms are determined to be 103-04. manifestly unreasonable. The Commissioners used the “manifestly unreasonable” standard as exists under Section 9-603 of the Uniform Commercial Code. Report at 105.

Orrick, Herrington and Sutcliffe LLP 13 Third-Party Releases

Current Law efforts if they might be exposed to liability. Report at Generally, a third-party release provision in a plan 255. However, the Commission also recognized that extinguishes identified non-debtor parties from liability “limiting creditors’ recoveries to those provided under for claims or causes of action that third-parties may the plan may substantially change the nature of their hold against them. Third-party releases—which usually rights against non-debtor parties, and in turn further cover parties such as the debtor’s directors and officers, reduce their overall recoveries.” Id. the official committee of unsecured creditors and its When determining the propriety of granting a non- members, non-debtor plan sponsors and proponents, consensual third-party release, the Commission debtor-in-possession lenders and estate professionals— recommends that a bankruptcy court should be guided are typical in most chapter 11 plans, especially in cases by several factors derived from In re Master Mort. of large-scale corporate . Third-party Inv. Fund Inc., 168 B.R. 930 (Bankr. W.D. Mo. 1994). releases may be binding on parties that have consented Specifically, the court should consider and balance each to the release or voted for (or abstained from voting of the following factors: on) the plan and the release. They may also be non- consensual where parties are forced to release third- • the identity of interests between the debtor and the party claims by virtue of confirmation of the plan. third party, including any indemnity relationship, and the impact on the estate of allowing continued claims There is a split in authority as to whether third-party against the third party; releases are permissible under the Bankruptcy Code. While most courts have held that third-party releases • any value (monetary or otherwise) contributed by the may be granted in certain circumstances, the Ninth and third party to the chapter 11 case or plan; Tenth Circuits, and to some degree the Fifth Circuit, • the need for the proposed release in terms of have found that Section 524(e) of the Bankruptcy Code facilitating the plan or the debtor’s reorganization generally precludes bankruptcy courts from discharging efforts; the liabilities of non-debtors. Moreover, the courts that do allow third-party releases have devised numerous • the level of creditor support for the plan; and legal standards and relevant factors to assess the propriety of granting such releases. • the payments and protections otherwise available to creditors affected by the release. Commission Recommendation In the case of parties that did not vote in favor of the The Commission has recommended that a debtor or plan, the Commission recommends that a court give plan proponent should be permitted to seek approval significant weight to the last of these factors. The of consensual and non-consensual third-party releases Commission also believes that a court should consider in connection with the solicitation and confirmation these factors when analyzing the propriety of releasing of a plan, thereby resolving the split in authority. a debtor’s affiliates pursuant to a chapter 11 plan. However, the release must be clearly and conspicuously highlighted and explained in the plan and the disclosure Potential Impact statement and must identify the proposed scope of, and If the Commission’s recommendations are adopted, we parties to be covered by, the release. expect reduced forum shopping by debtors. With the The Commission observed that third-party releases are possibility of third-party releases becoming subject to appropriate from a practical perspective since a “debtor greater certainty, parties who may benefit from such a may need the assistance of non-debtor parties to effect release may be willing to assume a more active role in a its reorganization” and such parties may be reluctant chapter 11 case. to contribute to the plan or the debtor’s reorganization

Orrick, Herrington and Sutcliffe LLP 14 Formalizing Process of Rejection of Collective Bargaining Agreements

Current Law • First, the debtor should request a preliminary In the 1980s, Congress added section 1113 to the conference regarding initiation of a section 1113 Bankruptcy Code. Section 1113 heightened the proceeding, in which the debtor must certify that it standards for rejection of a collective bargaining has provided the employees’ representative with a agreement beyond the business judgment standard that written copy of its initial proposal; applies to rejection of most contracts under section 363 • Second, the court should schedule a status of the Bankruptcy Code. conference to discuss the section 1113 process Under section 1113 of the Bankruptcy Code, a court shall with the parties. The conference should permit the approve rejection of a CBA only if: employees’ representative sufficient time to review the proposal and meet and confer with the debtors to • the trustee has, prior to the hearing, (i) made a discuss a timetable for negotiations; proposal to the employees’ representative that details modifications in benefits necessary to • Within 30 days of the initial request, the court should permit an effective reorganization, and (ii) provided hold a status conference to discuss a timetable for the employees’ representative with all “relevant negotiations, resolve any issues regarding disclosure information necessary to evaluate the proposal”; of information, determine whether a mediator could assist, and discuss any other obstacles; and • the employees’ representative has refused to accept the proposal “without good cause”; and • If the parties, after a reasonable time, cannot resolve their issues, the court shall hold a second status • the balance of the equities favors rejection of the CBA. conference to assist in resolution and to set a hearing schedule, with the trial taking place within 180 days of Section 1113 also details timing around an effort to the debtor’s initial request. reject a CBA. The court shall schedule a hearing not later than 14 days after the debtor files a motion to The Commission also attempts to resolve a split legal reject and shall rule on the application within 30 days question regarding the treatment of rejection damages after commencement of the hearing (which time may be under section 1113 of the Bankruptcy Code. The extended with the consent of both parties). If the court Commission states that rejection under section 1113 does not rule within 30 days (or an agreed extension), should give rise to rejection damages under section 365 the debtor may terminate or alter any provisions of of the Bankruptcy Code. the CBA. Potential Impact Commission Recommendation These modifications, if accepted, would not alter The Commission notes that disputes over CBA rejection radically the substance of section 1113 jurisprudence. “can be time-consuming, expensive and litigious . . . However, they would make the negotiation—and [and] also can be emotionally charged and disruptive ultimately rejection—process more formal. This should at key points in the chapter 11 process.” Report at 156. provide a more robust negotiation period for unions— The Commission also asserts that the current process thus likely providing employees with additional leverage provides little meaningful opportunity to negotiate in a negotiation. modification of the CBA. Instead, “many debtors in possession viewed the bargaining required under the Bankruptcy Code as a means to the litigated end they desire.” Report at 161. Therefore, the Commission has proposed several key changes to the process for rejection of a CBA.

Orrick, Herrington and Sutcliffe LLP 15 Executory Contracts Under Section 365 of the Bankruptcy Code

Subject to court approval, a debtor may assume, assign, other party. Ultimately, the Commission concluded or reject any executory contract under section 365 of the that, despite its limitations, the Countryman definition Bankruptcy Code. The Commission addressed a number appropriately balances the rights of debtors and non- of issues related to exeucutory contracts. Below we debtors to a contract, and the case law applying the discuss three: the definition of executory; the required definition is already well developed. performance by non-debtors during the bankruptcy; and the impact of rejection. Potential Impact Because the Countryman definition is already widely Definition of Executory Contract used, we do not expect much impact from this recommendation. If adopted, it should encourage more Current Law consistent treatment of executory contracts across The term “executory contract,” is not defined in the jurisdictions. We also think it is unlikely that codifying Bankruptcy Code. Courts have therefore adopted several the Countryman definition will significantly curtail the different tests for determining what constitutes an amount of litigation on this issue. Although debtors and executory contract. Of these, the most widely used is the their counterparties will have more certainty as to what “Countryman” definition, which defines an executory test will apply, they will still need to establish whether a contract as one under which the obligations of both particular contract fits the Countryman definition. parties are so far unperformed that the failure of either to complete performance would constitute a material Required Continued Performance by Non- breach excusing the performance of the other. Over time, Debtor to Executory Contract Post-Petition some courts have adapted the Countryman definition in various ways to overcome its perceived shortcomings. Current Law Section 362(a) of the Bankruptcy Code provides for a Commission Recommendations broad stay of litigation and lien enforcement against a After considering a number of alternatives— debtor upon the filing of a bankruptcy petition. This stay including the possibility of eliminating the concept of is intended to provide the debtor with sufficient time, executoriness from the Bankruptcy Code altogether— (i.e., a “breathing spell”) to determine, among other the Commission recommended that the Countryman things, which of its executory contracts and unexpired definition be incorporated into the Bankruptcy Code. leases it should assume, assign or reject. The Commission noted that a number of courts have found the Countryman definition to be a poor test of For non-debtors, this breathing spell often results in whether certain types of agreements are executory, a performance gap between the Petition Date and the specifically options, covenants not to compete, and debtor’s decision date. While the Bankruptcy Code oil and gas leases. One alternative to the Countryman addresses performance during this gap period for definition, called the functional approach, focuses parties to non-residential real property leases, certain on whether the assumption or rejection of a contract personal property leases and intellectual property would create a benefit for the bankruptcy estate and licenses, it does not address the obligations for parties its creditors. The Commission rejected this approach, to executory contracts and unexpired leases. Courts primarily out of concern that it too heavily favors the often interpret this silence, coupled with the importance interests of debtors over the rights of non-debtors. The of the breathing spell, to mean that the contract remains Commission also evaluated the exclusionary approach, enforceable by the debtor only. This interpretation which deems a contract to be executory if each party leaves the non-debtor at a significant disadvantage. has unperformed obligations and the debtor's failure Although the non-debtor is able to compel to perform eliminates its right to performance by the performance or a treatment decision under section

Orrick, Herrington and Sutcliffe LLP 16 365 of the Bankruptcy Code, and can also request an extent to which these additional rights will sway the administrative expense claim under section 503(b)(3) to debtor during settlement. the extent the debtor fails to perform any post-petition obligation, these avenues often take time to produce Impact of Rejection of Executory Contracts results. Moreover, case law differs as to whether a non- debtor can compel the cure of prepetition nonmonetary Current Law defaults before the debtor assumes such agreement. Section 365(g) of the Bankruptcy Code provides that when a debtor rejects an executory contract it breaches Commission Recommendations the contract; however, there are questions as to what Recognizing the burden of the gap period on non- rights the non-debtor has upon such a rejection. debtors, the Commission found that prior to the debtor’s Specifically, bankruptcy courts often find that a non- decision to assume, assign or reject an agreement, the debtor is unable to exercise all of the rights it bargained non-debtor should be required to continue to perform for under the contract. The non-debtor also loses under agreements necessary for the debtor's continued any right to demand specific performance or enforce business, but only to the extent the debtor continues to equitable remedies, and the non-debtor cannot continue pay for goods or services under those agreements. By to use property otherwise available to it under the paying for such goods and services, the debtor would terms of the contract. These courts reason that available not be subject to any modifications otherwise intended remedies outside of bankruptcy must be limited in to be imposed on account of the bankruptcy, default or bankruptcy to ensure similarly situated creditors are not insolvency. The non-debtor would still have the ability treated differently and debtors are provided with all of to compel a decision on the agreement or post-petition the benefits of the automatic stay. performance thereunder but such performance would only be required where it was necessary to mitigate Commission Recommendations the harm to the non-debtor. The Commission also While the Commission agreed rejection should be recommended that a debtor should not be required viewed as a breach and not a termination of the to cure prepetition nonmonetary defaults before executory contract, the Commission did not believe a assumption of an agreement where defaults are non-debtor should be able to exercise all contractual impossible to cure at the time of assumption. remedies available to it upon this breach. In finding this, the Commission reasoned that federal law trumps the Potential Impact state law contract rights of the non-debtor. By providing certainty in connection with the post- petition obligations of parties to executory contracts and unexpired leases, we expect that the Commission’s recommendations will reduce litigation and provide greater incentives for parties to settle disputes. Moreover, the Commission’s recommendations provide non-debtors with additional avenues to obtain relief during the period between the Petition Date and the debtor’s decision whether to assume, assign or reject the executory contract. This may provide non-debtors with additional bargaining power during settlement negotiations. On balance, because the Commission emphasized that the burden to require immediate post- petition performance should be high, it is unclear the

Orrick, Herrington and Sutcliffe LLP 17 Potential Impact Once again, the Commission’s conclusions are closely aligned with how courts currently treat rejection of executory contracts. However, the express limitations the Commission advocates (i.e., elimination of a non-debtor’s right to seek specific performance and/ or equitable or injunctive relief and the denial of post-petition retention or use of debtor property in accordance with the terms of the contract) work to the debtor’s benefit. Specifically, if adopted, debtors will have one less thing to negotiate with their counterparties. This means less litigation but perhaps also a deterrent to doing business with distressed companies to the extent that non-debtors intend to rely on specific performance, equitable remedies, or continued use of property under the agreement for the operation of their business.

Orrick, Herrington and Sutcliffe LLP 18 Professional Compensation

Current Law Commission Recommendations Pursuant to section 327 of the Bankruptcy Code, To improve the transparency of the professional a debtor must seek court approval to retain compensation process, the Commission proposes the “disinterested” professionals to assist with its chapter following recommendations: 11 case. The fees of these retained professionals are • A debtor’s professionals should be clearly classified subject to court approval after a determination of as either working on matters relating to the chapter “reasonableness” under section 330 of the Bankruptcy 11 case (chapter 11 professionals) or on matters Code. Upon a determination that, among other things, unrelated to the chapter 11 case (nonbankruptcy the fees were (i) reasonable, necessary or beneficial to professionals). the estate (11 U.S.C. § 330(a)(3)(C)), and (ii) the amount of time spent was commensurate with the complexity, • Only chapter 11 professionals should be subject nature and importance of the issue or task (11 U.S.C. § to the retention standards in section 327 and to 330(a)(3)(D)), a court will usually approve payment of the disclosure of reasonableness standards for such fees out of estate funds. professionals’ fees and expenses in section 330 of the Bankruptcy Code. Nonbankruptcy state laws Other parties in a chapter 11 case such as secured governing many professions (e.g., accountants, creditors, creditors who are parties to an agreement financial advisors, consultants) are sufficient to or settlement with the debtor, parties to intercreditor protect the interests of the estate with respect to agreements, and ad hoc committees may also seek nonbankruptcy professionals. payment of professional fees and expenses from estate funds. The Bankruptcy Code does not subject these • To the extent professionals representing secured professionals’ fees to the compensation standards of creditors, creditors who are parties to agreements section 330. Rather, the request for payment is often or settlements approved by the court, or ad hoc part of an underlying bargain, a chapter 11 plan, or a committees would be paid their fees and expenses court-approved settlement between the debtor and from the estate, those fees and expenses should creditor for payment of professional fees out of be subject to the reasonableness standards set estate funds. forth in section 330(a) of the Bankruptcy Code. The Commission did not go so far as to recommend that Debtors in possession also often seek court approval to these professionals’ fees and expenses be subject to retain and compensate “ordinary course professionals” a fee application process, recognizing instead that during the pendency of a chapter 11 case. These the standard of review was more important than the professionals do not consult or work on bankruptcy- form of the fee disclosures. To the extent the court related issues. Rather, they perform services that the disallows any professionals’ fees and expenses debtor would have required outside the bankruptcy under this standard, the creditor or ad hoc committee context. The process for retaining and paying these should not be permitted to seek reimbursement for “ordinary course professionals” is less stringent disallowed fees from other stakeholders in the case. than the process for retaining and paying chapter 11 professionals under sections 327 and 330 of the • Professionals retained by the debtor in possession Bankruptcy Code. It typically requires the debtor to or any statutory committee should not be considered identify the specific or general types of professionals fiduciaries of the estate. Rather, those professionals’ to be retained and to establish a cap that limits the duties should run to their respective clients and be amounts that can be paid to these entities out of estate governed by applicable nonbankruptcy law. funds during the chapter 11 case.

Orrick, Herrington and Sutcliffe LLP 19 • Courts and professionals are encouraged to use creative alternative billing arrangements (e.g., fixed-fees, flat-rates, unbundling of services with different prices for various aspects of cases, incorporate escalators or de-escalators in flat-rate fee arrangements) in lieu of the traditional hourly billing model. Courts should not review alternative fee arrangements under the lodestar method, which is applicable to the hourly billing model. standard under the Bankruptcy Code. Typically, such Potential Impact fees are contractually but not statutorily subject to a If the Commission’s recommendations are adopted, reasonableness standard today. we do not expect there to be a material impact on Finally, the Commission’s forward-thinking approach the professional compensation process for chapter with respect to alternative billing arrangements and 11 professionals. The biggest impact would be felt by the move away from the traditional hours-based billing professionals representing secured creditors, creditors model reflects a long-expected but slow-developing who are parties to agreements or settlements approved change in legal fees in the market. by the court, or ad hoc committees. Such professionals’ fees would now be subject to a formal “reasonableness”

Orrick, Herrington and Sutcliffe LLP 20 Contact Us

Orrick’s restructuring lawyers deliver winning results, client-focused service and efficient strategies to clients involved in and . We routinely work on complex restructurings and financing transactions and offer clients value-added legal advice, from negotiation and mediation to litigation and counseling. We have successfully represented many different constituencies in virtually every aspect of corporate reorganizations, out-of-court restructurings, insolvency and liquidation matters.

Our lawyers—who have a track record of leadership and creativity—draw on the experience of other Orrick practitioners, including those in the corporate, finance, securities, litigation, tax, pension and real estate groups, to deliver a full range of restructuring-related legal services to major financial, commercial and industrial institutions worldwide.

Raniero D’Aversa Jonathan Guy Frederick Holden Jr. Marc Levinson Partner & Chair Partner Partner Partner New York Washington, D.C. San Francisco Sacramento (212) 506-3715 (202) 339-8516 (415) 773-5985 (916) 329-4910 [email protected] [email protected] [email protected] [email protected]

Lorraine McGowen Laura Metzger Douglas Mintz Thomas Mitchell Partner Partner Partner Partner New York New York Washington, D.C. San Francisco (212) 506-5114 (212) 506-5149 (202) 339-8518 (415) 773-5732 [email protected] [email protected] [email protected] [email protected]

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