Good academic workshops are hard to run. I know, because this is a task that I have failed at, and continue to fail at, repeatedly.
For that reason though, it is a treat to see someone else run their workshop successfully. I was at one recently that was spectacularly run: Jill Hasday's Public Law workshop at the University of Minnesota. The setting is intimate: a small group of students and faculty gathers in the late afternoon (without wine -- which I usually think of as being key) and they take apart whatever paper is the focus of the discussion. Indeed, after about an hour, the paper that is being discussed almost becomes secondary to the idea that the participants have by then honed in on as being central. My colleague, Joseph Blocher, and I were lucky enough to have our paper "Puerto Rico and the Right of Accession" be deconstructed last week and it was a special treat for the both of us. We have a concrete measure for whether a workshop was good (taken from our dear friend, Steve Choi): Did it help generate ideas for a new paper? This workshop gave us at least three. That's more than any other workshop I've been to. I don't know how Jill inspires her students or what magic potion her colleagues who attend take, but I want the secret sauce to use next semester at my workshop series with Guy-Uriel Charles.
The one question that Jill, Daniel Schwarcz and at least two students asked that keeps bugging me is: Why didn't Puerto Rico use the fact that the overwhelming majority of its bonds were governed by its own local law to directly restructure it? Couldn't Puerto Rico have passed a set of laws to enable it to engineer a sharp reduction of its debt? Greece did precisely that in March 2012; and it faced constitutional protections of property and prohibitions on expropriation very similar to what Puerto Rico would have (as an aside, the challenges to the Greek restructuring of 2012 -- and there have been dozens of suits filed -- have failed so far). Indeed, the US did something like this with the gold clauses in the 1930s, to jumpstart the economy and get it out of the depression (actions that withstood legal challenge in a set of famous cases such as U.S. v. Perry).
The reason I bring this up is that Jill, Daniel and the Minnesota students refused to let me go with an "I simply don't know". They thought that the answer to that question could itself shed light on why the crisis occurred in the first place. It might, for example, give us some clues as to the dysfunctionality of the Puerto Rico government; a level of dysfunctionality that resulted in an un-elected control board being imposed on the Commonwealth by the federal government. The more I think about it, the more I'm curious as to why this happened.
It makes no logical sense to me that the government, mired in a financial crisis that was only getting worse, should refuse to try to reduce the debt even though it had powerful tools to do so (instead of reducing the debt, the Puerto Rican government kept borrowing more at higher and higher rates, until even that option was closed and the whole thing came crashing down). And it isn't that Puerto Rico's lawyers didn't know how to engineer this technique: the same law firm that did the Greek restructuring was working for them (no longer though) and even some of the same financial advisers (I think). Of course, history tells us that this movie has played out elsewhere before (Greece in 2010-2013, and Venezuela now). But we don't know why.
It should be possible though to do interviews with enough of the key players in the Puerto Rican crisis to try and figure out what happened. Indeed, some of the slipsters probably have answers. Now, to try and persuade my associate dean that I should be allowed a research leave to spend a year in the West Indies investigating this question.
Mitu Gulati & Mark Weidemaier
The confusion over the status of Venezuelan debt over the past week has been remarkable. The government and its oil company, PDVSA, have, variously, defaulted, promised to pay, paid, claimed the money got stuck in bank purgatory, gotten a Russian bailout, triggered CDS contracts, hosted sham restructuring talks (with gift bags!), and more. All while humanitarian conditions worsen. The charade of being able to meet debt obligations may be nearing its end. The prevailing narrative is that investors are willing to be patient as long as they think the government wants to pay. But the investor mix may also be changing. Have the vultures (i.e. distressed debt investors) arrived?
Two recent articles suggest that the answer is close to being a yes. In this article, from a couple of days ago, Landon Thomas of the NYT reports that, while more traditional investors are beginning to pull out, others who specialize in distress scenarios, like David Martinez of Fintech (a “mysterious” figure, Landon tells us), are entering. The next day, Bloomberg’s Katia Porzecanski published an interview with Jay Newman, formerly of Elliott Associates and infamous for leading the pari passu litigation against Argentina, who seemed very knowledgeable about the legal risks in Venezuelan bonds. (He is ostensibly retired, but one wonders if Venezuelan debt might tempt him out of retirement).
The Bloomberg story highlights an interesting difference of opinion. The markets seem to view PDVSA bonds as significantly safer than Republic bonds. Jay Newman views the former as near-worthless. Why the difference?
One answer may be that market prices, as of today, still reflect the views of short-term players betting on getting out after a few more coupon payments. Investors in distressed debt, by contrast, are interested in end-game scenarios. Perhaps there is also a sense that the current government will do everything possible to keep PDVSA current, given the importance of oil to the economy and the risk of asset seizure after default. (Note: there are no cross-default clauses connecting PDVSA bonds to Republic bonds.) But in the long run (which, in Venezuela’s case, could be rather short), when the money runs out and there is a default, PDVSA bonds are more vulnerable to a restructuring, as the government has many ways to threaten holdouts on those bonds. Conversely, as Anna has written, some of the Republic bonds may be especially tempting to holdouts. In any event, if distressed debt funds are indeed entering the picture, the end may be closer than people think.
As a side note, we generally agree with Newman that PDVSA bonds are more vulnerable to an aggressive restructuring. Some of the blunter proposals, however, risk subjecting the government to liability on a veil piercing theory. We have talked about that possibility here before. As one of us has described elsewhere, veil piercing claims in the sovereign context are hardly a sure thing. But an unvarnished attempt to strip assets could backfire by converting restructurable PDVSA debt into an obligation of the government itself.
To conclude, we leave you with this delightful quote from Matt Levine of Bloomberg, commenting on Katia’s interview with Jay Newman:
Back in Newman's day, like two years ago, giants roamed the earth, and sovereign-debt bounty hunters were larger-than-life figures with strong hearts, iron stomachs, and lifelong commitments to fighting with Latin American debtors. They watch this generation of fainthearted tourists tangle with Venezuela, and they are not impressed.
Although technically emeritus and making history as a named plaintiff in a gerrymandering case before the U.S. Supreme Court, our commercial law colleague Professor Bill Whitford remains worried about law schools in a way in a way that connects with an issue well known to Credit Slips: student loans. Whitford's latest analysis of law school financial aid is forthcoming in the Journal of Legal Education but is available to us now on SSRN.
Several Credit Slips posts from earlier this year (here and here) focused on the virtues of courts releasing digital audio recordings of hearings, and specified the Judicial Conference authority for doing so. Over the summer, I found about three dozen bankruptcy courts for which at least one audio recording had been posted on a court docket in the prior year, albeit with significant variation in frequency of posting.
It is great to be able to report that the U.S. Bankruptcy Court for the District of Delaware has joined the group of bankruptcy courts using this technology (announcement here with the details). Proceedings before Judge Carey are the first to be posted, with other judges' hearings potentially to follow.
Confusion reigns. Venezuela might plan to default, but maybe it's just pretending so it can buy bonds back on the cheap. Then again, it could be a "giant money laundering operation." If there are restructuring talks, U.S. investors can attend, and listen. Except that the talks will likely be hosted by a drug "kingpin," and investors can't have any "transactions or dealings, directly or indirectly" with that person. And don't ask whether PDVSA's late(ish?) payment was a credit event, or what the CDS payout will be on bonds that have experienced a credit event despite having been paid in full.
Thankfully, the law is clear, right? Here's PDVSA motion to dismiss the lawsuit Crystallex has filed in federal court in Delaware, alleging that PDVSA is Venezuela's alter ego and seeking to enforce an arbitration award against the government by attaching PDVSA's equity stake in the ultimate U.S. parent of CITGO. Here's a summary of the arguments the parties have made thus far. The case matters, first, because if successful Crystallex will sever PDVSA's indirect ownership stake in CITGO. It also matters because, as we've discussed here repeatedly, any debt restructuring will implicate questions of alter ego liability. For instance, many restructuring proposals begin by urging Venezuela to withdraw PDVSA's right to exploit oil reserves, so as to better insulate oil-related assets from creditors. This short article explains some of the issues of alter ego liability raised by these and other proposals.Actually, the law is a bit of a mess. In the normal corporate context, elaborate, multi-factor tests determine whether a corporation's liabilities can be imputed to other entities or to shareholders. Many of the factors seem entirely unrelated to the purposes underlying the rule of limited liability--which include encouraging investment (by shareholders) and enabling access to credit (for corporations). For instance, a corporation would have difficulty borrowing if lenders had to worry that a shareholder's creditors would make claims against firm assets. (That's exactly what Crystallex wants to do here.) A good reason to disregard the separate legal status of a corporation is because failing to do so will undermine important policies underlying other laws, such as those governing creditor priorities. For example, it makes sense to pierce the corporate veil when a shareholder strips the corporation of assets needed to pay creditors, because the shareholder is trying to invert the normal priority scheme, in which shareholders are last in line. Multi-factor tests aren't very helpful in making these kinds of judgments.
These tests make even less sense when applied to corporations owned by foreign governments. In this context, the important underlying policies are set by the law of foreign sovereign immunity. There's an argument that courts should more readily pierce the corporate veil (i.e., impute corporate liabilities to a government shareholder) when it appears the government has removed substantial assets from the corporation. In such cases, the government's actions circumvent a fundamental bargain struck by the law of sovereign immunity: That foreign governments and their entities can access U.S. commercial markets, but only by placing at risk commercial assets related to these activities. Stripping a state-owned corporation of its assets, while relying on the entity protections offered by the corporate form, is contrary to this bargain. For what it's worth, I'll add that the consequences of veil piercing are often not that extreme, because the law of sovereign immunity will continue to protect the government's non-commercial assets (and even, in many cases, commercial assets without a nexus to the liability-generating activity).
Crystallex, however, isn't trying to pierce the corporate veil. It wants to impute the government's liabilities to PDVSA. Here, there's reason for caution. For one thing, state-owned corporations, like other corporations, need access to credit on reasonable terms. Considerations of comity (and the desire to protect U.S. businesses operating abroad) likewise suggest that courts should proceed cautiously.
In general, my view is that a finding of alter ego liability is most appropriate when the government uses the corporation to shelter assets that the law of foreign sovereign immunity would otherwise have made available to the government's own creditors. Thus far, however, Crystallex's case against PDVSA has turned largely on generic allegations of government control. To be sure, there's extensive evidence that Venezuela has interfered with, and even dominated, PDVSA. What's unclear is just how this domination harmed Crystallex. The most relevant evidence Crystallex cites is that Venezuela transferred the mining interests expropriated from Crystallex to PDVSA, for no consideration. Like much the government does these days, that's bad, in some broader sense. But Crystallex does not explain how the transfer materially worsened its position as a creditor of the government. Without such a showing, the case for alter ego liability seems thin to me. Crystallex has a reply brief due on November 22. Perhaps we'll see more of its argument there.
Several days ago, Stephanie McNeal at BuzzFeed News published a short piece on Lularoe's intersection with consumer bankruptcy filings. I've blogged about multi-level marketing (MLM) companies' potential role in bankruptcy filings a couple times. So when BuzzFeed sent me a list of twenty-four chapter 7 and chapter 13 bankruptcy filings from the past two years in which the debtor listed Lularoe as a part of its DBA or FDBA, I was intrigued. Much of what I could glean from the sample of those petitions and schedules I reviewed is in the short piece. The debtors' reports of past years' income from their Lularoe businesses show a precipitous decline in income, some schedules include unsecured loans from online lenders (seemingly to fund purchases of inventory), and most schedules include a large amount of credit card debt. The debtors also are overwhelmingly married with children, and the couples together owe quite a bit in student debt (over $50,000 on average).
Of course, as the story notes, there likely are many more filings stemming, in part, from Lularoe businesses, and these cases very likely are not representative of all the cases. But it was interesting to review them nonetheless. Lularoe reminds me very much of Rodan + Fields and Herbalife, two other well-known MLMs. Which led me to run the same search that BuzzFeed ran for Rodan + Fields and Herbalife.Some background on why I thought I might find something similar in recent bankruptcy filings. Rodan + Fields is similar to Lularoe in that it targets women--and from what I can tell, particularly women with children--to become "consultants" who buy product for resale to clients. Herbalife has operated longer, and recruits men and women to sell its line of nutrition supplements. Lularoe currently is embattled in two class action suits, one alleging that it is a pyramid scheme, and the other alleging that LuLaRoe sold its "independent fashion consultants" subpar products that ripped like "wet toilet paper." Herbalife too has been called a pyramid scheme, and entered into a settlement with the FTC in July 2016 which required it to change its business model.
My findings, in short, are that there are significantly less filings identifiable by searching debtors' names, and thus much, much less of note discernable from the filings. I found six cases in which Herbalife was listed as a DBA or FDBA, and four cases in which Rodan + Fields was listed as such. As with the Lularoe cases, some debtors list inventory among their assets and have loans outstanding to online lenders (such as Lending Club) combined with large amounts of credit card debt. There are less married couples among the debtors, fewer homes owned, and less student loan debt. All of which, ultimately, does not reveal much. One might conjecture that Lularoe's MLM business model includes greater encouragement of its consultants to refer to themselves as businesses, which would increase the number of petitions found via BuzzFeed's method of searching. Or one might conjecture that there is something to the two class actions alleging lightning-fast market oversaturation and unsellable products.
It is rare that the ideas in academic articles fundamentally change the world. A package of pieces by Clay Gillette and David Skeel (starting with "Governance Reform and the Judicial Role in Bankruptcy" in 2014, followed by a NY Times Op Ed in 2015, and concluding with "A Two-Step Plan for Puerto Rico" in 2016) have arguably done just that though. The context, as many slipsters have written about, was the enormous financial crisis that Puerto Rico has been mired in for multiple years now. The three Gillette-Skeel articles were the foundation for the institution of a federal control board to displace the local elected authorities in the Commonwealth of Puerto Rico and, in their place, run Puerto Rico's debt restructuring.
Oversimplifying, the idea is that there are occasions when an electoral system becomes so dysfunctional in its running of the local government's operation that a more command-based system needs to be put in place temporarily. Clay has an aptly titled piece "Dictatorships for Democracy" that also explicates this idea. In political economy terms, the problem that Clay and David attack in their pieces is the one where the local competition among electoral candidates is, for whatever reason, consistently delivering severely sub-optimal local governance -- a consistently bad electoral equilibrium that eventually produces a severe government bankruptcy. And the way to get out of the bad equilibrium, they argue, is a temporary dictatorship (aka control board) that is not beholden to the kinds of political interests that were causing the dysfunction.
The question of why the local government system in Puerto Rico produced such immense fiscal mismanagement is a complicated one. I am inclined to put a big portion of the blame for bad governance on the fact that Puerto Rico has not been allowed to meaningfully govern itself in the same fashion as the states for over a century ("foreign in a domestic sense" and all that). That said, it is hard to argue with the observation that, whatever the reason, Puerto Rico seems to be stuck in a bad governance equilibrium that it needs to be pushed out of. And Clay and David have provided one solution that might just work. (My preferred solution would be that Puerto Rico be allowed meaningful governance rights at the federal level, but no one in Washington DC seems to be willing to give them that).
Two things got me thinking about their idea over the past few days, and induced me to write this post. First, the hearing on the legal challenge to the constitutionality of the control board is coming up soon (based on a challenge from a NY hedge fund). Second, there was an interesting article Simon Davis-Cohen of The Nation (a lengthy piece about Clay and David and their ideas) that appeared about a week or so ago. Davis-Cohen's article, to my mind, manages to be both admiring of the ideas and goals that Clay and David have and also question the whether they are appropriate in the Puerto Rican context.Slipsters, who almost all know a great deal more than I do about these ideas, would probably trace these ideas back further to Mancur Olson's classic APSR piece in 1993, and to the bigger literature on optimal governance mechanisms. Joseph Blocher and I describe some of this literature here in an article on the "Market for Sovereign Control". The basic "bad governance equilibrium" question/problem Joseph and I were tackling there was similar to the one Clay and David take on, albeit in the sovereign context (and it is safe to say that no one is going to adopt our proposals anytime soon). Slipsters, Anna G and Mark W, in a couple of superb pieces, point to flaws in our analysis here and here.
The news out of Venezuela with regards to its debt situation has been keeping investors (who love the high returns, but dislike the uncertainty) in a tizzy, to put it mildly. But today's news was perhaps the most bizarre yet. Mr. Maduro, on the one hand, announced that PDVSA (the big state-owned oil company that produces 95% of Venezuela's foreign currency earnings) was making its latest payment to creditors (due today) and, on the other hand, announced that a restructuring was being planned immediately.
What? Why? How?
If the plan is to restructure because there is no money, then why were the payments today (and a few days ago) made? That makes no sense to my little brain.
And how in the world is there going to be a restructuring when there are US sanctions prohibiting just that? Through some Russian proxy? Or Chinese? Via a loophole in the sanctions regime?
Katia Porzecanski, sovereign debt guru, has a super article up on this puzzle already at Bloomberg (with co authors Patricia Laya, Ben Bartenstein, and Christine Jenkins).
A few days ago, I put up a post about a very interesting recent article by Richard Kilpatrick on highly sticky (and inefficiently so) shipping contracts. The focus of Richard's article was on the failure of these standard-form ship contracts to pre-specify the allocation of financial responsibility among the various parties (ship owner, chartering party, etc.) when refugees need to be picked up and the ship's pre-planned journey gets diverted. Refugees needing to be rescued at sea has, as we know, become a huge international issue over the last couple of years. In that post, I wondered aloud about what the explanation for the stickiness in the ship contracts might be. Theory, after all, would suggest that in a market with highly sophisticated repeat players, inefficient contract clauses would get reformed quickly -- yet they do not. Richard, whom I had never corresponded with before this, was kind enough to send me his thoughts on the question. With his permission, since his thoughts on this are fascinating -- especially the bit at the bottom about how these same parties are simultaneously highly innovative (with ship technology) and highly conservative (with contracts) -- I'm reproducing them below.
I’ve thought about these same questions over the past months and certainly agree that there is a more work to be done in understanding and exposing why there is continued reliance on these antiquated contract forms. In the charterparty context, this is especially surprising given that new iterations of similar forms have been promulgated by the same organization (BIMCO) that drafted the ‘46 form. One answer that invariably comes up is that the shipping industry is deeply conservative and resistant to change. At a recent Singapore Shipping Law Forum, a bunch of us legal and industry people discussed this phenomenon in the context of international conventions on carriage of goods. The Hague Rules governing bills of lading were drafted in the 1920’s (and revised very minimally in the 1960’s via the Visby amendments). These rules desperately need updating because containerization and multimodalism has completely changed the shipping landscape. The subsequent "Hamburg Rules" largely failed. And while the recently drafted "Rotterdam Rules" attempt to rectify some of these problems, they are already viewed by some observers as unlikely to catch-on. Only 4 countries have ratified them so far (including Cameroon in Oct 2017): http://www.uncitral.org/uncitral/en/uncitral_texts/transport_goods/rotterdam_status.html .
At least in part, this appears to be because the industry folks, including their fancy shipping lawyers, don't like change. Note also that the shipping industry is constantly evolving in other ways, particularly in its reliance on technology. Larger and more sophisticated vessels are constantly entering the market, and ports (as well as the vessels themselves) are increasingly being operated by computers rather than traditional labor. So I think it is fair to say there is a very traditional view towards regulation and liability allocation, but a relatively innovative approach towards operations. This creates an increasingly widening gap between the legal framework and the realities of business practice.
My inbox is being bombarded with law firm commentary on the Court of Appeals for the Second Circuit's decision that cramdown interest rates should be determined by "market rates," rather than by formula, when the relevant debt market is efficient. A good summary of the commentary can be found over at the Harvard Bankruptcy Roundtable.
And then we have a Bloomberg story this morning, filled with hand wringing about what might happen if a particular mutual fund were to sell a particular bond position – where the fund owns less than 20% of the issue. Nevertheless, the suggestion is that such a sale could have big, market moving effects. That does not sound like a very efficient market.
Given that the high yield market is apt to be the most relevant market to a chapter 11 case, what precisely, then, has the Court of Appeals achieved?
HT: Joseph Blocher
I didn’t think it was possible for an article to hit all three of the issues mentioned in the title: Refugees, Allocation of the Costs of Refugee Care, and Sticky Contracting (I care because they are three topics near and dear to me –although I’ve never come close to combining them). But a recent article by Richard Kilpatrick of Northern Illinois Law and National University Singapore on the "Refugee Clause" does just this. The issue that Kilpatrick tackles is fascinating and highly relevant in the context of today’s refugee crisis, which is arguably at one of its worst points in history. The connection of Kilpatrick’s article (on the responsibilities of commercial ships) to the current crisis – particularly in terms of the horrors perpetrated by the regimes in Myanmar and Syria – is that many of the refugees flee in overcrowded and flimsy boats and then need to be rescued at sea.
It turns out that although there is a legal obligation on ship captains to rescue people who are in peril at sea (makes eminent sense to me – we want people rescued right away if they are struggling at sea), it is not clear who is to pay this cost. The question of allocation is particularly tricky when someone charters a ship and crew to transport goods from point A to point B. If that ship has to take a detour along the way to rescue refugees they find struggling on the ocean, who is to bear the extra cost of the additional journey? The charter-party or the ship owners? As an aside, it appears that the penalties on the ship captains for failing to rescue promptly can be quite substantial (there were “failure to rescue” issues with respect to the Titanic that received immense publicity).
Ordinarily, one would think that this allocation of the extra costs that result from a deviation from course to do a rescue would be clearly allocated up front; before the ship’s journey begins. As Kilpatrick explains, this is not the case. Even though there have literally been hundreds, if not thousands, of rescue operations needed over the past few years (and this is not exactly new – remember the Vietnamese boat crisis that went from 1975-1990, where many countries in the region desperately tried to push the refugees away), the standard contract form – that apparently lots of transactions use again and again – has not been changed. And this is a NY contract form that goes back to 1946. Wow. What is going on?
The bottom line of Kilpatrick’s article is to plead that the standard form be revised to deal with the question of how to allocate these costs of unexpected refugee rescues. And he points to examples from the past that could serve as a model; such as the adjustments that had to be made to the standard contracts when maritime piracy exploded explored some years ago, resulting in increases in costs and questions about allocation of those costs.
A couple of questions interest me here, beyond what Kilpatrick super article discusses.
First, why is the question of burden allocation all with respect to the charterers and the ship owners? What about the sovereign states – that is, the ones creating the refugee problem, who are violating international law by doing so? Why is there not an allocation of the legal claim in their direction? And then there are the sovereign states who are supposed to give shelter to the refugees (and who often don’t want to let the ships land). What about an allocation of some of the costs in their direction? (and then they can go after the refugee-creating state).
Second, what is going on in this industry such that folks – rich companies with fancy lawyers, I’d imagine – are still using a 1946 that doesn’t fit modern circumstances well at all? Kilpatrick is concerned with getting the industry folks to fix the contract stickiness problem. I want to know more about why it is there in the first place. Indeed, I’d argue that one needs to understand the cause of the problem first, so as to be able to figure out the optimal solution. It would help, therefore, to have data: Who drafts these contracts? What law governs them? How often are they litigated? What kinds of external shocks does the drafting respond to?
I find this question of contract stickiness fascinating (in case you haven’t guessed). And the longer the stickiness lasts, the more interesting it is. Chris French (of Penn State) and Michelle Boardman (of GMU) did fascinating presentations on contractual black holes in the insurance industry at a recent conference. (the papers are available here and here – Michelle has a very cool prior paper on boilerplate as well – “The Allure of Ambiguous Boilerplate”). The standard forms that don’t get revised in the insurance world are often even older than 1946. And better still, those standard forms are sometimes so ossified and over-laden with legal jargon that sometimes no one has a clue as to what they were supposed to mean in the first place.
Three other slipsters, Adam (with Bill Bratton), Mark (with John Coyle) and Anna, also had super papers at the contractual black holes conference (here). And John (with Omri Ben-Shahar) has one of the classic theoretical pieces on this topic. Indeed, one might say that this is a slipster dominated field.
I have no doubt that I’ll say more about contract stickiness soon since Anna, Jeromin Zettelmeyer and I have a new paper on it where we report on over a hundred interviews with market participants in the international bond market on why they keep using old, and seemingly sub-optimal, formulations of contract terms (“If Boilerplate Could Talk”). But for now, I want to see more ship contracts. A trip to ship contract archives, wherever they are, next!
Netflix has long interested me as a company, not only because of shows like "Master of None" (Aziz Ansari and Alan Yang have delivered brilliantly), its darwinian management philosophy (very cool podcast on Planet Money), but because of its uncertain future. It is competing against rich giants like Amazon and Apple to deliver original content in a field that is getting increasingly crowded. My guess is that it is having to spend more and more on content, but is unable to increase its prices very much. One solution for Netflix: borrow at a high interest rate from investors who are willing to bet on your future. And that it has done, in spades. Most recently -- a few days ago -- it borrowed $1.6 billion (yes, billion). I was intrigued and trying to avoid doing my real work, so I went looking for its offering documents and while I didn't immediately find the current docs, I found the offering circular for the bond issue Netflix did a few months prior in Europe (Euro 1.3 billion) in an offering listed on the International Stock Exchange, which is an exchange licensed by the Bailiwick of Guernsey. Yes, really. So, surely, at least some of you are asking the same questions I am. What? Where? Who?
Guernsey, for those of you who are clueless like I am, is a British Crown "dependency" (not sovereign, but not independent, and not quite like a former colony like the British Virgin Islands or Bermuda (they are "British Overseas Territories")). Basically, a cynic might say: Perfect for a tax haven. But it is the stock exchange that interested me, especially since it seems to have been quickly rising in popularity for US and EU companies over the last couple of years.
If I remember my basic corporate finance class (I don't), we were told that exchanges performed a monitoring and disciplinary role; they were "gatekeepers", as the fancy corporate types liked to say. So, is Netflix going all the way to the Isle of Guernsey to get extra special monitoring from the Channel Islanders? Curious, I went to the website for the Guernsey exchange, to see what it said. And it does say that it has wonderfully rigorous regulatory standards ("some of the highest regulatory standards globally"). But does it really?
The paragraph that follows the "highest regulatory standards globally" stuff on their website caught my eye. I've underlined my favorite bits. From the website:
The exchange is present in the three British Crown Dependencies, which are leading international finance centres at the forefront of cooperation on international tax initiatives and have some of the highest regulatory standards globally. In addition, they are English speaking, use the British pound sterling and in the same time zone as and with close links to the UK but outside of the European Union.
Being outside of the EU means that its regulations and directives do not apply unless voluntarily accepted. For example, from July 3 last year, the EU introduced the Market Abuse Regulation (MAR) aimed at improving transparency of trading in the equity markets where there are retail investors. However, the blanket approach has also brought into scope debt listings, and is disproportionately onerous on high yield bonds which are less frequently traded and held by sophisticated investors.
TISE has not changed its rules and the fact that it has the ability to regulate according to the type of product means it can offer a more proportionate regime. As a result, we have seen some migrations from Ireland and Luxembourg but predominantly, we are seeing new issuances coming to us. Since July last year, TISE has been chosen by more than 30 issuers – comprising a mix of private and public, and EU and US companies – including a €1.3 billion ($1.45 billion) high yield bond from Netflix.
It strikes me that it is possible, just maybe, that the foregoing is saying that their main selling point on the Guernsey exchange is not the "highest standards globally" bit, but that they aren't anywhere near as rigorous as the EU with its evil new MAR regs. The fact that these are considered particularly onerous for "high yield" bonds struck me as especially hilarious, given that "high yield' (like Netflix) is high risk and, at least to me, seemingly especially in need of rigorous monitoring. But maybe there is a deeper story along the lines of the EU regs just being inefficient and asking for the wrong types of information blah blah.
In more academic terms then: Is this a race to the top (highest regulatory standards in the world?) or to the bottom (we won't ask you for all of that regular reporting about your lack of profits that the meanies in Brussels demand)?
On the Netflix side, I was intrigued by the contract clause governing Netflix's promise to list that is reported in summary form in the offering memo. It seems to say that Netflix, can at any time, if the folks in Guernsey ask for too much stuff (that is, they start taking that "highest regulatory standards" stuff seriously) promptly de-list. If I were an investor counting on the folks in Guernsey to be my gatekeepers or police or whatever the right metaphor is, I'm not sure I'd want de-listing to be this easy. And that in turn suggests--if we assume smart investors . . .
In a different world, Elisabeth de Fontenay, Josefin Meyer and I have a paper on listings where we suggest that, at least in the area we examine, modern listings are something of a sham (I am a tag-along third author on that paper; Elisabeth and Josefin did 99% of all the real work). Elisabeth and Josefin find from empirical tests over thousands of bond issuances in the sovereign area that there is no indication that the market sees listing in the dominant jurisdiction (Luxembourg, in that study, although Dublin is a rising star) as providing a credibility premium. What I find hilarious here is that the interviews that E&J did to try and understand this puzzle suggest that the people doing these deals (at least the senior lawyers) are themselves puzzled by why anyone (at least in the sovereign area) lists anywhere. Rigorous oversight does not seem to be the answer. Although maybe it is on the Isle of Guernsey? (yes, I like saying "Guernsey").
On November 6, the Supreme Court will hear arguments in a case only a lawyer--and probably only a commercial or bankruptcy lawyer--could love, Merit Management Group v. FTI Consulting. Simplifying quite a bit, the issue is whether a payment by wire transfer (or presumably a check) is "made by" the bank who implements the funds transfer, or the customer who initiates the transfer. The issue arises from the safe harbor for securities contract-related settlement payments, insulating such transfers from avoidance (clawback) by a bankruptcy trustee, and the question whether a money transfer made by wire from the buyer of stock to the purchaser(s) was "made by or to ... a financial institution." 11 USC § 546(e). Several circuit courts have held the safe harbor applies even if the bank-transferor is a simple conduit, performing nothing more than the ministerial task of moving the money (so to speak) from buyer's account to seller's bank. The 7th Circuit held to the contrary in this case, noting that a letter might be said to be "sent by" either the sender or the Postal Service, but the former interpretation is more sensible and consonant with likely congressional intent in this context (again, vastly simplifying to prevent boring readers to death).
Ordinarily I would leave it to those smarter than I to blog about these kinds of big-money cases, but after I was asked to write a little squib for the ABA about it, the extremely perceptive Henry Kevane of the famous insolvency firm Pachulski Stang in San Francisco saw my little piece and called me to ask about an argument relevant to the case. Did anyone point out, Henry asked me, that the definition of "financial institution" in section 101(22)(A) includes the bank's customer within the ambit of "financial institution" in cases where the bank is "acting as agent or custodian for a customer ... in connection with a securities contract"? Well, no, no one appears to have made this seemingly dispositive observation! A transferor bank implementing a wire transfer would certainly be acting as the customer's (account holder's) agent, and the whole point of the case is that the payment was made "in connection with a securities contract" (the same language in section 546(e)). If the Bankruptcy Code oddly defines the customer and the bank as both being a "financial institution" in this context, then regardless of who made the payment, it was made "by" and "to" a financial institution, since the same logic would apply on the recipient side, too. Hmmmmmmmm.
Surprising as it may be that such a hidden-gem argument might have escaped all of the able lawyers on the case (and similar cases), another counter-argument not made surprised me even more. FTI's brief is very aggressive in disparaging the position accepted by the several other circuit courts and made by Merit here. One of FTI's more bellicose "aha!" arguments is a repeated and emphatic assertion that the avoidance statutes all refer to transfers made, quote, “by the debtor.” The problem is ... the statutes do not say this. The very provision on which FTI sued Merit, 11 U.S.C. § 548(a)(1)(B), provides for avoidance of a “transfer … of an interest of the debtor in property.” The identity of the transferor is concealed here and also later in the statute by the use of the passive voice, as it refers to a transfer “that was made or incurred on or within 2 years before the date of the filing of the petition.” The debtor is identified as the transferor only in the actual fraud portion of the statute, not implicated here, and in the insider-preference constructive fraud part, also not implicated here. Neither is any mention made of a transfer, quote, “by the debtor” in the other section on which FTI based its suit against Merit, 11 U.S.C. § 544(b), allowing recovery of a “transfer of an interest of the debtor in property” if state law criteria are met (though the state laws that this statute incorporates generally do refer to a transfer by the debtor). The language "by the debtor" doesn't appear at all in the preference statute, which again allows recovery of a “transfer of an interest of the debtor in property.” 11 U.S.C. § 547(b). Merit doesn't take FTI to task for this rather obviously unsupported--or at least overextended--argument. A pox on both of their houses, methinks, but an interesting illustration of the power of definitional provisions. Three cheers for section 101!
By a 51-50 vote, with Vice President Pence breaking the tie, the Senate has voted to overturn the Consumer Financial Protection Bureau's rule forbidding the use of contract terms (in covered consumer loan products) barring consumers to bring or participate in class actions. The affirmative vote was supported by the usual narratives: Class actions make credit more expensive, arbitration is a better and more efficient means for resolving consumer disputes, class action lawyers are greedy parasites, etc. The truth of these narratives is irrelevant, it seems. For instance, though it is possible arbitration might be used to efficiently and effectively vindicate consumer rights, there isn't much evidence that it does so in practice, and there is evidence to the contrary. As a mechanism for collecting consumer debts, the history of arbitration is uglier still. And even if the availability of class actions increases the cost of credit--emphasis on if--it's not obvious this would be bad. If class actions deter lender misconduct--not that there's any history of bank misconduct!--, and if this increases some lenders' costs and ultimately the cost of their financial products, then... I don't know. Who cares, I guess? Why should consumers victimized by fraudulent lender conduct subsidize cheaper credit for others? The contrary narrative--that class actions are just so darn expensive to defend that banks settle even the bogus ones for large sums of money--is so implausible that it should not be taken seriously without credible supporting evidence.
Adam Lerrick, of the American Enterprise Institute, has offered an intriguing approach to the Republic of Venezuela/PDVSA debt problem. Call a spade a spade. The distinction in the market between Republic of Venezuela and PDVSA bonds has always been artificial and the market has normally perceived it as such. Only recently have market participants begun trying to figure out which bonds -- PDVSA or Republic of Venezuela -- will be more likely candidates for a debt restructuring and therefore which should trade higher in the market.
PDVSA accounts for 95 percent for the foreign currency earnings of the entire country. Without PDVSA, there is no credit standing behind Republic bonds. At base, there is only one public sector credit risk in the country and Lerrick invites us to acknowledge this fact.
He proposes that the Republic assume the indebtedness of PDVSA and proceed to restructure that debt as part of a generalized Republic debt workout. As part of this process -- and to discourage potential holdouts from the Republic's offer to exchange PDVSA bonds and promissory notes -- he suggests that the Government take back PDVSA's concession to lift and sell Venezuelan oil. This risk has always been prominently disclosed in the PDVSA offering documents and should not come as a surprise to anyone.
Lerrick's proposal adds to the growing list of suggestions for how a future Venezuelan debt restructuring (and there almost certainly will be such a debt restructuring) may be accomplished without holdout creditors devouring the process. No one wants to repeat the experience of Argentina.
Recently, in the context of trying to work out the knotty problem of how to restructure Venezuela’s promissory notes, Lee Buchheit and I made a similar suggestion along these lines. (our friends, Bob Lawless and Bob Scott, two gurus of this world of secured financing and contracts, were invaluable in helping us figure this structure out -- all blame for errors is ours, of course).
The structure we suggest differs from the Lerrick proposal mainly on the question of what should happen to the PDVSA oil assets, including receivables for the sale of oil. We suggest that PDVSA pledge those assets to the Republic in consideration for the Republic's assumption of PDVSA bond/promissory note liabilities (as opposed to transferring title to the assets back to the Republic). Such a pledge is expressly permitted by the terms of the PDVSA bonds and promissory notes and should operate to shield the assets from attachment by holdout creditors.
A while back, political scientist Mirya Holman and I wrote a book chapter making sense of existing (and dueling) studies of the relationship between medical problems and bankruptcy, and presenting new findings from the 2007 Consumer Bankruptcy Project on debtors who entered into payment plans with their medical providers and fringe and informal borrowing for medical bills. Given the enduring interest in household management of out-of-pocket expenses associated with illness and injury, we recently posted an unformatted version of the chapter so it can be useful to more researchers and advocates. Download it here.