The financial crisis has dovetailed with sea change in bankruptcy law and not always with predictable results. Heather Lennox, a bankruptcy partner at Jones Day, sees a number of unexpected drifts, from a diminution in restructurings, to an increase in prepackaged bankruptcies. Crediting a dedicated bankruptcy bench for helping to shape the law, Lennox concedes the practice is "a lot more contentious" than it used to be. In handicapping future trends, Lennox muses on fallout from Dodd-Frank and potential consolidation in the healthcare industry as consequences of a "slow and fragile" economic recovery.
Business Law Currents: There have been major revisions to Chapter 11 bankruptcy law over the last five or six years. In your practice, what trends are you seeing in Chapter 11 filings, consumer versus commercial? Considering the economy, are you getting busier in the bankruptcy practice or less so?
HL: That is really a dynamic question. I think consumer bankruptcy certainly in the last financial go-round has soared; for a period of time, Chapter 11 cases did as well, largely in the late 2008 to 2009 time-frame. Since then they have tailed off quite a bit. And there is a big topic of discussion within the restructuring community right now, because when the banks themselves got into financial distress, they reached a point where they could not recognize any more bad loans on their books; otherwise they would be in trouble.
So they started doing what we call in the industry, “amend, pretend and extend.” Essentially what that means is that they just pushed their troubled issues off for a couple of years. One might have expected with the tepid economy recovery that we are witnessing, that the boom that we had in 2009 would continue, through 2010 and 2011 but it has not, and in fact it is quite dead right now. Certainly there is activity but not what one would have predicted.
This is a big topic of discussion within the restructuring and commercial Chapter 11 bar and particularly at the Business Law Section meeting in April 2011 in Boston. There is a lot of activity in the middle market rather than the bigger cases that get the headlines. However, there is a general consensus that activity will not pick up until about 2013.
Business Law Currents: Really, and that is because of the “amend, pretend and extend” principle? Is it your judgment that this is as far as the extension can go on the troubled loans?
HL: Yes, and I think we will see the next wave of workouts and restructuring. I personally believe that it’s going to be a while before “values” — which is part of the equation here — will get back to the pre-crash level for some time, if at all. They are coming back, certainly, but just not at that level. And of course at some point the banks will have to recognize this fact and do something to clean up their portfolios. It is taking a little longer than many of us in the industry would like, but this is the trend that many of us are seeing. But it will happen.
The other thing that has folks waiting around to see what to do, within the banking practice and the bankruptcy practice, has to do with what is happening in the regulatory environment and what will come out of Dodd-Frank. What can banks do? What regulations are going to affect hedge funds? So a lot of capital that is coming into the market and folks that have capital in the market are just waiting to see what is going to drop in terms of regulations, capital requirements, and other issues.
Business Law Currents: That is a nice segue to Dodd-Frank. With everything that is being written, and the rules changing almost on a daily basis, how does that impact your practice and your ability to plan and advise your clients? What kinds of concerns are you hearing from your clients?
HL: On the corporate side of the transaction, the biggest concern for banks is “what are their capital requirements going to be?” What is the transparency going to be? What kind of restrictions on proprietary trading are we going to face?
Hedge funds are wondering, when they actually write the rules, what are they going to be subject to in terms of their investments. There is a lot of capital out there waiting to be deployed, and looking for the right opportunities before they deploy it. But I do think that we have a lot of “wait and see” and I am not sure people that have firmly come down on how it is going to affect them until we see how this regulation process and this rule-making process play out.
Business Law Currents: As an attorney, is there anything that you can do to proactively prepare your clients for issues affecting them through Dodd-Frank? You could be a full-time attorney just on the rules and process that is coming out of Washington.
HL: You can, and interestingly there was a great panel at the ABI (American Banking Institute) just a couple of weeks ago on bank holding companies. The big question for them is whether it is better for them to go through the bankruptcy process or is it better to go through the process with Dodd-Frank and have the FDIC take care of it. And so there is a lot of debate, and frankly I am not sure if there is going to be “six of one or a dozen of the other” ultimately with the final regulations on that. There are some differences for sure, but it will just be a different process, and perhaps a less transparent process, meaning not in front of the bankruptcy court. You know, there are still over 800 troubled financial institutions out there, so it will either be some form of liquidation, or I think in the end what you will see is a lot of M&A activity in this space as a way to avoid bankruptcy or restructuring, just a lot of consolidating. There is lots of opportunity for strong institutions.
Business Law Currents: So we have talked about Bankruptcy trends and what is going on in the market today. Tell me a little bit about your background? Where did you start? How did you end up at Jones Day?
HL: I am a Cleveland native. I went to Georgetown Law School, and I toyed with staying in DC for a while. DC is more admin law-based, and that did not appeal to me so much. I had an international law firm that was based at home (Jones Day is headquartered in Cleveland), so that seemed like a pretty good opportunity for me.
I went back, and it was great! I was in the Cleveland office until just before this year when I joined our New York office. I still maintain an office in Cleveland but spend more time in NY.
Cleveland is great though, because you can do this cutting-edge international stuff right out of Cleveland. Moving to New York is just an acknowledgment of where all the activity is, and where my contacts are.
Business Law Currents: Do you live in New York or do you commute from Cleveland?
HL: I have an apartment in New York but commute. I have a daughter who is starting high school, so it is tough to move.
Business Law Currents: If you are going to do bankruptcy, you really have to focus on New York?
HL: If you do company-side work in bankruptcy, you may be all over the country, but most of the filings tend to be somewhere on the east coast.
Lately, a lot of my cases over the last six to eight years have been in New York.
Business Law Currents: How did you get interested in bankruptcy?
HL: Until the big cases, like Enron and Adelphia, GM and Chrysler started hitting the news, I don’t think students came out of law school saying “I want to be a bankruptcy attorney.” For me, I came out of Georgetown thinking that I wanted to be a litigator. I did some litigation when I first started at Jones day, and at the time Jones Day had a requirement that you also had to do some corporate work, so I did commercial law and bankruptcy. I picked out a project and it turned out that I loved it. For me bankruptcy is a fantastic hybrid between corporate deal-making and courtroom experience.
Business Law Currents: In the last few years, what have you seen in the courts in their tolerance of some of the larger, and more complicated bankruptcies?
HL: The bankruptcy court judiciary is phenomenal, and New York is one of the best. The judges are really smart and dedicated people, and I do think we have some interesting evolution in the law over the past two decades that I have been practicing and it has evolved for the better.
It is hard to say, depending on the side of the fence you are practicing on, whether the court favors the debtor or creditor. I think that the ball has shifted back towards favoring creditors, with some recent rule changes. Naturally the judges are constrained by the statute, and statutory interpretation, but they are highly creative and practical, and they usually come up with the right decision when applying the statutes.
But there has been a proliferation of case law that has benefited the legal community. When I first started, for example, there was not much guidance in case law towards some of the issues we faced. But judges started to write some very thoughtful decisions that have helped the evolution of the law.
Plus the bankruptcy statute is not going to change anytime soon. Congress does not have time to take up bankruptcy reform; they have other important issues to deal with first. So we are getting more thoughtful guidance from the court itself in the decision, they are writing.
Business Law Currents: You mentioned something very interesting. Regarding how many practice areas or professions touch a bankruptcy filing — for example, you, financial and litigation experts, analysts, forensic accountants — has that increased as a trend within bankruptcy law? Do some of these filings and actions seem to be getting more complicated and sophisticated?
HL: Yes, I think that is true to some extent, but there were always those groups that were there to help interpret actions. It has proliferated though over the years, certainly since I began practicing, and certainly in sophistication of the issues that we are dealing with, the debt structure and other issues.
But what we have also seen is the nature of the folks who are investing in distressed vehicles has changed quite a bit too. What we have seen in the last decade is a rise in litigation because you have very sophisticated financial entities that don’t always have long term relationships with their borrowers, as many institutions and investors had before. Consequently we have seen more litigation as these financial institutions try to collect on bad loans and bad investments.
In addition we have seen a lot of competing plans where we did not see a lot of those 20 years ago, again all driven by more sophisticated investors. It just makes it more difficult to settle.
Business Law Currents: Are you seeing more prepackaged bankruptcies because of the competing plan consideration?
HL: Well, let’s take the Chicago Tribune and Lehman Brothers as examples. In the Tribune you got the debtor’s plan, and some creditors are siding with the debtor’s plan, then you have a competing creditors’ plan. Same thing with the Lehman bankruptcy. I was also involved in a case where I represented the lending group and we proposed the first plan before the debtors even did.
It is that sort of dynamic we did not see in the past that has really changed, and it is making it really tough. It slows down the process while at the same time eroding the value of some of these companies. The longer a company stays in bankruptcy, the optionality of it goes down and therefore the value.
We are seeing more pre-packs and then sales. One reason is that prior to the financial crisis they were over-leveraged. Also, as a result of the financial crisis, there is not a lot of restructuring to be done now. What you are seeing now are mostly sales or liquidation.
Creditors also have a very large voice in what happens now in bankruptcy. They have a better understanding of their options, they have good advisors, and again, this is something that has changed over the last two decades.
Overall, it is just a lot more contentious than it was 10 years ago.
Business Law Currents: Any particular cases you wish to highlight?
HL: Yes, the Metaldyne case that I did recently. It was a really fun case, with some very interesting issues. It is one of the credit bidding cases that people are talking about right now.
We had some very interesting credit bids by some of our term lenders. That auction was one of the most interesting things I have been involved in.
We originally had competing bids for assets but the creditors came in with some bids for the company. We had a credit bid that had some cash tied to it, and we had some pure cash bids too. The opinion that Judge Glenn wrote was very interesting, and solid. The company is doing very well right now as the auto industry rebounds.
In that case, our DIP loan was provided by GM, Chrysler and Ford. So when one DIP lender is in bankruptcy and another is heading into bankruptcy that raises all sorts of the issues.
But we had a great board and they helped steer this company through some very rough waters.
Business Law Currents: That is really key, isn’t it, to have a really good, engaged board of directors during bankruptcy and any restructuring phase.
HL: Absolutely essential; that was a good team and they moved fast. That was a nine month case, which certainly had its share of issues. That case was sandwiched by the Chrysler and GM bankruptcy which was a good thing actually for Metaldyne, because it kept them out of the public eye, which enabled them to move fast through bankruptcy, and maintain some value in the company as it moved out of bankruptcy.
Business Law Currents: Do any industries that are still in pretty rough shape right now?
HL: Shipping of course because of fuel prices, retail, and energy and I think healthcare, particularly hospitals that are not affiliated with big systems. It is going to big issue in the next four or five years. The general consensus is that healthcare reform may not be a very good thing for the unaffiliated hospitals, since slower payments mean greater stress on cash flows. So it may not mean bankruptcy, but rather a lot of M&A activity within healthcare, and a lot of restructuring over the next four or five years.
Every time there is a big change there is a lot of opportunity.
Business Law Currents: Do you get involved in planning on M&A activity? For example bankruptcy touches so many areas, are there some acquisitions which are strategic acquisitions of a distressed company out of bankruptcy?
HL: We have a very robust M&A department at Jones Day. When a client is either in distress or looking at a target that is in distress, they will consult with us.
This is the advantage of a big firm, and why I like bankruptcy. It is the last bastion of the generalist, because your practice touches so many areas, and you get to touch so many areas.
Business Law Currents: What are you hearing regionally?
HL: Southern states are stronger, but the Midwest has been hit hard. A lot of how well a recovery is doing is masked or buried in the states, in that you really have to dig deep to find out the real picture. Municipalities and states are struggling to meet obligations.
The recovery is occurring, but it is very slow and fragile.
Heather Lennox has played a leading role in Jones Day's representations of debtors and potential debtors, creditors' committees, prepetition secured lenders, bank groups, DIP lenders, credit card processors, and other significant creditors in many of the nation's largest in-court and out-of-court corporate restructurings. She has substantial experience counseling clients in fraudulent conveyance, illegal dividend, preferential transfer, fiduciary duty, and piercing the corporate veil issues as well as mass tort issues in bankruptcy. She has represented a number of entities in the structuring and consummation of spin-offs, secured financings, distressed sales and acquisitions, and other out-of-court restructuring transactions.
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