On October 20, 2021, Democratic senators Elizabeth Warren
(D-Mass.), Tammy Baldwin (D-Wisc.), Sherrod Brown (D-Ohio), and
Jeff Merkley (D-Oregon), and Independent senator Bernard Sanders
(I-Vermont), introduced to the United States Senate proposed
legislation S. 3022, the Stop Wall Street Looting Act of
2021 (the “SWSLA”),1 as a reworked
version of legislation previously proposed in 2019.
In what appears to be an attempt at wholesale reform of the
private equity industry and bankruptcy practice, the SWSLA proposes
to:
- require “controlling private funds” and certain other
insiders to be “jointly and severally liable for all
liabilities of each target firm [and its affiliates],”
including any debt, legal judgments, WARN act violations, and
pension-related obligations; - carve out transfers made in connection with “change in
control transactions”2 from the safe harbor
protections of Section 546(e) of the Bankruptcy Code, and impose a
statutory presumption that both a constructive and actual
fraudulent transfer under Section 548 of the Bankruptcy Code has
occurred with respect to various “change in control
transactions” undertaken in the eight years prior to a
bankruptcy filing; - address so-called “sham” independent directors by
vesting an unsecured creditors committee, as opposed to a debtor in
possession, with certain chapter 5 causes of action and claims
against company insiders; and - increase protections for employees in bankruptcy cases by
increasing wage claim amounts and priority status, limiting
payments to executives, and directing bankruptcy courts to favor
employee-friendly bids for a debtor’s assets.3
The notion that core legal concepts of corporate separation and
limited liability are considered “looting” suggests that
clinical analysis may not be the order of the day—with at
least a few unintentional echoes of Atlas Shrugged. And, despite
its breadth, the SWSLA seems almost singularly focused on the
interests of very specific creditor constituencies, as opposed to
representing a measured approach to legislative reform. In many
respects, the SWSLA seems almost to have been drafted as a
“wish list” from a highly litigious plaintiff rather than
reflecting a holistic analysis of key bankruptcy principles.
Regardless, the SWSLA presents perhaps the most substantial
proposed re-write of core bankruptcy concepts since the Bankruptcy
Code’s enactment. And, viewed together with the Nondebtor
Release Prohibition Act of 2021,4 practitioners should
be mindful of the extent to which ‘bankruptcy reform’ may
become the latest soundbite in legislative discourse.
SWSLA Title I
The twin concepts of corporate separateness and limited
liability are cornerstones of American corporate law. SWSLA Title I
proposes a significant departure from these core principles by (i)
requiring “controlling private funds” to be jointly and
severally liable for all liabilities of the private fund’s
portfolio companies, including their debt, employee, and pension
obligations, and (ii) voiding any obligation of a portfolio company
to indemnify a “controlling private fund” or certain
related parties as against public policy. Broadly speaking, the
SWSLA defines a “controlling private fund” to be any
private fund that becomes a “control person” through a
“change in control transaction” in that it (i) owns,
controls, or holds with power to vote, 20{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} or more of the
outstanding voting interests of a portfolio company, (ii) operates
the portfolio company or substantially all of the property of a
portfolio company under a lease or an operating or management
agreement, or (iii) otherwise has the ability to direct the actions
of a portfolio company.
The legal and economic rationales for demanding that
equityholders guaranty substantially all the debts of a wholly
separate corporate entity are, at best, unclear. As noted above,
limited liability and corporate separation are core principles of
American corporate law and capital markets generally. Put another
way, causing equityholders to become de facto (and de jure)
guarantors for substantially all corporate debts is difficult to
square with a capital market and legal system predicated on
concepts of limited liability. In any event, if passed in its
present form, the SWSLA would require any “controlling private
fund” to literally guaranty substantially all liabilities of
its respective portfolio companies.
SWSLA Title II
SWSLA Title II proposes, among other things, to carve out
“change in control transactions” from the safe harbor
protections of Section 546(e) of the Bankruptcy Code,5
and create the presumption that (i) any “change in control
transaction” occurring in the eight years prior to the
bankruptcy filing, or (ii) any transfer made or obligation incurred
by the debtor to or from a “control person,” affiliate,
or insider during a “protected period”6 are
both constructively and actually fraudulent transfers under Section
548(a)(1) of the Bankruptcy Code. Again, it is unclear how a
statutory presumption of fraudulent conduct, let alone such a
presumption with an eight-year lookback, could be squared with
traditional legal concepts regarding what is (or is not)
“fraud.”7 It is also unclear how the
SWSLA’s authors believe that providers of capital will react
when required to fund transactions that are quite literally
presumed to be frauds.
In addition, SWSLA Title II attempts to address the issue of
so-called “sham” independent directors by giving an
unsecured creditors’ committee the exclusive right to bring an
action (i) to avoid transfers in connection with “change of
control transactions,” or (ii) against insiders of the debtor.
SWSLA Title II, in particular, seems to underscore the extent to
which the SWSLA appears to serve as an advocacy piece for a
particular creditor class in a manner that is fundamentally at odds
with core principles of the Bankruptcy Code.
SWSLA Title II presents a particularly unique departure in
this regard. It is a baseline proposition of American bankruptcy
law that the debtor in possession stands as a fiduciary for all
stakeholders in bankruptcy. This reality reflects the fact that the
bankruptcy process involves the balancing of a number of competing
stakeholder interests: administrative creditors, priority
creditors, secured creditors of different priority and with
different collateral rights, unsecured creditors, and others. To
this end, the prosecution of estate causes of action is not
typically viewed through the narrow lens of how such prosecution
benefits any one stakeholder constituency.8
The SWSLA proposes to turn this proposition on its head. The
SWSLA would entrust a particular asset class (i.e., estate causes
of action) to a single stakeholder constituency—an official
committee of unsecured creditors (a “UCC”). In this
regard, it is difficult to read Title II as something other than an
attempt to create a favored creditor class at the expense of all
stakeholders. Nowhere else does the Bankruptcy Code vest a
particular stakeholder class with control over any particular
estate asset in this fashion, and a UCC is particularly ill-suited
to the task as the SWSLA proposes. At the risk of stating the
obvious, a UCC is not a fiduciary for all stakeholders; a UCC
serves as a fiduciary for unsecured creditors alone. A UCC has no
fiduciary obligation to maximize value for administrative
creditors, priority creditors, secured creditors, or
equityholders—indeed, a UCC can be (and often is) directly
adverse to some or all of those stakeholders, and a UCC can be
incentivized to use litigation, or the threat of litigation, as a
means to an end where unsecured creditor recoveries may otherwise
be de minimis when viewed in terms of unencumbered value.
Yet unsecured creditors stand junior in priority to
administrative and priority creditors (with respect to unencumbered
assets) and also to secured creditors (with respect to encumbered
assets). But the SWSLA disregards this baseline priority system by,
in effect, handing the disposition of a particular class of estate
assets to a stakeholder that may have no economic interest in the
asset at issue and that has no duty, fiduciary or otherwise, to
consider the interests of any other stakeholder in that analysis.
Such an approach makes little sense under the Bankruptcy Code,
although it would perhaps serve the interests of a narrow set of
favored constituents.
SWSLA Title III
SWSLA Title III seeks to, among other things, (i) increase
priority claim amounts for unpaid wages, severance, and employee
benefit plan contributions from $10,000 to $20,000 and eliminate
the 180-day prepetition cut off date, (ii) elevate the priority
status of claims relating to unpaid wages, severance, employee
benefit plan contributions, and damages arising from WARN Act
violations to administrative expense status, (iii) condition or
limit payments to executives, and (iv) direct bankruptcy courts to
favor employee-friendly asset sales under Section 363 of the
Bankruptcy Code.
Footnotes
1 The full text of the SWSLA, as introduced, can be found
here. A sister version of the SWSLA, H.R.5648,
was also introduced in the United States House of Representatives
by Democratic representatives Mark Pocan (D-Wisc.), Pramila Jayapal
(D-Wash.), Eleanor Norton (D-D.C.), and Jesús García
(D-Ill.).
2 Generally, the SWSLA defines a “change in control
transaction” as a change of economic interest with respect to
“the power to vote more than 50 per centum of any class of
voting securities of a corporation that engages in interstate
commerce” or any lesser percentage that gives the acquirer the
“the ability to direct the actions of that
corporation.”
3 The SWSLA also proposes to implement substantial
changes to the Internal Revenue Code with respect to the tax
treatment of private equity investments, particularly regarding
carried interest. The SWSLA’s tax implications are beyond the
scope of this alert. We encourage you to contact your Ropes &
Gray team to discuss these provisions more fully.
4 See Gregg M. Galardi, Ryan Preston Dahl &
Mark Maciuch, The Way Is Shut: Nondebtor Release Legislation
Proposes Mandatory Dismissal on Account of Pre-Bankruptcy Liability
Management Transactions, Ropes & Gray LLP, https://www.ropesgray.com/en/newsroom/alerts/2021/October/The-Way-Is-Shut-Nondebtor-Release-Legislation-Proposes-Mandatory-Dismissal-On-Account.
5 Section 546(e) of the Bankruptcy Code provides that a
trustee may not avoid certain payments made by or to (or for the
benefit of) a commodity broker, forward contract merchant,
stockbroker, financial institution, financial participant, or
securities clearing agency, or a transfer made by or to (or for the
benefit of) such entities in connection with a securities contract,
commodity contract, or forward contract as such terms are defined
in the Bankruptcy Code. See 11 U.S.C. § 546(e); 5
Collier on Bankruptcy ? 546.06 (16th 2021).
6 The SWSLA defines the “protected period” to
be “(i) the eight-year period beginning on the date on which a
change in control transaction closed; or (ii) the period beginning
on the date on which a change in control transaction closed and
ending on the earliest subsequent date on which a public offering
of a controlling share of the common equity securities of the
target firm occurs.”
7 See, e.g., Fed. R. Civ. P. 9(b).
8 See In re STN Enterprises, 779 F.2d 901, 905
(2d Cir. 2000) (“In order to decide whether the debtor
unjustifiably failed to bring suit so as to give the creditors’
committee standing to bring an action, the court must also examine
. . . whether an action asserting such claim(s) is likely to
benefit the reorganization estate.”) (citation omitted);
In re Sabine Oil & Gas Corp., 547 B.R. 503, 568
(Bankr. S.D.N.Y. 2016) (“The Court must determine whether the
Debtors’ refusal to bring [fraudulent transfer] claims is in
the best interests of the
estates, i.e., whether, when considering the
effect of the litigation on the estates and conducting a
cost-benefit analysis, the potential benefits of the litigation
outweigh the costs, monetary and otherwise, to the Debtors’
reorganization.”).
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
