The highly publicized battle over the location (venue) of the Caesars bankruptcy case illustrates yet again the futility of hedge fund creditors’ pushing debtors into involuntary bankruptcy in the U.S.
The bankruptcy petition two-step that launched the Caesars case is not uncommon, though the result is seldom fully what hedge funds and other bondholders seem to expect or desire.
When a large commercial bond issuer begins to falter, debt stakeholders often need to act fast to preserve the value of the company. Theoretically, the most effective way to put a tourniquet on an asset-hemorrhaging business, or to put the brakes on mismanagement, is to push the company into the court-supervised bankruptcy process.
Unlike most world insolvency laws, however, the U.S. Bankruptcy Code is decidedly skeptical of so-called “involuntary” bankruptcy initiated by creditors. While the phrase “debtor-friendly bankruptcy law” is often thrown around in a loose and inaccurate way, that phrase aptly describes the operation of U.S. law in the context of involuntary bankruptcy.
First, to initiate an involuntary bankruptcy case against a large bond-issuing company, usually three or more significant creditors have to act in concert, and these creditors must have non-contingent and undisputed claims.1 Many a petitioning creditor has been rebuffed when the debtor raises a colorable defense as to some essential aspect of the claimed liability.
More challenging is a requirement that the petitioning creditors establish that the debtor is “generally not paying” its debts as they come due. If the debtor is favoring certain creditors over others, paying some and not paying others, this factor may well not be established.
Worse yet, creditors who fail to navigate this gauntlet of requirements face the risk that the court might award the debtor costs and attorney’s fees for a petition filed in “bad faith,” a notoriously slippery standard.
Second, if creditors think they can impose a liquidating trustee on the debtor by winning a race to the bankruptcy courthouse, they have another thing coming. Some creditors would prefer a traditional liquidation under Chapter 7, rather than a “debtor-friendly” Chapter 11 that would presumably leave current management in charge of the debtor-company’s business and the bankruptcy process.
The most common response to an involuntary Chapter 7 petition, however, is a voluntary Chapter 11 petition by the debtor. This might be called the “Brer Rabbit” problem.2 U.S. bankruptcy court is not at all the uncomfortable briar patch that many creditors might think; rather, distressed debtors are relatively content to continue their struggles with creditors in the comfortable, formal venue of a Chapter 11 case, where debtors generally maintain control of their assets, business, and cases.
Third, speaking of venue, not only does an involuntary petition offer creditors little if any control over the type of bankruptcy proceeding, but it also offers little control even over the location of the case. Several hedge fund creditors discovered this in the recent case of casino-entertainment giant Caesars (formerly Harrah’s).3
The U.S. bankruptcy courts are not uniform in their interpretation and application of the law. Some differences can be substantial, and creditors might well prefer a case to be managed under, for example, the rules as applied by the bankruptcy court in Delaware, as opposed to New York or anywhere else.
The rules for where in the country a bankruptcy case can be initiated are somewhat flexible, allowing for a filing in the location of the debtor’s domicile (state of incorporation, most often Delaware), principal place of business or principal assets (often, as in Caesar’s case, hard to determine, with business locations and assets strewn across the country).4
Creditors were aware that Caesar’s planned to file in the surprising venue of Chicago, Illinois, in the middle of the country, far from the usual Delaware or New York venues for cases of this size and complexity. Caesars’ creditors therefore filed a pre-emptive involuntary petition in Delaware.
Later, after the debtor had filed a voluntary petition in Chicago, Caesars revealed that one motivating factor in its choice of the Chicago forum was the supposedly more favorable treatment of third-party releases in the judicial circuit governing the Chicago court, as opposed to the strict limitations on such releases in the circuit governing Delaware.
A major sticking point in the Caesar’s bankruptcy will be the treatment of several “controversial” transactions resulting in a transfer of Caesar’s asset value to related third parties. The debtor’s anticipated attempt to insulate these third parties from liability for receiving these potential self-dealing fraudulent conveyances was a crucial factor in the creditors’ attempt to locate the case in Delaware.
While the Delaware court, as the venue of first filing, had the prerogative of deciding whether the case would be heard in Delaware or Chicago, it ceded to the Chicago court “in the interest of justice.” Consistent with the debtor-friendly approach to involuntary petitions generally, the Delaware court held that the debtor’s Chicago choice of venue in the later-filed voluntary action was entitled to deference.
Surprisingly, the Delaware court candidly acknowledged that the debtor had chosen Chicago based on “different applications of the law in the judicial circuits,” and it accepted this blatant forum shopping for more favorable law as an acceptable basis for the debtor’s choice of forum.
The petitioning creditors may yet have the last laugh. The timing of their involuntary petition was designed to preserve potential attacks on the “controversial” related-party transfers, while the timing of the debtor’s case was designed to come just too late for this purpose.
The Chicago court will now get to decide whether to treat the creditors’ or the debtor’s filing date as the operative point in time, and given the conservatism of the circuit governing Chicago, Caesars may well be less than happy with the court’s choice. So while involuntary bankruptcy petitions are almost futile, the Caesars creditors might at least preserve the benefit of their good timing, if nothing else.
- See 11 USC section 303.
- See Jason Kilborn and Adrian Walters, “Involuntary Bankruptcy As Debt Collection: Multi-Jurisdictional Lessons in Choosing the Right Tool for the Job,” 87 American Bankruptcy Law Journal 123 (2013), online at http://ssrn.com/abstract=2171441.
- See In re Caesars Entertainment Operating Co., Inc., Case No. 15-10047 (KG), “Opinion re Determination Pursuant to Federal Rule of Bankruptcy Procedure 1014(b) as to the District in which the Debtor’s Bankruptcy Case Shall Proceed” (2 Feb. 2015).
- See 28 USC section 1408.