Lessons from the Hertz Bankruptcy for Indian Bankruptcy Law
The pandemic induced Hertz bankruptcy in the US has upended a whole lot of what we thought we knew about how to run a bankruptcy proceeding.
What we used to think
It is optimal to complete the bankruptcy as quickly as possible. An insolvent business is like a melting ice cube that would lose all value if the bankruptcy were not sorted out very quickly. The gold standard of this approach was the Lehman bankruptcy in which the judge approved a sale agreement (filled with handwritten corrections) after midnight at the end of a chaotic day-long hearing. In India, the law mandates tight deadlines for the whole process, but it has not proved possible to adhere to them.
The big players know best and everybody else is basically a nuisance. In India, this is written into the law where a bunch of supposedly omniscient and incorruptible “financial creditors” have complete control over the proceedings and everybody else is left to their mercy (I have blogged about this here, here, and here). In the US, this is thankfully only an unwritten law, but there is little doubt that the big distressed debt investors are in charge.
The Absolute Priority Rule (APR) is the ideal way to distribute value: the sale proceeds or liquidation value should be distributed to creditors in the order of their seniority. This implies that the junior creditors as well as the shareholders often get wiped out. Bankruptcy courts do find ways to bypass the APR, but, to a first approximation, it more or less determines the allocation of value. In India, the APR is twisted to prioritize financial creditors over operational creditors, but in that modified form, it holds sway.
What Hertz taught us
Hertz reminds us that there are many exceptions to the received wisdom that guides our thinking and statutes about bankruptcy.
Hertz is likely to realize substantial value only because the bankruptcy court has run the proceedings at a leisurely pace allowing a sequence of ever higher bids to emerge as the pandemic abated. In some ways, this was an accident caused by the unplanned bankruptcy filing that was not accompanied by a Debtor in Possession (DIP) financing package, but it is at least partly due to the incessant prodding by the shareholders’ committee.
The retail shareholders who bought Hertz stock after it filed for bankruptcy were ridiculed at the time, but they now seem to have been at least partly right. The latest bids show that the shareholders will get some payout in bankruptcy after all. Some commentators have even compared the retail shareholders’ optimism to Bill Ackman’s legendary exploits during the General Growth Properties (GGP) bankruptcy.
Some scholars are now arguing that the Hertz bankruptcy exposes problems with the Absolute Priority Rule and that a Relative Priority Rule makes more sense. Casey and Macey argue that the option value of junior creditors and shareholders should not be extinguished as in the APR, but they should be allowed to recover that value as a payout in the bankruptcy proceeding, a stake in the reorganized firm, or a warrant that allows them to buy shares of the reorganized firm at a predetermined exercise price at a future date (see Casey, A.J. and Macey, J.C., 2020. The Hertz Maneuver (and the Limits of Bankruptcy Law). U. Chi. L. Rev. Online, p.1. available at https://lawreviewblog.uchicago.edu/2020/10/07/casey-macey-hertz/). In fact, I must acknowledge that Casey and Macey as well as Best Interest Blog inspired many of the ideas in this post.
Posted at 1:20 pm IST on Mon, 3 May 2021 permanent link