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Lessons learned from judging Lehman

Kyriaki Karadelis

11 April 2016

Lessons learned from judging Lehman Judge James Peck Morrison & Foerster

One week in September 2008 changed the life of Judge James Peck. He talks to GRR about the proposed changes for the restructuring of systemically important financial institutions since Lehman, and suggests ways to enhance international cooperation between bankruptcy courts and regulators in the event of another crisis of that scale.

Judge Peck had been a bankruptcy judge at the US Bankruptcy Court for the Southern District of New York for less than three years when the Lehman Brothers bankruptcy fell into his hands as a result of random case assignment.

It began with five days and five sleepless nights of chaos, and what he has termed “extreme judging”, as a sale was negotiated for Lehman’s complex North American assets to Barclays Capital. This week of crisis was followed by years of decision-making to untangle the most complex and economically significant bankruptcy in history.

The figures during his time overseeing Lehman speak for themselves: Judge Peck was assigned 24 related Chapter 11 cases; four cases under Chapter 15 of the US Bankruptcy Code filed by foreign affiliates of the bank; 218 adversary proceedings; and the largest liquidation under the Securities Investor Protection Act of all time. He wrote 29 opinions, and approved a protocol for multilateral cooperation and communication between mutiple jurisdictions that had cases related to Lehman’s international affiliates.

When he stood down after eight years as a judge in 2014 to take up the role of global co-chair of business restructuring and insolvency at Morrison & Foerster in New York, the repercussions from Lehman were still bubbling on. They continue to do so today: creditors of the bank are now estimated to have recovered over US$100 billion, but there is still a lot more work to do in resolving litigation claims. Notably, Lehman Brothers International Europe survived the bankruptcy process as a solvent entity with over £7 billion in assets ready to distribute, but with many unanswered questions regarding that distribution.

Lehman wasn’t the only major bankruptcy that Judge Peck oversaw while holding the gavel. He also presided over the Chapter 11 cases of satellite communications services provider Iridium, printing multinational Quebecor and cable television company Charter Communications, and heard a Chapter 15 filing by Japanese flag carrier airline Japan Airlines. Moreover, he helped parties reach settlements in the restructuring of derivatives broker MF Global, as well as in the General Motors and American Airlines bankruptcies and several other large cases. 

Now back in private practice, where he spent 35 years of his career before his judicial appointment, Judge Peck is working to build up the restructuring capabilities in Morrison & Foerster’s London office. At the end of last year he invited partners Peter Declercq and Sonya Van de Graaff to join the firm from Schulte Roth & Zabel, where he had been co-head of the business reorganisation department before becoming a judge. In February, he played a key role in the hire of another experienced insolvency lawyer for Morrison & Foerster’s New York office: Jonathan Levine, from Andrews Kurth.

Judge Peck is active in a number of membership organisations specialising in cross-border insolvency and restructuring matters, including serving as a member of the executive committee of the International Insolvency Institute (III). He is a fellow of the American College of Bankruptcy and a member of the World Bank’s Task Force on Insolvency and Creditor/Debtor Regimes.

Has your experience as a judge in the Lehman case, and other cases, had an effect on the way you operate in private practice?

It’s a unique perspective to be a practitioner who knows how a court is going to react to arguments, and I think that I am more focused now than ever before on careful, concise communications to the court. I recognise, as a result of having spent time reviewing the work product of others, what works best: a “less is more” approach to legal writing. The point should be made clearly and without unnecessary elaboration, the credibility of the advocate needs to be preserved at all times – because the lawyer in one case is going to be appearing again in another case, and to be conscious of maintaining his or her reputation as a trustworthy advocate.

Is it strange being on the other side of the podium in what was your courtroom?

I have never appeared in my former courtroom and doubt that I will ever choose to do so. When I do appear in other courtrooms, I will have the advantage of knowing how an argument is likely to be received. I believe that having experience as a judge enriches the overall experience of practising insolvency law now, because there is this remarkable ability to imagine what it’s like to be sitting on the bench and responding to arguments. For that reason, I tend to avoid arguments that create vulnerabilities. The overall process is in better balance when a person who is doing the advocacy also knows what it’s like to listen to that advocacy.

After Lehman, you praised Chapter 11 of the US Bankruptcy Code but recommended some changes to accommodate the Financial Stability Board’s single-point-of-entry resolution strategy. Have these changes to Chapter 11 been implemented, and what positive impact are they likely to have?

There is legislation currently pending in the US Congress to implement changes: one bill in the House of Representatives and another bill in the Senate, but they’re not entirely congruent. If passed, these amendments to the Bankruptcy Code would specifically accommodate single-point-of-entry resolution, and will adopt certain other recommendations made by academics and regulators who have observed the financial crisis and how it has unfolded.

I believe that the amendments are unlikely to pass any time soon, partly due to 2016 being an election year, and because I think that there are other commercial priorities for Congress, one of which is an amendment to the Bankruptcy Code to deal with Puerto Rico and its massive debt obligations. So we are currently dealing with the statute in its 2005 form, which doesn’t specifically accommodate a single point of entry.

I believe that it may be possible to use Chapter 11 effectively for major financial institutions even without the proposed amendments, although there are increased risks. In effect, the regulators would need to make an argument to a well-informed bankruptcy judge that a transfer of the institution’s holding company to a so-called bridge institution has to occur within 48 hours. That is a very short period of time for a bankruptcy court or any court to be making a significant decision.

In Lehman the sale to Barclays was approved on a very accelerated schedule of five days. But single point of entry contemplates an even more expedited transfer to a bridge institution within 48 hours, because that’s the period of time during which the derivative contracts of the subject institution can be preserved. The goal of single point of entry, as I understand it, is to make it possible for an institution to be resolved without forcing its various affiliates and subsidiaries to file for insolvency relief in various parts of the world. The concept is a resolution that minimises the involvement of insolvency courts and that maximises the opportunity for operating companies to avoid bankruptcy altogether.

Is it a good thing to minimise the involvement of the courts?

In this instance it probably is, because courts, in the exercise of their discretion, necessarily add an element of delay, uncertainty and risk to a transaction – and from a transactional perspective, in order to manage systemic risk, it is critically important for the transfer of the institution in distress to occur as promptly as possible and to restore confidence to market participants. Importantly, this approach eliminates the risk of competing insolvency proceedings in different parts of the world.

Can anything be done apart from these amendments, whether via legislation or soft law, to ease the tension around frenetic assets sales of the type that happened between Lehman and Barclays?

The only thing that can really be done is to plan in advance and have truly expedited and predictable transactions in place, consistent with the so-called living wills that large institutions are in the midst of preparing and updating on an annual basis. The 2010 Dodd-Frank Act provides in Title 1 for certain identified, large, systemically important financial institutions, to plan for what might happen in the event of financial failure, and this planning by itself may be a way to minimise the frenetic atmosphere that surrounded the sale to Barclays.

It wasn’t just the sale to Barclays: during that week, major financial institutions were stressed by bank runs, by customers who were insecure and withdrawing their funds. Asset values in virtually all classes plummeted. The credit markets stopped functioning. One way to better manage that risk is for each of the major institutions to have in place resolution plans that provide for how the organisation can either be wound down or transferred to another institution with a stronger financial statement. Additionally, this process can become less frenetic with “bail-in-able” debt: debt that predictably will convert to equity. Additionally, there is the ability – and this is the work of the regulators – to require more robust capital adequacy for each of these major institutions thereby minimising the risk that any such institution will fail, and increasing the odds in the event of failure that there will be sufficient capitalisation to support an orderly transfer.

These are all untested procedures, but they represent our best efforts to avoid some of the problems of the last financial crisis.

Is there an argument for introducing a special expedited procedure under the US Bankruptcy Code for cases of Lehman’s scale?

Well it’s certainly possible to have expedited hearings in bankruptcy court, and they happen all the time, not only in cases involving major financial institutions, but in all manner of Chapter 11 cases for different kinds of businesses. The approval of financing quite typically occurs on an expedited basis with shortened notice and with hearings that take place at the very beginning of a case, when many parties and entities are just learning about the bankruptcy. So yes, it is absolutely possible; indeed it is ordinary course behaviour for US Bankruptcy Courts to afford emergency relief in appropriate circumstances. In effect, the special procedures already exist.

What often occurs at the beginning of a bankruptcy case is that the debtor company will file a whole series of so-called first-day motions that require expedited attention. The bankruptcy court invariably provides that attention and hears evidence often in the form of declarations. The court makes decisions designed to deal with the emergency requests, and those have the effect of stabilising the operations of the debtor company in bankruptcy. The challenge is to act quickly while at the same time respecting the procedural rights of all stakeholders.

You once suggested that cases of systemic significance such as Lehman should be judged in the US by a national panel of expert judges. How far is this from becoming a practical reality?

It’s not that far away provided that the legislation I referred to earlier is passed by Congress, because there is a provision for a panel of experienced and sophisticated judges to be identified for cases involving systemically important financial institutions. It’s impossible to predict whether that legislation will ever be enacted. I think it’s important for cases that could impact the world economy to be heard by a select group of highly qualified judges.

In Lehman, you approved a protocol for cross-border cooperation that was signed by representatives in seven different countries, and which has been described as precedent-setting. What examples did you have to go by when approving that protocol and were they helpful?

There was a body of precedent for bilateral protocols between courts in the US and Canada dealing with cases on both sides of the border. That precedent existed, but this multilateral protocol was really unprecedented to the best of my knowledge. It was created at my urging to encourage parties to work together cooperatively without imposing restrictions or liabilities on the various foreign representatives in different parts of the world. There was a delicate balance in the protocol to provide something that was meaningful and that encouraged communication and cooperation, but it also provided a great deal of flexibility. I believe that in practice, those who worked under the protocol ended up filling in the blanks of the protocol’s language by attending meetings, sharing financial information and discussing with one another how to reconcile claims. All of that happened on its own without prescriptive language. The parties simply acted in accordance with the spirit of the protocol.

To what extent did the other judges who were on the different Lehman cases have any input in shaping the protocol?

Those other judges did not have any role in drafting the language of the protocol. It was designed in the US, but it served its purpose better than I could have imagined.

Looking back, is there anything that you would have done differently to further enhance the protocol’s effectiveness?

It did work very well, but the protocol functioned in private without judicial involvement or oversight. Meetings took place with estate representatives who understood the issues first-hand. Looking back on the results achieved, the protocol far exceeded my expectations. The parties were actually able to align their interests and reach agreement on a variety of very difficult issues that most of the parties involved had never confronted before. The protocol demonstrates the potential for well-informed individuals acting in good faith to solve problems on their own.

As cross-border cases are becoming more frequent, is there a need to formalise the protocol procedure, either by soft law or even a voluntary provision?

It would be highly desirable for there to be a precedent of general application that parties could adopt to facilitate cooperation in cross-border cases. I’m aware that Working Group V is currently involved in ongoing discussions as to how best to manage corporate groups, those enterprises that end up in multiple insolvency proceedings in different parts of the world. I’m not involved in those conversations and it’s probably best for me not to comment on the current status of those discussions, but I’m hopeful that Working Group V will promulgate proposals that will provide for efficient and fair management of global cases in the future.

If you could have sat as a judge in any of the other courtrooms around the world that heard Lehman, which courtroom would it have been and why?

I wouldn’t have minded being one of the judges in the High Court of Justice, Chancery Division dealing with the significant questions that arose within Lehman Brothers International Europe. That case was and remains one of the most significant insolvency challenges ever to find its way into a court of law. I would have also enjoyed experiencing the English insolvency system on a first-hand basis.

Is there room for alternative dispute resolution in cross-border bankruptcies – be that mediation, conciliation or arbitration – and are these methods already being applied? How often have you used them or recommended their use?

Mediation is increasingly being used. In the MF Global bankruptcy cases, which took place in New York and London simultaneously, I was the court-appointed mediator to facilitate agreements among the Chapter 11 trustee and the SIPA trustee in the US, and the special administrators of MF Global in the UK. That was a very successful mediation, which resulted in the avoidance of expensive and uncertain litigation in the High Court. So mediation clearly is something that has been used successfully in appropriate cases, and I expect it will be used increasingly in cross-border insolvency cases.

Arbitration is a more difficult and challenging subject, because it requires an agreement by the parties to refer their dispute to either a single arbitrator or a panel of arbitrators, and in effect, to give up the procedural advantages of a court proceeding where you have traditional due process and appellate rights. In parts of the world where the court systems are not as fully evolved as they are in the US and in the UK, however, I can see parties choosing to refer disputes to a panel of commercial arbitrators. It is possible that these private judges are well suited to the efficient resolution of complex and sophisticated commercial disputes.

For example, if there is a major dispute regarding what a particular business is worth, that disagreement makes it difficult, if not impossible, for the parties to negotiate a reallocation of value through debt or equity that might be issued in a restructuring. Parties conceivably could refer the question of value to an expert arbitration panel. Once that question has been answered, the parties would be in a better position to negotiate a reallocation under a new capital structure for that enterprise. Now, this is a somewhat idealistic view because, generally speaking, parties prefer to maintain their own value proposition as opposed to allowing any third party to have control of disputed questions that are material to their economic wellbeing. So this is a long way of saying that I do think arbitration is a trend we’ll be seeing with increasing frequency in cross-border cases, but it remains not fully tested and I suspect the commercial reality is that many parties will not agree to arbitrate their disputes.

In the past, you’ve suggested it would be good to have a means of alternative dispute resolution to solve differences of opinion between courts in cross-border cases. What would be the ideal tribunal to do this? Where would it sit and what law would apply?

Very tough question. I presume it could sit in an international centre. So it might sit, say, in New York, perhaps as an adjunct to the UN; or in The Hague. Given the international reputation of The Hague as a venue for dispute resolution, that might be a good place. Either the contracts in question would determine governing law or the parties would need to stipulate on the law to be applied by the tribunal. I would envision retired judges that have international prominence and standing serving as members of this tribunal, and I believe that this tribunal would best function in an advisory capacity. I don’t think many parties would be inclined to surrender their disputes to an international court when it comes to commercial issues, unless of course such provisions are already included in relevant agreements. Presumably, such a tribunal could function as a super-mediation facility providing recommendations and direction in complex cross-border cases that wouldn’t necessarily be binding, but would be persuasive authority. It would help parties reach consensus.

What other projects are you currently involved in to enhance corporation in cross-border cases?

As a member of the International Insolvency Institute’s executive committee, I am chairing the planning and programme committee for our next annual conference in Tokyo, in June. We have programmes that we will be presenting during the conference relating to UNCITRAL’s Working Group V. We also have committees that are focused on improving the quality of cross-border cooperation.

This is, however, a very difficult subject, and it is particularly challenging to harmonise the differences in cultural perspective worldwide: among those jurisdictions that have adopted the Model Law on cross-border insolvency, and those that have not; those that observe common law traditions and those with civil law traditions, just to cite two examples.

You’ve said before that it’s still doubtful whether we are prepared for the next failure of a major financial institution, and that bankers and banks alone wouldn’t be able to manage and resolve such an event in future. If the banks can’t do it, what role can lawyers play?

I frankly think we lawyers have little to do with this other than as advisers to those in a position to implement meaningful changes in the manner that advanced economies work together. This is a subject that requires a high level of cooperation among central bankers and the regulators of the major world economies – the US, UK, Germany, Switzerland and Japan come to mind. I don’t mean to limit it, but that’s a pretty good list.

Do you think that cooperation is achievable between these regulators?

Yes, I think that cooperation among central bank regulators in the major world economies is not only achievable, but essential. I also think that systemically important global financial institutions and their affiliates that have entered into the ISDA Universal Resolution Stay Protocol – which enacted a 48-hour stay on the ability to terminate derivative contracts – demonstrates that the institutions themselves are fully capable of adopting procedures to address certain problems of systemic risk. I believe that cooperation in the planning state may be the easy part. The hard part will be cooperation at the time of an actual failure of a global institution. Only time will tell if we are actually prepared well enough for such an adverse event.