Bankruptcy Academics Oppose Possible Bond Law Changes

Clouds pass over the U.S. Capitol Building in Washington. A group of bankruptcy scholars have come out against possible changes to a Depression-era law that could wiggle their way into the spending bill currently before Congress. --Michael Reynolds/European Pressphoto Agency

A group of bankruptcy scholars have come out against possible changes to a Depression-era law that could wiggle their way into the spending bill currently before Congress.

The law, called the Trust Indenture Act, has come up in two significant cases this year involving Caesars Entertainment Corp. and Education Management Corp. In the cases, minority bondholders have used the law to argue that their rights under the bonds cannot be stripped without their consent, even if a majority consents. Judges have sided with the minority bondholders so far, but an amendment to the law, written into the 2016 appropriations bill, could alter that framework. Congress has passed a temporary funding extension with the goal of completing the full year’s bill by Wednesday.

The letter, written by Adam Levitin of Georgetown University and signed by 17 others, urges Congress not to take this action, saying a change “should take place only after legislative hearings and opportunity for public comment.”

Mr. Levitin says the scholars—which include Lynn LoPucki of the University of California, Los Angeles, Stephen Lubben of Seton Hall University and David Skeel of University of Pennsylvania—that signed the letter have “substantial disagreement” on whether and how the Trust Indenture Act needs to be changed, but they joined together to protest the amendment in this form.

“This is no way to do business,” Mr. Levitin said Monday, adding that these kinds of appropriation riders, that are slid into other, larger bills are what “destroy faith people have in the congressional process.”

Although the proposed changes aren’t finalized, the amendment would generally make it easier to force minority bondholders to comply with the terms of an out-of-court restructuring.

Mr. Levitin said his personal views on whether it is necessary to change the law have shifted since he weighed in on the topic as part of Bankruptcy Beat’s Examiners series, in which he advocated for alternations.

Now, he says that he doesn’t believe the current law should be changed and that congressional action is an overreaction to this year’s rulings. He added that the Second U.S Circuit Court of Appeals will also weigh in soon on the Caesars appeal, which will further clarify the issue.

Congressional action on the law could particularly benefit other for-profit education companies, not just EDMC, many of which are very distressed but cannot access the bankruptcy courts due to restrictions on federal funding for education companies, he said. A change could prompt other distressed for-profits to execute out-of-court restructurings.

Going forward, if the law is changed, Mr. Levitin predicted that indenture contracts in the future will be constructed so as to recreate the Trust Indenture Act in the contract.

However, a change in the law could leave some bondholders in limbo under agreements drafted before the law was changed, and for them, “we may see some more stripping of guarantees,” he said.

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