Restructure This! Podcast Ep. 11
Litigation Risks to Private Equity Sponsors in Chapter 11
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Listen to the original podcast released May 18, 2022 here: https://www.sheppard.com/multimedia-397
Sheppard Mullin’s Restructure THIS! podcast explores the latest trends and controversies in Chapter 11 bankruptcy, commercial insolvency, and distressed investing. For this episode, Ben Finestone of Quinn Emanuel, David Dunn from Province, and Cesar Bello of Corbin Capital join us to discuss the litigation risks to private equity sponsors in Chapter 11 bankruptcy, including potential fraudulent transfer and breach of fiduciary duty claims, what triggers prepetition investigation into a sponsor’s conduct, and the role that litigation finance can play in reaching a fair settlement.
Guests:
Ben Finestone
Ben Finestone is a Partner with Quinn Emanual, an internationally recognized litigation firm with offices in 11 different countries on four continents. As a Partner in the firm’s New York City Office, his areas of practice include Bankruptcy & Restructuring and Lender Liability & Other Banking Financial Institution Litigation.
Ben is ranked as a leading New York Bankruptcy/ Restructuring individual by Chambers USA (2013-2021), was recognized as a National Practice Area Star [Bankruptcy] and Litigation Star by Benchmark Litigation (2022), and has been repeatedly honored by Law.com's “Litigator of the Week” publication, including for trial victories against Citibank and concerning Sanchez Energy. He has also been recognized as a “Recommended Lawyer” by Legal 500, a “Super Lawyer” by New York Metro Super Lawyers (2013-2021), was one of 12 attorneys nationwide named as one of Turnarounds & Workouts’ “Outstanding Young Restructuring Lawyers” in 2011, and received Turnaround Awards by the M&A Advisor in 2013 and 2018.
David Dunn
David Dunn is a Principle at Province, a nationally recognized financial advisory firm focusing on growth opportunities, restructurings, and fiduciary-related services. As a Principle, he serves in executive officer roles, as advisor to or member of boards of directors, in ad hoc and official creditors’ committees, and as a Litigation/Liquidating Trustee, Plan Administrator, or Examiner.
A strategic thinker and decision maker, David possesses over 20 years of experience as a restructuring advisor, distressed investor, and fiduciary in a number of complex in- and out-of-court restructurings, M&A transactions, distressed financings, and litigation-oriented investments. He also has experience executing principal investments in distressed debt and equity instruments across a diverse range of industries such as energy, gaming, insurance & financial services, media, metals & mining, oil & gas, and retail & consumer products.
Cesar Bello
Cesar is a Partner for Research and Portfolio Management with Corbin Capital Partners, an independent alternative asset management firm offering multi-strategy hedge fund and opportunistic credit investing to clients throughout the United States. He works mainly on the firm’s private investment program, leading the litigation finance effort, while also focusing on private credit secondaries, structured credit transactions, manager seeding, and workouts.
Transcript:
Justin Bernbrock:
On this installment of Restructure This!, we welcome Ben Finestone of the law firm Quinn Emanuel, David Dunn from Province, and Cesar Bello of Corbin Capital to discuss litigation risks and opportunities in the context of Chapter 11 cases.
Justin Bernbrock:
Ben's a partner in Quinn Emanuel's Bankruptcy and Restructuring Group and focuses on high-stakes bankruptcy litigation for debtors, committees, lenders, and investors. In his capacity as a Principal at Province, David serves in executive officer roles as an advisor to, or as a member of Boards of Directors, as litigation trustee, plan administrator or examiner, and as an advisor to ad hoc and official creditors’ committees. Finally, Cesar is a Partner at Corbin Capital where he works mainly on the firm's private investment program, leading the litigation finance effort while also focusing on private credit secondaries, structured credit transactions, manager seeding and workouts.
Justin Bernbrock:
As always, stay tuned after the interview for a rundown of current restructuring news and notable stories.
Justin Bernbrock:
All right, well, welcome back. It's another episode of Restructure This! Today, we are privileged to be joined by some old friends and hopefully new friends, specifically Ben Finestone from the law firm Quinn Emanuel, David Dunn is also on, and Cesar Bello from Corbin Capital. David, of course, is at Province.
Justin Bernbrock:
Gentlemen, thank you very much for taking the time to chat with us. I think that we're going to get into some interesting topics and particularly the litigation risks surrounding complex Chapter 11 practice. Before we really dive into the substance however, I would like to just get a sense for each of your backgrounds. And Ben, since I think I've known you probably the longest, you want to kick us off and tell folks what your background is?
Ben Finestone:
Yeah, thanks Justin. It's great to be here to talk about the things that we're going to talk about today. I think we'll have a really good time. I was watching the NBA last night and I was watching the 76'er game. That game ended with Joel Embiid, a seven foot center, hitting a three-point shot to win the game. Pretty dramatic and impressive shots happen all the time in the NBA, last second shot, but for a seven footer center, probable MVP of the league this year, to hit a three pointer, you don't see that too often. And I remember that was sort of the feeling when I was very young. The first time that I saw Earvin "Magic" Johnson, 6'10" point guard, bring the ball up to the court. You just think this is sort of unfair.
Ben Finestone:
Centers are not supposed to hit threes. And point guards are not supposed to be 6' 10", but that's sort of how I feel about David and Cesar here. And I think it sort of just reflects the nature of how competitive things are getting, but someone like David Dunn, who started out as a lawyer at Akin Gump and then went to Cross Sound, started his own hedge fund as a Principal Investor, and now acting both as a financial advisor and a fiduciary. The kind of perspective that he can bring to that job, it's almost unfair. And I know we're going to talk a lot about litigation, but that's exactly the kind of fiduciary that you want if you're a stakeholder in a company. There really are no issues that could be brought to him that would be outside of his ability to render the right business judgment.
Ben Finestone:
And also as a lawyer that may be seeking to depose and cross examine David, that's the kind of witness that would keep someone like me up at night and be very, very nervous entering into that deposition. And Cesar is the same way. I went to law school with Cesar at NYU Law, so we both have this legal background, and he's had several stepping stones in his career and now he's in a place where I think he can speak for himself, but I think he's pushing in a lot of capital into special situations, including litigation funding, which I think we'll talk about a little bit today.
Ben Finestone:
And he brings, compared to other investors, investing in special situations and it's also unfair. It's also like Joel Embiid hitting that three pointer because he brings all of those different expertise. So maybe this is the way the world is going. Maybe there'll be more Cesar Bello's and David Dunn's out there. And we all need to spend more time gaining our experience if we're going to compete in 2022, but certainly good for stakeholders and entities that David is governing and maybe not so good for other sources of capital that are looking at the same situations that Caesar is. But I know we'll have a good time today, Justin, talking about these issues.
Justin Bernbrock:
Ben, tell us about where you're at now and how you got there.
Ben Finestone:
Well, that's funny. Let me first just say none of this is planned or rehearsed because it's about to sound planned and rehearsed but it's really not. If David is Joel Embiid, and if Cesar is Magic Johnson, I'll take a more humble option. I'll say that I'm Steve Smith, a similarly tall point guard for those people who can remember him. But it is true that before I got into the practice of law and bankruptcy litigation in particular that I did two years of public accounting, got my CPA, and then I went and I day traded on level two NASDAQ for two years. So in some respects, if someone was watching me day trade, they wouldn't see the substance of it. We traded stocks without really even knowing or caring what the operations of the company was.
Ben Finestone:
All we knew was the ticker. And it was funny. There were certain companies that we didn't even know the name of. There was this B2B internet company called Ariba, I remember, but it was just ARBA to us because we were just trading it on the screen. But what you did learn, you didn't really realize it, but subconsciously you were learning the essence of markets, which really is just supply and demand. And when more people want something and fewer people have it, the price is going up and vice versa and those kind of fundamental concepts drilled into your brain, underlie everything that we look at and they allow you to make things simple and explain them to judges and get the right things out of witnesses like David Dunn and feed them to people like Cesar so that he can make good investments. So I'll take Steve Smith's much less All Star games than Embiid or Magic Johnson.
Justin Bernbrock:
I'm at a severe disadvantage here knowing very little about basketball. Cesar, tell us a bit to the extent you want to correct the record that Ben gave, or otherwise talk about your firm, your background. I would love to hear it.
Cesar Bello:
Yeah. I don't know about the Magic Johnson comparison, but you know, I've been called worse, so I'll take it. I started out at big law at Skadden, been in house for a long time as an in-house counsel on the transactional side, doing workouts and structuring deals. And the last few years I've been more involved directly investing. I spent a lot of my time on private matters, mainly litigation finance and private credit. Obviously when things get distressed, get a little more involved there as well. I have a long standing relationship with Ben. Use him a lot. When we have material, slashed at the firm type risk, that's the only call I have and it's not necessarily because of my personal relationship. I just think he's a tremendous lawyer. So happy to share my experiences here today and answer any questions you guys have.
Justin Bernbrock:
Excellent. David, why don't you tell us a bit about your background experience?
David Dunn:
Sure. I wouldn't go with Steve Smith. I think I'd go with silky, silky smooth lefthanded Jay, but also a hard edge, which, which has served Ben well, served me well because Ben's represented me a number of times and I would rather hire him than have him deposing me or otherwise cross examining me, because that would not be fun. As far as my background, Ben touched on it. I've been in the distress special situations vertical for my entire career. And I'd like, I guess, to think that I've sat at every seat at the table, which does give me a bit of a differentiated lens to look at distress situations. My interest in distress started when I was in law school. A professor of mine, Bob Zinman, was one of the drafters of the Bankruptcy Code, the modern Bankruptcy Code back in 1978.
David Dunn:
And so I clerked for him during the summer between my first and second year of law school. And really got a great appreciation for the statute and sort of how restructuring in bankruptcy is yes, there's statutory underpinning, but it's really what you make of it. And that intrigued me, the thought of sort of applying what I was learning to different industries and different companies and learning about those underlying industries was also very attractive. And so I started off my career as a corporate restructuring lawyer at Greenberg Traurig, at Akin Gump and Sidley Austin, and then decided to move to the buy side. And I was with a multi-strategy fund initially called Arrowgrass and helped build out their distress team and helped them build their presence. They were London based and helped them build their presence in the U.S. and then saw an opportunity with the fall and in oil prices.
David Dunn:
That was occasioned by OPEC. At the end of 2014, I saw an opportunity to do something on my own, looking at the sort of EMP and services industry and how it had been newly financed post 2008, 2009 crisis. I'd never been under pressure before. It was a business model that was a free cash flow, negative business model, and really was dependent on successive rounds of equity and/or debt financing. And so I thought that would be an interesting industry to attack and a way to sort of launch our own fund. And so ultimately launched and ran that for approximately four years. And the last couple years I had done some reflecting around, continuing on the investing side or what it was that was ultimately giving me more satisfaction.
David Dunn:
And ultimately the answer to that question was, well, I really like the process of restructuring; so whether it's sitting on an ad hoc committee or steering group of an ad hoc committee, sitting on a board, sitting in some quasi sort of management type position or sitting as a trustee, or other sort of wind down officer. And so I joined Province at the beginning of 2020, or sorry, the beginning of 2021, in order to sort of further build out the fiduciary practice as well as sort of litigation services practice. And so now I sit as an independent director. I sit as an officer, whether it's in a chief restructuring officer role or wind down officer role and also serve as a financial advisor, whether it's to independent directors or even a financial advisor to unsecured creditors’ committees or ad hoc committees of funded debt creditors.
Justin Bernbrock:
I think among the three of you, we've got nearly every base covered here. Well, let's dive into some of the substance of the episode, which of course is to chat about litigation risks as well as opportunities in the context of complex restructuring situations. And I think it's fair to say that a lot of the restructuring and distress situations that we've seen over the last decade or so, or perhaps even two decades, have been dominated by issues that relate in some way to a sponsor's control of a portfolio company. I think that this is largely a product of really the boom of the private equity industry, which of course has done tremendous things, but it also has created a dynamic where there is an easily identified target.
Justin Bernbrock:
And perhaps to level set the analysis here, why don't we just kind of chat through all of the risks that exist when there is a scenario with a distressed or troubled portfolio company of a private equity sponsor. So in the very early days, what things can go wrong, do go wrong, could go wrong, such that someone in the future is going to focus on that activity? Ben, you want to kick it off here? And maybe just as you think about the issues let's identify the potential risks for the sponsor or any real control party of a distressed entity.
Ben Finestone:
Yeah. So, in a distressed context, Justin, obviously the so-called risk for the sponsor in a distressed context is the fact that as we head into a chapter 11 scenario, there's going to be losses, not per se, because we all know chapter 11 is still an option for a solvent company, but let's presume there's going to be losses. There's going to be unsecured creditors who are going to want to take all the steps that they can that Congress has made available to them or the debtor and possession acting as trustee to mitigate those losses. And chapter five is one of the tools that Congress has adopted and put into the bankruptcy code and sponsors are often going to have to face the assertion of chapter five avoidance sections. What we've seen a ton of is that because it's not like chapter five is a hidden and unknown tool, these companies start to conduct their own investigations before their debtor in possession, before they have the duties of a trustee in bankruptcy and an attempt to make chapter 11 go as efficiently as possible.
Ben Finestone:
So these pre-petition investigations, if done correctly, can be a very, very efficient tool that can drive the chapter 11 case towards consensus and save a lot of administrative expenses, which are ultimately one of the biggest enemies to unsecured creditors recovery. If they're done in an abusive manner, though, they can just produce the opposite result because whatever conclusion the pre-petition investigator is going to reach may be rejected by the unsecured creditors or by an independent director that's appointed post-petition. And then you've got all that additional pre-petition waste and hasn't driven the stakeholders towards consensus, and we're just going to redo the entire thing. And we're seeing a lot of that.
Ben Finestone:
We're seeing a lot of duplication and waste, and sometimes even post-petition, you see the debtor in possession doing an investigation, and you see the unsecured creditors committee doing investigation, and it's almost like an arms race, so it needs to be done the right way. It needs to be done in a way that it has the trust of all the stakeholders and the faith put into the investigation by all the stakeholders and then it can really avoid some of the protracted costs of litigation.
Justin Bernbrock:
David, let me ask you why you think there is, or has been such an uptick or, or focus on the pre-petition conduct of sponsors.
David Dunn:
Well, look, there are more sponsored companies out there. There's certainly been billions of dollars that have flowed into, certainly in the last, let's say after '08, '09, that have flowed into private equity companies, private equity firms, and ultimately that money has to be spent, has to be deployed. And it's been deployed into any number of companies at increasingly sort of higher levels of evaluation, but ultimately aren't sustainable or certainly often not sustainable and then you end up in a distress situation. And so we're seeing there are more and more sponsor companies and then therefore there are obviously more and more sponsored companies that have some element of distress. I think the sponsor company construct presents its own particular set of issues. You typically have principals of a private equity firm that are sitting on a board or at least sitting as observers.
David Dunn:
And, away from the CEO, you often have other designees, friends and family, if you will, of a private equity firm that are also sort of sitting on the board. You don't typically see much in the way of any independent fiduciary, whether that's sort of at the management level or at the board level in a sort of regular way sponsor situation. And so when these situations get into the "zone of insolvency" or some level of distress, I think most companies, portfolio companies are advised to get an independent future involved ahead of that as much as possible, not after the fact. So to the extent that, for instance, there are liability management transactions, which may be perfectly fine under the documents, but they're being contemplated, their asset sales contemplated. And, in particular, if there are sort of insider transactions contemplated.
David Dunn:
So if the private equity sponsor, for example, wants to try to extend the runway by putting a new equity or wants to extend the runway or extend their option by buying into the capital structure and buying up the cap stack and given the level of information that they have, given the access that they have that others don't, that creates issues with respect to conflict of interest. Conflicts of interest certainly creates issues with respect to trading and puts the company potentially, or certainly foreseeably, on an antagonistic footing to the extent that they have other creditors in structure. So whether those are lenders or bondholders or both for shareholders, you name it. And so in that type of situation, it certainly makes sense to get some independence involved, to bless or otherwise scrutinize those transactions before they happen.
Justin Bernbrock:
So Cesar, turning to you with this one, Ben mentioned I think what is probably the growing practice of conducting pre-petition investigations into the sponsor's conduct often by an independent committee on the board of directors of a distressed company. From an investor's perspective, can you share a bit about efficacy, the efficiency, the wisdom of these pre-petition investigations?
Cesar Bello:
I think it's fact and circumstances dependent, right? Sometimes it makes sense, sometimes they don't. You're always super cost conscious and weighing all of those fiduciary considerations with sort of real practical kind of P&L drivers and every situation, there’s no sort of silver bullet, right? You need to sort of be mindful of all the stakeholders, what the company's doing, what the most likely nodes are and get good advice on what to do from good lawyers. That's always helpful. So it's a hard one to answer in a vacuum, unless you're sort of thinking about a particular case study, right?
Justin Bernbrock:
Granted, and I do think that you touched on at least the idea that I was having, which is this has just got to drive investors crazy to be told that not only am I going to be investigated by some creditors committee in the future, I'm going to have to refresh my investigation during the course of the chapter 11 case. You're telling me I have to do one now on the front end as well. I can imagine friction in sponsors' offices at this duplication, which I think you squarely highlighted. So let's transition into the scenario where the company's filed chapter 11, a committee's been appointed, and almost immediately, people are talking about claims and causes of action for fraudulent transfer. They're talking about fiduciary duty claims, the whole litany of claims that are often asserted in this context. So Ben, do you want to sketch out from your experience just sort of how this typically plays out?
Ben Finestone:
Yeah. Thanks Justin. Without sounding too intellectual, I think it's helpful to start out with the proposition that there are two important policies underlying chapter 11. One, we all know. Restructure the company, save jobs, allow this going concern to continue to pay tax revenues to the country going forward. That's for the good of everybody, but it's not the only policy of chapter 11. Obviously the other policy is maximizing returns to creditors. And judges have to balance those two policies. And those two policies are often at tension with each other. And certainly debtors in possession, do everything they can to use that tension for their own benefit to minimize litigation. They're not so focused on maximizing creditor recoveries. They're focused exclusively on the former, but certainly management is - chapter 11 is not their cup of tea. They want to emerge as soon as possible and kill distracting litigation.
Ben Finestone:
All they want to do is operate their business. And so the answer to your question, unfortunately, Justin, is that fraudulent transfer claims are more often than not, not prosecuted because debtors in possession are skillful at settling them, doing everything they can to settle them, because they don't really have an interest in pursuing them. And unsecured creditors are often worse off given that these claims are not prosecuted. The best chapter 11 cases in my view are when both those policies can be respected and allowed to breathe. Well, one recent example of that is the Sanchez Energy Corp bankruptcy case, in which out of a mediation overseen by Judge Jones in the Southern district of Texas, the company was allowed to emerge and stopped the administrative expense burn. But in connection with emerging valuable avoidance actions were not settled. They didn't go poof. They weren't swept under the rug.
Ben Finestone:
They were allowed to breathe and be prosecuted at the creditor's own dying. And so the estate wasn't going to pay for the cost of prosecution, which we all know can become quite significant. The company was going to emerge and operate, but unsecured creditors' recoveries were not going to be sacrificed because both of those chapter 11 policies need to be respected. And what this plan did is it put the stock that was going to be distributed to creditors into a lockbox and that the fraudulent transfer litigation could proceed over time. There could be due process. There could be due civil procedure. The truth would come out and the right creditors will receive that stock and the business would be no worse off for it. So that's the perfect chapter 11 when those two policies, when smart professionals and/or mediators can figure out a way that those two policies don't do violence to each other.
Justin Bernbrock:
I've often heard it said that fraudulent transfer claims, in particular, Ben, are difficult or challenging to prove. Is that your experience? Does that ring true for you?
Ben Finestone:
It's definitely true. And it's not controversial for me to agree with the proposition and the question, Justin, because I can cite to you the statutory support for the affirmative answer to your question. You look. The badges of fraud are in every state's statute. The reason the badges of fraud exist is an acknowledgement to the premise of your question, Justin, which is that it is often difficult for creditors to prove the, I'll put it in quotes, "fraudulent intent of the debtor" because it wasn't their intent. And so each one of the 50 states has acknowledged the fact that we're going to lessen the burden of proving the debtors, or the borrowers, the issuers fraudulent intent by allowing people to prove actual intent through badges of fraud. So easy for me to say yes to that, very difficult to prove, but the law has acknowledged that and those badges of fraud have been accepted in federal bankruptcy law as well, because we all know the causes of action under federal chapter five are significant overlap in terms of how courts evaluate them with state law.
Justin Bernbrock:
I want to take a slight left turn here, Cesar, and come to you because I know you in your firm do a fair bit of litigation finance, given what Ben just mentioned about the difficulties surrounding fraudulent transfer claims and causes of action. They nonetheless at least seem to be targets for firms that specialize or that have a practice of funding litigation. And I'm curious as to why, why do you, if you do, see that as a beneficial target opportunity for deployment of capital?
Cesar Bello:
Well, there's a lot of reasons people may or may not find a particular case attractive, right? From a trustee's perspective or, I guess in this case, the claimant's perspective it's risk allocation, right? So you, as the company or the trustee of the company may not want to expend little resources you have on a case that you think is uphill, but somebody else may look at it with a different lens and if it's structured correctly and they think it can capture enough of the upside may be willing to take that bet. So it can be a call option for one person where they really can monetize an “asset,” which is this claim that otherwise is not monetizable if they're not willing to spend time and years and sort of run a whole process. And for somebody like us, we just assess the merits of the case and the risk reward. And whether it's a fraudulent transfer claim or any other type of claim, if it's well-structured and there's enough upside, I'm happy to fund it, right?
Justin Bernbrock:
Yeah, it's interesting. And I think it's fair to say, you'll correct me if I'm wrong, but that has become more and more popular as a tool to achieve the dual aims that Ben highlighted of the bankruptcy process. I do want to shift gears a little bit and David, I'm going to come to you ultimately with this in the first instance, but I want to talk about fiduciary duty claims more specifically. And I think that these are very often discussed, perhaps rarely litigated, but David, given your experience as an independent director and/or manager you're really the closest to the decision making. I'd like to get your initial thoughts on how prevalent, in your view, are breaches of fiduciary duties that give rise or ought to give rise to liability or is it really the case that this is the scary tactic employed by creditors’ committees?
David Dunn:
Well, you start with the, let's say, the Delaware Law Proposition, right? That a fiduciary has a duty of care, fiduciary has a duty of loyalty, and then there's also this more amorphous oversight duty, right? Making sure that the company is effectively risk managing the way that they should be, whether that's from a regulatory perspective or otherwise. From a breach of fiduciary duty perspective yes, you may see breaches of duty, of loyalty, sort of insider dealings and whatnot and appropriation of company opportunities, although that's certainly much more infrequent. But from a duty of care perspective, from a negligence perspective, from an oversight perspective, you certainly often see boards that are asleep, are entrenched, aren't asking the right questions, aren't following proper corporate governance, aren't documenting things, aren't requesting materials from their advisors, aren't keeping minutes.
David Dunn:
So they really don't have any evidence of any sort of deliberation or exercise of their duty of care with respect to decision making. And so that gives rise to the actionable breach of fiduciary duty claims. Now it could be that, and we'll get into, I think, releases later on, but more often than not, especially if there are arguably breach fiduciary claims that are live more often than not you'll have a UCC, or a trustee for that matter, looking at well, is there a D&O policy, how much that D&O policy is left, has it been wasted? And there's often a tradeoff there, where in order to preserve breach of fiduciary duty claims, essentially the trustee, the UCC, whoever those claims are being preserved on account of, right, will at a minimum, certainly have the D&O policy to go after if not also sort of personal liability or essentially the personal assets, right, of target directors and officers.
Justin Bernbrock:
So I know, Cesar, in your experience, you've sat on boards. Can you talk through for us, just what that experience has been like for you and thinking about these issues, whether you've considered getting separate counsel in your capacity as a board member, because I do think that it's interesting to hear from folks that have spent time in that seat.
Cesar Bello:
Yeah. I think, in particular, if you're walking into a distressed situation where maybe not everybody's playing nice in the sandbox, you certainly want to get separate counsel. I actually had Ben advise me on one rather contentious situation a couple of years ago, because there's sort of your north star should be being mindful of who your fiduciary duties are to, and that should guide all of your decision making, but doesn't mean you need to stick your head in the sand and be blind to other practical dynamics in terms of creditor agendas, minority, majority creditors, what else may be going on with different stakeholders? So it gets a little bit sensitive in particular, like the situation we were in where I was a minority board member, the other creditor we were having some issues with in terms of different approaches we wanted to take were majority.
Cesar Bello:
They were doing things that we didn't necessarily think were in the best interest of the company and were sort of furthering their own interests. And you want to be able to sort of defend your actions and decisions and have sound rationale and be on solid legal footing for whatever you're proposing. However, you're challenging what other members of the board want to do. You want to be above reproach and getting good counsel and advice is a big part of that because you always have to assume, especially if you're entering into a situation that's already sort of not so nice, that it's going to end up a motivation, right? So view everything through that lens and act accordingly.
Justin Bernbrock:
Ben, coming to you on this one. And as Cesar mentioned, you advised I think in that situation, but more generally, what are some of the things that you think about, that you recommend, that you advise when you have clients that are in we'll call them sticky boardroom situations.
Ben Finestone:
Yeah. Thanks Justin. I did want to comment on this because there is something interesting going on in the law right now that I think everybody can begin to think about. We all know, Justin, that prior to the turn of the century, there were creditors that were advancing claims against directors saying you owe me a fiduciary duty that whether the duty is to put the company into liquidation or to stop operating, as we see in Europe, like in Ireland, that those arguments do have some force. You owe me a duty and what the law responded then said, no, there's no duty to creditors. Of course there's a duty to shareholders, they own the company, but there is this duty to the company. And that was in response to creditors. Context matters. That was in response to creditors saying, you owe me a duty as creditors.
Ben Finestone:
But it's funny the way things evolve and the way humans advance things for whatever their benefit is in any specific case. And so this concept of duty to the company, now we're seeing it used sometimes it's been taken and sometimes even asserted adversely to the shareholders who created and own the company and who the directors and who appointed these directors. You see professionals sometimes get a hold of situations and tell their shareholders "We're going to file this company. We're going to restructure it. Now we're going to terminate your shareholder interests. Not because there's an impending default, not because the assets are about to be dismembered. We don't need the automatic say for that, but we have a duty to the company." And that's the end of the soundbite. But if you take a step back, what they're really saying is that the law should recognize a duty to a legal fiction to this going concern, not to any specific stakeholder, but to this non-organic being, which is the company.
Ben Finestone:
And we've seen professionals use that to their advantage. Sometimes convince management to go along with generous management incentive programs. And there are owners of those companies that are understandably upset with that use of this so-called duty of the company. And in Europe, you see it's being used also in different ways. I don't know, I'm not a European lawyer, whether this has been endorsed by any high courts in Europe, but you're seeing some momentum to the idea that we all have a duty to have this company operate, not for the benefit of any specific stakeholder, but for the benefit of society, the benefit of us as a people, and directors need to start to take that into account.
Ben Finestone:
And that has not been endorsed in the capitalist society that we live in, but it is something that we should all be thinking about, because this world is in fact, an organic being and things are constantly changing and what has been used by professionals for whatever their specific interests in this country will continue to morph. So fiduciary duties for better or worse need to be looked at with precision and we need to stop and can't just accept soundbites from people saying duty to the company. That means we wrap this up and restructure it for the fun of the game, if you will, Justin. So ever-changing and makes all of our jobs fun in that regard.
David Dunn:
Ben and Justin, let me just jump in there on one of the things that Ben mentioned. So I think from an evolutionary standpoint, the point that Ben made around where things are trending in Europe, as far as what duty do you as a company have to society writ large? I think it's easy to see, I wouldn't call this a slippery slope, but it probably is one, ultimately it's easy to see, with the ESG pressure that public companies are under and private companies will increasingly be under, it's easy to see how a company that didn't adhere to its "duties" from an ESG perspective how that could down the road turn into claims or that could give rise to potential claims, whether it's breaches of fiduciary duty or negligence or otherwise. And so I think it will be interesting to see how the perceived duties and claims arising out of perceived breaches of those duties sort of evolves whether it's ESG or corollaries of ESG.
Cesar Bello:
That's particularly, I think, particularly interesting in the ESG context, because I don't think there's any real consensus on what anybody's ESG duties are at this point, right? Depending on who you ask. So that's ripe for Pandora's box.
Justin Bernbrock:
Yeah. And, and I think it'll certainly be interesting to watch that unfold over the next 10, 20 years. There have been, any reasonably close observer will know, examples of directors having suboptimal experiences in the courtroom recently. And I want to get into a bit of the nuts and bolts of serving in that capacity and how a lawyer ought to prepare a director, an officer that is going to potentially testify in bankruptcy court. So Ben, what are your key tips and key advice for clients facing that situation?
Ben Finestone:
Thanks, Justin, let me give a narrow response to that from the perspective of a lawyer that is adverse to the putative witness in your question, and then maybe David could comment more affirmatively about being that witness and preparing for trial. But litigation is obviously an inherently contentious matter. I don't ever go into a cross examination with any expectation short of this is going to be very, very painful for the witness, unless I haven't had the chance to take the deposition of the witness which is sometimes the case on a first day hearing, Justin, as you know. But if I've had the opportunity to depose this witness and I've had time to prepare an outline, it hasn't been rushed and I can prepare a cross examination. I've been humbled before, Justin, but my belief going into that hearing is that this is going to be very, very painful.
Ben Finestone:
And this witness is going to wish that he or she exerted a greater amount of energy to have settled this thing before it went to trial. And I'm surprised at how many times these witnesses, after I've deposed them, go back on to their side of the fence and speak to their lawyers. And they convinced themselves that everything is going to be alright, because if they truly studied that deposition transcript, they should be able to see the same cross examination outline that I'm preparing on. But there's a saying that I got from a song of the genius from the Wu-Tang Clan and it's always stuck with me and it is people tend to break the mirrors that reminds them of their ugliness.
Ben Finestone:
And that's the same thing as putting your head in the sand or just being irrationally optimistic about things, but it doesn't pay. We need to consider our own warts in addition to our own positive traits. And I'm always surprised that witnesses don't truly get what's about to happen to them, but that's litigation. The adverse lawyer is not there to be your friend. He's there with a duty to faithfully prove his case. And you're in the way of that, that witness is in the way of that. So that's the perspective I wanted to bring. And it's certainly different from the perspective that David will have taking the stand.
Justin Bernbrock:
Maybe you could sum that up by saying that you represent the guns of Navarone tearing up your battle zone.
Ben Finestone:
Yeah, that's a good reference, Justin. We're on the same page, you and me.
Justin Bernbrock:
I love the Wu-Tang Clan. David, will you accept Ben's invitation to speak about your experiences sort of in the seat?
David Dunn:
Yeah, sure. I mean, I think I will agree with what Ben said in that it's never pleasant. It's sort of a necessary part of the job, but don't ever anticipate it will be pleasant, nor would I ever anticipate that, whether it's Ben or someone else, that opposing counsel is going to be nice. So look, I think it starts with a couple of things. One, get good counsel. So if I'm in a situation where I'm in a fiduciary position and I know that I will have to be deposed or I'll have to submit a declaration, of which will be subject to cross examination, it starts at the beginning, which is sort of preparing along the way. And anticipating what's going to be attacked ultimately and making sure that things are properly documented, making sure to the extent I'm submitting a declaration in a chapter 11 proceeding, making sure I can justify.
David Dunn:
And I can speak to in depth everything that's in that declaration. I'm signing it ultimately. And I know I'm going to be cross examined on it. I think that when I'm being deposed or whether I'm on the stand, I think being transparent is, first and foremost, not responding with vagueness, not responding with textbook standards, to the extent that someone's asking me about my understanding of a fraudulent transfer, my understanding of my fiduciary duties. I think you need to answer with substance and particularity, to the extent that there's a mistake made, there's been a mistake made on my watch or I made a mistake and something I said at a deposition, I think we need to fess up.
David Dunn:
I was listening to, or I was at a panel with the Houston bankruptcy judges the other day and there was a comment made by Judge Jones, which I thought was a good one, which is to the extent you a mistake, own up to it, you can be fixed and then he said then you move on. I think lack of transparency and obfuscation and vagueness certainly don't play well in Houston, but I don't think play well in any court, and just gives whoever's cross examining you or otherwise opposing you the sort of opportunity to cast a negative light on your credibility and on your process.
Justin Bernbrock:
So I do want to dive back into a subject that we briefly talked about earlier, which Cesar is coming to you on: litigation finance or the rise of litigation finance in the context of bankruptcy cases. And I think that you gave us what the fundamental investment thesis is, but now that we've been talking about sort of the risks for individuals and for firms and for professionals involved in this context, do you see specific ethical issues from the perspective of a litigation financier, or is it truly third party uninvolved financing?
Cesar Bello:
Yeah. So you have to be careful to remain passive, right? You don't want to be perceived as controlling the case. That's what the plaintiff is for. And it would be bad if a judge or anyone else thought that you were really directing things and making key decisions along the way. Now that's not to say you can't structure things ex ante, be a waterfall or, however, to incentivize settlements at certain levels or disincentivize settlements below other levels. That's something we think about a lot. There's also a lot of chatter about disclosure and whether the actual litigation finance arrangements should be disclosed or not. I'm in the camp that, especially in the bankruptcy context, it's helpful to have it blessed by the court. You can run into issues afterwards where people may get buyer’s remorse and are challenging, whether you had standing or whatever, as you go into sort of enforce on the contract.
Cesar Bello:
And then the last thing you want is anybody calling into question ex post the validity of the arrangement. I'll also add bankruptcy is particularly attractive, I think for us as investors and funders in this space, because one of the biggest issues we run into is duration, right? Think about like the mass torts, MDL type context in particular, these things can really, really drag. And although it may not feel like at times bankruptcy court actually can be a super useful tool to shorten that and help put some guardrails around the timing concerns we have, which obviously impacts our IRR. And, and that's kind of how our success is measured in terms of the investment.
Justin Bernbrock:
I have a friend who is at a litigation financing firm and called with an interesting question that I hadn't seen. And I'm curious, Cesar, whether you see this as a new frontier, but the idea posited was using a litigation finance tool as also debtor in possession financing and having the structure upfront and for all to see at the outset of the case. And is that something you see as an opportunity going forward?
Cesar Bello:
Yeah. And you've seen that already sort of deployed - the Paragon case comes to mind, but it's just like any other form of financing, right? So from a trustee’s perspective, a lot of times all they want is to be able to create pressure for settlement, right? And you need to sue sometimes to do that, but maybe they don't have the money, maybe they don't want to spend the money that way. So it can be sort of as the stars align, a good way to solve everybody's problem, if that makes sense.
Justin Bernbrock:
It does. It does very much. So just sort of bringing things to a bit of an apex here. There has been lots of conversation, lots of ink spilled over the practice of third party releases in the context of chapter 11 proceedings. I expect this is a product of chapter 11 cases that enter the public domain more commonly given the conduct of the company or the product that the company makes. Listeners of this podcast will know that our last episode was with Professor Ralph Brubaker, who is a strong advocate against the practice of third party releases and specifically those which are non-consensual, non-debtor, true third party releases. I think that this is a topic and a subject that is going to continue to get a lot of attention and with the backdrop of the conversation that we've had here about risks arising from fraudulent transfer, fiduciary duties, breaches thereof, I'd like to know whether you all or, or any of you have particular thoughts on the practice of these releases and what the future might entail for them.
Ben Finestone:
I'll go first, Justin. I think you're asking in particular about non-consensual third party releases, or at least I'll answer with respect to that subset of your question. And apologies for saying it, but let me just say, these are my views. I'm a mere servant. I'm a mere lawyer. They're not the views of prior or future clients, but, but I will give you my views, because I do have, for whatever they're worth, I do have a pretty strong view about them. There should be none. They should be off the table. This is America. An individual's property is an individual's property.
Ben Finestone:
And if that party hasn't filed for bankruptcy and put its property within the jurisdiction of the bankruptcy court, I don't think there should be any takings of anyone's personal claims. I think that's the best interpretation of the statute. And if it's not, then I think the statute should make that expressed. By analogy, even if you merely have a property interest in the debtor's estate, the code there at least requires that you get adequate protection and that analysis is done on an individual basis. The creditor with the property interest must get adequate protection. So we're treating secured lenders better than the individuals who didn't extend credit to the estate when their personal property gets taken in that non-consensual third party release context. So I don't think there should be any, and to me that's the end of the analysis, but again, that's merely my personal view.
Justin Bernbrock:
David, you want to chime in on this one?
David Dunn:
Yeah, sure, but I'll chime in on it in the context of litigation finance and sort of tie that to releases. So I think there's definitely been a shift in the fifth circuit in other jurisdictions that a shift against and away from true third party releases, nonconsensual releases being sort of easy to get. So they're definitely tougher to obtain now. And in that context, in the context of this conversation that will preserve more litigation on a go forward basis. And in that context we've been talking about litigation finance and I think litigation finance could become certainly more prevalent and more useful because there'll be more claims to pursue. And I think that it makes it more likely that litigation is pursued in a real way, in a substantive way. Often you, and I've certainly have been in this position as a trustee before myself, you've got limited funding coming out of a case.
David Dunn:
You have let's call it a skinny pod of claims that have been preserved, getting the breadth of third party releases and you're sort of left with limited resources, maybe make a demand on the central defendant or you file sort of a skinny type complaint hoping that you will survive the motion to dismiss and maybe get to a mediation and thereafter or some sort of other settlement context. To the extent that the third party releases are becoming less available. There'll be more claims and doesn't mean there's going to be more funding around out of a particular chapter 11 plan. So I think litigation finance as a tool, you could certainly see becoming more prevalent and certainly more useful as a result.
Cesar Bello:
So just to take the other side of that for a second, just as a question, because I'm more curious. How do you weigh that ban against the practical considerations of resolving multi-year, multi-billion litigation where you have these third parties, could be insurance companies, willing to contribute billions and get people who've been wrong, versus the arguments you made, which I think are valid, but just practical concerns. Use it as a whole. Does that change your view at all?
Ben Finestone:
Look, we've all just spent a significant amount of time talking about a lot of great things that are in title 11, that's the bankruptcy code. We're all big fans of title 11. It does a lot of good for society. And so if parties want to achieve the benefit of a release, if parties want to achieve and deliver the benefits to society that you just described, Cesar, which is not having protracted litigation muck up the U.S. Judicial Court System for years and years and years, title 11 is there for those punitive defendants. And I think it's a great thing about our country, but I don't think you get the benefits of title 11 without filing a petition. And it's just my personal view.
Ben Finestone:
Of course, on a case by case basis, great cases can be made and evidentiary records can be submitted and evaluated and lead to the subjective conclusion that in this case we should force releases on people. But, for me, that in and of itself is a very, very unmanageable process. And if you take third party releases off the table, that's something that no one needs to negotiate around and try to push for. It seems like we have title 11 for that. And that's the end of the analysis as far as I'm concerned.
Justin Bernbrock:
Alright. Well, I do have one final question which is not substantive and sort of a tradition we've developed here with the podcast. Ben, I'll start with you. If you were not a partner at Quinn Emanuel and assuming no physical or financial limitations, what would you be doing?
Ben Finestone:
I'll go with living in Hawaii and being a professional body surfer.
Justin Bernbrock:
Alright, David, same question.
David Dunn:
I'd be on the PGA Tour.
Justin Bernbrock:
And Cesar.
Cesar Bello:
I'm going to go back to where we started with Magic Johnson running the Showtime Lakers in the 80's.
Justin Bernbrock:
Excellent. Well gentlemen, thank you so very much for the time and for sharing your wisdom and your experience. It's certainly been very fascinating for me and we really appreciate it.
David Dunn:
Thanks for having us.
Ben Finestone:
Nicely done Justin.
Cesar Bello:
Thank you.
Robbie McLellarn:
Hello again, everyone. This is Robbie McLellarn of Sheppard Mullin for Restructure This! with this week's restructuring news. The Third Circuit Court of Appeals has granted the request of the talc claimant's committee, in the LTL management chapter 11 case, to directly appeal their motions to dismiss, which the bankruptcy court denied back in February. As you may recall, the motion sought to dismiss LTLs case as a bad faith filing in the wake of its Texas two-step strategy. On May 12th, 2022, Judge Garrity of the Southern district of New York confirmed Stoneway Capital Corporation's chapter 11 plan. By doing so Judge Garrity approved consensual third party releases based on an opt out mechanism. Given the scrutiny that third party releases have received recently and the different perspectives on what constitutes consent, even among judges in the Southern district of New York, Judge Garrity's ruling is perhaps worth keeping in mind for practitioners.
Robbie McLellarn:
In other news, amid struggling earnings reports and shifting consumer habits with respect to at home fitness trends in the post pandemic world, Peloton Interactive seems poised to take on a new $750 million term loan to fund general corporate purposes. A lender call to discuss the new financing was held on May 16th. Further, it looks like the pending motions to dismiss in the Infowars sub chapter five cases won't be heard after all. At a status conference on May 13th, Sandy Hook plaintiffs indicated that they sought to dismiss the debtor entities from their state court litigation, thereby sidestepping the effect of the automatic stay and presumably allowing them to proceed with their suits in the relatively near term. Finally, as our listeners all know, equity markets continue to struggle. The S&P has posted an approximately 8% loss during the last month and a nearly 16% loss this year, leaving some investors to wonder whether to buy the dip now or wait for the market to continue to slide. Well, that's it for this week's restructuring news. This has been Robbie McLellarn of Sheppard Mullin for Restructure This! See you soon.
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