Fasten Your Seatbelts
Harvey Miller, the godfather of bankruptcy, says it's going to be a bumpy ride. Why this wave of restructurings will be different.
By Aleksandrs Rozens March 3, 2008
Harvey Miller, a veteran of the bankruptcy world, may be the Zelig of modern finance. The senior partner with the international law firm of Weil, Gotshal & Manges worked with and was tutored by renowned bankruptcy attorney and scholar Charles Seligson.
Miller has been on bankruptcy cases involving a wide range of businesses, from airlines to New York garment center businesses to REITs, and was even involved with the workout of New York City during the 1970s. Mayor Abraham Beame hired Weil, Gotshal to represent New York City during its crisis and restructuring.
After graduating from Brooklyn College, Miller studied at Columbia University School of Law. He has taught and lectured at Yale Law School, Columbia University Law School and New York University Law School. He was a member of Weil's management committee and created Weil's business finance and restructuring department.
Harvey Miller
Miller developed a taste for opera when he was stationed in Germany after the Korean War. In Frankfurt he saw a local opera company's performances and, later, a federal district judge with a subscription to New York's Metropolitan Opera sold Miller his first tickets to performances there. These days, Miller is on the board of directors at the famed opera house and lately, he says, he has been thrilled by Renee Fleming's performance in Verdi's Otello.
Looking back over his career in bankruptcy, Miller points out recurring themes in many distressed companies: "The numbers change, the nomenclature changes, but nothing else changes. It is all a game of leverage."
Asked how he got into bankruptcy Miller responds, "Accidentally. I had not taken creditor's rights in law school. I had signed up for it and found it boring and [thought] that I would probably never be involved in that kind of situation. Once I got involved in the process it was interesting to me because it exposes you to clients immediately, which was a big thing because if you worked on securities transactions you never saw the client. In reorganization cases, there was a real story, a narrative. There were real people that you dealt with and within a fairly short period of time it had a beginning, a middle, and an end. You were involved with all parts of the drama."
The godfather of bankruptcy recently sat down with IDD for a wide-ranging interview.
IDD: Are we about to enter a new wave of bankruptcies?
MILLER: I believe you are seeing the very, very beginning. Lenders were so anxious to get the business in the past few years that they were willing to excise from standard loan and credit agreements covenants that gave the lender a certain level of control and oversight. Borrowers had to maintain ratios like assets to debt and so on. Credit agreements became cov-lite. Even when you violated some of the covenants, if they existed, you could cure it by giving equity securities. PIK [payment-in-kind] arrangements, equity participations, automatic suspensions of covenants for periods of time helped a borrower avoid reality. We have been going along for the last three or four years in an economic circumstance where defaults did not occur.
IDD: Did we put off what naturally should have been an uptick in bankruptcies?
MILLER: Yes, definitely. When things got really bad and a liquidity crisis loomed because of the huge amounts of liquidity in the marketplace somebody would refinance [the distressed business]. Some entity would come along -- a hedge fund or a mezzanine lender -- and say "Hold it, you don't have to call a default and you don't have to go into bankruptcy because that will be the worst thing to happen as it will expose everybody to the fact that this was a bad company." So, you got refinanced. Now the refinancing, generally, was at a higher interest rate and tighter conditions. It may have included some second-lien financing. You took, basically, a sick animal and imposed on that sick animal refinancing with all the fees that go with a refinancing and probably a higher interest rate because the risk was higher. However, it deferred the adjustment that should have been made six months or a year ago.
IDD: Will the next bankruptcy wave be the worst we've ever had?
MILLER: What the environment means, initially, is that distressed companies that will be seeking reorganization under bankruptcy code are going to take that action as the ultimate last resort. We had this experience many years ago, back in the seventies. In the early 1970s bankruptcy was a distasteful subject before the Bankruptcy Reform Act of 1978. In many areas of the country if a company filed a Chapter XI, you got a receiver. If you filed a Chapter X, which was corporate reorganization, it was mandatory that the court appoint a trustee or trustees. In those days when a company was in trouble and you advised that it needed relief under the bankruptcy law the first question from the board of directors would be "What's going to happen to us?" Answer: "Well, you are going to be supplanted by a trustee in bankruptcy." Reply: "Well, why should we do that? What happens to the CEO?" Answer: "The same thing that happens to you." The trustee becomes the CEO. On top of that, in Chapter X, the attorney who is giving that advice could not represent the company once it filed under Chapter X because the attorney would not be disinterested.
IDD: So, today we have put off what would have been a natural uptick in bankruptcies. Will that make it tougher for us this time around?
MILLER: It is making it more difficult for the companies that are finally finding bankruptcy imperative because they don't have the flexibility to reorganize. Today, you find financial institutions have liens on everything. What we're seeing in the cases now which, I would say, is the first wave of distressed cases, is that the financial institutions -- whether they be banks or hedge funds -- are not going to be sitting around while the borrower is in Chapter 11 for two years. If the borrower wants debtor-in-possession financing the terms of the DIP set the conduct of the case. Think about Tower Records [bankruptcy]. "We'll give you a DIP for 60 days. You must sell the assets by the end of that 60 days."
IDD: So, we'll see more liquidation through Chapter 11?
MILLER: They are hoping, and I am hoping, that they are going-concern sales. The effort is to find somebody who is willing to buy those assets as a going concern. The availability of money in the last four or five years has been so great that there has not been a shortage of buyers. You could almost sell anything in the last four or five years. Academics have said that sales are a better thing to do than having long, drawn out cases.
IDD: Will there be more 363 sales in this wave?
MILLER: Or sales pursuant to a plan. It is premised on the fact that there has been a robust market and the Supreme Court has said the market determines value. As long as you have people coming to bid on these assets you are getting true value. Ten years ago, if you had a bankruptcy sale, generally nobody showed up other than the secured creditor. In the last four or five years even Warren Buffett has come to the bankruptcy court to bid for a debtor's assets. Now, I think, that is a transitory process. Meaning that as credit dries up you are not going to get so many active bidders.
IDD: DIP money -- has it gotten pricier or is it more stringent?
MILLER: The issue on DIP money is: who is giving it to you? If it's the pre-petition lender, which it generally is, it is pricier in the sense that the fees are up. The interest rate is bumped 100 to 200 basis points. Early termination fees are thrown in. It is expensive. It is more expensive than being out of court. But from a secured creditor's perspective it gives more and more control. It does not leave any excess cash that the debtor in possession can work with. You have a dynamic change in Chapter 11. Most Chapter 11s -- if you go back to the 1980s and 1990s -- were 18 months to 3 years. LTV was six years because there were complications. It was the first case which really dealt with ERISA [the Employee Retirement Income Security Act] and nobody knew what ERISA required or how it works or how you deal with pensions in Chapter 11. Congress didn't think about that in 1978.
IDD: In the next wave of bankruptcies, some of the larger businesses will have large pension plans.
MILLER: Yes, though, I believe that problem has gotten smaller. It was very big when LTV filed in the 1990s. ERISA was so new. Because of LTV and what happened in the early 1990s with rust belt companies -- and that's where you had really big pensions that were underfunded -- there were a lot of amendments to ERISA and much more strict enforcement to build up the funds. A lot of that has happened. When it comes to pensions the biggest issues are in the automobile parts supply businesses and the automobile companies and airlines, but it is not as big a problem as it was back then.
IDD: Is the Pension Benefit Guaranty Corp. [PBGC] adequately funded to handle this?
MILLER: Not if a really big company goes down. When Delphi Corp. went into Chapter 11 -- at that time, as I recall -- the PBGC did make a statement that if Delphi was to be liquidated it [PBGC] faced insolvency. The PBGC was very active in 2005 and 2006 in the automobile and the airline industries. Actually, the PBGC was a prime player in the airline cases of United, Delta and Northwest.
IDD: Are they ready for this next bankruptcy wave?
MILLER: If there is a really big collapse will they have enough money without additional federal support to meet all of their obligations? I don't know. In my last encounter with the PBGC in the Delta case intellectually they were ready. Has there been a change in the staff? I don't know. But the people that were there at the time were very realistic, very well educated and not bureaucratic in any sense of the word.
IDD: Are any of the big three automakers likely candidates for bankruptcy?
MILLER: Well, I read Mr. Feinberg's letter from Cerberus on Chrysler. I would not say he was exactly particularly bullish. If you confine it to the Big Three or the so-called Big Three, the Big Three, I think, have got problems. GM has made valiant and successful efforts to restructure its business. Its last proposal basically says that they would like to buy out all of their organized employees. That -- and I am speaking with no knowledge so I speak with absolute authority -- would mean that unless a plant is demonstrably productive in the US you are going to move all of its production offshore. If you look at Delphi, the restructured Delphi, as compared to the pre-Chapter 11 Delphi, it has gotten rid of a large number of plants in US. The plan of reorganization only contemplates, approximately seven US plants. And those will be on a short tether. Ultimately, if Delphi has its way -- with the exception of whatever plant produces something that is not easy to ship -- everything will be offshore.
IDD: Do you think automakers could do a better job restructuring their business by going into Chapter 11? Would it make sense for any of them?
MILLER: If they got to a point where their liquidity was at stake, yes. However that is unlikely.
IDD: How did you come up with the critical vendor concept?
MILLER: There was in railroad reorganizations a six-month rule. If you gave unsecured credit to a railroad in the six months prior to its going into receivership that allowed it to operate, you became an administrative expense creditor entitled to payment. That's where I got the idea for the doctrine of necessity. It was also stimulated by a Chapter 11 case called Storage Technology Corp. Storage Technology was a computer hardware manufacturer. An essential part for these computers was manufactured in Japan. The Japanese creditors got together and said, "We're not going to sell Storage Technology any products unless they pay their old bills." The old bills were not that much. Everybody said, "Oh, what are we going to do?" So we sat around in a committee meeting one day and I said: "Well why don't we go to the bankruptcy court and say this is a necessity. We have to do this and when you look at the overall liabilities it does not make much difference. The only thing we have to worry about is will this set a precedent for other people?" When I got to the Eastern Airlines Chapter 11 case and we had a big problem about vendors of critical supplies I said the doctrine of necessity applies. The court agreed. That ultimately converted to the critical vendors doctrine.
IDD: So, a lot of American reorganization today has its roots in railroad bankruptcies?
MILLER: Reorganization comes out of railroads. After the US Civil War, everybody wanted to build a transcontinental railroad. It was sort of like the telecoms building networks. The concept was that if you build a railroad, the people will come. The freight will come. They did the same thing that Global Crossing and others did. Nobody counted on how long it took to build and the difficulties you have in building. Just like with Global Crossing when they were building a global network, they never did it on time and were always late. They always needed more capital. The other thing nobody counted on was competition. So instead of having one railroad going across the US, every entrepreneur got together a group. They had six or seven [railroads] going. When they came on to take on passengers they were competing with each other. The same thing happened with these telecom networks. They never generated enough money to service the debt. It had become obvious in the railroad cases that dismemberment of the railroad would result in loss of going concern value. If you dismember the railroad you destroy all of the value. Finally someone came up with the concept "you know why the railroad has value? Because it's a going concern." As long it is running it has more value than if you liquidate and rip it apart. A federal judge in Connecticut bought into that and said: "We'll appoint an equity receiver. I'll give an injunction that nobody can sue the railroad. The equity receiver will run the railroad, finish the construction and that's how we will reorganize." The theory is going-concern value is better than liquidation value. If you liquidate a company you will destroy value. We took that paradigm and moved it into the commercial world. It took 20 years to reorganize some of the railroads. What happened was a reorganization manager was appointed and that reorganization manager was generally a Wall Street firm. JP Morgan was very active in this area and that reorganization manager would collect powers of attorney from the creditors and there would be a protective committee.
IDD: Sort of like a creditors committee?
MILLER: Yes. The protective committee would hold these powers of attorney and it would create a plan to rehabilitate and reorganize the railroad. They would publish the plan and they would vote on it and there were disputes about disclosure and the Supreme Court would begin to write decisions. The absolute priority rule came out of a railroad reorganization because of what was going on between Wall Street and the stock holders. The stock holders of these railroads were like some of the hedge funds and the private equity investors of today. They were very friendly with the Morgans. They said: "What do we need the bond holders for? We'll squeeze them out." The Supreme Court said "Wait you can't do that. Stock holders come after bondholders." So today we have the absolute priority rule, or fair-and-equitable rule. Then the question was disclosure. In some of these cases they would nail a notice on a tree and say were having a hearing on reorganization. The Supreme Court said you can't do that. As a result the Supreme Court developed a body of law which was finally incorporated into the [bankruptcy] statute.
IDD: Do you think that the companies that were levered up within some of the private equity fund portfolios are some of the most prime candidates for bankruptcy?
MILLER: Some people made an awful lot of money out of the process. If you go back and look in 2006 and 2007 you find one PE firm selling to another PE firm selling to another PE firm and each time they sell the price goes up. It is almost like musical chairs. The question is: "Who is the last one standing when the music stops?" And that's what is going to happen. I think you now have a situation in which portfolio companies of very respectable and reputable firms are going to have some level of problems.
IDD: Could you not make the argument of fraudulent conveyance in the case of failed companies within PE portfolios? What is the time limit on fraudulent conveyance?
MILLER: Fraudulent transfers raise a big problem generally because the statute of limitations is so long. Under the Bankruptcy Code it is two years from the time you file the petition. But under state law -- and it varies from state to state -- New York is four years. A lot of states are six years. There is one state that I recall is 13 years. That has been a big problem in leveraged buyouts. Was the leveraged buyout a fraudulent transfer? We had the very active leveraged buyout environment when Michael Milken was operating with Drexel and then in 1990 they collapsed we called them fallen angels. They were basically good businesses but too highly leveraged. Were those fraudulent transfers?
IDD: Do you think there are some out there now?
MILLER: It may be similar. Bankruptcy reorganization and bankruptcy is a zero sum game. That means once you establish the sum, if it is less than the liabilities, somebody is going to be discounted or wiped out. In the environment we live in the US where litigation is so prone, somebody is going to say wait a minute that transfer had to be a fraudulent transfer. My personal view is that it is very hard to prove a fraudulent transfer. I do note that I have been on the other side and defended many transactions.
IDD: What do you think about credit default swaps? In the fall of 2005 GM five-year CDS were trading as if they were going to go bankrupt in as soon as six to 12 months. Obviously, the automaker did not petition for bankruptcy. Do you think that this kind of product can propel a company into bankruptcy sooner or hurt it and make it fail?
MILLER: I think the markets have gotten, I won't say immune, but more realistic about CDS. CDS are a very strange subject. There is $45 trillion in notional value of CDS outstanding. This is more than the value of NYSE companies. It is more than the US Treasuries. It is amazing -- the notional value of CDS outstanding. It only relates to actual debt of $5.7trillion. CDS is a marketable security. People trade them that don't actually hold the debt. People are now saying "what is a CDS?" It is supposed to be an insurance policy or a hedge against default, but it trades so rapidly that the so-called insurer may be 10 or 12 parties down the line. And, will that last party have the wherewithal to settle the swap or the CDS at the end? Nobody knows that. Everybody is petrified about what's going to happen to this market if they are ever called. Who is the one that is going to deliver? They do not know who is at the other end of the swap. It's a factor but I don't think its going to push companies into Chapter 11.
IDD: It's a factor in what sense?
MILLER: It could cause a company to pay more for debt. The most effective precipitator of a Chapter 11 or a bankruptcy is liquidity. If a company has liquidity, it will try to stay out. We have moved into an era where bankruptcy, even though it does not have a stigma it is the last resort because management does not want somebody looking over its shoulder. It does not want a bankruptcy court, a US trustee, a creditors committee, a secured creditor looking over and impairing its ability to run a company.
IDD: In this new age of credit we have introduced a wide pool of interested parties. People syndicating debt to 10 different folks such as CLOs and CDOs.
MILLER: Which has made a big difference.
IDD: What do you think that does to the process of 180 days of exclusivity?
MILLER: It makes it extremely difficult because I know of a situation where there are 300 lenders. It is not a case right now. It is in discussion. How do you get 300 lenders to work together without a lot of litigation, particularly in a distressed situation? It is very hard. Go back to the case of W.T. Grant Co., a major retailer that went into bankruptcy in 1975. Originally, W.T. Grant had over 150 bank lenders. That was a day and age when there was relationship banking. The banks were the first ones to recognize that Grant was having problems because Grant came to them for waivers. The large banks realized that to restructure Grant it would be too cumbersome with so many lenders. So what they did is they bought out the small banks. That made it more manageable.
IDD: Do you think that's what will happen now?
MILLER: No. I don't think the banks have the capital to do that. Banks are so undercapitalized that they can't do it. Also, those were the days that debt did not trade and banks kept the loan on their books because they didn't have to take a charge. Today banks are required to mark-to-market and they can't hold bad loans. They have to liquidate them. The relationship of the bank to the debtor is gone. There is nobody to work with them. The debt goes out to hedge funds, distressed debt traders etc. It is very hard to deal with them because they balkanize the situation. They all hire their own attorneys and you have potentially disfunctional proceedings.
IDD: What happens when exclusivity is lost? That's when the fighting starts and it gets more heated, no?
MILLER: I think it is a real conundrum. I have seen cases where exclusivity ends and nothing happens. They continue to negotiate because everybody wants one plan. The problem when exclusivity ends is in a lot of cases you have strange creditors, outliers, and because exclusivity ends the outliers can file a plan. Technically, they can press a plan and unless a judge is very strong you have to start the process. The judge can also defer. That's been done in a few cases where exclusivity has ended. Somebody has filed a plan and the court has said "No, I'm not going to process this. I'm going to give the company some more time." The court has some power there, but it's a new era. Look, if you don't like what the debtor is doing and you are at the 120th day, you just break off negotiations and wait for 60 days.
IDD: Where do you think well see the most bankruptcies?
MILLER: Retail will be at the forefront. Real estate, homebuilding. I don't think were finished with the automobile parts suppliers.
IDD: More Chapter 22s from some of those auto parts companies that already emerged?
MILLER: Yes. And unless consolidation really works you may see some of the airlines back. The business plans for some airlines projected fuel at around $70 a barrel before the cracking fees. The facts speak for themselves. Also, I've noticed on trips that I've been taking first class is full but the back of the plane is not.
IDD: Do you think that is what is propelling Delta and Northwest to talk to each other?
MILLER: No. I think Delta and Northwest are sort of a natural combination based on their complementary route systems. When I was with Greenhill we were one of the advisors for the company. We did go through a process in the Chapter 11 case after US Airways made its hostile bid in which we did sit down with Northwest as part of the due diligence and discussed with Northwest the possibility of a merger. Delta came to the conclusion that in the Chapter 11 case a merger would not be beneficial or doable.
IDD: But outside of Chapter 11, it is something to be considered?
MILLER: It was something that could be considered. It was certainly in the realm of possibility, but I no longer work for Delta. My off-the-cuff, candid opinion is if you don't get the unions to cooperate it can be a disaster. Trying to mesh the pilots' seniority plans is the most difficult thing in the world in terms of airline consolidation.
IDD: What do you think about this mortgage crisis? Do you think a judge ought to be able to reconfigure an individual's loan?
MILLER: It is not the judge that rewrites it. You have to be clear on that. The issue is that the real estate mortgage industry was able to lobby Congress and get through into Chapter 13 this provision that you could not modify the terms of a residential real property mortgage. Prior to that, there certainly was power in a bankruptcy court to approve a plan that did it. So it wasn't exactly the judge doing it. It was the proponent of the plan or the trustee. It had been in the bankruptcy law and reorganization for a long time. In personal bankruptcies you could rewrite the terms of a real property mortgage, based on the value of the property and the ability to service the debt over a reasonable period of time. You had to give the secured creditor the indubitable equivalent of what it had. So you could not take a mortgage and say "OK I'm changing the terms by extending the term of this mortgage for ten years and during the first three years there will be no interest payments." I don't even think you can do a bullet payment after 10 years.
IDD: So, there is no way of refinancing a mortgage?
MILLER: I think there is a way. But you can't do it under under existing Chapter 13. In Chapter 11 you could, but the way they changed the code in 2005 you can't go into Chapter 11, if you meet the standards for Chapter 13.
IDD: Sometimes laws are created to deal with issues or problems that have occurred in recent history, but create their own set of problems down the road.
MILLER: The legislation some people are proposing is to change Chapter 13 and allow the court to approve the modification of an existing mortgage. It still would be subject to the rules and principles that have evolved with the indubitable equivalent test. If they amend the statute to the way it was before, the court will have to determine that the mortgagee is being protected and the mortgage -- as revised -- will give the mortgagee the present value of that mortgage. There will have to be a determination that however the mortgage is rewritten that when the mortgage is paid, the mortgagee will have gotten the full present value of that mortgage as it was on the day the plan was confirmed. What the real estate lobby hated was bankruptcy judges making those determinations. What we have seen here since 1979 is every time the statue has been amended ... every amendment has had a claw back taking something away from the debtor such as excluding some commercial sector from all of the provisions of the statute.
IDD: Which runs counter to the very notions of usury and bankruptcy in this country.
MILLER: In 2005, that BAPCPA statute revoked for all intents and purposes the ability for a fresh start for some individuals which was in our bankruptcy law from the very beginning. An individual who was in distress and filed a bankruptcy petition and agreed to hand over all of his or her assets to a trustee and had not committed any fraud that individual was entitled to a full discharge so that he or she could go back into the world and contribute to the economy. That was the fresh start principle. The Supreme Court reaffirmed it in a case called Local Loan vs. Hunt. It's a basic premise of our law that if you are willing to turn over your assets you are entitled to a discharge. They took that away in 2005.
IDD: So, we do have fault lines in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005?
MILLER: Yes.
IDD: For corporate bankruptcies is there a problem within BAPCPA?
MILLER: It's the whole accumulation of provisions. That statute was only supposed to deal with consumer credit. Well, lobbyists can't resist whenever there is a statute the opportunity to get something in. It was not supposed to deal with Chapter 11 but we got the 180 days [limit] in and the real estate leases.
IDD: What do you think that real estate leases clause does?
MILLER: It accelerates making decisions about assumptions or rejections.
IDD: Is that a good or bad thing for a workout?
MILLER: A bad thing. When you go through the statute and look at every provision that was added or revised the conclusion is inescapable. Wherever possible, the ammendment takes away any discretion for the bankruptcy judge. When you are dealing with a reorganization you need to have flexibility. You have to have grey areas and that is what made reorganization successful.
IDD: The court has less flexibility now?
MILLER: Many of the provisions that came out in 2005 say the bankruptcy court has no discretion. You add to that this business about bankruptcy judges should not determine value which they have been doing for a hundred years. You put that all together and it is anti-reorganization. It is premised on the ability that you be able to sell these assets very quickly after the commencement of a case for true value.
IDD: Are 363 sales always getting people the best price?
MILLER: No, because the way we have set it up now is we have the stalking horse concept. You start with the premise that nobody buys something unless they think they can make some money. So, there is already a built-in discount. Then you put in the stalking horse breakup fee. That cuts down on further recoveries. The company is at that point in time just a conduit. There is no reorganization. It is just a sale and you have none of the protective provisions of Chapter 11: a disclosure statement and voting by creditors. 363(b) has become an alternative to Chapter 11 reorganization.
IDD: It is a liquidation then?
MILLER: It's a liquidation, but you're hoping it's a liquidation at going-concern values. There are situations in which you have a deteriorating asset or perishable asset where 363 serves a useful function. The origins of 363 and what Congress may have had in mind at the time was a situation with the perishable assets, deteriorating assets. If you file Chapter 11 and you have a [railroad] siding with freight cars with tomatoes in them, you can't leave them sitting in the sun.
IDD: Has anybody offered you a judgeship?
MILLER: Yes, but I would not take a judgeship. People have said: "Why don't you apply for a judgeship?" Not colleagues, but people in academia. One judge, in particular. But that's a big problem for me. It creates conflicts with the firm. Even if I left, Weil Gotshal would not be able to appear before me because I have a pension here. They would say that could color your judgment. As a bankruptcy judge you don't only preside over Chapter 11 cases. You do Chapter 7, you do Chapter 13, and maybe at stages of my life the economics did not make any sense. I think the judges are very underpaid. I think many of them make big sacrifices to be judges.
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Harvey Miller
