01 October 2014

Debt Forgiveness Pays

Some time ago I posted a series of comments about the twin virtues of promise-keeping and forgiveness. You can read them here, here, here, and here. While the virtue of promise-keeping regularly receives legal sanction through the the legal system (think contract law), the virtue of forgiveness features less prominently tucked away, as it is, in bankruptcy law. One supposes that the imbalance in the laws's pedagogy of virtue lies in the mundane: creditors have more political power than debtors.

Even though debt forgiveness is more limited than debt collection, it appears that a robust system of bankruptcy law like America's is good for more than the debts it discharges. Go here to read an insightful account of a research study that concludes that bankruptcy is an efficient policy of social insurance:
Getting approved for Chapter 13 bankruptcy protection "increases annual earnings by $5,562, decreases five-year mortality by 1.2 percentage points, and decreases five-year foreclosure rates by 19.1 percentage points."
While not part of the research study, I think it's also important to note is that these benefits accrue not only to the debtors but have positive effects on third parties and not only immediate family members. Reduction in foreclosure rates also benefits neighboring property owners.

The standard economic argument against liberal bankruptcy laws posits that the gains to debtors will be offset by the cost to other consumers of credit. In other words, the rest of us pay marginally more for credit because some don't pay at all. Such a result, even were it true, might nonetheless be warranted as a form of compulsory insurance. In other words, we all pay a small insurance premium in the form of higher interest rates to protect ourselves from the downside risk of the occurrence of certain financial contingencies.

But even the "common sense" observation that reducing access to bankruptcy would save the rest of us money isn't true.

Another study linked in the news account account concluded that the benefits from Congressional tightening of access to consumer bankruptcy in 2005 accrued to the financial services industry, not other consumers. Of course, that provides investors with interests in that industry with unbargained-for upside risk but, as I noted recently, that's simply another example of rent-seeking in the public square.

All in all, the virtue of forgiveness has tangible benefits, which shouldn't surprise anyone who has read the Gospel accounts.

30 September 2014

Detroit Bankruptcy: The Final Deal May Be Struck

Go here to read the latest news account of what appears to be a deal with Detroit's remaining large creditor, Financial Guaranty Insurance Corporation (FGIC). My earlier accounts of FGIC's increasingly isolated position can be found here and here.

All of which is to say that confirmation of Detroit's plan of adjustment seems almost a forgone conclusion. It shouldn't be. Serious questions about the plan's feasibility remain. (Check my Municipal Bankruptcy: When Doing Less Is Doing Best (download here) and Who Bears the Cost? The Necessity of Taxpayer Representation in Chapter 9 (download here) for explanations of feasibility and its requirements.)

Yet with the skids greased and the public looking forward to a quick exit from the straitjacket of bankruptcy court supervision, I expect Judge Rhodes to enter an order confirming the plan before the end of October.

26 September 2014

Crystal Cathedral Metamorphosis

I seem to remember promising that my post here would be the final one on the bankruptcy of the Crystal Cathedral in Southern California. (For some earlier ones go here, here, and here).

But as I have before, I must again repent before posting a link here to an article about the design of the building for its new purpose, as seat of the Diocese of Orange (California). Given the building materials, the appearance of the repurposed building will not change greatly, to the disappointment of the traditionally minded. Nonetheless, there's no way the Diocese could have built anything better anywhere else for less than the cost of this project

25 September 2014

Answers To Some of (My) Life's Persistent Questions

Those who read my article, Municipal Bankruptcy: When Doing Less Is Doing Best (download here) may have joined in my wonderment at why the pensioners of the small Rhode Island city of Central Falls didn't balk at the state-enable grab of the city's future income by bondholders. Now we know the answer. But first, some background.

Central Falls was a clearly insolvent city and was permitted to file for a Chapter 9 municipal bankruptcy under Rhode Island law. Based on the the analysis of the Bankruptcy Code that I describe in the article, both the city's retired workers and bondholders should have received payment of an equal percentage of their claims. Both were unsecured in the sense that neither retirees nor bondholders had a lien on any of the city's assets. But that's not what happened.

Shortly before Central Falls filed bankruptcy, the Rhode Island legislature passed a law providing that all previously unsecured bond payments were immediately secured by all of a city's general revenue. In other words, the bondholders would be paid in full and the retirees--and other general creditors--would be left to share in the leftovers. A sweet deal to say the least.

Download and read Professor David Skeel's latest piece, What's A Lien? Lessons From Municipal Bankruptcy (download here). Among many interesting conclusions, David explains why the shafted retirees voted in favor of the city's plan that implemented the last-minute grab by the bondholders. The retirees may not have had any legal grounds to object to the plan of Central Falls but that doesn't mean they had to roll over and vote for it. Voting against the plan would have forced the city to resort to "cramdown," which is a tougher row to hoe on the way to confirmation, and might have been a way to squeeze at least some concessions from the bondholders.

So why didn't the retirees vote no? As David asks and answers,
Why did the pension recipients, many of whose pensions were cut by 55%, not object to this special protection for [the] bonds? The acquiescence appears to be explained by a key feature of Central Falls’ general obligation bonds. Nearly all of the money used for the bond payments comes from Rhode Island itself, rather than from Central Falls. As a result, restructuring the bonds would not have freed up any additional value to pay pension recipients and other Central Falls creditors. (Emphasis added.)
One of life's little mysteries solved. Of course, one might now wonder how it came to be that Rhode Island pays the bond debt of its cities but the answer to that question must wait to another day.

David's paper addresses a number of other interesting questions including why the repo safe harbors should be repealed (for a short explanation of repos read my A Fable of Financial Contracts: A Guide for the Perplexed (download here)) and how Detroit (and likely Stockton as well) can legitimately restructure pension obligations in the face of state law and state constitutional protections. Well worth the time to get a handle on issues currently roiling municipal bankruptcy law.

24 September 2014

Rent Seeking in Action. Or, A Reason Markets Fail

Go here (behind paywall) to read an article in the Wall Street Journal about how Senator Chuck Schumer (D-NY) is putting pressure on the Federal Reserve to change a rule designed to reduce bank collapses like those faced in 2008.

To its credit, the Fed is requiring banks to maintain a larger portion of their investments in highly liquid assets so they will be able to withstand a run by depositors. Given the bankruptcies of cities like Stockton and Detroit, and the underfunded pensions of many cities and states, one might think a rule eliminating bonds issued by municipalities from the category of such liquid assets was a good idea. Unless you're Senator Schumer. He's pressing for the Fed to permit bonds issued by municipalities, no matter how risky they may be, to count as "gold" for banks. I'm sure this has nothing to do with the gargantuan need of New York City for access to the credit markets.

I addressed a number of political (mis)calculations that have lead to the financial straits of many American cities in Municipal Bankruptcy: When Doing Less Is Doing Best (download here) but those machinations were at the state and local levels, not the Congressional. But I should have known better: Leave it to our elected leaders to create risk at the expense of others.

22 September 2014

The Short and the Long of It

Last week we saw two movies in two days: Into the Storm and Boyhood. The first, an updating of the "classic" Twister was chock full of special effects and lasted but 89 minutes. Boyhood, filmed over the course of twelve years, had not a single special effect but ran 165 minutes.

One assumes the target audiences for Into the Storm are adolescents and 20-something guys. Stock characters living the oft-repeated American cinematic version of a coming-of-age plot ending in transformation and pretty much happiness ever after. The tornadic special effects were exceptionally good and there was even an homage to the "cows blowing in the wind" scene from Twister. Not as much fun as one might have expected but worth a discounted admission if you can score it.

Boyhood, by contrast was an authentic story of aging as we get to to see young Mason, his sister Samantha, and their parents (played by Ethan Hawke and Patricia Arquette) actually age. Written with a fine ear for realistic dialog and the heartfelt disappointments of life through the eyes of a boy. No happy ending but not an altogether sad one either. In other words, we saw something far closer to real life with all its unexpected turns and as-yet unknown results. "Life is hard but we muddle on" might describe the theme of Boyhood, which was not too long even at over two and one-half hours.

19 September 2014

"Public Policy" and Non-Enforcement of Contracts. Or, An Agreement to Terminate

A pregnancy, that is.

For the first decade or so of law teaching, my classes worked through the Baby M case to demonstrate the sort of circumstances that would justify non-enforcement of a contract on the ground of public policy. See a post about teaching the case from several years ago here.

For those who don't remember, the battle in Baby M was over the enforceability of a contractual obligation to terminate parental rights. The gestational surrogate (and biological mother) who gave birth to "Baby M" refused to surrender the newborn to the sperm-donor father and asserted her parental rights, both in contravention of the contract she had signed.

The New Jersey Supreme Court held the contract was unenforceable as against the state's public policy of terminating parental rights only when in the best interests of the child. In other words, the biological mother could not contract away the rights entailed by motherhood.

I no longer teach this case in part because "Baby M," Melissa Stern, is now an adult who as such terminated her legal relationship with her biological mother, agreed to be adopted by the wife of her biological father, and has gone on to pursue graduate studies. More to the point, the particular facts of the case are largely out of date because no longer does the gestational surrogate contribute her egg to the child in her womb. Instead, the child is conceived in vitro outside anyone's womb and only later implanted in the one who bears the baby through the course of pregnancy and delivery. Instead of Baby M, we now read and discuss two cases on the enforceability of such contracts, one concluding "no problem" and the other reaching the contrary result. We also look at Virginia's statute that requires judicial pre-approval for such contracts.

All of this is a long introduction to "You Are Obligated to Terminate This Pregnancy Immediately: The Contractual Obligations of a Surrogate to Abort Her Pregnancy (download here). Cribbing form the abstract:
When Crystal Kelley learned that a couple wanted to hire her as their surrogate, she was ecstatic. Raising two children of her own, Crystal yearned for the opportunity to help another couple achieve their dream to become parents. And while Crystal’s motives were certainly altruistic in part, she was a single mother with a high school degree, doing her best to provide for her own family. The $22,000 fee that Crystal would be paid would help not just with medical expenses, but also with rent and birthday gifts for her own girls. It seemed to be a perfect situation for everyone, especially when one of the two embryos that the intended parents already had frozen was successfully implanted and Crystal became pregnant.
About halfway through her pregnancy, Crystal and the intended parents learned some heartbreaking news about the fetus. The fetus appeared to have a cleft palate, a heart abnormality, and potentially Down syndrome. While Crystal was devastated by the news, the response of the intended parents was simply shocking: the intended parents mandated that the child be aborted — and soon. When Crystal refused, even after being offered $10,000 for her to have the abortion, Crystal and her lawyer returned to the surrogacy contract that the parties had signed months before, which included a clause discussing the termination of the pregnancy. The surrogacy agreement, which was signed in Connecticut where surrogacy contracts are legally enforceable, stated in part that Crystal would abort "in case of severe fetus abnormality." Crystal adamantly believed that the child should be given a chance to survive, even if it meant a childhood of countless surgeries and likely lifelong disabilities, so when her options were to abort the fetus, to surrender the child to the intended parents — who made clear that they intended to abandon the child to the foster system immediately upon her birth — or to flee to a state that did not legally recognize surrogacy agreements, Crystal took her two children and moved to Michigan. A few weeks later, Baby S was born and adopted by a loving family.
The shocking nature of the facts of this particular case and its contract, whose "termination term" apparently is standard in such contracts, recall to mind the limits of contract law. Commodification of all aspects of human life dominates the way of life with only a secular horizon. Thus, there would be no objection to enforcement of a termination term in a purely libertarian world, at least one in which there was no philosophical anthropology. In any event, I urge folks to download and read Brittney Kern's complete article.

A thick notion of human nature provides warrant for limits on the tool of contract. For my thoughts about that "nature" feel free to read Looking for Bedrock: Accounting for Human Rights in Classical Liberalism, Modern Secularism, and the Christian Tradition (download here). When considered from the point of view of full human beings--bearers of the image of God--the social practice of contracting represents more than a means of maximizing one's welfare. (Download and read my more-developed thoughts on the theological underpinnings of contracts and contract law in articles found here (short) and here (not-so-short).) Contract are a means by which such image bearers cooperate to carry out the blessing of dominion afforded the human race at its creation. A contract to eliminate one of those image bearers falls outside the end of contracting and should not receive state-sanction through judicial recognition.

18 September 2014

More on Unfair Discrimination in Bankruptcy!

For those who have followed the never-ending saga of posts first on the Stockton municipal bankruptcy and now on Detroit's (some recent ones here and here), you may have noticed that I've frequently directed those whose interest in the topic includes the legal details to an article I published in the late spring in the American Bankruptcy Law Journal: Municipal Bankruptcy: When Doing Less Is Doing Best (download here).

My article addressed several issues in connection with Chapter 9 bankruptcy but there and subsequently I argued for one point consistently: the Bankruptcy Code's prohibition of "unfair discrimination" in a city's plan creates a strong presumption that all creditors of equal priority, say, retirees with their pensions and bondholders with their bonds, should be treated equally. In other words, whatever percentage of claims is paid to one set of creditors should be matched with respect to the other set(s) of creditors. To be fair to myself, I also argued that the rule that a plan be in the "best interests" of creditors required a plan to discriminate in favor of pensioners in a state like Michigan which protects public employees pensions by law. (Read my article if you want to know my solution to this statutory conundrum.)

Of course, I acknowledged that there was only a presumption in favor of equality, which suggests it can be rebutted. Indeed, Congressional antipathy toward unfair discrimination suggests that there's such a thing as fair discrimination.

Go here to read Andrew B. Dawson's unpublished draft piece, Pensioners, Bondholders, and Unfair Discrimination in Municipal Bankruptcy (download here). Dawson addresses the history of unfair discrimination in municipal bankruptcy and, taking a cue from yet another rule (actually, an exception to another rule, i.e., the new value exception to the absolute priority rule), argues for a wide notion of "fair" discrimination permitted by the Code.

In short (and here I'm going deep into the weeds), just as a class of creditors who would receive nothing in a Chapter 11 liquidation may nonetheless retain an interest in a reorganized debtor if they contribute "new value," so too a Chapter 9 plan may tilt its distributions in favor of a class of creditors if that class contributes new value.

I would be hard pressed to disagree but for Dawson's additional assertion that the "new value" contributed by a class such as Detroit's retirees can include such non-quantifiable (or unrelated) matters as not opposing Detroit's eligibility to be in bankruptcy, the state of Michigan's "micro-bailout," and the contributions of various foundations to the city to enable it to keep the Detroit Institute of Art. Even reducing something to which the retirees had no special statutory right in bankruptcy, their retiree health benefits, counts as "new value" in Dawson's analysis.

Dawson's piece is a valuable contribution to what remains a largely unexplored topic. Yet I fear that his nebulous conception of new value will in practice be nothing more that the nose of the camel that will quickly occupy the tent. If giving up weak legal arguments and claims not backed by law is enough to make discrimination fair, then the prohibition of unfair discrimination is infinitely malleable that may in some cases be satisfied by nothing more than an appeal to the bankruptcy court's sympathies.

16 September 2014

Personalism and Contract Theory (Part 2)

Last week I posted a moderately long piece on part 1 of Robin Bradley Kar's Introduction to Contract as Empowerment: A New Theory of Contract (read it here). I expressed support for Kar's arguments but also wrote that I was reserving my criticisms to a later piece. This isn't that piece. Instead, I want to explore Kar's critique of the so-called contract law doctrine of promissory estoppel.

For those who haven't enjoyed the blessing of a semester of contract law, what makes a promise in a contract enforceable is the presence of "consideration." But for the secret sauce of consideration, failure to perform an unaccompanied promise (or nudum pactum as they used to say) is likely a moral fault but it raises no legal consequences. Although the origins of the doctrine of consideration wasn't the primary burden of my piece, The Puritan Revolution and the Law of Contracts (download here), there's enough about it from the sixteenth and seventeenth centuries to warm an antiquarian's heart. (Plus, so far as I am aware, the only analysis of a question and answer from the Westminster Larger Catechism in a law review article.)

In short, consideration is most simply understood as a bargained-for exchange. Or, in slightly shorter form, consideration is equivalent to reciprocal inducement. In any event, there must be two to dance the contract tango. Most of the time we find consideration expressed as a promise for a promise; I promise to paint your house in exchange for your promise to pay me $2000, for example.

The exchange-nature of a contract explains why a promise standing alone isn't a contract; it wasn't made in exchange for anything else. The promise may have been motivated by altruism or with a less-than-honorable motive but that makes no difference. Or at least it didn't until the early decades of the twentieth century.

The history of the rise of promissory estoppel is complicated but suffice it to say that by the 1930s the august American Law Institute recognized as a rule of contract law that a promise, made to induce reliance, and which did induce the promisee to rely--to his detriment, anyway--was a breach of contract that could give rise to a claim for contract damages. The purists among us have always doubted the wisdom of such a rule and the courts of some states, like Virginia and North Carolina (the two states where I've taught contract law), persist in their view that whatever promissory estoppel may be, it's not part of contract law. But suffice it say that a rule recognizing a claim for promissory estoppel has largely carried the day throughout most of the United States.

I'm pleased to report that Kar agrees with the paleo-conservatives and that his theory of "contract as empowerment" provides a sound rationale for his conclusion. Consider the policy Kar provides for contract law: "People sometimes need to use promises to induce other people to make return promises or engage in various actions in return." In other words, the purpose of the subset of contract-type promises is to empower the promisor so she may induce the promisee. Many promises are made for other reasons including altruistic ones but those promises, however real they are and as significant as they may be, are not contract promises.

Contract law, according to Kar, goes one step further:
The effectiveness of promises for this purpose will typically depend upon whether the specific addressees of these promises trust the specific promisors to fulfill them. interpersonal trust of this kind can sometimes be generated in informal ways, but--especially among relative strangers in many modern settings--is often lacking absent law. When this is the case, legal enforcement mechanisms can therefore empower people to use promises as tools to influence other peoples' actions.
Contract law backstops a contract-party's promise with the threat of legal sanctions for non-performance. By exposing herself to such sanctions, the promisor makes it more likely the other contract party will trust her to perform. As paradoxical as it may seem, contract law works primarily to increase the influence of the promisor and only secondarily to rectify an injury to the promisee. That such is the case is clear from the fact that very few contracts lead to breach and of those even fewer result in litigation. Contract law clearly works to accomplish its purpose: to empower promisors.

By now it should be clear why a naked promise is not a contract; the promisor did not make it to induce the promisee to make a return promise or engage in a particular action. Perhaps the promisor intended the promise as an expression of love. Perhaps as a means of increasing social status. But, unless sought in connection with an exchange of some evident sort, the unaccompanied promise was not made to empower the promisor vis-a-vis the promisee.

Kar is quick to note that failure to keep a non-contract promise may give rise to a claim by a promisee who has relied to his detriment under some body of law other than contract. Tort springs easily to mind. But contract as empowerment is effective to scrub the barnacle of promissory estoppel from contract law and for that I am grateful.

15 September 2014

It's Only Money, Isn't It?

More details on the settlement between Syncora and the city of Detroit that will go far (but not necessarily all the way) toward confirmation of Detroit's plan of adjustment. Financial Guaranty Insurance Corporation (FGIC) and others remain opposed, and the issue of feasibility remains a large speed bump (download and read my articles about feasibility here, here, and here), but the skids have been greased and the car given a giant push.

The title of this post is a point I regularly mention to my students in Contracts. Sufferers of a breach of contract, especially the institutional sorts I regularly represented, are not interested in abstract vindication of their moral rectitude. Sure, a few paid me to battle with breachers far beyond any likely improvement in the litigation return because they deemed a reputation for a hard-nosed strategy in their long-term benefit. But that was only one or two. The balance of my clients wanted to get as much as they could for as little as they could pay (me) and call it a day.

So too Syncora and, one assume FGIC and the other objectors to Detroit's plan. The problem Detroit's holdouts face, however, is that bankruptcy is a zero-sum game. In other words, every additional dollar paid to one creditor must come from either another creditor (which would only create another objector) or the future taxpayers or the recipients of the city's services. In Detroit's case, the current city has apparently come to believe that its future iteration will have "just a little bit more" than previously thought and so be able to pay Syncora more than originally offered.

All the newly-discovered future income renders the success of the city as it operates for years into the future under the plan less and less likely. Hence, with every settlement, the "feasibility" of Detroit's plan is called into greater question. And, of particular interest to me, the report and opinion of Martha Kopacz, the court-appointed expert who has opined that Detroit's plan is feasible, becomes less and less relevant. After all, the plan on which she opined has changed and not for the "better" in terms of feasibility. (I must admit that I'm partial to her report because in it she quoted from one of my articles. But I digress.)

All of this is to raise a question larger than Detroit's bankruptcy: Why is it that Western culture in general and Americans in particular don't take breach of contract more seriously? Indeed, why do we as a culture say "It's only money"? Such is not historically the case. For hundreds if not thousands of years, failure to pay one's debts was a mark of dishonor and the one thus dishonored would treat it as such, a duel or at least imprisonment representing the way of "honorably" treating one's debtors.

I established in Principled Pluralism and Contract Remedies (download here) that a civil polity may offer recourse for breach of contract in the form of expectation damages but I did not address why a lawsuit for damages should be the preferred remedy. The answer to the why question would take me far afield but suffice it to say that the transposition of money for honor is one aspect of the secularization of Western culture. For my elaborations on that topic you can read my comments on an article about the market by Nate Oman here or simply search my blog for my multiple entries on Charles Taylor's "A Secular Age." (You can start here.)

Before not reading any of those links note that I am not opposed to the process of secularization. Secularism is a problem as the folks at Trinity Western University can tell you but I am certainly not one to denigrate the advances Western culture has made since the desacralization of society beginning in the Middle Ages.

In any event, the growth of political liberalism (not to be confused with so-called progressivism) and a market economy have brought many blessings. And both (indeed, all three) find their roots in the pluralizing Christianized society of the medieval era.

None of this is to say there are no moral aspects to contract law. I have previously addressed them in connection with the mortgagor's moral obligation to pay even on a mortgage where the value of mortgaged property has fallen below the amount of the debt. (Check here and here.) But even there, I made a point that the mortgagee has a reciprocal duty of forgiveness, one that the market has spun off into bankruptcy law. And more to the point, failure to perform a moral duty is not equivalent to an affront to honor.

In any event, the balance has clearly and decisively shifted in favor of money over honor. Thus, when it comes to contract law, indeed, it's only money.

14 September 2014

More Intolerance from the Northland

A whopping 137 out of 1,600 members of the New Brunswick Law Society (the equivalent of an American state bar association) voted to ask their bar council to reverse its decision to permit graduates of Trinity Western University's law school (scheduled to open its doors to students in the fall of 2016) to practice law in New Brunswick. Sadly, however, 137 were a majority of those who voted. Read the details here.

Yet another step along the road to "totalitarian libertarianism." (For earlier comments go here, here, and here.)

12 September 2014

The Sun Isn't Shining in San Bernardino ...

... at least not for some unionized employees. Yahoo News report here that Bankruptcy Judge Meredith Jury has approved the city's motion to cut drastically its share of the cost of employee benefits for its firefighters.

A private employee, even one undergoing a Chapter 11 reorganization, as a practical matter could not do what San Bernardino will do. Congress, however, exempted cities in a Chapter 9 municipal bankruptcy from the restrictions it imposed on the power of private employers to modify collectively bargained agreements with unions.

This exemption for cities in bankruptcy strikes me as a fair one. As I argued in Municipal Bankruptcy: When Doing Less Is Doing Best (download here), increases in public employee benefits have far outstripped those in the private sector. Coupled with state laws like California's that prohibit any reduction in pensions, shifting the cost of OPEBs ("Other Post-Employment Benefits") to employees is one of a bankrupt city's few resources when it comes to reducing its costs of operations.