Sound and Fury: Will Sen. Warren’s Proposed Legislation Forever Impact Private Equity and the Restructuring Process?

Senator Elizabeth Warren (among others) recently re-introduced a bill to “fundamentally reform” the private-equity system “by closing the legal, tax, and regulatory loopholes that allow private equity firms to capture all the rewards of their investments while insulating themselves from risk.” [1] If enacted, the legislation will greatly impact several critical features of the Bankruptcy Code, disrupt the restructuring process more broadly, and likely inspire costly litigation (and compliance measures). This reintroduced bill is titled the Stop Wall Street Looting Act (the “Anti-Looting Act”).

As may be obvious from the title, the bill targets private-equity firms that Sen. Warren accuses of using the Bankruptcy Code’s restructuring process to “gut companies” and “kill jobs” all the while “drooling over companies to exploit.” [2] The Anti-Looting Act is more than a piece of political rhetoric. It will dramatically re-shape the way “Wall Street” — or, more aptly, “private equity” — approaches the restructuring and corporate merger process. This article provides a high-level overview of the Act, with a particular focus on bankruptcy-specific reforms and reforms that may be of note for members of this Committee.

The Anti-Looting Act and Its Monumental Implications

Sen. Warren (D-Mass.), Tammy Baldwin (D-Wis.) and Sherrod Brown (D-Ohio) re-introduced the Anti-Looting Act in the Senate, and Reps. Mark Pocan (D-Wis.) and Pramila Jayapal (D-Wash.) introduced similar legislation in the House of Representatives. As of the date of this article, the proposed legislation has been referred to the Senate Finance Committee.

Although this article is not intended to pick a side between private equity and the Anti-Looting Act, this much is true: If enacted, the Act would have disastrous implications for private-equity actors generally and in the financial restructuring space specifically.

First, Section 101 of the Anti-Looting Act would make certain private-equity funds and their insiders liable for the liabilities (e.g., debt and pension obligations) of target companies in which they seek to invest, including liabilities that arise as part of the target’s acquisition. [3] At the same time, Section 102 would outright void any indemnification provision on which certain private-equity firms would rely on to hedge against the liabilities of the target firm. [4] The result would be that certain private-equity firms would effectively assume the liabilities of the target companies in which they seek to invest and, at the same time, forfeit any right to indemnification.

Sections 101 and 102 also threaten turn decades of corporate law on its head by blurring the distinction between separate, legal corporate entities. These provisions cast serious doubt on classic notions of limited liability in an industry that relies on such a concept in undertaking the often-risky proposition of investing in, for example, start-up companies or other investments that banks and other large publicly traded Wall Street institutions would not otherwise pursue.

Second, § 202 of the Anti-Looting Act revamps and beefs up critical fraudulent transfer provisions of the Bankruptcy Code. For example, the act would —

1. remove existing safe harbors in, e.g., § 546(e) of the Bankruptcy Code, for certain species of transfers connected to a change in the control of target companies or firms (i.e., changes of control endemic to mergers or leveraged buyout transactions); [5]
2. create a positive presumption of fraudulent transfer and insolvency connected to transactions involving a change in control of such targets; [6]
3. extend the statute of limitations for fraudulent transfers for at least eight years after the transfer was made if it was connected to a change in control; [7] and
4. grant unsecured creditors’ committees the exclusive right to avoid transfers in connection with change-of-control transactions and against the target-debtor’s insiders. [8]

Third, in addition to adding arrows to the chapter 5 plaintiff’s quiver, the act also reorganizes creditor priorities and the nuts-and-bolts chapter 11 aspects of the Bankruptcy Code. For instance, target companies that seek chapter 11 relief would face higher priorities for worker pay, severance and pension claims. [9] It would also classify severance pay owed to employees as administrative expenses for purposes of the priority of such claims in chapter 11, and increase the priority of claims arising from any violation of federal or state labor and employment law. [10] Further, Title III of the act would also prohibit bankruptcy courts from approving any payments to an insider or executive if the company has not paid promised severance pay to employees or has reduced employee benefits within the year before filing for bankruptcy protection. [11]

These proposed adjustments to the Bankruptcy Code’s fraudulent transfer provisions and priority schemes would dramatically shift the balance of chapter 11 proceedings away from the trustee-like debtor-in-possession in favor of unsecured creditor constituencies and employee creditors.

Fourth, Title IV of the Anti-Looting Act would also dramatically increase the tax liabilities of certain private-equity actors. The act proposes a 100% surtax on fees like “monitoring” or “transaction” fees paid by target firms to private fund managers. It restricts the right of private actors to deduct interest. [12] It also eliminates the carried-interest “loophole” for such actors. [13]

Conclusion and Observations

The severity of the Anti-Looting Act is not surprising, given Sen. Warren’s condemnation of private-equity firms as “vampires” that purchase companies by “bleeding the company dry and walking away enriched as the company succumbs.” [14] In Sen. Warren’s view, private equity has “kill[ed] more than 1.3 million retail jobs over the last decade,” precipitated about two-thirds of retail bankruptcies between 2015 and 2019, dramatically accelerated bankruptcies of companies purchased in leveraged buyouts, and helped drive income inequality. [15]

Others have pushed back against the rhetoric, pointing out that since 2013, private-equity firms have invested more than $400 billion per year in thousands of American companies, [16] and that an estimated 5.8 million Americans or more are employed by 35,000 private-equity-owned companies, with $3.4 trillion having been invested between 2013 and 2018. [17] Wherever the reader lands in this debate, the Anti-Looting Act, if enacted, will dramatically alter the financial restructuring and private-equity landscapes. Undoubtedly, bankruptcy and restructuring professionals would have to reevaluate whether chapter 11 would even be a suitable mechanism for target and portfolio companies.

The legislation would also push private-equity firms, which pump billions of dollars into businesses and various market sectors, to consider bankruptcy alternatives like assignments for the benefit of creditors or receiverships. That result necessarily means that a substantial and growing component of the U.S. economy will no longer be afforded the protections of federal law and will be forced into state law remedies.

If enacted, these controversial issues (and leverage points among chapter 11 participants) will most certainly come to a head in bankruptcy courts (and other courts) around the country. Those battles would undoubtedly be costly, and potentially seismic in their repercussions.