eNews May 4, 2017


Supreme Court’s Take on Safe Harbor Bankruptcy Code Provision Greatly Impacts Clawbacks for Creditors

The U.S. Supreme Court has agreed to hear a case that will further clarify when the “safe harbor” section of the Bankruptcy Code protects transfers that were made through financial institutions when the entity is a conduit in the transaction instead of the debtor or transferee.

The case, Merit Management Group LP v. FTI Consulting Inc., could have a great impact on unsecured creditors’ recoveries in bankruptcy cases by determining whether a bankruptcy trustee can prevail in a fraudulent conveyance litigation arising out of a failed leveraged buyout, said Bruce Nathan, Esq., of Lowenstein Sandler LLP of New York.

The Supreme Court will resolve a disagreement among the U.S. circuit courts as to whether the safe harbor provision defense to such fraudulent conveyance actions applies when the funds that are part of the claim flow through a financial institution. The U.S. Court of Appeals for the 7th Circuit ruled in July 2016 that a financial entity must have a “beneficial interest” in a transaction for the safe harbor provision to apply, reversing the judgment of a lower court. The 7th Circuit’s decision is similar to one made by the 11th Circuit in 1996, but goes against rulings by the 2nd, 3rd, 6th, 8th and 10th circuits that the safe harbor applies as a defense to a fraudulent conveyance claim in a conduit situation.

Merit evolved out of the bankruptcy of Valley View Downs LP, an owner of a Pennsylvania racetrack that made a deal with a competitor, Bedford Downs, to operate a horse track and casino, according to court documents. In the deal, Valley View bought all of Bedford Downs’ $55 million worth of shares through escrow agent Citizens Bank of Pennsylvania. Valley View borrowed money from Credit Suisse and other lenders to pay for the shares. After the deal went through, Valley View failed to obtain the needed gambling license and filed for Chapter 11. FTI Consulting, as trustee of the In re Centaur LLC et al. Litigation Trust, which includes Valley View Downs as one of the debtors, sued Merit Management, a shareholder in Bedford Downs, alleging Bedford’s transfer to Valley View of about $16.5 million is avoidable under the Bankruptcy Code and the money is part of Valley View’s bankruptcy estate and the Litigation Trust.

In its ruling, the 7th Circuit said, “We are not troubled by any potential ripple effect through the financial markets from returning the funds to FTI. … Nor are we persuaded that the repercussions of undoing a deal like this one outweigh the necessity of the Bankruptcy Code’s protections for creditors. We will not interpret the safe harbor so expansively that it covers any transaction involving securities that uses a financial institution or other named entity as a conduit for funds.”

The case is likely to be argued in the fall, according to


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Construction Sector Sees Shortfall in Skilled Workers

The construction industry is still trying to find a way to increase its workforce. The number of jobs being added is not an issue, yet the field is struggling to find skilled workers, creating a shortfall that has increased home prices among other things. Construction employment gained nearly 100,000 jobs the first three months of 2017, according to the Bureau of Labor Statistics, and the construction unemployment rate dropped to match its lowest rate ever in March.

It is easier to find someone to hammer in nails than it is to weld steel, said Chris Ring of NACM’s Secured Transaction Services. As far as affecting payments, Ring does not see the skilled labor deficit as an issue. “No one is saying they aren’t getting paid because of the lack of skilled workers,” Ring said. Trade schools near Ring’s home outside Akron, Ohio, are doing well financially. He added that the challenge of finding skilled workers in the construction industry has not had an effect at the material supplier level. The difference between using union versus non-labor union workers could also be affecting the issue.

“The path to employment has been very tough for many, but at the same time, there are millions of jobs that are well-paid and still go unfilled because there are not enough people with the correct skills,” said NACM Economist Chris Kuehl, Ph.D. “It would seem a simple fix. Train those who are seeking jobs to do the work that is in demand.” Creating more opportunities and targeting and training the younger generation will help increase the skilled labor workforce in the construction industry, said a Florida credit manager in the construction sector.

The lack of workers has “increased construction costs, becoming one of the under-reported factors behind America’s rising home sale prices,” according to Forbes.

More than half of respondents to a survey from the National Association of Home Builders (NAHB) last summer said there was a shortage in the industry. That number has increased every year since 2012, when one in five respondents said there was a shortage. Some of the effects caused by the shortage are: builders paying higher wages, higher subcontractor bids, rising home prices and failure to complete projects on time, according to NAHB.

Home prices increased 1.6% between February and March, according to this week’s CoreLogic Home Price Index (HPI). On a year-over-year basis, prices have jumped more than 7%. The median home value in the U.S. is back to levels seen 10 years ago, according to Zillow, and the website expects prices to continue trending upward.

HomeAdvisor also had a survey out last year about skilled labor shortages. Among key findings were that hiring challenges hindered business growth and a lack of exposure to the industry has prevented the younger generation from joining. Four out of five responses to a 2017 construction outlook survey by the Associated General Contractors of America said worker shortages was the biggest concern in their business. Work quality came in second at nearly 60%.

“The construction sector remains healthy even as employers cope with shortages of skilled construction workers,” said Bernard M. Markstein, Ph.D., president and chief economist of Markstein Advisors, in a news release from Associated Builders and Contractors.


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Kamakura Troubled Company Index Signals Improving Credit Quality

The Kamakura Corporation’s troubled company index ended April with a slight decrease, indicating improving conditions in corporate credit quality. Though volatility in the index has been below normal for the last couple of months, the long-term outlook may indicate a significant increase in default probabilities.

The current economic environment has been benign in terms of default probabilities, according to Martin Zorn, president and chief operating officer at Kamakura Corporation. The cost of borrowing has been low, and though growth is below the historical average after a downturn, it has been steady. “Low unemployment, low interest rates and steady economic growth have translated into an environment of low default,” Zorn said.

The Kamakura troubled company index reflects the percentage of 38,000 public firms in 68 countries that have a default probability over 1%. An increase in the index reflects declining credit quality while a decrease indicates improvement in credit quality. The index finished the month at 7.77%, a decrease of 0.3% from the month prior.

The riskiest sectors measured by the one-year Kamakura Default Probability index are energy, media, telecommunications services and retail, in that order. “We’ve seen energy pick up a number of defaults,” Zorn said, who explained that energy is tied to oil prices and retail is tied to technology and changes in buying habits. “Retail is riskiest in the traditional brick-and-mortar stores and is safest in Amazon, Netflix and other online retailers, or those like AutoZone that are more of a niche-type of retailer.” Media and telecommunications are very much like retail, Zorn said, because they are affected by technology, with print media being pushed aside by tech and the “half-life” of a cell phone being so short.

“Oil prices have continued to be volatile,” Zorn said. The downturn in prices that started a few years ago helped those who were able to strengthen themselves. Strong companies stayed strong. “While well counts are back up again, there are still companies that are at risk, while others are better able to respond to the environment,” he said. With energy prices likely to come back up again, an opportunity exists for investment or acquisition in that sector; however, “in media and retail, the weakness is more broadly based.”

While short-term default probabilities are very low, “when you start looking out five years, it’s a different story,” Zorn said. Default probabilities in that time frame are higher than before the 2007 downturn, he added. “Once interest rates start rising, unless you have a corresponding rise in GDP, you are likely to see a rise in defaults.” The riskiest sectors by the five-year Kamakura Default Probability index are telecommunications services, media, retailing and automobiles and components.

Zorn advises that credit professionals who are evaluating companies that may be at risk take a combined approached when assessing data. “I’ve come to appreciate the value of combining qualitative analysis with quantitative analysis to avoid being blindsided by defaults,” he said.


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Manufacturing Growth Slows

Growth in manufacturing production has slowed after reaching a 22-month peak in January. Manufacturers have reduced their stocks of purchases, putting a stop to six months of inventory building, while a slower rise in output volumes reveals a more tepid pace for new business growth.

The seasonally adjusted IHS Markit U.S. Manufacturing Purchasing Managers’ Index was down just half a point in March, though it signals the slowest improvement in overall business conditions since September 2016. Over the same time frame, purchasing activity has seen its weakest upturn due to slower growth of total new work. Even as manufacturing production increased for the eleventh successive month in April, the rate of expansion eased to its weakest in seven months.

“The overall sense within the manufacturing sector (as well as the economy in general) is that expectations are starting to encounter reality,” commented Chris Kuehl, Ph.D., economist to NACM, about the Purchasing Managers’ Index. “There is an acknowledgement that changes will not be swift or certain. Many still expect improvements, but the instant changes are now seen as far less likely than before. That has introduced a measure of caution.”

Activity may be settling into a more sustainable pace, following some of the strongest readings in manufacturing in more than two years, said Wells Fargo Securities in a recent report. The Institute for Supply Management’s manufacturing index also edged lower in March, while manufacturing output, recorded in the Federal Reserve’s industrial production report, fell for the first time in seven months, Wells Fargo said. A continued recovery in the factory sector is expected, however, due to a relatively stable dollar and improvements in global growth and commodity prices.

There is an overall level of confidence among manufacturers. In the latest Credit Managers’ Index (CMI) report from NACM, impressive gains were seen in the manufacturing sector’s sales and new credit applications categories. In addition, the amount of credit extended is at a high level. Data from the CMI reflects an enthusiasm in the manufacturing community, with gains that are higher than anything seen for the last several years, the report said.

“The signs of slowing growth are most evident in the domestic consumer sector, but investment goods manufacturers continue to fare well, enjoying stronger capital equipment spending from the energy sector in particular,” said Chris Williamson, chief business economist at IHS Markit. “Exports have also perked up, with April seeing the steepest increase in foreign orders for eight months.”


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Avoiding Surety Denial Letters on Bond Claims in Texas

Material suppliers, subcontractors and other parties to public projects in Texas may find out the hard way that by missing a few key steps, the payment security they believed was assured through a bond claim is no longer of any value.

Take an example of a recent situation encountered by NACM’s Secured Transaction Services’ (STS) Connie Baker, CBA, director of operations, and Carol Davis, legal placement assistant, mechanic’s lien and bond claims, in which a company failed to send a bond claim notice to the public owner, the original contractor and the surety. According to Texas Government Code, a payment bond beneficiary has to mail all of these parties a written notice of the claim. Further, the claim has to be mailed via certified or registered mail on or before the 15th day of the third month after each month in which any of the claimed labor was performed or any of the material was delivered. (Those suppliers who have job accounts with remote contractors have to send a written notice to the prime contractor on or before the 15th day of the second month following each month in which labor was performed or materials were delivered.)

Not mailing a notice to all of the parties would have been enough to receive a denial of bond claim rights to thousands of dollars’ worth of work, but there’s another important step that needs to be taken. Such a notice has to be accompanied by a sworn statement of account. It should state that the amount of the claim is just and correct, and that all just and lawful offsets, payments and credits have been allowed. Further, the sworn statement has to be signed and notarized, and a separate job statement reflecting the balance due must also be enclosed.

This sworn statement is not simply a printed copy of a job statement balance, explains Baker. As part of its bond and lien service, STS helps prepare these sworn statements for clients to sign before a notary. If suppliers and others fail to perfect bond claims on unpaid accounts, they may find their only recourse to obtaining payment would be through filing a separate lawsuit against their customer based solely on a violation of contract.



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