ABI Commission Considers Future of Chapter 11 (Austin Hearing Pt. 1)

The ABI Commission studying reform of Chapter 11 met for its seventeenth and final time at the UT Bankruptcy Conference in Austin, Texas on Friday November 22, 2013.   The Commission heard from a total of eight witnesses on a variety of topics.   Seven of the eight witnesses touched on the venue issue with a substantial majority favoring reform.   Part 1 will discuss the future of Chapter 11 and proposed reforms to address the Stern problem, while Part 2 will discuss venue.

The Future of Chapter 11

Commission Co-Chair Al Togut introduced the topic with a discussion of how the world had changed since the Bankruptcy Code was adopted. He stated that in 1979, companies were likely to be based in the United States, employ American workers and have very little secured debt. Today, companies are likely to be multinational and have manufacturing facilities overseas with assets that are frequently leveraged to the point that unsecured creditors are out of the money. He stated that Commissioner Ken Klee who worked on drafting the Bankruptcy Code estimated that the Code would have a shelf life of no more than 30 years and then would have to be reworked. This set the stage for a discussion on the future of chapter 11.

Former Bankruptcy Judge William Greendyke and practitioner Buzz Rochelle discussed the future of chapter 11 with particular emphasis on the results of a survey of Texas bankruptcy lawyers. Among the conclusions of the survey were that Chapter 11 is being used for more section 363 sales, the process is faster today, the use of Chief Restructuring Officers is largely positive and Chapter 11 fills a role in providing clean assets to buy but that Chapter 11 has gotten more expensive.

In response to a question, Greendyke stated that section 363 and increased costs make cases move faster. He said that "faster is less expensive and less expensive is better."

By a two to one margin, respondents felt that the U.S. Trustee has been a net negative in chapter 11 cases. One commenter described the U.S. Trustee as "bring(ing) only the ants to the picnic." Judge Greendyke was more sanguine stating that his experiences with the U.S. Trustee's program as a judge had been positive. He said that the reason for the negative responses was "difficult to discern from the survey results" but that "there are different personalities in different offices" and there can be disparities in prosecutorial discretion.

Buzz Rochelle (brother of Bloomberg News correspondent Bill Rochelle) described how problems with the jurisdictional system of the Bankruptcy Courts have persisted. He stated:

I went to college on what my father earned litigating jurisdiction. My sons went to college on what I earned on jurisdiction.

He said that the problems in the current system were "way past the irritation point" and used the illustration of a lawyer who told a Dallas bankruptcy judge that she was not bound by the Court's confirmation order "because Stern said she wasn't."

Rochelle also sounded an apocalyptic note about the future of bankruptcy, stating that "unsecured creditors do not regard the bankruptcy court as their friend" and that "the message sent is that this is a place for debtor's management and more than that for secured creditors."

He urged the commission to reconsider the absolute priority rule saying that "it is not holy writ." Rochelle argued that the absolute priority rule was originally intended to lead to a reasonable accord and to protect the little people, but has been turned on its head as a tool to protect secured lenders.

Rochelle described claims trading as a casino that "does not serve a legitimate economic function." In response to a question, he said that claims traders are in a "very dicy ethical situation." He said that they have studied real hard and can accurately gauge the value of a claim but will pay only a small fraction of that amount to the original creditor. He also said that claims trading gives creditors an easy out of a case and causes them to lower underwriting standards. He recommended that claims buyers only be allowed to vote what they had paid to purchase claims so that they would not have a disproportionate impact on the outcome of cases.

Mr. Rochelle added that the secured lender's group has become "a wild place with competing agendas" because of claims trading He said that all they are interested in is the dividend and not reorganization, which he said "brings the reorganization system into disrepute," a result that he described as "not cool."
 

Commissioner James Markus asked Greendyke and Rochelle if there were conflicts in their testimony with regard to the need to choose between classes of creditors or preserve value. Judge Greendyke stated that "there is nothing wrong with section 363 sales" and that just because "there are less opportunities for unsecured creditors does not mean that there should be a tax imposed on secured creditors." Mr. Rochelle said that he would "put down his torch and pitchfork for a moment" and acknowledged that the Bankruptcy Code is the tail of the dog while the dog itself is the financial system. He said that the huge growth in neo-lenders and non-bank lenders "makes the banks we grew up with look like sweet, good-natured Sunday School teachers." He admitted that "you can't change that in the Code" but that "we don't have to lay back and enjoy it." He said that there should be some disincentive to the lender who grabs onto everything. He added that

The common law grows in response to problems. This is a problem.

The shy and retiring Mr. Rochelle added:

The real question in my mind is why the federal government should be subsidizing the liquidation efforts of one group of people.

He further stated that the justification for section 363 sales is preserving jobs and that we are seeing far fewer jobs preserved.

Stern and the Allocation of Jurisdiction

Veteran Supreme Court litigator Eric Brunstad stated that "our current jurisdictional system is broken." He recommended amending the definition of core proceeding to move counterclaims to claims and fraudulent transfers to the non-core category. He said that "there is a very small category of things that need to be moved from the core bucket to the non-core bucket."

He also recommended a statutory process for consent which would be similar to what is used in the U.S. Magistrate Judge system. In response to a question, he said that he proposed express written consent because he wanted to take the most conservative position.

Finally, he recommended that the Code's jurisdictional scheme be construed to avoid conflicts with the U.S. Constitution and that Bankruptcy Judges be specifically authorized to submit proposed findings and conclusions in any case in which they could not enter a final judgment.

Brunstad also emphasized the need to get as much of the case as possible in front of the bankruptcy judge and encouraged the practice of District Judges re-referring matters to the Bankruptcy Court.

He also said that one problem with the Supreme Court's approach to Article III jurisprudence is that it relies on the traditional model of the judge as a neutral adjudicator while the bankruptcy court is "the quintessential problem solving court." Commission Reporter Prof. Michelle Harner asked whether the judge in a problem-solving court is placed in a mediator/negotiator role. In response, Brunstad stated that you don't have to use that particular label, but that it is the "reality of large chapter 11 cases." He urged the Commission to "be up front and recognize it."