This
is a combination of two programs. One of the NCBJ plenary sessions offered a
Shark Tank like program where three lawyers pitched their proposals to reform
the Bankruptcy Code. Meanwhile, at the ABI luncheon, Bill Brandt and Robert
Keach offered their prognostications as to what might actually change in the
Code. Since both programs involved legislation, I have chosen to combine them
here. As you read through this article, you should note that the first part
contains the idealism of would-be reformers while the second part contains
the realpolitik.
Shark
Tank
Student
Loans
In
the first program, John Rao of the National Consumer Law Center offered his
proposal to amend 11 U.S.C. Sec. 523(a)(8) to rollback dischargeability of
student loans to the law as it existed in in 1998 when student loans could be
discharged after seven years or on a showing of undue hardship. He said
that the seven-year period deals with the concern that people can come straight
out of school and file bankruptcy. He said it's not a complete solution. He
said we still need to deal with cost of higher education.
To
make the case for change, he gave the illustration of Karen in Arkansas. She
borrowed $10,000 thirty years ago. She never used her degree. Over thirty
years, she paid $20,000 but still owed $106,000. Mr. Rao said that there is
something fundamentally broken with a system if that is how we treat our
debtors. Now the federal student loan creditors can garnish her Social Security
and tax refunds and even the Earned Income Tax Credit. There is no statute of
limitations on federal student loans so her debts will only disappear when she
dies.
Why
did Congress change the law? (Congress changed the law in 2005 to add
some private student loans to the list of non-dischargeable debts and eliminate
the ability to discharge student loans after seven years). He pointed out that
there was not a single Congressional hearing or GAO report on abuse. He
characterized the change in law as a Congressional gimmick to balance the
budget.
Mr.
Rao was asked if his proposal would protect the public fisc. There are $1.7
trillion in federal student loans. Why not require payment of disposable income
over period?
Mr.
Rao responded that most debts are performing. Only about 10% in default. There
is no evidence that denying discharge increases revenues to government. Instead,
the federal government can capitalize the interest and seek returns that would
make a predatory lender blush. The problem with requiring debtors to complete a
chapter 13 is that about 50% of Chapter 13 debtors never get a discharge.
Mr.
Rao was asked about his proposal to leave undue hardship in in his proposal. He
was asked whether it be better to have objective criteria for undue hardship.
Mr. Rao said that objective criteria would help but we already have a workable
standard for undue hardship in connection with reaffirmation agreements and it
would make sense to use that standard. However, he pointed out that the debtors
who need relief the most can't afford to litigate.
He
was asked whether his proposal would roil the markets. Wouldn't lenders increase
the price to address the risk? He pointed out that the pricing only affects
private lenders. When private loans were made non-dischargeable in 2005 there
was either no decrease in rates or an actual increase based on different
studies.
President
Biden has proposed cancelling some student loan debt. Doing this would be a
stimulus to economy according to Moody's as more people would be able to buy
homes and have children. However, requiring bankruptcy to get that cancellation
would avoid the moral hazard of general cancellation.
KERPs
Metta Kurth pitched a proposal to
close loopholes to BACPA's limitations on "pay to stay." She called
her proposal "stop the heist." In 2005, BAPCPA limited Key Employee
Retention Programs ("KERPs") by requiring that a company demonstrate
three things: that the person receiving the KERP has received a better offer,
that their services are essential and that the amount of the KERP is either not
more than 10 times the mean amount paid to non-management employees for similar
purposes or, if no similar amounts were paid out in the prior year, it did not
exceed 25% of any similar payment made to an insider during the prior year. 11
U.S.C. Sec. 503(c).
Some
companies shifted away from KERPs and went to "keeps," incentive payments
to be earned for meeting certain benchmarks. Ms. Kurth said that
"keeps" had a greater sense of integrity. However, other companies
made an end run around the KERP rules by simply making these payments
pre-petition. She gave the example of JC Penney which paid out $7.5 million to
four executive five days before the petition.
Ms.
Kurth proposed to amend 11 U.S.C. Sec. 548 in three ways:
(a)
Existing Sec. 548(a)(1)(B)(ii)(IV) states that insider compensation given for
less than reasonably equivalent value and outside of the ordinary course of
business can be recovered as a fraudulent transfer. She would extend this to
apply to all insider compensation given during the 90 days before bankruptcy.
(b)
She would also add a provision that insider compensation would be presumed to
be for less than reasonably equivalent value if it was greater than the normal
pre-bankruptcy compensation and did not meet the requirement for a KERP; and
(c)
Make non-dissenting directors who approve compensation in violation of this
provision liable similar to state laws applicable to illegal dividends.
She
was asked if companies would just give out insider bonuses 91 days before
bankruptcy if her proposal was adopted. She answered that the petition date is
often fluid and that 90 days will catch most abuse.
She
said that her proposal would motivate companies to use a "keep" or
stay within guardrails for KERPs during the runup to the petition.
She
acknowledged that her proposal would not fix the imbalance in executive
compensation. 20 years ago, executives earned 70 times the wage of their
typical worker while today that ratio is now 200 times.
She
said that she was not trying to fix entire system, just the perception of
abuse.
(Ed.:
While I admire Ms. Kurth's enthusiasm, her proposal would continue the trend of
making the Bankruptcy Code resemble the Tax Code in its complexity. The problem
with ever more specific prohibitions is that ever more clever lawyers will find
ways around them. To be very clear, she had identified a very real and very
serious problem. My quibble is with the specifics of her proposal rather than
the need for it)
The
Means Test
Eric
Brunstad proposing the means test as the gateway for determining substantial
abuse. He proposed going back to the standard existing before BAPCPA when
Bankruptcy Judges had discretion to find substantial abuse based on the
circumstances of the case rather than a statutory presumption.
He
said that the means test was a solution in search of a problem that never
existed and a bad solution at that.
He
said that judges know abuse when they see it and have ample tools to address it
when it actually arises.
He
asked the rhetorical question of where did the means test come from? He said it
came from the history of credit card underwriting. At one time, credit card
underwriting was done on an individual basis. Then it went to a portfolio
underwriting system. The model predicted 4% default rate. As time went on,
credit cards became less profitable. He said that the credit card companies
wanted to squeeze a couple more bucks out of the system by making bankruptcy
more difficult and expensive to pursue. (Ed. Prof. Ronald Mann described this
as the "sweatbox" in an influential paper).
He
said that the means test was a very inefficient solution. If you are $1 above
the test, you are deemed to be a substantial abuse.
Prof.
Brunstad said that the empirical data said abuse was not out there. He also
said that a one size fits all test was not useful. He quoted Tolstoy who said,
"All happy families are alike; each unhappy family is unhappy in
its own way.” He said that by analogy, every abusive debtor is abusive in its
own way.
He stressed that there was
not a problem with too many people filing bankruptcy. According to Sen.
Elizabeth Warren, 43 million people were in financial
distress after the Great Recession, but only 1.5 million filed
bankruptcy. He said that people do not file for bankruptcy willy-nilly
He
repeated the proverb that you can't get blood out of stone and then described
the means test as a very expensive blood test for the stone.
He
said that this kind of discretionary thing (i.e., ferreting out abuse) is what
bankruptcy judges are paid to do.
He
also said that there is a huge externality problem. He asked who gets the
benefit and who bears the cost? The credit card companies reap the benefit from
debtors who continue to pay because they cannot afford to file bankruptcy. The
cost is borne by higher fees paid by debtors. He said that if a debtor is
required to file chapter 13, it is like a 25% tax.
In
the end, the audience voted to invest in all three proposals. Unfortunately,
legislative reform depends on a dysfunctional Congress, not what bankruptcy
judges and professionals would like to see. That offer a nice segue into the
second legislative program I watched.
ABI's
Program on Legislative Likelihoods
The
three proposals contained in the Shark Tank program were each thought
provoking. However, when the American Bankruptcy Institute put on a program on
likely changes to legislation, it focused on different proposals altogether.
Bill Brandt and Robert Keach are both ABI members who have been active in
proposing legislation. Although ABI does not take positions on legislative as a
group, its individual members have been active in lobbying Congress. I want to
stress that the very opinionated and outspoken Mr. Brandt and Mr. Keach were
speaking for themselves rather than for the ABI as an institution.
SubChapter
V
Mr.
Brandt started the conversation off with discussion of SubChapter V. He said
that when it was passed, the debt limit of $2.7 million was too low. Shortly
after it was passed, they were able to increase the limit to $7.5 million but
only on a temporary basis. Now he said that the goal would be to increase the
limit to $20 million. However, at higher limits, SubChapter V would take on
more of a hybrid nature. He said that U.S. Trustee fees would need to kick in
at somewhere between $7.5 million to $10.0 million to keep the program funded.
He also said that legislation would likely give courts the option to have a creditors'
committee beginning at $12-$15 million.
He
said that if the debt limit was increase to $20 million, it would cover 95% of
Chapter 11 cases. He said that this would take the wind out of the venue issue,
which he described as "our abortion issue."
This
raises two very interesting questions. Was he assuming that mega SubChapter V
cases would not be forum shopped? If the law allows forum shopping and
litigants see an advantage to doing so, why would they stop? Also, it wouldn't
address the problem of the large public companies seeking out favorable venues
to the detriment of smaller creditors, employees, retirees and other
constituencies. Also, as a Texan, I am very familiar with the emotions
triggered by abortion. On the one hand are those with moral certainty about the
importance of lives as yet unborn while on the other there is the moral
certainty of those who want to control their own bodies. Abortion stirs the
outrage of moral certainty in its combatants. Is bankruptcy venue really that
divisive or was Mr. Brandt merely engaging in hyperbole?
Mr.
Keach acknowledged that he had lost the debate over having a facilitating
trustee in SubChapter V and that it was good that he lost. He described the
trustee as one of the reasons why the Small Business Reorganization Act has
worked so well.
Mr.
Brandt said that raising the SubV debt limit could make its way into a
reconciliation bill because it would raise fees. He also explained that because
the support of Sen. Grassley was critical that SubChapter V was intentionally
made similar to Chapter 12.
Venue
Mr.
Brandt had a very cynical view on venue reform. He said that with this
President and Rep. Nadler chairing the House Judiciary Committee, venue would
be a non-starter. He said that venue was a good way for Sen. Cornyn and Sen.
Warren to raise a lot of money but that it would not be a factor for the
balance of this decade.
Mr.
Keach said that the option to allow affiliate filings was designed to placate
New York bankruptcy lawyers but "no one in New York believes that."
(Ed.:
Dissenting Opinion here. For the last three years, Sens. Cornyn and Warren have
worked together on a venue bill. This year bills have been introduced into the
Senate and House at an earlier stage with more co-sponsors than before. As
cases like Purdue Pharma draw national outrage, bankruptcy venue will continue
to build momentum. However, I must acknowledge that our scrappy, grass-roots
crusade has very determined and well-organized opposition).
Mr.
Brandt said that there was a study that concluded that the bankruptcy industry
had the same effect for the Delaware economy as having a minor league baseball
team would have. He also said that having increased debt limits for SubChapter
V would be a pretty good second choice for the venue reformers.
Mr.
Brandt noted that the fire for venue reform has weakened as the New
York-Delaware duopoly has expanded to include Houston and Virginia. (Ed.:
Dallas, TX, Corpus Christi, TX and Charlotte, N.C. have also been the
recipients of recent attempts at forum shopping. Will forum shopping become so
widespread as to draw a collective "meh" from the bar? As the
blogger, I get to ask the questions, but I honestly don't have an answer).
He
said that 10-15% of the Senate will always oppose venue reform making it an
uphill battle.
He
also said that another needed reform would be to allow a single asset real
estate debtor to be a SubV debtor if it was a landlord to a small business
debtor.
Third
Party Releases
Mr.
Keach mentioned that when Jon Oliver did a program on third party releases, he
had a researcher spend an hour with Mr. Keach. He said that Mr. Oliver gave the
issue a very serious presentation. He then said that the issue was not going
anywhere. He characterized it as a solution in search of a problem. He said
that it was not the bankruptcy system that was broken but the tort system. He
said that bankruptcy delivers money to victims faster and more efficiently than
the tort system. He said that it is easy to forget that what we are about is
compensating people. He said that if you want to punish people, prosecute them.
"If you can't prosecute them, then shut up."
Mr.
Brandt said that legislation barring third party releases even with an opt out
were going nowhere. He said it was a chance for Democrats to say that they
voted against Darth Vader.
Student
Loans
Mr.
Brandt said that the Fresh Start Bill proposed by Sen. Dick Durbin is the
closest bill that might actually achieve passage. It would reinstate
dischargeability after ten years and is close to the ABI Commission's proposal.
However, he said it was "probably not a this year thing." He added
that bankruptcy reform always starts out with consumer provisions. He indicated
that it would not be this Congress. Probably the next Congress or the one after
that and it would be part of a bill with lots of ornaments on it.
He
said that one problem with achieving bankruptcy reform is that there is not an
association of past and future debtors but that student loan borrowers vote. Unfortunately,
they cannot afford campaign contributions.
Mr.
Keach said that the purveyors of private student loans hired really good
lobbyists in the past but that maybe the problem is becoming too significant to
ignore.
Final
Thought: I really appreciated the fact that Mr. Brandt and Mr. Keach didn't
pull any punches. I may not have agreed with them, but they certainly gave
their unvarnished opinions without resorting to polite euphemisms.
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