NCBJ Explores Role of Equity Under the Code

This year's National Conference of Bankruptcy Judges featured a symposium on the role of equity under the Bankruptcy Code.   "Senators" Melissa Jacoby, Ken Klee and Rich Levin convened a mock hearing in which they questioned professors Diane Lourdes Dick, Bruce Markell, Laura Coordes  and Jay Westbrook about the role of equity.   Some of the themes they covered included the difference between equity and discretion, the public interest and whether the Bankruptcy Court is a court of equity.   A version of the symposium will be published in the American Bankruptcy Law Journal.

Prof. Dick surveyed 51 bankruptcy judges to find their views on the role of equity.   She found that their answers fell into four clusters.  The first group said that bankruptcy courts have inherent equitable powers but they are largely supplanted by Code.  The second group was similar.  Banruptcy courts have inherent equitable powers which are supplanted by the Code, but they can still exercise discretion to level playing field.   The third group said that substantive discretion and equitable powers are one in the same.   The final group said that the Code yields to equitable powers when judges are given discretion.   The judges surveyed had a common belief that all federal judges possess equitable powers that serve to protect the integrity of the court.

Venue Takes Center Stage At ABI Commission Hearing (Austin Hearing Pt. 2)

Venue occupied the second half of the commission hearing held on November 22, 2013 and produced some of the liveliest discussion.  While there were five panelists slated to discuss venue, Judge Greendyke and Buzz Rochelle added their comments as well.   (I mention them here out of order for clarity of presentation).   

The Case for Reform

Former Judge Greendyke related his experiences with two Texas debtors that filed out of state.   He said that when Enron filed in New York, "I had to go to church and answer questions about why the company was filing there."   When American Airlines filed for bankruptcy in the same location, he expressed frustration that "you're going to have to rely on ABC News to find out what is going on."   

Mr. Rochelle emphasized that "chapter 11 needs to be seen and not just occur" and that "when it happens halfway across the country" this doesn't happen.  He emphasized the need for "the judge in the local community to make decisions."

First up on the venue panel was Judge Steven Rhodes from the Eastern District of Michigan. Judge Rhodes started with the "blunt observation" that:

The venue law we have is a venue non-law.   Any lawyer can figure out a way to file any case in any location.

Judge Rhodes urged the Commission to take a fresh look at the current "non-law" and to consider the purpose of venue laws.  He identified two key purposes as the interests of the parties and the institution as a whole.   He said that venue laws should "protect the parties who the moving party brings into court from inconvenience arising from choices made by" the debtor.    He said that the institutional purpose for venue laws was to provide legitimacy to the court and its proceedings.

He acknowledged that there were no perfect solutions in a world with multi-state and multi-national parties but said that "that doesn't excuse us from doing the best we can."    Judge Rhodes recommended principal place of business as the best solution for venue.

Judge Rhodes responded to the argument that concentrating cases in two forums creates predictability in how the law will be applied by saying that "if we had perfect predictability we wouldn't need judges."   He added that, "The biggest problem with predictability is that (people who use the term) mean predictability that I'm going to win."   He said that too much concentration reduces innovation and experimentation and thereby the opportunity to improve.  

He concluded with a plea for integrity.   He said:

Courts work because people have confidence they can send disputes to them, be heard and have a just result.   Everything that we do that enhances confidence needs to be encouraged.   Our non-law detracts from legitimacy.

Douglas Rosner of Goulston & Storrs in Boston testified on behalf of an ad hoc group of over 100 attorneys in 35 states seeking venue reform.   (Disclosure:   The Commercial Law League of America of which I am a member supports this effort and I helped Doug prepare for his testimony.).

Mr. Rosner laid out the statistical case for reform stating:

Substantial evidence demonstrates that a disproportionate number of chapter 11 cases are being filed in Delaware and New York which have little connection to those forums. A recent study by Associate Prof. Samir Parikh of Lewis & Clark School of Law found that 70% of large public companies that have filed bankruptcy in the last 5 years have forum shopped; 80% of which filed in Delaware or the Southern District of New York. Unlike the studies done in the mid-1990s, we know now that forum shopping affects companies of all sizes. In fact, almost half of the 559 out-of-state cases that filed in Delaware since 2003 had assets of less than fifteen million dollars and middle market companies comprise the vast majority of the filings in Delaware. The statistics demonstrate that chapter 11 debtors forum shop at such a staggering rate, it can no longer be ignored.

Rosner also gave examples from his home state of Massachusetts in which 33 companies with assets of over $6.2 billion and 65,000 employees filed in other states over a ten year period. Examples included Evergreen Solar, a company that received $58 million of assistance from Massachusetts, Polaroid, which drastically affected local employees and retirees, and Friendly Ice Cream, a cultural institution in Massachusetts for more than 75 years. (Ed.: Imagine the furor that would result if Bluebell filed for bankruptcy in Delaware).

Mr. Rosner also raised the specter of manipulation, pointing out that "The chapter 11 landscape is littered with examples of debtors trying to manufacture venue or using immaterial affiliates as a hook to establish venue."   

He also addressed creditor expectations, stating:

Prior to a bankruptcy filing, a debtor’s creditors and employees are used to dealing with the company’s headquarters. When they read in the papers that the company filed in another jurisdiction, their reaction is likely to be one of suspicion. They can reasonably question whether the company filed in a distant forum to obtain an advantage over other parties or discourage participation by local interests.

Mr. Rosner argued that the transfer of venue for Patriot Coal out of New York was not proof that the system is working.   He pointed out that the process took four months and millions of dollars in professional fees.   He quoted Bloomberg News for the prospect that Patriot Coal proved "the near impossibility of having venue transferred in large cases."

Next up was Prof. Jay Westbrook of the University of Texas School of Law who said he was delighted to see the attention being given to the venue issue.   Sounding a familiar theme, he said that:

Justice must not only be done; it must be seen to be done.   If not, the system fails in an important part of its social, political and economic role.

Prof. Westbrook argued that reform often comes from "spectacular trials or puzzling verdicts."   He said that "proceedings in a distant court will not receive the same coverage" as a local case would, being relegated to the financial press rather than the local media on which most people rely.   He also stated that when cases are filed closer to home, that local officials will be more likely to intervene.

He summed up his thoughts with the memorable phrase that when debtors are required to file in their principal place of business "the windows of justice will not be frosted by distance."

"There Is No Problem"

James Patton of Young, Conaway, Stargatt & Taylor in Delaware was the first of two witnesses favoring the status quo.   He argued that place of incorporation was the "only uncontestable standard" for venue and that a principal place of business requirement would lead to litigation such as encountered in Chapter 15 cases over the Center of Main Interest.   (The requirement in Chapter 15 cases that the proceeding be filed where the business has its main economic activity).  

Mr. Patton praised the experience of the Delaware bench, stating that they provide "the opportunity to go to a court with a great deal of depth and a great deal of experience."    He said that if state of incorporation venue was abolished

We will never again be able to grow another forum with the depth of experience and body of case law.   There will be no other place where cases can be concentrated.  

(Ed.:    Do you hear the refrain of "My judge is better than your judge, my judge is better than yours, my judge is better 'cause he's from Delaware, my judge is better than yours"?).

He also argued for predictability, stating:

We can argue about whether "law shopping" is a good thing or a bad thing, but loss of flexibility means less chances to maximize value for stakeholders.

(Ed.:  law shopping refers to the practice of filing in a venue where judges take the legal position that you favor.  It is a variant on forum shopping).   

Mr. Patton argued that requests for transfer of venue are "granted far more often than denied" and that cases with "a clear center of gravity" are being adequately addressed through transfer of venue.

Finally, he said that principal place of business would not eliminate forum shopping, pointing to a survey of 50,000 companies which had an average of 15 headquarters each.   

In response to a question from Commissioner Deborah Williamson, Mr. Patton admitted that Delaware's local counsel rule was outdated.

Michael Luskin, appearing on behalf of the New York City Bar Association's Committee on Bankruptcy and Corporate Reorganization bucked the prevailing mood when he boldly stated, "This is a solution in search of a problem.   There is no problem."    He argued that the current system "as applied by judges and practitioners serves efficiency and justice" and that "cases get transferred when they need to be."

Like his colleague from Delaware, Mr. Luskin raised the specter that a nerve center test would lead to endless litigation.

His suggestion was to ensure that all constituencies be represented through committees.    He said that committees are able to find superb representation for cases in Delaware and New York which protects parties.   He also said that "what's important" is that parties are able to "participate in a meaningful way" in negotiating the DIP order, plan and exit financing.   

Mr. Luskin pointed out that while airline cases have been filed across the country, the same firm represents the employees regardless of where the case is filed.

He said that "it is a fact that you can't run from" that people don't have a problem traveling to New York.

Luskin also sang the praises of the New York court, stating that it is a great advantage to have a case administered by a court that has a deep bench and where "the whole courthouse is set up for it."    

He said that another solution would be televising hearings much as the ABI Commission hearing was being livestreamed. Judge Rhodes pointed out that the current policy of the administrative office of the courts prevents audio or video broadcasting of court proceedings. He said that he requested permission to broadcast hearings in the City of Detroit case and was turned down.

Thinking Outside the Box

Each of the five venue panelists was asked to step outside of the box and propose a solution other than their proposed resolution.

Judge Rhodes said that having a national bankruptcy court process might be a solution but that "the devil is in the details."     He also suggested re-examining the appellate structure for bankruptcy courts to avoid avoid law shopping.    

Douglas Rosner said that a possibility would be making principal place of business the presumptive choice and placing the burden on the debtor to justify a filing elsewhere.    

Prof. Westbrook said that a national bankruptcy court was not the solution, even if judges were appointed from across the country, because it would not solve the problem of engaging the local community.   

James Patton said that the community problem would not be solved by venue reform because "there's always going to be a choice."   He suggested having a hearing at the beginning of a case to determine whether there is a better place to administer the case and what could be done to make the present venue a better place.   He gave the example of a Delaware case involving a Florida debtor where local Florida officials wanted the case transferred but other parties, including Florida creditors, did not want the case transferred.   In that instance, the court did not transfer venue but did order that the debtor pay for first class plane tickets and hotel accommodations for the local officials so that they could attend the proceedings.   

Mr. Luskin suggested that they should make it easier to get to court.   He proposed a system of national admission.   He said he was "horrified" to hear that the judicial conference prohibited broadcasting  and said "I can't think of a single reason not to do that."  He also went back to his suggestion to have more committees.    (Ed.:  Was it Marie Antoinette who said, "Let them have committees?").   

Commissioner James Markus asked Judge Rhodes about how his experience with the City of Detroit Chapter 9 bankruptcy compared to Chapter 11.

Judge Rhodes said that the City of Detroit case illustrated two points about the importance of having cases in the local community.

First, he said, citizens came to every hearing.   He used the largest courtroom available to him as well as two overflow rooms where citizens could watch on closed-circuit television.   (Apparently this does not constitute broadcasting).    He said that the citizens who came were very attentive and very interested in everything that occurred.

Second, he said that he devoted a full day to hearing remarks from 90 citizens who filed pro se objections to the City's eligibility for chapter 9.    Judge Rhodes said that the citizen comments were thoughtful, objective and angry and that he found them to be "of extraordinary value."    The Judge added that it was "an extraordinary day of process" and that he was "as grateful as I could be to have participated in that day."   

Closing Thoughts

The venue discussion was lively and thoughtful.   The advocates for change focused on the political and social values that are lost when cases are heard in distant forums while the advocates for the status quo argued that they had superior courts which knew how to transfer venue when it was needed.    As I have disclosed above, I am biased in favor of Texas companies filing bankruptcy in Texas, and yes, part of the reason is that I would like to see Texas firms get the work.   I thought that the Delaware and New York representatives were a bit patronizing toward judges in the rest of the country.   I have no doubt that there are some really good judges in Delaware and New York.   However, what does that make the judges in the other 88 districts?    Are they so sub-par that big cases have to be kept out of their reach?   I don't think so.   Also, I don't buy the argument that it is so easy to transfer venue.  According to James Patton, the Delaware Courts granted motions to transfer venue in nine out of thirteen cases between 2006 and 2012.   The fact that only two venue transfer motions per year are filed in Delaware says something.   It could say that most people feel that Delaware is a superior forum and are happy to have their case litigated there.   However, I think it is more likely that most creditors are too intimidated to hire a Delaware lawyer to tell a Delaware Judge that the case should be somewhere else.   

While Mr. Luskin believes that no one has a problem traveling to New York,  that doesn't mean that it is affordable for small creditors to travel to Delaware or New York.   Delaware is a poster child for parochialism.   Its local counsel requirement (which Mr. Patton agreed was outmoded) requires creditors wanting to appear in that court to hire an attorney with an office in Delaware.  To get to Delaware, it is necessary to fly into Philadelphia and take a 30 mile ride by car or limo.   New York has much better access.   However, once you get there, a hotel will run you $250-$400/night.  

I can somewhat understand the argument for filing large cases in the Southern District of New York.  New York is a major center of commerce, but so are Houston, Chicago and Los Angeles.  And Delaware:  Delaware is a state where companies go to incorporate   While half of the companies in the counrty are incorporated in Delaware, only two Fortune 500 companies have their headquarters there, compared to 53 in California, 52 in Texas, 50 in New York and 32 in Illinois.  Having two Fortune 500 companies located there places Delaware on a par with such states as Oregon and Rhode Island.   What Delaware does have is friendly corporation and tax laws.   According to the New York Times, the Cayman Islands complain that "Delaware is today playing faster and looser than the offshore jurisdictions that raise hackles in Washington."   Thus, while the Delaware courts possess a certain expertise, this is as a result of an historical accident favoring incorporation there. However, Nevada is also gaining a reputation as a tax haven.   I wonder whether the proponents of state of incorporation venue would be quite so bullish on this theory if Nevada started to usurp their business.  

Highlights from the National Conference of Bankruptcy Judges Day 1

I am attending the National Conference of Bankruptcy Judges meeting in New Orleans this week. Here are some highlights.

Lawrence P. King Award

The Commercial Law League of America presented the Lawrence P. King Award to Judge Burton Lifland from the Southern District of New York. In his acceptance speech, he stated that he has some concerns about the most recent phenomenon that has overtaken bankruptcy practice. According to judge Lifland, bankruptcy is becoming nothing more than a marketplace and that rehabilitation is on the back burner. He regretted that the pendulum has swung too far.

Philadelphia Newspapers and Credit Bidding

The topic du jour was credit bidding and inter-creditor agreements. Three out of six panels that I attended discussed some combination of these issues. There is another panel on Philadelphia Newspapers scheduled for Friday. (Note to planning committee: try to avoid duplication).

There was a lot of discussion of the Third Circuit opinion in In re Philadelphia Newspapers, 2010 U.S. App. LEXIS 5805 (3rd Cir. 2010), including a presentation from debtor’s counsel. In that case, the Third Circuit held that a sale pursuant to a plan of reorganization could eliminate the lender’s right to credit bid. Under 11 U.S.C. Sec. 1129(b)(2)(A), there are three alternatives for dealing with a secured claim separated by the word “or.” Option (iii) allows the realization of the “indubitable equivalent” of the lender’s collateral. The majority opinion held that a sale without the right to credit bid could provide the “indubitable equivalent.” The dissent argued that the more specific provision, which allowed credit bidding, should control.

I think the dissent had the better argument, but the more intriguing question is why it would be advantageous to avoid credit bidding. Lawrence McMichael, who represented the debtor, said that the rationale (apart from “torturing the lenders”) was to encourage bidders who would want to operate the newspaper, rather than simply sell it. The specter of a bidder with an unlimited right to credit bid was thought to be a deterrent to third party bidders. After the sale was allowed without credit bidding, the number of bidders who signed confidentiality agreements increased from three to thirty and the sale price went from the stalking horse bid of $30 million to $105 million. However, the winning bidder was still members of the bank group who had put together a cash bid.

The counter argument to eliminating credit bidding was that bank group relationships have grown so complex that a cash bid may be difficult to prepare. While the indenture trustee can make a credit bid on behalf of the group, it cannot require the members to advance new capital. Individual members of the group may be deterred from making a cash offer out of concerns about liability to the non-participating members.

An interesting side note is that section 363(k) allows the court to eliminate a right to credit bidding “for cause.” If there are compelling reasons for eliminating credit bidding, it seems more intellectually honest to do it directly.

International Insolvency

The panel on international insolvency included E. Bruce Leonard from Canada, Bankruptcy Judge Charles Case from Phoenix, Michael Crystal from England, Thomas Felsberg from Brazil and Prof. Jay Westbrook from the University of Texas Law School. They provided a good primer on chapter 15.

The purpose of chapter 15 is to allow an ancillary proceeding to be opened in the United States in support of a main proceeding in another country. Chapter 15 consists of two stages: recognition and relief. Recognition of a foreign proceeding is intended to be easy to obtain, although Prof. Westbrook pointed out the problem of haven countries, which incorporate companies but have no economic activity there.

The relief portion is highly discretionary and can include “any other relief than can be granted to a trustee” other than avoidance actions under the Bankruptcy Code. Judge Case stressed the importance of making a record to support the court in exercising its discretion. Any interesting example offered was a case where the chapter 15 proceeding sought to pursue fraudulent transfers under Nevis law. The Fifth Circuit ruled that only avoidance actions under the United States Bankruptcy Code were prohibited.

Individual Chapter 11s

The panel on individual chapter 11 cases included Judge Mary Diehl, Peter Lively, Sally Neely and Riley Walter. They approached the problem from the perspective of chapter 13 lawyers having to learn chapter 11 concepts and chapter 11 lawyers having to learn chapter 13 concepts which apply in individual chapter 11 cases.

They raised several interesting issues.

1. Can the same lawyer represent the debtor and the debtor in possession? What happens when a creditor files an objection to exemptions? Can the debtor’s lawyer defend the objection and get paid for it? In chapter 7 and chapter 11, the trustee may employ professionals, but the debtor may not. Can the attorney for the debtor in possession perform services for the benefit of the individual debtor? In re Dixon, 2010 Bankr. LEXIS 3305 (Bankr. N.D. Cal. 2010) was discussed as an extreme case, which held that not only could the attorneys not be compensated for defending the objection, but that they placed all of their fees at risk by taking a course of action adverse to the estate. Intellectually it is possible to connect the dots, but it is a terrible result practically. It would mean that an individual chapter 11 debtor would be required to hire one lawyer to represent the estate and a second attorney, who could not be paid from estate property, to represent him individually.

A better approach would be to recognize that the debtor in possession is a flesh and blood person with a right to claim exempt property. Once a creditor objects to the claim of exempt property, both the individual debtor and the debtor in possession have an interest in determining whether the property is exempt or not. My personal view is that if there is a conflict, it is one built into the structure of the Bankruptcy Code. An attorney has a duty to zealously represent his client which extends to both roles of the human being. Any other result means that a creditor could hold the debtor hostage by filing frivolous objections to exemptions or complaints to determine dischargeability, knowing that the debtor will be hamstrung in responding.

2. Is there an absolute priority rule for individual chapter 11 debtors? Three cases say no, holding that section 1129(a)(15)’s requirement to pay projected disposable income for five years overrides the absolute priority rule. In re Shat, 2010 WL 702443 (Bankr. D. Nev. 2010); In re Rodemeier, 374 B.R. 264 (Bankr. D. Kan. 2007); In re Tegeder, 369 B.R. 477 (Bankr. D. Neb. 2007). However, four cases have found that the absolute priority rule does apply. In re Gelin, 2010 Bankr. LEXIS 3217 (Bankr. M.D. Fl. 2010); In re Gbadeo, 431 B.R. 222 (Bankr. N.D. Cal. 2010); In re Mullins, 2010 Bankr. LEXIS 2826 (Bankr. W.D. Va. 2010); In re Steedley, 2010 Bankr. LEXIS 3113 (Bankr. S.D. Ga. 2010). Three of the cases finding that the absolute priority rule applies are so new that they came out after the materials were prepared.

3. How do you calculate “projected disposable income” under section 1129(a)(15)? The section says to look to section 1325(b)(2). However, section 1325(b)(2) defines defines “disposable income” as “current monthly income” less expenses reasonably necessary. “Current monthly income” is based on the means test form. However, the expense portion of the means test is contained in section 1325(b)(3), which is not incorporated. Both Collier on Bankruptcy and the Bankruptcy Forms take the position that the expense calculation under the means test is not incorporated so that the court retains discretion to determine which expenses are “reasonably necessary.”

4. Can you close the case prior to discharge to avoid paying U.S. Trustee fees? The panel stated that an increasing number of courts are allowing this practice. However, they cautioned that the automatic stay goes away when the case is closed and the discharge injunction does not apply until discharge is granted at the end of the plan. They recommended including an injunction in the closing order.