Timothy Blixseth v. Stephen Brown, et al
Filing
FILED OPINION (ALEX KOZINSKI, RICHARD A. PAEZ and MARSHA S. BERZON) AFFIRMED IN PART; VACATED IN PART; REMANDED IN PART. The parties shall bear their own costs. Judge: AK Authoring. FILED AND ENTERED JUDGMENT. [10211115]
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AMERICAN
B A N K R U P TC Y
INSTITUTE
in
cited
CO M M I S S I O N
D.J. Baker
James E. Millstein
Donald S. Bernstein
Harold S. Novikoff
William A. Brandt, Jr.
James P. Seery, Jr.
Jack Butler
Sheila T. Smith
Babette A. Ceccotti
James H.M. Sprayregen
Hon. Arthur J. Gonzalez
Albert Togut, Co-chair
Steven M. Hedberg
Clifford J. White III
Robert J. Keach, Co-chair
Bettina M. Whyte
Prof. Kenneth N. Klee
Deborah D. Williamson
Richard B. Levin
Geoffrey L. Berman
FINAL REPORT AND RECOMMENDATIONS
Harvey R. Miller
James T. Markus
SPONSORED BY THE ANTHONY H.N. SCHNELLING ENDOWMENT FUND
Reporter: Prof. Michelle M. Harner
TO S T U DY T H E R E F O R M
OF CHAPTER 11
2012~2014
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American Bankruptcy Institute
Copyright © 2014 by the American Bankruptcy Institute.
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system
or transmitted in any form or by any means electronic, mechanical, photocopying, recording or
otherwise, without the prior permission of the publisher and copyright holder. Printed in the United
States of America.
“This publication is designed to provide accurate and authoritative information in regard to the subject
matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal,
accounting or other professional services. If legal advice or other expert assistance is required, the
services of a competent professional person should be sought.”
— From a Declaration of Principles jointly adopted by a Committee of the American Bar Association
and a Committee of Publishers and Associations.
ISBN: 978-1-937651-84-8
Additional copies may be purchased from the American Bankruptcy Institute. Discounts are available
to ABI members. Copies also may be purchased at ABI’s website, ABI World, www.abiworld.org.
Founded on Capitol Hill in 1982, the American Bankruptcy Institute (ABI) is the only multidisciplinary, nonpartisan organization devoted to the advancement of jurisprudence related to
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problems of insolvency. The ABI membership includes more than 13,000 attorneys, bankers, judges,
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accountants, professors, turnaround specialists and othervebankruptcy professionals, providing
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a forum for the exchange of ideas and information.63
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unbiased testimony and research on insolvency issues. For further information, contact ABI.
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ABI Commission to Study the Reform of Chapter
Table of Contents
I. Introduction .....................................................................................................................................
II. Executive Summary of Proposed Principles ...............................................................
III. Background on the Commission and the Study Project ...................................
A. Brief History of U.S. Business Reorganization Laws................................................................
B. The Need for Reform ....................................................................................................................
C. The Commission’s Study................................................................................................................
D. The Commission’s Deliberations ................................................................................................
IV. Proposed Recommendations: Commencing the Case ..........................................
A. Oversight of the Case .................................................................................................................
. The Debtor in Possession Model ................................................................................................................
. The Chapter Trustee .................................................................................................................................
. The Estate Neutral.........................................................................................................................................
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. Statutory Committees ...................................................................................................................................
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. Estate Fiduciaries............................................................................................................................................
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. Valuation Information Packages ...............................................................................................................
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. Professionals and Compensation Issues ..................................................................................................
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. Costs in Chapter t Cases ............................................................................................................................
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B. Financing the Case ........................................................................................................................
. Adequate Protection .....................................................................................................................................
. Terms of Postpetition Financing ...............................................................................................................
C. Breathing Spell for Debtor upon Filing ..................................................................................
. Timing of Approval of Certain Postpetition Financing Provisions ..............................................
. Timing of Section x Sales .......................................................................................................................
D. Payment of Certain Claims upon Filing....................................................................................
. Prepetition Claims and the Doctrine of Necessity............................................................................
. Wage and Benefits Priorities ......................................................................................................................
E. Financial Contracts, Derivatives and Safe Harbor Provisions ..........................................
. Scope of Section (e) Safe Harbors.......................................................................................................
. Treatment of Repurchase Agreements Under Safe Harbors ...........................................................
. Assumption of Financial Contracts.......................................................................................................
. Section and “Commercially Reasonable Determinants of Value” .......................................
. Walkaway Clauses ........................................................................................................................................
. Exclusion of “Ordinary Supply Contracts” from Safe Harbors...................................................
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V. Proposed Recommendations: Administering the Case ......................................
A. Executory Contracts and Leases ............................................................................................
. Definition of Executory Contract ........................................................................................................
. General Rights of Private Parties to Executory Contracts and Unexpired Leases ............
. Rejection of Executory Contracts and Unexpired Leases.............................................................
. Intellectual Property Licenses ...............................................................................................................
. Trademark Licenses ......................................................................................................................................
. Real Property Leases ...................................................................................................................................
B. Use, Sale, or Lease of Property of the Estate .......................................................................
. General Provisions for Non-Ordinary Course Transactions ......................................................
. Finality of Orders ........................................................................................................................................
. Transactions Free and Clear of Interests...........................................................................................
. Credit Bidding ................................................................................................................................................
C. Avoiding Powers ..........................................................................................................................
. Preference Claims.........................................................................................................................................
. Recoveries Under Section ...................................................................................................................
D. Labor and Benefits .....................................................................................................................
. Collective Bargaining Agreements Under Section ................................................................
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. Retiree Benefits and Section ...........................................................................................................
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E. Administrative Claims ...............................................................................................................
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. Section (b)() and Reclamation .........................................................................................................
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. WARN Act iClaims ..........................................................................................................................................
. Severance Benefits .......................................................................................................................................
F. General Valuation Standards ...................................................................................................
G. Standard for Reviewing Settlements and Compromises ....................................................
H. The In Pari Delicto Doctrine ...................................................................................................
VI. Proposed Recommendations: Exiting the Case ...................................................
A. General Authority of Debtor in Possession and Its Board of Directors.......................
. Preemption and the Authority to Approve Transactions and Plan .........................................
. Role of Debtor in Plan Process ...............................................................................................................
B. Approval of Section x Sales ................................................................................................
C. Value Determinations, Allocation, and Distributions ......................................................
. Creditors’ Rights to Reorganization Value and Redemption Option Value ..........................
. New Value Corollary ..................................................................................................................................
. Section (c) and Charges Against Collateral ..............................................................................
. Section (b) and Equities of the Case ................................................................................................
. Cramdown Interest Rates ..........................................................................................................................
. Class-Skipping and Intra-Class Discriminating Distributions ....................................................
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ABI Commission to Study the Reform of Chapter
D. Disclosure and Use of Postconfirmation Entities and Claims Trading .........................
E. General Plan Content ...............................................................................................................
. Default Plan Treatment Provisions .......................................................................................................
. Exculpatory Clauses ....................................................................................................................................
. Third-Party Releases ..................................................................................................................................
F. Plan Voting and Confirmation Issues .....................................................................................
. Class Acceptance Generally and for Cramdown Purposes...........................................................
. Assignment of Voting Rights ....................................................................................................................
. Designation of Votes....................................................................................................................................
. Settlements and Compromises in Plan ..................................................................................................
. Discharge of Claims upon Confirmation .............................................................................................
G. Orders Resolving Chapter Case (Exit Orders) ................................................................
VII. Proposed Recommendations: Small and Medium-Sized Enterprise
(SME) Cases ................................................................................................................................
A. Definition of SME .......................................................................................................................
B. General Application of SME Principles..................................................................................
C. Oversight of SME Cases.............................................................................................................
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D. Plan Timeline in SME Cases .......................................................................................................
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E. Plan Content and Confirmation in SME Casesi.....................................................................
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Proposed Recommendations: Standard of Review
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A. General Standard of Review ....................................................................................................
B. Key Definitions and Concepts in Principles ..........................................................................
IX. Other Issues Relating to Chapter Cases ..........................................................
A. Venue of Chapter Cases ........................................................................................................
B. Core and Noncore Matters in Chapter Cases ..................................................................
C. Individual Chapter Cases .....................................................................................................
D. SIFIs and Single Point of Entry Schemes ................................................................................
E. Cross-Border Cases.....................................................................................................................
X. Conclusion ....................................................................................................................................
Appendix A:
Members of the ABI Commission to Study the Reform of Chapter ........
Appendix B:
Research Assistants and Empiricists.................................................................................
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Appendix C:
Advisory Committee Members ...............................................................................................
Appendix D:
Public Field Hearing Witness List ......................................................................................
Appendix E:
Summary of Field Hearings and Topics of Discussion ............................................
Appendix F:
Academics Involved in April Symposium ..............................................................
Appendix G:
Additional Views on Severance Benefits Principles ..............................................
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I. INTRODUCTION
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American Bankruptcy Institute
A robust, effective, and efficient bankruptcy system rebuilds companies, preserves jobs, and facilitates
economic growth with dynamic financial markets and lower costs of capital. For more than 35 years,
the U.S. Bankruptcy Code has served these purposes, and its innovative debtor in possession chapter
11 process, which allows a company to manage and direct its reorganization efforts, is emulated
around the globe. As with any law or regulation, however, periodic review of U.S. bankruptcy laws
is necessary to ensure their continued efficacy and relevance.
Whether by design or chance, efforts to review and assess U.S. business reorganization laws are
undertaken approximately every 40 years. Such efforts have led to federal legislation effecting
meaningful revisions to business reorganization laws in 1898, 1938, and 1978. It may be that
four decades is the maximum amount of time that any financially driven regulation can remain
relevant. Markets and financial products, as well as industry itself, often evolve far more quickly
than the regulations intended to govern them. It may be that significant economic crises tend to
occur cyclically and encourage reevaluation of the federal bankruptcy laws. Regardless, the general
consensus among restructuring professionals is that the time has come once again to evaluate
U.S. business reorganization laws. Accordingly, the American Bankruptcy Institute (the “ABI”)
established the Commission to Study the Reform of Chapter 11 (the “Commission”) for this precise
purpose.
The Commissioners are among the most prominent insolvency and restructuring practitioners in
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the United States, who have represented debtors, creditors, and other stakeholders, such as private
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equity investors, in the largest and most significant cases in U.S. history. em Commissioners included
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the Chair and former Chair of the influential Nationalr
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Chairs of the New York City Barth
e Committee on Bankruptcy and Reorganization, the former Chief
Blixs
Restructuring Officer itof the United States Treasury, a past Chair of the Turnaround Management
ed in
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Association, three prominent turnaround consultants, a past member of the National Bankruptcy
Review Commission, a former Chief Bankruptcy Judge of the Southern District of New York, the two
principal draftsmen of the 1978 Bankruptcy Code, several past members of the Advisory Committee
on Bankruptcy Rules of the Judicial Conference of the United States, the current President of INSOL
International, the Director of the Executive Office for U.S. Trustees in the Department of Justice,1 five
past Presidents of the American Bankruptcy Institute, and nine current and former global heads of
the bankruptcy departments at major U.S. law firms. The Commissioners and their full professional
biographies, as well as that of the Reporter, are attached collectively at Appendix A.
In assembling those who would serve as Commissioners and as members of the topical advisory
committees, special attention was paid to the fact that although large cases capture headlines,
the overwhelming number of business bankruptcies are by small and medium-sized enterprises.
Professionals with unique experiences in these kinds of cases lent their special expertise to the
Commission process. As a result, the Report includes, among others, recommendations focused
on small and medium-sized enterprises that will materially improve the Bankruptcy Code for
stakeholders in this broad market.
1
As a nonvoting member, Director Cliff White took no position on legislative proposals. Mr. White provided institutional
perspectives and technical assistance on issues considered by the Commission.
I. Introduction
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ABI Commission to Study the Reform of Chapter
The Commission adopted a holistic and inclusive approach to its study and was guided by its mission
statement, which reads:
In light of the expansion of the use of secured credit, the growth of distressed-debt
markets and other externalities that have affected the effectiveness of the current
Bankruptcy Code, the Commission will study and propose reforms to Chapter 11
and related statutory provisions that will better balance the goals of effectuating the
effective reorganization of business debtors — with the attendant preservation and
expansion of jobs — and the maximization and realization of asset values for all
creditors and stakeholders.
In furtherance of its mission statement, the Commission undertook an in-depth three-year study
process. The study focused exclusively on the resolution of financially distressed businesses under
chapter 11 of the Bankruptcy Code.2 This Report explains the components of the Commission’s
study process, summarizes the results of the study, and presents the Commission’s resulting
recommendations for reform in a series of principles organized generally by issue and sequence in
the chapter 11 process.
Although the Commission designed its three-year process around concepts of inclusiveness, diversity
of thought, leadership, and transparency, the Commission, working with the Commission’s Reporter,
Professor Michelle M. Harner, University of Maryland Francis King Carey School of Law, maintained
2016
exclusive control over the substance of the final Report. All decisions ber 2recommendations set forth
and 1,
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in the Report were made solely by the Commissioners ed on No
in accordance with the voting procedures
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described herein. The Reporter worked closely 63 a the Commissioners to draft the language of
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the recommended principles andrown, supporting narrative for each of those principles. Although
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the Reporter acted as thesprincipal draftsperson of the Report, the Commissioners reviewed and
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commented on cited
various iterations of this Report to achieve this final product. The Commission
voted unanimously to adopt this Report on December 1, 2014. During the three-year study and
the drafting process, the Commission was assisted in its research by Leah Barteld Clague, Jennifer
Ivey-Crickenberger, and Sabina Jacobs, as well as each of the Commission’s advisory committees and
their respective reporters. The Commission appreciates the assistance of all of these individuals, and
acknowledges the substantial value added to this Report by the work of the advisory committees and
the international working group.3
2
3
The Commission did not address issues unique to the resolution of an individual debtor’s financial distress under chapter 11. For
a general discussion of these issues, see Section IX.C, Individual Chapter 11 Cases.
Additional information regarding the Commission’s research assistants and the empiricists who assisted with research
underlying the report are identified at Appendix B. Members of the advisory committees are listed at Appendix C, and members
of the international working group are listed below, infra note 53. In addition, this Report also benefited from datasets made
available to the Commission by New Generations, UCLA-LoPucki Bankruptcy Research Databases, and the Loan Syndications
and Trading Association.
I. Introduction
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II. EXECUTIVE SUMMARY
OF PROPOSED PRINCIPLES
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Bankruptcy Institute
Chapter 11 works to rehabilitate companies, preserve jobs, and provide value to creditors only if
distressed companies and their stakeholders actually use the chapter 11 process to facilitate an incourt or out-of-court resolution of the company’s financial distress.4 Chapter 11 in turn needs to
offer tools to resolve a debtor’s financial distress in a cost-effective and efficient manner. To that end,
the recommended principles seek to, among other things:
Reduce barriers to entry by providing debtors more flexibility in arranging debtor in
possession financing, clarifying lenders’ rights in the chapter 11 case, disclosing additional
information about the debtor to stakeholders, and providing a true breathing spell at the
beginning of the case during which the debtor and its stakeholders can assess the situation
and the restructuring alternatives;
Facilitate more timely and efficient diligence, investigation, and resolution of disputed
matters through an estate neutral — i.e., an individual that may be appointed depending
on the particular needs of the debtor or its stakeholders to assist with certain aspects of the
chapter 11 case, as specified in the appointment order;
Enhance the debtor’s restructuring options by eliminating the need for an accepting
impaired class of claims to cram down a chapter 11 plan and by formalizing a process
to permit the sale of all or substantially all of the debtor’s assets outside the plan process,
while strengthening the protection of creditors’ rights in such situations; 6
1
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emb debtor and of creditors,
Incorporate checks and balances on the rights and remediesvof the
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including through valuation concepts that potentially
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the case, permit secured creditorsNo. realize the reorganization value of their collateral at
to 14-3
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the end of the case, andth v. Bro value allocation to junior creditors when supported by the
e provide
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reorganizationdvalue; and
cite
Create an alternative restructuring scheme for small and medium-sized enterprises that
would enable such enterprises to utilize chapter 11 and would enable the court to more
efficiently oversee the enterprise through a bankruptcy process that incentivizes all parties,
including enterprise founders and other equity security holders, to work collectively
toward a successful restructuring.
The Report organizes the recommended principles based on the key stages of a chapter 11 case:
Commencing the Case; Administering the Case; and Exiting the Case. In addition, the Report
proposes a set of principles for Small and Medium-Sized Enterprises. Finally, the Report includes
a section on issues related to chapter 11 cases, but not directly tied to the Commission’s mission
statement or addressed by this Report. This final section discusses, among other things, issues
relating to venue and jurisdiction in chapter 11 cases.
4
The utility of the chapter 11 process is important not only for companies that file chapter 11 cases, but also for companies trying
to achieve an out-of-court resolution. Distressed companies and their stakeholders frequently consider the federal bankruptcy
alternative in deciding whether to pursue or ultimately agree to an out-of-court restructuring plan.
II. Executive Summary of Proposed Principles
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III. BACKGROUND ON THE
COMMISSION AND THE
STUDY PROJECT
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Bankruptcy Institute
Congress historically has turned to U.S. bankruptcy laws to help stabilize the economy in times
of crisis and, beginning in 1867, to provide both individuals and corporations a single forum to
address multiple creditor claims.5 Although the law has evolved significantly since the late 1800s, the
law remains focused on strengthening the economy and society more generally and, in the process,
instilling confidence in businesses and markets. These objectives require a delicate balance that
encourages appropriate growth and innovation in business, but provides sufficient protection and
certainty to creditors.6 Chapter 11 of title 11 of the U.S. Code (the “Bankruptcy Code”) can achieve
this balance for U.S. companies and markets. This section reviews the historical development of the
Bankruptcy Code, explains why it is important and necessary to consider reforms to the Bankruptcy
Code at this point in time, and details the Commission’s study process that generated this Report
and Recommendations.
A. Brief History of U.S. Business Reorganization Laws
The United States has one of the strongest and most well developed business reorganization schemes
in the world.7 This business reorganization scheme has a rich history, stemming in large part from
the railroad failures of the late 19th century.8 The Bankruptcy Acts of 1867 and 1898 introduced the
basic conceptual underpinnings of modern bankruptcy law, including business2bankruptcy.9 These
016
21,
berand rehabilitate” policy
laws, particularly the 1898 Bankruptcy Act, were grounded in a Novem
“rescue
n
ed o the business debtor, to obtain a
intended to allow the honest but unfortunate debtor, archiv
including
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fresh start and a second chance at becoming. 14productive, contributing member of society.10 As
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with all U.S. bankruptcy laws, the v. B Bankruptcy Act sought to balance the need of the debtor
1898
th
e
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ed in
cit
5
6
7
8
9
10
See, e.g., Charles Jordan Tabb, The History of the Bankruptcy Laws in the United States, 3 Am. Bankr. Inst. L. Rev. 5, 18–23 (1995).
One commentator explained:
The current U.S. bankruptcy system grew directly out of the United States’ unique capitalist system, which rewards
entrepreneurialism as well as extensive consumer spending. It makes sense that a society in which dollars rule would
have a forgiving personal bankruptcy system in order to keep consumer spending high, and an equally forgiving
business reorganization system to encourage risk taking and economic growth. Both systems are part of a larger
scheme to keep economic players alive and active in the game of capitalism. U.S. bankruptcy systems are among the
country’s few social programs and they address many of society’s ills. Thus, they are broad and form an integral part
of the social system from which they sprung.
Nathalie Martin, The Role of History and Culture in Developing Bankruptcy and Insolvency Systems: The Perils of Legal
Transplantation, 28 B.C. Int’l & Comp. L. Rev. 1, 3 (2005). See also Viral V. Acharya et al., Creditors Rights and Corporate RiskTaking, 102 J. Fin. Econ. 150, 150–66 (Oct. 2011) (“In cross-country analysis, we find that stronger creditor rights induce greater
propensity of firms to engage in diversifying acquisitions that are value-reducing, to acquire targets whose assets have high
recovery value in default, and to lower cash-flow risk. Also, corporate leverage declines when creditor rights are stronger.”).
See, e.g., Martin, supra note 6, at 4 (“[M]any countries have attempted to create a reorganization scheme for failing enterprises
like Chapter 11 of the U.S. Bankruptcy Code (Chapter 11), in which existing management stays in place and manages the
reorganizing company. These systems are perhaps the most common U.S. legal exports today.”) (citations omitted).
Harvey R. Miller & Shai Y. Waisman, Does Chapter 11 Reorganization Remain a Viable Option for Distress Businesses for the
Twenty-First Century?, 78 Am. Bankr. L.J. 153, 160 (2004) (“The foundation of United States reorganization law is the equity
receivership, also known as the federal consent receivership, that was fashioned in the late nineteenth century to resolve the
financial distress and failures that permeated the railroad industry after the Civil War.”).
For general discussions of the historical development of federal bankruptcy law, see, e.g., David A. Skeel, Jr., Debt’s Dominion
56–60 (2001) (explaining equity receivership process); Charles Jordan Tabb, The History of the Bankruptcy Laws in the United
States, 3 Am. Bankr. Inst. L. Rev. 5, 21–23 (1995) (same). See also Charles Warren, Bankruptcy in United States History (1935);
Donald R. Korobkin, Rehabilitating Values: A Jurisprudence of Bankruptcy, 91 Colum. L. Rev. 717, 747–49 (1991); Stephen J.
Lubben, A New Understanding of the Bankruptcy Clause, 64 Case W. Res. L. Rev. 319 (2014).
See Jason J. Kilborn, Bankruptcy Law, in Governing America: Major Decisions of Federal, State, and Local Governments from
1789 to the Present 41–49 (Paul J. Quirk & William Cunion eds., 2011) (“With the rise of private business corporations in the
mid- to late-1800s, the rescue- and rehabilitation-oriented bankruptcy policy was extended to the ‘big business’ context.”). The
1898 Bankruptcy Act initially permitted “[c]ompositions in lieu of liquidations,” and then subsequent amendments, described
below, enlarged rehabilitation alternatives for businesses. See Tabb, supra note 9, at 26–30.
III. Background on the Commission and the Study Project
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to rehabilitate and the rights of creditors to recoveries. The basic notion that a business generally
is more valuable to creditors and society as a whole if it rehabilitates rather than liquidates also
emerged during this period.11
Bankruptcy law progressed in response to, among other things, the Great Depression of the 1930s,12
and a more formalized process evolved that allowed distressed companies to remain in business
while restructuring their obligations.13 These developments produced Sections 77 and 77B of the
Bankruptcy Act14 and then the Bankruptcy Code’s immediate predecessor, the Chandler Act,15 which
added three new chapters for reorganizing ongoing businesses (Chapters X and XI concentrated on
businesses, and Chapter XII addressed real estate organizations).16 Each iteration of the law focused
on strengthening business reorganizations and seeking an appropriate balance between the rights
and obligations of the debtor and its stakeholders.
Under Chapter X of the Chandler Act, a trustee was appointed to replace the debtor’s management,
and the Securities and Exchange Commission had a formal oversight role in the reorganization
process.17 The large public companies subject to Chapter X did not embrace these two requirements.18
They worked to avoid a bankruptcy filing — even when arguably necessary or prudent under the
circumstances — or tried to come within the provisions of Chapter XI of the Chandler Act.19
Chapter XI was intended for smaller, nonpublic companies and only addressed unsecured debt in
the debtor’s capital structure. Nevertheless, companies generally preferred this chapter because it
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11 See, e.g., Charles J. Tabb, The Future of Chapter 11, 44 S.C. L. Rev. 791, 803on N (“This idea that the preservation of a business
ed (1993) employees, and the public generally — is
as a going concern is better for everyone — creditors, stockholders, bondholders,
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not a new one. It has been around for at least a century, really ever since the Industrial Revolution reached full flower.”). James
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4
Madison was a proponent of early recognition of o. 1
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intimately connected with the regulationowcommerce, and will prevent so many frauds where the parties or their property may
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lie or be removed into different states, that the expediency of it seems not likely to be drawn into question.” Miller & Waisman,
xset
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i
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13
14
15
16
17
18
19
& n. 4 (quoting The Federalist No. 42, at 271 (James Madison) (Clinton Rossiter ed., 1961)).
See, e.g., Tabb, supra note 9, at 22.
“One of the primary purposes of the Bankruptcy Act is to ‘relieve the honest debtor from the weight of oppressive indebtedness,
and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes.” Local Loan
Co. v. Hunt, 292 U.S. 234, 244 (1934). See also David S. Kennedy & R. Spencer Clift III, An Historical Analysis of Insolvency Laws
and Their Impact on the Role, Power, and Jurisdiction of Today’s United States Bankruptcy Court and Its Judicial Officers, 9 Norton
J. Bankr. L. & Prac. 165, 176 (2000) (“The Chandler Act was the Congressional response to the depression and was modeled
after the emergency legislation of the early 1930’s. Since 1938, there has existed in America a Congressional policy favoring
reorganization over liquidation, where possible.”).
Sections 77 and 77B of the 1898 Bankruptcy Act adopted various features of the equity receivership model of reorganization
historically used for railroads and applied those features to railroads and other business entities. See, e.g., Skeel, supra note 9, at
54, 106; Bussel, infra note 17, at 1555–56.
“[The Chandler Act] was far-reaching in its scope and purpose. The Act comprised 15 chapters; the first seven chapters dealt with
the liquidation provisions substantially based upon the original 1898 Act while chapters eight through fifteen dealt primarily
with the rehabilitation of various classes of debtors.” Kennedy & Clift, supra note 13, at 176. For a detailed history and analysis of
the Chandler Act, see Vincent L. Leibell, Jr., The Chandler Act — Its Effect Upon the Law of Bankruptcy, 9 Fordham L. Rev. 380,
385–409 (1940).
See, e.g., Alexander L. Paskay & Frances Pilaro Wolstenholme, Chapter 11: A Growing Cash Cow Some Thoughts on How to Rein
in the System, 1 Am. Bankr. Inst. L. Rev. 331, 331 nn. 3 & 4 (briefly explaining Chapters X, XI, and XII).
See, e.g., SEC v. Am. Trailer Rentals Co., 379 U.S. 594, 603–06 (1965) (explaining development of the Chandler Act); Daniel J.
Bussel, Coalition-Building Through Bankruptcy Creditors’ Committees, 43 UCLA L. Rev. 1547, 1557–58 (1996) (explaining key
elements of Chapter X).
See Skeel, supra note 9, at 123–27 (explaining the general negative corporate reaction to Chapter X and noting that “[t]he
independent trustee requirement discouraged the managers of large firms from filing for bankruptcy if there was any way to
avoid it”).
See id. at 125–27. See also A. Mechele Dickerson, Privatizing Ethics in Corporate Reorganizations, 93 Minn. L. Rev. 875, 890
(2009) (“The harsh treatment managers received in Chapter X discouraged managers from using that Chapter and ultimately
caused Chapter XI to become the dominant reorganization vehicle for even large, publicly traded companies that ostensibly
should have filed under the trustee-controlled Chapter X.”). See Harvey R. Miller, Bankruptcy and Reorganization Through the
Looking Glass of 50 Years (1960–2010), 19 Norton J. Bankr. L. & Prac. 3 Art. 1 (1993) for a brief comparison about the treatment
of debtors and their management under Chapter X versus Chapter XI). For example, one source suggests that only a minor
portion of business bankruptcies were in fact commenced through Chapter X (e.g., 0.6 percent of total filings in 1971). David T.
Stanley & Marjorie Girth, The Brookings Inst., Bankruptcy: Problems, Process, and Reform (1971).
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placed the reorganization largely in the hands of the debtor and its unsecured creditors’ committee
and was premised on the efforts of these parties to structure a negotiated resolution to the debtor’s
financial distress.20 After almost 40 years of restructuring experience under Chapter X and Chapter
XI of the Chandler Act, policymakers and practitioners agreed that reform was needed.21
Consequently, in 1970, Congress created the Commission on the Bankruptcy Laws of the United
States (the “Commission on Bankruptcy Laws”) to “study, analyze, evaluate and recommend
changes to the [1898] Act.”22 In 1973, the Commission on Bankruptcy Laws issued a report and a
draft of proposed bankruptcy legislation.23 The National Conference of Bankruptcy Judges, excluded
from the Commission on Bankruptcy Laws, submitted a competing legislative proposal.24 President
Carter ultimately signed into law the 1978 Bankruptcy Code, which combined various concepts
from both legislative proposals and merged Chapters X, XI, and XII of the 1898 Bankruptcy Act
into a single business reorganization chapter (the current chapter 11).25 In passing the Bankruptcy
Code, Congress believed that “the purpose of a business reorganization case [under chapter 11] .
. . is to restructure a business’s finances so that it may continue to operate, provide its employees
with jobs, pay its creditors, and produce a return for its stockholders”26 with the understanding that
“reorganization, in its fundamental aspects, involves the thankless task of determining who should
share the losses incurred by an unsuccessful business and how the values of the estate should be
apportioned among creditors and stockholders.”27
6
1
After its enactment, Congress amended the Bankruptcy Code on a eperiodic and piecemeal
1, 20
b r2
ve
basis. In 1982, Congress broadened protections for the commodities m securities markets.28 In
n No and
ed o
rch
1984, Congress clarified the jurisdiction of the bankruptcyivcourts, set the term and appointment
63 a
-353
.1
procedures of bankruptcy judges, and enacted4 specialized rules for the treatment of collective
, No
rown
bargaining agreements.29 In 1986,h v. B
et Congress created additional bankruptcy judgeships, expanded the
Blixs
U.S. Trustee pilot program to a nationwide program,30 and codified chapter 12 for family farmers.31
ed in
cit
In 1988, Congress added protections for retirees and intellectual property licensees, and resolved
conflicts between bankruptcy law and state laws.32 In 1990, Congress added various provisions, such
as swap protections, making certain debts nondischargeable, and establishing bankruptcy appellate
panels.33 In 1992, Congress added more provisions related to, among others, judgeships and chapter
20
21
22
23
24
25
26
27
28
29
30
31
32
33
See Bussel, supra note 17, at 1557–58 (explaining key elements of Chapter XI).
Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 Mich. L. Rev. 336, 371–73 (1993) (“One of the key reasons
for the adoption of the 1978 Code was the widespread perception that the old Code was unworkable.”).
Act of July 24, 1970 Establishing a Commission on the Bankruptcy Laws of the United States, Pub. L. No. 91-354, 84 Stat. 468
(1970). For further discussion about the Commission on Bankruptcy Laws and its composition, see Report of the Commission on
the Bankruptcy Laws of the United States, 29 Bus. Law. 75, 75–76 (1973).
Report of the Commission on the Bankruptcy Laws of the United States, H.R. Doc. No. 93-137 (1st Sess. 1973). See also Report,
supra note 22; Frank R. Kennedy, The Report of the Bankruptcy Commission: The First Five Chapters of the Proposed New
Bankruptcy Act, 49 Ind. L.J. 422 (1974).
See Kenneth N. Klee, Legislative History of the New Bankruptcy Law, 28 DePaul L. Rev. 941, 943–44 (1979).
See Tabb, supra note 9, at 35.
Harvey R. Miller & Shai Y. Waisman, Is Chapter 11 Bankrupt?, 47 B.C. L. Rev. 129, 181 (2005) (quoting H.R. Rep. No. 95-595, at
220 (1978), reprinted in 1978 U.S.C.C.A.N. 5963, 6179).
Id. (quoting S. Rep. No. 95-989, at 10 (1978), reprinted in U.S.C.C.A.N. 5787, 5796).
See 1 Norton Bankr. L. & Prac. 3d § 2:11.
See id. § 2:12.
The U.S. Trustee Program was piloted in certain judicial districts prior to the 1986 legislation. The 1986 legislation made the
program permanent nationwide, with the exception of North Carolina and Alabama. Bankruptcy cases in Alabama and North
Carolina are not under the jurisdiction of the U.S. Trustee, but rather are administrated by Bankruptcy Administrators in those
jurisdictions.
See 1 Norton Bankr. L. & Prac. 3d § 2:13.
See id. § 2:14.
See id. § 2:15.
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12.34 In 1994, Congress again added various provisions, including changes in time limits, exemptions,
and criminal penalties.35
In 1994, Congress also created the National Bankruptcy Review Commission (the “NBRC”) to foster
a more systemic look at studying and reforming the Bankruptcy Code.36 The NBRC issued its report
in 1997,37 and several of its recommendations were addressed to varying degrees in the amendments
to the Bankruptcy Code set forth in the Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005 (the “BAPCPA Amendments”).38 BAPCPA implemented an extensive overhaul of both
the business and consumer provisions of the Bankruptcy Code.39
BAPCPA and the prior amendments affecting chapter 11 tried to address perceived deficiencies
in the Bankruptcy Code, but have in some respects altered the Bankruptcy Code’s original careful
balance between a debtor’s need to rehabilitate and its creditors’ rights to recoveries on their claims
against the debtor. In addition, the amendments have introduced perceived inequities among
different creditor constituencies. These factors, combined with the changing economic environment
and other externalities discussed below, have diluted the effectiveness of chapter 11 for many
companies and their stakeholders. Reminiscent of the time preceding the work of the Commission
on Bankruptcy Laws, companies once again are working to find alternatives to filing bankruptcy
cases, potentially at the expense of their creditors, shareholders, and employees.40 Accordingly, after
more than 35 years of experience under chapter 11, many practitioners and commentators agree
6
, 201
that it is again time for reform.41
er 21
34
35
36
37
38
39
40
41
in
ited
b
ovem
on N
ived
arch
363
-35
o. 14
n, N
Brow
th v.
lixse
B
See id. § 2:16. c
See id. § 2:17.
National Bankruptcy Review Comm’n Act, Pub. L. No. 103-394 §§ 601–702, 108 Stat. 4147 (codified at 11 U.S.C. § 101 (1994)).
For more information about the NBRC and its composition, see http://govinfo.library.unt.edu/nbrc/index.html.
National Bankruptcy Review Commission Final Report: Bankruptcy: The Next Twenty Years, Oct. 20, 1997, available at http://
govinfo.library.unt.edu/nbrc/reporttitlepg.html [hereinafter NBRC Report].
See Susan Jensen, A Legislative History of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, 79 Am. Bankr.
L.J. 485, 487–88 (2005).
Lubben, supra note 9, at 407–08.
A restructuring law that companies seek to avoid at all costs can exasperate companies’ financial distress and negatively impact
the overall economy. It can cause companies to increase leverage beyond sustainable levels in the hopes of buying time to find outof-court solutions. It can encourage companies to engage in speculative projects, undertake precipitous reductions in workforce,
and delay payments to vendors and suppliers who in turn may experience financial difficulties. This was the state of U.S. business
bankruptcy laws in 1978 when Congress enacted the Bankruptcy Code to overhaul Chapters X and XI of the 1898 Bankruptcy Act. It
is again the state of U.S. business bankruptcy laws, with companies — particularly small and medium-sized enterprises — avoiding
a chapter 11 filing whenever possible because of inefficiencies, uncertainty, and costs associated with the chapter 11 process. See,
e.g., infra note 60; Exploring Chapter 11 Reform: Corporate And Financial Institution Insolvencies; Treatment of Derivatives: Hearing
Before the Subcomm. on Regulatory Reform, Commercial and Antitrust Law of the H. Comm. on the Judiciary, 113th Cong. (Mar. 26,
2014) (written testimony of Professor Michelle M. Harner, Co-Director, Business Law Program, University of Maryland Francis
King Carey School of Law), at 2 & nn. 7–9 (noting that chapter 11 has become too expensive for businesses and causes companies to
close rather than timely file for bankruptcy, which has adverse consequences for the companies, their employees, and the economy)
(citations omitted), available at http://judiciary.house.gov/index.cfm/2014/3/hearing-exploring-chapter-11-reform-corporate-andfinancial-institution-insolvencies-treatment-of-derivatives.
See Richard Levin & Kenneth Klee, Rethinking Chapter 11, Int’l Insolvency Inst., Twelfth Annual Int’l Insolvency Conf. (June
21–22, 2012), available at http://www.iiiglobal.org/component/jdownloads/finish/337/5966.html. See also Douglas G. Baird &
Robert K. Rasmussen, Chapter 11 at Twilight, 56 Stan. L. Rev. 673 (2003); Stephen J. Lubben, Some Realism About Reorganization:
Explaining the Failure of Chapter 11 Theory, 106 Dick. L. Rev. 267 (2001); Harvey R. Miller, Chapter 11 in Transition — From
Boom to Bust and into the Future, 81 Am. Bankr. L.J. 375 (2007); Miller & Waisman, Does Chapter 11 Reorganization Remain a
Viable Option for Distressed Businesses for the Twenty-First Century?, supra note 8; Miller & Waisman, Is Chapter 11 Bankrupt?,
supra note 26; James H. M. Sprayregen et al., Chapter 11: Not Perfect, but Better than the Alternative, Am. Bankr. Inst. J., Oct.
2005, at 1; Written Statement of Bettina M. Whyte: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11
(Apr. 19, 2012) (providing an intriguing narrative story of how times have changed and the Bankruptcy Code has not), available
at Commission website, infra note 55.
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B. The Need for Reform
Chapter 11 of the Bankruptcy Code has served us well for many years. Nevertheless, today’s financial
markets, credit and derivative products, and corporate structures are very different than those
existing in 1978 when Congress enacted the Bankruptcy Code. Companies’ capital structures are
more complex and rely more heavily on leverage, which is secured under state enactments of the
Uniform Commercial Code that encumber vastly more assets than in 1978;42 their asset values are
driven less by hard assets (e.g., real estate and machinery) and more by services, contracts, intellectual
property, and other intangible assets; and both their internal business structures (e.g., their affiliates
and partners) and external business models are increasingly multinational. In addition, claims
trading and derivative products have changed the composition of creditor classes. Although these
developments are not unwelcome or unhealthy, the Bankruptcy Code was not originally designed to
rehabilitate companies efficaciously in this complex environment.43
Moreover, anecdotal evidence suggests that chapter 11 has become too expensive (particularly for
small and medium-sized enterprises) and is no longer capable of achieving certain policy objectives
such as stimulating economic growth, preserving jobs and tax bases at both the state and federal
level, or helping to rehabilitate viable companies that cannot afford a chapter 11 reorganization.44
Some professionals suggest that more companies are liquidating or simply closing their doors
without trying to rehabilitate under the federal bankruptcy laws.45 Commentators16 professionals
, 20 and
er 21
emb
also suggest that companies are waiting too long to invoke the federal v
No bankruptcy laws, which limits
d on
46
chive
companies’ restructuring alternatives and may lead to 3 ar
6 premature sales or liquidations.
42
43
44
45
46
53
14-3
No.
wn,
. Bro
eth v
Blixs
See, e.g., Mark Jenkins &ted in C. Smith, Creditor Conflict and the Efficiency of Corporate Reorganization, (paper presented at
David
ci
April 2014 symposium) (draft on file with Commission) (“Secured debt represented less than 45 percent of the debt of Moody’srated firms filing for bankruptcy in 1991; by 2012, secured debt accounted for more than 70 percent of the debt of Moody’srated bankruptcy filers.”), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2444700. For a discussion of the
amendments to the Uniform Commercial Code and their potential impact on secured creditors’ collateral packages, see Section
VI.C.4, Section 552(b) and Equities of the Case.
See, e.g., Ralph Brubaker, The Post-RadLAX Ghosts of Pacific Lumber and Philly News (Part II): Limiting Credit Bidding, Bankr.
L. Letter, July 2014, at 4 (“Two monumental developments in Chapter 11 practice that the Code drafters likely did not anticipate,
though, have skewed negotiations over allocation of reorganization surplus decisively in favor of senior secured creditors, in a
manner that the Code drafters also likely did not anticipate. The first is the ascendancy of secured credit in Chapter 11 debtors’
capital structures, such that it is now common that a dominant secured lender has blanket liens on substantially all of the debtor’s
assets securing debts vastly exceeding the value of the debtor’s business and assets. The second, related phenomenon is the rise of
‘relatively expeditious going-concern sales of the debtor’s business and assets to a third-party purchaser’ as a prominent means
of realizing the debtor’s going-concern value in Chapter 11.”) (citations omitted).
See, e.g., Oral Testimony of Joseph McNamara: NACM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11 (May 21, 2013) (“In my experience, over the last half decade, companies have had a harder and harder time successfully
reorganizing their debt and using the chapter 11 process, and thus are more prone to either fold their reorganization procedure
into a liquidation or successfully exit and then re-enter bankruptcy a few short years later.”), available at Commission website,
infra note 55. See also Stephen J. Lubben, What We “Know” About Chapter 11 Cost is Wrong, 17 Fordham J. Corp. & Fin. L. 1 (2012)
(reviewing literature and presenting empirical data to contradict common perceptions of bankruptcy costs); Written Statement
of John Haggerty, Argus Management Corp.: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Apr.
19, 2013) (describing an increase in the use of nonbankruptcy alternatives, including increased unsupervised winddowns, as a
result of the costs and loss of control associated with chapter 11), available at Commission website, infra note 55; Oral Testimony
of John Haggerty, Argus Management Corp.: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 36
(Apr. 19, 2013) (ASM Transcript) (describing how the DIP budget for professionals’ fees has ballooned and noting that such
costs keep small businesses out of chapter 11), available at Commission website, infra note 55.
See, e.g., Douglas G. Baird & Robert K. Rasmussen, The End of Bankruptcy, 55 Stan. L. Rev. 751, 777–85 (2002) (discussing
decrease in traditional stand-alone reorganizations). See also Oral Testimony of Dan Dooley: ASM Field Hearing Before the
ABI Comm’n to Study the Reform of Chapter 11, at 37 (Apr. 19, 2013) (ASM Transcript) (describing increased use of state and
local receiverships and ABCs in lieu of chapter 11 or chapter 7 because of the reduced costs and reduced delay), available at
Commission website, infra note 55.
See, e.g., Michelle M. Harner & Jamie Marincic Griffin, Facilitating Successful Failures, 66 Fla. L. Rev. 205 (2014) (analyzing
literature and presenting results of empirical survey on, among other things, timing of bankruptcy filings). See generally infra
note 66 and accompanying text (generally discussing limitations of chapter 11 empirical studies).
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Not all commentators agree that significant reform to chapter 11 is necessary. Some suggest that any
changes could have unintended consequences or negatively impact credit markets. Others simply
suggest that the system continues to work well enough.47
These issues are at the heart of the Commission’s study. As explained below, the Commission’s process
was designed to explore the new environment in which financially distressed companies operate and
to determine what aspects of the current system are — and are not — working as well as possible.
C. The Commission’s Study
The Commission has undertaken a methodical study of chapter 11 of the Bankruptcy Code. Over
250 corporate insolvency professionals (including the Commissioners, committee members, and
hearing witnesses) participated in this study. The Commission has strived to include all perspectives,
ideologies, and geographic and industry segments.
Notably, the Commission’s process resembles that of the 1970 Commission on Bankruptcy Laws and,
more recently, the 1994 NBRC in several respects. For example, the Commission used an advisory
committee structure, described below, similar to the eight-topic committee2016
structure invoked by the
21,
48
ber for addressing and deciding
NBRC. Similar to the NBRC, the Commissioners retained authority
m
Nove
e by
each issue.49 Moreover, each of the field hearings hosted d onthe Commission and described below
hiv
3 arc
3536
was open to the public, and the transcripts -(and, in many cases, video recordings) are posted on
14
No.
the Commission’s website at v. Brown,
www.commission.abi.org (the “Commission website”). In addition,
eth
similar to the process followed by the NBRC, the Commissioners appeared at restructuring events
Blixs
ed in
cit
throughout the country to discuss and publicize the Commission’s work and to solicit feedback from
affected constituents.50
The Commission has met on a regular basis since January 2012. During these meetings, the
Commission has, among other things, discussed issues perceived as potential problems in chapter
11, reviewed recent developments in the case law and practice norms, and developed an effective
process for identifying, researching, and analyzing chapter 11 as a whole. As explained below,
the Commission used its advisory committees and numerous public field hearings to amass the
information and research it required to critically analyze chapter 11 and consider any reform
measures.
The Advisory Committees. To launch its study, the Commission identified 13 broad study topics to
facilitate a detailed analysis of the various components of chapter 11. These study topics are: (1)
administrative claims and other pressures on liquidity; (2) avoiding powers (e.g., preferences and
fraudulent conveyances); (3) bankruptcy-remote and bankruptcy-proof entities; (4) distributional
issues under plans; (5) executory contracts and unexpired leases; (6) financial contracts, derivatives,
47
48
49
50
See, e.g., Stuart C. Gilson, Coming Through a Crisis: How Chapter 11 and the Debt Restructuring Industry Are Helping to Revive
the U.S. Economy, 24 J. Applied Corp. Fin. 23 (2012).
See NBRC Report, supra note 37, at 60–61.
See id. at 61.
See id. at 63.
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Bankruptcy Institute
and safe harbors; (7) financing issues; (8) governance and supervision of cases; (9) labor and benefits
issues; (10) multiple entities and corporate groups; (11) procedural and structural issues under
plans; (12) role of valuation; and (13) asset sales in chapter 11.51 The Commission then enlisted the
volunteer service of more than 150 of the insolvency profession’s expert judges, lawyers, financial
advisors, academics, and consultants to serve on advisory committees for each of these study topics.52
In forming the advisory committees, the Commission carefully vetted individuals who were
qualified to address particular issues within any given advisory committee’s charge. This vetting
process considered not only the individual’s knowledge and expertise in the area, but also whether
the individual would be likely to add a particular perspective on the issues while still considering the
overall integrity of the bankruptcy system. As such, each advisory committee received input from
the perspective of the various chapter 11 constituents — e.g., lenders, trade creditors, landlords,
employees, etc. — on each of the issues they addressed and presented to the Commission. The
diverse perspectives of the Commissioners and of the advisory committees added substantial value
to the Commission’s deliberations and decisions and the proposals encompassed in this Report.
The advisory committees began their work in April 2012. The Commission provided each advisory
committee with a preliminary assessment containing initial study questions for its general topic area.
Each advisory committee devoted significant time to researching and evaluating the study questions.
The advisory committees met either in-person or telephonically on a frequent basis to review their
6
research and debate the issues. The advisory committees engaged in this work ,for1
1 20 approximately 18
ber 2
months before submitting research reports on most topics to the n Novem
o Commission in December 2013.
ived
arch
363
5
The Commission then held a three-day ,retreat-3in February 2014 to meet with each advisory
o. 14
n N
Brow
committee and discuss the research .reports. At the retreat, the advisory committees presented their
th v
lixse
in B
reports and highlighteddcomplex and nuanced issues for the Commission, and the Commissioners
cite
actively engaged in a direct dialogue with advisory committee members. The Commission also used
the forum to begin integrating the study topics and reconciling overlapping issues. The retreat and
the work of the advisory committees leading up to the retreat sessions were informative and very
helpful to the Commission in this process. Since then, the Commission has reviewed the entire body
of work produced by the advisory committees and conducted follow-up research and analysis on a
variety of issues.
The Commission also formed an international working group consisting of leading practitioners and
academics from 13 different countries.53 The working group has studied targeted questions posed
51
52
53
The Commission deferred the work of the advisory committee on multiple entities and corporate groups; in the end, many
of the study questions initially assigned to that committee overlapped with and were addressed by other committees or the
Commission as a whole.
As noted above, supra note 3, the names and affiliations of members of the advisory committees are listed at Appendix C. In
addition, several of the advisory committees identified, and the Commission appointed, research fellows to provide research and
other support for the work of those advisory committees. The Commission is grateful for the service and contributions of the
advisory committee research fellows.
Members of the international working group are: Dr. A. Klauser and L. Weber, from Austria; S. Atkins and Professor R. Mason,
from Australia; Professor M. Vanmeenen and N. Wouters, from Belgium; S. Golick, from Canada; J-L. Vallens, M. André and
R. Dammann, from France; Professor R. Bork, Professor S. Madaus and A. Tashiro, from Germany; Professor S. Bariatti and G.
Corno, from Italy; H. Sakai, from Japan; Professor P.M. Veder and R.J. van Galen, from the Netherlands; Professor Wang Weigo
and Professor Li Shuguang, from the People’s Republic of China; Professor F. Garcimartín and A. Núñez-Lagos, from Spain;
Professor A. Boraine and A. Harris, from South Africa; Professor I.F. Fletcher, I. Williams, S. Bewick and R. Heis, from England
and Wales; and G. Stewart and M. Robinson from INSOL International, and Professor B. Wessels and R.J. de Weijs, from the
Netherlands as organizing members. Further contributions were made by E. Dellit, L. Farley, T. Hamilton, L. McCarthy and D.
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by the Commission and the advisory committees to provide a comparative analysis of the relevant
issues. These questions generally involved the following broader topics: (i) the use of surcharges
in sales; (ii) the treatment of intellectual property licenses in insolvency; (iii) financing options
for insolvent companies; (iv) the role of administrators and monitors; (v) plan issues (presenting,
voting, plans variations, and allocation rules); (vi) creditors’ or stakeholders’ committees; and (vii)
claims trading.
The Field Hearings. The Commission held its first public hearing in April 2012 at the U.S. House of
Representatives Committee on the Judiciary in the Rayburn House Office Building in Washington,
D.C. Since that time, the Commission has held 16 public field hearings in 11 different cities: Boston,
Las Vegas, Chicago, New York, Phoenix, San Diego, Tucson, Philadelphia, Austin, Atlanta, and
Washington, D.C. Collectively, almost 90 individuals testified at these hearings.54 The testimony at
each of these hearings was substantively rich and diverse. The hearings covered a variety of topics,
including chapter 11 financing, general administrative and plan issues, governance, labor and
benefits issues, priorities, sales, safe harbors, small and medium-sized enterprise cases, valuation,
professionals’ fees, executory contracts (including commercial leases and intellectual property
licenses), trade creditor issues, and reform of avoiding powers. Transcripts and videos of the
hearings, and the related witness statements, are available at the Commission website.55 A summary
of the hearing topics is attached at Appendix E.
6
1
Several common themes emerged from the field hearings. First, many rwitnesses acknowledged that
1, 20
be 2
include:
chapter 11 cases have changed over time.56 These changes on Novem (1) a perceived increase in the
d
chive
number and speed of asset sales under section 363 3 athe Bankruptcy Code;57 (2) a perceived decrease
of r
3536
. 14- decrease in recoveries to unsecured creditors;58 and
in stand-alone reorganizations; (3) anperceived
, No
ow
v. Br associated with chapter 11.59 Second, the witnesses who testified
(4) a perceived increase insthe costs
eth
Blix
on issues relatingitto small and medium-sized enterprises generally opined that chapter 11 no longer
ed in
c
54
55
56
57
58
59
Elliott (Australia), C. Fell, M. Rochkin, S. Obal and Professor J. Sarra (Canada), L. Valentovish (Japan), L. Harms (South Africa)
and C. E. Poolis (England).
The names and affiliations of these witnesses are listed at Appendix D.
All testimony and statements related to the Commission’s study from 2012 through 2014 that are cited in the Report are available
at the Commission website at www.commission.abi.org [hereinafter Commission website].
See Oral Testimony of Bryan Marsal: NCBJ Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 15–19
(Oct. 26, 2012) (NCBJ Transcript) (“There is a gradual erosion of the underlying public principle of the Code which was to
preserve jobs and maximize value through rehabilitation.”), available at Commission website, supra note 55; First Report of the
Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial Fin. Ass’n Annual
Meeting, at 2 (Nov. 15, 2012) (“[A] principal criterion for evaluating any proposed amendments to the Code is the extent to
which they maximize the value of companies as going concerns (thereby preserving jobs and maximizing value for creditors),
either through a reorganization in those situations where reorganization is a realistic option, or through a sale or liquidation
where reorganization is not a realistic option.”), available at Commission website, supra note 55.
See Oral Testimony of Gerald Buccino: TMA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 19 (Nov.
3, 2012) (TMA Transcript) (“When sales occur too quickly before the rehabilitative process, the yield to prepetition creditors is
diminished.”), available at Commission website, supra note 55; Oral Testimony of Michael Richman: NCBJ Field Hearing Before
the ABI Comm’n to Study the Reform of Chapter 11, at 20 (Oct. 26, 2012) (NCBJ Transcript) (recommending that section 363
sales should be modified so that courts can restrain hasty sales and better monitor expedited sales), available at Commission
website, supra note 55.
See Written Statement of Paul Calahan: NACM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (May 21,
2013) (“The Code and the economic environment have made it more difficult for unsecured creditors to realize fair payment of
their claims . . . A voice for unsecured creditors is clearly needed and provides valuable insight to the court and other parties.”),
available at Commission website, supra note 55; Written Statement of Joseph McNamara: NACM Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11 (May 21, 2013) (“A tremendous disparity remains between payment of secured
and unsecured claims and some evidence suggests secured creditors with first liens experienced outstanding recoveries, while
unsecured recoveries were around 20%, with the median recovery set at 10%.”), available at Commission website, supra note 55.
See Written Statement of John Haggerty, Argus Management Corp.: ASM Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11 (Apr. 19, 2013) (recommending that the level of professionals should be rationalized at the onset of a case and fees
and billing should be more transparent and have greater oversight during the process to keep overall costs down), available at
Commission website, supra note 55.
III. Background on the Commission and the Study Project
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works for these companies. Witnesses cited cost and procedural obstacles as common barriers.60
Third, the witnesses who testified on financial contracts and derivatives generally agreed that the
safe harbor protections have been extended to contracts and situations beyond the original intent
of the legislation.61 They did not necessarily agree, however, on appropriate limitations or revisions
to the relevant sections of the Bankruptcy Code.62 Finally, witnesses — even those who were highly
critical of certain aspects of chapter 11 — all perceived value in the U.S. approach to corporate
bankruptcies, including the debtor in possession model.63
In addition, the Commission worked with the University of Illinois College of Law to organize
and host an academic symposium on the role of secured credit in business bankruptcies in April
2014. Nineteen of the nation’s leading bankruptcy scholars contributed to the symposium.64 The
symposium was open to the public, and both the scholarship presented and a video recording of the
event are posted on the Commission website. Many of the scholarly papers from this symposium
will also be published in a forthcoming issue in the 2015 volume of the Illinois Law Review.
D. The Commission’s Deliberations
Immediately following its February 2014 retreat, the Commission began its in-depth review of the
16
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advisory committees’ reports and recommendations, various issue-specific white papers prepared
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Commissioners and research fellows, the
a
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papers from the Illinois symposium, and testimony
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restructuring professionals.65 ThehCommission then held five separate executive session retreats to
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deliberate, formulate, tandn vote on the content of this Report. Two of these retreats were held in
ed i
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60
61
62
63
64
65
See Written Statement of the Honorable Dennis Dow: Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Apr.
19, 2013) (noting that the complexity, time, and costs of the chapter 11 process impose obstacles that small business debtors
often cannot overcome), available at Commission website, supra note 55; Written Statement of Professor Anne Lawton: NCBJ13
Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Nov. 1, 2013) (“The Code’s small business debtor
definition should be simplified.”), available at Commission website, supra note 55; Oral Testimony of Gerald Buccino: TMA Field
Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 7, 15 (Nov. 3, 2012) (TMA Transcript) (“A one-size-fits-all
approach for the Code does not work because smaller businesses have special needs.”), available at Commission website, supra
note 55; Oral Testimony of Jeff Wurst: NYIC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 28 (June
4, 2013) (NYIC Transcript) (stating smaller companies can no longer afford to seek protection under chapter 11), available at
Commission website, supra note 55.
See Written Statement of Daniel Kamensky on behalf of Managed Funds Association: LSTA Field Hearing Before the ABI Comm’n to
Study the Reform of Chapter 11 (Oct. 17, 2012) (asserting that the breadth of safe harbors has had unintended consequences and
some courts have held that safe harbors extend to protect one-off private transactions that do not affect financial institutions),
available at Commission website, supra note 55; Oral Testimony of Jane Vris on behalf of the National Bankruptcy Conference:
NYCBC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 9 (May 15, 2013) (NYCBC Transcript)
(“The original purpose of the safe harbors was to preserve the clearing of payments and delivery within a fair closed system, the
protections have now expanded beyond that.”), available at Commission website, supra note 55; Written Statement of Jane Vris
on behalf of the National Bankruptcy Conference: NYCBC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11
(May 15, 2013), available at Commission website, supra note 55.
See Oral Testimony of the Honorable James Peck: NYCBC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 31–32 (May 15, 2013) (NYCBC Transcript) (recommending that judges should have more discretion to determine whether
contracts fit the criteria for protection under the safe harbors), available at Commission website, supra note 55.
See Written Statement of William Greendyke: UT Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Nov. 22,
2013) (reporting that the membership of the Bankruptcy Law Section of the State Bar of Texas noted that the chapter 11 process
still worked, but found it to be more expensive and “faster” than 10 years ago), available at Commission website, supra note 55.
The names and affiliations of the academics who presented at this symposium are listed at Appendix F.
Certain of the materials that the Commission reviewed and discussed during the three-year study and deliberative process are
identified in the footnotes in this Report. These citations capture but a fraction of the materials collected and reviewed by the
Commissioners during this process. It simply was not feasible to cite all relevant sources and materials. The absence of a citation
to a particular court opinion, empirical study, law review article, or witness’s testimony does not mean that such material was not
considered and analyzed by the Commissioners.
III. Background on the Commission and the Study Project
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Virginia, two in New York, and one in Chicago. The Commission also held numerous subcommittee
meetings in between each of these executive session retreats.
At each of the executive sessions, the Commission reviewed issues raised by witness testimony or
examined in the research materials prepared by the Reporter and the advisory committees, including
the advisory committee’s recommendations on the initial study topics posed by the Commission.
Moreover, the reports of the international working group informed many of the Commission’s
deliberations. From these discussions, the Commissioners worked to identify areas of potential
reform that would, among other things, improve case efficiencies, enhance business rehabilitations
and creditors’ recoveries, and resolve uncertainty or ambiguity in the current law.
During the three-year study process, and in connection with its deliberations, the Commission
compiled and reviewed, among other materials, an extensive database of empirically based articles
and working papers concerning different aspects of chapter 11 of the Bankruptcy Code. In reviewing
all empirical data, including the data cited in this Report, the Commissioners were aware of the
limitations that frequently impact chapter 11 data, including the following. First, endogeneity bias
often is a problem in chapter 11 studies: (i) to the extent that omitted or unattainable information
affects results (e.g., off-docket activity and negotiations; makeup of creditor body; talent or dynamics
of management team; financial condition of debtor prior to and on petition date; impact of prepetition
management decisions on company’s case; and, in some instances, economic or industry cycles),
6
omitted variable bias occurs; and (ii) when the causal direction between 201 variables cannot be
1, two
ber 2
ve
determined, simultaneity bias might occur (e.g., does the presence m private funds in a case make it
n No of
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more successful or do private funds invest in cases3 archiv better positioned to be more successful).66
that are
3536
. 14- of available data sources are not randomly sampled
Second, selection bias can occur whenNo
, subsets
own
v. Br
or the pool from which xsethsample is drawn is not representative of the entire population (selfthe
Bli
d in
selection bias cantealso limit empirical survey studies). Third, coder bias and intercoder reliability
ci
can skew interpretation or results (e.g., if more than one coder is involved in the project, each may
interpret the often subjective items on a chapter 11 docket in different ways, despite efforts to achieve
an acceptable intercoder reliability rate). Fourth, data are limited and subjective: for example, it is
difficult to define “success” in chapter 11; it is difficult to determine if a plan is a traditional standalone reorganization or a merger or a third party sale — they are all change of control events, and
many datasets do not capture these nuances; and outside of public bondholders, it is difficult to
determine recoveries in chapter 11 cases, particularly for smaller cases. Finally, because of the biases
and limitations noted above, as well as others not discussed here, it might be difficult to establish
strong claims of causality in empirical studies of chapter 11 cases. Nevertheless, the Commission
reviewed empirical data from numerous sources and supporting a variety of different positions on
the issues before it; it found all of the data informative, and it used the data in its overall consideration
of all relevant factors.
The recommended principles set forth in this Report are the result of the Commission’s study and
deliberative process. The Commissioners voted on each principle, and a principle was adopted
as a Commission recommendation if it received support from two-thirds of the Commissioners
voting, with 11 favorable votes being the minimum required for a principle being reported as a
66
See generally Michael R. Roberts & Toni M. Whited, Endogeneity in Empirical Corporate Finance, in Handbook of the Economics
of Finance (2014) (discussing these issues with endogeniety, as well as measurement errors in that context).
III. Background on the Commission and the Study Project
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recommendation. If the requisite level of support was not obtained, this Report includes a description
of the issue, a summary of the factors considered by the Commission in connection with the issue,
and a notation that no consensus emerged. The Commission believed that this Report achieves its
core mission to “study and propose reforms to Chapter 11 and related statutory provisions that
will better balance the goals of effectuating the effective reorganization of business debtors — with
the attendant preservation and expansion of jobs — and the maximization and realization of asset
values for all creditors and stakeholders.”67
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67
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See Commission’s mission statement, supra at 3.
III. Background on the Commission and the Study Project
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IV. PROPOSED
RECOMMENDATIONS:
COMMENCING THE CASE
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The financially distressed company is typically the party that commences the chapter 11 case by
filing a voluntary petition for relief under chapter 11 of the Bankruptcy Code. Although creditors
may file an involuntary chapter 11 petition against a company under section 303 of the Bankruptcy
Code, creditors rarely invoke this remedy.68 One study reported that involuntary bankruptcies
“have represented less than one-tenth of one per cent of all U.S. liquidation bankruptcy cases for
over a decade.”69 Creditors may consider an involuntary chapter 11 filing during their prepetition
negotiations with a debtor. It is most common, however, for the debtor to then file a voluntary case
or for the parties to reach an out-of-court resolution.70
Companies do not undertake a chapter 11 filing lightly. A company’s management is commonly
concerned about the public nature of a chapter 11 case and the potential distractions to the business
caused by enhanced oversight from the court, the U.S. Trustee, creditors, and other parties in interest.71
In fact, some commentators and practitioners suggest that financially distressed companies tend to
wait too long to file a chapter 11 case, which makes it more difficult to use the restructuring tools
of chapter 11 in an effective manner.72 Regardless, chapter 11 provisions should help companies
achieve a “soft landing” in bankruptcy — i.e., minimize business disruptions to foster reorganization
prospects — and develop a feasible restructuring strategy that benefits all stakeholders.
Witnesses before the Commission testified concerning the various perceived barriers to successful
reorganizations under chapter 11, including challenges to financing chapter 11 cases, uncertainty
6
and costs associated with the bankruptcy process, delays built into the process, and1insufficient value
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available to support a restructuring.73 Some witnesses suggestednthatvem perceived barriers may
No these
do
74 e
chivAnecdotal evidence likewise indicates
cause companies to forego the chapter 11 process entirely.
3 ar
3536
. 14that distressed companies are increasinglyNturning to state law remedies (e.g., receiverships and
, o
own
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assignments for the benefit of eth
creditors) and equity receivership law with more frequency now
xs
i
in Bl
cited
68
69
70
71
72
73
74
The Administrative Office of the U.S. Courts stopped collecting data on involuntary bankruptcies apparently because of their
rarity. See Robert M. Lawless & Elizabeth Warren, The Myth of Disappearing Business Bankruptcy, 93 Cal. L. Rev. 743, 750 n. 11
(2005).
Jason Kilborn & Adrian Walters, Involuntary Bankruptcy as Debt Collection: Multi-Jurisdictional Lessons in Choosing the Right
Tool for the Job, 87 Am. Bankr. L.J. 123, 125 (2013).
See Susan Block-Lieb, Why Creditors File So Few Involuntary Petitions and Why the Number Is Not Too Small, 57 Brooklyn L. Rev.
803, 805–06 (“Creditors file few involuntary petitions because they often prefer a negotiated resolution of a debtor’s financial
troubles.”).
See, e.g., Stephen J. Lubben, The Direct Costs of Corporate Reorganization: An Empirical Examination of Professional Fees in Large
Chapter 11 Cases,74 Am. Bankr. L.J. 509, 543 (“The indirect costs [of chapter 11] . . . include loss in value due to managerial
distraction, foregone investment opportunities, erosion of customer confidence, increases in employee turnover, and increased
cost of supplier credit.”).
See, e.g., Harner & Griffin, supra note 46, 324–38 (2014) (presenting empirical survey of 453 restructuring professionals and data
showing that, of those professionals who had clients refuse to file a bankruptcy case at a time the professional thought advisable,
90 percent of those companies ultimately had to file a case). See generally supra note 66 and accompanying text (generally
discussing limitations of chapter 11 empirical studies).
See Oral Testimony of Josh Gotbaum: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 18 (Mar.
14, 2013) (ACB Transcript) (“[I]n many cases financial institutions and financial markets have outstripped the law’s ability to
comprehend them and the bankruptcy court’s ability to preserve fair treatment of other constituencies in the face of them.”),
available at Commission website, supra note 55; Oral Testimony of Wilbur Ross: ASM Field Hearing Before the ABI Comm’n to
Study the Reform of Chapter 11, at 4–7 (Apr. 19, 2013) (ASM Transcript) (discussing unpredictable cost increases in chapter 11),
available at Commission website, supra note 55; Oral Testimony of the Honorable James Peck: VALCON Field Hearing Before the
ABI Comm’n to Study the Reform of Chapter 11, at 29–30 (Feb. 21, 2013) (VALCON Transcript) (discussing problems faced in
some cases, including waste and delay as a result of valuation issues), available at Commission website, supra note 55.
See Written Statement of John Haggerty, Argus Management Corp.: ASM Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11 (Apr. 19, 2013) (stating that a large majority of clients avoid chapter 11 and seek state law relief because of the
costs, delay, structure of case administration, control by the secured creditor, and lack of flexibility attendant in a chapter 11
case), available at Commission website, supra note 55; Oral Testimony of John Haggerty, Argus Management Corp.: ASM Field
Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 34–36 (Apr. 19, 2013) (ASM Transcript) (same), available
at Commission website, supra note 55.
IV. Proposed Recommendations: Commencing the Case
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than in the past 75 years.75 Moreover, there is no meaningful way to discern how many distressed
companies that could have used chapter 11 simply closed their doors instead of pursuing alternatives
through the reorganization process.
The Commission was very mindful of these considerations in reviewing issues relating to the filing,
financing, and initial steps of a chapter 11 case. The principles in this section strive to address several
of these issues.
A. Oversight of the Case
1. The Debtor in Possession Model
Recommended Principles:
The ability of the debtor to act as a debtor in possession and assume the duties
and powers of a trustee in bankruptcy is a central feature of chapter 11 of the
Bankruptcy Code. It allows the debtor to continue its operations16
with minimal
20
r 21,
disruptions while still serving the interests of the debtor’sbcreditors and, in many
e
ovem
on N
cases, its equity security holders as well. Accordingly, the debtor in possession
ed
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63 a
model should continue as the default3rule under chapter 11.
4-35
.1
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rown
Applicable stateslaw v. B
h fiduciary duties should continue to govern the conduct of the
x et
n Bli
i
debtor iindpossession’s board of directors, officers, or similar managing persons.
c te
For a discussion of directors’, officers’, and similar managing persons’ fiduciary
duties in the plan context, see Section VI.A.2, Role of Debtor in Plan Process.
The Debtor in Possession: Background
A fundamental feature of chapter 11 of the Bankruptcy Code is the “debtor in possession” concept.
This feature allows the financially distressed company to remain in control of its assets and to
continue to operate its business after commencing the chapter 11 case. Accordingly, on the petition
date, the company assumes the new legal capacity of a “debtor in possession.”76
In a typical chapter 11 case, the debtor in possession’s prepetition board of directors and officers will
continue to manage the debtor’s affairs and make decisions regarding both the debtor’s business and
its reorganization efforts in the chapter 11 case. The debtor in possession model was expanded by
75
76
Oral Testimony of Dan Dooley: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 36–39 (Apr. 19,
2013) (ASM Transcript) (discussing increased use of state law alternatives to chapter 11 such as local and state receiverships and
assignments for the benefit of creditors (ABCs)), available at Commission website, supra note 55. For a further discussion of the
use of receiverships, see Section VII.B, General Application of SME Principles.
This Report refers only to the trustee in certain principles, and those references are intended to include the debtor in possession
as applicable under section 1107 of the Bankruptcy Code. In addition, the Report discusses the implications of certain principles
for debtors in possession, which likewise apply to any chapter 11 trustee appointed in the case.
IV. Proposed Recommendations: Commencing the Case
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chapter 11 in the 1978 Bankruptcy Code from the company’s active role in the rehabilitation process
under Chapter XI (but not Chapter X) of the 1898 Bankruptcy Act.77 Practice under the Bankruptcy
Act suggested that boards of directors and management resisted a process — even if arguably beneficial
to their restructuring efforts — that required them to cede control of their business and restructuring
efforts to an outside party. This requirement contributed in part to the failure of Chapter X of the
Bankruptcy Act because it mandated the appointment of a trustee to run the debtor’s business and
bankruptcy case.78 Notably, section 1107 of the Bankruptcy Code authorizes the debtor in possession
to, among other things, exercise all “the rights . . . and powers, and [requires it to] perform all the
functions and duties . . . of a trustee serving in a case under this chapter,” with only minor exceptions
that do not detract from the central role of the debtor in possession in the case.79
Proponents of the debtor in possession model highlight the knowledge and expertise of the debtor’s
prepetition directors, officers, or similar managing persons concerning the debtor’s business and
financial affairs.80 The ability of the debtor in possession to continue to operate through its prepetition
management team facilitates the company’s seamless transition into chapter 11 and allows the debtor
to avoid the additional time, cost, and resulting inefficiencies of bringing in an outsider who is not
familiar with the debtor’s business specifically or the debtor’s industry generally.81 The prepetition
management team may also have industry relationships or “know-how” that would benefit the
debtor’s restructuring efforts.
6
Critics of the debtor in possession model note that the debtor’s financial er 2operational difficulties
or 1, 201
b
may relate, at least in part, to the conduct or decisions of theon Novem prepetition directors and
debtor’s
d
82
chive team that was in charge during the
officers. Some critics argue that allowing the management
3 ar
3536
. 14- rewards subpar performance and undermines
debtor’s financial decline to remain in ncontrol
, No
ow
v. Br for the debtor’s stakeholders.83 Some critics also worry that
confidence in the reorganization tprocess
eh
Blixs
prepetition management may be motivated by factors not necessarily aligned with the best interests
ed in
cit
77
78
79
80
81
82
83
See Clifford J. White III & Walter W. Theus, Jr., Chapter 11 Trustees and Examiners After BAPCPA, 80 Am. Bankr. L.J. 289, 292
n. 15 (2006) (“[T]he debtor generally remained in possession of its property and had all of the rights and powers of a trustee,
subject to such limitations as the court might impose.”) (citations omitted). See generally John Wm. Butler, Jr., et al., Preserving
State Corporate Governance Law in Chapter 11: Maximizing Value Through Traditional Fiduciaries, 18 Am. Bankr. Inst. L. Rev.
337 (2010) (detailing the history and role of the debtor in possession model in chapter 11).
See H.R. Rep. No. 95-595, at 222, reprinted in 1978 U.S.C.C.A.N. 6182 (“Less than ten percent of all business reorganization cases
are under Chapter X. Chapter XI is the much more popular procedure, even though what can be done under Chapter XI is less
than under Chapter X.”) (citation omitted). See also Douglas E. Deutsch, Ensuring Proper Bankruptcy Solicitation: Evaluating
Bankruptcy Law, the First Amendment, the Code of Ethics, and Securities Law in Bankruptcy Solicitation Cases, 11 Am. Bankr. Inst.
L. Rev. 213, 217–18 (2003) (explaining debtors’ preference for Chapter XI under the Bankruptcy Act). The inflexible, mandatory
absolute priority rule was also arguably a contributing factor to its failure. See Skeel, supra note 9, at 163 (“The draconian effect
of Chapter X, together with the fact that so many large firms had already failed during the depression, caused a dramatic drop in
Chapter X cases.”).
11 U.S.C. § 1107.
See, e.g., In re Marvel Entm’t Grp., Inc., 140 F.3d 463, 471 (3d Cir. 1998) (“[V]ery often the creditors will be benefited by
continuation of the debtor in possession, both because the expense of a trustee will not be required, and the debtor, who is
familiar with his business, will be better able to operate it during the reorganization case.”).
See H.R. Rep. No. 95-595, at 233, reprinted in 1978 U.S.C.C.A.N. 6192 (“A trustee frequently has to take time to familiarize
himself with the business before the reorganization can get under way.”). See also David A. Skeel, Jr., Markets, Courts, and
the Brave New World of Bankruptcy Theory, 1993 Wis. L. Rev. 465, 517 & n.188 (1993) (“In the nonclosely held firm context,
immediate removal of management would create significant indirect costs both before and during the bankruptcy.”).
See, e.g., A. Mechele Dickerson, The Many Faces of Chapter 11: A Reply to Professor Baird, 12 Am. Bankr. Inst. L. Rev. 109, 135
(2004) (“[T]here should be a rebuttable presumption that the directors of insolvent firms are unfit for board service and that they
should be disqualified from future board service”); Lynn M. LoPucki, The Trouble with Chapter 11, 1993 Wis. L. Rev. 729, 732
n.11 (1993) (noting that prepetition management may pursue “directions that are not in economic interests of the company”).
Written Testimony of the Honorable Joan N. Feeney: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 5 (Apr. 19, 2012) (citing a Cornell University study indicating that the strongest contributor to post-bankruptcy success is new
management and arguing that bankruptcy judges need tools to deal with failed managers), available at Commission website,
supra note 55.
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of the estate, such as retaining their jobs or downplaying prepetition events that may implicate them
in the debtor’s financial distress.84
Although the criticisms of the debtor in possession model raise some valid concerns, rather than
being caused by management, a company’s chapter 11 filing is frequently triggered by a downturn
in the overall economy, a fluctuation in markets particular to the debtor’s industry (e.g., pricing of a
commodity necessary to the debtor’s operations), or a failed (but not negligent or fraudulent) business
strategy. In these instances, the debtor’s management team typically maintains the confidence of the
debtor’s stakeholders and can be an asset to the debtor’s reorganization efforts. Moreover, in some
cases, the debtor may have replaced certain (or all) of its directors or officers either well before
or shortly before filing in anticipation of the chapter 11 filing. These management changes may
include the appointment of a chief restructuring officer who is often an experienced restructuring
professional.85 Accordingly, the debtor’s management immediately preceding the petition date may
be completely divorced from the decisions, actions, and circumstances that contributed to the
debtor’s distress.
The Bankruptcy Code also places certain checks on the debtor in possession’s power and decisionmaking authority in chapter 11. For example, the debtor in possession may be replaced by a trustee
for cause; a statutory unsecured creditors’ committee frequently is appointed to oversee the debtor
in possession’s conduct and to represent the interests of unsecured creditors; major decisions and
6
transactions require notice, hearing, and court approval; and the U.S.er 21, 201and parties in interest
Trustee
b
em
have standing to raise and be heard on matters in the case.86 Novaddition, the directors, officers, or
n In
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iv
ar h
similar managing persons of the debtor in possessioncare bound by their state law fiduciary duties.87
363
The Debtor
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in Possession: Recommendations
in B
cited
and Findings
The Commission considered the arguments in favor of and against the debtor in possession model.
It also reviewed the potential alternatives to the debtor in possession model, which include the
mandatory appointment of a trustee (as under Chapter X of the 1898 Bankruptcy Act), a receiver,
or an administrator to replace the debtor’s management as of the petition date. In these alternative
structures, management could stay in place and continue to work for the debtor, but it would
be stripped of all management powers, which would then be vested in the trustee, receiver, or
84
85
86
87
See LoPucki, supra note 82, at 733 (“Because the[] [management] retain[s] the benefits of risk taking without suffering a
corresponding share of the losses, it may be in their interests that the company take risks not justified by the expected returns to
the company.”).
See, e.g., Butler, et al., supra note 77, at 356 (“Employing turnaround professionals as CROs has become common in recent years.
Often creditors insist that companies install third-party CROs in the midst of a dire financial situation.”).
For a general discussion of the parties overseeing the debtor in possession in chapter 11, see Butler, et al., supra note 77. See also
11 U.S.C. § 1103 (detailing duties of statutory committees; id. § 1104 (appointment of trustee); id. § 1109 (explaining standing
of parties in interest).
Courts generally defer to the fiduciary duties of the debtor in possession’s directors and officers under applicable state law. See,
e.g., In re Schipper, 933 F.2d 513, 515 (7th Cir. 1991) (applying state law fiduciary duties and rejecting common law or other
duties akin to those of a trustee). The case law concerning the beneficiary of these duties is mixed, with some courts suggesting,
for example, that the duties might be owed to the estate, specific creditors, or all creditors, while others again defer to state law.
See, e.g., Petit v. New Eng. Mortg. Servs. Inc., 182 B.R. 64, 69 (D. Me. 1995) (quoting In re Ionosphere Clubs, Inc., 113 B.R. 164,
169 (Bankr. S.D.N.Y. 1990)) (“[D]ebtor in possession is a fiduciary of the creditors and, as a result, has an obligation to refrain
‘from acting in a manner which could damage the estate, or hinder a successful reorganization.’”) (citation omitted). See also
In re Brook Valley VII, Joint Venture, 496 F.3d 892, 900 (8th Cir. 2007) (“Debtors in possession and those who control them
owe fiduciary duties to the bankruptcy estate. The fiduciary obligations consist of two duties: the duty of care and the duty of
loyalty.”); In re Coram Healthcare Corp., 271 B.R. 228, 235 (Bankr. D. Del. 2001) (“The DIP must not self-deal, cannot act with a
conflict of interest and must not take actions which are improper.”). As explained below, the Commission addressed these issues
in its deliberations.
IV. Proposed Recommendations: Commencing the Case
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administrator. Moreover, the trustee, receiver, or administrator could terminate the employment of
the debtor’s management altogether.
The Commissioners debated the potential utility of a third-party manager to the bankruptcy estate.
The Commission determined that these third-party alternatives could add the most value to cases
involving fraudulent or incompetent management. The Commissioners acknowledged, as discussed
further below, that section 1104 of the Bankruptcy Code currently mandates the appointment of
a trustee in such cases.88 The Commission also considered that in recent years many countries
have adopted some form of the debtor in possession model either in lieu of or as an alternative
(at the company’s election) to a receiver or administrator.89 This trend suggests broad recognition
of the potential benefits of allowing the honest-but-unfortunate company debtor to lead its own
restructuring efforts. Thus, on balance, the Commission concluded that the potential value of a
mandatory trustee-like actor was significantly outweighed by the potential disruption, costs, and
inefficiencies associated with the displacement of the debtor’s management. Accordingly, the
Commission recommended retention of the debtor in possession model.
As part of that decision, the Commission also agreed that directors, officers, and similar managing
persons who operate a business in chapter 11 should remain subject to their state law fiduciary
duties.90 The Commissioners analyzed whether creating a new fiduciary standard under federal
bankruptcy law would better serve the purposes of the Bankruptcy Code. Any federal standard
6
would incorporate the traditional duties of care and loyalty, as well as good r 21, 2either as a subset of
faith 01
be
vem
the duty of loyalty or an independent duty.91 As the Commissionersodiscussed this possibility, they
nN
ed o
recognized significant value in aligning the fiduciary 363 archivthe debtor in possession’s management
duties of
35
. 14- consistency to the process and is informed by the
with state law fiduciary duties. This approach o
, N lends
own
v. Brfiduciary duties.
wealth of case law discussing state law
h
xset
i
in Bl
cited
88
89
90
91
11 U.S.C. § 1104(a) (providing that, upon the request of a party in interest or the U.S. Trustee, the court shall appoint a trustee “for
cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management,
either before or after the commencement of the case, or similar cause”) (emphasis added). In addition, section 1104(e) provides:
“The United States trustee shall move for the appointment of a trustee under subsection (a) if there are reasonable grounds
to suspect that current members of the governing body of the debtor, the debtor’s chief executive or chief financial officer, or
members of the governing body who selected the debtor’s chief executive or chief financial officer, participated in actual fraud,
dishonesty, or criminal conduct in the management of the debtor or the debtor’s public financial reporting.” 11 U.S.C. § 1104(e).
See, e.g., Business Continuity Act of 31 Jan. 2009 (Belgium: debtor remains in control during moratorium period with limited
control by the court); Companies’ Creditors Arrangement Act (Canada: debtor remains in control and is assisted by a courtappointed monitor frequently selected by the debtor); Insolvenzordnung, German Insolvency Act §§ 80, 270 (Germany: provides
for “self-administration” in which the debtor works to reorganize under the surveillance of a supervisor; debtor may elect selfadministration provided that there are “no facts known which give reason to expect that the order will lead to disadvantages to
the creditors”); Civil Rehabilitation Act (Japan: debtor remains in control and is monitored by a supervisor).
This Report refers to “applicable state entity governance law” to capture not only state corporate law, but also applicable state
law governing unincorporated entities (e.g., partnerships, limited liability companies, etc.). In addition, references to “board of
directors” and “directors, officers, and similar managing persons” are intended to refer to the individuals or entities acting on
behalf of unincorporated entities in capacities similar to those of the board, directors, and officers in the corporate context.
See, e.g., Lange v. Schropp (In re Brook Valley VII, Joint Venture), 496 F.3d 892, 900 (8th Cir. 2007) (explaining that, in the
bankruptcy context, “[t]he fiduciary obligation consists of two duties: the duty of care and the duty of loyalty”); Ad Hoc Comm.
of Equity Holders of Tectonic Network, Inc. v. Wolford, 554 F. Supp. 2d 538, 558 n.135 (D. Del. 2008) (duty of good faith is a subset
of the duty of loyalty in the bankruptcy context); Unif. P’ship Act § 404 (1997) (fiduciary duties of partners in partnership). See
also Gantler v. Stephens, 965 A.2d 695, 708–09 (Del. 2009) (“In the past, we have implied that officers of Delaware corporations,
like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors.
We now explicitly so hold.”) (citation omitted); Stone v. Ritter, 911 A.2d 362, 369–70 (Del. 2006) (“The failure to act in good faith
may result in liability because the requirement to act in good faith ‘is a subsidiary element[,]’ i.e., a condition, ‘of the fundamental
duty of loyalty.’”) (quoting Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003)); Lyman P.Q. Johnson & Mark A. Sides, The
Sarbanes-Oxley Act and Fiduciary Duties, 30 Wm. Mitchell. L. Rev. 1149, 1205–06 (2004) (“Although often overlooked, corporate
officers, including senior officers such as the Chief Executive Officer, the Chief Financial Officer, Chief Technology Officer,
General Counsel, Executive Vice Presidents, the Treasurer, the Secretary, and others are ‘agents’ of the corporation. Agency is
a fiduciary relationship. Even though senior officers of corporations typically have employment agreements, they still occupy a
fiduciary status in relation to the corporate principal.”) (citations omitted).
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The Commissioners also discussed the potential conflicts in duties that could result from federalizing
the fiduciary duties of directors, officers, and similar managing persons. For example, most state laws
provide that directors, officers, and similar managing persons owe a fiduciary duty to the company,
which is enforceable by its shareholders when the company is solvent and also by its creditors when
it is insolvent.92 Some courts have suggested that this allocation of rights between shareholders and
creditors shifts as a company approaches insolvency (i.e., the “zone of insolvency”), but many courts
tend to maintain the status quo until the company becomes insolvent.93 If the Bankruptcy Code
imposed separate duties on a debtor in possession’s directors, officers, or similar managing persons,
those duties might differ from the duties owed by those individuals under state law. Although federal
preemption principles might resolve such conflicts from a legal perspective, the conflict could cause
substantial confusion and uncertainty for directors, officers, and similar managing persons. The
Commission agreed that state law adequately governs fiduciary duties and should continue to govern
the fiduciary duties of directors, officers, and similar managing persons in bankruptcy.
92
93
See United States v. Byrum, 408 U.S. 125, 138 (1972) (“[T]he directors . . . have a fiduciary duty to6
promote the interests of the
201
corporation.”); N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 99 (Del. 2007) (“It is well established
r 21,
b
that the directors owe their fiduciary obligations to the corporation and its shareholders.e); Revlon, Inc. v. MacAndrews & Forbes
ovem ”
Holdings, Inc., 506 A.2d 173, 179 (Del. 1986) (“[T]he directors owe fiduciary duties of care and loyalty to the corporation and its
on N
ved
shareholders.”); Woodward v. Andersen, 627 N.W.2d 742, 751 (Neb. i2001) (“An officer or director of a corporation . . . occupies
arch
363
a fiduciary relation toward the corporation and its stockholders, and is treated by the courts as a trustee.”). See, e.g., N. Am.
4-35
Catholic Educ. Programming Found., Inc. v.n, No. 1 930 A.2d 92, 101 (Del. 2007) (“When a solvent corporation is navigating
Gheewalla,
in the zone of insolvency, the focus v. Brow
for Delaware directors does not change: directors must continue to discharge their fiduciary
duties to the corporation andseth
lix its shareholders by exercising their business judgment in the best interests of the corporation for
in B
the benefit of its shareholder owners.”); Quadrant Structured Prods. Co. v. Vertin, 2014 Del. Ch. LEXIS 193, at *58 (Del. Ch.
cited
Oct. 1, 2014) (“In a solvent corporation, the standard of conduct for directors requires that they strive in good faith and on an
informed basis to maximize the value of the corporation for the benefit of its residual claimants, the ultimate beneficiaries of the
firm’s value. In a solvent corporation, the residual claimants are the stockholders. Consequently, in a solvent corporation, the
standard of conduct requires that directors seek prudently, loyally, and in good faith to manage the business of a corporation
for the benefit of its shareholder owners.”); In re Bear Stearns Litig., 23 Misc. 3d 447, 475 (N.Y. Sup. Ct. 2008) (“The directors
still have the ‘duty to maximize the value of the insolvent corporation for the benefit of those having an interest in it’ and are
required to ‘engage in vigorous, good faith negotiations with individual creditors for the benefit of the corporation.’”) (citing
N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 103 (Del. 2007)); Dodge v. Ford Motor Co., 170
N.W. 668, 684 (Mich. 1919) (“A business corporation is organized and carried on primarily for the profit of the stockholders.
The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means
to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of
profits among stockholders in order to devote them to other purposes.”). See also James Gadsden, Enforcement of Directors’
Fiduciary Duties in the Vicinity of Insolvency, Am. Bankr. Inst. J., Feb. 2005, at 16 (“The corporation laws of all states agree that
directors owe fiduciary duties to the corporation.”); Royce de R. Barondes, Fiduciary Duties of Officers and Directors of Distressed
Corporations, 7 Geo. Mason L. Rev. 45, 63 (1998) (explaining that when the corporation reaches insolvency, “[t]he majority rule,
and the law in Delaware, is that . . . a board’s duties are owed to the creditors of the enterprise”); Bruce A. Markell, The Folly
of Representing Insolvent Corporations: Examining Lawyer Liability and Ethical Issues Involved in Extending Fiduciary Duties to
Creditors, 6 Norton J. Bankr. L. & Prac. 403, 404 (1997) (“Indeed, [when a company is solvent], most states impose fiduciary
duties of loyalty and care on the directors and officers in favor of shareholders.”); Ramesh K.S. Rao, et al., Fiduciary Duty a
la Lyonnais: An Economic Perspective on Corporate Governance in a Financially-Distressed Firm, 22 J. Corp. L. 53, 64 (1996)
(explaining that “[a]s the firm slides into insolvency,” fiduciary responsibilities are “extended to creditors in order to ensure
adequate protection of their interests”); Jeffrey N. Gordon, Corporations, Markets, and Courts, 91 Colum. L. Rev. 1931, 1977
(1991) (shareholder wealth maximization is “the bedrock of corporate law”). But see Margaret M. Blair & Lynn A. Stout, Specific
Investment: Explaining Anomalies in Corporate Law, 31 J. Corp. L. 719, 731 (2006) (“There is very little in corporate law that
supports [shareholder wealth maximization] and much that cuts against it.”).
See, e.g., Berg & Berg Enters., LLC v. Boyle, 100 Cal. Rptr. 3d 875, 894 (Ct. App. 2009) (“[W]e hold that there is no fiduciary duty
prescribed under California law that is owed to creditors by directors of a corporation solely by virtue of its operating in the
‘zone’ or ‘vicinity’ of insolvency.”) (using the trust fund doctrine to determine the directors’ fiduciary duties); N. Am. Catholic
Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007). But see Geiger & Peters, Inc. v. Berghoff, 854 N.E.2d
842, 850 (Ind. Ct. App. 2006) (“Indiana does not adhere to the ‘trust fund’ theory. . . .”); St. James Capital Corp. v. Pallet Recycling
Assocs. of N. Am., Inc., 589 N.W.2d 511, 516 (Minn. Ct. App. 1999) (“‘Corporate property is not held in trust’. . . . [C]reditors
have the right to be repaid, [but] it is equally true that they do not have the right, absent an agreement to the contrary, to dictate
what course of action the directors and officers of a corporation shall take in managing the company. . . .”) (citation omitted).
IV. Proposed Recommendations: Commencing the Case
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2. The Chapter 11 Trustee
Recommended Principles:
The standard for appointing a chapter 11 trustee under section 1104(a) of the
Bankruptcy Code should not change.
The burden of proof with respect to requests for the appointment of a chapter 11
trustee under section 1104(a) should be based on the preponderance of the evidence
standard. Case law requiring application of the clear and convincing standard should
be overturned by statutory amendment.
As is currently provided by section 1104(d), the U.S. Trustee should continue to
select and appoint a disinterested person to serve as chapter 11 trustee after the
court enters an order under section 1104(a) directing such appointment and after
consultation with parties in interest.94
A party in interest should be able to object to the person appointed as the chapter
11 trustee. An objecting party should plead with particularity the facts supporting its
objection. The objection should be filed and heard on an expedited basis. The court
16
should approve the person appointed by the U.S. Trustee unless the2objecting party
1, 20
ber did not properly
m
establishes by clear and convincing evidence that: (1) the U.S.oTrustee
N ve
d n
eis o eligible to serve as trustee
consult with parties in interest; (2) the person selected not
rchiv
63 a
-353 not qualified to serve as trustee under
under section 321; (3) the person selected has
. 14
, No
rown is not disinterested; or (5) the person selected has
B
section 322; (4) the person.selected
hv
xset
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i
a disqualifying conflict of interest. If an objection is filed, the court should approve
cited
or disapprove the person appointed as chapter 11 trustee by the U.S. Trustee, but the
court should not otherwise be involved in the chapter 11 trustee selection process.
Section 1104(b), which provides for the election of a chapter 11 trustee, should be
deleted.
Once appointed, the chapter 11 trustee may take any actions and exercise any powers
with respect to the estate as authorized under section 1106 without the approval or
consent of the debtor, the debtor’s board of directors (or similar governing body), any of
the debtor’s officers or similar managing persons, or the debtor’s equity security holders.
The appointment of a chapter 11 trustee should not terminate the debtor’s exclusivity
period to file, or its time to solicit acceptances of, a plan, but should preserve such
exclusivity period solely for the benefit of the trustee. Accordingly, the trustee should
receive the benefit of any remaining exclusivity period under section 1121, provided
that a party in interest should be able to file a motion seeking to shorten or terminate
such period as provided in section 1121(d). Section 1121(c)(1) should be amended
accordingly.
94
Bankruptcy cases in Alabama and North Carolina are not under the jurisdiction of the U.S. Trustee, but rather are administrated
by Bankruptcy Administrators in those jurisdictions. Accordingly, the applicable rules of those jurisdictions would govern the
appointment process.
IV. Proposed Recommendations: Commencing the Case
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The Chapter 11 Trustee: Background
A trustee is appointed in a chapter 11 case only upon a motion of a party in interest or the
U.S. Trustee and the entry of an order of the court granting such motion. Section 1104 of the
Bankruptcy Code provides that the court shall order the appointment of a trustee “for cause,
including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor
by current management” or “if such appointment is in the interests of creditors, any equity
security holders, and other interests of the estate.”95 In addition, section 1104(e) requires the
U.S. Trustee to file a motion requesting a trustee “if there are reasonable grounds to suspect that
current [management] . . . participated in actual fraud, dishonesty, or criminal conduct in the
management of the debtor or the debtor’s public financial reporting.”96
Notwithstanding this statutory authority, anecdotal evidence suggests that chapter 11 trustees are
the rare exception rather than the rule.97 The paucity of cases in which chapter 11 trustees serve
may suggest that the overall system is working and that stakeholders either have confidence in
the debtor’s management or have replaced troublesome managers prior to or shortly after the
petition date.98 Parties in interest may also be using the possibility of seeking the appointment of
a trustee in negotiations with the debtor in a way that fosters meaningful results and eliminates
the need for a trustee.99 A case warranting a chapter 7 trustee may convert to a case under chapter
7 of the Bankruptcy Code, thereby eliminating the need for a chapter 11 trustee.100 Some contend
16
that a systemic antipathy to reorganization trustees, arising from pre-Bankruptcy Code practice,
1, 20
ber 2
ve of
found its way into early decisions that construed the language m the Bankruptcy Code.101 For
n No
ed o
example, courts may be discouraging parties fromarchiv motions requesting the appointment of a
filing
63
-353
chapter 11 trustee by applying the clearoand convincing standard to the determination.102 Parties
. 14
,N
rown by the debtor or other stakeholders if the court denies the
B
in interest also may fear retribution
h v.
xset
n Bli
motion, or may cited i having individuals with whom they are familiar (even if they do not like or
prefer
necessarily trust them) rather than an individual they do not know. Moreover, some parties may
raise concerns regarding the costs associated with chapter 11 trustees, which may be driven by a
perception that chapter 11 trustees are inclined toward litigation to ensure that they fulfill their
fiduciary duties to the estate.103
If the court enters an order appointing a chapter 11 trustee, the U.S. Trustee identifies a disinterested
and qualified individual to serve as the trustee.104 Section 1104(d) requires the U.S. Trustee to
95
96
97
98
99
100
101
102
103
104
11 U.S.C. § 1104(a)(1), (2).
Id. § 1104(e).
See, e.g., Dickerson, supra note 19, at 888–900 (explaining that “[t]hough the Code provides that managers can be replaced
or supervised by a public trustee, trustee appointments are, and always have been, rare”); Kelli A. Alces, Enforcing Corporate
Fiduciary Duties in Bankruptcy, 56 U. Kan. L. Rev. 83, 84–85 (2007) (noting rarity of chapter 11 trustees).
See, e.g., John D. Ayer, et al., Bad Words to a Debtor’s Ear, Am. Bankr. Inst. J., Mar. 2005, at 20 (“Creditors force out the old
management before the chapter 11 begins, and so the nominal ‘DIP’ is someone in whom creditors have faith, sent in to clean up
the mess that others left behind.”).
See, e.g., Stuart C. Gilson & Michael R. Vetsuypens, Creditor Control in Financially Distressed Firms: Empirical Evidence, 72 Wash.
U. L.Q. 1005, 1012 (1994) (discussing creditors’ threats to petition the court to appoint a trustee if managers do not resign).
See, e.g., Ayer et al., supra note 98.
Clifford J. White III & Walter W. Theus, Jr., Chapter 11 Trustees and Examiners after BAPCPA, 80 Am. Bankr. L. J. 289, 314–15
(2006).
See, e.g., In re G-I Holdings, Inc., 385 F.3d 313 (3d Cir. 2004) (applying clear and convincing standard). But see Tradex Corp. v.
Morse, 339 B.R. 823 (D. Mass. 2006) (applying preponderance of the evidence standard).
In addition, the increasing use of chief restructuring officers, at least in larger chapter 11 cases, may suggest that parties are
working around the concerns often associated with chapter 11 trustees.
See Clifford J. White III & Walter W. Theus, Jr., Taking the Mystery Out of the Chapter 11 Trustee Appointment Process, Am. Bankr.
Inst. J, May 2014 (“Beyond independence, the U.S. Trustee will consider a candidate’s experience, qualifications and ability to
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
consult with parties in interest during this process, and the selection is subject to court approval.105
Although section 1104(d) is silent on the scope of court review, the court generally will review
only whether the U.S. Trustee consulted with parties as required by the Bankruptcy Code and
whether the candidate is disinterested and is formally qualified to serve as trustee. A party in
interest may also request that the U.S. Trustee hold an election for the trustee in accordance with
section 702 of the Bankruptcy Code.106
Once identified and approved, the chapter 11 trustee assumes all of the powers of the debtor’s
management, is vested with certain other powers, and is subject to certain duties under
section 1106 of the Bankruptcy Code. The trustee can, among other things, operate the debtor’s
business, manage and administer the bankruptcy estate, file and implement a chapter 11 plan,
and investigate the debtor’s affairs and prepetition activities.107 The trustee must also ensure
that certain materials and reports are filed with the court on a timely basis.
The Chapter 11 Trustee: Recommendations and Findings
The debtor in possession model should not be the sole structure for a chapter 11 case. The
Bankruptcy Code needs an effective mechanism for appointing a chapter 11 trustee to displace
management in appropriate cases. The Commissioners discussed the kinds of cases that
warrant chapter 11 trustees, including instances of fraud or illegal conduct by management.
016
They also acknowledged the value of appointing a trustee to increase ber 21, 2
accountability in chapter
m
Nove
11 cases, to protect against “bankruptcy rings” and collusive nconduct, and to create dynamic
ed o
rchiv
tension by introducing an outsider to the negotiationaprocess.108 As referenced in the previous
63
-353
14
section, however, the CommissionersoalsoNo.
, evaluated the potential disadvantages of appointing a
r wn
v. B
trustee, such as the potentialxcollateral impact of the appointment, additional costs, delays, and
seth
n Bli
ted i
inefficiencies in thecicase. In light of the foregoing, the Commission determined to retain the
grounds for the appointment of a chapter 11 trustee set forth in section 1104(a) because they
are warranted and strike an appropriate balance between the benefits and drawbacks of such
appointment.
The Commission also considered the relatively low percentage of trustee appointments in chapter
11 cases. It was not able to determine if the relatively small number of trustee appointments
suggested a flaw in the current system or reflected the judgment of stakeholders that grounds
either did not exist to support an appointment or were remedied through prepetition changes
105
106
107
108
muster necessary bankruptcy, financial and business expertise.”). Bankruptcy cases in Alabama and North Carolina are not
under the jurisdiction of the U.S. Trustee, but rather are administrated by Bankruptcy Administrators in those jurisdictions.
11 U.S.C. § 1104(a). See also Chapter 11 Trustee Handbook 7 (May 2004) (explaining that the U.S. Trustee consults, either by
telephone or in person, with parties in interest to identify candidates and then interviews potential candidates to determine if
they are qualified for the particular case and disinterested); White & Theus, supra note 104 (“Once the court enters the order,
the U.S. Trustee expeditiously consults with major creditors, the creditors’ committee, the debtor and other interested parties.
This consultation might be in person, by telephone or by email. U.S. Trustees take seriously and place a high value on the input
provided by parties in interest.”).
11 U.S.C. § 1104(b) (providing that motion requesting an election must be filed within 30 days of the entry of the order appointing
a chapter 11 trustee).
Id. § 1106(a).
For a historical overview of the purpose of the U.S. Trustee in response to so-called “bankruptcy rings,” see 6 Collier On
Bankruptcy ¶ 6.01 (Alan N. Resnick & Henry J. Sommer eds., 16th ed.) (“[I]n many parts of the country, the Bankruptcy
Act principle of creditor control of cases had degenerated into a system of attorney control. That fostered the development of
‘bankruptcy rings,’ closed bankruptcy practices heavily favoring the appointment of insiders, who were obliged to one another,
to trustee positions. Cases were too often administered solely for the benefit of the members of the bankruptcy rings, with
creditors receiving nothing.”).
IV. Proposed Recommendations: Commencing the Case
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in management. The Commissioners were persuaded by the suggestion that the burden of proof
governing a motion to appoint a chapter 11 trustee under section 1104 could influence the decision
of a party in interest to file such a motion in the first place. Indeed, courts often expressly state that
the appointment of a chapter 11 trustee is the exception and that the standard for approval is very
high.109 The Commissioners evaluated the potential chilling effect of requiring the moving party
to demonstrate the need for a trustee by clear and convincing evidence and the justifications for
this standard.110 They also discussed whether a lower standard, such as the preponderance of the
evidence standard, could be subject to abuse and cause unnecessary distractions in the chapter
11 case.
The Commissioners carefully weighed the competing considerations and relevant policy
objectives underlying the debtor in possession model and the Bankruptcy Code. Reflecting
on the discussion of cases that may warrant and benefit from a trustee, the Commission
determined that the lower preponderance of the evidence standard — and not the clear and
convincing evidence standard — should apply to motions to appoint a chapter 11 trustee under
section 1104(a). This change is likely to not only encourage parties in interest to seek the
appointment of a chapter 11 trustee in appropriate cases, but it would also resolve a split among
the courts on this important legal issue.
The Commissioners also discussed their various experiences with trustees in chapter 11 cases and
6
acknowledged that, particularly in cases involving massive fraud by the 1, 201 chapter 11 trustees
debtor,
ber 2
em
have served with distinction.111 They discussed the value of havingvthe U.S. Trustee, as an independent
n No
ed o
r hiv
agency with no financial stake in the case, identify cand vet trustee candidates, because multiple
63 a
-353
o. 1 in
stakeholders may have competing interests 4 the selection process.
n, N
h v.
xset
n Bli
i
Brow
The Commissionted
ci reviewed at length the current consultation process and believed that the U.S.
Trustee should, as under current law, continue to consult with parties in interest to both identify
potential candidates and to better understand the needs and circumstances of the particular case.
The Commission did not find any value in imposing a public meeting requirement on the trustee
selection process; rather, all evidence indicates that the private consultation practice currently in
place works well, and imposing a public meeting requirement is likely to add cost and delay to the
process and to chill participation and openness.
The Commission considered whether the election process incorporated into section 1104(b)
provides stakeholders with a sufficient alternative to a candidate selected by the U.S. Trustee. In
theory, the election process should enable stakeholders to nominate directly and then to vote on
109 See, e.g., In re Taub, 427 B.R. 208, 225 (Bankr. E.D.N.Y. 2010) (“The appointment of a trustee is an unusual remedy and ‘[t]he
standard for § 1104 appointment is very high. . . .’”) (quoting Adams v. Marwil (In re Bayou Grp., LLC), 564 F.3d 541, 546 (2d Cir.
2009)).
110 See, e.g., In re LHC, LLC, 497 B.R. 281, 291 (Bankr. N.D. Ill. 2013) (“Applying the clear and convincing evidence standard appears
. . . to be more consistent with the presumptions that a debtor should generally be permitted to remain in control and possession
of its business and that the appointment of a Chapter 11 trustee is an extraordinary remedy.”) (citation omitted).
111 But see Written Statement of Daniel Kamensky on behalf of Managed Funds Association: LSTA Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (“MFA therefore suggests that Congress should make clear that parties
in interest and the U.S. Trustee may seek appointment of a trustee in circumstances other than fraud – where management
entrenchment, misalignment of interests or other factors have significantly impaired the reorganization process such that a
neutral third party is necessary to break the logjam. Appointment of a trustee should be authorized if the court believes that a
trustee will be better equipped than management to navigate competing interests and facilitate a successful reorganization. The
preference of all creditors should be taken into account – both in the appointment of an interim trustee and in any subsequent
election.”).
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
qualified candidates. Unfortunately, the anecdotal evidence suggests that stakeholders rarely request
an election process and are skeptical that the process benefits the estate for at least two reasons.
First, it is hard to displace a trustee that has already been put in place, even if a different person
with greater support among the constituents might have been picked in the first instance. Second,
several of the major constituencies are not entitled to vote under section 1104(b), including secured
creditors and unions.112
The Commissioners found the election process unsatisfactory in light of these concerns. Consequently,
the Commission considered alternative ways to provide all stakeholders with a stronger voice in the
trustee-selection process, based on the belief that such a process may further mitigate any resistance
to trustee appointment in appropriate cases. The Commissioners discussed a variety of ways to allow
stakeholders to voice objections to trustee candidates and to have some role in the selection process.
In exploring these alternatives, the Commissioners were very mindful of the need for the U.S. Trustee
to maintain flexibility and discretion as the independent appointing official. Allowing the court or
stakeholders to second-guess the U.S. Trustee’s decision too easily could come with substantial costs,
including introducing bias into the process and paralyzing the debtor’s reorganization efforts while
parties in interest attempt to agree on a trustee candidate.
Section 1104(d) provides for court approval of the U.S. Trustee’s trustee appointments, but does not
specify any grounds upon which the court may disapprove an appointment. Furthermore, parties
16
in interest are given no role in the appointment approval process. TheerCommission concluded
1, 20
b 2
that specifying grounds for disapproval and providing stakeholdersovem a more defined ability to
N with
d on
chive The Commissioners explored how
object to the U.S. Trustee’s appointment would be 3beneficial.
3 ar
35 6
. 14to discourage frivolous objections and tonencourage full disclosure in a manner that informed the
, No
ow
v. Brrelevant to the appointment of the trustee. The Commission
parties and the court about the eth
issues
Blixs
determined that anyciobjections should be pled with particularity and that the objection process
ed in
t
should incorporate a strong presumption favoring the U.S. Trustee’s candidate. The court should
approve the person appointed by the U.S. Trustee unless the objecting party establishes by clear
and convincing evidence that: (1) the U.S. Trustee did not properly consult with parties in interest;
(2) the person selected is not eligible to serve as trustee under section 321 of the Bankruptcy Code;
(3) the person selected has not qualified to serve as trustee under section 322 of the Bankruptcy
Code; (4) the person selected is not disinterested; or (5) the person selected has a disqualifying
conflict of interest. A court should not reject the U.S. Trustee’s selection based on a party in interest’s
assertion that another individual would better serve the estate or is better qualified for the position.
Moreover, neither the court nor the objecting party should be able to displace the U.S. Trustee in
the appointment process. The court should only be able to approve or disapprove the U.S. Trustee’s
appointment. If the court disapproves an appointment, the U.S. Trustee should still maintain control
of the appointment process by vetting additional candidates and making a substitute appointment.
Once a chapter 11 trustee has been appointed, the Commission found that the current process
works for vesting the trustee with all control and management authority concerning the debtor
and the estate. Specifically, if grounds exist to warrant the appointment, the chapter 11 trustee
112 Eligibility to vote for the trustee is determined by section 702 of the Bankruptcy Code. In order to vote, creditors must, among
other things, hold an allowable undisputed, fixed, liquidated, and unsecured claim. Secured creditors are thus not eligible to vote
because their claim is not unsecured, and unions are frequently not eligible to vote because their claims are contingent, disputed,
or unliquidated.
IV. Proposed Recommendations: Commencing the Case
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10211115, DktEntry: 37-2, Page 37 of Chapter
should be able to take any actions and exercise any powers with respect to the estate as authorized
under section 1106 without the approval or consent of the debtor, the debtor’s board of directors
(or similar governing body), any of the debtor’s officers or similar managing persons, or the debtor’s
equity security holders. Accordingly, the chapter 11 trustee should, for example, be able to cause the
estate to retain managers and employees deemed necessary to the reorganization process, but such
personnel should act only under the supervision of the trustee.
The Commissioners debated whether the debtor’s exclusivity periods to file a plan and solicit
acceptances of a plan should terminate upon the appointment of a trustee. The Commissioners
explored why termination may be appropriate; indeed, displacement of the debtor’s management
suggests a need for different approaches to the reorganization, and stakeholders should have some
say in the new process. The trustee, however, is appointed in large part to facilitate this new direction
and should have some ability to negotiate with the various stakeholders to try to reach a resolution
that benefits the estate and its stakeholders. Accordingly, the Commission determined that if
the debtor has any remaining exclusivity periods under section 1121 at the time of the trustee’s
appointment, the trustee should be able to step into the shoes of the debtor and receive the benefit
of such remaining exclusivity periods, but should not be able to seek extensions of those periods.
In discussing the chapter 11 trustee appointment process, as well as the estate neutral appointment
process described below, the Commission considered the current dual system for bankruptcy
16
administration: (i) U.S. Trustees for 48 states, Puerto Rico, the U.S. Virgin2Islands, and Guam; and
1, 0
ber 2
vem
(ii) Bankruptcy Administrators for Alabama and North Carolina. The Office of the U.S. Trustee
n No
ed o
rc v
operates as a division of the Department of Justice,hiand the Executive Office for U.S. Trustees
63 a
-353
coordinates and oversees the activitiesNof. 14 U.S. Trustees in 21 regional offices.113 This structure
, o the
own
v. Br
promotes uniformity andxconsistency in the application of federal bankruptcy laws. The Bankruptcy
eth
Bli s
Administrator programs are separately administered in each state through the judiciary in those
ed in
cit
states.114
The Commissioners debated the efficiency of continuing these two separate systems. Some
Commissioners believed that unifying the administration and oversight of bankruptcy cases in all
jurisdictions under the Office of the U.S. Trustee would promote the uniformity in the application
of federal bankruptcy laws as envisioned by the Bankruptcy Clause of the Constitution115 and would
serve the interests of parties in the system. They encouraged the Commission to recommend making
the U.S. Trustee program a national program that would be responsible for bankruptcy administration
in all 50 states, as well as Puerto Rico, the U.S. Virgin Islands, and Guam. Other Commissioners
expressed a concern that this issue was not directly within the scope of the Commission’s mandate.
Consequently, the Commission decided not to address this matter.
113 For more information about U.S. Trustees and the Executive Office for the U.S. Trustees, see U.S. Trustee Program, http://www.
justice.gov/ust/index.htm.
114 For more information about Bankruptcy Administrators, see Bankruptcy Administrators, http://www.uscourts.gov/
FederalCourts/Bankruptcy/BankruptcyAdministrators.aspx.
115 U.S. Const. art. I, § 8, cl.4. See also Charles Jordan Tabb, The Bankruptcy Clause, the Fifth Amendment, and the Limited Rights of
Secured Creditors in Bankruptcy, 2015 Ill. L. Rev. __, at *1 (forthcoming 2015) (noting that the powers granted to Congress under
the Bankruptcy Clause are extremely broad), available at http://ssrn.com/abstract=2516841.
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
3. The Estate Neutral
Recommended Principles:
The Bankruptcy Code should be amended to delete any reference to an “examiner”
and to incorporate the concept of a more flexible “estate neutral,” as described in
these principles.
Section 1104(c) of the Bankruptcy Code should be amended to set forth the
standards for, and potential authority and duties of, an estate neutral, as described
in these principles.
Section 1104(c) should not mandate the appointment of an estate neutral in any
circumstances.
The court should be permitted to order the U.S. Trustee to appoint an estate neutral
if (i) a trustee is not appointed and (ii)(a) the appointment is in the best interests
of the estate, or (b) for cause.116
An order directing the U.S. Trustee to appoint an estate neutral should specify the
scope of the estate neutral’s duties and the duration of the appointment. The court
6
may direct the U.S. Trustee to appoint more than one estate neutral 201any given
, in
er 21
bthe circumstances
case to serve different functions if necessary or warranted em
v by
n No
ed o
of the case. Nevertheless, the Bankruptcy Codeivshould include a presumption
rch
63 a
-353estate neutral in any given case.
against the appointment of more No. 14one
than
wn,
. Bro
eth vU.S. Trustee to appoint an estate neutral should not
An order directing sthe
Blix
ed in
citindividual to: (i) propose a chapter 11 plan for the debtor; (ii) act as
permit that
a mediator in any matter affecting the chapter 11 case, unless such action is the
primary purpose of the individual’s original appointment; (iii) initiate litigation
on behalf of the debtor or the estate, unless such action is within the scope of the
individual’s original appointment and the individual was not previously engaged
to investigate or examine matters relating to the litigation or the debtor’s chapter
11 case; or (iv) except as provided in the principles for small and medium-sized
enterprise cases, operate the debtor’s business.
Upon the entry by the court of an order directing the U.S. Trustee to appoint
an estate neutral, the U.S. Trustee should, in conformity with the procedures
established for the appointment of a chapter 11 trustee, appoint a disinterested
person to serve as the estate neutral. A party in interest should have the ability to
object to the person appointed as the estate neutral under the same procedures and
subject to the same standards established in the principles governing objections
to the person appointed as the chapter 11 trustee. See Section IV.A.2, The Chapter
11 Trustee.
116 Bankruptcy cases in Alabama and North Carolina are not under the jurisdiction of the U.S. Trustee, but rather are administrated
by Bankruptcy Administrators in those jurisdictions. Accordingly, the applicable rules of those jurisdictions would govern the
appointment process.
IV. Proposed Recommendations: Commencing the Case
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10211115, DktEntry: 37-2, Page 39 of Chapter
The Estate Neutral: Background
A chapter 11 trustee is not the only alternative to the debtor in possession. An examiner with a
specific directive may be appointed to investigate the affairs of the debtor.117 An examiner does not
displace the debtor in possession or its management, and it is available only if no trustee has been
appointed and only upon request of a party in interest or the U.S. Trustee and after notice and a
hearing. In those circumstances, section 1104(c) requires the court to appoint an examiner if such
appointment is in the interests of creditors, equity security holders, or the estate, or if “the debtor’s
fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes, or owing to an
insider, exceed $5,000,000.”118
Whether the appointment of an examiner is truly mandatory in any given case has met with resistance
by some courts and created a split in the law.119 Professor Jonathan C. Lipson reviewed “dockets
from 576 of the largest chapter 11 cases commenced between 1991 and 2007” and discovered that
“examiners were requested in only 87 cases, or about 15 percent of the sample,” and that the “motions
were granted in only 39 cases, less than half of cases where [an examiner was] sought, and about
6.7 percent of all cases in the sample.”120 Professor Lipson concluded that despite statements by
some commentators to the contrary, examiners “are neither ‘routinely’ sought nor ‘automatically’
appointed in large cases.”121 Professor Lipson also concluded that examiners were more likely
appointed in “huge,” contentious cases, and that a request for the appointment of a trustee increases
016
the odds that an examiner will be appointed.122
21, 2
r
mbe
Nove
on
ived
Setting aside the debt threshold in section 1104(c)(2), courts have generally interpreted the
arch
5363
“interests” test in section 1104(c)(1) to obroadly encompass the interests of all parties in interest.
14-3
N .
n,
As one court explained, “thehbasicow of an examiner is to examine, not to act as a protagonist in
. Br job
et v
ixs
in Bl
cited
117 For a general discussion of the role and appointment of examiners in chapter 11 cases, see Jonathan C. Lipson, Understanding
Failure: Examiners and the Bankruptcy Reorganization of Large Public Companies, 84 Am. Bankr. L.J. 1 (2010).
118 11 U.S.C. § 1104(c).
119 See, e.g., In re Wash. Mutual, Inc., 442 B.R. 314, 324 (Bankr. D. Del. 2011) (“The Court denied the Initial Examiner Motion .
. . finding that there was no appropriate scope for an examiner to conduct an investigation given that issues pertinent to, and
even beyond the scope of, the chapter 11 cases had been ‘investigated to death.’”); In re Spansion, Inc., 426 B.R. 114, 127 (Bankr.
D. Del. 2010) (“I find no sound purpose in appointing an examiner, only to significantly limit the examiner’s role when there
exists insufficient basis for an investigation. To appoint an examiner with no meaningful duties strikes me as a wasteful exercise,
a result that could not have been intended by Congress.”); In re Erickson Ret. Communities, LLC, 425 B.R. 309, 312 (Bankr.
N.D. Tex. 2010) (“At first blush, the issue here seems to be whether, because the $5 million unsecured debt threshold is met .
. . the appointment of an examiner is mandatory. Many courts have been confronted with this issue and have held yes — an
examiner is required whenever the $5 million unsecured debt threshold of Section 1104(c)(2) is met. This court agrees with such
courts that, where the $5 million unsecured debt threshold is met, a bankruptcy court ordinarily has no discretion. The only
judicial discretion that comes into play is in defining the scope of the examiner’s role/duties. The court can make the scope of
an examiner’s duties very broad or very narrow.” (citations omitted)); In re Vision Dev. Grp. of Broward Cnty., LLC, 2008 WL
2676827, at *3 (Bankr. S.D. Fla. Jun 30, 2008) (“[A] request for, and appointment cannot be waived by request made late in case
of, an examiner may be made ‘at any time before the confirmation of the plan.’”) (quoting 11 U.S.C. § 1104(c)(2)). See also Walton
v. Cornerstone Ministries Invs., Inc., 398 B.R. 77, 81 (N.D. Ga. 2008) (“[E]very district court and nearly every bankruptcy court
that has confronted the question has also read the provision to be mandatory on its face.”); In re Schepps Food Stores, Inc., 148
B.R. 27, 30 (S.D. Tex. 1992) (“This reasoning is both grammatically and contextually wrong. In the provision, ‘as is appropriate’
modifies ‘investigation.’ The statute allows the court to determine the scope, length, and conduct of the investigation, rather than
the appointment itself.”).
120 Jonathan C. Lipson, Understanding Failure: Examiners and the Reorganization of Large Public Companies, 84 Amer. Bankr. L. J. 1
(2010). See generally supra note 66 and accompanying text (generally discussing limitations of chapter 11 empirical studies).
121 Id. at 4. Indeed, Professor Lipson includes this quote from the Honorable Robert Gerber of the U.S. Bankruptcy Court for the
Southern District of New York: “[M]andatory appointment [of examiners] is terrible bankruptcy policy, and the Code should be
amended . . . to give bankruptcy judges . . . the discretion to determine when an examiner is necessary and appropriate. . . .” Id.
122 Id. at 5. Professor Lipson also notes that examiners are more likely to be sought in cases pending in Delaware or the Southern
District of New York (where most of the “huge” cases are filed), and that allegations of fraud do not automatically result in either
a request for, or order appointing, an examiner. Id.
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
the proceedings.”123 For this reason, “appointment under § 1104(c)(1) must, therefore, be in the
interests of everyone with a stake in the case, including creditors, equity security holders, and other
interests of the estate.”124 When only certain parties (i.e., the movants) would likely benefit from
the appointment of an examiner, such request was not deemed to satisfy the “interests” test.125 In
deciding whether to appoint an examiner, courts have also considered the overall financial benefit
that an examiner could bring to the estate.126 Allegations of corporate fraud and misconduct by
a debtor’s insiders or affiliates are often cited as reasons for appointing an examiner so that the
examiner may investigate such allegations.127
It is noteworthy that although the language in section 1104 is not explicit, some courts and scholars
have stated that the “interests” test for the appointment of examiners is the same “interests” test that
is applied to the appointment of trustees: the “best interests” test.128 This reasoning may be based
on the fact that the “interests” test in section 1104(a) respecting trustee appointments and section
1104(c) respecting examiner appointments is substantially identical;129 indeed, the statute does not
explicitly provide for a “best interests” test.130
123 Official Comm. of Asbestos Pers. Injury Claimants v. Sealed Air Corp. (In re W.R. Grace & Co.), 285 B.R. 148, 156 (Bankr. D. Del.
2002).
124 In re Gliatech, Inc., 305 B.R. 832, 836 (Bankr. N.D. Ohio 2004) (citations omitted). Another court explained that “[a] single
creditor group ‘cannot justify the appointment of a[n] . . . examiner simply by alleging that it would be in its interests.’” In re
Sletteland, 260 B.R. 657, 672 (Bankr. S.D.N.Y. 2001) (citations omitted). See also In re Lenihan, 4 B.R. 209, 212 (Bankr. D.R.I.
1980) (“[W]ill such an appointment benefit the estate of the debtor and the interests of creditors? A bankruptcy court, which
must eventually pass upon questions of fairness, good faith, best interest, etc. prior to confirmation, cannot blindfolded by the
016
tactical jockeying of the parties in determining what is in the interest of the estate.”) (citations omitted).
21, 2
berand remanded on other grounds,
125 See, e.g., In re Loral Space & Commc’ns Ltd., 313 B.R. 577, 583–84 (Bankr. S.D.N.Y. 2004),m d
ove rev’
2004 WL 2979785 (S.D.N.Y. Dec. 23, 2004) (“The Ad Hoc Committee’s motion clearly fails the ‘in the interests of the estate’ test
on N
edthe appointment of an examiner must be in the
hiv
of section 1104(c)(1) of the Bankruptcy Code. First, under section 1104(c)(1)
3 arc
interests of the estate in general. Here, however, the appointment6of an examiner would, at best for the shareholders, advance
-353
4
only their interests in opposition to the Debtors’ plan.”). . 1 appeal, the district court reversed and remanded to the bankruptcy
, NoOn
rown
court, mandating the appointment of an examiner but solely on the ground that “[o]n its face, Section 1104(c)(2) mandates the
v. B
appointment of an examiner where seth in interest moves for an examiner and the debtor has $5,000,000 of qualifying debt.”
a party
Blix
n Ltd., 2004 WL 2979785, at *4 (S.D.N.Y. Dec. 23, 2004).
i
In re Loral Space & Commc’ns
cited
126 See, e.g., In re Loral Space & Commc’ns Ltd., 313 B.R. 577, 584 (Bankr. S.D.N.Y. 2004), rev’d and remanded on other grounds,
2004 WL 2979785 (S.D.N.Y. Dec. 23, 2004) (“[T]he appointment of an examiner would not be in the estates’ interest in the light
of the negligible benefits of the requested valuation balanced against its cost.”); In re Shelter Res. Corp., 35 B.R. 304, 305 (Bankr.
N.D. Ohio 1983) (“The appointment of an examiner would entail undue delay in the administration of this estate and most
likely cause the debtor to incur substantial and unnecessary costs and expenses detrimental to the interests of creditors and
parties in interest.”); In re Hamiel & Sons, Inc., 20 B.R. 830, 837 (Bankr. S.D. Ohio 1982) (conducting cost/benefit analysis when
considering appointment of trustee or examiner).
127 See, e.g., In re Keene Corp., 164 B.R. 844, 856 (Bankr. S.D.N.Y. 1994) (“Often, appointment of an examiner is warranted when the
debtor’s transactions with affiliates should be investigated.”) (quoting M. Bienenstock, Bankruptcy Reorganization 299 (1987)).
Another bankruptcy court appointed an examiner because it found that it was in the interest of creditors to involve an examiner
in light of the significant amount of debt, receivables, and other obligations at stake and that “[t]he involvement of an examiner
will contribute valuable perspective to a case with many competing interests at stake.” In re First Am. Health Care of Ga., Inc.,
208 B.R. 992, 995 (Bankr. S.D. Ga. 1996).
128 See In re Lenihan, 4 B.R. 209, 211 (Bankr. D.R.I. 1980) (holding that the decision to appoint an examiner “rests on a determination
by the court that such appointment would be in the best interests of creditors, equity security holders, and the estate; the same
test used to determine whether the appointment of a trustee is warranted”) (emphasis added); Ryan M. Murphy, Does the Recent
String of Examiner Appointments in Delaware Represent a Sea Change in Approach or Merely a Perfect Storm of Cases?, Norton
J. Bankr. L. 2011.04-2 (2011) (“[A] bankruptcy court is authorized to appoint an examiner under two scenarios: (1) where it is
in the best interest of the estate and interested parties; or (2) where the debtor’s fixed, unliquidated debts (excluding claims for
goods, services, taxes and insider transactions) exceed $5 million.”) (citations omitted) (emphasis added); 5 Norton Bankr. L.
& Prac. 3d § 99:25 (“The ‘best interests’ test for the appointment of an examiner, like the Code § 1104(a)(2) provision for the
appointment of a trustee6 is a flexible and discretionary standard.”).
129 Section 1104(a) provides that the court shall appoint a trustee if, among other reasons, “such appointment is in the interests of
creditors, any equity security holders, and other interests of the estate.” 11 U.S.C. § 1104(a)(2). Section 1104(c) provides that the
court shall appoint an examiner if, setting the debt threshold aside, “such appointment is in the interests of creditors, any equity
security holders, and other interests of the estate.” 11 U.S.C. § 1104(c)(1).
130 “Sections 1104(a)(2) and (c)(1) of the Bankruptcy Code, using identical language, authorize the appointment of a trustee or
examiner, respectively, if ‘such appointment is in the interests of creditors, any equity security holders, and other interests of
the estate.’ Under these provisions, a creditor group, no matter how dominant, cannot justify the appointment of a trustee or
examiner simply by alleging that it would be in its interests. It must show that the appointment is in the interests of all those
with a stake in the estate, which in this case would include the Debtor. As Collier points out, ‘Use of the word ‘and’ suggests that
creditors cannot on their own obtain the appointment of a trustee under the provision in order to disenfranchise equity security
holders or other interests.’” In re Sletteland, 260 B.R. 657, 672 (Bankr. S.D.N.Y. 2001).
IV. Proposed Recommendations: Commencing the Case
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10211115, DktEntry: 37-2, Page 41 of Chapter
If appointed, the primary duty of an examiner under current law is to (i) “conduct such an investigation
of the debtor as is appropriate, including an investigation of any allegations of fraud, dishonesty,
incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of
the debtor of or by current or former management of the debtor”131 and (ii) “(A) file a statement
of any investigation conducted . . . including any fact ascertained pertaining to fraud, dishonesty,
incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the
debtor, or to a cause of action available to the estate; and (B) transmit a copy or a summary of any
such statement to any unsecured creditors’ committee or equity security holders’ committee, to any
indenture trustee, and to such other entity as the court designates.”132
The examiner’s investigation and report may have an important effect on the direction of the case, as
well as on the pursuit of claims for the benefit of creditors. For example, the examiner’s reports in the
chapter 11 cases of Lehman Brothers, Residential Capital, and Tribune Company assessed the merits
of claims asserted by parties in the case, identified additional potential claims and causes of action,
and provided parties in interest with substantial information concerning the debtor and its case that
otherwise likely would have been undiscovered or unavailable.133 Commentators summarize these
benefits as follows:
If equipped with a mandate of sufficiently broad scope, an examiner may promote
efficiency by navigating among the frequent multiplicity of other investigations by
government authorities, boards of directors, creditors, and shareholders.6 examiner
The
201
r 21,by conducting an
may play the lead role among the players in the bankruptcybe
case
ovem
on N later in pursuing monetary
expansive and timely investigation that will aidved
i parties
arch
363
recoveries and other remedies. In many respects, the examiner should preempt the
-35
o. 14
bankruptcy field by vastlyown, N
reducing the need for early and duplicative discovery
v. Br
efforts by separate seth
lix creditors or committees. 134
in B
cited
Notwithstanding the potential benefit to the estate, some observers argue that an examiner simply
adds another layer of cost and delay to the process and that the debtor in possession or unsecured
creditors’ committee can serve the same function.135 The primary response to this potential critique
is that an examiner comes to the process with a special, independent, and neutral role, which no
other party can claim. The principle that the proper role of an examiner is that of a disinterested,
nonadversarial officer of the court has been so widely accepted that it can hardly be doubted.136
131 11 U.S.C. § 1104(c).
132 Id. § 1106(a)(4) (referred to in 11 U.S.C. § 1106(b)).
133 See Report of Kenneth N. Klee, Examiner, In re Tribune Co., No. 08-13141 (July 26, 2010) [Docket Nos. 5130, 5131, 5132, 5133];
Report of Anton R. Valukas, Examiner, In re Lehman Bros. Holdings, Inc., No 08-13555 (Bankr. S.D.N.Y. Mar. 11, 2010) [Docket
No. 7531]; Report of Arthur J. Gonzalez, Examiner, In re Residential Capital, LLC, No. 12-12020 (Bankr. S.D.N.Y. May 13, 2013)
[Docket No. 3698]. (Kenneth N. Klee and Arthur J. Gonzalez are Commissioners.)
134 Clifford J. White III & Walter W. Theus, Jr., Chapter 11 Trustees and Examiners after BAPCPA, 80 Am. Bankr. L. J. 289, 290
(2006).
135 See, e.g., Dickerson, supra note 19, at 904 (“[H]aving an examiner in a case can substantially increase the costs of the
reorganization and, accordingly, reduce the amount available to pay creditor claims. Because examiners are often appointed in
cases that have active creditor committees, courts have refused to appoint an examiner if doing so would increase the number of
fiduciaries already involved in a case. Some courts have argued that examiners often duplicate the work already being performed
by creditors’ committees.”).
136 Examples of cases stating this principle: Kovalesky v. Carpenter, 1997 WL 630144, at *3 (S.D.N.Y. Oct. 9, 1997) (“Examiners .
. . play a chiefly information-seeking role and, like the court itself, must remain a neutral party in the bankruptcy process.”);
In re Big Rivers Elec. Corp., 213 B.R. 962, 977 (Bankr. W.D. Ky. 1997) (“[The examiner is] a party who is not an adversary but
rather an independent third party and officer of the Court.”); In re Interco Inc., 127 B.R. 633, 638 (Bankr. E.D. Mo. 1991) (“[T]
he Examiner’s role is by its nature disinterested and nonadversarial. There is no doubt that the Examiner is a neutral party in a
bankruptcy case.”); In re Baldwin United Corp., 46 B.R. 314, 316 (Bankr. S.D. Ohio 1985) ([The Examiner] is first and foremost
disinterested and nonadversarial. . . . [H]e answers solely to the Court.”).
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
Accordingly, the examiner provides an independent assessment of the matter at hand and can identify
value, encourage parties to recognize the strengths and weaknesses of their respective positions in
the case, facilitate quicker resolutions of disputes, and ultimately produce benefits for the estate.
Nevertheless, one criticism of the process is that the examiner’s report, which may identify this value
and was paid for by the estate, may not be admissible as evidence in prosecuting or defending the
causes of action investigated in the report.
Under current law, the role of an examiner is limited to the investigatory function described above.
Yet examiners may add value to cases in other capacities given their uniquely independent and
neutral posture. For example, courts have appointed mediators and facilitators to help chapter
11 cases progress, either when plan negotiations are stalled or major litigation threatens to derail
reorganization efforts.137 Such mediators and facilitators have proven effective in some cases, but
they currently are appointed on an ad hoc basis and with little governing authority. Expanding the
potential scope of an examiner to include the role of mediator and facilitator as well as similar
functions would allow parties in interest and the court to use an independent neutral party to address
specific issues in a particular case in an efficient and controlled manner. Many courts interpret
section 1104 as currently prohibiting this kind of appointment, whether termed an “examiner” with
expanded powers or a “trustee” with limited powers.138
The Estate Neutral: Recommendations and Findings
16
1, 20
ber 2
em
n concerning the frequency and
The Commission reviewed the case law and academic literatureNov
ed o
hiv
use of examiner appointments and the interpretation rc the current statute, which mandates
63 a of
-353
. 14
the appointment of an examiner in certain ocircumstances. The Commissioners explored, in the
,N
rown
B
h v.
alternative, the utility of a newsestate neutral, particularly in cases when, for example, stakeholders
x et
n Bli
i
c ed
found value in leavingitthe debtor in possession in control, but certain matters in the case needed an
independent assessment either because it was difficult for a debtor to investigate itself or because the
debtor and stakeholders were too vested in their respective positions to identify areas of potential
137 Examples of cases using court-appointed mediators: In re R.H. Macy & Co., Inc. 1994 WL 482948 (Bankr. S.D.N.Y. Feb. 23,
1994); In re Lehman Bros., Inc., Ch. 11 Case No. 08-13555 (JMP) (Bankr. S.D.NY.) (Jan. 16, 2009) [Docket No. 2569]. See also
Cassandra G. Mott, Macy’s Miracle on 34th Street: Employing Mediation to Develop the Reorganization Plan in a Mega-Chapter
11 Case, 14 Ohio St. J. on Disp. Resol. 193, 207–10 (1998); Harvey R. Miller, The Changing Face of Chapter 11: A Reemergence
of the Bankruptcy Judge as Producer, Director, and Sometimes Star of the Reorganization Passion Play, 69 Am. Bankr. L.J. 431,
437 (1995). For an example of a court-approved arbitration procedure in the context of claims resolutions, see Meyer v. Dalkon
Shield Claimants Trust, 164 F.3d 623, at *1 (4th Cir. 1998) (unpublished table decision) (explaining alternative dispute resolution
procedures used to address products liability claims).
138 See, e.g., Official Comm. of Asbestos Pers. Injury Claimants v. Sealed Air Corp. (In re W.R. Grace & Co.), 285 B.R. 148, 156–57
(Bankr. D. Del. 2002) (denying debtor’s motion to appoint examiner with expanded powers or trustee with limited purpose
to prosecute fraudulent transfer claims because “the basic job of an examiner is to examine, not to act as a protagonist in the
proceedings” and “[t]here is no such entity as a limited purpose trustee under the [Bankruptcy] Code”); Kovalesky v. Carpenter,
1997 WL 630144, at *3 (S.D.N.Y. Oct. 9, 1997) (“Examiners . . . play a chiefly information-seeking role and, like the court itself,
must remain a neutral party in the bankruptcy process.”); In re Interco Inc., 127 B.R. 633, 638 (Bankr. E.D. Mo. 1991) (“[T]he
examiner’s role is by its nature disinterested and non-adversarial. There is no doubt that the examiner is a neutral party in a
bankruptcy case.”); In re Baldwin United Corp., 46 B.R. 314, 316–17 (Bankr. S.D. Ohio 1985) (“[W]e never contemplated, nor
in our opinion does the Bankruptcy Code contemplate, that the examiner act as a conduit of information to fuel the litigation
fires of third-party litigants.”); In re Hamiel & Sons Inc., 20 B.R. 830, 832 (Bankr. S.D. Ohio 1982) (an examiner “constitutes
a court fiduciary and is amenable to no other purpose or interested party”). But see S. Rep. No. 989, 95th Cong. 2d Sess. 116
(1978), reprinted in 1978 U.S.C.C.A.N. 5787 (“The [bankruptcy] court is authorized to give the examiner additional duties as
circumstances warrant.”); In re Mirant Corp., 2004 WL 2983945, at *2–3 (Bankr. N.D. Sept. 1, 2004) (examiner authorized to
monitor and mediate plan negotiations); In re Pub. Serv. Co. of N.H., 99 B.R. 177 (Bankr. D.N.H. 1989) (examiner authorized to
mediate negotiations related to chapter 11 plan); In re UNR Indus., Inc., 72 B.R. 789 (Bankr. N.D. Ill. 1987) (examiner appointed
to negotiate chapter 11 plan and facilitate resolution of substantive differences).
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compromise. As further explained below, the Commission determined that the concept of an estate
neutral should replace examiners under the Bankruptcy Code.
The Commissioners found little correlation between the standards for a mandatory appointment
and the utility of the appointee in any given case, based on experiences with examiners under section
1104(c) of the Bankruptcy Code. Accordingly, the Commission voted to eliminate the mandatory
nature of the appointment process and to permit the court to order the appointment of an estate
neutral, upon request of a party in interest or the U.S. Trustee and after notice and a hearing, if such
appointment would be in the best interests of the estate. The Commission specifically considered the
existing case law, and it rejected a standard that required all interests to be served by the appointment.
It found that, given the role contemplated for estate neutrals under these principles, the appointment
standard should be flexible and tailored by the court to the particular case. Courts should determine
if, on balance, the best interests of the estate would be served by the appointment.
The Commissioners further discussed the proper role of estate neutrals in the reorganization process.
Absent the appointment of a trustee, all parties in the chapter 11 case have potentially diverging
interests and may be motivated purely by self-interest. For example, the debtor in possession acts
as a fiduciary for the estate, but the estate itself likely has different constituencies. The debtor in
possession is also working to reorganize its business and preserve relationships with employees,
vendors, and other constituents that ultimately serve the interests of the estate. Likewise, a statutory
6
unsecured creditors’ committee owes its duties to general unsecureder 21, 201 but those creditors
creditors,
b
are not the only stakeholders in the case. The Commissioners ovem
N observed that an estate neutral-like
d on
chive independent and neutral perspective in
appointee is the only party uniquely situated to3provide an
3 ar
35 6
. 14the case. The Commission also considered other potential rationales for expanding the role of the
, No
own
. traditional examiner in chapter 11 cases, such as facilitating dispute
va Br
new estate neutral from thattof
eh
Blixs
resolution and reducing information asymmetries.
ed in
cit
The Commissioners recognized the costs associated with the appointment of an examiner under
the current law, as well as the additional costs that might accompany the new estate neutral, which
could be used more frequently and for a wider array of tasks. Not only would the estate compensate
the estate neutral, but the estate also would compensate any professionals that the court authorizes
the estate neutral to retain. The Commissioners explored ways to contain these costs, including
through court-approved budgets and restrictions on the efforts by the debtor in possession and
the unsecured creditors’ committee that may be duplicative of those assigned to the estate neutral.
The Commissioners believed that this kind of oversight by the court and other stakeholders could
mitigate the potential increases in costs. The Commissioners did not believe, however, that such
restrictions should be statutorily mandated, but rather left to the court and parties in interest to
determine in any given case.
The Commission also considered the potential cost savings that an estate neutral may generate in
cases when the parties are at an impasse in negotiations or need an independent investigation to
facilitate resolution of particular matters. The Commissioners discussed how courts should balance
the costs associated with an estate neutral with the potential efficiencies created by the appointment.
The Commissioners also observed that, even under this cost-benefit analysis, the circumstances of the
case could warrant the appointment of more than one estate neutral to perform different functions
IV. Proposed Recommendations: Commencing the Case
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in the case, but the Commissioners believed that this should be the exception rather than the rule.
The Commissioners did not want to create roles for third parties in the case or impose additional
costs on the process if unnecessary or if the benefits would be marginal at best. Accordingly, the
Commission recommended a presumption against the appointment of more than one estate neutral
in any given case, which could be rebutted by evidence that the circumstances of the case and a costbenefit analysis support the additional appointment. The Commission also concluded that, with
the elimination of the mandatory appointment provision, if the circumstances of the case warrant
the appointment of an estate neutral, the potential benefit of the estate neutral to the estate would
likely outweigh any additional costs to the estate. The Commission ultimately voted to provide more
flexibility to the court and the parties in using estate neutrals, as set forth in the principles above, and
to recommend use of estate neutrals in lieu of examiners.
The Commissioners discussed the related concept of a statutory reorganization executive, which
would be similar in some ways to an examiner with expanded powers but different in several key
respects. For example, a statutory reorganization executive would likely be suggested and supported
by the debtor and could operate the debtor’s business, work directly with the parties to help facilitate
a plan, and function more as an insider of the debtor (akin to a chief restructuring officer).139 The
Commissioners explored the contours of this new fiduciary, which some Commissioners believed
would need to be accountable to the debtor’s board of directors and subject to applicable state
fiduciary duty laws. The Commissioners who supported the concept of a statutory reorganization
16
executive viewed it as a private solution that parties would use moreber 21, 20 than seeking the
readily
vem
appointment of a trustee or examiner. The Commissioners whooopposed the concept of a statutory
n No
ed
r iv
reorganization executive voiced concerns similar to5those ch
63 a noted above respecting an examiner with
-3 3
. 4
expanded powers and viewed the appointment1of a trustee as the better alternative. Ultimately, the
, No
rown
Commission voted against the seth v. B of a statutorily recognized reorganization executive, but did
concept
Blix
ed in of such a position in considering and developing the parameters of the
consider the potentialitvalue
c
role of an estate neutral.
4. Statutory Committees
Recommended Principles:
Except as provided in the principles for small and medium-sized enterprise cases,
the appointment of an unsecured creditors’ committee should remain mandatory
as provided under section 1102(a) of the Bankruptcy Code unless the court orders
otherwise for cause. The term “cause” should include that such an appointment
would not be in the best interests of the estate or that the interests of general
unsecured creditors do not need representation in the particular case because, for
139 The Commissioners distinguished a chief restructuring officer from the proposed statutory reorganization executive, as the
chief restructuring officer typically is retained as an officer of the company under applicable state law, subject to the same duties
and obligations as the debtor’s other officers. The Commissioners found the current process for engaging chief restructuring
officers in appropriate cases sufficient and not inconsistent with the Commission’s position on either the estate neutral or the
restructuring officer.
IV. Proposed Recommendations: Commencing the Case
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example, they will not receive any distributions in the case or their claims will be
paid in full.
The court sua sponte, the U.S. Trustee, or a party in interest should be able to
initiate a hearing to determine whether the appointment or continuation of an
unsecured creditors’ committee would be in the best interests of the estate.
The U.S. Trustee should continue to retain discretion to appoint a committee of
equity security holders, more than one committee of unsecured creditors, or a
single statutory committee for multiple affiliated debtors. Accordingly, no change
to existing law is suggested on this point.
Statutory Committees: Background
The concept of a committee of creditors formed to monitor the debtor and its reorganization efforts
stems from the equity receiverships of the late 1800s and Chapter XI of the Bankruptcy Act.140 The
unsecured creditors’ committees that were formed in the equity receivership context were criticized
for their close and arguably collusive relationships with the debtor.141 Nevertheless, Congress
recognized the value in the committee structure, both in terms of their oversight functions and the
142
dynamic tension that their presence and participation adds to restructuring 2016
1, negotiations. Congress
ber 2
thus maintained some form of committees in the Bankruptcy Noveand extended that structure to all
Act m
n
ed o Code.
hiv
business reorganizations under chapter 11 of the Bankruptcy
3 arc
536
14-3
No.
n,
of the Bankruptcyrow
. B Code provides that “the United States trustee shall appoint a
eth v
ixs
creditorsBholding unsecured claims”143 that “shall ordinarily consist of the persons,
in l
cited
Section 1102
committee of
willing to serve, that hold the seven largest claims against the debtor of the kinds represented on
such committee. . . .”144 The legislative history of section 1102 suggests that Congress intended to
give unsecured creditors a stronger voice in the reorganization process.145 The unsecured creditors’
140 In an equity receivership, “creditors would petition the court for the receivership and form a protective or reorganization
committee. In most cases, the reorganization committee, working with management, would be the successful bidder at the
receivership sale.” Michelle M. Harner & Jamie Marincic, Committee Capture? An Empirical Analysis of the Role of Creditors’
Committees in Business Reorganizations, 64 Vand. L. Rev. 749, 758–760 nn. 46–59 (2011) (explaining history of creditors’
committees in bankruptcy and providing citations to additional resources). “Chapter XI charges creditors’ committees with
overseeing the conduct of the debtor and negotiating the debtor’s plan of reorganization; for the most part, they were active
participants in cases.” Id. at 760.
141 Justice Douglas observed: “In the welter of conflicting interests, ulterior objectives, and self-serving actions which flow from
investment banker-management dominance over committees, these committees have lost sight of their essential functions
which they can perform to advance the interests of investors.” To Amend the Securities Act of 1933: Hearing on H.R. 6968 Before
the H. Interstate and Foreign Commerce Comm’n., 75th Cong. 24 (1937) (statement of William O. Douglas).
142 “The mandatory appointment of a creditors’ committee was intended to provide dynamic tension with the debtor that would
stimulate the reorganization process through effective and efficient oversight and negotiation.” Miller, supra note 41, at 449.
See also Michelle M. Harner & Jamie Marincic, The Potential Value of Dynamic Tension in Restructuring Negotiations, Am.
Bankr. Inst. J., Feb. 2011, at 62–65; Thomas C. Given & Linda J. Philipps, Equality in the Eye of the Beholder — Classification of
Claims and Interests in Chapter 11 Reorganizations, 43 Ohio St. L. J. 735, 735–36 (1982) (explaining “dynamic tension” in context
of reorganization vs. liquidation restructuring options); Donald R. Korobkin, Bankruptcy Law, Ritual and Performance, 103
Colum. L. Rev. 2124, 2130 (2003) (explaining that results under bankruptcy laws often “spontaneously emerge . . . at a juncture
of futility and loss, from the dynamic and generative tension of normative directives in unavoidable conflict”).
143 11 U.S.C. § 1102(a)(1).
144 Id. § 1102(b)(1).
145 “This section [1102] provides for the appointment of creditors’ and equity security holders’ committees, which will be the
primary negotiating bodies for the formulation of the plan of reorganization. They will represent the various classes of creditors
and equity security holders from which they are selected. They will also provide supervision of the debtor in possession and of
the trustee, and will protect their constituents’ interests.” H.R. Rep. No. 95–595, at 401 (1977), reprinted in 1978 U.S.C.C.A.N.
5963, 6357.
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committee has been viewed not only as necessary to protect the interests of the many unsecured
creditors unable to participate directly in the process, but also to further monitor the actions of the
debtor in possession during the chapter 11 case. It can play “many roles” in a chapter 11 case.146
The appointment of a committee of unsecured creditors is mandatory in chapter 11 cases, but cases
do proceed without committees in certain circumstances. For example, the U.S. Trustee can only
constitute a committee if a sufficient number of creditors are willing to serve on the committee.147
An individual creditor will often engage in a cost-benefit analysis to decide whether to serve on the
unsecured creditors’ committee. As a committee member, a creditor owes certain fiduciary duties,
and its service consumes time and effort that could otherwise be devoted to the creditor’s own
business. Consequently, unsecured creditors may decide, particularly in smaller chapter 11 cases,
that the economics do not favor service on a committee of unsecured creditors.
The U.S. Trustee must form (or try to form) a committee “as soon as practicable after the order for
relief.”148 To meet this requirement, the U.S. Trustee, shortly after the petition date, actively solicits
interest in committee service from the debtor’s unsecured creditor body. “The size and exigencies
of a case guide the solicitation and formation process.”149 The U.S. Trustee typically solicits the
debtor’s 20 largest unsecured creditors, but may expand its search to the top 30 if warranted by
the case. Although many committee formation meetings are held in person, the U.S. Trustee also
constitutes committees through telephone interviews, particularly in smaller cases.150 “What does
16
not vary, however, is the U.S. Trustee’s need to gauge a creditor’s genuine willingness to serve on the
1, 20
ber 2
vem
committee for legitimate reasons and the committee members’ obligation to act as fiduciaries to the
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arch
entire unsecured creditor constituency.”151
363
-35
o. 14
n, N
ow
The U.S. Trustee generally triesthto. appoint members to the committee who reflect the general
v Br
lixse
B
unsecured claims pooled inthe particular case — e.g., bonds, trade, landlords, etc.152 Section 1102
cit in
allows parties in interest to request, and the court to direct, a change in the composition of the
unsecured creditors’ committee or the appointment of additional committees.153 The U.S. Trustee
is the party, however, that implements the change in the composition of the unsecured creditors’
committee or constitutes any additional committees. Moreover, section 1102 does not specifically
address whether a single unsecured creditors’ committee may represent the interests of unsecured
creditors in multiple, jointly administered cases. The U.S. Trustee has used a single unsecured
146 In re Haskell-Dawes, Inc., 188 B.R. 515, 521 (Bankr. E.D. Pa. 1995). “[T]he Bankruptcy Code authorizes such committees to, inter
alia: consult with the trustee concerning the administration of the case; investigate the acts, conduct and financial condition of
the debtor; investigate the operation of the debtor’s business and the desirability of having such business continue; participate in
the formulation of a plan; and provide advice to those whom the committee represents regarding any plan that is formulated.”
Id. at 519.
147 Roberta A. DeAngelis & Nan Roberts Eitel, Committee Formation and Reformation: Considerations and Best Practices, Am.
Bankr. Inst. J., Oct. 2011, at 20 n. 2 (noting that the U.S. Trustee “often cannot appoint a committee in other cases because
an insufficient number of creditors are willing to serve”). See Harner & Marincic, Committee Capture?, supra note 140, at 777
(finding that in a study of chapter 11 cases filed between 2002 and 2008, 48.3 percent of cases involved at least one creditors’
committee and 51.7 percent involved no creditors’ committee). See also In re Aspen Limousine Serv., Inc., 187 B.R. 989, 994 n.6
(Bankr. D. Colo. 1995), aff ’d as modified, 198 B.R. 341 (D. Colo. 1996) (“[I]n practice, a committee is rarely appointed in a smaller
case.”); In re ABC Auto. Prods. Corp., 210 B.R. 437, 442–43 (Bankr. E.D. Pa. 1997) (“[A]s courts and commentators alike have
noted, in many cases creditors’ committees are inactive or ineffectual.”).
148 11 U.S.C. § 1102(a)(1).
149 DeAngelis & Eitel, supra note 147, at 20.
150 Id.
151 Id.
152 In re Park W. Circle Realty, LLC, 2010 WL 3219531, at *2 n. 6 (Bankr. S.D.N.Y. Aug. 11, 2010) (“Although committees do not
necessarily need to reflect the precise composition of the creditor body, committees should adequately represent the various
creditor types.”); accord In re Hills Stores Co., 137 B.R. 4, 7 (Bankr. S.D.N.Y. 1992).
153 11 U.S.C. § 1102(a)(2), (4).
IV. Proposed Recommendations: Commencing the Case
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creditors’ committee in such cases under certain circumstances, and courts have generally approved
this approach.154
Once appointed, the unsecured creditors’ committee serves in a fiduciary capacity with respect to
the other unsecured creditors it represents and is granted certain powers under section 1103 of the
Bankruptcy Code.155 The committee may, among other things, meet with the debtor, investigate the
debtor’s affairs, participate in the plan formulation process, and request the appointment of a trustee
or examiner.156 The committee may also retain professionals to represent it in the chapter 11 case.157
The expenses of committee members and the fees and expenses of the committee’s counsel and other
professionals are generally paid from the estate.
Statutory Committees: Recommendations and Findings
The Commissioners had a robust discussion regarding the ongoing utility of unsecured creditors’
committees in chapter 11 cases. Some Commissioners felt that the mandatory nature of a committee
of unsecured creditors was no longer warranted given that the fulcrum claims are now secured claims
in many debtors’ capital structures. Thus, a committee may not be needed because (i) unsecured
creditors anticipate being paid in full or (ii) the creditors it represents may be out of the money in
many cases. These Commissioners proposed treating the appointment of all statutory committees
as discretionary, the way in which the current law treats the appointment of equity security holders’
16
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committees.158
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Other Commissioners believed that the oversight rch
63 a function served by the unsecured creditors’
-353
. 14
committee is critical to the process and should be preserved. The Commissioners noted the valuation
, No
rown
challenge of determiningxseth v.in a chapter 11 case that classes of debt are in the money or out of
early B
n Bli
the money. For cited ireason alone, a per se rule based on the value of unsecured claims would be
this
inadequate. The Commissioners also highlighted the role of the unsecured creditors’ committee in
creating value or critically analyzing the debtor’s proposed reorganization plan to ensure that the
enterprise value would not be artificially depressed or removed from the estate.
154 See, e.g., In re Orfa Corp. of Phila., 121 B.R. 294, 299 (Bankr. E.D. Pa. 1990) (rejecting a per se rule regarding the appointment
of a committee for each related debtor due to “the additional and unnecessary administrative costs that would result if another
committee and a potential enclave of additional professionals [are] appointed”); In re McLean Indus, Inc., 70 B.R. 852, 862
(Bankr. S.D.N.Y. 1987) (noting the cost of separate committees “could be extreme”). But see In re White Motor Credit Corp., 18
B.R. 720, 722 (Bankr. N.D. Ohio 1980) (“As a matter of law, section 1102 indicates that each case should have a Court-appointed
committee. While such language does not preclude the Court from appointing identical committees in related cases, it cannot be
said to authorize a single committee under the circumstances of these proceedings.”); In re Proof of the Pudding, Inc., 3 B.R. 645,
649 (Bankr. S.D.N.Y. 1980) (noting that “completely independent committees, devoid of overlapping membership, can better
serve the interests of all of the other creditors in closely related cases”).
155 See, e.g., In re Fas Mart Convenience Stores, Inc., 265 B.R. 427, 432 (Bankr. E.D. Va. 2001) (“Members of the committee also
have another duty — a fiduciary duty to all creditors represented by the committee.”); In re Firstplus Fin., Inc., 254 B.R. 888, 894
(Bankr. N.D. Tex. 2000) (“In a Chapter 11 case, an Unsecured Creditors’ Committee is appointed by the Office of the United
States Trustee and owes a fiduciary duty to act on behalf of all unsecured creditors.”).
156 11 U.S.C. § 1103(c).
157 Id. § 1103(a).
158 See, e.g., Written Statement of Daniel Kamensky on behalf of Managed Funds Association: LSTA Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (“In such cases, the statutory creditors’ committee is not an equal
negotiating partner of the debtor, since it represents creditors with a de minimis stake in the future company. In fact, the only
avenue of recovery for unsecured creditors in such cases is typically litigation of sometimes dubious causes of action, which
can cause the statutory committee to focus unduly on future litigation value. It therefore may not be appropriate for a statutory
creditors’ committee to be appointed in these cases; or, at least, limits should be placed on the committee’s role.”) (citations
omitted).
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After extensive deliberation, the Commission recommended retaining the mandatory appointment
of a committee of unsecured creditors in all cases, except small and medium-sized enterprise cases
(addressed in a subsequent section).159 The Commissioners found value in the traditional “watchdog”
function of the committee, not only as a check on the debtor in possession, but also as a check on other
stakeholders and the allocation of the estate’s value among stakeholders. Indeed, unlike secured or
administrative creditors — whose claims must be paid in order to confirm a plan — the Bankruptcy
Code does not mandate any minimum return for general unsecured creditors (other than that they
receive more than they would in a chapter 7 liquidation). The unsecured creditors’ committee is
the primary statutory protection for general unsecured creditors. Nevertheless, the Commission
did find merit in the argument that a committee should not be appointed if its constituents have no
need for representation in the case (i.e., their claims are out of the money or are being paid in full).
The Commission agreed that this standard should be part of a “for cause” standard that would, if
established by evidence at the hearing, allow the court to direct the U.S. Trustee not to appoint, or to
disband, an unsecured creditors’ committee.
The Commission agreed that the potential benefits of an active committee of unsecured creditors must
be carefully balanced against the costs and potential delays associated with the various actions that
such a committee could be entitled to take. For example, the Commissioners discussed the kinds of
cases in which tactics by a committee can increase costs or delay the resolution of a case or a material
transaction in the case. Although many of the Commissioners acknowledged the infrequency of such
16
1, 20
instances, they also recognized the potential harm to the estate and its constituents when they do
ber 2
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occur. The Commission agreed, however, that the court and thedU.S. Trustee have sufficient authority
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under the law to monitor the activity of unsecured creditors’ccommittees and to implement appropriate
63 a
-353
. 14
protections as needed. On that point, the Commissioners also discussed cases in which a committee
, No
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of unsecured creditors was ordered v. Bshare professionals with other committees (or even the debtor,
eth to
Blixs
ed in
it
provided appropriatecprotections were put in place) or in which a committee’s professionals’ fees and
expenses were capped either overall or with respect to certain matters.160
Finally, the Commission considered the impact of potential conflicts of interests associated with
the diverse membership of a typical committee of unsecured creditors. Specifically, the interests of
one committee member may not align with those of other members or even with those of general
unsecured creditors in a particular chapter 11 case.161 For example, the interests of an unsecured
creditor seeking to acquire equity in the reorganized debtor in exchange for its claims may not
align with the interests of the debtor’s trade creditors.162 Also, committee members who hold equity
159 See Section VII, Proposed Recommendations: Small and Medium-Sized Enterprise (SME) Cases.
160 For a discussion of the costs and potential complications associated with multiple committees, see Kenneth N. Klee & K. John
Shaffer, Creditors’ Committees Under Chapter 11 of the Bankruptcy Code, 44 S.C. L. Rev. 995, 1024–25 (1993) (“[M]ultiple
committees can complicate negotiations, delay the reorganization process, and create additional administrative expenses to the
debtor’s estate, particularly in terms of higher professional fees.”).
161 See, e.g., Michael P. Richman & Jonathan E. Aberman, Creditors’ Committees Under the Microscope: Recent Developments Highlight
Hazards of Self-Dealing, Am. Bankr. Inst. J., Sept. 2007, at 22 (examining chapter 11 cases involving committee member conflicts
of interest); Burke Gappmayer, Protecting the Insolvent: How a Creditor’s Committee Can Prevent Its Constituents from Misusing
a Debtor’s Nonpublic Information and Preserve Chapter 11 Reorganizations, 2006 Utah L. Rev. 439, 445–46 (discussing conflicts
of interest that may affect creditors’ committee members); Carl A. Eklund & Lynn W. Roberts, The Problem with Creditors’
Committees in Chapter 11: How to Manage the Inherent Conflicts Without Loss of Function, 5 Am. Bankr. Inst. L. Rev. 129, 130–33
(1997) (analyzing problems posed by committee member conflicts); Nancy B. Rapoport, Turning and Turning in the Widening
Gyre: The Problem of Potential Conflicts of Interest in Bankruptcy, 26 Conn. L. Rev. 913, 916–17 (1994) (examining conflict of
interest issues in bankruptcy, including in committee context).
162 For example, section 1122(b) of the Bankruptcy Code permits a debtor use an administrative convenience class to pay trade
creditors in full even when the plan is not able to fully repay claims of other unsecured creditors that will be discharged. See Brad
B. Erens & Timothy W. Hoffmann, The Triumph of the Trade Creditor in Chapter 11 Reorganizations, J. Bankr. L., Jan. 2013, at
IV. Proposed Recommendations: Commencing the Case
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in a competitor of the debtor may have adverse interests. The Commissioners acknowledged that
the U.S. Trustee was asking more nuanced questions concerning a creditor’s interests in a debtor’s
case during the committee formation process.163 They recognized, however, that some conflicts of
interest are inevitable. The Commission concluded that the court and the U.S. Trustee are both well
positioned to address any problematic conflicts of interest that may arise on a committee on a caseby-case basis, in the same way in which they are empowered to address unnecessary costs and delays
associated with unsecured creditors’ committees.
5. Estate Fiduciaries
Recommended Principles:
The doctrine set forth in Barton v. Barbour, 104 U.S. 126, 127–29 (1881) (which
provides that to sue a court-appointed receiver, a party must obtain leave from the
court that ordered such appointment) should also apply to the following parties
in chapter 11 cases: trustees, estate neutrals, and statutory committees and their
members, as well as professionals retained to represent any of the foregoing parties
in their fiduciary capacity.
16
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Estate Fiduciaries: Background
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6 a
In Barton v. Barbour, the U.S. Supreme 1Court 3confirmed the “general rule that before suit is
-353
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brought against a receiver leave Brown, N
of the court by which he was appointed must be obtained.”164 The
h v.
Supreme Court alsoinheldset
Blix that this general rule applies equally to suits seeking equitable relief
cited
165
(e.g., to recover specific property) and damages (i.e., money). Courts have generally extended
the Barton doctrine to trustees166 in bankruptcy and other officers appointed by the court. “As the
Sixth Circuit has observed, under the Barton doctrine, ‘court appointed officers who represent the
estate are the functional equivalent of a trustee.’”167 Accordingly, some courts have determined that
postconfirmation trustees and members of the unsecured creditors’ committee are also deemed
officers appointed by the court and thus covered by the Barton doctrine.168
163
164
165
166
167
168
26 (“[D]ebtors sometimes have promulgated plans with very large administrative convenience claim caps for trade claims. Any
claim up to that cap would be paid in full. Even claims above such cap could voluntarily elect to reduce their claims to the cap
and, to that extent, often receive close to full payment. In this manner, debtors have been able to pay trade creditors under a plan
a higher percentage on account of their claims then, for instance, similarly situated unsecured bondholders.”).
See, e.g., DeAngelis & Eitel, supra note 147, at 58–59 (explaining that the U.S. Trustee considers, among other things, whether
“the creditor will be paid as a critical vendor, has an executory contract or lease that will be assumed (and defaults cured), holds
claims among multiple levels of the company’s debt structure, or has insurance or other hedges that may limit its exposure or
affect the identity of the true beneficial holder of the claim”).
Barton v. Barbour, 104 U.S. 126, 128 (1881).
“A suit . . . brought without leave to recover judgment against a receiver for a money demand, is virtually a suit the purpose of
which is, and effect of which may be, to take the property of the trust from his hands and apply it to the payment of the plaintiff ’s
claim, without regard to the rights of other creditors or the orders of the court which is administering the trust property.” Id. at
129.
As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
In re Crown Vantage, Inc., 421 F.3d 963 (9th Cir. 2005) (quoting Allard v. Weitzman (In re DeLorean Motor Co.), 991 F.2d 1236
(6th Cir. 1993)).
Id. See also Blixseth v. Brown, 470 B.R. 562 (D. Mont. 2012) (applying Barton doctrine to chair of the creditors’ committee).
IV. Proposed Recommendations: Commencing the Case
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The Barton doctrine is addressed, in part, by section 959(a) of title 28 of the U.S. Code, which
provides that “[t]rustees, receivers or managers of any property, including debtors in possession, may
be sued, without leave of the court appointing them, with respect to any of their acts or transactions
in carrying on business connected with such property.”169 Courts have interpreted section 959(a) as
an implicit limitation of the Barton doctrine and have acknowledged that litigation not covered by
section 959(a) requires leave of court.170 A litigant is thus required to seek leave of the court with
respect to litigation against a chapter 11 trustee or other officer appointed by the court in connection
with the liquidation or administration of a debtor’s estate, except as provided in section 959(a).
Moreover, some courts have extended the Barton doctrine to counsel for the trustee appointed by
the court to the extent that such counsel was acting at the direction of the trustee for purposes of
liquidating or administering the debtor’s estate.171
Estate Fiduciaries: Recommendations and Findings
The Commissioners discussed the value of extending limited immunity to the chapter 11 trustee
and similar fiduciaries for actions taken by them in their fiduciary capacity. In this context, the
Commission reviewed the parameters of the Barton doctrine and its underlying policy justifications.
The Commission agreed that the Barton doctrine should be codified to clarify its scope and
application to any trustee, estate neutral, and statutory committee and its members 6
appointed in the
20
,for 1
chapter 11 case. The Commissioners found value in the following justification
such extension of
r 21
mbe
Nove
n
the Barton doctrine:
ed o
iv
arch
5363
Just like an equity receiver, a trustee in. bankruptcy is working in effect for the court
14-3
No
that appointed or approved .him, n,
Brow administering property that has come under the
th v
lixseof the Bankruptcy Code. If he is burdened with having to
court’s control by in B
virtue
cited
defend against suits by litigants disappointed by his actions on the court’s behalf, his
work for the court will be impeded.172
The Commissioners believed that this clarification would (i) allow any trustee, estate neutral, and
statutory committee and its members to perform their fiduciary duties with confidence and focus,173
and (ii) eliminate unnecessary litigation concerning the application of the Barton doctrine and
whether the court in which a litigant files the action has subject matter jurisdiction over the dispute.174
For similar reasons, the Commission voted to extend the Barton doctrine to any professionals
retained by any trustee, estate neutral, or statutory committee or its members to the extent that the
litigation involves the professionals’ representation of such party in a fiduciary capacity.
The Commissioners recognized that this recommended principle could also apply to cases filed
under other chapters of the Bankruptcy Code. Although the Commission did not study bankruptcy
169
170
171
172
173
28 U.S.C. § 959(a).
See, e.g., In re VistaCare Grp., LLC, 678 F.3d 218, 224–25 (3d Cir. 2012).
McDaniel v. Blust, 668 F.3d 153 (4th Cir. 2012).
In re Linton, 136 F.3d 544, 545 (7th Cir. 1998).
Id. (explaining the importance of the Barton doctrine because without it, “[t]he threat of [the bankruptcy trustee] being distracted
or intimidated is then very great”). “This concern is most acute when suit is brought against the trustee while the bankruptcy
proceeding is still going on.” Id.
174 Courts generally hold that if the Barton doctrine applies and the litigant does not obtain leave of the bankruptcy court, other
courts do not have subject matter jurisdiction over the matter. See, e.g., In re Crown Vantage, Inc., 421 F.3d 963, 971 (9th Cir.
2005).
IV. Proposed Recommendations: Commencing the Case
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cases under these other chapters, it believed that the Barton doctrine should apply to all cases and
proceedings under the Bankruptcy Code.
6. Valuation Information Packages
Recommended Principles:
Except as provided in the principles for small and medium-sized enterprise cases,
the debtor should compile a “valuation information package” (“VIP”) containing
the following information: (i) tax returns for the previous three years (inclusive of
all schedules); (ii) annual financial statements (audited if available) for the prior
three years (inclusive of all footnotes); (iii) most recent independent appraisals of
any of the debtor’s material assets (including any valuations of business enterprise
or equity); and (iv) to the extent shared with prepetition creditors and existing
or potential purchasers, investors, or lenders, all business plans or projections
prepared within the past two years.
In connection with any motion filed under section 361, 362, 363, or 364 of the
Bankruptcy Code or any chapter 11 plan filed within 60 days after the petition
date or date of the order for relief, whichever is later, the debtor should file with
16
1, 20
the court a list of the information included in its VIP, unless the court orders
ber 2
ovem
otherwise for cause. A party in interest may hived on N copy of the VIP for a proper
request a
rc
6 a
purpose, which includes the evaluation3of the pending motion or proposed plan.
-353
. 14
Unless the court ordersrown, No
otherwise for cause, the debtor should provide a copy of
v. B
the VIP promptlyth any such requesting party, provided that the party executes
xse to
n Bli
i
cited
a confidentiality agreement and, to the extent that the VIP contains material
nonpublic information, agrees to restrict its trading activity in the debtor’s
claims, interests, and securities. The debtor should be able to redact or withhold
information otherwise included in its VIP to the extent that the debtor determines
in good faith that such redaction is necessary to prevent harm to the estate, unless
the court orders otherwise.
Valuation Information Packages: Background
A debtor is required to file a variety of forms, schedules, and other information upon commencement
of its chapter 11 case or shortly thereafter. The Bankruptcy Code generally gives debtors a short
grace period after the petition date to file the required forms,175 and debtors typically can request
additional time for the filing of certain materials.176 Nevertheless, a debtor’s timely and full disclosure
is a necessary component of the chapter 11 process. Without this basic information, the court, the
U.S. Trustee, and parties in interest cannot assess the debtor’s reorganization efforts and make
meaningful decisions in the case.
175 Fed. R. Bankr. P. 1007(c), (d).
176 Fed. R. Bankr. P. 1007(a)(5) (permitting extensions of deadlines upon a showing of cause).
IV. Proposed Recommendations: Commencing the Case
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The debtor’s financial information is perhaps among the most important of its disclosures. Under
current law, a debtor is required to file some, but not necessarily the most relevant financial data
early in the chapter 11 case, unless the court orders otherwise for cause. For example, every debtor
that files periodic reports with the Securities and Exchange Commission must file “Exhibit A” along
with its chapter 11 petition, which requires the debtor to list the value of its assets and the amount of
its liabilities plus basic information regarding its capital structure (public and private debt and equity
securities). Similarly, section 521(a) of the Bankruptcy Code and Rule 1007 of the Federal Rules of
Bankruptcy Procedure (the “Bankruptcy Rules”) require the debtor to file schedules of assets and
liabilities and a statement of financial affairs, unless the court orders otherwise for cause. There is no
specific requirement that such schedules and statements be prepared in accordance with generally
accepted accounting principles (“GAAP”), and extensions of the deadline to file these documents are
routinely requested and granted by courts. Separately, the U.S. Trustee requires a debtor to submit its
financial information within one week of its petition date, as outlined in the applicable U.S. Trustee’s
Operating Guidelines and Reporting Requirements for Debtors in Possession and Chapter 11 Trustees,
to facilitate the U.S. Trustee’s oversight functions. The required information includes a list of bank
accounts and insurance policies.177 Finally, Bankruptcy Rule 2015 contains additional obligations
to disclose financial information relating to inventory, receipts, disbursements, and other relevant
matters.
Notably, none of these required disclosures provide the court, the U.S. Trustee, or parties in interest
16
with financial data that could assist the parties in valuing the debtor’s ber 21, 20 or assets.178 Such
business
m
valuation information may be critically important early in dthe Nove when a debtor is seeking
n case
e o
iv
permission to use cash collateral, obtain debtor in 363 arch
possession financing, or sell some or all of its
-35
4
assets, and when creditors are seeking reliefNo. 1 stay.
from
wn,
ited
h v.
xset
n Bli
i
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c
Valuation Information Packages: Recommendations and Findings
The Commissioners analyzed the potential benefits of the requirement that debtors provide additional
and earlier disclosures of meaningful financial data, particularly data that may assist parties in
interest to assess valuation issues.179 Among other potential benefits, such disclosures may help
reduce information asymmetries and allow parties to make better-informed decisions regarding the
impact of the debtor’s proposed exit strategy on their recoveries in the case. Such disclosures could
177 The U.S. Trustee also has discretion to request additional information. In addition, the debtor must complete a monthly operating
report for filing and submission to the U.S. Trustee.
178 See, e.g., Legislative Update: Valuation Issues a Key Topic at Chapter 11 Commission Hearing in Las Vegas, Am. Bankr. Inst. J., Apr.
2013, at 125 (recommending earlier disclosures about debtor’s business plan and business projections) (citing testimony by Eric
Siegert of Houlihan Lokey).
179 Some commentators have expressed dissatisfaction with the current lack of sufficient disclosures by the debtor early in the
bankruptcy case. See, e.g., id. (“I’m generally frustrated with the notion of . . . confidentiality around a debtor’s business plan
early in the process. I understand that there are competitive secrets and things of that nature that need to be safeguarded, but at
the end of the day when you look at a chapter 11 confirmation process, the business projections, almost without exception, are
included in a disclosure statement, so they’re made public anyway.”) (citing testimony by Eric Siegert, Houlihan Lokey); id. at 126
(“Creditors’ committees are frustrated by the amount of time [that] it takes for debtors to provide timely and thorough financial
information. . . . As a result of this sluggish and time-consuming process of getting information, I believe that committees are
often stymied in fulfilling their fiduciary obligations.”) (citing testimony by Sandi Horwitz, CSC Trust Co.). Other commentators
have suggested that the debtor’s control of the flow of financial information, imprecise financial data, and the use of strategic
valuation can have significant wealth consequences. See, e.g., Stuart Gilson et al., Valuation of Bankrupt Firms, Rev. of Fin. Stud.,
Spring 2000, at 45–46 (“[S]enior claimants have incentives to underestimate cash flows to increase their recovery in Chapter 11
proceedings. The junior claimants, of course, have the opposite incentive: overestimating value increases their recovery. . . . [V]
aluation errors are systematically related to proxies for the competing financial interests and relative bargaining strengths of the
participants. . . . [V]aluations are used ‘strategically’ in a negotiation to promote a desired bargaining outcome.”).
IV. Proposed Recommendations: Commencing the Case
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also facilitate more meaningful discussions regarding the debtor’s viable reorganization options
earlier in the chapter 11 case.
Based on the collective experiences of the Commissioners and recommendations from the advisory
committee, the Commissioners identified various kinds of information that may be useful in making
early valuation assessments. Such information includes the debtor’s prepetition tax returns, appraisals,
and business plans, because these documents would contain information potentially relevant to
valuation issues. Some of the Commissioners, however, voiced concerns about the required disclosure
of such information, especially relating to the debtor’s business plans. These Commissioners were
specifically concerned that the requirement to disclose business plans, including restructuring
strategies that would be available to any requesting creditor upon the commencement of the debtor’s
chapter 11 case, could result in a chilling effect on chapter 11 filings. The Commissioners therefore
acknowledged the need to balance the benefits of additional and earlier disclosures with the likely
confidentiality and strategic concerns of a potential chapter 11 debtor.
The Commissioners engaged in an in-depth discussion concerning the competing interests and
potential value to the estate and stakeholders from additional and earlier disclosures. The Commission
found that, on balance, additional and earlier disclosures by the debtor could assist in valuation
determinations and should be required in certain specified circumstances. The Commission
considered the advisory committee’s recommendation that a debtor should be required to disclose
6
prepetition business plans only to the extent that the debtor shared rsuch 01
1, 2 information with third
be 2
parties prior to the petition date; requiring disclosure of this Novem of information would prevent
subset
d on
chive would be similarly situated and on equal
information asymmetries and ensure that all stakeholders
3 ar
3536
. 14- the debtor’s financial affairs. Conversely, proprietary
footing with respect to their informationoabout
,N
own
v. Brto withhold from third parties before filing its chapter 11 petition
information that a debtor seth
elected
Blix
would be protecteddfrom mandatory disclosure in the case.
e in
cit
To mitigate some of the valid concerns raised by the Commissioners regarding the debtor’s
confidentiality and strategy, the Commission agreed that the disclosure obligations should be
subject to appropriate provisions regarding confidentiality and fiduciary outs. In addition, the
debtor should be required to file only a list of the information included in its VIP if the trustee180 or
a party in interest requests certain relief under the Bankruptcy Code. A party in interest would then
be able to request copies of such disclosure documents. Finally, the Commission concluded that the
additional disclosure information should not be filed with the U.S. Trustee as a matter of course to
alleviate a debtor’s confidentiality concerns.181 With these modifications, the Commission approved
the recommended VIP as outlined in the principles above.
180 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
181 The Freedom of Information Act generally applies to information in the possession of the U.S. Trustee. See Freedom of
Information Act, http://www.justice.gov/ust/eo/foia/foia_request.htm. The U.S. Trustee’s obligation to comply with FOIA
likely would weaken any confidentiality restrictions and intensify a debtor’s concerns regarding confidential and proprietary
information. The Commission believed that the debtor and U.S. Trustee will be able to negotiate an acceptable protocol that
provides the U.S. Trustee with sufficient information while protecting valid confidentiality and strategic concerns of the debtor.
IV. Proposed Recommendations: Commencing the Case
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7. Professionals and Compensation Issues
Recommended Principles:
The debtor’s professionals should be clearly identified as either working on matters
relating to the chapter 11 case (“chapter 11 professionals”) or on matters unrelated
to the chapter 11 case (“nonbankruptcy professionals”).
The Bankruptcy Code should define a “nonbankruptcy professional” as an
individual or firm of lawyers, financial advisors, accountants, consultants, or other
professionals retained by the debtor prior to or after the petition date working
exclusively on business or legal matters that arise in, or relate primarily to, the
day-to-day operations of the debtor’s business and that could not have a material
effect on the chapter 11 case.
Only chapter 11 professionals should be subject to sections 327 and 330.
The debtor should file with the court a list of its nonbankruptcy professionals
with its chapter 11 petition and then subsequently on a quarterly basis. That filing
should include the name of each professional and a general description of the
work being performed by that professional. The court sua sponte, the U.S. Trustee,
16
, professional
or a party in interest should be able to object to the classificationrof1a 20
be 2
m
N ve
as a nonbankruptcy professional. If the court, afterenoticeoand a hearing, sustains
d on
rchiv
such objection, the professional should be3subject to sections 327 and 330 only on
63 a
-35
. 14
a prospective basis. This principleNdoes not obviate the trustee’s need to otherwise
, o
rown
B
comply with the U.S.seth v.
Trustee’s requirements for quarterly operating reports.
lix
in B
cited
To the extent professionals representing ad hoc committees, parties to any
agreement or settlement, or secured creditors in the chapter 11 case would be
paid their fees and expenses directly or indirectly (e.g., contractual provisions with
junior creditors) from the estate under the Bankruptcy Code (either through a
substantial contribution motion, the creditors’ proof of claim, the chapter 11 plan,
or other order of the court), the approval and payment of their fees and expenses
should be subject to the reasonableness standards set forth in section 330(a).
Professionals retained by the debtor in possession or any statutory committee
should not be considered fiduciaries of the estate. Rather, those professionals’
duties should run to their respective clients and be governed by applicable
nonbankruptcy law.
A court should be permitted to authorize a trustee or an estate neutral to act
not only as an attorney or an accountant for the estate, but also as a professional
service provider for the estate to the extent that such authorization is in the best
interests of the estate. The employment of a trustee or an estate neutral to act as a
professional service provider should remain subject to appropriate limitations and
restrictions to avoid self-dealing or other action that is improper or not in the best
interests of the estate. Section 327(d) should be amended accordingly.
IV. Proposed Recommendations: Commencing the Case
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Professionals and Compensation Issues: Background
Nonbankruptcy Professionals
A debtor in possession182 generally must seek court approval to retain professionals to assist it with
the chapter 11 case. Specifically, section 327(a) of the Bankruptcy Code provides: “the trustee, with
the court’s approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or
other professional persons, that do not hold or represent an interest adverse to the estate, and that
are disinterested persons, to represent or assist the trustee in carrying out the trustee’s duties under
this title.”183 The fees and expenses of professionals retained under section 327 are subject to court
approval under section 330 of the Bankruptcy Code.184
The Bankruptcy Code does not define “professional persons” or specifically address the debtor in
possession’s ability to hire and pay professionals to assist with nonbankruptcy matters that arise in
the operation of the debtor’s business. The one exception to this statement involves lawyers retained
for a special purpose. Section 327(e) provides: “The trustee, with the court’s approval, may employ,
for a specified special purpose, other than to represent the trustee in conducting the case, an attorney
that has represented the debtor, if in the best interests of the estate, and if such attorney does not
represent or hold any interest adverse to the debtor or to the estate with respect to the matter on
which such attorney is to be employed.”185 In general, courts tend to define “professional” in one
6
of two ways, focusing on whether the entity either (i) plays a central role 1in the administration
1, 20
ber 2in matters concerning the
of the estate, or (ii) is allowed to exercise judgment and autonomy
vem
n No
186
ed o
administration of the estate. Accordingly, debtorsainhpossession frequently seek clarification from
iv
3 rc
-353
the court concerning the scope of “professionals”6retained by the debtor in possession and its ability
14
No.
to pay these professionals in the Brown, course of business.187
ordinary
v.
eth
Blixs
ed in
cit
The disinterestedness standard generally requires that the professional not be a creditor or, within the
two years before the petition date, a director, officer, or employee of the debtor. It also mandates that
the professional not hold “an interest materially adverse to the interest of the estate or of any class of
creditors or equity security holders, by reason of any direct or indirect relationship to, connection
with, or interest in, the debtor.”188 Some courts interpret disinterestedness strictly, disqualifying any
professional holding actual or potential conflicts of interest with the debtor.189 Other courts take
182 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
183 11 U.S.C. § 327(a).
184 Id. § 330. In addition, the U.S. Trustee has formulated guidelines for reviewing professionals’ fees and expenses in the chapter
11 context. See Guidelines for Reviewing Applications for Compensation and Reimbursement of Expenses, 28 C.F.R. Part 58,
Appendices A & B.
185 11 U.S.C. § 327(e).
186 See, e.g., In re Am. Tissue, Inc., 331 B.R. 169, 173 (Bankr. D. Del. 2005) (using six-factor test to evaluate role of entity in case,
including those above); In re Fretheim, 102 B.R. 298, 299 (D. Conn. 1989) (focusing on autonomy and judgment factors); In re
Seatrain Lines, Inc., 13 B.R. 980, 981 (Bankr. S.D.N.Y. 1981) (focusing on role of entity in administration of estate). But see In
re Metro. Hosp., 119 B.R. 910, 916 (Bankr. E.D. Pa. 1990) (defining professional as “someone with special knowledge and skill
usually achieved through study and educational attainments whether licensed or not”). See also In re New Orleans Auction
Galleries, Inc., 2013 WL 1196680 (Bankr. E.D. La. Mar. 25, 2013).
187 A debtor in possession also may seek authority to pay service providers who are not characterized as professionals and who are
retained outside the ordinary course of business under section 363(b) of the Bankruptcy Code. 11 U.S.C. § 327(a).
188 Id. § 101(14)(E).
189 See, e.g., Dye v. Brown (In re AFI Holding, Inc.), 530 F.3d 832, 838 (9th Cir. 2008) (“[B]ankruptcy court did not abuse its
discretion in concluding removal was proper due to the Trustee’s past affiliations with insiders that created a potential for a
materially adverse effect on the estate and an appearance of impropriety resulting in ongoing disharmony in the estate’s
administration.”); In re Marvel Entm’t Grp., Inc.,140 F.3d 463, 476 (3d Cir. 1998) (“(1) Section 327(a), as well as § 327(c),
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a more limited view and only disqualify the professional if it holds an interest that is “materially
adverse” to the estate.190
Under the current law, debtors in possession will often seek court approval of procedures for
retaining and compensating “ordinary course professionals” during the pendency of the chapter
11 case. These procedures typically require the debtor to identify the specific or general types of
professionals or service providers covered by the motion and to establish a cap that limits the amounts
that can be paid to these entities (usually on a quarterly basis) during the case. Such ordinary course
professionals may be required to file a verified statement under Bankruptcy Rule 2014(a), although
debtors generally agree to submit quarterly summaries of the fees paid to these professionals. Courts
routinely approve motions related to ordinary course professionals to enable a debtor to continue its
operations during the chapter 11 case as efficiently as possible.
Other Professionals
The ability of debtors in possession, trustees or other estate representatives, and statutory committees
to retain professionals is subject to approval by the court under section 327 of the Bankruptcy Code;
the court thereafter reviews and scrutinizes the compensation requests of professionals under section
330. Other parties in the chapter 11 case may also seek reimbursement for, or payment of, their
professionals’ fees and expenses from estate funds. These parties include secured creditors, creditors
16
who are parties to an agreement or settlement with the debtor or the trustee,2parties to intercreditor
1, 20
berhoc committees, a party
191
with ad
agreements, and ad hoc committees. In some instances, such as Novem
n
ed o of the Bankruptcy Code, which
may seek payment for its professionals under section 503(b)(3)(D)
rchiv
63 a
-353
permits the payment of the reasonable fees o. 14 expenses of “a creditor, an indenture trustee, an
and
,N
own
rrepresenting creditors or equity security holders other than a
B
equity security holder, or a committee
th v.
lixse
n Bsection 1102 of this title, in making a substantial contribution in a case
committee appointed iunder
ted i
c
imposes a per se disqualification as trustee’s counsel of any attorney who has an actual conflict of interest; (2) the district court
may within its discretion — pursuant to § 327(a) and consistent with § 327(c) — disqualify an attorney who has a potential
conflict of interest and (3) the district court may not disqualify an attorney on the appearance of conflict alone.”); In re Martin,
817 F.2d 175, 182 (1st Cir. 1987) (“The question is not necessarily whether a conflict exists — although an actual conflict of any
degree of seriousness will obviously present a towering obstacle — but whether a potential conflict, or the perception of one,
renders the lawyer’s interest materially adverse to the estate or the creditors.”) (citation omitted); In re Lease-A-Fleet, Inc., 1992
U.S. Dist. LEXIS 407, at *2 (E.D. Pa. Jan. 15, 1992) (“I reject [the] argument that § 327(e) requires disqualification whenever there
is a potential conflict. While some courts hold that simultaneous representation of the debtor and its guarantors is prohibited
under § 327(e), such is clearly not the rule in this Circuit.”) (citing In re G&H Steel Service, Inc., 76 B.R. 508, 510 (Bankr. E.D.
Pa. 1987)).
190 See, e.g., Beal Bank, S.S.B. v. Waters Edge Ltd. P’ship, 248 B.R. 668, 695 (D. Mass. 2000) (quoting In re Martin, 817 F.2d 175,
182 (1st Cir. 1987)) (“[A]n inquiry does not have to ask ‘whether a conflict exists . . . but whether a potential conflict, or the
perception of one renders the lawyer’s interest materially adverse to the estate or the creditors.’”) (citations omitted); In re Leslie
Fay Cos. Inc., 175 B.R. 525, 536 (Bankr. S.D.N.Y. 1994) (“[R]etention under section 327 is only limited by interests that are
‘materially adverse . . . .’”) (citations omitted). Notably, section 327(a) of the Bankruptcy Code refers to “an interest adverse to the
estate” while section 101(14)(E) refers to “an interest materially adverse to the interest of the estate.” 11 U.S.C. § 327(a).
191 “A lock-up agreement — sometimes referred to as a plan-support agreement or restructuring-support agreement — often serves
as an integral component of the bankruptcy process by allowing a debtor and its key creditors to memorialize the resolution of
their legal and economic disputes and permit that debtor to attempt to confirm its plan and exit bankruptcy as expeditiously as
possible.” Kristopher M. Hansen et al., Post-Petition Lock-Up Agreements and Designation Standards Clarified, Am. Bankr. Inst.
J., Apr. 2013, at 30. Ad hoc or unofficial committees play an important role in reorganization cases. By appearing as a ‘committee’
of shareholders, the members purport to speak for a group and implicitly ask the court and other parties to give their positions
a degree of credibility appropriate to a unified group with large holdings. Moreover, the Bankruptcy Code specifically provides
for the possibility of the grant of compensation to “a committee representing creditors or equity security holders other than
a committee appointed under section 1102 of this title [an official committee], in making a substantial contribution in a case
under chapter 9 or 11 of this title.” In re Nw. Airlines Corp., 363 B.R. 701, 703 (Bankr. S.D.N.Y. 2007) (citing 11 U.S.C. § 503(b)
(3)(D)).
IV. Proposed Recommendations: Commencing the Case
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under chapter 9 or 11 of this title.”192 In other instances, the operative loan documents, intercreditor
agreement, or other agreement may provide for such payment.
Courts generally require a party making a request under section 503(b)(3)(D) to prove “extraordinary
efforts” to benefit the estate.193 Some courts also require a showing that the party in fact intended to
benefit the estate through such efforts.194 Moreover, if a party establishes a substantial contribution
claim under section 503(b)(3)(D), it may also be entitled to reasonable compensation “for professional
services rendered by an attorney or an accountant of an entity whose expense is allowable under
subparagraph (A), (B), (C), (D), or (E) of paragraph (3) of this subsection, based on the time, the
nature, the extent, and the value of such services, and the cost of comparable services other than in
a case under this title, and reimbursement for actual, necessary expenses incurred by such attorney
or accountant.”195
Trustee and Estate Neutral Issues
As suggested above, section 327 generally permits the trustee to retain lawyers, accountants, financial
consultants, and other professionals to represent the estate and assist with the administration of
the estate and the debtor’s reorganization. These professionals must be disinterested and may not
hold interests adverse to the estate.196 Section 327(d), in turn, “permits the court to authorize the
trustee, if qualified to act as his own counsel or accountant.”197 Notably, section 327(d) is limited to
16
the trustee and to the trustee (or its firm) acting as lawyer or accountant.2This provision does not
1, 0
ber 2 add value to the estate by
account for other professionals who may serve as trustees andNwho could
vem
n o
ed o
representing the estate in their professional capacities.hiv
3 arc
536
14-3
No.
n,
In addition, a chapter 11 trustee. isrsubject to the same compensation provisions applicable to chapter
B ow
eth v
7 trustees under sectionsixs
in Bl 326(a) and 330. In a chapter 7 liquidation, the mechanics of section 326(a)
cited
198
work well ; a trustee is compensated based on a percentage of the moneys distributed to parties in
interest other than the debtor. In a chapter 11 case, however, the limitations of section 326(a) might
serve as a disincentive for a trustee to seek recoveries that would result in a return of funds to equity.
In fact, some courts have denied compensation to chapter 11 trustees under section 326(a) when
distributions are made to the debtor, or property or value other than money is distributed in the
case.199
192 11 U.S.C. § 503(b)(3)(D).
193 See, e.g., In re Granite Partners, L.P., 213 B.R. 440, 445 (Bankr. S.D.N.Y. 1997) (“[C]ompensation is limited to those extraordinary
actions . . . that lead to an ‘actual and demonstrable benefit to the debtor’s estate, the creditors, and to the extent relevant, the
stockholders.’”) (citations omitted); In re White Motor Credit Corp., 50 B.R. 885, 892 (Bankr. N.D. Ohio 1985) (“‘Extraordinary
efforts and remarkable results’ are required for consideration of a premium payment.”).
194 See, e.g., In re Lister, 846 F.2d 55, 57 (10th Cir. 1988) (“Administrative expenses incurred prior to the filing of a bankruptcy petition
are compensable under 11 U.S.C. § 503(b)(3)(D), if those expenses are incurred in efforts which were intended to benefit, and
which did directly benefit, the bankruptcy estate.”); In re Alert Holdings Inc.,157 B.R. 753, 758 (Bankr. S.D.N.Y. 1993) (court held
that “[n]either [the creditor’s] asserted help in forming the ad hoc committee, nor his participation in the multidistrict litigation
demonstrates an intent to substantially benefit the debtors’ estates, and any benefit that may have otherwise enured to the estates
can be considered unintentional and incidental.”); In re 9085 E. Mineral Office Bldg., Ltd., 119 B.R. 246, 251–52 (Bankr. D. Colo.
1990) (“[T]his Court cannot find that [the creditor’s] efforts were in no way intended to confer a benefit upon the estate as a
whole.”).
195 11 U.S.C. § 503(b)(4).
196 11 U.S.C. § 327(a).
197 S. Rep. 95-989, 38 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5824. See also 11 U.S.C. § 327(d).
198 See, e.g., Pritchard v. U.S. Trustee, 153 F.3d 232 (5th Cir. 1998) (“The section is consistent with the duty of a Chapter 7 trustee to
collect and reduce the property of the bankrupt’s estate to money.”).
199 See, e.g., id. at 237 (declining to follow “bankruptcy courts [that] have interpreted the section to include disbursements other
than money within the calculation of a trustee’s maximum compensation”) (collecting cases). In addition, some courts hold that
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
Professionals and Compensation Issues: Recommendations and Findings
Nonbankruptcy Professionals
Many professionals employed by a debtor in possession during the course of a chapter 11 case do not
consult or work on bankruptcy-related issues. Rather, these professionals perform services that the
debtor would have required outside the bankruptcy context and even if the chapter 11 case had not
been filed. For example, the debtor may employ lawyers, forensic accountants, tax accountants, and
other service providers to help with ordinary course business matters such as patent applications,
regulatory compliance, or litigation relating to employee claims or disputes that are not material to
the chapter 11 case. The Commission referred to these types of professionals as “nonbankruptcy
professionals.”
The Commissioners debated the utility of subjecting nonbankruptcy professionals to the retention
standards in section 327(a) and the disclosure and reasonableness standards for professionals’ fees
and expenses in section 330 of the Bankruptcy Code. The Commissioners discussed the purpose
underlying the retention standards of section 327(a). In the case of professionals working on
bankruptcy matters that directly impact the estate, the relationships between the professionals and
the debtor, creditors, and other stakeholders in the case are material and speak to potential conflicts
that could bias the advice and actions of the professionals. Conversely, nonbankruptcy professionals
generally do not work on matters that affect the rights of creditors and other 2stakeholders in the
16
1, 0
ber 2 of the estate’s assets.
debtor’s estate and do not address the claims of these parties or the ovem
allocation
nN
ed o professionals even if it had not
The debtor also would have likely retained these nonbankruptcy
hiv
3 arc
filed the chapter 11 case; the retention would 4-3536been governed by state law, including state
have
1
No.
ethical codes for lawyers that address rown,
conflicts of interest and fee arrangements. Consequently, the
.B
eth v
Commission agreed that in Blixs
nonbankruptcy state laws governing many professions are sufficient to
cited
protect the interests of the estate with respect to nonbankruptcy professionals.
The Commissioners, however, recognized that the work of nonbankruptcy professionals can
impact the value of an asset of the estate or the debtor. The advice of nonbankruptcy professionals
concerning a certain product or their assessment or management of a particular piece of litigation
could underlie a substantial gain or loss by the debtor. The Commissioners discussed examples of
nonbankruptcy litigation that could have a material effect on the chapter 11 case. They weighed the
costs and benefits of setting a materiality threshold or compensation cap, and whether either such
limitation would capture the significant matters with which they were concerned. On balance, the
Commission agreed that requiring disclosure of the name of each nonbankruptcy professional and
the nature of the services provided by such professional would provide the court, the U.S. Trustee,
and parties in interest with sufficient information (and perhaps more meaningful information than
that provided by a compensation cap) to determine if the professional should be reclassified as a
chapter 11 professional subject to the requirements of sections 327, 328, and 330, even though the
professional is not rendering bankruptcy-related services. In addition, the Commission determined
that, with respect to professional firms, this classification should be made based on the firm as a
whole, not based on the individual professionals in such firm (i.e., if a law firm or financial firm
a credit bid by a secured creditor is not moneys for purposes of section 326(a). See, e.g., In re Lan Assocs. XI, L.P., 192 F.3d 109,
116 (3d Cir. 1999); U.S. Trustee v. Tamm (In re Hokulani Square, Inc.), 460 B.R. 763, 777–78 (B.A.P. 9th Cir. 2011).
IV. Proposed Recommendations: Commencing the Case
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is providing bankruptcy-related services in a debtor’s chapter 11 case, the firm’s status is imputed
to all professionals, such that all professionals within that firm should be considered chapter 11
professionals).
The Commission also considered whether the reasonableness standards of section 330 should apply
to the compensation requests of all professionals. Section 330 sets forth a variety of factors that
the court should consider in reviewing and approving professionals’ fees and expenses. The court’s
review requires meaningful disclosures from the professionals concerning their fees and expenses.
Each professional retained by the debtor, unsecured creditors’ committee, and any estate neutral or
trustee (collectively, the chapter 11 professionals) is required to file detailed fee applications with
the court to facilitate this review. The Commissioners believed that the disclosure and transparency
demanded by section 330 was warranted when the professionals’ services directly affected, assisted,
or were performed on behalf of the estate and when the requested compensation would be paid
by the estate. In these instances, the court, the U.S. Trustee, and parties in interest should have an
opportunity to review the specific services performed and whether they justified the use of estate
resources.
After comparing the roles of chapter 11 professionals versus nonbankruptcy professionals, the
Commission determined that only chapter 11 professionals should be subject to the retention and
compensation standards of sections 327 and 330. The Commissioners did not believe that the types
16
of services provided by, and the typical compensation paid to, nonbankruptcy professionals warrant
1, 20
ber 2
vem
the time and expense associated with compliance under osections 327 and 330. Moreover, they
n No
ed
hiv
found that the disclosure about nonbankruptcy 6professionals and their services would adequately
3 arc
-353
1
protect the interests of the estate and ,allow 4
No. reclassification if necessary or appropriate. In reaching
rown
its conclusions, the CommissionB
h v. emphasized that nonbankruptcy professionals should include only
xset
n Bli— on an individual or firm basis — work exclusively on matters unrelated
i
those professionalsdwho
cite
to the chapter 11 case. If a professional firm retained by the estate to perform services relating to
the chapter 11 case also provides services to the debtor on general litigation or employment matters,
for example, that firm and the professionals working at that firm should be considered chapter 11
professionals.
Other Professionals
The Commission reviewed similar issues and concerns with respect to professional compensation
paid by the estate for services provided to secured creditors; creditors who are parties to settlements or
agreements with the debtor, trustee, estate or other parties in the case (e.g., intercreditor agreements);
and ad hoc committees. The Commissioners recognized that the services of these professionals
could add value to a chapter 11 case. Moreover, the payment of the attendant professionals’ fees
and expenses is often part of the underlying bargain and is authorized by an order of the court in
connection with a substantial contribution motion, a motion to approve the settlement or agreement
under the Bankruptcy Code, the creditor’s proof of claim, or the chapter 11 plan. Nevertheless,
some of the Commissioners expressed concern that parties often stipulate to the reasonableness of
professionals’ fees and expenses, such that they are no longer subject to any meaningful review by
the court or other parties in interest.
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
The Commission considered whether these professionals’ fees and expenses should be subject to a fee
application process, but ultimately determined that for these professionals, on balance, the standard
of review was more important than the form of disclosures. The Commission also agreed that, to
the extent the court disallows any professionals’ fees and expenses under this standard, the creditor
or ad hoc committee should not be permitted to seek reimbursement for disallowed fees from other
stakeholders in the case. The Commission found that any such reimbursement mechanism would
undermine the utility of the reasonableness review in that it could indirectly effect the obligations of
the estate to other creditors. In light of the foregoing, the Commission voted to require the review of
any professional compensation requested by professionals retained to represent secured creditors,
creditors who are parties to agreements or settlements approved by the court, and ad hoc committees
under the reasonableness standard of section 330(a) of the Bankruptcy Code. The Commission also
agreed that this principle should not otherwise affect the permissibility or authorization of such
professionals’ fees and expenses under the Bankruptcy Code and current law.
Trustee and Estate Neutral Issues
The Commission considered the justifications for limiting the trustee’s professional services to the
estate to those provided by lawyers and accountants. Some Commissioners suggested that these
particular professional services were identified in section 327(d) because they were the primary
services provided to bankruptcy estates at the time section 327 was adopted. Since that time,
individuals serving as trustees may have different expertise and professional 21, 2016 This change,
capacities.
er
emb
in part, reflects the evolution of bankruptcy cases and the bankruptcy profession. Although lawyers
Nov
d on
chive 11 cases, management consultants,
and accountants continue to play important roles in 3chapter
ar
536
financial advisors, and other professional service -3
. 14 providers also are actively involved in bankruptcy
No
wn,
cases and can add value to the process. o
v. Br
eth
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in Bl
cited
The Commissioners discussed the potential benefits and cost savings to the estate by permitting a
trustee (or its firm) to act as, for example, a management consultant to the estate in connection with
operating the debtor’s business and administering the case. Although the Commissioners appreciated
the need to ensure thersat professionals representing the estate are disinterested and do not hold
adverse interests to the estate, they did not perceive significant issues when appointed trustees seek
to perform certain specified professional services for the estate. Moreover, many Commissioners
believed that estate neutrals, whom the U.S. Trustee also would determine to be disinterested and
qualified, should be able to seek the same authority to represent the estate in their professional
capacities. Accordingly, the Commission recommended expanding section 327(d) to include
trustees and estate neutrals and to add “professional service provider” to the list of authorized roles
for the trustee or estate neutrals.
The Commissioners also discussed the compensation structure of section 326(a) and whether it
provided proper incentives to trustees to maximize the value of the estate. As explained above,
section 326(a) compensates trustees based on a percentage of the amount of moneys distributed or
turned over to parties in interest in the case other than the debtor. Some Commissioners suggested
modifying section 326(a) to exclude only distributions to “chapter 7 debtors and individual
chapter 11 debtors” from the compensation calculation, recognizing the different focus of case
administration in chapter 11 cases involving business debtors. These Commissioners noted that the
IV. Proposed Recommendations: Commencing the Case
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10211115, DktEntry: 37-2, Page 61 of Chapter
exclusion of distributions to the debtor from the compensation calculation could encourage trustees
to administer the estate in a manner that restricts recoveries or liquidates assets for the benefit of
parties in interest other than the debtor in order to maximize the trustee’s compensation. Other
Commissioners suggested that such conduct likely would be a violation of the trustee’s fiduciary
duties, which should be a sufficient deterrent of such conduct. The Commissioners debated these
points, focusing on the alignment of section 326(a) with a trustee’s fiduciary duties to better serve
the estate. The Commission ultimately was not able to reach a consensus on the issue. Nevertheless,
several Commissioners believed that certain modifications could add value to cases and eliminate
ambiguities in the application of section 326 to chapter 11 business cases.200
8. Costs in Chapter 11 Cases
Recommended Principles:
The Bankruptcy Code should be clarified to expressly permit professionals
retained pursuant to section 327 or 1103 of the Bankruptcy Code to seek the
court’s approval, at the outset of the engagement or of a particular matter, of
alternative fee arrangements in lieu of the traditional hourly billing model. Such
alternative fee arrangements could include the following: fixed fees, flat fees, task16
specific fees, and contingent fees. Courts should assess the reasonableness of, and
1, 20
ber 2
the potential benefits to the estate from, a professional’smproposed alternative fee
ve
n No
ed o
arrangement at the time that the court aischiv
r evaluating the professional’s original
63
-353 of the matter or engagement that will be
retention application or at the. outset
14
, No
rown
B
subject to the proposed alternative fee arrangement. The professional seeking an
h v.
xset
n Bliarrangement should bear the burden of proving by a preponderance
alternativei fee
cited
of the evidence that the arrangement is reasonable, has been thoroughly reviewed
with the client, and is reasonably likely to be beneficial to the estate. Section 328
should be clarified to incorporate this approval standard.
Once a court has approved an alternative fee arrangement, it should not alter the
approved arrangement once the matter or engagement has terminated unless, in
accordance with section 328 as it currently provides, the “terms and conditions [of
the arrangement] prove to [be] improvident in light of developments not capable
of being anticipated at the time of the fixing of such terms and conditions.” Courts
should not review alternative fee arrangements under the lodestar method, which
is applicable to the hourly billing model.
Congress should amend sections 328 and 330 to clarify that alternative fee
arrangements based in whole or in part on non-hourly billing models are permitted
and subject to review solely under section 328, in accordance with the changes
proposed in these principles.
200 Such beneficial modifications to section 326(a) might include limiting the exclusionary language of that section to “chapter 7
debtors and individual chapter 11 debtors” (rather than “the debtor”) and expanding the concept of disbursements to moneys,
property, or other value disbursed or turned over to parties in interest.
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
Costs in Chapter 11 Cases: Background
A common critique of chapter 11 is that it is too expensive: distressed companies cannot afford to file
for bankruptcy and engage in the process of reorganizing under the protections of the Bankruptcy
Code.201 Although commentators debate the accuracy of this statement, the perception persists that
chapter 11 is cost-prohibitive for many distressed companies.
The chapter 11 process is not free. It introduces costs into a company’s budget that do not exist
outside the bankruptcy context.202 The debtor in possession also must retain and compensate
bankruptcy professionals to assist with its chapter 11 case.203 Importantly, the debtor’s estate is also
responsible for paying the fees and expenses of bankruptcy professionals that are retained by any
statutory committees, examiners, and trustees that are appointed in the debtor’s chapter 11 case.204
The estate’s administrative outlay for professionals’ fees is often the focal point of debates concerning
the costs of chapter 11.205 Headlines such as Extra! Extra! Tribune Fees Top $150 Million,206 and
American Airlines Bankruptcy Advisors Seek $400 Million in Fees, Expenses207 catch the attention of
201 One prominent bankruptcy attorney at a major law firm observed that “bankruptcy has become so expensive that, ironically,
poor companies or businesses with no cash cannot afford to go through the procedure.” Natalie Posgate & Mark Curriden,
American Airlines Insiders Provide Exclusive Behind-the-Scenes Recap of Historic Bankruptcy and Merger, Texas Lawbook (2014),
available at http://www.law.smu.edu/getmedia/7430e732-144d-4fbf-ba3a-3273d2be862b/American-Airlines-Insiders-Reprint.
Another seasoned turnaround consultant opined that “the cost of bankruptcy has gotten so high — because of professional and
16
other costs — that the ability to continue the company under current ownership has reached almost,zero.” Ian Mount, Adviser to
1 20
ber 2
m
Businesses Laments Changes to Bankruptcy Law, N.Y. Times (Feb. 29, 2012).
Nove
202 For example, currently a company must submit a filing fee of $1,717.00 to d onbankruptcy court along with its petition to
e thein possession also must remit quarterly fees to
commence a chapter 11 case. During the pendency of its chapter 11 case, a debtor
rchiv
63 a
the Office of the U.S. Trustee, which are calculated each quarter5based on the amount the debtor disbursed during such quarter.
-3 3
o 14
These fees currently range from $325 (for disbursement. of $0 to $14,999.99) up to $30,000 (for disbursements of $30,000,000
n, N
or more). Pursuant to 11 U.S.C. § 1930(b),Brow
the Judicial Conference prescribes filing fees in all cases under the Bankruptcy
v.
Code. The current schedule of feesxeffective as June 1, 2014 is available at http://www.uscourts.gov/FederalCourts/Bankruptcy/
seth
n Bli
i
BankruptcyResources/BankruptcyFilingFees.aspx. Bankruptcy courts enforce these filing fees. See, e.g., Fee Schedule, United
cited
States of Bankruptcy Court, District of Delaware (effective June 1, 2014), available at http://www.deb.uscourts.gov/fee-schedule;
Fee Schedule, United States of Bankruptcy Court, Southern District of New York (effective June 1, 2014), available at http://www.
nysb.uscourts.gov/sites/default/files/pdf/filingFees.pdf.
203 The Administrative Office of the U.S. Courts on behalf of the Federal Judiciary advises that “[c]orporations and partnerships
must have an attorney to file a bankruptcy case. While individuals can file a bankruptcy case without an attorney or ‘pro se,’ it
is extremely difficult to do it successfully.” Filing for Bankruptcy Without an Attorney, http://www.uscourts.gov/FederalCourts/
Bankruptcy/BankruptcyResources/FilingBankruptcyWithoutAttorney.aspx.
204 Bankruptcy Code section 330 provides for compensation of all professionals — not just professionals retained by the debtor —
whose retention was approved by the court. Specifically, section 330(a) provides, in relevant part:
[T]he court may award to a trustee, a consumer privacy ombudsman appointed under section 332, an examiner, an
ombudsman appointed under section 333, or a professional person employed under section 327 or 1103 —
(A) reasonable compensation for actual, necessary services rendered by the trustee, examiner, ombudsman,
professional person, or attorney and by any paraprofessional person employed by any such person; and
(B) reimbursement for actual, necessary expenses.
11 U.S.C. § 330(a). A 2007 comprehensive study of professionals’ fees in bankruptcy revealed that “[c]ommittee professionals
cost the estate about two-fifths of what the debtor’s professionals cost.” Jesse Greenspan, Time Spent In Chapter 11 Doesn’t
Affect Costs: Study, Law 360 (Dec. 7, 2007, 12:00 AM), http://www.law360.com/articles/41896/time-spent-in-chapter-11-doesnt-affect-costs-study.
205 But see Lubben, What We “Know” About Chapter 11 Cost is Wrong, supra note 44, at 144 (“[T]oo much of the debate about
chapter 11 costs rests on a false premise . . . that professional fees in bankruptcy represent nothing more than wealth transfers,
taking value from creditors and giving it to bankruptcy professionals”). A recent study of professionals’ fees found that “[i]n
almost 35% of [chapter 11] cases, professionals received no payment whatsoever,” and typically these cases were smaller and were
often converted to chapter 7 or dismissed. Greenspan, supra note 204. Based on a 2008 study of professionals’ fees, Professor
Lubben concluded that factors like the size of the debtor, the number of professionals retained, and whether a committee is
appointed, which are all proxies for the complexity of the case, have much more significant effects on costs, as compared to the
time spent in chapter 11, and that professionals’ fees in chapter 11 are subject to economies of scale, especially in larger cases.
Stephen J. Lubben, Corporate Reorganization & Professional Fees, 82 Am. Bankr. L.J. 77, 79–80 (2008).
206 Eric Morath, Extra! Extra! Tribune Fees Top $150 Million, Wall St. J. Blog (May 25, 2011, 3:54 PM), http://blogs.wsj.com/
bankruptcy/2011/05/25/extra-extra-tribune-fees-top-150-million/.
207 Sara Randazzo, American Airlines Bankruptcy Advisers Seek $400 Million for Fees, Expenses, Wall St. J. (June 26, 2014, 4:20 PM),
http://online.wsj.com/articles/american-airlines-bankruptcy-advisers-seek-400-million-for-fees-expenses-1403814038.
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policymakers and the public alike, but a look behind the numbers cited in these headlines may reveal
a different story.208 In fact, empirical studies show that the total amount in professionals’ fees in a
chapter 11 case is generally a modest percentage of the debtor’s assets, revenues, and distributions to
creditors.209 But these studies do not change the perception — whether or not accurate — that every
dollar an estate pays in chapter 11 costs is one less dollar available to pay creditors.210 As pointed out
by one professor who has studied professionals’ fees extensively, this perception necessarily ignores
the value that professionals add to the estate during the pendency of a chapter 11 case for the benefit
of all parties in interest.211
The U.S. Trustee and some commentators have criticized not only the overall amount of professionals’
fees, but also the hourly rates of bankruptcy professionals, particularly in large chapter 11 cases.212
The Office of the U.S. Trustee, for example, has raised concerns about lawyers charging hourly rates
of $1,000 or more in some of the larger chapter 11 cases.213 These and other compensation concerns
recently led the Office of the U.S. Trustee to propose and ultimately adopt fee guidelines specifically
applicable to professionals in chapter 11 cases involving $50 million or more in assets or liabilities.214
208 It is noteworthy that the court-appointed fee examiner recommended that the bankruptcy court approve the fees and expenses
for 47 professional firms in the American Airlines case in the amount of nearly $400 million, noting that these professionals
engineered “perhaps the most efficient airline reorganization case on record.” Id. (The fee examiner in the American Airlines
case was Robert Keach, Co-Chair of the Commission. In addition, several other Commissioners were involved in the American
Airlines case.) Indeed, the value created in the merger of American Airlines and US Airways as part of American Airlines’
reorganization plan resulted in all of American Airlines’ creditors receiving full value on their claims and American Airlines’
shareholders receiving shares amounting to approximately 40 percent of the merged company —16 a market cap that exceeded
at
the stand-alone value of American Airlines at any prior point in its history. Scholars have21, 20
r not analyzed whether the cost of fee
be
examiners exceeds their benefit to the estate.
ovem
209 Professor Lubben’s study revealed that across all bankruptcy cases, and evenon N large chapter 11 cases specifically, professionals’
across
d
fees totaled 4.0 percent to 4.5 percent of the sum of the debtor’s assets ive debts. Lubben, Corporate Reorganization & Professional
archand
363 These results are consistent with earlier fee studies. Based on a
Fees, supra note 205, at 103. See also Greenspan, supra -35
note 204.
o. 4
2004 study of large chapter 11 reorganization,cases 1 from 1980 through April 2003, Professors LoPucki and Doherty found
n Nlessfiled 3 percent of their total assets to pay for professionals’ fees. Lynn M.
that some of the largest debtor cases Brow
expended
than
th v.
LoPucki & Joseph W. Doherty,eThe Determinants of Professional Fees in Large Bankruptcy Reorganization Cases, 1 J. Empirical
lixs
Legal Stud. 111, 140 d in B (“For a group of 48 firms with assets ranging from about $65 million to $7.5 billion, and averaging
ite (2004)
$881 million, wecfound that total fees and expenses were 1.4 percent of total assets reported in the court file at the beginning of
the bankruptcy case, and that firms expended, on average, 2.2 percent of assets on professional fees (1.9 percent after the removal
of a single outlier).”). Professors LoPucki and Doherty explained that economies of scale were at play in large chapter 11 cases,
such that the larger the debtor, the lower the ratio of restructuring fees and expenses the debtor incurred relative to its assets.
Id. at 126. Earlier, Professor Baird also observed that the direct costs of bankruptcy for large, publicly traded companies was
relatively small, between 0.9 percent and 7.0 percent, and an average of 2.8 percent, of the book value of the assets before the
filing of the bankruptcy petition, which was comparable to or less than the costs of an initial public offering, private placement,
or leveraged buyout. Douglas G. Baird, The Hidden Virtues of Chapter 11: An Overview of the Law and Economics of Financially
Distressed Firms, Coase-Sandor Inst. for L. & Econ. Working Paper No. 43, 1997, at 11–12, available at http://chicagounbound.
uchicago.edu/law_and_economics/527/.
210 Under Bankruptcy Code section 503(b)(2), “compensation and reimbursement awarded under section 330(a) of [the Bankruptcy
Code]” are classified as “administrative claims.” 11 U.S.C. § 503(b)(2). Section 507, which sets forth the priority order for the
payment of unsecured creditors, elevates the payment of “administrative expenses allowed under section 503(b)” above the
payment of all other unsecured debts (except domestic support obligations). 11 U.S.C. § 507(a)(1). Therefore, in a chapter 11
case that cannot support full recoveries to all creditors, administrative claims reduce the amount of funds that will be available
for distribution to unsecured creditors.
211 “Being in chapter 11 means that creditors’ recovery on their claims becomes higher than zero. The professional fees are the cost
of moving to that higher recovery. The notion that money paid to professionals belongs to creditors is true only if the creditors
could realize that value without the professionals.” Lubben, What We “Know” About Chapter 11 Cost is Wrong, supra note 44, at
144. “The cost paid to chapter 11 professionals is an example of the old truism that sometimes you have to spend money to make
money. In chapter 11, creditors have to spend some money to recover some of what is due to them. In the main, the value of
chapter 11 professionals’ time was never a value that creditors could capture. Pretending that fees paid to professionals represents
a real loss to the creditors demonstrates little more than muddled thinking.” Id. at 145.
212 Nancy B. Rapoport, Rethinking Professional Fees in Chapter 11 Cases, 5 J. Bus. & Tech. L. 263, 270–271 & n. 28 (2010), available
at http://digitalcommons.law.umaryland.edu/jbtl/vol5/iss2/5 (summarizing published criticisms of professionals’ fees in chapter
11 context).
213 Jacqueline Palank, $1,000/Hour Bankruptcies: Attorneys Justify Their Fees, Wall St. J. (June 3, 2012, 6:29 PM) (“The Justice
Department has grown increasingly restless with attorney fees — often exceeding $1,000 an hour — paid by companies going
through a bankruptcy reorganization.”).
214 The new fee guidelines became effective for cases filed on or after November 1, 2013. Appendix B — Guidelines for Reviewing
Applications for Compensation and Reimbursement of Expenses Filed Under 11 U.S.C. § 330 by Attorneys in Larger Chapter 11
Cases, 78 Fed. Reg. 36,248, 36,249 (June 17, 2013), available at http://www.justice.gov/ust/eo/rules_regulations/guidelines/docs/
Fee_Guidelines.pdf [hereinafter UST Fee Guidelines]. “Generally, the final guidelines provide for a showing that rates charged
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
The stated goals of the new fee guidelines are to, among other things, “ensure that bankruptcy
professionals are subject to the same client-driven market forces, scrutiny, and accountability as
professionals in nonbankruptcy engagements;” “increase disclosure and transparency in the billing
practices of professionals seeking compensation from the estate;” and “increase public confidence
in the integrity and soundness of the bankruptcy compensation process.”215 Notably, only a small
number of chapter 11 cases fall within these new fee guidelines.216
Additionally, the increasing cost of chapter 11 has had a significant impact on the perceived ability —
and perhaps actual ability — of small and middle-market companies seeking restructuring options
to invoke chapter 11.217 One commentator observed that, based on a small sampling of cases filed
in 2010 in the Southern District of New York, “professional fees for the middle-market Chapter
11 cases typically approached or exceeded $1 million.”218 This commentator suggested that high
professionals’ fees, among other factors,219 have encouraged lawyers representing middle-market
companies to pursue alternatives to traditional chapter 11 reorganization, such as section 363 asset
sales on an expedited basis, followed by a liquidating plan, or to invoke alternatives under state law,
including general assignments for the benefit of creditors and composition agreements to restructure
debt.220 Although this particular study was limited in size and geographic area, the commentator’s
findings mirror the testimony and anecdotal evidence presented to the Commission during its study
process.221
16
215
216
217
218
219
220
221
, 20
reflect market rates outside of bankruptcy; the use of budgets and staffing plans; the disclosure of rate increases that occur during
er 21
the representation; the submission of billing records in an open, searchable electronicoformat; and the use of fee examiners and
emb
v
‘efficiency’ counsel.” Statement of Clifford J. White III, Director, Executive OfficeoforN
d n United States Trustees, U.S. Department of
Justice, before the Subcomm. on Regulatory Reform, Commercial and Antitrust Law of H. Comm. on the Judiciary, at 10 (Sept. 19,
chive
ar
2014) [hereinafter White Statement]. For a one-page summary5of63 UST Fee Guidelines prepared by the U.S. Department of
3 3 the
. 14Justice, see Summary of Material Differences from n, No
1996 Guidelines, http://www.justice.gov/ust/eo/rules_regulations/guidelines/
ow
docs/One_Page_Summary_AppxB_Guidelines.pdf. See also Marina Fineman, For Lawyers Only: New Fee Application Guidelines
v. Br
eth
for Attorneys in Large Chapter 11 lCases, ABI Ethics & Professional Compensation Committee News, Vol. 10, no. 4, available at
B ixs
http://www.abiworld.org/committees/newsletters/ethics-and-professional-compensation/vol10num4/lawyers.html.
ed in
cit
UST Fee Guidelines, supra note 214, at 36,251–36,254. See also White Statement, supra note 214, at 10 (explaining objectives
underlying study of fees leading to new fee guidelines as including “(1) ensur[ing] that fee review is subject to client-driven
market forces, accountability, and scrutiny; (2) enhance[ing] meaningful disclosure and transparency in billing practices;
(3) decreas[ing] the administrative burden of review; (4) maintain[ing] the burden of proof on the fee proponent; and (5)
increase[ing] public confidence in the integrity and soundness of the bankruptcy compensation process”).
The UST Fee Guidelines apply only to the so-called mega-chapter 11 cases, which are referred to as “larger chapter 11 cases.” A
“larger chapter 11 case” is defined as “a chapter 11 case with $50 million or more in assets and $50 million or more in liabilities,
aggregated for jointly administered cases and excluding single asset real estate cases as defined in 11 U.S.C. § 101(51B).” UST
Fee Guidelines, supra note 214, at 36,249. See also Fee Guidelines for Attorneys in Larger Chapter 11 Cases, http://www.justice.
gov/ust/eo/rules_regulations/guidelines/; White Statement, supra note 214, at 10 (“To date, 61 cases have been filed to which the
guidelines apply, and we are monitoring them closely.”).
With respect to small and middle-market companies, “if they have to go into Chapter 11, the odds of the owners keeping the
business are much lower. So there’s no incentive for the owners to enter Chapter 11 and reorganize. Why save a company for
somebody else?” Mount, supra note 201.
Jeffrey A. Wurst, Is Chapter 11 Still a Viable Option or Has High Cost Rendered the Process Unaffordable?, ABJ Journal, Mar. 2013,
at 57.
“There are several reasons why traditional reorganizations have been sparse. Amongst them are: 1.) the high cost of professional
fees; 2.) uncertainty as to the outcome; 3.) lack of availability of unencumbered assets that otherwise may be utilized to secure a
DIP lending facility or to fund post-petition obligations under a plan of reorganization; and 4.) alternatives such as out-of-court
restructurings and assignments for the benefit of creditors.” Id. at 56.
“Liquidating Chapter 11 cases, for better or worse, have been the rule and not the exception in this Court and others over the
last decade, if not longer.” Id. (quoting In re Applied Theory Corp., Case No. 02-11868 (Bankr. S.D.N.Y. Apr. 24, 2008) (Gerber,
J.)). A study of approximately 60 chapter 11 cases filed in 2010 in the U.S. Bankruptcy Court for the Southern District of New
York concluded that alternatives to chapter 11 proved to be more affordable for middle-market debtors. For example, although
professionals’ fees typically approached or exceeded $1 million for a chapter 11 reorganization, “sales of assets pursuant to
§ 363 of the Bankruptcy Code, coupled with a structured dismissal, resulted in significantly lower fees, especially in those
cases where the sale was conducted very early in the proceedings.” Id. at 57. “Out-of-court restructurings have become a more
favorable alternative by streamlining the restructuring process allowing cost savings to be passed down to the creditor body.” Id.
Assignments for the benefit of creditors (“ABCs”) as well as composition agreements to restructure debt have become low-cost
alternatives to chapter 11 reorganization, and in some cases, even alternatives to section 363 sales. Id.
See, e.g., John Haggerty, Written Statement to the Commission (Apr. 19, 2013) (“In the last ten years, there has been an increase
in the use of out-of-court alternatives . . . because the process is too time consuming and complex, and as a result, too costly.”),
available at Commission website, supra note 55; The Honorable Dennis Dow, Written Statement to the Commission (Apr. 19, 2013)
IV. Proposed Recommendations: Commencing the Case
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Costs in Chapter 11 Cases: Recommendations and Findings
The costs associated with chapter 11 and the desires to make the chapter 11 process more efficient
and cost-effective were among the central themes of the Commission’s study. The Commission
was mindful that improving the utility of chapter 11 would do little for distressed companies if the
process was perceived to be — or was in fact — cost-prohibitive. The Commission was keenly aware
that tackling this issue would require most Commissioners to ask hard questions about their own
practices and those of their colleagues, who are not only bankruptcy professionals in chapter 11 cases,
but who are also, in many instances, subject to the U.S. Trustee’s new fee guidelines. Nevertheless,
the Commission agreed that it could and would perform this task because it believed that addressing
chapter 11 costs is necessary for effective chapter 11 reform.
The Commissioners discussed the various costs associated with filing a chapter 11 case and
continuing to conduct business as a debtor in possession.222 The Commission focused its inquiry on
several factors that may contribute to the increasingly high cost of chapter 11. These factors included
the prolonged duration223 and complexity of a case leading to inefficiencies, the use of strategic
or protective litigation in the case by the debtor or other stakeholders, the inherent uncertainty
about the outcome of certain processes or legal standards that become the subject of litigation,
and the professionals’ fees and expenses incurred in connection with the case.224 The Commission
considered various ways to mitigate each of these factors.
16
1, 20
ber 2 strived to develop reform
To improve the efficiency of, and certainty in, the process, the Commission
vem
n No
ed o
principles to achieve these objectives in different aspects of chapter 11. For example:
rchiv
63 a
-353
. 14
, No
rown
The Commission identified, analyzed, and, wherever possible, recommended principles to
.B
eth v
resolve splits Blixs case law governing chapter 11 cases to reduce the need for litigation
n in the
i
cited
and provide greater certainty about outcomes. To this end, the Commission sought to
resolve the following splits, among others:
(“The process of preparing a disclosure statement, obtaining approval of that document, soliciting creditor votes and satisfying
the numerous requirements to obtain confirmation of the plan takes time and money. Adding to the costs is the requirement
that the Chapter 11 debtor pay the costs of professional fees incurred by other entities in the case, such as creditor’s committees.
Provisions offering accommodations for small business debtors have been in the Code for some time, but do not appear to have
alleviated these problems.”), available at Commission website, supra note 55; Daniel Dooley, Statement to the Commission, at 37
(Apr. 19, 2013) (ASM Transcript) (“It’s really widely understood and agreed, I think, in the community right now, that Chapter
11 just isn’t cost-effective in the middle market. It doesn’t really provide an opportunity of companies to rehabilitate themselves.
. . . So people believe and I think I’m in this category as well, that Chapter 11 and the middle market is simply too slow, and it’s
simply too costly for almost all the cases.”), available at Commission website, supra note 55; Professor George Kuney, Written
Statement to the Commission (Nov. 7, 2013) (“The number of middle-market and smaller businesses entering chapter 11 and
emerging as viable enterprises is falling. Administrative costs for plans in middle-market and smaller cases are too high and as a
result, debtors are increasingly relying on numerous alternatives to the traditional chapter 11 process.”), available at Commission
website, supra note 55.
222 As suggested above, the filing fee is relatively modest and the quarterly fees owed to the U.S. Trustee are largely scaled to a
debtor’s business size, measured by the debtor’s disbursements as reported in its debtor’s monthly operating reports. Although
these fees may be difficult for some debtors to pay, as a general matter neither fee is unduly burdensome, and the proceeds from
these fees support the oversight and administration of the chapter 11 case.
223 The general consensus of the Commissioners was that the duration of chapter 11 cases was perceived as a cost enhancer. Notably,
this perception is refuted by Professor Lubben’s studies. See generally Lubben, Corporate Reorganization & Professional Fees,
supra note 205; Lubben, What We “Know” About Chapter 11 Cost is Wrong, supra note 44.
224 These conclusions are consistent with a comprehensive fee study conducted by Professor Lubben. See Lubben, Corporate
Reorganization & Professional Fees, supra note 205. Professor Lubben found that “factors such as the retention of several
additional professionals and the appointment of an unsecured creditors’ committee are big factors that determine how much a
chapter 11 reorganization ultimately costs. These factors are proxies for the size of the debtor and, more directly, the complexity
of its reorganization.” Id. at 80. “The complexity of the bankruptcy and the compensation structure for the professionals retained
(which may itself reflect further aspects of complexity) are the key determinants of cost.” Lubben, What We “Know” About
Chapter 11 Cost is Wrong, supra note 205, at 147.
IV. Proposed Recommendations: Commencing the Case
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o The standard of review applicable to the appointment of a chapter 11 trustee under
section 1104;225
o The permissibility of cross-collateralization and roll-up provisions in postpetition
financing facilities;226
o The proper use of the doctrine of necessity in chapter 11 cases;227
o The ability of drop shipment transactions to qualify for administrative claim treatment
under section 503(b)(9);228
o The interplay between the priority afforded to wage claims under section 507(a)(4)
and the priority afforded to employee benefit plan claims under section 507(a)(5);229
o The ability of a debtor to apply section 1114 to terminate retiree benefit plans that
the debtor has the right to unilaterally terminate outside the bankruptcy context;230
o The definition of “executory contract” for purposes of section 365;231
o The effect of rejecting an executory contract or unexpired lease under section 365;232
o The ability of a debtor to assume intellectual property licenses under section 365(c)
(i.e., the hypothetical test versus the actual test)233 and the treatment of trademark
6
, 201
licenses generally;234
er 21
o
o
b
ovem
on N
The proper calculation of a landlord’s archivedagainst the estate (i.e., the accrual
claim
3
approach versus the billing date 14-3536
approach);235
.
, No
rown
B
The applicationseth v. safe harbor in section 546(e) to bar fraudulent transfer actions
x of the
n Bli
i
cit d
broughteunder applicable nonbankruptcy law (i.e., state laws including the Uniform
Fraudulent Transfer Act or similar statutes as adopted in each state);236
o The treatment of ordinary supply contracts as qualified financial contracts subject to
the protection of the Bankruptcy Code’s safe harbor provisions;237
o The meaning of “for the benefit of the estate” under section 550;238
o The fiduciary duties of a debtor (as opposed to a debtor in possession) proposing a
chapter 11 plan;239
225
226
227
228
229
230
231
232
233
234
235
236
237
238
239
See Section IV.A.2, The Chapter 11 Trustee.
See Section IV.B.2, Terms of Postpetition Financing.
See Section IV.D.1, Prepetition Claims and the Doctrine of Necessity.
See Section V.E.1, Section 503(b)(9) and Reclamation.
See Section IV.D.2, Wage and Benefits Priorities.
See Section V.D.2, Retiree Benefits and Section 1114.
See Section V.A.1, Definition of Executory Contract.
See Section V.A.3, Rejection of Executory Contracts and Unexpired Leases.
See Section V.A.4, Intellectual Property Licenses.
See Section V.A.5, Trademark Licenses.
See Section V.A.6, Real Property Leases.
See Section IV.E.1, Scope of Section 546(e) Safe Harbors.
See Section IV.E.3, Assumption of Financial Contracts.
See Section V.C.2, Recoveries Under Section 550.
See Section IV.A.5, Estate Fiduciaries.
IV. Proposed Recommendations: Commencing the Case
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10211115, DktEntry: 37-2, Page 67 of Chapter
o The fiduciary duties of professionals paid from the estate;240 and
o The permissibility of gifting241 and nonconsensual third party releases242 in the
context of a chapter 11 plan.
The requirement that a debtor identify and disclose information relevant to valuation
issues earlier in the case should provide a more transparent and expedient chapter 11
process for all parties in interest.243
The creation of an “estate neutral” offers the court, the debtor, and other parties in interest
a tool to more cost-effectively investigate and resolve disputes and other potential barriers
to a debtor’s reorganization efforts.244
The enhanced procedures governing a debtor’s request to modify or terminate a collective
bargaining agreement under section 1113 should encourage (i) the debtor to initiate
this process earlier in the case and (ii) both the debtor and authorized representatives to
undertake meaningful negotiations before moving forward with litigation strategies.245
A clear set of rules governing a sale of all or substantially all of a debtor’s assets in chapter
11 — with appropriate protections and adequate time to allow the court, the debtor’s
stakeholders, and potential bidders to identify and resolve issues relating to the debtor’s
proposed exit strategy — should reduce delay, diminish the risk of losing value for the
016
estate, and should simplify and expedite procedures.246 ber 21, 2
ovem
on N
ed down a chapter 11 plan without the need
The ability of a debtor or plan proponent torchiv
cram
63 a
-353claims should eliminate (i) manipulative, strategic,
to have an accepting impaired o. 14 of
class
,N
rown the debtor and creditors (e.g., class construction, acquiring
B
and tactical maneuvering by
h v.
xset
n Bli
blockinged i
positions within classes, etc.), and (ii) litigation concerning classification and
cit
impairment issues and focus the confirmation process on the merits of the plan.247
Similarly, the refinement of the absolute priority rule to permit distributions to junior
creditors when supported by the reorganization value and redemption option value in the
case,248 as well as the codification of the new value corollary,249 should reduce litigation and
expedite the confirmation process.
Specific guidelines tailored for small and medium-sized enterprises should streamline and
simplify the chapter 11 process for these kinds of debtors and eliminate litigation and
expense concerning the new value corollary, the absolute priority rule, and the section
1129(a)(10) issues that are prevalent in these cases.250
240
241
242
243
244
245
246
247
248
249
250
See Section IV.A.7, Professionals and Compensation Issues.
See Section VI.C.6, Class-Skipping and Intra-Class Discriminating Distributions.
See Section VI.e.3, Third Party Releases.
See Section V.F, General Valuation Standards.
See Section IV.A.3, The Estate Neutral.
See Section V.D.1, Collective Bargaining Agreements Under Section 1113.
See Section V.B, Use, Sale, or Lease of Property of the Estate.
See Section VI.F.1, Class Acceptance Generally and for Cramdown Purposes.
See Section VI.C.1, Creditors’ Rights to Reorganization Value and Redemption Option Value.
See Section VI.C.2, New Value Corollary.
See Section VII, Proposed Recommendations: Small and Medium-Sized Enterprise (SME) Cases.
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
The Commission also discussed the increased costs imposed on the estate by professionals’ fees and
expenses in a chapter 11 case. In this context, the Commissioners reflected on the testimony of field
hearing witnesses regarding the costs of chapter 11, including the following testimony by Wilbur
Ross:
The most persistent investor complaint about the Chapter 11 process is the level of
professional fees. . . . I believe there are several reasons for the high level of fees. At the
onset of a case and sometimes even well into it, it is difficult for the judge to decide
how many constituencies may be out of the money. This can lead to a proliferation
of committees . . . The second problem is that committees whose claims are at or
near the cusp of worthlessness have every reason to delay the case in the hope that
the Debtor’s business may turnaround . . . The third problem is the individual large
creditor or ad hoc group of such creditors who may or may not be on the official
committee for that class but who in any event play a proactive individual role in
the proceeding and ultimately seek reimbursement of professional fees based on the
argument of “substantial contribution.”251
The Commissioners engaged in an in-depth review of professionals’ fees and expenses in chapter
11. The Commissioners started this process by discussing the history and evolution of professionals’
fees in bankruptcy. The state of professionals’ fees prior to the Bankruptcy Code can be summarized
as follows:
016
2
r 21,
be
Under the former Bankruptcy Act, the “economy of administration” standard
ovem
on N
prevailed. That standard required the courts archconsider the public interest in
to ived
363
-3
conserving and administering the estate4as5efficiently as possible. Many concluded
o. 1
n, N
w
that this standard effectively rkept the “best and brightest” attorneys out of the
.Bo
eth v
lixsthey could make more in other fields.252
bankruptcy practice, as
in B
ited
c
The Commissioners examined pre-Bankruptcy Code practices and generally agreed that bankruptcy
professionals often were characterized as “second-class” citizens under the Bankruptcy Act. They
did not believe that returning to an “economy of administration” system was a productive pursuit
because of its deterrent effect and the resulting negative impact it could have on debtors and their
stakeholders in chapter 11 cases.
In rejecting the pre-Bankruptcy Code system, the Commissioners acknowledged that any reforms
to professionals’ fees in bankruptcy needed to address the criticism that a market does not exist to
control or monitor such fees. Indeed, some commentators suggest that bankruptcy professionals
set the standards for fees of professionals in other transactional disciplines. Some Commissioners
refuted this criticism, noting that the rates of bankruptcy professionals are in fact determined
by the market and must be comparable to the rates that such professionals charge clients outside
the bankruptcy context.253 The Commissioners also observed that the criticism may not apply
251 Wilbur Ross, Written Statement to the Commission (Apr. 19, 2013), available at Commission website, supra note 55.
252 Clifford J. White III & Walter W. Theus, Jr., Professional Fees Under the Bankruptcy Code: Where Have We Been and Where Are
We Going?, Am. Bankr. Inst. J., Dec. 2010/Jan. 2011, at 22.
253 See Lubben, What We “Know” About Chapter 11 Cost is Wrong, supra note 44, at 147 (“[I]f the market is efficient the professionals
are limited in their ability to overcharge. Even if the market is somewhat inefficient, we have to ask if the market is any more
inefficient than the larger market for corporate professionals. Bankruptcy professionals seem to be easy to pick on, because their
fees are disclosed in open court. However, one might suspect that this same fact may also make them more conservative in their
billing.”).
IV. Proposed Recommendations: Commencing the Case
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10211115, DktEntry: 37-2, Page 69 of Chapter
to all bankruptcy professionals, but may be most applicable in the larger chapter 11 cases. Many
Commissioners highlighted that the amount of fees and expenses ultimately charged by bankruptcy
professionals is driven largely by the complexity of the chapter 11 case and, perhaps more importantly,
by the litigious and contentious posture of a case.254 Regardless, the Commissioners believed that all
criticisms of, and potential issues with, the current treatment of bankruptcy professionals’ fees had
to be considered in studying any reforms, which many Commissioners believed should focus on
aligning incentives with case efficiency.
The Commission reviewed several large chapter 11 cases in which professionals’ fees and expenses
garnered media attention, such as the American Airlines and Tribune Co. cases, as well as City of
Detroit, even though it is a chapter 9 case.255 In these cases, either the complexity (in the case of
American Airlines)256 or the novelty (in the case of City of Detroit)257 of the issues presented and
the litigation initiated by stakeholders to protect or pursue their interests in the case (in the case
of Tribune),258 or some combination of these factors, contributed to the relatively large amount
of professionals’ fees and expenses that were incurred in these particular chapter 11 cases.259 The
Commissioners debated whether the Bankruptcy Code could or should scrutinize more closely the
conduct of clients and professionals in these circumstances to try to regulate professionals’ fees.
Such ex post oversight by the court, particularly with respect to what actions lawyers should or
should not have taken on behalf of their clients, could raise ethical issues for lawyers in chapter 11
cases.260 Indeed, lawyers generally are required to defer to their clients in service of their clients’
16
“reasonable and necessary”
lawful objectives.261 Moreover, professionals are already subject to the 21, 20
ber
vem
n No
ed o
rchiv
63 a
254 See supra note 224.
-353
o. 14
255 In the American Airlines and City of DetroitNcases, the courts approved the use of fee examiners to review and control
n,
professionals’ fees and expenses in v. Bcases. Notably, the UST Fee Guidelines “encourage greater use of fee examiners to help
the row
th
evaluate technical compliances(e.g., no lumping of tasks into a single time entry) and assess the reasonableness of a fee request.”
lix e
Cliff J. White III, New FeeB
ed in Guidelines for Attorneys in Larger Chapter 11 Cases Enhance Transparency and Promote Market Forces
cit
in Billing, available at http://www.justice.gov/ust/eo/public_affairs/articles/docs/2013/abi_201308.pdf.
256 The American Airlines case was filled with complex issues that required negotiation and resolution, including labor union
agreements, airport agreements, aircraft leases, intercompany claims, a complicated merger agreement, and an antitrust lawsuit
brought by the Department of Justice and the Texas Attorney General. See Glenn West & Stephen Youngman, American Airlines:
From Chapter 11 to the World’s Largest Airline, Texas Lawbook (2014), available at http://texaslawbook.net/american-airlinesfrom-chapter-11-to-the-worlds-largest-airline/.
257 Detroit’s “historic” bankruptcy case is the largest municipal bankruptcy in the United States. Matthew Dolan, Cost of Detroit’s
Historic Bankruptcy Reaches $126 Million, Wall St. J. (Sept. 12, 2014, 5:24 PM), http://online.wsj.com/articles/cost-of-detroitshistoric-bankruptcy-reach-126-million-1410557043. “Detroit’s bankruptcy case has been both complex with more than 100,000
creditors and fast-paced with a goal of exiting bankruptcy as soon as possible so the city can again be run by locally elected
officials.” Id. The cost of the city’s bankruptcy case has reached, and is expected to surpass, $126 million, despite the presence of a
fee examiner that was appointed by the bankruptcy court to monitor professionals’ fees. Id. However, city officials and a leading
bankruptcy professor who studies professionals’ fees agree that the fees are reasonable and consistent with corporate bankruptcy
costs, given the size of the case and the city’s plans to eliminate $7 billion in debt and reinvest $1.4 billion into blight removal and
city services. Id.
258 Morath, supra note 206 (noting that Tribune’s chapter 11 case, “which began in December 2008, is one of the longest-running
bankruptcies of the recent financial crisis as an ongoing fight between bondholders and the company has prevented Tribune
from exiting Chapter 11 protection”).
259 Similarly, the Lehman Brothers bankruptcy case was viewed by a law professor as a “really complicated case” that was “really big
and had some novel issues.” James O’Toole, Five Years Later, Lehman Bankruptcy Fees Hit $2.2 Billion, CNN Money (Sept. 13,
2013), http://money.cnn.com/2013/09/13/news/companies/lehman-bankruptcy-fees/. Judge Peck, the bankruptcy judge who
presided over the case, observed that although the fee total was “a whopping number” in absolute terms, it was appropriate given
the scale and complexity of the case. Id.
260 “Billing arrangements deal with the business of lawyering, but unlike other business contracts in the marketplace, lawyers cannot
engage in unfettered arm’s-length transactions to negotiate with and provide services to their clients. . . . Lawyers’ duties affect, ex
ante, the amount of the fees and the kind of arrangements available, the need to adjust fees as the conditions of the representation
unfold, and the enforcement of fee contracts ex post. The duties owed by lawyers to their clients are founded on basic principles
of fiduciary law: the duty of loyalty and fair dealing, and the duty of candor.” A.B.A. Comm. on Lawyer Bus. Ethics, Business and
Ethics Implications of Alternative Billing Practices: Report on Alternative Billing Arrangements, 54 Bus. Law. 175, 190–201 (1998)
(discussing various ethical issues that are raised by flat fees and contingency fees).
261 Model Rules of Prof ’l Conduct R. 1.2(a) (2013) (“[A] a lawyer shall abide by a client’s decisions concerning the objectives of
representation and . . . shall consult with the client as to the means by which they are to be pursued.”); R. 1.4(a)(2) (“A lawyer
shall . . . reasonably consult with the client about the means by which the client’s objectives are to be accomplished . . . .”).
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
standard of review under Bankruptcy Code section 330 that assesses whether the fees requested by
a professional are “reasonable” for actual and “necessary” services rendered by such professional.262
Lawyers are also subject to a similar standard under their ethical code of conduct enforceable by
their respective state bars.263
Some Commissioners believed that the Bankruptcy Code could do more to facilitate review of
the results achieved by professionals in chapter 11 cases when determining the fees and expenses
that should be awarded. For example, the court could grant a supplemental fee for extraordinary
results or require disgorgement or reduce requested fees for actions that dissipated the value of
the estate. Specifically, the Commissioners debated codifying directives that would require courts
to (i) enhance fee awards for “exceptional efficiencies” or “exceptional results” and (ii) reduce
lodestar compensation if the court finds that professionals’ actions led to otherwise avoidable and
unacceptable inefficiencies or outcomes (without making professionals the “guarantors” of chapter
11 outcomes). Some Commissioners highlighted how such directives would be consistent with
other decisions made by the Commission to encourage professionals to be more cost-effective in
the representation of their clients, including the requirement that professionals for secured creditors
and ad hoc committees demonstrate the reasonableness of their fees and expenses under section
330 of the Bankruptcy Code.264 These Commissioners felt that the Bankruptcy Code should induce
professionals to strive for efficiency both in terms of the provision of professional services and the
results for the estate.
16
1, 20
ber 2
vem
The Commission considered the potential benefits to, and the potential unintended consequences
n No
ed o
rch v
of, such a review process. Although many Commissioners isupported the process in concept, they
63 a
-353
.1
expressed concerns about the implementation 4 and the potential litigation invited by, such a
, No of,
rown
B
results-oriented fee review process.. These Commissioners were not persuaded that professionals
hv
ixset
n Bllabel or the effects of hindsight bias in such a review process. Other
i
could avoid the “guarantor”
cited
Commissioners believed that structuring the review process to focus on administrative efficiencies
fostered or impeded by professionals’ conduct could significantly mitigate these concerns. The
Commissioners were not able to reach a consensus on a results-oriented fee review process because
of these concerns, as well as the lack of objective data and academic literature evaluating the
advantages and disadvantages of such a review process.
The Commission also considered ex ante ways to control and mitigate professionals’ fees and expenses
in chapter 11 cases. Reliance on the traditional lodestar method of billing and assessing professionals’
fees has arguably stifled innovation in fee structures and subjected debtors and unsecured creditors’
committees in bankruptcy to a one-size-fits-all fee structure that may be detrimental to bankruptcy
estates in certain cases. The Commissioners generally agreed that professionals could develop more
efficient ways to deliver cost-effective services to debtors and unsecured creditors’ committees.
262 Bankruptcy Code section 330(a) permits a court to award only “reasonable compensation for actual, necessary services rendered
by the trustee, examiner, ombudsman, professional person, or attorney and by any paraprofessional person employed by any
such person,” and permits only “reimbursement for actual, necessary expenses.” 11 U.S.C. § 330(a)(1).
263 Model Rules of Prof ’l Conduct R. 1.5(a) (2013) (“A lawyer shall not make an agreement for, charge, or collect an unreasonable
fee or an unreasonable amount for expenses.”). “Every lawyer practicing in federal bankruptcy court holds at least one state bar
card, and every state has an ethics rule regarding the duty of a lawyer to keep fees reasonable.” Rapoport, Rethinking Professional
Fees in Chapter 11 Cases, supra note 212, at 291.
264 See Professionals and Compensation Issues. See also Wilbur Ross, Written Statement to the Commission (Apr. 19, 2013) (“The
third problem is the individual large creditor or ad hoc group of such creditors who may or may not be on the official committee
for that class but who in any event play a proactive individual role in the proceeding and ultimately seek reimbursement of
professional fees based on the argument of ‘substantial contribution.”), available at Commission website, supra note 55.
IV. Proposed Recommendations: Commencing the Case
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Professionals could provide services on a fixed-fee or flat-rate basis; they could unbundle services
and price different aspects of the case in different ways; or they could use discounted or alternative
fee models.265 For example, counsel for the debtor in possession could charge a standard fixed rate
for monthly monitoring and administrative matters in a case, a fixed rate for claims administration
matters, and an hourly rate (subject to lodestar review) for plan negotiation and confirmation
matters.
Some Commissioners observed that alternative fee structures, such as a fixed-fee model, could
overcompensate professionals in some cases, such as when the matter is less complex or is resolved
more quickly than previously anticipated. Other Commissioners noted that the opposite is also
possible when the estate would benefit because professionals underestimated the time and labor that
a particular matter would demand.266 To compensate for this uncertainty, bankruptcy professionals
could incorporate escalators or de-escalators in their original fee arrangements to address potential
changes in either direction.
As the Commissioners evaluated alternative fee structures, they recognized that the applicable
standard of review was very important to the effectiveness of this reform. The standard of review
had to permit variation from the traditional lodestar method, but require evidence from the
professional that would allow the court to assess ex ante the potential advantages and disadvantages
of the proposed alternative fee arrangement. The Commissioners did not believe that alternative
6
fee arrangements would be permissible in every scenario, and they er 21, 201 that courts could be
believed
b
m
guided (though not bound) by the types of alternative feenarrangements used in the market for
Nove
ed o
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comparable engagements and transactions. Indeed, rthev Commissioners viewed this reform as one
63 a
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way to address the perception that bankruptcy professionals are not compensated in accordance
, No
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with market standards. The tCommission determined that the professional should bear the burden
h v.
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of establishing theed i
cit reasonableness of the arrangement, that the professional thoroughly reviewed the
arrangement with the client (and the client consents to the arrangement), and that the arrangement
is reasonably likely to be beneficial to the estate.
The last of these factors — that the arrangement is reasonably likely to be beneficial to the estate
— was fully vetted by the Commission. Indeed, the Commissioners contemplated that this factor
would allow courts to prospectively consider the impact of proposed alternative fee arrangements.
In assessing such arrangements under this factor, courts could consider, among other things: (i) how
the arrangement might work during the case and the likely impact (both positive and negative) on
the estate given various scenarios; (ii) the professionals’ justifications for the arrangement and any
alternatives to the arrangement; (iii) the use of such arrangements in the market and whether the
265 See generally A.B.A. Comm. on Lawyer Bus. Ethics, supra note 260, at 182–87 (1998) (describing common types of alternative
billing arrangements, including contingency-based fees (i.e., value billing or incentive billing), flat fees (based on tasks or
percentages), and modification to hourly billing (e.g., caps, budgets, discounts, or phased billing)). See also Nancy B. Rapoport,
The Case for Value Billing in Chapter 11, 7 J. Bus. & Tech. L. 117, 157–60 (2012) (encouraging law firms to consider alternative
fee arrangements).
266 See Rapoport, Rethinking Professional Fees in Chapter 11 Cases, supra note 212, at 288 (“The advantage of a fixed fee is that it
puts the onus of deciding the cost effectiveness of an activity on the person whose bottom line is affected: the professional. The
disadvantage, although it’s not a major disadvantage, is that the size of the fixed fee could end up being woefully low for the
amount of work that the professional needs to do, resulting in the professional having to finish up the job for free.”). “The rub
with using a flat fee, of course, is that there’s a very real possibility that the flat fee will undercompensate the amount of work that
the professional has to do. That risk, though, exists in non-bankruptcy cases as well, and as long as clients push for, and get, flat
fees outside of bankruptcy, there’s no reason that courts can’t establish flat fees in bankruptcy cases.” Rapoport, The Case for Value
Billing in Chapter 11, supra note 265, at 162.
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
proposed arrangement includes relevant and customary terms; and (iv) the overall potential benefit
to the estate. The Commissioners underscored the need to have the court make these determinations
at the beginning of the case or engagement, as applicable, to allow the professional, client, and estate
to proceed with confidence in the bargain reached. This approach comports with market standards
for alternative fee arrangements and promotes efficiency in their structure and use in chapter 11.
Notably, section 328 currently allows alternative fee structures, and the Commission considered
professionals’ and courts’ frequent reluctance to use or approve such structures.267 The Commissioners
discussed the possible reasons underlying this reluctance. Many Commissioners believed that
professionals and courts were reacting, at least in part, to the section 330 imperative, which prompts
courts to review professionals’ fees and expenses using the lodestar method.268 Courts apply the
lodestar method to determine — after the fact — the “reasonable” amount of attorney’s fees for a
particular matter by multiplying the number of hours that should have reasonably been devoted to
a particular matter by what the court deems to be a reasonable hourly rate. Applying the lodestar
method ex post to review the amount that a professional has charged pursuant to an alternative fee
structure, however, can skew incentives for professionals by creating uncertainty, and make the fee
review process more labor-intensive than necessary for the courts.269
The Commissioners believed that, whatever the alternative fee agreement, the incentive for
professionals to pursue such arrangements would depend, in part, on the willingness of courts
6
to enforce the original terms of the fee agreement, subject to ordinary client 201
1, defenses (including
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fraud or misrepresentation) and the current standard of review undervsection 328. The Commission
n No
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chiv
agreed that the ex ante standard of review outlined aboverwould provide appropriate incentives and
63 a
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a meaningful way for courts to assess alternative fee arrangements at the outset. On balance, the
, No
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Commission determined thatxseth v. B
alternative fee structures and more flexibility and innovation in fee
Bli
structures could generate isignificant cost savings for bankruptcy estates and could remove a barrier
ed n
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for many companies that could not otherwise afford to pursue a chapter 11 reorganization.
Finally, the Commission reviewed and evaluated recommended principles in other areas that,
directly or indirectly, addressed professionals’ fees and expenses. For example, the principles
discuss the standard of review that should apply to any fees and expenses of professionals for any
secured creditor or ad hoc committee that requests payment of those amounts from the estate. The
Commission agreed that such fees and expenses should be subject to the reasonableness standard
of section 330 of the Bankruptcy Code.270 The principles also clarify the process for the debtor’s
267 Bankruptcy Code section 328(a) authorizes “the employment of a professional person under section 327 or 1103 of this title, as
the case may be, on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fixed or
percentage fee basis, or on a contingent fee basis.” 11 U.S.C. § 328(a). However, section 328(a) also permits courts to deviate from
these terms and conditions: “Notwithstanding such terms and conditions, the court may allow compensation different from the
compensation provided under such terms and conditions after the conclusion of such employment, if such terms and conditions
prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms
and conditions.” Id.
268 Section 330(a)(3) of the Bankruptcy Code prompts the court to “consider the nature, the extent, and the value of such services,
taking into account all relevant factors, including — (A) the time spent on such services; (B) the rates charged for such services;
. . . .” 11 U.S.C. § 330(a)(3).
269 One bankruptcy court, for example, approved retention of debtor’s counsel on the basis of a flat fee pursuant to section 328(a),
which the court fixed at the outset at $1,200,000 plus costs. Rapoport, The Case for Value Billing in Chapter 11, supra note 265,
at 161–62 (citing In re Kobra Props., 406 B.R. 396 (Bankr. E.D. Cal. 2009)). However, the court also reserved the right to adjust
the fee downward based on a reexamination upon the occurrence of certain events or the deviation of the case from a traditional
chapter 11 case. Id. Ultimately, the court awarded counsel fees that were indeed lower than the flat fee in the retention order. Id.
270 See Section IV.A.7, Professionals and Compensation Issues.
IV. Proposed Recommendations: Commencing the Case
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retention and payment of nonbankruptcy professionals.271 Furthermore, in reviewing and discussing
the U.S. Trustee’s appointment of multiple committees in a case, the Commission observed several
examples of courts authorizing committees to share professionals.272
B. Financing the Case
1. Adequate Protection
Recommended Principles:
The amount of adequate protection required under section 361 of the Bankruptcy
Code to protect a secured creditor’s interest in a debtor’s property should be
determined based on the foreclosure value of the secured creditor’s collateral.
Nothing in this principle prohibits the trustee from seeking to sell a secured
creditor’s collateral under section 363; in such a sale, the secured creditor’s allowed
secured claim should be determined by the value actually realized from the sale of
16
its collateral under section 363. In the case of a chapter 11 rplan2contemplating a
1, 0
be 2
m
reorganization of the debtor, the secured creditor’s Nove
n allowed secured claim should
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be determined by the reorganization363 archof its collateral. For the definition of
value i
-35
1 defined for both the plan and the section 363x
“reorganization value” (whicho.is 4
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sale contexts),ixseehSection VI.C.1, Creditors’ Rights to Reorganization Value and
et v
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n Option Value.
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Redemption
cited
For purposes of these principles, the term “foreclosure value” means the net value
that a secured creditor would realize upon a hypothetical, commercially reasonable
foreclosure sale of the secured creditor’s collateral under applicable nonbankruptcy
law. In evaluating foreclosure value, a court should be able to consider a secured
creditor’s ability to structure one or more sales, or otherwise exercise its rights,
under applicable nonbankruptcy law, in a manner that maximizes the value of
the collateral. In the case of a foreclosure sale in which the secured creditor would
acquire the collateral through a credit bid, the foreclosure value should be based
on the net cash value that a secured creditor would realize upon a hypothetical,
commercially reasonable foreclosure sale, and not on the face amount of the debt
used to acquire the property through the credit bid.
The foreclosure value of a secured creditor’s collateral should be determined at the
time of the request for, or agreement by the parties to provide, adequate protection
under section 361. In granting adequate protection to a secured creditor under
271 See id.
272 See id. See also Rapoport, Rethinking Professional Fees in Chapter 11 Cases, supra note 212, at 290 (“[N]ot every fiduciary needs
its own financial advisor. . . . Perhaps in some cases, one party (the DIP) could pay full freight for a financial advisor’s work, and
other parties in interest could hire financial advisors for the limited purpose of reviewing the primary financial advisor’s work.”).
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
section 361(3), the court should be able to consider evidence that the net cash
value that a secured creditor would realize upon a hypothetical sale of the secured
creditor’s collateral under section 363 exceeds the collateral’s foreclosure value (a
“value differential”). If the court makes a finding based on the evidence presented
at the adequate protection hearing that a value differential exists, the court should
be able to premise adequate protection under section 361, in whole or in part, on
such value differential. In so doing, the court’s order also should provide that, if the
court determines at a subsequent hearing that the secured creditor has presented
sufficient evidence to warrant relief from the automatic stay with respect to the
collateral, the trustee will conduct a sale of the collateral under section 363, unless
the secured creditor elects otherwise. For purposes of this principle, the court
may not enforce any waiver or agreement affecting a court’s ability to consider
evidence and make determinations regarding the existence of a value differential
or a secured creditor’s entitlement to relief from the automatic stay.
This formulation of adequate protection complies with the original purpose of
section 506(a), which provides that value “shall be determined in light of the
purpose of the valuation and of the proposed disposition or use of such property,
and in conjunction with any hearing on such disposition or use or on a plan
affecting such creditor’s interest.” 11 U.S.C. § 506(a). Accordingly, the 016
foreclosure
2
r 21,
value of a secured creditor’s collateral should not necessarilymbe
determine the value
ove
on N other purposes in the
of such collateral or the secured creditor’s allowedivclaim for
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arch
363
chapter 11 case.
5
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.
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A secured creditor etshould continue
h v.
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section 507(b) ifor
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to receive priority treatment under
of its collateral at the time of its request
for adequate protection under section 361. To the extent existing law has been
interpreted by courts to mean that the secured creditor must be “provided” with
adequate protection in order to gain this benefit, such case law should be overturned
by statute. It is sufficient that the secured creditor be deprived of the requested
relief from the automatic stay to implicate the protections of section 507(b).
A court should be able to approve a provision to cross-collateralize a secured
creditor’s prepetition debt with the debtor’s or the estate’s postpetition property
only for the purpose of providing adequate protection under section 361 and only
to the extent that such cross-collateralization covers any decrease in the value of
the secured creditor’s collateral as of the petition date.
The court should not approve any proposed adequate protection under section
361 that grants a lien on, or any direct or indirect interest in (including through a
superpriority claim), the estate’s avoidance actions or the proceeds of such actions
under chapter 5 of the Bankruptcy Code. Nevertheless, this prohibition should
not limit the proceeds available to satisfy a prepetition secured creditor’s claim
arising solely under section 507(b).
IV. Proposed Recommendations: Commencing the Case
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10211115, DktEntry: 37-2, Page 75 of Chapter
Adequate Protection: Background
The filing of a chapter 11 case stays the enforcement of many creditors’ actions against the debtor,
including the collection and foreclosure actions of secured creditors. Moreover, following a filing,
the debtor in possession273 may continue to use its property, including any cash collateral, to operate
its business and to facilitate its reorganization efforts. Although the debtor’s right to the automatic
stay and the continued use of its property ultimately benefit all stakeholders, the debtor’s exercise of
these rights directly affects the rights of secured creditors holding interests in the debtor’s property.
On the other hand, allowing a secured creditor to foreclose immediately on the debtor’s property or
to demand payment in full from the debtor would crater the debtor’s reorganization efforts at the
outset; such a provision would essentially turn chapter 11 into a liquidation statute.
The concept of adequate protection is intended in part to balance the prepetition rights of secured
creditors with the postpetition rehabilitative purposes of the Bankruptcy Code. If a debtor seeks
to use cash collateral or prime a prepetition secured creditors’ interests as part of, or pursuant to,
a postpetition financing arrangement, or if the secured creditor requests relief from the automatic
stay that is denied, section 361 of the Bankruptcy Code requires the debtor to provide the secured
creditor with adequate protection of its interest in property. The Bankruptcy Code does not define
the term “adequate protection,” but courts generally have interpreted it to mean compensation to
secured creditors for any depreciation or diminution in the value of the secured creditor’s interest
caused by the debtor in possession’s use of collateral during the chapter 21, 2016 274 The extent of this
11 case.
er
emb
protection turns on the court’s determination of the “value” n Nov secured creditors’ interest in the
of the
do
chive
debtor’s interest in property.275
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63 a
53
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No.
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Section 361 offers three nonexclusive means for providing a secured creditor with adequate
. Bro
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protection of its securedliinterest: (i) cash payments; (ii) a replacement lien; or (iii) other protection
in B
cited
that will result in the realization of the indubitable equivalent of the secured creditor’s interest in the
property.276 The language of section 361 is permissive and suggests that other means for providing
adequate protection may also exist. Nevertheless, courts and debtors in possession mostly rely on
these three articulated means, with the types of adequate protection that would satisfy the third
option — providing the indubitable equivalent of the secured creditor’s interest — largely determined
on a case-by-case basis.277
In addition, issues of valuation often are at the heart of the adequate protection determination.
Courts have used a variety of valuation standards in assessing the sufficiency of adequate protection
under section 361. These standards have included liquidation value, going concern value, and various
market valuations.278 Section 361 does not specify the appropriate valuation standard. In the context
273 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
274 See, e.g., United Sav. Ass’n of Tex. v. Timbers of Inwood Forest Assocs., Ltd, 484 U.S. 365 (1988); In re Delta Res., Inc., 54 F.3d
722, 730 (11th Cir. 1995), cert. denied, 516 U.S. 980 (1995); In re Cason, 190 B.R. 917, 928 (Bankr. N.D. Ala. 1995).
275 See, e.g., Wright v. Union Cent. Life Ins. Co., 311 U.S. 273 (1940).
276 11 U.S.C. § 361(1), (2), (3).
277 The legislative history of section 361(3) suggests that “abandonment of the collateral to the creditor would clearly satisfy
indubitable equivalence, as would a lien on similar collateral . . . Unsecured notes as to the secured claim or equity securities of
the debtor would not be the indubitable equivalent.” H.R. Rep. No. 95-595 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6544
(statement of Senator Dennis DeConcini).
278 See, e.g., Christopher S. Sontchi, Valuation Methodologies: A Judge’s View, 20 Am. Bankr. Inst. L. Rev. 1, 2 & n. 5 (2012) (“Broadly
speaking, a firm, its assets or its equity can be valued in one of four ways: (i) asset-based valuation where one estimates the value
IV. Proposed Recommendations: Commencing the Case
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of determining the value of a secured creditor’s allowed claim, section 506(a) of the Bankruptcy
Code provides that “[s]uch value shall be determined in light of the purpose of the valuation and
of the proposed disposition or use of such property, and in conjunction with any hearing on such
disposition or use or on a plan affecting such creditor’s interest.”279
Adequate Protection: Recommendations and Findings
Adequate protection is a critical determination made early in a chapter 11 case that can affect the
ultimate outcome of the debtor’s reorganization and creditor recoveries. It serves both to protect
the particular interests of secured creditors and to facilitate the overall objectives of the estate.
By permitting the use of collateral subject to the provision of adequate protection, the debtor in
possession can put its property to work for the estate and focus on implementing an effective
reorganization strategy.
The Commissioners engaged in a detailed review of the conceptual underpinnings and purpose
of adequate protection under section 361 of the Bankruptcy Code. Although the Commissioners
generally agreed on the purpose and importance of the adequate protection concept, they heavily
debated and vetted the various approaches to providing adequate protection to secured creditors. The
Commissioners discussed the potentially competing needs early in the case from the perspectives of
the debtor in possession and the secured creditors. To illustrate, debtors in possession need to use
16
1, 20
their property — at least such property that is necessary to their reorganization efforts — and they
ber 2
em
need liquidity typically through postpetition financing and theon Nov cash collateral. Meanwhile,
use of
ed
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secured creditors need assurance that the debtor’s-35363 arc
reorganization efforts will not adversely affect the
. 14
value of their interests in the debtor’s property.
, No
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B
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i
ited
Commissioners cdiscussed the kinds
The
of prepetition liens and security interests often placed
on a debtor’s property and the impact of a “blanket lien” that encumbers all of the debtor’s assets
under applicable state law.280 The Commissioners acknowledged the increasing use of blanket liens
in secured financing transactions and discussed the potential value of these liens to the extent they
reduce the cost of capital and provide prepetition liquidity to the debtor. The Commissioners also
recognized the general proposition, which is reflected in the legislative history of section 361, that
the Bankruptcy Code should provide secured creditors with the value of their prepetition bargain.281
To that end, the Commission considered the various ways of providing secured creditors with the
value of their prepetition bargain in the context of adequate protection.
of a firm by determining the current value of its assets, (ii) discounted cash flow or ‘DCF’ valuation where one discounts cash
flows to arrive at a value of the firm or its equity, (iii) relative valuation approaches, which include the ‘comparable company
analysis’ and the ‘comparable transaction analysis’ that base value on how comparable assets are priced, and (iv) option pricing
that uses contingent claim valuation.”) (citing cases that considered these various methodologies).
279 11 U.S.C. § 506(a).
280 See, e.g., Kenneth M. Ayotte & Edward R. Morrison, Creditor Control and Conflict in Chapter 11, 1 J. Legal Analysis 511, 523
(2009) (reviewing prepetition financing arrangements and observing that approximately 97 percent of prepetition financing
facilities are secured by liens akin to blanket liens). See also Juliet M. Moringiello, When Does Some Federal Interest Require a
Different Result?: An Essay on the Use and Misuse of Butner v. United States, 2015 Ill. L. Rev. __, at *33 (forthcoming 2015) (“These
blanket liens, coupled with the expanded definition of proceeds as a result of the 2001 amendments to Article 9 of the Uniform
Commercial Code, leave no unencumbered assets for unsecured creditors. Some have argued that the 2001 amendments to
Article 9 impermissibly amend bankruptcy law.”), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2445584.
281 H.R. Rep. No. 95-595 (1977) (“Secured creditors should not be deprived of the benefit of their bargain. . . . [T]he purpose of the
section is to insure that the secured creditor receives the value for which he bargained.”).
IV. Proposed Recommendations: Commencing the Case
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Given that adequate protection turns on the value attributable to the secured creditor’s interest in a
debtor’s interest in property, the Commission discussed the various methods of determining such
value, explored situations in which different methods may apply, and considered the consequences
to the estate and secured creditors of applying these methods. First, the Commission evaluated the
potential use of “liquidation value,” which is typically applied in the event of a forced or orderly
liquidation. The use of a forced liquidation standard may produce a lower valuation of the property
interest, facilitating the debtor’s use of the property, but potentially reducing the secured creditor’s
recoveries in the case. Second, the Commission evaluated the potential use of “going concern value,”
which is used to evaluate the enterprise value of a debtor with an assembled workforce and operating
business.282 The use of a going concern valuation may produce a higher valuation of the property
interest, providing greater protection of the secured creditor’s interest in the debtor’s property, but
perhaps reducing significantly the debtor’s financing and reorganization options. A going concern
valuation also may provide more protection than necessary in those cases when the secured creditor
does not have an interest in the entirety of the debtor’s assets.283
Ultimately, however, the Commission agreed that, for purposes of determining adequate protection
under section 361, a secured creditor’s interest in the debtor’s property should be determined based
on the “foreclosure value” of such interest, instead of more commonly used valuation standards such
as liquidation value and going concern value. The foreclosure standard is meant to capture the value
of the secured creditor’s interest as of the petition date (i.e., the value that a secured creditor’s state
16
law foreclosure efforts would produce if the automatic stay were lifted 21, the bankruptcy case had
or 20
ber
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not been filed).284 The foreclosure value should be determinedocase by case based on the evidence
nN
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presented at the adequate protection hearing, 3taking into account the realities of the applicable
63 a
-35
4
foreclosure markets and legal schemes.No. 1
wn,
cited
h v.
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n Bli
i
Bro
282 See generally Robert Rhee, Essential Concepts of Business for Lawyers 155–59 (2012) (explaining different ways to value a
company).
283 A secured creditor may have interests in only certain of the debtor’s assets or something less than the entirety of the enterprise.
See, e.g., Melissa B. Jacoby & Edward J. Janger, Ice Cube Bonds: Allocating the Price of Process in Chapter 11 Bankruptcy, 123 Yale
L.J. 862, 922–23 (2013) (“Yet, not all property can be encumbered by a security interest as a legal or practical matter. Whatever
the intentions of the parties, the so-called blanket lien is likely to have gaps.”). See also Edward Janger, The Logic and Limits
of Liens, 2015 Ill. L. Rev. __, at *5–6 (forthcoming 2015) (noting that so-called blanket liens under Article 9 of the Uniform
Commercial Code may exclude tort claims, real estate, recoupment and setoff claims, insurance claims, and others); Michelle
M. Harner, The Value of Soft Assets in Corporate Reorganizations, 2015 Ill. L. Rev. __, at *24 (forthcoming 2015) (“If a company
holds a going concern surplus … some portion of that value is attributable to soft variables and, if realized postpetition, is not
(or should not be) subject to a prepetition security interest. … [There is] support for this position under the Bankruptcy Code.”),
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2444699. But see First Report of the Commercial Fin. Ass’n to
the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial Fin. Ass’n Annual Meeting, at 4–5 (Nov. 15,
2012) (“While some commentators have advocated limiting a secured creditor’s interest to ‘liquidation value’ while preserving
incremental ‘going-concern surplus’ for the benefit of others, CFA submits that prepetition lending expectations should
be preserved. For example, with an increasingly large segment of the secured lending market dedicated ‘cash-flow lending’
predicated upon the present value of anticipated future income streams or cash-flows based upon a multiple of EBITDA, when
those proceeds are realized upon a sale (whether voluntary or involuntary), the net proceeds of sale should be allocable to the
secured party. On the other hand, consistent with pre-bankruptcy expectations, the secured creditor should also be required to
bear the reasonable costs and expenses incurred in connection with the preservation and disposition of the collateral (a concept
presently addressed by §506(c) of the Code). Accordingly, CFA believes that the Commission should consider codifying the
principal that the secured creditor’s interest includes the realizable value of the collateral including going-concern value.”),
available at Commission website, supra note 55.
284 Under the parties’ prepetition agreements, the secured creditor generally is entitled to foreclose on its collateral upon the debtor’s
default. The chapter 11 case and the automatic stay prevent a secured creditor from being able to exercise its state law foreclosure
rights. The foreclosure valuation standard for adequate protection purposes preserves the value of the secured creditor’s interest
under its prepetition bargain with the debtor. Edward Janger, The Logic and Limits of Liens, supra note 283 (arguing that the
lienholder should only be entitled to the value it could have received if it had pursued state law remedies) (emphasis added). As
discussed below, however, the Commission determined that for distribution purposes in the case, a secured creditor should be
entitled to receive the reorganization value of its collateral.
IV. Proposed Recommendations: Commencing the Case
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Notably, the Commission’s decision to use foreclosure value is an integral part of the delicate
balance the Commission struck between the rights of secured creditors, on the one hand, and the
reorganizational objectives of the estate, on the other hand. Specifically, the Commission agreed
that the foreclosure value of an interest should be used early in the case when determining adequate
protection issues, but that the secured creditor should be entitled to receive the reorganization value of
its interest in the debtor’s property through the claims allowance and distribution process later in the
case.285
In addition, the Commission agreed that a secured creditor should receive additional assurances if
the court permits the debtor to provide adequate protection by showing a sufficient equity cushion
in the property — i.e., a sufficient differential between the foreclosure value and the section 363x
sale value of the secured creditor’s interest in the debtor’s property. In this instance, the Commission
determined that the court should have the ability to provide in the adequate protection order that,
if the debtor in possession’s reorganization efforts fail, or if the court subsequently finds cause
that would support lifting the automatic stay with respect to the secured creditor’s collateral, the
debtor in possession or the chapter 11 trustee must sell the secured creditor’s collateral under
section 363 of the Bankruptcy Code, unless the secured creditor elects otherwise. This compromise
reflects the reality that, if adequate protection is provided based on the reorganization value of
the collateral, the secured creditor should have a means of realizing such reorganization value if
adequate protection is subsequently proven to insufficiently protect the secured creditor’s interests.
16
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Although the Commissioners discussed potential ways that secured creditors, could try to impede
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the debtor’s reorganization efforts by triggering their need for additional assurance, the Commission
n No
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ultimately determined that the court could monitor5such rch
63 aconduct by enforcing its orders. Moreover,
-3 3
. 4
the Commission concluded that such conduct 1 rare and likely counterproductive for the secured
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creditor, which would otherwise tbe .entitled to receive the reorganization value (which is defined in
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the sale context as the iactual sale price) of its collateral upon the confirmation of the debtor’s plan or
c ted
the approval of a section 363x sale.
The Commissioners discussed the general uses for, and the current split in the case law regarding
the permissibility of, cross-collateralization. They recognized that, on the one hand, crosscollateralization may serve valid interests that would benefit the estate, but on the other hand,
it may also result in overreaching and an impermissible improvement of a prepetition lender’s
position. The Commission ultimately decided that debtors in possession should be able to use crosscollateralization to provide adequate protection to prepetition secured creditors, but only to the
extent that such cross-collateralization would protect against the decrease in the value of the secured
creditor’s interest in the debtor’s property.
The Commission also considered whether a debtor in possession should be able to grant a replacement
lien in its chapter 5 avoidance actions or the proceeds of such actions to provide adequate protection
to a secured creditor under section 361.286 The Commission reviewed the original policies underlying
the trustee’s avoiding powers under chapter 5 of the Bankruptcy Code, including allowing the
trustee to avoid prepetition transfers that preferred certain unsecured creditors and reallocating the
285 The term “reorganization value” and its role in the claims distribution process is discussed below. See Section VI.C.1, Creditors’
Rights to Reorganization Value and Redemption Option Value.
286 For a discussion of the treatment of liens in chapter 5 avoidance actions in the postpetition financing context, see Section V.C,
Avoiding Powers.
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recovered value from such avoidance actions more fairly through the bankruptcy claim distribution
process. The Commissioners also observed that chapter 5 avoidance actions and recoveries often
are among the few unencumbered assets of a debtor’s estate and therefore may be the only resource
available to repay unsecured claims. On balance, the Commission determined that the debtor in
possession should not be permitted to use chapter 5 avoidance actions or recoveries to provide
adequate protection to secured creditors. The only exception to this general rule is that if the adequate
protection granted to a secured creditor is determined to be insufficient, then such secured creditor
should be allowed to receive recoveries from avoidance actions through the creditor’s superpriority
claim under section 507(b) of the Bankruptcy Code.
2. Terms of Postpetition Financing
Recommended Principles:
A court should not approve any proposed postpetition financing under section
364 of the Bankruptcy Code that contains a provision to roll up prepetition debt
into the postpetition facility or to pay down prepetition debt in part or in full with
proceeds of the postpetition facility. This provision should not apply to postpetition
financing, including a facility that refinances in part or in full prepetition debt, to
the extent that —
016
21, 2
berwho do not directly
o the postpetition facility (a) is provided by Novem
lenders
n
ed o
or indirectly through their affiliates hiv prepetition debt affected by the
rc hold
63 a
-353
facility or (b) repays No. 14
the prepetition facility in cash, extends substantial
,
rown
B
new credit ttovthe debtor, and provides more financing on better terms than
h .
xse
n Bli
i
alternative facilities offered to the debtor; and
cited
o the court finds that the proposed postpetition financing is in the best
interests of the estate.
A court should not approve any proposed postpetition financing under section
364 that grants a lien on, or any interest in (including through a superpriority
claim), the estate’s avoidance actions or the proceeds of such actions under chapter
5 of the Bankruptcy Code.
Subject to a 60-day restriction on milestones, benchmarks, and similar provisions
(see Section IV.C.1, Timing of Approval of Certain Postpetition Financing Provisions),
a court should be able to approve, in a final order, permissible extraordinary
financing provisions in connection with any proposed postpetition financing under
section 364. For the definition of “permissible extraordinary financing provisions,”
see Section IV.C.1, Timing of Approval of Certain Postpetition Financing Provisions.
Any prepetition contractual prohibition on subordinated prepetition junior secured
creditors offering or providing postpetition financing to the debtor should not be
enforced in the chapter 11 case, provided that: (i) any such subordinated prepetition
junior secured creditors should not be permitted to prime the perfected security
interests of the prepetition senior secured creditors with the postpetition financing
IV. Proposed Recommendations: Commencing the Case
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facility; and (ii) if the court approves the postpetition financing facility offered by the
subordinated prepetition junior secured creditors, the prepetition senior secured
creditors should have the option to match the terms of, and to provide the financing
facility in lieu of, the subordinated junior secured creditors within a reasonable time
as specified in the court’s interim order approving the postpetition financing. These
provisions would render unenforceable any contractual damages provisions that
would otherwise allow prepetition senior secured creditors to recover damages for
breach of contract against subordinated prepetition junior secured creditors under
nonbankruptcy law based on the provision of postpetition financing. Sections 364
and 510 should be amended accordingly.
Terms of Postpetition Financing: Background
A debtor in possession287 needs liquidity to operate its business during the chapter 11 case and to
finance its reorganization efforts. Some debtors in possession may be able to use cash collateral and
its ongoing revenue streams for these purposes, but many debtors need a new, postpetition financing
facility to achieve their postpetition objectives.288 Section 364 of the Bankruptcy Code generally
governs a debtor in possession’s requests to obtain postpetition financing.
6
, 201
Section 364 is structured in part to incentivize lenders to extend credit vember 21
to a company in bankruptcy.289
No
on
Currently, this section permits a debtor in possession to hobtain postpetition financing on either
ived
arc
5 63
an unsecured basis or, after notice and a hearing,3in exchange for administrative priority.290 In
14-3
No.
w ,
addition, upon making certain showings,na debtor may be authorized to incur postpetition debt as
. Bro
eth v a secured claim in unencumbered property, a junior secured
ix
a superpriority administrative s
in Bl claim,
cited claim (by priming prepetition senior secured creditors).291 The last of these
claim, or a senior secured
incentives is the most difficult for debtors in possession to obtain because section 364(d) requires
the debtor in possession to show that no other financing is available and that the interests of the
prepetition secured creditors that would be primed by the new facility are adequately protected.292
Because a debtor in possession may not be able to prime its prepetition secured lenders under the
current standards for adequate protection, a debtor in possession often tries to negotiate a postpetition
financing facility with its prepetition secured lenders. Such postpetition facilities may include crosscollateralization or roll-up provisions that provide additional protection to the prepetition lenders
on their prepetition claims against the estate. Whether a court should approve cross-collateralization
287 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
288 Prepetition loan agreements are considered “financial accommodations” that the trustee cannot elect to assume (and thereby
require performance) under section 365 of the Bankruptcy Code. “[Section 365(c)] permits the trustee to continue to use and
pay for property already advanced, but is not designed to permit the trustee to demand new loans or additional transfers of
property under lease commitments.” H.R. Rep. 95-595, 1978 U.S.C.C.A.N. 5963, 6304. Accordingly, the debtor in possession
needs to negotiate a new financing arrangement, which may be provided by new lenders or some or all of its prepetition lenders.
289 See, e.g., Paul M. Baiser & David G. Epstein, Postpetition Lending Under Section 364: Issues Regarding the Gap Period and
Financing for Prepackaged Plans, 27 Wake Forest L. Rev. 103, 103–04 (1992) (“To counter the understandable reluctance of
financial institutions to lend to Chapter 11 debtors, section 364 of the [Bankruptcy] Code provides incentives to lenders to
provide financing to borrowers who are the subject of bankruptcy cases.”) (citations omitted).
290 11 U.S.C. § 364(a) (unsecured credit); id. § 364(b) (administrative claim).
291 Id. § 364(c) (superpriority administrative claim, junior lien, or lien on unencumbered property); id. § 364(d) (priming lien).
292 Id. § 364(d)(1) (requirements for priming lien); id. § 364(d)(2) (burden on the trustee/debtor in possession).
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and roll-up provisions is subject to debate and frequently depends on the jurisdiction in which the
chapter 11 case is pending.293 In addition, the debtor may be limited to negotiating its postpetition
financing facility with only its prepetition senior secured creditors if the debtor’s prepetition junior
secured creditors are prohibited from extending postpetition financing to the debtor pursuant to a
prepetition intercreditor or subordination agreement.294
Terms of Postpetition Financing: Recommendations and Findings
The Commissioners analyzed a variety of issues relating to debtor in possession financing. They
considered, among other things, the impact of the terms of a postpetition facility on the chapter 11
case and the debtor’s stakeholders, as well as the importance of a robust financing market to
the chapter 11 process. The Commissioners discussed the kinds of provisions that protect the
interests of postpetition lenders and encourage the extension of credit to chapter 11 debtors. Some
Commissioners suggested that lenders do not need additional incentives because postpetition
financing has historically been not only safe, but also very profitable.295 Other Commissioners
challenged this assumption, noting the tightening of the postpetition credit market during the 2008
financial crisis.296
The Commission reviewed extensive materials on postpetition financing markets, terms, and
impact, including a detailed report from the advisory committee and data compiled by the Loan
6
, 201
r 21
mbe
Nove
on
ived
arch
293 For cases allowing cross-collateralization, see In re Ames 5363 Stores, Inc., 115 B.R. 34, 39–40 (Bankr. S.D.N.Y. 1990); In re FCX,
4-3Dep’t
Inc., 54 B.R. 833, 840 (Bankr. E.D.N.C. 1985);No. 1Vanguard Diversified, Inc., 31 B.R. 364, 366 (Bankr. E.D.N.Y. 1983); In re
n, In reE.D.N.Y. 1982). For cases disallowing cross-collateralization, see Shapiro v.
w
Gen. Oil Distrib., Inc., 20 B.R. 873,v875–76 (Bankr.
. Bro
Saybrook Mfg. Co., Inc. (Inlixseth
re Saybrook Mfg. Co., Inc.), 963 F.2d 1490, 1494–96 (11th Cir. 1992) (cross-collateralization is per se
impermissible); Intred in B Corp., 596 F.2d 1092 (2d Cir. 1979); In re Fontainebleau Las Vegas Holdings, LLC, 434 B.R. 716 (S.D.
Texlon
ci e
Fla. 2010). For cases allowing roll-ups in certain circumstances, see In re Uno Rest. Holdings Corp., Ch. 11 Case No. 10-10209
(MG) (Bankr. S.D.N.Y. Jan. 20, 2010); In re Foamex Int’l Inc., Ch. 11 Case No. 09-10560 (KJC) (Bankr. D. Del. Feb. 18, 2009); In
re Aleris Int’l, Inc., Ch. 11 Case No. 09-10478 (BLS) (Bankr. D. Del. Feb. 12, 2009); In re Tronox Inc., Ch. 11 Case No. 09-10156
(ALG) (Bankr. S.D.N.Y. Jan. 12, 2009); In re Lyondell Chem. Co., Ch. 11 Case No. 09-10023 (REG) (Bankr. S.D.N.Y. Jan. 6, 2009).
Notably, the permissibility of these and other provisions in a postpetition facility are governed by section 364 of the Bankruptcy
Code and are generally protected on appeal and subject only to reversal if lack of good faith is established. See 11 U.S.C. § 364(e).
294 For a general discussion of issues in intercreditor agreements, see Mark N. Berman & David Lee, The Enforceability in Bankruptcy
Proceedings of Waiver and Assignment of Rights Clauses Within Intercreditor or Subordination Agreements, 20 Norton J. Bankr. L.
& Prac., Art. 1 (2011).
295 See, e.g., Marshall S. Hueber, Debtor-in-Possession Financing, RMA J., Apr. 2005, at 33 (“[DIP lending] can be an eminently
logical and profitable endeavor. Indeed, because of the many lender protections enshrined in the U.S. Bankruptcy Code to
induce DIP lending, the safest loans in a troubled industry may well be those made to bankruptcy debtors.”); David A. Skeel, Jr.,
The Past, Present and Future of Debtor-in-Possession Financing, 25 Cardozo L. Rev. 1905, 1906 (2004) (“[T]he generous terms
offered to DIP financers have encouraged lenders to make loans to cash-starved debtors, and that these lenders have used their
leverage to fill a governance vacuum that was created by the enactment of the 1978 Code.”); Joseph V. Rizzi, Opportunities in
DIP Financing, Bankers Mag., July/Aug. 1991, at 49 (“New postpetition lenders can earn attractive returns from relatively secure
assets and participate in a growing market.”). See also Written Statement of Kathryn Coleman, Attorney at Hughes Hubbard &
Reed, LLP: TMA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1–6 (Nov. 3, 2012) (noting that DIP
lending is profitable and safe but is no longer being used to help rehabilitate the debtor and arguing that some roll-up facilities
can have a significant negative effect on a debtor’s ability to exit chapter 11), available at Commission website, supra note 55
296 See, e.g., Kenneth Ayotte & David A. Skeel, Jr., Bankruptcy or Bailouts?, 35 Iowa J. Corp. L. 469, 488 (“A system-wide lending
failure like the recent credit crisis raises the question whether private sources of bankruptcy financing will always be available.
Through much of 2008, few companies that filed for bankruptcy were able to obtain financing.”); Robert H. Barnett & Brian J.
Grant, Credit Crisis Puts Focus on Out-of-Court Restructurings, J. Corp. Renewal, June 14, 2010 (“DIP financing sources seized up
at the onset of the credit crunch and banking crisis in 2008. Several large institutions in the third quarter of that year dramatically
tightened new DIP lending; Lehman Brothers filed for bankruptcy in September of 2008, and Merrill Lynch and Wachovia,
two other top players in the market, were sold in last-minute distressed deals to Bank of America and Wells Fargo, respectively.
As credit vanished throughout the financial system, other DIP lenders followed suit. . . . [T]he number of active DIP lenders
dropped from more than 30 at the beginning of 2008 to only five or six by the end of the year. Aside from some high-profile
deals in which lenders pulled together to support large companies (such as Lyondell Chemical Co.’s $8 billion Postpetition
financing facility, which came with a 13 percent interest rate and a 7 percent fee), DIP financing remained scarce in 2009, forcing
companies either to restructure by other means or to move straight to liquidation.”), available at http://www.turnaround.org/
Publications/Articles.aspx?objectID=13015.
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Syndications and Trading Association (the “LSTA”).297 The LSTA’s data suggest that the majority of
debtors that enter into postpetition financing agreements do not liquidate, but rather reorganize.298
Specifically, based on the Commission’s review of the LSTA data: (i) 69 percent of firms that had
postpetition financing reorganized, whereas 52 percent of firms that did not have postpetition
financing reorganized; (ii) 38 percent of firms without postpetition financing liquidated, whereas 23
percent of firms with postpetition financing liquidated; (iii) 16 percent of firms that had postpetition
financing were eventually sold pursuant to a section 363 sale, whereas only 8 percent of firms that
did not have postpetition financing were sold pursuant to a section 363 sale; and (iv) any relationship
between postpetition financing agreements and chapter 7 liquidations is inconclusive.299
In addition, the Commissioners evaluated testimony that (i) markets for secured leveraged debt,
especially with the benefits of senior secured status, and high-yield bonds are large and critical
to economic growth; (ii) secondary trading markets are deep and liquid even during times of
great distress; (iii) assets in bankruptcy are liquid and volatile, but can appreciate and increase the
enterprise value or provide a less certain path toward profitability; and (iv) debtor in possession
financing provides much needed liquidity to distressed companies at market rates based on the
risk profile of the particular debtor.300 They also considered testimony that postpetition financing
agreements include tighter covenants and milestones often designed to facilitate a loan-to-own
297 The LSTA dataset is found at Exhibit B, with related materials at Exhibits A and C, to Mr. Shapiro’s supplemental testimony.
16
Supplemental Written Statement of Mark Shapiro: ABI Winter Leadership Conference Field Hearing 20
1, Before the ABI Comm’n to
ber 2 supra note 55. See generally
Study the Reform of Chapter 11, at Exhibits A, B, C (Nov. 30, 2012), available at Commission website,
ovem
supra note 66 and accompanying text (generally discussing limitations of chapter n N
d
eitso 11 empirical studies). LSTA’s dataset focuses
298 The Commission appreciated the LSTA’s contribution to the field hearings hiv
arc and work on this dataset. The
on postpetition financing facilities in large chapter 11 cases-35363
since 2006. It is an extension of the UCLA-LoPucki Bankruptcy
o. 4
Research Database, and it records information on chapter 1 cases filed since 2006 with reported assets of between $500 million
n, N 11
ro not
and $10 billion, with the addition of fivevcases w in the UCLA-LoPucki Bankruptcy Research Database. The LSTA dataset
.B
contains 167 observations, with eacheth
observation representing a separate postpetition financing facility (so one company may
Blixs
n had more than one facility or filed more than one chapter 11 case). Of the 167 observations, 157
have multiple observationsd iit
ite if
of the observations arec
unique cases, reflecting the fact that some firms have more than one DIP facility per case. Of these, 149
are unique companies, reflecting the fact that 8 firms have filed for bankruptcy more than once in the dataset. Supplemental
Written Statement of Mark Shapiro: ABI Winter Leadership Conference Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at Exhibit C (Nov. 30, 2012), available at Commission website, supra note 55. See generally supra note 66 and
accompanying text (generally discussing limitations of chapter 11 empirical studies).
299 These analyses were based on the data in Exhibit B to Mr. Shapiro’s supplemental testimony. Supplemental Written Statement
of Mark Shapiro: ABI Winter Leadership Conference Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
Exhibit B (Nov. 30, 2012), available at Commission website, supra note 55. In performing these analyses, cases with multiple
postpetition financing observations and the cases added to the dataset from outside of the UCLA-LoPucki Bankruptcy Research
Database (they did not meet the criteria of the original database and could skew observations; notably, the percentages do not
vary greatly if all observations are included) were excluded. Accordingly, these data are based on 157 cases: 91 of these cases had
a postpetition financing facility; 69 percent (or 63 out of 91) of cases reorganized. This means 31 percent (or 28 out of 91) of cases
did not reorganize. Conversely, 42 of the cases did not have DIP Financing; 52 percent (or 22 out of 42) of cases reorganized; 48
percent (or 20 out of 42) of cases did not reorganize. It is important to note that 24 of these cases were missing data. Also, these
observations are limited by the qualifications typically associated with empirical analyses of chapter 11 cases, as well as the fact
that the dataset was missing some data and focused only on large, public company cases. Nevertheless, the data are still very
informative, and align with general perceptions that many distressed companies need some form of postpetition financing to
use chapter 11 effectively. Id. See generally supra note 66 and accompanying text (generally discussing limitations of chapter 11
empirical studies).
300 Written Statement of Ted Basta on behalf of LSTA: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11 (Oct. 17, 2012) (describing leveraged loan and high yield markets and noting resulting liquidity to distressed companies),
available at Commission website, supra note 55; Supplemental Written Statement of Mark Shapiro: ABI Winter Leadership
Conference Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3 (Nov. 30, 2012) (explaining dynamics
of postpetition financing negotiations and detailing components of, and factors considered in pricing, such financing), , available
at Commission website, supra note 55. “The DIP lending market provides a complex and challenging arena for lenders. Not only
must they engage in all analyses that are attendant to a more typical loan to a non-distressed commercial borrower, but they
also must understand the legal and financial framework that encompasses a potential borrower in a Chapter 11 case, including
the impact of Chapter 11 on the Debtor’s business.” Id. See also Edward I. Altman, The Role of Distressed Debt Markets, Hedge
Funds and Recent Trends in Bankruptcy on the Outcomes of Chapter 11 Reorganizations, 22 Am. Bankr. Inst. L. Rev. 75, 84
(2014) (observing that the size and sophistication of the distressed debt market has “provided the incentive for a special breed
of investors, experienced in distressed investing, to attract capital and . . . provide a potential outlet for original investors to
monetize their troubled assets. . . . This liquidity is crucial to those [] investors who do not have the resources, expertise or desire
to hold their claims until the resolution of the reorganization” and impacts other financing markets”).
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transaction for the lender or a sale of the assets in the chapter 11 case.301 In reviewing the testimony,
the Commissioners debated the advantages and disadvantages of postpetition financing terms.302
As a general matter, the Commissioners recognized the need for a robust, competitive postpetition
financing market and the value it provides to distressed companies. They also appreciated the
potential impact that any suggested reforms might have on that market; they aimed to encourage a
competitive postpetition financing market that provided debtors with access to necessary financing
on terms that would facilitate their restructuring efforts — an outcome that benefited all stakeholders.
Accordingly, the Commissioners carefully analyzed the materials discussing, and the implications of
issues involving postpetition financing. The Commissioners further acknowledged that the focus of
section 364 should be on permitting parties to negotiate market agreements that do not overreach or
negatively impact the rights of other stakeholders beyond the terms necessary to obtain postpetition
credit in a particular case.
To strike this balance, the Commissioners first evaluated the use of roll-up and cross-collateralization
provisions in postpetition facilities. The Commissioners discussed the different kinds of rollup provisions and their different justifications, specifically comparing provisions in postpetition
facilities provided by a prepetition lender with provisions in postpetition facilities provided by a
completely new lender.303 The Commissioners generally agreed that the greatest opportunity for
abuse in the context of roll-up provisions occurs when a prepetition lender provides a postpetition
16
1, 20
ber 2
vem
n No
301 See, e.g., Written Statement of Kathryn Coleman, Attorney at Hughes Hubbard & Reed, LLP: TMA Field Hearing Before the ABI
ed o of where the debtor gets its DIP financing, the game
Comm’n to Study the Reform of Chapter 11, at 4–5 (Nov. 3, 2012) archiv
(“Regardless
has dramatically changed. Lenders providing postpetition 363
-35financing no longer do so in order to make good returns with assured
4
repayment, or protect their prepetition positions o. 1
, N by getting collateral for previously unsecured loans. Instead, they often do so in
rown
order to take control of the debtor, through covenants, deadlines, and default provisions. And these are no mere financial tests to
B
h v.
ensure the safety of the lender’serepayment.”), available at Commission website, supra note 55; Written Statement of Holly Felder
xs t
n Bli the ABI Comm’n to Study the Reform of Chapter 11, at 2–3 (Apr. 19, 2013) (“Post BAPCPA, DIP
i
Etlin: ASM Field Hearing Before
cited
agreements routinely require a full resolution to the case or rejection of any lease not consensually extended by the 210th day.
In the case of a retailer . . . [this] effectively shorten[s] the timeline to reorganize the company to generally only 120 days and
sometimes as short as 90 days . . . .” and this generally means that the debtor’s management often has very little time to decide
whether to pursue reorganization by obtaining consensual lease extensions or to begin a sale process.), available at Commission
website, supra note 55; Oral Testimony of Richard Mikels: TMA Field Hearing Before the ABI Comm’n to Study the Reform of
Chapter 11, at 40–42 (Nov. 3, 2012) (TMA Transcript) (arguing there should be a presumption against rollups, particularly where
the company seeks to reorganize rather than sell), available at Commission website, supra note 55. See also Stephen J. Lubben,
The Board’s Duty to Keep Its Options Open, 2015 Ill. L. Rev. __, at *4–5 (forthcoming 2015) (“But in many cases, the reality is that
the debtor has no choice but to commence a sale process, because its DIP loan only provides funding for a relatively short period
of time. Lenders are able to impose such terms on debtors because the lender has a virtual stranglehold on the debtor’s operations
coming into bankruptcy by virtue of a lien on all of the debtor’s assets and possession of all the debtor’s cash.”), available at http://
papers.ssrn.com/sol3/papers.cfm?abstract_id=2434699.
302 See, e.g., Kenneth N. Klee & Richard Levin, Rethinking Chapter 11, 21 Norton J. Bankr. L. & Prac. 5 (2012) (discussing use of
roll-ups and milestones in postpetition financing agreements); Supplemental Written Statement of Mark Shapiro: ABI Winter
Leadership Conference Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3 (Nov. 30, 2012) (reviewing
various types of milestone, benchmark, roll-up, and other postpetition financing terms and their role in structuring and pricing
the agreement; also addresses criticisms of such provisions), available at Commission website, supra note 55.
303 “When the debtor in possession’s prepetition lender is acting as the postpetition lender, the elimination of prepetition debt —
termed a ‘roll–over’ — often attracts intense scrutiny from the court and the United States trustee. Roll-overs come in two basic
forms. First, a gradual roll-over occurs when a prepetition lender agrees to advance postpetition funds with the agreement that
proceeds of prepetition accounts receivables will be applied to reduce the prepetition loan. Alternatively, a postpetition lender
can simply lend enough postpetition to pay off the prepetition loan, whether owing to the postpetition lender or a different
lender, immediately converting all of the lender’s prepetition debt to postpetition debt. Postpetition lenders often prefer the
latter alternative because they prefer to be the sole holder of a lien on the collateral pool.” 3 Collier on Bankruptcy ¶ 364.04[1]
[e]. See also In re Capmark Fin. Grp. Inc., 438 B.R. 471, 511 (Bankr. D. Del. 2010) (explaining that a “roll-up” is “the payment
of a pre-petition debt with the proceeds of a post-petition loan. Roll-ups most commonly arise where a pre-petition secured
creditor is also providing a post-petition financing facility under section 364(c) or (d) of the Bankruptcy Code. The proceeds of
the post-petition financing facility are used to pay off or replace the pre-petition debt, resulting in a post-petition debt equal to
the pre-petition debt plus any new money being lent to the debtor. As a result, the entirety of the pre-petition and post-petition
debt enjoys the post-petition protection of section 364(c) or (d) as well as the terms of the DIP order.”); Mark J. Roe & Frederick
Tung, Breaking Bankruptcy Priority: How Rent-Seeking Upends The Creditors’ Bargain, 99 Va. L. Rev. 1235, 1238 (2013) (“[B]ank
lenders have convinced judges to “roll up” their possibly unsecured pre-bankruptcy debts — debts that were quite likely not
entitled to priority payment — into new, secured, and highly-prioritized loans to the debtor in bankruptcy.”).
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facility and the true “new credit” extended by such facility may be nominal (or nominal in relation to
the amount of prepetition debt rolled up into the postpetition facility).304 Although the Commission
viewed a refinancing with a new lender differently, the Commission also noted the potential
challenge in distinguishing among prepetition and postpetition lending groups. To assist in this
task, the Commission methodically worked through the various scenarios in which one or more
prepetition lenders may participate in a postpetition facility that provides new credit to the debtor
in possession. The Commission crafted the related principles to allow roll-up provisions in those
circumstances if certain conditions are met, but to disallow roll-up provisions that provide little or
no value to the estate.
With respect to cross-collateralization, the Commissioners discussed its uses and the split in the case
law regarding the permissibility of cross-collateralization. The Commissioners articulated concerns
similar to those expressed in the roll-up context. In fact, some of the Commissioners viewed crosscollateralization as subject to greater abuse because of the ability of prepetition lenders to improve
their prepetition position through the use of cross-collateralization in postpetition facilities. As
noted in the adequate protection principles above, the Commission ultimately supported the ability
of a debtor in possession to use cross-collateralization, but only in the adequate protection context
and only to the extent such cross-collateralization is used if there is actual diminution in the value
of a secured creditor’s interest in the debtor’s property.305
6
The Commission considered whether a debtor in possession should be able1, 20grant postpetition
to 1
ber 2
ve such actions to secure the
lenders a lien in its chapter 5 avoidance actions or the proceedsoof m
nN
ed o
postpetition facility. As discussed above in the adequate 3 archiv
protection context, the Commission reviewed
3536
. 14the original policies underlying the trustee’soavoiding powers under chapter 5 of the Bankruptcy
,N
own
v. Brin such assets. The Commission determined that the debtor
Code and the estate’s unique interests
eth
Blixs
in possession shouldcnot ibe permitted to use chapter 5 avoidance actions or the proceeds of such
ed n
it
actions (directly or indirectly through any superpriority claim) to secure postpetition financing
under section 364 of the Bankruptcy Code. In the adequate protection context, section 507(b) of
the Bankruptcy Code grants prepetition lenders a superpriority claim in situations when they have
sought adequate protection, and adequate protection has failed. In contrast, a postpetition lender
has other means to secure or protect its postpetition extension of credit to the debtor from the outset.
The Commissioners also evaluated the impact of provisions in a prepetition intercreditor or
subordination agreement that precludes a prepetition junior secured lender from offering
postpetition financing to the debtor without the consent of the senior secured lender. This kind
of waiver by a junior lender in the prepetition intercreditor agreement can have a significant
negative impact on the debtor in possession, who is often not a party to the agreement. Among
304 The Commission considered the testimony of Mark Shapiro, who in part analyzed the LSTA data and concluded that only about
10 percent of the 167 observations (total sample) in the LSTA dataset involved a postpetition financing with roll-up provisions
that resulted in the conversion of a case to chapter 7, approval of a section 363 sale of substantially all of its assets, or confirmation
of a liquidating plan. Supplemental Written Statement of Mark Shapiro: ABI Winter Leadership Conference Field Hearing Before
the ABI Comm’n to Study the Reform of Chapter 11, at 7 (Nov. 30, 2012), available at Commission website, supra note 55. The
Commissioners also observed in the LSTA dataset, however, a correlation between postpetition financing agreements with
roll-up provisions and some type of milestone or benchmark requirement. Specifically, if the financing included a roll-up, it
was more likely to also include milestones or benchmarks. These analyses were based on the data in Exhibit B to Mr. Shapiro’s
supplemental testimony. Supplemental Written Statement of Mark Shapiro: ABI Winter Leadership Conference Field Hearing
Before the ABI Comm’n to Study the Reform of Chapter 11, at Exhibit B (Nov. 30, 2012), available at Commission website, supra
note 55. See generally supra note 66 and accompanying text (generally discussing limitations of chapter 11 empirical studies).
305 See Section IV.B.1, Adequate Protection.
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other things, this waiver often removes an interested and viable source of financing from the
debtor’s pool of potential postpetition lenders, which may affect both the availability and terms of
any postpetition financing for the debtor in possession.
The Commissioners recognized that this kind of waiver is increasingly common in intercreditor
agreements, along with a variety of other provisions that affect bankruptcy rights, including rights
of the debtor and potentially other nonparties to the intercreditor agreement. The Commissioners
discussed the role and value of these provisions from the perspective of the prepetition senior secured
lenders. The Commissioners debated different ways to provide the debtor with the ability to discuss
postpetition financing with junior lenders subject to this kind of waiver while still respecting the
interests of the prepetition senior secured lenders. The Commission reached a consensus that would
allow a subordinated junior secured lender subject to this kind of waiver and prohibition to provide
postpetition financing to the debtor on two conditions: (i) the proposed facility does not prime the
liens of the prepetition senior secured lender, and (ii) if the court approves the postpetition facility
offered by such junior lenders, the prepetition senior secured lender has the right to step in and
provide postpetition financing (in lieu of the financing offered by the junior lender) to the debtor on
the same terms and subject to the same conditions as the postpetition facility offered by the junior
secured lender and approved by the court. In that event, the Commission supported an amendment
to the Bankruptcy Code rendering unenforceable any contractual damages provisions that would
otherwise allow senior secured creditors to recover damages for breach of contract against junior
16
306
secured creditors under nonbankruptcy law based on the provisionbof 21, 20
er postpetition financing. In
em
v
addition, the Commission agreed that the senior secured lenders should be required to take such
n No
ed o
chivin the interim financing order.
action within a reasonable time as directed by 5363court
the ar
in
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-3
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Brow
th v.
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B
C. Breathing Spell for Debtor upon Filing
1. Timing of Approval of Certain Postpetition
Financing Provisions
Recommended Principles:
A court should not approve any proposed postpetition financing under section
364 of the Bankruptcy Code that (i) is subject to milestones, benchmarks, or
other provisions that require the trustee to perform certain tasks or satisfy certain
conditions within 60 days after the petition date or date of the order for relief,
306 The Commission’s discussion of the use and approval of provisions in a postpetition facility that may impact the course of the
chapter 11 case or implement waivers of, or otherwise affect, rights under the Bankruptcy Code is set forth in Section IV.C.1,
Timing of Approval of Certain Postpetition Financing Provisions; Section VI.C.3, Section 506(c) and Charges Against Collateral;
and Section VI.C.4, Section 552(b) and Equities of the Case.
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whichever is later, or (ii) otherwise conflict with another section of the Bankruptcy
Code.
In this context, the phrase “milestones, benchmarks, or other provisions that
require the trustee to perform certain tasks or satisfy certain conditions”
refers to tasks or conditions that relate in a material or significant way to the
debtor’s operations during the chapter 11 case or to the resolution of the case,
including deadlines by which the debtor must conduct an auction, close a sale,
or file a disclosure statement and a chapter 11 plan. It does not include payment
of scheduled loan amounts, customary loan covenants, reporting requirements,
ministerial tasks, or the debtor’s compliance with a budget, provided that the
budget does not impose disguised milestones or benchmarks.
A court should not approve permissible extraordinary financing provisions in
connection with any proposed postpetition financing under section 364 in any
interim order.
In this context, “permissible extraordinary financing provisions” include:
(i) milestones, benchmarks, or other provisions that require the trustee to perform
certain tasks or satisfy certain conditions; (ii) representations regarding the validity
1
or extent of the creditor’s liens on the debtor’s property or property2of the 6
1, 20 estate; or
ber
m
(iii) if some or all of the proposed postpetition lendersnholdeprepetition debt that
Nov
ed o that refinances prepetition
would be affected by the postpetition facility, 3 provision
a rchiv
6 a
-353
debt with proceeds of the postpetition4facility that is otherwise permissible under
.1
, No
rown
B
the principles relating ttov.postpetition financing terms. See Section IV.B.2, Terms
h
xse
n Bli
i
of PostpetitiondFinancing.
cite
For the recommended principles on section 506(c) and section 552(b), see Section
VI.C.3, Section 506(c) and Charges Against Collateral; Section VI.C.4, Section
552(b) and Equities of the Case.
Timing of Approval of Certain Postpetition Financing Provisions:
Background
Although an often necessary and critical source of postpetition liquidity, the postpetition facility
negotiated between a debtor and its postpetition lenders may be subject to terms that could affect the
chapter 11 case. For example, the terms of the proposed postpetition financing may require the debtor
in possession307 to pursue a sale process under section 363 of the Bankruptcy Code on an expedited
basis; may set certain deadlines for the debtor to file its disclosure statement and chapter 11 plan;
may contain waivers of certain rights held by the debtor in possession under the Bankruptcy Code,
such as the right to assert surcharges under section 506(c); or may exclude the application of certain
other provisions of the Bankruptcy Code, such as the equities of the case exception under section
307 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
IV. Proposed Recommendations: Commencing the Case
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552(b). The facility may also be subject to provisions addressing the validity of any prepetition liens
of the lenders, granting a lien in chapter 5 avoidance actions and any recoveries thereon, and default
or termination provisions tied to a variety of developments in the particular chapter 11 case, such
as motions for relief from the automatic stay or challenges to the liens held by postpetition lenders.
Bankruptcy Rule 4001(c)(1)(B) requires the debtor in possession to provide a “concise statement”
that “lists or summarizes . . . all material provisions of the proposed credit agreement and form of
order, including interest rate, maturity, events of default, liens, borrowing limits, and borrowing
conditions.” In addition, many jurisdictions supplement this requirement in their local rules with,
among other things, provisions that require additional disclosures and limit the effect and extent of
interim orders.308 Bankruptcy Rule 4001(c)(2) requires the debtor in possession to provide at least 14
days’ notice of the court’s final hearing on a motion to obtain postpetition financing; however, many
cases involve an interim hearing and the entry of an interim order shortly after the petition date and
then a final hearing and the entry of a final order only after the statutory committee of unsecured
creditors has been appointed and has had an opportunity to review and respond to the debtor’s
motion for the requested relief.
Timing of Approval of Certain Postpetition Financing Provisions:
Recommendations and Findings
6
1
1, 20
ber 2 in a postpetition credit
em
The Commissioners discussed at length the potential impact vof terms
n No
ed o the chapter 11 case, or that implement
agreement that dictate or attempt to influence the course of
rchiv
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-353
waivers of, or otherwise affect, rights under4the Bankruptcy Code.309 The Commissioners identified
.1
, No
rowninto this category, including (i) milestones and benchmarks
a variety of provisions that th v. B fall
may
se
that require the debtorBlix take certain actions or satisfy certain conditions by deadlines set forth in
n to
i
cited
the postpetition financing documents; (ii) concessions regarding the validity or enforceability of
prepetition liens; (iii) deadlines by which the debtor must conduct an auction, close a sale, or file a
disclosure statement and chapter 11 plan; and (iv) waivers of, or stipulations concerning, the section
506(c) surcharge and the section 552(b) equities of the case exception.310 Although Bankruptcy Rule
4001(c) requires the debtor to summarize these kinds of provisions, parties in interest may not have
sufficient time or information to accurately assess the import of such provisions and the impact they
may have on the case. Notably, the data compiled by the LSTA included information concerning
postpetition financing with the following kinds of milestones or benchmarks: “Milestone re Bidding
Procedures Orders,” “Milestone re Sale Orders,” “Milestone re Closing a Sale,” and “Conditions for
308 See, e.g., Southern District of New York Bankruptcy Court Local Rule 4001-2.
309 See Written Statement of Kathryn Coleman, Attorney at Hughes Hubbard & Reed, LLP: TMA Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11, at 6–7 (Nov. 3, 2012), (describing how onerous the conditions of postpetition financing can be,
including use of provisions that require a section 363 sale within 60 days of the lending date), available at Commission website,
supra note 55; Written Statement of Lawrence Gottlieb, Partner, Cooley LLP: NYIC Field Hearing Before the ABI Comm’n to Study
the Reform of Chapter 11, at 5 (June 4, 2013) (discussing how prepetition secured lenders of retail debtors demand postpetition
financing provisions that result in quick liquidation sales), available at Commission website, supra note 55; Written Statement
of Elizabeth Holland on behalf of the International Council of Shopping Centers: NYIC Field Hearing Before the ABI Comm’n to
Study the Reform of Chapter 11, at 5 (June 4, 2013) (describing how restrictive DIP lending conditions prevent retail debtors from
reorganizing), available at Commission website, supra note 55; Written Statement of David L. Pollack, Partner, Ballard Spahr LLP:
NYIC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3 (June 4, 2013) (describing how postpetition
financing terms have prevented retail reorganizations), available at Commission website, supra note 55.
310 The Commission addressed this latter category in Section VI.C.3, Section 506(c) and Charges Against Collateral and in Section
VI.C.4, Section 552(b) and Equities of the Case.
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the Bidding Process for a 363 Sale.”311 A review of the 112 observations in the LSTA dataset with
postpetition financing agreements (112 of 167 total sample) revealed that a postpetition facility
subject to certain milestones or benchmarks in the chapter 11 case actually produced the required
result — i.e., postpetition credit agreements that required a section 363 sale resulted in a section 363
sale, and postpetition credit agreements that required the filing of a plan resulted in a confirmed
plan.312 Moreover, postpetition financing facilities with sale-oriented milestones were significantly
less likely to result in a reorganization, as shown in the table below.313
Proportion of Debtors (%)
Whether Postpetition Facility Had Sale Milestones
16
1, 20
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. 14
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rown
B
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xset
n Bli BETWEEN CHAPTER 11 REORGANIZATION AND
i
RELATIONSHIP
cited
SALE MILESTONES IN POSTPETITION FACILITY
311 These milestones are defined as follows:
Milestone re Bidding Procedures Orders: If there was DIP Financing, was it an event of default not to have an order
approving the bidding procedures for a sale of substantially all of the debtor’s assets entered by a certain date? Yes/No.
Milestone re Sale Orders: If there was DIP Financing, was it an event of default not to have an order approving a sale
of substantially all of the debtor’s assets entered by a certain date? Yes/No.
Milestone re Closing a Sale: If there was DIP Financing, was it an event of default not to [close a sale] by a certain
date? Yes/No.
Conditions for the Bidding Process for a 363 Sale: If there as a DIP Financing, did it the process under which any
auction of the debtor’s assets had to occur? Yes/No.
Supplemental Written Statement of Mark Shapiro: ABI Winter Leadership Conference Field Hearing Before the ABI Comm’n to
Study the Reform of Chapter 11, at Exhibit A p.4 (Nov. 30, 2012), available at Commission website, supra note 55.
312 Based on the LSTA dataset, if the postpetition financing agreement contained a sale-related milestone or benchmark, the
case was more likely to result in a sale or liquidation. This relationship was statistically significant at the 1.0 percent level.
These analyses were performed using logistic regression, confirmed by the Chi Squared test, the Chi Squared Test with Yates
Correction test, and the Likelihood Ratio test. These analyses were based on the data in Exhibit B to Mr. Shapiro’s supplemental
testimony. Supplemental Written Statement of Mark Shapiro: ABI Winter Leadership Conference Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11, at Exhibit B (Nov. 30, 2012), available at Commission website, supra note 55. See also
Written Statement of Kathryn Coleman, Attorney at Hughes Hubbard & Reed, LLP: TMA Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11, at 22 (Nov. 3, 2012) (stating that DIP lenders often require debtors to obtain the lenders’
consent for any action outside the ordinary course of business, including filing a plan, and require the sale of the debtors’ assets
in a very short period of time, such as 60 days), available at Commission website, supra note 55. See generally supra note 66 and
accompanying text (generally discussing limitations of chapter 11 empirical studies).
313 Mr. Roberts prepared this chart for the Commission based on data from the LSTA dataset.
IV. Proposed Recommendations: Commencing the Case
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The Commissioners discussed ways to provide more effective notice of these kinds of provisions
to the unsecured creditors’ committee and other parties in interest in the debtor’s chapter 11
case, and highlighted the need to provide these parties with sufficient time to review and vet such
provisions. In light of the potentially significant impact of these provisions on chapter 11 outcomes,
the Commission determined that such extraordinary provisions in postpetition facilities should be
highlighted and clearly explained in the motion seeking approval of the postpetition financing. In
addition, the Commission agreed that (i) such extraordinary provisions should not be subject to
approval in an interim order, and (ii) milestones, benchmarks, or similar provisions should not be
permitted to take effect until at least 60 days after the petition date.
2. Timing of Section 363x Sales
Recommended Principles:
The trustee should not be permitted to conduct an auction of, or to receive final
approval of a sale transaction involving, all or substantially all of the debtor’s assets
within 60 days after the petition date or date of the order for relief, whichever is
later. The court should not shorten this 60-day moratorium unless (i) the trustee
or a party in interest demonstrates by clear and convincing evidence that there is
a high likelihood that the value of the debtor’s assets will decrease significantly
2016
r 21,
beproposed sale satisfies
during such 60-day period, and (ii) the court finds thatethe
v m
n No
ed o 363x sales. See Section VI.B,
the standards set forth in the principles archsection
for iv
63
-353 the purposes of this rule, the court may
Approval of Section 363x Sales.14
o. For
n, N
rowor not the secured creditor has requested or received
B
authorize a sale whether
h v.
xset
n Bli
i
adequatedprotection of its interests under section 361 of the Bankruptcy Code if
cite
the risk of decrease in the value of the debtor’s assets is sufficient to warrant a sale
before the expiration of the 60-day moratorium.
Timing of Section 363x Sales: Background
Section 363 of the Bankruptcy Code currently allows the trustee314 to sell assets in the ordinary
course of business as well as outside the ordinary course of business during the chapter 11 case.315
A sale outside the ordinary course of business requires, among other things, notice and a hearing.
It also typically requires an auction and public sale process.316 Although courts frequently use the
314 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
315 11 U.S.C. § 363(b), (c).
316 See Rachael M. Jackson, Survey: Responding to Threats of Bankruptcy Abuse in a Post-Enron World: Trusting the Bankruptcy Judge
as the Guardian of Debtor Estates, 2005 Colum. Bus. L. Rev. 451, 469–70 (2005) (“The process of conducting an auction generally
establishes that a successful bidder has paid the fair market value for the asset. Therefore, considering the tremendous emphasis
that bankruptcy courts place on maximizing the value of the estate, auction sales are advisable because judges do not tend to
scrutinize closely such transactions before approving the final sale. In addition, the security of an auction sale is enhanced
because appellate courts review bankruptcy court confirmations with considerable deference and, therefore, disgruntled bidders
are rarely successful in challenging a court-approved sale.”); Brett Rappaport & Joni Green, Calvinball Cannot Be Played on
This Court: The Sanctity of Auction Procedures in Bankruptcy, 11 Norton J. Bankr. L. & Prac. 189, 193 (2002) (“Public auctions
are preferred over private auctions to ensure a market price, so that optimal return can be realized for creditors.”); Philip A.
Schovanec, Bankruptcy: The Sale of Property Under Section 363: The Validity of Sales Conducted Without Proper Notice, 46 Okla.
L. Rev. 489, 498 n. 63 (1993) (“While bankruptcy sales may be conducted privately, a public auction is usually held because
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auction process as a means to ensure that the assets are sold for the best and highest price, the plain
language of section 363 and of the Bankruptcy Rules do not expressly require an auction and public
sale process, and courts will, in certain instances, approve private sale transactions.
Courts also have long debated whether section 363 permits the sale of all or substantially all of a
debtor’s assets prior to the filing and confirmation of a chapter 11 plan.317 The primary concerns of
courts and commentators with this practice are premised on the absence of stakeholder protections
that are otherwise incorporated into the section 1129 plan process: section 1125 requires meaningful
disclosures; section 1126 requires a vote by holders of impaired claims and interests; section 1129
requires, among other things, that the plan (i) satisfy administrative and certain other claims against
the estate; (ii) be in the best interests of creditors; and (iii) be accepted by all impaired classes of
creditors, or have the support of at least one class of impaired creditors and be fair and equitable.318
In addition, sales of all or substantially all of a debtor’s assets on an expedited basis, particularly
early in the chapter 11 case, can raise concerns about (a) the proper valuation and marketing of
assets, (b) whether other restructuring alternatives were fully explored, and (c) whether the court,
the U.S. Trustee, and stakeholders have sufficient information and time to review and comment on
the proposed transaction.319
Courts have been increasingly willing to approve expedited sales of all or substantially all of a debtor’s
assets, provided that a debtor can demonstrate exigency and certain other showings. This section
16
1, 20
addresses the timing of such sales; the requirements for the approvalmbesuch sales are discussed
of r 2
ve
n No
below.320
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3a
3536
. 14, No
Prior to the early 2000s, a traditional chapter 11 sale process under section 363 could take at least
own
v. Br
et
three months, if not more.321 liThishcourse typically involved a thorough postpetition marketing and
B xs
ed in
cit
317
318
319
320
321
competitive bidding ensures that fair and valuable consideration is received, thus helping to avoid any suspicion of collusion or
impropriety.”).
The Second Circuit in Lionel examined this debate, as well as whether a sale of all or substantially all of a debtor’s assets should
be permitted absent an emergency situation. In re Lionel Corp.,722 F.2d 1063, 1066 (2d Cir. 1983) (explaining, among other
things, the history of section 363 sales, which the court traced to the Bankruptcy Act of 1867, and noting that under the 1867
Bankruptcy Act, “when it appears . . . that the estate of the debtor, or any part thereof, is of a perishable nature or liable to
deteriorate in value, the court may order the same to be sold, in such manner as may be most expedient”) (internal quotation
marks omitted). The Second Circuit determined that such sales should be permitted but not without standards:
Just as we reject the requirement that only an emergency permits the use of § 363(b), we also reject the view that
§ 363(b) grants the bankruptcy judge carte blanche . . . such construction of § 363(b) swallows up Chapter 11’s
safeguards. . . . [T]here must be some articulated business justification, other than appeasement of major creditors for
using, selling or leasing property out of the ordinary course of business before the bankruptcy judge may order such
disposition under 363(b).
Id. at 1069–70.
11 U.S.C. § 1129(a), (b).
See, e.g., In re Fisker Auto. Holdings, Inc., 510 B.R. 55, 60–61 (Bankr. D. Del. 2014) (“It is the Court’s view that Hybrid’s rush to
purchase and to persist in such effort is inconsistent with the notions of fairness in the bankruptcy process. The Fisker failure has
damaged too many people, companies and taxpayers to permit Hybrid to short-circuit the bankruptcy process.”); In re On-Site
Sourcing, Inc., 412 B.R. 817, 824 (Bankr. E.D. Va. 2009) (listing the following nine areas of concern when analyzing a section
363 motion seeking expedited relief: (1) Is there evidence of a need for speed? (2) What is the business justification? (3) Is the
case sufficiently mature to assure due process? (4) Is the proposed APA sufficiently straightforward to facilitate competitive bids
or is the purchaser the only potential interested party? (5) Have the assets been aggressively marketed in an active market? (6)
Are the fiduciaries that control the debtor truly disinterested? (7) Does the proposed sale include all of a debtor’s assets and does
it include the ‘crown jewel’? (8) What extraordinary protections does the purchaser want? (9) How burdensome would it be to
propose the sale as part of confirmation of a chapter 11 plan?) (citation omitted).
See Section VI.B, Approval of Section 363x Sales.
Cases typically provided set deadlines for a meaningful auction process and then sufficient time for objections to, and a hearing
on, the sale transaction itself. In addition, Bankruptcy Rule 2002(a)(2) requires 21 days’ notice by mail of “a proposed use, sale or
lease of property of the estate other than in the ordinary course of business, unless the court for cause shown shortens the time
or directs another method of giving notice.” Fed. R. Bankr. P. 2002(a)(2).
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auction process; sufficient opportunity for notice, objections, and hearings on both the auction
process and sale transaction; and the closing of the sale.322 This practice allowed the court, the debtor
in possession, the U.S. Trustee, and parties in interest a full opportunity to consider the value of the
assets and alternatives to a sale, instilled a certain level of confidence in the bankruptcy sale process,
and resulted in the conclusion that the approved sale was in the best interests of the estate.
In recent years, the sale process has become much more abbreviated. Although the General Motors
and Chrysler323 chapter 11 cases — in each case a section 363 sale was completed in approximately
41 days — were more fast-paced than many cases, the average time between the petition date and
the sale date has steadily decreased, as illustrated by the following chart.324
in
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Note: In this bar chart above, the y-axis shows the number of days between the petition date and the date of
the sale order for a sale of all or substantially all of the debtor’s assets. The median number of days between
the petition date and the sale order approving a section 363 sale has declined from a high of 1982 days in 1992
to 51 days in 2012. Notably, in some years, the data only show one (e.g., 1992) or just a few orders approving
section 363 sales for substantially all of the debtor’s assets. (These data may not have captured sales, for example,
consummated through a plan of reorganization, which was coded separately in the dataset.) The table below
identi es the number of section 363 sale orders per year, as well as the mean and median duration between the
petition date and the sale order.
322 For a general description of the steps required in a typical sale and auction process under section 363(b), see, e.g., In re Adoption
of Amended Guidelines for the Conduct of Asset Sales, General Order Amending M-331, M-383 (Bankr. S.D.N.Y. Nov. 18,
2009), available at http://www.nysb.uscourts.gov/sites/default/files/m383.pdf.
323 See, e.g., In re Gen. Motors Corp., 407 B.R. 463, 491–92 (Bankr. S.D.N.Y. 2009), aff ’d sub nom. In re Motors Liquidation Co., 430
B.R. 65 (S.D.N.Y. 2010); In re Chrysler LLC, 405 B.R. 84, 96 (Bankr. S.D.N.Y. 2009), appeal dismissed, 592 F.3d 370 (2d Cir. 2010).
See also In re Lehman Bros. Holdings Inc., Case No. 08-13555 (Bankr. S.D.N.Y 2008) (sale approved within seven days of petition
date).
324 Mr. Shrestha prepared this chart and table for the Commission based on data from the UCLA-LoPucki Bankruptcy Research
Database. Accordingly, it was limited to large public companies. The duration above is the time between the petition date and
the date of the sale order.
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DURATION BETWEEN BANKRUPTCY FILING AND SECTION 363 SALE ORDER
Year
Mean No. of
Days
Median No.
of Days
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
156
97
1,982
868
127
203
114
470
137
275
156
97
1,982
868
80
203
114
249
109
219
No. of 363
Sales
2
2
1
2
3
2
2
7
14
22
Year
Mean No. of
Days
Median No.
of Days
No. of 363
Sales
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
287
227
72
63
205
34
187
81
134
116
63
82
102
140
68
63
205
34
110
77
95
141
51
74
15
15
3
2
2
2
12
17
5
3
4
3
The speed with which section 363 sales are now approved and consummated causes some courts,
stakeholders, and commentators to question whether value is being removed from the estate by
permitting a value realization event such as a sale too early and too quickly in a chapter 11 case.325
016
Many commentators recognize that there could be exceptions — true “melting1, 2 cubes” that require
ber 2 ice
vem
n No
immediate resolution to preserve any value for the estate — but those exceptions, they argue, should
ed o
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not define the rules.326
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Blixs
Timing of Sectionted in Sales: Recommendations and Findings
363x
ci
The Commissioners examined the process relating to a sale of all or substantially all of a debtor’s assets
(referred to as a “section 363x sale” in these principles) at great length. In addition to reconsidering
325 See, e.g., Jessica Uziel, Section 363(b) Restructuring Meets the Sound Business Purpose Test with Bite: An Opportunity to Rebalance
the Competing Interests of Bankruptcy Law, 159 U. Pa. L. Rev. 1189, 1214 (2011) (“Section 363 sales’ expedited process and
lesser disclosure requirements make investigation of the purchaser’s behavior vital in order to protect creditors, equity security
holders, and debtors from exploitation. Increased potential for abuse threatens creditors’ interests as well as the debtor’s ability
to maximize the value of the estate.”); Elizabeth B. Rose, Chocolate, Flowers, and § 363(b): The Opportunity for Sweetheart Deals
Without Chapter 11 Protections, 23 Emory Bankr. Dev. J. 249, 272 (2006) (“Without comprehensive information available to the
court and the committee the sale is vulnerable to sweetheart deals or unfair dealing.”). See generally Lynn M. LoPucki & Joseph
W. Doherty, Bankruptcy Fire Sales, 106 Mich. L. Rev. 1 (2007) (comparing recoveries from bankruptcy sales of large corporations
to those of bankruptcy reorganizations from 2000 to 2004). But see Written Statement of Honorable Melanie Cyganowski (Ret.),
former U.S. Chief Bankruptcy Judge, E.D.N.Y.: CFA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
4 (Nov. 15, 2012) (asking the Commission not to impose a delayed time frame for section 363 sales), available at Commission
website, supra note 55. “In the SMEs and middle-market cases, the Chapter 11 debtors have, in many instances, little flexibility,
little bargaining power and even more minimal lines of credit. The Court needs in many instances to force a sale on very short
notice . . . to maximize value for the estate.” Id. But see Written Statement of Robert D. Katz, Managing Director of Executive
Sounding Board Associates Inc.: CFA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–4 (Nov. 15,
2012) (asking the Commission not to impose a delayed time frame for section 363 sales), available at Commission website, supra
note 55.
326 A “melting ice cube” case refers to a case involving assets subject to rapid decline because of the nature of such assets (often
referred to as “perishable” assets) or unique, exigent circumstances that cannot otherwise be avoided. For a general discussion
of these cases and some of the challenges they pose, see Jacoby & Janger, Ice Cube Bonds, supra note 283. The challenge for
most courts is that bankruptcy by its nature often is an emergency procedure, so articulating a need to sell today as opposed to
tomorrow is easy; assessing the validity of that assertion is not. See, e.g., In re Humboldt Creamery, LLC, 2009 WL 2820610, at
*2 (Bankr. N.D. Cal. Aug. 14, 2009) (“[T]he problem with the ‘melting ice cube’ argument is that it is easy enough for the debtor
to unplug the freezer prior to bankruptcy.”); In re Gulf Coast Oil Corp., 404 B.R. 407, 423 (Bankr. S.D. Tex. 2009) (“The Court
must be concerned about a slippery slope. Not every sale is an emergency, and, as discussed more fully below, the reliability of
uncontested evidence (and particularly the reliability of testimony that is not adequately cross-examined) is suspect.”).
IV. Proposed Recommendations: Commencing the Case
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the standard of review and substantive requirements for section 363x sales, the Commission also
scrutinized the timing issues surrounding these sales.
The Commissioners discussed the potential benefits to a quick sale — e.g., potentially less time in
chapter 11; potentially less expensive reorganization strategy; typically preferred by postpetition
lenders and prepetition secured creditors because of faster payoff; and typically preferred by stalkinghorse bidders because a quick sale disfavors outside bidders.327 The Commission also recognized
that if a debtor’s business assets are of a perishable nature or otherwise subject to a rapid decline in
value, then a quick sale may be the best and perhaps only option for maximizing value for the estate
and its stakeholders.
The Commission generally agreed, however, that section 363x sales are proceeding more quickly
than is necessary in many chapter 11 cases. The Commissioners noted that quicker than necessary
sales can potentially reduce the value available for stakeholders in the chapter 11 case. Such a sale
may (i) not facilitate a robust auction, (ii) not allow the debtor sufficient time to explore a standalone reorganization or other restructuring alternatives, and (iii) take advantage of a decline in the
applicable markets without giving parties in interest a reasonable time to assess the likelihood that
such markets will rebound during the pendency of the debtor’s chapter 11 case. The Commissioners
also acknowledged the problems with insufficient notice and opportunity for parties in interest to
assert meaningful objections or perform reliable asset valuations within the abbreviated time frames
6
, 201
of a quick sale.
er 21
b
ovem
on N
ved
After extensive deliberation, the Commission found thatiin many cases, the potential harm to the estate
arch
363
- 5
from a sale that is pushed through the ,process3more quickly than necessary under the circumstances
o. 14
n N
Brow
significantly outweighs any tpotential benefits of such a sale. Accordingly, the Commission agreed
h v.
lixse
that the Bankruptcy in B should include a 60-day moratorium on section 363x sales, absent the
cited Code
most extraordinary of circumstances, which must be established by clear and convincing evidence
at the hearing on the motion requesting an expedited sale process.
D. Payment of Certain Claims upon Filing
When a debtor files a chapter 11 case, the automatic stay of section 362 of the Bankruptcy Code
prohibits the debtor in possession from paying any prepetition claims outside the chapter 11 plan
or without prior approval of the court. A key factor underlying this prohibition is that sections 507
and 1129 of the Bankruptcy Code incorporate a fairly stringent priority scheme for the payment of
prepetition claims. Payments outside the chapter 11 plan may result in an unfair allocation of value
among stakeholders in the chapter 11 case.
327 First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial Fin.
Ass’n Annual Meeting, at 5 (Nov. 15, 2012) (“CFA submits that promoting an efficient sale of collateral to a purchaser who is able
to continue to use those assets in a productive form is good for the economy in general and for the selling debtor’s stakeholders
in particular.”), available at Commission website, supra note 55.
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
Nevertheless, a debtor in possession strives to achieve a soft landing in chapter 11, which requires
the continuation of “business as usual” to the greatest extent possible. A debtor in possession thus
frequently requests court authorization to pay certain prepetition claims that are asserted to be
either necessary to the ongoing operations of the business or are consistent with the priority rules
set forth in section 507.
1. Prepetition Claims and the Doctrine
of Necessity
Recommended Principles:
The court should have the authority to enter an order permitting the payment of
certain prepetition claims when such remedy is directed toward: (i) employee wages
or other compensation; or (ii) claims for vendor goods or services for which the trustee
establishes an evidentiary record supporting such extraordinary relief, provided that
any such relief should not include claims for the kinds of goods covered by section
503(b)(9) of the Bankruptcy Code unless the court finds some relief is compelled
for a particular kind of good by applicable nonbankruptcy law that is not otherwise
preempted by the Bankruptcy Code and is not deemed a disguised priority.
16
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ber 2 503(b)(9)
For a discussion of section 503(b)(9), see Section V.E.1, vSection
em
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Reclamation.
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63 a
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. 14
, No
rown
v. B
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Prepetition Claimsdandxthe Doctrine of Necessity: Background
i
cite
and
The doctrine of necessity originates from the early railroad equity receivership cases.328 In those
cases, courts generally granted priority status to the railroad’s current operating expenses that
were incurred within six months of the filing and were deemed necessary to keep the railways and
interstate commerce moving.329 Although not expressly authorized by the Bankruptcy Code, courts
have continued to invoke the doctrine of necessity330 in certain circumstances under the court’s
general equitable powers set forth in section 105(a) of the Bankruptcy Code.331
328 See, e.g., Miltenberger v. Logansport, 106 U.S. 286 (1882), superseded by statute, Bankruptcy Act of 1898, as recognized in In re
Kmart Corp., 359 F.3d 866, 871 (7th Cir. 2004), cert. denied, 543 U.S. 986 (2004) (payment of pre-receivership claims to prevent
interruption in business).
329 Id.
330 See, e.g., In re Just For Feet, Inc., 242 B.R. 821, 826 (D. Del. 1999); In re NVR L.P., 147 B.R. 126, 128 (Bankr. E.D. Va. 1992); In re
Eagle-Picher Indus., Inc., 124 B.R. 1021, 1023 (Bankr. S.D. Ohio 1991); In re Ionosphere Clubs, Inc., 98 B.R. 174 (Bankr. S.D.N.Y.
1989).
331 Section 105(a) provides:
The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this
title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude
the court from . . . taking any action or making any determination necessary or appropriate to enforce or implement
court orders or rules, or to prevent an abuse of process.
11 U.S.C. § 105(a). Notably, some courts have found or suggested authority to authorize the payment of critical vendor claims
under section 363(b) of the Bankruptcy Code. See, e.g., In re Kmart Corp., 359 F.3d 866 (7th Cir. 2004), cert. denied, 543 U.S. 986
(2004); In re Ionosphere Clubs, Inc., 98 B.R. 174 (Bankr. S.D.N.Y. 1989).
IV. Proposed Recommendations: Commencing the Case
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Debtors in possession332 commonly rely on the doctrine of necessity and the court’s equitable powers
when requesting authority to pay prepetition claims outside the chapter 11 plan. One type of claim
that a debtor in possession seeks to pay is the so-called “critical vendor” claim. “Critical vendors”
are commonly defined as essential vendors or suppliers who are indispensable to the debtor’s
business — either because of the types of goods or services they supply, their knowledge of the
debtor’s business, or some other unique aspect to the business relationship — and without whom the
debtor likely cannot achieve a successful reorganization.333 A debtor’s request typically will propose
conditions for the payment of these claims, such as percentage payments and an agreement that the
vendor or supplier will continue with the debtor on the same terms as their prepetition agreement.
Courts authorizing the payment of critical vendor claims generally rely on the doctrine of necessity
and section 105(a).334 Notably, not all courts agree that the doctrine of necessity and section 105(a)
can be used for these purposes.335
Prepetition Claims and the Doctrine of Necessity:
Recommendations and Findings
Whether the Bankruptcy Code should condone the early or priority payment of the prepetition claims
of certain “critical vendors” may be influenced by the Bankruptcy Code’s treatment of certain vendor
claims as “administrative claims” under section 503(b)(9). The Commission separately analyzed
16
the treatment of vendor claims under section 503(b)(9).336 As discussed 2below, the Commission
1, 0
ber 2
em
recommended the continued application of section 503(b)(9). vIn making this recommendation,
n No
ed o
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however, the Commission also determined that section 503(b)(9) should be the sole remedy available
63 a
-353
to creditors who are deemed eligible toNo. 14 early or priority payment on their prepetition claims
, receive
own
v. Br
against the debtor.
seth
ix
in Bl
cited
The Commission reviewed justifications most commonly articulated to support critical vendor
payments. These include a debtor’s need to: (i) continue to receive a steady supply of goods and
services required for the operation of the debtor’s business; (ii) appease creditors who threaten to
discontinue supply or services without payment; (iii) obtain products from a single-source supplier;
(iv) comply with applicable state or other nonbankruptcy law that requires performance on a
contract and is not otherwise preempted by the Bankruptcy Code; and (v) make payments that may
be necessary for the survival of a key vendor.337 The Commissioners noted the danger of viewing
332 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
333 See, e.g., In re Just For Feet, Inc., 242 B.R. 821 (D. Del. 1999).
334 Courts continued to use the doctrine in connection with their authority under section 105 to authorize, among other things,
payments deemed necessary to the debtor’s reorganization efforts. See, e.g., In re Just For Feet, Inc., 242 B.R. 821, 826 (D. Del.
1999); In re NVR L.P., 147 B.R. 126, 128 (Bankr. E.D. Va. 1992); In re Eagle-Picher Indus., Inc., 124 B.R. 1021, 1023 (Bankr. S.D.
Ohio 1991); In re Ionosphere Clubs, Inc., 98 B.R. 174 (Bankr. S.D.N.Y. 1989).
335 For courts rejecting the use of section 105 and the doctrine of necessity to authorize the payment of prepetition claims, see, e.g.,
In re Kmart Corp., 359 F.3d 866 (7th Cir. 2004), cert. denied, 543 U.S. 986 (2004); Chiasson v. J. Louis Matherne & Assocs. (In re
Oxford Mgmt., Inc.), 4 F.3d 1329 (5th Cir. 1993); Official Comm. of Equity Sec. Holders v. Mabey, 832 F.2d 299 (4th Cir. 1987),
cert. denied, 485 U.S. 962 (1988); B&W Enters., Inc. v. Goodman Oil Co. (In re B&W Enters., Inc.), 713 F.2d 534 (9th Cir. 1983).
336 See Section V.E.1, Section 503(b)(9) and Reclamation.
337 See, e.g., J.M. Blanco, Inc. v. PMC Mktg. Corp., 2009 WL 5184458, at *2 (D.P.R. Dec. 22, 2009) (debtor offered evidence to support
that critical vendor supplied “merchandise [that] was critical and that no other vendor was available to offer the same inventory
under equal terms and conditions”); In re Tropical Sportswear Int’l Corp., 320 B.R. 15, 20 (Bankr. M.D. Fla. 2005) (“This Court
finds that the Debtors’ situation with its Critical Vendors is precisely the situation where critical vendor status is warranted. Each
of the four Critical Vendors is a major supplier of specialty goods or services to the Debtors, and any interruption in the flow
of their products to the Debtors would substantially jeopardize the Debtors’ ability to conduct business. As such, the Critical
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
these needs in isolation without considering the rights of other stakeholders and commonly applied
protections of the Bankruptcy Code, such as the automatic stay in section 362.
Although the Commissioners generally understood the potential hardship imposed on certain
vendors by the automatic stay and the nonpayment of prepetition claims, some of the Commissioners
observed that critical vendors are not substantively distinguishable from other prepetition creditors
and should therefore be similarly situated. These Commissioners warned against the dangers of
diluting various protections provided by the Bankruptcy Code that were originally intended to
allow a debtor to catch its financial breath, assess its financial and operational condition under the
protection of the automatic stay, and develop a plan that would treat all similarly situated creditors
alike.338 The increasing categories of priority claims have reduced the debtor’s discretionary cash
resources and made priority payments the rule rather than the limited exception they were intended
to be.
The Commission decided to recommend that the Bankruptcy Code specifically authorize the
payment of prepetition claims to vendors for goods and services in certain instances, provided that
such vendors are not eligible for administrative priority under section 503(b)(9). (As discussed in
the context of section 503(b)(9), the Commissioners found that the priority afforded to vendor
claims under section 503(b)(9) should provide sufficient protection and incentive for vendors to
continue doing business with the debtor in possession.) In reaching its conclusion, the Commission
6
recognized that certain vendors may in fact be indispensable to the debtor’s201
1, reorganization but
ber 2
ve without some compromise
not be eligible for section 503(b)(9) treatment and unable to performm
n No
ed o
rc iv
and payment of their prepetition claims. The Commissionhdetermined, however, that the standard
63 a
-353
should be stringent and require evidence to No. 14 why, for example, the debtor cannot obtain the
, establish
own
v. Br the state law obligation is not preempted by the Bankruptcy
particular services from another source,
eth
Blixs
Code, or the state lawitobligation is not otherwise deemed an impermissible disguised priority. The
ed in
c
Commission agreed that clarifying the court’s ability to authorize the payment of prepetition vendor
claims under the Bankruptcy Code would reduce uncertainty and litigation, as well as the related
costs, for the estate and creditors.
In the context of prepetition vendor claims for goods, the Commission considered instances in
which state law might prohibit a nondebtor party from providing goods to a debtor that has not paid
a vendor’s invoices. The Commissioners analyzed whether the Bankruptcy Code needed to provide
the court and the debtor in possession some flexibility in this context to preserve the business. In
so doing, the Commissioners discussed the federal preemption doctrine, which is rooted in the
Vendors are absolutely critical to the maintenance of the Debtors’ estates.”). See also Joseph Gilday, “Critical” Error: Why Essential
Vendor Payments Violate the Bankruptcy Code, 11 Am. Bankr. Inst. L. Rev. 411, 416 (2003) (“Debtor’s counsel usually claims
that losing such services or products would have, in the words of one, a ‘severely pernicious effect on [its] efforts to rehabilitate
and reorganize.’ The inability to operate its business as it normally does would decrease the debtor’s cash flow and cripple its
operations before it had a chance to propose a reorganization plan, according to its counsel.”) (citations omitted).
338 See Mason v. Official Comm. of Unsecured Creditors (In re FBI Distrib. Corp.), 330 F.3d 36, 41–42 (1st Cir. 2003) (“[T]he
fundamental principle of bankruptcy law [is] that the debtor’s limited resources are to be distributed equally among similarly
situated creditors [so] . . . statutory priorities are narrowly construed. . . .”); In re Mirant Corp., 296 B.R. 427, 429 (Bankr. N.D.
Tex. 2003) (“[T]his court has reservations about granting such relief [to critical vendors] when to do so could result in certain
favored unsecured creditors receiving treatment preferential to that received by other unsecured creditors under a plan.”); In
re Structurlite Plastics Corp., 86 B.R. 922, 932 (Bankr. S.D. Ohio 1988) (“[R]e-payment of pre-petition debt should not be
authorized as a result of threats or coercion by disgruntled creditors. Such activity violates the automatic stay imposed by 11
U.S.C. § 362(a) and, if tolerated, would negate the fundamental principle of equality of treatment among similarly situated
creditors.”).
IV. Proposed Recommendations: Commencing the Case
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10211115, DktEntry: 37-2, Page 97 of Chapter
Supremacy Clause of the U.S. Constitution,339 and its well-established application to override state
bankruptcy laws that interfere with federal bankruptcy law.340 The distributional requirements and
priority rules under Bankruptcy Code section 507 therefore preempt any contrary state laws that
seek to grant priority to certain claims.341 For example, Bankruptcy Code section 545 was enacted
specifically to preempt statutory liens that are not good against a bona fide purchaser under state
law.342 The Commissioners analyzed these concepts in trying to balance a debtor in possession’s
need to satisfy a nonbankruptcy law requirement that was not a disguised priority in order to
continue its business operations and the general restraints of the doctrine of necessity and federal
bankruptcy priorities. In striking this balance with respect to state laws applicable to vendor goods,
the Commission articulated a standard similar to that imposed by courts under section 545: courts
should not authorize payment of prepetition claims that become due upon the debtor’s insolvent
financial condition or the commencement of the debtor’s bankruptcy case, or have no legitimate
purpose outside the bankruptcy context.343
The Commission did not address or recommend codification of standards to allow the payment of other
prepetition claims that may be permissible under current bankruptcy law and the doctrine of necessity.
Rather, other than the two categories of claims specifically addressed in the recommended principles, the
Commission determined that such claims should continue to be governed by current law.
16
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ovem
n which shall
339 U.S. Const. art. VI, ¶ 2 (“This Constitution, and the laws of the United States N
and all
ed oStates, shall be be made in pursuance thereof;and the
treaties made, or which shall be made, under the authority of the hiv
the supreme law of the land;
arc United
judges in every state shall be bound thereby, anything4-3the 63
in 53 Constitution or laws of any State to the contrary notwithstanding.”).
1
340 Stellwagen v. Clum, 245 U.S. 605, 613 (1918) ,(“In .view of this grant of authority [over bankruptcy] to the Congress it has been
No
n
settled from an early date that state laws row extent that they conflict with the laws of Congress, enacted under its constitutional
. Bto the
eth v
authority, on the subject of lbankruptcies are suspended.”).
ixs
i B
341 “Under the SupremacynClause, U.S. Const. Art. VI, contrary provisions of state law must give way before the distributional
cited
requirements of the Bankruptcy Act [predecessor to the Bankruptcy Code].” In re Faber’s, Inc., 360 F. Supp. 946, 949 (D. Conn.
1973). See, e.g., Int’l Bhd. of Teamsters, AFL-CIO v. Kitty Hawk Int’l, Inc. (In re Kitty Hawk, Inc.), 255 B.R. 428, 439 (Bankr.
N.D. Tex. 2000) (“Although the nature of a creditor’s claim is determined under state law, the [Bankruptcy] Code establishes
the priorities of claims. . . . Where a state statute would alter the priority of claims in a bankruptcy case, the state statute is preempted by the Code.”) (holding that Michigan statute providing employees with a preference over other general unsecured
creditors is preempted by Bankruptcy Code sections 507 and 1113); In re Lull Corp., 162 B.R. 234, 240 (Bankr. D. Minn. 1993)
(“A state statute cannot reset bankruptcy priorities.”) (holding that Minnesota statute allowing workers’ compensation fund to
have the same priority accorded to employee wages is preempted by section 507).
342 Section 545 provides, in relevant part, that “[t]he trustee may avoid the fixing of a statutory lien on property of the debtor” under
certain conditions. 11 U.S.C. § 545. One bankruptcy court explained that the provisions from which section 545 derived were
“intended to prevent state laws which prioritized liens on the happening of insolvency from undercutting federal bankruptcy
laws.” Davis v. IRS, 22 B.R. 523, 525 (Bankr. W.D. Pa. 1981). For cases upholding state law provisions under section 545, see In
re Merchs. Grain, Inc., 93 F.3d 1347, 1358 (7th Cir. 1996), cert. denied, 519 U.S. 1111 (1997) (Ohio statute creating lien upon
delivery of grain is not avoidable under section 545); In re Anchorage Int’l Inn, Inc., 718 F.2d 1446, 1452 (9th Cir. 1983) (Alaska
statute requiring proceeds of sale of a liquor license to be used first to pay creditors holding debts related to the liquor licensed
business creates valid lien); In re Nicolls, 384 B.R. 113, 122 (Bankr. W.D. Pa. 2008) (Indiana statute creating hospital lien in
favor of patient with judgment against tortfeasor for injuries requiring medical case creates valid lien). For cases striking down
and refusing to enforce state law provisions, see Perez v. Campbell, 402 U.S. 637, 652 (1971) (Arizona statute that suspended
driving privileges unless, among other things, motorist subject to judgment posted security sufficient to satisfy judgment, even
if judgment claim was discharged in bankruptcy is invalid); In re Universal Trend, Inc., 114 B.R. 936, 938 (Bankr. N.D. Ohio
1990) (Ohio statute that establishes statutory trust in favor of employees is preempted by employees’ bankruptcy rights and thus
invalid, and does not prevent any such trust funds from being withheld as property of the estate).
343 One court explained that to withstand scrutiny, “the state law must attend to the realities and technicalities of the property rights
created, or else those rights will be dismissed as disguised priorities under the Bankruptcy Code.” In re Universal Trend, Inc., 114
B.R. 936, 938 (Bankr. N.D. Ohio 1990) (“The Bankruptcy Code often takes account of property rights which are determined by
state law, as for example, the perfection of security interests and exempt property of the Debtor. Nonetheless, the state law must
attend to the realities and technicalities of the property rights created, or else those rights will be dismissed as disguised priorities
under the Bankruptcy Code.”) (quoting In re Davis, 13 B.R. 456, 460 (Bankr. S.D. Ohio 1980)). “Statutory enactments may
operate to create trust funds in favor of certain specified persons. . . . However, such trusts must stand the tests of being termed
disguised priorities in violation of section 507 or statutory liens avoidable under section 545.” Id. at 940 (citations omitted). See
also In re Anchorage Int’l Inn, Inc., 718 F.2d 1446, 1450 n. 3 (9th Cir. 1983) (“[W]hen a state-created entitlement is enforceable
inside and outside bankruptcy, ‘there is no reason stemming from the justifications underlying condemnation of state-created
priorities . . . to refuse recognition of the entitlement’ in the bankruptcy situation.”) (citations omitted).
IV. Proposed Recommendations: Commencing the Case
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2. Wage and Benefits Priorities
Recommended Principles:
Section 507(a)(4) and (5) of the Bankruptcy Code should be combined to create a
single priority in an aggregate amount of $25,000 per employee, without an earnings
period limit, for the kinds of prepetition employee compensation and benefit plan
claims identified in the current section 507(a)(4) and (5). To the extent that the
aggregate limit is insufficient to meet all such obligations, the current prepetition
priority order — wages and other compensation as identified in section 507(a)(4),
followed by employee benefit plan contributions as described in section 507(a)(5) —
should continue to be observed in applying the combined, aggregate priority. As under
current law, the amount of this aggregate per-employee priority should be increased
based on the Consumer Price Index for All Urban Consumers under section 104(a).
In addition, section 549 should be amended to permit the trustee to pay prepetition
employee wages, other compensation, and benefit plan contributions up to the peremployee priority limit without requiring the filing of a motion or order of the court,
although the trustee should provide notice of such payments to be made. Authority
for payments in excess of the priority cap should continue to be requested by motion.
16
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Wage and Benefits Priorities: Background
, No
rown
B
h v.
xset
Employees are the heartdof many businesses. They make the debtor’s product, service its customers,
n Bli
i
cite
and innovate, manage, and generate value. Although some commentators view employees as
liabilities, in many industries, the success of a business often relates directly to the commitment and
efforts of its employees.
Employees, in turn, frequently depend on timely payments from their employers for their livelihood
and subsistence. As observed by one court: “The bankruptcy act, while primarily intended to secure
an equal distribution of the assets of the bankrupt among his creditors, evinces a strong intent on
the part of Congress to protect those who are dependent on their daily earnings for their support.”344
In this respect, employees arguably differ from other creditors who either may have other revenue
sources in addition to payments owed and made by the debtor, or may have a greater capacity to
perform diligence on the debtor to negotiate for stronger contractual protections and leverage.345
344 See In re Caldwell, 164 F. 515 (E.D. Ark. 1908).
345 See Lucian Arye Bebchuk & Jesse M. Fried, The Uneasy Case for the Priority of Secured Claims in Bankruptcy, 105 Yale L.J. 857,
885 (1996); Elizabeth Warren & Jay Lawrence Westbrook, Contracting Out of Bankruptcy: An Empirical Intervention, 118 Harv.
L. Rev. 1197, 1232 (2005). Professors Warren and Westbrook explain:
The substantial sophistication and the high transaction costs required to obtain the necessary information present
significant barriers. Moreover, the costs of moving from one employer to another can be quite onerous. . . . Similarly,
although most creditors have the option of spreading their risks by extending credit to several customers, this option
is not available to employees, who are unlikely to work for more than a single employer.
Id.
IV. Proposed Recommendations: Commencing the Case
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Priority treatment for wage claims under U.S. bankruptcy laws has a long history.346 Their priority
was clearly articulated in the short-lived 1841 Act, and was included and refined in the laws that
followed. Such priority was initially limited to certain kinds of employees, but more recent laws have
focused on limiting this priority based on (i) when the wages were earned and (ii) the amount of
wages earned.347
The Bankruptcy Code has continued this model in two sections: section 507(a)(4) provides a priority
for wages and other compensation up to $11,725 per employee earned by the employee during 180
days before the earlier of the petition date or the date of the cessation of the debtor’s business;
and section 507(a)(5) provides a priority for employer contributions to employee benefit plans for
services provided during 180 days before the earlier of the petition date or the date of the cessation
of the debtor’s business in an aggregate amount of $11,725, multiplied by the number of covered
employees less any amounts paid to such employees under section 507(a)(4).
Wage and Benefits Priorities: Recommendations and Findings
Congress added section 507(a)(5) to address a split in the case law about whether the “wage” priority
covered contributions to certain kinds of employee benefit plans.348 The language of section 507(a)
(5) clarified this point, but courts, debtors, and employees have continued to struggle with the
application of section 507(a)(4) and (5) priorities. Common issues include: (i) whether the section
16
1, 0
507(a)(5) priority imposes an aggregate or per-employee cap,349 andr (ii) 2
be 2 whether the mandatory
vem
n No
offset of the section 507(a)(4) “wage priority” against the section 507(a)(5) “benefit plan priority”
ed o
hiv
results in often inadequate protection for the 35363 arc The latter issue also causes calculation and
employee.
14
administrative issues for debtorsrown, Nperhaps more importantly, substantial hardship for many
and, o.
.B
eth v
employees.
Blixs
in
cited
The Commissioners articulated various ways to restructure the wage and employee benefits priorities.
As a conceptual matter, the Commission determined that one overall monetary cap covering both
wages and employee benefit plan contributions on a per-employee basis was consistent with the
historical development of these priorities and achieved a fair result. It also determined that the base
aggregate cap should be raised to $25,000 per employee, with that amount being applied first toward
wage claims and second toward employee benefit plan contributions, in the event that such cap is
insufficient to satisfy all covered claims.
Finally, the Commissioners discussed the common practice by debtors in possession350 of filing a
first-day motion requesting authority to pay employee wages and benefit plan contribution claims,
typically on the ground that such claims are entitled to priority treatment under section 507. Such
346 See Ex Parte Steiner, 22 F. Cas. 1234 (C.C.E.D. Pa. 1842) (No. 13,354) (interpreting wage priority under the 1841 Bankruptcy
Act).
347 For example, section 64(b) of the 1898 Bankruptcy Act provided fourth priority to “wages due to workmen, clerks, or servants
which have been earned within three months before the date of the commencement of proceedings, not to exceed three hundred
dollars to each claimant.” Bankruptcy Act of 1898, 30 Stat. 544, 563, c. 541 (Comp. St. § 9648).
348 See, e.g., Howard Delivery Serv., Inc. v. Zurich Am. Ins. Co., 547 U.S. 651, 658–60 (2006).
349 See In re Consol. Freightways Corp. of Del., 363 B.R. 110, 123 (Bankr. C.D. Cal. 2007), aff ’d in part, rev’d in part, 564 F.3d 1161
(9th Cir. 2009) (discussing different approaches to calculating the section 507(a)(5) priority cap).
350 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
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motions and the attendant responsive pleadings, hearings, and orders unnecessarily consume both
debtor and judicial resources and can delay the debtors’ normal payroll cycles, even though these
motions are often noncontroversial and ultimately granted by the court. Many courts, debtors,
and commentators recognize the value to the debtor of receiving uninterrupted service from its
employees. Accordingly, the Commission recommended that section 549 of the Bankruptcy Code
be amended to allow the debtor in possession to pay wage priority and benefit plan priority claims
up to the proposed per-employee priority cap, pursuant to section 507(a)(4) and (5) without an
order of the court, provided that the debtor files a notice of the amount of such proposed payments.
E. Financial Contracts, Derivatives
and Safe Harbor Provisions
The filing of a chapter 11 case typically effects an automatic stay of, among other things, all
prepetition collection efforts against the debtor, its property, and property of the estate.351 In addition,
counterparties to many prepetition executory contracts with the debtor cannot unilaterally terminate
their contracts or otherwise affect the debtor’s rights under such contracts, and the trustee may avoid
prepetition fraudulent and preferential transfers.352 The Bankruptcy Code, however,6exempts certain
1
1, 20
kinds of financial contracts from these and certain other bankruptcyvprovisions. These exemptions
ber 2
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No e
generally cover financial contracts qualifying as a securities hived on commodities contract, forward
contract,
arc
contract, repurchase agreement, swap agreement,-or 363
35 master netting agreement (collectively referred
o. 14
to as “qualified financial contracts”)..353rown, N
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The protections underte Bankruptcy Code for qualified financial contracts — commonly referred
to as “safe harbors” — find their origins in sections 362(b)(6) and 746(c) of the Bankruptcy Code,
which were both included in the 1978 version of the Bankruptcy Code to promote stability in the
commodities market.354 Congress built on this concept in 1982 by adding certain kinds of securities
contracts to the exemptions and enhancing the protections afforded to those contracts (it also
replaced section 746(c) with section 546(e)).355 Similar to the original legislation, Congress identified
market stability as the primary purpose underlying these amendments: “[C]ertain protections are
351 11 U.S.C. § 362(a).
352 Id. §§ 365, 547, 548.
353 Id. §§ 362(b)(27), 546(e)–(g), (j), 555, 556, 559, 560, 561, 562. Each of these terms is defined in section 101 or 741 of the
Bankruptcy Code. Id. §§ 101, 741. Steven L. Schwarcz, Derivatives and Collateral: Balancing Remedies and Systemic Risk, 2015
Ill. L. Rev.__, at *1–2 (forthcoming 2015) (“Bankruptcy law in the United States provides unique protections to creditors in
derivatives transactions. Unlike other creditors of a debtor, derivatives counterparties have special rights and immunities in the
bankruptcy process, including virtually unlimited enforcement rights against the debtor (the ‘safe harbor’). The safe harbor’s
articulated justification is that it is necessary to protect against systemic risk — the risk that an event will trigger a loss of
economic value or confidence in a substantial segment of the financial system that is serious enough to have significant adverse
effects on the real economy.”), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2419460.
354 S. Rep. No. 95-989, at 8 (1978), reprinted in 1978 U.S.C.C.A.N. 5787.
355 The legislative history provides, in relevant part:
The resulting discrimination in treatment [between commodities and securities] appears to have been inadvertent.
It plainly is not supportable on policy grounds. It is further the Commission’s view that the amendments now under
consideration present an effective solution to these problems by assuring equality of treatment as between the securities
and commodities industries.
Bankruptcy of Commodity and Securities Brokers: Hearings before the Subcomm. on Monopolies and Commercial Law of the H.
Comm. on the Judiciary, 97th Cong. 239 (1981) (testimony of Bevis Longstreth, Comm’r, Sec. & Exch. Comm’n).
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ABI Commission to Study the Reform of Chapter
necessary to prevent the insolvency of one commodity or securities firm from spreading to other
firms and [possibly] threatening the collapse of the affected market.”356
Congress further expanded the safe harbors in 1982, 1990, 1994, 2005, and 2006.357 Some
commentators argue that these amendments expanded the safe harbors well beyond their original
purpose and now impede a debtor’s reorganization efforts to the detriment of other stakeholders.358
The Commission considered the important role that the safe harbors play in financial markets
and carefully balanced the competing concerns throughout its deliberations. As described below,
the Commission recommended certain targeted amendments to the safe harbors that continue
protections for qualified financial contracts in appropriate circumstances, but reduce opportunities
for manipulation or abuse.
1. Scope of Section 546(e) Safe Harbors
Recommended Principles:
Section 546(e) of the Bankruptcy Code should be amended to remove protection
from avoidance actions for beneficial owners of privately issued securities in
connection with prepetition transactions using some or all of the debtor’s assets to
facilitate the transaction (e.g., leveraged buyouts).
16
1, 20
er 2
emb
Novfrom avoidance actions for
Section 546(e) should continue the existing protection
on
ived
arch conduits in both public and private
(i) securities industries participants3who act as
5363
. 14Nopublic securities holders.
securities transactions andn(ii)
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Sectionte546(e) and the parallel provisions of section 546 applicable to other
ci d
qualified financial contracts should continue to exclude from the safe harbors
transfers made with actual intent to hinder, delay, or defraud, and such transfers
should remain voidable under section 548(a)(1)(A).
The exclusion from the safe harbors for transfers made with actual intent to hinder,
delay, or defraud should also apply to transfers made with similar intent that are
356 H.R. Rep. No. 97-420, at 1 (1982), reprinted in 1982 U.S.C.C.A.N. 583, 583. For a review of the justifications for and impact of
the bankruptcy safe harbors, see Schwarcz, Derivatives and Collateral, supra note 353, at *4–5 (“The purpose of the safe harbor
is to help ensure that large derivatives dealers can enforce their remedies against a failed counterparty, thereby minimizing the
dealer’s losses and reducing its chances of collapse. There are however, at least three possible flaws in that logic. The first flaw
is that if a dealer itself is a defaulting counterparty, the safe harbor enables the dealer’s other counterparties to enforce their
remedies, thereby hastening the dealer’s collapse. This occurred, for example, in the case of [Lehman Brothers]. The second flaw
is that there is ‘little actual evidence to support’ the claim that the collapse of a dealer might systemically disrupt the derivatives
market. . . . [Lastly], the safe harbor itself appears to incentivize market concentration by enabling dealers and other parties to
virtually ignore counterparty risk. . . . For this reason, creditors ‘are not overly concerned with their debtor’s financial stability,
because they protect themselves with the debtor’s collateral, rather than with their understanding of the firm itself.’”).
357 For a review of the history of the safe harbors, see Charles W. Mooney, The Bankruptcy Code’s Safe Harbors for Settlement
Payments and Securities Contracts: When is Safe Too Safe?, 49 Tex. Int’l L.J. 243, 245–50 (2014); Stephen J. Lubben, Systemic Risk
& Chapter 11, 82 Temp. L. Rev. 433 (2009); Edward R. Morrison & Joerg Riegel, Financial Contracts and the New Bankruptcy
Code: Insulating Markets from Bankrupt Debtors and Bankruptcy Judges, 13 Am. Bankr. Inst. L. Rev. 641 (2006). See generally
Eleanor Heard Gilbrane, Testing the Bankruptcy Code Safe Harbors in the Current Financial Crisis, 18 Am. Bankr. Inst. L. Rev. 241
(2010) (discussing legislative history of safe harbor provisions and amendments thereto).
358 See, e.g., Stephen J. Lubben, Repeal the Safe Harbors, 18 Am. Bankr. Inst. L. Rev. 319 (2010); Frank Partnoy & David A. Skeel,
Jr., The Promise and Perils of Credit Derivatives, 75 U. Cin. L. Rev. 1019 (2007); Franklin R. Edwards & Edward R. Morrison,
Derivatives and the Bankruptcy Code: Why the Special Treatment?, 22 Yale J. on Reg. 91 (2005).
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voidable under applicable state fraudulent transfer or conveyance laws avoidable
by the trustee under section 544(b).
o For purposes of this principle, a publicly issued security should include
a security of a debtor or its affiliate that is registered under section 12 of
the Securities Exchange Act of 1934 (15 U.S.C. § 78l) or sold in reliance
on Rule 144A or Regulation S under the Securities Act of 1933 (15 U.S.C.
§ 77a et seq.).
Scope of Section 546(e) Safe Harbors: Background
Section 546(e) of the Bankruptcy Code protects certain types of transactions from avoidance by
the trustee359 under sections 544, 545, 547, 548(a)(1)(B) and 548(b). (These sections generally allow
the trustee to avoid, among other things, prepetition fraudulent or preferential transfers, as well
as unperfected securities interests, and to recover the value of those transfers for the benefit of the
estate.) Specifically, a trustee may not avoid a margin payment or settlement payment made by, to, or
for the benefit of a commodity broker, forward contract merchant, stockbroker, financial institution,
financial participant, or securities clearing agency. In addition, similar protection applies to transfers
made by, to, or for the benefit of any of these parties in connection with a securities contract.
16
1, 20
2
A “settlement payment” is defined in section 741(8) of the Bankruptcy rCode as a “preliminary
mbe
Nove
settlement payment, a partial settlement payment, an interimon
ived settlement payment, a settlement
arch
363
payment on account, a final settlement payment, 5 any other similar payment commonly used
-3 or
o. 14
360
n, N
in the securities trade.” Courts haverow
B interpreted the term to include many kinds of transactions
th v.
lixse legislative intent to insulate the securities transfer system from
arguably not within the original
in B
cited
fraudulent conveyance and preference action. For example, courts have protected transfers to the
beneficial holders of privately issued securities in leveraged buyouts that arguably have no impact
on the securities transfer system.361 Some commentators also question whether the provision should
protect the beneficial owners of publicly held securities or, rather, should be limited solely to securities
industries participants who act as conduits in both public and private securities transactions.362
359 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
360 11 U.S.C. § 741.
361 Courts originally limited application of section 546(e) in the fraudulent transfer context to conduits and the beneficial owners
of publicly held securities; they did not protect the beneficial owners of privately issued securities. See, e.g., Jewel Recovery, L.P.
v. Gordon, 196 B.R. 348, 353 (N.D. Tex. 1996); Kapila v. Espirito Santo Bank (In re Bankest Capital Corp.), 374 B.R. 333, 346
(Bankr. S.D. Fla. 2007); Official Comm. of Unsecured Creditors v. Lattman (In re Norstan Apparel Shops, Inc.), 367 B.R. 68,
77 (Bankr. E.D.N.Y. 2007). Nevertheless, the Third, Sixth, and Eighth Circuit Courts have held that beneficial owners of both
publicly and privately held securities are protected. See, e.g., Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009);
QSI Holdings, Inc. v. Alford (In re QSI Holdings, Inc.), 571 F.3d 545 (6th Cir. 2009), cert. denied, 558 U.S. 1148 (2010); Brandt v.
B.A. Capital Co. (In re Plassein Int’l Corp.), 590 F.3d 252 (3d Cir. 2009), cert. denied, 559 U.S. 1093 (2010).
362 For a discussion of related approaches to limiting the scope of section 546(e), see, e.g., Samir D. Parikh, Saving Fraudulent
Transfer Law, 86 Am. Bankr. L.J. 305, 344 n. 225 (2012) (“Another basis for narrowing the scope of section 546(e) has been
termed the ‘mere conduit’ argument. The argument was introduced by the Eleventh Circuit Court of Appeals in Munford v.
Valuation Research Corp. (In re Munford, Inc.), 98 F.3d 604 (11th Cir. 1996), cert. denied, 522 U.S. 1068 (1998). In Munford, the
settlement payments at issue were made to a recognized financial institution. But the court held that the financial institution ‘was
nothing more than an intermediary or conduit’ because it did not acquire a beneficial interest in the funds. The court reasoned
that since the financial institution ‘never acquired a beneficial interest in either the funds or the shares,’ it was not a ‘transferee’
as that term is used in the Bankruptcy Code, and section 546(e) was inapplicable. The argument has been roundly criticized,
and it is unclear if any other court has relied on this rationale in narrowing section 546(e)’s exemption. The deficiency in the
‘mere conduit’ argument is that section 546(e) in no way requires that the financial institution to which or from which payments
were made or received acquire a ‘beneficial interest’ in the funds. Financial institutions involved in securities transactions rarely
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ABI Commission to Study the Reform of Chapter
Scope of Section 546(e) Safe Harbors: Recommendations and Findings
As written and applied, the section 546(e) safe harbor has insulated settlement payments to the ultimate
beneficiaries of leveraged buyouts (“LBOs”) and similar transactions, even if the securities were privately
issued. Absent the safe harbors, these payments would be potentially voidable as fraudulent transfers.
This outcome appears anomalous in light of the policy underlying section 546(e): to insulate the securities
transfer system from fraudulent conveyance and preference actions.
The Commission reviewed the development of section 546(e) under both the Bankruptcy Code and
the case law. They noted the uncertainty in the courts’ interpretations of the term “settlement payment”
and suggested that similar issues may arise with respect to the term “transfers . . . in connection with
a securities contract,” which was added by the BAPCPA Amendments. The Commissioners discussed
how to balance the expectations of the financial markets with the need to protect the debtor’s estate and
other stakeholders from prepetition transfers that (i) do not affect secondary markets and (ii) constitute
preferences or fraudulent transfers under bankruptcy law or applicable state law.
The Commissioners evaluated the different types of transactions that may be protected by the section
546(e) safe harbor and noted the particular imbalance in LBOs involving privately issued securities.
As explained by the Honorable Christopher S. Sontchi of the U.S. Bankruptcy Court for the District of
Delaware during his testimony before the House Judiciary Committee’s Subcommittee on Regulatory
16
Reform, Commercial and Antitrust Law:
1, 20
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No harbor has insulated from
As written and applied, however, the section 546(e) nsafeve
do
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preference and fraudulent conveyance 5363 ar the
actions
3
. 14- in private transactions. The result has been to
settlement payments, including, insiders
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provide officers andedirectors
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ed to preference and fraudulent conveyance actions.363
true” defense
cit
In these instances, the Commissioners found it difficult to reconcile the protections that courts were
affording the beneficial owners of privately issued securities with the original purpose of the legislation.
The Commissioners were most troubled by situations involving prepetition transfers in connection with
an LBO that leaves the debtor with insufficient capital and that is attributable, at least in part, to bad faith
on the part of the debtor’s insiders. Absent the section 546(e) safe harbor that has been extended to LBO
transactions, the debtor in possession could challenge such a prepetition transfer as a fraudulent transfer364
and possibly avoid it for the benefit of the estate and other stakeholders harmed by the depletion in the
debtor’s value. Nevertheless, section 546(e) prevents the debtor in possession from bringing fraudulent
transfer claims, even against insiders of the debtor, unless the transfer was made within two years before
bankruptcy and with actual intent to hinder, delay, or defraud creditors.
In balancing the competing considerations in the LBO context, the Commissioners discussed the need
to continue to protect securities industries participants that act as conduits in prepetition transfers. The
acquire a beneficial interest in the funds that they handle. The ‘mere conduit’ argument is an outlier in the debate regarding
section 546(e).” Id. at 609–10 (citations omitted).
363 Exploring Chapter 11 Reform: Corporate and Financial Institution Insolvencies; Treatment of Derivatives, Hearing Before the H.
Subcomm. on Regulatory Reform, Commercial and Antitrust Law, 113th Cong. 12 (2014) (statement of the Honorable Christopher
S. Sontchi, U.S. Bankruptcy Judge for the District of Delaware).
364 A fraudulent transfer generally involves a transfer of a company’s assets for less than reasonably equivalent value at a time that
the debtor is insolvent or is rendered insolvent by the transfer (a “constructively fraudulent transfer”).
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Commissioners noted that the beneficial owner of the privately issued securities should be deemed the
initial transferee for purposes of fraudulent transfer law, and that conduits should not be affected by any
limited change to section 546(e) in this respect. The Commission agreed, however, that conduits should
be expressly covered by section 546(e) to avoid any uncertainty that might implicate the financial markets.
The Commission likewise considered the merits of limiting section 546(e) solely to securities industries
participants that act as conduits, but ultimately it determined that allowing fraudulent transfer claims
against the beneficial owners of publicly issued securities would have the potential to affect the securities
transfer system — a considerable difference from privately issued securities transfers. The Commissioners
explored whether they could strike a reasonable compromise by limiting the protections of the section
546(e) safe harbor to beneficial holders of publicly issued securities that received the transfers in good
faith. The Commission generally agreed that the good faith standard could align with the objectives of
both the safe harbor and fraudulent transfer law, but it acknowledged the difficulty in administering and
litigating such a standard. Some of the Commissioners strongly believed that application of the good faith
standard and the attendant challenges posed by distinguishing good faith transactions from bad faith
transactions could create substantial uncertainty in the markets. Accordingly, the Commission voted to
maintain the safe harbor protections for publicly issued securities, without any good faith qualification.
Another issue that arises with respect to the section 546(e) safe harbor is whether its protections are
limited to fraudulent transfer actions under section 548 of the Bankruptcy Code or whether they also
16
extend to such actions under state law that are avoidable by the trustee under ,section 544(b) of the
1 20
ber 2
Bankruptcy Code or avoidable by a litigation trust or individual creditors em confirmation of a chapter
Nov after
d on
chive purports to limit the trustee’s ability
11 plan. The courts are split on this issue. Even though6therstatute
3a
353
. 14to bring avoidance actions, some courts have o
, N extended the protection to preclude state law causes of
own
365
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actions. Other courts have heldth
e that “there is no statutory text making section 546(e) applicable to
Blixs
claims brought on behalf of individual creditors, or displacing their state law rights, by plain meaning
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cit
analysis or otherwise.”366 The Commission evaluated each of these positions and discussed the practical
consequences of allowing state law actions to proceed while precluding federal causes of action brought
by the trustee on behalf of the estate. Ultimately, the Commission concluded that the exclusion from
the safe harbors for transfers made with actual intent to hinder, delay, or defraud should apply whether
the action is brought under federal or state law. Thus, the trustee will be able to avoid an actual intent
fraudulent transfer whether brought under section 544(b) or 548. The Commission was not able to reach
a consensus on extending the protections of the section 546(e) safe harbor to actions outside a federal
bankruptcy case.
Notably, the Commission’s recommended principles on section 546(e) concentrate largely on prepetition
transactions in which some or all of the debtor’s assets are being used to facilitate the transaction
(e.g., LBOs). Except as otherwise specifically discussed in this Report, the Commission does not
recommend reducing the coverage of section 546(e) for securities purchases and sales, securities
options, securities loans, margin loans, and other transfers and transactions that are currently
protected by section 546(e).
365 See Whyte v. Barclays Bank PLC, 494 B.R. 196 (S.D.N.Y. 2013).
366 Weisfelner v. Fund 1 (In re Lyondell Chem. Co.), 503 B.R. 348 (Bankr. S.D.N.Y. 2014). See also In re Tribune Co. Fraudulent
Conveyance Litig., 499 B.R. 310 (S.D.N.Y. 2013).
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ABI Commission to Study the Reform of Chapter
2. Treatment of Repurchase Agreements
Under Safe Harbors
Recommended Principles:
The safe harbor for repurchase agreements should be narrowed as a means to foster
financial stability, reduce interconnectedness, and exclude disguised financing
arrangements.
o As a preferred option, the safe harbors for repurchase agreements should be
limited to the kinds of agreements included in the pre-BAPCPA definitions
of “repurchase agreement” in section 101(47) and “securities contract” in
section 741(7) of the Bankruptcy Code.
o Alternatively, at a minimum, the safe harbors for repurchase agreements
should be amended to exclude repurchase agreements that are, in
essence, committed financing arrangements for mortgage loan portfolios.
Specifically, the definitions of “repurchase agreement” in section 101(47)
and “securities contract” in section 741(7) should be amended to exclude
repurchase agreement facilities that have the economic attributes of
traditional mortgage warehouse facilities, which typically are more akin
to committed secured financing arrangements than, 2016 repurchase
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Background
Sections 555 and 559 of the Bankruptcy Code allow certain parties, including financial institutions
and financial participants, to liquidate, terminate, or accelerate a securities contract or repurchase
agreement without relief from the automatic stay of section 362 or concern for the prohibition
on enforcement of ipso facto clauses in section 365(e) of the Bankruptcy Code.367 In addition,
the automatic stay generally does not apply to setoffs and the exercise of other remedies by the
nondebtor party under a repurchase agreement.368 Section 559 was added to the Bankruptcy Code
in 1984 to treat repurchase agreements the same as commodities and securities contracts under the
safe harbors, in large part to protect the financing of the national debt.369
367 11 U.S.C. §§ 555, 559.
368 Id. § 362(b)(7).
369 See 5 Collier on Bankruptcy ¶ 559.LH (“The effective functioning of the repo market can only be assured if repo investors will be
protected against open-ended market loss arising from the insolvency of a dealer or other counterparty in the repo market. The
repo market is as complex as it is crucial. It is built upon transactions that are highly interrelated. A collapse of one institution
involved in repo transactions could start a chain reaction, putting at risk hundreds of billions of dollars and threatening the
solvency of many additional institutions. Since the repo market is important to the health of the country’s financial system, it
is desirable that the Code be interpreted and implemented in a manner which protects that market without creating an unfair
result for debtors. . . . The proposed amendments will take an important first step toward meeting the full objective of Public
Law 97-222 by expressly providing that similar protections apply to the crucial portions of the repo market involving U.S.
Government and agency obligations, certificates of deposit, and eligible bankers’ acceptances. The structure of the proposed
amendments is based upon the addition to the Code of new definitions of ‘repo participant’ and ‘repurchase agreement’ and the
making of conforming changes in relevant provisions of the Code. The proposed amendments are intended to afford participants
in the repo market the same treatment with respect to the stay and avoidance provisions of the Code that Public Law 97-222
explicitly provided stockbrokers, securities clearing agencies, commodity brokers and forward contract merchants in connection
with securities contracts, commodity contracts and forward contracts.”) (citations omitted).
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In 2005, pursuant to the BAPCPA Amendments, Congress amended the scope of sections 555 and
559 by expanding the definitions of “securities contracts” and “repurchase agreements” and adding
“financial participants” to the list of protected parties under these sections.370 Specifically, Congress
added mortgage loans and any interests in mortgage loans, including repurchase transactions, to
the definition of securities contracts in section 741(7) of the Bankruptcy Code.371 Similarly, it added
mortgage-related securities, mortgage loans, and interests in mortgage-related securities or mortgage
loans, to the definition of repurchase agreements in section 101(47) of the Bankruptcy Code.372 It
also defined financial participant as “an entity with at least $1 billion in notional or principal amount
outstanding or $100 million in mark-to-market securities contracts, commodities contracts, swap
agreements, repurchase agreements, or forward contracts, with the debtor at the time of filing or on
any day during the fifteen-month period preceding filing.”373
Some commentators have questioned whether the expanded definitions of securities contracts
and repurchase agreements further the underlying policies of the safe harbors.374 For example, a
committed mortgage loan repurchase agreement facility can function similarly to a conventional
secured mortgage warehouse facility, but arguably qualify for protections under the safe harbors.
In a typical mortgage warehouse transaction, the loan originator obtains short-term financing
from a lender through a credit facility or similar arrangement secured by a pledge of mortgages
or other assets owned by the originator (often to provide short-term financing until the mortgages
can be deposited into a securitization pool). The originator can transfer or sell the mortgages or
16
assets and would typically use any proceeds to pay down the facility with ber 2lender.375 Such secured
the 1, 20
vem
transactions do not, however, present the same contagion or marketorisks posed by true repurchase
nN
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iv
agreements and arguably fall outside the scope of the 63 arch
safe harbors.
53
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Moreover, commentators robustlyh v. B the ongoing utility of safe harbors for repurchase agreements
t debate
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in B
covering mortgage loansdand nonagency mortgage-backed securities. Some commentators argue that
cite
mortgage loan repurchase agreements should no longer be protected by the safe harbors.376 These
commentators have called for excluding mortgage interests and mortgage-related transactions from
the definitions of repurchase agreements and securities agreements. They assert, among other things,
that mortgages are illiquid assets and therefore fall outside the justification for safe harbor protection
(i.e., “preservation of the liquidity of investments”).377 Others support maintaining broad protection for
repurchase agreements, including mortgage repurchase agreements, based on the interconnectedness
of the markets and the increasing importance of repurchase agreements in both domestic and global
370
371
372
373
374
See id.
11 U.S.C. § 741(7).
Id § 101(47).
Id § 101(22A). See also Mooney, supra note 357, at 249.
See, e.g., Calyon N.Y. Branch v. Am. Home Mortg. Corp. (In re Am. Home Mortg., Inc.), 379 B.R. 503 (Bankr. D. Del. 2008). See
also Mooney, supra note 357, at 251–52.
375 These secured transactions are to be contrasted with repurchase agreements, which typically involve two agreements: first, the
originator sells its mortgages or other assets to the lender in exchange for funds; second, the originator agrees to repurchase the
mortgages or other assets for the original price plus a premium at a date certain (usually one year after the original sale).
376 See, e.g., Edward R. Morrison et al., Rolling Bank the Repo Safe Harbors, 69 Bus. Law. 1015, 1019 (2014) (proposing to “scal[e]
back the repo safe harbor to approximately the 1984 scope for ‘repurchase agreements’, namely, safe harboring only repos on
U.S. Treasury and Agency securities backed by the government’s full faith and credit, certificates of deposits, and bankers
acceptances”).
377 Exploring Chapter 11 Reform: Corporate and Financial Institution Insolvencies; Treatment of Derivatives, Hearing Before the H.
Subcomm. on Regulatory Reform, Commercial and Antitrust Law, 113th Cong. 9 (2014) (statement of the Honorable Christopher
S. Sontchi, U.S. Bankruptcy Judge for the District of Delaware). Judge Sontchi also explained: “The current safe harbors for
repurchase agreements allow for ‘runs’ on financial institutions such as American Home Mortgage by counterparties/lenders
which are not subject to the automatic stay and, thus, are free to terminate repos and other financial contracts en masse.” Id. at
10.
IV. Proposed Recommendations: Commencing the Case
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ABI Commission to Study the Reform of Chapter
investment portfolios.378 With respect to repurchase agreements specifically, these supporters believe
that the protections afforded to such contracts by the safe harbors reduce the cost of credit and support
domestic real estate markets.379 These supporters also suggest that any restrictions on investment in
mortgage loans by financial institutions are best implemented through carefully considered prudential
regulation rather than through the “blunt instrument” of a change to the Bankruptcy Code’s safe
harbors. Both sides rely on anecdotal evidence to support their respective positions.
Treatment of Repurchase Agreements Under Safe Harbors: Recommendations
and Findings
Repurchase agreements as financial instruments provide liquidity and flexibility to market
participants. They also represent a large component of the financial markets.380 The Commissioners
recognized the important role that repurchase agreements play in the markets, particularly
those initiated on an overnight or short-term basis. Some of the Commissioners agreed with
those commentators who distinguish mortgage loan repurchase agreements from other kinds of
repurchase agreements structured around more liquid assets such as U.S. government and agency
securities. The ability to liquidate the transferred assets immediately upon a default is a central
and important feature of traditional repurchase agreements.
The Commissioners discussed the advantages and disadvantages of providing safe harbor protections
016
to mortgage loan repurchase agreements and recognized the challenges r 21, 2
beto reducing these protections.
em
Some of the Commissioners believed that the risks posed on Nov
by removing mortgage loan repurchase
ed
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agreements from the safe harbors were significantly outweighed by the potential benefits. These
63 a
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Commissioners were persuaded by n, No.
the arguments that inclusion of these repurchase agreements
row
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encouraged runs on debtorthoriginators and accelerated (rather than reduced) contagion.381 The
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i
cite
Commission voteddto scale back the safe harbors for repurchase agreements to the pre-BAPCPA
definitions of repurchase agreement and securities contract.382
378 See Steven L. Schwarcz & Ori Sharon, The Bankruptcy-Law Safe Harbor for Derivatives: A Path-Dependence Analysis, 71 Wash. &
Lee L. Rev. 1715 (2014).
379 See, e.g., Exploring Chapter 11 Reform: Corporate and Financial Institution Insolvencies; Treatment of Derivatives, Hearing Before
the H. Subcomm. on Regulatory Reform, Commercial and Antitrust Law, 113th Cong. 35 (2014) (statement of Seth Grosshandler,
Partner at Cleary, Gottlieb, Steen & Hamilton LLP) (“In particular, the safe harbor for repurchase agreements on residential
mortgage-backed securities and whole loan mortgages serves to reduce the cost of mortgage financing to homeowners.”).
380 Data as of June 2014 suggest that the value of outstanding repurchase agreements in the United States is approximately $4
trillion. See Elizabeth Holmquist & Josh Gallin, Repurchase Agreements in Financial Accounts of the United States, June 30,
2014, available at http://www.federalreserve.gov/econresdata/notes/feds-notes/2014/repurchase-agreements-in-the-financialaccounts-of-the-united-states-20140630.html.
381 See Morrison, et al., Rolling Back the Repo Safe Harbors, supra note 376, at 1017 (discussing safe harbors for repurchase agreements
and observing that “there is little evidence that they serve this purpose”). “Instead, considerable evidence shows that, when they
matter most — in a financial crisis — the safe harbors exacerbate the crisis, weaken critical financial institutions, destabilize
financial markets, and then prove costly to the real economy.” Id. For a general discussion of these issues, see Schwarcz, Derivatives
and Collateral, supra note 353, at *4–5 (“The purpose of the safe harbor is to help ensure that large derivatives dealers can enforce
their remedies against a failed counterparty, thereby minimizing the dealer’s losses and reducing its chances of collapse. There
are however, at least three possible flaws in that logic. The first flaw is that if a dealer itself is a defaulting counterparty, the safe
harbor enables the dealer’s other counterparties to enforce their remedies, thereby hastening the dealer’s collapse. This occurred,
for example, in the case of [Lehman Brothers]. The second flaw is that there is ‘little actual evidence to support’ the claim that
the collapse of a dealer might systemically disrupt the derivatives market. . . . [Lastly], the safe harbor itself appears to incentivize
market concentration by enabling dealers and other parties to virtually ignore counterparty risk. . . . For this reason, creditors
‘are not overly concerned with their debtor’s financial stability, because they protect themselves with the debtor’s collateral, rather
than with their understanding of the firm itself.’ “).
382 Between 1994 and 2006, the Bankruptcy Code had defined “securities contract” as follows:
“securities contract” means contract for the purchase, sale, or loan of a security, including an option for the purchase
or sale of a security, certificate of deposit, or group or index of securities (including any interest therein or based on
the value thereof), or any option entered into on a national securities exchange relating to foreign currencies, or the
guarantee of any settlement of cash or securities by or to a securities clearing agency; . . . .
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Other Commissioners observed that markets are increasingly global and interconnected, and they
found value in maintaining the same level of protection for all true repurchase agreements. Some
of these Commissioners, however, also agreed that the safe harbors should not protect disguised
mortgage warehouse arrangements. The Commissioners explored removing transactions that
facilitate short-term financing through a pledge of the assets, rather than a true sale. In the course
of these discussions, the Commissioners discussed specifically excluding committed mortgage loan
repurchase agreement facilities that function as mortgage warehouse facilities from the definitions
of repurchase agreements and securities contracts and the safe harbors under the Bankruptcy Code.
The Commission voted in favor of this exclusion, subject to its preference for a more extensive
reduction in the safe harbors for repurchase agreements, as described in the preceding paragraph.
3. Assumption of Financial Contracts
Recommended Principles:
Under current law, several aspects of the safe harbors make it difficult for a trustee
to exercise the traditional power under section 365 of the Bankruptcy Code to
assume a derivative or other financial contract. For example, counterparties’ ability
to enforce ipso facto clauses and terminate contracts protected by the safe harbors
often make assumption of a derivative or other financial contract2016
impossible.
r 21,
e to
Moreover, the safe harbors arguably allow counterparties mberemove valuable
ov
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assets from the estate, such as when the debtor his ed the money on the contract
c iv in
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3536
in question, especially if damages paid-upon termination do not compensate the
. 14
, No
own
estate fully for loss of the. contract. Nevertheless, these challenges for the trustee
v Br
seth
need to be ited in Blix against the volatile and systemic nature of the financial
balanced
c
markets and the need to mitigate contagion in the larger economy.
On balance and considering the proposed revisions to the safe harbors regarding
the treatment of ordinary supply contracts, repurchase agreements, and walkaway
clauses under these principles, the Commission does not believe further amendments
to the safe harbors with respect to a trustee’s ability to assume derivative and other
financial contracts are necessary or advisable. In addition, the Commission is aware
of ongoing efforts to provide financially distressed systemically important financial
institutions (or their subsidiaries that are parties to such contracts) with some
ability to transfer derivative and other financial contracts in certain circumstances
in the event that such institutions become debtors under the Bankruptcy Code. The
Commission has decided to take no action with respect to such institutions.
11 U.S.C. § 741(7) (effective Oct. 22, 1994 to Dec. 11, 2006). Between 2000 and 2004, the Bankruptcy Code had defined
“repurchase agreement” as follows:
“repurchase agreement” (which definition also applies to a reverse repurchase agreement) means an agreement,
including related terms, which provides for the transfer of certificates of deposit, eligible bankers’ acceptances, or
securities that are direct obligations of, or that are fully guaranteed as to principal and interest by, the United States or
any agency of the United States against the transfer of funds by the transferee of such certificates of deposit, eligible
bankers’ acceptances, or securities with a simultaneous agreement by such transferee to transfer to the transferor
thereof certificates of deposit, eligible bankers’ acceptances, or securities as described above, at a date certain not later
than one year after such transfers or on demand, against the transfer of funds; . . . .
11 U.S.C. § 101 (effective Dec. 21, 2000 to Oct. 24, 2004).
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ABI Commission to Study the Reform of Chapter
Assumption of Financial Contracts: Background
One consequence of the safe harbors is that counterparties can liquidate and close out qualified
financial contracts with the debtor in possession, even if the debtor in possession’s383 positions under
those contracts are in the money or the debtor in possession may be able to continue to perform or
assign the contracts.384 As explained above, counterparties to qualified financial contracts generally
are not subject to the automatic stay under section 362 and the prohibition on ipso facto clauses
under section 365(e). These exceptions almost always preclude a debtor in possession’s ability to
assume or assign qualified financial contracts because the contracts are terminated, liquidated, or
accelerated on the debtor in possession’s petition date or shortly thereafter.385
Some commentators have argued against this result and in favor of a short stay that would allow
the debtor in possession some ability to assume or assign some or all of its qualified financial
contracts.386 This approach would be similar to that provided for systemically important financial
institutions under the Orderly Liquidation Authority (“OLA”), Title II of the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010.387 Under OLA, counterparties are enjoined
for one business day from terminating, liquidating, or accelerating their positions under qualified
financial contracts.388 Likewise, under different pieces of legislation proposed in Congress to address
systemically important financial institutions under federal bankruptcy law, counterparties would be
subject to a 48-hour stay before they could exercise any of their rights.389 Under OLA, the receiver is
16
given a brief opportunity to assign the bank’s qualified financial contracts (likely to a bridge or similar
1, 20
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vem
institution) to facilitate its resolution, provided that certain conditions are satisfied. In the case of the
n No
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proposed Financial Institutions Bankruptcy Act,63 ardebtor (a systemically important bank holding
the chiv
-353 the stock of its subsidiaries to a special trust under
14
company) is given a brief opportunity,tootransfer
N .
rownestate is the beneficial owner of such trust.390
.B
certain conditions, when thehdebtor’s
et v
ixs
in Bl
cited
Assumption of Financial Contracts: Recommendations and Findings
The Commission considered the potential utility of incorporating a short stay imposed on
counterparties before they would be able to exercise their rights under qualified financial contracts
against a debtor in possession upon the filing of its chapter 11 case. The Commissioners noted
that this kind of short-term stay would primarily benefit the debtor in possession by allowing it
to potentially (i) assume certain contracts when the debtor in possession is in the money or could
continue to perform or (ii) assign such contracts to another entity. Although in theory both options
383 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
384 See, e.g., Stephen J. Lubben, The Bankruptcy Code Without Safe Harbors, 84 Am. Bankr. L.J. 123, 129 (2010).
385 For a critique of the Bankruptcy Code’s treatment of qualified financial contracts in this respect, see Stephen Lubben, Derivatives
and Bankruptcy: The Flawed Case for Special Treatment, 12 Univ. Penn. J. Bus. L. 61, 65–75 (2019).
386 Written Statement of Professor David Skeel: NYCBC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
2–3 (May 15, 2013) (suggesting a three-day stay), available at Commission website, supra note 55; Written Statement of Edward
Murray: NYCBC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 4 (May 15, 2013) (stating that a short
stay may be useful and that both the FDIC regime for U.S. banks and the Dodd-Frank Orderly Liquidation Regime both allow a
short stay), available at Commission website, supra note 55.
387 12 U.S.C. § 5390(c)(10)(B).
388 Id.
389 See Taxpayer Protection and Responsible Resolution Act of 2014, S.1861, 113th Cong. § 1407 (2014) (adopting a proposal
commonly referred to as “chapter 14”); Financial Institution Bankruptcy Act of 2014, H. 5421, 113th Cong. § 1187 (2014)
(adopting a proposal commonly referred to as “subchapter V”).
390 OLA is discussed further in Section IX.D, SIFIs and Single Point of Entry Schemes.
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are appealing and hold potential value for the estate, the Commissioners questioned the ability of a
debtor in possession to review its qualified financial contracts in such a meaningful and expeditious
manner early in the chapter 11 case. They also raised concerns about structuring and funding a
transaction early in the case in which the debtor in possession could effectively assign and transfer
its qualified financial contracts. Many of the Commissioners also believed that, given the market
stability and the systemic issues relating to these contracts, the debtor in possession would need to
provide some type of adequate assurance to counterparties during the short-term stay, or otherwise
compensate counterparties for any loss in value that they suffered while they were enjoined from
exercising their rights under the contracts.
Given these challenges, the Commissioners reexamined the concerns commonly expressed by
parties in the safe harbor context in connection with the termination, liquidation, or acceleration
of qualified financial contracts. These concerns often involve an estate losing the value of the
debtor in possession’s position under a contract that is in the money or involve perceived abuses
or unwarranted expansion of the safe harbor protections to transactions not directly related to the
securities transfer system. The Commission agreed that its recommended principles addressing
ordinary supply contracts, repurchase agreements, and walkaway clauses adequately addressed its
primary concerns about the safe harbors. On balance, imposing a stay of the safe harbor protections
would not enhance the debtor’s rehabilitation efforts. The Commission also acknowledged that the
balancing of these issues may be different for systemically important financial institutions, but it
16
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noted pending legislative proposals on this topic.
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ived
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. Bro
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4. Section 562 and “Commercially Reasonable
Determinants of Value”
in
cited
Recommended Principles:
Section 562(b) should define “commercially reasonable determinants of value” as
determinants of value specified in the contract that are not manifestly unreasonable
or, in the absence of such determinants of value, commercially reasonable market
prices.
Section 562 and “Commercially Reasonable Determinants of Value”:
Background
Section 562 of the Bankruptcy Code addresses the “timing of damage measurement” when a qualified
financial contract is rejected by a trustee391 or liquidated, terminated, or accelerated by a nondebtor
counterparty.392 As a general rule, section 562(a) provides that damages should be measured as of
the earlier of the date when the trustee rejects the qualified financial contract or the date when the
nondebtor counterparty liquidates, terminates, or accelerates the qualified financial contract. If no
391 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
392 11 U.S.C. § 562.
IV. Proposed Recommendations: Commencing the Case
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ABI Commission to Study the Reform of Chapter
commercially reasonable determinants of value exist on that date, however, section 562(b) provides
that damages should be measured as soon as commercially reasonable determinants of value are
available.393 Accordingly, the meaning of the term “commercially reasonable determinants of value”
may play a central role in measuring damages under qualified financial contracts.
Two issues commonly arise under section 562(b) and the application of the commercially reasonable
determinants of value standard. First, there may be many commercially reasonable determinants of
value, and what is “commercially reasonable” may depend on the surrounding circumstances. The
court in American Home Mortgage Holdings, Inc. addressed this precise issue: the debtor suggested
that the assets could be valued using a discounted cash flow analysis on one date (showing assets
were worth more than the repurchase price) and the counterparty argued that the assets could not
be valued until a later date when an actual price was available for the assets (showing assets were
worth less than the repurchase price).394 The district and appellate courts in American Home agreed
with the debtor’s analysis. The Commissioners questioned this result and noted that “commercially
reasonable” is used in Article 9 of the Uniform Commercial Code in the context of sales procedures
that are customary for the relevant market.
Second, section 562 does not address the methodology to be used in calculating damages. Specifically,
it is uncertain whether parties must adhere to a valuation methodology established by their contract
or if they may use an alternative methodology provided that it is commercially reasonable under
6
the circumstances. The importance of this decision becomes more acute 1, commercially reasonable
if 201
ber 2
v m
determinants of value for purposes of the methodology requiredeby the contract do not exist on a
n No
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particular date, but the assets could be valued as363that date under another commercially reasonable
of archiv
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o. 14
methodology.
n, N
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Brow
cite
Section 562 and “Commercially Reasonable Determinants of Value”:
Recommendations and Findings
The Commission focused on two goals relating to section 562 of the Bankruptcy Code: providing
certainty and preserving the expectations of the parties to prepetition contracts to the extent that
they would not directly conflict with bankruptcy law or policy. The Commissioners reflected on the
issues presented by the American Home Mortgage case and whether courts would potentially benefit
from a determination about which type of valuation methodology should be used to calculate
damages. Given the relevant policies of promoting market stability and respecting prepetition
bargains whenever possible, the Commission determined that the contract terms should govern
damages calculations in the first instance, unless those terms are manifestly unreasonable. The
Commission used the “manifestly unreasonable” standard because precedent for that term in this
context exists under Section 9-603 of the Uniform Commercial Code.
393 The legislative history of section 562 provides:
The party determining damages is given limited discretion to determine the dates as of which damages are to be
measured. Its actions are circumscribed unless there are no “commercially reasonable” determinants of value for it to
measure damages on the date or dates of either rejection or liquidation, termination or acceleration. The references
to “commercially reasonable” are intended to reflect existing state law standards relating to a creditor’s actions in
determining damages.
H.R. Rep. 109-31(I), H.R. Rep. No. 31(I) (2005), reprinted in 2005 U.S.C.C.A.N. 88.
394 In re Am. Home Mortg. Holdings, Inc., 411 B.R. 181 (Bankr. D. Del. 2009), aff ’d, 637 F.3d 246 (3d Cir. 2011).
IV. Proposed Recommendations: Commencing the Case
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Bankruptcy Institute
In addition, the Commission found value in specifying an appropriate methodology in the event
that the contract is silent about damages calculation, or the contract provides a methodology that
is determined to be manifestly unreasonable. The Commissioners discussed different alternatives,
but ultimately agreed that the assets should be valued on the earliest date (after the triggering
event) on which market prices are available. The Commissioners believed that specifying the role
of the parties’ contract, as well as the use of market prices when a contract fails, for purposes of
“commercially reasonable determinants of value” will facilitate more efficient damages calculations
under section 562.
5. Walkaway Clauses
Recommended Principles:
The Bankruptcy Code should be amended to (i) include a definition of “walkaway
clauses” substantially similar to the corresponding definitions in the Federal Deposit
Insurance Act and Orderly Liquidation Authority and (ii) render unenforceable
walkaway clauses in securities contracts, forward contracts, commodity contracts,
repurchase agreements, swap agreements, and master netting agreements (i.e.,
qualified financial contracts).
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Walkaway Clauses: Background
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In general, the terms “one-way payment,” N
rown “limited two-way payment,” and “walkaway” refer to
B
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provisions in qualified financial tcontracts that, upon termination, liquidation or acceleration of a
n Bli
i
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particular transaction by the nondefaulting party, based on a default by the counterparty, eliminate
the benefit of the contract to the defaulting counterparty even if the contract is in the money for that
counterparty. The Bankruptcy Code does not specifically address walkaway clauses, other than in the
context of repurchase agreements under section 559.395 Yet, these provisions can significantly impact
the estate’s rights under qualified financial contracts if the debtor is deemed to be the defaulting party
at the time of the rejection, termination, liquidation, or acceleration of the contract. For example,
pursuant to a walkaway clause, a defaulting party is generally not entitled to any payments that are
otherwise owed to it under the qualified financial contract (for example, if the debtor’s position is
in the money at the time of the triggering event). Alternatively, the defaulting party may only be
permitted to use its right to any payments to offset amounts it owes to the nondefaulting party.
Notably, other laws specifically prohibit the enforcement of walkaway clauses. The Federal Deposit
Insurance Act includes provisions that make walkaway clauses in qualified financial contracts of
depository institutions that are in default unenforceable.396 The Orderly Liquidation Authority, which
is a resolution regime that could apply to systemically important financial institutions, also renders
395 Section 559 of the Bankruptcy Code provides that, when a repo participant or financial participant liquidates one or more
repurchase agreements with the debtor under which the repo participant or the financial participant agreed to deliver assets
to the debtor, the repo participant or financial participant must pay to the debtor any excess value over the repurchase price
that such liquidation yields, less any expenses in connection with the liquidation sale. See 11 U.S.C. § 559. Section 559 applies
regardless of whether or not a repurchase agreement provides the debtor with payment rights.
396 12 U.S.C. § 1821(e)(8)(G)(i).
IV. Proposed Recommendations: Commencing the Case
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ABI Commission to Study the Reform of Chapter
walkaway clauses unenforceable.397 In addition, the Insurer Receivership Model Act, which is a model
insurer insolvency act promulgated by the National Conference of Insurer Commissioners, renders
walkaway clauses unenforceable in qualified financial contracts against an insurer undergoing
insolvency proceedings that is deemed to be the defaulting party.398
Walkaway Clauses: Recommendations and Findings
The Bankruptcy Code’s silence on walkaway clauses, other than in the section 559 context, creates
ambiguity around their enforcement. The Commissioners discussed the cost of this uncertainty,
both in terms of ex ante bargaining and ex post litigation. Courts are required to interpret walkaway
clauses in qualified financial contracts in chapter 11 cases with little guidance and, presumably, in
reliance on state law.399 This approach could produce results that are not only inconsistent with other
chapter 11 cases, but also conflict with other federal and state laws. Accordingly, the Commission
voted to preclude the enforcement of walkaway clauses in qualified financial contracts in chapter 11
cases.
6. Exclusion of “Ordinary Supply Contracts”
from Safe Harbors
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The Bankruptcy Code should be amendedrch prevent nondealer counterparties to
63 a to
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physical supply contractswn, No.benefiting from the safe harbor protections.
from 1
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Recommended Principles:
Exclusion of “Ordinary Supply Contracts” from Safe Harbors: Background
As noted above, the safe harbors provide significant protections for counterparties to qualified
financial contracts that otherwise are not available to creditors and contract parties under the
Bankruptcy Code. These protections provide exceptions to several generally applicable bankruptcy
rules and are focused on protecting the securities transfer system and the commodity hedging system
and promoting market stability. Accordingly, the contracts included within the scope of “qualified
financial contracts” are important from the perspectives of both the estate and counterparties.
Generally speaking, qualified financial contracts include commodity contracts, forward contracts,
securities contracts, repurchase agreements, and swap agreements, as well as related master netting
agreements, as those terms are defined in the Bankruptcy Code. These definitions are worded fairly
broadly. For example:
397 Id. § 5390(c)(8)(F)(i). OLA and systemically important financial institutions are discussed in greater detail in Section IX.D, SIFIs
and Single Point of Entry Schemes.
398 Model Insurer Receivership Act § 711.
399 See Drexel Burnham Lambert Prod. Corp. v. Midland Bank PLC, 1992 U.S. Dist. LEXIS 21223 (S.D.N.Y. Nov. 10, 1992) (applying
New York law to render walkaway clause unenforceable).
IV. Proposed Recommendations: Commencing the Case
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The term “forward contract” is defined as including “a contract (other than a commodity
contract, as defined in section 761) for the purchase, sale, or transfer of a commodity, as
defined in section 761(8) of this title, or any similar good, article, service, right, or interest
which is presently or in the future becomes the subject of dealing in the forward contract
trade, or product or byproduct thereof, with a maturity date more than two days after the
date the contract is entered into, including, but not limited to, a repurchase or reverse
repurchase transaction (whether or not such repurchase or reverse repurchase transaction
is a ‘repurchase agreement’, as defined in this section) consignment, lease, swap, hedge
transaction, deposit, loan, option, allocated transaction, unallocated transaction, or any
other similar agreement.”400
The term “commodities contract” means, among other things, “with respect to a futures
commission merchant, contract for the purchase or sale of a commodity for future delivery
on, or subject to the rules of, a contract market or board of trade.”401
The term “swap contract” includes, “a commodity index or a commodity swap, option,
future, or forward agreement.”402
Consequently, parties have argued and some courts have held that ordinary supply agreements
constitute protected qualified financial contracts under the Bankruptcy Code safe harbors.403 As the
Fifth Circuit explained, courts must “apply the statutory provisions as Congress wrote them,” and it
6
found no grounds for excluding the electricity requirements contract from 21, 2Bankruptcy Code’s
the 01
ber
ovem
definition of forward contracts.404
on N
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5
Although many long-term supply contracts o. 14-3
have some hedging component to them, some courts
n, N
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and commentators have questionedBwhether the objectives of the safe harbors are best served
th v.
lixse
by including ordinaryted in B agreements within those protections. As explained by the court in
ci supply
National Gas Distributors:
Congress determined that there are legitimate reasons for creating, in the financial
markets, these special exceptions to the overall protections and policies of the Code.
The court understands that if contracts traded on a financial market are unraveled,
the market itself could become unstable and a domino effect could occur. There is
nothing to suggest that the contract between Smithfield and the debtor was traded
on a financial market, so in this case only the debtor’s estate and Smithfield would
be affected by a recovery. There is no reason to disturb the established ability of the
trustee to avoid the alleged fraudulent transfers at issue in this case.
The consequences of including agreements such as the one before the court within
the definition of swap agreement would be far-reaching. . . . These exceptions to
the trustee’s avoidance powers were intended to avoid the greater danger of market
disruption and instability in the financial markets due to the domino effect likely as
400
401
402
403
11 U.S.C. § 101(25).
Id. § 761(4).
Id. § 101(53B).
See, e.g., Lightfoot v. MXEnergy Elec., Inc. (In re MBS Mgmt. Servs., Inc.), 690 F.3d 352 (5th Cir. 2012); (5th Cir. Aug. 2, 2012)
(characterizing electric requirements contracts as forward contracts under the Bankruptcy Code); In re Nat’l Gas Distribs., LLC,
556 F.3d 247 (4th Cir. 2009) (finding that natural gas supply contract could constitute a commodities forward contract and, as
such, a swap agreement under the Bankruptcy Code).
404 Lightfoot v. MXEnergy Elec., Inc. (In re MBS Mgmt. Servs., Inc.), 690 F.3d 352 (5th Cir. 2012).
IV. Proposed Recommendations: Commencing the Case
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ABI Commission to Study the Reform of Chapter
a result of some types of transfer avoidance. Congress certainly did not intend by the
amendment to create a new, equally disruptive ripple effect within the administration
of bankruptcy estates. The court must take into consideration the effect its decision
will have on the overall scheme of the Bankruptcy Code. If this agreement is a swap
agreement, then many of the most important aspects of the Code, including priorities
of distributions to creditors and the automatic stay, will be eviscerated in even the
smallest case of a farmer who contracts to sell his hogs at the end of the month for a
set price. No public purpose would be served, and the result would be wholly at odds
with the established aims and order of bankruptcy proceedings. . . .405
Exclusion of “Ordinary Supply Contracts” from Safe Harbors:
Recommendations and Findings
The Commissioners discussed the potential inclusion of ordinary supply contracts in the Bankruptcy
Code safe harbors. The safe harbors were designed to promote liquidity and stability in financial
markets. Market liquidity and stability are not furthered in a meaningful way when ordinary supply
agreements are safe harbored. Although distinguishing “ordinary” supply agreements from bona
fide financial contracts is difficult, the Commission found value in considering (i) whether the
contract involved dealers, market makers, or other parties; and (ii) whether the contract called for
the physical supply of goods used, traded, or produced by the debtor in the ordinary course of
16
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The Commissioners analyzed the courts’ interpretation of the terms “forward contracts” and “swap
63 a
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agreements” under the BankruptcyoCode. They acknowledged how an ordinary supply contract could
, No
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B
be construed or drafted lito eth v. the technical requirements of these definitions. The larger issue,
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however, for thecCommission was whether these terms should include ordinary supply contracts.
The legislative history of the safe harbors clearly establishes a desire to protect the securities transfer
system and promote market stability. Although the Commissioners could hypothesize scenarios
in which subjecting the nondebtor party to an ordinary supply contract to the Bankruptcy Code’s
automatic stay and other provisions could possibly affect others in the market, the Commissioners
found those scenarios highly unlikely and, even if possible, very limited in scope. Most ordinary
supply contracts are bilateral agreements that impact only the rights of the parties bound by the
contract. The Commissioners acknowledged the hardship that may be imposed on the nondebtor
party by the chapter 11 filing, but they did not find such hardship significantly different from that
experienced by most of the debtor’s stakeholders.
In discussing the scope of qualified financial contracts, several Commissioners noted the need
to critically analyze any exceptions to, or priorities created by, the Bankruptcy Code.406 These
405 In re Nat’l Gas Distribs., LLC, 369 B.R. 884, 899–900 (Bankr. E.D.N.C. 2007), rev’d on other grounds, 556 F.3d 247 (4th Cir. 2009)
(citations omitted).
406 See, e.g., Howard Delivery Service, Inc. v. Zurich Am. Ins. Co., 547 U.S. 651, 667 (2006) (noting that the Court was “guided in
reaching [its] decision by the equal distribution objective underlying the Bankruptcy Code, and the corollary principle that
provisions allowing preferences must be tightly construed.”); Trustees of Amalgamated Ins. Fund v. McFarlin’s, Inc., 789 F.2d
98, 100 (2d Cir. 1986) (“Because the presumption in bankruptcy cases is that the debtor’s limited resources will be equally
distributed among his creditors, statutory priorities are narrowly construed.”). See also Written Statement of Daniel Kamensky
on behalf of Managed Funds Association: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 17,
2012) (“These changes reflect a pervasive trend away from the fundamental concept of equality for similarly situated creditors
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Commissioners reiterated the importance of the policies underlying the Bankruptcy Code, including
a breathing period for the debtor, a level playing field among the debtor and its stakeholders, and
fair treatment of all similarly situated creditors, in facilitating a successful reorganization.407 For
example, if all or a substantial majority of a debtor’s contracts could be terminated by the nondebtor
parties, or most creditors were entitled to priority payments or protected from avoidance actions,
the utility of chapter 11 would be significantly reduced, if not eliminated.
The Commission voted to exclude ordinary supply agreements from the safe harbors. In reaching
this conclusion, the Commissioners emphasized that the exclusion from the safe harbors should be
limited to nondealer counterparties’ physical supply contracts, including contracts for the supply of
natural gas and electricity.
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in bankruptcy and, in the aggregate, make it harder for a company to reorganize. As such, MFA urges the Commission to take
a fresh look at the existing categories of preferred creditors, and to strongly oppose any proposals that would create additional
priority categories or other preferential treatment for particular creditor groups.”).
407 Numerous courts have held that “it is the clear policy of the Bankruptcy Code to provide the debtor with breathing space
following the filing of a bankruptcy petition, continuing until the confirmation of a plan, in which to assume or reject an
executory contract.” In re Adelphia Commc’ns Corp., 291 B.R. 283, 292 (Bankr. S.D.N.Y. 2003) (citations omitted). See also
Theatre Holding Corp. v. Mauro, 681 F.2d 102, 105–06 (2d Cir. 1982); In re Enron Corp., 279 B.R. 695, 702 n.8 (Bankr. S.D.N.Y.
2002); In re Teligent, Inc., 268 B.R. 723, 738 (Bankr. S.D.N.Y. 2001); In re Beker Indus. Corp., 64 B.R. 890, 897 (Bankr. S.D.N.Y.
1986). But see In re Enron Corp., 279 B.R. 695, 702 (Bankr. S.D.N.Y. 2002) (noting that “the breathing space afforded to the
debtor for the assumption or rejection of executory contract is not without limits.”).
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V. PROPOSED
RECOMMENDATIONS:
ADMINISTERING THE CASE
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A. Executory Contracts and Leases
Section 365 of the Bankruptcy Code generally allows a debtor in possession to assume, assign, or
reject executory contracts and unexpired leases in the chapter 11 case.408 The debtor in possession
typically makes this determination based on a variety of factors, including whether the contract
or lease is above or below market, necessary to its ongoing business operations, and subject to
assumption under the Bankruptcy Code. It also may consult with the unsecured creditors’ committee
on these issues or attempt to renegotiate the contract or lease with the nondebtor party. A debtor in
possession’s decision to assume, assign, or reject an executory contract or unexpired lease is subject
to court approval, certain deadlines, and several other requirements detailed in section 365.409
1. Definition of Executory Contract
Recommended Principles:
The Bankruptcy Code should define the term “executory contract” for purposes
of section 365 as “a contract under which the obligation of both the bankrupt
and the other party to the contract are so far unperformed that the failure of
either to complete performance would constitute a material breach16
excusing
1, 20
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the performance of the other,” provided that forbearancevshould
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performance. Vern Countryman, Executory Contracts
rchiv
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Minn. L. Rev. 439, 460 (1973). Theocontours of this definition are well developed
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under the case law and vreflect ,an appropriate balance between the rights of a
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trustee to assumeBorsreject contracts unilaterally under the Bankruptcy Code and
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the nondebtor’s obligations and rights in those circumstances.
Definition of Executory Contract: Background
Section 365(a) provides that a debtor in possession,410 “subject to the court’s approval, may assume
or reject any executory contract or unexpired lease of the debtor.”411 The Bankruptcy Code does
not define “executory contract,” and the legislative history of section 365 provides little guidance.412
Accordingly, the court on a case-by-case basis determines whether a particular contract is executory.
Courts traditionally have used what is commonly referred to as the “Countryman” definition of
executory contracts.413 This test was developed by Professor Vern Countryman and defines an
408 11 U.S.C. § 365.
409 See, e.g., id. § 365(b) (requirements for assumption); id. § 365(c) (contracts not subject to assumption or assignment); id. § 365(f)
(requirements for assignments).
410 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
411 11 U.S.C. § 365(a).
412 H.R. Rep. No. 95-595, at 347 (1977) (“Though there is no precise definition of what contracts are executory, it generally includes
contracts on which performance remains due to some extent on both sides.”).
413 See In re Baird, 567 F.3d 1207, 1211 (10th Cir. 2009); In re Columbia Gas Sys., Inc., 50 F.3d 233, 239 (3d Cir. 1995); In re Streets
& Beard Farm P’ship, 882 F.2d 233, 235 (7th Cir. 1989); Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043,
1045 (4th Cir. 1985); In re Select-A-Seat Corp., 625 F.2d 290, 292 (9th Cir. 1980).
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executory contract for bankruptcy purposes as “a contract under which the obligation of both the
bankrupt and the other party to the contract are so far unperformed that the failure of either to
complete performance would constitute a material breach excusing the performance of the other.”414
Although widely used, courts have recognized limitations and potential inconsistencies in the
application of the Countryman test.415 In addition, the test may not be a good fit for certain kinds of
contracts.416
Given the noted flaws in the Countryman test, courts have developed alternative approaches to
assess executoriness. For example, some courts use the “functional approach” to evaluate a debtor
in possession’s request to assume or reject an executory contract. Under this approach, developed
by Professor Jay Westbrook, there is no threshold standard of “executoriness” that the debtor in
possession must meet to assume or reject the contract.417 Rather, the functional approach focuses on
whether assumption or rejection would create a benefit for the bankruptcy estate and its creditors.
The functional approach recognizes that courts often manipulate the threshold requirement of
executoriness in order to produce the desired outcome.418 Several courts have adopted the functional
approach or used it in connection with the Countryman test.419
Another alternative approach is commonly referred to as the “exclusionary approach.” This approach
is a deviation from the Countryman test and was developed by Michael Andrew.420 The following
are the primary differences between the Countryman test and the exclusionary approach: (i) the
6
concept of executoriness is irrelevant in the rejection context;421 ander 21,a 01
(ii) 2 contract is executory if
b
each party has unperformed obligations, and if the debtor’s Novem
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414 Vern Countryman, Executoryseth
lix Contracts in Bankruptcy: Part I, 57 Minn. L. Rev. 439, 460 (1973).
415 See, e.g., In re Gen.ted inCorp., 84 F.3d 1364, 1374 (11th Cir. 1996); In re RoomStore Inc., 473 B.R. 107, 111–12 (Bankr. E.D. Va.
Dev. B
ci
2012).
416 Some courts have struggled with the application of the Countryman definition in the context of the following kinds of agreements:
options and rights of first refusal; restrictive covenants (covenants not to compete; restrictive covenants on land); oil and gas
agreements (e.g., the oil and gas leases themselves and variations thereof, like farmout agreements;, and related agreements,
like surface use agreements and joint operating agreements); licenses, distributor agreements, and trademark agreements;
warranties; rights of first refusal; employment contracts; and severance agreements; arbitration clauses; forum selection clauses;
distributor agreements; trademark agreements; and indemnity clauses; and settlement agreements. See, e.g., Water Ski Mania
Estates Homeowners Ass’n v. Hayes (In re Hayes), 2008 Bankr. LEXIS 4668, at *31–32 (B.A.P. 9th Cir. Mar. 31, 2008) (“[A]
lthough restrictive covenants contain the characteristics of both a contract and an interest in land, the primary nature of such
covenants is preservation of a land interest, not future duties in contract. Although there will almost always be some incidental
continuing obligations under a restrictive covenant, those duties were not the kind of obligations Congress intended to impact
in enacting § 365.”) (citation omitted); Frontier Energy, LLC v. Aurora Energy, Ltd. (In re Aurora Oil & Gas Corp.), 439 B.R.
674, 680 (Bankr. W.D. Mich. 2010) (“The court’s conclusion that the [oil and gas leases] qualify as ‘leases’ within the meaning
of Section 365 makes it unnecessary to consider whether the [oil and gas leases] meet either the functional test or Countryman
definition for executory contracts. Given the confusion in the case law, it is also improvident to opine on the question.”) (citations
omitted); In re Bergt, 241 B.R. 17, 29–31 (Bankr. D. Alaska 1999) (discussing the application of the Countryman test in recent
case law to options); Bronner v. Chenoweth-Massie, P’ship (In re Nat’l Fin. Realty Trust), 226 B.R. 586, 589 (Bankr. W.D. Ky.
1998) (“The contingent nature of the obligations arising from an option agreement make them quite distinguishable from the
typical contract. This distinction has puzzled many courts, resulting in two distinct lines of cases. The first line of cases, while
recognizing the contingent nature of the obligations arising under option agreements, and while also expressly acknowledging
that they are unilateral contracts until exercised, have nevertheless engaged in what could be described as analytical gymnasts
to arrive at a finding that they are nonetheless executory contracts.”) (citations omitted); Cohen v. Drexel Burnham Lambert
Grp., Inc. (In re Drexel Burnham Lambert Grp., Inc.), 138 B.R. 687, 699 (Bankr. S.D.N.Y. 1992) (“Our readings persuade us that
in each case, use of the Countryman test was neither necessary nor determinative. It was, rather, merely window dressing for
results determined in the first instance by resort to another, sometimes unspecified criterion.”) (analyzing case law regarding
application of Countryman test to employment agreements). See also infra note 424.
417 Jay L. Westbrook, A Functional Analysis of Executory Contracts, 74 Minn. L. Rev. 227, 282–85 (1989).
418 Id. at 287.
419 See, e.g., Route 21 Assoc. of Belleville, Inc., v. MHC, Inc., 486 B.R. 75 (S.D.N.Y. 2012); In re Majestic Capital, Ltd., 463 B.R. 289,
300 (Bankr. S.D.N.Y. 2012).
420 Michael T. Andrew, Executory Contracts in Bankruptcy: Understanding “Rejection,” 59 U. Colo. L. Rev. 845 (1988); Michael T.
Andrew, Executory Contracts Revisited: A Reply to Professor Westbrook, 62 U. Colo. L. Rev. 1 (1991).
421 Andrew, Executory Contracts in Bankruptcy, supra note 420, at 894.
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to the other party’s performance.422 Although courts have not adopted this approach, they have
considered its factors in applying other tests.423
Definition of Executory Contract: Recommendations and Findings
The Commission conducted an in-depth review of the literature and case law on executoriness under
the Bankruptcy Code. Some of the Commissioners noted their experience with litigation concerning
the executoriness issue and the attendant uncertainty and expense. The focus of the executoriness
inquiry is whether each party has significant unperformed obligations under the contract.424 The
Commissioners discussed examples of contracts when this issue may be of particular concern,
such as options, covenants not to compete, and oil and gas leases.425 Although executoriness is not
necessarily a bright-line determination, the Commissioners generally agreed that courts resolve this
issue fairly or parties are able to negotiate a resolution.
The Commission also considered the possibility of eliminating the concept of executoriness from
the Bankruptcy Code. Both the advisory committee and the 1997 NBRC endorsed this position.426
The Commissioners debated at length the potential utility to this approach. They discussed the
meaningful benefits to refocusing contract disputes on the merits of the proposed assumption or
rejection rather than extensive litigation on executoriness. The Commissioners supporting this
approach emphasized the value to such a clean solution: with the distraction of executoriness off
16
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Further deliberations about the elimination No. 1
, proposal revealed, however, the potential of unintended
rown
consequences of such a dramaticth v. B in a fundamental bankruptcy principle. The Commissioners
ixse shift
in Bl
edorigins of the executoriness requirement of section 365,427 and they also
noted the common law
cit
422 Id. at 893.
423 See, e.g., In re Family Snacks, Inc., 257 B.R. 884, 905 (B.A.P. 8th Cir. 2001).
424 The Seventh Circuit Court of Appeals explained:
The Bankruptcy Code’s legislative history states that the term “executory contract” “generally includes contracts
on which performance is due to some extent on both sides.’ A common definition, which this court has cited with
approval, states that a contract is executory for bankruptcy purposes where “the obligation of both the bankrupt and
the other party to the contract are so far unperformed that the failure to complete performance would be a material
breach excusing the performance of the other.”
In re Crippin, 877 F.2d 594, 596 (7th Cir. 1989). See also Counties Contracting & Constr. Co. v. Constitution Life Ins. Co., 855
F.2d 1054, 1060 (3d Cir. 1988) (“The [Bankruptcy] Code does not define the term executory contract, however, courts have
generally employed what has become known as the ‘Countryman’ definition of an executory contract, i.e., a contract under
which the obligations of both the bankrupt and the other party remain so far unperformed that failure of either to complete
performance would constitute a material breach excusing performance of the other.”) (citation omitted).
425 See, e.g., COR Route 5 Co., LLC v. Penn Traffic Co. (In re Penn Traffic Co.), 524 F.3d 373, 380 (2d Cir. 2008) (“While some
courts have held that options contracts under which the optionee fully paid its price for the option to buy property before the
debtor filed for bankruptcy are not executory (because no performance is due from the optionor unless the option is exercised),
. . . others treat such contracts as executory.”) (citing conflicting case law) (citations omitted); Powell v. Anadarko E&P Co.,
L.P. (In re Powell), 482 B.R. 873, 877–78 (Bankr. M.D. Pa. 2012) (“Some courts have assumed that an oil and gas lease is an
executory contract. Other courts have considered an oil and gas lease a transfer of an interest in real property and therefore
not an executory contract.”) (citing conflicting case law) (citations omitted); In re Teligent, Inc., 268 B.R. 723, 730–31 (Bankr.
S.D.N.Y. 2001) (“As a rule, Delaware law treats the covenant not to compete and the reciprocal promise to pay as material. As a
result, the failure to make payment will discharge the obligation not to compete. . . . Where the covenant is given in connection
with the sale of a business, it is even more likely to be deemed material. A covenant not to compete is often included in a contract
to sell a business to protect the purchaser and allow him to enjoy the built-up good will.”).
426 See NBRC Report, supra note 37, at 21 (“Title 11 should be amended to delete all references to ‘executory’ in section 365 and
related provisions, and ‘executoriness’ should be eliminated as a prerequisite to the trustee’s election to assume or breach a
contract.”).
427 See In re Austin Dev. Co., 19 F.3d 1077, 1081 (5th Cir. 1994) (“Section 365 derives from § 70(b) of the former Bankruptcy Act,
a provision that broadly codified the common law doctrine that allowed the trustee either to assume and perform the debtor’s
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perceived value in maintaining some type of gating feature to vet those contracts that a debtor
in possession could assume, assign, or reject in the chapter 11 case. Thus, the elimination of the
executoriness concept could simply shift, rather than reduce, the amount of litigation or uncertainty
in the first instance under section 365. Moreover, many Commissioners believed that the assumption
or rejection decision was largely irrelevant to contracts that have already been fully performed by at
least one of the parties.
The Commissioners also discussed the functional approach to determining executoriness, but most
perceived the test to be unfair toward counterparties and too heavily weighted in favor of the interests
of the debtor and the estate. The Commissioners acknowledged the potential value of allowing a
debtor in possession to assume or reject any contract that would provide a benefit to the estate. As
with the elimination proposal, however, the Commissioners were concerned about diminishing the
rights of the nondebtor counterparties under the contracts. Subjecting any contract to section 365
primarily, if not solely, for the benefit of the estate imposed a greater burden on nondebtor parties
than necessary to achieve a fair result for the estate in a chapter 11 case.
On balance, the Commission voted to adopt the Countryman test and to recommend its express
incorporation into the Bankruptcy Code. The Commission found that, although imperfect, the
Countryman test strikes an appropriate balance between the rights of debtors in possession and
nondebtor counterparties to a contract. If the parties have material unperformed obligations, it is
16
fair and reasonable to allow a debtor to choose to assume, assign, or reject,such an agreement under
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section 365. The Commission also determined that many ofothe ovem
N potentially challenging issues under
d n
chive that this case law is a valuable resource
the Countryman test have been resolved by the363 ar and
courts
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2. General Rights of Private Parties to Executory
Contracts and Unexpired Leases
Recommended Principles:
A nondebtor party to an executory contract or unexpired lease with the debtor
should be required to continue to perform under such contract or lease after the
petition date, provided that the trustee needs such continued performance and
pays for any products or services delivered after the petition date on a timely
basis as required by the contract or lease. In paying for such products or services,
however, the trustee should not be subject to any modifications or rate changes
in the contract or lease triggered by the debtor’s bankruptcy filing, insolvency, or
prepetition default.
Except as provided in section 365(d)(3) of the Bankruptcy Code (and the
principles for that section, see Section V.A.6, Real Property Leases) and in section
365(d)(5) of the Bankruptcy Code, the trustee does not otherwise have an
leases or executory contracts or to ‘reject’ them if they were economically burdensome to the estate.”).
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obligation to perform, or to cure any defaults, under such contract or lease prior
to the assumption of that contract or lease under section 365(a). The nondebtor
party should be permitted to compel the trustee to perform other postpetition
obligations under the contract or lease if the court determines, after notice and
a hearing, that the harm to the nondebtor party resulting from the trustee’s
nonperformance significantly outweighs the benefit to the estate derived from
such nonperformance. The court should limit the trustee’s performance obligation
to that which is necessary to mitigate the harm to the nondebtor party pending
assumption or rejection. The nondebtor party should bear the burden of proof in
any such hearing.
The trustee should not be required to cure nonmonetary defaults that occur
prior to the assumption of the executory contract or unexpired lease and that are
impossible for the debtor to cure at the time of the proposed assumption under
section 365(a) and (b).
These principles governing the rights of parties to executory contracts and
unexpired leases are intended to apply only to contracts and leases between
private parties and should not affect the debtor’s contracts or leases with any state
or federal governments.
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Leases: Background
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In most chapter 11 cases,i the
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or reject executory contracts and unexpired leases on, or even shortly after, the petition date. As
such, there is a gap period between the petition date and the treatment decision under section 365.
The Bankruptcy Code requires the debtor in possession to perform timely obligations arising under
nonresidential real property leases, certain personal property leases,429 and intellectual property
licenses,430 but does not otherwise address performance during the gap period.431 In light of this
silence, “most courts agree that before an executory contract is assumed or rejected under § 365(a),
that contract continues to exist, enforceable by the debtor in possession, but not enforceable against
the debtor in possession.”432
428 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
429 11 U.S.C. § 365(d)(5). This provision for personal property leases applies only in chapter 11 cases. Id. If the case is initially
filed under chapter 11 and later converted to chapter 7, section 365(d)(5) will no longer apply. 3 Collier on Bankruptcy ¶
365.04[2][c].
430 11 U.S.C. § 365(n).
431 Id. § 365(d)(3). The court “may extend, for cause, the time for performance of any such obligation that arises within 60 days after
the date of the order for relief, but the time for performance shall not be extended beyond such 60-day period.” Id.
432 See, e.g., In re Nat’l Steel Corp., 316 B.R. 287, 305 (Bankr. N.D. Ill. 2004) (collecting cases). See also Howard C. Buschman
III, Benefits and Burdens: Postpetition Performance of Unassumed Executory Contracts, 5 Bankr. Dev. J. 341, 343 (1988) (citing
Douglas Bordewieck & Vern Countryman, The Rejection of Collective Bargaining Agreements by Chapter 11 Debtors, 57 Am.
Bankr. L.J. 239, 332 (1983)); 2 Collier on Bankruptcy ¶ 365.03, 365-28, 365-29 (15th ed. 1988); 8 Collier on Bankruptcy ¶ 3.15(6)
at 204 (14th ed. 1978).
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Courts generally justify this one-sided performance requirement by emphasizing the importance
of the breathing spell created by the automatic stay for the debtor in possession,433 and the severe
consequences that may result from a rushed or premature decision to assume, assign, or reject
an executory contract or unexpired lease.434 They also acknowledge the burden such one-sided
performance may impose on the nondebtor party, but on balance find in favor of the estate. The
nondebtor party may seek to compel performance or a treatment decision by the debtor in possession
under section 365, and it frequently requests an administrative claim under section 503(b)(3) for
any postpetition obligations that the debtor in possession fails to perform.435
Once a debtor in possession decides to assume an executory contract or unexpired lease, section
365(b) requires the debtor in possession to cure or provide adequate assurance of a prompt cure of
any defaults under the contract or lease. Section 365(b)(1) indicates that nonmonetary defaults that
are impossible to cure under unexpired leases for nonresidential real property do not require cure,
“except that if such default arises from a failure to operate in accordance with a nonresidential real
property lease, then such default shall be cured by performance at and after the time of assumption in
accordance with such lease, and pecuniary losses resulting from such default shall be compensated in
accordance with the provisions of this paragraph.”436 Section 365(b)(2) further provides that a debtor
in possession’s general cure obligations under section 365(b)(1) do not apply to “the satisfaction of
any penalty rate or penalty provision relating to a default arising from any failure by the debtor to
perform nonmonetary obligations under the executory contract or unexpired lease.”437 Some courts
6
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have interpreted section 365 to preclude the assumption of executorybcontracts and unexpired leases
er 21
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(other than real property leases) if non-curable historicalon Nove
nonmonetary defaults exist under the
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cite
General
Leases: Recommendations and Findings
Contracts and Unexpired
The chapter 11 filing can have significant negative implications for a nondebtor party’s business.
Accordingly, the Commission carefully scrutinized the postpetition needs of a debtor in possession
with respect to executory contracts and unexpired leases. The Commissioners discussed the
importance of a reliable, steady supply of goods and services used in the debtor’s business to the
debtor in possession’s reorganization efforts. They also acknowledged that nondebtor parties
frequently threaten to stop providing goods or services unless the debtor in possession satisfies
certain conditions. Although the Commissioners understood the nondebtor party’s desire for more
433 See, e.g., In re Cont’l Energy Assocs. Ltd. P’ship, 178 B.R. 405, 408 (Bankr. M.D. Pa. 1995) (“Not only does this saddle an ailing
company with an additional burden which it is unlikely to overcome, it pressures the Debtor to surrender the ‘breathing space’
normally allowed to it to consider the assumption or rejection of the contract.”).
434 11 U.S.C. § 365(g)(2). Post-assumption rejection is treated as a breach at the time of rejection (i.e., postpetition). Id. Where a
contract or lease is assumed in a chapter 11 case that is later converted to a chapter 7 and then the contract or lease is rejected
in the chapter 7 case, the rejection would be treated as having occurred immediately before the date of conversion. 1 Collier
Handbook for Trustees & Debtors in Possession ¶ 14.07 (2012).
435 11 U.S.C. § 503(b). The extent of the nondebtor party’s administrative claim, however, may be limited by the court under the
“benefit to the estate” standard of section 503(b). See Mason v. Official Comm. of Unsecured Creditors (In re FBI Distrib. Corp.),
330 F.3d 36, 42–43 (1st Cir. 2003) (“[T]he nondebtor party will be entitled to administrative priority only to the extent that the
consideration supporting the claim was supplied to the debtor in possession during the reorganization and was beneficial to the
estate.”); In re Nat’l Steel Corp., 316 B.R. 287, 301 (Bankr. N.D. Ill. 2004) (“Claims under § 503(b)(1)(A) are to be measured by
the benefit received by the estate rather than the cost incurred by a claimant.”).
436 11 U.S.C. § 365(b)(1).
437 Id. § 365(b)(2).
438 See, e.g., In re Carterhouse, Inc., 94 B.R. 271, 273 (Bankr. D. Conn. 1988) (holding that section 365(b)(1) “extends to nonmonetary
as well as monetary breaches”).
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certainty and for some kind of adequate assurance, they found the general principles underlying the
postpetition performance requirements to be sound.
Reflecting on the circumstances of nondebtor parties in these cases, however, the Commissioners
considered various ways to mitigate the burden imposed by the general postpetition performance
requirement. They did not believe that the debtor in possession should be required to provide
adequate protection under section 361 of the Bankruptcy Code or to cure any historical defaults
prior to assumption or rejection of the contract or lease. They also rejected full performance of the
contract or lease by the debtor in possession, agreeing with courts that hold such a requirement
undercuts the value of the automatic stay in the debtor in possession’s reorganization efforts.
The Commissioners debated the feasibility of requiring the debtor in possession to pay for goods
and services actually provided to the debtor in possession postpetition in accordance with the terms
of the contract or lease. Some Commissioners commented that the debtor in possession may not
have the liquidity to meet this standard on an immediate postpetition basis, while others indicated
that the debtor in possession’s needs in this respect could be factored into the postpetition financing
budget.439 The Commissioners stressed the need for any such payment obligation to be limited to
those goods and services needed by, and provided to, the debtor in possession postpetition and that
the nondebtor party should not be able to enforce more onerous payment terms from, or demand
any other type of performance of, the debtor in possession pending assumption or rejection of the
6
contract or lease.440 The terms of the prepetition contract or lease should 21, 201 the timing and
govern
ber
ve unless the parties mutually
amount of the debtor in possession’s postpetition payment obligations,m
n No
ed o
iv
arch
agree to more beneficial terms for the estate.
363
-35
o. 14
n, N
B w
The Commissioners also analyzed the ro
th v. circumstances under which nondebtor parties should be able
lixse
to seek to compel fullited in B
c or greater postpetition performance by the debtor in possession under the
contract or lease. The Commissioners generally believed that nondebtor parties should have this
option, but that the standard of proof should be stringent and that the nondebtor party should bear
the burden of proof, particularly in light of the Commission’s recommendation to require some
postpetition payment by the debtor in possession. The Commission ultimately determined that this
standard was an appropriate balance and recommended the joint proposal of requiring payment solely
for goods or services provided to the debtor in possession postpetition and placing a high evidentiary
burden on the nondebtor party that seeks to compel further or other postpetition performance. The
Commissioners also discussed the potential impact of these provisions on government contracts.
In light of the different and varied interests that may be implicated by government contracts, the
Commission agreed that these contracts be excluded from the recommended principles governing
postpetition performance of executory contracts and unexpired leases and that such principles be
limited to the rights of private parties to executory contracts and unexpired leases with a debtor.
439 Some of the Commissioners proposed incorporating an “adequate assurance” concept similar to Section 2-609 of the Uniform
Commercial Code, but others believed that this would provide too much leverage for counterparties in terms of holdup value.
440 Written Statement of Elizabeth Holland on behalf of the International Council of Shopping Centers: NYIC Field Hearing Before the
ABI Comm’n to Study the Reform of Chapter 11, at 3–4 (June 4, 2013) (stating that retailers are failing because of the reluctance
of trade creditors to extend credit on reasonable terms and the difficulty of obtaining DIP and exit financing to support
reorganization), available at Commission website, supra note 55; id. at 5 (citing the January 2013 Senior Loan Officer Opinion
Survey on Bank Practices from the Federal Reserve which indicates that DIP lending is tight and trade vendors are unwilling to
extend credit except on onerous terms).
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ABI Commission to Study the Reform of Chapter
Finally, the Commissioners addressed the continued confusion in the case law concerning a debtor
in possession’s obligation to cure historical nonmonetary defaults in order to assume the executory
contract or unexpired lease. The Commissioners acknowledged that the BAPCPA Amendments
to the Bankruptcy Code clarified this issue for real property leases, but that ambiguity remained
for other kinds of leases and executory contracts. The Commissioners debated whether certain
kinds of historical nonmonetary defaults were so central to a contract’s or lease’s purpose that their
nonperformance should bar assumption. On balance, the Commission determined that, with respect
to all executory contracts and unexpired leases, a debtor in possession should not be required to
cure nonmonetary defaults occurring prior to the assumption decision that are impossible to cure at
the time of assumption under section 365(b) of the Bankruptcy Code.
3. Rejection of Executory Contracts
and Unexpired Leases
Recommended Principles:
The rejection of an executory contract or unexpired lease should continue to
constitute a breach of the contract or lease as of the time immediately preceding
the commencement of the case under section 365(g) of the Bankruptcy Code. The
16
trustee’s rejection of an executory contract or unexpired lease should not, however,
1, 20
ber 2
v m
entitle the nonbreaching, nondebtor party to a rightNof e
n o specific performance or to
ed o
v
ar
retain possession or use of any property of chi debtor or the estate.
363 the
-35
o. 14
n, N
w
A nonbreaching, nondebtor party should be able to retain possession or continue
. Bro
eth v
lixsof the debtor or the estate if expressly authorized by a section of
to use property
in B
cited
the Bankruptcy Code (e.g., section 365(n)).
If the nondebtor party to an executory contract or unexpired lease breaches the
executory contract or unexpired lease prior to the trustee’s assumption or rejection
decision, the trustee may treat such contract or lease as breached and exercise
any rights or remedies it may have under the contract or lease or applicable
nonbankruptcy law.
Rejection of Executory Contracts and Unexpired Leases: Background
A debtor in possession441 may reject (i.e., disavow) most executory contracts and unexpired
leases under section 365(a) of the Bankruptcy Code. A debtor in possession’s decision to reject
an executory contract or unexpired lease generally relieves the debtor in possession of further
performance obligations under the contract or lease. Courts, however, have differed on whether
rejection terminates the contract or lease or, rather, constitutes a breach by the debtor in possession
of such contract or lease.
441 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
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Section 365(g) of the Bankruptcy Code specifically provides that rejection “constitutes a breach of
such contract or lease.” As such, section 365(g) answers the initial question concerning the effect
of rejection and expressly equates rejection with a breach of the contract or lease by the debtor.442
In some cases, that determination may end the inquiry, but in other cases, questions still remain
regarding what rights the nondebtor party may pursue under the contract or lease or under applicable
nonbankruptcy law because of the debtor’s breach. As explained by the Seventh Circuit in Sunbeam
Products, Inc. v. Chicago American Manufacturing, LLC,
[w]hat § 365(g) does by classifying rejection as breach is establish that in bankruptcy,
as outside of it, the other party’s rights remain in place. After rejecting a contract, a
debtor is not subject to an order of specific performance. . . . The debtor’s unfulfilled
obligations are converted to damages; . . . But nothing about this process implies that
any rights of the other contracting party have been vaporized.443
Courts and commentators agree that rejection gives the nondebtor party a right to assert monetary
damages against the debtor in possession, which is deemed a prepetition claim against the estate.444
They also generally agree that the nondebtor party cannot compel continued performance by the
debtor in possession, unless otherwise specifically permitted by section 365.445 They do not, however,
agree whether the nondebtor party can enforce equitable remedies against the debtor in possession
that such party otherwise would be able to assert under applicable nonbankruptcy law.446 The court’s
perspective on this issue can have significant implications for the estate.
016
,2
er 21
emb
Nov
d on
chive Leases:
Rejection of Executory Contracts and Unexpired
ar
363
Recommendations and Findingsn, No. 14-35
Brow
th v.
lixse
The Commission focusedinaBsubstantial amount of time on the concept of rejection
cited
and whether a
debtor in possession’s decision to reject an executory contract or unexpired lease should trigger a
breach or termination of such contract or lease. The Commissioners discussed the language of section
365 and specifically contrasted it with the chapter 5 avoiding powers of the debtor in possession.
Congress did not intend section 365 to operate as an avoiding power that would allow a debtor in
possession to terminate or unwind prepetition agreements or completely extinguish the rights of
the nondebtor counterparty to an agreement. Such a result would be contrary to the language and
structure of the Bankruptcy Code and well-settled federal policy that state law generally determines
442 See, e.g., Sunbeam Prod., Inc. v. Chi. Am. Mfg, LLC, 686 F.3d 372 (7th Cir. 2012), cert. denied, 133 S. Ct. 790 (2012). Both the
National Bankruptcy Conference’s Bankruptcy Code Review Project in 1993 and the NBRC in 1997 expressly considered the
question of whether rejection should result in termination and provided a negative answer. A.L.I.-A.B.A., Bankruptcy Reform
Circa 1993 183–87 (Nat’l Bankr. Conf. 1993); NBRC Report, supra note 37, § 2.4.1.
443 Sunbeam Prod., Inc. v. Chi. Am. Mfg, LLC, 686 F.3d 372, 377 (7th Cir. 2012), cert. denied, 133 S. Ct. 790 (2012).
444 11 U.S.C. § 365(g)(1).
445 See, e.g., In re Walnut Assocs., 145 B.R. 489, 494 (Bankr. E.D. Pa. 1992) (“[N]on-debtor party to the contract subject to
rejection is limited in its claims for breach to the treatment accorded to a debtor’s general unsecured creditors. . . . [U]nless
specific performance is available to the non-debtor party under applicable state law, the debtor cannot be compelled to render
its performances required under the contract. However, if state law does authorize specific performance under the rejected
executory contract, it means that the non-debtor should be able to enforce the contract against the Debtor, irrespective of his
rejection of it.”).
446 See, e.g., Abboud v. Ground Round, Inc. (In re Ground Round, Inc.), 335 B.R. 253 (B.A.P. 1st Cir. 2005) (“[A] party is entitled
to specific performance of a rejected executory contract if such remedy is clearly available under applicable state law.”); In re
Annabel, 263 B.R. 19 (Bankr. N.D.N.Y. 2001) (same with respect to covenant not to compete). But see, e.g., In re Register, 95 B.R.
73, 75 (Bankr. M.D. Tenn. 1989) (refusing to enforce covenant not to compete in rejected sale agreement). See also Route 21
Assoc. of Belleville, Inc. v. MHC, Inc., 486 B.R. 75 (S.D.N.Y. 2012) (injunctive relief could be reduced to monetary claim).
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ABI Commission to Study the Reform of Chapter
property rights in bankruptcy.447 The Commission voted to reinforce the principle that rejection of
an executory contract or unexpired lease constitutes a breach, not a termination, of such contract
or lease.
The Commissioners fully vetted the potential consequences of equating rejection with breach of the
applicable contract or lease, using various examples to explore the nuances and variances in possible
results. In analyzing these scenarios, the Commissioners worked to balance the state law rights and
interests of the nondebtor party with the federal interests that are central to the reorganization efforts
of a debtor in possession. These federal interests include equal treatment of all similarly situated
creditors, automatic stay of actions based on prepetition transactions and relationships with the
debtor, and the ability of the debtor in possession to reject burdensome contracts and leases to
facilitate its reorganization.448
The Commission considered the rejection of different kinds of contracts and leases, and identified
the competing interests of the debtor in possession and the nondebtor, and the needs of the estate,
following rejection. For example, the debtor in possession, on behalf of the estate, needs (i) any
property that may be held by the nondebtor party to be returned; (ii) the ability to use such property
free from restraints or limitations; and (iii) relief from any performance obligations under the
contract or lease. Congress was aware of these needs and carefully balanced them against the interests
of the nondebtor party. In specific instances when the interests of the nondebtor party outweigh the
6
needs of the debtor in possession, Congress specified the nondebtoreparty’s1rights upon rejection.
1, 20
b r2
Specifically, these exceptions arise in the context of certain Novem
real property leases, timeshares, and
d on
449
chive
ar
intellectual property licenses.
363
-35
o. 14
n, N
w
The Commission agreed that, v. Bro than the exceptions already made by Congress, the nondebtor
th other
lixse
in B
party to the rejected contract or lease should be required to immediately return the debtor’s property
cited
to the debtor in possession and should not be able to enforce any equitable or injunctive relief against,
or otherwise require performance by, the debtor in possession. In addition to the factors previously
noted, the Commissioners pointed to section 542 in support of requiring the counterparty to return
personal property to the estate upon rejection.450 They also believed that allowing the nondebtor
party to enforce equitable or injunctive relief against the debtor in possession would elevate the
rights of such counterparty beyond those of other similarly situated prepetition creditors. Indeed,
general unsecured creditors typically are not entitled to relief from the automatic stay or to take
actions affecting the debtor in possession’s postpetition business operations, despite the terms of
the creditors’ prepetition contracts or applicable nonbankruptcy law. Accordingly, the Commission
447 “Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason
why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding.”
Butner v. United States, 440 U.S. 48, 54 (1979).
448 See, e.g., In re Am. Suzuki Motor Corp., 494 B.R. 466, 477 (Bankr. C.D. Cal. 2013) (“The purpose of contract rejection under
section 365 is to permit the debtor to receive the economic benefits necessary for reorganization (which includes liquidation
under chapter 11) for the ultimate benefit of the estate and its creditors. State legislatively imposed buyback requirements, fair
market value awards and treble-damages penalties are superimposed onto the normal contract damage remedy provisions under
state common or statutory law. While Florida and many other states believe that their public policy should provide special
protections for the economic interest of local car dealerships, in the area of federal bankruptcy law those remedies run counter to
the federal policy of bankruptcy reorganization and are therefore preempted.”); In re PPI Enters. (U.S.), Inc., 228 B.R. 339, 344–
45 (Bankr. D. Del. 1998) (“In enacting the Bankruptcy Code, Congress made a determination that an eligible debtor should have
the opportunity to avail itself of a number of Code provisions which adversely alter creditors’ contractual and nonbankruptcy
law rights.”).
449 11 U.S.C. § 365(h), (i), (n).
450 Id. § 542(a) (“[A]n entity . . . shall deliver to the trustee, and account for, such property or the value of such property, unless such
property is of inconsequential value or benefit to the estate.”).
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endorsed the conclusions that rejection should constitute a breach, but it should not (i) deprive the
debtor in possession of the right to possess or use estate property or (ii) require specific performance
by the debtor in possession or the estate.
4. Intellectual Property Licenses
Recommended Principles:
A trustee should be able to assume an intellectual property license in accordance
with section 365(a) of the Bankruptcy Code notwithstanding applicable
nonbankruptcy law or a provision to the contrary in the license or any related
agreement.
The trustee should be able to assign an intellectual property license to a
single assignee in accordance with section 365(f) notwithstanding applicable
nonbankruptcy law or a provision to the contrary in the license or any related
agreement. If the trustee seeks to assign an intellectual property license under
which the debtor is a licensee to a competitor of the nondebtor licensor or an
affiliate of such competitor, the court may deny the assignment if the court
determines, after notice and a hearing, that the harm to the nondebtor licensor
2016
resulting from the proposed assignment significantly outweighs 1, benefit to
ber 2 the
vem
n o
the estate derived from the assignment. The nondebtorN
ed o licensor should bear the
rchiv
burden of proof in any such hearing. 4-35363 a
.1
, No
rown
B
and etcopyrights should
h v.
Blixs
Foreign patents
be included within the definition of
d in
“intellectualeproperty” set forth in section 101(35A) and subject to section 365,
cit
including section 365(n). In addition, foreign trademarks should also be included
in this definition, subject to the limitations and conditions imposed on domestic
trademarks under the recommended principles in Section V.A.5, Trademark
Licenses.
Intellectual Property Licenses: Background
A debtor’s or the estate’s assets often include intellectual property. The Bankruptcy Code defines
“intellectual property” as a “(A) trade secret; (B) invention, process, design, or plant protected
under title 35 [of the U.S. Code; (C) patent application; (D) plant variety; (E) work of authorship
protected under title 17 [of the U.S. Code]; or (F) mask work protected under chapter 9 of title 17;
to the extent protected by applicable nonbankruptcy law.”451 In the context of section 365 of the
Bankruptcy Code, debtors in possession452 commonly face issues with respect to their ability to
assume, assign, or reject their intellectual property licenses.453
451 11 U.S.C. § 101(35A).
452 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
453 Courts generally characterize intellectual property licenses as executory contracts. In re Kmart Corp., 290 B.R. 614, 618 (Bankr.
N.D. Ill. 2003) (“Generally speaking, a license agreement is an executory contract as such is contemplated in the Bankruptcy
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ABI Commission to Study the Reform of Chapter
A “license” is an agreement that generally allows an owner to monetize the value of its intellectual
property. Licenses permit, often for a fee, a third party (licensee) to use the owner’s (licensor’s)
intellectual property for a specified purpose, within a specified geographic region, for a specified
time period, under specified conditions. Licenses range on a sliding scale from conferring very
limited nonexclusive rights to all or essentially all rights to the intellectual property. Licenses are,
in essence, a form of covenant by which the licensor agrees not to sue the licensee for using the
licensor’s intellectual property.
When a debtor in possession is the licensee under an intellectual property license, two potentially
competing federal interests are at play: (i) the Bankruptcy Code generally allows the debtor in
possession to unilaterally decide whether to assume, assign, or reject an executory contract; and
(ii) the federal law on intellectual property licenses respects the right of the licensor to control
its intellectual property.454 Some courts have turned to section 365(c) of the Bankruptcy Code to
address this potential conflict. Section 365(c) generally restricts the ability of a debtor in possession
to assume or assign if “applicable law excuses a party, other than the debtor, to such contract or lease
from accepting performance from or rendering performance to an entity other than the debtor or
the debtor in possession, whether or not such contract or lease prohibits or restricts assignment
of rights or delegation of duties.”455 Such contracts can be assumed or assigned by the debtor in
possession only with the consent of the nondebtor party to the contract.
6
1
Courts applying section 365(c)(1) to the rights of a debtor in possession 0as a licensee under an
1, 2
ber 2
ve
intellectual property license are split regarding whether a odebtorm possession may assume (i.e.,
n No in
ed
a assigning the license to a third party, without
keep and perform under) the license, as opposed3torchiv
3536
. 14- that permit a debtor in possession to assume a license
the consent of the nondebtor licensor., Courts
No
own
v. Brthe “actual approach,” which treats the debtor in possession as the
under these circumstances eth
follow
Blixs
same entity to which ithe third party licensor extended the license in the first instance.456 Because the
ed n
cit
identity of the parties has not changed under this theory and the action would not be deemed an
impermissible assignment under applicable nonbankruptcy law, these courts authorize the debtor in
possession to assume such license under section 365(a) and (b).
Other courts, however, find the actual test in contravention of the statutory language. These courts
follow the “hypothetical approach,” which preclude the debtor in possession from assuming an
agreement if applicable nonbankruptcy law would preclude the debtor from assigning the license
to a third party, even if the debtor in possession has no intention of effecting such an assignment.457
Some commentators have criticized the hypothetical approach as providing the nondebtor licensor
Code.’”) (citations omitted).
454 See Unarco Indus., Inc. v. Kelley Co., Inc., 465 F.2d 1303, 1306 (7th Cir. 1972), cert. denied, 410 U.S. 929 (1973) (citations
omitted) (“[L]ong standing federal rule of law with respect to the assignability of patent licenses provides that these agreements
are personal to the licensee and not assignable unless expressly made so in the agreement.”).
455 11 U.S.C. § 365(c)(1).
456 The First and Fifth Circuits adopted the “actual test.” In re Mirant Corp., 440 F.3d 238 (5th Cir. 2006); Institut Pasteur v.
Cambridge Biotech Corp., 104 F.3d 489 (1st Cir. 1997), abrogated by Hardemon v. City of Boston, 1998 WL 148382 (1st Cir.
Apr. 6, 1998), superseded by 144 F.3d 24 (1st Cir. 1998). See also In re Footstar, Inc., 323 B.R. 566 (Bankr. S.D.N.Y. 2005) (taking
a slightly different approach but holding that section 365(c)(1)’s use of the word “trustee” does not include the debtor or debtor
in possession when assumption is sought because assumption does not require the nondebtor party to accept performance from
a new party other than the debtor or debtor in possession).
457 The Third, Fourth, Ninth, and Eleventh Circuits have adopted the “hypothetical test.” In re Sunterra Corp., 361 F.3d 257 (4th Cir.
2004); In re Catapult Entm’t, Inc., 165 F.3d 747 (9th Cir. 1999); In re James Cable Partners, L.P., 27 F.3d 534 (11th Cir. 1994); In
re West Elec. Inc., 852 F.2d 79 (3d Cir. 1988).
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with holdup power that can frustrate or completely derail the reorganization efforts of the debtor in
possession.458
Conversely, when a debtor in possession is the licensor under an intellectual property license and
decides to reject the license, section 365(n) of the Bankruptcy Code allows the nondebtor licensee
to treat the license as either (i) terminated, or (ii) effective through the end of the remaining term.
If the licensee elects to retain the license, it cannot compel any performance by the debtor, but it
retains the ability to use certain of its rights under the license for the remaining term, for which it
must continue to pay any royalties or other fees required by the terms of the license. Additionally,
the nondebtor licensee may not assert any damages for nonperformance by the debtor through a
setoff against any fees or payments it owes under the license. Notably, the definition of intellectual
property does not include foreign intellectual property or trademarks, which often poses an issue
under section 365(n). In the context of trademarks, the issue is particularly challenging when the
trademarks are integrated into a license with intellectual property (as that term is currently defined
under the Bankruptcy Code). The treatment of trademarks under section 365 is addressed separately
in the following section.
Intellectual Property Licenses: Recommendations and Findings
Intellectual property licenses can represent valuable assets of the estate and may be6necessary to the
01
reorganization of the debtor in possession. Thus, the treatment of these ber 21, 2 under section 365
licenses
em
n case.
of the Bankruptcy Code is often a critically important issue indthe Nov The Commission reviewed
e o
hiv
open issues relating to intellectual property licenses 363chapter 11.
in arc
-35
. 14
, No
rown
v. B
The Commissioners evaluated seth statutory interpretation
x the
n Bli
i
between supporters ofethe hypothetical approach, on the
cit d
and practical issues raised by the debate
one hand, and supporters of the actual
approach, on the other hand, concerning the ability of a debtor in possession (as licensee) to assume
(i.e., keep and use) an intellectual property license without the consent of the nondebtor party (as
licensor).459 The Commissioners acknowledged that nondebtor licensors may have legitimate concerns
about providing their intellectual property to a party other than the debtor, but those concerns
should not exist when the debtor in possession proposes to assume and perform in accordance
with the license. In those instances, the licensor would be receiving the benefit of its bargain. The
Commissioners recognized that application of the hypothetical test results in artificial barriers to
the reorganization of the debtor in possession — an outcome that directly undercuts a fundamental
policy underlying the Bankruptcy Code. The Commission voted to reject the hypothetical approach
and to adopt and codify the actual approach. The Commission further recommended that Congress
amend the Bankruptcy Code to expressly authorize the debtor in possession to assume executory
intellectual property licenses.
458 See, e.g., David R. Kuney, Intellectual Property in Bankruptcy Court: The Search for a More Coherent Standard in Dealing with a
Debtor’s Right to Assume and Assign Technology Licenses, 9 Am. Bankr. Inst. L. Rev. 593 (2001).
459 See Written Statement of Robert L. Eisenbach III, Partner, Cooley LLP: NYIC Field Hearing Before the ABI Comm’n to Study the
Reform of Chapter 11, at 3–6 (June 4, 2013) (discussing the tests in practical terms), available at Commission website, supra note
55; Written Statement of Lisa Hill Fenning, Partner, Arnold & Porter LLP: NYIC Field Hearing Before the ABI Comm’n to Study the
Reform of Chapter 11, at 3–6 (June 4, 2013) (discussing impact of bankruptcy law on intellectual property licenses), available at
Commission website, supra note 55.
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ABI Commission to Study the Reform of Chapter
The Commissioners also critically analyzed whether the result of the hypothetical test (i.e., no
assumption without the consent of the nondebtor licensor) was good policy in the actual assignment
context. Admittedly, the ability to exclude others from using your intellectual property is a key element
of intellectual property ownership. This right provides intellectual property owners some control
over the use of their property and a means to monetize at least some of the value of their property.
The assignment by the debtor in possession of an intellectual property license, in accordance with the
terms of section 365(f) (requiring, among other things, adequate assurance of future performance
and assumption of the entire agreement), arguably does not significantly decrease the value of the
licensor’s right to exclude users.
The Commissioners debated the advantages and disadvantages of providing debtors in possession
with more flexibility to assign intellectual property licenses under the Bankruptcy Code. Some of
the Commissioners believed that this flexibility was necessary to maximize the value of the estate
and to facilitate certain reorganization transactions. In considering the value of the license from
both the licensor’s and licensee’s perspectives, they observed that U.S. assignment laws are more
restrictive than those in many foreign jurisdictions.460 Moreover, many of the Commissioners did
not believe that the identity of the debtor, absent unusual circumstances, was per se a critical factor
in the licensing relationship. Rather, factors such as the licensee’s ability to pay, to maintain the
desired integrity and quality of the intellectual property, and to comply with all obligations imposed
by the license are likely more relevant and important.
16
1, 20
ber 2
ve could be critical if the proposed
The Commissioners acknowledged that the identity of the licenseem
n No
ed o
rchiv
assignee was a competitor of the licensor. In thoseainstances, nondebtor licensors should have the
63
-353
14
ability to block a proposed assignment, by the debtor licensee. The Commission supported a proposal
No.
rown
that would permit a debtorthin. B
e v possession to assign an intellectual property license freely under
Blixs
n (2), subject to a nondebtor licensor’s right to demonstrate that the hardship
i
section 365(f)(1)itand
c ed
imposed on it by the proposed assignment to one of its competitors would significantly outweigh
the benefit to the estate.
The Commission also reviewed the exclusion of foreign patents and copyrights from the definition
of intellectual property in section 101(35A) of the Bankruptcy Code. Foreign patents and copyrights
are excluded from this definition because they are not covered by title 35 or title 17 of the U.S. Code.
The Commissioners believed that licenses for foreign patents, copyrights and trademarks (subject to
the limitations proposed for U.S. trademarks below), although generally not governed by U.S. law,
should receive the same treatment in bankruptcy as U.S. licenses. Moreover, licensees under licenses
of foreign intellectual property should receive the same protections as licensees under U.S. licenses
pursuant to section 365(n) of the Bankruptcy Code. The Commission found no reasonable basis for
treating foreign intellectual property differently.
460 See, e.g., M. Reutter, Intellectual Property Licensing Agreements and Bankruptcy, in Research Handbook On Intellectual Property
Licensing 281 (Jacques de Werra ed., 2013).
V. Proposed Recommendations: Administering the Case
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5. Trademark Licenses
Recommended Principles:
“Trademarks,” “service marks,” and “trade names,” as defined in section 1127
of title 15 of the U.S. Code, should be included in the definition of “intellectual
property” under the Bankruptcy Code. Section 101(35A) of the Bankruptcy Code
should be amended accordingly.
If a debtor is a licensor under a trademark, service mark, or trade name license and
the trustee elects to reject that license under section 365, section 365(n) should
apply to the license, with certain modifications. The nondebtor licensee should
be required to comply in all respects with the license and any related agreements,
including with respect to (i) the products, materials, and processes permitted or
required to be used in connection with the licensed trademark, service mark, or
trade name; and (ii) any of its obligations to maintain the sourcing and quality
of the products or services offered under or in connection with the licensed
trademark, service mark, or trade name. The trustee should maintain the right to
oversee and enforce quality control for such products or services and should not
be under any continuing obligation to provide products or services to the rejected
16
licensee. In addition, the concept of “royalty payments” under 2section 365(n)
1, 20
ber
vem
should be expanded to include “other payments” contemplated by the trademark,
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service mark, or trade name license.
63 a
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Trademark Licenses:n Background
cited
As noted above, trademarks are not included in the definition of “intellectual property” under section
101(35A) of the Bankruptcy Code. Congress made the conscious decision in the 1988 amendments
to exclude this kind of intangible property because trademarks have slightly different characteristics
as compared to other intangible property that is included in the definition of intellectual property.
One key difference is that any transfer of a trademark, including a license or assignment, must
include a transfer of the associated business operations (referred to as “good will” under applicable
nonbankruptcy law).461 In addition, trademark licenses raise other challenges, as explained by the
legislative history of Bankruptcy Code section 365(n):
461 The relevant portion of the Lanham Act provides:
(1) A registered mark or a mark for which an application to register has been filed shall be assignable with the good
will of the business in which the mark is used, or with that part of the good will of the business connected with the
use of and symbolized by the mark. Notwithstanding the preceding sentence, no application to register a mark under
section 1051(b) of this title shall be assignable prior to the filing of an amendment under section 1051(c) of this title
to bring the application into conformity with section 1051(a) of this title or the filing of the verified statement of use
under section 1051(d) of this title, except for an assignment to a successor to the business of the applicant, or portion
thereof, to which the mark pertains, if that business is ongoing and existing.
(2) In any assignment authorized by this section, it shall not be necessary to include the good will of the business
connected with the use of and symbolized by any other mark used in the business or by the name or style under which
the business is conducted.
15 U.S.C. § 1060(a).
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ABI Commission to Study the Reform of Chapter
[T]he bill does not address the rejection of executory trademark, trade name or
service mark licenses by debtor licensors. While such rejection is of concern because
of the interpretation of section 365 by the Lubrizol court and others, such contracts
raise issues beyond the scope of this legislation. In particular, trademark, trade name
and service mark licensing relationships depend to a large extent on control of the
quality of the products or services sold by the licensee. Since these matters could
not be addressed without more extensive study, it was determined to postpone
congressional action in this area and to allow the development of equitable treatment
of this situation by bankruptcy courts.462
Several commentators have discussed the uncertainty created for nondebtor licensees of a debtor’s
trademarks given the exclusion of trademarks from the definition of intellectual property and section
365(n). Courts have struggled with the treatment of trademark licenses and the consequences of
rejection pursuant to section 365 by a debtor licensor of a license with a nondebtor licensee.463 Some
courts have determined that the rejection of such an agreement terminates the nondebtor licensee’s
rights to use the relevant trademarks and any associated goodwill, and grants the nondebtor party
only the right to file a claim for monetary damages against the estate.464 Other courts have determined
that the debtor in possession’s465 rejection of a license constitutes only a breach of such agreement,
which is consistent with section 365(g), and that the nondebtor licensee may continue to exercise its
rights under the rejected agreement consistent with applicable nonbankruptcy law.466 In addition,
16
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some courts have determined that trademark licenses are not executory2contracts and therefore
ber 2
m
Nove
cannot be rejected.467
d on
ive
arch
363
-35
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Similar to other intellectual property,Na . trademark license may be an integral component of a
n,
Brow
nondebtor’s business — particularly in the franchising context. In the event that a licensor files for
th v.
lixse
in B
bankruptcy, a bankruptcy provision that automatically strips the nondebtor licensee of all rights to
cited
use the debtor’s trademarks and any associated goodwill upon the debtor in possession’s rejection
of the trademark license could devastate the nondebtor’s business. Conversely, the ability of the
debtor in possession to reorganize successfully may hinge, at least in part, on its ability to repossess
462 S. Rep. No. 100–505, at 5 (1988), reprinted in 1988 U.S.C.C.A.N. 3204 (citations omitted).
463 See, e.g., In re Old Carco LLC, 406 B.R. 180, 211 (Bankr. S.D.N.Y. 2009), aff ’d sub nom. Mauro Motors Inc. v. Old Carco LLC, 420
F. App’x 89 (2d Cir. 2011) (“Trademarks are not ‘intellectual property’ under the Bankruptcy Code . . . [, so] rejection of licenses
by licensor deprives licensee of right to use trademark. . . .”); In re HQ Global Holdings, Inc., 290 B.R. 507, 513 (Bankr. D. Del.
2003) (“[S]ince the Bankruptcy Code does not include trademarks in its protected class of intellectual property, Lubrizol controls
and the Franchisees’ right to use the trademark stops on rejection.”); In re Centura Software Corp., 281 B.R. 660, 674–75 (Bankr.
N.D. Cal. 2002) (“Because Section 365(n) plainly excludes trademarks, the court holds that [licensee] is not entitled to retain any
rights in [licensed trademarks] under the rejected . . . Trademark Agreement.”).
464 See Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043, 1048 (4th Cir. 1985) (no right to continue to use mark
upon rejection). Such a claim is treated as an unsecured prepetition claim.
465 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
466 See Sunbeam Prods., Inc. v. Chi. Am. Mfg., LLC, 686 F.3d 372, 377 (7th Cir. 2012), cert. denied, 133 S. Ct. 790 (2012) (holding
that Lubrizol was wrongly decided and that the transfer of rights embodied in trademark or other IP licenses could not be
“vaporized” by rejection). “[R]ejection is not the ‘functional equivalent of a rescission, rendering void the contract and requiring
that the parties be put back in the position they occupied before the contract was formed.’ It ‘merely frees the estate from the
obligation to perform’ and ‘has absolutely no effect upon the contract’s continued existence.’” Id. (citations omitted).
467 See also In re Exide Techs., 607 F.3d 957 (3d Cir. 2010) (trademark license not executory and not subject to rejection under facts
of case). Courts may use § 365 to free a bankrupt trademark licensor from burdensome duties that hinder its reorganization.
They should not — as occurred in this case — use it to let a licensor take back trademark rights it bargained away. This makes
bankruptcy more a sword than a shield, putting debtor-licensors in a catbird seat they often do not deserve. Id. at 967–68. But
see In re New York City Shoes, Inc., 84 B.R. 947, 960 (Bankr. E.D. Pa. 1988) (exclusive trademark licensing agreement providing
for annual royalties was executory).
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Bankruptcy Institute
its trademarks and any associated goodwill and then redeploy these assets in a more productive
manner consistent with its reorganization efforts.
Trademark Licenses: Recommendations and Findings
The Commission considered whether adding trademarks to the definition of intellectual property
under section 101(35A) of the Bankruptcy Code was a workable solution. Several Commissioners
noted that the concerns underpinning the decision by Congress in the 1988 amendments to
exclude trademarks from the definition of intellectual property still persist. Generally, applicable
nonbankruptcy law continues to treat trademarks differently in comparison to other intangible
property. These Commissioners did not believe that the process provided in section 365(n) would
necessarily work for all trademark licenses or generate the fair result — considering both the interests
of the estate and the nondebtor licensee — in every case.
The Commissioners recognized, however, the uncertainty surrounding the treatment of trademark
licenses in chapter 11 cases. They discussed how these licenses, to the extent they are deemed
executory contracts under the Bankruptcy Code, would be treated under the recommended principles
for rejection of executory contracts and leases.468 For example, the rejection of the trademark
license would constitute a breach by the debtor. It would not terminate the license or eviscerate
the nondebtor licensee’s rights under the license. The rejection likely would require, however, the
016
nondebtor licensee to turn over the right to use the trademark and any ber 21, 2 goodwill to the
associated
m
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estate. Moreover, the nondebtor licensee would not be able toerequirevperformance by the debtor in
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possession or seek equitable or injunctive relief. -35363 arc
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The Commission consideredxswhether section 365(n) could be modified to accommodate the
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i
unique attributes of trademark licenses and the related concerns of both the debtor licensor and the
cited
nondebtor licensee. The Commissioners discussed the advantages and disadvantages of including
trademarks within the definition of intellectual property under the Bankruptcy Code. Some
Commissioners believed that such inclusion was problematic because of the goodwill associated
with the marks and the frequent need of trademark licensees to have access to the related products
or goods, or components thereof, to utilize the marks legitimately under the license. Moreover,
these Commissioners raised concerns about a debtor licensor’s need to monitor quality control of
the use of any marks by a licensee. Other Commissioners believed that the statute could incorporate
appropriate protections and limitations to protect debtor licensors and mitigate the valid concerns
regarding goodwill and ongoing compliance with the license by the licensee. The Commissioners
expressed concern about the ongoing ambiguity surrounding trademarks in bankruptcy, and the
related costs imposed on a debtor in possession and the estate, as well as the potential harm to the
nondebtor licensee’s business.
After considering the alternatives and the 2014 Innovation Act proposed in Congress,469 the
Commission determined that trademark licenses should be included in the definition of intellectual
property licenses under the Bankruptcy Code. In reaching this conclusion, the Commission agreed
468 See Section V.A.3, Rejection of Executory Contracts and Unexpired Leases.
469 See Innovation Act of 2013, H.R. 3309, 113th Cong. § 6(d) (1st Sess. 2013), available at https://www.congress.gov/113/bills/
hr3309/BILLS-113hr3309rfs.pdf.
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ABI Commission to Study the Reform of Chapter
that section 365(n) should be amended to address certain unique aspects of trademark licenses,
including a provision that would allow a debtor in possession to monitor quality control, but otherwise
not impose obligations on the debtor in possession if the license is rejected. The Commission also
agreed that section 365(n) needs to expressly require a nondebtor licensee electing to retain its rights
under the trademark license to comply in all respects with the license and any related agreements,
including with respect to (i) the products, materials, and processes permitted or required to be used
in connection with the licensed marks; and (ii) any of its obligations to maintain the sourcing and
quality of the products or services offered under or in connection with the licensed marks.
6. Real Property Leases
Recommended Principles:
The trustee’s time to assume or reject unexpired nonresidential real property
leases under section 365(d)(4) of the Bankruptcy Code should be extended from
210 days to one year after the petition date or date of the order for relief, whichever
is later, in the interest of enhancing prospects for reorganization.
The calculation of postpetition rent under a real property lease should be calculated
under the accrual method, allowing the trustee to treat rent accrued prior to the
16
1 20
petition date as a prepetition claim and rent accruedeon eand, after the petition
b r2
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date as a postpetition obligation. The trusteeivshould be required to pay any such
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postpetition rent obligation on or -35363 a
before 30 days after the petition date or date of
. 14
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the order for relief, whicheverois later. The trustee should pay all subsequent rent
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obligationsnaccruing postpetition but prior to any rejection of the lease on a timely
Blixs
di
ci accordance with the terms of the lease.
basis inte
A landlord’s claim for unperformed obligations under section 365(d)(3) should
apply only to monetary obligations. Such claim for unperformed monetary
obligations should not receive superpriority treatment, but should instead
constitute an administrative claim under section 503(b)(1) that is payable under
section 507(a)(2).
The meaning of the term “rent” under section 502(b)(6) should not be based on
whether an obligation is labeled as “rent” under the lease. Rather, the Bankruptcy
Code should define “rent” as any recurring monetary obligations of the debtor
under the lease.
The calculation of rejection damages for real property leases under section 502(b)
(6) should be clarified as follows:
The claim of a lessor for damages resulting from the termination of a lease of
real property shall not exceed:
(i) The greater of (A) the rent reserved for one year under the lease following
the termination date and (B) the alternative rent calculation; plus
(ii) Any unpaid rent due under the lease on the termination date.
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Bankruptcy Institute
For purposes of this section:
The “alternative rent calculation” is the rent reserved for the shorter of
the following two periods: (a) 15 percent of the remaining term of the lease
following the termination date and (b) three years under the lease following
the termination date.
The “termination date” is the earlier of the petition date and the date on
which the lessor repossessed, or the lessee surrendered, the leased property.
In calculating the rent due or reserved under the lease, such calculation
should be done without acceleration.
A landlord should be required to make reasonable efforts to mitigate damages in
the event that the trustee rejects the lease under section 365, regardless of whether
mitigation is required by applicable nonbankruptcy law. Any mitigation or cover
received by, or security deposit held by, the landlord should reduce the landlord’s
prepetition claim for purposes of calculating the section 502(b)(6) claim. A
landlord’s obligation to mitigate damages should continue through the claims
objection deadline or the date of the order allowing the claim, whichever is earlier.
A landlord’s claims for the debtor’s acts and omissions resulting in 0damage to
6
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the real property, other than those claims relating to the rejection 1 the lease or
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for rent under the lease, should not be subject to isection 502(b)(6). The landlord
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63 a
should be permitted to assert any such3claim as a prepetition claim against the
- 53
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estate, subject to the trustee’srown, N
or a party in interest’s right to object and the general
B
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xset
claims allowance process.
n Bli
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cited
Real Property Leases: Background
Many chapter 11 debtors have one or more unexpired leases of nonresidential real property as of
the petition date. These leases may be for the debtor’s headquarters, stores, warehouses, or factories.
They may be necessary to the debtor in possession’s470 reorganization efforts or otherwise represent
valuable assets that the debtor in possession can use to maximize the value of the estate. Alternatively,
they may be above-market leases or used in a part of the business being closed or downsized through
the reorganization. In either scenario, a debtor in possession’s ability to assume, assign, or reject
unexpired leases of nonresidential real property is important to the resolution of its case.
The Bankruptcy Code includes several provisions that specifically address the rights and obligations
of the debtor in possession and the nondebtor landlord under unexpired leases of nonresidential real
property leases. For example, section 365(d)(3) requires the debtor in possession to timely perform
obligations “arising from and after the order for relief under any unexpired lease of nonresidential real
470 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
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ABI Commission to Study the Reform of Chapter
property, until such lease is assumed or rejected.”471 In addition, section 365(d)(4) requires the debtor in
possession to assume or reject any nonresidential real property lease within 120 days after the petition
date, with one 90-day extension of that deadline for cause.472 The debtor in possession generally is given
until plan confirmation to assume or reject executory contracts and other kinds of leases.473
Commentators and practitioners have raised issues concerning several of these provisions. Many
commentators have criticized the shortened deadline for the debtor in possession to assume, assign,
or reject a nonresidential real property lease under section 365(d)(4) of the Bankruptcy Code.474
Prior to the BAPCPA Amendments, a debtor in possession had an initial 60 days to review its
unexpired nonresidential leases, but it could obtain one or more extensions of this deadline for cause
and with court approval.475 Some commentators and landlords believed that courts were granting
debtors in possession very lengthy extensions of the section 365(d)(4) deadline on a routine basis.476
They believed that these open-ended extensions significantly impaired the landlords’ rights under
the leases and nonbankruptcy law, as well as their ability to identify substitute lessees and negotiate
substitute leases in a timely manner.477
As a result of the BAPCPA Amendments, section 365 provides a debtor in possession with 210
days following the petition date to decide whether it will assume or reject each of its nonresidential
real property leases, unless the applicable landlord consents to an extension of this deadline. Some
commentators suggested, immediately following the BAPCPA Amendments, that this single change
16
to the Bankruptcy Code would discourage large retail chains from filingr chapter 11 petitions.478 Large
1, 20
be 2
retail chains, in particular, frequently have hundreds of unexpired em
Novnonresidential real property leases
d on
hive
cand making prudent assumption or rejection
r
as of the petition date, and the prospect of reviewing
63 a
-353
. 14of the petition date, according to these commentators,
decisions for each location within 210 No
, days
own
v. Br
would likely be too dauntingth thus discourage filings in the first place.479 Empirical and anecdotal
e and
Blixs
evidence since 2005 isuggests that this change in a debtor in possession’s time to assume or assign
ed n
cit
nonresidential real property leases is at least a contributing factor to both the decline in retail filings
and the results that were achieved in certain retail debtor cases since 2005.480
471
472
473
474
475
476
477
478
479
480
11 U.S.C. § 365(d)(3).
Id. § 365(d)(4).
Id. § 365(d)(2).
Id. § 365(d)(4).
Circuit City Unplugged: Why Did Chapter 11 Fail to Save 34,000 Jobs?, Hearing before the H. Subcomm. on Commercial and
Administrative Law, 111th Cong. 96 (2009) (statement of Professor Jack F. Williams, Robert M. Zinman ABI Resident Scholar
(2008–09)) [hereinafter Williams Statement].
See, e.g., Written Statement of Elizabeth Holland on behalf of the International Council of Shopping Centers: NYIC Field Hearing
Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (June 4, 2013) (discussion prior law), available at Commission
website, supra note 55. See generally Transcript, NYIC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
available at Commission website, supra note 55.
“The deadline was originally enacted to address problems caused by extended vacancies or partial operation by a debtor of
tenant space located in shopping centers which reduced customer traffic to other nondebtor tenants due to delays in debtors
deciding whether to assume or reject real property leases.” In re FPSDA I, LLC, 450 B.R. 392, 399 (Bankr. E.D.N.Y. 2011).
See, e.g., Williams Statement, supra note 475, at 97 (“Professor Ken Klee suggests one other possible outcome — retail debtors
with a significant number of leases will simply refuse to file voluntary petitions during slower periods and will instead wait to be
forced into involuntary cases.”) (citations omitted).
See, e.g., id. at 96–97; Written Statement of John Collen, Partner, Tressler LLP: NCBJ Field Hearing Before the ABI Comm’n to Study
the Reform of Chapter 11, at 2–3 (Apr. 26, 2012) (stating that 210 days may not be sufficient for a debtor to make an informed
decision), available at Commission website, supra note 55; Written Statement of Commercial Finance Association: CFA Field
Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 8 (Nov. 15, 2012) (stating that the 210-day period to assume
or reject a nonresidential lease is too short, discourages reorganization, and impairs secured creditor recoveries), available at
Commission website, supra note 55.
See Kenneth Ayotte, An Empirical Investigation of Leases and Executory Contracts, (paper presented at 2014 symposium) (draft on
file with Commission) (finding that BAPCPA is “associated with a significantly lower probability of reorganization for the most
lease-intensive firms”). See also Written Statement of Gerald Buccino: TMA Field Hearing Before the ABI Comm’n to Study the
Reform of Chapter 11, at 5 (Nov. 3, 2012) (arguing that the 210-day period is insufficient, particularly for retail debtors), available
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Courts also take different approaches to calculating the timely payments a debtor in possession
is obligated to make under its nonresidential real property leases pursuant to section 365(d)(3).
Some courts determine the prepetition or postpetition status of rent amounts owed by a debtor in
possession using a billing approach based on the landlord’s invoice date.481 Other courts take an
accrual approach and allocate the outstanding amounts between the prepetition and postpetition
periods accordingly.482 Courts also differ on the priority accorded to any unpaid postpetition
amounts due under section 365(d)(3).483
Similarly, if a debtor in possession rejects a nonresidential real property lease, the landlord’s claim
for rejection damages is generally subject to the cap provided by section 502(b)(6) of the Bankruptcy
Code. Section 502(b)(6) generally “limits a landlord’s ‘damages resulting from the termination of
a lease of real property’ to an amount equal to the rent the debtor-tenant would have paid for a
period of one to three years, depending on the remaining term of the lease.”484 The calculation of
the section 502(b)(6) cap, as well as what constitutes rent or otherwise should be included in the
calculation, often produces litigation and uncertain results in chapter 11 cases.485 Notably, courts are
split regarding the application of the section 502(b)(6) cap to nontermination damages relating to
the lease, which could constitute millions of dollars and significantly impact unsecured creditors’
pro rata share of estate assets.486
16
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o. 14
n, N
r Statement of Elizabeth Holland on behalf of the International Council of Shopping
at Commission website, supra note 55; Writtenow
v. B
Centers: NYIC Field Hearing Before theth Comm’n to Study the Reform of Chapter 11, at 4–5 (June 4, 2013) (testifying that the
xse ABI
n Bli
primary problem in retail d i
reorganizations is lender control and stating that “[l]enders are sometimes willing to provide only
cite
481
482
483
484
485
486
enough financing to position a debtor for liquidation in the first few months of the case, and then impose restrictive covenants
in post-petition financing agreements that either direct an immediate liquidation of the company, or include covenants or
borrowing reserve rights that effectively allow the lender to ‘pull the plug’ on the retailer only a few months into the case”),
available at Commission website, supra note 55; Written Statement of Lawrence C. Gottlieb, Partner, Cooley LLP: NYIC Field
Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 4–5 (June 4, 2013) (explaining the tension in the timing
regarding the desire of the secured creditor to liquidate the debtors’ assets and the ability of the debtor to effectively conduct
going-out-of-business (“GOB”) sales at its retail locations; given the 210-day limit set by BAPCPA and given the fact that a
GOB sale takes at least 120 days in most cases, the debtor has 30 to 90 days to sell its company; landlords are also unwilling to
negotiate, which increases the prevalence of quick liquidations in retail cases), available at Commission website, supra note 55;
Written Statement of Holly Felder Etlin: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3
(Apr. 19, 2013) (stating that the 210-day limit to assume or reject nonresidential leases puts retailers in a timing pinch; because
GOB sales generally take at least 120 days and must take place in their retail locations, the 210-day limit to assume or reject
leases puts inordinate pressure on debtors to decide within 90 to 120 days after filing to either quickly file a chapter 11 plans
while complying with all their lenders’ requirements, or to liquidate; also stating that the 210-day deadline to assume or reject
nonresidential leases means it is nearly impossible for a middle-market retail company to do anything but conduct a GOB sale),
available at Commission website, supra note 55.
See Centerpoint Props. v. Montgomery Ward Holding Corp. (In re Montgomery Ward Holding Corp.), 268 F.3d 205, 209–10 (3d.
Cir. 2001); Written Statement of Elizabeth Holland on behalf of the International Council of Shopping Centers: NYIC Field Hearing
Before the ABI Comm’n to Study the Reform of Chapter 11, at 6–8 (June 4, 2013) (describing how this “stub rent” problem means
that landlords are, perhaps unfairly, losing money because of the timing of debtors’ bankruptcy filings), available at Commission
website, supra note 55.
See In re Stone Barn Manhattan LLC, 398 B.R. 359, 362–65 (Bankr. S.D.N.Y. 2008) (using the accrual method but providing
historical overview and case cites of the accrual versus billing date approach).
Compare In re Oreck Corp., 506 B.R. 500 (Bankr. M.D. Tenn. 2014) (holding that debtor’s obligation to pay occurred prepetition
was not subject to priority treatment) with In re Leather Factory Inc., 475 B.R. 710 (Bankr. C.D. Cal. 2012) (holding that “stub
rent” owed to landlord was a priority administrative claim).
11 U.S.C. § 502(b)(6); Michael St. Patrick Baxter, The Application of § 502(b)(6) to Nontermination Lease Damages: To Cap or Not
to Cap?, 83 Am. Bankr. L. J. 111 (2009).
See, e.g., In re Heller Ehrman LLP, 2011 WL 635224 (N.D. Cal. Feb. 11, 2011) (discussing challenges in determining remaining
term of lease); In re Titus & McConomy, LLP, 375 B.R. 165 (Bankr. W.D. Pa. 2007) (holding that, because one year’s rent was
greater than 15 percent of remaining term of lease following petition date, section 502(b)(6)(A) determined amount of cap was
equal one year’s rent).
Baxter, supra note 484, at 113–14.
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ABI Commission to Study the Reform of Chapter
Real Property Leases: Recommendations and Findings
The Commission reviewed several issues relating to nonresidential real property leases. Several
Commissioners voiced strong concerns regarding the shortened deadline for a debtor in possession
to assume or reject nonresidential real property leases under section 365(d)(4). The Commissioners
suggested that the current deadline is preventing potential debtors from using chapter 11, at least
on a voluntary and timely basis, and is making it more difficult for retail chains to reorganize their
businesses.487 The Commissioners also noted that the 210-day deadline is misleading because
postpetition lenders have been requiring debtors in possession to make their decisions about
nonresidential real property leases as early as 120 to 150 days after the petition date to permit these
lenders to preserve their security interests in the debtors’ leaseholds before the expiration of the
section 365(d)(4) deadline.488
Other Commissioners, while acknowledging these troubling facts, emphasized the need to balance
the concerns raised by landlords before the BAPCPA Amendments when courts were granting very
lengthy extensions.489 They encouraged the Commission to find a compromise that would provide
more flexibility to debtors in possession to secure financing and to review their unexpired leases
within a reasonable time frame without eliminating the certainty that section 365(d)(3) currently
487 See, e.g., Sharon Bonelli, Isabel Hu, Gregory Fodell, U.S. Retail Case Studies in Bankruptcy Enterprise Value and Creditor
Recoveries, Fitch Ratings, Apr. 16, 2013; Written Statement of Lawrence Gottlieb, Partner, Cooley LLP: NYIC Field Hearing Before
16
the ABI Comm’n to Study the Reform of Chapter 11, at 3 (June 4, 2013) (“The deadline established under BAPCPA for a debtor
1, 20
ber 2
to assume or reject unexpired leases of nonresidential property has had a substantial and unfortunate affect on retailers’ ability
vem
n No
to meet liquidity needs and obtain extended postpetition financing —dthe lynchpin to any successful retail reorganization.”),
e o Buccino: TMA Field Hearing Before the ABI Comm’n
available at Commission website, supra note 55; Written StatementcofiGerald
r hv
63 a
to Study the Reform of Chapter 11 (Nov. 3, 2012) (noting that the maximum time limit to assume or reject nonresidential real
-353
4
property leases should be amended, as it takes No. 1 thoroughly assess whether a lease should be maintained for the value of
, time to
rown
reorganization efforts), available at Commission website, supra note 55; Oral Testimony of Grant Stein: AIRA Field Hearing Before
v. B
the ABI Comm’n to Study the seth of Chapter 11, at 3 (June 7, 2013) (AIRA Transcript) (noting that the court should allow
x Reform
n Bli or rejection if it is appropriate in the circumstances), available at Commission website, supra note
i
more time for the iassumption
c ted
55; First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial
Fin. Ass’n Annual Meeting, at 8–9 (Nov. 15, 2012) (“Debtors and their secured and unsecured creditors must make decisions
about whether to retain leases in a period of time that is often unrealistically short. As a result, businesses that might have been
reorganized or sold as going concerns to new owners are liquidated instead. Because they know that debtors with significant
leases will have difficulty reorganizing, lenders are less willing to support reorganizations with DIP financing. They do not want
to begin lending money to a chapter 11 debtor only to have to choose, 7 months later, between agreeing to an unfavorable deal
with a landlord that has such significant leverage and liquidating the debtor, possibly at a loss to the lender. So they simply refuse
to provide DIP financing in the first place, forcing debtors to liquidate before they have had an opportunity to make operational
changes, regardless of the potential for reorganization. In addition, going concern asset sales (a frequent form of ‘reorganization’
without a plan) become more difficult and less advantageous to creditors and owners because buyers have insufficient time to
assess the value of an enterprise with important leases. Uncertainty about value always results in lower prices and therefore lower
payments to creditors. Worse, such uncertainty can render going concern sales so difficult that they are not even pursued, again
resulting in otherwise avoidable liquidations.”), available at Commission website, supra note 55.
488 See Written Statement of Lawrence C. Gottlieb, Partner, Cooley LLP: NYIC Field Hearing Before the ABI Comm’n to Study the
Reform of Chapter 11, at 4–5 (June 4, 2013) (stating that the deadline should be expanded to allow time for a debtor to secure
postpetition financing and conduct a going-out-of-business sale and stating that prepetition lenders often demand provisions
that result in a liquidation sale before the expiration of the 210-day period), available at Commission website, supra note 55.
But see Written Statement of David L. Pollack, Partner, Ballard Spahr LLP: NYIC Field Hearing Before the ABI Comm’n to Study
the Reform of Chapter 11, at 2–3 (June 4, 2013) (stating that neither section 365(d)(4) time limits nor commercial landlords are
causing retailers to fail and providing specific case examples to support assertion; also noting that retailers are failing because
of other reasons, such as DIP financing conditions and reluctance of trade creditors to continue to extend credit), available at
Commission website, supra note 55. See also Ayotte, An Empirical Investigation of Leases and Executory Contracts, supra note
480 (finding that the seven-month limit to assume or reject a commercial lease instituted by BAPCPA (absent an extension from
the landlord) “accelerated real estate lease disposition decisions”). See generally supra note 66 and accompanying text (generally
discussing limitations of chapter 11 empirical studies).
489 See, e.g., Written Statement of Elizabeth Holland on behalf of the International Council of Shopping Centers: NYIC Field Hearing
Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (June 4, 2013) (“The 2005 amendments that created more certainty
for shopping center owners now provide an important ‘firewall’ which prevents the failure of one retailer from cascading to
other businesses. Under the prior law, lingering uncertainty caused neighboring stores to suffer from reduced traffic and sales
while potential new tenants were reluctant to rent space in a shopping center with an uncertain future. For property owners, the
contraction in credit has been even more problematic; a bankrupt tenant can cause a shopping center to default on a mortgage
with no ability to cure the default. Such defaults include covenants to maintain minimum occupancy and debt service coverage.”),
available at Commission website, supra note 55.
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provides to landlords.490 After considering and debating different approaches that ranged from
reversion to the pre-BAPCPA standard to maintenance of the status quo, the Commission voted to
provide the debtor in possession one year from the petition date to make its assumption, assignment,
or rejection decision with respect to nonresidential real property leases.
The Commission also discussed the split in the courts regarding the method — i.e., the billing
approach or the accrual approach — that should be used to determine whether certain rent owed
under the lease should be deemed a prepetition or a postpetition obligation. The Commission
reviewed case law citing both approaches to determine which approach should be adopted and
codified, and focused its efforts on creating, first and foremost, a uniform standard. Ultimately, the
Commission decided that the accrual method, which allocates rent between the prepetition and
postpetition periods based on the date of filing, was a fair method and most closely aligned with the
purpose of section 365(d)(3).
The Commission further considered the scope of a debtor in possession’s obligations under
section 365(d)(3). Some of the Commissioners commented on the ambiguity in the case law
regarding which obligations were captured by section 365(d)(3) and how those obligations, if
deferred or unpaid, should be treated. With respect to which obligations should be deemed “rent,”
the Commission reviewed the language of section 365(d)(3), which references section 365(b)(2), but
not historical nonmonetary obligations in section 365(b)(1). The Commissioners debated whether
16
this omission in the statute suggests that a debtor in possession should ber required to perform all
1, 20
be 2
nonmonetary obligations on and after the petition date as providedvem section 365(d)(3). Several
No in
d on
hiv section 365(d)(3) may be inconsistent
cof e
ar
Commissioners, however, highlighted that such a reading
363
4-35
. 1and approaches. Specifically, these Commissioners
with the Commission’s recommended policies
, No
rown
v. B(i) should not be required to perform under any executory
asserted that a debtor in possession
eth
Blixs
contracts or unexpired d in
e leases, except to pay for postpetition goods and services (including rent),
cit
pending assumption or rejection; and (ii) should not be required to cure nonmonetary defaults that
occurred prior to assumption. In light of these recommendations and the Commission’s proposal
for a relatively modest extension of the section 365(d)(4) deadline, the Commission decided to
recommend limiting section 365(d)(3) to monetary obligations under the leases and to provide
ordinary administrative priority (not superpriority) to any such unpaid or deferred obligations
under section 365(d)(3).
In addition, the Commissioners evaluated the inconsistent application of section 502(b)(6) to
calculate the maximum amount of a landlord’s rejection damages. The Commission agreed with
courts that have held that whether a given obligation is labeled as “rent” under a lease should not
determine whether such obligation is subject to the section 502(b)(6) cap. The Commissioners
identified obligations that have been commonly considered as “rent” (e.g., monthly payments
for occupying the property (including base rent, additional rent, percentage rent), common area
490 Id. at 2 (June 4, 2013) (stating that the time limits for debtors to assume or reject a nonresidential lease introduced by BAPCPA
have “provid[ed] shopping center owners with reasonable certainty as to the disposition of leases, have prevented deterioration
in shopping center properties and helped owners have access to credit to finance construction and renovation”), available at
Commission website, supra note 55; Oral Testimony of the Honorable Melanie Cyganowski (Ret.), former U.S. Chief Bankruptcy
Judge, E.D.N.Y.: CFA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 19 (Nov. 15, 2012) (CFA
Transcript) (stating that it would be beneficial to the court and will encourage more secured lenders to support middle-market
borrowers if the BAPCPA Amendments relating to lease and plan deadlines were repealed, or at a minimum amended to provide
judicial discretion to be exercised to modify the deadlines as appropriate), available at Commission website, supra note 55.
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ABI Commission to Study the Reform of Chapter
maintenance charges, taxes, and insurance) and determined that the definition of “rent” suggested
by the advisory committee — “any recurring monetary obligations of the debtor under the lease” —
adequately captured these obligations. The Commissioners also analyzed the varying interpretations
and applications of the formula for calculating the cap on rejection damages under section 502(b)(6). The
Commission agreed that many courts have confused or misapplied the formula and that, simply stated,
the cap should be the rent reserved under the lease for the greater of (i) one year and (ii) the shorter of 15
percent of the remaining term and three years, plus unpaid rents. Accordingly, the Commission voted to
recommend clarifying the calculation formula.
Finally, the Commission considered the treatment of nontermination damages that a landlord may
assert against the estate. These claims typically arise out of the debtor’s use or occupancy of the
property and are not related to the debtor’s rejection of the lease. Notably, section 502(b)(6) applies
to, and limits, “the claim of a lessor for damages resulting from the termination of a lease of real
property.” Accordingly, the Commission agreed that a landlord should be able to file a prepetition
claim against the estate, to the extent that the landlord can establish a legal basis and adequate
factual support for such claim, for damages not resulting from the rejection of the lease. Such claim
would be subject to the claims objection and allowance process under the Bankruptcy Code.
2
B. Use, Sale, or Lease of Property vofbethe016
r 21, Estate
em
No
d on
chive
ar
5363
Section 363 of the Bankruptcy Code addresses3the debtor in possession’s use, sale, or lease of property
. 14, No
o
during the chapter 11 case. Sectionwn
v. Br 363(c) permits the debtor in possession to engage in certain of
eth
these transactionsed inthexs
in Bli ordinary course of business without court approval.491 If the debtor in
cit
possession wants to use, sell, or lease property outside the ordinary course of business, section 363(b)
requires, among other things, notice and a hearing, and prior court approval.492 Section 363(f), in
turn, allows the debtor in possession to sell property free and clear of any interest in such property
under certain circumstances.493
1. General Provisions for Non-Ordinary
Course Transactions
Recommended Principles:
Except in the context of a sale of all or substantially all of a debtor’s assets
(i.e., a section 363x sale), the court should approve the use, sale, or lease of a
debtor’s assets outside the ordinary course of business only if the court finds by
a preponderance of the evidence that the trustee exercised reasonable business
judgment in connection with the proposed transaction. This approach often is
491 11 U.S.C. § 363(c)(1). Nevertheless, if a debtor is selling, leasing, or using assets that constitute “cash collateral,” then the debtor
must obtain the secured creditor’s consent or court approval. Id. § 363(c)(2).
492 Id. § 363(b).
493 Id. § 363(f).
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Bankruptcy Institute
referred to as an “enhanced” or “intermediate” level of review that considers not
only the process adopted by the board of directors (or similar governing body) to
approve the transaction but also the reasonableness of the decision itself.
Only the trustee should be able to propose the use, sale, or lease of a debtor’s assets
outside the ordinary course of business. Accordingly, no change to existing law is
suggested on this point.
A secured creditor’s collateral should not be subject to a mandatory surcharge in
favor of the estate but the court should retain the authority to make appropriate
allocations of value to the estate as may be warranted under the circumstances
pursuant to sections 506(c) and 552(b) of the Bankruptcy Code, as clarified by
the related principles. See Section VI.C.3, Section 506(c) and Charges Against
Collateral; Section VI.C.4, Section 552(b) and Equities of the Case.
For the standard of review governing section 363x sales, see Section VI.B, Approval
of Section 363x Sales.
General Provisions for Non-Ordinary Course Transactions: Background
2016
,
In general, section 363(b) of the Bankruptcy Code provides that the debtor2in possession,494 “after
er 1
emb
v
notice and a hearing, may use, sell, or lease, outside the ordinary n No of business, property of the
d o course
chive
estate.”495 The debtor in possession can use, sell, or3lease ar single asset, multiple assets, a division, or
5363 a
14No.
more. A sale of all or substantially all ofothe, debtor’s assets is addressed separately in these principles
wn
. Br
eth v of review and additional procedures.496
and is subject to a different Blixs
standard
in
cited
Under section 363(b), a debtor in possession generally must provide at least 21 days’ notice of a
motion to approve a proposed use, sale, or lease of property.497 In general, any party in interest
may object to the motion. At the hearing, the debtor in possession bears the burden of proof on
the motion and generally must satisfy that burden by a preponderance of the evidence.498 Courts
generally evaluate section 363(b) motions under a business judgment standard. More precisely,
courts often state they will approve the motion only if it represents an exercise of the debtor in
possession’s sound business judgment.499 But, courts are not always clear or consistent in explaining
the factors they consider under this business judgment standard.
494 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
495 Id. § 363(b).
496 See Section VI.B, Approval of Section 363x Sales.
497 Fed. R. Bankr. P. 2002.
498 In re Lionel Corp., 722 F.2d 1063, 1071 (2d Cir. 1983) (“[A] debtor applying under § 363(b) carries the burden of demonstrating
that a use, sale or lease out of the ordinary course of business will aid the debtor’s reorganization . . . .”); In re Telesphere Commc’ns,
Inc., 179 B.R. 544, 552 (Bankr. N.D. Ill. 1994) (“[T]he proponent of the sale bears the ultimate burden of persuasion . . . .”); In re
Ionosphere Clubs, Inc., 100 B.R. 670, 675 (Bankr. S.D.N.Y. 1989) (“[Debtor] clearly bears the burden of demonstrating that a sale
of property out of the ordinary course of business under § 363(b) of the [Bankruptcy] Code will aid [debtor’s] reorganization
and is supported by a good business justification.”).
499 In re On-Site Sourcing, Inc., 412 B.R. 817, 822 (Bankr. E.D. Va. 2009) (“‘A § 363(b) sale is generally viewed as quicker. Only a
motion and a hearing are required, and most courts apply a ‘business judgment test’ to determine whether to approve the sale.’”)
(quoting In re Gulf Coast Oil Corp., 404 B.R. 407, 415 (Bankr. S.D. Tex. 2009)).
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ABI Commission to Study the Reform of Chapter
General Provisions for Non-Ordinary Course Transactions:
Recommendations and Findings
The Commissioners engaged in a detailed review of the various kinds of non-ordinary course
transactions pursued by debtors in possession under section 363(b). Debtors in possession have used
this provision to enter into long-term equipment lease arrangements or new real property leases that
require a substantial outlay of resources; to hire a service provider who is not a professional under
section 327; and even to compromise and settle a cause of action.500 The most common use of section
363(b), however, is to sell the debtor’s assets. In each of these instances, the estate is potentially losing
something — i.e., cash in the lease, hiring, and settlement scenarios, and assets in the sale context.
The Commissioners thus emphasized the important roles of process and review in the approval of
these transactions.
The Commissioners examined the various standards of review applicable to similar transactions
under state law. In many cases, directors’ decisions are protected under state law by the business
judgment rule, which presumes that “‘in making a business decision the directors of a corporation
acted on an informed basis, in good faith, and in the honest belief that the action taken was in the
best interests of the company.’”501 Courts have articulated slightly different standards for reviewing
proposed transactions under either the business judgment rule or some enhanced form of scrutiny.
These variations typically depend on the kind of transaction at issue and the parties involved in the
016
transaction.
21, 2
r
mbe
Nove
on
i
For example, some courts undertake a very deferentialved
arch review of a company’s business judgment,
363
focusing largely on the process followedNo.the-35
by 14 board of directors to evaluate and approve the proposed
n,
transaction; these courts then v. Brow the company’s articulated business justifications.502 This type
defer to
eth
s
of deferential judicial Blix
in review often is explained by the notion that business decisions are better
cited
made in the boardroom than the courtroom.503 Other courts scrutinize proposed transactions more
closely, reviewing not only the process implemented by the company, but also the reasonableness of
the board of directors’ business judgment under the circumstances of the case.504 This latter review
often is referred to as an “enhanced” or “intermediate” business judgment standard. In certain
500 In re Schipper, 933 F.2d 513, 515 (7th Cir. 1991) (holding that debtor had “sound business reasons for making the sale”); In re
Cont’l Air Lines, Inc., 780 F.2d 1223, 1226 (5th Cir. 1986) (“[F]or the debtor-in-possession or trustee to satisfy its fiduciary duty
to the debtor, creditors and equity holders, there must be some articulated business justification for using, selling, or leasing
the property outside the ordinary course of business.”); In re Ionosphere Clubs, Inc., 100 B.R. 670, 680 (Bankr. S.D.N.Y. 1989)
(finding that debtor “articulated sound business reasons for, and is appropriately exercising business judgment with respect to, its
decision to sell [certain assets]”); In re Baldwin United Corp., 43 B.R. 888, 897 (Bankr. S.D. Ohio 1984) (finding that debtors “met
their burden of demonstrating that the disposition will aid their reorganization, and is supported by sound business reasons”).
501 In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 52 (Del. 2006) (quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)).
502 Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34, 45 n.17 (Del. 1994); In re Walt Disney Co. Derivative Litig., 906
A.2d 27, 74 (Del. 2006) (quoting Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971)).
503 See, e.g., Brehm v. Eisner, 746 A.2d 244, 266 (Del. 2000) (holding that the Court of Chancery correctly deferred to the business
decision of the board because “[t]o rule otherwise would invite courts to become super-directors, measuring matters of degree in
business decisionmaking and executive compensation. Such a rule would run counter to the foundation of our jurisprudence”).
See also King v. Terwilliger, 2013 WL 708495, at *7 (S.D. Tex. Feb. 26, 2013) (finding that compensation issues are business
questions “far better suited to the boardroom than the courtroom”); In re Curlew Valley Assocs., 14 B.R. 506, 511 (Bankr. D.
Utah 1981) (“[D]isagreements over business policy are not amenable to judicial resolution. The courtroom is not a boardroom.
The judge is not a business consultant. While a court may pass upon the legal effect of a business decision, (for example, whether
it violates the antitrust laws), this involves a process and the application of criteria fundamentally different from those which
produce the decision in the first instance. In short, the decision calls for business not legal judgment.”).
504 In re Netsmart Techs., Inc. Stockholders Litig., 924 A.2d 171, 192 (Del. Ch. 2007). See also Paramount Commc’ns Inc. v. QVC
Network Inc., 637 A.2d 34, 45 (Del. 1994) (“[C]ourt applying [the Revlon standard] should be deciding whether the directors
made a reasonable decision, not a perfect decision. If a board selected one of several reasonable alternatives, a court should not
second-guess that choice even though it might have decided otherwise or subsequent events may have cast doubt on the board’s
determination.”).
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Bankruptcy Institute
limited circumstances, courts apply heightened scrutiny under which the court exercises its own
business judgment and determines if the decision is in the best interests of the company.505 Finally, if
the proposed transaction involves potential self-dealing, conflicts of interests, or insiders, the court
may require the company to establish the entire fairness of the transaction.506
After much deliberation, the Commission determined that an enhanced business judgment standard
was appropriate for evaluating general asset sales and other transactions under section 363(b). The
court should approve the sale if it represents a reasonable process and a reasonable exercise of the
debtor in possession’s business judgment. Moreover, the Commission agreed that only the debtor
in possession should be permitted to request the use, sale, or lease of property of the estate, which
currently is the structure of section 363.
The Commissioners discussed situations in which the debtor in possession sells assets, and unsecured
creditors seek recoveries from that sale, despite the fact that such assets are fully encumbered by a
secured creditor’s lien. The Commissioners recognized that this situation has occurred more frequently
in the most recent economic cycle. Debtors have filed chapter 11 cases with substantially all of their
assets fully encumbered by prepetition liens, leaving little value for the debtors’ other creditors, at
least at the outset of the case. The Commissioners noted that, in some cases, secured lenders will
agree to set aside certain amounts for administrative or unsecured claims. The Commissioners,
however, did not believe that such surcharges should be mandatory in every section 363 transaction.
16
Rather, parties should remain free to negotiate these types of set-asides based2on the facts of any
1, 0
ber 2
em
given case. In addition, the Commission reviewed the recommendedvprinciples relating to sections
n No
ed o
rchiv
506(c)507 and 552(b),508 and found that those sections,3together with the new procedures proposed
6 a
-353
o 14
for section 363x sales,509 sufficiently addressed. the underlying concerns.
n, N
cited
h v.
xset
n Bli
i
Brow
505 See Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981) (indicating that judicial business judgment may be warranted in
derivative litigation involving a special litigation committee in which demand was excused under applicable state law). See also,
e.g., In re Telesphere Commc’ns, Inc., 179 B.R. 544, 552 (Bankr. N.D. Ill. 1994) (“Where an objection is made, the standard to be
applied by the court in approving a disposition of assets is variously stated, but the general thrust is that the proposed sale should
be in the best interests of the estate.”); In re Am. Dev. Corp., 95 B.R. 735, 739 (Bankr. C.D. Cal. 1989) (“The proposed transaction
is certainly not in the ordinary course of business and requires [the court’s] approval. Debtor has the burden of proof to persuade
[the court] that the proposed transaction is appropriate in light of its reorganization effort and should be approved.”). Also, some
courts have been less deferential with respect to break-up fees. See, e.g., In re Tiara Motorcoach Corp., 212 B.R. 133, 137 (Bankr.
N.D. Ind. 1997) (“This court agrees with the position taken in S.N.A., America West, and Hupp. A sale pursuant to § 363 of the
Bankruptcy Code is outside the ordinary course of business, and the business judgment of the debtor should not be solely relied
upon. Rather, a court should insure that revenues are maximized and that the best interests of the debtor’s estate, creditors and
equity holders are furthered. Therefore, ‘the proposed break-up fee must be carefully scrutinized to insure that the Debtor’s estate
is not unduly burdened and that the relative rights of the parties in interest are protected.’”) (citations omitted); In re Am. W.
Airlines, Inc., 166 B.R. 908, 912 (Bankr. D. Ariz. 1994) (“[T]he Court must take into consideration what is in the best interests
of the estate. As stated, the standard is not whether a break-up fee is within the business judgment of the debtor, but whether
the transaction will ‘further the diverse interests of the debtor, creditors and equity holders, alike.’”) (citing In re Lionel Corp.,
722 F.2d 1063, 1071 (2d Cir. 1983)). But see Official Comm. of Subordinated Bondholders v. Integrated Res. (In re Integrated
Res., Inc.), 147 B.R. 650 (S.D.N.Y. 1992), appeal dismissed by 3 F.3d 49 (2d Cir. 1993) (finding that the business judgment rule
applied in nonbankruptcy contexts and thus relied upon that standard in the bankruptcy context as well to determine whether
the proposed breakup fee at issue was appropriate).
506 Telxon Corp. v. Meyerson, 802 A.2d 257, 264 (Del. 2002). See also Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34,
42 n.9 (Del. 1994) (“Where actual self-interest is present and affects a majority of the directors approving a transaction, a court
will apply even more exacting scrutiny to determine whether the transaction is entirely fair to the stockholders”).
507 See Section VI.C.3, Section 506(c) and Charges Against Collateral.
508 See Section VI.C.4, Section 552(b) and Equities in the Case.
509 See Section VI.B, Approval of Section 363x Sales.
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ABI Commission to Study the Reform of Chapter
2. Finality of Orders
Recommended Principles:
The court should not be permitted to reconsider a non-ordinary course transaction
after the entry of an order approving the transaction or to reopen an auction unless
the court finds extraordinary circumstances or material procedural impediments
(such as the lack of adequate notice or an improperly conducted sale process) to
the auction process that may have had a material effect on the sale results. For
purposes of this principle, the potential that a new or continued auction would
generate a higher value for the transaction alone does not constitute extraordinary
circumstances.
Finality of Orders: Background
In the section 363 sale context, a debtor in possession510 seeks to obtain the highest and best price
for the assets. As explained above, a debtor in possession typically conducts an auction process to
facilitate this result.511 The auction procedures are reviewed and approved by the court and may
include a marketing and diligence period and rules governing the auction itself.512 The auction
16
procedures also may contemplate certain bid protections for any stalking, horse bidder.513 After the
1 20
ber 2
m
auction, the debtor in possession presents the winning bidoat Noveauction to the court for approval
n the
ed
hv
under the motion to approve the sale. After the6court ienters the sale order, parties generally have
3 arc
-353
14 days to appeal the order or it becomes. 14 514 Generally, courts are not permitted to reopen an
, No final.
own
515
v. Br
auction or sale.
h
ixset
in Bl
cited
510 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
511 See Section IV.C.2, Timing of Section 363x Sales.
512 One court concluded that “it was necessary to have in place bidding procedures that would provide a reasonable opportunity for
the APA to be tested against the market.” In re Tex. Rangers Baseball Partners, 431 B.R. 706, 711 (Bankr. N.D. Tex. 2010). See also
In re Innkeepers USA Trust, 448 B.R. 131, 148 (Bankr. S.D.N.Y. 2011) (explaining that bid procedures provide “the market and
the Debtors the certainty and the ‘rules’ that they need to complete the auction process and move on to plan confirmation”).
513 A leading bankruptcy treatise explains the rationale for deciding such bid protections in advance of the auction:
Frequently, the issue of whether the court should approve buyer protections arises upon a motion to approve bidding
procedures. The court is asked to approve, before the fact, procedures the propriety of which may be better determined
after the “auction” of the property. For example, the reasonableness of a breakup or topping fee may be more difficult
to evaluate in a vacuum before the sale. Whether a particular procedure chilled bidding may not be determinable until
after the trustee offers the successful bid to the court for approval. However, the fees are to compensate the bidders for
facilitating the auction, for example, by guaranteeing a floor on the bidding. If the court were not to approve the fee
until after the auction, the leading bidder would not have the assurance necessary to commit to support the auction.
Therefore, authorizing the fee only after the auction would defeat its purpose, and the court should address the issues
upon a motion to approve the bid procedures.”
3 Collier on Bankruptcy ¶ 363.02[7].
514 Bankruptcy Rule 6004(h) provides that “[a]n order authorizing the use, sale, or lease of property other than cash collateral is
stayed until the expiration of 14 days after entry of the order, unless the court orders otherwise.” Fed. R. Bankr. P. 6004(h).
515 See Contrarian Funds, LLC v. Westpoint Stevens, Inc. (In re Westpoint Stevens, Inc.), 333 B.R. 30 (S.D.N.Y. 2005), aff ’d in part
and rev’d in part sub nom. Contrarian Funds v. Aretex LLC (In re WestPoint Stevens, Inc.), 600 F.3d 231 (2d Cir. 2010). See also
In re Gil-Bern Indus., Inc., 526 F.2d 627, 628, 629 (1st Cir. 1975) (“[I]t is an abuse of discretion for a bankruptcy court to refuse
to confirm an adequate bid received in a fairly conducted sale merely because a slightly higher offer has been received after the
bidding has closed.”); In re Bigler, LP, 443 B.R. 101, 112 (Bankr. S.D. Tex. 2010) (“To reopen the bidding process to allow [a losing
bidder] to make its late bid would be an abuse of this Court’s discretion. Accordingly, this Court will not reopen bidding.”).
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Several issues can arise during the course of the sale process, including modifications to the auction
procedures without notice to or approval by the court, bidders wanting to submit noncompliant
bids, and even late bidders who cause the debtor in possession, the unsecured creditors’ committee,
or other party in interest to question whether the bid selected at the auction really is the best and
highest offer for the debtor’s assets. In this context, courts have granted motions to reopen an auction
if it would likely result in a better offer.516 Accordingly, courts face challenging issues and competing
interests when confronted with requests to reopen the auction process or to reconsider the order
approving the sale under section 363 of the Bankruptcy Code.
Finality of Orders: Recommendations and Findings
The closing of an auction and the entry of a sale order are key steps in the sale of the debtor’s assets.
They allow the debtor in possession to close the sale and move forward in the case and the successful
bidder to take possession of the assets. The Commissioners discussed the importance of the value
generated by section 363 sales to the estate, and the common desire to want to ensure that the sale
process is extracting as much value as possible from the assets. The Commission reviewed examples
in which this desire caused the debtor in possession, the unsecured creditors’ committee, or a party
in interest to second-guess the auction results or the sale order and to seek related relief from the
court.
016
,2
For example, in the WestPoint Stevens517 chapter 11 case, the debtor in possession obtained approval
er 21
emb
of the court to conduct an auction for substantially all of the d on Nov assets.518 One of the debtor’s
debtor’s
ive
arch
secured creditors, Aretex LLC, along with its affiliates, emerged as the winning bidder at the
5363
14-3
519
No.
auction. The court approved the salerand,entered a sale order permitting the consummation of the
n
B ow
e best
sale to Aretex for the highest landth v. bid.520 But, before the sale closed, certain other lenders moved
xs
nBi
ted i
for a stay of the saleciorder pending appeal of certain provisions in the sale order related to lien
releases, claim satisfaction, and distributions.521 On appeal, however, the Second Circuit rejected the
appeal as statutorily moot under section 363(m).522
The Commission also reviewed a contrary example found in the Foamex chapter 11 case. In that
case, the debtors had selected an all-cash bid that was $5 million lower than the all-cash bid of the
stalking horse because the stalking horse had conditioned its bid on the inclusion of a credit bid
if the auction continued past the then-present round. The bankruptcy reopened the auction and
directed the debtors in possession to accept the stalking horse bid (which included the credit bid),
even though the debtors in possession had complied with the court-approved bid procedures in
516 In re Foamex Int’l, Inc., No. 09-10560 (KJC) (Bankr. D. Del. May 27, 2009). See also Lithograph Legends, LLC v. U.S. Trustee,
2009 WL 1209469, at *3 (D. Minn. Apr. 30, 2009) (“A bankruptcy court may disapprove a proposed sale recommended by a
debtor-in-possession ‘if it has an awareness there is another proposal in hand which, from the estate’s point of view, is better or
more acceptable.’”) (quoting G-K Dev. Co v. Broadmoor Place Invs., L.P. (In re Broadmoor Place Invs., L.P.), 994 F.2d 744, 746
(10th Cir. 1993)).
517 Contrarian Funds, LLC v. Westpoint Stevens, Inc. (In re Westpoint Stevens, Inc.), 333 B.R. 30 (S.D.N.Y. 2005), aff ’d in part and
rev’d in part sub nom. Contrarian Funds v. Aretex LLC (In re WestPoint Stevens, Inc.), 600 F.3d 231 (2d Cir. 2010).
518 Id. at 35.
519 Id. at 36.
520 Contrarian Funds LLC v. Aretex LLC (In re WestPoint Stevens, Inc.), 600 F.3d 231, 242 (2d Cir. 2010) (noting that bankruptcy
court entered order confirming that “the winning bid presented ‘the highest and best bid at the Auction’”) (citations omitted).
521 Contrarian Funds, LLC v. Westpoint Stevens, Inc. (In re Westpoint Stevens, Inc.), 333 B.R. 30, 37 (S.D.N.Y. 2005), aff ’d in part
and rev’d in part sub nom. Contrarian Funds v. Aretex LLC (In re WestPoint Stevens, Inc.), 600 F.3d 231 (2d Cir. 2010).
522 Contrarian Funds v. Aretex LLC (In re WestPoint Stevens, Inc.), 600 F.3d 231, 247 (2d Cir. 2010).
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ABI Commission to Study the Reform of Chapter
accepting the previous bid. The court thereafter overruled the objection by the previous winning
bidder to the sale.
The Commissioners acknowledged that, in some cases, reopening the auction or reconsidering the
sale order may generate additional value for the estate. They also raised concerns, however, that
endorsing this type of relief may prevent robust auctions in the first instance because prospective
bidders need to understand the rules of the auction and to know that, if they participate according to
the rules and win, they will be able to close the sale. This type of certainty and respect for the auction
rules and sale order can enhance the auction itself and prevent gamesmanship by prospective bidders.
The Commissioners also noted that courts currently have the ability to reconsider their orders under
Rule 60(b) of the Federal Rules of Civil Procedure, which provides that the court may relieve a party
from a final order if presented with “newly discovered evidence which by due diligence could not
have been discovered in time to move for a new trial” and due to “fraud . . . misrepresentation, or
other misconduct of an adverse party.” The Commissioners reviewed cases in which courts have
reconsidered (or refused to reconsider) sale orders. 523 They acknowledged that a motion to reconsider
a section 363 sale order can be clouded by the prospect of more value for the estate. Nevertheless, the
Commissioners believed that more value alone as ground for reopening an auction or setting aside a
sale order was too low of a barrier, did not comply with Rule 60(b), and would introduce too much
uncertainty into the sale process.
16
1, 20
ber 2
Consequently, the Commission voted to recommend codifyingovemstandards governing requests to
N the
d on
chive
reopen an auction or to reconsider and set aside 3 asale order. Specifically, it determined that such
a r
3536
. 4relief should be warranted only in instances1when the evidence presented at the hearing demonstrates
No
wn,
procedural impediments in th v. auction or sale process or extraordinary circumstances.
the Bro
e
Blixs
ed in
cit
3. Transactions Free and Clear of Interests
Recommended Principles:
In general, the trustee should be able to sell a debtor’s assets free and clear of
all interests in a debtor’s assets, including liens and encumbrances, to the extent
permitted by the U.S. Constitution and the guidelines set forth in these principles.
In addition, the trustee should be able to sell a debtor’s assets free and clear of
all claims related to a debtor’s assets in the context of a sale of all or substantially
all of a debtor’s assets under section 363x (or a transaction involving less than
substantially all of the debtor’s assets if the court determines that the trustee has
otherwise complied with the requirements of section 363x).
A trustee should be able to sell assets free and clear of interests if applicable
nonbankruptcy law would permit the owner of such assets to sell them free and
clear of such interests. The foreclosure rights of a creditor or other third party
523 For examples of courts considering the finality issue and refusing to reopen auction, see In re Bigler, LP, 443 B.R. 101 (Bankr.
S.D. Tex. 2010); In re Extended Stay Inc., No. 09-13764 (JMP) (Bankr. S.D.N.Y. June 17, 2010) [Docket No. 1102] (transcript of
record); In re Finlay Enters., Inc., No. 09-14873 (Bankr. S.D.N.Y. Nov. 12, 2009) [Docket No. 378] (transcript of record). But see
Corporated Assets, Inc. v. Paloian, 368 F.3d 761 (7th Cir. 2004) (auction reopened due to improper procedures).
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should not be determinative in this context. Bankruptcy Code section 363(f)(1)
and (5) should be amended accordingly.
A trustee should be able to sell assets free and clear of interests without the consent
of any lienholder and regardless of whether the assets generate value in excess
of the aggregate value of the liens in the assets, provided that the liens attach to
the proceeds of the sale or the lienholder receives another appropriate form of
adequate protection of the lien. Section 363(f)(3) should be amended accordingly.
In the context of a section 363x sale, a trustee should be able to sell assets free
and clear of any successor liability claims (including tort claims) other than those
specifically excluded from free and clear sales by these principles.
The court should not approve a sale of a debtor’s assets free and clear of the
following kinds of interests: (i) easements, covenants, use restrictions, usufructs,
or equitable servitudes that are deemed to “run with the land” under applicable
nonbankruptcy law; (ii) environmental obligations that are deemed to “run with
the land” under applicable nonbankruptcy law; (iii) successorship liability for
purposes of federal labor law; and (iv) partial, competing, or disputed ownership
interests, except to the extent specified in section 363(h) or (i).
6
, 201
r 1
The sale of a debtor’s assets free and clear of executory contracts2and unexpired
mbe
Nove
on
leases should be governed by section 365 or, for collective bargaining agreements,
ived
arch
section 1113. Accordingly, the trustee should3be permitted to sell the debtor’s assets
536
14-3
No. and unexpired leases only to the extent such
free and clear of executoryBrown,
contracts
v.
ethrejected in accordance with section 365 or section 1113, as
contracts and leasesxare
i s
in Bl
ited
cand the trustee is permitted by section 365 to recover the property free
applicable,
and clear of the nondebtor counterparty’s rights to use or possess such property.
The court’s approval of a sale free and clear of interests or claims under
section 363(f) should continue to be considered part of the court’s approval of the
overall transaction under section 363(b) or (c). Accordingly, no change to existing
law is suggested on this point.
To the extent permitted by these principles for other claims, the trustee should be
able to sell a debtor’s assets free and clear of any monetary claims by the federal
government or a state government against the debtor or the estate, provided that
such monetary claims constitute “claims” under section 101(5) under current
law. The trustee should not be able to sell a debtor’s assets free and clear of any
enforcement rights of such government to the extent that such rights are within
such government’s police or regulatory powers and could be enforced against
the debtor or the estate under section 362(b)(4), or to the extent that the state or
federal government incurs costs post-sale in the exercise of its police or regulatory
powers.
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ABI Commission to Study the Reform of Chapter
Transactions Free and Clear of Interests: Background
In many chapter 11 cases, some or all of the debtor’s property is encumbered or subject to the
liens, interests, and claims of various stakeholders. The holders of these liens, interests, and claims
may have rights under nonbankruptcy law or prepetition agreements that make the transfer of the
debtor’s assets difficult or less attractive to prospective lessees and purchasers. These liens, interests,
and claims may include mortgages, security interests, easements, or successor liability claims.
Under section 363(f), a debtor in possession524 may sell its assets under section 363(b) or (c) “free
and clear of any interest in such property of an entity other than the estate” only if: (1) ”applicable
nonbankruptcy law permits sale of such property free and clear of such interest”; (2) “such entity
consents”; (3) “such interest is a lien and the price at which such property is to be sold is greater than
the aggregate value of all liens on such property”; (4) “such interest is in bona fide dispute”; or (5)
“such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of
such interest.”525 Section 363(f) is limited to “any interest in such property.” Notably, this language is
different from that used in section 1141(c), which speaks to “property dealt with by the plan [being]
free and clear of all claims and interests of creditors, equity security holders, and of general partners
in the debtor.”526
The legislative history of section 363(f) provides little guidance on the scope of the term “interest,”
other than to acknowledge that a lien should be considered an interest016 property.527 Courts
, 2 in
er 21
bfirst construes section 363(f)
em
interpreting this section have taken two general approaches:ovthe
nN
ed o mortgages, and money judgments;528
narrowly and limits its application to liens, security rinterests,
chiv
63 a
-353interests and captures claims against the debtor or
and the second takes a more expansive o. 14 of
view
,N
rown
estate property, including successor liability claims, discrimination claims, personal injury claims,
v. B
seth
and other “claims” d in Blix the meaning of section 101(5) of the Bankruptcy Code.529 Some courts
within
cite
and commentators argue that the expansive approach is necessary to facilitate sales under section
363(f) and to achieve the underlying policy objectives of the Bankruptcy Code.530
524 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
525 11 U.S.C. § 363(f).
526 Id. § 1141(c).
527 The legislative history provides, in relevant part:
At a sale free and clear of other interests, any holder of any interest in the property being sold will be permitted to bid.
If that holder is the high bidder, he will be permitted to offset the value of his interest against the purchase price of
the property. Thus, in the most common situation, a holder of a lien on property being sold may bid at the sale, and
if successful, may offset the amount owed to him that is secured by the lien on the property (but may not offset other
amounts owed to him) against the purchase price, and be liable to the trustee for the balance of the sale price, if any.
H.R. Rep. 95-595 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6302; S. Rep. 95-989 (1978), reprinted in 1978 U.S.C.C.A.N. 5787,
5842.
528 See, e.g., In re White Motor Credit Corp., 75 B.R. 944, 948 (Bankr. N.D. 1987); In re New England Fish Co., 19 B.R. 323, 329
(Bankr. W.D. Wash. 1982).
529 See, e.g., In re Trans World Airlines, Inc., 322 F.3d 283, 289 (3d Cir. 2003) (“[T]he trend seems to be toward a more expansive
reading of ‘interests in property’ which ‘encompasses other obligations that may flow from ownership of the property’”) (citing
3 Collier on Bankruptcy ¶ 363.06[1]); In re WBQ P’ship, 189 B.R. 97, 105, (Bankr. E.D. Va. 1995).
530 See, e.g., In re Trans World Airlines, Inc., 322 F.3d 282, 290 (3d Cir. 2003) (suggesting a trend toward an expansive view of section
363(f) to include claims); Folger Adam Sec., Inc. v. DeMatteis/MacGregor, JV, 209 F.3d 252 (3d Cir. 2000) (holding that pursuant
to section 363(f), the debtors’ contractual payment rights was free and clear of a contractor’s previously unexercised setoff rights,
but was not free and clear of the contractor’s recoupment rights because by their very nature, recoupment rights simply cannot
be considered an “interest” in property extinguished by a section 363(f) free-and-clear sale”); In re Tougher Indus., Inc., 2013
WL 1276501, at *6 (Bankr. N.D.N.Y. Mar. 27, 2013).
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Courts also take different approaches to whether a debtor in possession has satisfied one of the
grounds set forth in section 363(f) to support a sale free and clear of interests in the property.531
For example, some courts require the sale price to exceed the face value of secured claims asserted
against the property to satisfy section 363(f)(3).532 Other courts require only that the sale price
exceed the economic value of the creditors’ allowed secured claims under section 506.533 Courts
also disagree as to what constitutes a bona fide dispute for purposes of section 363(f)(4).534 They
also have taken different approaches to whether the language in section 363(f)(5) providing that the
“entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such
interest” includes a cramdown of a chapter 11 plan under section 1129(b).535
Transactions Free and Clear of Interests: Recommendations and Findings
The Commissioners analyzed section 363(f) of the Bankruptcy Code and the concept of sales
“free and clear” of liens, interests, and claims. They reviewed the original focus of that section on
“interests” in estate assets, and they discussed the expansion of that concept to claims of various
kinds. The Commissioners identified different kinds of claims that courts have included within
section 363(f), including litigation claims, discrimination claims, and successor liability claims. The
Commission agreed that this expansive approach to section 363(f) fostered more competition for
the debtors’ assets and likely enhanced the value of the assets sold through the section 363(f) sale
process. The Commissioners questioned whether the historical nexus between “free and clear” sales
2016
under section 363(f) and in rem notions of property interests still servedber 21,
bankruptcy policy.
m
ve
n No
ed o
hiv
To analyze this question, the Commission considered 3 arclanguage and purpose of section 1141(c)
6 the
-353
. 14
of the Bankruptcy Code and the inclusionnof claims in the discharge injunction in connection with a
, No
row
B
h v.
chapter 11 plan. The Commissioners suggested that this difference may relate to the more significant
xset
n Bli
i
ci provided to creditors in the plan process. Although creditors holding general
notice and due processted
unsecured claims (including the kinds of litigation and other claims mentioned above) do not have
any particular interest in the debtor’s property, they receive notice and an opportunity to object to
the treatment of their claims under the plan. In the section 363 context, such creditors may or may
not receive notice of the sale motion or an opportunity to object.
531 See generally George W. Kuney, Misinterpreting Bankruptcy Code Section 363(f) and Undermining the Chapter 11 Process, 76 Am.
Bankr. L.J. 235, 244 (2002).
532 See, e.g., Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25, 40–41 (B.A.P. 9th Cir. 2008). See also Criimi Mae
Servs., Ltd. P’ship v. WDH Howell, LLC (In re WDH Howell, LLC), 298 B.R. 527, 534 (D.N.J. 2003). See also Robert M. Lawless,
BAP Prohibits Sale Free and Clear of an Underwater Junior Lien, Bankr. L. Letter, Oct. 2008, at 7 (“Although the result in Clear
Channel will be controversial, its specific holding on section 363(f)(3) should not be. Its reasoning is compelling on the statutory
language, and it reaches a result well within the mainstream of other court decisions. To sell free and clear under section 363(f)
(3), the sales price must exceed the total value of all liens regardless of whether those are totally secured or undersecured.”)
(citations omitted).
533 See, e.g., WBQ P’ship v. Va. Dep’t of Med. Assistance Servs. (In re WBQ P’ship), 189 B.R. 97, 105–06 (Bankr. E.D. Va. 1995); In re
Beker Indus. Corp., 63 B.R. 474, 475–76 (Bankr. S.D.N.Y. 1986).
534 See, e.g., Union Planters Bank v. Burns (In re Gaylord Grain LLC), 306 B.R. 624 (B.A.P. 8th Cir. 2004).
535 See, e.g., Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25, 46 (B.A.P. 9th Cir. 2008). See also Lawless,
BAP Prohibits Sale Free and Clear of an Underwater Junior Lien, supra note 532, at 8 (“Instead of the Chapter 11 cramdown,
a state foreclosure proceeding would seem to be a proceeding where the second lienholder could be compelled to accept a
monetary satisfaction of its lien and thus satisfy the requirements of (f)(5). Indeed, the word ‘foreclosure’ means exactly that —
the foreclosure of junior interests. A hypothetical state foreclosure proceeding seems so obvious that one wonders why the BAP
[in Clear Channel] did not simply take judicial notice of it to hold that (f)(5) was satisfied. Perhaps the court’s concern was the
lack of a solid record on how the foreclosure sale process would play out and specifically what value the property would bring at
a foreclosure sale, although the bidding at the bankruptcy court would again seem to be an obvious place to look for the value
of the property. The concern about the lack of a record perhaps can be seen in the BAP’s references to 363 sales being used to
bypass the more procedurally robust confirmation requirements of section 1129 that could protect third-party rights.”) (citations
omitted).
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ABI Commission to Study the Reform of Chapter
The Commissioners evaluated whether this difference in process should preclude an expansive
reading of section 363(f) that would include liens, interests, and claims. With respect to singleasset sales or smaller transactions, the Commission agreed that the notice currently required by the
Bankruptcy Rules was likely sufficient, as assets remained in the estate to potentially fund claims
through a chapter 11 plan. In a sale of all or substantially all of a debtor’s assets, however, the calculus
may be different. On that point, the Commissioners noted that these principles recommend notice
and due process procedures similar to what creditors are entitled to in the plan context. Accordingly,
under the principles applicable to section 363x sales, creditors holding the kinds of claims subject
to section 363(f) under the expansive view would receive notice and an opportunity to object to the
proposed sale.
The Commissioners were also persuaded that permitting the debtor in possession to transfer clean
title to a purchaser under section 363(f) held potentially significant value for the estate. To that
end, the Commissioners analyzed the conflicting interpretations of certain subsections of section
363(f) and identified approaches that would foster a competitive sale process while still protecting
creditors’ rights against the estate. The Commission agreed that the scope of section 363(f)(1) and
(5) should be clarified to focus on the property owner’s rights under applicable nonbankruptcy law.
The Commission also determined, however, that these ambiguities and perceived barriers to free and
clear transfers in a chapter 11 case would likely be mitigated by its recommended change to section
363(f)(3). With the additional notice and process being recommended in the context of sales of all
16
1, 2
or substantially all of the debtor’s assets, the Commission determined 2that0adopting an expansive
ber
m
N the
view of section 363(f) was warranted and adequately protected ove interests of stakeholders.
d on
ive
arch
363
-35
The Commissioners further considered o. 14
n, N whether any particular liens, interests, or claims should be
Brow
excluded from section 363(f) under this expansive approach. They methodically evaluated different
th v.
lixse
in B
kinds of claims and interests. They decided that the debtor in possession should be able to transfer
cited
property free and clear of all liens, interests, and claims, including without limitation: civil rights
liabilities; successor liability in tort; and successor liability in contract. The Commissioners also
concluded that the debtor in possession should not be able to transfer property free and clear of the
following: easements, covenants, use restrictions, usufructs, or equitable servitudes that run with
the land; environmental liabilities and related social policies that run with the land; successorship
liability under federal labor laws; and partial, competing or disputed ownership interests, except to
the extent specified in section 363(h) or (i). Moreover, the Commissioners recognized that a debtor in
possession should not be able to sell or transfer assets under section 363(f) in a manner that violates
or impedes the police or regulatory power of the federal government or a state government to the
extent that such government could enforce those rights against the debtor in possession or estate
property during the case, notwithstanding section 362(a) of the Bankruptcy Code. The Commission
thus recommended that section 363(f) recognize the government’s police and regulatory powers to
the extent such powers would be enforceable under section 362(b)(4).
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4. Credit Bidding
Recommended Principles:
In a sale under section 363 of the Bankruptcy Code involving a secured creditor’s
collateral, the secured creditor should be permitted to credit bid up to the amount
of its allowed claim relating to such collateral unless the court orders otherwise
for cause. For purposes of this principle, the potential chilling effect of a credit bid
alone should not constitute cause, but the court should attempt to mitigate any
such chilling effect in approving the process. Section 363(k) should be clarified
accordingly.
Credit Bidding: Background
A creditor with a perfected lien in the debtor’s property has certain rights and remedies against
the debtor and property within the creditor’s collateral package. Among other things, the secured
creditor can credit bid the amount of its allowed claim in any sale of its collateral. A secured creditor’s
right to credit bid exists under both state law and section 363(k) of the Bankruptcy Code. Section
363(k) provides: “At a sale under subsection (b) of this section of property that is subject to a lien
16
that secures an allowed claim, unless the court for cause orders otherwiseethe ,holder of such claim
1 20
b r2
m
may bid at such sale, and, if the holder of such claim purchases d on Nove
such property, such holder may offset
e
v
ar
such claim against the purchase price of such property.”536chi
363
-35
o. 14
n, N
w
A credit bid allows the secured eth v. Bro to purchase the property constituting its collateral if other
creditor
lixs
in B
bidders are not willingitto pay sufficient value or the creditor prefers to possess the collateral in lieu of
c ed
payment. The secured creditor also does not need to pay any cash for the property at the sale to the
extent the allowed amount of its claim is sufficient to cover the price of its winning bid. Rather, the
secured creditor can set off its secured claim against the debtor or the property against the purchase
price it otherwise would be required to pay the estate.537
Although credit bidding is an integral part of the secured creditors’ rights package, it is not without
limit. Specifically, section 363(k) allows the court to limit a secured creditor’s credit bid for cause.538
Courts typically have found cause to limit a credit bid if the amount of the secured creditor’s claim
is disputed or unliquidated.539 Courts also have found cause to limit a credit bid, however, based on
the conduct of the secured creditor. For example, In re Free Lance-Star Publishing Co., the court held
that the secured creditor did not have the right to credit bid on assets that did not secure its allowed
claim and found cause to limit the creditor’s right to credit bid at the auction based on, among other
things, the creditor’s “overly zealous loan-to-own strategy,” in which the creditor acquired the loan
536 11 U.S.C. § 363(k).
537 Written Statement of Danielle Spinelli, Partner, WilmerHale, TMA Field Hearing Before the ABI Comm’n to Study the Reform of
Chapter 11 (Nov. 3, 2012) (providing historical overview and describing the evolution of credit bidding in bankruptcy), available
at Commission website, supra note 55.
538 11 U.S.C. § 363(k) (“At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed
claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim
purchases such property, such holder may offset such claim against the purchase price of such property.”).
539 See, e.g., In re RML Dev., Inc., 2014 WL 3378578 (Bankr. W.D. Tenn. July 10, 2014) (valid claims objection that could not be
resolved without delaying auction was cause to limit amount of credit bid).
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ABI Commission to Study the Reform of Chapter
for the sole purpose of obtaining the right to credit bid at an expedited sale of the debtor’s assets
and discouraged any competitive bidding.540 Similarly, in Fisker Automotive Holdings, the court
found cause to limit the secured creditor’s ability to credit bid the entire amount of its secured claim
because the amount was uncertain, and allowing the creditor to credit bid its entire claim would
freeze out all competitive bidding by attractive and capable bidders.541
Credit Bidding: Recommendations and Findings
The Commission considered credit bidding under section 363(k) in light of recent case law
developments and an arguably expanded application of the cause standard for limiting credit bids.
The Commissioners discussed the fundamental role of credit bidding under state law and section
363(k).542 They also acknowledged that all credit bidding chills an auction process to some extent.
Accordingly, the Commissioners did not believe that the chilling effect of credit bids alone should
suffice as cause under section 363(k).
The Commissioners noted that, in some cases, it may be difficult to discern any chilling effect caused
by the credit bid itself from a chilling effect resulting from the conduct of the secured creditor
seeking to exercise its right to credit bid. For example, the Commissioners discussed situations in
which the secured creditor demands a relatively short period to market the property and conduct
the sale, requires the marketing materials to highlight the secured creditor’s right to credit bid, or
016
takes other actions to discourage a competitive bidding process. The er 21, 2
b Commission agreed that such
em
conduct could, in fact, depress the value of the property on Nopreclude the estate from receiving
and v
ed
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3 arc
any return from the sale.543 The Commissioners,6however, did not want to endorse a principle that
-353
14
would suggest that the chilling effect n, Nocredit bid warrants restrictions on the right to credit bid.544
of a .
row
v. B
The Commission ultimatelyhagreed to maintain the current standard under section 363(k), with
xset
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the recommendation that the chilling effect of a credit bid not be deemed sufficient cause to limit a
credit bid, but that courts should attempt to mitigate any chilling effect through the auction and sale
procedures approved in the case.
540 In re Free Lance-Star Publ’g Co. of Fredericksburg, Va., 512 B.R. 798 (Bankr. E.D. Va. 20141), appeal denied, 512 B.R. 808 (E.D.
Va. 2014).
541 In re Fisker Auto. Holdings, Inc., 510 B.R. 55 (Bankr. D. Del. 2014), appeal denied, 2014 WL 576370 (D. Del. Feb. 12, 2014).
542 See, e.g., Brubaker, The Post-RadLAX Ghosts of Pacific Lumber and Philly News, supra note 43, at 3 (“For secured creditors,
operating on the assumption that in a free-and-clear sale of its collateral the sale price itself establishes the value of the collateral,
credit bidding serves two protective functions — both as an undervaluation protection and a proceeds protection. Not only
can the undersecured creditor bid in its claim to acquire the assets when it believes the otherwise prevailing sale price is too
low, the undersecured creditor can also bid in its claim to acquire the assets when it believes that the proposed plan would not
return to the undersecured creditor the full value of the proceeds generated by sale (i.e., the value) of its collateral.”); Ralph
Brubaker, Credit Bidding and the Secured Creditor’s Baseline Distributional Entitlement in Chapter 11, Bankr. L. Letter, July 2012,
at 8 (“[T]the legislative record indicates that the Code drafters also considered the credit bidding rights separately codified in §
363(k) to be an integral component of adequately protecting the secured creditor’s lien rights.”). “By holding that a dissenting
secured creditor must be afforded credit-bidding rights under § 363(k) in any free-and-clear sale of its collateral under a plan of
reorganization, RadLAX ensures that secured creditors have the same credit-bidding rights in plan sales that they have in § 363
sales.” Id.
543 See, e.g., Brubaker, The Post-RadLAX Ghosts of Pacific Lumber and Philly News, supra note 43, at 4 (“When the undersecured
creditor’s collateral is the entirety of the debtor’s assets, therefore, credit-bidding rights in any going-concern sale of the debtor’s
business and assets give that senior secured creditor the leverage to always insist upon capturing all of the debtor’s reorganization
surplus, to the detriment of unsecured creditors and other junior classes.”).
544 Written Statement of Danielle Spinelli, Partner, WilmerHale, TMA Field Hearing Before the ABI Comm’n to Study the Reform of
Chapter 11 (Nov. 3, 2012) (“To the extent that the argument here is that cash bidders will be chilled because they fear that a
secured creditor may outbid them, it lacks force. That would be equally true of any deep-pocketed bidder, and no auction can
afford to exclude the bidders with the greatest resources on the ground that they might outbid everyone else.”), available at
Commission website, supra note 55.
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C. Avoiding Powers
1. Preference Claims
Recommended Principles:
The trustee’s ability to pursue preference claims under section 547 of the Bankruptcy
Code preserves value for the estate and tempers the “run on the debtor” that may
occur immediately prior to a bankruptcy filing. The avoiding power in section
547 may, however, be subject to abuse in certain cases. The Commission analyzed
a variety of potential reforms to section 547, including refining elements of, or
shifting the burden of proof for, certain defenses under section 547(c). After much
research and deliberation, the Commission determined that the potential abuses
under section 547 are addressed most effectively through the changes in small
preference actions, pleading requirements, and demand requirements described
in these principles, and continued judicial oversight in accordance with the
Bankruptcy Code.
The trustee should be precluded from issuing a demand letter to, or filing a
16
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complaint against, any party for an alleged claim under section 547 ,unless, based
ber 2
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on reasonable due diligence, the trustee believesved ogood faith that a plausible
in n No
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claim for relief exists against such party-underar
3536 section 547, taking into account the
. 14
party’s known or reasonablyrown, No affirmative defenses under section 547(c).
knowable
B
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i
The trustee imust plead with particularity factual allegations in the complaint that
c ted
establish a plausible claim for relief under section 547. In accordance with the
U.S. Supreme Court’s decisions in Bell Atlantic Corp. v. Twombly, 550 U.S. 544
(2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009), legal conclusions or speculative
allegations should not be sufficient to support a preference complaint.
The dollar amount of the defense against preference claims provided in
section 547(c)(9) should be increased to $25,000 in the aggregate. This dollar
amount should continue to be increased based on the Consumer Price Index for
All Urban Consumers under section 104(a).
The small claims venue provision in 28 U.S.C. § 1409(b) should be amended
to (i) clarify that the section applies to preference actions under section 547
and (ii) increase the dollar limit for debts (excluding consumer debts) against
noninsiders to $50,000 in the aggregate. This dollar amount should continue to
be increased based on the Consumer Price Index for All Urban Consumers under
section 104(a).
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Preference Claims: Background
The concept of preference law dates back to the 1584 English King’s Bench decision, The Case of
Bankrupts (finding postpetition transfers ineffective against a bankrupt’s estate)545 and the 1768
decision of Alderson v Temple (authorizing the recovery of property preferred to a particular
creditor).546 Since that time, the law has undergone numerous variations with regard to the underlying
purpose of the transfer, the necessary intent of the parties, and the insolvent state of the debtor at
the time of the transfer. In 1978, Congress revised the preference law to omit the requirement that
the trustee547 establish that the creditor had reasonable cause to believe the debtor was insolvent, in
exchange for the reduction of the noninsider reachback period from 120 to 90 days and the addition
of a 90-day presumption of insolvency.
The primary goals of preference law are (i) to equalize distribution and (ii) to maximize estate
value.548 It seeks to achieve these goals through property recapture and deterrence.549 Under the
Bankruptcy Code’s original conception of preference law, the trustee could recover payments or
property transferred to creditors prepetition to the extent those transfers preferred such creditors
over other similarly situated creditors (typically general unsecured creditors).550 The trustee would
then distribute the recovered value to all similarly situated creditors. Even the creditors from which
the trustee recovered preferences were, in many instances, entitled to receive a pro rata share of the
recovered value.551
16
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Since 1978, the application of preference law has changed. Someem
v commentators question whether
n No
552 ived o
preference law continues to serve its original goals. rchThese commentators suggest that preference
a
363
law is not an effective deterrent and does 14-35
. not necessarily equalize distributions. In fact, anecdotal
, No
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evidence shows that, in manyhcases, w value of preference recoveries no longer is reallocated among
v. Br the
set
general unsecured d in Blix
e creditors. Rather, secured creditors are granted liens in preference claims and
cit
recoveries as part of adequate protection, cash collateral, or debtor in possession financing orders
in the case.553 Alternatively, the estate may not have sufficient resources to pay administrative and
priority claims in the case, and the trustee applies preference recoveries to these claims.554 Moreover,
545 7 Eng. Rep. 441 (K.B. 1584).
546 96 Eng. Rep. 384 (K.B. 1768).
547 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
548 John C. McCoid, Bankruptcy, Preferences, and Efficiency: An Expression of Doubt, 67 Va. L. Rev. 249, 261 (1981).
549 Id. at 262.
550 See, e.g., G.H. Leidenheimer Baking Co., Ltd. v. Sharp (In re SGSM Acquisition Co., LLC), 439 F.3d 233, 238 (5th Cir. 2006) (“The
theory is that when the preferential payments are returned, all creditors can share ratably in the debtors’ assets, and the race to
the courthouse, or the race to receive payment from a dwindling pre-bankruptcy estate, will be averted.”).
551 For examples of statutory authority for such distributions, see Section 57g of the Bankruptcy Act and section 502(h) of the
Bankruptcy Code.
552 See, e.g., Brook E. Gotberg, Conflicting Preferences in Business Bankruptcy: The Need for Different Rules in Different Chapters, 100
Iowa L. Rev. 51 (2014).
553 Terry Brennan, Miller: Liquidations Set to Rise, The Deal, Dec. 2, 2003, available at 2003 WLNR 4666298; Kenneth N. Klee &
Richard Levin, 21 Norton J. Bankr. L & Prac. 5, §§ 3.0, 3.6 (Nov. 2012); see Thomas D. Goldberg, Curbing Abusive Preference
Actions — Rethinking Claims on behalf of Administratively Insolvent Estates, Am. Bankr. Inst. J., May 2004, at 14.Goldberg. See
also In re Furr’s Supermarkets, Inc., 373 B.R. 691, 697 (B.A.P. 10th Cir. 2007) (proceeds of avoidance actions split between
secured lender and administrative claims); Mellon Bank, N.A. v. Dick Corp., 351 F.3d 290, 294 (7th Cir. 2003), cert. denied, 541
U.S. 1037 (2004) (proceeds of avoidance actions used solely to pay claims of secured lenders); In re Payless Cashways, Inc., 290
B.R. 689, 696–97 (Bankr. W.D. Mo. 2003) (preference action recoveries solely to satisfy administrative claims).
554 Companies increasingly utilize easy to obtain prepetition financing, through mezzanine funding, leveraged lending, second lien
debt, and securitization, such that potential debtors are now contemplating bankruptcy with extremely leveraged balance sheets.
As a result, little, if any, unencumbered collateral is often available to offer prospective DIP lenders. See Stephen A. Donato &
Thomas L. Kennedy, Trends in DIP Financing: Not as Bad as It Seems?, J. Corp. Renewal, Sept/Oct. 2009, ¶¶ 11–12, available at
http://www.turnaround.org/Publications/Articles.aspx?objectId=11602. See also Goldberg, supra note 553, at 14.
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trustees may pursue preference claims in situations in which a cost-benefit analysis indicates little
value for the estate, but significant cost and burden for the targeted creditors.
Preference Claims: Recommendations and Findings
Preference law is one aspect of a chapter 11 case that affects creditors on an individual basis. Unlike
other aspects of bankruptcy law that generally affect creditors’ rights, preference law challenges
transfers made to a particular creditor and may require that creditor to disgorge prepetition payments
to the estate. The Commissioners acknowledged that from the unsecured creditor’s perspective,
preference law appears unfair and potentially increases the losses by that particular creditor as a
result of the chapter 11 case, particularly if preference recoveries are not available to pay general
unsecured claims.
The Commission reviewed the testimony from the various public hearings, which evidenced strong
frustrations with preference law. Witnesses testified that some trustees pursued preference actions
with little diligence and without regard to the merits of the underlying claim.555 They suggested that,
at least from an outside perspective, some trustees appear to file preference actions not necessarily to
recover the alleged preference, but to extract a settlement payment.556 The Commissioners discussed
different options for addressing these concerns and enhancing the efficiency of the preference
process,557 as well as the potential abuses associated with each.558
6
1
1, 20
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m
Under section 547 of the Bankruptcy Code, the trustee currently Nove the burden of proving the
n bears
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elements of a preference claim under section 547(b), and then the creditor bears the burden of
63 a
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proving one of the affirmative defenseswn, No. 1 in section 547(c). The Commission considered
contained
ro
supplementing the elements liof eth v. B 547(a) with an affirmative statement concerning diligence
section
B xs
d in
ethe merits of the preference claim in light of any section 547(c) defenses
performed to evaluate
cit
available to the creditor. Alternatively, some of the Commissioners suggested a presumption in favor
of the creditor that the prepetition transfer was in the ordinary course of business, which the trustee
could rebut as part of its prima facie case.559 Although the Commissioners found potential utility
555 See Oral Testimony of Kathy Tomlin: NACM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 27–29
(May 21, 2013) (NACM Transcript) (noting how she spends tremendous time and resources successfully defending preference
actions and arguing that trustees and debtors should have an obligation to evaluate preference claims and defenses before making
a repayment demand), available at Commission website, supra note 55; Oral Testimony of Joe McNamara: NACM Field Hearing
Before the ABI Comm’n to Study the Reform of Chapter 11, at 12 (May 21, 2013) (NACM Transcript) (providing specific example
of time and costs associated with preference action in a particular case), available at Commission website, supra note 55.
556 See Oral Testimony of Valerie Venable: NACM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 34–37
(May 21, 2013) (NACM Transcript) (“The trustee knows [that preference defense] is going to get expensive to me to continue to
defend and is counting on a monetary settlement just to get rid of them.”), available at Commission website, supra note 55.
557 The Commissioners also discussed eliminating the preference statute in its entirety but that principle was rejected. The
Commissioners agreed that any such elimination would only accelerate the prepetition depletion of a debtor’s assets.
558 In re Ames Dep’t Stores, Inc., 450 B.R. 24 (Bankr. S.D.N.Y. 2011), aff ’d, 470 B.R. 280 (S.D.N.Y. 2012), aff ’d, 506 Fed. App’x 70 (2d
Cir. 2012), cert. denied, 134 S. Ct. 65 (2013).
559 First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial Fin.
Ass’n Annual Meeting, at 12 (Nov. 15, 2012) (“Since 1978, it has become common in cases of any size that post-confirmation
liquidation trustees or post-conversion chapter 7 trustees assert claims against all creditors who received payments from the
debtor within 90 days before the commencement of the case that those payments may be avoidable preferences. In some, but
not all, such cases, the trustees at least perform new value analyses and claim only the net balance; in virtually no cases do the
trustees assess the likelihood of an ordinary course defense. There are usually exchanges of letters and spreadsheets resulting in
settlements for a fraction of the amount of the original claims. Often, the creditors settle for nuisance value just to avoid the costs
of litigation. This practice imposes costs on creditors vastly disproportionate to the gain to estates, and is particularly difficult for
factors who do not have direct access to the original vendors’ records. Since factors are a major source of financing for small and
medium sized firms, this burden should be of concern to everyone. Requiring the trustees to plead that challenged transfers were
not in the ordinary course or subject to new value setoff would reduce the number and burden of weak claims without imposing
undue burdens on the trustees. The same records that allow the trustees to identify the payments they question would also allow
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ABI Commission to Study the Reform of Chapter
in each option, they raised concerns regarding a trustee’s ability to obtain information sufficient to
make affirmative statements or rebut such a presumption as part of its prima facie case. Some of the
Commissioners noted that, in many cases, the books and records of the debtor do not provide the
information necessary to make these assessments at the outset, and that trustees typically perform
due diligence and make good faith attempts to assess the merits of the potential preference action
before filing the complaint against, or issuing a demand letter to, the creditor. These Commissioners
acknowledged the concerns of the hearing witnesses, but believed those represented the exception
rather than the rule concerning a trustee’s pursuit of preference claims. The Commission reviewed
the steps commonly taken by trustees in evaluating preference claims to try to develop a threshold
standard that would not be unduly burdensome on trustees, but also would provide some protection
to creditors in the process.
The Commission ultimately determined that codifying a standard that required the trustee to perform
reasonable due diligence and to make good faith efforts to evaluate the merits of the preference
claim was a reasonable compromise. It also agreed that the statute should require the trustee to
plead with particularity in the complaint the facts supporting each element of the preference claim
under section 547(b), in accordance with the U.S. Supreme Court’s decisions in Bell Atlantic Corp.
v. Twombly and Ashcroft v. Iqbal,560 which provide that legal conclusions or speculative allegations
should not be sufficient to support a complaint. Finally, the Commission recommended increasing
the monetary caps in section 547(c)(9) of the Bankruptcy Code and section 1409(b) of title 28 of
16
1, 0
the U.S. Code (the small claims venue provision) to $25,000 and $50,000,2respectively (indexed in
ber 2
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accordance with section 104(a) of the Bankruptcy Code). oTheoCommission voted to recommend
nN
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these three changes. The Commissioners firmly believed that these changes collectively would
63 a
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14
mitigate many of the perceived or actualoabuses in the preference process.
N .
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The Commissionited reviewed the potential impact of fee shifting or sanctions in the context of
c also
preference litigation. Many of the Commissioners did not support a straight “loser pays” rule, as it
could penalize preference defendants in close cases when the claims were disputed and the creditor
loses. The Commissioners were also concerned about requiring the estate to pay when the trustee
loses on a preference claim because of the nature of preference litigation, which often is uncertain
and involves trustees initially working with limited information, and the harm to other beneficiaries
of the estate. The Commission determined that neither fee shifting nor sanctions were warranted or
workable in the preference context.
2. Recoveries Under Section 550
Recommended Principles:
The trustee should be permitted to name an alleged subsequent transferee as a
defendant in the original complaint to avoid any transfer under Bankruptcy Code
section 544, 545, 547, 548, 549, or 553(b), and to recover such property under
them to assess sufficiently for Rule 9011 purposes the ordinary course and new value issues at little additional cost to them. On
the other hand, the savings to factors and other creditors that would result from weeding out weak claims before they are even
asserted would be substantial.”), available at Commission website, supra note 55.
560 Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007); Ashcroft v. Iqbal, 556 U.S. 662 (2009).
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Bankruptcy Institute
section 550. If any alleged subsequent transferee is not named as a defendant in
the original complaint, the trustee should be required to sue such transferee in a
subsequent action under section 550, and such transferee should have the ability
to raise any and all defenses, including those relating to the original avoidance
action, in that litigation. Section 550 should be amended accordingly.
The term “for the benefit of the estate” under section 550(a) should be interpreted
broadly to permit recoveries for the benefit of “all creditors according to their
statutory and contractual entitlements.” Mellon Bank, N.A. v. Dick Corp., 351 F.3d
290, 293 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004). This interpretation
of section 550(a) should include all creditors, including administrative claimants
and prepetition equity security holders, but should not include lenders under a
postpetition financing facility. See Section IV.B, Financing the Case. It also should
not expand or otherwise affect the underlying causes of action that a trustee must
establish prior to seeking recoveries under section 550.
The trustee should be able to file an action under chapter 5 of the Bankruptcy Code
to avoid and recover transfers occurring outside the United States to the same extent
it could file such an action with respect to domestic transfers. In reviewing any
avoidance action involving transfers occurring solely outside the United States, the
16
1, 20
court should consider whether allowing such action to proceedeis2consistent with
b r
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general principles of comity and is reasonably necessary Nove
n to protect the interests of
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the estate, considering the expectations of3thearch
63 defendants, the laws of the foreign
-35
4
jurisdiction, and the relief available o. 1the trustee in the foreign jurisdiction.
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Recoveries Under Section 550: Background
Section 550 of the Bankruptcy Code complements the trustee’s chapter 5 avoiding powers by
allowing the trustee561 to recover the property involved in, or the value of, any avoided transfers.562
For example, a debtor in possession may avoid preferential transfers under section 547 or fraudulent
transfers under section 548 or 544(b) and then seek to recover the security interest, lien, asset,
or money transferred in those avoided transactions under section 550. Specifically, section 550(a)
provides as follows:
(a) Except as otherwise provided in this section, to the extent that a transfer is avoided under
section 544, 545, 547, 548, 549, 553(b), or 724(a) of this title, the trustee may recover, for
the benefit of the estate, the property transferred, or, if the court so orders, the value of such
property, from —
(1) the initial transferee of such transfer or the entity for whose benefit such
transfer was made; or
561 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
562 11 U.S.C. § 550.
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ABI Commission to Study the Reform of Chapter
(2) any immediate or mediate transferee of such initial transferee.563
Section 550 establishes a two-step process: the debtor in possession first files a complaint to avoid the
subject transfer or transaction; and then, after the court grants the relief requested by the complaint,
the debtor in possession files a separate action to recover the property (or the value of the property)
involved in the avoided transfer or transaction. Although the debtor in possession may assert the
avoidance action and the recovery action against the transferee in the same complaint, the language
of the statute suggests that a separate action must be filed against any subsequent transferees.564
Some courts also are uncertain whether a debtor in possession is authorized to seek to recover
property from foreign subsequent transferees under section 550.565
In addition, courts are divided concerning the interpretation of the phrase “for the benefit of the
estate” as used in section 550.566 Some courts interpret the phrase broadly, permitting recovery as soon
as there is some identifiable benefit to the estate.567 Other courts utilize a narrower interpretation,
restricting recoveries to those circumstances in which a more direct benefit to creditors (at times,
specifically unsecured creditors) can be shown.568
The Fifth, Seventh, and Tenth Circuits, as well as certain lower courts within those Circuits,
interpret section 550 broadly.569 These courts hold that there is a benefit to the estate when any
interested party in a bankruptcy case stands to benefit from avoidance action recoveries.570 The term
1
“interested party” has been interpreted not only to include secured creditors,6unsecured creditors,
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and administrative claimants,571 but also equity security holders.572 In addition, the benefit to the
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estate does not need to be direct, but may arise indirectly by, for example, increasing the likelihood
63 a
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.
of effectuating a successful reorganization 14 meeting payment obligations under a plan.573
, No or
563
564
565
566
567
568
569
570
571
572
573
h v.
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n
Brow
Id.
Id.
See Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 2014 U.S. Dist. LEXIS 91508 (S.D.N.Y. July 6, 2014).
See e.g., In re Acequia, Inc., 34 F.3d 800, 811–12 (9th Cir. 1994).
In re C.W. Mining Co., 477 B.R. 176, 189 (B.A.P. 10th Cir. 2012), aff ’d, 749 F.3d 895 (10th Cir. 2014) (explaining that the phrase
“for the benefit of the estate,” as used in section 550, should be construed broadly, rather than narrowly, to include indirect
benefits). See also Weaver v. Aquila Energy Marketing Corp., 196 B.R. 945, 956 (S.D. Tex. 1996) (noting that section 550’s
“benefit” requirement is satisfied as soon as there is some identifiable benefit to the estate).
See In re Burlington Motor Holdings, Inc., 231 B.R. 874, 877 (Bankr. D. Del. 1999) (holding that “any recovery of preferences
in this case will benefit only the Successor Corporation” and that “unsecured creditors must be benefitted by recovery”) (citing
In re Resorts Int’l, Inc., 145 B.R. 412, 474–75 (Bankr. D.N.J. 1990)); Harstad v. First Am. Bank, 39 F.3d 898, 905 (8th Cir. 1994)
(holding that “ increas[ing] the likelihood that [debtors] will be able to pay their creditors as the Plan requires, even though it
will not increase the amount paid to the creditors” is insufficient benefit to the estate to permit recovery under section 550(a)).
Mellon Bank, N.A. v. Dick Corp., 351 F.3d 290, 293 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004) (holding that the term
“estate,” as used in section 550(a), means the set of all potentially interested parties, and not any one particular class of creditors);
In re NETtel Corp., Inc., 364 B.R. 433, 442 (Bankr. D.C. 2006); In re Furrs, 294 B.R. 763, 783 (Bankr. D. N.M. 2003).
See MC Asset Recovery LLC v. Commerzbank A.G. (In re Mirant Corp.), 675 F.3d 530, 532–34 (5th Cir. 2012); Mellon Bank,
N.A. v. Dick Corp., 351 F.3d 290, 293 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004); In re NETtel Corp., Inc., 364 B.R. 433,
442 (Bankr. D. D.C. 2006).
Silverman Consulting, Inc. v. Hitachi Power Tools, U.S.A., Ltd. (In re Payless Cashways, Inc.), 290 B.R. 689, 696–97 (Bankr. W.D.
Mo. 2003) (holding that a chapter 11 trustee had standing to pursue preference claims even though recoveries would go solely to
satisfy administrative claims).
See Kipperman v. Onex Corp., 411 B.R. 805, 876–88 (N.D. Ga. 2009) (holding that all interests, including those of all creditors
and equity security holders, are comprised in the estate); In re Bayou Grp., LLC, 372 B.R. 661, 664 n. 2 (Bankr. S.D.N.Y. 2007)
(refusing to adopt a bright-line rule that avoidance actions can never be brought in whole or in part for the benefit of equity
security holders).
In re P.A. Bergner & Co., 140 F.3d 1111, 1118 (7th Cir. 1998), cert. denied, 525 U.S. 964 (1998) (explaining that though preference
action recovery will benefit reorganized debtor and thus owners of reorganized debtor, recovery under section 550(a) is
permissible because owners of reorganized debtor were the largest creditor group of old debtor, so benefit to these creditors
provides a sufficient benefit to the estate to satisfy the requirements of section 550); In re Furrs, 294 B.R. 763, 780 (Bankr. D.N.M.
2003) (holding that “an action which will generate funds for the payment of administrative claims is a proper use of [t]rustee’s
avoiding and recovery powers”). See also Weaver v. Aquila Energy Marketing Corp., 196 B.R. 945, 956 (S.D. Tex. 1996) (holding
that section 550’s “benefit” requirement is satisfied as soon as there is some identifiable benefit to the estate).
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Courts narrowly interpreting section 550(a) do not require an absolute direct benefit to unsecured
creditors, but they generally require a more direct benefit to those creditors than do courts that
employ the broader interpretation.574 For example, the Eighth Circuit575 and the Bankruptcy Court
for the District of Delaware576 have interpreted section 550(a) as effectively requiring that the
contemplated recovery be somehow targeted, or legally tied, to the benefit of creditors (e.g., pursuant
to a plan in which avoidance action proceeds are distributed or in a settlement under Bankruptcy
Rule 9019). In both cases, the courts found that the demonstrated benefit was insufficient to permit
recovery under section 550(a).577
Recoveries Under Section 550: Recommendations and Findings
The Commission reviewed several issues relating to avoidance action recoveries under section 550.
This section of the Bankruptcy Code is an integral component of the trustee’s avoiding powers under
chapter 5 of the Bankruptcy Code. It essentially represents the mechanism by which the trustee
can recover any value resulting from avoidance actions for the estate. Recognizing the section’s
importance in the avoidance process and the need to provide a clear, efficient, and fair path to
recoveries, the Commissioners discussed the actual mechanics of section 550.
Several Commissioners commented on the sometimes cumbersome process of suing on the
underlying avoidance action and then bringing the recovery action under section 550 after the fact.
016
Many of the Commissioners believed that providing subsequent transferees 1, 2 at least notice of
ber 2 with
em
n would
the underlying avoidance action and an opportunity to intervene Nov improve this system. This
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kind of notice would prevent duplicative litigation5363 arcno notice is provided, and a subsequent
when
-3
14
transferee disputes the existence of a valid, No. of action. Others suggested requiring the trustee
cause
rown
B
h
to name any potential subsequentv.transferees as defendants in the underlying avoidance action.
xset
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cited
Some of the Commissioners questioned whether such a requirement was feasible, because often the
identity of any subsequent transferees is discovered in the litigation on the underlying avoidance
claim and is not necessarily known to the trustee at the time of filing the complaint. Notice would
not be possible in those cases.
574 See, e.g., In re Acequia, Inc., 34 F.3d 800, 811 (9th Cir. 1994) (allowing recovery of fraudulent transfers even though creditors
have been paid in full when recovery would aid continuing performance under plan and pay administrative creditors because
“[c]ourts construe the ‘benefit to the estate’ requirement broadly, permitting recovery under section 550(a) even in cases where
distribution to unsecured creditors is fixed by a plan of reorganization and in no way varies with recovery of avoidable transfers”);
Harstad v. First Am. Bank, 39 F.3d 898, (8th Cir. 1994) (“We do not hold that a bankruptcy trustee or a debtor in possession (or a
debtor or an appointed representative under powers reserved via § 1123(b)(3)) must demonstrate a direct benefit to the creditors
in the form of a distribution to the creditors of the preference recovery (although that would certainly make this a much easier
issue to decide). Nevertheless, we do hold that those wishing to bring preference actions must show a more definite benefit to
creditors than the [debtors] have shown here.”); Wellman v. Wellman, 933 F.2d 215, 218 (4th Cir. 1991), cert. denied, 502 U.S.
925 (1991) (holding that there is no benefit to the estate “when the result is to benefit only the debtor rather than the estate”);
Adelphia Recovery Trust v. Bank of Am., N.A., 390 B.R. 80, 94 (S.D.N.Y. 2008), aff ’d, 379 Fed. App’x 10 (2d Cir. 2010), cert.
dismissed, 131 S. Ct. 896 (2011) (“[I]t is well settled in the Second Circuit, that avoiding powers may be exercised by a debtor in
possession only for the benefit of creditors, and not for the benefit of the debtor itself.”) (citations omitted) (internal quotation
marks omitted); Trans World Airlines, Inc. v. Travellers Int’l AG (In re Trans World Airlines, Inc.), 163 B.R. 964, 972 (Bankr. D.
Del. 1994) (“[T]he Code clearly contemplates the use of avoidance action recoveries in the operation of the business in a manner
which only indirectly benefits creditors.”).
575 Harstad v. First Am. Bank, 39 F.3d 898, 904–05 (8th Cir. 1994).
576 In re Burlington Motor Holdings, Inc., 231 B.R. 874, 877 (Bankr. D. Del. 1999) (“[The] Plan does not delegate preference
recoveries to the estate or list them as a source of funds designated to pay down the Note. Rather, any recovery of preferences in
this case will benefit only the Successor Corporation.”).
577 See Harstad v. First Am. Bank, 39 F.3d 898, 904–05 (8th Cir. 1994); In re Burlington Motor Holdings, Inc., 231 B.R. 874, 877
(Bankr. D. Del. 1999).
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ABI Commission to Study the Reform of Chapter
Given those obstacles, the Commissioners discussed whether the federal notice standards as
articulated by the U.S. Supreme Court in Mullane v. Central Hanover Bank & Trust Co. would
suffice.578 The Mullane standard basically requires notice by means “reasonably calculated, under all
the circumstances, to apprise the interested parties of the pendency of the action, and afford them an
opportunity to present their objections.”579 The Commission determined, however, that to the extent
the trustee would be seeking to recover value from the subsequent transferees, actual notice should
be required. Based on these considerations, the Commission recommended clarifying section 550 to
permit the trustee to name a subsequent transferee as a defendant in the original, underlying cause
of action and, if not named, to require the trustee to sue the subsequent transferee in a subsequent
action, at which time the subsequent transferee should be permitted to assert defenses to the original
avoidance cause of action.
The Commissioners then analyzed the extra-territorial application of the trustee’s avoiding powers
and recovery rights under section 550 to subsequent transferees. The Commissioners acknowledged
the primary competing interests at stake: the perceived unfairness in permitting avoidance of
transfers made to parties within the United States, but then precluding that remedy as to any
subsequent transferees overseas; and the reasonable expectations of foreign transferees, particularly
those who may not know that the transfer originated from the debtor, including the expectation
that any payments they received were governed by the laws of their respective jurisdictions. The
Commissioners methodically walked through examples when this issue may present itself. They
16
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considered situations were a feeder fund is the initial transferee and 2noted the relevance of the
ber
vem
solvency of the feeder fund. They examined the facts of the Madoff and Maxwell cases and discussed
n No
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the factual nuances of these cases.580 The Commissioners acknowledged and appreciated the delicate
63 a
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4
balance required in these instances.wn, No. 1
h v.
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Bro
The Commissioners discussed how best to balance the competing interests with well-established
cited
principles of comity. The Commissioners generally agreed with the notion that foreign transfers
should be subject to the chapter 5 avoiding powers, but only if such application was consistent with
principles of comity. Accordingly, the Commission approved the recommendation that section 550
cover domestic or foreign subsequent transferees extra-territorially to the same extent as domestic
subsequent transferees, but agreed that the court should consider whether allowing such action
to proceed is consistent with general principles of comity and is reasonably necessary to protect
the interests of the estate considering the expectations of the defendants, the laws of the foreign
jurisdiction, and the relief available to the trustee in the foreign jurisdiction.
Once a trustee identifies potential avoidance and recovery actions under chapter 5 of the Bankruptcy
Code, courts have differed on whether the trustee may pursue those actions if recoveries will go to
stakeholders other than general unsecured creditors. The Commissioners discussed the origins of
the concept that avoidance action recoveries should inure only to the benefit of general unsecured
creditors and whether such a limited purpose aligned with the concept of the estate.581 The
Commissioners discussed witness testimony that supported limiting the beneficiaries of preference
578 Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306, 314 (1950).
579 Id.
580 See, e.g., In re Maxwell Commc’n Corp., 93 F.3d 1036, 1047–48 (2d Cir. 1996); Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv.
Sec. LLC, 2014 U.S. Dist. LEXIS 91508 (S.D.N.Y. July 6, 2014).
581 See, e.g., Mellon Bank NA v. Dick Corp., 351 F.3d 290, 293 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004) (explaining that
section 550 “speaks of benefit to the estate — which in bankruptcy parlance denotes the set of all potentially interested parties”).
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Bankruptcy Institute
actions to unsecured creditors. They also considered whether administrative claimants or old equity
should be permitted to benefit from recoveries under section 550. The Commissioners drew on
the facts and holding in Mirant Corp., in which the Fifth Circuit interpreted section 550(a) and
found that “[a] bankruptcy trustee may still have standing to avoid a fraudulent transfer after the
unsecured creditors are satisfied in full.”582
The Commissioners found the reasoning of courts following a broader interpretation of section
550(a) to be sound and consistent with the general concept of the bankruptcy estate. The estate
does not represent only general unsecured creditors in a case, but often represents a variety of
stakeholders whose interests also may have been harmed by improper transfers and transactions
subject to avoidance under chapter 5 of the Bankruptcy Code. The Commission voted to endorse
a broad interpretation of the term “for benefit of the estate” in section 550(a) to mean all parties
with claims against, or interests in, the estate, including administrative claimants and old equity
but not including claims of postpetition secured creditors. In reaching this conclusion, however,
the Commission agreed that this principle only affected a trustee’s action for recoveries against
transferees under section 550; it did not expand or otherwise affect a trustee’s underlying cause of
action under section 544, 545, 547, 548, 549, or 553(b).
D. Labor and Benefits
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1. Collective Bargaining Agreements
n
UnderciSection 1113
ted i
Recommended Principles:
Disputes regarding modification and rejection of a company’s collective bargaining
agreements can be time-consuming, expensive, and litigious. These disputes also
can be emotionally charged and disruptive at key points in the chapter 11 process.
Moreover, and perhaps most importantly, they involve a resource many consider
critical to a company’s successful restructuring — its employees. Accordingly, the
Bankruptcy Code should be amended to further the objectives of negotiation and
consensual resolution underlying the collective bargaining process and section
1113.
To that end, section 1113 should be amended to add requirements that, in addition
to the provisions of section 1113(b)(1), the trustee should: (i) provide notice to
the applicable labor organization(s) that modifications to the collective bargaining
agreement are being proposed along with an initial proposal and description of
the information to be made available for the labor organization to evaluate the
proposal; and (ii) file a notice of intent to initiate proceedings under section 1113(b)
582 MC Asset Recovery LLC v. Commerzbank A.G. (In re Mirant Corp.), 675 F.3d 530, 534 (5th Cir. 2012).
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ABI Commission to Study the Reform of Chapter
and schedule an initial conference with the court regarding such proceedings. The
foregoing is intended to promote transparency, disclosure, and communication
among the parties, and to provide a reasonable time to conduct negotiations in
an effort to reach a consensual agreement prior to the commencement of any
litigation by the trustee to reject the collective bargaining agreement. Accordingly,
section 1113 should be amended as follows:
o The trustee should file a request for an initial conference regarding
the initiation of section 1113 proceedings with the court and serve the
request on the authorized representative of the affected employees (the
“authorized representative”) and any other party entitled to notice
of matters pending in the case under the Bankruptcy Rules. In the
request, the trustee should certify that it has provided the authorized
representative with a written copy of its initial proposal and the other
information required by section 1113(b)(1).
o The court should set a status conference to discuss the process with the
trustee and the authorized representative. This conference should be
scheduled so as to allow the authorized representative sufficient time to
(i) review the trustee’s notice, initial proposal, and proposed information
disclosures; and (ii) meet and confer with the trustee to discuss a timetable
for conducting negotiations, any information-related1,matters, and any
2016
ber 2 including whether
other particulars relevant to the conduct of negotiations,
vem
n No
ed o in their discussions. The court
the parties believe a mediator wouldhassist
rc iv
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should conduct the initial1conference on or before 30 days after the filing of
. 4
, No
rownfor an initial conference.
the trustee’shrequest
v. B
xset
n Bliinitial conference, the trustee and the authorized representative
i
o iAt the
c ted
should be prepared to: (i) discuss the timetable for conducting negotiations
over the proposal; (ii) resolve any initial issues regarding the disclosure
of information relevant for the evaluation of the proposal; (iii) identify
any issues regarding the resources available to the parties so that they may
engage in informed discussions regarding the request for modifications;
(iv) discuss whether the participation of a mediator would assist the parties;
and (v) discuss any other issues that may present obstacles to conducting
informed, good faith negotiations regarding the trustee’s request for
modifications. The court may also wish to establish an expedited process
for the resolution of any information-related disputes.
o If, following a reasonable period of time and consistent with the timetable
established at the initial conference (which should take into consideration
the nature and scope of the modification proposal), the parties have not
reached an agreement regarding mutually acceptable modifications, the
trustee may request a further status conference in order for the parties to
report to the court regarding the status of the process and for the trustee
to request a case management process for a motion to reject the collective
bargaining agreement. At such status conference, the court should set a
date by which the trustee and the authorized representative would submit
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Bankruptcy Institute
a case management and scheduling order. The proposed hearing schedule
may incorporate a bifurcation of the trial into an initial hearing schedule for
the presentation of the trustee’s case and then, following an adjournment,
a second hearing schedule for the authorized representative to present its
case. The scheduling order may provide for the (continued) participation
of a mediator to facilitate discussions between the parties if requested by
the parties or otherwise warranted under the circumstances. The court
should schedule the start of the trial on the motion to reject the collective
bargaining agreement on or before 180 days after the filing of the trustee’s
request for an initial conference, unless the trustee and the authorized
representative agree to extend, or the court for cause extends, this deadline.
The parties should factor this trial deadline into the timetable established
at the initial conference.
o Statutory committees should be able to attend and observe any status
conferences conducted under this principle, but participation, including
at any hearing on rejection, should be limited to receiving and reviewing
information from the trustee and the authorized representative and
evaluating the trustee’s business judgment regarding the decision to seek
rejection under section 1113. Statutory committees would also be heard in
6
the usual manner in connection with any settlement reached 201
1, between the
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trustee and the authorized representative.
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o The foregoing recommendations should rnotvbe read to, and are not intended
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to, alter current law with ,respect to section 1113(e).
o. 14
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lixse of a collective
trustee’s rejection
in B
cited
The
bargaining agreement under section 1113
should be treated as a breach of such agreement. The authorized representative
may assert a claim for monetary damages arising from the rejection of the
collective bargaining agreement against the estate, on behalf of the affected
employees, which claim should be a general unsecured claim, if the rejection
order occurs prior to assumption of the agreement, similar to the assertion of
rejection damages claims by counterparties to contracts rejected under section 365
pursuant to sections 365(g) and 502(g). Any such rejection damages claims should
be determined in accordance with applicable nonbankruptcy law for breach of
contract and subject to mitigation.
Collective Bargaining Agreements Under Section 1113: Background
The U.S. Supreme Court’s decision in N.L.R.B. v. Bildisco resolved disparate rulings among the lower
courts regarding the treatment of collective bargaining agreements in bankruptcy.583 In Bildisco, the
Supreme Court reaffirmed the characterization of a collective bargaining agreement as an executory
contract subject to rejection under section 365 of the Bankruptcy Code.584 The Supreme Court also
583 N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513 (1984), superseded by statute, Public Law 98-353 (section 1113 of the Bankruptcy
Code), as recognized in N.L.R.B. v. Manley Truck Line, Inc., 779 F.2d 1327, 1331 n. 7 (7th Cir. 1985).
584 Id. at 522–23.
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ABI Commission to Study the Reform of Chapter
held that, in recognition of the “special nature” of a collective bargaining agreement, the debtor in
possession’s585 proposed rejection of a collective bargaining agreement was subject to a “somewhat
stricter standard” of review than the generally applicable business judgment standard.586 The Court
rejected a very strict standard proposed by the National Labor Relations Board, which was adopted
by the Second Circuit in REA Express,587 i.e., that the debtor in possession should not be permitted to
reject a collective bargaining agreement unless it can show that rejection is necessary to prevent the
liquidation of the debtor. Instead, the Court endorsed a standard that it viewed as “somewhat higher
than that of the ‘business judgment rule’ but a lesser one than that embodied in the REA Express
opinion.”588 The Court also held that a debtor in possession’s unilateral modification of a collective
bargaining agreement prior to court approval of the rejection was not an unfair labor practice in
violation of the National Labor Relations Act (the “NLRA”).589
Congress enacted section 1113 of the Bankruptcy Code in direct response to the Bildisco decision.590
Section 1113 establishes particularized rules regarding the treatment of collective bargaining
agreements when an employer is in chapter 11.591 Among other things, section 1113 establishes
special procedures and standards that are applicable when a debtor in possession seeks to modify, or
ultimately reject, a collective bargaining agreement. The statute prescribes a process of bargaining
between the debtor in possession and the authorized representative of the affected employees as
a prerequisite to seeking court-approved rejection. In the absence of an agreed-upon resolution
regarding the debtor in possession’s proposed modifications, the debtor in possession may seek
16
1, 2 the
court-approved rejection. In doing so, the debtor in possession must rmeet 0 rejection standards
be 2
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set forth in the statute in order to obtain court approval, including demonstrating compliance with
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the statutory bargaining requirements.592
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585 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
lixse
in and
of the BankruptcytCode, B implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
ci ed
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
586 Id. at 524 (“We agree with these Courts of Appeals that because of the special nature of a collective-bargaining contract, and the
consequent ‘law of the shop’ which it creates, [citation omitted] a somewhat stricter standard should govern the decision of the
Bankruptcy Court to allow rejection of a collective-bargaining agreement.”).
587 Bhd. of Ry., Airline & Steamship Clerks v. REA Express, 523 F.2d 164 (2d Cir. 1975).
588 See id. at 525 (holding that bankruptcy court should permit rejection if “the debtor can show that the collective- bargaining
agreement burdens the estate, and that, after careful scrutiny, the equities balance in favor of rejecting the collective bargaining
agreement”). The standard adopted by the Supreme Court drew upon the rejection standard proposed by the Eleventh Circuit
in In re Brada Miller Freight Sys., Inc., 702 F.2d 890 (11th Cir. 1983).
589 Id. at 532–33. The Supreme Court’s rationale was that a collective bargaining agreement, like other executory contracts, was
not enforceable by the nondebtor party upon the debtor’s bankruptcy filing. The Court’s ruling meant that, where an employer
in chapter 11 committed an unfair labor practice by unilaterally modifying a collective bargaining agreement on filing for
bankruptcy, statutory remedies under labor law would be unavailing. See 29 U.S.C. § 158(a)(5) (providing that it shall be an
unfair labor practice for an employer “to refuse to bargain collectively” with the employees’ authorized representative); id. § 158
(d) (establishing the parties’ mutual obligation to bargain collectively, including, among other things, “that no party to [a labor
contract] may terminate or modify such contract” absent compliance with the statute’s requirements).
590 See In re AMR Corp., 477 B.R. 384, 405–06 (Bankr. S.D.N.Y. 2012) (relating enactment of section 1113 in response to Bildisco).
See also Andrew B. Dawson, Collective Bargaining Agreements in Corporate Reorganizations,” 84 Am. Bankr. L. J., 103, 104 (2010)
(same).
591 Section 1113 applies to collective bargaining agreements covered by the National Labor Relations Act, 2 U.S.C. §§ 151–169 (the
“NLRA”) and to agreements covered by Title II of the Railway Labor Act, 45 U.S.C. §§ 181–188, which is applicable to the airline
industry. Railroad collective bargaining agreements covered by Title I of the Railway Labor Act, 45 U.S.C.§§ 151–165, are subject
to section 1167 of the Bankruptcy Code. See 11 U.S.C. § 1167.
592 In addition to the rejection requirements, and to counteract the Supreme Court’s ruling in Bildisco that unilateral modification
of a collective bargaining agreement prior to court-approved rejection does not constitute an unfair labor practice, Congress
amended section 1113 to prohibits the trustee from unilaterally altering or terminating any provision of a collective bargaining
agreement “prior to compliance with the provisions of [section 1113].” 11 U.S.C. § 1113(f). See Shugrue v. Air Line Pilots Ass’n,
Int’l (In re Ionosphere Clubs, Inc.), 922 F.2d 984, 990 (2d Cir. 1990), cert. denied, 502 U.S. 808 (1991) (reviewing section 1113(f)
and concluding that “Congress intended that collective bargaining agreement remain in effect. . . after the filing of a bankruptcy
petition unless and until the debtor complies with the provisions of § 1113”). See also In re Cont’l Airlines, 125 F.3d 120, 137
(3d Cir. 1997), cert. denied, 522 U.S. 1114 (1998) (finding that the “intent behind section 1113 is to preclude debtors or trustees
in bankruptcy from unilaterally terminating, altering or modifying the terms of a collective bargaining agreement without
following its strict mandate”).
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Thus, prior to seeking rejection, a debtor in possession must make a proposal to the authorized
representative of the employees that provides relevant information necessary to evaluate the
proposal, and meet and confer in good faith with the authorized representative in an attempt to reach
a mutually acceptable modification to the labor contract.593 When the parties’ efforts do not result in
a mutually acceptable modification to the collective bargaining agreement, the debtor in possession
may seek court-approved rejection. Under section 1113, the filing of the debtor in possession’s
motion to reject the collective bargaining agreement requires the court to hold a hearing within
14 days after the filing date, upon at least 10 days’ notice to the authorized representative, although
the court may extend the time for commencement of the hearing for seven days or for additional
periods of time when the debtor in possession and the authorized representative agree.594
The statute also sets out the standards for approval of a motion to reject a collective bargaining
agreement. Under section 1113(c), the court may approve the motion to reject if the court determines
that: (i) the debtor in possession complied with the statutory requirements attendant to making its
proposal; (ii) the authorized representative refused to accept the debtor in possession’s proposal
“without good cause”; and (iii) “the balance of the equities clearly favors rejection.”595 In evaluating
the “balance of the equities” standard, courts have articulated certain factors to be considered.596
Section 1113 requires that the court enter a ruling on the motion to reject within 30 days of the date
of the commencement of the hearing, unless the parties consent to an extension of this period.597
Although an early division in the interpretation of the rejection standard occurred when the Second
16
and Third Circuits issued divergent rulings on the application of the ber 21, 20
“necessary” and “fair and
em
equitable” standards applicable to the debtor in possession’s proposalvunder section 1113(b)(1),598 a
n No
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study by Professor Andrew Dawson suggests that the6difference in interpretation has not appeared
3 arc
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4
to impact the courts’ ultimate rulings — n, No. 1 have generally approved the debtor in possession’s
courts
row
motion to reject under section seth v. B 599
1113(c).
lix
in B
cited
593 See In re Pinnacle Airlines Corp., 483 B.R. 381, 404–05 (Bankr. S.D.N.Y. 2012) (describing general operation of section 1113).
The particular requirements regarding the proposal, provision of information, and good faith negotiations are set forth in section
1113(b)(1)(A) (standards for proposal), section 1113(b)(1)(B) (requirement to provide “relevant information as is necessary to
evaluate the proposal”), section 1113(b)(2) (requirement that trustee meet with authorized representative and “confer in good
faith in attempting to reach mutually satisfactory modifications”). 11 U.S.C. § 1113(b).
594 See 11 U.S.C. § 1113(d)(1). Section 1113 requires the court to rule on a section 1113 motion to reject within 30 days of the date
of the commencement of the hearing, unless the parties consent to an extension of this period. 11 U.S.C. § 1113(d)(2).
595 Id. § 1113(c). The debtor bears the burden of proof on the elements of a section 1113 motion to reject. See Truck Drivers Local
807 v. Carey Transp. Inc., 816 F.2d 82, 88 (2d Cir. 1987).
596 See e.g., Truck Drivers Local 807 v. Carey Transp. Inc., 816 F.2d 82, 93 (2d Cir. 1987) (detailing six factors to be considered in
evaluating the balance of the equities).
597 In addition to the procedures set forth in section 1113(b) through (d), section 1113 also provides for emergency “interim
relief ” whereby a court may authorize a debtor to make interim changes to wages, benefits, or work rules under the collective
bargaining agreement “if essential to the continuation of the debtor’s business, or in order to avoid irreparable damage to the
estate.” 11 U.S.C. § 1113(e). See Wheeling-Pittsburgh Steel Corp. v. United Steelworkers of Am., AFL-CIO-CLC, 791 F.2d 1074,
1088 (3d Cir. 1986) (explaining that, in enacting section 1113, “Congress recognized that there might be immediate problems
of an emergency nature in individual cases” and therefore provided for “interim changes” if the court finds “that an interim
change is ‘essential to the continuation of the debtor’s business, or in order to avoid irreparable damage to the estate’”) (citations
omitted). See also 7 Collier on Bankruptcy ¶ 1113.02[3] (describing interim relief provision and “high standards” generally
applied to requests for such relief); In re Salt Creek Freightways, 46 B.R. 347, 349–50 (Bankr. D. Wy. 1985) (explaining enactment
of section 1113(e)).
598 See 11 U.S.C. § 1113(b)(1)(A). Compare Wheeling-Pittsburgh Steel Corp. v. United Steelworkers of Am., AFL-CIO-CLC, 791
F.2d 1074, 1088–89 (3d Cir. 1986) with Truck Drivers Local 807 v. Carey Transp. Inc., 816 F.2d 82, 89 (2d Cir. 1987).
599 See, e.g., Dawson, supra note 590, at 104 (collecting data on how courts interpret the factor that the proposal be “necessary to
the reorganization of the debtor” and concluding that “[b]ased on data from every large publicly traded company bankruptcy
between 2001 and 2007, the present study reveals that the outcome of [section] 1113 motions was the same regardless of the legal
standard applied: the court granted the debtor’s motion to reject its CBA”).
V. Proposed Recommendations: Administering the Case
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ABI Commission to Study the Reform of Chapter
Collective Bargaining Agreements Under Section 1113:
Recommendations and Findings
For debtors with a unionized workforce, the treatment of their labor contracts may represent one
of the most important and difficult decisions in the chapter 11 case.600 These contracts represent the
company’s obligations to its employees and are an integral component of the company’s relationship
with its employees. These contracts, however, also may impose monetary obligations on the
company that it no longer can sustain in light of financial distress and its need to reorganize.601 The
Commission appreciated fully the crucial considerations and potentially dynamic elements in the
collective bargaining process in a chapter 11 case. In particular, the Commissioners noted that labor
relations following rejection should be taken into consideration in utilizing section 1113: even if a
collective bargaining agreement is ultimately rejected through the section 1113 process, the company
remains obligated to continue to bargain with the authorized representative over modifications to
the agreement.602
Most of the testimony received by the Commission on section 1113 issues concerned the bargaining
process itself and the deadlines imposed by this section.603 Witnesses expressed concern that the
statutory requirements did not, in practice, foster meaningful negotiations.604 Rather, some witnesses
suggested that many debtors in possession viewed the bargaining required under the Bankruptcy
Code as a means to the litigated end they desired.605 The Honorable Stephen Mitchell of the U.S.
016
Bankruptcy Court for the Eastern District of Virginia (whose cases 1included the US Airways
2 ,2
r
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on
ived
arch
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600 Oral Testimony of the Honorable Stephen S. Mitchell: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
ixs
in Bl
at 13–14 (Mar. 14,t2013) (ASM Transcript) (“I have to say at the outset that I thought that the decisions I had to make in terms
ci ed
601
602
603
604
605
of termination of pension plan or termination of retiree benefits or modification of a collective bargaining agreement or proving
interim changes to a collective bargaining agreement were some of the toughest I’ve had to make as a judge . . . I could tell you
in no other matters that have come before me in 16 years on the bench that I receive so much mail in chambers and they were
profoundly affecting. I mean, I fully understood that for some people it means they themselves might end up having to file up
for bankruptcy because necessary financial support was being taken away from them.”), available at Commission website, supra
note 55.
Written Statement of Michael Robbins: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (Mar.
14, 2013) (acknowledging that there is a need for labor representatives to make meaningful economic concessions for employers
to survive), available at Commission website, supra note 55.
See e.g., N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 534 (1984), superseded by statute, Public Law 98-353 (section 1113 of the
Bankruptcy Code), as recognized in N.L.R.B. v. Manley Truck Line, Inc., 779 F.2d 1327, 1331 n. 7 (7th Cir. 1985) (noting that
debtor in possession remains obligated to bargain collectively with labor organization following formal approval of rejection).
Written Statement of Michael Robbins: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3
(Mar. 14, 2013) (“[T]he expedited schedule mandated under Section 111 creates tremendous downward pressure on wages
and working conditions. . . . [T]he 1113 process has become in practice a rushed 51-day countdown to destruction of their
agreements.”), available at Commission website, supra note 55.
See Oral Statement of Bob Keach: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 4 (Mar. 14,
2013) (ASM Transcript) (“The predominance of Section 363 sales of substantially all the assets of debtors means that often the
purchaser do not assume collective bargaining agreements or pension liabilities. This has particularly challenged the statutory
regime for addressing such agreements and liabilities.”), available at Commission website, supra note 55; Oral Testimony of
Robert Roach Jr.: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 51 (Mar. 14, 2013) (ASM
Transcript) (“In normal contract negotiations there’s give and take, there’s talking and there’s a result at the end of it. . . . When
you bargain on 1113 after a period of time, and it’s two weeks and a week after they file, it’s either you accept what the company
gives you or you don’t have a collective bargaining agreement.”), available at Commission website, supra note 55. “Negotiation is
you come in with a position and both sides are compromised. There is no need for the corporation to compromise in the chapter
1113 proceeding.” Id. at 58.
See Oral Testimony of Debora Sutor: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 42–45 (Mar.
14, 2013) (ASM Transcript) (“Bankruptcy should only be used as a last resort. Instead . . . companies . . . are routinely placed
in bankruptcy soles as a means to escape obligations and reward top executives and middle managers for simply executing
a bankruptcy plan.”), available at Commission website, supra note 55; Oral Testimony of James Campbell Little: ACB Field
Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 35 (Mar. 14, 2013) (ASM Transcript) (stating that the
debtor (company) essentially had a gun to labor’s head — it was a take it or leave it proposition, not a negotiation), available at
Commission website, supra note 55.
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bankruptcy cases) also testified that the statutory deadlines simply did not work, particularly the
14-day hearing requirement.606
The Commission considered whether refinements to the statutory process would better serve the
goals of the statute. Section 1113(b)(2) provides: “During the period beginning on the date of the
making of a proposal provided for in paragraph (1) and ending on the date of the hearing provided for
in subsection (d)(1), the trustee shall meet, at reasonable times, with the authorized representative to
confer in good faith in attempting to reach mutually satisfactory modifications of such agreement.”
Thus, with respect to the bargaining process, section 1113 does not provide any minimum period
during which the parties must engage in good faith bargaining.607 A debtor in possession could,
consistent with the statute, serve a proposal and then, subject only to the requirements of proof set
forth in section 1113(c), file a rejection motion quite soon thereafter. The motion would then be
subject to the statutory hearing and notice schedule.
Courts and commentators have emphasized that an important goal of section 1113 is to encourage
negotiated resolutions when a debtor in possession seeks modifications to its collective bargaining
agreements and when litigation should be a last resort.608 And, as one court has explained, the
amount of time to be allowed for negotiations “must depend on the facts and circumstances of
each case.”609
The Commissioners discussed these perspectives and whether the requirements 016
, 2 currently provided
er 21
emb the debtor in possession
in section 1113(b) were sufficient to generate a meaningful dialogueNov
between
d on
chive
and the authorized representative. The Commissioners rgenerally agreed that the effectiveness of
3a
3536
. 14section 1113 was case dependent, but some, suggested the process could be improved by more clearly
No
own
separating the bargaining and thehlitigation processes. These Commissioners noted that the current
v. Br
t
lixse
process often placed thed in B
e bargaining and the potential litigation on parallel tracks that had the parties
cit
trying to reach a compromise while the debtor in possession was preparing its case to support,
and the authorized representative was working to identify good cause to block, the rejection of the
agreement. These Commissioners also agreed with the witness testimony that bargaining under
606 Oral Testimony of the Honorable Stephen S. Mitchell: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 13–17 (Mar. 14, 2013) (ASM Transcript) (“Section 1113 and 1114 relief actually require that the judge hold a hearing within
14 days. . . . In reality there were no 14-day hearings or even 21-day hearings in the matters that came in front of me. Everybody
understood that there had to be a certain amount of discovery, we [review] the underlying financials, there are opportunities to
depose each side’s experts and things like that.”), available at Commission website, supra note 55.
607 See, e.g., Oral Testimony of Robert Roach, Jr., ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 25
(Mar. 14, 2013) (ASM Transcript) (stating that the current good faith negotiation requirement in section 1113 “is not adequate
because negotiating in good faith just means coming to the table and talking, it doesn’t mean give or take. . . . [There may be]
back and forth, but . . . no negotiation”), available at Commission website, supra note 55.
608 E.g., N.Y. Typographical Union No. 6 v. Maxwell Newspapers, Inc. (In re Maxwell Newspapers, Inc.), 981 F.2d 85, 90 (2d Cir.
1992) (explaining that the statute’s “entire thrust” is to “ensure that well-informed and good faith negotiations occur in the
market place, not as part of the judicial process”); Dawson, supra note 590, at 119 (noting that the statutory “text clearly indicates
that Congress preferred the outcome of negotiated settlements to labor disputes”). See also In re Century Brass Prods., Inc., 795
F.2d 265, 273 (2d Cir. 1986), cert. denied, 479 U.S. 949 (1986) (finding that section 1113 “encourages the collective bargaining
process as a means of solving a debtor’s financial problems insofar as they affect its union employees”); In re Hostess Brands, Inc.,
477 B.R. 378, 382 (Bankr. S.D.N.Y. 2012) ([“Section 1113’s] unique purpose is . . . to provide for expedited, good faith bargaining
and, ultimately, a determination by the court, if that doesn’t occur.”); Richard H. Gibson, The New Law on Rejection of Collective
Bargaining Agreements in Chapter 11: An Analysis of 11 U.S.C. § 1113, 58 Am Bankr. L. J. 325, 327 (1984) (reviewing the statute
and legislative history and describing principal purpose to “discourage both unilateral action by the debtor and recourse to the
bankruptcy court”). “Instead, the law seeks to encourage solution of the problem through collective bargaining.” Id.
609 Wheeling-Pittsburgh Steel Corp. v. United Steelworkers of Am., AFL-CIO-CLC, 791 F.2d 1074, 1093–94 (3d Cir. 1986) (noting
that the need for haste, in and of itself, is not a determining factor, citing the interim relief provision under section 1113(e) which
is available to address emergency situations).
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section 1113 could be shallow and perceived as a formality in the process.610 Other Commissioners
disagreed with this characterization of the process, but acknowledged the benefit to all parties of a
more effective and efficient process.
The Commissioners then analyzed improving the current framework under section 1113. They
recognized the delicate balance between encouraging meaningful negotiations and allowing the
debtor in possession to move to litigation when necessary. To evaluate potential reforms to the
section 1113 process, the Commissioners reviewed practices that have been employed in many
chapter 11 cases, in which the parties opted for case management procedures in lieu of the statutory
scheduling requirements, and have identified certain “best practices” from these cases. Their
discussion focused on the realities of chapter 11 practice — as suggested by Professor Dawson’s
study, the debtor in possession usually can prevail on the motion to reject, but that result typically is
not in the best interests of the debtor or its employees. Rather, a consensual resolution typically is in
the best interests of both parties; it can avoid potential ill will between the parties, lost production
for the debtor, and hardship for its employees.
The Commissioners proposed a more structured process for exchanging information and establishing
the parameters of bargaining. The Commissioners debated whether the court should be involved in
the process from the outset. The Commission determined that requiring an initial status conference
with the court would encourage meaningful disclosures and discussions earlier in the process. In
6
this context, it also considered the mandatory appointment of a mediator 201help the parties reach
1, to
ber 2
vem
a potential resolution more quickly. The Commissioners perceived value in the mediator’s role, but
n No
ed o
rchiv
expressed concerns regarding costs and a one-size-fits-all approach to a mediator. They believed that
63 a
-353
a mediator likely would be an asset in No. 14 cases, but believed it would be a more effective tool if
, many
rown
v. Bparticular case.611
invoked based on the facts eth the
of
xs
i
in Bl
cited
Under the principles adopted by the Commission, there would be an initial conference that would
follow disclosure of the proposal by the debtor in possession to the authorized representative and a
notice to parties in the case of the debtor in possession’s intention to seek modifications to a collective
bargaining agreement by commencing a section 1113 process. The Commission determined that, at
an initial conference with the court, the parties should discuss their bargaining timeline, any issues
regarding disclosures made by the debtor in possession regarding its proposal, and any potential
barriers to meaningful, good faith negotiations. It did not believe that the statute should establish
specific deadlines for negotiations. Instead, it wanted the parties and the court to have flexibility
under the general guidance that the bargaining parties have reasonable time to engage in meaningful,
good-faith negotiations.
610 Oral Testimony of Robert Roach, Jr.: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 58 (Mar. 14,
2013) (ASM Transcript), available at Commission website, supra note 55; Oral Testimony of Debora Sutor: ACB Field Hearing
Before the ABI Comm’n to Study the Reform of Chapter 11, at 42–45 (Mar. 14, 2013) (ASM Transcript), available at Commission
website, supra note 55; Oral Testimony of James Campbell Little: ACB Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 35 (Mar. 14, 2013) (ASM Transcript), available at Commission website, supra note 55.
611 Oral Testimony of Robert Roach, Jr.: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 60 (Mar. 14,
2013) (ASM Transcript) (stating that whether a mediator would be helpful depends on the circumstances of the case), available
at Commission website, supra note 55; Oral Testimony of James Campbell Little, Jr.: ACB Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11, at 60 (Mar. 14, 2013) (ASM Transcript) (noting that mediators are not a panacea and that the
utility of a mediator will vary by case, by mediator, etc.), available at Commission website, supra note 55.
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The Commissioners also discussed an appropriate trigger for permitting a debtor in possession to
proceed to litigation to reject the agreement. They compared a trigger similar to one proposed by
labor-backed legislation (i.e., the NLRA standard), based upon standards under nonbankruptcy
labor law requiring an employer to bargain to “impasse” prior to unilateral implementation,612 and
the alternative of imposing an outside deadline based only on the passage of time. Although the
Commissioners understood labor’s preference for the NLRA standard, many of the Commissioners
believed that the debtor in possession needed certainty as to when the case could move forward if a
consensual resolution was not forthcoming. These Commissioners noted that the impasse standard
could stall a debtor in possession’s restructuring efforts indefinitely to the detriment of the debtor
in possession and its other stakeholders (and arguably the employees as well). After considering
various triggers, the Commission voted to recommend that the procedures incorporate an outside
date for the start of the trial on the debtor in possession’s motion to reject within 180 days of the
debtor in possession’s request for an initial conference. The Commissioners noted specifically that
the forgoing recommended principles regarding the new case management procedures applied
only when a debtor in possession pursued relief under section 1113(b), (c), or (d), and that the
principles were not intended to change the current law under section 1113(e) applicable to a debtor
in possession’s request for interim, emergency relief.
In developing the principles for the enhanced case management process, the Commission also
considered whether and to what extent other parties in interest should participate in the section
16
1113 proceedings.613 For example, some of the Commissioners suggestedber 21a 20
that , statutory unsecured
m
creditors’ committee should be permitted to participate in dthe Nove
n process. Others noted that the
e o
iv
committee is not a party to the agreement and raised63 arch about introducing third parties into
concerns
-353
4
the negotiation process.614 The Commission o. 1
, Nsettled on the approach used in the Delphi chapter 11
rown
h
case, where, in ruling on a motion v. Blimit participation in the section 1113 proceedings, the court
xset to
n Bli
ed iparties, including the statutory unsecured creditors’ committee, could
determined that certain
cit
participate in the section 1113 process solely with respect to asserting a position regarding the debtor
in possession’s business judgment in seeking section 1113 relief and not with respect to whether the
section 1113 factors had been met.615 The Commission found persuasive the Delphi court’s distinction
between the role of the statutory committee in fulfilling its due diligence obligations regarding the
debtor in possession’s business judgment to pursue the rejection motion, as a non-ordinary course
action by the debtor in possession, and the particulars of the bargaining process and related section
1113 factors, which are matters that should be left to the debtor in possession and the authorized
representative both in terms of their negotiations and litigation regarding the debtor in possession’s
proposal and related bargaining.
612 See The Protecting Employees and Retirees in Business Bankruptcies Act of 2013, H.R. 100, 113th Cong. § 102 (1st sess. 2013)
(proposing that a debtor may file a motion to reject a collective bargaining agreement, if, after a period of negotiations, the
debtor and labor representative have not reached agreement on modifications “and further negotiations are not likely to produce
mutually satisfactory modifications”). See also N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 533 (1984) (describing “impasse”
requirement under the NLRA).
613 See 11 U.S.C. § 1113(d)(1) (providing that, at a hearing on the motion to reject a collective bargaining agreement, “[a]ll interested
parties may appear and be heard at such hearing”). The Seventh Circuit has held that section 1113(d)(2) limits the participants—
the parties who are authorized to modify the agreement (and any guarantor of the agreement) — to the debtor and the applicable
bargaining representative(s) of the affected employees. In re UAL Corp., 408 F.3d 847 (7th Cir. 2005).
614 See, e.g., Oral Testimony of David R. Jury: ACB Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 23 (Mar.
14, 2013) (ASM Transcript) (“Collective bargaining is a relationship that in most cases long predated the filing of the petition
and if the parties are successful will continue long after the bankruptcy case closes. On the other hand, creditor’s committees
[are transient]. It came into existence with the case, it will go out of existence with the end of the case.”), available at Commission
website, supra note 55.
615 In re Delphi Corp., Case No. 05-44481 (Bankr. S.D.N.Y. May 9, 2006) (oral decision).
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The Commission also considered the consequences of the rejection of a collective bargaining
agreement; specifically, does rejection give rise to a rejection damages claim, and if so, how should
the claim be determined? The Commissioners discussed the current split in the case law regarding
rejection damages under section 1113. One court decision, In re Blue Diamond Coal Co., held that
rejection damages were unavailable under section 1113 as a matter of statutory construction.616
The Blue Diamond court’s view was that section 1113 completely removed collective bargaining
agreements from the provisions of section 365 of the Bankruptcy Code.617 Other courts have
disagreed with the Blue Diamond analysis of section 1113 and its relationship to section 365 and
other provisions of the Bankruptcy Code, and instead have interpreted sections 1113 and 365 as
working in tandem, thus permitting the assertion of rejection damages claims for the rejection
of collective bargaining agreements under section 1113. As one court has explained, “[s]ection
1113 is designed to provide additional procedural requirements for rejection or modification
of collective bargaining agreements, and only to that degree supersedes and supplements the
provisions in § 365.”618
The Commissioners also noted the discussion by the court in Northwest Airlines.619 In this decision,
the court labeled the effect of rejection as an “abrogation” of the agreement rather than a breach
of the agreement, thus calling into question whether an order granting rejection could give rise to
a claim for rejection damages. The Commissioners were persuaded by the reasoning and results
of courts interpreting section 1113 as supplementary to section 365, as well as the practicalities
16
1, 0
of the availability of a rejection damages claim in reaching a resolution. 2The Commission voted
ber 2
m
to recommend that section 1113 be amended to clarifyd that ove
n N rejection of a collective bargaining
e o
hiv
agreement constitutes a breach of the agreement3asrcof the time of rejection, and that a claim for
6 a
-353
. 14
rejection damages may be asserted. TheoCommissioners also discussed how such claims would be
,N
rown
B
h v.
determined. First, the Commission determined that, like damages claims asserted by nondebtor
xset
n Bli
parties to contracts irejected under section 365, such claims would be general unsecured claims
cited
where rejection occurs prior to assumption of a collective bargaining agreement.620 In addition,
the Commission agreed that, generally, such claims would be based on the difference between the
reductions implemented following rejection and the collective bargaining agreement terms prior
to rejection, akin to a breach of contract claim under federal labor law, noting specifically that to
the extent actual mitigation of damages by particular employees would apply to such claims, such
mitigation would similarly apply to a rejection damages claim.621
616 In re Blue Diamond Coal Co., 147 B.R. 720 (Bankr. E.D. Tenn. 1992), aff ’d, 160 B.R. 574 (E.D. Tenn. 1993).
617 See Michael St. Patrick Baxter, Is There a Claim For Damages from the Rejection of a Collective Bargaining Agreement Under
Section 1113 of the Bankruptcy Code?, 12 Bankr. Dev. J. 703 (1996) (reviewing Blue Diamond decision).
618 Mass. Air Conditioning & Heating Corp. v. McCoy, 196 B.R. 659, 663 (D. Mass. 1996) (citing Norfolk and Western Railway Co.
v. Am. Train Dispatchers Ass’n, 499 U.S. 117, 136 n. 2 (1991) (Stevens, J., dissenting)). See also In re Moline Corp., 144 B.R. 75,
78 (Bankr. N.D. Ill. 1992) (ruling that section 365 operates to fill in the gap left in section 1113 regarding rejection damages and
that such omission was a legislative error); Baxter, supra note 617 (concluding that section 365 continues to apply except to the
extent inconsistent with section 1113 and that section 365(g) applies to permit a claim for rejection damages).
619 Nw. Airlines Corp. v. Ass’n of Flight Attendants (In re Nw. Airlines Corp.), 483 F.3d 160 (2d Cir. 2007).
620 The allocation of a rejection damages among affected employees generally is handled in the context of the proof of claim filed by
the authorized representative, but different procedures have been applied depending on the circumstances. See In re U.S. Truck
Co., Inc., 89 B.R. 618 (E.D. Mich. 1988) (basing allocation on union’s proof of claim). The Commission’s recommendation on
rejection damages under section 1113 does not affect these various approaches to allocation.
621 See id. at 625 (overruling objections to union claim for rejection damages and, where employer based need for rejection on
ability to continue operation of the business, allowing union’s claim to be calculated as the difference between reductions in
compensatory terms and other monetary terms implemented post-rejection and terms under nonrejected collective bargaining
agreement, based on analogy to claim under federal labor law for unilateral breach of collective bargaining agreement).
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2. Retiree Benefits and Section 1114
Recommended Principles:
The trustee should comply with the requirements of section 1114 of the Bankruptcy
Code for all retiree benefits (as defined in section 1114(a)), even if the trustee
contends that such benefits are terminable at will under the terms of the benefit
plan or applicable nonbankruptcy law. The trustee’s compliance with section 1114
for benefits that the trustee contends may be terminable at will should not create
any new claims on behalf of retirees or otherwise affect the existence, nature, or
scope of any retirees’ claims upon the termination or modification of such benefits
in accordance with section 1114, which claims should be determined consistent
with the terms of the plan or applicable nonbankruptcy law.
Retiree Benefits and Section 1114: Background
Section 1114 requires the debtor in possession622 to timely pay any retiree benefits and to follow a
notice, disclosure, and bargaining process before seeking to modify any retiree benefits during the
chapter 11 case. It also provides administrative priority for payments of retiree benefits required to
16
be made before the effective date of a confirmed plan.623 The protections rafforded retiree benefits
1, 20
be 2
m
under section 1114 are supplemented by a corresponding plannconfirmation requirement under
Nove
ed o
v
section 1129(a)(13). Section 1114 defines the term363 archi benefits” as “payments to any entity
“retiree
-35
or person for the purpose of providing or No. 14
, reimbursing payments for retired employees and their
own
v. Brsurgical, or hospital care benefits, or benefits in the event of
spouses and dependents, for imedical,
eth
Bl xs
ed in or death under any plan, fund, or program (through the purchase of
sickness, accident, disability,
cit
insurance or otherwise) maintained or established in whole or in part by the debtor prior to filing a
petition commencing a case under this title.”624
With respect to the modification of retiree benefits, the section 1114 process resembles the section
1113 process for the rejection of collective bargaining agreements, with at least one key difference.625
Under section 1114, a committee authorized by the court to serve as an “authorized representative” of
such retirees will represent retirees who are receiving benefits not covered by a collective bargaining
agreement in the section 1114 process.626
As suggested above, the term “retiree benefits” is broad and covers such payments under any
prepetition “plan, fund, or program (through the purchase of insurance or otherwise) maintained
or established” by the debtor. In fact, some courts interpret this language to include payments under
a prepetition retiree benefit plan even if the debtor contends that it has expressly reserved the right
622 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
623 11 U.S.C. § 1114(e).
624 11 U.S.C. § 1114(a).
625 See In re Farmland Indus., Inc., 294 B.R. 903, 918 (Bankr. W.D. Mo. 2003) (“A consideration of § 1113 of the [Bankruptcy] Code
provides further support for the Court’s understanding of § 1114.”).
626 11 U.S.C. § 1114(b)(1), (2), (d). The union under the collective bargaining agreement that gave rise to the retiree benefits
presumptively serves as the authorized representative for retirees receiving such benefits. 11 U.S.C. § 1114(c).
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to unilaterally terminate or modify such plan at any time. 627 For example, in Visteon, the relevant
plan documents provided that “the Company reserves the right to suspend, modify or amend the
benefits provided under the Plan, or even terminate the Plan or any of the benefits provided under
the Plan. . . . [T]his handbook is not a contract, nor is it a guarantee of your coverage.”628 The Third
Circuit adopted a strict reading of the statute and determined that “[t]he fact that the debtor could
have unilaterally stopped the payments had it not been in chapter 11 is . . . irrelevant.”629 Nevertheless,
other courts have ruled that a debtor in possession is not required to comply with the section 1114
process when the debtor in possession establishes that it has the right under the prepetition program
of benefits to unilaterally modify or terminate the benefits.630
Retiree Benefits and Section 1114: Recommendations and Findings
Bankruptcy Code sections 1114 and 1129(a)(13) evidence a strong policy preference for protecting
the rights of retirees in a debtor in possession’s chapter 11 case. Section 1114 was enacted in
response to the LTV Steel Company chapter 11 case in which the debtor in possession announced
its intention to discontinue health benefits for approximately 70,000 retired employees immediately
upon the petition date on the basis that such benefits would be considered prepetition claims.631 The
Commissioners understood the history behind section 1114 and the special protections afforded
retirees under the Bankruptcy Code. They also observed that retiree issues, when present in a chapter
11 case, can create complex and challenging issues for the debtor in possession.
16
, 20
er 21
emb
The Commissioners discussed the current split in the case on Nov
law regarding whether the section 1114
ived
arch
procedures apply to all prepetition retiree benefit plans, including those that were found to be
5363
14-3
No. bankruptcy. The Commissioners acknowledged the plain
terminable at will by the debtor outside of
n,
Brow
meaning interpretation lofseth v. 1114 endorsed by the Third Circuit in Visteon. They discussed
section
ix
in B
ited
the focus of thiscdecision on the application of section 1114 during the pendency of the chapter 11
case. As the Third Circuit explained in discussing the treatment of retiree benefits under a chapter
11 plan, “the duration of the period the debtor has obligated itself to provide such benefits plainly
encompasses any durational obligations, including those arising outside of the bankruptcy context.”632
Accordingly, even if bound by the section 1114 process during the chapter 11 case, the reorganized
627 See, e.g., IUE-CWA v. Visteon Corp. (In re Visteon Corp.), 612 F.3d 210, 219–20 (3d Cir. 2010) (“Section 1114 could hardly
be any clearer. It restricts a debtor’s ability to modify any payments to any entity or person under any plan, fund, or program
in existence when the debtor files for Chapter 11 bankruptcy, and it does so notwithstanding any other provision of the [B]
ankruptcy [C]ode.”); In re Farmland Indus., Inc., 294 B.R. 903, 914 (Bankr. W.D. Mo. 2003) (“In this court’s view, §1114 prohibits
a debtor from terminating or modifying any retiree benefits (as defined in that section) during a Chapter 11 case unless the
debtor complies with the procedures and requirements of §1114, regardless of whether the debtor has a right to unilaterally
terminate benefits.”). See also IUE-CWA v. Visteon Corp. (In re Visteon Corp.), 612 F.3d 210, 227 (3d Cir. 2010) (explaining
legislative history indicating a desire to protect “the ‘legitimate expectations’ of retirees, and the necessity in a ‘just society’ of
giving effect to those expectations wherever possible”); S. Rep. No. 100-119, at 1–2 (1987), reprinted in 1988 U.S.C.C.A.N. 683,
684 (“[T]o provide additional protections for the insurance benefits of retirees, their spouses and dependents, of debtors under
the Bankruptcy Code”).
628 IUE-CWA v. Visteon Corp. (In re Visteon Corp.), 612 F.3d 210, 213 (3d Cir. 2010).
629 Id. at 222.
630 See, e.g., In re Gen. Motors Corp., No. 09-50026, Hr’g Tr. at 109:24-110:2 (Bankr. S.D.N.Y. June 25, 2009) (“Section 1114 doesn’t
apply to employee benefit plans that are terminable or amendable unilaterally by the plan sponsor.”); In re Delphi Corp., 2009 WL
637259, at *19 (S.D.N.Y. Mar. 11, 2009) (“[I]f, in fact, the debtors have the unilateral right to modify a health or welfare plan . .
. the debtors’ pre-Bankruptcy rights [are not] abrogated by the requirements of section 1114.”); In re N. Am. Royalties, Inc., 276
B.R. 860 (Bankr. E.D. Tenn. 2002); Retired W. Union Employees Ass’n v. New Valley Corp. (In re New Valley Corp.), 1993 WL
818245 (D.N.J. Jan. 28, 1993); In re Doskocil Cos. Inc., 130 B.R. 870 (Bankr. D. Kan. 1991).
631 See In re Chateaugay Corp., 64 B.R. 990, 992 (S.D.N.Y. 1986); 133 Cong. Rec. H8558 (daily ed. Oct. 13, 1987) (“[T]he triggering
event for [enacting § 1114] was [the] bankruptcy of LTV Steel. . . .”).
632 IUE-CWA v. Visteon Corp. (In re Visteon Corp.), 612 F.3d 210, 224 (3d Cir. 2010) (citations omitted) (internal quotation marks
omitted).
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debtor could exercise any applicable contractual or nonbankruptcy law rights after the bankruptcy.
The Commissioners also noted certain procedural advantages provided by the statute, including the
designation of a statutory authorized representative for retirees to engage in the process.
The Commissioners weighed the Visteon approach against several competing considerations. For
example, courts finding that certain retiree benefit plans fall outside the scope of section 1114 and
rely heavily on the parties’ prepetition nonbankruptcy rights. Some commentators have noted the
practical appeal to this approach given that, even under Visteon, the debtor in possession presumably
could pay retiree benefits during the case and then, as a reorganized debtor, terminate or modify
those benefits immediately after the case, provided that the prepetition benefit plan was found to
support a reservation of that right for the company as plan sponsor.
The Commissioners also factored into their deliberations the significant complexity of conducting
“at will” litigation over the scope of section 1114 during bankruptcy and the time and expense
consumed by such litigation. They evaluated the utility of this litigation to the chapter 11 case. The
Commissioners generally found nominal value in the litigation because section 1114 is a processbased provision. Any such changes could occur only if the parties agreed to them through the
section 1114 negotiation process or the court authorized the modifications proposed by the debtor
in possession after the required negotiations.
1
Moreover, the Commissioners discussed the purpose and value of the process 6itself. The steps
1, 20
ber 2
required by section 1114 provide retirees with representation on Noa eseat at the negotiation table
and v m
ed
rchiv
during the chapter 11 case. The process not only gives retirees a voice, but it also ensures that any
63 a
-353
changes proposed or made by the debtor ,in o. 14
N possession to retiree benefits are not precipitous and
own
rThe Commissioners found value in the process for both the
are understood by all affected seth v. B
parties.
x
n Bli
debtor in possession cand iretirees in cases in which the debtor in possession believed some change
ited
to retiree benefits was necessary — regardless of whether the debtor could implement such change
unilaterally outside of bankruptcy.
In light of the various relevant factors, the Commission determined that requiring a debtor in
possession to follow the section 1114 process for any proposed change to, or termination of, any
retiree benefits was the better approach. In reaching this conclusion, however, the Commission also
agreed that the debtor in possession’s initiation of the section 1114 process where the debtor could
have asserted a unilateral right to modify or terminate outside of bankruptcy should not create
new claims or otherwise change the claims currently provided under the statute. Accordingly, if
the parties agreed to, or the court approved, a change to, or termination of, retiree benefits through
the section 1114 process, a debtor in possession asserting an “at will” or other defense limiting its
obligations under the prepetition plan could assert such defense in objecting to the amount of any
claims asserted by the retirees or their authorized representative arising from the termination or
modification of the benefit plan through the section 1114 process. Likewise, the respective rights and
remedies of the reorganized debtor and retirees under the prepetition plan (unless such obligations
were altered by agreement as part of the 1114 negotiation process) would continue following the
debtor’s emergence from chapter 11.
V. Proposed Recommendations: Administering the Case
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ABI Commission to Study the Reform of Chapter
E. Administrative Claims
1. Section 503(b)(9) and Reclamation
Recommended Principles:
The protections afforded by section 503(b)(9) of the Bankruptcy Code should be
limited to the value of goods received by, or at the direction of, the debtor in the
ordinary course of business within 20 days before the commencement of the case.
Section 503(b)(9) should be amended accordingly to permit creditors providing
goods on a drop shipment basis to assert appropriate claims under this section.
A creditor should be required to file a proof of claim and appropriate supporting
documentation for any claims it may hold against the estate under section 503(b)
(9) on or before the applicable bar date unless otherwise provided by an order of
the court. Any such proof of claim should specifically identify the amount of the
claim that the creditor asserts is subject to section 503(b)(9). A creditor’s failure
to file a timely proof of claim should constitute a waiver of such claim unless
otherwise provided by an order of the court.
16
, 20
er 21
emb rights or remedies that
A party’s rights under section 503(b)(9) should replacevany
No
d on
chive
the party may have under applicable nonbankruptcy law based upon reclamation
ar
5363
. 14section 546(c) should be amended accordingly.
or similar doctrines. Accordingly, -3
, No
own
v. Br
eth
Blixs
ed in
cit
Section 503(b)(9) and Reclamation: Background
Section 503(b)(9) of the Bankruptcy Code provides administrative claim treatment to trade creditors
for “the value of any goods received by the debtor within 20 days before the date of commencement
of a case under this title in which the goods have been sold to the debtor in the ordinary course of
business.”633 The BAPCPA Amendments added this section to the Bankruptcy Code. “The legislative
history surrounding this section is scant, but presumably Congress was concerned about providing
a vehicle to enhance payment to creditors who shipped goods to a debtor in the ordinary course of
business on the eve of bankruptcy.”634
Under section 503(b)(9), trade creditors selling goods (but not providing services) to the debtor
during the immediate prepetition period receive an administrative priority claim for the value of
those goods that remains unpaid on the petition date, regardless of whether the seller satisfies the
requirements for reclamation. Prior to the BAPCPA Amendments, the entirety of a trade creditor’s
claims were treated as general unsecured claims, unless such creditor could establish a valid
reclamation claim under Section 2-702 of the Uniform Commercial Code and section 546 of the
633 11 U.S.C. § 503(b)(9).
634 Judith Greenstone Miller & Jay L. Welford, 503(b)(9) Claimants — The New Constituent, a/k/a “The 500 Pound Gorilla,” At The
Table, 5 Depaul Bus. & Com. 487 (2007).
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Bankruptcy Institute
Bankruptcy Code. To establish a reclamation claim, a creditor was required to, among other things,
send its reclamation demand within 10 days after the buyer received the goods.
The BAPCPA Amendments implemented two key changes. First, they elevated certain of a trade
creditor’s claims to administrative priority under section 503(b)(9). Second, they extended the
reclamation reachback period to 45 days and, if the 45-day period had not expired when the
bankruptcy petition was filed, granted the creditor an additional 20 days from the commencement of
the bankruptcy case to send its written reclamation demand. Although the second change appeared
favorable to trade creditors in theory, it has turned out, in practice, to be often illusory. Section
546(c) also states that reclamation rights are expressly subject to the prior rights of a creditor with a
security interest in the goods, largely reaffirming prior case law.635
Accordingly, as a practical matter, trade creditors seek to protect a portion of their prepetition claims
under section 503(b)(9) and rarely pursue their reclamation rights under state law and section
546(c). One issue that frequently arises in this context is the process trade creditors must follow to
preserve their administrative claim under section 503(b)(9). Section 503(b) states that allowance of
a claim under that section is subject to notice and a hearing. This may require a creditor asserting
a section 503(b)(9) claim to retain counsel and to file a motion because there is no Bankruptcy
Code provision or Bankruptcy Rule permitting creditors to assert their section 503(b)(9) claims by
filing a proof of claim. In certain cases, in order to simplify the process of asserting section 503(b)
6
(9) claims and to minimize the costs of addressing those claims, debtors er 21, 201
have moved for approval
b
of, and courts have approved, procedures that have either authorized vem modification of the official
No the
d on
chive reference to section 503(b)(9) claims
proof of claim form (the “Official Form”) to include3a 3 ar
specific
35 6
. 14- to assert the section 503(b)(9) claim.
or authorized the filing of a separate proof ,of o
n N claim
h v.
xset
n Bli
i
Brow
Although section 503(b)(9) has provided additional protections to trade creditors who supply goods
cited
to the debtor, certain aspects of section 503(b)(9) are ambiguous. The ambiguities include: (i) what
constitutes “goods,”636 (ii) how is the “value” of goods determined,637 (iii) when goods have been
“received,”638 (iv) whether section 503(b)(9) claims should be disallowed or be subject to setoff when
a preference or other claim is asserted against the subject creditor,639 and (v) when should section
635 See, e.g., In re Furrs Supermarkets, Inc., 2012 WL 3396146, at * 3 (Bankr. D.N.M. 2012); In re Circuit City Stores, Inc., 441 B.R.
496, 508–10 (Bankr. E.D. Va. 2010); In re Advanced Marketing Servs., Inc., 360 B.R. 421, 427 (Bankr. D. Del. 2007); In re Dana
Corp., 367 B.R. 409, 419 (Bankr. S.D.N.Y. 2007).
636 In re NE Opco, Inc., 2013 WL 5880660 (Bankr. D. Del. Nov. 1, 2013) (holding that electricity provided by municipal lighting
plant was a service not a good, but natural gas provided by the same plant was a good); In re S. Mont. Elec. Generation &
Transmission Coop., Inc., 2013 WL 85162 (Bankr. D. Mont. Jan. 8, 2013) (holding that electricity was a good where debtor was
not an end user, but only a wholesaler of electricity); GFI Wis., Inc. v. Reedsburg Util. Comm’n, 440 B.R. 791 (W.D. Wis. 2010)
(holding that electricity is a good where debtor was not an end user of electricity); In re Erving Indus., Inc., 432 B.R. 354 (Bankr.
D. Mass. 2010) (holding that electricity is a good, not a service); In re Plastech Engineered Prods., Inc., 397 B.R. 828 (Bankr. E.D.
Mich. 2008) (natural gas is a good). But cf. In re Pilgrim’s Pride Corp., 421 B.R. 231 (Bankr. N.D. Tex. 2009) (holding that natural
gas and water are goods subject to section 503(b)(9), but where debtor is the end user of electricity, electricity is not a good but
rather a service, and thus is not subject to section 503(b)(9)); In re Samaritan Alliance, LLC, 2008 WL 2520107 (Bankr. E.D. Ky.
June 20, 2008) (holding that electricity is better characterized as a service, not a good).
637 In re S. Mont. Elec. Generation & Transmission Coop., Inc., 2013 WL 85162 (Bankr. D. Mont. 2013) (holding that invoice price
is proper value of goods); In re SemCrude, L.P., 416 B.R. 399 (Bankr. D. Del. 2009) (same); In re Pilgrim’s Pride Corp., 421 B.R.
231 (Bankr. N.D. Tex. 2009) (holding that replacement cost is the proper value of goods).
638 In re Momenta, Inc., 455 B.R. 353 (Bankr. D.N.H. 2011) (addressing whether drop shipped goods were received by the debtor);
In re Circuit City Stores, Inc., 432 B.R. 225 (Bankr. E.D. Va. 2010) (addressing when consigned goods were received by the
debtor); In re Plastech Engineered Prods., Inc., 397 B.R. 828 (Bankr. E.D. Mich. 2008) (addressing whether drop shipped good
were received by the debtor).
639 In re Ames Dep’t Stores, Inc., 582 F.3d 422 (2d Cir. 2009) (holding that section 502(d) is not a ground for disallowance of an
administrative priority claim); In re Energy Conversion Devices, Inc., 486 B.R. 872 (Bankr. E.D. Mich. 2013) (same); In re
Plastech Engineered Prods., Inc., 394 B.R. 147 (Bankr. E.D. Mich. 2008) (same). See also In re Momenta, Inc., 455 B.R. 353
(Bankr. D.N.H. 2011) (holding that section 502(d) is not a ground for disallowance of a section 503(b)(9) claim); In re TI
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ABI Commission to Study the Reform of Chapter
503(b)(9) claims be paid (on the effective date or sometime earlier).640 Both creditors and the estate
are affected by these issues and frequently incur litigation costs to try to resolve the uncertainty.
Section 503(b)(9) and Reclamation: Recommendations and Findings
The Commission received conflicting testimony concerning the administrative priority of trade
claims for certain goods under section 503(b)(9). Some witnesses testified that this additional class
of administrative claims made it more difficult for debtors to reorganize because the chapter 11
plan must pay these claim in full on the effective date under section 1129(a)(9).641 This testimony
was consistent with testimony provided to Congress on the topic of the Circuit City bankruptcy
and similar retail chapter 11 cases.642 Other witnesses strongly disputed that trade claims were an
impediment to confirmable plans of reorganization.643
The Commissioners weighed this testimony with anecdotal evidence concerning the types of
challenges faced by chapter 11 debtors, including retail debtors, since 2005.644 For example, debtors
are more highly leveraged.645 As a result, they have less value available to support their reorganization
efforts. The economic recession that started in 2008 affected several industries and accelerated or
contributed to firms’ financial distress. The BAPCPA Amendments also made other changes to the
Bankruptcy Code that arguably altered chapter 11 practice, at least as compared to the pre-2005
period.646
6
1
1, 20
ber 2
m
Nove
d n
eIn o MicroAge, Inc., 291 B.R. 503 (B.A.P. 9th Cir. 2002)
Acquisition, LLC, 410 B.R. 742, (Bankr. N.D. Ga. 2009) (same).aBut icf. re
rch v
63
(holding that debtor could assert preference claim as4basis for temporarily disallowing section 503(b)(9) priority claims); In re
-353
o 1
Circuit City Stores, Inc., 426 B.R. 560 (Bankr.,E.D..Va. 2010) (same).
n N
640 In re Arts Dairy, LLC, 414 B.R. 219 . Brow N.D. Ohio 2009) (explaining that a debtor was not immediately required to pay a
(Bankr.
hv
section 503(b)(9) claim); InliresGlobal Home Prods., LLC, 2006 WL 3791955 (Bankr. D. Del. Dec. 21, 2006) (holding that section
x et
n B after confirmation of plan); In re Bookbinders’ Rest., Inc., 2006 WL 3858020 (Bankr. E.D. Pa. Dec.
503(b)(9) claim shouldi be paid
cited
28, 2006) (holding that claimant was not entitled to immediate payment of section 503(b)(9) claim).
641 Written Statement of John Collen, Partner, Tressler LLP: NCBJ Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11, at 2–3 (Apr. 26, 2012) (stating that section 503(b)(9) puts huge demands on the cash of the debtor and undermines the debtor’s
reorganization), available at Commission website, supra note 55; Written Statement of Dan Dooley, CEO of MorrisAnderson:
ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Apr. 19, 2013) (stating that section 503(b)(9)
increases the cost of reorganization which in turn fuels trend toward bankruptcy alternatives), available at Commission website,
supra note 55; First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at
Commercial Fin. Ass’n Annual Meeting, at 10 (Nov. 15, 2012) (“Because holders of administrative claims are not placed in classes
and do not vote on a plan, and each administrative creditor must be paid in full in cash at the time of confirmation, unless that
creditor agrees otherwise, §503(b)(9) creates holdout power in all members of a particular group of creditors, contrary to the
policy of bankruptcy law to reduce such power. Because of that power, and the requirement to pay all administrative expenses
even in sale cases, secured creditors will reserve for such claims, reducing the resources available to distressed debtors for
reorganization.”) (citations omitted), available at Commission website, supra note 55.
642 See Circuit City Unplugged: Why Did Chapter 11 Fail to Save 34,000 Jobs?: Hearing Before the Subcomm. on Commercial and
Administrative Law of the Comm. on the Judiciary, 111th Cong. 44 (2009) (statements of Harvey R. Miller and Richard M.
Pachulski). But see id. (statement of Professor Todd J. Zywicki, George Mason School of Law) [hereinafter Zywicki Statement];
Lehman Brothers, Sharper Image, Bennigan’s and Beyond: Is Chapter 11 Bankruptcy Working?: Hearing Before the Subcomm. on
Commercial and Administrative Law of the Comm. on the Judiciary, 110th Cong. 21 (2008) (statement of Professor Barry E. Adler,
Esq., New York University School of Law) [hereinafter Adler Statement].
643 See generally Transcript, NACM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (May 21, 2013), available
at Commission website, supra note 55.
644 See, e.g., Bob Duffy, Broken Beyond Repair: Is BAPCPA Unfairly Blamed for Rash Retail Liquidations, J. of Corp. Renewal (Jan.
8, 2009); Written Statement of Lawrence Gottlieb, Partner, Cooley LLP: NYIC Field Hearing Before the ABI Comm’n to Study the
Reform of Chapter 11, at 3 (June 4, 2013) (stating that BAPCPA deadlines are hurting retail debtors’ chances of rehabilitation),
available at Commission website, supra note 55
645 See U.S. Retail Case Studies in Bankruptcy Enterprise Values and Creditor Recoveries, Fitch Case Studies — Retail Edition 1–2
(Apr. 16, 2013) [hereinafter Fitch Report] (observing that there is a “tendency of distressed retailers to maximize secured
borrowings, subordination of significant administrative claims and dilution of recoveries from pension, general unsecured trade
and operating lease rejection claims placed downward pressure on unsecured recoveries”) Analyzing a sample of 20 retail cases,
the Fitch Report observed that in each case at least one first lien claim was paid in full, but, alternatively, the median unsecured
claim recovery was less than 10 percent, while the average was 20 percent. Id. See also Stephen A. Donato & Thomas L. Kennedy,
Trends in DIP Financing: Not as Bad as It Seems?, J. Corp. Renewal, Sept./Oct. 2009.
646 See Section III.A, Brief History of U.S. Business Reorganization Laws.
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The Commissioners acknowledged that trade creditors are aware of, and rely on, their rights under
section 503(b)(9) in making prepetition credit and shipment decisions. Some of the Commissioners
raised concerns about the increasing number of administrative and priority claims categories.647
Each additional administrative or priority claim category undercuts the Bankruptcy Code’s policy
of fair and pro rata distributions among similarly situated creditors. The Commission agreed
that administrative and priority status should be a limited exception and that general unsecured
status should be the rule. Several Commissioners did not believe, however, that eliminating the
section 503(b)(9) category would provide significant benefits to the estate, but they did believe
that it may make operating the debtor’s prepetition business more challenging or expensive to the
extent that trade creditors refuse to ship goods or will do so only on modified credit or all-cash
terms. On balance, the Commission voted to retain the section 503(b)(9) administrative claims
priority, provided that this provision represent the only priority treatment made available to such
creditors. The Commission also agreed to recommend the elimination of all reclamation rights in
bankruptcy under section 546(c), as well as any doctrine of necessity arguments related to these
claims.648
In making this determination, the Commissioners discussed whether a valid basis existed for
excluding drop shipment transactions, when the trade creditor supplies goods on the debtor’s behalf
to another party, from section 503(b)(9). The Commissioners acknowledged the statutory support
for the exclusion given that the debtor does not “receive” the goods in this instance and given that
16
1, 2 Nevertheless, they
section 503(b)(9) was intended to benefit creditors with reclamation rights.649 0
ber 2
m
No to
discussed the substance of drop shipment transactions and theirnuseve increase efficiencies in the
ed o
iv
transactions, which may still be provided for the benefitrch the debtor’s business. Accordingly, the
63 a of
-353
14
Commission determined that, if the debtor, directed the creditor to ship the goods directly to a third
No.
rown
party in lieu of the debtor making v. B shipment, then applying section 503(b)(9) serves the same
eth that
Blixs
ed in trade creditors to supply goods on credit and should apply to the drop
policy goal of encouraging
cit
shipment transaction.
The Commissioners also discussed the inclusion of services in section 503(b)(9). Again, the
Commissioners recognized the difficulty in drawing a bright line to limit the scope of the exception
to that necessary to achieve the desired policy goals. They distinguished service providers from
suppliers of goods based on their respective state law rights and the use of section 503(b)(9) as a
substitution for creditors’ state law reclamation rights. They also believed that a debtor in possession
would have adequate ability to justify and request authority to pay service providers critical to the
business and reorganization efforts through the Commission’s proposed codification of the doctrine
of necessity, as explained above.650
The Commissioners did note the confusion and uncertainty regarding the process for creditors to
assert and preserve section 503(b)(9) claims. Some of the Commissioners suggested that, just as
with any other administrative claim request, the creditor should be required to file a motion and
justify the request. Other Commissioners believed that such a requirement would add unnecessary
647 See, e.g., Howard Delivery Serv. Inc. v. Zurich Am. Insur. Co., 547 U.S. 651, 655 (2006) (explaining that exceptions to general
equality principle should be “clearly authorized by Congress” and strictly construed).
648 See Section IV.D.1, Prepetition Claims and the Doctrine of Necessity.
649 See, e.g., Ningbo Chenglu Paper Prods. Mrf. Co., Ltd v. Momenta, Inc. (In re Momenta, Inc.), 2012 WL 3765171, at *4 (D.N.H.
Aug. 29, 2012).
650 See Section IV.D.1, Prepetition Claims and the Doctrine of Necessity.
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ABI Commission to Study the Reform of Chapter
cost to the process and would not be particularly efficient for either the debtor in possession or
the estate in many cases. After discussing various alternatives, the Commission agreed that these
principles should recommend a modification to section 503(b)(9), the Bankruptcy Rules, and the
Official Form to require creditors asserting section 503(b)(9) claims to file a proof of claim for such
claims on or before the general bar date or a specific section 503(b)(9) bar date established by the
court.
2. Administrative Claims Committee
Recommended Principles:
Neither the court nor the U.S. Trustee should be authorized to constitute an official
committee of administrative claimants. Accordingly, a new provision should be
added to section 1102 to clarify this point.
Administrative Claims Committee: Background
Section 1102 of the Bankruptcy Code currently mandates the appointment of a committee of creditors
holding unsecured claims and allows the court to order the appointment 016other committees of
of
2
r 21,
creditors or equity security holders “if necessary to assure adequatembe
representation” of such creditors
ove
on Ncommittee are vetted and appointed
or equity security holders. In all instances, the members ed the
iv of
arch
363
by the U.S. Trustee. As discussed in Section 5
-3 IV.A.4, Statutory Committees, committees generally
o. 14
n, N in the case, protect the rights and interests of unsecured
provide a voice for unsecured .creditors
Brow
hv
ixset
creditors, and serve as a lstatutory watchdog or check on the debtor in possession.
in B
cited
Traditionally, unsecured creditors were viewed as one of the more vulnerable classes of stakeholders
in a chapter 11 case. Many debtors had liquidity or other resources to pay their secured creditors
and administrative and priority claimholders, but often did not generate sufficient value to pay
unsecured creditors in full, or even a meaningful distribution, in the case. Moreover, the Bankruptcy
Code requires a debtor to pay the allowed claims of secured creditors and holders of administrative
claims in order to confirm a chapter 11 plan. Accordingly, secured creditors and the holders of
administrative claims typically have sufficient protection in a chapter 11 case.
In recent years, the more vulnerable (or perceived vulnerable) classes of stakeholders in a chapter 11
case have moved up in a debtor’s capital structure. The debtor often does not generate sufficient value
to pay its administrative claimants. As “administratively insolvent” cases have become more common,
some practitioners have questioned whether administrative claimants need representation through
the committee structure. Most courts have rejected requests for the appointment of administrative
claims committees. The one notable exception is In re LTV Steel.
Administrative Claims Committee: Recommendations and Findings
Committees serve oversight and representative functions that generally are lacking in the chapter
11 case. The latter is particularly important in the context of unsecured creditors and, in some cases,
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equity security holders whose distributions in the chapter 11 case are determined largely by the
value of the estate, or value generated for the benefit of the estate during the case. The Bankruptcy
Code does not require a minimum distribution to general unsecured creditors or equity security
holders. Rather, plan confirmation standards require only that these parties receive at least as much
as they would receive in a chapter 7 liquidation and that, to the extent they are impaired, no junior
class receive a distribution.
The Commissioners did not perceive the same risks for administrative claimholders. Although the
value generated in a case may prove inadequate and administrative claims may not be satisfied in full,
the Bankruptcy Code incorporates protections for these claimholders at least in the confirmation
context. In addition, the Commissioners noted that the recommended principles on section 363x
sales propose extending similar protection to administrative claimholders in the context of sales of all
or substantially all of a debtor’s assets. Accordingly, the Commission determined that the additional
time and expense often associated with statutory committees were not necessary or warranted with
respect to administrative claims.
3. WARN Act Claims
Recommended Principles:
16
1, 20
ber 2 the Worker
When a plant closing, mass layoff, or other triggering Novem under
event
n
ed o
Adjustment and Retraining Notification Act r(the “WARN Act”) occurs on or
chiv
63 a
-353claims for (or on behalf of) employees
after the filing of the bankruptcy petition,
. 14
, No
for damages under the v. Brown Act should be treated as administrative claims
WARN
eth
Blixs
under section i503(b) of the Bankruptcy Code for the number of postpetition
ed n
cit
days comprising the violation, provided that the claims are otherwise entitled to
protection under the WARN Act.
WARN Act Claims: Background
The Worker Adjustment and Retraining Notification Act (the “WARN Act”)651 requires covered
employers to provide affected employees with at least 60 days’ advance notice prior to effecting a
plant closing or covered mass layoff. The WARN Act is intended to “provide[] protections to workers,
their families and communities by requiring employers to provide notification 60 calendar days in
advance of plant closings and mass layoffs. Advance notice provides workers and their families some
transition time to adjust to the prospective loss of employment, to seek and obtain alternative jobs
and, if necessary, to enter skill training or retraining that will allow these workers to successfully
651 29 U.S.C. §§ 2101–2109.
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ABI Commission to Study the Reform of Chapter
compete in the job market.”652 When the required notice is not given, employers may be liable for
back pay and benefits for the period of the violation, up to a maximum of 60 days.653
There are statutory exceptions that, if established by the employer, would permit a notification period
of fewer than 60 days. Under the “faltering company” exception, a company may provide fewer
than 60 days’ notice of a plant closing if, during the 60 days prior to shutdown, the company was
“actively seeking capital or business, which, if obtained, would have enabled the employer to avoid
or postpone the shutdown and the employer reasonably and in good faith believed that giving the
notice required would have precluded the employer from obtaining the needed capital or business.”654
In addition, when a mass layoff or plant closing is caused by business circumstances that were “not
reasonably foreseeable as of the time the notice would have been required,” the notification period
may be reduced.655 Similarly, a natural disaster may reduce the notice period.656 An employer relying
one of the statutory bases for a reduction in the notice period must still provide “as much notice as
is practicable.”657 Other defenses to WARN Act liability may apply as well.658
Employees aggrieved by a violation of the notice requirement, or their representatives,659 may assert
claims for back pay for “each day of the violation,” and for benefits under an employee benefit plan.660
Liability is calculated for the period of the violation, up to a maximum of 60 days. Certain reductions
may apply, for example, for any wages paid by the employer for the period of the violation.661
Liability for WARN Act damages when the requisite notice was not given 016 been analogized to
, 2 has
er 21
emb such pay to be earned in full
liability for severance pay in lieu of notice, when courts haveNov
n viewed
ed o
chivWARN Act damages give rise to a right to
upon the triggering event. Thus, courts have held ar
3 that
3536
. 14payment upon the occurrence of the event triggering the violation (i.e., the employment termination
No
wn,
or mass layoff). Accordingly,th v. Bro
the timing of the triggering event generally has determined the payment
lixse
classification of citedclaim for bankruptcy purposes. When employment loss occurred prepetition,
the in B
due to a plant closing or mass layoff that is covered by the WARN Act, the WARN Act damages claim
generally has been held to arise in full prepetition, even if the termination occurred close in time
to a bankruptcy filing such that a portion of the 60-day period covered by the notice requirement
652 20 C.F.R. § 639.1(a). See In re FF Acquisition Corp., 438 B.R. 886, 891 (Bankr. N.D. Miss. Oct. 26, 2010), aff ’d and appeal
dismissed sub nom. Angles v. Flexible Flyer Liquidating Trust, 471 B.R. 182 (N.D. Miss. 2012), aff ’d sub nom. In re Flexible
Flyer Liquidating Trust, 511 Fed. App’x 369 (5th Cir. 2013). See also Hotel Employees & Rest. Employees Int’l Union Local 54
v. Elsinore Shore Assocs., 173 F.3d 175, 182 (3d Cir. 1999) (noting adoption of WARN Act “in response to the extensive worker
dislocation that occurred in the 1970s and 1980s”).
653 In re FF Acquisition Corp., 438 B.R. 886, 891 (Bankr. N.D. Miss. Oct. 26, 2010), aff ’d and appeal dismissed sub nom. Angles v.
Flexible Flyer Liquidating Trust, 471 B.R. 182 (N.D. Miss. 2012), aff ’d sub nom. In re Flexible Flyer Liquidating Trust, 511 Fed.
App’x 369 (5th Cir. 2013). See also 29 U.S.C. § 104(a)(1)(A)–(B).
654 29 U.S.C. § 2102(b)(1). See 20 C.F.R. § 639.9(a) (setting forth qualifying requirements for “faltering business” exception).
655 29 U.S.C. § 2102(b)(2). See 20 C.F.R. § 639.9(b)(2) (setting forth indicators where business circumstance may not be reasonably
foreseeable).
656 See 29 U.S.C. § 2102(b)(2)(B); 20 C.F.R. § 639.9(c).
657 29 U.S.C. § 2102(b)(3).
658 E.g., id. § 2104(a)(4) (providing that, in an action to recover damages, where an employer proves “reasonable grounds for
believing that the act or omission was not a violation” of the statute, court may reduce the amount of the liability). See also id.
§ 2103 (listing exemptions where plant closing or mass layoff constitutes a strike or lockout, or closing relates to a temporary
facility).
659 See United Food & Commercial Workers Local 751 v. Brown Grp., Inc., 517 U.S. 544 (1996) (holding that union representing
affected employees has standing under WARN Act to sue for damages on their behalf).
660 See 29 U.S.C. § 2104(a)(1)(A)–(B).
661 See id. § 2104(a)(1), (2).
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included time following the petition date.662 When applicable, prepetition WARN Act claims have
been held to be subject to the wage priority.663
When the event triggering WARN Act liability occurs postpetition, courts have held that employees
terminated postpetition have claims that accrue in full postpetition.664 Thus, these cases hold that
WARN Act claims based on a postpetition termination are entitled to administrative priority.665
One case held differently, although in the context of deciding whether a WARN Act claim should
proceed as an adversary proceeding or through the claims adjudication process. In In re Circuit City,
the plaintiff was terminated postpetition, but the date on which notice should have been given, had
his employer complied with the WARN Act, was eight days prior to the petition date.666 The debtor
argued that the claim arose on the date that notice was due, not on the date of termination. The
court’s rationale was that, as of the date the company gave notice of the store closing, which occurred
prior to the bankruptcy, the employees had a “contingent” claim against the debtor, in the event the
debtor’s notice was inadequate under the WARN Act.667 Thus, the court concluded that (at least for
purposes of determining the mechanism for pursing the claim) the claim arose on the date notice
was due. The court thus concluded that the claim should proceed through the claims adjudication
process and dismissed the plaintiff ’s adversary proceeding.
WARN Act Claims: Recommendations and Findings
16
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v m
In considering cases involving postpetition closures or other triggeringeevents under the WARN Act,
n No
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the Commission agreed that the event giving rise to 363 arch Act damages is the loss of employment
WARN
-35
4
due to the WARN Act triggering event, and No. 1the date the notice should have been given. In order
, not
rown
B
h v.
xset
n Bli Corp., 394 B.R. 765, 772–73 (Bankr. D. Del. 2008); Int’l Bhd. of Teamsters, AFL-CIO v. Kitty
662 See, e.g., In re Powermate ed i
Holding
cit
663
664
665
666
667
Hawk Int’l, Inc. (In re Kitty Hawk, Inc.), 255 B.R. 428, 438 (Bankr. N.D. Tex. 2000) (Bankr. N.D. Tex. 2000). See also In re First
Magnus Fin. Corp., 403 B.R. 659, 665–66 (D. Ariz. 2009) (holding that WARN Act rights of workers discharged without requisite
notice accrue in their entirety upon termination and damages are vested prepetition); In re Continentalafa Dispensing Co., 403
B.R. 653, 658 (Bankr. E.D. Mo. 2009) (“Here, Plaintiff was terminated before Debtors filed their petitions and therefore, Plaintiff
performed no work after the petitions were filed. Thus, Plaintiff has a prepetition claim.”).
E.g., In re Powermate Holding Corp., 394 B.R. 765, 772–73 (Bankr. D. Del. 2008); Int’l Bhd. of Teamsters, AFL-CIO v. Kitty Hawk
Int’l, Inc. (In re Kitty Hawk, Inc.), 255 B.R. 428, 438 (Bankr. N.D. Tex. 2000). Courts generally have held that WARN Act damages
are considered “wages.” E.g., In re Powermate Holding Corp., 394 B.R. 765, 771 (Bankr. D. Del. 2008); In re Hanlin Grp., Inc., 176
B.R. 329, 333 (Bankr. D.N.J. 1995); In re Riker Indus., Inc., 151 B.R. 823 (Bankr. N.D. Ohio 1993); In re Cargo, Inc., 138 B.R. 923,
927 (Bankr. N.D. Iowa 1992).
Courts have considered whether to apportion WARN Act damages between prepetition and postpetition periods under section
503(b)(1)(a)(A)(ii), a section added to the Bankruptcy Code pursuant to BAPCPA. However, although courts have consistently
declined to apply revised section 503(b) where a WARN Act event occurs prepetition, they have not agreed on an interpretation
of this provision that would encompass WARN Act damages. Compare In re First Magnus Fin. Corp., 390 B.R. 667, 679 (Bankr.
D. Ariz. 2008) (interpreting section 503(b)(1)(a)(A)(i) and (ii) such that both subparts must apply for subpart (ii) to apply at all,
so that statute is inapplicable where no services are rendered postpetition) with In re Continentalafa Dispensing Co., 403 B.R.
653, 658 (Bankr. E.D. Mo. 2009) (holding that BACPA was not meant to “slant” the law to cover prepetition terminations); In re
Powermate Holding Corp., 394 B.R. 765, 777 (Bankr. D. Del. 2008) (holding that statutory use of “and” meant that subparts (i)
and (ii) were independent examples of administrative claims, but BAPCPA was not meant to “drastically change the outcome
of prepetition employment terminations”). But see In re Phila. Newspapers, LLC, 433 B.R. 164, 174–75 (Bankr. E.D. Pa. 2010)
(disagreeing with Powermate’s conclusion that statute must be applied based on the timing of accrual or vesting of right to
payment, but holding that statute is inapplicable to back pay award based upon contractual violation). The Commission did
not address whether an employment loss resulting from a prepetition WARN Act triggering event could nonetheless fall within
BAPCPA.
E.g., In re Beverage Enters., Inc., 225 B.R. 111, 115–16 (Bankr. E.D. Pa. 1998) (holding that WARN Act claims of workers who
were terminated approximately four months after chapter 11 petition was filed were deemed “severance” benefits that was earned
immediately upon termination, that it was indisputable that termination occurred postpetition, and that WARN Act claims were
therefore entitled to administrative priority); In re Hanlin Grp., Inc., 176 B.R. 329, 334 (Bankr. D.N.J. 1995) (“Back pay under
WARN [Act] is deemed to be earned at the date of termination. Because the date of termination occurred postpetition, any back
pay due for a WARN [Act] violation will be deemed as earned postpetition, and therefore in the nature of wages for services
rendered after the commencement of the case entitled to administrative priority status.”).
In re Circuit City Stores, Inc., 2010 WL 120014 (Bankr. E.D. Va. Jan. 7, 2010).
Id. at *4.
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ABI Commission to Study the Reform of Chapter
to violate the WARN Act, an employer must effect a mass layoff or plant closing that takes place
without providing the requisite WARN Act notice. Until such an event occurs, there has been no
violation of the WARN Act. Thus, aggrieved employees should have a postpetition administrative
claim for WARN Act damages for the number of postpetition days comprising the violation. The
principle would apply assuming the claim for WARN Act damages is otherwise determined to be a
valid claim under the WARN Act. The Commission did not address the substance of any potential
defenses that may be applicable under the WARN Act, and instead proposed its recommendation
strictly on the basis that the appropriate forum has otherwise determined that damages were owed.
The Commission considered whether a bright-line rule that postpetition WARN Act violations give
rise to administrative claims might create an incentive for companies with plants or operations that
are of doubtful viability to close such plants or operations prepetition rather than trying to turn them
around postpetition and risk an administrative priority WARN Act claim if the turnaround effort
fails. However, strategic decisions based solely on the economics of a potential WARN Act claim
seem unlikely, particularly because most courts already determine payment priority status based
on the timing of the triggering WARN Act event, and the Commission’s clarifying recommendation
would not represent a significant change in current law.
4. Severance Benefits
16
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An employee’s claim for postpetition severance benefits should be eligible
. 14
, No
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for treatment as anv.administrative claim under section 503(b)(1)(A)(i) of the
B
h
xset
Bankruptcy Code.
n Bli
i
cited
If an employee is terminated postpetition and entitled to severance benefits
that are calculated based on length of service, the employee’s claim against the
estate for severance benefits should be bifurcated between the prepetition and
postpetition periods, such that the employee is permitted to assert (i) a prepetition
claim for severance benefits based on prepetition service and (ii) a postpetition
administrative claim for severance benefits based on postpetition service. Such
an employee also should be permitted to assert a priority claim for any qualifying
portion of the prepetition severance benefits claim under section 507.
Severance Benefits: Background
Severance benefits generally are described as payments due to an employee as a result of the
termination of employment or some other significant adjustment to or change in the employee’s
employment circumstances.668 In a chapter 11 case, a debtor may reduce its workforce because, for
example, it is downsizing, restructuring its business operations, or liquidating. Employees impacted
668 5 Collier on Bankruptcy ¶ 507.06[5](b) (16th ed. 2012).
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by these decisions may be covered by prepetition severance plans. These plans may be based on (i) a
fixed payment at termination in lieu of notice, or (ii) the terminated employee’s length of service.669
The treatment of employees’ severance benefits in the chapter 11 case is important to both the debtor
and its employees. The primary issue in this respect is whether the severance benefits are treated as
prepetition unsecured claims or postpetition administrative claims. Section 503(b) of the Bankruptcy
Code grants administrative priority to the “actual, necessary costs and expenses of preserving the
estate.”670 These claims generally include costs associated with operating the debtor’s business and
administering the estate during the chapter 11 case. Section 503(b)(1)(A)(i) specifically identifies
“wages, salaries, and commissions for services rendered after the commencement of the case” as
administrative claims.671 These claims are entitled to payment priority (i.e., paid before prepetition
unsecured claims are paid) and generally must be paid in full under the chapter 11 plan. Accordingly,
the characterization of severance benefits can have significant consequences for the debtor and the
terminated employees.
Although not specifically referenced in the statute, courts analyze the treatment of severance benefits
under section 503(b)(1)(A)(i).672 In general, courts tend to treat severance benefits as prepetition or
postpetition claims based on the type of severance plan at issue: if it is a lump sum payment plan
in lieu of notice, courts treat the benefits as postpetition claims;673 if it is a plan based on length of
service, courts generally allocate the benefits between prepetition and postpetition claims according
6
to when the severance benefits were earned.674 Notably, the Second Circuit has 1, 201 the allocation
rejected
ber 2
of severance benefits — even under plans based on length of service vemfinding that the purpose of
No —
d on
chive
ar
severance benefits is to compensate the employees for3termination, which is the event that should
3536
. 14-675 Courts in the Second Circuit thus treat all true
determine the treatment of claims in bankruptcy.
, No
own
v. Br
severance benefits triggered byeth postpetition termination as postpetition administrative claims.
a
Blixs
Moreover, in the context of section 507(a)(4) priority claims, the Fourth Circuit has determined that
ed in
cit
severance compensation was “earned” upon the employees’ termination.676
669 See, e.g., Lines v. Sys. Bd. of Adjustment No. 94 Bhd. of Ry., Airline & Steamship Clerks (In re Health Maint. Found.), 680 F.2d
619, 621 (9th Cir. 1982); Richard F. Broude, Reorganizations Under Chapter 11 of the Bankruptcy Code 6-12.3 (Law Journal
Press, 2005).
670 11 U.S.C. § 503(b).
671 Id. § 503(b)(1)(A)(i).
672 Id. Before a debtor can provide or pay any insider of the debtor administrative priority severance pay, the debtor must satisfy the
requirements of section 503(c)(2). Id. § 503(c). The Commission did not address the payment of severance or other compensation
to insiders under section 503(c).
673 5 Collier on Bankruptcy ¶¶ 503.06[7](d), 507.06[5](b) (16th ed. 2012).
674 See, e.g., Preferred Carrier Svcs. Va., Inc. v. Phones For All, Inc.(In re Phones For All, Inc.), 288 F.3d 730 (5th Cir. 2002); Bachman
v. Commercial Fin. Svcs., Inc. (In re Commercial Fin. Svcs., Inc.), 246 F.3d 1291, 1294 (10th Cir. 2001); In re Roth Am., Inc.,
975 F.2d 949 (3d Cir. 1992); Lines v. Sys. Bd. of Adjustment No. 94 Bhd. of Ry., Airline & Steamship Clerks (In re Health Maint.
Found.), 680 F.2d 619, 621 (9th Cir. 1982); Cramer v. Mammoth Mart, Inc. (In re Mammoth Mart, Inc.), 536 F.2d 950 (1st Cir.
1976); In re Public Ledger, Inc., 161 F.2d 762 (3d Cir. 1947); Rawson Food Svcs., Inc. v. Creditors’ Comm. (In re Rawson Food
Svcs., Inc.), 67 B.R. 351 (Bankr. M.D. Fla. 1986).
675 Rodman v. Rinier (In re W.T. Grant Co.), 620 F.2d 319 (2d Cir. 1980), superseded by statute (Bankruptcy Code) as recognized in In
re Hooker Investments, Inc, 145 B.R. 138 (Bankr. S.D. New York. 1992); Straus-Duparquet, Inc. v. Local Union No. 3, Int’l Bhd.
of Elec. Workers, AFL-CIO (In re Straus-Duparquet, Inc.), 386 F.2d 649, 651 (2d Cir. 1967), superseded by statute (Bankruptcy
Code) as recognized in In re Drexel Burnham Lambert Grp., Inc., 138 B.R. 687, 711 (Bankr. S.D.N.Y. 1992) See also Supplee v.
Bethlehem Steel Corp. (In re Bethlehem Steel Corp.), 479 F.3d 167, 175 (2d Cir. 2007) (“The key inquiry is whether the payment
is a new benefit earned at termination or instead an acceleration of benefits [which the employee accrued over time].”).
676 Matson v. Alarcon, 651 F.3d 404, 409 (4th Cir. 2011). The Fourth Circuit specifically highlighted the difference in language
between section 503(b)(1)(A)(i) and section 507(a)(4), noting that the former — dealing with characterization of employee
payments as administrative claims — expressly tied such claims to “services rendered after the commencement of the case.”
Id. Accordingly, the Fourth Circuit’s decision may have limited application in the analysis of severance benefits arising from a
postpetition termination.
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Severance Benefits: Recommendations and Findings
The Commission considered two issues with respect to severance benefits in chapter 11: first,
whether section 503(b)(1)(A)(i) should be amended to specifically reference severance benefits, in
addition to “wages, salaries, and commissions for services rendered after the commencement of the
case”; and second, whether the Bankruptcy Code should be amended to address the treatment of
severance benefits relating to a postpetition termination or other triggering event. The Commission
agreed that “severance benefits” should be added to section 503(b)(1)(A)(i) and largely viewed this
change as a technical amendment. The Commissioners engaged in a more in-depth analysis of the
treatment of severance benefits as prepetition or postpetition claims.
The Commissioners discussed the underlying nature of severance benefits. Some of the
Commissioners viewed severance benefits in all circumstances as compensation for the termination
itself, not wages or compensation for services previously rendered. These Commissioners
emphasized that severance benefits are intended to mitigate at least some of the hardship imposed
upon employees by the termination of employment and the resulting loss of wages and benefits.
They also observed that, even if a severance plan uses length of service to calculate the amount
of the severance benefit, that reference is solely a calculation tool and does not necessarily speak
to the nature or purpose of the benefit. Finally, these Commissioners highlighted the additional
burden on more senior employees imposed by an allocation rule. These employees may have the
majority of their severance benefits calculated based on a long prepetition 016
, 2 tenure with the debtor,
er 21
emb
arguably penalizing them for their loyalty and service to the Nov
debtor.
n
o
ived
arch
363
Other Commissioners strongly believed that -35
14 severance benefits calculated based on length of service
No.
n,
should be deemed earned whenBrow services were provided. This approach requires an allocation
. such
eth v
s
of the severance ibenefitsixbetween the prepetition and postpetition periods. These Commissioners
in Bl
c ted
observed that many claims are bifurcated in this manner under the Bankruptcy Code, and they
did not find justification for varying it in the employment context. They also emphasized that
administrative claims must be grounded in value provided to the estate — whether to preserve or
enhance the estate — and focused on the general purpose and language of section 503(b) of the
Bankruptcy Code.
In vetting these issues, the Commission considered the U.S. Supreme Court’s decision in United
States v. Quality Stores.677 In Quality Stores, the Supreme Court held that severance payments were
wages for purposes of FICA, and provided guidance on how to characterize these types of payments.
Specifically, the Supreme Court explained:
[S]everance payments often vary, as they did here, according to the function and
seniority of the particular employee who is terminated. For example, under both
termination plans, Quality Stores employees were given severance payments based on
job grade and management level. And under the second termination plan, nonofficer
employees who had served at least two years with their company received more in
severance pay than nonofficer employees who had not — a standard example of a
company policy to reward employees for a greater length of good service and loyalty.
677 United States v. Quality Stores, Inc., 134 S. Ct. 1395 (2014).
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In this respect severance payments are like many other benefits employers offer to
employees above and beyond salary payments. Like health and retirement benefits,
stock options, or merit-based bonuses, a competitive severance payment package
can help attract talented employees. Here, the terminations leading to the severance
payments were triggered by the employer’s involuntary bankruptcy proceeding, a
prospect against which employees may wish to protect themselves in an economy
that is always subject to changing conditions.678
Some of the Commissioners asserted that the Supreme Court’s holding in Quality Stores suggested
that the characterization of severance benefits as payment either due upon termination or for
services previously provided by an employee should be left to the courts to resolve on a case-by-case
basis. The advisory committee recommended this approach as well. Other Commissioners did not
necessarily disagree with this assessment, but argued that the Bankruptcy Code should still clarify
the treatment of severance benefits if the court determines they are earned based upon length of
service under the applicable severance plan. The Commission recommended that the Bankruptcy
Code codify an allocation rule for severance benefits triggered postpetition and calculated based on
length of service. For additional views on the recommended principles for severance benefits, see
Appendix G.
16
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B
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Recommended Principles:
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F. General Valuation Standards
The court should continue to determine valuation issues based on the evidence
presented by the parties. The Bankruptcy Code should not dictate the valuation
methodology to be used by the court in resolving these issues. Accordingly, no
change to existing law is suggested on this point.
The court should be permitted to use a court-appointed expert and to rely on the
hearing testimony of a court-appointed expert in addition to any expert offered by
the parties to assist in determining valuation issues. Section 105 of the Bankruptcy
Code and Rule 706 of the Federal Rules of Evidence permit the court to appoint
valuation experts. Accordingly, no change to existing law is suggested on this point.
General Valuation Standards: Background
Valuation issues arise at various points in a chapter 11 case. Parties may need a valuation of the
debtor’s assets early in the case to resolve, for example, a secured creditor’s request for adequate
protection under section 361 or to assess a proposed sale of some or all of a debtor’s assets under
section 363. They may need to revisit valuation issues later in the case in connection with creditors’
678 Id. at 1499.
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ABI Commission to Study the Reform of Chapter
requests for relief from the automatic stay or confirmation of a chapter 11 plan. Indeed, the value of
a debtor’s assets impacts adequate protection requests, postpetition financing terms and collateral,
the amount of secured creditors’ allowed secured claims against the estate, distributions available
to creditors in the case, the feasibility of a plan, and the application of the absolute priority rule in
the plan cramdown context.679 Nevertheless, the Bankruptcy Code does not address valuation issues
directly in the chapter 11 context or mandate a particular methodology for valuing a debtor’s assets.
Accordingly, courts generally determine the value of a debtor’s assets, and resolve any related
valuation disputes, based on the evidence presented by the parties at the hearing on the matter. This
method, commonly referred to as “judicial valuation,” introduces some uncertainty into the process,
but it also allows courts to consider various valuation methodologies and to tailor the valuation to
the facts and circumstances at hand. Parties may value the debtor’s assets based on, among other
factors, a balance sheet analysis, a discounted cash flow analysis, or market comparables.680 Parties
typically introduce this evidence through expert testimony at the hearing, and courts weigh and
consider this testimony and the other evidence in reaching their valuations. Empirical studies
suggest that courts thoughtfully consider valuation disputes and do not simply resolve such matters
by splitting the difference.681
In addition to relying on the parties’ experts, courts also may appoint an expert to testify on valuation
issues. Rule 706 of the Federal Rules of Evidence provides that “the court may appoint any expert
16
that the parties agree on and any of its own choosing.” In addition,r the 2court may establish the
1, 0
be 2
expert’s duties and compensation in the order of appointment.ovem
N Court-appointed experts generally
d on
chive some courts have invoked section 105 of
ar
are subject to discovery and cross-examination.3Moreover,
5 63
14-3
. Federal Rules of Evidence to appoint “experts with teeth,”
the Bankruptcy Code and Rule 706 of,the
No
own
v. Br served both as a valuation expert for the court and a mediator
in that the court-appointed texpert
eh
Blixs
between the partiesdon the valuation issues.682
e in
cit
General Valuation Standards: Recommendations and Findings
In general, valuation is more art than science. Regardless of the valuation methodology, the results
depend on a variety of factors, including timing, market conditions, assumptions, and appraisers.683
As one court explained:
679 Section 506(a)(1) provides that a secured creditor’s claim is secured to the extent of the value of its collateral and that “[s]uch
value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and
in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.” 11 U.S.C. § 506(a)(1).
In addition, section 506(a)(2) provides more specific guidance in the case of an individual under chapter 7 or 13. Id. § 506(a)(2)
(mandating valuation based on the replacement value of the property as of the petition date in individual chapter 7 and 13 cases).
680 See Bernard Trujillo, Patterns in a Complex System: An Empirical Study of Valuation in Business Bankruptcy Cases, 53 UCLA L.
Rev. 356 (2005). In addition, parties may present testimony of a potential purchaser or prospective user of the property at issue;
the contract method or rates agreed to by the parties, or general observations about market or industry trends for such property.
Id. at 383–85.
681 Compare id. at 370 (study of 180 observations drawn from 145 published opinions reported in the Westlaw computer database
decided from 1979 through 1998, finding “complete success for the debtor or for the creditor — about equally . . . [C]ourts very
rarely split the difference between the debtor’s and the creditor’s numbers”) with Keith Sharfman, Judicial Valuation Behavior:
Some Evidence from Bankruptcy, 32 Fla. St. U. L. Rev. 387, 396 (2005) (study of 24 valuation disputes, finding “(1) bankruptcy
judges on average allocated 65.2% of the value in controversy to debtors and only 34.8% to secured creditors; and (2) bankruptcy
judges were more than three times as likely to allocate most of the value in controversy to debtors as they were to secured
creditors”). See generally supra note 66 and accompanying text (generally discussing limitations of chapter 11 empirical studies).
682 See, e.g., In re Calpine Corp., 377 B.R. 808 (Bankr. S.D.N.Y. 2007).
683 See, e.g., Douglas G. Baird & Donald S. Bernstein, Absolute Priority, Valuation Uncertainty, and the Reorganization Bargain,
115 Yale L.J. 1930, 1941–42 (2006) (“A business, however, cannot be valued with such precision. There are different methods of
valuing a business, but in the end all are merely estimates of the present value of the business’s future earning capacity.”).
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[T]he valuation of an enterprise . . . is an exercise in educated guesswork. At worst it is
not much more than crystal ball gazing. There are too many variables, too many moving
pieces in the calculation of value . . . for the court to have great confidence that the result
of the process will prove accurate in the future. Moreover, the court is constrained by the
need to defer to experts and, in proper circumstances, to Debtors’ management.684
The Commissioners discussed the uncertainty surrounding valuation generally and considered whether
judicial valuation significantly enhanced this uncertainty. Such inherent uncertainty is recognized in
the legislative history of the Bankruptcy Code, which explains that, “[a]s Peter Coogan has aptly noted,
such a valuation [of the enterprise in connection with applying the absolute priority rule] is usually
‘a guess compounded by an estimate’.”685 The Commission reviewed valuation methodologies used
as part of, or independent from, judicial valuation to value a debtor’s assets or business as a going
concern. These methodologies include discounted cash flow, market comparables, and securities based
valuations, among others. The Commissioners explored how different components of these valuation
methodologies are subject to varying interpretation or application, which can cause fluctuation in asset
or business valuations.686 For example, an empirical study of companies emerging from chapter 11
prior to 1994 finds “that estimates of value are generally unbiased, but the estimated values are not very
precise — the sample ratio of estimated value to market value varies from below 20 percent to more than
250 percent.”687 The authors of this study suggest that the variance in valuations may result from the
administrative bankruptcy process or from strategic distortion. “The strategic distortion explanation
16
1 20
for the imprecision of the cash flow forecasts implies that the valuation errors rare ,systematically related
be 2
m
No strengths of the parties.”688
to proxies for the competing financial interests and relative bargaining ve
d on
ive
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-35
o.
The Commissioners also examined the impact 14 valuation uncertainty on chapter 11 cases. Many
n, N of
Brow
of the Commissioners commentedv.that although valuation litigation can be time-consuming and
th
lixse
B
expensive,689 judicial cited in
valuation and any related uncertainty can encourage negotiated resolutions.690
A negotiated resolution of valuation uncertainty aligns with the consensual nature of the chapter
11 process. Although disputes arise and not every chapter 11 is consensual, commentators
typically describe “the goal of a Chapter 11 restructuring [as achieving] a consensual plan of
reorganization.”691 Chapter 11’s preference for consensual resolutions evolved at least in part from
business reorganization’s Chapter XI roots. A consensual plan between the debtor and its unsecured
creditors was the hallmark of the Chapter XI process under the Bankruptcy Act.692
The Commissioners found continued utility in the judicial valuation approach, including the
flexibility it gives the parties in selecting the best valuation methodology. Judicial valuation allows
the court and parties to consider market valuations, book and adjusted book valuations, and other
684 In re Mirant Corp., 334 B.R. 800, 848 (Bankr. N.D. Tex. 2005).
685 1977 House Judiciary Committee Report on Public Law 95-598, at 222.
686 See Baird & Bernstein, supra note 683, at 1943 (“Differences of 10% are almost inevitable, and often the differences are far
larger.”).
687 Stuart C. Gilson et al, Valuation of Bankrupt Firms, 13 Rev. Fin. Studies 43–74 (2000) (“This study explores the relation between
the market value of 63 publicly traded firms emerging from Chapter 11 and the values implied by the cash flow forecasts in their
reorganization plans.”).
688 Id.
689 In re Mirant Corp., 334 B.R. 800, 809, 824 (Bankr. N.D. Tex. 2005) (conducting 27-day valuation trial with separate valuation
experts for key parties testifying to values ranging from $7.2 billion to $13.6 billion).
690 See Baird & Bernstein, supra note 683, at 1963 (“These dynamics regularly lead to negotiated reorganization plans with basic
features consistent with the idea that valuation uncertainty plays a key role in dictating the contours of such plans.”).
691 Miller & Waisman, Is Chapter 11 Bankrupt?, supra note 26, at 144–45.
692 For discussion of Chapter XI of the Bankruptcy Act, see Section III.A, Brief History of U.S. Business Reorganization Laws.
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ABI Commission to Study the Reform of Chapter
factors that may be relevant to particular debtor and its reorganization efforts. The Commissioners
were also mindful, however, of witness testimony suggesting that judges may need assistance with
complex or contested valuations. For example, the Honorable James Peck of the U.S. Bankruptcy
Court for the Southern District of New York testified as follows:
An inexperienced judge navigating unfamiliar territory introduces an extra element
of risk and uncertainty into what necessarily is an unpredictable process in which
the skills and personality of the advocate and witness may be the most important
variables. An experienced judge is likely to be more facile in deciding these questions
but reliability and predictability remain a problem because the experienced judge
will be applying his or her own valuation judgments without being able to confer
with someone deeply grounded in the subject. Such a valuation professional would
be more skilled than most judges in being able to verify or question the assumptions
and adjustments that so often dictate the conclusions reached. Valuation is an art
more than a science, and it would be helpful for the Court to have access to a seasoned
art critic in deciding whether a particular challenged valuation is genuine or a fake.693
The Commission reviewed witness testimony and related anecdotal evidence on valuation. The
Commission agreed that courts should be permitted and encouraged to appoint valuation experts in
cases in which such an expert can provide assistance to the court. The Commissioners debated whether an
appointed expert should be permitted to consult with, and to advise the court, but not necessarily be called
6
, 201
to testify in the case. After debating the benefits to the court and the due ber 21 and procedural concerns
process
vem
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for the parties, the Commission agreed that, if the court intends to rely on the court-appointed valuation
ed o
iv
arch
expert, such expert must testify in the case 14-35be3subject to cross-examination. The Commissioners
and 36
o.
also observed that estate neutrals Brown, the recommended principles could now perform the expanded
under N
.
eth v
role, including that ofnmediator, served by court appointed valuation experts in the past. Finally, the
Blixs
i
cited
Commissioners evaluated the language of Rule 706 of the Federal Rules of Evidence and found it sufficient
as written for the contemplated role of court-appointed valuation experts.
G. Standard for Reviewing Settlements
and Compromises
Recommended Principles:
The principles and standards of Bankruptcy Rule 9019 should be codified to foster
uniform application of a court’s authority to approve a settlement or compromise of
controversies in a chapter 11 case. Accordingly, the court, after notice and a hearing,
should approve a trustee’s proposed settlement or compromise of a controversy only
if the court finds, based on the evidence presented, that the proposed settlement or
compromise is reasonable and in the best interests of the estate.
693 Written Statement of Honorable James M. Peck, VALCON Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11, at 2 (Feb. 21, 2013), available at Commission website, supra note 55.
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Bankruptcy Institute
Standard for Reviewing Settlements and Compromises: Background
In general, “compromises are favored in bankruptcy.”694 Negotiated resolutions of disputes can
create efficiencies in the process and cost savings for the parties. Bankruptcy Rule 9019, like its
predecessor Rule 919 under the Bankruptcy Act, provides a process for parties to request court
approval of settlements and compromises. Specifically, Bankruptcy Rule 9109 states, in relevant part:
“On motion by the trustee and after notice and a hearing, the court may approve a compromise or
settlement.”695 Notably, neither the Bankruptcy Rules nor the Bankruptcy Code provide a standard
or criteria for the court to use in assessing proposed settlements and compromises.
Given general bankruptcy policy and the lack of guidance in the Bankruptcy Rules and the Bankruptcy
Code, courts tend to invoke a “presumption in favor of settlements,” and approve a proposed
settlement or compromise unless it “‘fall[s] below the lowest point in the range of reasonableness.’”696
Various courts have developed factors to assist in this determination, but not all courts use the
same factors or apply the factors in a uniform manner.697 This variation can cause uncertainty
for the parties filing motions under Bankruptcy Rule 9019 and inconsistent rulings on proposed
settlements and compromises. In addition, courts take different approaches to reviewing settlements
and compromises incorporated into plans of reorganization.698 This latter issue is discussed below.699
Standard for Reviewing Settlements and Compromises: Recommendations
16
1, 20
and Findings
ber 2
vem
n No
ed o
chivthe chapter 11 case, including claims
A trustee may seek to settle any number of disputesr in
3a
3536
. 14resolution matters, avoidance claims, and o
, N prepetition litigation. Because any such settlement
own
necessarily impacts the estate —eth v. Brbecause the estate will fund at least a portion of the settlement
either
lixs
in third parties are being compromised — the court and parties in interest
or the estate’s claims againstB
cited
700
694 Myers v. Martin (In re Martin), 91 F.3d 389, 393 (3d Cir. 1996), quoting 9 Collier on Bankruptcy ¶ 9019.03[1] (15th ed. 1993).
695 Fed. R. Bankr. P. 9019(a).
696 In re Tower Auto., Inc., 342 B.R. 158, 164 (Bankr. S.D.N.Y. 2006), aff ’d, 241 F.R.D. 162 (S.D.N.Y. 2006). See also Hicks, Muse &
Co., Inc. v. Brandt (In re Healthco Int’l, Inc.), 136 F.3d 45, 50 n.5 (1st Cir. 1998) (holding that court may accord deference to
the position of the trustee or debtor in possession); In re WorldCom, Inc., 347 B.R. 123, 137 (Bankr. S.D.N.Y. 2006) (“While
the bankruptcy court may consider the objections lodged by parties in interest, such objections are not controlling . . . the
bankruptcy court must still make informed and independent judgment.”); In re Hibbard Brown & Co., Inc., 217 B.R. 41, 46
(Bankr. S.D.N.Y. 1998) (holding that court may exercise its discretion under Bankruptcy Rule 9019 “in light of the general public
policy favoring settlements”).
697 Courts consider a variety of factors, including:
(1) the balance between the litigation’s possibility of success and the settlement’s future benefits; (2) the likelihood
of complex and protracted litigation, with its attendant expense, inconvenience and delay, including the difficulty in
collecting on the judgment; (3) the paramount interests of the creditors, including each affected class’s relative benefits
and the degree to which creditors either do not object to or affirmatively support the proposed settlement; (4) whether
other parties in interest support the settlement; (5) the competency and experience of counsel supporting, and the
experience and knowledge of the bankruptcy court judge reviewing, the settlement; (6) the nature and breadth of
releases to be obtained by officers and directors; and (7) the extent to which the settlement is the product of arm’s
length bargaining.
In re Iridium Operating LLC, 478 F.3d 452, 462 (2d Cir. 2007) (internal citations omitted). Although several of these factors were
developed by courts in the plan settlement context, they also apply outside the plan context in certain instances.
698 A related but different issue arises when the proposed settlement “has the effect of dictating the terms of a prospective chapter
11 plan.” In re Capmark Fin. Grp. Inc., 438 B.R. 471, 513 (Bankr. D. Del. 2010). In those instances, courts may deny approval
of the settlement because it constitutes an impermissible sub rosa plan. See generally, Craig A. Sloane, The Sub Rosa Plan of
Reorganization: Side-Stepping Creditor Protections in Chapter 11, 16 Bankr. Dev. J. 37 (1999).
699 See Section VI.F.4, Settlements and Compromises in Plan.
700 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
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ABI Commission to Study the Reform of Chapter
should have an opportunity to review the terms of the proposed settlement. The settlement or
compromise also should be subject to court approval.
The Commissioners discussed the soundness of the notice and hearing process required by Bankruptcy
Rule 9019, but acknowledged the discretion given the trustee in presenting the settlement, and the
court in approving or denying the settlement. Beyond requiring notice and a hearing, Bankruptcy
Rule 9019 establishes no parameters for the content or timing of settlements. It also does not set
forth a standard or criteria for the assessment of settlements. The Commission agreed that codifying
the settlement approval process, including an appropriate standard of review, would further facilitate
the bankruptcy policy of encouraging consensual resolution of disputed matters.
The Commission reviewed the courts’ various approaches to assessing proposed settlements and
compromises under Bankruptcy Rule 9019. This review identified a wide range of approaches, from
“the lowest point of reasonableness” to the “fair and equitable” standard used to evaluate compromises
and plans under the Bankruptcy Act. The Commissioners generally agreed that the lowest point of
reasonableness standard did not sufficiently scrutinize the terms of the proposed settlement and
its impact on the estate. Several Commissioners suggested using the fair and equitable standard
as applied by the U.S. Supreme Court in TMT Trailer Ferry.701 Other Commissioners expressed
concern regarding the ambiguity surrounding “fair and equitable” and its common association with
approval of a chapter 11 plan in the cramdown context.702 The Commissioners generally agreed
6
that something less than fair and equitable, but still meaningful, should201
1, govern the approval of
ber 2
ovem
settlements and compromises.
on N
ived
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363
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After discussing different approaches, ,the .Commission agreed to use a hybrid standard that requires
o 14
n N
w
the settlement or compromise v. Bro “reasonable and in the best interests of the estate.” It favored this
th to be
lixse
in B
standard becauseitedwould adequately protect the estate and allow the court to weigh the evidence
c it
presented on the particular settlement or compromise. Although the Commission believed that the
proposed “reasonable and in the best interests of the estate standard” is better suited than a “fair and
equitable” standard for the review and approval of settlements and compromises, it also believed
that courts should still engage in a totality of the circumstances analysis that considers factors such
as those articulated by courts under the fair and equitable approach.703
701 Protective Comm. for Indep. Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414, 424–25 (1968).
702 The fair and equitable standard is used in the cramdown context under section 1129 of the Bankruptcy Code. The Bankruptcy
Code also incorporates elements necessary to make a plan fair and equitable to any particular class of creditors or equity
securities holders that reject the plan.
703 See, e.g., Protective Comm. for Indep. Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414, 424–25 (1968) (“[T]he
judge should form an educated estimate of the complexity, expense, and likely duration of such litigation, the possible difficulties
of collecting on any judgment which might be obtained, and all other factors relevant to a full and fair assessment of the wisdom
of the proposed compromise.”).
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Bankruptcy Institute
H. The In Pari Delicto Doctrine
Recommended Principles:
The in pari delicto defense should be inapplicable to claims for relief that a trustee
appointed under section 1104 in the chapter 11 case asserts against third parties
under section 541 of the Bankruptcy Code. The absence of the in pari delicto
defense should not otherwise affect the trustee’s burden to establish the claims for
relief under applicable law.
The Commission was unable to reach a consensus on eliminating the in pari delicto
defense with respect to claims for relief that other estate fiduciaries or parties
authorized to act on behalf of the estate (e.g., litigation trustees, postconfirmation
entities, unsecured creditors’ committees, debtors in possession) might assert
against third parties under the Bankruptcy Code.
The In Pari Delicto Doctrine: Background
The Latin phrase in pari delicto means “in equal fault,”704 and the in pari delicto 016
doctrine generally
1, 2
bars the pursuit of a cause of action by a plaintiff who allegedly actedoveconcert with the defendants,
in mber 2
N
d on
or was otherwise involved, in the wrongful conduct underlying the plaintiff ’s complaint. The in pari
chive
ar
delicto doctrine is “grounded on two premises:1first,363 courts should not lend their good offices
35 that
. 4, No
to mediating disputes among wrongdoers; and second, that denying judicial relief to an admitted
own
v. Br
eth
wrongdoer is an effective imeans of deterring illegality.”705 The in pari delicto issue arises in a variety
Blixs
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cit
of instances in chapter 11 cases, but perhaps most commonly in cases precipitated by a prepetition
Ponzi scheme.706
In many cases, the underlying cause of action is grounded in prepetition conduct and belongs to
the estate under section 541 of the Bankruptcy Code. The target defendant might be an accountant,
auditor, attorney, bank, broker, insider, or others. The state law claim might be aiding and abetting
fraud, breach of fiduciary duty, negligence, malpractice, aiding and abetting breach of fiduciary
duty, negligent misrepresentation, negligent supervision, or conspiracy. Among the defendant’s
affirmative defenses is in pari delicto. Under present law, because the debtor’s wrongdoing would bar
any recovery by the debtor, the trustee is likewise entitled to no relief. Every circuit except the Ninth
Circuit has ruled on the issue and has held that, under section 541, the in pari delicto doctrine bars
a trustee’s claims when the doctrine would bar the claims if brought by the debtor.707
704 See, e.g., Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306 (1985).
705 Mosier v. Callister, Nebeker & McCullough PC, 546 F.3d 1271, 1275 (10th Cir. 2008).
706 In the context of reviewing fraudulent transfer law under section 548 of the Bankruptcy Code, the Commission considered
codifying the “Ponzi scheme presumption,” which would basically create a rebuttable presumption that transfers made in
furtherance of a Ponzi scheme are fraudulent transfers subject to avoidance. See, e.g., In re Manhattan Inv. Fund Ltd., 397 B.R.
1, 11–13 (S.D.N.Y. 2007). The term “Ponzi scheme” is not well defined under the case law. Id. After much deliberation, the
Commission decided that this issue was best left to further development under the case law.
707 See, e.g., Peterson v. McGladrey & Pullen, LLP (In re Lancelot Investors Fund, L.P.), 676 F.3d 594 (7th Cir. 2012); Gray v. Evercore
Restructuring L.L.C., 544 F.3d 320, 324–25 (5th Cir. 2008); Mosier v. Callister, Nebeker & McCullough, 546 F.3d 1271, 1276
(10th Cir. 2008); Baena v. KPMG LLP, 453 F.3d 1, 6 (1st Cir. 2006); Nisselson v. Lernout, 469 F.3d 143, 153 (1st Cir. 2006), cert.
denied, 550 U.S. 918 (2007); Official Comm. of Unsecured Creditors of PSA, Inc. v. Edwards, 437 F.3d 1145, 1149–56 (11th Cir.
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ABI Commission to Study the Reform of Chapter
Courts have recognized certain exceptions to the application of the in pari delicto doctrine. For
example, the “adverse interest” exception provides that if the officers and directors of the debtor who
participated in the fraudulent transactions were acting in their own interests and to the detriment
of the debtor, then the adverse interest exception defeats the in pari delicto doctrine.708 Another
exception, known as the “innocent decision maker” exception, may apply if not all of the “shareholders
or decision makers are involved in the fraud” — i.e., there was at least one innocent insider to whom
the defendant could have reported their findings.709 Some courts have found the innocent decision
maker exception inapplicable, however, when an innocent member of management “could and
would have prevented the fraud had they been aware of it.”710
In addition, the in pari delicto doctrine applies only to a trustee’s claims under section 541.
Accordingly, courts have determined that the doctrine should not apply to, for example, the trustee’s
“strong arm” claims under section 544;711 preference claims under section 547;712 and fraudulent
transfer claims under section 548.713
Despite the various exceptions, the in pari delicto doctrine may preclude the trustee from pursuing
causes of action that benefit the estate and the beneficiaries of the estate who are innocent victims
as to the underlying cause of action. Several commentators thus have questioned the relevance and
fairness of applying the in pari delicto doctrine in bankruptcy cases. These commentators note,
among other things, that state and federal law receivers generally are not subject to the in pari delicto
6
defense.714 The question persists whether trustees in bankruptcy should, 201 the same ability to
1 have
ber 2
m
pursue actions against third parties to the same extent as anstateelaw receiver (or a receiver under
Nov
ed o
chiv
the Federal Depository Insurance Act or the federal rsecurities laws), or whether trustees should be
63 a
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. 14
treated differently, given the bankruptcyomaxim that a trustee stands in the shoes of the debtor and
,N
rown
B
is subject to the same defensesvas the debtor.715
h .
xset
i
in Bl
cited
708
709
710
711
712
713
714
715
2006), cert. denied, 549 U.S. 811 (2006); Grassmueck v. Am. Shorthorn Ass’n, 402 F.3d 833, 836–37 (8th Cir. 2005); Logan v.
JKV Real Estate Servs. (In re Bogdan), 414 F.3d 507, 514–15 (4th Cir. 2005), cert. denied, 546 U.S. 1093 (2006) (noting exception
where claims have been assigned to trustee); Official Comm. of Unsecured Creditors of Color Tile, Inc., v. Coopers & Lybrand,
LLP, 322 F.3d 147, 158 (2d Cir. 2003); Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., Inc., 267 F.3d 340, 354–60
(3d Cir. 2001); Terlecky v. Hurd (In re Dublin Sec., Inc.), 133 F.3d 377, 380 (6th Cir. 1997), cert. denied, 525 U.S. 812 (1998);
Sender v. Buchanan (In re Hedged-Invs. Assocs., Inc.), 84 F.3d 1281, 1284–86 (10th Cir. 1996); Hirsch v. Arthur Andersen &
Co., 72 F.3d 1085, 1094–95 (2d Cir. 1995); Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 118–20 (2d Cir. 1991). But
see USACM Liquidating Trust v. Deloitte & Touche, 754 F.3d 645, 649 (9th Cir. 2014), aff ’g 764 F. Supp. 2d 1210, 1229 (D. Nev.
2011). Notably, the Second Circuit appears to treat the issue not as a defense like the other circuits, but as an issue of standing.
See Breeden v. Kirkpatrick & Lockhart LLP (In re Bennett Funding Grp., Inc.), 336 F.3d 94, 100 (2d Cir. 2003); Hirsch v. Arthur
Andersen & Co., 72 F.3d 1085, 1094–95 (2d Cir. 1995); Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 118 (2d Cir.
1991).
Bankruptcy Servs., Inc. v. Ernst & Young (In re CBI Holding Co., Inc.), 529 F.3d 432 (2d Cir. 2008). Importantly, there are
variations on the adverse interest exception. For example, some courts narrowly interpret the exception to apply when the
guilty manager has “totally abandoned” the interest of the principal corporation, while other courts engage in an analysis of
the respective benefits received by the corporate entity and the wrongdoer insider, Thabault v. Chait, 541 F.3d 512, 527 (3d Cir.
2008); Baena v. KPMG, LLP, 453 F.3d 1, 8 (1st Cir. 2006); Breeden v. Kirkpatrick & Lockhard LLP (In re Bennett Funding Grp.),
336 F.3d 94, 100 (2d Cir. 2003). Other courts have found that the adverse interest exception should be determined by the agent’s
subjective motives, rather than by a strict rule of whether the debtor received any benefit as a result of the agent’s activities,
Bankruptcy Servs. Inc. v. Ernst & Young (In re CBI Holding Co., Inc.), 529 F.3d 432, 451 (2d Cir. 2008).
Smith v. Andersen L.L.P., 175 F. Supp. 2d 1180, 1199 (D. Ariz. 2001); Breeden v. Kirkpatrick & Lockhart, LLP, 268 B.R. 704, 710
(S.D.N.Y. 2001), aff ’d, In re Bennett Funding Group, Inc., 336 F.3d 94 (2d Cir. 2003); SIPC v. BDO Seidman, LLP, 49 F. Supp. 2d
644, 650 (S.D.N.Y. 1999), aff ’d in part, 222 F.3d 63 (2d Cir. 2000).
See, e.g., In re CBI Holding Co., Inc., 311 B.R. 350, 372 (S.D.N.Y. 2004), aff ’d in part, rev’d in part, 529 F.3d 432 (2d Cir. 2008).
Kaliner v. MDC Sys. Corp., LLC, 2011 U.S. Dist. LEXIS 5377, at *15 (E.D. Pa. Jan. 20, 2011).
See, e.g., In re CBI Holding, Inc., 311 B.R. 350, 372 (S.D.N.Y. 2004), aff ’d in part, rev’d in part, 529 F.3d 432 (2d Cir. 2008).
McNamara v. PFS (In re Pers. & Bus. Ins. Agency), 334 F.3d 239, 245–47 (3d Cir. 2003).
See FDIC v. O’Melveny & Myers, 61 F.3d 17, 18–19 (9th Cir. 1995); Scholes v. Lehmann, 56 F.3d 750, 754–55 (7th Cir. 1995), cert.
denied, 516 U.S. 1028 (1995); Goldberg v. Chong, 2007 U.S. Dist. LEXIS 49980, *28–29 (S.D. Fla. July 11, 2007).
Some courts follow the bankruptcy analogy and conclude that because the receiver simply steps into the shoes of the receivership
entity in pursuing the entity’s claims, and because the in pari delicto doctrine would bar the entity’s claim, it bars the receiver’s
claim. See, e.g., Wuliger v. Mfrs. Life Ins. Co., 567 F.3d 787, 792 (6th Cir. 2009); Knauer v. Jonathon Roberts Fin. Grp., Inc.,
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The In Pari Delicto Doctrine: Recommendations and Findings
The in pari delicto doctrine’s application to certain of a trustee’s or other estate representative’s claims
against third parties in a bankruptcy case is subject to much debate in the literature. The conclusion
that parties cannot assert the in pari delicto defense against claims that are available only to the
trustee in a bankruptcy case — such as preference claims and fraudulent conveyance claims — is well
supported. A debtor has no rights in, or ability to pursue, such claims, and the trustee does not stand
in the shoes of the debtor for purposes of those actions. Prepetition claims of the debtor that become
property of the estate under section 541 of the Bankruptcy Code may, however, require a different
analysis. The Commission considered current trends in the case law on the in pari delicto doctrine,
the underlying justifications for the doctrine, and whether a trustee or estate representative should
be subject to the in pari delicto defense in bankruptcy, irrespective of the genesis of the claims.
The Commission reviewed the primary purposes of the in pari delicto doctrine, most commonly
articulated as follows: that “courts should not lend their good offices to mediating disputes among
wrongdoers” and “denying judicial relief to an admitted wrongdoer is an effective means of deterring
illegality.”716 The Commissioners generally agreed that the doctrine served these basic goals when
applied outside of bankruptcy: a company that participated in a wrong should not be able to benefit
from that wrong. For some of the Commissioners, however, the intervention of a bankruptcy case
changed the calculus dramatically.
16
1, 20
ber 2 may bring the action
In bankruptcy, a party not involved with the alleged prepetition wrongdoing
vem
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ed o That party typically is the trustee,
for the benefit of the estate (e.g., innocent creditors of therdebtor).
chiv
63 a
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unsecured creditors’ committee, litigationNo. 14
trustee,
,
rown trustee, or other estate representative did not participate
unsecured creditors’ committee, tlitigation
v. B
se h
in the wrong and is not d in Blix recoveries that would benefit any of the wrongdoers. Indeed, to the
seeking
cite
extent that the debtor’s prepetition shareholders, officers, or directors who may have been involved
with the alleged wrongdoing are creditors of the estate, those claimants can be barred from receiving
any recoveries from the litigation.
Several of the Commissioners found the case for not allowing third parties to assert the in pari delicto
defense against the trustee or other estate representative very compelling. These Commissioners
348 F.3d 230, 236 (7th Cir. 2003); In re Wiand, 2007 WL 963165, at *6–7 (M.D. Fla. Mar. 27, 2007). Other courts conclude that
because the receiver’s role is to protect innocent investors, and because these investors were not complicit in the fraud, the in
pari delicto doctrine does not bar the receiver’s claim. See, e.g., Jones v. Wells Fargo Bank, N.A., 666 F.3d 955, 966 (5th Cir. 2012)
(“A receiver is ‘the representative and protector of the interests of all persons, including creditors, shareholders and others, in the
property of the receivership.’ . . . The receiver has a duty to pursue a corporation’s claims.’ . . . Although a receiver generally ‘has
no greater powers than the corporation had as of the date of the receivership,’ it is well established that ‘when the receiver acts to
protect innocent creditors . . . he can maintain and defend actions done in fraud of creditors even though the corporation would
not be permitted to do so.’ . . . The receiver thus acts on behalf of the corporation as a whole, an entity separate from its individual
bad actors.”) (citations omitted); FDIC v. O’Melveny & Myers, 61 F.3d 17, 19 (9th Cir. 1995) (“A receiver, like a bankruptcy
trustee and unlike a normal successor in interest, does not voluntarily step into the shoes of the bank; it is thrust into those shoes.
It was neither a party to the original inequitable conduct nor is it in a position to take action prior to assuming the bank’s assets to
cure any associated defects or force the bank to pay for incurable defects. This places the receiver in stark contrast to the normal
successor in interest who voluntarily purchases a bank or its assets and can adjust the purchase price for the diminished value
of the bank’s assets due to their associated equitable defenses. In such cases, the bank receives less consideration for its assets
because of its inequitable conduct, thus bearing the cost of its own wrong.”); Javitch v. Transamerica Occidental Life Ins. Co., 408
F. Supp. 2d 531, 538 (N.D. Ohio 2006) (“An equity receiver’s duties are fashioned and may be modified by the appointing court.
Because this Court has expressly given the Receiver’s broad authority to pursue claims on behalf of Liberte and the investors, the
Receiver is not precluded from these actions under the doctrine of in pari delicto.”); Isp.com LLC v. Theising, 805 N.E.2d 767,
773 (Ind. 2004) (“The receiver is in some respects a new entity, untainted by the corporation’s wrongdoing. He is not necessarily
barred by in pari delicto.”).
716 Official Comm. of Unsecured Creditors of PSA Inc. v. Edwards, 437 F.3d 1145 (11th Cir. 2006), cert. denied, 549 U.S. 811 (2006).
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ABI Commission to Study the Reform of Chapter
emphasized the distinction between the prepetition debtor company and a trustee or litigation trust
for purposes of the defense. They posited that the justifications for the in pari delicto doctrine, as
articulated above, simply did not apply in the trustee context. In fact, they noted that innocent
creditors actually were being penalized because, outside of bankruptcy: (i) state law receivers
and receivers appointed by the Securities and Exchange Commission or the Federal Depository
Insurance Company could pursue claims previously belonging to the alleged company wrongdoer
and not be subject to the defense;717 and (ii) individual creditors harmed by the wrong could sue the
third parties without being subject to the defense.718 The Commissioners supporting elimination of
the in pari delicto defense in bankruptcy viewed its enforcement as penalizing the debtor’s innocent
creditors, who likely were already suffering losses as a result of the bankruptcy itself.
The Commissioners parsed through the likely practical implications of eliminating the in pari delicto
defense in bankruptcy. The Commissioners acknowledged that including the debtor in possession
in the concept of an “estate representative” not subject to the in pari delicto defense may raise closer
policy issues. Although the debtor in possession has a legal status different from the prepetition
debtor under the Bankruptcy Code, the Commissioners acknowledged that the debtor in possession
could still employ some of the individuals who allegedly participated on behalf of the debtor in
the wrongdoing. They also presented a closer conceptual question on the policy issues. Some of
the Commissioners supported including the debtor in possession among the estate representatives
that should not be subject to the in pari delicto defense.719 Some of the Commissioners believed it
16
was more important to eliminate the defense, at least as to bankruptcy 21, 20 and then also as to
trustees,
ber
m
unsecured creditors’ committees, litigation trustees, and similar ve
n Noestate representatives that were not
ed o
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affiliated with the prepetition debtor.
5363
-3
o. 14
n, N
row
Commissioners voiced v. B
th concern that any change to the current law essentially would create
lixse
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cause of action for the estate not otherwise available under state law. These Commissioners
cited
Other
a new
focused on the fact that the debtor (or an entity acting on behalf of the debtor) generally could not
pursue such claims under nonbankruptcy law, unless a receiver was appointed.720 They believed
that eliminating the in pari delicto defense in bankruptcy directly conflicted with the long-standing
principle that bankruptcy does not enhance a debtor’s rights in property.721 From that principle flow
the equally important concepts that the estate’s interest in property is limited to that held by the debtor
prepetition, and that the trustee steps into the debtor’s shoes with respect to those property interests
and is subject to any defenses otherwise applicable against the debtor.722 These Commissioners could
717 O’Melveny & Myers v. FDIC, 512 U.S. 79 (1994) (remanding on grounds that state law should determine if defense applies). On
remand, the Ninth Circuit held that the defense did not apply to receiver even under California law. FDIC v. O’Melveny & Myers,
61 F.3d 17 (9th Cir. 1995). See also Scholes v. Lehmann, 56 F.3d 750, 754 (7th Cir. 1995), cert. denied, 516 U.S. 1028 (1995) (“Put
differently, the defense of in pari delicto loses its sting when the person who is in pari delicto is eliminated.”).
718 FDIC v. O’Melveny & Myers, 61 F.3d 17, 19 (9th Cir. 1995) (“While a party may itself be denied a right or defense on account of its
misdeeds, there is little reason to impose the same punishment on a trustee, receiver or similar innocent entity that steps into the
party’s shoes pursuant to court order or operation of law. Moreover, when a party is denied a defense under such circumstances,
the opposing party enjoys a windfall. This is justifiable as against the wrongdoer himself, not against the wrongdoer’s innocent
creditors.”).
719 These Commissioners noted that, in most cases, management of the old debtor has been replaced or a Chief Restructuring
Officer has been appointed.
720 These Commissioners noted that the receiver context was different than the collective action process of bankruptcy and believed
that the different treatment was justified on that basis.
721 See, e.g., S. Rep. No. 95-989, at 82 (1978), reprinted in 1978 U.S.C.C.A.N. 5787; H.R. Rep. No. 95-595, at 367–68 (1977), reprinted
in 1978 U.S.C.C.A.N. 5963 (explaining that section 541 cannot “expand the debtor’s rights against others more than they exist at
the commencement of the case”).
722 See, e.g., McNamara v. PFS (In re Personal & Bus. Ins. Agency), 334 F.3d 239, 245 (3d Cir. 2003) (“[I]n actions brought by the
trustee as successor to the debtor’s interest under section 541, the ‘trustee stands in the shoes of the debtor and can only assert
those causes of action possessed by the debtor. [Conversely,] the trustee is, of course, subject to the same defenses as could have
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not reconcile these principles with the elimination of the in pari delicto defense. They also pointed to
the inherent unfairness of allowing the principal wrongdoer, or someone standing in the shoes of the
wrongdoer, to prosecute a claim against a party who may have been negligent when the wrongdoer’s
conduct was intentional (i.e., the defendant is liable to the plaintiff because it negligently failed to
detect the plaintiff ’s intentionally concealed fraud).
These Commissioners objected not only to eliminating the defense as to a debtor in possession but
also as to the trustee and any other estate representative. They argued that it would be bad policy to
allow an estate representative to pursue professionals and institutions on claims that may lack merit
and for which one of the alleged wrongdoers — the debtor — is not subject to collection actions.
They suggested that such a proposal would encourage “shakedowns” and unfounded settlements
because defendants would be forced to settle (regardless of merit) to avoid the risk of potentially
significant liability. They likewise noted that eliminating the defense could skew incentives and
create unintended challenges for professionals in the distressed industry.
The Commissioners supporting the elimination of the in pari delicto defense in bankruptcy focused
on the parties represented by the trustee in bankruptcy — e.g., typically general unsecured creditors.
They repeatedly emphasized that these creditors are innocent in the process and generally harmed
by the types of wrongful conduct alleged in lawsuits in which third parties may assert the in pari
delicto defense. They suggested that eliminating just the in pari delicto defense and preserving a
6
defendant’s other defenses would strike the appropriate balance between er 21bankruptcy policy of
the , 201
b
allowing an estate representative to pursue claims to maximize the Novemof the estate for the benefit
value
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of creditors and allowing parties to appropriately defend rthemselves in unfounded litigation. From
3a
3536
. 14- in pari delicto defense against the bankruptcy
this perspective, allowing defendants to n, No the
assert
Brow
v. creditors) at a significant disadvantage and provide defendants
trustee would place the trustees(and
eth
Blix
with a shield that theyitwould not be able to use under state or federal receivership law.
ed in
c
The Commission explored several alternatives for bridging the disparate views of the
Commissioners on this issue. Some of the Commissioners suggested a compromise of a federal
comparative default rule for these actions, wherein the in pari delicto defense would not be
available, but defendants could assert that the debtor or its management was primarily at fault.
Others suggested modifications to this proposal that would allow defendants to assert that they
should not be liable because they were not primarily at fault (i.e., the debtor or another defendant
was primarily at fault). The Commissioners expressed concern that this approach would only
result in finger-pointing and not serve the purpose of compensating the estate and creditors for
prepetition wrongs against their interests.
The Commission then attempted to identify areas of agreement to build consensus on this issue.
First, the Commissioners discussed allowing individual creditors to pursue claims that they in fact
hold under applicable nonbankruptcy law against third parties allegedly acting in concert with
the prepetition debtor free of the in pari delicto defense (which would not be applicable in any
event) in the bankruptcy case. The Commissioners were generally comfortable with this approach,
been asserted by the defendant had the action been instituted by the debtor.’”) (quoting Official Comm. of Unsecured Creditors
v. R.F. Lafferty & Co., 267 F.3d 340, 356 (3d Cir. 2001)); Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1093 (2d Cir. 1995) (“[T]
he trustee stands in the shoes of the debtors, and can only maintain those actions that the debtors could have brought prior to
the bankruptcy proceedings.”).
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ABI Commission to Study the Reform of Chapter
provided that any recoveries were available only to those creditors holding the claims. Second, the
Commissioners discussed allowing a creditor or creditors to pursue such claims in the bankruptcy
case on behalf of all creditors when a generalized harm existed. The Commission was fairly evenly
split on this component, with some arguing that, in substance, it was no different than allowing an
estate representative to bring the claim free of the in pari delicto defense.
After extensive deliberation, the Commission recommended the elimination of the in pari delicto
defense solely with respect to any trustee appointed in the chapter 11 case. The Commission
determined that this modification would provide the trustee with rights similar to those possessed
by receivers in other contexts, and it would not expose defendants to claims brought by a party
controlled or influenced by alleged wrongdoers (e.g., directors, officers, or employees of the debtor).
The Commission viewed this as an extension of the potential liability of defendants outside of
bankruptcy, where creditors (or a receiver on behalf of creditors) could assert claims not subject
to the in pari delicto defense, and not as a significant expansion of the trustee’s powers against the
defendants in bankruptcy. The Commission did not reach a position with respect to the availability of
the in pari delicto defense in actions brought by other estate representatives, the debtor in possession,
or unsecured creditors’ committees. Accordingly, the Commission is not making a proposal on the
in pari delicto defense in actions brought by those entities in the chapter 11 case.
in
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VI. PROPOSED
RECOMMENDATIONS:
EXITING THE CASE
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A. General Authority of Debtor in Possession
and Its Board of Directors
1. Preemption and the Authority to Approve
Transactions and Plan
Recommended Principles:
A debtor in possession’s board of directors or similar governing body should be
able to act on behalf of the debtor in possession in the chapter 11 case without
seeking or obtaining approval of the debtor’s equity security holders, including with
respect to transactions under section 363 of the Bankruptcy Code. Accordingly,
the Bankruptcy Code should preempt any applicable state entity governance law
on these matters, and section 1107 should be amended.
An order of the court confirming a plan under section 1129 of the Bankruptcy Code
should govern the implementation of all transactions contemplated by the plan in
accordance with section 1123(a)(5) and preempt any applicable nonbankruptcy
016
law. Sections 1141 and 1142 should be amended to clarify this ber 21, 2
point.
m
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The preemptive effect of the chapter 11 plan,hiconfirmation order, or section
rc v
63 a
-353 included therein should not relieve
14
363x sale order with respect to ,transactions
No.
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the directors, officers,thor B
v. similar managing persons of the debtor, debtor in
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possession, itor reorganized debtor of their fiduciary duties under applicable state
c ed
entity governance law in implementing or affecting any transactions under the
plan or sale order.
Preemption and the Authority to Approve Transactions and Plan:
Background
In general, the Bankruptcy Code defers to state law governance principles with respect to the
fiduciary duties of a debtor in possession’s723 governing body, whether a board of directors, board of
managers, or similar concentrated management structure, as well as its directors, officers, or similar
managing persons.724 As discussed above, this deference generally means that those individuals or
entities owe the duties of care and loyalty, and an obligation of good faith.725 These state law duties
and obligations govern the conduct of those individuals or entities in operating the business and
managing its affairs. In addition, state or other applicable nonbankruptcy law may require the debtor
723 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
724 See, e.g., David A. Skeel, Rethinking the Line Between Corporate Law and Corporate Bankruptcy, 72 Tex. L. Rev. 471, 491 (1994)
(explaining tradition deference to state governance law). See also Fogel v. U.S. Energy Sys., Inc., 2008 WL 151857, at *1 (Del.
Ch. Jan. 15, 2008) (“[C]orporate governance does not cease when a company files a petition under Chapter 11 and that issues of
corporate governance are best left to the courts of the state of incorporation.”).
725 See Section IV.A.1, The Debtor in Possession Model.
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ABI Commission to Study the Reform of Chapter
in possession or its governing body to obtain approvals or satisfy specified conditions before taking
certain actions for, or on behalf of, the debtor.
For example, state law or the debtor’s charter may require the debtor’s board of directors to obtain
the approval of shareholders before selling all or substantially all of the debtor’s assets.726 State law
also may require the board of directors to hold an annual shareholders meeting. Although courts
commonly allow a debtor in possession to sell all or substantially all of its assets under section 363(b)
of the Bankruptcy Code without seeking or obtaining shareholder approval, courts have taken a
different approach to the shareholders meeting requirement. Most courts review a demand on the
debtor in possession to hold the annual shareholders meeting under a “clear abuse” standard, which
considers whether the shareholders’ rights to vote for directors “and thus to control corporate policy
. . . will not be disturbed unless a clear case of abuse is made out.”727 Some courts have, however,
enjoined the shareholders meeting or denied a shareholder’s request to compel the meeting when
the strategic objectives of the requesting shareholders are determined to be adverse to the interests
of the estate.728
Additionally, a debtor’s chapter 11 plan will likely propose a new capital structure and new board
members or managers, and it may propose a merger or other change in control transaction, as well
as other various actions required or permitted by section 1123 of the Bankruptcy Code. Section
1123(a)(5) specifically provides:
2016
r 21
(a) Notwithstanding any otherwise applicable nonbankruptcyelaw,, a plan shall —
mb
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...
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. 4
(5) provide adequate meansNfor1the
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(A) retentionhby the debtor of all or any part of the property of the
xset
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cited
estate;
(B) transfer of all or any part of the property of the estate to one or
more entities, whether organized before or after the confirmation of
such plan;
(C) merger or consolidation of the debtor with one or more persons;
(D) sale of all or any part of the property of the estate, either subject to
or free of any lien, or the distribution of all or any part of the property
of the estate among those having an interest in such property of the
estate;
(E) satisfaction or modification of any lien;
(F) cancellation or modification of any indenture or similar
instrument;
(G) curing or waiving of any default;
726 See Esopus Creek Value LP v. Hauf, 913 A.2d 593, 596, 605–06 (Del. Ch. 2006). See also Del. Code Ann. tit. 8, § 271(a) (2008)
(requiring a majority of shareholders to approve the sale of all or substantially all of a corporation’s property and assets).
727 Fogel v. U.S. Energy Sys., Inc., 2008 WL 151857, at *1 (Del. Ch. Jan. 15, 2008) (citing In re Lionel Corp., 30 B.R. 327, 329–30
(Bankr. S.D.N.Y. 1983)).
728 See, e.g., Manville Corp. v. Equity Sec. Holders Comm. (In re Johns-Manville Corp.), 801 F.2d 60 (2d Cir. 1986) (discussing
court’s ability to limit shareholders’ rights during chapter 11 case).
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(H) extension of a maturity date or a change in an interest rate or
other term of outstanding securities;
(I) amendment of the debtor’s charter; or
(J) issuance of securities of the debtor, or of any entity referred to in
subparagraph (B) or (C) of this paragraph, for cash, for property, for
existing securities, or in exchange for claims or interests, or for any
other appropriate purpose;729
The legislative history of section 1123(a)(5) provides that the section is “intended to indicate that
a plan may provide for any action specified in section 1123 in the case of a corporation without a
resolution of the board of directors” and, if confirmed, “any action proposed in the plan may be taken
notwithstanding any otherwise applicable nonbankruptcy law in accordance with section 1142(a)
[of the Bankruptcy Code].”730
The phrase “[n]otwithstanding any otherwise applicable nonbankruptcy law” was added to section
1123 in 1984 to clarify the preemptive nature of the section. Nevertheless, the Ninth Circuit Court
of Appeals has read section 1123(a)(5) narrowly to limit its preemptive effect to the scope of section
1142(a), which arguably is limited to “applicable nonbankruptcy law, rule, or regulation relating to
financial condition.”731 Other courts have, however, declined to graft section 1142(a)’s limitation onto
section 1123(a), noting that Congress used different language in section 1123(a), 016 though it was
even
1, 2
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aware of section 1142(a)’s language at the time of the amendment. ovem
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No
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Recommendations andixFindings
eth
Bl s
ed in
cit
and Plan:
State entity governance law continues to play an important role in the debtor’s operations
postpetition and postconfirmation. In light of the Bankruptcy Clause of the U.S. Constitution733
and well-established principles of federal preemption, however, there are instances in which state
entity governance law and other related law must yield to the Bankruptcy Code. The Commission
endeavored to clarify these boundaries and better articulate the debtor in possession’s ability to
transact business during the chapter 11 case.
The Commissioners discussed areas of the federal bankruptcy law and state entity governance law
that might conflict, focusing on sale transactions, plan implementation, and equity security holders
729 11 U.S.C. § 1123(a)(5). See also 7 Collier on Bankruptcy ¶ 1123.01[5] (16th ed. 2009) (“The types of means listed in section
1123(a)(5) are clearly illustrative and not exclusive.”).
730 Section 1142(a) provides: “Notwithstanding any otherwise applicable nonbankruptcy law, rule, or regulation relating to financial
condition, the debtor and any entity organized or to be organized for the purpose of carrying out the plan shall carry out the plan
and shall comply with any orders of the court.” 11 U.S.C. § 1142(a).
731 In re Pac. Gas & Elec. Co. v. Cal. Dep’t of Toxic Substances Control, 350 F.3d 932, 949 (9th Cir. 2003), cert. denied, 543 U.S. 956
(2004).
732 In re Renegade Holdings, Inc., 429 B.R. 502 (Bankr. M.D.N.C. 2010) (declining to follow Pacific Gas). See also In re FederalMogul Global Inc., 684 F.3d 355 (3d Cir. 2012) (same); In re FCX, Inc., 853 F.2d 1149, 1155 (4th Cir. 1988), cert. denied, 489
U.S. 1011 (1989) (holding that section 1123(a)(5) is an “empowering statute” that “does not simply provide a means to exercise
the debtor’s pre-Bankruptcy rights; it enlarges the scope of those rights”); In re Stone & Webster, Inc., 286 B.R. 532, 543 (Bankr.
D. Del. 2002) (explaining that “the provisions of a plan as articulated in § 1123(a) can be effected without regard to otherwise
applicable nonbankruptcy law, including the corporation law of the State of Delaware or any other state corporation laws having
bearing on the debtors”).
733 U.S. Const. art. I, § 8, cl.4.
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meetings. The Commissioners found that courts generally allow debtors in possession to proceed
with section 363 sales of all or substantially of its assets without any equity security holder approval
under applicable state law or the debtor’s organizational documents. The Commissioners discussed
the protections for stakeholders provided by the Bankruptcy Code in the sale context, including
the new principles proposed for section 363x sales. They also considered the delay and uncertainty
introduced into the process by requiring an equity security holders’ vote, the fact that equity security
holders are often out of the money in these cases, and the ability of equity security holders to object
or otherwise be heard on the proposed sale under sections 1109 and 363 of the Bankruptcy Code.
The Commission agreed that the Bankruptcy Code should be amended to clarify the ability of the
board of directors or similar governing body to pursue and consummate section 363 transactions
without approvals required by state entity governance law, including an equity security holders’ vote.
The Commissioners also discussed the different approaches of courts to a debtor in possession’s
obligations under state law to hold annual or special shareholders’ meetings. The Commissioners
recognized that complying with an annual meeting requirement, or responding to a shareholder’s
request for a special meeting, may impose costs on the estate and delay the case. They did not
believe, however, that a general prohibition on shareholders’ meetings during chapter 11 cases
was an appropriate response. When the debtor acting as such for the benefit of its shareholders
(as opposed to the debtor in possession acting as representative of the estate; see next section) may
propose a plan, it may be inappropriate to deny the shareholders the right to elect the directors who
16
1, that this issue was best
are representing the shareholders’ interests. The Commission determined20
ber 2
m
Nove
resolved by courts under the current law and the facts of thenparticular case.
do
ive
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363
-35
o. 14
In addition, the Commissioners discussed the interplay of bankruptcy law and applicable
n, N
ow
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nonbankruptcy law in thethcontext of transactions necessary to implement, or contemplated
lixse
B
by, a chapter 11ited in The Commission reviewed the case law on the scope and application
c plan.
of section 1123(a), and along with 1984 amendment suggesting that Congress was expressly
preempting nonbankruptcy law in that particular context. Indeed, “notwithstanding” is one of the
most common indicators of expressed preemption, discarding any need to consider whether implied
preemption was intended. The Commission considered whether there was a justification for linking
the section 1123(a) preemption to the more limited preemption suggested in the section 1142(a)
context. Notably, section 1123(a) speaks to matters necessary to obtain confirmation of the plan
and to then implement the transactions, transfers, and distributions contemplated in the confirmed
plan. The Commission agreed with those courts interpreting section 1123(a) as an empowering
statute and recommended that sections 1141 and 1142 be amended to clarify the preemptive effect
of that section.
2. Role of Debtor in Plan Process
Recommended Principles:
Section 1121 of the Bankruptcy Code should be amended to clarify that a debtor,
in its capacity as such and as a plan proponent, is required to comply only with
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its fiduciary duties under applicable state entity governance law in negotiating,
drafting, and seeking confirmation of a chapter 11 plan.
Section 1121 should be amended to clarify that a debtor in possession’s board of
directors, officers, or similar managing persons act as fiduciaries for the debtor
in connection with the plan process (including, but not limited to, formulation,
confirmation, and consummation of the plan), and applicable state law fiduciary
duties should continue to govern their conduct.
In addition, to foster efficient and effective representation, professionals for the
debtor in possession should be able to represent the debtor in possession in its
capacity as an estate fiduciary and in its separate capacity as a debtor and plan
proponent without violating section 327. Accordingly, section 327 should be
amended to clarify this point.
For a discussion of the fiduciary duties of the debtor in possession’s board of
directors, officers, or similar managing persons, see Section IV.A.1, The Debtor in
Possession Model.
Role of Debtor in Plan Process: Background
16
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When a company files a chapter 11 case, it assumes the role ofvdebtor in possession, which has certain
ed o
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rights, powers, and duties different from the prepetition debtor. Specifically, under section 1107 of
-353
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the Bankruptcy Code, the debtor in Brown, N has the rights, powers, and duties of a bankruptcy
possession
h v.
xse
trustee. The debtor in possession tis also a fiduciary for the estate. Most provisions of the Bankruptcy
n Bli
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Code relevant to a chapter 11 case authorize the trustee, and in turn the debtor in possession, to
take certain actions and exercise certain rights.734 Other provisions that require disclosures, impose
obligations, or concern creditors’ rights in the case tend to apply to, or reference, the debtor. One
important exception to this general categorical divide is section 1121 of the Bankruptcy Code, which
provides that “[t]he debtor may file a plan with a petition commencing a voluntary case, or at any
time in a voluntary case or an involuntary case.” Moreover, “only the debtor may file a plan until the
120 days after” the petition date.
The legislative history of section 1121 focuses primarily on mitigating the practices under Chapter
XI of the Bankruptcy Act that did not allow nondebtor parties to submit a plan of reorganization.735
Congress was concerned that complete exclusivity in the plan context might hold creditors hostage
734 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
735 One court cited the legislative history of the Bankruptcy Act in support of creditor involvement:
Within certain limits, the Chapter XI debtor can effectively dictate the essential ingredients of a Chapter XI plan to its
creditors. In many cases, the alternative to creditors may be to accept the proverbial ‘ten cents on the dollar’ offered
or be confronted with an adjudication in bankruptcy and the resultant liquidation. . . . The substantial loss that may
be faced by creditors as a consequence of the forced auction sale of work in process, inventory, machinery and plant
may be overwhelming. . . .
The take-it-or-leave-it attitude on the part of debtors as permitted by Chapter XI is fraught with potential abuse.
The granting of authority to creditors to propose plans of reorganization and rehabilitation serves to eliminate the
potential harm and disadvantages to creditors [and] democratizes the reorganization process.
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and subject them to unfavorable treatment in the plan.736 Nevertheless, Congress recognized that
the debtor was in the best position to serve as an honest broker and to negotiate a consensual plan.
There is some suggestion that Congress was also concerned with providing appropriate incentives
for prepetition management to invoke chapter 11 and to use the plan process to rehabilitate the
debtor’s business.
Although the company’s directors and officers remain the same whether it is serving as the debtor or
the debtor in possession, the Bankruptcy Code arguably contemplates different roles for these two
entities. Some courts interpret the language of the Bankruptcy Code as endorsing this approach,
and they treat the debtor and the debtor’s fiduciary duties differently than those of the debtor in
possession. For example, the court in In re Water’s Edge determined that the debtor in possession,
acting as the debtor and plan proponent under sections 1121, 1127, 1129, 1141, and 1142, had no
fiduciary duties to the estate.737 The court explained:
A debtor in possession [as a debtor/plan proponent] is therefore permitted to place
its own interests above those of the unsecured creditors with respect to what it
proposes to pay under its plan. This is of course inconsistent with the concept that
the debtor in possession is a fiduciary of the unsecured creditors owing them a duty
of loyalty. The conclusion seems inescapable. As to its proposed plan dividend, a
debtor in possession is not a fiduciary of the unsecured creditors owing them a duty
of loyalty. Its bargaining and cramdown rights necessarily exclude such a fiduciary
16
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obligation.738
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em
Nov
d on
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Other courts are imprecise in discussing the5debtor’s or debtor in possession’s roles in the plan
3 36
. 14, No
process, and some have determinednthat the debtor in possession continues to owe duties to the
ow
v. Br
estate in formulating and seth a plan. In addition, this confusion often spills over to the role and
ix filing
in Bl
citedin possession’s professionals.739
duties of the debtor
Role of Debtor in Plan Process: Recommendations and Findings
Under section 1121 of the Bankruptcy Code, the debtor, as distinct from the debtor in possession,
may file a chapter 11 plan. This distinction is important given the often competing and conflicting
interests present in the bankruptcy estate and the challenges that a debtor would face if required
In re Lake in the Woods, 10 B.R. 338, 344 (E.D. Mich. 1981) (quoting Bankr. Act Revision, Serial No. 27, Part 3, Hearings on H.R.
31 and H.R. 32 before the Subcomm. on Civil and Constitutional Rights of the Comm. on the Judiciary, 94th Cong., 2d Sess., at
1875–76 (Mar. 29, 1976) (statement of H. Miller, W. Rochelle and J. Trost)).
736 The Fifth Circuit explained the imbalance between debtors and their creditors that section 1121 was designed to mitigate:
While we are not called upon here to decide what factors constitute “cause” for the extension of the exclusivity period,
we think that any bankruptcy court involved in an assessment of whether “cause” exists should be mindful of the
legislative goal behind Section 1121. The bankruptcy court must avoid reinstituting the imbalance between the debtor
and its creditors that characterized proceedings under the old Chapter XI. Section 1121 was designed, and should be
faithfully interpreted, to limit the delay that makes creditors the hostages of Chapter 11 debtors.
United Sav. Ass’n v. Timbers of Inwood Forest Assocs., Ltd. (In re Timbers of Inwood Forest Assocs., Ltd.), 808 F.2d 363, 372 (5th
Cir. 1987), aff ’d, 484 U.S. 365 (1988).
737 In re Water’s Edge Ltd. P’ship, 251 B.R. 1,7 (Bankr. D. Mass. 2000).
738 Id. at 8.
739 See, e.g., Hansen, Jones & Leta, P.C. v. Segal, 220 B.R. 434, 459–60 (D. Utah 1998).
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to negotiate and draft a chapter 11 plan that satisfied some fiduciary duty to these competing
stakeholders.740
The Commission considered the continued utility of the distinction between the debtor and the debtor
in possession in the plan process context. The Commissioners observed that the debtor as a plan
proponent must consider the interests of the company and the company’s obligations to creditors and
equity security holders in developing its chapter 11 plan. In this capacity, the debtor may be called
upon to make difficult decisions concerning the business, its workforce, its assets, and its relationships
with stakeholders. Although the debtor will negotiate with key stakeholders and attempt to achieve a
consensus on its plan, it may not be able to start (or end) those negotiations with a plan structure that
primarily benefits creditors alone. Moreover, what is in the best interests of creditors may not necessarily
be in the best long-term interests of the company or its equity security holders in the plan context.
The Commissioners analyzed whether it would be feasible for a debtor in possession to serve multiple
masters by acting as a fiduciary for equity security holders and creditors in the plan process. The
Commissioners discussed the potential conflicts of interests and competing objectives that could
paralyze a debtor in possession acting in this dual role. A debtor in possession should not be placed
in the position of negotiating a plan for the company and its equity security holders with the creditors
whose interests the debtor in possession represents as a fiduciary of the estate. A party negotiating on
behalf of different parties in the same deal rarely produces the best or a fair result. Accordingly, the
6
Commission agreed that the debtor should be separated from the debtor er 2possession in the plan
in 1, 201
b
em
context, and that the debtor acting as plan proponent should not be vconsidered a fiduciary for the
n No
ed o
iv
arch
creditors.
363
-35
o. 14
n, N
Brow
The Commissioners then discussed. what fiduciary duties, if any, the debtor’s directors, officers, or
th v
lixse
similar managing personsin B
cited should owe in the plan process. They reviewed a proposal by Stephen Case
that would allow the debtor to select the beneficiary for its duties — e.g., shareholders, creditors,
etc.741 Although that approach would provide certainty to the process, the Commissioners expressed
concerns about strategic maneuvers, collusion, and conflicts with state entity governance law. As
such, the Commissioners found that the most efficient approach would be to impose whatever duties
applicable state entity governance law would impose in these circumstances. This approach also
would be consistent with other duty-related principles discussed by the Commission. In addition,
the Commission agreed that professionals for the debtor in possession should not be disqualified
from representing the debtor in the plan process solely on the basis that such professionals were
representing the debtor in two different capacities. The Commissioners acknowledged that requiring
separate professionals would impose unnecessary and likely duplicative costs on the estate with no
real advantages, provided that the professionals otherwise were disinterested and satisfied section
327 or 328 of the Bankruptcy Code.
740 See, e.g., Written Statement of Thomas J. Salerno: CFRP Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 5 (Nov. 7, 2013) (“[C]ertain provisions of the Bankruptcy Code related to the plan negotiation process appear inconsistent
with imposition of a duty of loyalty to creditors of the estate occurring in plan negotiations. In light of these provisions, and the
sheer impossibility of absolute loyalty to two adverse interests in the negotiating process, it appears that directors and officers
are not held, and should not be held, to the same fiduciary duty of loyalty to the estate in the negotiation of a plan.”), available at
Commission website, supra note 55.
741 See Stephen H. Case, Fiduciary Duty of Corporate Directors and Officers, Resolution of Conflicts Between Creditors and Shareholders,
and Removal of Directors by Dissident Shareholders in Chapter 11 Cases 13, in C371 A.L.I.-A.B.A. 1, 17 (Study Materials for
A.L.I.-A.B.A.’s Williamsburg Conference on Bankruptcy, Oct. 17–19, 1988) (explaining that the duty of impartiality imposed
on directors of a debtor in possession should permit those directors to elect to act in a pro-creditor, pro-equity, or stakeholder
mediator capacity).
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ABI Commission to Study the Reform of Chapter
B. Approval of Section 363x Sales
Recommended Principles:
The court should approve a sale of all or substantially all of a debtor’s assets only if
the court finds by a preponderance of the evidence that the proposed sale is in the
best interests of the estate and satisfies the following requirements:
o The sale complies with the applicable provisions of the Bankruptcy Code.
(Comparable plan provision found at 11 U.S.C. § 1129(a)(1).)
o The proponent of the sale complies with the applicable provisions of the
Bankruptcy Code. (Comparable plan provision found at 11 U.S.C. § 1129(a)(2).)
o The sale has been proposed in good faith and not by any means forbidden
by law. (Comparable plan provision found at 11 U.S.C. § 1129(a)(3).)
o Any payment made or to be made by the debtor or by a person acquiring
property in the sale for services or for costs and expenses in or in connection
with the case, or in connection with the sale and incident to the case, has
been approved by, or is subject to the approval of, the court as reasonable.
(Comparable plan provision found at 11 U.S.C. § 1129(a)(4).)
o Except to the extent that the holder of a particular claim 6 agreed to
has
01
a different treatment of such claim, the trustee proposes 2 use or reserve
r 21, to
be
vem
sufficient proceeds from the sale to satisfyon Nfull allowed claims of a kind
in o
d
hive
specified in section 507(a)(2) 536(3) rincurred through the date of the closing
or 3 a c
-3
o 14
of the sale. (Comparable .plan provision found at 11 U.S.C. § 1129(a)(9)(A).)
n, N
Brow
th v.
o All feesxspayable under section 1930 of title 28 of the U.S. Code, as
li e
nB
ted i
cidetermined by the court at the hearing on the sale, have been paid or the
trustee provides for the payment of all such fees on the date of the closing
of the sale. (Comparable plan provision found at 11 U.S.C. § 1129(a)(12).)
o The trustee has provided adequate notice and an opportunity to be heard
to all creditors and equity security holders who may be affected by a release
or discharge that provides claims protection for the purchaser in the order
approving the sale.
A section 363x sale is subject to the principles on orders resolving chapter 11
cases. See Section VI.G, Orders Resolving Chapter 11 Case (Exit Orders).
These principles refer to “a sale of all or substantially all of a debtor’s assets” as
a “section 363x sale.” For the timing of section 363x sales, see Section IV.C.2,
Timing of Section 363x Sales.
The other recommended principles relating to transactions outside the ordinary
course also apply in the section 363x sale context. See Section V.B, Use, Sale, or
Lease of Property of the Estate.
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Bankruptcy Institute
Approval of Section 363x Sales: Background
As explained above, a debtor in possession742 may seek to sell all or substantially all of its assets
under section 363(b) of the Bankruptcy Code.743 This kind of sale (referred to in these principles
as a “section 363x sale”) is a value realization event in the chapter 11 case, as it involves monetizing
nearly all of the assets available to satisfy claims against and interests in the estate. Because a section
363x sale terminates the estate’s and, in turn, creditors’ interests in the assets, the process to facilitate
such a sale is critically important to the recoveries ultimately received by creditors. The timing of a
section 363 sale can significantly impact value and raises notice and due process concerns; timing
issues are addressed separately above.744
A section 363x sale transforms the estate from illiquid assets with fluctuating value to a fixed sum
of money or securities.745 Consequently, it potentially alters the value of the estate in a positive or
negative direction, depending on factors such as the timing of the sale, the marketing of the assets,
the competitive nature of the auction, and the sale and restructuring alternatives explored by the
debtor in possession leading up to the section 363x sale. Anecdotal evidence suggests that section
363x sales can facilitate quicker sales that create value for the estate.746 Such evidence also suggests,
however, that a bidder may pursue certain strategies such as a “loan-to-own” strategy or streamlined
sale process that may chill bidding and depress the value of the assets.747
742
743
744
745
16
1, 20
ber 2applicable under section 1107
As previously noted, references to the trustee are intended to include the debtor in possession as
ovem
of the Bankruptcy Code, and implications for debtors in possession also apply ton N chapter 11 trustee appointed in the case.
ed o any
See supra note 76 and accompanying text. See generally Section IV.A.1, rchiv
The Debtor in Possession Model.
63 a
See Section V.B, Use, Sale, or Lease of Property of the Estate.4See5also George W. Kuney, Let’s Make It Official: Adding an Explicit
-3 3
.1
Preplan Sale Process as an Alternative Exit from Bankruptcy, 40 Hous. L. Rev. 1265, 1267–68 (2004) (discussing increasing use of
, No
rown
chapter 11 to sell assets).
B
h v.
See Section IV.C.2, Timing of Section 363x Sales.
ixset
n BlLeary: SABA/NAAG Annual Seminar Field Hearing Before the ABI Comm’n to Study the Reform
i
See Written Statement ofiMaureen
c ted
of Chapter 11 (Oct. 8, 2013) (describing the potential negative consequences to creditors and, in turn, problems with sales of
substantially all of a debtor’s assets under section 363), available at Commission website, supra note 55.
746 For a thorough discussion of the competing perspectives on section 363 sales of all or substantially all of a debtor’s assets in
chapter 11, see In re Gulf Coast Oil Corp., 404 B.R. 407, 419 (Bankr. S.D. Tex. 2009) (reviewing the relevant case law, treatises,
and academic literature). See also Stuart Gilson, Coming Through in a Crisis: How Chapter 11 and the Debt Restructuring Industry
Are Helping to Revive the U.S. Economy, 24 J. Applied Corp. Fin. 23 (2012) (“Increasingly, distressed companies have also taken
advantage of Chapter 11 as a more efficient way to sell assets.”); Jared A. Wilkerson, Defending the Current State of Section 363
Sales, 86 Am. Bankr. L. J. 591 (2012) (refuting criticism of section 363 sales in chapter 11 and highlighting potential efficiencies
of such sales). See generally Section IV.C.2, Timing of Section 363x Sales.
747 See, e.g., Michelle M. Harner, Trends in Distressed Debt Investing: An Empirical Study of Investors Objectives, 16 Am. Bankr. L.
Rev. 69 (2008) (reporting results of empirical survey on, among other issues, investors’ loan-to-own strategies in bankruptcy).
See generally supra note 66 and accompanying text (generally discussing limitations of chapter 11 empirical studies). See also
Jonathan M. Landers, Reflections on Loan-to-Own Trends, Am. Bankr. Inst. J., Oct. 2007, at 44–46 (explaining loan-to-own
transactions); Kenneth M. Ayotte & Edward R. Morrison, Creditor Control and Conflict in Chapter 11, 1 J. Legal Analysis 511,
513 (2009) (discussing, among other things, impact of creditor control on the decision to sell assets in bankruptcy); Tabb, The
Bankruptcy Clause, the Fifth Amendment, and the Limited Rights of Secured Creditors in Bankruptcy, supra note 115 (“Controlling
secured lenders often use chapter 11 as a vehicle to foreclose on their assets. Traditional corporate reorganizations are becoming a
rara avis; the strongly emerging norm is for debtors to be liquidated in speedy ‘§ 363 sales,’ the reference being to the Bankruptcy
Code section authorizing sales. This practice has become so prevalent that a coauthor and I have spoken of the ‘new ‘Chapter
3’ reorganization.’”); Brubaker, Credit Bidding and the Secured Creditor’s Baseline Distributional Entitlement in Chapter 11, supra
note 542, at 10 (“The ‘loan to own’ phenomenon has caused some to question the advisability of credit bidding. The basic concern
seems to be that a ‘loan to own’ lender’s primary incentive is, unlike a traditional lender, acquiring the debtor’s assets as cheaply
as possible, rather than maximizing the recovery on its secured loan. A traditional lender has every incentive to maximize the
sale price of its collateral through vigorous competitive bidding, sincerely hoping that bid prices will exceed the amount it could
credit bid with its existing secured loan, as this would mean a full recovery on that loan. A ‘loan to own’ lender, though, has every
incentive to inhibit competitive bidding in order to ensure that bid prices will not exceed the amount it can credit bid with its
existing secured loan, as this would mean that the ‘loan to own’ lender can acquire the debtor’s assets solely through a credit bid
of its existing secured loan and with no additional investment.”); Jay Lawrence Westbrook, The Control of Wealth in Bankruptcy,
82 Tex. L. Rev. 795, 846 (2004) (“In both judicial and private auction sales, there are often strict requirements for a bidder other
than the secured party. In particular, the bidder may have to bring sufficient cash to cover its bid or to provide cash payment
very shortly after the bidding. For this and other reasons, it is often the case that few other bidders appear at foreclosure and
repossession sales. This fact combines with the bidding-in rules to make it possible for secured parties to buy at their own sales
at a price well below market value while avoiding sanctions for violating Article 9’s notice and sale procedures.”).
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ABI Commission to Study the Reform of Chapter
The limited empirical data on section 363x sales are mixed in results and difficult to interpret
because the coding of the debtor’s exit strategy as a liquidation, going concern sale (i.e., section 363x
sale), or confirmed plan often is very subjective, and the data are “noisy” in this respect.748 It also
is challenging for empiricists to collect and code creditors’ recoveries, particularly in cases that do
not have publicly traded securities. In fact, much of the data on chapter 11 cases speak only to the
large chapter 11 cases.749 For example, the chart shown below demonstrates a positive linear trend
(illustrated by the dotted line) in the number of section 363 sales in chapter 11 cases, but it also is
limited to large public companies.750
in
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63 a
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. 14
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eth v
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Year
748 See, e.g., Lynn M. LoPucki & Joseph W. Doherty, Bankruptcy Fire Sales, 106 Mich. L. Rev. 1 (2007) (study analyzing large
public company bankruptcy cases and finding that recoveries in reorganization cases are more than double recoveries from
going concern sales); James J. White, Bankruptcy Noir, 106 Mich. L. Rev. 691 (2007) (critiquing the LoPucki & Doherty study
and finding no statistical difference between sale prices and reorganization prices); Lynn M. LoPucki & Joseph W. Doherty,
Bankruptcy Verite, 106 Mich. L. Rev. 721 (2008) (responding to the White study). See also, e.g., Jenkins & Smith, Creditor Conflict
and the Efficiency of Corporate Reorganization, supra note 42 (developing model to assess efficient and inefficient liquidations in
bankruptcy and concluding that about 8 percent of firms are inefficiently liquidated — i.e., they were liquidated when it would
have been more efficient to reorganize); Edith S. Hotchkiss & Robert M. Mooradian, Acquisitions as a Means of Restructuring
Firms in Chapter 11, 7 J. Fin. Intermediation, 240–262 (1998) (providing “empirical evidence that takeovers can facilitate the
efficient redeployment of assets of bankruptcy firms”). See generally supra note 66 and accompanying text (generally discussing
limitations of chapter 11 empirical studies).
749 For example, many chapter 11 empirical studies use the UCLA-LoPucki Bankruptcy Research Database or a similarly restricted
database. The UCLA-LoPucki Bankruptcy Research Database includes all bankruptcy cases filed between 1980 and 2012 by or
against a business debtor or group of affiliated debtors that had assets worth $100 million or more, measured in 1980 dollars.
750 Mr. Shrestha prepared this chart for the Commission based on data from the UCLA-LoPucki Bankruptcy Research Database.
Accordingly, it was limited to large public companies. The chart analyzes all Section 363 Sales in the UCLA-LoPucki Bankruptcy
Research Database (including confirmed, pending, converted, and dismissed cases). Because certain of the cases included in
this analysis did not include data for the date of the sale order, some of these data are not included in the chart describing the
median duration between the petition date and sale order date in bankruptcy cases. See Section IV.C.2, Timing of Section 363x
Sales. But see Jay Lawrence Westbrook, The Role of Secured Credit in Chapter 11 Cases: An Empirical Review, 2015 Ill. L. Rev.__,
at *6 (forthcoming 2015) (finding, in an empirical study of 424 cases covering a broad cross section of chapter 11 debtors in nine
districts, that only about 25 percent of cases and any sales out of the ordinary course, suggesting that section 363 sales are less
common that previously thought) (draft on file with Commission). See generally supra note 66 and accompanying text (generally
discussing limitations of chapter 11 empirical studies).
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Moreover, chapter 11 cases — unlike consumer bankruptcy cases — often present unique facts and
involve dynamics not reflected on the court docket. Accordingly, although the data are extremely
informative, they should be read with caution, and any claims of causality should be critically
analyzed given the foregoing factors and related research limitations (e.g., endogeneity bias, sample
selection bias) that may impact research issues in this area.751
As suggested above, a section 363x basically determines the maximum recovery any particular
creditor will receive in the case. In a case where the debtor’s assets are sold for less than the value of
the secured claims asserted against the estate, junior creditors — including those holding prepetition
unsecured claims and, potentially, postpetition administrative claims relating to the administration
of the case following the sale — may not receive any distributions. Although a debtor that liquidates
in chapter 11 does not receive a discharge, for all practical purposes, a section 363x essentially
discharges the primary source of recovery in business cases (i.e., the debtor’s assets).
Accordingly, many courts raise concerns regarding section 363x sales in chapter 11 cases. Among
other things, courts and commentators note that these sales skirt the notice and due process
protections of the plan process, are often pursued before parties in interest have adequate information
to assess the sale and a debtor’s restructuring alternatives, and may determine ultimate distributions
to creditors without creditors having a vote or the protections of the “fair and equitable” standard
of section 1129(b).752 Nevertheless, as many of these courts recognize, a debtor in possession may
6
have no viable restructuring alternatives, and the section 363x sale mayein 1, 201
fact represent its best
b r2
opportunity for providing recoveries to at least some stakeholders.ovem
N In these circumstances, many
d on
chive
ar
courts strive to make a going concern sale work under3the current Bankruptcy Code, but it was not
3536
753
. 14an intended, and thus is not a perfect, fit. n, No
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xset
n Bli
i
Brow
cite
Approval of Section 363x Sales: Recommendations and Findings
Some commentators argue that a sale of all or substantially all of a debtor’s assets is akin to a
traditional reorganization in that it is a change-of-control event that facilitates distributions of value
to creditors and frequently continues the business of the debtor in some form. The Commissioners
debated this general proposition at length. Although the Commissioners held differing views on
what qualifies as “reorganization” under chapter 11, many of the Commissioners believed that
sales of all or substantially all of a debtor’s assets have become part of the restructuring landscape.
As such, the Commission agreed that the most constructive approach to the issue was to analyze
critically the sale process, recognizing the potential utility of the process in achieving certain policy
goals, including maximizing value for creditors and preserving jobs for at least part of the debtor’s
workforce.
751 See generally supra note 66 and accompanying text (generally discussing limitations of chapter 11 empirical studies).
752 See, e.g., In re Gen. Motors Corp., 407 B.R. 463, 491 (Bankr. S.D.N.Y. 2009), aff ’d, In re Motors Liquidation Co., 430 B.R. 65
(S.D.N.Y. 2010) (“[A] debtor cannot enter into a transaction that ‘would amount to a sub rosa plan of reorganization’ or an
attempt to circumvent the chapter 11 requirements for confirmation of a plan of reorganization.”). But see Comm. of Equity
Sec. Holders v. Lionel Corp.(In re Lionel Corp.), 722 F.2d 1063, 1071 (2d Cir. 1983) (“Every sale under § 363(b) does not
automatically short-circuit or side-step Chapter 11; nor are these two statutory provisions to be read as mutually exclusive.
Instead, if a bankruptcy judge is to administer a business reorganization successfully under the Code, then . . . some play for the
operation of both § 363(b) and Chapter 11 must be allowed for.”).
753 See, e.g., In re Chrysler LLC, 405 B.R. 84, 96 (Bankr. S.D.N.Y. 2009), appeal dismissed, 592 F.3d 370 (2d Cir. 2010) (“A debtor may
sell substantially all of its assets as a going concern and later submit a plan of liquidation providing for the distribution of the
proceeds of the sale. This strategy is employed, for example, when there is a need to preserve the going concern value because
revenues are not sufficient to support the continued operation of the business and there are no viable sources for financing.”).
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ABI Commission to Study the Reform of Chapter
As discussed above, a key concern among the Commissioners was the timing of section 363x sales,
which they believed should be conducted in a methodical manner and on a reasonable timeline
so that the debtor can identify, and creditors can confirm, that the sale not only provides the best
and highest offer for the assets, but also the best restructuring alternative for the debtor and all of
its stakeholders. The Commission recommended a 60-day moratorium on section 363x sales to
promote these objectives.754
The Commissioners reflected on the meaningful differences between a section 363x sale process and
the chapter 11 plan process. They considered both substantive and procedural aspects of the process.
For example, courts use slightly different standards of review in approving sales of substantially all
of a debtor’s assets under section 363 of the Bankruptcy Code.755 Most courts employ some form of
heightened scrutiny, but that review may simply turn on whether the debtor in possession has a “good
reason” for the proposed sale under the circumstances of the particular case.756 Such a standard is a
much different and arguably lower standard than that applied to confirmation of a chapter 11 plan
in the cramdown context.757 The Commissioners observed that a cramdown analysis generally is
applicable because most classes of creditors will be impaired by the sale and receive nominal, if any,
distributions from the sale proceeds. Moreover, creditors do not get a “vote” on the sale. To confirm
a plan under the section 1129 cramdown standard, a debtor must establish that the plan (i) satisfies
754 See Section IV.C.2, Timing of Section 363x Sales.
755 See Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1072 (2d Cir. 1983) (reviewing historical
16
standard applicable to bankruptcy sales and finding more flexibility under section 363(b), 20
1, noting that “[i]n fashioning its
ber 2 interest groups; rather, he should
findings, a bankruptcy judge must not blindly follow the hue and cry of the mostvem special
vocal
n No
consider all salient factors pertaining to the proceeding and, accordingly, act to further the diverse interests of the debtor,
ed o Inc., 2008 WL 2951974, at *6 (Bankr. D. Del. July
v
creditors and equity holders, alike”). See also In re Whitehall JewelersiHoldings,
arch
28, 2008) (“[W]hen a preconfirmation [section] 363(b)-353is3 all, or substantially all, of the Debtor’s property, and is proposed
sale 6 of
4
during the beginning stages of the case, the saleNo. 1
, transaction should be ‘closely scrutinized, and the proponent bears a heightened
rown
burden of proving the elements necessary for authorization’”) (citation omitted); In re George Walsh Chevrolet, Inc., 118 B.R. 99,
v. B
101 (Bankr. E.D. Mo. 1990)ixsesale of substantially all of the Debtor’s assets other than in the ordinary course of business and
(“A th
naBl
i
without the structure of Chapter 11 Disclosure Statement and Plan . . . must be closely scrutinized and the proponent bears a
cited
heightened burden of proving the elements necessary for authorization.”); In re Indus. Valley Refrigeration & Air Conditioning
Supplies, Inc., 77 B.R. 15, 17 (Bankr. E.D. Pa. 1987) (holding that a sale of virtually all of the debtor’s assets “can be permitted only
when a good business reason for conducting a preconfirmation sale is established and . . . the burden of proving the elements for
approval of any sale out of the ordinary course of business — including provision of proper notice, adequacy of price, and ‘good
faith’ — is heightened”).
756 See Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1071 (2d Cir. 1983) (“The rule we adopt
requires that a judge determining a § 363(b) application expressly find from the evidence presented before him at the hearing a
good business reason to grant such an application.”). See also In re Boston Generating, LLC, 440 B.R. 302, 321 (Bankr. S.D.N.Y.
2010) (“[A] court rendering a section 363(b) determination must ‘expressly find from the evidence presented . . . a good
business reason to grant such application.’”) (citations omitted); In re Daufuskie Island Props., LLC, 431 B.R. 626, 637 (Bankr.
D.S.C. 2010) (“(Because the sale is one of substantially all assets of the Estate prior to confirmation of a Chapter 11 plan in this
case, authorization for the sale under § 363(b)(1) requires that the Trustee satisfy the ‘sound business purpose’ test for preconfirmation sales.”); In re Gen. Motors Corp., 407 B.R. 463, 489 (Bankr. S.D.N.Y. 2009), aff ’d, In re Motors Liquidation Co., 430
B.R. 65 (S.D.N.Y. 2010) (“[I]t is plain that in the Second Circuit, as elsewhere, even the entirety of a debtor’s business may be
sold without waiting for confirmation when there is a good business reason for doing so.”); In re Nicole Energy Servs., Inc., 385
B.R. 201, 10 (Bankr. S.D. Ohio 2008) (“[T]he Court may approve a sale of all of a debtor’s assets under § 363(b) ‘when a sound
business purpose dictates such action.’”).
757 First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial
Fin. Ass’n Annual Meeting, at 16–17 (Nov. 15, 2012) (“Chapter 11 plans of liquidation continue to grow in popularity as a
‘reorganization’ option but offer less protection to creditors, including secured creditors, than a liquidation under Chapter 7. In
almost all cases, once the Chapter 11 plan of liquidation has been confirmed, it is the debtor or liquidating trustee who conducts
the liquidation without further input from creditors and often with limited (if any) judicial oversight. As a result, creditors have
little or no input into the liquidation decisions made by the liquidating trustee/debtor beyond the information contained in the
disclosure statement, and there is no real ability on the part of creditors to oversee the liquidation that is being accomplished
— allegedly for their benefit. . . . It is becoming commonplace that courts will not condone a §363 sale which disposes of
substantially all of the estate’s assets without the court and the creditors being advised as to the terms of ‘wind-down’ or a plan
of liquidation. Similarly, many courts allow for what are referred to as “structured dismissals” in lieu of either a Chapter 11 plan
of liquidation or a conversion to Chapter 7, without any specific statutory underpinning. Without giving any real guidance as
to when a Chapter 11 liquidation is appropriate and the level of interaction available to creditors if the Debtor has not complied
with the plan or refuses to cooperate, the secured lender is left only with the option of reclaiming its collateral.”), available at
Commission website, supra note 55; See Written Statement of Maureen Leary: SABA/NAAG Annual Seminar Field Hearing Before
the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 8, 2013) (suggesting higher standard of review for sales under section
363(b) and (f)), available at Commission website, supra note 55.
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all of the requirements of section 1129(a) (including good faith, the best interests of creditors test,
and payment of all administrative claims and certain priority claims), except section 1129(a)(8); and
(ii) does not discriminate unfairly and is fair and equitable with respect to each dissenting impaired
class under section 1129(b).758
In general, a plan discriminates unfairly against an impaired dissenting class if it provides greater
value to a class of claims or interests with equal priority. “In a nutshell, if the plan protects the legal
rights of a dissenting class in a manner consistent with the treatment of other classes whose legal
rights are intertwined with those of the dissenting class, then the plan does not discriminate unfairly
with respect to the dissenting class.”759 Section 1129(b)(2) sets forth certain standards that must be
met for the plan to be considered fair and equitable as to dissenting impaired classes of secured and
unsecured claims and equity interests. The legislative history, however, also makes clear that certain
factors that are relevant to the fair and equitable determination are not specified in section 1129.760
The most common factor considered in this context is a prohibition on a senior class receiving more
than 100 percent of its claim in a cramdown scenario.
In addition to substantive distinctions, the Commissioners observed that, particularly in an
expedited sale process, many creditors do not receive notice of the sale or sufficient information to
evaluate the sale. Yet the sale may eviscerate any recoveries for unsecured creditors in the case, and
could subject some or all of the creditors to third-party releases or discharges that impact the parties
16
and property potentially available to satisfy their claims. The Commissioners2believed that more
1, 0
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ov
meaningful notice to a broader audience is necessary and appropriate em many cases.
on N in
ived
arch
363
5
Overall, the Commissioners found little , No. 14-3 in the consequences to creditors’ rights and
difference
n
w
claims under an order approving v. Bro
th a section 363x sale or an order confirming a chapter 11 plan.
lixse
in B
They did find, however,dsignificant differences in the creditor protections available under the two
cite
processes. Considering the potentially greater exposure to loss of value in the sale context where
the assets are being removed from the estate, the Commission ultimately determined that creditors
should be afforded at least the same level of protection in the section 363x sale process and in the
chapter 11 plan process. The proposed procedural principles for section 363x incorporate these
recommendations.
758 11 U.S.C. § 1129(a), (b).
759 Kenneth N. Klee, All You Ever Wanted to Know About Cram Down Under the New Bankruptcy Code, 53 Am. Bankr. L. J. 133, 142
(1979).
760 Id.
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ABI Commission to Study the Reform of Chapter
C. Value Determinations, Allocation,
and Distributions
1. Creditors’ Rights to Reorganization Value
and Redemption Option Value
Recommended Principles:
A class of senior creditors should be entitled to receive in respect of their secured
claims distributions under the chapter 11 plan or order approving a section
363x sale having a value equal to the reorganization value (or portion thereof)
attributable to the collateral securing their claims as of the effective date of the
plan or the date of a section 363x sale order, unless such classes agree to accept
different treatment. For purposes of this principle, the term “reorganization
value” means (i) if the debtor is reorganizing under the plan, the enterprise value
attributable to the reorganized business entity, plus the net realizable value of its
assets that are not included in determining the enterprise value and are subject to
subsequent disposition as provided in the confirmed plan; or (ii) 16 the debtor is
0 if
21, 2
ber or a chapter 11 plan,
selling all or substantially all of its assets under section 363x
vem
n No
ed o
the net sale price for the enterprise plus archiv realizable value of its assets that
the net
3
-3 subject to subsequent disposition as provided
are not included in such sale and1are 536
. 4
, No
in the confirmed plan Brown contemplated at the time of the section 363x sale.761
or as
v.
eth
Blixs
ed in date set
cit
valuation
The
by the effective date of a plan or the date of a section 363x
sale order should not foreclose, in appropriate cases, a distribution in the chapter
11 case on account of the possibility of future appreciation in the firm’s value
due to the firm’s continuation as a going concern. Although the valuation at any
point in time will necessarily reflect the debtor’s future potential, the valuation
may occur during a trough in the debtor’s business cycle or the economy as a
whole, and relying on a valuation at such a time may result in a reallocation of
the reorganized firm’s future value in favor of senior stakeholders and away from
junior stakeholders in a manner that is subjectively unfair and inconsistent with
the Bankruptcy Code’s principle of providing a breathing spell from business
adversity.
Accordingly, except in small and medium-sized enterprise cases, the general
priority scheme of chapter 11 should incorporate a mechanism to determine
whether distributions to stakeholders should be adjusted due to the possibility
of material changes in the value of the firm within a reasonable period of time
after the plan effective date or section 363x sale order date, as the case may be.
This adjustment should consider whether the class immediately junior to a senior
761 In the case of a sale, the reorganization value is limited to the net value actually available for distributions to creditors after any
applicable reductions, expenses, or charges.
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Bankruptcy Institute
class762 benefiting from preserving the firm’s value as a going concern in connection
with a chapter 11 plan or section 363x sale (the “immediately junior class”)
should receive an allocation of value to recognize that the future possibilities of
the ongoing firm include the possibility that such an immediately junior class
might have been in the money or received a greater recovery if the firm had been
valued at a later date.763
In furtherance of this principle, except in small and medium-sized enterprise
cases, an immediately junior class that might otherwise be permanently cut off
from receiving value based on the reorganization value as of the effective date
of the plan or the date of the section 363x sale order should be entitled to an
allocation of value referred to as the “redemption option value” attributable to such
class, as defined below. A distribution of redemption option value, if any, would
be made to an immediately junior class to reflect the possibility that, between
the plan effective date or sale order date and the third anniversary of the petition
date (the “redemption period”), the value of the firm might have been sufficient
to pay the senior class in full with interest and provide incremental value to such
immediately junior class.764 As explained below, the redemption option value in
any given case may be negligible or non existent; it is not a percentage or fixed
payment to junior creditors.
016
,2
er 21
emb
In accordance with the above general principles, on Nov 1129(b) should be
section
d
chive
amended to provide that, subject to the conditions described below,
3 ar
3536
. 14, No
(a) a chapter 11 plan may be confirmed over the non-acceptance of the immediately
own
v. Br
junior class if Blixseonly if such immediately junior class receives not less than
and th
ed in option value, if any, attributable to such class, and
cit
the redemption
(b) a chapter 11 plan may be confirmed over the non-acceptance of a senior class
of creditors, even if the senior class is not paid in full within the meaning of
the absolute priority rule, if the plan’s deviation from the absolute priority rule
762 For purposes of applying these principles in connection with a chapter 11 plan when there is no sale of the firm, the relevant
senior stakeholders are the class or classes of senior creditors receiving the residual interests (e.g., equity securities) in the firm
that will benefit from the firm’s appreciation after the effective date of the plan. Generally speaking, outside the sale context
(whether the sale is under section 363x or pursuant to a plan), a senior class paid in cash or solely in debt securities of the
reorganized firm that receives no ongoing interest in the residual value (e.g., equity) of the firm would not be required to
share reorganization option value, which is intended to represent an allocation of value arising from the possibility of future
appreciation in the value of the reorganized firm, with a junior class. How the principles would be applied when the residual
interests in the firm are allocated among several senior classes is an issue that requires further development. In the context
of a sale of substantially all of the assets of the firm, whether under section 363x or pursuant to a plan, the distribution to the
immediately junior class would, generally speaking, be from the senior class’s or classes’ otherwise-applicable entitlement to the
proceeds of the sale and would be made in cash or such other consideration that allocates the redemption option value to such
immediately junior class from such proceeds.
763 In theory, this principle should apply to the allocation of the estate’s value between senior and junior classes of creditors, whether
the relative priority of their claims arises from liens, contractual subordination, or otherwise.
764 Because redemption option value is determined based on the presumption that the senior class, including any unsecured
deficiency claims of the senior class if the senior class holds secured claims, is paid in full, under this principle the deficiency
claims held by the senior class generally would not be entitled to share in redemption option value even if such a deficiency claim
would be otherwise included in the immediately junior class.
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ABI Commission to Study the Reform of Chapter
treatment of the senior class is solely for the distribution to an immediately
junior class of the redemption option value, if any, attributable to such class.
Notwithstanding clause (a) above, however, if a chapter 11 plan is rejected by the
immediately junior class and such class challenges the reorganization value used
to determine such class’s entitlement to redemption option value under such plan,
the plan should be confirmed over the non-acceptance of such immediately junior
class if (i) the court finds, based on the evidence presented at the confirmation
hearing, that such reorganization value was not proposed in bad faith, and (ii) the
plan satisfies, with respect to such immediately junior class, the requirements of
section 1129(b) other than the requirement that reorganization option value be
provided to such class.
Similarly, except in small and medium-sized enterprise cases, section 363 should
be amended to provide that, in the context of a section 363x sale, if the members
of an immediately junior class do not object to the sale, the immediately junior
class should be entitled to receive from the reorganization value attributable to
such sale not less than the redemption option value, if any, attributable to such
immediately junior class.765 If, however, the immediately junior class objects to the
sale, they will not be entitled to such redemption option value.
6
, 201
er 21
bclass would otherwise
Based on these principles, even if an impaired senior
vem
n No
ed o
be entitled to the entirety of the reorganization value of the firm based on its
hiv
3 arc
reorganization value on the effective 36 of the plan or date of the section 363x
-35 date
14
No.
sale order, the courtv.should, not confirm the plan over the non-acceptance of the
rown
B
th
immediatelyBlixse class or approve a sale under section 363x that is not objected
n junior
i
cited
to by members of the immediately junior class, as the case may be, unless the
plan or the order approving the section 363x sale, as applicable, provides for an
allocation of redemption option value to the immediately junior class to the extent
of its entitlement thereto as described above.
o The “redemption option value” attributable to such immediately junior
class is the value of a hypothetical option to purchase the entire firm with
an exercise price equal to the redemption price (as defined below) and a
duration equal to the redemption period (as defined above).766
o Generally speaking, the immediately junior class will be the class of
stakeholders that would first derive material benefit from future increases
in the reorganization value of the firm after payment in full of all senior
classes receiving distributions under the plan. The immediately junior class
765 The Commission recognized that an individual creditor, several creditors, or the entire class could file objections to the sale.
The Commission did not resolve the level of objection required, or whether an objection that was overruled by the court would
preclude only that creditor’s entitlement to any redemption option value.
766 Since this principle establishes a minimum recovery for the junior class where the class members have not objected to the section
363x sale, the reorganization value is fixed at the net value realized by the estate in connection with the sale. As noted below, the
junior class can still dispute how the redemption option value is being calculated for such reorganization value (by presenting
evidence on other components of the redemption option value calculation, such as volatility). On the other hand, if there is no
section 363x sale, the junior class may contest the reorganization value under the plan, and trigger application of the absolute
priority rule by rejecting the plan and in that context the junior class could assert the right to a portion of a higher reorganization
value.
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will typically be the class immediately junior to the fulcrum security class
(i.e., the most junior class in the debtor’s capital structure receiving material
distributions in the case and at which the firm’s reorganization value is
exhausted at the time of the enterprise valuation in the case). However, if
under the plan the fulcrum class will receive a relatively small participation
in the residual value of the firm at the current reorganization value because
the bulk of such participation is allocated to other more senior classes, the
fulcrum class may be the immediately junior class for these purposes.
o Where the senior class would otherwise be entitled to the entire value of the
firm, the “redemption price” of the hypothetical option would be the full face
amount of the claims of the senior class,767 including any unsecured deficiency
claim, plus any interest at the non-default contract rate768 plus allowable
fees and expenses unpaid by the debtor, in each case accruing through the
hypothetical date of exercise of the redemption option, as though the claims
remained outstanding on the date of the exercise of the option.
o A redemption period would be specified for purposes of setting the duration
of the redemption option commencing on the effective date of the plan or
the date of the section 363x sale order and ending on the third anniversary
of the petition date.
6
, 201
The court would determine the redemption option value, emany,21
if ber attributable to
Nov
on
the immediately junior class based on the evidenceepresented by the parties at the
iv d
arch
hearing under section 1129(b) or section363
5 363x, as the case may be. The parties
14-3
No.
may, for example, demonstraten,the existence, or lack, of any redemption option
Brow
th v.
value through generally accepted market-based valuation models, including the
lixse
in B
cited
Black-Scholes option pricing model, using reasonable assumptions based on the
facts of the particular case.
The redemption option value could be paid pursuant to the plan or section 363x sale
order in the form of cash, debt, stock, warrants, or other consideration, provided
that any non-cash consideration would be valued on a basis consistent with the
manner in which reorganization value was determined. The form of consideration
used to provide redemption option value to the immediately junior class should
be subject to the election of the senior class being required to give up such value,
regardless of whether such senior class has accepted the plan.
The value distributed to the immediately junior class under these principles need
not be, and in most cases likely would not be, in the form of an actual option.
767 In more complex cases, where a single senior class is not entitled to the entire reorganization value of the firm and other classes
senior to the immediately junior class are receiving distributions, the redemption price would have to be adjusted to include
the claims of all of such senior classes, whether or not they are receiving residual interests in the firm or are among the classes
required to share reorganization option value with the immediately junior class.
768 The Commission discussed the appropriate interest rate to be used in determining the redemption option value and decided
to use the non-default contract rate. Some Commissioners expressed the view that the default contract rate or a rate reflecting
the risk of investing in the equity of the reorganized debtor should be used because the senior creditor is absorbing all of the
downside risk inherent in such equity while sharing the upside potential.
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ABI Commission to Study the Reform of Chapter
The requirement is that the requisite value of such an option be distributed to the
immediately junior class, regardless of form.
If an immediately junior class is not entitled to redemption option value for any
of the reasons set forth above, such immediately junior class would be entitled to
receive distributions only on a strict absolute priority basis under section 1129(b)
as of the effective date of the plan, as under current law, and no special provision
for redemption option value would have to be made for such class in accordance
with the above principles.
A senior creditor’s election under section 1111(b) of the Bankruptcy Code should
not dilute or otherwise affect the immediately junior class’s rights to receive any
redemption option value under the distribution rules set forth in this principle.
The principles set forth above are not intended to alter the order of creditor priorities
or to affect allocations within a particular class of creditors; rather, the principles
speak generally to how courts should determine whether the reorganization value
of the debtor or its assets is sufficient to support a distribution to the immediately
junior class.
The principles set forth above attempt to provide a conceptual framework for an
6
, 201
adjustment to the current absolute priority rule, which often1results in wasteful
ber 2
em
nN
and time-consuming litigation over reorganizationovvalue in recognition that
ed o
hiv
the determination of reorganization5valuerc the effect of cutting off alternative
63 a has
-3 3
. 4
distributional possibilities based 1 the fortuity of timing of the reorganization or
, No on
rown
B
h .
sale. It is importantvto note, however, that the conceptual principle of allocating
xset
n Bli
i
cited
redemption option value to the immediately junior class requires further
development to determine whether and how it should be applied in more complex
contexts, for example where a senior class is entitled to less than all of the firm’s
enterprise value (for example where it is secured by only some of the assets of the
firm), where contractual or structural subordination (rather than a lien) results in an
immediately junior class, where there are multiple classes senior to the immediately
junior class and not all such senior classes are receiving distributions in the form of
interests in the residual value of the firm, where only part of the immediately junior
class objects to a sale or challenges reorganization value under a plan, or where some
enterprise value is distributable at the current enterprise valuation to an immediately
junior class, but the junior class is not being paid in full.
Creditors’ Rights to Reorganization Value and Redemption Option Value:
Background
The Bankruptcy Code operates, among other things, to evaluate creditors’ rights based, in part, on
their state law entitlements and priorities. Commentators and practitioners frequently debate exactly
what state law entitlements and priorities mean in the context of secured creditors. Exactly which
secured creditors’ rights can be modified? Are any of those rights inviolate? A variety of factors affect
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Bankruptcy Institute
this analysis, including the secured creditors’ rights under state law and the Fifth Amendment of the
U.S. Constitution, and Congress’s ability to “establish . . . uniform Laws on the subject of Bankruptcies
throughout the United States” under the Bankruptcy Clause of the U.S. Constitution.769
The Fifth Amendment provides in relevant part: “No person shall be . . . deprived of life, liberty,
or property, without due process of law.”770 Justice William O. Douglas notably explained that in
bankruptcy, “[s]afeguards were provided to protect the rights of secured creditors, throughout the
proceedings, to the extent of the value of the property. There is no constitutional claim of the creditor
to more than that.”771 Commentators and practitioners have interpreted Justice Douglas’s explanation
in a variety of ways, with some suggesting that it means that a secured creditor is only entitled to
the liquidation value of its interest in the debtor’s property in bankruptcy, and others suggesting a
broader meaning. Still another perspective is articulated by Prof. Tabb, who concludes that “a Fifth
Amendment takings analysis simply is not helpful or indeed even applicable when considering the
nature and scope of the protection constitutionally due to secured creditors in bankruptcy.”772
The value of a secured creditor’s interest in the debtor’s interest in property is relevant at various
points in the chapter 11 case. As explained above in the context of adequate protection, section 506(a)
provides in relevant part that “[s]uch value shall be determined in light of the purpose of the valuation
and of the proposed disposition or use of such property, and in conjunction with any hearing on
such disposition or use or on a plan affecting such creditor’s interest.”773 The valuation of a secured
16
creditor’s claim thus involves at least two questions, both of which can provoke0litigation: What is
1, 2
ber 2
the appropriate valuation standard for the property included in theNovem creditor’s collateral, and
on secured
iv d
chofethe secured creditor’s interest in such
what is the appropriate standard for determining the 63 ar
value
353
. 14- third issue concerning the appropriate valuation
collateral under that standard? It also can ,raise a
No
own
v. Brflow, precedent sale transactions, and comparable company
methodology — e.g., discountedth
e cash
Blixs
analysis.
ed in
cit
Courts have taken different approaches to questions of valuation in chapter 11. Some courts
suggest that liquidation value is always an appropriate standard for determining the value of the
secured creditor’s interest in collateral because the debtor is operating in bankruptcy. Other courts
apply a liquidation standard when valuing claims in chapter 7, and a going concern standard in
reorganizations under chapter 11 on the theory that the valuation should be based on how the
collateral is being used. Still other courts struggle with whether a liquidation standard, if appropriate,
should be analyzed on a forced-sale or orderly-sale basis. The uncertainty surrounding valuation
issues generates both litigation and, arguably, consensual resolutions.
In the plan context, chapter 11 encourages consensual resolutions and permits parties to agree to
distributions under a chapter 11 plan that may modify or otherwise affect their rights against the
estate. Sections 1126 and 1129 codify this concept by providing that if the debtor proposes to impair
the rights of a class of creditors or interest-holders under the plan and that impaired class accepts
769
770
771
772
U.S. Const. art. I, § 8, cl. 4.
Id. amend. V.
Wright v. Union Cent. Life Ins. Co., 311 U.S. 273, 278 (1940).
Tabb, The Bankruptcy Clause, the Fifth Amendment, and the Limited Rights of Secured Creditors in Bankruptcy, supra note 115, at
*1 (arguing that the “Fifth Amendment Takings Clause does not and should not constrain the power of Congress to modify the
substantive rights of secured creditors under the Bankruptcy Clause.”).
773 11 U.S.C. § 506(a).
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ABI Commission to Study the Reform of Chapter
the plan, the proposed treatment of the claims or interests is permissible even if it provides those
creditors or interest-holders with arguably less than otherwise required.774 If an impaired class of
claim- or interest-holders, however, does not accept the plan, the debtor can impose the proposed
treatment on the class only if the plan satisfies the cramdown provisions of section 1129(b) of the
Bankruptcy Code, including the absolute priority rule.775
The absolute priority rule as applied under Section 1129(b) in essence provides that a dissenting
class of creditors must be paid in full before junior creditors or interest-holders may receive any
distributions under the plan. The rule originates from the railroad equity receivership cases in the
early 1900s and the U.S. Supreme Court’s decision in Northern Pacific Railway Co. v. Boyd.776 In that
case, the railroad company reorganized by selling itself to bondholders and equity security holders
and providing no distributions to junior creditors. The Supreme Court rejected this scheme and
held that “[i]f the value of the [rail]road justified the issuance of stock exchanged for old shares,
the creditors were entitled to the benefit of that value, whether it was present or prospective, for
dividends or only for purposes of control.”777
The absolute priority rule codified in section 1129(b) is a variation of the rule announced by the
Supreme Court in Boyd, but it continues the basic tenet that priority matters — i.e., secured creditors
have a right to receive payment in full prior to junior creditors and interest-holders receiving any
value. Section 1129(b) also articulates an application of the absolute priority rule for secured claims,
6
which preserves those payment rights in the waterfall payment scheme 21, a 01
of 2 chapter 11 plan. As one
ber
v m
commentator noted shortly after the enactment of the BankruptcyeCode, “the [absolute priority] test
n No
ed o
hiv
for secured claims is completely novel, affording6protection for classes of secured claims that is not
3 arc
-353
o. 14
provided under present law.”778
n, N
h v.
xset
n Bli
i
Brow
The absolute priority rule is an important creditor protection in chapter 11 cases, but it also has proven
cited
to be inflexible and often a barrier to a debtor’s successful reorganization. It also can allocate value
among creditors in an arguably random manner depending on the timing of the value realization
event — i.e., plan confirmation. For example, to the extent that a plan is confirmed during a
downturn in the economy generally or the debtor’s industry more specifically, the valuations used to
support the plan distributions may value the reorganized entity at a low point in the valuation cycle.
Creditors may not have an appetite for, or the debtor may not have the financial ability to, continue
to operate in chapter 11 until the valuation improves, or the debtor may not have the ability to offer
adequate protection to secured creditors for the use of cash collateral or to obtain DIP financing,
which may limit (or allow the secured creditor to limit) the duration of the case. Accordingly, under
the absolute priority rule, junior creditors and interest-holders may lose their rights against the
estate and receive no value on account of their claims simply because of the timing of the valuation
of the enterprise in the chapter 11 case, while secured creditors, whose rights outside of bankruptcy
774 Id. §§ 1126, 1129(a).
775 Id. § 1129(a), (b). For a discussion of the “no unfair discrimination” requirement of section 1129(b), see Section VI.B, Approval
of Section 363x Sales.
776 N. Pac. Ry. Co. v. Boyd, 228 U.S. 482 (1913).
777 Id. at 507–08. See also Ecker v. W. Pac. R.R. Corp., 318 U.S. 448 (1943); Marine Harbor Props., Inc. v. Mfrs. Trust Co., 317 U.S. 78
(1942); Consol. Rock Prods. Co. v. Du Bois, 312 U.S. 510, 520 (1941); Case v. L.A. Lumber Prods. Co., 308 U.S. 106, 122 (1939)
(noting that Boyd adopts an absolute priority rule).
778 Klee, All You Ever Wanted to Know About Cram Down Under the New Bankruptcy Code, supra note 759, at 143 (citations omitted).
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Bankruptcy Institute
would have been limited to foreclosure, get the benefits of the chapter 11 case and the exclusive right
to the future possibilities of the firm as a reorganized going concern.
Notably, similar valuation and distribution issues may arise in the context of a sale of all or
substantially all of a debtor’s assets under section 363(b) and proposed section 363x under these
principles. Although the price being offered for a debtor’s assets in a section 363 sale arguably
reflects the current market value of those assets, to the extent the market is dysfunctional at the time
of the sale, or economic or industry factors are negatively impacting valuations, the debtor’s estate
may be monetized at value far below what the estate could be worth at a later date to the prejudice
of stakeholders lower in the pecking order of priorities. The arguable unfairness of this result is
potentially intensified when the secured creditor is the purchaser of the assets, for example using a
credit bid, and is able to capture the future increments in value solely for its own benefit.
Creditors’ Rights to Reorganization Value and Redemption Option Value:
Recommendations and Findings
Throughout their deliberations, the Commissioners held lengthy and thoughtful discussions
concerning the rights of senior creditors in bankruptcy and how best to balance these rights with
the reorganization needs of the debtor and the interests of other stakeholders.779 The Commissioners
analyzed changes and trends in the secured lending industry and financial markets generally.780 They
16
1, 20
considered credit pricing and its relation to collateral valuations and riskeassessments.781 And they
b r2
vem
n No
reviewed the literature representing all sides of these issues, including the commentary and studies
ed o
hiv
on the perceived increase in senior creditor control5in 3 arc
6 chapter 11 cases.782
-3 3
. 14
, No
rown
B
h v.
779 See Written Statement of A.J. Murphy: tLSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 17,
xse
n Bli of secured creditors’ rights and the need for certainty for the capital markets when debtors
i
2012) (describing the importance
cited
are in bankruptcy), available at Commission website, supra note 55; Written Statement of Lee Shaiman: LSTA Field Hearing
Before the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (same), available at Commission website, supra note
55; Written Statement of Michael Haddad, President of the Commercial Finance Association: CFA Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11 (Nov. 15, 2012) (stating that secured creditors need certainty that their prepetition
contractual agreements will be upheld in bankruptcy and that significant changes to this certainty will cause the cost of credit to
increase), available at Commission website, supra note 55.
780 See, e.g., Written Statement of Ted Basta on behalf of LSTA: LSTA Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 4 (Oct. 17, 2012) (“The primary leveraged loan market has grown dramatically in the last 10 to 15 years.”),
available at Commission website, supra note 55; Written Statement of A.J. Murphy: LSTA Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11, at 1 (Oct. 17, 2012) (“Secured lending is a critical part of the capital markets, particularly for
non-investment-grade borrowers. Indeed, virtually 100% of leveraged loans are secured, and secured debt makes up 50% of the
leveraged finance market as a whole.”), available at Commission website, supra note 55.
781 See, e.g., Written Statement of Ted Basta on behalf of LSTA: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of
Chapter 11, at 7 (Oct. 17, 2012) (“Senior secured loans sit atop the capital structure of corporations — situated above high yield
bonds, convertible securities, preferred stock, and common stock — and offer corporate America a private and cheaper source of
funding than would otherwise be available. Because of the senior secured nature of leveraged loans, and the protections afforded
to secured lenders, investors are willing to accept a far lower yield on their investment. For example, over the last three years,
leveraged B-rated loans have been priced in the primary market — that is, they yield — approximately 200 basis points less
than B-rated unsecured bonds, with this substantial savings (25%) passing directly to the borrower.”), available at Commission
website, supra note 55; Written Statement of A.J. Murphy: LSTA Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 2 (Oct. 17, 2012) (“By providing collateral for a loan, borrowers have the option of providing their lenders
with a lower-risk basis on which to extend credit, in exchange for which the borrower obtains capital at a lower price. Indeed,
non-investment-grade borrowers essentially have no access to the unsecured loan market, and absent secured loans, would be
forced to issue high-yield bonds or risk being shut out of access to the capital markets altogether. Borrowing on an unsecured
basis at extraordinarily punitive interest rates — or being denied credit altogether — may do far more harm to a company than
borrowing at more reasonable rates on a secured basis.”), available at Commission website, supra note 55.
782 Written Statement of Lawrence C. Gottlieb, Partner, Cooley LLP: NYIC Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 4 (June 4, 2013) (noting that the adequate protection rules are increasingly resulting in retailer liquidation
because substantially all of a distressed retailer’s assets are subject to prepetition liens and because of the adequate protection
provision, debtors may not use or sell their assets without the lender’s consent; and lenders are not consenting), available at
Commission website, supra note 55. See generally Kenneth M. Ayotte & Edward R. Morrison, Creditor Control and Conflict in
Chapter 11, 1 J. Legal Analysis 511, 523 (2009); Barry E. Adler, Bankruptcy Primitives, 12 Am. Bankr. Inst. L. Rev. 219, 239 (2004)
(“Chapter 11 is not for every firm, and the Bankruptcy Code should not permit chapter 11 to be an option for a debtor with a
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ABI Commission to Study the Reform of Chapter
As discussed more fully in the context of adequate protection above, the Commissioners recognized
the competing interests at stake and that the extreme position on either the pro-senior creditor or the
pro-residual stakeholder side was not in the best interests of chapter 11 or the bankruptcy system. They
strived to reach an appropriate balancing of these interests to the greatest extent possible. That balancing
provides for valuing a senior creditor’s collateral at (i) foreclosure value (as defined in these principles)
for purposes of adequate protection, and (ii) reorganization value (as defined in these principles) for
purposes of distributions in the case. The Commissioners believed that this balance would enhance a
debtor’s ability to obtain much-needed liquidity early in the case while allowing the senior creditor to
benefit from the reorganized debtor’s continued use of collateral in the ongoing business by receiving
the value of its collateral on an enterprise or going concern basis later in the case. They also found that
it comported with the mandate of section 506(a) that “[s]uch value shall be determined in light of the
purpose of the valuation and of the proposed disposition or use of such property.”783
The definition of reorganization value in these principles is designed to capture the total enterprise
value of the firm, including value generated through the chapter 11 case. Subject to the principles
regarding redemption option value described below and the courts’ powers under sections 506(c)
and 552(b), as described in Section VI.C.3, Section 506(c) and Charges Against Collateral and Section
VI.C.4, Section 552(b) and Equities of the Case, the principles further provide that a senior creditor
should be entitled to receive the reorganization value of its collateral under a chapter 11 plan or in a
section 363x sale.
16
1, 20
ber 2
e
The Commission received substantial testimony on the allocationvofm
n No value in chapter 11 cases. Several
ed o
witnesses posited that chapter 11 cases were beingarchiv for the benefit of the senior creditors and
3 run
3536
784
785
. 14generating little, if any, value for other No
, creditors. Commentators have also observed this trend.
rown
B
h v.
xset
n Bli an alternative process in the event of default.”); Douglas G. Baird & Robert K. Rasmussen, Private
i
corporate charter ithat provides
c ted
Debt and the Missing Lever of Corporate Governance, 154 U. Pa. L. Rev. 1209, 1211 (2006) (discussing increased role of creditors
in chapter 11 process); David A. Skeel, Doctrines and Markets: Creditors’ Ball: The “New” New Corporate Governance in Chapter
11, 152 U. Pa. L. Rev. 917, 918 (2003) (“Whereas the debtor and its managers seemed to dominate bankruptcy only a few years
ago, Chapter 11 now has a distinctively creditor-oriented cast.”). But see Westbrook, The Role of Secured Credit in Chapter 11
Cases, supra note 750, at *1 (forthcoming 2015) (stating that “secured creditor control is less pervasive than has been asserted”).
783 11 U.S.C. § 506(a).
784 See, e.g., Oral Testimony of Bryan Marsal: NCBJ Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 19 (Oct. 26,
2012) (NCBJ Transcript) (“I think what you’ve got today is that because of the move from being unsecured creditor status to secured
creditor status, which is happened over the last number of years that I’ve been in the business, it’s increased the leverage of the secured
creditors and thus reduced the flexibility of a rehabilitation during this process.”), available at Commission website, supra note 55;
Statement of John Haggerty, Argus Management Corp.: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
1–2 (Apr. 19, 2013) (“Over the years the secured lenders have increased their control over the company during the pre-petition period
by taking dominion of the cash via lockbox sweeps; and requiring strict budgets and forbearance agreements. These actions enable the
secured creditor to significantly increase their control over borrower cash and ultimately over a Chapter 11 filing should the borrower
choose to go that route.”), available at Commission website, supra note 55; Written Statement of Jim Millstein, Chairman of Millstein &
Co.: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (Apr. 19, 2012) (“[B]y virtue of the significant
protections afforded secured debt under Chapter 11, sophisticated creditors take pains to structure their credit extensions in secured form
when lending to companies in distress. As a result, in cases where the aggregate amount of secured debt exceeds the going concern value
of the enterprise, a Chapter 11 reorganization has become little more than a court-supervised assignment for the benefit of creditors.”),
available at Commission website, supra note 55; Written Statement of Clifford J. White, Director, Executive Office for the U.S. Trustees:
ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Apr. 19, 2012) (describing how DIP lending conditions
often ultimately control the fate of the debtor), available at Commission website, supra note 55; Oral Testimony Ted Basta on behalf of
LSTA: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 13 (Oct. 17, 2012) (LSTA Transcript) (noting
that secured creditors have great influence over DIP lending terms), available at Commission website, supra note 55. See also Tabb, The
Bankruptcy Clause, the Fifth Amendment, and the Limited Rights of Secured Creditors in Bankruptcy, supra note 115, at *3–4 (“One of the
most notable developments in chapter 11 reorganization practice in this millennium is the dramatic expansion in the power exercised by
secured creditors. Financing has experienced a sea change, and today many firms enter chapter 11 with their assets full (or almost fully)
encumbered. The reality then is that the entire reorganization is dependent on the good graces of the prebankruptcy controlling secured
lender. That means that important stakeholders — bondholders, trade creditors, tort victims, employees, and shareholders, to name but a
few — are excluded from any recovery but for the whims of the controlling secured creditor.”).
785 See, e.g., Jacoby & Janger, Ice Cube Bonds, supra note 283, at 922–23 (discussing lender control exerted over timing of sales
through postpetition financing and blanket liens); Anthony J. Casey, The Creditor’s Bargain and Option-Preservation Priority
in Chapter 11, 78 U. Chi. L. Rev. 759, 760 (2011) (“A secured creditor, exercising control over the debtor firm, determines that
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Similarly, witnesses expressed concerns regarding the lack of a debtor’s equity in its property at the
commencement of its case and the challenges presented to restructuring the debtor under these
circumstances.786 The Commission also heard testimony concerning how the timing of a chapter 11
case — and the value realization event in the case (e.g., plan confirmation or sale approval) — can
impact value allocations among creditors, and also how capital structures overwhelmed by secured
debt and a resulting difficulty in obtaining postpetition financing to continue operations are creating
increasing pressure to monetize the assets of the debtor’s estate through quick section 363 sales.787
The Commissioners debated both the underlying premises in this testimony, as well as possible ways
to address the concerns.788 The Commissioners noted the increasing concerns among commentators
and practitioners regarding administratively insolvent chapter 11 cases, structured dismissals, and
issues regarding value allocation in chapter 11 cases.789 They observed that in the recent cycle of
chapter 11 cases, the fulcrum security (i.e., the priority level of the class of debt in the debtor’s capital
786
787
788
789
a bankruptcy filing to facilitate such a sale is the optimal strategy for the distressed firm. The debtor then files, and the sale is
accomplished”).
See Written Testimony of Michael R. (“Buzz”) Rochelle: UT Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11, at 1 (Nov. 22, 2013) (“Today the newly-filed debtor is already under water; the secured lender is under-secured; and use of
cash collateral generally comes with concessions that tighten security documentation and tie the debtor to a short-term budget
which allows for little but locating an asset purchaser.”), available at Commission website, supra note 55; Written Statement of
Kathryn Coleman, Attorney at Hughes Hubbard & Reed, LLP: TMA Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 3, 4–5, 6 (Nov. 3, 2012) (stating that secured creditors have often “liened up” all the debtor’s assets prior to the
bankruptcy, hurting the debtor’s chance at rehabilitation), available at Commission website, supra note 55. “Lenders providing
postpetition financing no longer do so in order to make good returns with assured repayment, or protect their prepetition
16
positions by getting collateral for previously unsecured loans. Instead, they often do so in order 1, 20 control of the debtor,
to take
ber 2
through covenants, deadlines, and default provisions.” Id.
ovem
See, e.g., Written Statement of Professor Anthony J. Casey: CFRP Field Hearing on N the ABI Comm’n to Study the Reform of
ed Before foreclosure and liquidation rights when
Chapter 11, at 3 (Nov. 7, 2013) (“On the other hand, the secured creditor chiv exercise its
ar may
the debtor defaults. But that liquidation cuts off the future 4-35363 as part of a going concern. Thus, the secured creditor’s
of the assets
claim on going concern is extinguished along withn, Njunior creditors’ claims. The secured creditor essentially has two options:
the o. 1
r w
take the liquidation value or keep the firm aliveosubject to the junior creditors’ claims.”), available at Commission website, supra
v. B
note 55; Written Statement of Sandra E.th
ixse Horowitz: VALCON Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
n Blthird challenge confronting creditors’ committees is the growing use of quick Section 363 asset
i
11, at 3 (Feb. 21, 2013) (“Finally, a
cited
sales, a situation that can undermine their efforts to maximize recoveries for general unsecured creditors. While I recognize that
a sale can be viewed as the real value of the estate and the only viable option, I would argue that this alternative can benefit the
DIP lenders and possibly other secured creditors to the complete detriment of the unsecured credits who may well benefit from a
classical operational and financial restructuring from which value can ultimately be realized.”), available at Commission website,
supra note 55.
Notably, the Commission also received and considered at length testimony on the value of secured credit in bankruptcy and the
important role markets play in providing liquidity to distressed companies. See, e.g., Oral Testimony of Elliot Ganz: LSTA Field
Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1 (Oct. 17, 2012) (“There are two things that are especially
important to the smooth functioning of the market, legal clarity and financial liquidity. First, lenders and investors need to
know what the rules are prior to entering into a transaction. They need to have the confidence that the rights they’ve bargained
for will be respected and enforced. Second, they need to know that they have the ability to sell their positions, especially when
things go south.”), available at Commission website, supra note 55; Written Statement of A.J. Murphy: LSTA Field Hearing Before
the ABI Comm’n to Study the Reform of Chapter 11, at 2-3 (Oct. 17, 2012) (“Secured credit is also vital when the capital markets
constrict, as they did just a few years ago in the aftermath of the 2008 financial crisis. At that time, when leveraged markets were
barely functioning, investors were extraordinarily (and understandably) careful about investing in non-investment-grade debt.
At the same time, due to the economic downturn, many companies were facing challenges to their businesses and needed capital
just as the markets were freezing up. For a very large number of those companies, the solution was to access the secured debt
markets.”), available at Commission website, supra note 55; Written Statement of Lee Shaiman: LSTA Field Hearing Before the
ABI Comm’n to Study the Reform of Chapter 11, at 2 (Oct. 17, 2012) (“[L]essening the protections accorded secured creditors
would affect loan sizes going forward. Lenders would not be willing to lend as much if they cannot be sure that they will be able
to collect as much as they are owed or the value of their collateral in the event of default.”), available at Commission website,
supra note 55; Written Statement of Michael Haddad, President of the Commercial Finance Association: CFA Field Hearing Before
the ABI Comm’n to Study the Reform of Chapter 11, at 1 (Nov. 15, 2012) (“Asset-based financing extended by CFA members has
played an important role in financing the growth of U.S. companies for many decades. It allows companies the opportunity to
obtain the working capital they need to operate and grow, and create jobs, and also provides financing for capital expenditures
and the acquisition of other companies.”), available at Commission website, supra note 55. Throughout deliberations — on all
issues — the Commission worked to balance competing interests and perspectives.
See, e.g., Nan Roberts Eitel, T. Patrick Tinker & Lisa L. Lambert, Structured Dismissals, or Cases Dismissed Outside of Code’s
Structure?, Am. Bankr. Inst. J., Mar. 2011, at 20; Bruce S. Nathan & Bruce D. Buechler, Who Pays the Freight? Interplay Between
Priority Claims and a Debtor’s Secured Lender, Am. Bankr. Inst. J., Nov. 2011, at 26; Norman L. Pernick & G. David Dean,
Structured Chapter 11 Dismissals: A Viable and Growing Alternative after Asset Sales, Am. Bankr. Inst. J., June 2010, at 1; Charles
R. Sterbach & Keriann M. Atencio, Why Johnny Can’t Get Paid on His General Unsecured Claims: a Potpourri of Lingering Abuses
in Chapter 11 Cases, 14 J. Bankr. L. & Prac. 1, Art. 3 (2005).
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structure at which the firm’s enterprise value is exhausted at the time of the enterprise valuation in
the case) was higher in the debtor’s capital structure than in the past. Although in 1978 the fulcrum
security was almost always general unsecured claims, in more recent cycles, the fulcrum security
was increasingly often at the senior creditor or subordinated senior creditor level.790
The Commissioners discussed the potential reasons for this trend, including the testimony from the
lending community on these issues.791 They acknowledged the potential role of various confounding
factors such as economic cycles, lending practices, delay in commencing chapter 11 cases (which can
be facilitated by the economic cycle and the availability of cheap money, as well as a management’s
resistance to a filing), outdated or underperforming business models, ineffective management,
and other market or constituent pressures. They also recognized and discussed the arguments of
commentators and practitioners who believe that value allocation and creditors’ recoveries should
remain relatively unchanged and are appropriate given parties’ state law rights.792 The Commission
790 See, e.g., Oral Testimony of Bryan Marsal: NCBJ Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 22
(Oct. 26, 2012) (NCBJ Transcript) (“If you just looked at the Lehman example, you see that at the 11th hour, various sophisticated
creditors went from unsecured status to secured status and, in fact, used the safe harbors to the tune of $17 billion. The answer is
more sophisticated the creditor, in this case, would be your banker. Your banker has an opportunity to take advantage of all other
classes of creditors by moving effectively from unsecured status to secured status. That’s happened in Lehman, and it happens
every day.”), available at Commission website, supra note 55; Written Statement of Honorable Melanie L. Cyganowski (Ret.),
former Chief Bankruptcy Judge, Eastern District of New York: CFA Field Hearing Before the ABI Comm’n to Study the Reform of
Chapter 11, at 2 (Nov. 15, 2012) (“In the middle market cases, it is the secured debt that is the fulcrum credit.”), available at
Commission website, supra note 55. See also Christie Smythe, “Fulcrum” Deals Rising to Prominence, Experts Say, Law 360 (Oct.
9, 2009, 1:26 PM) (“While in the past fulcrum securities were generally unsecured bonds, secured bonds have also become
16
fulcrum securities in some recent bankruptcy scenarios as a result of the lending practices before0 credit crisis, experts said.”),
1, 2 the
ber 2
available at http://www.law360.com/articles/122360/fulcrum-deals-rising-to-prominence-experts-say.
ovem
791 See, e.g., Written Statement of Ted Basta on behalf of LSTA: LSTA Field d on N Before the ABI Comm’n to Study the Reform of
e Hearing
Chapter 11, at 10 (Oct. 17, 2012) (“During the financial crisis of 2008-2009, primary markets for both leveraged loans and high
rchiv
63 a
yield unsecured bonds seized up (illustrated on Slide 353Importantly, the senior secured high yield bond market increased
- 6).
. 4
dramatically to take up some of the slack, providing1crucial liquidity that was otherwise unavailable. In 2007, leveraged lending
, No
rown
volume plunged from $535 billion to $152 billion and $76 in 2008 and 2009, respectively. Similarly, unsecured high yield bond
B
h v.
volume fell from $143 billionset2007 to $68 billion in 2008, before recovering to $163 billion in 2009. Despite the precipitous
x in
n Bli unsecured high yield bonds, secured high yield bond volume moved to fill the void in 2009, with
decline in leveraged d i and
loans
cite
issuance of $60 billion, a ten-fold increase from 2008, and a four-fold increase from 2007, when respective volume was $6 billion
and $15 billion.”), available at Commission website, supra note 55; Oral Testimony of A.J. Murphy: LSTA Field Hearing Before the
ABI Comm’n to Study the Reform of Chapter 11, at 28 (Oct. 17, 2012) (transcript) (“What I would say is, we’ve definitely seen an
increase in percentages of debt raised in the high-yield bond that’s secured, so you’re probably talking about 25% of the highyield bond market having any kind of security around it back in ‘06. Today you’re in the low 30s, and we peaked about 34–35%
number, so it definitely picked up by about 10% during that period of time, and it was noticeable because the debt overall in the
bond market was down then, so it felt like there were so many bond issuers in there, and there were because that was how you
raised capital. . . . I would say that the other side of that equation was there was no loans being issued for the most part, so the
secured bonds in no way filled the hole that was left behind by the loans that were not being raised. The loan market has been
recovering pretty steadily, more or less, for the last three years now, but I don’t know that we are back to where we were in that
Golden Day of the CLO.”), available at Commission website, supra note 55.
792 See, e.g., Written Statement of Ted Basta on behalf of LSTA: LSTA Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 8 (Oct. 17, 2012) (“Since bank loans are typically the most senior debt in a company’s capital structure, and
generally have first lien claim to a company’s assets in the event of bankruptcy, they fare far better upon default than other
indebtedness. Moreover, that level of recovery has stayed remarkably consistent over the last four credit cycles. According to an
analysis by Moody’s Investor Services, which tracked more than 1,000 corporate defaults since January 1987, average recoveries
for bank loans were approximately 80 cents on the dollar, compared with recovery of less than 50 cents on the dollar for senior
unsecured bonds and 30 cents on the dollar for subordinated bonds.”), available at Commission website, supra note 55; Written
Statement of A.J. Murphy: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (Oct. 17, 2012)
(“[F]ocusing only on the debtors that fail to reorganize in chapter 11 ignores the far greater number of companies who avoid
bankruptcy entirely, and instead develop their businesses and create jobs, because they are able to access low-cost, secured credit.
The ability to pledge collateral is particularly vital to both healthy non-investment-grade and financially distressed companies.
In both cases, the security interest is a critical tool in reducing the cost of credit, and in many cases is a necessary condition to
the extension of credit at all. Without the ability to offer an enforceable security interest, non-investment-grade borrowers may
lack sufficient access to the capital markets.”), available at Commission website, supra note 55; Written Statement of Lee Shaiman:
LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (“[B]ankruptcy reforms will not
affect bankruptcy alone. Weakening the protections available to secured creditors, or reducing the recovery of holders of debt
bought on the secondary market, will have a profound, and negative, effect on the availability and price of credit — particularly
credit extended to non-investment-grade companies.”), available at Commission website, supra note 55; Oral Testimony of Lee
Shaiman: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 27 (Oct. 17, 2012) (transcript) (“If you
look at capital structures 10 years back and the ratios of senior secured debt to subordinated debt I would suspect that, in general,
that those capital structures are not dramatically different.”), available at Commission website, supra note 55; Written Statement
of Michael Haddad, President of the Commercial Finance Association: CFA Field Hearing Before the ABI Comm’n to Study the
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ultimately concluded that trying to isolate the cause was futile and that a better approach would be
to explore ways to enhance the value allocation rules and distribution mechanisms in chapter 11 so
as to continue to protect the rights of senior creditors, protect junior creditors against being cut off
entirely from the future possibilities of the firm based on a valuation at a single moment in time and
based on other factors that may be outside of the debtor’s control, and incentivize the major parties
to reach a consensual reorganization if the underlying economics justified the debtor’s emergence as
an ongoing enterprise.
The Commissioners worked extensively to identify ways to achieve these goals. The Commission
generally agreed that the timing of a judicially supervised reorganization in the life cycle of the credit
markets generally and in the business life cycle of a given company should not dictate hard and fast
distributional rules that advantage the creditors who happen to be in the senior position at a given
moment in time. The Commissioners discussed this basic premise at length and the concept that a
valuation date set by the effective date of a plan or the date of a section 363x sale order should not
cut off all future possibilities associated with the affected assets for a junior class that appears to
be significantly impaired or out of the money on the plan or sale valuation date. Accordingly, the
Commission determined to recommend the following overarching principle: the general priority
scheme of chapter 11 should incorporate a mechanism to determine whether distributions to
stakeholders should be adjusted due to the possibility of material changes in the value of the firm
within a reasonable period of time after the plan effective date or section 363x sale order date, as
16
1 20
the case may be, which would enable junior creditors to “redeem” in fullethe ,allowed claim of the
b r2
m
impaired senior creditors receiving the reorganization value of d on company under such plan or sale.
the Nove
ive
arch
363
-35
o. of
Under this principle, even if an impaired ,class14 senior creditors would otherwise be entitled to
n N
row
the entirety of the reorganizationth v. B of the firm based on its reorganization value on the effective
value
lixse
nB
date of the plan or date iof the 363x sale order, the court should not confirm the plan over the
cited
non-acceptance of the immediately junior class or approve a sale under section 363x that is not
objected to by members of the immediately junior class, as the case may be, unless the plan or the
order approving the section 363x sale, as applicable, provides for an allocation of redemption option
value to the immediately junior class to the extent of its entitlement thereto as described in the
principles above.793 Specifically, a chapter 11 plan may be confirmed (a) over the non-acceptance
of the immediately junior class if and only if such immediately junior class receives not less than
the redemption option value, if any, applicable to such class, and (b) over the non-acceptance of a
Reform of Chapter 11, at 3 (Nov. 15, 2012) (“If the Commission ultimately proposes reducing the rights of secured lenders in
Chapter 11, then it is our organization’s view that anything short of allowing secured lenders the ability to obtain the benefits
provided under their pre-chapter 11 loan agreements in Chapter 11 will have the direct effect of increasing our members’ risk
analysis which will result in increasing the cost of credit and reducing the amount of credit extended to SME borrowers who seek
relief under Chapter 11.”), available at Commission website, supra note 55.
793 For a thoughtful analysis of “option” value in chapter 11 cases, see Casey, supra note 785 (explaining value distortions created
by the creditors’ bargain and strict adherence to the absolute priority rule, and proposing a creditors’ call option to address
such valuation distortions). See also Douglas G. Baird & Donald S. Bernstein, Absolute Priority, Valuation Uncertainty, and the
Reorganization Bargain, 115 Yale L.J. 1930, 1936 (2006) (“The presence of valuation uncertainty can, by itself, give option value to
the claims of junior creditors even when they are, in expectation, out of the money.”) It should be noted that Professor Casey talks
about preserving secured creditors’ nonbankruptcy foreclosure value. See Casey, supra note 785, at 789 (“The creditors’-bargain
model requires a distributional rule that — while respecting nonbankruptcy contract rights — maximizes the aggregate pool of
assets in bankruptcy. This means protecting the secured creditor’s right to nonbankruptcy foreclosure value and the unsecured
creditor’s call option, while allocating bankruptcy rights in a way that creates the optimal incentives for the creditors. The
proposed Option-Preservation Priority does precisely that.”). The Commissioners debated the “foreclosure” vs. “reorganization”
value issue at length and the Commission determined that, as part of the overall compromise reached in the principles, if a plan
is confirmed or a sale is approved, secured creditors should be permitted to receive the reorganization value of their collateral,
which could be greater than the nonbankruptcy foreclosure value.
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ABI Commission to Study the Reform of Chapter
senior class of creditors, even if the senior class is not paid in full within the meaning of the absolute
priority rule, if the plan’s deviation from the absolute priority rule treatment of the senior class is
solely for the distribution to an immediately junior class of the redemption option value, if any,
attributable to such class. Notwithstanding the foregoing, however, if a chapter 11 plan is rejected by
the immediately junior class and such class challenges the reorganization value used to determine
such class’s entitlement to redemption option value under such plan, the plan should be confirmed
over the non-acceptance of such immediately junior class if (i) the court finds, based on the evidence
presented at the confirmation hearing, that such reorganization value was not proposed in bad faith,
and (ii) the plan satisfies, with respect to such immediately junior class, the requirements of section
1129(b) other than the requirement that reorganization option value be provided to such class.
Similarly, section 363 should be amended to provide that, in the context of a section 363x sale, if
the members of an immediately junior class do not object to the sale, the immediately junior class
should be entitled to receive from the reorganization value attributable to such sale not less than
the redemption option value, if any, attributable to such immediately junior class. If, however, the
immediately junior class objects to the sale, they will not be entitled to such redemption option
value.
The Commission agreed that the principles governing redemption option value in chapter 11 cases
should not apply to cases involving small and medium-sized enterprises. The Commission believed
that further study and development of the principles would be needed to determine whether they
16
could be applied in a cost-effective and meaningful manner in such cases. 1, 20Commission proposed
The
ber 2
m
separate principles governing confirmation of chapter 11 plans Nove
n in small and medium-sized enterprise
ed o
iv
arch
cases, in Section VII, Proposed Recommendations:3Small and Medium-Sized Enterprise (SME) Cases.
536
-3
o. 14
n, N
row
In developing these principles, Bthe Commissioners discussed, debated, and refined several key
th v.
lixse
in B
concepts necessarydto determine whether distributions to stakeholders should be adjusted due to
cite
the possibility of changes of the value of the firm within a reasonable period of time after the plan
effective date or section 363x sale order date, as the case may be. The Commission concluded that
the redemption option value attributable to the immediately junior class should be the value of a
hypothetical option to purchase the entire firm with an exercise price equal to the redemption price
and a duration equal to the redemption period. Notably, value distributed to the immediately junior
class under these principles need not be, and in most cases likely would not be, in the form of an
actual option. The requirement is that the requisite value be distributed to the immediately junior
class, regardless of form.
Although a relatively straightforward concept in a simple capital structure (see example below),
the Commissioners recognized the potential complexities of applying these principles in more
involved corporate and financing structures. Accordingly, the Commissioners strived to identify
principles that define the basic parameters of junior creditors’ rights, with the expectation that there
would be further development of the appropriate mechanisms for applying the principles in more
complex cases. Indeed, the principles set forth above are not intended to alter the order of creditor
priorities or to affect allocations within a particular class of creditors; rather, the principles speak
generally to how courts should determine whether the value of the debtor or its assets is sufficient
to support a distribution to the immediately junior class. The Commissioners acknowledged that, in
implementing the redemption option value concept, the mechanism invoked by the parties and the
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Bankruptcy Institute
courts will likely require further development to determine whether and how it should be applied
in more complex contexts, for example where a senior class is entitled to less than all of the firm’s
enterprise value (for example where it is secured by only some of the assets of the firm), where
contractual or structural subordination (rather than a lien) results in an immediately junior class,
where there are multiple classes senior to the immediately junior class and not all senior classes are
receiving distributions in the form of interests in the residual value of the firm, where only part of
the immediately junior class objects to a sale or challenges reorganization value under a plan, or
where some enterprise value is distributable at the current enterprise valuation to an immediately
junior class, but the junior class is not being paid in full.
In their discussions of redemption option value, the Commissioners methodically examined various
formulas and procedures for addressing the potential deficiencies in chapter 11 valuations based on
the timing of the effective date of the plan or the date of the section 363x sale order. For example, in a
simple capital structure, the Commissioners considered the following factors and steps appropriate,
and they are set forth here solely for purposes of illustration:
First, the Commissioners analyzed the problem at hand — e.g., timing can cause the
value realization event to allocate value among creditors at a historically low valuation.
The Commissioners examined the economic and financial literature and determined
that most economic cycles, industry events, operational issues, etc. resolve themselves
6
in approximately three to five years. Recognizing the need for eparties 1to have certainty
1, 20
b r2
em
as soon as possible in the distribution context and despitevstrong arguments from some
n No
ed o
rch decided to recommend using, as the
Commissioners for five years, the Commission iv
63 a
-353
expiration date of the exercisen, No. 14 for the hypothetical redemption option, a date
period
row
v. Bpetition date. Based on several factors, including the factors
that is three years fromhthe
et
Blixs
discussed abovein the average duration of chapter 11 cases as shown in the chart below,
ed and
cit
the Commission found that determining redemption option value based on a hypothetical
option expiring at the end of such a three year period (the redemption period) should be
sufficient to redress the potential unfairness of permanently crystalizing the value of the
firm as of a single plan confirmation date or sale date.794
794 Mr. Shrestha prepared this chart for the Commission based on data from the New Generation’s Public and Major Private
Companies Database. Accordingly, it was limited to public and large private companies. The duration above is from the petition
date to the date of the confirmation order. In recent years, the mean and median durations for chapter 11 reorganizations (from
petition date to confirmation) are respectively: 2009 (342, 275); 2010 (269, 206); 2011 (360, 338); 2012 (281, 274); 2013 (116,
108). See generally supra note 65 and accompanying text (generally discussing limitation of chapter 11 empirical studies).
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
Nu ber of Days Before on r ation
Year Bankruptcy Petition Filed
DURATION BETWEEN BANKRUPTCY FILING AND CONFIRMATION ORDER
016
,2
Second, the Commissioners evaluated different ways to calculate the redemption option
er 21
emb
Nov
value — i.e., the potential value allocation to theoimmediately junior class at the time of
d n
chive
the value realization event. After much 3 ar
debate, including discussion of concerns of some
3536
. 14Nooption valuation methodology was not a good fit for the
of the Commissioners thatn,an
Brow
th v
redemption concept,. the Commission concluded that using a market-based method
lixse
in B
c the
such asited Black-Scholes model purely as a working formula would likely be the best
way to consistently and accurately determine the value of the hypothetical redemption
option. Traditionally, a Black-Scholes model uses four factors to value an option: the
strike price of an option, the term of the option, volatility, and the risk-free rate. In the
context of calculating any redemption option value, (i) the strike price is 100 percent of
the redemption price described above (i.e., senior class or classes must be repaid in full
before any redemption option value exists), (ii) the term of the option would expire three
years from the petition date (i.e., the redemption period); (iii) volatility could vary but can
be determined for a particular debtor by looking at the historical volatility of comparable
companies, using an agreed upon volatility rate, or using a set metric like the average 60
day forward volatility of the S&P 500 Index for the past four years (i.e., approximately 15%
at the time of this Report); and (iv) the risk-free rate generally is based on the U.S. Treasury
rate.795
Third, the Commissioners tested the rule using the agreed upon calculation formula under
a variety of scenarios. For example, if the senior class is entitled to the entire value of
the firm and is determined to be receiving 50 percent of the principal amount of their
795 The Black-Scholes formula or similar methodologies could identify the redemption option value once these four factors are
identified and the percentage recovery of the secured creditors based on the reorganization value of the firm is determined as of
the plan confirmation or section 363x sale order date. The Binomial Options Pricing Model, Monte Carlo options models, and
other formulas may have to be considered where Black-Scholes is not effective to value an option on a particular enterprise.
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
claims (before giving effect to bifurcation of the their secured claims, if any, pursuant
to section 506(a)) based on the reorganization value of the firm on a plan confirmation
date as specified in the plan, and the confirmation date occurs one year after the petition
date, the redemption option value likely holds no value for the immediately junior class
under reasonable assumptions. Specifically, this result occurs with a 50 percent recovery
to the senior class; a “strike” price (the redemption price) of 100 percent (payment in full
to the senior class); a redemption period of two years (confirmation date one year after
the petition date); a volatility rate of 15 percent; and a risk-free rate of 2.23 percent. If
you change the percentage recovery of the senior class to 90 percent, meaning that the
reorganization value of the firm is sufficient to repay the senior creditors 90 percent of the
principal amount of their claims (before giving effect to bifurcation of the their secured
claims, if any, pursuant to section 506(a)), the redemption option value (under the previous
assumptions) is approximately 5 percent of the reorganization value, which would be
distributed to the immediately junior class. Specifically, this result occurs with a 90 percent
recovery to the senior class; a “strike” price (the redemption price) of 100 percent (payment
in full to the senior class); a redemption period of two years (confirmation date one year
after the petition date); a volatility rate of 15 percent; and a risk-free rate of 2.23 percent.
The following chart depicts these results:
REDEMPTION VALUE CALCULATION BASED ON S&P 500 OPTION FORMULA
16
1, 20
ber 2
Additional Assumptions
vem
n No
Risk-Free Rate:
2.23%
ed o
rchiv
Term (years):
2 years remaining
63 a
-353
. 14
Strike Price:
100% Recovery
, No
rown
B
h v.
xset
Volatility
n Bli
i
cited
Recovery %
on
Senior Debt
90.00
80.00
70.00
60.00
50.00
12.0%
3.84
1.11
0.18
0.01
0.00
15.0%
5.32
2.06
0.54
0.08
0.00
18.0%
6.83
3.15
1.10
0.25
0.03
Redemption Option Value
as a % of
Reorganization Value
Notes
The above option pricing uses Black-Scholes to determine value based on assumptions noted.
Midpoint volatility assumption of 15% is based on 60D historical volatility for S&P 500 from July 2010 to present.
Risk-Free Rate is based on US Treasury (2 Year) average yield from July 2000 to present.
Bottom-line implications of the redemption option value rule: Where the senior class’s
distributions on the plan confirmation or sale order date are close to the full principal
amount of their claims (before giving effect to bifurcation of the their secured claims, if
any, pursuant to section 506(a)), the immediately junior class is likely to be entitled to some
redemption option value. On the other hand, where the senior class is deeply impaired and
its distributions on the plan confirmation or sale order date are low in comparison to the
full amount of the senior class’s claims, the immediately junior class is likely to be entitled
to receive little or nothing. Likewise, the time remaining on the redemption period (i.e.,
three years from the petition date) could affect the redemption option value, with a longer
period working in favor of some redemption option value (but not necessarily in all cases, as
VI. Proposed Recommendations: Exiting the Case
Case: 14-35363, 11/28/2016, ID: 10211115, DktEntry: 37-2, Page 229 of 402
ABI Commission to Study the Reform of Chapter
again the initial percentage recovery for the senior class greatly influences the calculation).
Volatility and the risk-free rate can also impact the calculation, but likely less so than the
other two factors in the redemption option value context. Moreover, as indicated in the
principles, the class entitled to receive the redemption option value generally will be the
class immediately junior to the fulcrum security class, assuming that the fulcrum security
class is the principal beneficiary of the residual value of the firm under the plan.
Note: Redemption option value only exists if the senior class would receive the full face
amount of the claims of the senior class, including any unsecured deficiency claim, plus
any interest at the non-default contract rate plus allowable fees and expenses unpaid by the
debtor, in each case accruing through the hypothetical date of exercise of the redemption
option, as though the claims remained outstanding on the date of the exercise of the option
(i.e., the redemption price). If any redemption option value exists under the foregoing
calculation as of the plan effective date or section 363x sale order date, it could be paid
pursuant to the plan or section 363x sale order in the form of cash, debt, stock, warrants,
or other consideration, provided that any non-cash consideration would be valued on a
basis consistent with the manner in which reorganization value was determined. The form
of consideration used to provide redemption option value to the immediately junior class
should be subject to the election of the senior class being required to give up such value,
regardless of whether such senior class has accepted the plan. If no redemption option
value exists on that date (or such class is not otherwise entitled1to 016
, 2 receive any redemption
er 2
emb
option value under these principles), nothing furtherNov
is required and no value is distributed
d on
to such junior creditors in the case.
chive
3 ar
536
14-3
No.
As explained above, the Commission, recommended the addition of the redemption option value
wn
. Bro
eth v
rule to the general priority scheme of the Bankruptcy Code as a minimum entitlement for the
ixs
in Bl
cited
immediately junior class based on the reorganization value of the firm as of the plan effective date or
section 363x sale order date. The Commissioners believed that adding the redemption option value
rule would appropriately balance the competing issues at stake in the context of value realization
events in a case while respecting the value of the senior creditors’ interest in the debtor’s property.796
As suggested by the principles, the redemption option value rule would apply in both the chapter
11 plan and section 363x sale process.797 The Commissioners discussed the potential challenges to
796 Tabb, The Bankruptcy Clause, the Fifth Amendment, and the Limited Rights of Secured Creditors in Bankruptcy, supra note 115,
at *5 (“Outside of bankruptcy, the secured lender may have considerable difficulty capturing anything above liquidation value.
If the bankruptcy process itself allows the recovery of more value, why should all of that bankruptcy-enabled excess go to the
secured lender.”).
797 For a thoughtful discussion of potential value distortion in chapter 11 sales, see Jacoby & Janger, supra note 283, at 894–95 (“This
going-concern premium is a product of the federal bankruptcy regime. Sometimes, the going-concern premium can only be
obtained by acting quickly. Thus, a Bankruptcy Code created speed premium exists (as part of the going-concern premium)
when a quick sale is necessary to preserve value. While both premia are worth preserving, we are concerned that parties not be
able to exploit the perceived need for speed to distort the Code’s distributional scheme.”). In addition, Professor Casey explains
such potential value distortion as follows:
Indeed, a recent study by Kenneth Ayotte and Edward Morrison shows that the outcomes of these sales are distorted
by conflict between junior and senior creditors. This conflict stems from the mismatched incentives of the different
classes of creditors. On the one hand, senior creditors have an incentive to sell the company in a quick sale even when
reorganization has a higher expected return for the estate. Thus, when senior creditors are exercising control — which
they do in most cases — the result is an inefficient fire sale of the debtor’s assets. On the other hand, junior creditors
have an incentive to block the quick sale in favor of a drawn-out reorganization even when the sale has the higher
expected return for the estate. Thus, in cases where the junior creditors can obtain some control — usually by prevailing
on procedural objections — there may be a distortion in favor of an inefficient and prolonged reorganization.
Casey, supra note 785, at 761–62 (citations omitted).
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
applying the redemption option value rule in a section 363x sale process, particularly where the
purchaser is a third party and not the senior class. In those situations, the redemption option value
can still be calculated based on the net purchase price and parties can determine what, if anything,
must be allocated to the immediately junior class. Some of the Commissioners were concerned,
however, about paying the redemption option value when the senior class was not getting the future
value of the firm per se. Other Commissioners noted that the senior class in these situations typically
receives distributions and the benefits of the section 363x sale on a quicker timeline; from that
perspective, the decision to sell forecloses the plan of reorganization alternative and the future value
distributions that would flow from the reorganization. The Commission agreed that the estate —
and not the third party purchaser — should be responsible for paying any redemption option value
to the immediately junior class. (Of course, any such value paid from the estate will reduce the
value available for the senior class.) They also recognized that excluding section 363x sales to third
parties from the redemption option value rule could encourage gamesmanship and alternative deal
structures that avoid the rule but effectively transfer the assets or their future value to the senior class.
Likewise, excluding all section 363x sales could discourage reorganizations without addressing the
important issues surrounding the timing of value realization events and value allocation in chapter
11 cases discussed above.798
On balance, the Commission voted to apply the redemption option value rule to plans and all section
363x sales (except in small and medium-sized enterprise cases), recognizing that in both the plan
16
1, 20
and the sale contexts, this default rule will likely encourage consensual resolutions that benefit all.
ber 2
m
The Commission also acknowledged that the redemption option Nove principles set forth in this
n value
ed o
rc iv
Report are essentially guidelines for courts and parties ato huse in developing such value allocation
63
-353
14
principles for more nuanced and complex ,capital structures than those vetted by the Commission.
No.
rown
The Commission found greatlixseth v. B utility to the redemption value option, and it encourages the
potential
B
ed in
restructuring community and commentators to build upon this concept to more completely develop
cit
fair allocation rules in chapter 11 cases.
2. New Value Corollary
Recommended Principles:
A prepetition interest-holder, including an insider, should be permitted to retain
or purchase an interest in the reorganized debtor without violating the absolute
priority rule of section 1129(b)(2)(B)(ii) or section 1129(b)(2)(C)(ii) of the
Bankruptcy Code, if applicable, provided that such interest-holder contributes
new money or money’s worth to the debtor’s reorganization efforts in an aggregate
amount that is reasonably proportionate to the interest retained or purchased and
that is subject to a reasonable market test.
798 The Commissioners discussed similar considerations in determining that a secured creditors’ section 1111(b) election should
not be operative under the redemption option value rule.
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
New Value Corollary: Background
As described in the preceding section, the absolute priority rule requires that senior classes of claims
or interests be paid in full prior to junior classes receiving any distributions under the chapter 11 plan.
Consequently, prepetition equity security holders generally cannot retain or receive new equity in
the reorganized debtor unless all creditors are paid in full under the plan. This general rule predates
the Bankruptcy Code and finds its origins in the equity receiverships of the early 1900s. As the U.S.
Supreme Court explained in Boyd, “creditors [are] entitled to be paid before the stockholders could
retain [equity] for any purpose whatever.”799
One question that arises in the context of prepetition equity security holders and the absolute priority
rule is whether prepetition equity security holders can purchase equity from, or contribute new
value to retain equity in, the reorganized debtor. This potential exception to the absolute priority
rule is commonly called the new value exception or corollary.800 The Supreme Court provided
some guidance on the new value corollary in Bank of America National Trust and Savings Assn. v.
203 North LaSalle Street Partnership.801 In 203 North LaSalle, the Supreme Court held: “A debtor’s
pre-Bankruptcy equity security holders may not, over the objection of a senior class of impaired
creditors, contribute new capital and receive ownership interests in the reorganized entity, when
that opportunity is given exclusively to the old equity security holders under a plan adopted without
consideration of alternatives.”802 Although the Supreme Court acknowledged that the new value
16
corollary might exist under some circumstances,803 it did not resolve the, issue. Lower courts have
1 20
ber 2
ve
adopted different approaches to assessing this potential exception. m
n No
o
ived
arch
5363
Courts and commentators generally have.interpreted 203 North LaSalle as requiring a “market test”
14-3
No
n,
before a court confirms a chapter w plan in which prepetition equity security holders retain or
. Bro 11
eth v
s
receive equity in ithe in Blix
reorganized entity in violation of the absolute priority rule.804 Courts do not,
c ted
however, necessarily agree regarding the parameters of this market test or the minimum process
required to satisfy the 203 North LaSalle standard. In fact, some courts appear to limit the potential
market tests to the two examples identified by the Supreme Court in 203 North LaSalle — i.e., a
competing chapter 11 plan or competitive bidding.805
799 N. Pac. Ry. Co. v. Boyd, 228 U.S. 482 (1913).
800 Courts consider several factors in assessing the new value corollary and generally require that the purported new value be
(i) new, (ii) substantial, (iii) in money or money’s worth, (iv) necessary for a successful reorganization, and (v) reasonably
equivalent to the value of the stock being retained or received. See, e.g., Bonner Mall P’ship v. U.S. Bancorp Mort. Co. (In re
Bonner Mall P’ship), 2 F.3d 899, 908 (9th Cir. 1993), cert. granted sub nom. U.S. Bancorp Mortg. Co. v. Bonner Mall P’ship, 510
U.S. 1039 (1994), motion to vacate denied and case dismissed, 513 U.S. 18 (1994).
801 Bank of Am. Nat’l Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434 (1999).
802 Id.
803 See id. (“The upshot is that this history does nothing to disparage the possibility apparent in the statutory text, that the absolute
priority rule now on the books as subsection (b)(2)(B)(ii) may carry a new value corollary.”). See also Nicholas L. Georgakopoulos,
New Value After LaSalle, 20 Bankr. Dev. J. 1, 2 (2003) (observing that the Supreme Court affirmed the new value corollary in
LaSalle).
804 See, e.g., In re Castleton Plaza, LP, 707 F.3d 821 (7th Cir. 2013) (rejecting new value plan because lack of market competition
prevented court from being able to test purported new value in exchange for grant of 100 percent of reorganized equity to insider
in violation of absolute priority rule). See also Robert J. Keach, LaSalle, The “Market Test” and Competing Plans: Still in the Fog,
Am. Bankr. Inst. J., Dec. 2002, at 18 (2002).
805 See Bank of Am. Nat’l Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 458 (1999) (“Whether a market test would
require an opportunity to offer competing plans or would be satisfied by a right to bid for the same interest sought by old equity
is a question we do not decide here.”). See also In re Situation Mgmt. Sys., 252 B.R. 859, 861, 865 (Bankr. D. Mass. 2000) (rejecting
new value plan “was not confirmable in the absence of competitive bidding for the equity interests to determine the adequacy of
the new value contribution”).
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New Value Corollary: Recommendations and Findings
The Commissioners discussed the new value corollary and its potential role in facilitating plans of
reorganization. Several Commissioners commented on the need to provide some mechanism to
allow prepetition equity security holders to retain or receive equity in the reorganized debtor. They
noted that this issue was particularly relevant in cases where prepetition equity security holders
included founders or other individuals whose continued association with the business was critical
or valuable to the reorganized debtor. In this regard, these Commissioners believed that authorizing
the new value corollary furthered the underlying reorganization goals of chapter 11.
The Commissioners also discussed instances in which prepetition equity security holders were
the only, or most viable source, of funding for the chapter 11 plan. Some of the Commissioners
observed that, in such cases, the requirements of the new value corollary, including the market test
component, should be easily satisfied. Other Commissioners noted, however, that the uncertainty
surrounding the application of the new value corollary can make this an expensive and, in some
cases, impracticable process. The Commission reviewed the testimony it received on the new value
corollary and the impediment it can pose to plan confirmation.806
The Commission determined that chapter 11 reorganizations would benefit from further clarity on
the new value corollary. It agreed that codifying the new value corollary as an expressed exception
16
to the absolute priority rule and identifying the key elements of the exception2would enhance the
1, 0
ber 2
confirmation process in many cases. Accordingly, the Commission ovem
recommended a statutory new
nN
ed o
value corollary that required (i) new money or money’sarchiv (ii) in an amount proportionate to
worth;
63
-353
the equity received or retained by prepetitionoequity security holders; and (iii) that would be subject
. 14
,N
rown
to a “reasonable” market test. Theth v. B
Commission declined to define an appropriate market test; rather,
se
n Bl
it believed that courtsitshouldixmake this determination based on the facts, the evidence presented,
i
c ed
and what would be reasonable in the particular case before the court.
3. Section 506(c) and Charges Against Collateral
Recommended Principles:
The trustee should not be permitted to waive its ability to surcharge collateral, or to
agree not to pursue such a surcharge, to the extent permitted under section 506(c)
of the Bankruptcy Code. The surcharge under section 506(c) should continue to
apply only to collateral securing prepetition debt and should not apply to new
money extended solely on a postpetition basis.
806 See, e.g., Written Statement of Maria Chavez-Ruark: CFRP Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11, at 2 (Nov. 7, 2012) (discussing inconsistencies in the application of the new value corollary). “The corollary makes sense from
a policy standpoint. The underlying policy for a reorganization is rehabilitation of the business, as failed businesses lead to a loss
of jobs and loss of capital, both manifestations of economic inefficiency. The new value corollary recognizes that equity holders
who inject new capital into a restructured business are not gaining a position ahead of creditors because of their old equity
position. Instead, they are taking a concrete step to restore the business to solvency by paying fair value for the reorganized
debtor’s stock.” Id.
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
Section 506(c) and Charges Against Collateral: Background
Two common questions arise in the context of proceeds from property serving as collateral for a
secured creditor: Can those proceeds be used to reimburse the estate for the cost of maintaining
and monetizing the property, and can those proceeds be used to pay general administrative or other
claims against the estate? The Bankruptcy Code addresses the first question, but it does not speak
directly to the second.
Section 506(c) of the Bankruptcy Code provides: “The trustee may recover from property securing
an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing
of, such property to the extent of any benefit to the holder of such claim, including the payment of
all ad valorem property taxes with respect to the property.”807 This section protects the estate, and
it allows the trustee808 to request payment for money expended on, or resources committed to, a
secured creditor’s collateral.809 In addition, the trustee must establish that the expenditures were
“reasonable” and “necessary” and provided a benefit to the secured creditor. The section protects a
secured creditor’s collateral by incentivizing the trustee to preserve that collateral. It also protects the
estate by ensuring that the secured creditor pays for this protection.810
Courts have encountered several issues in applying section 506(c), including the scope of expenses
included within the section and the identity of parties with standing to request payment under the
16
section. Determining the kind of expenses that may be paid from a secured0creditor’s collateral is a
21, 2
berpreservation of the collateral
811
fact-intensive inquiry. Costs directly related to the maintenance m
veand
n No
812
ed oto recover certain costs associated with
typically are covered. In addition, the trustee may rbeiv
ch able
63 a
-353
operating the business if those expenditures in turn benefited the secured creditor.813 Whether the
. 14
, No
own
rfees and expenses, however, is less clear. Courts scrutinize such
trustee can recover its attorneys’
v. B
seth
requests closely andin Blix recovery in only very limited circumstances. The Third Circuit has
permit
cited
explained that a debtor in possession’s attorneys’ fees and expenses “may be charged only against the
surplus of the debtor’s estate.”814
The trustee’s attorneys’ fees and expenses are only one type of administrative claim that may be
incurred pending the sale of a secured creditor’s collateral. As suggested above, whether any particular
administrative claim is within the scope of section 506(c) turns on whether the expenditure was
807 11 U.S.C. § 506(c).
808 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
809 “Any time the trustee expends money to provide for the reasonable and necessary cost and expenses of preserving or disposing
of a secured creditor’s collateral, the trustee is entitled to recover such expenses from the secured party or from the property
securing an allowed secured claim held by such party.” 124 Cong. Rec. H11089 (Sept. 28, 1978), reprinted in 1978 U.S.C.C.A.N.
6436, 6451.
810 See, e.g., Loudoun Leasing Dev. Co. v. Ford Motor Credit Co. (In re K&L Lakeland, Inc.), 128 F.3d 203 (4th Cir. 1997); In re TIC
Memphis RI 13, LLC, 498 B.R. 831 (Bankr. W.D. Tenn. 2013). See also Hartford Underwriters Ins. Co. v. Union Planters Bank,
N.A., 530 U.S. 1 (2000) (explaining that section 506(c) stems from practices under the Bankruptcy Act and “trac[ing] its origin to
early cases establishing an equitable principle that where a court has custody of property, costs of administering and preserving
the property are a dominant charge”) (citations omitted).
811 See 4 Collier on Bankruptcy ¶ 506.05[9] (16th ed. 2014).
812 See id.
813 See In re Flagstaff Foodservice Corp., 739 F.2d 73 (2d Cir. 1984). What costs are “reasonable” and “necessary” in the operation
of the business again is a fact-specific inquiry. For example, in sale-based cases, under section 506(c), a court may entertain
requests for: (i) the costs of plan completion after the sale of the asset (i.e., “burial expenses”); (ii) professional expenses until the
sale date; (iii) the tax consequences of any realized gain from the sale; (iv) payment of section 503(b)(9) claims; (v) break-up fees
or expenses; and (vi) costs of preserving the going concern of a portion of a business that is sold.
814 In re Towne, Inc., 536 Fed. App’x 265 (3d Cir. 2013).
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
reasonable and necessary to preserve or monetize the collateral, and whether it provided some
benefit to the secured creditor as a result. The statute clearly allows the trustee to assert a claim
under section 506(c) for such expenses, and most courts have held that administrative claimants
themselves lack standing to assert such claims.815 In Hartford Underwriters (In re Hen House),
the U.S. Supreme Court specifically held that section 506(c) “does not provide an administrative
claimant an independent right to use the section to seek payment of its claim.”816 The Court declined
to address, however, whether administrative claimants could assert such claims derivatively through
the trustee.817 Lower courts are split on this standing issue.818
The payment of general administrative claims and other types of claims not related to the preservation
or monetization of the secured creditor’s collateral is not addressed by section 506(c).819 As discussed
above, the language of section 506(c) links the use of collateral proceeds to costs associated in some
way with that collateral, and courts generally construe the statute narrowly. The statute thus does
not cover “carve-outs” from a secured creditor’s collateral to pay other administrative claims or
unsecured claims. “As generally used, a carve out is an agreement between a secured lender, on the
one hand, and the trustee . . . on the other, providing that a portion of the secured creditor’s collateral
may be used to pay administrative expenses.”820
A secured creditor can agree with the trustee to allow certain costs and claims to be paid from the
proceeds of the secured creditor’s collateral. Such carve-outs are common in debtor in possession
6
financing facilities and are subject to approval by the court. The trustee er 21, request authority to
may 201
b
vem
pay administrative claims and other claims from a secured creditor’socollateral, but absent satisfying
nN
ed o
hiv
the elements of section 506(c) or obtaining the securedrccreditor’s consent, courts generally deny
63 a
-353
14
requests for these types of surcharges.821 In,practice, debtor in possession financing facilities suggest
No.
rown
B
that secured creditors may consent .to limited carve-outs in exchange for an ex ante waiver of the
hv
xset
n Bli surcharge the collateral under section 506(c).822
i
debtor in possession’s iright to
c ted
Section 506(c) and Charges Against Collateral:
Recommendations and Findings
The scope of section 506(c) and a trustee’s ability to surcharge property has gained importance as
debtors file chapter 11 cases with fewer unencumbered assets or little free cash flow to facilitate
the reorganization. Any funds expended by the trustee on account of a secured creditor’s collateral
arguably deplete the funds available to rehabilitate the debtor or pay general administrative claims.
815
816
817
818
819
820
821
822
11 U.S.C. § 506(c).
Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000).
Id.
Standing to bring a section 506(c) claim was addressed in In re Ramo Practice Mgmt., Inc., 2005 WL 6483309, at *1 (Bankr. S.D.
Cal. June 17, 2005), where the court declined to grant the debtor’s attorney a section 506(c) claim for services rendered that
fell within the “normal scope of services” and the trustee explicitly agreed with the court. In contrast, in In re Sak Dev., Inc.,
2008 WL 619378, at *1 (Bankr. E.D.N.C. Feb. 29, 2008), without any analysis of standing, the court granted a section 506(c)
reimbursement claim to a creditor for work performed on a project.
See, e.g., United Jersey Bank v. Miller (In re C.S. Assocs.), 29 F.3d 903, 907 (3d Cir. 1994) (explaining that section 506(c) “was
designed to extract from a particular asset the cost of preserving or disposing of that asset”).
Richard B. Levin, Almost All You Ever Wanted to Know About Carve Out, 76 Am. Bankr. L. J. 445 (2002).
See, e.g., In re Cal. Webbing Indus., Inc., 370 B.R. 480 (Bankr. D.R.I. 2007).
But see In re Tenney Village Co., Inc., 104 B.R. 562, 567 (Bankr. D.N.H. 1989) (“Under the guise of financing a reorganization, the
Bank would disarm the Debtor of all weapons usable against it for the bankruptcy estate’s benefit, place the Debtor in bondage
working for the Bank, seize control of the reins of reorganization and steal a march on other creditors in numerous ways.”).
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ABI Commission to Study the Reform of Chapter
Yet, from the secured creditor’s perspective, the debtor’s retention of the collateral is helping to
facilitate the reorganization and delaying the secured creditor’s ultimate recovery on the collateral.
The Commission considered these competing perspectives and the tension created when estate
resources are devoted to the preservation or disposition of a secured creditor’s collateral, and
administrative claims and unsecured creditors are not being paid.823 The Commissioners discussed
the types of claims typically surcharged against collateral under section 506(c), and the courts’
approach to identifying whether a charge benefited the secured creditor. They also acknowledged
that section 506(c) claims are litigated infrequently because those rights are commonly waived in
connection with postpetition financing facilities or cash collateral agreements. This waiver often
forces the trustee to rely on any consensual carve-outs negotiated in the case, or upon the secured
creditor’s ex post agreement to fund certain claims necessary to facilitate a sale of the collateral.
In light of these experiences, the Commission considered whether section 506(c) should be expanded
to allow a court to charge a secured creditor’s collateral for costs associated with the administration of
the case that may not evidence a direct benefit to the secured creditor or the collateral. For example,
the Commissioners engaged in an in-depth debate concerning costs incurred to wind down an
estate subsequent to a sale of a secured creditor’s collateral. Some of the Commissioners believed
that such “burial costs” could provide a direct benefit to the secured creditor because, without some
assurance that the case can be completed in an orderly fashion, the court should not allow the
16
debtor and the secured creditor to sell the collateral under section 363 ,of0the Bankruptcy Code.
1 2
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Other Commissioners disputed this characterization andon Novem
noted that the secured creditor could
d
chive
have sold the collateral outside of bankruptcy 363 athat often it is the debtor, and not the secured
and r
4-35
. 1this context, the Commissioners discussed the benefits
creditor, electing to invoke chapter 11. In
, No
own
v. Br
of the chapter 11 processxasth
e providing a national foreclosure forum, the avoided costs to using the
Bli s
bankruptcy process, and whether the Bankruptcy Code should, as a matter of policy, permit chapter
ed in
cit
11 to be used for this purpose. The Commissioners agreed that asset and business sales had become
an integral part of the chapter 11 process and considered ways to balance competing claims to the
debtor’s limited resources in this environment.824
The Commission determined that the current scope of section 506(c) was appropriate, and that
the required nexus between the estate’s expenditures and the secured creditor’s collateral was an
appropriate gating feature of this provision.825 The Commissioners were comfortable with courts’
interpretations and applications of the “reasonable” and “necessary” standards, as well as the
circumstances in which secured creditors benefit from the expenditures. The Commissioners noted
that in certain instances, burial costs and other costs associated with the operation of the business or
the winding down of the case, may satisfy the section 506(c) elements, but that those determinations
should be made by the courts on a case-by-case basis.
823 Barry E. Adler, Priority in Going-Concern Surplus, 2015 Ill. L. Rev. __ (forthcoming 2015) (discussing the potential difficulties of
the proposed surcharge of the debtor’s estate to reallocate a debtor’s going-concern surplus instead of allowing it all to go to the
secured creditor) (draft on file with Commission).
824 For a discussion of the payment of these costs in the sale context, see Section V.B.1, General Provisions for Non-Ordinary Course
Transactions and Section VI.B, Approval of Section 363x Sales.
825 See, e.g., First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at
Commercial Fin. Ass’n Annual Meeting, at 4-5 (Nov. 15, 2012) (explaining that while “prepetition lending expectations should
be preserved . . . the secured creditor should also be required to bear the reasonable costs and expenses incurred in connection
with the preservation and disposition of the collateral (a concept presently addressed by §506(c) of the Code)”), available at
Commission website, supra note 55.
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The Commissioners observed that the utility of section 506(c) in this context turns in part on the
trustee being able to assert, and the court being able to assess, claims for reimbursement of expenses
under that section. If the trustee has waived its right to assert claims under section 506(c), the court
does not have the opportunity to consider the appropriate allocation of expenses between the estate
and the secured creditor.
The Commission considered whether this type of waiver should be permissible.826 Although the
Commissioners recognized that even if section 506(c) claims are waived, the trustee may have
negotiated a carve-out, and they did not believe that consensual carve-outs always represent a good
alternative for the estate. The trustee typically has little bargaining leverage in negotiating the carveout, and these provisions are limited in amount and can be limited in scope to only those items
approved by the secured creditor. The Commissioners also expressed concerns regarding a waiver
that impacts not just the trustee, but also other stakeholders who are beneficiaries of the estate.
On balance, the Commission determined that although section 506(c) should continue in its current
form, the Bankruptcy Code should be amended to prohibit any waivers of, or stipulations regarding,
a trustee’s rights under section 506(c). The trustee’s ability to invoke, and the court’s authority to
review, claims brought under section 506(c) should be preserved for the benefit of the entire estate.
The Commissioners also believed that consensual carve-outs should still be permissible, but not to
the exclusion of section 506(c) claims.
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4. Section 552(b) and Equities of the Case
The trustee should not be able to waive, or to enter into any agreement affecting,
a court’s ability to limit or alter a secured creditor’s interest in the debtor’s or the
estate’s property based on the equities of the case under section 552(b) of the
Bankruptcy Code.
A trustee should not be required to establish an actual expenditure of funds to show
that the estate enhanced the value of a secured creditor’s collateral for purposes
of the equities of the case determination under section 552(b). Rather, the trustee
should be able to make such a showing with evidence of any value provided,
obligation incurred, or other actions taken with respect to the collateral. With
this clarification, the court should continue to determine the scope and meaning
of the term “equities of the case” based on the facts of, and evidence presented in,
the particular case.
The Commission considered and declined to adopt a federal definition of the term
“proceeds” for purposes of chapter 11 cases.
826 If approved in connection with postpetition financing, courts generally enforce the waivers. See, e.g., Weinstein, Eisen & Weiss
v. Gill (In re Cooper Commons LLC), 512 F.3d 533, 535–36 (9th Cir. 2008) (denying section 506(c) claim by debtor’s former
counsel, who represented the debtor in negotiating postpetition financing agreement including the waiver, based on res judicata).
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
Section 552(b) and Equities of the Case: Background
Section 552 of the Bankruptcy Code addresses the postpetition effect of prepetition liens on the
debtor’s property.827 Section 552(a) establishes the general rule that the bankruptcy filing cuts off
a creditor’s rights under any after-acquired property clause in a prepetition security agreement
with the debtor.828 Section 552(b) sets forth two exceptions to this general rule, one dealing with
proceeds of prepetition collateral,829 and the other dealing with rents and similar payments relating
to prepetition collateral.830 The exceptions basically allow the secured creditor’s prepetition lien to
continue in postpetition proceeds of, or postpetition rents relating to, prepetition collateral. Each
exception in turn is subject to an exception: the court, after notice and a hearing, may treat the
secured creditor’s prepetition lien differently “based on the equities of the case.” The language
of section 552(b) represents a compromise between the House and Senate versions of the 1978
bankruptcy bill: The final version allowed prepetition liens to continue in postpetition proceeds, but
cabined such liens when necessary to protect the estate based on the equities of the case.831
The equities of the case exception allows a court to limit, alter, or terminate the extension of a secured
creditor’s prepetition lien to postpetition property of the estate. Although the Bankruptcy Code does
not define “equities of the case,” the legislative history suggests that the exception was intended to
compensate the estate for use of unencumbered property or expenditures that enhanced the value
of the secured creditor’s lien and to protect the rehabilitative purposes of the Bankruptcy Code.
16
For example, the legislative history provides: “[T]he ‘equities of the case’ ,provision . . . is designed,
1 20
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among other things, to prevent windfalls for secured creditors andem give the courts broad discretion
Nov to
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to balance the protection of secured creditors, on thehone hand, against the strong public policies
ar
5363
favoring continuation of jobs, preservation 4-3going concern values and rehabilitation of distressed
. 1 of
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debtors, generally.”832 The Fourth Circuit has explained: “It appears clear from the legislative history
v. Br
eth
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related to § 552 that Congress undertook in that section to find an appropriate balance between the
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rights of secured creditors and the rehabilitative purposes of the Bankruptcy Code.”833
In applying the equities of the case exception, courts generally consider three factors: (i) the amount
of time and estate funds expended on the collateral; (ii) the relative position of the secured party
827 11 U.S.C. § 552.
828 Section 552(a) provides: “Except as provided in subsection (b) of this section, property acquired by the estate or by the debtor
after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor
before the commencement of the case.” 11 U.S.C. § 552(a).
829 Section 552(b)(1) provides:
Except as provided in sections 363, 506(c), 522, 544, 545, 547, and 548 of this title, if the debtor and an entity entered
into a security agreement before the commencement of the case and if the security interest created by such security
agreement extends to property of the debtor acquired before the commencement of the case and to proceeds, products,
offspring, or profits of such property, then such security interest extends to such proceeds, products, offspring, or
profits acquired by the estate after the commencement of the case to the extent provided by such security agreement
and by applicable nonbankruptcy law, except to any extent that the court, after notice and a hearing and based on the
equities of the case, orders otherwise.
11 U.S.C. § 552(b)(1).
830 11 U.S.C. § 552(b)(2). The language of section 552(b)(2) is similar to that of section 552(b)(1) except that it applies “to amounts
paid as rents of such property or the fees, charges, accounts, or other payments for the use or occupancy of rooms and other
public facilities in hotels, motels, or other lodging properties.” Id.
831 Section 552(b) represents a compromise between the House bill and the Senate amendment. Proceeds clauses, but not afteracquired property clauses, are enforceable under the Bankruptcy Code. The provision allows the court to consider the equities
of the case. In the course of such consideration, the court may evaluate any expenditures by the estate relating to proceeds and
any related improvement in the secured party’s position.
832 140 Cong. Rec. H. 10,768 (Oct. 4, 1994).
833 United Va. Bank v. Slab Fork Coal Co. (In re Slab Fork Coal Co.), 784 F.2d 1188, 1191 (4th Cir. 1986), cert. denied, 477 U.S. 905
(1986).
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following the expenditure of estate time and money (i.e., whether the collateral has been enhanced);
and (iii) the rehabilitative nature of the bankruptcy case.834 Neither the language of the statute nor
the legislative history requires the estate to have devoted money or unencumbered assets to the
improvement of the secured creditor’s position, but some courts have applied the equities of the
case exception in this manner. For example, in Laurel Hill, the court held that when a postpetition
financing facility was repaid from proceeds that were subject to the security interests of various
secured claimants whose liens had been transferred to the sale proceeds, the payments were not
at the expense of the estate and thus did not support an equities of the case award to the unsecured
creditors.835 Nevertheless, in Residential Capital, the court invoked the equities of the case exception
under section 552(b)(1) to cut off the secured creditor’s lien in postpetition goodwill when “time,
effort, and expense by the Debtors’ estates” enhanced the value of the assets sold in the case.836
Similar to section 506(c), the trustee837 often waives its right to assert the equities of the case exception
under section 552(b), or stipulates that no such equities exist, in connection with postpetition
financing or the use of cash collateral.838 Perhaps because of these waivers, relatively little case law
exists on section 552(b).
Section 552(b) and Equities of the Case: Recommendations and Findings
Section 552 represents a basic compromise: Prepetition secured creditors can maintain their interests
16
1 20
in the debtor’s prepetition property, including proceeds, but the trustee caneuse ,property acquired by
b r2
em
the estate unencumbered by any prepetition liens. This balance on Nov the trustee with resources
provides
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to help facilitate the debtor’s reorganization. Nevertheless, to the extent the trustee expends any of
63 a
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these or other estate resources in a manner, that enhances the value of a secured creditor’s collateral,
rown
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section 552(b) permits the court ttovassess the equities of allowing the secured creditor to retain that
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enhancement.
The Commissioners observed the relationship between sections 506(c) and 552(b) of the Bankruptcy
Code in that both seek to give the secured creditor the value of its allowed secured claim while
preventing the secured creditor from receiving any windfalls in the case. These sections are also
tied in certain respects to the valuation of a secured creditor’s collateral for purposes of adequate
protection requests and ultimate distributions in the case. Accordingly, the Commission considered
the appropriate scope and use of section 552(b) in the context of the recommended principles
relating to section 506(c), foreclosure value, and reorganization value.839
834 See In re Laurel Hill Paper Co., 393 B.R. 89, 93 (Bankr. M.D.N.C. 2008).
835 Id.
836 See Official Comm. of Unsecured Creditors v. UMB Bank, N.A. (In re Residential Capital, LLC), 501 B.R. 549, 612 (Bankr.
S.D.N.Y. 2013).
837 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
838 For example, the court made the following finding in its final order approving postpetition financing in the General Growth
Properties chapter 11 case:
In light of the Lenders’ agreement to subordinate their liens and superpriority claims to the Carve-Out, the Lenders
are entitled to a waiver of (i) the provisions of section 506(c) of the Bankruptcy Code and (ii) any “equities of the case”
claims under section 552(b) of the Bankruptcy Code, in each case, in respect of the DIP Documents.
In re Gen. Growth Props., Inc., 09-11977 (ALG) (May 14, 2009).
839 See Section VI.C.3, Section 506(c) and Charges Against Collateral; Section VI.C.1, Creditors’ Rights to Reorganization Value and
Redemption Option Value.
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
The Commissioners identified several issues in the application of section 552(b), including defining
the scope of the secured creditor’s prepetition collateral package and the broad interpretation of
“proceeds” and related terms under applicable state law. With respect to collateral identification, the
Commission reviewed the Residential Capital decision and its discussion of postpetition goodwill by
the Honorable Martin Glenn of the U.S. Bankruptcy Court of the Southern District of New York.840
In that case, Judge Glenn rejected the prepetition secured creditor’s claim to postpetition goodwill
on several grounds. Specifically, he determined that the prepetition secured creditors failed to show
that their collateral was converted into postpetition goodwill and that, even if the secured creditor’s
collateral “was used to generate goodwill (either by maintaining or improving the value of assets or
by diminishing liabilities), Debtor resources were used as well.”841 Judge Glenn concluded that the
use of the debtor’s resources, at least in part, to transform the collateral into postpetition goodwill
precluded the goodwill from being characterized as proceeds for purposes of section 552(b).
The Commissioners debated the facts and holding in Residential Capital and the potential approaches to
resolving those issues. Some of the Commissioners supported excluding all postpetition goodwill from
a prepetition secured creditor’s collateral package. They reasoned that the value generated postpetition
by the debtor in possession’s efforts and resources, as well as value associated with costs and obligations
avoided through the chapter 11 process, should be available to support the debtor’s reorganization. The
Commissioners discussed the impact of such a bright-line rule regarding goodwill on credit markets
and the challenge of allocating value between prepetition and postpetition goodwill. The Commission
16
agreed that the treatment of goodwill was best determined through a er 21, 20
case-specific inquiry based on
b
m
the facts of the case and the evidence presented at the hearing. Nove
d on
ive
arch
363
35
. 14Similarly, the Commissioners examinedothe scope of the term “proceeds” under state law. Several
n, N
row
of the Commissioners noted v. B significant expansion of the definition of proceeds under state
th the
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in B
law since the enactment of the Bankruptcy Code in 1978. They discussed how these kinds of
cited
amendments arguably allowed state commercial law to restrict the resources available to support a
debtor’s reorganization under chapter 11. They provided examples of parties litigating the scope of
proceeds and reflected on two articles by Professor Ray Warner concerning the continued expansion
of the concept under state law.842 Professor Warner posits that certain amendments to Article 9 of
the Uniform Commercial Code, including the expanded definition of proceeds, “had little or no
nonbankruptcy function, but were designed primarily to alter bankruptcy law outcomes in favor of
secured creditors.”843 Several of the Commissioners supported a federal definition of proceeds that
would scale back the definition to the replacement or substitution of collateral concept originally
assigned to proceeds of collateral. Other Commissioners suggested that a federal definition of
proceeds that conflicted with state law would create uncertainty and increase costs in secured credit
transactions. The Commission ultimately declined to adopt a federal definition of proceeds.
840 Official Comm. of Unsecured Creditors v. UMB Bank, N.A. (In re Residential Capital, LLC), 501 B.R. 549, 612 (Bankr. S.D.N.Y.
2013).
841 Id.
842 See, e.g., G. Ray Warner, Article 9’s Bankrupt Proceeds Rule: Amending Section 552 Through the UCC’s “Proceeds” Definition, 46
Gonzaga L. Rev. 521 (2011); G. Ray Warner, The Anti-Bankruptcy Act: Revised Article 9 and Bankruptcy, 9 Am. Bankr. Inst.
L. Rev. 3, 5–6 (2001). See also Moringiello, When Does Some Federal Interest Require a Different Result?, supra note 280 (“The
Code recognizes the secured creditor’s entitlement to the value of its collateral, and also recognizes that the creditor’s security
interest extends to proceeds of its collateral, even if those proceeds are realized after the debtor has filed for bankruptcy. The 2001
Amendments to Article 9 of the Uniform Commercial Code expanded the definition of proceeds to include ‘rights arising out of
the collateral’ a definition that could so expand the idea of proceeds as to deprive unsecured claimants of any recovery at all.”).
843 Warner, Article 9’s Bankrupt Proceeds Rule, supra note 842, at 521.
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
The Commissioners then considered whether section 552(b) strikes the appropriate balance between
the rights of secured creditors and the estate. The Commissioners generally agreed with the continuation
of a secured creditor’s lien in proceeds subject to the equities of the estate exception, but several of the
Commissioners expressed discomfort with the kinds of expenditures and evidence required for the
trustee to establish the exception. These Commissioners commented that, if the section is concerned
with enhancements of value and promoting rehabilitation, the trustee should be able to satisfy the
equities of the case exception with evidence of the estate contributing value, whether through time,
effort, money, property, other resources, or cost savings. The basic premise should be that, if the estate
creates value through any means during the chapter 11 case and such value enhances the secured
creditor’s collateral, the estate should receive the benefit of such value. The extent of value attributed
to the estate would be determined by the court based on the evidence presented under the equities
of the case exception. The Commission agreed that so long as the evidence establishes the estate’s
expenditures (in whatever form), this clarification to the scope of the equities of the case exception
would be beneficial and aligned with the objectives of the related principles.
Finally, as with section 506(c) and for similar reasons, the Commission voted to recommend that
parties not be permitted to waive the equities of the case exception under section 552(b) or to stipulate
that no equities exist to invoke the exception. The Commission agreed that such determinations should
be made ex post based on the circumstances of the case and the evidence presented by the parties.
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Under section 1129(b)(2)(A), the court should apply an appropriate discount rate
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5. Cramdown Interest Rates
to determine the present value of any deferred cash payments being made to the
secured creditor under the chapter 11 plan on account of the creditor’s allowed
secured claim. The present value of such deferred cash payments should equal at
least the amount of the secured creditor’s allowed secured claim as of the effective
date of the chapter 11 plan.
In selecting the appropriate discount rate, the court should consider the evidence
presented by the parties at the confirmation hearing and, if practicable, use the
cost of capital for similar debt issued to companies comparable to the debtor as
a reorganized entity, taking into account the size and creditworthiness of the
debtor and the nature and condition of the collateral, among other factors. If
such a market rate is not available or the court determines that an efficient market
does not exist, the court should use an appropriate risk-adjusted rate that reflects
the actual risk posed in the case of the reorganized debtor, considering factors
such as the debtor’s industry, projections, leverage, revised capital structure, and
obligations under the plan. The court should not apply the “prime plus” formula
adopted by the Supreme Court in Till v. SCS Credit Corp., 541 U.S. 465 (2004) in
the chapter 11 context.
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ABI Commission to Study the Reform of Chapter
Cramdown Interest Rates: Background
Section 1129(b)(2)(A) sets forth three options for cramming down secured creditors. The plan must
generally (i) permit the secured creditor to retain its lien and provide the secured creditor with
deferred cash payments having a present value equal to the amount of the secured creditor’s allowed
secured claim; (ii) sell the collateral and permit the secured creditor’s lien to attach to the proceeds;
or (iii) provide the secured creditor with the indubitable equivalent of its claim. Although the first
option of lien retention and cash payments is relatively straightforward as a concept, its application
has proven challenging.
The primary issue under the first option is the appropriate discount rate (i.e., interest rate) for
calculating the present value of the deferred cash payments to ensure that the secured creditor
receives total distributions under the plan equal to the allowed amount of its secured claim as of the
effective date of the plan. The objective is to make sure payments received by the secured creditor
in the future represent the value of its secured claim on the effective date (following the general
principle that a dollar received today is more than a dollar received tomorrow). The discount rate
used by the court affects the amount of deferred cash payments required under the plan to satisfy
section 1129(b)(2)(A)(i).
There are several approaches to determining an appropriate discount rate for purposes of section
1129(b)(2)(A)(i), including the “formula” approach (also referred to as the2“prime plus” approach),
016
21,
ber“presumptive contract rate”
the “coerced loan” approach, the cost of funds approach, andem
v the
n No
ed o often based on the circumstances of the
approach. Prior to 2004, courts applied different approaches,
rchiv
63 a
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case before it. Nevertheless, in 2004, the Supreme
14
No.
wn,
roCredit Corp.844 Specifically, the Supreme Court determined that
of a chapter 13 plan in Till v. v. B
h SCS
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for purposes of calculating the present value of deferred cash payments to a secured creditor under
i
cited
a chapter 13 plan, a court should use the risk-free rate of interest at the time of the determination,
adjusted by 100 to 300 basis points to account for the risk of default in the given case, the nature and
quality of the collateral, and the duration and feasibility of the chapter 11 plan.845
In Till, the Supreme Court was faced with a consumer loan used by the chapter 13 debtors to
purchase a truck prior to the petition date. At the time of the plan, the debtors owed approximately
$4,895 to the lender, and the truck was valued at approximately $4,000. A plurality of the Supreme
Court determined that the formula or prime plus approach was simple, cost-effective, and the most
appropriate approach for determining the present value of the proposed deferred cash payments
to the lender under the plan. As observed by the Court, “[u]nlike the other approaches proposed
in this case, the formula approach entails a straightforward, familiar, and objective inquiry, and
minimizes the need for potentially costly additional evidentiary hearings.”846
Although the Supreme Court noted that its decision was limited to the chapter 13 context, and
some dicta in the decision suggest that the analysis may be quite different for chapter 11 cases,847
844
845
846
847
Till v. SCS Credit Corp., 541 U.S. 465 (2004).
Id.
Id.
For example, the Supreme Court notes the following in a footnote:
This fact helps to explain why there is no readily apparent Chapter 13 “cram down market rate of interest”: Because
every cram down loan is imposed by a court over the objection of the secured creditor, there is no free market of
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some courts have followed the Till formula approach for purposes of section 1129(b)(2)(A)(i).848 For
example, in In re MPM Silicones LLC, the court adopted the Till formula approach in the chapter 11
context, noting that the Supreme Court had specifically rejected the coerced loan approach in Till
because that approach required courts to consider market rates and such rates might include profit
components not available in bankruptcy.849 In so holding, the MPM Silicones court placed little value
on the Supreme Court’s dicta in Till.
Other courts and commentators have criticized the use of a formula approach in chapter 11 cases.850
These commentators focus on the differences in debt instruments and assets in a chapter 11 and
a chapter 13 case, and that an efficient market is more readily ascertainable for chapter 11 debt.
They further argue that Till’s oversimplified approach to the present value calculation frequently
undervalues the secured creditor’s claim. Finally, critics suggest that the application of the formula
approach to chapter 11 cramdown payments could negatively impact distressed debt markets and
the liquidity that flows from those markets.
Cramdown Interest Rates: Recommendations and Findings
The Commission recognized the uncertainty created by the Supreme Court’s decision in Till and
the different interpretations of that decision by lower courts. The Commissioners discussed the
potential methods for calculating present value for purposes of cramdown under section 1129(b)(2)
016
(A)(i). Some of the Commissioners found the simplicity and certainty ofbthe 1, 2 formula approach
er 2 Till
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attractive. Other Commissioners argued for use of market comparables, recognizing that a market
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typically will exist for the kinds of debt instruments6andc the businesses/assets at issue in chapter
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11 cases. Still other Commissioners suggested a hybrid approach that would establish a formula
, No
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to guide the court’s determination,. but that would consider factors more relevant to chapter 11
xset
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cases. For example, the dcourt could consider the weighted average cost of capital component for
the particular tranche of debt at issue in the discounted cash flow valuation accepted by the court
for purposes of determining the debtor’s enterprise value in connection with confirmation of the
chapter 11 plan.
The Commissioners did not try to decipher the Supreme Court’s holding or dicta in Till; rather, they
focused on the purpose of section 1129(b)(2)(A)(i) and the best method to achieve that objective.
The Commission agreed that the section was intended to provide the secured creditor with the
willing cram down lenders. Interestingly, the same is not true in the Chapter 11 context, as numerous lenders advertise
financing for Chapter 11 debtors in possession. Thus, when picking a cram down rate in a Chapter 11 case, it might
make sense to ask what rate an efficient market would produce. In the Chapter 13 context, by contrast, the absence of
any such market obligates courts to look to first principles and ask only what rate will fairly compensate a creditor for
its exposure.
Id. at 476 n. 14 (citing to websites advertising debtor in possession lending).
848 See, e.g., In re Tex. Grand Prairie Hotel Realty, L.L.C., 710 F.3d 324 (5th Cir. 2013); In re Mendoza, 2010 WL 1610120 (Bankr.
N.D. Cal. Apr. 20, 2010); In re Princeton Office Park, L.P., 423 B.R. 795 (Bankr. D.N.J. 2010); In re Price Funeral Home, Inc., 2008
WL 5225845 (Bankr. E.D.N.C. Dec. 12, 2008); In re Deep River Warehouse, Inc., 2005 WL 2319201 (Bankr. M.D.N.C. Sept. 22,
2005); In re Field, 2005 WL 3148287 (Bankr. D. Idaho Oct. 17, 2005).
849 In re MPM Silicones, LLC, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014) (explaining that cramdown is intended to “put the
creditor in the same economic position it would have been in had it received the value of its allowed claim immediately . . . the
value of a creditor’s allowed claim does not include any degree of profit”).
850 See, e.g., Bank of Montreal v. Official Comm. of Unsecured Creditors (In re Am. HomePatient, Inc.), 420 F.3d 559 (6th Cir. 2005),
cert. denied, 549 U.S. 942 (2006); Gen. Elec. Credit Equities, Inc. v. Brice Rd. Devs., L.L.C. (In re Brice Rd. Devs., L.L.C.), 392 B.R.
274, 280 (B.A.P. 6th Cir. 2008); In re DBSD N. Am., Inc., 419 B.R. 179 (Bankr. S.D.N.Y. 2009), aff ’d, 2010 WL 1223109 (S.D.N.Y
Mar. 24, 2010), aff ’d in part, rev’d in part, 627 F.3d 496 (2d Cir. 2010); In re Good, 413 B.R. 552 (Bankr. E.D. Tex. 2009), aff ’d sub
nom. Good v. RMR Invs., Inc., 428 B.R. 249 (E.D. Tex. 2010); In re Winn-Dixie Stores, Inc., 356 B.R. 239 (Bankr. M.D. Fla. 2006).
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ABI Commission to Study the Reform of Chapter
value of its allowed secured claim as of the effective date of the plan, even if that amount would
be paid over an extended period of time. In other words, the secured creditor should receive the
same return, regardless of whether the debtor elects to pay the allowed secured claim in cash on the
effective date or through deferred cash payments over several years. Accordingly, the discount rate
applied to the deferred cash payments should reflect the economic realities of the case, including the
rate of interest available on similar debt and risks associated with the future income stream available
to fund the payments. Some of the Commissioners also asserted that any discount rate should factor
in the opportunity costs associated with the deferred cash payments.
The Commissioners debated the precise calculation method, discussing each of the potential
approaches identified above (i.e., the formula approach, a cost of capital/market comparables
approach, and a weighted average cost of capital approach). They generally agreed that it was difficult
to develop a one-size-fits-all approach. In some cases, markets may be efficient and provide relevant
data; in other cases, markets may be dysfunctional and a prime plus type formula may produce more
reliable results. Accordingly, the Commission voted to recommend: (i) clarifying section 1129(b)
(2)(A)(i)(II) to emphasize the present value calculation required to implement the purpose of that
section; (ii) adopting a general market approach to determining an appropriate discount rate; and
(iii) rejecting the Till “prime plus” formula.
The Commissioners discussed how courts could best ascertain appropriate market rates in any given
6
case. They examined various factors and approaches. After extensive er 21, 201
deliberation, the Commission
b
concluded that, as a general matter, the court should use the n Novof capital for similar debt issued to
cost em
ed o
rch v
companies comparable to the debtor as a reorganized ientity. The Commission further agreed that
63 a
-353
if a market rate cannot be determined No. 14 particular debtor, the court should use an appropriate
, for a
own
v. Br
risk-adjusted rate that reflects the actual risk posed in the case of the reorganized debtor considering
eth
Blixs
d in
factors such as theedebtor’s industry, projections, leverage, revised capital structure, and obligations
cit
under the plan. The Commission did not find the prime plus formula articulated in Till appropriate
for business chapter 11 cases, even if an efficient market does not exist. Among other things, the
discount rate used in that prime plus formula is not based on the economic realities of the particular
case and, consequently, likely undercompensates creditors for the risk present in the postconfirmation
credit.
6. Class-Skipping and Intra-Class
Discriminating Distributions
Recommended Principles:
Senior creditors should not be permitted to make class-skipping, class-discriminating,
or intra-class discriminating transfers to junior creditors or interest holders under
a chapter 11 plan if such transfers would violate the absolute priority rule of
section 1129(b)(2)(B)(ii) or section 1129(b)(2)(C)(ii) of the Bankruptcy Code.
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Class-Skipping and Intra-Class Discriminating Distributions: Background
Creditors frequently contest the debtor’s proposed allocation of value and related distributions in
the chapter 11 case. These disputes may focus on the valuation of the debtor’s assets or business or
the validity or priority of creditors’ claims. In either scenario, the junior creditors’ claims may in fact
be entitled to a portion of the value available for distribution in the case, or they may at least have
“holdup value.” Creditors’ claims have holdup value when they have meritorious or colorable claims
against the senior creditors and the resolution of those claims is delaying distributions in the case.
This potential delay can arise with respect to sale proceeds or in the context of a chapter 11 plan,
particularly in the cramdown context under section 1129(b).
Courts are divided as to the permissibility of class-skipping transfers in chapter 11 cases. Some
courts view class-skipping transfers as a voluntary arrangement between the senior creditors giving,
and the junior creditors receiving, the transfers (also referred to as “gifting” in this context).851 Once
the value of the senior creditors’ allowed claims are determined, these courts hold that the senior
creditors can use or allocate that value in any manner suitable to them. The working assumption
underlying these cases is that the senior creditors are using their own money to pay the junior
creditors so the estate is not harmed. To the contrary, many commentators and some courts assert
that class-skipping gifts lead to efficient resolutions and foster the bankruptcy policy of consensual
plans.852
16
1, 20
ber 2 on the purpose of the
Other courts refuse to approve class-skipping transfers. These courtsm
ve focus
n No
ed o
absolute priority rule and view class-skipping transfers archivworkaround of the Bankruptcy Code’s
as a
3
3536
-regarding self-enrichment and collusive activities
confirmation standards. They also raise concerns
. 14
, No
rownexpense of others who do not have sufficient bargaining
that can benefit some stakeholdersv. B the
at
seth
power to participate intthein Blix
negotiations. These courts are also willing to designate the senior creditor’s
ci ed
853
votes under section 1126(e) of the Bankruptcy Code for, among other things, facilitating a payment
in contravention of the Bankruptcy Code for its own benefit and to the exclusion or harm of others.
The concerns with class-skipping transfers find their origins in Northern Pacific Railway Co. v. Boyd.854
The Boyd case involved an equity receivership of a railroad in which the secured creditors transferred
part of their recovery to the prepetition equity security holders, while unsecured creditors in the case
received no recoveries. The U.S. Supreme Court held that “[a]ny device . . . whereby stockholders
were preferred before the creditor was invalid [under the Bankruptcy Act].”855 Accordingly, Boyd
is one of the key cases in the development of the absolute priority rule and the fair and equitable
standard used in the cramdown context under section 1129(b) of the Bankruptcy Code.856 Supreme
Court cases addressing the absolute priority rule under the Bankruptcy Code focus primarily on
851 See, e.g., In re SPM Mfg. Corp., 984 F.2d 1305 (1st Cir. 1993) (permitting class-skipping in chapter 7 case). For a discussion of
gifting and the SPM case, see Daniel J. Bussel & Kenneth N. Klee, Recalibrating Consent in Bankruptcy, 83 Am. Bankr. L.J. 663,
711 (2009).
852 See, e.g., In re DBSD N. Am., Inc., 419 B.R. 179, 187–88 (Bankr. S.D.N.Y. 2009), aff ’d, 2010 WL 1223109 (S.D.N.Y Mar. 24, 2010),
aff ’d in part, rev’d in part, 627 F.3d 496 (2d Cir. 2010).
853 See, e.g., DISH Network Corp. v. DBSD N. Am., Inc. (In re DBSD N. Am., Inc.), 634 F.3d 79 (2d Cir. 2011); In re Armstrong
World Indus., 432 F.3d 507 (3d Cir. 2005).
854 N. Pac. Ry. Co. v. Boyd, 228 U.S. 482 (1913).
855 Id. at 504.
856 See also In re Iridium Operating LLC, 478 F.3d 452, 463 n. 17 (2d Cir. 2007) (“The absolute priority rule originated as a ‘judicial
invention designed to preclude the practice in railroad reorganizations of ‘squeezing out’ intermediate unsecured creditors
through collusion between secured creditors and stockholders (who were often the same people.’”)) (citations omitted).
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ABI Commission to Study the Reform of Chapter
whether equity security holders can receive distributions under a plan on account of new value
contributed to the plan.857
Class-Skipping and Intra-Class Discriminating Distributions:
Recommendations and Findings
Debtors are increasingly seeking to confirm their plans on a nonconsensual basis with one or more
classes of creditors. Although consensual plans are the desired result, achieving a fully consensual
plan is difficult in cases with valuation disputes and one or more classes of creditors significantly
impaired or arguably out of the money. In such cases, allowing senior creditors to pay a small gift or tip
to junior creditors can resolve objections to plan confirmation, facilitate the debtor’s reorganization,
and disperse value further down the debtor’s capital structure.858 From this perspective, the absolute
priority rule can be viewed as frustrating distribution to junior creditors. The Commission studied
the impact of the absolute priority rule in a variety of circumstances in chapter 11 cases.
The Commissioners recognized the high hurdle frequently posed by the absolute priority rule and
the fair and equitable standard in cramdown cases. They considered eliminating the absolute priority
rule or adopting a relative priority standard. They evaluated academic articles discussing these
alternatives, as well as an in-depth report on these articles and the related issues from the advisory
committee. The Commissioners generally favored lowering barriers to confirmation of feasible
16
1 20
plans, particularly if such plans provided distributions to more creditors., They were not willing to
ber 2
vem
n No
do so, however, at the expense of creditor priorities or appropriate checks on self-interested behavior
ed o
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and undue influence by creditors.
63 a
-353
. 14
, No
rown
B
hv
In the context of class-skipping. transfers (i.e., nonconsensual gifting), the Commissioners reviewed
xset
n Bli
i
the historical underpinnings of the absolute priority rule. They debated the policies underlying the
cited
Supreme Court decisions in Boyd859 and Los Angeles Lumber.860 The Commissioners weighed the
benefits of using class-skipping transfers to facilitate confirmation against concerns regarding senior
creditors imposing their will or unduly influencing plan negotiations if payments outside of the strict
priority waterfall were permitted. They also discussed recent cases in which gifting was either permitted
or denied (including DBSD861 and Iridium862), and the justifications for variations from the absolute
priority rule. The Commission agreed that — in the nonconsensual (i.e., cramdown) context — the
potential abuses of gifting outweighed any benefits in class-skipping, class-discriminating, and intra-
857 See Bank of Am. Nat’l Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 437 (1999); Norwest Bank Worthington
v. Ahlers, 485 U.S. 197, 206 (1988). The Second Circuit has interpreted these cases as endorsing a strict interpretation of the
absolute priority rule. See DISH Network Corp. v. DBSD N. Am., Inc. (In re DBSD N. Am., Inc.), 634 F.3d 79, 97 (2d Cir. 2011).
858 First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial Fin.
Ass’n Annual Meeting, at 15 (Nov. 15, 2012) (“CFA believes that senior creditors should be permitted to reallocate their recovery
to junior classes because doing so would foster the reorganization process, even if it means skipping out-of-the-money junior
classes. The law should favor efficient ventures between managers and senior lenders and encourage reorganizations that share
in the growth in the value of the debtor. Accordingly, CFA encourages the Commission to reexamine the prohibition against ‘gift’
plans.”), available at Commission website, supra note 55.
859 N. Pac. Ry. Co. v. Boyd, 228 U.S. 482 (1913).
860 Case v. L.A. Lumber Prods. Co., 308 U.S. 106 (1939).
861 See DISH Network Corp. v. DBSD N. Am., Inc. (In re DBSD N. Am., Inc.), 634 F.3d 79, 97 (2d Cir. 2011).
862 See Motorola, Inc. v. Official Comm. of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007) (holding
that “a rigid per se rule cannot accommodate the dynamic status of some preplan bankruptcy settlements” but that “whether a
particular settlement’s distribution scheme complies with the [Bankruptcy] Code’s priority scheme must be the most important
factor for the bankruptcy court to consider when determining whether a settlement is ‘fair and equitable’”).
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Bankruptcy Institute
class discriminating cases. Some of the Commissioners also emphasized the need to define the phrase
“under a chapter 11 plan” broadly to prohibit direct or indirect gifting under plans.
D. Disclosure and Use of Postconfirmation Entities
and Claims Trading
Recommended Principles:
“Adequate information” for purposes of section 1125(a) should include (i) specific
information regarding the governance of, and assets being transferred to, the
reorganized debtor, any successor to the debtor, or any postconfirmation entity
(including any litigation trust), as well as drafts of the operative documents; (ii)
the mechanics for resolving claims and making distributions postconfirmation to
holders of claims and interests under the chapter 11 plan; and (iii) the procedures
for parties to raise and resolve any postconfirmation issues relating to the chapter
11 plan or any postconfirmation entity (including a litigation trust).
016
The debtor or plan proponent should be permitted to usema er 21, 2
b postconfirmation
Nove only to the extent
entity (including any litigation trust) under a chapter n plan
o 11
ived
arch
that the court finds, in connection with3the 3
536 confirmation hearing and order, that
14No. any litigation trust) and the material terms
the postconfirmation entity rown,
(including
.B
eth v
governing its operation sufficiently protect the interests of the beneficiaries of
xs
n Bli
te i
such entityciordtrust.
No change is suggested with respect to the current law governing the trading of
claims in a chapter 11 case or the disclosures required by Bankruptcy Rule 2019.
Disclosure and Use of Postconfirmation Entities and Claims Trading: Background
Disclosure Concerning Postconfirmation Governance and Postconfirmation Entities
Chapter 11 requires a debtor or plan proponent to disclose various information concerning the
debtor’s business, chapter 11 case, and proposed chapter 11 plan in a disclosure statement.863 The
disclosure statement, together with the proposed plan, must then be approved by the court and
distributed to creditors and other stakeholders. The primary purpose of the disclosure statement is to
provide stakeholders with adequate information to evaluate and cast a vote on the proposed plan.864
Specifically, section 1125(b) provides: “An acceptance or rejection of a plan may not be solicited after
the commencement of the case under this title from a holder of a claim or interest with respect to
863 11 U.S.C. § 1125.
864 The legislative history of section 1125 provides: “This section is new. It is the heart of the consolidation of the various
reorganization chapters found in current law. It requires disclosure before solicitation of acceptances of a plan of reorganization.”
H.R. Rep. No. 95-595, at 409 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6365.
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ABI Commission to Study the Reform of Chapter
such claim or interest, unless, at the time of or before such solicitation, there is transmitted to such
holder the plan or a summary of the plan, and a written disclosure statement approved, after notice
and a hearing, by the court as containing adequate information.”865
The key inquiry in assessing a debtor’s or plan proponent’s disclosure statement is whether it contains
adequate information. The Bankruptcy Code defines “adequate information” as follows:
“[A]dequate information” means information of a kind, and in sufficient detail, as far
as is reasonably practicable in light of the nature and history of the debtor and the
condition of the debtor’s books and records, including a discussion of the potential
material Federal tax consequences of the plan to the debtor, any successor to the
debtor, and a hypothetical investor typical of the holders of claims or interests in the
case, that would enable such a hypothetical investor of the relevant class to make an
informed judgment about the plan, but adequate information need not include such
information about any other possible or proposed plan and in determining whether
a disclosure statement provides adequate information, the court shall consider the
complexity of the case, the benefit of additional information to creditors and other
parties in interest, and the cost of providing additional information. . . .866
Moreover, courts have developed a list of factors to guide their review in this context. These factors
consider whether the disclosure statement discusses, among other things (i) the6circumstances giving
201
rise to the chapter 11 case; (ii) the debtor’s assets and liabilities; (iii) er 21,
b the company’s future business
vem
n No
plans and the funding sources for those endeavors; (iv)vinformation regarding the chapter 11 case,
ed o
hi
3 arc
including claims, litigation, and the condition 536the debtor’s business; (v) an analysis of recoveries
-3 of
. 14
for creditors under the plan and rowa ,hypothetical chapter 7 liquidation; (vi) the debtor’s financial
in n No
.B
condition, a valuation oflixseth v
the business, and projected future performance; (vii) the tax consequences
nB
i
ited
of the plan; and c(viii) risks posed to creditors under the plan.867 Overall, courts assess whether the
disclosure statement identifies and explains material aspects of the debtor’s business, chapter 11
case, and proposed plan so that creditors and other stakeholders can make an informed decision
about voting on the plan.868
A key area of discussion in a disclosure statement from the creditors’ perspective is often the
information provided concerning the future operation of the business and how claims, recoveries,
and distributions will be handled postconfirmation. The former is of particular importance in
cases in which creditors are receiving equity or another security whose value is dependent on the
future success of the business. The latter is crucial when a litigation or liquidation trust (or other
postconfirmation entity) is being established to, for example, pursue claims and causes of action that
belong to the estate, review claims asserted against the estate, and make distributions to creditors.869
865 11 U.S.C. § 1125(b).
866 Id. § 1125(a).
867 See, e.g., In re U.S. Brass Corp., 194 B.R. 420, 424 (Bankr. E.D. Tex. 1996); In re Cardinal Congregate I, 121 B.R. 760, 765 (Bankr.
S.D. Ohio 1990); In re Scioto Valley Mortg. Co., 88 B.R. 168, 170 (Bankr. S.D. Ohio 1988); In re Metrocraft Publ’g Servs., Inc., 39
B.R. 567 (Bankr. N.D. Ga. 1984).
868 See, e.g., In re Copy Crafters Quickprint, Inc., 92 B.R. 973, 980 (Bankr. N.D.N.Y. 1988) (denying motion to approve disclosure
statement where disclosures were “unsupported by factual information so that voting parties were unable to independently
evaluate the merits of the plan”) (citations omitted).
869 For a general explanation of the use and potential issues with postconfirmation entities, see Andrew M. Thau et al., Postconfirmation
Liquidation Vehicles (Including Liquidating Trusts and Postconfirmation Estates): An Overview, 16 Norton J. Bankr. L. & Prac. 201
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In both, creditors and the court must receive sufficient information to understand the mechanics of
the plan postconfirmation and to determine whether the plan complies with the Bankruptcy Code
and other applicable nonbankruptcy law.
Disclosure and Role of Claims Trading
The term “claims trading” generally refers to the buying and selling of claims against a bankrupt
company. For example, a debtor’s supplier may sell its claim for unpaid goods to an investor at a
discount in order to monetize its claim quicker and avoid interaction with the bankruptcy case.
Investors also actively trade claims they own as lenders, as well as those that they purchase from
other creditors. Although the practice of claims trading is not new, it has grown exponentially in
recent years. As explained by one industry publication, “A slowdown in large corporate Chapter 11
filings in 2012 didn’t stop distressed investors, who bought and sold more than $41 billion worth of
bankruptcy claims last year.”870
Commentators debate the impact of claims trading on chapter 11 cases. Critics suggest that claims
trading (i) destabilizes the debtor’s reorganization efforts, (ii) removes creditors with a vested interest
in the debtor’s business from the process, and (iii) provides arbitrage and takeover opportunities for
investors that may depress value and harm other creditors.871 Proponents suggest that claims trading:
(i) provides liquidity to, and an efficient exit strategy for, creditors who do not want to be involved
16
in the case, (ii) may consolidate claims against the debtor and minimize the number of stakeholders
1, 20
ber 2
the debtor must negotiate with to achieve a consensual plan, and (iii) ovem permit the entry of longermay
nN
ed o
term, well-capitalized investors into a restructuring process iv
rch through claims purchasing, which may
63 a
-353
result in increased access to debtor in possession 4 exit financing.872 Commentators also assert that
. 1and
, No
rown creditors increases liquidity overall in capital markets
B
the possibility of an early exit and return for
th v.
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n Binvestment environment.
i
and allows a more forgiving
ited
c
A review of the literature on claims trading reveals that transparency and disclosure are key issues
in this debate. To that end, Bankruptcy Rule 2019 was amended in 2011 to increase disclosures by
investors that are members of ad hoc committees, groups, or investors otherwise acting collectively
in the bankruptcy case. Bankruptcy Rule 2019 requires investors in these circumstances to disclose,
(2007). See also William L. Medford, Retention of Claims Post-Confirmation: Fifth Circuit Clarifies Necessary Level of Specificity,
Am. Bankr. Inst. J., Dec./Jan. 2012, at 24; Andrew J. Morris, Clarifying the Authority of Litigation Trusts: Why Post-Confirmation
Trustees Cannot Assert Creditors’ Claims Against Third Parties, 20 Am. Bankr. Inst. L. Rev. 589 (2012); Robert M. Quinn, Not So
Fast, Mr. Liquidating Trustee! May Anyone Other Than a Bankruptcy Trustee Exercise Avoidance Powers After Confirmation?, Am.
Bankr. Inst. J., Apr. 2003, at 28.
870 Dow Jones Daily Bankr. Rev., Jan. 28, 2013.
871 See, e.g., Kevin J. Coco, Empty Manipulation: Bankruptcy Procedure Rule 2019 and Ownership Disclosure in Chapter 11 Cases,
2008 Colum. Bus. L. Rev. 610 (2008) (discussing potential issues with bankruptcy claims trading and voting in chapter 11);
Frederick Tung, Confirmation and Claims Trading, 90 Nw. U. L. Rev. 1684 (1996) (analyzing advantages and disadvantages for
claims trading); Aaron L. Hammer & Michael A. Brandess, Claims Trading: The Wild West of Chapter 11s, Am. Bankr. Inst. J.,
July/Aug. 2010, at 1 (“Despite the vast benefits created by the market, claims trading has also generated negative implications on
the structure of the reorganization process.”).
872 See, e.g., Written Statement of John Greene on behalf of Halcyon Asset Management LLC: LSTA Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (describing the value of the distressed debt market for debtors),
available at Commission website, supra note 55; Written Statement of Jennifer Taylor: WLC Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11 (Nov. 30, 2012) (same), available at Commission website, supra note 55; Written Statement
of Professor Edward I. Altman: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012)
(describing liquidity offered by distressed debt markets), available at Commission website, supra note 55; Written Statement of
Professor Edward I. Altman: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (same),
available at Commission website, supra note 55; Written Statement of the Honorable Edith H. Jones, Fifth Circuit Court of Appeals:
VALCON Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3 (Feb. 21, 2013) (noting that claims
trading improves liquidity and reduces risk for traditional lenders), available at Commission website, supra note 55.
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ABI Commission to Study the Reform of Chapter
among other things, their names, addresses, and nature and amount of each “disclosable economic
interest” they hold against the debtor. In addition, courts have addressed questionable conduct by
investors in the claims trading context through various means, including by reducing the investor’s
claim, subordinating the investor’s claim, or designating the investor’s vote on the chapter 11 plan.873
Commentators continue to debate the utility of claims trading and regulation of the bankruptcy
claims trading market.874
Disclosure and Use of Postconfirmation Entities and Claims Trading:
Recommendations and Findings
Disclosure Concerning Postconfirmation Governance and Postconfirmation Entities
The Commissioners discussed the kinds of information necessary to inform stakeholders about key
components of the chapter 11 plan. The Commission determined that, as a general matter, debtors
and plan proponents provide an acceptable level of disclosures with respect to events leading up
to, and occurring during, the chapter 11 case, as well as with respect to the current state of its
assets, liabilities, and business. Many of the Commissioners believed, however, that disclosure is
frequently insufficient with respect to the governance and operations of the reorganized debtor and
any postconfirmation entity established in connection with the plan.
The Commissioners discussed the proliferation of postconfirmation entities in 16
, 20 chapter 11 plans. These
er 21
emb
entities can take a variety of forms, including a litigation trust, a liquidation trust, a postconfirmation
Nov
d on
chive
business trust, or the reorganized debtor itself whenathe debtor is no longer operating a business, but
3 r
3536
. 14- outside of the bankruptcy process. Section 1123(b)
is solely winding down the affairs ofntheoestate
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v. B“the settlement or adjustment of any claim or interest belonging to
states that a plan may provide for
th
lixse
the debtor or to citedestate; or . . . the retention and enforcement by the debtor, by the trustee, or by a
the in B
representative of the estate appointed for such purpose, of any such claim or interest.”875 Debtors and
plan proponents generally rely on the language of section 1123(b) to establish a postconfirmation
entity under a plan, and courts approving such entities often perceive them as a means to efficiently
resolve the chapter 11 case.876
873 Courts have reduced claim amounts with respect to insiders or other fiduciaries. See, e.g., In re MC2 Capital Partners, LLC, Case
No. 11-14366 (Bankr. N.D. Cal. Feb. 27, 2013) (“[T]he exception to the general rule that transfers are to be taken at face value
applies when the transferee has fiduciary duties to the debtor or the transfer is an attempt to circumvent the consequences of
those duties.”); Citicorp Venture Capital, Ltd. v. Comm. of Creditors Holding Unsecured Claims (In re Papercraft Corp.), 211
B.R. 813, 825 (W.D. Pa. 1997), aff ’d, 160 F.3d 982 (3d Cir. 1998); Bernstein v. Donaldson (In re Insulfoams, Inc.), 184 B.R. 694
(Bankr. W.D. Pa. 1995), aff ’d sub nom. Donaldson v. Bernstein, 104 F.3d 547 (3d Cir. 1997). Equitable subordination is addressed
by section 510(c) of the Bankruptcy Code and generally requires some harm (e.g., delay in emergence from bankruptcy or
impairment of other creditors) resulting from the alleged inequitable conduct. See, e.g., Shubert v. Lucent Techs. Inc. (In re
Winstar Commc’ns, Inc.), 554 F.3d 382, 413 (3d Cir. 2009) (“A bankruptcy court should attempt to identify the nature and
extent of the harm it intends to compensate in a manner that will permit a judgment to be made regarding the proportionality
of the remedy to the injury that has been suffered by those who will benefit from the subordination.”) (citations omitted).
Section 1126(e) provides a mechanism for disqualification (known as “designation”) of an acceptance or rejection of a plan if
the acceptance or rejection was not obtained in good faith or the vote to accept or reject was not cast in good faith. 11 U.S.C. §
1126(e) (“On request of a party in interest, and after notice and a hearing, the court may designate any entity whose acceptance
or rejection of such plan was not in good faith or was not solicited or procured in good faith or in accordance with the provisions
of this title.”).
874 See, e.g., Adam J. Levitin, Bankruptcy Markets: Making Sense of Claims Trading, 4 Brook. J. Corp. Fin. & Com. L. 67 (2010);
Maneuvering in the Shadows of the Bankruptcy Code: How to Invest or Take Over Bankruptcy Companies Within the Limits of the
Bankruptcy Code, 30 Emory Bankr. Dev. J. 73 (2013); Michelle M. Harner, Activist Distressed Debtholders: The New Barbarians
at the Gate?, 89 Wash. U. L. Rev. 155 (2011).
875 11 U.S.C. § 1123(b)(3). See also In re Sweetwater, 884 F.2d 1323 (10th Cir. 1989) (explaining that an estate representative under
section 1123 “may not be accomplished by unilateral declaration of the debtor in possession”).
876 See, e.g., In re Acequia, Inc., 34 F.3d 800 (9th Cir. 1994) (“[The] aim [of section 1123(b)(3)(B)] was to make possible the
formulation and consummation of a plan before completion of the investigation and prosecution of causes of action such as
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The Commissioners recognized the potential utility of postconfirmation entities in facilitating plan
implementation and a debtor’s emergence from chapter 11. Some of the Commissioners expressed
concerns, however, regarding the uncertainty of the postconfirmation entity’s authority, governance,
operation, and accountability after confirmation of the plan. Although the terms of these entities
are set forth in the trust or other organizational documents, those documents are not often filed
with the court until immediately before the confirmation hearing, giving parties little time to review
the documents and depriving stakeholders of this information before they cast their votes on the
plan. Moreover, once the debtor emerges from chapter 11, the court does not actively oversee the
operations of the postconfirmation entity. Rather, at most, the court will entertain disputes arising
from the operation of the postconfirmation entity if stakeholders request such review and the court
has retained jurisdiction under the plan confirmation order. Some of the Commissioners noted
that stakeholders frequently do not have the information, or access to the information, necessary to
contest the decisions or operation of the postconfirmation entity.
The Commission considered recommending statutory guidelines for any postconfirmation entities.
Nevertheless, as the Commissioners started to consider the elements of those guidelines, they quickly
determined that a one-size-fits-all rule was not workable in this context and likely would create more
litigation than efficiencies. They further determined that an important element underlying the potential
problems with postconfirmation entities was disclosure. Parties need to understand, and have an
opportunity to assess, the material terms of the postconfirmation entity and the trust or other applicable
16
organizational documents. The Commissioners also noted that these disclosures21, 20just as relevant and
were
ber
m
useful with respect to the reorganized debtor proposing to continue n Nove
operations postconfirmation.
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Accordingly, the Commission recommended. amending section 1125 of the Bankruptcy Code to
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require specific disclosures concerning: (i) the governance (e.g., individuals or entities managing
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the entity’s affairs, general decision-making process, procedures for changing key personnel
cited
and voting protocols, equity security holders’ or beneficiaries’ rights with respect to governance
matters, etc.) and assets of the reorganized debtor or other postconfirmation entity; (ii) the details
of the claims and interests dispute, reconciliation, and distribution process; and (iii) the process
to raise issues with the court concerning the postconfirmation entity or the implementation of the
chapter 11 plan. It also voted to recommend that a debtor or plan proponent be permitted to use a
postconfirmation entity, including a litigation trust, only if the court finds, based on the evidence
presented at the confirmation hearing, that the entity and its organizational documents provide
sufficient protections and procedures for creditors and other beneficiaries relying on the entity for
their recoveries in the case.
Disclosure and Role of Claims Trading
Claims trading is often identified as a driving force behind the changing chapter 11 landscape.
Harvey Miller has posited:
Claims trading has dramatically changed the dynamics of the reorganization process.
Distressed debt traders have different motivations and objectives than the old line
those for previous insider misconduct and mismanagement of the debtor. Thus, the statute was in furtherance of the purpose of
preserving all assets of the estate while facilitating confirmation of a plan.”) (quoting Duvoisin v. East Tenn. Equity, Ltd. (In re S.
Indus. Banking Corp.), 59 B.R. 638 (Bankr. E.D. Tenn. 1986).
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relationship banks and trade creditors. Quick and significant return on investment is
the imperative to the traders.877
Other commentators disagree with this characterization, citing benefits to claims trading such as
enhanced liquidity and cost savings associated with quicker case resolutions.878 The Commissioners
likewise expressed varying positions on the value of claims trading, but they all recognized its
increasing presence and arguable influence in chapter 11 cases.
The Commissioners discussed both whether increased regulation or increased disclosure would
mitigate perceived problems with claims trading and add or help preserve value in chapter 11 cases.
The Commission reviewed the changes to Bankruptcy Rule 3001(e) in 1991 and Bankruptcy Rule 2019
in 2011. These two rule changes arguably move in different directions on the issue of claims trading.
Bankruptcy Rule 3001(e) governs the transfer of claims. Specifically, it addresses the mechanics of filing and
preserving transferred claims, depending on the timing of the transfer and the kind of claim transferred.
The comments to the 1991 amendment to Bankruptcy Rule 3001(e) suggest that it was intended “to limit
the court’s role to the adjudication of disputes regarding transfers of claims.”879 For example, unlike its
predecessor, Bankruptcy Rule 3001(e)(1) does not require the transferor to acknowledge the transfer or
to disclose the consideration exchanged in the transfer.880 The amendments to Bankruptcy Rule 2019,
on the other hand, increase the disclosure obligations of certain investors acting collectively in the case.
6
Although not targeted at claims traders per se, investors actively engaged in claims1trading and potentially
1, 20
ber 2
taking positions in, or trying to influence, the chapter 11 case areNovem its scope.
within
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35
The Commissioners acknowledged the oconflicting anecdotal evidence on claims trading and its
. 14n, N
Bro witnesses argued for increased disclosures and restrictions on
impact on chapter 11 cases.hSome w
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in
claims trading itself.881BOthers testified in favor of claims trading.882 For example, Professor Edith
cited
Hotchkiss explained that her “own and other academic research has shown that this consolidation of
claims is associated with more oversight of the process and more efficient reorganizations, evidenced
877 Harvey Miller, Chapter 11 in Transition: From Boom to Bust and Into the Future, 81 Am. Bankr. L. J. 375, 390 (2007).
878 See, e.g., Written Statement of John Greene on behalf of Halcyon Asset Management LLC: LSTA Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (describing the value of the distressed debt market for debtors),
available at Commission website, supra note 55. See also supra note 872.
879 See Advisory Committee Notes accompanying 1991 Amendment to Bankruptcy Rule 3001(e).
880 See, e.g., Preston Trucking Co., Inc. v. Liquidity Solutions, Inc. (In re Preston Trucking Co., Inc.), 333 B.R. 315 (Bankr. D. Md.
2005), aff ’d, 392 B.R. 623 (D. Md. 2008) (finding that court cannot review transfer of claim for insufficient consideration).
881 Written Statement of Jonathan C. Lipson: AIRA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–5
(June 7, 2013) (arguing for more disclosures regarding who holds the debtor’s debt and what other positions they might have),
available at Commission website, supra note 55; Oral Testimony of Michael R. (“Buzz”) Rochelle: UT Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11, at 27–28 (Nov. 22, 2013) (UT Transcript) (stating that the ability of creditors to sell
their debt to claims traders can undermine the bankruptcy case), available at Commission website, supra note 55.
882 See Oral Testimony of Professor Anthony J. Casey: CFRP Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 44–45 (Nov. 7, 2013) (CFRP Transcript) (stating that claims trading is a positive development in bankruptcy), available at
Commission website, supra note 55; Written Statement of the Honorable Edith H. Jones, Fifth Circuit Court of Appeals: VALCON
Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3 (Feb. 21, 2013) (claims trading improves liquidity
and reduces risk for traditional lenders), available at Commission website, supra note 55; Oral Testimony of Jennifer Taylor:
ABI WLC Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 24 (Nov. 30, 2012) (ABI WLC Transcript)
(suggesting that transparency and disclosure in the claims trading market would likely have a significant negative impact on
the secondary debt market), available at Commission website, supra note 55; Written Statement of Professor Edward I. Altman:
LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (describing liquidity offered
by distressed debt markets), available at Commission website, supra note 55; Written Statement of Jennifer Taylor: WLC Field
Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Nov. 30, 2012) (describing the value of the distressed debt
market for debtors), available at Commission website, supra note 55; Written Statement of John Greene on behalf of Halcyon Asset
Management LLC: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Oct. 17, 2012) (same), available
at Commission website, supra note 55.
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by a greater likelihood of out-of-court restructurings or prepackaged bankruptcies, less time spent
in reorganizations, and a greater likelihood that the firm continues as a going concern.”883
The Commission agreed that a robust secondary market exists for claims trading and that this
market enhances liquidity opportunities for both debtors and creditors: it provides an exit strategy
for creditors, which can induce credit extensions to potentially distressed companies in the first
instance. As such, the Commissioners generally perceived little benefit to increased regulation of
claims trading activities. They did, however, debate whether increased disclosure requirements could
benefit parties in the chapter 11 case and those traded on the secondary markets. They considered,
for example, extending the Bankruptcy Rule 2019 disclosures to all creditors, perhaps limited to
those filing pleadings in connection with a section 363 sale, a plan, a postpetition financing facility,
or a motion to appoint a trustee or examiner. The Commissioners examined the purpose and use
of any additional disclosures by claims traders in the case. Many of the Commissioners believed
that in many circumstances, what an investor paid for a claim or why it purchased the claim would
be irrelevant to the merits or substantive legal issues in a dispute in the case. These Commissioners
further noted that when price or motive may matter, courts already have means to determine and
sanction inappropriate conduct through the claims subordination and vote designation processes.
On balance, the Commission found nominal value to these additional disclosures. The Commission
also rejected any specific restrictions on claims trading or the participation of claims traders in
16
chapter 11 cases, particularly in light of the Commission’s recommended , clarification to vote
1 20
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designation under section 1126(e) of the Bankruptcy Code.
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E. General cPlan Content
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1. Default Plan Treatment Provisions
Recommended Principles:
A debtor or plan proponent should not be permitted to provide in its chapter 11
plan that, if a class of claims or interests does not vote on the plan, such class is
deemed to have accepted the plan for all purposes.
A debtor or plan proponent should be able to provide default treatment in the chapter
11 plan for any executory contracts and unexpired leases not specifically assumed or
rejected under the Bankruptcy Code. If the chapter 11 plan does not provide such
default treatment, executory contracts and unexpired leases not otherwise assumed
or rejected under section 365 or, for collective bargaining agreements, section 1113
should be permitted to “ride through” the chapter 11 case and be unaffected by the
section 1141 discharge. Section 1123 should be amended to implement this change.
883 Oral Testimony of Professor Edith Hotchkiss: LSTA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 35
(Oct. 17, 2012) (LSTA Transcript), available at Commission website, supra note 55.
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Default Plan Treatment Provisions: Background
A chapter 11 plan may include provisions that specify the treatment under the plan of certain actions
or nonactions by the debtor or other parties. Two common provisions include: (i) a statement that
classes of creditors or interest holders not voting on the plan are deemed to accept the plan; and
(ii) either the assumption or rejection of executory contracts and unexpired leases not otherwise
assumed or rejected prior to the confirmation of the plan. These provisions enable a debtor or plan
proponent to articulate bright-line rules for areas of uncertainty under the Bankruptcy Code and
applicable law, but the permissibility and consequences of the provisions are less clear.
Section 1129(a)(8) of the Bankruptcy Code requires that each class of claims or interests accept
the plan or remain unimpaired under the plan in order for the debtor or plan proponent to obtain
confirmation. In addition, under sections 1129(a)(10) and 1129(b) as currently written, a debtor
or plan proponent can seek to cram down a plan on objecting creditors and interest-holders only
if, among other things, at least one impaired class of claims has accepted the plan. A debtor or
plan proponent thus may include a provision in the plan purporting to treat classes of claims
or interests that do not vote on the plan as accepting the plan. This situation may arise when
creditors or equity security holders in the class simply do not submit ballots indicating acceptance
or rejection of the plan.
16
Section 1126(c) of the Bankruptcy Code states that a class of claims or interest-holders accepts a plan
1, 20
ber 2votes in favor of the plan.884
em
if two-thirds in amount and a majority in number of those votingvsubmit
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Bankruptcy Rule 3018(c) provides in relevant part3thath“acceptance or rejection [of the plan] shall be
rc iv
6 a
-353rejected, be signed by the creditor or equity security
in writing, identify the plan or plans accepted or
14
No.
wn,
roconform to the appropriate Official Form.”885 Notably, the courts
B
holder or an authorized agent,vand
h .
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are split as to whether these provisions permit the plan to deem creditor silence as acceptance of the
i
cited
plan. For example, courts in the Second, Third, and Tenth Circuits tend to follow the Tenth Circuit’s
decision in Ruti-Sweetwater, in which the court held that inaction by a single-creditor class with
respect to the plan could be treated as an acceptance for purposes of section 1129(a)(8).886 Other
courts have rejected the Ruti-Sweetwater approach, highlighting that the Bankruptcy Code expressly
addresses “deemed acceptance” and permits it only in the case of unimpaired classes.887
Similar uncertainty exists in the context of executory contracts and unexpired leases not expressly
assumed, assigned, or rejected by the trustee888 prior to plan confirmation. Section 365(d)(2) provides
that the trustee may assume, assign, or reject executory contracts and some kinds of unexpired leases “at
884 11 U.S.C. § 1126(c).
885 Fed. R. Bankr. P. 3018(c).
886 Heins v. Ruti-Sweetwater, Inc (In re Ruti-Sweetwater, Inc.), 836 F.2d 1263 (10th Cir. 1988). “The general rule is that the acceptance
of the plan by a secured creditor can be inferred by the absence of an objection.” In re Szostek, 886 F.2d 1405, 1413 (3d Cir. 1989).
See also In re Accuride Corp., 2010 WL 5093173, at *6 (Bankr. D. Del. Feb. 18, 2010); In re DBSD N. Am., Inc., 419 B.R. 179
(Bankr. S.D.N.Y. 2009), aff ’d, 2010 WL 1223109 (S.D.N.Y Mar. 24, 2010), aff ’d in part, rev’d in part, 627 F.3d 496 (2d Cir. 2010);
In re Adelphia Commc’ns Corp., 368 B.R. 140 (Bankr. S.D.N.Y. 2007), appeal dismissed, stay vacated, 2007 WL 7706743 (2d Cir.
Feb. 9, 2007).
887 See, e.g., In re M. Long Arabians, 103 B.R. 211, 216 (B.A.P. 9th Cir. 1989); In re Vita Corp., 380 B.R. 525, 528 (C.D. Ill. 2008); In
re Castaneda, 2009 WL 3756569 (Bankr. S.D. Tex. Nov. 2, 2009); In re Jim Beck, Inc., 207 B.R. 1010, 1015 (Bankr. W.D. Va. 1997),
aff ’d, 214 B.R. 305 (W.D. Va. 1997), aff ’d, 162 F.3d 1155 (4th Cir. 1998); In re Higgins Slacks Co., 178 B.R. 853, 855 (Bankr. N.D.
Ala. 1995); In re Adkisson Vill. Apts. of Bradley Cty., Ltd., 133 B.R. 923 (Bankr. S.D. Ohio 1991); In re Townco Realty, Inc., 81
B.R. 707, 708 (Bankr. S.D. Fla. 1987).
888 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
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any time before the confirmation of a plan.”889 Unlike in the chapter 7 context,890 however, the Bankruptcy
Code does not state what happens in the chapter 11 context to contracts or leases not assumed or rejected
prior to confirmation, other than with respect to nonresidential real property leases.891
In many cases, a debtor or plan proponent will include a default provision that provides for the deemed
assumption or rejection of executory contracts or unexpired leases not otherwise expressly assumed
or rejected prior to confirmation. If the plan is silent, however, the question arises whether such
contracts and leases can “ride through” the chapter 11 case and remain enforceable postconfirmation.
Under the ride-through doctrine, “executory contracts that are neither affirmatively assumed or
rejected by the debtor under § 365, pass through bankruptcy unaffected.”892 Many courts considering
the issue have endorsed the ride-through doctrine,893 finding it consistent both with the permissive
language of section 365(a) (i.e., a trustee may assume or reject executory contracts and unexpired
leases) and the revesting of estate property in the debtor postconfirmation under section 1141(b).894
Nevertheless, the Bankruptcy Code does not expressly authorize the ride-through doctrine. It also
can create unexpected consequences for the reorganized debtor and the counterparty, including
ongoing performance obligations for the debtor and a loss of rights in the chapter 11 case for the
counterparty.895
Default Plan Treatment Provisions: Recommendations and Findings
016
,2
The Commissioners discussed the cost of uncertainty in the plan-confirmation context. Such
er 21
emb
Nov
uncertainty can not only slow down plan negotiations, but it can also impact the prospective business
d on
chive
3 ar
of the reorganized debtor operating, at least in part,3under the terms of the confirmed plan. In this
35 6
. 14context, the Commissioners discussed rthenappropriate treatment of (i) classes of claims and interests
, No
B ow
v.but take no action; and (ii) executory contracts and unexpired
eth
that are entitled to vote on thesplan
Blix
ed in
cit
leases not otherwise assumed or rejected in the chapter 11 case.
The Commission reviewed the split in the courts regarding the ability to deem silence as acceptance
for purposes of section 1129(a)(8) and (a)(10) and section 1129(b). Many of the Commissioners
found the reasoning of courts rejecting the Tenth Circuit’s approach in Ruti-Sweetwater persuasive.
These Commissioners noted that Congress knew how to provide for deemed acceptance, as evidence
in the unimpaired claim context. Section 1126(e) states: “Notwithstanding any other provision of
this section, a class that is not impaired under a plan, and each holder of a claim or interest of
889 11 U.S.C. § 365(d)(2).
890 Section 365(d)(1) provides: “In a case under chapter 7 of this title, if the trustee does not assume or reject an executory contract
or unexpired lease of residential real property or of personal property of the debtor within 60 days after the order for relief,
or within such additional time as the court, for cause, within such 60-day period, fixes, then such contract or lease is deemed
rejected.” 11 U.S.C. § 365(d)(1).
891 Under section 365(d)(4), a trustee has 120 days, plus potentially one 90-day extension, to assume, assign, or reject unexpired
leases on nonresidential real property. If the trustee fails to act, such leases are deemed rejected. 11 U.S.C. § 365(d)(4).
892 In re Hernandez, 287 B.R. 795, 799 (Bankr. D. Ariz. 2002). See also In re Polysat, Inc., 152 B.R. 886, 890 (Bankr. E.D. Pa. 1993).
893 See, e.g., Stumpf v. McGee (In re O’Connor), 258 F.3d 392, 404 (5th Cir. 2001); Bos. Post Rd. Ltd. P’ship v. FDIC (In re Bos. Post
Road Ltd. P’ship), 21 F.3d 477, 484 (2d Cir. 1994), cert. denied, 513 U.S. 1109 (1995); Pub. Serv. Co. of N.H. v. N.H. Elec. Coop.,
Inc. (In re Public Serv. Co. of N.H.), 884 F.2d 11, 14–15 (1st Cir. 1989).
894 Section 1141(b) provides: “Except as otherwise provided in the plan or the order confirming the plan, the confirmation of a plan
vests all of the property of the estate in the debtor.” 11 U.S.C. § 1141(b).
895 See, e.g., In re Greystone III Joint Venture, 995 F.2d 1274 (5th Cir. 1992), cert. denied, 506 U.S. 821 (1992), cert. denied, 506 U.S.
822 (1992) (holding that a nondebtor party to a contract riding through bankruptcy case has no claim against the estate and thus
no right to vote on plan); In re Cochise College Park, Inc., 703 F.2d 1339, 1352 (9th Cir. 1983), superseded by statute, Bankruptcy
Code, as recognized by In re Sturgis Iron & Metal Co., Inc., 420 B.R. 716, 726 n. 23, 737 n. 44 (Bankr. W.D. Mich. 2009) (holding
that executory contract not otherwise assumed or rejected “continues in effect and the nonbankrupt party . . . is not a creditor
with a provable claim against the bankrupt estate”).
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ABI Commission to Study the Reform of Chapter
such class, are conclusively presumed to have accepted the plan, and solicitation of acceptances
with respect to such class from the holders of claims or interests of such class is not required.”896
Other Commissioners emphasized the policy considerations articulated by the Tenth Circuit and
courts following Ruti-Sweetwater: “To hold otherwise would be to endorse the proposition that a
creditor may sit idly by, not participate in any manner in the formulation and adoption of a chapter
11 plan and thereafter, subsequent to the adoption of the plan, raise a challenge to the plan for the
first time.”897 These courts also observe that treating inaction as rejection makes the deadlines for
rejecting a plan or filing objections meaningless.898
In considering the competing issues on silence as deemed acceptance, the Commissioners discussed
reasons why creditors may not vote. These reasons could include that the creditor is unfamiliar with
the bankruptcy process or uninformed regarding the consequences of voting or not voting, the
creditor may make a cost-benefit decision to abstain from voting, the creditor may be agnostic about
the overall plan, the creditor may not like contingencies associated with an affirmative vote on the
plan (such as a consent to a release), or the creditor may inadvertently fail to timely submit a ballot.
The Commissioners did not necessarily believe that creditors should be deemed to accept a plan in
all of these circumstances. Moreover, the Commissioners found it impracticable to suggest a caseby-case or creditor-by-creditor analysis in these situations. Accordingly, the Commission agreed
that the better rule is to prohibit a plan from providing for “deemed acceptance” if an impaired
class of claims fails to vote on a plan. The Commissioners also noted that the import of deemed
16
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acceptance would be reduced under these principles, given the Commission’s recommendations to
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eliminate the need for an accepting impaired class for cramdownepurposes and the introduction of
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redemption option value into the cramdown analysis.899
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The Commission also considered the most appropriate treatment for executory
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unexpired leases itthatn are not otherwise assumed or rejected prior to confirmation
c ed
contracts and
in accordance
with section 365(d)(2). The Commissioners commented that this issue most often arises by surprise
— at or after confirmation, the reorganized debtor discovers an executory contract or unexpired
lease, or the counterparty finally comes to discover the debtor’s chapter 11 case, and the parties are
trying to deal with the impact, if any, of the debtor’s chapter 11 case on that contractual relationship.
The Commissioners articulated the different approaches for handling these situations. For example,
the Bankruptcy Code could provide that all executory contracts and unexpired leases not otherwise
assumed or rejected by confirmation are deemed rejected. Alternatively, the Bankruptcy Code could
provide for deemed assumption in such cases. The Commissioners noted that, under either of those
default rules, the rule could produce significant unintended consequences for the debtor or the
counterparty. In particular, deemed rejection could result in the debtor or counterparty unknowingly
losing rights and access to products, services, or receivables necessary to the reorganized business.
Accordingly, the Commission agreed that the better default rule was the ride-through doctrine,
which is consistent with how nonexecutory contracts are treated and would preserve the parties’
896 11 U.S.C. § 1126(f). See also 7 Collier on Bankruptcy ¶ 1126.04 (suggesting that the holding in Ruti-Sweetwater was incorrect).
897 Heins v. Ruti-Sweetwater, Inc (In re Ruti-Sweetwater, Inc.), 836 F.2d 1263, 1266 (10th Cir. 1988).
898 Id. at 1266–67. See also In re Adelphia Commc’ns Corp., 368 B.R. 140, 216–62 (Bankr. S.D.N.Y. 2007), appeal dismissed, stay
vacated, 2007 WL 7706743 (2d Cir. Feb. 9, 2007) (“Regarding nonvoters as rejecters runs contrary to the [Bankruptcy] Code’s
fundamental principle, and the language of section 1126(c), that only those actually voting be counted in determining whether a
class has met the requirements, in number and amount, for acceptance or rejection of a plan, and subjects those who care about
the case to burdens (or worse) based on the inaction and disinterest of others.”).
899 See Section VI.F.1, Class Acceptance Generally and for Cramdown Purposes; Section VI.C.1, Creditors’ Rights to Reorganization
Value and Redemption Option Value.
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rights, whatever those may be, for further negotiation. In addition, the Commission agreed that the
Bankruptcy Code should expressly allow the debtor or plan proponent to alter this default rule and
specifically provide for deemed assumption or rejection in its particular case.
2. Exculpatory Clauses
Recommended Principles:
A debtor or plan proponent should be permitted to include an exculpatory clause
in the chapter 11 plan that covers parties participating in the chapter 11 case
and identified in the chapter 11 plan, including estate representatives, subject to
customary exclusions consistent with public policy, that provides for exculpation
with respect to acts or omissions during the case and prior to the effective date of
the plan, including in connection with the negotiation, drafting, and solicitation
of the plan. Confirmation of the chapter 11 plan under section 1129 should also
include the approval and authorization of such permissible exculpatory clauses,
provided that adequate disclosure of the scope of, and parties covered by, the
exculpatory clause is included in the disclosure statement and the plan. Sections
1125(e) and 1129 should be amended accordingly.
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Exculpatory Clauses: Background
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A chapter 11 plan is in many respects ra wn, N
o contract between the debtor or the plan proponent and the
B
h v.
debtor’s stakeholders. As inin Blixset
other contractual settings, courts have permitted parties to include provisions
cited
that exculpate the debtor’s directors, officers, similar managing persons, and professionals; the unsecured
creditors’ committee and its professionals; and certain other parties with respect to conduct occurring
during the chapter 11 case and prior to the effective date of the plan. Notably, exculpatory clauses differ
from estate or third-party releases that may also be included in a chapter 11 plan. (Third-party releases are
discussed below.) A release generally is a relinquishment of claims and causes of action that the debtor or
third parties may have against certain nondebtor parties. An exculpatory clause is more akin to limited
immunity for the identified parties for conduct during the chapter 11 case.
The Bankruptcy Code does not specifically address the inclusion of exculpatory clauses in chapter 11
plans. Nevertheless, courts tend to approve exculpation when it is reasonable considering the specific
circumstances of the case.900 For example, one court has held that exculpatory clauses are more likely
to be reasonable when the conduct covered has already occurred, the exculpatory clause was clearly
contained in the plan, and parties entitled to vote have accepted the plan.901 Another court has found an
900 See, e.g., Unsecured Creditors’ Comm. v. Pelofsky (In re Thermadyne Holdings Corp.), 283 B.R. 749, 755–56 (B.A.P. 8th Cir.
2002) (noting there is no per se rule that indemnification and exculpation provisions are impermissible under section 328(a)
and holding that the provisions were unreasonable in this particular case); In re Metricom, Inc., 275 B.R. 364, 371 (Bankr.
N.D. Cal. 2002) (holding that indemnity and exculpation provisions must be reasonable under the circumstances and “such a
determination can only be made on a case by case basis”). See also In re Comdisco, Inc., 2002 WL 31109431 (N.D. Ill. 2002); In
re DEC Int’l, Inc., 282 B.R. 423 (W.D. Wis. 2002); In re Friedman’s, Inc., 356 B.R. 758, 762 (Bankr. S.D. Ga. 2005) (citing United
Artists Theatre Co. v. Walton, 315 F.3d 217 (3d Cir. 2003)). For a more complete discussion and additional case citations, see Kurt
F. Gwynne, Indemnification and Exculpation of Professional Persons in Bankruptcy Cases, 10 Am. Bankr. Inst. L. Rev. 711 (2002).
901 In re Friedman’s, Inc., 356 B.R. 758, 761–63 (Bankr. S.D. Ga. 2005).
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ABI Commission to Study the Reform of Chapter
exculpatory clause reasonable when it was narrowly tailored, exculpated only negligent conduct, and
was in the best interests of the estate.902 Nevertheless, some courts have rejected exculpatory clauses
outright, particularly in the context of professionals retained during the bankruptcy case.903
A typical exculpatory clause may protect the debtor’s directors, officers, employees, advisors, and
professionals from “incur[ring] any liability to any holder of a Claim or Equity Interest for any act or
omission in connection with, related to, or arising out of, the Chapter 11 Cases, the pursuit of confirmation
of the Plan, the consummation of the Plan or the Administration of the Plan or the property to be
distributed under the Plan, except for willful misconduct or gross negligence.”904 Courts generally find that
exculpatory clauses fall outside the scope of section 524(e),905 which limits the reach of the bankruptcy
discharge.906 They also frequently focus on the policy justifications underlying exculpation, including
encouraging parties to engage in the process and assist the debtor in achieving a confirmable plan —
actions that committees, committee members, other estate representatives and their professionals, and
certain parties (such as key lenders) may not be willing to undertake in the face of litigation risk. As one
court observed: “Exculpation provisions are frequently included in chapter 11 plans, because stakeholders
all too often blame others for failure to get the recoveries they desire; seek vengeance against other parties;
or simply wish to second-guess the decision makers in the chapter 11 case.”907
Exculpatory Clauses: Recommendations and Findings
16
1, 20
ber 2
ve
The Commission holistically reviewed the issues of discharge,mreleases, and exculpation. The
n No
ed o
rchiv
Commissioners viewed exculpation as a targeted provision intended to protect good faith actors
63 a
-353 11 case. They generally agreed with those courts
14
with respect to their conduct during ,the .chapter
No
rown
.
interpreting exculpatory clauses B establishing acceptable (or nonactionable) standards of conduct
eth v as
Blixs
nwaiver of, or injunction against, third-party claims. The Commissioners thus
i
and not as affecting a
cited
perceived a distinct difference between the contractual standards of conduct and limited immunity
of exculpatory clauses and the more encompassing waivers often proposed by third-party releases.
Although the Commission agreed that both types of provisions might be permissible in appropriate
cases if certain factors were satisfied, it determined that different standards of review were warranted.
The Commission reviewed the potential parties and types of conduct that should be covered by
exculpatory clauses. The Commission agreed that estate representatives (e.g., the debtor in possession, a
trustee, an estate neutral, unsecured creditors’ committees, committee members) and their professionals
should be included within exculpatory clauses. It also acknowledged that the facts of particular cases
might support the inclusion of other parties who actively engaged in the reorganization or plan process
and could be the target of litigation by claimants unhappy with, among other things, the results of the
902 Upstream Energy Servs. v. Enron Corp. (In re Enron Corp.), 326 B.R. 497, 504 (S.D.N.Y. 2005).
903 In re Drexel Burnham Lambert Grp., Inc., 133 B.R. 13, 27 (Bankr. S.D.N.Y. 1991) (“Simply stated, indemnification agreements
are inappropriate”) (citing In re Realty Trust, 123 B.R. 626, 630–31 (Bankr. C.D. Cal. 1991)). See generally Ryan M. Murphy,
Shelter from the Storm: Examining Chapter 11 Plan Releases for Directors, Officers, Committee Members, and Estate Professionals,
20 J. Bankr. L. & Prac. 4 Art. 7, Sept. 2011 (general review of case law addressing exculpatory clauses).
904 In re PWS Holding Corp., 228 F.3d 224, 246 (3d Cir. 2000), aff ’g 1999 WL 33510165 (Bankr. D. Del. Dec. 30, 1999).
905 Section 524(e) provides: “Except as provided in subsection (a)(3) of this section, discharge of a debt of the debtor does not affect
the liability of any other entity on, or the property of any other entity for, such debt.” 11 U.S.C. § 524(e).
906 See id. (explaining that exculpation “does not affect the liability of these parties, but rather states the standard of liability under
the Code.”). See also In re Metromedia Fiber Network, Inc., 416 F.3d 136, 227 (2d. Cir. 2005).
907 In re DBSD N. Am., Inc., 419 B.R. 179, 217 (Bankr. S.D.N.Y. 2009), aff ’d, 2010 WL 1223109 (S.D.N.Y Mar. 24, 2010), aff ’d in part,
rev’d in part, 627 F.3d 496 (2d Cir. 2010).
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
chapter 11 case or their recoveries under the plan. The Commissioners debated objective factors to
determine whether a party sufficiently contributed to the process to be included in the exculpatory
clause, but determined that a fact-intensive analysis would work best. They also emphasized that this
limited immunity was not intended to protect bad actors, but rather to protect only those parties who
act in good faith and who should be protected against claims relating to matters that should be resolved
once the plan is confirmed and becomes effective.
The Commissioners discussed whether exculpatory clauses should protect the identified parties
from simple negligence or something more. The Commission determined that immunity for
conduct arguably constituting simple negligence should be subject to exculpation. It was not able to
agree on the desirability of allowing exculpation for gross negligence or other standards of conduct,
but believed that the parties and the court should make such decisions based on the facts of the
case and public policy considerations. The Commission voted to recommend amendments to the
Bankruptcy Code to clarify the permissibility of exculpatory clauses consistent with these principles
and properly disclosed in the disclosure statement and plan.
3. Third-Party Releases
Recommended Principles:
16
1, 20
ber 2 of third-party
seek ovem
approval
on N
A debtor or plan proponent should be permitted to
ved
releases in connection with the solicitation and iconfirmation of the chapter 11
arch
363
plan. Such third-party releases should -35 clearly and conspicuously highlighted
. 14 be
, No
rown
and explained in the plan. and the disclosure statement, identifying the proposed
B
hv
xset
scope of, andd parties to be covered by, the releases. The court should approve
n Bli
i
cite
any such third-party releases based on evidence presented at the hearing and in
accordance with the factors set forth below.
In reviewing a proposed third-party release included in a chapter 11 plan, the
court should consider and balance each of the following factors: (i) the identity
of interests between the debtor and the third party, including any indemnity
relationship, and the impact on the estate of allowing continued claims against the
third party; (ii) any value (monetary or otherwise) contributed by the third party
to the chapter 11 case or plan; (iii) the need for the proposed release in terms of
facilitating the plan or the debtor’s reorganization efforts; (iv) the level of creditor
support for the plan; and (v) the payments and protections otherwise available to
creditors affected by the release. In a case involving the application of third-party
releases to creditors and interest-holders not voting in favor of the plan, the court
should give significant weight to the last of these factors.
A proposed release of a debtor’s affiliates in the chapter 11 plan should be subject
to the same review and approval process proposed above for general third-party
releases in these principles.
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
Third-Party Releases: Background
A confirmed chapter 11 plan “discharges the debtor from any debt that arose before the date of such
confirmation.”908 The discharge voids any judgments, and enjoins collection and similar actions,
asserting personal liability against the debtor based on debts discharged under the plan.909 Section
524(e) also provides that “[a] discharge of a debt of the debtor does not affect the liability of any
other entity on, or the property of any other entity for, such debt.”910 Courts and plan proponents
often grapple with the scope and application of this limitation under section 524(e) in the context
of third-party releases included in a chapter 11 plan. The Bankruptcy Code recognizes an exception
to this limitation for debtors establishing trusts for asbestos claimants; in those cases, the court may
enter an order enjoining actions against nondebtor parties.911
A release provision in a chapter 11 plan essentially relieves the identified nondebtor parties of any
liability for any claims or causes of actions that third parties might hold against them. In a chapter
11 plan, a release may seek to cover the debtor’s directors and officers, an unsecured creditors’
committee and its members, a nondebtor plan proponent, a plan sponsor, the debtor’s lenders and
their agents, and other parties who may have been actively engaged in the chapter 11 case and
perhaps made contributions to the process.912 The release may encompass any and all claims or
causes of action, or resulting liability, of these nondebtor parties. The release may be binding on
only those third parties who consent to the release or who vote in favor of (or abstain from voting
on) the plan and the release; it may also be binding on all third parties 21,the1release is approved in
if 20 6
ber
vem
connection with confirmation of the plan.913
n No
o
ived
arch
363
Some commentators assert that section o. 14-35 prohibits all third-party releases, regardless of their
524(e)
N
wn,
scope or the parties purportedly rbound by the provision. Two circuits, the Ninth and the Tenth,
.Bo
eth v
s
have adopted thisitstrictBlix of third-party releases.914 Specifically, the Ninth Circuit has stated: “The
in view
c ed
bankruptcy court lacks the power to confirm plans of reorganization which do not comply with the
908 11 U.S.C. § 1141(d)(1)(A).
909 Id. § 524(a). Specifically, section 524(a) provides that a discharge “voids any judgment at any time obtained, to the extent that
such judgment is a determination of the personal liability of the debtor with respect to any debt discharged under section 727,
944, 1141, 1228, or 1328 of this title, whether or not discharge of such debt is waived.” Id.
910 11 U.S.C. § 524(e).
911 11 U.S.C. § 524(g). See generally Written Statement of Professor S. Todd Brown, SUNY Buffalo Law School Before the ABI
Comm’n to Study the Reform of Chapter 11 (Nov. 7, 2013) (discussing issues related to resolution of asbestos claims), available at
Commission website, supra note 55.
912 Nondebtor releases for insiders such as officers and directors may be subject to more rigorous scrutiny, in part because “[t]hose
who benefit from this type of release are most likely the ones asserting that the debtor will be irreparably harmed without it.”
Elizabeth Gamble, Nondebtor Releases in Chapter 11 Reorganizations: A Limited Power, 38 Fordham Urb. L.J. 821, 840 (2011)
(analogizing to Spach v. Bryant, 309 F.2d 886 (5th Cir. 1962) and noting that bankruptcy court must apply “careful attention and
special scrutiny when the claimants are officers, directors or stockholders of the corporate bankrupt”). See also Hopper v. Am.
Nat’l Bank of Cheyenne, Wyo. (In re Smith-Chadderdon Buick, Inc.), 309 F.2d 244, 247 (10th Cir. 1962) (“A claim presented by
an officer or director of the bankrupt is subjected to rigorous scrutiny and the claimant must prove good faith and fairness in the
transaction”).
913 “[T]he provisions of a confirmed plan bind the debtor, any entity issuing securities under the plan, any entity acquiring property
under the plan, and any creditor, equity security holder, or general partner in the debtor, whether or not the claim or interest
of such creditor, equity security holder, or general partner is impaired under the plan and whether or not such creditor, equity
security holder, or general partner has accepted the plan.” 11 U.S.C. § 1141(a). See also Sharon L. Levin et al., The WaMu Lesson:
Craft Your Release Carefully, Law360, Jan. 28, 2011 (discussing rejection of releases in chapter 11 cases of Washington Mutual Inc.
and WMI Investment Corp. ).
914 See Resorts Int’l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1402 (9th Cir. 1995), cert. denied, 517 U.S. 1243 (1996)
(holding that section 524(e) precludes bankruptcy courts from discharging the liabilities of nondebtors); Am. Hardwoods, Inc.
v. Deutsche Credit Corp. (In re Am. Hardwoods, Inc.), 885 F.2d 621, 625 (9th Cir. 1989) (same); Underhill v. Royal, 769 F.2d
1426, 1432 (9th Cir. 1985) (“Section 524(e) precludes discharging the liabilities of nondebtors.”). See also Landsing Diversified
Props.-II v. First Nat’l Bank & Trust Co. of Tulsa (In re W. Real Estate Fund, Inc.), 922 F.2d 592, 601 (10th Cir. 1990) (holding
that nondebtor release “improperly insulate[s] nondebtors in violation of section 524(e)”), modified, Abel v. West, 932 F.2d 898
(10th Cir. 1991).
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
applicable provisions of the Bankruptcy Code. . . . This court has repeatedly held, without exception,
that § 524(e) precludes bankruptcy courts from discharging the liabilities of nondebtors.”915 The
Ninth Circuit has, however, recognized that nondebtor releases may be permitted in asbestos claims
cases pursuant to specific statutory authority.916 The Fifth Circuit also appears to be more restrictive
than permissive with respect to third-party releases.917
The other circuits that have considered the issue focus instead on section 105(a) of the Bankruptcy
Code, which gives the court authority to “issue any order, process, or judgment that is necessary
or appropriate to carry out the provisions of [the Bankruptcy Code].”918 These courts are willing
to consider and approve third-party releases under appropriate circumstances. To make this
determination, these courts undertake a fact-intensive inquiry analyzing factors such as any
contractual or consensual basis for the releases, the role and contributions of the nondebtor parties
in the chapter 11 case, the protections afforded by the plan for third parties bound by the releases,
and whether the releases are necessary for the debtor’s effective reorganization. 919
Courts adopting a permissive approach to third-party releases do not find section 524(e) as
impermeable barrier.920 They generally point out that section 524(e) does not contain “language of
prohibition” and thus should not be interpreted to limit the court’s power under section 105(a).921
They also may distinguish the releases based on the facts of the given case, such as when the third
16
1, 20
ber 2
915 Resorts Int’l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1402 (9th Cir. 1995), m denied, 517 U.S. 1243 (1996).
ve cert.
n No
916 Id. at 1402, n. 6 (“The Bankruptcy Reform Act of 1994 added § 524(g) to the [Bankruptcy] Code. That section provides that
ed o connection with a reorganization plan may
in asbestos cases, if a series of limited conditions are met, an injunctionhiv
rc issued in
63 a
preclude litigation against third parties.”).
-353
4
917 The Fifth Circuit view on nondebtor third-party n, No. 1and exculpation clauses is less clear. In several cases, the court has
releases
ow
rejected such third-party releases, particularlyrwhen such releases are nonconsensual. See, e.g., Bank of N.Y. Trust Co. v. Official
B
h v.
Unsecured Creditors’ Comm. (InliresPac. Lumber Co.), 584 F.3d 229, 253 (5th Cir. 2009); Feld v. Zale Corp. (In re Zale Corp.),
x et
nB
62 F.3d 746, 760 (5th Cir.ted i However, some Fifth Circuit cases suggest that the court does not categorically disprove of such
1995).
ci
918
919
920
921
releases and may approve them in certain limited circumstances. Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm.
(In re Pac. Lumber Co.), 584 F.3d 229, 253 (5th Cir. 2009) (suggesting that nondebtor releases are “most appropriate as a method
to channel mass claims toward a specific pool of assets”); Feld v. Zale Corp. (In re Zale Corp.), 62 F.3d 746, 760 (5th Cir. 1995)
(suggesting that a release may be approved where the third party nondebtor liability is not extinguished but instead channeled to
a settlement fund). But see Ad Hoc Group of Vitro Noteholders v. Vitro S.A.B. de C.V. (In re Vitro S.A.B. de C.V.), 701 F.3d 1031,
1062 (5th Cir. 2012) (stating that “[the Fifth Circuit] has firmly pronounced opposition to [nonconsensual nondebtor] releases”).
The Fifth Circuit’s decision in Vitro contains very strong language suggesting a complete prohibition on nonconsensual thirdparty releases. Nevertheless, even in Vitro, the Fifth Circuit acknowledges that specific, rather than general, third-party releases
may be permissible under certain limited circumstances: “We have distinguished other cases for including general, as opposed
to specific, releases. As a result, Republic Supply Co. provides no guidance where, as here, we are confronted not by a specific
release, but by a general release of all the non-debtor subsidiaries.” Id. at 1068–69 (citations omitted). Accordingly, the Fifth
Circuit appears to lean more toward the restrictive approach of the Ninth and Tenth Circuits but may not be as all-inclusive in
its prohibition. In addition, the Fifth Circuit has actually approved of releases in some limited circumstances, although the court
has utilized different statutory authorization to do so. See, e.g., Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm.
(In re Pac. Lumber Co.), 584 F.3d 229 (5th Cir. 2009) (using section 1103(c) to approve exculpation provisions for members of
the creditors’ committee but rejecting other release provisions).
See, e.g., MacArthur Co. v. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89 (2d Cir. 1988), cert. denied, 488
U.S. 868 (1988) (noting that section 105(a) “has been construed liberally to enjoin suits that might impede the reorganization
process”).
Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136, 142 (2d Cir.
2005) (“Courts have approved nondebtor releases when: the estate received substantial consideration; the enjoined claims were
‘channeled’ to a settlement fund rather than extinguished; the enjoined claims would indirectly impact the debtor’s reorganization
‘by way of indemnity or contribution’; and the plan otherwise provided for the full payment of the enjoined claims. Nondebtor
releases may also be tolerated if the affected creditors consent.”) (citations omitted). “But this is not a matter of factors and
prongs. No case has tolerated nondebtor releases absent the finding of circumstances that may be characterized as unique.” Id.
See also Gillman v. Cont’l Airlines (In re Cont’l Airlines), 203 F.3d 203, 212 (3d Cir. 2000) (indicating that nondebtor releases
may be appropriate in extraordinary cases); Feld v. Zale Corp. (In re Zale Corp.), 62 F.3d 746, 761–62 (5th Cir. 1995) (holding
that nondebtor releases could be issued because case satisfied “unusual circumstances” requirement; released parties provided
substantial consideration to the estate and the release was a key provision of the plan).
See generally Ryan M. Murphy, Shelter from the Storm: Examining Chapter 11 Plan Releases for Directors, Officers, Committee
Members, and Estate Professionals, 20 J. Bankr. L. & Prac. 4 Art. 7, Sept. 2011 (general review of case law addressing third-party
releases).
Monarch Life Ins. Co. v. Ropes & Gray, 65 F.3d 973, 979 (1st Cir. 1995) (citations omitted).
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ABI Commission to Study the Reform of Chapter
party claims subject to the release are not extinguished, but channeled to allow recovery from
separate assets, which commonly means the nondebtor did not receive a complete discharge.922
Notably, some courts have held that the court’s power under section 105(a) in the nondebtor release
context should be exercised only when there are unique circumstances. The U.S. Supreme Court also
has, in dicta, provided an additional factor to consider: whether the claims against the nondebtor
third party are derivative of the debtor’s wrongdoing.923
Third-Party Releases: Recommendations and Findings
The Commission considered this basic question: Should the Bankruptcy Code prohibit third-party
releases in chapter 11 plans? The Commission agreed that a blanket prohibition on third-party
releases was inadvisable. The Commissioners discussed case examples and particular fact patterns
in which third-party releases facilitated a confirmable plan and ultimately benefited all stakeholders.
They recognized, however, that third-party releases might not be appropriate in every chapter 11
case. For example, a release provision could be overly broad or not really necessary, particularly
in cases where the benefits of the release to the estate are nominal, but the harm to creditors is
significant. Accordingly, the Commission rejected carte blanche approval of third-party releases, as
well as a presumption in favor of such releases.
The Commissioners discussed the competing considerations underlying the third-party release
016
debate. A debtor may need the assistance of nondebtor parties tober 21, 2its reorganization. This
effect
m
Nove
assistance may be in the form of service, collaboration,efunding, business commitments, or other
d on
rchiv
means that allow the debtor to achieve its objectivesain the chapter 11 case or in its postconfirmation
63
-353
14
operations. Nondebtor parties mayownreluctant to contribute to the plan or the debtor’s reorganization
be , No.
r
B
efforts if the nondebtorlixseth v.
party might be exposed to liability or will have ongoing liability despite
nB
ted i
confirmation ofcithe chapter 11 plan. On the other hand, limiting creditors’ recoveries to those
provided under the plan may substantially change the nature of their rights against nondebtor
parties, and in turn further reduce their overall recoveries. In these instances, from the creditors’
perspective, nondebtor parties may be receiving a windfall at the creditors’ expense.
In light of these considerations, the Commission methodically worked through the various issues
that arise in the context of third-party releases. The Commissioners started from the premise that
consensual third-party releases — those releases binding only on creditors who expressly consent
to the release through a vote on the plan that includes consent to the third-party release, a separate
indication on the ballot that the creditor consents to the third-party release, or a separate agreement
from the creditor in which it consents to the release — should be enforceable. The Commission
disagreed with the Ninth and Tenth Circuits’ position that contractual agreements between the
affected parties regarding a third-party release should not be enforced. The Commissioners found
these kinds of contractual agreements outside the scope of section 524(e) and consistent with the
underlying policies of the Bankruptcy Code.
922 Feld v. Zale Corp. (In re Zale Corp.), 62 F.3d 746, 760–61 (5th Cir. 1995).
923 Travelers Indemnity Co. v. Bailey, 557 U.S. 137, 155 (2009) (“Our holding is narrow. We do not resolve whether a bankruptcy
court . . . could properly enjoin claims against nondebtor insurers that are not derivative of the debtor’s wrongdoing.”).
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Bankruptcy Institute
The Commissioners then reviewed the different kinds of nonconsensual third-party releases
commonly included in chapter 11 plans. The Commissioners observed the challenges in crafting a
bright-line test or general approval standard for such nonconsensual releases. They then considered
the different tests used by courts to evaluate nonconsensual third-party releases. Specifically, the
Commissioners analyzed the multi-factor tests used by the courts in the Dow Corning and the
Master Mortgage cases, respectively. For example, the court in Dow Corning stated:
We hold that when the following seven factors are present, the bankruptcy court may
enjoin a nonconsenting creditor’s claims against a nondebtor: (1) There is an identity
of interests between the debtor and the third party, usually an indemnity relationship,
such that a suit against the nondebtor is, in essence, a suit against the debtor or will
deplete the assets of the estate; (2) The nondebtor has contributed substantial assets
to the reorganization; (3) The injunction is essential to reorganization, namely, the
reorganization hinges on the debtor being free from indirect suits against parties who
would have indemnity or contribution claims against the debtor; (4) The impacted
class, or classes, has overwhelmingly voted to accept the plan; (5) The plan provides
a mechanism to pay for all, or substantially all, of the class or classes affected by the
injunction; (6) The plan provides an opportunity for those claimants who choose not
to settle to recover in full and; (7) The bankruptcy court made a record of specific
factual findings that support its conclusions.924
6
, 201
r2
The court in Master Mortgage articulated a five-factor test that considers:b(1) 1 identity of interest
m e the
Nove
on
between the debtor and the third party, usually an indemnitydrelationship, such that a suit against
ive
arch
the nondebtor is, in essence, a suit against the debtor 63 will deplete assets of the estate; (2) whether
53 or
14-3
No. to the reorganization; (3) whether the injunction is
the nondebtor has contributed substantial assets
wn,
. Bro
eth v a substantial majority of the creditors agree to such injunction
essential to reorganization; (4)xwhether
i s
in Bl
citedthe impacted class or classes have “overwhelmingly” voted to accept the
— specifically, whether
proposed plan treatment; and (5) whether the plan provides a mechanism for the payment of all, or
substantially all, of the claims of the class or classes affected by the injunction.925
The Commission considered the application of each factor to different scenarios, including the
relationship of the factors to nonconsensual releases. It agreed that in the context of nonconsenting
creditors or classes of claims, the factors focusing on the contributions of nondebtor parties,
percentage recoveries by the affected creditors, and mechanisms established to facilitate recoveries
to those creditors were of particular importance, with specific emphasis on the last of these factors.
On balance, the Commission recommended a standard based on the Master Mortgage factors and
rejected application of the Dow Corning factors. It further determined that the Master Mortgage
factors adequately captured the careful review required in these cases and declined to incorporate
separate identification of unique or unusual circumstances.
924 In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002), cert. denied, 537 U.S. 816 (2002).
925 In re Master Mortg. Inv. Fund Inc., 168 B.R. 930 (Bankr. W.D. Mo. 1994).
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ABI Commission to Study the Reform of Chapter
F. Plan Voting and Confirmation Issues
1. Class Acceptance Generally
and for Cramdown Purposes
Recommended Principles:
The numerosity requirement of section 1126(c) of the Bankruptcy Code should
be replaced with a “one creditor, one vote” concept. Accordingly, a class of claims
should be treated as voting in favor of the chapter 11 plan if the plan is accepted
by: (i) creditors (other than an entity designated under section 1126(e)) holding
at least two-thirds in amount of the allowed claims in such class; and (ii) more
than one-half in number of the creditors (other than an entity designated under
section 1126(e)) holding allowed claims in such class. For purposes of this
requirement and voting on a plan, (a) a creditor holding separate claims in different
capacities (e.g., as an indenture trustee and as an individual creditor) should be
able to vote once in each capacity; and (b) the “one creditor, one vote” voting rule
includes and aggregates all claims in a particular class held by an entity and its
16
affiliates (as defined in section 101(2)) that are subject to rcommon investment
1, 20
be 2
ovem
management.
on N
ived
arch
363 should not require
The confirmation of a chapter111 5plan
-3
o. 4
n, N of claims impaired under the
the plan by at leastv.one w
Bro class
th
lixse should be deleted.
section 1129(a)(10)
in B
cited
the acceptance of
plan. Accordingly,
Class Acceptance Generally and for Cramdown Purposes: Background
In general, creditors whose rights are impaired by the chapter 11 plan are entitled to vote to accept
or reject the plan.926 Although creditors vote on an individual basis, the plan typically groups claims
into classes and proposes particular treatment (e.g., terms and amount of recoveries) for each class.
Section 1122(a) provides that “a plan may place a claim or an interest in a particular class only if such
claim or interest is substantially similar to the other claims or interests of such class.” Accordingly,
a debtor or plan proponent attempts to group similarly situated creditors in the same class, though
strategic considerations may complicate this analysis.
The classification of claims is important for at least two reasons. First, class acceptance determines
creditor support for the plan. Specifically, section 1126(c) provides, “A class of claims has accepted a
plan if such plan has been accepted by creditors, other than any entity designated under subsection
(e) of this section, that hold at least two-thirds in amount and more than one-half in number of the
926 11 U.S.C. § 1126(a), (f) (subsection (a) establishes general rights of holders of claims and interests to vote on plan; subsection (f)
provides that unimpaired classes “and each holder of a claim or interest of such class, are conclusively presumed to have accepted
the plan, and solicitation of acceptances with respect to such class from the holders of claims or interests of such class is not
required”).
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Bankruptcy Institute
allowed claims of such class held by creditors, other than any entity designated under subsection
(e) of this section, that have accepted or rejected such plan.” Second, the debtor or plan proponent
generally needs at least one accepting impaired class of creditors to cram down the plan under
section 1129(b).
The two requirements of section 1126(c) — i.e., two-thirds in amount and more than one-half in
number of allowed claims — set the minimum support required for the class as a whole to accept
the plan. If the class accepts and the plan is confirmed, even creditors in the class who voted against
the plan, or abstained from voting, are bound by the plan. As such, the level of approval required for
class acceptance is often heavily scrutinized and contested. Of the two requirements, the numerosity
requirement (more than one-half in number of allowed claims) is the more difficult to interpret and
apply in many cases. For example, under appropriate circumstances, a single creditor may exercise
more than one vote so long as the court determines that the claims are sufficiently “separate” to
warrant more than one vote.927 The determination of sufficient separateness is based on whether the
claims in question derive from independent underlying transactions with the debtor, and whether
separate proofs of claim were, or will be, filed for the claims.928 Notably, this determination may
resolve whether the class accepts or rejects the plan.929
Similarly, the requirement that one impaired class of creditors accepts the plan under section 1129(a)
(10) may prevent a debtor or plan proponent from confirming a plan under the cramdown provisions
16
of section 1129(b). Although some courts and commentators suggest that rsection 1129(a)(10) was
1, 20
be 2
intended to ensure that a plan had some creditor support, neitherovem legislative history nor the
n N the
ed o
930
chivthe variation in class composition and
given
Bankruptcy Code indicate such a purpose. Notably, 3 ar
3536
. 14- non-accepting class does not necessarily equate
the different motives and objectives of creditors, a
, No
own
v. BrSome commentators have questioned the section’s continued
to lack of creditor support for xseth
the plan.
Bli
utility in light of the barriers to confirmation and the creditor holdup value it creates in many chapter
ed in
cit
11 cases.
927 Figter Ltd. v. Teachers Ins. & Annuity Ass’n of Am. (In re Figter Ltd.), 118 F.3d 635 (9th Cir. 1997), cert. denied, 522 U.S. 996
(1997); In re Gilbert, 104 B.R. 206 (Bankr. W.D. Mo. 1989). See also Wendell H. Adair, Jr. & Kristopher M. Hansen, One Claim,
One Vote: The Purchase of Claims to Avoid Cramdown, J. CORP. RENEWAL, Jul. 1, 2000 (“Once again citing the voting formula
contained in Section 1126(c) of the Bankruptcy Code, the court held that acceptance or rejection of a plan by a class of creditors
is determined by “the number of claims, not the number of creditors, that actually vote for or against a plan.”), available at http://
www.turnaround.org/Publications/Articles.aspx?objectID=1294.
928 See, e.g., In re Gilbert 104 B.R. 206, 211 (Bankr. W.D. Mo. 1989). See also David M. Feldman & Keith R. Martorana, The Pervasive
Problem of Numerosity, Law360, June 2, 2010, available at http://www.gibsondunn.com/publications/Documents/FeldmanThePervasiveProblemOfNumerosity.pdf.
929 See In re Kreider, 2006 Bankr. LEXIS 2948 (Bankr. E.D. Pa. Sept. 27, 2006). In Kreider, the creditor class consisted of four
American Express funds and five completely unrelated entities; the five unrelated entities voted to accept the plan and the four
American Express funds voted to reject the plan. The court rejected the debtor’s calculation that the voting resulted in five votes
in favor and one against the plan (counting the American Express funds as one vote against the plan). Id. at *8–9. The court
explained: “[I]t appears that the Debtors’ unstated premise — i.e., multiple claims voted by a single creditor are counted as a
single vote for purpose of the ‘more than one-half in number of allowed claims’ requirement for acceptance of a plan set forth in
11 U.S.C. § 1126(c) — is simply incorrect.” Id. at *9.
930 See generally S. Rep. No. 95-989, at 128 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5914 (stating that at least one class must
accept the plan). See, e.g., Clark Boardman Callaghan & Randolph J. Hines, Bankruptcy Review Commission Fails to Achieve
Significant Chapter 11 Reform, 8 Norton Bankr. L. Adviser 1, Aug. 1997 (“No case law or commentator has identified any
important social or reorganization policy that [section 1129(a)(10)] serves. The historical genesis for the requirement reveals it
to be a vestigial mutation that serves no evolutionary purpose.”); Scott F. Norberg, Debtor Incentives, Agency Costs, and Voting
Theory in Chapter 11, 46 U. Kan. L. Rev. 507, 537–38 (1998) (noting that neither the legislative report to the 1978 version of the
Bankruptcy Code nor 1984 revisions provide insights concerning the purpose of section 1129(a)(10)). Cf. In re Windsor on the
River Assocs., Ltd., 7 F.3d 127, 131 (8th Cir. 1993) (interpreting legislative history to suggest that the purpose of section 1129(a)
(10) “is to provide some indicia of support by affected creditors and prevent confirmation where such support is lacking”).
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ABI Commission to Study the Reform of Chapter
Class Acceptance Generally and for Cramdown Purposes: Recommendations
and Findings
The composition of a creditor class for plan purposes can significantly impact a chapter 11 case.
A debtor or a plan proponent may consider whether classes can be structured to isolate or dwarf
dissenting creditors, or to ensure that creditors supporting the plan dominate the class. Likewise,
creditors seeking to delay or disrupt confirmation can raise questions concerning why certain
creditors were, or were not, included in a particular class; they also can diversify or strategically
purchase claims so that they hold blocking positions in one or more classes. In sum, claims
classification and voting under section 1122 and 1126 are subject to significant gamesmanship.931
The Commissioners discussed the distraction and diversion of resources caused by this gamesmanship.
The Commissioners noted that the original purpose of classification was to provide equal treatment
for similarly situated creditors. Likewise, the dollar amount and numerosity requirements of section
1126(c) were intended to protect minority holders. Nevertheless, some of the Commissioners
observed that changes in debtors’ capital structures and the dynamics of chapter 11 cases arguably
decreased the relevance of these objectives. In particular, these Commissioners asserted that a nexus
no longer exists between minority protection and the numerosity requirement. A class dominated by
smaller claims may face an apathy problem, in which inaction by creditors fails to give any creditor
a meaningful voice in the vote.932 The consolidation of claims by creditors eliminates the “small”
or typical minority holder in many cases. In addition, strategic purchases 2016 same or affiliated
, by the
er 21
emb
v
entities of “separate” claims can skew the counting for purposesoof numerosity.
nN
o
ived
arch
5363
The anecdotal evidence that the numerosity requirement served, at best,
14-3
No.
n,
determining class support tfor. Brow persuaded the Commissioners. They
a plan
ehv
s
alternatives to theed in Blix
numerosity requirement, including the elimination of the
cit
a nominal role in
considered various
voting requirement
completely, maintaining the status quo, distinguishing among types of creditors (e.g., financial
instrument holders and all others), and introducing additional disclosures to address the perceived
empty voting problem, as discussed in Section VI.F.2, Assignment of Voting Rights. In discussing
the alternatives, the Commissioners found the “one creditor, one vote” rule most democratic and
less susceptible to abuse than the current numerosity requirement. Although identifying the “one
creditor” for purposes of this requirement may still raise issues, the Commissioners believed that
these concerns could be mitigated by treating all affiliated entities under common investment
management as a single creditor, and expressly recognizing the different capacities (e.g., indenture
trustee and lender) in which a single creditor may hold claims. The Commissioners emphasized
931 The Commission heard testimony in favor of clarifying the section 1122(a) standard for classification of “substantially similar”
claims. See, e.g., First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing
at Commercial Fin. Ass’n Annual Meeting, at 14 (Nov. 15, 2012) (“While the Bankruptcy Code mandates that similarly situated
creditors be classified for plan purposes in substantially similar classes, the Code offers no guidance as to how to determine
which claims are in fact “substantially similar.” As a result, creditors in general, and secured creditors in particular, do not often
get the benefit of their contractual bargain with the debtor. Indeed, it is the debtor who, in the first instance, makes the economic
determination of the creditors’ rights when it comes to classification of claims based upon the specific prepetition contractual
agreements with the debtor, rather than merely whether the claim is secured or unsecured. All too often, factors come into play
in determining classification of claims that should be irrelevant, such as motivation of the parties, purchase price and third-party
rights.”), available at Commission website, supra note 55.
932 Wendell H. Adair, Jr., Kristopher M. Hansen, One Claim, One Vote: The Purchase of Claims to Avoid Cramdown, J. CORP.
RENEWAL, Jul. 1, 2000 (“Once again citing the voting formula contained in Section 1126(c) of the Bankruptcy Code, the
court held that acceptance or rejection of a plan by a class of creditors is determined by “the number of claims, not the
number of creditors, that actually vote for or against a plan.”), available at http://www.turnaround.org/Publications/Articles.
aspx?objectID=1294.
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that the “common investment management” requirement for aggregation was intended to exclude
situations in which affiliates are not only separate entities, but also have different decision-makers
overseeing the claims being asserted against the estate. The Commission agreed that the “one creditor,
one vote” rule should replace the current numerosity requirement in section 1126(c).
The Commission also considered the impediment to confirmation created by sections 1129(a)(10)
and 1129(b), which require at least one accepting impaired class of creditors for the debtor or plan
proponent to achieve confirmation through the cramdown provisions of the Bankruptcy Code.933
The Commissioners debated the utility of section 1129(a)(10), focusing on whether the provision
protected creditor interests or simply allowed creditors to hold up the confirmation process. For
example, the Commissioners discussed cases with a limited number of impaired creditor classes
and a lender or other large creditor who purchases a sufficient number of claims in each class to
control the plan vote. By voting against the plan in each of these classes, that single creditor can
block a cramdown because there will be no accepting impaired class of creditors for purposes of
section 1129(a)(10).
The Commissioners also highlighted issues raised by artificial impairment, in which the debtor
or plan proponent strategically grouped claims to achieve at least one accepting impaired class of
creditors. Courts are split concerning whether the debtor or plan proponent can achieve impairment
of a class through minor changes in the terms of the creditor’s claim or repayment rights or whether
16
impairment follows only meaningful economic changes to the debt. For example, the Fifth Circuit
1, 20
ber 2
em
(agreeing with the Ninth Circuit, but declining to follow the Eighth vCircuit) held that artificial or
n No
ed o
rchiv
minor impairment was sufficient for purposes of section 1129(a)(10).934 The Fifth Circuit noted that
63 a
-353
such an approach aligned with the policy n, No. 14
of encouraging reorganization and that to hold otherwise
w
. Bro
vinquiry and materiality requirement into section 1129(a)(10)”
would be to “shoehorn[] a motive
eth
Blixs
As in
that did not exist.935 citednoted by one well-respected commentator: “Congress apparently did not
consider the impact of some creditors having more than one vote. [Bankruptcy] Code § 1129(a)
(10) causes debtors to attempt to create friendly creditors, to impair creditor classes that need not be
impaired and to manipulate classification systems.”936
The Commissioners acknowledged the potential gating role served by section 1129(a)(10) —
ensuring that some creditors whose claims were impaired by the plan supported its confirmation.
They discussed the validity of this inquiry and the integrity it potentially added to the confirmation
process. They debated the advantages and disadvantages of retaining the requirement, particularly in
light of the potential abuses of the section by both creditors and debtors. They considered alternatives,
such as retaining section 1129(a)(10) on a per plan basis937 or only in single asset real estate cases.938
933 Written Statement of Daniel Kamensky on Behalf of Managed Funds Association: LSTA Field Hearing Before the ABI Comm’n to
Study the Reform of Chapter 11 (Oct. 17, 2012) (“Decisions such as this invite management manipulation of the classification
rules for strategic purposes. This, in turn, creates uncertainty regarding creditor recovery and treatment under a plan. This is of
particular concern for financial creditors.”).
934 W. Real Estate Equities, L.L.C. v. Vill. at Camp Bowie I, L.P. (In re Vill. at Camp Bowie I, L.P.), 710 F.3d 239 (5th Cir. 2013).
935 Id.
936 Norton Bankr. L. & Prac. 3d § 113:10 (Jan. 2013).
937 In Tribune, the court held that section 1129(a)(10) required an impaired creditor class of each debtor in the corporate organization
to vote for the plan instead of a single impaired creditor class across the corporate organization (i.e., among all affiliated debtors)
in the joint plan. In re Tribune Co., 464 B.R. 126 (Bankr. D. Del. 2011). Prior cases had held that in a joint plan only one accepting
class in a joint plan was required. See, e.g., JPMorgan Chase Bank, N.A. v. Charter Commc’ns Operating, LLC (In re Charter
Commc’ns), 419 B.R. 221 (Bankr. S.D.N.Y. 2009), aff ’d, 691 F.3d 476 (2d Cir. 2012), cert. denied, 133 S. Ct. 2021 (2013).
938 The Commission reviewed the application of section 1129(a)(10) in single asset real estate cases and agreed with the advisory
committee that, on balance, the section was an impediment to confirmation and subject to significant abuse. Both the
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ABI Commission to Study the Reform of Chapter
Ultimately, the Commission determined that the potential delay, cost, gamesmanship, and value
destruction attendant to section 1129(a)(10) in all cases significantly outweighed its presumptive
gating role. The Commission recommended eliminating section 1129(a)(10) in its entirety from the
Bankruptcy Code.
2. Assignment of Voting Rights
Recommended Principles:
The contractual assignment or waiver of voting rights in favor of senior creditors
under an intercreditor, subordination, or similar agreement should not be enforced.
Subordinated creditors should retain the right to vote on a plan (or their right to
be deemed to have done so under section 1126(g) of the Bankruptcy Code) and to
invoke the protections of section 1129(b).
The contractual assignment of voting rights in favor of an assignee or purchaser
of a claim against the estate should be enforced only to the extent of the portion
of the claim and economic interest also transferred to the assignee or purchaser.
For purposes of this principle, the holder of a claim should be the party entitled to
exercise the voting rights assigned or associated with the claim. 16
, 20
er 21
emb
Nov
d on
chive
3 ar
Assignment of Voting Rights: Background
3536
. 14, No
own
v. Br
Creditors may enter intoixseth
subordination agreements or intercreditor agreements prior to the debtor
in Bl
edcase. These agreements commonly address the priority of payment as between
filing its chapterc11
it
the creditors from the proceeds of shared collateral. These agreements also may address certain other
matters relating to the debtor and the collateral. For example, they may limit the junior creditors’
rights to (i) request adequate payment; (ii) offer or participate in postpetition financing for the
debtor; (iii) foreclose on the collateral; or (iv) vote on a chapter 11 plan in any chapter 11 case. The
last of these provisions may be accomplished through a waiver or assignment of the voting right
or underlying claim for voting purposes. Assignments of voting rights also occur between parties
outside of the subordination and intercreditor agreement context.
The assignment or waiver of voting rights raises several issues under the Bankruptcy Code. Section
510(a) of the Bankruptcy Code speaks to the enforceability of a prepetition subordination agreement,
providing that “[a] subordination agreement is enforceable in a case under this title to the same
extent that such agreement is enforceable under applicable nonbankruptcy. [law]”939 Courts generally
enforce the payment terms of subordination agreements, to the extent that the agreement is otherwise
enforceable under state law. Some courts question, however, whether creditors should be permitted to
affect or waive specific bankruptcy rights prior to, or in anticipation of, a bankruptcy filing.940
Commission and the advisory committee supported its elimination in single asset real estate cases.
939 11 U.S.C. § 510(c).
940 Sharon L. Levine et al., If You Assign Your Plan Vote — Mean It, Law360, July 9, 2013, 5:35 p.m. (discussing recent trends in
the enforcement of assignment provisions under subordination agreements). See also Edward Rust Morrison, Rules of Thumb
for Intercreditor Agreements, 2015 Ill. L. Rev. __, at *11 (forthcoming 2015) (suggesting that waivers and assignments in an
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Bankruptcy Institute
Courts that have declined to enforce assignments or waivers of voting rights in a chapter 11 case
focus on the voting provisions of section 1126 and emphasize that the section permits a “holder of
a claim . . . under section 502 of this title [to] accept or reject a plan.”941 These courts underscore
that the junior creditors are the holders of the claim and that, in turn, only those creditors may
exercise the right to vote on the debtor’s chapter 11 plan.942 Courts also question the ability of parties
generally to waive rights created by, and only available in a case under, federal bankruptcy laws.943
Other courts have enforced voting assignment or waiver provisions in subordination agreements.944
These courts read section 1126(c) more broadly, noting that it does not prohibit the delegation
of rights associated with claims held by a creditor. They also rely on the expressed language of
section 510(c) and Bankruptcy Rules 3018 and 9010 and emphasize that the only qualification to
enforcement of subordination agreements is that the agreements be enforceable under state law. As
one court explained, the Bankruptcy Rules “explicitly permit agents and other representatives to
take actions, including voting, on behalf of other parties.”945
Another issue that arises in the context of voting or claim assignments in chapter 11 cases is whether
the assignment decouples the economic and voting rights. This kind of decoupling — sometimes
referred to as the “empty creditor problem” — may change the interests or objectives of the party
actually exercising the vote. A party with no economic risk or stake in the chapter 11 estate may not
be a similarly situated creditor with others in the voting class. Similar concerns exist with a party
6
holding disproportionate voting and economic interests. Although the empty 201
1, creditor problem is
ber 2
also vem
typically discussed in the context of credit default swaps,946 it on Nocan arise in a simple claim or
ed
iv
arch
voting assignment agreement.
363
Assignment of
-35
o. 14
n, N
Brow
th v.
lixse
Voting B
in Rights: Recommendations
cited
and Findings
The Commission’s deliberations on assignments and waivers of voting rights focused largely on
two policy considerations: respecting the private contract rights of nondebtor parties and fostering
the underlying goals of chapter 11.947 The Commissioners observed that a simple response would
be to endorse freedom of contract principles among nondebtor parties. The Commission agreed,
however, that this response oversimplified the dilemma and was unsatisfactory in several respects.
The core issue concerns the impact that private ordering among nondebtor parties may have on the
debtor, the estate, and other stakeholders in the chapter 11 case.
941
942
943
944
945
946
947
intercreditor agreement should only be enforced if it is “unlikely to affect the outcome of the Chapter 11 process (sale versus
reorganization, or confirmation of one plan versus another) and primarily to affect the distributions of parties to the agreement.”)
(draft on file with Commission). See generally Tally M. Wiener & Nicholas B. Malito, On the Nature of the Transferred Bankruptcy
Claim, 12 U. Penn. J. Bus. L. 35 (2009) (discussing claims assignment in bankruptcy generally).
11 U.S.C. § 1126(a).
See, e.g., In re 203 N. LaSalle St. P’ship, 246 B.R. 325 (Bankr. N.D. Ill. 2000).
In re Hart Ski Mfg. Co., Inc., 5 B.R. 734 (Bankr. D. Minn. 1980).
See, e.g., Blue Ridge Investors II, LP v. Wachovia Bank, N.A. (In re Aerosol Packaging, LLC), 362 B.R. 43, 45–47 (Bankr. N.D. Ga.
2006).
Id.
See, e.g., Henry T.C. Hu & Bernard Black, Debt, Equity and Hybrid Decoupling: Governance and Systemic Risk Implications, 14
Eur. Fin. Mgmt. 663, 680 (2008) (“Debt decoupling involving the unbundling of the economic rights, contractual control rights,
and legal and other rights normally associated with debt, through credit derivatives and securitization. Corporations can have
empty and hidden creditors, just as they can have empty and hidden shareholders.”); Henry T.C. Hu & Bernard Black, Equity and
Debt Decoupling and Empty Voting II: Importance and Extensions, 156 U. Pa. L. Rev. 625, 728–35 (2008).
Written Statement of Daniel Kamensky on behalf of Managed Funds Association: LSTA Field Hearing Before the ABI Comm’n to
Study the Reform of Chapter 11 (Oct. 17, 2012) (“Specifically, lenders and investors must have confidence in their ability to realize
upon their investment in the event of a bankruptcy. This includes reliance on the enforcement of contracts, applicable state and
federal legal rights, including enforcement of lien priority, and the absolute priority rule.”).
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ABI Commission to Study the Reform of Chapter
The Commissioners discussed the potential impact of voting assignments on the chapter 11 case. They
evaluated situations in which senior creditors influence the plan structure or control the vote on the
plan through the assignment provision.948 Such conduct can affect valuations of the debtor’s assets,
the debtor’s postconfirmation operations and capital structure, and the value ultimately available
for distributions to other stakeholders.949 The Commissioners generally were uncomfortable with
nondebtor parties being able to change, arguably in very substantive ways, the rights of the debtor
and other stakeholders in the chapter 11 case.
The Commissioners also evaluated the classification and voting provisions of the Bankruptcy Code.
Many of the Commissioners agreed with courts that have held that section 1126(a) is relevant to the
enforceability of voting assignments. Although the section does not address delegation of rights, the
reference to “holder of the claim” suggests some nexus between the vote and the holder of the legal
right to payment on the claim. They recognized the language of section 510(c), which expressly permits
the enforceability of subordination agreements. Many of the Commissioners noted, however, that the
provisions included in subordination and intercreditor agreements have significantly expanded beyond
the mere ordering of payment among nondebtor parties.950 The Commission thus considered whether
prohibiting voting assignments would significantly affect the payment priority agreed to by the parties
under the subordination agreement. Some of the Commissioners argued that allowing junior creditors
to vote on the plan may give those creditors bargaining power or control over the plan process, as they
would have incentive to increase distributions to their class to provide for repayment of the senior
6
, 201
debt and some value for the junior debt. On balance, the Commission1found that preserving the
ber 2
vem
agreed-to payment priority was the crucial element of subordination agreements, and that prohibiting
n No
ed o
iv
arch
assignments or waivers of voting rights would not6disturb such a feature.
53 3
-3
o. 14
n, N
row
The Commissioners alsoxseth v. B and discussed many of the same concerns with partial claim
identified
li
nB
assignments andcivoting assignments outside the subordination agreement context. The Commission
ted i
determined that requiring economic and voting rights (in whole or in part) to be transferred as a package
was aligned with the relevant sections of the Bankruptcy Code and mitigated to some extent the empty
creditor problem. The Commission also agreed that the holder of the assigned claim should be entitled
to exercise any transferred voting rights and may agree to exercise its vote as directed by the beneficial
owner (e.g., a bond held in street name is held by a broker, but voted as directed by the account-holder,
a holder of a claim that is subject to a participation interest may vote as directed by the participant). The
Commissioners recognized that simply requiring transfers of voting and economic rights in the same
proportion would not necessarily remedy those situations in which a creditor has hedged its economic
losses in the chapter 11 case through a derivative or swap product. Nevertheless, the Commission
determined that any potential issues in that context could be best resolved by the court on a case-by-case
basis under the new principles addressing designation of votes under section 1126(e).
948 See Morrison, Rules of Thumb for Intercreditor Agreements, supra note 940, at *7–8 (noting that intercreditor agreements “reduce
decisionmaking costs in the event of default, but also give senior lenders power to exploit subordinated creditors and potentially
other investors in the firm”).
949 Morrison, Rules of Thumb for Intercreditor Agreements, supra note 940 (discussing In re SW Boston Hotel Venture, LLC, 460 B.R.
38 (Bankr. D. Mass. 2011), in which the secured creditor which was party to an intercreditor agreement ultimately only raised
the cost of cramming down a chapter 11 plan that had been accepted by all other classes and which offered full repayment of the
secured creditor’s claims).
950 See generally Morrison, Rules of Thumb for Intercreditor Agreements, supra note 940 (noting that some intercreditor agreement
provisions (which may provide that certain creditors waive their rights to object to DIP financing or the sale or use of collateral,
to seek adequate protection, or to vote on the plan (by assigning their voting rights to senior creditors)) reorder the Bankruptcy
Code’s bargaining environment).
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Bankruptcy Institute
3. Designation of Votes
Recommended Principles:
The court should be permitted to designate a party’s vote in one or more classes
under section 1126(e) of the Bankruptcy Code based on evidence presented at
the hearing that such party voted in a manner manifestly adverse to the economic
interests of the other creditors in the class or did not act in good faith.
Designation of Votes: Background
Section 1126(e) of the Bankruptcy Code allows a court to disqualify a vote on a chapter 11 plan if
such vote was not obtained in good faith.951 Specifically, section 1126(e) provides that, “[o]n request
of a party in interest, and after notice and a hearing, the court may designate any entity whose
acceptance or rejection of such plan was not in good faith or was not solicited or procured in good
faith or in accordance with the provisions of this title.”952 The party seeking designation bears the
burden of proof, and this burden has been described as being a “heavy” one.953
Courts have disallowed votes under section 1126(e) on the grounds of bad faith when, for example,
the claimholder attempts to extract or extort a personal advantage not available 16 other creditors
, 20 to
er 21
emb collateral or competitive
in its class, the creditor has an “ulterior motive” such as to procureosome
N v
d on
chive
advantage that does not relate to its claim, or the motivation behind the vote is not consistent with
3 ar
3536
954
. 14a creditor’s protection of its self-interest as, a o
N creditor. “[B]adges of the requisite bad faith include
wn
v. B control of the debtor, (2) put the debtor out of business or
creditor votes designed to (1) assumero
eth
Blixs
otherwise gain a competitive advantage, (3) destroy the debtor out of pure malice or (4) obtain
ed in
cit
benefits available under a private agreement with a third party that depends on the debtor’s failure
to reorganize.”955 Courts generally agree that self-interest alone is not sufficient to designate a vote
under section 1126(e).956
Designation of Votes: Recommendations and Findings
Some commentators have expressed concerns regarding conflicts of interest that may influence a
creditor’s conduct, including its vote on a plan, in a chapter 11 case. Such conflicts of interest may
include holding claims in multiple classes under the plan, holding interests in competitors of the
debtor, having a business agenda that conflicts with the debtor’s reorganization, or having nominal
economic exposure compared to other creditors in the class because of private agreements or a
hedging strategy. The Commission determined that section 1126(e) was the most effective means to
address these concerns.
951 11 U.S.C. § 1126(e).
952 Id.
953 See, e.g., In re Adelphia Commc’ns Corp., 359 B.R. 54, 61 (Bankr. S.D.N.Y. 2006) (“The party seeking to have a ballot disallowed
has a heavy burden of proof.”).
954 See, e.g., In re Dune Deck Owners Corp., 175 B.R. 839 (Bankr. S.D.N.Y. 1995); In re Kovalchick, 175 B.R. 863, 875 (Bankr. E.D.
Pa. 1994).
955 In re Adelphia Commc’ns Corp., 359 B.R. 54, 61 (Bankr. S.D.N.Y. 2006).
956 Figter Ltd. v. Teachers Ins. & Annuity Ass’n of Am. (In re Figter Ltd.), 118 F.3d 635, 639 (9th Cir. 1997), cert. denied, 522 U.S. 996
(1997).
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ABI Commission to Study the Reform of Chapter
The Commission agreed that holding interests potentially in conflict with the interests of the debtor
or other creditors in the voting class should not automatically disqualify a creditor from participating
in the case or voting on the chapter 11 plan. Likewise, considering these interests and voting in the
creditor’s self-interest should not necessarily warrant designation. The Commissioners acknowledged,
however, that at some point self-interested conduct by a creditor holding interests adverse to the debtor
or other creditors in the class should result in the creditor losing its voting rights in the case.
The Commissioners examined different standards for designating votes and factors relevant to
those determinations. For example, the Bankruptcy Code could permit a creditor to vote only in the
class representing the holder’s predominant economic interest in the case. It could allow the court
to designate the holder’s vote (including in all classes) if the creditor voted in a manner that was
manifestly against the interest of the general holders of claims in that class. Alternatively, it could
specifically adopt the “ulterior motive” standard used by some courts under the current version of
section 1126(e).
In reviewing these alternatives, the Commissioners started from the basic premise that creditors
should be able to vote in their own interests, and that the mere existence of a potential conflict in
holdings should not warrant designation. They debated whether section 1126(e) and existing case
law adequately address cases in which a creditor votes in a manner intended to delay or disrupt the
case, or to disadvantage the treatment of a particular class. The Commission agreed that section
16
1126(e) arguably allows for remedies in these instances, but many of rthe, Commissioners believed
1 20
be 2
ve
that courts are reluctant to extend the section to these and similar m
n No scenarios. These Commissioners
ed o
argued for a stronger directive in section 1126(e) 3 aguide courts in making these determinations.
to rchiv
36
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o. 14
n, N
w
The Commissioners vetted eth v. Bro “ulterior motive” standard and one in which courts would focus
both the
lixs
in B
on whether the conduct or vote was manifestly adverse to other creditors in the class. Some of the
cited
Commissioners asserted that the ulterior motive standard was too ambiguous and may not capture
cases involving conflicts of interest that cause a creditor to vote adversely to the general interests of
creditors in the class — e.g., a creditor who holds a conflict or potential conflict of interest and is the
only creditor in the class voting against the plan. Such conduct may not be bad faith or necessarily
rise to the level of ulterior motive, but it may objectively be sufficiently harmful that designation is
warranted. In this regard, many Commissioners observed significant overlap between the ulterior
motive standard and the general bad faith inquiry.957 On balance, the Commission agreed that
section 1126(e) should be amended to permit courts to consider both whether the creditor’s vote was
“manifestly adverse” to the interests of the general creditors in the class or was cast in bad faith. This
hybrid standard would preserve creditor autonomy, but also provide courts with statutory authority
to protect the estate and general creditors when a class vote has been infected by a creditor’s conflict
of interest.
957 For a thoughtful exploration of the grounds for vote designation in chapter 11, see Christopher W. Frost, Bankruptcy Voting and
the Designation Power, 87 Am. Bankr. L.J. 155 (2013) (discussing the policy and use of claims designation under the case law and
recommending certain parameters for designation).
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
4. Settlements and Compromises in Plan
Recommended Principles:
In confirming a chapter 11 plan under section 1129 of the Bankruptcy Code, the
court should evaluate any settlements and compromises incorporated into the
plan under the standard proposed for codification in these principles and grant
or deny approval of any such settlements and compromises in the confirmation
order under section 1129. This requirement should include any consensual
resolution of a material dispute affecting property of the estate, including matters
in pending or threatened litigation or regulatory review, but not including the
customary resolution of claims or interests asserted against the estate. Accordingly,
section 1129(a) should be amended to add a new provision that requires the
court to find, based on evidence presented by the debtor or plan proponent at
the hearing, that each settlement or compromise incorporated into the plan is
reasonable and in the best interests of the estate.
For the recommended principles on codifying the review standard, see Section
V.G, Standard for Reviewing Settlements and Compromises.
16
1, 20
ber 2
Settlements and Compromises in Plan: Background Novem
on
ived
arch
3
A chapter 11 plan in many respects embodies. 14series of compromises between the debtor and its
a -3536
No
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creditors to resolve the debtor’s financial n
. Bro distress and allow the debtor to emerge from bankruptcy.
eth v
s
Indeed, the heart of thedplanixis typically the proposed treatment of creditors’ claims, which often
in Bl
cite
compromises creditors’ rights, and creditors accept or reject this proposed compromise by voting on
the plan. A chapter 11 plan can also, however, include more substantive settlements or compromises
that do not necessarily relate to the claims allowance process, but do have a material role to play
in the debtor’s emergence from chapter 11. Outside the plan process, these kinds of settlements
and compromises would require separate notice and approval by the court, under Bankruptcy Rule
9019, which these principles propose be codified with certain modifications.958
Courts employ different approaches to reviewing settlements and compromises incorporated
into a chapter 11 plan. Some courts evaluate the settlement or compromise as part of the plan
confirmation process under section 1129, without necessarily requiring separate evidence to
support the appropriateness of the agreement. These courts in some respects treat creditors’ votes
on the plan as sufficient for approving or scrutinizing the terms of settlements contained in the plan,
including those not involving claims-resolution matters. Other courts require separate motions
under Bankruptcy Rule 9019, or at least separate evidence on the proposed settlement in connection
with the confirmation hearing. These courts often distinguish settlements involving claims or causes
of action held by the estate from those concerning claims against the estate and wrapped up in the
claims allowance process. They generally will require some separate consideration of the former, but
handle the latter under the section 1129(a) factors.
958 See Section V.G, Standard for Reviewing Settlements and Compromises.
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
Settlements and Compromises in Plan: Recommendations and Findings
Settlements and compromises in chapter 11 cases may affect a debtor’s chapter 11 plan indirectly or
directly. A settlement proposed prior to the filing of a chapter 11 plan might indirectly affect the plan
by dictating the flow of funds for creditors’ recoveries under the plan.959 Parties may challenge these
kinds of preplan settlements as inappropriate sub rosa plans — i.e., disguised plans that are not being
subjected to the scrutiny of the plan confirmation process under section 1129.960 A settlement also
may directly affect a chapter 11 plan if it is incorporated into the plan or is a prerequisite to the plan.
The Commission analyzed the interplay between settlements and plans. The Commissioners
discussed the facts of the Iridium decision and preplan settlements as potential workarounds of the
absolute priority rule of section 1129(b).961 They observed that these issues are largely mitigated if
the settlement is considered in connection with plan confirmation, but they realized that this process
forces the issue of whether settlements require separate approval. Some of the Commissioners
asserted that the vote on the plan should be sufficient, but others argued that the minority should
not be bound by unfavorable compromises. The Commissioners also noted that plan settlements
often are not linked to class treatment, so that creditors may not appreciate the terms or import of
the settlement in casting their votes.
The Commissioners wrestled with how to identify settlements and compromises that should be
subject to separate approval from those integrated into the claims allowance 16
20 process and addressed
r 21,
by creditors’ votes and related provisions in section 1129. Theovembe
Commission generally agreed that
N
d on
the court should separately approve any consensualivresolution of a material dispute affecting
ch e
ar
5363
property of the estate, including matters .in4-pending or threatened litigation or regulatory review,
1 3
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own
but not including the customary rresolution of claims or interests asserted against the estate. After
v. B
eth
Bl s
weighing the advantagesix disadvantages of various approaches, the Commission recommended
ed in and
cit
requiring separate consideration of all settlements and compromises included in, or proposed in
connection with, a chapter 11 plan under the “reasonable and in the best interests of the estate”
standard recommended for settlements and compromises outside of the plan process under these
principles. Notably, the Commissioners did not vote to require a separate motion or hearing on
plan-related settlements and compromises. Rather, the Commission agreed that section 1129(a)
should be amended to require that the court specifically find that all settlements and compromises
included in, or related to, the plan are “reasonable and in the best interests of the estate” as part of
the confirmation process.
959 See, e.g., United States v. AWECO, Inc. (In re AWECO, Inc.), 725 F.2d 293, 298 (5th Cir 1984), cert. denied, 469 U.S. 880
(1984) (“[A] bankruptcy court abuses its discretion in approving a [preplan] settlement with a junior creditor unless the court
concludes that priority of payment will be respected as to objecting senior creditors”). Cf. Motorola, Inc. v. Official Comm. of
Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452, 464 (2d Cir. 2007) (rejecting AWECO test as “too rigid” and
not “accommodate[ing] the dynamic status of some preplan bankruptcy settlements”); In re World Health Alternatives, Inc., 344
B.R. 291, 298 (Bankr. D. Del. 2006) (holding that absolute priority rule is not relevant to approval of preplan settlements).
960 See Craig A. Sloane, The Sub Rosa Plan of Reorganization: Side-Stepping Creditor Protections in Chapter 11, 16 Bankr. Dev. J. 37,
51 (1999).
961 Motorola, Inc. v. Official Comm. of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007).
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
5. Discharge of Claims upon Confirmation
Recommended Principles:
Except as provided in section 1141(d)(2) and (d)(3) of the Bankruptcy Code and
except as otherwise provided in the chapter 11 plan or in the order confirming the
plan, after confirmation of a plan, the property dealt with by the plan should be
free and clear of all claims and interests of creditors, equity security holders, and of
general partners in the debtor, including any interests, liens, or claims that would
be removed from the debtor’s assets in the context of a section 363x sale under the
recommended principles for section 363(f). Section 1141(c) should be amended
accordingly. See Section V.B.3, Transactions Free and Clear of Interests.
Discharge of Claims upon Confirmation: Background
Confirmation of a plan binds the debtor, its creditors, and its interest-holders to the terms of the
plan.962 These parties generally may receive distributions on account of their prepetition claims
and interests only in accordance with the plan, and a business debtor that reorganizes is otherwise
discharged from these claims and interests.963 Moreover, under section 1141(c) of the Bankruptcy
6
, 01
Code, property dealt with under the plan is free and clear of all such claims and2interests.
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b
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The language of section 1141(c) is broad, covering “all claims and interests of creditors, equity security
arch
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holders, and of general partners in the n, No. 14964 Yet, some courts have limited its application,
debtor.”-3
Brow
particularly in the successor liability .context.965 These courts acknowledge the language of the statute,
th v
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but also raise due processin B notice concerns.966 The uncertainty surrounding a debtor’s ability to
cited and
transfer property free and clear of all claims and interests can increase transaction costs, generate
litigation, and limit the utility of the property in the hands of the reorganized debtor. It also may
impede a debtor’s ability to reorganize, or may affect its restructuring options in chapter 11.
Discharge of Claims upon Confirmation: Recommendations and Findings
Throughout their deliberations, the Commissioners were focused on, among other things, reducing
costs in chapter 11, increasing efficiencies, and helping facilitate the restructuring of viable businesses.
To that end, the Commission decided to clarify and broaden the kinds of interests, liens, and claims
subject to a debtor in possession’s ability to sell assets free and clear under section 363(f) of the
Bankruptcy Code. In so doing, the Commission recommended a principle that provides, “In the
962 11 U.S.C. § 1141(a).
963 Id. § 1141(d).
964 Id. § 1141(c). See also George M. Treister et al., Fundamentals of Bankruptcy 425 (7th ed. 2010) (“Congress in Chapter 11
intended that the confirmed plan would . . . discharg[e] all obligations to creditors, whether or not the creditors participated in
the reorganization process.”).
965 For a thorough examination of successor liability law, see George W. Kuney, A Taxonomy and Evaluation of Successor Liability, 6
Fla. St. Bus. L. Rev. 9 (2007).
966 See, e.g., Kewanee Boiler Corp. v. Smith (In re Kewanee Boiler Corp.), 198 B.R. 519, 540 (Bankr. N.D. Ill. 1996) (explaining that
“enjoining [the tort victim’s] efforts to liquidate his claim against the reorganized debtor and forcing him to partake in [the]
bankruptcy would be an inadmissible deprivation of his property interest in that claim, wholly without prior due process notice
or bankruptcy notice”).
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
context of a section 363x sale, a trustee should be able to sell assets free and clear of any successor
liability claims (including tort claims) other than those specifically excluded from free and clear
sales by these principles.”967 The Commission determined that a similar provision should govern
property dealt with under a plan.
The Commissioners discussed the relevant policy considerations, and they believed that a chapter
11 plan should provide protection from claims as broad as that recommended by the Commission
to be available in a section 363x sale. In addition, some Commissioners voiced concerns that
treating these two situations differently could encourage a sale of the debtor’s assets even when
reorganization was feasible or a better alternative for many of the debtor’s stakeholders. Although
the Commission recommended principles to govern the sale of substantially all of a debtor’s
assets under section 363x, the Commission agreed that such sales should not provide better
or meaningfully different treatment for parties than the plan process. Accordingly, if a debtor
in possession968 could sell assets free and clear of a particular claim under the recommended
principles for section 363(f), a debtor or plan proponent also should be able to achieve a similar
result under sections 1129 and 1141.
G. Orders Resolving Chapter 11 Case (Exit6 Orders)
01
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er 21
emb
Nov
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3 ar
Recommended Principles:
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The Bankruptcy eCode rshould be amended to clarify that a chapter 11 case can
v. B
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be resolved B
ed in only in the following three ways: (i) confirmation of a plan under
cit
section 1129; (ii) conversion of the case under section 1112; and (iii) dismissal of
the case subject to section 349.
Orders Resolving Chapter 11 Case (Exit Orders): Background
In general, a debtor exits chapter 11 through a confirmation order, a dismissal order, or a conversion
order. Section 1129 governs the entry of an order confirming a chapter 11 plan.969 Section 1112
generally provides that “on request of a party in interest, and after notice and a hearing, the court
shall convert a case under this chapter to a case under chapter 7 or to dismiss a case under this
chapter, whichever is in the best interests of creditors and the estate, for cause.”970 Section 305 permits
a court to dismiss or suspend a case under the Bankruptcy Code if “the interests of creditors and the
debtor would be better served by such dismissal or suspension.”971 Moreover, section 349 addresses
967 See Section V.B.3, Transactions Free and Clear of Interests.
968 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107
of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
969 11 U.S.C. § 1129.
970 Id. § 1112(b).
971 Id. § 305(a).
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
the effect of a dismissal order and provides, among other things, that such an order reinstates certain
liens and actions, vacates certain orders, and revests property in its prepetition owner.972
The Bankruptcy Code’s alternatives for ending a chapter 11 case are fairly straightforward.
Nevertheless, courts have been confronting an exit strategy for chapter 11 debtors that does not
necessarily fall within the traditional exit alternatives, commonly called a structured dismissal.973
A “structured dismissal” is a hybrid dismissal and confirmation order in that it typically dismisses
the case while, among other things, approving certain distributions to creditors, granting certain
third party-releases, enjoining certain conduct by creditors, and not necessarily vacating orders or
unwinding transactions undertaken during the case. These additional provisions — often deemed
“bells and whistles” — are usually the result of a negotiated and detailed settlement arrangement
between the debtor and key stakeholders in the case.
Structured dismissals are subject to some controversy as a result of these bells and whistles. Opponents
of structured dismissals argue that the Bankruptcy Code either does not authorize or expressly
prohibits some of the provisions included in these dismissal orders.974 Proponents of structured
dismissals, on the other hand, argue that the Bankruptcy Code does authorize the practice and note
how practical and efficient structured dismissals can be in certain cases.
Some of the common features present in structured dismissal cases are noted below:
16
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Substantially all of the debtor’s assets have been sold pursuantm a section 363 sale.
ve to
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The debtor’s estate is essentially reduced 353cash to be distributed.
- to
. 14
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The secured creditors th v. Bundersecured and there are insufficient funds to pay
e are
Blixs
administrativedclaims associated with the case (the case is administratively insolvent).
e in
cit
the
A detailed settlement agreement (or similar) that disposes of significant issues in the case
has been approved by the court and may have been consummated.
As a result of the settlement agreement (or similar), the proceeds of the sale of the debtor
are transferred from the estate to the undersecured lender.
There is an alternative claims-allowance process.
There are third-party release provisions.
A portion of the sale proceeds have been carved out to create a “gift” trust to benefit lower
priority creditors, proceeds to which they would likely not be entitled in a chapter 11 plan.
972 Id. § 349.
973 Although structured dismissals appear to be increasingly common, some cases suggest that structured dismissals are not a recent
development. See In re Buffet Partners, L.P., 2014 WL 3735804 (Bankr. N.D. Tex. July 28, 2014) (“On a smaller scale, structured
dismissals occur regularly in this and other bankruptcy courts. Often the parties enter the case on the eve of foreclosure, work
out their differences through a sale or giveback of property, and the parties enter an agreement submitted to this court for
approval that results in the dismissal of the case.”); In re Aerospace & Indus. Mfg., Inc., 2008 WL 2705071 (Bankr. N.D. Tex.
July 7, 2008) (dismissing case pursuant to a settlement agreement because dismissal will result “in a more favorable return to
unsecured creditors . . . who otherwise risk receiving nothing in the case”).
974 See 11 U.S.C. § 349(b).
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ABI Commission to Study the Reform of Chapter
The court retains jurisdiction over the case after dismissal and all prior court orders survive
the dismissal.
The debate regarding the authority of a court to issue an order approving a structured dismissal
is grounded in the Bankruptcy Code. Parties on both sides of the debate agree that (i) the court
is authorized to issue a “plain vanilla” case dismissal order for cause when in the best interests of
creditors and the estate, and (ii) the Bankruptcy Code is silent regarding what a dismissal order may
or may not contain. Proponents of structured dismissals focus on sections 1112(b) and 305(a) of
the Bankruptcy Code as grounds for approving such dismissals. Opponents focus on the purpose of
section 349975 and the general principle that section 305(a) is considered an extraordinary remedy
because a court’s order under that section is not subject to review on appeal.976 Other Code sections
and legislative history also are cited on both sides of the debate.
Orders Resolving Chapter 11 Case (Exit Orders): Recommendations
and Findings
Anecdotal evidence suggests that the increasing use of structured dismissals is linked directly to
the rise in sales of all or substantially of a debtor’s assets under section 363 and outside of the plan
process. Parties may request a structured dismissal because of the actual or perceived costs and
delays associated with the plan-confirmation process or a conversion to chapter 7 of the Bankruptcy
16
Code. Parties also may resist a conversion because of the automatic appointment of a trustee and the
1, 20
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v m
subordination of unpaid administrative claims in the chapterN11ecase to the administrative claims
n o
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incurred by the chapter 7 trustee.
63 a
53
14-3
No.
n,
The Commissioners acknowledged w courts are approving structured dismissals to try to facilitate
. Bro that
eth v
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in Bl
efficient case resolutions. Some of the Commissioners supported the use of structured dismissals
cited
when no other alternative is available to monetize the debtor’s assets for the benefit of at least some
creditors. Other Commissioners observed that there are always alternatives — e.g., a sale followed
by a clean section 1112/349 dismissal order, a sale followed by conversion to chapter 7, a sale in
chapter 7, a sale after a clean dismissal under state law. These Commissioners noted that a lack of
alternatives was not the issue; rather, it really was driven by the desire of the purchaser, debtor, or
other key stakeholder to sell the assets free and clear under section 363(b) and (f) of the Bankruptcy
Code quickly, plus to get some of the benefits of a confirmation order without complying with the
disclosure and soliciting provisions of the confirmation process.
975 See, e.g., H.R. Rep. No. 95-595 (1977), reprinted in 1978 U.S.C.C.A.N. 5787, 6294 (“The basic purpose of [section 349] is to
undo the bankruptcy case as far as practicable, and to restore all property rights to the position in which they were found at the
commencement of the case.”). See also Armel Laminates, Inc. v. Lomas & Nettleton Co. (In re Income Prop. Builders, Inc.), 699
F.2d 963, 965 (9th Cir. 1982) (“11 U.S.C. § 349, treating the effects of a bankruptcy, obviously contemplates that on dismissal
a bankrupt is reinvested with the estate, subject to all encumbrances which existed prior to the bankruptcy. After an order of
dismissal, the debtor’s debts and property are subject to the general laws, unaffected by bankruptcy concepts. After dismissal a
debtor may file another petition for bankruptcy unless the initial petition was dismissed with prejudice.”); Citizens First Nat’l
Bank of Princeton v. Rumbold & Kuhn, Inc. (In re Newton), 64 B.R. 790, 793 (Bankr. C.D. Ill. 1986) (“[T]o the extent possible a
dismissal of a petition reverses what has transpired during a bankruptcy.”); In re Safren, 65 B.R. 566, 571 (Bankr. C.D. Cal. 1986)
(“The objective of section 349(b) is to restore all property rights, insofar as is practicable, to their positions when the case was
filed.”).
976 See, e.g., In re Monitor Single Lift I Ltd., 381 B.R. 455, 463 (Bankr. S.D.N.Y. 2008) (“Granting an abstention motion pursuant to
§ 305(a)(1) requires more than a simple balancing of harm to the debtor and its creditors; rather, the interests of both the debtor
and its creditors must be served by granting the requested relief.”).
VI. Proposed Recommendations: Exiting the Case
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Bankruptcy Institute
The Commissioners debated the advantages and disadvantages of structured dismissals. The
Commissioners generally believed that debtors should be able to sell all or substantially all of their
assets under section 363(b) when that is the best and most efficient way to maximize value and
potentially rehabilitate the business. They did not, however, endorse a process that short-circuits
or completely eliminates creditor protections under the Bankruptcy Code. The Commissioners
discussed certain components of structured dismissals that were particularly troubling in this
respect, including provisions that violate the absolute priority rule,977 grant third-party releases,978
or deviate from the traditional claims-allowance process.979 As explained by the U.S. Trustee in
LCI Holding Co.:
The Motion [requesting approval of a term sheet in aid of consummation of a courtapproved sale] attempts to restructure the rights of existing creditors and equity,
without affording parties in interest the protections of a plan, disclosure statement
and the confirmation solicitation process. . . . Were the Term Sheet presented as a
plan, the Court would be required to approve a disclosure statement to be used to
solicit votes from the impaired creditor classes. The Term Sheet raises multiple issues
that a disclosure statement would address. These issues include claim resolution
procedures, resolution of fee claims[, etc.]. . . . A disclosure statement would also
have to address facts not disclosed in the Motion, including but not limited to a
budget, a liquidation analysis, and the existence of any additional assets.980
6
, 201
The Commissioners first considered whether provisions could be ember 21 that would facilitate
drafted
ov
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some of the objectives of a structured dismissal, but thativwould
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key protections for, creditors in the case. As the -Commissioners started to carve out problematic
35
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provisions from an “acceptable” structured dismissal, they recognized that it likely was an
Brow
th v.
unworkable solution. TheyBbolstered this conclusion by reviewing the recommended principles
lixse
in
ci d
for section 363x sales.teUnder these recommended principles, a sale of all or substantially all of a
debtor’s assets will incorporate appropriate creditor protections from the confirmation process.
If these protections are implemented, the court may approve the sale, and its order may include
(i) a release or discharge to affect claims protection for the purchaser and (ii) certain specified
distributions to priority creditors. The Commissioners believed that the recommended principles
for section 363x sales should render the use of structured dismissals unnecessary.
Accordingly, the Commission recommended strict compliance with the Bankruptcy Code in terms
of orders ending the chapter 11 case. Specifically, the Commission agreed that a court should be
977 See, e.g., In re Jevic Holding Corp., No. 14-01465 (3d Cir. Aug. 14, 2014) [Docket. No. 45] (citing Begier v. I.R.S., 496 U.S. 53, 58
(1990)).
978 In re Jevic Transp. Corp., No. 13-00104 (SLR) (D. Del. Jan. 24, 2014) [Docket No. 22]. Indeed, a structured dismissal may provide
a broader third-party release than otherwise would be permissible in the chapter 11 case. For example, the release provision in
TLG Liquidation is particularly notable:
The Debtors, for themselves and their estates, and the Committee, for itself and its members, representatives, agents,
professionals, successor and assigns . . . release and forever discharge any and all Claims and Defenses against the Agent,
each of the Lenders and their respective shareholders, partners, members, officers, directors, managing members,
employees, representatives, agents, professionals, successors and assigns, from the beginning of time through the date
the Approval Order becomes a final and nonappealable order.
In re TLG Liquidation Corp., No. 10-10206 (MFW) (Bankr. D. Del. Apr. 30, 2010) [Docket No. 275].
979 For example, in some cases, claims are allowed in the amounts submitted in the dismissal motion unless there is an objection.
See In re GI Joe Holding Corp., No. 09-10713 (KG) (Bankr. D. Del. Feb. 23, 2011) [Docket No. 746]; In re Wickes Holdings LLC,
No. 08-10212 (Bankr. D. Del. May 12, 2009) [Docket No. 1418].
980 In re LCI Holding Co., No. 12-13319 (KG) (Bankr. D. Del. May 21, 2013) [Docket No. 773].
VI. Proposed Recommendations: Exiting the Case
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ABI Commission to Study the Reform of Chapter
permitted to confirm a plan under section 1129, convert a case under section 1112, or dismiss a case
provided that the requested dismissal and the dismissal order satisfy the applicable provisions of,
and do not permit the parties to work around, the Bankruptcy Code.
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VII. PROPOSED
RECOMMENDATIONS:
SMALL AND MEDIUMSIZED ENTERPRISE (SME)
CASES
in
cited
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Bankruptcy Institute
Most business bankruptcy cases filed in the United States involve small and middle-market
enterprises. These businesses include family owned businesses, entrepreneurial ventures, and
startup companies. They form the backbone of the American economy. As explained in one survey,
“[a]ccording to the U.S. Economic Census, companies with 50 to 5,000 employees account for more
employment than those with over 5,000.”981 This survey also noted that “in terms of output, the sheer
number of mid-market firms accounts for the fact that, in aggregate, their revenues surpass those
of the top 100 U.S. companies by capitalization and are equivalent to roughly 40 percent of the U.S.
GDP.”982
Nevertheless, small and middle-market enterprises are prone to preliminary setbacks and initial
failures, and they can be among the hardest hit in economic downturns.983 The chart below from the
Bureau of Labor Statistics generally indicates that among new businesses, approximately 50 percent
of those businesses fail within the first five years of operation and approximately 70 percent fail
before their tenth anniversary.984
in
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16
1, 20
ber 2
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63 a
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. 14
, No
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981 Deloitte Development LLC, Mid-Market Perspectives: America’s Economic Engine — Competing in Uncertain Times 4
(2011), available at http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/us_dges_competing_in_
uncertain_times_09202011.pdf.
982 Id. See also Written Statement of the Honorable Melanie L. Cyganowski (Ret.), former Chief Bankruptcy Judge, Eastern District of
New York: CFA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1, 4 (Nov. 15, 2012) (“The importance
of facilitating reorganizations, especially for SMEs, cannot be overstated. Start-up and small businesses create and provide a
significant portion of jobs in the United States. . . . For example, in 2010, 505,473 new businesses were started. These businesses
employed over 2,456,000 people.”), available at Commission website, supra note 55; Written Statement of Gerald Buccino: TMA
Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (Nov. 3, 2012), available at Commission website,
supra note 55.
983 Donald R. Korobkin, Vulnerability, Survival, and the Problem of Small Business Bankruptcy, 23 Cap. U. L. Rev. 413, 426–27
(1994) (“Larger businesses also tend to have more operational flexibility, and sometimes may weather economic slow-downs by
shifting from one product line to another, or from one geographical area to another. In contrast, small businesses are less likely
to have cash reserves, and they are generally undiversified in their products and customer base. Furthermore, small businesses
are often in industries characterized by intense price competition. During inflationary times, they may not have the luxury of
raising prices in order to compensate for rising operating expenses. Meanwhile, regulatory burdens and tax increases hit small
business the hardest, depleting severely limited working capital.”) (citations omitted); First Report of the Commercial Fin. Ass’n
to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial Fin. Ass’n Annual Meeting, at 2 (Nov. 15,
2012), available at Commission website, supra note 55 (“[A]lthough large U.S. corporations play an important role in the U.S.
economy, CFA believes that an even greater role is played by small and medium-sized enterprises (“SMEs”). Commercial finance
(in both its asset-based lending and cash-flow lending forms) has traditionally been, and continues to be, the backbone of
financing for SMEs in the United States. Although many of the current suggestions for amending the Code (including some from
Commissioners) are designed to address perceived problems arising in the chapter 11 cases of large corporations, these concerns
are not necessarily applicable to chapter 11s of SMEs (which currently comprise the greatest number of chapter 11 cases).”).
984 See Bureau of Labor Statistics, Business Development Dynamics, Entrepreneurship and the U.S. Economy, available at http://www.
bls.gov/bdm/entrepreneurship/bdm_chart3.htm.
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Survival Rates of Establishments, by Year Started and Number of Years Since Starting, 1994–2010 (%)
No. of
Year
Years
Since
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Starting
100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
1
79.8 79.2 79.0 78.8 80.6 79.6 78.9 75.5 78.4 79.2 79.1 80.0 78.3 77.2 74.4 76.3
–
2
68.5 68.5 67.6 68.7 69.1 67.6 66.3 64.5 67.5 68.4 69.1 68.7 66.2 63.4 62.4
–
–
3
61.2 60.5 60.4 60.6 60.2 59.0 58.5 57.5 60.2 61.4 61.3 60.1 56.1 54.9
–
–
–
4
54.9 54.7 54.1 53.5 53.6 53.2 53.1 52.4 55.0 55.3 54.7 52.2 49.3
–
–
–
–
5
50.2 49.5 48.8 48.1 48.7 48.7 48.6 48.2 50.4 50.1 48.2 46.5
–
–
–
–
–
6
45.8 45.0 44.5 44.2 45.0 45.0 45.1 44.5 46.3 44.7 43.7
–
–
–
–
–
–
7
42.1 41.4 41.2 41.0 41.9 42.1 42.1 41.2 42.0 40.9
–
–
–
–
–
–
–
8
38.9 38.6 38.5 38.2 39.4 39.3 39.1 37.6 38.7
–
–
–
–
–
–
–
–
9
36.4 36.3 36.0 36.2 37.0 36.8 36.0 34.7
–
–
–
–
–
–
–
–
–
10
34.2 34.1 34.0 34.0 34.8 33.9 33.4
–
–
–
–
–
–
–
–
–
–
11
32.4 32.2 32.1 32.1 32.2 31.7
–
–
–
–
–
–
–
–
–
–
–
12
31.0 30.5 30.4 29.8 30.3
–
–
–
–
–
–
–
–
–
–
–
–
13
29.3 29.0 28.6 28.1
–
–
–
–
–
–
–
–
–
–
–
–
–
14
27.8 27.1 26.9
–
–
–
–
–
–
–
–
–
–
–
–
–
–
15
16
26.0 25.7
–
–
–
–
–
–
–
–
– r 21, 20 –
–
–
–
–
–
16
e
emb –
24.6
–
–
–
–
–
–
–
– on–Nov –
–
–
–
–
–
17
d
chive
Note: Dashes indicate not applicable.
3 ar
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Source: Bureau of Labor Statistics, Business Development Dynamics, Entrepreneurship and the U.S. Economy,
. 14, No
own
available at http://www.bls.gov/bdm/entrepreneurship/bdm_chart3.htm.
v. Br
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ed in
cit
In addition, established small and middle-market companies can experience failed acquisitions,
underperforming product lines, overcapitalization, and other factors that contribute to financial
distress and threaten their survival. Yet many commentators and practitioners assert that the
Bankruptcy Code no longer works to help rehabilitate these companies.985 As one witness testified,
“Chapter 11 is now viewed as too slow and too costly for the majority of middle-market companies
to do anything other than sell its going concern assets in a 363 sale or to simply liquidate the
company . . . [usually] almost exclusively for the sole benefit of the secured lender.”986
985 See, e.g., Written Statement of the Honorable Barbara Houser: ASM Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 1 (Apr. 19, 2013) (“[C]omplexity, time, and costs of the Chapter 11 process impose obstacles that small and
middle-market businesses often cannot overcome.”), available at Commission website, supra note 55. See also Written Statement
of the Honorable Dennis Dow: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1 (Apr. 19, 2013),
available at Commission website, supra note 55; Written Statement of Daniel Dooley: ASM Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11, at 2–3 (Apr. 19, 2013) (“It is widely understood and agreed in the insolvency community that
Chapter 11 is no longer a cost effective process in the middle market. . . . Chapter 11 is now viewed as too slow and too costly
for the majority of middle-market companies to do anything other than sell its going concern assets in a 363 sale or to simply
liquidate the company . . . [usually] almost exclusively for the sole benefit of the secured lender.”), available at Commission
website, supra note 55.
986 Written Statement of Daniel Dooley: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3 (Apr.
19, 2013), available at Commission website, supra note 55. See also Written Statement of the Honorable Barbara Houser: ASM
Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1 (Apr. 19, 2013), available at Commission website,
supra note 55; Written Statement of the Honorable Dennis Dow: ASM Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 1 (Apr. 19, 2013), available at Commission website, supra note 55.
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The Commission heeded the concerns raised by several witnesses regarding the plight of small and
middle-market enterprises in financial distress.987 These perspectives aligned with the results of an
empirical survey conducted by Professor Dalié Jiménez, as illustrated in the following chart:988
The Commissioners solicited the testimony and input of practitioners and judges familiar with
small and middle-market cases and thoroughly studied the issues identified as barriers to effective
6
reorganizations in this space. They also, with the assistance of the Reporter21, 201 report from the
and a
ber
ve
governance advisory committee, reviewed the literature and empiricalm
n No evidence on small business
ed o
rch the
cases in chapter 11. The Commission strongly believed that iv following set of principles for small
63 a
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and middle-market enterprises can have n, significant and positive influence on the ability of these
a No. 14
row
B
companies to effectively reorganizevin and outside of chapter 11.
h .
xset
i
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987 For example, one witness noted that data from the Census Bureau and the Bureau of Labor Statistics indicate that entrepreneurship
has decreased since 1994. The witness suggested that changes in the Bankruptcy Code were partially to blame. Written Statement
of Richard Mikels: TMA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 8 & n. 1 (Nov. 3, 2012),
available at Commission website, supra note 55. See also Michelle J. White, Bankruptcy and Small Business, Reg. Mag. 18,
Summer 2001 (arguing that the BAPCPA reforms would make entrepreneurs less likely to start businesses), available at http://
object.cato.org/sites/cato.org/files/serials/files/regulation/2001/7/white.pdf.
988 See Dalié Jiménez, ABI Chapter 11 Survey Results, Am. Bankr. Inst. J., July 2014, at 11 (containing the results of Professor
Jiménez’s entire survey). Professor Jiménez found that “[a]bout 15% of the then 2,158 members of the Business Restructuring
Committee responded to the survey, for a total of 322 responses. While the response rate could have been higher, this is typical
of online surveys and in line with previous ABI surveys. Nonetheless, these findings must be interpreted with a grain of caution.”
Id. See generally supra note 66 and accompanying text (generally discussing limitations of chapter 11 empirical studies).
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A. Definition of SME
Recommended Principles:
For purposes of these principles, the term “small or medium-sized enterprise”
(“SME”) means a business debtor with —
(i) No publicly traded securities in its capital structure or in the capital
structure of any affiliated debtors whose cases are jointly administered
with the debtor’s case; and
(ii) Less than $10 million in assets or liabilities on a consolidated basis with
any debtor or nondebtor affiliates as of the petition date.
A debtor purporting to qualify as an SME under this definition must file a balance
sheet reflecting a good faith estimate of its assets and liabilities as of the petition
date with its chapter 11 petition.
The court sua sponte, the U.S. Trustee, or a party in interest should be able to
object to the debtor’s indication in the petition that it satisfies subsections (i) and
(ii) above and qualifies as an SME, but only on the grounds that the debtor does
not in fact meet the definition of SME under the Bankruptcy Code. Such objection
should be filed on or before 14 days after notice of the debtor’s 2016
, indication in the
er 21
embon an expedited basis.
petition that it qualifies as an SME, and it should beNov
heard
n
o
ived
arch
363
In addition, if a business debtor1satisfies subsection (i) above and has more than
4-35
No.
$10 million but less than wn, million in assets or liabilities on a consolidated basis
$50
. Bro
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with any debtor or nondebtor affiliates, the debtor may file a motion seeking to
in Bl
cited
be treated as an SME in its chapter 11 case. Such motion must be filed with the
debtor’s voluntary petition or within seven days after the entry of the order for
relief in an involuntary case. The court should grant such motion and classify the
debtor as an SME only if the motion is timely filed and the court determines based
on evidence presented at the hearing that treating the debtor as an SME in the
chapter 11 case is in the best interest of the estate. Any objection to such motion
should be filed on or before 14 days after the filing of the motion, and the motion
and any objections should be heard on an expedited basis.
The definition of SME does not include a “single asset real estate” case as defined
in section 101(51B) of the Bankruptcy Code.
The “small business case” and “small business debtor” provisions of the Bankruptcy
Code should be deleted in their entirety.
Definition of SME: Background
The utility of chapter 11 for smaller companies is not a new concern. Shortly after the enactment
of the Bankruptcy Code, commentators raised concerns regarding the ability of smaller debtors to
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confirm chapter 11 plans.989 Congress attempted to address these concerns in 1994 by introducing a
small business election provision in chapter 11.990 The 1994 amendments defined “small business” as
“a person engaged in commercial or business activities (but does not include a person whose primary
activity is the business of owning or operating real property and activities incidental thereto) whose
aggregate noncontingent liquidated secured and unsecured debts as of the date of the petition do
not exceed $2,000,000.”991 A person qualifying as a small business could elect themselves into a fasttrack chapter 11 plan process that allowed the court, among other things, to conditionally approve
the debtor’s disclosure statement and to combine the hearing on the adequacy of the disclosure
statement and the approval of the plan.992 The amendments also allowed the court to order that a
committee of unsecured creditors not be appointed in a small business case.993
Congress further amended the small business provisions of chapter 11 in 2005 in response, at least in
part, to the ongoing issues with small business cases identified by the National Bankruptcy Review
Commission’s (the “NBRC”) study and report (the “NRBC report”).994 The NBRC report concluded
that small business debtors fell into two categories: (i) a small number with a reasonable likelihood
of reorganizing and succeeding as a going concern; and (ii) a larger number with no reasonable
prospect of rehabilitation.995 The NBRC suggested that reform focus on increasing the likelihood of
success for those debtors who might succeed and reducing the amount of time a likely-to-fail debtor
spends in chapter 11.996
6
1
The NBRC report concentrated to some extent on those small business debtors0that were unlikely
1, 2
ber 2
to rehabilitate.997 The NRBC report indicated that small businesses ovem
N benefited from the protections
d on
hive
cthe business, ability to delay payments to
of chapter 11 — the automatic stay, retention of control of
3 ar
3536
. 14- 11 plan — while administrative costs increased,
creditors, and ability to delay formulatingna No
, chapter
ow
v. Br
even though there was no realistic prospect of rehabilitation.998 Chapter 11 arguably only prolonged
eth
Blixs
these debtors’ imminentd in
e demise and reduced recoveries for creditors.999 The NBRC proposed reforms
cit
to address these likely-to-fail debtors and to try to reduce overall cost and delay for small business
debtors.1000 These changes included establishing presumptive plan filing and plan confirmation
989 See LoPucki, The Trouble with Chapter 11, supra note 82, at 749–51 (1993) (discussing how the initial identical treatment of large
and small business cases evolved).
990 See id. at 751–52 (describing how the procedures developed by Judge Small resulted in the small business reorganization pilot
program in 1992 and ultimately the legislative changes to the Bankruptcy Code in 1994); James B. Haines, Jr. & Phillip J. Hendel,
No Easy Answers: Small Business Bankruptcies After BAPCPA, 47 B.C.L. Rev. 71, 73 (2005).
991 11 U.S.C. § 101(51C) (1994).
992 Id. §§ 1121, 1125 (1994).
993 Id. § 1102(a) (1994).
994 NBRC Report, supra note 37. See also Thomas E. Carlson & Jennifer Frasier Hayes, The Small Business Provisions of the 2005
Bankruptcy Amendments, 79 Am. Bankr. L.J. 645 (2005).
995 NBRC Report, supra note 37, at 609.
996 Id.
997 See H. Rep. No. 109-31, Part 1, at 3 (2005), reprinted in 2005 U.S.C.C.A.N. 88, 89 (noting that the legislation includes “several
significant provisions intended to heighten administrative scrutiny and judicial oversight of small business cases, which often are
the least likely to reorganize successfully”).
998 See Edward R. Morrison, Bankruptcy Decision Making: An Empirical Study of Continuation Bias in Small-Business Bankruptcies,
50 J. L. & Econ. 381, 382–83 (2007) (citing others who believe that chapter 11 allows firms that should be liquidated to linger on
indefinitely).
999 NBRC Report, supra note 37, at 612–13 (“The length of time a business remains in Chapter 11 is critically important. ‘During
that time, the business is at risk because management incentives are inappropriate, professional fees build up at a rapid rate, and
business uncertainties increase.’ Furthermore, unsecured creditors lose the time value of money while they wait to collect their
debt during the pendency of the case. The longer they await distribution, the greater is their loss.”) (citing Lynn M. LoPucki, The
Debtor in Full Control — Systems Failure Under Chapter 11 of the Bankruptcy Code? (First Installment), 57 Am. Bankr. L.J. 99, 100
(1983); Philip J. Hendel, Position Paper to the National Bankruptcy Review Commission Proposing Expanded Use of Chapter 13 to
Include Closely Held Corporations and Other Business Entities (Dec. 17, 1996).
1000 See H. Rep. No. 109-31, Part 1, at 19 (2005), reprinted in 2005 U.S.C.C.A.N. 88, 105 (stating that the “variety of time frames and
enforcement mechanisms [were] designed to weed out small business debtors who are not likely to reorganize”); NBRC Report,
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deadlines,1001 additional postpetition documentation requirements, more reporting, and changes
to the burden of proof for small business debtors.1002 In adopting these provisions, Congress also
removed the elective nature of the small business provisions and amended the definition of the
“small business debtor” that would be subject to these mandatory provisions.1003
At that time, some commentators testified before the NBRC that the reduced deadlines would provide
too little time and shifting the burden of proof would be too onerous, and that these provisions
would deprive debtors of a fair opportunity to reorganize in chapter 11.1004 Others commented that
the system was working relatively well and that bankruptcy judges were doing a good job of filtering
failing firms from viable ones.1005 Unfortunately, time has proven those commentators right to some
extent. Witnesses before the Commission generally testified that chapter 11 is not working for small
and middle-market debtors, and several of these witnesses suggested that certain of the deadlines
imposed by the BAPCPA amendments were particularly challenging and counterproductive for
small business debtors.1006
supra note 37, at 609 (stating that for the large group of debtors with “no reasonable prospect for rehabilitation . . . the primary
goal is to reduce the amount of time they consume in Chapter 11”).
1001 NBRC Report, supra note 37, at 615.
6
1002 Id. at 618–25.
, 201
1003 Id. at 618. See also Haines & Hendel, supra note 990. Section 101(51D) defines “small ber 21 debtor” as follows:
business
ovem
(A) subject to subparagraph (B), means a person engaged in commercialn Nbusiness activities (including any affiliate
d o or
eperson whose primary activity is the business of
of such person that is also a debtor under this title and excludingiv
rch a
63 a
owning or operating real property or activities incidental thereto) that has aggregate noncontingent liquidated secured
-353
4
and unsecured debts as of the date of the filingo. 1 petition or the date of the order for relief in an amount not more
, N of the
ro ton
than $2,000,000 (excluding debtsvowed w 1 or more affiliates or insiders) for a case in which the United States trustee
.B
has not appointed underixseth 1102(a)(1) a committee of unsecured creditors or where the court has determined
section
Bl
nunsecured creditors is not sufficiently active and representative to provide effective oversight of
i
that the committee of
cited
the debtor; and
(B) does not include any member of a group of affiliated debtors that has aggregate noncontingent liquidated secured
and unsecured debts in an amount greater than $2,000,000 (excluding debt owed to 1 or more affiliates or insiders).
11 U.S.C. § 101(51D). Several commentators have criticized the definition as being too complex and difficult to apply in many
cases. See, e.g., Anne Lawton, An Argument for Simplifying the Codes “Small Business Debtor” Definition, 21 Am. Bankr. Inst.
L. Rev. 55 (2013). For example, the types of assets at issue may give rise to questions concerning whether the debtor is a small
business case or a single asset real estate case. Id. at 72–76. Likewise, determining whether liabilities are noncontingent and
liquidated may not be a straightforward calculation. Id. at 83–88.
1004 NBRC Report, supra note 37, at 616.
1005 See Douglas G. Baird, Remembering Pine Gate, 38 J. Marshall L. Rev. 5, 15 & n. 35 (2004) (“The benchmark by which to judge
the bankruptcy system in small cases is not the sheer number of businesses saved, but their ability to sort effectively and quickly.
Most important is identifying those cases in which the debtor is only playing for time. The evidence suggests that bankruptcy
judges can do this job exceedingly well. Indeed, the data are consistent with the conjecture that bankruptcy judges perform
this job as well as a market actor subject to the same constraints.”) (citing Morrison, Bankruptcy Decisionmaking, supra note
998). Morrison conducted an empirical study of nearly all the chapter 11 cases filed by corporations outside the real estate
sector who filed in the Northern District of Illinois in 1998. He found that the bankruptcy process identified over 70 percent of
nonviable firms within six months and 44 percent were identified within three months; only 8.5 percent of nonviable firms had
not been identified by one year. See Morrison, Bankruptcy Decisionmaking, supra note 998, at 14. See generally supra note 66 and
accompanying text (generally discussing limitations of chapter 11 empirical studies). See also Elizabeth Warren & Jay Lawrence
Westbrook, The Success of Chapter 11: A Challenge to the Critics, 107 Mich. L. Rev. 603 (2009) (finding that the pre-BAPCPA
system was successfully screening cases).
1006 Written Statement of Holly Felder Etlin: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1–2
(Apr. 19, 2013) (stating it is nearly impossible to do anything but have a section 363 sale in the middle market), available at
Commission website, supra note 55. “Middle-market companies just do not have either the management or financial resources
to attempt to remain in Chapter 11 long enough to reorganize.” Id. See also Written Statement of the Honorable Dennis Dow:
ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1–2 (Apr. 19, 2013), available at Commission
website, supra note 55; Written Statement of the Honorable Melanie L. Cyganowski (Ret.), former Chief Bankruptcy Judge, Eastern
District of New York: CFA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Nov. 15, 2012) (requesting
that the BAPCPA plan deadlines be repealed because “the secured lender is concerned about these deadlines and consequently
takes action (or requires the debtors to take action) months before these deadlines occur in order to reduce its credit risk — all
of which hurts the flow of funds to the debtor and ultimately inures to the detriment of the reorganization process”), available at
Commission website, supra note 55.
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Moreover, several witnesses and commentators have observed an increasing use of state and federal
law insolvency alternatives by small and middle-market enterprises in lieu of a chapter 11 filing.1007
These alternatives include state and federal receiverships and assignments for the benefit of creditors
(“ABCs”) under state law.1008 This testimony again generally aligned with the results of the empirical
survey conducted by Professor Jiménez, as illustrated by the following chart:1009
16
1, 20
ber 2
vem
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rchiv
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4
In a receivership, a person — the receiver ,—ois1appointed by a court to take property into custody
N .
rownused as a method for liquidating entire businesses.1010
and preserve it; receivershipsseth v.often
are B
x
n Bli
Commentators argue ithati receiverships are attractive for several reasons: Receivers may be granted
c ted
powers that are broader and more flexible than those under the Bankruptcy Code;1011 nonbankruptcy
courts are able to use summary remedies to allow, disallow, and subordinate the claims of creditors,
1007 Written Statement of Daniel Dooley: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 3 (Apr.
19, 2013) (stating that the use of federal receiverships is growing in the insolvency community but noting that the federal
statute on receiverships does not have well-developed processes and rules), available at Commission website, supra note 55;
Written Statement of John Haggerty: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1 (Apr. 19,
2013) (noting that there has been an increase in the use of out-of-court alternatives for turnarounds, restructurings, sales and
liquidations, particularly for smaller businesses), available at Commission website, supra note 55.
1008 See id. See also Edward R. Morrison, Bargaining Around Bankruptcy: Small Business Workouts and State Law, 38 J. Legal Stud.
255, 256 (2009) (stating that in 2003, about 540,000 small businesses closed their doors but only 34,000 filed for bankruptcy and
that the “vast majority of small businesses resolve distress under state law”); Edward R. Morrison, Bankruptcy’s Rarity: Small
Business Workouts in the United States, 5 Euro. Co & Fin. L. Rev. 172 (2008) (asserting that federal bankruptcy filings account
for only three to four percent of all business closures). Accord Edward I. Altman et al., The Value of Non-Financial Information
in SME Risk Management, J. Credit Risk, Summer 2010, at 7 (distinguishing between failure and closure and citing a study that
indicated about 33 percent of new businesses closed because they were unsuccessful) (citation omitted), available at http://
people.stern.nyu.edu/ealtman/Altman-Sabbato-Wilson-JCR_2010.
1009 See Jiménez, supra note 988, at 79. Professor Jiménez found that “[m]ore than a quarter (26 percent) had been involved in an
equity receivership in the past five years. Most of these (69 percent) noted that their participation in federal equity receivership
cases had increased in the last five years, 27 percent thought it was about the same, and only 5 percent responded that it had
decreased.” Id.
1010 Business Organizations with Tax Planning § 155.01.
1011 M. Colette Gibbons et al., Lien on Me, Ohio Lawyer, May/June 2011,at 18; M. Colette Gibbons & Jason Grimes, A Model Statute
for Free-and-Clear Sales by Equity Receivers, Am. Bankr. Inst. J., Mar. 2009, at 3. See also 16 Charles Alan Wright & Arthur R.
Miller, Federal Practice and Procedures § 3925 (3d ed.) (“A receivership can drastically curtail existing property rights. . . . .”);
SEC v. Black, 163 F.3d 188 (3d Cir. 1998) (“[W]here there is a receiver with equitable power in a proceeding before it, the District
Court has wide discretion as to how to proceed.”); SEC v. Hardy, 803 F.2d 1034 (9th Cir. 1986) (“[A] district court’s power to
supervise an equity receivership and to determine the appropriate action to be taken in the administration of the receivership is
extremely broad.”); SEC v. Safety Fin. Serv., Inc., 674 F.2d 368 (5th Cir. 1982) (“It is a recognized principle of law that the district
court has broad powers and wide discretion to determine the appropriate relief in an equity receivership.”).
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ABI Commission to Study the Reform of Chapter
which promotes judicial efficiency and reduces litigation costs;1012 lack of certainty in chapter 11 due
to divergent case law;1013 and lastly, receiverships are less time-consuming and costly than chapter 11
to liquidate property.1014 Receivership has traditionally been considered an extraordinary remedy1015
and may only be available in specific circumstances,1016 particularly when statutory authority for the
receivership is lacking.1017
An ABC involves a consensual transfer of assets by the debtor to an assignee who holds them in trust
for the benefit of creditors.1018 ABCs are a function of state law, with many states requiring court
supervision of the ABC and with other states not requiring such oversight.1019 The law governing
ABCs, like the law covering receiverships, is often a mixture of common law and statutory law and
varies significantly by state.1020
These state law alternatives are subpar remedies in many circumstances and present their own
problems. For example, some debate a receiver’s ability to sell property free and clear of liens without
the consent of all lienholders.1021 Case law is inconsistent as well.1022 In an ABC, any nonconsenting
creditors are not bound by any conditions contained in the assignment and the ABC does not
displace even the consenting creditors’ original claims, unless there is a release.1023 And even though
these nonbankruptcy procedures are generally faster and cheaper, they are also more private and
generally less transparent.1024 This may hide insider self-dealing or preferential treatment of certain
creditors.1025 Nevertheless, the prevailing perception that chapter 11 no longer works for small and
6
, 201
middle-market enterprises has forced many companies to consider these1alternatives.
er 2
b
ovem
on N
ived
arch
363
-35
o. 14
1012 Gibbons & Grimes, supra note 1011, at 3 (citing SEC v. Basic Energy & Affiliated Res. Inc., 273 F.3d 657, 668 (6th Cir. 2001)). See
n, N rev’d in part on other grounds sub nom. SEC v. Elliott, 998 F.2d 922 (11th 1993)
also SEC v. Elliott, 953 F.2d 1560 (11thBrow
Cir. 1992),
th v.
(per curiam).
lixse
in note 1011, at 3 (discussing the decision in Clear Channel Outdoor, Inc. v. Knupfer, 391 B.R. 25 (B.A.P.
1013 Gibbons & Grimes, supraB
cited
9th Cir. 2008), in which the court held that the sale of the debtor’s assets was not free and clear of all liens when the price paid
did not exceed the aggregate value of all liens on the property, in violation of section 363(f)(3)).
1014 See Business Organizations with Tax Planning § 155.01 (“Cost is often the major factor that makes a receivership attractive when
compared to a federal bankruptcy proceeding”).
1015 Id. (citing Solis v. Matheson, 563 F.3d 425, 437 (9th Cir. 2009), in which the court held that a receivership is an “extraordinary
remedy” requiring “clear necessity” and should be “employed with the utmost caution”); Peterson v. Islamic Republic of Iran, 563
F. Supp. 2d 268, 277 (D.C. 2008) (“[A]ppointment of a receiver is an equitable remedy of rather drastic measure.”)).
1016 Id. (citing Case v. Murdock, 528 N.W.2d 386, 388 (S.D. 1995); Kuenning v. Broad & High Corp., 28 Ohio Misc. 211 (1971); Hoiles
v. Watkins, 157 N.E. 557 (Ohio 1927)).
1017 Id. (stating that when a receiver is appointed according to equitable principles — rather than being authorized by statute — a
higher showing of imminent danger to the property may be necessary).
1018 See id. (noting that “an assignment for the benefit of creditors is based on trust law, sometimes supplemented or modified by a
specific state statute”). See also Ronald J. Mann, An Empirical Investigation of Liquidation Choices of Failed High Tech Firms, 82
Wash. U.L.Q. 1375 (2004) (discussing use of the ABC as an alternative to bankruptcy).
1019 See generally Geoffrey L. Berman, General Assignments for the Benefit of Creditors (second edition) (2006).
1020 Id. See also Morrison, Bargaining Around Bankruptcy, supra note 1008, at 4 (“An ABC, for example, is regulated by statute and
overseen by courts in New York; it is unregulated and requires no court involvement in Illinois.”).
1021 Compare Gibbons & Grimes, supra note 1011, at 2 (asserting that receivers are able to sell property free and clear without the
consent of all lienholders, with some caveats, and acknowledging there is case law to the contrary), with Baird & Rasmussen,
The End of Bankruptcy, supra note 45, at 786–87 (arguing that the liabilities sometimes follow the assets in such asset sales, even
when that is not what the parties intended). See also Mellen v. Moline Malleable Iron Works, 131 U.S. 352, 367 (1889); Broadway
Trust Co. v. Dill, 17 F.2d 486 (3d Cir. 1927); Gibbons, Lien on Me, supra note 1011, at 19–20.
1022 See Director of Transp. of Ohio v. Eastlake Land Dev. Co., 894 N.E.2d 1255, 1261 (Ohio Ct. App. 2008) (holding that the court
did not have the ability to authorize receiver to sell debtor’s property free and clear of all liens over the creditor’s objection)
(“[W]e believe the courts do not have the power in receiver proceedings to take away lien rights in property which were vested
by contract or by operation of law without the consent of lien holders.”) (citations omitted); Quill v. Troutman Enters, Inc., 2005
WL 994676 (Ohio Ct. App. Apr. 29, 2005) (allowing receiver to sell property free and clear of liens over creditor’s objection). See
also Gibbons & Grimes, supra note 1011, at 2; M. Colette Gibbons & Melanie Shwab, Park National Bank Affirms the Ability of
Receivers to Sell Real Property Free and Clear of Liens, Cleveland Metropolitan Bar J., Dec. 2010, at 14–16.
1023 Business Organizations with Tax Planning § 156.01.
1024 Morrison, Bargaining Around Bankruptcy, supra note 1008, at 8–9 (noting that it may be difficult for creditors to audit the
distressed business outside of bankruptcy).
1025 Id.
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Bankruptcy Institute
Definition of SME: Recommendations and Findings
The Commission reviewed the history of the small business debtor provisions and the various
proposals to address small business chapter 11 issues that have been proposed in the past, including
the NBRC report discussed above and proposals by the Honorable A. Thomas Small of the U.S.
Bankruptcy Court for the Eastern District of North Carolina1026 and the American Bar Association’s
Select Advisory Committee on Business Reorganizations.1027 It also considered empirical data,
including thoughtful studies by Professor Anne Lawton and Professor Edward Morrison,1028 and
the industry and academic literature analyzing the financial distress of, and restructuring options
for, small and middle-market enterprises. Finally, the Commission was aided in its deliberations by
witness testimony.
The first question raised by the Commissioners concerned the need for, and the value of, separate
chapter 11 provisions for different types of debtors. The Commissioners discussed the very large —
or “mega” — chapter 11 cases that often dominated the media headlines. These cases certainly would
benefit from the general reform principles proposed by the Commission, but the Commission did not
believe that targeted chapter 11 provisions would further assist these debtors. The Commissioners
also observed the relatively small number of mega cases filed on an annual basis and that many
jurisdictions had adopted special local rules to address certain administrative and procedural issues
that commonly arise in those cases.1029
16
1, 20
ber 2 approach to chapter
The Commissioners did not generally believe, however, that a “one-size-fits-all”
vem
n No
ed o
11 is the best approach. In addition to the mega cases, archiCommissioners found that the general
the v
63
-353
reform principles being proposed identified o. 14 responded to key issues for the more established,
and
,N
rown cases. These cases often struggled with liquidity early
upper-middle-market and largerhcompany
v. B
xset
nBi
in the process, timingitissues lsurrounding their exit strategy and value allocation, and case-specific
i
c ed
investigations, litigation, or negotiations. These debtors also typically benefit from the advice and
counsel of restructuring professionals and have more experienced management teams.1030
On the other hand, the Commissioners identified significant and troubling issues for small and
lower-to-middle-market enterprises. (These principles refer to these companies as “small and
medium-sized enterprises (SMEs).”) In working to develop the parameters of companies in this
1026 See, e.g., A. Thomas Small, Suggestions for the National Bankruptcy Review Commission: Small Business Reorganization Chapter,
4 Am. Bankr. Inst. L. Rev. 550, 550 (1996).
1027 See Karen M. Gebbia-Pinett, Small Business Reorganizations and the SABRE Proposals, 2 Fordham J. Corp. & Fin. L. 253 (2002).
1028 Anne Lawton, Chapter 11 Triage: Diagnosing a Debtor’s Prospects for Success, 54 Ariz. L. Rev. 985, 995–1001 (2012); Morrison,
Bankruptcy Decisionmaking, supra note 998; Morrison, Bargaining Around Bankruptcy, supra note 1008; Morrison, Bankruptcy’s
Rarity, supra note 1008, at 3 (asserting that federal bankruptcy filings account for only three to four percent of all business closures).
1029 See, e.g., Laura B. Bartell, A Guide to the Judicial Management of Bankruptcy Mega-Cases (2d ed. 2009), available at http://www.
fjc.gov/public/pdf.nsf/lookup/BkMega21.pdf/$file/BkMega21.pdf.
1030 First Report of the Commercial Fin. Ass’n to the ABI Comm’n to Study the Reform of Chapter 11: Field Hearing at Commercial
Fin. Ass’n Annual Meeting, at 15–16 (Nov. 15, 2012) (“The “mega” cases and the “pre-arranged” or “pre-pack” cases come to the
Bankruptcy Court with many issues having already been pre-negotiated among the various constituencies in the debtor’s capital
structure. There is often consensus among the debtor and the various creditor groups and their representatives as to financing
and management and, indeed, many times even agreement on an exit strategy. These creditor groups are in almost all cases
represented by counsel. These cases differ markedly from the typical SME filing where the debtor has had little, if any, contact
with any creditors other than its secured lender. Given these differences, and many more not touched upon herein, it seems that
in “mega” cases, the consent of the parties should override the normal findings and statutory pre-requisites for such issues as
DIP financing and other “first day” decisions, such as the payment of pre-petition obligations (including the payment of “critical
vendors”). However, in the non-mega or non-pre-arranged cases, it is necessary to maintain the statutory construction set forth
in the Code, tempered by the Court’s judicial discretion and the exercise of business judgment.”), available at Commission
website, supra note 55.
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ABI Commission to Study the Reform of Chapter
space, the Commissioners discussed companies that have less experienced management teams,1031
relatively smaller pools of assets and liabilities, relatively smaller revenue streams,1032 challenges with
understanding the nature of their financial issues or the potential tools available to help them address
those issues,1033 and vested equity owners who likely either founded the company or help manage
the company.1034 The Commissioners also stressed the importance of these companies possessing
viable business models, recognizing that chapter 11 should not be used to delay the inevitable failure
of a company. The Commissioners firmly believed, however, that many of these SMEs were failing
not because of fatally flawed business models, but because they were not receiving the assistance
they needed in the context of a financial restructuring. This belief has been supported by witness
testimony and some of the related literature.1035
1031 Korobkin, Vulnerability, Survival, and the Problem of Small Business Bankruptcy, supra note 983, at 427–28 (“Small business
managers may be unable to afford adequate managerial training for themselves or their employees, or regularly to hire
accountants, bookkeepers, and other professional persons to assist their monitoring efforts. As a result of these factors, they may
not discover that their business is in serious financial distress until the situation has deteriorated beyond the point of repair.”).
1032 Small businesses often have higher debt-to-equity ratios than larger firms, and financing tends to come in the form of short-term
bank financing for which they generally pay higher interest rates. Korobkin, Vulnerability, Survival, and the Problem of Small
Business Bankruptcy, supra note 983, at 426 (“As a result of these real limits on obtaining capital, small businesses often confront
cash flow problems. Without available funds, they may be unable to exploit market opportunities in their purchase of raw
materials and inventory, or to pursue attractive investment opportunities. Cash flow constraints may amplify the ramifications of
simple management errors and, in less prosperous times, make small businesses more susceptible to default.”); Brian A. Blum, The
Goals and Process of Reorganizing Small Businesses in Bankruptcy, 4 J. Small & Emerging Bus. L. 181, 194–95 (2000) (“Inadequacy
of financial resources, combined with little leverage and market power, can lead to a host of other difficulties such as shortage
of operating funds, lack of cash flow, and lack of access to long-term credit. The difficulty in obtaining long-term financing,
which leads to heavy reliance on short-term credit (often in the form of credit cards or personal borrowing by the proprietor),
is regarded by many writers as one of the most significant reasons for small business failure. Short-term financing allows the
16
business to continue operations without profit for a period of time, but leaves it illiquid and2unable to absorb fluctuations in cash
1, 20
ber
m
flow.”).
Nove
1033 Written Statement of Gerald Buccino: TMA Field Hearing Before the d on Comm’n to Study the Reform of Chapter 11, at 2
e ABI new management or hire experienced insolvency
(Nov. 3, 2012) (“[Small business debtors] often lack the resources hivrecruit
arc to
professionals. Their reorganization is also made more4-35363by challenges that are common to smaller businesses, such as lack
difficult
o 1
of proprietary products, customer concentration, .vendor concentration, difficulty in raising capital, and relative insignificance
n, N
to many of their lenders and creditors. row it might take the experienced turnaround professional only weeks to determine
While
B
h v.
if the company is a candidatesfor turnaround and restructuring, the aforementioned circumstances make rehabilitation more
x et
n Bli
i
challenging and time consuming.”), available at Commission website, supra note 55; Korobkin, Vulnerability, Survival, and the
cited
Problem of Small Business Bankruptcy, supra note 983, at 426 (noting that small businesses are less likely to have cash reserves
and do not have a diverse product line or diverse customer base; also stating that “small business managers may be less likely to
detect the symptoms of financial distress at the very earliest stages” because of their short-term perspective); Blum, supra note
1032, at 195.
1034 See, e.g., Haines & Hendel, supra note 990, at 85 (noting that small business managers are often the owners and discussing
how bankruptcy can be a significant distraction); LoPucki, The Trouble with Chapter 11, supra note 82, at 758 (noting that the
market for small companies is virtually nonexistent because “[w]ithout their owner-managers, most have no value at all”);
LoPucki, The Debtor in Full Control, supra note 999, at 264 (noting that owner-managers exist in a significant majority of all
reorganizing companies); Elizabeth Warren, A Theory of Absolute Priority, 1991 Ann. Surv. Am. L. 9, 39–42 (1991) (noting that
owner-managers of small businesses may be able, despite the absolute priority rule, to retain control of the emerging company by
purchasing the equity for new value); Korobkin, Vulnerability, Survival, and the Problem of Small Business Bankruptcy, supra note
983, at 425 (stating that because of the absolute priority rule, the owner-managers common in small businesses may be reluctant
to file a petition before the company is in dire condition because in bankruptcy, they risk losing their financial interests in the
business).
1035 See, e.g., Robert N. Lussier, Reasons Why Small Businesses Fail, 1 Entrepreneurial Exec. 10, 11–14 (1996) (noting that there is
no agreement on the factors that cause small businesses to succeed or fail but noting that lack of adequate financing is among
the most commonly cited factors for failure); Teresa A. Sullivan et al., Financial Difficulties of Small Businesses and Reasons for
Their Failure 23–24 (1998), available at http://archive.sba.gov/advo/research/rs188tot.pdf; Elizabeth Warren & Jay Lawrence
Westbrook, Financial Characteristics of Businesses in Bankruptcy, 73 Am. Bankr. L.J. 499, 556–59 (1999) (finding that in a survey
of small business debtors, the most cited reason (38.5 percent) for bankruptcy was financing issues such as high debt service,
loss of financing, or inability to get financing); Written Statement of the Honorable Melanie L. Cyganowski (Ret.), former Chief
Bankruptcy Judge, Eastern District of New York: CFA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
3 (Nov. 15, 2012) (“Without the historical secured lender coming forward on Day 1, the middle-market Chapter 11 case usually
cannot survive until the final hearing. Consequently, those Code provisions, . . . which require the debtor to seek other financing
and competitive rates, are in most cases irrelevant because the debtor — in almost all of the cases over which I presided — had
difficulty maintaining its existing credit relationships upon the filing of a bankruptcy petition, much less discovering alternative
relationships.”), available at Commission website, supra note 55; Written Statement of Holly Felder Etlin: ASM Field Hearing
Before the ABI Comm’n to Study the Reform of Chapter 11, at 3–4 (Apr. 19, 2013) (“While the pre and post BAPCPA provisions
are necessary for financial markets to function, they did not properly take into account their use as financing vehicles. When the
principal lender to a business has the absolute ability to liquidate the assets subject to their agreement, the company is DOA on
the steps of the bankruptcy court.”), available at Commission website, supra note 55; Written Statement of Gerald Buccino: TMA
Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (Nov. 3, 2012) (“[T]he challenges to finance smaller
businesses have been well documented, even for those that are making a profit. The challenge is far greater for those companies
VII.ProposedRecommendations:SmallandMedium-SizedEnterprise(SME)Cases
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Bankruptcy Institute
To assess the types of companies within the SME category, the Commission reviewed historical data
regarding the types of companies filing for bankruptcy. The Commissioners analyzed data prepared
from a database of all business bankruptcy filings (both chapter 7 and chapter 11) maintained by New
Generation Research. These data included annual revenue for all but 670 of the 11,261 businesses that
filed for chapter 7 or chapter 11 bankruptcy in 2013. These revenue data break down as follows:1036
Revenue of Debtors Filing for Bankruptcy in 2013
Note:
Based on the New
Generation data, 74%
o o anies that led
16
bankruptcies in 2013
1, 20
ber 2
had revenue below $1
vem
n No
million. In addition,
ed o
rchiv
based on this same
63 a
-353
. 14
dataset, 90% of the
, No
rown
B
companies that led
th v.
bankruptcy in 2013 had in Blixse
cit d
50 or fewer employees.e
The Commissioners found the revenue and employee information very informative, but they
acknowledged that these data points were not readily available on the petition date for any particular
debtor. Accordingly, using these measures to define SMEs would be administratively difficult and,
although feasible prospectively, such measures would not have the benefit of precedent in terms of
interpretation and scope.
The Commissioners then reviewed data points more readily available for chapter 11 debtors: assets
and liabilities. All debtors list these data points in a general manner in the bankruptcy petition
and in a more specific manner in the schedules of assets and liabilities. Although also subject to
facing financial stress and for those seeking a DIP loan. Shareholders of smaller companies are also reluctant to lend money, even
well documented and at reasonable interest rates, for fear that their loan might be treated as additional equity. Some file without
a DIP loan in place, compelling management to spend [an] inordinate amount of time to obtain capital or face liquidation.”),
available at Commission website, supra note 55; Written Statement of Robert Katz: CFA Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11, at 3 (Nov. 15, 2012) (“While seemingly there is more money and more potential lenders/
investors today than ever, it doesn’t necessarily trickle down to the middle market. Some middle- and lowe-middle-market
companies going through a Chapter 11 process are still having trouble attracting capital. . . .”), available at Commission website,
supra note 55.
1036Mr. Shrestha prepared this chart for the Commission based on data from the New Generation’s Business Bankruptcy Filing
Database. Accordingly, it was limited to public and large private companies.
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ABI Commission to Study the Reform of Chapter
definitional and interpretational issues, courts and practitioners have dealt with these concepts since
the inception of the Bankruptcy Code and are more familiar with their application. The Commission
asked Professor Anne Lawton to prepare several analyses of chapter 11 debtors’ assets and liabilities
based on the datasets she built for chapter 11 filings in 2004 and 2007.1037 The data in Professor
Lawton’s dataset are taken from a random sample drawn from the population of chapter 11 cases
filed in calendar year 2007.1038 The population includes all chapter 11 cases filed in each of the 94
judicial districts in the United States. Individual and business filers alike are included, as are both
voluntary and involuntary cases. The asset and liability data are summarized in the following charts:
DEBTORS’ ASSETS BASED ON SCHEDULES
Asset Ranges
$0 – $ 100,000
$100,001 – $500,000
$500,001 – $1 million
$1,000,001 – $2.19 million
$2,190,001 – $5 million
$5,000,001 – $10 million
$10,000,001 – $50 million
$50,000,001 – $100 million
Over $100 million
Total
Number of Cases
111
119
91
117
99
47
44
4
7
639
Percent of Total
Number of Cases
17.4%
18.6%
14.2%
18.3%
15.5%
7.4%
6.9%
0.6%
1.1%
100%
Cumulative Percent of
Cases
17.4%
36.0%
50.2%
68.5%
84.0%
91.4%
98.3%
98.9%
100%
6
DEBTORS’ LIABILITIES BASED ON SCHEDULES21, 201
er
b
ovem
Percent of Total
on N
Liability Ranges
Number of Cases
ived
arch Number of Cases
363
35
$0 – $100,000
34 5.3%
o. 14
n, N111
$100,001 – $500,000
17.3%
row
B
$500,001 – $1 million
80
12.5%
th v.
$1,000,001 – $2.19 millionlixse
149
23.2%
nB
i
$2,190,001 – $5 million
126
19.7%
cited
$5,000,001 – $10 million
56
8.7%
$10,000,001 – $50 million
66
10.3%
$50,000,001 – $100 million
8
1.2%
Over $100 million
11
1.7%
Total
641
100%
Cumulative Percent of
Cases
5.3%
22.6%
35.1%
58.3%
78.0%
86.7%
97.0%
98.3%
100%
The Commissioners carefully analyzed Professor Lawton’s data and discussed its implications. They
observed a natural breaking point in the data at the $10 million threshold.1039 They examined the
types of companies that might be captured by a definition that included companies with $10 million
or less in assets or liabilities. They considered this question based on industry and geographic region,
methodically walking through the different companies that could be captured by such a definition.
Through this analysis, the Commissioners agreed that public companies (i.e., those with publicly
issued debt or equity securities) should be excluded from any SME designation in all instances.
Moreover, at the end of these deliberations, the Commissioners determined that the $10 million or
1037 Professor Lawton used the same process to create both the 2007 and 2004 datasets. For a more detailed explanation of this
process, see Lawton, Chapter 11 Triage, supra note 1028, at 995–1001.
1038 The initial sample consisted of 690 cases. The number of chapter 11 cases filed in 2007 was much smaller than that in 2004 and,
hence, the population of cases from which the random sample was drawn was smaller. The initial random sample, however, was
approximately the same in 2004 and 2007 — in the range of 10.5 percent to 10.8 percent of the respective year’s population.
1039 Professor Lawton’s 2004 dataset suggests that for all chapter 11 filings, 91.6 percent of the debtors had assets (based on schedules)
of $10 million or less, and 88.2 percent had liabilities (based on schedules) of $10 million or less. See generally supra note 66 and
accompanying text (generally discussing limitations of chapter 11 empirical studies).
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Bankruptcy Institute
less in assets or liabilities standard corresponded with the characteristics identified above of SMEs
that are not being well served by current law.
The Commissioners recognized that this standard would capture around 85 percent to 90 percent
of the chapter 11 filings, at least based on Professor Lawton’s datasets and adjustments to exclude
individual chapter 11 filings (the overwhelming majority of which fall under the $10 million
threshold) and any small public companies.1040 As previously noted, the Commission did not consider
reform proposals for individual chapter 11 debtors, and it did not intend individuals to be covered
by the recommended principles for SME debtors.
The Commissioners also discussed whether to include any of the factors or qualifications in the current
definition of small business debtor. The Commission rejected making the definition overcomplicated
and, as such, declined to require liabilities to be “noncontingent” or “liquidated,” for example.1041 It
also agreed that a debtor should be able to qualify as an SME based on either assets or liabilities.
Nevertheless, the Commission determined that the asset and liability calculations should be performed
on a consolidated basis with any affiliates to ensure that smaller businesses within a larger, more
complex corporate family were excluded. It further concluded that single asset real estate cases should
be excluded from the definition of SME, but that such determinations should be based solely on the
single asset real estate definition in section 101(51B) of the Bankruptcy Code.1042
20 not
Several Commissioners raised two related points: (i) nonpublic companies that, do16 qualify under
er 21
emb
this standard based solely on an asset or liability basis may have n Nov simple business and capital
a very
do
chive
structure that could benefit from the tools and process proposed for small and middle-market
3 ar
3536
. 14enterprises, but (ii) a standard that allowedNlarger nonpublic companies to qualify for the process
o
wn,
. Bro
also could capture companies withvvery complex business and capital structures that need to filter
eth
Blixs
through the general cchapter 11 process. The Commissioners acknowledged the validity of both
ed in
it
scenarios and examined alternatives to appropriately address each. The Commission agreed that
nonpublic companies with assets or liabilities in excess of $10 million but less than $50 million
should be able to request to be treated as an SME, but that the U.S. Trustee and parties in interest
should have the ability to challenge the designation. The Commission also agreed that the court
should only grant the request if it is in the best interests of the estate.
The Commissioners used this definition of SMEs and the underlying objectives to develop a
comprehensive set of principles to guide and facilitate more effective chapter 11 cases for SMEs.
Accordingly, the Commission voted to recommend the adoption of the SME principles and the
deletion of the small business debtor and small business case provisions from the Bankruptcy Code.
1040 For example, in the 2007 dataset, Professor Lawton was able to identify 171 individual chapter 11 filings with liabilities of $10
million or less. Removing these individual filers (and the four individual filers with more than $10 million in liabilities) from
the dataset reduced the percentage of business chapter 11 filings with $10 million or less in liabilities (based on schedules) to 83
percent. Similarly, in the 2004 dataset, the percentage of business chapter 11 filings with $10 million or less in liabilities (based
on schedules) drops to 86 percent. See generally supra note 66 and accompanying text (generally discussing limitations of chapter
11 empirical studies).
1041 See Lawton, Chapter 11 Triage, supra note 1028, at 992–93 (explaining complex calculation issues under current definition of
“small business debtor”).
1042 The Commissioners did not recommend maintaining the current qualifier in the definition of “small business debtor” in section
101(51D) that the debtor be involved in “commercial or business activities (including any affiliate of such person that is also
a debtor under this title and excluding a person whose primary activity is the business of owning or operating real property or
activities incidental thereto).” 11 U.S.C. § 101(51D) (emphasis added). See also Lawton, Chapter 11 Triage, supra note 1028, at
1026 n. 149 (explaining challenges in applying real estate exclusion in definition of “small business debtor”).
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ABI Commission to Study the Reform of Chapter
B. General Application of SME Principles
Recommended Principles:
A debtor that satisfies the definition of an SME should be subject to the principles
set forth herein for SME cases without further action by the court, trustee, or
debtor in possession.
If an objection is timely filed to the debtor’s indication in the petition that it
qualifies as an SME under the Bankruptcy Code definition, such debtor should
be treated as an SME unless and until the entry of an order of the court sustaining
any such objection.
If a debtor timely files a motion seeking to be treated as an SME, such debtor should
be treated as an SME only upon the entry of an order of the court overruling any
objections thereto and authorizing the debtor’s designation as an SME.
If a debtor qualifies or is designated as an SME, the court may for cause, after notice
and a hearing, permit the SME debtor to use good faith estimates in compiling
its valuation information package, as required by the principles, if audited or
6
unaudited financial statements are not readily available. The 1, 201 also may set
court
ber 2
m
a deadline by which the SME debtor should turnnovereits valuation information
Nov
ed o
rc iv
package, to a requesting party in interest. SeehSection IV.A.6, Valuation Information
63 a
-353
o. 14
Packages.
n, N
Brow
th v.
lixse
general Brecommended
in
cited
The
principles proposed for chapter 11 cases apply to
SME cases, unless the principles expressly exclude SME cases or would otherwise
conflict with the SME principles.
General Application of SME Principles: Background
As noted above, Congress introduced the small business provisions into the Bankruptcy Code as
an elective process. Debtors who satisfied the original definition of “small business” could elect to
proceed with the fast-track plan confirmation procedures. Congress removed the elective nature of
the small business provisions in 2005 pursuant to the BAPCPA Amendments. The current provisions
mandate small business treatment if, among other things, the debtor has less than $2,190,000 in total
secured and unsecured debts and there is no active unsecured creditors’ committee in the case.
Although the current small business provisions are mandatory and self-executing, several
commentators have suggested that small business debtors are not self-reporting and may not be
proceeding as small business cases. For example, Professor Robert Lawless observed that “there were
2,299 chapter 11s filed in 2007 where (i) the debtor was not an individual, (ii) [the debtor] said they
had predominately business debts, and (iii) the total liabilities were between $50,000 and $1,000,000.
Because very few small chapter 11 cases have unsecured creditors’ committees, almost every one of
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Bankruptcy Institute
these 2,299 cases should have identified as small business debtor, but only 36.8 percent did so.”1043
Now, the failure to self-identify as a small business debtor may be an oversight, it may be the result
of the somewhat complicated definition of “small business debtor” described above, or it may be a
desire to avoid the obligations and deadlines imposed on small business debtors under current law.
Regardless of the reason, however, the consequences can be significant, including a determination
that the small business debtor deadlines apply from the petition date, even if the non-designation is
not corrected or is not deemed incorrect by the court until much later in the case.1044
General Application of SME Principles: Recommendations and Findings
The three primary objectives underlying the Commission’s approach to the SME principles were (i)
simplifying the process; (ii) reducing costs and barriers; and (iii) providing tools to facilitate effective
reorganizations for viable companies. With these objectives in mind, the Commission determined
that a hybrid approach to the application of the SME principles would work best. Accordingly, if the
debtor is a nonpublic company that satisfies the asset or liability standard, it automatically invokes
the SME principles. If the debtor is a nonpublic company that does not qualify, but it has assets or
liabilities less than $50 million and believes that the SME principles would better serve its estate and
stakeholders, it can make a request to be treated as an SME debtor.
The Commissioners were mindful that some companies might try to manipulate6the standard or
1
1 20
self-identify as an SME when the standard is not satisfied, but they believed, that those concerns
ber 2
em
are appropriately addressed by allowing the U.S. Trustee and on Nov in interest to object to the
parties
ed
hiv
designation in the petition or a debtor’s request to-353treated as an SME. In both instances, however,
be 63 arc
. 14
the Commissioners understood the importance of these matters being resolved quickly to allow
, No
rown
B
h .
the debtor either the full benefit tofvthe SME principles or appropriate time to consider proceeding
xse
n Bli
i
cited
under the general chapter 11 principles. They believed that any delay in these determinations could
significantly prejudice both the debtor and its stakeholders. The Commission also considered
whether debtors would fail to self-report, as some commentators have suggested might be the
case under the current law. Again, the Commissioners recognized that this was a possibility, but it
believed that the SME principles incorporated appropriate incentives for the debtor and its estate so
as to mitigate that risk.
1043 Bob Lawless, The Disappearing Small Businesses (Designation) in Bankruptcy, Credit Slips, (Apr. 30, 2010, 10:26 AM), available
at http://www.creditslips.org/creditslips/2010/04/the-disappearing-small-businesses-designation-in-bankruptcy.html.
1044 See, e.g., In re Display Grp., Inc., 2010 WL 4777550 (Bankr. E.D.N.Y. Nov. 16, 2010). Notably, the U.S. Trustee reviews a debtor’s
chapter 11 petition and generally has 30 days following the section 341 meeting of creditors to object to the debtor’s designation
or non-designation as a small business case. See Fed. R. Bankr. P. 1020(b) (2011).
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ABI Commission to Study the Reform of Chapter
C. Oversight of SME Cases
Recommended Principles:
The debtor should be permitted to operate as a debtor in possession with all rights,
powers, and duties set forth in section 1107 of the Bankruptcy Code and subject to
the appointment of a chapter 11 trustee for cause under section 1104.
A committee of unsecured creditors under section 1102(a) should not be appointed
in an SME case unless an unsecured creditor or the U.S. Trustee files a motion
with the court requesting the appointment of a committee and the court, after
notice and a hearing, determines that the appointment is necessary to protect the
interests of unsecured creditors in the case.
If the debtor does not satisfy the Bankruptcy Code definition of SME but files a
timely motion to be treated as an SME in the chapter 11 case, the U.S. Trustee
should not appoint a committee of unsecured creditors unless the court denies
the debtor’s motion. The U.S. Trustee should suspend its ordinary appointment
process pending resolution of the debtor’s motion.
6
If the debtor qualifies as an SME or is designated an SME byer 21court, the notice of
the , 201
b
the chapter 11 case served upon creditors should on Novem
explain that the U.S. Trustee will
d
chive in the case unless such committee
not appoint a committee of unsecured 63 ar
creditors
353
. 14- or the U.S. Trustee and the court orders such
is requested by an unsecuredNo
, creditor
own
v. Br indicates in its petition that it qualifies as an SME, such
appointment. Ifseth debtor
the
Blix
ed i
noticecialsonshould explain that parties in interest have 14 days from the date of
t
such notice to object to the debtor’s treatment as an SME.
The court sua sponte, the U.S. Trustee, the debtor in possession, or a party in
interest should be able to request the appointment of an estate neutral that also
has the authority to advise the debtor in possession on operational and financial
matters, as well as the content and negotiation of its plan. The standard for approval
of an estate neutral and the U.S. Trustee’s authority to appoint the estate neutral,
if ordered by the court, should be governed by the general principles on estate
neutrals. See Section IV.A.3, The Estate Neutral.
Any estate neutral should represent the interests of the estate and be paid by the
estate. The Bankruptcy Code could establish a fee structure available for the estate
neutral in an SME case to control costs and increase certainty. Such structure
could be based on the size of the case or the amount of creditor distributions.
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Oversight of SME Cases: Background
As discussed above, the debtor in possession model used in chapter 11 cases makes oversight of the
case particularly important.1045 In most cases, the Bankruptcy Code establishes the U.S. Trustee and
the committee of unsecured creditors as the statutory watchdogs in the case. Both of these parties have
the ability to oversee and investigate certain aspects of the case and to appear and be heard with respect to
matters pending in the case.1046 (In addition, other creditors and equity security holders have standing to
appear and be heard in the case under section 1109 of the Bankruptcy Code.) Nevertheless, in many SME
cases, the U.S. Trustee may not be able to appoint a committee of unsecured creditors typically because of
a lack of creditor interest in serving on the committee.1047
The lack of creditor engagement was one reason cited by Congress in using the absence of a committee as
a defining feature of a small business case. The legislative history of the BAPCPA Amendments explains:
Most chapter 11 cases are filed by small business debtors. Although the Bankruptcy Code
envisions that creditors should play a major role in the oversight of chapter 11 cases,
this often does not occur with respect to small business debtors. The main reason is that
creditors in these smaller cases do not have claims large enough to warrant the time and
money to participate actively in these cases.1048
If an unsecured creditors’ committee is not appointed in the small business debtor case, the debtor may
6
, 201
drift in its case, achieving little, or it may cede to the desires of its secured creditors,1even if those objectives
ber 2
v m
do not align with the best interests of the estate.1049 Accordingly, althoughe absence of a committee or
n No the
ed o
v
creditor engagement may correspond to the size of the 63 archior the complexity of the case, it does not
debtor
-353
14
mean that the debtor does not need oversight, oroassistance in the case.1050
N .
wn
ed
h v.
xset
n Bli
i
Bro
it
Oversight of SMEcCases: Recommendations and Findings
The Commission viewed the administrative and oversight functions in an SME case as critical to the utility
and effectiveness of the SME principles. The Commissioners wanted to develop principles that encouraged
SMEs to file chapter 11 cases when appropriate, which meant reducing costs, simplifying disclosures and
the process, and providing a way for the prepetition managers to stay in control of the business with some
1045 In the debtor in possession model, the business’s prepetition board of directors, officers, and managers continue to manage the
company’s affairs and make decisions regarding the business and the reorganization. Some critics of the debtor in possession
model argue that these prepetition actors contributed to the business’s failure and also express concern that the prepetition
management may not be aligned with the best interests of the estate. See Section IV.A.1, The Debtor in Possession Model.
1046 For a general discussion of the parties overseeing the debtor in possession in chapter 11, see Butler, et al., supra note 77. See also
11 U.S.C. § 1103 (detailing duties of statutory committees); id. § 1104 (appointment of trustee); id. § 1109 (explaining standing
of parties in interest).
1047 See, e.g., Lawton, Chapter 11 Triage, supra note 1028, at 1006 & n. 119 (“The reason for such a low rate of committee formation
[in SME cases] is that in most cases an insufficient number of creditors were willing to serve.”).
1048 See H.R. Rep. No. 109-31, pt. 1, at 19 (2005), reprinted in 2005 U.S.C.C.A.N. 88, 89.
1049 See Oral Testimony of the Honorable Barbara Houser: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11, at 27 (Apr. 19, 2013) (ASM Transcript) (“[T]he case I worry about is th[e] case . . . with no committee and you have a debtor
who is often lock-step with their secured creditor, because they have no choice but to be lock-step with their secured creditor,
and there is nobody to tell me when there’s a problem in the case.”), available at Commission website, supra note 55; Blum, supra
note 1032, at 199–201 (“[M]any small business debtors are left to operate too freely in chapter 11 without adequate control [by
a unsecured creditors’ committee].”).
1050 This concept was a significant motivator for the BAPCPA reforms. Blum, supra note 1032, at 201 (“The central component of the
proposed [BAPCPA] reform is the creation of an alternative monitoring system to compensate for lack of creditor involvement
in the case. In essence, it demands a more aggressive role of the U.S. Trustee and the court as a substitute for the lack of creditor
vigilance and increases the accountability of the [small business] debtor by placing greater responsibility on it to provide
information about its business affairs and to move with reasonable speed in formulating and obtaining approval of its strategy
for rehabilitation.”) (citing NBRC Report, supra note 37, at 643).
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financial guidance and counseling when needed. These factors allowed the Commissioners to reflect on
various alternatives for structuring the SME principles, including a chapter 13-like process for SMEs.
Some Commissioners suggested that the best oversight for SME cases was a standing trustee
system similar to that used in the chapter 13 context. In chapter 13 cases, the U.S. Trustee appoints
a standing trustee in each jurisdiction. The trustee represents the estate, and he or she oversees
the administration of the case, including the confirmation of, and distributions under, the debtor’s
rehabilitation plan. The trustee does not represent the debtor, but he or she may consult with the
debtor, including with respect to issues in the proposed rehabilitation plan. A few Commissioners
even suggested either raising the chapter 13 debt limits to permit small businesses to file under
chapter 13 or incorporating a more chapter 13-like process into chapter 11 for small businesses.1051
Most Commissioners strongly rejected the notion of either a standing trustee for SMEs or a chapter
13-like process for SME cases. These Commissioners noted that small business cases are not simply big
chapter 13 cases. They highlighted the structural differences in business cases, including the debtor’s
contractual relationships with vendors and suppliers and its obligations to customers. SMEs also have
employees to consider and operational issues that may complicate their restructuring alternatives.
Finally, these Commissioners highlighted the likely reluctance of SMEs to file bankruptcy cases if the
administration of their cases and perhaps their businesses would be turned over to a standing trustee.
The Commissioners then considered whether the traditional unsecured16
, 20 creditors’ committee
er 21
emb
structure was an effective oversight mechanism for SMEncases. They reflected on the witness
Nov
do
chive
testimony concerning the costs associated with63 ar
unsecured creditors’ committees, particularly in
53
. 14 apathy that might prevent the formation of a committee
smaller cases.1052 They also noted the creditor -3
No
wn,
in the first instance in SMEeth v. B1053 Most Commissioners agreed that committees could be effective
cases. ro
lixs
in SME cases if cited in B were engaged and representative of the general unsecured creditor body,
creditors
and if costs could be contained. They also agreed, however, that satisfying both of these criteria in an
SME case was likely the exception rather than the rule.1054
The Commissioners analyzed whether an estate neutral might provide appropriate oversight in SME cases
when a committee was not appointed and when the SME debtor needed monitoring or assistance.1055 They
reviewed the witness testimony on the types of tools that witnesses believed would be helpful to SME
debtors. For example, the Honorable Barbara J. Houser of the U.S. Bankruptcy Court for the Northern
1051 For a similar proposal that would create a process similar to chapter 12 for small business debtors, see Haines & Hendel, supra
note 990.
1052 See Written Statement of the Honorable Dennis Dow: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11, at 1 (Apr. 19, 2013) (citing professionals’ fees associated with unsecured creditors’ committees as one of the bankruptcy
process obstacles facing small business debtors), available at Commission website, supra note 55.
1053 See, e.g., Lawton, Chapter 11 Triage, supra note 1028, at 1006 & n. 119; Honorable A. Thomas Small, Small Business Bankruptcy
Cases, 1 Am. Bankr. Inst. L. Rev. 305, 320–21, 320 n. 74 (1993) (“In most cases, however, unsecured creditors are apathetic
and creditors’ committees are ineffective, particularly in smaller Chapter 11 cases. Removing the creditors’ committee would,
however, benefit the debtor by eliminating the possibility that a creditors’ committee might incur substantial professional fees
that could easily jeopardize confirmation of the debtor’s plan.”).
1054 See id.
1055 See, e.g., Written Statement of Gerald Buccino: TMA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
2 (Nov. 3, 2012) (stating that it could take an experienced turnaround professional only a few weeks to determine if a debtor’s
business is viable, whereas it would likely take an unassisted small business debtor much longer), available at Commission
website, supra note 55; Written Statement of the Honorable Melanie Cyganowski (Ret.), former Chief Bankruptcy Judge, Eastern
District of New York: CFA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–3 (Nov. 15, 2012) (noting
there is very little oversight in most small business cases and that these cases seem to “live” from one emergency to the next),
available at Commission website, supra note 55.
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District of Texas suggested that “a third party who is more of a financial person, who could come in and
evaluate the viability of the business,”1056 may be of assistance to both the court and the debtor in possession
in assessing the debtor’s prospects for reorganization. Several Commissioners observed that the estateneutral concept might apply particularly well in SME cases. The court could appoint an estate neutral
for specific purposes, including a financial review of the debtor, consulting with the debtor concerning
its finances and restructuring options, or investigating the debtor’s affairs when necessary or appropriate.
The estate neutral, with court authority, also could assist the SME debtor in developing its chapter 11
plan, which would provide oversight of the debtor in possession and a counterbalance to any particular
individual creditor influence in the case. Although the estate neutral would impose an additional cost
on the estate, the Commissioners believed that the courts could and should closely monitor the fees and
expenses of the estate neutral and could even use caps or budgets to protect the estate.
On balance, the Commission voted to recommend the use of estate neutrals to assist SME debtors achieve
effective outcomes in appropriate cases. The Commissioners underscored the case-by-case nature of this
inquiry and, accordingly, declined to make it a mandatory appointment. They specifically found, however,
that if the court orders the appointment of an estate neutral, the U.S. Trustee should be the party responsible
for the appointment of the neutral to ensure objectivity and fairness in the process. The Commission also
determined that the U.S. Trustee and parties in interest should be able to request the appointment of a
committee in an SME case. As noted above, if there is creditor interest, a committee may be very
valuable in an SME case. Nevertheless, the Commissioners found no basis for the existence (or
16
1, that
non-existence) of a committee to affect an SME designation. They also believed 20 the cost of, and
ber 2
m
the historical issues with, appointing a committee in smaller d on Nosupported a default rule of no
cases ve
e
iv
arch
committee appointment.
5363
in
cited
-3
o. 14
n, N
Brow
th v.
lixse
B
D. Plan Timeline in SME Cases
Recommended Principles:
Within 60 days of the entry of the order for relief, the SME debtor should develop
and file with the court a timeline for filing and soliciting acceptances of its plan.
If an estate neutral or a committee is appointed, the SME debtor should consult
with such estate neutral or committee in developing its timeline.
After the SME debtor files its timeline for filing and soliciting acceptances of
its plan, the court should enter an order under section 105(d)(2)(B) setting the
deadlines for the SME debtor’s plan process.
The SME debtor should be subject to the exclusivity periods provided in
section 1121.
1056 Oral Testimony of the Honorable Barbara Houser: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 29 (Apr. 19, 2013) (ASM Transcript), available at Commission website, supra note 55.
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ABI Commission to Study the Reform of Chapter
Plan Timeline in SME Cases: Background
The Bankruptcy Code, as amended in 2005, requires that a debtor’s chapter 11 plan be confirmed
within 45 days of its filing. Several witnesses before the Commission testified that this is nearly
impossible for small business debtors to achieve.1057 Although it is possible to obtain a continuance,
one witness noted that the burden for doing so is quite high, and that there is confusion regarding
what the court must find and how it must make the necessary determinations, given the tight
timelines and significant requirements.1058 Thus, practically speaking, even viable small business
debtors face considerable challenges to confirming a plan.
The Bankruptcy Code also provides that a small business debtor must file the chapter 11 plan within
300 days of the petition date.1059 One witness noted that the 300-day deadline creates interpretive
and practical problems similar to those identified above for the 45-day deadline, plus gives rise to
additional concerns.1060 For example, confusion exists regarding the application of the provision to
parties other than the debtor, and the Bankruptcy Code does not specify the effect of an amended
plan.1061 The Bankruptcy Code also does not address the consequences for failure to submit a plan
by the 300-day deadline.1062
Plan Timeline in SME Cases: Recommendations and Findings
The Commissioners debated the utility of firm deadlines in the context16 SME cases. They
, 20 of
er 21
embthan later in the case; no party
understood the need to assess the viability of a debtor earlier Nov
rather
d on
chive
benefits from prolonging a dismissal and incurringr additional costs and expenses that cannot be
3a
3536
. 14paid. They also discussed the danger ,ofohandcuffing debtors to artificial deadlines that might not
N
own
v. Br
facilitate the debtor’s reorganization or serve the interests of the estate in the particular case.
seth
ix
in Bl
cited
The Commission reviewed the recommendations of the advisory committee, which focused on
helping both viable and nonviable debtors reach their fate efficiently. The advisory committee’s
recommendations included simplifying the definition of “small business debtor,” and eliminating
the 300-day plan proposal and 45-day plan confirmation deadlines for small business cases.
The Commission also considered reforms suggested by witnesses, including more discretion for
1057 Written Statement of the Honorable Dennis Dow: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
1–2 (Apr. 19, 2013), available at Commission website, supra note 55; Written Statement of the Honorable Barbara Houser: ASM
Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1 (Apr. 19, 2013) (“[E]ven when these [small and
medium-sized] businesses make it to a confirmation hearing, the challenges they face may be virtually impossible to overcome.”),
available at Commission website, supra note 55.
1058 Written Statement of the Honorable Dennis Dow: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
4–6 (Apr. 19, 2013), available at Commission website, supra note 55. See also 11 U.S.C. § 1129(e) (providing that the court shall
confirm a plan within 45 days for small businesses, unless time is extended in accordance with section 1121(3)(3)); id. § 1121(e)
(3) (“[T]he time periods . . . may be extended only if — (A) the debtor, after providing notice to parties in interest (including the
United States trustee), demonstrates by a preponderance of the evidence that it is more likely than not that the court will confirm
a plan within a reasonable period of time; (B) a new deadline is imposed at the time the extension is granted; and (C) the order
extending time is signed before the existing deadline has expired.”).
1059 11 U.S.C. § 1121(e) (“In a small business case . . . the plan and a disclosure statement (if any) shall be filed not later than 300 days
after the date of the order for relief. . . .”).
1060 Written Statement of the Honorable Dennis Dow: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 6–7 (Apr. 19, 2013), available at Commission website, supra note 55.
1061 Id.
1062 Although the Bankruptcy Code does not address the consequences of the failure to file a plan within the 300-day period, “the
consensus appears to be that if no party files a plan within the 300-day period, no relief can be afforded and the case must be
dismissed.” Id.
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bankruptcy judges concerning the procedures in small business cases,1063 and additional clarification
regarding the standard of review and procedural requirements if the current 45- and 300-day
confirmation and plan deadlines remain in place.1064
The Commissioners worked to develop a process striking an appropriate balance between the need
to assess the viability of an SME debtor case early while still allowing viable SME cases a reasonable
opportunity to succeed. The Commission voted to recommend a mandatory requirement that the
SME debtor file a timeline for filing and soliciting acceptances of its chapter 11 plan within 60 days
of the petition date. It set this deadline to allow time for the SME debtor to settle into the chapter
11 case, resolve any issues relating to its SME designation, and consult with any committee or estate
neutral appointed in the case, but still allow the court time to develop deadlines for the filing and
solicitation of a chapter 11 plan consistent with other provisions of the Bankruptcy Code, such as the
debtor’s exclusivity periods under section 1121. The Commission determined that section 105(d)
(2)(B) adequately authorizes the court to establish these deadlines, and that the Bankruptcy Code
should be amended to simply require the court to exercise this authority in SME cases.
E. Plan Content and Confirmation in SME Cases
16
1, 20
ber 2
vem
n No
Recommended Principles:
ed o
rchiv
63 a
-353provide for the following treatment of
A chapter 11 plan in an SME case oshould
. 14
,N
rown case:
.B
allowed claims and interests in the
eth v
Bl xs
n ofi all administrative and priority claims in accordance with
i
o Payment
cited
section 1129(a)(9) of the Bankruptcy Code.
o Bifurcation of each undersecured claim into an allowed secured claim
in accordance with section 506 and a general unsecured claim for any
deficiency claim; neither section 1111(b) nor section 1129(a)(7)(B) should
apply in an SME case.
o Distributions to secured creditors (i) as provided in the plan and accepted
by each class of secured creditors; or (ii) in accordance with section
1129(b)(2)(A).
o Distributions to unsecured creditors (i) as provided in the plan and
accepted by each class of unsecured creditors; (ii) in accordance with
section 1129(b)(2)(B) (subject to the recommended principles codifying
1063 Written Statement of the Honorable Melanie L. Cyganowski (Ret.), former Chief Bankruptcy Judge, Eastern District of New York:
CFA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 3 (Nov. 15, 2012) (“[I]t is essential that the
Bankruptcy Court have flexibility to exercise judicial supervision regarding the SME debtor’s business judgment when dealing
with secured credit. The reasons are many but in most instances, these middle-market cases seemingly ‘live’ from one emergency
to the next and therefore legislating ‘fixed’ criteria when it comes to the treatment of secured debt would not be in the best
interest of promoting reorganization. It is not at all unusual in these middle-market Chapter 11 cases for a deadline or a budget
requirement to be missed which, but for the Court’s intervention and ability to step in and permit the waiver of an otherwise
arbitrary provision, would lead to the automatic lifting of the automatic stay or the dismissal of the case without hearing or
opportunity to be heard.”), available at Commission website, supra note 55.
1064 Written Statement of the Honorable Dennis Dow: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 3–7 (Apr. 19, 2013), available at Commission website, supra note 55.
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ABI Commission to Study the Reform of Chapter
the new value corollary); or (iii) as provided below for an SME Equity
Retention Plan. See Section VI.C.2, New Value Corollary.
o Prepetition equity interests may receive voting common stock or ownership
units in the reorganized debtor, provided that (i) all impaired classes have
accepted the plan; (ii) the plan complies with section 1129(b) (subject to
the recommended principles codifying the new value corollary); or (iii) the
plan complies with section 1129(b)(2)(A) and provides impaired classes
of unsecured creditors that have rejected the plan with preferred stock, or
similar economic interests, in the reorganized debtor as described below
(an “SME Equity Retention Plan”).
The court should confirm an SME Equity Retention Plan that is not accepted by
any class of unsecured claims only if:
o (i) The prepetition equity security holders will continue to support the
debtor’s successful emergence from chapter 11 by remaining involved,
on a basis reasonably comparable to their prepetition involvement, in the
ongoing operations of the reorganized debtor; and (ii) the reorganized
debtor will pay to the holders of unsecured claims, no less often than
annually, its excess cash flow calculated in a manner reasonable in relation
to the company’s operating cash flow for each of the three016 fiscal years
full
2
r 21,debtor should file
following the effective date of the chapter 11 plan. e
mb The
Nove
onchapter 11 plan that describes
a budget with its disclosure statementved
hi and
3 arc
36method and includes projections of excess
the excess cash flow calculation
-35
o. 14
cash flow for therown, Nfiscal years following the effective date of the plan.
three
v. B
o Thein Blixseth equity security holders receive or retain 100 percent of the
prepetition
ted
cicommon stock, or similar ownership interests, issued or outstanding as of
the effective date entitling the holders as a class to receive 15 percent of any
economic distributions from the reorganized debtor, including dividends,
liquidation or sale proceeds, merger or acquisition consideration, or other
consideration distributed to the economic owners of the reorganized debtor.
o The prepetition unsecured creditors as a class receive 100 percent of a
class of preferred stock, similar preferred interests, or payment obligations
issued by the reorganized debtor on the effective date in accordance with
the chapter 11 plan with the following features (referred to as the “creditors’
preferred interests”): (i) pro rata voting rights, limited to voting only on the
extraordinary transactions identified in these principles; and (ii) entitlement
as a class to receive 85 percent of any economic distributions from the
reorganized debtor, including dividends, liquidation or sale proceeds,
merger or acquisition consideration, or other consideration distributed to
the economic owners of the reorganized debtor.
o The creditors’ preferred interests mature on the fourth anniversary of the
effective date, at which time the interests should convert into 85 percent
of the common stock, or similar ownership interests, of the reorganized
debtor, unless redeemed in cash on or before the maturity date for their full
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Bankruptcy Institute
face amount. The face amount of the creditors’ preferred interests should
equal the amount of the allowed unsecured claims held by those creditors
receiving the creditors’ preferred interests and established under the plan or
confirmation order. Any cash or other distributions received by the holders
of the creditors’ preferred interests (whether under the plan on account of
their unsecured claims or on account of the creditors’ preferred interests)
prior to the maturity date should reduce the redemption or conversion
value of such interests.
o The following kinds of post-effective date transactions are deemed
“extraordinary transactions” subject to the vote of holders of creditors’
preferred interests: (i) any change to the compensation of, or payments
to, insiders of the reorganized debtor as set forth in the chapter 11 plan,
including any compensation or payments to or for the benefit of relatives
or affiliates of such insiders; (ii) dividends or other distributions of value to
equity security holders of the reorganized debtor; (iii) decisions to forego
or roll over any dividends or other distributions of value required to be
paid under the organizational documents on account of the economic
ownership interests held by holders of creditors’ preferred interests;
(iv) the sale of all or substantially all of the assets of the reorganized debtor,
dissolution of the reorganized debtor, or merger of the reorganized debtor
16
1, 20
with or its acquisition of another entity; and (v) any amendments to the
ber 2
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Nove
organizational documents that would modify,n alter, or otherwise affect
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the rights of holders of creditors’3preferred interests. An extraordinary
63 a
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transaction should require at. least an absolute majority vote of the holders
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of creditors’xseth v.
preferred interest, but the chapter 11 plan may require a
n Bli
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cite
higherdlevel of approval. Whether an extraordinary transaction has been
approved by the requisite majority vote (or such higher level as required
by the plan) should be determined in accordance with applicable state
entity governance law.
o The consummation of an extraordinary transaction without the requisite
approval should constitute a default under the chapter 11 plan, and
holders of creditors’ preferred interests should have the ability to request
appropriate relief for such breach from the court that confirmed the plan.
In addition, upon any such default, the creditors’ preferred interests should
be entitled to a liquidation preference over the common stock in the full
face amount of the creditors’ preferred interests, reduced by any cash
or other distributions received by the holders of the creditors’ preferred
interests (whether under the plan on account of their unsecured claims or
on account of the creditors’ preferred interests) prior to liquidation.
The general recommended principles proposed for chapter 11 plans apply to
SME cases, unless the principles expressly exclude SME cases or would otherwise
conflict with the SME principles.
VII.ProposedRecommendations:SmallandMedium-SizedEnterprise(SME)Cases
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ABI Commission to Study the Reform of Chapter
Plan Content and Confirmation in SME Cases: Background
Many commentators agree that chapter 11 is failing for small business debtors, but they disagree on
both the cause and solution to this problem. As discussed above, some suggest that the deadlines
concerning the plan process pose significant barriers. Others suggest that the plan process itself and
the confirmation standards make emergence from chapter 11 almost impossible for small business
debtors.1065 Still, others have posited that reorganization is simply not feasible for small business
debtors, benefits only the business owner, and that going concern sales may be a more effective
restructuring option for these debtors.1066
The Commission received testimony from several witnesses arguing that the absolute priority rule1067
and courts’ disparate treatment of the new value corollary doom many small business debtors’
plans.1068 As Judge Houser explained:
So, where a small to mid-sized business debtor cannot pay its unsecured claims in
full with a market rate of interest over the life of the plan (a common occurrence),
the junior class of interest holders may not receive or retain any property under the
plan “on account of ” their former interests. This is because of the application of what
we call the absolute priority rule. The application of this rule and the so-called “new
value exception” to it in small to mid-size Chapter 11 cases proves problematic.1069
Witnesses suggested that this uncertainty in the plan process can cause delay 6 expense, and can
and
201
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r 21,
even deter lings in the rst instance.
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eth v
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in
1065 Id. at 1 (“The complexity, time and costs of the Chapter 11 process impose obstacles that small businesses often cannot
cited
overcome.”); Written Statement of the Honorable Barbara Houser: ASM Field Hearing Before the ABI Comm’n to Study the Reform
of Chapter 11, at 1 (Apr. 19, 2013) (“As Judge Dow has already observed, the complexity, time, and costs of the Chapter 11 process
impose obstacles that small and middle-market businesses often cannot overcome. But, even when these businesses make it to
a confirmation hearing, the challenges they face may be virtually impossible to overcome.”), available at Commission website,
supra note 55.
1066 Baird & Rasmussen, The End of Bankruptcy, supra note 45, 753, 786–89 (2002) (noting that Sweden’s insolvency code only
provides for the sale of an insolvent firm and that it works well for both large and small businesses, and that many such small
business debtors are run by “marginally competent owner-managers” with few corporate assets and few long-term employees).
See also Douglas G. Baird & Edward R. Morrison, Serial Entrepreneurs and Small Business Bankruptcies, 105 Colum. L. Rev. 2310
(2005) (“The typical Chapter 11 debtor is a small corporation whose assets are not specialized and rarely worth enough to pay tax
claims. There is no business worth saving and there are no assets to fight over. The focal point is not the business, but the person
who runs it.”).
1067 The absolute priority rule is implicated when there is an undersecured creditor who rejects the debtor’s plan. This undersecured
creditor receives a lot of power in this circumstance because the creditor’s claim is bifurcated such that the creditor is able to vote
in the secured class and the unsecured class. The small business debtor likely has only a few classes of claims. This ultimately
makes the plan very difficult to confirm under the cramdown provisions. Written Statement of the Honorable Barbara Houser:
ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 1–2 (Apr. 19, 2013), available at Commission
website, supra note 55.
1068 The new value exception presents problems in small business cases because there may be tension between the oversecured
creditor and the owner-operators (equity security holders). These equity security holders may give new value to retain some
stake in the reorganized business. However, there may be challenges in appropriately applying the new value exception in small
business cases. Id. at 2–6.
1069 Id. at 2. See also Written Statement of Richard Mikels: TMA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11, at 9 (Nov. 3, 2012) (“Inclusion of limited exclusivity and the implementation of the absolute priority rule in the bankruptcy
regime make the most sense with respect to large public entities whose creditors and equity holders made informed investment
decisions and understood their risk and relative priorities. I am not sure that the considerations are the same with respect to
smaller businesses. Should entrepreneurs and families who are involved in the day to day operations of their businesses be
provided some level of protection not available to holders of securities in public companies?”), available at Commission website,
supra note 55.
1070 Written Statement of Richard Mikels: TMA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 9 (Nov. 3,
2012) (suggesting that small businesses that are managed by equity security holders delay filing because of the personal financial
detriment that such filings will cause them), available at Commission website, supra note 55.
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Plan Content and Confirmation in SME Cases: Recommendations
and Findings
A debtor’s emergence from chapter 11 frequently turns on its ability to confirm a chapter 11 plan.
Although it may consider a sale of all or substantially all of its assets under section 363x as an
exit strategy, a debtor — particularly an SME who likely has founders or managers as part of its
prepetition ownership structure — strives to reorganize and emerge from chapter 11 as a stronger
and more efficient version of its prepetition business.
The Commission considered at length the interests of an SME’s prepetition stakeholders and the
challenges to confirmable plans for SME debtors.1071 The Commissioners acknowledged that many
SMEs are family-owned businesses or businesses in which the founders are still actively involved.1072
For this reason, many SMEs find the common result of plan confirmation extinguishing prepetition
equity interests in their entirety unsatisfactory or completely unworkable. The Commissioners
discussed the tension created by these expectations: prepetition equity views their contributions
and continued participation as necessary to the reorganization, but stakeholders may hold a very
different perspective. Prepetition equity or managers may be considered part of the problem or
ineffective.
The Commissioners debated how best to mitigate this tension and foster a meaningful reorganization
16
process for SMEs. Most Commissioners agreed that the SME principles should, include some option
1 20
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for prepetition equity security holders to retain or receive the equity ofothe reorganized debtor, beyond
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ed Commissioners asserted that SMEs
that currently permitted under the new value corollary.archiv
These
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needed a reorganization path that encouraged 14
. founders and prepetition equity not only to invoke
, No
rownefforts to the debtor’s successful reorganization. Indeed,
chapter 11, but also to devote allhof. their
v B
set
n stakeholders like them or not — the prepetition founders or managers
for many SMEs — whetherBlix
i
cited
often possess the knowhow and relationships necessary to facilitate a successful restructuring of the
business.1073
The Commissioners determined that the SME principles should create an equity retention structure
that would appropriately align the interests of prepetition management and equity with the debtor’s
reorganization and protect the interests of unsecured creditors, despite noncompliance with the
traditional absolute priority rule. The basic elements of this structure include:
A reorganized capital structure that (i) permits prepetition equity to retain or receive 100
percent of the voting interests in the reorganized debtor, subject to the limited voting
rights of the creditors’ preferred interests, and no more than 15 percent of the economic
ownership interests in the reorganized debtor (akin to common stock ownership
1071 See, e.g., Written Statement of the Honorable Barbara Houser: ASM Field Hearing Before the ABI Comm’n to Study the Reform of
Chapter 11, at 1–6 (Apr. 19, 2013) (discussing how the absolute priority rule and the new value exception create challenges in the
bankruptcies of owner-operated small businesses), available at Commission website, supra note 55.
1072 See, e.g., Written Statement of Richard Mikels: TMA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 13 (Nov. 3, 2012) (“While it is beneficial that value is being realized for creditors, the blood, sweat and tears of the owners
are not being accorded the [appropriate] considerations [which affect the use of chapter 11 by small businesses].”), available at
Commission website, supra note 55.
1073 Written Statement of Maria Chavez-Ruark: CFRP Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11,
at 2 (Nov. 7, 2012) (“[I]n smaller Chapter 11 proceedings the debtor’s competitive advantage is [often] based on the owners’
relationships with customers, suppliers or others.”), available at Commission website, supra note 55.
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ABI Commission to Study the Reform of Chapter
with limited economic rights); and (ii) grants preferred ownership interests to general
unsecured creditors that include limited voting rights on extraordinary transactions and at
least 85 percent of the economic ownership interests in the reorganized debtor (creditors’
preferred interests).
A provision in the plan that directs the reorganized debtor to pay to the holders of
unsecured claims, no less often than annually, its excess cash flow calculated in a manner
reasonable in relation to the company’s operating cash flow for each of the three full fiscal
years following the effective date of the chapter 11 plan. This provision is intended to
provide cash dividends to unsecured creditors prior to maturity of the preferred interests
and to fairly allocate the reorganized debtor’s excess cash to claims impaired by the chapter
11 plan.
The creditors’ preferred interests mature on the fourth anniversary of the effective date
of the chapter 11 plan, at which time the interests should convert into 85 percent of the
common stock, or similar ownership interests, of the reorganized debtor, unless redeemed
in cash on or before the maturity date for their full face amount. The face amount of the
creditors’ preferred interests should equal the amount of the allowed unsecured claims
held by those creditors receiving the creditors’ preferred interests and established under
the plan or confirmation order. Any cash or other distributions received by the holders of
the creditors’ preferred interests (whether under the plan on account of their unsecured
6
, 201
claims or on account of the creditors’ preferred interests) mber 2to the maturity date should
prior 1
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reduce the redemption or conversion value ofivsuchninterests.
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The holders of creditors’ preferred interests are entitled to vote on any and all of the following
, No
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extraordinary transactions: (i) any change to the compensation of, or payments to, insiders
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of the reorganized debtor as set forth in the chapter 11 plan, including any compensation
cited
or payments to or for the benefit of relatives or affiliates of such insiders; (ii) dividends
or other distributions of value to equity security holders of the reorganized debtor; (iii)
decisions to forego or roll over any dividends or other distributions of value required to be
paid under the organizational documents on account of the economic ownership interests
held by holders of creditors’ preferred interests; (iv) sale of all or substantially all of the
assets of the reorganized debtor, dissolution of the reorganized debtor, or merger of the
reorganized debtor with or its acquisition of another entity; and (v) any amendments to
the organizational documents that would modify, alter, or otherwise affect the rights of
holders of creditors’ preferred interests. This provision is intended to protect the value
of, and entitlement to, the cash, creditors’ preferred interests, and other distributions
allocated to unsecured creditors under the plan from diminution or impairment by the
postconfirmation actions of common interest-holders, managers, or insiders. The failure
to adhere to the voting or other rights granted to holders of creditors’ preferred interests
under or in connection with the plan constitutes a default under the plan that may be
enforced in the bankruptcy court. In addition, upon any such default, the creditors’
preferred interests should be entitled to a liquidation preference over the common stock
in the full face amount of the creditors’ preferred interests, reduced by any cash or other
distributions received by the holders of the creditors’ preferred interests (whether under
VII.ProposedRecommendations:SmallandMedium-SizedEnterprise(SME)Cases
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Bankruptcy Institute
the plan on account of their unsecured claims or on account of the creditors’ preferred
interests) prior to liquidation.
Finally, the prepetition equity must commit to support the plan, the debtor’s emergence
from chapter 11, and its postconfirmation operations.
The Commission voted to recommend an equity-retention plan structure built on these basic
elements. It believed that such a structure will provide appropriate incentives and protections,
basically giving prepetition equity security holders four years after confirmation to repay the
business’s prepetition unsecured creditors. If the prepetition equity security holders are not able
to achieve this result in that time period, then the unsecured creditors may convert their preferred
interests into common ownership interests, significantly diluting the common ownership held by the
prepetition equity security holders. Under this structure, both prepetition equity security holders
and unsecured creditors have incentives to foster a sustainable and profitable reorganized business.
Finally, the Commissioners recommended other modifications to the section 1129(a) confirmation
standards, including a mandatory bifurcation of undersecured creditors’ claims so that only the
allowed secured claim of such creditor would be subject to the cramdown requirements of section
1129(b)(2)(A), and its unsecured deficiency claim would be subject to the treatment provided general
unsecured creditors. In addition, certain other modifications proposed by these principles to plan
confirmation requirements for all chapter 11 cases would apply to SME cases, such 16 the elimination
as
20
r 21,the Commission did
of an accepting impaired class of creditors under section 1129(a)(10). Notably,
be
vem
not recommend application of the redemption option valueived on No to SME cases.1074
principles
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1074 For a discussion of the redemption option value principles and the potential challenges to applying them in SME cases, see
Section VI.C.1, Creditors’ Rights to Reorganization Value and Redemption Option Value.
VII.ProposedRecommendations:SmallandMedium-SizedEnterprise(SME)Cases
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VIII. PROPOSED
RECOMMENDATIONS:
STANDARD OF REVIEW
AND KEY DEFINITIONS
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Bankruptcy Institute
A. General Standard of Review
Recommended Principles:
The burden of proof in all matters under title 11 of the U.S. Code should be the
preponderance of the evidence standard unless otherwise expressly stated in
the applicable section of the Bankruptcy Code. Accordingly, section 102 of the
Bankruptcy Code should be amended to clarify this point.
General Standard of Review: Recommendations and Findings
Throughout its study of chapter 11, the Commission identified multiple instances of courts adopting
a different standard of review — either the preponderance of the evidence, or the clear and convincing
standard — for the same issue under the same section of the Bankruptcy Code. The Bankruptcy
Code is silent on the appropriate standard of review in these instances. The Commission thoroughly
vetted the standard of review in connection with each of the substantive issues addressed in the
Report. The Commission also considered related issues that were not being specifically discussed
in the principles, but that also invoked a split in the courts concerning the appropriate standard of
review. The Commission voted to recommend that the general standard of review016chapter 11 cases
, 2 in
er 21
emb Code section specifically
be the preponderance of the evidence standard, unless the Bankruptcy
Nov
d on
chive
notes otherwise. The Commission has recommended3principles for each instance in which it has
ar
3536
. 14- is necessary and more appropriate.
determined that the clear-and-convincing ,standard
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Brow
B. Key Definitions and Concepts in Principles
The following definitions and concepts, among others, are used in the recommended principles.
This section provides only (i) a summary of the definitions and (ii) cross-references for the concepts.
Readers should consult each identified section of the Report for a complete explanation of these
definitions and concepts.
“chapter 11 professional”
This concept is described in Section IV.A.7, Professionals and Compensation Issues.
“commercially reasonable determinants of value”
Determinants of value specified in the contract that are not manifestly unreasonable or, in
the absence of such determinants of value, commercially reasonable market prices.
See Section IV.E.4, Section 562 and “Commercially Reasonable Determinants of Value.”
“creditors’ preferred interests”
This concept is described in Section VII.E, Plan Content and Confirmation in SME Cases.
VIII. Proposed Recommendations: Standard of Review and Key Definitions
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ABI Commission to Study the Reform of Chapter
“estate neutral”
This concept is described in Section IV.A.3, The Estate Neutral.
“executory contract”
A contract under which the obligation of both the bankrupt and the other party to the contract
are so far unperformed that the failure of either to complete performance would constitute
a material breach excusing the performance of the other, provided that forbearance should
not constitute performance.
See Section V.A.1, Definition of Executory Contract.
“foreclosure value”
The net value that a secured creditor would realize upon a hypothetical, commercially
reasonable foreclosure sale of the secured creditor’s collateral under applicable
nonbankruptcy law.
See Section IV.B.1, Adequate Protection.
“milestones, benchmarks, or other provisions that require the trustee to perform certain tasks or
satisfy certain conditions”
Tasks or conditions that relate in a material or significant way to the 016
debtor’s operations
1, 2
ber 2 deadlines by which the
during the chapter 11 case or to the resolution of the case,Novem
including
n
ed o
debtor must conduct an auction, close a sale, or rchiva disclosure statement and a chapter 11
file
63 a
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plan.
o. 14
,N
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v. Br
See Section IV.C.1, Timing of Approval of Certain Postpetition Financing Provisions.
eth
Blixs
ed in
cit
“nonbankruptcy professional”
An individual or firm of lawyers, financial advisors, accountants, consultants, or other
professionals retained by the debtor prior to or after the petition date working exclusively on
business or legal matters that arise in, or relate primarily to, the day-to-day operations of the
debtor’s business and that could not have a material effect on the chapter 11 case.
See Section IV.A.7, Professionals and Compensation Issues.
“permissible extraordinary financing provisions”
(i) Milestones, benchmarks, or other provisions that require the trustee to perform certain
tasks or satisfy certain conditions; (ii) representations regarding the validity or extent of the
creditor’s liens on the debtor’s property or property of the estate; or (iii) if some or all of the
proposed postpetition lenders hold prepetition debt that would be affected by the postpetition
facility, a provision that refinances prepetition debt with proceeds of the postpetition facility
that is otherwise permissible under the principles relating to postpetition financing terms.
See Section IV.C.1, Timing of Approval of Certain Postpetition Financing Provisions.
VIII. Proposed Recommendations: Standard of Review and Key Definitions
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“redemption option value”
The redemption option value attributable to such immediately junior class is the value of a
hypothetical option to purchase the entire firm with an exercise price equal to the redemption
price and a duration equal to the redemption period.
See Section VI.C.1, Creditors’ Rights to Reorganization Value and Redemption Option Value.
“redemption period”
The period between the plan effective date or sale order date and the third anniversary of the
petition date.
See Section VI.C.1, Creditors’ Rights to Reorganization Value and Redemption Option Value.
“redemption price”
Where the senior class would otherwise be entitled to the entire value of the firm, the
redemption price of the hypothetical option would be the full face amount of the claims
of the senior class, including any unsecured deficiency claim, plus any interest at the nondefault contract rate plus allowable fees and expenses unpaid by the debtor, in each case
accruing through the hypothetical date of exercise of the redemption option, as though the
claims remained outstanding on the date of the exercise of the option.
16
See Section VI.C.1, Creditors’ Rights to Reorganization Value and Redemption0Option Value.
21, 2
r
mbe
Nove
on
ived
“rent”
arch
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Any recurring monetary obligations of, the. debtor under the lease.
No
wn
. Bro
eth v Leases.
See Section V.A.6, Real Property
ixs
in Bl
cited
“reorganization value”
(i) If the debtor is reorganizing under the plan, the enterprise value attributable to the
reorganized business entity, plus the net realizable value of its assets that are not included
in determining the enterprise value and are subject to subsequent disposition as provided
in the confirmed plan; or (ii) if the debtor is selling all or substantially all of its assets under
section 363x or a chapter 11 plan, the net sale price for the enterprise plus the net realizable
value of its assets that are not included in such sale and are subject to subsequent disposition
as provided in the confirmed plan or as contemplated at the time of the section 363x sale.
See Section VI.C.1, Creditors’ Rights to Reorganization Value and Redemption Option Value.
“section 363x sale”
This concept is described in Section VI.B, Approval of Section 363x Sales.
“small or medium-sized enterprtise” (“SME”)
A business debtor with —
(i) No publicly traded securities in its capital structure or in the capital
structure of any affiliated debtors whose cases are jointly administered with
the debtor’s case; and
VIII. Proposed Recommendations: Standard of Review and Key Definitions
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ABI Commission to Study the Reform of Chapter
(ii) Less than $10 million in assets or liabilities on a consolidated basis with
any debtor or nondebtor affiliates as of the petition date.
See Section VII.A, Definition of SME.
“SME Equity Retention Plan”
This concept is described in Section VII.E, Plan Content and Confirmation in SME Cases.
“valuation information package” (“VIP”)
(i) Tax returns for the previous three years (inclusive of all schedules); (ii) annual financial
statements (audited if available) for the prior three years (inclusive of all footnotes); (iii) most
recent independent appraisals of any of the debtor’s material assets (including any valuations
of business enterprise or equity); and (iv) to the extent shared with prepetition creditors
and existing or potential purchasers, investors, or lenders, all business plans or projections
prepared within the past two years.
See Section IV.A.6, Valuation Information Packages.
“value differential”
This concept is described in Section IV.B.1, Adequate Protection.
in
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VIII. Proposed Recommendations: Standard of Review and Key Definitions
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VIII. Proposed Recommendations: Standard of Review and Key Definitions
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IX. OTHER ISSUES RELATING
TO CHAPTER 11 CASES
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Bankruptcy Institute
A. Venue of Chapter 11 Cases
The Commissioners engaged in extensive deliberations concerning the existing venue statute, the
merits of the venue debate, and the potential advantages and disadvantages to reforming the statute.
These deliberations included an analysis of the reported case law on chapter 11 venue, the academic
research, and the various reforms proposed by commentators and policymakers to address some
or all of the alleged deficiencies in the venue statute. The Commissioners found these issues among
some of the most difficult and divisive issues considered during the Commission project. Although
all Commissioers appreciated and understood the various perspectives represented in the debate,
they were unable to reach a consensus regarding whether reform of the venue statute was necessary
or what potential reform might best serve the diverse interests in chapter 11 cases. Ultimately,
the Commission concluded that it could contribute most meaningfully to the ongoing dialogue
concerning chapter 11 venue by providing this summary of its research and deliberations.
Section 1408 of title 28 of the U.S. Code generally provides that a bankruptcy case may be filed in a
jurisdiction where the debtor is domiciled or maintains its residence, principal place of business, or
principal assets.1075 In addition, the case may be filed in the same jurisdiction as a previously filed
case of the debtor’s affiliate, general partner, or partnership (the “affiliate-filing rule”).1076 Although
not an issue unique to chapter 11 cases, disputes concerning the application of the venue statute
2016
arise most frequently in the chapter 11 context.1077
r 21,
be
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The primary venue options for a business debtor archivthe debtor’s domicile (i.e., place of
are e
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incorporation),1078 principal place of business,. location of principal assets, and place of an affiliate’s
o 14
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Bro each of these four locations may be a viable venue option.
filing. Particularly for larger businesses,w
th v.
lixse
in B
The debtor may be incorporated in one state, with its headquarters in another state and its principal
cited
assets in multiple states and jurisdictions. Likewise, its affiliated businesses may have multiple venue
options that then become effectively available to the debtor under the affiliate-filing rule.
The venue selected by a business debtor in a voluntary chapter 11 filing often depends on several
relevant factors. These factors include: (i) the proximity of the venue to the debtor’s professionals,
key creditors, and management; (ii) the legal precedent in the jurisdiction on potentially key issues
in the debtor’s restructuring efforts; and (iii) the facts available to support the filing of the case in a
particular jurisdiction under the venue statute. In addition, a debtor also may consider the perceived
expertise of the bankruptcy judges and the efficiencies of the processes available in potential venue
jurisdictions.1079
1075 28 U.S.C. § 1408.
1076 Id. See also In re Patriot Coal Corp., 482 B.R. 718 (Bankr. S.D.N.Y. 2012).
1077 See, e.g., In re Enron Corp., 274 B.R. 327 (Bankr. S.D.N.Y. 2002) (holding that venue was proper in the Southern District of New
York, even though none of the debtors’ core operations were located in New York, none of the debtors were organized under the
laws of New York, a significant portion of the then current or former officers of the debtors resided in the Southern District of
Texas, and substantially all of the debtors’ books and records were located in Houston, Texas).
1078 See Barry E. Adler & Henry N. Butler, On the “Delawarization of Bankruptcy” Debate, 52 Emory L. J. 1309, 1311 (citing In re
Ocean Props. of Del., Inc., 95 B.R. 304, 305 (Bankr. D. Del. 1988)).
1079 See Robert K. Rasmussen & Randall S. Thomas, Timing Matters: Promoting Forum Shopping by Insolvent Corporations, 94 Nw.
U. L. Rev. 1357, 1359, 1389–90 (2000) (noting that counsel may advise debtors to choose Delaware because of the bench’s
experience and the attending increase in certainty).
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A party in interest who disagrees with the debtor’s venue selection, or simply believes that another
venue is more convenient for the parties, may file a motion to transfer venue of the case to another
jurisdiction or, in certain circumstances, to dismiss the case. Specifically, section 1412 of title 28
provides that “[a] district court may transfer a case or proceeding under title 11 to a district court
for another district, in the interest of justice or for the convenience of the parties.”1080 Section 1406
of title 28 provides, in turn, that “[t]he district court of a district in which is filed a case laying venue
in the wrong division or district shall dismiss, or if it be in the interest of justice, transfer such case
to any district or division in which it could have been brought.” Despite these statutory provisions,
relatively few motions to transfer venue or to dismiss cases based on venue are filed.1081
The dearth of venue motions is in stark contrast to the long-running, high-profile debate concerning
the utility of the existing venue statute. Beginning in the 1990s, some academics, practitioners, and
judges began to question venue choices by large chapter 11 debtors and calling for the reform of
section 1408 of title 28. This debate focused on the large concentration of business bankruptcies
being filed in the Southern District of New York in the 1980s, in the District of Delaware in the
1990s, and in both of these two jurisdictions since that time. Some commentators estimate that
approximately 70 percent of all large, public company chapter 11 cases are now filed in either the
Southern District of New York or the District of Delaware.1082
Critics of the existing venue statute argue that business debtors may use the venue rules to file cases
16
in jurisdictions thousands of miles away from the company’s management,, employees, communities,
1 20
ber 2
ve
and key constituencies, making it difficult and expensive for thesemparties to participate in or even
n No
ed o
out that
follow the chapter 11 case.1083 Critics also point 363 archivthe venue selected often appears to bear no
35
. 14meaningful relationship to the business, its operations, its financial difficulties, or its stakeholders.1084
, No
own
v. Br that the fees and publicity associated with large chapter 11 cases
In addition, some critics alsohargue
et
Blixs
has led certain jurisdictions to cater to these types of debtors, encouraging businesses to file in their
ed in
cit
jurisdictions and creating a “race to the bottom” in chapter 11 practice.1085 The two reforms most
1080 28 U.S.C. § 1412. See also In re Patriot Coal Corp., 482 B.R. 718, 744 (Bankr. S.D.N.Y. 2012) (granting motion for venue transfer
in the interest of justice and noting that although the debtors had complied with the letter of the law, the court “cannot allow the
Debtors’ venue choice to stand, as to do so would elevate form over substance in way that would be an affront to the purpose
of the bankruptcy venue statute and the integrity of the bankruptcy system”); Bankruptcy Court Transfers Venue of Patriot Coal
Chapter 11 Cases from SDNY to St. Louis in the Interest of Justice, Weil Bankruptcy Blog (Nov. 28, 2012), available at http://
business-finance-restructuring.weil.com/venue/bankruptcy-court-transfers-venue-of-patriot-coal-chapter-11-cases-fromsdny-to-st-louis-in-the-interest-of-justice/.
1081 Lynn M. LoPucki & William C. Whitford, Venue Choice and Forum Shopping in the Bankruptcy Reorganization of Large, Publicly
Held Companies, 1991 Wis. L. Rev. 11, 23–24 (1991) (noting that even if a case is filed in an improper venue, the case may not be
transferred unless a party in interest files a motion, and even then, it is unclear if the court is obligated to transfer venue).
1082 See Marcus Cole, ‘Delaware Is Not A State’: Are We Witnessing Jurisdictional Competition in Bankruptcy?, 55 Vand. L. Rev. 1845,
1850 (2002); Gordon Bermant, et al., Chapter 11 Venue Choice by Large Public Companies 38–42 (Federal Judicial Center ed.
1997).
1083 There is a value to stakeholders in having locally held proceedings. See Gulf Oil Corp. v. Gilbert, 330 U.S. 501, 509 (1947) (“In
cases which touch the affairs of many persons, there is reason for holding the trial in their venue and reach rather than in remote
parts of the country where they can learn of it by report only. There is a local interest in local controversies decided at home.”).
1084 Theodore Eisenberg & Lynn M. LoPucki, Shopping for Judges: An Empirical Analysis of Venue Choice in Large Chapter 11
Reorganizations, 84 Cornell L. Rev. 967, 1001–02 (1999) (finding, through empirical research, that the reasons offered for venue
choice — efficiency and convenience — are not supported by the data, and concluding that New York and Delaware are chosen
either for the expertise of their bankruptcy judges or to avoid the debtor’s local bankruptcy judge).
1085 Lynn M. LoPucki & Sara D. Kalin, The Failure of Public Company Bankruptcies in Delaware and New York: Empirical Evidence of
a “Race to the Bottom,” 54 Vand. L. Rev. 231, 231, 235 (2001) (concluding that companies overwhelmingly chose Delaware as a
bankruptcy venue because they lacked sufficient information about alternatives).
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frequently proposed by critics are the elimination of venue based on place of incorporation1086 and
on the affiliate-filing rule.1087
Supporters of the existing venue statute argue that its flexibility allows business debtors to select
the jurisdiction that will facilitate the most effective and value-maximizing reorganization.1088 They
observe that many businesses are geographically diverse, with operations, management, employees,
and stakeholders dispersed throughout the country (and often overseas).1089 There may not be one
particular jurisdiction that is better or more convenient for the business and all stakeholders.1090 They
also note that the Southern District of New York and the District of Delaware are typically convenient
for most businesses’ financial creditors, have expertise in complex financial and operational matters,
and have relatively efficient procedures for handling large cases.1091 Moreover, they find value in
place of incorporation as a potential venue option because it is easy to identify and it is known, or
knowable, by all stakeholders ex ante.1092
The academic and empirical literature on venue selection is as diverse as the debate itself.1093
Professor Lynn LoPucki suggests that venue selection may result in a higher repeat filing rate.1094
Other commentators have reached different conclusions.1095 Moreover, one study found that when
corporate debtors file in New York or Delaware, creditors receive approximately 25 percent less
than those of debtors filing their cases elsewhere.1096 Another empirical study of the 159 largest
16
1, 20
ber 2
1086 See NBRC Report, supra note 37, at 719 § 3.1.5 (recommending that 28 U.S.C. § 1408(1)m amended “to prohibit a corporate
ve be
n No
filing for relief in a district based solely on the debtor’s incorporation in the state where that district is located”).
ed o
1087 See id. (suggesting that the affiliate-filing rule be reconfigured such archthe affiliate may file in the same location where the
that iv
parent has filed for bankruptcy, but not vice-versa unless venue 63
-353is otherwise appropriate for the parent). See also Chapter 11
. 14
Bankruptcy Venue Reform Act of 2011, Hearing Beforeothe H. Subcommittee on Courts., 112th Cong. 61 (2011) (statement of
,N
rown
Professor Melissa B. Jacoby, University of .North Carolina Chapel Hill) (“In bankruptcy, a major corporation also can follow
v B
a small subsidiary into a district in seth the rest of the company has no relationship. Enron took this path. This practice has
x which
n Blifederal venue rules. Indeed, to the extent that a plaintiff claims that a parent ‘resides’ in a
i
no intentional analogueitin other
c ed
district merely because its subsidiary is deemed to reside there for purposes of personal jurisdiction, the parent is likely to raise
objections.”) (citations omitted), available at http://judiciary.house.gov/_files/hearings/printers/112th/112-88_68185.PDF.
1088 Rasmussen & Thomas, supra note 1079, at 1359.
1089 See, e.g., Written Statement of James L. Patton, Jr., Esq., Young Conaway Stargatt & Taylor LLP: UT Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11, at 2–6 (Nov. 22, 2013), available at Commission website, supra note 55.
1090 See, e.g., Written Statement of Michael Luskin on Behalf of the New York City Bar Association’s Comm. on Bankruptcy and Corporate
Reorganization: UT Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (Nov. 22, 2013), available at
Commission website, supra note 55.
1091 Rasmussen & Thomas, supra note 1079, at 1371; Kenneth Ayotte & David A. Skeel, Jr., An Efficiency-Based Explanation for
Current Corporate Reorganization Practice, 73 U. Chi. L. Rev. 425, 453 (2006) (finding that Delaware bankruptcy courts are
quite efficient as they handle cases more quickly and do not interfere with the firm’s decisionmaking processes); David A. Skeel,
Jr., What’s So Bad About Delaware?, 54 Vand. L. Rev. 309 (2001) (arguing that firms benefit from Delaware incorporation and
bankruptcy proceedings); David A. Skeel, Jr., Lockups and Delaware Venue in Corporate Law and Bankruptcy, 68 U. Cin. L. Rev.
1243 (2000) (arguing that Delaware venue in bankruptcy offers some of the benefits Delaware offers in corporate law).
1092 Cole, supra note 1082, at 1905.
1093 Bermant, supra note 1082; Adler & Butler, supra note 1078; Ayotte & Skeel, An Efficiency-Based Explanation for Current Corporate
Reorganization Practice, supra note 1091; Eisenberg & LoPucki, supra note 1084; LoPucki & Kalin, supra note 1085; LoPucki &
Whitford, supra note 1081; Cole, supra note 1082; Parikh, Modern Forum Shopping in Bankruptcy, supra note 1083; Rasmussen
& Thomas, supra note 1079; Skeel, What’s So Bad About Delaware?, supra note 1091; Skeel, Lockups and Delaware Venue in
Corporate Law and Bankruptcy, supra note 1091; Skeel, Bankruptcy Judges and Bankruptcy Venue, infra note 1100.
1094 See Lynn M. LoPucki, Courting Failure: How Competition for Big Cases Is Corrupting the Bankruptcy Courts 100 tbl.4 (2005).
1095 See Robert K. Rasmussen, Empirically Bankrupt, 2007 Colum. Bus. L. Rev. 179, 221–26 (2007) (“The problem is obvious.
Companies that reorganized in Delaware need a second reorganization at rates substantially higher than companies that
reorganized elsewhere. This difference is statistically significant. . . . LoPucki has defined his population so that he could conduct
a census rather than take a sample. . . . These tables reveal that the Delaware refiling effect that forms the heart of LoPucki’ s
normative conclusion is really a prepackaged refiling effect.”).
1096 See Patrick Fitzgerald, Bankruptcy Venue Change Linked to Recovery Rates, Wall St. J. (Jan. 24, 2007) (citing an academic study
completed by Wei Wang in 2007 titled “Bankruptcy Filing and the Expected Recovery of Corporate Debt,” which reviewed
182 companies that filed for bankruptcy from 1995 to 2003, used trading prices of distressed debt as a measure of creditors’
recoveries, and found that when debtors filed their case in New York or Delaware, creditors of those firms recovered around
25 to 35 percent less than those of firms that filed their cases elsewhere; the study offered to explain the disparity by the large
proportion of fraudulent bankruptcies that were filed in New York and led to lower recoveries), available at http://online.wsj.
com/article/SB116961550859886124.html.
IX. Other Issues Relating to Chapter Cases
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bankruptcy cases between June 7, 2007, and June 30, 2012, found that 69 percent of those cases
involved venue selection, which the article defined as “forum shopping.”1097 This study asserts that
venue selection leads to disparate treatment and undermines the perception and integrity of the
bankruptcy system.1098
Since the 1990s, several reform proposals have been discussed as part of the debate. For example,
some suggest that statutory standards should be tightened and judicial discretion regarding venue
should be narrowed.1099 Others suggest altering the bankruptcy judge selection process or giving
bankruptcy creditors a direct say in the forum selection process.1100 Still others suggest loosening
the forum selection provision, claiming that venue choice should be further encouraged rather
than discouraged.1101 The National Bankruptcy Review Commission recommended requiring a
bankruptcy filing where the principal assets are located and, if this location is undeterminable, then
where the principal place of business is located.1102 In 2005, Senator John Cornyn proposed changes
to the venue provisions.1103 The bill was introduced to address the venue-choice issues raised in cases
such as Enron, K-Mart, Polaroid, and WorldCom; this proposal would have amended section 1408
to prevent a debtor from filing in a district where the debtor is incorporated, unless that district was
also the debtor’s principal place of business.1104 Testimony supporting the bill suggested that because
corporations identify strongly with communities, to have an iconic company file in a venue other
than in that community undermines the judicial process, and further, that the current transfer of
venue statute is ineffective.1105
16
1, 20
ber 2
Notably, the testimony before the Commission reflects the n Novem of perspectives evidenced by
diversity
do
chive
the historical debate and reform proposals. The 63 ar
Honorable Steven Rhodes of the U.S. Bankruptcy
-353
. 14has stated that venue choice has a negative impact on
Court for the Eastern District of Michigan
, No
own
v. Br it prevents or impairs the meaningful participation of any of the
judicial legitimacy, especially when
eth
Blixs
d in
parties, ultimatelyeundermining the integrity of the adjudication process itself.1106 Another witness
cit
expressed a similar sentiment: “The unspoken but implicit message in a filing across the country
1097 Parikh, supra note 1083, at 159, 177. A debtor was deemed to have “forum shopped” based on a review of the debtor’s bankruptcy
petition and analysis of its basis for establishing venue in a particular district in light of supporting documentation, like firstday motions. The study found that over a two-decade period, the frequency with which large corporate debtors forum shopped
increased 14 percent and the absolute number of such debtors who forum shopped increased 130 percent. Id. at 159, 177–78.
1098 See id. at 198 (“A cornerstone of our judicial system is that the law be subject to a variety of interpretations at the trial level. . . .”).
1099 See LoPucki & Whitford, supra note 1081, at 11(recommending tighter statutory standards and narrower judicial discretion).
1100 David A. Skeel, Jr., Bankruptcy Judges and Bankruptcy Venue: Some Thoughts on Delaware, 1 Del. L. Rev. 1, at 4–5 (1998).
1101 Rasmussen & Thomas, supra note 1079, at 1359 (arguing that venue choice should be encouraged, perhaps even prior to
experiencing financial distress; considering venue choice in advance, they argue, would allow managers to choose the forum
most likely to maximize the value of the firm).
1102 NBRC Report, supra note 37, at 719.
1103 Fairness in Bankruptcy Litigation Act of 2005, S. 314, 109th Cong. (2005).
1104 See Jeffrey Morris, S. 314 — Fairness in Bankruptcy Litigation Act of 2005: Restricting Venue Choices for Corporate Debtors, Am. Bankr. Inst.
(Mar. 1, 2005), available at http://www.abiworld.org/AM/Template.cfm?Section=Home&CONTENTID=40272&TEMPLATE=/
CM/ContentDisplay.cfm.
1105 H.R. 2533: Chapter 11 Bankruptcy Venue Reform Act of 2011, Hearing Before the H. Subcomm. On Courts, Commercial and
Administrative Law, 112th Cong. 30–31 (Sept. 8, 2011) (statement of the Honorable Frank J. Bailey, Chief Judge of the U.S.
Bankruptcy Court for the District of Massachusetts) (stating that a big business bankruptcy should be filed in its “community”
and that the transfer of venue statue is not effective because “[i]t is enormously expensive for a party to mount a challenge to
venue”). On the other hand, the Commissioners reviewed information indicating that when venue transfer motions are filed,
they are often granted. See, e.g., Written Statement of James L. Patton, Jr., Esq., Young Conaway Stargatt & Taylor LLP: UT Field
Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2–6 (Nov. 22, 2013) (“From 2006 through 2012, however,
motions to transfer venue out of Delaware bankruptcy court were ruled upon by the bankruptcy court in 13 different nonaffiliated chapter 11 cases. In nine of these 13 different chapter 11 cases, or roughly 69.2 percent, the Delaware bankruptcy court
transferred venue.”), available at Commission website, supra note 55.
1106 Written Statement of the Honorable Steven Rhodes, U.S. Bankruptcy Judge, E.D. Michigan: UT Field Hearing Before the ABI
Comm’n to Study the Reform of Chapter 11, at 7–8 (Nov. 22, 2013), available at Commission website, supra note 55.
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from home base is that nobody counts but the lenders and the debtor’s management.”1107 Yet another
witness decried venue choice, arguing that it “disenfranchises smaller and local parties in interest,
erodes the credibility of the bankruptcy system and gives rise to the perception that the system is
being manipulated.”1108 Witnesses also defended the current venue statute, with one arguing that a
change in the venue statute limiting venue to the principal place of business would only increase
uncertainty and ultimately increase litigation regarding the location of the debtor’s principal place
of business and proper venue.1109 That witness also noted that the convenience of the parties may not
necessarily be served by limiting venue to the principal place of business as creditors are often widely
dispersed because of the global nature of the economy.1110 Another witness defended the venue
statute on the grounds that “[t]here is no reason to believe that the jurisdiction where a corporate
parent is headquartered or holds its principal assets is always a more appropriate venue, or one more
convenient to creditors.”1111
B. Core and Noncore Matters in Chapter 11 Cases
1112
When Congress enacted the Bankruptcy Act of 1978, it conferred broad subject matter jurisdiction
upon bankruptcy courts. Jurisdiction was granted over all “civil proceedings arising under title 11
16
or arising in or related to cases under title 11.”1113 Although the bankruptcy2courts operated under
1, 20
ber matter of practice, they
the supervision of the district court under the former BankruptcyNovem a
Act as
n
ed o
hiv
operated with considerable independence.
3 arc
536
14-3
No.
,
In 1982, the Supreme Court in Northernwn
. Bro Pipeline Constr. Co. v. Marathon Pipe Line Co. struck down
eth v
ixs
the Bankruptcy Act of 1978’sBbroad jurisdictional provisions, asserting that the Act unconstitutionally
in l
cited
conferred Article III judicial power upon Article I bankruptcy judges.1114 Article III, Section 1 of the
U.S. Constitution provides that “[t]he judicial Power of the United States, shall be vested in one
Supreme Court, and in such inferior Courts as the Congress may from time to time ordain and
establish.” Bankruptcy judges, without lifetime tenure and protections against salary diminution,
are not created under Article III and so are not vested with the “judicial Power of the United States.”
1107 Written Statement of Michael R. (“Buzz”) Rochelle: UT Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
6–7 (Nov. 22, 2013), available at Commission website, supra note 55. Mr. Rochelle also noted that perception matters on the issue
of whether justice is being served, and having cases heard far from a business’s community erodes that community’s perception
that justice is being done. Id. at 7. See also Written Statement of Lawrence J. Westbrook: UT Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11, at 1–3 (Nov. 22, 2013) (arguing that bankruptcy proceedings should be held in the business’s
community to increase the transparency of the proceedings and ultimately to improve the administration of justice (or at least
the appearance of it)), available at Commission website, supra note 55.
1108 Written Statement of Douglas B. Rosner on behalf of the National Ad Hoc Group of Bankruptcy Practitioners in Support of Venue
Fairness: UT Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (Nov. 22, 2013), available at Commission
website, supra note 55..
1109 Written Statement of James L. Patton, Jr., Esq., Young Conaway Stargatt & Taylor LLP: UT Field Hearing Before the ABI Comm’n
to Study the Reform of Chapter 11, at 2–6 (Nov. 22, 2013), available at Commission website, supra note 55.
1110 Id. at 7.
1111 Written Statement of Michael Luskin on Behalf of the New York City Bar Association’s Comm. on Bankruptcy and Corporate
Reorganization: UT Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 2 (Nov. 22, 2013), available at
Commission website, supra note 55. Mr. Luskin also noted that technology has made it possible for far off parties to participate
in proceedings via telephonic appearances. Id. at 4.
1112 Professor Lois Lupica, University of Maine School of Law, Robert M. Zinman ABI Resident Scholar (Fall 2014), drafted this
section (Core and Noncore Matters in Chapter 11 Cases).
1113 28 U.S.C. § 1471(b).
1114 Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982).
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To address this problem and provide a “fix,” Congress enacted the Bankruptcy Amendments and
Federal Judgeship Act of 1984. The 1984 jurisdictional scheme vested bankruptcy jurisdiction in the
first instance in the district courts, deeming bankruptcy courts as units of the district court for each
district.1115 Pursuant to the 1984 Act, district courts may refer cases and matters within the scope
of such jurisdiction to the bankruptcy courts. Once referred, whether a bankruptcy court may hear
and render a final judgment on a matter in a bankruptcy case, absent the parties’ consent, turns on
whether a matter is deemed to be core or noncore.
Title 28, Section 157(b) sets forth a nonexhaustive list of matters deemed to be core matters.1116
Generally, these “core” matters are those with which the bankruptcy court has greater familiarity
and expertise than the district court.1117 Final orders with respect to core matters are subject to
appellate review by the district courts or bankruptcy appellate panels.
In contrast, “noncore” proceedings are ones that have a “life of [their] own in either state or federal
common law or statute independent of the federal bankruptcy laws.”1118 The bankruptcy judge in
noncore proceedings is limited to submitting proposed findings of fact and conclusions of law
to the district court.1119 Once such proposed findings and conclusions are submitted, the district
court judge enters a final order or judgment.1120 The district court also conducts a de novo review
1115 28 U.S.C. § 151.
16
1116 Examples of core proceedings include but are not limited to:
1, 20
ber 2
vem
(A) matters concerning the administration of the estate;
n No
ed o
(B) allowance or disallowance of claims against the estate rchiv
or exemptions from property of the estate, and estimation of
6 a
claims or interests for the purposes of confirming 3 plan of reorganization but not the liquidation or estimation of
-353 a
4
contingent or unliquidated personal ,injury1 or wrongful death claims against the estate for purposes of distribution
No. tort
rown
in a bankruptcy case;
.B
eth v
(C) counterclaimsn Bthesestate against persons filing claims against the estate;
by lix
i
cited
(D) orders in respect to obtaining credit;
(E) orders to turn over property of the estate;
(F) proceedings to determine, avoid or recover preferences;
(G) motions to terminate, annul or modify the automatic stay;
(H) proceedings to determine, avoid, or recover fraudulent conveyances;
(I) determinations as to the dischargeability of particular debts;
(J) objections to discharges;
(K) determinations of the validity, extent, or priority of liens;
(L) confirmations of plans;
(M) orders approving the use or lease of property, including the use of cash collateral;
(N) orders approving the sale of property other than property resulting from claims brought by the estate against persons
who have not filed claims against the estate; and
(O) other proceedings affecting the liquidation of the assets of the estate or the adjustment of the debtor-creditor or the
equity security holder relationship, except personal injury tort or wrongful death claim.
28 U.S.C. § 157(b)(2).
1117 Artra Grp., Inc. v. Salomon Bros. Holding Co., Inc. (In re Emerald Acquisition Corp.), 170 B.R. 632 (Bankr. N.D. Ill. 1994).
1118 Salomon v. Kaiser (In re Kaiser), 722 F.2d 1574, 1582 (2d Cir. 1983); Bethlahmy, IRA v. Kuhlman (In re ACI-HDT Supply
Co.), 205 B.R. 231 (B.A.P. 9th Cir. 1997); Wechsler v. Squadron, Ellenoff, Plesent & Sheinfeld LLP, 201 B.R. 635 (S.D.N.Y 1996)
(explaining that noncore matters are those in which the district court is more proficient than the bankruptcy court); Scotland
Guard Servs. v. Autoridad de Energia Electrica (In re Scotland Guard Servs., Inc.), 179 B.R. 764 (Bankr. D.P.R. 1993) (explaining
that noncore proceedings, where the action “would survive outside of bankruptcy,” include causes of action by the debtor against
a third party based on nonbankruptcy law).
1119 28 U.S.C. § 157(c)(1).
1120 See McFarland v. Leyh (In re Tex. Gen. Petroleum Corp.), 52 F.3d 1330, 1337 (5th Cir. 1995) (holding that district court must
review bankruptcy court’s judgment de novo); Moody v. Amoco Oil Co., 734 F.2d 1200 (7th Cir. 1984), cert. denied, 469 U.S. 982
(1984) (holding that a new trial is not required but the record should be examined without giving deference to proposed factual
findings).
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of those matters to which a party has timely objected.1121 Until recently, it has been understood that
affirmative consent of the parties allows bankruptcy judges to conduct trials and enter final orders,
whether or not a proceeding or matter is core or noncore.1122
Notwithstanding the enumerated list of core matters found in section 157(b), as a practical matter
the distinction between core and noncore can be difficult to discern.1123 When a case or proceeding
presents a mix of core and noncore claims, the bankruptcy court must perform a claim-by-claim
analysis to determine the extent of its jurisdiction and authority.1124
The Supreme Court in Stern v. Marshall recently revisited bankruptcy judges’ authority to hear and
finally determine statutorily prescribed “core” matters under section 157(b).1125 In Stern, the Court
addressed the question of whether a debtor’s state law counterclaim was a core claim, and if so, whether
the bankruptcy court had the authority to enter a final order. In a self-described “narrow” decision, the
Supreme Court found that although the bankruptcy court had statutory authorization to enter a final
judgment on the debtor’s tortious interference counterclaim (as a core claim), the bankruptcy court
lacked the constitutional authority to do so. This ruling opened the door to several questions, including
(i) whether bankruptcy judges are statutorily authorized under 28 U.S.C. § 157(c) to propose findings
of fact and conclusions of law in core proceedings, and (ii) whether Article III allows a bankruptcy
court to enter a final judgment on a Stern claim, with the consent of the parties. The Stern decision
has resulted in increased litigation.1126 In an effort to address these open issues (and resolve the Circuit
6
Court splits), the Supreme Court recently heard two cases: Executive Benefits 201
1, Insurance Agency v.
ber 2
ovem
Arkinson1127 and Wellness International Network v. Sharif.1128
on N
ived
arch
363
5
In the Arkinson decision, the Supreme , Court-3held that the reasoning of Stern v. Marshall
o. 14
n N
Br w
constitutionally prohibits a bankruptcyo
th v. court from entering final judgment on a bankruptcy “related
lixse
B
to” claim (one deemed d inbe noncore); nevertheless, section 157(c) allows a bankruptcy court to
cite to
issue proposed findings of fact and conclusions of law to be reviewed de novo by the district court.
The Supreme Court has not heard oral argument nor issued a decision in Wellness Int’l Network v.
Sharif.1129 The Court is expected to address the open issue of whether bankruptcy courts can issue
a final judgment in core matters where they lack constitutional authority (known as a Stern claim)
if the parties expressly consent. Specifically, the Court certified two questions for consideration: (i)
whether an action brought against a debtor to determine whether property in the debtor’s possession
1121 “Timely” is defined as within 10 days of service of proposed findings of fact and conclusions of law. 28 U.S.C. § 157(c)(1); Fed.
R. Bankr. P. 9033.
1122 See Stern v. Marshall, 131 S. Ct. 2594 (2011). See also infra note 1125 and the accompanying discussion. In an adversary
proceeding, the complaint, counterclaim, cross-claim, or third party complaint must state whether the proceeding is core or
noncore and, if noncore, it must affirmatively state whether each party consents to entry of a final order by the bankruptcy court.
Fed. R. Bankr. P. 7008(a).
1123 See In re U.S. Brass Corp., 110 F.3d 1261, 1268–69 (7th Cir. 1997) (finding that the impact of the claim on estate showed that it
was “related to” the case and thus a noncore proceeding, rather than a core proceeding). See generally Houbigant, Inc. v. ACB
Mercantile, Inc. (In re Houbigant, Inc.), 185 B.R. 680 (S.D.N.Y. 1995) (noting that a proceeding is core if it invokes a substantive
right under the Bankruptcy Code or could arise only in a bankruptcy case).
1124 Halper v. Halper, 164 F.3d 830, 838–40 (3d Cir. 1999).
1125 Stern v. Marshall, 131 S. Ct. 2594 (2011).
1126 See Written Testimony of the Honorable Joan N. Feeney: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter
11, at 6–7 (Apr. 19, 2012) (describing delays and increases in costs as a result of the Stern decision, sometimes merely as a delay
tactic), available at Commission website, supra note 55.
1127 Exec. Benefits Ins. Agency v. Arkinson, 133 S. Ct. 2880 (2014).
1128 Wellness Int’l Network, Ltd. v. Sharif, 727 F.3d 751 (7th Cir. 2013), reh’g en banc denied, (Oct. 7, 2013), cert. granted in part, 134
S. Ct. 2901 (2014).
1129 Id.
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is property of the bankruptcy estate stems “from the bankruptcy itself ” or whether such an action is
outside of the bankruptcy court’s constitutional authority to enter a final order; and (ii) whether the
parties’ consent allows the exercise of Article III judicial power by the bankruptcy courts, and if so,
whether implied consent based on a litigant’s conduct is sufficient.1130
The Commission, and all those interested in the efficient operation of the U.S. bankruptcy system,
look forward to further clarity with respect to the scope of the bankruptcy court’s authority to hear
and finally determine bankruptcy-related issues.
C. Individual Chapter 11 Cases
1131
The number of chapter 11 cases filed by individuals has increased dramatically in recent years,
rising steadily since 2006. Although chapter 11 has long been available to individuals,1132 numerous
BAPCPA modifications, coupled with a post-recession increase in the number of individuals needing
the bankruptcy remedy but precluded from filing under chapter 13 because of statutory debt limits,
have led to many question the adequacy and suitability of chapter 11 for individual debtors. The
reform of those provisions in chapter 11 applicable to individual debtors was determined to be
beyond the scope of the Commission’s charge. An ABI-sponsored study ,examining many of these
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The Individual Chapter 11 Study researchers 3will be examining the many questions arising in
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B identifying the key issues in need of resolution. For example,
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BAPCPA’s expanded in B
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debtor’s earnings from services performed after the commencement of the case, but before the case
is closed, dismissed or converted,1133 has resulted in uncertainty with respect to the allowable sources
of payments to professionals.1134 In addition, whether funds from postpetition earnings ought to
1130 Wellness Int’l Network, Ltd. v. Sharif, 134 S. Ct. 2901 (2014) (granting certiorari to Questions 1 and 3 presented by the petition);
Petition for Writ of Certiorari, Wellness Int’l Network, Ltd. v. Sharif, 2014 WL 466827 (Feb. 5, 2014).
1131 Professor Lois Lupica, University of Maine School of Law, Robert M. Zinman ABI Resident Scholar (Fall 2014), drafted this
section (Individual Chapter 11 Cases).
1132 See 11 U.S.C. § 109(d) (“Only a person that may be a debtor under chapter 7 of this title, except a stockbroker or commodity
broker, and a railroad may be a debtor under chapter 11 of this title.”). See also Toibb v. Radloff, 501 U.S. 157 (1991) (“[T]he
Bankruptcy Code’s plain language permits individual debtors not engaged in business to file for relief under Chapter 11. Toibb
is a debtor within the meaning of 109(d).”).
1133 See 11 U.S.C. § 1115. Section 1115 provides, in relevant part:
(a) In a case in which a debtor is in individual, property of the estate includes, in addition to the property specified in
section 541 –
(1) all property of the kind specified in section 541 that the debtor acquires after the commencement of the case
but before the case is closed, dismissed, or converted to a case under chapter 7, 12 or 13, whichever occurs first;
and
(2) earnings from services performed by the debtor after the commencement of the case but before the case is
closed, dismissed or converted.
(b) Except as provided in section 1104 or a confirmed plan or order confirming a plan, the debtor shall remain in
possession of all property of the estate.
1134 Section 330 of the Bankruptcy Code states that professionals may only be compensated from estate property if their services
were reasonably likely to result in a benefit to the estate. If an individual chapter 11 debtor seeks to pay a professional during
the pendency of his or her case, such as, for example, counsel to object to exemption objections or even a divorce attorney,
the resulting professional’s fees arguably do not provide a benefit to the estate, and thus may not be paid from the debtor’s
postpetition wages.
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be factored into a chapter 7 liquidation analysis, and how these funds in the estate’s DIP account
are disposed of in the event of a conversion to chapter 7, remain open questions.1135 Courts have
grappled with these issues but have arrived at no consistent answers.
The “fit” of chapter 11 and all its complexity has also presented significant hurdles to individual
debtors seeking reorganization. The Commission addressed the matter of chapter 11’s complexity
in the context of its Proposed Recommendations for Small and Medium-Sized Enterprise Cases,1136
and the past years’ individual chapter 11 cases have illustrated the need to similarly attend to the
issue of the efficiency of the process for individual debtors.1137 There have been improvised solutions
to reduce administrative costs and burdensome deadlines by, for example, allowing an individual
chapter 11 debtor to disclose the information required by section 1125 of the Bankruptcy Code in
the chapter 11 plan document without the necessity of filing a separate disclosure statement. Some
courts have also combined the plan/disclosure statement hearing with the confirmation hearing for
individual chapter 11 debtors.1138 Model individual chapter 11 plan forms have been adopted in some
jurisdictions in order to further streamline the plan development and confirmation process.1139 These
ad hoc solutions illustrate the need for a comprehensive examination of the operation of chapter 11
in the context of individuals’ cases.
Finally, the issue of the applicability of the absolute priority rule in individual chapter 11 cases1140 has
been a fundamental-yet-troublesome issue addressed by the courts. Currently, there is no judicial
16
consensus on whether (and to what extent) the BAPCPA Amendmentsr abrogated the absolute
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Until these issues are addressedth v. Bdefinitively resolved, the utility of chapter 11 for individual
and ro
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debtors cannot be fullyerealized. The Individual Chapter 11 Study and Report will be released upon
cit d
its completion.
1135 A debtor’s postpetition wages are deposited in the bankruptcy estate’s DIP account, in a bank approved by the U.S. Trustee,
unless the bankruptcy court orders otherwise for “cause.” 11 U.S.C. § 345(b) (2013). See In re Service Merchandise Co., Inc., 240
B.R. 894 (Bankr. M.D. Tenn. 1999) (establishing a totality of the circumstances test to determine “cause”). Following conversion
or dismissal of the case, it is not clear who has a claim to the DIP account proceeds — the debtor or the chapter 7 trustee.
1136 See Section VII, Proposed Recommendations: Small and Medium-Sized Enterprise (SME) Cases.
1137 See In re Berko, Case No. 12-33631, Docket No. 98 (Bankr. D.N.J. Sept. 24, 2013); In re Tassel, Case No. 10-11742-A-11, 2011
Bankr. LEXIS 5641 (Bankr. E.D. Cal. June 7, 2011).
1138 See In re Gulf Coast Oil Co., 404 B.R. 407, 425 (Bankr. S.D. Tex 2009) (expressly recognizing that section 1125(f) “authorizes
combined plans and disclosure statements in small business cases and § 105(d) authorizes the court to combine them in other
cases”).
1139 The U.S. Bankruptcy Court for the Southern District of Texas, www.txs.uscourts.gov/bankruptcy/individual_11_plan_
example.pdf, and the U.S. Bankruptcy Court for the Northern District of California, www.canb.uscourts.gov/announcements/
standardform-combined-plan-and-disclosurestatement-individual-chapter-11-debtors, are two such jurisdictions.
1140 11 U.S.C. § 1129(b)(2)(B)(ii).
1141 See In re Walsh, 447 B.R. 45, 49 (Bankr. D. Mass 2011); In re Gelin, 437 B.R. 435 (Bankr. M.D. Fla. 2010); In re Gbadebo, 431
B.R. 222, 228 (Bankr. N.D. Cal. 2010) (holding that BAPCPA abrogated the absolute priority rule only as to postpetition assets
incorporated into the estate by section 1115); In re Mullins, 435 B.R. 352 (Bankr. W.D. Va. 2010); In re Shat, 424 B.R. 854 (Bankr.
D. Nev. 2010) (holding that the absolute priority rule no longer applies in individual chapter 11 cases).
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D. SIFIs and Single Point of Entry Schemes
Following the financial crisis of 2008, policymakers focused on the procedures for resolving financial
distress at large financial institutions. Some commentators and policymakers asserted that the
Federal Deposit Insurance Corporation (the “FDIC”) lacked effective tools for resolving these issues
during the crisis.1142 The result was Title II, Orderly Liquidation Authority (“OLA”), of the DoddFrank Act.1143 OLA established a new mechanism for resolving the failure of certain systemically
important financial institutions (“SIFIs”) if it is determined that resolution under the Bankruptcy
Code is not appropriate.1144
Commentators have raised concerns about how OLA would work in practice,1145 and several
alternative and supplemental proposals have been advanced. The FDIC, which will act as a receiver
in OLA cases, has proposed a “single point of entry” (“SPOE”) procedure to address these concerns.
Many commentators suggest, however, that the Bankruptcy Code should be amended to reduce the
likelihood that OLA will need to be invoked.1146
Notably, there are two proposals to amend the Bankruptcy Code to deal with failing SIFIs. The
first was introduced in the U.S. Senate and proposes to add a new chapter 14 (chapter 14) to the
Bankruptcy Code.1147 The second was introduced in the U.S. House of Representatives and proposes
16
to add a subchapter V to chapter 11 (subchapter V) of the Bankruptcy Code.1148 As discussed below,
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the subchapter V proposal before the House and the chapterovemproposal before the Senate are
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structurally similar. Both proposals would, for example,ive
ch apply only to covered financial corporations
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1142 See Regulation and Resolving Institutions ow
Br Considered “Too Big to Fail” Hearing Before the Senate Committee on Banking, Housing,
th v.
and Urban Affairs, 111th Cong.e52 (May 6, 2009) (statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corp.) (“In
ixs
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the case of a bankitholding company, whether systemically significant or not, the FDIC has the authority to take control of only
c ed
the failing bank subsidiary, thereby protecting the insured depositors. However, in some cases, many of the essential services for
the bank’s operations lie in other portions of the holding company and are left outside of the FDIC’s control, making it difficult
to operate and resolve the bank. . . . [W]here the holding company structure includes many bank and non-bank subsidiaries,
taking control of just the bank is not a practical solution.”), available at http://www.gpo.gov/fdsys/pkg/CHRG-111shrg53822/
pdf/CHRG-111shrg53822.pdf; Sir Jon Cunliffe, Deputy Governor for Financial Stability of the Bank of England, Remarks at
the Barclays European Bank Capital Summit (May 13, 2014) (“Nowhere was failure more disruptive than for the liquidation
of Lehman Brothers, where the FDIC lacked the requisite powers to resolve the firm in an orderly fashion. The process was
disorderly, time consuming and expensive. And it was very contagious. . . . The FDIC estimates that, had a legal framework
existed to put the firm through a resolution and receivership process, a quick resolution could have recovered far more value. . .
.”), available at http://www.bis.org/review/r140515b.htm.
1143 Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, 111th Cong. tit. II, §§ 201 et seq. (2010) [hereinafter
Dodd-Frank], available at https://www.sec.gov/about/laws/wallstreetreform-cpa.pdf; see also David A. Skeel, Jr., Single Point of
Entry and the Bankruptcy Alternative, in Across the Great Divide: New Perspectives on the Financial Crisis 311 (Martin Neil
Baily & John B. Taylor eds., 2014), available at http://scholarship.law.upenn.edu/faculty_scholarship/949.
1144 “[B]ecause the rights of creditors are significantly more limited under the orderly liquidation authority [than in bankruptcy],
Title II requires that before the FDIC may be appointed as receiver of a financial company, a non-judicial evaluation [must]
be made as to why a case under the Bankruptcy Code is not appropriate for the financial company.” Hollace T. Cohen, Orderly
Liquidation Authority: A New Insolvency Regime to Address Systemic Risk, 45 U. Rich. L. Rev. 1143, 1151 (2011). See generally
Thomas H. Jackson, Resolving Financial Institutions: A Proposed Bankruptcy Code Alternative, Banking Perspective, Mar. 2014,
at 22; Exploring Chapter 11 Reform: Corporate and Financial Institution Insolvencies; Treatment of Derivatives, Hearing Before the
H. Subcomm. on Regulatory Reform, Commercial and Antitrust Law, 113th Cong. 99 (2014) (statement of Thomas H. Jackson,
Distinguished University Professor & President Emeritus of the University of Rochester) [hereinafter Jackson Statement],
available at http://judiciary.house.gov/_cache/files/832fe54a-bf55-4567-8eeb-54cdcbec5e5e/113-90-87331.pdf.
1145 See Stephen J. Lubben, OLA After Single Point of Entry: Has Anything Changed? (Seton Hall Public Law Research Paper No.
253035) (noting that if we push beyond the happy press releases trumpeting the wonder of single point of entry, we see what
questions remain), available at http://ssrn.com/abstract=2353035.
1146 Jackson Statement, supra note 1144, at 106 (recommending amending the Bankruptcy Code so that bankruptcy can serve as its
intended role as the “primary resolution device” so that OLA under Dodd-Frank will be a “just in case” backup).
1147 Taxpayer Protection and Responsible Resolution Act, S. 1861, 113th Cong. (1st Sess. 2013) [hereinafter Chapter 14 Bill], available
at https://www.govtrack.us/congress/bills/113/s1861/text.
1148 Financial Institution Bankruptcy Act of 2014, H.R. 5421, 113th Cong. (2d Sess. 2014) [hereinafter Subchapter V Bill], available at
http://judiciary.house.gov/_cache/files/94c89efd-5d4c-46bc-bbe6-a3b8c6f74f56/webhr-5421-financial-institution-bankruptcyact.pdf.
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and are intended to implement an SPOE-type process.1149 As drafted, only the Senate bill proposes
to repeal OLA.1150
The FDIC’s Single Point of Entry Procedure for Orderly Liquidations
OLA seeks to provide a process to quickly and efficiently liquidate a large, complex financial company
that is failing.1151 It designates the FDIC to serve as a receiver to carry out the liquidation and windup of such a company when the Bankruptcy Code is found lacking.1152 The FDIC was given broad
authority to develop rules regarding its authority under OLA.
As such, the FDIC proposed the SPOE process whereby the FDIC would become the receiver of the
financial institution’s top-level U.S. holding company, leaving the operating subsidiaries to continue
operations uninterrupted.1153 The FDIC would then work to ensure that the holding company can
absorb the organization’s losses, including those incurred by subsidiaries and thereby recapitalize
the subsidiaries. The FDIC would also be able to take control of the holding company and transfer
its assets to a newly created, solvent “bridge bank.”1154 All of this may happen quite quickly:
[T]he FDIC has focused, in its SPOE proposal, on a ‘two-step’ recapitalization rather
than a formal bail-in. Under the FDIC’s approach, a SIFI holding company . . . is
effectively ‘recapitalized’ over a matter of days, if not hours, by the transfer of virtually
all its assets and liabilities, except for certain long-term unsecured liabilities,6to a new
1
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bridge institution whose capital structure, because of the absence ber those long-term
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unsecured liabilities, is both different and presumptivelyo‘sound.’1155
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The mechanics of OLA incorporateowseveral bankruptcy principles. For example, it allows
v. Br
1156
reorganization and liquidation,sethdebtor in possession (postpetition) or similar financing, asset sales
Blix
ed in
1157
cit
free and clear of existing liens, and clawback of prepetition fraudulent and preferential transfers.
Unlike the Bankruptcy Code, however, OLA permits assumption of qualified financial contracts and
overrides cross-defaults in qualified financial contracts of affiliates.
1149 See Subchapter V Bill, supra note 1148; Chapter 14 Bill, supra note 1147.
1150 See id. at 1 (“(a) In General. — Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Law 111203) is repealed and any Federal law amended by such title shall, on and after the date of enactment of this Act, be effective as
if title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act had not been enacted.”). Notably, the chapter 14
proposal also would impose limitations on the ability of the Federal Reserve to act as lender of last resort.
1151 Dodd-Frank, supra note 1143, §§ 201 et seq.
1152 Dodd-Frank, supra note 1143, § 203(a)(2)(F) (noting the FDIC, when it seeks to designate an institution a systemic risk to be
subject to OLA, must make a written recommendation indicating why bankruptcy would not be appropriate for the financial
company).
1153 Federal Deposit Insurance Corporation, The Resolution of Systemically Important Financial Institutions: The Single Point of Entry
Strategy, 78 Fed. Reg. 76614 (Dec. 18, 2013).
1154 12 U.S.C. § 5390 (2010); see also Douglas G. Baird & Edward R. Morrison, Dodd-Frank for Bankruptcy Lawyers, 19 Am. Bankr.
Inst. L. Rev. 287, 300–01 (2011) (“The FDIC’s powers include the right to sell substantially all of the institution’s assets to another
company, ‘without obtaining any approval, assignment, or consent with respect to such transfer,’ unless the sale raises antitrust
or related concerns. The FDIC’s powers also include (implicitly) the ability to reorganize the failing institution by transferring
selected assets and claims to a “bridge financial company” that is owned, controlled, and potentially capitalized by the FDIC. The
FDIC can run this bridge company for up to five years, with a view to merging it with another institution or selling a majority
of its equity to private investors.”); Lubben, OLA After Single Point of Entry, supra note 1145, at 1 (“The latter allows the FDIC to
split the good assets from the bad, in a process that is very much like that used in ‘363 sales’ under chapter 11”).
1155 Jackson Statement, supra note 1144, at 100–01.
1156 The provision in Dodd-Frank seems to technically only authorize liquidation. See David A. Skeel, Jr. Institutional Choice in an
Economic Crisis, 2013 Wis. L. Rev. 629, 642–43 n. 95, n. 96 (2013).
1157 See Baird & Morrison, supra note 1154, at 1–3 (“[T]he FDIC can authorize the equivalent of DIP financing on terms virtually
identical to those permitted by § 364 . . . [and] the FDIC the ability to implement rough approximations of § 363 sales and
chapter 11 reorganizations”).
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Many commentators have criticized OLA.1158 Some suggest that it will ultimately be ineffective
because it does not include resolution of foreign entities (which would be controlled by foreign
regulators)1159 and most SIFIs have important components overseas.1160 (The SPOE plan and focus
on the holding company could alleviate this concern depending on the corporate structure of the
institution.) Others suggest that the FDIC will not be able to enforce derivative trading contracts
between operating subsidiaries and their counterparties, a circumstance that was quite important in
the Lehman Brothers bankruptcy,1161 and an issue that regulators are seeking to address by imposing
contractual solutions, such as the so-called “ISDA Protocol.” Still others argue that the FDIC may
not be able to extend sufficient credit to maintain an institution’s liquidity because of statutory
limitations on a receivership’s borrowing.1162 Others wonder whether the FDIC will be successful
as a receiver of financial institutions that are unfamiliar and not traditionally insured by the FDIC,
such as hedge funds.1163 Perhaps most importantly, commentators worry that OLA may ultimately
be a destabilizing force, rather than a stabilizing force, because it is new, flexible, and perhaps
unpredictable, creating uncertainty for creditors.1164 Others have noted the balance of powers in a
bankruptcy case, and that OLA concentrates power in the FDIC.1165
Proposed Subchapter V in Chapter 11
The subchapter V proposal is contained in a House bill titled “Financial Institutions Bankruptcy
Act.”1166 The primary function of the proposal is to enable the Bankruptcy 6Code to effectuate a
1
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rapid two-step recapitalization of a SIFI holding company’s subsidiaries, similar to OLA SPOE
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procedure.1167 The intended result is to get the bank holdingdcompany’s assets in and out of bankruptcy
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quickly: the bridge holding company immediately acquires all of the SIFI holding company’s
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assets, including its contracts andown, equity interests in recapitalized operating companies, while
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allowing the nonbankrupt eoperating subsidiaries to carry on business as usual.1168 Cross-defaults
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1158 For example, the FDIC will retain discretion to prefer some creditors over others of equal rank and will be able to distribute
funds other than according to the bankruptcy absolute priority rule. The FDIC, rather than the market, will be making critical
determinations regarding the bridge company and its equity, and the FDIC will likely attempt to run the bridge company
for a while. Tom Jackson, Building on Bankruptcy: A Revised Chapter 14 Proposal for the Recapitalization, Reorganization, or
Liquidation of Large Financial Institutions, at 9, App’x § 3 (Working Paper, July 9, 2014), available at http://www.hoover.org/sites/
default/files/rp-14-july-9-tom-jackson.pdf. See also Kenneth E. Scott, Chapter 14: Designing a Better Bankruptcy Resolution, in
Across the Great Divide: New Perspectives on the Financial Crisis 304, 305–06 (Martin Neil Baily & John B. Taylor eds., 2014)
(discussing the discretion allowed the FDIC to pick and choose which creditors to “bail out” and also discussing the superficial
role of judges in OLA process), available at http://www.hoover.org/sites/default/files/across-the-great-divide-ch14.pdf.
1159 Baird & Morrison, supra note 1154, at 31.
1160 Lubben, OLA After Single Point of Entry, supra note 1145, at 1.
1161 Id. at 2 (noting that many derivative transaction contracts provide that failure of a “credit support provider” — the holding
company — allows the counterparty the right to terminate the trade); Baird & Morrison, supra note 1154, at 32 (discussing how
OLA could in theory help alleviate the derivative trade issue but noting that the two-day window will not be enough time to
evaluate all of a large institution’s derivative contracts).
1162 Baird & Morrison, supra note 1154, at 22, 30 (“The [FDIC] must finance its activities as receiver through an ‘orderly liquidation
fund,’ which is funded by borrowings from the Treasury. The FDIC’s authority to borrow from the Treasury, however, is tightly
constrained. The [FDIC] cannot issue debt in connection with a receivership that exceeds specified thresholds. During the first
thirty days of the receivership, loans cannot exceed ten percent of the covered financial company’s total consolidated assets,
as measured by the most recent financial statements. As soon as the FDIC determines the fair market value of assets available
for repayment of new debt (or after the first thirty days of the receivership, whichever occurs first), the FDIC can extend larger
loans to the company, but the loans cannot exceed ninety percent of those assets’ fair market value.”) (“But the resources deemed
necessary far, far exceed the modest resources that Title II make available to the FDIC”).
1163 Id. at 31.
1164 Id. at 33.
1165 Id. at 2 (“traditional bankruptcy law reflects a balance of power in which the debtor in possession (DIP), the creditors’ committee,
the DIP lender, and the bankruptcy judge play discrete roles; this regime concentrates power in a single entity, the FDIC.”).
1166 See Subchapter V Bill, supra note 1148.
1167 See Jackson Statement, supra note 1144, at 108.
1168 See Stephen D. Adams, House Advances Bipartisan Financial Institution Bankruptcy Act, Harv. L. Sch. Bankr. Roundtable (Sept.
30, 2014), available at http://blogs.law.harvard.edu/bankruptcyroundtable/2014/09/30/house-advances-bipartisan-financialinstitution-bankruptcy-act/; Jackson Statement, supra note 1144, at 104.
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in subsidiaries’ qualified financial contracts would be overridden, as under OLA. The Bankruptcy
Code, as currently written, would make these outcomes difficult to accomplish.1169 The proposed
subchapter V in chapter 11 seeks to make chapter 11 more hospitable to an SPOE rapid two-step
recapitalization process.
Overview of Recapitalization Process
Subchapter V contemplates that within the first 48 hours of a bankruptcy case, assets of a SIFI
holding company would be transferred to a bridge company, and long-term unsecured debt, certain
subordinated debt, and old equity would remain with the old holding company in the chapter 11
case.1170 Assuming that the bankruptcy court approves of the transfer, the old holding company’s
operations, including ownership of its subsidiaries, would shift to the new bridge company that is
not in bankruptcy.1171 Market participants are presumed to perceive the bridge company as solvent,
based on new “loss absorbency” requirements being imposed on SIFIs by regulators.1172
After the transfer is completed, the old holding company remains a debtor in bankruptcy, but its
assets may only consist of a beneficial interest in a special trust created solely to hold the equity
interests in the bridge company until such interests are sold or distributed pursuant to a chapter 11
plan.1173 The indirect beneficiaries of this trust would likely be the holders of the long-term debt that
is not transferred to the bridge company and the equity interests of the old holding company.1174
6
Any distributions to the chapter 11 creditors or interest-holders would depend 1on the value and
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monetization of the interests held by the special trust. For example,oa em
v distribution may occur if the
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bridge company is sold or otherwise merged into anotherccompany.
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Subchapter V provides that after notice and a hearing, the court may order a transfer of property of
the estate to a bridge company1176 only if the court finds that the transfer:
(a) [will] preserve or promote the financial stability in the United States, and (b) does
not provide for any assumption of the long-term unsecured debt and, in addition, the
Federal Reserve Board certifies that it has found that the bridge company adequately
provides assurance of future performance of any executory contract, unexpired lease,
or debt agreement being transferred to the bridge company.1177
The court may not hold a hearing on the proposed transfer sooner than 24 hours after filing so that
notice may be given to the 20 largest holders of unsecured claims, the Board of Governors of the
Federal Reserve System (the “Board”), the FDIC, the Secretary of the Treasury, and the primary
1169 Jackson Statement, supra note 1144, at 104–05 (discussing derivative contracts and other financial contracts that are not subject to
the automatic stay and cross default and change of control provisions in such financial contracts and also noting that speediness
of the FDIC procedure would be difficult to achieve in bankruptcy).
1170 See id. at 108.
1171 Id.
1172 See id. at 108–09. See also Financial Stability Board, Adequacy of Loss-Absorbing Capacity of Global Systemically Important
Banks in Resolution, Nov. 2014, available at https://www.g20.org/sites/default/files/g20_resources/library/adequacy_lossabsorbing_capacty_global_systemically_important_banks.pdf.
1173 Id. at 109.
1174 Id.
1175 Id.
1176 See Subchapter V Bill, supra note 1148, at § 1185(a).
1177 See Jackson Statement, supra note 1144, at 110–11.
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ABI Commission to Study the Reform of Chapter
financial regulator (whether domestic or foreign) with respect to any subsidiary whose ownership
is proposed to be transferred to the bridge company.1178 Further, subchapter V provides for a stay on
qualified contract termination rights for a period of up to 48 hours to allow the transfer to the bridge
company to be substantially completed.1179 In addition, subchapter V includes provisions that are
designed to permit the successful transfer of assets, contracts, liabilities, rights, licenses, and permits
of both the old holding company, and of its operating subsidiaries, to the bridge company.1180
Who Would Hear Subchapter V Cases
The subchapter V proposal provides for the creation of a group of designated bankruptcy judges to
hear cases arising under subchapter V of chapter 11.1181 As mentioned below, the Senate’s chapter 14
proposal also provides for a special arrangement of judges to hear its cases, but the two proposals
offer different procedures on this point.1182 Under subchapter V, “the Chief Justice of the United
States shall designate not fewer than 10 bankruptcy judges to be available to hear a case under
subchapter V. . . .”1183 Cases are then assigned to a specific bankruptcy judge by the chief judge of the
court of appeals in the district in which the case is pending.1184 Subchapter V also provides that “the
Chief Justice of the United States shall designate a particular number of judges to hear appeals under
section 1183 of title 11.”1185
Proposed Chapter 14
16
1, 20
ber 2
An alternative SIFI resolution scheme has been proposed n NovemSenate as Senate Bill 1861, the
in the
do
1186
chive This bill proposes a new chapter of the
Taxpayer Protection and Responsible Resolution3 Act.
ar
3536
. 14- failing institutions, and it proposes to repeal OLA.1187
Bankruptcy Code — chapter 14 — to ,address
No
own
v. Br
The chapter 14 concept findsth origins in, but differs from, the Hoover Institute’s “Resolution Project,”
it
lixse
which launched cited in B and has continued to evolve since that time.1188
in 2009
Similar to the subchapter V proposal, the chapter 14 goal in effecting a rapid recapitalization of
the holding or operating company is to ensure that the recapitalized institution: (i) is solvent;
(ii) appears solvent to market participants; and (iii) is subject to market discipline, rather than
being under the “protection” of a bankruptcy proceeding.1189 To achieve such a recapitalization,
1178 See id. at 117; see also Subchapter V Bill, supra note 1148, at § 1186(b).
1179 Generally speaking, the automatic stay under section 1187 terminates when the court issues an order authorizing transfer under
section 1185, or after 48 hours if the court has not ordered a transfer under section 1186. See Jackson Statement, supra note 1144,
at 110; Subchapter V Bill, supra note 1148, at §§ 1187, 1188.
1180 See Jackson Statement, supra note 1144, at 111.
1181 Subchapter V proposes amendments to 28 U.S.C. § 298. See Subchapter V Bill, supra note 1148, at 32.
1182 The judges designated to hear chapter 14 cases are all bankruptcy judges. The chapter 14 proposal calls for at least one district
judge from each circuit to be available to hear appeals under the chapter. See Chapter 14 Bill, supra note 1147, at 28–29, § 298.
1183 See Subchapter V Bill, supra note 1148, at 32.
1184 Id.
1185 Id.
1186 Chapter 14 Bill, supra note 1147. Stephen D. Adams, The Chapter 14 Proposal in the Senate, Harv. L. Sch. Bankr. Roundtable
(June 17, 2014), available at https://blogs.law.harvard.edu/bankruptcyroundtable/2014/06/17/the-chapter-14-proposal-in-thesenate/. See also Jackson, Building on Bankruptcy, supra note 1158, Part I.
1187 See Jackson, Building on Bankruptcy, supra note 1158, at 23 (noting that while the original proposal envisioned a chapter 14, the
current proposal is, in substance, similar to a new subchapter of chapter 11).
1188 The Resolution Project, Hoover Institution, available at http://www.hoover.org/research-teams/economic-policy-workinggroup/resolution-project (last visited Nov. 13, 2014); Kenneth E. Scott, A Guide to the Financial Resolution of Failed Financial
Institutions: Dodd-Frank Title II and Proposed Chapter 14, at 1 (Stanford Law & Economics Olin Working Paper No. 426, Feb. 29,
2012) (naming the members of the project and noting that the project held several meetings, a conference, several papers, and a
book), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2018035.
1189 Id. at 19.
IX. Other Issues Relating to Chapter Cases
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the proposal contemplates a “quick sale” that would effect a sale of a holding company’s assets and
liabilities (other than long-term unsecured debt, subordinated debt, and “old” equity) to a bridge
company very quickly following the commencement of a bankruptcy case. This “Special Transfer,” to
be codified in section 1406 of the Bankruptcy Code,1190 would remove the holding company’s assets
from the bankruptcy process.
Creation of a New Chapter 14
As a starting point, the chapter 14 bill notes that such cases will generally use existing bankruptcy
rules except where chapter 14 was designed to explicitly change them.1191 The changes proposed for
chapter 14 cases cover the creation of a new chapter 14 and provisions related to commencement of
a chapter 14 case, the role of the primary regulator in the bankruptcy proceeding, the rapid transfer
of the debtor to a bridge company, and qualified financial contracts treatment in chapter 14.
Who Would Hear Chapter 14 Cases
Chapter 14 calls for the Chief Justice of the United States to select at least one district judge from
each circuit who will be available to hear an appeal in a chapter 14 case.1192 Designated bankruptcy
judges will hear chapter 14 cases.1193 In two-entity recapitalization cases, the designated bankruptcy
judge must handle the case at least up to the point of the section 1406 transfer.1194
16
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ber 2
The Role of the Primary Regulator in the Bankruptcy Proceeding
vem
n No
ed o
rchiv
In addition to its ability to file petitions (discussed5above), the Board will also have standing to be
63 a
-3 3
14
heard on any issue relevant to the regulation o. the debtor by the Board, or to the financial stability
, N of
rown
B
h .
of the United States.1195 The lFDIC vis afforded more limited standing.1196 If there is a section 1406
xset
nBi
i
cited
transfer, the Board’s regulatory interest as to the debtor will shift to the bridge company,1197 although
the Board will still have standing in the debtor’s case with regard to its equity ownership of the
bridge company.1198
Postpetition Financing
Debtor in possession (postpetition) financing will be available in chapter 14, pursuant to the
procedures and limitations set out in section 364.
1190 Chapter 14 Bill, supra note 1147, at 14–16 (discussing proposed § 1406).
1191 Id. at 5 (“(m) Except as otherwise provided in chapter 14 of this title, chapter 11 of this title applies in a case under chapter 14 of
this title.”).
1192 Id. at 28 (discussing § 298(a)).
1193 Id. at 28 (§ 298(b)(1), (2), and (3)).
1194 Id. at 30 (discussing amendments to 28 U.S.C. § 1334).
1195 Id. at 11 (discussing proposed § 1404(a)). “The Board may raise and may appear and be heard on any issue in any case or
proceeding under this title relevant to the regulation of the debtor by the Board or to financial stability in the United States.” Id.
1196 Id. at 11 (discussing proposed § 1404(b): ‘‘(b) The Federal Deposit Insurance Corporation may raise and may appear and be
heard on any issue in any case or proceeding under this title in connection with a transfer under section 1406.”) (emphasis added).
1197 Jackson, Building on Bankruptcy, supra note 1158, at 28.
1198 Id. Chapter 14 Bill, supra note 1147, at 11–12 (discussing proposed § 1405).
IX. Other Issues Relating to Chapter Cases
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Section 1406 Transfer
The “section 1406 transfer” is the key to implementing the two-entity recapitalization in chapter
14,1199 and is quite similar to the subchapter V proposal.1200 A trustee of the debtor or the Board may
immediately make a motion in a chapter 14 proceeding for a transfer of the property of the estate
(including contracts) and liabilities (except for the long-term unsecured and subordinated debt and
old equity — termed “capital structure debt” in chapter 14) of the debtor to a newly created bridge
company.1201 The court must then approve the transfer.1202 The court may not hear the transfer motion
sooner than 24 hours after the filing, and it must make a decision within 48 hours after the filing
(as with subchapter V). The court may order the transfer only if it finds, or the Board certifies that
it has found, that the bridge company adequately provides assurance of future performance of any
executory contract, unexpired lease, or debt agreement being transferred to the bridge company.1203
Making the Section 1406 Transfer Effective and Qualified Financial Contracts
The provisions of chapter 14 designed to ensure that the bridge company (in a section 1406 transfer)
has the assets, rights, and liabilities of the former holding company (minus certain long-term
subordinated debt and old equity) are substantially the same as the subchapter V provisions designed
for those same purposes. Also similar to the subchapter V proposal, the debtor in a transfer case
will essentially be a shell company, and claimants that were “left behind” must wait until the bridge
company is able to make distributions under a plan.1204
016
,2
er 21
emb
ov
Moreover, to ensure that the bridge company receiveshall d on N relevant assets and liabilities of the
of the
c ive
r
debtor, qualified financial contracts would4be 363 a to the automatic stay in chapter 14 for 48
35 subject
.1 , No
hours.1205 This is a change fromBthe ncurrent law in chapter 11, which exempts qualified financial
ow
v. r
eth
contracts from the automatic stay altogether.
Blixs
ed in
cit
Conclusion
The House bill containing the subchapter V provisions was introduced in Congress on September
9, 2014.1206 It was subsequently referred to the House Judiciary Committee, where it has since been
referred and discharged by the Subcommittee on Regulatory Reform, Commercial and Antitrust
Law, has been considered and marked up by the Judiciary Committee, and has been ordered to be
1199 Chapter 14 Bill, supra note 1147, at 14–16.
1200 Compare Chapter 14 Bill, supra note 1147, at 14–16 (discussing proposed § 1406), with Subchapter V Bill, supra note 1148, at
12–16 (discussing proposed § 1185). The provisions share a large amount of common language, though the subchapter V bill has
more specific provisions regarding executory contracts, unexpired leases, and the like).
1201 Chapter 14 Bill, supra note 1147, at 14 (“(a) On request of the trustee or the Board, and after notice and hearing and not less
than 24 hours after the commencement of the case, the court may order a transfer under this section of property of the estate to
a bridge company.”).
1202 Id.
1203 Id. at 16.
1204 Jackson, Building on Bankruptcy, supra note 1158, at 37. See Chapter 14 Bill, supra note 1147, at 7, 11–12 (“The term ‘bridge
company’ means a newly formed corporation the equity securities of which are transferred to a special trustee under section
1405(a)”) (emphasis added) (“[T]he court may order [the appointment of a] special trustee and transfer to the special trustee
all of the equity securities in a corporation to hold in trust for the sole benefit of the estate. . . .”). See also Chapter 14 Bill, supra
note 1147, at 7, section 1405(c) (“The special trustee shall distribute the assets held in trust in accordance with the plan on the
effective date of the plan, after which time the office of the special trustee shall terminate, except as may be necessary to wind up
and conclude the business and financial affairs of the trust.”).
1205 See Chapter 14 Bill, supra note 1147, at 22–26 (discussing treatment of qualified financial contracts in Chapter 14).
1206 H.R. 5421: Financial Institution Bankruptcy Act of 2014, Congress. Gov, available at https://www.congress.gov/bill/113thcongress/house-bill/5421/all-actions (last visited Nov. 17, 2014).
IX. Other Issues Relating to Chapter Cases
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reported by voice vote.1207 The Senate bill containing the chapter 14 proposal was introduced in the
Senate on December 19, 2013. It was read twice and referred to the Senate Judiciary Committee.1208
Although the Commission was aware of both bills during its deliberations, the Commission viewed
issues particular to SIFIs as outside its core mission. Accordingly, the Commission stayed informed
regarding the content of both bills and referenced them as appropriate or relevant during discussions.
The Commission, however, did not specifically study or make recommendations on the resolution
of financially distressed SIFIs or the SPOE procedure.
E. Cross-Border Cases
Geographic borders do not limit the impact of a company’s financial distress. A U.S. chapter 11
debtor may have assets and creditors located in foreign jurisdictions, and a foreign debtor likewise
may have assets and creditors located in the United States. Traditionally, two different approaches
to these kinds of cross-border insolvency situations have been advanced: universalism (i.e., a
single country’s laws should govern a single company’s assets) and territorialism (i.e., the laws of
the country where the assets are located should govern those assets).1209 More recently, a modified
approach to universalism, encouraging cooperation and gradual adoption of 1, 2016 standards, has
unified
ber 2 Nations Commission
gained increasing acceptance, most notably by the adoption of thevUnited
em
n No
ed o
on International Trade Law (“UNCITRAL”) Model LawrchivCross-Border Insolvency (the “Model
on
63 a
1210
-353
Law”) in several countries.
o. 14
,N
own
v. Br
eth
a version of the Model
Blixs
The United States adopted
Law in 2005 with the enactment of chapter 15 of
ed in
cit1211
the Bankruptcy Code. Chapter 15 replaced section 304 of the Bankruptcy Code, and expanded
1207 Id. See also Stephen D. Adams, House Advances Bipartisan Financial Institution Bankruptcy Act, Harv. L. Sch. Bankr. Roundtable
(Sept. 30, 2014), available at http://blogs.law.harvard.edu/bankruptcyroundtable/2014/09/30/house-advances-bipartisanfinancial-institution-bankruptcy-act/.
1208 S. 1861: Taxpayer Protection and Responsible Resolution Act, Congress. Gov, available at https://www.congress.gov/bill/113thcongress/senate-bill/1861/all-actions (last visited Nov. 17, 2014).
1209 See, e.g., Jay Lawrence Westbrook, Chapter 15 at Last, 79 Am. Bankr. L.J. 713, 715 (2005) (“In general, universalism would treat
a multinational bankruptcy ideally as a unified global proceeding administered by a single court assisted by courts in other
countries, while territorialism is the traditional approach by which each court in a country in which assets are found seizes
them (the ‘grab rule’) and uses them to pay local creditors.”). See also Edward S. Adams & Jason Fincke, Coordinating CrossBorder Bankruptcy: How Territorialism Saves Universalism, 15 Colum. J. Eur. L. 43 (2008) (discussing two approaches); Lynn
M. LoPucki, Cooperation in International Bankruptcy: A Post-Universalist Approach, 84 Cornell L. Rev. 696 (1999) (analyzing
approaches); Jay Lawrence Westbrook, Theory and Pragmatism in Global Insolvencies: Choice of Laws and Choice of Forum, 65
Am. Bankr. L.J. 457 (1991) (explaining universalism).
1210 Donald S. Bernstein, et al., Recognition and Comity in Cross-Border Insolvency Proceedings, in The International Insolvency
Review, at 3, (Donald S. Bernstein ed., 2013) (“[T]here is no question that the universalist approach has been in the ascendency,
culminating in the adoption in not fewer than 19–20, counting the British Virgin Islands — countries of laws based on the
UNCITRAL Model Law on Cross-Border Insolvency (the Model Law).”), available at http://www.davispolk.com/sites/default/
files/52350054_1.PDF.
1211 Section 1501 explains:
(a) The purpose of this chapter is to incorporate the Model Law on Cross-Border Insolvency so as to provide effective
mechanisms for dealing with cases of cross-border insolvency with the objectives of —
(1) cooperation between —
(A) courts of the United States, United States trustees, trustees, examiners, debtors, and debtors in possession;
and
(B) the courts and other competent authorities of foreign countries involved in cross-border insolvency
cases;
(2) greater legal certainty for trade and investment;
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ABI Commission to Study the Reform of Chapter
the ability of courts to recognize foreign insolvency proceedings. “Echoing the Model Law, the
stated purpose of Chapter 15 is to promote ‘cooperation’ between courts and to provide ‘greater
legal certainty’ in multi-jurisdictional cases.”1212
Under chapter 15, a foreign representative1213 may seek recognition of the foreign insolvency
proceeding by filing certain evidence of such proceeding with its chapter 15 petition.1214 Section
1516 of the Bankruptcy Code creates a presumption (i) in favor of the evidence filed by the foreign
representative; and (ii) that the location of the foreign debtor’s registered office is its center of main
interests (commonly referred to as “COMI”).1215 The chapter 15 recognition process is more simple
and straightforward than under prior law.1216
The consequences of the court’s recognition of a foreign proceeding under chapter 15
turn largely on the classification of the foreign proceeding as either main or non-main.
Section 1517 provides that the foreign proceeding is a “main” proceeding if it is pending in
the country of the debtor’s COMI.1217 Otherwise, the foreign proceeding is considered a “nonmain” proceeding. 1218 In a main proceeding, among other things, the automatic stay of section
362 of the Bankruptcy Code applies, and the foreign representative may operate the debtor’s
business and sell, lease, or use the debtor’s assets under section 363.1219 In addition, the court
may order certain additional relief in a main or non-main proceeding “where necessary to
effectuate the purpose of this chapter and to protect the assets of the debtor or the interests
16
of the creditors.” 1220 Absent such an order by the court, however, rno, other relief generally is
1 20
be 2
ovem
available in a non-main proceeding.
on N
ived
arch
363
-35
o. 14
n, N
Brow
th v.
lixse
B
(3) fair and efficientin
administration of cross-border insolvencies that protects the interests of all creditors, and other
cited
interested entities, including the debtor;
(4) protection and maximization of the value of the debtor’s assets; and
(5) facilitation of the rescue of financially troubled businesses, thereby protecting investment and preserving
employment.
11 U.S.C. § 1501. For articles generally discussing the adoption and implementation of chapter 15, see Jay Lawrence Westbrook,
Chapter 15 and Discharge, 13 Am. Bankr. Inst. L. Rev. 503 (2005); Samuel L. Bufford, International Accord: Included in the New
Bankruptcy Law Are Provisions Adopting the U.N. Model on International Insolvencies, L. A. Law., July/Aug. 2006, at 32; John J.
Chung, Chapter 15 of the Bankruptcy Code and Its Implicit Assumptions Regarding the Foreign Exchange Market, 76 Tenn. L. Rev.
67 (2008).
1212 See Bernstein, et al., supra note 1210, at 5.
1213 Section 101(24) of the Bankruptcy Code defines “foreign representative” as “a person or body, including a person or body
appointed on an interim basis, authorized in a foreign proceeding to administer the reorganization or the liquidation of the
debtor’s assets or affairs or to act as a representative of such foreign proceeding.” 11 U.S.C. § 101(24).
1214 Section 1515 provides in pertinent part:
(b) A petition for recognition shall be accompanied by —
(1) a certified copy of the decision commencing such foreign proceeding and appointing the foreign representative;
(2) a certificate from the foreign court affirming the existence of such foreign proceeding and of the appointment
of the foreign representative; or
(3) in the absence of evidence referred to in paragraphs (1) and (2), any other evidence acceptable to the court of
the existence of such foreign proceeding and of the appointment of the foreign representative.
11 U.S.C. § 1515(b).
1215 11 U.S.C. § 1516.
1216 See Westbrook, Chapter 15 at Last, supra note 1209, at 721–23.
1217 Section 1502(4) defines “foreign main proceeding” as “a foreign proceeding pending in the country where the debtor has the
center of its main interests.” 11 U.S.C. §§ 1502(4), 1517(b)(1).
1218 Section 1502(5) defines “foreign non-main proceeding” as “a foreign proceeding, other than a foreign main proceeding, pending
in a country where the debtor has an establishment.” 11 U.S.C. §§ 1502(5), 1517(b)(2).
1219 11 U.S.C. § 1520.
1220 11 U.S.C. § 1521(a).
IX. Other Issues Relating to Chapter Cases
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Chapter 15 and the Model Law are premised on notions of increased cooperation and respect for
foreign proceedings in cross-border cases. Nevertheless, some courts limit their deference to comity
in cases involving transfers of assets within the territorial jurisdiction of the United States. For
example, the court in Elpida Memory noted the absence of any reference to comity in section 1520 of
the Bankruptcy Code, and required the foreign representative to meet the standards of section 363
of the Bankruptcy Code to sell or assign the U.S. assets at issue.1221 Other courts, however, suggest a
more prominent role for comity in chapter 15 cases.1222
Section 1507(b) expressly incorporates considerations of comity into chapter 15 proceedings,
providing:
In determining whether to provide additional assistance under this title or under other laws
of the United States, the court shall consider whether such additional assistance, consistent
with the principles of comity, will reasonably assure —
(1) just treatment of all holders of claims against or interests in the debtor’s
property;
(2) protection of claim holders in the United States against prejudice and
inconvenience in the processing of claims in such foreign proceeding;
(3) prevention of preferential or fraudulent dispositions of property of the
debtor;
16
1, 20
ber 2
(4) distribution of proceeds of the debtor’s property em
v substantially in
n No
ed o and
accordance with the order prescribed by this iv
title;
arch
5363
.
(5) if appropriate, the provisionNof 14-3opportunity for a fresh start for the
, o an
rown proceeding concerns.1223
.B
individual that suchvforeign
seth
ix
in Bl
cited
This section suggests that courts should undertake a balancing of the interests at hand, specifically
considering the rights and expectations of the various parties in the different jurisdictions, based
on the law of those jurisdictions. Section 1521(b) also incorporates a similar balancing test when
the foreign representative requests authority over the debtor’s U.S. assets. That section provides that
1221 In re Elpida Memory Inc., 2012 WL 6090194, at *7 (Bankr. D. Del. Nov. 20, 2012):
Section 1520(a)(2) provides that section 363 of the Bankruptcy Code applies “to a transfer of an interest of the debtor
in property that is within the territorial jurisdiction of the United States to the same extent that the section would
apply to property of the estate.” Section 363(b)(1), in turn, provides that the “trustee, after notice and a hearing, may
use, sell, or lease, other than in the ordinary course of business, property of the estate.” Under section 1520(a)(3), “the
foreign representative may operate the debtor’s business and may exercise the rights and powers of a trustee under
and to the extent provided by section[ ] 363.” . . . The section 363(b) standard is well-settled. A debtor may sell assets
outside the ordinary course of business when it has demonstrated that the sale of such assets represents the sound
exercise of business judgment. In determining whether a sale satisfies this standard, the courts in this Circuit require
that a sale satisfy four requirements: (1) a sound business purpose exists for the sale; (2) the sale price is fair; (3) the
debtor has provided adequate and reasonable notice; and (4) the purchaser has acted in good faith.
Id. at *4. For different approaches to comity between the bankruptcy court and the court of appeals, see In re Fairfield Sentry
Ltd., 484 B.R. 615, 627 (Bankr. S.D.N.Y. 2013) (“[i]n fashioning relief [under chapter 15], courts must ‘take into account the
interests of the United States, the interests of the foreign state or states involved, and the mutual interests of the family of nations
in just and efficiently functioning rules of international law.’”) (quoting In re Vitro S.A.B. de CV, 701 F.3d 1031, 1053 (5th Cir.
2012)), vac’d, 768 F.3d 239 (2d Cir. 2014) (noting that the bankruptcy court was required to apply section 363 of the Bankruptcy
Code (made applicable by 11 U.S.C. § 1520(a)(2)) when the property to be transferred is within the territorial jurisdiction of the
United States).
1222 See, e.g., In re Vitro S.A.B. de CV, 701 F.3d 1031, 1053 (5th Cir. 2012).
1223 11 U.S.C. § 1507(b). Section 1509(c) also discusses comity, providing that “[a] request for comity or cooperation by a foreign
representative in a court in the United States other than the court which granted recognition shall be accompanied by a certified
copy of an order granting recognition under section 1517.” 11 U.S.C. § 1509(c).
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“the court may, at the request of the foreign representative, entrust the distribution of all or part
of the debtor’s assets located in the United States to the foreign representative or another person,
including an examiner, authorized by the court, provided that the court is satisfied that the interests
of creditors in the United States are sufficiently protected.”1224
The Jaffe v. Samsung Electronics Co. case is one example of the tension that can arise when courts
consider the competing interests of parties in the respective countries.1225 In Jaffe, the foreign
representative sought discretionary relief under section 1521(b), including the right to control and
dispose of U.S. licenses. The foreign representative then terminated the U.S. licenses, and the licensees
asserted their rights to continue to use the underlying intellectual property pursuant to section
365(n) of the Bankruptcy Code.1226 After several hearings, the Fourth Circuit ultimately affirmed
the bankruptcy court’s decision that, under section 1521(b), the licensees’ interests would only be
reasonably protected if the court enforced section 365(n) against the foreign representative.1227 In
reaching this decision, the Fourth Circuit did not discuss the bankruptcy court’s use of section
1506, which states that “[n]othing in this chapter prevents the court from refusing to take an action
governed by this chapter if the action would be manifestly contrary to the public policy of the United
States.”1228 The treatment of intellectual property licenses in a chapter 15 case is just one of the several
issues that may implicate issues of comity because the Bankruptcy Code often provides greater
powers for the trustee, or more protections for nondebtor parties (as in the case of intellectual
property licenses), than may be available in the foreign jurisdiction.1229
16
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The Commission did not find chapter 15 issues specifically Novem its mission, but it recognized
within
d on
chive
the important interplay between chapter 11363 ar chapter 15 for multinational debtors. The
and
-35
. 14of comity at several points during their deliberations,
Commissioneres discussed the importance
, No
own
v. Br
frequently considered theseth
implications of their recommendations in the international insolvency
Blix
context, and reviewed the approaches of different countries to many of the issues they ultimately
ed in
cit
addressed in the recommended principles. Notably, the Commission recommended including
foreign patents, copyrights, and trademarks (subject to the limitations recommended for domestic
trademarks in the related principles) in the definition of “intellectual property” under the Bankruptcy
Code, which would extend section 365(n) protections to licensees under foreign intellectual property
licenses.1230 Additionally, in approving a principle to allow the trustee to pursue foreign subsequent
transferees under section 550 of the Bankruptcy Code, the Commission voted to specifically limit this
remedy by notions of comity.1231 Moreover, the Commission is aware that Congress has considered
legislation that would have addressed the issue presented by the Jaffe case1232 and that the Rules
1224 11 U.S.C. § 1521(b).
1225 See, e.g., Jaffe v. Samsung Electronics Co. Ltd. (In re Qimonda), 737 F.3d 14 (4th Cir. 2013).
1226 For background on the issues in the case, see generally In re Qimonda AG, 462 B.R. 165, 167 — 70, 173 — 77 (Bankr. E.D. Va.
2011).
1227 See Jaffe, 737 F.3d at 31–32 (“We conclude that the bankruptcy court’s findings in this regard are not unreasonable and that the
bankruptcy court was justified in its skepticism of Jaffé’s claim that the Licensees’ interests would now be ‘sufficiently protected’
by his commitment not to charge them an exorbitant rate during their re-licensing negotiations.”).
1228 11 U.S.C. § 1506. See also Qimonda, 462 B.R. at 185 (finding that, under section 1506, “deferring to German law, to the extent it
allows cancellation of the U.S. patent licenses, would be manifestly contrary to U.S. public policy”).
1229 For a general discussion of the intersection of section 365(n) and chapter 15, see Peter M. Gilhuly, et al., Intellectually Bankrupt?
The Comprehensive Guide to Navigating IP Issues in Chapter 11, 21 Am. Bankr. Inst. L. Rev. 1, 43–45 (2013).
1230 See Section V.A.4, Intellectual Property Licenses.
1231 See Section V.C.2, Recoveries Under Section 550.
1232 See Innovation Act of 2013, H.R. 3309, 113th Cong. § 6(d) (1st Sess. 2013), available at https://www.congress.gov/113/bills/
hr3309/BILLS-113hr3309rfs.pdf:
(d) Protection of Intellectual-Property Licenses in Bankruptcy. –
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Committee has proposed amendments to the Bankruptcy Rules that, if approved, would make the
following three changes to rules relating to chapter 15: “(i) remove the chapter 15-related provisions
from Bankruptcy Rules 1010 and 1011; (ii) create a new Bankruptcy Rule 1012 to govern responses
to a chapter 15 petition; and (iii) augment Bankruptcy Rule 2002 to clarify the procedures for giving
notice in cross-border proceedings.”1233 Accordingly, the Commission includes this summary of
cross-border cases under chapter 15 to highlight issues that may indirectly relate to the chapter 11
principles proposed in the Report.
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(1) In General. — Section 1522 of title 11, United States Code, is amended by adding at the end of the following:
“(e) Section 365(n) shall apply to cases under this chapter. If the foreign representative rejects or repudiates a
contract under which the debtor is a licensor of intellectual property, the licensee under such contract shall be
entitled to make the election and exercise the rights described in section 365(n).”
1233 See Preliminary Draft of Proposed Amendments to the Federal Rules of Appellate, Bankruptcy, Civil, and Criminal Procedure,
at 82, Aug. 2014, available at http://www.uscourts.gov/uscourts/rules/preliminary-draft-proposed-amendments.pdf.
IX. Other Issues Relating to Chapter Cases
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X. CONCLUSION
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Bankruptcy Institute
The Commission’s process revealed a growing consensus for the reform of chapter 11. Although
not every witness who testified or professional who worked on the project agreed with this broad
statement or on the particular aspects in need of reform, most identified general areas of chapter
11 practice that no longer work as effectively as possible. Moreover, the field hearings and the
Commission’s research found that these deficiencies in chapter 11 are having an adverse impact on
distressed companies and their stakeholders, particularly with respect to small and medium-sized
enterprises.
Overall, the Commission concluded that the Recommended Principles, when taken in concert,
would significantly improve chapter 11 and make it a more viable and effective restructuring option
for distressed companies of all sizes, including small and medium-sized enterprises. The Commission
believed that its process was thorough, inclusive, transparent, and robust. This Report sets forth as
fully as possible the issues; the different perspectives on those issues; the relevant research (including
witness testimony, academic literature, empirical studies, and case law); and the Commission’s
deliberations, findings, and recommendations. The Commission hopes that the Report not only
further informs the dialogue surrounding chapter 11 reform and leads to spirited debate on the
issues, but also that it leads to serious consideration and adoption by policymakers of many, if not
all, of the Recommended Principles in the Report.
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APPENDIX A:
MEMBERS OF THE ABI
COMMISSION TO STUDY THE
REFORM OF CHAPTER 11
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Bankruptcy Institute
D.J. (Jan) Baker
Latham & Watkins LLP
New York, NY
Jan Baker is a partner in the New York office of Latham & Watkins
and Global Co-Chair of the firm’s insolvency practice. Mr. Baker
represents companies, lenders, committees, acquirors and other
parties in connection with restructuring matters. He also regularly
advises boards of directors of public and private companies on
matters related to corporate governance and fiduciary duty.
During his career, Mr. Baker has had primary responsibility in
numerous restructuring matters. Some of the companies that he
has represented in either out-of-court restructurings or Chapter
11 cases include: American Pad & Paper Company, Archstone,
Boston Generating, CIRCLE K Company, The Delaco Company,
16
Diamond M, DRECO Energy Services, FiberMark, Inc., FoxMeyer
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Drug Company, GenTek, Inc., Global Marine Inc., Graham-Field Health Products, Inc., Kaneb, Inc.,
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MCorp., MicroAge, Inc., Owens Corning, RCN Corporation, Safety Kleen Systems, Inc., Spectrum
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Brands, Sterling Chemicals, Inc., The Stroh Brewery Company and Winn-Dixie Stores, Inc.
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immediate past chair
Mr. Baker is a Fellow, then
and a former president of the American College
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of Bankruptcy. He frequently lectures and writes on issues involving corporate reorganization and
restructuring. Mr. Baker was selected by The Best Lawyers in America 2012 as a recommended
attorney for Bankruptcy Litigation. He was recently named one of the “Most Admired Attorneys” by
Bankruptcy Law360 and was recognized by The International Who’s Who as “most highly regarded”
in the Insolvency & Restructuring Lawyers 2011 category. Mr. Baker has also been named among
the top attorneys in the US in the 2010 Lawdragon 500 Leading Lawyers in America guide and is
recognized as a leading corporate restructuring attorney by legal guides and directories such as
Chambers Global, Chambers USA, Euromoney, Legal Media Group, Turnarounds and Workouts and
K&A Restructuring Register. The most recent Chambers Global 2010 directory refers to Mr. Baker as
the “ultimate bankruptcy lawyer – the one you want on your team at all times.”
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Donald S. Bernstein
Davis Polk & Wardwell LLP
New York, NY
Donald S. Bernstein is a partner with the international law firm
Davis Polk & Wardwell LLP based in New York, where he is
Practice Group Coordinator and co-Head of the firm’s Insolvency
and Restructuring Practice Group. Mr. Bernstein’s practice includes
representing debtors, creditors, liquidators, receivers and acquirers
in major corporate restructurings and insolvency proceedings, as
well as advising financial institutions regarding resolution planning
and the credit risks involved in derivatives, securities transactions,
and other domestic and international financial transactions.
He is a past chair of the National Bankruptcy Conference, a
Commissioner on the ABI Commission to Study the Reform of
Chapter 11, a director and member of the Executive Committee
of the International Insolvency Institute1, 2016 past director of the
and a
er 2
American College of Bankruptcy. He has been Treasurer andnaNovemb of the Executive Committee
member
o
of The Association of the Bar of the City of New York,rchived a former Chair of the New York City Bar
a and is
363
14 Corporate Reorganization and of the TriBar Opinion
Association’s Committee on Bankruptcyoand-35
N .
wn,
Committee. He is also on the vBoard of Editors of Collier on Bankruptcy and is Editor-in-Chief of
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the International iInsolvency Review. Mr. Bernstein served as a member of the Official United States
c ted
Delegation to the United Nations Commission on International Trade Law and participated in the
development of UNCITRAL’s Model Law on Cross Border Insolvency. He also has been a member
of the Legal Advisory Panel of the Financial Stability Board. Mr. Bernstein is invited frequently to
lecture and teach on insolvency law and bank regulatory and resolution issues, including in recent
years at Princeton, Harvard, The University of Chicago, Columbia, The University of Pennsylvania,
New York University and St. John’s University. Mr. Bernstein graduated from Princeton University
and received his J.D. from the University of Chicago Law School.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
William (Bill) A. Brandt, Jr.
Development Specialists, Inc.
Chicago, IL
Bill Brandt has been in the business of workout, turnaround and
insolvency consulting for more than thirty years and is widely
recognized as one of the foremost practitioners in the field. He
is President and CEO of Development Specialists, Inc. (“DSI”), a
firm specializing in the provision of management, consulting and
turnaround assistance to troubled or reorganizing enterprises.
Mr. Brandt and his firm continue to be involved with some of
the more celebrated financial restructuring cases in the nation’s
history, including Mercury Finance Company, Southeast Banking
Corporation, Malden Mills, the Keck, Mahin & Cate law firm, the
Coudert Brothers law firm, the Ohio “Coin Fund” scandal, and
the Bernie Ebbers Settlement Trust. The firm maintains offices in
6
Chicago, New York, Philadelphia, Los Angeles,1London, Miami,
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San Francisco, Cleveland, and Columbus.
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Mr. Brandt has advised Congress on matters 1of3insolvency and bankruptcy policy, and in that
No.
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capacity was the principal author . ofrothe amendment to the Bankruptcy Code permitting the
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election of Trustees initChapter 11 cases. He was also involved in drafting several amendments to the
in Bl
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Bankruptcy Code enacted into law in April 2005 as part of the Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005, which substantially rewrote the nation’s bankruptcy laws. During
the Clinton administration, he served as a member of the President’s National Finance Board as
well as serving as a delegate from the State of Florida to the 1996 Democratic National Convention.
During that decade as well, and upon the invitation of both business and political leaders in the
People’s Republic of China, Mr. Brandt worked with various public policy, law and banking leaders
in that country on approaches to the reorganization and restructuring of some of China’s stateowned industries. In 2000, he served as a member of the Democratic Party’s National Convention
Platform Committee. In 2002, he served on the Illinois Gubernatorial Transition Team as well as
on the State of California’s Business Delegation dispatched to Cuba to discuss politics, business and
trade. In 2008, Mr. Brandt served as a delegate from the State of Illinois to the Democratic National
Convention.
By Gubernatorial appointment, Mr. Brandt is serving his second consecutive term as Chair of the
Illinois Finance Authority, having been first appointed in 2007 and then reappointed in 2010. The
IFA is one of the nation’s largest self-financed entities principally engaged in issuing taxable and taxexempt bonds, making loans, and investing capital for businesses, non-profit organizations and local
government. The Governor has also appointed Mr. Brandt to the Illinois Broadband Deployment
Council, which works to ensure that advanced telecommunications services are available to all the
citizens of Illinois. He serves as a member of the National Advisory Council for the Institute of
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Governmental Studies at the University of California at Berkeley, while also serving as a member
of the Board of Trustees of Loyola University Chicago, and is a life trustee of Fenwick High School
in Oak Park, Illinois. Additionally, he was also featured in What Happened, a documentary film
humorously chronicling the dot-com “bust,” which premiered at the New York City Film Festival.
Mr. Brandt has written for publications that span a broad spectrum of thought, ranging from Maclean’s,
Canada’s Weekly Newsmagazine, to Directors & Boards, Corporate Board Magazine, the Florida Real
Estate Journal, and the American Bankruptcy Institute Law Review, published in conjunction with
St. John’s University School of Law. He is the co-author of the “Due Diligence” chapter in the 2nd
edition of Bankruptcy Business Acquisitions, published by the American Bankruptcy Institute. He is
a frequent lecturer and speaker on topics of corporate restructuring, bankruptcy and related public
policy issues and regularly appears on CNN, CNBC, CNNfn, Bloomberg, and Canada’s BNN, as well
as the CBS Radio and National Public Radio networks. He has been profiled and interviewed in a
wide array of periodicals including, among others, The Wall Street Journal, The New York Times, The
International Herald Tribune, Business Week, The Miami Herald, The Chicago Tribune, The Boston
Globe, Billboard Magazine and Bank Bailout Litigation News.
He served several terms as a member of the Board of Directors of the American Bankruptcy
Institute, as well as also serving several terms on the Advisory Board for that organization’s Law
Review. He served for almost 20 years as a member of the private Panel of Trustees for the United
6
States Bankruptcy Court for the Northern District of Illinois and briefly1, 201 as a member of the
served
ber 2
ve Florida in the late 1980s. He is a
same panel for the Bankruptcy Court in the Southern District oof m
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member of the Executive Committee of the Bankruptcy Section of the Commercial Law League
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of America and serves on their National .Government Affairs Committee. Mr. Brandt is a member
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for v. B
n Bli Los Angeles and is also currently serving his third consecutive three-year
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term as a member of the Board of Directors of the San Francisco Bay Area Bankruptcy Forum. In
addition to the Commercial Law League of America and the American Bankruptcy Institute, he
holds memberships in the National Association of Bankruptcy Trustees, the International Council
of Shopping Centers and the Urban Land Institute.
His biography appears in a number of reference works including Who’s Who in America, Who’s Who
in Finance and Industry, and Who’s Who in American Law. For well more than a dozen years, his
firm, Development Specialists, Inc., has been rated as one of the outstanding turnaround firms in
the world by the publication Turnarounds & Workouts. Mr. Brandt has also been routinely listed in
the K & A Restructuring Register, an annual roster of the country’s top 100 restructuring advisors.
He received his B.A. from St. Louis University and his M.A. from the University of Chicago, where
he also completed further post-graduate work toward a doctoral degree.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
Jack Butler
Hilco Global
Northbrook, IL
Jack Butler works with healthy and distressed companies, their
boards, management, owners, creditors and investors on a broad
range of asset valuation, monetization and strategic solutions and
transactions for which Hilco Global acts as advisor, agent, coinvestor and/or as a principal.
One of the most well-known and highly regarded dealmakers and
thought leaders in the restructuring, corporate reorganization and
M&A community, prior to joining Hilco Global, Jack was a founder
and leader of the corporate restructuring practice at Skadden, Arps,
Slate, Meagher & Flom LLP. Jack has advised on restructuring
solutions for such companies as Delphi Corporation, Kmart
Corporation and Xerox Corporation and on 2behalf of creditors
016
r 21,
bewith US Airways Group,
including most recently in American Airlines’ reorganization and Novem
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by the Financial Times, which separately profiled Jack
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Jack is a member of the M&A Advisors’ Hall of Fame and the Turnaround, Restructuring and
Distressed Investing Industry Hall of Fame. He is also a recipient of the Ellis Island Medal of
Honor, which is given to Americans who exemplify outstanding qualities in both their personal and
professional lives. A founder and past chairman of the Turnaround Management Association, Jack
has served in leadership positions for many other industry organizations, including the American
Bankruptcy Institute, American Board of Certification, the Commercial Finance Association and
its Education Foundation, INSOL International, and the New York Institute of Credit. He is also a
fellow in the American College of Bankruptcy and International Insolvency Institute. In addition
to serving in leadership positions with numerous civic and charitable organizations, Jack officiated
high school and college football for many years and is a lifetime member of the American Football
Coaches Association.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Babette A. Ceccotti
Cohen, Weiss and Simon LLP
New York, NY
Babette A. Ceccotti joined the firm in 1983, and became a partner
in 1990.
Ms. Ceccotti focuses on the firm’s bankruptcy and employee benefits
practice areas. As part of her bankruptcy work, she represents unions
and employee benefit plans in employer bankruptcy proceedings.
President Clinton appointed her to the nine-member National
Bankruptcy Review Commission from 1995-1997.
Ms. Ceccotti’s employee benefits practice includes litigation and
counseling regarding regulatory compliance, plan administration
governance and other matters.
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Ms. Ceccotti is the author of severalbarticles on labor and employee
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benefit issues in bankruptcy, including publicationshiin dthe American Bankruptcy Institute Law
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Review, in Business Law Today and in the14-35363
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Labor and Employment Law. She is w
Bro co-author of a chapter on protecting union interests in employer
th v.
lixseand Business Change. She has also been a contributing editor of the
bankruptcy in Laborn Law
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Employee and Union Member Guide to Labor Law, published by the National Lawyers Guild, and a
contributing author of supplements to the ABA/BNA Employee Benefits Law treatise.
Ms. Ceccotti graduated cum laude from Clark University in 1977, and from the New York Law
School in 1983.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
Hon. Arthur J. Gonzalez (retired)
U.S. Bankruptcy Court, Southern District of New York; NYU School of Law
New York, NY
Judge Gonzalez was born in Brooklyn, New York in 1947. Judge
Gonzalez received an undergraduate degree in accounting from
Fordham University in 1969 and a master’s degree in education
from Brooklyn College in 1974. He received a J.D. from Fordham
University School of Law in 1982 and received an LL.M. in taxation
from New York University School of Law in 1990. Judge Gonzalez
was an attorney in the Office of Chief Counsel of the Internal
Revenue Service earning the Chief Counsel’s Special Achievement
Award for three consecutive years. Thereafter, he practiced with the
firms of Pollner, Mezan, Stolzberg, Berger & Glass, P.C. and Gaston
& Snow in New York City. Judge Gonzalez was appointed Assistant
United States Trustee in the Southern District of New York in
1991 and United States Trustee for Region21, 2016
2 (Second Circuit) in
er
1993, serving in that position until his appointment to the United NovembBankruptcy Court for the
States
on
Southern District of New York in 1995 for a fourteen-year hived At the completion of his first term
arc term.
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in 2009, he was reappointed to another term.oIn4early 2010, Judge Gonzalez became Chief Judge of
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the Bankruptcy Court for the SouthernwDistrict of New York. On March 1, 2012, Judge Gonzalez
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retired as a BankruptcyeJudgeliand became a full-time professor of law as a Senior Fellow at New York
cit d
University School of Law.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Steven M. Hedberg
Perkins Coie LLP
Portland, OR
Steve Hedberg is the Chief Operating Officer of Perkins Coie LLP.
As the firm’s most senior business professional, Steve is responsible
for all aspects of the firm’s operations and strategic growth. Steve
was previously a partner at Perkins Coie with an active insolvency
practice for more than two decades and sat on the firmwide
Management and Executive Committees. Steve also served as the
firm’s National Co-Chair of its Insolvency Practice.
An elected Fellow in the American College of Bankruptcy, Steve’s
practice achievements include creditor representation in some of
the nation’s largest bankruptcy cases, such as Enron, Pacific Gas &
Electric, Delta Airlines, Northwest Airlines, and American Airlines
16
as well as counsel to debtors, Creditors’ 0Committee and other
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constituencies in bankruptcy cases, receiverships, compositionsoof creditors and assignments for the
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benefit of creditors. He is listed in The Best LawyersainhAmerica and Oregon Law and Politics, which
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named him a “Top 50 Super Lawyer” in o. 14
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Creditors’ Rights law by the tAmerican Board of Certification for over 20 years.
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Steve obtained his business degree from Portland State University and earned his J.D. from the
Northwestern School of Law of Lewis and Clark College. He has served in leadership roles in several
community organizations, including as a board member of the United Way of the ColumbiaWillamette and the Oregon Trail Chapter of the American Red Cross. Additionally, Steve maintains
a long-standing affiliation with the Portland Center Stage, a regional theater company in which he
served as Treasurer, Secretary and Chair of its board of directors.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
Robert J. Keach (Co-chair)
Bernstein, Shur, Sawyer & Nelson
Portland, ME
Robert J. Keach is a shareholder at Bernstein, Shur, Sawyer & Nelson,
Portland, Maine. Mr. Keach is a Fellow of the American College
of Bankruptcy and a Past President (2009-2010) of the American
Bankruptcy Institute (“ABI”). Mr. Keach is also the Co-chair of
the ABI’s Commission to Study the Reform of Chapter 11. Mr.
Keach focuses on the representation of various parties in workouts
and bankruptcy cases, including debtors, creditors, creditors
committees, lessors and third parties acquiring troubled companies
and/or their assets. Mr. Keach has appeared as a panelist on national
bankruptcy, lender liability and creditors rights programs, and is
the author of several articles on bankruptcy and creditors’ rights
appearing in the ABI Law Review, Commercial Law Journal and
ABI Journal, among other publications. Mr. 21, 2016 a contributing
Keach is
er
emb
author to Collier Guide to Chapter 11: Key Topics and Selected Industries (2011 Ed.). Mr. Keach is
Nov
d on
recognized as a “Star Individual” in Corporate M&A/Bankruptcy in Chambers USA, in Best Lawyers
chive
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in America (Ten-Year Certificate), and by New 4-35
. 1 England Super Lawyers (Bankruptcy and Top 100
, No
own
Lawyers in New England regardless .ofrspecialty). Mr. Keach is also certified in business bankruptcy
v B
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xset
by the American Boardd of Bli
e in Certification. Most recently, Mr. Keach has, inter alia, represented ad
cit
hoc committees in the Homebanc Mortgage, New Century TRS Holdings, and Nortel Networks cases
in Delaware, as well as a public utilities commission in the FairPoint Communications case in the
Southern District of New York. Mr. Keach was the fee examiner in In re AMR Corporation (the
chapter 11 cases of American Airlines and its parent and certain affiliates). Mr. Keach is currently
the chapter 11 trustee in the railroad reorganization case of Montreal Maine & Atlantic Railway, Ltd.,
as well as the fee examiner in Exide Technologies.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Prof. Kenneth N. Klee
University of California at Los Angeles, School of Law; Klee, Tuchin, Bogdanoff & Stern LLP
Los Angeles, CA
Prof. Kenneth N. Klee joined the UCLA Law faculty in July 1997
after teaching bankruptcy and reorganization law as a Visiting
Lecturer. He taught at Harvard Law School during the 1995–1996
academic year as the Robert Braucher Visiting Professor from
Practice and at Georgia State University College of Law during 2003
as the SBLI Visiting Professor.
From 1974 to 1977, Professor Klee was associate counsel to the
Committee on the Judiciary, U.S. House of Representatives, where
he was one of the principal draftsmen of the 1978 Bankruptcy
Code. He served as a consultant on bankruptcy legislation to the
U.S. Department of Justice in 1983 and 1984. Professor Klee served
as a member of the Standing Committee016 Discipline for the
on
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ber 2 2001-2005. He served as
United States District Court for the Central District of California from
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a lawyer delegate to the Ninth Circuit Judicial Conference
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From 1992 to 2000 he served as a member 4 the
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Judicial Conference of the United rStates. He also served as an adviser to the American Law Institute’s
v. B
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Transnational InsolvencyxProject.
n Bli
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c
Professor Klee is a founding Member of Klee, Tuchin, Bogdanoff & Stern LLP, specializing in
corporate reorganization, insolvency, and bankruptcy law. Representative clients of Mr. Klee have
included: Equity investors in 203 N. La Salle Street Assocs.; Boston Chicken Plan Trust as majority
equity owner of Einstein/Noah Bagel Corp.; First Trust and Bank of New York, trustees, as appellees
before the New York Court of Appeals and the United States Court of Appeals for the Eleventh
Circuit in Chemical Bank v. First Trust (In re Southeast Banking Corp.); Maxwell Communication
Corp. PLC, as appellant before the United States Court of Appeals for the Second Circuit in Maxwell
Communication Corp. PLC v. Societe Generale, et al.; the out-of-court Bondholders’ Steering
Committee in Primestar; 400 South Hope Street Associates L.P., in which he served as lead debtor’s
counsel; the debtors in Barney’s Inc., et al., as debtors’ special counsel; the debtors in Anacomp, Inc.;
the debtors in Sun World; the debtors in the five administratively consolidated Standard Brands
Paint Company cases; the debtor in Financial Corporation of America; the creditors’ committees in
the Adelphia, Del Taco, Iridium, Papercraft and Griffin Resorts, Inc. chapter 11 cases; the noteholders’
committee in PG&E National Energy Group, the out-of-court bondholders’ committees in the
Charter Medical and Orion Pictures restructurings; and Pennzoil, in the Texaco Inc. chapter 11 case.
He also has served as an expert witness in over 50 matters and also renders services as an arbitrator
or mediator.
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Bankruptcy Institute
Professor Klee has served as member of the executive committee of the National Bankruptcy
Conference from 1985 to 1988, 1992 to 2000, and 2004 - 2007. He served as Chair of the National
Bankruptcy Conference’s legislation committee from 1992 to 2000. Professor Klee is past president
of the Financial Lawyers Conference and serves on its board of governors. He has also served
as chairman of the Subcommittee of New and Pending Legislation of the Business Bankruptcy
Committee of the Section on Corporations, Business and Banking Law of the American Bar
Association. He is a frequent lecturer and panelist on programs for bankruptcy lawyers sponsored
by the American Law Institute/American Bar Association.
Professor Klee is the author of: Bankruptcy and the Supreme Court (Lexis-Nexis 2008) (Supreme Court
bankruptcy case data base available at http://www.law.ucla.edu/home/apps/supremecourtcases/);
and co-author of Business Reorganization in Bankruptcy (West 1996; 2d ed. 2001; 3d ed. 2006) and
Fundamentals of Bankruptcy Law (ALI-ABA 4th Ed. 1996). He has authored or co-authored twenty
nine law review articles on bankruptcy law. Among his most recent published works are “One Size Fits
Some: Single Asset Real Estate Bankruptcy Cases,” 87 Cornell L. Rev. 1285-1332 (September 2002);
also published in 4 Legal Scholarship Network: UCLA School of Law Research Paper Series (Mar.
20, 2002), available at http://www.ssrn.com; “Asset-Backed Securitization, Special Purpose Vehicles
and Other Securitization Issues,” (with Brendt C. Butler), 35 U.C.C. Law Journal 23-67 (September
2002); “Teaching Transactional Law,” 27 Calif. Bankr. J. 295-311 (2004); and “The Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005 -- Business Bankruptcy.”
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Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Richard B. Levin
Cravath, Swaine & Moore LLP
New York, NY
Richard Levin is a partner in Cravath’s Corporate Department and
serves as the Chair of its Restructuring practice. His practice focuses on
creditors’ rights, insolvency, reorganization and bankruptcy.
Mr. Levin has negotiated and structured complex domestic and
international transactions involving distressed or insolvent companies
and guided corporate debtors, creditors and acquirers through Chapter
11 and out-of-court restructurings both in negotiated resolutions and
in litigation. His clients have included companies in the manufacturing,
auto, technology, energy, utility, financial, telecommunications, real
estate, restaurant, retail, gaming and agricultural industries.
Mr. Levin was counsel to a subcommittee 0of6 the House Judiciary
1
21, 2
berof the 1978 Bankruptcy Code.
Committee from 1975 to 1978, where he was one of the primary authors
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He currently serves as Chair of the National BankruptcyivConference and is a Fellow of the American
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College of Bankruptcy. Mr. Levin has served. as a3consultant to the World Bank and to the Central Bank of
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Brazil regarding Brazil’s 2005 bankruptcy legislation, as Faculty at the Federal Judicial Center’s Bankruptcy
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Judge Workshops since 2002, and as a Lecturer in Law at Harvard Law School. He is a frequent lecturer on
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bankruptcy law in continuing legal education programs and is a regularly published author in the legal press.
Mr. Levin has been repeatedly cited as one of the country’s leading practitioners of bankruptcy and
creditor-debtor rights law by, among others, Chambers USA: America’s Leading Lawyers for Business from
2009 through 2014; Chambers Global: The World’s Leading Lawyers for Business in 2013 and 2014; The
Legal 500 from 2009 through 2014; IFLR1000: The Guide to the World’s Leading Financial Law Firms from
2013 through 2015; The Best Lawyers in America from 2007 through 2015; The International Who’s Who of
Insolvency & Restructuring Lawyers; the Guide to the World’s Leading Insolvency and Restructuring Lawyers
in the 9th edition; and the K&A Restructuring Register America’s Top 100, a peer listing of bankruptcy
experts, in its 2002 through 2007 and 2009 through 2011 editions. He was ranked number one among the
practitioners in the New York Metro area by Super Lawyers in 2014. Mr. Levin was named in Lawdragon’s
500 Leading Lawyers in America from 2007 through 2010 and has been ranked in Benchmark Litigation
as a National Star and as a Local Litigation (NY) Star in Bankruptcy from 2012 through 2015. He was also
recognized by The Legal 500 for his work in municipal bankruptcy from 2012 through 2014.
Mr. Levin received an S.B. from the Massachusetts Institute of Technology in 1972 and a J.D. from Yale Law
School in 1975, where he was an Editor of the Yale Law Journal.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
James E. Millstein
Millstein & Co.
Washington, DC
James E. Millstein is the chairman of Millstein & Co., LLC, a
financial advisory firm based in Washington, D.C., and an adjunct
professor of law at Georgetown University Law Center, where he
teaches a graduate seminar on financial regulation and the crisis of
2008. Before forming Millstein & Co., Mr. Millstein was the Chief
Restructuring Officer of the U.S. Department of the Treasury, where
he was primarily responsible for the management and restructuring
of the government’s TARP investments in AIG and Ally Financial
and was a senior advisor to the Secretary in the policy-making
process that resulted in the Dodd-Frank Consumer Protection and
Financial Reform Bill. Before joining the Treasury in 2009, Mr.
Millstein was the global co-head of Lazard’s Restructuring Group,
6
having joined Lazard in 2000 after an 18-year 1career at Cleary,
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Gottlieb, Steen & Hamilton, where he ran its Restructuring Practice.mHe received his bachelor’s
ve
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degree in politics from Princeton University in 1978, 3 arcmaster’s
his hiv
6
-353 his J.D. from Columbia University School of
the University of California at Berkeley in No. 14and
1979
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Law in 1982.
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Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Harold S. Novikoff
Wachtell Lipton Rosen & Katz
New York, NY
Harold S. Novikoff is a partner and the chair of the Restructuring and
Finance Department at Wachtell, Lipton, Rosen & Katz. He focuses on
creditors’ rights, bankruptcy, debt restructurings and financial market
transactions. Mr. Novikoff has 39 years of professional experience in
representing the principal lenders, bondholders and underwriters
in Chapter 11 cases and out-of-court debt restructurings of a wide
range of public and private companies; purchasers of and investors
in financially distressed companies; and dealers and other market
participants in connection with derivatives, repurchase agreements,
securities loans and other financial market transactions.
In addition to his role in the firm’s restructuring and finance practice,
Mr. Novikoff has chaired and taught numerous continuing legal
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education and professional programs on
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creditors’ rights and bankruptcy-related topics, includingvChapter 11 plans and disclosure statements,
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distressed company and debt purchases, valuation
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bankruptcy, structuring of loans and other credit transactions and
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avoidance actions.eHenis la co-author of Collier on Bankruptcy, and an author of numerous published
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articles and outlines on bankruptcy-related topics.
Mr. Novikoff is a former chair of the Committee on Bankruptcy and Corporate Reorganization of the
Association of the Bar of the City of New York, a member of the Executive Committee of the National
Bankruptcy Conference, a fellow of the American College of Bankruptcy, and a member of the Steering
Committee of the Board of Visitors of Columbia Law School.
Recent representations include the United States Treasury in the rescue of Fannie Mae and Freddie
Mac, JPMorgan (the largest secured creditor) in the Lehman Brothers and MF Global bankruptcies
cases, and major creditors of Thornburg Mortgage, Collins & Aikman, KKR Atlantic and Pacific, Axon
Financial, Victoria Finance, Dreier, American Home Mortgage, 360networks and National Century
Financial Enterprises.
Mr. Novikoff received his bachelor’s degree with distinction from Cornell University. He received his
juris doctor from Columbia University School of Law, where he was a member of the Board of Editors
of the Columbia Law Review.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
James P. Seery, Jr.
River Birch Capital, LLC
New York, NY
James P. Seery, Jr., is a partner at the investment firm of RiverBirch
Capital in New York. He was formerly a partner and co-head of the
Corporate Reorganization and Bankruptcy Group in Sidley & Austin’s
New York office. Prior to joining Sidley in mid-2009, Mr.Seery was
a Managing Director of Barclays Capital and, previously, the Global
Head of Lehman Brothers’ Fixed Income Loan business. In that
position, he was responsible for managing the Lehman Brothers
Fixed Income investment grade and high yield loan businesses,
including commitments, global distribution, hedging, trading
and sales portfolio management, and restructuring. Mr. Seery was
also a member of the Lehman Brothers’ Fixed Income Operating
Committee and Global Credit Products Operating Committee as
well as the High Yield Commitment and New 1, 2016 Committees.
Business
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Before assuming management of Lehman Brothers’ loanrcbusiness in 2005, Mr. Seery was a senior
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member of the Lehman High Yield and Distressed Debt groups responsible for investing and
14-3
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managing proprietary distressed tdebtBrown
. positions. From 2000 to 2004, Mr. Seery ran Lehman Brothers’
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in businesses with responsibility for management of distressed corporate
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investments made by Lehman Brothers.
In 1999 Mr. Seery was selected as one of the Top Restructuring Lawyers in the U.S. Under 40 by
Turnarounds and Workouts. Mr. Seery graduated in 1990 from New York Law School, magna cum
laude, where he was an editor of the Law Review, and from Colgate University in 1984. He was a
member of the Board of Directors of the Loan Syndications and Trading Association from 2006 to
2008.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
Case: 14-35363, 11/28/2016, ID: 10211115, DktEntry: 37-2, Page 355 of 402
ABI Commission to Study the Reform of Chapter
Sheila T. Smith
Deloitte Financial Advisory Services LLP
Boston, MA
Sheila T. Smith is a Principal in Deloitte Financial Advisory
Service LLP. She leads the National Reorganization Services
Practice providing workout, turnaround and bankruptcy services.
In addition, Ms. Smith leads the New England Financial Advisory
Services Function overseeing Corporate Finance, Forensic &
Dispute, Valuation, Economic Consulting and Business Intelligence
Services.
Ms. Smith has over sixteen years of professional experience in
providing restructuring and financial consulting services, litigation
support and corporate finance experience. Her particular focus
derived from having worked in the consumer products industry
is delivering cost containment and performance improvement
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services to return companies to profitability. Ms. Smith was thevem
2005
No
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eIndividual Contribution Award for her
Management Association’s International Outstanding
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eminence in the profession.
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Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
James H.M. Sprayregen
Kirkland & Ellis LLP
Chicago, IL
James H.M. Sprayregen is a Restructuring partner in the Chicago
and New York offices of Kirkland & Ellis LLP. Mr. Sprayregen is
recognized as one of the country’s outstanding restructuring
lawyers. Mr. Sprayregen has extensive experience representing
major U.S. and international companies in and out of court as well
as buyers and sellers of assets in distressed situations. He also has
extensive experience advising boards of directors, and generally
representing domestic and international debtors and creditors in
workout, insolvency, restructuring, and bankruptcy matters. He has
handled matters for clients in industries as varied as manufacturing,
technology, transportation, energy, media, and real estate. Chambers
& Partners has described Mr. Sprayregen as a “great clients’ lawyer,
6
admired for his ‘unflustered ways.’” In March12010, Mr. Sprayregen
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was selected by The National Law Journal as one of “The Decade’s Mostm
ve Influential Lawyers.”
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Mr. Sprayregen returned to Kirkland & Ellis oin 4-353
1 December 2008. He rejoined the Firm after nearly
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three years with Goldman Sachs,h where n was co-head of Goldman Sachs’ Restructuring Group
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and advised clients initrestructuring and distressed situations. The 2009 edition of Chambers USA,
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America’s Leading Lawyers for Business highlighted Mr. Sprayregen’s return to Kirkland & Ellis after
his nearly three years with Goldman Sachs. Mr. Sprayregen was listed as a first tier lawyer practicing
in the bankruptcy/restructuring category, and was described as having an “outstanding reputation
for complex Chapter 11 cases.” The 2011 edition of Chambers USA, America’s Leading Lawyers
for Business recognized Mr. Sprayregen as a key individual, noting that sources refer to him as “a
restructuring genius and one of the best strategists in the country.” Prior to joining Goldman Sachs,
Mr. Sprayregen spent 16 years at Kirkland & Ellis, where he led bankruptcy cases for United Airlines
and Conseco, among many others. Some of his recent representative matters include General Growth
Properties, Innkeepers USA Trust, Japan Airlines Corporation as U.S. and international counsel, The
Great Atlantic & Pacific Tea Company, Visteon Corporation, Lear Corporation, The Reader’s Digest
Association, Corus Bankshares, Inc., Majestic Star Casino LLC, and ION Media Networks, Inc.
Mr. Sprayregen is a frequent lecturer and speaker, and has published numerous articles on insolvency,
fiduciary duty, and distressed M&A issues. He also served as an Adjunct Professor at the University
of Chicago Booth School of Business. He earned a J.D. from the University of Illinois College of Law
and a B.A. from the University of Michigan.
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Albert Togut (Co-chair)
Togut, Segal & Segal, LLP
New York, NY
For the past 40 years, Albert Togut has specialized in bankruptcy
law to the exclusion of all other areas of practice. His law firm,
established in 1980, has extensive experience in hundreds of cases
representing Chapter 11 debtors, creditors committees, trustees and
secured creditors. The firm was debtor’s counsel in some of the largest
and highest profile Chapter 11 cases, including: General Motors,
Chrysler Automotive, Enron, Rockefeller Center; Ambac Financial,
Loehman’s, DBSD North America, Delphi, Collins & Aikman, St.
Vincent’s Hospitals, Charter Communications, Frontier Airlines,
Loew’s Cineplex, AbitibiBowater Inc. (for the BCFC Debtor); SK
Global, Daewoo International (America) Corp. (which together
with its Korean parent underwent the largest non-sovereign debt
16
restructuring in history with aggregate , liabilities exceeding $70
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billion); Olympia & York (World Financial Center), Allegiance vTelecom, OnSite Access, joan and
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david helpern inc; ContiFinancial Corporation, et3al.;chiv
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His firm was co-counsel to the creditors o. 14
N committees of American Airlines and Kodak.
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represented the iretired employees
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He
committee in Nortel and has represented the Creditors’
Committees and went on to be trustee of the Finley Kumble, Shea & Gould, Bower & Gardner and
Berger Steingut law firms. He was lead counsel to Dewey & LeBoeuf in its Chapter 11 case and to
Patton Boggs in its merger with Squire Sanders.
For 33 years, Mr. Togut has been an active member of the trustee panel maintained by the Southern
District of New York. He has served as Trustee in bankruptcy in several thousand bankruptcy
cases, under Chapter 11 and Chapter 7 of the Bankruptcy Code, including the $4 billion Refco,
LLC (registered commodities broker) estate; Anthracite Capital, Inc., a specialty finance company
that invests in commercial real estate assets having an estimated current value of $120 million; 313
West 77th Street Corp. (cooperative apartment building between West End and Riverside Drive in
Manhattan); Kingston Square (which owned several apartment complexes subject to secured claims
of approximately $400 million.), Axona International Credit & Commerce Limited (the liquidation of
a Hong Kong banking institution),for several large manufacturing companies (including Arrowhead
Jewelry, Inc. and Art Steel Company, Inc.).
Mr. Togut is a Fellow of the American College of Bankruptcy, a Fellow of the International Insolvency
institute, a past Director and Officer of the American Bankruptcy Institute (“ABI”) and past Chair of
its New York City program, twice a member of the Committee on Bankruptcy and Reorganization
of the Association of the Bar of the City of New York, a member of the International Bar Association
and INSOL, and is an Advisory Board member of the LLM in Bankruptcy program at St. John’s
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
University School of Law, a past President of the Bankruptcy Lawyers Bar Association of New York,
and for six years, Chaired a Task Force of the Business Bankruptcy Committee of the American
Bar Association Section of Business Law which analyzed disclosure statement requirements and
confirmation practices in Chapter 11 cases. He has written and lectured on many topics under the
former Bankruptcy Act and current Bankruptcy Code and has particular expertise in conflicts of
interest and ethics. He served on the ABI’s fee-study commission that studied professional fees
in chapter 11 business bankruptcy cases. The national commission’s report provides the most
comprehensive, independent look at professional fees in chapter 11 cases to date. He was also
the recipient of the 2008 Prof. Lawrence P. King award and was chosen as a “Leading Lawyer” by
Chambers USA. Mr. Togut was named as a New York Super Lawyer for 2007-2014, and named in
the Top 100 lawyers in New York. In addition, he has been profiled by St. John’s University School of
Law as a “success story.”
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Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Bettina M. Whyte
Alvarez & Marsal LLC
New York, NY
Bettina M. Whyte is a Managing Director and Senior Adviser
with Alvarez & Marsal. She is a nationally recognized leader in the
financial and operational restructuring industry.
Prior to joining A&M, Ms. Whyte chaired the advisory board of
Bridge Associates, LLC, a crisis management and restructuring firm.
Until October of 2007, she was a Managing Director and the Head
of the Special Situations Group at MBIA Insurance Corporation.
Before joining MBIA, Ms. Whyte was a Managing Director of
AlixPartners from 1997 to 2005.
Ms. Whyte has served as an interim CEO, COO and Chief
Restructuring Officer of numerous large ,and 6
1 mid-sized public and
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private corporations and partnerships. She has also been appointed by
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Chapter 11 and a Chapter 7 Trustee and by state andrchiv
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she has been charged with the responsibility3of daily management of the company, including
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implementation of cost reductions;omaximization of asset productivity and development of strategies
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for returning products, ldivisions and overall operations to profitability; preparation of valuations
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for operations that may be divested and negotiations with potential purchasers; and negotiation of
restructuring proposals with creditors and / or new sources of capital.
Additionally, Ms. Whyte has been appointed by the Bankruptcy Court as an Examiner to review
allegations of fraud and mismanagement on the part of previous management / owners and to act
as an independent arbitrator where disputes between parties were hindering the reorganization
process. She has also served as a Liquidating Trustee where no successful plan of reorganization can
be accomplished. Most recently, Ms. Whyte was retained by the Federal District Court in Eugene,
Oregon to serve as a mediator and arbitrator of several complex matters related to a multibillion
dollar SEC Receivership matter.
Ms. Whyte has been active in a broad range of industries, including real estate, airlines, aircraft
manufacturing, not-for-profits, oil and gas, commodity trading, retail, real estate, food services,
transportation, distribution, manufacturing, high technology, telecommunications, healthcare,
professional services, entertainment and financial services.
Ms. Whyte serves on the boards of directors of AGL Resources (NYSE) and is a member of the
Finance and Risk Management Committee and the Chair of the Compensation Committee; of RockTenn Company (NYSE), where she serves on the Compensation and Audit Committees; Armstrong
World Industries, Inc. (NYSE), where she sits on the Audit and Corporate Strategy Committees; and
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
the board of Amerisure Insurance, a mutual insurance company, where she is the Chair of the Audit
Committee and a member of the Investment and Acquisition Committee. She is on the Business
Advisory Board of Solera Capital, a private-equity firm; the Advisory Board of St. John’s Law School;
and the Dean’s Advisory Council for the Krannert School of Business at Purdue University. She is
an Adjunct Professor of Law at Fordham University and has been a guest lecturer at The Harvard
Business School, Kellogg School of Management at Northwestern University, Columbia Business
School, The Stern School of Business at New York University and The Krannert School of Business
at Purdue University. She has been featured in BusinessWeek, Working Woman, CEO magazine,
The Daily Deal and Boards and Directors magazine, and has appeared on NBC’s “Nightly News”,
CNN, National Public Radio and Sky Radio. Ms. Whyte is also the Past President of the American
Bankruptcy Institute (ABI) and is a Fellow of the American College of Bankruptcy.
Ms. Whyte earned a bachelor’s degree in industrial economics from Purdue University and a
master’s degree in business administration in finance and accounting from the Kellogg School of
Management at Northwestern University.
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Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Deborah D. Williamson
Cox Smith Matthews Incorporated
San Antonio, TX
Deborah Williamson is the Managing Director of Cox Smith
Matthews Incorporated. She is also the senior member of the
Bankruptcy and Creditors Rights Department. Deborah has
been recognized for her experience in bankruptcy cases with
an emphasis on her knowledge of the recent developments in
bankruptcy, including co-authoring the ABI Benchnotes column
for 25 years. Deborah has served as counsel for debtors, including
TXCO Resources, Inc. a publicly traded exploration and production
company based in the Eagle Ford shale. She has also served as
committee counsel as well as individual creditors in cases around
the country.
16
Deborah is also a frequent speaker and, author, and recently co1 20
ber 2 published by the American
authored When Gushers Go Dry: the Essentials of Oil and Gas Bankruptcy,
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Bankruptcy Institute. Deborah was President of theaAmerican
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received the ABI’s Lifetime Achievement .Award
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the Boardlixs Directors of the
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She serves on
American College of Bankruptcy. She is also a former
Chair of the Texas State Bar Bankruptcy Law Section. Deborah was recently featured in Texas
Lawyer’s Go-To Guide as one of five lawyers in the bankruptcy category (published only every five
years). Named a leader in her field by Chambers USA since 2003, Deborah was selected for inclusion
by Law and Politics magazine as one of the Top 100 Lawyers in Texas (regardless of practice) since
2007. She has been selected for inclusion as one of the Top 50 Women Lawyers in Texas and one of
the Top 50 Lawyers in Central Texas by Law and Politics since the honor’s inception and in The Best
Lawyers in America consecutively for more than a decade.
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Bankruptcy Institute
Geoffrey L. Berman (ex officio)
Development Specialists, Inc.
Los Angeles, CA
Geoff Berman is a Senior Vice-President with Development
Specialists, Inc. resident in its Los Angeles office. Geoff brings over
35 years’ experience in all types of insolvency case administrations
with a special emphasis in the area of general assignments for the
benefit of creditors and post confirmation estate management
through liquidating and creditor trusts under confirmed Chapter
11 Plans of Reorganization.
Notable assignments include:
Trustee of the USA Commercial Mortgage Liquidating Trust,
arising out of the largest bankruptcy in Nevada history.
016
Trustee of the HNR (Horizon Natural 21, 2
r Resources) Liquidating
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Trustee for the Syntax Brillian Corporation
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Overseeing DSI’s rolesethLiquidating Trustee for the Appalachian Fuels Creditor Trust.
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Post-Confirmation Plan Administrator and sole remaining officer of Vista Hospital
Systems.
Trustee of the Sizzler Restaurants International Creditor Trust.
Trustee of the WATTSHealth Foundation Creditor Trust.
Oversight of hundreds of general assignments, including the largest general assignment
in Maine history (Avian Farms, Inc.), Howard and Phil’s Western Wear, Granny Goose
Foods, Inc., Morgan Confections, Inc. SVTC Technologies., Medical Selfcare, Inc. and
EnerTech Environmental, LLC.
Examiner and Federal Equity Receiver cases.
Prior to joining DSI, Mr. Berman was with Credit Managers Association of California, where he
was the Manager of the Adjustment Bureau and a member of the Association’s senior management.
Mr. Berman has previous experience with Union Bank (of California) and Mitsui Manufacturers
Bank. Mr. Berman served as ABI’s President from April 2011 to April 2012 and Chairman of the
Board from April 2013 to April 2014. He also served as ABI’s Vice President of Publications, with
oversight of the ABI Journal and other publication projects, and as a member of ABI’s Executive and
Management Committees. He chaired the ABI Task Force on General Assignments, and wrote the
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
ABI manual on general assignments, The ABCs of ABCs, and has contributed chapters on ABC’s to
the three editions of Strategic Alternatives for Distressed Businesses. He also served as contributing
editor and co-Executive Editor to the American Bankruptcy Institute Journal and has authored a law
review article published in the ABI Law Review. He was an ex officio member of ABI’s Ethics Task
Force, which released its Report on ethical issues in bankruptcy practice at the ABI’s April 2013
Annual Spring Meeting.
Mr. Berman, a certified mediator, is on the Bankruptcy Mediation Panel for the Central District of
California as well as the Register of Mediators for the District of Delaware. He was a member of the
inaugural faculty for the ABI’s Mediation Training program, conducted at the St. John’s University
Hugh Carey School for Dispute Resolution in New York. He is a member of the Los Angeles and
Bay Area (CA) Bankruptcy Forums, and AIRA. He speaks frequently on out-of-court and postconfirmation case administration issues.
Mr. Berman graduated with honors from the University of the Pacific, Stockton, California, with a
degree in business administration (accounting and finance) and wrote an Undergraduate Honors
Thesis in Finance. He also has a Juris Doctor from Southwestern University School of Law, Los
Angeles, California.
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Bankruptcy Institute
James T. Markus (ex officio)
Markus Williams Young & Zimmermann, LLC
Denver, CO
James Markus is a co-founder and member of Markus Williams
Young & Zimmermann LLC, and is a past President of the American
Bankruptcy Institute. Previously he served as Vice-president
for Education of the ABI. Jim is also certified by the American
Board of Certification as a Business Bankruptcy Specialist. Jim
specializes in the representation of secured creditors, lessors, asset
purchasers, official committees, debtors and trustees in commercial
transactions, distressed debt transactions, workouts, restructurings,
and Chapter 11 bankruptcy proceedings. He has a law degree from
the University of Michigan Law School, J.D. and an undergraduate
degree from the University of Wisconsin-Madison.
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Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Harvey R. Miller (ex officio)
Weil, Gotshal & Manges LLP
New York, NY
Harvey R. Miller is currently a partner in the New York City based
international law firm of Weil, Gotshal & Manges, LLP where he
had been a member of the firm’s management committee for over
25 years and created and developed the firm’s Business Finance &
Restructuring department specializing in reorganizing distressed
business entities.
From September 2002 to March 2007, he was a managing director
and vice chairman of Greenhill & Co.; adjunct associate professor
of Law 1974-76, and adjunct professor of Law 1976 to present, New
York University Law School; visiting lecturer, Yale Law School, 198384; lecturer in Law 2000 to present, Columbia University School of
Law; member, board of visitors Columbia, University School of Law
2016
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through 2002; member, Dean’s Council Columbia University School Law 2003-present; member,
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National Bankruptcy Conference; fellow, American rchiv
College
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Bar Foundation; trustee, Committee on Economic
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Admissions: US iCourt of Appeals 1st
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Bar
Cir.; US Court of Appeals 2nd Cir.; US Court of Appeals
3rd Cir.; US Court of Appeals 9th Cir.; Eastern District New York; New York State; Southern District
New York; US Supreme Court.
Education: Brooklyn College (B.A., 1954); Columbia University Law (J.D., 1959).
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
Clifford J. White III (ex officio)
Executive Office for United States Trustees
Washington, DC
Clifford J. White III is the Director of the Executive Office for
United States Trustees. He has served in the Federal Government for
30 years, including previously as an Assistant United States Trustee,
as a Deputy Assistant Attorney General within the Department of
Justice, and as an official at two other federal agencies. He is an honors
graduate of the George Washington University and the George
Washington University Law School. Mr. White was recognized with
a Presidential Rank Award for Distinguished Executive in 2009, a
Presidential Rank Award for Meritorious Executive in 2006, and the
Attorney General’s Award for Distinguished Service in 2003.
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Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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ABI Commission to Study the Reform of Chapter
Professor Michelle M. Harner, Reporter
University of Maryland Francis King Carey School of Law
Baltimore, MD
Michelle Harner joined the University of Maryland Francis King
Carey School of Law faculty in the fall of 2009. She teaches courses in
Bankruptcy and Creditors’ Rights, Business Associations, Business
Planning, Corporate Finance, and Professional Responsibility. Prior
to joining the faculty at UM Carey Law School, where she also has
served as Associate Dean for Academic Programs, Professor Harner
served on the faculty of the University of Nebraska College of Law
and was voted “Professor of the Year” by the upperclass students
during the 2006–07 and 2008–09 academic years. Professor Harner
is an elected Fellow in the American College of Bankruptcy, and an
elected Member in the American Law Institute.
1
Professor Harner is widely published , and6 lectures frequently
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on various topics involving corporate governance, financially ovem
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issues. Her publications appear or are forthcomingainhthe
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Review, Washington University Law Review, 4
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Commentator), FloridaBLaw Review, Washington & Lee Law Review and Illinois Law Review, among
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others. She also has published or will be publishing articles in specialty law reviews at the Moritz
College of Law (The Ohio State University), Rutgers School of Law, St. John’s University School of
Law, University of Miami School of Law, University of Tennessee College of Law and UM Carey Law
School.
Professor Harner’s scholarship has been cited by numerous courts, including the United States
Courts of Appeal for the First, Third, Fifth and Ninth Circuits and the United States District Courts
for the Districts of Massachusetts and Nevada. Professor Harner’s current research interests include
shareholder and creditor activism and its impact on enterprise value; legislative responses to serial
business failures and related implications for discrete industries; and the ethical implications of
insolvency for directors, officers and other fiduciaries.
In March 2009 and April 2012, Professor Harner received research grants from the American
Bankruptcy Institute Endowment Fund to study the role of creditors’ committees in chapter 11
business bankruptcies and potential reforms to chapter 11, respectively. She also serves as a member
of the Dodd-Frank Study Working Group for the Administrative Office of the United States Courts.
Professor Harner previously was in private practice in the business restructuring, insolvency,
bankruptcy and related transactional fields, most recently as a partner at the Chicago office of the
international law firm Jones Day. Before joining that firm in 1996, she served as law clerk to Judge
Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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Bankruptcy Institute
William T. Bodoh of the United States Bankruptcy Court for the Northern District of Ohio. Professor
Harner is admitted to practice law in Illinois and Ohio.
Professor Harner is an honors graduate of Boston College and was the valedictorian of her class at
the Moritz College of Law at The Ohio State University, where she served as the Executive Editor of
the school’s law journal.
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Appendix A: Members of the ABI Commission to Study the Reform of Chapter
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APPENDIX B:
RESEARCH ASSISTANTS
AND EMPIRICISTS
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Bankruptcy Institute
In addition to the valuable work of the advisory committees and the international working group,
the following individuals assisted Professor Harner in her research efforts for the Commission. The
work was performed by the identified individuals and not by the firms with which they are now or
currently were affiliated, although the Commission acknowledges the value of those firms allowing
the individuals to devote time and effort to the Commission’s project.
Leah Barteld Clague, Senior Research Fellow for the Commission, served the Commission
from July 2012 through July 2014. Ms. Clague supported Professor Harner’s research for the
Commissioners and assisted with preparing materials for the Commission in anticipation
of field hearings, monthly meetings, and deliberations. Ms. Clague is a graduate of the
University of Maryland Francis King Carey School of Law, and she is currently a Policy
Analyst with the Department of Legislative Services for the Maryland General Assembly.
Jennifer Ivey-Crickenberger, Business Law Fellow, University of Maryland Francis King
Carey School of Law, served the Commission periodically through May 2014 and then
again from October 2014 through December 2014. Ms. Ivey-Crickenbereger supported
Professor Harner’s research for the Commission and the Report, and assisted Professor
Harner with editing and proofing the Report. Ms. Ivey-Crickenberger is a graduate of the
University of Maryland Francis King Carey School of Law.
Sabina Jacobs, Research Fellow for the Commission, Associate with6 Gibson, Dunn
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& Crutcher LLP and formerly an Associate with Latham &ber 21,
Watkins LLP, served the
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Harner’s research for the Commission-3and3the Report, and assisted Professor Harner
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with editing and proofing theoReport. Ms. Jacobs is a graduate of Loyola Law School, Los
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Angeles, and a formerelaw clerk for the Honorable Brendan Linehan Shannon of the U.S.
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Bankruptcy iCourt for the District of Delaware.
Albert Togut, Managing Partner of Togut, Segal & Segal, LLP, and Samantha J. Rothman,
Associate with Togut, Segal & Segal, LLP, provided research regarding the history of the
federal bankruptcy laws.
Professor Lois Lupica, University of Maine School of Law, assisted the Commission and
the Reporter in drafting Section IX.B, Core and Noncore Matters in Chapter 11 Cases, and
Section IX.C, Individual Chapter 11 Cases, of the Report.
Ashish A. Shrestha, a Senior Manager with Deloitte Financial Advisory Services LLP,
assisted the Commission and the Reporter with analyzing empirical data and performing
empirical analyses on several issues relating to the Report.
James Katchadurian, Executive Vice President with Epiq Bankruptcy Solutions LLC,
assisted the Commission and the Reporter with analyzing empirical data and performing
empirical analyses on several issues relating to the Report.
Michael Roberts of Roberts Capital Advisors, LLC, assisted the Commission and the
Reporter with analyzing empirical data and performing empirical analyses on several
issues relating to the Report. Mr. Roberts is a graduate of the University of Maryland
Francis King Carey School of Law.
Appendix B: Research Assistants and Empiricists
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ABI Commission to Study the Reform of Chapter
Professor Anne Lawton, Michigan State University College of Law, assisted the Commission
and the Reporter with analyzing empirical data and performing empirical analyses on
issues relating to small businesses for purposes of the Report.
Professor Dalié Jiménez, University of Connecticut School of Law, assisted the Commission
and the Reporter by sharing the results of her empirical survey regarding chapter 11 reform.
Professor Harner also was assisted by the following current or former law students at the
University of Maryland Francis King Carey School of Law: Chris Jorgenson, David Nohe,
and Robert Walker. In addition, Hilary Hansen, Associate Director, Business Law Program
at the University of Maryland Francis King Carey School of Law, assisted Professor Harner
with proofing the Report; and Shyala Rumsey, Coordinator, Faculty Committees, and
Camilla Tubbs, Acting Director, Library, at the University of Maryland Francis King Carey
School of Law, assisted Professor Harner with certain graphics for the Report.
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Appendix B: Research Assistants and Empiricists
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Bankruptcy Institute
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Appendix B: Research Assistants and Empiricists
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APPENDIX C:
ADVISORY COMMITTEE
MEMBERS
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Bankruptcy Institute
(Note: Members of the international working group are listed in the Report at note 53.)
ADMINISTRATIVE CLAIMS, CRITICAL VENDORS AND OTHER PRESSURES ON LIQUIDITY
Commissioners: William Brandt and James Sprayregen
Advisory Committee Members:
1. Professor Jean Braucher, University of Arizona College of Law (Tucson, AZ)
2. Deborah A. Crabbe, Foster Pepper PLLC (Seattle, WA)
3. Matthew R. Goldman, Baker Hostetler (Cleveland, OH)
4. Robert S. Hertzberg, Pepper Hamilton LLP (Detroit, MI)
5. Stephen E. Hessler, Kirkland & Ellis LLP (New York, NY)
6. Honorable Jeffrey P. Hopkins, U.S. Bankruptcy Court (S.D. Ohio)
7. Reginald W. Jackson, Vorys Sater Seymour & Pease (Columbus, OH)
8. Clifton R. Jessup, Greenberg Traurig LLP (Dallas, TX)
9. Steve B. Towbin, Shaw Gussis et al. (Chicago, IL)
10. Honorable Mary Walrath, U.S. Bankruptcy Court (D. Del)
11. Professor Todd J. Zywicki, George Mason University School of Law (Fairfax, VA)
Committee Chairs: Robert S. Hertzberg and Stephen E. Hessler
Reporter: Matthew R. Goldman
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1. Professor Christopher W. Frost, University of Kentucky College of Law (Lexington, KY)
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2.
3.
4.
5.
6.
7.
8.
9.
10.
Debra I. Grassgreen, Pachulski Stang Ziehl & Jones LLP (San Francisco, CA)
Honorable Stacey Jernigan, U.S. Bankruptcy Court (N.D. Tex.)
Bruce S. Nathan, Lowenstein Sandler PC (New York, NY)
John D. Penn, Perkins Coie LLP (Dallas, TX)
Ronald R. Peterson, Jenner & Block LLP (Chicago, IL)
Honorable Steven Rhodes, U.S. Bankruptcy Court (E.D. Mich.)
Professor G. Ray Warner, St. John’s University School of Law (Jamaica, NY)
David B. Wheeler, Moore & Van Allen PLLC (Charleston, SC)
R. Scott Williams, Rumberger, Kirk & Caldwell, P.A. (Birmingham, AL)
Committee Chairs: Bruce S. Nathan, Ronald R. Peterson, and Professor G. Ray Warner
Reporters: John Penn and David Wheeler
Appendix C: Advisory Committee Members
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ABI Commission to Study the Reform of Chapter
BANKRUPTCY REMOTE ENTITIES, BANKRUPTCY-PROOFING AND PUBLIC POLICY
Commissioners: D.J. (Jan) Baker and Deborah Williamson
Advisory Board Members:
1. Paul Aronzon, Milbank Tweed (Los Angeles, CA)
2. Professor Jack Ayer, University of California Davis Law School (Davis, CA)
3. Jodie E. Buchman, DLA Piper (Baltimore, MD)
4. Robert M. Fishman, Shaw Gussis et al. (Chicago, IL)
5. Brian E. Greer, Dechert LLP (New York, NY)
6. Professor Bruce A. Markell, Florida State University Law School (Tallahassee, FL)
7. Jeffrey J. Murphy, SNR Denton (New York, NY)
8. Sally S. Neely, Sidley Austin LLP (Los Angeles, CA)
9. Damian S. Schaible, Davis Polk & Wardwell LLP (New York, NY)
10. Professor Steven Schwarcz, Duke University Law School (Durham, NC)
11. Professor Keith Sharfman, St. Johns University School of Law (Jamacia, NY)
Committee Chair: Robert M. Fishman
Reporter: Jodie E. Buchman
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1. HonorableeShelleysC. Chapman, U.S. Bankruptcy Court (S.D.N.Y.)
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ALLOWANCE AND PRIORITY OF CLAIMS; DISTRIBUTION ISSUES
2.
3.
4.
5.
6.
7.
8.
9.
10.
Marcia L. Goldstein, Weil, Gotshal & Manges LLP (New York, NY)
Professor Ingrid Hillinger, Boston College Law School (Boston, MA)
Honorable Laurel Myerson Isicoff, U.S. Bankruptcy Court (S.D. Fla.)
Daniel Kamensky, Paulson & Co. Inc. (New York, NY)
Peter S. Kaufman, Gordian Group LLC (New York, NY)
Alan W. Kornberg, Paul, Weiss, Rifkind, Wharton & Garrison (New York, NY)
Marc A. Levinson, Orrick, Herrington & Sutcliffe LLP (San Francisco, CA)
Peter V. Pantaleo, Simpson Thacher & Bartlett LLP (New York, NY)
Alan Resnick, Fried, Frank, Harris, Shriver & Jacobson LLP (New York, NY
Committee Chair: Peter V. Pantaleo
Reporter: Professor Ingrid Hillinger
Appendix C: Advisory Committee Members
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Bankruptcy Institute
EXECUTORY CONTRACTS AND LEASES
Commissioners: Richard Levin and Deborah Williamson
Advisory Committee Members:
1. Lawrence R. Ahern, Burr & Forman LLP (Nashville, TN)
2. Ingrid Bagby, Cadwalader, Wickersham & Taft LLP (New York, NY)
3. Professor David G. Epstein, University of Richmond School of Law (Richmond, VA)
4. Lisa Hill Fenning, Arnold & Porter LLP (Los Angeles, CA)
5. Susan M. Freeman, Lewis & Roca LLP (Phoenix, AZ)
6. Honorable Kevin Huennekens, U.S. Bankruptcy Court (E.D. Va.)
7. David R. Kuney, Sidley Austin LLP (Washington, D.C.)
8. Berry D. Spears, Fulbright & Jaworski LLP (Houston, TX)
9. Mark G. Stingley, Bryan Cave LLP (Kansas City, MO)
10. Professor Charles J. Tabb, University of Illinois College of Law (Champaign, IL)
11. Professor Jay Westbrook, University of Texas School of Law (Austin, TX)
Committee Chair: Honorable Kevin Huennekens
Reporters: Lisa Hill Fenning and Berry Spears
Consultant: David L. Pollack, Ballard Spahr LLP (Philadelphia, PA)
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Commissioners: Donald Bernstein, Arthur J. Gonzalez, archiv
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1. Lawrence Brandman,liLAMCO, LLC (New York, NY)
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FINANCIAL CONTACTS, DERIVATIVES AND SAFE HARBORS
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Mark C. Ellenberg, Cadwalader Wickersham & Taft LLP (Washington, D.C.)
Seth Grosshandler, Cleary Gottlieb (New York, NY)
Professor Stephen Lubben, Seton Hall University School of Law (Newark, NJ)
Professor Edward Morrison, Columbia Law School (New York, NY)
Honorable James G. Peck, U.S. Bankruptcy Court, Ret. (S.D.N.Y.)
Honorable Christopher S. Sontchi, U.S. Bankruptcy Court (D. Del.)
Kimberly Summe, Partner Fund Management (San Francisco, CA)
Shmuel Vasser, Dechert LLP (New York, NY)
Professor Mark Roe, Harvard Law School (Cambridge, MA)
Eric Waxman, Westerman Ball et al. (Uniondale, NY)
Committee Chairs: Honorable James G. Peck and Seth Grosshandler
Reporters: Professor Edward Morrison and Eric Waxman
Appendix C: Advisory Committee Members
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ABI Commission to Study the Reform of Chapter
FINANCING CHAPTER 11
Commissioners: Robert Keach, Harvey Miller, Harold Novikoff, and James Seery
Advisory Committee Members:
1. Marc Abrams, Wilkie Farr & Gallagher LLP (New York, NY)
2. Jo Ann J. Brighton, Winston & Strawn (Charlotte, NC)
3. Norma Corio, JP Morgan Chase (New York, NY)
4. Honorable Robert D. Drain, U.S. Bankruptcy Court (S.D.N.Y.)
5. William Fox, Alvarez & Marsal (New York, NY)
6. Elliot Ganz, Loan Syndications and Trading Association (New York, NY)
7. Marshall S. Huebner, Davis Polk & Wardwell LLP (New York, NY)
8. Christopher R. Mirick, Pillsbury Winthrop Shaw Pittman LLP (New York, NY)
9. Rebecca A. Roof, AlixPartners (Houston, TX)
10. Paul S. Singerman, Berger Singerman LLP (Miami, FL)
11. Professor David A. Skeel, University of Pennsylvania Law School (Philadelphia, PA)
12. Honorable Gregg W. Zive, U.S. Bankruptcy Court (D. Nev.)
Committee Chairs: JoAnn Brighton and Rebecca Roof
Reporter: Christopher Mirick
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Commissioners: Donald Bernstein, Jack Butler, andrBettina Whyte
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Advisory Committee Members: Brow
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1. Professor itDouglas Baird, University of Chicago Law School (Chicago, IL)
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2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Michael St. Patrick Baxter, Covington & Burling, LLC (Washington, D.C.)
David G. Heiman, Jones Day (Cleveland, OH)
William H. Henrich, Getzler Henrich & Associates (New York, NY)
Honorable Michael Hogan, U.S. District Court (D. Or.)
Honorable Barbara A. Houser, U.S. Bankruptcy Court (N.D. Tex.)
Mark Kronfeld, Owl Creek Asset Management (New York, NY)
Professor Nancy Rapoport, University of Nevada Las Vegas School of Law (Las Vegas, NV)
M. Freddie Reiss, FTI Consulting, Inc. (Los Angeles, CA)
John C. (“Kit”) Weitnaur, Alston & Bird LLP (Atlanta, GA)
Clifford J. White [ex officio], U.S. Department of Justice (Washington, D.C.)
Committee Chairs: William H. Henrich and David G. Heiman
Reporters: Nancy Rapoport and Douglas Baird
Appendix C: Advisory Committee Members
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Bankruptcy Institute
LABOR AND BENEFITS ISSUES
Commissioners: William Brandt, Babette Ceccotti, and James Sprayregen
Advisory Committee Members:
1. Michael L. Bernstein, Arnold & Porter LLP (Washington, D.C.)
2. Joseph A. Bondi, Alvarez & Marsal (New York, NY)
3. Professor Andrew B. Dawson, University of Miami School of Law (Miami, FL)
4. Israel Goldowitz, Pension Benefit Guaranty Corp. (Washington, D.C.)
5. David Jury, United Steelworkers Union (Pittsburgh, PA)
6. Professor Thomas A. Kochan, Massachusetts Institute of Technology (Cambridge, MA)
7. Sharon L. Levine, Lowenstein Sandler, PC (Roseland, NJ)
8. Michael Nicholson, United Auto Workers (Detroit, MI)
9. David E. Rogers, McDermott Will & Emery, LLP (Washington, D.C.)
10. David R. Seligman, Kirkland & Ellis LLP (Chicago, IL)
11. Sina Toussi, VR Capital Group (New York, NY)
12. Honorable Eugene R. Wedoff, U.S. Bankruptcy Court (N.D. Ill.)
13. Steven Zelins, Blackstone Group (New York, NY)
Committee Chairs: Michael L. Bernstein and Sharon L. Levine
Reporter: Professor Andrew B. Dawson
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-Hedberg, and Al Togut
Commissioners: Professor Kenneth Klee, Steven
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Advisory Committee iMembers:
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2.
3.
4.
5.
6.
7.
8.
9.
10.
Lisa G. Beckerman, Akin Gump Strauss Hauer & Feld LLP (New York, NY)
Martin J. Bienenstock, Proskauer (New York, NT)
Daniel C. Cohn, Murtha Cullina LLP (Boston, MA)
Peter M. Gilhuly, Latham & Watkins LLP (Los Angeles, CA)
Daniel M. Glosband, Goodwin Procter LLP (Boston, MA)
Honorable Allan L.Gropper, U.S. Bankruptcy Court (S.D.N.Y.)
Professor Adam J. Levitin, Georgetown Law Center (Washington, D.C.)
Thomas Moers Mayer, Kramer Levin Naftalis Frankel LLP (New York, NY)
Honorable Michael G. Williamson, U.S. Bankruptcy Court (M.D. Fla.)
Daniel A. Zazove, Perkins Coie LLP (Chicago, IL)
Committee Chair: Martin J. Bienenstock
Reporter: Adam J. Levitin
Appendix C: Advisory Committee Members
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ABI Commission to Study the Reform of Chapter
PLAN ISSUE; PROCEDURE AND STRUCTURE
Commissioners: Richard Levin, Steven Hedberg, and James Millstein
Advisory Committee Members:
1. Honorable Elizabeth E. Brown, U.S. Bankruptcy Court (D. Colo.)
2. Kenneth Buckfire, Miller Buckfire (New York, NY)
3. Ephraim Diamond, Davidson Kempner (New York, NY)
4. Jay M. Goffman, Skadden Arps Slate Meagher & Flom (New York, NY)
5. Laura Davis Jones, Pachulski Stang Ziehl & Jones (Wilmington, DE)
6. Professor George W. Kuney, University of Tennessee College of Law (Knoxville, TN)
7. David A. Lander, Greensfelder, Hemker & Gale, P.C. (St. Louis, MO)
8. Richard E. Mikels, Mintz, Levin, Cohn, Ferris et al. (Boston, MA)
9. Honorable Elizabeth Perris, U.S. Bankruptcy Court (D. Or.)
10. Thomas J. Salerno, Gordon & Silver (Phoenix, AZ)
11. Glenn E. Siegel, Morgan, Lewis & Bockius, LLC (New York, NY)
Committee Chairs: Richard E. Mikels and Jay M. Goffman
Reporter: George W. Kuney
ROLE OF VALUATION IN CHAPTER 11 CASES
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Advisory Committee Members:
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v. Peabody LLP (Boston, MA)
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2. HonorableeKevinix Carey, U.S. Bankruptcy Court (D. Del)
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3.
4.
5.
6.
7.
8.
9.
10.
Honorable Mary Grace Diehl, U.S. Bankruptcy Court (N.D. Ga.)
Van C. Durrer II, Skadden Arps Slate Meagher & Flom LLP (Los Angeles, CA)
Professor Stuart Gilson, Harvard Business School (Cambridge, MA)
Ronald F. Greenspan, FTI Consulting Inc. (Los Angeles, CA)
Melissa Kibler Knoll, Mesirow Financial Consulting (Chicago, IL)
David Resnick, Rothschild (New York, NY)
Barry W. Ridings, Lazard (New York, NY)
Professor Mark Scarberry, Pepperdine University Law School (Malibu, CA)
Committee Chairs: Honorable Kevin J. Carey and Barry W. Ridings
Reporters: Professor Mark Scarberry and Van C. Durrer II
Appendix C: Advisory Committee Members
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Bankruptcy Institute
SALES OF SUBSTANTIALLY ALL OF THE DEBTORS ASSETS, INCLUDING GOING CONCERN SALES
Commissioners: D.J. (Jan) Baker, Arthur Gonzalez, and Professor Kenneth Klee
Advisory Committee Members:
1. Professor Barry Adler, New York University School of Law (New York, NY)
2. John W. Ames, Bingham Greenebaum Doll LLP (Louisville, KY)
3. Corinne Ball, Jones Day (New York, NY)
4. James E. Bromley, Cleary Gottlieb Steen & Hamilton LLP (New York, NY)
5. Professor Ralph Brubaker, University of Illinois College of Law (Champaign, IL)
6. Mark D. Collins, Richards Layton & Finger PA (Wilmington, DE)
7. Matthew A. Feldman, Willkie Farr & Gallagher LLP (New York, NY)
8. Honorable Robert E. Gerber, U.S. Bankruptcy Court (S.D.N.Y.)
9. Lee Grinberg, Elliott Management (New York, NY)
10. David M. Hilty, Houlihan Lokey (New York, NY)
11. David S. Kurtz, Lazard (New York, NY)
12. Michael P. Richman, Hunton & Williams LLP (New York, NY)
Committee Chairs: Mark D. Collins and Michael P. Richman
Reporter: Professor Barry Adler
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Appendix C: Advisory Committee Members
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APPENDIX D:
PUBLIC FIELD HEARING
WITNESS LIST
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Professor Edward I. Altman, New York University Stern School of Business (New York, NY)
Honorable Ronald Barliant, Goldberg Kohn Ltd., U.S. Bankruptcy Court (N.D. Ill.) (Ret.)
Ted Basta, Loan Syndications & Trading Association (New York, NY)
Michael L. Bernstein, Arnold & Porter (Washington, D.C.)
Professor S. Todd Brown, University of Buffalo School of Law (Buffalo, NY)
Howard Brownstein, The Brownstein Corp. (Conshohocken, PA)
G. Eric Brunstad, Jr., Dechert LLC (Hartford, CT)
Gerald Buccino, Buccino & Associates (Chicago, IL)
Paul D. Calahn, CCE, CICP, Cargill, Inc.(Kansas City, MO)
Professor Anthony J. Casey, University of Chicago School of Law (Chicago, IL)
Maria Chavez-Ruark, Saul Ewing LLP (Baltimore, MD)
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Janet Chubb, Armstrong Teasdale (Reno, NV)
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in Hubbard & Reed (New York, NY)
Kathryn Coleman, Hughes,B
cited
John Collen, Tressler, LLP (Chicago, IL)
Honorable Melanie Cyganowski, Otterbourg, Steindler, Houston & Rosen, PC, U.S. Bankruptcy
Court (E.D.N.Y.) (Ret.)
Thomas Demovic, CCE, CICP, Sharp Electronics Corp. (Mahwah, NJ)
Honorable Dennis R. Dow, U.S. Bankruptcy Court (W.D. Mo.)
William Derrough, Moelis & Company LLC (New York, NY)
Daniel F. Dooley, MorrisAnderson (Chicago, IL)
Honorable Robert D. Drain, U.S. Bankruptcy Court (S.D.N.Y.)
Dennis F. Dunne, Milbank, Tweed, Hadley & McCloy, LLP (New York, NY)
Daniel J. Ehrmann, Alvarez & Marsal (New York, NY)
Appendix D: Public Field Hearing Witness List
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ABI Commission to Study the Reform of Chapter
Robert L. Eisenbach, III, Cooley, LLP (San Francisco, CA)
Courtney Engelbrecht Barr, Locke Lord LLP (on behalf of IWIRC)
Brad B. Erens, Jones Day (Chicago, IL)
Holly Felder Etlin, AlixPartners (New York, NY)
Honorable Joan Feeney, U.S. Bankruptcy Court (D. Mass.)
Lisa Hill Fenning, Arnold & Porter (Los Angeles, CA)
Mark A. Gittelman, PNC Bank (Philadelphia, PA)
Craig Goldblatt, Wilmer Hale (Washington, D.C.)
Joshua Gotbaum, Pension Benefit Guaranty Corporation (Washington, D.C.)
Lawrence C. Gottlieb, Cooley, LLP (New York, NY)
Senator Charles E. Grassley (R-IA)
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William R. Greendyke, Norton Rose Fulbright (Houston, d on Nove
TX)
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Michael Haddad, Newstar Business Credit1(on behalf of CFA)
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h v.
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n Bli Management (Grafton, MA)
i
John M. Haggerty,eArgus
cit d
John Greene, Halcyon Asset Management LLC (Boston, MA)
Jonathan N. Helfat, Otterbourg, Steindler, Houston & Rosen, PC (on behalf of CFA)
Elizabeth I. Holland, Abbell Credit Corporation (Chicago, IL)
Sandra E. Horwitz, CSC Trust Company of Delaware (Wilmington, DE)
Professor Edith S. Hotchkiss, Boston College School of Management (Chestnut Hill, MA)
Honorable Barbara G. Houser, U.S. Bankruptcy Court (N.D. Tex.)
David R. Jury, United Steelworkers (Washington, D.C.)
Daniel B. Kamensky, Paulson & Co., Inc. (New York,NY) (on behalf of Managed Funds Association)
Robert Katz, Executive Sounding Board Associates, Inc. (Philadelphia, PA)
Peter S. Kaufman, Gordian Group LLC (New York, NY)
Appendix D: Public Field Hearing Witness List
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Bankruptcy Institute
Professor Daniel L. Keating, Washington University School of Law (St. Louis, MO)
Christopher K. Kiplok, Hughes Hubbard & Reed LLP (New York, NY)
Randall Klein, Goldberg Kohn Ltd. (Chicago, IL)
Richard M. Kohn, Goldberg Kohn Ltd. (on behalf of CFA)
Professor George W. Kuney, University of Tennessee College of Law (Knoxville, TN)
Professor Anne Lawton, Michigan State University College of Law (Lansing, MI)
Professor Jonathan C. Lipson, Temple University School of Law (Philadelphia, PA)
James C. Little, Transportation Workers Union (Washington, D.C.)
Michael Luskin, Luskin Stern & Eisler LLP (New York, NY)
Bryan P. Marsal, Alvarez & Marsal (New York, NY)
W. Clarkson McDow, United States Trustee, Region 4 (Ret.) (Columbia, SC)
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Joseph P. McNamara, CCE, Samsung Electronics USA (Ridgefield,Nove
n NJ)
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Richard Mikels, Mintz, Levin, Cohn, Ferris,No. 14
, Glovsky and Popeo, P.C. (Boston, MA)
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Kathleen M. Miller, Smith, Katzenstein & Jenkins LLP (on behalf of IWIRC)
ed in
cit
Honorable Stephen S. Mitchell, U.S. Bankruptcy Court (E.D. Va) (Ret.)
A.J. Murphy, Bank of America Merrill Lynch (New York, NY)
Edward Murray, Allen & Overy LLP (London, U.K.)
Grant Newton, Association of Insolvency and Restructuring Advisors (Medford, OR)
James L. Patton, Jr., Young Conaway Stargatt & Taylor, LLP (Wilmington, DE)
Honorable James M. Peck, U.S. Bankruptcy Court (S.D.N.Y.) (Ret.)
Honorable Pamela Pepper, U.S. Bankruptcy Court (E.D. Wis.)
David L. Pollack, Ballard Spahr LLP (Philadelphia, PA)
Michael P. Richman, Hunton & Williams LLP (New York, NY)
Honorable Steven W. Rhodes, U.S. Bankruptcy Court (E.D. Mich.)
Appendix D: Public Field Hearing Witness List
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ABI Commission to Study the Reform of Chapter
Robert Roach, International Association of Machinists and Aerospace Workers (Hyattsville, MD)
Michael Robbins, Air Line Pilots Association (Washington, D.C.)
Michael R. Rochelle, Rochelle McCullough, LLP (Dallas, TX)
Douglas B. Rosner, Goulston & Storrs, PC (Boston, MA)
Wilbur L. Ross, WL Ross & Co. (New York, NY)
Thomas J. Salerno, Gordon & Silver LLP (Phoenix, AZ)
Sandra Schirmang, CCE, ICCE, Kraft Foods Global, Inc. (Northfield, IL)
Lee Shaiman, GSO Capital Partners, Blackstone (New York, NY)
Mark Shapiro, Barclays Capital (New York, NY)
Eric Siegert, Houlihan Lokey (Los Angeles, CA)
Professor David A. Skeel, University of Pennsylvania School of Law (Philadelphia, PA)
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Professor David C. Smith, University of Virginia McIntire School of Commerce (Charlottesville, VA)
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William K. Snyder, Deloitte CRG (Dallas,. TX)
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i
Danielle Spinelli,itWilmer
c ed
Grant Stein, Alston & Bird LLP (on behalf of AIRA) (Atlanta, GA)
Debora Sutor, CWA – Association of Flight Attendants (Washington, D.C.)
Jennifer Taylor, O’Melveny & Myers LLP (San Francisco, CA)
Kathleen M. Tomlin, CCE, Central Concrete Supply Co., Inc. (San Jose, CA)
Valerie Venable, CCE, Ascend Performance Materials LLC (Houston, TX)
J. Scott Victor, SSG Capital Advisors, LLC (Conshocken, PA)
Jane L. Vris, Millstein & Co. (on behalf of National Bankruptcy Conference)
Honorable Eugene R. Wedoff, U.S. Bankruptcy Court (N.D. Ill.)
Professor Jay Westbrook, University of Texas School of Law (Austin, TX)
Brady C. Williamson, Godfrey & Kahn, S.C. (Madison, WI)
Appendix D: Public Field Hearing Witness List
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Bankruptcy Institute
Jeffrey A. Wurst, Ruskin Moscou Faltischek, P.C. (Uniondale, NY)
Honorable Gregg W. Zive, U.S. Bankruptcy Court (D. Nev.)
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Appendix D: Public Field Hearing Witness List
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APPENDIX E:
SUMMARY OF FIELD
HEARINGS AND TOPICS
OF DISCUSSION
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Bankruptcy Institute
The October 17, 2012 field hearing was at held the Loan Syndications and Trading Association (LSTA)
annual meeting in New York, New York. The hearing generally covered finance and governance
concerns in chapter 11, and witnesses testified on debtor in possession (DIP) lending, distressed
debt trading, and the role of secured credit. The Managed Funds Association (MFA) testified on
various aspects of governance reform, suggesting changes involving the appointment of trustees, the
addition of new members to a debtor’s board of directors, and the appointment and management of
unsecured creditors’ committees.1234 Representatives from LSTA presented data on the relationship
between dip lending and reorganization, and witnesses encouraged the Commission to consider the
positive role that distressed debt trading has on the market.
The Commission hosted a roundtable discussion on sales as part of a field hearing on October 26,
2012 during the annual meeting of the National Conference of Bankruptcy Judges (NCBJ) in San
Diego, California. During the roundtable, witnesses recommended reviewing the time limits on the
section 363 sale process, in particular for small and medium-sized enterprise cases, and with respect
to plan exclusivity.1235 Another witness discussed the scope and ambiguity in sales approved under
section 363(f) of the Code.1236 Witnesses also spoke more generally on the challenges faced by small
and medium-sized enterprises using chapter 11, and on potential reforms in credit bidding and
lender control provisions.
On November 3, 2012, the Commission held a field hearing at the Turnaround Management
16
Association’s annual meeting in Boston, Massachusetts. During the efield 2hearing, witnesses
1, 0
b r2
provided comments on reforming the Bankruptcy Rules, the impact em Stern v. Marshall, the role
Nov of
d on
chiveComments from witnesses included:
of judicial discretion, executory contracts, and DIP3lending.
3 ar
35 6
. 14- nonresidential real property was too short; that
the suggestion that the time to assume or No
n, reject
Brow
v.too quick, diminishing value to prepetition creditors; and that
the speed of a section 363 saleswas
eth
Blix
section 503(b)(9) protections should be abolished. One witness suggested reforms to DIP lending
ed in
cit
and amending the standard in section 1111(b) in the context of credit bidding.
The field hearing on November 15, 2012 was held at the annual convention of the Commercial
Finance Association (CFA) in Phoenix, Arizona. The primary focus of the field hearing was finance,
and the witnesses testified on DIP lending, the use of carve-outs, and challenges to small and mediumsized enterprises. The leadership of CFA testified on behalf of their membership and suggested the
Commission study the following topics: adequate protection for secured creditors, carve-outs, the
inclusion of all contract rights in the definition of secured claims, and the enforceability of intercreditor agreements. Included among the potential reforms proposed by witnesses were: modifying
the Code to allow for the statutory appointment of a sale monitor or examiner; codifying local rules
1234 See Written Testimony of Dan Kamensky on behalf of the Managed Funds Ass’n: LSTA Field Hearing Before the ABI Comm’n to
Study the Reform of Chapter 11 (Oct. 17, 2012), available at Commission website, supra note 55.
1235 See Written Statement of Gerald Buccino: TMA Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 3
(Nov. 3, 2012) (recommending the 18-month limitation on exclusivity periods be amended), available at Commission website,
supra note 55; Oral Testimony of John Collen: NCBJ Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at
49 (Oct. 26, 2012) (NCBJ Transcript) (stating that there are times when the absolute time limits to formulate a plan and solicit
acceptances has a negative impact on the reorganization efforts of the debtor), available at Commission website, supra note 55;
Oral Testimony of Michael Richman: NCBJ Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 27–29 (Oct.
26, 2012) (NCBJ Transcript) (suggesting that a section 363 sale should not be allowed within the first 90 days unless there are
genuine reasons to do so), available at Commission website, supra note 55; Written Statement of John Collen, Tressler LLP: NCBJ
Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 4 (Apr. 26, 2012) (stating that the plan exclusivity time
limits do not provide enough time to construct a feasible plan in many cases), available at Commission website, supra note 55.
1236 Oral Testimony of Brad Erens: NCBJ Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 30–33 (Oct. 26,
2012) (NCBJ Transcript), available at Commission website, supra note 55.
Appendix E: Summary of Field Hearings and Topics of Discussion
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ABI Commission to Study the Reform of Chapter
to provide guidance or standards for the court to base its discretion on; clarifying sections 1129 and
1104 of the Code; codifying gifting; providing for the enforcement of fraudulent conveyance savings
clauses; and shifting the burden of proof in preferential transfer claims.
During the ABI Winter Leadership Conference in Tucson, Arizona, the Commission held a field
hearing on November 30, 2012. This field hearing centered on finance and governance under
chapter 11, in particular the role of unsecured creditors’ committees, DIP lending, the use of
secondary markets, surcharges, and roll-ups. While discussing the use of secondary markets, one
witness suggested that the Code should clarify that bad faith does not turn solely upon a creditor’s
motivation and that bad faith does not exist solely because a creditor took actions that are associated
with distressed investing.
The Commission held a field hearing during the VALCON Conference in Las Vegas, Nevada,
on February 21, 2013. The field hearing focused on valuation, including: different valuation
methodologies; the advantages and disadvantages of judicial valuation; and the timing of valuations
in chapter 11 cases. Witnesses made several suggestions to improve the valuation process used
during chapter 11, including the use of the Discounted Cash Flow Analysis over the Market Test,
and offering the court, at its election, access to a valuation consultant.
The March 14, 2013 field hearing was held at the spring meeting of the American College of
16
Bankruptcy in Washington, DC. The field hearing centered on labor provisions within the chapter
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11 process, in particular sections 1113 and 1114 of the Codeoandothe impact of the proposed Conyers
nN
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Bill. Recommendations for reform included: eliminating the 14-day time frame for a court hearing
arch
363
-35the test to terminate a defined-benefit pension plan;
on section 1113 and 1114 motions; modifying
o. 14
n, N
rowcreditors ultimately get paid in full or receive value equal to
B
restoring concessions if unsecured
h v.
xset
n Bli
100 percent of their iclaims; and maintaining the right to self-help. Many of the witnesses felt that
cited
payment into pension funds or 401(k) plans should be more strongly enforced and that the labor
force should be permitted to participate more actively in a debtor’s business plan.
In conjunction with the ABI Annual Spring Meeting in Washington, DC, the Commission held a
field hearing on April 19, 2013. This particular field hearing included testimony on professionals’ fees
and the challenges of small and medium-sized enterprises utilizing the chapter 11 reorganization
process. Several recommendations were made to address the perception of excessive professionals’
fees, including: a guideline in the present billing system that would provide a ceiling for the class’s
fees as a percentage of total recovery;1237 weekly reports accompanied by memos that explain the
firm’s prior week’s fees and expenses; or other systems that would promote greater transparency,
enhance debtor supervision of professionals, and rationalize the level of professionals at the
onset. Other witnesses provided insight into the unique challenges that small and medium-sized
enterprises face in efforts to reorganize under chapter 11 of the Code, such as the 300-day deadline
for filing a plan and disclosure statement, the section 1129(a) 45-day requirement to confirm a plan,
and the application of the Absolute Priority Rule. For comparison purposes, the witnesses offered
observations about the increased use of state law alternatives to chapter 11.
1237 Oral Testimony of Wilbur Ross: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 6 (Apr. 19, 2013)
(ASM Transcript), available at Commission website, supra note 55.
Appendix E: Summary of Field Hearings and Topics of Discussion
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Bankruptcy Institute
As part of the New York City Bankruptcy Conference, the Commission held a field hearing on May
15, 2013 in New York, New York. The focus of the field hearing was the role of financial contracts and
derivatives, and the use of safe harbors, in chapter 11 cases. Several recommendations for reform
were proffered by the witnesses, including: tailoring the settlement payment definition to confirm
more closely to Congress’s original intent; imposing a self-reporting requirement on counterparties
exercising safe harbors; allowing the debtor continued access to information from its clearing banks;
and providing more protection to the estate’s operating assets. In addition, a discussion was held
surrounding the appropriateness of a three-day automatic stay for the exercise of safe harbors, the
level of judicial discretion that should be granted within the definition and enforcement of safe
harbors, and whether a set interest rate should apply to payouts.
The Commission heard from several witnesses regarding administrative claims and avoiding powers
during its May 21, 2013 field hearing at the National Association of Credit Management conference
in Las Vegas, Nevada. During a robust discussion on section 503(b)(9), one witness suggested
the inclusion of drop shipment transactions in the protections of that section. Several witnesses
supported changes to the preference statute to afford more protections and defenses to creditors and
place more of the burden on trustees and debtors to evaluate preference claims prior to demands.
Additionally, witnesses shared that the window for bringing preference actions was too broad and a
cost-benefit analysis should be required when evaluating preference demands, demonstrating that
pursuing the preference action would provide benefit to the unsecured creditors above the cost to
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On June 4, 2013, the Commission held a field hearing archexecutory contracts, leases, and related
63 on
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14
intellectual property issues in bankruptcy, atothe New York Institute of Credit conference in New
N .
rown
York, New York. A panel of witnesses B
h v. represented two distinct and opposite views on the impact and
xset
n Bli
value of the 210-day cited to assume or reject nonresidential leases. The witnesses also discussed the
rule i
treatment of stub rents, a lessee’s postpetition obligations under section 365(d)(3), and the definition
of adequate assurance of future performance in the context of the assumption and assignment of
leases.1238 The panel of witnesses that discussed intellectual property issues offered suggestions to
reform section 365(c) to adopt the “Actual Test,” and to reform sections 365(g), (n) to adopt the
Lubrizol decision. Further, the suggestion was made to modernize the definition of patents to include
foreign-issued patents and to clarify change of control provisions.
Another field hearing of the Commission was held on June 7, 2013 in Chicago, Illinois, at the annual
meeting of the Association of Insolvency & Restructuring Advisors (“AIRA”). The field hearing
began with a report from AIRA leadership on those issues most concerning to their membership,
including the format and detail of disclosure statements, the use of judicial discretion, and the revival
of “KERPs.” The Commission also heard from two academics regarding the interaction between
labor law and the Code, and the role of governance and the value of information, in particular
control discovery, in chapter 11.
1238 Written Statement of David L. Pollack, Ballard Spahr LLP: NYIC Field Hearing Before the ABI Comm’n to Study the Reform of
Chapter 11, at 10–12 (June 4, 2013) (arguing that the statutory language regarding adequate assurance of future performance in
nonresidential leases is unclear, often to the detriment of commercial landlords; specifically, the statute “should be clarified to
provide meaningful benchmarks which will allow those [debtors] that can survive to do so while avoiding simply delaying the
inevitable for those companies which should not be either sold or reorganized”), available at Commission website, supra note 55.
Appendix E: Summary of Field Hearings and Topics of Discussion
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ABI Commission to Study the Reform of Chapter
The Commission again held a field hearing at the National Conference of Bankruptcy Judges Annual
Meeting, which took place on November 1, 2013 in Atlanta, Georgia. The discourse of this hearing
focused on several general proposals for reform of the Code, including: the oversight of committee
work; the value of a third party reorganization professional; and the role and selection of a trustee.
The Commission also heard from an academic reporting on her study of small business debtors
under the current Code and proposals for reform, including modifying the definition of “small
business debtor” and eliminating the 45-day plan-confirmation deadline for those debtors.
On November 7, 2013, the Commission held its first field hearing in the third judicial circuit at the
10th Annual Complex Restructuring Program at the Wharton School of Business in Philadelphia,
Pennsylvania. The Commission heard from several different witnesses who testified on the role and
responsibility of the debtor in possession and other parties in interest, the unique challenges faced
in asbestos-related chapter 11 cases, and issues within priority rules, in particular, codifying the
new value corollary of the absolute priority rule. One witness focused on reform proposals that
would reduce the costs and ease the timetables applicable in small and medium-sized enterprise
cases. The Commission also heard testimony on behalf of the International Women’s Insolvency and
Restructuring Confederation (IWIRC). IWIRC’s testimony focused on streamlining the process for
asserting section 503(b)(9) claims, including standardizing the forms and procedures for asserting
such claims and establishing a timeline in which they must be asserted.
6
, 2 of
The last field hearing of 2013 for the Commission occurred at the University 01 Texas/Jay Westbrook
er 21
embheard from two representatives
Conference in Austin, Texas on November 22, 2013. The Commission
Nov
d on
chive on the results of an online survey of its
of the Bankruptcy Law Section of the State Bar6ofar
3 Texas
-353
. 14reform of the chapter 11 process like standardizing the
members, including general suggestionsofor
,N
own
v. Br
role and practices of thexU.S. Trustee across districts or regions, legitimizing the section 363 sale
eth
Bli s
process, and makingin
ed bankruptcy judges Article III judges. In addition to several focused proposals
cit
on reform within the Code, the Commission heard testimony regarding two larger issues: the impact
of Stern v. Marshall and the role that venue plays in bankruptcy proceedings.
Appendix E: Summary of Field Hearings and Topics of Discussion
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Appendix E: Summary of Field Hearings and Topics of Discussion
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APPENDIX F:
ACADEMICS INVOLVED
IN APRIL 2014 SYMPOSIUM
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Bankruptcy Institute
Academics
Barry E. Adler, New York University, School of Law
Kenneth M. Ayotte, Northwestern University, School of Law
David G. Carlson, Yeshiva University, Benjamin N. Cardozo School of Law
Steven L. Harris, IIT Chicago-Kent, College of Law
Michelle M. Harner, University of Maryland, Francis King Carey School of Law
Gary Holtzer, Weil, Gotshal & Manges LLP
Melissa B. Jacoby, University of North Carolina, School of Law
Edward J. Janger, Brooklyn Law School
Mark Jenkins, University of Pennsylvania, Wharton School of Business
Stephen J. Lubben, Seton Hall University, School of Law
Bruce A. Markell, Florida State University, College of Law
Charles W. Mooney, Jr., University of Pennsylvania, School of Law
Juliet M. Moringiello, Widener University, School of Law
Edward Morrison, Columbia Law School
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David A. Skeel, Jr., University of Pennsylvania, School of Lawn Novem
o
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arch of Commerce
David C. Smith, University of Virginia, McIntire3School
5 63
14-3
No.
Charles J. Tabb, University of Illinois, n,
Brow College of Law
th v.
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Adrian J. Walters, iIIT in B
c ted Chicago-Kent, College of Law
Steven L. Schwarcz, Duke University, School of Law
Jay Lawrence Westbrook, University of Texas, School of Law
Papers Presented at April 2014 Symposium
Barry E. Adler, Priority in Going-Concern Surplus
Kenneth Ayotte, Leases and Executory Contracts in Chapter 11
David Gray Carlson & Gary T. Holtzer, Default Penalties in Chapter 11: Enforceability of Ipso
Facto Clauses in NonExecutory Contracts
Michelle M. Harner, The Value of Soft Assets in Corporate Reorganizations
Melissa B. Jacoby, Renaissance Judging and Bankruptcy Reform
Edward J. Janger, The Logic and Limits of Liens
Mark Jenkins & David Carl Smith, Creditor Conflict and the Efficiency of the Corporate
Reorganization Process
Stephen J. Lubben, The Board’s Duty to Keep Its Options Open
Bruce A. Markell & Charles W. Mooney, Jr., The (Il?)legitimacy of Bankruptcies for the Benefit
of Secured Creditors (presentation)
Juliet M. Moringiello, An Essay on the Use and Misuse of Butner v. United States
Appendix F: Academics Involved in April Symposium
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ABI Commission to Study the Reform of Chapter
Edward R. Morrison, Rules of Thumb for Intercreditor Agreements
Steven L. Schwarcz, Derivatives and Collateral: Balancing Remedies and Systemic Risk
David A. Skeel, Jr., What is a Lien? Lessons from Municipal Bankruptcy
Charles J. Tabb, The Bankruptcy Clause, the Fifth Amendment, and the Limited Rights of
Secured Creditors in Bankruptcy
Adrian J. Walters & Ralph L. Brill, Statutory Erosion of Secured Creditors’ Rights: Some Insights
from the United Kingdom
Jay L. Westbrook, The Role of Secured Credit in Chapter 11 Cases: An Empirical View
(presentation)
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Appendix F: Academics Involved in April Symposium
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Appendix F: Academics Involved in April Symposium
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APPENDIX G:
ADDITIONAL VIEWS
ON SEVERANCE BENEFITS
PRINCIPLES
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Additional Views Regarding the Priority of Severance Benefits Based on Length of Service
Prepared by Commissioner Babette A. Ceccotti1239
Responding to a divergence in the case law regarding the payment of severance pay as an
administrative expense, the Commission has recommended a uniform rule for severance benefits
calculated based on an employee’s length of service. Following case law which has allocated the
payment priority for severance pay based on pre- and post-petition length of service, the amount
paid as an administrative expense would be limited to the amount of the benefit allocated to the postpetition services provided to the debtor. Although this approach has been followed in many cases,
an allocation of severance pay priority where severance benefits are determined based on length
of service is rooted in a time when courts were just beginning to grapple with the compensation
features of labor agreements following the enactment of labor legislation in the 1930s. The allocation
approach stems from the Third Circuit’s 1947 case, In re Public Ledger,1240 in which the court was
confronted with a series of bankruptcy claim disputes over workers’ pay, including whether vacation
and severance benefits constituted wages and whether severance pay would be owed for a layoff
caused by bankruptcy, and, if such obligations were payable, what priority would be assigned under
the bankruptcy law.
The Public Ledger decision reflects the fledging nature of compensation features such as paid
vacation time and severance payments in the event of a layoff. In rulingr on, 2016 arising from
claims
e 21
emb a contractual vacation
labor agreements covering the debtor’s workforce, the court decided that
Nov
d on
chive into a day by day accrual, and then
pay entitlement of two weeks per year could be brokenadown
3 r
3536
. 14
allocated for priority based upon the time served -under bankruptcy trustee. With little analysis, the
No
wn,
court applied the same accrual eth v. Bro in ruling on a separate claim for severance pay where the
method
lixs
contract provided thatted in B
ci severance benefits were determined based upon specified lengths of service.
Thus, both severance pay and vacation pay were deemed to be accrued day by day and the priority
apportioned accordingly. Taking up another contract provision which required two days’ notice
in advance of a layoff, or up to two days’ pay in lieu thereof, the court ruled that, where the trustee
failed to provide the notice, the two days’ pay in lieu of notice (which was owed regardless of length
of service) was an expense of administration. Although the court recognized both the two days’
“notice” pay and the dismissal pay as “severance” pay owed because the employees lost their jobs,
the court’s differing rulings regarding priority transformed the latter into something more akin to
vacation pay merely because the entitlement had a length of service component (measured by one
year in the case of the vacation pay and one or more length of service determinants in the case of
the severance pay).
A different approach to the same issue — the payment of severance benefits as an administrative
claim — was forged by the Second Circuit, beginning with the court’s ruling in Straus–DuParquet.1241
In Straus-DuParquet, the Second Circuit rejected the “accrual” theory of severance benefits,
ruling instead that the entire severance payment constituted an expense of administration where
employment was terminated postpetition, because “[s]everance pay is not earned from day to day
1239 The views set forth in this Appendix G are the individual views of Commissioner Ceccotti.
1240 In re Public Ledger, Inc., 161 F. 2d 762 (3d Cir. 1947),
1241 Straus–DuParquet, Inc. v. Local Union No. 3, Int’l Bhd. of Elec. Workers, 386 F.2d 649 (2d Cir. 1967).
Appendix G: Additional Views on Severance Benefits Principles
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and does not ‘accrue’ so that a proportionate part is payable under any circumstances. After the
period of eligibility is served, the full severance pay is due whenever termination of employment
occurs.”1242
Rudimentary though it was in its treatment of severance pay, the distinction created by Public
Ledger between the priority treatment of pay in lieu of notice and of severance benefits calculated
based on length of service has been adopted by many courts, largely without analysis save for an
acknowledgement that adopting court would not follow the Second Circuit’s rulings.1243
Whether under labor agreements or employment policies for non-organized workforces, severance
benefits are now established features of compensation programs and better developed and understood
today than at the time of Public Ledger. Moreover, federal regulation of employee benefits under the
Employee Retirement Income Security Act, enacted in 1974 (ERISA) and regulatory guidance under
the Internal Revenue Code has added a wealth of depth and detail to an understanding of common
forms of compensation such as retirement benefits and other benefits such as severance pay.
Recent case law addressing severance benefits in bankruptcy cases bears this out. Tackling severance
pay priority as a matter of first impression in 2011, the Fourth Circuit in Matson v. Alarcon1244 rejected
the accrual approach for severance pay calculated based on length of service and followed StrausDuparquet on the issue of how severance benefits are “earned” for purposes of priority treatment.
Ruling that employees “earned” severance pay in full upon their termination 16 employment, the
, 20 from
er 21
emb pay, i.e., that severance pay is
court cited what it termed the “ordinary” understanding ofoseverance
Nov
d n
chive employment.1245
r
compensation for losses associated with the termination of
63 a
53
14-3
No.
wn,
Even more recently, the Supreme rCourt’s 2014 decision in United States v. Quality Stores,1246
.Bo
eth v
ixs
in Bl
is cited in the Commission’s report, presented a contemporary depiction of severance pay
cited
which
in the
course of the Court’s ruling that severance paid to employees terminated as part of the company’s
bankruptcy was subject to withholding under the Federal Insurance Contributions Act (FICA).
The Court recognized, matter of factly, that severance benefits were often determined by company
position and seniority, and deemed a “length of service” feature paying a larger sum to more senior
employees “a standard example of a company policy to reward employees for a greater length of
good service and loyalty.”1247 Viewed in more contemporary terms, a severance benefit calculated
with reference to length of service serves particular functions that relate to the purpose of the benefit
as compensation for loss of employment, rather than, as Public Ledger suggested, a feature defining a
distinct benefit more akin to compensation an employee would receive regardless of an unforeseen
contingency.
Federal regulation of employee benefits, which has increased exponentially following the enactment
of ERISA (well after Public Ledger ), reinforces the particularized view of severance pay as a benefit
intended to address an unforeseen contingency — job loss — and not a benefit in the nature of a
1242 Id. at 651. See also In re W .T. Grant Co., 620 F.2d 319 (2d Cir. 1980).
1243 See, e.g., In re Roth Am., Inc., 975 F.2d 949, 957 (3d Cir. 1992); In re Mammoth Mart, Inc., 536 F.2d 950, 953 (1st Cir. 1976); Lines
v. Sys. Bd. of Adjustment No. 94 Bhd. of Ry., Airline & Steamship Clerks (In re Health Maint. Found.), 680 F.2d 619, 621 (9th Cir.
1982).
1244 Matson v. Alarcon, 651 F.3d 404 (4th Cir. 2011).
1245 Id. at 409.
1246 United States v. Quality Stores, 134 S. Ct. 1395 (2014).
1247 Id. at 1499.
Appendix G: Additional Views on Severance Benefits Principles
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Bankruptcy Institute
retirement or annuity benefit payable merely upon the passage of time. Notably, the distinctions
that have arisen under employee benefit regulations do not depend upon whether the benefit is
calculated by length of service. Under ERISA, a plan providing a severance benefit is an “employee
welfare benefit plan” and not an “employee pension plan,” a distinction which exempts severance
benefits from the more comprehensive requirements applicable to pension plans.1248 In addition,
the regulation of Voluntary Employees Beneficiary Associations (VEBAs) as tax exempt entities
under the Internal Revenue Code underscores the essential attribute of severance pay as a benefit
designed to compensate for unforeseen employment loss. Severance benefits are eligible to be paid
through a VEBA but retirement, annuity and similar benefits are not.1249 Distinguishing between
severance benefits eligible for payment from a VEBA and retirement and similar benefits that
are not, the regulations specify that “a benefit will be considered similar to that provided under a
pension, annuity, stock bonus or profit-sharing plan [and therefore not eligible as a VEBA benefit] if
it provides for deferred compensation that becomes payable by reason of the passage of time, rather
than as the result of an unanticipated event.”1250
These more recent developments signal that setting a uniform allocation rule which is grounded
in distinctions that were articulated in the newly emerging world of bargained-for employee
compensation is out of step with the Commission’s goal to update the features of the Bankruptcy
Code to better reflect the current business environment — an environment which includes more
modern compensation arrangements.1251 A uniform allocation rule also does not adequately
16
recognize that severance benefits can vary based upon the particularsbof 21, 20 plan terms. In
er written
v m
reaching its decision that severance benefits were earned in fulloupone
n No termination of employment,
ed
iv
the Matson court relied upon the terms of the plan, 3 arch stated a purpose consistent with the
6 which
-353
4
accepted understanding of severance wn, No. 1well as the eligibility and payment rules for the
pay, as
ro
benefit.1252 Following the termssofh v. B
et the plan may also result in disallowance of payment as a severance
Blix
ed in Second Circuit declined to apply the severance pay rule established
benefit. For example,it the
c
in Straus-Duparquet to an executive compensation payment in Bethlehem Steel,1253 ruling that
the terms of the plan revealed that the payment at issue was actually a deferred compensation
payment despite being labeled as severance pay.
In deference to more recent developments, particularly the Supreme Court’s pragmatic assessment
of the role of severance pay “in an economy that is always changing,”1254 the Commission should not
1248 See 29 U.S.C. § 1003(1) (defining the two types of plans); 29 C.F.R. § 2510.3-2 (specifying that welfare benefit plans are not
subject to rules applicable to pension plans regarding, among other things, vesting, accruals and funding ).
1249 See 26 C.F.R. § 1.503(c)(9)-3(d) (describing a qualifying VEBA benefit as one that “protects against a contingency that interrupts
or impairs a member’s earning power.”).
1250 26 C.F.R. § 503(c)(9)-3(f).
1251 Matson v. Alarcon illustrates the anomalies resulting from an allocation of severance over the entire period of an employee’s
service: an employee who worked for the company for over eight years — a total of 437 weeks — would receive under the
company’s severance plan $8,500 in severance compensation. Because the employee worked only 22 of the total 437 weeks
during the pre-petition priority period, or 5.03% of the employee’s 437 total weeks of employment, only 5.03% of $8,500, or
$429.31, would be allocated to the priority period. See Matson v. Alarcon, 651 F.3d 404, 407 (4th Cir. 2011). A benefit intended to
cushion the effects of an unanticipated job loss would yield only a small fraction paid in full dollars. Moreover, such an allocation
penalizes longer-term employees. .
1252 See Matson v. Alarcon, 651 F.3d 404, 410 (4th Cir. 2011) (noting that the accrual rule favored by the trustee conflicted with the
terms of the plan).
1253 Supplee v. Bethlehem Steel Corp., 479 F.3d 167 (2d Cir. 2007).
1254 United States v. Quality Stores, 134 S. Ct. 1395, 1400 (2014).
Appendix G: Additional Views on Severance Benefits Principles
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ABI Commission to Study the Reform of Chapter
adopt a dated allocation approach as a uniform rule. At a minimum, the law regarding the payment
of postpetition severance pay should be left to continue to develop in the courts.1255
in
cited
16
1, 20
ber 2
vem
n No
ed o
rchiv
63 a
-353
. 14
, No
rown
.B
eth v
Blixs
1255 In 2005, Congress added section 503(c)(2) to the Bankruptcy Code and set limits on the payment of severance pay to insiders.
Notwithstanding the divergence among the courts, Congress did not distinguish among types of severance pay or add an
allocation rule to the limits under section 503(c)(2). Instead, Congress imposed the requirement that such severance payments
be made only as part of a program that is generally applicable to the company’s full time work force and that the payments be
limited to no more than 10 times the mean severance payment to nonmanagement employees during the calendar year of such
payment. These relatively recent additions to section 503 also suggest that the time for a rule limiting the payment of severance
as an administrative expense based upon a length of service formula has passed.
Appendix G: Additional Views on Severance Benefits Principles
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in
cited
16
1, 20
ber 2
vem
n No
ed o
rchiv
63 a
-353
. 14
, No
rown
.B
eth v
Blixs
Appendix G: Additional Views on Severance Benefits Principles
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