THE NATIONAL BANKRUPTCY REVIEW COMMISSION
United States Senate Dirksen Office Building
Commission Members Present:
Commission Advisors and Staff Present:
Chair Williamson, at approximately 8:40 a.m., commenced the morning session of the meeting by extending thanks to the Senate Judiciary Committee, Senator Grassley and his staff for their assistance in making the meeting facilities available to the Commission. He then reviewed the meeting agenda and the status of proposed bankruptcy legislation pending before Congress. Upon the conclusion of his opening remarks, Chair Williamson called upon Professor Lawrence P. King, Senior Advisor for the Service to the Estate and Ethics Working Group, to introduce the next session.
OPEN FORUM: ISSUES RELATED TO THE UNITED STATES TRUSTEE PROGRAM
Professor King explained that the United States Trustee Program played an "important part" in the administration of bankruptcy cases and that the Commission should accordingly examine the Program as well as obtain comments on it from people around the country. He said that this open forum session would be the first attempt to obtain this input, a process that would continue at future meetings.
Mr. Richard Levine of Hill & Barlow began his remarks by noting that he was the first Director of the United States Trustee Program, where he served for two years, and that he was currently in private practice. He recalled that at the time the Bankruptcy Reform Act of 1978 was enacted there was a perception that some bankruptcy judges were too involved in case administration and that the United States Trustee should become proactive in the process by which creditors' committees select counsel. He also noted that there was "significant pressure" placed on himself and the Executive Office for United States Trustees to refrain from being unduly involved in the day-to-day operations of individual United States Trustee offices.
At its inception, the Program became involved and continues to be involved in the chapter 11 disclosure statement process, which "was a mistake," Mr. Levine said. He asserted that this function should be performed by either the creditors' committee or the bankruptcy judge in those cases lacking committees. The role of the United States Trustee, he stated, was not to assist bankruptcy judges, but to play an independent role.
When asked by Professor King if the role of the United States Trustee should be expanded in those cases that lack committees, Mr. Levine said no. One problem about the Program, he noted, was that there were no clear limits on what role the United States Trustee should play and thus, as a result, the Program had become involved in substantive areas and lacked focus.
Commissioner Shepard noted that the Small Business Proposal contemplated giving the United States Trustee more responsibilities with regard to identifying "dead on arrival cases." Mr. Levine indicated that he was not opposed to the United States Trustee being required to identify "moribund cases." Commissioner Shepard then asked whether these additional responsibilities would cause the present work force of the United States Trustees to be spread "too far."
Mr. Levine observed that the Program had historically been "ignored" in the Department of Justice and likened it to a "stepchild." He suggested that the United States Trustee should have a major role in determining whether a case should be converted or dismissed and whether a trustee or examiner should be appointed. He also recommended that the United States Trustee should supervise chapter 13 cases as there was no reason to have chapter 13 trustees. While acknowledging that the United States Trustee Program should monitor chapter 7 trustees, Mr. Levine did not support having United States Trustees conducting criminal investigations as this was the province of the Federal Bureau of Investigation and United States Attorney.
In response to Commissioner Jones' query regarding what the supervision of chapter 7 trustees entailed, Mr. Levine identified various administrative aspects. Commissioner Jones questioned whether these supervisory responsibilities had to be performed on a full-time basis if the chapter 7 trustees were capable appointees. Mr. Levine responded that trustees occasionally needed to be "goad[ed]."
In light of certain statements made at the January meeting regarding the lack of investigation into instances of civil fraud, Commissioner Shepard asked whether the United States Trustee should undertake this responsibility. Mr. Levine said no based on the Program's lack of human resources. Commissioner Shepard observed that it was problematic that chapter 7 trustees were not compensated for these efforts. Mr. Levine agreed that this was one of the "many defects in the system" and suggested that a trustee should "receive extra money" for successfully obtaining the denial of a debtor's discharge. Given the likelihood that funds would not be made available for this purpose, Mr. Levine concluded that this may mean that some debtors "go free and not have their discharge[s] barred."
When asked by Commissioner Jones to identify the responsibilities that should be performed by United States Trustees, Mr. Levine said reviewing fee applications, serving as the trustee in chapter 13 cases, and being more vigilant with regard to solicitation practices by creditors' committee counsel. He said that the present solicitation practices of attorneys and accountants was no better now than they were in 1978. With regard to the historical budgetary shortfall of the Program, Mr. Levine observed that this reflected the "non-support traditionally the Department [of Justice] has given the Program."
Commissioner Jones noted Mr. Levine's reticence regarding the ability of the United States Trustee to monitor small business cases. She observed that the Small Business Proposal was modeled on the practices of certain United States Trustees who functioned "pretty effectively." Mr. Levine explained that his concern pertained to the Program's lack of staff and the lack of support from the bench. He was also concerned that United States Trustees became too involved in cases that, in turn, interfered with their ability to fulfill their other responsibilities such as monitoring fees. When asked by Commissioner Shepard to clarify his position regarding the role of the United States Trustee Program in small business cases, Mr. Levine said that it should play a "superficial role" and that any supervision should be performed on a "spot check" basis.
Professor King summarized Mr. Levine's comments as that if there was more funding, then the United States Trustee should have greater responsibilities. Agreeing with this summary, Mr. Levine observed that there was no significant support for the United States Trustee Program, especially outside the Department of Justice. He noted, for example, that the Program had "disappeared from the radar screen of . . . the Congress."
Joseph Wittman, President of the National Association of Bankruptcy Trustees, discussed several matters. These included due process and grievance procedures for trustees, how trustees are compensated, providing immunity or quasi-immunity for trustees, the ability of a trustee to retain his or her own self as counsel, and micro-management of trustees by United States Trustees.
As to due process, Mr. Wittman noted that trustees who were suspended or removed received "very little notice" or reason for these actions by United States Trustees. Although the Executive Office for United States Trustees promulgated proposed grievance procedures, he said that they were "totally inadequate." His Association favored some form of independent review of these actions. He said that many trustees across the nation were currently operating in an "arena of suppressed fear."
Commissioner Jones asked Mr. Wittman what the closest analogy would be to the type of due process that his Association wanted for chapter 7 trustees. Although Mr. Wittman responded that nothing was completely analogous, he asserted that there should be some form of administrative review. He explained that his Association supported the amendment of 11 U.S.C. ' 324 to mandate that this review be performed by an independent person. The Association also supported the institution of an internal review process by either the United States Trustees or the Executive Office for United States Trustees.
When asked by Commissioner Ginsberg whether these procedures would require an administrative law judge to hold a hearing every time a trustee was removed or suspended, Mr. Wittman responded "[p]ossibly." He explained, however, that these actions occurred infrequently and that many of them were ultimately resolved. He said that the system had lost many "good trustees" because they "simply find it is not worth the hassle." Mr. Wittman then complained about the "phenomenal" amount of paperwork in connection with their case administration responsibilities that trustees must submit to United States Trustees twice a year as well as the "extraordinary amount of time" required to respond to various questions posed to them by United States Trustees on matters pertaining to their cases.
Commissioner Jones questioned the purpose of such monitoring. Mr. Wittman said that he had no problem with the United States Trustee periodically checking or "prodding the trustees along." When asked by Commissioner Jones whether bankruptcy judges or creditors typically served this function, Mr. Wittman said that most judges did not get involved and only a few creditors performed this role. In response to Commissioner Shepard's query as to the average case load for chapter 7 trustees, Mr. Wittman stated that it was approximately 300 to 500 cases per year, excluding California where a trustee handled 1,500 to 2,000 cases annually.
Keith Shapiro of Holleb & Coff said that he was Vice President of the American Bankruptcy Institute and was a founder of the American Bankruptcy Board of Certification, in addition to having served as a chapter 7 panel trustee.
Among Mr. Shapiro's observations were the following. First, he noted that where a creditors' committee is appointed in a case, the United States Trustee's role should be greatly reduced. While not favoring the elimination of the United States Trustee Program in those cases where it served as a "watch dog," he did not think it was appropriate for the United States Trustee to "second guess[ ]" the creditors' committee, unless where there are "unholy alliances."
Second, he said that the United States Trustee Program "absolutely" had a role to play in those chapter 11 cases lacking creditors' committees. There were, for example, some districts that were very effective in monitoring these cases.
Third, Mr. Shapiro observed that although the United States Trustee had a major role in the fee application process, the Program lost credibility when it failed to support certain applications. He noted that fee objections were increasingly becoming weapons used to disincentivize trustees or their professionals. Accordingly, he said that the United States Trustee Program could be very helpful in these cases if it did not just focus on abuses by fee applicants. He suggested that this requirement could be effectuated through the enactment of an amendment.
The fourth area that Mr. Shapiro discussed concerned the issue of a trustee retaining himself or herself as counsel. He noted that he chaired a survey on professional fees conducted by the American Bankruptcy Institute in 1991 that found trustees in most districts were not required to propound a reason why their own firms should be employed. Currently, there was increasingly unequal application of this provision around the nation, he said. The survey also showed that the bankruptcy judges supported the retention by trustees of their own firms.
Mr. Shapiro then discussed the appointment process for trustees. He observed that with the politicalization of the United States Trustees' appointment process, it should be assumed that over time these political appointees will, in turn, appoint "cronies" to trustee panels and perhaps remove trustees "to make room for these cronies." Accordingly, he said that trustees should be protected by being given some meaningful due process rights.
Observing that there was a "lack of control" over consumer bankruptcy cases, Commissioner Jones explained that this problem began with the failure of debtors' counsel to provide sufficient credit counseling advice as well as to scrutinize the debtors' schedules or question their accuracy. This lack of oversight then continued with the chapter 7 trustees who claimed to not have sufficient funds to scrutinize the accuracy of these schedules and to determine whether debtors were honestly taking advantage of the law. Chapter 13 trustees as well, she noted, had the same concerns. She then asked whether the United States Trustee or chapter 7 trustee should perform this oversight function.
Mr. Shapiro recalled that when he was first appointed as a panel trustee he was advised by several of his peers to not "overwork" his cases because he would "lose a fortune." While it was a "shame" given there was "tremendous abuse" in the filing of the schedules in these cases, he said that most trustees could not afford to undertake the type of scrutiny posed by Commissioner Jones. He observed that a perception had developed over the past six years that credit card issuers were the most appropriate parties to attack consumer fraud. Recently, however, he noted that there was a backlash reflected in the case law "slamming" credit card issuers for overreaching and filing blanket discharge complaints. In sum, he was not able to identify an "appropriately incentivized party" who would perform "serious due diligence" on these bankruptcy schedules.
Mr. Wittman agreed that Commissioner Jones had identified the "tip of the iceberg that's out there" and that the problem started with debtor's counsel. Commissioner Shepard asked who should investigate into these abuses. Mr. Wittman responded that although all attorneys had an ethical obligation to do this, unfortunately it was not done. Commissioner Shepard questioned whether trustees or an agency within the United States Trustee Program should be responsible for monitoring this problem. Commissioner Ginsberg observed that there were no studies documenting particular abuses or determining whether any such problems were nationwide. He suggested that the existence of any problems should first be identified. Professor Warren agreed that the level of analysis was only anecdotal. Mr. Shapiro noted, however, that the present system did not fund investigations by trustees and that, accordingly, "most of the rats aren't investigated." Mr. Levine agreed with Mr. Shapiro's comments.
Bill Fry, Executive Director of HALT, a nonprofit reform group, discussed his association's efforts in promoting the concept of non-attorneys assisting people in the preparation of "simple legal documents." As a result of the enactment of 11 U.S.C. ' 110, he observed that many petition preparers were being driven out of business. One of his association's two "major recommendations" was that there should be no fee caps, he stated. The other problem that Mr. Fry discussed was the lack of a statutory definition of what activities constituted the unauthorized practice of law.
Mr. Fry noted that there was a "great deal of hostility" over the issue of whether non-attorneys were capable of performing the same professional services that attorneys perform. He said non-attorneys who worked for attorneys reported that the amount of scrutiny that attorneys gave their cases was "close to nil" He suggested that the law should be amended to permit non-attorneys to provide basic procedural information, namely, the same type of information available in self-help and government manuals.
Commissioner Shepard asked Mr. Fry whether he was, in effect, seeking to authorize non-attorneys to practice law without a license. As an example Commissioner Shepard said that the question of whether a claim was secured or unsecured presented a legal issue. Mr. Fry disagreed and suggested that a non-attorney should be able to refer his or her client to a standard definition. Commissioner Ginsberg observed that most law was not "black letter" and instead had "various shades of grey" even with respect to the classification of a claim. Mr. Fry responded that if the classification was not clear, then the petition preparer should refer the client to an attorney.
Jean FitzSimon, a member of Johnston, Maynard, Grant and Parker, noted that she primarily practiced in the area of business reorganizations and that she chaired the American Bar Association subcommittee that was responsible for bankruptcy courts, the United States Trustee and Bankruptcy Administrators.
Ms. FitzSimon had four recommendations with regard to the United States Trustee Program. First, she recommended that there should be complete separation between administration and adjudication. Second, she supported the creation of an Assistant Attorney General for the Program. As her third suggestion, Ms. FitzSimon said that United States Trustees should be appointed on a circuit-wide basis. Her fourth recommendation was that the Program should be made nationwide and include the two remaining districts that were still outside of the Program.
With regard to her first recommendation, Ms. FitzSimon explained that if bankruptcy judges were given Article III status, then the delineation between administration and adjudication would become essential. To effect this goal, she suggested that all administrative matters be assigned to the United States Trustee Program, particularly compensation issues. Many of the problems with the Program, she noted, related to uniformity and resource issues. On the other hand, she stated that the Program had made substantial improvements.
Noting that it was critical that the bankruptcy system is predictable and fair, Ms. FitzSimon said that the United States Trustee Program unfortunately suffered because of the intentional and "possibly misguided and probably misunderstood" emphasis of the legislation on local variances. As a result, several United States Trustees had taken positions and instituted programs that were contrary to sound bankruptcy administration. She noted that United States Trustees were "largely unsupervised" and that the local variance was not based on local considerations, but was in many instances based solely on the predilections of individual United States Trustees. As an example, she cited how trustees were treated in different regions. While trustees in some districts were supported by United States Trustees, in others, they were treated like "all but convicted criminals." She noted that the current Director of the Executive Office was "powerless" to prevent these practices, because the United States Trustees "trumped him in the pecking order."
Ms. FitzSimon supported the NAPA Study recommendations that the number of United States Trustee Program regions be reduced to the number of federal circuits, and that the Program has sufficient funding and authority to contract out such services as reviewing debtors' financial reports and reviewing bankruptcy schedules. Commissioner Shepard queried Ms. FitzSimon as to whether this process would identify assets missing from debtors' schedules without an audit being conducted. While Ms. FitzSimon acknowledged that not every instance of hidden assets would be uncovered through this process, she suggested that it could serve to identify internal inconsistencies and utilize computerized valuation systems to determine whether or not assets were correctly valued. Commissioner Shepard responded that such computer programs were currently available. Ms. FitzSimon responded that individual trustees had their own systems and that if the United States Trustee Program had authority to contract out this service, the Program, in turn, could make it available to all chapter 7 trustees.
Nathan Feinstein of Piper & Marbury began his remarks by noting that he agreed with virtually all of Ms. FitzSimon's prior statements. He also noted that he had great respect for the current Director of the United States Trustee Program.
Among his specific recommendations were the following. First, he said that the bankruptcy administration model recommended by the 1973 Commission should be adopted. To effectuate this goal, the authority accorded to the Director of the United States Trustee Program should be strengthened. Second, he said that much of the administrative responsibilities should be removed from the bankruptcy judges and given to the agency responsible for bankruptcy administration. He observed that the current fee application review process worked well.
Kevyn Orr, Deputy Director of the United States Trustee Program, prefaced his remarks by noting that one of the Program's goals was to ensure that bankruptcy cases were properly and expeditiously administered. Another goal of the Program was to be receptive to suggestions on how to improve its efforts in this regard. He observed that the Program was only ten years old and was the smallest component in the bankruptcy system with a staff of approximately 1,075 people. Despite increased bankruptcy filings, he noted that the size of the Program's staff remained "relatively stable" over the years.
With regard to the Program's supervision of chapter 7 trustees, Mr. Orr explained that these supervisory efforts included monitoring and ranking the performance of trustees in 14 different categories. In addition, the Program and the Office of Inspector General performed audits. He observed that much of the bankruptcy system with respect to fraud was deterrent-based. He also noted that fraud and civil enforcement efforts involved resource allocation and cost issues.
Commissioner Shepard questioned Mr. Orr as to whether he was aware of any formal program that examined into the extent of fraud. Responding in the affirmative, Mr. Orr stated that the Program had launched a new fraud initiative. In addition, he said that trustees made criminal referrals and that the Program reviewed schedules to determine whether there was any fraud. This process was furthered by referrals received from confidential sources. He noted, however, that there was no database that could provide a quantifiable number of the cases presenting some element of fraud.
Commissioner Jones asked Mr. Orr to explain the deterrents that were present in the bankruptcy system. Mr. Orr responded that the deterrent was "getting caught." Commissioner Jones then asked how many discharges were denied each year. While Mr. Orr could not cite an exact number, he noted that there was a "record number" of criminal referrals this year, namely, 740.
Commissioner Jones recalled that at last month's meeting, at which Mr. Orr was present, all the United States Trustee representatives agreed that the United States Attorney Offices did not actively prosecute bankruptcy fraud. Mr. Orr said that it was not so much that the United States Attorney did not prosecute bankruptcy crimes, but that there was a resource allocation issue. Given this fact and the fact that bankruptcy judges did not routinely deny discharges, Commissioner Jones observed that there were no deterrents in the current bankruptcy system. Mr. Orr responded that the United States Trustees also pursued civil remedies, such as dismissal of cases, where there was evidence of "improper behavior in the system." Based on discussions with trustees nationwide, Commissioner Shepard observed that trustees did not move to bar discharges or undertake actions beyond the filing of simple motions because they lacked the resources and that they were not rewarded for these actions.
Although Mr. Orr said that the Program tracked enforcement reports, he acknowledged that there was a "wide disparity" between what could be done and what was presently done in this area. He wanted to dispel the impression that the Program was doing nothing with regard to fraud. Mr. Orr concurred with Commissioner Shepard that a "great deal more should be done." In addition, he noted that the current Attorney General was supportive of the Program's efforts with regard to bankruptcy fraud and cited Operation Total Disclosure as an example. In addition, the Program's current budget sought 20 additional positions specifically targeted toward prosecuting fraud.
Commissioner Jones asked Mr. Orr to comment on the suggestions from the other panelists that certain auditing functions be outsourced. Mr. Orr noted that he and Jerry Patchan, Director of the Executive Office for United States Trustees, were discussing this possibility, its cost and potential funding sources.
Mr. Orr then discussed two other issues. One was the due process concerns expressed by some trustees. He mentioned that Program representatives met with representatives from the National Association of Bankruptcy Trustees and asked them to submit a proposal that addressed these concerns. The second was the perception that United States Trustees were viewed as political appointees who made trustee appointments based on favoritism. He explained that the United States Trustee position was actually a "confidential policy advocation, policy making" position. There was no attempt by the Department of Justice or the Program, he noted, to politicize this position.
Commissioner Shepard asked Mr. Orr whether the Program had sufficient resources to adequately monitor small chapter 11 business cases. Mr. Orr said that the Program agreed that its role should be "somewhat limited" in those cases where there was adequate representation by a creditors' committee. And, in response to those criticisms alleging that the Program lacks uniform policies, he noted that the Program had issued manuals on all substantive areas of the Program's duties. Chair Williamson then inquired about a proposal to reorganize the Program's regions. Mr. Orr explained that this proposal would restructure the Program's regions on either a circuit-based or some other rationalized model. He said that while it was included in the Program's proposed budget for 1997, it required further study.
Upon the conclusion of Mr. Orr's comments, the plenary session recessed at approximately 10:47 a.m. to allow the Commissioners to attend the following working group sessions: Small Business Working Group, Consumer Bankruptcy Working Group and Service to the Estate and Ethics Working Group.
PRESENTATION: COMMERCIAL LAW LEAGUE OF AMERICA
The Commission reconvened into plenary session at approximately 1:25 p.m. which began with a presentation from the Commercial Law League of America ("CLLA").
Jay L. Welford of Jaffe, Raitt, Heuer & Weiss introduced the panel appearing on behalf of the CLLA and explained the purpose of the presentation. He said that the panelists would highlight the CLLA's positions as set out in its prior written submissions to the Commission.
Elliott Levin, the first panelist, began his comments by noting that the CLLA was not convinced that there needed to be a special provision for small business bankruptcy cases. He noted that small debtors had the same problems as larger debtors and that their cases may be as equally complex as their larger counterparts. In particular, he observed that top management in small business bankruptcy cases typically was less sophisticated and therefore needed more time than the ninety-day period presently set forth in the Small Business Proposal. He said that the CLLA was opposed to "micro-managing" chapter 11 cases and putting too many burdens on the debtor. In addition, he said that these debtors would generally need two to four months to stabilize their financial condition and that it took time to deal with secured creditors.
Regarding other proposals under consideration by the Commission, Mr. Levin said that the CLLA "wholeheartedly" supported the proposals dealing with voting, the absolute priority rule and the review of creditors' committee appointments. On the other hand, he said that many other proposals under consideration by the Commission already existed either through practice or by case law. He noted, for instance, a chapter 11 debtor in the Southern District of Indiana must demonstrate that it is able to confirm a plan in defense of a motion to terminate the automatic stay or in support of a motion to extend the exclusive period.
With regard to the Small Business Proposal's definitional provisions, Mr. Levin observed that they would include almost 90 percent of small business debtors in the Southern District of Indiana. Accordingly, the CLLA recommended that the definition be changed to apply to debtors with $2 million of liquidated, non-contingent, non-disputed debt as this would include the debtors that really needed fast track treatment.
In summarizing his remarks, Mr. Levin said that the CLLA was not convinced that there was any need for either a small business chapter or a small business definition. Nevertheless, to the extent that there is a recommendation providing for separate treatment for small business debtors, he said that the CLLA supported extending the 90-day time period for filing a plan and that the present version of the definition should be reviewed further.
Alan Gordon, the next speaker, discussed three recommendations by the CLLA. The first concerned a proposed amendment to the ordinary course exception provisions under 11 U.S.C. ' 547(c)(2) as the present provisions were too uncertain. In particular, he noted that this provision spawned litigation and wasted a tremendous amount of judicial resources. He said that the CLLA recommended that this Section incorporate an objective test with a reach back period of either 90 or 120 days based on the date the goods were delivered or the services were rendered.
The second proposal discussed by Mr. Gordon concerned the release of third parties under a reorganization plan. The CLLA wanted it to be clear that parties voting on a plan would retain their guarantees and other rights against third parties. The release, he said, should not be incorporated as a plan provision, but should be accomplished by a separate explicit written document such as a ballot form. Creditors who voted on a plan, he noted, should not be forced to give up their rights against third parties unless they explicitly agreed to this treatment. To effectuate this recommendation, Mr. Gordon observed that Section 1141 should also be amended in addition to Sections 524(e) and 1123.
The third CLLA suggestion that Mr. Gordon described consisted of a proposed technical amendment to the 60-day period under 11 U.S.C. ' 365(d)(4). The recommendation would toll this period upon the filing of a motion seeking authority to assume a lease or to extend the time within which the lease must be assumed, assigned or rejected.
Judith Greenstone Miller, the third panelist, discussed seven tentative proposals emanating from the Commission's Government Working Group. She began her remarks by noting that the government creditor had "enhanced rights" and that to the extent these enhancements were procedural in nature, the CLLA would support these. On the other hand, to the extent that the enhancements were substantive and thereby provided additional rights and benefits to government creditors that extended beyond those available to non-government creditors, then the CLLA would object to such enhancements. She said that as government creditors were "large enough and sophisticated enough" and had sufficient resources to protect their interests, then they did not need such substantive enhancements.
Specifically addressing the Government Working Group's proposal to repeal Section 724(b)(2), Ms. Miller said that the CLLA favored the implementation of "less drastic means" to protect a government creditor's lien by limiting the provision's subordination provisions to administrative expense claimants. With regard to the Government Working Group's proposal to extend the "deemed filed" rule to chapter 7 cases for government creditors, she said that the CLLA would endorse extending this proposal to all creditors in chapter 7 cases. Concerning the proposal on trust fund taxes, Ms. Miller reported that the CLLA believed that Energy Resources was "good law" and that it has been consistently applied. As a result, it has maximized assets for the benefit of all creditors, she observed.
Ms. Miller then discussed the proposal that would alter the burden of persuasion under 11 U.S.C. ' 505. She said that the CLLA opposed this recommendation because the government should be on an "equal footing" with other creditors based on the fact that it can access information as easily as other creditors.
Regarding the proposal that would make the filing of tax returns and payment of administrative taxes mandatory, Ms. Miller said that the CLLA viewed this suggestion as "onerous and unreasonable" as well as costly with regard to its implementation. In addition, she noted that it could have a "chilling effect" on the reorganization process.
With regard to the proposal that would permit the setoff of tax obligations against tax refunds without requiring the taxing authority to obtain relief from the automatic stay, Ms. Miller said that this assumed the claims were accurate. She also noted that it would deprive other creditors from receiving notice of the setoff and their right to object.
The final proposal that Ms. Miller discussed pertained to the requirement that the debtor engage in good faith settlement negotiations as a condition to the imposition of contempt sanctions automatic stay violations. She said that this would foster violations of the automatic stay.
Ms. Miller concluded her remarks by noting that the CLLA would likely submit comments with regard to the 100 one-page tax proposals under consideration by the Commission.
At the conclusion of Ms. Miller's presentation, Commissioner Shepard questioned her regarding the legislative history of Section 724(b) and why there was no explanation on how ad valorem taxes became included in this provision. He expressed concern that the current provision redirected money that would have paid for health, police and fire protection, and education, to subsidize instead "the lawyers of a failed chapter 11."
Ms. Miller responded that the amount of revenue derived by the government from a bankruptcy estate was "insignificant as against the whole" and that there were better ways of policing the bankruptcy system to ensure that "dead on arrival" cases were "booted out before you have a large administrative hit." As an example, she mentioned improved case administration by courts, attorneys, and the United States Trustee Program. Disagreeing, Commissioner Shepard said that the Commission should not support any policy that "in effect would take taxpayer money and subsidize lawyers."
Commissioner Shepard then addressed Ms. Miller's comments concerning Energy Resources and observed that chapter 11 debtors were using this decision to discharge non-dischargeable taxes. Ms. Miller responded that in the majority of cases, at least two-thirds of the plan period was used to extinguish trust fund tax obligations. If the government was concerned about the risk, then it had other alternatives, she said. Ms. Miller also noted that the bankruptcy courts may be confirming plans that were not feasible.
With regard to Mr. Levin's comments concerning chapter 11 debtors who experience losses for three to four months, Commissioner Shepard asked who should sustain these losses. Mr. Levin said the creditors would. Commissioner Shepard noted that Ms. Miller would allow the taxpayers to subsidize attorneys who "drag" out cases as long as there is money to fund their fees. Mr. Levin concluded his remarks by noting that there were cases where he was not paid for his services.
PLENARY SESSION: EXECUTORY CONTRACTS
Following the CLLA presentation, the meeting continued with a plenary session on executory contracts. Chair Williamson prefaced this session by noting that the subject of executory contracts has been described as "one of the most difficult challenges" presented by the Bankruptcy Code. Professor Warren noted that this discussion was a continuation of one that began at the Commission's September meeting.
Invited participants at this session included the following: Hon. Prudence Carter Beatty, United States Bankruptcy Judge - S.D.N.Y.; Richard Broude, Mayer, Brown & Platt; George Hahn, formerly of Hahn & Hessen; Professor Alan Resnick, Hofstra University School of Law; Myer Sigal, Simpson, Thatcher & Bartlett; Professor Charles Tabb, University of Illinois College of Law; and Professor Jay Westbrook, University of Texas School of Law.
Professor Westbrook explained that the "difficulty" with Section 365 of the Bankruptcy Code was that it was very complex and that the law was in a "state of turmoil." He suggested that it may be useful to try to prioritize issues presented by this Section given its complexity.
The first issue introduced by Professor Westbrook was the notion of executoriness. He explained that this doctrine evolved in response to apparent mistakes committed by trustees and debtors in possession in the assumption and rejection process. Out of this doctrine, however, many serious problems had arisen, he noted. As an example, he cited the treatment of option contracts as non-executory contracts.
The second issue identified by Professor Westbrook concerned the use of rejection as an avoiding power. He explained that the power to reject an executory contract was simply a power to breach that contract and pay damages, not a power to rescind or avoid a previously transferred property right such as a patent license.
The third area under Section 365 that Professor Westbrook suggested should be reviewed was the issue of interim performance, that is, the period of time during which the debtor in possession or the trustee decided whether to assume or reject. He noted that during this period, the other party to the agreement must remain ready to perform, but may not be fully compensated for the losses it incurred over the course of this period.
Professor Westbrook observed that if the executoriness aspect of contracts treated under Section 365 was abolished and if rejection was eliminated as an avoiding power, then this would, in turn, eliminate many of the special exceptions under this Section. As the subject of contracts in bankruptcy was "so enormously important economically and in such serious disarray in the statute and the court," he recommended that there be "some serious level of reform" to this provision.
At the conclusion of his opening remarks, Professor Westbrook then reviewed specific aspects of his recommendations. For example, the terms "assumption" and "rejection," he said, should be replaced with "election to perform" and "election to breach." In addition, he suggested that the term "pre-bankruptcy contract" replace "executory contract." Further, there would be an express provision in the statute to eliminate the concept of executoriness as a threshold requirement.
Judge Beatty observed that under Section 70 of the former Bankruptcy Act of 1898, the definition of property of the estate included "assumption" and "rejection." She noted that the problem presented by this provision occurred principally in business cases and that very different issues were presented by consumer cases. For instance, she said that a trustee never assumed a residential lease, unless it had value for an estate such as a cooperative or condominium lease. She said that the decision to perform should be based on whether the contract had value and not on whether it is executory.
Noting that he agreed with her last comment, Professor Westbrook explained that part of the problem was that a contract was both an asset and a liability. Judge Beatty said that judges had very differing views about contracts. She also noted that the definition of property of the estate under Section 70 of the former Bankruptcy Act included contract actions.
Messrs. Broude and Hahn agreed with Professor Westbrook's suggestion regarding the elimination of executoriness. Mr. Hahn asked whether matters that were essentially payables and receivables should be included under Section 365. Professor Westbrook responded that there was no reason to "lop those things off."
Saying that he "cautiously" agreed with Professor Westbrook, Professor Resnick said that it was extremely difficult to foresee how it would work and the scope of its impact. For example, he noted that the elimination of executoriness from Section 365 would increase its scope "tremendously" and now include for the first time accounts payable, accounts receivable, and warranty claims that arise from the prepetition sale of goods. He also expressed concern about whether this would change the dynamics and bargaining power factors or alter the policy of equality of treatment for creditors through the assumption process. Concerning warranties, Professor Resnick posed the hypothetical where the debtor-manufacturer in the plan assumed certain contracts and two years thereafter the product explodes. He asked whether the debtor would have to pay that claim in full. The answer, he noted, might be for the debtor to reject all possible breach of warranty claims and all prepetition contracts. He also asked whether the debtor would actually have to make a motion before the court to assume account receivables.
Professor Tabb had similar substantive concerns regarding the ability to assume a contract where the non-debtor party has already fully performed and the administrative burden of having to either assume or reject all contracts. He agreed, however, that the executoriness requirement had caused "much more grief than it has caused good." He suggested that there should be some type of presumptive default rule that would permit certain types of pre-bankruptcy contracts to be automatically rejected such as where the non-debtor party has fully performed.
Mr. Broude, noting that he did not share Professor Resnick's concerns, said that the good that would derive from eliminating the executoriness requirement would outweigh the administrative burdens. He said that there were many different ways that problems and exceptions can arise.
Acknowledging Professor Tabb's suggestion that a default rule may be a good idea, Professor Westbrook observed that the choice was not between "no difficulties and new difficulties," but between enormous difficulties and fewer difficulties.
Citing the district court's decision in Lubrizol, Judge Beatty suggested that the problems under Section 365 could be resolved by amending the definition of property of the estate under Section 541. She explained that bankruptcy judges "get sort of off the mark" because they did not merge the contract and property concepts back together again.
Then Professor Westbrook addressed Professor Resnick's concerns regarding prepetition warranties. Ordinarily, he observed, these are "dead weight obligations" that the debtor in possession did not want to assume. Under current law, this type of obligation would not be deemed an executory contract and thus it cannot be assumed. Judge Beatty stated that a debtor should be able to assume any contract whether or not it was executory. Mr. Broude observed that some courts hold that a warranty claim constituted an executory contract based on the condition that the claimant must somehow notify the manufacturer of the warranty breach. Professor Westbrook agreed and noted that these courts "make up something in order to make it work."
Professor Resnick asked why warranty claims could not be treated as a separate class in a plan of reorganization instead of under the assumption and rejection provisions of Section 365. Mr. Broude responded by noting that assumption is a method of disenfranchisement and that it would be very difficult to identify the members of any such class of warranty claimants. Professor Resnick said that where such claims were unimpaired the plan would so provide.
Mr. Sigal said that Professor Westbrook's analysis was "very good and very flexible," given the likelihood that bankruptcies over the next 20 years would be "heavily laden" with contracts as their main assets. He also characterized the recommended change of terminology as "good." Mr. Sigal then described a situation where there was a debtor-guarantor that was the holding company of a non-debtor operating company to illustrate the need for flexibility. Under Professor Westbrook's concept, the debtor would have the option, but would not be required to perform.
In response to Commissioner Jones' question as to whether his proposal would alter the rights that the parties would have under state law, Professor Westbrook said that the thrust of the proposal would be to return the parties back to where they were under state law, subject to the fact that the damages would be paid in "little tiny bankruptcy dollars" and that ordinarily specific performance was not available against the trustee. Mr. Sigal added that there were three parts to this system: an election to perform, an election to breach, and an election to modify with court approval. Professor Westbrook clarified that his proposal with regard to the first two parts was very much oriented to applying state law.
Observing that rejection was fundamentally a bankruptcy right that may not exist under state law, Judge Beatty questioned whether it would be better to adopt a more sensible result as a matter of federal law, rather than state law. Otherwise, she said that there will be bankruptcy judges from fifty different states who would have to see "what the handwriting on the wall is in their state." Professor Westbrook responded that these matters had to operate on the basis of state law with only those modifications that were appropriate for a financially distressed or liquidating debtor. Judge Beatty said that a federal system would prevent the states from defeating the effect of bankruptcy law.
While not agreeing that rejection was a bankruptcy-specific remedy, Mr. Broude asked Professor Westbrook whether the property rights referred to in his proposal were state-defined or based on some overriding federal definition of property rights. Professor Westbrook observed that under the Bankruptcy Code there was always the problem of whether or not property was defined exclusively under state law or pursuant to some federal concept. This issue was, he said, under the second prong to his proposal, namely, that Section 365 cannot be used to avoid a property interest that existed under non-bankruptcy laws. He thought that non-bankruptcy laws to a "large extent" should define property rights.
Speaking on behalf of the National Bankruptcy Conference, Mr. Hahn said that the Conference agreed with this aspect of Professor Westbrook's proposal, that is, rejection should not be viewed as an avoiding power. Nevertheless, he noted there were several concerns about this result. Commissioner Jones asked why state law consequences should not be preserved in bankruptcy. With regard to specific performance, Professor Warren explained that this would permit one party to obtain all the value and leave nothing or nominal value for the other parties. Professor Resnick added that specific performance had expanded as a remedy that went beyond just having a property interest in particular property. Mr. Hahn explained that the Conference resolved this issue by not deeming specific performance to be a property interest. Professor Warren recharacterized this statement to mean that whether or not a party is entitled to specific performance would be a bankruptcy question, not a state law question.
Mr. Broude said that he would like to consider "more deeply" the choice between federal and state law and the best interest of the estate together with constitutional principles presented by executory contracts. Professor Westbrook noted that the issue was whether or not specific performance under certain circumstances should be recognized under the bankruptcy laws.
Mr. Hahn questioned whether the adoption of the first two prongs of Professor Westbrook's proposal would eliminate the special interest provisions under Section 365. Some of these provisions, he observed, dealt with specific problems that general concepts do not address such as the ability to offset damages for rejection breaches. Judge Beatty agreed with Mr. Hahn that some of these exceptions were necessary.
To set up the issues presented by the third prong of Professor Westbrook's proposal, Mr. Sigal described a hypothetical where a bank financed a manufacturer's acquisition of goods in exchange for an assignment of the contract. Thereafter, the manufacturer filed for bankruptcy relief. He then questioned whether this aspect of the proposal was really an election to perform and an election to breach system with two options or whether it was an election to modify a system that would clearly change state law.
With regard to present law, Professor Westbrook observed that the bankruptcy courts have frequently found ways to give landlords and others in executory contract situations only use and benefit results. Instead, he proposed that these parties should receive the contract rate or reasonable compensation as it may be difficult to determine the contract rate.
Judge Beatty disagreed with Professor Westbrook's statement regarding the bankruptcy courts' decisions on this matter. She said that generally there was not much of a problem with non-real estate contracts.
Referring to Commissioner Jones' concerns regarding policy implications, Mr. Sigal asked whether the Commission wanted to recommend a system mandating that state law controlled and prohibited the modification of a contract absent commercial and reasonableness standards under the Uniform Commercial Code. On the other hand, he asked whether the Commission wanted to recognize an overriding federal policy that would permit some bending of contract rights to promote reorganization.
Mr. Broude commented that the purpose of postponing the election to perform was not to permit the debtor to play the market, but to determine if the case would be successful. He then discussed a hypothetical where the non-debtor had an obligation to manufacture a special purpose piece of equipment for the debtor that would have taken four years to build, but the debtor filed for bankruptcy relief two years after the agreement was made. He suggested that the non-debtor party was entitled to some adequate protection.
Professor Westbrook noted that as it appeared that everyone agreed that there was no problem with regard to the protection of the non-debtor party during this interim period, an empirical question was presented. He said that if he could be persuaded that the current law was ideal, then there would be no reason to change it and, thus, he would withdraw the third component of his proposal. On the other hand, he noted that he had heard an "enormous amount of complaint" that the courts were not compensating the non-debtor party during this period. He said that the third prong of his proposal was concerned about fairness to the non-debtor party.
Commissioner Jones observed that there had been letters written to the Commission expressing concern about non-debtor parties being held in abeyance without knowing whether or not they have an administrative claim and whether the debtor will have the money to pay the administrative claim. Mr. Broude said that the debtor's ability to pay at the end of a case presented a different issue.
Professor Warren asked the panelists to address certain other aspects of this proposal, including its provisions for establishing a standard by which the non-debtor would be paid and providing tools to enforce this right. She then asked them to respond as to whether this presented a problem that had to be solved. Judge Beatty said that the answer depended on what bankruptcy judges did. While some "put blinders on" and characterized it as an issue under Section 365, others characterized it as an issue under Section 362, she commented.
Professor Resnick observed that two problems were presented by this Section. The first was the problem of delay. The vehicle available to the non-debtor party seeking to address this problem was to ask the court under Federal Rule of Bankruptcy Procedure 6006 to set a deadline for assuming or rejecting. The other problem was how the non-debtor party who fully performed should be compensated, that is, by immediate full compensation or as an administrative expense.
Professor Tabb asked whether or not there should be a prerequisite to having administrative expense treatment, such as the requirement to demonstrate that there was a benefit to the estate. Alternatively, he asked whether there should be a presumptive rule as in Section 365(d)(3).
Responding to Professor Warren's comment regarding the protections currently available to non-debtor parties, Professor Westbrook said that these remedies were very limited. He recommended that they should be more flexible and provide for reasonable compensation during the interim. Mr. Sigal observed that Professor Westbrook's concept was "very good" for two reasons. First, it was more flexible. Second, it was more promotive of a reorganization. The real issue, he said, was the quantum of fair protection.
While saying that he "kind of love[d]" the first two prongs of Professor Westbrook's proposal, Mr. Broude did not favor the last prong at all and agreed with Professor Resnick that the present law adequately protected the non-debtor party. Commissioner Jones suggested that a presumption could be created that if the debtor had an option to assume or reject, then the other party to the contract should be entitled to be paid at the contract rate.
Upon the conclusion of this colloquy, the session on Section 365 ended.
STATUS REPORT ON TRANSNATIONAL INSOLVENCY
Professor Westbrook, United States Reporter for the American Law Institute Project, said that the Project was ongoing, but that the more immediate concern was the UNCITRAL Project. After providing an update on UNCITRAL, he projected that a draft model law would be available in a "couple of weeks" and that final approval of the text was expected by May.
STATUS REPORT ON FUTURE CLAIMS
Professor Warren reviewed the Commission's progress with regard to future claims and recounted that the concept under consideration would treat future claims as a subset of claims. It would define a future claim as one based on prepetition acts and that these acts would be sufficient to establish liability. She noted that the Working Group had focused on such factors as the amount and kind of restrictions that should apply so that it did not become a "monster" within the system that "gobbles up unknown and unexpected events." Factors under consideration in this regard included the ability to identify claims with reasonable certainty and to estimate them. Other aspects include issues pertaining to materiality, opt out provisions, and a future claims representative.
With regard to the concept of a future claims representative, Professor Warren said that the Working Group was examining the appropriate standard that should apply to this professional. The Working Group also was considering the concept of a channeling injunction as a means to deal with future claims.
Commissioner Shepard said that he would "absolutely insist" that the concerns expressed by Francis Allegra of the Department of Justice be addressed with regard to discharging the liability of manufacturers. Professor Warren responded that the concept under consideration would not permit a debtor in possession to continue to pollute postpetition.
After reviewing the meeting agenda for the following day, Chair Williamson recessed the meeting.
MEETING - FRIDAY, FEBRUARY 21, 1997
United States Senate Dirksen Office Building
Chair Williamson reviewed the day's meeting agenda and made several administrative announcements. These included the announcement that the Commission would be holding a regional meeting in Des Moines on April 1 that would focus on chapter 12, consumer bankruptcy and small business bankruptcy issues. Upon the conclusion of his introductory remarks, the next session commenced.
CONSUMER DEBTOR REPRESENTATIVES PANEL
Norma Hammes, President of the National Association of Consumer Bankruptcy Attorneys ("NACBA"), began her comments by noting that NACBA had closely followed the Commission's work and that it had submitted a "modest" list of proposals that would improve the bankruptcy system.
Ms. Hammes then observed that the Commission appeared to be more concerned with creditor-driven proposals such as limiting repeat filings, state exemptions, the dischargeability of taxes, and other procedural matters. On the other hand, she complimented the Commission for attempting to obtain "some excellent" statistical information regarding the cause of the current magnitude of consumer bankruptcy filings. She cited, for example, the unrebutted data supplied by the Congressional Budget Office and Professor Lawrence Ausubel that clearly proved that the high filing rate was directly related to improvident, but highly lucrative lending practices by the consumer credit industry. She was also encouraged by the Consumer Bankruptcy Working Group's discussion of the prior day on how some creditors abuse the bankruptcy system by improperly obtaining and enforcing invalid reaffirmation agreements, and by filing baseless nondischargeability actions to obtain a default judgment or coerce nuisance settlements.
While acknowledging that there were some instances where debtors abused the system, Ms. Hammes said that the "vast majority" of consumer debtors were "conscientious, hard working, honest Americans." She noted that NACBA would help formulate "precise corrections" to address these abuses, without imposing additional burdens on honest debtors. In addition, NACBA believed that the bankruptcy system would be greatly improved if the benefits available to chapter 13 debtors were enhanced, she reported. Under the present law, there were significant disincentives to debtors to file for relief under chapter 13. Ms. Hammes cited, for example, the federal law that permits credit agencies to report both chapter 7 and chapter 13 cases for ten years. In addition, she cited the erosion of the chapter 13 super discharge, particularly with regard to student loans. Under current law, chapter 13 debtors emerged from bankruptcy "still saddled with unmanageable student loans" and they had no greater ability to repay because significant debts were not discharged.
Creditors also benefitted from chapter 13, Ms. Hammes stated. She noted that creditors agreed that the dividends paid under chapter 13 "can be substantial." In addition, she said that the government also benefitted from chapter 13 as these debtors paid their most recent three years of taxes in full and returned to the "tax paying system." As a result, "[h]undreds of millions of dollars are paid to the IRS and state taxing agencies."
Ms. Hammes said that NACBA, in prior correspondence to the Commission, had suggested many other ways of improving chapter 13. These recommendations included giving chapter 13 debtors the right to separately classify and pay in full nondischargeable debts, the elimination of any requirement that debtors make a minimum payment to unsecured creditors to satisfy the good faith requirement, to permit the discharge of otherwise nondischargeable debts if paid over a period of time in excess of three years, to treat rent-to-own contracts as installment purchase agreements, and to provide for a default discharge where the debtor met the best interest of creditors test, unless a creditor sought dismissal or conversion of the case to one under chapter 7.
Gary Klein, the next presenter, appeared on behalf of the National Consumer Law Center, a nonprofit advocate for low and moderate income consumers. He began his remarks by noting that he was heartened by the recognition of creditors, as noted during sessions before the Commission and the American Bankruptcy Institute, that the majority of debtors were "people who simply can't make ends meet and need a fresh start."
The "central challenge" for the Commission, he said, would be to preserve and perhaps enhance the core of the bankruptcy system for honest debtors. To achieve this goal, Mr. Klein recommended that the Commission measure any reform by two tests. First, will the reform undermine the effectiveness of the system for debtors experiencing "real financial problems?" Second, will the reform increase the cost of the bankruptcy system for people who cannot afford it? Three types of costs that he cited were user fees, such as case filing fees; administrative costs, that would be passed on to all debtors in the bankruptcy system; and legal fees, resulting from the increased need for debtors to litigate. In particular, he cited 11 U.S.C. ' 523(a)(2)(A), which was being used for leverage by creditors as low and moderate income debtors could not afford to pay for legal representation.
Two other areas required reform, according to Mr. Klein. First, he recommended that further erosion of the debtor's fresh start be stemmed. Second, he asked that the success rate of chapter 13 cases be enhanced. With regard to the first area, he said that exceptions to discharge should be limited and that the current exceptions should be reviewed to make sure that they were necessary. He also suggested that the Commission search for ways to control reaffirmation abuses. The best way to effectuate this reform, he noted, would be to eliminate reaffirmations entirely. If they were to be allowed, however, he suggested that they be limited to a narrow class of instances where debtors received some benefit for reaffirming these debts.
Other areas of reform discussed by Mr. Klein included the following. He recommended that ways to enhance the discharge injunction and to prevent discrimination against debtors who file for bankruptcy be explored such as through the establishment of statutory damages and/or the award of attorney fees for lawyers who handle discharge injunction violations. To protect the debtor's fresh start, Mr. Klein asked that the Commission examine methods to bring "baseless credit card dischargeability actions under control."
With regard to chapter 13, Mr. Klein said that the Commission should address how the success rate of chapter 13 cases could be improved. Among the possible solutions that he suggested was ensuring that a trustee's compensation was no greater than the amount necessary to administer the trustee's office. He recommended that strip down of all non-purchase money security interests be permitted. In addition, there should be a provision in the Bankruptcy Code that would encourage consensual loan modifications. He concluded his opening remarks by recommending that bankruptcy policy ought to bring high rate lending under control because it would generate more defaults and, therefore, more failures and a greater need for bankruptcy.
Chair Williamson asked the panelists whether they agreed or disagreed that there should be ways to encourage debtors to file for relief under chapter 13 as opposed to chapter 7 as a matter of public policy. Ms. Hammes responded "[a]bsolutely" and explained that this was one of NACBA's major goals. She noted that debtors would choose chapter 13 if there was "some reason for them to take that option." Mr. Klein said that the key word was "encourage" as problems would arise if debtors were forced to file under chapter 13. A forced system would create a "new federal collection agency forcing people to pay debts."
Turning to the Commission's tentative proposal on uniform federal exemptions, Chair Williamson asked the panelists for their comments. Ms. Hammes observed that "politically it's a touchy issue," but noted that it was important to have a reasonable minimum amount of personal property and homestead exemption provisions. She agreed that a floor with regard to state exemptions would be "very advantageous to the system." Mr. Klein stated that he was in favor of the "floors and ceilings approach."
Commissioner Jones observed that there was a lack of correlation between the level of exemptions and the number of bankruptcy filings. Ms. Hammes responded that there was a correlation between the type of exemptions available and the type of bankruptcy relief that the debtor needed. Noting her disagreement with this statement, Commissioner Jones cited Texas as a state with an unlimited homestead exemption, which should encourage debtors to file for chapter 7 relief, but that it, in fact, did not. Professor Warren agreed that statistically one could not demonstrate a correlation either between the filing rate and available exemptions or between the choice of chapter and exemptions. Mr. Klein observed that while the correlation may not be apparent in the filing rates, it may be present in the outcomes of these bankruptcy cases. Professor Warren responded that if debtors lost property, then it "certainly" would relate to the effectiveness of their fresh start.
Citing Ms. Hammes' comments regarding student loans, Commissioner Hartley asked her to address the issue of whether debtors should be held responsible for voluntarily entering into agreements. Objecting to the implication that her clients were not responsible, Ms. Hammes said that, on the contrary, they were "very responsible" and often struggled with their debts for a considerable period of time before seeking relief. Mr. Klein noted that part of the response to Commissioner Hartley's question involved consideration of the financial condition of the debtors in the bankruptcy system. It was "almost always clear," he said, that these debtors had very significant financial problems and lacked the ability to repay their debts outside of bankruptcy.
Commissioner Hartley then asked the panelists to define serial filings. Mr. Klein said that there had yet to be a demonstration that serial filings represented a significant portion of all bankruptcy filings. Asking Mr. Klein to "[f]orget the word significant," Commissioner Hartley said that there was a problem. Ms. Hammes disagreed. Commissioner Shepard cited studies in Oregon demonstrating that there was a "significant problem" with serial filings. Mr. Klein responded that solutions to the problem of abusive filings already existed under the Bankruptcy Code. Commissioner Shepard said that these solutions had not worked. Disagreeing, Mr. Klein said that debtors were constantly "being tossed out of the system" based on lack of good faith, substantial abuse, relief from the automatic stay, involuntary dismissal, denial of discharge, and the imposition of Rule 11 and criminal sanctions. Noting his agreement with Mr. Klein, Commissioner Ginsberg said that serial filings were a problem, but not a serious problem in most of the country.
Mr. Klein suggested that the Commission find some narrowly tailored solutions. He noted, for example, chapter 13 for some debtors did not work initially, but that subsequently these debtors experienced changed circumstances and needed to refile for chapter 13 relief. Commissioner Jones queried why this could not be addressed by modifying the chapter 13 plan. Mr. Klein answered that this solution would not be sufficient if the debtor had a significant financial problem. Commissioner Jones asked whether this reflected "a lot of real bad planning" in the drafting of the chapter 13 budget. Mr. Klein responded that "for the most part these are unexpected life events." Ms. Hammes agreed and noted that these events included illnesses or periods of unemployment. In addition, she noted that many of these debtors were marginal in many respects. Commissioner Jones commented that "[b]asically society ought to pay for people who are too dumb to manage their affairs over and over and over again." Ms. Hammes said it was not a "matter of dumbness" and that most creditors would agree that the serial filing problem was "fairly small." Commissioner Jones noted that some trustees have said that up to 20 percent of their chapter 13 caseloads consisted of refiled cases. Ms. Hammes disagreed with that number. Mr. Klein said he had numerous clients whose cases were successful on the "second try."
Chair Williamson brought the discussion to a close by asking the panelists to identify the one aspect of the current bankruptcy system they would change. Ms. Hammes recommended that the incentives for chapter 13 should be increased. Mr. Klein said that the effectiveness of the fresh start should be preserved and enhanced. Thereupon the meeting recessed to allow the chapter 11, Government and Jurisdiction and Procedure Working Groups to meet.
PLENARY SESSION: DECISIONS ON PENDING PROPOSALS AND RELATED MATTERS
CONSUMER BANKRUPTCY WORKING GROUP PROPOSAL NUMBER 1- UNIFORM FEDERAL EXEMPTIONS
Noting that this proposal was "still a work in progress," Professor Warren explained that the 1973 Commission had recommended that there be uniform federal exemptions, but this recommendation was not adopted at the last minute as part of the Bankruptcy Reform Act of 1978. She noted that exemptions presented the "single biggest source of non-uniformity" in consumer bankruptcy around the country. She then acknowledged that the Working Group's deliberations benefitted from the views of Professor Lawrence Ponoroff of Tulane University and Judge William Brown.
Professor Warren then explained that the proposal would set a floor of $40,000 and a cap of $100,000 for a homestead exemption. It would be left to the states to determine, however, what constituted a homestead. In addition, she observed that the proposed exemption scheme would be available on a household basis and did not "double up" for married debtors.
As for medical devices and health aids, an unlimited exemption would be available under the proposal. For retirement plans, the current exception for ERISA-qualified plans from the definition of property of the estate would be retained and certain plans that did not qualify would be exempt under this proposal. Rather than placing a dollar cap on this exemption, the intent, she explained, would be to examine contributions within a period preceding the bankruptcy filing to prevent a debtor from "parking a great deal of money in something denominated a retirement plan." Professor Warren noted that a debtor under this proposal would be able to retain up to $25,000 in value in any form. In addition, there would be inflation adjustments, but no opt out provisions. After explaining the general contours of the proposal, she noted that it may require some adjustment for involuntary petitions.
Upon the conclusion of Professor Warren's overview of Consumer Bankruptcy Working Group No. 1 - Uniform Federal Exemptions, Commissioner Jones expressed interest in hearing from the bankruptcy community. Chair Williamson noted that the proposal was very specific and that it involved an important policy matter.
Commissioner Hartley observed that the dollar amount of the homestead exemption would be a "lightning rod." Chair Williamson noted that the current homestead exemption scheme ranged from a low of zero to a high of limitless.
Commissioner Shepard said that there were several aspects of the proposal that concerned him a "great deal." First, he was concerned about a dollar cap, particularly as applied to farmers. Second, he said that the proposal as it applied to medical devices was "meaningless" as he was not aware of any practices by creditors to levy on "pacemakers and heart lung machines." Third, he cited the proposal's treatment of retirement plans and that it would enable debtors to protect "substantial amounts of money" from their creditors. Fourth, he was concerned about eve of bankruptcy asset planning.
With regard to Commissioner Shepard's fourth point, Commissioner Jones explained that the proposal was intended to prevent these practices. Professor Warren agreed. Nevertheless, Commissioner Shepard explained that the $25,000 limit was "meaningless" for farmers and otherwise failed to take account of geographic differences.
Regarding Commissioner Shepard's concerns as to the proposal's retirement plan provisions, Commissioner Ceccotti responded that the proposal would protect those retirement plans that have tax code or ERISA limitations. On the other hand, she suggested that the Working Group review the proposal with regard to his concerns pertaining to farmers. Professor Warren concurred that different people plan for retirement in different ways.
Commissioner Alix asked Professor Warren to explicate the ramifications of involuntary bankruptcy under the proposal. In particular, he expressed concern whether it would "spawn a state level bankruptcy system." Professor Warren explained that the "key" aspect of a bankruptcy system is the discharge of debt and refinancing of secured obligations.
Then Commissioner Gose asked whether the proposal had any provision for tools of the trade. Professor Warren said that there was no separate category for this type of exemption, although under current law the exemption was $1,500. Commissioner Shepard was concerned how this would apply to farm debtors. Commissioner Alix observed that an exemption for tools of the trade presented a "slippery slope" as applied to farmers.
Commissioner Butler recalled that while federal exemptions were considered in connection with the 1978 legislation, the opt out provisions prevailed. He said that local representatives, particularly members of the House of Representatives, were not satisfied with the uniformity aspect of federal exemptions. He noted that the homestead exemption amount as set forth in the proposal may be too high, especially when combined with the $25,000 "wild card" exemption. He was not sure how the proposal would apply to tenancies by the entireties. In southern California, Commissioner Shepard said that $125,000 would not purchase a "shack."
In closing the discussion on this proposal, Chair Williamson said that the "single most important factor" in this proposal was the integrity of the federal bankruptcy system and the appearance of fairness.
JURISDICTION & PROCEDURE WORKING GROUP PROPOSAL NUMBER 11- ARTICLE III TRANSITION
Professor King prefaced his comments on this proposal by noting the contributions of Judge Conrad Cyr of the 1st Circuit Court of Appeals, U.S. Bankruptcy Judge Robert Martin, U.S. Bankruptcy Judge Mary Davies Scott, and former U.S. Bankruptcy Judge Ralph Mabey.
The proposal, Professor King noted, addressed two issues: personnel and the jurisdictional and procedural requirements of title 28 of the United States Code. Beginning with the issue of personnel, the proposal would permit sitting Article I bankruptcy judges to finish the remainder of their 14-year terms. On the basis of attrition, Article III judges would be appointed. The appointments would be made by the President with the advice and consent of the Senate. The proposal would not affect the present retirement provisions for those bankruptcy judges who complete a 14-year term.
With regard to the jurisdictional and procedural aspects of the proposal, Professor King explained that the constitutional problems that presently existed would not be affected by it and that, for example, the dichotomy between core and non-core proceedings would remain in effect. As Article III bankruptcy judges were appointed in the districts, they would, in effect, displace the need for district court review.
Upon the conclusion of Professor King's explication of the proposal, the Commissioners expressed their observations. While noting that she had not changed her view on the issue of whether bankruptcy judges should be accorded Article III status, Commissioner Jones said that the proposal was "reasonable." Commissioner Butler said that he was "comfortable" with the proposal. Commissioner Hartley, agreeing with Commissioner Jones, said that the proposal was reasonable. Commissioner Alix observed that the proposal was very "pragmatic."
JURISDICTION & PROCEDURE WORKING GROUP PROPOSAL NUMBER 10 - AFFILIATE VENUE
Professor King explained that this proposal pertained to the affiliate venue provisions of 28 U.S.C. ' 1408(2). Citing the Eastern Airlines case as an example, he noted that Working Group deemed the practice to be "unseemly," but also recognized that there should be some flexibility.
The proposal, according to Professor King, would permit affiliated companies to follow a parent company into a particular venue. On the other hand, the proposal would not permit an affiliate to file in the district of another affiliate, if there was no independent basis for the subsidiary to file in that district. The bankruptcy court would retain the authority to transfer venue for those situations where it would serve the interest of justice and the parties' convenience.
The Commissioners then voiced their comments. Commissioner Jones said that the proposal was a "good idea." Expressing support for the proposal, Commissioner Hartley noted that it brought closure to an important issue.
SMALL BUSINESS, PARTNERSHIPS AND SINGLE ASSET REAL ESTATE WORKING GROUP PROPOSAL NUMBER 1 - SMALL BUSINESS PROPOSAL
Stephen Case introduced the next proposal, which he explained was embodied in a memorandum dated February 14 and a supplemental one dated February 20. He then reviewed the "four pillars" supporting this proposal.
First, he cited the high degree of "creditor apathy" in smaller chapter 11 cases. Second, chapter 11 was generally not "terribly successful" based on the confirmation rate of these cases although there were certain districts such as the Eastern District of North Carolina where the confirmation rate was 62.9 percent. He also cited a study by Deputy Counsel Susan Jensen-Conklin that found that chapter 11 debtors had only a 6.5 percent chance of consummating and reorganizing. Third, he said that there was data indicating that nearly two-thirds of chapter 11 confirmations did not occur until two years following the date of filing. Fourth, there was "some measure of abuse" by unsupervised small chapter 11 debtors, he said.
The proposal, Mr. Case explained, would define small business debtors and put them on a special track. In addition, the proposal would require uniform financial reporting rules and enlarge the grounds for conversion and dismissal under 11 U.S.C. ' 1112. Further, the proposal would expand the responsibilities of the United States Trustee and Bankruptcy Administrators with regard to the monitoring of these cases. Other technical aspects of the proposal would require shorter time frames for the filing of schedules and impose the requirement that the debtor in possession maintain segregated bank accounts for withholding deposits and sales taxes collected.
Time frames under the proposal would require the filing of a reorganization plan within 90 days of the filing, followed by confirmation to be effected within 120 days from the petition date. The debtor's "safety valve" under the proposal would be in the form of an extension hearing initiated by the debtor who, in turn, would have the burden of proof to show by a preponderance of the evidence that it would likely confirm a plan within a reasonable time.
Under the proposal, Mr. Case added, the automatic stay would not be automatically reimposed in subsequently refiled chapter 11 cases. Rather, these debtors would have to seek court authorization. With regard to the proposal's definition of "small business," Mr. Case explained that various choices were considered and the current version of the proposal relied on a gross revenue test.
Upon the conclusion of Mr. Case's explication of the proposal, Commissioner Hartley commented that it provided a "reasonable approach" to a recognized problem. Commissioner Gose agreed. Commissioner Shepard acknowledged that the primary focus of the proposal was to rid the bankruptcy system of "dead on arrival" cases.
Chair Williamson noted that the Commission had the invaluable assistance of a very wide cross section of practitioners, judges, United States Trustees, private trustees and others involved in the chapter 11 process. In particular, he cited the contribution of United States Bankruptcy Judge Thomas Carlson. He then suggested that the Commissioners first address their comments to discussing the positive aspects of the proposal.
Commissioner Jones said that she enthusiastically supported 90 percent of this proposal. Commissioner Ceccotti noted that she endorsed the proposal's premise that the rules and procedures facilitating large business reorganizations may not work as well for small business cases. She also supported that aspect of the proposal that would reduce unnecessary delays and the attendant expense. Further, she favored those provisions of the proposal that left the details of oversight to the existing administrative and judicial structures rather than assigning them to third parties. In addition, Commissioner Ceccotti supported the simplification of the disclosure statement process and encouraged the Working Group to identify additional efficiencies that would streamline the process and reduce its cost. Commissioners Butler and Ginsberg concurred with Commissioner Ceccotti's comments. Commissioner Alix agreed that many have cited the prevalence of languishing small business cases and the need to address this problem.
As to the negative aspects of the proposal, Commissioner Ceccotti said that the $10 million definitional limit was "too big." She suggested that the test should be one that was easily susceptible of application. In addition, she cited the comments of United States Bankruptcy Judge Lisa Hill Fenning that questioned the apparent rigidity of the proposal's deadlines as well as the observations of other bankruptcy judges. Commissioner Ceccotti said that much of the proposal's provisions were already codified in the Bankruptcy Code. On the other hand, she supported those provisions that would institute additional guidelines under 11 U.S.C. ' 1112.
Among the other concerns that Commissioner Ceccotti discussed was whether a "double standard" was being created for business cases with regard to the proposal's financial reporting requirements. She suggested that the Working Group review Federal Rule of Bankruptcy Procedure 2015. She expressed concern that these requirements would overly burden a small business debtor. She concluded her comments by questioning some of the proposal's phraseology and how a bankruptcy judge would apply its standards.
Commissioner Alix said that he favored the gross revenue concept but suggested that it be defined under GAAP, rather than under the Internal Revenue Code. As to the $10 million cap, he suggested that the Working Group utilize the services of the United States Trustee Offices or the Administrative Office of the United States Courts to obtain some data to support a Pareto analysis. Once this figure is determined, he advised that it should be indexed to an inflation rate.
Thereafter, Commissioner Alix questioned the proposal's provisions regarding debtors who are more than 30 days delinquent on filing any federal annual income tax return. He described this provision as "overreaching, overbearing, and unacceptable."
As to that aspect of the proposal requiring the promulgation of uniform national reporting guidelines for small business debtors, Commissioner Alix observed that as troubled companies had bad books and records, this requirement was unreasonable. Turning to the proposal's provisions with regard to the failure to pay administrative claims, he had a "real problem" with this as often these only consisted of professional fees. Under current law, he observed, the failure to pay administrative expenses already constituted cause for relief. He also expressed concern about rigid filing dates.
Agreeing that there may be some questions about the wording of this aspect of the proposal, Commissioner Jones noted, however, that in practice the United States Trustee would not seek relief immediately because a debtor missed a deadline as there would be some prosecutorial discretion. Nevertheless, the proposal addressed those cases where the principal reaped the benefits of the business to the detriment of the creditors, she said. Noting that he agreed in principal with Commissioner Jones, Commissioner Alix said that his concern was about balance, that is, dealing with the four factors identified by Mr. Case against the individual rights of debtors especially given the environment from which they emanated.
In addition, Commissioner Alix questioned who should appear on behalf of the debtor at the various mandatory hearings and interviews fixed by the proposal. Commissioner Ginsberg, in response to this comment, cited Federal Rule of Bankruptcy Procedure 9015, which permits the court to designate a person who must act on behalf of the debtor. Commissioner Alix noted that one could not assume that this person would be the owner, as owners did not always run businesses. Commissioner Ginsberg said that the debtor could be required to identify this party in the petition. Commissioner Alix concurred with this suggestion.
As to that aspect of the proposal requiring initial interviews with the debtor's "controlling owners and top operating managers," Commissioner Alix expressed similar concerns. He said that the proposal, in this respect, went "a little too far." He also questioned whether anyone could ascertain the accuracy of a debtor's books and records. For example, if the debtor supplied copies of its tax returns, how would one determine whether they complied with the law, absent an audit, he asked. And, if the debtor was not in compliance under the proposal, he queried what would be the next step.
Mr. Case responded that after the United States Trustee or Bankruptcy Administrator moved for relief, the debtor would then be able to establish whether there was a good reason excusing its noncompliance. Commissioner Alix said this was why the debtor should have the initial burden of establishing compliance. Nevertheless, he observed that there was a theme throughout the proposal of placing burdens on debtors that no one can monitor.
After the lunch recess, Commissioner Alix continued his critique of the Small Business Proposal. He suggested that rather than having the United States Trustee make the assessment, the responsible party for the debtor should be required to sign a statement that verifies that the debtor's books and records are being properly maintained and in compliance with United States Trustee Guidelines.
Observing that this alternative was considered by the Working Group, Commissioner Hartley said that he was concerned about whether it would accomplish anything. The current form of the proposal was drafted in response to an idea originally premised on the concept of an independent examiner or monitoring agent. Commissioner Alix said that the goal can be met if a debtor complies with the United States Trustee Guidelines without having someone come in to make a separate assessment. As no one can tell if a debtor is in compliance with the tax laws, then it became a "losing job," he observed.
While noting that some of the proposal's language may require some "tweaking" in this regard, Commissioner Shepard explained that the goal of the proposal was to establish "marching orders" for small business debtors and to provide the tools for the United States Trustee to accomplish their work.
Again, Commissioner Alix recommended that the burden should be placed on the debtor's responsible party to supply copies of filed tax returns to the United States Trustee. Saying that this was a "very legitimate point," Commissioner Hartley suggested that this aspect of the proposal be reviewed further.
Addressing the proposal's provisions regarding the use of "reasonable discretion" by the United States Trustee or Bankruptcy Administrator, Commissioner Alix expressed concern that this should instead be the responsibility of the bankruptcy judge. Mr. Case said that the February 20 memorandum recognized this concern. Commissioner Hartley also explained that the court would still in the end decide the issue. Commissioner Alix suggested that the language be refined so that it did not appear that the bankruptcy judge was being instructed to follow whatever the United States Trustee or Bankruptcy Administrator recommended.
The next provision of the proposal that Commissioner Alix addressed concerned the requirement to deposit taxes withheld or collected by the debtor. Commissioner Shepard said that there had been "considerable testimony" that debtors use these funds to survive even though these funds were not property of the estate. Expressing disagreement with this concept, Commissioner Alix said that companies outside of bankruptcy typically have access to these funds until they were required to be deposited. The proposal, as presently drafted, placed a heavier burden on the debtor, he observed.
In response to Commissioner Gose's request for clarification, Commissioner Alix explained that he was not opposed to the concept of requiring these funds to be placed in an escrow account when they are due, but he objected to accelerating this process. Commissioner Shepard asked how could one assure that these funds would not be consumed by corporate officer salaries, professional fees and other expenditures. Commissioner Alix said one could not and that the proposal was just providing a carve-out for one creditor, even though there were other creditors, such as employees and professionals, extending administrative funds who risked nonpayment.
Turning to that component of the proposal requiring the debtor to file missing tax returns, Commissioner Alix said that this was an unreasonable demand for small business debtors as they generally lacked the ability to comply. On the other hand, he favored that aspect of the proposal that would allow greater flexibility for disclosure statements and create standard forms for disclosure statements and plans. As approximately 90 percent of a small business debtor's creditors had claims of less than $500, it did not "make a lot of sense to have the full disclosure statement" for these cases. He recommended that an expedited hearing and shortened notice apply to those debtors who use a streamlined form of the disclosure statement and plan to provide an incentive.
Commissioner Alix then discussed the 90-day period for filing plans. He observed that many small businesses "have real seasonality" to them, especially retailers. Accordingly, the time frame may leave a debtor in a "hopeless situation." He suggested that there should be "some balancing language" included in the proposal. Mr. Case responded that the proposal provides for those instances by requiring the debtor to come forward with evidence to prove that it is more likely than not that the debtor, if granted an extension, will confirm a plan within a reasonable period of time. Nevertheless, Commissioner Alix noted that as most small businesses got into trouble after a period of many years, it was unlikely they could get out of trouble in just 90 days. He estimated that ten to 20 percent of the cases would require an extension of this time period.
Mr. Case explained that the theory behind the proposal was to prevent a debtor from reaping the benefit of the automatic stay forever. Rather, the debtor should be required to come forward and establish that it can confirm a plan in exchange for the continued protection. Commissioner Alix, however, questioned the proposal's language, "evidence that is more likely than not to confirm a plan of reorganization within a reasonable time." He suggested that "in light of the circumstances" be added. The proposal should not make it hard for debtors to reorganize, he advised.
Commissioner Alix then discussed other components of the proposal. Concerning that aspect of the proposal that would require scheduling conferences, Commissioner Alix generally was not opposed to this requirement. As to its provisions regarding serial filings, Commissioner Alix noted that the bankruptcy judge who was assigned the original case would be in the best position to assess the subsequently filed case.
At the conclusion of Commissioner Alix's comments, Commissioner Ginsberg noted that he
virtually agreed with all of his observations. In addition, he had several other concerns. First, he
that the proposal had a "strident note" that debtors are "tax cheats." He
suggested that a different tone be used. Second, he stated that the proposal "reads like a tax
collector's wish list." Most of the protections afforded by the proposal favor only the
Revenue Service. Third, he questioned the definition's amount and dependence on Section 61 of
Internal Revenue Code. In particular, he was concerned about potential disputes developing over
definition's application given the fact that Secti