The National Bankruptcy Review Commission

Minutes of Meeting Held:
Wednesday, January 22, 1997
Thursday, January 23, 1997

Federal Judicial Center Auditorium
Thurgood Marshall Federal Judiciary Building
Washington, D.C.

Approved: April 17, 1997
Prepared by: Susan Jensen-Conklin
Deputy Counsel











Thursday, JANUARY 23, 1997

Federal Judicial Center Auditorium
Thurgood Marshall Federal Judiciary Building
Washington, D.C.


Commission Members Present:
Brady C. Williamson, Chair
John A. Gose
Honorable Robert E. Ginsberg, Vice Chair
Jeffery J. Hartley
Jay Alix (January 23, 1997)
Honorable Edith Hollan Jones
M. Caldwell Butler (telephonically - January 22, 1997)
James I. Shepard
Babette A. Ceccotti

Commission Advisors and Staff Present:
Professor Elizabeth Warren, Reporter/Senior Advisor Elizabeth I. Holland, Staff Attorney
Professor Lawrence P. King, Senior Advisor Melissa B. Jacoby, Staff Attorney
Stephen H. Case, Senior Advisor Judith K. Benderson, Legislative Counsel
Susan Jensen-Conklin, Deputy Counsel Carmelita Pratt, Administrative Officer
Jennifer C. Frasier, Staff Attorney Joseph Kuehne, Administrative Assistant

Public Attending:

Over the course of the two-day meeting, approximately 200 people attended, including representatives from the American Bankers Association, American Bankruptcy Institute, American Bar Association, Association of Bankruptcy Professionals, International Council of Shopping Centers, National Association of chapter 13 Trustees, National Association of Federal Credit Unions, National Bankruptcy Conference, National Consumer Law Center, and the National Multi Housing Council/National Apartment Association, among others. Federal agencies such as the Administrative Office of the United States Courts, the Congressional Budget Office, Executive Office for United States Trustees, Pension Benefit Guaranty Corporation, United States Department of Housing and Urban Development, United States Department of Justice, the Securities and Exchange Commission, and the Internal Revenue Service were represented. A Congressional staff member was present as well as members of the federal judiciary, professors of law, chapter 7 and chapter 13 trustees. Representatives from state government, credit unions, banking and credit industry, professional and trade associations, private industry, law firms, debtors and the media were also present.


At approximately 8:40 a.m., Chair Williamson commenced the morning session of the meeting by extending thanks to Leonidas Ralph Mecham, Director, Administrative Office of the United States Courts, and Frank Szczebak, Chief, Bankruptcy Judges Division, for their assistance in making the meeting facilities available to the Commission. He then reviewed the meeting agenda.

Among the administrative matters that Chair Williamson discussed were the following. He noted that the Commission’s Internet web site was activated. He mentioned that a regional meeting was tentatively scheduled for March in Iowa and for May 9 in New York City. In addition, a regional meeting that would primarily focus on tax issues was tentatively scheduled for May 10 in Washington, D.C. Further, he stated that a regional meeting would be held in Mobile, Alabama on June 6. Another administrative matter that he discussed concerned the payment of an obligation incurred by the prior Chair and that a final decision by the Commission on this matter would be made at the February meeting. Chair Williamson then reported on the bankruptcy legislation that had been introduced into the 105th Congress.

Elaborating on the regional meetings scheduled for May, Commissioner Ceccotti explained that the May 9 regional meeting would be held at New York University Law School in New York City and that it would likely include an open forum that may focus on the United States Trustee Program. To coordinate with a meeting of the tax section of the American Bar Association, a regional meeting devoted to tax issues will be held on May 10 in Washington, D.C.


The participants at the plenary session on small business included the following: Hon. Thomas E. Carlson, United States Bankruptcy Judge - N.D. Cal.; Joseph Giampapa, BankOne Corporation; J. James Jenkins, BDO Seidman; David A. Lander, Thompson Coburn; Hon. Robert D. Martin; United States Bankruptcy Judge - W.D. Wis.; Hon. Elizabeth L. Perris, United States Bankruptcy Judge - D. Ore.; Keith J. Shapiro, Holleb & Coff; J. Ronald Trost, Sidley & Austin; and Katherine Vance, Assistant United States Trustee in Tulsa, Oklahoma.

Stephen H. Case, moderator for this session, explained that the goal of the Small Business Working Group was twofold. First, it sought to identify ways to "cleanse" from the chapter 11 bankruptcy system those small business debtors who were floundering and incapable of succeeding. Second, it sought to remove these debtors from the system as "expeditiously and cheaply as possible."

Based on information supplied to the Small Business Working Group, Mr. Case said that two issues were presented. One was whether or not there was a problem with small business chapter 11 cases. The other was what, if anything, should be done about this problem.

Concerning the first issue, Mr. Case said that the "overwhelming bulk" of the information given to the Small Business Working Group stated that there were more cases in chapter 11 thanbelonged there and that it took too long to eliminate these cases from the system. In response to these submissions, the Small Business Working Group devised a proposal consisting of several components, he reported. The first component would establish a bright line definition for small business cases as debtors with $10 million or less in revenues as reported on their tax returns. The second component would require these cases to move through the system faster. The third tranche of the proposal would require those debtors unable to meet certain statutorially established deadlines to carry the burden of persuasion by a preponderance of the evidence that they have a reasonable probability of obtaining confirmation within a reasonable period of time.

While noting that the proposal was premised on information supplied by United States Trustees’ Offices as well as other sources, Mr. Case said it was not based on any systematic study as there were no data. Nevertheless, he observed that there was a "high empirical correlation" between small business debtors who were delinquent on their postpetition taxes, insurance premiums and other obligations and debtors unable to effectuate confirmation.

Other aspects of the proposal would require debtors to maintain segregated bank accounts and to prove on a continuing basis that they were current with respect to the payment of these obligations. Further, the proposal would amend 28 U.S.C. § 586 to enlarge the scope of the United States Trustee’s responsibilities with regard to small business debtors. It would also expand 11 U.S.C. § 1112 to include additional grounds for conversion and dismissal. In addition, the proposal would also require the United States Trustee to conduct initial debtor interviews and visit the debtor’s place of business. Although the Small Business Working Group initially supported the concept of having a professional evaluation of the business viability of these debtors performed, it currently favored shifting that responsibility to the United States Trustee.

Describing the proposal as "well thought through," Mr. Jenkins noted, however, that the definition of small business chapter 11 debtors may be too inclusive. He suggested that a $2 million or $2.5 million limit may be more appropriate.

Mr. Shapiro thought that a portion of the proposal belonged in the "whacko category." He explained that the proposal captured too many cases, was "far too Draconian," and would hurt too many "good" small business debtors. Except for a small category of these cases, he said that small business debtors deserved to reorganize no differently than large corporations. Small business debtors needed time to work out a plan and restructure their product lines or otherwise diversify, among undertaking other actions, he asserted. On the other hand, he said that the "dog cases" were readily identifiable and that "without any question" they had less than $2 million in revenues. In addition, he observed that incompetent counsel frequently "torpedo[ed]" a case that otherwise could be successful.

Commissioner Jones asked Mr. Shapiro what percentage of cases in the range of $2 million to $10 million confirmed reorganization plans in his district. Although he did not have empirical statistics, Mr. Shapiro said that a "significant percentage" of these cases either were confirmed or sold. He estimated this percentage to be approximately one third, but not more than 60 percent.

In response to Commissioner Jones’ query as to whether there was reasonably active creditor participation in these cases, Mr. Shapiro said yes. He noted that cases with $2 million to $10 million in revenues were "far more likely" to have a creditors’ committee than smaller debtors.

Commissioner Jones then asked Mr. Shapiro why the number of chapter 11 cases being filed had declined. Mr. Shapiro speculated that there were several reasons. The economy in the Midwest, he observed, was much better than it was in the 1980s. In addition, he noted that many of the chapter 11 filings in the late 1980s and early 1990s were fueled by leveraged transactions "in vogue" at that time. Further, he said that many matters were being handled out of court through prepetition workouts, assignments for the benefit of creditors, and other out-of-court mechanisms.

Judge Robert Martin stated that the proposal reflected a "tremendous distrust" of the debtor in possession model as envisioned in 1978. He said that the proposal attempted to cure problems resulting from the lack of responsiveness of debtors in possession to creditors. Nevertheless, he was concerned that the proposal would introduce new avenues for litigation. He cited, for example, the proposal’s bright line definition for small business cases. He was also concerned that the bankruptcy judge would be drawn into the administrative aspects of these cases.

As an alternative to the small business proposal, Judge Martin noted that his proposal, modifying 11 U.S.C. § 1104 with regard to the appointment of chapter 11 trustees, would make it easy for creditors to participate in these cases. He then explained the elements of his proposal. These included a provision that would shift the burden to the party objecting to the appointment of a trustee to establish the following: (1) the debtor in possession was in compliance with the Bankruptcy Code and rules, (2) insurance, taxes and wages were current, (3) the debtor was in compliance with United States Trustee reporting requirements and current on quarterly fee payments, (4) negotiations with creditors toward a proposal or plan had commenced, and (5) it would not be in the best interest to appoint a trustee. Procedurally, the hearing on this motion would be similar to the expedited time frames currently in effect for motions under 11 U.S.C. § 362, he explained. In addition, the person appointed would be an operating trustee who, in turn, would hire professionals who could quickly and efficiently evaluate the viability of the business. In addition, he suggested that no fee should be charged for filing this motion. Should a creditor prevail on this motion, he said, it should be entitled to be reimbursed as an administrative expense.

Responding to Commissioner Jones' query regarding the drop in chapter 11 filings, Judge Martin explained that in his district many farms, which were originally filed as chapter 11 cases, were now being filed under chapter 12. He speculated that Mr. Shapiro's comments regarding the bar’s increased familiarity with a mature law may be another reason.

Mr. Giampapa agreed with Mr. Shapiro's observations concerning out of court work outs as well. He did not, however, favor making chapter 11 "highly Draconian" as the present bankruptcy system served as a "very healthy component" for structuring turnarounds.

Addressing specific aspects of the small business proposal, Mr. Giampapa observed that its time line and administrative tax requirements should encourage "prompt sales," successfulreorganizations, or weed out the non-performing debtors from the system. He also supported the proposal's employment of a reasonable probability standard. On the other hand, he was not sure if the $10 million cap was the "right number." He favored Mr. Shapiro's definition and noted that the cap should be based on revenues rather than gross income because the former was more closely related to assessing a debtor's cash flow net of available debt and equity. In addition, he did not concur with the proposal's provision for increasing the United States Trustee's role in providing independent testimony on reasonable probability issues. He suggested that there were other sources where the leverage could be increased to flush non-performing chapter 11 cases from the system, such as expanding the provisions of 11 U.S.C. § 1112. In response to Commissioner Hartley's question as to how his firm decided whether or not to serve on a creditors' committee, Mr. Giampapa identified such factors as the existence of any preferences, the amount of the claim, and the overall administration of the case.

Judge Thomas Carlson began his remarks by noting that there were many factors involved with the decline in chapter 11 filings. First, the economy in his district was good. Second, there were certain local events in his district that previously led to increased filings such as the earthquake of 1989 and the fire that occurred in 1991 in Oakland. Third, there was "increased attorney discretion" concerning the quality of the case and the likelihood that it would get through the system. This discretion, he said, was attributable to the United States Trustee in his district who had done "a very good job of policing the cases." In addition, the bankruptcy judges in his district conducted scheduling conferences where deadlines for plans were fixed. Fourth, he observed that a cyclical aspect of the availability of credit may be a factor.

With regard to the criticisms of the small business proposal, Judge Carlson noted that the Working Group from the outset had two goals. One was to identify and eliminate those small chapter 11 cases from the system lacking any reasonable prospect of reorganization. The second was to reduce the cost and delay involved in effecting confirmation.

Judge Carlson suggested that these goals may be better achieved if the proposal addressed identification and elimination through modifications to 11 U.S.C. §§ 1112 and 1104. The plan deadline would be reserved for those cases that survive this identification and elimination process. He agreed that the provisions of Section 1112 should be expanded. He also concurred with Judge Martin's suggestions concerning Section 1104. With regard to Section 1112, he said that the debtor should have the explicit duty to file operating reports, maintain insurance, attend the Section 341 meeting of creditors, and timely file its schedules. It should also include some "objective benchmarks" that would flag nonperforming cases as evidenced by the presence of accrued postpetition losses or unpaid administrative expenses. In addition, he said that it should be easier for creditors to file motions in "unsuitable cases." The "keystone" to this suggestion would be to change the burden of proof, he explained.

With the implementation of these measures, Judge Carlson noted that the deadlines could be extended as there would no longer be any need to catch these "unsuitable cases" at their inception. It would also allow the bankruptcy judge and the United States Trustee to retain their traditional roles. Nevertheless, he recommended that the proposal retain the requirement that bankruptcy judgesconducted status conferences.

Judge Elizabeth Perris noted that there was an expectation in her district that reorganization should occur within a reasonable period of time. As a result of this expectation, the litigation as well as the cost for debtors and creditors was reduced. Another reason why chapter 11 filings were lower may be the impact of the Tax Reform Act of 1986, she said.

Concerning the small business proposal, Judge Perris observed that it was a "good step in the right direction." She suggested, however, that it be simplified to reduce the number of required hearings and meetings. She then discussed specific recommendations to effectuate this suggestion. She noted that the 45-day period was "unrealistic." If a debtor proposed a liquidating plan, Judge Perris recommended that the debtor should have the burden of proving that creditors will fare better under the plan than they would under chapter 7. She observed that as there may be more serial filings as a result of the proposal's dismissal provisions, thought should be given as to whether they should be tolerated. She also recommended that there should be provision for the appointment of a trustee in small business cases with limited powers to take control of the debtor's finances, but not necessarily operate the debtor's business.

Commissioner Hartley asked how the cost of these recommendations would be borne by these debtors. Judge Perris said that if less responsibility was given to a trustee, then it would be easier to find someone who could "do the job."

Mr. Jenkins observed that the trustee proposal would probably not be necessary if the threshold was lowered to $2 million. Judge Perris disagreed as there were some cases that can be reorganized, but for the existence of problematical lawyers or management. She expressed concern that Judge Martin's proposal would enable creditors to use a motion to appoint a trustee as leverage to extract an adequate protection order or obtain relief from the automatic stay as opposed to this motion being utilized to obtain a collective remedy. Based on his experience, Mr. Shapiro stated that trustees appointed in "dog chapter 11 cases" would likely seek to convert these cases to chapter 7 to stay ahead of all of the chapter 11 administrative expense claimants.

Responding to Judge Perris' concerns, Mr. Jenkins observed that the Bankruptcy Code was intended to protect against entities using someone else's funds. Judge Perris presumed that the appointment of a trustee should be for the collective good. Judge Martin said that the standard for the appointment of a trustee had nothing to do with issues pertaining to adequate protection or relief from the automatic stay. Mr. Jenkins added that while the typical chapter 11 case was "dead on arrival" upon being converted to chapter 7, this proposal would enable a chapter 11 trustee to examine the case while it was "still alive, still functioning, [and] still [had] employees."

While agreeing with the prior reasons proffered for the decline in chapter 11 filings, David Lander speculated that the main reasons were that the economy and the system were working well. With regard to the 45-day period, Mr. Lander said that it was "absolutely counterproductive." Instead, he suggested that a "natural point" be fixed where a meaningful number of small businessdebtors would be able to file a "decent plan." He supported the elimination of the disclosure statement requirement or restructuring it so that it did not delay the process or lead to additional expense.

With regard to mandated status conferences, he expressed concern that they may not be very meaningful where the bankruptcy judge did not support them. He said the current provisions were adequate. The United States Trustee, he said, should play the role of a compliance officer or class representative as the creditors' committee concept was economically driven. He expressed concern regarding the ability of the reasonable probability standard to solve problems or "do magic."

Katherine Vance, an Assistant United States Trustee, explained the procedures used in her district. These included the utilization of initial debtor interviews and the review of financial reports. In addition, a certified public accountant on her staff performed financial analyses. As a practical matter, she conceded that her office would serve no purpose if there was active creditor participation in chapter 11 cases. After reviewing certain statistics with regard to confirmation and the appointment of creditors' committees, she concluded that the creditors' committee process did not work. She generally favored the changes discussed by the participants. In particular, she said that the standards for the appointment of a chapter 11 trustee in her district were "fairly vague." She was also concerned about the cost of a chapter 11 trustee.

Ronald Trost noted that the National Bankruptcy Conference was "very supportive" of the goals reflected in the small business proposal. He agreed with Mr. Landers' comments about the proposal's definitional component. He also noted that the proposal's time limits were "very short." Judge Martin's proposal, he stated, deserved "a lot of consideration." Although "eons ago" there was a notion that the focus of bankruptcy was to protect unsecured creditors, secured creditors were the principal beneficiaries of the bankruptcy system, he said.

Comparing the private and public sector solutions, Mr. Trost said that while the Conference had been very supportive of the United States Trustee system, there was a lack of uniformity and he was "very reluctant" to have the United States Trustee make business viability determinations. He supported the role of the United States Trustee as monitoring compliance as distinguished from exercising business judgment. On the other hand, he noted that a private monitoring system would have to be funded by the bankruptcy estate. It would also require some form of supervision to assure that the estate was not being administered for the benefit of the administrators, he added.

Judge Carlson explained that his concept contemplated that the United States Trustee would file motions based on either of two grounds: lack of compliance with the requirement to file monthly operating reports and unpaid administrative expenses or continuing losses on an accrual basis. He said that this concept was not intended to have the United States Trustee file these motions on subjective criteria. He also noted that he did not see much difference between his proposal and that espoused by Judge Martin other than his would give more discretion to the bankruptcy judge to appoint a trustee, convert the case to one under chapter 7, or dismiss the case.

Procedurally, Mr. Case asked whether this motion had to be made by a party in interest or sua sponte by the bankruptcy court. Judge Carlson responded that his proposal contemplated that amotion would be made by a party in interest.

Mr. Shapiro reminded the discussants that the focus should be on chapter 11 abuse, which was not necessarily a concern that only affected small business debtors. He noted that unsecured creditors sometimes did not appear in chapter 11 cases because it was factored into their decision to extend credit.

Responding to Mr. Trost’s comments that secured creditors were the principal beneficiaries of chapter 11, Commissioner Jones observed that while this may be a "realistic, verging on cynical, approach," a "great deal" of the economic effects caused by a chapter 11 filing were felt by unsecured creditors. She noted that there was some benefit to "fast tracking" these cases as it may serve to discourage the filing of "dead on arrival" cases.

Acknowledging that Commissioner Jones may not be "entirely incorrect," Mr. Shapiro stated that his unsecured clients were more interested in keeping these debtors "alive" so that they can continue to sell products to them. Mr. Lander observed that unsecured creditors in smaller chapter 11 cases did not become involved because they had already suffered their losses and realize that there was no value in these enterprises.

Ms. Vance said that the United States Trustee Program had evolved internally through regional and national dialogue efforts as well as the "steady hand" of the Program’s current Director. She then recounted several instances that illustrated the contributions of the United States Trustee Program to the administration of chapter 11 cases.

At the conclusion of Ms. Vance’s comments, Commissioner Butler said that the discussion was "very instructive" and noted that there did not appear to be anyone who supported a bright line definition of small business based on the amount of gross revenues set forth in the proposal. He also thought that the level was too high. Instead, he recommended that the definition be based on the number of employees and independent contractors who work for the debtor. He said that this was a measure of whether a business was "small or infinitesimal." He recommended that the standard be coupled with some other factors such as the amount of secured debt.

Mr. Case closed this session by noting that it was Chair Williamson’s goal to have the Small Business Working Group refine the proposal "to the point of conclusion" so that it can be voted upon at the February meeting.



The participants at this session included Joseph "Jerry" Patchan, Director, Executive Office for United States Trustees; Kevyn D. Orr, Deputy Director, Executive Office for United States Trustees; Martha L. Davis, General Counsel, Executive Office for United States Trustees; William Neary, United States Trustee - Region 6; Linda Ekstrom Stanley, United States Trustee - Region 17; Stephen Goldring, Assistant United States Trustee - Western District of Pennsylvania; Kim Lefebvre,Assistant United States Trustee - Northern District of New York; Corinne Ball, Weil, Gotshal & Manges; Jean FitzSimon, Chair, American Bar Association Bankruptcy Subcommittee on Bankruptcy Administration, United States Trustees, Jurisdiction and Venue in Bankruptcy Courts; Mark Greenberger, Katz Greenberger & Norton; William H. Schorling, Klett Lieber Rooney & Schorling; Bernard Shapiro, Murphy, Weir & Butler; and Gerald K. Smith, Lewis & Roca.

Professor Lawrence P. King, the moderator for this session, explained that while the focus of prior discussions regarding the United States Trustee Program was from the perspective of trustees, the focus of this session would be different. He asked the participants to address two questions. First, what were or should be the goals of the United States Trustee Program? Second, were those goals being met by the Program? If not, what changes should be made to better insure that they were met? At the Commission's next meeting in February, he mentioned that there may be an open forum devoted to the United States Trustee Program. This open forum would be supplemented by other open forums held in conjunction with regional meetings to provide members of the bankruptcy community the opportunity to comment on how the Program functioned in their region, he said.

Responding to the first question posed by Professor King, Mr. Patchan explained that the Program's goals included maintaining the integrity of the bankruptcy system, promoting its efficiency, investigating fraud, monitoring the conduct of parties in the system to assure compliance with the law and rules, and overseeing certain administrative functions within the system. Mr. Neary added that the Program also sought to encourage creditor participation in the process, especially in chapter 11 cases, through the formation of creditors' committees.

With regard to creditor participation, Professor King asked for clarification. While Mr. Neary said that this included the formation of creditors' committees, Mr. Lefebvre added that this also applied to instances where conversion motions were made in chapter 11 cases. Often "conditional orders" directing the debtor to file financial information were entered by the bankruptcy judges in response to these motions, he explained. These orders may, in addition, direct the debtor to supply creditors with this information as well. Ms. Stanley noted that her office worked to provide a record for the court so that it could make a decision.

Mr. Greenberger stated that the Program had an even greater function than what had been described. It served as a "very important resource" for panel trustees and that this role should be expanded. While Mr. Patchan explained what may occur in an "ideal situation," Mr. Greenberger said that it depended on the region and the United States Trustee in charge of that region. The "biggest concern," he observed, was that there should be standards on who can be appointed to serve as a United States Trustee. He noted that in some regions, the United States Trustees did not actively seek to appoint creditors' committees where there initially was insufficient creditor interest.

Concerning panel trustees, Mr. Greenberger said that they should be able to obtain guidance from United States Trustees. He explained that chapter 7 trustees must file interim reports every six months for each of their bankruptcy cases so that the United States Trustee can monitor any instances of trustee defalcation. Ms. Stanley agreed that there was a very comprehensive accountability systemused by the United States Trustee Program to review the administration of chapter 7 cases.

Professor King asked the discussants to address the issue of uniformity. Mr. Goldring noted that the Program was becoming "more uniform all the time" and had an internal evaluation mechanism that was effectuating this goal. Commissioner Jones observed that many people had informed her that United States Trustees in certain regions were unresponsive to claims of debtor abuse and too active in large chapter 11 cases.

Mr. Neary responded that in large chapter 11 cases, the United States Trustee appeared on issues running to the integrity of the system such as conflicts of interest and compensation issues. With regard to retention applications, Commissioner Shepard said that the United States Trustees tended "to nit-pick" and spend "a great deal of time" in trying to save "nickels and dimes" while overlooking more important matters.

Mr. Orr responded that the Executive Office conducted a quarterly review of each United States Trustee region with regard to how Chapters 7, 11, 12 and 13 cases pending in that region were moving through the system. In addition, the Executive Office monitored, during this review, how well criminal referrals, surcharge motions and other matters were processed in a region. This review had the effect of standardizing certain processes among regions, he noted.

In response to Professor King's request to Mr. Greenberger to discuss his observations concerning debtor fraud, he explained that the United States Trustee had a reporting system in effect. Speaking from the perspective of a panel trustee, he observed that fraud was most often brought to his attention by one who was dissatisfied with the bankruptcy schedules filed in the case such as a former spouse or business partner. In turn, he then would notify the United States Trustee and conduct a Rule 2004 examination of the debtor. He mentioned that this examination would have to be conducted at the trustee's expense if the case had no assets. Mr. Lefebvre explained that his office collected as much information as possible about any case where fraud was alleged.

Commissioner Jones asked Mr. Lefebvre if his office contacted the complainant to inform him or her that the matter has been addressed. She also asked whether there was any tracking mechanism for these complaints. Concerning the first question, Mr. Lefebvre said that his office did keep the complainant informed because his or her testimony may be necessary if the complaint is serious and meritorious. The complaint, in addition, may evolve into a formal criminal referral, he noted.

Professor King asked the discussants to state whether the reporting procedure mentioned by Mr. Greenberger was uniform. Ms. Davis said that debtor fraud was one of the Program's "primary focus points" and that one of the first initiatives launched after the 1986 Amendments was to formalize the criminal referral process. Currently, however, she said that the system did not require the use of standardized forms as written correspondence or memoranda were sufficient to initiate this procedure. Ms. Stanley observed that complaints pertaining to trustee defalcation or allegations of fraud were taken "very seriously." She said that her office determined whether or not to initiate a Section 727 denial of discharge proceeding.

Mr. Shapiro observed that criminal referrals was one area where there should be uniformity in the United States Trustee Program. Nevertheless, when he sought information regarding the coordination between the United States Trustee Program and the United States Attorney's Office, he was unable to obtain any definite guidance. Based on his experience, Mr. Smith said that the "ball [was] dropped" at the United States Attorney level, even when the United States Trustee fully prepared the referral.

Ms. Stanley said that her office met monthly with representatives from the United States Attorney's Office, Federal Bureau of Investigation and the Internal Revenue Service in order to track these matters. Although a "very small percentage" of these referrals led to prosecution, those that were prosecuted were usually successful. Mr. Orr stated that there was another issue involved in tracking criminal referrals, namely, the number that lead to indictments. He explained that most United States Attorneys only tracked the first five counts included in a criminal action. Thus, if a bankruptcy crime constituted the sixth or seventh count, it would not be tracked and not appear as an indictment for a bankruptcy crime.

Commissioner Jones asked Mr. Orr how many discharge denial actions were tracked by his office. He answered that this was tracked during the periodic review. He also explained that criminal referrals did not just emanate from panel trustees. He said that disgruntled relatives, friends and associates of the debtor were other potential sources of criminal referrals. They could also derive from congressional referrals. Often the persons making these referrals did not receive any feedback from the United States Trustee so that the integrity of the prosecution would not be compromised. There was a "big discrepancy" between the number of cases referred and the level of prosecutions, he said.

In addition to the United States Trustee, Mr. Schorling observed that bankruptcy judges were obligated to refer criminal acts to the United States Attorney's Office. In his district, however, "very, very, very few of those have ever been brought to prosecution or indictment," he said. He cited budgetary constraints as one reason for this result.

Ms. Ball questioned whether there was a "good fit" between the Program’s objectives and the allocation of resources to meet them. She noted that there needed to be some focus on civil remedies. While insufficient to result in criminal prosecution, the actions may be sufficient to dislodge a debtor in possession or to result in the appointment of an examiner. She asked whether the United States Trustee made these motions based on these types of referrals.

Ms. Stanley said that her office "definitely" reacted when it was made aware of questionable debtor actions. If those actions were criminal, her office prepared a criminal referral. In addition, her office would either seek conversion of the case or the appointment of a trustee under Section 1104 if grounds existed.

Noting that the present legislation provided the tools to address the problem, Ms. Ball observed that it was "just a question" of resource allocation. Although she heard the discussants mention several times that the level of United States Trustee involvement was lesser in those caseswhere there was active creditor participation, she suggested that this flexibility be reflected in 28 U.S.C. § 586. While Professor King noted that this should be rectified, Ms. FitzSimon replied that Section 586's provisions were permissive.

With regard to debtor fraud, Mr. Patchan said that the United States Trustee Program had several Assistant United States Trustees who were formerly United States Attorneys and that there was one Assistant whose sole responsibility was to educate the bench, bar and Assistant United States Attorneys on bankruptcy fraud, including how to try these cases and develop indictments.

If sufficient funding was provided, Commissioner Shepard asked whether the principal authority to investigate should be imposed on United States Trustees to ensure that there was more work done especially in the civil fraud area. Mr. Patchan agreed that the Program could "certainly do more in education." Nevertheless, he was "very sensitive" about "stepping over the line" and adversely affecting the prosecution of a case. In effect, as the United States Attorneys were "experts," he did not want to "invade their territory and ruin a case for them." He stated that Attorney General Janet Reno had been "very supportive" in promoting a "higher priority" for bankruptcy fraud litigation.

Commissioner Jones asked what percentage of the Program's resources were used to monitor consumer cases, panel trustees, fraud and chapter 11. Mr. Neary explained that in his office, approximately half of his staff's time was expended on chapter 11 cases and 40 percent was expended on chapter 7 matters. The remaining time was consumed by a "variety of other things." He noted that fraud issues were "obviously" involved in both chapter 7 and chapter 11 cases. With regard to chapter 11 cases, he said that his office worked to move these cases through the system by filing numerous motions to dismiss or convert or to set a deadline by which a plan must be filed. In this respect, he said that his office was "very successful." Among the components of this process that he identified were conducting initial debtor interviews, holding Section 341 meetings, reviewing monthly operating reports, identifying those debtors who fail to meet their basic fiduciary duties as well as those who lack a realistic prospect of reorganization.

Professor King queried Mr. Neary as to whether or not the small business proposal, which would mandate more active United States Trustee oversight, would require him to increase the time and resources that his office was currently spending in connection with these cases. Mr. Neary said it would not as his office was already performing these activities. By making 11 U.S.C. § 1112 and 28 U.S.C. § 586 more explicit, the proposal would assist his office in performing its responsibilities. Mr. Goldring agreed. He observed that his office moved against nonperforming debtors "very, very quickly."

Concerning bankruptcy fraud cases, Mr. Goldring explained that bankruptcy was not the only area where the United States Attorney was not active. The number of cases referred to the United States Attorney was "just overwhelming" and thus the fact that there was a "small percentage" was "really no surprise." In addition, he said that the United States Trustee Program was trying to do more alternative civil litigation such as dismissal and disgorgement motions. Further, he observed that although the Program took "a while to get up and running," it had accomplished much given itsrelatively short life span.

Referring to 11 U.S.C. § 707(b), Mr. Neary mentioned that his office spent "a great deal of time" reviewing chapter 7 cases for substantial abuse. He said that it would be "extremely helpful" if this provision was amended to define "substantial abuse." Ms. Stanley added that it should also define "primarily consumer."

Chair Williamson asked from whom did Section 707(b) referrals emanate. Mr. Neary said that his office took an "initial look" at all chapter 7 cases filed. In addition, his office also accepted referrals from panel trustees in his district. Many of these referrals were not acted upon because the preparation of the bankruptcy schedules was "just sloppy," he explained.

Mr. Smith observed that he was "extremely gratified" that the Program was staffed with "bright, dedicated and energetic people and a good leader" and that it was "really beginning to work." The "primary functions," such as removing some of the administrative matters from the bankruptcy court, eliminating the "so-called stigma of the bankruptcy ring," and policing were "well under way," he noted.

In other areas, Mr. Smith noted that the Program was "just at the threshold," such as developing guidelines for compensation. He suggested that the Program should develop guidelines in other areas. Although the original Commission envisioned that the Securities and Exchange Commission would "disappear from the system," the Program had not yet filled the void, he observed. As a result, many of the smaller chapter 11 cases involving securities issues did not receive the necessary supervision or guidance. He also said that there was an expectation that "marvelous statistical information" would be compiled. In addition, it was anticipated that there would be valuation assistance for assets regionally and nationally. Concerning chapter 7 cases, Mr. Smith had hoped that the Program would have tested, on a pilot basis, administering no asset cases to remove this burden from the chapter 7 trustees so that they could focus on the productive cases.

Commissioner Jones asked the United States Trustee representatives to comment on her prior query regarding resource allocation. Mr. Lefebvre estimated that his office expended approximately 35 percent of its time on chapter 11 cases and that a "large chunk of time" was spent on processing chapter 7 cases and reviewing trustee final reports. Ten percent of his office's resources were allocated to criminal referrals. Ms. Stanley concurred with the allocation described by Mr. Neary. Mr. Goldring estimated that 33 to 40 percent of the time at his office was devoted to monitoring chapter 7 trustees. He approximated that 10 percent of the time was expended on fraud. Forty percent of the time was spent on chapter 11 cases.

Professor King asked the discussants to comment on whether the United States Trustee over-allocated resources to chapter 11. Mr. Schorling responded that where there was an active creditors' committee, the United States Trustee office brought "relatively little to the table." He then cited various instances that illustrated this observation. He asserted that where parties can protect their own economic interests, the United States Trustee should not be involved.

At the conclusion of these remarks, Professor King noted that the United States Trustee wasrequired by statute to perform certain duties. He also said that there was no provision under the Bankruptcy Code that permitted parties to waive the disinterestedness requirement for professionals. Mr. Schorling responded that given the limited resources of the United States Trustees, they should devote these resources to monitoring fraud and administering those bankruptcy cases lacking active creditor involvement.

Mr. Shapiro observed that it was "not always true" that parties having an economic interest would promote the integrity of the system. With regard to compensation issues, he reminded practitioners to be "very careful" about bringing their own "individual, nit-picking problems." He preferred to have the United States Trustee review fee applications rather than having this work performed by fee auditors who were "paid in order to cut."

Upon the conclusion of Mr. Shapiro's comments, Professor King thanked the discussants for their participation. The session thereupon concluded.


Participants in this session included Malcolm M. Gaynor, Schwartz, Cooper, Greenberger & Krauss; Barbara Houser, Sheinfeld, Maley & Kay; Ralph Mabey, LeBoeuf, Lamb, Greene & MacRae; Hon. Ralph Mark, United States Bankruptcy Judge - S.D. Fla.; and Michael Reed, Pepper, Hamilton & Scheetz.

Professor Warren prefaced the discussion by asking the participants to focus on developing a specific proposal with regard to future claims in bankruptcy cases. She explained that a written summary of the proposal based on this session would first be circulated to the discussants and thereafter sent to the bankruptcy community for comment. She also stated that the focus was deliberately, at this point, not on environmental claims as they raised different issues concerning liability. Professor Warren concluded her opening remarks by suggesting that a specific paradigm, such as defective products, be utilized for this session.

The general conceptual contours of the future claims working paper were outlined by Professor Warren. She explained that it was permissive only if certain conditions were met. These conditions included the following: the liability was based on prepetition actions or omissions of the debtor, the liability and future claimants can be identified with reasonable certainty, and the liability can be estimated. In addition, the working paper provided for the appointment of a future claims representative and permitted channeling injunctions.

Mr. Gaynor said that it was "extremely important" to have some limitations on what constituted a future claim as the interest of existing creditors may otherwise be "destroyed" without any corresponding benefit to future claimants. He asked whether the definition under consideration for future claims would apply to chapter 7 as this would be relevant to the plan negotiation process under chapter 11.

Commissioner Ceccotti responded that the initial approach was to limit the definition toChapter 11. Citing the UNR case, he said that the strategy utilized there contemplated liquidation.

Mr. Mabey said that the discussion should focus on how the marketplace viewed future claims and how this depressed the company's value for all creditors and parties in interest. He said that the proposal accordingly made "some good sense."

To explicate his concern, Mr. Gaynor asked how one would determine under Section 11129(b)(1) whether the plan discriminated unfairly unless there was some clarification of whether the claim was allowable under chapter 7. Mr. Reed added that this clarification was necessary given the ability to liquidate under chapter 11. Commissioner Ceccotti said that she was comfortable with focusing on what the concept was and what the tests should be rather than on the label.

Mr. Gaynor said that the question was whether a profitable enterprise with many employees should be torn apart in an auction sale whereby the going concern value would be "sacrifice[d] . . . on the altar of future claims." Mr. Mabey said that care should be taken in drawing a line between liquidation and reorganization because the former may include selling the business as a going concern in chapter 11 and that this would involve the same economic issues presented in reorganization, namely, a depressed value for creditors.

Commissioner Ceccotti asked for clarification of how the proposal would apply to those situations where the marketplace had yet to recognize any future claim liability problems. Professor Warren said that while the current proposal would not prevent a debtor from doing this, there may be an issue of whether or not the liability was reasonably capable of estimation. Mr. Gaynor explained how the concept of a future claims representative was conceived in connection with the UNR case.

Judge Marks observed that the concept as presently structured in the working paper would not create an incentive for debtors to use it unless it made sense. A problem present in early formulations of the proposal was that it could force "noneconomic results" by allowing purported future claimants to demand that a plan include them. This problem, he said, should be resolved definitionally. He stated that the permissive aspect of the concept should work only where it made economic sense such as where the reorganization value is going to be enhanced or where existing creditors support it because a buyer will pay a premium for a reorganized company that will have a better future as a result of this protection.

Commissioner Ceccotti expressed concern about the potential for either intentional or unintentional collusion. Mr. Gaynor suggested that contingent and unliquidated claims historically were not provable or allowable. Under chapter X, some future claimants would have received nothing other than a discharged debt, he recalled. The drafters of the Bankruptcy Code, on the other hand, decided that it was acceptable to estimate claims. Now, he noted that the discussants were saying that they could not understand why estimation was necessary. Professor Warren clarified that there was no intent to create a distinction between acts and omissions.

With regard to Commissioner Ceccotti's concern that the proposal be more limited, ProfessorWarren suggested a fifth element whereby the court must actually determine that the resolution of these future claims was necessary to an effective reorganization. Commissioner Ceccotti responded that she did not view a "necessary to an effective reorganization" test as offering a meaningful limitation. Judge Mark posed a possible solution whereby the judge would make an actual value determination to insure that these claims were discharged for a "very good purpose."

Concerning the future claims representative, Commissioner Ceccotti asked what standards applied to the representative's actions and to whom was he or she accountable. When asked by Ms. Houser whether or not there should be a distinction between products that were no longer being manufactured from products still being produced, Commissioner Ceccotti thought that may be one approach.

To better illustrate the application of the proposal, Commissioner Ceccotti suggested that the defective product issues in Piper case be "plug[ged]" into the definition of future claims. Professor Warren recommended that the issues presented by the Dalkon Shield be used instead as Piper was a "really unusual case" because of the difficulty of identifying the class of future claimants.

With regard to the liability factor, Judge Mark suggested that "substantial risk of liability" be used in order to encourage debtors to use the process without having to admit liability. Mr. Reed questioned the efficiency of a process that encouraged a debtor to wait until it was on the "precipice of its demise" before it sought relief. Mr. Mabey thought that the definition was flexible enough to accommodate this concern. Mr. Reed responded that if the statute was clearer, it would be more "user friendly" and, as a result, companies would not wait "until they're dead" to use it.

The discussants then reviewed possible modifications to the language of the proposed definition of future claim to address this concern. Among the suggested modifications were the following: substitute language for the word "claim," include an opt-out provision, and changing the tense of certain verbs used in the definition. The discussants generally agreed that the definition of future claim should be distinct from that of a claim.

Thereafter, the discussants reviewed the future claims representative component of the proposal. Mr. Case asked if the "competence in process" standard should be enhanced. Judge Ginsberg noted that the only role of the court would be to approve the representative selected by the United States Trustee or Bankruptcy Administrator. Ms. Ceccotti expressed concern with this proposition, but suggested that the qualifications could be specified in guidelines.

With regard to the powers of a future claims representative, Mr. Gaynor said that he or she should have the right to file a class claim. Individuals would also be permitted to opt out and file their own claims. He was concerned about the consequences of giving an individual, having no economic stake in the case, too much power. Mr. Mabey did not view this as problematic because the future claimant would file a claim and the others would be represented by the future claims representative.

Mr. Gaynor asked whether future claimants would have an unjustified advantage over othercreditors if the concept of present value was not considered. Ms. Houser asked whether a creditors’ committee could agree to represent future claimants. Mr. Gaynor said that a future claimant can serve on a committee, but the committee could not represent the future claimant if none are appointed to it. Mr. Case observed that if this logic was followed, there would be "conflicts all over the place." Mr. Mabey said that this problem was present whether a future claimant was on a creditors' committee or on a separate committee. Ms. Houser noted that if a creditors' committee was prepared to undertake the representation of future claimants, this should be a possibility subject to court approval. Professor Warren responded that there was nothing in the future claims concept that prohibited that result.

Judge Mark was concerned as to whether or not the proposed definition of future claims would implicitly narrow the definition of claims under 11 U.S.C. § 101(5). Specifically, he wondered whether the future claims definition would limit the rights of claimants as compared to their rights under Section 101(5). Mr. Gaynor observed that just because a claim was not capable of estimation did not mean that it would not have a profound effect on the plan. Professor Warren summarized that there were three categories forming the focus of this discussion: claimants, entities with future claims and parties in interest.

Mr. Gaynor questioned how claimants who did not satisfy the estimation requirement would be treated and whether this would affect the feasibility of the plan. He observed that many believed that it was "impossible" to estimate these claims. Professor Warren explained that while it was initially "very hard" to undertake this estimation process, the estimates had become more accurate since those initial efforts. In addition, she noted that this process may depend on whether the number of known claimants can be determined. Judge Mark added that there was a "savings clause" in the definition that provided no harm would result from the failure to estimate.

While acknowledging that perfection did not exist, Mr. Gaynor said that there should be provisions to deal with those cases where the claims cannot be estimated so that these claimants did not "walk away" with the "whole company." Professor Warren acknowledged that several Commission members were concerned about the difficulty of estimation. Mr. Gaynor recalled that under former chapter X these claims would have been discharged. He asked whether it was better to have them receive something and not to have them "wiped out." He suggested that there be some reasonable provision for the future claimants.

Although Ms. Houser questioned how one would decide what was "reasonable," Mr. Gaynor said its determination would be derived through the negotiation process and if negotiation was not possible, then it should be determined within certain time parameters that would not unduly impede the administration of the estate. Professor Warren noted that the proposal concerned a more strategically limited concept. Commissioner Ceccotti suggested that this issue may be resolved when the discussion focused on the purposes of estimation.

The discussants than reviewed the exculpatory provisions of the future claims representative component of the working paper and possible resolutions to the "fear of acting" problem. Mr. Gaynor said that the representative should be insulated for good faith efforts. Commissioner Ceccottinoted that the standard should be one that applied to fiduciaries. Mr. Gaynor said that standard was "too high" and recommended instead that the standard be gross negligence. Mr. Case observed that as the representative was acting for people who did not even know that they needed to be defended, the duty of care and loyalty should apply. If the duty of care applied, he noted, then it would be a debate over whether an ordinary or gross negligence standard should apply. He added that the reorganized entity could indemnify the representative for defense costs. Commissioner Ceccotti said that it was important to clarify what a future claims representative can do and how he or she can exercise those functions. She analogized this concern to a board of trustees for a pension plan.

Mr. Mabey observed that courts had the ability to estimate and that the process had become more formal with an evidentiary base. Mr. Gaynor responded that his focus was not on what a court could do, but on what the legal representative should do. For example, if the representative settled for ten percent of what he or she should have received, then the representative could become the subject of multiple suits by personal injury lawyers who represent these claimants. Commissioner Ceccotti said that the standard required a significant degree of latitude and likened it to the standard that applied in labor law, namely, the duty of fair representation. This standard, she explained, gave a labor organization a "rather wide degree of latitude," providing one did not act arbitrarily, capriciously, or in bad faith, among other factors.

Professor Warren wondered whether this process should be referred to as "determination" or "evaluation" rather than "estimation." Ms. Houser asked whether two approaches to claim estimation can be reconciled: Section 502(c), which permits estimation for the purpose of determining the feasibility of a plan, and estimation for the purpose of distribution under a plan. Mr. Case said that the phrase "determination" of fair and reasonable value was better than "estimation." Commissioner Ginsberg agreed that estimation "traditionally" had a lower standard than valuation. Mr. Reed confirmed that the intent was to have an inclusive effect on collateral litigation.

The discussants then addressed channeling injunctions. Mr. Reed explained that this concept was integral to liquidating chapter 11 or 7 debtors who are ineligible to receive a discharge. Mr. Case added that the concept also applied to third parties such as insurance companies. Mr. Mabey said that the asset purchaser was another potential third party. Judge Mark said that the channeling injunction was the "key" to this whole structure. To ensure fair and reasonable treatment within a plan, trust or other mechanism, the channeling injunction was necessary, he noted. In addition, he said that there should be some jurisdictional provisions and that the bankruptcy or district court should have the authority to issue and enforce these injunctions. Mr. Case observed that if these claims were dischargeable, then the only function remaining for the channeling injunction would be to "attack third parties."

Citing the Manville case as an example of a trust with insufficient funds, Commissioner Ceccotti asked how the proposal would deal with those situations where more funds are needed than were originally estimated. Judge Mark, referring to the Piper case, said that there was provision for an actuarial process that would occur five years after confirmation. In addition, the plan was funded by a future claims note that was secured by the buyer's assets in a variable amount as determined by the results of the actuarial process.

Judge Mark asked whether the permissive aspect of the proposal meant that there would be no future claims class in a bankruptcy case unless the plan proponent proposed to include them in a plan. Professor Warren said that was correct. Judge Mark also asked about the timing of when a representative would be appointed. Ms. Houser expressed concern about the ability to "take the money and run." Professor Warren presumed that issue would be before the court in the context of the plan's feasibility. The more difficult case, she observed, would be liquidation. Judge Mark commented about the extent of litigation that may result over the issue of whether these claimants had claims under the present definition and whether they could "force their way" into a bankruptcy case.

Before the discussion concluded, Professor Warren mentioned the notion of successor liability. Commissioner Ceccotti said that if she was satisfied with the other components of the working paper, successor liability would not be as problematic. Professor Warren then asked the discussants to submit their comments and questions to her and that she would prepare a memorandum identifying the "open questions." The session was thereupon concluded.



Samuel Gerdano, Executive Director of the American Bankruptcy Institute ("ABI"), presented a summary of ABI's consumer bankruptcy forum held January 17 and 18, 1997. He noted that the forum was successful in that it generated a meaningful dialogue among debtors, creditors, judges, trustees and others on some of the difficult issues regarding consumer bankruptcy. In particular, he cited the salutary effect of having 51 persons with diverse perspectives to be in close proximity with each other and have a "civil discussion." On the other hand, he noted that many issues were not yet resolved.

Regarding the format of the forum, Mr. Gerdano explained that the group was divided into concurrent workshops, each of which was monitored by an academic. Among the issues discussed were reaffirmations, redemption, exemptions, pre-bankruptcy planning, serial filings, chapter 13 and sanctions. He said that a written summary containing the highlights of these discussions would be prepared and submitted to the Commission. He noted that there was "substantial support" for certain principles, but there was no support for any theoretical proposals that would institute a single or unitary chapter for consumer bankruptcy relief.

Among the specific proposals that were discussed at the ABI forum, Mr. Gerdano reported that there was general agreement although not a consensus that a "federal floor-ceiling" for exemptions may be appropriate. In addition, there was general agreement that most personal property exemptions should be selected on a lump sum basis rather than according to discrete categories of property.

With regard to reaffirmation agreements, Mr. Gerdano said that while there was no consensus that they should be prohibited, there was "significant concern" that illegal reaffirmations were beingused to circumvent the system and that something should be done about this problem.

Concerning discharge and dischargeability, Mr. Gerdano stated that there was a consensus that no additional categories of nondischargeable debts are added to 11 U.S.C. § 523. Specifically as to Section 523(a)(2), he observed that there was the "beginning of a consensus" that a debtor should not be permitted to defend this action solely based on his or her subjective intent. Rather, he said that there was agreement that there should be a more objective standard for intent.

Mr. Gerdano concluded his remarks by noting that he hoped to reconvene the group or a similar one within the next couple of months. Professor Flint thereupon continued the presentation.

Professor Flint reported that there was an "obvious willingness" among all of the forum's participants to work together to create "some real bankruptcy reform." Among the "most remarkable" areas where there was "clearly a majority," was the view that any changes directed at stemming abuses not be devised in such a way that they adversely impact on low income debtors. With regard to chapter 13, Professor Flint said that there was a general view that the Bankruptcy Code should specify what valuation and interest rate should apply, but there was no consensus as to what they ought to be. In addition, there was no agreement as to whether there was a need for a uniform definition of disposable income.

Upon the conclusion of Professor Flint’s comments, Chair Williamson expressed appreciation to the ABI for undertaking this effort. Commissioner Shepard was concerned about certain statements that remedies directed at abuses in the consumer bankruptcy system not impact the low income debtors as he thought abuse was throughout the system. Citing Section 523(a)(2) as an example, Professor Flint responded that there was a concern about creating a "huge dragnet" that may create an intolerable burden for certain low income debtors. Commissioner Shepard said that he was informed by a legal services representative that she saw "a lot of abuse."


Bernard Shapiro, Chair of the National Bankruptcy Conference ("NBC"), was the next speaker. Mr. Shapiro explained that the NBC was composed of professors, bankruptcy judges, district court judges, attorneys for secured creditors and consumer debtor attorneys. He then conveyed the Conference's position on certain proposals under consideration by the Commission.

Expressing support for the Article III status for bankruptcy judges proposal, Mr. Shapiro said that the NBC would work with the Commission with regard to devising the transition details. He added that the Conference concurred that the district court level of review should be eliminated, in the event that Article III status was not obtained.

Regarding the venue proposal, Mr. Shapiro reported that the NBC supported elimination of the state of incorporation as a basis of obtaining venue. As to affiliate venue, he said that the NBC recognized that this presented an opportunity for forum shopping and that his organization was exploring ways to limit this as much as possible. In addition, the NBC had a technical suggestion onpartnership affiliation.

With regard to the mandatory withdrawal proposal, Mr. Shapiro stated that the NBC supported it as well as the list of appealable interlocutory orders.

Among the other proposals that the NBC supported, as identified by Mr. Shapiro, were the following: referring personal injury and wrongful death claims; giving contempt power to bankruptcy judges, including the power to incarcerate for civil contempt; the elimination of magistrate judges from the bankruptcy system; mandatory abstention; the amendment of Section 1129(b) with regard to the "new value rule" and the tie-in to the termination of exclusivity; permitting separate classification of claims; and judicial review of creditors' committee appointments to ensure adequate representation. As to Section 365, Mr. Shapiro observed that the NBC had struggled with this provision for "a long time" and that it had reached a consensus on how it should be amended, which will be made available to the Commission.

Mr. Shapiro then discussed several other proposals. The NBC, he noted, was not yet prepared to comment on the treatment of payroll deductions proposal. Although the NBC generally favored the concept of moving small business cases faster through the system, the current proposal needed refinement. Concerning single asset real estate cases, he said that the NBC did not entirely support the limitation of the $4 million cap. As to the repeal of 11 U.S.C. § 724(b), he stated that the NBC did not support this proposal as it would "unfairly advance" the treatment of government priority claims over the claims of labor and consumer interests. In addition, the NBC was not in support of the tax trust fund proposal to reverse Energy Resources. As to 11 U.S.C. §§ 105 and 362(b)(4), Mr. Shapiro said that the NBC "strongly believe[d]" that public policy required the bankruptcy court, as a court of equity, to have the power to issue injunctions in appropriate circumstances.

Specifically referring to Government Working Group Proposal Number 7, Mr. Shapiro observed that there were times when governmental authorities overreached. Thus, if their exercise of police and regulatory was unsupervised, property of the estate could be thereby "damaged." He said that the bankruptcy courts can be relied upon to handle these issues in a "responsible manner." The NBC did not want estate assets to be subject to government seizure without the protection of the automatic stay.

Concerning Section 365 and future claims, Mr. Shapiro said that if the Commission could deal with these two areas, then it would make a "major contribution" to limiting the amount of litigation in these areas, although it was not an "easy mission" for any Commission.

As to consumer bankruptcy, Mr. Shapiro said that the NBC urged the Commission to "protect the discharge" and, accordingly, opposed any efforts to curtail it by expanding the list of nondischargeable debts or by forcing consumers into mandatory chapter 13 cases. He observed that an "effective discharge" had long been part of this nation's bankruptcy policy. In its review of the Bankruptcy Code, the NBC concluded that the basic principles embodied therein provided a sound and beneficial system for dealing with the problems of financially distressed consumers. He observedthat the consumer bankruptcy system had worked "remarkably well" even as ever greater numbers of debtors have entered this system.

Stating that the basic structure of chapter 7 and chapter 13 should not be changed, Mr. Shapiro noted that an "oppressive debt burden" created a disincentive for debtors to be productive and that the discharge provisions of the Bankruptcy Act of 1898 as well as the Bankruptcy Code of 1978, as originally enacted, reflected these concepts. He said that the 1973 Commission and others focused on the merits of mandatory chapter 13 provisions and concluded that forced participation by a debtor in such a system would have little prospect for success. Nevertheless, he noted that the adoption of Section 707(b) had limited a debtor's access to discharge in an "important way" and that the list of nondischargeable debts continued to grow unabatedly. The adoption of a mandatory chapter 13 system, he said, would interfere with the essential goal of freeing debtors from oppressive debt so that they can again become productive members of society.

Upon the conclusion of Mr. Shapiro's comments, Chair Williamson thanked the speakers for their presentations and then reviewed the meeting agenda for the remainder of the day.


Federal Judicial Center Auditorium
Thurgood Marshall Federal Judiciary Building
Washington, D.C.


The consumer debt and bankruptcy panelists included the following: Lawrence Ausubel, Professor of Economics from the University of Maryland; Kim Kowalewski, Chief of the Financial and General Macro Economic Analysis Unit of the Congressional Budget Office; Thomas A. Layman, Senior Vice President and Chief Economist for Visa, USA; Professor Michael Staten, Director, Credit Research Center at Purdue University; and William Whitford, Professor of Law from the University of Wisconsin Law School. Reporter/Senior Advisor Professor Elizabeth Warren served as moderator.

Chair Williamson introduced the panel by explaining that it would continue the dialogue on consumer bankruptcy, focusing this time on data. Professor Warren noted that the panelists would be addressing two kinds of consumer bankruptcy data: macro data, concerning large economic trends; and micro data, which examined individual consumer debtors.

The first panelist, Thomas Layman, stated that he was speaking on behalf of the credit card industry, including Visa and MasterCard. His presentation, he explained, would examine the factors contributing to the "bankruptcy problem," that is, the "unprecedented rise" in the number ofbankruptcy filings.

Noting that the bankruptcy problem was very complex, Mr. Layman said that focusing on any one variable could yield "very false results." Referring to certain charts, he noted that credit card debt, representing the bulk of revolving credit, had experienced a "steep" increase over the period of 1981 to 1996. Bankruptcy filings, on the other hand, increased and decreased over this period.

Based on a recent survey conducted by Visa, he said that the average debt structure of a personal bankruptcy filing suggested that bank card debt was not the cause of bankruptcy and that a "little over 14 percent" of the total debt listed in these bankruptcy schedules was bank card debt. He said that 14 percent of the debt "simply cannot" be the cause of the "bankruptcy problem." One area where there was a "relatively strong inverse correlation" was between changes in employment growth and bankruptcy filing rates.

In response to Chair Williamson's query, Mr. Layman explained that "revolving credit" was a subset of credit and represented all types of revolving unsecured credit such as bank credit cards, store credit cards, and lines of unsecured credit that were not closed-in. Two other categories of debt that he described were consumer installment credit, such as automobile loans, and mortgage credit.

Mr. Layman then displayed a chart that showed a "strong inverse correlation" between employment growth and bankruptcy filings. He said, however, that this did not "tell the whole story." He referred to a study conducted by WEFA, an econometric forecasting group located in Pennsylvania, that tested more than 100 different variables to determine causality and covered the period of 1980 to 1996. Among the variables that "proved statistically very significant" in this study were babyboomers, divorce rate, median existing home prices, and other social factors such as legal advertising and the decreased stigma of bankruptcy. The WEFA study also showed that the impact of the number of bank credit cards per adult and consumer debt service ratios and consumer debt service payments divided by disposable, after-tax income was "quite small." In addition, he said that there was "other parallel research" indicating that the Bankruptcy Code permitted a "large number" of consumer debtors to "wrongfully benefit" by not having to pay at least a portion of their debts. He said that this finding "strongly suggest[ed]" that the consumer bankruptcy system should be restructured to allow individuals to obtain debt relief based on need.

Commissioner Jones asked how the numbers substantiated this conclusion. Mr. Layman replied that it was difficult to analyze individual social factors such as legal advertising and that he did not yet have consistent data. When asked by Chair Williamson how the study measured stigma, Mr. Layman said that there was no way to quantify this factor in terms of "this kind of econometric analysis." He explained that all that econometricians can do is to "throw in" "'dummy variables.'" In this study, it was treated as a "trend factor" as opposed to a specific dummy variable so that unexplained items would be captured. He said that the trend variable reflected all of the factors that could not be quantified. Referring to another chart, Mr. Layman said that it collectively depicted the factors that helped to explain what was occurring with consumer bankruptcy, but it did not definitively identify any one as the "root cause."

Commissioner Alix asked Mr. Layman to provide more background on WEFA. Mr. Laymanexplained that it was an acronym for Wharton Econometric Forecasting Associates, located in Bala Cynwyd, and that Visa had sponsored the study. Commissioner Alix questioned the factors examined in the study as they relate to cause and effect on a quarter to quarter basis. He suggested that if the filing graph was "smoothed out" along with the consumer debt graph and placed in a regression program, then they may look very similar. Mr. Layman responded that a regression analysis was performed and that the study tested for all types of different variables in a simultaneous format. He explained that correlations did not prove causality.

In response to Commissioner Jones' question as to whether there would be a lag time between an increase in credit and bankruptcy filings, Mr. Layman responded "[a]bsolutely" and that his presentation reflected the "best fit equation."

Professor Ausubel, the next speaker, prefaced his presentation by saying that he would focus on two arguments. First, the cyclical state of the economy and the extra-normal profitability of the credit card industry combined to generate high current levels of consumer default. Second, tightening the treatment of credit card debt under bankruptcy laws would likely lead to an increase in the expected profitability of lending to marginal consumers and thus to an increase in the outstanding balances of marginal consumers. As a result, there would be an increase in the "already high rate" in credit card delinquencies.

He observed that the WEFA study appeared to have missed a very important variable, one that could account for 90 percent of bankruptcy filings, namely, the rate of credit card delinquencies. He said that by using the Ringer Causality Test, the sufficiency of the correlation between the causal effect of credit card delinquencies and bankruptcy filings could be established.

As to the causes of credit card delinquencies, Professor Ausubel observed that there was an inverse relationship between credit card charge-offs and the growth rate of GDP. He also noted that there was a "mirror image representation" between credit card delinquencies and payroll growth.

The second factor related to the growth in credit card delinquencies that Professor Ausubel identified was the profitability of bank credit cards. This, in turn, had led to increased credit card solicitations, relaxed credit standards and increased credit limits, he said.

In response to Commissioner Jones' question as to when the usury laws changed, Professor Ausubel said that the market was functionally deregulated as of 1982. He reviewed the upward trend in the growth of the credit card market, beginning in 1971. Whereas the credit card outstandings in 1970 were $3 billion, he said that currently they were $450 billion.

Professor Ausubel then discussed the effect of limiting the dischargeability of credit card debt in the context of supply and demand side analysis. On the supply side, he said that banks would be more willing to lend with the knowledge that they were more likely to collect their claims. On the demand side, however, he did not project that there would be a corresponding demand downward shift and that, instead, it would be much smaller than the change on the supply side. The reason for this was the "'underestimation hypothesis,'" that is, credit card consumers tend to systematically underestimate the extent of their borrowing, both current and balance looking forward. He predictedthat there would be even more lending to marginal consumers and that there would be higher delinquency rates.

The next presenter, Kim Kowalewski, explained that his "mission" was to provide the Commission with objective facts behind non-business bankruptcies. He summarized two points at the outset of his presentation. First, non-business bankruptcies increase during periods of economic expansion. Second, non-business bankruptcies correlate very closely with the debt to income ratio of the household sector, which suggested that the socioeconomic factors such as stigma, attorney advertising, amendments in the Bankruptcy Code, may not play a very large role in determining the cause of increased bankruptcy filings.

Referring to certain charts, Mr. Kowalewski noted that bankruptcy filings increased during economic recessions and that they increased even more during economic expansion. He found a very close correlation between debt, consisting of consumer installment credit and home mortgage debt, to income ratio and bankruptcy filings for a very long period of time. He said that thecorrelation between debt to income ratio and bankruptcy filings was striking in how the turning points so closely matched. In response to Commissioner Gose's query about the cause for the debt to income ratio, Mr. Kowalewski said that it was a "very complicated story" that could be traced to the post-World War II boom in family formation.

Mr. Kowalewski than addressed the issue of whether the debt to income ratio was an overstatement of the indebtedness of the household sector. While there was a component of credit card debt that consisted of convenience use, there was an offset in that consumers were increasingly leasing their automobiles instead of purchasing them. According to the Federal Reserve Board, these two effects "wash out" each other. He also noted that there was a "sharp drop" in home mortgage interest rates during the early 1990s. Relying on certain graphs that he displayed to the Commission, he said that they showed how the debt ratio continued to increase, but that the debt service payments decreased.

Professor Michael Staten was the next presenter. He began his remarks by noting that his study had been "a bit of a lightening rod" on the matters it discussed, but that it was a work in progress. He noted that although the study was paid through a grant received from Visa and MasterCard, his Center retained full control over the project’s design and that several steps were undertaken to ensure the credibility of the study’s results. In addition, the Center was distributing a mail questionnaire to gather information about the consumer attitudes about the process and what caused them to file for bankruptcy relief, whether they tried credit counseling, as well as other matters. Further, the Center was doing extra sampling to ensure that the data were adequately representative.

After these introductory remarks, Professor Staten explained that the study selected 300 chapter 7 and chapter 13 petitions from 12 cities around the nation and that a thirteenth city was later added, but not yet included in the study. His focus for this presentation, however, was on the chapter 7 data with respect to the ability to fund a repayment plan solely out of current income. He noted that there was no attempt to perform an estimated asset liquidation analysis of nonexempt assets, although he was not sure if this information would affect the results that much.

He explained that the study results were based on information listed in the debtors' schedules as to income, expenses and debt by category, although there was an adjustment for tax liability for non-wage income, to obtain a "reasonably accurate picture" of after-tax net income. He then discussed the technical aspects of the study and methodology employed. He also explained that certain additional information on a disaggregated basis was compiled in response to Professor Warren's request following his initial presentation to the Commission during its December 1996 meeting.

Gary Klein from the National Consumer Law Center asked Professor Staten if the study tested whether the information listed on Schedule J correlated at all to actual expenses. Mr. Klein asserted that the expense information in Schedule J did not present a complete picture of a debtor's expenses.

After reviewing the various components of the study data, Professor Staten reported that 53 percent of chapter 7 debtors had no available income to fund a repayment plan over any period of time. On the other hand, the study showed that 25 percent of all chapter 7 debtors in the sample could have repaid at least one third of their non-housing debt over a 60-month repayment period and that 17 percent could have paid one-third or more over a 36-month repayment period. Breaking down this data further, Professor Staten said that five percent of the chapter 7 debtors in the study could have repaid 100 percent of their non-housing debt in 60 months; ten percent of chapter 7 debtors could have paid 80 percent or more; 15 percent could have paid 62 percent or more, and that 20 percent could have paid 45 percent or more. He acknowledged that some of these debtors would be voluntarily repaying their obligations through reaffirmations.

Professor William Whitford, the next speaker, began his remarks by noting that his presentation would address two points: mandatory chapter 13 and Professor Staten's study. As to the first point, Professor Whitford said that two-thirds of confirmed chapter 13 plans were not consummated. If debtors were forced into filing for relief under chapter 13, then that percentage, he said, would necessarily increase. As to the high failure rate of chapter 13 cases, he noted that there were many causes such as unexpected layoffs, medical expenses and a debtor's inability to adhere to a tight budget for 36 months. Professor Whitford then discussed the historical justification and public policy decisions supporting discharge provisions in bankruptcy. Among the factors that he mentioned was the need to incentivize debtor productivity.

With regard to Professor Staten's study, Professor Whitford noted that the non-housing debt factor included secured as well as unsecured debt. He noted that virtually all secured debt was repaid in a chapter 7 case. He said that if this information was separated out in Professor Staten's study, the repayment percentages would be "considerably lower." As to the study's reliance on expense data reported in the bankruptcy schedules, Professor Whitford said that this information was "often junk" and that its reliability depended upon the chapter under which the debtor was seeking relief.

At the conclusion of Professor Whitford's comments, Professor Warren noted that Dr. Theresa Sullivan had planned to participate in this discussion, but was unable to attend as the result of certain family commitments. Nevertheless, Dr. Sullivan would submit a written report.

Responding to Professor Whitford's comments about the accuracy of information contained in debtor's expense schedules, Professor Staten said that the validation of expense information provided by chapter 13 debtors was "remarkably similar." Professor Whitford replied that counsel for a chapter 13 debtor has an incentive to "squeeze those expenses down" to make the plan "look" feasible. In certain districts, debtor's counsel may encourage the client to increase those expenses to avoid coming into conflict with the substantial abuse standard under Section 707(b).

Recalling his experience, Commissioner Shepard said that he had "sent debtors home" to review the accuracy of their expense figures. Professor Whitford responded by noting that he knew many ethical and responsible chapter 13 attorneys such as Commissioner Shepard, but that there were chapter 13 attorneys who were worried about getting the plan confirmed.

At the conclusion of Professor Whitford's presentation, Professor Warren asked the Commissioners if they had any questions. Commissioner Hartley asked whether or not there was any alternative to the present system that was based on inaccurate schedules. Professor Whitford said that there was no real incentive to produce accurate information. Commissioner Jones observed that bankruptcy schedules were filed under penalties of perjury and asked whether that meant anything.

Likening bankruptcy schedules to the "great American novel," Commissioner Ginsberg observed that they were crafted after the debtor's attorney determined what chapter under which the client should seek relief. Stating that debtors could be prosecuted for perjury, Commissioner Jones stated that this was "extremely offensive as an operative concept." Observing that the incentive to overstate expenses in chapter 7 cases may be district dependent, Professor Whitford wondered whether the study was skewed based on the district's standard for substantial abuse.

Chair Williamson asked Mr. Layman and Professor Ausubel to comment on Mr. Kowalewski's presentation. Mr. Layman responded that while his study was focused on causality, Professor Ausubel looked at profitability. He noted, however, that profitability was premised on "many different dynamic factors" and that if those individual dynamic factors were not examined, there was no conclusion that could be drawn.

Professor Ausubel said that he was confused with regard to the profitability issue as Visa reported not only profits, but all of the income and revenue and cost factors comprising credit card profits. Mr. Layman said that the issue of profitability was irrelevant to the panel discussion. Professor Ausubel observed that the debt to income factor was more meaningful when it included other debt beside revolving credit.

Noting that he was "somewhat frustrated," Commission Shepard asked the panelists to comment on what debtors were purchasing with their additional credit and if they were spending it on necessities or other items such as vacations or gambling. He also asked what the role of credit card debt played in the national economy.

Mr. Layman responded that credit card debt represented less than seven percent of total consumer debt. He generally concurred with Professor Ausubel regarding his presentation on the supply and demand curve.

Referring to Dr. Chimerine's statements made at the Commission's December 1996 meeting, Professor Whitford said that he made a "big mistake" in assuming that there was a correlation between the denial of a discharge and repayment.

Professor Ausubel said that there was "very little reason" to conclude that the tightening of bank credit regarding credit card loans would reduce the credit card interest rate. When asked by Commissioner Gose if limiting credit card profit would reduce the number of bankruptcies, ProfessorAusubel said that would be the "predictable effect." Mr. Layman said that pricing was not just based on interest rates as there were other revenue sources associated with this figure. He expressed concern that there was an "intonation" that there was a lack of competition in the credit card industry, given the fact that there were 6,000 entities trying to obtain a market share in this industry. He was not aware of any "extraordinary profits" that were being reaped by this industry. Professor Ausubel, in the interest of full disclosure, said that he had acquired stock in single-line credit card issuers several years ago and had done "quite well."

Commissioner Jones asked Mr. Layman to estimate on a disaggregated basis the proportion of credit card debt that represented convenience use. Mr. Layman said that in the general population approximately two-thirds of the accounts revolved. Commissioner Jones asked whether the expanding use of credit cards represented a market that was in a growth phase and that the market would eventually level itself. She questioned whether the problem was a factor of the usury rates. Professor Ausubel noted, however, that economists were "pretty hostile" to the notion of usury ceilings and favored, instead, other measures to encourage competition. Professor Ausubel favored measures that allowed consumers to make their credit choices more efficiently, such as requiring credit card companies to display the annual percentage rate prominently on their credit applications.

As to specific amendments to the Bankruptcy Code, Professor Ausubel argued against the implementation of objective standards as applied to the dis