Working Group on Small Business, Partnerships, and Single Asset Real Estate
Proposal # 1: chapter 11"Small Business" Debtors

I.NEED FOR REFORM: COST SAVINGS AND FASTER RESOLUTION FOR ALL SMALL BUSINESS DEBTORS

chapter 11 can be a remarkable tool for saving jobs, protecting going-concern values, and producing recoveries for creditors. The Working Group supports the continued availability of relief under chapter 11 for debtors of all types, large and small. As explained more fully below, the Working Group recommends reform measures designed to strengthen the 1994 "small business" amendments to reduce the cost and delay in small business chapter 11 cases.

The evidence collected by the Working Group suggests that there are two distinct categories of small business chapter 11 cases. Each requires its own reform measures. The first category consists of the relatively small proportion of cases in which the debtor has a reasonable likelihood of confirming a plan and succeeding as a going business. For this group of cases, the primary goal is to increase the likelihood of successful reorganization and the return to creditors, by reducing the high cost of, and time delays in, chapter 11. The second category consists of the much larger proportion of cases in which the debtor has no reasonable prospect of rehabilitation. [ FN: See , e.g. , J. James Jenkins, " Letter to the Commission regarding the Small Business Proposal " (April 14, 1997).] For this group of cases, the primary goal is to reduce the amount of time they consume in chapter 11.

With respect to the first category, the Working Group has identified need for the following reforms: (1) simplification of the disclosure and plan confirmation process; (2) prompt plan-filing and plan-confirmation deadlines, subject to extension upon proper showing by the debtor; and (3) additional reporting by the debtor regarding postfiling operations and review of that information by the U.S. Trustee or Bankruptcy Administrator. [ FN: Herinafter, " U.S. Trustee " is defined to include Bankruptcy Administrator.]

With respect to the second category, those cases in which reorganization is improbable, the Working Group has found a need for a longer list of reforms aimed at identifying those cases early and removing them from chapter 11 via dismissal or conversion to chapter 7.

The detailed text of the Working Group’s proposal appear at the end of the Proposal, under Heading III below.

A.THE COST OF THE PLAN AND DISCLOSURE PROCESS

One of the central features of chapter 11, and a major achievement of the Bankruptcy ReformAct of 1978, is the great flexibility it permits in fashioning a plan of reorganization. A plan may include virtually anything upon which the debtor and its creditors agree. A second central feature of chapter 11 is its strong disclosure requirements. In soliciting acceptances of a plan, the plan proponent must provide creditors and equity holders all information a typical investor would require to cast an informed vote regarding the plan. In exchange for this securities-law-type disclosure, the plan proponent gets broad protection from suits brought under the securities laws.

These disclosure concepts lead to three aspects of chapter 11 practice that increase cost and delay. In each chapter 11 case, the debtor’s counsel typically drafts the plan of reorganization and a long, prospectus-type disclosure statement from scratch. In most cases, the court conducts a hearing regarding the adequacy of disclosure before the plan is submitted to creditors. [ FN: Under current law relating to small business debtors, the disclosure hearing and confirmation hearing can be combined in cases involving small business debtors in which the debtor elects to be treated as a small business. 11 U.S.C. õ 105(d) (1994). Very few such debtors so elect, probably because the election shortens the debtor ’ s plan exclusivity period and requires the debtor to file a plan within 160 days of filing the petition. See 11 U.S.C. õ 1121(e), 1125(f) (1994).] The disclosure hearing often results in litigation that frequently has more to do with final bargaining about the contents of the plan than the adequacy of disclosure.

The complexity detailed above may be appropriate in large cases. The large debtor’s financial and operational problems are generally complex, requiring a specially tailored plan of reorganization. Detailed disclosure is appropriate. Moreover, the transaction costs of disclosure, although high in absolute terms, are usually a small percentage of the large amount of debt, income, and assets at stake in large chapter 11 cases.

In small chapter 11 cases, however, the drafted-from-scratch plan, the prospectus-type disclosure statement, and the separate disclosure hearing are more of a costly burden than an aid for cost-effective reorganization. [ FN: See, e.g. , The Honorable Robert D. Martin, " Letter to Stephen H. Case Regarding the Bankruptcy Review Commission Small Business Working Group " (Nov. 8, 1996)( " I would submit that there would be little loss to the integrity of the system if disclosure statements were done away with altogether. " ); see also The Honorable Geraldine Mund, " Letter to George Singer Regarding the September 7, 1996 Small Business Proposal " (Nov. 22, 1996); James Lawniczak, " Electronic Mail Message Regarding Judge Robert Martin ’ s Proposals, " (I . . . agree with Judge Martin that the disclosure statement be simplified. . . " ).] The small chapter 11 case simply cannot support the high costs of this process. Debtor’s counsel is often left with the choice of submitting a poorly drafted plan and a perfunctory disclosure statement, or creating legal fees greater than the debtor can bear. The Working Group even heard anecdotal evidence that the expected expense of drafting a plan and disclosure statement dissuades some businesses genuinely in need of rehabilitation from filing under chapter 11 to begin with.

Accordingly, as more fully explained below, two keystones of the Working Group’s proposalare (1) the promulgation of easy-to-use, standard forms for disclosure statements and chapter 11 plans for small business cases; [ FN: The Working Group recommends that these standard forms be designed to facilitate the collection and dissemination of accurate and comprehensive data and statistics.] and (2) granting the court broader discretion to combine the disclosure and confirmation hearings in all small business cases or waive the filing of a disclosure statement altogether in appropriate cases.

B.LACK OF CREDITOR PARTICIPATION

When Congress fashioned a consolidated approach to business rehabilitations, an underlying assumption was that debtors-in-possession would work together with active committees of creditors in negotiating a plan of reorganization. [ FN: See H.R. R EP . N O . 595, 95 th Cong., 1 st Sess. 401 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6357 (indicating that committees of creditors and equity security holders " will be the primary negotiating bodies for the formulation of the plan or reorganization " ). Congress believed that: Under the consolidated reorganization chapter, the procedure will be a combination of features of current chapters X and XI. There will be at least one committee in each case . Because unsecured creditors are normally the largest body of creditors and most in need of representation, the bill requires that there be a committee of unsecured creditors. H.R. R EP . N O . 595, 95 th Cong., 1 st Sess. 235 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6195 (emphasis added). But see Richard B. Levin, " Letter to Stephen H. Case regarding the NBRC Small Business Working Group Proposal " (April 15, 1997)(citing the House Committee Report which noted that " [t]he notion of creditor control, while still theoretically sound, has failed in practical terms. Creditor control in bankruptcy cases is a myth. " ).] The role of committees was also viewed by Congress to be integral to the "supervision of the debtor in possession" and would serve to "protect their constituents’ interests." [ FN: See supra note 6 . See also 11 U.S.C. õ 1102 (1978) (amended)(providing that " the court shall appoint a committee of creditors holding unsecured claims " )(emphasis added).]

Available data, however, indicate that creditors are apathetic in the vast majority of business bankruptcies. [ FN: S ENATE C OMM . ON THE J UDICIARY , 103 D C ONG ., R EPORT ON S.540 at 43 (Oct. 28, 1993).] Indeed, national statistics reveal that a committee of creditors was constituted in only 15.3% of the 8,606 pending chapter 11 cases filed between January 1993 and January 1996. [ FN: S UMMARY BY C IRCUIT OF C REDITOR C OMMITTEE D ATA , E XECUTIVE O FFICE OF U NITED S TATES T RUSTEES (February 21, 1996). Accord L INDA E. S TANLEY , C HAPTER 11 S TATISTICS BY B USINESS T YPE & Y EAR , D EVELOPED BY THE S AN F RANCISCO O FFICE OF U.S.T RUSTEE , Oct. 18, 1996 (reporting that a creditors ’ committee was appointed in only 6 out of 119 chapter 11 cases (5%) filed in the Northern District of California in 1995. In only 20 % of these cases was counsel to the committee appointed).] In other words, 84.7% of chapter 11 lacked the participation and "supervision" of a creditors’ committee thatCongress envisioned would be a cornerstone to a consolidated chapter. [ FN: See supra notes 6-7 and accompanying text; see also , The Honorable A. Thomas Small, chapter 11: A Growing Cash Cow. Some Thoughts on How to Rein in the System , 1 A M . B ANKR . I NST . L. R EV . 331 (1993)] The fusion of the previous relief chapters has thus not resulted in the contemplated joint administration of the bankruptcy estate by debtors and creditors, but rather has led to a system dominated far too often by the exclusive and largely unsupervised direction of the debtor-in-possession. [ FN: See Lynn M. LoPucki, The Debtor in Full Control--Systems Failure Under chapter 11 of the Bankruptcy Code (Second Installment) , 57 A M . B ANKR . L.J. 247 (1983).]

Lack of creditor participation does not necessarily mean that creditors are satisfied with the manner in which chapter 11 cases progress. In small cases, individual creditors often have too little at stake to justify the cost of active participation in the chapter 11 case. Thus, creditors’ lack of participation often reflects an unwillingness to "throw good money after bad," rather than an endorsement of the present system. As more fully explained below, for purposes of administrative supervising, the reforms proposed by the Working Group substitute the U. S. Trustee for absent creditors. [ FN: J. James Jenkins, " Letter to the Commission regarding the Small Business Proposal " (April 14, 1997) (recognizing the importance of the U.S. Trustee in cases lacking creditor supervision).]

C.CASES WITH NO GENUINE PROSPECT OF REORGANIZATION

Available statistics reveal that only a small fraction of the chapter 11 cases filed nationwide end in confirmation of a plan of reorganization. [ FN: See E DWARD M . F LYNN , S TATISTICAL A NALYSIS OF C HAPTER 11 , A DMINISTRATIVE O FFICE OF THE U NITED S TATES C OURTS -- S TATISTICAL A NALYSIS & R EPORTS D IVISION (SARD), Bankruptcy Division 10 (Oct. 1989)(unpublished report) (finding that the confirmation rate for chapter 11 cases filed between 1979 to 1986 was only 17%); Lynn M. LoPucki, The Debtor in Full Control--Systems Failure Under chapter 11 of the Bankruptcy Code? (First Installment) , 57 A M . B ANKR . L.J. 99, 100 (1983). But see Honorable A. Thomas Small, " Letter to the National Bankruptcy Review Commission Regarding the Small Business Proposal " (Feb. 12, 1997) (reporting a 62.9% plan confirmation rate in the Eastern District of North Carolina).] The vast majority of cases are dismissed or converted. Furthermore, only a fraction of confirmed plans are fully performed. [ FN: F LYNN , supra note 13, at 13 (concluding that only 10 to 12% of the chapter 11 cases filed ever result in successful reorganization ). Accord Susan Jensen-Conklin, Do Confirmed chapter 11 Plans Consummate? The Results of a Study and Analysis of the Law , 97 C OM . L.J. 297, 325 (1992)(finding that only 10% of the chapter 11 cases filed in a particular study area resulted in a consummated plan); Nancy Rhein Baldiga, Is This Plan Feasible? An Empirical Legal Analysis of Plan Feasibility , 101 C OM . L.J. 115 (1996)(concluding that even in cases in which the chapter 11 reorganization plan has undergone an extensive feasibility challenge, half of the confirmed, nonliquidating plans failed to fully consummate ).] One study reported that, based on historical data, a debtor entering chapter 11 only has a 6.5% chance of confirming andperforming a plan, i.e., surviving as a rehabilitated entity. [ FN: Jensen-Conklin, supra note 14, at 325. In light of the facts [sic] that 17% of chapter 11 cases get confirmed, about one-quarter of these involve liquidating plans, and that some of the reorganizations are not successful, it can be estimated that only about 10 to 12 percent of chapter 11 cases result in an actual reorganization of the filing entity. Further, some of these reorganizations may not be considered fully successful even if the business is reorganized and the creditors are paid. Some reorganized businesses will falter a second time. This may lead to a second chapter 11, a liquidation, or the sale of the business. F LYNN , supra note 13, at 13] Another study suggests that the overall success rate for chapter 11 cases appears lower than under the Bankruptcy Act. [ FN: LoPucki, supra note 13, at 100 (finding in a discrete survey area that cases during the first year following the inauguration of the Bankruptcy Code yielded a confirmation rate of only 26%).]

Reasonable people differ about how to define "success" in chapter 11 cases. [ FN: E.g. , A BI B ANKRUPTCY R EFORM S TUDY P ROJECT , D EFINING S UCCESS IN B USINESS B ANKRUPTCY (May 6, 1995)(unpublished paper presented at the Annual Meeting of the American Bankruptcy Institute).] Some argue that a chapter 11 case in which no plan is confirmed should be considered successful where the case produces an orderly sale of assets or a negotiated solution without a formal plan. Creditors may define success in terms of distribution amounts or in terms of preserving future dealings with the debtor. The debtor, on the other had, may define success in terms of job preservation, enhancement of going-concern value, or future returns to equity. The public may define success in terms of overall fairness. [ FN: Id.]

The Working Group believes that the appropriate use of chapter 11 is one in which the debtor confirms and materially performs a plan of reorganization. [ FN: See 11 U.S.C. õ 1129(a)(11) (1994)(requiring a judicial determination that confirmation is not likely to be followed by liquidation or further reorganization); id. õ 1112(b)(2), (7) (providing grounds for the conversion or dismissal of a chapter 11 case if there is an " inability to effectuate a plan " or an " inability to effect substantial consummation of a confirmed plan " ).] The benefits of an orderly liquidation can be realized through a liquidating chapter 11 plan or a chapter 7 case. A case which is converted or dismissed after a lengthy, inconclusive protection of the debtor in possession in reliance on the automatic stay should not be considered a success.

According to the experts who appeared before the Working Group, the primary reason for the low chapter 11 confirmation rate is that the great majority of chapter 11 debtors lack any genuineprospect for reorganization, i.e. fundamentally, business viability is measured in terms of a consistent generation of cash revenue in excess of cash disbursed does not exist. Debtors are not required to make any showing of viability to file chapter 11 (and the Working Group does not propose the imposition of such a requirement). At the same time, a moribund business generally has little to lose by seeking relief in bankruptcy. By filing under chapter 11, the debtor gets the immediate benefit of the automatic stay, retains control of the business, and is under no requirement to pay creditors or file a plan promptly. Chapter 11 thus lures many small business debtors who have no realistic hope of confirming a plan. [ FN: " chapter 11 is more an intensive-care ward (or mortuary) than a healing potion for sick businesses. " Honorable Edith H. Jones, chapter 11: A Death Penalty for Debtor and Creditor Interests , 77 C ORNELL L. R EV . 1088 (1992).]

Far too [frequently], counsel file a chapter 11 petition for a debtor, the business of which is in such straits and so incapable of recovery that the chapter 11 case is nothing more than a holding pattern before an inevitable conversion to chapter 7 or dismissal. Such a case serves no useful purpose and instead merely prolongs a painful process. Clients would be far better served if counsel examined the economic potential of the business before filing a petition to "rehabilitate" a moribund debtor. [ FN: 5 A SA S. H ERZOG & L AWRENCE P. K ING , C OLLIER B ANKRUPTCY P RACTICE G UIDE ô 84.02[1][d] (1992). As one bankruptcy judge has remarked in the context of one plan found to be unfeasible: Bankruptcy is perceived as a haven for wistfulness and the optimist ’ s valhalla where the atmosphere is conducive to fantasy and miraculous dreams of the phoenix arising from the ruins. Unfortunately, this Court is not held during the full moon, and while the rays of sunshine sometimes bring the warming rays of the sun, they more often also bring the bright light that makes transparent and evaporates the elaborate financial fantasies constructed of nothing more than the gossamer wings and of sophisticated tax legerdemain.In re Maxim Indus. Inc. , 22 B.R. 611, 613 (Bankr. D. Mass. 1982).]

It is essential to the legitimacy and continued public acceptance of chapter 11 that its exceptional protections be limited to those cases in which the public derives a benefit therefrom. [ FN: See , e.g. , J. James Jenkins, " Letter to the Commission regarding the Small Business Proposal " (April 14, 1997) (noting that the current resolution of small business chapter 11 cases undermines the reputation of the bankruptcy system).] Creditors in an open economy have a legitimate interest in a prompt, fair determination of the viability of chapter 11 debtors. As explained more fully below, a central feature of the Working Group proposal is to identify promptly those cases in which there is no real likelihood of rehabilitation and provide an effective mechanism for dismissing those cases or converting them to chapter 7.

D. DELAY IN THE CHAPTER 11 PROCESS

The length of time a business remains in chapter 11 is critically important. "During that time, the business is at risk because management incentives are inappropriate, professional fees build up at a rapid rate, and business uncertainties increase." [ FN: LoPucki, supra note 11. See also Philip J. Hendel, " Position Paper to the National Bankruptcy Review Commission Proposing Expanded Use of chapter 13 to Include Closely Held Corporations and Other Business Entities " (Dec. 17, 1996) ( " Most small business chapter 11 cases fail. They do, however, take a while to filter through the system. There are usually substantial administrative fees and expenses that have been paid to the professionals. When the well runs dry, the cases therefore die from dehydration. When they are finally converted to chapter 7 there is rarely a dividend to unsecured creditors).] Furthermore, unsecured creditors lose the time value of money while they wait to collect their debt during the pendency of the case. The longer they await distribution, the greater is their loss. [ FN: " Time is money. " Since unsecured creditors are not paid pendency interest on their claims, the loss becomes exponentially greater the longer they are forced to await payment. See Honorable A. Thomas Small, 1 A M . B ANKR . I NST . L. R EV . 305 (1993).]

Yet studies reveal that chapter 11 debtor often live under the protection of the Bankruptcy Code for literally years, [ FN: Cf. Marcy J.K. Tiffany, A Study of chapter 11 Confirmation Statistics: Central District of California, Los Angeles Division for Cases Filed in 1994 (unpublished study on file with the author and the National Bankruptcy Review Commission)(analyzing 1349 cases filed during 1994 in the Los Angeles Division of the Central District of California in terms of the rate at which cases were converted, dismissed or confirmed as related to their size measured in terms of assets and liabilities as indicated on the petition at the time of filing. The study concludes that (1) The smallest of cases (less than $500,000 in liabilities or assets) that are not capable of reorganizing move just as quickly through chapter 11, if not more quickly, than cases with more than $500,000 in liabilities or assets; (3) There is some indication that cases with less than $500,000 in liabilities or assets take somewhat longer to confirm plans than cases with more than $500,000 in assets or liabilities; and that (4) Overall, the data indicate that cases with less than $500,000 in liabilities or assets are no less successful in chapter 11 than cases with more than $500,000 in liabilities or assets ) .] often without providing any meaningful return to unsecured creditors. Indeed, the average time from filing to the confirmation of a plan has been historically estimated by one government analyst to exceed two years. [ FN: F LYNN , supra note 13, at 23-24 (indicating that the median time from filing to confirmation ranged from a low of 461 days to a high of 941 days).] Nearly two-thirds of the chapter 11 confirmations occur in the second or third years after filing, with some cases taking more than five years. [ FN: Id .]

Current law may actually work to slow the resolution of small business chapter 11 cases. It has been persuasively argued that the consolidation of the separate reorganization chapters under the Bankruptcy Act into a single chapter that imposes a uniform set of rules for all business cases hascaused small business cases to be resolved more slowly than under pre-Code law. [ FN: See Lynn M. LoPucki, The Trouble with chapter 11 , 1993 W IS . L . R EV . 729 (comparing the results of five empirical studies of the length of reorganization cases resulting in the confirmation of a plan of reorganization). See, e.g. , Jeffrey W. Morris, " Letter from Porter, Wright, Morris & Arthur Regarding the Proposals Before the Small Business Working Group " (Dec. 13, 1996) ( " There is little dispute that chapter 11 cases take too long to complete. " ).] chapter 11 contains a number of procedures that were designed for large cases. [ FN: LoPucki, supra note 28 at 745.] "When these large-case procedures were applied to ordinary reorganization cases, the dynamics of ordinary cases became more like the dynamics of large cases. Time in chapter 11 for the two kinds of cases simply converged." [ FN: Id.]

Congress has in recent years recognized that a "one-size-fits-all approach" to business reorganizations fails to adequately address the needs of a system dominated by small business bankruptcies. [ FN: See 11 U.S.C. õ õ 101(51C), 1102(a)(3), 1121(e) (1994)( " small business " amendments added to the Code by the Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, 108 Stat. 4106); S. 1985, 102d Cong., 1 st Sess. (1991)(failed legislative effort which attempted to create a separate chapter for small business cases).] Commentators have also noted that typical chapter 11 practice is not well suited to small business cases.

It takes no elaborate empirical study to justify the conclusion that the problems facing a publicly held corporation facing a mass-tort problem, are quite removed from a "mom-pop" corporation running a shoe repair shop . . . . Obviously, a case involving a publicly held corporation with varied constituents requires safeguards, and therefore, the process is justifiably slow. The cost of administration, while it is subject to the court’s control, is unavoidably high . . . . However, these same safeguards become insurmountable obstacles to . . . small corporations, elevating the costs of the system to unacceptable proportions. [ FN: Honorable Alexander L. Paskay & Frances Pilaro Wolstenholme, chapter 11: A Growing Cash Cow: Some Thoughts on How to Rein in the System , 1 A M . B ANKR . I NST . L . R EV . 331 (1993).]

The Working Group proposal addresses the need to move small business chapter 11 cases at a pace appropriate for those cases by (i) establishing presumptive plan-filing and plan-confirmation deadlines specially tailored to fit small business cases; and (ii) directing bankruptcy judges to use modern case-management techniques in all small business cases to further reduce cost and delay. [ FN: The use of " fast track " procedures in bankruptcy was pioneered in the mid 1980's by the Honorable A. Thomas Small, Chief Bankruptcy Judge for the Easter District of North Carolina. Judge Small ’ s fast track involves three simple procedures: (i) requiring early filing of the plan; (ii) conditional approval of the disclosure statement; and (ii) a combined hearing on the disclosure statement and plan confirmation. See The Honorable A. Thomas Small, Small Business Bankruptcy Cases , , 1 A M . B ANKR . I NST . L. R EV . 305 (1993). A number of other districts have since similar " fast track " procedures, see, e.g. Pamela J. Griffith, Fast Track chapter 11 in the District of Oregon , 41 F ED . B AR N EWS & J. 185 (1994). But see infra note 67 and accompanying text.]

The need for reform can perhaps best be underscored by the fact that nearly every jurist, academician, practitioner, and representative who appearing before the Small Business Working Group has expressed the unmistakable sentiment that the system needs to be tailored in order to better serve the interests of justice and the special needs of small business debtors and their creditors. Although there were certainly differences in opinion as to the nature and extent of reform that should be made, there has little been more than a handful of advocates for retaining the status quo. To address these concerns, the Small Business Working Group has undertaken to develop a proposal which will both expedite the process for debtors that can be saved, and conclude the process quickly for those which cannot benefit from the protections of chapter 11.

II. THE SMALL BUSINESS PROPOSAL: CONTENTS AND DEVELOPMENT

Nearly one ago, on June 20, 1996, the Small Business Working Group held its first public meeting to develop a proposal to improve the administration of small business chapter 11 cases. Since its first session, the Working Group has met across the country at seven meetings and formulated the proposal, which appears in italics under Heading III below. At these numerous gatherings, the Working Group members have invited comment, and presented their concerns and ideas to the public. The Working Group first memorialized its proposal in a memorandum dated September 7, 1996, Ideas Being Considered by the Small Business Working Group. Since this first draft, the Working Group has publicly circulated and solicited comment on seven revised versions. [ FN: Seven drafts of the Proposal have been circulated. They were dated October 30, November 25, and December 9, 1996; January 14; February 14; March 27; and May 1, 1997.] As a result of these discussions, the Working Group has significantly modified its initial proposal. The Small Business Proposal is described below.

A.DEFINITION OF "SMALL BUSINESS"

The concept of a "small business" is a fluid one. To a large extent, crafting a definition requires consideration of the context in which the definition will be applied. Selecting a definition of small business for purposes of bankruptcy requires a series of trade-offs between accuracy and precision, in light of the availability and quality of information available to classify the small business debtor at the outset of a bankruptcy case.

Under current bankruptcy law, a "small business" is defined as:

a person engaged in commercial or business activities (but does not includea person whose primary activity is the business of owning or operating real property and activities incidental thereto) whose aggregate noncontingent liquidated secured and unsecured debts as of the date of the petition do not exceed $2,000,000. [ FN: 11 U.S.C. õ 101(51C) (1994).]

The Small Business Administration ("SBA"), [ FN: The Small Business Administration is a nonincorporated, federal agency created to aid, counsel, and financially assist small-business concerns so that free competitive enterprise is preserved for small, private businesses. See 15 U.S.C. õ 631(a) (1994).] by contrast, defines a "small business concern" [ FN: 15 U.S.C. õ 632(a) (Supp. 1996). See George H. Singer, " Small Business & Single-Asset Working Group: chapter 10 " (Aug. 12, 1996)(memorandum on file with the National Bankruptcy Review Commission).] as "one which is independently owned and operated and which is not dominant in it field of operation." [ FN: Id.] Other relevant factors to the SBA’s definition of an entity as a small business concern include the number of employees, dollar volume of the business, net worth, net income, a combination thereof, or "other appropriate factors." [ FN: Id. õ 632(a)(2)(A), (B) (Supp. 1996).] In a typical case, the SBA judges the size of a business by number of employees or annual receipts. [ FN: George H. Singer, " Small Business & Single-Asset Working Group: chapter 10 " (Aug. 12, 1996)(memorandum on file with the National Bankruptcy Review Commission) (citing telephone conversation with John Haitsuka, Attorney, Office of the Small Business Administration, Washington, D.C. (August 13, 1996); Business Credit & Assistance, 13 C.F.R. õ 121.201 (March 1, 1996)). The SBA calculates annual receipts as follows: (1) Receipts means " total income " (or in the case of a sole proprietorship " gross income " ) plus the " costs of goods sold " as these terms are defined or reported on Internal Revenue Service (IRS Federal tax return forms (Form 1120 for corporations; Form 1120S for Subchapter S corporations; Form 1065 for partnerships; and Form 1040, Schedule F for farm or Schedule C for other sole proprietorships). However, the term receipts excludes net capital gains or losses, taxes collected for and remitted to a taxing authority if included in gross or total income, proceeds from the transactions between a concern and its domestic or foreign affiliates (if also excluded from gross or total income on a consolidated return filed with the IRS), and amount collected for another by a travel agent, real estate agent, advertising agent, or conference management service provider. (2) Complete fiscal year mans a taxable year including any short period. Taxable year and short period have the meaning attributed to them by the IRS. (3) Unless otherwise defined . . . all terms shall have the meaning attributed to them by the IRS . . . Business Credit & Assistance, 13 C.F.R. õ 121.104 (March 1, 1996).] Similar to this definition, Senate Bill 1985 would have definedsmall business by reference to a number of factors including the number of employees and creditors, the value of the debtor’s assets, the dollar volume of the debtor’s sales, the nature and substance of the debtor’s business, and others. [ FN: S. 1985 proposed to add the following definition to õ 101 of Title 11 : (54) " small business " means a person engaged in commercial and business activities where, if appropriate, after court determination, it is found that the best interests of an estate will be served by having such person deemed to be a small business, in light of -- (A) the number of employees of the person ’ s business activity; (B) the number of creditors of the person ’ s activity; (C) the number of secured, priority, and unsecured creditors of the person ’ s business activity; (D) the value of the assets of the person ’ s business activity; (E) the dollar volume of sales of the person ’ s business activity; (F) the nature and substance of the person ’ s business activity; (G) the history of the person ’ s business activity; (H) the nature and substance of the person ’ s business activity as measure by similar persons engage in the same business activity; and (I) other pertinent factors.]

Although a searching inquiry by the court under a multifaceted definition might define small business in a precise manner, it is also likely to engender litigation at the outset of a chapter 11 case, during which time a debtor is preoccupied with preparing schedules, obtaining cash collateral orders, and the like. By contrast, a bright-line definition minimizes litigation and enables the court and counsel to focus on the merits of the chapter 11 case.

Developing a bright line in the context of bankruptcy is a difficult task. Very often, little financial information even approaching public-company quality is available upon the commencement of a bankruptcy proceeding, [ FN: The only financial information required as of the petition date are summary statistics on the debtor ’ s assets, liabilities, creditors and employees. This information is reported in categories, such as " less than $50,000 " or " greater than $100,000,000. " See Official Form 1 of the Bankruptcy Code.] although more detailed information is available within fifteen days postpetition. [ FN: F ED . R. B ANKR . P. 1007(c); Official Forms 6 & 7 of the United States Bankruptcy Code. The court may grant an extension of time for the filing of a debtor ’ s schedules and statements on motion for cause shown. Id . Anecdotal reports to the Working Group suggest that such extensions are routinely granted.] Specifically, under current laws, the voluntary debtor must file, inter alia, a petition, [ FN: O FFICIAL F ORM 1 of the United States Bankruptcy Code.] a Summary of Schedules, [ FN: O FFICIAL F ORM 6 of the United States Bankruptcy Code.] Schedules of Assets and Liabilities, [ FN: See id. , Schedule A (Real Property), Schedule B (Personal Property), Schedule D (Creditors Holding Secured Claims), Schedule E (Creditors Holding Unsecured Priority Claims), and Schedule F (Creditors Holding Unsecured Nonpriority Claims).] and "gross amount of income" received from business operations for the beginning of the calendar year preceding the date on which the case was filed and the two years immediately preceding this calendar year. [ FN:[O FFICIAL F ORM 7 of the United States Bankruptcy Code (question numbers 1 & 2).]

The forms on which these financial data are filed must follow the Official Forms prescribed by the Judicial Conference of the United States. [ FN: F ED . R . B ANKR . P . 9009 .] Existing forms draw out much balance-sheet information, reflecting a historical background based on asset liquidation rather than capitalization of income. Schedules A & B require the debtor to list all real and personal property owned by the debtor. [ FN: See Official Form 6 of the United States Bankruptcy Code. ] Schedules D, E & F require the debtor to list each secured, unsecured priority, and unsecured nonpriority claim against the debtor. [ FN: Id.] However, less detailed information is available about the debtor’s income. Questions 1 & 2 of the Statement of Financial Affairs requires the debtor to "[s]tate the gross amount of income the debtor has received"from the beginning of the prepetition calendar year to the date of the petition, and from the two years immediately preceding the calendar year. [ FN: See Official Form 7. It is unclear whether the debtor should provide information on its gross income as defined by the Internal Revenue Code, on its net income, or on its gross or net revenues.] Data on a debtor’s monthly and historical gross and net revenues are not available on a going-forward basis, until six to eight weeks into the case, when the debtor files its first monthly operating report as required by the U.S. Trustee.

The information reported by debtors on their schedules and statements has been criticized as routinely inaccurate or missing, despite the requirement that debtors provide it. [ FN: See The Honorable Lisa H. Fenning & Craig A. Hart, Measuring chapter 11: The Real World of 500 Cases , 4 A M . B ANKR . I NST . L. R EV . 119 (1996); see also Jennifer C. Frasier, Caught in a Cycle of Neglect: The Accuracy of Bankruptcy Statistics , 101 C OM . L.J. 307 (1996).] This problem appears to be endemic to the nature of bankruptcy, which is generally filed by those in financial distress. Regardless of a debtor’s best intentions and willingness to disclose accurate financial information to the court, the debtor may not have such information if it has not kept good books and records or regularly filed its tax returns. Smaller debtors may not be able to afford a bookkeeper oraccountant to maintain proper financial records, and may not have the expertise or time to perform this work themselves. As between information on liabilities and information on revenues, however, the business in financial trouble is more likely to have information on its liabilities, as this is the where the debtor’s focus is most likely to be directed. [ FN: See, e.g. , William T. Neary, Letter to Linda Stanley re chapter 11 Statistics for the National Bankruptcy Review Commission (June 3, 1997)( " [L]ike you, I found the gross income figure both difficult to compile and of questionable validity. In 17 cases, were were unable to obtain any information regarding gross income--either the SFA [Statement of Financial Affairs] wasn ’ t filed, or question #1 wasn ’ t answered. . . In another 14 cases, the debtor reported negative gross income figures. ([T]]his is an accounting impossibility.) I ’ m quite sure that a number of debtors are reporting gross revenues or adjusted gross income or some other figure in response to question #1. " ).] This conclusion comports with testimony of a number of people appearing before the Working Group, who have reported that the nature and size of the debtor’s liabilities is the single best predictor of case complexity. [ FN: See id . at 2 ( " My experience has been that it is the size of the debts owed to individual creditors, rather than the level of the debtor ’ s gross income, that determines the level of creditor interest in a case " ); see also The Honorable Elizabeth L. Perris, " Letter to John Gose Regarding the chapter 11 Special Track " (Feb. 18, 1997)( " It is usually debt structure rather than income that creates complexity in chapter 11. " ).] For these reasons, the Working Group has concluded that a bright-line, liabilities-based test is the most cost-effective manner to accurately categorize a business as large or small for chapter 11 purposes.

A mandatory liabilities-based test which calculates debts based on the filer’s noncontingent liquidated aggregate debts has several potential drawbacks. First, small business debtors may have an incentive to "game the system" by reporting their debts as contingent or unliquidated in order to avoid small business treatment. Second, it is arguable that chapter 11 independently creates strategic incentives for debtors to understate their liabilities and overstate their assets on the face sheet in order to obtain postpetition financing. [ FN: At least one empirical study has found that chapter 11 debtors systematically underreport their liabilities on the face sheet of the bankruptcy petition. Jennifer C. Frasier, Caught in a Cycle of Neglect: The Accuracy of Bankruptcy Statistics , 101 C OM . L.J. 307, 333-34 (1996) (Finding that liabilities are erroneously reported in chapter 11 and 13 cases twice as often as in chapter 7 filings.).] These potential problems would appear to be either illusory or endemic to the nature of bankruptcy for several reasons. First, the debtor is obliged under penalty of perjury to accurately report information on its schedules and statements. [ FN: See O FFICIAL F ORM 6 of the United States Bankruptcy Code; see also F ED . R. B ANKR . P. 9011.] In addition, as noted above, accurate information is difficult to obtain at the outset of any bankruptcy proceeding despite a debtor’s best intentions to accurately report its financial history.

The current bankruptcy-law definition of small business sets the eligibility limit at $2,000,000 in aggregate, noncontingent, liquidated secured debts. [ FN: 11 U.S.C. õ 101(51C) (1994).] Based on available liabilities data from two of the ninety-four total bankruptcy districts, a liabilities-based definition of $2,000,000 or less wouldcapture approximately 72%of all chapter 11 cases filed. Tables which detail this finding and break down liabilities and "gross amount of income" by million dollar categories are provided below:

Liabilities on petition date	% of chapter 11 "small business" debtors
	M.D. Ala.	S.F/Santa Rosa	Del.	Phila.	Chicago	Dallas	Average
$10,000,000	100%	94%	16%	92%	96%	82%	93%**
$5,000,000	93%	92%	15%	87%	88%	72%	86%
$4,000,000	93%	89%	14%	85%	85%	71%	85%
$3,000,000	93%	86%	13%	80%	80%	65%	81%
$2,000,000	83%	74%	13%	73%	73%	59%	72%
$1,000,000	70%	53%	13%	65%	65%	49%	60%

M.D. Ala. [ FN: The data from the Middle District of Alabama and the Northern District of California represent chapter 11 cases filed in 1995. See Dwight H. Williams, Jr., Letter to Jennifer C. Frasier Regarding Small Business Chapter 11 Data (Dec. 5, 1996)(on file with the National Bankruptcy Review Commission); Linda E. Stanley, Letter to Jennifer C. Frasier Regarding Chapter 11 Data (Nov. 14, 1996)(on file with the National Bankruptcy Review Commission).

Del. [ FN: The data from the remaining districts represent open chapter 11 cases filed between October 1, 1996 and April 30, 1997. See Linda E. Stanley, Letter to Jennifer C. Frasier Regarding Statistics for Open chapter 11 Cases filed between 10/01/96 and 04/30/97 " (June 5, 1997)(on file with the National Bankruptcy Review Commission).]

Average [ FN: This average excludes Delaware cases as this district appears to be anomalous.]

** [ FN: See Jennifer C. Frasier, Caught in a Cycle of Neglect: The Accuracy of Bankruptcy Statistics , 101 C OM . L.J. (1996) (Empirical study which examines a random sample of 454 chapter 7, 11, and 13 bankruptcy cases filed during the first and second quarters of 1994 in the following districts: (i) Connecticut; (ii) Louisiana, Eastern District; (iii) Massachusetts; (iv) New Hampshire; (v) New Jersey; (vi) New York, Southern District; and (vii) Texas, Northern District. The author found that debtors filed their schedules of liabilities (schedules D-F) in 369 out of 454 cases. Of these 369 cases (which include chapters 7, 11, and 13 filings) there were a total of seven cases in which the debtor ’ s aggregate, noncontingent, liquidated secured and unsecured debts, as reported on the schedules, totaled $10,000,000 or more. As the study ’ s data are not broken down by both size and chapter, it is unclear whether or not these seven cases are all chapter 11 cases. Assuming, however, that all seven cases were filed under chapter 11, then approximately 5% (7/137) of all chapter 11 debtors have liabilities of $10,00,000 or more).]