Statement Of The American Bankruptcy Institute
Before The House Judiciary Committee
Subcommittee On Commercial And Administrative Law
On The Business Bankruptcy Provisions of H.R. 3150
Mr. Chairman and members of the Subcommittee, my name is
Christopher F. Graham. I serve as Chairman of the Real Estate
Committee of the American Bankruptcy Institute ("ABI") as well as
Director of the ABI's Medal of Excellence Program for our nation's
law schools. The ABI's 6,000 members, with backgrounds in law,
accounting, academia and lending, form the nation's largest
multi-disciplinary organization dedicated to education and research
on bankruptcy issues.
The ABI is a non-profit and non-partisan organization.
Therefore, even though members of the ABI regularly appear before
Congressional Committees, the ABI does not take any advocacy position
on pending legislation. To the extent that I take a personal
position before you today rather than an official ABI position, it is
based on my experience as a bankruptcy and creditors' rights
practitioner and as a member of the firm of Thacher Proffitt &
Wood in New York.
The ABI commends Representative Gekas for conducting hearings
on single asset real estate and small business cases as well as the
Subcommittee for its continued interest in addressing
problems, whether real or perceived, with the bankruptcy laws.
The ABI is committed to assisting all of you in these endeavors.
Small Business Debtor
The Bankruptcy Reform Act of 1994 introduced the concept of a
"small business debtor" to Chapter 11 of the Bankruptcy Code. Those
amendments were designed to streamline the Chapter 11 proceedings of
a qualifying debtor which elects such treatment within 60 days of the
order for relief and reduce the administrative expenses incurred
during such Chapter 11 proceedings, which expenses are often a true
burden on small debtors. The amendments reduced the exclusive period
during which only the debtor may file a plan of reorganization,
relaxed the stringent requirements for disclosure statements and
solicitation of acceptances for a plan of reorganization and did away
with the automatic appointment of a creditors' committee.
The amendments proposed by H.R.3150 go even further in
streamlining the Chapter 11 case of a small business debtor. More
debtors will be eligible for treatment as a small business because
the indebtedness cap will be raised from $2,000,000 to $5,000,000.
Additionally, the disclosure statement and solicitation process will
be further streamlined by, inter alia, not requiring a disclosure
statement in all circumstances. The proposed bill also mandates the
creation of uniform forms of disclosure statements and plans of
reorganization. However, to keep the process balanced and address
the needs of creditors, the amendments call for increased reporting
requirements, a longer solicitation period and strict rules
prohibiting serial filings. The role of the Office of the United
States Trustee also becomes more prominent.
Single Asset Real Estate Debtor
The Bankruptcy Reform Act of 1994 also incorporated the concept
of "single asset real estate" ("SARE") cases into the Bankruptcy
Code. SARE bankruptcy filings increased in the late 1980s and early
1990s as a result of rising interest rates, a surplus of commercial
space and the loss of tenants -- often through relocation or
bankruptcy. The amendments to the Bankruptcy Code regarding SARE
cases were designed to address potential abuses of the Bankruptcy
Code by certain debtors. Typically, these debtors had one
significant asset composed of improved real estate which was in
foreclosure, one or two secured creditors, few unsecured creditors
with relatively small claims, few or no employees and conducted no
operations other than the maintenance and operation of the real
estate asset. Frustrated mortgagees would find their enforcement
actions stayed on the eve of foreclosure, usually after protracted
and expensive litigation. Thereafter, the mortgagees were required
to wait even longer while debtors attempted to sort out their
financial difficulties, often at the expense of the mortgagees.
The major change proposed by H.R.3150 is to eliminate the
$4,000,000 ceiling on SARE cases and codify the New Value Exception
to the Absolute Priority Rule -- a hotly debated issue over the past
decade. Additionally, the bill clarifies certain aspects of the
Bankruptcy Code's SARE provisions. These clarifications are
necessary because certain cases have tested the SARE provisions and
found them to be open to differing interpretations.
H.R. 3150 ("Bankruptcy Reform Act of 1998")
Small Business Debtor
The small business bankruptcy provisions of the proposed bill
-- sections 321-343 -- are designed to create a "faster track" for
debtors whose liabilities do not exceed $5,000,000 including SARE
debtors with debts of $5,000,000 or less. The provisions of the new
bill modify certain sections of Chapter 11 and create additional
duties of the debtor and the United States Trustee. Most of the
changes shorten various time periods by which debtors are required to
perform certain acts. The appointment of a creditors' committee
remains optional with the bankruptcy court in order to reduce
administrative costs and expedite the Chapter 11 process.
Section 231. ("Definitions.")
Section 101(51C) of the Bankruptcy Code currently defines a
"small business" as one in which the aggregate noncontingent
liquidated secured and unsecured debts do not exceed $2,000,000.
Section 231 of H.R. 3150 would expand the definition of "small
business debtor" in three ways. First, section 231 clarifies that a
small business debtor includes its affiliates. Second, section 231
increases the amount of debt from $2,000,000 to $5,000,000 that may
be carried by a small business debtor. Finally, section 231
expressly includes SARE debtors, except to the extent that such a
SARE debtor, together with its affiliates has aggregate debt greater
The impact of the change. Many more businesses would be
eligible for the small business provisions of the Bankruptcy Code.
Section 232. ("Flexible Rules for Disclosure Statement and Plan.")
Section 1125(f) of the Bankruptcy Code currently provides
liberal rules for disclosure and solicitation of acceptances of a
plan of reorganization which expedites the process by which a small
business debtor may reorganize. Section 232 proposes to add
substantially more flexibility to the requirements of section
1125(f). Specifically, section 232 would grant the court the
flexibility to determine whether a disclosure statement provides
adequate information by weighing the complexity of the case and a
creditor's need for such information against the cost associated with
providing such information. Additionally, section 232 would allow a
court to combine the disclosure statement process with plan
confirmation if the plan provides information that the court deems
adequate for creditors to determine how their claims will be treated.
Section 232 likewise would attempt to expedite the disclosure and
confirmation process for small business debtors by allowing a court
to conditionally approve a disclosure statement.
Section 233. ("Standard Form Disclosure Statements and Plans.")
To promote uniformity in Chapter 11 proceedings of small
business debtors, Section 233 would require the Advisory Committee on
Bankruptcy Rules of the Judicial Conference ("Advisory Committee") to
develop and adopt a standard form of disclosure statement and plan.
Section 234. ("Uniform National Reporting Requirements.")
To balance the streamlined nature of a small business debtors'
Chapter 11 proceeding with the creditors' need for information,
section 234 would create new Bankruptcy Code section 308 which would
require a small business debtor to file periodic financial and other
reports not presently required.
Section 235. ("Uniform Reporting Rules and Forms.")
Section 235 would require the Advisory Committee to propose
amended federal rules of bankruptcy procedure and official forms
consistent with new Bankruptcy Code section 308.
Section 236. ("Duties of Debtor in Small Business Cases.")
Section 236 would create a new Bankruptcy Code section 1115
which would create additional duties for a debtor to provide more
timely information to the courts, its creditors and the Office of the
United States Trustee.
The impact of the change. Section 236 of H.R. 3150 would
impose quicker reporting requirements on debtors absent
"extraordinary and compelling circumstances" as determined by the
bankruptcy judge. The bankruptcy judge retains considerable
Section 237. ("Plan Filing and Confirmation Deadlines.")
Section 237 of H.R. 3150 would amend section 1121(e) of the
Bankruptcy Code to shorten by 30 days the debtor's exclusive period
within which only a debtor may propose a plan of reorganization.
Furthermore, the threshold showing which a small business debtor
would need to establish to extend such exclusive period is
considerably higher and would essentially require a hearing and a
showing by the debtor that it is "more likely than not that the court
will confirm a plan in a reasonable amount of time."
The impact of the change. Like section 236 of H.R. 3150, this
section although continuing to give great discretion to the
bankruptcy judge, indicates Congressional intent that a small
business debtor cases should proceed to confirmation more quickly
than larger cases. Failing this, the creditors will have greater
rights to file their own plan of reorganization or liquidation in a
small business Chapter 11 case.
Section 238. ("Plan Confirmation Deadline.")
Section 238 would mandate that a plan be confirmed within 150
days after the order for relief is entered. The 150 day deadline
could only be extended by the Bankruptcy Judge if the debtor
established that it is "more likely than not that the court will
confirm a plan within a reasonable time period."
The impact of the change. Like sections 236 and 237, section
238 of H.R. 3150 is designed to expedite small business Chapter 11
Section 239. ("Prohibition Against Extension of Time.")
Section 239 would modify section 105(d) of the Bankruptcy Code
by incorporating a higher standard for extension of time in a small
business Chapter 11 case.
The impact of the change. Section 239 would not effect the
level of equitable discretion accorded a bankruptcy judge, it is
merely instructive as to the level of proof which must be maintained
by a small business debtor in order to avail itself of the equitable
powers of the Bankruptcy Court to extend time deadlines. Again, this
indicates Congressional intent that such small business cases should
move more quickly than has occurred in the past.
Section 240. ("Duties of the United States Trustee and Bankruptcy
Section 240 would greatly expand the responsibilities of the
Office of the United States Trustee in small business bankruptcy
The impact of the change. The United States Trustee would
become more involved in the activities of debtors. The United States
Trustee would be responsible for additional tasks and monitoring the
activities of the small business debtor to ascertain whether a plan
is confirmable. In order to ensure effective performance of such
additional duties, the Office of the United States Trustee may need
to be expanded.
Section 241. ("Scheduling Conferences.")
Currently, the Bankruptcy Code allows for optional status
conferences regarding any case or proceeding. Section 241 would make
such status conferences mandatory to the extent they are "necessary
to further the expeditious and economical resolution of the case."
The authority of the Bankruptcy Court to issue orders at such
conferences appears to be expanded by deletion of the limiting
Section 242. ("Serial Filer Provisions.")
Section 242 would create a broad exception to the automatic
stay under new Bankruptcy Code section 362(i). It would allow all
actions described in Bankruptcy Code section 362(a) in a voluntary or
collusive involuntary case if any of the following four conditions
are met: (1) the debtor is already in a pending small business case
when the current petition is filed; (2) the debtor was in a small
business case which was dismissed by a final order for any reason
within 2 years prior to the entry of the order for relief in the
second/current bankruptcy case; (3) the debtor was in a small
business case wherein a plan was confirmed within 2 years prior to
the entry of the order for relief in the second/current bankruptcy
case; or (4) the debtor has succeeded to substantially all of the
assets or business of a small business debtor described in (1), (2)
or (3) unless the debtor can prove that the current bankruptcy filing
is due to circumstances beyond the control of and not foreseeable to
the prior debtor when its case was pending, and that it is more
likely than not that the court will confirm a feasible,
non-liquidating plan within a reasonable time.
The impact of the change. While seeming to address the problem
of serial filings by small businesses by making the automatic stay
inapplicable for bankruptcy filings within 2 years of each other,
Section 242 would not, by itself, prevent delays of a creditor's
actions by serial filings. Assuming that the applicable provision
above is debatable - for example, whether the new debtor succeeded to
"substantially all" of the prior debtor's assets - a creditor would
be unlikely to take action without first obtaining a comfort order
from the Bankruptcy Court. This is because the creditor runs the
risk of losing the litigation concerning the proposed new section
362(i)(4) and thus being sanctioned for willfully violating the
automatic stay pursuant to Bankruptcy Code Section 362(h).
Alternatives. One alternative would be to allow for relief
from the stay or grant comfort orders on an expedited basis unless
the debtor could prove one of the four exceptions listed above.
Additionally, another alternative would be to amend Bankruptcy Code
section 362(h) to provide that it does not apply to creditors who in
good faith believe the automatic stay does not apply because of the
application of Bankruptcy Code section 362(i).
Section 243. ("Expanded Grounds for Dismissal or Conversion and
Appointment of Trustee.")
Section 243 would clarify and codify existing case law
concerning conversion from a Chapter 11 case to a case under Chapter
7 or dismissal of the case pursuant to Bankruptcy Code section
1112(b). Additionally, it would provide for the appointment of a
Chapter 11 trustee if cause existed for conversion or dismissal
pursuant to Bankruptcy Code section 1112.
Single Asset Real Estate Debtor
As noted earlier, the major changes proposed by H.R. 3150, with
respect to SARE debtor cases, are the elimination of the $4,000,000
ceiling for entities that are SARE debtors as well as the
codification of the controversial "New Value Exception" to the
"Absolute Priority Rule." Additionally, the start date for
post-petition payments to mortgage lenders is extended until the
completion of litigation over the issue of whether or not the debtor
is, in fact, a SARE debtor. All these issues have been fonts of
bankruptcy litigation and the proposed changes would only eliminate
litigation over the cap issue. Contested valuation and confirmation
hearings in "New Value Exception" matters as well as litigation over
the SARE status of debtors would continue.
Section 251. ("Single Asset Real Estate Defined.")
Under current law, in order to qualify as a SARE case, the
debtor must have "aggregate noncontingent, liquidated secured debts
in an amount no more than $4,000,000." In addition, SARE status is
presently limited to debtors whose asset is not residential real
property with less than four residential units and whose asset
"generates substantially all of the gross income of [the] debtor and
on which no substantial business is being conducted by [the] debtor
other than operating the real property." Section 251 would eliminate
the $4,000,000 cap for a single project or development but exclude a
debtor whose property is being used by a "commonly controlled" group
of entities, all of which are concurrently debtors in a Chapter 11
case, for a substantial business other than the real estate business.
In short, SARE debtors whose affiliates operate a business on the
debtors' property are not covered. For example, a single purpose
property holding company that leases land to its affiliate which
operates a computer factory on that land would not be considered a
SARE debtor under the new bill.
The impact of the change. The principal change is the
elimination of the $4,000,000 cap.
Alternatives. The cap could be increased instead of being
eliminated. Several other pending bills have addressed this issue.
H.R. 73, if enacted, would also eliminate the $4,000,000 cap. H.R.
764, if enacted, would raise the $4,000,000 cap to $15,000,000. A
$15,000,000 cap would cause many, if not most, real estate developer
cases to be excluded from the SARE provisions. H.R. 764 was passed
by the House of Representatives on November 12, 1997 and received in
the Senate the following day.
Section 252. ("Plan Confirmation.")
Under current law, a plan of reorganization shall be confirmed
if: (a) all the classes of creditors that would receive less than
their full claim under the plan vote in favor of the plan; or (b) if
one such class of creditors votes in favor of the plan and the court
finds that the plan does not discriminate unfairly and is "fair and
equitable" with respect to the classes that would not receive full
payment on their claims under the plan. The latter alternative,
colloquially called a "cram down" among bankruptcy practitioners, is
a classic tactic employed by SARE debtors.
For example, suppose Dan Developer, Inc., a debtor in
possession in a Chapter 11 bankruptcy, owns as its only significant
asset a large apartment complex called Black Acre Apartments worth
$3,000,000. Additionally, assume that the following claims have been
filed against Dan Developer, Inc.: (i) Ace Insurance Corp. claim in
the amount of $4,000,000 secured by a first mortgage on Black Acre
Apartments and (ii) $100,000 in various general unsecured claims.
Because Ace Insurance Corp.'s claim is undersecured, Ace Insurance
Corp. has the right to elect to be treated as having a secured claim
in the amount of $4,000,000 or having a secured claim in the amount
of $3,000,000 and an unsecured claim in the amount of $1,000,000. 11
U.S.C. § 1111(b). Assume that Ace Insurance Corp. elects the
latter treatment and has its claim bifurcated.
Dan Developer, Inc., as a debtor-in-possession, presumably
wants to retain control of the Black Acre Apartments. However, under
what is commonly referred to as the "Absolute Priority Rule," a
junior unsecured claim cannot receive any property or interest in
property unless the unsecured claims senior to that claim receive an
amount equal to the allowed amount of those senior unsecured
claim(s). Therefore, the holder of equity shares in the debtor,
cannot retain their equity interests because Dan Developer, Inc. does
not have enough assets to pay the senior unsecured claims - Ace
Insurance Corp.'s unsecured claim and the general unsecured claims -
their full allowed amounts.
There may be an exception, however. Under the former
Bankruptcy Act of 1898, the Supreme Court established the "New Value
Exception" in Case v. Los Angeles Lumber Products Co., 308 U.S. 106
(1939). The New Value Exception allows debtors to keep their equity
interests, despite the Absolute Priority Rule, if they contribute new
value to the debtor. In re Bonner Mall Partnership, 2 F.3d 899, 908
(9th Cir. 1993), cert. granted, 510 U.S. 1030, case dismissed as
moot, 513 U.S. 118 (1994). Current case law has established five
requirements for the use of the New Value Exception. Id. The new
value must be: (1) new; (2) in money or money's worth; (3)
substantial; (4) necessary; and (5) reasonably equivalent to the
interest retained. Id. It is worth noting that there is significant
controversy over whether the New Value Exception survived the passage
of the Bankruptcy Code in 1978 which codified the "Absolute Priority
Rule" but not the "New Value Exception." See generally 4 Collier on
Bankruptcy ¶ 1129[c] (15th rev. ed. 1998).
In its plan of reorganization, the plan proponent typically
classifies the claims. Returning to our hypothetical, Dan Developer,
Inc. may classify the unsecured claims separately if a court approves
the classification as "reasonable and necessary for administrative
convenience." 11 U.S.C. § 1122(b). Assuming that the New Value
Exception has survived the passage of the Bankruptcy Code, under
current law, Dan Developer, Inc. may propose the following treatment
of claims in its plan of reorganization: Class One, consisting of
administrative expenses such as attorneys fees and United States
Trustee fees will be paid in full out of cash; Class Two, consisting
of Ace Insurance Corp.'s secured claim, will continue as a secured
claim on the property and will be paid according to the existing
contractual payment schedule or an agreed upon payment schedule;
Class Three, consisting of Ace Insurance Corp.'s unsecured claim,
will be paid 10 cents on each dollar of unsecured claim or $10,000;
Class Four, consisting of the general unsecured claims, will be paid
10 cents on each dollar of claims or $10,000; and, Class Five,
consisting of the equity shareholders, will retain their equity
interests in Dan Developer, Inc. and will contribute at least
$500,000 in new value. (Note: there is no bright line test that
determines the necessary amount of new value).
Ace Insurance Corp. will likely vote against the plan because
it would rather own the property and the upside potential rather than
immediately lose $900,000 and have no upside potential. The general
unsecured creditors will vote in favor of the plan. After this vote,
Dan Developer, Inc. will ask the court to "cram down" the plan
pursuant to Bankruptcy Code section 1129(b)(1). This type of plan is
generally referred to as a "New Value - Lien Stripping Plan."
Courts, to date, have "crammed down" or confirmed such a plan over
the objection of secured creditors such as Ace Insurance Corp., Inc.
See generally Matter of 203 N. LaSalle St. Partn., 126 F.3d 955 (7th
Section 252 of H.R. 3150 would amend Bankruptcy Code section
1129(b) to codify the "New Value Exception" in SARE cases. Under
section 252, a New Value-Lien Stripping Plan would be "fair and
equitable" as is required by Bankruptcy Code section 1129 if three
conditions are satisfied. First, the new value must be contributed
on or before the effective date of the plan of reorganization, must
be in cash and must be contributed as equity that cannot be converted
into or exchanged for debt. Second, the new value must be applied on
the effective date towards the reduction of the secured claims to at
least a 75% loan to value ratio. Third, the payments and other terms
for the remainder of the secured debt must satisfy the
then-prevailing local market terms for new loans secured by liens on
similar real estate regarding maturity dates, amortization, interest
rates, fixed-charge coverages and loan documentation.
The impact of the change. There has been considerable
controversy over both whether the New Value Exception has survived
the passage of the Bankruptcy Code, as well as whether the New Value
Exception should be applied to SARE cases, or even any other type of
case. While this section would provide clarity in an area that has
been the subject of considerable litigation, it could circumvent the
"higher and better offer" requirement thereby allowing a debtor to
"purchase" its equity at a price lower than a third party might be
willing to pay for it, to the detriment of the creditors,
particularly to secured creditors. Since the "New Value Exception"
is popular with real estate developers, passage of this provision
would probably lead to more Chapter 11 filings by SARE companies.
Lenders would receive a 25% cushion against further declines in
property values. Lenders would gain no economic benefit if property
values thereafter increased with all such appreciation being retained
by the SARE debtor's owners. This provision would weaken the
Absolute Priority Rule thus giving more leverage to SARE debtors in
Section 253. ("Payment of Interest.")
Section 362(d) of the Bankruptcy Code currently provides that
the Bankruptcy Court shall grant relief from the stay to a creditor
whose claim is secured by an interest in the real property of a SARE
debtor if the debtor has not filed a feasible reorganization plan
within 90 days of the entry of an order for relief, or commenced
monthly payments to the secured creditor by such date. Section 253
would loosen the time restrictions within which a debtor must file
its plan or commence making monthly payments to creditors secured by
the real estate and modify Bankruptcy Code section 362(d) in two
ways. First, section 253 specifies that relief from the stay will
not be granted until after the later of the 90 day period or 30 days
after a determination is made by the court that the debtor qualifies
as a SARE debtor. Section 253 clarifies that the monthly payments
that the debtor must make to the secured creditor may be made from
rents generated from the property. Additionally, section 253
provides that the interest rate used to calculate payments is the
then applicable nondefault contract rate, rather than the "current
fair market rate" as now specified.
The impact of the change. This proposed change delays the
commencement of monthly payments by a SARE debtor (or lifting of the
stay) until 30 days after the Bankruptcy Court decides the issue of
whether the debtor is a SARE debtor. Since this issue will be hotly
litigated, the 90 days rule will rarely come into play from the day
of the order for relief or the 90th day thereafter to avoid tactical
litigation over SARE status merely aimed at delaying the start date
for the payment of interest.