Viewpoint/Daily Bankruptcy Review: July, 2005

Bankruptcy Reform: Take a Deep Breath and Step Down from the Ledge

John D. Penn

On April 20, 2005, bankruptcy practice dramatically changed with the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Act”). In various presentations around the country, you hear pleas by various groups for a “return to the good old days,” even before the ink had dried at the signing ceremony. Some groups call for Congressional action before the vast majority of the changes are effective on October 17. Others predict that debtors will not be able to find attorneys to file their cases and get whatever limited relief is available. Since bankruptcy professionals are among the best and brightest when it comes to finding ways to deal with apparently insurmountable challenges, I am confident that my colleagues around the nation (and the judges before whom they appear) will find creative ways to deal with all of the new rules that Congress imposed.

Without a doubt, the Act represents a big swing of a pendulum, and all pendulums naturally seek a sense of balance. The Bankruptcy Code was perceived by Congress as a move in favor of debtors. The equilibrium between debtors and their creditors will hang somewhere between debtors’ prison and easily discharging all debts every seven years. It will linger somewhere between businesses being tossed into receivership, followed by liquidation and having discharge-cleansed corporations readily available for their securities to trade. Exactly where the equilibrium will rest—and how long it will last—is anyone’s guess.

Before demanding more changes, everyone in the bankruptcy and reorganization world should take a deep breath and a larger view of this change to see what actually happens. Changes should be based on actual events and practice rather than fears or projections of what might occur.

For example, a number of attorneys and our professional associations have protested loudly about the provisions exposing attorneys to potential liability for errors in a debtor’s schedules of assets and liabilities. Strangely absent from the protests is any comparison to the consequences of a party filing an affidavit (or verification under penalty of perjury) reciting false information in federal civil litigation. If the consequences of such a filing in a federal district court are significantly different from a similar act in the federal bankruptcy court, there must be a clear justification for that disparity. If the consequences are, or can be, the same, those complaining should both demonstrate that disparity and work to standardize the responsibility for all attorneys in all federal civil litigation, including bankruptcy cases.

Likewise, credit card companies were villianized by some during the numerous sessions of Congress that considered bankruptcy reform. It remains to be seen whether their bankruptcy-related charge-offs increase or decrease since the limiting “lien stripping” on vehicles, among other changes, might actually shrink the distributions they anticipated receiving.

The “means test” may or may not be a “show stopper,” since no one knows what percentage of potential debtors are actually affected. The early projections by an academic study funded by the American Bankruptcy Institute indicated that it could affect less than 5 percent of the total filings.

The much larger question for our society as a whole becomes one of personal responsibility. Everyone wants to be relieved from the effects of decisions and actions that turn out poorly (whether or not the outcome was foreseeable). Does requiring people who can pay their creditors something to make some payments before the balance is discharged increase or decrease our society’s sense of personal responsibility? Will requiring many debtors to make some payment actually result in creditors being relieved from responsibility for some poor credit decisions?

It is entirely possible that a) the changes are not actually as “earth-shattering” as they are hyped to be, b) the Act’s sponsors might not like the unintended consequences that will flow from the changes, c) professionals may find many ways around the Congressional “intent” by creatively applying (and strictly construing) the language of the Act itself or d) there could be different outcries for change after we have actually practiced under the Act for a while.

Examples of how the Act could be implemented in creative ways on the commercial bankruptcy side include:

• “Critical vendor” orders becoming either commonplace or extinct (since suppliers will receive an administrative expense claim for goods delivered during the 20 days before a bankruptcy and courts generally allowing payment of administrative and priority claims before plan confirmation);
• “Chapter 18” cases spiking because companies determine that they can best sell their assets in chapter 11 and then convert to a chapter 7 to distribute any proceeds when they realize that the newly minted administrative priority expenses preclude confirming a chapter 11 plan;
• The 210-day time to assume or reject non-residential real property leases being used as a weapon against landlords who must make quick decisions about whether to work with a debtor or “eat dirt” by having an empty building returned to them;
• The enhanced rights of utility companies (to require cash or near-cash deposits) being addressed in “mega-cases” by creating a “pool” of cash to secure all utility deposit obligations rather than having to deal with each utility separately; and
• Investment bankers declining engagements where they would have previously been automatically disqualified (as an underwriter or investment banker for a debtor’s outstanding securities) when they realize that their participation might require a “Pillowtex”-type, early evaluation as part of their engagement to see whether disqualifying claims against them exist from their prior work.

These are but a few of the possible effects that may or may not materialize once the Act is fully effective in October. While only time will tell how bankruptcy professionals adapt to the new environment, we can be certain that there will be adaptations. Until we see how the Act works, or does not work, lobbying for even more changes (to either “go further” or to “go back”) is premature.

About the Author

John D. Penn is a partner at Haynes and Boone LLP in Fort Worth, Texas, and the president of the American Bankruptcy Institute. He is board-certified in business bankruptcy law by both the Texas Board of Legal Specialization and the American Board of Certification. Mr. Penn received his B.B.A. from Baylor University and his J.D. from the Baylor University School of Law.