PLENARY SESSION: SMALL BUSINESS
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.
BIFURCATED SESSION:
UNITED STATES TRUSTEE PROGRAM
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.
BIFURCATED SESSION: FUTURE CLAIMS
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.
AMERICAN BANKRUPTCY INSTITUTE
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."
NATIONAL BANKRUPTCY CONFERENCE
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.
OPEN FORUM: PANEL ON CONSUMER BANKRUPTCY
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
