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News Room

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

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

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

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

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

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

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

A.THE COST OF THE PLAN AND DISCLOSURE PROCESS

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

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

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

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

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

B.LACK OF CREDITOR PARTICIPATION

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

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

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

C.CASES WITH NO GENUINE PROSPECT OF REORGANIZATION

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

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

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

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

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

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

D. DELAY IN THE CHAPTER 11 PROCESS

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

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

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

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

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

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

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

II. THE SMALL BUSINESS PROPOSAL: CONTENTS AND DEVELOPMENT

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

A.DEFINITION OF "SMALL BUSINESS"

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

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

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

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

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

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

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

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

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

The current bankruptcy-law definition of small business sets the eligibility limit at $2,000,000 in aggregate, noncontingent, liquidated secured debts. [ FN: 11 U.S.C. õ 101(51C) (1994).] Based on available liabilities data from two of the ninety-four total bankruptcy districts, a liabilities-based definition of $2,000,000 or less wouldcapture approximately 72%of all chapter 11 cases filed. Tables which detail this finding and break down liabilities and "gross amount of income" by million dollar categories are provided below:
Liabilities on petition date% of chapter 11 "small business" debtors
M.D. Ala.S.F/Santa RosaDel.Phila.ChicagoDallasAverage
$10,000,000100%94%16%92%96%82%93%**
$5,000,00093%92%15%87%88%72%86%
$4,000,00093%89%14%85%85%71%85%
$3,000,00093%86%13%80%80%65%81%
$2,000,00083%74%13%73%73%59%72%
$1,000,00070%53%13%65%65%49%60%

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

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

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

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

"Gross amount of income" on petition datePercentage of chapter 11 "small business" debtors
S.F/Santa RosaDel.Phila.ChicagoDallasAverage
10,000,00098%76%99%95%92%96%
5,000,00097%67%96%91%87%93%
4,000,00095%67%96%88%85%91%
3,000,00094%65%96%83%82%89%
2,000,00091%62%91%79%77%85%
1,000,00078%58%76%71%65%73%
** [ FN: It is unclear whether these data reflect a high percentage of debtors with low income levels or the high percentage of cases in which income information is missing from the debtor ’ s schedules and statements. It is also unclear whether these data are meaningful given the ambiguity concerning the definition of " gross amount of income " in the Statement of Financial Affairs. See supra notes 51-53 and accompanying text.]

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

Although these data represent only a small percentage of all bankruptcy districts, and may not be generalizable to the population of chapter 11 debtors, it would appear that defining small business as one with three to five million dollars in debt would capture approximately 81-86% of all chapter 11 cases.

B.REDUCING COST AND DELAY

1.Disclosure Statement and Plan: Flexibility, Standard Forms, Statutory Deadlines

Lifting onerous disclosure requirements is an important step forward in making chapter 11 more efficient for small businesses. Accordingly, the Working Group proposes several recommendations. First, the courts, after notice and a hearing, should have the power to waive ormodify the disclosure requirements to adapt them as appropriate on a case-by-case basis. [ FN: Although courts already have power to modify the disclosure statement and plan confirmation process under 11 U.S.C. õ 105(d)(2)(B), this power would be both expanded and modified to require that the small business debtor file and confirm a plan of reorganization within, respectively, 90 and 150 days.] Second, the Advisory Committee on Bankruptcy Rules of the Judicial Conference ("Rules Committee") should promulgate standard-form disclosure statements and plans of reorganization for small business debtors. [ FN: These forms should be compatible with current statistical database systems and designed to facilitate the collection of reliable data.]

In small chapter 11 cases, the drafted-from-scratch, prospectus-type disclosure statement and separate disclosure hearing are not cost-effective. The high costs of this process are simply greater than most debtors can bear, and do not yield information to creditors that could not otherwise be provided by use of a standard form. Indeed, standard forms increase the likelihood that all required topics will be covered, as they are easier to use than custom-created documents. [ FN: See The Honorable Elizabeth L. Perris, " Letter to John Gose Regarding the chapter 11 Special Track " (Feb. 18, 1997).] To minimize a debtor’s inadvertent failure to disclose significant information, the standard forms would provide a blank for other material information critical to making a decision on how to vote. [ FN: Id . Such forms have been successfully created and used in the District of Oregon.] For all relevant compliance purposes, including compliance with applicable securities laws, these standard forms would serve as "safe harbors" for debtors electing to file them, but would not preclude any debtor from deviating from the forms, as long as the alternate filing complied with applicable requirements.

In addition to simplifying the disclosure process, the Working Group proposes to reduce cost and delay by requiring the debtor to promptly file and confirm a plan of reorganization on an expedited basis. Reducing time spent in chapter 11 has a predicted effect of reducing the direct and indirect costs of administering a chapter 11 case, and thereby preserving assets for distribution to unsecured creditors. [ FN: But see Jim Kakalik, Just, Speedy and Inexpensive? Summary of Main Findings , 5 F ACTS & T RENDS , R AND I NSTITUTE FOR C IVIL J USTICE (April 1997) (finding that reducing time to disposition through case-management procedures has a limited role in reducing litigation costs).] Ninety days is a reasonable amount of time to allow the debtor to develop a feasible plan, [ FN: Existing chapter 12 also requires the debtor to file a plan no later than 90 days after the order for relief. 11 U.S.C. õ 1221 (1994). But see , The Honorable Geraldine Mund, " Letter to the National Bankruptcy Review Commission Regarding the Proposal of the Small Business Working Group Dated March 27, 1997 " (May 13, 1997) ( " It seems to take about 45 days for the 341(a) hearing, and I believe that 90 days is simply too short for the debtor to prepare a quality product. I found that 120 days was more reasonable. " ).] which can often not be developed until one or more events occur, such as negotiatingterms for restructuring secured debts, finding a new source of capital, or decreasing the vacancy rate of rental properties. [ FN: Terrance L. Stinnett, " Letter from Goldberg, Stinnett, Meyers & Davis Regarding the Small Business Working Group Proposals " (Nov. 22, 1996).] Moreover, early in a chapter 11 case, the debtor is preoccupied with schedules to prepare, motions to employ professionals, cash collateral motions, and the like. [ FN: E.g. , William C. Beall, " Letter from Beall & Burkhardt to the National Bankruptcy Review Commission Regarding the Small Business Working Group Proposal " (Jan. 13, 1997).] Finally, a debtor whose books and records have not been properly maintained may need several months to develop a plan which complies with the Bankruptcy Code’s confirmation requirements. [ FN: National Bankruptcy Review Commission: Hearings Before the Working Group on Small Business Bankruptcy (Sept. 19, 1996) (testimony of Judge Lisa Hill Fenning).] To ensure that the court promptly concludes the plan-confirmation process, the Working Group proposes to require the court to rule on the plan within sixty days of the date on which the plan was filed. [ FN: See 11 U.S.C. õ 362(e)(1994) (requiring the court to rule on a request to modify the stay within thirty days).] Allowing the court sixty days to make a ruling appropriately balances the important need for creditors to receive notice of the plan confirmation hearing and adequate time to review the plan and prepare objections, and the need to reduce delay in the plan confirmation process.

2. Extensions of Deadlines and Shifting the Burden of Proof

Some debtors who will be able to successfully emerge from chapter 11 will need extensions of the disclosure statement and plan filing deadlines. These deadlines are not intended to derail valid reorganization efforts, but rather to achieve early dismissal or conversion of those cases which have no genuine prospect of confirming a plan, and therefore no business benefitting from the protections of chapter 11. To implement this concept, the Working Group proposes that debtors requiring deadline extensions must bear the burden of proof to establish entitlement thereto by a "more likely than not" standard.

This standard has been designed to introduce, early in the case, an analysis of the debtors business viability and prospects for feasibility. This standard is not thought to be highly onerous. It would require any debtor needing an extension to bear the burden of coming forward and of persuasion to establish, by a preponderance of the evidence, that the debtor has more than a fifty percent chance of confirming a plan. A frame of reference for the court to use in making this finding would be whether in a hypothetical sample of fifty cases substantially similar to that before the court, at least twenty-six would confirm a plan.

3.Scheduling Conferences

Whether to require the court to hold at least one status conference has sparked controversy. Proponents of a mandatory, on-the-record status conference agree with the Working Group that such a conference would quicken the pace for disposition of a chapter 11 plan [ FN: See, e.g. , American College of Bankruptcy, " Questionnaire Based on Focus Group Reports " (Jan. 31, 1997); see also Terrance L. Stinnett, " Letter from Goldberg, Stinnett, Meyers & Davis Regarding the Small Business Working Group Proposals " (Nov. 22, 1996); see also Jim Kakalik, Just, Speedy and Inexpensive? Summary of Main Findings , 5 F ACTS & T RENDS , R AND I NSTITUTE FOR C IVIL J USTICE (April 1997) (finding that case-management procedures have a substantial effect on time to disposition, but a limited role in reducing litigation costs).] by involving the power and prestige of the court and the authority inherent in court orders. [ FN: See The Honorable Elizabeth L. Perris, " Letter to John Gose Regarding the chapter 11 Special Track " (Feb. 17, 1997)( " One of the purposes of the scheduling conference is to inventory the impediments to confirmation and to set deadlines for the debtor to act to remove those deadlines. Such deadlines may include, without limitation, the filing of past-due prepetition tax returns, the commencement of litigation, or the filing of a claim objection. " ).]

Data from the Central District of California support required conferences. [ FN: See The Honorable Samuel L. Bufford, chapter 11 Case Management and Delay Reduction: An Empirical Study , 4 A M . B ANKR . I NST . L.R. 85 (1996).] In a study of chapter 11 cases filed over a six-year period, Judge Bufford found that case management techniques of one judge, the Honorable Geraldine Mund, [ FN: Judge Mund followed the process developed by the Honorable A. Thomas Small, described below.] (applied to 81.2% of chapter 11 cases), which did not include a judicial status conference, shortened by 24.1% the time to confirmation of a plan; reduced by 44.1% the time to conversion to a case under another chapter; and shortened by 53.4% the time to dismissal of a typical nonviable chapter 11 case. [ FN: Id . at 85, 113-14.] In a more expansive study of the case management techniques of six judges, Marcy J.K. Tiffany, U.S. Trustee for Region XVI, challenged Judge Bufford’s conclusions, attributing a portion of delay reduction to general case management techniques, a portion to judicial status conferences, and the another part to the active role of the U.S. Trustee. [ FN: Marcy J.K. Tiffany, Fast Track, Statistics and Delay Reduction: A Comparative Analysis at 18-20 (unpublished manuscript on file with the author and the National Bankruptcy Review Commission)(Oct. 11, 1996).] According to Ms. Tiffany’s data, the most dramatic decreases in the days to dismissal of a chapter 11 case resulted from a combination of U.S. Trustee motions and judicial status conferences. [ FN: Id. at 20-21.]

A number of commentators, however, including one member of the Commission, have challenged these conclusions, arguing that status conferences are an administrative duty that shouldbe performed by U.S. Trustees, rather than resource-strapped judges. [ FN: E.g., National Bankruptcy Review Commission: Plenary Hearings (Feb. 21, 1997)(testimony of The Honorable Robert E. Ginsberg).] One commentator, the Honorable A. Thomas Small, supported his criticism of mandatory status conferences with data from chapter 11 cases filed in the Eastern District of North Carolina from October, 1992 to October, 1996. Based on these data, Judge Small concludes that chapter 11 cases can be effectively managed without "elaborate and expensive conferences." [ FN: The Honorable A. Thomas Small, " Letter to Stephen H. Case and the National Bankruptcy Review Commission Regarding the Small Business Proposal " (Feb. 21, 1997).] Rather than hold routine status conferences to expedite the processing of chapter 11 cases, Judge Small, like Judge Mund, implements several simple procedures: (i) entry of an order at the outset of the case setting a plan confirmation deadline; (ii) conditional approval of the disclosure statement; and (iii) a combined hearing on the disclosure statement and plan confirmation. [ FN: The Honorable A. Thomas Small, supra note 33.]

There is no question that Judge Small and his colleagues expeditiously and successfully administer chapter 11 cases in their district. For example, Judge Small’s data reveal a remarkably high confirmation rate of 68.3%, and a quick confirmation speed of 7 months, as opposed to a 12.5 month confirmation speed in the Central District of California. With respect to dismissed chapter 11 cases, the average speeds from filing to dismissal in the Eastern District of North Carolina and the Central District of California are comparable at, respectively, 5.6 months and 5.3 months. Thus, with respect to confirmation and dismissal speeds, one possible conclusion is that status conferences are irrelevant to effective case management.

Comparison of conversion speeds, however, reveals that chapter 11 cases in the Central District of California are dismissed at a significantly faster pace, 5 months, than are chapter 11 filings in the Eastern District of North Carolina, where the conversion speed is 9 months. Interestingly, prior to implementation of judicial status conferences and the increased activity of the U.S. Trustee in the Central District of California, the "conversion speed" of chapter 11 cases in the Central District of California was also nine months. Thus, it would appear from these limited samples that status conferences can significantly reduce delay in at least one class of chapter 11 debtors, i.e., those which should have filed chapter 7 at the outset.

Based on the data as well as anecdotal evidence, the Working Group has concluded that judges should be required to promptly hold at least one on-the-record status conference for chapter 11 debtors. [ FN: See The Honorable Elizabeth L. Perris, " Letter to John Gose Regarding the chapter 11 Special Track " (Feb. 18, 1997).] No status conference would be required however, if the debtor and U.S. Trustee were able to file an agreed scheduling order with the court prior the judicial scheduling conference. Thestatus conference or the agreed order will serve an important function of inventorying any impediments to confirmation and scheduling the resolution of those impediments early in the proceeding.

4.Require Proof of Fact for Certain Serial Filers as Condition for Application of the Automatic Stay

The Working Group has considered problems that might be created if certain debtors, e.g. those whose cases were dismissed owing to failure to prove entitlement to extensions, simply refile a chapter 11 case. Unregulated, seriatim refilings would completely undermine the purpose of the small business rules. The Working Group has concluded that a stringent prohibition on re-filing is not justified, however, since genuine changes in circumstances may have occurred to justify another trip to the courthouse. Accordingly, the Working Group proposes a limited rule, applicable only to small business debtors who file a second case while the first case is pending or in the event that the it again becomes a debtor in a chapter 11 case within two years after an order of dismissal in the prior case has become a final order or a plan has been confirmed. In these cases, the debtor would be denied the protection of the section 362(a) stay unless, after it becomes a debtor, it bears the burdens of coming forward and of persuasion, by a preponderance of the evidence, that (1) the new case has resulted from circumstances beyond the control of the debtor and (2) the debtor is more likely than not to confirm a chapter 11 plan, other than a liquidating plan, within a reasonable time. In cases involving such debtors when the owners have transferred the business to a new legal entity, owned and managed by them, the section 362(a) stay would apply on filing but would be lifted on verified, ex parte motion of the U.S. Trustee or any party in interest, with the right to have it reimposed upon a demonstration of (1) and (2) above. The Federal Rule of Civil Procedure governing injunctions would apply to the court’s award of a stay to the debtor. [ FN: F ED . R. C IV . P. 65.]

C.IDENTIFYING CHAPTER 11 CASES WITH NO GENUINE PROSPECT FOR REORGANIZATION

Perhaps the most difficult problem in reforming chapter 11 for small business cases is to find a way to identify both promptly and reliably those cases that have no genuine prospects for reorganization. It is important to preserve and protect the benefits of chapter 11 to those debtors with genuine rehabilitation prospects. It is also important to limit the exceptional privileges of chapter 11 to those cases in which creditors and the public benefit thereby.

Under current law it is easy to file a non-meritorious chapter 11 case, but sometimes hard to remove such a case from chapter 11. A business about to file bankruptcy is strongly encouraged to file under chapter 11, whether or not it has any genuine prospect for rehabilitation. This is so because a chapter 11 debtor gets the benefit of a special form of preliminary injunction, the automatic stay, while keeping control of all its assets, without making any initial showing of likelihood of confirminga plan of reorganization. In all other fields of American law, a party seeking preliminary injunctive relief must establish a likelihood of prevailing on the merits. [ FN: E.g.,Rodriguez v. United States of America , 66 F.3d. 95, 97 (5 th Cir. 1995), cert. denied , __ U.S. __116 S.Ct. 1058, 134 L.Ed.2d 202 (1996).] chapter 11 reverses this usual burden of proof by imposing a heavy burden on a party seeking to dismiss a chapter 11 case, convert it to chapter 7, or appoint a chapter 11 trustee. Many courts have held that any such action against the debtor-in-possession is an "extraordinary remedy." [ FN: E.g. In re Fisher & Son Inc. , 70 B.R. 7, 8 (S.D. Ohio 1986) ] This reversal of the ordinary burden of proof is not justified by the aggregate success of chapter 11 cases. As noted previously, only about fifteen percent of chapter 11 cases result in confirmation of a plan. [ FN: See supra note 13 and accompanying text.]

The proposal adopts a burden of proof halfway between existing chapter 11 practice and the burden of proof imposed on nondebtor litigants seeking injunctive relief against creditor action. A debtor could continue to file under chapter 11 and get the benefit of the automatic stay without making any initial showing of likelihood of confirming a plan. If the debtor failed to meet certain benchmarks while in chapter 11, however, the burden would shift to the debtor to establish a likelihood of confirming a plan within a reasonable period of time.

1.Establishing Statutory Benchmarks of Cases Unlikely to Confirm a Plan

Section 1112(b) of the Bankruptcy Code, which governs conversion or dismissal of a chapter 11 case, already establishes a number of benchmarks of likely failure. [ FN: Section 1112(b), as originally codified, set forth nine examples of cause for conversion or dismissal of a chapter 11 case. L AWRENCE P . K ING , 7 C OLLIER ON B ANKRUPTCY ô 1112.04[5], 1112-30, 48-49 (15 th ed. 1996) .] The Working Group recommends adding additional benchmarks to the current non-exhaustive list of ten examples of "cause" enumerated in section 1112(b). The party seeking conversion or dismissal (a creditor or the U.S. Trustee) would be required to show a material act, omission, or event identified in amended section 1112 as "cause" for conversion or dismissal. Moreover, if the moving party met this initial burden of proof, the burden would then shift to the debtor to show: (1) adequate justification or excuse for any act or omission of the debtor constituting "cause;" (2) that any such act or omission will be corrected promptly; and (3) that it is more likely than not that the debtor will confirm a plan within a reasonable period of time. If the debtor failed to establish this burden, the case would be converted or dismissed, or a chapter 11 trustee appointed. [ FN: Section 1104 would also be amended to provide that the court could order the appointment of a chapter 11 trustee where grounds to convert or dismiss exist but the court determines that appointment of a chapter 11 trustee is in the best interests of the estate.] The many witnesses who testified before the Small Business Working Group helped the working group identify the following benchmarks thatindicate likely failure of the chapter 11 case or that otherwise justify requiring the debtor to show that confirmation of a plan is likely.

a.Postpetition losses

A debtor who continues to incur losses postpetition should be watched very closely by the U.S. Trustee and the bankruptcy judge. Not only do postfiling losses make reorganization less likely, but they also diminish the assets available to pay creditors. Section 1112 now provides for conversion or dismissal where there are continued postpetition losses and the moving party establishes that there is no reasonable likelihood of reorganization. [ FN: See 11 U.S.C. õ 1112(b)(1) (1994).] Additional "causes" for conversion should include losses that are either continued or otherwise "significant," and once such losses are established, the burden should fall upon the debtor to show that reorganization is likely.

b. Failure to Provide Adequate and Timely Financial Disclosure

A major objective of the Working Group has been to improve techniques for early identification of those debtors which have a reasonable probability of succeeding in chapter 11 and those which do not. Under present practice, fulfillment of this objective is sometimes difficult because basic business data about the enterprise are often not available. The majority, but not all, of jurisdictions require the prompt and regular filing of useful financial reports. Furthermore, while some courts have held that a debtor’s failure to file monthly operating reports or other essential financial documentation constitutes cause to dismiss or convert a chapter 11 case, [ FN: See In re Tornheim , 181 B.R. 161, 164 (Bankr. S.D.N.Y. 1995)(concluding that, although not specifically enumerated, the debtor ’ s failure to file monthly operating reports as required by the United States trustee may constitute cause for dismissal), appeal dismissed , 1996 WL 79333 (S.D.N.Y. 1996);In re Great American Pyramid Joint Venture , 144 B.R. 780, 790 (Bankr. W.D. Tenn. 1992) (failure to file monthly operating report).] nothing in the Bankruptcy Code or Rules expressly requires routine financial reporting during the pendency of a proceeding. [ FN: Federal Rule of Bankruptcy Procedure 2015 imposes only the following minimal duties on the chapter 11 debtor to keep records, make reports, and give notice of its bankruptcy filing. The duties are imposed at the discretion of the court and, apart from the unlikely possibility of dismissal or conversion under section 1112(b), there are no sanctions for failure to comply with the rule: (a) Trustee or Debtor in Possession. A trustee or debtor in possession shall (1) . . . if the court directs, in a chapter 11 reorganization case file and transmit to the United States trustee a complete inventory of the property of the debtor within 30 days after qualifying as a trustee or debtor in possession, unless such an inventory has already been filed; .(2) keep a record of receipts and the disposition of money and property received; . . . (4) as soon as possible after the commencement of the case, give notice of the case to every entity known to be holding money or property subject to withdrawal or order of the debtor . . .; (5) in a chapter 11 reorganization case, on or before the last day of the month after each calendar quarter until a plan is confirmed or the case is converted or dismissed, file and transmit to the United States trustee a statement of disbursements made during such calendar quarter and a statement of the amount of the fee required pursuant to 28 U.S.C. õ 1930(a)(6) that has been paid for such calendar quarter. . . (d) Transmission of Reports. In a chapter 11 case the court may direct that copies or summaries of annual reports and copies or summaries of other reports shall be mailed to the creditors, equity security holders, and indenture trustees. . . F ED . R . B ANKR . P . 2015 (1991).] Thus, the Working Group proposes to amend the Bankruptcy Code or Rules toexpressly require the periodic filing of financial and other reports, such as monthly operating reports, and the filing of schedules and statements within thirty days postpetiion. [ FN: The March 27 version attached as exhibit " 1 " an example of a monthly operating report.] Such reporting will assist the U.S. Trustees and the court in determining the appropriateness of dismissal or conversion of a case.

Providing for dismissal or conversion of a debtor which is unable to perform certain basic duties, such as failing to disclose financial information, is appropriate because such debtor is unlikely to survive as an on-going concern. [ FN: National Bankruptcy Review Commission: Plenary Hearings (Feb. 21, 1997)(testimony of Commissioner Jay Alix) at 111.] Failure to enforce reporting obligations harms both debtors, who may not learn valuable accounting skills, but it also deprives creditors of important economic information about the debtor which is needed to evaluate the feasibility of the debtor’s plan. From a public policy perspective, it is only fair to require debtors, who enjoy the privilege of a broad injunction, to disclose information to creditors and the court. [ FN: See, D ISCUSSION O UTLINE , N EW M ONTHLY O PERATING R EPORT R EQUIREMENTS U NITED S TATES B ANKRUPTCY C OURT -- N ORTHERN D ISTRICT OF C ALIFORNIA , Jan. 1, 1995. This outlines explains the dual purpose of the monthly operating report: The first [purpose] is to provide factual information to the creditors, the judges, and the Office of the United States Trustee regarding the financial progress of the debtor. The operating report is designed to provide a broad overview of the progress of the debtor toward effectuating a plan. The second purpose is to benefit the debtor. The reason many businesses find themselves in chapter 11 is that they lack financial discipline and/or financial expertise. By having the operational report due monthly, the debtor is forced to stop and review the financial occurrences of the past month. By having the operating report in a comparative format, hopefully the debtor will begin to view the current months trends in context to the prior months.]

c.Failure to File Tax Returns, [ FN: 28 U.S.C. õ 960 provides as follows: Tax Liability. Any officers or agents conducting any business under authority of a United States court shall be subject to all Federal, State and local taxes applicable to such business to the same extent as if it were conducted by an individual or corporation.] Maintain Current Insurance and Timely Pay Administrative Expense Tax Claims [ FN: The Commission rejected the notion that the debtor must be current on all administrative expense claims as a condition to continued enjoyment of chapter 11.]

Once a debtor files a chapter 11 petition, the automatic stay protects the debtor from actions by creditors, and allows the debtor a breathing spell during which to reorganize its affairs in an orderly manner, under the supervision and protection of the court. In these circumstances, the debtor should be able to comply with basic obligations of its business, such as filing tax returns and maintaining current insurance. Debtors who are unable to meet their minimal obligations under protected circumstances are also unlikely to be able to do so once their daily activities return to normal. Indeed, witnesses noted a high anecdotal correlation between failure to (i) file postpetition tax returns, (ii) pay postpetition taxes, [ FN: Some courts have held that failure to pay postpetition taxes may constitute cause to convert or dismiss under section 1112(b). See, e.g., Berryhill v. United States (In re Berryhill ), 189 B.R. 463, 466 (N.D. Ind. 1995).] or (iii) maintain current insurance and failure to confirm a plan of reorganization. [ FN: See Philip J. Hendel, " Position Paper to the National Bankruptcy Review Commission Proposing Expanded Use of chapter 13 to Include Closely Held Corporations and Other Business Entities " (Dec. 17, 1996) ( " When no creditors ’ committees are formed in smaller cases, a substantial administrative burden is imposed on the United States Trustee to monitor these cases in the public interest. Unfortunately, there are the cases that frequently present compliance problems such as non-payment of taxes, failure to file accurate or timely reports, failure to report cancellation of insurance, etc. . . There are usually substantial administrative fees and expenses that have been paid to the professionals. " ).] In addition there was a consensus among the witnesses that it is reasonable to require a chapter 11 debtor-in-possession to meet these obligations in return for the protections of chapter 11. As noted above, failure to meet these obligations would not result in automatic conversion, dismissal, or appointment of a trustee, but would require the debtor to show that it was likely to confirm a plan within a reasonable time.

d.Failure to Create Segregated Deposit Accounts

The Working Group has received considerable anecdotal data supporting its conclusion that numerous debtors, suffering from cash shortages, finance their day-to-day operations by using cash withheld from employee paychecks or sales-tax revenues, or other like "trust fund" taxes, to pay bills and provide the business with working capital. This chronic problem is often witnessed by chapter7 trustees in cases converted from chapter 11. [ FN: E.g. , J. James Jenkins, " Letter to the Commission regarding the Small Business Proposal " (April 14, 1997) (noting that in the typical converted small chapter 11 case there is no cash, wages are unpaid, payroll and sales taxes are unpaid, valuable property has ben foreclosed upon, sold or is missing, employees are disgruntled, there may be allegations of theft, assumed executory contracts have created increased postpetition claims, professional fees are unpaid, tax returns are delinquent, and there are pre-planned foreclosures or other transactions which are benefitting insiders).]

The Working Group proposes to remedy this abuse by requiring all small business debtors to establish, promptly after the petition is filed, segregated bank accounts for timely deposit of tax funds withheld or collected from third parties after the commencement of the case. This requirement will not pose problems for well managed debtors who, in or out of chapter 11, would never use third-party tax funds for working capital. The Working Group’s proposed requirements would thus stop the practice of using government money for unauthorized business loans.

2.Enlarged Supervisory and Monitoring Role for U.S. Trustees and Bankruptcy Administrators

Although many U.S. Trustees actively, carefully, and professionally supervise chapter 11 debtors in possession and ensure prompt disposition of chapter 11 proceedings, no statute imposes any clear duty to do so. The Working Group has proposed to remedy this deficiency in several ways.

To expedite the identification of cases that are unlikely to reorganize and expedite the administration of small business cases, the U.S. Trustee will play a more active role throughout the chapter 11 proceeding. At case commencement, the U.S. Trustee will be called upon to hold an "initial debtor interview" ("IDI") with the debtor. The IDI is an informal forum, attended by the debtor and, if applicable, the debtor’s attorney, the general purpose of which is to familiarize the debtor with its chapter 11 obligations and the role of the U.S. Trustee, and to familiarize the U.S. Trustee with the debtor’s case. The IDI also provides an opportunity for the U.S. Trustee and the debtor to jointly review the accuracy of the debtor’s schedules and statements, determine the debtor’s reorganization "game plan," and agree to a scheduling order. In advance of the IDI, the U.S. Trustee will require the debtor to create a debtor-in-possession bank account, including separate deposit accounts for taxes collected or withheld by the debtor for governmental units, and to obtain current insurance for the debtor’s business.

In appropriate cases, the U.S. Trustee will visit and inspect the debtor’s business premises. It is intended that the U.S. Trustee has discretion about which debtors to visit and when. The Working Group considers this flexibility important. In fulfilling its duties, the U.S. Trustees will develop standards and guidelines about how and when to use their resources in conducting visitations in order to maximize the benefits of this effort. The U.S. Trustee will diligently review and monitor small business debtors to ensure compliance with required financial reporting.

III. DETAILED TEXT OF PROPOSAL

A.DEBT-BASED DEFINITION

Define "small business debtor" as (1) any debtor in a case under chapter 11 (including any group of affiliated debtors) which has aggregate noncontingent, liquidated secured and unsecured debts as of the petition date or order for relief of five million dollars ($5,000,000) or less [ FN: This dollar figure will be periodically adjusted for inflation pursuant to 11 U.S.C. õ 104(a) which provides as follows: The Judicial Conference of the United States shall transmit to the Congress and to the President before May 1, 1985, and before May 1 of every sixth year after May 1, 1985, a recommendation for the uniform percentage adjustment of each dollar amount in this title and in section 1930 of title 28. 11 U.S.C. õ 104(a) (1994).] or (a menu of options of three million dollars ($3,000,000), five million dollars ($5,000,000), or ten million dollars ($10,000,000) or less [ FN: The issue of a menu of choices for selecting a debt amount to define small business, and how such a menu would be structured still need to be resolved. The Working Group will more fully explain this concept at the June 19- 20 meeting of the Commission in Detroit, Michigan.] and 2) any single asset real estate debtor as defined under title 11 of the United States Code [ FN: 11 U.S.C. õ 101(51B).] ("Bankruptcy Code" or "Code"), regardless of the amount of such debtors liabilities.

B.AUGMENT THE RESPONSIBILITIES OF THE DEBTOR-IN-POSSESSION

Amend the appropriate sections of the Bankruptcy Code to require the debtor to comply with the enhanced responsibilities described below:

(1) Require the debtor [ FN: As used herein, " debtor " includes the debtor, the debtor-in-possession and the trustee, if any.] to append to the voluntary petition or, in an involuntary case, to file within three days after the order for relief, either(A)(i) its most recent balance sheet, statement of operations and cash-flow statement and (ii) its most recent federal income tax return or (B) a statement made under penalty of perjury that no such financial statements have been prepared or that no federal income tax return has been filed or (C) both, as the case may be.

(2) Require the debtor [ FN: Federal Rule of Bankruptcy Procedure 9010(a) allows a debtor to perform acts either by an attorney authorized to practice in the court where the case is pending or, for acts not constituting the practice of law, by an authorized agent, attorney in fact, or proxy. F ED . R . B ANKR . P . 9010(a) (1991).] to attend meetings, at which the debtor is represented by its senior management personnel and counsel, scheduled by the court, the U.S. Trustee, or the Bankruptcy Administrator [ FN: " U.S. Trustee " is hereinafter defined to include both U.S. Trustees and Bankruptcy Administrators.] including, but not limited to:

(a)initial debtor interviews, described infra;

(b)court-ordered scheduling conferences; and

(c)meetings of creditors convened under 11 U.S.C. õ 341;

(3) allow the U.S. Trustee or its designated representative to inspect the debtors business premises, books and records at reasonable times on reasonable prior written notice to the debtor;

(4) file all schedules and statements of financial affairs for small business debtors within the limits set by the Bankruptcy Rules, unless the court, upon notice to the U.S. Trustee and a hearing, grants an extension, which extension or extensions shall not, in any event, exceed 30 days after the order for relief absent extraordinary and compelling circumstances;

(5) comply with postpetition obligations including but not limited to the duties to: file tax returns, maintain appropriate and reasonable current insurance as is customary and appropriate to the industry, and timely pay all administrative expense tax claims, [ FN: The Commission rejected the notion that the debtor must be current on all administrative expense claims as a condition to continued enjoyment of chapter 11.] except those being contested by appropriate proceedings being diligently prosecuted;

(6) create within ten (10) business days (or as soon thereafter as possible in case all banks contacted during the first ten (10) business days decline the business) of the entry of order for relief separate deposit accounts with a bank or banks in which the debtor shall be required to timely deposit, until a plan is confirmed or the case is dismissed or converted or a trustee is appointed, after receipt, all taxes collectedor withheld by it for governmental units; in compelling circumstances, the court may dispense with these requirements after notice and a hearing;

C.NEW REPORTING REQUIREMENTS

To create uniform national reporting requirements to permit U.S. Trustees, as well as creditors and the courts, better to monitor the activities of chapter 11 debtors, the Advisory Committee on Bankruptcy Rules of the Judicial Conference ("Rules Committee") shall be called upon to adopt, with a reasonable time after enactment, amended rules requiring small business debtors to comply with the obligations imposed thereunder. The new rules will require debtors to file periodic financial and other reports, such as monthly operating reports, designed to embody, upon the basis of accounting and other reporting conventions to be determined by the Rules Committee, the best practical balance between (i) on the one hand, the reasonable needs of the court, the U.S. Trustee, and creditors for reasonably complete information and (ii) on the other hand, appropriate affordability, lack of undue burden, economy and simplicity for debtors. Specifically, the Rules Committee, shall be called upon to prescribe uniform reporting as to:

(a) the debtors profitability, i.e., approximately how much money the debtor has been earning or losing during current and relevant recent fiscal periods;

(b) what the reasonably approximate ranges of projected cash receipts and cash disbursements (including those required by law or contract and those that are discretionary but excluding pre-petition debt not lawfully payable after the entry of order for relief) for the debtor appear likely to be over a reasonable period in the future;

(c) how approximate actual cash receipts and disbursements compare with results from prior reports; [ FN: The Association of Insolvency Accountants ( " AIA " ) supports requiring debtors to submit uniform operating reports; however, the AIA has proposed that the focus on cash flow statements be on cash flow from operating activities of the business (EBITDA--earnings before interest, taxes, depreciation and amortization). The AIA also proposes that the reports clearly distinguish cash flows from operations from those related to liquidation and other nonoperating, extraordinary activities. Simple schedules of cash receipts do not take into account any estimate of the administrative obligations being incurred by the debtor. See Grant W. Newton, " Letter from the Association of Insolvency Accountants to the Bankruptcy Review Commission " (not dated).]

(d) whether the debtor is or is not (i) in compliance in allmaterial respects with post-petition requirements imposed by the Bankruptcy Code and the Bankruptcy Rules and (ii) filing tax returns and paying taxes and other administrative claims as required by applicable nonbankruptcy law as will be required by the amended statute and rules and, if not, what the failures are, how and when the debtor intends to remedy such failures and what the estimated costs thereof are; and

(e) such other matters applicable to small business debtors as may be called for in the best interests of debtors and creditors and the public interest in fair and efficient procedures under chapter 11.

D.ENLARGE SECTIONS 1104, 1112 AND OTHER APPROPRIATE SECTIONS

3.Modify section 1112 for to read as follows: [ FN: This text would apply to all chapter 11 cases, and would not be limited to small business chapter 11 cases.]

(b)(1) Except as provided in section (c) of this section or in section 1104(a)(3) of this title, on request of a party in interest or the U.S. Trustee, and after notice and a hearing, the court shall convert a case under this chapter to a case under chapter 7 of this title or shall dismiss a case under this chapter, whichever is in the best interest of creditors and the estate, where movant establishes cause, except that such relief shall not be granted if the debtor or another party in interest objects and establishes both:

(A) that it is more likely than not that a plan will be confirmed within a time as fixed by this title or by order of the court; and

(B)if the cause is an act or omission of the debtor:

(i)that there exists a reasonable justification for the act or omission; and

(ii)that the act or omission will be cured within a reasonable time fixed by the court not to exceed thirty days after the court decides the motion unless the movant expressly consents to a continuance for a specific period of time or there are compelling circumstances beyond the control of the debtor which justify an extension.

(2)For purposes of this subsection, cause includes:

(A)substantial or continuing loss to or dimunition of the estate;

(B)gross mismanagement of the estate;

(C)failure to maintain appropriate insurance;

(D)unauthorized use of cash collateral harmful to one or more creditors;

(E)failure to comply with an order of the court;

(F)failure timely to satisfy any filing or reporting requirement established by this title or by applicable rule;

(G)failure to attend the section 341(a) meeting of creditors or an examination ordered under Bankruptcy Rule 2004;

(H)failure timely to provide information or attend meetings reasonably requested by the U.S. Trustee or;

(I)failure timely to pay taxes due after the order for relief or to file tax returns due after the order for relief;

(J)failure to file or confirm a plan within the time fixed by this title or by order of the court; and

(K) failure to pay any fees or charges required under chapter 123 of title 28.

(3)The court shall commence the hearing on any motion under this subsection within 30 days after filing of the motion, and shall decide the motion within 15 days after commencement of the hearing, unless the movant expressly consents to a continuance for a specific period of time or compelling circumstances prevent the court from meeting the time limits established by this paragraph.

2.Add a new section 1104(a)(3) specifying additional gr

 

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