Corporate Chapter 11 Bankruptcies: The Case for Venue Reform
Baker Donelson Attorney Susan Mathews makes a case for venue reform, explaining why corporate debtors should be accountable to local trade creditors, employees and communities and be required to file Chapter 11 at their home base.
What do General Motors (based in Detroit), MGM Studios (based in Los Angeles), American Airlines (based in Dallas) and Enron (based in Houston) have in common? These companies filed their Chapter 11 bankruptcy cases in the Southern District of New York even though their principal place of business and principal assets were located elsewhere. Similarly, Washington Mutual (based in Seattle), the Tribune Company (based in Chicago) and, most recently, Energy Future Holdings (based in Dallas) filed their bankruptcy cases in Delaware. Unfortunately, current law does not require that a bankruptcy case be filed in the district where the company’s principal place of business or principal assets are located. Chapter 11 debtors have the option of filing where the entity is “domiciled” or incorporated. As a result, there has been a shift in the past 20 years for publicly traded companies and many private companies to file in Delaware and New York based either upon domicile or the claim that an affiliate of the parent entity has some minimal business operations in those states.
Is this what Congress intended when it enacted the Bankruptcy Code, and is this fair to creditors, employees and the local community where the company operates? If not, what considerations should determine where a Chapter 11 business case is filed? Should the case be filed in the city where the company’s headquarters are located, in the federal district where the company’s principal assets are located, or where the company’s principal creditors (i.e., financial institutions, equity funds or the indenture trustee for bondholders) or their professionals are located? Does it matter whether the company is publicly traded or privately held? Putting these factors aside, does it matter if the jurisdiction of the case is convenient to employees and the majority of trade creditors?
All of these questions show that the venue analysis for filing a Chapter 11 case can become complex, particularly for a publicly traded company with assets located throughout the country. Unfortunately, more frequently than not, the “venue” choice boils down to politics among the various creditor constituencies of the company and the perception of what court or judge will be the most favorable to the debtor or secured creditor’s interests. Whether the end game is a true business reorganization or an orderly liquidation of a company that continues to operate during the course of the case, the company should have some nexus with the venue where it files, from an accountability standpoint as well as economic standpoint. Reform legislation is needed to correct the inequities of allowing a company to “forum shop” and file its bankruptcy case in jurisdictions such as Delaware or New York if it has no real nexus to these districts.
History of Venue Statute for Corporations
Prior to 1987, corporations were required to file bankruptcy cases where the debtor had its principal place of business or principal assets for the preceding six months.1 In 1987, Congress enacted the Bankruptcy Code and the federal statutes that provide for jurisdiction and venue of bankruptcy cases.2 The current bankruptcy laws allow a person or entity to file bankruptcy in the district “in which the domicile, residence, principal place of business in the United States, or principal assets in the United States” have been located for the 180 days immediately preceding the filing. Courts have interpreted the word “domicile” to mean a company’s state of incorporation. The legislative history of the Bankruptcy Code does not indicate that Congress intended to make a substantive change in the law for bankruptcy filings by corporations and other business entities. Rather, it appears that the legislative intent was to draft a single statute that addressed bankruptcy filings by both individuals and business entities.
The Prevalence of Venue Shopping
Whether done by design or inadvertence, the consequence of the inclusion of the word “domicile” in the venue statute has allowed corporations to file in remote jurisdictions without regard to the location of their corporate offices or assets. A recent survey showed that 70% of the public companies that have filed Chapter 11 cases in the last five years have filed in districts other than the district where the corporation’s principal place of business or principal assets were located, and 80% of these cases were filed in either the Southern District of New York or Delaware.3 The filings in these jurisdictions are generally based upon at least one of the affiliate debtors being incorporated or organized under Delaware or New York law, or the company having some minor business operations in these districts.4 The decision to file in these venues seems to be driven by lenders that find these venues more favorable on debtor-in-possession financing terms, including provisions that post-petition liens secure prepetition debt, provisions relating to lien priorities, waiver of any pre-petition claims against the lender, payment of the lender’s professional fees, and charging high interest rates and other fees. At times, debtors also seem to prefer to distance themselves from trade creditors, customers, employees and perhaps even their community, particularly if there is negative publicity associated with the filing. While bankruptcy law permits a creditor to request a transfer of venue “in the interest of justice” or for the convenience of the parties, these motions are seldom granted.
The most recent example of forum shopping was seen in the “mega case” filing by Energy Future Holdings (EFH). EFH, together with 70 affiliated entities, filed Chapter 11 in Delaware on April 29, 2014, listing liabilities of approximately $42 billion. EFH, formerly TXU, is a Dallas-based, privately held energy company with a portfolio of competitive and regulated energy businesses which serve the Texas market.5 It is the parent company of TXU Energy, which serves approximately 1.75 million residential and commercial retail electricity customers in Texas. Its businesses are regulated by the Public Utility Commission of Texas, the Railroad Commission of Texas and the Texas Commission on Environmental Quality. EFH and its related companies employ approximately 9,100 employees. EFH is a Texas corporation and its corporate headquarters and business records are located in Dallas.6 EFH does not have any business operations or assets in Delaware. EFH, the parent entity, filed its bankruptcy case in Delaware because 21 of the 71 debtor companies were incorporated in Delaware.7
On the same day as the filing of the bankruptcy cases, Wilmington Savings Fund Society, FSB (WSFS), one of EFH’s secured creditors, filed a motion to transfer the case to the company’s hometown of Dallas. The motion to transfer, of course, was contested by EFH who claimed that the case should remain in Delaware because “the Debtors are in Chapter 11 to restructure their balance sheet” and the debtor’s professionals and their largest creditors and their professionals are in the Northeast.8 EFH also argued that the creditors who had executed the debtors’ pre-petition restructuring agreement did so with the understanding that the bankruptcy case would be filed in Delaware. WSFS’ motion to transfer was supported by the ad hoc committee of unsecured creditors of Texas Competitive Electric Holdings, the immediate parent of TXU Energy. Interestingly, the State of Texas filed a notice, stating it took no position on the motion to transfer.
After the motion to transfer was filed, WSFS conducted discovery and took depositions of the debtors’ representatives, including the general counsel. The debtors’ general counsel testified as to the business reasons for filing the case in Delaware, but would not answer questions that involved her analysis of the venue selection or advice received from bankruptcy counsel, claiming such information was privileged. Following a full day hearing on the motion to transfer venue, the Delaware bankruptcy court denied the motion, finding that venue should remain in Delaware since the company was engaged in a financial restructuring as opposed to an operational restructuring. This distinction is not contained in the Bankruptcy Code and makes little sense because virtually all Chapter 11 corporate cases involve a restructure of the debtor’s financial obligations. Suffice it to say, the Delaware bankruptcy court has created a precedent that will likely serve as further justification for venue shopping in future cases.
Consequences of Venue Shopping
There are legal and economic consequences arising from venue shopping. As a result of the increased number of cases filed by out-of-town/state businesses, a disproportionate number of cases are being heard by 16 bankruptcy judges, without regard to the other 450 judges in the country. Indeed, Delaware has added three bankruptcy judges to handle the increased caseload since 1993. Not only does this create an unnatural distribution of cases among the courts and underutilization of experienced judges, the judges in the favored districts likely will not be as knowledgeable on state laws involving property rights, oil and gas, or mechanics and materialmen’s liens.9 In addition, the judicial perspective of the bankruptcy court becomes dominated by a particular region and does not evolve fully from the perspective of members of the judiciary from other regions. Critics of the current venue law point out that if Congress had intended to make bankruptcy a federal practice in a single court such as the U.S. Tax Court it could have done so. Instead, Congress created bankruptcy courts as ancillary courts to the federal district courts located in every state.
Bankruptcy cases that are filed in New York and Delaware are typically more expensive for the debtor than filings in other jurisdictions because of the higher billing rates of the professionals in those markets and travel expenses incurred by both the company representatives and their professionals. These higher costs also impact trade creditors of the debtor, making it both difficult and expensive for these creditors to participate in a bankruptcy case. In many cases, these creditors will have to defend preference claims or fraudulent transfer claims in out-of-state jurisdictions. The cost of retaining local Delaware or New York counsel can make it cost-prohibitive for smaller creditors to participate in the case and may force some companies to settle claims in lieu of retaining counsel.10
There is also a local economic impact if a bankruptcy filing occurring away from a corporation’s home base. The transportation industry, hospitality industry and restaurant industry benefit from a case because of the business persons and professionals who are in the city in connection with court hearings, meetings, inspecting and valuating fixed assets and reviewing corporate records and other documents. If the case is filed in another jurisdiction, this business is lost by the debtor’s hometown.
In addition, a bankruptcy judge in New York or Delaware may not fully appreciate or be concerned about the impact of the bankruptcy filing on the local community of the debtor when there is a remote filing. Imagine, for argument sake, if the City of Detroit had filed its Chapter 9 case in Delaware.11 Was the impact of Chrysler or General Motors’ bankruptcy filings in New York any less significant to the creditors and employees of these automobile companies or the City of Detroit?
Finally, venue shopping creates an appearance of cronyism among the Delaware and Southern District of New York professionals representing the debtors, lenders and creditors’ committees with the high concentration of large commercial cases in those districts. The Energy Futures Holding bankruptcy cases underscore the influence that the location of the professionals has on a debtor’s venue selection.
Corporate debtors should be accountable to their trade creditors, employees and local community. If a company is a major employer in a community or significant revenue source to local vendors, the company should be required to file its case at “home” so trade creditors and employees can participate in the bankruptcy proceedings and do so without incurring significant travel expenses and expenses to hire out of state counsel.
Prospects for Legislative Reform
Legislation to change the venue laws for bankruptcy cases has been proposed several times over the past 20 years, including a bill by Senator John Cornyn (R-TX) (after Enron’s 2001 bankruptcy filing in New York) and a more recent bill co-authored by Representatives Lamar Smith (R-TX), John Conyers (D-MI), Howard Coble (R-NC) and Steve Cohen (D-TN), which was introduced in 2011. The Smith bill proposed to create a separate statute for corporations and eliminated the “domicile” or “residence” as a possible venue location. The bill also proposed a change to venue being based upon the location of a nominal affiliate entity or its assets. Unfortunately, this legislation was stymied by congressional politics among the delegations that seek to protect their jurisdictions. In 2011, the American Bankruptcy Institute appointed a Commission to study whether Chapter 11 needed to be reformed to reflect the current economy and debt markets. To that end, the Commission held 15 field hearings throughout the country in 2012 and 2013 and heard testimony on any needed reforms to Chapter 11. Venue reform was addressed by a national ad hoc group of bankruptcy practitioners at the field hearing held on November 22, 2013 in Austin, TX. The Commission is expected to issue its report in December 2014 and, hopefully will address the need for venue reform.
Venue reform is necessary to restore the balance to the bankruptcy courts and make companies who seek Chapter 11 protection more accountable to their local creditors, employees and the communities in which they operate. A company seeking Chapter 11 bankruptcy protection must keep in mind that it is seeking relief from the bankruptcy court, which is a court of equity. One of the oldest legal maxims is: “He who seeks equity must do equity.” This adage should not be forgotten. Achieving a reorganization or orderly liquidation in Chapter 11 should be done in a venue that is equitable to all constituents and not be determined by politics.
Susan Mathews is a transactional and commercial bankruptcy attorney in Baker Donelson’s Houston Office. She can be reached at smathews [at] bakerdonelson [dot] com.
1. See former Rule 116 of the Rules of Bankruptcy Procedure (effective Oct. 1, 1973). ↩
2. §§1334 and 1408 of Title 28 of the United States Code.↩
3. See Written Statement entitled Venue Fairness presented by Douglas B. Rosner, Esq. at the November 22, 2013 field hearing in Austin, Texas (“ABI Texas Field Hearing”) conducted by the American Bankruptcy Institute Commission appointed to study the reform of Chapter 11.↩
4. This venue provision has been liberally applied to allow filings in New York for companies that may have a small branch office in the city, such as in the case of Enron Corporation. Enron was based in Houston and one of its affiliate companies had a small office in New York.↩
5. See www.energy.futureholdings.com/news/facts.aspx. The 2007 acquisition of TXU by Kohlberg Kravis Roberts & Co., Goldman Sachs Group and Texas Pacific Group for $32 billion and approximately $13 billion in assumed debt was the largest private equity buyout in history. See “Energy Futures Holdings Files For Chapter 11 Bankruptcy,” The Wall Street Journal, onlinewsj.com (April 29, 2014).↩
6. See Motion of Wilmington Savings Fund Society, FSB Pursuant to 28 U.S.C. §§1408 & 1412 and Rule 1014 of the Federal Rules of Bankruptcy Procedure to Transfer Cases to the United States District Court for the Northern District of Texas at 4-7.↩
7. See Debtors’ Objection to the Motion of Wilmington Savings Fund Society, FSB … to Transfer Cases to the United States District Court for the Northern District of Texas (“Debtors’ Objection to Motion to Transfer”) at 7. ↩
8. The debtors filed the EFH bankruptcy cases with a “partially pre-negotiated plan.” See Debtors’ Objection to Motion to Transfer at 2-3.↩
9. Opponents of venue reform legislation have argued that the New York bankruptcy courts have greater expertise in bankruptcy and debtors should have the discretion to seek the “benefits of those sophisticated courts and the investor confidence they bring, in favor of jurisdictions with less predictable and potentially conflicting laws.” See Comments of Michael Luskin on behalf of the New York City Bar Association’s Committee on Bankruptcy and Corporate Reorganization presented at the ABI Texas Field Hearing at pp. 3-4.↩
10. Delaware firms have profited considerably as a result of the surge in bankruptcy filings since Delaware’s local district court and bankruptcy court rules make it difficult for a non-Delaware licensed attorney to practice before these courts. ↩
11. The venue of a Chapter 9 case is determined by the same statute which governs the venue of bankruptcy filings by corporations. A municipality, however, would not be able to file outside of its home district since all of its assets, its principal place of business and its charter would be issued by the state in which the municipality is located.↩