Nearly 40 years have passed since the current U.S. Bankruptcy Code (the 1978 Code) was enacted, and a consensus has emerged that the current law needs an overhaul. The 1978 Code has been largely overwhelmed by changes in the economy, in lending practice and the makeup of the lending community, and in the meteoric rise of the distress debt markets, among other changes. A monthly column in the American Bankruptcy Institute Journal titled “Problems in the Code,” edited by ABI member Howard Brownstein, has published more than 30 articles since 2011, each highlighting specific Bankruptcy Code provisions on which circuit courts of appeal have disagreed (resulting in a split of legal authority), or for which “workarounds” have been created, or which are just believed not to effectively serve the overall purposes of bankruptcy reorganization.1
In 2012, the American Bankruptcy Institute (ABI) created the ABI Commission to Study the Reform of Chapter 11. The Commission is co-chaired by the authors of this article and consists of 22 members, drawn from leading bankruptcy law practitioners, judges, academics and restructuring professionals. This article will provide a brief overview of its processes, and in particular the input the Commission has received from the secured lending community, among others, and how that input is being considered by the Commission as it moves forward with its report.
The continued vitality and fairness of the bankruptcy reorganization process is of keen interest to lenders, especially secured lenders and factors. Throughout its processes, the Commission has considered the interests of lenders.
The Commission has held public hearings since 2012, including at meetings of the National Conference of Bankruptcy Judges (NCBJ), the Turnaround Management Association (TMA), the Commercial Finance Association (CFA), and other venues. The Commission also created 13 advisory committees, comprised of more than 150 experts, to focus on a variety of topics, and an international working group that consists of leading practitioners and academics from more than 12 countries. The Commission’s findings and recommendations are to be released in December 2014 at the ABI’s Winter Leadership Conference.
Throughout its study, the Commission, as detailed above, has welcomed — and received — input from the secured lending community. In particular, that input has emphasized that changes to the treatment of secured claims, if any, must be considered in a broader context, with concern being taken not to unduly impact broader credit markets and lending decisions whenever possible. The goal is to balance the interests of debtors, secured lenders and other stakeholders, creating a restructuring regime that encourages the preservation of jobs and going concern value, while recognizing and protecting the legitimate interests and rights of lienholders. The Commission’s approach is to seek that balance.
Since the Code’s enactment, there has been a marked increase in the use of secured credit, placing secured debt at all levels of the capital structure. State law changes, including changes to the UCC, have made it easier to place a lien on every form of asset, tangible or intangible, that a debtor may possess, including all manner of proceeds or other value. Many of the 1978 Code’s provisions assume the presence of asset value above the secured debt, asset value that is too often not present in many of today’s Chapter 11 cases. The debt and capital structures of most debtor companies are more complex, with multiple levels of secured and unsecured debt, often governed by equally complex intercreditor agreements. There is nothing wrong with the growth of collateralized debt per se; indeed, that growth brought credit to many companies who could not have obtained it otherwise. However, the 1978 Code’s baseline assumption of value above the amount of liens on assets was challenged, if not cast asunder.
Similarly, the growth of distressed debt markets and claims trading introduced another factor not present when the 1978 Code was enacted, a factor that challenges certain other premises underlying the 1978 Code. Again, in many ways, this development was a net positive, providing creditors with a means of monetizing claims more quickly, rather than awaiting the outcome of sometimes lengthy cases. However, the rapidity of the development of these markets also created collateral consequences with which the 1978 Code was simply not designed to deal.
Many of today’s companies are less dependent on “hard” assets (real estate, machinery and equipment, and inventory), and more dependent on contracts and intellectual property as principal assets. The 1978 Code does not clearly provide for the efficient treatment of such assets and affected counterparties. Debtors are more often multinational companies, with the means of production and other operations offshore, bringing international law and choice of law implications. Today’s “debtor” is likely to be a group of related, often interdependent, entities. The impact of these changes on the efficacy of the current restructuring regime has been dramatic.
The way both courts and commentators discuss the purpose of Chapter 11 has also changed. Early decisions (and the legislative history of the 1978 Code) emphasized that the primary purposes of the Code were the rehabilitation of businesses and the preservation of jobs and tax bases at the state, local and federal level. As time passed, these purposes competed with “maximization of value” as an equal (and perhaps competing) goal. More recent discussions of the purpose of Chapter 11 tend to emphasize value maximization, to the exclusion of other goals and purposes. That emphasis allowed for — even blessed — a conversion of Chapter 11 into a mechanism for change of control, often via speedy sales of assets rather than restructurings. These developments also call for a fresh assessment of the purposes and goals of a U.S. restructuring regime.
Since the first public hearing of the Commission, held in connection with the April 2012 ABI Annual Spring Meeting, the Commission has held 15 public field hearings in 11 different cities at which almost 90 individuals have testified.2
One of the earliest field hearings was at held the Loan Syndications and Trading Association (LSTA) annual meeting in New York. The hearing generally covered finance and governance concerns in Chapter 11, and witnesses testified on debtor-in-possession (DIP) lending, distressed debt trading and the role of secured credit. Representatives from LSTA presented data on the relationship between DIP lending and reorganization, and witnesses encouraged the Commission to consider the positive role that distressed debt trading has on the market.
A subsequent field hearing was held at the CFA’s Annual Convention in Phoenix. Witnesses testified on DIP lending, the use of carve-outs, and challenges to small- and medium-size enterprises. The leadership of CFA testified on behalf of its membership, and suggested the Commission study the following topics: adequate protection for secured creditors, carve-outs, the inclusion of all contract rights in the definition of secured claims and the enforceability of inter-creditor agreements. Included among the potential reforms proposed by witnesses were to modify the Code to allow for the statutory appointment of a sale monitor or examiner, codifying local rules to provide guidance or standards for the court to base its discretion on, clarifying §1129 and §1104 of the Code, codifying gifting, providing for the enforcement of fraudulent conveyance savings clauses and shifting the burden of proof in preferential transfer claims.
In addition, the Commission worked with the University of Illinois College of Law to organize and host an academic symposium on the role of secured credit in business bankruptcies in Chicago. Nineteen of the nation’s leading bankruptcy scholars contributed to the symposium, and the papers and a video recording of the event are (or will be) posted on the ABI Commission’s website, with the papers from this symposium to be published in the Illinois Law Review.
The Commission believes that the public field hearings served a key function in its study process. The hearings helped the Commission identify and evaluate the current structure of Chapter 11 and how it is working for debtors and their various stakeholders. The Commission is now in the midst of its review of the two-year study process and its deliberations on the effectiveness of the Code and any potential reform proposals. This deliberation process is expected to consume the remainder of 2014.
There is still time for last minute input. Anyone interested in submitting written suggestions to the Commission should contact the authors or Michelle Harner, the Commission’s Reporter.
Robert J. Keach, Esq. and Albert Togut are the co-chairs of the ABI Commission to Reform Chapter 11. Keach is a shareholder at Bernstein, Shur, Sawyer & Nelson in Portland, ME, and is co-chair of its Business Restructuring and Insolvency Practice Group. Togut is managing partner of Togut, Segal & Segal in New York City.
More information about the Commission is available at www.commission.abi.org.
1. A list of articles are available at http://journal.abi.org/category/column-name/problems-code-0↩
2. The hearings and the statements prepared by witnesses and others in connection with the hearings are available at www.commission.abi.org.↩