American Bankruptcy Institute
12 III. Background on the Commission and the Study Project
B. the need for reform
Chapter 11 of the Bankruptcy Code has served us well for many years. Nevertheless, today’s financial markets, credit and derivative products, and corporate structures are very different than those existing in 1978 when Congress enacted the Bankruptcy Code. Companies’ capital structures are more complex and rely more heavily on leverage, which is secured under state enactments of the Uniform Commercial Code that encumber vastly more assets than in 1978;42 their asset values are driven less by hard assets (e.g., real estate and machinery) and more by services, contracts, intellectual property, and other intangible assets; and both their internal business structures (e.g., their affiliates and partners) and external business models are increasingly multinational. In addition, claims trading and derivative products have changed the composition of creditor classes. Although these developments are not unwelcome or unhealthy, the Bankruptcy Code was not originally designed to rehabilitate companies efficaciously in this complex environment.43
Moreover, anecdotal evidence suggests that chapter 11 has become too expensive (particularly for small and medium-sized enterprises) and is no longer capable of achieving certain policy objectives such as stimulating economic growth, preserving jobs and tax bases at both the state and federal level, or helping to rehabilitate viable companies that cannot afford a chapter 11 reorganization.44 Some professionals suggest that more companies are liquidating or simply closing their doors without trying to rehabilitate under the federal bankruptcy laws.45 Commentators and professionals also suggest that companies are waiting too long to invoke the federal bankruptcy laws, which limits companies’ restructuring alternatives and may lead to premature sales or liquidations.46
42 See, e.g., Mark Jenkins & David C. Smith, Creditor Conflict and the Efficiency of Corporate Reorganization, (paper presented at April 2014 symposium) (draft on file with Commission) (“Secured debt represented less than 45 percent of the debt of Moody’s-rated firms filing for bankruptcy in 1991; by 2012, secured debt accounted for more than 70 percent of the debt of Moody’s-rated bankruptcy filers.”), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2444700. For a discussion of the amendments to the Uniform Commercial Code and their potential impact on secured creditors’ collateral packages, see Section VI.C.4, Section 552(b) and Equities of the Case. 43 See, e.g., Ralph Brubaker, The Post-RadLAX Ghosts of Pacific Lumber and Philly News (Part II): Limiting Credit Bidding, Bankr. L. Letter, July 2014, at 4 (“Two monumental developments in Chapter 11 practice that the Code drafters likely did not anticipate, though, have skewed negotiations over allocation of reorganization surplus decisively in favor of senior secured creditors, in a manner that the Code drafters also likely did not anticipate. The first is the ascendancy of secured credit in Chapter 11 debtors’ capital structures, such that it is now common that a dominant secured lender has blanket liens on substantially all of the debtor’s assets securing debts vastly exceeding the value of the debtor’s business and assets. The second, related phenomenon is the rise of ‘relatively expeditious going-concern sales of the debtor’s business and assets to a third-party purchaser’ as a prominent means of realizing the debtor’s going-concern value in Chapter 11.”) (citations omitted). 44 See, e.g., Oral Testimony of Joseph McNamara: NACM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (May 21, 2013) (“In my experience, over the last half decade, companies have had a harder and harder time successfully reorganizing their debt and using the chapter 11 process, and thus are more prone to either fold their reorganization procedure into a liquidation or successfully exit and then re-enter bankruptcy a few short years later.”), available at Commission website, infra note 55. See also Stephen J. Lubben, What We “Know” About Chapter 11 Cost is Wrong, 17 Fordham J. Corp. & Fin. L. 1 (2012) (reviewing literature and presenting empirical data to contradict common perceptions of bankruptcy costs); Written Statement of John Haggerty, Argus Management Corp.: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11 (Apr. 19, 2013) (describing an increase in the use of nonbankruptcy alternatives, including increased unsupervised winddowns, as a result of the costs and loss of control associated with chapter 11), available at Commission website, infra note 55; Oral Testimony of John Haggerty, Argus Management Corp.: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 36 (Apr. 19, 2013) (ASM Transcript) (describing how the DIP budget for professionals’ fees has ballooned and noting that such costs keep small businesses out of chapter 11), available at Commission website, infra note 55. 45 See, e.g., Douglas G. Baird & Robert K. Rasmussen, The End of Bankruptcy, 55 Stan. L. Rev. 751, 777–85 (2002) (discussing decrease in traditional stand-alone reorganizations). See also Oral Testimony of Dan Dooley: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 37 (Apr. 19, 2013) (ASM Transcript) (describing increased use of state and local receiverships and ABCs in lieu of chapter 11 or chapter 7 because of the reduced costs and reduced delay), available at Commission website, infra note 55. 46 See, e.g., Michelle M. Harner & Jamie Marincic Griffin, Facilitating Successful Failures, 66 Fla. L. Rev. 205 (2014) (analyzing literature and presenting results of empirical survey on, among other things, timing of bankruptcy filings). See generally infra note 66 and accompanying text (generally discussing limitations of chapter 11 empirical studies).