American Bankruptcy Institute
22 IV. Proposed Recommendations: Commencing the Case
chapter 11 in the 1978 Bankruptcy Code from the company’s active role in the rehabilitation process under Chapter XI (but not Chapter X) of the 1898 Bankruptcy Act.77 Practice under the Bankruptcy Act suggested that boards of directors and management resisted a process — even if arguably beneficial to their restructuring efforts — that required them to cede control of their business and restructuring efforts to an outside party. This requirement contributed in part to the failure of Chapter X of the Bankruptcy Act because it mandated the appointment of a trustee to run the debtor’s business and bankruptcy case.78 Notably, section 1107 of the Bankruptcy Code authorizes the debtor in possession to, among other things, exercise all “the rights . . . and powers, and [requires it to] perform all the functions and duties . . . of a trustee serving in a case under this chapter,” with only minor exceptions that do not detract from the central role of the debtor in possession in the case.79
Proponents of the debtor in possession model highlight the knowledge and expertise of the debtor’s prepetition directors, officers, or similar managing persons concerning the debtor’s business and financial affairs.80 The ability of the debtor in possession to continue to operate through its prepetition management team facilitates the company’s seamless transition into chapter 11 and allows the debtor to avoid the additional time, cost, and resulting inefficiencies of bringing in an outsider who is not familiar with the debtor’s business specifically or the debtor’s industry generally.81 The prepetition management team may also have industry relationships or “know-how” that would benefit the debtor’s restructuring efforts.
Critics of the debtor in possession model note that the debtor’s financial or operational difficulties may relate, at least in part, to the conduct or decisions of the debtor’s prepetition directors and officers.82 Some critics argue that allowing the management team that was in charge during the debtor’s financial decline to remain in control rewards subpar performance and undermines confidence in the reorganization process for the debtor’s stakeholders.83 Some critics also worry that prepetition management may be motivated by factors not necessarily aligned with the best interests
77 See Clifford J. White III & Walter W. Theus, Jr., Chapter 11 Trustees and Examiners After BAPCPA, 80 Am. Bankr. L.J. 289, 292 n. 15 (2006) (“[T]he debtor generally remained in possession of its property and had all of the rights and powers of a trustee, subject to such limitations as the court might impose.”) (citations omitted). See generally John Wm. Butler, Jr., et al., Preserving State Corporate Governance Law in Chapter 11: Maximizing Value Through Traditional Fiduciaries, 18 Am. Bankr. Inst. L. Rev. 337 (2010) (detailing the history and role of the debtor in possession model in chapter 11). 78 See H.R. Rep. No. 95-595, at 222, reprinted in 1978 U.S.C.C.A.N. 6182 (“Less than ten percent of all business reorganization cases are under Chapter X. Chapter XI is the much more popular procedure, even though what can be done under Chapter XI is less than under Chapter X.”) (citation omitted). See also Douglas E. Deutsch, Ensuring Proper Bankruptcy Solicitation: Evaluating Bankruptcy Law, the First Amendment, the Code of Ethics, and Securities Law in Bankruptcy Solicitation Cases, 11 Am. Bankr. Inst. L. Rev. 213, 217–18 (2003) (explaining debtors’ preference for Chapter XI under the Bankruptcy Act). The inflexible, mandatory absolute priority rule was also arguably a contributing factor to its failure. See Skeel, supra note 9, at 163 (“The draconian effect of Chapter X, together with the fact that so many large firms had already failed during the depression, caused a dramatic drop in Chapter X cases.”). 79 11 U.S.C. § 1107. 80 See, e.g., In re Marvel Entm’t Grp., Inc., 140 F.3d 463, 471 (3d Cir. 1998) (“[V]ery often the creditors will be benefited by continuation of the debtor in possession, both because the expense of a trustee will not be required, and the debtor, who is familiar with his business, will be better able to operate it during the reorganization case.”). 81 See H.R. Rep. No. 95-595, at 233, reprinted in 1978 U.S.C.C.A.N. 6192 (“A trustee frequently has to take time to familiarize himself with the business before the reorganization can get under way.”). See also David A. Skeel, Jr., Markets, Courts, and the Brave New World of Bankruptcy Theory, 1993 Wis. L. Rev. 465, 517 & n.188 (1993) (“In the nonclosely held firm context, immediate removal of management would create significant indirect costs both before and during the bankruptcy.”). 82 See, e.g., A. Mechele Dickerson, The Many Faces of Chapter 11: A Reply to Professor Baird, 12 Am. Bankr. Inst. L. Rev. 109, 135 (2004) (“[T]here should be a rebuttable presumption that the directors of insolvent firms are unfit for board service and that they should be disqualified from future board service”); Lynn M. LoPucki, The Trouble with Chapter 11, 1993 Wis. L. Rev. 729, 732 n.11 (1993) (noting that prepetition management may pursue “directions that are not in economic interests of the company”). 83 Written Testimony of the Honorable Joan N. Feeney: ASM Field Hearing Before the ABI Comm’n to Study the Reform of Chapter 11, at 5 (Apr. 19, 2012) (citing a Cornell University study indicating that the strongest contributor to post-bankruptcy success is new management and arguing that bankruptcy judges need tools to deal with failed managers), available at Commission website, supra note 55.