Oversight Hearing on the Need for Bankruptcy Reform Legislation

Subcommittee on Commercial and Administrative Law

of the Judiciary Committee of the House of Representatives

of the United States Congress

Tuesday, March 4, 2003

2:00 p.m. (E.S.T.)

Room 2141, Rayburn House Building

Washington, D.C.

Written Testimony of the

Commercial Law League of America

and its Bankruptcy Section

Judith Greenstone Miller, Esq.

Raymond & Prokop, P.C.

Southfield, Michigan

Chair: Bankruptcy Section

Co-Chair: Governmental Affairs Committee of

The Commercial Law League of America

            Good afternoon. Thank you for inviting me to testify before the Subcommittee on behalf of the Commercial Law League of America (“League”). The League, founded in 1895, is the nation’s oldest creditors’ rights organization, comprised of attorneys and other experts in credit and finance, actively engaged in the fields of bankruptcy, insolvency, reorganization and commercial law. The League has long been associated with creditor interests, while at the same time seeking fair, equitable and efficient administration of bankruptcy cases for all parties in interest. The Bankruptcy Section, comprised of 1,200 bankruptcy professionals (lawyers, judges and other workout professionals) from across the country, represents divergent interests in bankruptcy cases. The League has testified on numerous occasions and submitted position papers before Congress as experts in the bankruptcy and reorganization fields.

The League has consistently advocated that bankruptcy laws must strike a balance that is both fundamentally fair and practically sound for all parties involved. The bankruptcy legislation that has been proposed the last three Congresses, and most recently introduced in almost the identical form last Thursday, February 27, 2003, is neither fair nor practically sound. It is unfortunate that the legislation was again introduced prior to the conclusion and findings of this Subcommittee, because, in essence, the premise, fears and conditions underlying the original perceived need for bankruptcy reform six years ago do not exist. Moreover, the changes that have occurred over the last eighteen months, such as the changed economy, the terrorist events of 9-11 and the mega-bankruptcy filings, such as Enron, WorldCom, K-Mart and the major airlines, suggest that not only the need for bankruptcy reform be reviewed and analyzed, but moreover, that consideration be given to the real abuses and true issues that need to be addressed as the Bankruptcy Code (“Code”) currently exists.

             Bankruptcy is a delicate and complicated process. It is more than simply a two-party dispute between the debtor on the one side, and creditors on the other. Rather, multiple parties and constituents, often with vastly different interests and goals, play significant roles in the overall process. Therefore, any reform effort must take into consideration not only the interests of the particular party seeking redress, but also the overall impact on the bankruptcy estate as a whole. This legislation suffers from such infirmities.

            First, the majority of the hearings devoted to the legislation have focused on consumer, rather than business issues. The business issues must be subject to the same attention before enacted in a tenuous economy.

Second, the final bill that ultimately evolved from the conference committee had numerous amendments, many of which have not been subject to prior comment, hearings or careful analysis regarding their impact and consequences on the system. Many of these amendments, like the overall bill, cater to special interests, thereby enhancing the right of a few at the expense of the general body of creditors of the estate. For example, lessors of non-residential real property currently have extensive power over debtor lessees. Despite the protections already contained in the Code, the legislation seeks to enhance their rights in a manner that is likely to deprive the debtor and the unsecured creditors of valuable assets of the estate needed to reorganize or alternatively create large administrative priority claims from a pressured, and subsequently determined to be an improvident assumption. Lien stripping in Chapter 13 cases is also severely limited by the bill in direct contravention of the stated purpose for reform - greater repayment to unsecured creditors. Losses to unsecured creditors from passage of this proposal have been estimated to approach $100 million annually. The League has repeatedly objected to legislation that favors special limited interests as being fundamentally unfair and inappropriate to the creditors of the estate.

Third, despite the numerous amendments proffered as part of the legislation, real issues that currently confront the system haven’t even been considered. For example, the issue of forum non-conveniens, governing the location where a bankruptcy case should be filed so as not to negatively impact the creditors, is not addressed in the bill. The administration of a bankruptcy case is often dealt with in a location that has minimal contacts to the operation and assets of the debtor.

Moreover, in a number of the large national corporate scandals and mega-filings, many of which were precipitated by fraudulent conduct, one of the major assets that creditors’ committees seek to pursue in order to provide recovery and a distribution to the creditors is causes of action against the officers, directors, principals and affiliates, i.e., the “insiders.” Generally, the actions allege breaches of fiduciary duties, transfers of assets on the eve of bankruptcy and other improper and/or fraudulent conduct. Standing to pursue such avoidance actions on behalf of the creditors has been seriously questioned by some courts recently based on rules of statutory construction that preclude a court from looking at legislative intent and history.

The Third Circuit Court of Appeals in Official Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery (In re Cybergenics Corp.), 304 F.3d 316 (3rd Cir. 2002), vacated, 310 F.3d 785 (3rd Cir. 2002), interpreted Section 1103(a) of the Code to preclude the creditors’ committee from pursuing avoidance actions based on its use of the phrase “the trustee may,” to imply a limitation of those parties-in-interest that may actually proceed to avoid impermissible transfers. In a number of instances, debtors and debtors-in-possession refuse or fail to act because it would require them to sue their own principals, officers, directors and affiliates to seek recovery of assets improperly transferred to them prior to or on the eve of bankruptcy. While the initial decision of the court has been vacated for rehearing and determination by the entire Third Circuit, this holding, if upheld, will make it increasingly difficult for creditors to seek recovery of valuable assets.

It bears note that throughout the last six years that the legislation has been pending in Congress, it has been consistently criticized by every major bankruptcy organization, bankruptcy professionals and scholars. The bill, however, does contain some noncontroversial and much needed reforms, that if passed, would enhance and provide significant benefits to the overall system. Such things, for example as, the permanent extension of Chapter 12, adoption of the international cross-border provisions contained in chapter 15 of the bill, the addition of thirty-six (36) new bankruptcy judgeships, cure and elimination of the DePrizio problem in Sections 547 and 550 of the Code, elimination of the Claremont nonmonetary penalty cure under Section 365(d)(2) of the Code, remediation and clarification of the ability to assign and assume personal services contracts and other nonassignable interests under Section 365(c) in response to Catapult, rules governing appellate procedure of bankruptcy cases and trustee liability and removal provisions, have been held hostage, as placeholders, with the hope that pressure for enactment of these individual reforms would ultimately fuel passage of the entire bill. Much acknowledged and needed reforms have been held at bay. Instead, Congress has repeatedly reintroduced the same basic legislation, rather than reevaluating the need for reform legislation, and if so, on what basis.

Congress first suggested the need to review and address bankruptcy reform as part of the 1994 amendments to the Code through the creation of the National Bankruptcy Review Commission (“Commission”). Even before the Commission issued its final report, Congress introduced the legislation. At that time, we were facing unprecedented growth and prosperity in the country. At the same time, individual bankruptcy filings had reached an all time high. Congress perceived that many individual debtors were abusing the system and that filings would continue to rise. While filings may have incrementally increased since that time, the individual filings, in large part, have been attributable to real needs triggering financial relief (i.e., divorce, medical bills, loss of jobs, 9-11, displaced military personnel, corporate downsizing and uncertainty that the current pending legislation and its predecessors would be enacted into law by Congress), not merely to escape one’s obligations.

Relying simply on the number of filings as a barometer is dangerous and misleading. For example, while the statistics of filings for 2002 suggest that business bankruptcies declined, it is indisputable, based on the number of mega-filings during that time, that 2002 will go down as the year of large business bankruptcies. The country still has not even begun to face all of the repercussions that are likely to result from these large filings, such as closure of facilities, decreased work forces and elimination of retirement benefits. The economic climate of the country has also changed dramatically since bankruptcy reform was first envisioned. The reticence of the country to expend resources in the wake of 9-11 and the continued fears of war and terrorism suggest that recovery is going to be slow at best. Therefore, prior to enacting legislation that will create sweeping changes, at a time when financial relief is likely to be needed the most, Congress must pause, take a step back, and carefully analyze and reexamine that which it has proposed against the current realities and needs of the system for debtors and creditors alike.

Thank you for the opportunity to address the Subcommittee this afternoon. In addition to the filing of this written testimony, the League has also submitted a written position paper setting forth its critical issues for consideration by Congress.