Testimony of Frederick M. Luper, Esq.
Representing the Commercial Law League
before the Subcommittee on Commercial and Administrative Law
of the Committee on the Judiciary, U.S. House of Representatives


April 30, 1997

Dear Congressman Gekas:

Thank you for the opportunity to appear before the Commercial and Administrative Law Subcommittee and discuss the pending legislation to make technical corrections to the bankruptcy code of the United States.

The CLLA, founded in 1895 is the nation's oldest organization of attorneys and other experts in credit and finance actively engaged in the field of commercial law, bankruptcy and reorganization. Its membership exceeds 4,600 individuals. The CLLA has long been associated with the representation of creditor interests, while at the same time seeking fair, equitable and efficient administration of bankruptcy cases for all parties in interest. Its Bankruptcy and Insolvency Section is made up of approximately 1,800 bankruptcy lawyers and bankruptcy judges from virtually every state in the United States. Its members include practioners with both small and large practices who represent divergent interests in bankruptcy cases.

The CLLA has testified before Congress on numerous occasions as experts in the bankruptcy and reorganization field as well as in the areas of credit and collections. In addtion, the CLLA has appeared several times before the National Bankruptcy Review Commmission over the past year. This presentation will focus specifically on two bills currently pending before the Subcommittee - H.R. 120 and H.R. 764 introduced by Congressmen John Conyers, Jr. and Henry Hyde, respectively. It will highlight those provisions of the bills that are not technical in nature and where appropriate will provide a recommendation from the Commercial Law League of America. Further, it will indicate in which bill the provision can be located, the differences, if any between the versions in each bill and if there isn't a similar provision in the other bill.

H.R. 120: SECTION 6. ELIGIBILITY TO SERVE AS TRUSTEE.

This section would amend Section 321 of the Bankruptcy Code to eliminate the requirement that a Chapter 7 trustee reside or have an office in the judicial district in which the bankruptcy case is pending or in an adjacent district. This would apply to either individuals or corporations.

This is not a technical amendment. The residency requirement existed prior to the enactment of the Bankruptcy Reform Act of 1978.

Presumably this amendment recognizes the fact that bankruptcy practice has expanded to include national firms providing a wide variety services, including trustee work.

However, it potentially undermines what is inherant about the trustee system that make it econominally feasible. In most jurisdictions, the vast majority (upwards of 90 -95%) of all cases assigned to panel trustees are no asset cases for which trustees receive a flat fee. Generally, there aren't enough no asset cases assigned to any one trustee to provide sufficient revenue to cover overhead. In most jurisdictions, accepting no asset cases is the "loss leader" in anticipation of receiving the case with some assets in order to generate sufficient revenue to provide some profit.

It is very likely that the elimination of the residency requirement may allow for the large national firms that seek trustee work to effectively "cherry pick" the good cases to the detriment of the local panel trustees. This might very well result in the inability to find local persons willing to serve as trustees.

There is no similar provision in H.R. 764.

The Commercial Law League would recommend that this provision not be enacted into law.

H.R. 120: SECTION 7. EMPLOYMENT OF PROFESSIONAL PERSONS

A proposed change to subsection (c) of Section 327 is exceptionally confusing.

Part of the confusion arises from how subsection (c) has been published in various versions of the Bankruptcy Code. Depending upon the version of the code one reads, the current language could be either "Chapter 7, 12, or 11" OR "chapter 7, 11, or 12".

The provision in H.R. 120 calls for 'striking "chapter 7" and all that follows through `or` the first place is [sic] appears, and inserting `chapter 7, 12, or',..."

If the current code provision reads "chapter 7, 12, or 11" then the proposal in H.R. 120 does nothing. If the current code reads "chapter 7, 11, or 12", then the new law would change it to read "chapter 7, 12, or 12".

Clearly this is redundant if not totally confusing.

Intended or not, the latter reading would eliminate chapter 11 from the subsection and thus presumably preclude employment of a professional in a Chapter 11 case because of his or her employment by or representation of a creditor.

If this is the case, the Commercial Law League would strenously oppose any such change. There has been no indication that there are problems that have resulted from current law. There are provisions whereby those who believe that there exists an actual conflict of interest may bring their objection to the attention of the bankruptcy court for review and a determination. There are adequate protections to the system, the estate and the parties and no need to tamper with this provision in this manner.

H.R. 764 does not contain a similar provision.

Another portion of H.R. 120 would amend subsection (d) of Section 327 to allow the trustee to act as his or her own appraiser, auctioneer or other professional person in addition to current authority to act as attorney or accountant.

Presumably this is intended to encourage the increased use of non-attorney/non-accountants as trustees. Clearly this makes it more beneficial to those seeking to act as trustee if he or she may act in another capacity.

The CLLA believes that it would be inappropriate for trustees to be authorized to retain themselves in a capacity as outlined in H.R. 120. The role played by appraisers, for example, is that of an independent outside expert who is called upon to provide valuation information and might ultimately be called upon to testify in court on the basis for his or her conclusions. This is distinguished from the attorney for the trustee whose role is more that of an advocate.

Auctioneers and the auction process is public and visible. Often it is a primary means used by the bankruptcy estate for converting property to cash. The integrity of the process must be maintained at the highest level so that the public does not have even the hint of possible self-dealing.

The CLLA would oppose the change to Section 327(d).

Other provisions in H.R. 120 (see changes contained in Section 6. Limitation on Compensation of Professional Persons impacting 11 USC 328(a)) contain amendments to bring 11 USC 328(a) in line with the suggested changes above. Further, it recognizes and specifically authorizes additional forms of compensation other than retainer, hourly basis or contingent fee basis by adding "on a fixed or percentage fee basis". As these changes merely recognize the latest trends in compensation, and are not solely the purview of appraisers, auctioneers and other professionals, the CLLA endorses these proposals despite its opposition to the proposed amendment to Section 327(d) discussed above.

HR 120: SECTION 10. AUTOMATIC STAY

This provision would amend Section 362(b)(3) to provide that the automatic stay does not operate as a stay "with respect to a security interest that is created by a transfer to which section 547(c)(3) of this title applies.

HR 764, in Section 23, also addresses this issue by adding "a security interest in real property to which section 547(c)(3) applies".

The purpose of this provision is to address the decision in the 9th Circuit Court of Appeals decision in Thompson v. David Margen and Lowton Associates (In re McConville) 1997 WL 136529 (9th Cir.(Cal)).

In that case, a lender provided credit (secured by an unemcumbered piece of real property) to borrower who was in bankruptcy. Unfortunately, the fact of the borrower's bankruptcy was not known to the lender. Even more unfortunate for the lender, was their failure to require a loan statement from the borrower or any representation of the borrower's assets and liabilities.

One month after the loan was made, the borrower's previouly filed Chapter 11 converted to a Chapter 7 proceeding. The lenders sought relief from the automatic stay to foreclose the deed of trust. The bankruptcy court denied the relief. The trustee then filed a complaint to void the lien created by the deed of trust as an unauthorized, post peitition transfer, voidable under Section 549(a). The bankruptcy court entered judgment for the Trustee. The District Court affirmed the judgment of the bankruptcy court.

An appeal was taken to the 9th Circuit which issued an opinion on May 21, 1996. That original opinion was subsequently amended on September 26, 1996 and ultimately withdrawn and replaced by the March 26, 1997 decision cited above.

The September 26, 1996 amended opinion noted that under Section 549(c) a trustee may not avoid a transfer of real property to a good faith purchaser without knowledge of the bankruptcy. However, the Court ruled that no transfer of property occurred in this case because, under California law, all the execution of a deed of trust accomplishes is the creation of a lien in favor of the creditor.

There is no specific exception to the automatic stay as enumerated under Section 362(b)(1) through (18) for the creation, perfection or enforcing of a lien obtained by a simple lender to the estate. Thus the creation of the lien falls neither under an exception nor is it considered a transfer of property such that the trustee may not avoid the transfer.

A final attempt by the Lender fell short as well. It argued that Section 549(c) further provides that the trustee cannot avoid a "lien on the property transferred to the extent of any present value given." However, the Court rejected this argument based upon the holdings in In re Shamblin 890 F.2d 123 (9th Cir. 1989) and In re Schwartz 954 F.2d at 569 (9th Cir. 1992) stating that no real property was transfered and thus there was no property on which the lien referred to in Section 549(c) may operate, thus no transfer was made.

In its most recent permutation, the 9th Circuit noted that to change the rulings In re Shamblin and In re Schwartz an en banc court would be needed and the Court decided that was not necessary in order to now resolve the case.

The Court looked at Section 364(c) and (c)(2) and determined that the borrower violated those provisions of the Bankruptcy Code because it failed to gain approval from the court prior to obtaining the new secured credit and it is within the power of the bankruptcy court to rescind the contract.

However, the Court further stated that the equities in the case should not be disregarded. Among other items, the Court noted that the "lenders' failure to ask for any representation of the Debtors' finanical condition amounted to pretty much wilful blindness. The Lenders' lack of knowledge of the Debtors' bankruptcy was not unavoidable."

The Court then ruled that the Lenders be entitled to a lien on the amount they lent less what they have already been paid, but that they should get no benefit from their loan.

It is against this set of facts that Congress is being asked to amend the bankruptcy code to address the issues as framed by the American Land Title Association (ALTA).

The ALTA recommendations were significantly more extensive that either of those contained in H.R. 120 or H.R. 764. However, the amendments currently before this Subcommittee are an attempt to as narrowly as possible address the void created by the now withdrawn September 26, 1996 opinion in in re McConville.

It accomplishes that by specifically including as one of the exceptions to the automatic stay a security interest in property described under the "new value" exception to the preferences provisions of the code (i.e. Section 547(c)(3)).

There are several questions that should be addressed:

1. Does the withdrawal of the September 26, 1996 opinion in In re McConville and the subsequent March 27, 1997 decision render the need for corrective legislation moot? If so, then Congress need not invest any more resources on this issue.

2. If not, does the attempted fix outlined in H.R. 120 and H.R. 764 solve the problem narrowly enough so as to avoid creating other problems. It appears that the approach taken in H.R. 764 is more narrowly drafted and specifically notes that it would only apply to real property situations. However, the language in H.R. 120 merely makes reference to the key provisions under Section 547(c)(3) without making a distinction between real property and personal property. As the specific concerns raised by the ALTA relate to real property title insurance issues, the more specific language contained in H.R. 764 should survive, if in fact there should even be an amendment.

3. Were the facts in the McConville case so unique and the efforts (or lack thereof) by the lender to perform any due diligence so minimal as to place this case into the "bad facts make bad law" situation, such that Congress need not address this legislatively. Is it also possible that the treatment of the effect of the execution of a deed of trust under California law may be unique in and of itself. The proponents of this amendment would presumably argue that this is not a unique situation but rather the McConville decision raises the spectre of a virtual inability by the land title insurers to obtain any comfort level because of undisclosed bankruptcies particularly in light of the current unavailability of a national bankruptcy filing database. An exception for undisclosed bankruptcies might be needed in title insurance policies thus potentially leading to a chilling impact on the lending industry's willingness to extend credit. It appears that this case involved a debtor that was not as forthcoming as it should have been and a lender that was more trusting that it should have been. That situation is probably not all that unique. However, should the bankruptcy code be used to remedy stupidity, greed and slights of hand that go awry? The CLLA believes that is not an appropriate purpose for amending the Bankruptcy Code.

4. Section 1 of H.R. 120 does contain a proposed change to paragraph 54 of Section 101 of the Bankruptcy Code by adding "creation of a lien," after the term "security interest" in the definition of transfer. Our concern is that definitional changes often have unintended results. Therefore this is not an appropriate approach.

5. It appears that the appropriate way to fix the problem is through a very specific change to Section 549 which was the subject of the McConville case. Unfortunately, neither H.R. 120 nor H.R. 764 contains any amendments. Should one be drafted succinctly enough to address only the narrow issue raised in the McConville case, the CLLA would be favorably inclined to consider such a narrow, specific fix.

However, the CLLA opposes adoption of the provisions currently contained in H.R. 120 and H.R. 724 as detailed above.

H.R. 120: SECTION 11. EXECUTORY CONTRACTS AND UNEXPIRED LEASES.

This provision is intended to address the result in the 1995 decision In re Claremont Acquisition Corp. , 186 B.R. 977 (C.D. Cal. 1995). That decision relates to an amendment adding Section 365(b)(2)(D) to the Bankruptcy Reform Act of 1994.

However, the court in the Claremont decision determined that the word "penalty" modified on "rate" and not the phrase "provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations..." Thus the trustee could assume these contracts or leases without being first required to cure these non-monetary penalties.

The facts of the Claremont case involve automobile dealer franchises where one requirement of the agreement was continuous operation. The stores were closed for a few days prior to filing Chapter 11 and thus the non-monetary provision was impossible to cure.

The proposed new language would presumably address these non monetary provisions but effectively carves out an exception for leases of personal property. The trustee would still be required to cure non-monetary penalty obligations under any executory contract or unexpired lease other than an unexpired lease of personal property.

Section 6 of H.R. 764 contains identical language.

It is the position of the Commercial Law League of America that the Claremont decision does not carry out the specific legislative intent of Congress when it enacted the Bankruptcy Reform Act of 1994. It is also special interest legislation that is intended to favor one party in interest in the bankruptcy process. The Commercial Law League of America has long taken the stance that such special interest legislation should not be a part of the bankruptcy code. The CLLA would oppose enactment of this provision as written.

Further, the CLLA suggests that the issue that Congress should address legislatively is to:

a. make the statute specific enough to carry out its
original intent
b. address those situation where there is a requirement
that is impossible to cure

H.R. 120: SECTION 21. LIABILITY OF TRANSFEREE OF AVOIDED TRANSFER.

This provision would amend Section 550(c) by replacing the language "recover under subsection (a) from a transferee that is not an insider." with "avoid under section 547 such transfer, to the extent that such transfer was made for the benefit of a transferee that was not an insider at the time of such transfer, or recover under subsection (a) from a transferee that was not an insider at the time of such transfer."

Section 14 of H.R. 764 contains identical language.

It appears that this is intended to address the situation where the tranferee simply acts as a conduit for funds intended for the ultimate recipient. For example, an insurance broker may accept a check on behalf of the insurance company but is entitled only to a commission rather than the entire premium. Another example is a collection agency that receives payment from a debtor on behalf of a creditor and remits the funds, less a commission, to the creditor.

The CLLA supports this amendment.

H.R. 120: SECTION 25. APPOINTMENT OF ELECTED TRUSTEE

This provision is intended to address a void created by the Bankruptcy Reform Act of 1994 which allowed for the election of trustees by creditors in Chapter 11 cases. There was no specific provision for the termination of the appointment of the interim appointed trustee nor any provision for resolve disputes arising under the election.

The bill would address both questions by specifically providing that the service of the interim trustee ceases upon submission of a report by the U.S. Trustee of the election of the new trustee. The bankruptcy court is specifically granted authority to resolve disputes arising under the election.

Identical language is found in Section 20 of H.R. 764.

The Commercial Law League supports this amendment.

H.R. 764: SECTION 2. DEFINITIONS

One of the provisions in this section of the bill would amend Section 101(51B) of the Bankruptcy Code by eliminating the dollar limitation on the definition of single asset real estate cases.

There is no similar provision in H.R. 120.

The National Bankruptcy Review Commission has a proposal before it to accomplish the same result. The Commercial Law League has appeared before the Commission and has endorsed the elimination of the dollar limitation on the definition of single asset real estate.

These cases, which are essentially two party disputes, clutter the bankruptcy system. The clear intent of Congress when enacting a definition of single asset real estate cases under the Bankruptcy Reform Act of 1994 was to expedite the handling of these two-party disputes. Elimination of the $4 million cap will help accomplish that goal. Moreover, there is no logic behind the limination and it has simply resulted in needless litigation over the issue of the how the $4 million cap should be calculated.

The Commercial Law League of America supports this provision.

OTHER BANKRUPTCY MATTERS

A. EXPENSES FOR CHAPTER 13 STANDING TRUSTEES
The 1996 version of the Technical Amendments bill (S 1559) contained provisions relating to due process when there is a reduction of case load for panel trustees by the U.S. Trustee and when there is a dispute relating to reimbursable expenses for Chapter 13 Standing Trustees with the U.S. Trustee.

It is the CLLA's understanding that provisions will be recommended for inclusion in the current Bankruptcy Technical Amendments bills that will again address the above enumerated problems.

Congress has not defined the term "actual, necessary" as it relates to reimbursable expenses for Chapter 13 Standing Trustees. Thus, when there is a dispute over the application of those terms of art to specific items of expenditure, there is no mechanism for resolving those honest disagreements. An amendment to 11 USC 330 would afford the Chapter 13 Standing Trustee the opportunity, once he or she has exhausted all administrative remedies, to have the bankruptcy court resolve - with appropriate criteris - the dispute with the U.S. Trustee.

The following language has been suggested by the Association of Bankruptcy Professionals, Inc.

Section 330 of Title 11 of the United States Code is amended by adding to the end thereof the following:
"(e) Upon the motion of a trustee appointed under Sec ction 586(b) of Title 28, and after all available administrative remedies have been exhausted, the court shall have the authority, notwithstanding Section 326(b) of this title, to determine the actual, necessary expenses of the standing trustee. In determining actual, necessary expenses, the court shall consider all relevant factors, including:

(1) whether the expense will benefit the administration of
cases by the trustee; and
(2) whether the expense is reasonable, based upon the
customary and usual expenses incurred by fiduciaries rpviding
services of comparable nature in matters other than cases
under this title."

The CLLA supports the change proposed by the Association of Bankruptcy Professionals

. B. REDUCTION IN CASELOAD FOR PRIVATE PANEL TRUSTEE
The position of trustee has become a rather important one in the bankruptcy system with hundreds if not thousands of Chapter 7 bankruptcy cases assigned annually to trustees appointed by the U.S. Trustees. At times, the interests of the private trustee and that of the U.S. Trustee relative to a particular case may differ. Periodically personality conflicts may exist.

While infrequent, the reduction in caseload assigned by the U.S. Trustee to panel trustees has been used as a weapon to resolve differences between the U.S. Trustee and some private trustees. Under current law, there is no redress for the private trustee despite the immediate and irreparable harm such a reduction in caseload can cause the trustee and the debtors and creditors of bankrutpcy estates.

The CLLA supports due process for such trustees so aggrieved after all administrative remedies have been exhausted.

The Association of Bankruptcy Professionals, Inc. plans to proffer the following language:
Section 324 of Title 11, United States Code, is amended by adding to the end thereof the following:
"(c)(1) Notwithstanding any provision of Section 586 of Title 28, in the event the Attorney General ceases assigning cases to a trustee appointed under Section 586(a) or (b) of Title 28, the trustee, after exhausting all available administrative remedies, may seek judicial review of the Attorney General's determination. upon review, the court may reverse the Attorney General's determination only if the Attorney General has accted unreasnably or without cause. The failure of the Attorney General to make a final administrative disposition of a trustee's request to reconsider the deicision to cease assigning cases within thirty days of such request shall be deemed an exhaustion of all administrative remedies for the purposes of this subsection."
"(2) Notwithstanding any other provision of law, and pending the exhaustion of available administrative remedies or a judicial determination on the merits, the court may order injunctive relief in favor of the trustee."

The CLLA supports the change proposed by the Association of Bankruptcy Professionals.

C. HOMESTEAD EXEMPTIONS
Senate Bill 1559 from the 104th Congress contained provisions to provide for a $500,000 cap on homestead exemptions. This was primarily intended to address the so called bankruptcy havens of Texas and Florida that have significantly higher exemptions. The CLLA would support such a limitation for enactment in this Congress as well.

The Commercial Law League of America appreciates the opportunity to provide input to the Subcommittee and offers its assistance on an ongoing basis.

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