Long lines on sidewalks outside bankruptcy courts last October 16 testified to a significant change in the way American law treats debtors. Thousands queued up to file for protection from their creditors the day before the new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) went into effect.
Businesses got in line, too, including such giants as Northwest Airlines and Delta Air Lines. Robert "Steve" Miller, CEO of auto-parts maker Delphi Corp., and no stranger to bankruptcy in his long career as nursemaid to troubled companies, famously told The Wall Street Journal he did not want his current company to be a guinea pig for the new law. Delphi filed for Chapter 11 a week before the new law took effect.
Most observers agree that the provisions Congress wrote for individual consumers represent a significant philosophical shift, one that deliberately puts more onus on debtors. Less clear is the intent — or the ultimate impact — of the separate provisions related to business (see "Strapped for Cash and Time" at the end of this article). A July 2005 article in the American Bankruptcy Law Journal dubs those provisions "The Creeping Repeal of Chapter 11." But that effect, the authors argue, is the result of legislative incompetence and special-interest lobbying rather than any deliberate effort to undo the basic purpose of the code.
So is a key pillar of American capitalism in danger of collapsing, as some suggest? Or has Chapter 11 simply been dented by an exceptionally ham-handed effort on Capitol Hill?
Creditors Gain Leverage
In the latter camp is Alan Kornberg, chair of the bankruptcy and corporate reorganization department at New York law firm Paul Weiss. "Many of [BAPCPA's] amendments are bad policy, ill-conceived, poorly drafted, and likely to generate substantial litigation," he concedes. "Having said that, I don't believe the fundamentals have changed at all."
The authors of the "Creeping Repeal" article, Richard Levin and Alesia Ranney-Marinelli of Skadden, Arps, Slate, Meagher & Flom LLP, agree with Kornberg's assessment of legislators' work, noting that even provisions intended to address perceived abuses or problems "have been so poorly conceived or drafted that they are likely to do more harm than good." And most of the provisions, they write, "reflect active lobbying by certain creditor groups to improve their positions in bankruptcy cases." But they also declare that those provisions "will adversely affect the ability of businesses to reorganize."
That suggests that the bankruptcy code's historic emphasis on debtor rehabilitation may be shifting, even if that wasn't Congress's overt intent, and legal articles on this theme are legion. "Many of these provisions are aimed at curbing perceived abuses in the length of time and the cost of Chapter 11 bankruptcy cases," writes Lorraine S. McGowen of Orrick, Herrington & Sutcliffe LLP. "While not stated as an express goal, it appears that creditors have gained tremendous leverage over a debtor's ability to reorganize."
Arnold & Porter LLP's Brian Leitch, who served as lead bankruptcy attorney for US Airways and is currently an attorney for the Northwest Airlines bankruptcy, sees "no coherent, thoughtful revision" in Congress's effort. "I would call it tinkering," he says. Nonetheless, tinkering can have significant consequences. Leitch and other observers note that BAPCPA's various business provisions reduce the discretion of judges, force companies to make faster decisions, increase administrative expenses at the very point when a company has precious little cash, and limit incentives for management to stick around. "It's clear there is increased risk to the debtor and its management," says Leitch.
A Social Good Gone Bad?
That increased risk is bad, argues Jack Williams, a law professor at Georgia State and director of BDO Seidman Financial Recovery Services. Rehabilitating companies is a social goal that "meant the preservation of a business, of jobs, of a customer for trade creditors, and of a tax base for local communities," says Williams. Historically, he explains, U.S. bankruptcy law hasn't villainized bankruptcy, considering failure to be an essential part of capitalism. "We know competition brings out the best and worst in people, and we wanted to get the losers back in the economic game." That is no longer Congress's attitude toward individual debtors, Williams contends, and he sees certain business provisions as evidence that Congress applied the same moral opprobrium to companies.
Now, says Williams, the new emphasis on faster bankruptcies abandons the goal of reorganization in favor of liquidations or prepackaged Chapter 11 filings. "Sales or blessings — that's what it's all about now," he declares. "That's the sea change."
Whether or not Williams's analysis proves true, most observers agree that the greatest obstacles to successful reorganization will now be faced by companies that find themselves unexpectedly propelled into bankruptcy. And arguably, those are the ones most in need of bankruptcy protection, particularly now that the Enron-era rash of sudden fraud-induced insolvencies has largely passed.
Indeed, the political rap on bankruptcy has already changed. Critics now complain that Chapter 11 is simply a mechanism for companies to evade long-deferred obligations like pension payments. The new law isn't likely to change that perception — so long as a company is more timely about its bankruptcy filing than it was in meeting its obligations in the first place.
Tim Reason is a senior editor at CFO.
|Strapped for Cash and Time|
Key business provisions of the Bankruptcy Act of 2005 that demand more cash, require faster action, and increase risk to executives.
|Debtor's exclusive right to submit a reorganization plan is limited to 18 months, after which creditors may submit competing plans.|
|Companies have 210 days maximum to assume or reject real property leases.|
|Vendors have increased rights to promptly reclaim or be paid for goods sold to the debtor before bankruptcy, increasing the drain on debtor's cash.|
|Debtor must offer utilities an acceptable assurance of payment — another drain on cash.|
|Interest rates on taxes are raised and payment terms are tightened, also draining cash.|
|If fraud by directors, CEO, or CFO is suspected, U.S. Trustee must move for court-appointed trustee to replace management.|
|Retention bonuses are limited and may be paid only if executive has another offer.|
Blame the Courts?
Lynn LoPucki, a law professor at the University of California at Los Angeles, says that the corporate bankruptcy process is seriously flawed — but not because of the new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). LoPucki has long contended that different U.S. bankruptcy courts, notably those in Delaware and New York, compete for large corporate cases. He says the new law did not address this "systemic" problem, which he argues tilts the courts in favor of venue shoppers.
But if competition for bankruptcy cases skews the system against creditors, it has been "a disaster for debtors, too," adds LoPucki. "[Reorganized] companies are failing at rates three times as high as they were before this competition emerged."
Others object to LoPucki's contention that bankruptcy judges are "corrupted" by their desire to attract larger cases. "While not perfect, [the U.S. bankruptcy code] is the most sophisticated reorganization law anywhere and the role model for many other countries," says Alan Kornberg of New York law firm Paul Weiss, adding, "I vigorously disagree with those who are critical of the bankruptcy bench."
Indeed, even a harsh critic of the reform act like Georgia State law professor Jack Williams echoes that last sentiment. He argues that many of the perceived abuses of bankruptcy actually stem from larger policy failings — underfunded pensions, runaway asbestos litigation, or other issues that are allowed to reach a crisis point. "I'm skeptical about a number of [BAPCPA's] provisions, but it's still the best bankruptcy law in the world," he says. "You have to have a mechanism to get the losers back into the game, and ours is the best out there." — T.R.