Last December, the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 released a 400-page report on recommended changes to Chapter 11 of the Bankruptcy Code. ABI formed the Commission in 2012 to evaluate business reorganization laws in light of the challenging economic climate and the perception that the costs and complexities associated with filing Chapter 11 have made Chapter 11 filings substantially less viable for businesses experiencing financial difficulty. The Commission’s report explores the current environment in which financially distressed companies operate and evaluates whether the current bankruptcy system is—or is not—working as well as it could.
The Commission’s study touched on the following themes: 1) a perceived increase in the number and speed of asset sales under section 363 of the Bankruptcy Code; 2) a perceived decrease in reorganizations that are not merely a vehicle for prepackaged 363 sales; 3) a perceived decrease in recoveries to unsecured creditors; and 4) a perceived increase in the costs associated with Chapter 11. Many of the Commission’s recommendations are aimed at addressing these concerns.
One of the Commission’s most interesting recommendations relates to sales involving substantially all of the debtor’s assets. The new provision would be called “Section 363x.” The provision would subject the traditional 363 sale to longer timetables and subject sales within sixty days of filing to greater judicial scrutiny. The Commission’s goals with this recommendation are to give debtors more breathing room and to allow a meaningful amount of time for parties in interest to evaluate the debtor’s assets. Sales within sixty days of filing would be permitted only in limited circumstances when absolutely necessary to preserve “significant” value.
Even with the new restrictions, the bankruptcy court would still have the power to order sales free and clear of liens. The Commission acknowledged that unsecured carve-outs are frequently negotiated, but the Commission did not recommend making these carve-out arrangements mandatory. Secured lenders would retain their ability to credit bid. Although the Commission recognized that credit bids may have a “chilling effect” on competitive bidding, the Commission recommends reinforcing auction and competitive sale procedures to mitigate this effect.
Trustees & Estate Neutrals
The Commission recommends keeping the current debtor-in-possession model, but with a few tweaks. The Commission recommends that a distressed company’s current officers and board continue to be permitted to manage and operate the debtor. The Commission also recommends retaining the current grounds for removing the debtor from possession and appointing a Chapter 11 trustee. Notably, however, the Commission recommends formalizing a lower burden of proof for motions to appoint a trustee—a preponderance of the evidence standard. Codifying the standard would resolve a current split amongst courts.
The Commission recognized that court-appointed bankruptcy examiners have played a crucial role in some of the largest Chapter 11 cases to date. Under current law, their role is limited to an investigatory function—particularly to investigate if the debtor is being mismanaged.
Although the Commission recognized their utility, the Commission also recognized that bankruptcy examiners may result in substantial cost to the estate. To curtail the expense associated with examiners and to maximize the utility of a neutral third party, the Commission proposes eliminating the concept of examiners under section 1104(c). Instead, the Commission recommends a more flexible court-appointed “estate neutral”—i.e., an individual who may be appointed depending on the particular needs of the debtor or its stakeholders to assist with certain aspects of the case. Given the unique vantage point of the estate neutral, the Commission recommends expanding the role of the estate neutral from the current examiner role and allowing the estate neutral to also facilitate dispute resolution and reduce information asymmetries.
As is the case with bankruptcy examiners now, and subject to certain exceptions, the estate neutral would not be permitted to: (i) propose a Chapter 11 plan; (ii) act as a mediator in any matter affecting the case; (iii) initiate litigation on behalf of the debtor or the estate; or (iv) operate the debtor’s business.
The Commission recommends that, unlike bankruptcy examiners currently, the appointment of an estate neutral would not be mandatory for any particular circumstances. The Commission also rejected a proposed standard that would require an estate neutral to serve the interests of all stakeholders in a bankruptcy. The Commission does recommend a requirement for court-approved budgets to curtail any excessive estate neutral fees or fees of professionals retained by the estate neutral.
Valuation Information Packages
The Commission recommends that debtors be required to compile (not file) the following:
- Tax returns for the three years prior to filing;
- Annual financial statements for the prior three years;
- Most recent independent appraisals of material assets; and
- All business plans or projections prepared within the two prior years that were previously shared with prepetition creditors.
This information would be available upon request. Requesting parties would be required to execute a confidentiality agreement.
A few of the other notable recommendations from the report include:
- The Commission proposes reducing the appointments of official committees to represent the interests of unsecured creditors.
- The Commission did not suggest any material changes to the claims trading and disclosure requirements. The Commission did recommend that courts be allowed to designate votes that are exercised “in a manner manifestly adverse to the economic interests of the other creditors in the class.”
- The Commission did not take a position on jurisdictional issues but stated: “[the] Commission, and all those interested in the efficient operation of the U.S. bankruptcy system, look forward to further clarity with respect to the scope of the bankruptcy court’s authority to hear and finally determine bankruptcy-related issues.”
- The Commission recommends eliminating section 1129(a)(10) in its entirety—this is the rule that at least one impaired creditor class must vote to accept a company’s Chapter 11 plan. The Commission opined that this provision tends to delay confirmation and ultimately increases costs. The Commission also opined that this provision gives secured creditors an opportunity for unfair gamesmanship, and may result in value destruction.
- The Commission’s changes would alter the method for valuing certain payments made to creditors.
- The Commission did not recommend significant changes to evaluating the cost and fees associated with bankruptcy professionals.
Proponents of the Commission’s findings think the prevalence of secured debt has given lenders too much control in a Chapter 11 proceeding. As a result, supporters of the Commission’s proposals opine that too many cases end in a quick asset sale rather than a meaningful operational-reorganization.
Other commentators have criticized the Commission as biased in favor of bankruptcy professionals and creating a system that results in longer, more lucrative cases. In particular, the Commission’s report has raised concerns among lenders. The Commercial Finance Association and Loan Syndication and Trading Association issued the following joint statement: “Indeed, many of the report’s recommendations are solutions in search of a problem. Moreover, some of the recommendations would undermine the Bankruptcy Code’s fundamental protections for secured creditors’ rights — protections that are central to the success of our bankruptcy system.”
The Commission’s recommendations are not legally binding. Members plan to present their recommendations to Congress, but it is unclear whether and on what timetable Congress may consider the proposals.
* This article first appeared in the April 2015 issue of Disclosure Statement, a publication of the Bankruptcy Section of the North Carolina Bar Association.