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Federal bankruptcy reform legislation is moving closer to becoming law, and academics, attorneys and judges are taking sides. Approved by the Senate and the House of Representatives by wide margins in April, the bill will most likely go to a conference committee to reconcile the two versions. President Bush has said he intends to sign the legislation, which would then go into effect 180 days later. Touted by Congress as consumer bankruptcy legislation, the 450-page bill nonetheless contains nearly a dozen corporate provisions. The most controversial of them are designed to shorten a company’s stay in Chapter 11 at the risk of forcing a liquidation. The legislation strips bankruptcy judges’ abilities to use wide discretion in allowing a company to work out its situation under Chapter 11 of the U.S. Bankruptcy Code, which was last reformed in 1978. Finally, the legislation would impose a number of deadlines on corporate debtors that don’t exist under current law. Todd Zywicki, 35, a law professor at George Mason University in Virginia who calls himself a “neutral commentator” on bankruptcy reform, has played a significant role in the legislation. He worked closely with Judge Edith Jones of the U.S. Court of Appeals while she was on the National Bankruptcy Review Commission, a body appointed by Congress to recommend changes to the nation’s bankruptcy law. In 1997, the commission submitted its report to Congress, which used it to fashion the current legislation. Since then, Zywicki — who thinks the Chapter 11 process is ripe for reform — advised Congress on reform legislation year after year as it attempted to pass the bill. Former President Clinton vetoed the legislation before leaving office. Roger Whelan, 64, current outside counsel for law firm Shaw Pittman in Washington, D.C., is a former bankruptcy judge who served in Maryland and Washington. Whelan, who left the bench in 1984 but has been active in the bankruptcy bar ever since, urged a congressional committee to create the National Bankruptcy Review Commission in 1991. But he disagrees with some of its recommendations, especially its efforts to drastically scale back judicial discretion. The Deal‘s Shanon D. Murray recently spoke with Zywicki and Whelan, who gave opposing views on the bankruptcy legislation, as well as the Chapter 11 system as a whole. Shanon D. Murray: How significant is this reform legislation? Todd Zywicki: We’ve had basically the same bankruptcy system since 1978. There were some efforts in 1984 to rein in some of the excesses in the system, but those efforts were very marginal. We’ve seen over the past 20 years that there are problems with the way the system works. There is a sense that Chapter 11 is simply too expensive, occasions too much delay and creates too much prejudice on creditors. There is a sense that we need to rebalance Chapter 11 proceedings so as to make the whole system less expensive and more efficient. What Congress is trying to do with the reform bill is move us back more towards a consistent and coherent system and rein in some of the excesses that have developed. Murray: How do you respond to complaints from the bankruptcy bar that there were no real opportunities to comment on the corporate provisions before they were drafted? Zywicki: I think that a lot of people did not pay enough attention to the corporate provisions, partly because most of the concern was over consumer bankruptcies. Basically what happened was because Chapter 11s were at an all-time low until recently, it was off the radar screen. People just weren’t focused on it. But Chapter 11 has been ripe for a looking at for many years now. I do think there are important flaws in Chapter 11. It’s good they are actually scrutinizing the provisions a little bit more. The big problem has been that most of the bankruptcy bar has not been constructive in the way they have dealt with this bill. They have demagogued it. They decided very early on a scorched-earth policy. There wanted to kill bankruptcy reform. Period. They only have themselves to blame for not exerting more constructive input on the Chapter 11 provisions early on. Now when we see their critiques of the business provisions, it is just more rock throwing and more of the same rhetoric. It’s impossible to tell what’s constructive criticism from their side and what are more poison pills attempting to derail the legislation. Murray: What are some of the most important provisions in the legislation that would affect corporate filings? Zywicki: The most important provisions in the bills will affect retail bankruptcies. There is a provision affecting the assumption and rejection of leases of real property. Under current law, retailers don’t have to decide to assume or reject leases until their reorganization plan is confirmed. In a case like Montgomery Ward, it could take more than two years to decide to assume or reject because a retailer wants to run through two Christmas cycles in order to find out whether the company could be reorganized. The legislation would create a hard and fast six-month deadline. There’s also a provision that affects administrative claims for suppliers, which seems also to affect retailers the most. It creates a 45-day window that any goods shipped by suppliers to the debtor within that window would automatically be accorded administrative priority instead of unsecured claims, and they would get paid dollar for dollar. That would boost priority of those suppliers. That could have a large impact on the distribution to other creditors. Murray: Any other important provisions? Zywicki: There’s also a provision in the bill that seems to make accusations of securities fraud nondischargeable. That potentially would have a very large impact on high-tech companies, which seem to be the ones most prone to these harassing lawsuits by class action lawyers. And it may end up making a lot of those companies liquidate and start a new business rather than reorganize and be stuck with these fraud claims after bankruptcy. So these companies basically have a double whammy. They have these class action lawsuits on one hand and now no ability to get out from under them because of bankruptcy on the other hand. Murray: Will the corporate provisions be tinkered with in conference committee? Zywicki: I think there is a very high likelihood. The consumer provisions are pretty much set in stone at this point. Because they’ve gotten so much scrutiny, the deals that need to be cut have been. But the corporate provisions have not gotten the same degree of scrutiny by players in the system or by the media. So there is a lot of room for negotiation and what the final shape of the corporate provisions will look like. Murray: What about the accusation that the bankruptcy court system is naturally pro-debtor? Zywicki: Specialty courts are too prone to being provincial and concerned only about the small constituencies and repeat players that come before them and not well enough attuned to the more general social interests of capital markets and what bankruptcy law should be all about. That is an accusation that has been leveled against the Delaware bankruptcy court. I think the system is already prone too much in favor of supporting far-fetched and devious reorganization plans. If you get a court that seems to be especially debtor-friendly, then that already prevalent bias is reinforced. Murray: What are some of the trends in corporate bankruptcies? Zywicki: I think that changes in the economy are going to require us to rethink our traditional model of bankruptcy, which raises the possibility of a radically more privatized system of bankruptcy law with a substantially reduced role for bankruptcy courts and public oversight. Murray: Would that be the same as prepackaged bankruptcies? Zywicki: That’s the idea. There is a lot of room for more prepackaged bankruptcies and workouts. I think that’s going to be the future model. A lot of it is the fear that the bankruptcy system now is inefficient. Filing for bankruptcy is a threat that debtors make to delay creditors rather than a last resort. Now a debtor says work out with us or we’ll toss it into bankruptcy and maybe you’ll get paid 30 cents on a dollar four years from now. As financial instruments and financing arrangements become more sophisticated, there will be ways of privatizing bankruptcies in advance, anticipating problems that might surface and then resolving them before getting close to bankruptcy. But there remain things a company can do in bankruptcy it can’t do outside, such as getting rid of certain liabilities. So the idea is for a company to work out with the creditors it needs to go forward and then use bankruptcy to carve off other liabilities. Murray: What works in the legislation and what doesn’t? Roger Whelan: Like all law, there are many good portions to it. Essentially the whole concept of bankruptcy is being changed. The troublesome aspect of the legislation is that the concept is very difficult to argue with. Essentially the obligation that people have to repay their debts is something you really can’t argue about. The real issue is how that concept is going to be adequately and sufficiently implemented. Murray: How do you respond to complaints from the bankruptcy bar that the legislation takes away judicial discretion? Whelan: Again, these concepts sound like they are good, but a lot of judges do not like being deprived of discretion. In a Chapter 11 case, a judge lives with the case for the duration. He knows the case, the parties, the corporation and its financial problems. By setting fixed deadlines, the legislation fails to recognize that each case will usually be somewhat unique and it is the presiding judge who has the ability to properly evaluate the case and then make the appropriate decision. In any system there will be mistakes and erroneous judgment calls. We have to recognize that when a judge exercises discretion, it won’t always be done in a perfectly ideal way or at least to the satisfaction of certain parties. Murray: What about repeat filings? Are judges confirming bad reorganization plans, or are some companies simply unable to make confirmed plans work? Whelan: Certainly some of it can be attributed to the judge, but I think it’s unfair to say the bulk of the failure belongs to the judge. The most important factor in a Chapter 11 case is the requirement that a bankruptcy judge finds that the reorganization plan is feasible. That’s not a defined term, and it can’t be defined. It depends on a number of intangible or future factors. So to say that the judge made a mistake or ignored the established case law precedent to determine whether or not a particular plan is feasible is a very difficult area. For a judge, it’s kind of like looking into the crystal ball. By and large, most bankruptcy judges make a very conscientious effort at requiring that evidence be introduced at the confirmation hearing to establish that a plan is, in fact, feasible, but case law makes it clear it can’t be done with absolute certainty. Because of the goals of Chapter 11 and where the facts are balanced, bankruptcy judges will give the benefit of the doubt to the debtor. Clearly if the evidence shows that this plan is not feasible and the debtor was not able to survive and would clearly be back in the mill again, the judge should not confirm the plan. But for most judges, it’s not that easy a task because the evidence in most cases will present a reasonable picture of success. And that is essentially all that is required. Murray: Do you believe there is a need for more bankruptcy judges? Whelan: It’s absolutely necessary, and it’s a matter that Congress has been well aware of for some time. But the issue of bankruptcy judgeships and the number of appointees are linked to the reform legislation, and when the reform legislation becomes law, then of course we will have approximately 28 additional authorized judgeships. And I strongly suspect there will be an additional need. Right now, when you look at the dockets, bankruptcy judges are literally swamped. Clearly, we are going to have a real dire need for more judges. In fact, we needed a vast number of bankruptcy judgeships nearly 10 years ago. But the legislative process takes time. There should have been a separate bankruptcy judges bill, so that issue could have been dealt with on its own merits. The tragedy of it is the bankruptcy judgeship issue is being held hostage because of the legislation, and the bankruptcy judges around the country are suffering. Murray: What are the inefficiencies of the corporate bankruptcy system? What works well? Whelan: There have been discussions and law review articles advocating doing away with Chapter 11 and letting the marketplace and economic forces take over, which, in most cases, would mean the liquidation of companies. But while there will always be inefficiencies; the structure of Chapter 11 was really a superb piece of legislation. Chapter 11 serves a very valuable function in our economy. Instead of merely liquidating a faltering business, we want to protect as many of the fringe interests as we can. And that’s where balance and negotiation comes in. The whole purpose of Chapter 11 is to foster negotiation. The bankruptcy code is designed to be a leavening force. It brings about the ability of judges to interpret and implement the sections of bankruptcy law in a substantive way and hopefully balance the interests of debtors and creditors. Copyright (c)2001 TDD, LLC. All rights reserved.

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