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For years, Delaware’s corporate bar and judiciary have zealously guarded the state’s reputation as the premier jurisdiction for corporate law. Now Delaware has assumed an analogous position in bankruptcy law, and the judiciary and bar in that field are being equally protective. In April, Delaware U.S. District Court Chief Judge Sue Robinson removed bankruptcy judge Randall Newsome from three cases after he questioned whether Delaware was the proper jurisdiction for them. Newsome, from California, was brought to Delaware along with five other judges to help with a deluge of cases that reflect the respect creditors, debtors and their counsel have for the federal bankruptcy court in Wilmington. Not everyone thinks that court’s ascendancy, which began a decade ago, is a good idea. Lawyers and judges in other jurisdictions complain they are being unfairly deprived of the largest, most interesting cases. And there could be more significant flaws. In an April article in the Vanderbilt Law Review, Lynn LoPucki, a professor at the University of California, Los Angeles Law School, claims companies that file for Chapter 11 reorganization in Delaware are as much as seven times more likely to refile for bankruptcy than companies that file in nearly every other federal bankruptcy court jurisdiction. (The lone exception is the Southern District of New York, whose perceived pro-debtor stance in the 1980s enticed many companies to file there.) LoPucki says his findings show that forum-shopping in bankruptcy cases by either creditors or debtors — the decision to file for Chapter 11 in a court other than the one nearest to the debtor company’s headquarters — isn’t good for any of the participants in the process, whatever their own beliefs about the value of a particular forum. Delaware has a strong hegemony over the bankruptcy reorganizations of large public companies. More than 60 percent of such cases filed in the U.S. are filed in Wilmington, according to LoPucki. As in corporate law, most companies that use Delaware’s bankruptcy courts do so because they are incorporated in the state. That percentage rankles lawyers and judges in other jurisdictions. PREDICTABLE COURT Many bankruptcy lawyers with a national practice wave aside such concerns. “For businesses that have a liquidity problem, Delaware is predictable, meaning that you know what you’re going to face from the Delaware judges,” said J. Ronald Trost, a partner at Sidley Austin Brown & Wood in New York. David Skeel Jr., University of Pennsylvania Law School professor, says there is a sound basis for having the country’s leading bankruptcy court a stone’s throw from its leading forum for corporate law disputes: “It really doesn’t make sense to separate bankruptcy law from corporate law. Bankruptcy is full of state law. There is a central principle of bankruptcy law that wherever possible, it incorporates state law.” Delaware has worked to promote such an image. Since 1997, the state’s four federal district judges have also been allowed to hear Chapter 11 cases, a practice unique to Delaware. Robertson curtailed the practice in February but reinstated it, recognizing the overwhelming caseload Delaware’s two bankruptcy judges face. While Newsome’s actions might have reduced the Delaware bankruptcy docket, they won no favor in the court. Ironically, in a 1996 report to the National Bankruptcy Review Commission in support of maintaining existing venue choices, the Delaware Bar Association argued that the court’s ability to transfer a case to a more appropriate venue limits parties’ ability to file cases inappropriately in Delaware. Robinson reassigned to herself from Newsome the case of Worldtex Inc., a Hickory, N.C.-based, Delaware-incorporated elastic yarn and fabric maker that filed for Chapter 11 March 12. At an April hearing, Newsome asked Worldtex’s counsel to prove Delaware was the proper venue. Newsome was also removed from the bankruptcy cases of Columbia, Md.-based W.R. Grace & Co. and Geismar, La.-based Borden Chemicals and Plastics after raising questions about the suitability of Delaware for their Chapter 11 proceedings. He still presides over seven other cases. DELAWARE DETRACTORS Newsome didn’t return phone calls, so his motivation is impossible to discern, but his actions and LoPucki’s scholarship indicate Delaware’s bankruptcy court still has its detractors. LoPucki’s has scrutinized the court before. In 1996, 12 of the 14 large, publicly traded companies that filed for bankruptcy did so in Delaware, LoPucki wrote in a 1999 Cornell Law Review article, “Shopping for Judges: An Empirical Analysis of Venue Choice in Large Chapter 11 Reorganizations.” On Feb. 3, 1997, then-Chief Judge Joseph J. Farnan, Jr. of Delaware’s U.S. District Court stopped the automatic reference of Delaware bankruptcy cases to the bankruptcy court and instead took over the assignment of Chapter 11 cases in the jurisdiction. Farnan justified the move by pointing to the increase in bankruptcy filings, but the number of Chapter 11 cases in Delaware actually fell from 242 in 1995 to 209 in 1996, and bankruptcy judges Helen Balick and Peter Walsh had not requested additional help, LoPucki wrote. Instead, said Skeel, “The big thing people complained about was Judge Balick’s ex-parte contacts with lawyers,” in which Balick would indicate which judge was likely to get a particular case. Farnan’s edict had a chilling effect: Between its issuance Feb. 3, 1997 and July 7, 1997, only one large public company filed for bankruptcy in any U.S. bankruptcy court. When filing resumed, Delaware got a more modest 50 percent of such bankruptcy cases. Delaware wasn’t the first jurisdiction to try to become a de facto national bankruptcy court. In the 1980s, Judge Burton Lifland of the Southern District of New York gained a reputation both for his pro-debtor stance and his considerable experience in the reorganizations of large, public companies. As a result, New York became a bankruptcy mecca, aided by its convenience for creditors, lawyers and corporations with headquarters in New York or substantial operations there. LoPucki writes that in the 1980s the court heard 13 of the 28 bankruptcies of large, publicly traded companies filed in jurisdictions other than that of the debtor’s headquarters. PLACE OF INCORPORATION Two events in 1988 helped change that. The New York court took steps to ensure that its random assignment system lived up to its name, which hindered Lifland’s ability to ensure that he would hear large cases. In the same year, LoPucki notes, “Judge Balick, the only bankruptcy judge in the District of Delaware, ruled that a corporation’s ‘residence or domicile’ for venue purposes was at its place of incorporation.” Delaware thus became a proper venue for the 89 percent of the large, public companies that filed for Chapter 11 from 1980 to 1997 and were Delaware corporations or had a Delaware-incorporated subsidiary. Had Balick ruled the other way, Delaware would have been a proper venue for fewer than 1 percent of those companies, LoPucki noted. Delaware didn’t start to attract large cases until 1990, when Continental Airlines filed for its second bankruptcy. Balick did a good job in the case — Continental has yet to return to bankruptcy court — so debtors began to gravitate to Delaware, attracted both by Balick and by the belief that Delaware’s judicial competence in corporate law would influence the bankruptcy court in the state. Since 1994 Delaware has heard more than 80 percent of the cases heard in a jurisdiction other than that of the debtor’s headquarters, LoPucki has noted. Lawyers say there are considerable advantages to having a court with Delaware’s expertise. First, they say, many bankruptcy courts lack the sophistication needed to deal with the complexities of a large Chapter 11 case. Second, lawyers believe Delaware courts are faster, which appeals to creditors who want to be able to sell their debt to vulture investors. And lawyers say both Delaware bankruptcy and district court judges are more predictable and less idiosyncratic than their peers elsewhere. “I’ve had a number of cases before the district court judges, and they came up the learning curve very quickly. They’ve sat on some very complex cases and have done an excellent job,” said Harvey Miller, a bankruptcy partner at Weil, Gotshal & Manges who has represented debtors in numerous large cases. Indeed, LoPucki concluded that the mean unnegotiated Delaware case took 510 days, versus 765 days in New York. Aside from speed, lawyers praise Delaware courts for their efficiency and ease of use. LoPucki thinks such virtues come at too high a cost. FILE AND REFILE “Delaware probably does an effective job of letting both creditors and debtors deal with their problems in the way they want to deal with them, so of course the lawyers are happy,” he said. “The result is that the court doesn’t deal with the company’s problems.” Thus, companies reorganized in Delaware are up to seven times more likely to refile for bankruptcy than companies reorganized in jurisdictions other than the Southern District of New York, which has a similarly high refiling rate, LoPucki claims in an April Vanderbilt Law Review study. LoPucki argues that creditors and debtors both have an interest in reorganizing rather than liquidating. The companies want to continue to operate, and the creditors hope to be able to sell their bonds to other investors. Lawyers respond that vulture investors are sophisticated investors who don’t need court protection. LoPucki wonders if such investors recognize that the securities of companies reorganized in Delaware are riskier than those in other jurisdictions. “I am saying that they’re sophisticated people, and they’re making a mistake,” he said. Though he admits that he hasn’t talked directly to any vulture investors, LoPucki hopes to do research on the relationship between the jurisdiction in which a company was reorganized and the financial performance of its securities. Trost said that creditors often drive a bankruptcy and hope for the speediest possible reorganization. “When there’s a default, the distressed debt traders get into trading bond and bank debt,” he said. “When they get in, they need something to happen fast. It’s a function of the fact that this industry of trading in distressed debt has grown up, and so sometimes cases are resolved too quickly. It’s because the publicly traded securities get into the hands of the traders.” FORUM-SHOPPING Such a dynamic has arisen independently of the rise of Delaware as a bankruptcy haven, Trost added. “I think you’d have the same result in any other jurisdiction. I do not think the fact that there was a trading market caused these cases to gravitate to Delaware.” LoPucki believes the forum-shopping encouraged by Delaware and New York’s Southern District is directly responsible for the higher refiling rates in both districts. “What we see is New York, particularly Judge Lifland, and then Delaware courts trying to attract cases, and they run a high failure rate,” LoPucki said. “What New York gave companies in the 1980s was delay. What Delaware courts offer to companies is laissez-faire. It’s beyond the possibility of coincidence that the two places that have garnered a lot of cases have garnered the highest failure rates.” Moreover, he said, the Delaware Bankruptcy Court requires that local counsel represent each party in a case, an unusual requirement that adds to the cost of a case. LoPucki has written that prepackaged bankruptcies Delaware’s bankruptcy court approves are more likely to fail than those approved by other courts, a difference LoPucki says is not statistically significant. PREPACKAGED CASES Miller is especially skeptical of this part of LoPucki’s argument. “You can’t expect a judge to become a prosecutor,” Miller said. “People come in to court arm-in-arm singing ‘We Shall Overcome.’ ” Moreover, judges in most jurisdictions are reluctant to interfere with prepacks, said Harold Novikoff, a partner at Wachtell, Lipton, Rosen & Katz who represents creditors. “In major cases with sophisticated parties, the courts will generally leave it to the parties to negotiate the deal,” Novikoff said. “Unless some party objects to the deal, the court doesn’t really go out of its way to second-guess creditors or debtors have done the right thing. It’s difficult to go back and blame it on the judge when the plan was the result of extensive negotiation by sophisticated, well-advised parties.” LoPucki acknowledged those arguments: “No court has ever failed to approve a prepack,” he says. He also found in his 1999 study that Delaware courts take an average of 52 days to approve a prepack, while the 17 prepacks in venues other than New York or Delaware took courts an average of 59 days to approve. Oddly, then, the rate of forum shopping for prepackaged cases has been higher than the rate for nonprepackaged cases since 1991, according to LoPucki. Delaware also receives a disproportionate number of prepacks, LoPucki found. Between 1990 and 1998, 19 of the 49 filings in Delaware — 38.8 percent — were prepackaged versus 20 of the 140 cases in other districts (14.3 percent). Trost has a one-word explanation for that phenomenon: Southland. A Dallas court heard the 1990 bankruptcy of the owner of 7-11 stores, “which was in bankruptcy six months more than it needed to be,” Trost said. By LoPucki’s records, Southland was only in bankruptcy for the 120 days from Oct. 24, 1990 to Feb. 21, 1991, but the bankruptcy bar still remembers such snafus, Trost said: “It’s more likely than not that a court will approve a prepack, and much more likely than not if you’re in Delaware.” SUGGESTIVE DATA Even Skeel, an admitted fan of Delaware’s bankruptcy court, finds LoPucki’s data suggestive. The problem is, Skeel doesn’t know what they suggest. “The Delaware cases are fast, so it’s not that the creditors are being worn down,” Skeel said of the higher rate of refilings in the state. “Lynn doesn’t have a credible explanation for the data.” Lawyers posed several possible explanations for LoPucki’s findings. Some said that parties are more reluctant to let large companies fail than they are to liquidate smaller companies, and larger companies are more likely than smaller companies to file in Delaware rather than in their home districts, Miller said. LoPucki replies that among companies with over $100 million in assets in 1980 dollars, the larger companies were in fact somewhat less likely to fail than the smaller companies. Miller also said that a company’s creditors often push companies out of bankruptcy before they’re ready, a fault LoPucki attributes to both creditors and debtors. “Often, it’s the creditors forcing companies out of bankruptcy,” Miller said. “The motto is, we’ll fix your balance sheet, and you can fix the operational problems when you come out.” LoPucki hasn’t researched the issue of whether companies that emerge from shorter bankruptcy proceedings are more likely to refile than companies that stay in Chapter 11 for long stretches of time. He did say that refiling rates ebb and flow while bankruptcy proceedings have become progressively shorter, which suggests that there’s no relationship between the time it takes a company to reorganize and the likelihood of having to refile. At least two lawyers argue that bankruptcy courts have very little ability to affect the fate of the companies before them. Trost emphasized that bankruptcies are driven by creditors’ desire that debtors reorganize quickly so that the creditors can sell their debt. And Ralph Mabey, a partner at LeBoeuf, Lamb, Greene & MacRae in Salt Lake City and himself a former bankruptcy judge in Utah, pointed to the three bankruptcy filings by TransWorld Airlines Inc. as an example of the limits of a bankruptcy court’s ability to fundamentally change a company’s competitive position. COURT CONTROL “I have been involved in all three TWA cases,” said Mabey, who represented the Airline Pilots Association, the TWA pilots union, in two proceedings in Delaware and a third in St. Louis, where TWA has its headquarters. “Those courts in ruling upon the matters that came before them could not control the competitive forces that were at work against TWA. I see nothing that the courts did that precipitated these refilings.” Finally, there’s the possibility that LoPucki’s figures reflect Balick’s pro-debtor orientation rather than that of the Delaware court, since she heard most of the cases in his study. Skeel argued that Delaware courts are likely to correct their own excesses. “I don’t think there are lots and lots of things Delaware has done wrong,” Skeel said. “The big thing people complained about was Judge Balick’s ex parte contacts with lawyers, and that’s changed.” LoPucki said the issue has broad implications: “What this situation demonstrates is that markets do fail, and this is a good time in history for getting acknowledgement that markets fail, because we can see with hindsight that stock prices were too high last year. Bankruptcy is a highly emotional, personal process that goes horribly wrong sometimes.” Copyright (c)2001 TDD, LLC. All rights reserved.

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