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Florida food retailer Winn-Dixie’s bankruptcy filing in New York has rekindled allegations that a forum-shopping war between the states includes bankruptcy judges engaging in unseemly competition for cases. It has become so common for big corporations to file bankruptcy reorganization cases in either Delaware or New York, no matter where the headquarters are, that many consider the states de facto victors in wooing big cases. “Delaware went from no forum shopping during the entire decade of the 1980s to having 87 percent of the [large cases] by 1996,” said Lynn LoPucki, a professor at the University of California at Los Angeles School of Law. New York gained ground with the bankruptcy filing by Houston-based Enron Corp. in 2002, followed quickly by WorldCom Inc., Adelphia Communications Corp. and others. About 60 percent of recent big corporate bankruptcies have been filed outside the firms’ hometown headquarters, according to LoPucki’s figures. “It is a billion-dollar-a-year industry and judges are competing for this,” said LoPucki, adding, “[t]here is a legitimate question, if it is corrupt competition.” LoPucki’s recently released book, “Courting Failure,” based on his 20 years of research on large bankruptcies, makes the same controversial assertion, and that has the bankruptcy bar steamed. LoPucki says his numbers show: • The competition has caused courts to lose control of professional fees. • Allowed managers of failing companies to retain control. • Failed managers began paying themselves huge retention bonuses with the acquiescence of the judges. • Increasing payment to creditors dubbed “critical vendors” allowed a few to grab portions that might have gone to other unsecured creditors. • Managers began selling their companies at bargain-basement rates for personal benefit rather than reorganizing. “These allegations are baseless and offensive to both the bench and the bar,” said James Sprayregen, a bankruptcy specialist with Chicago’s Kirkland & Ellis. “The idea that judges are going to do the wrong thing so they will have more work to do isn’t something I have seen in 20 years of practice all over the country.” But others, including some judges, believe widespread venue shopping has changed bankruptcy practice in unhealthy ways that disadvantage the small and midsized creditors and the debtor’s employees who can’t afford to challenge the practices. A U.S. bankruptcy judge in Madison, Wis., Robert Martin, said, “As far as I can tell, [LoPucki's assertions] are pretty accurate.” Martin said it was unfortunate that he “chose to use incendiary words like corruption. I have been a judge 27 years and there is some joy in getting a big case. It is not venal in the sense there is no money in it. Judges don’t get paid piece work. “I think quite clearly the examples Lynn used were accurately drawn, that the Southern District of Florida quite publicly tried to make itself attractive, and Chicago at one time tried to make itself attractive.” Jay Westbrook, a University of Texas bankruptcy and international litigation professor, said he agrees with many of LoPucki’s assessments. “Enron did not end up in Manhattan because someone took the wrong plane,” he said. Westbrook also takes exception to LoPucki’s use of the word “corruption,” and called it unfortunate because it got a lot of lawyers “riled up.” Forum shopping, the selection of a court venue likely to be the most beneficial to a client, has the cache of seeking an unfair advantage, but it is perfectly legal. Sprayregen and Laura Davis Jones, a leading debtor’s lawyer in Delaware with Pachulski Stang Ziehl Young Jones & Weintraub, said attorneys have a duty to their clients to look for the most advantageous venue the law allows. There is forum shopping, “but in the way [LoPucki] suggests, absolutely not,” Jones said. “He is just trying to sell books,” she said. Jones insists that the experience of a particular judge and the law in the circuits play a greater role in the choice of forum. Bankruptcy law permits wide latitude in choice of forum for large companies. It allows filing in courts nearest the company’s principal place of business or location of the debtor’s principal assets or where the bankruptcy of an affiliate company is already pending. WINN-DIXIE BANKRUPTCY Winn-Dixie Stores Inc., which is headquartered in Jacksonville, Fla., with 920 stores in eight Southern states and the Bahamas, created a New York affiliate and 12 days later placed the fledgling firm in bankruptcy in the Southern District of New York. With the affiliate in a proceeding in New York, Winn-Dixie quickly filed its own Chapter 11 case in the same court. When a major creditor, Buffalo Rock Co., an Alabama beverage bottler, objected, Winn-Dixie agreed to move the case to Florida, but quickly found itself the center of news accounts for what Buffalo Rock called “blatant forum shopping.” Winn-Dixie’s initial filing strategy points up the efforts that, LoPucki said, have been typical of placing large cases in a desired court. LoPucki contends that as Delaware and New York drew more and more of the largest corporate bankruptcies in the 1990s, and thus the largest professional fees to their respective bars, other courts began to compete by matching practices in those courts, to the detriment of small creditors. To counter the dominance of Delaware and New York courts, LoPucki said some bankruptcy judges have contorted and stretched the law to accommodate powerful debtors, large lenders and the lawyers who represent them. Some bankruptcy courts, pressured by their local bankruptcy bars, searched for ways to keep the lucrative reorganization filings by large hometown corporations in the local courts, he said. LoPucki singled out Chicago, South Florida and Houston bankruptcy courts among those that competed to retain business in their courts, while Boston and Los Angeles found themselves losing out. He maintains that the case histories he has studied since 1980 show that some courts made it clear they would pay higher New York attorney fees to attract the higher-priced out-of-town practitioners. POWERFUL DEBTORS He faulted some courts for expanding the power of debtors to offer some creditors status as “critical vendors,” thus allowing them to be paid for prebankruptcy petition debts. Traditionally, prepetition debts cannot be paid until a reorganization plan is in place, and then creditors share equally from the money left. Payments to critical vendors shift more money to one creditor over another. In Kmart Corp.’s Chicago bankruptcy, “they paid $200 million to 2,300 [critical] creditors,” LoPucki said. “Those creditors got paid in full, while 43,000 others got 10 cents on the dollar.” Critical vendor orders expanded from being a rarity to being very prevalent, said Westbrook. “It gives enormous power to management. Under prior rules, nobody gets paid for prepetition debt. Now management says, ‘I can decide who gets paid,’” he said. Another way, LoPucki said, that judges have made their courts more attractive to debtors is by granting large retention bonuses. In the 1980s, companies limited retention bonuses to employees in short supply, such as nurses or pilots, according to LoPucki. The practice skyrocketed in the 1990s during the period, according to LoPucki, that competition for cases was in full swing. Martin said in one of his cases an executive with 60 percent of the stock in a closely held corporation wanted a retention bonus. “What was he going to do, walk away? He was up to his neck in this company. I wouldn’t even pay his salary. I was amazed by [the request],” he said. “If someone has just driven the bus off the cliff, why do we let him keep driving?” Martin asked. “At a point in a turnaround when cash is king, why dissipate it by paying bonuses or prepetition debt?” LoPucki considers refusal to replace management in a bankrupt company with an independent trustee as another lure offered by courts in competition. He pointed to Judge Arthur J. Gonzalez, who presided over the Enron case but delayed ruling on creditors’ requests for a trustee for several critical months, which gave CEO Ken Lay time to put his own man in place. “I was amazed when Enron filed … why a trustee was not appointed immediately,” said Linda Ekstrom Stanley, the former trustee for the Northern District of California and now a bankruptcy law professor at University of California Hastings College of the Law. Gonzalez declined to comment. Bankruptcy Judge Dennis Montali of San Francisco said the Northern California court does not get much forum shopping. He believes one of the factors considered in forum selection is controlling precedents in the particular circuit court. Jones backed that up. As an example, she pointed to the difference between the 2nd and 3rd U.S. circuit courts of appeals on the issue of allowing the voiding of a union contract in bankruptcy. That might make a critical difference to a client that could file in either venue, she said. Montali, who presided over the largest utility bankruptcy in U.S. history in the 2001 Pacific Gas & Electric Co. case, helped organize a 2003 conference on large Chapter 11 cases that was sponsored by the Judicial Conference of the United States, the judiciary’s policy-making body. The panel recommended last year that judges be allowed to consider changing venue without waiting for motions from a creditor, the education of judges on handling megacases and further study of rules for first-day orders, which set many cases’ parameters. But those recommendations pulled back from the 2001 proposal of the conference’s Bankruptcy Committee to limit venue statutes, including a prohibition on corporations basing their filing solely on the locale of a subsidiary’s filing or the state of incorporation — most commonly Delaware. In February, Senator John Cornyn, R-Texas, who was Texas attorney general when Enron filed for bankruptcy in New York, introduced legislation requiring companies to file in the court nearest their principal place of business or where principal assets are located. Laura Bartell, a Wayne State University bankruptcy law professor, disputed LoPucki’s theory of courts’ competing for bankruptcy business. “These are a group of conscientious bankruptcy judges. They don’t sell their rulings,” she said. She doesn’t fault the failure to appoint a trustee in a case like Enron’s. “Appointment is very rarely done. It is such a major step and it can be costly and damaging to the business.” Sprayregen said LoPucki’s accusations were “obviously preconceived conclusions and the data manipulated to reach the conclusion.” LoPucki responded: untrue. “I was on the other side of this before I found the data in 2000. I had to eat crow to come down on the other side of it.” Martin said that “the 1978 code struck a balance. It was an elegant law and the courts have surrendered some of that elegance.”

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