The More Things Change... Reflections on 34 Years of Practice

Journal Issue

Oct 2006

Column Name

On the Edge

Citation

ABI Journal, Vol. XXV, No. 8, p. 22, October 2006

Topic Tags

Practice and Procedure

Journal HTML Content

I recently
participated in a program about trends in the bankruptcy field.1
While thinking about trends in preparation for the program, what struck me most
was that bankruptcy attorneys today struggle with the same issues they did 34
years ago, when I started practicing. For example, whether a debtor can use
collateral over the objection of a secured creditor or whether the stay should
be lifted were, and likely always will be, hotly-contested issues in reorganizations.
Even though the issues remain the same, the criteria we apply and resolutions
we reach change over time. Sometimes these changes appear to be permanent trends.
In other cases, these changes are more like the movements of a pendulum that
swings back and forth over long periods of time. As these changes occur, at
least in the short-term, it is extremely difficult to distinguish between the
two.
 It is my belief that most of the issues discussed in this article are not
one-way trends, but rather are like pendulums that will swing back and forth
depending on the political, economic and legal factors of the time. In particular,
I have observed three philosophical pendulums that have contributed to the changing
state of bankruptcy jurisprudence over the past 34 years: (1) the debtor-orientation
or creditor-orientation of judges, Congress and society; (2) the inherent tension
between sanctity of contract as an important basis of capitalist society versus
the overriding social value derived from successful reorganizations; and (3)
the debate between judges advancing a strict constructionist judicial philosophy
versus judges that apply a more flexible approach in their reading of the Bankruptcy
Code.
I could pick any point in time as a base from which to look forward and discuss
these pendulum swings. A good place to start is with an illustration from the
mid-70s that sticks out in my mind as an obvious example of how things have
changed. At that time, I was a young associate, and my boss called me into his
office and told me that I should leave immediately to go to court to cover a
hearing. I had little background on the case and no time for preparation, but
I dutifully hustled over to the court (some things never change for young associates).
When I arrived, I discovered that my hearing was low on the calendar. I took
a seat in the back of the courtroom so I could watch what was going on and learn
from more-experienced attorneys. The judge that day was Judge Paul Glennon,
who was one of the nicest men that I have had the pleasure to know. Judge Glennon
would almost never convert a case. He believed that chapter XI offered people
an opportunity to save the businesses that they had built through their "blood,
sweat and tears." He thought that honest people deserved that opportunity,
and he did not want to be the one to take it away. His views were probably at
the pro-debtor extreme, even for that day, but that only makes this example
more compelling because this was a pro-debtor period of time.
As I sat in the back of the courtroom, I watched a hearing about the chapter
XI equivalent of a chapter 11 motion to convert. The debtor was a record distributor.
It soon became clear that the judge was not going to convert the case, even
though all the parties in the case (except maybe the debtor) wanted the case
converted because, quite frankly, it needed to be. Finally, a creditor jumped
up from the back of the courtroom and asked if he could be heard. Judge Glennon
said, "of course, you come right up here." The creditor said, "but
judge, I'm not an attorney." The judge responded, "that's okay, you
come right up here and you tell me what it is on your mind." The creditor
replied, "your honor, this is a record distributor. If you don't convert
this case and liquidate today, the inventory will be worthless in three months."
Judge Glennon paused and looked at the young creditor and said, "well,
I'm always walking up to Filene's or to Jordan's, and I buy Lawrence Welk records
and I buy Guy Lombardo records, and they never go out of style." The poor
creditor was becoming apoplectic because he could see his money flying out the
window. He sputtered, "Your Honor, Your Honor, Your Honor...I personally
have a million-dollar record inventory and I don't have even one of the artists
you just named." Judge Glennon looked down from the bench and calmly stated,
"young man, you are obviously out of step."2
 Now, what does this illustrate in terms of trends and pendulums?
The above story occurred during a pro-debtor period, and Judge Glennon was
a debtor-oriented judge who read the Bankruptcy Act in a flexible way to give
every debtor a chance to reorganize. If Judge Glennon had not been a debtor-oriented
judge, or if he did not believe that the bankruptcy laws should be interpreted
flexibly, or if he believed that the value of a reorganization should not override
contractual expectations, this hearing would have come out quite differently.
Obviously, not every judge in a particular time will be debtor-oriented, or
creditor-oriented, or a strict constructionist, or take a flexible approach.
These are movements of a pendulum, not absolutes. As a result, there will always
be some debtor-oriented opinions even during markedly creditor-oriented periods,
just as you will find some creative and flexible jurisprudence even in times
when a strict constructionist philosophy is favored.3

Debtor- or Creditor-Oriented Pendulum 
In order to understand whether debtors or creditors tend to be favored at any
particular point in time, it is necessary to consider trends in the economy,
law and politics, including trends in the outlook of judges and Congress. Some
judges are debtor-oriented, while other judges tend to favor creditors. This
may be more difficult to interpret than it first appears. This is because there
are some judges who are very concerned that a reorganization be successful,
but have no particular bias in terms of the outcome on the debtor or the creditors.4
Most creditor-oriented judges are in fact secured creditor-oriented judges,
although a few that I have seen actually interpret the Code in a manner favorable
to unsecured creditors. There will always be judges who will view reorganizations
as being for the primary purpose of allowing debtors to restructure their businesses,
while other judges feel that reorganizations should maximize value for the benefit
of creditors. Therefore, the outcome of a particular case is greatly affected
by the philosophy of the judge on this key issue. Not only will the results
differ on confirmation issues, but, among other things, determinations regarding
the debtor's use of collateral and the time afforded the debtor to reorganize
can differ depending on the perspective of a particular judge.
 In addition to the orientation of judges, there is the question of the outlook
of Congress. During the Great Depression, Congress passed provisions of the
Bankruptcy Act to provide for reorganization. Among those provisions were chapters
X and XI. Chapter X was originally designed for large public companies and usually
provided for the immediate appointment of a trustee, the absolute priority rule
was a requirement for plan confirmation, and the debtor did not enjoy any right
of plan filing exclusivity. By contrast, chapter XI provided for a presumption
of management continuation, there was no absolute-priority rule requirement
for plan confirmation (at least after the early 1950s), and the debtor was the
only party that could ever file a plan. Obviously, chapter X was disadvantageous
to debtors and to the people making decisions for debtors on whether to file
and under which chapter. As a result, by the end of the reign of the Bankruptcy
Act, even most large public companies filed under chapter XI rather than chapter
X. Because only the debtor could file a chapter XI plan, and because there was
no absolute priority rule, creditors were usually faced with the option of taking
liquidation value or dividing the difference between liquidation value and going-concern
value with equity. While chapter XI technically only dealt with restructuring
unsecured claims, bankruptcy judges were not quick to terminate the automatic
stay, making it in the best interest of secured creditors to agree to a restructuring.
In sum, chapter XI was wonderful for debtors and their shareholders, who were
often able to retain the residual value of the company.
Contrast this with the current approach to exclusivity and the absolute-priority
rule. Exclusivity (particularly after BAPCPA) is limited in time, and the absolute-priority
rule is a cramdown requirement designed to protect nonconsenting classes of
unsecured creditors. The absolute-priority rule can be waived, but if it is
not, lower classes of debt and equity must be eliminated unless the senior unsecured
classes are paid in full. Accordingly, it has become more likely that business
entities (particularly middle-market companies whose directors are more likely
to have a financial stake significant to their net worth and less likely to
be concerned about securities law issues) will attempt to solve their financial
problems outside the context of formal proceedings. The logical result, therefore,
is that many companies will delay filing until it is too late to actually reorganize.
It is not surprising, given these developments, that a large percentage of chapter
11 cases today are actually asset-disposition vehicles for the benefit of creditors.
Clearly, for better or worse, the development of the bankruptcy statutes themselves
has significantly contributed to creditor-oriented trends.
Last October, as we approached the effective date for BAPCPA, it was not an
uncommon opinion for bankruptcy professionals to predict a deluge of chapter
11 filings so that companies could reorganize free from the new and more restrictive
amendments to the Code. That deluge, however, proved to be at most a trickle
as only three major companies—Delta, Northwest and Delphi—opted
to file prior to Oct. 17, 2005. Why, unlike the consumer side, where a record
number of people filed chapter 7 to avoid the new amendments, weren't there
more filings of corporate entities at that time?
It is my view that the pre-amendment chapter 11 statute was already sufficiently
negative for debtors5 that companies did not file just to avoid the
amendments.6 During periods when chapter 11 is not favorable to debtors,
it should be expected that debtors will attempt out-of-court solutions rather
than chapter 11 filings. Under such circumstances, the filings that do occur
will tend to be after such out-of-court attempts have failed, and regrettably
after it is too late for an economic restructuring to be successful.7

Indeed, over the past few years, the bankruptcy bar has observed the debtor/creditor
pendulum shift to create a system more favorable to creditors. By way of example,
some of these creditor-oriented trends8 include:9
• New lenders, new types of lending. Over the last few periods,
new types of lenders and new tranches of lending have increased the likelihood
that debtors facing financial difficulty will be more susceptible to being over-leveraged.
An over-leveraged company is less likely to be able to yield significant continuing
value to equity in a reorganization. The new breed of lenders and lending comes
in many varieties, including mezzanine financing, second-lien financing, hedge
fund investments, securitization and junk bonds. The proliferation of this new
lending and similar aggressive investing has tended to make it significantly
more difficult to restructure successfully under chapter 11 while preserving
value for equity. In the event of a sale, the proceeds will be distributed in
order of priority unless a "tip" can otherwise be negotiated for out-of-the-money
creditors or equity. Even if there is not a sale, the reorganization of an over-levered
company is more likely than in the past to provide for the exchange of the lower
tranches of debt for equity, leaving little or no value for pre-existing equity.10
Of course, there are examples of cases that are successful from the perspective
of equity; however, as a trend, changes in the capital markets have made it
increasingly difficult for equity to retain value in a reorganized debtor.
• Expanding notions of fiduciary duty. In the past, board members
and officers of companies owed a fiduciary duty solely to stockholders. Today,
when a company approaches insolvency, that duty begins to run to creditors,
or to creditors and stockholders together. This shift changes the dynamics of
out-of-court workouts and reorganizations. In fact, this trend may be one of
the few pro-creditor trends that makes a chapter 11 filing more likely because
directors and officers are less likely to be second-guessed for decisions made
in the context of a chapter 11, particularly if such decisions are approved
by a bankruptcy court.
• The lessening impact of lender liability. It was not so long
ago that the very mention of the word "control" would cause bank officers
to break out in a rash. Today, that fear has been minimized in comparison to
the past.11 Not only are lenders less afraid of being accused of
being in control; in fact, effective control is often their goal. For example,
lenders have become much more aggressive in their negotiation of debtor-in-possession
(DIP) financing orders, sometimes seeking to include a requirement of a sale
of the company at particular points, a grant of relief from the automatic stay
upon default, and the inclusion of tight budgets and negative covenants, which
together can impact operations. Sometimes even the content of any plan the debtor
may file is impacted by the DIP financing order. Further, lenders are requiring
that debtors hire professionals who can help the lender assess the overall situation
and, in some cases, liquidate the debtor in the manner most beneficial for the
lender.

• The rise of new professionals. Thirty-four years ago, bankruptcy
attorneys handled most issues that are today carried out by workout consultants
or investment bankers. With most information flowing from opposing counsel,
or from the debtor's management, a lender had to be concerned about the quality
of the information it was receiving and what it might find if it took possession
and commenced foreclosure. Workout consultants (now "financial advisors")
became major players in the field in the 1980s. These professionals benefited
the debtor by helping solve operational and balance-sheet problems. Ultimately,
lenders required that debtors hire such professionals, generally from a short
list of "suggestions" provided by the lender. With a workout consultant
in place, the lender had increased confidence that the debtor's management was
receiving sound outside business advice. Significantly, the lender was better
able to rely on the information it was receiving and gained assurance that it
would have a better idea on how to proceed if a liquidation was necessary. The
flow of more reliable information provided the lender with increased leverage
because it was able to make more informed decisions and to execute on those
decisions without as much uncertainty.
Over the past few years, the role of the workout consultant has expanded in
one sense and contracted in another. It has expanded into the role of chief
restructuring officer (CRO). Now instead of being merely an outside professional,
the CRO is part of the debtor's inside operation and is a manager of certain
aspects of the company's operations. The employment of CROs is often required
by lenders, and the lenders are usually allowed (by specific agreement with
the debtor) to confer directly with the CRO. From the lender's perspective,
a CRO will be in a position to provide reliable information from the debtor
itself. Further, the lender will have the ability to participate in strategy
discussions with a manager of the company who will be making decisions about
whether to reorganize or liquidate. Obviously, it is more beneficial for creditors
than for the debtor to have in place managers with less allegiance to shareholders
and other management.
Simultaneously, the role of the workout consultant has been diminished by the
increased role of investment bankers in insolvency cases. The expansion of the
role of the investment banker was predictable considering that more and more
chapter 11 cases result in sales. However, investment bankers are now also heavily
involved in other functions traditionally performed by lawyers or business consultants,
including obtaining alternative sources of financing and even restructuring
the balance sheet. Sometimes investment bankers are hired by the debtor on its
own, but quite often, investment bankers are required by lenders. The investment
banker can provide the debtor and the lender with a professional analysis of
the benefits of a likely sale, which can be compared with any proposal for reorganization.
• Claims trading. Claims trading has had a significant impact
on chapter 11 cases. At one time, the likely members of a creditors' committee
were suppliers or other entities that had an inherent interest in the debtor's
survival. Today, these claims are frequently sold to claims traders whose primary
interest is either to earn a rapid return on their investment or even to take
over the ownership and control of the debtor and its operations. Both goals
are a disadvantage to the debtor and an incentive for the debtor to try to reorganize
without a chapter 11 filing.
The notion that the debtor/creditor orientation of judges and Congress, and
that the legal, economic and political trends that might favor debtors or creditors,
play an important role in determining the outcome of reorganizations is not
surprising. It is only common sense that the history of bankruptcy laws would
reflect our country's economic prosperity, or lack thereof. In times of economic
downturn, Congress is more likely to respond to the plight of so many of its
constituents and become more forgiving of debtors. In contrast, during lengthy
periods of relative prosperity, trends would naturally tend to stress the sanctity
of contract, providing more certainty in commercial dealings but also making
it more difficult for companies to reorganize.
Sanctity of Contract or Value of Reorganization Pendulum 
For a capitalist system to work efficiently, it is critically important for
people to be able to engage in contractual relations with others. Contracting
parties must be able to assume that their agreements will be carried out and
that courts will generally enforce these contracts. The concept of reorganization,
however, constitutes a major exception to such expectations. By its nature,
reorganizations will restructure or even obliterate contractual expectations.
The tension between sanctity of contract and the value of reorganization can
be illustrated by the following hypothetical: a lender is owed $50 million,
and the debtor is in default. The liquidation value of the debtor is slightly
more than $50 million, but the debtor's going-concern value is $100 million.
Under this set of facts, it may well be in the lender's interest to foreclose
as soon as possible in order to get paid in full before risking any deterioration
of its collateral. Absent reorganization statutes that would restrict the lender's
ability to enforce its loan documents according to their terms, the lender would
likely foreclose on its collateral and liquidate the debtor. Of course, this
would eliminate the other $50 million in going-concern value that could potentially
go to subordinate creditors and perhaps equity, and would probably eliminate
jobs and other social benefits that flow from a reorganized company.
Congress' position in this debate has changed over time. As discussed above,
in enacting the Code in the late 1970s, Congress moved away from the flexibility
afforded debtors under chapter XI of the Bankruptcy Act by requiring compliance
with the absolute-priority rule unless creditors voluntarily waive their rights.
Other additions to the 1978 Code favored sanctity of contract as well, including
the introduction of the §1111(b)(2) election12 and more concrete
rules governing a debtor's use of collateral. Moreover, Congress' latest statement
has clearly been in favor of recognizing the sanctity of contracts as BAPCPA,
among other things, reduced time for debtor protections (e.g., time for plan
exclusivity, time for determining whether to assume or reject leases), increased
available causes for dismissing or converting cases, expanded the rules making
reorganization more difficult for single-asset real estate debtors, and provided
new advantages for certain creditors, including utilities, wage claims of retired
employees, unions, equipment lessors and lessors of real estate. With the granting
of each new priority or other benefit to a particular constituency, Congress
makes a determination that the value of protecting the rights of such a constituency
in accordance with, or closer to, its contractual expectations is more important
than the value of reorganization.
Courts have generally (not without exception) also embraced this trend in favor
of sanctity of contract as well. See, e.g., Bank of America
NT & SA v. 203 North LaSalle P'ship, 526 U.S. 434 (1999) (requiring
a market test of value before new value exception can be utilized by equity);
Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997) (allowing a
secured claim for cramdown purposes to be valued depending on its use by the
debtor, rather than limiting the secured claim to a lower liquidation value).

Strict-Constructionist or Flexible-Approach Pendulum 
For years, bankruptcy courts recognized the benefit of flexibility in the administration
of reorganizations. Many times, the requirements for a successful reorganization
will not fit neatly into the black-and-white rules set forth in a statute. The
willingness of courts to fashion remedies appropriate to the goals favoring
successful reorganizations has led to numerous bankruptcy innovations that were
not specifically drafted into the statute. While some of these innovations have
been criticized on the merits, all were developed by judges with a view toward
the goals and purposes of bankruptcy and reorganization administration. Examples
of these judge-made innovations include the new-value exception to the absolute-priority
rule, the creation of the "channeling injunction" that became the
model for §524(g), payments to pre-petition critical vendors that were
deemed by the court to be necessary for the debtor's reorganization, third-party
releases, the substantive consolidation of debtors' estates, equitable subordination
of claims, and the extension of the benefits of the stay to nondebtors in cases
where the debtor's reorganization efforts would otherwise be impaired.
Currently, the Supreme Court's strict constructionist approach has become central
to bankruptcy jurisprudence. Consider, for example, Hartford Underwriters
Insurance Co. v. Union Planters Bank N.A., in which Justice Scalia admonishes
courts to start any statutory interpretation with the idea that Congress "says
in a statute what it means and means what it says...." See 530 U.S.
1 (2000), quoting Connecticut Nat. Bank v. Germain, 503 U.S. 249 (1992).
Contrast the approach advocated by Justice Scalia to that of Justice Douglas,
who wrote the following: "[W]e do not read these statutory words with the
ease of a computer... There is an overriding consideration that equitable principles
govern the exercise of bankruptcy jurisdiction." Bank of Marin v. England,
385 U.S. 99 (1966) (internal citations omitted). Today, the strict constructionist
approach is dominant, but it was not so long ago that the flexible approach
was the accepted view.
The trend toward the strict-constructionist approach can be illustrated by
the case In re Catapult Entertainment Inc., 165 F.3d 747 (9th Cir. 1999),
decided by the Ninth Circuit and followed by other circuits including the Third,
Fourth, Fifth and Eleventh Circuits. Based on nonbankruptcy federal law dealing
with patent licenses, the licensee of a nonexclusive patent license cannot transfer
its rights to the license without the consent of the licensor. The reasoning
of Catapult recognizes a debtor's inability to transfer such licenses,
but further reads §365(c)(1) of the Code to restrict the ability of debtors
to even assume patent licenses without the consent of the licensor. These decisions,
taking a strict constructionist approach, could lead to debtors being unable
to even retain patent licenses that may be very valuable and critical to the
debtor's reorganization. Since this is a trend and not an absolute, there are
courts that adopt an approach more consistent with the goals of reorganization.

For example the First Circuit in Institut Pasteur v. Cambridge Biotech Corp.,
104 F.3d 489 (1st Cir. 1997), agreed that a nonexclusive patent license could
not be assigned under federal nonbankruptcy law, but interpreted §365(c)
to allow the debtor to assume and retain the patent license. While this is the
minority approach, it is likely that 20 years ago it would have been the majority
approach, reflecting a more flexible reading of the Code in order to realize
the goals and values of reorganization. The flexibility judges once enjoyed
under §105 of the Code is being limited as well. See, e.g.,
Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988) ("whatever
equitable powers remain in bankruptcy courts must and can only be exercised
within the confines of Bankruptcy Code"). For years, bankruptcy judges
seemed to use this section as a way of reaching what they perceived to be the
right and equitable solution. See, e.g., In re Just For Feet
Inc., 242 B.R. 821 (D. Del. 1999) (relying on §105(a) to permit certain
pre-petition vendors to be paid under "necessity of payment" doctrine).
Yet courts are now less likely to find creative solutions by the application
of §105 because of the trend toward strict judicial interpretation.13
For example, the First Circuit in In re Jamo, 283 F.3d 392 (1st Cir.
2002), declared that §105 may be invoked only if the equitable remedy dispensed
by the court is necessary to preserve an identifiable right inferred elsewhere
in the Code. As courts take a less-flexible approach to a court's equitable
powers and to §105, there will logically be a corresponding negative impact
on many debtors' ability to reorganize successfully.

Conclusion
The purpose of this article is to point out observed trends over the past few
decades. No value judgment has been made in this article regarding whether such
changes are beneficial or detrimental. In reality, all of these changes have
been good for someone and bad for someone else. For example, as chapter 11 administration
becomes less flexible and therefore more predictable, that tends to be a good
thing for lenders and a bad thing for debtors. Lenders are able to make better
underwriting decisions if there is more certainty as to the disposition of the
loan in the event the debtor faces financial difficulty. As has happened in
the real world, in such circumstances, lenders (as well as equity investors),
comforted by additional certainty, are more willing to make loans (or investments)
into increasingly risky opportunities. Further, advance rates will tend to increase
so that more debt can be placed on the same assets. This is, of course, good
in the sense that the aggressive lending stimulates the economy. However, when
the inevitable recession occurs, the more aggressive lending may well transform
itself into layers of risk that the economy can no longer absorb, leading to
a deeper recession. This is, of course, what happened in the real estate boom
of the mid-1980s, leading to a real estate recession of almost catastrophic
proportions in the late 1980s and early 1990s.
As discussed, there have been significant changes in the capital markets. If
the administration of reorganization does not keep up with the changes in the
capital markets, then chapter 11 administration will become irrelevant or even
detrimental to the economy. Therefore, it could be credibly argued that the
significant changes to the capital markets have been a major impetus to the
changes that have occurred in the administration of reorganization. However,
there is cause and effect running in both directions. It is certainly true that
changes in the capital markets have had a significant impact on chapter 11 case
administration. But it is also true that if only the debtor could file a plan,
there were no absolute-priority rule, and creditors could not control the chapter
11 process as much as they currently do, there likely would be much less claims
trading, and second-lien lending would be much more risky and probably less
prevalent.
In the early 1980s, a young but prominent debtor's attorney14 explained
to me that debtors enjoyed two forms of leverage: the exclusive right to file
plans and the ability to threaten the shutdown of a business, which would substantially
diminish asset values for creditors. It is certainly true that the effectiveness
of each of these sources of debtor leverage has eroded over time. This is, of
course, good news for creditor constituencies that seek certainty in their dealings
with troubled companies. However, it makes it substantially harder for debtors
to reorganize in a manner that creates value and opportunity for management,
equity and even lower levels of debt. To some, this may simply reflect a just
outcome for reorganizations. Why, after all, they would ask, should out-of-the-money
classes receive anything until senior classes are paid in full? However, there
will always be those that believe that the reorganization process is designed
to allow people a last chance at saving their business. It is this controversy
between the two sides, neither of which is inherently right or wrong, that will
keep the pendulums swinging back and forth with the political, economic and
legal changes of the future.
<blockquote> </blockquote>

<hr>
<h3>Footnotes</h3>
 1 On April 26, 2006, Massachusetts Continuing Legal Education held a conference
titled "Business Bankruptcies for Nonspecialists." The particular
panel referred to in this article was titled "Corporate Bankruptcies after
BAPCPA: What To Do about New Provisions You Don't Like." 
2 All of the quotes included in the foregoing story are to the best of the
author's recollection.

3 By way of example, the Supreme Court's decision in Till v. SCS Credit
Corp., 541 U.S. 465 (2004), might be viewed as a debtor-oriented decision
in a period that has generally been dominated by creditor orientation. 
4 Reorganization-oriented judges are often thought to be debtor-oriented judges.
Debtor's counsel must be aware of the difference, however, to avoid overplaying
a perceived advantage. For example, in the case of Capitol Enterprises Inc.,
Chapter 11 Case No. 90-42186-JFQ (Bankr. D. Mass.), a judge universally viewed
as debtor-oriented surprised all sides by terminating exclusivity at the request
of the creditors' committee. The order, however, restricted the creditors' committee
from filing a plan calling for the liquidation of the debtor. In fact, the judge
was not debtor-oriented but reorganization-oriented. For purposes of this article,
reorganization-orientation is similar to debtor-orientation in the sense that
creditors will remain restricted from realizing on their collateral. However,
in terms of assessing relative leverage, a reorganization-oriented judge is
less favorable to the debtor than a debtor-oriented judge would be. A debtor-oriented
judge will try to give the debtor an opportunity to restructure. A reorganization-oriented
judge, by contrast, would argue that the purpose of chapter 11 is to realize
the benefits of a restructuring, but would be less interested in how particular
stakeholders fare in the process. 
5 Among the people making decisions on behalf of debtors are shareholders and
managers. While the trends in chapter 11 have not been favorable for shareholders,
chapter 11 entails its own set of risks for management including potential loss
of jobs and loss of equity value from stock-option plans and the like. However,
lenders seeking to induce management to support a sale of the company's assets
in chapter 11 often agree to key employee retention programs (KERPs), which
allow significant value to flow to management. Under BAPCPA, the use of KERPs
was significantly restricted, but early cases decided under BAPCPA have allowed
incentive bonus systems to provide similar incentives. See, e.g.,
In re Nobex Corp., Chapter 11 Case No. 05-20050 (Bankr. D. Del.) 
6 For articles discussing the effectiveness of chapter 11 as it currently exists,
see the following: Miller, Harvey R., and Waisman, Shai Y., "Is Chapter
11 Bankrupt?," 47 B.C.L. Rev. 129 (2005); Sprayregen, James H.M.,
Friedland, Jonathan, and Higgins, Roger J., "Chapter 11: Not Perfect, But
Better than the Alternative," J. Bankr. L. & Prac., Vol. 14,
No. 6 (2005); Miller, Harvey R., and Waisman, Shai Y., "Does Chapter 11
Reorganization Remain a Viable Option for Distressed Businesses in the Twenty-First
Century?," 78 Am. Bankr. L. J. 153 (2004); Baird, Douglas G., "The
New Face of Chapter 11," 12 Am. Bankr. Inst. L. Rev. 69 (2004); Mikels,
Richard E., and Kaufman, Peter S., "Balancing Creditor and Equity Interests
Provides Incentive to Utilize Chapter 11 for Mutual Benefit," 22-Dec/Jan.
Am. Bankr. Inst. J. 26 (2004); and Baird, Douglas G., and Rasmussen,
Robert K., "Chapter 11 at Twilight," 56 Stan. L. Rev. 673 (2003).

7 For further discussion of this, see Mikels and Kaufman, supra
note 6. 
8 These trends tend to impact the relative positions of debtors and creditors,
both during out-of-court workouts and chapter 11 proceedings. As changes occur
in debtor/creditor trends, there is a resulting change in the bargaining leverage
between debtors and creditors. These changes impact the benefits and uses of
out-of-court restructurings and chapter 11 proceedings. 
9 A more detailed discussion of creditor-oriented trends appears in an article
by Harvey Miller and Shai Waisman. See Miller & Waisman, 47 B. C.
L. Rev. 129, supra note 6. This is an excellent article and should be
required reading for anyone practicing bankruptcy law.

10 The position in the economy that banks occupied 30 years ago is now populated
with nonbank, nonregulated entities. At that time, banks generally did not want
to take possession of operating assets and run companies. This provided the
debtor with enormous leverage in the form of the threat of "handing over
the keys" and thereby limiting the bank's recovery to liquidation value.
Lenders in the market today tend to be more willing to preserve the going-concern
value of companies by assuming ownership and/or operations of the debtor. Indeed,
some of these lenders are known for their "loan-to-own" philosophy.
As a result, "handing over the keys" is far less likely to be as threatening
to the lender today, particularly if a chief restructuring officer is in place.

11 It is possible that this particular pendulum may have already begun to inch
back. The case Official Comm. of Unsecured Creditors v. Credit Suisse First
Boston (In re Exide Techs. Inc.), 299 B.R. 732 (Bankr. D. Del. 2003),
dealt with assertions by a creditors' committee that lenders can be held liable
on account of a debtor's "deepening insolvency." The facts of this
case, however, bear a striking resemblance to old-fashioned lender liability
cases where lender control was alleged. 
12 The §1111(b)(2) election was designed to protect secured creditors
from having their secured claim diminished by a bankruptcy judge's opinion of
value, rather than an actual testing of the market. 
13 As pointed out elsewhere in this article, we are dealing with trends, not
absolutes. Even though a trend is currently favoring one point of view, there
will be decisions that fall on the other side. For example, while there is a
clear trend restricting the bankruptcy court's powers under §105, the Sixth
Circuit recently relied on §105 to conclude that a bankruptcy court may
enjoin a nonconsenting creditor's claims against a nondebtor. See In re Dow
Corning Corp., 280 F.3d 648 (6th Cir. 2002). It is interesting to compare
the Sixth Circuit's reasoning to the Third Circuit's analysis of §105 powers
in In re Combustion Engineering Inc., 391 F.3d 190 (3rd Cir. 2005).

14 Daniel C. Cohn, now of Cohn Whitesell & Goldberg LLP.

Journal Authors

Charles W. Azano

Richard E. Mikels

Journal Date

Sunday, October 1, 2006 - 12:00

Bankruptcy Rule

2006

none