SPEAKERS CONTENTS INSERTS
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63–847
2000
BANKRUPTCY REFORM ACT OF 1999
(PART III)
HEARING
BEFORE THE
SUBCOMMITTEE ON
COMMERCIAL AND ADMINISTRATIVE LAW
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
ON
H.R. 833
MARCH 18, 1999
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Serial No. 10
Printed for the use of the Committee on the Judiciary
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
COMMITTEE ON THE JUDICIARY
HENRY J. HYDE, Illinois, Chairman
F. JAMES SENSENBRENNER, Jr., Wisconsin
BILL McCOLLUM, Florida
GEORGE W. GEKAS, Pennsylvania
HOWARD COBLE, North Carolina
LAMAR S. SMITH, Texas
ELTON GALLEGLY, California
CHARLES T. CANADY, Florida
BOB GOODLATTE, Virginia
ED BRYANT, Tennessee
STEVE CHABOT, Ohio
BOB BARR, Georgia
WILLIAM L. JENKINS, Tennessee
ASA HUTCHINSON, Arkansas
EDWARD A. PEASE, Indiana
CHRIS CANNON, Utah
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JAMES E. ROGAN, California
LINDSEY O. GRAHAM, South Carolina
MARY BONO, California
SPENCER BACHUS, Alabama
JOE SCARBOROUGH, Florida
JOHN CONYERS, Jr., Michigan
BARNEY FRANK, Massachusetts
HOWARD L. BERMAN, California
RICK BOUCHER, Virginia
JERROLD NADLER, New York
ROBERT C. SCOTT, Virginia
MELVIN L. WATT, North Carolina
ZOE LOFGREN, California
SHEILA JACKSON LEE, Texas
MAXINE WATERS, California
MARTIN T. MEEHAN, Massachusetts
WILLIAM D. DELAHUNT, Massachusetts
ROBERT WEXLER, Florida
STEVEN R. ROTHMAN, New Jersey
TAMMY BALDWIN, Wisconsin
ANTHONY D. WEINER, New York
THOMAS E. MOONEY, SR., General Counsel-Chief of Staff
JULIAN EPSTEIN, Minority Chief Counsel and Staff Director
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Subcommittee on Commercial and Administrative Law
GEORGE W. GEKAS, Pennsylvania, Chairman
ED BRYANT, Tennessee
LINDSEY O. GRAHAM, South Carolina
STEVE CHABOT, Ohio
ASA HUTCHINSON, Arkansas
SPENCER BACHUS, Alabama
JERROLD NADLER, New York
TAMMY BALDWIN, Wisconsin
MELVIN L. WATT, North Carolina
ANTHONY D. WEINER, New York
WILLIAM D. DELAHUNT, Massachusetts
RAYMOND V. SMIETANKA, Chief Counsel
SUSAN JENSEN-CONKLIN, Counsel
JAMES W. HARPER, Counsel
C O N T E N T S
HEARING DATE
March 18, 1999
OPENING STATEMENT
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Gekas, Hon. George W., a Representative in Congress from the State of Pennsylvania, and chairman, Subcommittee on Commercial and Administrative Law
WITNESSES
Asofsky, Paul H., Weil, Gotshal & Manges, LLP, Houston, TX, American Bar Association, Section of Taxation
Baird, H. Elizabeth, Assistant General Counsel, Bank of America Corporation, Charlotte, NC
Bergmeyer, Harley D., Chairman, President and CEO, Saline State Bank, Wilbur, NE, on behalf of the American Bankers Association
Brozman, Tina, Chief United States Bankruptcy Judge, Southern District of New York, New York, NY
Carlson, Thomas, United States Bankruptcy Judge, Northern District of California, San Francisco, CA
Entmacher, Joan, Vice President and Director, Family Economic Center, National Women's Law Center, Washington, DC
Glover, Jere W., Chief Counsel, Office of Advocacy, United States Small Business Administration, Washington, DC
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Gross, Karen, Professor, New York Law School, New York, NY
Grosshandler, Seth, Partner, Cleary, Gottlieb, Steen & Hamilton
Harris, Don, Special Assistant to the Attorney General, State of New Mexico, on behalf of the States' Association of Bankruptcy Attorneys
Ireland, Oliver, Associate General Counsel, Board of Governors, Federal Reserve System, Washington, DC
Leach, Hon. James A., a Representative in Congress From the State of Iowa
Miller, Judith Greenstone, Clark Hill, PLC, Birmingham, MI, on behalf of the Commercial Law League of America
Peiffer, Joseph, Peiffer Law Office, Grand Rapids, IA
Picker, Randal C., Leffmann Professor of Commercial Law, University of Chicago Law School, Chicago, IL, on behalf of the National Bankruptcy Conference
Roukema, Hon. Marge, a Representative in Congress From the State of New Jersey
Saperstein, Stephanie M., Assistant Attorney General, Office of the Utah Attorney General, on behalf of the National Association of Attorneys General
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Schorling, William H., Klett, Lieber, Rooney & Schorling, Philadelphia, PA
Silvers, Damon, Associate General Counsel, American Federation of Labor and Congress of Industrial Organizations, Washington, DC
Strauss, Philip L., Assistant District Attorney, Family Support Bureau of the Office of the District Attorney, San Francisco, CA
Tatelbaum, Charles M., Cummings & Lockwood, Naples, FL, on behalf of the National Association of Credit Managers
Valdes, Ray, Tax Collector, Seminole County, FL, Treasurer of the National Association of County Treasurers and Finance Officers, on behalf of the National Association of County Officials, the National League of Cities, and the National Association of County Treasurers and Finance Officers
LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING
Asofsky, Paul H., Weil, Gotshal & Manges, LLP, Houston, TX, American Bar Association, Section of Taxation: Prepared statement
Baird, H. Elizabeth, Assistant General Counsel, Bank of America Corporation, Charlotte, NC: Prepared statement
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Bergmeyer, Harley D., Chairman, President and CEO, Saline State Bank, Wilbur, NE, on behalf of the American Bankers Association: Prepared statement
Brozman, Tina, Chief United States Bankruptcy Judge, Southern District of New York, New York, NY: Prepared statement
Carlson, Thomas, United States Bankruptcy Judge, Northern District of California, San Francisco, CA: Prepared statement
Entmacher, Joan, Vice President and Director, Family Economic Center, National Women's Law Center, Washington, DC: Prepared statement
Glover, Jere W., Chief Counsel, Office of Advocacy, United States Small Business Administration, Washington, DC: Prepared statement
Gross, Karen, Professor, New York Law School, New York, NY: Prepared statement
Grosshandler, Seth, Partner, Cleary, Gottlieb, Steen & Hamilton: Prepared statement
Harris, Don, Special Assistant to the Attorney General, State of New Mexico, on behalf of the States' Association of Bankruptcy Attorneys: Prepared statement
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International Council of Shopping Centers: Prepared statement
Ireland, Oliver, Associate General Counsel, Board of Governors, Federal Reserve System, Washington, DC: Prepared statement
Leach, Hon. James A., a Representative in Congress From the State of Iowa: Prepared statement
Miller, Judith Greenstone, Clark Hill, PLC, Birmingham, MI, on behalf of the Commercial Law League of America: Prepared statement
Peiffer, Joseph, Peiffer Law Office, Grand Rapids, IA: Prepared statement
Picker, Randal C., Leffmann Professor of Commercial Law, University of Chicago Law School, Chicago, IL, on behalf of the National Bankruptcy Conference: Prepared statement
Roukema, Hon. Marge, a Representative in Congress From the State of New Jersey: Prepared statement
Saperstein, Stephanie M., Assistant Attorney General, Office of the Utah Attorney General, on behalf of the National Association of Attorneys General: Prepared statement
Schorling, William H., Klett, Lieber, Rooney & Schorling, Philadelphia, PA: Prepared statement
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Silvers, Damon, Associate General Counsel, American Federation of Labor and Congress of Industrial Organizations, Washington, DC: Prepared statement
Strauss, Philip L., Assistant District Attorney, Family Support Bureau of the Office of the District Attorney, San Francisco, CA: Prepared statement
Tatelbaum, Charles M., Cummings & Lockwood, Naples, FL, on behalf of the National Association of Credit Managers: Prepared statement
Valdes, Ray, Tax Collector, Seminole County, FL, Treasurer of the National Association of County Treasurers and Finance Officers, on behalf of the National Association of County Officials, the National League of Cities, and the National Association of County Treasurers and Finance Officers: Prepared statement
Williams, Jack F., Professor, Georgia State University, College of Law: Prepared statement
APPENDIX
Material submitted for the record
BANKRUPTCY REFORM ACT OF 1999, PART III
THURSDAY, MARCH 18, 1999
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House of Representatives,
Subcommittee on Commercial
and Administrative Law,
Committee on the Judiciary,
Washington, DC.
The subcommittee met at 10:00 a.m. in Room 2141 of the Rayburn House Office Building, the Honorable George W. Gekas, chairman of the subcommittee, presiding.
Present. Representatives George W. Gekas, Ed Bryant, Jerrold Nadler, Tammy Baldwin, and Melvin L. Watt.
Staff present: Raymond V. Smietanka, Subcommittee Chief Counsel; Susan Jensen-Conklin, Subcommittee Counsel; Peter Levinson, Full Committee Counsel; Audray Clement, Subcommittee Staff Assistant; and David Lachmann, Minority Professional Staff Member.
OPENING STATEMENT OF CHAIRMAN GEKAS
Mr. GEKAS. Well, 11 o'clock having arrived, the committee will come to order.
The schedule for today calls for us to hear testimony from witnesses on subjects ranging from child support to tax provisions that have to be revised to placate our taxing authorities across the Nation, and to give them a sense of belonging in the bankruptcy arena.
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The first panel will be primarily devoted to testimony from two valued colleagues who have independent views on the efforts at bankruptcy reform, and who will add to the debate, I am certain, salient suggestions and critiques.
The individuals poised for presentation as Members are Marge Roukema of New Jersey, who is present, and from whom we will be hearing in a moment, and Jim Leach, the chairman of the Banking Committee, the gentleman from Iowa, a Member of Congress who is totally steeped in the questions and answers, we hope, of bankruptcy, by virtue of his position on that committee, as is Mrs. Roukema.
So that when we as the Judiciary Committee, proceed along the path of bankruptcy reform, we will have the benefit of those portions of Banking Committee's suggestions that come into play for our total effort.
We note now the presence of Chairman Leach, thus completing the first panel. I will allow Jim and Marge to toss the coin as to who should go first.
Mrs. ROUKEMA. I wouldn't toss a coin with my committee chairman. I will defer to his suggestion.
I have a second subject to raise, so I want to associate myself with the comments of the chairman.
Mr. GEKAS. Thank you. We will begin with Chairman Leach, but first, a quick anecdote to demonstrate to the audience and to the viewers, if this ever appears on CSPAN, that the Banking Committee, insofar as it works in fields that overlap with the work of the Judiciary Committee, some times in the past, has created the natural tension that such crossover sometimes causes.
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But I must tell you that Chairman Leach and the members, generally, of the Banking Committee, and those of us who are involved in quasi-banking, or they in quasi-judiciary matters, have worked very handsomely together over the recent past, and, in fact, I must say over the last 4 of 5 years.
That quick anecdote. Our committee decided to have a hearing on what was known as the odious know-your-customer regulation to be promulgated by the FDIC and the Federal Reserve and the other agencies, in which Big Brother would invade every single banking account in the Nation, and force banks to report any unusual transactions like the withdrawal of $500 from an account where before no such withdrawal appeared.
That seemed very invasive, and a pervasive invasion of privacy. I consulted with Chairman Leach on the matter.
He knew that I had intended to hold a hearing on it in our committee, and, of course, that has banking repercussions, and he said, as only he can do it, in his quiet way, he said, you proceed; that will be very helpful, and we in the Banking Committee will simply observe and hold your hand, and help in any way we can.
Well, that was very encouraging, and we proceeded to hold that hearing. The point is that in bankruptcy reform, every citizen in the country must be involved in one way or another.
Every citizen is affected, and that's why every citizen should be involved.
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With the leadership of the two individuals that we have here today in the Congress, we are making it an inclusive investigation into the best ways in which we can bring about much needed bankruptcy reform.
With that personal anecdote, I now recognize the gentleman from Iowa for a statement.
We note the presence of a hearing quorum by the attendance of the gentleman from Tennessee and the lady from Wisconsin.
Please proceed.
STATEMENT OF HON. JAMES A. LEACH, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF IOWA
Mr. LEACH. I thank the chairman. Before—and I appreciate the presence of our two distinguished colleagues as well.
Let me first say as an aside, and in reference to what the chairman just said, in recent weeks, in relationship to legislation on banking modernization, the Banking Committee chose in a near unanimous vote to rescind the rule that the gentleman held a hearing objecting to. We concur fully in his judgment that there is a Big Brother implication that can get out of control if one isn't very careful in financial services.
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In any regard, I come before you to comment on one aspect of your major, in fact, seminal legislation on bankruptcy, and this is title X, which is a title derived from an approach that's been introduced as a separate bill that is under the jurisdiction of the Banking Committee.
By background, title X relates to an injunction from a report of 1993, stemming from the Banking Committee minority, pushing for some sort of greater credibility and resolution of problems that occur in financial institutions when there may be a bankruptcy setting, and how contracts are netted.
We have pushed the Administration to come up with specific recommendations, which they did last year. So the bill that we have introduced that is incorporated as title X is a bill that is derived from the recommendations of the principal banking regulators, as well as the Department of the Treasury in general.
And it is an issue which is a little different than the tradition of Congressional concerns that are of an historic nature on bankruptcy, where there is total concern on how values of assets are meted out in bankruptcy circumstances, which often takes an element of time and, in effect, adjudication.
In financial services, there is an extra element that goes just beyond the element of fairness, which is what is called systemic risk.
Systemic risk is all about not what happens, exactly, between the parties at issue, but with regard to parties that are not at issue, and with regard to the system as a whole.
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And so people that have looked at the whole issue of financial contracts have come to the conclusion that it is better and fairer for the parties and for the system as a whole to have what, in effect, are instantaneous netting arrangements that work out on a virtual immediate time basis if there is a company that comes to be in difficulty in financial services.
If you don't have such a netting arrangement, several things happen:
One, you can have problems that apply to other companies that aren't directly involved, or to the system as a whole. In addition, you also have an impulse to greater government intervention of another kind.
For example, we have recently seen this fall, in a much reviewed circumstance, the failure of a major hedge fund called Long Term Capital Management.
With regard to that hedge fund, a decision was made in the Executive Branch, both the Federal Reserve and the Treasury, that there be a forced recapitalization from parties that have created another kind of circumstance, one that I think has some antitrust implications that have not been well thought through by the government.
But in any regard, if you don't have the netting arrangements that are immediately available, you, for systemic reasons, force consideration of other kinds of alternatives.
Whereas if you do have netting arrangements that are immediately available, if a large institution such as a hedge fund or, conceivably, a financial firm like a bank or an investment bank that gets into difficulty, you have real problems with the system as a whole.
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And so that is the principal reason for having this provision. I will tell the committee that it is a very sophisticated provision, and that I bring it to you with some comfort, based on the unanimous endorsement of the Federal regulatory institutions, as well as the fact that it was based upon a multiyear study.
And it is a seminal change in the Bankruptcy Codes. Its provision in your bill, I think, makes it an emblem of farsightedness that would go and redound, I think, to the great credit of your committee.
One final observation. From the Banking Committee, you've also adopted a recommendation that we have suggested that was also in last year's bill, that is a consumer protection provision that I think makes eminently good sense from an individual as well as a social perspective.
That is, there is a preclusion of credit card companies from pulling credit cards from consumers who pay their debt back on time. The irony that credit card companies want to force cards from the hands of people that are managing their debt prudently is an irony that I do not think the Congress should give a stamp of approval to.
Even though this is a bit of an intrusion into how the private sector operates, I think it is a very decent kind of consumer protection that makes a good deal of sense.
And so I have a very lengthy statement dealing with the netting arrangements that I would like to ask unanimous consent be placed in the record, and I think and I am hopeful that it will answer some of the questions of your counsel that might want to be looking at some of the nuances of the netting circumstance.
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[The prepared statement of the Honorable James Leach follows:]
PREPARED STATEMENT OF HON. JAMES A. LEACH, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF IOWA
Mr. Chairman, Mr. Nadler and members of the Subcommittee on Commercial and Administrative Law. I appreciate the opportunity to discuss those provisions of H.R. 833, the Bankruptcy Reform Act of 1999, which amend laws under the jurisdiction of the House Committee on Banking and Financial Services.
With regard to the principal issue I wanted to address this morning, title X incorporates the Financial Contract Netting Improvement Act, legislation which along with Rep. LaFalce, I have introduced as a separate measure. The House Banking Committee reported out this approach last year by voice vote and it was incorporated into last year's bankruptcy conference report.
Title X contains legislative proposals forwarded to Congress by the nation's financial regulators in order to guard against systemic risk to the nation's financial system. The netting provisions of this title build on recommendations first contained in an October 1993 Banking Committee minority report on derivatives. The specific proposals are derived from the President's Working Group on Financial Markets following a review of current statutory provisions governing the treatment of qualified financial contracts and similar financial contracts upon the insolvency of a counterparty.
The Working Group consists of the Securities and Exchange Commission; the Commodity Futures Trading Commission; the Federal Deposit Insurance Corporation; the Department of the Treasury, including the Office of the Comptroller of the Currency; the Board of Governors of the Federal Reserve System; and the Federal Reserve Bank of New York. The recommendations of the Working Group were transmitted to Congress by Treasury Secretary Rubin in his role as Chairman of the Working Group on March 16, 1998.
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The provisions amend the U.S. Bankruptcy Code and a number of Federal banking laws to address the treatment of certain financial transactions following the insolvency of a party to such transactions. The amendments clarify and improve consistency between the applicable statutes and minimize risk of a disruption within or between financial markets upon the insolvency of a market participant. Last year's near failure of Long-Term Capital Management LP highlights the need for the U.S. to further refine its bankruptcy and insolvency laws in order to avoid systemic risk to the nation's financial system in the event of a failure of a large bank, hedge fund, or securities firm with huge exposures to interest rate and currency swaps and other complex financial instruments.
As noted above, in order to provide more consistency among Federal insolvency laws concerning the treatment of qualified financial contracts, a number of changes are made to the Bankruptcy Code, which is of jurisdictional concern to the Judiciary Committee. In reviewing these amendments to the Bankruptcy Code, it would be my hope that the Judiciary Committee be cognizant of the concerns of the Treasury Department and Federal financial regulators mentioned above in ensuring that the insolvency of a large corporation or institution will not pose systemic risks to the nation's financial system. Historically systemic risk has not always been at the forefront of Congressional concerns when designing the legal construct for how a debtor's estate is to be divided among various competing creditors in a bankruptcy. However, the avoidance of systemic risk is a key component of Federal banking laws and a growing concern in international finance as financial markets become more complex, volatile and globally focused.
Systemic risk is the risk that the failure of a firm or disruption of a market or settlement system will cause widespread difficulties at other firms, in other market segments or in the financial system as a whole. If participants in certain financial activities are unable to enforce their rights to terminate financial contracts with an insolvent entity in a timely manner, or to offset or net their various contractual obligations, the resulting uncertainty and potential lack of liquidity could increase the risk of inter-market disruption.
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Congress has taken steps in the past to ensure that the risk of such systemic events is minimized. For example, currently both the Bankruptcy Code and the Federal Deposit Insurance Act contain provisions that protect the rights of financial participants to terminate swap agreements, forward contracts, securities contracts, commodity contracts and repurchase agreements following the bankruptcy or insolvency of a counterparty to such contracts or agreements. Furthermore, other provisions prevent transfers made under such circumstances from being avoided as preferences or fraudulent conveyances (except when made with actual intent to defraud). Protections also are afforded to ensure that the netting, set off and collateral foreclosure provisions of such transactions and master agreements for such transactions are enforceable.
It is my understanding that you will hear later today from the Federal Reserve and other interested parties on this matter. Last year in its consideration of this legislation, the Banking Committee heard from a wide array of witnesses on this legislation. Federal Reserve Board Chairman Alan Greenspan testified that the legislation would shore up the infrastructure of U.S. markets, would enhance U.S. market competitiveness, and would address the concern that the traditional insolvency process can create serious risks to counterparties due to the price volatility of financial assets. A representative from the Federal Deposit Insurance Corporation stated that as a result of the legislation, market participants will have a better understanding of their rights and will be able to more accurately assess and manage the risks arising from derivative contracts. Without this legislation, the FDIC representative noted, the current statutes governing netting will not adequately address market innovations.
In summary, the insolvency provisions of Title X are designed to clarify the treatment of certain financial contracts upon the insolvency of a counterparty and to promote the reduction of systemic risk. All these changes are designed to further minimize systemic risk to the banking system and the financial markets and to ensure that U.S. financial markets remain competitive with the financial markets in other countries, such as the United Kingdom, where cross-product netting is legally recognized.
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Title X also incorporates an amendment to the Federal Reserve Act transmitted to the House Banking Committee on July 30, 1998, by the Chairman of the Board of Governors of the Federal Reserve System. This section expands the kinds of assets that the Federal Reserve can use as collateral to back currency. In his transmittal letter to the Committee, Chairman Greenspan stated that the current ''limitations on eligible currency collateral could become potentially problematic for the implementation of monetary policy under unusual circumstances'', citing as an example problems stemming from the century date change.
I know that there is some concern about the cross product netting and asset-backed securitization amendments to the Bankruptcy Code that are contained in Title X. With regard to the cross product netting provisions, nothing in this title expands netting to any new contracts. As mentioned above, netting has been a feature of both the bankruptcy code and bank insolvency laws for a number of years because netting is an important component in reducing the risk that a single failure could cascade into multiple failures. Cross product netting simply extends those benefits to get one net amount for all contracts that are already netable by permitting a wide variety of financial transactions between two parties to be netted, thereby maximizing the present and potential future risk-reducing benefits of the netting arrangement between the parties. Legal recognition of cross product netting furthers the policy of increasing legal certainty and reducing systemic risks in the case of an insolvency of a large financial participant.
In addition, it will allow the United States to be a leader in the development of financial markets, along with the economic benefits of continuing to be a major location for international financial trading.
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With regard to the asset-backed securities provision, the bill simply excludes from the bankruptcy estate asset-backed financial instruments which have been sold to a third party. The following specific elements are incorporated into the legislation to reduce any chance that secured borrowings or other non-securitization transfers will be protected:
the securities must be investment grade;
the source of payment on issued securities is limited to ''eligible assets'';
an ''eligible entity'' must issue the securities;
the assets can be recaptured if fraud exists or inadequate consideration is paid; and
a written agreement is required indicating that the eligible assets were transferred with the intent to remove them from the estate of the debtor.
Protection for asset-backed securitization is necessary because the multi-trillion dollar securitization market is threatened if auditors and counsel are unable to opine that assets sold to a specially designated trust or subsidiary are truly sold and will be treated that way in bankruptcy. Currently, the Federal Accounting Standards Board has raised questions about whether there is sufficient ''isolation'' between originators and the trusts or subsidiaries that issue the securities to permit favorable accounting treatment. In addition, securitization provides major liquidity and financial benefits to the American economy, such as lower cost financing, new sources of capital and liquidity and more effective use of assets and capital. These benefits are discussed in further detail below.
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BENEFITS OF SECURITIZATION
For the originating banks or businesses, asset securitization can provide significant financial and regulatory benefits.
1. Securitization usually permits lower cost financing, because the resulting securities represent a better credit risk than the originator itself. This is dependent on separation of the securities from the credit risk of the originator.
2. Securitization opens new alternative sources of capital and increases the participation of the business in the financial markets. Many institutional investors could not invest in the originator directly and could not directly purchase the securitized assets, but can purchase the investment-grade securities created by the securitization.
3. Securitization offers opportunities to more effectively manage assets produced by the originator's business and to improve its liquidity. The pooling and securitization of assets allows the originator to more precisely match the duration and market characteristics of its assets and liabilities. In addition, the originator can reinvest the cash received by a securitization for optimal returns.
4. Securitization also may permit the removal of the securitized assets from corporate balance sheets for financial and regulatory accounting purposes and thereby free up equity capital that otherwise would be used to support the assets on the institution's balance sheet.
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Securitization has received legislative review, and approval, since the 1980s. In 1984, Congress adopted the Secondary Mortgage Market Enhancement Act that provided for the exemption of highly rated mortgage-backed securities from the registration requirements of most state securities laws and made them eligible for investment by certain regulated entities. In 1994, Congress amended the Secondary Mortgage Market Enhancement Act to provide an exemption from state securities laws for highly rated securities backed by certain lease receivable and small business loans similar to the exemption already enjoyed by mortgage-backed securities. Then, as part of the Tax Reform Act of 1986, Congress enacted new tax legislation permitting the creation of real estate mortgage investment conduits—called ''REMICS''—facilitating the issuance of multiclass, pass-through securities.
In addition to Title X there are several provisions of H.R 833 which provide consumers more protections and disclosures concerning credit card and other kinds of debt, which were also included in last year's conference report on the Consumer Bankruptcy Reform Act. I want to thank Chairman Hyde, Chairman Gekas and the other conferees last year for taking the House Banking Committee's views into consideration in House-Senate negotiations on these sections that fall under the Banking Committee's jurisdiction.
Of these provisions, Section 1128, is of particular importance. It prohibits a creditor from terminating a credit card account before the expiration date solely because the consumer has not incurred finance charges because he or she has paid off the full amount charged each month. It is individually counter-intuitive and socially counter-productive for lenders to establish incentives to pull credit away from individuals who pay their bills on time.
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In closing, let me say that it is my hope that your broad bankruptcy reform legislation can more forward in a timely basis. If not it will be my intention to move separately these crucial Title X provisions. Thank you.
Mr. GEKAS. Without objection, the statement will be included for the record, and will be distributed promptly to the members for their consideration.
We now turn to the lady from New Jersey, Mrs. Roukema.
STATEMENT OF HON. MARGE ROUKEMA, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW JERSEY
Mrs. ROUKEMA. Thank you, Mr. Chairman. Am I free to speak on both subjects?
Mr. GEKAS. You can speak until 6 p.m., if you wish.
Mrs. ROUKEMA. Not quite, not quite, no.
With respect to the banking issues, I'm here as the Chairwoman of the Financial Institutions Subcommittee, and really to associate myself with all the comments that Chairman Leach has just made with regard to title X, or the so-called netting bill.
Certainly, Chairman Leach and I gave strong support last year to this subject, and do appreciate the opportunity to work with you.
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I was particularly interested in the fact that Chairman Leach specifically referenced how more recent experiences with hedge funds has given an added impetus to this question, and also I want to particularly endorse the statement of the chairman on the consumer protection aspects of this.
Mr. Chairman Gekas, I really do appreciate your reference to your customer privacy questions. These are very complex, and they are issues that we have grappled with on the Banking Committee in connection with H.R. 10, our Financial Institutions Modernization Act.
But this is evidently incorporated into your legislation, and I would very much appreciate being able to work with you. It's a very delicate issue and one that I feel strongly about as well. So I would like to work with you in that regard.
And so I'd like to hold that open and hope that we could be included, since we have joint jurisdiction, that we could be included in terms of the conference committee deliberations when I hope we will get to that conference committee in due course and in a short time period, at least I would hope that.
That would be my request to you and the House Leadership.
But I do want to go on to the second aspect of the question, which is child support enforcement. I just want to reference the fact that I have been a longstanding crusader and pioneer, going back more than 10 years on the subject of child support enforcement.
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As a result of those initiatives that I took, I served on the U.S. Commission for Interstate Child Support Enforcement, which made recommendations on the second or third round of child support enforcement provisions that the Congress has passed.
I want to stress that we are talking not only about children who are the first victims, but we're also recognizing that before we put these—we've made a lot of progress, not enough, but a lot of progress on child support.
But before we did, it was absolutely astonishing and shocking, how many families were falling onto the welfare roles and were at taxpayer expense, being paid welfare payments because they were not getting their legal child support orders under the individual laws of their States and their State courts and not getting interstate cooperation.
So, I want to commend you for your interest in this. I also want to associate myself with the improvements that you've put in this bill that strengthen child support enforcement.
I won't go into all of the points, but certainly it is my understanding that you are putting it as number one in terms of bankruptcy cases.
I also want to give confirmation that I not only support this, but also want to note that the State of New Jersey, which has an outstanding record in child support, gives their support; that this change, that is, the change providing that the automatic stay does not apply—does not apply to State child support collection agencies, is very important to a State like New Jersey and many other States throughout the country.
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But I did want it to be on record that our child support group in New Jersey does support that.
I also want to associate myself with the additional provision that I understand will be again provided—presented by Congressman Clay Shaw of Florida, with respect to an amendment that he proposed and that was adopted last year in the provision that will require the Trustee to notify a claimant parent of the bankruptcy proceedings.
That notification is absolutely essential, and it will ensure the parents are not left out when the debtor parents enter into bankruptcy, that is, the claimant parents.
It's important to note that unfortunately that this provision, although adopted in the House, was dropped in the conference committee report, and it was for that reason that I cast a protest vote, no, on the provision.
I am hopeful that you remember that, Mr. Gekas. You looked a little shocked at the time.
In any case, I know that we can work together, cooperatively, on this and see to it that the right thing is done for these children and these families and for the taxpayers that frequently end up with the obligation.
I would just like to say that I would like to work with the committee, the subcommittee, in one area, and all other interested parties to see that if we can further improve the provisions.
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One of the areas in which I want to explore an avenue with you is to ensure that trustee notice is received by the claimant, that is, advance notice. It happens with some frequency, for whatever reason, but it is my understanding, working with certainly the groups in New Jersey, that incorrect or insufficient information is given by the debtor to the court.
This hampers and sometimes seriously delays the delivery of child support. I want to work on a way that will ensure to the best of our ability, that proper information is supplied at an appropriate time, in advance, by the debtor.
In this effort, of course, we must also understand that we have to protect the privacy of the ex-spouse and the children in the case. But the important thing is that notification in advance. I'm sure that we can work together on that and complete this project in the interest of the children that are the first victims here, and too often in the past, the taxpayers who have picked up the tab.
Thank you, Mr. Chairman.
[The prepared statement of the Honorable Marge Roukema follows:]
PREPARED STATEMENT OF HON. MARGE ROUKEMA, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW JERSEY
Thank you Mr. Chairman for allowing me to speak before the committee on bankruptcy reform as the Chairwoman of the Financial Institutions Subcommittee. I voted for last year's bill and plan on supporting HR 833—the Bankruptcy Reform Act of 1999.
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INTRODUCTION
Consumer bankruptcy reform is an important issue that needs to be addressed now. In 1997 Americans filed a record of 1.33 million consumer bankruptcy petitions representing an over 650 percent increase since 1978. Those who entered into bankruptcy erased an estimated $40 billion in consumer debt. This resulted in a hidden tax of almost $400 per household for families who have to pay monthly bills including mortgages, student loans, and insurance. It is important to note that this surge in bankruptcies in the last few years occurred at a time when the national economy has grown at a strong rate. In fact, between 1986 and 1996, real per capita annual disposable income grew by over 13 percent while personal bankruptcies more than doubled.
Bankruptcy is fast becoming the first stop financial planning tool rather than a last resort. The purpose of reform is to improve bankruptcy law and practice by restoring personal responsibility and integrity in the bankruptcy system but also ensuring that the safety net of the Bankruptcy code is intact for those who need it most. I am a strong supporter of the consumer bankruptcy reforms contained in the bill and I will continue to work hard for bankruptcy reform legislation.
BANKING ISSUES
I'd like to speak for a moment regarding the banking issues in the bill and associate myself with the positions stated by Chairman Leach and strongly support the provisions of this bill.
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First, the Committee has just heard from Chairman Leach regarding Title X of the Bill or the ''Netting Bill'' as the Banking Committee referred to it last year. I support the inclusion of Title X in the Bill. This Title will harmonize banking and bankruptcy law with respect to the netting of financial contracts. It was produced by the President's Working Group on Financial Markets and is strongly supported by the Federal Banking agencies. I support Chairman Leach on this and appreciate that the Committee has included this Title in the Bankruptcy Bill.
I also want to express my concerns with the problems presented by Hedge Funds. I particularly want to work with you, Chairman Gekas on your expressed concerns of privacy protections and other consumer protections. We have dealt with the issue to some degree in the Financial Modernization bill but not in a comprehensive manner. I would offer to work with your Subcommittee as you address this complex issue.
Secondly, I would like to note that there are 4 sections in the Bankruptcy Bill which are clearly within the jurisdiction of the Banking Committee. These provisions, which address disclosures for home equity loans, minimum credit card payments and the ability of credit card companies to terminate inactive cards, are within the jurisdiction of the Subcommittee which I chair.
It is important to not that since there are provisions in this bill which are clearly within the Banking Committee's jurisdiction, that Banking Committee members should be included in any conference on this legislation in the future. I am submitting a copy of the Letter I sent last year to the Speaker requesting that Banking Committee members be made conferees. When this bill moves to Conference, I look forward to working with your Committee on these issues.
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CHILD SUPPORT
I would also like to make a statement on the child support provisions in the Bankruptcy Reform Bill
I have a long history of standing up for child support enforcement, having been a pioneer on child support reforms and having served on the U.S. Commission for Inter-State Child Support Enforcement. It's a national disgrace that our child support enforcement system continues to allow so many parents who can afford to pay for their children's support to shirk these obligations. The so-called 'enforcement gap'—the difference between how much child support could be collected and how much child support is collected—has been estimated at $34 billion!
This legal abuse is a criminal violation as well as neglect of our children's most basic needs. In addition, the taxpayers are abused because billions of tax dollars are paid out because these families are falling onto the welfare roles at alarming rates.
I am very pleased that HR 833—the Bankruptcy Reform Act of 1999 strengthens child support enforcement. I thank the Chairman and the Subcommittee for all their hardwork and their reaching out to diverse groups to form a consensus that the payment of child support should be protected.
HR 833 strengthens Child Support Enforcement by:
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Child support payments are moved to NUMBER ONE when determining which debts are paid first in a bankruptcy case. Currently, child support payments rank seventh behind such ''priorities'' as attorney's fees.
Confirmation and discharge of Chapter 13 plans are made conditional upon the debtor's complete payment of child support. This will help further ensure that child support receives the priority it deserves.
Providing that the automatic stay DOES NOT apply to a state child support collection agency that is trying to recover child support payments. I know from speaking with child support advocates in New Jersey, that this change is a top priority for them to ensure continued payment of important child support.
I also want to associate myself with an additional provision, to be offered on the floor by Representative Clay Shaw of Florida, that will require the trustee to notify a claimant parent of the bankruptcy proceeding. This will ensure that claimant parents are not left out when a debtor parent enters into bankruptcy. It is important to note that this was dropped from the Conference report last year. I voted no on that report in protest over that action.
The current child support obligation for this year in New Jersey is $767 million. The total child support payments in arrears is $1.3 Billion. Yes, I said $1.3 Billion, of which about $800 million is still collectable. Bergen county in my district, along with six other New Jersey counties, make up 53 percent of the total collections.
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I would like to work with the Subcommittee and all interested parties to see if we can further improve the child support provisions. One of the areas where I want to work is to ensure the trustee notice is received by the claimant. It happens with some frequency, for whatever reason, that incorrect or insufficient information is given by the debtor to the court. This hampers and sometimes seriously delays the delivery of child support. I want to work on a way to ensure to the best of their ability that the proper information is supplied by the debtor. In this effort though I want to issue a strong caveat. The privacy of the ex-spouse and children MUST BE protected in all cases. I want to work with the concerned groups so this important protection is ensured while at the same time we can get the most accurate information for child support payments to be issued.
CONCLUSION
These are important and significant improvements that ensure that child support enforcement is strengthened. I supported these provisions last year and plan to support them this year.
It is important to remember that failure to pay child support is not a victimless crime. The children are the first and most important victims. We must ensure that these children are taken care of and I applaud the work of the Subcommittee to this end and will continue my work on this issue. I also look forward to reviewing the testimony of the panel on child support today and to further working with the Subcommittee. Thank you.
Mr. GEKAS. We thank your colleagues. I must say that I'm encouraged by the fact that Mrs. Roukema states that New Jersey is in support of our efforts toward the primacy of support in the whole area of bankruptcy. That's very encouraging.
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Mrs. ROUKEMA. They're in strong support.
Mr. GEKAS. We hear that from a lot of States now. One-by-one they seem to be happy with our effort, not that it's a final word on it, but we're moving toward it.
Mrs. ROUKEMA. Yes.
Mr. GEKAS. I'm also encouraged by the fact that the chairman of the Banking Committee has emphasized the issue of netting, because we intend to deal with it, and we intend to deal with it now, even more so with the concerns that you have stated, Mr. Chairman, in mind.
So, we're very grateful to you for your opening shots at the subjects of the day, both the concerns of the chairman and the support concerns of the lady are going to be part of the witnesses' testimony that we will hear today.
Thank you for getting us off to a good start.
Mrs. ROUKEMA. It's the leadership, though, that we're most appreciative of.
Mr. WATT. Mr. Chairman?
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Mr. GEKAS. The gentleman from North Carolina is recognized.
Mr. WATT. I recognize that this is not the regular protocol for members of the subcommittee to pose questions to Member panels, but I wonder if the Chair might indulge me for a minute or two.
Mr. GEKAS. If our colleagues don't mind, I don't.
Mr. WATT. I thank the chairman. I do this not because I want to break the protocol, but because I may be in a somewhat unique position of being on both the Banking Committee and on this subcommittee.
One of the reasons that I decided to get on this subcommittee this year was because I started to see more and more of the linkages between what's happening in this subcommittee on the bankruptcy bill, and some of the things that we have been dealing with in the Banking Committee.
First of all, on the netting issue, since this is a pretty heavy and complex issue, I'm wondering whether the chairman expects maybe to have a separate panel on that title of the bill, where all of the subcommittee members might be able to get a better understanding of that aspect of the bill so that we might cast more informed votes and make more informed decisions, and make more informed offers of amendments, quite possibly.
Mr. GEKAS. If the gentleman would yield, the final panel for today will delve into and give testimony for and against whatever tax and netting provisions we have.
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Mr. WATT. So that's included.
Mr. GEKAS. The forum is already established.
Mr. WATT. Okay, thank you.
Finally, I wanted to just, not so much ask Chairman Leach a question, but to kind of create a little dialogue here, because there are a number of witnesses who have asserted that it is not only the credit card companies' practices, the one that you specifically made reference to, of withdrawing credit cards from people who pay their debts on time, but there may be a number of other practices that actively encourage greater and greater irresponsible debt.
In fact, Mr. LaFalce, the ranking member of the Banking Committee, appeared before this panel yesterday or the day before. I forget which day.
And he suggested that we include many of the provisions from a bill that he had introduced in this bankruptcy bill as a means of addressing lender responsibility, particularly credit card company responsibility, acknowledging that there is a linkage between teaser rates and the onset or taking on of additional debt.
I wonder if the Chair cares to comment on other consumer-related matters that we might take into account in this bill, in addition to the one that you have already testified about? Or do you want to stay out of that more controversial territory?
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Mr. LEACH. I could only respond by saying that the provisions that I have testified to, have been vented thoroughly through the Banking Committee. For example, we had a markup on the netting bill last year.
And so I'm very confident of those provisions.
I think Mr. LaFalce has raised some very serious concerns, and my only caution would be, I think any committee, before moving into these kinds of areas, would be well advised to have very substantial hearings of industrial input to make sure that there aren't counterproductive effects.
The general thrust of the ranking members's concerns, however, I think, have a great deal of validity. But I think one would want to be very cautious of making sure that there was wide input, including regulatory input into each of the provisions.
And that might be a subject you want to address to some of the regulators later today.
Mr. WATT. I thank the chairman for his indulgence, and assure him that I'm not trying to break the protocol.
Mr. LEACH. Let me also respond to Mr. Gekas. As I'm sure you're well aware, it's a boon to the United States Congress to have the counsel of Mr. Watt on any and all related matters.
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Mr. GEKAS. We'll reserve judgment on that, after I consult. [Laughter.]
Mr. WATT. I don't think Mr. Gekas has been quite convinced of that to the extent that my colleagues on the Banking Committee may be convinced of it. I'm not sure that any of them are convinced of it yet, either.
Mr. GEKAS. I repeat our gratitude to our colleagues, and we'll excuse you with good wishes and more to come. Thank you very much.
We will now acknowledge, for the record, the attendance of the gentleman from North Carolina, Mr. Watt, and the gentleman from New York, Mr. Nadler.
We will now call the first panel to the witness table. They are:
Philip L. Strauss—Mr. Strauss is an Assistant District Attorney in the Family Support Bureau of the San Francisco District Attorney's Office, where he became principal attorney and head of the Legal Division within that Bureau in 1980.
Prior to joining that agency, Mr. Strauss worked in the Civil Division of the Judge Advocate General at Fort Jackson in South Carolina.
Since 1976, Mr. Strauss has been an active member of the California Family Support Council where he has held various offices during the past 15 years.
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For 3 years, he served on the Executive Committee of the California State Bar, Family Law Section.
He has lectured extensively on the topics of enforcement of domestic support obligations in paternity litigation.
Mr. Strauss received his bachelor's in history from the University of California at Berkeley and his juris doctor from the University of California Hastings College of Law.
He is joined by Joan Entmacher, the Vice President and Director of Family Economic Security, National Women's Law Center. Prior to assuming her responsibilities at the Center, Ms. Entmacher was the Director of Legal and Public Policy for the National Partnership for Women and Families. Before coming to Washington, DC, Ms. Entmacher was an assistant professor of political science at Wellesley College. She was also Chief of the Civil Rights Division of the Massachusetts Attorney General's Office. Ms. Entmacher has written and lectured extensively on child support policies. She is a graduate of Wellesley College and Yale Law School.
Joining them at the table is Stephanie Meistus Saperstein, the Assistant Attorney General in the child and family support division of the Utah Attorney General's Office. Her current responsibilities include the collection of domestic support obligations in bankruptcy cases and Medicaid lien collection efforts. Before joining the Attorney General's Office in 1993, Ms. Saperstein was in private practice for 6 years. Ms. Saperstein received her bachelor of arts from the University of Utah in 1984 and her juris doctor from the University of Utah College of Law in 1987.
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Professor Karen Gross joins the panel, a professor of law at New York Law School. She has published extensively and is author of the book, FAILURE AND FOREGIVENESS. REBALANCING THE BANKRUPTCY SYSTEM. Prior to entering academia, Professor Gross practiced law at Arvery, Hoades, Costello & Burman in Chicago and at Weil, Gotschal & Manges in New York City. From 1991 to 1993, Professor Gross was a national adviser to the Bankruptcy Task Force of the Ninth Circuit Gender Bias Task Force. From 1994 to 1997, she was Co-Chair of the Bankruptcy Working Group of the Second Circuit Gender Fairness Committee.
With that, we begin by stating that the written statements of all the witnesses will be, without objection, entered into the record, and we will ask each to try to limit the review of the written statement to 5 minutes.
We will begin with——
Mr. NADLER. Mr. Chairman?
Mr. GEKAS. The gentleman from New York is recognized.
Mr. NADLER. Thank you.
I just want to add a particular welcome to Professor Gross who comes from New York, and in fact from my District and who, besides being a distinguished Professor at New York Law School which is also in my District, has had a noted career dealing with issues of women and the courts, and children and the court system, and a general family support system.
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So I want to add a special welcome to her.
Ms. GROSS. Thank you.
Mr. GEKAS. We thank the gentleman. We will begin with Mr. Strauss.
STATEMENT OF PHILIP L. STRAUSS, ESQUIRE, ASSISTANT DISTRICT ATTORNEY, FAMILY SUPPORT BUREAU OF THE OFFICE OF THE DISTRICT ATTORNEY, SAN FRANCISCO, CA
Mr. STRAUSS. Thank you very much. I appear here today not only as a representative of my own office but I am authorized to appear on behalf of the California District Attorneys' Association and the California Family Support Council.
Those organizations are responsible for the enforcement of child support in California under the Federal Child Support Program.
For the last 26 years, I have been Assistant District Attorney, and for the last 23 years I have been engaged in the enforcement and collection of child support in the City and County of San Francisco. For the last 11 years, I have handled primarily all of the bankruptcy issues.
I teach bankruptcy both at the State and national levels. One aspect I teach is the enforcement of support during that period of time in which a debtor is engaged in bankruptcy.
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I am extremely happy to be here for a number of reasons, not the least of which is the fact that I drafted the child support amendments last year.
Mr. Gekas, I cannot thank enough. He has the appreciation of virtually every national organization that has looked at these issues by taking those drafts and putting them into last year's bankruptcy reform legislation.
Those drafts were polished by a lot of work between myself and the National Association of Attorneys General.
They appeared in final form in the final conference report of H.R. 3150 last year, and they appear verbatim as child support amendments to the current bankruptcy reform legislation, H.R. 833.
Before I address the comments specifically, I would like to say what I believe is the overall effect of these child support amendments.
First and most importantly, many of them are self-executing. They reduce the need for many people, including custodial parents and child support attorneys, to deal with these issues in Bankruptcy Court.
This reduces the cost of litigation, and it makes far more efficient use of the limited time of attorneys who are otherwise charged with the responsibility for collecting child support.
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It reduces conflicts between the bankruptcy process and the Federally mandated Child Collection Program.
It ensures that child support collection mechanisms are not interrupted by the bankruptcy process, and it gives the same preferential treatment during the bankruptcy process to all child support debts as they are generally recognized.
First of all, so that everyone understands what I am talking about and because we get into issues of child support versus bankruptcy before this committee, I would like to say that when I am referring to a debt which is assigned I am talking about child support which is retained by the government, and likewise unassigned child support is the child support which is paid directly to the spouse or family.
In discussing the changes that this bill will have on the collection of support, none can be more important than is found in section 144 which addresses the elimination from the reach of the automatic stay for various child support collection processes.
Of these, by far the most important is the automatic stay as it applies to the enforcement by the earnings withholding process.
The earnings withholding process is required under Federal law to apply to every child support order which is issued by a court of competent jurisdiction which deals with this issue.
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Therefore, even though many child support obligors are not wage earners and would not be affected by this law, according to the Congressional Green Book which was published in 1998, the last year they have statistics shows that, in 1996, 56 percent, or by far the lion's share of support was collected by the wage withholding process.
Not interfering with that process means that a large chunk of collection is not going to be interrupted when a debtor files a chapter 12 or 13 case. This is extremely important.
In addition, it not only collects the current child support obligation but the past-due obligation, and this is very important because the past-due obligation often is reflective of the needs of the family, especially when a court has reduced the current obligation in order to allow the debtor to pay off the past obligation.
The second most important aspect of the bill—and I see that I am running out of time so I am going to very briefly describe it—is that also exempted from the bankruptcy process is an important issue which not only encourages but makes it essential that a debtor continue making his post-petition child support payments after bankruptcy is filed.
This means that a plan cannot be confirmed unless all support becoming due after the petition date is paid. This at a very early stage in the bankruptcy process, teaches a debtor the importance the Federal Government places on this issue, and encourages the payment throughout the course of the bankruptcy. And, of course, finally, a discharge—the entire goal of the bankruptcy process for a debtor—cannot be accomplished.
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In fact, it will be doomed unless all post-petition child support is paid.
[The prepared statement of Mr. Strauss follows:]
PREPARED STATEMENT OF PHILIP L. STRAUSS, ESQUIRE, ASSISTANT DISTRICT ATTORNEY, FAMILY SUPPORT BUREAU OF THE OFFICE OF THE DISTRICT ATTORNEY, SAN FRANCISCO, CA
I welcome the opportunity to discuss the effect the Bankruptcy Reform Act of 1999 (H.R. 833) will have on the collection of child support and alimony when a support debtor has filed a petition for relief under the Bankruptcy Code. For the past 26 years I have been employed as an Assistant District Attorney for the City and County of San Francisco, the last 23 of which have been spent establishing and enforcing support obligations in the Family Support Bureau of the Office of the District Attorney. This Bureau operates under the federal child support program, Title IV–D of the Social Security Act. For the last 11 years I have specialized in the collection of support during bankruptcy and have taught this subject matter to child support attorneys both in California and nationally.
Last year I drafted amendments to the Bankruptcy Code which were incorporated into the House bankruptcy reform legislation (H.R. 3150). The language of those amendments was subsequently refined by myself and a bankruptcy specialist for the National Association of Attorneys General. These amendments were added to the Final Conference Report on H.R. 3150 and appear verbatim in the current bankruptcy reform legislation, H.R. 833. It is my opinion, and the opinion of every professional support collector with whom I have discussed this issue, that the child support and alimony amendments contained in H.R. 833 will enhance substantially the enforcement of support obligations against debtors in bankruptcy. These changes will result in a more efficient and economical use of attorney and court resources.
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The support amendments have been endorsed by many individuals and organizations, including the three national organizations whose members consist of persons having the primary duty of enforcing support obligations in the federal child support enforcement program. These organizations include the National District Attorneys Association, the National Association of Attorneys General, and the National Child Support Enforcement Association. In giving my testimony on this issue, I am authorized to speak on behalf of the California District Attorneys Association and the California Family Support Council. The membership of these organizations carries out the federal child support enforcement program in California.
During the last 11 years in which I have taught the subject of the enforcement of support during bankruptcy, I have appeared continuously in bankruptcy court, written a manual for support attorneys to use when dealing with bankruptcy cases, counseled support attorneys in the handling of bankruptcy cases, and have reviewed virtually every court opinion written on this subject since enactment of the Bankruptcy Code in 1978. Based on this experience, I developed what essentially became a wish list of amendments to the Bankruptcy Code aimed a facilitating support collection against bankruptcy debtors. This wish list is reflected in sections 141–147 of H.R. 833. In this statement I will discuss not only how these amendments affect support debtors in bankruptcy, but what they mean in the larger context of support enforcement generally.
Prior to discussing specific sections, I would like to comment on the overall effect of these amendments. I believe they will do the following: (1) reduce the need to appear in bankruptcy court and the consequential cost of litigation; (2) reduce conflicts in law and policy between the Bankruptcy Code and the child support enforcement program; (3) insure that significant support enforcement mechanisms are not interrupted by the bankruptcy process; and (4) provide that all generally recognized support debts are given preferential treatment in the Code.
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The most important amendment is found in section 144 which removes from the effect of the automatic stay several support collection remedies. Of these, the most significant by far is the provision allowing the continued operation of earnings withholding orders, as defined in the Social Security Act, 42 U.S.C. §666(b). Since state courts or administrative agencies have already determined the appropriate level of support and arrearage repayment, the removal of the withholding orders from the reach of the automatic stay will require a support debtor to construct his or her bankruptcy plan to accommodate support debts—the highest and foremost of financial obligations. Under current law the reverse is true. The support creditor is often be forced to accommodate the needs of other creditors when support arrearage debts are paid pursuant to a bankruptcy plan.
The importance of this amendment cannot be underestimated. Federal law requires all support to be paid through the wage withholding orders. Such orders account for the lion's share of support collection receipts.(see footnote 1) Under current law, when a debtor files for protection under chapters 12 or 13, the collection of even ongoing support orders is stayed. The economic detriment to a debtor's family which is not receiving public assistance can be devastating. Clearly, there are some obligations which must be met, even when a debtor seeks relief from general creditors. Of these obligations, none is greater than the one requiring the payment of support. And because all too often a current support obligation may be reduced by a court in order to allow a debtor some relief in paying an arrearage debt, the total amount being paid through the earnings withholding may be not only helpful, but crucial, in meeting the daily needs of the debtor's spouse, former spouse, and children.
This amendment, therefore, not only insures that the payment of support from wage earners will not be interrupted by bankruptcy, it will also avoid the need to entangle the debtor's family in the bankruptcy process. Under current law the support creditors would have to seek relief from the automatic stay to re-institute the earnings withholding and file a claim to obtain arrearage payments from the bankruptcy trustee. Even if these procedures were performed by an attorney in the federal child support program, delays in support enforcement would be inevitable.
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In addition to the removal of the earnings withholding process from the automatic stay, other federally mandated collection processes would be exempted under Section 144. These include the interception of the debtor's income tax refunds to pay support arrears; the license revocation procedures for those debtors who are not paying support; the continued enforcement of medical support obligations; and the continued reporting of support delinquencies to credit reporting agencies.
Perhaps the second most important and useful proposed amendment to the Code is found in Section 143 which precludes a support debtor from obtaining confirmation of a Chapter 13 plan and subsequently a discharge of debts, if that debtor has not made full payment of all support first becoming due after the petition date. Section 143 currently has similar rules for Chapter 11 debtors. This section is significant for two reasons. First, it will prevent a support debtor from paying other creditors at the expense of his familial obligations. And secondly, this provision is self-executing. Thus, neither the support creditor, an attorney for the creditor, nor a public attorney will have to seek and enforce this provision in bankruptcy court.
Moreover, this provision will affect the support debtor at two crucial stages in the bankruptcy process. At the earlier confirmation stage, the support debtor will learn that payment of the all important on-going support obligation is a critical step in getting approval of a bankruptcy plan. It will also set an example for the debtor early in the bankruptcy process, teaching the importance of making timely postpetition support payments. And since the goal of the bankruptcy from the debtor's viewpoint is to obtain a discharge of debt, the support debtor will, at the outset, understand that the failure to meet continuing support obligations will doom the prospects of a discharge.
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Section 141 of H.R. 833 provides a definition of support obligations. This definition is then incorporated in other areas of the Bankruptcy Code. The purpose of this definitional addition is to streamline provisions of the Code dealing with support debts and to give all debts generally recognized as deriving from a support obligation similar treatment in the Code. This provision will not necessarily change current law, but it will end many conflicting bankruptcy decisions which turn upon very technical interpretations of what is a support debt and what might not be such a debt. Most significantly, highly arcane decisions concerning the dischargeability of such debts will be made consistent and litigation over these issues will be minimized. Furthermore, support debts of all kinds will be subject to the same dischargeability, lien avoidance, and preference recovery rules.
Under current law only a lien securing unassigned support is exempted from statutory lien avoidance procedures. With the new definition of support in section 141, all support obligations will be excepted from lien avoidance procedures. Not only will this change protect the taxpayer to whom the debt may be assigned, it may also benefit the support creditor who assigned the debt if that debt becomes unassigned under the new assignment rules established in the 1996 welfare reform legislation (the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 or PRWORA). For example, under current law if a support debtor files a Chapter 7 case when his support obligation has been assigned to the government under the Social Security Act, the bankruptcy court might rule that a lien securing this debt impaired the debtor's homestead exemption and void it. The debtor would then be free to sell property. If this property was the only known asset of the debtor, the debt would be uncollectible. And, if the support creditor then ceased receiving public assistance, that debt, now unassigned, would be likewise uncollectible. However, under Section 146 of H.R. 833, the lien would not be removed and the support debt would remain collectible.
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Under current law if a debtor pays support during the 90 day period prior to filing a bankruptcy petition, the bankruptcy trustee cannot recover this payment for the benefit of the estate unless the debt is assigned. Under section 147 of H.R. 833 the trustee would not be able to recover any support paid by the support debtor during the preference period. This rule significantly benefits the debtor because this debt is not dischargeable. If the payment were recovered as a preference it may well be distributed to creditor whose debts are dischargeable, leaving the debtor with additional nondischargeable debt.
No more significant statement of public policy has been made concerning the primacy of support obligations than that found in section 142 of H.R. 833. Here the code provides child support with the first priority for payment of unsecured claims. That section is divided into two subpriorities so that distribution within the child support priority will go first to the family of the debtor, then to the government if the support has been assigned. It should be noted that some national organizations do not insist on first priority, but have requested a very high priority, thus leaving it to Congress to determine if first priority would provide essential benefits to support creditors or whether some lesser priority would suffice.
When these proposed amendments are reviewed it is not difficult to see why support enforcement professionals so strongly endorse them and are so thankful to the sponsors of this legislation for their inclusion. As one can easily see, many of these amendments literally remove bankruptcy as an obstacle to support enforcement, and they do so in a self-executting manner. Thus no claims or stay litigation would be needed to continue to collect the debt when an earnings withholding order is viable; no confirmation litigation would be needed when the debtor is not paying a postpetition preconfirmation support order; and no dismissal or stay relief litigation would be required to insure postpetition support was paid before a discharge could be granted.
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Avoiding bankruptcy court is important to support creditors and their attorneys. Even when a support creditor is financially able to hire a bankruptcy attorney, litigation of support issues in bankruptcy is likely to eat up large chunks of recoverable support. Most support creditors would be totally lost attempting to seek relief in bankruptcy court themselves. And government support attorneys are generally ill equipped to litigate bankruptcy issues and do not have the luxury of referring the case to bankruptcy specialists. After all, it should be remembered that the law of bankruptcy is a speciality with its own bar, judges, code, rules, procedures and, indeed, its own language.
Some criticism has been raised that the 1999 Bankruptcy Reform Act would be detrimental to women and children because it would pit them against banks and credit card companies for collection of nondischarged credit card debt. Although this argument has some surface logic, no support collection professional that I know deems this concern to be serious. Of course if support and credit card creditors were playing on a level field, banks with superior resources might have an advantage. However, nonbankruptcy law has so tilted the field in favor of support creditors that competition with financial institutions for the collection of postdischarge debts presents no problems for support collectors.
In the first place the ubiquitous earnings withholding process for support collection absolutely trumps any financial institution's attempt to collect this debt from the debtor's wages or salary since withholding orders have priority, no matter when issued or served. In most cases if the support collection was 25% or more of the debtor's wages, the Consumer Credit Protection Act would lock out the financial institution from collection of its debt from the debtor's wages. Thus as to wage earners, there is no conceivable way that the existence of postpetition credit card debt, dischargeable under current law, would adversely affect the collection of support.
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Even when the debtor is not a wage earner, support creditors have numerous and highly significant advantages over other creditors. While this list is certainly not exhaustive, support creditors have the following remedies not possessed by other creditors, and certainly not credit card creditors: (a) support debts are already reduced to judgments and have the advantages of judgments; (b) tax intercept collection; (c) interception of unemployment benefits/worker compensation benefits; (d) free or low cost collection services by the government; (e) license revocation for nonpayment of support; (f) free or low cost interstate collection, including interstate wage withholding and interstate real property liens; (g) criminal prosecution or contempt actions; (h) no avoidance of liens securing the support debt; (i) federal collection and prosecution for support debts; (j) denial of passports; (k) collection from otherwise protected sources: ERISA plans; trusts; federal remuneration.
To say that these advantageous remedies will necessarily result in the collection of support is not possible. Many support debtors are actually quite skillful evaders of support obligations. These same people will probably be just as adept at avoiding collectors from financial institutions. However, the point to be made is not that support debts will necessarily be collected after bankruptcy, but that the collection of support debt is in no way hampered simply because credit card debt has survived bankruptcy and financial institutions are going to attempt to collect it.
Some have argued that after bankruptcy a support debtor will pay credit card debt to retain a credit card and not pay support. Of course this argument assumes that after bankruptcy the debtor will find an institution willing to extend credit. Even if one did so, it seems unlikely that retention of a credit card would be more important than retention of a driver's license, staying out of jail, or keeping a passport.
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The bottom line as I see it in analyzing H.R. 833 with respect to its effect on the collection of support is to note that the advantages explicit in the bill far outweigh any speculative concerns that some debtors might not pay support if they are left with credit card debt after bankruptcy. What concerns support collection professionals the most in carrying out their duties is not competition with financial institutions outside bankruptcy, but competition with other creditors during bankruptcy. H.R. 833 readjusts the position of support creditors during the bankruptcy process, giving them meaningful, even crucial, assistance. The support provisions of this bill certainly justify the praise given them by the most significant national public child support collection organizations in this country.
Mr. GEKAS. We thank the gentleman, and some of the points that you wish to make will probably come up during the question and answer period, which is to follow.
With that, we will turn to Ms. Entmacher—five minutes.
STATEMENT OF JOAN ENTMACHER, VICE PRESIDENT AND DIRECTOR, FAMILY ECONOMIC CENTER, NATIONAL WOMEN'S LAW CENTER, WASHINGTON, DC
Ms. ENTMACHER. Chairman Gekas and members of the subcommittee, I am Joan Entmacher.
I appreciate the opportunity to testify before you today on behalf of the National Women's Law Center concerning the child support implications of H.R. 833.
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I will focus on the impact of the bill from the perspective of two especially vulnerable groups:
Parents, especially single mothers struggling to make ends meet and forced into bankruptcy often because of an inability to collect child support from the noncustodial parent; and parents, again usually single mothers, who need to collect support from someone who has filed for bankruptcy.
From the perspective of single mothers forced into bankruptcy as debtors, this bill would make life even harder.
It would make it harder for them to access the bankruptcy process and, if they got there, to save their homes, cars, and essential household items.
For example, many evictions would be exempt from the automatic stay, a provision that would hit battered women trying to avoid homelessness extremely hard.
There is a pitiful list of exempt household goods—one radio, one TV, educational materials and hobby equipment for minor children, but 18-year olds apparently can bid all their precious stuff of childhood goodbye. Compare that with the still unlimited homestead exemption.
More debts would survive bankruptcy, making it harder for a woman to get a fresh start and focus on supporting her children.
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For example, if a woman took cash advances of as little as $25 a week or charged as little as $25 a week on a single credit card during the 3 months before filing, that might become nondischargeable debt under the new luxury goods exception. Some luxury.
The same provisions are also a concern for women who are support creditors in a bankruptcy, because the child support provisions do not ensure that the increased rights the bill would give to commercial creditors do not come at the expense of families owed support.
First, the child support provisions only affect the collection of support during bankruptcy, not what happens afterwards.
They have been endorsed by government agency representatives, and I understand why. From their perspective, the provisions are clearly a plus. For families, however, the picture is mixed.
The bill gives government support agencies acting as creditors themselves, not just on behalf of families, a higher priority than they have under current law. Especially in chapter 13, this could actually make it harder for families to collect the child support that they are due.
The bill also makes child support first priority in chapter 7, ahead even of administrative expenses.
This is a nice symbolic move, but it may actually make it harder for any creditor to get paid even in the few cases where there are assets.
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If administrative expenses are not paid, there may be no one to administer the estate. That may mean that assets are abandoned back to the debtor instead of being liquidated for the benefit of support recipients and other creditors.
Another set of changes made by the bill that affects procedures during bankruptcy is to exempt some enforcement procedures used by government agencies from the automatic stay, and these can be positive.
When government support agencies have gotten wage withholding orders on behalf of families, these changes could help families by making collection during the bankruptcy process easier and quicker.
However, these provisions do not ensure that all or even most families will get the support that they are due ahead of other creditors whose rights would be expanded by this bill.
Wage withholding orders are great collection tools when they exist, but they do not exist in most cases.
An estimated half of all support cases are outside the government child support system, and 40 percent of cases in the government system lack a support order, much less a wage withholding order.
During the period after bankruptcy, the child support provisions have no effect, but families may still have many years during which they are still trying to collect support.
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The other provisions of the bill will make that harder. Families owed support after bankruptcy will have to compete with all the increased nondischargeable or reaffirmed debts of large commercial creditors.
Some child support agency representatives have said, that is not a problem because with the legal authority that they have been given by Congress, child support agencies can get to any money first.
Unfortunately, many agencies are not using the tools that they have been given very effectively.
In fiscal year 1997, government child support agencies made some, not necessarily full, collection in only 22 percent of all cases in the government system.
If they have to compete with the credit card industry, whose representatives testified last week that 96 percent of their accounts pay as required, I am afraid that mothers and children will lose out.
I hope the subcommittee will carefully reconsider the provisions of this bill and put the interests of families ahead of those of the credit card companies and secured creditors. Thank you.
[The prepared statement of Joan Entmacher follows:]
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PREPARED STATEMENT OF JOAN ENTMACHER, VICE PRESIDENT AND DIRECTOR, FAMILY ECONOMIC CENTER, NATIONAL WOMEN'S LAW CENTER, WASHINGTON, DC
SUMMARY
The impact of H.R. 833 must be considered from the perspective of two especially vulnerable groups: parents, especially single mothers, forced into bankruptcy—often because of an inability to collect child support from the noncustodial parent; and parents, usually single mothers, who need to collect support from someone who has filed for bankruptcy.
The bill would make life even harder for single mothers forced into bankruptcy. It would make it harder for them to access the bankruptcy process, and, if they got there, to save their homes, cars, and essential household items. After bankruptcy, women would be burdened with more debt, making it harder for them to support their families. The bill would give creditors more leverage to secure reaffirmations while, at the same time, stripping debtors of important protections against creditor abuse. And, for those women in bankruptcy who are receiving support payments, it does not fully protect income earmarked for support.
Many of the same provisions are a concern for women who are support creditors in a bankruptcy, because the child support provisions of the bill fail to ensure that the increased rights the bill would give to commercial creditors do not come at the expense of families owed support.
The child support provisions of the bill only relate to the collection of support during the period of a bankruptcy. From the perspective of government child support agencies, the provisions are clearly a benefit; for families, the picture is mixed. Government agencies would benefit from the provisions because under current law, only child support owed to families is a priority debt; child support assigned to states to reimburse assistance to families is nondischargeable, but not priority. Under H.R. 833, child support assigned to states would become a priority. Unfortunately, especially under Ch. 13, this would put the government's claims to support arrears in direct competition with the family's. In Ch. 7, on paper, support claims would become ''first priority,'' with the family's claim coming ahead of the state's. Unfortunately, few Ch. 7 cases have any assets to distribute, and the bill may make it impossible for anyone to collect; putting support claims ahead of administrative expenses may mean that no one will liquidate assets for the benefit of support recipients and other creditors.
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During bankruptcy, the child support provisions also would add more exceptions to the automatic stay for governmental support enforcement activities. When government child support agencies are enforcing support on behalf of families, especially through income withholding, these changes could make collection during the bankruptcy process easier and quicker. However, the provisions do not ensure that all, or even most, families will get the support they are due ahead of other creditors whose rights have been expanded by the legislation. Many support cases are outside the government system, and 40% of cases in the government system lack a support order, much less an income withholding order.
After bankruptcy, families owed support will have to compete with the increased claims of other, commercial creditors. Unfortunately, even if they are assisted by government child support agencies, they are likely to lose out. The credit card industry secured payment per agreement in 96% of its accounts. In contrast, in FY 97, government child support agencies made some—not necessarily full—collection in only 22% of all cases, and 38% of cases with orders.
STATEMENT
Chairman Gekas and members of the Subcommittee on Commercial and Administrative Law, my name is Joan Entmacher. I am Vice President and Director of Family Economic Security of the National Women's Law Center. I appreciate the opportunity to testify before you today on behalf of the Center concerning the child support implications of H.R. 833.
The National Women's Law Center is a non-profit organization that has been working since 1972 to advance and protect women's legal rights. The Center focuses on major policy areas of importance to women and their families including employment, education, women's health, and family economic security, with special attention given to the concerns of low-income women and their families. Most relevant to this hearing, the Center has worked for more than two decades on child support issues, especially on behalf of the interests of low-income women. Center staff have presented testimony on child support to Congress, commented on child support regulations of the Department of Health and Human Services, litigated child support cases and met with officials in the Administration, Congress and the states in furtherance of the Center's efforts to improve child support enforcement across the country. A Center staff member also served on the U.S. Commission on Child and Family Welfare, established by Congress to provide recommendations on custody and visitation issues that affect the children of separating, divorcing and unmarried parents.
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The Center received a grant of $92,456 from the U.S. Department of Education for the period 11/95 to 4/97, and another grant of $92,456 from the U.S. Department of Education for the period 10/96 to 3/98, unrelated to its child support work.
My testimony will discuss the impact of H.R. 833 from two perspectives: first, the perspective of parents, especially single mothers, forced into bankruptcy and struggling to support their children at the same time; and, second, from the perspective of parents, again usually single mothers, who are owed support by someone who has filed for bankruptcy. The groups are about of equal size; of the estimated 300,000 bankruptcy cases filed in 1997 involving alimony and child support orders, about half involve women who filed for bankruptcy as they tried to stabilize their economic position after divorce, and half involved women as creditors seeking support from someone who filed for bankruptcy.(see footnote 2)
This bill certainly was not intended to hurt these women and their children. But it was intended to, and does, provide greater rights for institutional creditors—credit card companies, secured lenders, and states. And in the context of bankruptcy—where resources are, by definition, insufficient—increased rights for some creditors come at the expense of other creditors, and debtors.
The bill is not carefully targeted at the small group of debtors who may be abusing the system. It will hit the most economically vulnerable, including single mothers and children, especially hard—notwithstanding the child support provisions that have been included in the bill.
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Women as Bankruptcy Debtors
In this debate over bankruptcy reform, a lot of numbers have been cited, especially statistics on the increase in bankruptcy filings in recent years. What gets lost in the debate over the numbers, however, is that each number represents a person with a particular story—and that person is increasingly likely to be a woman.(see footnote 3)
The statistics tell us a little about her. Unlike her male counterpart, she is probably a single parent,(see footnote 4) and is more likely to be caring for aging parents.(see footnote 5) She earns less than the men who file for bankruptcy,(see footnote 6) and is disproportionately represented among the neediest debtors.(see footnote 7) Interestingly, her earnings are not all that different from those of women who don't file for bankruptcy, but her income is lower—with unpaid child support and alimony accounting for much of the difference.(see footnote 8) There's a high probability she filed when she got divorced, or when the support checks stopped coming,(see footnote 9) when she lost her job, or got shifted to part time and lost her medical insurance—just after her employer learned she was pregnant.(see footnote 10) She may have filed after she tried to escape domestic violence.
She, and her children, are especially poor and vulnerable. They are the people for whom the bankruptcy system was intended to provide a safety net. But many provisions of this bill hit them especially hard.
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The bill makes it harder to access the bankruptcy process.
The means test will make it more difficult, and expensive, even for women whose household income is clearly below the median to access the bankruptcy process. And women whose average income was at the median during the last 180 days—before the support checks stopped—or women whose child care expenses exceed the IRS standards—may be denied access to Chapter 7.
Another barrier—at least for the unsophisticated—is created by the counseling provision (§302). Debtors who aren't thinking strategically about filing bankruptcy, but who wait until the sheriff is at the door will have to satisfy the counseling requirements, or successfully petition for an exemption, before they can get the protection of the automatic stay.
87The bill makes it harder for women to save their homes, their cars, and essential household items through the bankruptcy process.
An innovative program in Pennsylvania—the Women Against Abuse Save-A-Home Project—has worked to protect victims of domestic violence from becoming homeless, using the protections of the automatic stay to keep battered women from being evicted while they try to get their finances reestablished. If this bill passes, their job will be a lot harder. Even if they manage to access the bankruptcy process and secure a stay on behalf of a battered woman, landlords will be able to keep going with an eviction if the woman fails to make a rent payment after the case is filed (§139).
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The bill also makes it harder for women to hold onto the used car they need to get to work, or the refrigerator and washing machine they need to care for their families, if they purchased them on credit within the last five years. To keep these essential items, women would now have to pay the creditor not just the value of the property, but the full outstanding balance—which could be much more than the property is worth (§124–125). Indeed, the balance could be more than the purchase price, due to high interest charges and late fees. At the very beginning of a Chapter 13—when she is struggling to get her finances sorted out—the bill would require her to make ''adequate protection payments''—double payments—to secured creditors if she wanted to keep her property (§137). And these higher payments, in turn, make it less likely that a woman will be able to make the mortgage payments required to hang onto her home under Chapter 13.
Only a very limited list of household goods are protected from repossession—or threats of repossession (§148). The list is painfully explicit—1 radio, 1 television, 1 VCR per household. Tape players, CD players: not on the list. Educational materials, toys, and hobby equipment for minor children are protected; 18 year-Olds can bid the mementoes of their childhood goodbye. A personal computer is protected, but only if it's used primarily for minor children; older children who use a computer for research and parents who do some work at home are out of luck. In contrast, no dollar limits are placed on the homestead exemption—owners of multimillion dollar estates in Florida, Texas, and a few other states are secure (§126). And the alternative the bill adopts to capping the homestead exemption—making state exemptions inapplicable to debtors who have not lived there for two years—may inadvertently deny any exemptions to a person who moved to find a job, or a woman who moved to escape domestic violence.
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Even after bankruptcy, women will be burdened with more debt—especially credit card debt—making it harder for them to support their families.
The bill redefines the ''luxury goods'' exception. It provides that debts of $250 or more owed to a single creditor—that is, the aggregate on one credit card—for cash advances or luxury goods charged within 90 of bankruptcy are nondischargeable. To be sure, the bill gives the debtor the right to show that the charges were for necessities, not for luxuries. But low income debtors without counsel, disproportionately women, will be less able to challenge a claim of nondischargeability. And if the purpose of the provision is to place a ''limitation on luxury goods,'' as the section title suggests—that is, to catch people who go on spending sprees right before they file for bankruptcy—why does the presumption apply to people who are charging, or taking cash advances, that average less than $25/week? (§135)
In addition, any debt incurred to pay a nondischargeable debt within 90 days of filing would be nondischargeable, even if there were no intent to discharge the debt in bankruptcy (§149). And many debts, especially credit card debts, that can now be discharged through completion of a Chapter 13 plan would now survive—leaving a woman with less to support her family.
These and other provisions give creditors more leverage to secure reaffirmations while, at the same time, the bill strips debtors of important protections against creditor abuse.
H.R. 833 gives creditors many additional rights which they can use in a bankruptcy proceeding—or can threaten to use, and thus pressure debtors to reaffirm debts that would be dischargeable. At the same time, the bill would strip debtors, especially less affluent debtors, of their most, and perhaps only, effective form of redress: the class action lawsuit or suit for punitive damages (§116, 117).
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The bill does not fully protect income earmarked for support for those women in bankruptcy who are receiving support payments.
The bill does exempt child support, foster care payments from the definition of disposable income (§132). However, income from support payments is included when applying the means test (§102). And the bill does not ensure that alimony and child support payments received within six months after filing a bankruptcy are excluded from the property of the estate, and not distributed to creditors, in states which lack such an exemption.
Women as Support Creditors
Looking at the bill from the position of women as support creditors in a bankruptcy, rather than as debtors, raises some additional issues—but many of the provisions that are a concern for women as debtors are also a problem for women as creditors. The reason is that bankruptcy is a classic zero sum game: when resources are limited, increasing the rights of some creditors may come at the expense of other creditors, as well as the debtor.
Some have said that this bill protects families owed support: that even though the bill increases what credit card companies and secured lenders can demand from debtors, the child support provisions of this bill ensure that the claims of these powerful creditors won't come at the expense of families owed support. Unfortunately, that is not the case. Indeed, the child support provisions of the bill expand the rights of another yet group of institutional creditors whose interests, in some cases, may conflict with those of families owed support: state and county governments collecting support on their own behalf, rather than for families.
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The testimony will address how the bill affects the ability of families to collect support at two stages: during the bankruptcy process and after the bankruptcy is over.
Collection of Support During Bankruptcy
The child support provisions of the bill, §141–147, relate only to the collection of support during bankruptcy. And even from that limited perspective—which doesn't include the concerns of women as debtors, or women trying to collect after bankruptcy—the effects of the provisions on families are mixed. Some are positive; some are not. The bill does, however, confer clear advantages to states and counties that they do not enjoy under current law, which may explain some of the governmental support for the child support provisions.
The bill changes the priority of child support, especially child support owed to the state, during bankruptcy.
Under current law, child support owed directly to families is a priority debt. Child support assigned to the state to reimburse assistance to families is nondischargeable, but it is not a priority debt. The bill would define ''domestic support obligation'' to include child support owed to the family or to a governmental unit, giving states a new priority status in Chapter 7 and Chapter 13 (§141).
In Chapter 7, the bill moves the priority of domestic support obligations from seventh to first. Within this priority, claims owed to families are to be paid first, and claims owed to the state second.(see footnote 11) The change is well-intentioned, but largely symbolic, and may actually make it harder for families and states to collect support. It will have limited practical benefit, because most Chapter 7 cases do not have assets to distribute, and it is rare for cases to combine the kind of commercial claims that now occupy priorities two through six with a child support claim.(see footnote 12) Notwithstanding the limited impact, the National Women's Law Center endorses giving child support claims a higher priority than they now have. However, putting child support ahead of administrative expenses may make it impossible for anyone to collect; if administrative expenses are not paid, there may be no one to administer the estate, and any assets may be abandoned back to the debtor, instead of being liquidated for the benefit of support recipients and other creditors..
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In Chapter 13, the bill would require that all domestic support obligations—including all arrears owed to states—be certified as paid in full before a discharge under Chapter 13 can be granted. Under current law, only child support owed to the family must be paid in full before a discharge can be granted. And current law gives a woman owed support the option to agree to allow the Chapter 13 discharge to proceed, even if her arrears have not been fully paid. That might be in her best interest: her claim for arrears is nondischargeable, and allowing other debts to be discharged may make it easier for her to collect both current support and arrears in the future. Especially when combined with the other increased payments that must be made to secured creditors under Chapter 13, the requirement that state arrears as well as family arrears must be paid in full would make it more difficult for a debtor to get a Chapter 13 plan confirmed and successfully completed, and adversely affect the family.
A better approach, that protects families while giving greater rights to the states, would be to require a Chapter 13 plan to provide for the full payment of current support, whether owed to the family or the state. In addition, as under current law, arrears owed to the family would have to be paid in full, unless the individual agreed otherwise. Payment of state claims for arrears in Chapter 13 would be required to the extent the debtor can pay them out of disposable income. This would put states ahead of credit card companies and other unsecured creditors in Chapter 13, and require debtors to make all current support payments, including those assigned to the state, but would avoid blocking approval of a Chapter 13 plan that might work well for the family, because it was simply impossible to repay arrears owed to the state in full.
The bill creates some additional exceptions to the automatic stay for governmental support enforcement activities during bankruptcy.
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Under current law, as amended by the bankruptcy reform act of 1994, a number of support-related actions are exempt from the automatic stay, including actions to establish paternity, to establish or modify an order for alimony, maintenance and support, or to collect support or alimony from property that is not property of the estate, such as the postpetition earnings of a debtor who has filed under Chapter 7. Under Chapter 13, however, postpetition earnings are property of the estate. Although bankruptcy trustees routinely grant exceptions to the automatic stay to allow income withholding for current support in Chapter 13,(see footnote 13) a motion is required—and this can delay the receipt of badly needed support by some families.
The bill would create additional exceptions to the automatic stay for enforcement actions undertaken by state and county child support agencies, including income withholding in cases being enforced by public agencies; actions to withhold, suspend or restrict drivers', professional and occupational, or recreational licenses; reporting overdue support to credit bureaus; intercepting tax refunds; and enforcing medical support (§144).
The National Women's Law Center strongly supports changes to the bankruptcy code that would make it make it easier and quicker for families owed support by a debtor who has filed for bankruptcy to collect that support, including an exception for all withholding orders for current support and alimony. Unfortunately, the additional exceptions to the automatic stay created by the bill would help only a fraction of the families owed support, and would make it more difficult for some families to collect arrears owed to them. The provisions fail to ensure that families owed support will get their money before the secured creditors, whose rights would be substantially expanded by the bill, for several reasons.
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First, the provisions of the bill only apply to income withholding orders issued by government agencies under §466(b) of the Social Security Act. However, an estimated 40–50% of all child support cases, and all alimony-only cases, are enforced privately, not by government child support agencies.(see footnote 14) These families would not be helped by the changes in the law.
Second, although income withholding is extremely effective when an order is in place against an obligor with regular income, within the government enforcement system, many families lack a support order, much less a wage withholding order. In FY 1997, more than four out of ten cases in state child support systems across the country lacked a support order. In only 22% of all cases, and 38% of cases with orders, was some collection—not necessarily full collection—made. Nationally, only 54% of current support owed, and only 8% of prior year support owed, was collected in FY 1997.(see footnote 15) Moreover, because bankruptcy cases often involve someone who has lost a job, or suffered reverses in a small business, the effectiveness of income withholding orders in bankruptcy cases is likely to be more limited than in the caseload generally.
A recent series in the Los Angeles Times documented the problems with child support enforcement in Los Angeles County—and the human costs of those delays.
When Catherine Sanford applied for welfare in 1996, she viewed it as a desperate, stopgap measure in the hopes that the district attorney's office would swiftly find the father of her 2-year-old daughter, a married man who owned a business. She said she was inspired by news accounts of Garcetti's resolve to crack down on deadbeat dads.
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The stakes were high: She was losing her house.
On her welfare application, Sanford named the girl's father and provided his home and work addresses, as well as his Social Security number. As required, welfare officials notified the district attorney's office to begin the collection process.
''I believed the God would take care of [them],'' Sanford said of her daughter and a second child. ''And he does. But his timing is different than mine.''
So was the district attorney's.
The case languished, and Sanford's life crumbled.
The child support bureau initiated a complaint against the father but did not begin court proceedings. Sanford soon lost her Altadena home and was forced to move her family into homeless shelters while working part time as a security guard.
Last month, she got word that the district attorney's office had secured a payment order in her case, although she is still waiting for the checks.
''I gave them all the information that was needed,'' she said, ''and they still stalled.''(see footnote 16)
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In recent years, Congress has given government child support agencies many additional enforcement tools. The National Women's Law Center has worked with other advocates and representatives of state child support enforcement agencies for more than two decades to secure those reforms. Unfortunately, the tools—even when mandated by Congress—are not being fully utilized. In 1988, over ten years ago, Congress required states to automate their child support enforcement systems statewide, so that—among other things—income withholding orders could be generated automatically, whenever the computer located someone who owed child support working anywhere in the state. The deadline for developing the systems—after Congress extended the deadline for two years—was October, 1997. To date, only 37 state systems have been certified. Some additional state systems are under review; however 9 states, including California, have not even begun the review process.(see footnote 17)
Third, even if an income withholding order has been obtained by the agency on behalf of a family, it may not fully protect the rights of the family under Chapter 13 to secure full payment of arrearages, unless the family agrees otherwise. Even if the order included partial payment towards arrears, it would be purely fortuitous if the existing withholding order secured full payment of arrears during the life of the Chapter 13 plan. To fully protect the rights of the family, the child support agency still would have to appear in the Chapter 13 proceeding.
Fourth, exempting procedures to collect arrears owed to the state from the automatic stay may make it more difficult, in some cases, for families to collect the support they are due. For example, under the 1996 welfare law, in any case in which child support is assigned to the state, states will continue indefinitely to have the first priority claim on money collected through intercepting federal tax refunds. Only after the state's claim to assigned support has been satisfied will families get a portion of money collected through the federal tax intercept (42 U.S.C. 657(a)(iv)). The tax intercept process is the most effective tool in the child support enforcement arsenal for collecting arrears.(see footnote 18) When it is used to collect arrears owed to families, it should be exempt from the automatic stay . However, allowing the exception when the state is collecting assigned support may mean that the state gets its money first—and there's not enough left for the family.
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Finally, the other enforcement tools that would be exempted from the automatic stay by the bill—license revocations and credit bureau reporting—won't do much to help child support creditors get to the debtor's money ahead of the secured creditors. These tools are very helpful in getting the attention of a debtor who cannot be reached by income withholding, because he or she is self-employed (or works off the books). But license revocation, by itself, doesn't bring in money; the agency would still have to try to collect in Chapter 13. And reporting a debtor already in bankruptcy to a credit bureau isn't much of an additional sanction. These provisions are of especially limited utility given the fact that the bill also gives secured creditors bigger and more numerous claims to the debtor's limited resources. These provisions protect state agencies from being cited for violations of the automatic stay, but they don't ensure that families will get their money ahead of secured creditors.
Support collections after bankruptcy
In considering the impact of H.R. 833 on child support, it is important to keep in mind the special nature of child support debt. Child support is a continuing, long-term obligation; it lasts for 18 years or more. So it is necessary to consider the impact of the bill not just during the several months of a Chapter 7 proceeding, or even the several years of a Chapter 13, but throughout the life of a child.
As discussed above, under H.R. 833, more debts would survive a discharge at the end of the bankruptcy process. Under increased pressure, more debts would be reaffirmed. And even fewer debtors will be able to successfully complete the bankruptcy process, and get a discharge of any of their non-support debts. Thus, women owed support post-bankruptcy—those with ongoing support claims and those who were unable to collect their arrears during the bankruptcy process—will be in stiffer competition with commercial creditors.
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The bill does not include any provisions that would give special protection to support post-bankruptcy. A provision added to last year's House bill that would have required other creditors who collect certain nondischargeable debts to hold the money in trust for two years for payment of support claims was dropped from the conference report and H.R. 833.
Some child support agency representatives say that even so, there is no problem because child support agencies can always get to the money ahead of other creditors. However, when the collection record of child support enforcement agencies is compared to the collection record of commercial creditors, there is cause for concern.
On March 11, 1999, Bruce Hammonds, Senior Vice Chairman and Chief Operating Officer of the MBNA Corporation, testified to this subcommittee that more than 96% of credit card accounts pay as agreed. In contrast, the U.S. Department of Health and Human Services reported that in FY 1993, some collection was made in 18.3% of cases in the child support system; by FY 1997, that percentage had increased—at a rate of less than one percentage point per year to 22.1%. The percentage of cases with some collections compared to cases with orders increased at a slightly faster rate: from 32.9% in FY 1993 to FY 38.4% in 1997.(see footnote 19) Nevertheless, it will be some time before we can be confident that state and county child support agencies will prevail in a competition with commercial creditors.
Conclusion
Single mothers and their children are among the most economically vulnerable groups in our society. H.R. 833 would put them at even greater risk. I hope this Subcommittee will carefully reconsider the provisions of this bill from their perspective—and develop a balanced reform bill that protects families, not the credit industry.
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Mr. GEKAS. We thank the lady, and we turn to Ms. Saperstein.
STATEMENT OF STEPHANIE M. SAPERSTEIN, ESQUIRE, ASSISTANT ATTORNEY GENERAL, OFFICE OF THE UTAH ATTORNEY GENERAL, ON BEHALF OF THE NATIONAL ASSOCIATION OF ATTORNEYS GENERAL
Ms. SAPERSTEIN. Thank you. Good morning, Mr. Chairman and members of the committee. I thank you for allowing me to testify before you today.
I have been asked by NAAG, the National Association of Attorneys General, to come and speak to you today and represent the thousands of line attorneys across the country who are on the front lines to collect this child support for the State agencies.
I support the proposed amendments as they relate to the collection of child support.
These changes could make the difference for a custodial parent in paying a utility bill or school fees or even, in some instances, buying groceries for that week.
Everyday I see firsthand the legal conflicts that arise when a child support obligor files for protection under the Bankruptcy Code.
Even though child support is a nondischargeable debt, the filing of a bankruptcy by a noncustodial parent currently disrupts the flow of the support into the child's household.
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Frequently, child support enforcement professionals will invest months of investigation to locate an absent parent and initiate legal proceedings, only to have that process disrupted by a bankruptcy filing.
These families are barely existing financially, and child support means the difference as to whether they will need public assistance just in order to survive.
I would like to focus on two of the amendments I consider vital to the collection of child support.
One of the important changes to the Code is in section 362. This section would except from the automatic stay the income withholding process that Mr. Strauss described to you and the enforcement of medical support.
The income withholding exception is important for two reasons:
First, it resolves the legal conflict between the Federal mandate under title IV–D of the Social Security Act that all child support collections be collected via income withholding and the bankruptcy automatic stay.
This conflict places my client agency in the legal quandary of either violating the automatic stay by keeping the income withholding in place or terminating the income withholding pursuant to the automatic stay and risk losing Federal money for failure to comply with that mandate.
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Second, it prevents the disruption of the flow of financial and medical support into the child's household.
The income withholding process is the most valuable tool that a collection professional can use.
As a line attorney, one of the hardest things I have done is to explain to a custodial parent why the noncustodial parent is temporarily protected under the automatic stay from forcibly complying with their child support obligation.
Of course, the line attorney can move the Bankruptcy Court for a lift of the automatic stay, but this motion involves the time and effort of an attorney who is not intimately familiar with the bankruptcy procedure and is at the mercy of crowded court dockets, procedural time requirements, and opposition to the motion by competing creditors.
All of this simply to force a recalcitrant noncustodial parent to satisfy a legal and moral obligation to their children, an obligation that has priority over other debts both by statute and by public policy.
While the line attorney is working hard to get the automatic stay lifted, the 295 other cases in that caseload are not getting the attention that each case so desperately needs.
In the past 2 years, the Bankruptcy Court in the District of Utah has enacted a local rule that excepts the collection of current monthly support and post-petition child support debt from the automatic stay.
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This is a wonderful tool in protecting the interests of children and custodial parents, and at the same time emphasizes to the debtors and their attorneys the importance of their support obligations.
But, because it is only a local rule, we are in constant fear that it will be repealed at any time.
It also does not solve our problems in collecting child support in other jurisdictions. There is no guarantee that a similar rule would be adopted in each jurisdiction.
Resolving this issue by rule would only allow the disparate treatment of child support debt among the many jurisdictions.
This amendment will ensure that all child support obligations will be treated consistently throughout the country.
The other amendments that I support are to sections 1129 to 1325. These require a bankruptcy debtor to stay current on post-petition child support obligations in order to obtain confirmation of a plan and discharge.
This is especially important in cases involving self-employed bankruptcy debtors where wage income withholding is not enforceable because there is no employer.
I thank you, and I hope that you consider these amendments. I support them. Thank you.
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[The prepared statement of Stephanie M. Saperstein, Esquire, follows:]
PREPARED STATEMENT OF STEPHANIE M. SAPERSTEIN, ESQUIRE, ASSISTANT ATTORNEY GENERAL, OFFICE OF THE UTAH ATTORNEY GENERAL, ON BEHALF OF THE NATIONAL ASSOCIATION OF ATTORNEYS GENERAL
Good morning, Mr. Chairman and members of the committee. It is an honor to appear before you today. I thank you for the opportunity to testify on these bankruptcy amendments as they relate to child support collection. The National Association of Attorneys General has asked me to testify on behalf of the thousands of line attorneys who have been charged with the task to collect child support.
I support the proposed amendments as they relate to the collection of child support. These changes could make the difference for a custodial parent in paying a utility bill, school fees, a doctor bill or even buying food. Everyday, I see first hand the legal conflicts that arise when a child support obligor files for protection under the bankruptcy code. Even though child support is nondischargeable, the filing of a bankruptcy petition by the noncustodial parent disrupts the flow of support into the child's household. Frequently, child support enforcement professionals will invest months of investigation to locate an absent parent and initiate legal proceedings only to have the process disrupted by a bankruptcy filing. These families are barely existing and child support means the difference as to whether they will need public assistance in order to survive.
I would like to focus on two of the amendments that I consider vital to the collection of child support. One of the important changes in the Code is to Section 362. This amendment would except the income withholding process and the enforcement of medical support from the automatic stay. The income withholding exception is important for two reasons. First, it resolves the legal conflict between the federal mandate under Title IV–D of the Social Security Act that all child support obligations be collected via income withholding and the bankruptcy automatic stay. This conflict places my client agency in the legal quandary of either violating the automatic stay by keeping the income withholding in place or terminating income withholding pursuant to the automatic stay and risk losing federal money for failure to comply with the mandate.
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Second, it prevents the disruption of the flow of financial and medical support into the child's household. The income withholding process is the most valuable tool that a collection professional can use. As a line attorney, one of the hardest things I have done is to explain to a struggling custodial parent, why the noncustodial parent is temporarily protected under the automatic stay from forcibly complying with their child support obligation.
Of course, the line attorney can move the bankruptcy court for a lift of the automatic stay. But this motion involves the time and effort of an attorney who is not intimately familiar with bankruptcy procedure and is at the mercy of crowded court dockets, procedural time requirements and opposition to the motion by competing creditors. All of this, simply to force a recalcitrant noncustodial parent to satisfy a legal and moral obligation to their children; an obligation that has priority over other debts both by statute and by public policy. While the line attorney is working hard to get the automatic stay lifted, the 295 other cases in that caseload are not getting the attention that each case so desperately needs.
In the past two years, the bankruptcy court in the District of Utah has adopted a local rule for Chapter 13 cases that allows income withholding to remain in place for the collection of post-petition support unless the debtor specifically objects to collection. This local rule has been a wonderful tool in protecting the interests of children and custodial parents and at the same time emphasizing to debtors and their attorneys, the seriousness of the child support obligation. But because it is only a local rule, we are in constant fear that it will be repealed at any time. It also doesn't solve our problems in collecting child support in other jurisdictions. There is no guarantee that a similar rule would be adopted in each jurisdiction. Resolving this issue by local rule would only allow the disparate treatment of child support debt among the many jurisdictions. This amendment will ensure that all child support obligations will be treated consistently throughout the country.
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The other amendments that will significantly aid in our collection efforts are the amendments to Sections 1129(a) and 1325(a). These amendments require the bankruptcy debtor to remain current on all postpetition child support obligations in order to obtain plan confirmation and a discharge. The most difficult child support cases to enforce often involve self-employed child support obligors. The self-employed obligor may make the required payments to the trustee pursuant to the terms of the proposed plan but refuse to pay the current monthly support. Income withholding is not helpful because the obligor has no employer. Currently the line attorney must file a motion to dismiss or convert the bankruptcy case. Under these amendments this problem would be resolved, enabling the attorney to work on another case, thus helping another household.
In conclusion, these amendments and those discussed by my fellow panel member Mr. Strauss will tremendously enhance the child support attorney's ability to enforce child support obligations. I urge you to adopt these amendments on behalf of the line attorneys who collect child support and the households that benefit from these collection efforts.
Mr. GEKAS. We thank the lady, and we will turn to Professor Gross.
STATEMENT OF KAREN GROSS, PROFESSOR, NEW YORK LAW SCHOOL, NEW YORK, NY
Ms. GROSS. Thank you. Can I just ask for one preliminary indulgence from the committee?
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Due to the short notice, I would ask that my full written comments be able to be made part of the record if I tender them within the next three business days?
Mr. GEKAS. Without objection we will accommodate the lady.
Ms. GROSS. Thank you. My name is Karen Gross, and I am a Professor of Law at New York Law School, and I appreciate the opportunity to appear again before this committee.
I want to commend the committee and its Chair for recognizing the importance of women and children affected by the bankruptcy system.
I commend the committee and its Chair for recognizing that the current Code does not do all that it can and should do to protect women and children.
Before I begin, I want to just make two preliminary comments.
First, I appreciate Representative Nadler's recognition of my work in this area. I am not a recent convert to the issues involving women and children, and I appreciate that recognition.
I also want to say that the tenor of the bankruptcy debate to date has not been pleasant. Indeed, it has been vituperative and nasty.
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But, the issues of import, like those involving women and children, cannot and should not be addressed in that manner, and so I welcome the opportunity to discuss them, I hope, in a thoughtful way.
A February 24th press release stated, referring to H.R. 833, that this is fair, bipartisan legislation that improves the treatment under the law of those who need it the most: women, children, and consumers.
I wish, I truly wish, the bill did that but I have to say, with deep regret, that in my professional judgment, H.R. 833 does not accomplish its professed and laudable goal of protecting women and children.
Let me explain why briefly.
For starters, H.R. 833 affects only a limited pool of women and children affected by bankruptcy, and that is women and children in non-intact families.
Now, most assuredly, this is a deserving group. And, if one looks at page 2 of my submission, you'll see that in fact women enter the bankruptcy system today in lots of ways.
Women in non-intact families who are creditors are only one piece of a much larger problem.
So, while it is important and I think significant, to focus on this group, it is not the only group that deserves attention.
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Indeed, in this bill, women as debtors in intact and non-intact families are ignored.
In sum, we're focusing on only a small piece of the problem.
Now, I appreciate that this is a wonderful media soundbite that ''women and children come first.'' It has tremendous appeal but it isn't accurate. We are not protecting, by this bill, all women and children. Indeed, intact families will suffer.
It reminds me actually of an anecdote. Suppose we say that we could give you something to improve your red blood cell count, but by the way, it does away with all your platelets.
Now, just to give you a sense, women are accessing the bankruptcy system as debtors much more frequently than ever before. Indeed, the current data suggest that women as debtors in the system appear in something upwards of 70 percent of all cases. I care about this group of debtors because many of these women have what is termed, what I term actually, ''sexually transmitted debt.'' This is debt that they acquired not of their own doing. This is debt that they acquired through other means. These are women who deserve protection.
Now, to return to the actual support provisions, and I appreciate Mr. Strauss' and Ms. Saperstein's observations that these help the government. But, the government cares about a subcategory of the group of people who need to be protected, and indeed the interests of the government are not always consonant with the interests of women and children.
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Now, what is a critical point, it seems to me, is that women also need the ability to collect out of future income. The issue is not just past and current child support; it is future income. To the extent that the provisions of this bill diminish the pool of assets that will be available after bankruptcy, women and children will be hurt.
And, in the fight over what would now be a decreased pool of assets, I ask you who has the better ability to collect: a woman recipient of alimony, or the credit card company and its lawyer?
I would suggest to you that while I say that in a somewhat loose fashion here, that's an important, a very important issue.
Now there's one more thing I'd like to say, which is that this bill, in addition to focusing on only a very narrow range of issues and not solving those completely and then not paying sufficient attention to women as debtors, has one more significant flaw for me. It misses the opportunity to protect women.
It does it in several ways. One is it does away with class actions and punitive damages when creditors are bad actors, and it does it by not including adequate disclosures of the costs of credit.
Now, as Representative Gekas knows, I am an advocate of debtor education, and there is in this bill still a woeful lack of protection for this unsophisticated group. Studying the issue now is not enough. We have to do more.
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So, I urge this subcommittee to look beneath the slogans and the rhetoric and to consider how H.R. 833 will harm women.
Women appear in bankruptcy in a myriad of ways, and this bill is not protective of all women, of all ages, of all races, and of all socioeconomic classes.
Thank you.
[The prepared statement of Professor Gross follows:]
PREPARED STATEMENT OF KAREN GROSS, PROFESSOR, NEW YORK LAW SCHOOL, NEW YORK, NY
My name is Karen Gross, and I am a tenured law professor at New York Law School. I appreciate the opportunity to appear before this Subcommittee once again, and I welcome the chance to share with you my thoughts on how H.R. 833, the bankruptcy legislation sponsored by Representative Gekas and introduced on February 24, 1999, affects women and children. This is an important topic, and I commend the Subcommittee for recognizing its significance. I also commend the Subcommittee for recognizing that current law does not do all it could to protect women and children affected by the bankruptcy process.
Let me begin by addressing my qualifications to speak on this topic. I am not a recent addition to the ''women and children'' bandwagon. I have worked on issues affecting women and children in the bankruptcy system for over a decade. My experiences range from the academic to the practical. For example, I have conducted historical research on the first women debtors in the United States (funded by the National Conference of Bankruptcy Judges Educational Endowment Fund) and have compared those women to contemporary women in debt. (See Appendix A detailing my work on this topic with Professor Marie Newman.) I have worked one-on-one with women debtors at the New York Legal Aid Society, counselling them regarding solutions to their financial distress. I served from 1991–1993 as a National Advisor to the Bankruptcy Task Force of the Ninth Circuit Gender Bias Task Force. I was also appointed as co-chair of the Bankruptcy Working Group of the Second Circuit Gender Fairness Committee and served in that capacity from 1994–1997. I have written and lectured both within and outside the legal academy about women in the bankruptcy system and have published several articles on this topic. My recent book, FAILURE AND FORGIVENESS: REBALANCING THE BANKRUPTCY SYSTEM (published in 1997 and released in paperback in March 1999), touches on these issues. My next book, which I will be completing during my sabbatical in Calendar Year 2000, is on women in debt in America from 1800 to the present.
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I have one more observation of a preliminary nature. To date, the bankruptcy debate has been rather biting and vituperative. The debate's tenor has been far too angry, far to personal, and far too nasty for my taste. Reasoned discourse has been hard to hear above the roar. One thing is very clear to me. The topic I am addressing—women and children—is far too important to be addressed with hostility. Instead, we need to think in a non-political way about how our bankruptcy law does and should treat women and children. Witnesses on this topic need not speak based on the side of the proverbial aisle from which they hail. Instead, we must think broadly about how this important group can be protected—for their sake and our own as a nation.
In a February 24, 1999 press release regarding H.R. 833, Representative Gekas said, ''This is fair, bipartisan legislation that improves the treatment under the law of those who need it the most: women, children and consumers.'' I truly wish that this statement were true. Unfortunately, and I say this with deep regret, it is my professional opinion that the proposed legislation does not accomplish its professed and laudatory goal of protecting women and children. There are four primary reasons for this. First, H.R. 833 only addresses women and children as creditors in non-intact families. This means that many women and children affected by bankruptcy are not within the considered provisions. Second, as to this important but limited subcategory of individuals, the proposed legislation does not live up to its billing; it fails to protect women and children adequately. Third, bankruptcy impacts women and children in a myriad of ways—as creditors and as debtors in both non-intact and intact families. The provisions affecting women and children in these equally (if not more important) roles fail to reform current law; indeed, they ''deform'' it by making these vulnerable groups worse off. Fourth and finally, the bill misses the opportunity to provide meaningful and easily attainable reform by adding certain provisions to current law that would clearly benefit women and children.
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It is easy to speak in generalities about protecting women and children, and such statements do have immediate and understandable appeal. They create very effective sound-bites. However, over-broad statements are inaccurate and camouflage how women and children will actually be treated in the bankruptcy system. They fail to recognize the practical realities of how the bankruptcy system operates. They focus on a narrow question and treat that narrow issue as if it were the only consideration. Sound-bites ignore the enormous harm that will be wrought upon women and children under H.R. 833. I am reminded of someone who points out that a new drug will help your white blood count but fails to note that the same medication will destroy your platelets and harm your kidneys. You won't die of an infection; you'll just bleed to death.
The Narrow Focus Problem: H.R. 833's provisions dealing with women and children have a narrow focus. Sections 141–147 address women as creditors in non-intact families. Although Section 144 is beneficial, other provisions are problematic, partially because they focus on protecting the government as ''debt collector'' of alimony, maintenance and child support—without recognizing that the interests of the government are not always consonant with those of women. At times, the government is acting to refill its own coffers, not the coffers of women and children. This does not mean that the government should be disinterested in replenishing state or federal deficits; however, the government's deficits are distinct from the financial deficits of women.
The annexed chart (See Appendix B) shows, in the shaded, upper right hand corner, where H.R. 833 has placed its attention. Pay particular attention to the sub-box within this already limited box. It represents the interests of the government. Note the unshaded areas; they represent the areas in which women and children are impacted by bankruptcy but which are ignored by H.R. 833. Women as debtors and women as part of intact families need to be protected. A perverse aspect of H.R. 833 is that it favors, indeed almost encourages, non-intact families. Ironically, H.R. 833 places a woman who is married, single or elderly in a worse position than a divorced or separated woman—hardly the message Congress intends to convey.
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There are many women in the bankruptcy system—as debtors or creditors—who are members of intact families or who are single or elderly. These women are not receiving support payments. There are also many women in the bankruptcy system who are part of non-intact families who enter the system as debtors, not creditors. Although the government does not collect this demographic data, studies suggest that women are accessing the bankruptcy system with increasing frequency.(see footnote 20) (See Appendix C for a selected bibliography listing articles on this subject.) Several examples suffice. Oliver Pollak, a professor of history and a lawyer, has studied trends of women accessing the bankruptcy system in his home state of Nebraska. His work indicates, based on sampling, that 11.2% of all consumer cases filed in 1977 were by women. That number rose to 22.1% in 1988 and 32.2% in 1996–7. The extant data suggest that the women debtors have a different demographic profile than their male counterparts. The women filing are poorer than their male counterparts. They have fewer assets; they have lower incomes. Many have children to support. They reaffirm debts more frequently than their male counterparts. Many women debtors have what I term ''sexually transmitted debt.'' This is not debt they incurred but rather debt for which they became obligated to pay through a man. Common sexually transmitted debts include obligations on a joint credit card where the benefits of the purchase inured solely to the male partner, debt incurred without a female spouse's knowledge and the spouse is no longer part of the family, joint and several tax liabilies and inherited debt. A recent study conducted by the Federal Judicial Center noted that women were seeking relief on an in forma pauperis basis at a much higher rate than their male counterparts in the two pilot regions studied. Many women are uncomfortable dealing with money and lack money management skills. This profile suggests that the feminization of poverty that is occurring outside the bankruptcy arena is mirrored within it.
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In considering women in the bankruptcy system, one also has to take into account the significant number of joint cases filed (although it appears that the number of joint filings is decreasing). Since joint cases under Section 302 are only permitted for husbands and wives, every joint case involves a woman. Taking joint cases together with cases where a woman files singly (not referring to her marital status), over 70% of all consumer cases involve a woman debtor. Therefore, it is imperative that legislation addressing consumer bankruptcy focus on more than women as creditors in non-intact families; it must pay attention to women as debtors as well.
We also cannot overlook that women from intact families as well as single women and elderly women may be creditors. They may be owed money from a debtor who may (or may not) be their spouse. We also cannot ignore that bankruptcy rules affect those who are not yet within the system. The lives of women and children who are not creditors or debtors in any official sense are affected by the bankruptcy of their spouse or family members.
Problems with Sections 141–147: I have several distinct criticisms in terms of what H.R. 833 accomplishes (or fails to accomplish) in respect of support obligations. But, I want to be very clear on one point. Protecting alimony, maintenance and child support for those who receive it is a very important social issue. Successful efforts to enhance a recipient's ability to collect what is rightfully hers is essential. In that regard, Section 144 of H.R. 833 is meritorious. It permits the automatic stay under Section 362 to be lifted to enable wage orders, interception of tax refunds, enforcement of medical obligations or actions to withhold a license to proceed. This provision most assuredly assists the government as debt collector. It also assists many women seeking to collect support without the assistance of the government—either on their own or with the assistance of counsel.
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However, the other support provisions are not as neatly tailored to accomplish their intended goals. Several examples suffice. Section 142 treats domestic support obligations as a first priority under Section 507. On the surface, this seems appealing in that it literally places women and children first in line; it produces an inviting sound-bite: women and children will now be placed first in bankruptcy. However, the change is elliptical; it does not do what many may suppose. Under current law, support obligations are a seventh priority. But, in reality, the only priority obligations of relevance in front of support are administrative priorities. While a debtor could owe back wages to employees, such a situation is not common. Hence, leapfrogging is, in a practical sense, not from 7th to 1st place; it is from 2nd to 1st place.
Moreover, priorities affect past due and current obligations; priorities cannot and do not affect future obligations. For many women, the collection of future obligations is as important, if not more important, than the collection of past due amounts. So, the priority leapfrogging impacts on only a narrow range of cases. Additionally, a priority is only useful in a Chapter 7 case if there are available assets with which to make priority payments. With an ever increasing portion of the debtor's assets and income needed to pay secured creditors under H.R. 833 (due to the elimination, among other things, of lien stripping in Section 124), the amount of unencumbered assets is diminished. It is unencumbered property that is used to pay unsecured debts in a Chapter 7 case, including priority obligations. Thus, having a priority is meaningless if there are no assets.
In an asset case, the new provisions does not work either. It is questionable how much effort a trustee will assert to pursue an asset if s/he is not going to get paid for this work. If an asset has sufficient value to pay both the support priority and the trustee's expenses, then the trustee may pursue same. However, if the asset has insufficient value to even cover the support priority (not an unlikely scenario), the trustee will abandon the asset to the debtor. The priority claimant could pursue same on her own, although one has to question whether that is feasible. Moreover, this new provision, when coupled with Section 143, will hold up confirmation of Chapter 13 cases when the past due or current support obligations are not paid. This is fine if the unpaid creditor is a woman or child. However, as drafted, the provision enables the government to hold up a Chapter 13 confirmation when it is not paid. If the government is acting as the debt collector for a woman or child, this is appropriate; the benefits of this inure to women and children directly. However, if the government is collecting for its own benefit (say, for example, the woman recipient is on welfare and the government is collecting arrearages to reduce a state or federal deficit), then the result is inappropriate.
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H.R. 833 makes support obligations (however created) non-dischargeable. This expands the category of non-dischargeable debt under current law. On the surface, this change is unobjectionable (except it may hurt a very limited subcategory of women debtors required to pay a former spouse under a property settlement). However, its benefits need to be evaluated in the context of other aspects of H.R. 833—namely Sections 129, 135 and 149. These sections increase the number of other non-dischargeable debts. What this means is that a debtor's future income can be attacked by a broader range of creditors of whom former spouses will be just one. Stated differently, H.R. 833 diminishes the pool of available resources from which creditors with non-dischargeable debts can collect. Among these competing creditors, who is more likely to prevail—the former female spouse or the credit card company? If the government is the debt collector, it arguably, at least in certain situations and in certain regions of the country, is in a strong position to prevail against the creditor. However, many women creditors do not use the government as their collector. Again, what works for the government as debt collector may not work for women collecting support on their own; helping the government is only a small piece of the problem! Further, even those using the government may be doing so to collect past due alimony while they are attempting to collect current alimony on their own. Assuming that the government's rights to collect past due support are subordinate to the female spouse collecting current amounts, there remains a rush to a decreased pool of assets. The government may not even know the female spouse is struggling to collect current support. Ironically, this superficially palatable provision leads to a rush to assets; it creates a bad version of the old movie, ''It's a Mad, Mad, Mad, World.''
The Forgotten Group of Women as Debtors: Turning our attention to women as debtors, H.R. 833 is clearly NOT an improvement over current law. H.R. 833 actually discriminates against women as debtors, an unintended and perverse consequence. Perhaps this result has not gone unnoticed by the government officials who favor H.R. 833's domestic support provisions; these officials clearly limit their comments to the support provisions; their comments are noteworthy in their silence in respect of the other aspects of H.R. 833. The comments that follow must be taken in the context of understanding who women debtors are. As profiled earlier, the women debtors currently accessing the bankruptcy system are generally poorer than their male counterparts; they have less income; they reaffirm more debts; they have less comfort dealing with money issues; they lack financial management skills; they are the primary caretakers of minor children and are increasingly responsible for aging parents. In sum, the profile of women in debt in our bankruptcy system is that of individuals truly living on the edge. For those women with sexually transmitted debt, there is no abuse of the bankruptcy system; these women were abused. Women debtors are not the prototypical debtor singled out by Judge Jones as abusers of the system. They are not Kim Basinger.
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If Sections 141–147 of H.R. 833 are viewed as a virtual ''wish list'' of protections for the government as debt collector, the other provisions of H.R. 833 are a virtual anti-wish list for women. Before turning to specific problems, two general comments are needed. H.R. 833 creates numerous opportunities for added costs to debtors—increased burdens, increased hearings and increased opportunities to litigate. Access to and exiting from the system has been made harder. Judge Randy Newsome estimated that the new legislation raises more than 58 new issues that can be litigated. For women debtors, whose financial situation is marginal at best, these burdens decrease the likelihood of their being able to navigate the bankruptcy system; they simply do not have the resources to do so. Increased lawyers' fees, increased filing fees, increased non-dischargeable debts all take money which women in debt do not have. It is easy to minimize the burden of increased costs of the system on women. To that end, I direct you to the poignant words of the late Justice Thurgood Marshall. In his dissent to United States v. Kras (the decision denying in forma pauperis relief for debtors), Justice Marshall stated, ''It may be easy for some people to think that weekly savings of less than $2 are not a burden. But no one who has had close contact with those poor people can fail to understand how close to the margin of survival many of them are. It is perfectly proper for judges to disagree about what the Constitution requires. But it is disgraceful for an interpretation of the Constitution to be premised upon unfounded assumptions about how people live.'' Second, H.R. 833 will hurt many consumer debtors, not just women. However, what is significant to me is that, given the profile of women debtors, the bill's effect will more adversely affect women. Stated differently, H.R. 833 threatens to harm women debtors more than their male counterparts.
Since so many of these issues only become apparent through examples, I hope that the following list—replete with concrete situations—will demonstrate the considerable and increased risk placed on women and children by H.R. 833. By creating this list, I am not being all inclusive; instead, I am trying to highlight the potential for horrific results.
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MEANS–TESTING: Means-testing will make it more difficult for women to access the bankruptcy system—and we currently have no in forma pauperis system to serve as a safety net. Moreover, many women debtors file pro se, and legal aid and pro bono panels, while in place in some regions, are not uniformly available. Without regard to their income level, an assessment will be made to determine if they can repay creditors 25% or $5,000 over five years. In calculating expenses, the IRS guidelines are used. If a debtor wants to rebut the characterization, she can do so based on a showing of extraordinary circumstances. Because of the nature of the IRS guidelines, women with low income and relatively low debts may satisfy the means-test; as such, they will be denied access to Chapter 7. Their income, formerly dedicated to support of themselves and their children in amounts they deemed satisfactory, will be reallocated to creditors. Indeed, with increased categories non-dischargeable debt (See Sections 129, 135, 149), less money will be available post-discharge to satisfy these basic support needs. Ironically, a woman with an intact family who seeks bankruptcy relief is less protected (in terms of available income to support herself and her family) than a woman in a non-intact family whose former spouse (who pays support) files for bankruptcy relief. Additionally, since a sizable portion of the women debtors have sexually transmitted debt, the woman who is a debtor because she cannot pay her former spouse's debts will emerge from bankruptcy in an even worse position than a non-debtor, non-filing ex-spouse.
LIFTING OF THE AUTOMATIC STAY TO PERMIT EVICTION: Section 139 of H.R. 833 permits landlords of residential real property to vacate the stay if (a) a debtor does not remain current on post-filing rent payments; (b) filed for relief within the last year and failed to pay rent in that prior case; (c) the eviction is based on ''endangerment to person or property . . .'' or illegal drug use; or (d) the lease has terminated pre-petition and eviction is sought. This provision appears to apply to all landlords—including well-established management companies and the government serving as landlord in public housing. This provision entitles a landlord to evict a debtor and her family even if she is current on rental payments. Indeed, suppose that the debtor has been in an unsuccessful joint Chapter 13 case with her spouse, and that case failed because the marriage failed. This woman debtor could now be evicted if she were not current on rent during the prior case, even though she is current now—and remaining so on her own. Suppose a landlord alleges damage to property because the debtor has teenage children. Clearly, tossing debtors out into the street makes no sense from a policy perspective. Well-deserving landlords, whose own livelihood is threatened, can move for an immediate halt to the stay upon a showing of ''cause'' under Section 362(d).
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EXPANDS THE DEFINITION OF DISPOSABLE INCOME: Section 132 changes the definition of disposable income in the guise of making it more beneficial to debtors. Under current law, the debtor retains that which is necessary to support the debtor and her dependents. Dependents are not defined and the term is not, and has not been, limited to children. The new legislation is tailored for dependents who are children. Since a disproportionately large number of women support individuals in addition to their children (parents among others), these women will be disadvantaged (as will their dependents) as money formerly dedicated to these very real but non-minor dependents will be re-routed to compensate unsecured creditors.
CHANGING THE AMOUNT OF CASH ADVANCES PRESUMPTIVELY DEEMED NON–DISCHARGEABLE: Section 135 provides that cash advances aggregating $250 within 90 days before bankruptcy are presumed non-dischargeable. Although the luxury goods exception excludes goods and services for support and maintenance of the debtor or her dependent, there is no similar caveat for cash advances. Suppose a woman took cash advances of $25 per week for bus fare as well as her children's lunches and her own. She would easily exceed the $250 cap, and this amount would be considered non-dischargeable. Now, if she had money and counsel, she could try to rebut that presumption, but how likely is that?
FEWER REAFFIRMATION PROTECTIONS: Despite the rash of bad acts by certain consumer lenders, Section 110 provides even fewer protections in the context of reaffirmations than current law. Ironically, hearings are only required for unsecured obligations; none are required for nominally secured debts. Recent studies suggest that women reaffirm more than their male counterparts; they reaffirmed secured debt for automobiles way more frequently than men. Yet, this section does away with needed protections for these women. Importantly, virtually all of the class action lawsuits based on reaffirmation violations have had both class representatives and class members who are women. Although I am currently seeking a detailed breakdown of the plaintiffs in these actions based on gender, women were clearly wronged by creditors in this context.
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ELIMINATION OF REMEDIES AGAINST BAD–ACTOR CREDITORS: Sections 116 and 117 do away with class actions for breach of the reaffirmation and discharge provisions and violations of the automatic stay. (Punitive damages are also eliminated for breach of the discharge injunction and reaffirmation provisions.) This means that many women wronged will not be able to be members of a class; this is particularly egregious since these individuals frequently have no other basis upon which to seek a remedy. Many of the recent bankruptcy class actions have involved bad acts against women; indeed, they are a particularly vulnerable group since they are commonly less sophisticated financially. Indeed, based on conversations with John Roddy, Esq., one of the nation's leading consumer bankruptcy class action lawyers, virtually ALL of the reaffirmation class actions had some women named plaintiffs, and they all had a sizable number of women class members. To make this point very concretely, if these provisions in H.R. 833 were adopted, Evelyn Migut would not have been able to be a named class plaintiff in TANDY. Victoria Lafromboise would not have been able to be a named class plaintiff in HURLEY STATE BANK. Desiree Rogers would not be a member of the newly certified class in NATIONSCREDIT. Diana Mazola would not be able to be a named class plaintiff in MAY DEPARTMENT STORE. The best available consumer protection for women is eliminated while bad acting creditors get a free ride. One can only surmise that the experiences of Sears, Federated, Mays and GECC taught us nothing. Even Sears' pleading guilty to a criminal offense seems to have had no impact on lawmaking.
The Important Missed Opportunities: There are also numerous missed opportunities in H.R. 833 for legislative reform designed to assist women and children. For example, the bill calls only for study of increased credit disclosure; it does not mandate new disclosure that would assist women. (See Sections 112 and 114.) The bill does not provide that the stay should be lifted for domestic abuse cases; recollect, instead, that the bill provides that the stay can be lifted to allow landlords to evict. H.R. 833 does not provide that the stay should be lifted for a divorce itself (apart from any property distribution). The bill does not provide that support obligations should be treated as exempt property, regardless of whether state or federal exemptions are employed; instead, under Section 148, the categories of liens that can be avoided under Section 522(f) are curtailed by significantly narrowing the definition of household goods. The bill does not provide for uniform exemptions, which while a politically sensitive issue, would allow all debtors, wherever they are located, to be treated similarly. I have prepared a short list of improvements that could have been considered for protecting women in non-intact families. (See Appendix D.) Should the Subcommittee request, I could develop a similar list for improvements for the other categories of women touched by the bankruptcy system.
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Conclusion: I urge this Subcommittee to move beyond the slogans and the rhetoric. The Subcommittee needs to consider the issue of women and children in ALL its dimensions. It is not enough to look just at women as creditors in non-intact families when the government is acting as a collection agent for the women (as opposed to for itself). The Subcommittee needs to look at the effects of H.R. 833 contextually. This bill is, stated most simply, not protective of all women of all ages, of all races, of all socioeconomic classes. Congress has an important opportunity to get it right. Women and children are far too important to let their needs go unheard, unrecognized and unheralded. Thank-you.
NOTE: Appendix A of Ms. Gross' prepared statement has not been printed here. The citation for the article is:
Jeff Mangum, A History Lesson: Women & Bankruptcy, The Journal News, October 27, 1998, at 1D.
APPENDIX B
63847a.eps
APPENDIX C
BIBLIOGRAPHY
SELECTED ARTICLES ON WOMEN IN THE BANKRUPTCY SYSTEM
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Reports:
The Final Report of the Ninth Circuit Gender Bias Task Force, 67 S. CAL. L. REV. 745 (1994)
Report of the Special Committee on Gender to the D.C. Circuit Task Force on Gender, Race and Ethnic Bias, 84 GEO. L.J. 1657 (1996)
Report of the Second Circuit Task Force on Gender, Racial and Ethnic Fairness in the Courts, 1997 Ann. Survey of American Law 9
Implementing and Evaluating the Chapter 7 Filing Fee Waiver Program, Federal Judicial Center 1998
Books:
Teresa Sullivan et. al., AS WE FORGIVE OUR DEBTORS: BANKRUPTCY AND CONSUMER CREDIT IN AMERICA (1989)
Karen Gross, FAILURE AND FORGIVENESS: REBALANCING THE BANKRUPTCY SYSTEM (1997)
Teresa Sullivan, et. al., THE FRAGILE MIDDLE CLASS (forthcoming Yale University Press, 1999)
Articles:
Zipporah B. Wiseman, ''Women in Bankruptcy and Beyond,'' 65 IND. L.J. 107 (1989)
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Karen Gross, ''Re-Vision of the Bankruptcy System: New Images of Individual Debtors,'' 88 MICH. L. REV. 1506 (1990)
Karen Gross, ''Some Preliminary Findings on Women in Bankruptcy Law Practice,'' National Bankruptcy Judges Conference Materials 8–5 (1993)
Sheila Driscoll, ''Consumer Bankruptcy and Gender,'' 83 GEO. L.J. 525 (1994)
Peter Alexander, ''Divorce and Dischargeability of Debts: Focusing on Women as Creditors in Bankruptcy,'' 43 CATH. U. L. REV. 363 (1994)Karen Gross et. al., ''Ladies in Red: Learning From America's First Female Bankrupts,'' 40 Am. J. Leg. Hist. 1 (1996)
Oliver Pollak, ''Gender and Bankruptcy: An Empirical Analysis of Evolving Trends in Chapter 7 and Chapter 13,'' 102 COMM. L.J. 333 (1997)
Kathy Davis, ''Bankruptcy: A Moral Dilemma for Women Debtors,'' 22 Law & Psychology Rev. 235 (1998)
Interviews and Conferences:
Proceedings of the International Conference on Consumer Bankruptcy (Toronto, 1998; forthcoming in the Osgoode Hall Law Rev.)
Telephonic Interview with Professor Marianne Culhane (March 1999)
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Telephonic Interview with John Roddy, Esq. (March 1999)
APPENDIX D
SUGGESTED SHORT LIST OF NEW PROPOSALS TO ASSIST WOMEN AND CHILDREN IN SUPPORT-RELATED MATTERS
PREPARED BY PROFESSOR KAREN GROSS
Create an exception to the automatic stay under Section 362(b) for the commencement or continuation of child custody cases;
Create an exception to the automatic stay under Section 362(b) for commencement or continuation of domestic abuse cases;
Create an exception to the automatic stay under Section 362(b) for commencement or continuation of a divorce action, except to the extent same seeks a property division; and
Amend Section 522 to exempt alimony and support, regardless of whether state or federal exemptions are applied.
Mr. GEKAS. The time of the lady has expired.
The Chair will yield itself 5 minutes for a period of examination of the witnesses.
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Professor Gross, we believe we helped the woman, as a debtor, who is one of your concerns, because of what we consider the outside paramaters within which any debtor can find relief under chapter 7 to be.
In other words, if the median income below which a woman as a debtor falls, we give them primacy for the fresh start that is afforded by chapter 7.
Don't you agree?
Ms. GROSS. Well, as to the woman as a debtor, I think one has to think about how the woman as debtor in both intact and non-intact families will be impacted by the proposal.
First of all, let me suggest to you several ways in which I don't believe you're right.
Mr. GEKAS. Pardon me?
Ms. GROSS. I don't believe your characterization is accurate.
Mr. GEKAS. Okay, then I would like to have maybe a special memo from you, if you don't mind, on how we are mistreating women as debtors who qualify under chapter 7. I'd like that, but I don't want to spend much more time on that.
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Ms. GROSS. I would be happy to submit it in my written remarks, but——
Mr. GEKAS. It sounds in a perverse way that we're discriminating against women as debtors and I'd like to clear that up, if I could.
Ms. GROSS. I appreciate that.
Mr. GEKAS. Ms. Entmacher said that part of the fault of this bill or the flaw in this bill is that we can't control or do not control or do not mandate that agencies use all their tools to enforce support payments.
Do you think that's a flaw in our bill?
Ms. ENTMACHER. Well, the flaw and the problems with child support collection definitely go well beyond the scope of any legislation that could be adopted here.
What I'm saying is that because other creditors get more rights, both within the bankruptcy process—for example, secured creditors in chapter 13 have to get full payment under the contract. It isn't enough that they are paid simply what it's worth. That's going to make it harder to get payment in chapter 13.
And afterwards, debtors are going to have more debt.
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So you're taking agencies that have difficulty now and having them compete with other creditors who have even greater rights.
And what I'm saying is you're making the job worse——
Mr. GEKAS. But isn't that the point that the system now has those very same defects about which you comment?
So any efforts we undertake to try to strengthen these still fail, from your standpoint because of what now exists as a failure on the part of agencies?
Ms. ENTMACHER. Well, what I'm saying is that if there is difficulty collecting child support now from people, by giving other creditors better access to that limited pool of income and assets, both during and after bankruptcy, then you make the job of child support agencies tougher.
It's a harder job.
Mr. GEKAS. Oh, I don't mind that. I mean I think no matter how the job is, if we're going to make primacy and child support synonymous, then if it becomes tougher, so be it.
Mr. Strauss, can you comment on this little colloquy here?
Mr. STRAUSS. Well, first of all, as somebody who has to go out and do this, I do not believe that you will find any child support collection professional that thinks that's a problem.
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I mean, when we are in direct competition, and the only reason is that there are non-discharged credit card debts, we don't think we have any problem either before or after bankruptcy in collecting our debts before any financial institution can collect their debts.
And one of the main reasons is the primacy of the wage withholding orders which this bill protects.
Mr. GEKAS. Yes. Now, Ms. Saperstein, you mentioned that the current system allows for a disruption, I think is what you said, or disrupts the flow of support obligations because of the automatic stay and other features of the current system?
Ms. SAPERSTEIN. Yes.
Mr. GEKAS. And that you perceive in our bill a valiant attempt at least, as others will not believe it's a cure, but a valiant attempt to address that by giving that primacy which will eliminate that disruption.
Am I characterizing that correctly?
Ms. SAPERSTEIN. Yes. For cases that have income withholding in place. Income withholding orders apply automatically to all child supporters, whether they are title IV–D cases, if they are collected by the State agency, or collected privately. The income wage withholding order must be in the child support order unless there is a finding by the court that wage withholding is not in the best interests of the child.
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So this would affect, in our State, the IV–D agency, the State agencies collections, and the private collection.
We have attempted to deal with this by local rule. It has made our jobs tremendously easier. We have to spend less time in the bankruptcy court. It's not being disrupted.
We know how lucky we are in Utah, and we're very nervous that that could change at any time at the whim of the court.
Mr. GEKAS. Thank you. The time of the Chair has expired.
We turn to the gentleman from New York.
Mr. NADLER. Thank you, Mr. Chairman.
Let me say that I put particular importance on the collection of child support. I spent 14 years in the legislature of New York personally writing and passing 22 laws on this subject.
I wrote most of the laws of New York in child support collections and the Child Support Standards Act, to try to get the collections up, with some success.
Let me observe that Ms. Entmacher, Professor Gross and Ms. Saperstein appear to see a problem with some of this non-dischargeability.
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How successful have the State administrators in, let's say, California been in collecting child support on behalf of women who need it?
Ms. ENTMACHER. Well, there was actually a report recently done by three child advocacy groups in California, which I'm happy to leave with the committee as an exhibit, which actually breaks down, county-by-county, the percentage of support that's collected.
Picking the largest county, which of course is Los Angeles, the total percentage of support that was collected was 5.9 percent.
Mr. NADLER. They've collected 5.9 percent and 94 percent remains uncollected?
Ms. ENTMACHER. That's correct, 94 percent with no collection.
If you look at another critical——
Mr. NADLER. So wait a minute. Right now, credit card companies are collecting 96 percent of what's owed them, and on behalf of child supported-owed-women, the California State agency is succeeding in collecting 6 percent in Los Angeles County?
Ms. ENTMACHER. In Los Angeles County, yes, 6 percent of the total support owed was collected.
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Mr. NADLER. That's very successful.
Let me ask you a different question.
I understand why State IV–D administrators like Mr. Strauss and Ms. Saperstein like this bill. It will make their lives somewhat easier. But I don't think that it'll make the lives of custodial parents, mostly women, in collecting owed child support very easy.
One of the distinctions we have to make that I know I used to fight with Governor Cuomo about making in New York all the time, and I don't think this bill or the proponents of this bill understand the distinction, is the distinction between the interests of the State child support collection agencies and the interests of the women who are rearing children who are owed child support.
Yes, this bill provides that a chapter 13 plan cannot be confirmed unless all post-petition support is paid.
This means that if all the money owed to the custodial parent is paid, but the money owed to the government to reimburse it for let's say welfare payments made a few years ago is not paid, the plan cannot be confirmed.
Is that correct?
Ms. ENTMACHER. Yes. The problem with the bill, and I should say we support a requirement that all current support debts, whether they are being collected by the State or by the family, be paid post-petition.
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We definitely support making a requirement that the plan provide for the payment of current support, and that such wage withholding, whether it's an order obtained privately or through a government agency, be exempt from the automatic stay.
The problem, as you've identified the problem, Mr. Nadler, correctly, is the requirement that all of the past arrearages to the State that are owed be paid off before a chapter 13 plan can be approved.
In some cases that may not be possible, particularly when you consider the much higher payments that secured creditors have to get.
If there's not enough money to go around and the chapter 13 plan can't be confirmed, and there can't be a discharge, then everybody's back to square one.
Mr. NADLER. Including the custodial mother.
Ms. ENTMACHER. Including the custodial mother.
Mr. NADLER. So in other words, this provision which presumably is intended to help the custodial mother collect child support would make it harder for her to collect child support in any instances wherever there is not sufficient funds to pay arrearages to the State, as well as in addition to current child support, in addition to arrearages to her, in addition to other things that must be paid in order for a plan to be confirmed?;
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Ms. ENTMACHER. That's correct, yes.
Mr. NADLER. And if the plan cannot be confirmed, then there's less money to pay her child support, correct?
Ms. ENTMACHER. Correct.
Mr. NADLER. Let me ask you——
Mr. GEKAS. The time of the gentleman has expired.
Mr. NADLER. I'd ask for an extension of time since we only have——
Mr. GEKAS. Without objection.
Mr. NADLER. I think this panel deserves more than 5 minutes for the Republicans and Democrats.
Let me ask a further question, Professor Gross.
In chapter 13, additional, what-do-you-call-it, unsecured credit, credit card debt, among other things, is made nondischargeable in this bill.
And some of us have said that that means that mom now has to compete with Chemical Bank's attorney to try to get payment and that will hurt the collection of child support.
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Now we are told by the proponents of this bill that, oh, we've solved that problem, and the way we've solved it is by giving child support a priority over the other debts, over the unsecured creditors.
Could you tell us if they have solved this problem by so doing, and if not, why not?
Ms. GROSS. The simple answer is they have not solved the problem.
Let me back up for a moment.
By increasing the number of non-dischargeable debts in a chapter 13, what you effectively do is make chapter 13 less appealing to many people.
So, for starters, it discourages the use of chapter 13, not encourages it, which is counter to the entire purpose underlying this bill. So we have this bad effect.
As soon as you increase the amount of non-dischargeable debt, what that also does is it makes child support share with those other debts in trying to collect.
The way in which priority does not solve that is that the priority issue relates to past and current priority, not future, and the whole difficulty relates to future issues.
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And, by the way, the first priority, which sounds wonderful, isn't nearly as beneficial as it appears on paper, but it doesn't help——
Mr. NADLER. Because?
Ms. GROSS. It doesn't help in your situation because it doesn't relate to that issue. Priority in a chapter 13 doesn't relate to future on-going obligations. It relates to the priority of current and past debts. So, it doesn't even touch this issue.
Mr. NADLER. The conclusion on that question, and then I have one more question to ask, and then I'll be finished, the conclusion of that question, despite what the IV–D administrators say, which is essentially it makes it easier for government to collect what's due government and, assuming that to be true, as I do, and despite the amendments added to this bill late last year along the priority lines, and despite the section 144, which is a good provision, on balance, because of the non-dischargeability provisions, on balance, are more women going to find it harder to collect child support with this bill?
Ms. GROSS. It is my judgment that, yes, more women will find it difficult.
Mr. NADLER. Because of the non-dischargeability provisions?
Ms. GROSS. Yes, amongst other reasons. That is one of several. There are other reasons why, as well, but yes.
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And, can I just also add that I appreciate the government in its effort to collect. However, the point where there's a problem is when the government is competing with the woman who's trying to collect. That's where the difficulty rests.
In that competition, the priority should be to the woman and not the government.
Mr. NADLER. And under current law, that priority is with the woman, but this would change it?
Ms. GROSS. Yes. In fact, it elevates the status of the government.
Mr. GEKAS. What a conclusion.
Mr. Strauss, do you have any thoughts on what we've just said?
Mr. STRAUSS. I think we're on different planets.
First of all, when we were talking about, you know, what the government does to the collection of child support, the distribution regulations are very clear. You distribute first to the non-welfare cases, that is where it's owed directly to the women and children.
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It's only after that that the government can collect and retain its interest in these funds.
And let me tell you also, we talk about these various provisions just benefit the government. That couldn't be more untrue.
When, under the current welfare reform legislation, there is a lot of give-and-take, and one of the things was there was a limited access, you know, to the right to receive public assistance.
And in exchange for that, what was formerly assigned to the government becomes unassigned and payable directly to the family.
And so all of these collection techniques, we say, well these are just government techniques, are when a woman terms out and no longer is eligible for public assistance, are now used directly to give those payments to the mother and children, despite the fact that the obligated parent is in bankruptcy.
And that's what most of these provisions are aimed at.
Mr. GEKAS. Could you comment on that, Professor Gross?
Ms. GROSS. Absolutely.
We are not on different planets, Mr. Strauss. We are talking about different things.
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You're talking about current and past child support.
I'm talking about future ability to collect child support.
It's not a different planet; it's a different issue.
Mr. GEKAS. With that——
Mr. NADLER. I had one more question, if I could.
As I said, my last question is also for Professor Gross.
Could you just briefly tell us about the other three boxes on your page two.
We've been talking about——
Ms. GROSS. Absolutely.
In brief, the focus of the legislation, which is on the box in the upper right hand corner, is on women in non-intact families. The significance of this chart is to suggest that there are women in both intact and non-intact families who are debtors.
That's a significant group of women.
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Then, there is another group of women who are affected, which is women in intact families and single women and elderly women and widowed women who are creditors. They are also not benefitted by the package of suggestions.
Mr. NADLER. But are they harmed?
Ms. GROSS. Yes, they are harmed.
Mr. NADLER. Thank you very much.
Mr. GEKAS. Well, we end on discord, but at least we heard the opinions of our distinguished panel, very valuable input for us to consider.
I'll expect, if you don't mind, a memo on the subject that you and I discussed before from Professor Gross.
Ms. GROSS. Absolutely, Mr. Gekas.
Mr. GEKAS. And we'll ask that you all stand by in your separate worlds for further inquiry from this committee.
Thank you very much.
Ms. GROSS. My pleasure. Thank you.
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Mr. GEKAS. I note the entrance of a gentleman from New Jersey.
Would you care to take a microphone for not more than 45 minutes? [Laughter.]
The gentleman from New Jersey, Mr. Andrews, may take a seat, and if he wishes to place something into the record, we're willing to accommodate him.
Mr. ANDREWS. I thank you, Mr. Chairman. I thank you for your accommodation of our schedule, and for the opportunity for me to appear at this hearing.
I come today to first of all thank the members of this committee for the hours and hours and months and months of work they put into this issue.
It is an arcane and evidently controversial issue, and it's not one that is very glamorous or very easy to work on. I think all of us in the body owe each of you a debt of gratitude for your work on it.
Mr. Chairman, I come today as someone who wants to strongly speak in favor of your bill and that of Mr. Boucher, and to add this perspective on it:
I know that very often the focus in the debate on your bill has been the argument or the competing interests between debtors and creditors.
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I'd like to speak a little bit about the competing interests among debtors that I think is raised by your legislation. I believe that the party that bears the greatest share of the cost of irresponsible practices of people who have the ability to pay their bills and who choose not to, the parties who bear the greatest burden there are other debtors.
Ultimately, these costs are passed on to those other consumers and other debtors in some way.
High income debtors have access to credit facilities and credit pools that very often shelter them from that. They get the better deals from the credit card companies, they get the more favorable rates on the home equity loans and mortgage loans.
People of relatively high means can buy or earn their way into more favorable credit environments.
It is people of more modest means who are responsible, who do pay their bills, who bear the lion's share of the burden for those who do not.
It is the custodian or the fast food worker or the person working in industrial America who is low paid, at the bottom of the totem pole, who is responsible, who makes a budget, maintains it, pays careful attention to her or his credit, it is that person that is visited with the increased costs of irresponsible practices by people who can afford to pay their bills but do not.
Creditors—I think the great fallacy of some of the arguments against your bill is that creditors somehow bear the costs of defaulted obligations. Creditors pass those costs along, and the people to whom they pass them along are debtors, consumers, who don't have the financial wherewithal to earn or buy their way into a higher credit or more favorable credit category.
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Your legislation, I support it because I think it will do a lot of good for people of modest means who qualify for the earned income tax credit, who qualify for subsidized child care assistance for their families, who qualify for kids healthcare insurance under legislation we passed together in 1997.
It is these people who are the responsible people who pay attention to their bills are the ones who I believe will be most helped by the legislation that you have proposed, and that's why I enthusiastically support it.
I just wanted to, as someone who is not on the committee, but who is a believer in what you and Mr. Boucher and 300 others attempted to do in the last Congress, I wanted to encourage you to continue those efforts this time.
Mr. GEKAS. We thank the gentleman. In the same vein as you have indicated that debtors, bona fide debt-paying debtors, are harmed by nonpaying debtors or those who try to do the system, I learned something from the last session that I never contemplated. When taxing authorities, who in previous cases are unable to participate in some of the benefits of bankruptcy to recover at least part of what is due to taxing authorities, when they fail to do so, that impacts on all the taxpayers because of a shortfall which has to be made up by increased taxation and revenue.
Mr. ANDREWS. Let me explain what happens in my native State of New Jersey, which is very heavily dependent upon the property tax.
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Property tax liens have a superior position under our State law, and obviously they're a favored lien under bankruptcy law as well.
But that doesn't mean they always get satisfied. As a matter of fact, more often they do not.
New Jersey requires each municipality to have what's called a reserve for uncollected taxes. What that means is that if you have a lot of people in a given community declare bankruptcy, and if the ultimate collection of the debts owed by those debtors to the municipalities is low, if it's deficient, then the amount of money for the foreseeable future that that town has to set aside in its budget each year as a reserve for uncollected taxes, goes up.
Now, what would that mean? In a town like the one I live in in New Jersey, every time they have to raise the reserve for uncollected taxes by $30,000, it's one more police officer we can't hire. It is a day of recycling or trash pickup that has to be cancelled.
It is a recreation program for our children in the summer, or our senior citizens during the rest of the year that goes by the wayside.
New Jersey is a very conservative State, fiscally, in some ways, that requires its local governments to set aside a great deal of money in the event they can't achieve full collection of their taxes.
When full collection doesn't occur because of bankruptcy, then everyone in that community pays for that behavior in a very significant way. That's another way that your legislation would help us.
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I'm here to offer my voice in support of it.
Mr. GEKAS. We thank the gentleman, and we will consult with him as this moves to its final vote on the floor.
And we will ask him to help us then, as he is helping us now. Thank you.
Mr. ANDREWS. I thank the chairman very much. Thank you.
Mr. GEKAS. The Chair declares a recess for the purpose of recouping our energies, until 1:05 p.m. We stand in recess till 1:05 p.m.
[Recess]
Mr. GEKAS. The hour of 1:05 p.m. having arrived, the recess has been concluded, and pending the arrival of the hearing quorum, we will proceed to introduce the next panel so that their vitae will reach the record that we're creating in this matter.
We see familiar faces, not just from last year, but from last week, so we know that this is an ongoing process that some day will result in legislation.
The gentleman from Tennessee has joined us, thus constituting a legitimate hearing quorum.
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We will proceed with the introductions.
The Honorable Thomas E. Carlson is a United States Bankruptcy Judge for the Northern District of California. Since his appointment to the bench in 1985, he served on the Executive Committee of the Conference of Chief Bankruptcy Judges of the Ninth Circuit from 1992 to 1995, and also served as its Chair from 1992 to 1993.
Judge Carlson is a graduate of Harvard Law School. He received his master's of law degree in taxation from New York University School of Law.
After serving as a law clerk to the Honorable Donald Wright, Chief Justice of the California Supreme Court, he entered private practice.
Judge Carlson has been active in legislative affairs. He chaired a committee of the National Conference of Bankruptcy Judges that prepared several legislative proposals for the Federal Court Study Committee.
He also actively participated in the National Bankruptcy Review Commission's work. He has been one of our steady consultants over the tenure of this program.
Mr. Schorling is with us. He is a managing shareholder at the Philadelphia Law Office of Klett, Lieber, Rooney & Schorling.
Mr. Schorling received his bachelor of arts degree, cum laude, in 1971 from Dennison University, and his juris doctor degree, cum laude, from the University of Michigan.
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In addition to his law practice, Mr. Schorling is an Adjunct Professor of Law at the Temple University School of Law.
He has lectured frequently on bankruptcy and lending law.
Mr. Schorling is a Fellow of the American College of Bankruptcy, and at the American Bar Association. He is Chair of the Business Bankruptcy Committee, and a member of the Joint Task Force on Bankruptcy Court structure, as well as the Commercial Financial Services Committee.
With us is H. Elizabeth Baird, Assistant General Counsel at Bank America Corporation headquarters in Charlotte, North Carolina. She is in-house bankruptcy counsel for the Global Corporate and Investment Banking Unit where she is responsible for restructurings and bankruptcies in the Corporate Real Estate and Investment Banking Industries.
Ms. Baird received her bachelor of arts degree, cum laude, from Welsely College in 1984, and her juris doctor degree from Emery University in 1987, where she was Editor in Chief of the Bankruptcy Developments Journal.
She's a member of the American Bar Association and the American Bankruptcy Institute.
Charles Tatelbaum is a partner with Cummings and Lockwood where he concentrates his practice on bankruptcy, creditors' rights and litigation matters.
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Prior to joining that firm, he was the senior partner in charge of the creditors' rights department at the Tampa-Clearwater, Florida firm of Johnson, Blakely, Pope, Bocher, Ruple and Burns.
Mr. Tatelbaum has been a contributing author to Colliers Bankruptcy Guide, and coauthored the Bankruptcy Rules and Forms Handbook, among other writings.
In addition, Mr. Tatelbaum has held various leadership positions with the American Bankruptcy Institute, and currently serves as Director and Co-Chair of the Institute's Law Review Advisory Board.
Mr. Tatelbaum received his B.A. and juris doctor degree from the University of Maryland Law School, where he served on the editorial board of the Maryland Law Review.
He clerked for the Honorable R. Dorsey Watkins of the United States District Court for the District of Maryland.
For several years, he was an Adjunct Professor at the University of Maryland School of Law.
Judith Greenstone Miller, who receives the second introduction within a week, received her juris doctor degree, cum laude, from Wayne State University of Law in 1978.
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Prior to that, she attended the University of Michigan where she obtained her bachelor of arts degree, also cum laude, in 1975.
Ms. Miller's practice focuses on bankruptcy and insolvency matters, creditors' rights, and commercial litigation. Her practice involves representation of secured and unsecured creditors, debtors, bankruptcy trustees, and chapter 11 reorganizations.
She is a member of the Commercial Law League of America, its bankruptcy and insolvency section, and its creditors' rights section. Founded in 1895, the Commercial Law League is the Nation's oldest organization of professionals engaged in the credit and finance industry. Its current membership exceeds 4600 individuals.
Damon Silvers is Associate General Counsel of the AFL–CIO. He's responsible for business law and complex legislation.
He has represented unions in various chapter 11 credit committees.
Mr. Silvers graduated from Harvard Law School with honors, and Harvard Business School with high honors.
Jere Glover is the Chief Counsel for the Office of Advocacy at the U.S. Small Business Association. We're very familiar with his work in the past and recent past. He was nominated to this position by President Clinton and confirmed by the United States Senate on May 4, 1994.
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The Office of Advocacy was created in 1976 to monitor the concerns of small business and to advocate for policies that support small business growth and reduce regulatory burdens.
Prior to joining the SBA, Mr. Glover was Trade Associate Executive, and served as CEO and Chair of several businesses.
In 1978, he was counsel to the Subcommittee on Antitrust, Consumers, and Employment of the House Small Business Committee.
Mr. Glover received his bachelor's degree from Memphis State University, and his law degree from Memphis State University School of Law.
He, thereafter, received an advanced law degree in administrative law and economic regulation from George Washington University School of Law.
It looks like I've been abandoned here. [Laughter.]
Mr. GEKAS. I will sing a few stanzas from Home on the Range——[Laughter.]—until we do a roll call of possible participants from the members.
[Pause.]
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Mr. GEKAS. As a matter of housekeeping, I will repeat the edict that the written statements of the witness will be accorded the privilege of being entered into the record, verbatim, and we'll ask each participant to try to restrict the review of those written statements to 5 minutes, in pursuit of equilibrium in the presentation of testimony.
[Pause.]
Mr. GEKAS. While we're waiting, I simply want to ruminate loudly to the effect that when the Contract with America was first instituted, one of the basic tenets of it was that if the Republicans should gain the majority in 1995, that one of the first things they would do would be to remove, to obliterate, what we felt was the odious practice of proxy voting in committee.
I remember one time in this very chamber where I offered an amendment as a member of the minority, and I had six or seven full votes on my side, and Chairman Brooks had only Chairman Brooks there, and I lost it, I lost the motion because he had in his hand, proxy voting.
Now, that I'm the Chair, I wish we had it back. But, no, not really.
But the other portion of procedure that I wanted to try to instill in the workings of Congress—and I have to confess that it's only a one-man effort up till now, one-Member effort—that is, to try to begin every meeting, every hearing, on time.
I've tried religiously to do that, I've tried to set an example for my colleagues. I have rarely failed to be at the gavel at the appointed time, but you are suffering, as I am, from the ineptitude that I find in enforcing the rule.
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But the absence of proxy voting is a benefit to the process, I must say. It removes a lot of the potential unfairness and strong-arm tactics that had persisted in the past when committee functions were reduced to whether or not the chairman was going to be present.
If the chairman was present, he wins every vote in the old days. Now, we have to count and measure.
We will continue the recess until some body should appear.
[Recess.]
Mr. GEKAS. The time of the recess having expired, we acknowledge the attendance of the gentleman from Tennessee, and we will begin the testimony with Judge Carlson.
STATEMENT OF THOMAS CARLSON, UNITED STATES BANKRUPTCY JUDGE, NORTHERN DISTRICT OF CALIFORNIA, SAN FRANCISCO, CA
Mr. CARLSON. Thank you, Mr. Chairman. My name is Tom Carlson. I'm a Bankruptcy Judge from San Francisco, and I'm very honored to be here before the committee today.
I encourage you to approve the small business provisions of H.R. 833, with only minor amendments. The small business provisions will improve the administration of justice because they address the central problem in chapter 11—delay.
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The problems in chapter 11 lie in the provisions that govern prior to confirmation of a plan. Merely by filing, the debtor obtains a broad injunction against all its creditors. The debtor is not required to make any showing, is not required to post a bond, does not lose control of its assets, can continue to pay salaries to insiders.
While the debtor receives protection from the petition date, the debtor's obligation to pay creditors starts only when a plan is confirmed. This imbalance between the rights of the debtor and the obligations of the debtor increases the importance of speeding the confirmation process, but at the same time, it gives the debtor no incentive to move the plan forward. The combination of delay and this imbalance causes many creditors to believe that the process is unfair.
Congress has shown its concern over chapter 11 delay many times in the past 15 years. Most of the statutory amendments that affect the chapter 11 process were enacted either to speed confirmation, or to achieve a fairer balance of rights during the pre-confirmation period.
I note specifically, the single-asset real estate provisions, the provisions for active case management in chapter 11 cases, interlocutory appeal of orders extending exclusivity, the provisions that require post-petition payments to real and personal property lessors, and the fast-track provisions for small business cases.
These provisions have been helpful, but they have not done the job. The small business provisions of H.R. 833 provide more effective cost and delay reduction by incorporating a series of well established techniques:
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First, the bill directs judges to manage their chapter 11 cases actively. Judicial case management has long been a centerpiece of civil justice reform, and it should be used in chapter 11 as well.
Second, the bill encourages the development of standard form plans and disclosure statements. The drafted-from-scratch, prospectus-type plan and disclosure statement currently in use is the most expensive part of the chapter 11 process.
Third, the bill establishes flexible deadlines for the filing and confirmation of a plan. A plan deadline is essential. As noted previously, the debtor has no real incentive to file a plan early. The more questionable the prospects for reorganization, the greater the incentive for delay.
Fourth, the bill makes it easier to appoint a trustee or convert or dismiss the case in those instances in which the debtor is not playing by the rules of the chapter 11 process, or the estate is being diminished by serious post-petition losses.
The small business provisions can be improved. And I have submitted to you, a series of amendments to that end. These amendments would make two significant changes in the bill: First, they would make it easier for the debtor to obtain a 60-day extension of the plan deadline. To do so, the debtor would be required to show only that it was in compliance with the rules, and that there was no obvious bar to confirmation. The second amendment would prevent creditors from harassing the debtor by filing motions to dismiss or convert, based on wholly technical violations of the rules. Under the proposed amendment, only the United States Trustee could bring a motion based on the debtor's failure to file operating reports or to provide other information.
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I am firmly convinced that speeding up the confirmation process will not make it harder for viable businesses to reorganize. I've served as a Bankruptcy Judge for 13 years. I have handled over 1200 chapter 11 cases. In my experience, when a business fails to reorganize, it is generally because the business is unable to make a profit on a going-forward basis, or because the debtor has been dishonest. Businesses do not fail in chapter 11, simply because they are required to file and confirm a plan promptly. By the same token, however, speeding the chapter 11 process will reduce cost and will bolster the perceived fairness of the system.
Thank you.
[The prepared statement of the Honorable Thomas Carlson follows:]
PREPARED STATEMENT OF THOMAS CARLSON, UNITED STATES BANKRUPTCY JUDGE, NORTHERN DISTRICT OF CALIFORNIA, SAN FRANCISCO, CA
SUMMARY
The small-business provisions will improve the administration of justice because they address the central problem of chapter 11: delay. Although the debtor is protected against creditor action from the petition date, the debtor has no obligation to pay creditors until a plan is confirmed. The combination of delay and this imbalance between the rights and obligations of the debtor causes many creditors to perceive the process as unfair.
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Congress has expressed its concern over chapter 11 delay frequently in the past 15 years. Several amendments have attempted to speed confirmation or to achieve a fairer balance of rights during the preconfirmation period. Although helpful, these provisions have not done the job.
H.R. 833 would provide more effective cost and delay reduction by incorporating several time-tested techniques.
Judicial case management.
Development of standard-form plans and disclosure statements.
Flexible deadlines for the filing and confirmation of a plan.
Easier conversion or dismissal when the debtor is not playing by the rules.
I propose amendments that would make two significant changes in the present bill.
Make it easier for the debtor to obtain a 60-day extension of the plan deadline.
Prevent creditors from harassing the debtor by bringing motions to convert or dismiss on the basis of purely technical violations of the rules.
Speeding up the confirmation process will not prevent viable businesses from reorganizing. When a business cannot reorganize, it is because the business is not profitable on a going forward basis, not because the debtor is required to file and confirm a plan promptly.
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STATEMENT
I encourage you to adopt the small-business provisions of H.R. 833 with only minor revisions. The small-business provisions will improve the administration of justice because they address the central problem of chapter 11: delay. The problems with chapter 11 lie in the provisions that govern prior to confirmation of a plan. Merely by filing, the debtor obtains a broad injunction against all its creditors. The automatic stay is an injunction on demand. The debtor is not required to make any showing, does not lose control of its assets, is not required to post a bond, and can continue to pay insider's salaries. Although the debtor receives protection from the petition date, the debtor has no obligation to pay creditors until a plan is confirmed. This imbalance between the rights of the debtor and the obligations of the debtor increases the importance of speeding up confirmation, but gives the debtor an incentive to delay confirmation. The combination of delay and this imbalance causes many creditors to perceive the process as unfair.
Congress has expressed its concern over chapter 11 delay frequently in the past 15 years. Most of the amendments affecting the chapter 11 process were designed either to speed confirmation or to achieve a fairer balance of rights during the preconfirmation period. I note specifically:
the single-asset real estate provisions,
the provisions for interlocutory appeal of orders extending exclusivity,
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the chapter 11 case-management provisions,
the requirement for postpetition payments to real and personal property lessors, and
the fast-track procedures for small business cases.
Although helpful, these provisions have not done the job. H.R. 833 would provide more effective cost and delay reduction by incorporating several time-tested techniques.
First, the bill directs judges to manage chapter 11 cases actively. Judicial case management has long been the centerpiece of civil justice reform. It should be used in chapter 11 as well.
Second, the bill encourages the development of standard-form plans and disclosure statements. The drafted-from-scratch, prospectus-type disclosure statement currently in use is the most expensive part of the chapter 11 process.
Third, the bill establishes flexible deadlines for the filing and confirmation of a plan. A plan deadline is essential. As noted previously, current law actually discourages the debtor from filing a plan promptly. The more dubious the debtor's prospects for reorganization, the stronger the incentive for delay.
Fourth, the bill makes it easier to appoint a trustee or dismiss or convert the case when the debtor is not playing by the rules of the chapter 11 process, or the estate is being diminished by serious post-petition losses.
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The small-business provisions of H.R. 833 can be improved. I submit to you proposed amendments drafted by a group that includes the three members of the Bankruptcy Commission who created the small-business proposal and Bankruptcy Judge Thomas Small of North Carolina, a pioneer in reducing cost and delay in small business cases.
The proposed amendments would make two significant changes in the present bill. First, they would make it easier for the debtor to obtain a 60-day extension of the plan deadline. The debtor would only have to show that it is in compliance with the rules and that there is no obvious bar to confirming a plan. The second amendment would prevent creditors from harassing the debtor by bringing motions to convert or dismiss on the basis of purely technical violations of the rules. Under the proposed amendments, only the United States trustee would be permitted to bring a motion based on the debtor's failure to file monthly operating reports or provide other information.
I am firmly convinced that speeding up the confirmation process will not prevent viable businesses from reorganizing. I have served as a bankruptcy judge for more than 13 years, during which time I have handled more than 1,200 chapter 11 cases. In my experience, when a business cannot reorganize, it is generally because the business is not profitable on a going forward basis or because the debtor has been dishonest with its creditors. Businesses do not fail in chapter 11 simply because the debtor is required to file and confirm a plan promptly.
APPENDIX A
The undersigned have been long involved in efforts to reduce cost and delay in small-business chapter 11 cases, and have watched closely the evolution of the legislation that is currently before the House as H.R. 833. While strongly supportive of the small-business provisions of H.R. 833, the undersigned believe the bill would be improved through the adoption of the following amendments.
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John A. Gose, Member, National Bankruptcy Review Commission
Jeffrey J. Hartley, Member, National Bankruptcy Review Commission
James I. Shepard, Member, National Bankruptcy Review Commission
Thomas E. Carlson, United States Bankruptcy Judge
A. Thomas Small, United States Bankruptcy Judge
Stephen H. Case, Esq., Advisor to the National Bankruptcy Review Commission
Section 401: Disclosure
The proposed amendment would allow the court to apply the flexible rules for disclosure in any chapter 11 case, not just in a small-business case. The court would still have to determine that disclosure was adequate under the circumstances of the case.
Section 402: Definition of Small-Business Debtor
The proposed amendment would delete the language in the current definition excepting from the definition of ''small-business'' any case in which there is a creditors committee that the court determines is sufficiently active and representative to provide effective oversight of the debtor. Under the proposed amendments, the language regarding creditors committees would be moved to sections 407 and 408 of the bill, which establish the plan-filing and plan-confirmation deadlines. In a case in which there was an active committee, there would be no plan-filing or plan-confirmation deadlines, but the case would otherwise be treated as a small-business case.
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The proposed amendment would also delete language in the current version specifying the sanctions that may be imposed for violation of the discharge injunction. It appears that this language was included in section 402 in error. Remedies for violation of the discharge injunction are addressed in section 116 of the bill.
Sections 407 and 408: Plan Filing and Confirmation Deadlines
As noted above (see section 402), the proposed amendment would eliminate both the plan-filing and plan-confirmation deadlines in any small-business case in which the court determined that there was a creditors committee that was sufficiently active and representative to provide active oversight of the debtor.
The proposed amendment would also make it easier for the debtor to obtain a short extension of the plan-filing and plan-confirmation deadlines. The debtor could obtain an extension of up to 60 days by showing that there are no grounds for conversion, etc. under section 1112 of the Code, and that there is a ''reasonable possibility'' of reorganization. This means that the debtor must show that it is in compliance with the rules, that it is not sustaining substantial postpetition losses, and that there is no obvious bar to confirming a plan. To obtain a subsequent extension of the deadlines, the debtor would have to meet the standard set forth in the current version of the bill, which requires the debtor to show it is ''more likely than not'' it will confirm a plan within a reasonable period of time. The logic of the proposed amendment is to grant a short extension to a ''good debtor,'' but still require a showing of likelihood of confirming a plan for any longer extension.
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Section 412: Serial Filers
The proposed amendment would not make any substantive change. The current version of the bill contains language that appears to make the automatic stay inapplicable in all chapter 11 cases. The proposed amendment corrects this error. The current version of the bill also makes the serial filer provisions inapplicable to ''an involuntary case involving no collusion by the debtor with creditors.'' Because the serial filer provisions are intended to be self-executing, and because the quoted term is vague, the proposed amendment provides a more objective test. The serial filer provisions would not apply to ''an involuntary petition filed by a creditor that is not an affiliate or insider of the debtor.'' Both ''affiliate'' and ''insider'' are defined in section 101 of the Code.
Section 413: Conversion, Dismissal, and Appointment of a Trustee
The proposed amendments would make four changes in this section.
First, the court would be permitted to appoint an examiner under section 1112 of the Code. Under the current version of the bill, the court may dismiss the case, convert the case to chapter 7 liquidation, or appoint a chapter 11 trustee. As under the current bill, the court would be directed to select the remedy in light of the best interests of creditors and the estate. The amendment is intended to permit the court to fine-tune the remedy to the facts and circumstances of the case.
Second, failure to maintain insurance would constitute cause only if that failure posed a material risk to the estate or the public. Thus, for instance, an operating company's failure to maintain worker's compensation insurance or fire insurance on its plant could constitute cause, but failure to maintain collision insurance on one auto or director's and officer's liability coverage would not constitute cause.
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Third, a motion based on the debtor's failure to maintain insurance, failure to file reports, failure to attend the meeting of creditors, failure to provide information to the U.S. trustee, or failure to pay U.S. trustee fees could be brought only by the U.S. trustee. This amendment is based on a concern that a creditor might harass a debtor by filing a motion to dismiss, convert, etc. on the basis that the debtor was one week late with a monthly operating report, or some other minimal violation of the debtor's duties. The U.S. trustee is an appropriate party to enforce the duties in question, and can be relied upon to do so with appropriate judgment.
Fourth, the court would be permitted, but not required, to impose monetary sanctions on the debtor, or a professional employed by the debtor, where cause is established that is an act or omission of the debtor.
APPENDIX B
PROPOSED AMENDMENTS TO H.R. 833
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Mr. GEKAS. We thank the Judge. We'll continue with the statement of Mr. Schorling, and perhaps with that of Ms. Baird before we have to retire to the Floor of the House to cast a vote.
So, Mr. Schorling, please proceed.
STATEMENT OF WILLIAM H. SCHORLING, KLETT, LIEBER, ROONEY & SCHORLING, PHILADELPHIA, PA
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Mr. SCHORLING. Thank you, Mr. Chairman.
My name is Bill Schorling, and I'm a practicing attorney in Philadelphia, Pennsylvania, and the Chair of the Business Bankruptcy Committee of the Business Law Section of the American Bar Association, a committee consisting of 1500 lawyers, U.S. Trustees, professors, and judges representing all aspects of the legal profession, concentrating on business bankruptcy law.
In that capacity, I have been designated to present the views of the American Bar Association and its more than 400,000 members on the important issues raised by H.R. 833, the Bankruptcy Reform Act of 1999.
The bill contains many technical and substantive provisions. While the American Bar Association has not yet taken a position on many of the bill's provisions, we believe that any comprehensive bankruptcy reform legislation passed by Congress should include a number of other specific reforms not currently contained in the bill.
In particular, we believe that H.R. 833 should be amended to include new provisions allowing direct appeals of Bankruptcy Court orders to the Courts of Appeal, allowing sharing of attorneys' fees with bona fide public service lawyer referral programs, establishing a partnership bankruptcy structure, and clarifying that an attorney representing a debtor-in-possession need not be a disinterested person
In addition, the ABA has concerns regarding a number of provisions in H.R. 833 that would create new priorities for certain types of creditors. All of these recommendations are discussed at length in my written statement.
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In the interest of time, however, I would like to focus on two of these recommendations, namely, direct appeals and fee-sharing, both of which were addressed in last year's bankruptcy bill, H.R. 3150, but not in the current version of H.R. 833.
The American Bar Association believes that any comprehensive bankruptcy reform legislation should provide for some system of direct appeals of Bankruptcy Court orders to the Circuit Courts. Under current law, Bankruptcy Court orders are appealable in the first instance to a U.S. District Court, or with the parties' consent, to a Bankruptcy Appellate Panel, then to the Court of Appeals, and finally, review may be sought in the U.S. Supreme Court.
This four-tiered appellate structure is problematic and should be replaced with a more streamlined system.
We believe the multiple benefits of permitting direct appeals to the Circuit Courts of Appeal outweigh other considerations.
First of all, eliminating one level of appeal will result in fewer appeals in the court system as a whole. Perhaps more importantly, direct appeals will result in a body of useful binding precedent which will reduce the number of appeals over time, while providing valuable guidance on a host of currently unresolved bankruptcy issues.
Although direct appeals has clear benefits, it has been criticized on the grounds that it may increase the workload of the Courts of Appeals.
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To the contrary, elimination of a second level of appeals would reduce the aggregate number of bankruptcy appeals by at least 1200 cases, because in a direct appeals system, these second appeals would no longer exist.
That elimination alone, almost one-fifth of all bankruptcy appeals, would represent a major reduction in the amount of time Article III judges would be required to devote to bankruptcy appeals.
In sum, the ABA recommends that a new provision be added to H.R. 833 that is similar to section 411 of last year's Bankruptcy Reform Act, H.R. 3150, authorizing direct appeals to the Courts of Appeal.
The Bar Association also recommends that a provision be added to H.R. 833 that would allow an attorney to share her fee with a bona fide public service lawyer referral program.
Public service lawyer referral programs serve two critical functions. to provide information to consumers about their legal concerns; and, if appropriate, make a referral to a capable attorney.
The majority of lawyer referral programs support their operations by charging a percentage fee to each attorney receiving a case from the service.
As of 1997, 34 States had adopted percentage-fee programs. Unfortunately, section 504 of the Bankruptcy Code prohibits a lawyer from sharing a fee with a public interest referral program.
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Therefore, the ABA supports an amendment to the Bankruptcy Code similar to section 202 of last year's Bankruptcy Reform Bill H.R. 3150 allowing a lawyer to share her fee with a public interest referral program.
The ABA strongly believes that the Bankruptcy Code can be improved and made more efficient and more equitable by adopting the common-sense reforms outlined in my written testimony.
In addition, in order to ensure that most unsecured creditors are treated fairly and equally, the ABA urges Congress to resist the temptation to create any new priorities for particular types of creditors, absent compelling circumstances.
We appreciate the opportunity to testify before the subcommittee today, and we look forward to working with your subcommittee and with other advocates of positive bankruptcy reform in an effort to achieve these goals.
Thank you.
[The prepared statement of Mr. Schorling follows:]
PREPARED STATEMENT OF WILLIAM H. SCHORLING, KLETT, LIEBER, ROONEY & SCHORLING, PHILADELPHIA, PA
SUMMARY
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My name is William H. Schorling, and I have been designated to present the American Bar Association's views on bankruptcy reform in general and H.R. 833 in particular. I am a practicing attorney in Philadelphia, Pennsylvania, and I am also the Chair of the Business Bankruptcy Committee of the American Bar Association Business Law Section.
The ABA's Views on H.R. 833—Bankruptcy Reform Act of 1999
While the ABA has not yet taken a position on many of the consumer bankruptcy reform provisions of H.R. 833—including the concept of ''means testing''—we believe that any comprehensive bankruptcy reform legislation should include a number of other specific reforms not currently contained in H.R. 833.
The ABA's position on direct appeals. The ABA recommends that a provision be added to H.R. 833, similar to the language contained in Section 411 of last year's bill, H.R. 3150, that would allow direct appeals to the regional circuit courts of appeals. The benefits of direct appeals to the regional circuit courts of appeals include fewer appeals in the court system as a whole and creation of a body of binding precedent which will reduce the number of appeals over time. Allowing direct appeals would significantly reduce the cost and expense of bankruptcy proceedings. Further, the important economic and commercial decisions which often arise in the context of bankruptcy cases are worthy of the valuable resources of the circuit courts.
The ABA's position on partnerships in bankruptcy. The ABA believes that a partnership bankruptcy structure should be added to the existing Code. The ABA endorses an automatic stay inhibiting post-bankruptcy suits against general partners for partnership liabilities, to remain in effect for sixty days after a bankruptcy filing. Also the ABA favors automatic stays of transfers outside the ordinary course of non-bankruptcy property by general partners of the filing partnership.
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The ABA's position on sharing fees. The ABA recommends that a provision be added to H.R. 833, similar to the language contained in Section 202 of last year's bill, H.R. 3150, regarding sharing of fees. Such a provision should allow attorneys to remit a percentage of a fee awarded or received under the Code to a bona fide public service lawyer referral program, operating in accordance with state or territorial laws regulating lawyer referral services or the rules of professional responsibility governing the acceptance of referrals.
The ABA's position on disinterestedness. The ABA recommends amending H.R. 833 by adding a provision clarifying that an attorney who represents a debtor in possession need not be a disinterested person. A finding that counsel is ''interested'' in the debtor because the counsel was owed a pre-petition fee ignores the invariably more significant ''interest'' an attorney acquires whenever the attorney engaged to represent a post-petition debtor.
The ABA's position on claims priorities or retroactive legislation. The ABA opposes the enactment, in the absence of the most compelling circumstances, of special interest legislation designed to increase the types of claims entitled to priority under the Bankruptcy Code. For this reason, the ABA has concerns regarding a number of provisions in H.R. 833 that would create new priorities. The ABA also generally opposes amendment of the Bankruptcy Code by legislative process which avoids fair opportunity for open hearings, on well-publicized notice, before the judiciary committees of Congress. It is imperative that the Judiciary Committee carefully consider the full effects of bankruptcy reform legislation before reporting a bill.
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STATEMENT
Mr. Chairman and Members of the Subcommittee:
My name is William H. Schorling and I have been designated to present the American Bar Association's views on business issues concerning H.R. 833, the Bankruptcy Reform Act of 1999.
I am the current chair of the Business Bankruptcy Committee of the Business Law Section of the American Bar Association, a committee consisting of 1,500 bankruptcy lawyers, professors and judges representing all aspects of the legal profession concentrating on business bankruptcy law. In that capacity, I have been authorized to express the position of the American Bar Association, and its more than 400,000 members, on the important issues raised in the bill.
The ABA appreciates the opportunity to present testimony to this distinguished Subcommittee stating the views of our membership. We welcome the opportunity to work with you and your staff to improve the law and serve the interests of the public.
H.R. 833—The Bankruptcy Reform Act of 1999
The bill under consideration by the subcommittee, H.R. 833, contains many technical and substantive provisions. While the American Bar Association has not yet taken a position on many of the consumer bankruptcy reform provisions of H.R. 833—including the concept of ''means testing'' for debtors—we believe that any comprehensive bankruptcy reform legislation should include a number of other specific reforms not currently contained in H.R. 833.
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My testimony today will focus on several areas of concern that were excluded from H.R. 833, particularly provisions dealing with (1) direct appeals, (2) partnerships in bankruptcy, (3) allowing attorneys to share referral fees, (4) disinterestedness, and (5) claims priorities.
A. Direct Appeals
The American Bar Association believes that any comprehensive bankruptcy reform legislation should provide for some system of direct appeals of final bankruptcy orders to the circuit courts.
Pursuant to 28 U.S.C. §158(a) and (b), final and interlocutory orders of a bankruptcy court currently are appealable in the first instance to a U.S. district court or, with the parties' consent, to a bankruptcy appellate panel provided (i) that a bankruptcy appellate service has been established for the circuit in which the particular bankruptcy court is located, and (ii) that the district court for the particular district has not opted out of participation. Pursuant to Section 158(d), the final orders of either a district court or a bankruptcy appellate panel may be appealed to the appropriate court of appeals. In turn, review of a decision by the court of appeals may be sought in the U.S. Supreme Court. The four-tiered appellate structure, complete with two divergent paths at the second layer of review, is problematic and should be replaced with a more streamlined system.
As one of its first acts, the National Bankruptcy Review Commission adopted its Recommendation 3.1.3 proposing that the first stage of the appellate process, appeals to the district courts, be eliminated. The NBRC recommendation followed Conference Plan Recommendation 22 of the Proposed Long Range Plan for the Federal Courts (the ''Conference Plan'') proposed by the Judicial Conference's Committee on Long Range Planning in 1995. Recommendation 22 had recommended that the existing mechanism for review of dispositive orders of bankruptcy judges should be studied to determine what appellate structure will ensure prompt, inexpensive resolution of bankruptcy cases and foster coherent, consistent development of bankruptcy precedents. Recommendation 21 in the Conference Plan provided the general rule that actions of decisions of Article I courts should be reviewable directly in regional courts of appeal.
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The American Bar Association's response to each recommendation in the Conference Plan was comprised of a statement of ABA Policy and a more expansive Comment thereon. The ABA Comment regarding Recommendation 22 states:
''The bankruptcy appellate process does not produce a coherent body of guiding precedent. One reason for the amount of bankruptcy litigation—and the attendant cost and duration of insolvency proceedings—is the failure of stare decisis to function in the bankruptcy system.
''Bankruptcy appeals may be argued either before the almost 550 district judges or may proceed to bankruptcy appellate panels where they exist. Virtually none of the decisions of those courts are viewed as binding upon bankruptcy judges or on district judges hearing appeals in bankruptcy cases. Notwithstanding the hundreds of bankruptcy opinions, little binding precedent has emerged. One result is that issues which commonly arise are litigated again and again throughout the country. Note should also be taken of the shortcomings of ''finality'' as a standard for appealability in bankruptcy matters.
''Substantial portions of the bankruptcy bench and bar believe that the bankruptcy appellate process is time-consuming, expensive, and fails to produce useful bankruptcy precedent. There is a growing consensus that the time has come for a study which might lead to solutions in the form of legislation or reorganization of the bankruptcy appellate structure.''
Thus, the recommendations of the NBRC and the Committee on Long Range Planning and the Comment by the ABA all recognize the problems created by the lack of binding bankruptcy law precedent and suggest direct appeals to the regional circuit courts of appeal as a possible solution.
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Generally speaking, the ABA believes that both shortcomings of the existing system would be dramatically improved through some system of direct appeals to the circuit courts.
We believe the multiple benefits of permitting direct appeals to the regional circuit courts of appeal outweigh other considerations. First, eliminating one level of appeal will, as a necessary corollary, result in fewer appeals in the court system as a whole. Second, direct appeals will result in a body of binding precedent which will reduce the number of appeals over time. Third, a significant number of bankruptcy appeals filed with the district courts are not prosecuted so that the burden of the circuit courts will be less than would be indicated by the gross number of bankruptcy appeals filed. Fourth, the important economic and commercial decisions which often arise in the context of bankruptcy cases are worthy of the valuable resources of the circuit courts. The relative burden of such cases does not justify dismissing the benefits and efficiencies of direct appeals out-of-hand.
Moreover, from a comparative perspective, it is difficult to understand why the bankruptcy appellate structure should afford bankruptcy litigants more opportunities for appellate review than almost every other type of litigant in the federal system. Most types of federal cases are subject to the standard three-tired system of review (e.g., review in a district court, court of appeals, and the U.S. Supreme Court), and there is nothing inherent in bankruptcy jurisprudence that demands an additional layer of appellate scrutiny. On the contrary, given that bankruptcy cases tend to be especially cost-sensitive, the expense associated with the current system's four-tiered structure is an unfortunate extravagance.
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Although direct appeals has it benefits, it has been criticized as increasing the workload of the courts of appeals in that the courts of appeals would need more judges. To the contrary, elimination of a second level of appeals would reduce the aggregate number of bankruptcy appeals by at least 1200 cases. Statistics provided by the Federal Judicial Center or gleaned from the Annual Reports of the Administrative Office of the United States Courts report the number of 'second appeals'', that is bankruptcy appeals from the district courts, in recent years as 1250 in 1998, 1187 in 1997, 1436 in 1996, 1658 in 1995 and 1389 in 1994. In a direct appeals system, ''second appeals'' would no longer exist. That elimination alone—almost one-fifth of all bankruptcy appeals—would represent a major reduction in the amount of judicial time Article III judges would be required to devote to bankruptcy appeals in future years.
In sum, the American Bar Association strongly endorses the concept of streamlining the bankruptcy appellate structure. The ABA recognizes the problems created by the lack of binding bankruptcy law precedent. As such, the ABA believes that the existing system would be dramatically improved through some system of direct appeals to the circuit courts.
B. Partnerships in Bankruptcy
The American Bar Association also favors legislation that would add a partnership bankruptcy structure to the existing Bankruptcy Code.
Partnerships are a popular vehicle for doing business. Partnerships include the two person small business, the single asset real estate venture, and the large professional service firm. By its nature, the general partnership does not afford limited liability to its members. Rather, the liability of general partners for partnership debt is determined by state law and the partnership agreement. Consequently, the determination and enforcement of liability for the debts of an insolvent partnership involves a multitude of difficult and seemingly unanswerable questions.
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The complexities of the intersection between partnership and insolvency laws have defied resolution. The result is that currently only one provision of the Bankruptcy Code—11 U.S.C. §723—addresses a partnership bankruptcy. This section authorizes the trustee of a partnership in a Chapter 7 liquidation to claim and collect a deficiency of the partnership estate from a general partner and does not apply to Chapter 11 reorganizations.
In 1996, an Ad Hoc Committee of the ABA, comprised of representatives from the tax, partnership, and business bankruptcy communities proposed amendments to the Bankruptcy Code which form the basis for administration and resolution of partnership cases under the Bankruptcy Code. There was broad based participation in the work of the Ad Hoc Committee and the proposed amendments represent a strong consensus. The proposed amendments to the Bankruptcy Code, and the ABA resolution endorsing these amendments, are attached as Appendix A.
An overview of the proposed amendments is found in an article by Morris W. Macey and Frank R. Kennedy entitled ''Partnership Bankruptcy and Reorganization: Proposals for Reform,'' which appears in Volume 50, Number 3 of The Business Lawyer, a quarterly journal published by the ABA Business Law Section. Professor Kennedy, the original Reporter for the Bankruptcy Code, has served as the Reporter for the Ad Hoc Committee.
The estate of many partnerships, especially professional or service partnerships, can be preserved only by the Chapter 11 process. This fact has been exemplified by five recent bankruptcies involving insolvent professional partnerships: (1) Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson & Casey (Bankr. S.D.N.Y.); (2) Myerson & Kuhn (Bankr. S.D.N.Y.); (3) Laventhol & Horwath (Bankr. S.D.N.Y.); (4) Heron, Burchette, Ruckert & Rothwell (Bankr. D.D.C.); and (5) Gaston & Snow (Bankr. S.D.N.Y.).
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These five cases involve remarkably similar facts. Each involved either a large law or accounting firm which sought Chapter 11 bankruptcy relief to wind up its affairs. In each case, the bankruptcy court was forced to formulate a remedy that would encourage voluntary contribution by general partners to maximize the distribution of property of the state and simultaneously avoid unnecessary bankruptcy filings by partners and unnecessary litigation. In each of the cases it was clear that the issuance of an injunction or its equivalent to bar future actions against contributing partners was the sine qua non of the confirmed plan.
The American Bar Association has carefully evaluated the problems and solutions set forth in the foregoing cases in formulating the proposed amendments to the Bankruptcy Code. The extended stay, which is analogous to a permanent injunction, is a key factor of the amendments. Although the foregoing cases involve large professional partnerships, the problems encountered and the resolutions embraced are equally applicable to all partnership bankruptcy cases.
As such, the American Bar Association believes that the Bankruptcy Code should be amended so that a partnership bankruptcy will trigger an automatic stay of a limited duration of sixty days. Although general partners may be liable for some or all of the debts of the partnership under nonbankruptcy law, the courts have generally given heed to the literal language of the Bankruptcy Code and its legislative history negating the argument that the property of a partnership includes the property of its member general partners. Thus, the automatic stay has been generally held not to bar actions, proceedings, or acts directed against a general partner or its property.
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Experience in the administration of partnership cases has demonstrated the crucial importance in Chapter 11 partnership cases of the issuance of an injunction against the enforcement of partnership creditors' rights against general partners and their property. The automatic stay will prohibit partnership creditors from exercising their collection efforts against partners or partners' property. The purpose of the automatic stay is to preserve the partners' property for distribution in the partnership case. By obviating the necessity for the partnership trustee or the partnership as a debtor-in-possession to seek and obtain an injunction against actions, proceedings and acts by partnership creditors directed against general partners, the extended stay accomplishes the same purpose and result for the benefit of the partnership creditors, insofar as the general partner's assets liable for the partnership debts are concerned, as the automatic stay of Section 362 does with respect to the partnership assets.
Further, the American Bar Association proposes an amendment which would allow the stay to be extended to nondebtor partners as a part of the confirmation of a plan. Courts should be permitted to issue an extended stay of actions, proceedings and acts against a general partner in a partnership case when the general partner has made a contribution to the payment of the partnership's debts, or assumed a commitment to make such a contribution in accordance with the provisions of a confirmed plan or order confirming a plan. Experience has demonstrated that recoveries by partnership creditors may be significantly enhanced if general partners can be persuaded to contribute to a recovery pool, post-petition future earnings, exempt property, and other assets not otherwise available to partnership creditors, in exchange for protection against collection suits by partnership creditors and suits for contribution and indemnification by copartners and the trustee of the partnership or the partnership as a debtor-in-possession.
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Without the extended stay, individual creditors would sue individual general partners, and general partners would then cross-claim against each other for contribution and sue the debtor for indemnification. The probable result would be a costly and time-consuming web of litigation replete with attendant attachments, garnishments and executions. Personal bankruptcy would be a likely consequence for many. By preventing a haphazard scramble for the assets of general partners, and by facilitating an orderly distribution scheme, the permanent injunction under the extended stay ensures that general partners will be protected and that creditors' recoveries will be maximized. The extended stay should not bar actions, proceedings, or acts against general partners who do not assume a commitment or fail to fulfill a commitment to pay partnership debts. The extended stay does not constitute nor may it be deemed to be a release of joint tortfeasors. Because the extended stay is tied to confirmation of a plan, compliance with the best interests of creditors test, which is inherent in the confirmation process, is ensured.
In sum, the American Bar Association believes that any comprehensive bankruptcy reform bill should establish a partnership bankruptcy structure, and the ABA recommends amending the Code, generally in the form of the attached Appendix A. As part of this new partnership bankruptcy structure, the ABA endorses an automatic stay inhibiting post-bankruptcy suits against general partners for partnership liabilities, to remain in effect for sixty days after a bankruptcy filing. The ABA also believes that such an amendment should include automatic stays of transfers outside the ordinary course of non-bankruptcy property by general partners of the filing partnership.
C. Sharing Fees with a Bona Fide Lawyer Referral Program
The American Bar Association recommends that a provision be added to H.R. 833, similar to the language contained in Section 202 of last year's bankruptcy reform bill, H.R. 3150, that would allow an attorney to share his fee with a bona fide public service lawyer referral program.
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In August 1993, the ABA House of Delegates adopted a Resolution endorsing the ''Model Supreme Court Rules Governing Lawyer Referral and Information Services'' and a ''Model Lawyer Referral and Information Service Quality Assurance Act.'' These Rules established specific public service criteria for lawyer referral programs, and urged adoption of these standards by each state.
Model Rule IX provides that ''a qualified service, may, in additional to any referral fee, charge a fee calculated as a percentage of legal fees earned by any lawyer panelist to whom the service has referred a matter.'' This method of funding is often the only way a public service lawyer referral program can operate in a financially self-sufficient manner. The Bankruptcy Code provision 11 U.S.C. Section 503(b) describes the allowance of expenses and fees, and is qualified by restrictions and prohibitions described under Section 504(a) and (b). These restrictions prohibit an attorney from agreeing to the sharing of compensation or reimbursement with another person. These provisions effectively prohibit a lawyer referral service from collecting a fee for bankruptcy case referrals.
The ABA believes that the prohibition contained in the Bankruptcy Code was not intended to apply to a public service-oriented lawyer referral program. Therefore, in February 1997, the ABA adopted a formal resolution urging that 11 U.S.C. Section 504 be amended to permit the remittance of a fee to bona fide lawyer referral programs. A copy of the ABA's resolution, and Recommendation 3.3.6 of the National Bankruptcy Review Commission, which was based on the ABA's resolution, is attached as Appendix B.
Lawyer referral services provide a valuable and highly visible service to the community. Lawyer referral serves two critical functions—to provide information to consumers about their legal concerns and, if appropriate, make a referral to an attorney capable of providing appropriate legal services to the consumer. Without lawyer referral, thousands of people are without an agency to turn to for legal assistance. Fortunately, however, lawyer referral services have been enormously successful and according to recent estimates, over 3 million calls around the country are handled by public service lawyer referral programs each year.
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The majority of lawyer referral programs in the U.S. support their operations by charging a percentage fee to each attorney receiving a case from the service. The question of the permissibility of percentage fee funding, or ''fee splitting'' has long been settled. When this funding method was originally conceived more than forty years ago, it immediately raised questions about fee splitting among ethics experts across the country. In 1956, the ABA adopted an ethics opinion allowing an attorney to remit a percentage of the fee to ''help finance the service by a flat charge or a percentage of fees collected.'' (Formal Opinion No. 291, dated August 1, 1956, reaffirmed in Informal Opinion 1076, dated October 1968). In Emmons v. State Bar of California, (1970) 6 Cal. App.3d 565, 86 Cal. Reporter 367, the court was asked if it was improper to charge a percentage fee to panel members. The court said in part,
''Serious and progressive elements, within and outside the legal profession have for several decades sought means of making legal services more readily available to the public. . . . the lawyer reference program has been evolved to establish communication between qualified attorneys and clients needing their services.''
The court recognized, as we do, that it is the role and responsibility of lawyers to provide legal services to the public, and that any fair and legitimate method of providing funding for information and access programs must be considered.
In the past, lawyer referral services have been funded through a combination of panel membership fees and substantial subsidies from their sponsoring bar associations. The economic pressures faced by the legal profession in the late 1980's and 1990's resulted in a corresponding decrease in dues dollars available to bar associations for public service programs. Lawyer referral programs must find a method of becoming financially self-sufficient if they are to survive and serve their communities. The recent reductions in federal dollars for legal services to the poor, and funding reductions to the Legal Services Corporation, have further restricted the resources available for moderate-income programs.
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The system of generating revenues through a percentage fee funding system allows the bar to accept a small percentage of the fee when the panel attorney is retained for any cases referred by the lawyer referral and information service. Thirty-four states have percentage fee programs. Ethics opinions have consistently held that a percentage fee program is a legitimate way for a lawyer referral and information service to generate income if two conditions are met. First, the funds collected through percentage fee funding must be used solely for the purpose of defraying the costs of operating the service, or for other public service programs such as pro bono services, and second, the attorney must not increase the costs of his/her legal services to offset the fees remitted to the lawyer referral program. In every state where the issue of payment of a percentage fee to a legitimate lawyer referral service has arisen, there has been a ruling which has found that the payment of a percentage of the fee earned back to a legitimate referral service is legal and ethical.
Unfortunately, collecting a percentage of an attorney's fee as a means of funding the lawyer referral service does not comport with certain provisions of the Bankruptcy Code. Section 504 of the Code prohibits fee-splitting arrangements except where (1) a person is a partner or otherwise associated with an individual compensated from an estate, or (2) an estate-compensated attorney for a creditor who filed an involuntary case under Section 303 is assisted by another attorney. But this prohibition is similar to the fee splitting prohibition contained in the Model Rules of Professional Conduct, for which an exception has been made specifically for public service lawyer referral programs.
In sum, because of the tremendous benefits that could be realized from allowing bankruptcy attorneys to share fees with bona fide public service lawyer referral programs, the ABA supports an amendment to the Bankruptcy Code utilizing language similar to that contained in Section 202 of last year's bankruptcy reform bill, H.R. 3150.
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D. Disinterestedness
The American Bar Association also believes that comprehensive bankruptcy reform legislation should clarify that an attorney who represents a debtor in possession need not be a disinterested person.
An attorney with historic ties to a debtor should not be automatically disqualified as bankruptcy counsel for that debtor. Certain bankruptcy judges have suggested that the attorney for a debtor in possession should have considerable independence from the management of that debtor, and some decisions have denied compensation because the attorney was not a person ''disinterested'' in the client. Those results are inconsistent with provisions of the Model Rules of Professional Conduct, however, which require a lawyer to abide by the client's decisions and which, in the corporate context, holds that the lawyer represents the entity under instructions issued by its officers and board of directors, unless they seek to violate legal obligations. The attorney is not to be ''disinterested'' in the client; he must be guided by the client's objectives.
While ''disinterestedness'' is an appropriate standard when dealing with the ''trustee''—a person who himself must be ''disinterested''—its use in respect of counsel for the debtor has resulted in the wrongful disqualification of debtor's counsel in a number of cases. Most bankruptcy judges effectively ignore the ''disinterestedness'' provision when dealing with prebankruptcy counsel for the debtor. Generally speaking, a disclosure to the Court at the time of engagement that a pre-bankruptcy fee remained unpaid—thus rendering the law firm a creditor of the debtor—or that the law firm represented shareholders or corporations affiliated with the debtor, was not automatically disqualifying. Obviously, if a party in interest presented reasons for disqualification, such considerations came before the bankruptcy judge for evaluation and decision.
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During recent years, however, several courts have determined that ''a violation of the disinterestedness rule'' required disqualification of the debtor's counsel. In some cases, the court did not make that disqualification determination until long after the law firm had been appointed by the same court and had put thousands of dollars of time and costs into the case.
The difficulty with the disinterestedness standard being applied to counsel for the debtor in possession is that it causes substantial problems. It does not fill the vacuum left by the abandonment of an independent trustee and the idea that it might is misleading.
The disinterestedness standard is problematic in that it often disqualifies that counsel who is most knowledgeable and best equipped to handle the reorganization. It does this by focusing on the counsel's historical identity with the debtor, which should not be disqualifying in and of itself. The relevant test should be whether any of the historical connections with the debtor creates a materially adverse interest. The fact that the lawyer or a partner of the lawyer may be a creditor, stockholder, director or officer should not be the end of the inquiry; the issue is whether it creates a problem. Whether the debtor is represented by the historical lawyer or a new lawyer, the lawyer must still take direction from those in control, and is therefore not disinterested.
The American Bar Association supports the enactment of legislation to amend the Bankruptcy Code to make clear that an attorney who represents a debtor-in-possession need not be a ''disinterested person,'' as that term is defined in the Bankruptcy Code, but that such counsel should comply with non-bankruptcy standards of professional responsibility generally applicable in the district where the case is pending and should not hold or represent an interest materially adverse to the estate.
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The American Bar Association also recommends the adoption of additions to the Bankruptcy Rules and to the Official Bankruptcy Forms which provide for more detailed disclosure than is presently required of potentially conflicting interests and similar information, and which provide that if such data has been filed in good faith, a subsequent termination of the attorney's employment will not disqualify that attorney from receiving compensation under applicable standards. These provisions should be added to H.R. 833, or to any other comprehensive bankruptcy reform legislation considered by Congress.
E. Claims Priorities
Finally, the American Bar Association opposes the enactment, in the absence of the most compelling circumstances, of special interest legislation designed to increase the types of claims entitled to priority under the Bankruptcy Code. As a result, the ABA has concerns regarding a number of specific provisions in H.R. 833 that would create new priorities.
Although H.R. 833 contains many new priorities, several stand out. In particular, the ABA has concerns that the following provisions of H.R. 833 create priorities where the circumstances are less than compelling: Section 131 (adding a priority for claims for injuries resulting from the operation of a motor vehicle or vessel while the debtor was intoxicated), Section 137 (mandating payments to lessors and purchase money secured creditors in Chapter 13 cases), Section 205 (requiring the surrender of non-residential real property subject to a lease if the lease is not assumed within 180 days after the order for relief), Section 207 (declaring warehouseman's liens unavoidable notwithstanding Code Section 545(2) and (3)), Section 208 (extending the limitation in Code Section 546(c)(1)(B) for reclaiming sellers from 20 to 45 days) and Section 1127 (restricting transfers of certain property by debtors that are not moneyed business or commercial corporations or trusts).
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The primary function of the bankruptcy process is to gather together an insolvent debtor's assets and to distribute those assets fairly among the debtor's creditors. This ''equality of distribution'' policy is modified by the establishment of priorities—payments ''off the top''—to accomplish certain limited goals. The Bankruptcy Code allows, for example, a first priority for costs of administration (i.e., costs incurred during the administration of the bankruptcy estate after the bankruptcy petition was filed). The Code recognizes that in order to get suppliers to provide goods and services needed to preserve or enhance the bankruptcy estate, or to get lawyers or security guards to perform required services, they will have to be paid in cash or at least promised ''good payment''.
A major reason that the bankruptcy laws, and particularly the Chapter 11 reorganization process, have worked well in the United States is that priority payments—those payments which come ahead of the distributions to unsecured creditors—are relatively limited. Over the years, however, a constant stream of bills have been introduced in Congress that would provide that one or another special interest group receive priority payments in bankruptcy ahead of all other creditors. A multitude of special interest groups have emerged to demand priorities, and federal agencies have used their positions as ''government insiders'' to bring about priority legislation without any public hearing.
Moreover, in recent years, government agencies with powerful Congressional constituencies have proposed Bankruptcy Code amendments in Congress to provide priority to one favored governmental entity or another. Had these priorities been adopted, it would have virtually destroyed any opportunity for Chapter 11 reorganization or for meaningful distribution of assets to unsecured creditors.
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Fair and equitable treatment of creditors' claims is and should remain a primary goal of the bankruptcy process. The Chapter 11 provisions of the United States Bankruptcy Code work well largely because the ''delicate balance'' of claims and priorities is further subjected to a negotiating process which impels each claimant or category of claimant to assess carefully the relative worth of their claims against the value of having the debtor emerge as a viable enterprise, thus preserving the going concern value of its assets, the jobs of employees, and the contribution of its products and services to its community. For these reasons, the ABA opposes legislation that would create a new unjustified priority of claims for certain creditors. The ABA also opposes the enactment, in the absence of the most compelling circumstances, of special interest legislation which upsets the delicate balance of rights existing under current law by establishing new priorities for particular types of creditors, including those new priorities contained in H.R. 833.
The ABA also generally opposes amendment of the Bankruptcy Code by legislative process which avoids fair opportunity for open hearings, on well-publicized notice, before the judiciary committees of Congress. Open deliberations preceding the enactment of legislation which affects thousands of cases should be a prerequisite for any legislation. The statement seems so obvious, and would seem so central an idea in our Congressional system, that it is surprising that it has to be repeated.
Open hearings on reasonable notice is a clear requirement in an open society. We are not now speaking about declarations of war or other emergency measures, nor are we speaking of simple legislation which is straightforward and has clearly predictable effects. The Bankruptcy Code is a tightly constructed piece of technical legislation which has indirect effects on many other laws and on the American economy. Bankruptcy is a field in which procedure is substance. As such, Bankruptcy Code provisions have far-reaching effects, not only in bankruptcy proceedings themselves, but often throughout the economy as a whole. Indeed, in some instances, a Code provisions can influence whether a business transaction will be entered into in the first place. For these reasons, it is imperative that the Judiciary Committee carefully consider the full effects of bankruptcy reform legislation before reporting a bill.
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Conclusion
The ABA strongly believes that the Bankruptcy Code can be improved and made both more efficient and more equitable by adopting several common-sense reforms, including new provisions (1) allowing direct appeals of final bankruptcy court orders to the regional courts of appeal, (2) establishing a partnership bankruptcy structure, (3) allowing greater sharing of attorneys' fees with bona fide public service lawyer referral programs, and (4) clarifying that an attorney representing a debtor in possession need not be a disinterested person. On the other hand, in order to ensure that most unsecured creditors are treated fairly and equally, Congress should resist the temptation to create any new priorities for particular types of creditors, absent compelling circumstances. In this way, Congress can ensure that the Bankruptcy Code continues to fulfill its function of gathering an insolvent debtor's assets and then distributing them fairly among the debtor's creditors, without imposing any unintended consequences on the American economy.
The ABA has been a consistent advocate of legislation designed to improve and streamline the bankruptcy system, while at the same time preserving the due process protections of all participants . We appreciate the opportunity to testify before the Subcommittee today, and we look forward to working with your Subcommittee—and with other advocates of positive bankruptcy reform in Congress and in the Administration—in an effort to achieve these goals.
NOTE: The materials listed below, submitted on behalf of the American Bar Association, are on file with the Subcommittee on Commercial and Administrative Law of the House Committee on the Judiciary.
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Appendix A—The proposed amendments to the Bankruptcy Code and the ABA resolution endorsing these amendments.
Appendix B—ABA resolution, and Recommendations 3.3.6 of the National Bankruptcy Review Commission based on the ABA's resolution.
Report of the Section of Taxation of the American Bar Association on the Tax Provisions of H.R. 3150, Tax Lawyer, Vol. 51, No. 3, 105th Congress, 2nd Session (1998), pp. 635–648
Mr. GEKAS. We thank you, Mr. Schorling.
I think the Chair will exercise some discretion and recess for the purpose of the vote so that we can give Ms. Baird full time when she gets ready to testify.
With that, we will stand in recess until 1:55 p.m. We stand in recess.
[Recess.]
Mr. GEKAS. The time of the recess has expired.
The gentleman from North Carolina is recognized for the purposes of a recognition.
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Mr. WATT. Thank you, Mr. Chairman.
I unfortunately was not here at the beginning of the panel when you introduced the witnesses, and wanted to extend a special welcome to Ms. Baird who is here representing, I guess it's Bank America, now, which is based in my congressional district, and I just wanted to acknowledge that and thank her for being here in particular today, not that the other witnesses are not welcome, but——[Laughter.]
Mr. WATT [continuing]. But I don't think you all carry the influence that she's carrying with me. [Laughter.]
Mr. WATT. Thank you, Mr. Chairman.
Mr. GEKAS. We thank the gentleman.
We'll segue right into the testimony of Ms. Baird.
STATEMENT OF H. ELIZABETH BAIRD, ESQUIRE, ASSISTANT GENERAL COUNSEL, BANK OF AMERICA CORPORATION, CHARLOTTE, NC
Ms. BAIRD. As a bankruptcy attorney working with our corporate bank, I deal with many types of business debtors; manufacturers, real estate developers, retailers, health care concerns, professional sports organizations, and unfortunately recently sub-prime mortgage and automobile lenders.
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Our loans are both unsecured and secured by everything from stock, to equipments to receivables.
With such a varied array of debtors, collateral and financing, it is imperative to have a reorganization scheme that is flexible enough to deal with the uncertainties, but certain enough in its outcome so that reasonable credit decisions can be made on the front end of these deals.
That is why we commend the subcommittee for addressing these pressing commercial matters in this time of great turmoil in the consumer bankruptcy area.
As our economy grows and changes, we need to continue to make the needed reforms to keep our system flexible and working.
We are generally supportive of the majority of the commercial provisions of H.R. 833, such as the changes proposed in titles IX and X. They are reflective of the global nature of our economy and the new financing structures that our institutions have developed to keep capital flowing into our economy at lower costs and risk.
We are also strongly supportive of the limits on exclusivity in the bill in section 213. We consider this one of the most significant benefits of this legislation.
We'd like to take this opportunity, however, to draw the subcommittee's attention to aspects of the bill that are troublesome to us and that we currently oppose in their current form.
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The most significant objection we have to the bill is section 205. We are generally opposed to allowing any one creditor constituency preferential treatment unless there is a compelling public policy reason, such as the protections in H.R. 833 for child support and alimony collection in consumer cases.
However, there is no such policy reason in the legislation to support this provision which benefits the commercial landlords and disadvantages all other creditors and the debtor's ability to reorganize.
Section 205 amends section 364(d)(4) of the Bankruptcy Code to provide that when a debtor is a tenant under a commercial lease, the lease will be deemed rejected by the court and the debtor forced to vacate the property within 180 days after the filing of the case, or by the time a plan is confirmed, whichever is earlier.
This decisionmaking period can only be extended upon the agreement of the commercial lessor.
Now this may not sound too onerous and we're all in favor of hard deadlines in cases in some instances.
However, you need to understand the effect that the assumption of a lease has on a bankruptcy case.
Currently, if a debtor does not assume a lease but simply remains current in his lease payments and stays in possession of the property during the case, as he's required to do, and then he rejects the lease at some point later in the case, the landlord's claim for rejection is a general, unsecured, pre-petition claim and it is capped at a statutory level.
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If the debtor assumes the lease and then has to reject the lease later in the case because his business plan changes or fails, or because the store becomes unprofitable, then the entire claim of the landlord for damages under the lease becomes an administrative expense priority claim which is unlimited in amount.
This means it must be paid one hundred percent before any unsecured trade creditor in the case is paid one red cent.
Because this provision will force early assumptions of leases, it will dramatically reduce the recovery in chapter 11 to unsecured creditors in both successful and unsuccessful cases, and we urge its deletion in its entirety.
The next issue I'd like to address is the small business reforms. These reforms have been under consideration for many years, which is appropriate for reforms that will affect a large number of chapter 11 cases, in some estimates, up to 90 percent.
We agree that it is time for enactment of these provisions. They will streamline the reorganization process for viable small businesses, and will also provide a sufficient mechanism for identifying small businesses that are not viable.
We would suggest a few changes to the confirmation process in the small business section to improve it.
First, there should be an adjustment to plan filing deadlines to allow for the filing of a creditor's plan.
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The current section proposes a 90-day deadline for the filing of both the creditor's plan and a debtor's plan. This deadline encourages the debtor to wait until the last possible moment to file its plan, and discourages third parties from proposing a competing plan.
We would propose a 90-day exclusivity period during which only the debtor may file a plan, and either a 120- or 150-day period by which all plans must be filed.
This would give a competing plan proponent at least 30 days within which to file their plan of reorganization.
We are generally opposed to section 208 of the bill which extends the reclamation period from 20 to 45 days. This provision was addressed in the 1994 amendments and we see no substantial justification for revisiting this issue.
And we generally support the amendment that is being offered to section 546(g) by the American Bankers Association and the Commercial Law League to clarify the return-of-goods provision.
And finally, we agree on appeals.
In the last session, the bill contained a section which was designed to expedite the appeals process, and this is a procedural change that has been needed for quite some time.
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It was removed in conference last year, and we are currently working with a number of groups to come up with language that will be suitable for everyone.
[The prepared statement of Ms. Baird follows:]
PREPARED STATEMENT OF H. ELIZABETH BAIRD, ESQUIRE, ASSISTANT GENERAL COUNSEL, BANK OF AMERICA CORPORATION, CHARLOTTE, NC
Chairman Gekas and members of the Subcommittee, I am pleased to have this opportunity to present the views of Bank of America regarding H.R. 833, ''The Bankruptcy Reform Act of 1999''. I am H. Elizabeth Baird, Assistant General Counsel to Bank of America, and in that capacity I am involved on a daily basis in commercial bankruptcy cases. I am also a member of the American Bankers Association's Advisory Committee on Commercial Bankruptcy (ACCB), a group of both inside and outside counsel to commercial banks that provides continuing input to ABA regarding the need for commercial bankruptcy law changes and the potential impact of proposed commercial bankruptcy legislation.
Bank of America commends Chairman Gekas for introducing H.R. 833 which addresses the need for a variety of changes to commercial provisions of the Bankruptcy Code. This proposal follows up on and incorporates some of the best work of the National Bankruptcy Review Commission (NBRC) and of legislative debate in the last Congressional Session. As my testimony details, H.R. 833 includes many provisions that we wholeheartedly support. Other provisions require technical improvements and clarifications. We also must oppose a number of the Bill's Sections on the grounds that they undermine the position and rights of commercial lenders and reduce the probability that businesses will successfully reorganize in Chapter 11. We look forward to working with Chairman Gekas and members of the Subcommittee to improve H.R. 833 so that it can receive our unqualified endorsement and support.
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EXECUTIVE SUMMARY
Bank of America can support advancement of the majority of this Bill's commercial provisions, subject to improvements and clarifications being made as described in our testimony.
In particular, we strongly support Title IV, which would streamline the treatment of small business and single asset real estate cases in Chapter 11 and improve the prospects of successful reorganization for viable entities. There are several changes recommended in our testimony to further improve on these provisions. We also strongly support the striking of the debt cap in single asset realty cases.
We support the advancement of Title X financial contract reforms and commend the Subcommittee for continuing to ensure that the Bankruptcy Code reflect current economic changes and practices in the financial markets.
We support the changes made in Section 213 of the bill which are designed to eliminate one of the most abusive practices in Chapter 11, continued extensions of the exclusive period in which the debtor alone has the right to file a plan of reorganization.
We support the additions made to the Bankruptcy Code in Title IX which recognize the increasing importance of cross border insolvencies in our global economy.
We also support and are pleased to see the changes made in Sections 211 and 212 which are designed to curb abusive litigation practices in commercial and consumer cases.
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We are strongly opposed to Section 205, which is clearly special interest legislation that would make retail reorganizations significantly more difficult, if not impossible in many cases while unjustifiably enhancing the position of commercial lessors at the expense of all other unsecured creditors.
We oppose Section 206 as proposed because it inserts the court into administrative matters, and could lead to detrimental conflict within creditors and equity holders committees. We would not oppose a limited new opportunity for court review of committee composition at the inception of a case.
Finally, we are also opposed to Section 208 which extends the reclamation notification and demand period an additional 25 days from 20 to 45. This extended period is unwarranted and will cause less assets to be available for unsecured creditors.
TITLE II
Section 205 would amend Section 364(d)(4) of the Code to provide that when a debtor is a lessee under a commercial lease, the lease will be deemed rejected and the debtor forced to vacate the premises unless the lease is assumed within 180 days after the beginning of the case, or by the date of the order confirming a plan of reorganization, whichever is earlier. This decision-making period could only be extended upon filing of a motion by the commercial lessor.
We are strongly opposed to this provision. It would make successful reorganization more difficult or impossible in the great majority of retail bankruptcies. It would provide shopping center developers and other commercial lessors with unprecedented and undeserved leverage to force premature assumptions. Its adoption would severely prejudice the rights and prospects of other parties in interest to such cases; such as the debtor-in-possession and unsecured lenders, including financial institutions and supplying trade creditors, as well as their employees.
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Shopping center developers contend that they suffer unjustifiable uncertainty in Chapter 11 cases regarding whether a reorganizing retailer will continue to occupy leased space. Whatever the merits of their complaints, Section 205 goes much too far in providing redress. Landlords are entitled under current law to receive post-petition rents from reorganizing tenants and to have them be in compliance with all material lease provisions; they can petition the court for relief if those conditions are not being met.
The nation's retail sector remains in economic doldrums, underscoring the need for Congressional caution. When a retailer reorganizes, its success is important not only to its own employees, but to the employees of the many companies which supply it with goods. Most retail Chapter 11 cases are filed shortly after a disappointing Christmas shopping season. A major national retailer requires many months to analyze the failings of its prior strategy, implement a new management and marketing plan, and evaluate it after going through future peak sales periods. If bankruptcy law prematurely compels a lessee to assume or reject a lease, it may make unwise and detrimental business decisions that ultimately doom its reorganization effort to failure. If the retailer has been fortunate enough to negotiate a lease which provides it with a below market rate of rent at the time it enters into reorganization effort, the landlord is likely to rebuff any requests for extensions of the decision-making period in the hope that it can force an abandonment and bring in a new tenant at a higher rent.
Adoption of this Section would also unjustifiably and unfairly boost the position of landlords if the reorganization fails. The primary reason that a creditors committee is generally reluctant to permit a retail debtor to assume its lease is that an assumption not only requires the curing of defaults and compensation of the lessor for actual damages, but also elevates all future damages to an administrative expense priority. That is, should the reorganization ultimately fail, the landlord holding an assumed lease will have a large administrative expense claim that may well prevent recovery by any other unsecured creditor. Congress should not permit commercial lessors to use uncertainty as an excuse to boost their own status above all other similarly situated creditors. This would be a deathblow to reorganization prospects, as trade creditors would likely ease to ship to a retailer if their claims would, as a practical matter, be extinguished if it eventually liquidated.
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We do agree with commercial landlords that assumption should be required no later than the date of plan confirmation. But extensions of the initial decision-making period should not be subject to the landlord's sole discretion but should be available at the request of any party in interest. While we are concerned that any fixed time limit on extensions will be damaging to the prospects of successful reorganization, it would at least have to be sufficient to allow a retail debtor to adequately test its new strategy in the marketplace; 180 days absolutely fails to meet that standard. Finally, if some variation of this time period is adopted, we would insist on a corresponding change to the Code to address the situation in the case where a landlord does force an assumption, if a liquidation subsequently occurs the landlord should receive administrative priority treatment only for rents and expenses due for the period in which the debtor actually occupied its leased premises subsequent to assuming. But it should be treated as a general unsecured creditor for any rents and expenses owed under any unexpired period of the remaining lease term subsequent to abandonment.
Section 206 would permit the court, on its own motion or that of a party in interest, to order a change in the membership of a creditors or equity security holders committee. We oppose this proposal as presently constituted. As with some other provisions of H.R. 833, it erodes the distinction between the judicial functions of the court and the administrative functions of the U.S. Trustee, and in so doing undermines the fundamental structure of the 1978 Code. In addition, its open-ended nature raises the possibility that it will be utilized by ''vulture investors'' who may purchase distressed debt and then seek a place on the creditors committee. Such investors have fundamentally different interests than original lenders, and their presence on the committee may lead to conflict and litigation that generate unnecessary expense and are detrimental to the prospects of a successful reorganization.
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We would not object to a limited new grant of authority to the court to review the initial composition of committees, if a party in interest makes such request within 30 days after such appointment.
Section 208—The proposed amendment to Section 546(c) of the Code is in our experience unnecessary, as this issue was addressed in the Bankruptcy Reform Act of 1994. Section 546(c ) of the Code recognizes the state law right under the Uniform Commercial Code of an unsecured trade creditor to enforce its limited rights to reclaim goods shipped to the debtor within 10 days of a bankruptcy filing. The 1994 amendments did not enlarge the reclamation rights, but simply expanded procedurally the number of days after filing that a creditor had to make a reclamation demand against the debtor. The number of days was extended from 10 days after receipt of goods to 20 days after the bankruptcy filing if the filing occurred during the aforementioned 10 day period. The current amendment seeks to extend this time further to 45 days. There has been no justification for the extension of this time period and we submit that the current statutory maximum of 30 days, and minimum of 20 days is sufficient.
TITLE IV—SMALL BUSINESS BANKRUPTCY
Title IV is based upon the small business bankruptcy recommendations of the National Bankruptcy Review Commission (the ''NBRC''). The NBRC found that less than ten percent of businesses filing in Chapter 11 ever successfully confirm a reorganization plan. It also found that the great majority of cases lingered in Chapter 11 for several years. Based upon those findings, it recommended that Chapter 11 be altered so that those small businesses that had reasonable prospects of a successful reorganization could do so in an expedited and less administratively burdensome manner. Its recommended changes would also more quickly ferret out those small businesses with no realistic prospects for success in reorganization, and in so doing remove a burden on the bankruptcy courts and provide fairer treatment to other parties in interest.
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We commend Congressman Gekas for following the general thrust of the NBRC's recommendations in this area. We support Section 402's revised definitions for business debtors with liquidated debts of $4 million or less as well as all single asset real estate (SARE) cases. The issue of an appropriate measure of ''small business'' received extensive NBRC discussion, and the $4 million dividing line is a reasonable demarcation. It is also appropriate to encompass SARE cases within this framework. Since by definition there is only a single asset involved and no other significant business being engaged in by the SARE debtor, the prospects for successful reorganization can be discerned quickly.
We note that there seems to be an unintended inclusion in Section 402 of an amendment to Section 524 regarding violation of reaffirmation agreements. This is a consumer provision and it should be moved to Title I if retained at all. For the record, we also oppose this provision and direct you to the testimony of the American Bankers Association in this regard.
The flexible rules for disclosure statements in Section 401 will significantly simplify procedures in small business bankruptcies. Section 403 will mandate standard form disclosure statements and plans that balance the need for the court, creditors, and other parties in interest to receive reasonably complete information against the debtor's need for simplicity. This Section has the potential for reducing the time the debtor spends in bankruptcy and the total expense of the case. This same balance is struck in Section 405 in regard to uniform reporting rules and forms.
Section 404 requires uniform national reporting requirements regarding profit and loss, financial projections, current financial data compared with past projections, and statutory, rules, and tax compliance. These desirable reports will generally require debtors to obtain some professional assistance, but it will help them focus on key measurements and factors that are crucial to successful reorganization. Consideration should be given to harmonizing these requirements with the U.S. Trustee's Operating Guidelines and Reporting Requirements to avoid undesirable inconsistency and unnecessary duplication. We also question this Section's requirement that such reports be filed with the court rather than the trustee, which appears to erode the Code's beneficial structure of assigning administrative and business aspects of cases to the U.S. Trustee so that the court can focus on application of the law.
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Section 406 codifies a debtor's duties in a small business case. Some of these, such as attending a Section 341 meeting, are the existing practice of the U.S. Trustee. The additional financial disclosures are typical of the items that will be requested by a creditors committee in a larger Chapter 11. There has been some criticism that asking the debtor to produce these documents concurrently with the filing may be unrealistic, and we would not object to considering whether provision for a short extension is appropriate. However, we note that this Section allows a debtor to file an affidavit in lieu of this information if the financial records do not exist. The very reasons that most small business cases languish in Chapter 11 without eventual confirmation is that there is often not a creditors committee forcing the debtor to focus on fundamental financial issues.
Sections 407, 408 and 409 collectively establish expedited deadlines for plan filing and confirmation. These deadlines are necessary to achieve the title's goal of quickly separating promising from hopeless cases. We would suggest several improvements to further that goal. First, we believe that extensions should only be granted a single time, and only in circumstances for which the debtor should not be held accountable. Second, third parties should be given a reasonable period in which to prepare a competing plan. The Section proposes a 90 day deadline for both a debtor's plan and a competing plan of reorganization, which would encourage the debtor to wait until the last moment to file, and discourage third parties from proposing a competing reorganization plan. We would propose a 90 day exclusivity period and a 120 period by which all plans must be filed. This would give a competing plan proponent 30 days within which to file a plan after the exclusive period elapses. Third, the provision should also permit a shortening of the filing period on request of a party in interest upon a showing that such acceleration is in the best interest of the estate. Finally, extensions of the plan confirmation deadline should have an absolute limit of one year from the date of the order for relief.
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Section 410 establishes unprecedented statutory duties for the U.S. Trustee. We believe this provision should be substantially narrowed to prevent the generation of excessive expenses and to prevent an undesirable assumption of judicial duties by this administrative officer.
We draw the Subcommittee's attention again to what appears to be an error in section placement at the beginning of Section 412. This initial paragraph is an amendment to Section 362 of the Bankruptcy Code as it is amended by Section 122 (note that the reference to Section 124 in the statute is also incorrect) which then refers back to Section 117 of the Bill. This Section should be moved to Section 117 of the Bill. (And also note that as currently drafted, there are two paragraph (2)s to that subsection)
Section 412 as it applies to small business cases would prevent abuse of the Code's automatic stay provisions by serial filers who have no intent or ability to confirm a plan. However, there is one substantive change that must be made to this Section. As presently drawn, it applies to all Chapter 11 cases. To correct this, the words ''by or against a small business debtor'' should be inserted after the word ''title.''
Section 415 requires the debtor to pay a contract rate of interest on the value of the creditors' stake in collateral in a SARE case; and provides that such payments may begin as early as 30 days from the date that the court determines that the debtor is a SARE case. We support the thrust of this provision as furthering the prevention of abuse in such cases. However, it requires substantive and technical modification. It appears to grant the debtor unbridled discretion to use cash collateral (rents) even if other funds are available; the Code presently permits the use of cash collateral only with the consent of lenders. The ''sole discretion'' proviso should be deleted and replaced by language which makes clear that rents and other cash collateral may only be used in the absence of any other available funds. In addition, the Section should be clarified to remove any doubt that the contract rate of interest to be applied is that applicable in the absence of a default, so that a hyper-literal judge cannot conclude that there is no ''then applicable'' contract rate.
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TITLE VIII
Section 812 amends current Section 506(c) of the Bankruptcy Code to explicitly provide for recovery of ad valorem taxes from property securing a claim. This provision appears to be unnecessary and creates an unintended problem in Section 506(b) of the current Code. It is unnecessary because in most if not all instances, a property that a secured creditor takes over will remain subject to the ad valorem tax and that tax will be paid upon the eventual sale of the property, or if the property remains in the possession of the debtor, the taxes will be paid as a part of the plan of reorganization. Adding the taxes to Section 506(c) expenses only reduces the likelihood that a secured creditor will be able to recover its interest and fees and expenses under Section 506(b) as an oversecured creditor. We strongly urge the Subcommittee to delete this Section as unnecessary and punitive to the interests of secured claimants.
TITLE XI
Section 1111, dealing with priorities appears to incorporate a typographical error. It refers to the Section as amended by ''Section 323'' of the Bill. There is no Section 323. It should instead reference Section 142 of the Bill. The same comment applies to Section 1112; there is no Section 320 of the Bill.
ADDITIONAL SUGGESTIONS
In addition to our commentary on select provisions of H.R. 833 we offer an additional recommendation for the Subcommittee's consideration:
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In Section 603 of S.1914 introduced in the last Congress, there was an attempt to deal with the problem of bankruptcy appeals. This Section responded to the NBRC's determination that the current absence of an expeditious bankruptcy appeals process creating a broad body of binding precedents is a serious deficiency in our system. We would encourage the Subcommittee to take up this issue again, but perhaps in a different manner. We are working with other constituencies to develop language that would address this issue.
We are fully supportive of the proposed clarifying amendment to Section 546(g) of the Code that the American Bankers Association has suggested. This is a technical amendment to changes made in 1994 which allow a debtor to return goods to a trade creditor shipped prebankruptcy within 120 days after the filing of a petition in full satisfaction of the creditor's claims and with the consent of such creditor. The amendment would clarify that the return of the goods to the creditor is subject to superior rights of secured lenders in the goods. For example, if a secured lender loaned the debtor money to purchase the goods, and took a security interest in the goods, the debtor would not be able to return the goods to the trade creditor without paying the secured creditor for the value of its security interest in the goods.
We would like to take this opportunity to make the Subcommittee aware of a pending bankruptcy case before the United States Supreme Court, which may be decided during your consideration of commercial bankruptcy reform and which decision may prompt requests for changes in the Code. In 203 North LaSalle Street Partnership, the Supreme Court will decide whether the new value exception to the absolute priority rule survived the enactment of the 1978 Code.
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CONCLUSION
Mr. Chairman, Bank of America appreciates having this opportunity to present our views regarding commercial bankruptcy reform. We look forward to working with the Subcommittee in the days ahead to perfect H.R. 833. I would be happy to answer any questions.
Mr. GEKAS. We thank the lady, and we turn to Mr. Tatelbaum.
STATEMENT OF CHARLES M. TATELBAUM, ESQUIRE, CUMMINGS & LOCKWOOD, NAPLES FL, ON BEHALF OF THE NATIONAL ASSOCIATION OF CREDIT MANAGERS
Mr. TATELBAUM. Mr. Chairman, members of the committee, coming from Naples, Florida, yesterday, I left a lot of your constituents, judging from the license plates, that were there, given the recent weather.
I am here again on behalf of the National Association of Credit Management, the more than 100-year-old organization of more than 30,000 unsecured trade credit professionals.
We do support the small business provisions, and I would echo many of the statements stated by Judge Carlson.
If the statistics are, as we believe, that 80 to 90 percent of the chapter 11s are small business cases, then the NACM constituency represents 80 or 90 percent of the creditors in those cases.
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It seems strange sometimes that a creditor organization would seek to speed up the process and move things along, which seems to give the debtors a greater opportunity, but NACM members believe that a process that either gets the debtor out successfully quickly by reorganization, or dismissed quickly, will serve the best of the interests of the legitimate debtors that can reorganize but cannot do so because they are caught in the one-size-fits-all chapter 11 that currently exists.
We believe that the provisions contained in sections 401 through 415 should be adopted, although I have had a chance to review Judge Carlson's suggestions and believe that they do have merit as far as slight modifications.
Mr. GEKAS. Was that on the 60-day extension, or on the other portions of avoiding delay?
Mr. TATELBAUM. On both of the comments that Judge Carlson made to the subcommittee.
NACM is very supportive of the provisions in section 211 and 212 dealing with preference reform.
As I stated last year to this committee, and it has shown statistically, preference litigation has in fact become a feeding frenzy for attorneys who wish to try to get back money where the unsecured trade creditors, who are supposedly on an equal playing field, have to disgorge the money, only to pay attorneys' fees and other priorities and not receive any benefit of the equality that is supposed to be achieved in preference litigation.
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NACM also supports the language in section 206 which allows the court to change the composition of the creditors' committee where the court finds the balance needs to be made to create adequate representation.
Currently, that is totally within the purview of the U.S. Trustee Office. There's no judicial arbiter of a dispute. This section would correct that inequity.
NACM would like to call to the subcommittee's attention its view with respect to section 208 dealing with reclamation.
Normally, unsecured trade creditors would welcome an expansion of the time to 45 days for reclamation, but on reflection, we, who are the recipients of the reclamation claims, do not believe that this is a wise choice because if it is extended to 45 days, it will only create a very great burden for debtors to come out of chapter 11 with respect to the administrative claims that will be created.
Additionally, it will preclude legitimate business debtors, especially those who are in retail, from coming out of chapter 11 to benefit only a few of the creditors that have the reclamation claims.
In our written testimony, we have suggested a change to change reclamation altogether, and to simply make it an administrative priority claim that will have to be satisfied on confirmation with respect to any goods or services delivered within 20 days.
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We understand that some of the proponents in the Senate who brought this bill last term now agree with our position.
We oppose the 180-day rule with respect to executory contracts and leases, as other witnesses have testified.
Yesterday, in Tennessee, there was a massive chapter 11 filing for a company called ''Service Merchandise.'' If this bill were enacted now, Service Merchandise would have to try to reorganize and deal with all of its leases throughout the country before the Christmas season, when it could determine how viable the stores would or would not be.
We would respectfully submit that for everyone's benefit, having the artificial 180-day absolute deadline would not benefit any constituency, perhaps except the landlord lobby.
We thank the subcommittee for all of the responsiveness it has given to the unsecured creditor body because we do become the involuntary partners of the debtors in most of these cases.
Thank you.
[The prepared statement of Mr. Tatelbaum follows:]
PREPARED STATEMENT OF CHARLES M. TATELBAUM, ESQUIRE, CUMMINGS & LOCKWOOD, NAPLES FL, ON BEHALF OF THE NATIONAL ASSOCIATION OF CREDIT MANAGERS
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I am Charles Tatelbaum, a practicing attorney with the Connecticut and Florida 90-year old law firm of Cummings & Lockwood. I am pleased to appear before you in my capacity as general counsel to the National Association of Credit Management. The NACM is celebrating its one hundred and third year as the largest non profit trade association representing the interests of more than 30,000 commercial credit granting businesses. The NACM's membership is spread throughout the United States and is representative of businesses spanning every size and nature.
The NACM is very pleased to support HR 833 because of the commercial laws it improves, and my comments will only focus on these commercial issues raised in the proposed legislation.
Sections 401 through 415 contain the provisions dealing with small business reorganizations. NACM supports the efforts to create substance and procedure to expedite the administration and conclusion of reorganization cases for small businesses. Considering the hundreds of billions of dollars of creditor claims that are tied up in business bankruptcies, the expeditious conclusion of a reorganization proceeding, whether by confirmation or dismissal, promotes the economic interests of all concerned. Studies and statistics have continued to dramatically show that where small businesses which could successfully reorganize, fully or partially satisfy claims of creditors, continue in the economic stream, create employment and pay taxes, have been unable to do so because of the pressures of the time and expense because of their languishing in Chapter 11. NACM has been a constant supporter of efforts to streamline the process for the prompt resolution of small business reorganizations which will benefit the entire economy.
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It has been statistically demonstrated that more than 80 percent of business bankruptcy cases that are filed involve small businesses. If this legislation is enacted, it could have the effect of helping to streamline the bankruptcy process by eliminating much of the time consuming issues that currently involve such cases. Moreover, given the very low rate of successful reorganizations of businesses who file Chapter 11, the improvements contained in the legislation to the reorganization process for small businesses should dramatically affect the reorganizations on a positive basis.
NACM is equally supportive of the provisions contained in Sections 211 and 212 of the Bill to correct inequities which currently exist with respect to the avoidance of preferential transfers. While NACM supports the concept of the equality of treatment of creditors, the current statute creates an environment for the feeding frenzy of trustees and attorneys and others not part of the creditor body at the expense of vigilant trade creditors, with no ultimate benefit being derived by creditors of the bankruptcy estate.
The changes rectify problems in two important areas. The clarification of what constitutes an ordinary course of business transfer rectifies doubt and uncertainty which has permeated the case law and created difficulties for the ordinary transaction of business with distressed debtors. The mere fact that a business may be in financial distress should not create an impediment to ordinary course dealings. Indeed, if this were to be the case, it would only precipitate additional bankruptcy filings. The change created by the legislation clarifies that creditors willing to continue to extend credit to financially distressed businesses will not be penalized.
Likewise, the changes with respect to when and where certain preference actions may be filed are equally beneficial. Statistics have shown that bringing preference actions for $5,000 or under does nothing to substantially enhance distribution to creditors, but does provide for substantial attorneys fees. Additionally, bringing preference actions in distant courts only forces unreasonable capitulation by creditors where they may have legitimate defenses, but cannot put them forward due to the cost involved. These changes will, as well, protect creditors who act in good faith when dealing with financially distressed businesses.
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These changes, which are consistent with the recommendations of the National Bankruptcy Review Commission, will help to create an environment of an ''even playing field'' with respect to bankruptcy administration. Additionally, these provisions, if enacted, will eliminate unnecessary and unproductive litigation which can affect the already overburdened bankruptcy court system which, as I have noted, produces no real benefit to the creditors of the bankruptcy estate.
Currently, instead of having the trade creditor class be the beneficiary of preferential transfer recoveries, the funds that are recovered are paid to the professionals who are employed to recover them, secured creditors, and those unaffiliated with the general creditor body. This has resulted in a large ''breakdown'' of the system requiring vigilant trade creditors to expend considerable sums for representation only to learn that the ultimate beneficiaries of the recoveries do not correlate to those intended by the original legislation.
NACM wholeheartedly supports the language in Section 206 which permits the court to change the membership of the creditors committee if the change is necessary to ensure adequate representation of creditors and equity security holders. Presently, there is no judicial redress in the event that for whatever reason a creditors committee that is appointed does not adequately represent the creditors as a whole. This provision correctly provides for appropriate judicial oversight of a very important component of the bankruptcy reorganization process.
NACM does wish to call to the Committee's attention its view that the efforts to change the reclamation provisions contained in Section 208 of the bill may not achieve the purposes intended, and, to the contrary, may be detrimental to effective reorganization. Currently, when dealing with the reclamation of goods, the current law does not protect the rights of manufacturers and distributors in most cases. Some of the legal and practical problems that have been created are the following:
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Vendors do not know of the filing of a bankruptcy proceeding in sufficient time in order to give a reclamation notice.
Current law permits reclamation only when the goods are still in the possession of the Debtor when notice is received. With multiple operations of a Debtor, this becomes impossible to prove or verify.
The rights of secured creditors pre-empt any reclamation rights.
There is no sanction on the Debtor for failing to comply with the reclamation notice.
Vendors are required to immediately hire counsel in order to protect reclamation rights, only to be delayed by the lengthy court proceedings.
The procedure gives the Debtor opportunities to force concessions from vendors with respect to post-petition credit in order to gain concessions with respect to reclamation.
Traditionally, manufacturers, distributors and other vendors receive little benefit from the current reclamation law.
Increasing the reclamation period from 20 to 45 days will not solve the problem. While this initially appears to protect vendors, it may have the opposite effect. If the reclamation date reaches too far back, Chapter 11 debtors will not be able to confirm a Chapter 11 Plan because of the burden of administrative claims that may be required to be paid on confirmation as a result of the reclamation demands. Placing unreasonable burdens on debtors in order to effect a confirmation does not protect the interests of creditors in the long run.
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NACM suggests that rather than changing Section 546(c) of the Bankruptcy Code, the Section should be deleted. NACM suggests that the following new subparagraph c be added to Section 503 of the Bankruptcy Code:
A person that is a seller of goods or a provider of services that has sold goods or provided services to the debtor in the ordinary course of such person's business shall have the right to an administrative expense for all goods or services received by the debtor within 20 days of the commencement of the case.
NACM believes that the following will be the benefits of such a change:
All vendors of goods will be protected.
There will be no ''race'' to the courthouse to file notices.
Vendors will not be adversely prejudiced if they do not know of the bankruptcy filing during the first days following the filing.
All vendors of goods will be entitled to an administrative priority claim for the goods actually received by the Debtor within 20 days of the filing of the bankruptcy case. Thus, Debtors contemplating the filing of a bankruptcy proceeding will have a deterrent to ''loading up'', as they will know that in order to confirm any Chapter 11 Plan, they will have to pay in full for all goods received within the 20-day period at the time of confirmation, not just those that are in inventory when notice is received.
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This does not in any way alter the rights of secured creditors, so there should be no opposition by lenders. It does, however, impose a payment obligation on the Debtor which may have to be funded by the lenders in order for a Chapter 11 Plan to be confirmed.
Solvency or insolvency of the Debtor is no longer an issue to be considered or litigated.
The issue of whether the goods are on hand and are identifiable is no longer an issue to be considered or litigated.
NACM has previously expressed its concern with the language contained in Section 205 of the bill. While NACM clearly supports the most expeditious administration of bankruptcy cases as possible, artificial deadlines should not be created merely to enhance the rights of one constituency. Artificially limiting a debtor's right to assume or reject the lease at 180 days may not always be in the best interest of all creditors and other parties in interest. There is no problem in establishing a deadline which should be the ''normal'' deadline, but there must be flexibility built into the law to permit the court to modify the deadline if facts and circumstances so warrant. The current Section 205 creates a burden upon large retailers and other similar businesses which may lead to decisions which have a long term effect on the reorganization process being hastily made. NACM urges that the proposed legislation be modified to provide that the court may extend the period to be determined under the amendment within the discretion of the court.
When dealing with the provisions of Section 202 of the Bill, as a practical matter, NACM recognizes that in most prepackaged reorganization proceedings, there is no need for a meeting of creditors, and, upon appropriate motion to the court, after appropriate notice, the court should be able to order that no meeting of creditors need be held. NACM's recognition is based on the continued insertion in the bill of the phrase ''after notice and hearing'' so that the Court is not able to eliminate a meeting of creditors without first giving those creditors affected an opportunity to respond.
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NACM is extremely supportive of the legislation to create new and additional bankruptcy judges. Given the very substantial increase in bankruptcy filings over the last several years, this has created a hardship on the bankruptcy courts. Even though the greatest proliferation of bankruptcy cases is in the consumer area, a clogged bankruptcy court does not effectively permit business debtors and creditors to have their issues resolved on a timely basis.
NACM totally supports the sense of the Congress reflected in Section 607 of the Bill which urges a modification of the Bankruptcy Rules to place a greater responsibility on principals of the debtor and attorneys for the debtor with respect to information provided to the court and creditors on which all parties and the court rely. While the vast majority of papers filed in bankruptcy cases are based upon facts and law that are verified, the courts have noted instances where important documents, especially schedules and statements of affairs, are haphazardly and irresponsibly filed with the court. The clarification to Bankruptcy Rule 9011, as suggested by the sense of Congress, will clarify and strengthen the rights of creditors.
With respect to Section 1012 of the Bill dealing with asset based securitization, NACM has some deep concerns. The effect of this provision would be to remove from the jurisdiction of the bankruptcy court assets that in some instances may be part of the estate for the sole benefit of the secured creditor. This shift will have an adverse impact on other classes of creditors. This will have a chilling effect on Americas trade credit grantors in the day to day extension of credit, by removing any potential for recovery in the event of a default. Additionally, the Committee might want to consider the impact that this provision will have on the ability of the I.R.S. to collect taxes in a default situation.
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Mr. Chairman, I ask that the written submission of the National Association of Credit Management which contains additional comments with respect to the proposed legislation be made a part of the record of these proceedings. I thank the Chair, the Committee and its staff for not only the opportunity to participate in these hearings, but also the cooperative responsiveness in working towards a prompt passage of this most important legislation.
Mr. GEKAS. We thank you, Mr. Tatelbaum.
Ms. Miller?
STATEMENT OF JUDITH GREENSTONE MILLER, ESQUIRE, CLARK HILL, PLC, BIRMINGHAM, MI, ON BEHALF OF THE COMMERCIAL LAW LEAGUE OF AMERICA
Ms. MILLER. Good afternoon. It's an honor to appear before the subcommittee for the second time in 7 days.
I am here on behalf of the Commercial Law League of America. The League supports changes to the Bankruptcy Code to limit abuses by debtors and creditors and to improve and facilitate reorganization of financially-troubled businesses.
I'd like to address a number of the provisions that deal with business issues, some of which we support and some of which we'd like to see some modification.
As a number of the witnesses that have appeared before you today have suggested, section 205 presents problems because it changes the time for assumption or rejection of non-residential leases from 60 to 180 days and provides that the period may only be extended with the consent of the lessor.
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This tips the balance that's inherent in the Code to the detriment of the debtor and its unsecured creditors. Either a debtor will prematurely assume a lease, and then if he doesn't successfully confirm a plan, create a huge administrative expense, such that unsecured creditors are likely to receive nothing, or prematurely reject the lease that is necessary and essential to facilitate a plan, and thereby negate the ability to confirm a plan and provide for distribution to unsecured creditors.
By placing the power solely with the lessor and not giving the court any discretion to determine whether justification exists, it gives the lessors too much bargaining power and to exert additional concessions from the lessee.
This is particularly troubling in the cases that Mr. Tatelbaum just suggested. The Christmas example is the example that's in my written material, so I won't repeat it for you, other than to say there are safeguards in the Code currently in terms of administrative priority rent, and the lessor, as long as he is getting paid under the terms of contract, which is what the Code provides for, is getting the benefit of his bargain.
He is protected more than the unsecured creditors currently and that balance shouldn't be tipped.
With respect to section 211 of the Code, we support the amendment of the ordinary course defense for preferences, the disjunctive tests, by focusing on the historical business relationship, rather than having to prove industry standards which is typically cost-prohibitive except for in the largest types of cases, is an improvement.
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We also support establishing the per se safe harbor at $5,000 for avoidance of non-consumer debt.
However, we do not support the change-of-venue provision in section 212 for preference actions between the levels of $5,000 and $10,000 to the creditor's place of business.
It will make it more costly for the estate to administer, it'll have potential inconsistent adjudications, and it may prompt manipulation and forum shopping to a jurisdiction where a more favorable result may have been received, based upon a court's ruling.
Section 212 restricts the ability of the court to extend the time for confirmation and filing of a plan. Historically, rigid standards have not worked well. It's likely to squelch negotiations.
Creditors are likely to exert leverage with the threat of a competing plan, and debtors are likely to move for confirmation of non-consensual plans, which are costly and undesirable.
District courts currently have the jurisdiction to hear interlocutory appeals and that is an adequate remedy to address creditors' concerns.
With respect to section 216, which is proposed to remedy the Claremont decision, as drafted, the section does not apply to executory contracts involving intellectual property and does not address cures of non-punitive, non-monetary defaults.
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If those two items could be addressed, we would support it.
With respect to the small business proposal, we endorse the adoption of a small business proposal. In fact, the Commercial Law League in conjunction with the National Bankruptcy Conference submitted a draft small business proposal to Congress last Session and has again submitted it this Session.
Our proposal differs in three significant respects. We provide greater flexibility for extensions. We provide different types of reporting requirements, and lastly we suggested the debt limit for small business cases be at the $2 million level rather than at the $4 million level.
A $4 million case may be a small case in New York, but it's definitely not a small case in most of the jurisdictions across the country.
It's important to provide flexibility for small businesses and sufficient time to work under a new business plan.
Allowing small businesses to succeed not only results in payment to creditors but employees retaining their jobs and communities not suffering from diminutions of their tax bases.
I'd like to also suggest that we support the removal of the cap in single-asset cases under section 1101. We also support section 1117, but suggest that a substantive change be made to change the reference to transfers rather than security interests.
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Lastly, section 1127 of the bill proposes to limit the ability of nonprofit corporations from transferring their property to the extent that such transfers do not comply with applicable nonbankruptcy law.
With the rising number of health care bankruptcies and the fact that most health care facilities are nonprofit corporations, that will severely impact the ability of health-care facilities to reorganize.
If they cannot successfully reorganize, unsecured creditors will not get paid.
I thank you very much for the opportunity to speak before you today.
[The prepared statement of Judith Greenstone Miller, Esquire, follows:]
PREPARED STATEMENT OF JUDITH GREENSTONE MILLER, ESQUIRE, CLARK HILL, PLC, BIRMINGHAM, MI, ON BEHALF OF THE COMMERCIAL LAW LEAGUE OF AMERICA
I. INTRODUCTION
The Commercial Law League of America (the ''League''), founded in 1895, is the nation's oldest organization of attorneys and other experts in credit and finance actively engaged in the fields of commercial law, bankruptcy and reorganization. Its membership exceeds 4,600 individuals. The League has long been associated with the representation of creditor interests, while at the same time seeking fair, equitable and efficient administration of bankruptcy cases for all parties involved.
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The Bankruptcy and Insolvency Section of the League (''B&I'') is made up of approximately 1,600 bankruptcy lawyers and bankruptcy judges from virtually every state in the United States. Its members include practitioners with both small and large practices, who represent divergent interests in bankruptcy cases. The League has testified on numerous occasions before Congress as experts in the bankruptcy and reorganization fields.
The League, its B&I Section and its Legislative Committee have analyzed the business provisions of H.R. 833, the Bankruptcy Reform Act of 1999 (the ''Bill''). The League supports changes to the Bankruptcy Code (the ''Code'') to limit abuses by debtors and creditors and to improve and facilitate the reorganization of financially troubled businesses. Any proposed change will have consequences on the system. It is the goal of the League to help Congress carefully consider the practical implications of each change in order to maintain the delicate balance between debtors' rights and creditors' remedies and to effectuate fair treatment for all parties involved in the process.
II. ANALYSIS OF BUSINESS PROVISIONS
Section 205—Executory Contracts and Unexpired Leases
This sections proposes to change the time for assumption or rejection of nonresidential leases from 60 days to 180 days. The 180-day time period may only be extended with the consent of the lessor. The League opposes this provision because it tips the delicate balance contained in the Code by placing landlords of nonresidential real property in the position of forcing assumption or rejection within the earlier of 180 days after the entry of the order for relief or the date of entry of the order confirming a plan. As long as landlords are receiving rental payments consistent with Section 365(d)(3), there is no reason to create an arbitrary, inflexible and unrealistic deadline, which will inure to the detriment of the debtor and its unsecured creditors. The debtor is likely to prematurely assume a lease in order to facilitate a reorganization, and thereby create a large administrative expense for the estate if subsequently it is unable to successfully reorganize. On the other hand, this proposed modification to Section 365 of the Code may force a debtor to prematurely reject a lease necessary and essential to facilitate a reorganization and to negate the potential prospective administrative hit from failing to confirm a plan. In addition, the only way the time period may be extended is upon motion of the lessor; the court would no longer have any discretion to determine whether justification existed to extend the time period or whether an extension was in the best interest of creditors and the estate. This provision gives too much bargaining power to the lessor, is likely to result in the extraction of additional benefits or concessions by lessors, and impacts the debtor's ability to successfully reorganize, particularly in cases involving multiple shopping center locations. For example, take a debtor with multiple retail locations in shopping centers who files bankruptcy in March. Under the proposal, the debtor will be forced to make a decision to assume or reject prior to the Christmas season, when sales at that time are so crucial in assessing the likelihood of its reorganization and new business plan.
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The League believes that the Code, as currently drafted, appears to be working well, and is not in need of revision. If, however, Congress nevertheless believes that landlords are not adequately protected by the current safeguards contained in the Code (e.g., requirement that debtors timely pay postpetition rental charges, administrative priority treatment for nonpayment of postpetition rental charges, 60-day period to assume or reject that can be extended upon showing of ''cause''), Congress may wish to consider bolstering the current Code provisions to provide a better remedy for lessors when debtors fail to perform their postpetition obligations under the lease. However, as long as lessors are receiving what they are entitled to under the lease, they are receiving the benefit of their bargain and should not be able to tip the delicate balance by suggesting that Congress establish a rigid and inflexible period by which assumption or rejection takes place, particularly when that decision ultimately affects the potential distribution made to unsecured creditors under a plan.
Section 211—Preferences
According to its legislative history, the purpose of the ordinary course of business exception was to leave undisturbed normal financial relations because it does not detract from the general policy of the preference section to discourage unusual actions by either the debtor or its creditors during the debtor's slide to bankruptcy. Despite the noble intentions of Congress, the ordinary course of business exception in its present form has not left normal financial relations undisturbed, but rather has produced a tremendous amount of legal uncertainty. This uncertainty has arisen due to the development of complicated standards that courts apply on a case by case basis. Currently Section 547(c)(2) of the Code requires compliance with a subjective test (e.g., a creditor show that a voidable preference was received was ordinary in relation to prior dealings between the creditor and the debtor) and an objective test (e.g., a creditor must show that the payment received was not ''unusual'' within relevant industry norms). Evaluating relevant industry norms has proved complex, expensive and cumbersome, and has produced uncertainty in the application of the ordinary course of business exception.
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The League supports the provision to amend the ordinary course of business exception to Section 547(c)(2). The disjunctive test allows preference defendants to defend a preference claim by focusing on the historical business relationship between the debtor and the creditor without also having to prove industry standards (which is typically cost prohibitive except in the largest types of preference litigation). Because this proposal creates an objective standard, if adopted, it would substantially decrease the legal uncertainty that pervades current case law involving the ordinary course of business exception and would make preference litigation more efficient and predictable. Moreover, administrative costs relating to preference suits would be diminished, leaving more assets available for distribution to creditors.
The League also recommends the establishment of ''per se'' safe harbors, thereby reducing the amount of preference litigation. The League supports the increase of the minimum threshold requirement for commencement to $5,000 for avoidance of nonconsumer debt. Adoption of this proposal will protect the small trade creditor from abusive litigation tactics by aggressive trustees.
Section 212—Venue of Certain Proceedings
The League opposes the proposed change requiring venue of preference actions involving the avoidance of nonconsumer debts against noninsiders of less than $10,000 be commenced at the creditor's place of business. This change will be detrimental to the estate and the unsecured creditors because (i) it will be more costly to pursue these claims outside of the court where the main bankruptcy case is filed, (ii) such litigation could result in inconsistent adjudications on the elements of a preference and (iii) it could prompt manipulation and forum shopping to establish the elements of a preference action.
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Section 213—Period for Filing Plan Under Chapter 11
This provision restricts the ability of the court to extend the 120-day period for filing a plan and the 180-day period for confirming a plan to 18 and 20 months respectively from the filing of the petition. The League opposes this provision because it does not provide the requisite flexibility to permit longer periods of exclusivity under compelling circumstances. Data from the Executive Office for the United States Trustees accurately indicates that plans are confirmed more quickly now than in the 1980's; other data shows that the exclusivity period in successful larger cases averages longer than 18 to 20 months. Historically, inflexible, rigid standards have not worked well, and in the context of exclusivity, are likely to squelch negotiations long before the exclusivity periods expire, as creditors exert leverage with the threat of a competing plan. More debtors in possession will seek confirmation of nonconsensual plans, a costly and undesirable result. Under the 1994 amendments, district courts have jurisdiction to hear appeals from orders increasing the exclusivity period, 28 U.S.C. §158(a)(2), which provides creditors and parties in interest a remedy to address unwarranted extensions of exclusivity.
Section 216—Defaults Based on Nonmonetary Defaults
The genesis for amending subsection 365(b)(2)(D) of the Code is the decision by the Bankruptcy Court and the Ninth Circuit Court of Appeals in Worthington v. General Motors Corp. (In re Claremont Acceptance Corp.), 186 B.R. 977 (C.D. Cal. 1995), aff'd., 113 F.3d 1029 (1997). This provision seeks to clarify the requirements for cure of nonmonetary defaults in executory contracts and leases by providing that a trustee's requirement to cure does not apply to a penalty rate or penalty provisions relating to a default arising from failure to perform nonmonetary obligations under an unexpired lease of real or personal property. Requiring cure and performance of nonmonetary defaults and obligations as part of an assumption can be critical (e.g., maintenance of equipment). The provision, as drafted, does not apply to executory contracts involving intellectual property and does not address cure of nonpunitive, nonmonetary defaults. The League believes it is important to remedy the problem created by the Claremont decision, however the language proposed by Congress does not achieve the intended result. The League previously submitted alternative draft language for consideration by Congress, and welcomes the opportunity to assist Congress with addressing this recognized problem.
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Section 301—Disinterestedness
Section 301 defines ''disinterestedness,'' presumably addressing concerns that certain minor conflicts (such as a minor amount owed by a debtor to a prospective attorney) should not prohibit the employment of a professional. The standard set forth in the Bill, however, is not as broad as initially proposed by the League. The League suggested that the Bankruptcy Court be given broad discretion to review possible conflicts after full disclosure, using a materially adverse interest standard, rather than a standard of any adverse interest. The League continues to support this broader standard because it believes that bankruptcy courts are in the best position to evaluate and exercise discretion on this issue. This change must also be reconciled with Section 327 of the Code, which uses the standard, ''adverse interest.'' A professional may be ''disinterested,'' but nevertheless be disqualified because of the existence of a conflict which constitutes an adverse, but not material, interest. Accordingly, the League recommends that Section 327 be amended by adding ''materially'' between the words ''adverse interest'' in Section 327(a) of the Code.
Title IV—Small Business Bankruptcy Provisions
The League endorses the adoption of small business provisions to address the reorganization of small businesses. The League, in conjunction with the National Bankruptcy Conference, drafted proposed legislation and submitted it to Congress for consideration. A copy of the small business proposal is attached to this statement. The small business proposal of the League differs in three significant respects from the provisions of the Bill.
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First, the League has proposed that the small business provisions be limited to entities having no more than $2.0 million in debts, while the Bill proposes a limit of $4.0 million. The larger dollar limit would encompass 85% of the Chapter 11 business cases. Moreover, a business with debt of $4.0 million is not a small business. Shorter deadlines will not permit such a business to effectively reorganize. It is important to allow the larger businesses with greater employees the opportunity to reorganize under traditional standards—fostering such reorganizations serves to foster jobs and retain the tax base for local taxing authorities.
Second, the League has recommended that debtors be required to comply with various reporting requirements in order to provide meaningful information to creditors and parties in interest. The League's reporting requirements are not as stringent as contained in the Bill. For example, the League's proposal requires the debtor and its attorney to file a statement within three days of the entry of the order of relief verifying that the debtor has been informed of its duties. No such comparable provision is contained in the Bill. The filing of such a statement ensures that the debtor is adequately advised of its duties upon the commencement of the proceeding so the case does not languish for lack of information about one's obligations. The Bill requires the debtor to file various financial reports within three days of the commencement of the case. The League believes that this time period is too short and likely to result in less accurate information. Therefore, the League suggests that such financial information be filed within twenty days of the commencement of the case. Such information should include most recent tax returns, balance sheets, income statements and cash flows prepared on a monthly, or if not available, a quarterly basis for the one year period preceding the filing. Requiring reports on profitability and projected cash, as set forth in the Bill, is difficult for a small business to prepare and not likely to prove accurate or reliable in gauging the success and viability of a small business.
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Third, the League has stressed flexible standards for the extension of time periods. For example, while the League believes that the schedules and statements of affairs should be filed within thirty days of the filing of the petition, the debtor should not be required to demonstrate ''compelling and extraordinary circumstances'' to obtain an extension of this time period—a reasonable justification should suffice. The League, like the Bill, endorses a ninety day exclusivity period for the filing of a plan of reorganization by a small business. The Bill, however, requires a debtor to demonstrate that there is a reasonable likelihood that a plan will be confirmed to obtain an extension of the exclusivity period, while the League has suggested that demonstrating that the extension is in the best interest of the creditors and the estate be sufficient to extend the exclusivity period. If the creditors and the estate, the primary beneficiaries of a plan, are benefitted from such an extension, the confirmability of the plan should not be the focus at that juncture.
The League's small business proposal also contains a serial filing provision that prohibits a Chapter 11 or Chapter 12 debtor from filing a subsequent Chapter 11 or 12 absent demonstrating, by a preponderance of the evidence, ''circumstances that were not reasonably foreseeable at the time of the dismissal/conversion of the prior case.'' In contrast, the Bill requires the debtor to demonstrate ''circumstances beyond the control of the debtor and not foreseeable at the time the case then pending was filed and that it is more likely than not that the court will confirm a feasible plan, not a liquidating plan, within a reasonable time.'' The standard delineated in the Bill is overly onerous and subject to litigation and manipulation. If the debtor cannot demonstrate the need for the second filing under the League's proposal, the automatic stay is lifted fifteen days after the filing. This time period allows for a swift determination so that in abusive cases debtors are not permitted to maintain the benefits derived from an improper serial filing. The Bill, unlike the League's proposal, does not except out successors who are not related to the prior debtor (e.g., purchasers of assets, where the purchaser is not an insider of the prior debtor or otherwise related to the prior debtor). There is no policy justification to preclude filings under such circumstances.
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The success and viability of financially troubled small businesses depends on the drafting of legislation that permits the small business to develop a new business and competitive plans. While the League recognizes it is important not to allow ''DOA'' cases to languish when there is no hope of reorganization, it is equally important to provide small businesses with a breathing spell to determine whether and how they can successfully reorganize. If such businesses are not given sufficient time and flexibility, a successful reorganization is doomed from the filing, and ultimately will result in losses—the creditors will not be able to obtain repayment on their debts, employees will lose their jobs and local communities will suffer diminution of their tax bases. Recognizing that small businesses are vital to our economy and that four out of five small businesses do not succeed, it is important to provide a mechanism that fosters such reorganizations.
Title VIII—Bankruptcy Tax Provisions
Section 724(b)(2) delineates the treatment for certain liens in Chapter 7 proceedings. Specifically, it sets forth the distribution of property, or proceeds of such property, in which the estate has an interest subject to an otherwise unavoidable lien that secures an allowed claim for a tax. Section 801 of the Bill proposes to limit the extent to which such liens may be subordinated and for whose benefit. The Bill precludes the subordination of ad valorem tax liens. Moreover, the Bill limits subordination solely for wage claimants. The proposal fails to consider that these limitations will significantly impact the success of a reorganization effort. Restricting the section's applicability to wage claimants will inhibit participation of administrative and trade creditors during the bankruptcy process. Financially strapped businesses may be unable to obtain quality representation or trade credit. If such businesses are unable to successfully reorganize and forced to liquidate, jobs will be lost, the going concern value of the assets will dissipate and tax bases will be eroded. These ramifications must be considered and balanced against the government's interest in protecting tax revenues as part of the overall legislative process.
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Section 810 of the Bill proposes to eliminate balloon payments for taxes under Chapter 11 plans and to require equal, quarterly payments for taxes, even if they are secured, within five years, instead of the current six year time period. This provision is likely to have a devastating effect on the ability to confirm or consummate chapter 11 plans of reorganization. Moreover, taxing authorities are being preferred over the unsecured creditors of the estate—if this provision is adopted, they will have to await years to receive payment so that the taxing authorities receive payment within the proposed parameters. The League, therefore, recommends that the provision be redrafted to provide for the payment of ''regular,'' as opposed to ''equal,'' payments over a six year period, as currently required under the Code.
Several of the provisions in Title VIII of the Bill favor the government as a creditor over other creditors of the estate. See e.g., Sections 804, 812 and 818. The League has consistently opposed any legislation that represents ''special interests'' and without policy justification that prefers one class of creditor over another class of creditor. These provisions attempt to favor the government at the expense of the other creditors of the estate without any justification, and therefore, are opposed by the League.
Section 1012—Asset Backed Securitizations
This section would allow many transactions to be structured so that in the event of bankruptcy no cash collateral would be available for funding a reorganization or repaying unsecured creditors. This is because of the overly broad definition which treats many secured loans as asset transfers, which in turn would remove those assets from property of the bankrupt's estate. Removal of such assets from the estate will virtually ensure a shortage of cash, and thereby create a crisis for many troubled businesses whose receivables represent the only sources of liquidity. Because this provision represents a departure from the federal policy of favoring reorganizations over the liquidation of viable business enterprises, the League opposes this provision.
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Section 1101—Definitions
This provision of the Bill proposes to eliminate the $4.0 million cap for single asset real estate cases contained in Section 101(51B) of the Code. The League has consistently endorsed this proposal and believes that the characteristics of a single asset real estate case (e.g., two party dispute, no employees, claims of unsecured creditors are minimal) do not justify maintenance of the cap. Substantive rights should not be determined on the amount of debt or the amount of assets and claims. Unusually large isolated cases do not justify maintenance of the cap—in such cases, debtors retain the protections under the Code as long as they commence making adequate protection payments or file a plan within the 90 day period. The League also recommends that Congress consider modifying Section 362(d)(3)(B) to provide that the adequate protection payments required by a single asset real estate debtor be calculated at the contract rate in order to preclude needless and costly litigation over the adequacy of the proposed payment. Moreover, such payment represents the benefit of the bargain negotiated between the parties, and precludes either party from receiving a windfall as a result of a change in market rates.
Section 1117—Preferences
Congress has added Section 547(h) to include additional anti-Deprezio language, e.g., the avoidance of a security interest would only be avoidable as to the insider and not as to an entity that is not an insider. The League supports this substantive change. The amendment could be improved, however, by referring to ''transfers'' rather than ''security interests.'' In particular, ''security interest given'' should be replaced with ''transfers made'' and ''such security interest shall be considered to'' should be replaced with ''such transfer may be avoided.''
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Section 1121—Appointment of Elected Trustee
The provision amends Section 1104(b) of the Code to provide for a reporting requirement by the U.S. Trustee regarding the election of a Chapter 11 trustee. Where and to whom is the report required to be filed? Although the provision gives the court the authority to resolve any disputes regarding the election of a trustee, the League recommends that Section 1104(b)(2)(B) be revised to definitively provide that the court ''shall'' resolve any dispute arising out of an election under subparagraph (A). The court is clearly the appropriate venue and arbiter of such disputes.
Section 1127—Transfers Made by Nonprofit Charitable Corporations
This provision limits the ability of nonprofit corporations from transferring their property to the extent that such transfers do not comply with applicable nonbankruptcy law. This provision is likely to have a devastating impact on the ability of health care facilities to successfully reorganize. Most health care facilities are nonprofit corporations, and therefore, they will be severely impacted by passage of this provision. With heath care bankruptcies on the rise, it is important to consider the impact that this provision will have on their viability. Adoption of this provision will also injure creditors in their ability to be repaid on their debts, and therefore, is opposed by the League.
Section 1129—Protection of Purchase Money Security Interests
This section extends the time to perfect a security interest from 20 to 30 days, and thereby precludes its avoidance as a preference. However, this extended time period should be made consistent with applicable state law perfection time periods. The League, therefore, proposes that the applicable state law perfection time periods apply to such transactions, but in no case should the effective date for such a transfer for preference purposes be less than 10 days or more than 30 days. Adoption of this modification would not serve as a trap for the unwary creditor, who complies with applicable state law but then ends up trapped by different standards in the Code.
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III. CONCLUSION
The League appreciates the opportunity to testify and comment on the business proposals contained in the Bill. The League believes that such legislation must carefully weigh debtors' rights with creditors' remedies to maintain a balanced system in order to foster non-special interest, bankruptcy reform. Through such a process, financially troubled businesses can be successfully reorganized, jobs maintained, creditors repaid and the economy fostered and made healthier.
Respectfully submitted,
| Jay L. Welford, Co-Chair, Legislative Committee, |
| Bankruptcy & Insolvency Section of the |
| Commercial Law League of America |
| Judith Greenstone Miller, Co-Chair, |
| Legislative Committee, |
| Bankruptcy & Insolvency Section of the |
| Commercial Law League of America. |
Enclosure:
TITLE II—SMALL BUSINESS AND FAMILY FARMER CASES
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SUBTITLE I—SIMPLIFICATION OF SMALL BUSINESS CASES
Sec. 201. Short Title.
This title may be cited as the ''Small Business Bankruptcy Simplification Act''.
SEC. 202. SMALL BUSINESS DEFINED.
(a) Section 101 of title 11, United States Code, is amended by striking paragraph (51C) and inserting:
''(51C) 'small business case' means case filed under chapter 11 of this title in which the debtor is engaged in a business that has fixed, liquidated debts as of the date of the filing of the petition of $2,000,000 or less (excluding any debt owed to an insider), unless the debtor is a member of a group of affiliates that have in the aggregate fixed, liquidated debts greater than $2,000,000 (excluding any debt owed to an insider).
(b) Conforming Amendment. Section 1102(a)(3) of title 11, United States Code, is amended by deleting ''a case in which the debtor is'' and inserting ''case'' after ''small business''.
Sec. 203. Flexible Rules for Disclosure Statements and Plans.
(a) Section 1125(f) of title 11, United States Code, is amended to read as follows:
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''(f) Notwithstanding subsection (b) of this section—
''(1) in determining whether a disclosure statement contains adequate information, the court shall consider the complexity of the case, the benefit of additional information to creditors and other parties in interest, and the cost of providing additional information; and
''(2) in a small business case, the court may approve a disclosure statement submitted on standard forms approved by the court or adopted under section 2075 of title 28.
(b) Section 1125 of title 11, United States Code, is amended by adding at the end thereof:
''(g) Notwithstanding subsection (b) of this section, in a small business case—
''(1) the court may conditionally approve a disclosure statement subject to final approval after notice and a hearing;
''(2) an acceptance or rejection of a plan may be solicited after the commencement of the case under this title from a holder of a claim or interest with respect to the claim or interest, if, at the time of or before the solicitation, there is transmitted to such holder a written disclosure statement, conditionally approved by the court as containing adequate information; and
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''(3) a hearing on final approval of a disclosure statement may be combined with the hearing on confirmation of the plan.''.
Sec. 204. Standard Form Disclosure Statement and Plan and Uniform Reporting Rules and Forms.
Section 2075 of title 28, United States Code, is amended by adding at the end thereof:
''The Supreme Court shall have the power to prescribe by general rules, for use in small business cases under title 11, the forms of plans and disclosure statements and, for use in small business cases and cases under chapter 12 of title 11, rules and the forms to be used to comply with sections 1115 and 1209 of title 11, United States Code. Any such forms and rules shall be designed to satisfy the needs of the court, the United States trustee or bankruptcy administrator, creditors, and other parties in interest for adequate information, while seeking to achieve economy and simplicity for the debtor.''.
Sec. 205. Duties and Uniform National Reporting Requirements in Small Business Cases.
(a) DUTIES AND REQUIRED REPORTING. (1) Title 11 of the United States Code is amended by inserting after section 1114 the following:
''§1115. Duties of debtor in possession in a small business case
''(a) This section applies only in a small business case.
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''(b) A debtor in possession shall—
''(1) within three days after the date of the order for relief under this chapter, file a statement, verified by the debtor in possession and by any counsel employed or proposed to be employed under section 327 of this title, that the debtor has been informed of the duties and responsibilities of a debtor in possession;
''(2) within 20 days after the date of the order for relief under this chapter, transmit to the United States trustee—
''(A) a copy of the debtor's most recent Federal income tax return, which the United States Trustee shall make available, on request, to a party in interest for inspection only ; and
''(B) any balance sheet, income statement and statement of cash flows for the debtor prepared on a monthly or, if not available, quarterly basis within one year before the date of the order for relief, which the United States Trustee shall make available, on request, to any party in interest, or if any such document does not exist, a verified statement that the document does not exist,;
''(3) attend, through management and with counsel, any initial debtor interview, scheduling conference, confirmation hearing, meeting of creditors under section 341 of this title and any other meeting or hearing if so ordered by the court;
''(4) file all schedules and statements of financial affairs within the time required, without extension, under the Federal Rules of Bankruptcy Procedure, unless the court extends the time to not more than 30 days after the date of the order for relief under this chapter, or, if there is a reasonable justification, a later time;
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''(5) timely file periodic reports that provide the following information—
''(A) the debtor's receipts and disbursements for the fiscal periods specified by the Federal Rules of Bankruptcy Procedure;
''(B) whether the debtor is in material compliance with all postpetition requirements imposed by this title and the Federal Rules of Bankruptcy Procedure;
''(C) whether the debtor has timely filed all tax returns and paid all administrative claims when due, and, if not, what the failures are and how, at what cost, and when the debtor intends to remedy such failures; and
''(D) such other information as the court determines is needed in the best interest of the debtor and creditors and in the public interest in fair and efficient procedures under this chapter.
''(6) timely file all other reports required by the Federal Rules of Bankruptcy Procedure or by local rule;
''(7) to the extent commercially practicable, maintain insurance customary for the kind of business in which the estate is engaged after the date of the order for relief under this chapter;
''(8)(A) timely file all tax returns required for the estate;
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''(B) timely pay all administrative expense tax claims, except claims being contested by appropriate proceedings being diligently prosecuted; and
''(C) establish a separate deposit account not later than ten business days after the date of the order for relief under this chapter (or as soon as possible after the ten-day period if during the ten-day period all banks contacted decline to open the necessary account) and deposit in the account, not later than five business days after receipt, all taxes collected or withheld for a governmental unit;
''(9) timely pay all administrative wage claims; and
''(10) allow the United States trustee to inspect the business premises, books, and records of the debtor in possession at reasonable times, after reasonable prior written notice, unless the debtor in possession waives notice.''.
(b) Conforming Amendment.—The table of sections of chapter 11 of title 11, United States Code, is amended by inserting after the item relating to section 1114 the following:
''1115. Duties of a debtor in possession in a small business case.''.
Sec. 206. Plan Filing Deadline.
Section 1121(e) of title 11, United States Code, is amended to read as follows:
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''(e) In a small business case—
''(1) unless a trustee has been appointed, only the debtor may file a plan until 90 days after the date of the order for relief under this chapter;
''(2) all plans shall be filed within 160 days after the date of the order for relief; and
''(3) on request of a party in interest made within the respective periods specified in paragraphs (1) and (2), and after notice and a hearing, the court may—
''(A) reduce the 90-day period or the 160-day period specified in paragraph (1) or (2) of this subsection for cause;
''(B) increase the 90-day period specified in paragraph (1) of this subsection for cause; and
''(C) increase the 160-day period specified in paragraph (2) of this subsection, after notice and a hearing, if to do so would be in the best interest of creditors and the estate.''.
Sec. 207. Duties of the United States Trustee and Bankruptcy Administrator.
(a) DUTIES OF THE UNITED STATES TRUSTEE.—Section 586(a) of title 28, United States Code, is amended—
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(1) in paragraph (3)—
(A) in subparagraph (G) by striking ''and'' at the end;
(B) by redesignating subparagraph (H) as subparagraph (K); and
(C) by inserting after subparagraph (G) the following:
''(H) in small business cases (as defined in section 101 of title 11), scheduling and holding such meetings with the debtor in possession, at such places as the United States trustee considers appropriate, as may be reasonably necessary to permit the United States trustee to assess the debtor in possession's compliance with the duties and responsibilities of a debtor in possession under title 11 and whether there are material grounds for conversion or dismissal of the case under section 1112 of title 11;
''(I) visiting the appropriate business premises of the debtor in possession and ascertaining the state of the debtor in possession's books and records and verifying that the debtor has filed any required tax returns; and
''(J) in cases in which the United States trustee finds cause for conversion or dismissal under section 1112 of title 11, requesting conversion or dismissal; and''.
(b) DUTIES OF THE BANKRUPTCY ADMINISTRATOR.—A bankruptcy administrator appointed under section 302(d)(3)(I) of the Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986 (Pub. L. 99–554, 100 Stat. 3123), as amended by section 317(a) of the Federal Courts Study Committee Implementation Act of 1990 (Public Law 101–650; 104 Stat. 5115), or the bankruptcy administrator's designee, in a small business case (as defined in section 101 of title 11 of the United States Code) pending in the district for which the bankruptcy administrator has been appointed, shall perform the duties specified in section 586(a)(3)(H), (I), and (J) of title 28 of the United States Code, and the debtor shall transmit to the bankruptcy administrator any information that the debtor is required to transmit to the United States trustee under section 1115(b) or 1209 of title 11.
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Sec. 208. Scheduling Conferences.
Section 105(d) of title 11, United States Code, is amended—
(1) by striking out everything through paragraph (1) and inserting in lieu thereof:
''As soon as practicable after the date of the order for relief, the court—
''(1) in a small business case or a case under chapter 12 of this title shall, and on its own motion or on request of a party in interest in any other case under this title may, hold an initial status conference and such additional status conferences as are necessary to further the expeditious and economical resolution of the case and may direct that a status conference in a case under chapter 12 of this title be held with the standing trustee; and''; and
(2) in paragraph (2) by inserting ''may, on its own motion or on request of a party in interest,'' immediately after ''Procedure,''.
Sec. 209. Serial Filer Provisions.
Section 362 of title 11, United States Code, is amended by adding at the end:
''(k)(1) Notwithstanding any other provision in this section, the filing of a petition under section 301 of this title or of a collusive petition under section 303 of this title does not operate as a stay if and only if—
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''(A) the debtor is a debtor in a case under chapter 11 or 12 of this title that is pending at the time the petition is filed; or
''(B) the case is a case under chapter 11 or 12 of this title and the debtor—
''(i) was a debtor in a case under chapter 11 or 12 of this title that was dismissed for any reason other than excusable neglect by an order that became final within two years before the date of the filing of the petition;
''(ii) was a debtor in a case under chapter 11 or 12 of this title in which a plan was confirmed within two years before the date of the filing of the petition; or
''(iii) has succeeded to substantially all of the assets or business of a debtor described in subparagraph (B) or (C) of this paragraph and was, at the time of the prior debtor's case, an insider of the debtor.
''(2) In a case that is subject to this subsection—
''(A) if the case is the first case in which the provisions of this subsection apply to the debtor or insider successor to the debtor, then the petition shall operate as a stay under subsection (a) of this section for 15 days after the date of the filing of the petition; and
''(B) on request of a party in interest, after notice and a hearing, the court may issue or extend a stay, subject to such conditions as may be appropriate under the circumstances, if the court determines based on a preponderance of the evidence that the circumstances leading to the filing of the petition were not reasonably foreseeable at the time of the dismissal or confirmation, as the case may be, of the prior case, and that there is a reasonable likelihood that the debtor will file a plan that meets the requirement of section 1129 or 1225 of this title, as the case may be. Subsections (c), (d), (e), (f), (g), and (h) of this section apply to any stay issued under this paragraph.''.
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Sec. 210. Conversion or Dismissal of a Chapter 11 Case.
(a) Section 1112(b) of title 11, United States Code, is amended to read as follows:
''(b) Except as provided in subsection (c) of this section, on request of a party in interest or the United States trustee or bankruptcy administrator, and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interest of creditors and the estate, for cause, including—
''(1) unreasonable delay or gross mismanagement by the debtor that is prejudicial to creditors;
''(2) nonpayment of any fees or charges required under chapter 123 of title 28;
''(3) failure to file a plan and disclosure statement within any time fixed under section 1121 of this title or by the court;
''(4) inability to effectuate substantial consummation of a confirmed plan;
''(5) denial of or failure to seek confirmation of a plan within any time fixed under section 1121 of this title or by the court and denial of a request made for additional time for filing another plan or a modification of a plan;
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''(6) material default by the debtor with respect to a confirmed plan;
''(7) revocation of an order of confirmation under section 1144 of this title, and denial of confirmation of another plan or a modified plan under section 1129 of this title;
''(8) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan;
''(9) continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation;
''(10) in a voluntary case, the debtor's failure to file, within fifteen days after the filing of the petition commencing such case or such additional time as the court may allow, the information required by paragraph (1) of section 521, including a list containing the names and addresses of the holders of the twenty largest unsecured claims (or of all unsecured claims if there are fewer than twenty unsecured claims), and the approximate dollar amounts of each of such claim;
''(11) material failure to comply with any applicable reporting requirements of section 1115 of this title;
''(12) failure by a debtor in possession to attend the meeting of creditors under section 341(a) of this tile or an examination ordered under Rule 2004 of the Federal Rules of Bankruptcy Procedure;
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''(13) unauthorized use of cash collateral in disregard of the requirements of this title, causing material harm to one or more creditors; or
''(14) material failure of the debtor in possession to comply with a material order of the court.''.
(b) Section 1112 of title 11, United States Code, is amended by striking subsection (e) and redesignating subsection (f) as subsection (e).
SUBTITLE II—CORRESPONDING AMENDMENTS FOR FAMILY FARMER CASES
Sec. 221. Short Title
This title may be cited as the ''Family Farmer Bankruptcy Simplification Act''.
Sec. 222. Retention of Attorneys for the Debtor.
Section 327(a) of title 11, United States Code, is amended by inserting ''or the debtor in possession in a case under chapter 12 of this title,'' after ''in this section, the trustee,''.
Sec. 223. Duties of Trustee.
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Section 1202(5) of title 11, United States Code, is amended by deleting ''and'' and inserting and '', and 1209'' after ''1203''.
Sec. 224. Duties and Uniform National Reporting Requirements in Family Farmer Cases.
(a) DUTIES AND REQUIRED REPORTING. (1) Title 11, United States Code, is amended by inserting after section 1208 the following:
''§1209. Duties of debtor in possession in chapter 12 case
''A debtor in possession shall—
''(1) within three days after the date of the order for relief under this chapter, file a statement, verified by the debtor in possession and by any counsel employed or proposed to be employed under section 327 of this title, that the debtor has been informed of the duties and responsibilities of a debtor in possession;
''(2) within 20 days after the date of the order for relief under this chapter, transmit to the United States trustee—
''(A) a copy of the debtor's most recent Federal income tax return, which the United States Trustee shall make available, on request, to a party in interest for inspection only; and
''(B) any balance sheet, income statement and statement of cash flows for the debtor prepared on a monthly or, if not available, quarterly basis within one year before the date of the order for relief, which the United States Trustee shall make available, on request, to any party in interest, or if any such document does not exist, a verified statement that the document does not exist;
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''(3) attend, through management and with counsel, any initial debtor interview, scheduling conference, confirmation hearing, meeting of creditors under section 341 of this title and any other meeting or hearing if so ordered by the court;
''(4) file all schedules and statements of financial affairs within the time required, without extension, under the Federal Rules of Bankruptcy Procedure, unless the court extends the time to not more than 30 days after the date of the order for relief under this chapter, or, if there is a reasonable justification, a later time;
''(5) timely file periodic reports that provide the following information—
''(A) the debtor's receipts and disbursements for the fiscal periods specified by the Federal Rules of Bankruptcy Procedure;
''(B) whether the debtor is in material compliance with all postpetition requirements imposed by this title and the Federal Rules of Bankruptcy Procedure;
''(C) whether the debtor has timely filed all tax returns and paid all administrative claims when due, and, if not, what the failures are and how, at what cost, and when the debtor intends to remedy such failures; and
''(D) such other information as the court determines is needed in the best interest of the debtor and creditors and in the public interest in fair and efficient procedures under this chapter.
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''(6) timely file all other reports required by the Federal Rules of Bankruptcy Procedure or by local rule;
''(7) to the extent commercially practicable, maintain insurance customary for the kind of business in which the estate is engaged after the date of the order for relief under this chapter;
''(8)(A) timely file all tax returns required for the estate;
''(B) timely pay all administrative expense tax claims, except claims being contested by appropriate proceedings being diligently prosecuted; and
''(C) establish a separate deposit account not later than ten business days after the date of the order for relief under this chapter (or as soon as possible after the ten-day period if during the ten-day period all banks contacted decline to open the necessary account) and deposit in the account, not later than five business days after receipt, all taxes collected or withheld for a governmental unit;
''(9) timely pay all administrative wage claims; and
''(10) allow the United States trustee to inspect the business premises, books, and records of the debtor in possession at reasonable times, after reasonable prior written notice, unless the debtor in possession waives notice.''.
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(b) CONFORMING AMENDMENT.—The table of sections of chapter 11 of title 11, United States Code, is amended by inserting after the item relating to section 1114 the following:
''1209. Duties of a debtor in possession in a chapter 12 case.''.
Sec. 225. Conversion or Dismissal of Chapter 12 Cases.
(a) Section 1208(b) of title 11, United States Code, is amended by striking ''or 1112'' and inserting '', 1112, or 1307'' in lieu thereof.
(b) Section 1208(c) of title 11, United States Code, is amended to read:
''(c) On request of a party in interest, or the United States trustee or bankruptcy administrator, and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interests of creditors of the estate, for cause including—
''(1) unreasonable delay or gross mismanagement by the debtor that is prejudicial to creditors;
''(2) nonpayment of any fees and charges required under chapter 123 of title 28;
''(3) failure to file a plan within the time fixed under section 1221 of this title;
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''(4) failure to commence making payments under section 1226 of this title within the time fixed by the plan or by the court;
''(5) denial of confirmation of a plan under section 1225 of this title and denial of a request made for additional time for filing another plan or a modification of a plan;
''(6) material default by the debtor with respect to a term of a confirmed plan;
''(7) revocation of the order of confirmation under section 1230 of this title, and denial of confirmation of a modified plan under section 1229 of this title;
''(8) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan;
''(9) continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation;
''(10) fraud committed by the debtor in connection with the case;
''(11) material failure to comply with the reporting requirements of section 1209 of this title;
''(12) failure by the debtor to file, within 15 days after the date of the filing of the petition or such additional time as the court allows, the information required by section 521(1) of this title and a list containing names and addresses of the holders of the 20 largest unsecured claims (or of all unsecured claims if there are fewer than twenty unsecured claims), and the approximate dollar amounts of each such claim;
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''(13) failure by a debtor to attend the meeting of creditors under section 341(a) of this tile or an examination ordered under Rule 3004 of the Federal Rules of Bankruptcy Procedure.
''(14) unauthorized use of cash collateral in disregard of the requirements of this title, causing material harm to one or more creditors; or
''(15) material failure of the debtor to comply with a material order of the court.''.
(c) Section 1208 of title 11, United States Code, is amended by striking subsection (d) and redesignating subsection (e) as subsection (d).
SUBTITLE III—EFFECTIVE DATE
Sec. 241. Effective Date
(a) Except as otherwise provided in this section, this Act and the amendments made by this Act shall take effect 30 days after the date of enactment, but only with respect to cases under title 11 of the United Stated Code commenced 30 days or more after the date of enactment.
(b)(1) The reporting requirements of sections 1115(b)(5), 1115(b)(6), 1209(b)(5), and 1209(b)(6) of title 11, United States Code, as added by this Act, shall take effect 60 days after the date on which rules and forms are prescribed under section 2075 of title 28, United States Code.
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(2) Notwithstanding paragraph (1) of this subsection, the reporting requirements of sections 1115(b)(6) and 1209(b)(6) of title 11, United States Code, as added by this Act, shall take effect 60 days after the date on which, where permitted by section 1115(b)(6), local rules are prescribed by the court in which there is pending a case under title 11 of the United States Code that is governed by section 1115 or 1209, as the case may be, if the requirements have not already taken effect under paragraph (1) of this subsection.
(c) The requirement imposed under sections 1115(b)(1) and 1209(b)(1) of title 11, United States Code, as added by this Act, shall take effect on the date of enactment of this Act, but for cases under title 11 commenced before or within 25 days after the date of enactment, the required statement shall be filed within 30 days after the date of enactment. Until rules and forms are prescribed under section 2075, title 28, United States Code for compliance with sections 1115(b)(1) and 1209(b)(1) of title 11, the court may by local rule prescribe the form of statement to be used.
Mr. GEKAS. We thank the lady, and we turn to Mr. Silvers for 5 minutes.
STATEMENT OF DAMON SILVERS, ESQUIRE, ASSOCIATE GENERAL COUNSEL, AMERICAN FEDERATION OF LABOR AND CONGRESS OF INDUSTRIAL ORGANIZATIONS, WASHINGTON, DC
Mr. SILVERS. Thank you, and good afternoon, Mr. Chairman.
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On behalf of the American Federation of Labor and Congress of Industrial Organizations——
Mr. GEKAS. Could you turn your microphone on?
Mr. SILVERS. Good afternoon, Mr. Chairman, and thank you.
On behalf of the American Federation of Labor and Congress of Industrial Organizations representing over 13 million working men and women and their unions, I would like to thank the subcommittee for the opportunity to represent our views on the important subject of bankruptcy reform.
The AFL–CIO is committed to improving the economic lives of working people and their families.
We support reforms that allow the bankruptcy system to work effectively for families in need of financial relief and to protect workers in financially troubled businesses.
Congress is once again considering significant changes that would affect both consumer and business bankruptcy cases.
Last year, the AFL–CIO opposed provisions of H.R. 3150 and S. 1301 that would have placed jobs at risk, burden the court system, and unfairly prejudice working families who look to the bankruptcy system for assistance.
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The Bankruptcy Reform Act of 1999, H.R. 833, contains many of the same controversial provisions. We again urge Congress to proceed with great caution in crafting legislation that will have a profound impact on the remedies available to consumers and companies in economic distress.
I now turn to business bankruptcy provisions of the bill. The principal goal of chapter 11 is to preserve going concern value by encouraging troubled firms to reorganize rather than liquidate.
Reversing the fundamental pro-reorganization features of chapter 11 increases the risk of business shutdowns and threatens workers' jobs.
We enjoy today unprecedented prosperity, but all around the world we can see reminders that recessions and even depressions are still very much with us.
The bankruptcy system is one of our most important cyclical dampers, allowing businesses to weather economic cycles.
Tilting this system in favor of creditors in good times is dangerously shortsighted policy. Unfortunately, H.R. 833 appears designed to encourage liquidations which will necessarily lead to job loss.
Key provisions that would have this effect include the small business amendments restricting access to chapter 11, the expansion of the definition of single asset real estate debtors, the expansion of remedies available to secured creditors in the transportation industry, the changes to the deadlines for assumption and rejection of certain leases that several of my co-panelists have discussed, the imposition of mandatory deadlines for extensions of exclusivity, and the amendments regarding asset securitization limiting the assets available to a debtor during a bankruptcy case.
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I would like to address the small business and single asset real estate provisions in a little more detail.
The proposed amendments to the small business section in H.R. 833 are unfortunately mandatory and anti-reorganization, and in our view fundamentally hostile to small business.
They would add strict time limits and extensive mandatory requirements for filing and confirming a reorganization plan.
Chapter 11 cases could be converted or dismissed from bankruptcy altogether for failure to meet these and other new requirements.
Harsh new rules limiting subsequent bankruptcy filings are also proposed despite the lack of any credible evidence that serial filing is a problem among business bankruptcies.
As burdensome as these new strictures would be, they are made more onerous by severely limiting the court's exercise of discretion to manage these cases.
Rules for obtaining relief from these provisions create a high burden for the debtor and would curtail the court's authority to meet the exigencies of a particular case.
The ostensible purpose of these amendments is to weed out cases that cannot reorganize by imposing an early detection system.
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We believe this purpose can best be accomplished—which is a worthy purpose—by making better use of the tools already in the law to promote greater oversight in case management.
Finally, lest anyone think that these small business provisions are an unimportant exception as several of my fellow panelists have remarked, the definition of a small business in H.R. 833 would sweep in businesses with debts of up to $4 million, which would mean that many if not most of the business cases in an average District would be covered by these rules.
On the single asset real estate cap, both this bill and H.R. 624, the Technical Corrections Bill, propose changing the definition to eliminate the $4 million cap in the single asset real estate area.
Unfortunately, secured lenders have tried to apply the single asset definition to non-real estate business such as the steel plants and marinas.
Businesses with significant real estate components such as hotels, casinos, shopping centers, nursing homes, and office complexes of all types may be fair game under the current definition, even where they have none of the attributes of the single asset real estate debtor.
For these reasons, absent laws that specifically exclude properties housing significant business enterprises, there should be no expansion in the definition of single-asset real estate debtors.
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I would ask the committee's indulgence in briefly speaking about consumer bankruptcy.
Academic research has shown that the vast majority of individuals who file bankruptcy cases are truly in need of financial relief.
They are working families overloaded with debt in proportion to their incomes. They file bankruptcy cases because of catastrophic events in their lives such as divorce, job loss, and unexpected medical bills, and they have very low incomes by national standards.
We at the AFL–CIO read these studies, and we see our members' working families trying to manage debt burdens necessary to function in our society during years when this has been very difficult for people with low incomes.
We believe, in light of this research, that the consumer provisions of H.R. 833 will close the door to the Bankruptcy Court for many such families and will not solve their problems.
It will merely further victimize America's most vulnerable working families at their time of greatest need.
Our written testimony discusses further some areas in business bankruptcy where we believe H.R. 833 takes constructive steps, and some areas where we believe additional changes to the Code are in order.
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I would be happy to answer questions about those portions of our testimony.
Finally, the AFL–CIO looks forward to a continuing dialogue in these and other matters of concern as Congress considers the important subject of bankruptcy reform.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Silvers follows:]
PREPARED STATEMENT OF DAMON SILVERS, ESQUIRE, ASSOCIATE GENERAL COUNSEL, AMERICAN FEDERATION OF LABOR AND CONGRESS OF INDUSTRIAL ORGANIZATIONS, WASHINGTON, DC
Good morning, my name is Damon Silvers, I am an Associate General Counsel of the American Federation of Labor and Congress of Industrial Organizations, representing over 13 million working men and women and their unions. We would like to thank the Subcommittee for the opportunity to present our views on the important subject of bankruptcy reform. The AFL–CIO is committed to improving the economic lives of working people and their families. We support reforms that allow the bankruptcy system to work effectively for consumers in need of financial relief and to protect workers in financially troubled businesses.
Congress is once again considering significant changes that would affect both consumer and business bankruptcy cases. Last year, the AFL–CIO opposed provisions of H.R. 3150 and S. 1301 that would placed jobs at risk, burdened the court system, and unfairly prejudiced working families who looked to the bankruptcy system for assistance. The Bankruptcy Reform Act of 1999, H.R. 833 contains many of the same controversial provisions. We again urge Congress to proceed with great caution in crafting legislation that will have a profound impact on the remedies available to consumers and companies in economic distress.
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Our statement first addresses changes to the business bankruptcy code that undermine Chapter 11's goals of promoting reorganization and preserving jobs. Next, I will briefly address H.R. 833's consumer provisions. Finally, we identify portions of H.R. 833 that we support and suggest other proposed reforms that should be included in bankruptcy legislation.
BUSINESS BANKRUPTCY
The principal goal of Chapter 11 is to preserve going concern value by encouraging troubled firms to reorganize rather than liquidate. In 1978, when Congress overhauled business bankruptcy and enacted Chapter 11, Congress expressly recognized that encouraging businesses to reorganize helps preserve jobs. Reversing the fundamental pro-reorganization features of Chapter 11, increases the risk of business shut-downs and threaten workers' jobs.
We enjoy today unprecedented prosperity. But all around the world we can see reminders that recessions and even depressions are still very much with us. The bankruptcy system is one of our most important cyclical dampers—allowing businesses to weather economic cycles. Tilting the system in favor of creditors in good times is dangerously short-sighted policy.
H.R. 833 appears designed to encourage liquidations, which will necessarily lead to job loss. Key provisions that would have this effect include: the small business amendments restricting access to Chapter 11; the expansion of the definition of single asset real estate debtors; the expansion of remedies available to secured creditors in the transportation industry; the changes to the deadlines for assumption and rejection of certain leases; the imposition of mandatory deadlines for extensions of ''exclusivity;'' and the amendments regarding asset securitization limiting the assets available to a debtor during a bankruptcy case.
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Small Business Amendments
The Bankruptcy Code already contains several provisions applicable to small businesses. These are principally designed to streamline the bankruptcy process for less complex cases, and apply on a voluntary basis to businesses with debts not exceeding $2 million. In sharp contrast, the proposed amendments in H.R. 833 are mandatory, anti-reorganization and hostile to small business. They would add strict time limits and extensive mandatory requirements for filing and confirming a reorganization plan. Chapter 11 cases could be converted or dismissed from bankruptcy altogether for failure to meet these and other new requirements. Harsh new rules limiting subsequent bankruptcy filings are also proposed, despite the lack of any credible evidence that ''serial filing'' is a problem among business bankruptcies. As burdensome as these new strictures would be, they are made more onerous by severely limiting the court's exercise of discretion to manage these cases. Rules for obtaining relief from these provisions create a high burden for the debtor and would curtail the court's authority to meet the exigencies of a particular case.
The ostensible purpose of these amendments is to weed out cases that cannot reorganize by imposing an early detection system. We believe this purpose can best be accomplished by making better use of the tools already in the law to promote greater oversight and case management. For example, business examiners can already investigate businesses and determine whether they are candidates for reorganization. Operating trustees are also possible in cases of gross mismanagement or incompetence. Imposing inflexible requirements and strict deadlines on companies that can least afford them will lead to unnecessary business shut-downs as companies that may well be capable of reorganization are instead forced into liquidation because they cannot scale the hurdles imposed by these requirements. In addition to the companies that try to reorganize but can't navigate their way through the new mandates, there will be companies that simply don't try at all. The ultimate result will be lost jobs and lost value.
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Lest anyone think this is an unimportant exception, the definition of a small business in H.R. 833 would sweep in businesses with debts of up to $ 4 million. This would mean that many—if not most—of the business cases in an average district would be covered by these rules.
Elimination of the $4 million Single Asset Real Estate Cap
Both H.R. 833 and H.R. 624, the technical corrections bill, propose to change the definition of a ''single asset real estate debtor'' to eliminate the $ 4 million cap which restricts the real estate businesses that are subject to special rules limiting the application of the automatic stay. The definition of ''single asset real estate'' added in 1994 as section 101(51B) of the Code was not precise enough to limit it to the widely recognized prototype single asset debtor. Secured lenders have tried to apply the single asset definition to non-real estate businesses, such as a steel plant and a marina, for example. Businesses with significant real estate components, such as hotels, casinos, shopping centers, nursing homes, and office complexes of all types may be fair game under the current definition, even where they have none of the attributes of the classic single asset real estate debtor. Hotels, shopping centers and office buildings may be especially vulnerable because they can be single projects or parcels and generate their income through the collection of rents. A sudden takeover of the property by the secured creditor under the rules limiting the automatic stay places those working at the site (either employees of the debtor or of a management company hired by the debtor, or of tenants of the debtor) at risk of losing their jobs.
To date, the significant limiting factor in the application of these rules has been the $4 million cap. The amendment to eliminate the cap would place a wide variety of properties large and small at risk of foreclosure and threaten jobs at these properties. Absent rules that specifically exclude properties housing significant business enterprises, there should be no expansion in the definition of single asset real estate debtor.
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Other Amendments Discouraging Successful Reorganizations
Section 126 of H.R. 833 would amend sections 1168 and 1110 of the Bankruptcy Code, covering railroads and aircraft. to extend the already broad right of a secured creditor to enforce its rights and remedies under a security agreement, lease or sales contract, including amendments to require immediate surrender of the equipment where the secured lender is entitled to exercise its rights. These provisions create substantial obstacles to reorganizing firms in job-intensive industries vital to the functioning of the larger economy. The remedies currently available are already too broad and should not be enlarged further.
Section 205 would amend Section 365(d)(4) regarding non-residential leases to virtually eliminate the court's discretion to extend the period of time in which the debtor may assume or reject the leases. Leases of this kind are significant in cases involving retailers. Assumption of executory contracts, including leases, carry significant financial consequences, which is why the Code permits the debtor some flexibility in deciding to assume or reject the contract. This provision should be eliminated.
Similarly, Section 213 would place an outside limit of 18 months on the period of time during which only the debtor may file a reorganization plan. This is merely another attempt to arbitrarily limit the court and the debtor in developing a reorganization plan. Courts routinely entertain motions for extension of exclusivity and are capable of limiting exclusivity when circumstances warrant.
Section 1012, ''Asset-backed securitization,'' would exclude from the debtor's estate certain assets transferred in an asset securitization transaction. The provision could reduce the assets available to the estate for funding operations during a reorganization. As currently drafted, the provision would not permit the determination of whether the assets are property of the estate, except as characterized by the parties to the transaction. This provision should either be eliminated entirely, or amended to permit the court to determine whether, based upon the characteristics of the transaction, the assets are property of the estate.
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Taken as a whole, these provisions threaten the ability of the bankruptcy code to accomplish its mission of encouraging orderly reorganizations that preserve going concern value and jobs. They are particularly a threat to small businesses, who are less likely to have sophisticated bankruptcy counsel or adequate access to financing sources. This seems perverse in light of the widely acknowledged role of small business as a source of job creation and economic activity.
CONSUMER BANKRUPTCY
I would now like to speak briefly about consumer bankruptcy. H.R. 833 proposes to dramatically limit access to Chapter 7 and Chapter 13 in response to the increase in the number of consumer bankruptcy filings in recent years. Proponents of the bill attribute the increase in filings to widespread instances of abuse by indivduals who actually are not in financial distress.
Academic research has shown that the vast majority of individuals who file bankruptcy cases are truly in need of financial relief. They are working families overloaded with debt in proportion to their incomes, they file bankruptcy cases because of catastrophic events in their lives such as job loss, divorce and unexpected medical bills; they have very low incomes by national standards—including many at or below poverty level.(see footnote 21) A comparison of debt and income profiles of debtors over a 17 year period suggests that incomes of Chapter 7 consumer debtors has fallen over time while debt to income ratios have remained consistent.(see footnote 22) Data such as this suggests that the cause of increased filings is a growing number of low income debtors, rather than growing abuse or a decline in the stigma of bankruptcy.(see footnote 23) Attempts to suggest otherwise in the Credit Research Center study sponsored by the credit card industry have met with considerable skepticism in the peer-reviewed academic literature.(see footnote 24)
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Not surprisingly, consumer bankruptcy filings closely track increases and decreases in household debt.(see footnote 25) Studies have shown that debt levels have risen among lower-earning households.(see footnote 26) In 1997, the growth in household debt exceeded the growth in disposable income, according to the Federal Reserve.(see footnote 27)
In addition, the growth in lending vehicles has added other readily available sources of debt—some that precariously places people's homes at risk.(see footnote 28) In the sub-prime market, for example, lenders seek out riskier borrowers and now offer home equity financing at loan-to-value ratios exceeding 100%, charging high rates to offset the greater risk. Another lending practice targets low income and minority neighborhoods with ''serial'' refinancing loans which carry high interest rates and other onerous terms.(see footnote 29)
We at the AFL–CIO read these studies and we see our members—trying to manage the debt burdens necessary to function in our society during years when economic security has been hard to come by for working families. We read this bill, and we see some of the most powerful financial institutions in the world trying to squeeze a few dollars more out of America's most vulnerable working families at the most vulnerable time in their lives.
The growth in personal bankruptcy filings implicates difficult issues such as low wage jobs; inadequate access to health care; the aftermath of divorce and other personal catastrophes. Closing the door to the bankruptcy court will not eliminate these problems and certainly will not solve them. It will merely further victimize America's most vulnerable working families at their time of greatest need.
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MEASURES THE AFL–CIO SUPPORTS
Protection of Retirement Funds
We support Section 203, which would provide a property exemption for retirement monies held in tax exempt retirement plans; permit loan repayments to certain retirement and thrift savings plans and exempt such loans from discharge. These provisions would make the treatment of retirement monies more consistent and clarify the law with regard to loans.
Section 724(b) Amendment
H.R. 833 would amend Section 724(b) to change the payment priority where proceeds of property subject to a tax lien are distributed. The amendment is drafted to preserve the relative position of the wage priority claims under Section 507(a)(3) and Section 507(a)(4) ahead of the tax liens, and in that respect follows current law favoring the payment of priority wages and benefits in Chapter 7 cases. The AFL–CIO supports and appreciates this provision of the proposed amendment. However, further clarification is needed in proposed sections 724(e) and (f) regarding recoveries from unencumbered property and the obligation of secured creditors to make payments prior to invading the tax lien. Absent further statutory changes, which we can provide upon request, employees may find themselves caught between the taxing authority and other secured creditors in attempting to obtain payment.
OTHER REFORMS CONGRESS SHOULD CONSIDER
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Payroll Deductions
Employee payroll deduction monies owed to third parties should be excluded from property of the estate. Funds of this kind may be trapped in company bank accounts by a bankruptcy filing. A statutory change would protect monies owed by employees to third parties, such as an employee's Section 401(k) plan contributions, credit union payments and the like, and avoid the risk of non-payment by the employee. Allowing the debtor to remit the payments to the intended third-party recipients would prevent the employee from becoming an involuntary debtor.(see footnote 30)
Employee Representation.
Requiring better disclosure of employee claims on bankruptcy petitions, explicit encouragement of employee creditors committees and better written policy guidelines for the United States Trustee when forming creditors committees would improve the ability of employee representatives to participate in business bankruptcy cases. We urge Congress to implement these changes as proposed by the National Bankruptcy Review Commission.
Chapter 9
Finally, Congress should work with organized labor and other interested parties to draft rules that protect collective bargaining agreements in Chapter 9 municipality cases. Improving labor-management relations and encouraging collective bargaining are important and recognized goals that are equally important to bankruptcy reorganizations in the public and private sector. Reform in this area is long overdue.
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The AFL–CIO looks forward to a continuing dialogue on these and other matters of concern as Congress considers the important subject of bankruptcy reform.
Mr. GEKAS. We thank you, Mr. Silvers.
Mr. Glover?
STATEMENT OF JERE W. GLOVER, CHIEF COUNSEL, OFFICE OF ADVOCACY, UNITED STATES SMALL BUSINESS ADMINISTRATION, WASHINGTON, DC
Mr. GLOVER. Thank you, Mr. Chairman, members of the committee.
The last time I appeared before this committee was to support this committee's concerns about the Know-Your-Customer-Rules and also to thank you for the Small Business Regulatory Enforcement Fairness Act and report to you how it was improving the regulatory climate for small business.
Today I am here to raise a cautionary flag concerning this particular legislation. We all know of the importance of small business in the economy.
They have created virtually all of the new jobs in the last decade. What I want to do is focus on one other attribution to the small business, and that is their ability to take risks in innovations and develop innovations, and discuss how that applies to small business.
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Let me quote briefly from a National Academy of Engineering Report On Risk In Innovation:
''The committee concludes that small technically oriented companies often take types of risks and the amount of risks that is not usually tolerated by large companies. In the United States, both the consumers and the customers often depend on the high-tech companies to explore the commercial applications of technology in potential emerging and small markets.
''The principal economic function of small entrepreneur high-tech companies is to probe, explore, and sometimes develop the frontiers of the U.S. economy.
''Products, services, technology markets in search of unrecognized or otherwise ignored opportunities for economic growth.''
You can see that small business is important not only for the jobs but also for the innovations, technology, and even the whole new markets that it creates.
We all know of the Intels and the Hewlett Packards who had humble beginnings in the garages in the Silicone Valley, and the whole new industries that were created from those companies.
But there are literally thousands of companies that were not successful, but nevertheless created industries that followed in their footsteps.
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Osborne and K-Pro Computers developed the portable computer. Neither of those companies survived.
Professor Damien developed the Magnetic Resonance Imaging machine, and his company, while ultimately surviving, ran into significant difficulties for a long period of time.
What about the professor who developed DOS and got into financial difficulties and sold it to Bill Gates for $50,000?
What about the ''Mom & Pop'' video rental stores that proved the market existed so that Blockbusters and others could follow later on? Whole industries developed on the shoulders of small businesses who did not succeed.
Why is America so important when it comes to innovation in a vibrant small-business economy?
SBA receives thousands of foreign visitors who come and ask that question. We can, I believe, eliminate some explanations, genetics, the environment, and even access to capital.
The only true reasons that I have been able to identify that separate the U.S. from the rest of the world in this area is our patent system and the ability for entrepreneurs to fail and start again.
I am fearful that the proposed legislation threatens to weaken small businesses' abilities to fail and come back.
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In both Europe and Japan, we find that failure is totally unacceptable, and the result is not only the entrepreneur but his entire family being shunned.
Studies by our office show that many successful small business entrepreneurs in America failed in their first and even second attempts.
For this reason, I am concerned that we not weaken our entrepreneurial spirit and the risk-taking that flows from that.
Often, small businesses get into financial difficulty for reasons totally outside their control. Who could blame a small wheat farmer who has run into difficulty because of the Asian economy's collapse and the resulting collapse in the wheat market?
Who could blame home health care agencies who suddenly receive a 40 percent reduction in the reimbursements from HCFA, and of course, other examples?
Let me refer briefly to the charts attached to my testimony. Most importantly, you will notice that bankruptcies in chapter 11 in particular have declined dramatically from a high of 24,000 in 1991 to—the chart says 8.8 for 8800, but it really turned out to be 7500 in 1998, the most current year when we had the actual numbers come in.
This problem is not as severe as people would like it to be, and this is all happening at times when record numbers of small businesses are being created.
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We are very concerned with the taking away of the flexibility from the bankruptcy judges and creating harsh deadlines. One size doesn't fit all.
Education and training for small businesses who are in bankruptcy is very important, and some of the trustees have done a good job of that. Most have not.
For small businesses to have to meet the stringent deadlines when they're going through the most traumatic event of their business lives in such a short period of time is going to cause real hardship, and they are going to result in many businesses, who could otherwise succeed, failing.
Thank you very much.
[The prepared statement of Mr. Glover follows:]
PREPARED STATEMENT OF JERE W. GLOVER, CHIEF COUNSEL, OFFICE OF ADVOCACY, UNITED STATES SMALL BUSINESS ADMINISTRATION, WASHINGTON, DC
SUMMARY
The United States has a strong and vital economy envied by the world. We encourage entrepreneurship and the creation of businesses in order to drive our free market system. Currently, there are 23.3 million small businesses in the United States, the vast majority of which are very small, but all of which have aspirations to grow. Our small business community continues to maintain and sustain our economy.
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A number of small business trends are affecting our economy: 1) Since 1992, more than three-fourths of all net new jobs has been created by small businesses. While the Fortune 500's share of U.S. employment has declined steadily since 1968, small business entrepreneurs have filled the gap. 2) It is estimated that the fastest growing segment of the small business community, called ''gazelles,'' numbers 355,846 businesses. 3) Our country is experiencing a major ''information revolution'' similar to the earlier industrial revolution—propelled, at least initially, by small businesses. Our service-based industries are booming, with the information and technology sectors growing at an accelerated rate. 4) Small businesses are taking advantage of the global marketplace. A recent study completed for the Office of Advocacy shows that small businesses are exporting at a much higher rate than ever before.
The number of business-related bankruptcies is at a historic low. Last year, of the 1.4 million bankruptcy filings, the number filed by businesses was 44, 367, the lowest number since 1981. Of that number, only 7,524 were business filings under Chapter 11. According to the American Bankruptcy Institute, ''business bankruptcies have decreased by 31.6 percent since 1990, when they totaled 64,853.'' If you assume that 90% of all business bankruptcy filings are filed by small businesses, then statistically, small business bankruptcy filings in Chapter 11 accounted for less than one-half of 1 percent (0.48%) of the 1.4 million bankruptcy filings in 1998.
Experience and our research have shown that many entrepreneurs do indeed fail at their first attempts at business, but it is through their experience of failure that they find the right formula for success. A recent study funded by the Office of Advocacy confirmed this and showed that 24 percent of entrepreneurs in bankruptcy have either started another business or plan to start another business. Unlike some European and Asian countries where business failure is a stigma for those who do not succeed on the first try, the United States has built its free market on competitive principles and entrepreneurs' ability to try again. Failure should not be a hindrance to future success.
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Even though business bankruptcies are at a historic low, I am not advocating that the bankruptcy system is perfect. As of this date, I believe that the proposals in H.R. 833 go too far in addressing the relatively small number of problem cases. Under the proposals, small business owners who are legitimately using Chapter 11 proceedings to reorganize their businesses may be forced into a premature dismissal or conversion or may have to expend vital resources to fend off challenges by any creditor for relatively minor procedural infractions. I recommend the following with respect to H.R. 833: 1) Maintain the current definition of small business ($2 million in debt); 2) Put aside the provisions requiring mandatory use of the small business provisions; 3) Adopt standardized financial disclosure and confirmation forms with input from SBA to ensure that the documents do not discriminate against service-based industries; 4) Encourage voluntary education and debtor classes for the smallest of Chapter 11 debtors; 5) Do not codify additional duties of small business debtors; and 6) If additional grounds for dismissal or conversion are to be added then only the court or the U.S. Trustees should be able to use those provisions.
STATEMENT
Good Morning, Mr. Chairman and members of the Subcommittee. Thank you for inviting me to testify today before the Subcommittee concerning the Bankruptcy Reform Act of 1999, H.R. 833.
My name is Jere W. Glover and I am Chief Counsel for the Office of Advocacy at the U.S. Small Business Administration. Congress established the Office of Advocacy in 1976, and its statutory mission is to represent the views of small business before federal agencies and Congress.(see footnote 31) As Chief Counsel for Advocacy I am also charged with monitoring federal agencies' compliance with the Regulatory Flexibility Act (RFA)(see footnote 32) as amended by the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA).(see footnote 33)
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In addition, I am charged by Congress to monitor and report on the availability of capital and credit for small businesses. To fulfill this mandate, the Office of Advocacy has undertaken a series of studies analyzing bank lending to small businesses. The studies are titled, ''Small Business Lending in the United States,'' ''The Bank Holding Company Study,'' and the ''Micro-Business-Friendly Banks in the United States'' study. This year we have added the study, ''Small Farm Lending in the United States.''(see footnote 34) In addition, we have funded with the Federal Reserve Board two surveys entitled, ''The National Survey of Small Business Finances.'' As business bankruptcies and failures are also part of the access to capital equation, we have also funded research on how bankruptcies affect small businesses.
Before discussing the Bankruptcy Reform Act of 1999, I would like to give a brief overview of how entrepreneurism is vital to the U.S. economy.
Entrepreneurism and the U.S. Economy
As I stated in testimony last year before the Senate, the United States has a strong and vital economy envied by the world. We encourage entrepreneurship and the creation of businesses in order to drive our free market system. Currently, there are 23.3 million small businesses in the United States, the vast majority of which are very small, but all of which have aspirations to grow. Our small business community continues to maintain and sustain our economy.
A number of small business trends are affecting our economy:
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Since 1992, more than three-fourths of all net new jobs has been created by small businesses.(see footnote 35) While the Fortune 500's share of U.S. employment has declined steadily since 1968, small business entrepreneurs have filled the gap.(see footnote 36)
It is estimated that the fastest growing segment of the small business community, called ''gazelles,'' numbers 355,846 businesses.(see footnote 37)
Our country is experiencing a major ''information revolution'' similar to the earlier industrial revolution—propelled, at least initially, by small businesses. Our service-based industries are booming, with the information and technology sectors growing at an accelerated rate.(see footnote 38)
Small businesses are taking advantage of the global marketplace. A recent study completed for the Office of Advocacy shows that small businesses are exporting at a much higher rate than ever before.(see footnote 39)
As businesses and our economy diversify we must also have an economy that is flexible enough to accommodate the new problems and issues faced by businesses as they start up, expand, contract, and close.
Last year, the U.S. economy set another record—898,453 new firms with employees were created—an increase from the record set in 1997.(see footnote 40) The strength of our economy lies in part from the technology boom sparked by the tens of thousands of middle managers taking up entrepreneurism after being downsized by large corporations in the early and mid-1990's.
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In contrast, the number of business-related bankruptcies is at a historic low. Last year, of the 1.4 million bankruptcy filings, the number filed by businesses was 44, 367, the lowest number since 1981. Of that number, only 7,524 were business filings under Chapter 11. According to the American Bankruptcy Institute, ''business bankruptcies have decreased by 31.6 percent since 1990, when they totaled 64,853.''(see footnote 41) If you assume that 90% of all business bankruptcy filings are filed by small businesses, then statistically, small business bankruptcy filings in Chapter 11 accounted for less than one-half of 1 percent (0.48%) of the 1.4 million bankruptcy filings in 1998.
A high rate of business formation and dissolution is characteristic of a dynamic economy. Our nation's economy is characterized by this dynamic and by the special role played by small business entrepreneurs in sustaining overall growth.
Experience and our research have shown that many entrepreneurs do indeed fail at their first attempts at business, but it is through their experience of failure that they find the right formula for success.(see footnote 42) A recent study funded by the Office of Advocacy confirmed this and showed that 24 percent of entrepreneurs in bankruptcy have either started another business or plan to start another business.(see footnote 43) Unlike some European and Asian countries where business failure is a stigma for those who do not succeed on the first try, the United States has built its free market on competitive principles and entrepreneurs' ability to try again. Failure should not be a hindrance to future success.
Recently, studies have been undertaken in Europe and in Japan to understand the United States entrepreneurship system—in essence to find out what we are doing right. A study commissioned by EIM International of the Netherlands sought to understand the link between business failures and the ability of entrepreneurs to start again.(see footnote 44) Recent research in Japan compares the financing systems in Japan with those in the United States.(see footnote 45) The attached chart clearly shows the quick birth and growth rates of small companies in the United States in comparison with the much longer Japanese birth and growth rate. But it is also clear that bankruptcies and business failures are not an accepted part of the Japanese system. Business men and women who fail are stigmatized and are usually unable to continue in the business world.
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The competitive fundamentals of our free market system allow not only for innovation and creativity but also for forgiveness that allows entrepreneurs a fresh start. As businesses are being driven toward technology and service-based industries and globalization our economy is diversifying. This poses new challenges, and perhaps unfamiliar problems for our business community. We need a bankruptcy system that is flexible enough to accommodate and work with these concerns and to recognize the changing nature of our economy.
Comments on the Bankruptcy Reform Act of 1999
Even though business bankruptcies are at a historic low, I am not advocating that the bankruptcy system is perfect. As our research has shown, the majority of bankruptcy filings are made by very small businesses. Many of the small business owners would benefit greatly from additional education and guidance on the bankruptcy process. Unlike their large business counterparts, small businesses cannot afford top turnaround teams or management consultants. They may need additional time and guidance to become organized and educated about bankruptcy procedures. We applaud initiatives of some of the U.S. Trustees of the Department of Justice to help small businesses in this manner.(see footnote 46)
As of this date, I believe that the proposals in H.R. 833 go too far in addressing the relatively small number of problem cases. Under the proposals, small business owners who are legitimately using Chapter 11 proceedings to reorganize their businesses may be forced into a premature dismissal or conversion or may have to expend vital resources to fend off challenges by any creditor for relatively minor procedural infractions.
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As I mentioned above, there are many factors that are changing our economy and will require greater flexibility for small business debtors in bankruptcy. Two prime examples are the facts that our economy is moving from a manufacturing to a service and information base and that small businesses are taking advantage of a global marketplace. Small service business debtors may not have the real estate or manufacturing equipment assets typically available to other industries in reorganization efforts. Small business exporters may encounter international situations that present problems outside of the debtors' control. These businesses may require unique reorganization provisions in order to return to profitability. Under H.R. 833, the time and flexibility needed to address special circumstances will be severely restricted.
As I stated in my letter to the committee last year on similar legislation, the proposals would adopt a ''one-size-fits-all'' definition for small businesses regardless of the complexity of the bankruptcy, the industry of the small business, and/or any regional economic factors. I believe that this is not the correct approach for this situation. As Congress passed the Regulatory Flexibility Act to require federal agencies to consider the effects of proposed regulatory actions upon small entities, we should adopt the same approach here.
I have serious concerns that Congress would adopt, for the first time that I can remember, more stringent requirements on small businesses than on large businesses. I believe that this is a dangerous precedent to set. In light of the historically low number of business bankruptcy filings and the quicker time that business bankruptcies are going through the system, the real question is whether these proposals are really necessary at all.
I believe the following provisions of H.R. 833 would improve the bankruptcy system for small business filers:
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Flexible Rules for Disclosure Statement and Plan (section 401),
Standard Form Disclosure Statement and Plan (Section 403),
Uniform National Reporting Requirements (Section 404), and
Uniform Reporting Rules and Forms for Small Business Cases (Section 405).
These sections would greatly benefit both small business debtors and creditors. They offer flexibility and provide very small business filers with the essential documents necessary for bankruptcy reorganization. These combined with the educational courses and materials set up by the U.S. Trustees, would greatly enhance the ability of small businesses to focus on the future of their businesses. The only caution I have with standardized forms is that they may be drafted in a way that might discriminate against our growing service sector industries. We recommend that the SBA be consulted in the drafting of these documents.
The following are my recommended changes to H.R. 833 pertaining to small business debtors:
Definitions (Section 402): I believe that the current definition of small business debtor should remain in effect. The definition should be less than $2 million in debt and the provisions should be elected by the small business. If the provisions are to be mandatory then I strongly recommend that the $2 million threshold be retained. This threshold would still capture more than 70 percent of the business filers as opposed to 85 percent that would be captured under the proposed $4 million threshold.(see footnote 47) Congress should start with the smaller amount and then, if successful, the provision can be amended in the future.
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Deadlines and Prohibition Against Extension of Time (Sections 407, 408, and 409): These sections take away all discretion from the bankruptcy judge by setting mandatory time limits and curtailing the extensions of time. Chapter 11 was designed to be flexible, allowing the business to reorganize in the best possible way. As our economy is diversifying and our small businesses are pursuing international trade opportunities, there will be many new factors and challenges for businesses to overcome in order to reorganize effectively under our bankruptcy laws. I believe that the bankruptcy judge is the best individual to decide the timeline of a particular business bankruptcy based upon the complexity of the case, the regional economic factors and resources of the business to achieve reorganization. Based upon the judge's expertise, he or she would be able to calculate appropriate deadlines and extensions.
Expanded Grounds for Dismissal of Conversion and Appointment of Trustee (Section 413): Under these proposed amendments, small business entrepreneurs must attempt to comply with all of their additional duties and filing requirements in a shorter time frame while continuing to run their businesses. Since any party in interest may file , the slightest infraction or delay may elicit a creditor to petition the court for dismissal or conversion of the small business bankruptcy. As is common in small business bankruptcies, there are typically one or two secured creditors and many unsecured creditors (many of them small businesses). Unfortunately, one unintended result of the proposals is that they would give the creditors with the most resources the advantage of being able to file for minor procedural deficiencies. Such provisions may cause the debtor to spend considerable resources in court. In addition, small business creditors may not have the resources to actively participate in such proceedings. I strongly recommend, if the grounds for dismissal or conversion are expanded, that only the court, own its on motion, or the U.S. Trustee, be able to bring motions on procedural grounds.
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With regard to other provisions of H.R. 833, I believe that Section 206, regarding Creditors and Equity Security Holders Committees, should be amended to allow for any small business unsecured creditor that wants to serve on a creditors committee to be automatically considered by the U.S. Trustee as part of a creditors committee.
Finally, I believe that this legislation, as drafted, could have a chilling effect on entrepreneurism in the United States. Our free-market economy encourages entrepreneurs to take challenges and face risks in order to succeed. Our strong economy is evidence of our entrepreurial base. As I have previously stated, more than three-fourths of all net new jobs created since 1992 were created by small businesses.
Entrepreneurism is the foundation of this nation's economy and small businesses. As debtors and creditors, entrepreneurs need a bankruptcy system that is fair, equitable and flexible enough to accommodate the individual needs of different industries, the complexities of varying businesses and the regional economies around the country.
Conclusion
While I agree that the bankruptcy system is not perfect with regard to business bankruptcies, I believe that these proposals go too far in addressing the problem. It is clear from the statistics that small business reorganizations have not imposed a critical burden on the bankruptcy system. As stated earlier, only 0.48 percent of all bankruptcy filings in 1998 can be considered small business-related reorganizations under Chapter 11. According to the U.S. Trustees, the time businesses spend in Chapter 11 has also declined significantly since 1992.
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From a small business perspective, the system appears to be working in its intended manner. Before fundamental and irreversible changes to the bankruptcy system are made we need to quantify the problem. The opportunity is ripe for developing better statistical data and more comprehensive research on how the bankruptcy system for reorganizations has been beneficial and/or detrimental to small business debtors and creditors. H.R. 833 has several provisions that address the need for more statistical data on bankruptcies. I support those provisions.
In sum, I recommend the following with respect to H.R. 833:
Maintain the current definition of small business ($2 million in debt);
Put aside the provisions requiring mandatory use of the small business provisions;
Adopt standardized financial disclosure and confirmation forms with input from SBA to ensure that the documents do not discriminate against service-based industries;
Encourage voluntary education and debtor classes for the smallest of Chapter 11 debtors;
Do not codify additional duties of small business debtors; and
If additional grounds for dismissal or conversion are to be added then only the court or the U.S. Trustees should be able to use those provisions.
Thank you for the opportunity to appear today. I am happy to answer any questions that you may have about my testimony.
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Mr. GEKAS. We thank you, Mr. Glover. The Chair has taken the liberty of detaching, from a subsequent panel, the person of Mr. Bergmeyer, who will now give his oral presentation.
Otherwise, we would lose the benefit of it, so with the indulgence of everyone, we will listen to the 5 minutes' presentation of Mr. Bergmeyer.
His written statement will become a part of the record.
STATEMENT OF HARLEY D. BERGMEYER, CHAIRMAN, PRESIDENT AND CEO, SALINE STATE BANK, WILBUR, NE, ON BEHALF OF THE AMERICAN BANKERS ASSOCIATION
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Mr. BERGMEYER. Thank you, Mr. Chairman, for accommodating me on this panel. I appreciate that.
Chairman Gekas and members of the subcommittee, I am pleased to be here on behalf of the American Bankers Association to participate in this important hearing about bankruptcy in general, and chapter 12 in particular.
I am Harley Bergmeyer, Chairman and President, CEO, of Saline State Bank in Wilbur, Nebraska. In addition, I serve as Treasurer of the American Bankers Association.
Saline State Bank is a $52 million bank located in southeastern Nebraska. Our bank plays a vital role in the financial success of the farmers and agricultural support businesses in my part of Nebraska.
We presently have about a $34 million loan portfolio. Of that portfolio, 45 percent is loaned directly to farmers. Another 15 percent of our loan portfolio is loaned to businesses that are directly related to supporting and supplying farmers in our service territory.
I have been an agricultural banker since 1968, and during my career I have seen many changes come to agriculture.
Perhaps the most trying time for me and my customers was the late 1980's when agriculture experienced the worst financial crisis since the Great Depression.
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Fortunately for all of us, the situation in agriculture changed dramatically during the 1990's, and for the last 10 years banks have been the primary source of credit for American agriculture.
At the end of 1998, banks had over $72 billion loaned to farmers and ranchers, which amounts to about 41 percent of all farm loans.
Today, however, we face a new challenge in agriculture. The last 18 months have been very difficult, and the outlook for the future is uncertain.
In my written statement I have provided you with information that supports my contention that, while the challenges we face today are great, I believe that farmers and ranchers and their bankers are better positioned to deal with economic downturn than we were in the 1980's.
I provided this information to you because I am here to discuss what was the outgrowth of the agricultural crisis of the 1980's.
Chapter 12 was in response to the greatest agricultural crisis in America since the 1930's. Proponents of chapter 12 contend that it is intended to be for family farmers, since only those farmers who receive more than 50 percent of their gross income from farming or have total debts of less than $1.5 million and have 80 percent of their debt as a result of their farming operation are eligible for the protection under the current statute.
Bankers have two major concerns about chapter 12. First, chapter 12 is supposed to be the way for a family farmer to quickly reorganize his business through the courts.
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The primary justification for creating chapter 12 was that the existing bankruptcy chapters were too expensive and too time-consuming for the family farmer to be able to effectively use them to reorganize.
Under current law, a farmer that files for chapter 12 protection is supposed to file a reorganization plan within 90 days after the order for relief has been filed.
The debtor is to be allowed extensions by the court only in cases where the debtor should not be justly held accountable.
In practice, the courts have been very willing to grant extensions to the debtor at the expense of the creditors.
The ABA fully supported the provisions in H.R. 3150 last year that extended the time that a debtor is allowed to file a claim from 90 days to 150 days, but would have required the debtor then to convert to liquidation if he failed to produce a workable plan at the end of 150 days.
It is important to understand that during the period that the applicant is receiving the benefit of the automatic stay but has not filed a reorganization plan, none of the farmer's creditors are being paid.
This hurts all of the local businesses that may have extended terms to the farmer for things like feed, fertilizers, supplies, and other necessary inputs.
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Secondly, in chapter 12 lenders that have their claims crammed down to the value of the collateral lose any opportunity to attempt to recover the value of their claim in the future if the debtor defaults on the plan, or if the debtor chooses to go out of business.
In chapter 11, a lender may make an election that will allow them the opportunity to try to recover their unsecured claim if the debtor defaults on their plan or sells their business.
A similar allowance in chapter 12 would create a powerful incentive for the debtor to successfully complete the plan and would provide for equitable treatment of creditors in case of default or voluntary liquidation by the debtor.
A provision in H.R. 3150 last year would have given creditors the opportunity to attempt to collect the full value of the claim in case of default or voluntary debtor liquidation.
Mr. GEKAS. Would the gentleman conclude his remarks as fast as he can?
Mr. BERGMEYER. I'm sorry.
Mr. GEKAS. The written statement will be reviewed.
Mr. BERGMEYER. Thank you.
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In conclusion then, I would like to say that family farmers and ranchers are a national treasure. We must do everything that we can to ensure their success.
Many of our family farm customers are facing an uncertain and difficult future. Their success is our success, and I assure you that we are doing everything that we can to help our customers through this difficult and uncertain time.
At the same time, I have a responsibility to my institution and to my community, and each and every day I must assure you, my regulators, my stockholders, and my depositors that those farm loans are good loans and have a reasonable chance of success.
Congress can help us with this task by addressing the concerns we have regarding chapter 12 and by not expanding it to those that are not family farmers or ranchers.
Again, thank you, Mr. Chairman. I appreciate it.
[The prepared statement of Mr. Bergmeyer follows:]
PREPARED STATEMENT OF HARLEY D. BERGMEYER, CHAIRMAN, PRESIDENT AND CEO, SALINE STATE BANK, WILBUR, NE, ON BEHALF OF THE AMERICAN BANKERS ASSOCIATION
Chairman Gekas and members of the Subcommittee, I am pleased to be here on behalf of the American Bankers Association (ABA) to participate in this important hearing about bankruptcy in general, and Chapter 12 in particular. I am Harley Bergmeyer, Chairman, President and CEO of Saline State Bank in Wilber, Nebraska. In addition, I am the Treasurer of the American Bankers Association.
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Saline State Bank is a $52 million bank located in southeastern Nebraska. Our bank plays a vital role in the financial success of the farmers, ranchers and agricultural support businesses in my part of Nebraska. We presently have a $34 million loan portfolio. Of that portfolio, 45% ($15.5 million) is loaned directly to our farm customers. Another 15% of our loan portfolio is loaned to businesses that are directly related to supporting and supplying farmers and ranchers in our service territory.
The ABA brings together all categories of banking institutions to best represent the interests of this rapidly changing industry. Its membership—which includes community, regional and money center banks and holding companies, as well as savings associations, trust companies and savings banks—makes ABA the largest banking trade association in the country.
I have been an agricultural banker since 1968, and during my career I have seen many changes come to agriculture. Perhaps the most trying time for me and my customers was the late 1980's when agriculture experienced the worst financial crisis since the great depression. Many farmers in our service territory went out of business. Our community lost population since it seemed like there were no opportunities left in agriculture. We lost a generation of people that loved the land and loved agriculture.
Today, we face new challenges in agriculture. The last 18 months have been very difficult for me and my customers, and the outlook for the future is uncertain. While the challenges we face today are great, I think it is important and relevant to the discussion to point out that we are not facing a situation that is as dire as we faced in the 1980's.
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THE BANKING INDUSTRY AND AGRICULTURE
For the last ten years, banks have been the primary source of credit for American agriculture. At the end of 1998 banks had over $72 billion loaned to farmers and ranchers, which amounted to 41% of all farm debt. American farmers and ranchers receive more credit from banks than from any other source.
The bank portfolio of credit to farmers and ranchers is extremely diverse. USDA studies indicate that banks provide credit to a wider range of farm operations than any other lender. Banks have credit extended to part-time farmers, beginning farmers, moderate-sized family farms and large farming and ranching operations.
Lending to agriculture is a major line of business for my bank and for many banks in the US. Nearly 3,100 US banks have more than 16% of their total loans in direct farm and ranch loans. Banks with this percentage or higher of agricultural loans to total loans are considered to be ''agricultural banks'' by the federal regulators. With 45% of our total loans to farmers and ranchers, my bank clearly meets the definition. Agricultural banks tend to be smaller institutions located in rural areas. For my bank, and for many agricultural banks throughout rural America, many of the remaining loans in our portfolios are to farm and ranch dependent businesses.
THE CURRENT SITUATION IN US AGRICULTURE DIFFERS IN MANY WAYS FROM THE 1980S
While we have a difficult economic situation in agriculture today, there are many factors that make the current situation different than the 1980s. Farmers, ranchers and their bankers are better positioned to deal with a temporary downturn in the economy.
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FARMERS AND RANCHERS PROSPERED DURING THE 1990S
The 1990s have been very profitable years for farmers and ranchers. During much of the decade, US agriculture experienced record profits—net cash income in 1997 was a record $60.7 billion. Alternatively, in the 1970s and 1980s, many of the asset gains that farmers experienced were the result of inflation, not real profitability. The situation in the 1990s is clearly different. Farm and ranch businesses have increased their wealth through profits and retained earnings, not asset inflation.
Debt levels are significantly lower today. Farmers and ranchers used their profits from the 1990s to reduce debt and to build liquidity. Total farm debt at the end of 1998 was approximately $172. During the peak of the farm debt crisis in the 1980s, total farm debt reached nearly $200 billion (1984).
Farmers and ranchers have the strongest asset cushion they have ever had. The average debt to asset ratio for US farmers and ranchers is 15%. The average US farm or ranch has 85% owner equity in the business, the highest equity percentage in history. This sizable equity cushion will allow farmers and ranchers to more easily restructure debt as necessary to help compensate for temporarily reduced cash flows.
Interest rates have been relatively stable and low and are projected to continue this way. One of the key elements that drove the farm credit crisis of the 1980s was historically high interest rates. During the early 1980s, farmers experienced rates that exceeded 20%. Today, average interest rates are less than half that amount.
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Farmers and ranchers have become more astute borrowers and business managers as they have invested in computers, farm management software and marketing software.
THE BANKING INDUSTRY IS WELL POSITIONED TO MEET THE CHALLENGES IN AGRICULTURE
A healthy agricultural economy in the 1990s has allowed agricultural banks to build capital. Total capital at farm banks rose 9.1% to $18.1 billion in 1997 alone. Farm banks continue to maintain a higher equity capital to assets ratio than other banks. That ratio, at the end of 1997 was 10.3%. At the end of 1997, 98.6% of all farm banks met the regulatory definition of ''well-capitalized''.
The banking industry has abandoned lending practices that depended upon asset inflation as the primary source of repayment. One of the key lessons learned by farmers, ranchers and their lenders was that profit enables a business to successfully retire debt, not asset inflation.
Bankers have invested billions in technology that enables them to be better lenders. In the 1980s the banker's most powerful tool for credit analysis was a calculator. Today, bankers employ sophisticated credit analysis software, credit scoring systems and a host of other tools that allow them to manage credit risk, and to help them provide their customers with better service and more options.
Banks have more financial tools available to help them work with farmers and ranchers than they did in the 1980s. Since 1986, banks have greatly expanded their use of the USDA's guaranteed loan program, which allows banks to work with agricultural borrowers who have some type of credit deficiency. Banks write nearly all of the loans under this program, and the portfolio has grown from zero in the early 1980s to about $6.8 billion at the end of 1998. Through Farmer Mac, which Congress created in 1987, banks are able to structure long term fixed-rate farm real estate mortgages for their customers. Recent rule changes by the Federal Housing Finance Board allows banks under $500 million in assets to pledge farm and small business loans to the Federal Home Loan Bank system as collateral if there is a full time occupied dwelling on the property.
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During the farm crisis of the 1980s bankers and their customers learned the importance of open communication and the need for cooperation when there are credit problems. In the aftermath of the credit crisis of the 1980s, banks increased their loans to farmers and ranchers while other lenders retreated. Bankers worked through the problems with their customers while other lenders adopted inflexible and unworkable postures. These hard learned lessons have stayed with the agricultural community.
I wanted to review this information with you because what I am here to discuss today is an outgrowth of the agriculture crisis of the 1980s.
On October 27, 1986 the Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986 was signed into law. Chapter 12 was in response to the greatest agricultural crisis since the 1920s. Because it was an emergency response to a temporary crisis, the original act was set to sunset in October, 1993. While it was clear that the crisis had passed by 1993, Chapter 12 was extended, with little modification, to October 1998. In October 1998, Chapter 12 was extended until April 1, 1999 and legislation is pending to extend it for another 6 months.
After an initial surge of filings (6,122 in 1987), Chapter 12 filings have declined greatly (807 in 1998). In fact, by 1993, when Chapter 12 was supposed to have sunset, the number of filings had fallen to 1,200 nationwide.
Proponents of Chapter 12 contend that it is intended to be for ''family farmers'' since only those farmers who receive more than 50% of their gross income from farming, have total debts of less than $1.5 million and have 80% of their debts as a result of their farming operations are eligible for the protections under the statute.
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BANKER CONCERNS ABOUT CHAPTER 12
We have two major concerns about Chapter 12:
Chapter 12 was supposed to be a way for a family farmer to quickly reorganize his business through the courts. The primary justification for creating Chapter 12 was that the existing bankruptcy chapters were too expensive and too time consuming for a family farmer to be able to effectively use them to reorganize. Chapter 12 was supposed to make sure that any family farmer that could quickly reorganize would be able to do so. Under current law, a farmer that files for Chapter 12 protection is supposed to file a reorganization plan within 90 days after the order for relief has been filed. The debtor is to be allowed extensions by the court only in cases where the debtor should not be ''justly'' held accountable. In practice, however, the courts have been very willing to grant extensions to the debtor at the expense of the lender's claim.
The ABA fully supported the provision in HR 3150 last year that extended the time a debtor is allowed to file a claim from 90 days to 150 days, but would have required the debtor to convert to liquidation if he failed to produce a workable plan at the end of the 150 days.
We believe that any farmer that is seeking to reorganize their business should be able to produce a workable reorganization plan within 150 days. It is important to understand that during the period that the applicant is receiving the benefit of the automatic stay, but has not filed a reorganization plan, none of the farmer's creditors are being paid. This hurts my bank since the loan goes into default and non-accrual. It also hurts all of the other local businesses that may have extended terms to the farmer for things like feed, fertilizer, supplies and other necessary inputs.
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There is a very fundamental fairness issue here. I recognize the fact that reorganization plans can be difficult to structure, but I also strongly believe that if a farmer can not put together a plan that works for him within 150 days, then liquidation should be required.
In my town, many businesses get hurt when farmers that have taken Chapter 12 abuse the system by failing to produce a plan that requires them to begin repayment of their obligations.
Second, excessive cram downs of secured claims are often granted on the basis of unduly low appraisals provided by the debtor. In Chapter 12, lenders that have their claims crammed down to the value of the collateral lose any opportunity to attempt to recover the value of their claim in the future if the debtor defaults on the plan, or if the debtor chooses to go out of business. In Chapter 11 (business bankruptcy), a lender may make an election that will allow them the opportunity to try to recover their unsecured claim if the debtor defaults on their plan or sells their business. A similar allowance in Chapter 12 would create a powerful incentive for the debtor to successfully complete the plan, and would provide for equitable treatment of creditors in case of a default or voluntary liquidation by the debtor.
A provision in HR 3150 last year would have given creditors the opportunity to attempt to collect the full value of their claim in case of a default or voluntary debtor liquidation. The ABA fully supported this provision in HR 3150 last year and we again ask you to include such a provision again.
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Chapter 12 was created during a period of unprecedented deflation in agricultural assets. In the mid-west land values, by the mid 1980s, had declined by over 50% from where they were at the beginning of the decade. Chapter 12 was supposed to have been a way that the ''true'' market value of the farm property was recognized and the farmer's debt was then adjusted by the cram down to that ''true'' value. Unfortunately, the reality is that under the current law, the debtor and the primary lender both hire appraisers that try to establish to present market value of the property in question. The current law leaves it up to the Bankruptcy Court Judge to decide which appraisal most accurately reflects the market value of the real estate. I know that if the property is appraised at a present market value below the balance of the debt, I will lose that portion of my bank's loan. Because of this, I am forced to spend a great deal of time and money on appraisers. The farmer and his attorney also know it is to their advantage to have an appraisal that indicates the lowest possible present market value. Today, we have a situation where all parties are arguing about the validity of their respective appraisal. The current statute creates this unnecessarily adversarial situation.
It is important to note that bankers are not the only ones to recognize this inequity. Judge Richard Bohanon, then Chief Judge of the US Bankruptcy Court for the Western District of Oklahoma, testifying before the U.S. House Judiciary Subcommittee on Economic and Commercial Law on June 24, 1992 noted:
''The obvious pain to the banks in this procedure is that they must realize their deficiency and absorb that loss now rather than at some later time. Additionally, they normally are not in a position to benefit from some future increase in the value of the farm, should that ever occur''. Given time for thoughtful study, I believe that a solution could be found to the predicament of the banks and allow for an effective farm reorganization.''
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HR 3150 would have given banks and other lenders the opportunity to attempt to recover the full value of their claim only if a debtor voluntarily liquidated, or if the debtor defaulted on their plan. Debtors that successfully completed their plan as agreed would still be able to enjoy the full benefit of the cram down.
We believe that the provision in last years legislation would have gone a long way to address what is presently unfair, and what results in costly litigation and delay. If lenders knew that they at least had the opportunity to eventually recover the value of their crammed down debt, I believe that the process for the farmer, the lenders and the courts would function much more efficiently. We urge you to include this provision in legislation this year.
Recent efforts to expand Chapter 12 to include new classes of debtors are without merit. H.R. 763 would expand the protections of Chapter 12 to large mega-farms, allow people that have not farmed for many years to file, removes the provision that requires 50% of a debtor's gross income come from farming and waters down the requirement that the overwhelming majority of the debt be directly related to the applicant's farming operation.
We strongly oppose this expansive legislation. It is bad public policy and unconscionable that Congress would seek to extend special family farmer bankruptcy to mega-farms and to non farmers that have invested in farming operations as a way to shelter their income. We urge you to reject the proposal.
CONCLUSION
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Family farmers and ranchers are a national treasure; we must do everything we can to ensure their success. Many of our family farm and ranch customers are facing an uncertain and difficult future. Their success is our success, and I and the thousands of agricultural bankers that I am here representing, want to assure you that bankers are doing everything we can to help our customers through this difficult and uncertain time.
At the same time, I have a responsibility to my institution. Each and every day I must assure my regulators, our stockholders and our depositors that the farm loans my bank makes have at least a reasonable chance of success. Congress can help us with this task by addressing the concerns we have regarding Chapter 12, and by not expanding it to those that are not family farmers or ranchers. As the industry that provides American agriculture with so much of the needed credit to enable our national agricultural miracle to function, we believe it is appropriate for you to examine and correct some of the deficiencies in the original legislation.
I will be happy to address any questions you have at this time.
Mr. GEKAS. We thank the gentleman.
The Chair allots to itself 5 minutes for questions to be posed to the panel.
Mr. Silvers, just out of curiosity, of the 13 million members of the AFL–CIO, how many would you estimate or know belong to credit unions?
Mr. SILVERS. I could get you the precise number.
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Mr. GEKAS. Please do. That would be important to me because I'm schizophrenic about the fact that credit unions are unanimously begging us for reform in the consumer portion of the efforts that we're making.
And the AFL–CIO seems to have serious questions about it, so I would like that number.
Mr. SILVERS. I'd be happy to, Mr. Chairman.
I would just note that not all the credit unions are members or affiliated with our unions, and don't speak for us.
Mr. GEKAS. I know that well. That's why I've asked for the numbers.
Mr. SILVERS. I'd be happy to do so.
Mr. GLOVER. Mr. Glover and Judge Carlson, how do we get you two together on the need to make sure that our small businesses have the fullest opportunity to reorganize and not fail?
Judge Carlson has some questions about the delays.
Mr. Glover feels that maybe delays are warranted so that we can give the utmost opportunity for the small business to succeed.
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The 60-day extension is okay, is it not okay with you, Mr. Glover?
Mr. GLOVER. I think 60 days may work for some, but it may not be for others. I think we need to have the discretion within the bankruptcy judge.
But let me just say this. Often times when you schedule hearings and we get together and prepare to testify, good things happen outside the hearing room. And one of those has already happened.
The good judge and I have already had a conversation. We've agreed to talk more and we're going to try to work together and present to you some suggestions that we think may work, so let me just tell you that you've done a good deed today, and we will try to report to you in a few weeks if we've been able to come up with anything.
But certainly I did want to let you know that we have had conversations already, and we are probably not as far apart as we were last year, and as we were even a few weeks ago.
Mr. GEKAS. Well, I think maybe I should go to the Middle East for the peace process there. [Laughter.]
Mr. CARLSON. I agree with that. [Laughter.]
Mr. WATT. For the record, Mr. Chairman, I agree with that, too. [Laughter.]
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Mr. CARLSON. I should be more careful.
Mr. GEKAS. Mr. Schorling, we struggled right from the beginning on the question of direct appeals last term, and we thought that we had conquered the heights on that.
And then somehow that fell apart by the time of the conference.
We're going to try to revitalize our initial efforts but staff reminds me that why it fell at the end was the Article III, Article I dispute et cetera, and I have no clue as to how to try to remedy that at the moment.
So I would request your help, anybody who wants to help us in that because I firmly believed in the direct appeal process.
Mr. SCHORLING. If you're speaking of the concerns that were raised by the Justice Department last year, we submitted a fairly lengthy memorandum——
Mr. GEKAS. Yes, I know.
Mr. SCHORLING [continuing]. From Professor Bussel at UCLA, which I thought pretty convincingly rebutted the Justice Department's concerns.
But in short, Mr. Chairman, if an Article III judge at the district court level can review and render a final opinion, I don't see any constitutional issue raised by an Article III judge at the circuit court of appeals level.
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Mr. GEKAS. Neither do I.
What I'm talking about is the political problem.
Mr. SCHORLING. Oh, I don't know if I can do that, Judge. We lost it in '78, we lost it in '84.
Mr. GEKAS. That is we need somewhere along the line to get the signal from the White House that they're going to look favorably upon a bankruptcy reform bill in its final form, we trust.
In doing so, we want to eliminate whatever problems we can ahead of time.
If the Justice Department implores Mr. Sperling and others at the White House that they cannot tolerate our direct appeal, then we have to somehow adjust.
What I'm saying is you should now mount a kind of liaison with the White House/Department of Justice, et cetera, to advance that view.
Mr. SCHORLING. Thank you, we will.
Mr. GEKAS. The time of the Chair has expired, and I had so many questions for Mr. Tatelbaum and Ms. Miller and Ms. Baird and even for Mr. Bergmeyer, but I'll relent.
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The gentleman from North Carolina?
Mr. WATT. Thank you, Mr. Chairman.
I thought you were about to insult me there for a minute. [Laughter.]
Mr. WATT. We feel very strongly about those things in my part of the country.
Let me pick up on the discussions that are going on hopefully between Mr. Glover and Judge Carlson, and take those in support of a request that I've made to the chairman that hopefully he's beginning to heed, that we slow down this process long enough to let some of these issues work themselves through.
And I know he's been working on this for a long time. All of us have not been working on it a long time. And it seems to me that just about every witness on every panel that we have heard from has some problem or another with some aspect of this bill.
Not partisan problems, a lot of them are just practical, day-to-day administrative problems, and if we don't have time to try to work through resolving those problems, I think the chairman can anticipate that no amount of intervention by Mr. Schorling with the White House is likely to be sufficient to solve the problems that are insurmountable to be solved.
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I happen to agree with the chairman that it's ridiculous to say that an Article III district court judge can review a bankruptcy ruling and say that an Article III court of appeals judge cannot review it finally.
But there are resolutions to all of these problems if we will take the time to try to move this bill in ways that try to resolve some of those problems.
And so I hope the chairman is listening. That wasn't for your benefit, it was for his benefit.
Ms. Baird and Mr. Tatelbaum, I'm especially interested in trying to resolve the issue that you've raised that would make a reorganization, by someone such as Service Merchandise, a workable reorganization. It benefits Mr. Silvers' organization, it benefits the creditor, it benefits the debtors, it benefits the economy.
How can we structure this provision differently to accomplish that objective.
Ms. BAIRD. Well, this issue came up in the last legislative session as well, and we have worked very closely with the American Bankers Association in all of this, and we have made several overtures to the shopping center lobby, to revise this proposal, which have been rejected.
We tried to address their issue with the continued extensions of the time period to assume or reject by proposing certain standards that the judge would have to find to extend the time.
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Mr. WATT. But currently now the tenant is still, the debtor is still paying, or if he's in a reorganization, he's still got to pay the rent, right?
Ms. BAIRD. That's correct. The rent is paid current, just as if there were no bankruptcy filing made.
But one of their concerns was that the debtor currently is supposed to decide within 60 days, and the judge will keep putting that off and putting that off.
And that is uncertainty for them, so we tried to address that issue.
And then the other issue, the other way we approached it was to say, okay, we'll give you your certainty, we'll let you have the debtor decide within 120 days after the filing of the case.
However, if the debtor later rejects that lease during the case, then you lose your administrative expense priority for the period that the debtor is not actually in possession of the premises.
We think that would address the creation of these enormous administrative claims, and they rejected that as well.
So we are not giving up. We've got a meeting next week with them to address these issues again.
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Mr. TATELBAUM. If I may also respond.
We have come up with a little different suggestion, which is to leave the 180 days in the proposed law. But instead of having it extended only on the motion of the landlord, which is sort of folly, that be on the motion of any party in interest, but set a standard that the court can only extend it for good cause.
The entirety of bankruptcy is flexibility. I said earlier, it's not a pair of men's socks. One size does not fit all.
We have to assume that the judges have flexibility but by imposing that it has to be good cause, not just automatic, and any party in interest after hearing can do it, it creates a standard that needs to be followed which Congress can say, this is what we want, 180 days.
But in the Service Merchandise cases with good cause, the court can extend it as necessary because, as I said earlier, depending on what day of the year you file your chapter 11 may affect when you can decide what you're going to do with your leases.
Thank you, Mr. Chairman, my time has expired.
Mr. GEKAS. We thank the gentleman.
We turn to the gentleman from Tennessee.
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Mr. BRYANT. Thank you, Mr. Chairman.
Before I begin questioning the panel, I would ask unanimous consent to include in the record a statement from the International Council of Shopping Centers on the issue that's been raised before this panel.
Mr. GEKAS. Without objection.
[The prepared statement of the International Council of Shopping Centers on Business Bankruptcy Issues follows:]
PREPARED STATEMENT OF THE INTERNATIONAL COUNCIL OF SHOPPING CENTERS
I. INTRODUCTION
The International Council of Shopping Centers (ICSC) is pleased to present this written statement in conjunction with the Subcommittee's March 18, 1999 hearing on business bankruptcy issues.
Shopping centers are America's marketplace, representing economic growth, environmental responsibility, and community strength. Founded in 1957, the International Council of Shopping Centers is the trade association of the shopping center industry. Its 38,000 members in 70 countries represent owners, developers, retailers, lenders and all others having a professional interest in the shopping center industry. Its over 33,000 U.S. members represent almost all of the 43,661 shopping centers in the United States. In 1998, these centers accounted for $1,082.5 billion in retail sales, which is 53 percent of total retail sales, excluding sales by automotive dealers, and generated $44.5 billion in state sales tax revenue. In addition, shopping centers employ over 10 million people, about one out of every ten non-agricultural jobs in the United States. In a typical month, 188.8 million adults shop at shopping centers—94 percent of the population over 18 years of age.
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II. THE ADVERSE IMPACT OF RETAIL BANKRUPTCIES
Babbages, Barney's, Best, Bradlees, Braun's, Bruno's, Caldor, Camelot Music, County Seat, Crowley's, Edison Brothers, Homeplace, Jamesway, Macy's, Merry-Go-Round, McCrory's, Montgomery Ward, Petrie, Sassafrass, Sizzler, Today's Man, Woodward & Lothrop, Venture, and The Wiz. This is just a partial listing of the many retail companies that have filed, and, in some instances, refiled,(see footnote 48) for bankruptcy in the past five years.
Retail bankruptcies are a ''hidden'' problem in the shopping center industry. Owners don't like to talk about them—and they do their utmost to resolve them as quickly as possible to lessen the impact on the other tenants in the center. However, the number of retail bankruptcies has increased so dramatically in the last several years, that many in the industry and elsewhere are taking a second look at the reasons behind retail bankruptcy filings and their ultimate impact on the other segments of the economy.
ICSC members are concerned not only about the proliferation of bankruptcy filings, but also the delay and cost of the bankruptcy process, its failure to produce results consistent with the law, and the use of the system for economic gain by those who are not insolvent. These issues affect all creditors—not just shopping center owners.
However, shopping centers are especially affected by these problems because of the nature of the business and their treatment under the Bankruptcy Code. Thus, the position of shopping center owners and their solvent tenants is uniquely intertwined and their interests are often misunderstood or ignored.
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III. THE RELATIONSHIP BETWEEN A SHOPPING CENTER OWNER AND ITS RETAIL TENANTS
Shopping centers operate differently than other commercial enterprises. Shopping centers are a special type of commercial real estate that involves a unique interdependence and synergy between and among the shopping center owner and its tenants.
The shopping center owner designs a ''tenant mix'' to maximize the customer traffic drawn from a ''market area'' by leasing to a combination of stores that will draw customers. The tenant mix includes tenants based on their nature or ''use'', their quality, and their contribution to tenant mix, and is enforced by leases that describe the required uses, conditions, and terms of operation.
Rents and leases reflect the desirability of the tenant's use regarding tenant mix and vary among tenants. The owners rental income generally is tied directly to the success of the center through ''percentage rents.''
The tenants pay common area maintenance fees and other fees for the common areas and advertising along with the shopping center owner.
That is how a shopping center operates—and how the relationship between the owner and tenants is nurtured and maintained. However, tenant bankruptcies can deal a tremendous blow to the delicate balance and relationship between owners and tenants and leave a lingering economic blow to communities where shopping centers are located.
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IV. SHOPPING CENTER OWNER AS A COMPELLED CREDITOR
Bankruptcy poses risks to shopping center owners that are not faced by other creditors because the owner is a compelled creditor of its debtor retail tenants. As a compelled creditor, the shopping center owner must, under the Bankruptcy Code, continue to provide leased space and services to the debtor tenant. The Bankruptcy Code protects other compelled creditors, such as utilities, by providing security in the form of large post-petition deposits. However, shopping center owners must continue to lease space and provide services to the bankrupt tenant without any real assurance of payment. These services continue until the lease is assumed or rejected. Such disparate treatment of shopping center owners vis-a-vis other compelled creditors falls outside the equal and fair treatment of creditors the Bankruptcy Code purports to insure.
V. CONGRESS RECOGNIZES THE IMPACT OF RETAIL BANKRUPTCIES
In 1978, during consideration of the enactment of Section 365 of the Bankruptcy Code, Congress recognized the uniqueness of shopping center leases and the potential significant economic impact of a tenant bankruptcy on shopping centers and their solvent tenants. In 1984, Congress reaffirmed these policies by strengthening many of the provisions it enacted in 1978—in an effort to protect all parties who may be adversely impacted by retail bankruptcies.
Despite this strong commitment, the bankruptcy courts have eroded many of the protections Congress put in place. Today, we are faced with a bankruptcy system and process that is vastly different than what Congress envisioned.
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VI. RETAIL BANKRUPTCY TODAY: ECONOMIC DISTRESS OR BLATANT ABUSE?
Briefly, here is what is happening in retail bankruptcy today. During the past six years, over 75 major retail chains, representing over 7,500 leases, have filed for bankruptcy. Some of these filings can be tied to economic distress. However, many in the shopping center industry have observed that bankruptcy is too easily available, the stigma has disappeared, and it has become acceptable—even praiseworthy—for companies who are not in economic distress to use bankruptcy as a means to undo business agreements that have not worked out for them.
Now, let us look at several ''real life' examples of bankruptcy abuse. Sizzler, a national steakhouse chain, filed for bankruptcy protection in June 1996. At the time of its filing, Sizzler was in excellent financial condition—claiming three times the amount of assets to liabilities. However, the company wanted to move into a new format and close down unprofitable locations. Sizzler's chief executive officer portrayed the filing as a strategic move that would allow it to escape costly leases. Further he stated, ''Chapter 11 bankruptcy doesn't have the stigma it once did. It's seen as a legitimate business tool.'' This ''business tool'' allowed Sizzler to terminate 4,600 employees overnight.
Another example of blatant bankruptcy abuse involves the McCrory's Corporation. McCrory's, a large discount retailer, filed for bankruptcy in 1992. Amazingly, McCrory's managed to stay under the protection of Chapter 11—and safe from creditors—for more than five years before it eventually liquidated its remaining assets. During this time, the chairman of McCrory's continued to pay himself a salary in excess of $1 million per year, while the professionals hired by McCrory's to manage the bankruptcy case raked in another $40 million. And what did most of the creditors get in the end? Not a dime.
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Finally, here is an example of how retail bankruptcy can frustrate—and financially devastate—a shopping center and its owner. An ICSC member in Montgomery, Alabama had recently negotiated the sale of his shopping center. The day prior to the closing, the major anchor in the center filed for bankruptcy. As a result, the sale was placed ''on hold'' while the debtor determined whether it intended to keep that store operating. Meanwhile, the leases of several other tenants were coming up for renewal and those tenants were very concerned about the future viability of the center and whether they should continue to operate in a center whose major anchor store is in bankruptcy. Lastly, the purchase of the center underwent intense scrutiny from its financiers—who were understandably concerned regarding the prospects for successful reorganization of the debtor and the impact the bankruptcy would have on future revenues into the shopping center.
Shopping center owners are not the only parties impacted by retail bankruptcies. Other tenants in the shopping center lose valuable customer traffic tied to the existence of a healthy anchor tenant—and their incomes suffer. Employees lose their jobs. Finally, local communities—whose budgets depend on the sales and property tax revenues generated by a healthy retail climate—can be harmed immediately and irreparably by retail bankruptcies.
VII. THREE CRITICAL PROBLEMS AND SOLUTIONS
For shopping center owners and their nondebtor tenants, there are three critical problems in the current reorganization process for retail bankruptcies: 1) determining the fate of a debtor's assets in a reasonable timeframe; 2) adequate representation of the creditors' interests; and 3) providing adequate compensation to the holders of unexpired leases that have been rejected by the lessee. Following is a brief description of each of these problems and ICSC's proposed solutions.
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1. Determining the Fate of a Debtor's Assets Within a Reasonable Timeframe
Problem: Bankruptcy and district courts are not enforcing the timeline set forth in Sec. 365(d)(4) for the prompt assumption/rejection of unexpired leases. Further, the current statute provides no clear deadline by which the debtor must assume/reject a lease.
Discussion: For shopping center owners, the assumption/rejection of leases is one of the most frustrating aspects of a retail bankruptcy case. Due to over loaded dockets and the large number of retail case filings, courts have become increasingly biased in favor of the debtor in this area of law—and debtors have exploited this loophole in the Bankruptcy Code to their advantage.
Section 365(d)(4) of the Bankruptcy Code sets forth a timeline for assumption or rejection of a debtor's unexpired leases. At the inception of a bankruptcy case, the debtor is provided with a 60-day period in which to determine whether it intends to assume or reject unexpired leases. If 60 days is not sufficient time for the debtor to arrive at these decisions, the debtor can ask the court to extend this time period for cause. Current law does not define cause, limit the length of this extension, or mandate a deadline for the assumption/rejection decision.
Rarely does a retail debtor determine the fate of its unexpired leases in the initial 60-day period. Further, bankruptcy and district courts are not uniform in their response to requests for extensions of time. For instance, in Homeplace, a national home furnishings chain, the bankruptcy court judge granted Homeplace an additional extension of six months past its initial 60-day period. The locally prominent Woodward & Lothrop chain was given until confirmation of its plan of reorganization to determine the fate of its leases. (Woodward & Lothrop eventually liquidated its assets). And, finally, in Edison Brothers, the bankruptcy court granted the debtor (on a lease-by-lease basis) a timeline that extended past the confirmation of the plan of reorganization to determine which stores it intended to keep open or shutdown.
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Shopping center owners often object to these unreasonable extensions, but courts routinely deny owners' motions to compel assumption or rejection. The unfortunate result is that shopping center owners are left in limbo without a fixed, certain date for assumption or rejection of its leases.
Proposed Solution: ICSC proposes an approach 'that balances the equities between debtors and creditors. Specifically, ICSC proposes that debtors be granted a longer time period at the inception of the bankruptcy case—120 days as opposed to the current statutory 60-day period—to make sound, rational, decisions regarding its future reorganization. Further, if the debtor demonstrates that more time is truly needed, the affected shopping center owner, or the trustee with the prior written consent of the lessor, would be permitted to move the court for an extension of the initial 120-day period with a firm deadline to the extension.
We believe that this deadline provides a fair amount of time for a debtor to determine what to do with its leases. Please bear in mind that retailers undertake an analysis of their situation well before they actually file a bankruptcy petition. The 120-day deadline we are proposing is, as a practical matter, in addition to the time a retail debtor has already spent evaluating its business prior to seeking protection under the bankruptcy code.
2. Adequate representation of the creditors' interests.
Problem: U.S. Trustees in many districts have an unofficial policy of excluding shopping center owners from creditors' committee appointments. This ''exclusionary'' rule limits the owners ability to take a more active role in the reorganization process. Moreover, the U.S. Trustee's policy denies committees the special knowledge and perspective that shopping center owners bring to the table as a result of an owner's unique and historical relationship with the debtor.
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Discussion: The creditors' committee is the key decisionmaking body in the bankruptcy case. The members of the creditors' committee are appointed by the district office of the United States Trustee. Sec. 1102(b)(1) of the Bankruptcy Code sets forth the qualifications for membership on a creditors' committee. By statute, a creditors' committee ordinarily consists of persons willing to serve holding the seven largest claims against the debtor. In nearly every retail bankruptcy case, the debtors unexpired lease constitutes one of the largest assets to the estate. Thus, the shopping center owner, as the holder of that lease, would ordinarily quality under Sec. 1102(b)(1) for membership on a creditors' committee.
In recent years, many representatives of the U.S. Trustee's office have been reluctant to appoint shopping center owners to serve as members of a creditors' committee. Some Trustees have cited the relationship in size of the owners unsecured claim to those of other creditors' claims as a reason for excluding a shopping center owner from a creditor's committee. Also, they reason that an owner's focus will be too narrow (i.e., the owner will only be concerned about the stores it owns) to be a useful member of the committee. Neither rationale is correct.
First, if a shopping center owner's claim is one of the seven largest claims against the estate, by statute, the owner qualifies for membership on the creditors' committee. Further, in many retail bankruptcies, a debtors leases are held by a small number of shopping center owners—each holding leases on multiple locations. Thus, as members of a creditors' committee, shopping center owners will be focused on a successful reorganization as a means of protecting their interests in multiple locations.
Finally, the shopping center owner has maintained an integral relationship with the debtor—one that arms the owner with special knowledge of a debtor's business and prospects for successful reorganization. This knowledge can provide valuable insight to a creditors' committee as it assists the debtor in formulating its reorganization plan. As such, excluding shopping center owners from creditors' committees robs the committee of members with a unique ability to assist in the reorganization process.
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Proposed Solution: ICSC supports the provisions in Sec. 206 of H.R. 833 to provide all unsecured creditors greater access to creditors' committees. We urge Congress to adopt this measure.
3. Providing adequate compensation to holders of unexpired leases that have been rejected by the lessee.
Problem: Section 502(b)(6) of the Bankruptcy Code limits the allowed amount of a lessors claim for damages resulting from the rejection of a long-term lease. In addition, many courts require shopping center owners to mitigate the damages arising from the rejection of a lease. This further complicates the calculation of the rejection damage claim.
Background: Ultimately, a retail debtor will reject many of its long-term leases. Once a lease is rejected, the lessor can file an unsecured claim for damages for the rejection of its lease. Section 502(b)(6) of the Bankruptcy Code limits the allowed number of a lessor's claim for damages resulting from the rejection of a long-term lease.
There is no satisfactory discussion in the legislative history of Sec. 502 to indicate the origin or rationale for the terms of the complicated formula limiting a lessors damage claim. By statute, a lessor's claim is limited to ''the rent reserved by such lease, without acceleration, for the greater of one year, or 15% not to exceed three years, of the remaining term of such lease.'' However, in most cases courts limit the amount of a shopping center owner's claim to one year of future rent. In addition, many courts require shopping center owners to mitigate the damages arising from the rejection of a lease. In the current retail economic climate, and the increasing complexity of negotiating new lease terms, the supposition that the premises can be re-leased within one year is no longer valid.
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Contentions over the calculation of a shopping center owner's claim are the source of significant litigation in a bankruptcy proceeding. Owners, debtors, and the courts have struggled to calculate claims as set forth by the formula in Sec. 502(b)(6).
Shopping center leases typically have a term that is bigger than most other leases in the real estate industry. For example, an anchor tenant may have a lease term of 25 to 30 years, and smaller tenants may have lease terms of 10 to 15 years. Therefore, a retail tenant who files for bankruptcy protection in the early years of its lease may have many years remaining in its lease term.
To illustrate how a damage claim is calculated, assume that a tenant has a lease with a base term of 10 years. The tenant files for bankruptcy protection after 4 years of operation. The tenants remaining lease term is 6 years. Under current Sec. 502(b)(6), the shopping center owner is limited to a one-year cap on rent as damages because the alternative (15 percent of the 6 years of the remaining term of the lease) equals less than one year. Only items designated as rent are included in a damage claim—no consideration is given to other financial obligations under the lease such as insurance, repairs, and maintenance of obligations.
Shopping center owners who receive only a portion of the future rent payments anticipated under a lease as a result of a bankruptcy may themselves be subject to severe economic consequences. However, the economic burden does not cease when the lease. is rejected.
Once a lease is rejected, shopping center owners must absorb expenses associated with bringing a new tenant into the shopping center. Typically, it may take two to three years—with considerable costs incurred—to secure a new tenant. Costs associated with this process include marketing and advertising fees, broker fees, legal fees, and documentation and recording fees.
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Proposed Solution: No legislative language is included in H.R. 833 to address this issue. However, the ICSC believes that several changes should be made to Sec. 502(b)(6) to resolve one of the most onerous issues for shopping center owners. Specifically, ICSC recommends that Sec. 502(b)(6) be amended to allow all financial obligations reserved by the lease—such as rent, common area maintenance charges, and other fees—to be included in the shopping center owners damage claim. Further, the claim should be calculated using the period following the date of rejection by the lessee. Finally, the ICSC urges Congress to allow all actual costs incurred by the shopping center owner for the period of one year after the rejection for releasing the premises to a new tenant to be included by the shopping center owner in its unsecured claim for damages.
VIII. SUMMARY
The number of retail bankruptcy filings—and the attendant abuse—continue unabated. ICSC believes the solutions set forth in this statement to address the problems associated with retail bankruptcy are reasonable and fair to both debtors and creditors. They will eliminate much of the abuse and protect those most heavily impacted—the employees, the local economies, the solvent tenants, and the owners. If implemented, they will return the Chapter 11 process to what Congress intended—a means of rehabilitating economically distressed businesses into gainful enterprises without placing healthy entities into financial jeopardy.
Mr. BRYANT. Thank you.
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I've been a part of this discussion in the past, and I've listened to you, and certainly this is an issue for which there's no right or wrong answer.
I practiced bankruptcy years ago, and I know, as Mr. Tatelbaum said, that flexibility is important.
Having represented creditors, though, sometimes I felt the judges had a little bit too much flexibility, and seemed to side always with the creditor on every decision.
But I think in fairness to the shopping centers, and this statement indicates some of their positions on a number of issues, there is another side to this, and I think we almost seem to be starting from the premise that these companies like Service Merchandise wake up one day and say, I'm going to have to file chapter 11 today.
Obviously, these are problems that are longstanding and people know they're in financial trouble and I'm not saying they ought to pre-plan a bankruptcy but there certainly is some forethought to the fact that we are going to have to file a chapter 11 in a certain period of time, such as up to 180 days, I think in most cases, would be reasonable.
But again, I'm not quarreling with you. You have a great deal of expertise in this area, and I'm just optimistic when you say you're going to sit back down and talk again and maybe find ways that we can all agree to that.
Judge Carlson, I met and had lunch with a former partner of mine who is a bankruptcy judge yesterday, and he talked about the bankruptcy appellate panel.
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And I'm not clear, but is that kind of an adjunct to the circuit court, or can it be used that way, and perhaps on these direct appeals to maybe save time or let them sort of as a magistrate, or maybe make some decisions that could be adopted by the circuit court of appeals.
Is that how that works?
Mr. CARLSON. Right now, they serve as an alternative to the district court on the first level of appeal. And there's a subsequent second level of appeal to the court of appeals.
The pure direct appeal approach would have all the appeals go directly to the court of appeals, and would cut out both the bankruptcy appellate panel and the district court.
The committee, as I recall last year, ultimately approved a hybrid approach that would incorporate both the court of appeals and the bankruptcy appellate panels but would leave out the district court. And the way it worked, to balance the interests of minimizing the increase in workload in the court of appeals, but still provide precedential opinion from the court of appeals where it was really important, is that the parties were given the option of which court to go to.
And there was a convention that if neither party expressed a choice, the case would be heard by the bankruptcy appellate panel, and then the parties could appeal further to the court of appeals. But if either party felt that the case was a precedential one that had to go to the court of appeals in any event, either party could say, ''No, I want to go to the court of appeals,'' and then the case would be heard directly by the court of appeals.
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The Ninth Circuit, which was very concerned about a pure direct appeal, supported this approach because it wouldn't create such a great workload, and what we called it was ''direct appeal on request.''
I don't know if that answers your question or not, but a lot of people feel that the bankruptcy appellate panel is a very helpful device because it reduces the workload of the scarcest resource in the system, the Article III judges. It also incorporates the experience of experts in bankruptcy law. This hybrid approach permits parties who feel like they needed a truly binding opinion to get that at the court of appeals.
Is that helpful to you?
Mr. BRYANT. It is.
Real quickly with Mr. Bergemeyer.
Are you finding, and perhaps other people have an opinion, that we're not having as many chapter 12 filings and perhaps maybe farmers are reverting to the chapter 11s. Do you see—do you have any feeling there?
Mr. BERGMEYER. We have fewer numbers of chapter 12 because of the change in the economy from the eighties.
However, we are finding now because of the new problems that we're having in agriculture that more people are talking about filing chapter 12s.
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I guess I'm really concerned that by expanding this bankruptcy option, particularly in chapter 12, it will now move up another notch, open it up to a lot more people in higher levels and the family farmers going to be caught in all of these cases being filed in the courts.
And we're already having problems right now with the fewer numbers of chapter 12s being filed. We just had two recently that took a year to get approval.
So if we're having that kind of problem when the numbers are small, what kinds of problems are these family farmers, and I'm concerned about the businesses up and down mainstreet of my small community having the same problems, going to have getting into the courts and trying to get a plan filed and approved.
Mr. BRYANT. Thank you.
Mr. GEKAS. The time of the gentleman has expired.
Mr. WATT. Mr. Chairman, could I just ask Judge Carlson one quick question about this appellate situation?
Mr. GEKAS. The gentleman is recognized.
Mr. WATT. My impression has been that the bankruptcy judges view themselves as being essentially on the same level as the district court judges. They work out of the same courthouses, they typically are friends, and that the appeal from a bankruptcy judge to a district court judge is a charade.
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Would you care to comment on that, or am I just, is that just my perception?
Mr. CARLSON. Well, I would put it this way. I think the bankruptcy appellate panel is better-suited to hear appeals than a district court because it's set up as an appellate court.
Appellate courts typically have various characteristics. They usually are multi-judge courts. They usually specialize in hearing appeals. They are usually a small group of judges who review the decisions of a larger group of judges, and so that that small group of judges can keep track of precedent and can fashion, through the opinions they choose to publish, a coherent body of binding precedent.
It's not that district court judges simply can't do bankruptcy work; they're just not set up like a court of appeals.
Mr. WATT. I think they can do it. My impression is they pretty much rubberstamp what the bankruptcy judges do, because they're on the same floor, they're right down the hall from them in most cases, and they don't view themselves as any kind of adversarial review role. They're pretty much rubberstamping what the bankruptcy judges do.
Mr. CARLSON. I don't have a sense that their standard of review is consciously less. I think it may be more difficult for them because they're not appellate specialists and because they also don't have expertise in bankruptcy law. They neither have expertise in appellate law or bankruptcy law. It may be that they, in some sort of way, wind up not reviewing them as closely.
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A very close review comes from the appellate panel because the judges know the bankruptcy law very well, and they will catch their colleagues when they're wrong.
Mr. WATT. Thank you, Mr. Chairman.
Mr. GEKAS. This panel is composed of Mr. Ray Valdes, the tax collector for Seminole County in Florida. He appears today on behalf of several organizations. The National Association of County Treasurers and Finance Officers, the National Association of County Officials, and the National League of Cities.
Mr. Valdes was first elected as Seminole County's tax collector in 1988, and was subsequently reelected in 1992, and 1996.
Which is the chief community in Seminole County?
Mr. VALDES. Altamonte Springs. We have seven cities, half the county is unincorporated, half incorporated.
Mr. GEKAS. All right.
He has previously held senior management positions with the three major Fortune 100 Companies, U.S. Steel, Allis Chalmers, and Ralston Purina.
Mr. Valdes is active in numerous professional and civic organizations, including the National Association of Hispanic County Officials.
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Donald F. Harris, Special Assistant Attorney General of the State of New Mexico—do you speak Spanish, too?
Mr. HARRIS. A little.
Mr. GEKAS. He is Special Assistant Attorney General for the State of New Mexico, where he heads the Bankruptcy Program of the Taxation and Revenue Department.
He appears today on behalf of the States' Association of Bankruptcy Attorneys, a nonprofit association of attorneys who work in or with Attorneys General offices, and represents State taxing authorities in bankruptcy court.
After graduating with honors from the University of Connecticut School of Law in 1990, Mr. Harris clerked for the Honorable Robert L. Krushevsky, Chief United States Bankruptcy Judge for the District of Connecticut, from 1990 to 1992.
Is Judge Krushevsky still active?
Mr. HARRIS. He's on senior status.
Mr. GEKAS. Pardon me?
Mr. HARRIS. He's on senior status.
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Mr. GEKAS. Mr. Harris has published several articles on bankruptcy tax and lectured on these topics.
Mr. Paul Asofsky, who is well known by our committee, is head of the Houston Tax Department of Weil, Gotshal & Manges, LLP. He appears today on behalf of the American Bar Association, the tax section thereof.
He is a member of numerous professional associations, including the American Bar Association where he serves on several committees. He is also a member of the National Bankruptcy Conference, where he chairs the Committee on Tax Matters.
In addition, Mr. Asofsky has actively participated in the New York University Tax Institute.
After obtaining his bachelor's degree, magna cum laude, from Columbia College in 1962, Mr. Asofsky received his law degree, cum laude, from Harvard Law School in 1965.
The Honorable Tina Brozman, Chief United States Bankruptcy Judge for the Southern District of New York is with us.
Prior to her appointment to the bench in 1985, she was a partner in the New York firm of Anderson, Russell, Kihl, and Alleg.
During her tenure on this bench, Judge Brozman has presided over very large and complex chapter 11 cases, many of which presented international insolvency issues.
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She has served as Special Advisor to the United States Department Delegation to the Working Group of the United Nations Commission on International Trade Law. After receiving her bachelor of arts degree from New York University in 1973, Judge Brozman obtained her juris doctor degree from Fordham University School of Law in 1976, where she was an Editor on the Fordham Urban Law Journal.
She is joined by Mr. Ireland, Oliver Ireland, the Associate General Counsel in charge of Monetary and Reserve Bank Affairs at the Board of Governors of the Federal Reserve System.
He is responsible for advising the Board on legal issues regarding Central Bank functions, including payments and clearing systems and financial markets.
Previously, he was Vice President and Associate General Counsel of the Federal Reserve Bank of Chicago.
Mr. Ireland obtained his undergraduate degree from Yale University, and thereafter received his law degree from the University of Texas at Austin.
He will testify with respect to title X of H.R. 833, which incorporates many of the recommendations of the Presidential Working Group on Financial Markets.
Professor Randal C. Picker is at the witness table. He is the Leffmann Professor of Commercial Law at the University of Chicago School of Law where he teaches bankruptcy, commercial law, regulated industries, and secured transactions, among other subjects.
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Professor Picker graduated from the College of the University of Chicago in 1980, cum laude, with a bachelor of arts in economics. He received a master's degree in 1982, and thereafter attended the University of Chicago Law School where he graduated cum laude in 1985, and was elected to the Order of the Coif.
Upon his graduation, Professor Picker clerked for the Honorable Richard Posner of the United States Court of Appeals for the Seventh Circuit.
He then spent 3 years in private practice in the Chicago office of Sidley and Austin.
Professor Picker appears today on behalf of the National Bankruptcy Conference, of which he is a member. He is also a Commissioner on the National Conference of Commissioners on Uniform State Laws, and we welcome him again to the Capitol.
Mr. Grosshandler, Seth Grosshandler, is a partner at the New York office of Cleary, Gottlieb, Steen & Hamilton, where his practice focuses on financial institutions, derivative products, security transactions, and structured finance matters.
He received his juris doctor degree, cum laude, from Northwestern University in 1983, where he served on the editorial board of the Law Review, and was elected to the Order of the Coif.
He received his undergraduate degree from Reed College in 1979.
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Mr. Joseph Peiffer graduated with distinction from the University of Iowa College of Law in 1982. He had previously received two undergraduate degrees in agriculture from Iowa State University.
He began his legal career as a law clerk for the Honorable William Tinness, a United States Bankruptcy Judge for the Northern District of Iowa.
Mr. Peiffer has represented numerous farmers and creditors in reorganizational bankruptcies and debt restructuring workouts. He is certified in business bankruptcy by the American Board of Certification.
It is significant that this panel constitutes the last panel of experts for our consumption in these proceedings. I consider it very important for us to hear and to rehear and to review some of the standards that you have set for us in considering what should go into the final product of our bankruptcy reform effort.
So I thank you in advance, and I do so in case I forget to thank you afterwards. We shall start with Mr. Valdes, in the order in which they were introduced.
Mr. Valdes?
STATEMENT OF RAY VALDES, TAX COLLECTOR, SEMINOLE COUNTY, FL, TREASURER OF THE NATIONAL ASSOCIATION OF COUNTY TREASURERS AND FINANCE OFFICERS, ON BEHALF OF THE NATIONAL ASSOCIATION OF COUNTY OFFICIALS, THE NATIONAL LEAGUE OF CITIES, AND THE NATIONAL ASSOCIATION OF COUNTY TREASURERS AND FINANCE OFFICERS
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Mr. VALDES. Thank you, Mr. Chairman and members of the committee. My name is Ray Valdes.
The organizations which I represent today, which you have enumerated, account for over 140,000 local elected officials across the country who have a responsibility to millions of American taxpayers. Approximately 75 percent of those are from counties, cities and towns with populations of less than 50,000.
My town and my county, Seminole County, has a population of 340,000, where your colleague and my good friend and neighbor and his wife, Bill McCollum, and Ingrid live, even though I'm represented by Congressman John Mica, but that's another story.
No one could be prouder to come before you and have the opportunity to offer support for H.R. 833 than myself, and I want to thank you, Mr. Chairman, and your staff, for the openness you've had in allowing input from so many sources such as ourselves to make sure that our concerns were heard.
More than 4 years ago, using a foundation paper that was created by Karen Cordry, the Bankruptcy Counsel for the National Association of Attorneys General, I undertook the challenge to become a focal point and seek a consensus from knowledgeable attorneys and laymen on the negative impact current bankruptcy law and court cases were having on the revenue of county governments and school boards.
Substantial local expected revenue is being lost, not only from existing Bankruptcy Code language, but through the increasing creativity and innovation of debtor attorneys and how they apply selected sections of the Code in their cases, and ultimately the interpretation and concurrence of some of the Federal bankruptcy judges.
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Each assessed property devaluation, each reduction in delinquent property tax interest, and the total loss of a secured position through multiple and cross-chapter filings become the precedent for an attorney in another jurisdiction to apply to the advantage of his or her case.
After 2 years pinpointing local government concerns, we had the first National Association of Treasurers, National County Association product (which I titled Local Governments' Recommendation of Reform to the United States Bankruptcy Code) completed.
It was presented to the National Bankruptcy Review Commission where we had a representative or myself attend every public hearing and provide input.
After 15 more rewrites, it was finally concluded on August 3, 1998, and it was distributed to every member of the U.S. Congress, in both the House and the Senate, and you got your own copy that said the House Judiciary Committee Members.
Most of those 13 pages are contained in title VIII of H.R. 833. We have no problems with any part of the bill.
However, we only pertain to a small part of the bill and that is what we have an interest in.
But we think the bill, and especially that portion of it pertaining to tax provisions is excellent.
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The bankruptcy reform tax provisions you're being asked to adopt reflect years of work, communication, cooperation, and compromise between various State, county, local, and national government interests.
The provisions were developed through meetings, conference calls, faxes, e-mails, including House and Senate staff members, the National Association of County Treasurers and Finance Officers, the National League of Cities, the National Association of Attorneys General, the National Association of School Boards, the Multiple Tax Association, the U.S. Department of Justice, the U.S. Securities and Exchange Commission, and others.
So we tried to make sure that our input, as we gathered it, and as we argued over every issue, was as finite as we could make it.
Local governments really cannot afford to wait much longer, Mr. Chairman, for relief from the U.S. Bankruptcy Code. Local governments are losing revenue weekly that is needed to fund the education budgets, fire and police protection, and other vital services of our counties and cities.
If the proposed tax changes to the Bankruptcy Code are not accepted, then counties and cities will be forced to either raise taxes or cut services to account for the dollars lost in increased bankruptcy filings.
Also, the tax provisions proposed are basically noncontroversial. They do not make any changes to the Internal Revenue Code.
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All recommendations that we have proposed primarily affect State and local tax collection systems, and dramatically benefit these governments and their constituents.
The impact that the proposed tax reforms will have is to clarify the priority of secured liens such as property taxes, allow counties and cities to receive the statutory interest due on liens, to provide sufficient clarification in a bankruptcy notice filed, and to limit the time of secured lien payout.
In conclusion, the U.S. House of Representatives has the opportunity through H.R. 833 to prevent the loss of millions of dollars of ad valorem tax revenue by modification of the Bankruptcy Code.
In many counties, cities, and towns, ad valorem taxes are the lifeblood of the education budget and the primary source for fire and police protection revenue.
It also provides funding for all other necessary services. The street will still become paved, and the children of a bankrupt debtor will still be allowed to go to school, regardless of whether their property taxes are paid on time.
But ultimately, through a bankruptcy court decision, taxes are completely lost in some cases, or reduced, or expected interest on the tax delinquency is subordinated.
In that case, the responsible elected officials must find substitute funding or reduce some public service. There is no hidden place to find new money for education, health, and safety.
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Thank you for allowing me to speak.
[The prepared statement of the Honorable Ray Valdes follows:]
PREPARED STATEMENT OF RAY VALDES, TAX COLLECTOR, SEMINOLE COUNTY, FL, TREASURER OF THE NATIONAL ASSOCIATION OF COUNTY TREASURERS AND FINANCE OFFICERS, ON BEHALF OF THE NATIONAL ASSOCIATION OF COUNTY OFFICIALS, THE NATIONAL LEAGUE OF CITIES, AND THE NATIONAL ASSOCIATION OF COUNTY TREASURERS AND FINANCE OFFICERS
Mr. Chairman and Members of the Committee, my name is Ray Valdes. I am the elected Tax Collector in Seminole County, Florida, and the Treasurer of the National Association of County Treasurers and Finance Officers (NACTFO). I am testifying for the benefit of, and as Immediate Past President of the Florida Tax Collectors, for NACTFO, as a member of the Finance and Taxation Committee of the National Association of County Officials (NACo)(see footnote 49), and on behalf of the National League of Cities. In all, this accounts for over 140,000 elected local office holders with a vast responsibility for millions of American taxpayers. Approximately 75 percent of this group are from small counties, cities, and towns with populations of less than 50,000.
No one could be prouder to come before you and have the opportunity to offer support for the ''Title VIII'' tax lien provisions included in HR 833, the ''Bankruptcy Reform Act of 1999''. I would ask that my full testimony be entered into the record for this hearing.
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More than fours years ago, I undertook the challenge to become a focal point and seek a consensus from knowledgeable attorneys and laymen on the negative impact current bankruptcy law and court cases were having on county governments and school boards. My indoctrination accelerated rapidly to recognize the need to include state, county, city, and municipality issues in the formation of ideas.
It was soon apparent that substantial local (non-federal) expected tax revenue was being lost, not only from existing Bankruptcy Code language, but the increasing creativity and innovation of debtor attorneys in applying selected sections of the Code in their cases, and the interpretation and concurrence of some federal bankruptcy judges in the outcome. Each assessed property devaluation, reduction in delinquent property tax interest, and the total loss of a secured position through multiple and cross-chapter filings, became the precedent for an attorney in another jurisdiction to apply to the advantage in his/her case.
Starting with the framework of an outstanding paper created in 1995 by Karen Cordry, Attorney and Bankruptcy Counsel of the National Association of Attorneys General, and with the blessing of NACTFO and NACo, I began compiling a mountain of suggestions as to what specific sentences, paragraphs, and sections of the Code were in need of revision to stem the flow of this needed lost revenue. After two years of pinpointing local government concerns, we had the first NACTFO/NACo product which I titled ''Local Governments Recommendations for Reform of the United States Bankruptcy Code'' completed. It was presented it to the National Bankruptcy Reform Commission, where we had a representative or myself attend every public hearing. After 15 or more additional rewrites, it was compiled into the ''Final Consolidated Recommendations, August 3, 1998'' of that paper and distributed to every member of the U.S. House of Representatives and the U.S. Senate.(see footnote 50)
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Last year, beginning with the drafts and amendments to the bankruptcy reform bills introduced by Representative Gekas and Senator Grassley, a group was developed of approximately 25 representatives of the associations and interested parties for whom I speak today. Working with House and Senate staffs, we communicated several days a week through conference calls, faxes, and e-mail to define areas of discernment on all tax provisions being offered.
It was that important for us to present a united front representing state, county, city, and municipal concerns, with input from the federal government, in seeking unanimous support of every tax provision in each bill. It is no small accomplishment that the objective was basically achieved.
BASIC CONCEPT ISSUES(see footnote 51)
Governments in the United States of America exist, function, and are funded through the voluntary consent of the governed. They survive because the vast majority of the populace willingly obey the laws and pay their taxes without the need for direct action by the government. That cooperation depends on the belief of the citizenry that their neighbors will also be expected to obey those same requirements. If there are easy ways to avoid the payment of legitimate taxes, voluntary compliance begins to break down. Others see no reason why they should obey the law if their neighbors do not. Thus, whatever benefits are provided to the relatively small number of persons who receive a bankruptcy discharge, they must be balanced against the possibility of harm to society as a whole if debtors are seen as people who use bankruptcy as a legal loophole to beat the system.(see footnote 52)
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Under the Federal Bankruptcy Code, what should the proper procedure and policy be for the treatment of taxes?
Some bankruptcy claims involve voluntary creditors who have some ability to decide how and when they wish to extend credit to the debtor and to obtain protection for themselves if they do. If they obtain a voluntary lien from the debtor, that security will be given substantial protection by the law. Other claims, such as taxes owing to governmental units, are held by involuntary creditors. This should give added equity to a claim held by a party who had no ability to avoid being embroiled with the debtor.
Local governments serve unique functions—public education, police powers, taxing powers, mandated requirements, regulatory processes—not duplicated in the private sector. They cannot restrict their activities to only a particular portion of their territories or to a desirable segment of the population. Just as the rain falls on the just and the unjust, so too are police and fire protection given to both timely and delinquent taxpayers. All of these services are provided from local taxes. A citizen that accepts the privileges and benefits of citizenship must accept the reciprocal duties and obligations. In light of the unique responsibilities owed by a government to its citizens, a bankruptcy system that makes it too easy to avoid taxes risks undermining the duty that citizens owe to their government and each other.4
Further, one must recognize that individual bankruptcies—which comprise the vast majority of all cases—almost never provide substantial sums to creditors; rather, they are merely a way of officially closing the books on bad debts.(see footnote 53) This is occurring at a time when ''the federal government expects states, counties, and municipalities to pay for more varied services. However the Bankruptcy Code, as it currently exists, hinders local governments from collecting the money to pay for these services.''(see footnote 54)
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''Some federal courts seem to take the position that local government tax liens are not real property interests and claims, but ''just'' the government's money. In fact, the public and other taxpayers become the ones who are burdened.''(see footnote 55)
Thus, one must balance carefully the limited value to society of giving a ''fresh start'' to some, against the damage that can be done to our overall social system if citizens are led to believe they can easily escape their tax obligations by filing bankruptcies.
In business bankruptcies, the theory is that reorganization will provide a stronger and more viable entity that will be able to produce a greater economic return for creditors than would a liquidation of the enterprise. The reality is that 90% of cases that start in Chapter 11 never achieve a viable reorganization. The prompt payment of taxes should be considered as an early ''litmus test'' when determining the feasibility of a Chapter 11 planned reorganization. ''Payment of taxes on a timely basis is not an expectation that will overly burden and/or prejudice a debtor seriously contemplating reorganization.''(see footnote 56)
It is the position of taxing authorities that revision of the Bankruptcy Code should adopt, as a prime principle, that taxes that are due and owing during the case must be paid in a timely fashion in the ordinary course of the debtor's activities. Taxes should not be treated worse than other expenses that are incurred by a debtor during its case, and they should not be sacrificed to generalized goals of achieving a ''fresh start''. When the debtor emerges from bankruptcy, it will again be required to pay its taxes in full. If it cannot successfully master those problems while it is under the protective wing of the bankruptcy court, how can it hope to do so when it returns to the harsh world of normal economic life? An equally important principle is that, in general, the debtor should not be able to discharge or avoid pre-petition taxes by filing for bankruptcy.
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EXAMPLES:
In the City of Syracuse, NY—a corporate bankruptcy filing left a $2 million property tax debt for the city to work out. Imagine how many computers and teachers that $2 million would have paid for. The debt was purchased by someone else who wanted to buy the building—but a judge ''crammed down'' the interest rate for the back taxes to 5% and also adjusted the payment schedule to 20 years. HR 833 would secure the initial interest rate and also limit the payout to 6 years.
In Florida, federal bankruptcy judges have: ruled to reassess property values years after non-bankruptcy appeal was possible, to reduce property tax values, and to arbitrarily establish new lower interest rates on delinquent taxes without regard to state statutes. In small St. Lucie County, Florida, revenues lost affected the budgeting decision of the county school board.
CONCLUSION:
The U.S. House of Representatives has the opportunity, through HR 833, to prevent the loss of millions of dollars in ad valorem tax revenue for local governments by modification to the Bankruptcy Code. In many counties, cities, and towns, ad valorem taxes are the lifeblood of the education budget and the primary source for fire and police protection revenue. It also provides funding for all other necessary local government services to all of the citizens. The street will still become paved, and the children of a bankrupt debtor will still be allowed to go to school regardless of whether their property taxes are paid on time. If ultimately, through a bankruptcy court decision based on the Bankruptcy Code, taxes are completely lost, are reduced, or expected interest on a delinquency is subordinated, the responsible elected officials must find substitute funding or reduce some public service. Local government tax revenue lost in a bankruptcy court must be made up by other taxpayers. There is no hidden place to find new money to provide for education, health and safety.
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Citing:
Appendix 1—''Resolution on Bankruptcy Reform Legislation''. A resolution passed by the National Association of Counties (NACo) Board of Directors on February 28, 1999.
Appendix 2—''Local Governments Recommendations for Reform of the United States Bankruptcy Code''. A paper prepared by the Honorable Ray Valdes representing and on behalf of the National Association of County Treasurers and Finance Officers (NACTFO) and NACo, Final Revision August 3, 1998.
APPENDIX I
RESOLUTION ON BANKRUPTCY REFORM LEGISLATION
Issue: Counties, cities, and school districts incur loss of revenue when ad valorem property taxes are subordinated to the claims of other creditors. With increasing numbers of bankruptcy filings, the amounts involved are substantial.
Adopted Policy: NACo urges Congress to consider and pass early in 1999 bankruptcy reform legislation that is similar to the House-Senate conference agreement (H.R. 3150) reached in 1998. NACo supports the state and local government tax provisions recommended by the National Association of County Treasurers and Finance Officers (NACTFO) which were included in the conference agreement.
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Background: Congress enacted a major bankruptcy bill in 1994 which included creation of a Bankruptcy Review Commission to recommend further changes to Congress and the President. Among the issues deferred to the Commission were most of the proposed amendments to the bankruptcy code affecting state and local government. NACTFO worked closely with several members of the Commission and other organizations including the National Association of Attorney Generals and were able to win Commission approval of most of their proposed changes. The Commission's recommendations were considered by Congress in 1997 and 1998. Legislation approved in the House contained most of NACTFO's proposals. To avoid a floor fight, the Senate passed a scaled-down bill and went to conference with the House. The final conference bill closely followed the House-passed legislation but was unacceptable to Senate Democrats and the White House. The House passed the conference bill but the Senate took no action in the final closing days.
Representative George Gekas (R-Pa.), chairman of the House Judiciary Subcommittee handling the bill, plans to reintroduce last year's conference bill. It is not clear how the Senate will proceed, but the Senate Judiciary Committee plans to take up bankruptcy reform legislation early in the Session.
Fiscal Rural/Urban Impacts: The legislation would allow counties, cities and school districts to receive delinquent and unpaid ad valorem property tax revenues in most bankruptcy cases.
Adopted by: NACo Board of Directors
February 28, 1999
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APPENDIX II
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Mr. GEKAS. We thank the gentleman, and we turn to Mr. Harris.
STATEMENT OF DON HARRIS, ESQUIRE, SPECIAL ASSISTANT TO THE ATTORNEY GENERAL, STATE OF NEW MEXICO, ON BEHALF OF THE STATES' ASSOCIATION OF BANKRUPTCY ATTORNEYS
Mr. HARRIS. Thank you, Mr. Chairman. I'd like to thank the rest of the subcommittee for inviting me here today. My name is Don Harris, and in addition to running the Bankruptcy Program for New Mexico, I'm also the President of the States' Association of Bankruptcy Attorneys, which is a group that represents the people who do the bankruptcy work for the different State and local government agencies.
I would especially like to thank the subcommittee for hearing from State and local governments. Though I'm much too young, I understand that when Congress went through the Bankruptcy Code and the tax provisions in 1978, they primarily relied on the IRS for input.
However, the State and local governments probably collect more money, on balance, both inside bankruptcy and out, and unlike the IRS, most State and local governments were not large enough to have a developed expertise in bankruptcy.
So what we've done within the last decade is, we've started to get together and develop sort of a collective expertise. But unlike the Federal Government, we are comparatively small, and I think that smallness sometimes enables us to respond more quickly, and to be more frank.
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So, please continue to consider our input, and, again, thanks for inviting me here today.
On balance, the States wholeheartedly support the provisions of H.R. 833. Currently, the Bankruptcy Code as applied in practice, enables the debtors to essentially play a game of gotcha. As you know, most tax debts are usually established by voluntary compliance.
The taxpayer has the information and he tells the government what the taxpayer owes. The taxing authorities do not have a lot of resources. We audit a tiny percentage of the taxpayers.
Bankruptcy is generally and justifiably based on the notion that creditors have to come into court and tell the debtor, tell the trustee what's owed to substantiate its claim and get paid that way.
Now, what happens is that because of the way the Code is really being used—and I don't think it was intended, but it's often being used where the debtors can effectively ambush the government. They do this through the discharge of hidden liabilities which the taxpayer knows about but the government does not.
The debtor has the records. Bankruptcy is a government-provided benefit. It is therefore fair to expect the debtor to have to actually provide for, rather than play hide-and-seek with, the government taxing authorities.
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We are glad that the subcommittee is taking an active interest in the 260 million people who do not file bankruptcy every year.
Very briefly, let me go through some of the provisions of the bill which I think are helpful.
One thing which I don't think Mr. Valdes got into is section 801, and the revamping of section 724[b]. There is no justification for taking the expenses of a failed chapter 11 and imposing that burden on the public.
Section 802, the effective notice to governmental agencies, is helpful for the reasons stated.
Section 840, the interest rate provisions, are really just a clarification and create certainty where the law is now uncertain and unpredictable.
Section 805, the tolling provisions for tax claims are necessary. They clarify the law and they would help create a disincentive for the gamesmanship and sequential filings which can sometimes happen.
Section 807 is very important. Chapter 13 should not discharge a non-filed return, should not discharge fraudulent tax returns, should not discharge taxes where the priority tax is not actually paid.
Right now, the law favors or actually rewards people who do not comply with bankruptcy law.
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The course of business provisions for tax payments are helpful. They will help give the government more tools to prevent what happens in all too many cases where the debtor uses the government to involuntary finance its bankruptcy proceeding.
The requirements to file tax returns as a condition of confirming chapter 13 plans will also help. They are fair and they will also help address the recurring problem where chapter 13 plans are confirmed, but they don't actually provide for the tax claim which they're supposed to do.
And let me get off the tax provisions. I heard a lot of comment on the direct appeal to the Court of Appeals. Very briefly, the government and lawyers that I've talked to, we uniformly back this provision.
When a State governmental attorney appeals an opinion of a bankruptcy court, he invariably wants to get to a court of general jurisdiction as soon as possible. We try to avoid the Bankruptcy Appellate Panels.
Now, finally, while the tax provisions that I haven't discussed and not specifically discussed in the written testimony are supported by the States' Association of Bankruptcy Attorneys.
I'd like to again thank you for letting me be here today.
[The prepared statement of Mr. Harris follows:]
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PREPARED STATEMENT OF DON HARRIS, ESQUIRE, SPECIAL ASSISTANT TO THE ATTORNEY GENERAL, STATE OF NEW MEXICO, ON BEHALF OF THE STATES' ASSOCIATION OF BANKRUPTCY ATTORNEYS
1. INTRODUCTION
Thank you for inviting me to come to speak today. The States' Association of Bankruptcy Attorneys is a non-profit association of attorneys who work in or with states' Attorneys' General offices in order to protect states' interests in bankruptcy court. Our primary concern is in developing a shared expertise among state and local government lawyers in the area of bankruptcy/tax law as it affects state and local governments. Our organization is in a truly unique position to observe and comment upon how the Bankruptcy Code's provisions operate with regard to tax debts, and the improvements that may occur if this bill becomes law.
A. Too Much ''Gotcha'' Going On
Bankruptcy is an important social safety net; but the net is currently being used by hundreds of thousands of businesses and consumers to obtain an unfair advantage over their creditors with regard to debts that could be paid. This is particularly true with tax debts. While governmental agencies are facing increased pressure to limit their resources, the bankruptcy system provides a way to stymie collection, and, all too often, eliminate debts that the government is completely unaware.
On the tax side of the ledger, on both the state and federal level, our governments rely on voluntary compliance. The government does not learn about most tax debts until and unless they have been reported to the taxing authority. Bankruptcy is generally based upon much the opposite principle: If a creditor wants to be paid, it must generally go into the bankruptcy court, tell the trustee or debtor what the creditor believes is owing, and ask for payment. The creditor must generally object to provisions in proposed plans that do not treat the creditor fairly.
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There are currently loopholes in the law which allow debtors to take advantage of the tension between the voluntary compliance nature of taxation and the debtor-oriented bankruptcy system. This creates the ''gotcha'' trap, which unfairly eliminates tax debts every day in bankruptcy courts throughout the country—particularly in Chapter 11, and Chapter 13 cases. The governmental entity is often either unaware of the debt altogether (because the debt was either unreported or misrepresented) or is not made aware of the debt in a timely manner. Alternatively, the debtor's lawyer may acquire a court order with respect to a tax debt, which order would not be anticipated and is contrary to the bankruptcy code. In any combination of the above scenarios, the debtors can, and often do, score a ''gotcha.'' It is grossly unfair to the honest taxpayers. It is currently the law, but it is not what Congress intended.
B. Who is Representing the Public in the Process?
This panel, and other committees considering bankruptcy legislation, will hear from a relatively tiny segment of those who are affected by the bankruptcy laws. The professionals will state that very little is wrong with the system. Of course, any real bankruptcy reform will threaten their livelihood as well as offend their sincere beliefs that bankruptcy should be a readily available mechanism for anybody with any financial difficulty.
The creditors' groups will predictably state that they are being treated poorly, that the system is being abused, and that the laws need to be tightened up. It might be valid to view the governmental groups as having this bias, but it should be remembered that the governmental representatives do not have a personal stake in the cases. I submit that we are a bit more objective.
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But before I move on to the substantive provisions of the bill, there are millions of people and businesses in this country whose voices may not be heard at all in these proceedings. Who is looking out for the millions of working people in this country who honestly pay their taxes every year, even though it is a struggle and even though they, like everyone, hate paying taxes? With the business community, especially small businesses, organizing one's affairs so that the taxes get paid is often not easy. Most business people dutifully pay their debts. Who is looking out for them? This is what Congress must do.
There is a moral component to paying one's debts. Congress must find the right balance that permits the honest but unfortunate debtor to acquire a ''fresh start,'' while protecting obligations owed to the public from being eliminated by ambush and removing the incentives for those debtors seeking an unfair advantage. The system is currently out of balance.
2. THE TAX PROVISIONS OF H.R. 833
The States' Association of Bankruptcy Attorneys (SABA) wholeheartedly supports the tax provisions in the bill. Although we would like to see more substantive changes, these proposed changes go a long way toward reducing a significant problem with the current system: The intended ''substance'' of the current law is too easy to obfuscate. The bill's tax provisions primarily clarify and even simplify areas of the bankruptcy code dealing with tax debts, while not significantly changing the result that Congress intended in most cases. The provisions would help insure that the public is treated fairly, while providing clearer guidelines that help make the results more certain. Any legal system is improved when the results are made more certain.
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I will now go through some of the items in the bill which are important to emphasize. Desiring to keep these comments brief, every provision will not be discussed. However, failure to address a section does not imply a lack of support for the tax provisions of the bill. SABA supports all of the tax provisions.
Section 801. Treatment of Certain Liens
This section will stop the practice of invading the public's tax lien, and therefore the public treasury, to pay for the administration of a failed Chapter 11 proceeding. Usually, the administration of a Chapter 11 will entail expenses of professionals who choose to perform services for Chapter 11 debtors. There is no economic or policy justification for shifting the burden of their unpaid fees to the public.
The bill would allow a Chapter 7 trustee to invade a tax lien, and would allow wages to be paid from a tax lien. The taxing authorities do not like this portion of the section, but this is a compromise, and is a significant improvement over the current law.
Section 802. Effective Notice to Government
For reasons stated above in the introduction, SABA believes that the greater notice to the government, the better. Debtors are already required to keep accurate records under both the bankruptcy laws and the state and federal tax laws. This provision is consistent with, and compliments, other areas of the tax codes and the bankruptcy code. It would not affect honest debtors who have complied with their legal record-keeping requirements, but could significantly cut down on the incidents of discharging hidden liabilities.
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Section 804. Rate of Interest of Tax Claims
With regard to secured, administrative, and real property tax claims, the bill would require that the non-bankruptcy interest rate apply. This would generally be the result in most cases under the current law, and the bill primarily adds certainty in those areas. It would also eliminate the ability to try to ''low ball'' out-of-state governmental entities who may not have resources to travel to different states to challenge interest rates which might be proposed in motions or in bankruptcy plans.
With regard to other tax claims, the bill would fix interest rates at the federal deficiency rate plus three points. Some of the members of SABA did not like this provision, because some aggressive and efficient attorneys general offices can negotiate even higher rates than the bill provides. The current law provides for the nebulous present value concept in many cases. However, most members of SABA like the bill because they find that objecting to interest rates is not a good allocation of resources, especially in out-of-state cases. The present value analysis in reported cases is confusing, inconsistent, and of questionable value to a tax claim for which there is no ''market'' to which to compare a ''market rate.'' The law sets a definite floor, which might often become the standard rate. It is helpful to both governments and debtors because it creates certainty.
Section 805. Tolling of Priority of Tax Claim Time Periods
Many courts reach a similar result as the language in the bill explicitly provides. However, there is a split of authority on this issue, and the current bankruptcy code does not provide the clear answer.
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One rationale for the priority time periods is to give the government an opportunity to collect the tax before it becomes ''stale'' and potentially dischargeable. Thwarting the collection activities through the use of a bankruptcy petition should suspend the time during which the taxes would otherwise become ''stale.'' Otherwise, the tax priority means little if it can be circumvented through the manipulation of sequential bankruptcy cases.
Section 807. Chapter 13 Discharge of Fraudulent and Other Taxes
This provision would address a significant problem. Often tax obligations are eliminated in Chapter 13, even though the government never knew of the debt. Chapter 13's often get confirmed very quickly, in some jurisdictions within 30–60 days of the case being initially filed. Governmental entities are inherently ill-equipped for Chapter 13's as they frequently occur in practice.
An honest debtor who is represented by a conservative debtor's lawyer will have filed all of the tax returns. The debtor can benefit by paying the more recent ''priority'' portion in full, but without interest, and perhaps discharge some old or ''stale'' tax debt with a small dividend. This is what Congress intended. Way too often, this is not what happens. The debtors skirt the system. There are several reasons why.
First, although there is a provision in the bankruptcy code which requires that priority taxes be paid in full, that provision does not have any teeth. Clever plan drafting might result in paying priority taxes less than the full amount. Because there is no exception to the discharge for these taxes, often they are not paid yet discharged. This is not what was intended.
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Second, often the debt is not discovered until well after the ''bar date'' for filing claims. This will occur because of non-filed returns or fraudulent returns. These debts will be discharged in a Chapter 13 with virtually no payment.
Third, state taxing authorities have been sued in Pennsylvania, Oregon and perhaps other states for filing estimated tax claims for non-filed periods in Chapter 13 cases. The basis of the lawsuits were that the estimated claims were Rule 11 violations. Most judges do not discourage taxing authorities from filing estimated or ''protective'' proofs of claim, and there have not been that many disputes. However, the existence of a reported opinion in Oregon, which sanctioned the state, and a publicized settlement in Pennsylvania puts taxing authorities in a difficult position in Chapter 13.
In summary, Section 807 does not remove the intended benefit of being able to stretch-out some taxes interest free and discharge others outright. However, it will put the burden on the proper party in the tax context. The debtor has the records and knowledge of his affairs, and he should be required to properly provide for the payment of his priority taxes through the plan. This is a burden no greater than filing the tax returns in the first place. Currently, the system often rewards those who either do not comply at all or who file false or fraudulent returns.
Section 812. Course of Business Payment of Taxes
Post-bankruptcy tax accruals, or pyramiding of tax debt, by debtors is very common. The government often involuntarily finances bankruptcy debtors. Reported opinions have ruled that taxing authorities must go into court and notify all creditors in the case that the government wants to be paid, and to get a court order authorizing the payment. Some trustees feel nervous paying some post-bankruptcy tax debts without a court order, because the bankruptcy code does not provide a clear directive that the post-bankruptcy taxes can be paid as a matter of course. This slows down the process, and can result in the bankruptcy estate incurring unnecessary interest.
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The bill would give the taxing authorities more tools to combat the recurring, and serious, problem of pyramiding of taxes in bankruptcy.
Section 816. Requirement to File Tax Returns to confirm Chapter 13 Plans
As stated in the comment above, the hidden tax liability issue is a problem in Chapter 13 cases. This section would help with that problem. It would help limit the relief to those who otherwise comply with the law. This provision gives clear guidance to trustees on this issue where there is none now—some trustees require tax returns, some trustees merely ask if they have been filed, and some trustees do not inquire at all. In addition, the provision provides clear and fair consequences for not filing the returns. Finally, there is a provision temporarily excusing non-compliance, but the debtor must show that there is good cause.
3. CONCLUSION
The tax provisions of H.R. 833 represent a significant improvement in the law, while not changing the original intent of statute in most cases. These provisions should help reduce the manipulation of the system at the public's expense. The provisions will help governments which are at a significant disadvantage with regard to information and without resources to investigate every debtor. The tax provisions should be adopted without modification.
Mr. GEKAS. We thank you, Mr. Harris.
Mr. Asofsky?
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Last year, you were really into it, as I recall.
Mr. ASOFSKY. I still am, Mr. Chairman. I've spent 20 years working for the American Bar Association on these issues, and I've tried to contribute as a public citizen, and as you'll see from my testimony, I think, not as a representative of debtors who are trying to get unfair advantages over the government, but in the interest of improvement of the law, as I think you'll see when I testify.
Mr. GEKAS. We won't count these preliminary statements against your time. [Laughter.]
Mr. ASOFSKY. Thank you.
STATEMENT OF PAUL H. ASOFSKY, WEIL, GOTSHAL & MANGES, LLP, HOUSTON, TX, AMERICAN BAR ASSOCIATION, SECTION OF TAXATION
Mr. ASOFSKY. Mr. Chairman and members of the subcommittee, my name is Paul H. Asofsky, and I'm appearing before you today in my capacity as the Chair of the Task Force on the Tax Recommendations of the National Bankruptcy Review Commission of the American Bar Association Section of Taxation.
This testimony is presented on behalf of the Section of Taxation; it hasn't been approved by the House of Delegates or the Board of Governors of the American Bar Association, and accordingly should not be construed as representing the policy of the Association.
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The Tax Section of the American Bar Association is comprised of approximately 25,000 tax lawyers located throughout the United States. It's the largest and broadest based professional organization of tax lawyers in the country.
On behalf of the Section, I'd like to thank the committee for inviting me to testify this afternoon. The Section of Taxation has a long history of active involvement in the development of bankruptcy tax legislation.
Over our many years of involvement with the bankruptcy legislative process, we have sought balanced legislative proposals that seek to reconcile the interest of efficient administration of the tax laws and the uniform application of those laws to all taxpayers, on the one hand, with the efficient operation of a national bankruptcy system and rehabilitation of distressed debtors on the other.
That sense of balance pervades our reactions to the provisions of this bill. Our positions, taken as a whole, tilt neither to government tax collectors nor to taxpayers seeking relief from tax debts.
We have looked at each provision and attempted to make an independent judgment. There is no reason why, with a little bit of give-and-take on all sides, a consensus bill could not be crafted with widespread support.
One of the problems is that the devil is sometimes in the details. There are many provisions of this legislation with which we agree as a matter of principle. There are many provisions, but the specific provisions are either ambiguously drafted or cut against the grain of the principal proposal, causing us to oppose what otherwise should be noncontroversial proposals.
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For example, we agree that government taxing authorities should be entitled to detailed notice of bankruptcy proceedings and requests for prompt audits as section 802 and section 803 of this bill would provide.
But we believe that those sections should be amended to require fair notice to debtors of governmental filing requirements.
We agree that the Bankruptcy Code should provide a fixed rate of interest on deferred tax claims, and the debtor should not be permitted to seek a lower rate as section 804 of the bill would provide.
But we believe that this section should be amended to preclude tax authorities from claiming a higher rate.
We agree that the debtor should not be permitted to shorten the period before a tax loses priority status by filing successive bankruptcy cases, as section 805 of the bill would provide.
But we believe that this section should be amended to prevent governmental taxing authorities from enlarging the period before which a tax loses priority by signing an installment payment agreement.
We believe the debtor should be encouraged to seek chapter 13, rather than chapter 7 relief when they can pay a portion of their debts over time.
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But we believe that debtors should not be discouraged from resorting to chapter 13 by denying them the broad discharge that present chapter 13 affords.
We agree that business debtors should not be permitted to back-load deferred payments of priority taxes as section 810 of the bill would provide.
But we believe that this section should be amended to provide that deferrals should not be denied to the most insolvent of corporate debtors when they turn their creditors into stockholders.
We agree that parties filing chapter 11 plans should be required to disclose the tax consequences of their plans to those who must vote on it, as section 817 of the bill would provide.
But we believe that this section should be amended to ensure that such parties should not be put to the expense of providing tax information that is of negligible interest in relation to the burden of compiling it.
We agree that governmental tax authorities should be able to set off pre-petition tax refunds against uncontested pre-petition tax liabilities as section 818 of the bill would provide.
But we believe that this section should be amended so as not to require the debtor to institute litigation against the government to protect his rights.
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There is much in article VIII that represents a step forward, but there are backward steps that should be corrected.
Finally, the bill fails to cover many areas that were the subject of Commission action. It would be a shame if the Congress missed a golden opportunity to make the bankruptcy and tax laws work in harmony.
Thank you once again, Mr. Chairman, for the opportunity to appear before you. Members of the Tax Section stand ready to assist you and your staff with this legislation in any way, and I would be pleased to answer any questions you may have when the time comes.
[The prepared statement of Mr. Asofsky follows:]
PREPARED STATEMENT OF PAUL H. ASOFSKY, WEIL, GOTSHAL & MANGES, LLP, HOUSTON, TX, AMERICAN BAR ASSOCIATION, SECTION OF TAXATION
Mr. Chairman and Members of the Subcommittee:
My name is Paul H. Asofsky and I am appearing before you today in my capacity as Chair of the Task Force on the Tax Recommendations of the National Bankruptcy Review Commission of the American Bar Association Section of Taxation. This testimony is presented on behalf of the Section of Taxation. It has not been approved by the House of Delegates or the Board of Governors of the American Bar Association and, accordingly, should not be construed as representing policy of the Association.
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The Tax Section of the American Bar Association is comprised of approximately 25,000 tax lawyers located throughout the United States. It is the largest and broadest-based professional organization of tax lawyers in the country. On behalf of the Section, I would like to thank the Committee for inviting me to testify this morning. The Section of Taxation has a long history of active involvement in the development of bankruptcy tax legislation. In 1978 and 1979, we testified and submitted written statements to various tax writing committees of the Congress in connection with the Bankruptcy Tax Act of 1980. In 1996, the Section created the current Special Task Force, that I am privileged to chair, to follow the development of bankruptcy tax proposals through the National Bankruptcy Review Commission and the Congress. The Task Force produced a report exceeding 250 pages in length and I personally testified before the Commission. In addition, three of our members were appointed by the Chair of the Commission to a special tax advisory committee consisting of representatives of the private sector, the government and the academic community. Many of the Tax Section's recommendations became consensus recommendations of the Advisory Committee that were unanimously approved by the Commission. Many of our other recommendations were adopted by the Advisory Committee and the Commission in divided votes. In short, we have been involved in this process continuously, and we offer our assistance to the Congress as we did to the Commission before it.
Over our many years of involvement with the bankruptcy legislative process, we have sought balanced legislative proposals that seek to reconcile the interests of efficient administration of the tax laws and the uniform application of those laws to all taxpayers on the one hand, with the efficient operation of a national bankruptcy system and rehabilitation of distressed debtors on the other. That sense of balance pervades our reactions to the provisions of this bill. Our positions taken as a whole tilt neither to government tax collectors nor to taxpayers seeking relief from tax debts. We have looked at each provision and attempted to make an independent judgment. For example, we agree with those provisions requiring more effective notice to governmental units of potential tax claims. We oppose attempts to repeal the superdischarge. We agree that governmental taxing authorities should be relieved of burdensome setoff rules that now exist. We disagree that taxpayers should lose their right to a discharge merely by entering into an installment payment agreement with the government. We agree that taxpayers should file some back returns as a condition for obtaining Chapter 13 relief.
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There is no reason why, with a little bit of give and take on all sides, a consensus bill could not be crafted with widespread support. One of the problems is that the devil is sometimes in the details. There are many provisions in this legislation with which we agree as a matter of principle, but the specific provisions are either ambiguously drafted or cut against the grain of the principal proposal, causing us to oppose what should be non-controversial proposals in their present form. For example:
We agree that governmental taxing authorities should be entitled to detailed notice of bankruptcy proceedings and requests for prompt audits, as Sections 802 and 803 of the Bill would provide. But we believe that those sections should be amended to require fair notice to debtors of governmental filing requirements.
We agree that the Bankruptcy Code should provide a fixed rate of interest on deferred tax claims, and that debtors should not be permitted to seek a lower rate, as Section 804 of the Bill would provide. But we believe that this section should be amended to preclude tax authorities from claiming a higher rate.
We agree that the debtor should not be permitted to shorten the period before a tax loses priority status by filing successive bankruptcy cases, as Section 805 of the Bill would provide. But we believe that this section should be amended to prevent governmental taxing authorities from enlarging the period before a tax loses priority by signing an installment payment agreement.
We agree that debtors should be encouraged to seek Chapter 13, rather than Chapter 7, relief when they can pay a portion of their debts over time, but we believe that debtors should not be discouraged from resorting to Chapter 13 by denying them the broad discharge that present Chapter 13 affords.
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We agree that business debtors should not be permitted to backload deferred payments of priority taxes, as Section 810 of the Bill would provide. But we believe that this section should be amended to provide that deferral should not be denied to the most insolvent of corporate debtors when they turn their creditors into stockholders.
We agree that parties filing Chapter 11 plans should be required to disclose the tax consequences of their plans to those who must vote on it, as Section 817 of the Bill would provide. But we believe that this section should be amended to insure that such parties should not be put to the expense of providing tax information that is of negligible interest in relation to the burden of compiling it.
We agree that governmental tax authorities should be able to set off prepetition tax refunds against uncontested prepetition tax liabilities, as Section 818 of the Bill would provide. But we believe that this section should be amended so as not to require the debtor to institute litigation against the government to protect his rights.
In short, there is much in Article Eight of this Bill that represents a step forward. But there are backward steps that should be corrected.
Finally, the Bill fails to cover many areas that were the subject of Commission action. It would be a shame if the Congress missed a golden opportunity to make the bankruptcy and tax laws work in harmony.
Thank you once again for the opportunity to appear before you. Members of the Tax Section stand ready to assist you and your staff with this legislation in any way. I would be pleased to answer any questions you may have.
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Mr. GEKAS. Yes. We will have some for you then.
Judge Brozman.
STATEMENT OF TINA BROZMAN, CHIEF UNITED STATES BANKRUPTCY JUDGE, SOUTHERN DISTRICT OF NEW YORK, NEW YORK, NY
Ms. BROZMAN. Thank you. You gave me a very nice introduction, so I do not think I need say who I am, but to add that I am the Chair of the Judges Section of Insol International, which is an organization of insolvency practitioners from around the world, and therefore of judges from around the world.
Although I sit as a general matter at about the same height you are at now, Mr. Chairman, in fact I actually work in the trenches presiding over a great many transnational insolvency cases in New York.
I would describe the state of transnational insolvency law right now as basically a mess. There are expensive jurisdictional battles which are lurking in all of these kinds of cases. In one of my cases, for example, where I have a companion bankruptcy in France it took the chapter 11 trustee whom I appointed over 2 years in order to get just recognition from the French courts—not any relief of any sort, but just to be recognized as an estate representative.
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In the cases as they exist now, assets are walking away. I have a case involving parallel proceedings in the United States and in Switzerland. The debtor also has assets, or had, I should say, assets in China and Russia.
Unfortunately, the assets in those latter countries just disappeared because there was no ability for me to work with anyone overseas to try to gather those assets for distribution to creditors.
Oftentimes in these transnational insolvency cases, because the law of the other jurisdiction is different from our own and there is no judicial cooperation, the ability to reorganize is either diminished or sometimes completely eliminated because say a valuable subsidiary cannot be reorganized and the debtor cannot survive without it.
As a result of these kinds of problems, the distributions to creditors and to United States creditors are of course lessened, and that is a terrible, terrible shame.
Further, in many countries around the world—and some of them are major trading partners like England—our own debtors-in-possession are not recognized as estate fiduciaries, as a result of which we have to go the route of appointing expensive estate professionals.
Now in a very large case that is not such a problem, but in a smaller chapter 11 case that can be a very expensive proposition and one which can itself cause a diminution in the likelihood of reorganization because of the increase in the administration costs.
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Previous efforts have been made on a variety of fronts at a universal, substantive law of bankruptcy. But as we have heard all through the day today and as we have heard over the last week in testimony from various parties, there really is at the base of bankruptcy a lot of philosophy.
We get into moral judgments about what is appropriate and not appropriate vis-a-vis the payment of debts. And because the mores are so different from one country to another, these efforts at having one universal law just have met with absolute failure across the board.
Finally, the United Nations Commission on International Trade Law came up with a much more modest solution, and it is that solution which I am here to advocate on behalf of today.
That solution was to deal with three specific areas: Access by foreign representatives to the courts; recognition of foreign proceedings; and judicial cooperation between U.S. courts or foreign courts.
That law, that model law, was negotiated by delegations from tens of nations and has received, at least in theory, tremendous support. And in fact, despite all of the controversy that surrounded the findings of the National Bankruptcy Review Commission, this was one of the areas where there was universal endorsement.
There are three very important features of the law for the United States: First, the recognition of debtors-in-possession; second, that if there is a recognition of foreign proceedings, there is an automatic stay which will end the dissipation of assets that I spoke about earlier; and finally, that the law expressly states that its goal is to enhance reorganization.
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In addition, we are hopeful that enactment of this legislation will eliminate appeals of U.S. court orders where it is questionable whether or not a bankruptcy judge has the power to do something which is not expressly stated in our law, and it will give U.S. estate representatives authority to repatriate assets where now they may not have such authority.
I believe it to be extraordinarily important that we encourage our trading partners to adopt this model law. At present, only Eritria has done so.
Cross-border cases are increasing, and they are increasing dramatically. We have NAFTA. We have rapidly changing technology. There is a common European currency now. There are foreign business failures which we can project as a result of the Y2K problem, and certainly there are problems all over the world in Asia and elsewhere.
As a result of this, I think it is important that we give confidence to lenders; that we maximize asset values; that we rehabilitate viable enterprises, and that we preserve employment by enacting this very important legislation.
I thank you for the opportunity of addressing you this afternoon.
[The prepared statement of Judge Brozman follows:]
PREPARED STATEMENT OF TINA BROZMAN, CHIEF UNITED STATES BANKRUPTCY JUDGE, SOUTHERN DISTRICT OF NEW YORK, NEW YORK, NY
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Cross-border insolvencies have confounded creditors, practitioners and jurists alike for decades. We have watched as jurisdictional battles and territorial approaches destroyed the possibility of saving viable enterprises and jobs and decimated the returns that creditors received on their claims. U.S. creditors have been particularly hard hit because of the frequent loss of going-concern values and because U.S. debtors in possession have been viewed with hostility in foreign venues, preventing the repatriation of assets for U.S. creditors. Private efforts by international bar associations to have enacted standardized insolvency laws have failed because their proponents aimed to change substantive law, too weighty an undertaking for a first step. We are poised to dramatically improve that status quo.
In 1994, the United Nations Commission on International Trade Law, known by the acronym UNCITRAL, received a clarion call from a multinational group of bankers, judges, regulators, insolvency professionals and academics to develop a more modest solution—one that would achieve three goals: cooperation between courts, recognition of foreign proceedings and access to foreign proceedings by estate representatives. Last year, UNCITRAL accomplished that objective, approving a Model Law for enactment by member states of the United Nations. The Model Law contains provisions which will accord relief to foreign representatives needing assistance in this country. But there are also three features of the Model Law which are especially important to the U.S. First, the Model Law recognizes debtors in possession as proper estate representatives. This outcome has been generally unavailable to bankruptcy judges, with the result that we have had to appoint examiners or trustees, at great expense to often modest estates, in order to even try to obtain foreign cooperation. In one case of mine with companion proceedings in France, notwithstanding that I appointed a trustee, it still took over two years just for the proceedings to be recognized—without any other relief being granted. The second important feature of the proposed law is that it contains an automatic stay once the foreign proceedings are recognized, ending the dissipation of assets by local creditors and staying the debtor from wholesale disposition or movement of assets. And third, the Model Law expresses as one of its fundamental goals enhancing the possibility of reorganization, thereby preserving value for out creditors as well as jobs. If we adopt the Model Law, spurring other nations to do so, this will go a long way toward furthering our national objectives and increasing stability for the banking community.
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Under the auspices of UNCITRAL and INSOL International, I have led the initial and subsequent Multinational Judicial Colloquia On Transnational Insolvency. I am also the chair of the Judicial Section of INSOL International. At our first Judicial Colloquium, one theme was commonly articulated by judges from civil law jurisdictions, who have less discretion than judges from common law jurisdictions like our own; they all agreed that some form of legislation was critical to enable them to cooperate as they wish to do in transnational insolvency cases. In addition to my role with INSOL and UNCITRAL, I am the Chief Judge of the Bankruptcy Court for the Southern District of New York, which is home to a great many of our transnational cases, cases which are centralized on the coasts and in a few of the farm states. I have presided over numerous cross-border cases. I can assure you that legislation is just as desirable for U.S. judges as it is for foreign ones, because it would eliminate unnecessary and costly appeals respecting the power of the bankruptcy judge to harmonize the U.S. and foreign proceedings. In addition, the legislation would afford to our estate representatives the statutory authority to seek assistance in foreign courts, ending claims that they are exceeding their statutory prerogatives and adding immeasurably to our ability to repatriate assets in appropriate cases.
Our second Judicial Colloquium considered an actual draft of the Model Law shortly before the final draft received UNCITRAL's approval. At the conclusion of a day and one-half of discussion, one of our evaluators, U.S. Bankruptcy Judge Leif Clark, from Texas, summarized the conclusions of the group respecting the importance of a legislative solution:
''At the outset all of us agree on one basic point . . . and that is that this effort and cooperation is vital in the cross-border arena. In most jurisdictions judges will in the main simply not feel comfortable inventing law on a case by case basis. Our hats must be off to the pioneers who dared to try something new and pave the way for this process. But the best way to ensure that most judges follow that lead is, it seems to us, to give them the statutory authority to do so. The express provision for judicial cooperation may thus appear to be innocuous on its face but is in reality one of the most important features of the UNCITRAL effort.''
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Notwithstanding the clear benefits which we will receive from enactment of the Model Law domestically, there is an even more important reason for its adoption. The international community is unlikely to embrace the Model Law if we do not do so. To date, only Eritrea has adopted the Model Law and the New Zealand Law Commission has recommended its adoption. If we do not act affirmatively on this legislation, I have grave fears that it will receive inadequate attention overseas. Just as we have led the way in creating ad hoc solutions for the problems of large transnational cases, we must lead the way in enacting a more comprehensive and long-lasting solution capable of governing not only the large, newsworthy cases but the smaller, less remarkable, multinational cases which, with the globalization of commercial enterprise, increasingly are becoming the bread and butter of our business bankruptcy dockets. No longer should U.S. creditors have to fear that they will lose out to creditors overseas who seize a bankrupt debtor's assets with impunity. No longer should our creditors have to worry that if a foreign enterprise fails, they will receive no notice of the right to participate in its insolvency proceedings. And no longer should our creditors be held hostage by shrewd debtors who can utilize technology to remove assets beyond the reach of our courts. Indeed, at our second Judicial Colloquium, one of our Norwegian judges expressed frustration about just such a case, where he was unable to follow the debtor's assets around the world as the debtor deftly moved them from nation to nation. If, through our leadership, we convince our trading partners to enact this legislation, we will have done a great deal to give confidence to the lending community, maximize asset values for all creditors, rehabilitate viable enterprises and preserve employment for our own citizens. In short, with the explosion of international commerce fostered by rapidly changing technology, a common European currency and initiatives such as NAFTA, coupled with the foreign business failures which may flow from the Year 2000 problem and the ills plaguing Asia, we simply cannot afford not to enact this legislation.
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Which brings me to my final point. I appear today not to express any view on the omnibus bankruptcy bill, many of whose provisions I disdain and others of which I applaud, but to advocate in favor of delinking the Model Law from the more general bill. In the last Congress, the identical proposed legislation for our adoption of the Model Law was defeated, despite its unanimous recommendation by the National Bankruptcy Review Commission, because it was part of the omnibus bill. This legislation is too important to the business community, banks and insurance companies, vendors and manufacturers alike, to be held hostage to the fate of the broader, more contentious legislation. Whatever happens in the larger context, cross-border cases are an ever-increasing fact of economic reality. We must enable the courts and the bankruptcy professionals to preserve viable enterprises and maximize value for parties in interest free from the unproductive and expensive jurisdictional warfare which lurks as the enemy of an orderly insolvency regime.
I thank you for the opportunity of addressing you.
Mr. GEKAS. We thank the Judge.
Mr. Ireland, I regret that we did not have you testify yesterday so you would have had extra highlights, but we will let you testify today.
STATEMENT OF OLIVER IRELAND, ASSOCIATE GENERAL COUNSEL, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM, WASHINGTON, DC
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Mr. IRELAND. I welcome the opportunity anyway, Mr. Chairman and members of the subcommittee.
I appreciate the opportunity to appear before this subcommittee to present the views of the Board of Governors of the Federal Reserve System on title X, Financial Markets Contracts of H.R. 833, the proposed Bankruptcy Reform Act of 1999.
Title X includes a number of proposed amendments to the Federal Deposit Insurance Act and the Bankruptcy Code, as well as other statutes relating to financial transactions.
Most of these provisions incorporate or are based on amendments to these statutes that were endorsed by the President's Working Group on Financial Markets.
The Board supports enactment of the provisions recommended by the President's Working Group. Enactment of these provisions would reduce uncertainty in the financial markets.
This reduced uncertainty would limit market disruptions in the event of an insolvency, would limit the risk to Federally supervised financial market participants including insured depository institutions, and limit systemic risk.
The importance of improving the legal regime underpinning the financial markets has been recognized by the Finance Ministers of the G7 countries as well.
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In this regard, the ability to terminate or close out and net contracts and to realize on collateral pledged in connection with these contracts is vital.
Closeout refers to the right to terminate a contract upon event of default and to compute a termination value due to or due from the defaulting party, generally based on the market value of the contract at that time.
By providing for termination of contracts on default—these are financial market contracts—nondefaulting parties can remove uncertainty as to whether the contract will be performed, fix the value of the contract at that point, and proceed to rehedge themselves against the market risk that they would otherwise incur during the pendency of the bankruptcy proceeding.
The right to terminate or close out contracts is important to the stability of market participants and reduces the likelihood that a single insolvency will trigger other insolvencies due to the market risk.
Further, absent termination and closeout rights the inability of market participants to control their market risk is likely to lead them to reduce their market risk exposure, potentially drying up market liquidity and preventing the affected markets from serving their essential risk-management credit intermediation and capital-raising functions.
Netting refers to the right to set off or net claims between parties to arrive at a single obligation between the parties.
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Netting can serve to reduce the credit exposure of counterparties to a failed debtor and thereby to limit systemic risks and, at the same time, foster market liquidity.
This liquidity can be important in minimizing market disruptions due to the failure of a market participant.
Finally, frequently credit exposure under financial market contracts is collateralized. The right to liquidate this collateral is important for preserving the liquidity of financial market participants and their stability in times of stress.
Recognizing the importance of termination or closeout and netting, and collateral, in March 1998 the Secretary of the Treasury on behalf of the President's Working Group on Financial Markets transmitted to Congress proposed legislation that would amend the banking laws and the Bankruptcy Code.
The provisions of title X, as I noted earlier, are largely based on the provisions that were endorsed by the Working Group.
I understand that there have been some concerns expressed over the effects that some of the provisions of title X may have on proceedings under the Bankruptcy Code.
The potential for the effects of these recommended provisions on other creditors was considered by the Working Group members and staff in formulating the Working Group recommendations. I continue to believe that the recommended statutory amendments weighed these considerations appropriately. I would note, there are additional provisions in title X that go beyond the recommendations of the Working Group. For example, section 1012 addresses asset-backed securitizations, and was not included in the Working Group's recommendations.
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While I believe that this provision fosters efficiency in the financial markets by promoting certainty in these transactions, we think the Working Group recommendations are sufficiently important to proceed with even if these provisions are not included.
This concludes my prepared statement. I would be happy to address any questions.
[The prepared statement of Mr. Ireland follows:]
PREPARED STATEMENT OF OLIVER IRELAND, ASSOCIATE GENERAL COUNSEL, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM, WASHINGTON, DC
I appreciate the opportunity to appear before this Subcommittee to present the views of the Board of Governors of the Federal Reserve System on Title X, Financial Contract Provisions, of H.R. 833, the proposed Bankruptcy Reform Act of 1999. Title X includes a number of proposed amendments to the Federal Deposit Insurance Act and the Bankruptcy Code as well as other statutes related to financial transactions. Many of these provisions incorporate, or are based on, amendments to these statutes that were endorsed by the President's Working Group on Financial Markets.
The Board supports enactment of the provisions recommended by the Working Group. Enactment of these provisions would reduce uncertainty for financial market participants as to the disposition of their financial market contracts in the event one of the parties becomes insolvent. This reduced uncertainty should limit market disruptions in the event of the insolvency of a financial market participant, limit risk to federally supervised financial market participants, including insured depository institutions, and limit systemic risk.
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STATUTORY RECOGNITION OF FINANCIAL MARKET TRANSACTIONS
Since its adoption in 1978, the Bankruptcy Code has been amended a number of times to recognize the nature and significance of certain financial market transactions and to provide these transactions special treatment in a bankruptcy proceeding. For example, in 1984, the Code recognized the right of a repo market participant to liquidate a repurchase agreement without regard to the otherwise applicable automatic stay provisions of the Code. In 1990, this recognition was extended to permit swap participants to terminate and net swap agreements. Similar rights had previously been given to stock brokers, financial institutions and clearing agencies with respect to securities contracts and commodity brokers and forward contract merchants with respect to commodities and forward contracts.
Similarly in 1989, in establishing the manner of the conduct of the receivership of insured depository institutions under Federal law, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 provided for the termination, or close-out, and netting of qualified financial contracts, including securities, commodity and forward contracts and repurchase and swap agreements. The Federal Deposit Insurance Corporation Improvement Act of 1991 provided further legal support for netting contracts between two or more financial institutions or members of a clearing organization.
IMPORTANCE OF CLOSE-OUT, NETTING, AND COLLATERAL
The importance of improving the legal regime underpinning financial markets has been recognized by the finance ministers of the G7 countries who, in 1997, agreed ''to introduce, where necessary and appropriate, legislative measures to ensure the enforceability of sound netting agreements in relation to insolvency and bankruptcy rules to reduce systemic risk in international transactions.'' In this regard, it is important to ensure that financial market participants have the ability to terminate or close-out and net financial market contracts, and to realize on collateral pledged in connection with these contracts.
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Close-out
Close-out refers to the right to terminate a contract upon an event of default and to compute a termination value due to or due from, the defaulting party, generally based on the market value of the contract at that time. This right is critical to the management of market risk by financial market participants. The value of most financial market contracts is volatile. While the degree of volatility varies with the nature and duration of the contract, this volatility can create significant market risk to the contracting parties. Many end users of these contracts have entered into them for hedging purposes. Dealers generally enter into these contracts in order to profit from meeting the needs of end users and other dealers. In both cases, the contracts typically either hedge or are hedged against market risk. Termination of the contract allows the nondefaulting party to rehedge the position in order to control that market risk. By providing for termination of contracts on default, nondefaulting parties can remove uncertainty as to whether the contract will be performed, fix the value of the contract at that point, and proceed to rehedge themselves against market risk. If this process were stayed while the trustee or the receiver for a failed counterparty determined whether to perform the contract, the delay would expose the nondefaulting party to potentially serious market risks during the pendency of this decision process.
Thus, the right to terminate or close-out financial market contracts is important to the stability of financial market participants in the event of an insolvency and reduces the likelihood that a single insolvency will trigger other insolvencies due to the nondefaulting counterparties' inability to control their market risk. The right to terminate or close-out protects federally supervised financial institutions, such as insured banks, on an individual basis, and by protecting both supervised and unsupervised market participants, protects the markets from systemic problems of ''domino failures.'' Further, absent termination and close-out rights the inability of market participants to control their market risk is likely to lead them to reduce their market risk exposure, potentially drying up market liquidity and preventing the affected markets from serving their essential risk management, credit intermediation, and capital raising functions.
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Netting
Netting refers to the right to set off, or net, claims between two or more parties to arrive at a single obligation between the parties. In financial market transactions, netting can serve to reduce the credit exposure of counterparties to a failed debtor and thereby to limit ''domino failures'' and systemic risks. As an incident to limiting credit exposure, the ability to net contributes to market liquidity by permitting more activity between counterparties within prudent credit limits. This liquidity can be important in minimizing market disruptions due to the failure of a market participant.
Collateral
Frequently, credit exposure under financial market transactions is collateralized. This practice is most visible in repurchase transactions where cash and securities are exchanged at the beginning of the transaction and the exchange is reversed at the end of the transaction with appropriate adjustment for intervening interest. In addition, market participants are requiring that credit exposure under over-the-counter derivative transactions be collateralized. The right to liquidate collateral immediately is important for preserving the liquidity of financial market participants.
WORKING GROUP RECOMMENDATIONS
Recognizing the importance of termination or close-out, netting, and collateral in financial market transactions, in March of 1998, the Secretary of the Treasury on behalf of the President's Working Group on Financial Markets transmitted to Congress proposed legislation that would amend the banking laws and the Bankruptcy Code. The proposed legislation was the result of a multi-year interagency effort to make recommendations to improve the legal regime governing certain financial market contracts in insolvency situations. Explanatory material accompanying the proposed legislation described it as having four principal purposes:
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''To strengthen the provisions of the Bankruptcy Code and the FDIA that protect the enforceability of termination and close-out netting and related provisions of certain financial agreements and transactions.
To harmonize the treatment of the financial agreements and transactions under the Bankruptcy Code and the FDIA.
To amend the FDIA and FDICIA to clarify that certain rights of the FDIC acting as conservator or receiver for a failed insured depository institution (and in some situations, rights of SIPC and receivers of certain uninsured institutions) cannot be defeated by operation of the terms of FDICIA.
To make other substantive and technical amendments to clarify the enforceability of financial agreements and transactions in bankruptcy or insolvency.''
TITLE X
The provisions of Title X, Financial Market Contracts, of H.R. 833 are largely based on the provisions that were endorsed by the Working Group. I understand that in these hearings there have been some concerns expressed over the effects that some of the provisions of Title X may have on proceedings under the Bankruptcy Code and potentially other creditors of an insolvent debtor. We recognize that amendments to the Bankruptcy Code that affect any particular class of creditors are likely to affect other creditors. At the same time, we believe that differing types of claims warrant differing treatment. The potential for effects on other creditors and the need for each recommended provision was considered in formulating the Working Group's recommendations. We continue to believe that the recommended statutory amendments weighed these considerations appropriately. Additional language in Title X is designed to further the same ends that the Working Group sought to further. Other provisions, such as section 1012 on Asset-Backed Securitizations, which was not included in the Working Group's recommendations, may foster the efficiency of the financial markets by promoting certainty. Nevertheless, I believe that the provisions endorsed by the Working Group are sufficiently important to be pursued in this Congress even if other provisions are not included.
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This concludes my prepared statement. I will be happy to address any questions that the members of the Subcommittee may have.
Mr. GEKAS. We thank you, Mr. Ireland.
Professor Picker.
STATEMENT OF RANDAL C. PICKER, LEFFMANN PROFESSOR OF COMMERCIAL LAW, UNIVERSITY OF CHICAGO LAW SCHOOL, CHICAGO, IL, ON BEHALF OF THE NATIONAL BANKRUPTCY CONFERENCE
Mr. PICKER. Thank you, very much. I am Randy Picker. I am a Professor at the University of Chicago Law School and I am here as Vice Chair of The National Bankruptcy Conference's Committee on Legislation.
We appreciate the chance to be here. I want to address two issues in the 5 minutes that I have. The first is the asset securitization issue, and the second is the cross-product netting issue.
As to the asset securitization issue, I think the starting point there is to recognize that the Bankruptcy Code does and should recognize that a true sale for fair consideration prior to bankruptcy is something we should respect in bankruptcy.
So if someone sells a car and they get back fair consideration for it before bankruptcy, we don't yank that car back into the bankruptcy estate and say we want to undo that transaction. Simple enough.
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The problem is that with regard to securitizations, understanding when you have a true sale and when you don't turns out to be really hard.
Mr. Grosshandler's written testimony reflects that fact in the sense that he gives you, I think, a good sense of the difficult, careful, reasoned, true sale opinion letters that he writes, I'm sure, on behalf of his client, and the fact that those letters are very difficult precisely because it's hard to tell whether you have a true sale or you don't.
The question is what to do with that difficulty.
The statute has taken what I would regard as what I think of as a deemed-tiger approach to solving this problem, and what I mean by that is as follows:
I think of my 5-year-old son, Adam, walking into the room with his pink stuffed elephant and saying, here's my tiger. I assume that would get some quizzical looks, right?
We'd all look at Adam and say, you know, that's an elephant, not a tiger.
He would say, no, I've deemed it to be a tiger, and because I've deemed it to be a tiger, it's therefore a tiger.
Well, that's exactly what this legislation does.
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If you look at the approach to a definition of transfer on page 286 of H.R. 833, and in particular line 10, a debtor who represents and warrants that a sale is a sale makes it a sale. All you have to do is say it's a sale. You represent and warrant it's a sale and you're done.
Well we have never in the history of commercial transactions law relied on the characterization of the parties to the transaction to determine what that transaction is, when it will have third party consequences.
Do understand that asset securitization will have third party consequences.
Mr. Silvers, on behalf of the AFL–CIO made that point in his earlier testimony today, where he said that the consequence of deeming to be sales things which are not true sales will mean that you'll reduce the amount of cash collateral in the estate, and that will make it more difficult for businesses to reorganize, and that will result in the loss of jobs.
That was Mr. Silvers' concern and that's the National Bankruptcy Conference's concern, and the ability to merely say that it's a sale, even though it's not a sale, is not the right approach on this.
It seems to me you can do one of two things. You can either leave current law in place, where we've had very little judicial development. Again, Mr. Grosshandler's testimony fairly reflects that fact, very little development and see what happens.
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And the other alternative would be to actually put into place, as a matter of Federal law, some standard of what counts as a true sale.
But what you have done so far is simply to empower parties to elect out of the Bankruptcy Code, if they're so, if they want to do that, and we have never done that as a matter of public policy.
Okay, that's asset securitization.
As to cross product netting, I'm not sure what to say about that. Mr. Ireland's testimony is based upon a concern about systemic risk and to consider sort of my animal metaphors, I think that is sort of the 800-pound gorilla of the financial world.
You sort of say systemic risk, and something's supposed to flow from that. I'm not sure what that is.
What we've learned from Mr. Ireland and what we've learned today is that bankruptcy disrupts people's lives. If someone owes me money and they file for bankruptcy and they don't pay me, that's a problem.
That's a problem if you're a multibillion dollar bank, but it's also a problem if you're a trade creditor or a single mother.
The question is who should bear that risk. And I would have thought that the right answer is, the people best in the position to bear that risk are the holders of the multi-million dollar banks.
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A single mother cannot put together a diversified portfolio of child support obligations. She's not in a position to do that.
Banks, in contrast, this is the business they're in. They live and die, they love to be in the business of doing these vast, complicated swaps and forward contracts and backwards contracts and all the things that they do, they are in the best position to bear this risk.
So except the fact that when you don't get paid, it disrupts someone's lives, except the fact, as Mr. Ireland's testimony fairly does, that this is an allocation question, if we reduce the risk for banks, we're probably boosting the risks for trade creditors, and in that connection we would reject the cross product netting provisions.
[The prepared statement of Professor Picker follows:]
PREPARED STATEMENT OF RANDAL C. PICKER, LEFFMANN PROFESSOR OF COMMERCIAL LAW, UNIVERSITY OF CHICAGO LAW SCHOOL, CHICAGO, IL, ON BEHALF OF THE NATIONAL BANKRUPTCY CONFERENCE
SUMMARY
We highlight two areas of particular concern in Title X of H.R. 833: asset securitization and master netting.
Asset Securitization. Section 1012 would change drastically the rules applicable to asset-backed securitizations. It would amend Section 541 of the Bankruptcy Code to make it possible for companies to isolate assets from bankruptcy by choice, regardless of whether there was an actual true sale of the assets in question. The debtor's say so—a simple representation and warranty—would be enough to remove these assets from the debtor's bankruptcy estate.
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True sales that are not otherwise subject to avoidance under the fraudulent transfer provisions should be respected in bankruptcy. This is true whether the sold asset is real estate or a car, securities or accounts receivable. The problem that arises—and here is where asset securitization comes in—is that for some assets, the basic notion of sale can be quite tricky. In some versions, true sales take place, in others, this is much less obvious, and the essential point here is that the basic notion of sale in these contexts is quite difficult to apply.
How should we deal with that uncertainty, that is, the uncertainty about whether the structure of a particular asset securitization is or is not a true sale? Current law appropriately leaves these questions to judges, to be resolved under state law, if and when a particular transaction is challenged. Some uncertainty does exist, but notwithstanding these issues, so far, trillions of dollars of asset-securitization deals have taken place, with only a handful of challenges. Section 1012 would overturn a long tradition in commercial law by allowing the mere say so of the debtor to determine how a transaction is characterized. The National Bankruptcy Conference thus believes that the statute should remain unchanged and that Congress should await further judicial development before legislating in this important area.
Master Netting. Section 1007 of H.R. 833 would permit the setoff or netting of claims arising under different financial products without running afoul of the automatic stay. There is no indication that the absence of such cross-product netting features has led to widespread difficulties or systematic disruptions in the financial markets for such products. In addition, master netting could deprive a debtor of much-needed cash collateral, which in some instances may lead to conversion and liquidation to the detriment of other creditors. For these reasons, the master netting provisions should be deleted.
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STATEMENT
Mr. Chairman and Members of the Subcommittee on Commercial and Administrative Law, I am Randal C. Picker, the Leffmann Professor of Commercial Law at the University of Chicago Law School. I am offering this testimony on behalf of the National Bankruptcy Conference, as Vice-Chair of its Committee on Legislation, and this testimony does not necessarily represent the views of the University. The Conference is a private organization of bankruptcy judges, practitioners, and law professors formed in 1932 to work on proposed revisions of the Bankruptcy Act of 1898. The Conference has functioned since 1932 to advise Congress with respect to issues regarding bankruptcy legislation and laws. As per House Rule XI, clause 2(g)(4), no federal grant, contract, or subcontract has been received by me or the National Bankruptcy Conference, and I have attached to this testimony as Appendix A a copy of my curriculum vitae.
You have asked me to address Title X of the Bankruptcy Reform Act of 1999, on financial contract provisions. These provisions would make many changes to the relevant areas of law. Some of these are largely technical in nature, and I will have very little to say about them. Other changes might appear ''technical,'' as they are not the stuff of everyday family dinner discussion. It would be a substantial mistake to lump the genuinely technical with the provisions that will make important substantive changes to bankruptcy law. In that connection, I will focus on two particular changes: Section 1012 on asset-backed securitizations and Section 1007, which makes a number of changes, including introducing to the Bankruptcy Code the idea of master netting. Both of these would make it possible for sophisticated entities to exclude assets from the bankruptcy estate. This runs contrary to the general history of our bankruptcy laws which have treated as void against public policy agreements seeking to avoid the application of the bankruptcy laws.
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I should indicate as a preliminary matter that, as of this date, the National Bankruptcy Conference does not have comments on the provisions of Title X making amendments to the Federal Deposit Insurance Act regarding the definitions and treatment of various financial contracts.(see footnote 57) The balance of this written testimony consists of two parts: a general discussion of the asset securitization and master netting issues and a detailed section by section analysis of selected provisions in Title X of H.R. 833.
Sec. 1001. Treatment of certain agreements by conservators or receivers of insured depository institutions;
Sec. 1002. Authority of the corporation with respect to failed and failing institutions;
Sec. 1003. Amendments relating to transfers of qualified financial contracts;
Sec. 1004. Amendments relating to disaffirmance or repudiation of qualified financial contracts;
Sec. 1005. Clarifying amendment relating to master agreements;
Sec. 1006. Federal deposit insurance corporation improvement act of 1991; and
Sec. 1008. Recordkeeping requirements.
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Sec. 1009, regarding exemptions from contemporaneous execution requirements, amends Federal Deposit Insurance Act section 13(e)(2) to provide that an agreement to provide for the lawful collateralization of bankruptcy estate funds pursuant to 11 USC §345(b)(2) and other agreements is not invalid solely because the agreement was not executed contemporaneously with the acquisition of collateral or because of pledges, delivery, or substitution of collateral made in accordance with such agreement. That provision is unobjectionable.
I. Asset Securitization and Master Netting
We highlight two areas of particular concern in Title X of H.R. 833:
Asset Securitization. Section 1012 would change drastically the rules applicable to asset-backed securitizations. It would amend Section 541 of the Bankruptcy Code to make it possible for companies to isolate assets from bankruptcy by choice, regardless of whether there was an actual true sale of the assets in question. The National Bankruptcy Conference believes that the statute should remain unchanged and that Congress should await further judicial development before legislating in this important area.
Master Netting. Through a series of inter-related amendments to the Bankruptcy Code, Section 1007 of H.R. 833 would permit the setoff or netting of claims arising under different financial products (see, e.g., portions of proposed new sections 11 USC §561, 362(b)(29)) without running afoul of the automatic stay. There is no indication that the absence of such cross-product netting features has led to widespread difficulties or systematic disruptions in the financial markets for such products. In addition, master netting could deprive a debtor of much-needed cash collateral, which in some instances may lead to conversion and liquidation to the detriment of other creditors. For these reasons, the master netting provisions should be deleted.
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I will take these one-by-one.
Asset Securitization. Section 1012 of H.R. 833 would introduce a new provision that would exclude from ''property of the estate'' assets transferred by the debtor in connection with an asset securitization under which investment grade rated debt has been created. ''Eligible assets'' would be defined broadly to include cash, securities, and all financial assets. A transaction essentially would be considered a transfer for asset securitization so long as the transaction documentation deemed it as such. Put differently, so long as the company ''selling'' the assets ''represented and warranted'' that the sale was a true sale—so long as the debtor-to-be just said it was a true sale—it would be treated as such for bankruptcy purposes, and the ''sold'' assets would be excluded from the bankruptcy estate if the company eventually filed for bankruptcy.
The issue can be framed quite generally. Suppose that a company sells an asset—a piece of real estate, for example—in a transaction in which it receives reasonably equivalent value for the asset. Say the real estate is worth around $100,000 and the company receives that amount in exchange for it. The company files for bankruptcy soon thereafter, with a good chunk, say $80,000 of the cash in hand. The company did not have title to the real estate when it filed for bankruptcy, so under the general rules for creating the bankruptcy estate under Section 541, the estate also does not have title to the real estate. Instead, the estate gets whatever the company has in hand that it received in exchange for the sold asset when the company files for bankruptcy, here the $80,000.
All of this is as it should be. True sales that are not otherwise subject to avoidance—undoing—under the fraudulent transfer provisions should be respected in bankruptcy. This is true whether the sold asset is real estate or a car, securities or accounts receivable. The problem that arises—and here is where asset securitization comes in—is that for some assets, the basic notion of sale can be quite tricky. I am owed in one year $10,000 by Smithco. I would like cash today. To raise that cash, I ''sell'' Smithco's promise to me to Buyer for $9,000. Of course, Buyer may not know Smithco at all, so to allay Buyer's concerns about Smithco's ability and willingness to repay the debt in one year, I agree to make good on the debt, in the full amount of $10,000, if Smithco doesn't pay when it is supposed to do so.
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Have I really ''sold'' the debt to Buyer, or has Buyer merely floated a loan to me for one year? The point of this exercise is not to answer this question, because if you are confident about your answer here, I can add or subtract provisions, wrinkle by wrinkle, until I should be able to get you to the point of uncertainty. Asset securitizations, which are essentially highly-complex variants on the Smithco hypothetical, do exactly this. In some versions, true sales take place, in others, this is much less obvious, and the essential point here is that the basic notion of sale in these contexts is quite difficult to apply.
How should we deal with that uncertainty, that is, the uncertainty about whether the structure of a particular asset securitization is or is not a true sale? One possibility—and this is current law—is just to leave these questions to judges, if and when a particular transaction is challenged. The uncertainty just exists and may create a cloud over some transactions, but we get a resolution of the true sale question only if a challenge is ultimately mounted. This will typically turn on the details of state law. Notwithstanding these issues, so far, trillions of dollars of asset-securitization deals have taken place, and we have had only a handful of challenges. A different approach—and this is the point of Section 1012—would be to allow the seller to just deem a sale a true sale by saying it was one, and making that statement dispositive for bankruptcy purposes. We have generally been reluctant to allow the characterization of a deal by the transacting parties to control, and with good reason. The parties to the deal will ignore the consequences to third parties—unsecured creditors, for example—who have no say in how the deal is characterized. There is a third position that would close the gap between simply leaving current law in place or moving to Section 1012's representation and warranty scheme. The third approach would create a separate federal definition of a true sale that would be applied by a judge, usually in bankruptcy, if a transaction was challenged. This would create greater uniformity in sales law as applied to asset securitizations, at the price of invading an area of law traditionally left to state control.
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As should be clear, in its current form, Section 1012 would change drastically the rules applicable to asset-backed securitizations. It would amend Section 541 of the Bankruptcy Code to make it possible for companies to isolate assets from bankruptcy by choice, regardless of whether there was an actual true sale of the assets in question. The National Bankruptcy Conference believes that the statute should remain unchanged and that Congress should await further judicial development before legislating in this important area.
The need for Section 1012 is highly questionable. The current existence of a robust asset-securitization business, coupled with the existence of minimal case law in the area, suggest that special Bankruptcy Code treatment is unnecessary. The broad definition of ''transferred'' in Section 1012 is likely to cause certain financing arrangements to be treated as sales to prevent the debtors' assets from being considered property of the estate even though they are only pledged as collateral. The proposed provision makes no effort to distinguish those transactions properly characterized as ''true sales'' from those legitimately subject to characterization as security interests. At the very least, the language should be amended to limit the provision's application to securitizations which are, in economic substance, true sales.
We should be clear on the purpose of securitization. As described by The Committee on Bankruptcy and Corporate Reorganization of The Association of the Bar of the City of New York in its report on ''Structured Financing Techniques'' in The Business Lawyer of February 1995, ''structured financings are based on one central, core principle—a defined group of assets can be structurally isolated, and thus serve as the basis of a financing that is independent as a legal matter, from the bankruptcy risks of the former owner of the assets.'' Assets that would otherwise be part of the bankruptcy estate had the original transaction been structured as a secured financing are outside of bankruptcy if the transaction structure is respected.
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Many believe that securitization is socially useful in that it may reduce the cost of obtaining cash by making it easier for our certain borrowers to access public markets. There is also a general concern that uncertainty about the status of asset securitization prevents deals from going forward, though you would not know it by the number of securitizations that take place. Notwithstanding this, we have had a long-standing policy in this country of not permitting individuals or companies to opt out of bankruptcy. Waivers of the right to file for bankruptcy are seen as void against public policy. Section 1012 obviously does not validate general waivers of the right to file for bankruptcy, but it does make it possible to isolate from bankruptcy assets that would otherwise become part of the bankruptcy estate.
We should tread cautiously here. What is less well understood, or at least less well-publicized, is the possible harm to the bankruptcy estate and other creditors that may result from securitized financings. There is an academic literature that emphasizes that securitization may have the consequence of creating judgment-proof entities. See Lynn M. LoPucki, The Death of Liability, 106 Yale L J 1, 28–29 (1996); Lois R. Lupica, Asset Securitization: The Unsecured Creditor's Perspective, 76 Tex L Rev 595 (1998). This debate is ongoing and is far from unanimous. See James J. White, Corporate Judgment Proofing: A Response to Lynn LoPucki's The Death of Liability, 107 Yale L J 1363 (1998), and the further response by Lynn M. LoPucki, Virtual Judgment Proofing: A Rejoinder, 107 Yale L J 1413 (1998).
These issues are unresolved, because there have been almost no cases addressing the consequences of securitization in bankruptcy. There are a handful of unreported opinions and almost no reported opinions. Usually, judicial development of an area gives us a full sense of the issues raised by any new practice. It is the interaction of case law and legislation that is the genius of the American system. We will artificially truncate this process were Congress to adopt the broad exemption set forth in Section 1012.
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The National Bankruptcy Conference thus believes that no change is warranted now and that we should wait additional judicial development to better understand consequences of this financial innovation for bankruptcy. The proposed change might easily hurt creditors and decrease the likelihood that a business can reorganize because the business will have no cash collateral to fund operations. Rating agencies and private parties should not be authorized to make the legal determination of whether an asset is property of a bankruptcy estate. This provision also would invade states right by treating ''sales'' voidable under state law as effective in bankruptcy.
Master Netting. H.R. 833 contains numerous provisions addressing the bankruptcy treatment of certain financial products and financial transactions. Most of these provisions are unobjectionable, as they seek to protect important financial markets by eliminating inconsistencies in the treatment of these transactions and products and to protect additional counterparties. However, the provisions relating to master netting are objectionable and should be eliminated.
The Bankruptcy Code currently contains a number of special provisions that exempt certain financial transactions from the scope of the automatic stay and from the general rules in Section 365 which ban ipso facto clauses (that is, contractual rights triggered by a bankruptcy filing). These are in Section 362(b) and Section 555 on securities contracts; Section 556 on commodities contracts and forward contracts; Section 559 on repurchase agreements (which includes reverse repurchase agreements); and Section 560 on swap agreements. There are also a series of corresponding definitions in Section 101. These provisions currently create a special exemption for these financial transactions to permit market participants to do with-in product setoff or liquidations. By ''within-in product'' I mean, for example, that that a swap participant can setoff claims against a debtor relating to the swap agreement against monies owed by the swap participant to the debtor in connection with that swap agreement or can liquidate securities held as collateral to support the debtor's obligations under the swap agreement.
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What a market participant cannot do is setoff across products, so-called cross-product netting, or in the language of H.R. 833, master netting. So, a market participant with securities collateral for a swap agreement cannot use the collateral with the benefits of the Section 362(b) exceptions to cover payments under a non-swap agreement, say a securities contract. The precise point of the new provisions in Section 1007 that would add Sections 561 and 362(b)(29), and a definition of a master netting agreement in 101(38B) is to make cross-product netting possible.
There is no indication that the absence of such cross-product netting features has led to widespread difficulties or systematic disruptions in the financial markets for such products. The expansion of these provisions would take us farther down the path of allowing sophisticated parties to opt out of bankruptcy. In addition, cross-product netting could deprive a debtor of much-needed cash collateral, which in some instances may lead to conversion and liquidation to the detriment of other creditors.
For these reasons, the master netting provisions should be deleted.
II. Section by Section Analysis of Certain Provisions of Title X of H.R. 833
Sec. 1007. Bankruptcy code amendments.
(A) DEFINITIONS OF FORWARD CONTRACT, REPURCHASE AGREEMENT, SECURITIES CLEARING AGENCY, SWAP AGREEMENT, COMMODITY CONTRACT, AND SECURITIES CONTRACT.
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This subsection provides revised definitions of the above listed contracts and parties.
Comments: These definitions are unobjectionable to the extent they are narrowly tailored to exclude transactions such as secured loans.
(B) DEFINITIONS OF FINANCIAL INSTITUTION, FINANCIAL PARTICIPANT, AND FORWARD CONTRACT MERCHANT.
This subsection revises the definitions of financial institution and forward contract merchant and provides a definition of financial participant.
Comments: These definitions are unobjectionable.
(C) DEFINITION OF MASTER NETTING AGREEMENT AND MASTER NETTING AGREEMENT PARTICIPANT.
Subsection (c) amends 11 USC §101 to add broad definitions of master netting agreement and master netting agreement participant. The definition of master netting agreement encompasses rights of netting, setoff, liquidation, termination, or closeout not only with a variety of financial instruments, but with security agreements and credit enhancement as well.
Comments: This provision is unobjectionable to the extent it protects single-product netting and is objectionable to the extent it permits and expands cross-product netting.
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(D) SWAP AGREEMENTS, SECURITIES CONTRACTS, COMMODITY CONTRACTS, FORWARD CONTRACTS, REPURCHASE AGREEMENTS, AND MASTER NETTING AGREEMENTS UNDER THE AUTOMATIC STAY.
This subsection revises the exceptions to the automatic stay for setoff by financial participants of claims against payments due, and adds an additional exception to section 362(b) to permit cross-product netting without violating the automatic stay.
Comments: This provision is objectionable to the extent that it permits cross-product netting and overrides the equitable powers of the bankruptcy court under 11 USC §105(a). Under appropriate circumstances, the court should retain the power to provide injunctive relief.
(E) LIMITATION OF AVOIDANCE POWERS UNDER MASTER NETTING AGREEMENT.
This subsection amends 11 USC §546 to preclude a trustee from avoiding a transfer made by or to a master netting agreement participant under or in connection with any master netting agreement, except if the transfer was made with the actual intent to hinder, delay, or defraud.
Comments: This provision is objectionable to the extent that it limits the ability of a trustee or debtor in possession to recover cross-product netting transfers under the avoiding powers.
(F) FRAUDULENT TRANSFERS OF MASTER NETTING AGREEMENTS.
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This subsection would amend 11 USC §548(d)(2) to insulate certain transfers to master netting agreement participants.
Comments: This provision is objectionable to the extent that it insulates cross-product netting from fraudulent transfer avoidance actions.
(G) TERMINATION OR ACCELERATION OF SECURITIES CONTRACTS.
(H) TERMINATION OR ACCELERATION OF COMMODITIES OR FORWARD CONTRACTS
(I) TERMINATION OR ACCELERATION OF REPURCHASE AGREEMENTS.
In the aforementioned three subsections, 11 USC §555, 556, and 559 are amended to refer to termination and acceleration in addition to liquidation.
Comments: These provisions are unobjectionable.
(J) LIQUIDATION, TERMINATION, OR ACCELERATION OF SWAP AGREEMENTS.
Subsection (j) amends 11 USC §560 to add a reference to liquidation and acceleration, in addition to termination.
Comments: This amendment is unobjectionable.
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(K) LIQUIDATION, TERMINATION, ACCELERATION, OR OFFSET UNDER A MASTER NETTING AGREEMENT AND ACROSS CONTRACTS.
This subsection adds 11 USC §561, which prohibits the application of the stay, avoidance, or any other limitations on a contractual right to terminate, liquidate, accelerate, or offset under a master netting agreement and across contracts.
Comments: This provision is objectionable to the extent it exempts cross-product netting from the avoidance powers, the automatic stay, and other otherwise applicable provisions.
(L) MUNICIPAL BANKRUPTCIES.
This subsection applies the securities contract liquidation provisions to chapter 9 municipal bankruptcy cases.
Comments: The National Bankruptcy Conference supports this provision.
(M) ANCILLARY PROCEEDINGS.
Pursuant to this subsection, cases ancillary to foreign proceedings are subject to all Bankruptcy Code provisions relating to securities contracts, commodity agreements, forward contracts, repurchase agreements, swap agreements, or master netting agreements.
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Comments: This provision should be coordinated with proposed chapter 15 and the proposed revision to 11 USC §304.
(N) COMMODITY BROKER LIQUIDATIONS.
(O) STOCKBROKER LIQUIDATIONS.
These two subsections add 11 USC §767 and 753 to address the liquidation of commodity brokers and stockbrokers. Under these provisions, the exercise of rights by a broker or participant would not affect the priority of unsecured claims held by brokers or participants after the exercise of their rights or the applicability of the commodity broker and stockbroker liquidation provisions.
Comments: These provisions are unobjectionable.
(P) SETOFF.
This subsection makes conforming amendments to 11 USC §553 to reflect the exceptions to the general rules of setoff provided for financial instruments. It creates a carveout to the exception to the right to setoff in section 553(a)(3)(C) for rights arising under provisions dealing with financial contracts. This subsection also amends 553(b)(1) to add additional references to these provisions.
Comments: This provision is unobjectionable.
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(Q) SECURITIES CONTRACTS, COMMODITY CONTRACTS, AND FORWARD CONTRACTS.
This subsection clarifies the language in several Bankruptcy Code provisions by replacing references to a variety of parties with the term ''financial participant.''
Comments: This provision is unobjectionable.
Sec. 1010. Damage measure.
This section addresses the calculation of damages following the rejection, liquidation, termination, or acceleration of certain agreements relating to financial instruments. It provides that damages shall be measured as of the earlier of the date of rejection or the date of liquidation, termination or acceleration. The resulting damage claim is treated as a prepetition claim, consistent with other claims arising from rejection.
Comments: This provision is unobjectionable.
Sec. 1011. SIPC stay.
This provision adds a new paragraph to section 5(b)(2) of the Securities Investor Protection Act of 1970 which states that nothing in the Bankruptcy Code stays the contractual rights of a creditor to liquidate, terminate, or accelerate a securities contract, but that a court order may operate as a stay of the foreclosure on securities collateral pledged by the debtor.
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Comments: This provision is unobjectionable.
Sec. 1012. Asset-backed securitizations.
This section explicitly excludes from ''property of the estate'' cash, receivables, securities, and other financial assets transferred by the debtor in connection with an asset securitization under which investment grade rated securities have been issued. The debtor is considered to have transferred assets prepetition if the assets were transferred pursuant to a written agreement that states that the assets were conveyed with the intention of removing them from the estate of the debtor, regardless of whether the debtor holds an interest in the issuer or securities held by the issuer, whether the debtor has continuing obligations to repurchase, service, or supervise the servicing of eligible assets, and the characterization of the transfer for other purposes.
Comments: The National Bankruptcy Conference opposes this provision, which inappropriately permits rating agencies and private parties to make the legal determination of whether an asset is property of a bankruptcy estate. Transactions that are not sales under state law should not be treated as sales by federal bankruptcy law to the detriment of the estate and unsecured creditors. This provision may undercut the ability of a business to reorganize by leaving it with no cash collateral, to the detriment of employees and suppliers.
Sec. 1013. Federal reserve collateral requirements.
This section changes the statutory references in section 16 of the Federal Reserve Act.
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Comments: The National Bankruptcy Conference does not have comments on this provision.
Sec. 1014. Severability; effective date; application of amendments.
This section provides that these amendments (presumably Title X, but the provision does not say so explicitly), remain in effect if provisions are found to be unconstitutional. The Act takes effect on the date of enactment, and the amendments made by the Act apply to cases commenced or appointments made after the date of enactment.
Comments: This provision is unobjectionable, but should say explicitly that it applies only to Title X of this bill.
Mr. GEKAS. I thank you, Professor Picker.
Mr. Grosshandler.
STATEMENT OF SETH GROSSHANDLER, ESQUIRE, PARTNER, CLEARY, GOTTLIEB, STEEN & HAMILTON
Mr. GROSSHANDLER. Thank you.
Thank you, Chairman Gekas, and good afternoon.
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My name is Seth Grosshandler. I'm a partner at Cleary, Gottlieb, Steen & Hamilton in New York City.
For the past 15 years or so, my practice has focused on the market safe harbors and the Bankruptcy Code and the Federal Deposit Insurance Act, and the treatment of financial market transactions in bankruptcy, swaps, forwards, et cetera.
Title X of your legislation, which addresses these issues, could be viewed as the Seth Grosshandler Unemployment Act of 1999, in that it would correct many of the glitches in the current market safe harbors.
This is my livelihood, these glitches in these safe harbors, because creditors worry about the glitches, they try to structure around the glitches, and I advise them on that, and I advise them on risks in case they fall within the glitches.
I'm confident that even when title X is enacted, I'll still have plenty to do, and I commend you and your colleagues for introducing this important piece of legislation and appreciate the chance to appear before the subcommittee.
As Mr. Ireland indicated, beginning all the way back in 1982, Congress enacted the securities contract provisions of the Bankruptcy Code.
In 1984, the repurchase provisions of the Bankruptcy Code.
In 1989, the qualified financial contract provisions of the Federal Deposit Insurance Act, which, by the way, provide for cross product netting.
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In 1990, the swap provisions of the Bankruptcy Code.
In 1991, the payment system risk reduction provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991.
All a mouthful to say that Congress has already legislated in this area and has decided, in balancing debtor protection, the rights of unsecured creditors versus so-called systemic risk.
And what is systemic risk? Systemic risk is a risk that market participants' financial condition will become impaired by virtue of an insolvency.
They might not go under, they might become impaired due to, for instance, the effect of the automatic stay.
Confidence is a very important thing in the financial markets, and when people lose confidence in financial intermediaries, they might be balance sheet solvent, but they might, nonetheless, go under, and the systemic risk is a chain reaction of insolvencies, a ripple effect, that fortunately we've never seen because these provisions are intended to be preventive medicine.
So Congress has already decided that the systemic risk concerns override the interests of a particular debtor or its creditors in a particular case, and in fact these provisions can be detrimental to a particular debtor in a particular case. No one is hiding that fact.
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It's been many years since the last safe harbor was enacted, and there have been a number of market developments since that time.
I think that largely most of the provisions of title X can be viewed as technical corrections, if you will, updating those market safe harbors to take into account the changes in the marketplace, and I don't think that many—most of the provisions I don't believe that Professor Picker believes are controversial with two notable exceptions of course; cross product netting and asset-backed securitization.
The concern about cross-product netting I frankly just don't get. Again, the Federal Deposit Insurance Act has had it since 1989.
The Bankruptcy Code actually has cross product netting for a variety of products; securities, forward and commodity contracts can all be netted.
I don't see why it makes a difference what you call it for whether you can net. The same overarching policy of systemic risk applies, no matter what the product, and it seems to me that it is frankly an arbitrary classification in the current Bankruptcy Code based on history because these provisions were added bit by bit.
Asset-backed securitization. There I understand better the source of the concern because there is clearly a debate between debtor protection and securitization.
I think that if you read Professor Picker's testimony, you will see at bottom that he really is not in favor of securitization. I think that's what this boils down to.
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That because the things that people are doing today are the things that Professor Picker is worrying about being protected, the markets rely on that, that's securitization.
It provides low-cost funds to all sorts of borrowers, including homeowners.
In 1983, there was a Bankruptcy Court decision in Lombard Wall where a Bankruptcy Court held that repurchase agreements which, by the way, are characterized basically as being outside of the purview of the Bankruptcy Code, by agreement of the parties were not entitled to the safe harbors of the Bankruptcy Code.
There was a demonstrable negative effect on the liquidity of the markets and the cost to the U.S. Treasury.
I don't think we should wait for an adverse court decision, in the case of securitization, which could throw that market into turmoil and impair liquidity and increase cost of funds to borrowers.
Thank you very much.
I look forward to answering questions.
[The prepared statement of Mr. Grosshandler follows:]
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PREPARED STATEMENT OF SETH GROSSHANDLER, ESQUIRE, PARTNER, CLEARY, GOTTLIEB, STEEN & HAMILTON
I. INTRODUCTION
Certain types of financial transactions involve ongoing economic relationships or commitments to be fulfilled in the future. For example, risk management tools such as forward contracts and swaps are based on contractual agreements between parties to transfer assets or payments at some future time. Repurchase agreements, which are important sources of liquidity in the debt markets and, to an increasing degree, in the equity markets, involve financial commitments that must be fulfilled at a later date. In these important market activities which can involve huge sums and concentrated exposures, the inability of one party to exercise its contractual ''self-help'' rights in the event of the insolvency of the other party could cause ripple effects by undermining the financial condition of the non-bankrupt party (and its counterparties) and the markets more generally.
Recognizing the important role of these transactions in capital formation and market liquidity and the potential for a chain reaction of insolvencies should non-bankrupt parties' contractual self-help rights be impaired, Congress has included provisions in the Bankruptcy Code, the Federal Deposit Insurance Act and the Federal Deposit Insurance Corporation Improvement Act of 1991 (applicable in proceedings under the Bankruptcy Code and the Federal Deposit Insurance Act) that expressly protect the exercise of such rights in the event of bankruptcy or insolvency. In 1982 and 1984, the ''securities,'' ''forward'' and ''commodity'' contracts and ''repurchase agreement'' provisions were added to the Bankruptcy Code. In 1989, the Federal Deposit Insurance Act was amended to enhance the FDIC's powers, and to provide ''market safe harbors'' from those powers for parties to ''qualified financial contracts'' (''securities,'' ''forward'' and ''commodity'' contracts and ''repurchase'' and ''swap'' agreements). In 1990, the ''swap agreement'' provisions were added to the Bankruptcy Code, and in 1991 the ''Payment System Risk Reduction'' provisions of the Federal Deposit Insurance Corporation Improvement Act (applicable to the treatment of ''netting contracts'' in proceedings under the Bankruptcy Code and the Federal Deposit Insurance Act) were enacted.
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It is almost ten years since the last of the Bankruptcy Code and Federal Deposit Insurance Act ''market safe harbors'' was enacted, and almost twenty years since the first of the Bankruptcy Code's ''market safe harbors'' was enacted. Unfortunately, the Bankruptcy Code and the Federal Deposit Insurance Act have not kept pace with the development of sophisticated financial markets transactions. The risks to the markets that Congress has previously addressed remain the same—the insolvency of a party to a financial markets transaction could cause a chain reaction of insolvencies—but the Bankruptcy Code and the Federal Deposit Insurance Act need important technical corrections to minimize these risks in light of market developments. The Bankruptcy Code, especially, needs corrections that were made in the analogous provisions of the Federal Deposit Insurance Act in 1989. In the last two decades, the financial markets have evolved and matured in ways that leave various transactions and parties subject to legal uncertainty. As more types of market participants have engaged in a broader range of transactions, statutory inconsistencies have surfaced that make it difficult to conclude that Congress's goal of minimizing systemic risk has been fully achieved through the existing market safe harbors.
Asset securitizations, which provide a secondary market for consumer, commercial and industrial loans and other debt obligations, are multi-stage transactions where the integrity of securities payment commitments rests on the finality of earlier transfers of underlying assets. The key to these transactions is that the underlying assets be separated from the creditworthiness of the seller through a ''true sale'' of the assets. The FDIC has published for comment a Policy Statement designed to give comfort to the markets that these transactions will not be impaired if a bank seller becomes the subject of insolvency proceedings. Similar comfort is important in the case of sellers that are potentially subject to proceedings under the Bankruptcy Code; investors counting on the predictability of certain cash flows rely on the finality of the earlier sale of underlying assets. Amendments to provide such comfort will not only enhance the development of future asset-backed securitizations, they will provide a safeguard against market turmoil should a seller become the subject of proceedings under the Bankruptcy Code and attempt to disrupt the cash flow on assets it has securitized.
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The Bankruptcy Reform Act of 1999 (H.R. 833) would bring the treatment of financial transactions under the Bankruptcy Code and the Federal Deposit Insurance Act up to date through a number of important amendments. This statement does not focus on all of the technical corrections that would be made by the bill. Instead if focuses on three sets of provisions in particular. The first set of provisions would modernize outdated definitions and classifications that can cause different types of parties in similar economic circumstances to receive dramatically different treatment under the law and that seem inconsistent with the goal of minimizing systemic risk. The second set of provisions would address situations where parties have multiple outstanding obligations to one another involving different types of products (so-called ''cross-product netting''). Although the Federal Deposit Insurance Act does not make arbitrary distinctions between netting among different products, the Bankruptcy Code does; these distinctions do not seem consistent with the goal of reducing the risk of a chain reaction of insolvencies. A third set of provisions is specifically designed to protect the integrity of certain asset securitizations from the bankruptcy of a seller of assets.
These proposed changes should not raise sweeping new policy issues—they are entirely consistent with many statutory provisions that have already been enacted, and are in the nature of technical corrections.
II. THE CURRENT MARKET SAFE HARBORS NEED TO BE UPDATED
A. Swap Agreements
Swap agreements are privately negotiated contracts between parties to exchange payments under specified conditions. The parties' obligations are linked to some index, commodity price, interest rate, currency or other indication of economic value. In an interest rate swap, for example, two parties agree to exchange payments based on some agreed upon notional principal amount. However, principal does not typically change hands in a swap contract. It merely serves as the reference for the calculation of the payments to be made.
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The primary purpose of swaps is risk management. The universe of parties actively engaged in swaps is expansive and growing: banks, securities firms, mutual funds, pension funds both public and private, manufacturing firms, state and local governments, just to name a few. Virtually all significant commercial enterprises face certain risks that can be managed through the use of a swap. In the example that follows, Party B attempts to manage its exposure to changes in interest rates through the use of an interest rate swap:
Example 1. Two parties to an interest rate swap agree to exchange payments based on a $1 million notional amount. Party A agrees to pay a fixed rate of seven percent, and Party B agrees to make floating payments based on some market index. Assuming payments are exchanged once per year, Party A would pay Party B $70,000 (seven percent of $1 million) and Party B would pay Party A $40,000 in the first year (four percent of $1 million), assuming that the floating rate index were four percent at the time of calculation. In practice, the payments are netted so that Party A simply pays Party B $30,000, or $70,000–$40,000. (In this example, Party B may have floating rate assets and fixed rate liabilities, and it desires to hedge that mismatch. In this example, the payment that Party B receives makes up for the reduced return Party B receives on its floating rate assets, allowing it to satisfy its fixed rate liabilities. Party A may be a dealer, who hedges its position by taking an offsetting position, either in the swaps market or in another fixed income market.)
The fundamental contractual terms in a swap for the exercise of remedies in the event of bankruptcy or insolvency provide for ''close-out,'' ''netting'' and foreclosure. Close-out involves the termination of future obligations between the parties and the calculation of gain or loss. Netting involves offsetting the parties' gains and losses to arrive at a net outstanding amount payable by one party to the other. Foreclosure involves the use of pledged assets to satisfy the net payment obligation. The ability to execute this process swiftly is key to the financial markets and the solvency of its participants due to the potential exposure a counterparty in such transactions has to market risks and the possibility of changes in the values of financial contracts and collateral due to market movements. The inability of a financial market participant to exercise these remedies promptly could impair its liquidity and solvency.
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The following is a basic example of the close-out, netting and foreclosure process:
Example 2. Party A and Party B enter into two interest rate swaps at different times (Swap X and Swap Y). Both contracts contain provisions that allow for close-out, netting and foreclosure and are in effect when Party A becomes insolvent. At the time of Party A's insolvency, Party A's mark-to-market loss under the terms of Swap X is $30 million and its mark-to-market gain under the terms of Swap Y is $20 million. Through the process of close-out and netting, the swaps are terminated and Party A owes Party B $10 million. If Party A had pledged $15 million of collateral to Party B, Party B would foreclose on the collateral, use $10 million to satisfy Party A's obligation, and return $5 million to Party A.
If Party A became subject to a proceeding under the Bankruptcy Code, Party B would be entitled under current law (Sections 362(b)(17) and 560 of the Bankruptcy Code) to exercise its self-help close-out, netting and foreclosure remedies as described above. If Party A were an FDIC-insured bank that became subject to a receivership (and Swaps X and Y were not transferred to a successor entity), Party B would be entitled under the Federal Deposit Insurance Act to exercise its self-help close-out, netting and foreclosure remedies as described above. Party B's inability to exercise such remedies could impair its liquidity and solvency, creating gridlock and posing the risk of systemic problems.
The swaps market has evolved since the protections for interest rate and other swaps were first put in place. Parties have learned to apply the principles of risk management in many different ways that are not expressly covered under the applicable definitions in the Bankruptcy Code and the Federal Deposit Insurance Act. As a result, the markets in some cases proceed under some degree of legal uncertainty regarding the enforceability of certain contracts, even though they are economically equivalent to other contracts that are expressly protected and pose the same risks that Congress has sought in the past to avoid.
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For example, if in the above hypothetical the two swaps were equity swaps in which the payments were calculated on the basis of an equity securities index, it is not entirely clear that the transactions would fall within the market safe harbor in the Bankruptcy Code or the Federal Deposit Insurance Act for ''swap agreements.'' If both of the parties were ''financial institutions'' under the Federal Deposit Insurance Corporation Improvement Act or the Federal Reserve Board's Regulation EE and the swap agreement were a ''netting contract,'' then Party B might (although it is not entirely clear) be able to exercise close-out, netting and foreclosure rights in respect of the equity swap transactions. If one of the parties were not a ''financial institution'' or the contract did not constitute a ''netting contract'' (for example, because it was governed by the laws of the United Kingdom), then Party B could be subject, among other things, to the risk of ''cherry-picking''—the risk that Party A's trustee or receiver would assume Swap Y and reject Swap X, leaving Party B with a $30 million claim (which would be undersecured because of the impairment of netting) and to the risk that its foreclosure on the collateral would be stayed indefinitely. This could impair Party B's creditworthiness, which in turn could lead to its default to its counterparties. The Bankruptcy Reform Act of 1999 would minimize these risks by making clear that an equity swap is a ''swap agreement,'' entitled to the same market safe harbors as interest swap agreements.
B. Repurchase Agreements
Repurchase agreements, also known as ''repos,'' are contracts involving the sale and repurchase of securities or other financial assets at predetermined prices and times. Although structured and treated for legal purposes as purchases and sales, economically repos resemble secured lending transactions. In economic terms, one participant in the repo transaction (the ''seller'') is borrowing cash at the same time that the other participant (the ''buyer'') is receiving securities. The recipient of cash agrees to pay the cash—to repurchase the securities—at a predetermined time and price, including a price differential (the economic equivalent of interest). The buyer agrees to purchase and later resell the securities.
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According to published reports, on an average day last year, nearly $1.7 trillion in repos were outstanding between dealers of U.S. government and federal agency securities, up from a daily average of $567 billion in 1987. Parties also routinely engage in repo transactions involving non-agency mortgage-backed securities, whole loans and other financial instruments. As a result of recent legislative changes enacted as part of the National Securities Markets Improvement Act and recent changes to federal margin regulations, repos may now involve equity securities. Participants in the repo market are diverse, including commercial banks, securities firms, thrifts, finance companies, non-financial corporations, state and local governments, mutual and money-market funds and the Federal Reserve Banks, among others.
In 1984, Congress acted to protect certain types of repos from the insolvency of market participants after the 1982 Lombard-Wall bankruptcy court decision cast uncertainty on the ability of market participants to close out their positions. According to the Senate Judiciary Committee report on the 1984 legislation, that decision had a distinct adverse effect on the financial markets. At that time, Congress granted protection only to repos involving certificates of deposit, eligible bankers' acceptances, and securities that are direct obligations of, or that are fully guaranteed as to principal and interest by, the federal government. In doing so, Congress expressly stated that repos serve a vital role in reducing borrowing costs in the markets for these securities and sought to encourage market participants to use repos with confidence.
Unfortunately, the list of instruments protected by those 1984 amendments to the Bankruptcy Code has grown outdated as market participants have entered into repos involving a wide range of financial assets. Besides repurchase agreements on government and federal agency securities, which are covered under the Bankruptcy Code and Federal Deposit Insurance Act definitions of ''repurchase agreement,'' firms now actively engage in repurchase agreements on the foreign sovereign debt of OECD countries, whole mortgage loans, and mortgage-backed securities of many types. Under H.R. 833, each of these types of repurchase agreements would be covered by the market safe harbors provided in the Bankruptcy Code (they are already covered by the Federal Deposit Insurance Act and regulations thereunder). Market participants could then enter into such transactions with greater confidence that they will be easily enforceable, improving the liquidity and cost of financing in the markets for the underlying instruments, and minimizing systemic risk.
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C. Securities Contracts, Forward Contracts and Commodity Contracts
Market participants enter into contractual arrangements for the sale of securities and commodities where payment and delivery obligations are fulfilled at some future date. Securities contracts, forward contracts, and commodity contracts all can take many forms, but they can also be similar from an economic perspective. ''Securities contracts'' include forward purchases of securities, pursuant to which the parties agree to exchange payments and securities at a fixed date in the future. ''Forward contracts'' include privately negotiated arrangements where one party agrees to sell a commodity to another party at a fixed price for delivery at a future date. The terms of forward contracts can closely resemble those of futures contracts (which are ''commodity contracts''). However, forward contracts are not traded on commodity exchanges under standardized terms and the parties envision actual delivery of the underlying commodity.
Despite the economic similarities of securities contracts, forward contracts and commodity contracts, the Bankruptcy Code and the Federal Deposit Insurance Act are inconsistent in their treatment of these transactions. Under the Federal Deposit Insurance Act, any counterparty can close out and net obligations under all securities contracts, forward contracts or commodity contracts it may have outstanding with the FDIC-insured bank in a liquidating receivership. However, if the failing counterparty is a debtor subject to the Bankruptcy Code, the enforceability of close-out provisions depends on a number of factors, including the type of counterparty, and the type of contract involved. In order to close out and net ''securities contracts,'' the non-bankrupt counterparty must be a ''stockbroker,'' ''financial institution'' or ''securities clearing agency.'' In order to close out and net ''forward contracts,'' the non-defaulting party must qualify as a ''forward contract merchant.'' A few examples illustrate these differences:
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Example 3. Party A, a mutual fund, and Party B, a securities dealer, have two outstanding contracts for the purchase of securities, one that is in-the-money to Party A, one that is out-of-the-money to Party A. If Party B becomes the subject of proceedings under the Bankruptcy Code, Party A would not be able to close out the contracts and net its obligations to Party B under the out-of-the-money contract against Party B's obligations under the in-the-money contract (unless it had acted through a bank agent). However, if it is Party A that becomes the subject of proceedings under the Bankruptcy Code, Party B would be able to close out the transactions and net its obligations. This is because Section 555 of the Bankruptcy Code allows liquidation of securities contracts only by stockbrokers, financial institutions and securities clearing agencies, none of which includes the mutual fund (unless it had acted through a bank agent).
Example 4. Now assume that in the above example Party B is an FDIC-insured depository institution. If Party B becomes the subject of receivership proceedings and the securities contracts with Party A are not transferred to a successor institution, Party A will be able to close out the transactions and net the obligations thereunder. This is because the Federal Deposit Insurance Act, since 1989, contains no counterparty restrictions.
Example 5. Party A, the mutual fund, and Party B, an affiliate of a securities dealer, have two outstanding forward foreign exchange contracts. If Party B becomes the subject of proceedings under the Bankruptcy Code, Party A would be able to close out and net the foreign exchange transactions. This is because Section 556 of the Bankruptcy Code allows liquidation of ''forward contracts'' (the foreign exchange transactions) by forward contract merchants, a classification that includes the mutual fund. (Note that the forward foreign exchange contracts would also be ''swap agreements,'' and the mutual fund, as a ''swap participant,'' could exercise its rights on that basis as well. Other ''forward contracts'' would not qualify as ''swap agreements.'')
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Thus, parties of similar size who enter the markets with equal frequency and in the same manner enjoy different degrees of protection under the Bankruptcy Code and the Federal Deposit Insurance Act. This makes no sense from the point of view of the reduction of systemic risk—the failure of these market players could trigger the same kind of chain reaction that a bank, broker-dealer or clearing agency failure could trigger. H.R. 833 would improve the current situation by making certain technical definitional changes under the Bankruptcy Code (to bring it closer to the Federal Deposit Insurance Act). The amendments would expand the universe of counterparties whose contractual rights would be enforceable. In addition to stockbrokers, financial institutions, registered investment companies and securities clearing agencies, large and sophisticated market participants would be able to close out their securities contracts, forward contracts and commodity contracts against Bankruptcy Code debtors. Such counterparties would be defined as ''financial participants'' under the Bankruptcy Code through certain quantitative tests modeled on the Federal Reserve Board's Regulation EE. Once amended, the counterparty limitations under the Bankruptcy Code would have a more rational scope than they do under current law.
D. Cross-Product Netting
Financial market participants often have a wide range of transactions outstanding with one another at any given time. Thus, a given party's exposure to the risk of default by another party may be understood only by considering the total value of the payments that party expects to receive and pay under all of the various contracts. The Federal Deposit Insurance Act reflects an understanding of this and permits the netting of obligations stemming from one type of ''qualified financial contract'' against obligations stemming from another type of ''qualified financial contract.'' This practice, known as ''cross-product'' netting, permits more rational risk management practices and allows market participants to resolve whatever problems arise from the insolvency of one of their counterparties in a more orderly fashion. Cross-product netting also reduces the likelihood of systemic risk, as it allows the non-bankrupt counterparty to crystallize its exposure and not be treated as a secured creditor with an interest in cash collateral subject to the automatic stay.
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Cross-product netting is also permitted under the Bankruptcy Code, but to a lesser degree. Parties can net their obligations under securities contracts, forward contracts and commodity contracts against one another. It is unclear whether cross-product netting is permitted, however, when the contracts involved are swaps and repurchase agreements.
Example 6. Party A, a securities dealer, and Party B, a large corporation, have an outstanding securities contract that upon close-out is profitable for Party A. The parties also have an outstanding forward contract that upon close-out is profitable for Party B. When Party B becomes the subject of a proceeding under the Bankruptcy Code, Party A would be able to close out each of the contracts and offset its obligation to pay Party B under the forward against Party B's obligation to Party A under the securities contract.
Example 7. Party A and Party B have an outstanding swap that upon close-out is profitable for Party A. The parties also have an outstanding repurchase agreement under which Party A holds securities purchased from Party B that upon close-out is profitable to Party B (i.e., the value of the securities exceeds the repurchase price). If Party B becomes the subject of proceedings under the Bankruptcy Code, Party A would not clearly be able to offset the excess repo proceeds against Party B's outstanding obligation under the swap. At worst, Party A would be treated as a secured creditor with a security interest in the repo proceeds. Its rights could, however, be subject to the automatic stay, thereby impairing its liquidity and creating the potential for systemic risk.
There is no plausible rationale for treating cross-product netting between securities, forward and commodity contracts differently from cross-product netting between those contracts, swap agreements and repurchase agreements. These anomalies emerged over time, as various protective provisions were added to the Bankruptcy Code to protect various types of markets. (Because the ''qualified financial contract'' provisions of the Federal Deposit Insurance Act were enacted at the same time, no such anomalies exist in those provisions.) However, the capital markets have grown and matured to such an extent that various types of market participants now engage in many types of transactions, and it is time for the market safe harbors to be rationalized and made consistent in their application to all financial products for all participants.
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Wider and more certain cross-product netting in cases of bankruptcy should allow parties to enter into additional types of transactions with the same counterparty without necessarily increasing, on a net basis, their overall credit exposure or risk to the markets as a whole. Indeed, some cross-product transactions will serve to reduce a counterparty's overall risk, facilitating better risk management and reducing overall risk in the financial markets.
III. MORTGAGE- AND ASSET-BACKED SECURITIES
The process of assembling pools of financial assets and selling securities with payments derived from the assets' cash flows is known as ''securitization.'' Almost any financial asset can be securitized. The earliest examples were home mortgage loans, but today financial services firms securitize car loans and leases, credit card receivables, business loans and many other assets generating current or future cash flows. The proceeds from sales of securities supported by those assets make their way back into the capital markets and become available for new lending to homeowners, car owners, consumers, businesses and myriad other borrowers. A larger supply of lendable capital means that home buyers, car buyers, consumers and companies can all borrow at lower interest costs.
A simple example demonstrates the process of financial asset securitization:
Example 7. Party O originates mortgage loans with a total principal amount of $100 million and sells the whole loans to a special-purpose vehicle (an ''SPV''). The SPV issues mortgage-backed securities (''MBS''), the payments on which are supported by cash flows from the mortgage loans. As borrowers make principal and interest payments on their mortgage loans, these payments pass through a servicer and eventually are distributed to the MBS investors. The proceeds of the sale of the loans by Party O to the SPV are available for new loans to home buyers.
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Certain types of mortgage-backed and asset-backed transactions raise issues under the Bankruptcy Code that make them more costly or difficult to complete. The central issue in such situations is the risk that securitized assets transferred to a special-purpose vehicle, which then issues securities backed by such assets, will be considered part of the bankruptcy estate of the party selling them into the pool if that seller becomes insolvent. Such treatment could subject the cash flows from the securitized assets to the automatic stay and inhibit the timely distribution of principal and interest payments to investors in the subsequently issued asset-backed securities. It could also subject the pool of transferred assets to attack by a bankruptcy trustee who might seek to reclaim them for the bankrupt's estate for the benefit of general creditors, denying beneficial holders of asset-backed securities the primary source of repayment that was intended to be provided by these securitized assets. Consider the following transaction:
Example 8. Party A originates mortgage loans with a total principal amount of $100 million and sells the loans to Party B. Party B sells two classes of asset-backed securities based on the pool. The Class A securities, totaling $90 million, have a senior claim on the cash flows generated by the mortgage loans and receive an investment-grade credit rating. The Class B securities, totaling $10 million, are subordinated to the Class A securities and not rated investment-grade. Assume Party B obtained the mortgage loans from Party A in exchange for (i) the $90 million raised through the sale of the Class A securities and (ii) the Class B certificates. If Party A becomes insolvent, Party A (as debtor-in-possession) or its trustee could attempt to recharacterize the sale of the mortgage loans as a pledge to secure a financing, based on Party A's retention of the Class B securities. If it were successful, notwithstanding that it had received fair value at the outset of the transaction and the reasonable expectations of the investors in the Class A securities, distribution of the principal and interest payments on the loans to the investors would be subject to the automatic stay, jeopardizing timely payment to the Class A investors. Such a result would not only harm the particular investors in question, it could have a material, negative effect on the mortgage-backed and asset-backed securities markets more generally.
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In order to obtain sales treatment under the relevant accounting standards, participants in mortgage-backed and asset-backed securitization transactions must obtain assurances from counsel that the sale of assets will be final under applicable bankruptcy law. Such legal advice is referred to as a ''true sale opinion.'' Unfortunately, there is a lack of guiding judicial precedent regarding what constitutes such a true sale of assets. The considerations in the analysis are highly subjective and depend on a qualitative assessment of a wide variety of facts and circumstances. For these and other reasons, any true sale opinion will generally be a reasoned one, with various assumptions as to factual matters and conclusions that introduce an unnecessary degree of legal uncertainty in the asset-backed market. As a result, for some types of transactions, true sale opinions can be extremely difficult, costly, and in a few cases, impossible to render.
The FDIC recently released for comment a proposed Policy Statement that would clarify that, with respect to certain securitizations by FDIC-insured institutions, the FDIC would not seek to reclaim the assets the subject of the securitization. In particular, the Policy Statement ''provides that subject to certain conditions, the FDIC will not attempt to reclaim, recover, or recharacterize as property of the institution or the receivership estate . . . the financial assets transferred . . . in connection with the securitization.'' 63 Fed. Reg. 71926 (December 30, 1998). Similar action is needed to cover transfers by market participants who later become debtors under the Bankruptcy Code. In an effort to clarify the rights of investors in asset-backed securities and bring the benefits of securitization to a broader spectrum of market activity, H.R. 833 includes a series of amendments to the Bankruptcy Code that would specifically exempt certain transferred assets from a debtor's bankruptcy estate and clarify whatever ''true sale'' confusion may exist. The amendments would be narrowly tailored to apply only to eligible assets transferred as part of a bona fide securitization involving the issuance of securities rated investment grade by at least one nationally recognized rating organization. Through a series of definitions, the proposed amendments would exclude from a debtor's estate any asset ''to the extent that such eligible asset was transferred by the debtor, before the date of commencement of the case, to an eligible entity in connection with an asset-backed securitization.''
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These changes would not only reduce transaction costs for future mortgage- and asset-backed securitizations, they would minimize the likelihood that an insolvent debtor could attempt to reclaim already-securitized assets in a proceeding under the Bankruptcy Code, notwithstanding the structural safeguards designed to avoid such a result. Even if such a debtor were not successful, the possibility of recharacterization could have a significant adverse impact on the markets in mortgage- and asset-backed securities.
IV. CONCLUSION
The above examples illustrate the need for Congress to enact the Bankruptcy Reform Act of 1999 which would make important, but highly technical, changes to the Bankruptcy Code and the Federal Deposit Insurance Act. These changes are consistent with the existing market safe harbors in the Bankruptcy Code and the Federal Deposit Insurance Act, will encourage broader use of sound risk management techniques and help to minimize overall systemic risk.
Mr. GEKAS. I thank the gentleman.
This is the first time that I believe that the record will show that the witnesses read each others' testimony. That's very good. I have suspected it, but now we have it officially.
Mr. Peiffer?
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STATEMENT OF JOSEPH PEIFFER, ESQUIRE, PEIFFER LAW OFFICE, GRAND RAPIDS, IA
Mr. PEIFFER. Thank you, Chairman Gekas, other members of the subcommittee.
I too have read the testimony of the other witness, and the dialogue has now begun between the American Bankers Association and myself regarding some of the provisions in changing chapter 12 bankruptcy that he so vehemently opposes.
And so what I'm going to do is address my remarks to some changes that I think could make chapter 12 a better vehicle for farmers.
Currently before the House, H.R. 833 will make chapter 12 permanent. In addition, though, there are two other bills that have been introduced in Congress this session dealing specifically with chapter 12.
One of them is H.R. 763 and the other one is S. 260.
I worked closely with Senator Grassley's office in drafting S. 260. The goal of S. 260, which is identical to H.R. 763, is to help farmers deal with the problem of paying capital gains taxes when their secured assets have been sold or liquidated, and the money's gone to the secured creditors.
Farming is an industry in which many of the assets that the farmers have can be low basis. We look back in the 1980's, farmland was relatively cheap. It had become a very cheap commodity, if you will.
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Today, it's come back to almost the historic levels that it had reached in price pre-farm-crisis. We are within 5 or 10 percent of that.
Many farmers have held that land, some of which was bought in the seventies, some of which was bought in the mid-eighties, until today.
If that farmer's business fails and there's a mortgage on it to a creditor, and it's sold, either in foreclosure or the farmer just says, I don't want to face a foreclosure, I'll sell it and give you the money, the farmer is generally faced with a very large capital gains income tax bill, which is nondischargeable.
It's nondischargeable until at least 3 years after the tax return is filed.
What H.R. 763 will do would be to treat a priority tax claim for the disposition of a farm asset used only in the debtor's farming business as a pre-petition unsecured claim.
This will have many positive effects. The first positive effect it will have is it will allow farmers an exit. Many of the farms that have failed and many of my clients filed the chapter 12 bankruptcy in the eighties seeking to make it work and skip the foreclosure stage, and if they could skip the foreclosure, then they would have the opportunity to not have to liquidate and be faced or strapped with those nondischargeable taxes.
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Most of those plans, although feasible on paper, didn't work. A disease hit, a drought hit, a flood hit, the farmer was out, the farm was sold, and the taxes were there.
They were playing a hunch, they'd rather deal with a creditor they knew, their banker, then the creditor they didn't like, the IRS.
These two bills would allow that farmer who, in many instances is ready to throw in the towel, and he'll give up, he'll sell and pay his creditors as much as he can.
The opportunity then to utilize the Bankruptcy Code to get rid of those taxes.
He has to make planned payments through chapter 12. That's part of the design of expansion of this. That's the main goal of that.
Mr. Bergmeyer and I will be talking further about that.
I'd like to move on to a couple of other things that we need to think about in the chapter 12 arena.
I'm glad to see that the single asset cases, the family farm will be excluded from the single asset definition.
I believe that's a very constructive thing to do. I think it's very important that we should do that.
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Finally, I'd like to move on to the concept of change to section 330. Section 330 deals with compensation of professionals.
I believe it's important that it be amended to add another factor the bankruptcy judge can consider, and that is whether a professional is board certified by a certifying body.
The rationale for that is to give the judge an objective polestar to say this person must know what they're doing.
I find in my practice that if I'm dealing with lawyers that really know what's going on, and other professionals, the case moves faster and it ends up costing less than when I have to help educate the other side's lawyers about what's going on.
We have a lot less bumbling around and we have a lot more negotiation and consensual plans.
Again, thank you for the opportunity to speak.
[The prepared statement of Mr. Peiffer follows:]
PREPARED STATEMENT OF JOSEPH PEIFFER, ESQUIRE, PEIFFER LAW OFFICE, GRAND RAPIDS, IA
SUMMARY
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Chapter 12 needs to be made permanent to provide stability for family farmers and their creditors to negotiate and adjust their debts fairly.
Chapter 12 eligibility should be expanded by increasing the debt limit to $3,000,000 from the current limit of $1,500,000.
Chapter 12 should be improved to deal with the severe capital gain tax problems experienced by many family farmers. S. 260 addresses these problems and should be passed.
§330(a) should be amended to direct bankruptcy judges to consider board certification when reviewing professional compensation applications.
Retirement Savings Plans should be made exempt from the claims of creditors both in and out of bankruptcy to provide equal protection for all Americans.
The provisions of H.R. 833 which essentially require a ''permission slip'' from a credit counseling service as a prerequisite to filing a bankruptcy should be eliminated.
Provisions to require consumer education classes in elementary and secondary schools should be enacted and funded.
§506(a) of the bankruptcy code should not be amended to protect creditors that make loans with little or no down payment.
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§149 of H.R. 833 wisely eliminates the incentive to obtain a loan to pay off a non- dischargeable debts.
STATEMENT
If enacted, H.R. 833 will have dramatic and far reaching effects upon the bankruptcy system of the United States. It will have a significant impact upon farmers that can avail themselves of Chapter 12 but it does not go far enough to provide the protection needed for farmers. First, I will outline the case for making Chapter 12 permanent. Second, I will suggest a significant change improvement to H.R. 833 to address the capital gains tax problem that family farmers face as they struggle to survive. Third, I will suggest changes to §330 of the Bankruptcy Code to increase the efficiency of the bankruptcy system. Finally, I will comment on some other aspects of H.R. 833.
I. Making Chapter 12 Permanent
§201 Reenactment of Chapter 12 is vitally necessary to provide farmers and their creditors with predictability of the reorganizational options available within bankruptcy. The current ''off again, on again'' approach to Chapter 12 is not beneficial to either lenders or farmers. On September 30, 1998, I filed a large Chapter 12 because it was the last day it was available. It would have been better for the farmer and its creditors not to have begun the Chapter 12 then as negotiations were slowly progressing with the affected creditors. However, when faced with the prospect that Chapter 12 might not be available again the bankruptcy was filed to allow the farmer to utilize Chapter 12. Chapter 12 has proven its worth in the agricultural sector since it was enacted in November of 1986. In Dr. Neil E. Harl's study, The Experience of Chapter 12 Bankruptcy Filers in Iowa, Dr. Harl(see footnote 58) concluded that Chapter 12 assisted many filers in continuing to farm, or at least maintain ownership of farm land. Dr. Harl observed that fifty-two percent of the Chapter 12 filers believed that Chapter 12 had been very helpful to them in maintaining their farming operations.
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Chapter 12 bankruptcy should be made a permanent part of the Bankruptcy Code. Without making Chapter 12 permanent farm borrowers will remain at a competitive disadvantage in negotiating equitable treatment from the lenders. In addition, if Chapter 12 is not made permanent, the cyclical nature of agriculture will result in an agricultural depression in the future which will be much deeper and longer than necessary if the playing field is not maintained on a nearly level basis. If Chapter 12 is allowed to expire it will take an extreme financial crisis, much like the farm crisis of the 1980's to arouse the consciousness of America to address the crisis and reenact Chapter 12. Family farmers should not be thrown to the wolves only to await another depression in the agricultural economy to get the national spotlight so that Chapter 12 can be reenacted.
II. Improvement to Chapter 12—Addressing the Capital Gains Tax Problems
While Chapter 12 should be made permanent, it will be of more vitality in assisting farmers to restructure their indebtedness if Congress passes S260. The practical impact of passing S260 is to expand the eligibility for participation in Chapter 12 and it will allow many family farmers to sell their under-productive business assets, pay their secured debt, pay the capital gains taxes which they can pay through the plan and have a truly fresh start unfettered by non-dischargeable capital gains taxes.
Thousands of family farmers fail each year. In many instances the family farmer has over encumbered assets with little, if any, adjusted tax basis. Upon sale, either through foreclosure or other forced liquidation, the sale proceeds are paid to secured creditors while the farmer is left with few, if any, funds to pay the capital gains income taxes. If the business owner has elected to file a Chapter 7 bankruptcy prior to forced sale the trustee will abandon the over encumbered assets and the taxable event (the forced sale) will occur after the debtor receives his discharge. The capital gains tax resulting from the forced sale will remain as it was not discharged by the Chapter 7 bankruptcy. Thus, the taxpayer will face the prospect of dealing with the Internal Revenue Service to pay this tax. The debtor will be unable to file a Chapter 7 bankruptcy to obtain a discharge of this tax for at least six years after filing his initial Chapter 7 petition.(see footnote 59) This is not a fresh start.
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If the individual taxpayer sells the over encumbered assets prior to filing a Chapter 7 bankruptcy and recognizes the capital gains income on a tax return, the tax assessed is not dischargeable until at least three years after the last date the tax return could have been timely filed.(see footnote 60) Until this time the taxpayer must face the collection activities of the Internal Revenue Service and, presumably, his other creditors before getting the fresh start envisioned by Congress when the bankruptcy code was enacted. If the taxpayer elects to file a Chapter 13 bankruptcy after the sale the tax can be paid through the Plan without interest or penalty assuming the Plan is otherwise feasible.(see footnote 61) The maximum time for payments under a Chapter 13 plan is five years.(see footnote 62) If a Chapter 11 is elected by the taxpayer, the maximum time for repayment of the tax can be extended is six years after the date of assessment.(see footnote 63) The Chapter 12 debtor that sells the over encumbered assets prior to filing a bankruptcy petition must pay the capital gains taxes over a maximum of five years.(see footnote 64) In addition, the Chapter 12 debtor is not given the option of paying the tax incurred in the year of filing the petition over the life of the Plan, an option given the Chapter 13 debtor.(see footnote 65)
Capital Gains Tax Solution
S. 260 provides a logical solution faced by thousands of American family farmers. It expands the definition of family farmer by expanding the debt limits and expanding the years in which the family farmer is required to earn greater than 50% of its gross income from farming activities. S. 260 allows a family farmer to liquidate its under producing assets, repay its secured creditors and save its farm operation. If saving the farming operation is not feasible S. 260 allows the family farmer to liquidate its farming operation and pay the amount of capital gains taxes the family farmer can pay. Since the priority taxes are treated as a pre-petition unsecured claim in S. 260, the honest Chapter 12 family farmer will be able to emerge from Chapter 12 unfettered by the non-dischargeable capital gains taxes and become a regular taxpayer. By passage of S. 260, Congress can insure that only the honest family farmer obtains this favorable tax treatment as only family farmers that receive a discharge will have their capital gains taxes discharged. If the family farmer does not obtain a discharge the capital gains taxes will remain and the IRS and other taxing bodies will seek to collect the tax debt.
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S. 260 should be passed to deal with the capital gains tax problems experienced by family farmers as they down size operations. Passage of S. 260 would encourage family farmers to make financially sound decisions regarding liquidation rather than continue to operate inefficiently out of fear of the capital gains taxes which liquidation would create. Making Chapter 12 permanent and passing S. 260 would greatly enhance the orderly liquidation of inefficient farms as well as facilitate the preservation of farms that are economically viable.
III. Professional Compensation
The administration of justice in bankruptcy courts could be enhanced by the following amendment to 11 U.S.C.§330. §330(a)(3) should be amended to read as follows:
(3)[(A)]* In determining the amount of reasonable compensation to be awarded, the court shall consider the nature, the extent, and the value of such services, taking into account all relevant factors, including—
(A) the time spent on such services;
(B) the rates charged for such services;
(C) whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title;
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(D) whether the services were performed within a reasonable amount of time commensurate with the complexity, importance, and nature of the problem, issue, or task addressed; [and]
(E) whether the professional is board certified or otherwise has demonstrated skill and experience in the bankruptcy field; and
(F) [E] whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title.
(Additions in italics, deletions in brackets.)
Rationale
Although section 330(a)(3) lists several factors that should be considered in setting reasonable compensation of professional persons, the list fails to include a factor relating to the professional's training and experience in the bankruptcy field. The efficient and economical operation of the bankruptcy system depends upon the active participation of professionals with special expertise in the bankruptcy field. A professional's lack of sufficient bankruptcy experience not only interferes with the reorganization or liquidation effort, but it also increases the cost of the bankruptcy proceeding both to the estate and to the other parties in interest.
The creation of independent certification boards in the bankruptcy specialty make it possible to easily identify those professionals who have the special skills and experience necessary to handle bankruptcy cases in the most efficient manner. Several states, like North Carolina, Texas and Tennessee have state-run board certification programs for bankruptcy attorneys. In addition, the American Bar Association and several states have accredited the national attorney board certification programs in consumer bankruptcy law and business bankruptcy law that are offered by the non-profit American Board of Certification. Each of those programs require proof of substantial experience in the bankruptcy field and knowledge of bankruptcy law. Similar national board certification programs are offered by the Association of Insolvency Accountants for insolvency accountants and by the Turnaround Management Association for turnaround management consultants.
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The proposed amendment to section 330 authorizes the courts to consider the important factors of skill and experience in determining reasonable compensation for bankruptcy professionals. Although board certification provides a simple and objective measure of competency in the bankruptcy field, the proposed amendment also authorizes the courts to consider other evidence of skill or expertise in the bankruptcy field.
*§224 of the Bankruptcy Reform Act of 1994, Pub. L. No. 103–394, rewrote §330(a) and added two subparagraphs 330(a)(3)(A). It appears that the first reference to paragraph 330(a)(3)(A) is extraneous and should be deleted.
IV. Review of Selected Provisions of H.R. 833
A. Sections of H.R. 833 to Retain
§203 Retirement Plan Exemptions This reform is long overdo, however, §203 does not appear to apply in some opt out states that do not provide for the exemption of pension plans. §203 should be changed to protect retirement savings both in and out of bankruptcy. This would provide fairness to all Americans, those with ERISA qualified plans and non-ERISA qualified retirement savings.
§1101 Eliminates the Family Farmer from the Effects of the Single-Asset Provisions of the code is warranted. This is valuable as many farmers only have one basic asset their land. The single asset legislative reforms were enacted by Congress to prevent abuse in the residential and commercial real estate cases.
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§149 Makes debts incurred to pay non-dischargeable debts non-dischargeable is a reasonable provision to prevent this abuse.
§109 Educational Programs for Elementary and Secondary Schools is essential to prevent Americans from continuing to over spend and to assist them in resisting the advertisements of creditors that would encourage overspending and imprudent borrowing.
§115 Protection of Post Secondary Education Funds is Overdue.
§816 Requiring Debtors to File All Tax Returns to Confirm a Chapter 13 is realistic. It should be extended to all chapters of reorganizational bankruptcies.
B. These Sections that Should be Eliminated from H.R. 833
§102 Dismissal or Conversion goes too far when requiring the attorney's signature on the petition a representation punishable under Rule 9011. What is reasonable inquiry? Does the attorney need to go to the debtor's house to view the assets? Does the attorney need to have an appraisal conducted? Will this increase the costs of bankruptcies?
§124 Which seeks to restrain abusive purchases on secured credit by amending §506 is really a bail out of creditors that made imprudent loans in the first place. If there is blame for any losses suffered by secured creditors it should be borne by the credit underwriting departments not the debtor. The secured creditors can easily protect themselves by requiring a reasonable down payment when the loan is made.
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§125 Valuation of Assets in Chapter 7 and Chapter 13 is unfair as it establishes an unrealistic value for the assets. The retail price typically includes some warranty. §125 does not make any allowance for the lack of a warranty. In addition, §125 also protects the creditor that elects to provide 100% financing for goods with little, if any, analysis by the creditor of the debtor's ability to repay the loan.
§126 Exemption Qualification changes of the length of time that a debtor must live in a state to claim exemptions from the greater part of the last 180 days to 730 days (2 years). This appears to leave some people forced to move to follow a job without exemptions. Or, potentially with more meager exemptions than they could utilize if they had not been forced to move. This is simply unfair.
§302 Misc. Improvements—Who May Be a Debtor requires in essence a ''permission slip'' to allow a debtor to utilize the bankruptcy courts. Many times debtors do not appear in my office until the foreclosure on their house has been completed and the foreclosure sale is imminent. In addition, I have needed to file many cases for debtors that are facing an IRS levy. To require the ''permission slip'' in order to utilize the bankruptcy courts cannot be what our founding fathers envisioned when they authorized the establishment of bankruptcy courts in Article One of the Constitution.
Conclusion
Representatives, I thank you for giving a small firm Iowa farmer's lawyer the opportunity to address you. I urge you to make Chapter 12 permanent and to enact the changes to Chapter 12 suggested by Senator Grassley in S.260 to eliminate the severe capital gain tax problems experienced by many struggling family farmers. I also urge a change in §330 to make certification of professional one of the factors which a bankruptcy judge should consider in fixing compensation for professionals. I believe that Congress should carefully consider the motivations of the credit industry is suggesting many of the changes to the code. Congress should not change the bankruptcy code merely to make collection by creditors that make improvident loans easier. Any changes should be balanced. Much of H.R. 833 does not appear balanced.
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Mr. GEKAS. We thank the gentleman and now the Chair assigns to itself 5 minutes for the first round of questions.
Judge Brozman, I wanted you to know that right at the outset when the Bankruptcy Review Commission first rendered its interim report in the summer of '97, and then later in the year, its final report, we were cognizant of the need for dealing with the international scope of our problem.
And as a result of that, at one point, I assigned our staffer here, Susan Jensen-Conklin, to concentrate on that issue, and I'm happy to see that you're testifying today to progress being made in addressing that problem.
I wanted you to know that. That this was a direct response to the concerns that you have issued.
Ms. BROZMAN. Thank you. I'm gratified to hear that.
I would make only one last point which is that, if for some reason, this bill meets the fate of the one in the last Congress, that you consider delinking, if I can use that word, this legislation from the omnibus legislation, because I think it is so very important that it go forward, regardless of whether the reforms are instituted now or somewhat later.
Mr. GEKAS. Well, we'll delink only if absolutely necessary.
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Mr. Asofsky, you jangled me again when you're bringing up certain things that I can't picture.
I wanted Mr. Valdes and Mr. Harris to respond to your assertion that a higher rate of interest would be applicable by the taxing authorities in the situation that you mentioned.
I never envisioned that that could occur, and I'm wondering what we missed here.
Mr. HARRIS. I asked, as soon as he said that, I whispered in Mr. Valdes' ear. I said, ''Have you ever heard of that?'' He said, ''No. I have never heard of a taxing authority asking for more interest under law.''
Mr. GEKAS. Nor I. Are you saying that this allows the taxing authority——
Mr. ASOFSKY. No, no, no. Your Honor, Chairman Gekas, the point I was making is that there is a general rule that there is a uniform rate of interest which, under your bill, is the short-term rate plus 3 percentage points.
There is an exception to that, which allows in the case of a whole bunch of taxes, some ad valorem real property taxes and others, a higher rate if that rate would apply under the applicable local law.
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So that what happens under this bill is that the Commission had unanimously, and the Tax Advisory Committee had proposed a uniform rate of interest on all deferred tax claims which would be the same as the Federal tax deficiency rate.
That was supported by all of the governmental people on the panel and all of the private people on the panel so there would not be litigation on a case-by-case basis over what the appropriate interest rate was.
That bill was introduced by you in the original version of H.R. 3150. In the mark-up, even though there had not been any testimony before you on the day that you took the tax testimony, an amendment was introduced and passed and found its way into the conference report and is once again in this bill, that would allow local tax authorities to have a higher rate of interest on ad valorem and certain other property tax claims if the applicable local law contained an interest rate that was higher than the rate that this bill would otherwise set.
And the American Bar Association opposes that provision.
Mr. GEKAS. Mr. Valdes?
Mr. VALDES. I thought at first he was talking about the Federal level, but what he's saying is, he would like to negate all the State statutes, whereby through State statute we have a certain fixed percentage rate that we can charge if there's a delinquency in ad valorem taxes.
It's what our whole system is based on at the State and the county level.
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Without that, we couldn't sell our tax priority liens. So he's saying, for instance, if a State had a statutory rate of 12 percent, but instead you took his rate based on the Fed standard plus 3 percent, and that came out to 9, he'd now like you to waive the State statute and say only 9 percent interest is due.
And that's the problem we already have with the bankruptcy courts in that some of the judges go ahead and they do downgrade our standard interest rate. They try to compare a tax lien to commercial paper, and there's no comparison. They are two different things.
A tax is a first priority lien against the property.
So I would strongly disagree with his suggestion.
Mr. ASOFSKY. Mr. Gekas, if I may just have one quick response to that.
The purpose of section 1129 of the Bankruptcy Code is to allow a debtor to defer a pre-petition tax liability, and is supposed to give to all of the creditors, as a result of that deferral, an interest rate which matches in the market what the cost of money is.
The State and local governments sometimes have very high interest rates.
In New York City, for example, there's a 21 percent interest rate on a deferred real estate tax. If that rate is continued into the Bankruptcy Code, because you incorporate that by reference, then it effectively does away with the ability of a debtor to defer a pre-petition liability which is one of the fundamental policy decisions of section 1129.
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So it shouldn't depend upon the local law, it should depend upon what the Congress believes is a proper rate of interest to make a debtor pay if he is going to take advantage of the deferral provision that you have already given him.
Mr. GEKAS. Well, that's a policy decision that——
Mr. ASOFSKY. Yes, it is a policy decision, yes.
Mr. GEKAS. The time of the Chair has expired.
The gentleman from New York.
Mr. NADLER. Thank you, Mr. Chairman.
First of all, I ask unanimous consent that the remarks of Professor Jack Williams, who was supposed to be a witness here and was unable to come here, be inserted into the record.
Mr. GEKAS. Without objection.
[The prepared statement of Professor Williams follows:]
PREPARED STATEMENT OF JACK F. WILLIAMS, PROFESSOR, GEORGIA STATE UNIVERSITY, COLLEGE OF LAW
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Mr. Chairman and members of the Subcommittee, my name is Jack F. Williams. I am a Professor of Law at Georgia State University College of Law in Atlanta, Georgia. In 1999–2000, I will serve as a Visiting Professor of Law at St. Johns University School of Law in New York City, where I will aid in the implementation of the first LL.M. program in Bankruptcy in the United States.
I have a keen interest in the interplay between the Bankruptcy Code and the Internal Revenue Code, having written numerous articles and a two-volume treatise on the subject. I was also honored to serve as the Tax Adviser to the National Bankruptcy Review Commission (''NBRC'') and as the Chair of the NBRC's Tax Advisory Committee. Additionally, I have frequently taught courses on Bankruptcy and Insolvency Taxation and Advanced Bankruptcy Tax Collection to Internal Revenue Service personnel and State and Local taxing authorities under the auspices of the New York University/Internal Revenue Service Continuing Education Program. I am also presently serving as Vice-Chair of the American Bankruptcy Institute Bankruptcy Taxation Committee. The views expressed are my own and not necessarily those of the institutions identified above.
In preparing these brief remarks, I have considered the tax proposals in HR 833. Specifically, I have considered Sections 603–604, 801–818, and have included a few remarks about the means-testing proposal based upon my research and observations on how federal taxes are collected. I divide my comments into three categories:
1. Comments on what should be added to HR 833
2. Comments on the tax provisions in HR 833
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3. Comments on the use of the IRS Collection Standards in the Means-testing proposal in HR 833.
Before I begin my specific remarks, however, I point out that most of the proposals in HR 833 were recommendations by the NBRC. Nonetheless, as others have noted, several of the proposals contradict both the NBRC recommendations and the opinion of the NBRC's Tax Advisory Committee. I find that I am in general agreement with most of the tax proposals made in HR 833, subject to some minor to moderate tinkering with the proposed statutory language. However, it is my opinion that the tax proposals in HR 833 are too one-sided; they portray just one side of the difficulties confronted in the bankruptcy tax arena. It was my intention as the Chair of the Tax Advisory Committee to the NBRC to ensure that a complete, unfettered airing of the issues took place among the members of the Advisory Committee. The purpose of the discussions was to move toward some consensus on a broad array of bankruptcy taxation issues. I was and continue to be extremely proud of those who served with me on the Advisory Committee and of their efforts to reach consensus on a package of highly controversial tax matters. Our goal was to present a comprehensive package of reform in the bankruptcy taxation area. Instead, what HR 833 includes are the provisions that tend to favor the taxing authorities while ignoring those proposals that would have resolved recurring problems in the actual practice of bankruptcy taxation or provided relief to debtor/taxpayers. Thus, what is HR 833 does not include our the recommendations in the Tax Advisory Committee Report that tend to balance the competing interests of other creditors (that is, those creditors other than the taxing authorities) and the debtor against the taxing authorities. I find this difficult to understand, particularly at a time when the Congress has, rightfully I may add, reigned in the powers of the Internal Revenue Service in the assessment and collection of taxes outside of the bankruptcy process.
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I. ADDITIONS TO HR 833
1. Conform State and Local Tax Issues to Federal Laws
One of the most significant discrepancies in present bankruptcy tax law is the significant differences in how federal taxes are treated on the one hand, and state and local taxes on the other. These discrepancies are confronted every day in countless bankruptcy cases at great time, expense, and confusion and to no one's benefit. HR 833 should contain a series of proposals to conform, §346 of the Bankruptcy Code to the IRC. In particular §346 should be modified to mirror the IRC §1398(d)(2) election and conform state and local tax attributes that are transferred to the estate to those transferred for federal income tax purposes. (NBRC Proposals 4.2.4, 4.2.16–4.2.17).
2. Bifurcate Corporate Taxes that Straddle the Bankruptcy Petition Date
The NBRC recommended that corporations have the same right as individuals to elect to have taxes incurred prior to the filing for tax years that straddle the petition date to be considered a prepetition tax and tax incurred for the balance of the tax year after the petition is filed to be classified as an administrative expense. The Eighth and Ninth Circuits presently allow the debtor to bifurcate the taxes to achieve this result. Although the Tax Advisory Committee split on this issue, a proposal in HR 833 is necessary to resolve this issue.
3. Subordination of Prepetition Nonpecuniary Loss Tax Penalties
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After having correctly observed that granting a priority to tax penalties unfairly harms the general unsecured creditors of the bankruptcy estate, the NBRC recommended that the payment of prepetition nonpecuniary tax penalties in chapters 11, 12 and 13 be subordinated to the payment of general unsecured claims. The argument against subordination is weak especially where creditors may not have the ability to monitor their debtor's compliance with tax reporting requirements.
4. Application of the Burden of Proof Rules to Tax Issues in Bankruptcy
The appropriate burden of proof for tax claims in the bankruptcy process is as yet unresolved. The Tax Advisory Committee recommended either following applicable nonbankruptcy law on the issue or allowing the shifting of the burden from the debtor to the taxing authority upon a proper showing. Either alternative is better than the present unsettled state of affairs.
II. TAX PROPOSALS IN HR 833
I am in general agreement with many of the proposals in HR 833. In particular, Proposals §603–604 contain much of the substance of the recommendations on the filing of tax returns in individual debtor cases that were recommended by the Tax Advisory Committee. Aside from a little minor tweaking with the language and greater protection against dissemination of confidential tax information, I would endorse these provisions. I am also in general agreement with Proposal 801 but would recommend the deletion of 801(b). My experience has shown that debtors in financial difficulty do not typically object to tax claims when the debtor has little financial incentive to do so, thus resulting in unreasonably high tax claims. I am in general agreement with 803, 804 (assuming that the interest rate is determined without reference to IRC §6621 (c)), and the part of 805 that provides for the tolling of priority tax claim time periods during a pending bankruptcy case. However, I do not agree with that part of 805 that would extend the tolling provisions of the Bankruptcy Code to installment agreements. This is an unfair proposal and amounts to over-reaching on the part of the government. It will also have a drastic impact on the incentive for debtors to attempt to informally work out their tax liabilities with the taxing authorities. Finally, I am in general agreement with Proposals 808, 810, 811, 812, 813, 814 (with modifications to include returns filed under IRC 6020(b)), 815, 816 (with modifications to provide that a return under IRC §6020(b) or similar federal, state, or local law constitutes a filed return for dischargeability purposes under the Bankruptcy Code), 817, and 818.
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III. MEANS TESTING
Under HR 833, §101–102, a Chapter 7 case may be dismissed or converted to a Chapter 13 case if the case would involve ''abuse'' of Chapter 7, instead of the ''substantial abuse'' now required under §707(b). Abuse under §707(b) would be presumed if, during a 5-year period, the debtor would have sufficient income to pay at least $5000 ($83.33 per month) toward general unsecured claims or to repay at least 25% of those claims. The debtor's ability to pay general unsecured claims would be calculated by deducting three categories of expenses from the debtor's current monthly income-defined on the basis of the debtor's average monthly income for 180 days prior to filing—(1) expenses allowed under IRS collection standards; (2) payments on secured claims that would become due during the 5-year period, divided by 60; and (3) all of the debtor's priority debt, again divided by 60. It appears that the only way for a debtor to rebut the presumption of abuse would be to show ''extraordinary circumstances that require additional expenses or adjustment of current monthly total income'' through detailed itemizations and explanations sworn to by both the debtor and the debtor's attorney.
Based on my experience as a practitioner and commentator in the fields of both bankruptcy law and tax law, I find the use of the Internal Revenue Service collection standards in the means testing proposal problematic if not outright silly. First, it is my experience that the IRS itself often deviates from the collection standards in the informal negotiation of tax liability and collection matters in the field. IRS personnel are vested with sufficient discretion to permit latitude in reaching installment agreements and offers in compromise based on the individual facts and circumstances of each taxpayer. In fact, the Congress has sent this clear signal to the IRS over the past two terms, demanding more cooperation by the IRS with taxpayers in the negotiation of tax liabilities. My experience has shown that the collection standards are merely a common reference for starting negotiation and nothing more. Tying debtor eligibility to a formula that the IRS deviates from on a regular basis makes no sense.
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Second, the collection standards are too parsimonious. One should carefully consider the specific items identified in the collection standards—not just bandy the collection standards about in a general manner. After some thought, one must conclude that the standards are unrealistic. The IRS personnel know this fact and often deviate from the collection standards in an effort to promote settlement of tax claims.
Third, the collection standards may be at odds with the clarity and the uniformity that the Congress seeks in its means-testing proposal. For example, the IRS collection standards in calculating disposable income include a category entitled ''other necessary expenses'' that may or may not be congruous with the means testing proposal's ''extraordinary circumstances'' language. Additionally, the IRS collection standards do not specify any particular allowance for ''other necessary expenses.'' Thus, trustees and courts will have to grapple with the issue on an ad hoc basis, lacking any clear guidance from the Congress. Finally, the folly of the IRS collection standards is experienced in full bloom where an expense arises from ''extraordinary circumstances'' under the means-testing proposal as opposed to the category of ''other necessary expenses'' contained in the IRS collection standards. If the expense is an ''extraordinary expense'' as opposed to a bona fide ''other necessary expense'' a debtor would be required to explain the expense under oath executed by both the debtor and the debtor's attorney. One is hard-pressed to believe that trustees will employ a coherent approach across the country as to how to determine whether any given expense should be categorized. Yet, the results of that characterization will have significant impact on debtor eligibility.
IV. CONCLUDING REMARKS
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In summary, the tax provisions in HR 833 are generally a good step in the right direction. Unfortunately, the proposals in HR 833 are out of balance. They fail to strike a careful and coherent balance among the many constituencies affected by bankruptcy tax proposals and miss outright some of the most difficult recurring problems in bankruptcy. Bankruptcy tax reform is too rare an opportunity to ignore all sides of these disputes. The taxing authorities' interests and concerns are forcefully put forth throughout the tax proposals. I agree with many of these proposals. However, the virtual lack of proposals seeking accommodation or reconciliation of competing constituencies in the bankruptcy tax process is detrimental to the overall structure and philosophy of bankruptcy taxation and is simply unfair. We can do better.
I thank you for the opportunity to share my thoughts on the tax proposals contained in HR 833. Please know that I shall be delighted to provide any additional information to the Committee and to the Congress in its commendable work on bankruptcy reform legislation.
Mr. NADLER. Thank you.
And second of all, on behalf of the minority, I have this letter which, under the rules, I have to present to you during the pendency of this committee, asking for a day of minority hearings in the event that we can get the CBO to stop hiding their testimony, since they weren't able to be here by now.
Let me ask my first question of Mr. Asofsky.
Professor Williams, in his testimony, says that he has a summary in here that talks about the IRS guidelines. He says the IRS finds the guidelines unrealistic and doesn't listen to them half the time anyway.
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But going away from the IRS guidelines, do you find that this legislation, the proposed bill, has a pro-IRS tilt that would in some way undo the IRS reform legislation that the Congress passed last year?
Mr. ASOFSKY. Well, it's pro-IRS and pro-State tax collectors.
The fact is this bill substantially strengthens the position of tax collectors in the bankruptcy case.
And the fact is that there are some times debtors who get into trouble who are innocent people, they are not wrongdoers, and they need the protection of the bankruptcy system against the arbitrary power of governments to seize their homes.
Mr. NADLER. Last year, we tried to rein in the arbitrary power, as you put it, of the IRS.
Does this restore some arbitrary power to the IRS?
Mr. ASOFSKY. Well, yes, because I think it takes away the opportunity, the last resort of the debtor, which is to go into bankruptcy and receive the protections that the Bankruptcy Code now gives him, procedural protections that the Bankruptcy Code now gives him, which this bill takes away——
Mr. NADLER. Not substantive but procedural protections?
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Mr. ASOFSKY. Yes, yes.
Well, the substance of tax law is the substance of tax law. Nothing in this bill changes the substance of tax law.
The question is what are the powers of a tax collector to collect the tax by——
Mr. NADLER. So this restores, in some situations, some of the arbitrary and unfair powers which Congress just——
Mr. ASOFSKY. Not restores, makes them worse. Because, for example, right now there is the possibility of discharging debt in chapter 13 that can't be discharged in chapter 7 if a debtor has a payment plan and adheres to it over a 5-year period and uses his best efforts to pay those tax deficiencies, he can nevertheless get discharged from the remainder of the tax.
This bill would take that away from him. It is not just restoring something that that bill took away, it gives the IRS and the State tax collectors something they never had before.
Mr. NADLER. Thank you.
And how would it disadvantage other creditors, other than the tax collectors?
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Mr. ASOFSKY. Well, let's take the example that we just gave. If the old law was that an interest rate on deferred taxes is a market rate of interest, and now you're going to let the State and local tax collectors collect a higher rate, that money has to come from somewhere. It's going to come out of the pockets of the other creditors.
So if you say a tax collector can collect a 21 percent interest on his tax claim, that's less money than would go to the other creditors.
Therefore, the creditors are disadvantaged.
Mr. NADLER. Thank you.
Professor, or Judge Brozman, how would some of the changes to the individual debtor and small business portions of the Code in this bill affect these debtors if we are hit in the United States with the fallout of the foreign financial crisis that most of the rest of the world is going through now, and that we have averted so far?
Ms. BROZMAN. Well, I would echo some of the comments that we heard earlier in the day about the restrictions on flexibility in the courts.
I certainly have no objection—in fact, I endorse the concept of trying to move cases along swiftly through the system, but we have the existing means to do that now.
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In our district, for example, and in many districts, judges conduct in every chapter 11 case, case management conferences at which, among other things, they can fix dates. They can fix dates for the filing of a plan. They can fix dates for the filing of a disclosure statement.
It seems to me that if you want to deal in the best way possible with trying to achieve reorganization where a business is viable, that you have to retain flexibility in the judge, with the person who is aware of the facts; and that the wrong place to set dates is in the statute.
Mr. NADLER. Thank you, very much.
Mr. GEKAS. The gentleman from North Carolina is recognized for 5 minutes.
Mr. WATT. Thank you, Mr. Chairman.
Let me use my 5 minutes to try to see if I can understand the dispute between Mr. Ireland and Professor Picker and Mr. Grosshandler on that end of this panel.
I do this because earlier today the chairman of the Banking Committee on which I serve came and made a presentation I believe in effect carrying the water of this Working Group that has put this proposal together and advocating for it.
I should confess that when the chairman of my committee comes and brings something and he says he is working on behalf of the Treasury, I start with a presumption in favor of that.
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So, Mr. Picker, I should warn you about that.
But I want to make sure I understand what this is all about.
Mr. Ireland, could you give me an example of when not providing this kind of cross-netting protection that you are advocating for would result in a systemic risk?
Mr. IRELAND. I would echo Mr. Grosshandler's comment, first. The cross-product netting thing I think is a technicality.
You currently would have under the Bankruptcy Codes three or four——
Mr. WATT. Well I think all of this is a technicality. Pull the mike a little bit closer to you, please.
Mr. IRELAND. If you were doing a variety of transactions with your counterparties, securities, commodities, and swap transactions, you would be able under the Bankruptcy Code today probably to net those down under each category that's under a separate paragraph or section of the Bankruptcy Code.
So you might wind up with three or four net numbers. Now the question is. Can you then net those three or four numbers together?
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Under Mr. Picker's economics, you should not be able to do the first netting. But the cross-product netting we think really allows financial market participants to manage the credit risk of their counterparties more efficiently to do more transactions with them and leads to more liquid markets.
The more liquid markets, in the event of a major participant insolvency, are likely to be more stable, are less likely to freeze up, and are less likely to cause ripple effects into the real economy.
By the ''real economy,'' I mean not just market dealers but actual end users of financial products that are benefitting from the wholesale portion of the system.
Mr. WATT. Help me understand what the category of creditors, I presume, in this equation, who would fall into this financial market participants category would be. Who is it that you are talking about?
Mr. IRELAND. Well you would have——
Mr. WATT. I assume we are talking about banks?
Mr. IRELAND. We are talking, on the dealers side we are talking about banks, principally affiliates of large broker-dealers, some large broker-dealers, some futures commission merchants which are normally affiliates of the banks or broker-dealers.
On the other side of the transactions, we are talking about commercial companies, pension funds, mutual funds, other investment vehicles or entities that affect the daily lives of average people.
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Mr. WATT. Okay, but I mean I can understand why we might give some special preference to banks because if there is a default, I mean if they go into bankruptcy there is some risk that we are standing behind.
Why would we create a whole separate category that is applicable to these other financial market participants? I don't understand that.
Mr. IRELAND. Well first of all——
Mr. WATT. Why would they not be subject to the same rules that everybody else would in a bankruptcy proceeding?
Mr. IRELAND. My testimony was characterized as being based on systemic risk. It is only in part based on systemic risk.
What the Working Group was trying to do is recognize financial developments and the evolution of financial products that has led to markets where the application of the traditional bankruptcy rules exposes market participants to extraordinary market risk which, on a day-to-day basis, is actively managed both by dealers and end users.
And they are unable to manage that risk during the automatic stay in the normal repudiation or affirmance process that goes on in bankruptcy.
Now there is $70 trillion out there today, perhaps $80 by now, $70 trillion according to the BIS last year, notional principal, in over-the-counter derivative transactions.
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A 100 basis point move in the interest on those kinds of transactions is worth $27 million a day, and there's $70 trillion of it out there.
The risk that we are concerned about that is new is this market risk that is based on movements in interest rates or other indices during that period.
And people cannot in the conventional bankruptcy process manage that market risk effectively. What you need to be able to do is close out the contracts and go about your business.
What we are trying to do is advocate a system that lets them do that.
Mr. WATT. Mr. Chairman, can I hear from Professor Picker so I can get the other——
Mr. GEKAS. It depends——
Mr. WATT. I assume I will get the other side of this.
Mr. GEKAS. It depends on whether or not Professor Picker wants to answer. [Laughter.]
Mr. WATT. Forgive me.
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Mr. GEKAS. You may proceed.
Mr. PICKER. Very briefly, because I know we are at the very end of the hearing.
What I did not hear in Mr. Ireland's response was a fundamental recognition of the question of who is a better risk-bearer in these circumstances.
As his testimony, both orally and in writing, fairly recognizes that is the choice you are making here. It is a question of whether we are going to put it on these very sophisticated parties who are in the business of managing these risks, or on people who are not in the business of doing that—trade creditors and the family support obligation beneficiaries.
That is the choice we are making.
As his testimony fairly recognizes, all we are doing is reallocating that risk between one and the other. He comes down, as he should, at the Fed in favor of protecting his market participants.
I think you guys have a duty to look at a broader group.
Mr. WATT. Well if it rises to the level of something that everybody would acknowledge creates a systemic risk. I am not sure I understand what gets it to that level.
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I mean, I can get——
Mr. PICKER. Me, too. But—Me, too.
Mr. WATT. But I guarantee you I will talk to the Department of the Treasury about it. They will call me this afternoon, because they will hear about this conversation. I have no doubt. [Laughter.]
Mr. PICKER. Thank you.
Mr. GEKAS. I thank the gentleman.
The time of the gentleman has expired.
The time for all the members has expired. The time for the panel has expired. My breath is about to expire, and I will dismiss this panel with the greatest possible degree of gratitude we can express. You have helped us a great deal, even by perplexing us. So thank you, very much.
Mr. NADLER. Mr. Chairman?
Mr. GEKAS. The gentleman is recognized.
Mr. NADLER. Mr. Chairman, because most of our members have been unable to attend the full 4 days of hearings, I ask unanimous consent that all members shall have five legislative days to submit additional questions for the witnesses and to submit additional materials for the record, and to revise and extend their remarks.
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Mr. GEKAS. Without objection, it is so ordered.
Mr. NADLER. Thank you.
Mr. GEKAS. We stand adjourned.
[Whereupon, at 4:06 p.m., Thursday, March 18, 1999, the meeting of the subcommittee was adjourned.]
A P P E N D I X
Material Submitted for the Hearing Record
PREPARED STATEMENT OF HON. LAMAR S. SMITH, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS
Reforming our nation's bankruptcy laws is a priority of the Committee and the Republican Congress. I commend Chairman Gekas for his leadership in this important area.
Unfortunately bankruptcy filings are on the rise. This is particularly disturbing since we are enjoying a period of economic well-being. In fact, in 1997 $40 billion in consumer debt was discharged through bankruptcy filings. This is a $10 billion increase in 1996.
I support H.R., 833, the Bankruptcy Reform Act introduced by Chairman Gekas. The bipartisan bill has a number of much needed reforms and passed the House and the Senate by a strong majority in the last Congress. I am confident that we can get this bill signed into law in the 106th Congress.
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Adding a needs-based bankruptcy test to the code is an important reform. It ensures that those who have the ability to repay some of their debts to do so while those who legitimately can not continue to have the opportunity of a fresh start.
Unfortunately we know that some who have the ability to repay have walked away from their responsibilities. It is estimated that this disregard for their obligation costs other hardworking American families an additional $550 a year in higher prices for goods and services.
Some have claimed that this bill will have a negative impact on women and children who depend on child support and alimony. This is simply not the case. In fact, the bill gives these types of debts a higher priority than does current law.
Specifically, I am very concerned about negative effects the current bankruptcy code has on school districts in Texas and across the country. School districts are constantly in search of more funds to better educate our children. They rely heavily on ad-valorem taxes. These taxes are assessed on business and corporations based on the value of their property.
In the current bankruptcy code, collection of these types of taxes from the debtors estate have a low priority. Consequently, much of this money is never collected, depriving schools of much needed revenue. The Houston School district lost $1 million from one such case. This is money that could have been used to hire more teachers or buy more computers. Texas school children lost out because the bankruptcy code does not give priority to taxes owed to state and local governments.
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H.R. 833 addresses this issue and helps state and local governments collect the money that they are due. Without collection of this money, school districts suffer.
There are a number of other non-controversial provisions included in H.R. 833 that are very important to state and local governments.
I urge my colleagues to support this important bill as it moves through the Committee process and when it is debated on the floor of the House.
PREPARED STATEMENT OF HON. BILL MCCOLLUM, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF FLORIDA
Last year, Congress came very close to sending a bill to the president that would have enhanced some important protections in the Bankruptcy Code and the bank insolvency laws for our financial markets. These so-called ''safe harbors'' and netting provisions in current law help ensure that the failure of one major market participant will not drag others down with it. I believe these protections serve a vital public policy function by allowing sophisticated counterparties to decide between themselves how to deal most efficiently and quickly with a possible failure. By planning in advance, such contractual agreements between parties protect the financial markets as a whole and mitigate systemic risk. Our laws correctly allows such contractual provisions to be enforced.
The bankruptcy code and the bankruptcy laws contain provisions that allow market participants to close out, net and set off certain types of contracts when a counter party becomes insolvent. This feature allows us to reduce the opportunity for the failure of one entity to infect others. It also encourages market participants to engage in transaction is that add market liquidity, which leads to lowers costs of capital.
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In recent years there has been a great expansion of the number and type of financial transactions. This innovation has created uncertainty as to whether certain types of financial transactions fit within the current provisions in the bankruptcy and banking codes. In addition, the asset-backed securities market has grown to exceed $500 billion. These developments require us to address these shortcomings and bring more stability to our financial markets.
It is time to bring these market protections up-to-date before a severe disruption occurs. It has been almost ten years since we revisited the safe harbors for financial transactions. More types of entities now engage in more types of transactions with greater frequency than they did when we last amended the Bankruptcy Code and bank insolvency laws. We should act to clarify and harmonize the rights of these parties to protect themselves through contractual agreements that will be enforceable in bankruptcy or insolvency proceedings. It is time for us to bring these market protections up to date, and to allow for market evolution to continue improving risk management and capital raising capabilities.
We should also act now to rectify a special problem in the asset-backed securities market. As we all know, mortgage-backed securities have played an important role in making home ownership possible for more people by bringing mortgage rates down over the past thirty years. Other sectors of the economy now benefit from securitization as well, but in some cases transactions are more difficult or more costly because of legal risk that the transactions will later be recharacterized in a bankruptcy proceeding.
In my view, a party who sells something to someone else and gets paid for it should not be able to come back to the table later and get the asset back again for free. Particularly in a securitization, where financial assets are sold and used to provide cash flows to investors, such a development would be exceedingly disruptive to the integrity of the securitization process. We must protect this important sector of the financial markets from irresponsible debtor claims and allow it to continue to lower borrowing costs for all Americans.
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In short, these provisions address the uncertainty in the treatment of certain financial transactions. I look forward to working with my colleagues toward enactment of these important financial products provisions.
PREPARED STATEMENT OF HON. RUSS FEINGOLD, A U.S. SENATOR FROM THE STATE OF WISCONSIN
I want to thank Mr. Chairman Gekas for hosting this joint hearing with the Senate Subcommittee on Administrative Oversight and the Courts. I appreciate his hospitality and willingness to accommodate the schedules of those of us from the Senate.
I also want to thank Mr. Chairman Grassley for the work he has done on the bankruptcy issue, and the courtesy that he and his staff have extended to those of us who have different views of what needs to be reformed in this bankruptcy system. I sincerely hope that once again we can work together to develop a product that will win a near unanimous vote in the Senate as last year's bill did.
Bankruptcy legislation is obviously a challenging issue for all of us. The stakes are high and the different viewpoints are passionately expressed by all of the players involved, from the different types of creditors to bankruptcy judges, trustees, and practitioners, to consumers and debtors. My view is that the legislation that came out of conference last year and that is now embodied in this year's House bill is not a balanced piece of legislation. It tilts the scales too far in favor of creditors, creating a new special status for certain credit card debts to the detriment of women and families in this country seeking to collect alimony and child support and state and local governments seeking to collect tax liabilities.
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The bill contains some provisions that in my view are almost indefensible, such as the requirement that debtor's attorneys bear personal responsibility for the trustee's costs and fees if the debtor loses a motion to convert a Chapter 7 filing to Chapter 13. That provision will have the result of denying many debtors adequate legal representation, making them even more subject to abusive and predatory practices by creditors.
I am very concerned that we are moving too quickly on this issue, and that if reform such as that contained in this year's House bill becomes law its unintended consequences may be even worse for consumers than the consequences we know about now. In light of that fear, Mr. Chairman, I cannot leave you without commenting on what to me is a very troubling aspect of this debate.
More and more the sense I get from talking to both experts in the field and average folks is that while there are some helpful and discrete reforms that could be made to our bankruptcy system, it is not in need of the wholesale revision contemplated by many in this room. And yet, there has been a massive lobbying push by creditor interests for this legislation. New analysis of reports recently filed under the Lobbying Disclosure Act shows that banks and other financial services firms spent more than even the tobacco industry on lobbying in the last six months of 1998.
And reports from good government organizations have noted that this lobbying is accompanied by substantial and highly targeted campaign contributions. I'm informed for example that one company gave a total of $25,000 in soft money to my party within days of the House passage of the bill last June. And another company gave $200,000 to the Republican party just two days after the conference report was issued last year, the very day that the report passed the House. Soft money giving by the consumer credit industry to our political parties increased from $1.2 million in the 1992 election cycle to more than $5.5 million in the 1996 cycle.
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Mr. Chairman, I ask that studies by Common Cause and the Center for Responsive Politics on campaign contributions by the consumer credit industry be placed in the record of this hearing.
We need to be cognizant as we proceed here of the extent to which bankruptcy reform has come to be seen as a gift to certain special interests. We bear a heavy burden, I believe, to make sure that we are serving the public interest with this kind of far reaching legislation. We cannot meet that burden unless we slow down and open our minds to the recommendations of nonpartisan experts in this field and try to make sure we don't make some very big mistakes with this bill.
PREPARED STATEMENT OF THE ASSOCIATION OF FINANCIAL GUARANTY INSURORS
Mr. Chairman, the Association of Financial Guaranty Insurors (AFGI), a trade association of financial guaranty insurors,(see footnote 66) appreciates the opportunity to submit testimony to the Subcommittee on suggested revisions tot he United States Bankruptcy Code related to asset-backed securities. AFGI fully supports H.R. 833, but we would like to limit our remarks to the provisions included in Title X, Section 1012 that relate specifically to asset-backed securities.
AFGI has supported the revisions incorporated in Title X, Section 1012 of H.R. 833 for several years. Through outside counsel, our Association submitted recommendations to the National Bankruptcy Commission in 1997; submitted testimony for the hearing record when this Subcommittee held hearings in the last Congress; and testified before the Senate Committee on the Judiciary's Subcommittee on Administrative Oversight and the Courts last year. Furthermore, as an Association, we appreciated the opportunity to work with you and your staffs on these proposed changes to the Bankruptcy Code during the last Congress, and look forward to working with you this year.
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Purpose of the Proposed Change to the Bankruptcy Code
AFGI believes that the suggested revisions incorporated in Title X of H.R. 833 relating to asset-backed securities reduces uncertainty under the Bankruptcy Code as it applies to the almost $200 billion per year of asset-backed securities issued in the United States. By reducing uncertainty, the proposed amendment will increase stability in the capital markets and thereby facilitate asset-backed financings and eliminate certain risks which otherwise indirectly increase interest rates for millions of consumers, small business and others seeking financing from the capital markets. The proposed revision is constructed to achieve these benefits without impairing any of the reorganization and fairness policies underlying; the Bankruptcy Code.
Application of the Proposed Change
The proliferation of asset-backed securities in the United States over the past two decades has dramatically increased both the number of lenders and the lending capacity of existing financial institutions. This increased capacity has, in turn, created intense competition for borrowers.
Today, consumers and small businesses have more choices when looking for a home, auto loan, a new credit card, or financing for a small business. More significantly, consumers and small businesses whose credit posed too great a risk to qualify for financing are now, in many cases, able to do so. This is because, in an asset securitization, loans and other receivables are sold by lenders to a company formed to see securities in a structure which takes into account the credit risks posed by these receivables. The sale proceeds paid to the lender enable it to fund the ''securitized assets'' to make additional loans to consumers and small businesses.
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The company to which lenders sell their loans or other receivables (the ''Securitized Assets''), will typically be a ''bankruptcy remote entity.'' The company's activities are restricted to the purchase and ownership of the Securitized Assets and issuance of the securities. Following its acquisition of the loan assets or other receivables, the bankruptcy remote entity will typically issue debt or other securities—the asset-backed securities—backed by Securitized Assets. By bankruptcy-remote, we simply mean that the company is required to maintain an existence that is completely separate from its affiliate companies such that it will not be affected by the bankruptcy of an affiliate.
Generally, the cash flow or other proceeds generated by the Securitized Assets are sufficient to pay the amounts due on the asset-backed securities. In certain instances credit enhancement is provided by third parties, including member of AFGI, guaranteeing the timely payment of amounts due to the holders of the asset-backed securities.
Under current law, uncertainty can arise when the transfer of the Securitized Assets by the lender or its operating company to the bankruptcy remote entity is deemed to be something other than a sale. If the transfer is not a sale and if the seller of the loan assets seeks relief under Chapter 11 of the Bankruptcy Code, the Securitized Assets purported to have been transferred to the bankruptcy remote entity may be included in the seller's bankruptcy estate. hi that event, the cash flow or other proceeds generated by the Securitized Assets (i) would be subject to the automatic stay provision of the Bankruptcy Code and would not be available to pay the holders of the asset-backed securities until relief was obtained from the automatic stay, and (ii) could be subject to cramdown or collateral substitution that would further impair the bankruptcy remote entity's ability to pay amounts due on the asset-backed securities.
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Any interruption or impairment of the cash flow or proceeds resulting from the application of the automatic stay, cramdown or collateral substitution, impairs the market value of the asset-backed securities and, in the case of insured asset-backed securities, requires the insurer of these securities to pay the amounts due the holders thereof which would otherwise have been paid by the bankruptcy-remote entity.
A ''true sale'' opinion is a fundamental requirement of every asset securitization. It is a ''reasoned'' opinion of legal counsel to the effect that the assets ''sold'' by an originator to the issuer of asset-backed securities will not be impaired in the event of the subsequent bankruptcy of the originator. The current Bankruptcy Code injects uncertainty into this opinion because it does not provide any clear guidance on what constitutes a ''true sale.'' Attached is a copy of a letter and an exhibit of a ''true sale'' opinion that was rendered in a recent asset-backed transaction rates by two rating agencies that the Association sent to Senator Grassley following last year's Senate hearing (Appendix 1). Both our letter to Senator Grassley and the ''true sale'' opinion more fully describe and illustrate the pressing need for the asset-backed security provision set out in Section 1012.
The Proposed Revision
In order to address the situation, in which the seller of loans or other receivables commences a Chapter 11 case under the Bankruptcy Code, the proposed change in Title X, Section 1012 of H.R. 833 prevents the Securitized Assets transferred to the bankruptcy remote entity from being included in the seller's bankruptcy estate. This enables the bankruptcy remote entity to continue using the cash flow or other proceeds from the Securitized Assets to make payments to the holders of the asset-backed securities. To the extent, if any, that the bankruptcy remote entity owes any amount to the seller, that obligation remains valid and the seller can obtain payment of that amount in accordance with its original terms.
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The revision recommended in Title X, Section 1012 of H.R. 833 is limited in its application to preventing the Securitized Assets conveyed by the seller to the bankruptcy remote entity from being included in the seller's bankruptcy estate. Thus, the proposed amendment simply confirms that the transfer intended by the parties as a sale will not be unwound and the reorganization of the bankrupt seller will not be otherwise impaired. Furthermore, the proposed amendment is limited to transactions involving the issuance of investment-grade, asset-backed securities, since a primary purpose of Section 1012 is to protect the legitimate expectations of investors in asset-backed securities sold in the capital markets. In addition, as explained in greater detail in the commentary at Appendix 2, limiting the application of the proposed amendment to investment grade securities substantially reduces the possibility that a lender or its operating company could transfer some or all of its loan assets or other receivables to a bankruptcy remote entity in an effort to defraud creditors of the company. In addition, Section 10 12 provides that securitized assets may be included in a debtor's bankruptcy estate to the extent such assets may be recoverable by the bankruptcy trustee under Section 550 of the Bankruptcy Code by virtue of evidence as a fraudulent conveyance under Section 548(a).
AFGI strongly supports the revisions recommended in Section 1012 of H.R. 833 relating to asset-backed securities. We believe the proposal will provide increased certainty to investors and other participants in the asset-backed securities market which, in turn, will create further stability in the capital markets, and facilitate future asset-backed financings. All of this will help maintain and foster an efficient funding source for mortgage loans, credit card receivables, automobile loans, and other loans available to citizens in small rural communities as well as our nation's cities. Section 1012 will ensure that consumers small businesses and others have the opportunity to access the least expensive source of financing, the capital markets.
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NOTE: The attachments listed below are on file with the Subcommittee on Commercial and Administrative Law of the House Judiciary Committee:
Appendix 1—Letter to The Honorable Charles E. Grassley, Chairman, Subcommittee on Administrative Oversight and the Courts, Senate Committee on the Judiciary, dated June 26, 1998.
Appendix 2—Proposed Revisions to Section 541 of the Bankruptcy Code.
PREPARED STATEMENT OF THE CONSUMER MORTGAGE COALITION
The Consumer Mortgage Coalition (''CMC''), a trade association representing national mortgage providers, appreciates the opportunity to submit testimony to the Subcommittee on H.R. 833, the ''Bankruptcy Reform Act of 1999,'' which you introduced on February 24th of this year.
On this very date, one year ago, the CMC submitted written testimony on H.R. 3150, the predecessor to H.R. 833. CMC's 1998 testimony, a copy of which is attached at Tab 1, identified several development sin the bankruptcy area that negatively impacted the residential mortgage loan market and suggested modifications to the United States Bankruptcy Code to address those concerns. A number of those modifications were incorporated into H.R. 3150 as reported out of your Subcommittee on April 23, 1998, and passed by the House by a vote of 306 to 118 on June 10th of last year. Most of those modifications are also contained in H.R. 833.
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This testimony suggests an additional refinement to the language in H.R. 833 intended to curb abusive filings and requests the addition of two provisions related to Section 1322(b)(2) of the Bankruptcy Code which were contained in H.R. 3150 but were subsequently deleted in conference.
Bad Faith Repeat Filings—Section 119 of H.R. 833
Section 119 provides:
If a debtor files for relief within one year after dismissal of a prior case, the automatic stay will terminate on the 30th day following the filing. The stay may be extended beyond the 30 days if a ''party in interest for continuation'' of the stay files notice within the 30-day period and demonstrates that the later case was ''filed in good faith as to the creditors to be stayed.'' The hearing must be completed before the 30th day.
If a debtor files for relief within one year of the dismissal of two prior cases, the automatic stay does not go into effect upon the filing of the third case. A party in interest may file a motion with 30 days of the filing of the third case requesting the court to cause the stay to take effect upon demonstration that the filing of the third case was ''in good faith as to the creditors to be stayed.'' If the motion is granted, the stay will be in effect from the date of entry of the order allowing the stay to go into effect.
In the context of the filing of a third bankruptcy case within one year of the dismissal of two prior cases. Section 119 at page 48, lines 7 through 9, requires the court, upon request of a party in interest, to ''enter an order confirming that no stay is in effect.'' In the context of a residential mortgage loan, this language permits a mortgage lender or servicer to obtain an order from the bankruptcy court to the effect that the automatic stay is not in effect with respect to the residence of the debtor securing the mortgage loan. The order can be entered upon the real estate records to ''clear title'' to the residence to facilitate the sale of the residence to a third party.
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Similar language, permitting a party in interest to obtain court order that the automatic stay is not in effect, should be added to Section 119 in the context of the filing of a second case within one year of the dismissal of a prior case. In that situation, the automatic stay terminates after 30 days. Specifically, language should be added allowing a party in interest to request that the court enter an order confirming that the 30 days have elapsed since the filing of the second case and that the automatic stay is no longer in effect. The following language (in italic) should be inserted on page 46 of H.R. 833 at line 11 following the word ''stayed'':
. . . Upon motion by a party in interest for continuation of the automatic stay and upon notice and a hearing, the court may extend the stay in a particular case as to any or all creditors (subject to such conditions or limitations as the court may impose) after notice and a hearing completed before the expiration of the 30-day period only if the party in interest demonstrates that the filing of the later case is in good faith as to the creditors to be stayed; provided that if the court has not extended the stay within the 30-day period or has extended the stay with respect to certain of the creditors, the court shall, upon the request of a party in interest, enter an order confirming that no stay is in effect or that the stay is in effect only with respect to those creditors identified in the order, and provided further, that if the court fails to enter an order on or before the expiration of the 30-day period, the stay under subsection (a) shall automatically terminate with respect to the debtor. A case is presumptively not filed in good faith as to . . .
''Debtor's Principal Residence''—1 to 4 Unit Residences—Cramdown
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In the context of a Chapter 13 reorganization, a debtor is permitted to bifurcate a secured loan into a ''secured'' and ''unsecured'' portion based on the value of the collateral securing the loan. This process is often called a ''cramdown.'' In a cramdown, the secured claim—the outstanding principal amount due on the loan—is reduced (crammed down) to the market value of the collateral securing the loan. The remaining amount due on the loan following the cramdown is treated as being unsecured.
Section 1322(b)(2) of the Bankruptcy Code provides that a residential mortgage loan is not subject to cram down if it is ''secured only by a security interest in real property that is the debtor's principal residence.'' The attached 1998 CMC testimony beginning at page 4 provides an extensive analysis of why Congress enacted Section 1322(b)(2) to protect residential mortgage loans from cramdowns. Congressional intent in enacting Section 1322(b)(2) was best summarized in the United States Supreme Court in Nobelman v. American Sav. Bank, 508 U.S. 324 (1993) in which Justice Stevens concluded that the provision was intended to give special protection to home lenders to encourage the flow of capital into the home lending market. Nobelman at 332 (Stevens, J. concurring) (citing Grubb v. Houston First am. Sav. Ass'n, 730 F.2d 236, 245–46 (5th Cir. 1984).
Following the Nobelman decision in 1993, the Third Circuit Court of Appeals in Hammond v. Commonwealth Mortgage Co. of Am., (In re Hammond) 27 F.3d 52 (3d Cir. 1994) narrowly read the word ''only'' in Section 1322(b)(2) which prohibits a cramdown on a residential mortgage loan ''secured only by . . . debtor's principal residence.'' The Third Circuit held that if a secured lender took a security interest in fixtures or personal property related to ''debtor's principal residence,'' the mortgage loan was no longer protected from cramdown under Section 1322(b)(2) because it was secured by more than debtor's principal residence.
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Recognizing that most residential mortgage loans are secured by fixtures and personal property related to the residence and the real estate on which it is situated and wanting to protect residential mortgage loans from cramdown, the Subcommittee amended H.R. 3150 at its April 23, 1998, markup to add a definition of ''debtor's principal residence'' and ''incidental property.'' Both definitions, taken from H.R. 3150 as passed by the House on June 10, 1998, are attached at TAB 2. The definitions were intended to overrule In re Hammond. The definition of ''debtor's principal residence'' contained language making it clear that residential structures comprised of ''1 to 4 units'' would qualify as a ''debtor's principal residence.'' The ''1 to 4 units'' language was deleted in the Conference Report to H.R. 3150.
Definitions of ''debtor's principal residence'' and ''incidental property'' are included in Section 302 of H.R. 833 beginning at page 117, line 21. The language is taken directly from the Conference Report to H.R. 3150 with the result that the definition of ''debtor's principal residence'' does not include ''1 to 4 unit'' residential structures.
CMC requested that the 1 to 4 units language be included in the definition because of a conflict among the courts as to whether a duplex, triplex or 4-unit structure in which the debtor lived in one unit and rented out the other units qualified as a ''debtor's principal residence'' under Section 1322(b)(2).
The United States Court of Appeals for the First Circuit in Lomas Mortgage, Inc. v. Louis, 82 F.3d 1 (1st Cir. 1996) determined that a triplex did not qualify as ''debtor's principal residence'' under Section 1322(b)(2) and that the mortgage loan secured by the triplex was therefor subject to cramdown. The First Circuit found that ''the legislative history [of Section 1322(b)(2)] does not state with clarity how a mortgage on a mixed property, one with both residential and investment characteristics, should be treated.'' Lomas, 82 F.3d at 5. The court noted that the Supreme Court in Nobelman had determined that Congress enacted Section 1322(b)(2) to encourage the flow of capital into the home lending market and went on to say that:
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If the antimodification provision [Section 1322(b)(2)] is meant to encourage home lending, then excluding multifamily houses would tend to harm (in relative terms) those purchasing property in urban neighborhoods, where owner-occupied multi-unit housing would tend to be more common and to favor those purchasing single-family homes, more common in suburbia. The theory is that lenders would face relatively more risk of modification [cramdown] in the case of default in urban areas, and interest rates on loans in those areas would rise accordingly. Lomas, 82 F.3d at 6.
The First Circuit notes that ''extending the antimodification provision to multi-family houses would create a difficult line-drawing problem. It is unlikely Congress intended the antimodification. provisions to reach a 100-unit apartment complex simply because the debtor lives in one of the units.'' Lomas, 82 F.3d at 6.
The First Circuit ended its decision by reiterating that the legislative history as to the treatment of multi-family residences is unclear and concluded with the following sentence: ''If we are wrong as to what Congress intended [in concluding that a multi-family residence does not qualify as ''debtor's principal residence], legislation can provide a correction.'' Lomas, 82 F.3d at 7.
The United States Bankruptcy Court for the Western District of New York in Brunson v. Wendover Funding, Inc. 201 B.R. 351 (Bankr. W.D.N.Y. 1996) concluded that a duplex qualified as ''debtor's principal residence'' and that the mortgage loan secured by the duplex was not subject to cramdown. The Brunson court shared the concern of the First Circuit in the Lomas decision, noting that the Lomas ''Court bemoaned a lack of 'clear guidance' on the question [of whether a multi-family property was subject to cramdown] from either the language or contemporaneous legislative history of Section 1322(b)(2) . . . This Court shares the frustration of numerous other courts in attempting to interpret this statute which is impenetrable when sought to be applied to a single parcel of land upon which the Debtor resides but which contains two or three dwelling units.'' Brunson, 201 B.R. at 350–51.
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Efforts by Congress to ''reform'' the Bankruptcy Code are infrequent. Courts addressing the question of whether a multi-family residence qualifies as debtor's principal residence for purposes of Section 1322(b)(2) have lamented the lack of clarity in that section as well as the legislative history related thereto. The current effort to reform the Bankruptcy Code offers an opportunity time to address and resolve the issue that has, divided the courts that have taken it up.
CMC recommends that the definition of ''debtor's principal residence'' at page 118 of H.R. 833, line 1, be revised to read as follows (revisions in italic):
(13A) 'debtor's principal residence'—
(A) means a residential structure containing 1 to 4 units, including incidental property, without regard to whether that structure is attached to real property; and
The proposed modification:
reflects the definition of 'debtor's principal residence' contained in H.R. 3150 as passed by the House in 1998 (see TAB 2), and
provides certainty to lenders by making it clear that a mortgage loan secured by 2 to 4 unit residential structure will not be subject to cramdown in the event of the insolvency of the borrower residing in one of the units. As set out in greater detail in the CMC 1998 testimony attached at TAB 1, that certainty encourages lenders to make residential mortgage loans to borrowers at lower rates and, equally important, permits lender to make loans to marginal borrowers who might not otherwise have received a loan. Additionally, adding the ''1 to 4 units'' language to the definition of ''debtor's principal residence'' addresses a concern raised by the First Circuit in Lomas that ''extending the antimodification provision to multi-family houses would create a difficult line-drawing problem'' because there was no clear guidance in Section 1322(b)(2) as to the number of units that could be in a multi-family complex protected from cramdown. As the Lomas court noted, ''it is unlikely that Congress intended the antimodification provisions to reach a 100-unit apartment complex simply because the debtor lives in one of the units.'' Lomas, 82 f.3d at 7. The proposed ''1 to 4 unit'' language makes it clear that Congress intends to limit the protection of Section 1322(b)(2) to the type of multi-family residential housing that most often serves as a debtor's principal residence-duplexes, triplexes and four-unit residences.
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''Debtor's Principal Residence''—180 Day Requirement
Section 130 of H.R. 3150 as passed by the House in 1998 (see TAB 2) modified Section 1322(B)(2) of the Bankruptcy Code as follows (modification in italic):
(2) modify the rights of holders of secured claims, other than a claim secured primarily by a security interest in property used as the debtor's principal residence at any time during 180 days prior to the filing of the petition, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims;
The 180-day language provides that a residence would be treated as ''debtor's principal residence'' under Section 1322(b)(2)—and the mortgage loan secured by the residence would be protected from cramdown—if the debtor had lived in the residence at any time within 180 days of the date of filing of the bankruptcy petition. The 180-day language is intended to avoid an abuse in which the debtor:
moves out of the mortgaged residence shortly before filing a Chapter 13,
claims that the residence is not his ''principal residence'' because he no longer resides there,
obtains an order from the bankruptcy court finding that the residence is no longer the debtor's principal residence and permitting a cramdown of the mortgage loan securing the residence, and
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moves back into the residence following cramdown relief.
The American Bankruptcy Institute (''ABI'') in its written testimony submitted to the Subcommittee on March 18, 1998, referenced the 180-day language contained in Section 130 of H.R. 3150 and noted that:
There have been reports of situations in which debtors vacated their homes shortly before filing Chapter 13 cases, so as to remove the [cramdown] protection given to the mortgage lender. The proposal negates such a tactic by applying the protection to homes used as the debtor's principal residence during a 180 day period prior to the bankruptcy. Statement of the American Bankruptcy Institute Before The Subcommittee on Commercial and Administrative Law on Consumer Bankruptcy Legislation, March 18, 1998, pages 27–28.
Members of CMC, which are among the nation's largest residential mortgage lenders and servicers, have seen an increase in attempts by debtors to circumvent Section 1322(b)(2) by moving out of their residences shortly before filing for Chapter 13 relief. Section 1322(b)(2) should be amended to include the 180-day language to curb a growing abuse.
Conclusion
CMC strongly supports your bipartisan effort to address bankruptcy abuses in the context of H.R. 833, particularly the provisions intended to curb bad faith, abusive filings (Sections 119 and 120). We are also appreciative of your efforts to clarify Section 1322(B)(2) of the Bankruptcy Code to assure that residential mortgage loans secured by a debtor's principal residence are not subject to cramdown. These issues are of critical importance to the residential mortgage loan industry and to all American homeowners. We look forward to working with you, Members of the Subcommittee and staff in further refining the provisions of H.R. 833 to make a good bill even better.
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NOTE: The appendix materials listed below are on file with the Subcommittee on Commercial and Administrative Law of the Committee on the Judiciary:
Appendix 1—CMC 1998 testimony.
Appendix 2—Section 130 of H.R. 3150.
PREPARED STATEMENT OF THE NATIONAL ASSOCIATION OF REALTORS and the Institute of Real Estate Management
The NATIONAL ASSOCIATION OF REALTORS, and its affiliate, the Institute of Real Estate Management support H.R. 833, the ''Bankruptcy Reform Act of 1999''. The NATIONAL ASSOCIATION OF REALTORS is comprised of over 730,000 real estate professionals involved in all aspects of the real estate industry, including the owners and managers of multifamily rental and commercial property. The Institute of Real Estate Management is comprised of over 9,000 property management professionals who manage over 24% of the nation's privately owned residential apartment properties, 44% of the nation's office buildings, and 10% of the nation's retail space.
In 1998, the House and Senate came very close to, passing a comprehensive bankruptcy reform bill. We applaud the efforts of Representative Gekas in reintroducing this legislation, and are hopeful that meaningful reform can be achieved in the coming months. There are three main issues of bankruptcy reform which specifically concern our members.
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The first of these is single asset bankruptcy. Single asset real estate refers to a single property or project, which generates substantially all of the gross income of a debtor, and on which the debtor conducts no substantial business other than the business of operating the real property. The related provision of the Code subjects single asset properties with a value of less than $4 million to an automatic stay from creditors for 90 days. However, the stay for properties of over $4 million can last for 6 months to well over a year. As there seems to be no justification for differentiation between properties based upon their value, and certainly property values differ in different geographic jurisdictions, we believe that the 90 day automatic stay should apply to all single asset properties, with no cap on the value of the! asset. H.R. 833 would eliminate the cap, treating all single asset bankruptcies the same, regardless of their value.
A second issue deals with automatic stay provisions in rental housing. Section 362 of the Code provides for an automatic stay, which is intended to provide debtors with due process protections. However, the Code does not specify to which assets the automatic stay applies. Due to this silence, some tenants are attempting to avoid eviction by filing for bankruptcy and listing the apartment as an asset protected by the automatic stay. This occurs despite the fact that a tenant-debtor does not have a legal or equitable interest in an apartment for purposes of liquidation or reorganization under the Code (i.e. the apartment is the property of the rental housing provider—NOT the tenant). Unscrupulous tenants use this loophole in the Code to abuse the bankruptcy system and live rent-free. Furthermore, there has been a growth of unethical companies who, for a fee, will teach tenants to abuse the: Code in this manner to get free rent. By closing this loophole, and not allowing bankruptcy to be a stay from eviction, H.R. 833 will curb an abusive use of the Code. It will not change any of the protections currently enjoyed by tenants under state landlord-tenant law and will not affect other creditors because it only allows rental housing providers to regain possession of the apartments and not back rent. Housing providers, like other small businesses, will be required to comply with the Code with respect to recovering unpaid debts.
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The last issue deals with shopping center bankruptcy. Under current law, shopping center tenants who declare bankruptcy have 60 days to decide to assume or reject their lease. However, courts routinely extend this time for months, and even years. Due to the delicacies of the landlord/tenant relationship in shopping centers, the impact of this delay can be severe. At a minimum, a shopping center owner faces uncertainty as to whether the tenant will on short notice, reject the lease and terminate rental payments; the impact of that uncertainty on lease-up or sales of the centers and/or redevelopment efforts; and if the store has gone ''dark''; interruption of percentage rents, diminished retail synergy and cross sales in the center and potential co-tenant exercises of rent abatement or escape provisions of leases tied to co-tenancy. The discretion of the courts to provide multiple, lengthy extensions of deadlines to assume or reject leases should be constrained by statute. We support increasing the initial time for a tenant to make this decision, however extensions must be made only upon a motion of the lessor.
The NATIONAL ASSOCIATION OF REALTORS and the Institute of Real Estate Management support responsible bankruptcy reform. We believe these common sense reforms will curb abusive use of the Bankruptcy Code. We support H.R. 833, and thank Representative Gekas for his efforts towards bankruptcy reform.
PREPARED STATEMENT OF GERALDINE JENSEN, PRESIDENT OF THE ASSOCIATION FOR CHILDREN FOR ENFORCEMENT OF SUPPORT, INC. (ACES)
ACES is the largest child support organization in the U.S. with almost 400 chapters in 48 states and over 40,00 members. The average ACES member is a low income, single parent whose children are entitled to child support payments. The parent has been trying to collect support for over two years through the government Title IV–D Child Support Agency with little or no success. The collection rate (number of cases with collections) for state IV–D agencies averaged only 20% last year per state government reports (form OCSE 156) filed with the U.S. Department of Human Services.
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Currently, over 30 million American children are owed over $ 41 billion in unpaid child support. States only collect about $15 Billion per year in child support payments. Almost one half of the child support cases in most states are currently awaiting action by the IV–D agency to either establish paternity orders and/or for those families who have been deserted. ACES appreciates your efforts to ensure that families entitled to child support are protected in HR 833.
Specifically, ACES supports the following provisions:
1. Non discharge of child support debts owed to a child.
Supporting one's child is a legal and moral obligation and bankruptcy should not alleviate this primary family obligation. ACES supports current laws allowing discharge of child support owed to the state. In fact, we support a program where by states would offer a non-custodial parent amnesty on state debt if he or she enters into and complies with a payment plan for current support as well as back support. We believe this would encourage the non-custodial parent to meet the obligations because he or she would then see the payment directly benefit the child for food, clothing, shelter, health care and educational opportunities. Our experience shows that once there is a large debt owed to the state, non-custodial parents often drop out of sight and never become emotionally or financially supportive of the children. However, the family truly benefits when these same parents are encouraged to spend time with their children and are required to meet current support obligations and make reasonable payment on arrears.
2. Prioritization of the domestic support debt.
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ACES supports prioritization because it ensures that families entitled to child support are not in direct competition with creditors for the non-custodial parent's income. Most families entitled to child support are headed by a low income, single parent who is reliant upon the government child support agency. These agencies have high caseloads and poor track records for efficient and quick action in comparison to private collection agencies.
3. Exception to the automatic stay so that current support as well as back support payments can continue to be collected via income withholding during the bankruptcy process.
The ability to use income withholding and other enforcement methods to collect support ensures that child support payments not only continue but are first in line to any creditors not included in the bankruptcy.
4. The broadening of the definition of domestic support claims to include administrative orders.
Due to federal laws for establishment of paternity and orders, via the administrative process, since 1984 more and more families have administrative rather than judicial orders for child support. About one half of the child support caseload involves a paternity action.
5. Requirement to obtain confirmation that domestic support claims have been satisfied
In the past, some parents have used bankruptcy to avoid their child support obligations rather than as way to ensure that the available income is used to meet their child support obligations. ACES is in support of strengthening this section to include a pro-active stance of notification of the custodial parent and the title IV–D agency about information listed on the bankruptcy such as current address, employer etc.
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ACES has concerns with issues involving a Chapter 13 bankruptcy. Our members report that the following is a common occurrence: the non-custodial parent owes a large arrearage , such as $20,000, and lists it as a Chapter 13 debt. The custodial parent is not notified of this and loses the opportunity to ask the bankruptcy judge not to include the child support debt in the Chapter 13. This request is made so that the child support payment can continue via an income withholding or other enforcement actions. Secondly, the IV–D agency is not notified of the inclusion of the child support as a Chapter 13 debt or the IV–D agency is notified but fails to notify the custodial parent.
IV–D agencies rarely take any action to protect arrears from being placed in Chapter 13 nor do they take action to ensure that adequate payments are made on the child support as part of the bankruptcy payment plan. The results of these oversights are that child support payments end up as part of a Chapter 13 payment plan, the child receives only $3–$5 a month payment and is not entitled to interest. Under an income withholding for current and back support, the child would receive a larger monthly payment, up to 20% of the current support in some states and an amount set via judicial discretion or IV–D agencies in other states. Also, the family is entitled to interest on arrears as part of the judicial or administrative enforcement process. ACES would appreciate language being added to HR 833 that requires notice to the custodial parent and an explanation of their rights to request that the debt not be placed in the Chapter 13. If child support debt is still placed in the Chapter 13 then the custodial parent needs to know his or her rights to a larger payment.
Any action you can take to ensure that government IV–D agencies can not use the proposed bankruptcy changes as a reason to do less to help our children is important. We are concerned that these agencies will take the stance that because the automatic stay is no longer applied to child support cases they have even less reason to assist us when a non-custodial parent files bankruptcy. This is why a direct notice to the custodial parent about the bankruptcy and their legal rights is needed.
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Our members have reported that when the company where the non-custodial parent was working filed a Chapter 11 bankruptcy, the company included child support payments garnished or withheld from the non-custodial parent's paycheck. The payment was withheld but never sent to the IV–D child support agency. We would like to see language in the bill prohibiting child support payments withheld by an employer from being placed in a Chapter 11 bankruptcy.
Additionally, ACES members report that unscrupulous, non-custodial parents hide many assets and commit fraud when filing bankruptcy. We believe that bankruptcy fraud should be more diligently prosecuted and that information provided by a custodial parent about fraud should be seriously considered rather than ignored because it is from an ''ex-wife or ex husband''.
Many low-income, single parent families have had to file bankruptcy in the past and unfortunately many more will need to do so in the future. This is due to a lack of adequate child support payments, adequate health insurance, and low paying jobs. Many are burdened with debts after a divorce. ACES has many members who have divorce decrees requiring an ex-spouse to pay the outstanding debts of the marriage. The ex-spouse often abandons these debts as well as the children. The creditor pursues the custodial parent. The ability to file bankruptcy and start with a clean slate is necessary for these families, especially if we are moving towards a society in which more single parent families are self sufficient rather than dependent on government benefits. It important to help these fragile single parent families keep enough money as well as be protect from creditors so that they do not become homeless, destitute and unable to take care of their children. Fifty percent of families with children experience divorce and 25% of children are now born to never married parents. Children born in the 1990s have a 60% chance of living in a single parent household at least part of their lives. Children are our most precious natural resource and your assistance to ensure that children are protected in bankruptcy is much appreciated.
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ACES members are clients of State Title IV–D child support enforcement agencies. We are representative of the families whose 30 million children are owed $41 billion in unpaid child support. We have banded together to work for effective and fair child support enforcement. ACES has surveyed our membership to gather information from families as they make the transition from welfare to self-sufficiency. We have asked welfare recipients about actions taken, or not taken, by child support enforcement agencies that have assisted them to become self-sufficient. Collection of child support when joined with available earned income allows 88% of our membership to get off of public assistance. Collection of child support enables our low income, working poor members to stay in the job force long enough to gain promotions and better pay. The collection of child support means our membership can pay rent, utilities, buy food, pay for health care and provide their children educational opportunities. Lack of child support most often means poverty and welfare dependency.
Annually, we publish a report entitled the Status of Child Support Enforcement in the U.S. In this report we use statistics supplied by state government to the U.S. Department of Health and Human Services. We look at each state's total number of the cases and the number of cases receiving payments to determine the collection rate. We include those cases that need paternity and/or child support orders established in the total since state IV–D agencies are required to provide families these services under federal and state laws. In our last report, which was based on 1997 statistics, we found that only 20% of the cases opened at a IV–D child support enforcement agency received payments. This poor collection rate is occurring at the same time states report record increases in the dollar amount of child support collected. This increase is actually due to higher case loads and higher child support order amounts in the period following the implementation of child support guidelines.
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Child support guidelines have caused a consistent increase in the dollar amount that judges or administrative hearing officers order paid. Child support payments are based on a mathematical formula rather than the old method often used by judges which was $25 for one child, $50 for two children, $75 for three children, no matter how much the non-custodial parent earned. The average ACES member with two children has experienced an increase from $40 to $80 per week. The use of guidelines began in 1989. Guidelines were optional until 1993, when judges were required to follow the guidelines or states could lose federal funding. This is also when we began to see a significant increase in the dollar amount collected.
States have already spent $2.6 billion on broken and non-existent automated child support enforcement tracking systems. As of today, only half of the states have certified systems and half of those are only partially certified. Currently, only 40% of children with open cases will live in states with a certified automated system. States such as California, Ohio, Michigan and Illinois have had problems with computerization for many years and are making little or no progress towards improvement. Children have now been waiting 13 years for all states to have effective computerized systems. Almost all of the provisions of the Personal Responsibility and Work Opportunities Reconciliation Act, such as new hire reporting and professional and driver's license suspensions cannot be implemented due to the lack of computerization.
Non-payment of child support is a solvable social problem. If we collected child support via payroll deduction just like we do federal income taxes the collection rate should increase to 58%. If we added a system to collect child support from self-employed non-payors just as we do self-employed social security taxes, we would see an increase to 85%. The Treasury Department is one of the few government agencies that have been developing a computer system for several years. It would be cheaper and more effective to have them add to their system than to continue to give states money to install new computer systems. The computer systems in different states are not compatible and will not assist 40% of families who have interstate cases. Children should be as important as taxes in the United States.
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Thank you for your concern and efforts for children entitled to child support. The time has come to set up an effective and fair national child support enforcement system. Only the public school system in this nation affects more children than the child support enforcement system.
| National District Attorneys |
| Association, |
| Alexandria, VA, March 17, 1999. |
Hon. GEORGE W. GEKAS, Chairman,
Subcommittee on Commercial and
Administrative Law,
Committee on the Judiciary,
House of Representatives, Washington, DC.
DEAR CHAIRMAN GEKAS: I am writing on behalf of the National District Attorneys Association, an organization of more than 7,000 local prosecutors throughout the United States. In that a significant number of local prosecutors are engaged in enforcing, child support obligations pursuant to Title IV–D of the federal Social Security Act, I requested that our Child Support Enforcement Committee review H.R. 833, the ''Bankruptcy Reform Act of 1999.'' In rendering their report to our full Board of Directors, the Committee unanimously endorsed the child support tenants of H.R.833. We believe that the legislation would substantially assist our efforts to collect support for the children and spouses of obligor-debtors who have filed for relief in bankruptcy.
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During the last Congress bankruptcy reform legislation was criticized in that it would pit child support creditors against financial institutions in competition for debt collections after bankruptcy; leaving support creditors worse off then they are now. It is our belief that this criticism is without merit and that those who pursue this challenge are not engaged in the collection of support payments and do not fully understand the collection process.
Local prosecutors who are involved with support cases do not believe that after bankruptcy it would be more difficult to collect support simply because credit card debts are not discharged. Support creditors actually have vastly more effective, and meaningful, collection remedies before a bankruptcy case is filed, or after the case is completed, than any other financial institution. Remedies include routine collection methods as well as civil contempt of court and criminal prosecution. It is under current law, during bankruptcy, that support collectors have the greatest difficulty because they are in competition with all other creditors for bankruptcy estate assets and because their most effective collections remedies have been stayed.
The enormous enhancements to support collection remedies provided in H.R.833 has earned the endorsement of those local prosecutors who are actively engaged in this process. The ''Bankruptcy Reform Act'', would eliminate from the reach of the automatic stay, and thus the bankruptcy process, the collection of support by federally mandated income or wage withholding procedures. It would also exempt from the stay other federally required collection processes such as license revocation and credit reporting. It would prevent confirmation of bankruptcy plans or discharge or debts in bankruptcy case, with respect to debtors who do make support payments, after filling for bankruptcy protection. In addition, distinctions between assigned and unassigned support would be largely eliminated, to the benefit of taxpayers who fund public assistance programs and to the formerly assisted parents and children who will, under the 1996 welfare reform legislation, be the direct beneficiaries of support previously assigned to the government.
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In that concerns have been expressed regarding many other provisions of the bankruptcy reform legislation, our comments are limited to only those provisions of the bills that would effect the enforcement of support obligations. As prosecutors, we have a legal and moral responsibility to collect support on behalf of children and parents living in our jurisdictions. In keeping with this we believe that this legislation provides a major improvement to the problems facing child support creditors in bankruptcy proceedings.
Sincerely,
| John R. Justice, Solicitor, |
| Sixth Judicial Circuit, Chester, SC, |
| President, National District Attorneys Association. |
cc:
Honorable James P. Fox, Chair, NDAA Child Support Enforcement Committee, District Attorney, San Mateo County, CA
Honorable Lynne Abraham, NDAA State Director, District Attorney, Philadelphia County
Honorable Michael J. Barrasse, NDAA Director at Large, District Attorney, Lackawanna County
Honorable Ralph A. Germak, President, Pennsylvania District Attorneys Association, District Attorney, Junita County
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Ms Annmarie Kaiser, Executive Director, Pennsylvania District Attorneys Association
NOTE: On file with the Subcommittee on Commercial Law of the House Committee of the Judiciary are the materials listed below:
Self-Correcting ''Crisis'': The Status of Personal Bankruptcy in 1999 by Lawrence M. Ausubel, Professor of Economics, University of Maryland, March 10, 1999.
Current Issues in Economics and Finance, Volume 5, Number 3, February 1999.
Journal of the National Association of Bankruptcy, Vol. 14, No. 4, Winter, 1998.
(Footnote 1 return)
According to the Committee on Ways and Means, U.S. House of Representatives, 1998 Green Book, p. 572, 56% of support collected in the last reported year (1996) was collected through the wage withholding process.
(Footnote 2 return)
Warren, ''Bankruptcy and Single Parents'' (April 1998).
(Footnote 3 return)
Schuchman, ''The Average Bankrupt: A Description and Analysis of 753 Personal Bankruptcy Filings in Nine States,'' 983 Com. L. Rev. 288, 289 cited in Driscoll, ''Consumer Bankruptcy and Gender,'' 83 Georgetown L.J. 525, 533 (1994); Coughenour & Hug, ''The Final Report of the Ninth Circuit Gender Bias Task Force,'' 67 S. Cal. L. Rev. 745, 897 (1994); Sullivan et als., As We Forgive Our Debtors: Bankruptcy and Consumer Credit in America (1989); Pollak, ''Gender and Bankruptcy: An Empirical Analysis of Evolving Trends in Ch. 7 and Ch.13,'' 102 Comm. L.J. 333,335–36 (1997)(Pollak's study of bankruptcy filings in Nebraska in 1996–7 found that the number of individual women filing exceeded the number of men).
(Footnote 4 return)
Driscoll, supra n. 2, at 537.
(Footnote 5 return)
Davis, ''Bankruptcy: A Moral Dilemma for Women Debtors,'' 22 Law & Psych. Rev. 235, 241 (1998).
(Footnote 6 return)
Driscoll, supra n. 2, at 534, citing Sullivan at 152.
(Footnote 7 return)
Commission on Gender, Race and Ethnicity, ''Report of the Third Circuit Task Force on Equal Treatment in the Courts,'' 42 Vill. L.Rev. 1355, 1537 (in the general Chapter 7 consumer population, 30% are women and 70% are men and joint filers; among the neediest filers, women represent 72% of the population and men and joint filers 28%).
(Footnote 8 return)
Driscoll, supra n. 2, at 535, citing Sullivan at 156.
(Footnote 9 return)
Coughenour & Hug, supra n. 2, at 897–98; Jackson et als., ''Report of the Special Committee on Gender to the DC Circuit Task Force on Gender, Race, and Ethnic Bias,'' 84 Geo. L.J. 1757; Sullivan, supra n. 2, at 156.
(Footnote 10 return)
Wiseman, ''Women in Bankruptcy and Beyond, 65 Ind. L.J. 107, 112 (1989).
(Footnote 11 return)
Exempting the tax intercept procedure from the automatic stay when it is used to collect arrears for the state may frustrate the intent of this provision to ensure that families are paid before states if there are assets to distribute under Chapter 7. See infra.
(Footnote 12 return)
Howard, ''A Bankruptcy Primer For The Family Lawyer,'' Special Issue on Family Law and Bankruptcy 31 Fam. L.Q. 377, 382 (1997).
(Footnote 13 return)
Straus, Bankruptcy Law And Procedures For IV–D Attorneys at 11 (1998).
(Footnote 14 return)
The most recent published Census Bureau data reports that 35% of custodial parents requested help from a government agency for obtaining child support. Child Support for Custodial Mothers and Fathers: 1991, p. 11. The federal Office of Child Support Enforcement has estimated that since 1991, the percentage of child support cases enforced by through the IV–D system has increased to 50–60%.
(Footnote 15 return)
All data from Department of Health & Human Services, Office of Child Support Enforcement, Child Support Enforcement FY 1997 Preliminary Data Report (August 1998).
(Footnote 16 return)
Krikorian and Riccardi, ''In Most Child Support Cases, D.A. Comes Up Empty-Handed,'' Los Angeles Times, p. A1, A9 (October 11, 1998).
(Footnote 17 return)
The states are California, Indiana, Kansas, Michigan, Nebraska, Nevada, Ohio, Pennsylvania, and South Carolina. The District of Columbia and the Virgin Islands also are lagging behind.
(Footnote 18 return)
In 1997, collections through the federal tax intercept were $1.1 billion. U.S. Department of Health & Human Services, News Release, ''Child Support Collections Reach New Records,'' Dec. 31, 1998. In FY 1997 (a slightly different time period), a total of $3.4 billion in prior year's support was collected. FY 1997 Preliminary Data Report, supra n. 14.
(Footnote 19 return)
FY 1997 Preliminary Data Report, supra n. 14, Table 2.
(Footnote 20 return)
Despite numerous requests, the government does not keep demographic data on debtors. So, we do not know how many women has accessed the bankruptcy system over time. We have also been unable to evaluate, using government data, whether certain subcategories of women are accessing the system more frequently than others—younger women, elderly women, minority women. However, non-government data have given us important clues.
(Footnote 21 return)
Teresa A. Sullivan, Elizabeth Warren and Jay Lawrence Washington, As We Forgive Our Debtors: Bankruptcy and Consumer Credit in America (1989); Sullivan, et al., ''Consumer Debtors Ten Years Later: A Financial Comparison of Consumer Bankruptcy 1981–1993,'' 68 Am. Bankr. L.J. 121 (1994).
(Footnote 22 return)
Elizabeth Warren, ''The Bankruptcy Crisis'', 73 Indiana Law Journal 1079, 1097–8 (November, 1998).
(Footnote 23 return)
Id.
(Footnote 24 return)
''Personal Bankruptcy, The Credit Research Center Report on Debtors' Ability to Pay.'' United States General Accounting Office, Report to Congressional Requesters (February, 1998); see also Klein, ''Means-Tested Bankruptcy: What Would it Mean?'' 28 Mem. St. U. L. Rev. 711 (Spring, 1998); Warren, ''The Bankruptcy Crisis,'' 73 Indiana Law Journal 1079 (November, 1998).
(Footnote 25 return)
Warren, ''The Bankruptcy Crisis,'' 73 Indiana Law Journal at 1080.
(Footnote 26 return)
Mark Zandi, ''Easy Credit, Profligate Borrowing, Tough Lessons,'' Regional Financial Review (January, 1997).
(Footnote 27 return)
Monetary Policy Report to Congress, 83 Fed. Reserve Bull. 1, 19 (March 1, 1997). See also ''Family Finances in the U.S.: Recent Evidence from the Survey of Consumer Finances.'' Federal Reserve Bulletin (January, 1997).
(Footnote 28 return)
Nussbaum, ''Lenders Laud the Value of Home Sweet Equity,'' The New York Times, Section 3, p. 10 (March 22, 1998). See also, ''Today's House Buyers Sometimes Live Closer to the Financial Brink,'' The Wall Street Journal, November 11, 1998, A1 (describing low-down payment mortgage lending).
(Footnote 29 return)
Nussbaum, ''Lenders Laud the Value of Home Sweet Equity,'' The New York Times, Section 3, p. 10 (March 22, 1998); Stevenson, ''How Serial Refinancings Can Rob Equity,'' The New York Times, Section 3, p. 10 (March 22, 1998). See also Forrester, ''Mortgaging the American Dream: A critical Evaluation of the Federal Government's Promotion of Home Equity Financing,'' 60 Tulane L. Rev. 373 (1994).
(Footnote 30 return)
This recommendation takes on particular significance after the decision of the Seventh Circuit Court of Appeals in In re Milwaukee Cheese of Wisconsin, Inc., 112 F.3d 845 (7th Cir. 1997). There, the court held that ''thrift savings plan'' monies held by the employer and repaid to employees prior to the company's bankruptcy filing had to be turned back to the estate—with some 12 years' worth of accrued interest.
(Footnote 31 return)
The Office of Advocacy, established by Public Law 94–305, is an independent office charged with representing the views and interests of small businesses before the Federal government. By law, the Chief Counsel is appointed by the President from the private sector and confirmed by the Senate. The Chief Counsel's comments and views are his own and do not necessarily reflect the views of the Administration or the U.S. Small Business Administration.
(Footnote 32 return)
5 U.S.C. §601 et seq.
(Footnote 33 return)
Public Law 104–121, 110 Stat. 857 (codified at 5 U.S.C. §601 et seq.).
(Footnote 34 return)
The studies are available on SBA's Internet website at ''www.sba.gov/ADVO/stats/''.
(Footnote 35 return)
See Appendix A.
(Footnote 36 return)
See Appendix B.
(Footnote 37 return)
Cognetics, Inc., Cambridge, MA, tabulation for the Office of Advocacy, U.S. Small Business Administration (1998).
(Footnote 38 return)
See Appendix C.
(Footnote 39 return)
''Exporting by Small Firms,'' Office of Advocacy, U.S. Small Business Administration, April 1998.
(Footnote 40 return)
Preliminary statistics tabulated by the Office of Advocacy, U.S. Small Business Administration based upon statistics by the Department of Labor.
(Footnote 41 return)
American Bankruptcy Institute press release, March 1, 1999.
(Footnote 42 return)
See Fullenbaum and McNeill, The Function of Failure, prepared by M & R Associates, for the Office of Advocacy, U.S. Small Business Administration (Springfield, Va.: National Technical Information Service, 1994).
(Footnote 43 return)
See Sullivan, Warren and Westbrook, Financial Difficulties of Small Businesses and Reasons for Their Failure, prepared for the Office of Advocacy, U.S. Small Business Administration (September 1998)
(Footnote 44 return)
See Poole, Micronomics, Inc., Business Failure and Entrepreneurship in the United States (September 20, 1998).
(Footnote 45 return)
Chart compiled by Professor Akio Nishizawa, Faculty of Economics Tohoku Univeristy, Kawauchi, Aoba-Ku, Sendai 980–8576, Japan. See Appendix D.
(Footnote 46 return)
The U.S. Trustees in Dallas and San Francisco have established voluntary debtors' schools to educate and help debtors file their financial statements.
(Footnote 47 return)
Small Business Proposals, National Bankruptcy Review Commission.
(Footnote 48 return)
Best, County Seat, Edison Brothers and Jamesway each filed a second case.
(Footnote 49 return)
See Appendix I, ''Resolution on Bankruptcy Reform Legislation''. (2/28/99)
(Footnote 50 return)
See Appendix II, ''Local Governments Recommendations for Reform of the U.S. Bankruptcy Code''. (8/3/98)
(Footnote 51 return)
Major portions and concept is patterned, copied, and condensed from the ''National Association of Attorneys General (N.A.A.G.) specific agenda'' for NBRC 1995, written by Karen Cordry, Attorney. This document relies heavily on that paper, changed to emphasize points, or delete sections, and for brevity and focus.
(Footnote 52 return)
Karen Cordry, N.A.A.G., 9/96.
(Footnote 53 return)
Only a small portion of all bankruptcy cases (2.5%) are initially filed under Chapter 11. The large majority of all cases are filed as Chapter 7 cases, and, of those, virtually all are no-asset cases (95%). GAO Report, Bankruptcy Administration: (July 1994).
(Footnote 54 return)
Stephany Carr, Attorney, Naples, FL, 12/15/95.
(Footnote 55 return)
Harlan Wright, Attorney, Sanford, FL, 12/20/95.
(Footnote 56 return)
Honorable John Clark, Tax Collector, Palm Beach, FL, 12/15/95.
(Footnote 57 return)
These sections are:
(Footnote 58 return)
Dr. Neil E. Harl, Charles F. Curtiss Distinguished Professor in Agriculture and Professor of Economics at Iowa State University, Ames, Iowa.
(Footnote 59 return)
11 U.S.C. §727(a)(8).
(Footnote 60 return)
11 U.S.C. §523(a)(1)(B)(ii).
(Footnote 61 return)
11 U.S.C. §1322.
(Footnote 62 return)
11 U.S.C. §1322(d).
(Footnote 63 return)
11 U.S.C. §1129(a)(9)(C).
(Footnote 64 return)
11 U.S.C. §1222(c).
(Footnote 65 return)
11 U.S.C. §1305(a)(1).
(Footnote 66 return)
The members of AFGI are AMBAC Indemnity Corporation, AXA Re Finance S.A., Capital Reinsurance, Enhance Reinsurance Company, Financial Guaranty Insurance Company, Financial Security Assurance, Inc, and MBIA Insurance Corporation.