SPEAKERS CONTENTS INSERTS
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94–939 PDF
2004
ADMINISTRATION OF LARGE BUSINESS BANKRUPTCY REORGANIZATIONS: HAS COMPETITION FOR BIG CASES CORRUPTED THE BANKRUPTCY SYSTEM?
HEARING
BEFORE THE
SUBCOMMITTEE ON
COMMERCIAL AND ADMINISTRATIVE LAW
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
JULY 21, 2004
Serial No. 114
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Printed for the use of the Committee on the Judiciary
Available via the World Wide Web: http://www.house.gov/judiciary
COMMITTEE ON THE JUDICIARY
F. JAMES SENSENBRENNER, Jr., Wisconsin, Chairman
HENRY J. HYDE, Illinois
HOWARD COBLE, North Carolina
LAMAR SMITH, Texas
ELTON GALLEGLY, California
BOB GOODLATTE, Virginia
STEVE CHABOT, Ohio
WILLIAM L. JENKINS, Tennessee
CHRIS CANNON, Utah
SPENCER BACHUS, Alabama
JOHN N. HOSTETTLER, Indiana
MARK GREEN, Wisconsin
RIC KELLER, Florida
MELISSA A. HART, Pennsylvania
JEFF FLAKE, Arizona
MIKE PENCE, Indiana
J. RANDY FORBES, Virginia
STEVE KING, Iowa
JOHN R. CARTER, Texas
TOM FEENEY, Florida
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MARSHA BLACKBURN, Tennessee
JOHN CONYERS, Jr., Michigan
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
TAMMY BALDWIN, Wisconsin
ANTHONY D. WEINER, New York
ADAM B. SCHIFF, California
LINDA T. SÁNCHEZ, California
PHILIP G. KIKO, Chief of Staff-General Counsel
PERRY H. APELBAUM, Minority Chief Counsel
Subcommittee on Commercial and Administrative Law
CHRIS CANNON, Utah Chairman
HOWARD COBLE, North Carolina
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JEFF FLAKE, Arizona
JOHN R. CARTER, Texas
MARSHA BLACKBURN, Tennessee
STEVE CHABOT, Ohio
TOM FEENEY, Florida
MELVIN L. WATT, North Carolina
JERROLD NADLER, New York
TAMMY BALDWIN, Wisconsin
WILLIAM D. DELAHUNT, Massachusetts
ANTHONY D. WEINER, New York
RAYMOND V. SMIETANKA, Chief Counsel
SUSAN A. JENSEN, Counsel
DIANE K. TAYLOR, Counsel
JAMES DALEY, Full Committee Counsel
STEPHANIE MOORE, Minority Counsel
C O N T E N T S
JULY 21, 2004
OPENING STATEMENT
The Honorable Chris Cannon, a Representative in Congress From the State of Utah, and Chairman, Subcommittee on Commercial and Administrative Law
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The Honorable Melvin L. Watt, a Representative in Congress From the State of North Carolina, and Ranking Member, Subcommittee on Commercial and Administrative Law
WITNESSES
Ms. Roberta A. DeAngelis, Acting United States Trustee, Region 3, on behalf of Executive Office for United States Trustees, Washington, DC
Oral Testimony
Prepared Statement
Mr. Lynn M. LoPucki, Security Pacific Bank Professor of Law, UCLA School of Law, Los Angeles, CA
Oral Testimony
Prepared Statement
Mr. Lester Brickman, Professor, Benjamin N. Cardozo School of Law, Yeshiva University, New York, NY
Oral Testimony
Prepared Statement
APPENDIX
Material Submitted for the Hearing Record
Study entitled, ''Financial Analysis of Asbestos Companies Under Chapter 11 Reorganization,'' submitted by Mr. Watt
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Study entitled, ''The Impact of Asbestos Liabilities on Workers in Bankrupt Firms,'' submitted by Lester Brickman
ADMINISTRATION OF LARGE BUSINESS BANKRUPTCY REORGANIZATIONS: HAS COMPETITION FOR BIG CASES CORRUPTED THE BANKRUPTCY SYSTEM?
WEDNESDAY, JULY 21, 2004
House of Representatives,
Subcommittee on Commercial
and Administrative Law,
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to notice, at 3:07 p.m., in Room 2141, Rayburn House Office Building, Hon. Chris Cannon (Chair of the Subcommittee) presiding.
Mr. CANNON. The Subcommittee will please come to order.
Increasingly, bankruptcy courts have become the courts of last resort for businesses that need to address extensive claims filed against them. From a societal perspective, Chapter 11 of the Bankruptcy Code reflects the premise that the debtor is economically ''worth more alive than dead.'' The perceived benefit of this process is that, theoretically, it preserves the going concern value of the business, enables the debtor to repay its creditors in part, and provides continued employment for its workers.
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From the creditor's perspective, Chapter 11 is a testing ground for the debtor's viability. The debtor can be made to account for its past and present activities, as well as its future business plans. Interested parties may investigate the debtor's financial health and the desirability of continuing the debtor's business.
The progress of a Chapter 11 case is also monitored by the judiciary and the Justice Department. Although bankruptcy judges were removed from the day-to-day administration of bankruptcy cases in 1978 in response to concerns about cronyism in the bankruptcy system, they still serve as the tribunals who must resolve most issues and controversies that arise in bankruptcy cases, including those that are important to the integrity of the system such as those dealing with conflicts of interest.
In addition, the United States Trustee Program, a component of the Justice Department, has administrative oversight responsibility for maintaining the integrity of the bankruptcy system. The program serves as the ''integrity watchdog'' and is charged with the responsibility to ensure that bankruptcy estates are administered promptly and efficiently. To that end, the program must review applications to retain and compensate professionals in Chapter 11 cases and file objections when appropriate grounds exist. In addition, the program must monitor the debtor's progress toward confirmation.
A series of recent trends and developments, however, have called into question whether the integrity of the bankruptcy Chapter 11 cases is being compromised. These concerns have not gone unnoticed by the media. The Wall Street Journal, for example, published not one but two editorials last month criticizing the bankruptcy system with respect to how it treats asbestos claims.
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Today's hearing will focus on some of these issues. For example, it is my hope that the witnesses will address the question of whether the current law and system adequately address the unique issues presented by mass torts and future claims. I believe Professor Brickman, in particular, is prepared to discuss that issue. In addition, my colleagues and I are interested to hear about whether the current law with respect to where Chapter 11 cases may be filed is being manipulated to the detriment of other interested parties and other ramifications of forum shopping. Professor LoPucki, I understand, is prepared to address that issue. We are also fortunate to have a representative from the Department of Justice who will explain the United States Trustee Program's efforts to proactively protect the integrity of the bankruptcy system particularly with respect to conflicts of interest by professionals retained in Chapter 11 cases, compensation requests, and other instances of overreaching by participants in these cases.
I now turn to my colleague Mr. Watt, the distinguished Ranking Member of the Subcommittee and ask him if he has any opening remarks.
Mr. WATT. Thank you, Mr. Chairman. I appreciate the Chairman convening the hearing. It's refreshing, I guess, to have a hearing that you don't really know what the outcome is likely to be. And that is the way the process really ought to work. We should be educating ourselves about these issues on an ongoing basis. And it looks like we've got an outstanding panel of people who are capable of educating us.
So, no sense in me talking any longer. We can get directly to it. And I look forward to hearing the testimony.
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Mr. CANNON. Thank you. Without objection, the gentleman's entire statement will be placed in the record. All Members may place their statements in the record at this point. Without objection, so ordered.
Without objection, the Chair will be authorized to declare recesses of the Subcommittee today at any point. Hearing none, so ordered.
I might point out we expect votes at about 4 p.m.. And so we are trying to move through so that we don't delay our witnesses while we vote.
I ask unanimous consent that Members have 5 legislative days to submit written statements for inclusion in today's hearing record. Without objection, so ordered.
I am now pleased to introduce the witnesses for today's hearing. Our first witness, Ms. DeAngelis, appears on behalf of the Executive Office of the United States Trustees, a component of the Department of Justice, that provides policy and management direction to the United States Trustees Program. The program operates through a system of 21 regions. Since March of last year Ms. DeAngelis has served as the acting trustee for Region 3 which comprises the judicial districts of Delaware, New Jersey, and Pennsylvania.
Prior to her present assignment, Ms. DeAngelis served as the Assistant United States Trustee for the District of Delaware from May 2001 to January 2003. Before entering public service, she was a partner in the law firm of Fox Rothschild where she specialized in bankruptcy law. Ms. DeAngelis obtained her undergraduate degree from Alvernia College, and law degree from Seton Hall School of Law.
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Our next witness is Professor Lynn LoPucki. Professor LoPucki is the Security Pacific Bank Professor of Law at the UCLA Law School. Before entering academia in 1980, Professor LoPucki practiced bankruptcy law for 8 years. Since then he has taught at Harvard, Cornell, Washington University, and the University of Pennsylvania Law Schools. Over the course of his academic career, Professor LoPucki has authored two books and numerous articles on debtor-creditor relations. His most recent book, ''Courting Failure: How Competition for Big Cases is Corrupting the Bankruptcy Courts,'' is scheduled to be published next year. Not soon enough.
Professor LoPucki received both his undergraduate and law degrees from the University of Michigan. He obtained his LL.M. from Harvard.
Our final witness is Professor Lester Brickman. Since 1976 Professor Brickman has been associated with the Yeshiva University's Benjamin N. Cardozo School of Law where he currently teaches contractual law and legal ethics. Over the course of his academic career he has taught at the University of Toledo Law School, Fordham Law School, and Oxford Universities.
Professor Brickman has both published and lectured extensively. He has participated in various activities intended to promote professional responsibility standards in the legal profession, including his work as a Member of the Committee on Professional and Judicial Ethics of the Association of the Bar of the City of New York and the New York State Bar Association's Committee on Professional Ethics. Professor Brickman obtained his undergraduate degree from Carnegie Tech, his law degree from the University of Florida, and his LL.M. from Yale University.
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I extend to each of you my warm regards and appreciation for your willingness to participate at today's hearing. In light of the fact that your written statements will be included in the hearing record, I request that you limit your oral remarks to about 5 minutes. Accordingly, please feel free to summarize or highlight the salient points of your testimony. You'll note we have a lighting system in front of you. After 4 minutes it turns yellow. After the fifth it turns red. You don't need to stop, but just be aware that the time is over and to finish your thoughts up. We would appreciate that. I don't like cutting people off, but I'll tap the gavel. It's our custom to tap the gavel at 5 minutes so we don't go on forever with our questions from Members, although when only the Ranking Member and I are here, we're pretty collegial about that as well.
I would now ask the witnesses to please stand and raise your hand right hand to take the oath. Are you all aware we need to do the oath?
[Witnesses sworn.]
Mr. CANNON. Let the record reflect each of the witnesses answered in the affirmative.
Ms. DeAngelis, would you now proceed with your testimony. Let me say Mr. Watt often laughs at how fast I read, but we need to get through these sort of technicalities quickly. And, by the way, we help the recorder by giving her a copy of what I have done. But we would appreciate now—as Mr. Watt said, we are both exploring here and the whole Committee is exploring this issue. It's an issue we care enormously about and look forward to hearing all of your testimony. Ms. DeAngelis.
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TESTIMONY OF ROBERTA A. DeANGELIS, ACTING UNITED STATES TRUSTEE, REGION 3, ON BEHALF OF EXECUTIVE OFFICE FOR UNITED STATES TRUSTEES, WASHINGTON, DC
Ms. DEANGELIS. Thank you, Mr. Chairman, Mr. Watt. I appreciate the opportunity to appear before you on behalf of the Department of Justice to discuss the role of the United States Trustee in reviewing applications to employ and compensate professionals in large Chapter 11 cases. Chapter 11 debtors are authorized to employ attorneys, accountants, and other necessary professionals to assist them in their reorganization efforts.
Similarly, official committees of creditors and equity security holders which are appointed under section 1102 of the Bankruptcy Code are authorized to employ professionals to assist in carrying out their responsibilities.
Congress has imposed special rules governing the employment and compensation of bankruptcy professionals. Most importantly, professionals may not be employed or paid without approval of the bankruptcy court. Court approval is sought by filing an application which is noticed to the United States Trustee and other parties in the case.
In my written testimony I describe in greater detail the activities of the United States Trustee regarding the retention and compensation of professionals. The number of actions we have taken in the amount of fee reductions, fee expense reductions, obtained alone cannot adequately convey the significance of the actions that we take. Just as with other regulatory or enforcement agencies, our selection of the right case and obtaining the right result may have deterrent and other salutary effects that promote the integrity of the process, including the expanded disclosure of conflicts and greater restraints on fees.
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In my written testimony I provide several examples of recent cases in which the United States Trustee litigated important matters of retention and compensation of professionals. Let me briefly describe two of them. In Re Pillow Tex, the Court of Appeals for the Third Circuit sustained the United States Trustee's position and held that the bankruptcy court could not approve an employment application until it had resolved allegations that proposed counsel for the debtor had received a preferential transfer and therefore was not disinterested.
The law firm settled the matter after remand for a six-figure disgorgement. In In Re Flemming Companies, the United States Trustee for Region 3 objected to the fee applications of debtor's counsel. In a published opinion, the bankruptcy court found that the two firms had rendered services which unnecessarily generated litigation and did not benefit the estate. The court also found that the hourly rates of one of the firm's practitioners were higher than the hourly rates charged by similarly experienced attorneys in other practice areas within the same firm.
In the area of fee review, the courts, the United States Trustee, and others have explored new approaches including some of the following: Courts have appointed fee examiners and fee review committees who submit periodic reports with recommendations for compensation awards. The United States Trustee sometimes uses an internal automated fee review program that permits computerized analysis of fee applications to identify, among other things, possible duplication of effort such as multiple attorneys appearing at meetings and interoffice conferences and the cost of particular tasks such as the aggregate time that is expended to develop a plan of reorganization, for example.
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Some courts require professionals to submit budgets reflecting anticipated fees and expenses so that the court, the debtor, and the parties have a better ability to evaluate the likely future course of the case and the costs of professionals.
In summary, Congress has prescribed a comprehensive regimen of legal standards and procedures governing the retention and compensation of professionals employed in Chapter 11 cases. Bankruptcy courts are expressly required to review and approve the employment of all professionals and the payment of all fees and expenses. The responsibility to identify noncompliance with these standards and procedures in Chapter 11 is a responsibility that is shared among the court, the United States Trustee, and other participants in the bankruptcy system.
I appreciate the opportunity to discuss some of the challenges that this responsibility presents as well as some of the emerging issues and possible approaches for future action. And I would be happy to answer any questions from the Subcommittee. Thank you.
Mr. CANNON. Thank you Ms. DeAngelis.
[The prepared statement of Ms. DeAngelis follows:]
PREPARED STATEMENT OF ROBERTA A. DEANGELIS
Mr. Chairman and Members of the Subcommittee:
I appreciate the opportunity to appear before you on behalf of the Department of Justice to discuss the role of the United States Trustee in reviewing applications to employ and compensate professionals in large chapter 11 bankruptcy cases. As the Acting United States Trustee for Region 3, I have responsibility for some of the largest cases filed in the country, including those filed in the district of Delaware.
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Title 11 of the United States Code, known as the Bankruptcy Code, provides a comprehensive scheme for the employment of bankruptcy professionals who are paid from bankruptcy estate funds. Under 28 U.S.C. §586 and other provisions of law, the United States Trustee has authority to review, comment upon, or object to applications to retain and compensate bankruptcy professionals.
Chapter 11 debtors are authorized to employ attorneys, accountants, and other necessary professionals to assist them in the reorganization process. Similarly, official committees of creditors or equity security holders, which are appointed under 11 U.S.C. §1102, are authorized to employ professionals to assist the committees in carrying out their responsibilities. In light of the multiplicity of interests present in bankruptcy cases and the frequent lack of natural tension that exists in the typical two-party civil proceeding, Congress has imposed special rules governing the employment of bankruptcy professionals. Most importantly, professionals may not be employed without approval of the bankruptcy court. Court approval is sought by filing an application which is noticed to the United States Trustee and, frequently, to other parties in the case. The terms of engagement must be disclosed, including any contingency fee arrangements.
The applicant must demonstrate that it is eligible for employment. The Bankruptcy Code and Rules impose a burden of full disclosure. The professional is required to submit to the court an application that states the following: the specific facts showing the need for the services to be rendered, the name of the person to be employed, the reasons for the selection, the particulars of the services to be rendered, and the terms of compensation. In addition, a verified statement is required from the professional that sets forth all connections the professional has or had with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States Trustee, or any person employed in the office of the United States Trustee. Full and complete compliance requires that the professional report all connections, not just those connections that, in the judgment of the professional, may be relevant. It is the court's task to determine whether the connections are disqualifying. In its administration of chapter 11 cases, the United States Trustee endeavors to assure that the self-reporting required of professionals is provided and that disqualifying connections are brought to the attention of the court.
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The basic requirements for the employment of a debtor's professionals are contained in 11 U.S.C. §327, 328, and 101(14). Among other things, professionals ''may not hold or represent an interest adverse to the estate [and must be] disinterested.'' In section 101(14), the term ''disinterested person'' is defined and sets forth five disqualifying conditions. Some of these conditions are general, but others are more specific. For example, directors and officers who served in those capacities within two years of the filing are per se excluded from employment. The basic requirements for committee professionals are contained in 11 U.S.C. §1103. These requirements are similar, but not identical to, those governing the debtor's professionals. The notice requirements are contained in Federal Rule of Bankruptcy Procedure 2014 and local rules.
Professionals employed by the debtor or official committees may be paid fees and reimbursed for expenses out of estate funds. Congress has established a scheme for the application, review, and approval of fees in 11 U.S.C. §330 and 331. Other basic requirements are set forth in the Federal Rule of Bankruptcy Procedure 2016 and local rules. Professionals may be compensated only after application, notice to parties, and approval by the bankruptcy court. Congress set forth the standards for approval of fees and expenses in §330. The court may allow ''reasonable compensation for actual, necessary services'' and ''reimbursement for actual, necessary expenses.'' By statute, the court must weigh such factors as time spent in rendering services, customary compensation charged by comparably skilled practitioners in non-bankruptcy cases, complexity of the services rendered, and benefit to the estate. Courts may award interim compensation, but all such interim awards are subject to final review and modification at the end of the case.
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There are also other provisions of the Bankruptcy Code governing compensation of third parties for making a substantial contribution to the chapter 11 estate, but those involve more narrow circumstances and are not addressed in this testimony.
Although only the bankruptcy court may approve employment and compensation, and although creditors and parties in interest may object to employment and compensation, the United States Trustee Program considers its authority to review these applications to be an important tool in carrying out its mission to uphold the integrity and efficiency of the bankruptcy system. The precise level of United States Trustee review depends upon a variety of factors, including the success of the case and participation by other parties. Review also may vary according to the size and staffing of an office. In some offices, trained paralegals may undertake an initial review, but attorneys may conduct the entire review in other offices. In addition, standard operating procedures may vary according to local practice and the circumstances of a particular case. Offices often are able to resolve many questions or disputes informally without resort to litigation. For example, some deficiencies can be remedied by supplemental disclosure. Similarly, fee reductions may be obtained prior to filing an objection or by amending the application. Furthermore, the substantive outcome may vary somewhat from district to district according to controlling case law.
The United States Trustee Program has published fee guidelines to help standardize the content and organization of applications. The centerpiece of the guidelines is a task-based billing approach by which applicants organize their time entries by discrete activities so that the costs and benefits of accomplishing specific tasks can be more easily determined.
As the Program has reported to the Subcommittee in previous hearings, we have made numerous management improvements over the past three and one-half years. Among our management advances has been institution of an automated Significant Accomplishments Reporting System by which we measure the work done in our field offices. In the future, these data should assist field office managers and the national Program leadership in setting priorities and allocating scarce resources. Although it is particularly difficult to quantify work done in the review of chapter 11 retention and fee applications, we do collect limited information.(see footnote 1)
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We have recently compiled our Fiscal Year 2003 data which will be published shortly and made available in an Annual Report to be distributed to members of Congress, the bankruptcy community, and the general public. Based upon data entered by our field offices, in Fiscal Year 2003, Program staff took 9,264 actions on employment and compensation applications. These actions ranged from informal negotiations to filing and arguing objections in court. A high percentage of these actions led to a successful result, including satisfactory amendment of an application or favorable adjudication by the bankruptcy judge. A total of 3,746 formal objections were filed in court. As best we can quantify the results, our actions directly resulted in fee or expense reductions of $44.8 million.
We also have compiled data for the first six months of Fiscal Year 2004. From October 1, 2003, through March 31, 2004, Program staff took 2,965 actions on employment and fee applications. A total of 1,559 formal objections were filed in court. As best we can quantify the results, our actions resulted in fee or expense reductions of $34.9 million.
Numbers alone cannot adequately convey the significance of the actions we have taken. Just as with other regulatory or enforcement agencies, our selection of the right cases and obtaining the right results may have deterrent and other salutary effects that promote the integrity of the process, including the expanded disclosure of conflicts and greater restraint on fees. Following are examples of recent cases in which the United States Trustee litigated important matters of retention and compensation of professionals.
In In re Pillowtex, Inc., 304 F.3d 246 (3d Cir. 2002), the Court of Appeals for the Third Circuit sustained the United States Trustee's position and held that the bankruptcy court could not approve an employment application until it resolved allegations that proposed counsel for the debtor had received a preferential transfer and, therefore, was not disinterested. The law firm settled the matter after remand for a six figure disgorgement.
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In In re Safety Kleen, Case No. 00–02303 (Bankr. D. Del.), the United States Trustee for Region 3 objected to the retention of a financial advisory firm because a principal of the firm had served as the debtor's CFO pre-petition and was connected to a lawsuit against the debtor. In a related matter arising in In re Harnischfeger, Case No. 99–02171 (Bankr. D. Del.), the United States Trustee moved to disqualify the same firm and for disgorgement due to its failure to disclose connections involving the firm's investment affiliate and the appointment of one of the firm's principals to the board of one of the debtors. After extensive litigation, a settlement was reached, which was approved by the court, in which the firm disgorged $3.25 million.
In In re Fleming Companies, Inc., 304 B.R. 85 (Bankr. D. Del. 2003), the United States Trustee for Region 3 objected to the fee applications of debtor's counsel. In a published opinion, the Bankruptcy Court found that the two firms had rendered services which unnecessarily generated litigation and did not benefit the estate. The court also found that the hourly rates of one of the firm's practitioners were impermissibly higher than the hourly rates charged by similarly experienced attorneys in other practice areas within the same firm.
In United States v. Schilling (In re Big Rivers Elec. Corp.), 355 F.3d 415 (6th Cir. 2004), approximately $2.6 million in fees awarded to the examiner were disallowed based on objections filed by the United States Trustee for Region 8 and other parties. The court ruled that the examiner failed to adhere to the standards of behavior required of a bankruptcy professional and was not entitled to any of the $2.6 million in fees originally awarded, including $960,000 in fees already in his possession which he was required to disgorge.
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In In re Jore Corp., 298 B.R. 703 (Bankr. D. Mont. 2003), the United States Trustee for Region 18 moved to disqualify debtor's counsel because of counsel's failure to disclose it represented the debtor's primary lender in unrelated matters. The court granted the motion to disqualify and disallowed more than $1.8 million in fees.
In In re 360Networks (USA), Inc., Case No. 01–13721 (Bankr. S.D.N.Y.), the debtor's law firm agreed to reduce its fees by $1.35 million after the United States Trustee for Region 2 questioned the nature and manner of the firm's disclosures. In its final fee application, the firm revealed for the first time that, pre-petition, it received significant payments from the debtor that might qualify as preferential payments. The reduction in fees was approved by the court.
In recent years, the chapter 11 bankruptcy landscape has changed and new issues have emerged. This may require new approaches by the courts, United States Trustees, and others. Some of these issues are highlighted in recent chapter 11 cases associated with corporate malfeasance that occurred in the late 1990s. Other issues have emerged as law firm, business, and finance practices have evolved.
In the area of conflicts of interest and compensation, the United States Trustee is confronting dynamic situations in which new fact scenarios must be applied to established statutory and case law. Examples include the following.
Investment banks, financial advisors, and turnaround firms often have affiliates that manage investment funds that provide financing or capital to reorganize bankrupt companies.
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Financial services firms wish to serve on creditors' committees and continue to trade in the debtor's securities. Case law does not proscribe trading, but requires, at a minimum, erection of ethical barriers.
Professionals and other third parties increasingly seek releases and exculpation, even though the bankruptcy discharge traditionally only protects debtors and is not designed to affect claims between third parties. In In re United Artists Theatre Co. v. Walton (In re United Artists Theatre Co.), 315 F.3d 217 (3d Cir. 2003), the United States Trustee brought an action decided by the U.S. Court of Appeals for the Third Circuit. The Court held that agreements to indemnify financial advisors for their negligence may be reasonable under §328(a).
Published reports from bankruptcy experts tell us that the spike in public company and other mega-chapter 11 filings has subsided. Although many of the largest business reorganization cases were filed in 2001 and 2002, some remain pending in bankruptcy court. The size and complexity of some of these cases are of unprecedented magnitude. The resulting fee applications are of similar unprecedented proportions. This has prompted the courts, United States Trustees, and others to consider new approaches to fee review. Among the new approaches taken have been the following.
Courts have appointed fee examiners and fee review committees who submit periodic reports to the court with recommendations for professional compensation awards. Some of these committees have professional staff and some are comprised only of major participants in the case. Several months ago, the United States Trustee Program conducted an informal survey of our field offices and identified at least fifteen on-going fee committees.
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Automated fee review procedures have been employed in a number of cases. Courts have allowed payment to private companies that conduct computerized analysis of fee applications to identify, among other things, possible duplication of effort (e.g., multiple lawyers at meetings and inter-office conferences) and the cost of particular tasks (e.g., aggregate time expended to develop a plan of reorganization). The United States Trustee also sometimes uses an internal computer program that is effective under certain circumstances. With automated fee review systems, professionals submit data in electronic format. The computer program allows fees to be analyzed across the board for all professionals employed in the case. Full text searching allows particular entries to be identified, grouped, and totaled. Among other things, this helps identify excessive meetings and consultations among professionals in different firms employed in the case.
Some courts require professionals to submit budgets reflecting anticipated fees and expenses so that the court, debtor, and parties may better evaluate the likely future course of the case and the costs of professionals. Other devices have also been employed to encourage cost-cutting, including discounts off of standard hourly rates.
These and other strategic approaches have been and ought to be continually explored by the courts, the United States Trustees, and others to enhance the quality of fee review, especially in larger chapter 11 cases. A single approach may not be effective for all cases. Cases of different size and complexity may call for different methods of review. In addition, scholarly research may assist in determining anticipated costs of reorganization. Although each case is different, compilations of empirical data may help identify excessive costs or raise red flags to prompt further inquiry of professionals whose charges exceed a normal range.
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Congress has prescribed a comprehensive regimen of legal standards and procedures governing the retention and compensation of professionals employed in chapter 11 cases. Bankruptcy courts are expressly required to review and approve the employment of all professionals and the payment of all fees and expenses. The responsibility to identify non-compliance with these standards and procedures in chapter 11 cases is a responsibility shared among the courts, the United States Trustees, and other participants in the bankruptcy system. I appreciate the opportunity to discuss some of the challenges that this responsibility presents, as well as some emerging issues and possible approaches for future action.
I would be happy to answer any questions from the Subcommittee.
Mr. CANNON. Mr. LoPucki, would you give us your testimony now?
TESTIMONY OF LYNN M. LoPUCKI, SECURITY PACIFIC BANK PROFESSOR OF LAW, UCLA SCHOOL OF LAW, LOS ANGELES, CA
Mr. LOPUCKI. For the past 20 years I have been engaged in empirical research regarding big bankruptcy cases. Since about 1990, the bankruptcy courts have been competing for these cases. The competition has corrupted the bankruptcy courts and it's also been damaging the companies themselves. The easiest way to understand this is historically. In 1974 and in 1975, the Bankruptcy Rules Committee adopted liberal venue rules that in the context of big bankruptcy cases essentially allowed companies to file wherever they schose. They could pick their court.
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During the 1980's the companies exercised that prerogative. The forum shopping rate, by which I mean companies filing in a district other than where their headquarters is located, increased from about 20 percent to about 40 percent. In 1990, Delaware, which had not been active at all in the 1980's—the bankruptcy court was a one-judge court with a single big case. In 1990 the Delaware court attracted two big cases; in 1991, four; in 1992, six; by 1996, the Delaware court had an 87 percent market share. That is, they got 13 of the 15 big cases filed anywhere in the United States.
That same year, the National Bankruptcy Review Commission recommended legislation to bring an end to the forum shopping. The Delaware district court revoked the reference of Chapter 11 cases that year to the bankruptcy court. It's a complicated story that I won't go into here, but by 1998—by the end of 1998, it was clear that Congress would not act on the National Bankruptcy Review Commission's recommendation. And the lawyers, and professionals throughout the United States in big cities, essentially took the matter into their own hands by pressuring the bankruptcy courts to become competitive for these cases. And the courts responded.
If you can go to the PowerPoint that will show the graph, the percentage of cases—can we get forward to that? You can see here the increase in cases over—I'm sorry, the increase in forum shopping over the past 24 years. Essentially that big peak there is when Delaware almost got all of the cases. Aside from that, it's been a steady increase. It has leveled off a little in recent years but it's leveled off at a rate of 60 to 70 percent of all the cases being forum shopped.
Going to the next graph, you can see the market shares of these courts. The New York court was dominant in the 1980's, the Delaware court dominant in the 1990's. You can see the Delaware court declining a little in recent years because the dockets are full in Delaware, and so the court is not quite as attractive as it previously had been.
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Now, with the next graph, you can see these boxes that represent the 98 large public companies that came out of bankruptcy during the years when Delaware—the years that I call Delaware's ascendency from the time they started in 1990 to 1996 when they had the 87 percent market share. They did reorganize 26 companies in Delaware during that period.
Then, going on to the next graph, you can see the failure rates for those reorganizations. Within 5 years of the company emerging from bankruptcy, supposedly reorganized, 42 percent of the companies failed as compared with only 4 percent in all of the other bankruptcy courts.
You can measure failure a lot of different ways. This one measures it by refiling, the next graph measures it including companies that fail without reentering bankruptcy, and you can see it's a different proportion but still four times as high in Delaware as in the other courts.
These failures are not explained by a difference in the cases. The Delaware and New York cases are larger, but larger cases don't fail more often.
The Delaware and New York companies were not in greater financial distress. We measured about eight different ways. They were not in greater financial distress than the companies that went into other courts. They were not apparently more complex cases, as some of the lawyers argued to us. We found that they had fewer classes of creditors in their plans than the companies that were reorganized in other courts. But the failure is explained by competition. The Delaware court was faster, and faster cases failed more often. Delaware attracted prepackaged cases, and prepackaged cases failed only in Delaware. New York had high failure rates in the 1980's when it was attracting cases. When it stopped attracting cases, its failure rates fell. When Delaware came in, they came in with high failure rates. And when the other courts more recently have begun tracking Delaware, adopting the same kinds of procedures, their failure rates have gone up.
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Now, there is also some other damage going on as a result of the competition. There have been, over this period of time since 1990, huge changes in the operation of the system. Some of these changes in the 1980's, there were almost no 30-day prepackage cases. You can't do a 30-day prepackage case and comply with the law. But by the 1990's, late 1990's, lots of courts were doing 30-day prepacks. In the 1980's, CEOs—the failed CEOs—were generally forced out of office. In the 1990's they began getting retention bonuses in order to stay. In the 1980's there were very few, almost none I think, companies—sales of companies that were approved by the court without planned formalities and disclosure to creditors. By the late 1990's it was commonplace. In the 1980's there were trustees appointed in some cases. In the 1990's—after 1992 that essentially disappeared. Even in Enron, perhaps the most egregious fraud case in history, no trustee was appointed.
There were no critical vendor orders in the 1980's, but in the 1990's and by 2002 there were critical vendor orders being entered, giving preferential treatment in the hundreds of millions of dollars; in a single case in K-Mart, $200 to $300 million of preferences for some creditors over other creditors.
All of these changes are happening without any legislative amendment. Nothing big happened in this field between the eighties and the 1990's to cause this change. No legislative amendments, no judicial opinions, no policy discussions of any of these things. It's competition that is driving the change in the courts today.
Thank you.
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Mr. CANNON. Thank you Mr. LoPucki.
[The prepared statement of Mr. LoPucki follows:]
PREPARED STATEMENT OF LYNN M. LOPUCKI
Mr. Chairman and Members of the Subcommittee:
I. INTRODUCTION
The Bankruptcy Courts of the United States have inadvertently been thrown into competition for big bankruptcy cases. That competition is changing bankruptcy law and practice in ways not contemplated by Congress and corrupting those courts.
By ''corrupting'' I mean that a substantial number of bankruptcy judges are deciding particular matters not as they believe they should, but as they believe they must to maintain the flow of cases to their courts. I can identify no particular decision as corrupt, but I can show a pattern of decisions by the bankruptcy courts for which corruption by the pressures of court competition is the most reasonable explanation. I can also show that the competition is having an adverse effect on reorganizing companies. Specifically, companies that reorganized in the courts most successful in attracting cases were two to ten times more likely to fail after bankruptcy than were comparable companies reorganized in other courts.
II. WHY BANKRUPTCY COURTS COMPETE FOR BIG CASES
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Bankruptcy judges want large cases for at least three reasons:
1. For the judge, a large bankruptcy case is a career opportunity. The judge will be able to work with the nation's leading bankruptcy professionals and the proceedings will be followed by the media and the bankruptcy community as a whole. Judges who attract numerous large cases are likely to become celebrities.
2. The cases are of economic importance to the judges' communities. The court-awarded professional fees in a single, large bankruptcy case are almost invariably in the millions of dollars, and may be as high as a billion dollars (the projected estimate for the total court-awarded fees in the not-yet-completed Enron case). Fees paid without court award in these cases may be equally large. In most large cases, most fees paid will go to local professionals. Thus, attracting the case of a large company to the bankruptcy court in a city brings substantial revenues to the bankruptcy professionals in that city. Attracting all of the big bankruptcies in the United States to a single court—as the Delaware Bankruptcy Court nearly succeeded in doing in 1996—could bring billions of dollars to a local economy annually.
3. The loss of cases to other courts humiliates the bankruptcy judges, lowers their standing in their communities, and may even cost them their jobs. Most—but not all—large, bankrupt companies are linked in the minds of the public to the city in which they have long maintained a national headquarters. Examples are Enron with Houston and Polaroid with Cambridge, Massachusetts. The bankruptcy court at that location is a sort of ''natural venue'' where the company is expected to file. The company that files in Delaware or New York is seen as rejecting the local court. That rejection often leads to criticism of particular bankruptcy judges for failure to take what action was necessary to retain ''their'' cases. To illustrate the scope of the problem, of the 24 companies headquartered in the Boston area that filed bankruptcy since 1980, only 4 (17%) filed in the Boston Bankruptcy Court. For Alexandria, Virginian, the number is 2 of 13 (15%). Some cites, including Philadelphia, West Palm Beach, and Ft. Lauderdale have lost all of their cases.
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In some cases, the criticisms appear warranted. One or more of the local judges may have poor skills or temperament. In other cases, the criticisms are unwarranted. The judge is simply following laws and rules the court-selecting lawyers and executives prefer to avoid.
Bankruptcy judges are not Article III judges and do not enjoy life tenure. They serve 14 year terms and must apply for reappointment to continue in office. A recent study by Bankruptcy Judge Stan Bernstein of the Eastern District of New York found that more than 8% of the bankruptcy judges who applied for reappointment during the period 1998 to 2002 were not reappointed. Stan Bernstein, The Reappointment of Bankruptcy Judges: A Preliminary Analysis of the Present Process (unpublished manuscript October 15, 2003). Other bankruptcy judges won reappointment, but only after their competence had been challenged and they had been, in Judge Bernstein's words, ''put through the wringer.'' Because the Courts of Appeals usually seek the opinions of local bankruptcy lawyers as part of the reappointment process, bankruptcy judges are probably more sensitive than Article III judges to how they are viewed in their communities.
III. HISTORICAL ROOTS OF THE PROBLEM
In 1974 and 1975, the Bankruptcy Rules Committee liberalized the venue rules for cases under Chapters X and XI of the Bankruptcy Code. The new rules gave corporations the option to file their bankruptcy cases at (1) the corporation's domicile or residence (later interpreted to mean its state of incorporation, (2) the corporation's principal place of business (essentially, its headquarters), (3) the corporation's principal assets in the United States, or (4) where the case of an affiliated corporation was already pending. A member of that Rules Committee informed me that at the time these rules were adopted, large public companies rarely filed bankruptcy cases and the committee was not focused on how the rule would apply to such companies. Committee members believed that if their liberal venue rules were abused, the bankruptcy courts would exercise their broad power to transfer cases to the most appropriate venues. 28 U.S.C. §1412.
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In the context of a large, public company that operates through subsidiaries in all parts of the United States, the effect of these liberal venue rules has been to allow the company to file in the bankruptcy court of its choice. The Enron case serves as an illustration. Enron Corporation was incorporated in Oregon. Enron's headquarters, and the bulk of its 25,000 employees were in Houston, Texas. Enron chose to file its bankruptcy in the New York Bankruptcy Court. (References to the ''New York Bankruptcy Court'' are to the Manhattan Division of the United States Bankruptcy Court for the Southern District of New York.) To accomplish that, Enron directed its New York subsidiary, a corporation with 157 employees, to file a bankruptcy petition with the New York Bankruptcy Court. A few minutes later, Enron Corporation filed in New York on the basis that the New York court was a court ''in which there [was] pending a case . . . concerning [Enron's] affiliate.'' Numerous creditors joined in a motion to transfer Enron's cases to Houston. The New York Bankruptcy Judge denied the motion.
Through the 1980s, the rate of forum shopping (defined as filing away from the company's headquarters) in large public company bankruptcies rose from about 20% to 40%. Most of the shopping was to New York. During that decade, the Delaware Bankruptcy Court had the case of only one large, public company. That company, Phoenix Steel, had both its headquarters and its operations in Delaware. The one-judge Delaware Bankruptcy Court began attracting cases in 1990. That year it had two, including Continental Airlines. Delaware attracted four big cases in 1991 and six in 1992. In 1992, Congress awarded the Delaware Court a second bankruptcy judgeship. The Delaware Court's market share rose steadily until 1996, when 87% of the large, public companies filing for bankruptcy in the United States (13 of 15) chose the Delaware Court.
In 1996, the National Bankruptcy Review Commission adopted a recommendation designed to end the rampant bankruptcy forum shopping. That recommendation was to delete the provisions of the venue statute that authorized filing at the debtor's place of incorporation or where the case of an affiliate was pending.
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In 1997, a study requested by the Judicial Conference of the United States and conducted by the Federal Judicial Center revealed that Delaware's Chief Bankruptcy Judge routinely had ex parte contacts (for scheduling purposes) with representatives of large, public companies that intended to file in Delaware, and in the course of those contacts, identified the judge that would be assigned to the case once it was filed. Seventeen days after the release of the Federal Judicial Center's report, the Delaware District Court took the unprecedented step of revoking the reference to the Bankruptcy Court of all newly-filed Chapter 11 cases. Although the District Court asserted that its action was taken merely to assist the Bankruptcy Court with its heavy docket, the action was widely interpreted as a rebuke to the Bankruptcy Court. Large, public company bankruptcy filings in Delaware declined in 1997, but resumed their rise in 1998.
By 1998, it was apparent that Congress would not act on the recommendation of the National Bankruptcy Review Commission. Over a period of two or three years, bankruptcy lawyers in at least a dozen cities, including New York, Chicago, Houston, Dallas, Los Angeles, and Miami, approached their local bankruptcy judges to request that the judges make their courts more competitive with Delaware by liberalizing their awards of professional fees and mimicking other Delaware practices. Beginning in 1999 and 2000, nearly all of the courts responded by making changes in local rules and practices, including those regarding the award of professionals fees.
By 2000, an unprecedented rise in the number of big case bankruptcy filings nationally had overwhelmed the resources of the Delaware Bankruptcy Court. The Delaware Court had been awarded its second bankruptcy judge on the basis of six big cases in 1992. In 2000, the Delaware Court attracted 45 big cases. The effect of the overload was to make Delaware a less-attractive venue. Most of the overflow went to New York. Since 2000, the Delaware Bankruptcy Court has captured 34% of all large, public company filings in the United States and the New York Bankruptcy Court has captured 20%.
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IV. ADVERSE EFFECT ON REORGANIZING COMPANIES
Evidence suggests that the court competition has resulted in the destruction of many large, public companies that otherwise could have been saved. In a study of all 98 large, public companies filing bankruptcy and emerging as public companies from 1991 through 1996, Joseph Doherty and I found that 42% of Delaware-reorganized companies filed a second bankruptcy case within five years of the confirmation of their plans, as compared with 19% of New York-reorganized companies, and only 4% of companies reorganized in Other Courts. Lynn M. LoPucki & Joseph W. Doherty, Why Are Delaware and New York Bankruptcy Reorganizations Failing?, 55 VANDERBILT LAW REVIEW 1933 (2002). Roughly twice as high a proportion of the Delaware and New York-reorganizing companies (25%) went out of business while in financial distress during that five-year period.
The high failure rates for Delaware and New York-reorganized companies cannot be explained by any salient differences in the companies choosing to reorganize in those courts. On a variety of measures, the Delaware and New York-reorganizing companies were not in worse financial difficulty than those reorganizing in Other Courts. The Delaware and New York-reorganizing companies were somewhat larger than the Other Court-reorganizing companies, but the larger companies in our study did not fail more frequently than the smaller ones. We found no significant differences by industry among the two sets of cases.
We found several indicators that the reorganization process was less effective in Delaware and New York. Although the firms filing in Delaware and New York had pre-bankruptcy earnings no lower than those of the firms filing in Other Courts, the firms filing in Delaware and New York had sharply lower earnings than the firms filing in Other Courts during the five years after they emerged from bankruptcy. Average post-bankruptcy earnings for firms emerging from Delaware reorganization were a negative nine percent. The corresponding average for firms emerging from New York reorganization was a negative three percent. For firms emerging from Other Court reorganization, the corresponding average was a positive one percent. Delaware and New York reorganizations were significantly quicker than reorganizations in Other Courts, and quicker reorganizations were generally more likely to fail. Even though the Delaware and New York-reorganizing companies were larger than the Other Court-reorganizing companies, the plans in Delaware and New York reorganizations divided the creditors into fewer classes, suggesting possible superficiality in the reorganization process.
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V. ADVERSE EFFECT ON COURT PROCESSES
In addition to its obvious adverse effect on the integrity of the bankruptcy courts, the competition for big cases is also having an adverse effect on court processes. The choice of a bankruptcy court is made by the top executives of a debtor corporation. Those executives usually have little experience with bankruptcy courts and so are heavily dependent on information and advice furnished by the bankruptcy attorneys retained to represent the corporation. In some cases, financial institutions that will make post-petition loans to the debtor corporation may also play a role in selecting the bankruptcy court. Generally speaking, however, pre-petition creditors are excluded from the court selection process.
It follows that courts wishing to attract cases must appeal to the debtor's executives, attorneys, and post-petition lenders. (I refer to them collectively as the ''case placers.'') To make this appeal, the judges are under pressure to favor case placers on a number of key issues in the court's cases generally. The court must establish a reputation for generosity with professional fees and tolerance for the professionals' conflicts of interest. The court must approve the compensation proposed for the top executives, even when that compensation includes huge ''retention'' loans and bonuses for the same executives that caused the company's failure. The court cannot appoint a trustee to replace corrupt management, even in such extreme cases as Enron, Worldcom, Global Crossing, and Adelphia. The court must be willing to approve provisions in the reorganization plan that release the case placers from liability for the case placers' own wrongdoing. A judicial panel that did not yield to these pressures would not be attractive to case placers and would not get future filings.
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Over the past fifteen years, the pressures of competition have resulted in major changes in the operation of the bankruptcy system. These changes were not preceded by Congressional action, appellate decisions, or even policy discussions. They evolved because the case placers wanted the changes and the bankruptcy courts stretched or broke the law to accommodate them. These are three examples of such systematic changes:
1. Thirty-day prepackaged cases. Prepackaged cases are specifically authorized in the Bankruptcy Code. A debtor ''prepackages'' its case by distributing a plan and disclosure statement to creditors prior to filing the bankruptcy case, and obtaining a sufficient number of votes in favor of the plan to meet the requirements of the Bankruptcy Code. Only then does the debtor file a bankruptcy case and submit the plan, disclosure statement, and ballots to the court for approval. The court can confirm a prepackaged plan only if the court first determines that the disclosure statement provided information adequate for informed voting, the plan complies with the provisions of the Bankruptcy Code, and the vote is sufficient for approval. To assist the court in that process, the Code requires that the U.S. Trustee appoint a Creditors' Committee and convene a meeting of creditors after the filing of the case.
Under the pressures of competition, some bankruptcy courts have dispensed with these two requirements—even though they have no legal authority to do so—and rubber-stamp whatever prepackaged cases are submitted to them. The creditors in these cases receive no official representation, even though there may be an unofficial committee purporting to represent their interests. By so doing, those courts make it possible for a debtor to obtain confirmation of its prepackaged plan in slightly over thirty days from the date of filing. Some of these courts have adopted local rules or guidelines directing that confirmation hearings be set thirty days after filing (Los Angeles). One court has adopted a local rule authorizing the cancelling of the meeting of creditors required by Congress in the event it cannot be completed by the confirmation hearing (New York).
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Before confirming a plan of reorganization, the court is required to determine that ''confirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor. . . .'' 11 U.S.C. §1129(a)(11). In our study, Doherty and I found that confirmation of a prepackaged plan by the Delaware Bankruptcy Court was followed by a distress liquidation or further financial reorganization in nine of 14 cases (54%).
2. ''Critical vendor'' orders. The Bankruptcy Code prohibits the preferential payment of some creditors over others when both have the same legal rights. The opinions of the appellate courts are pretty much uniformly in accord. But in the mid-1990s, under the pressures of competition, some bankruptcy courts began approving preferential payments to so-called ''critical vendors''—suppliers whose cooperation was needed for reorganization and who would not provide it unless the debtor paid its pre-petition debt to the supplier in full. In their early years, critical vendor orders were rare and covered only small numbers of creditors. But by 2002, critical vendor orders were being approved in most large public company cases. In some, the orders authorized preferential distributions of hundreds of millions of dollars to hundreds or even thousands of creditors. In the Kmart case, for example, the Chicago Bankruptcy Court permitted the distribution of $200 million to $300 million in preferential payments to 2,300 supposedly ''critical vendors'' selected by the debtor. The Bankruptcy Court's order was reversed on appeal, but the damage was in large part irreversible because the money had already been distributed.
3. Section 363 sales. The Bankruptcy Code specifically authorizes the use of Chapter 11 to sell a company. The Courts of Appeals held that debtors may do so pursuant to a plan of reorganization after adequate disclosure to creditors and a vote, or, if the debtor has ''sound business reasons'' for doing so, under section 363 of the Bankruptcy Code without a plan, adequate disclosure, or a vote. Until the courts began competing for cases in the 1990s, section 363 sales of entire companies were rare.
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In the 1990s, such sales became common. The competing courts so frequently and easily waived the requirement of ''sound business reasons'' that debtors began arranging sales and announcing those sales prior to even filing the debtors' bankruptcy cases. Since 1997, the Delaware Bankruptcy Court has given final approval to sales of seven large public companies, each in less than 50 days of the filing of the company's case. Once the bankruptcy court has finally approved a 363 sale, the sale is final. Section 363(m) of the Bankruptcy Code prohibits the reversal of that approval on appeal.
Section 363 sales of large public companies now routinely occur without adequate disclosure to creditors or the opportunity for creditors to vote on a plan. (A creditor's committee is generally appointed and consulted, but that committee often works under severe time pressure and may not be representative of creditors as a group.)
The section 363 sale procedure is fraught with potential for abuse. The case placers often have interests in the sales that conflict with those of the creditors, employees, suppliers, and taxing authorities of the debtor. The top managers may be purchasers or they may expect to be employed by the buyer. Some of the managers receive large stock bonuses from the buyer after the sale is complete. Investment bankers retained as financial advisors often recommend sales that will result in large fees to themselves; they may steer the debtor to a court that will approve the sale without question. Discovery of such abuses is difficult because the sales occur quickly, in near secrecy, and there is no legal avenue for review.
VI. SOLUTIONS
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In addition to the serious adverse effects described in the preceding section, the competition for big bankruptcy cases has also had some positive effects on the bankruptcy courts. The Delaware court pioneered the development of the omnibus hearing that reduced travel expenses and inconvenience for out-of-town lawyers. That court also set a new standard for judicial availability, achieved an unprecedented level of judicial experience and expertise in the handling of large cases, and has perhaps the best-functioning PACER website in the country. Unfortunately, these benefits are far outweighed by the accompanying problems.
The essence of the court competition problem is that only a few of the many parties interested in the outcome of the case select the court. To attract cases, the courts must cater to the interests of those few, at the expense of the debtor, the creditors, and other interested parties. Allowing those other parties to participate in case selection is not practical because so much activity occurs in the first few days of the bankruptcy case. To achieve a reasonable level of efficiency in the handling of a big bankruptcy case, the issue of venue must be settled no later than on the day the case is filed.
The simplest solution would be to amend the bankruptcy venue statute to require that debtors file in their local bankruptcy courts, that is, the courts where they have their headquarters or their principal assets. Such an amendment would not eliminate all forum shopping because firms could move their headquarters or assets in the period before filing. Complete elimination of forum shopping is not, however, necessary to solve the problem. Forum shopping need only be reduced to a level at which the loss of cases by a court no longer constitutes a serious threat to the judges of that court. The integrity of the judges can take care of the rest.
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An alternative solution would be to assign three or four regional courts to handle large bankruptcy cases. The law would require that all large debtors file their petitions with a single judge, along with a simple statement of facts relevant to venue. Based on that statement, the judge would assign the case to the most appropriate of the regional courts on the same day the case was filed. The advantage of this solution is that it would permit the development of large-case expertise among the judges, without forcing them to compete for the cases.
Each of the subjects discussed in this Statement is also discussed in greater detail in the manuscript of my book, Courting Failure: How Competition for Big Cases is Corrupting the Bankruptcy Courts. The book will be published by the University of Michigan Press in January, 2005.
Mr. CANNON. Mr. Brickman, would you please give us your testimony now?
TESTIMONY OF LESTER BRICKMAN, LESTER BRICKMAN, PROFESSOR, BENJAMIN N. CARDOZO SCHOOL OF LAW, YESHIVA UNIVERSITY, NEW YORK, NY
Mr. BRICKMAN. Mr. Chairman, I have focused my written statement on the process of administering the major bankruptcies of former producers and installers of asbestos-containing products.
Some brief history and background. Asbestos litigation today remains a high-growth enterprise. In the year 2003, more than 110,000 new claimants surfaced. That's the most ever in a single year. Though defendants and their insurers have so far paid out over $70 billion, they may have to pay out an additional $130 to $140 billion before the litigation is concluded.
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The litigation has become, in my judgment, a weapon of mass business destruction which cuts ever deeper into the American industrial process and product distribution system, thus far accounting for 70 bankruptcies, plus some insurance company bankruptcies, plus additional insurance company bankruptcies that will be happening over the next several years.
In my written statement I present a brief overview of asbestos litigation drawn largely from my article on the subject published earlier this year. In it I conclude that asbestos litigation today mostly consists of a massive client recruitment effort generating claims of injury by those with no medically cognizable asbestos-related injury, supported by specious medical evidence and by litigants' testimony, which frequently follows scripts prepared by their lawyers which are replete with critical misstatements. It is thus beyond cavil that asbestos litigation represents a massive civil justice system failure and has become what I term a malignant enterprise.
An increasing amount of asbestos claiming is now being channeled through the bankruptcy process where the leading plaintiff law firms, a baker's dozen or so, exercise substantial if not near total control. Latent with boundless conflicts of interest which are largely ignored by the bankruptcy courts, this handful of law firms not only constitutes the asbestos creditor's committees, they create the bankruptcy plans, establish the criteria for the payment of the very claims that they are asserting, effectively select the trustees to operate the section 524(g) bankruptcy trusts, and constitute the trust advisory committees which have authority over trustees' actions and veto power over changes in the trust structures.
The trust distribution procedures that they create allow these lawyers to treat substantial proportions of the trust's assets as piggy banks, essentially accessible at will, irrespective of whether their claimants are actually injured or had actual exposure to a defendant's product.
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In fact, for some trusts now being approved, all that is required to demonstrate the requisite exposure is for the claimant to sign a form saying ''I was exposed.''
Though bankruptcy trust assets already approximate $6 billion, that amount pales when compared to an additional approximately $40 billion to be added to trust assets as up to a score of companies now in the bankruptcy process create such trusts.
One effect of Congress's adoption of section 524(g) is that from the moment an asbestos bankruptcy commences, it is an overriding reality that the company will not be able to emerge from bankruptcy unless the plaintiff lawyers, representing the substantial portion of asbestos claimants, approve of the restructuring plan. The same small cadre of plaintiff lawyers who appear in most asbestos bankruptcies have thus been vested with near complete and substantially unchecked power to dictate the terms of the plan. Every bankruptcy judge understands this, and with rare exception, accepts, adopts, and otherwise ratifies whatever is needed to satisfy plaintiff lawyer demands. This unbridled power is compounded by the perverse provision in 524(g) that the 75 percent requirement be met by the number of claimants on a one-claimant/one-vote basis, not by the value of their claims.
While plaintiff lawyers hardly need any additional stimulus to sponsor additional screenings to generate additional claimants who have no asbestos-related illness, this provision does just that. Its perverseness, I suggest, is palpable.
The central conclusion I advance in my written statement is that the asbestos bankruptcy practices that I have described, coupled with some of the implementations of bankruptcy law in the bankruptcy courts that would cede this near unbridled power to plaintiff lawyers, constitutes an unprecedented assault on the integrity of the bankruptcy process.
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Besides invoking its oversight role to restore both the balance and the integrity of the bankruptcy process by creating an investigatory mechanism, I recommend that section 524(g) of the Bankruptcy Code be amended to modify those perverse provisions that promote bogus claims and repose near unbridled power in the hands of plaintiff lawyers.
Finally, Mr. Chairman, I would like to request approval to supplement my written statement with the article on asbestos litigation that I earlier referenced.
Mr. CANNON. Without objection, so ordered. Thank you Mr. Brickman. I really appreciate your testimony, the testimony of all the panelists.
And I must say Mr. Brickman you were pretty direct, very thoughtful in your statements. I don't think they were overdrawn, but very direct about what the cost to society could eventually be because of this.
[The prepared statement of Mr. Brickman follows:]
PREPARED STATEMENT OF LESTER BRICKMAN
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Mr. CANNON. I would like Ms. DeAngelis and Mr. LoPucki, if you wouldn't mind responding to some of the things that Professor Brickman said. Is this a crisis or has he overstated? Do we have tools in place, Ms. DeAngelis, to control that, or is Mr. Brickman correct when he says 524(g) gives unbridled power to claimants' attorneys. You in particular, Ms. DeAngelis, you're speaking for the trustees, have you some control over this? Are your controls sufficient?
Mr. LoPucki, if would you give us your comments, your perspective, I would appreciate that as well.
Ms. DEANGELIS. Mr. Chairman, the provisions of 524(g) and their workings are reviewed by the United States Trustee as a plan provision, and we review it to assure that the provisions that are set out in the plan comply with the requirements of the Code.
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As to how those provisions work after the plan has been confirmed, I cannot speak to that.
Mr. CANNON. Actually I'm asking another question here. I think what Mr. Brickman is saying is that the terms of 524(g) create a context for abuse. And what I am asking you, are you dealing with that abuse? I mean we're destroying—we destroyed 70 companies, according to Mr. LoPucki. Did you say that we have 70 companies in bankruptcy, plus some other bankruptcies of insurance companies, plus bankruptcies—and there are many of those; some of our leading companies of America are under terrific stress. When you think that Pfizer, a drug company, would have this problem, but in their history they owned a manufacturing facility that used asbestos.
What I need to understand from you—and I think that the whole panel will be interested—is do you think that either Mr. Brickman is overstating this, or that your tools are adequate to meet the concerns that he has raised?
Ms. DEANGELIS. I think many of the concerns that Mr. Brickman raised are problems that exist within mass tort litigation that are brought into bankruptcy and are not inherent or result from the 524(g) injunction. They're problems that exist within the tort system itself.
The statements that he makes with regard to the control by plaintiff's counsel, with respect to issues of conflict that they may have, with regard to the securing a number of plaintiffs to be represented by them, those are all issues that exist.
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Mr. CANNON. What Mr. Brickman is saying, there is an advantage in bankruptcy court to have more complainants who comprise 75 percent of the number of people that are creditors, therefore there is an inducement. Does the Justice Department have tools to deal with that tendency toward abuse?
Ms. DEANGELIS. The Justice Department, Mr. Chairman, has tools provided by the Code, which is to examine the issues presented to look at 524 to assure that it is met. I would note one thing; Mr. Brickman makes—there's a point that's made about approval that's needed in order for a plan to be confirmed that is not unique to section 524(g). Approval is an inherent provision that is required within plan confirmations generally. In order to obtain confirmation of a plan, generally classes within the plan must accept it. And so that's not a unique provision to 524.
Mr. CANNON. Right. But I am trying to go someplace else. Mr. Brickman is saying, with great clarity, that there is abuse in this system. I am asking you if you have the tools to deal with that abuse, or do we need more tools or does that abuse not exist? I need to join that issue with what is happening in our bankruptcy courts. I know what the effect is on businesses that are being targeted. Is the court in the confines—we have torts. These things are going through the tort system. But increasingly we're moving into these complex bankruptcies based upon the future claims in asbestos. Is that court stuff? Are the rules that we're playing under sufficient to avoid the kind of abuse that Mr. Brickman has so eloquently expressed?
Ms. DEANGELIS. The provisions of the Code as we deal with them in day-to-day cases are adequate to meet the needs, I think, of the cases that come before the courts. The issues that are raised, the concerns that are raised by Mr. Brickman, I think are issues that all of us can continue to think about, and if there are views that the Justice Department has that could better inform Congress at such time we'd be happy to he present them. I'm not prepared today to present any.
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Mr. CANNON. Thank you. We'll come back to this because my time has expired. But let me point out as we think about it—we're the deliberative body here—as we are thinking about it, companies are going bankrupt that are otherwise contributing dramatically to the success and benefit of our economy and country. So I want to come back to this.
Mr. LoPucki I'd ask you to follow up when I have time again. But now I yield 5 minutes to the gentleman from Virginia.
Mr. WATT. Thank you, Mr. Chairman. This is very disturbing testimony that we have heard from the last two witnesses at least. Reassuring testimony from the first witness. So I am trying to get to the bottom of a couple of things because I just want to be clear. The refilings—could I get maybe the one chart that was put up about refilings? I have it attached to my testimony, so I have the information or plan failures, plan failure within 5 years of confirmation. Let's look at that chart.
What I'd like to do is try to reconcile or merge the last two witnesses' testimony, Professor LoPucki and Professor Brickman, so that I am clear on whether the issues that we are dealing with, and perhaps even the purpose of this hearing, is an assault on asbestos litigation or whether we are talking about bankruptcies in general.
So the question I am asking, Mr. LoPucki, Professor LoPucki, is of the plan failures that are identified either from Delaware, New York, or all other courts, the 54 percent, the 31 percent in New York, the 14 percent from all other courts, how many of those were asbestos cases?
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Mr. LOPUCKI. I am not certain, but I believe none of them were.
Mr. WATT. So the issue that you have put your finger on as a witness here today is really an unrelated issue to the issue that Professor Brickman has put his finger on; is that right?
Mr. LOPUCKI. I think there are two separate problems here.
Mr. WATT. All right. And your concern is about forum shopping and Mr. Brickman—Professor Brickman's concern is about the abuse of the bankruptcy court by asbestos litigants. Is that—would I be fair in characterizing it that way?
Mr. LOPUCKI. I would put it a little differently. I was not disturbed by the first 15 years of forum shopping. It was when the courts began to react to the forum shopping by changing what they were doing in order to attract cases. That's what I see as the problem here.
Mr. WATT. What benefit would there be to a court to attract a bankruptcy case?
Mr. LOPUCKI. This is $1 billion a year business.
Mr. WATT. Well, but the courts, the judges, are not in a profit-making posture, I hope. I would like to think that a bankruptcy litigant filing a case in Delaware, New York, or North Carolina would get the same result theoretically. I like to look at our justice system as being a justice system that delivers justice regardless of where the case is filed. So what would be the benefit to a judge or—I mean, I can understand the potential convenience of lawyers, convenience of litigants, might be factors; the lawyers and the experts are getting a lot of money out of this, but certainly no court ought to be doing stuff to attract cases. Or are they?
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Mr. LOPUCKI. I agree that they should not be doing things to attract cases.
Mr. WATT. Why are they, if they are?
Mr. LOPUCKI. These are not article III judges. These are judges that serve 14-year terms. At the end of the 14 years they have to seek reappointment to the bench. The lawyers will be surveyed at that point about their competence. There are cities around the country where there are lots of corporate headquarters. The companies are filing bankruptcy, but they're all going out of town. Boston, for example, lost 20 of the 24 companies. Boston companies that file bankruptcy, those companies went somewhere else for their bankruptcy.
So the bankruptcy community in that city puts the pressure on to the judges, and the judges are from that community. These are their friends. These are the people who got them the judgeship in the first place. So they're sensitive to the needs of the people in their city.
Mr. WATT. Do you think that under that scenario, people, lawyers, would want to be filing in their home city, not someplace else? Am I missing something here? If I were trying to influence and get a hometown verdict, why would I, if I lived in Boston or North Carolina, move the case to Delaware?
Mr. LOPUCKI. If they go to Delaware or New York, they'll retain Delaware or New York counsel most likely. The local lawyers, the lawyer, say, from Boston will have little or no role in the case. There may not even be——
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Mr. WATT. But that seems counterproductive. I thought it was human nature of most lawyers that I know to want to retain authority and control and influence in a case, not to defer it to somebody in another State.
Mr. LOPUCKI. The Boston lawyer would like to retain the case but the Boston lawyer can't, because they go to a New York lawyer or they go to a Delaware lawyer who will file the case in Delaware or New York.
Mr. CANNON. Would the gentleman yield? If you have got a large—if you're outside counsel to a large corporation and you have a deal with the corporation to try to get it to the next phase of its existence, and that means bringing in Delaware counsel, for instance, isn't this actually a way to enhance fees? Is that where we're headed; that you got lawyers working the system to increase their revenues over the long term or what—in other words, I agree with Mr. Watt that nobody is going to try and give up business, but if it's a deal where your fees continue to get paid because you're in a bankruptcy court that is sensitive to the interest of bankruptcy counsel, and as counsel you're probably going to be better off going to Delaware, is that where we're headed?
Mr. LOPUCKI. Think of it as two different bankruptcy bars. Say the lawyers in Boston and the lawyers in New York, they're both trying to get a particular case. So the executives in that company are going to seek advice. If they happen to seek, as a lot of them do, seek advice from New York counsel, they will probably end up in a New York bankruptcy. The Boston attorney won't have anything to say about that. Their own in-house counsel will want what the executives want, and what the executives want is very often at odds with what the company needs. That is to say, the company often gets sacrificed in this to the interest of specific individuals involved.
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Mr. WATT. But if—aren't you just saying that the client in this case is the company who's looking for—looking to file bankruptcy? And isn't that always the case, that they're going to try to find counsel that will—I mean, the counsel is always going to be answerable; that happens in every case where you got a filing. They're going to start off being answerable to whoever retains them; isn't that right?
Mr. LOPUCKI. Yes.
Mr. WATT. And that changes in some way——
Mr. LOPUCKI. Well——
Mr. WATT.—in this process?
Mr. LOPUCKI. What's different here is that these companies have their choice of any court in the country. In most litigation you're very limited in the choices that you have. You select an attorney, there is some forum shopping going on in any kind—probably in almost any kind of litigation. But the forum shopping is more common in the bankruptcy litigation, and it's more dangerous because so many cases are moving that the courts are actually responding.
So that the executives will be told if you take this case to New York, you will not get a trustee appointed. If you file in your local bankruptcy court, you, the executive, may be out of office the day after you file. But if you go to one of these courts that is trying to get cases, they won't appoint a trustee in your case, because if they did, they wouldn't get the next case.
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Mr. CANNON. The gentleman's time has expired. I would like to follow up on this point. What I think you're saying compared with some of the things you said earlier, is all about executives and control of the company and not about the benefit of the company.
Mr. LOPUCKI. I call these people the case placers. The attorneys are a major part of this, the bankruptcy lawyers, because the executives have to rely on them. The executives themselves, though, typically a CEO and maybe some other people in the company, usually control where the case goes and then post-petition lenders may be involved. But the creditors don't get any involvement. They don't get any choice. They're dragged along to the court that will be best for those people placing the case.
Mr. CANNON. So going back to what you said earlier about law firms competing for the bankruptcy business, what they're saying to the leadership of the company, hey babe, come here, we got the best deal for you.
Mr. LOPUCKI. Our court can do more for you.
Mr. CANNON. So if Boston is losing out, that's because—I take it where you're going is because the lawyers in Delaware are saying we got a better deal for you down here.
Mr. LOPUCKI. That's exactly right.
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Mr. CANNON. That better deal is not for your creditors but for you the leadership of the company.
Mr. LOPUCKI. Yes. Precisely.
Mr. CANNON. Ms. DeAngelis, is this a problem that we need to deal with from your perspective? Because you got people flooding into your area because they get a better deal.
Ms. DEANGELIS. The issues that we look at with regard to retention of professionals is not why a company has chosen a particular law firm to represent it, but, rather, to look at the issue of whether the professional that is going to be—you know, that has been chosen by the company, whether it meets the test established.
Mr. CANNON. I understand you're looking at that rather—let me say this, but you have a case of a professional in the asbestos arena in particular—we have been looking generally—but in asbestos you have a guy who is sort of an old boy, at least as reported in the Wall Street Journal, who is making $100,000 a month compared to some relatively minor salary he was making as a professor of law. Isn't that the kind of thing that you need to look at in the big picture, to say my goodness, we have abuses going on here, we have enough money going to this professional—not in this case, but in aggregate—that we're getting distortion of the bankruptcy system.
Ms. DEANGELIS. I think we need to remember, though, that there is a distinction between those counsel over whom the bankruptcy court has jurisdiction to look at retention and fees and those that the court does not. The court does not look at the employment agreement, the terms of it, the scope of it, for individual attorneys who represent creditors. It only looks at the retention of sort of eligibility and compensation with respect to those professionals that are going to render service to the debtor, to the committees, to certain other constituencies, and will be paid from the estate.
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Mr. CANNON. Maybe from multiple estates. But if you've got somebody who is working on these complex issues, making an extraordinary amount of money, as a professor may be making $100,000 or $200,00 a year, 10 or 12 times that on a monthly basis over a year, if a person is that distorted in his payment, is it possible, is there some way—are you looking at, are people in your situation looking at the effect of that kind of payment on the judgment of the person who's there when the old—the Wall Street Journal talked about was the old-boy system. So you got people winking and nodding, having ex parte communications with the judges, and bankruptcy is moving on all to the benefit of some people like the executives and to the detriment of the creditors. Is this not—are you familiar with that article in the Wall Street Journal?
Ms. DEANGELIS. I am. And what I would indicate is the attorneys that were the subject of that article, the old boys in a sense, they're counsel who represent individual claimants. They are not counsel.
Mr. CANNON. You had a consultant who is subject to your review, as I understand it, who is consulting the courts, he was a special counsel to the courts; and that should be under your jurisdiction, is it not?
Ms. DEANGELIS. If it is, if it is a professional who has been retained in the case—some of the asbestos cases were a little different. The issue with respect to the particular consultant was not that he was retained in the case, but that he was retained by the court as the court's adviser.
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Mr. CANNON. Would you have any role in overseeing those kind of people who are retained by the court?
Ms. DEANGELIS. That's a very unique situation and they are not professionals who are being retained either under 327 or 1103 of the Code.
Mr. CANNON. So it is just the judge who is the person in a position to see that an adviser to his court gets paid.
Ms. DEANGELIS. And, again, I would suggest that is a very, very unusual, unique situation.
Mr. CANNON. I think Mr. Watt was making the point that this is not just about asbestos, but asbestos is the growing new complex bankruptcy prepackaged environment that we're going into. So that's—I'm actually quite concerned about where we're headed and about the uniqueness of bankruptcy if it means the system is not going to work.
Ms. DEANGELIS. I think the system does work with regard to those professionals over whom we have oversight. And with respect to them, we file the appropriate motions if we feel that the fees are unreasonable.
And I would bring to your attention a recent case which was a consultant whose retention was sought. And we were successful in disgorging $2 million with respect to those services.
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So with respect to professionals over whom the court has oversight, we will continue to exercise our authority in looking at the terms of the retention, looking at the fees to try to determine the reasonableness of them; you know, recognizing that some of these large cases now require additional ways of dealing with what are very substantial fees.
Mr. CANNON. You said oversight of the people, the consultants that the court hires, but you mean that are still subject to your jurisdiction so the court can hire a special master of some sort that is beyond your control; and, as I understand it, the only control on those people is the judge and his judgment.
Ms. DEANGELIS. That's the case. And, again, that was the case in—with respect to some of the asbestos litigation.
Mr. CANNON. So I understand we're agreed that there is a huge problem out there when you get forum shopping and judges that have old-boy networks and get paid huge amounts of money to people who end up exercising a significant role in this process.
And maybe, Mr. LoPucki and Mr. Brickman, if I could have you respond to that concern and where we're headed. Obviously most folks, Mr. Brickman—on asbestos, I am deeply concerned about asbestos. And, Mr. LoPucki, you're looking at asbestos. I think you said those are the next big cases. Can you give us feedback on what we need to be worried about there?
Mr. LOPUCKI. With respect to the asbestos cases, we're very specialized in academia. I am studying cases that are $220 million and over. I have all of those cases in any database. That includes about 8 or 10 asbestos cases. The asbestos companies generally are in good financial condition other than the fact that they have the asbestos liability hanging over them. That's the reason that they don't show up in the 5 years after emergence in those refilings. Within 5 years after emergence, you see none of these asbestos companies.
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And there was another study done by another academic that came to this same conclusion, I think more generally, that the asbestos companies are typically companies that are strong except for their asbestos problem.
Mr. BRICKMAN. Mr. Chairman, in my written statement I detailed numerous instances of abuses and conflicts of interest over which the U.S. Trustee does have jurisdiction. And with very rare exception, the U.S. Trustee does not exercise that jurisdiction to deal with conflicts of interest that are absolutely pervasive.
For example, there are in effect interlocking directorates running all of the asbestos bankruptcies. These are the Asbestos Claimants Committee. The U.S. Trustee appoints claimants to the claimants committee who immediately resign in favor of their lawyers. These lawyers serve on multiple ACCs, Asbestos Claimants Committees, so that they're controlling multiple asbestos bankruptcies; they are rife with conflicts of interest, because a number of these debtors have potential claims against other debtors, claims for contribution. These are some complex issues.
Nonetheless, what I can say, with great certainty, is that the office of U.S. Trustee here has not done the job that has been accorded to it by the statutes, by the Congress.
And you need look no further than what goes on with the office—with the asbestos claimants committee, which is that basically, once the U.S. Trustee appoints the claimants, it steps away and does not see, does not want to see, perhaps what results thereafter, which is that the plaintiff lawyers then step in. They have the proxies. You have plaintiffs lawyers that have conflicting interests. Some represent mesothelioma cases, some represent unimpaired cases. These conflicts of interest are endemic. They pervade the entire asbestos bankruptcy process.
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Mr. CANNON. Mr. Brickman, you have written a lot of material. If you'd make that available to us, we'd like to make that part of the record.
Mr. BRICKMAN. I will.
Mr. CANNON. Thank you. We both have gone over a little bit and if I can ask one more question. That was a pretty direct statement. Would you like to respond to that?
Ms. DEANGELIS. I would. The formation of creditors' committees in asbestos cases follows the same procedure that we utilize in all cases, which is for us to form a representative committee of the types of claims that are—that fall within that particular class. With respect to asbestos claimants, we will form a committee that's made up of the asbestos claimant, not attorneys.
And we will put on that committee claimants who have representative interests, those who have what some refer to as minimal impairment, you know, through those who are representatives of estates for claimants who have died as a result of their asbestos injury. Once that committee is formed, it has authority to act and to enact its own bylaws. And if in its process it allows and authorizes counsel to appear on its behalf, that is an appropriate exercise of its corporate authority. We will become involved when there are allegations of mismanagement and fraud or allegations that the individual member is not meeting the fiduciary duty and we will remove members from committees in those instances.
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Mr. CANNON. And that would mean removing the lawyer.
Ms. DEANGELIS. No, it would be removing the member. If, in fact, a member has resigned, then that information we clearly would want to know because then there would be no basis upon which an attorney sits, but if the attorney is sitting pursuant to appropriate bylaws that have been enacted or appropriate resolutions of the members, then we do not get, you know, we don't sort of impose ourselves within that process.
Mr. CANNON. Mr. Brickman, you seemed intent on responding to that.
Mr. BRICKMAN. The appointment of the claimants to the asbestos creditors' committees to represent the diverse interests is immediately superseded. The reality of asbestos litigation and bankruptcy is that these are immediately superseded by the plaintiff attorneys who control the show. The U.S. trustee is saying, well, we don't—that's not our purview. We don't pay any attention to the reality of the process. We look only at the formality of the process. But the reality of the process is that there are conflicts of interest on the part of the people who run the asbestos claimants committees. And as I said earlier, interlocking directorates, which compound those conflicts of interest in incestuous ways.
Mr. CANNON. And which, outside of the bankruptcy context, have resulted in many and apparently many, many more bankruptcies of companies caught in the problem. Mr. LoPucki has talked about where you have complex issues of whose interest is at stake, whose going to represent that interest, and where that counsel will come from. My time—we actually have gone way over time on both sides. I'll yield back and recognize the Ranking Member for 5 minutes.
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Mr. WATT. Thank you, Mr. Chairman. I obviously didn't walk into this hearing with any preconceived notions about where it would come out, but it seems to me that we probably ought to make sure that we don't leave some wrong impressions, which was why I wanted to be sure that the problem that Professor LoPucki identified and the problem that Mr. Brickman identified really are two separate problems. Both of you all agree.
Mr. BRICKMAN. Yes.
Mr. WATT. Okay. Mr. LoPucki, Professor LoPucki, apparently is concerned that creditors don't have enough input into the process once the bankruptcy is filed. Professor Brickman seems to be saying that the creditors in asbestos cases, if they were to exercise the authority that they had appropriately, might have too much authority in the process. It's the asbestos claimants that are the creditors in those cases. So I want to make sure that nobody goes out of here thinking that these two things come together to form one great big problem. That's what I want to be clear on, because asbestos cases have enough issues independent of getting them tied up into all the problems with bankruptcy for us to then give—pile on to them in another way to say that they are creating the bankruptcy problems that professor LoPucki has identified. They are not doing that, and I want to be clear on that. If we can be clear on it, I am going to give Professor Brickman a chance to clarify it for us if—not to express concerns about asbestos litigation in general, but to make sure that these are two separate problems. Professor Brickman, you're familiar with a study done by Professor George Benston.
Mr. BRICKMAN. No, I'm not.
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Mr. WATT. Okay. All right. In that study, which I ask unanimous consent that we be allowed to submit for the record.
Mr. CANNON. Without objection so ordered.
Mr. WATT. And I'm not defending the results of this study. I want to be clear on that because I don't have any idea whether his study is better than yours or is different than yours or even covers the same territory. But as relates to the problem that has been identified by Professor LoPucki, he makes it absolutely clear, if his study is correct, that those problems are not asbestos bankruptcy problems, they are—because it is a different—there are five or six points that he concludes in his executive summary.
First, each of the seven companies studies, and he lists them here, they will be part of the record. Remain profitable after the bankruptcy was over. Number two, changes in the Chapter 11 companies total assets showed that they continued to be viable ongoing enterprises after the bankruptcy. Number three, that total employment at these companies increased or did not materially decline after the bankruptcy.
Number four, that all the companies met their obligations to fund employee pensions after the bankruptcy. And Number five, or six or whatever the appropriate next number is, these companies should do well in the future. And he's identified these companies. So these are not repeat failure companies like the ones that have been identified by Professor LoPucki. Is that right? Are we together on that?
Mr. LOPUCKI. I agree entirely.
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Mr. WATT. Okay. All right. Now, the question I have—are you in agreement with that Professor Brickman, before I——
Mr. BRICKMAN. Is the study you're referring to a study of asbestos bankruptcies?
Mr. WATT. Yes.
Mr. BRICKMAN. Okay. I am familiar with that study. I didn't know it by title.
Mr. WATT. And the companies are Babcock and Wilcox, Owens Corning, Armstrong World Industries, Building Materials Corporation of America, W.R. Grace and Company, U.S. Gypsum Corporation, Federal Mogul Corporation, all of them have filed bankruptcy, and his study of those seven companies reached the conclusions that—now, I'm not verifying the accuracy of the study, but I'm saying that if you look at the criteria that have been applied by Professor LoPucki, those companies don't fit that criteria as the problems—as being the problems that Professor LoPucki has identified.
Now, that's not to say that there are not other problems. But I'm wondering whether the concerns you're having have more to do with—have less to do with bankruptcy and more to do with your concerns about the way asbestos litigation is proceeding.
Mr. BRICKMAN. I understand.
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Mr. WATT. Do they or do they not?
Mr. BRICKMAN. They do not. Asbestos bankruptcy is simply a continuation of asbestos litigation in another forum. And the problems that I pointed out in my written statement are problems in the bankruptcy process. To be sure, they're an outgrowth from problems in the litigation and the tort system, but the problems I point out are problems in bankruptcy. In the article that I'm going to make part of the record, I go into asbestos litigation in the tort system.
But in my written statement I look at the bankruptcy process. In addition, with regard to the study that you cite, it is contradicted by a study done by a Nobel Prize winning economist coupled with another study that indicates that approximately 500,000 jobs were either lost or not created as a consequence of asbestos litigation.
Mr. WATT. Well, let's make sure we get that one in the record too, for the purpose of—those two studies in the record. I mean I'm not trying to bias this one way or another. I started with my opening statement saying I didn't know what the problems were in this area, and/or what the real result of this hearing would be. So I don't have a dog in the outcome of this fight. I just want to make sure that the record is full and complete so that if we start trying to argue toward some particular result at the end of this hearing, we'll have the full range of information to make an intelligent set of judgements from it.
Mr. Brickman, can you make those two studies available to us for inclusion in the record.
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And I'm happy to yield back Mr. Chairman. I know I am well over my time.
Mr. BRICKMAN. Yes, I can. I cited to them in my law review article and be happy to make them available.
Mr. CANNON. Did you want to make any additional comment on the subject?
Mr. BRICKMAN. I just will give you the two studies, one is done by the Rand Institute and the other is a study by Joseph Stiglitz and the company that he runs titled ''The Impact of Asbestos Liabilities on Workers in Bankrupt Firms.''(see footnote 2)
Mr. CANNON. Thank you.
Mr. BRICKMAN. I'll make those available.
Mr. CANNON. Let me just, that in my mind there's a clear distinction between problems in bankruptcy and problems that are unique to asbestos. My concern and part of the reason for this hearing is that the new cases we're going to be seeing in bankruptcy, the new complex cases are these pre-packaged asbestos cases.
So my concern here and where I would like to go in the next couple of minutes is to get a sense of how the playing field is going to work as we move into these increasingly complex but narrowly issued bankruptcy cases, where I think you said, Mr. LoPucki, you've got healthy companies except for the asbestos and so their failure rate—there are many differences that exist between large bankruptcies and asbestos bankruptcies. They are huge. A large company with a complex bankruptcy, where the company's failing and is not healthy is I think substantially different from where you have the healthy company that has an asbestos problem that is going to suck resources out of it, reduce jobs available in America, and that's where I'm concerned about the playing field, and in particular, the trustees and the trustees' role.
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And Mr. Brickman, maybe if I can come back to you. Or actually, Mr. LoPucki. We're talking about the difference between these kinds of healthy companies that have asbestos and others. As you look at the future and see the kinds of distortions that you have testified about, relating to the motivations for companies to go to certain jurisdictions, the motivations for certain jurisdictions to try and attract this large legislation, how does that affect asbestos companies in particular in the future.
Mr. LOPUCKI. Most of these major asbestos companies have chosen the Delaware bankruptcy court. The question I have that I cannot answer, but I think it's important here, is the question whether the plaintiffs have figured out a way to participate in court selection. Because if they have not, then it will be the interests of others who will be served, because the cases will go to the courts that serve those others. Whoever's picking the court, that's whose going to win in this system. So the issue here, to my mind, is do the plaintiffs, do they have a way that they can get some leverage on the company to pick the court, which I'm doubting it, but I'm just not—I just don't have the information necessary to know.
Mr. BRICKMAN. Can I supplement that? In pre-packaged bankruptcies the plaintiff lawyers do have that control over picking the court.
Mr. CANNON. You're right. Because when you say ''plaintiffs,'' you're talking about the plaintiffs in the litigation system, not the plaintiffs in bankruptcy. So to be clear, you're saying that when you get a pre-packaged bankruptcy, that's because the tort lawyers are talking to the stakeholders, some of the stakeholders in the corporation. They're talking to the stakeholders and they have the choice about where to go and who are those stakeholders? The executives——
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Mr. WATT. If the gentleman will yield, that seems to me to be a big jump. It might be true, but it seems to me to be a big jump.
Mr. CANNON. Well, I think the reason we are taking that jump is because Mr. LoPucki said much earlier that the number of CEOs who are retained has skyrocketed. Is that not correct?
Mr. LOPUCKI. They are more likely to be retained in office now. Much more like the than they were in the 1980's.
Mr. CANNON. And I suspect that has a lot to do with where they choose to go to bankruptcy and how they negotiate with the plaintiffs bar to get them to a court where they are going to be——
Mr. WATT. Well, if the gentleman would yield, as I understand it, in asbestos litigation, that's not even an issue because you're not trying to chase the CEO out. So that's not a criteria. You're trying to retain the CEO because—and the objective, remember, of Chapter 11 in general is to come out the other side of the bankruptcy with a vibrant company that continues to hire people, that we don't lose a business. That was the whole—that's the whole purpose.
Mr. CANNON. Reclaiming my time. I can't believe that we are at odds on this particular issue because the guys who get screwed when the CEO stays in office and gets bonuses, are the people who work on an hourly rate.
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Mr. WATT. No.
Mr. CANNON. Or lose their jobs. Because a piece of the business disappears.
Mr. WATT. What I'm doing is differentiating this issue so that it doesn't make it sound like this is all about asbestos cases. That is not the objective in these asbestos cases because what you're trying to do in the asbestos cases is to—and Professor Brickman indicated, yes, they are trying to make the company stronger.
Mr. CANNON. Reclaiming my time. We agree, and I think we understand each other and the distinction between asbestos and nonasbesots is well taken because these are healthy companies as they come out. But my point and what I'd like to get some feedback from everyone on the panel is this question. Are we—are the interests of certain players like the executive team, and the plaintiffs coming into alignment at the cost of society, at the cost of the hourly worker, at the cost of the security of his job or even the possibility of a job?
Are we getting—as we move in from this complex litigation that has changed because of this complex bankruptcy litigation which has changed because we have had courts trying to attract business and trustees apparently trying to attract business, and a system trying to attract business, in the process, are we getting a distortion which means that CEOs and their executive team and their in-house lawyers, and the lawyers that are trying to attract business to their areas are working with, in particular, in the asbestos cases the plaintiff's bar to come through a system which minimizes the pain for the executives and optimizes their benefit? And that's, I think, the question and indicates the overlap between these two issues. Mr. LoPucki.
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Mr. LOPUCKI. If you have a pre-packaged asbestos case, I take that to mean that the plaintiffs attorneys have made an agreement with the company as to how they are going to settle the matter. They have not filed the bankruptcy yet, but they have made their deal. In that situation, historically what's happened is that the companies will go to a court like the Delaware court that will not inquire into the deal, but will simply approve the deal. They will rubber stamp the deal so you lose all of the bankruptcy protections for various parties in that case. Everything—the court will treat it as a 30-day pre-pack. They'll file the case. Thirty days later they'll have a hearing and it's all over with. Nobody to represent anyone in the case.
Mr. CANNON. And these courts can handle a lot of pre-packaged cases and the local bar gets the huge benefit of having a much better, much more attractive environment for the people making decisions in the corporations. Am I getting the point here?
Mr. LOPUCKI. Yes, you are.
Mr. CANNON. Mr. Brickman do you want to add to that? Because what I am seeing here, and this stinks. This really, really stinks.
Mr. BRICKMAN. What Professor LoPucki said hit the nail right on the head. That is exactly what happens. There's been only—in only one instance has a bankruptcy judge refused to approve the pre-packaged plan, and though it was a Delaware bankruptcy, he's a California bankruptcy judge who was, I guess, visiting in Delaware. But in all other cases, the bankruptcy judges just hold their noses and approve the plan. That's the plan with the $20 million bonus payment to Joe Rice. This is the plan—well, we haven't seen the approval yet, but in the Owens Corning bankruptcy, the first plan that the debtor brought forward aroused the wrath of the plaintiff lawyers. They came back with a second plan, which was far more accommodative to their interests at the expense of the commercial creditors.
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But in that second plan there was $70 million set aside for the corporate executives, which I did not see in the first plan, though I can't say with certainty that it didn't exist. It simply wasn't in the first plan. So that there is a coincidence of interest generated between the plaintiff lawyers and the CEOs and corporate officers; and the people that lose are the shareholders, the people that lose are the people with serious injuries because the plaintiff lawyers largely represent the persons without any injury, the claimants without any injury cognizable by medical science.
The mesotheliomas, the cancers, those claimants get short shrift in this process. The futures representative is selected by the company and the plaintiff lawyers, and they control the actions of that person. They pay his salary. It's laughable to suppose that that person is going to protect the interests of future claimants in that pre-packaged bankruptcy plan because he is under the direct control of the plaintiff lawyers and the company who are negotiating in their mutual interest.
Moreover, as these bankruptcies develop, especially the pre-packaged bankruptcies, they generate more power for the plaintiff lawyers in the pre-bankruptcy stage. That is to say, the ability of the plaintiff lawyers to control the bankruptcy process gives them leverage in what I'll call the pre-bankruptcy process to go to a CEO and demand that he agree to settle cases in the tort system because he understands the power that they exercise within the bankruptcy process. That accrues under the bankruptcy process because the plaintiff lawyers will end up controlling a majority of the stock of the reorganized company.
So the CEO knows that if they want to be a participant in that new company, he has to follow the wishes of plaintiff lawyers because they will be his bosses. It is rife with conflicts of interest throughout the entire process and I do hope this Committee does take additional steps of an oversight nature to spread this on the record.
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Mr. CANNON. I take it, Ms. DeAngelis, that as long as these things are all done by the rules, you don't—your division doesn't have much to do with the fraud or other problems that might occur here that seriously and substantially distort our system.
Ms. DEANGELIS. They are provisions within the Bankruptcy Code that set out the requirements for confirmation of a pre-packaged bankruptcy case. That's our job to review the plans that have been filed, to monitor the process, and to comment when the procedures or the provisions are not appropriate, to bring those matters to the attention of the court.
Mr. CANNON. If you've got, I think Mr. Brickman talked about people using a script from their lawyer. They're suggesting that they're not telling the truth when they give testimony, or people who go to doctors who don't—who produce evidence that may not objectively otherwise exist, do you have the power to deal with those kinds of abuses.
Ms. DEANGELIS. Those are generally issues with regard to validity of claims. With respect to validity of claims, very seldom will the United States trustee get involved in what is clearly a two-party dispute where parties are represented by counsel. We do not look at the validity of claims, unless there are allegations of fraud or misconduct or criminal conduct, in which case we would refer it to the U.S. attorney.
Mr. CANNON. For criminal action.
Ms. DEANGELIS. That's right.
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Mr. CANNON. So if you sense there's some problem out there you're going to call on the prosecutors.
Ms. DEANGELIS. That's right. If there is information presented to us that—that's credible, we will refer to.
Mr. CANNON. Let me just make a distinction for the record and you can correct me if I'm wrong. You refer to this as two-party actions with lawyers, with counsel. But what we are dealing with here are complex parties that have many, many people, and I think what Mr. Brickman is saying is that there are inherent conflicts between and among them and certainly between parties within and parties without that litigation. So my sense is that while you want to see the rules played by, we've got a group of people that have figured out, that is, the bankruptcy bar, including the plaintiffs and the defense and plaintiffs lawyers in asbestos cases and executives as we move out in the circle here, that are playing a game by your rules but coming up with outcomes that are highly distortive of our economic system. But you're going to play the referee in a relatively small area of that larger conflict and you think you have enough authority to do that.
Ms. DEANGELIS. We enforce the Bankruptcy Code as it is written. And I, again, want to reiterate that the conflicts that exist with regard to the asbestos plaintiffs bar are conflicts that are inherent in the mass tort system and they come into bankruptcy just by virtue of the bankruptcy having been filed. They are not the type of representations—because they are representations of individual claims, of claimant, they are not the representations over which either the bankruptcy court has authority, over—or over which we exercise oversight.
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Mr. CANNON. Thank you. Because that's, I think, exactly the point that I have been trying to get to for much of this discussion. The fact is you've got some people in America, some groups of people who figured out how to get out from under—how to solve their problems in ways that are inherently full of conflicts and inherently enormously important for the American economy. I think Mr. Watt had a question. I yield the time to him for that.
Mr. WATT. I just wanted to say that I think it's unfair for us to ask Ms. DeAngelis to defend the whole integrity of the bankruptcy system. I mean, she didn't come here to do that. If it's—if there are shortcomings in that system, as she said, her job is to enforce the Bankruptcy Code. And if the code itself is inadequate, it's because we wrote it inadequate. Now, there might be problems—and we ought to put our fingers on that.
Mr. CANNON. Will the gentleman yield? May I just point out that I don't mean to put on you the spot on this, Ms. DeAngelis. I think you answered the questions marvelously. You have performed very well here. But I think inherently what we have is we are asking the trustees to do things they can't do, and we need that clear so we can say what do we need to do here because we've got a system that doesn't have anything to do with trustees but is destroying our manufacturing base in America. And I think that's vitally important.
So I hope that this is not taken personally. I think you've done a marvelous job answering questions, and especially the last answer was very clear.
Mr. WATT. But I hope the Chair is also aware that that exists in a number of instances. It's not only in the bankruptcy system. It's not only in the tort litigation system. There are a number of instances where people are scratching each others' back, you know. There are mergers taking place constantly, where there are golden parachutes. I mean, you know, so this is not unique to just this area. And I'm not defending it in this area. But the question I wanted to get to, though, it seems to me that if anybody is not protecting the integrity of the system it's not Ms. DeAngelis' office. It might be the judge's. And so that leads us to the question of whether going to longer tenured judgeships—this whole thing of judges competing for cases is troubling, more troubling, is as troubling to me as some of the other allegations because I never thought a judge—none of the judges I ever went in front of competed for cases. They were trying to get rid of them so that they had less and less to do. I hear a different scenario here. Competition for cases that may be aimed at getting tenures extended at the end of the 7-year term or whatever the term is.
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Mr. LOPUCKI. Fourteen years.
Mr. WATT. Fourteen year term. Is a solution that you're suggesting or one of the solutions that you might be suggesting going to some different kind of an appointment system or a life-time tenure where they wouldn't have to compete or what would your suggestions about how to solve that be.
Mr. LOPUCKI. Life-time tenure would probably be a positive change. But at this stage of this competition, I think it's too late for that to solve the problem. We have the court in Delaware, which has created a large industry, many people have moved to Delaware in reliance upon this industry being there. Congress is about to give Delaware four more judges, it appears. You've got a very large thing that is in place there now and won't stop just because——
Mr. WATT. Maybe we should not just give them the judges and then they will be so overburdened that they can't frustrate the system like you're saying they're frustrated or are frustrated in another way.
Mr. LOPUCKI. That might be an effective approach to it. I would think that the judges in Delaware right now are working extremely hard, very long hours.
Mr. WATT. But they're still competing for cases is what I hear you say.
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Mr. LOPUCKI. They are. Less intensively now because they're awaiting these new judges that they're scheduled to receive and that they think they will receive. If they get the judges then those judges will be there and those judges will need to have cases. And even if they are article three judges, at that point in time, what can you do, if you're a bankruptcy judge in Delaware, where there are no cases unless you attract those cases.
Mr. WATT. I yield back.
Mr. CANNON. Mr. LoPucki, are you aware as to whether or not bankruptcy judges get retirement when they finish their 14-year term? In the claims court, a judge who finishes his or her tenure term then gets the same payment for life. It's a retirement. And the theory there is that you're not causing judges to try and get reappointed. In the case of the claims court, the biggest party is the Federal Government, and it would be unseemly to have a claims court judge against a—need to go to the Government to get reappointed. In that case, do you know, if——
Mr. LOPUCKI. No, I don't know how their retirement system works.
Mr. CANNON. We will check that. I want to thank the panel. I think this has been very, very instructive. The information has been very good. And I hope that we will take a deeper look at this. Maybe focusing on a—given the transition that we have here, between complex cases that are now moving into pre-packaged asbestos cases and the conflicts that are obvious and we appreciate your particular comments Mr. Brickman in that regard about the inherent conflicts. We may want to just take this up again and look more closely at it. So I want to thank you for your being here. And we are adjourned.
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[Whereupon, at 4:35 p.m., the Subcommittee was adjourned.]
A P P E N D I X
Material Submitted for the Hearing Record
STUDY ENTITLED, ''FINANCIAL ANALYSIS OF ASBESTOS COMPANIES UNDER CHAPTER 11 REORGANIZATION,'' SUBMITTED BY MR. WATT
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STUDY ENTITLED, ''THE IMPACT OF ASBESTOS LIABILITIES ON WORKERS IN BANKRUPT FIRMS,'' SUBMITTED BY LESTER BRICKMAN
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(Footnote 1 return)
Data reported herein include actions in chapter 7 and chapter 11 cases. Entered data exclude some reductions obtained by fee committees on which the United States Trustee is a participant. In addition, actions taken to achieve additional disclosures and fee reductions prior to filing an application are not captured in the database.
(Footnote 2 return)
The RAND Institute study entitled ''Asbestos Litigation Costs and Compensation: An Interim Report,'' is not reprinted in this hearing but is available on-line at www.rand.org/publications/DB/DB397/DB397.pdf. The study entitled ''The Impact of Asbestos Liabilities on Workers in Bankrupt Firms'' is reprinted in the Appendix.