Going for Broke

Did Congress undermine a key pillar of American capitalism by tinkering with Chapter 11?

Long lines on sidewalks outside bankruptcy courts last October 16 testified to a significant change in the way American law treats debtors. Thousands queued up to file for protection from their creditors the day before the new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) went into effect.

Businesses got in line, too, including such giants as Northwest Airlines and Delta Air Lines. Robert “Steve” Miller, CEO of auto-parts maker Delphi Corp., and no stranger to bankruptcy in his long career as nursemaid to troubled companies, famously told The Wall Street Journal he did not want his current company to be a guinea pig for the new law. Delphi filed for Chapter 11 a week before the new law took effect.

Most observers agree that the provisions Congress wrote for individual consumers represent a significant philosophical shift, one that deliberately puts more onus on debtors. Less clear is the intent — or the ultimate impact — of the separate provisions related to business (see “Strapped for Cash and Time” at the end of this article). A July 2005 article in the American Bankruptcy Law Journal dubs those provisions “The Creeping Repeal of Chapter 11.” But that effect, the authors argue, is the result of legislative incompetence and special-interest lobbying rather than any deliberate effort to undo the basic purpose of the code.

So is a key pillar of American capitalism in danger of collapsing, as some suggest? Or has Chapter 11 simply been dented by an exceptionally ham-handed effort on Capitol Hill?

Creditors Gain Leverage

In the latter camp is Alan Kornberg, chair of the bankruptcy and corporate reorganization department at New York law firm Paul Weiss. “Many of [BAPCPA's] amendments are bad policy, ill-conceived, poorly drafted, and likely to generate substantial litigation,” he concedes. “Having said that, I don’t believe the fundamentals have changed at all.”

The authors of the “Creeping Repeal” article, Richard Levin and Alesia Ranney-Marinelli of Skadden, Arps, Slate, Meagher & Flom LLP, agree with Kornberg’s assessment of legislators’ work, noting that even provisions intended to address perceived abuses or problems “have been so poorly conceived or drafted that they are likely to do more harm than good.” And most of the provisions, they write, “reflect active lobbying by certain creditor groups to improve their positions in bankruptcy cases.” But they also declare that those provisions “will adversely affect the ability of businesses to reorganize.”

That suggests that the bankruptcy code’s historic emphasis on debtor rehabilitation may be shifting, even if that wasn’t Congress’s overt intent, and legal articles on this theme are legion. “Many of these provisions are aimed at curbing perceived abuses in the length of time and the cost of Chapter 11 bankruptcy cases,” writes Lorraine S. McGowen of Orrick, Herrington & Sutcliffe LLP. “While not stated as an express goal, it appears that creditors have gained tremendous leverage over a debtor’s ability to reorganize.”

Arnold & Porter LLP’s Brian Leitch, who served as lead bankruptcy attorney for US Airways and is currently an attorney for the Northwest Airlines bankruptcy, sees “no coherent, thoughtful revision” in Congress’s effort. “I would call it tinkering,” he says. Nonetheless, tinkering can have significant consequences. Leitch and other observers note that BAPCPA’s various business provisions reduce the discretion of judges, force companies to make faster decisions, increase administrative expenses at the very point when a company has precious little cash, and limit incentives for management to stick around. “It’s clear there is increased risk to the debtor and its management,” says Leitch.

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