At bottom, the report told a betrayal story. While investors deserved reorganizations that were "expeditious, economical, fair, and honest," those who controlled the process had "self-serving objectives," deployed "mechanisms incompatible with the needs and requirements of investors," and "too often caused perversion of the functions of reorganization." (168) The reorganizers, the report alleged, enriched themselves at the expense of the mass of claimants in the firms they were entrusted to set right. (169) Control came with patronage, and therefore bankers, managers, and lawyers sought to perpetuate control. The lawyers were held up for particular condemnation. (170) The report alleged that they had served two masters. Counsel were supposed to be fiduciaries of the mass of claimants connected to the reorganization but instead served the managers and bankers whose interests were taken to be opposed to those of the dispersed claimants. (171)
The release of the SEC Report was followed by legislative proposals for more far-reaching reform than section 77B. One proposal would have created a bankruptcy "conservator" to police the reorganization process. (172) Rather than allow the parties to select the key officers in a reorganization, the conservator would intervene to break the cycle of patronage. (173) The bill that eventually became law, the Chandler Act, adopted an administrative supervision model. (174) Although the Chandler Act retained a court-based process for reorganizing firms, it introduced a sharp break from practices that had originated in the era of the equity receivership and had persisted through the enactment of section 77B.
The principal object of the Chandler Act was the removal of those who had previously controlled the reorganization process. (175) The "keystone of the reform program" was Chapter X, which provided for mandatory appointment of a disinterested trustee in all reorganizations involving liabilities of $250,000 or more. (176) Incumbent managers in Chapter X cases would no longer be able to call forth bankers and lawyers of their choosing to run the process. Rather than permit those forces to formulate a plan of reorganization and solicit support from the firm's dispersed claimants and equity holders, the statute provided that those duties would fall to the trustee. (177) In order to prevent a reproduction of the status quo ante, the statute took a firm view of the "disinterested" trustee requirement. Bankers and lawyers who previously had been connected with the firm (such as involvement in underwriting outstanding securities) fell within the prohibition. (178)
Sitting atop this new regime and exercising extensive influence over the reorganization process was the SEC. In keeping with the view of a reorganization as "an administrative problem" (179) and "primarily an exercise in corporate finance and management," (180) the Chandler Act contemplated resort to the expertise of the SEC. The Chandler Act gave the Commission the right to appear, with approval of the court, in any case. (181) Of even greater significance, the SEC could render an advisory opinion on the merits of any plan of reorganization. (182) Rather than allowing private ordering within the bounds of a loosely defined scheme, Chapter X contemplated a greater degree of influence by the agency in the basic process of reorganizing the affairs of the debtor. Although justified as an effort to introduce more transparency and public participation in the reorganization of firms, the trustee and SEC provisions of the Chandler Act left little room for claimants themselves to have a voice in the process. Remarkably, Chapter X did not require or encourage the formation of groups, such as official committees of creditors, to represent various constituencies during a negotiated resolution of the firm's financial distress. (183)
To be sure, the agency's role was described as advisory. (184) The SEC could not directly control the formulation of a plan of reorganization in Chapter X, and it could not directly run the affairs of the business. But the combination of the mandatory independent trustee and the SEC's advisory role fundamentally altered the process of negotiating a plan. Even if other parties in interest wished to advocate for a particular resolution of the reorganization and could force consideration of their preferred plan, they could not solicit the support of creditors for the plan until it had been approved by the judge. (185) And the judge could not approve the plan before the SEC had an opportunity to review its provisions. (186) When the plan was sent to creditors for purposes of voting, the trustee was required to provide a copy of the SEC's report. (187) Even when the SEC did not file a formal report, it could involve itself in other ways. The agency could provide assistance in preparation of the plan, scrutinize the qualifications of fiduciaries involved in the case, challenge the trustee's administration of the estate, and advise the court of its views. (188) In effect, the SEC's role would quash the ability to organize of those who had served the principal role in corporate reorganizations--the managers, bankers, and elite lawyers in control of the process before the Chandler Act.
The effect of the SEC's supervisory role did not escape sophisticated observers. They feared the agency would not be sympathetic to the view that the formulation of a plan of reorganization "is in essence a bargain between the various classes of security holders and creditors and that the parties should be free to agree upon the terms of the bargain, subject only to a judicial review of limited scope." (189) An American Bar Association special committee on developments in administrative law that was chaired by Dean Roscoe Pound of the Harvard Law School denounced the Chandler Act's provisions as an example of a trend toward "administrative absolutism," which tended "to subject the management of all individual property and enterprise to an unchecked administrative control." (190) Less hyperbolic commentators expressed theoretical and pragmatic concerns about the new role of the SEC. Robert Swaine, for example, thought agency control of corporate reorganizations to be incompatible with "private litigation between private parties." (191) But he presciently foresaw the resource limitations that would make agency involvement cumbersome as a practical matter. The SEC, he observed, did not have the ability to resolve the vast number of potential reorganization cases for which they would become responsible. (192)
There were, of course, prominent defenders of the experiment in agency supervision. Jerome Frank (who had been chairman of the SEC before his appointment to the Second Circuit in 1941) criticized positions in Pound's ABA report for lacking "logical, as distinguished from emotional," support. (193) In Frank's view, reorganization of financially distressed firms was "something more than a brawl" among private parties and was instead "an administrative problem in the solution of which the public, as well as the litigants, has an interest." (194) He also doubted that the SEC's role would cause serious practical difficulties. (195) He gave assurances that the agency's Reorganization Division, which would be tasked with carrying out the duties assigned by the Chandler Act, would be adequately staffed with lawyers carrying expertise in business reorganizations. (196) As he saw it, the SEC would also improve the outcome in reorganizations by making "an intensive study of the debtor, its background, its financial structure, prospects, earning power and management, and the situation of the industry as a whole." (197) Using its powers under the Chandler Act to examine witnesses and hold hearings in connection with a plan of reorganization, the agency would be able to inform the trustee and the court as to the running of the enterprise and its value. (198) The agency's expertise, he believed, had been positively received by attorneys and judges after an initial period. (199)
Frank may have had the more perceptive view on the quasi-public nature of the reorganization process, but his predictions about the capacity of the SEC and the practical effect of its supervisory role proved misguided. Resort to Chapter X, while initially robust, dropped off rapidly through the 1940s. (200) The decline did not come about because lawyers and bankers had perfected a way to resolve firms' financial distress without actually filing for bankruptcy. Coordinating large numbers of claimants without a bankruptcy filing would be quite difficult. (201) And one nonbankruptcy route for doing so quickly became unavailable. Underwriters tried to include group voting procedures in bond indentures so that a majority of a class of bondholders could vote to restructure a firm's debt outside of a bankruptcy filing. (202) But, in response to pressure from the SEC, Congress enacted the Trust Indenture Act in 1939, which restricts the inclusion of voting provisions of that sort in bond indentures. (203) Each bondholder must consent individually to the modification of any core term in the bond--including the amount of the principal, the interest rate, and the maturity date. (204) The Chandler Act and the Trust Indenture Act combined to limit the space for any private workout without resort to bankruptcy. (205)
THE RETURN OF BANKRUPTCY
The New Deal reforms essentially closed out the era of large corporate reorganizations. Railroad reorganizations--which had been codified in the early New Deal but were not included in the Chandler Act--remained, (206) but beyond those cases, bankruptcy lost much of its allure for large companies. In particular, the Wall Street reorganization lawyers who had been at the center of the practice exited it. (207) The imposition of an independent trustee meant that managers who sought to reorganize would lose control over a firm and...