Chapter 11's Descent into Lawlessness.

AuthorLoPucki, Lynn M.
  1. Court Competition for Big Bankruptcies II. Belk's Restructuring: Substance A. Belk's Route to Failure B. The Upside-Down Restructuring Plan C. The Right-Side-Up Restructuring Plan III. Belk's Restructuring: Procedure A. Belk's Five-Stage Restructuring Process 1. The Choice of Lien Holder Representatives 2. The Negotiations 3. The Restructuring Support Agreement Solicitation 4. The Prepackaged Plan Acceptance Solicitation 5. The Bankruptcy Case B. Prepetition Notice 1. Notice of Disclosure Statement Hearing 2. Notice of Plan Confirmation Hearing 3. Notice Period Reduction C. Bankruptcy Fee Control D. Schedules and Claims E. Meetings of Creditors F. Creditors' Committees G. Independent Bankruptcy Directors H. Third-Party Releases I. Inadequate Information IV. The Overvaluing of Plan Acceptance A. Choice and the Situation B. Restructuring's Effect on Other Stakeholders V. Other Illegal or Abusive Practices A. Manager Bonuses B. Examiners C. Case Transfer D. Section 363 Sales E. Collective Bargaining Agreement Rejection F. Critical Vendor Orders VI. Conclusions Each justice or judge of the United States shall ta\e the following oath ... "I will faithfully and impartially discharge and perform all the duties incumbent upon me ... under the ... laws of the United States." 28 U.S.C. [section] 4S3.

    On the evening of February 23, 2021, Belk, a Charlotte, North Carolina-based department-store chain with $3.7 billion in annual revenues, filed a Chapter 11 petition in the Houston division of the United States Bankruptcy Court for the Southern District of Texas. Belk had no grounds for Houston venue, but it did not need any. Houston was the hot new destination for big-bankruptcy forum shopping with just under a 50 percent market share. The Houston court was actively seeking to attract big cases. (1)

    At 8:00 a.m. the next morning, Bankruptcy Judge Marvin Isgur began the hearing on approval of Belk's 267-page Disclosure Statement and Prepackaged Plan of Reorganization. Near the end of the two-hour hearing, one of Belk's lawyers pointed out to the court that "emerging this afternoon will put Belk in a position to set a record for the quickest prepackaged case from filing to emergence ... any Bankruptcy Court has seen." (2) A few minutes after 10:00 a.m., the court entered an order approving the disclosure statement and confirming Belk's plan. (3)

    The court did not stay its confirmation order. The parties consummated the plan that same afternoon. That is, they exchanged securities, money, and documents as required to implement the plan. They also established their reliance on consummation by trading and transacting with third parties. After reliance, the equitable mootness doctrine made meaningful appeal impossible. (4)

    On the evening Belk filed, the United States Trustee-a division of the Department of Justice-filed an objection to confirmation. (5) The objection made the obvious point that a judicial decision finally determining the rights of Belk's 90,000 creditors before the court notified them of the proceeding violated due process. (6) The court responded by first irrevocably confirming the plan and then entering a "Due Process Preservation Order" giving parties in interest thirty-five days in which to object to the plan. (7)

    The thirty-five day objection period was illusory. Once the court entered the confirmation order, it could revoke the order "if and only if such order was procured by fraud." (8) If, during the thirty-five day period, an objector had proven Belk's Disclosure Statement inadequate, Belk's plan not feasible, or some other condition of confirmation lacking, the court lacked the power' legally or practically-to do anything about those objections. Even if they wanted to, the parties and the court could not unscramble the eggs. (9) Minor adjustments to satisfy complaining creditors aside, the Belk case was over upon plan consummation.

    Belk's one-day Chapter 11 was the culmination of four decades of competition among the bankruptcy courts for big cases. A liberal venue law adopted in the 1970s, pushed to its limits by aggressive strategists, enables big companies to file bankruptcy in any court they choose. (10)

    Rampant judge-shopping quickly led to competition among some bankruptcy courts to attract the big cases. Those cases offered prestige to the judges who attracted them, a billion-dollar-a-year restructuring industry to the jurisdiction that attracted them, and prosperity to the bankruptcy lawyers in those jurisdictions. (11) The result was a long descent into lawlessness as the competing courts waived one procedural requirement after another in their effort to attract cases. (12)

    Of the approximately twoTundred bankruptcy court panels in the United States (13) only five competed at the time Belk filed. But those five--Houston, Delaware, White Plains, Richmond, and New York--attracted more than ninety percent of the big cases nationally. (14) The courts compete by favoring, in their practices and decisions, the parties who can bring them more cases. Those parties are the debtors' managers, (15) the debtors' attorneys, and the DIP lenders who finance the cases. For convenience, I refer to them as the "case placers." (16) To attract cases, the competing courts routinely bend and break the law in the case placers' favor. (17)

    Belk, and a handful of other one-day Chapter 11s, (18) have achieved a high degree of lawlessness. This Article identifies numerous violations in Belk through a detailed review of the court file and hearing transcripts. The Article also identifies other issues that demonstrate the general lawlessness of the big-case Chapter 11 process as it currently operates.

    Several leading bankruptcy scholars have recently sounded the alarm about the accelerating disintegration of big-case Chapter 11 practices. Professors Jared Ellias and Robert Stark observed that "clever debtors and their lawyers ... have developed procedural strategies that effectively disable the formal machinery of creditor protection, including related doctrines like the law governing fraudulent transfers." (19) Professor David Skeel charges that "[t]wo of the most important developments in recent bankruptcy practice [restructuring support agreements and deathtraps] are intended to distort, and clearly do distort, the voting process." (20) Professor Lindsey Simon complains that "[o]ver the past decade, bankruptcy grifters ... have commandeered a process designed to equitably address failures, and instead used it to impose a binding universal settlement on claimants." (21) Professors Jared Ellias, Ehud Kamar, and Kobi Kastiel report a sharp increase in the use of "independent bankruptcy directors" who "often seek to bypass the procedure Congress created ... by claiming to replace the unsecured creditors' committee." (22) Several scholars have expressed alarm over DIP lenders' steadily increasing contractual control over the Chapter 11 process. (23)

    None of those scholars seemed to notice, however, that each of the changes they documented favored the interests of the case placers over other parties (24) and could easily have been prevented by the bankruptcy judge presiding over the case if that judge were so inclined. Nor did the scholars make the connection between the changes and the force that drove them: the bankruptcy court competition for big cases. Ironically, all of the scholars proposed to rely on the bankruptcy judges to implement their reform proposals. (25)

    What those leading scholars failed to realize is that as long as any court is willing to allow a practice, any other courts' refusals to allow it do not matter. The case placers will choose the courts that allow their preferred practices, thus ensuring that those practices will continue. (26) So long as some courts continue to compete, other courts cannot fix any illegality or dysfunction that benefits the case placers.

    Defenders of Chapter 11's increasing lawlessness argue that (1) courts have to violate the law to process cases efficiently, (2) no one is injured by the procedures employed, and (3) the affected creditors' acceptances of the plans prove the plans to be in the creditors' interests. Belk, for example, solicited and received acceptances from more than ninety-nine percent of the creditors who were impaired under its plan.

    The short answers to these arguments are first, that the bankruptcy courts have no authority to ignore the law. Routine disregard for the law creates a gangster-like atmosphere in which the case placers not only appear to be, but actually are, above the law. Second, the acceptance of a Chapter 11 plan signals approval of the plan no more than turning over one's wallet signals approval of an armed robbery. Creditors can only choose among the alternatives available to them in the particular situation. (27) In the competing courts, the case placers are in control and none of the creditors' alternatives are good. Third, Chapter 11's procedures are intended not just to satisfy impaired creditors, but to save companies and jobs for the benefit of all stakeholders. In Belk, for example, there were fewer than three hundred creditors entitled to vote on the plan but more than 90,000 creditors whose interests were at stake. (28)

    The Houston court's most important task was to determine the feasibility of Belk's plan. The court ignored that task almost entirely. (29) When the Delaware court elbowed its way to dominance in the early 1990s, it too ignored plan feasibility. For Delaware, the result was a plan failure rate ten times that of other courts during the five-year period of Delaware's ascendency, (30) leading to several unnecessary liquidations of large public companies. (31) Houston may be generating the same legacy.

    The structure of the bankruptcy community has largely prevented recognition and condemnation of the competition. Bankruptcy practitioners cannot speak out because they or members of their firms must...

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