Chapter VIII What's Next for Bankruptcy Reform

• Jurisdiction: United States

VIII. What's Next for Bankruptcy Reform

What's Next for Bankruptcy Reform

Robert J. Keach
Prof. Michelle M. Harner
Samuel J. Gerdano

It has been over 30 years since the current U.S. Bankruptcy Code (the "1978 Code") was enacted, and a consensus has emerged that the current law needs an overhaul. The 1978 Code, as it has been amended on numerous occasions, has served us well for years. Some would contend that the 1978 Code—and particularly chapter 11—offered a balance between creditor and debtor interests, establishing what was often described as a "level playing field" for restructurings. When first enacted, supporters of the 1978 version of chapter 11 argued that it served the interests of all those impacted by a debtor in distress including employees, the surrounding community, the public interest and creditor interests, but did so in a flexible way that balanced all interests while meeting the debtor's goal of succeeding in saving its business.

Others did not see the balance. Detractors contended that the 1978 Code was too "debtor-friendly," that it led to long and inefficient cases, and that it provided too much discretion to bankruptcy judges. To the extent that the Code was amended after 1978, the detractors largely prevailed in the legislative battles. For better or worse, most of the changes to the Code since 1978 have (a) exempted categories of claimants or transactions from the reach of bankruptcy law; (b) added additional categories of administrative or priority claims, thus burdening the already strained liquidity of distressed companies; (c) limited or eliminated the discretion of the courts in administering chapter 11 cases; and (d) provided for shorter time periods and faster, more-truncated cases. Supporters of the 1978 Code contend that the many changes to chapter 11 through the years have not helped further the goal of restructuring or have had unintended consequences.

Regardless of your perspective on this debate, it is difficult to deny that the changed legal, financial and economic landscape has had a profound effect on corporate restructurings. For example, since the Code's enactment, there has been a marked increase in the use of secured credit, placing secured debt at all levels of the capital structure. Many of the 1978 Code's provisions assume the presence of asset value above the secured debt, an asset value that is too often not present in many of today's chapter 11 cases. The debt and capital structures of most debtor companies are more complex, with multiple levels of secured and unsecured debt, often governed by equally complex inter-creditor agreements. There is nothing wrong with the growth of collateralized debt per se; indeed, that growth brought credit to many companies who could not have obtained it otherwise. However, the 1978 Code's baseline assumption of value above the amount of liens on assets has been challenged if not cast aside.

Similarly, the growth of distressed debt markets and claims trading introduced another factor not present when the 1978 Code was enacted, a factor that challenges certain other premises underlying the 1978 Code. Again, in many ways, this development was a net positive, providing creditors with a means of monetizing claims more quickly, rather than awaiting the outcome of sometimes-lengthy cases. However, the rapidity of the development of these markets also created collateral consequences that the 1978 Code was simply not designed to deal with.

Many of today's companies are less dependent on "hard" assets (real estate, machinery and equipment, or inventory), and more dependent on contracts and intellectual property as principal assets; the 1978 Code does not clearly provide for the efficient treatment of such assets and affected counterparties. Debtors are more often multinational companies, with the means of production and other operations offshore, bringing international law and choice of law implications. Today's "debtor" is likely to be a group of related, often interdependent, entities. The impacts of these changes on the efficacy of the current restructuring regime have been dramatic.

The way both courts and commentators discuss the purpose of chapter 11 has also changed. Early decisions (and the legislative history of the 1978 Code) emphasized that the primary purposes...