LEXIS-NEXIS® Congressional Universe-Document

LEXIS-NEXIS® Congressional

March 16, 1999, Tuesday

SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 2637 words

HEADLINE: TESTIMONY March 16, 1999 LEON S. FORMAN HOUSE JUDICIARY COMMERCIAL AND ADMINISTRATIVE LAW BANKRUPTCY REVISION

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TESTIMONY OF LEON S. FORMAN, ESQUIRE BLANK ROME COMISKY 81 McCAULEY LLP ONE LOGAN SQUARE PHILADELPHIA, PA 19103 BEFORE THE SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW COMMITTEE ON THE JUDICIARY UNITED STATES HOUSE OF REPRESENTATIVES MARCH 16, 1999 1 0:00 a.m. ROOM 2141 RAYBURN HOUSE OFFICE BUILDING HEARING REGARDING "THE BANKRUPTCY REFORM ACT OF 1999" (H.R. 833) TOPIC: A STATEMENT OF THE INTEREST OF CREDITORS IN A BANKRUPTCY CASE A STATEMENT OF THE INTEREST OF CREDITORS IN A BANKRUPTCY CASE Bankruptcy is a collective proceeding. One of its goals is the equal treatment of creditors with similar legal rights outside of bankruptcy. Although we tend to think narrowly about the definition of a creditor, creditors come in all shapes and sizes: banks, finance companies, mortgage companies, automobile lenders, credit unions, credit card companies, retailers, equipment lessors, rent-to-own establishments, franchisers, landlords, employees, children, ex-spouses,, relatives, neighbors, doctors, dentists, barbers, newspaper deliverers, federal, state and local taxing authorities, trade suppliers, parochial schools, charitable organizations, utility companies, and tort victims all may be creditors. Enhancement of the treatment of one type of creditor often comes at the cost of another. It is important to evaluate the Bankruptcy Reform Act of 1999 (H.R. 833) with this in mind. For this reason, my testimony addresses how the bankruptcy system deals with creditor interests,, many of which are competing for limited resources. The filing of a bankruptcy petition has a substantial impact on its creditors. It represents a cleavage in the economic life of the debtor. The occurrence of a bankruptcy proceeding automatically creates an estate consisting of all interests of the debtor in property. The debtor's assets are in custodia legis, subject to the pervasive jurisdiction of the Bankruptcy Court. The status of pre-petition claims and rights is determined as of the date of bankruptcy and such pre-petition claims and rights are generally separated from events and claims arising after the date of the petition. In order to implement the above concept,, the filing of a bankruptcy petition under the Bankruptcy Code automatically operates as a stay against lawsuits and lien enforcement. The purpose of the stay is to provide the protection necessary for administering the assets of the estate and to relieve the debtor from the pressure of creditor collection efforts. Creditors may not, while the stay is in effect, exercise their normal legal remedies without first obtaining a court order from the bankruptcy court unless their remedy falls within an exception to the automatic stay under subsection (b.) of section 362 of the Bankruptcy Code. In that respect, the rights of creditors are substantially altered. Creditors may only pursue their claims by filing them against the debtor and the estate in the bankruptcy proceeding. Secured creditors are also effectively controlled by the automatic stay. They may not foreclose on their collateral or exercise other rights in their security except as may be permitted by a properly obtained court order. Moreover, in chapter 11, the debtor-in-possession or trustee may use collateral of a secured creditor subject to certain safeguards that ensure the protection of the creditor's interest. The secured claim is also limited by a valuation process and the claim will be allowed as a secured debt, restricted to the value of the collateral. If there is a deficiency in the total amount of the claim, the amount exceeding the value of the collateral is treated as a general claim along with all other such claims. For the most part, creditors may litigate their rights and claims only in the bankruptcy court, subject to bankruptcy procedures. As a general rule, they may not use state court remedies without permission from the bankruptcy court. In chapter 7, the liquidation chapter, which prior to the Bankruptcy Code was called straight bankruptcy, and sometimes in chapter 11, the so- called reorganization chapter, the debtor's assets are usually liquidated by a trustee. Of course, a debtor may avoid liquidation (in which creditors generally receive a lower return) and seek rehabilitation in chapter 11 or 13, the latter being a rehabilitation proceeding available principally for individual wage earners, although sole proprietors may use chapter 13 to reorganize a small business as well. In chapter 11 or 13, the debtor retains its assets and,, instead of liquidation, presents a plan of payment to creditors in whole or in part. In chapter 13, the creditors are not given the right to vote on the plan, but may object if the plan does not meet all the requirements of the statute. 11 U.S.C. 1325. In chapter 11, creditors do vote upon the plan, but under certain conditions, the provisions of the plan may be crammed down or enforced against creditors if the court approves or confirms the plan upon finding that the requirements of the Bankruptcy Code have been met. 11 U.S.C. 1129. Thus, the rights of creditors may be seriously affected in a bankruptcy proceeding. Some creditors in bankruptcy are treated better than others but such preferential treatment generally is intended to reflect their rights outside of bankruptcy. Secured creditors are usually entitled to the benefit of their collateral or its proceeds ahead of the interest of other parties as long as the rights of a secured creditor have been properly validated under state law and are not avoided by some applicable provision of the Bankruptcy Code. In addition, Congress has established a system of priorities giving to certain creditors precedence in distribution over other unsecured claims. 11 U.S.C. 507. Historically,. these priorities fit into narrow categories and are strictly construed. They represent an overriding policy of Congress in favor of a small and limited group of claimants. The first priority is for administrative expenses. Bankruptcy is supposed to pay its own way and this priority is necessary for the administration of the debtor's estate. Thus, if the Bankruptcy Code did not give first priority to administrative claims,, it would be difficult to operate the system and make distributions to creditors. Another priority is given to wage claims, but limited in amount and limited to wages earned within a certain period before bankruptcy. Wage earners are considered to be more vulnerable than ordinary creditors, especially in a liquidation where jobs may be lost, and their favored treatment has been a longstanding policy of Congress. Another important priority is given to tax claims with some limitations. Taxes have always been favored as a governmental policy. The other priorities are restricted to very special situations in which Congress has found a policy basis for the category. To the extent that priority claims exist in a bankruptcy case, the rights and claims of general creditors are, of course, reduced. For this reason, it is critical to exercise great caution when considering whether to add other types of claims to the priority list to ensure that doing so is consistent with sound public policy. Perhaps the most substantial alteration of the rights of creditors in bankruptcy is the discharge of their claims. This means that in most cases the debt is released and may not thereafter be enforced by the creditor. Creditors will receive a distribution in bankruptcy if there are assets to be liquidated,, or a distribution under a plan in a rehabilitation proceeding, but they may not enforce their original claims. The purpose of this concept is to give the debtor a fresh start, whether as a consequence of a liquidation in chapter 7 or a reorganization in chapter 11 or 13. A promise by the debtor during a bankruptcy case to pay a pre-petition debt after bankruptcy is unenforceable unless the debtor enters into a reaffirmation agreement in accordance with the strict requirements of the statute 11 U.S.C. 524(c), (d). Making such promises unenforceable was thought to be necessary to prevent debtors from being induced by pressure or other motives from reinstating their discharged obligations and thereby losing the benefits of the fresh start. But, unfortunately some powerful creditor interests continue to pressure debtors, sometimes in contravention of the law. Of course, an individual debtor who was engaged in certain prohibited conduct may be denied a discharge as to all debts, but the grounds for denying a discharge apply only in a chapter 7 liquidation or in a chapter 11 case that amounts substantially to a liquidation. 11 U.S.C. 727; 1141(d)(3). These grounds are not relevant in chapters 12 and 13. Objections to discharge are rare, because the grounds are difficult to prove and the proceeding may be expensive for a creditor. Even though a discharge is granted, certain categories of debt are non dischargeable in chapter 7. 11 U.S.C. 523. The grounds for non dischargeability in chapter 7 are more frequently litigated by creditors. They represent limited and specialized categories of obligations, although the list of exceptions to discharge has expanded with special interest provisions over the years. Likewise, some debts are not dischargeable even after an individual has completed a chapter 13 repayment plan. 11 U.S.C. 1328(a). Like priority debts, exceptions to discharge should not be added absent an overwhelming public policy justification for doing so. Creditors who have ongoing contracts with the debtor are also seriously affected by a bankruptcy case. They may not enforce their contracts in a legal proceeding without the consent of the bankruptcy court. Moreover, the debtor or trustee may reject the contract and leave the other party to an unsecured claim. Landlords may not eject debtors who are tenants as long as rent accruing during the bankruptcy proceeding is paid. Utility companies must continue to provide service, here again as long as the charges accruing during the proceeding are paid. With the rights and claims of creditors so substantially altered by a bankruptcy case, does this mean that bankruptcy is bad for creditors, or does it work in some other way for their benefit? It is my opinion that the bankruptcy system is in the best interest of society and for the most part is better for creditors than no bankruptcy system at all. When a debtor is unable to make payment in the absence of bankruptcy, creditors must proceed under state law. Each creditor proceeds separately and a race of the diligence ensues. Creditors compete for the limited assets of the debtor and an unequal distribution results, those creditors proceeding more promptly than others, receiving the higher rewards. The debtor's assets are dismembered and chaos results. In that situation bankruptcy is a better course of action because it enforces the principal of equality of distribution and of treatment with the limited exception of secured claims and the priorities. If the debtor is an individual in financial distress, the discharge in bankruptcy gives the debtor a fresh start and may preserve his job, his housing and utility service. Although creditors generally lose their claims,, the debtor becomes a productive member of society and is able to resume purchasing products and otherwise participate in economic and social activities. This system is much better for creditors because without bankruptcy,, the creditors in most cases, would be unable to collect their debts and the debtors would merely flounder in a morass of greater financial distress. Through years of experience, suppliers of goods and services have been able to estimate the collectability of accounts receivable, and bad debts are now well recognized as a cost of doing business. Of course, there are some abuses in the bankruptcy system just as there are in any other system in our society. But neutrally based statistics have demonstrated that the abuses are minor in scope and the court system appears to have been able to handle certainly the most egregious cases. The doctrine of good faith pervades bankruptcy jurisdiction and the statute provides many tools to address most problems. Of course, there is room for improvement in the system. The subject of exemptions is one of the more glaring areas in need of reform. A number of other suggestions have been made by responsible organizations interested in and expert in the field of bankruptcy. These suggestions, many of which are designed to promote the fair treatment of creditors, should be given more serious attention. Chapters 11 and 13 are being used with some frequency. When successful, they avoid the liquidation of the debtor's assets and provide an opportunity for a plan of repayment and rehabilitation. Bankruptcy law provides incentives to a debtor to use these chapters, and creditors benefit from a debtor's choice to attempt to repay debts. A chapter 11 proceeding, if successful, preserves a business unit (rather than liquidating it), generally avoids the loss of jobs, and allows creditors to retain customers. In chapter 13 plans in which the debtor is able to make substantial payments, creditors will receive a return on their claims. Unfortunately, many chapter 13 cases are dismissed before a plan is confirmed or the plan deals primarily with secured and priority claims, leaving little or nothing for unsecured creditors. In addition, a large percentage of confirmed chapter 13 plans are not completed. Reliable statistical information demonstrates that an overwhelming number of debtors in financial distress are unable to support a payment program and the only reasonable relief for them is a chapter 7 proceeding. In such cases, creditors are still better off than if there was no bankruptcy system because the debtors are now free of debt and able to resume a normal productive life. They again become part of the purchasing community and a respectable credit risk. Some types of creditors, such as mortgage lenders and support recipients, actually may fare better if a debtor chooses chapter 7 over chapter 13. CONCLUSION Bankruptcy is an important safety valve in an imperfect economic society where free markets flourish. Most individuals and business interests intend and prefer to pay their debts. Bankruptcy still carries a stigma. Unfortunately, some debtors and businesses become so burdened with debt that bankruptcy relief is a necessary choice. In a dynamic economic society, there are bound to be upturns and downturns and provision must be made for recharging the batteries. If we consider the rapid and incredible growth of our economy and the enormous size of outstanding business and consumer debt, the increase in bankruptcy filings is not out of proportion and is an inevitable consequence. We should, of course, continue to study and improve our bankruptcy laws, but in a reasoned and balanced way rather than based upon the proposals and views of special interests which may benefit one type of creditor to the detriment of other creditors and society in general. It is my understanding that H.R. 833, the Bankruptcy Reform Act of 1999, is a restatement of the Conference Report on H.R. 3150 of the last Congress. If this is the case,, to a great extent, this bill represents extreme proposals both in consumer and business areas. I have set forth my views with respect to the specific provisions of the Conference Bill H.R. 3150 in an attachment to my letter dated November 12, 1998, responding to a request from Peter Levinson, Esquire, counsel to the House Judiciary Committee. I respectfully would refer this Subcommittee to such comments. (I have not received any federal grant, contract or subcontract in the current or preceding two fiscal years

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