Thursday, September 02, 2010
The Pros and Cons of Amending Chapters 11 and/or 12

Why is Chapter 11 of the Bankruptcy Code such a bad fit for small businesses?  And what are the pros and cons of amending Chapter 11 or moving small business bankruptcy in Chapter 12, with family farms?


American Bankruptcy Institute’s Resident Scholar, Juliet Moringiello, recently discussed this with Professor Melissa Jacoby of Univ. of North Carolina’s School of Law. Prof. Jacoby also sits on the National Bankruptcy Conference and participates in its Small Business Working Group.  Part I of Ms. Moringiello’s and Professor Jacoby’s interesting Q & A, paraphrased, was posted here on August 31, 2010. The entire podcast may be heard here www.podcast.abiworld.org (membership req’d).

 

What are the pros and cons of 1) expanding Chapter 12;

2) amending Chapter 11; and

3) creating a new chapter to deal with small business bankruptcies?

Benefits of expanding Chapter 12 to include small businesses.

1) Chapter 12 provides the kind of structure, such as monitoring, and statutes of limitation, that will benefit small business’s current problems with Chapter 11.

2) Business owners face the same kinds of issues as family farmers do.  Adopting Chapter 12 eliminates the need to rewrite the existing Chapter 11 rules or write a new chapter just for small businesses.

3) It will be difficult to change Chapter 11 to accommodate small business without interrupting large Chapter 11 proceedings.  Moreover, it is not possible to simply pick and choose various sections for elimination.

 

Drawbacks to expanding Chapter 12.  Creditors just don’t like it.

1) Many of the creditor’s rights found in Chapter 11, such as the Absolute Priority Rule (APR), and the requirement for creditor classes to vote for a plan, are not in Chapter 12.
 

2) The American Banking Association (ABA) dislikes the idea because, as the secured and, often, largest creditor, they don’t welcome other creditors’ involvement.
 

3) Currently, there are approximately 500 Chapter 12 bankruptcies every year and the some of the bankruptcy courts are not ready to add thousands of additional cases.
 

4) Farmers and fisheries don’t want their chapter and protections altered to accommodate small business bankruptcies.

 

Advantages of amending Chapter 11.
 

1) There is already a track record of Chapter 11 carve-outs as long as debtors make the election and “check the box.”

2) Chapter 11 provisions don’t automatically fit large bankruptcies either, so it’s possible that some Chapter 12 concepts should be added to Chapter 11, creating a hybrid Chapter 11/12..

 

The major obstacle to expanding Chapter 12 to include small businesses comes down to the definition:  What Constitutes a Small Business?  What is some of the thinking around this?

The Congressional Oversight reported listed several possible dimensions along which small businesses could be defined, among them are Total Debt and Number of Employees. For example, the current 2005 BAPCPA definitions has $2.0+ million debt limit and the current 2010 proposals use a $10 million debt limit.  This will probably be scaled back.

Creditor groups want to limit the scope of the small business definition for several reasons: they like the creditor protections found in Chapter 11, and they do not support the home mortgage modifications available to debtors under Chapter 12.

The other working assumption is that creditors in small business reorganizations are apathetic about the outcome because they lack an economic interest.

 

What is needed to improve the current situation?

1) A definition of small business that all parties can agree on, and that addresses the need.

2) A recognition that the necessary changes so that Chapter 11 actually works for small business are really creditor vs. creditor issues and not creditor vs. debtor issues. The National Bankruptcy Council addressed this, and ultimately it comes down to “Is there any remaining value that wouldn’t necessarily go to the secured creditors?”

It should be noted that Chapter 12 and Chapter 13 do have other rules, besides the APR, that protect creditors.

 

In summary, what “common denominators” exist in the proposed changes?

1) Reduce expenses for the benefit of both the debtors and the creditors.  For example, streamline reporting and disclosure requirements; permit the hiring of pre-petition professionals who already know the business; when the debtor is viable and has a feasible POR, permit the payment of administrative costs over time instead of at emergence (?).

2) Increase creditor involvement.  Without creditor committees, there is no monitoring and no counterbalance to the large secured creditors.  A framework that incents creditor participation must be created.  Also helpful are private trustees who can assess viability and work with creditors, but their addition must not significantly increase expenses.

3) There is also consideration of combining Chapters 11 and 12.  

 

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