Legislative Update Proposed Rules Amendments Published for Public Comment

Legislative Update Proposed Rules Amendments Published for Public Comment

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At its Jan. 10-11, 2002, meeting, the Committee on Rules of Practice and Procedure approved the recommendation of the Advisory Committee on Bankruptcy Rules to publish for comment proposed amendments to the following rules and forms. The comment period ends April 22, 2002.

Proposed Rules Amendments Published for Public Comment

The Advisory Committee on Bankruptcy Rules was scheduled to meet on Sept. 13-14, 2001, in Plymouth, Mass. The meeting was canceled due to the tragic events of Sept. 11.

Although the Advisory Committee did not meet in September, the committee did take action to approve a preliminary draft of amendments to Bankruptcy Rule 1005 and Official Forms 1, 3, 5, 6, 7, 8, 9, 10, 16A, 16C and 19. The action was taken in response to the approval of a Privacy and Public Access to Electronic Case Files policy by the Judicial Conference of the United States on the recommendation of the Committee on Court Administration and Case management in September 2001.

Preliminary Draft of Proposed Amendments to Bankruptcy Rule 1005, and Official Forms 1, 3, 5, 6, 7, 8, 9, 10, 16A, 16C and 19

Synopsis of Proposed Amendments

Rule 1005 is amended to implement the Judicial Conference policy to limit the disclosure of social security numbers in the title of the case.

Official forms 1, 3, 5, 6, 7, 8, 9, 10, 16A, 16C and 19 are amended to limit the disclosure of social security numbers and similar identifiers by requiring only the last four digits of the social security numbers and the last four digits of any account numbers that debtors may have with creditors. The forms also are amended to include a reference to 11 U.S.C. §110, which requires the full disclosure of the social security number of bankruptcy petition preparers.

Text of proposed amendments to Rule 1005 is as follows:

Rule 1005. Caption of Petition

The caption of a petition commencing a case under the Code shall contain the name of the court, the title of the case and the docket number. The title of the case shall include the name, last four digits of the social security number and employer's tax identification number of the debtor and all other names used by the debtor within the six years before filing the petition. If the petition is not filed by the debtor, it shall include all names used by the debtor that are known to the petitioners (new material in italics).

Committee Note

The rule is amended to implement the Judicial Conference policy to limit the disclosure of a party's social security number and similar identifiers. Under the rule, as amended, only the last four digits of these identifiers need be included in the caption of the petition.

Opportunity for Public Comment

Please provide as soon as possible any comments and suggestions on the proposed amendments whether favorable, adverse or otherwise. The comment deadline is April 22, 2002. The Advisory Committee on Bankruptcy Rules is scheduled to meet on March 21-22, 2002, and will consider all comments received by that time at the meeting. Comments submitted after the Advisory Committee's March 2002 meeting, accordingly, will be circulated to the Advisory Committee members for their review only by mail or electronic means. Please send all correspondence to: Secretary, Committee on Rules of Practice and Procedure, Administrative Office of the United States Courts, Washington, D.C., 20544. Comments may be sent elec-tronically via the Internet to www.uscourts.gov/rules/.

The Advisory Committee has scheduled a public hearing on the proposed amend-ments for April 12, 2002, in Washington, D.C. If you wish to testify, you must contact the committee secretary at the above address at least 30 days before the hearing.

The Advisory Committee will consider all comments received. After the public comment period, the Advisory Committee will decide whether to submit the proposed amendments to the Standing Committee on Rules of Practice and Procedure. At present, the Standing Committee has not approved these proposed amendments, except to authorize their publication for comment. The proposed amendments have not been submitted to nor considered by the Judicial Conference or the Supreme Court.

Law School Deans, Professors Ask Congress to Reconsider Securitization Provision

January 23, 2002

Senator Patrick Leahy
433 Russell Senate Office Bldg.
Washington, D.C. 20510

Congressman F. James Sensenbrenner
2332 Rayburn House Office Building
Washington, D.C. 20515-4909

Dear Chairman Leahy and Chairman Sensenbrenner:

The Enron tragedy should remind everyone of a fundamental principle of American regulatory and statutory law. The system does not work unless there is public disclosure and public accountability.ïInexplicably, however, Congress seems poised to adopt, as part of the proposed bankruptcy legislation now in a conference committee, a "technical" amendment that would institutionalize and encourage one of the practices that has led to Enron's failure and its harsh consequences.

As law professors specializing in bankruptcy law, commercial law, corporate law and corporate finance, we write to you as the Chairman of the Senate delegation and the House of Representatives delegation to the Conference Committee on S. 420/H.R. 333. We call your attention to §912 of both bills, which permits a debtor and one favored creditor to engage in a secret transaction to remove valuable, liquid assets from the corporate bankruptcy estate of a troubled borrower and place them beyond the reach of the courts and other creditors. Proposed §912 would eliminate the ability of the courts to police one form of sham sales. This would permit a favored party to escape the rules applicable to all other creditors in bankruptcy and would encourage more companies to recast liabilities so that they no longer appeared on balance sheets, much to the detriment of the investing public and other creditors of the business.

Cloaked in highly technical language, the asset securitization proposal would fundamentally change American bankruptcy law. It would permit large, sophisticated, well-counseled lenders to engage in "off-book transactions" that are not publicly reported and, if the company gets into financial trouble, to avoid the bankruptcy process entirely—to the lasting detriment of the corporation's employees, its other creditors, and its very prospects for survival. Especially in this economy, with Enron only the latest example of what can happen when a company and its auditors do not make full public disclosure of financial circumstances, the Congress should not adopt this proposal.


In any bankruptcy, all creditors are bound to a collective resolution of their relationships with a debtor. Every lender in every case would like a way to escape from bankruptcy, taking a disproportionate share of the assets and leaving behind the remaining creditors. Those left behind, of course, include the corporate debtor's employees, pension funds, trade creditors, tort victims and everyone else who extended credit, in one form or another, to the debtor. In bankruptcy, secured creditors receive preferential treatment because they hold an interest in collateral, while others, such as equity investors, are subordinated. Federal bankruptcy law controls the priority and timing of payment. Chapter 11 reorganization and chapter 7 liquidation work, however, only if all creditors are part of the bankruptcy process, and no single creditor is allowed more than its share from the estate.

The corporate bankruptcy system today, built on more than 20 years of experience and case law since the enactment of the Bankruptcy Code of 1978, generally works well. Indeed, the market for proper, deliberate asset securitization is booming under present law. There is no need for a change, especially one that would throw out a century of court decisions carefully distinguishing two types of transactions—sales and loans—that often look similar but have fundamentally different economic functions.

The proponents of §912 make the claim that every credit group makes when it petitions Congress for preferential treatment in bankruptcy: Financing costs will be reduced because of greater "predictability." Unfortunately, it is not possible to lower total costs when total risks remain the same. Instead, §912 simply gives one group of lenders a much better position than all the others, driving up the costs for all other parties. Naturally, giving one interest group the right to ignore the rules that all the other creditors have to obey makes it "predictable" that the favored group will do better if there is a bankruptcy of the debtor. Favored institutions may charge less to make loans if they know they will be given a substantial advantage over all the other creditors. Yet there is no reason that these securitized creditors should be given a special preference over banks, bondholders, suppliers, tort victims, pension funds and employees who will be forced to bear the increased risks, whether they can afford to or not.

Bankruptcy courts have always been charged with looking through transactions to determine their economic effect. Labels do not govern, as bankruptcy courts are quick to point out that they will not be fooled by form over substance. Section 912 proposes to do exactly that: strip the court of the authority to analyze the economics of the transaction to see if it was a loan or a sale, instead binding the courts to the labels selected by the very parties who benefit from those labels.

The Risks Associated with Asset Securitization

Some creditors have attempted to use the fundamental distinction in bankruptcy law between loans and true sales to disguise a commercial loan so that lenders will be treated instead as "buyers" of the debtor's property. If they can reclassify themselves as buyers, these lenders will be free from the collective treatment of bankruptcy. Not every asset securitization is a disguised loan transaction, and asset securitization is a valuable financial tool. Yet it is essential that the Bankruptcy Code not be amended to open a massive loophole so that parties interested in dealing with certain assets who simply rename a "loan" a "sale" will be exempt from bankruptcy because the property was no longer part of the debtor's estate.

There are significant risks associated with permitting loans to be treated as sales, as the proponents of §912 would do:

1. Asset securitization will prevent many businesses from being reorganized at all. Chapter 11 depends on a collective disposition of all assets of the estate. Lenders who have taken property of the debtor as collateral for a loan receive extensive protection under the Bankruptcy Code, but they are not granted the unilateral ability to walk away from the bankruptcy with the assets of the estate—leaving a business that cannot be reorganized. This has a direct impact on jobs. The most obvious case in point is LTV Steel, which would have shut down immediately on filing if the creditor claiming it had "purchased" LTV's accounts had been allowed to remove the corporation's most liquid assets. Currently, several airlines have securitized their receivables. The result: They could be cut off from their principal sources of cash if they filed for bankruptcy and §912 were law. We could face the spectacle of the government giving the airlines billions in tax dollars, only to have substantial assets of the business removed from the company in "off-book" transactions for which no one would be held accountable.

2. Creating an unregulated safe harbor for asset securitization has ominous implications for the securities markets. In the wake of the Enron debacle, when regulators, former employees and the investing public are calling for strengthened reporting requirements, §912 moves in the opposite direction. It would give safe harbor protection to transactions that facilitate the undisclosed reallocation of risk. While Article 9 security interests and real estate mortgages are always public, parties dealing with a business with securitized assets have no similar public notification that assets that appear to belong to the debtor have been, in fact, removed from the bankruptcy estate altogether. By its terms, §912 appears to exclude assets from the estate that would otherwise be treated as estate assets subject to only an unperfected security interest.

3. Enron demonstrates that the "off-book" transactions of asset securitization can mislead other creditors, investors, auditors and the public. Enron already has disclosed that it moved at least $2.4 billion in assets off its balance sheet but retained the risks associated with those assets through swap agreements. The employees, creditors, pension funds and other investors in Enron were forced to bear risks that were not disclosed. If the current proposal were in place, the bankruptcy court would be denied the opportunity to make certain these kinds of transactions were not disguised loans and to allocate the risks approximately.

Under current law, if a company in bankruptcy pays its workers and buys supplies to produce new goods, those goods belong to all the creditors collectively as property of the estate. When they are sold, the accounts receivable enrich the estate and give the business a chance to survive. Section 912 appears to alter this result. Anything the business produces that creates an account receivable would be swallowed by the party to the asset securitization who had "purchased" all the accounts, leaving the estate with nothing to pay the employees who did the work, the trade creditors who furnished the raw materials, and the other creditors who hoped to profit from the going-concern value of the business. Under those circumstances, it is fair to say that no business could survive. If this is not the intent of the proponents, then the whole section should be dropped or sharply amended.

The Border Between Sales and Loans

The question presented by §912 of H.R. 333 is how to patrol the border between a loan and a true sale—between what a company owns and what it owes. Under current law, that determination is based on who bears the risks and who receives the benefits of owning the asset. Property that has been sold is not part of the bankruptcy estate. Property that is collateral for a loan remains property of the estate, albeit subject to the creditor's lien. Section 912 would virtually eliminate this distinction from the law, so long as a private rating agency deemed at least one tranche of the securities issued under the securitization as "investment grade." Having this critical distinction turn on an assessment by a private rating agency is wholly inadequate:

1. Section 912 confers its extraordinary favors only upon transactions rated by private rating agencies, delegating to those rating agencies an extraordinary and very valuable power. There is no reason to suppose that the rating agencies will not consider their own self-interest in exercising that power. Rating agencies have virtually no accountability to anyone but their shareholders.

2. Private rating agencies rely, in turn, primarily on letters from attorneys, who are serving the parties to the transaction, to make legal proclamations about what is and what is not a "true sale." This bill provides no regulation or oversight of the agencies' own self-interest in the transactions. The agencies will not function as insurers, paying their own money if it turns out that the "selling" party was left with the risks commensurate with a loan, so that form of market discipline is missing. Instead, the agencies collect their fees whether the parties subsequently succeed or fail, pushing losses onto thousands of unsuspecting creditors and investors.

3. Legal opinions from the parties' own lawyers provide inadequate protection. The lawyers signing these letters are paid by the parties; they do not represent the interests of all the other creditors and investors affected by the characterization of the transaction—including the employees, retirees, pension funds, trade creditors and tort victims. Moreover, once the law is amended to eliminate any review standards, the opinion letter will simply reflect the state of the law. If the law has no standards, then the attorneys can truthfully say that no transaction fails those standards.

4. Section 912 specifically prohibits consideration of virtually all of the evidence that tells us today whether a transaction is a loan rather than a sale. Whether a debtor remains liable if the value of the asset is not as great as the amount advanced by the buyer/lender, whether the debtor continues to administer the asset, how the transaction is treated for accounting purposes, and how the transaction is treated for tax purposes—these factors are all relevant to whether the transaction is a sale or a loan. Yet the statute specifically prohibits consideration of these factors to determine whether it is a loan or a sale. In other words, the statute is designed to ratify an asset securitization even if every economic and legal standard otherwise applicable would hold it to be a loan—and, accordingly, property of the estate subject to creditor, investor and judicial oversight.

Fraudulent Conveyance Law Cannot Police Fraud in this Area

Section 912 does provide that a transaction will continue to be subject, after a fashion, to application of fraudulent conveyance law under 11 U.S.C. §548(a). This provision will do nothing, however, to protect investors and other creditors from being deceived by the mischaracterized transactions. Fraudulent conveyance law affords insufficient protection against a secured loan transaction disguised as a sale for purposes of helping lenders escape the bankruptcy laws:

1. Section 912 would erase the "intent to hinder, delay or defraud" standard of current fraudulent conveyance law. Under current law, an action taken with no intent other than to avoid the consequences of bankruptcy may be treated by a court as fraudulent under the "intent to hinder, delay or defraud" standard. But if federal law says that asset securitization, regardless of deliberate intent, is legally permissible, then any protection offered by fraudulent conveyance law would be overridden. According to its sponsors, the financial device is always undertaken to avoid bankruptcy; most courts probably would then read §912 as Congressional authorization of these devices without regard to the intent of the parties.

2. Fraudulent conveyance law is the wrong vehicle to police the difference between a loan and a sale. Loans from a lender to a debtor pass the "reasonably equivalent value" tests of fraudulent conveyance law; the debtor receives consideration and, if the loan is secured, the lender receives a security interest in collateral. Fraudulent conveyance law is designed to stop gifts or other transfers for too little value when a debtor is insolvent. It does nothing to police the boundary between a sale and a loan. The problem—disguising a loan so that it will be treated as a sale under bankruptcy law—is not solved with the "reasonably equivalent value" tests of fraudulent conveyance law.

3. Section 912 even limits the application of fraudulent conveyance law to §548(a), which has a one-year statute of limitations. This means that state fraudulent conveyance laws, which come into the Bankruptcy Code through §544, will be deemed inapplicable. State statutes of limitation are typically four to six years. Under §912, any "look back" would be limited to one year. This effectively means that one year after a securitization, there would be no legal oversight of any kind.

Protecting the Securitization Market

The result of this proposal will be to render impossible untold corporate reorganizations that would save jobs and would give most creditors a much higher return from a company in financial trouble. Instead, if §912 becomes law, those companies will liquidate, leaving little for creditors and nothing for stockholders and employees. It will also sharply reduce the public disclosure essential for a healthy marketplace.

The advocates for this bill repeatedly point out that asset securitization is a rapidly growing, multi-trillion dollar business. If so, it does not need help to survive, particularly if that help comes at the expense of smaller creditors, investors, jobs and increased business failures. In any case, as the Enron experience dramatically illustrates, the law in this area should not be changed without much greater investigation into current business practices and a thorough and thoughtful consideration of the implications of such change.

Yours truly,

Allan Axelrod
Professor Emeritus
Rutgers School of Law, Newark
The State University of New Jersey

Larry T. Bates
Associate Professor of Law
Baylor University School of Law

Susan Block-Lieb
Professor of Law
Fordham University School of Law

Jean Braucher
Roger Henderson Professor of Law
University of Arizona

Mark E. Budnitz
Professor of Law
Georgia State University College of Law

Andrea Coles Bjerre
Visiting Assistant Professor of Law
University of Oregon School of Law

Susan L. DeJarnatt
Associate Professor
Temple University School of Law

Wilson Freyermuth
Associate Professor of Law
University of Missouri-Columbia

Karen M. Gebbia-Pinetti
Professor of Law
University of Hawaii School of Law

Nicholas Georgakopoulos
Professor of Law
Indiana University School of Law
University of Connecticut School of Law

Joann Henderson
Professor of Law
University of Idaho College of Law

Edward Janger
Associate Professor of Law
Brooklyn Law School

Allen R. Kamp
Professor of Law
John Marshall Law School

Kenneth C. Kettering
Associate Professor
New York Law School

Kenneth Klee
Acting Professor of Law
University of California at Los Angeles

John W. Larson
Associate Dean for Academic Affairs
Florida State University College of Law

Robert Lawless
Earl. F. Nelson Professor of Law
University of Missouri

Jonathan C. Lipson
Assistant Professor of Law
University of Baltimore School of Law

Lynn LoPucki
Security Pacific Bank Professor of Law
University of California at Los Angeles

Lois R. Lupica
Professor of Law
University of Maine School of Law

Bruce A. Markell
Doris. S. & Theodore B. Lee
Professor of Law
University of Nevada Las Vegas

Juliet M. Moringiello
Associate Professor
Widener University School of Law

Larry Ponoroff
Vice Dean & Mitchell Franklin Professor of Privatization & Commercial Law
Tulane University School of Law

Nancy B. Rapaport
Dean & Professor of Law
University of Houston Law Center

Charles Schafer
Professor of Law
University of Baltimore School of Law

Charles J. Senger
Professor of Law
Thomas M. Cooley Law School

Charles J. Tabb
Alice C. Campbell Professor of Law
University of Illinois at Urbana-Champaign

William T. Vukowich
Professor of Law
Georgetown University

Thomas M. Ward
Professor of Law
University of Maine School of Law

Elizabeth Warren
Leo Gottlieb Professor of Law
Harvard Law School

Donald J. Weidner
Dean & Professor
College of Law, Florida State University

Jay Lawrence Westbrook
Benno Schmidt Chair of Law
University of Texas

William C. Whitford
Emeritus Professor of Law
Wisconsin Law School

Jane Kaufman Winn
Professor of Law
Dedman Law School
Southern Methodist University
University of California-Berkeley

William Woodward
I. Herman Stern Professor of Law
Temple University School of Law.

Editor's Note: To read the reply of the Bond Market Association to this letter, as well as more commentary on §912, visit ABI's home page at www.abiworld.org.

Journal Date: 
Friday, March 1, 2002