The Next Bankruptcy Bill

The Next Bankruptcy Bill

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No, I don't mean the technical corrections bill for S. 256—the one we all know needs to get passed. We all have our favorite examples—my personal one is that I don't see where there is any provision in the means test to deduct taxes from "current monthly income." I'm sure that Congress must have intended that, but I don't think the bill does it. "Current monthly income" is defined as all income "received" by the debtor, so one could argue that only the net income is "received" by the debtor. But that argument goes too far; debtors could have lots of bills paid through wage assignments if that were all it took to reduce their income. Perhaps taxes are accounted for someplace else, but I haven't found it yet.

But that's not the subject of this article; this one is about some of the many provisions in the Code that still need to be fixed and that haven't even been looked at during the last eight years of debate on this bill. In 1994, Congress turned out to be smarter than the bankruptcy community, which urged it not to make any substantive changes and just leave it all up to the Bankruptcy Review Commission. Had it listened, we might still be having a half dozen appellate decisions a year on how to determine the deadline for filing an avoidance action. Instead, Congress amended §546(a)(1) and shut down that cottage industry of litigation overnight.

So what other issues exist that would be nice to get resolved? Quite a few, as it turns out. Governments have a vested interest in the outcome of some of the issues I discuss below, but in many cases, these are areas that, like the avoidance deadline, simply cry out for an answer—any answer. It often doesn't matter much what the answer is, as long as it's clear and its outcomes are predictable. The points discussed in this article only skim the surface—and at that, I quit halfway through the list I compiled—but point up the wide range of recurring issues still left open even after passage of a 500-page bill. These issues are the kind that need Congressional action; the decisions on both sides are often equally compelling precisely because the Code and the Rules are inherently ambiguous or contradictory, or because the policy considerations point in different directions from the "plain meaning" of the provision. I humbly suggest these topics with the hope that it won't be another decade until that bill passes.

I start with §101 and the definition of a claim. There are many issues with the definition—not least of which is the fact that, as written, it is plainly unconstitutional. Read literally, it brings in any eventual consequence of the debtor's pre-petition actions, no matter how remote in time and causation and regardless of whether any actual damages have yet been caused by that action. As a result, it violates due process by destroying the rights of persons who may not yet have even suffered any injury from the debtor's conduct, much less have any reasonable way to know of their potential "claim" or to protect their rights during the bankruptcy.

The courts have struggled with this problem in cases such as In re Chateaugay Corp., 944 F.2d 997 (2nd Cir. 1991); In re Piper Aircraft Corp., 58 F.3d 1573 (11th Cir. 1995); and Amchem Products Inc. v. Windsor, 521 U.S. 591 (1997), and have, perhaps, wrested a degree of consensus on the issues, largely by engrafting significant constitutional limits on the actual language of the Code. There is much to be said, however, for actually debating those limits and drafting actual language to deal with the recurring situations, such as environmental contamination, hidden defects in products that cause post-confirmation injuries, and long latency illnesses caused by exposure to the debtor's products. In many respects, the problems here are the same addressed by legislatures in dealing with statutes of limitations, since the bankruptcy discharge is, in many ways, functionally equivalent to setting an artificial limitations period on raising a cause of action. If those problems can be dealt with by statute, the Code drafters can surely also address the concerns. The change could be to the definition of a claim, or it could be part of discharge exceptions. I need not define the proper amendments; I merely raise the issue.

The second problem with the definition of a claim is that it is quite murky as to whether equitable relief is or is not included.2 Governments are obviously deeply interested in this issue in that much of their enforcement activities are couched in the form of injunctive orders. Private parties as well, though, also need to know whether various forms of specific performance, for instance, will or will not be deemed to be claims and will or will not be subject to discharge upon pro rata payment from the usually minimal estate assets. Here, the case law suggests that the appropriate analysis is whether, under applicable nonbankruptcy law, the debtor can force the creditor to accept a monetary satisfaction of its injunctive rights (an analysis that tracks the standard in §363(f)(5)). If the creditor may demand specific performance or other equitable performance under state law, and the debtor cannot force the acceptance of damages, then the standard would find that such a right isn't a claim. That seems like a reasonable analysis—and it would be nice to have that issue settled once and for all.

Another change of special interest to governments would be clarification on whether §105 can be used to enjoin government actions that are excepted from the automatic stay and that enforce nonbankruptcy law pursuant to 28 U.S.C. 959(b). It is not unusual for a debtor to add a §105 fallback count, arguing that even if the action is not automatically stayed, the debtor should be able to enjoin the litigation because it costs too much, or because it's burdensome to litigate in another forum, or because the suits distract management's attention, or...well, the arguments are endless. Many of these arguments are rejected by the bankruptcy court, and when appealed, virtually every such §105 injunction has been overturned by the district courts and the courts of appeal, but the litigation is time-consuming and an unnecessary drain on all parties in the case.3 In each case, the government had to appeal a decision by the bankruptcy court to grant a discretionary stay. The government suggested changes to the National Bankruptcy Review Commission (NRBC) and continues to believe they are appropriate: explicitly require injunctions under §105 to satisfy the same standards as under nonbankruptcy law, and allow §105 injunctions against police and regulatory actions excepted from the automatic stay only if such actions may be enjoined under nonbankruptcy law.

Next, why not settle once and for all whether there is a second time period for objecting to exemptions after a case is converted from chapter 13 (or 11) to chapter 7? Everyone agrees that exemptions are not overly relevant in a chapter 13 case, and there is little reason to spend time carefully reviewing them. If the case is converted to chapter 7, however, challenging those exemptions may determine whether creditors receive anything from the case. So, it makes sense to give parties a chance to litigate the issue when it actually matters to someone. The cases, though, while recognizing these policy issues, differ markedly on whether the Code and the Rules accommodate them.4 The issue is certainly a continuing source of much scholarly thought, but is a prime candidate for being obliterated with language that clearly allows for the second objection period to be held (or not, if Congress so chose, but here the policy concerns seem to strongly point in one direction).

Next, should an action in violation of the automatic stay be void or voidable? In that courts agree that they can grant nunc pro tunc relief where appropriate, it is clear that no stay violation is truly void, in the sense that it cannot be salvaged. The main difference is who must affirmatively seek a ruling on the validity of the action.5 While it might be reasonable to leave the burden on the creditor during the initial case to obtain pardon for a violation, is there some point where, if the debtor does not object, the actions taken should become final and binding? If not, there is a great chance that transactions may go forward in good faith, and even with the debtor's agreement, yet remain liable to being upset much later by a claim that they were void ab initio. Is that necessary or desirable? Must every transaction involving a debtor be left perpetually open to attack?

And how about allowance of claims? There are numerous issues to be raised, but I'll limit the discussion to two. The first is the need for clarification on how to estimate claims. The current language gives courts no guidance as to how the estimation should be done or if the result should ensure that a creditor, if successful in a contested matter, will be able to receive its full pro rata share at the end of the day. Is the estimation a binding limit on the claim amount? The courts cannot agree.6 In addition, those courts that discount the estimated amount by the estimated likelihood of recovery, such as In re Eagle Bus Mfg. Inc., 158 B.R. 421 (S.D. Tex. 1993) (determined likely amount of backpay award in NLRB case, but then discounted by 75 percent and failed to reserve for any higher amount) ensure that claimants that win their case will not be equally compensated with other undisputed claimants because adequate reserves will not have been set aside. Requiring adequate reserves would solve the problem, so why not put this in the law?

There is no clear answer as to whether and how government regulators are to be notified of a proposed abandonment...nor any guidance as to what regulatory and financial showing must be made to justify barring abandonment.

The second point is the reference in §502(d) to disallowing a claim where a preference is "recoverable." The cases are split as to whether the trustee can object on that basis, even if he can no longer bring a preference action, so the transfer is not actually recoverable in any realistic sense.7 Even assuming the analysis should be whether there "could" have been a valid avoidance action, that still leaves many questions. Is the claim disallowed on the trustee's mere challenge to the creditor's rights, or must the court actually determine whether a preferential or fraudulent transfer occurred? Who bears the burden of proof on the issue? What about where the preference action is constitutionally barred (as the states believe is the case with respect to an action against them based on their sovereign immunity)? Can this section be used as an end-run on the states's immunity to the direct preference action?

The next area, and one that again states are deeply concerned with, is how the definition of administrative expenses relates to costs of complying with governmental obligations. The standard definition of such expenses in §503(b) says the expenses must "preserve" the estate, which is usually read to mean "benefit" the estate. That definition, though, seems quite problematic in the context of government actions. While regulations are not normally intended to harm business interests, it is fair to say that they are not often seen as being beneficial to the regulated party. Yet it is equally clear that bankruptcy is not to be a "haven for wrongdoers," and there is no generalized exemption from obeying applicable laws merely by filing bankruptcy. To be sure, many courts view 28 U.S.C. §959(b) as not applying to liquidating businesses, but that is not the same thing as saying there is any affirmative provision that exempts such businesses from obeying the law. Can a liquidating trustee, for instance, "preserve" the estate for the creditors by merely opening the faucets on the toxic chemical drums and claiming that "it's okay, §959(b) doesn't apply?" I think not. At most, there may be some category of costs for pre-petition remedial actions that courts will tend to avoid imposing on businesses.

However, a facile reliance on the "benefit the estate" test has led courts to say that back pay to illegally discharged employees was not administrative because the employees were not providing services to the employer (In re Palau Corp., 18 F.3d 746 (9th Cir. 1994)), and that costs to the state to conduct an orderly shutdown of a nursing home were also not administrative, because the shutdown was not illegal (In re Allen Care Centers Inc., 96 F.3d 1328 (9th Cir. 1996)). Congress stepped in to correct both of those rulings in the new law (see new Code §503(b)(1)(A)(ii) and (b)(8), respectively), but the same cramped view of administrative expenses, vis-a-vis government obligations, remains visible in other areas. It will continue to do so for so long as those legal obligations are being shoehorned into a provision meant to cover standard operating expenses. The result is continued battles over the costs of these obligations, most particularly regarding environmental clean-up costs, but also in other areas.

The resolution the states would like to see would go something like this. Section 959(b) would impose a general obligation to comply with applicable nonbankruptcy law (not tied to the "operation" of the facility). Section 503 would then include subsections, separate from the general "preserve the estate" language, that would make both the debtor's costs to comply with the law (and penalties for failing to do so) administrative, as well as the costs of the government if it was forced to step in to carry out such compliance where the debtor cannot or will not do so.8 The language would leave available all defenses under nonbankruptcy law, such as impossibility, so that if there are no unencumbered funds to use for compliance, that would excuse the failure to comply.

One other governmental concern is the treatment of costs for unemployment and workers' compensation benefits. Under current law, there are efforts to bring those costs under the employee benefit provisions in §507(a)4) or, for governmental entities, the excise tax provisions in §507(a)(8). There are problems with both approaches, the courts are split, and the decisions are filled with complaints about the difficulty in resolving the issues and applying the various standards.9 There is much to be said for the arguments on both sides, but isn't that beside the point? Workers' compensation benefits are, in essence, a combination of health care benefits and wage replacements, and unemployment compensation is straight wage relief. Both of those concerns—wages and health care—are explicitly protected when provided separately. Is there some reason why it makes sense not to directly protect those payments when made through statutory compensation systems? The issue was raised with Congress during the discussions on the new bill, but couldn't breach the "no amendments" wall. Its time must come soon, though, because the issues don't go away.

Let me end with two final sections of special interest to governments—§§525 and 554. These deal with "discrimination" against debtors and abandonment, respectively. Both were meant to deal with relatively straightforward issues—denying a debtor a driver's license for an unpaid debt, or allowing a debtor to remove useless junk, or fully encumbered property from the estate. Both, though, have developed in ways that seriously affect governmental regulatory authority.

Section 525, unlike §362, has no police and regulatory exception. As a result, even if a debt arises out of a regulatory process—and indeed, even if, as in F.C.C. v. NextWave Personal Communications Inc., 537 U.S. 293 (2003), the debt directly served a regulatory purpose—the government could not allow the nonpayment of the debt to affect its allocation of licenses. NextWave, perhaps, did not seem like such a problem for the government, since the debtor was, in fact, prepared, albeit belatedly, to pay the full price for the license it sought—but §525, by its literal terms, would not have required that. Indeed, applied literally, it could be a violation of §525 for the government to deny a license to a debtor that failed to pay a required fee that arises post-petition (since even post-petition debts are literally "dischargeable" under a confirmed plan). To be sure, eventually the debtor would presumably have to pay those costs when it confirmed its plan, but there is a literal argument that it can avoid doing so during the case, no matter how many years the case drags on. This is not a hypothetical; certain debtors, who will remain nameless, have actually made that claim to certain states. The states have responded by pointing to §959(b) and suggesting that they would bring this scofflaw behavior to the court's attention in the form of a motion to convert or dismiss, but surely it would be more sensible to take a critical look at §525 and redraft it so that it covers only what really needs to be protected.

As to abandonment, the primary goal of §554 was clearly never to deal with the complex issues involved in abandoning contaminated property. Nor does the brief language in Rule 6007 provide much further help. And of course, Midlantic Nat. Bank v. New Jersey Dept. of Env. Prot., 474 U.S. 494 (1986), raises far more questions than it answers. There is no clear answer as to whether and how government regulators are to be notified of a proposed abandonment, no defined standards as to whether governmental laws should be enforced in connection with such a request, nor any guidance as to what regulatory and financial showing must be made to justify barring abandonment. Indeed, it is not even clear whether, in the absence of adequate information about the hazards of a facility, the debtor is free to plunge ahead or whether some sort of assessment can be required to gain the necessary knowledge. The regulatory free-for-all that this causes serves little purpose for any party in the case. This has been, and will continue to be, an area that desperately needs to be part of the next bankruptcy bill that Congress takes up. And when that happens, it will be joined by the (literally) dozens more areas that equally beg for attention. For better or for worse, consumer debtors have held Congress's attention for the better part of a decade. It is surely time to turn attention back to all of the other areas that have not had the (perhaps dubious) pleasure of gaining equal time before Congress.


1 The views expressed herein are those of the author and should not be taken as the views of the National Association of Attorneys General or any individual attorney general. Return to article

2 See the discussions in In the Matter of Udell, 18 F.3d 403 (7th Cir. 1994); In re Ben Franklin Hotel Associates, 186 F.3d 301 (3rd Cir. 1999); and Kennedy v. Medicap Pharmacies Inc., 267 F.3d 493 (6th Cir. 2001). Return to article

3 See, e.g., In re Baker & Drake Inc., 35 F.3d 1348 (9th Cir. 1994) (regulation requiring cab drivers to be employees would not be preempted even if this made reorganization more difficult); In re Capital West Investors, 186 B.R. 497 (N.D. Cal. 1995) (HUD loan agreement must be enforced even if the bankruptcy court did not think the provisions were necessary in a particular case); In re 1820-1838 Amsterdam Equities Inc., 191 B.R. 18 (S.D.N.Y. 1996) (city's civil and criminal actions against landlord could not be enjoined just because lender was assertedly remedying violations). Return to article

4 Compare, for instance, In re Hopkins, 317 B.R. 726 (Bankr. E.D. Mich. 2004) (new challenge period applies) with In re Fonke, 321 B.R. 199 (Bankr. S.D. Tex. 2005) (not possible to raise a new challenge after conversion). Return to article

5 See In re Schwartz, 954 F.2d 569 (9th Cir. 1992) (failure to object to tax assessment entered without notice of chapter 11 bankruptcy did not bar debtor in later chapter 13 case from asserting that assessment was void). Return to article

6 Compare In re Baldwin, 55 B.R. 855, 898 (Bankr. S.D. Ohio 1985) ("estimation...conclusively sets the outer limits of a claimant's right to recover") with In re Nova Real Estate Inv. Trust, 23 B.R. 62 (Bankr. E.D. Va. 1982) (estimated claims can be reconsidered). Return to article

7 See In re Metiom Inc., 301 B.R. 634 (Bankr. S.D.N.Y. 2003), for a review of the conflict cases. Return to article

8 See, e.g., In the Matter of H.L.S. Energy Co. Inc., 151 F.3d 434 (5th Cir. 1998) (state's costs to plug closed oil wells, where debtor's cash flow issues precluded it from doing so, were administrative). Return to article

9 See, e.g., In re United Healthcare System Inc., 396 F.3d 247 (3rd Cir. 2005); In re Howard Delivery Service Inc., 403 F.3d 228 (4th Cir. 2005). Return to article

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Wednesday, June 1, 2005