S. 1914 Business Bankruptcy Reform Act
Analysis of S.1914 Business Reorganization Provisions
Christian C. Onsager, Co-chair
ABI Business Reorganization Committee
Faegre & Benson LLP
Prepared by the American Bankruptcy Institute<
Web posted and Copyright © June 16, 1998, American Bankruptcy Institute.
The purpose of this paper to analyze the potential impact of S.1914 as it relates to business reorganizations. It is the product of the Business Reorganization Committee of the ABI. The ABI is the nation’s largest multidisciplinary organization of professionals devoted to research and education on issues related to insolvency. ABI’s more than 6,200 members represent both debtors and creditors in business and consumer cases. While ABI takes no advocacy positions on pending legislation, it regularly testifies before Congressional committees and provides analysis of the impact of such legislation.
In 1994, Congress authorized and funded the National Bankruptcy Review Commission, which filed its report in October 1997. The Commission heard many hours of testimony by various interested parties and had the benefit of recommendations from its Working Groups. The ABI assisted the Commission by preparation of a survey on preference laws, a survey of ABI members’ impressions on various issues, and a series of symposia on nine different issues. The recommendations of the Commission are far-reaching and, in some instances, controversial.
The Commission’s final Report recognized that the Bankruptcy Code is a complicated and integrated system, composed of many pieces designed to balance the rights of the different interests. Since the adoption of the Code in 1978, there have been numerous amendments designed to address the concerns of a particular constituency. Such modifications to the system often have unintended consequences and provisions which appear to prefer a particular creditor group vis a vis a debtor may adversely affect the rights of other creditor groups. This often unintended effect can jeopardize potentially successful reorganizations. Successful cases preserve jobs and provide a source of continuing business for trade creditors.
Although the centerpiece of S.1914 relating to business reorganizations is the adoption of "small business bankruptcy" provisions, a number of other provisions of the Billcould significantly impact the business reorganization process and the rights of various constituencies.
Section by Section Analysis
General Comment. One impetus for the creation of a separate procedure for small business cases is the perception that Chapter 11 in its current state is not "one size that fits all." The small business provisions may, however, not eliminate the perceived problems for small and medium size cases, if there is not sufficient flexibility to create exceptions when appropriate for the benefit of creditors and reorganizing businesses.
Section 401—Small Business Defined. S.1914 proposes to define small businesses in terms of a total noncontingent, liquidated, secured and unsecured debt of $5 million or less (excluding insider debt) or unlimited debt for single asset real estate debtors. Under these limits, approximately 86% of current Chapter 11 cases would be small business cases. The use of total unliquidated noncontingent debt has the advantage of relative certainty, and Bankruptcy Judges are generally familiar with this test.
The disadvantage of a binding debt limit test is that it is not always an accurate guide to the potential complexity of a reorganization case. Thus, many debtors with smaller amounts of liquidated debt, but large amounts of unliquidated potential liabilities, may be forced into a faster track Chapter 11 which is not necessarily in the best interests of thevarious creditors constituencies. Indeed, some of these constituencies may be holders of the unliquidated debt, such as tort claimants or holders of claims relating to environmental liabilities. For example, a Chapter 11 case in Maine involved a small independent power producer, which was a small town’s major employer. A flood disrupted its operations and created serious "downstream contamination" issues. Sorting out environmental claims (both potential and actual) and insurance coverage, as well as sale of the business, took over a year. A 150 day deadline would have caused the failure of the case to the detriment of the employees, the economy of the small town and the creditors.
Such cases are not unusual. At a minimum, some mechanism should be considered which would allow the court to "opt out" of the small business procedure in the appropriate case.
Section 402—Rules for Disclosure Statement and Plan. A disclosure statement is intended to contain such information as is necessary to allow creditors to cast an informed vote, but is often an item of considerable cost to even a small business debtor. Following a trend in the Bankruptcy Courts, Section 402 grants significant additional flexibility regarding the form, content and timing for approval of a disclosure statement in Chapter 11 cases. The ability to streamline a disclosure statement, especially in cases where the creditors are already familiar with the business, offers the advantage of expense reduction.
One concern is the language in proposed § 1125(f)(2)(B), which would allow a courtto eliminate a separate disclosure statement. The disclosure statement requires the debtor to set down in writing its forecasts and the assumptions on which such forecasts are based. The disclosure statement process serves as an important control on business debtors, as well as an important source of information for unsecured creditors who, as a body, are often not represented in smaller cases. If this section is read to permit the total elimination of the disclosure statement, it would shift the burden of discovering critical information to unrepresented creditors, who may be in the least favorable position to obtain and disseminate the information in a cost efficient manner. The court’s ability to streamline the disclosure statement to fit the case would provide beneficial flexibility.
Section 403—Standard Form Disclosure Statements and Plans. Section 403 proposes the development of standard form disclosure statements for small business cases. Such forms, particularly in very small cases, offers the potential advantage of reducing costs and providing often unsophisticated debtors with help as to the type of information to provide. Care should be taken so that any rule mandating the use of standard forms does not conflict with the flexibility of the court under proposed Section 402.
Section 404—Uniform National Reporting Requirements. Proposed section 404 would require periodic reports to be filed by the small business debtor with certain current and projected financials. The proposal requires basic information which virtually any debtor,including small business debtors, should be able to produce in order to allow the Court to evaluate their prospects for reorganization on an ongoing basis. In addition, the section would give the Bankruptcy Court flexibility to expand the reporting requirements if deemed appropriate.
Any increase in the cost or potential burden on management of the debtor should be deminiums as Section 404 would require only relatively simple and basic information.
Section 405—Uniform Reporting Rules and Forms. This section would require the development of Bankruptcy Rules regarding the uniform national reporting requirements mandated under section 404. Such rules would have the advantage of potentially reducing the cost of the reporting requirements and thus the cost of the overall reorganization effort. Standard forms would be disadvantageous only to the extent the rules do not provide sufficient flexibility to vary the forms when appropriate.
Section 406—Duties in Small Business Cases. This section would expand on the duties of a small business debtor. It would require the debtor either (i) to file its most recent "balance sheet," "statement of operations and cash flow statement" and its most recent federal income tax return, or (ii) to state that the financial statements and income tax returns are not available, all within three days of the filing of the petition. The apparent object of this expanded duty is to provide creditors and the U.S. Trustee with increased informationfrom the outset of the case, pending the filing of the schedules. The additional information would supplement the initial financial report already required to be filed with the U.S. Trustee, which is due fifteen days after filing of the petition.
There is an ambiguity regarding the contents of the statement of operations or a cash flow statement. Also, there is some question as to the utility of the information at the outset of the case, particularly for unsecured creditors. Much of the information will be contained in the schedules which, under the proposed statutory amendments, will have more stringent requirements. Accordingly, the additional burden on the debtor may add some cost while being of little use to creditors.
Section 406 would require either senior management or counsel to attend court scheduling conferences, initial debtor interviews, and the meeting of creditors. This statutory amendment does not appear to change current practice in most courts.
Section 406 would make it more difficult for a small business debtor to obtain an extension of the time to file schedules. There is limited flexibility given to the court to extend the deadline. The books and records of many small business debtors are in disarray and are often a contributing cause to a reorganization filing. Under the proposed language, it is unclear whether such disarray would constitute "extraordinary and compelling circumstances" that would merit an extension, and thus a case may fail unnecessarily to the potential detriment of unsecured creditors.
Section 406 would require timely filing of post-petition financial and other reports, the maintenance of insurance, and the timely filing of tax returns. This does not change existing practice in many courts.
Section 406 would require timely payment of all administrative expense tax claims, which is generally consistent with existing practice in many courts. The proposal is unclear as to whether a debtor is required to only make payment in the amount shown in a filed return even if the governmental taxing unit asserts a larger claim.
The proposed amendment would also require the debtor to establish separate accounts for the deposit of trust fund taxes. Segregation of such taxes is not required outside of bankruptcy and may result in some small increase in administrative expense.
Section 406 would also allow the U.S. Trustee, bankruptcy administrator or a designated representative to inspect the debtor’s business premises, books, and records after reasonable prior written notice. This provision would expand upon the existing rights of the U.S. Trustee or bankruptcy administrator, which are available only after notice to the debtor and opportunity for hearing in the event of any dispute. The provision raises due process concerns. Moreover, as a practical matter, the U.S. Trustee or bankruptcy administrator may not have the resources to conduct such inspections or the expertise to accurately analyze the information. The intent of "designated representative" is unclear, and could allow the designation of creditors or others whose interests are potentially adverse to the debtor. For example, provisions to preserve trade secrets are not included.
Section 407—Plan Filing and Confirmation Deadlines. Section 407 of the bill would set a statutory deadline of 90 days for the small business debtor to file a plan of reorganization and imposes stricter requirements on any extension. This section must be considered in connection with Sections 408 and 409 , which would require a court to confirm a plan within 150 days of the petition date and would only allow extension of confirmation on the same conditions. In some cases, these shortened deadlines may be appropriate to bring a measure of objective discipline to the process.
However, the use of deadlines presumes that speed equates with efficiency, lower cost, and the best interests of creditors. In many cases, the interests of the unsecured creditors are better served if confirmation is delayed. For example, a debtor may need additional time to carry out a changed marketing strategy; a turn-around expert may need additional time to actually accomplish the task of turning around the company’s business; or a company’s product may need additional development time. In many cases, it would appear the primary beneficiary of statutory deadlines for plan filing and confirmation are secured creditors. Thus, absent the ability of the Courts to grant extensions that would benefit unsecured creditors, sections 407, 408 and 409 appear to strengthen the protection of secured creditors at the expense of the often unrepresented unsecured creditors.
Further, Chapter 11 is often used to effectuate an asset sale of the company to a buyer who will continue some or all of the business. The proceeds of sale often significantly enhance the return to secured and unsecured creditors. As a practical matter, such casescannot be filed initially as Chapter 7 liquidation cases because a trustee does not have the ability to operate the business in order to maintain its going concern value. Once the sale has taken place, however, such cases are often converted to Chapter 7 as a more efficient mechanism for distributing the sale proceeds. The bidding and sale process may take longer than the proposed deadlines. Conditioning an extension of the statutory deadlines on a showing that a plan of reorganization can be confirmed may thus allow one creditor constituency to disrupt the sale process to the detriment of the other creditors.
The statutory deadlines also create practical mechanical and practical problems. Bankruptcy Rule 2002 requires at least 25 days’ notice of the hearing on approval of the disclosure statement and an additional 25 days’ notice for the hearing on confirmation. The statutes, however, leave only a 60-day gap between the time a plan may be filed and the time it must be confirmed (the difference between 90 and 150 days). There may also be an issue of availability on a court’s calendar.
Section 410—Duties of the United States Trustee and Bankruptcy Administrator. Section 410 of the bill would impose significant new duties on the office of the United States Trustee, including the obligation to investigate the debtor’s viability and to review and monitor the debtor’s activities throughout the case. There may be benefits from an institutionalized role for a bankruptcy examiner who could evaluate and monitor the debtor’s business for the benefit of creditors. In reality, however, this institutionalization may createmany problems. Chapter 11 filings encompass every conceivable kind of business with every conceivable kind of problem. A useful investigation of a debtor’s viability and business plan and monitoring of the debtor’s activities require numerous different types of expertise for each type of business. The U.S. Trustee’s office currently neither has this diverse expertise nor the funds with which to develop such expertise.
Moreover, there is the potential for a dramatic increase in the bureaucracy that would be required to implement these investigatory duties. The investigation and continuous monitoring of a debtor’s viability is not a process which takes one or two hours, if it is to be accurate and useful. In a strong economy, there are approximately 27,000 Chapter 11 filings a year. Of these, it is conservatively estimated that at least 80% will be small business cases as defined by the statute even if the average investigation and monitoring were only ten (10) hours per case, and the case load remained constant - it would take over five thousand full time employees. The resulting manpower needs could be significant.
Section 411—Scheduling Conferences. This proposed section would require the court to hold a status conference on its own motion or the request of any party. Generally, it reiterates a power which virtually all bankruptcy courts believe they can now exercise. Consideration should be given to changing the language "shall hold such status conferences" to "may hold such status conferences," so that each court will not be required to hold a conference at the whim of every creditor.
Section 412—Serial Filer Provisions. Generally, section 412 provides that the automatic stay will not be available to a small business debtor that files a new Chapter 11 case within two years of obtaining confirmation of a plan of reorganization in a prior case. Currently, whether and under what circumstances a debtor may file successive Chapter 11 cases differ from court to court. Courts either (a) allow a successive Chapter 11 filing subject to requirements of good faith; (b) allow a successive filing after a showing that the prior confirmed plan has failed for reasons that could not reasonably be foreseen or (c) prohibit all successive Chapter 11 filings. This provision provides certainty with regard to the ability to file sequential Chapter 11 cases.
However, rather than defining the requirements for a permissible second Chapter 11 filing, the proposal would remove the protections of the automatic stay in the second case unless the debtor makes certain evidentiary showings sufficient to justify a reimposition of the stay. This provides little relief for the unsecured creditors in the second filing. The proposal would benefit secured creditors at the potential expense of unsecured creditors.
However, the secured creditor may be allowed to foreclose before the debtor (and the potentially unsecured creditors) has obtained relief. This concern is reflected in the current Bankruptcy Code which provides for the stay to be automatic, subject to the right of a creditor to obtain an order "lifting" the stay in the appropriate circumstances.
The proposal would allow the debtor to obtain an order reimposing the stay in a second Chapter 11 case upon a showing that it could confirm a feasible plan, other than aliquidating plan. This appears to statutorily reverse the current assumption that a second Chapter 11 filed for the purpose of liquidation is presumptively in good faith. As noted, an liquidating Chapter 11 is often a useful vehicle to maximize the return for creditors by preserving the going concern value of all or some of the business pending a sale (i.e., pending a liquidation). For that reason, liquidating plans are often favored by both secured and unsecured creditors and the statute appears to eliminate this valuable use of Chapter 11 in serial filings for no apparent countervailing benefit. If, as a matter of policy, the reversal of burdens regarding the automatic stay is deemed the appropriate control mechanism for serial filings, it may be more appropriate to provide for automatic imposition of the stay as in all other bankruptcy cases, subject to reduction in burden of proof on the part of the secured creditor for its removal or a shift of the burden of proof to the debtor to support continuation of the stay.
Further we note that the proposed statute appears to be internally inconsistent. Subsection (1)(D) would appear to remove the stay in those circumstances in which subsection (3)(A) would impose it.
Section 413—Expanded Grounds for Dismissal or Conversion and Appointment of Trustee. Section 413 of the bill establishes additional grounds for dismissal or conversion of a Chapter 11 case. It also would set short deadlines within which the court must hold a hearing and rule on a motion to dismiss or convert. The list of new grounds are generallyduplicative of those currently examined by the courts and codification could provide uniformity.
Other language in the proposal warrants scrutiny. Currently, the bankruptcy court "may" dismiss a case upon the requisite showing, which generally relates to the "best interests" of creditors. The proposed section 413 appears to make dismissal mandatory if a creditor makes the requisite showing regardless of the best interests of the general creditor body. As a result a single creditor with its own agenda can cause a dismissal of the case to the disadvantage of the majority of other creditors, secured or unsecured. There appears to be little reason deprive the bankruptcy court to weigh the interests of all constituencies.
The proposed amendment would also impose specific deadlines by which the court must (a) hold a hearing and (b) decide the matter. The impetus for such deadlines appears to be a perception that certain courts defer or delay such decisions. Assuming this to be the case, the setting of mandatory deadlines for hearings can create problems for the court and creditors. The Bankruptcy Code already sets deadlines, with potentially severe consequences if such deadlines are not met (e.g.. relief from stay hearings). A full hearing on a motion to dismiss may take a half to a full day or more of court time. The Bankruptcy Courts may have difficulty fulfilling another statutory mandate to hold hearings in a relatively short period.
Section 414—Single Asset Real Estate Defined. Section 414 of the bill proposes three changes: (1) defining a single asset real estate as "a single development or project" ratherthan a "single property or project;" (2) excluding from the definition of single asset real estate property on which an affiliate of the debtor is conducting a substantial business (provided the affiliate is also in Chapter 11); and (3) eliminating the current $4 million dollar secured debt cap.
Clarification of the definition of "single asset real estate" would be beneficial, as the current statute is somewhat ambiguous. However, the suggested change does not appear to accomplish such a goal. Moreover, the change to "single development or project" combined with the elimination of any dollar cap on secured debt would expand the definition of single asset real estate cases to include many large real estate projects, (i.e. large residential developments and most shopping center developments would be included) even though these projects do not generally display the characteristics of the more traditional "single asset real estate" cases.
Section 415—Plan Confirmation. Proposed section 415 would impose certain requirements for confirming a reorganization plan involving single asset real estate over the objection of secured creditors holding unsecured deficiency claims. In general, the proposal would condition confirmation on the contribution of new capital sufficient to pay down secured claims to a 75% loan-to-value ratio. In general, this proposal seeks to bring certainty to the concept of the "new value" rule and, assuming new value is permissible, the amount of "new value" that is required to confirm a plan.
The language may create unintended consequences. First, it is not clear that the class of secured claims holding unsecured deficiency claims are creditors that are secured by the single asset real estate. Thus, it is possible that the beneficiaries of the 75% loan-to-value ratio test would not be creditors who are secured by the real estate. Third, the proposal as drafted may be unintentionally overinclusive. A manufacturing business (or other substantial business) that leases its site from an unrelated party would be subject to the requirements of section 415. The Section should be restricted to debtors that own single asset real estate.
The statute provides that new value that must be infused cannot be convertible into any form of debt. Such a restriction would eliminate the possibility of infusion through unsecured or secured subordinated debt or debt that is secured by some other asset of the debtor. The purpose of the provision is apparently to provide the secured creditor with an equity cushion for its secured claim. This restriction on the form of the capital infusion does not appear to be logically related. Fourth, the provision requires a 75% loan to value ratio, notwithstanding the fact that the original loan may have been a high risk venture that was only marginally or even partially secured. As a matter of policy, should the position of such creditors be improved in a Chapter 11 case at the expense other potential beneficiaries of any new value infusion?
Section 416—Payment of Interest. Current law requires a debtor to commence payments to secured creditors in a single asset real estate case within 90 days of the filingequal to current fair market interest rates. The new proposal would require the payments to be made only after the later of ninety days or when the court determines that the case is a single asset real estate case. The proposed language would allow the debtor to make the payments from rents generated by the property, whether or not the secured creditors consent. This change cures a potential ambiguity.
The proposal would also change the applicable interest rate to the currently applicable contract rate rather than the current fair market rate. This change would prevent debtors with fixed rate mortgages from using Chapter 11 as a tool to force refinancing at a lower interest rate if the interest rates have dropped. However, the change is a departure from the rule that a secured creditor should be adequately protected only against the interest it would lose if it were entitled to foreclose and reinvest the funds realized from the foreclosure at current market rates. In all events, the proposal should follow that in H.R. 3150 by adding the words "non-default" between "then applicable" and "contract rate of interest" to prevent a creditor from obtaining an artificially high rate of interest at the expense of other creditors.
General Comment. In general, Sections 501 through 515 of the proposed bill clarify the rights of taxpayers in the government in bankruptcy cases. For the most part, these proposed changes would further clarify the law or fix minor but troublesome inconsistencies. A few provisions, however, have far-reaching consequences that should be evaluated carefully.
Section 501—Effective Notice to Government. Section 501 of the proposed bill would radically alter the current requirements for notice to governmental units. Any notice to a governmental unit would be required to include various items of information that might be helpful to the governmental unit, such as the taxpayer identification number, the account or contract number or real estate parcel number, a description of the nature of the debt and the particular subdivision, agency or entity of governmental unit that is concerned. The debtor would have the burden of proof regarding the issue of notice in any dispute. Governmental units could, at their election, file a "safe harbor address" with the clerk of the court and notice made to a safe harbor address would be presumed given.
In some instances, notices in bankruptcy cases are sent only to a general address for a state or municipality. Larger governmental units such as states and larger cities apparently encounter difficulties in routing these notices to their correct departments or agencies. Section 501 is an attempt to resolve this problem by requiring debtors to make their notices more specific when dealing with governmental units. The concept of a safe harbor address for each governmental unit would be very useful if governmental units uniformly elect to provide such addresses.
As proposed, however, the notice requirements are potentially very onerous and problematic. The proposed statute covers not only notice of the bankruptcy filing itself, but every motion or other notice sent by the debtor during a case. In a modest Chapter 11 case, such notices are numerous; in a large chapter 11 case, there may be hundreds of notices (which in turn would need to be sent to thousands of different governmental units). Under the proposed statute, the penalty for failing to give any one of these numerous notices in proper form would be to prevent discharge of the obligation to the governmental unit, regardless of the content of the notice.
The proposed notice procedure also treats governmental units significantly more favorably than private parties who may have similar notice difficulties, e.g., larger corporations with numerous divisions.
The mechanics of giving the required notices is likely to create practical difficulties for debtor and its counsel. In a typical Chapter 11 case, a debtor may be required to serve hundreds of parties at a time; the time and expense of giving special notice to governmental units is likely to be substantial. Even in a modest Chapter 11 case, the debtor may own numerous properties in different states or deal with numerous different governmental units in many different locales. In each notice to each of these local government units, the debtor would be required to provide the laundry list of particularized information. In a national retail case, the complexity is beyond comprehension.
Many chapter 11 filings are done on an emergency basis, with little opportunity to prepare. At the outset of many filings, however, a debtor needs emergency relief on matters such as use of cash collateral, financing, authority to pay employees, etc. In such circumstances, it is often impossible as a practical matter to give notice to all non-government creditors, much less all governmental units with the special information particularized for each unit. Yet the penalty for failing to do so even in such exigent circumstances would be the non-dischargeability of the governmental units’ claims, to the potential detriment of the other creditors, as well as to the debtor.
Determining the correct contact person for notices to a governmental unit can be a frustrating and difficult task, even for sophisticated debtors. For example, it is often difficult to determine exactly which governmental department may handle a particular kind of claim. Moreover, notice must often be sent to creditors who the debtor believes may have a claim, but who have yet to assert it. Ascertaining the correct department is difficult enough for debtors who are aware of actual claims by governmental units. The proposed legislation would shift the consequences of this confusion to the debtor and require nothing in return from the governmental units.
It should be noted that the statute imposes the potentially burdensome notice requirements on the debtor, but not on any other party to the case. Thus, notices of actions by other parties that may affect the interests of one or more governmental units will be given in a manner different than is required for notice by the debtor.
Most tax claims are already nondischargeable. In chapter 11 cases, a plan must provide to pay virtually all tax claims in full in order for the plan to be confirmed. The proposed notice requirements therefore are not necessary to ensure payment of tax claims. With regard to other debts, no other creditor is entitled to the same kind of detailed notice. Moreover, making government claims nondischargeable (if the notice is for any reason erroneous) leaves governmental units in competition with other creditors whose debts are automatically not dischargeable, e.g., mothers owed child support. Indeed, the effect of the notice statute may be to elevate the government’s general unsecured claims to nondischarged status while priority tax claims remain dischargeable.
Finally, the proposal as drafted is internally inconsistent regarding proof of notice. The proposed §342(f)(1) states that to take advantage of the statute, the governmental unit must demonstrate "by a preponderance of the evidence, that the governmental unit did not receive timely actual notice as required..." The proposed §342(f)(2) states that the "debtor shall have the burden of proof in refuting an assertion by a governmental unit under paragraph (1) that the governmental unit did not receive the timely actual notice referred to in that paragraph." Thus, each party appears to have the same burden. Further, it is unclear whether the statute is intended to alter the presumption that notice is received by a party if deposited into the U.S. mail, postage prepaid (known as the "mailbox rule") since the statute addresses timely "actual" notice.
Although the provision allowing the government to supply a safe harbor address may be of some assistance, it is effective only to the extent the governmental units voluntarily provide such addresses. Further, many chapter 11 debtors do business in numerous different states other than the district in which the bankruptcy case is filed. Unless every governmental unit files its safe harbor address in every bankruptcy court in the country, the notice of safe harbor addresses will not be effective.
Other less disruptive mechanism may be more effective. For example, the presumption in the statute might be reversed: notice would be ineffective if a governmental unit has filed a safe harbor address, but that address is not used. This would induce governmental units to file safe harbor addresses. The issue of where the addresses would be filed and how debtors and counsel could access them immediately from any jurisdiction would need to be addressed. Governmental units could establish a single central address for bankruptcy notices, e.g. city attorneys and Attorneys General.
Section 508—Periodic Payment of Taxes in Chapter 11 Cases. Section 508 would require payment of unsecured priority claims and tax claims secured by liens under a confirmed plan of reorganization in quarterly installments within six years of the petition date. This provision would resolve the perceived problem of irregular payment plans. Extending the requirement to secured tax claims, however, may have the effect of requiring non ad valorem tax liens to be paid more quickly than senior mortgages. This potentialrearranging of priorities of secured claims should be examined more closely.
Section 514—Standards for Tax Disclosure. Section 514 would require a disclosure statement to contain a full discussion of the potential federal and state tax consequences of a plan of reorganization, not only with respect to the debtor, but with regard to each class of claims or interests. The current practice in most courts is to require a discussion of the potential material federal and state tax consequences to the debtor. Requiring tax disclosures with regard to hypothetical claim holders may create significant problems for reorganizing debtors and their counsel, as well as significant increases in cost. The tax treatment of creditors’ claims very often depends upon the individual situation of the creditor and how the creditor already has treated the debt for tax purposes. Such disclosure would therefore require the debtor and its tax advisors to speculate on the possible ways in which distributions under a plan might be given different tax treatments in the hands of various creditors in different situations, even within a single class. In some instances, a creditor may be entitled to different or more favorable tax treatment than in another case, and the disclosure statement would be misleading if it did not cover that creditor’s special case. Taxing authorities who allow a potentially erroneous disclosure to go unopposed could be estopped from assessing taxes against creditors. The bankruptcy court and the office of the United States Trustee, which comments on disclosure statements (and, in some jurisdictions is required to preapprove disclosure statements before the court will set a hearing) would berequired to develop even more expertise in tax matters to cover this new disclosure. Further, the propenent plan might have to conduct discovery to ascertain the treatment of debts and, in some instances, the basis in such debt.
Section 601—Executory Contracts and Unexpired Leases. Section 601 would require business leases of real property to be assumed or rejected on the earlier of 120 days from the filing of a case or confirmation of a plan. The deadline could be extended only upon motion of the landlord.
Assumption of a lease in a Chapter 11 case converts a landlord’s claim for future damages from a general unsecured claim to a first priority administrative expense. In the event the Chapter 11 case fails, courts have held that a landlord’s claim for future unearned rent under unassumed lease is senior to all priority and general unsecured creditors (including employee wage claims, tax claims and the like). For this reason, current law balances the rights of the landlord and the other creditors. By requiring a Chapter 11 debtor to commence making payments to the landlord within 60 days of the filing of the case , while allowing the Court to defer the assumption decision until confirmation of a plan when success of the case is relatively assured. The proposed change accords landlords more favorable treatment to the potential detriment of other creditors.
Moreover, since current law not only requires current payment, but also requires that leases be assumed or rejected no later than plan confirmation, the adoption of small business Chapter 11 provisions with their accelerated time lines for confirmation creates a questionable rationale to grant landlords more of an advantage over other creditor classes.
Section 602—Allowance of Claims or Interests. Section 602 of the proposed bill would change the method of calculating a landlord’s claim by allowing future estimated costs to be added to the calculation for future rent damages, while requiring that the claim be reduced by any mitigation of damages "that is required by law."
Traditionally, a landlord’s claim is calculated under applicable state law, subject to a cap imposed by the Bankruptcy Code. The proposed change would add a federally mandated element to the damage calculation which the law of a particular state may not allow. At the same time, reduction of the claim would apparently only be required if required by the applicable state law. The result is therefore a somewhat non-uniform approach to calculating lessor damages.