S. 1914 Business Bankruptcy Reform Act

S. 1914 Business Bankruptcy Reform Act

To amend title 11, United States Code, provide for business bankruptcy reform, and for other purposes. S. 1914
Analysis Of Title VI
Miscellaneous Written by:
Mark N. Berman
Hutchins, Wheeler & Dittmar
Boston, Massachusetts

Prepared for the American Bankruptcy Institute
Web posted and Copyright © April 27, 1998, American Bankruptcy Institute.

Sec. 601. Executory Contracts and Unexpired Leases.

This section proposes to amend Section 365(d)(4) of the Bankruptcy Code to provide that when a debtor is the lessee under a commercial lease, the lease will be deemed rejected and the debtor forced to vacate the premises unless the lease is assumed within 120 days after the beginning of the case. There is also a provision that allows the commercial lease to be assumed at an earlier point in time, i.e. the date of the order confirming a plan of reorganization, but this would appear of limited utility since plans are seldom confirmed within 120 days after a case is filed. Under this amendment, the only way to extend the 120 day period is for the lessor to file a motion asking the court to grant such an extension. Once a lease is rejected, the amendment repeats the language contained in the current version of Section 365(d)(4) requiring that the property be surrendered to the lessor.

This amendment proposes a significant change in the law. It is a change that will most likely benefit lessors of commercial property at the expense of successful reorganizations and unsecured creditors. The current version of Section 364(d)(4) allows the debtor or the trustee a shorter period, 60 days, within which to either assume or reject a commercial lease, but also allows the court to extend that period if a motion seeking such an extension is filed within the 60 day period and the court finds cause for the extension. Cause usually requires that the lessor is being paid all of the rent due under the lease for the period of time subsequent to the filing of the case. In actual practice, it is common for the 60 day period to be extended. It is also common for the extension to exceed an additional 60 days.

Under Section 365(b), which is unaffected by this proposed amendment, a debtor or its trustee can assume a commercial lease by filing a motion, by curing any defaults under the lease, by paying the lessor any damages suffered as a result of the previous defaults and by providing the lessor with adequate assurance of future performance. In order to accommodate the timetable mandated by the proposed amendment to Section 365(d)(4), the debtor or the trustee would have 120 days within which to secure the funds necessary to cure defaults under a lease, to compensate the lessor for any damages and to provide adequate assurance of future performance. While the lessor might be convinced to move for an extension so as to allow the debtor or trustee more time within which to accomplish these tasks, the landlord is likely to do so only when it is in its economic best interest to do so. Where the lease is below market value, i.e. the rent is below what the lessor could now obtain from a new tenant, the landlord will have to weigh the benefits of a higher rental stream from a new tenant and recovery on the unsecured claim obtained by a lessor upon rejection, against the lower rental stream called for by the lease plus the chances that the debtor or trustee, given more time, may be able to secure the necessary funds to cure andcompensate the lessor.

The amendment is also a potential threat to the dividend available to unsecured creditors. When a lease is assumed, not only are defaults cured and the lessor receives compensation for actual damages, but all future damages that might accrue should the debtor or trustee later fail become elevated to the level of expenses of administration, i.e. they must be paid in full before unsecured creditors receive any distribution. As a result, unsecured creditors are usually reluctant to permit a debtor or trustee to assume a commercial lease unless it is done either 1) as part of the plan of reorganization where creditors know what they will receive, 2) as the first step in the ultimate transfer of the lease to a third party who will thereafter be responsible to the landlord for the future rent, or 3) when the debtor’s reorganization is so far along that the prospects for a successful reorganization are real enough to warrant the risk of a large administrative claim by a lessor should the reorganization fail.

The amendment also fails to take the opportunity to resolve a conflict that has arisen in case law concerning the requirement that the property be surrendered to the lessor once the commercial lease has been rejected. Some cases have held that despite the "immediately surrender" language in the statute, the bankruptcy court will not get involved in post-rejection disputes between the lessor and the debtor or trustee regarding the lessor gaining access to the premises. Instead, those courts require the lessor to rely on state court process thereby occasioning further delay and cost to the lessor. Other cases have interpreted the language to allow the bankruptcy court to be the forum in which the lessor can obtain an enforceable court order requiring the lessee to deliver possession to the lessor. Since the same "immediately surrender" language is brought forward in the amendment, it can be expected that this dispute will continue and the application of this law will not be uniform throughout the country.

Section 602. Allowance of Claims or Interests.

This section proposes to amend Section 502(b)(6) of the Bankruptcy Code to alter the way in which a lessor of real estate calculates its claim against the bankrupt estate. A lessor’s claim has long been a concern in bankruptcy legislation because that portion of the lessor’s claim related to future rent reserved under a long-term lease could dwarf the claims of other creditors who often do not have a similar opportunity to mitigate damages, i.e. reduce their damages by finding a new tenant for the premises. Historically, the lessor’s claim has been limited or "capped" with the current version of the statute limiting that claim to the rent reserved under the lease, without acceleration, for the greater of one year, or 15% of the remaining term of the lease, not to exceed three years, plus any rent owed as of the earlier of the date of the filing of the case or the date of surrender/repossession of the property. The proposed amendment will re-write the limit of the lessor’s claim to the sum of the following:

1) monies due under the lease from and after its termination, without acceleration, either; (a) for the next one year period after termination, or (b) for the next 15% of the remaining term of the lease not to exceed three years, plus

2) any monies owed to the lessor as of the filing of the case, plus

3) all costs reasonably incurred or that will be reasonably incurred by the lessor during the one year period after termination of the lease. A non-exclusive list of such costs is included.

The amendment also requires that the lessor mitigate its claim to the extent mitigation is required by law. The mitigation is applied against the lessor’s total damage calculation before applying the limitations or "cap" imposed on claims for future rent.

The amendment has the benefit of codifying the lessor’s obligation to mitigate its claim for damages, although the reference to "any mitigation required by law" suggests that mitigation requirements may vary from state to state and that some states may not require any mitigation at all. The amendment also resolves a conflict in the case law regarding whether mitigation, i.e. the reduction in the claim, is applied to the lessor’s damage calculation before it is limited by this section, or only after the lessor’s claim has been capped. By using the words "monetary obligations" rather than "rent", the amendment also attempts to prevent a lessor from including in its claim a sum attributable to a non-monetary obligation that is denominated as rent under the lease.

The amendment allows the lessor to include in its claim all rent accrued but unpaid up to the date of the filing of this case. The current version of Section 502(b)(6) uses the earlier of the date of the filing of the case or the date of surrender/repossession of the premises. As a result, in those situations where the lessor has recovered possession of the premises prior to the filing of the case but has not yet found a new tenant, the lessor will have a larger claim in the case.

The most significant change proposed by the amendment is to allow a lessor to include as part of its claim any cost reasonably incurred or that will be reasonably incurred within the next year after termination of the lease. The determination of what those costs are is made on the date the claim is to be "determined." It is unclear whether the date of determination is the date the lessor files its claim, the date the bankruptcy court rules on any challenge to the claim or the date an appellate court might overturn a bankruptcy court’s previously erroneous determination. This uncertainty could make debtors, trustees and creditors reluctant to object to a lessor’s claim because of fear that additional costs incurred within the year after termination of the lease, but not then part of the claim, might be added to the claim.The lessor can be expected to include in its claim the costs of brokers’ fees or commissions and tenant improvements relating to securing a new tenant, because those costs are specifically included in the ammendment as examples. Less obvious costs that a lessor can be expected to include in its claim include advertising, security, utilities, taxes, legal costs related to negotiating and documenting a new tenant’s lease, moving expenses paid by the lessor to the new lessee, and the like. Disputes are likely to flourish over whether these costs are "reasonably incurred." Advocates for other parties in a bankruptcy case would also be expected to argue that these costs should not be included in the lessor’s claim because they are as likely to be incurred by the lessor after the normal, non-bankruptcy related termination of a lease. They are only being accelerated due to the bankruptcy related termination of the lease.

Section 603. Expedited Appeals of Bankruptcy Cases to Courts of Appeals.

This section proposes to amend Section 158 of Title 28 of the United States Code which contains the statutory provisions governing appeals in bankruptcy cases. The proposed amendment maintains the existing structure of bankruptcy appeals, but adds a new feature which applies exclusively in circumstances where an appeal has been taken from a bankruptcy court to the federal district court. In that event, if the district court has not filed its decision within 30 days after the appeal was filed, then the amendment would permit the appeal to be taken to the appropriate court of appeals. In such an instance, the court of appeals is required by the amendment to issue an order directing the clerk of the district court from which the appeal was taken to make the bankruptcy court’s decision the decision of the district court. That decision is then made the subject of the appeal to the court of appeals.

The current bankruptcy appeal system provides for two levels of appeal. First, an appeal may be taken from the bankruptcy court to the district court or, if the circuit has established a bankruptcy appellate panel, then the appeal may go from the bankruptcy court to the bankruptcy appellate panel. A further appeal may then be taken from the decision of either the district court or the bankruptcy appellate panel to the courts of appeal. When the National Bankruptcy Review Commission considered recommendations to Congress, it issued recommendation 3.1.3 to the effect that Congress should eliminate the first layer of review, i.e. all appeals to the district court or the bankruptcy appellate panel should be eliminated. Instead, all appeals would go directly from the bankruptcy courts to the courts of appeal. The proposed amendment does not implement the Commission’s recommendation.

The amendment appears to address the situation where a decision is needed from the district court within a 30 days time frame but no decision is forthcoming. In such an instance, the amendment will allow a party to the appeal to jump from the district court and pursue the matter in the appropriate court of appeal. However, there is no time requirement for a decision in that higher court. Furthermore, no parallel provision is proposed for matters pending before the bankruptcy appellate panel. This might motivate appellants to choose to pursue an appeal in the district court rather than the bankruptcy appellate panel if they view quick access to the court of appeals as advantageous.

The amendment appears to anticipate the elimination of the district courts from appellate review of bankruptcy cases except to the extent emergency consideration requires a resolution within thirty days. It is unlikely that an appeal from a decision of a bankruptcy court will be capable of going through the normal process of designating an appellate record, designating issues on appeal, briefing and oral argument leading to a decision within 30 days after the appeal is filed with the district court. It is possible that adoption of the amendment will result in emergency appeals going to the district court and bankruptcy appellate panel, while regular, non-emergency appeals will be heard whether by the bankruptcy appellate panel or the court of appeals.

It is also curious that the proposed amendment refers to " [a]ny final judgment decision, order, or decree of a bankruptcy judge entered for a case in accordance with Section 157. . ." (emphasis added). Section 157 consistently uses the word "proceeding" in addition to the word "case" when referring to matters that are place before the bankruptcy courts. The proposed language leads to a suggestion that a "proceeding" may not be subject to the special 30-day right to remove a matter from the district court and send it the court of appeals. This could lead to litigation over whether an issue is presented in a "proceeding" or in a "case."

Sec. 604. Creditors in Equity Security Holders’ Committees.

Section 604 proposes to amend Section 1102(a)(2) of the Bankruptcy Code to permit the court to order a change in the membership of a committee appointed in a bankruptcy case. In order to make such an order, the court must first receive a request from a party in interest although it is allowed to act on its own motion. The court must also determine that the change in committee membership is necessary to ensure adequate representation of creditors or equity security holders.

The existing Section 1102(a)(2) allows the court to order the appointment of additional committees of creditors or of equity security holders. It is silent about the court’s authority to order a change in the membership of an appointed committee. Some bankruptcy courts have found that authority in Section 105 of the Bankruptcy Code. The amendment would eliminate any confusion in this issue.

Assuming the amendment is adopted, it will remain unclear whether a court order requiring a change in membership of a committee will allow the court to designate exactly how that change should be effected or whether responsibility for choosing the actual members of a committee will remain vested in the United States Trustee. It is reasonable to expect that the Office of the United States Trustee will take the position that only it has the authority to designate who will be members of the committee. To clear up this uncertainty, the amendment could specify who will have the power to designate members of a committee, i.e. the court or the United States Trustee, if the court feels that a change is necessary to ensure adequate representation.

Sec. 605. Repeal of Sunset Provisions.

Section 605 proposes to eliminate the sunset provision applicable to Chapter 12 of the Bankruptcy Code which governs the adjustment of debts of a family farmer with regular annual income. If the amendment is adopted, Chapter 12 will be become a permanent feature of the Bankruptcy Code.

The National Bankruptcy Review Commission proposed at 4.4.1 of its recommendations that the sunset provision be eliminated and Chapter 12 be made a permanent addition to the Bankruptcy Code. The amendment will implement that recommendation.

Sec. 606. Cases Ancillary to Foreign Proceedings.

Section 606 proposes to amend Section 304 of the Bankruptcy Code. The main purpose of Section 304 is to allow a foreign representative, i.e. a duly selected trustee administration or other representative of an estate in a foreign proceeding, to initiate a case ancillary to that foreign proceeding in the United States Bankruptcy Court. This amendment will increase the protections afforded to residents of the United States when a foreign insurance company, not engaged in the business of insurance or reinsurance in the United States, initiates a foreign proceeding. If the amendment is adopted, it will prohibit the bankruptcy court from enjoining actions, enforcing judgments, ordering turnover or ordering other appropriate relief, whenever there is a United States creditor with a claim against certain deposits or multi-beneficiary trusts authorized under state insurance laws.

Section 304 allows the United States Bankruptcy Court system to co-exist with foreign proceedings. The bankruptcy courts are given flexibility to enter orders which are requested by a foreign representative but the entry of those orders is not mandatory. Section 304(c) requires that the bankruptcy court be guided by what will best assure an economical and expeditious administration of the estate consistent with just treatment, protection of claim holders in the United States against prejudice and inconvenience in the processing of claims in the foreign proceeding, comity and similar notions. The proposed amendment is absolute in prohibiting the bankruptcy court from considering any order if the foreign proceedings meets the amendment’s qualifications. Such an absolute and inflexible provision may undercut efforts to generate uniformity of bankruptcy proceedings throughout the world.