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Published Articles by David Balovich

Title: Establishing Relationships
Published in: Creditworthy News
Date: 3/9/05
As we read the numerous business articles concerning bankruptcy it seems preferences is the most important concern to creditors today. However attorney/writers have focused our attention away from a more important concern to both secured and unsecured creditors.

Imagine your largest customer is going to file bankruptcy and they have the opportunity to choose among over 200 bankruptcy courts to file their petition. Most of these courts want your customer to file in their jurisdiction because the filing not only provides career opportunities for the judges but also millions if not billions of dollars in fees for local attorneys, accountants and other professionals. In many cases the competition is all or nothing.

To attract your customer's case, these competing courts will allow your customer's management to remain in control of the company and all its' remaining assets. They will let the company pay it's managers large bonuses, bend laws or in some cases just outright break them. And, if your customer chooses to reorganize the court will approve any plan they submit regardless if they can perform under the plan or not

Does this sound farfetched? Well, according to Lynn Lopucki,  a law professor at the University of California -Los Angeles Law School and author of Courting Failure: How Competition for Big Cases is Corrupting the Bankruptcy Courts, this is the United States bankruptcy system as it operates today and it is out of control.

According to Lopucki, two courts - Delaware and New York - hear more than half of the big bankruptcy cases in this country while many others get none. In 1996 Delaware heard 87 percent of the big case filings, 13 of the 15 cases filed. In 2003 Delaware heard 17 of the biggest cases while New York heard 12. Why? Because in 1970 a legislative accident gave big companies the right to choose their bankruptcy courts. In 1997, The National Bankruptcy Review Commission recommended Congress end the competition by revoking the companies' right to pick their courts. Congress never acted on that recommendation.

Delaware's two bankruptcy judges are so overworked that United Airlines and K-Mart elected to file in Chicago. Delaware needs four new bankruptcy judges to handle the overwhelming number of cases filed in their jurisdiction and under the bankruptcy bill now pending, Congress would provide those judgeships.

A New Bill to Prevent Court Shopping

Senator John Cornyn, R-Texas has introduced a stand alone bill (S.314) that would require companies to file in their local bankruptcy courts thereby eliminating the practice by big companies of shopping for sympathetic judges. Cornyn's action is prompted by the Enron bankruptcy filing. Then State Attorney General for Texas, Cronyn argued, unsuccessfully, that Enron bankruptcy court proceedings should have been litigated in Houston, home to the majority of its employees and others who were victimized by the scandal. Enron was able to use the place of incorporation of one of its small subsidiaries in order to file a bankruptcy claim in New York and then used that smaller claim as the basis for shifting all of its much larger bankruptcy proceedings into that same court 

Senator Cornyn's legislation would require (1) that corporate debtors file where their principal place of business or principal assets are located (rather than their state of incorporation), and (2) forbid parent companies from manipulating venue by filing first through a subsidiary.

Enron is only one example of abuse by the present bankruptcy system allowing large companies to "shop around" for friendly courts. Other examples include:

  • K-Mart. In January 2002, the executives delivered Michigan based K-Mart to the bankruptcy court in Chicago, which reportedly had been actively soliciting large corporate debtors to file in there jurisdiction. The Chicago judge permitted K-Mart executives to take millions of dollars in bonuses, perks and loan forgiveness.. Bankruptcy lawyers pocketed nearly 140 million in legal fees but 43,000 creditors received less than ten cents on the dollar.
  • Polaroid. In October 2001, the Boston based company filed for bankruptcy in Delaware, listing assets at 1.9 billion. Company executives claimed the company was a "melting ice cube" and arranged to sell the company to a single bidder for $465 million. Over creditor objections, the court refused to hear testimony as to the true value of the company and closed the sale in 70 days. Polaroid executive went to work for the new company and received millions of dollars in stock while disabled employees had their health coverage cancelled. The "melting ice cube" became profitable the day after the sale was finalized.
  • Continental Airlines. In 1990, a Delaware judge ruled that creditor's lawyers could not appear in a Houston court even though the company was headquartered in Houston and a bankruptcy proceeding was still pending in the Houston court. The Delaware judge ruled favorably for Continental on every major issue to the detriment of Continental's creditors.

Although legislation concerning "forum shopping" has been introduced previously in both the House and Senate beginning in 2002, Senator Cornyn's bill is the first known stand-alone legislation to specifically target the problem of bankruptcy forum shopping.

Floor debate on S.314 is scheduled to commence Monday, February 28. Interested parties are encouraged to contact their respective Senators and voice their concerns about this important piece of legislation to reform the bankruptcy venue rules.

I wish you well.  

The information provided above is for educational purposes only and not provided as legal advice. Legal advice should be obtained from a licensed attorney in good standing with the Bar Association and preferably Board Certified in either Creditor Rights or Bankruptcy.  

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