[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
 LEHMAN BROTHERS, SHARPER IMAGE, BENNIGAN'S AND BEYOND: IS CHAPTER 11 
                          BANKRUPTCY WORKING? 

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                   COMMERCIAL AND ADMINISTRATIVE LAW

                                 OF THE

                       COMMITTEE ON THE JUDICIARY
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                           SEPTEMBER 26, 2008

                               __________

                           Serial No. 110-212

                               __________

         Printed for the use of the Committee on the Judiciary


      Available via the World Wide Web: http://judiciary.house.gov

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                       COMMITTEE ON THE JUDICIARY

                 JOHN CONYERS, Jr., Michigan, Chairman
HOWARD L. BERMAN, California         LAMAR SMITH, Texas
RICK BOUCHER, Virginia               F. JAMES SENSENBRENNER, Jr., 
JERROLD NADLER, New York                 Wisconsin
ROBERT C. ``BOBBY'' SCOTT, Virginia  HOWARD COBLE, North Carolina
MELVIN L. WATT, North Carolina       ELTON GALLEGLY, California
ZOE LOFGREN, California              BOB GOODLATTE, Virginia
SHEILA JACKSON LEE, Texas            STEVE CHABOT, Ohio
MAXINE WATERS, California            DANIEL E. LUNGREN, California
WILLIAM D. DELAHUNT, Massachusetts   CHRIS CANNON, Utah
ROBERT WEXLER, Florida               RIC KELLER, Florida
LINDA T. SANCHEZ, California         DARRELL ISSA, California
STEVE COHEN, Tennessee               MIKE PENCE, Indiana
HANK JOHNSON, Georgia                J. RANDY FORBES, Virginia
BETTY SUTTON, Ohio                   STEVE KING, Iowa
LUIS V. GUTIERREZ, Illinois          TOM FEENEY, Florida
BRAD SHERMAN, California             TRENT FRANKS, Arizona
TAMMY BALDWIN, Wisconsin             LOUIE GOHMERT, Texas
ANTHONY D. WEINER, New York          JIM JORDAN, Ohio
ADAM B. SCHIFF, California
ARTUR DAVIS, Alabama
DEBBIE WASSERMAN SCHULTZ, Florida
KEITH ELLISON, Minnesota

            Perry Apelbaum, Staff Director and Chief Counsel
      Sean McLaughlin, Minority Chief of Staff and General Counsel
                                 ------                                

           Subcommittee on Commercial and Administrative Law

                LINDA T. SANCHEZ, California, Chairwoman

JOHN CONYERS, Jr., Michigan          CHRIS CANNON, Utah
HANK JOHNSON, Georgia                JIM JORDAN, Ohio
ZOE LOFGREN, California              RIC KELLER, Florida
WILLIAM D. DELAHUNT, Massachusetts   TOM FEENEY, Florida
MELVIN L. WATT, North Carolina       TRENT FRANKS, Arizona
STEVE COHEN, Tennessee

                     Michone Johnson, Chief Counsel

                    Daniel Flores, Minority Counsel



















                            C O N T E N T S

                              ----------                              

                           SEPTEMBER 26, 2008

                                                                   Page

                           OPENING STATEMENTS

The Honorable Linda T. Sanchez, a Representative in Congress from 
  the State of California, and Chairwoman, Subcommittee on 
  Commercial and Administrative Law..............................     1
The Honorable Chris Cannon, a Representative in Congress from the 
  State of Utah, and Ranking Member, Subcommittee on Commercial 
  and Administrative Law.........................................     3

                               WITNESSES

Jay Westbrook, Esq., Professor, University of Texas School of 
  Law, Austin, TX
  Oral Testimony.................................................     7
  Prepared Statement.............................................     9
Barry E. Adler, Esq., Professor, New York University School of 
  Law, New York, NY
  Oral Testimony.................................................    18
  Prepared Statement.............................................    20
Lawrence C. Gottlieb, Esq., Cooley Godward Kronish LLP, New York, 
  NY
  Oral Testimony.................................................    25
  Prepared Statement.............................................    27

          LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING

Prepared Statement of the Honorable Chris Cannon, a 
  Representative in Congress from the State of Utah, and Ranking 
  Member, Subcommittee on Commercial and Administrative Law......     4

                                APPENDIX
               Material Submitted for the Hearing Record

Letter from Kappa Alpha Psi Federal Credit Union (KAPFCU), dated 
  September 26, 2008.............................................    62
Response to Post-Hearing Questions from Jay Westbrook, Esq., 
  Professor, University of Texas School of Law, Austin, TX.......    65
Response to Post-Hearing Questions from Barry E. Adler, Esq., 
  Professor, New York University School of Law, New York, NY.....    69
Response to Post-Hearing Questions from Lawrence Gottlieb, Esq., 
  Cooley Godward Kronish LLP, New York, NY.......................    71


 LEHMAN BROTHERS, SHARPER IMAGE, BENNIGAN'S AND BEYOND: IS CHAPTER 11 
                          BANKRUPTCY WORKING?

                              ----------                              


                       FRIDAY, SEPTEMBER 26, 2008

              House of Representatives,    
                     Subcommittee on Commercial    
                            and Administrative Law,
                                Committee on the Judiciary,
                                                    Washington, DC.

    The Subcommittee met, pursuant to notice, at 10:26 a.m., in 
room 2141, Rayburn House Office Building, the Honorable Linda 
T. Sanchez (Chairwoman of the Subcommittee) presiding.
    Present: Representatives Sanchez, Lofgren, Delahunt, and 
Cannon.
    Staff Present: Eric Tamarkin, Majority Counsel; Adam 
Russell, Majority Professional Staff Member; and Stewart 
Jeffries, Minority Counsel.
    Ms. Sanchez. This hearing of the Committee on the 
Judiciary, Subcommittee on Commercial and Administrative Law, 
will now come to order. You guys can be seated. Without 
objection, the Chair will be authorized to declare a recess of 
the hearing. And I will now recognize myself for a short 
statement.
    Today we find our country in the midst of the most 
significant economic crisis of our Nation's history, perhaps 
since the 1929 depression. The subprime mortgage meltdown and 
housing market collapse have sent shock waves throughout all of 
the sectors in the United States economy and threaten the 
global economy.
    The cascading effect of tightened credit has led to 
unprecedented government bailouts of private companies and a 
surge in business bankruptcies. According to the American 
Bankruptcy Institute, during the first half of 2008, there have 
been 55 percent more Chapter 7 liquidations than last year. 
Chapter 11 filings, where a company attempts to stay in 
business, are up 30 percent.
    Last week, Lehman Brothers filed for bankruptcy under 
Chapter 11, with total debts of $613 billion against total 
assets of $639 billion. This filing is the largest in U.S. 
history, dwarfing the previous largest bankruptcy in 2002 of 
WorldCom Incorporated, which had $104 billion in assets. 
Although Lehman racked up huge losses in risky mortgage-backed 
securities that could undoubtedly have had a major impact on 
the market, the Federal Government refused to bail it out and, 
as a result, Lehman filed for bankruptcy.
    On the eve of Lehman's bankruptcy filing, it apparently 
utilized the netting provisions of the 2005 Bankruptcy Code 
Amendments to offset various financial contracts it had 
outstanding. Accordingly, I hope at least some of the witnesses 
will help us understand the ramifications of these netting 
provisions as a matter of bankruptcy policy.
    Other large financial institutions have found themselves in 
similar positions recently. Earlier this year, California-based 
IndyMac filed for liquidation under Chapter 7 of the Bankruptcy 
Code, making it the ninth largest bankruptcy in history. 
IndyMac was crippled when the housing crash and ensuing 
economic slump caused borrowers to default on their loans and 
depositors to pull their money out of the bank at the same 
time.
    Chapter 11 bankruptcy filings have not only become more 
prevalent in the financial sector, but they have been on the 
rise among retailers. Sharper Image, Levitz and Bennigan's are 
just a few of the household names that have recently sought to 
reorganize under Chapter 11. A disturbing trend that appears to 
be developing is that more and more retailers are opting to 
liquidate rather than to reorganize. Some blame the overall 
economic climate. Some blame the credit crunch.
    Those in the bankruptcy community believe that the 2005 
amendments, including, for example, the nonresidential 
leasehold provision, are the principal cause of retailers 
choosing to close their stores, lay off their employees, and 
liquidate their assets rather than to attempt to reorganize.
    The purpose of today's hearing is to examine whether 
Chapter 11 is working as Congress intended and whether the 
amendments to the Bankruptcy Code in 2005 have made it more 
difficult for business debtors to reorganize.
    We will also review how the increase in business bankruptcy 
fits in the current economic crisis that has engulfed our 
country.
    I should note that Judiciary Committee Chairman Conyers 
invited a representative from Lehman Brothers to participate in 
this hearing for the purpose of explaining the circumstances 
leading to the filing of its bankruptcy case and how the 
financial contract offsets will impact its bankruptcy case. 
Unfortunately, Richard Fuld, Jr., Chairman and Chief Executive 
Officer of Lehman, was not able to make himself available, even 
though we offered to have him participate via video conference. 
Given the significance of the issues presented by this hearing, 
I may suggest that we will conduct a further hearing at which 
Mr. Fuld will have an opportunity to testify.
    As this is our last scheduled hearing, I wanted to take 
this opportunity to thank all of the Members of the 
Subcommittee in our work during this Congress. It has been a 
busy 2 years, far busier for this Subcommittee than I think 
most would have imagined at the beginning of the term. So I am 
especially thankful to everyone for their hard work, including 
the staff.
    I particularly want to salute our Ranking Member, Mr. 
Cannon, and to wish him my very best in his future endeavors. 
Congressman Cannon has been a fearless leader in working to 
reauthorize the Administrative Conference of the United States, 
a highly respected administrative law and process think-tank 
that provided valuable guidance to Congress and the executive 
branch. Even in an area that has often been contentious, 
bankruptcy reform, Mr. Cannon was willing to work with us 
across the aisle on significant issues, including consideration 
of ways to address excessive executive compensation in Chapter 
11 bankruptcy cases.
    Mr. Cannon, I want to thank you for your service to the 
Subcommittee on Commercial and Administrative Law as both the 
Chair and Ranking Member, and as a distinguished Member on the 
full Committee, as well as a well respected Member of Congress 
in other areas. We are very sorry that you will be leaving 
Congress, but I know that you are going to go on to accomplish 
wonderful things, and we wish you well.
    Ms. Lofgren. Will the gentlelady yield?
    Ms. Sanchez. I would yield.
    Ms. Lofgren. If I may, I would just like to also note the 
tremendous service that Congressman Cannon has given to our 
country in his years in the House. It has been a pleasure to 
work with him. We don't agree 100 percent on things, but he is 
a smart person and he is an honest person and he is someone who 
can talk through things without a bunch of games or hidden 
agendas, just to try and get something done for the American 
people.
    So it has really been an honor for me to work with him on 
many issues. And he is a credit to his district and his State. 
And I will miss him tremendously next year as a Member of 
Congress. And I thank the gentlelady for yielding.
    Mr. Delahunt. Would the gentlelady continue to yield?
    Ms. Sanchez. I would yield to the gentleman from 
Massachusetts.
    Mr. Delahunt. Because I want to echo your sentiments and 
that of Ms. Lofgren's. I have had an opportunity to work with 
Chris on a number of issues. He is a straight shooter, he has a 
keen intellect, he has a passion for public policy and he is 
just a great guy. And he will be sorely missed. And it should 
be noted that he commands great respect on the Democratic side 
of the aisle, and we all wish you the very best, Chris.
    Ms. Sanchez. I think it is unanimous. We love you, Mr. 
Cannon, and are sorry to see you go.
    At this time, it is my pleasure to recognize my 
distinguished colleague, Mr. Cannon, the Ranking Member of the 
Subcommittee for his opening remarks.
    Mr. Cannon. I thank the Chair and ask unanimous consent to 
have my written statement included in the record.
    Ms. Sanchez. Without objection, so ordered.
    Mr. Cannon. Have you guys been campaigning for me in my 
district? I would like the record to reflect that I have one of 
the most conservative voting records in Congress. But that 
said, I do have many dear friendships in this body. There are 
many people that I will miss.
    Bill Delahunt and I came together. I think he had only been 
here a little while before I got here. The three of us have 
worked together for many years on issues that I think are very 
important.
    And it has been a pleasure to have our new Chair, Ms. 
Sanchez, take the Committee. We work sometimes at odds and 
sometimes together, but mostly--this is the coolest 
Subcommittee on Earth because the issues are really important 
and they are arcane and people don't get them and don't 
understand them generally. So the arguments are sort of in-
house. But I have been a big promoter of the jurisdiction of 
this Committee, and the new Chair also has been a promoter of 
the jurisdiction of this Committee.
    I think I am going to make one last statement about that. 
We have jurisdiction over the way the Federal Government 
oversees commerce and that, by nature, just includes 
administrative law. So this Committee ought to be reviewing--
and I hope we pass early next year the bill that we have 
introduced that will give this Committee jurisdiction over all 
regulations for review. And then, ultimately, I would hope that 
this Committee gets the authority to take regulations to the 
floor of the House to be voted on before they become law and 
thereby recapturing the legislative role that we have delegated 
away I think, unfortunately, to the executive branch.
    And secondly, we are evolving as a Nation and I don't think 
that this has been understood or recognized. We have thousands 
of organizations that should be interstate compacts but aren't 
because they don't understand that they need congressional 
ratification.
    The other side to that is that to the degree that we can 
move Federal activities to interstate compacts, I believe in 
many ways the country is going to be better off. I don't think 
anybody believes that FEMA has performed well, ever. It is an 
amazing concentration of power. The Senate reviewed what 
happened after Katrina and basically said we shouldn't have a 
Federal Emergency Management Agency. What did work were the 
interstate compacts, the compact between Louisiana and Texas 
and other States in that region that allowed, on the statement 
by the Governor, that there was an emergency that allowed Texas 
troopers to cross the border into Louisiana and help perform 
the police functions, as had been anticipated by that 
interstate compact.
    So this is a great Committee, one that I have loved being 
on, one that I hope the people that remain on the Committee 
will continue to work toward expanding the jurisdiction of. And 
let me just say that it has been a pleasure to work with all of 
you on many different issues. You said all kind things about 
me. Those things are things that you are saying because those 
traits are inherent to each of the three of you, and it has 
been a pleasure for me to work with you. And I don't intend to 
disappear. At least the Chair has pointed out that I have some 
kind of future, and I appreciate the fact that she thinks it 
will be bright. I intend to make it bright. And I will miss 
this Committee and Congress.
    And thank you and I yield back the balance of my time.
    Ms. Sanchez. I thank the gentleman. I'm sure we will be 
hearing much more from you, Mr. Cannon, and hope you will 
remain available for us to pick your brain next year in the 
next session when we work on some of these issues that you have 
raised.
    [The prepared statement of Mr. Cannon follows:]
 Prepared Statement of the Honorable Chris Cannon, a Representative in 
 Congress from the State of Utah, and Ranking Member, Subcommittee on 
                   Commercial and Administrative Law
    Thank you for calling this hearing on Chapter 11 bankruptcy. As 
Chairman Conyers is fond of pointing out, this ``sleepy Subcommittee 
Number 5'' has been very busy these last two years. And bankruptcy has 
been one of our busiest areas. According to my count, we have held no 
less than 10 prior hearings on bankruptcy related topics--including two 
other hearings on Chapter 11 bankruptcy.
    That is, I think, appropriate given the importance of bankruptcy as 
a means of addressing debt in this country. In fact, the Founders 
thought it so important that they explicitly listed it as one of the 
enumerated powers of Congress in Article I, section 8 of the 
Constitution. Given that Congress passed a major overhaul of the 
bankruptcy laws in 2005, it perhaps not surprising that it would take a 
hard look at that law in this Congress to see how it is performing. Of 
course, the current financial difficulties facing this country also 
make bankruptcy an unfortunately all too relevant of a topic.
    The hearings that we have had on bankruptcy have been 
illuminating--some perhaps unintentionally so. Whenever a major piece 
of legislation passes Congress, it inevitably involves compromises from 
all parties. The Bankruptcy Abuse Prevention and Consumer Protection 
Act of 2005 is no exception. What we have seen with these hearings are 
that many of the parties involved in the 2005 bankruptcy bill have come 
back to try and strike a better bargain for themselves now that the 
political power on the Hill has shifted from Republicans to Democrats. 
That is inevitable, but it is also unfortunate.
    Which brings us to today's hearing. The title of the hearing 
mentions Lehman Brothers, which is certainly one of the most famous--or 
perhaps infamous--bankruptcies of our times. Unfortunately, there is no 
one here to testify from Lehman Brothers, so I doubt that this hearing 
will shed much light on that subject.
    What I do expect it to highlight is the complaints of some 
retailers with respect to changes in the treatment of leases. Prior to 
2005, retailers could enter into Chapter 11 bankruptcy and, for all 
intents and purposes, refuse to make decisions about the future of 
their commercial leases for months and even years. This left shopping 
mall owners without any real way to locate new tenants for their malls. 
This hurt not only the owners of the mall, but also the other tenants 
that suffered from lower foot traffic due to closed stores. The changes 
to the bankruptcy code enacted in 2005 prevent a bankrupt tenant from 
tying up that property for years.
    We will also hear about the overall mix of Chapter 11 
reorganizations versus Chapter 7 liquidations. I am particularly 
interested to hear how that mix has changed over time, including trends 
that began before the changes of 2005. I am also curious what our 
witnesses have to say about the effects of the current economy--namely 
diminished consumer confidence and tightening credit--on the overall 
number of retail liquidations. I suspect that those factors may impact 
why companies choose liquidation rather than reorganization far more 
than any changes to the bankruptcy code.
    Finally, I know that this Congress will not implement any changes 
to Chapter 11. That will be the work of future Congresses. However, I 
hope that those future Congresses will take into account the positive 
changes that we made in 2005 and not just throw out the proverbial baby 
because of the rough economic times that we are now facing.
    I yield back the balance of my time.

    Ms. Sanchez. I am now pleased to introduce the witnesses on 
our panel for today's hearing. Our first witness is Jay 
Westbrook, one of the Nation's most distinguished scholars in 
the field of bankruptcy and a part of the University of Texas 
Law School faculty. Professor Westbrook has been a pioneer in 
two respects: empirical research and international comparative 
studies of bankruptcy. Professor Westbrook also teaches and 
writes in commercial law and international business litigation. 
He practiced in all of these areas for more than a decade with 
Surri & Morris, now part of Jones Day in Washington, D.C., 
where he was a partner before joining the University of Texas 
Law School faculty in 1980.
    Professor Westbrook is co-author of The Law of Debtors and 
Creditors: As We Forgive Our Debtors, Bankruptcy and Consumer 
Credit in America, and the Fragile Middle Class. He has been a 
visiting professor at Harvard Law School and the University of 
London and is a member of the American Law Institute, the 
National Bankruptcy Conference and the American College of 
Bankruptcy. I want to welcome you today.
    Our second witness is Barry Adler. Professor Adler is the 
Charles Seligson Professor of Law at New York University School 
of Law, and has just completed a term as Vice Dean. He joined 
the New York University School of Law faculty in 1996, leaving 
his position as the Sullivan and Cromwell Research Professor of 
Law at the University of Virginia.
    Professor Adler's course offerings have included 
bankruptcy, commercial law, contracts, corporate finance, and 
corporations. Professor Adler has written numerous articles on 
the application of corporate finance theory to issues of 
corporate insolvency. These articles suggest that bankruptcy 
law can be properly understood as an integral part of contract, 
property and tort law, rather than as a mere supplemental body 
of law applied after a financial failure. He is currently at 
work on a book, The Law of Last Resort, which will elaborate on 
this theme.
    In addition, Professor Adler is the editor of the recently 
published reader: Foundations of Bankruptcy Law. Beyond his 
bankruptcy scholarship, Professor Adler has been published and 
continues to write in the fields of contract and corporate law. 
I want to welcome you as well.
    Our final witness is Lawrence Gottlieb. Mr. Gottlieb is the 
Chair of Bankruptcy and Restructuring Practice and a member of 
the Cooley Godward--did I pronounce that correctly--Kronish, 
LLP's management committee. Mr. Gottlieb practices in the field 
of creditors' rights, bankruptcies and workouts. He has 
represented debtors in committees and Chapter 11 
reorganizations, out-of-court workouts and other insolvency 
proceedings in over 40 States and Canada as well. He has 
handled matters involving a broad array of businesses including 
retail apparel, luggage, software, furniture, sporting goods, 
telecom, tools, drug, construction, foodstuffs and giftware.
    Over the years, Mr. Gottlieb has represented creditors' 
committees and numerous Chapter 11 cases and frequently 
represents purchasers of assets and claims in bankruptcy. He 
regularly addresses creditor groups, corporate credit 
departments, credit associations, and other professional groups 
regarding creditors' rights and bankruptcy matters. I want to 
welcome you to our panel as well.
    I want to thank you all for participating in today's 
hearings. Without objection, your witness statements are going 
to be placed into the record and we are going to ask that you 
limit your oral testimony today to 5 minutes. We have a 
lighting system that, when we remember to employ it, will give 
you the green light when your time begins. When you have a 
minute of testimony remaining, you will get the yellow warning 
light. And then when your time has expired, you will get the 
red light. At that time we would ask, if you are caught 
midsentence or midthought, we will ask you to finish that 
sentence or thought and then we will move onto the next 
witness. After all of the witnesses have presented their 
testimony, Members will be permitted to ask questions subject 
to the 5-minute limit.
    So with that, I am anxious to get underway because we are 
expecting another series of votes.
    Professor Westbrook, if you would begin your testimony at 
this time.

         TESTIMONY OF JAY WESTBROOK, ESQ., PROFESSOR, 
         UNIVERSITY OF TEXAS SCHOOL OF LAW, AUSTIN, TX

    Mr. Westbrook. Good morning.
    Ms. Sanchez. Can you please turn your microphone on? And 
you might want to move it closer to you as well.
    Mr. Westbrook. How about that?
    Ms. Sanchez. Much better.
    Mr. Westbrook. Good morning. And thank you so much for 
asking me here to talk about this subject of exemptions of 
certain kinds of financial assets from bankruptcy law and 
bankruptcy court control.
    We come together today in the midst of a hurricane, and I 
am just going to talk about one particularly large hole in the 
roof, which is this set of exemptions for financial assets. I 
particularly want to focus on the 2005 amendments which greatly 
expanded the scope of these exemptions and, in my view, made 
them seriously--raise a serious question about the efficacy of 
Chapter 11 reorganization for many companies in light of that 
expansion.
    The 2005 amendments added to the list of financial assets, 
precisely the kinds of assets that are at the absolute center 
of the current crisis. It added mortgages, greatly expanded the 
coverage of derivatives and swaps, and it greatly expanded the 
possibility of netting values among all of those. All of those 
things have to be considered together because they are very 
much an integrated package of exemptions.
    Prior to 2005 we had exemptions for financial assets, but 
they were narrow exemptions and they were focused on fairly 
specialized, exotic kinds of assets like swap agreements, true 
swap agreements. And as a result, they were focused on fairly 
narrow and specialized markets. I think the best example is 
repurchase agreements or repos. Before 2005, the only exempted 
area--excuse me--the only exempted area was for repurchase 
agreements relating to government securities or government-
backed securities.
    All of a sudden in 2005, at a time when Congress was 
focused primarily on consumer provisions of various sorts, we 
had an expansion of this exemption of repo agreements to 
include agreements--any agreement involving mortgages or 
mortgage-backed securities. These are essentially secured loans 
that were suddenly exempted from the automatic stay, the 
preference provisions, and the other aspects of bankruptcy 
control at the moment when a debtor files bankruptcy. Without 
that control, the bankruptcy laws can't function effectively 
and the debtor finds itself with many of its most valuable 
assets walking out the door at the moment bankruptcy is filed.
    It also must discourage the filing of bankruptcy cases when 
the debtor really needs relief and when creditors need the 
orderly procedures that bankruptcy offers, because the debtor 
knows that these assets will disappear shortly before or 
shortly after the bankruptcy is filed.
    One example has to do with a company that might have 
valuable contracts. It is important to understand, as I know 
the Members of this Subcommittee do, that we have a lot of new 
creatures out there that aren't financial institutions, but 
hold a lot of financial assets. That is a big change, really, 
in our financial system. Hedge funds are the most common 
example, but there are many others.
    So you may have a company that is in financial trouble and 
nonetheless has a number of profitable contracts which the 
bankruptcy rules would normally protect and make sure they 
can't simply be terminated by the other party, but those 
contracts can be maintained and the value in those contracts 
can be preserved if they turned out to be good bargains for the 
debtor. That is an extremely important part of the 
reorganization process. It is one of the reasons our 
reorganization works and reorganizations in many other 
countries do not work because they don't have that feature.
    Unfortunately, the 2005 amendments not only expanded the 
scope of the exemptions but it made them much fuzzier, much 
more ambiguous than they had been before, so that now it is not 
clear exactly what a swap agreement is for this purpose; for 
example, to be exempted from these provisions and to be subject 
to the master netting provisions.
    I saw back in 2000--Enron, for example, loved to make 
ordinary contracts in the form of swap agreements, did it all 
the time. And I am told by my friends on Wall Street and 
elsewhere that more and more lawyers, since the 2005 
amendments, are recasting contracts that are not really 
financial contracts in the normal sense and swap agreements or 
as derivative contracts so that they can enjoy the benefits of 
this exemption.
    Essentially what I want to ask the Committee to consider as 
a short-term solution is to roll back the 2005 amendments to 
return to where we were. Not to eliminate the exemptions 
completely, because there is a case to be made for the narrow 
exemptions that previously existed, but to roll back the 
exemptions that were adopted in 2005. I can't offer you so many 
hard examples or hard data. I wish I could because we are in 
the first crisis that we have had since the 2005 amendments 
went into effect. So some might counsel let's wait and see what 
happens. I personally think that in the current crisis it is 
not a good idea to conduct a natural experiment on our business 
community to see how many of them can survive in light of these 
exemptions, among other difficulties. This is, of course, not 
the only problem.
    Thank you very much for letting me come and talk to you 
about these questions.
    Ms. Sanchez. Thank you, Professor Westbrook. We appreciate 
your testimony.
    [The prepared statement of Mr. Westbrook follows:]
                  Prepared Statement of Jay Westbrook

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Ms. Sanchez. Professor Adler.

         TESTIMONY OF BARRY E. ADLER, ESQ., PROFESSOR, 
        NEW YORK UNIVERSITY SCHOOL OF LAW, NEW YORK, NY

    Mr. Adler. Thank you, Chairwoman Sanchez. I will resist the 
academic instinct to try to debate Professor Westbrook and I 
will stick to my statement for now which is----
    Ms. Sanchez. You will probably have that opportunity during 
the questioning round.
    Mr. Adler. I am going to talk briefly this morning about 
large firm Chapter 11 bankruptcies and how they have changed 
over the past decade or so.
    In the 1980's and early 1990's, the beginning of the new 
Bankruptcy Code, a large firm would get into financial trouble 
and file for bankruptcy. And the process looked something like 
this. The managers that were representing equity and in charge 
of the firm prior to bankruptcy also controlled the debtor in 
the bankruptcy. They were in charge of the reorganization plan 
and continued to manage the firm. These managers sometimes even 
kept their jobs after the firm reorganized, notwithstanding the 
fact that they had been in charge as the firm sunk to need 
bankruptcy.
    In the bankruptcy process, there is a negotiation between 
the managers representing the equity holders and the creditors. 
The creditors often would go along with the manager's plan for 
reorganization and continuation of the firm, perhaps because 
they wanted to get out quickly or more quickly. These 
reorganizations sometimes dragged on. So quick wasn't always 
even possible. But the creditors would typically go down and 
not face a cram-down against their interests, but they 
bargained in the shadow of the possibility of that cram-down.
    As a result, not surprisingly, frequently firms that 
emerged from bankruptcy would provide a return to equity 
holders even though the creditors are not paid in full. But the 
firms would survive very often, which has its benefits.
    However, a theme of my comments this morning are that 
bankruptcy, which restructures the balance sheet of a firm, 
can't fix a broken firm. If the firm is economically 
distressed, if it is producing a product that no one wants and 
it costs a lot of money to make, that is going to be the case 
when it emerges from bankruptcy. And it was not uncommon for 
firms to fail a second time.
    A recent study by Professor Lynn LoPucki showed that 
between 1991 and 1996, 30 percent of large firms that 
reorganized failed within 5 years. They didn't even survive 5 
years.
    So what has changed? Beginning in the late 1990's, early 
2000, notably before the 2005 amendments, creditors became more 
aggressive and started to take control of the bankruptcy 
process. In fact, they started to take control of the firms in 
anticipation of the bankruptcy process. When a large firm 
enters bankruptcy today, they typically are already under the 
thumb. I may be more pejorative than I intend, but under the 
control of a secure creditor who has lent money to the debtor 
in an attempt to allow it to avoid bankruptcy. And when that 
fails, they are in control when they get into bankruptcy.
    The secured lenders also provide the financing; that is, 
debtor in possession financing which is just jargon for a loan 
that is needed to keep the firm going in bankruptcy. The 
managers are routinely replaced. More often than not, that is, 
the old managers are gone. And if the firm reorganizes, there 
is nothing left for equity. Equity no longer gets payment. The 
creditors get paid in full.
    A significant change which may be occurring in the data are 
somewhat complicated on this, but it is at least plausible that 
this change is occurring. These firms are liquidating more 
frequently than they used to.
    The title of this hearing makes mention of Bennigan's and 
Sharper Image, which liquidated instantaneously, virtually upon 
the filing of bankruptcy. And there is evidence to suggest 
again, though somewhat mixed, that there is a trend toward the 
liquidation of bankruptcy, liquidation in bankruptcy of these 
firms.
    It was mentioned in the Chairwoman's opening statements 
that there are new 2005 provisions that make this more common. 
The lease provisions, which give debtors a very short period of 
time to assume or reject leases, that may have contributed to 
this trend with respect to retailers in particular. But again 
the trend was organic, it was economic. It predates the 2005 
amendments. So we do have these more frequent liquidations than 
we had in the past. And the question that we can talk about 
later is whether this is good or bad.
    In sum, the point of my comments is it is potentially good. 
It is potentially better to have failed firms be liquidated. If 
they are dead economically, they are going to liquidate anyway. 
The assets can be redeployed to better uses. And if the 
liquidation is quick, creditors who get paid get a higher 
return than they otherwise would receive are more apt to lend 
to the next round of debtors. This will result in more 
employment and better plight for working families, which should 
be the focus of bankruptcy law anyway.
    So it is not that I oppose or think that reorganization is 
itself a bad thing. It is a good thing if the firms were 
healthy. But when firms get into bankruptcy, it is typically 
because--or frequently because they are not healthy, they are 
not healthy economically. And if there is a trend toward more 
liquidation, this creditor control that is creating the greater 
liquidation may benefit society more than it is injuring it.
    Ms. Sanchez. Thank you, Professor Adler. We appreciate your 
testimony.
    [The prepared statement of Mr. Adler follows:]
                  Prepared Statement of Barry E. Adler

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Ms. Sanchez. And now, Mr. Gottlieb, I want to invite you to 
give your testimony.

           TESTIMONY OF LAWRENCE C. GOTTLIEB, ESQ., 
            COOLEY GODWARD KRONISH LLP, NEW YORK, NY

    Mr. Gottlieb. Thank you, Chairwoman. Chapter 11 
reorganizations are dead, and that really is not much of an 
overstatement. In the 3 years since the 2005 amendments took 
effect, we have seen no more than two retailers emerge from 
Chapter 11 as reorganized entities. Chapter 11 for retailers 
has become nothing more than a vehicle through which secured 
lenders sell the assets of the company through a quick sale 
process which provides retailers no opportunity to restructure 
their debts and rehabilitate their businesses.
    Numerous prominent retailers have disappeared so far this 
year alone after filing for Chapter 11. They include Sharper 
Image, Levitz, The Bombay Company, Domain Furniture, Friedman 
Jewelers, Wilson's Leather and Luggage. The liquidation of just 
these seven retailers alone has resulted in the loss of 
approximately 15,000 jobs. The weak economy clearly has 
contributed to the downward spiral of retail reorganizations. 
But it just as clearly is not the cause of it. The real culprit 
are the amendments. Prior to the amendments, there were many 
successful and important retail reorganizations, including 
Federated Department Stores, Macy's, State Stores, P.A. Bergner 
and Zales, cases that often took years to be resolved. In my 
view, it is likely that most of these and other retail 
reorganizations would have failed if the amendments were in 
place at the time of their proceedings.
    Although there are several amendments which, working 
together, have conspired to choke off retail reorganizations, 
there is one provision of the amendments that in our experience 
is so problematic for retailers that if every other onerous 
provision were remedied, save for this one, reorganization 
would still remain a pipe dream for distressed retailers.
    We are talking about section 365(d)(4) of the Amendments of 
the Bankruptcy Code, which has been amended and provides for 
the time for which the debtor can assume or reject leases. In 
the old days before the amendments, they had 60 days to assume 
or reject the leases, which times could be extended and often 
were extended by the bankruptcy judges. The judges understood 
that it was important that the debtor have a sufficient time to 
try to reorganize. The problem with assuming or rejecting 
leases early is that if you assume a lease and then later 
reject it because the case fails or because your business plan 
determines that you should no longer have that lease, the 
landlords now have the enormous administrative claim which 
takes priority over taxes, employees, general unsecured 
creditors. The time before the Code when those amendments were 
in effect, the secured creditors were actually happy to fund 
the debtors because, after all, they could receive their 
interest, they were protected by the collateral. If and when it 
turned out that their collateral was in danger, they often 
would conduct going-out-of-business sales, which is really the 
place they need to liquidate that collateral. They have 
inventory. If they are going to liquidate it, they need to 
liquidate it in the stores, not on the street corners. As long 
as the debtors maintain those stores, the financial 
institutions are more than willing to continue financing the 
debtors.
    However, the amendments put an end to this dynamic by 
revising the section to provide a strict limit of 210 days, by 
which time a debtor must assume or reject its store leases. 
Extensions beyond the 210 days, irrespective of whether the 
retailer operates 10 stores or 1,000 stores, are not within the 
discretion of the bankruptcy courts. So even if a 1-day 
extension meant a difference between a reorganization or a 
liquidation that would cause 100,000 job losses, the bankruptcy 
judge, as a result of the amendments, is powerless to grant 
that extension. This new section has killed the Chapter 11 
financing market.
    The banks are saying essentially I need to be able to 
liquidate my inventory. It takes 90 days to liquidate that 
inventory. It takes 2 months to get the courts to approve that. 
That is 180 days or something like that. Because of that, the 
banks are going into the bankruptcies at the outset and are 
telling debtors at--retail debtors at the outset, we have no 
time; you either sell your assets within 2 months, and if you 
don't sell your assets within 2 months, you need to start your 
liquidation process. We are not helping you reorganize. We 
don't have time to let you reorganize. And my experience has 
been that every single case that I have been involved in, 
retail cases--and it has been dozens since the amendments went 
into effect--the banks have said the same things: You liquidate 
within 210 days, you start that liquidation 60 days into the 
case, one way or the other.
    Now, because of that, the financing from the banks has 
totally dried up. In addition to that, there are a couple of 
other sections which we won't discuss at great length yet, 
which drain liquidity from debtors when they file Chapter 11--
when retail debtors file Chapter 11. When the debtors file the 
Chapter 11 is when they need liquidity. They have no liquidity 
and that is why they are filing Chapter 11.
    And there are other provisions which drain that liquidity 
at the very time they need it. They have to pay deposits to 
utilities, they have enormous section 503(b)(9) claims to 
vendors who have shipped within 20 days of bankruptcy, all of 
which the amendments combined with the 365(d)(4) on the leases 
have served to drain liquidity, prevent absolutely, no question 
in my mind, have absolutely prevented retailers from 
reorganizing. It is not irreversible. This is not a problem 
that can't be resolved, but some action needs to be taken right 
away.
    Ms. Sanchez. Thank you, Mr. Gottlieb. We appreciate your 
testimony as well.
    [The prepared statement of Mr. Gottlieb follows:]
               Prepared Statement of Lawrence C. Gottlieb

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Ms. Sanchez. We will now begin the questioning round, and I 
will begin by recognizing myself for 5 minutes.
    Professor Westbrook, you indicated in your written 
statement that Wall Street held a chaotic private trading 
session for traders to settle or unwind their contracts with 
Lehman on the afternoon before Lehman filed for bankruptcy.
    To the extent that this trading session occurred on the eve 
of the Lehman bankruptcy filing and may have been done with the 
knowledge that the bankruptcy was eminent, do you believe that 
there are issues that the Court ought to examine in connection 
with the private trading session?
    Mr. Westbrook. That may well be true. I wasn't a fly on the 
wall, I am sorry to say. My information comes from the Wall 
Street Journal story on that private trading session. But it 
seems to me for sure Congress ought to find out what happens in 
a session like that where, because of the exemptions we have 
been discussing, all the rules about preferences and fraudulent 
conveyances are out the window when you are trading these kinds 
of financial assets.
    Whether or not there may also be something that the Court 
in the Lehman's bankruptcy should take a look at, I don't know 
enough to answer that question. But I would start with an 
assumption that somebody ought to consider whether it is a good 
idea for the Court to take a look at it. That far I could go.
    Ms. Sanchez. Thank you. The netting provisions that were 
added in 2005, largely at the urging of financial services--of 
the financial services industry and by the Federal Interagency 
Working Group, the argument at that time was unless counter 
parties were permitted to net out their provisions, one 
bankruptcy could have a ripple effect on the market with 
catastrophic results as a result of systemic risk. Do you 
believe that these amendments are having their intended effect?
    Mr. Westbrook. I think the amendments, if anything, may 
increase the domino risk. Because what we have seen in the 
present crisis is that without the control, the orderly control 
that bankruptcy brings to these kinds of crises, you don't have 
a slow and careful liquidation maximizing value.
    Frankly, one of the benefits, it is true that bankruptcy 
sometimes delays things too much, I give you that. But on the 
other hand, some delay is one of the benefits of bankruptcy. 
What we are seeing in the present crisis is a lot of collateral 
being thrown on the market at the same time. As a result, it 
declines in value. When sales are made at low prices, everyone 
else holding the same kind of asset has to mark down that 
asset, and then their balance sheets start looking bad and they 
may have to file bankruptcy. Part of the point of bankruptcy is 
that the government steps in in the form of the courts and 
imposes an orderly circumstance on the liquidation or 
reorganization of the company and the sale of the assets. So I 
think, if anything, the domino effect is exaggerated by these 
amendments.
    Ms. Sanchez. Thank you. Professor Adler, as part of the 
2005 amendments, the period in which a debtor had to assume or 
reject commercial leases was greatly shortened and the 
discretion of the Court to extend that period without the 
consent of the lessor was taken away. This provision was added 
at the urging of the shopping center industry.
    What impact has this change had on the ability of national 
retailers to organize successfully?
    Mr. Adler. I don't doubt, as Mr. Gottlieb suggests, that it 
has hindered reorganization of retailers. I don't know that it 
has hindered it quite as much as he suggests, because there is 
a good deal of discretion about when a debtor files for 
bankruptcy. Obviously, if a firm is illiquid or illsolvent, 
they can't wait forever.
    But insolvency and default on debts don't typically fall 
out of the sky. Firms can see them coming, and one thing they 
can do is plan their bankruptcy. Before they file their 
bankruptcies, they can look at the various outlets that are 
subject to lease, decide which they are going to want to close, 
and decide which they want to remain open prior to filing for 
bankruptcy. So the 210-day limit that has been mentioned may 
not be quite as restrictive as has been suggested.
    This also suggests that perhaps it is the economy and, as I 
mentioned, the fact that these retailers are in a weak 
condition that has led to the increase in their liquidations. 
As I mentioned in my testimony, Montgomery Ward was a dead 
business not because of the Bankruptcy Code, but because it had 
no customers and this was prior to the 2005 amendments and they 
lingered in bankruptcy for 2 years. They emerged from 
bankruptcy. They were reorganized, and then they closed all 
their stores a year later anyway.
    What replaced those Montgomery Ward stores were Targets and 
Wal-Marts which were successful and which had employees and 
still have employees. The Montgomery Ward employees are all 
gone. I don't mean to dismiss the benefit of the Ward employees 
in this hypothetical or this illustration, I should say. I 
don't mean to dismiss the benefit of their having their jobs 
for 2 years. There is nothing more important. However----
    Ms. Sanchez. So you think there is enough flexibility in 
the current system? I am just trying to get a brief answer 
because I have very little time left.
    Mr. Adler. I apologize. I believe there is significant 
flexibility, given that the debtor can plan to some extent when 
they file. Yes.
    Ms. Sanchez. Mr. Gottlieb, I would ask for your sort of 
reaction to that, and if you could also add in ways in which we 
could perhaps change that provision to give retailers a better 
chance of emerging from Chapter 11 bankruptcy.
    Mr. Gottlieb. Well, I guess it wouldn't be surprising that 
I disagree with Professor Adler in his response. My experience 
has been involved in cases such as Federated Department Stores, 
which took over 2 years to reorganize. But it did and they are 
still around. Macy's took over 2 years to reorganize. It did 
and it is still around. The amendments went into effect in 
October 2005. The economy was a bit healthier then. And as I 
stated in my remarks, only two retailers, to the best of my 
knowledge, that have filed since 2005 have reorganized. Before 
that time, retailers regularly reorganized; not all, and some 
failed, obviously. But clearly the empirical evidence would 
seem to indicate to me that they had a much better chance.
    The idea that they can plan ahead of time and extend the 
210 days really doesn't work for two reasons. Number one, 
debtors file Chapter 11 when they have to. They don't generally 
go to their attorneys a year ahead of time and say I have got 
to start planning for a Chapter 11. They file when the bank has 
called the loan when they've run out of liquidity, and it all 
happens very quickly, number one.
    And number two, and most important, the banks have decided 
that when a debtor files, they just don't have enough time to 
let it try to reorganize. So when they file the loan at the 
beginning of the case, the dip loan at the beginning of every 
single one of these cases provides for a liquidation within 210 
days. Whether they plan to assume those leases, whether they 
like these leases or not, the banks will not lend into a 
reorganization.
    Ms. Sanchez. Thank you. I appreciate your response. My time 
has expired and I recognize Mr. Cannon for 5 minutes of 
questions.
    Mr. Cannon. Thank you, Madam Chair. And I ask unanimous 
consent to include in the record the statement of Joyce Koons.*
---------------------------------------------------------------------------
    * The statement of Joyce Koons had not been received by the 
Subcommittee at the time of the printing of this hearing.
---------------------------------------------------------------------------
    Ms. Sanchez. Without objection, so ordered.
    Mr. Cannon. It seems to me, Mr. Gottlieb and Mr. Adler--in 
the first place, Mr. Adler, that was a very coherent statement 
that you made on the timing of the bankruptcy. And as I hear 
the two of you, Mr. Adler and Mr. Gottlieb, what we really have 
is a difference of view of the value of retail as institutions.
    I think Mr. Adler would suggest that, hey, if they can't 
make it, they can't make it, and let's get somebody else in 
those leases in those outlets in those malls. And, of course, 
Mr. Gottlieb, this is not a question. There is a balance here 
between the interests of the owners of malls and rental space 
and retail organizations when it comes to how we balance the 
interest in bankruptcy, is there not? Isn't there a difference?
    I mean, these people are--some people--the people that have 
invested in bricks and mortar want that to be productive with a 
new tenant and their neighbors. The other stores next door to 
them actually want them to be productive with new tenants.
    Mr. Gottlieb. I understand that. I agree with that, 
actually. The thing is, though, that during the Chapter 11, the 
landlords have to be paid on time. In fact, they normally have 
to be paid even more on time than was the case before the 
Chapter 11s.
    What we have talking about are landlords getting paid their 
rent that they've negotiated with their the debtors in Chapter 
11. If the retailer has more than 210 days to live, the 
landlord still has to get paid. So as long as they are getting 
the benefit of their bargain for those leases, I don't know why 
they should be in a position to decide that Chapter 11s should 
fail.
    I would also add one other thing. It will be interesting, I 
think, to speak to the landlords in 6 months to a year, the 
mall owners in 6 months to a year, after all these retailers 
fail, the economy is as it is now, and they are going to have 
vacancies. It will interesting to see when you bring them 
before this Committee whether or not they might be willing at 
this point to permit there to be some discretion in the 
Bankruptcy Court to extend that time to let retailers survive.
    Mr. Cannon. There may be. The benefit of the bargain, 
though, includes other things than just the rent payment. Often 
there is a percentage of sales, and clearly the other stores 
around it have a benefit from a vibrant operation as opposed to 
a dying operation. I think that we would agree on that, 
wouldn't we? You would agree with me on that?
    Mr. Gottlieb. I would agree with that also, and I think it 
is a balance of interest.
    Mr. Cannon. Right. Exactly. Mr. Adler, you appear to have 
something you would like to say.
    Mr. Adler. Yeah. If the lessors are unhappy with how 
quickly things are moving, even under the current law, they can 
consent to allow the lease to continue. This is a right that 
they have to have a decision on assumption or rejection occur 
quickly, in part because they want to protect the malls, as you 
say. Many of these leases are in malls. An anchor store in 
particular has effects on neighboring stores, some of which 
will close down if we have a dying enterprise allowed to extend 
for long periods of time.
    But in response to Mr. Gottlieb, if the lessors are unhappy 
with the quick decisions, they have it within their power under 
the current law, as I say, to change that simply by permitting 
an extended decision.
    Mr. Cannon. Thank you. I appreciate the insights because 
this has been very good testimony. We worked intensively on 
this issue beforehand and I hope that we will continue to look 
to see how--we are going to have to learn something about how 
it works over time. And the fact that we are interested in a 
difficult economic environment now is probably not the best 
time to make decisions but, rather, to see how it works through 
a cycle in the future.
    Thank you for that.
    Mr. Westbrook--Professor, I should say--one of the things I 
gave up in my life to become a Congressman was my very pleasant 
association with Jones Day, which is a great law firm. I love 
it.
    For the remainder of my time, I would like to have you talk 
just a little bit more about the transactions that are 
happening here based upon your earlier testimony and how the 
bankruptcy law affects those in particulars, because we are 
looking here now at this big revamp of the whole system or at 
least a bailout. Who knows what we are going to call it? But 
making liquidity available.
    And it would be interesting to hear what kind of 
instruments are sitting around that are going to be paid for or 
made liquid with Federal money and how those--how that is 
affecting, for instance, Lehman. I mean, this had to be a 
fairly significant decision by the Secretary of the Treasury 
not to rescue Lehman, given the context of bankruptcy and what 
was going to be liquid or not liquid or what pressures were 
going to come to bear on Lehman.
    If you would give us a little insight on that, I would 
appreciate that.
    Mr. Westbrook. Certainly. I will do the best I can. We 
still have relatively little information about Lehman's because 
it happened so recently and it is so enormous, as the Chair 
pointed out earlier. What we can say is that a very substantial 
portion of the assets of Lehman's consisted of these exempted 
sorts of assets, and those assets essentially went out the door 
either shortly before bankruptcy or shortly after bankruptcy 
because of the lack of application of the automatic stay, of 
the avoiding powers, and of things like the ipso facto 
provisions that say you can't cancel a contract because someone 
is calling it a bankruptcy. That doesn't apply with respect to 
these kinds of financial contracts.
    So as a result, we know that an awful lot of Lehman's 
assets, I can't put a number sitting here today--but an awful 
lot of Lehman's assets were simply disposed of privately. 
Contracts were terminated. One obligation maybe on a credit 
derivative was liquidated against another obligation secured by 
mortgage-backed securities, things that have nothing to do with 
each other, because of the expansion of the master netting 
provisions in 2005.
    So what we can be sure of is that a lot of value that might 
have been available either to try to reorganize Lehman's or at 
least to liquidate it in a way that would maximize value was 
instead permitted to be liquidated, walked away with, if you 
will, by the counter parties to all of those transactions. I 
wish I could give you more specifics.
    If we talked again in 2 or 3 months I suspect we could, 
because I am very interested in Lehman's and I plan to find out 
what my old friend Harvey Miller is doing over there with that 
company.
    But I will say this. It is striking that in Lehman's, the 
biggest assets, as far as I can see, other than these exempted 
assets, were the going concern value of its broker-dealer 
operations in the U.S., the U.K., and Japan. All of that has 
been sold for something like $5 billion or less. It is hard to 
tell from the exact figure from the reports. Frankly, $5 
billion is walking-around money in Lehman's case, whereas it 
was noted the debts are over $6 billion. So it is hard to know 
what else is left there for anybody.
    Unsecured creditors, including more than 150--it is even 
hard to say the word--billion dollars' worth of bonds, 
unsecured bonds, I have to assume, unless we hear something 
quite startling, are going to get little or nothing out of that 
Chapter 11. So there is going to be a dramatically unequal 
distribution of value, a dramatic lack of sharing of the pain 
among the creditors of Lehman's. But I can't put numbers on it. 
Forgive me for that.
    Mr. Cannon. Thank you. And I see my time has expired. Madam 
Chair, I yield back.
    Ms. Sanchez. The gentleman yields back. At this time, I 
would recognize the gentlelady from California, Ms. Lofgren, 
for 5 minutes.
    Ms. Lofgren. Thank you, Madam Chairwoman. And I would like 
to ask Professor Westbrook on this Lehman private session--and 
I don't want to make accusations because we don't know what 
happened. I mean, we have a press account, so let me just posit 
it as ``what if'' without being accusatory. What if the private 
session were as described in the press? Are there adequate 
tools available to the Bankruptcy Court via fraud statutes to 
unwind things that were done in that session, in your judgment?
    Mr. Westbrook. The answer is no. The reason, ma'am, is that 
the normal avoiding powers, as we call them, preference and 
fraudulent conveyance law in bankruptcy, are specifically among 
the things that--from which these financial assets are exempt. 
So I think the answer to that is no. There might be some State 
law that could be applied, but my sense is that couldn't be 
applied in the bankruptcy; it might be applied separately under 
State law. The reason we have those provisions in bankruptcy 
law, they don't work very well when they have to be applied by 
individual creditors under State law. So I think in terms of 
adequacy and in most cases even in an attempt to be able to do 
it at all, gosh, that the answer to your question is no.
    Ms. Lofgren. Mr. Adler looks like he is anxious to comment.
    Mr. Adler. Yeah. Thank you. Professor Westbrook is right 
that the fraudulent conveyance provisions of the Bankruptcy 
Code are called off in these netting of derivatives. But 
fraudulent conveyance of the bankruptcy law is a term of art 
having to do with transfers for--typically having to do with 
transfers for less than real value. I think if anything 
happened at this session, it was an honest to God fraud, crime, 
deceit, tort. I don't think the special provisions of 2005 
would prevent liability from being visited upon anyone who 
committed such tort or fraud.
    Ms. Lofgren. I am interested--obviously, we are here 
looking at Lehman as the topic, but we have got sort of the 
elephant in the room on what is going on in our economy 
generally. Since we have got three professors who know a lot, I 
am just going to take the opportunity to ask the broader 
question, which is what to do in the face of the current 
economic challenges.
    We have had a proposal made by the Secretary of the 
Treasury and Mr. Bernanke and the President that has been 
refined for more oversight and the like. One of the things that 
is not included is a provision that would permit individual 
homeowners facing foreclosure to renegotiate their loans and 
save their homes in bankruptcy, because that is in many cases 
the only way--the only forum where it actually can be done.
    I am concerned--I mean, people have different views about 
bankruptcy and the like. But just on a practical level, if we 
are unable to deal with the individual homeowner facing 
foreclosure, in your judgment will we be back here with an 
additional crisis a year from now or the like, if we don't 
allow for that steep decline in housing to be arrested in some 
fashion?
    Mr. Westbrook. I have two responses to that, if I may. The 
first one is I think that could be the case. That is, I think 
this problem needs to be solved from the bottom up, as well as 
from the top down. And I think if you solve it, either one or 
the other is not going to be enough.
    The second point is this. Much of the discussion, quite 
correctly, has focused on the difficulty of having a Federal 
program that deals with a million foreclosures, each in local 
areas, different and so forth and so on. The benefit it seems 
to me of doing something about this provision that prevents 
what we call lien stripping or adjustment of value for primary 
residences--and it is the only exception. Every other kind of 
secured debt--well, now certainly automobiles, but----
    Ms. Lofgren. Taxes and student loans, too.
    Mr. Westbrook. Right. But every other secured debt can be 
adjusted in terms of the value of the collateral. What we have 
is 300 bankruptcy judges around the United States who are 
experts in doing this. A Federal system actually exists, 
remarkably enough, for dealing with each of these individual 
problems if Congress will, forgive the expression, unleash the 
Bankruptcy Courts to do what I think is a necessary job.
    Now, I don't think that is a complete answer because some 
of these folks perhaps shouldn't go into bankruptcy in order to 
sort out a mortgage problem, particularly if they were lied to 
or whatever. But for many of them, it is probably the only 
lifeline as a practical matter that you in this building can 
give to many of these homeowners, and it would work because we 
have the people in place to do it and they know how to do it.
    Mr. Adler. I think the matter is somewhat complicated. I 
think anyone would agree that when a bank is holding a mortgage 
on someone who can't pay it in full and properly that can't 
satisfy the loan in full, it is in everyone's interests for 
them to reassess and renegotiate the loan so that payments are 
manageable and will give the bank the highest possible return. 
And we could all be happy if that were easy. The problem is it 
is not. It is not clear that cram-down is the way to do it. It 
might be better if negotiation directly were possible.
    One thing we are all discussing prior to this hearing is 
that part of the problem with the fact that these loans have 
been packaged and sold, the originator of the loan no longer 
owns them, so it is difficult to know who should be doing the 
negotiation and thus cram-down is a plausible response, not 
necessarily the best one.
    I do want to add that I think we should be careful not to 
think that it would necessarily be a good thing to reinflate 
the housing bubble by propping up prices if there is no real 
value in those properties anymore.
    Ms. Lofgren. I know my time has expired, Madam Chair, but I 
ask unanimous consent for an additional minute.
    Ms. Sanchez. Without objection.
    Ms. Lofgren. Property values are going to decline. I mean, 
that is going to happen. That is happening. So the question is 
not whether we are going to inflate a bubble. That is off the 
table. The question is, can we put a floor on a collapse, 
because as the inventory increases through these foreclosures, 
the entire market is going down and it is a spiral down, and we 
have gotten some information that over half of the foreclosed 
properties have a second. You can't get the second to agree to 
a renegotiated price. Plus, since all of the mortgages have 
been securitized and sold off, you can't even get the authority 
to do a renegotiation, which is--not that I love bankruptcy, 
but you need to have somebody with the authority to make a 
deal. And that is in the interests of actually everybody.
    Mr. Adler. Congresswoman, I agree completely that that is 
the fundamental problem. It is not clear whether that can be 
solved better by forcing these people into bankruptcy and cram-
down. But I entirely agree.
    Ms. Lofgren. The only thing I would add is that we have 
maybe a couple of days to figure it out.
    Mr. Adler. You do have a couple of days, though. You have 
to have the bailout by noon, so----
    Ms. Lofgren. A system that works versus something that, 
theoretically, if we had a couple of years, we could figure 
out.
    Mr. Westbrook. Let me just say if I may, Congresswoman, 
that it is possible that you could do something on a temporary 
basis. I mean, that happened a lot back in the thirties. Oh, I 
don't like to invoke that. But nonetheless, a lot of things 
were put in for 2 or 3 years.
    Ms. Lofgren. If I may, in the thirties, my grandparents had 
a little house that they built, and they were able to negotiate 
an interest-only payment because the bank had so many 
properties, they didn't want another property. But the 
difference there is they had a bank they could deal with. You 
can't make that today. I don't want to abuse the Chair's----
    Mr. Cannon. May I ask unanimous consent that the gentlelady 
be granted 2 more minutes, because I would like to follow up on 
this.
    Ms. Sanchez. Without objection, so ordered.
    Mr. Cannon. Ms. Lofgren and I have been working on this 
issue, trying to figure out where we go. And I would like to 
ask another question similar to what she has asked. You have 
this complicated environment, seconds and fractured or 
fractionated interest, and it is very difficult--I mean, you 
know, we were talking earlier about how does the Secretary of 
the Treasury resolve these problems without it taking--because 
you have got--any person who says I don't like the fact that 
you reworked that mortgage then has a taking and the claim for 
a taking among the many problems that happen if the Treasury 
has the authority to do this.
    On the other hand, we are in this very difficult 
environment and according to the Mortgage Banking Association, 
80 percent of the subprime loans are performing. Of the 20 
percent that aren't, half are being worked out. Of those half 
that have been worked out, the rest are being worked on in a 
way that will keep people in their homes, meaning you have got 
10 percent of the subprimes, which means a much smaller 
percentage of all the loans outstanding are now troubled and 
need the kind of resolution that Ms. Lofgren is talking about.
    Is it worth opening up, even in a limited sense as you--
because we were talking about limiting it by time or limiting 
it by nature of the loan, and both have problems. But is it 
worth opening that door to anybody, say, from 3 or 4 years ago, 
who got a loan for another year, giving them the opportunity to 
go into bankruptcy? Or do we open up so many--the opportunity 
for so many people to come in and get relief that it becomes 
vastly counterproductive. And that is the question I think we 
are asking, and I would love to hear your views on that.
    Ms. Sanchez. Who are you posing the question to?
    Mr. Cannon. I think principally Professor Adler and 
Professor Westbrook.
    Ms. Sanchez. Okay. I am going to ask that you answer as 
briefly as possible. We have just been summoned to votes. And 
in all fairness, I would like to give Mr. Delahunt an 
opportunity to ask his 5 minutes of questions. So if you can 
briefly answer Mr. Cannon's question.
    Mr. Adler. I think the Congressman puts his finger exactly 
on the problem. On the one hand, you don't want to induce the 
entire segment of the mortgage population into bankruptcy when 
it might be able to work out their mortgages outside of it. Nor 
do you want to favor, necessarily, those who are nonperforming 
on their mortgages as opposed to those who are dutifully paying 
it, which is why I think this cram-down provision would be 
problematic.
    Mr. Westbrook. Just very briefly. I've seen very different 
figures, Congressman, on how many voluntary workouts there are. 
I will give you at least some other sources of information on 
that subject. My sense is that the voluntary workouts are not 
working nearly that well. And also the problem extends way 
beyond subprime loans. And the Alt-A loans are in big trouble, 
even subprimes. I think it is a bigger problem.
    Mr. Cannon. We don't have a couple of days on this. If you 
can communicate with our staff and get some source information, 
that would be helpful.
    Ms. Lofgren. If I may. Like today would be helpful.
    Mr. Westbrook. I will do my best.
    Ms. Sanchez. The gentlelady's time has expired.
    Mr. Delahunt. I thank the Chair. And I would commend the 
Chair. I think it is interesting, here we are in the midst of a 
huge meltdown and where is everybody? Because these are 
absolutely essential questions to address, and I would hope 
that while we are here you continue to have these informative 
hearings.
    I would like to talk about the business reorganization, 
because I was on this Subcommittee when we went through 
bankruptcy reform. And we gave it very short shrift. And I 
appreciate what you are saying.
    It was, I think, Professor Westbrook that said we have 300 
bankruptcy judges out there. You, Professor Adler, talked about 
discretion in terms of planning when to file. I don't buy into 
that for the reasons that Mr. Gottlieb indicated. I believe in 
discretion, however. And I believe in discretion to those that 
do this professionally, such as our bankruptcy judges. I am not 
talking--this is really conceptual, if you will. I think we 
have got to give them a lot more leeway to make commonsense 
decisions in terms of what is happening in our economy today, 
particularly among, you know, Chapter 11 reorganizations.
    Any quick comments from either one of you?
    Mr. Adler. A lot of bankruptcies are filed exactly 92 days 
after a payment has been made, which forces the payment outside 
of the preference period. So that is evidence of some planning. 
There is some planning.
    Mr. Delahunt. I am not saying it doesn't exist. I am 
suggesting planning with the intent not to play a game or to 
game the system, but planning to make a sincere and genuine 
effort to sustain, you know, a viable, a potentially viable 
corporation.
    Mr. Adler. There is no doubt that there are limits. I am 
not suggesting that the planning is infinite, the planning 
opportunity is infinite. And there is a trade-off. The easier 
you make it for firms to reorganize, the more likely you are 
going to save good firms but the more likely you are going to 
save bad firms along with it. And the question is whether or 
not society is better off----
    Mr. Delahunt. But my point, Professor Adler, is that is why 
I vested in the bankruptcy judge to make those decisions. I 
mean if there is anyone that should be cognizant of who is 
gaming what here, I would hope it would be the bankruptcy 
judge. Mr. Gottlieb?
    Mr. Gottlieb. Yeah, I would like to respond also. I think 
first again, remember, as I stated, the problem is that even if 
you plan ahead of time as to which leases you like or you don't 
like, the point of fact is that the banks are unwilling to fund 
reorganizations no matter how you plan ahead. They walk in and 
they want to make sure their collateral is liquidated within 
210 days, in the stores and not on the streets.
    In addition to that, I would suggest, and I think as you 
suggested, when the business bankruptcy provisions were put 
into this bill it was put into this big consumer bill.
    Mr. Delahunt. Right.
    Mr. Gottlieb. And I think a lot of them were probably done 
quickly.
    Mr. Delahunt. You are being kind.
    Mr. Gottlieb. And what didn't happen----
    Mr. Delahunt. They were done without any--minimal thought 
and analysis. That is the honest response.
    Mr. Gottlieb. Right. So you had individual provisions that 
were lobbied for, and I understand the lobby----
    Mr. Delahunt. Correct.
    Mr. Gottlieb [continuing]. But no one, I suspect, looked at 
all those provisions together as one unit and said how will 
this affect business bankruptcies? The way they protected it is 
they have drained liquidity----
    Mr. Delahunt. The Bankruptcy Reform Act was driven by the 
credit card industry. Everybody understands that.
    Professor Westbrook, and this is just an observation to all 
of you, you are very informative, and I appreciate the tutorial 
that you are providing us, but you have got to change your 
language. You cannot presume that any of us know what netting 
means. You can't--what is the other word? Netting. Give me----
    Mr. Gottlieb. Exemptions.
    Mr. Delahunt. Exemptions. Don't make those presumptions. I 
happen to have an understanding of them, but it is not just for 
Members of this Committee, but when you are here you have a 
chance to begin to participate in educating the American 
people. Sometimes, even though there is no one here, they will 
run this thing on, you know, at 3 a.m. some Sunday. It is 
important that we all participate with a better understanding 
of what is out there. Nobody knows what is out there. And your 
language has to be clear so that the average citizen, okay, now 
I understand it, now I get it. Netting, you can come here, you 
can talk about, we can talk about swaps and derivatives, it 
ain't working.
    Ms. Sanchez. The time of the gentleman has expired. And I 
want to thank all of the witnesses for their testimony today.
    Without objection, Members will have 5 legislative days to 
submit any additional written questions, which we will then 
forward to you and ask that you respond to as quickly as 
possible so that we can make those a part of the record. And as 
I understand, there is also great interest in getting 
additional information even more quickly than 5 days from now.
    Without objection, the record will remain open for 5 
legislative days for the submission of any additional written 
materials. And, again. I want to thank the witnesses for their 
time and their patience in putting up with our crazy voting 
schedule. And with that, the hearing of the Subcommittee on 
Commercial and Administrative Law is adjourned.
    [Whereupon, at 11:29 p.m., the Subcommittee was adjourned.]



















                            A P P E N D I X

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               Material Submitted for the Hearing Record

      Letter from Kappa Alpha Psi Federal Credit Union (KAPFCU), 
                        dated September 26, 2008

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

     Response to Post-Hearing Questions from Jay Westbrook, Esq., 
        Professor, University of Texas School of Law, Austin, TX

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

     Response to Post-Hearing Questions from Barry E. Adler, Esq., 
       Professor, New York University School of Law, New York, NY

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

  Response to Post-Hearing Questions from Lawrence C. Gottlieb, Esq., 
                Cooley Godward Kronish LLP, New York, NY

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                                 
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