[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
----------
U.S. GOVERNMENT PRINTING OFFICE
44-631 PDF WASHINGTON : 2009
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
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
----------
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]