[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]



                    CIRCUIT CITY UNPLUGGED: WHY DID 
                  CHAPTER 11 FAIL TO SAVE 34,000 JOBS?

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                   COMMERCIAL AND ADMINISTRATIVE LAW

                                 OF THE

                       COMMITTEE ON THE JUDICIARY
                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 11, 2009

                               __________

                            Serial No. 111-6

                               __________

         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            DANIEL E. LUNGREN, California
MAXINE WATERS, California            DARRELL E. ISSA, California
WILLIAM D. DELAHUNT, Massachusetts   J. RANDY FORBES, Virginia
ROBERT WEXLER, Florida               STEVE KING, Iowa
STEVE COHEN, Tennessee               TRENT FRANKS, Arizona
HENRY C. ``HANK'' JOHNSON, Jr.,      LOUIE GOHMERT, Texas
  Georgia                            JIM JORDAN, Ohio
PEDRO PIERLUISI, Puerto Rico         TED POE, Texas
LUIS V. GUTIERREZ, Illinois          JASON CHAFFETZ, Utah
BRAD SHERMAN, California             TOM ROONEY, Florida
TAMMY BALDWIN, Wisconsin             GREGG HARPER, Mississippi
CHARLES A. GONZALEZ, Texas
ANTHONY D. WEINER, New York
ADAM B. SCHIFF, California
LINDA T. SANCHEZ, California
DEBBIE WASSERMAN SCHULTZ, Florida
DANIEL MAFFEI, New York
[Vacant]

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

           Subcommittee on Commercial and Administrative Law

                    STEVE COHEN, Tennessee, Chairman

WILLIAM D. DELAHUNT, Massachusetts   TRENT FRANKS, Arizona
MELVIN L. WATT, North Carolina       JIM JORDAN, Ohio
BRAD SHERMAN, California             DARRELL E. ISSA, California
DANIEL MAFFEI, New York              J. RANDY FORBES, Virginia
ZOE LOFGREN, California              HOWARD COBLE, North Carolina
HENRY C. ``HANK'' JOHNSON, Jr.,      STEVE KING, Iowa
  Georgia
ROBERT C. ``BOBBY'' SCOTT, Virginia
JOHN CONYERS, Jr., Michigan

                     Michone Johnson, Chief Counsel

                    Daniel Flores, Minority Counsel
























                            C O N T E N T S

                              ----------                              

                             MARCH 11, 2009

                                                                   Page

                           OPENING STATEMENTS

The Honorable Steve Cohen, a Representative in Congress from the 
  State of Tennessee, and Chairman, Subcommittee on Commercial 
  and Administrative Law.........................................     1
The Honorable Trent Franks, a Representative in Congress from the 
  State of Arizona, and Ranking Member, Subcommittee on 
  Commercial and Administrative Law..............................     2
The Honorable William D. Delahunt, a Representative in Congress 
  from the State of Massachusetts, and Member, Subcommittee on 
  Commercial and Administrative Law..............................     4

                               WITNESSES

Mr. Harvey R. Miller, Weil, Gotshal & Manges, LLP
  Oral Testimony.................................................     6
  Prepared Statement.............................................    10
Mr. Richard M. Pachulski, Pachulski Stang Ziehl & Jones, LLP
  Oral Testimony.................................................    25
  Prepared Statement.............................................    27
Mr. Daniel B. Hurwitz, President and COO, Developers Diversified 
  Realty Corporation, on behalf of International Council of 
  Shopping Centers
  Oral Testimony.................................................    41
  Prepared Statement.............................................    42
Mr. Todd J. Zywicki, Professor, George Mason University School of 
  Law
  Oral Testimony.................................................    45
  Prepared Statement.............................................    47
Mr. Isaac M. Pachulski, Strutman, Treister & Glatt, PC, on behalf 
  of National Bankruptcy Conference
  Oral Testimony.................................................    53
  Prepared Statement.............................................    56
Mr. Jack F. Williams, American Bankruptcy Institute Resident 
  Scholar, Georgia State University College of Law
  Oral Testimony.................................................    92
  Prepared Statement.............................................    94

                                APPENDIX
               Material Submitted for the Hearing Record

Prepared Statement of the Honorable John Conyers, Jr., a 
  Representative in Congress from the State of Michigan, 
  Chairman, Committee on the Judiciary, and Member, Subcommittee 
  on Commercial and Administrative Law...........................   125
Letter dated March 11, 2009, from Mallory B. Duncan, Senior Vice 
  President, General Counsel, the National Retail Federation.....   126
Response to Post-Hearing Questions from Harvey R. Miller, Weil, 
  Gotshal & Manges, LLP..........................................   128
Response to Post-Hearing Questions from Richard M. Pachulski, 
  Pachulski Stang Ziehl & Jones, LLP.............................   135
Response to Post-Hearing Questions from Daniel B. Hurwitz, 
  President and COO, Developers Diversified Realty Corporation...   143
Response to Post-Hearing Questions from Todd J. Zywicki, 
  Professor, George Mason University School of Law...............   146
Response to Post-Hearing Questions from Isaac M. Pachulski, 
  Strutman, Treister & Glatt, PC.................................   148
Response to Post-Hearing Questions from Jack Williams, American 
  Bankruptcy Institute Resident Scholar, Georgia State University 
  College of Law.................................................   184

 
  CIRCUIT CITY UNPLUGGED: WHY DID CHAPTER 11 FAIL TO SAVE 34,000 JOBS?

                              ----------                              


                       WEDNESDAY, MARCH 11, 2009

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

    The Subcommittee met, pursuant to notice, at 2:08 p.m., in 
room 2141, Rayburn House Office Building, the Honorable Steve 
Cohen (Chairman of the Subcommittee) presiding.
    Present: Representatives Cohen, Delahunt, Watt, Maffei, 
Lofgren, Johnson, Scott, Franks, Jordan, Coble, Issa, and 
Forbes.
    Staff present: Susan Jensen-Lachmann, Majority Counsel; 
Stewart Jeffries, Minority Counsel; and Adam Russell, Majority 
Professional Staff.
    Mr. Cohen. This hearing of the Committee on the Judiciary, 
Subcommittee on Commercial and Administrative Law will now come 
to order.
    Without objection, the Chair will be authorized to declare 
a recess of the hearing.
    I will now recognize myself for a short statement.
    We are in the midst of an economic maelstrom that is 
hurting virtually every sector of our Nation's economy. From 
businesses to consumers, there is no one and nothing that 
hasn't been touched by our economic crisis.
    While, in the past, this Subcommittee has concentrated 
solely on the impact of this crisis on the individual, it is 
important to examine the impact on businesses as well, which 
are also subject to the vagaries of the economic cycles and the 
bankruptcy process.
    When businesses encounter financial distress, they may file 
for bankruptcy relief under Chapter 11 as a last resort to 
remaining in business, a form of bankruptcy relief intended to 
give companies a temporary cooling-off period during which they 
can reorganize their financial affairs.
    Chapter 11, essentially, is like a hospital where sick 
businesses--under the careful scrutiny of a bankruptcy judge 
who wears white scrubs and a stethoscope, and creditors--are 
given a chance to rehabilitate themselves.
    By promoting reorganization, Chapter 11 is supposed to 
benefit everyone. Employees' jobs should be, and, often, are 
preserved. Creditors have a greater chance of receiving 
payment, rather than liquidation value from a forced asset 
sale. And, vendors continue to have the company as a future 
customer. So vendors benefit, creditors benefit, employees 
benefit, the economy benefits, and the community benefits from 
having this rehabilitated tax-revenue source.
    Clearly, Chapter 11 is not a panacea, but it is something 
that we need in our arsenal, to keep our economy moving. Just 
like sick individuals, some Chapter 11 businesses are too far 
gone too far for help, and they are beyond doctors' help.
    The goal of Chapter 11 is to give businesses at least a 
fighting chance to reorganize so they can reenter the 
marketplace and save jobs.
    Some of us feel, however, that Chapter 11 is no longer 
working as Congress intended it to, especially in light of the 
2005 amendments to the Bankruptcy Code. This concern may very 
well be illustrated by the recent Chapter 11 case filing of 
Circuit City.
    Before filing, Circuit City was one of the Nation's largest 
retailers, with more than 700 store locations, and more than 
34,000 employees. In less than 4 months after filing for 
Chapter 11, however, Circuit City closed all of its doors, and 
virtually all of its employees are now without jobs, jobless.
    What went wrong? Why didn't Chapter 11 work to save this 
business? If Chapter 11 couldn't save Circuit City, is it also 
failing to save other businesses? And with this economy, there 
are going to be a whole lot more Circuit Citys and businesses--
not of that size, but of that size--and lesser and greater--who 
will need to be reorganized. And what will happen? And what 
should Congress do with this new economic plight and condition 
that didn't exist in 2005.
    All of these are important questions we need to have 
answered. Accordingly, I look forward to receiving today's 
testimony and learning more about how we can adjust our laws to 
affect outcomes reflective of 2009.
    I would now like to recognize my colleague, Mr. Franks, the 
distinguished Ranking Member of the Subcommittee, for his 
opening remarks.
    Mr. Franks. Well, thank you, Mr. Chairman. And thank you 
for calling this hearing on this, the Subcommittee's first 
important hearing on the topic of bankruptcy.
    Over the last couple of years, bankruptcy has been one of 
our busiest areas. And, indeed, it has included three hearings 
on Chapter 11 bankruptcy alone.
    As our former colleague, and my esteemed predecessor, Chris 
Cannon, remarked last term, ``Bankruptcy is so important, that 
the founding fathers explicitly listed it as one of the 
enumerated powers of the Congress, in Article 1, Section 8 of 
the Constitution.''
    Our current economic distress only serves to underscore 
further the importance of our bankruptcy laws.
    In 2005, Congress passed a major overhaul of the bankruptcy 
code, through the Bankruptcy Abuse, Prevention and Consumer 
Protection Act of 2005. Four years on, in our current economic 
environment, it is not surprising that the Committee is taking 
a look at the laws--Chapter 11 provisions--to see how they are 
working.
    We should all, however, be careful as we review this act. 
The 2005 reform capped off years of debate on how to revise the 
bankruptcy code. And, as with many long-considered, major 
pieces of legislation, the final product incorporated a self-
reinforcing web of compromises made by all parties.
    In our hearings last term, and, now, again, this term, some 
of those parties have come back to us, trying to strike a new 
deal on part or some other parts of the act.
    That may be unsurprising, especially since political power 
at both ends of Pennsylvania Avenue have shifted from 
Republicans to Democrats. Nevertheless, partisan attempts to 
nibble at, or undermine, or begin to unravel, the 2005 reform, 
would be counterproductive and unfortunate.
    Today's hearing, in fact, serves well to highlight the need 
for caution. The 2005 reform, for example, carefully struck a 
better balance in Chapter 11's provision affecting relations 
between retail vendors and their mall and shopping-center 
landlords.
    Previously, it was too easy for vendors in Chapter 11 to 
squat in their already-leased space, holding landlords 
hostages, sometimes for years, as the vendors tried to work 
their way through Chapter 11. This was particularly problematic 
in the case of anchor-store bankruptcies, like those involving 
large department stores.
    The excessive leniency toward vendors in the code's prior 
provisions too often enabled ``ghost stores'' like those to 
convert their hosts into ``ghost malls.'' And, too often, it 
prevented vibrant, viable stores from coming into those malls 
and occupying space that they urgently needed.
    None of us, of course, wants Chapter 11 to force vendors 
into liquidation too fast. But at the same time, none of us 
should want Chapter 11 to allow anchor stores and other 
companies in bankruptcy to slowly bleed landowners and 
landlords dry. That would only kill the companies on which all 
retail vendors rely for space, and choke our economy in a time 
in which it is already struggling for breath.
    Accordingly, while some may partially ascribe Circuit 
City's eventual liquidation to problems with retail leases, we 
should be careful not to overreact to that charge. We should be 
careful to explore all of the issues that affected Circuit 
City's case, and consider whether they stem from problems 
inherent in the bankruptcy code, problems inherent to Circuit 
City, or--such as inadequate business model--or problems 
inherent in the current, highly unusual credit crisis.
    Circuit City's liquidation will, of course, cost many jobs, 
as the title of this hearing suggests. But mistaken repeals of 
the 2005 reform could cost other jobs such as those held by 
Circuit City's competitor, other vendors, suppliers, financiers 
and landlords. Those jobs could, in the end, number even more, 
although their loss may be even harder to trace through the 
system.
    This is a patter that we must be careful not to set in 
motion, whether in the electronic sector, the auto sector or 
the banking sector, or any other sector of our economy.
    And, Mr. Chairman, with that, I yield back my time. Thank 
you, sir.
    Mr. Cohen. I thank the gentleman for his statement.
    I now recognize Mr. Delahunt, the unofficial Vice Chairman 
of this Subcommittee, distinguished Member from--a former 
Attorney General and a man of many trades. And, yes--I can't go 
any further.
    Mr. Delahunt. Don't stop there.
    I think it is wise if we go and listen to those who are 
testifying.
    I want to commend you, however, for these hearings. And I 
hope that you would consider having a series of hearings from 
the perspective of oversight, to determine how we got here.
    You know, I think that we have an obligation, as a 
Subcommittee, to examine the causes of these bankruptcies that 
are going to multiply. We have had a debate on the floor, led 
by the gentlelady from California, Ms. Lofgren, who is a Member 
of this Committee.
    I think it is important we really deeply delve into the 
causes. How did we get here? I suspect that there are--most of 
the reasons are outside of the Bankruptcy Code. But I think we 
have that obligation to make every effort that we can to avoid 
bankruptcy.
    With that, I yield back.
    Mr. Cohen. Thank you, sir.
    Are there other Members that wish to make an opening 
statement?
    I would like to now introduce the witnesses for today's 
hearing. And make note that our first witness is not under the 
Witness Protection Program, but had difficulty with his flight, 
and was unable to be present--Mr. Miller, who I have not had 
the pleasure of meeting, but I have heard great statements 
about his knowledge of this issue--had a problem with his 
flight cancellation and inclement weather in New York City.
    It is unusual for a witness to participate telephonically, 
but we wanted him to do that. And with the indulgence of our 
Members, we will allow him to proceed in that fashion.
    I thank Mr. Franks for his cooperation to allow us to do 
that. And I think that is the reason for this large screen, 
here.
    The other witnesses we will have today--our first witness--
do we have him as first? Mr. Pachulski is first. But I just 
wonder, is he going to be in front of a TV camera the whole 
time? Is he there now?
    Why don't we go ahead and ask him to--we will have him 
first. But, in time, Mr. Richard Pachulski is an additional 
witness. He is a partner at Pachulski Stang Ziehl and Jones--
extensive experience in business reorganizations, as well as 
debtor-creditor litigation--and, during the 1980's, was a well-
known Chapter 7 and 11 trustee. He has represented numerous 
debtors and creditor committees, in both out-of-court workouts 
and in-court proceedings.
    Mr. Pachulski has been cited by several publications as a 
leader in the legal community. During 2007 and 2008, he 
represented debtors' and creditors' committees in numerous 
industries, though, primarily, in the real estate business and 
retail industry.
    A representative sampling of such matters include his 
current representation of the creditors committee of Circuit 
City and affiliates.
    Our first witness, who will precede Mr. Pachulski, because 
of the need to go to this extra-terrestrial type of video--or 
testimony--will be Harvey Miller.
    Mr. Miller is in the business, finance and restructuring 
department of Weil, Gotshal & Manges?
    Mr. Miller. Manges.
    Mr. Cohen. Manges--thank you. Where did that come from?
    He has played a leading role in many major business-
organization cases, involving, among others, Lehman Brothers, 
Texaco, Donald Trump, Federated Department Stores, Macy's, 
Chase Manhattan Mortgage and Realty Trust, Best Products 
Company, Continental Airlines and Eastern Airlines.
    Mr. Miller is a lecturer for the American Law Institute and 
American Bar Association, New York University Law Workshop on 
Bankruptcy and Reorganization, the New York State Bar 
Association, and various local bars and law schools.
    He co-authored numerous bankruptcy texts, is a contributing 
editor of Collier on Bankruptcy and a Federal attorney-fee 
awards reporter, an adjunct professor of law at NYU School of 
Law, and a lecturer at Columbia School of Law.
    Our third witness will be Mr. Daniel Hurwitz, who appears 
on behalf of the National Council of Shopping Centers. He is 
the former president and COO of Developers Diversified Realty. 
In May 2007, he previously served as senior executive vice 
president--chief investment officer since May 2005--and was 
executive vice president of DDR from June 1999 through April 
2005.
    He was on the company's board of directors from May 2002 to 
2004. He is responsible for Developers Diversified's core-
revenue departments, in addition to management of the various 
disciplines related to the day-to-day operations of the 
company. Moreover, he is a member of the company's executive 
management and investment committees.
    Prior to joining Developers Diversified, he served as 
senior vice president and director of real estate and corporate 
development for Boscov's Department Store, Inc. Prior to that, 
he served as development director for Shopco Group, a New York 
City based developer and acquirer of regional and super-
regional shopping malls.
    He is a member of the ICSC board of trustees, co-chair of 
its open-air centers committee, and a proud alumnus of the 
Wharton School.
    Our fourth witness is Todd Zywicki. Professor Zywicki 
teaches in the areas of bankruptcy and contract law at George 
Mason University School of Law. Previously, he taught at 
Mississippi College School of Law, where he has held a faculty 
position since 1996--or he had held one.
    During 2003-2004 academic year, he served as director of 
the Office of Policy Planning at the Federal Trade Commission. 
Professor Zywicki is the author of more than 30 articles in 
leading law reviews--economics journals.
    And our fifth witness is Isaac Pachulski, who appears on 
behalf of the National Bankruptcy Conference. Currently, he is 
a senior shareholder of Stutman Treister & Glatt professional 
corporation and specializes in corporate reorganization and 
solvency in bankruptcy law.
    He has been with the firm since 1974, and became a 
shareholder in 1980. He is the NBC's co-vice chair of the 
Chapter 11 committee, and a member of the executive committee. 
He is also a member of the American College of Bankruptcy and 
the International Insolvency Institute.
    In his more than three decades of practice as an insolvency 
attorney, Mr. Pachulski has represented both debtors and 
creditors, as well as other parties and interest in major 
reorganization cases around the country.
    He has been a lecturer on topics such as appellate 
practice, intellectual property licenses, security interests, 
and bankruptcy.
    And our final witness will be Mr. Jack Williams, who 
appears on behalf of the American Bankruptcy Institute. 
Professor Williams serves as the American Bankruptcy Institute 
residential scholar. As such, he assists the ABI with its 
educational programming and its role as the authoritative 
source of bankruptcy information for the Congress, media and 
the public.
    He teaches at Georgia State College of Law, where he 
instructs on a broad array of courses. He also teaches at the 
New York Law School Masters Program in Taxation, the NYU School 
of Law Continuing Professional Education Program for the IRS, 
and the Federal Law Enforcement Training Center.
    I want to thank all of our witnesses for participating in 
today's hearing. Without objection, your written statements 
will be placed in the record. And we would ask you limit your 
oral remarks to 5 minutes.
    There are systems in front of all of you, except for Mr. 
Harvey Miller, who has no buzzer in front of him. But we will 
let you know when the lights would have changed, if you would 
have been present.
    When the light turns yellow, it means you have a minute 
left. Then, you need to hurry your remarks or stretch them out, 
if you are close to the end. And when it gets to red, you are 
finished.
    After each witness has presented his testimony, 
Subcommittee Members will be--after each witness has presented 
his or her testimony, at the end of the panel--Subcommittee 
Members are free to ask questions, subject to the 5-minute 
limit.
    And, now, if we can go to the video screen, we would like 
Mr. Miller to start his 5-minute remarks. And we thank you for 
making yourself available through this unusual process.
    Mr. Miller, are you there?

                TESTIMONY OF HARVEY R. MILLER, 
                  WEIL, GOTSHAL & MANGES, LLP

    Mr. Miller. Thank you, Mr. Chairman.
    I deeply appreciate the opportunity to participate in this 
hearing telephonically. And I apologize for my inability to get 
to Washington this morning.
    It has been almost 30 years since the bankruptcy code now 
in effect, became effective. And in that 30-year period, we 
have had seismic changes in the way financial markets operate, 
and the way business is conducted, which is very different from 
the environment which existed in 1978, when the Bankruptcy 
Reform Act was passed.
    Among those changes has been the changes in creditor 
constituencies. At the time that the bankruptcy code was 
enacted, those changes--the code addressed itself to 
constituencies primarily made up of unsecured creditors; 
generally, in most cases, with a large trade-creditor 
community, particularly in the retail area, where supply has 
made up a good portion of the creditor constituency.
    Today, we find, in our cases, that the major creditors are 
secured creditors. And that has changed the dynamic of 
reorganization very significantly. In addition, there has been 
a change in the business practice for retailers, in particular, 
where suppliers are generally offshore, and their transactions 
are accomplished through letters-of-credit transactions. And, 
essentially, that becomes secured financing.
    So the vendor-supplier community is not really the major 
force in retailing anymore. And that was the group of creditors 
that were very interested in seeing the retail organizations 
survive, because they wanted a customer in the future.
    In addition to a major change in retailing--is back in 1990 
and 1991 and 1992, when Federated Department Stores and R.H. 
Macy went into bankruptcy code, and other retailers--in those 
cases, generally the merchandise inventory was not subject to 
liens and encumbrances, and the retailer would tell its lender 
that, ``We cannot give you a lien on the inventory, because, if 
we do that, we will not be able to get credit from our 
suppliers.''
    With the change in the business practice of suppliers 
coming offshore, that argument no longer was accepted by 
lenders. And the consequence is most merchandise inventories 
are liened in favor of a secured creditor, a bank syndicate.
    That bank syndicate, today, has a different view of 
rehabilitation and reorganization, because banking 
relationships are no longer what they were in 1978 and 1979. A 
secured lender looks at the merchandise inventory and sees it 
as being a liquid asset that is easily convertible into cash.
    Because of the changes in the 2005 amendments to the 
bankruptcy code, which put a 210-day cap on the ability to 
assume or reject an unexpired lease of non-residential real 
property, the retail-store locations, the secured lender is 
always thinking about, ``If this case is going to convert into 
a liquidation, I have to have sufficient time to have that 
inventory liquidated so that I can realize the outstanding 
amounts on my loans.''
    That has been a dramatic change in retailing. And, 
basically, within a period sometimes no more than 60 days, the 
retailer really had to demonstrate refinancing of the existing 
secured debt or a plan of reorganization, which it can't really 
do in 60 days. The result is that the debtor is forced to start 
the liquidation process.
    I know the process was somewhat different in Circuit City, 
because of the nature of its own business. But that is a 
dramatic change.
    The other big change which I would think the Committee 
ought to take into account is, in 1978, everybody agreed that 
rehabilitation and reorganization was a desired objective--that 
there was a virtue to reorganization.
    As the code was being applied over the years, starting in 
1979, there was a second principle which became evident, which 
was the maximization of creditor recoveries.
    Now, those two objectives may be in competition with each 
other and, sometimes, upset the balance of the administration 
of a Chapter 11 case.
    At this point in time, the goal of rehabilitation and 
reorganization is--does not appear to be the primary goal. As 
you look at Chapter 11 cases--and, particularly, since 2005 
amendments--more and more of those cases are turning into 
liquidation cases because, one, debtor-in-possession financing 
is very hard to get in the current credit crunch.
    Two, most of the assets are liened-up, and it is virtually 
impossible to prime a secured creditors. So the only source of 
debtor-in-possession financing turns out to be the existing 
secured creditor. And, generally, those are the defensive--
debtor-in-possession financings--but they carry with them very 
coercive provisions.
    They impose upon the debtor in possession dates, as to 
which a plan of reorganization must be filed. Very often, they 
give consent rights to the secured creditors.
    What has happened is the balancing of equities before--the 
balancing of interests that was incorporated into the 1978 
Bankruptcy Reform Act is no longer in place. The balance has 
been skewed very much in favor of the creditors, so that 
rehabilitation turns out not to be the primary objective of a 
Chapter 11 case.
    Chapter 11, in effect, has become a process for the 
sterilization of liquidation sales to buyers for liquidation of 
the assets. And very few of these cases currently are turning 
out to be rehabilitation reorganization.
    As a consequence of that, there are a great deal of jobs 
that are being lost. And the 34,000 jobs of Circuit City is 
compounded by--I am told that, over the last year, we have 
eliminated approximately 240,000 jobs in the retail sector. The 
retail sector is the employer of last resort.
    I am also told that there are only about 479,000 jobs left 
in retailing. If you read the papers today, you will see 
retailing is going to have a pretty bad 2009.
    The question is: How can we rehabilitate and reorganize 
these companies? We have to deal with the issue that debtor-in-
possession financing, under this Code, is generally not 
available.
    Can there be some provisions that are put into an amendment 
to the code, that will make debtor-in-possession financing more 
accessible, even if it may cause secured creditors to have to 
wait a longer period of time to get recoveries? Are we going to 
reinstate the objective of rehabilitation and reorganization, 
rather than liquidation of assets in Chapter 11?
    These are among the problems that are occurring now. And 
one more, which I will add in the last minute, I think, is 
that----
    Mr. Cohen. Thank you, sir. I have been----
    I think we are beyond the last minute, so if you can 
close----
    Mr. Miller. I will close with this statement----
    Mr. Cohen. Thank you.
    Mr. Miller [continuing]. If I may, Mr. Chairman.
    Claims trading has also become a big problem in Chapter 11 
cases. In 1991, when the rules of bankruptcy procedure were 
amended to allow, basically, free trading of claims against the 
debtor, a whole market opened up.
    Now, buyers of claims buy them in at a substantial 
discount. Their entry fee is much lower. Their objectives are 
much different. They have a much shorter horizon. They are 
particularly concerned about expeditious recoveries and big 
recoveries. Their objective is not so much the rehabilitation 
of the debtor. This has changed the dynamic.
    So, finally, my last sentence, sir, would be: The dynamic 
that was contemplated in 1978 is not the dynamic that is 
playing in Chapter 11 today. With all of the restrictions which 
were imposed in the 2005 amendment--they have had the effect of 
stopping the rehabilitation process, and leading cases, more 
often, into the sale of assets.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Miller follows:]
                 Prepared Statement of Harvey R. Miller



                               __________
    Mr. Cohen. Thank you, sir. And I appreciate your making 
yourself available through the telephonic communication. If you 
can stay with us, we are going to have the other witnesses 
testify. And then we will, at some point--I think we have to go 
have votes, and return. And if you could stay with us for 
questions, that would be great.
    Mr. Miller. I would be happy to, sir.
    Mr. Cohen. Thank you.
    I would now like to recognize Mr. Richard Pachulski, for 
his statement.

              TESTIMONY OF RICHARD M. PACHULSKI, 
               PACHULSKI STANG ZIEHL & JONES, LLP

    Mr. Richard Pachulski. Mr. Chairman and Members of the 
House Subcommittee, I first want to thank each of you for the 
opportunity for me to participate in this hearing, and to 
present my personal views regarding the factors that led to the 
liquidation of Circuit City, and the loss of over 34,000 jobs.
    While I am presently lead counsel to the creditors--to the 
Circuit City Creditors' Committee--all positions I present here 
are my own personal views, and not of the Creditors' Committee, 
or any client of the firm of which I am a law partner.
    In my almost 30 years as a restructuring attorney, with 
this being the fourth recessionary cycle that I have been a 
witness to, in that professional career, in no prior 
recessionary cycle have I seen such hopelessness in 
reorganizing financially troubled companies, particularly in 
the retail industry.
    As presented in my written testimony, while I could come up 
with many factors that ultimately led to Circuit City's 
liquidation, three factors are the most dominant: First, the 
general downturn of the United States economy; second, the 
unbelievable tight credit market, with specific emphasis on the 
lack of virtually any debtor-in-possession financing; and, 
third, Section 503(b)(9) of the bankruptcy code.
    For a simple background, as of mid-2008, Circuit City 
operated 712 superstores and nine outlet stores, providing over 
40,000 jobs. In addition, Circuit City also operated under a 
Canadian subsidiary known as InterTAN, with 700 retail stores 
and dealer outlets in Canada.
    As of calendar year 2007, Circuit City represented 8.1 
percent of the United States' consumer-electronics retail 
market. And during Circuit City's fiscal year ending February 
29, 2008, Circuit City had sales of approximately $11.7 
billion.
    I now would like to spend a moment discussing each of the 
three factors that I previously alluded to, that contributed to 
Circuit City's liquidation.
    As to the effect of the economic downturn on Circuit City, 
as with so many retailers in 2008, Circuit City suffered a 
significant decrease in customer traffic. Simply put, as 
consumers were limited in their borrowing from credit cards and 
equity loans, household and consumer-electronic products 
suffered a dramatic reduction in sales. For instance, it 
certainly didn't help that 75 percent of Circuit City sales 
were generated through credit card purchases.
    The next issue that so dramatically constrained Circuit 
City's ability to reorganize and to avoid liquidation and the 
loss of jobs was its relationship with its pre-Chapter 11 bank 
group. In fact, just weeks before the case commenced, the bank 
group reduced Circuit City's borrowing availability by over $50 
million.
    Upon filing Circuit City's Chapter 11 petition, the bang 
group provided what it termed as ``DIP financing.'' But when 
all was said and done, the bank group effectively gave back to 
Circuit City the $50 million it took away pre-petition, at a 
remarkable cost.
    In evaluating the bank group's DIP-financing package, for 
essentially $50 million in available credit, Circuit City had 
to pay $30 million in fees, had to consent to a forced timeline 
for the sale of the business, cram down immunity and the 
ability to call a default at almost any time, once the 
Christmas season ended. The very banking institutions that have 
received substantial bailout money effectively squeezed Circuit 
City to liquidation.
    If the economy and the bank group's DIP financing did not 
destroy any chance of Circuit City having sufficient time to 
achieve an internal reorganization by downsizing or selling 
Circuit City's businesses, bankruptcy code Section 503(b)(9) 
was the final death knell.
    What Section 503(b)(9) provided upon its enactment in 2005 
was that goods received by a debtor within 20 days before the 
date of the commencement of the Chapter 11 case would be 
provided administrative-claim status. In order to confirm a 
plan of reorganization, administrative claims must be paid in 
full on the effective date of a plan of reorganization.
    Accordingly, certain pre-position trade claims were 
elevated from unsecured-creditor status to administrative-claim 
status upon the enactment of Section 503(b)(9).
    In the case of Circuit City--filed Section 503(b)(9) claims 
of approximately $359 million. Circuit City's management 
estimates those claims will be allowed in an amount in excess 
of $215 million. In the event allowed Section 503(b)(9) claims 
were, for example, $215 million, at least that amount would 
have to have been available on the effective date of any 
Circuit City plan of reorganization, to pay Section 503(b)(9) 
claims, instead of those monies being used for distribution to 
similarly situated creditors who gave trade credit more than 20 
days before the petition date for needed capital expenditures, 
labor upgrades and other necessary costs to effectuate a 
successful reorganization.
    In conclusion, while Circuit City may have been bigger than 
any other retailer to have been forced to liquidate in 2008, 
the major factors that caused the liquidation are presently 
inherent in all retail bankruptcies: A difficult economy; risk-
averse lenders, facing their own financial struggles; and 
Section 503(b)(9) claims, making virtually any Chapter 11 more 
problematic.
    Again, I thank the Subcommittee for the opportunity to 
present my personal views regarding Circuit City's liquidation, 
and the likely causes of future retail-company liquidations, 
unless the economy corrects itself and other measures are taken 
by Congress to correct the increasingly difficult environment 
to restructure financially challenged retail businesses.
    Thank you, again.
    [The prepared statement of Mr. Richard Pachulski follows:]

               Prepared Statement of Richard M. Pachulski



                               __________
    Mr. Cohen. Thank you, Mr. Pachulski.
    And, now, I recognize Mr. Hurwitz, for his testimony.

 TESTIMONY OF DANIEL B. HURWITZ, PRESIDENT AND COO, DEVELOPERS 
  DIVERSIFIED REALTY CORPORATION, ON BEHALF OF INTERNATIONAL 
                  COUNCIL OF SHOPPING CENTERS

    Mr. Hurwitz. Good afternoon, Mr. Chairman, and Ranking 
Member Franks.
    My name is Daniel Hurwitz, and I am president and Chief 
Operating Officer of Developers Diversified Realty Corporation. 
I am pleased to testify today on behalf of the International 
Council of Shopping Centers.
    I have a unique perspective on the topic of the effect of 
Chapter 11 bankruptcy laws in the Circuit City bankruptcy 
filing, as my company was the largest landlord of Circuit City, 
with 50 leases, $38 million in unsecured claims, and as a 
member of the Creditors' Committee in that case.
    I look forward to sharing our direct experience with the 
Subcommittee.
    Mr. Chairman, Circuit City's liquidation can be directly 
traced to three principal factors: The company's poor financial 
results; its inability to obtain realistic credit terms from 
trade vendors; and the devastating reality that the U.S. 
financial markets are mired in such profound turmoil that 
financing is nearly impossible to secure.
    From our vantage point, Developers Diversified witnessed 
firsthand the collapse of this once-respected American brand. 
While the failure of Circuit City is a loss on many levels, to 
suggest that the company liquidated because of the current 
Chapter 11 process, or the deadline to assume or reject its 
leases, overlooks the complex set of factors which actually led 
to the company's demise.
    First, the 210-day period to assume or reject leases is 
only a deadline if the landlords will not agree to an 
extension. The vast majority of Circuit City landlords, led by 
my company, would have granted an extension, as was done in 
recent bankruptcy cases filed by Hancock Fabrics, Linens-N-
Things and Movie Gallery.
    Circuit City entered bankruptcy with a post-petition 
lending facility that required the company to file a plan of 
reorganization, or close on a sale transaction, by January 31, 
2009, less than 90 days after the filing date.
    The post-petition loan that Circuit City obtained from its 
lenders provided the company with a mere $50 million in 
additional liquidity at a cost of $30 million in fees.
    In light of the company's dismal post-bankruptcy sales 
results, its lenders were unwilling to extend the deadlines 
imposed by the lending facility, without clear support and 
participation from Circuit City's suppliers, which it simply 
could not achieve.
    Based on this recent experience, what lessons can we learn 
about retail bankruptcies in the current economic environment?
    First, we are experiencing an unparalleled business cycle 
that is testing even the best retail operators. Bank credit 
continues to tighten, debtor-in-possession financing has become 
specifically onerous, and trade vendors are reluctant to extend 
credit, except on the most egregious of terms. Without access 
to credit, even the best retailers will not be able to survive.
    Second, the current retail liquidations have little to do 
with the Chapter 11 process. This is particularly true as to 
the lease assumption-or-rejection deadline of 210 days.
    It is telling that, when the attorney for Circuit City 
explained to the bankruptcy court the reason why Circuit City 
was forced to liquidate, he never mentioned the 210-day 
deadline as a cause.
    In fact, he specifically told the court that the reason for 
the liquidation was, in his words, ``Due to the fact that 
financing in this market is extremely difficult.'' This is the 
hard truth, and it in no way implicated shopping-center 
landlords or the current Chapter 11 process.
    Third, a retail bankruptcy can have serious negative 
effects on the shopping centers and on other retailers. The 
2005 amendments that created more certainty for shopping-center 
owners now provides an important firewall which prevents the 
failure of one retailer from cascading to other businesses.
    It would be unwise to revert to a standard which gives 
tenants an unlimited amount of time to make decisions about 
assuming or rejecting a shopping-center lease, and therefore 
places the other tenants, and its employees within the shopping 
center at risk.
    My experience with the retail bankruptcies in recent years 
proves that the 210-day period has not been a factor in the 
fate of retailers who file for Chapter 11 protection. The 
catalyst for recent job losses and business liquidations is the 
poor economy and the lack of credit from vendors and lenders.
    In conclusion, Mr. Chairman, the relationship between a 
tenant and a landlord is one of partnership. We share 
customers, invest side-by-side, and work in the communities we 
serve together. We need each other to exist, and our interests 
are aligned.
    While some may paint a picture to the contrary, let there 
be no mistake that landlords thrive with healthy tenants, and 
tenants thrive with successful landlords.
    There is no incentive for landlords to put additional 
stress on tenants having operating difficulty. The 210-day 
provision ensures that all interested parties come together in 
a timely manner to listen, and be heard, in the best interest 
of the operating company and its employees.
    It is an honor to testify before you today, and I look 
forward to answering any questions you or other Members of the 
Subcommittee may have. Thank you, sir.
    [The prepared statement of Mr. Hurwitz follows:]
                Prepared Statement of Daniel B. Hurwitz
    Good morning, Mr. Chairman and Ranking Member Franks, my name is 
Daniel Hurwitz and I am President and COO of Developers Diversified 
Realty Corporation. I am pleased to testify today on behalf the 
International Council of Shopping Centers. Founded in 1957, ICSC is the 
premier global trade association for the shopping center industry. Its 
more than 70,000 members in over 90 countries include shopping center 
owners, developers, investors, lenders, retailers and other 
professionals as well as academics and public officials. I have a 
unique perspective on the topic of the effect of Chapter 11 bankruptcy 
laws in the Circuit City bankruptcy filing as my company was the 
largest shopping center landlord of Circuit City and we were members of 
the Creditors Committee in that case. I look forward to sharing our 
direct experience with the Subcommittee. I will also discuss more 
generally the perspective of shopping centers on the current round of 
retail bankruptcy filings. I have several attachments to my statement 
and I would ask that they be included in the record.
                      the circuit city bankruptcy
    Mr. Chairman, Circuit City's liquidation can be directly traced to 
three principal factors: the company's poor financial results, its 
inability to obtain realistic credit terms from trade vendors, and the 
devastating reality that the US financial markets were mired in such 
profound and unprecedented turmoil that financing--both debtor-in-
possession and exit financing--was impossible to secure. Indeed, from 
our vantage point, Developers Diversified witnessed firsthand the 
collapse of this once respected and iconic American brand. I feel we 
are uniquely qualified to speak to the factors which led to that 
collapse.
    DDR was Circuit City's largest landlord, with approximately 50 
leases and at least $38 million in potential unsecured claims. DDR's 
business representatives had met with Circuit City's management prior 
to the bankruptcy filing and assured them that DDR stood ready to 
assist with what was then an out-of-court restructuring plan.
    As it does in any bankruptcy case where it has a significant number 
of leases and potential exposure, DDR actively participated in Circuit 
City's bankruptcy proceedings. From the outset, our goal--for broader 
purposes as well as admittedly self-interested ones--was to see Circuit 
City survive. In fact, DDR proactively expressed a desire to extend the 
deadline to assume or reject leases. Further, along with other shopping 
center landlords, DDR agreed not to immediately press for post-petition 
rent in the amount of $25 million. DDR played a significant role in 
Circuit City's efforts to reorganize, not only in its capacity as 
Circuit City's largest landlord, but also as a vice chair of the 
Official Committee of Unsecured Creditors.
    At their first joint meeting in Washington in November 2008, we 
advised the other members of the Creditors' Committee, as well as 
Circuit City's management and retained professionals, that DDR would 
proactively seek to extend the 210-day period to assume or reject DDR's 
leases, even though the actual deadline was not until June 2009. DDR 
further proposed that it would advocate for extensions from other 
landlords. We repeated this proposal to counsel for the Committee and 
Circuit City on several occasions during the first two months of the 
case. In each instance, the company responded that its critical issues 
with other stakeholders took priority and would have to be resolved 
before it could turn to the extensions of time to assume or reject its 
leases.
    Eventually, these other issues--financing, trade credit and 
business results--overwhelmed and ultimately capsized the company, 
mooting any discussion of lease assumption deadlines.
    While the imminent absence of Circuit City as a fixture on the 
American retail landscape, coupled with the resulting loss of 34,000 
jobs, is an undeniable tragedy, to suggest that the company was forced 
out of business because of Chapter 11 or the deadline to assume or 
reject its leases wildly misses the point and overlooks a complex set 
of factors which actually led to the company's demise.
    First, the 210-day period to assume or reject leases is only a 
deadline if the landlords will not agree to an extension. As I stated, 
the vast majority of Circuit City's landlords, led by DDR, would have 
granted an extension, as they had done in the recent retail bankruptcy 
cases filed by Hancock Fabrics, Linens 'n Things and Movie Gallery.
    In Circuit City's case, as we have seen, the deadline was 
irrelevant. Even without landlord consent, the 210-day period would not 
expire until June 2009 and the liquidation of the company is already 
nearly complete as of early March.
    We do not deny for a moment that amended Section 365(d)(4) has 
changed the dynamic of retail bankruptcy cases. However, without 
sufficient liquidity to make post-bankruptcy payments to vendors, 
landlords, utility providers, and employees, a retailer simply cannot 
reorganize.
    The Subcommittee should note that the last reorganization of a 
significant post-amendment retail bankruptcy was Goody's, a regional 
department store which emerged from bankruptcy in October 2008, only to 
file a second Chapter 11 bankruptcy case less than four months later, 
citing restrictive financial covenants and lack of liquidity due to its 
exit financing which essentially ended the possibility of 
reorganization. Goody's is presently liquidating through its second 
case.
    We have also seen first-hand that some lenders refuse to permit the 
use and disposition of their collateral, or to extend additional 
financing, unless they have confidence in a debtor's ability to 
reorganize effectively without diminution in the value of their 
collateral. Not surprisingly, lenders have little incentive to 
participate in a reorganization process that will not result in a 
repayment of their indebtedness, which in most cases includes 
significant pre-petition borrowings.
    The debtor-in-possession financing product has significantly--and 
negatively--altered the course of recent retail bankruptcies and this 
is a fundamental cause of Circuit City's liquidation. Lenders are 
generally willing to provide only enough financing to position a debtor 
for a liquidation in the first few months of the case, and then impose 
restrictive conditions in post-petition financing agreements that 
either direct an immediate liquidation of the company, or include 
covenants or borrowing reserve rights that effectively allow the lender 
to ``pull the plug'' on the retailer only a few months into the case. 
Few debtors can survive these conditions. In fact, no recent 
significant retail debtor has.
    Circuit City entered bankruptcy in November 2008, with a post-
petition lending facility that required the company to file of a plan 
of reorganization or close on a sale transaction by January 31, 2009, 
less than 90 days after the filing date. The post-petition loan that 
Circuit City obtained from its lenders provided the company with a mere 
$50 million in additional liquidity at a cost of $30 million in fees. 
In light of the company's poor post-bankruptcy performance, its lenders 
were unwilling to extend the deadlines imposed by the post-petition 
lending facility (not the landlords' deadlines) without clear support 
and participation from Circuit City's suppliers, which it simply was 
not able to muster. In addition to this formal post-petition financing, 
the Subcommittee should be aware that Circuit City essentially borrowed 
$25 million dollars from its landlords, without paying interest, fees 
or providing any collateral. Circuit City took the position that it 
would not pay landlords post-petition rent (``stub rent'') due from the 
date it filed for bankruptcy on November 10, 2008, until the end of the 
month.
              lessons from recent retail bankruptcy cases
    So, after these recent experiences, what lessons can be learned 
about retail bankruptcies in the current economic conditions?
    First, we are experiencing a catastrophically difficult business 
environment that will challenge even the best-run retailers. Bank 
credit has tightened generally; bankruptcy debtor in possession 
(``DIP'') lending has specifically tightened and trade vendors are 
reluctant to provide credit, except on the most onerous of terms. 
Consumer spending and confidence are at all-time lows and unemployment 
has reached levels not seen since the early 1980s. This is a perfect 
storm. Reduced consumer spending reduces retailer profits, which in 
turn makes lenders reluctant to lend. Without access to credit, even 
otherwise well-run retail operations may not be able to survive.
    Second, the current retail liquidations have little to do with the 
Chapter 11 process. This is particularly true as to the lease 
assumption or rejection deadline of 210 days enacted in 2005. When 
retailers have asked for extensions, shopping owner owners have 
overwhelmingly granted those extensions. In fact, in the Circuit City 
case, landlords agreed not to pursue post-petition or stub rent in an 
effort to provide additional liquidity to the company. It is telling 
that when the attorney for Circuit City explained to the bankruptcy 
court in Richmond, Virginia, on January 16, 2009, the reason why 
Circuit City was forced to liquidate, he never mentioned the 210-day 
deadline as a cause. In fact, he specifically told the court that the 
reason for the liquidation was, in his words, due to ``the fact that 
financing in this market is extremely difficult.'' This is the hard 
truth, and it in no way implicates shopping center landlords or Chapter 
11.
    It is clear that what is pushing retailers into liquidation relates 
to credit availability and vendor willingness to ship consumer products 
on reasonable terms. Nothing in the bankruptcy law can change this 
unfortunate reality.
    Third, a retail bankruptcy can have serious negative effects on 
shopping centers and on other retailers. The 2005 amendments that 
created more certainty for shopping center owners now provide an 
important ``firewall'' which prevents the failure of one retailer from 
cascading to other businesses. Under the prior law, lingering 
uncertainty caused neighboring stores to suffer from reduced traffic 
and sales while potential new tenants were reluctant to rent space in a 
shopping center with an uncertain future. Also the bankrupt retailer 
has an unfair competitive advantage over other retailers in the same 
center. It would be unwise, to say the least, to revert to a bankruptcy 
standard which gives tenants an unlimited amount of time to make 
decisions about assuming or rejecting a shopping center lease. Such a 
change would do nothing to make vendors ship products on friendly 
terms. The only effect is to put others at risk.
                               conclusion
    In conclusion, Mr. Chairman, my experience with multiple retail 
bankruptcies in recent years plainly shows that the 210-day period for 
assuming or rejecting leases has not been a factor in the fate of 
retailers who file Chapter 11. The cause of recent job losses and 
business liquidations is quite simply the poor economy and tight 
credit. Troubled retailers will only be able to reorganize successfully 
when these negative market conditions change. No reform of Chapter 11 
would have induced trade creditors in Korea to ship consumer 
electronics to Circuit City. No reform of Chapter 11 would have 
lessened tight lending standards.
    I want to finish my remarks by restating the obvious fact that the 
success of shopping center landlords depends on having tenants who pay 
rent. Shopping center owners have a vested interest in the financial 
success of the retail sector. Especially now, as the landlord conduct 
in the Circuit City case shows, landlords are taking extraordinary 
steps in order to assist our retail tenants. As I said earlier, we 
agreed not to immediately press for payment of post-petition ``stub'' 
rent amounting to $25 million. Shopping center owners want retailers to 
succeed. But repealing or revising the 210-day deadline will not help 
struggling retailers; it will only harm other retailers and shopping 
center owners.
    I look forward to answering any questions you or other Members of 
the Subcommittee may have.
                               __________
    Mr. Cohen. You are welcome. Thank you, Mr. Hurwitz.
    And, now, Professor Zywicki, if you would, proceed with 
your testimony.

           TESTIMONY OF TODD J. ZYWICKI, PROFESSOR, 
             GEORGE MASON UNIVERSITY SCHOOL OF LAW

    Mr. Zywicki. Thank you, Mr. Chairman. It is a pleasure to 
be here.
    When BAPCPA was being considered, I testified a number of 
times before this Subcommittee, and did a number of staff 
briefings. And right now, I am writing a book on BAPCPA. So 
what I am going to try to do today is remind this Subcommittee 
of why BAPCPA is written the way it is, and the goals that it 
was trying to accomplish.
    But, first, let us keep in mind: The purpose of Chapter 11 
is to allow financially-distressed firms to reorganize. It is 
not to try to save companies that are economically failed, or 
prop up companies whose time has passed.
    This country used to have a lot of jobs in the typewriter-
manufacturing industry, and the makers of typewriter 
accessories. But, obviously, we don't make typewriters anymore. 
Jobs were destroyed in the typewriter industry. But it is 
difficult to say that we should have tried to save the 
typewriter industry at all costs.
    The goal is to try to efficiently distinguish between 
companies that should be reorganized, versus those companies 
whose time has passed.
    The second thing to keep in mind is there are multiple 
constituencies in a bankruptcy case. BAPCPA was, quite plainly, 
a response to the need to rebalance a system that had gotten 
out of whack.
    The system designed by 1978 was a system that was overly 
tilted toward debtor, and created undue hardships on a lot of 
other constituencies in the bankruptcy process. BAPCPA was a 
very well calibrated process to try to bring that system back 
into balance, and to try to restore some balance.
    So let us familiarize ourselves to remember why it is that 
BAPCPA does what it does. First, consider the issue of leases 
in the 210-day deadline. Let me illustrate this by a story that 
draws on my own experience.
    I live out in Northern Virginia, by Seven Corners. There is 
a strip mall in Seven Corners. There was a Montgomery Ward's in 
that strip mall. In 1997, Montgomery Ward's filed bankruptcy. 
It was a terrible, dingy store. Nonetheless, for 2 years, 
Montgomery Ward's sat in that strip mall, trying to reorganize. 
Finally, in 1999, Montgomery Ward's came out of bankruptcy. 
Soon thereafter, everybody realized that they should have been 
put to sleep, and not wasted 2 years.
    As soon as they--while Montgomery Ward's was in bankruptcy, 
foot traffic through the mall just plummeted. It was a terrible 
store. Nobody wanted to shop there. The store became shabby. 
And it took down other stores with it.
    Right next store to it was a PetSmart. The PetSmart finally 
had to close its door for, like, 6 to 9 months, because 
Montgomery Ward's wasn't generating enough foot traffic. 
Restaurants in the shopping mall were injured by the fact that 
the Montgomery Ward's, which was the anchor tenant in the mall, 
was not bringing in traffic.
    Finally, we got rid of that terrible Montgomery Ward's. 
Soon thereafter, a Target store came in. The Target store is 
booming. I can say, as a consumer, I am much more happy with 
the Target store there. The PetSmart is reopening. The other 
stores in the strip mall are booming.
    The point, here, is that by trying to save that Montgomery 
Ward's by that long, drawn-out process of 2 years, we tried to 
save a store that couldn't be saved. And we put off the entry 
of a new Target; a growing store with better jobs, that was 
creating benefits for the other stores in the strip mall, the 
restaurants, and everything else.
    That is what the 210-day deadline was designed to do--is to 
bring about a more swift reconciliation of these situations, 
like Montgomery Ward's, so that we wouldn't have stores sitting 
there for 2 years, bringing down all the other stores in the 
strip mall, with it.
    What about the administrative priority for vendors? The 
reason why we put in the--why the 20-day administrative 
priority for vendors was put in--was because, in fact, it was 
not the case that, prior to BAPCPA--that vendor claims were 
treated as unsecured claims.
    In fact, what was happening is that courts, on an ad hoc, 
case-by-case basis, were turning some of these unsecured claims 
into what were called critical-vendor claims.
    If you take Kmart, for instance, Kmart had $300 million in 
critical-vendor claims. Twenty-two hundred, out of 4,000, 
vendors were called critical-vendor claims. Who are critical 
vendors? Well, I will tell you what, it wasn't the small 
businesses who didn't have the political clout and couldn't 
hire the lawyers to get themselves on that magic list of being 
a critical vendor.
    All that 503(b)(9) does is rationalize and equalize what 
had been this ad hoc, and, really, unfair process of how people 
were being converted into critical vendors. As Kmart 
illustrates, $300 million in critical vendors, in that case, is 
about what we see as administrative priorities in the current 
case.
    Third, there is concerns about the expedited speed by which 
bankruptcy cases are supposed to proceed, such as reducing the 
time for exclusivity, and other checkmarks that try to make the 
bankruptcy case move along faster. That was to deal with a 
particular problem, especially in a lot of cases, which is 
cases that would just sit in the bankruptcy courts, and do 
nothing, much to the frustration of creditors, landlords, and 
everybody else.
    The only jobs those cases were saving were the jobs of the 
$700-an-hour lawyers who were continuing to administer those 
cases, and milk those cases, for months or years on end, until 
those cases were finally put out of their misery.
    What are those cases trying to do? They are trying to 
reduce the cost of dealing with those cases.
    Real administrative cases and bankruptcy cases, today--
talking about lawyers' fees and bankers' fees--can be tens or 
hundreds of millions of dollars. The process that BAPCPA tried 
to set up was to try to push more of that into the pre-filing 
period, to make the parties pay for it, rather than dumping 
these things in bankruptcy, and, thereby, rolling up tens or 
hundreds of million dollars of lawyers' fees, and to try to 
bring a faster reconciliation of these cases.
    The question we have to ask in a case like Circuit City, 
then, is: Is it really worth burning through $40 million or $50 
million of attorneys' fees to get to the point where we knew we 
were going to get with Circuit City, a company that was failed; 
a company that couldn't get debtor-in-possession financing; a 
company whose time had passed?
    Thank you.
    [The prepared statement of Mr. Zywicki follows:]
                 Prepared Statement of Todd J. Zywicki
    It is my pleasure to testify today on the subject of ``Circuit City 
Unplugged: Why Did Chapter 11 Fail To Save 34,000 Jobs?'' The American 
economy faces a major recession and there are clear signs of major 
struggles ahead for the retail industry. Several major retailers have 
filed bankruptcy in recent months and continued sluggish spending and 
access to credit by consumers augurs further struggles ahead for the 
retail sector of the economy. Some commentators have expressed concern 
that a disproportionate number of retail bankruptcies have ended up in 
liquidation rather than successful reorganization and have argued that 
several Bankruptcy Code amendments enacted as part of the Bankruptcy 
Abuse Prevention and Consumer Protection Act of 2005 (``BAPCPA'') as 
creating pressures for economically inefficient liquidations.
    It is possible that BAPCPA has at the margin helped to contribute 
to some of these liquidations. But it is far from clear that this is 
the case, as there are numerous other factors in the current that 
likely have contributed substantially to the liquidation of these 
firms. Moreover, to the extent that BAPCPA's amendments have arguably 
contributed to the problem, repealing the relevant provisions will 
create new problems of their own, such that the costs of their repeal 
might likely exceed the benefits. In fact, by bringing about a swift 
and decisive resolution of a failing company's prospects, thereby 
clearing the field for more vibrant competitors to grow, BAPCPA's 
impact in many cases is unquestionably productive. The amendments in 
BAPCPA were enacted to address particular problems under the pre-BAPCPA 
scheme and repealing those amendments would simply resuscitate those 
problems. Thus before taking this step, Congress should consider 
whether the benefits of their repeal exceed the costs.
    Macroeconomic Conditions and Chapter 11
    The overarching purpose of Chapter 11 reorganization is to 
distinguish between firms that are economically failed and those that 
are in financial distress. An economically-failed firm is one that is 
essentially better-off dead than alive--shut down operations and 
reallocate the financial, human, and physical capital of the enterprise 
elsewhere in the economy. A firm in financial distress is one that 
simply needs to reallocate its capital structure in order to be a 
prosperous enterprise. Chapter 11 exists to reorganize firms in 
financial distress but not those that are economically-failed. There is 
reason to believe that some of the retailers that have liquidated in 
recent months are economically-failed firms, rather than merely 
financially-distressed. Hence, efforts to reorganize and save those 
companies would likely be economically inefficient.
    The economy in general and the retail sector specifically are 
currently going through some very difficult times. Unemployment is 
rising and consumer spending and borrowing is falling. The result has 
been widespread difficulties for the retail sector.
    But these difficulties are not uniform. There are areas of the 
retail economy that are doing fine or even prospering--most notably 
discount stores such as Wal-Mart, BJ's Wholesale, Ross's, TJ Maxx, and 
Big Lots, which have reported rising sales and profits, sometimes 
reversing struggles during the recent economic boom years. High-end 
stores such as Saks and Nordstrom, by contrast, have suffered badly in 
the economic downturn. Going forward we can also expect the Circuit 
City's of the world to be faced with increasingly strong competition 
from on-line sellers such as Amazon or eBay, which can sell the same 
products more cheaply and conveniently than traditional bricks-and-
mortar sellers, and especially as financially-strapped consumers shop 
more aggressively for lower prices.\1\
---------------------------------------------------------------------------
    \1\ As a personal illustration, during the past two years or so I 
have purchased a laptop, headphones, and record album converter from 
on-line sellers, a high-definition television from Costco, and portable 
dvd player from Target. In none of those situations did I go to a 
traditional seller of electronics goods such as Circuit City or Best 
Buy.
---------------------------------------------------------------------------
    As part of the economic slowdown, therefore, we can expect to see 
the process of ``creative destruction'' at work in the economy--certain 
sectors of the retail industry will suffer while others prosper. 
Sellers of expensive discretionary items--such as big-screen 
televisions, high-end electronics, consumer durables, and automobiles--
will likely feel the pinch especially strongly in a slowing economy. 
Thus, it is to be expected that there will be some business casualties 
as consumers tighten their belts--and those casualties probably will be 
stores such as Circuit City, Sharper Image, and other purveyors of 
higher-end discretionary consumer and electronic goods. Other 
retailers, such as Linens 'n Things' were consistently losing money for 
many years before entering bankruptcy, a decline frequently exacerbated 
by subpar ownership or management.
    Circuit City was not immune to these trends. Reports indicate that 
its year-to-year foot traffic plummeted by double-digit amounts and its 
downward spiral was exacerbated by poor management, as exemplified by 
the short-sighted decision to fire several thousand of its most 
experienced and highly-paid hourly workers and replace them with 
inexperienced substitutes. Vendors also lost confidence in Circuit 
City's reliability and became reluctant to provide inventory. Consumers 
have scaled back spending and found credit card credit drying up, a 
particularly damaging hit to Circuit City which makes most of its sales 
on credit cards. None of these problems can be attributed to BAPCPA.
    Bankruptcy cannot and should not be used to save economically 
failed enterprises plagued by a bad business plan, poor ownership, or a 
fundamental inability to compete in a changing marketplace. Chapter 11 
can help financially-troubled but fundamentally-valuable firms live to 
fight another day. Chapter 11 cannot reverse the creative destruction 
of the competitive marketplace or force consumers to buy goods and 
services that they don't want. In such situations, the purpose of the 
bankruptcy system is to clear-out failed enterprises to allow new firms 
to expand to fill the void. Not every firm is worth saving and saving 
weak firms ties up physical, financial, and human capital that could be 
better deployed elsewhere in the economy. The manufacture of 
typewriters and typewriter accessories was once a huge industry in the 
United States but their disappearance isn't the fault of Chapter 11.
    Moreover, some experts have suggested that the bankruptcies and 
liquidations we are seeing now may be consistent with a long-overdue 
shake-out in the retail industry. Like many other areas of the economy, 
many retailers may have been kept alive artificially by access to cheap 
credit that delayed their inevitable day of reckoning. These companies 
may not have been economically viable for some time but only collapsed 
when their access to cheap credit dried up. Consumer spending was also 
artificially inflated by easy access to credit.
    In short, some of the liquidations that we see today may be a 
necessary macroeconomic adjustment to a leaner economic time where 
certain retailers will shrink or even disappear while others expand to 
take their place. It is not obvious, for instance, that Circuit City 
would have successfully reorganized in a market with fierce competition 
and sagging consumer demand. Thus, liquidation of some retailers may be 
a necessary medicine as the economy returns to a less-overheated state.
     non-bapcpa bankruptcy-related factors explaining liquidations
    There are also other factors in the economy today that may explain 
a trend toward liquidation independent of BAPCPA's changes in the law.
    First, many scholars have documented that over the past several 
years, the practice of Chapter 11 has changed dramatically away from 
the traditional focus on court-supervised reorganization in Chapter 11 
to a secured-creditor driven system that results much more often in 
liquidation.
    As Professor Barry Adler noted in his testimony before this 
Committee in September 2008, during the past decade there has been a 
sea change in the nature of Chapter 11 practice ``as debtor control of 
bankruptcy has given way to creditor dominance.'' \2\ When a firm 
enters bankruptcy today more or all of its assets are already pledged 
to one or a number of secured creditors. As a result, when bankruptcy 
is filed the debtor quickly loses control over the case. Shareholders 
are routinely wiped out and incumbent managers usually lose their jobs. 
These two constituencies (along with workers) typically are the 
strongest advocates for reorganization even if reorganization would be 
inefficient--the fact that they are typically sidelined in the 
bankruptcy process today both weakens internal political forces 
advocating reorganization as well as reflecting the reality of modern 
Chapter 11 practice.\3\ Secured creditors, by contrast, will often 
prefer a swift liquidation of the debtor (or sale as a going-concern) 
to the uncertainty and delay of an extended Chapter 11 process. In 
fact, the gradual move toward greater control of the Chapter 11 process 
by secured creditors has better-aligned the incentives of secured 
creditors with the needs of the bankruptcy case as secured creditors 
now have proper incentives to push for efficient resolution of 
financial distress instead of inefficient liquidation or 
reorganization.\4\ In the modern era of swift and competitive global 
capital flows investors will not tolerate bankruptcy laws and practice 
that impose undue delay, risk, and uncertainty.\5\
---------------------------------------------------------------------------
    \2\ Testimony of Professor Barry E. Adler, Hearing on Lehman 
Brothers, Sharper Image, Bennigan's, and Beyond: Is Chapter 11 
Bankruptcy Working?, House of Representatives Committee on the 
Judiciary, Subcommittee on Commercial and Administrative Law (Sept. 25, 
2008).
    \3\ Circuit City's Chief Executive Officer Philip Schoonover was 
paid $8.52 million in fiscal 2006, more than double that earned by Best 
Buy's CEO, even as Circuit City was sliding toward bankruptcy. See Mark 
Clothier, Circuit City to Fire 3,400, Hire Less Costly Workers, http://
www.bloomberg.com/apps/news?pid=20601087&sid=aw.zhHEzMpZU&refer=home 
(March 28, 2007).
    \4\ Barry E. Adler, Bankruptcy Primitives, 12 ABI L. Rev. 219, 226-
33 (2004).
    \5\ Todd J. Zywicki, The Past, Present, and Future of Bankruptcy 
Law in America, 101 Mich. L. Rev. 2016 (2003).
---------------------------------------------------------------------------
    As a result of these new realities of the bankruptcy landscape 
there has been a growing trend toward liquidation in large Chapter 11 
cases wholly independent of (and predating) BAPCPA's enactment. 
Professor Adler quotes the findings of Professor Lynn LoPucki, who 
finds that ``41 firms that filed bankruptcy as public companies each 
with assets exceeding approximately $218 million liquidated in 2002, 
although no more than 8 such firms did so in any year prior to 1999.'' 
\6\ Thus, it is likely that many of the retailers that have liquidated 
in recent months would have liquidated regardless of BAPCPA, especially 
those firms encumbered by high levels of secured debt.
---------------------------------------------------------------------------
    \6\ Lynn LoPucki, The Nature of the Bankrupt Firms: A Response to 
Baird and Rasmussen's The End of Bankruptcy, 56 Stanford L. Rev. 645 
(2003).
---------------------------------------------------------------------------
    Second, more specifically to the current environment, the continued 
problems in credit markets has reportedly made debtor-in-possession 
financing much less available than in the past. Major DIP lenders have 
scaled back their operations and lending volume. DIP lending is less-
available and has a greater number of strings and restrictions attached 
to it. For instance, it appears that one major reason--if not the major 
reason--for Circuit City's liquidation was its difficulty in acquiring 
DIP financing. Although it is possible that some of the problems in DIP 
financing markets are caused in parts by BAPCPA's amendments, this is 
by no means obvious. Major providers of DIP financing have either 
disappeared completely or scaled back operations. It seems much more 
plausible that the paucity of DIP financing reflects the same stresses 
exhibited in all other credit markets today rather than some unintended 
consequence of BAPCPA.
                     the possible impact of bapcpa
    Macroeconomic conditions and non-BAPCPA related bankruptcy forces 
thus may provide much of the explanation for the recent tendency toward 
liquidation in retail bankruptcy filings. Concern nevertheless has been 
expressed that various provisions of BAPCPA have resulted in a growing 
tendency toward liquidation rather than reorganization. Although this 
argument is possible in theory, it seems doubtful that this factor is 
especially important when compared to the two factors previously 
discussed. Moreover, several of those amendments were enacted to 
address particular chronic problems in the bankruptcy system; thus, 
even if their repeal or substantial amendment might marginally improve 
the prospects for reorganization, the costs associated with this course 
of action might exceed the benefits from marginally increasing the 
prospects for reorganization.
    There are several provisions in BAPCPA that might potentially 
create a stronger dynamic toward liquidation in cases involving 
retailers, most notably provisions related to the decision whether to 
assume or reject a lease of real property and increased protection for 
vendors that ship goods to the debtor in the period immediately 
preceding bankruptcy and employees of the debtor. Both of these 
provisions may arguably increase the likelihood of liquidation in any 
given case, but may be justified by other offsetting policy concerns.
Expedited Period for Assumption or Rejection of Leases
    BAPCPA amended section 365(d) of the Code to limit the time during 
which a debtor-lessee must decide whether to assume or reject an 
unexpired lease of non-residential real property. Prior to BAPCPA, the 
deadline for this decision was nominally fixed, but a Bankruptcy Judge 
could and routinely did grant an open-ended extension of time to the 
debtor up to the time of plan confirmation, a process that could take 
months or even years to resolve. This extended deliberation period 
certainly provided the debtor with substantial leisure and leeway to 
decide whether to liquidate or reorganize.
    But this luxurious time for the debtor to make up its mind came at 
a substantial cost to commercial landlords and other shopping-mall 
tenants who were forced to bear much of the cost and uncertainty during 
that period with minimal offsetting benefit. To ameliorate the 
potential harm to these parties BAPCPA provided for much tighter time-
limits for a debtor to decide whether to assume or reject these leases: 
an initial period of 120 days from the order for relief (the date of 
the bankruptcy petition in a voluntary case) that the court can extend 
for cause for an additional 90 days. Any extension beyond this 210 day 
period requires the consent of the lessor.
    The problem with the pre-BAPCPA regime can be illustrated by an 
example that draws on my own experience. I live in Falls Church, 
Virginia, near an area known as Seven Corners that is populated by 
several large strip malls. The anchor tenant in one such mall was a 
Montgomery Ward store.\7\ In 1997 Montgomery Ward filed for bankruptcy 
after having been routed by competition from department stores such as 
Target and Wal-Mart, big box specialty stores such as Home Depot, and a 
host of other rivals from on-line sellers to specialized boutiques. In 
fact, Montgomery Ward was just one of several old-line mid-sized 
department stores that expired during this time, including venerable 
chains such as Ames (2002), Bradlees (2001), Caldor (1999), Jamesway 
(1995), Woolco (1994), and numerous other national, regional, and local 
department stores that could no longer compete. Many other failing 
department stores were gobbled up by stronger rivals through mergers. 
Although many at the time predicted Montgomery Ward's eventual demise, 
they nonetheless launched an extended Chapter 11 reorganization, 
finally emerging in 1999 having closed many but not all of its outlets. 
The extended bankruptcy period did nothing to fundamentally rectify 
Ward's weak competitive position or draw consumers back into the store, 
and eventually Ward liquidated.
---------------------------------------------------------------------------
    \7\ Anchor tenants are often even given below-market rental rates 
in acknowledgement of the external benefits that they provide for other 
stores.
---------------------------------------------------------------------------
    This extended, drawn-out reorganization process certainly gave Ward 
ample time to decide whether to reorganize--a decision that almost 
immediately was revealed to be incorrect in the end. More importantly 
for current purposes, however, the delay and uncertainty of the process 
itself proved very harmful to consumers, the landlord, other tenants of 
the strip mall, and perhaps even the local government. During this 
period the store grew shabby and Ward's reorganization efforts failed 
to reverse its decline in popularity among consumers. Ward failed to 
draw the foot-traffic to the mall that is expected of an anchor tenant 
by the landlord and other smaller businesses and restaurants in the 
mall, not to mention the sales and property taxes for the local 
government. In fact, the Petsmart next door to the Ward store 
eventually suspended operations for a several-month period because of a 
lack of customers. Eventually Ward finally succumbed to economic 
reality and was replaced by a Target outlet. The Target has thrived and 
has buoyed its co-tenants in the mall. I can vouch from personal 
experience that consumers have been overjoyed by the conversion.
    Under the BAPCPA regime, it is plausible that rather than being 
given two years to try to reorganize, Montgomery Ward may have been 
liquidated earlier and the store near my house shuttered. It is worth 
noting that in hindsight it would have been better for everyone if Ward 
had been shuttered earlier, allowing Target to move in. But more 
importantly, the extended delay and uncertainty itself about Ward's 
future delayed the entrance of a highly-successful Target store, 
causing harm to consumers, the landlord, vendors, and the small 
businesses and restaurants in the mall suffered mightily from the 
uncertainty and delay over Ward's future. The demise of Ward and 
renaissance of Target brought with it many better jobs in a growing 
enterprise, not to mention the jobs created for the vendors supplying 
the prosperous Target rather than the weakling Montgomery Wards and the 
job-creation brought to the other stores in the strip mall.
    As this anecdote illustrates, there may be costs to a bankruptcy 
regime that brings about a swifter resolution of bankruptcy cases, 
including the possibility that this may lead to the liquidation of some 
firms that might otherwise have reorganized successfully. But this 
delay and uncertainty often has a cost to consumers, landlords, other 
tenants, vendors, and even local governments. There is harm from being 
too accommodating of delay as well as being insufficiently patient. One 
cannot say with certainty that 210 days is the exact right time period 
for these decisions, but it is evident that a much longer period of 
time will have substantial costs as well. Professor Adler stated the 
point well, this provision (and others in BAPCPA that expedited the 
resolution of bankruptcy cases), ``reflect the belief that if a debtor 
cannot be reorganized quickly, there may be no viable business to 
save.''
    Finally, it should be noted that the BAPCPA amendments permit an 
extension of the 210 day period with the consent of the landlord. Thus, 
where a landlord and co-tenants would be benefitted from an effort at 
reorganization, there are procedures in place to make this possible, so 
there should be minimal concern about inefficient liquidation where 
external costs to the landlord and co-tenants are absent. If the 
retailer is obviously viable and will make more-valuable use of the 
premises than other possible tenants, the landlord would be expected 
accommodate a reasonable extension of time if necessary. A landlord 
confronted with the choice between a weak Montgomery Ward store or a 
prosperous Target store will find the decision an easy one--a decision 
that will benefit workers, vendors, and the economy as well. A landlord 
in the current environment, by contrast, will be unlikely to evict a 
bankrupt tenant if there is no substitute tenant available.
    Moreover, many cases of financial distress are gradual, not 
immediate. As a result, debtors can and do plan their bankruptcy 
filings in advance of filing, and many cases are even ``pre-packaged.'' 
Thus, 210 days is only the period of time for the debtor to make a 
decision after filing but is not the limit of planning when financial 
distress is gradual. Many big cases will have extensive pre-bankruptcy 
planning and there is no reason why the debtor could not open 
negotiations with a landlord for a consensual extension of time before 
the debtor even files for bankruptcy.
Increased Administrative Priority for Certain Pre-Petition Claimants
    Critics of BAPCPA have pointed to a second factor that has been 
argued to undermine efforts to reorganize in Chapter 11, provisions 
that increased protection for certain categories of pre-petition 
claimants by providing them with administrative priority or enlarging 
existing administrative priority provisions. By increasing the amount 
of claims against the debtor that are subject to an administrative 
priority claim, these priority claims leave fewer assets available to 
pay other creditors and post-petition operating expenses. Moreover, the 
fact that a greater percentage of post-petition resources are being 
diverted to pay unproductive prepetition claims may make potential DIP 
lenders more reluctant to lend to finance the Chapter 11 effort.
    Two basic amendments in BAPCPA have been singled out as unwisely 
increasing administrative priority for pre-petition against the debtor, 
thereby diverting assets to payment of pre-petition claims that 
otherwise could be used to fund reorganization efforts.\8\ It should be 
noted at the outset that the theoretical logic of this argument is open 
to question--it is not clear why the relative priority of claims 
against a financially-troubled debtor should matter to its ability to 
reorganize. Nonetheless, there is a perception that increasing the size 
of administrative claims ties the hands of debtors, limiting their 
flexibility to reorganize.
---------------------------------------------------------------------------
    \8\ See Testimony of Lawrence C. Gottlieb, The Disappearance of 
Retail Reorganization in the Post-BAPCPA Era, House of Representatives 
Committee on the Judiciary, Subcommittee on Commercial and 
Administrative Law (Sept. 25, 2008).
---------------------------------------------------------------------------
    The first is the addition of section 503(b)(9) to the Code, which 
creates a new administrative claim for goods actually received by the 
debtor within the 20 days prior to the Chapter 11 filing. For a 
retailer with rapid inventory turnover, this may create a substantial 
administrative priority claim, arguably making reorganization more 
difficult. Moreover, this administrative priority claim status may have 
the unintended consequence of encouraging liquidation in another way: 
vendors are a constituency in bankruptcy that tends to favor 
reorganization because this maintains a market for their products. By 
reducing the value of their unsecured claims in bankruptcy, however, 
this may reduce their voice and clout in the reorganization process. 
Thus, while this increased priority helps them in the short run it 
ironically might create offsetting harm in the long-run by increasing 
the probability of liquidation.
    But the impact of this change in the law may be overstated. Under 
pre-BAPCPA law these claims were nominally treated as general unsecured 
claims. But, in practice, in many retailer cases bankruptcy courts 
would grant administrative priority for pre-petition goods to many 
vendors as so-called ``critical vendors'' that were thought especially 
necessary for the debtor's successful reorganization. It was commonly 
argued, and accepted by most bankruptcy judges, that the likelihood of 
administrative priority for goods shipped in the pre-bankruptcy period 
was necessary to provide assurance to induce vendors who might 
otherwise be unwilling to ship to a struggling debtor because of fear 
of non-payment. Or the vendors might be willing do so only if the 
debtor paid C.O.D., which would likely exacerbate the problems of a 
cash-starved firm already on the verge of bankruptcy. If the vendors 
would not ship goods, the debtor would be unable to stock its shelves, 
thereby disappointing customers and bringing on a death-spiral into 
bankruptcy. Thus, it was thought necessary to assure vendors that it 
was safe to ship goods on credit to the struggling debtor in the period 
preceding bankruptcy.
    In the Kmart bankruptcy case, for instance, 2330 of 4000 vendors 
were classified as ``critical vendors'' who were to be paid in full 
under the plan, thereby consuming $300 million of Kmart's $2 billion 
DIP financing. Although Kmart's particular proposal was eventually 
struck down by the Seventh Circuit, it illustrates the scope and 
ubiquity of these critical vendor payment proposals. Entitlement to 
this preferred status, however, was wholly discretionary by the court, 
allowing some well-connected and influential vendors to achieve 
critical vendor status while others were left out in the cold. 
Moreover, there were no set guidelines on how far back these unpaid 
bills could reach or the amount that could be treated as critical 
vendors.
    One evident purpose of section 503(b)(9) was to rationalize this 
previously ad hoc ``critical vendor'' analysis by replacing it with a 
statutory scheme that would serve the same function but without the 
apparent arbitrariness and unfairness of the discretionary ``critical 
vendor'' regime and to limit the scope of these claims. Thus, section 
503(b)(9) may not have created a major increase in overall 
administrative claims against the estate when compared to the actual 
pre-BAPCPA practice. It also makes the rules more reliable and 
predictable for vendors. Section 503(b)(9) recognizes the need for the 
functions previously played by critical vendor orders; eliminating it 
would either lead to the resuscitation of the ad hoc critical vendor 
analysis or bring about the very results that doctrine was intended to 
avoid.
    The second set of potentially-problematic amendments in BAPCPA is 
changes to sections 507(a)(4) and (a)(5), which increased the aggregate 
monetary limits on employee wage and pension benefit priority claims. 
Formerly, the aggregate amount that an employee could assert as a 
priority wage or pension benefit claims was limited to $4,925 in wages 
and pension benefits earned within 90 days prior to filing. BAPCPA 
increases the aggregate cap to $10,950 for wages and pension benefits 
earned within 180 days prior to filing. Unlike the argued explanation 
of the increased priority for venders, however, there is no obvious 
economic justification for this increased priority for employee wages, 
unless it is thought that many employees would quit their jobs because 
of a fear of bankruptcy if refused this heightened priority extended 
for six months prior to the filing rather than just three months. This 
seems doubtful and, in fact, this priority is usually justified on 
grounds of ``fairness,'' rather than economics. By tying-up more assets 
to pay pre-petition claims, however, it tends to reduce the prospects 
for a successful reorganization and thus may not only bring about 
liquidation but in so doing create job losses for precisely those who 
it is intended to benefit.
Summary on BAPCPA's Impact
    Thus, even if certain provisions of BAPCPA are criticized as 
potentially encouraging liquidation instead of reorganization, at least 
some of these criticisms are mitigated or even outweighed by offsetting 
concerns. With respect to the stricter deadlines for deciding whether 
to assume or reject leases of non-residential real property, the 
purpose of BAPCPA's amendments were to protect landlords and co-tenants 
from the delay and uncertainty caused when a firm files for bankruptcy, 
especially a bankruptcy involving an anchor tenant. Although there are 
economic costs from forcing an unduly-swift decision on the debtor 
there are costs to many other parties from extended delay of the 
process. Moreover, BAPCPA does include a safety valve by making it 
possible to extend the 210-day deadline with the consent of the 
landlord.
    With respect to increased administrative priority for vendors for 
pre-petition shipments of goods, the primary effect of section 
503(b)(9) was to rationalize the ad hoc system of ``critical vendor'' 
orders that had grown up in recent years in acknowledgement of the need 
to provide assurances to vendors to continue to supply goods on credit 
to struggling retailers.
    In contrast to these provisions for which there are offsetting 
policy goals that may justify them, sections 507(a)(4) and (a)(5) 
increase the administrative priority for pre-petition wages and pension 
benefits. There is no obvious bankruptcy policy purpose furthered by 
these priorities and thus they contribute to the potential for 
liquidation with no offsetting economic benefit.
                               conclusion
    As the economy dips deeper into recession it is evident that the 
near-future will present difficult challenges for the retail industry. 
In recent times several major retailers have filed bankruptcy and it is 
foreseeable that more will before the recession is done. Many of these 
cases will result in liquidation, perhaps more commonly than a decade 
or two ago. It is tempting to blame BAPCPA's amendments for this trend.
    In reality, however, it is not so easy to point to BAPCPA as a 
scapegoat. General macroeconomic conditions, higher credit costs, and 
reduced consumer spending would likely have driven many of these 
retailers out of business regardless. Moreover, prior to BAPCPA there 
was a distinct trend toward liquidation in large Chapter 11 cases. 
These trends have been exacerbated in the recent downturn by a 
restricted access to DIP financing.
    To the extent that BAPCPA has also accelerated this trend, its 
influence is likely small. Moreover, where BAPCPA potentially has had 
an impact that impact is mitigated if not offset by other benefits that 
arise from its reforms. Perhaps the only BAPCPA amendment that has 
increased the trend toward liquidation with no obvious offsetting 
benefits is the enhanced administrative expense claim for wages and 
benefits added by BAPCPA.
                               __________
    Mr. Cohen. Thank you, Professor.
    And, now, I am going to presume it is Pachulski, the 
younger, right?
    You are recognized, sir, to testify.

 TESTIMONY OF ISAAC M. PACHULSKI, STRUTMAN, TREISTER & GLATT, 
        PC, ON BEHALF OF NATIONAL BANKRUPTCY CONFERENCE

    Mr. Isaac Pachulski. Thank you.
    On behalf of the National Bankruptcy Conference, I would 
like to thank the Subcommittee for the opportunity to testify 
about the adverse impact of the 2005 amendments on the 
reorganization of debtors under Chapter 11.
    Basically, the 2005 amendments worked some very major, 
substantive changes in provisions of the bankruptcy code that 
affect the ability of debtors, in particular, retailers, to 
reorganize. Those provisions provided special and preferential 
and enhanced treatment for vendors of goods--not vendors of 
services, just vendors of goods--for landlords, but not any 
other party to an executory contract with a debtor, and to 
utilities.
    The impact of these amendments, and their adverse impact, 
is most pronounced in the case of retailers. And that is 
something that should give us cause for pause, when we realize 
that, in the last 12 months, we have seen Chapter 11 filings by 
retailers who, in the aggregate, operated at over 6,000 
locations, and had over 200,000 employees--something that is 
unprecedented in my experience, and that of everyone else here.
    Now, we have to start with the basic premise that companies 
file for Chapter 11 relief because they have liquidity 
problems. They don't have enough cash.
    The 2005 amendments, in the case of retailers, poured oil 
on this fire, by creating a new, unprecedented priority for 
vendor claims. Previously, unsecured, pre-petition vendor 
claims could be modified like every other claim--like tort 
claims, like contract claims, like vendors of services.
    The 2005 amendments created an administrative priority 
claim for these pre-petition claims, which means they have to 
be paid in full, and in cash, in order for the company to 
emerge from Chapter 11. In the case of a large retailer, this 
increases the exit fee to get out of Chapter 11 by hundreds of 
millions of dollars.
    And in the economy where we are repeatedly told that there 
is no financing, what this means is that, unless you can 
cannibalize operations, defer deferred maintenance some more, 
and take money away from operating changes, you can't comply 
and you can't come out of Chapter 11.
    And this problem is exacerbated by the new reclamation 
provisions, which were previously--the right of reclamation was 
limited to goods delivered 10 days before the Chapter 11 
filing. They are now expanded to goods delivered within 45 
days, which increases both the amount of these claims and the 
cost of resolving these reclamation claims.
    To a lesser extent, the amendments to Section 366, which 
basically give a utility the right to demand a cash deposit or 
a deposit of cash equivalents, also impose additional liquidity 
constraints at the outset of a Chapter 11 case, at the very 
time that the debtor is having trouble getting debtor-in-
possession financing.
    Imagine a debtor with hundreds of locations, each one with 
multiple utilities. The utilities now have a right to demand 
cash deposits. The only thing you can argue about is the 
amount. And, by the way, when you are arguing about the amount, 
the court is not allowed to consider whether the debtor had a 
good payment record, and is not allowed to consider whether the 
utility ever obtained a security deposit before. This is simply 
too narrow a standard.
    The 2005 amendments also changed the rules governing one 
type of the executory contract, commercial real estate leases, 
in a way that had a material adverse impact on Chapter 11. But 
to put this in context, there are two things that I would 
request the Subcommittee to keep in mind, because they are 
important.
    First, the basic rule in Chapter 11 that applies to every 
executory contract, except a commercial real property lease, is 
that the debtor has until confirmation of a Chapter 11 plan to 
decide whether to assume or reject the contract. But the court 
can terminate it for cause. It is not in the sole and unbridled 
discretion of the debtor. The party can tell the court, ``This 
contract has to be addressed sooner.''
    In the case of landlords, a different rule was adopted--
basically, a landlord-veto rule, which is that, unless the 
landlord agrees, once 210 days expires from the filing of the 
Chapter 11 case, if the debtor doesn't assume the lease, it is 
deemed rejected, and the debtor has to vacate the premises 
immediately.
    This is unrealistic, especially for a seasonal business, 
like a retailer. And we will get into that in a moment. But the 
other point to remember is that the landlords have already 
gotten a different protection through earlier amendments, which 
is that from the beginning of a Chapter 11 case until the lease 
is assumed or rejected, the debtor has to perform all 
obligations arising after the Chapter 11 filing. The landlord 
has to be paid on a current basis.
    Now, the effect of the amendment is this: Consider the fact 
that we all know that the retailers' best and most profitable 
quarter is the last quarter of the year. If a debtor files a 
Chapter 11 case, and it is a retailer, and it files before the 
end of May, it will have to decide whether to assume or reject 
its leases before it even knows the results of the holiday 
season, before it has any kind of a realistic opportunity to 
determine whether particular locations work or don't work. And, 
remember, this decision is supposed to be made on an informed 
basis, for every location, location by location.
    Yet, we now require the debtor to make all of those 
decisions within 7 months, unless the landlord agrees 
otherwise, which gives the landlord something that no other 
party in a Chapter 11 case who is a party to an executory 
contract, has--a veto.
    In addition, this creates an impetus for secured lenders to 
push for liquidation. Because if you are a lender with a lien 
on inventory, you know that if the inventory is not liquidated 
in place, if you have to move it and sell it at a warehouse, 
you will get substantially less. So what you have in the back 
of your mind is: You have got a 210-day limit. And if the 
liquidation is going to occur, it better occur before then.
    You can't work with a debtor any more for a year or a year 
and a half, as long as you keep paying rent on the lease, and 
know that, if you have to liquidate, you can do it orderly and 
in place.
    You have to press the debtor for an early liquidation and 
for early decisions, which is a perverse and, I think, 
unintended result of the 2005 amendment.
    So, again, we would like to thank the Subcommittee for 
considering this. We realize you are being asked to revisit 
issues that may have been considered in 2005, but I don't think 
that anybody expected that we would see this many retailers 
with this many employees crashing or going into Chapter 11 in 
so short a period of time. Thank you.
    [The prepared statement of Mr. Isaac Pachulski follows:]
                Prepared Statement of Isaac M. Pachulski



                               __________
    Mr. Cohen. Thank you, sir. We appreciate your testimony.
    And, now, Professor Williams, if you would, conclude our 
testimony.

 TESTIMONY OF JACK F. WILLIAMS, AMERICAN BANKRUPTCY INSTITUTE 
   RESIDENT SCHOLAR, GEORGIA STATE UNIVERSITY COLLEGE OF LAW

    Mr. Williams. Thank you very much.
    Mr. Chairman and Members of the Subcommittee, I want to 
thank you for the opportunity to visit with you today over a 
number of the issues that are percolating in retail bankruptcy.
    I want to begin with this simple observation: 2008 was a 
very bad year for bankruptcy. During that time period, we 
witnesses 1.1 million bankruptcy filings. And it is not going 
to get any better for 2009. At the American Bankruptcy 
Institute, we are estimating that at least 1.4 million 
bankruptcy filings will be made in 2009. We also anticipate an 
increase in business bankruptcy filings of approximately 40 
percent.
    Retail bankruptcies are not faring any better, as well. 
Eight major retailers have already filed bankruptcy petitions 
for this year, following the 27 major retailer bankruptcy 
filings in 2008. The 2008 total was the most since the 32 
retailers that filed in calendar year 2001.
    Of these 27 retailers that filed in 2008, 37 percent of 
those filed in the fourth quarter of that year, during the 
Christmas season, which is highly unusual. As Mr. Pachulski has 
pointed out, the Christmas season, or the fourth quarter of the 
calendar year, in many retail sub-sectors, will generate 50 
percent or more of that year's revenue.
    The present market and lending environment is also 
important to consider to provide what I think is the contextual 
space of which to look at three tension points that we are 
focusing on today.
    For retailers, the top-line numbers, revenues, are way 
down; the profit margins are way down. Businesses are reducing 
their prices to draw customers into the facility. Consumer 
spending and credit are down, with consumer savings increasing, 
and increasing at an increasing rate. Now, that is good for 
consumers with debt, but not so good for a weak economy that is 
driven by consumer demand.
    Vendors are aggressive managing their credits. They are 
reducing credit turns. They are pulling back in volume 
shipments. Vendors are no longer serving as short-term banks 
for the retailers.
    Banks are simply not making loans. They are not lending 
beyond what it may take for a quick sale, or to liquidate the 
business, unless the business has very good cash flows and a 
good brand.
    And, in short, in retail, what we have seen is we have hit 
a liquidity wall. There are no financial buyers to speak of 
because of the scarcity of available capital.
    The present bankruptcy strategy is to find a strategic 
buyer quickly, because your creditors are giving you very 
little time, or, simply, to liquidate the business and shut it 
down.
    Now, the 2005 amendments to the bankruptcy code created a 
Chapter 11 for good times, not a Chapter 11 that is most 
effective for financially bad times. This Subcommittee should 
consider addressing some of the structural flaws in the 
bankruptcy code that were infused through the 2005 amendment.
    A major thrust of the drafters of Chapter 11 of the 
Bankruptcy Reform Act of 1978 was to develop a flexible, 
adaptive and transparent system that was business-plan 
agnostic.
    Our original Chapter-11 design permitted a debtor a broad 
range of discretion, consistent with the exercise of sound 
business judgment, and the best interest of the bankruptcy 
estate, to develop a business plan with the greatest chances of 
success.
    If anything, recent amendments to Chapter 11 of the 
bankruptcy code have failed to serve the law's original 
purposes and policy goals. The points for consideration have 
been discussed by my panelists.
    And I will just add a few observations to that: The 
consideration for removing the administrative priority for 
goods sold to the debtor within 20 days, and returning that 
pre-petition claim back to the prior practice of either 
establishing a reclamation claim, or living with a general 
unsecured claim is precisely the type of thing we need when we 
are looking at the serious crunch on liquidity for a business.
    The 503(b)(9) claim is, in itself, an anomaly. It is a 
distortion of the priority-and-distributions theme that is in 
the bankruptcy code.
    Consideration of relaxing the deadline by which commercial 
real property leases must be either assumed or rejected--again, 
the prior practice was not unbridled discretion on the part of 
the debtor-in-possession; yet, a third-party neutral, the 
bankruptcy court--and any determination had to be not only 
consistent with the sound business judgment of the debtor, but 
also with the best interest of the estate.
    And, finally, consideration of relaxing the deadline for 
the period of exclusivity--that time period in which the debtor 
has the sole authority and power to propose a plan of 
reorganization. I believe that also would be consistent with 
infusing sufficient judicial discretion so that each case can 
be adapted. The system, itself, can be flexible, and we provide 
the greatest chance of success within--well, what is consistent 
with the best interest of the estate.
    I want to thank you very much for the opportunity to share 
some thoughts on the issues raised by retail bankruptcies. I 
appreciate it.
    [The prepared statement of Mr. Williams follows:]
                 Prepared Statement of Jack F. Williams



                               __________
    Mr. Cohen. Thank you, Mr. Williams. I appreciate your 
testimony.
    We have got--those buzzers didn't mean somebody else went 
into bankruptcy. It probably happened, but it meant we need to 
vote. We have got 11 minutes.
    Well, I think we have got time--if I could do my 
questioning, if the panel doesn't mind, then we can leave 6 
minutes, and we will have time to go. So if we can start with 
the questioning. And I will start and recognize myself.
    Mr. Miller, are you still with us? Mr. Miller?
    Mr. Miller. Yes, sir.
    Mr. Cohen. Thank you. I didn't know if you had taken a 
siesta or not.
    If Circuit City had filed before the 2005 amendments went 
into effect, would it have been able to successfully 
reorganize?
    Mr. Miller. That, sir, is a difficult question. Let me make 
this comment----
    Mr. Cohen. That is why I asked you.
    Mr. Miller. Here, you have a situation in the environment, 
where, in 1978, when the code was adopted, it contained many 
provisions which were intended to induce debtors to go into 
Chapter 11 before it became too late, when there was nothing 
left to reorganize.
    In Chapter Three of the bankruptcy code, you have these 
administrative provisions like the automatic stay, the ability 
to sell lease property, use collateral security, and, 364, to 
allow DIP financing.
    The issue which arose even before 2005, and from 2003 to 
2008, was that bankruptcy had become an unattractive thing for 
a company to reorganize in. It became the last possible resort. 
And the 2005 amendments made it even worse.
    So companies stayed out of Chapter 11, and they tried to 
survive outside of Chapter 11. With all their secured debt, 
going into Chapter 11, very often, meant they were going to end 
up in liquidation anyway. So the issue would have been: When 
would Circuit City have made the decision to go into 
bankruptcy, when it had the resources to survive in a 
bankruptcy?
    The bankruptcy code was intended to give a debtor a 
reasonable opportunity for the courts to determine, for the 
creditors to determine, whether there was a possibility of 
reorganization. And that depends on when you go in.
    Unfortunately, because of all the clawbacks, i.e. special 
interest amendments, starting with the amendments in 1984, and 
many of them in favor of the real estate lobby, bankruptcy 
reorganization became less and less attractive.
    In the case of Circuit City, because of the liens on the 
inventory, the seasonal nature of retailing, the decision would 
have been a decision that would have had to be made by that 
corporation, at a point in time when it had more resources and 
more ability to survive a Chapter 11. In large fashion, that 
would have been dependent upon the ability to get the DIP 
financing, which is critical.
    Now, Professor Zywicki referred to the Montgomery Ward 
store. That is one store out of--I think Montgomery Ward had at 
least 200 or 300 department stores. It employed thousands and 
thousands of people. It was being financed by the General 
Electric Company.
    The effort that was being made in Montgomery Ward saved 
jobs for a long time. It was not a futile effort. The company 
actually did come out of one Chapter 11.
    So the decision to file or not to file is a very critical 
one, based upon the ability--could you survive? As the 
environment of Chapter 11 has become more hostile, and the 
balance which Professor Zywicki referred to--the balance 
between the debtors' protections and the creditors' rights, 
which was affected in 1978, long after 1984, became skewed in 
favor of creditors. So that affects the decision-making.
    I think if Circuit City had filed much earlier, it would 
have had a much better chance of survival. I don't think, with 
very rare exceptions, there has been a successful retail 
reorganization, since the beginning of 2008.
    Essentially, every retail chain that has gone in, starting, 
I think, with Sharper Image, in February of 2008, has ended up 
in a liquidation, with the possible exception of Boscov's, 
where the family bought the company out.
    Mr. Cohen. So, Mister----
    Mr. Miller. So that decision has to be dependent upon: 
``What resources do we have? What kind of financing do we 
have?''
    You have to recognize companies don't go into Chapter 11 
because they are financially vibrant. They need time to get 
back to financial vibrance, if we are going to have a 
reorganization policy in our law.
    Mr. Cohen. We are about to run out of time here, and have 
to go vote.
    Let me ask you this quickly, if you can: This economy we 
are in, particularly in regard to Chapter 11--are the 2005 
amendments effectively hurting our country's ability to keep 
people employed, in jobs, and get out of this recession?
    Mr. Miller. In my opinion, Mr. Chairman, absolutely. It has 
just skewed the balance so much in favor of the secured 
creditors, that no company--I will tell you very frankly: CEOs 
will say to me, ``I don't want to be seen with you, and I am 
not going into bankruptcy. I can't survive in the environment 
of bankruptcy.''
    So these companies wait too long. There is not enough asset 
left--free assets--with which to reorganize. This is exactly 
what Congress was looking at in 1975, 1976 and 1977--``How do 
we get companies to file before it is too late?'' And we have 
taken away those protections.
    Mr. Cohen. Thank you, sir. My time has expired, and we have 
5 minutes and 30 seconds to get to the floor.
    If you and the other witnesses would remain available for 
questions when we return from voting, which should be 
approximately, maybe, 25 minutes--and, in the intermittent 25 
minutes, if the five panelists would come up with a model bill, 
we would appreciate it.
    We are in recess.
    [Recess.]
    Mr. Cohen. We don't have any Republican Members here yet, 
and they are next in line for questioning. I think we should 
wait until at least one of them returns.
    Mr. Franks was making a statement, a 1-minute, and he 
didn't know when he was going to get a chance to make that 1-
minute. And he said it might affect an election in South 
America. I would be very interested in hearing his 1-minute.
    And, then, Mr. Issa was going to be back shortly. So we 
will wait for Mr. Issa and let him have questions first.
    Meanwhile, have you got your bill together?
    Done? Good. Good.
    Mr. Miller, are you there?
    Mr. Miller. Yes, sir.
    Mr. Cohen. Thank you, sir. We will get going in a few 
minutes. Thank you.
    We are back and convened for questions.
    And I now would like to recognize the honorable gentleman 
from Southern California, Mr. Issa, for his 5 minutes of 
questions.
    Mr. Issa. Thank you, Mr. Chairman.
    I must first say that I am not without some conflict as to 
Circuit City. They were a customer of mine from the mid 1980's. 
And my former company enjoyed hundreds of millions of dollars 
in business with them, and--right up until the very end.
    Having said that, it also allows me to see that the very 
end had been inevitable for a very long time. And to that end, 
I have a couple of questions, because this is more about 
bankruptcy than about anything else.
    But I want to, first, say one more thing, which is: I don't 
think there was any saving of Circuit City. I don't think any 
shrewd investor would have saved a substantial portion of it, 
given their holdings, the indivisibility and the historic level 
of traffic.
    So having said that, I would like to go to a round of 
questioning that is more real estate appropriate.
    Mr. Hurwitz, now, you are the largest owner, I understand, 
or one of the largest owners of the real estate from Circuit 
City. Is that correct?
    Mr. Hurwitz. That is correct, sir.
    Mr. Issa. In order to understand the bankruptcy and the 
conversations that have been made here, I want to phrase a 
couple of questions. First of all, would you have been helped 
or hurt from a more protracted Chapter 11 period for Circuit 
City, in your opinion?
    Mr. Hurwitz. We would have been significantly hurt by a 
more protracted bankruptcy proceeding for Circuit City, 
primarily because everyone knew, as you just mentioned, sir, 
that Circuit City was not going to survive. And it would have 
been death by a thousand cuts for us to sit through a process 
whereby people were pursuing, really, a folly for trying to 
prop up a company that had failed.
    And in so doing, it would have significantly hurt the value 
of our shopping centers, and significantly impacted negatively 
the business viability of the tenants that are in our shopping 
centers that didn't have any direction on what was going to 
ultimately happen to that box.
    So it makes leasing vacant space very, very difficult. And 
it doesn't drive any business to the shopping center when you 
are a failed retailer, like Circuit City was, or is. And so a 
protracted process would have been very damaging to our 
company.
    Mr. Issa. Well and to that extent, my understanding is when 
Circuit City made the decision quite a few years ago to give up 
white goods--washers, dryers, refrigerators and the like--that 
drove a lot of traffic through the stores--that impacted the 
traffic not just to Circuit City, but to the entire centers 
that you owned that they were in. Isn't that correct?
    Mr. Hurwitz. That is correct, sir.
    And if you look at the difference, for example, in our 
shopping centers, between a Best Buy that has white goods, and 
a Circuit City that didn't, the difference in volume per square 
foot in Best Buy was double that of Circuit City. And a lot of 
that had to do with the mix of the merchandise.
    Mr. Issa. Now, because we are talking bankruptcy, and I 
want to understand this, you have had many years in real estate 
as a head of a REIT and so on. My understanding--you have seen 
it before the 2005 changes, and after.
    Tell us what you think is the single biggest difference for 
you, as the holder of an asset which they get to keep if they 
want, they get to get rid of, if they want, in Chapter 11, and 
you have no choice but to wait for their ultimate end of lease. 
How was it different before and after 2005, for you?
    Mr. Hurwitz. Well, the biggest difference between before 
and after 2005 is the fact that we have, as landlords, a seat 
at the table, and we are engaged in conversation with retailers 
far in advance of a bankruptcy filing.
    For really the first time, with the 2005 amendments, we are 
able to engage our retailers, listen to what they have to say. 
They have to listen to what we have to say. And more 
importantly, the retailer is being forced to plan much more in 
advance.
    One of the things that people, I think, have to remember is 
that bankruptcy is a process. It is not an event. You don't 
wake up one morning and decide to file bankruptcy. We were 
having conversations with Circuit City 18 months before they 
decided to file. And we had conversations with Circuit City 
right on through the process.
    Had we not had a seat at the table, which was afforded to 
us by the 2005 amendments, we would not have been in that 
position, and really would not have been able and willing to 
help Circuit City, even though they were beyond hope at that 
point.
    Mr. Issa. Well, Mr. Zywicki, how do you feel? Because this 
is an area that some would like to reverse--that this, before 
and after 2005, would impact other similar landlords and 
creditors.
    Mr. Zywicki. I think that Mr. Hurwitz hits the nail on the 
head, which is that 210 days is just the outer limits. Most 
bankruptcies are gradual. You engage in a lot of planning 
before that.
    And as I mentioned earlier, one of the whole purposes of 
the 2005 amendments was to increase the amount of planning that 
goes into bankruptcy. I mean, we have to keep in mind that 
bankruptcy is not a cheap process. They are going to come up 
with--lawyers are going to charge over $1 billion in the Lehman 
Brothers' bankruptcy--$1 billion for lawyers and bankers, 
right?
    When these cases go into bankruptcy, we are talking about 
tens or hundreds of millions of dollars of lawyers and 
accountants and bankers. And what the 2005 amendments were 
trying to do, as Mr. Hurwitz said, was not just have these 
things go into bankruptcy, and let everything go all over the 
place, and let the chips fall where they may, but to negotiate 
things ahead of time.
    As you said, there is plenty of time in most of these 
situations, when a debtor knows they are going to have to file 
bankruptcy. They can negotiate things out ahead of time and, 
thereby, reduce the amount of disruption and uncertainty when 
they actually do file bankruptcy.
    So I think that once you take that into account, it makes 
for a much smoother and more predictable process in the same 
way that increasing the administrative claims for vendors gets 
rid of the uncertainty and--of the critical-vendor process, 
which was just, you know, catch as catch can--whether of not 
you could get on the critical-vendor list--not saving any 
money. All you were doing was just making it a completely 
chaotic and unpredictable process. For now, at least you know 
what the rules are.
    I can understand why they had a critical-vendor list, which 
was to try to get vendors to deal with a retailer that was in 
trouble. That is why they invented the doctorate. All 503(b)(9) 
did was make it better and make it more predictable, I think. 
And I think, if we get rid of 503(b)(9), then we are going to 
go right back into that world of whether or not you can engage 
in critical-vendor transactions, and whether Kmart was 
correctly decided, and all those different sorts of questions.
    Mr. Issa. Thank you.
    And thank you for your indulgence, Mr. Chairman.
    Mr. Cohen. Thank you, sir. I appreciate it.
    Now, I would like to recognize the Ranking Member, and, 
possibly, the savior of South America, Mr. Franks.
    Mr. Franks. Well, thank you, Mr. Chairman. I hope I can be 
as effective here, and we can save Western civilization, here, 
if we work at it.
    Mr. Chairman, I know that, oftentimes, you know, our 
economy is--the conservatives make the argument that the free 
markets are critical to its survival. And I think there is some 
consensus in that regard.
    But I think that we forget that there is an even more 
important element than competition in our economy, to hone it 
and to make it efficient and effective, and that is the word 
``trust.'' That, when people make agreements with other 
entities within the society, that it is important to keep their 
promises. Otherwise the investor or those who are willing to go 
out and put themselves at risk to try to make a productive 
element of our economy--are less willing to do so.
    So I think that is an important premise to be laid. And I 
hope that that is a central consideration in the discussion 
today.
    With that, I thought the Chairman asked a very pertinent 
and intelligent question to Mr. Miller, which, essentially 
asked, you know, ``What would have happened, had the 2005 
amendments to the bankruptcy--Chapter 11 code--what would have 
happened to Circuit City, had those things not been in place?''
    Mr. Zywicki, with your permission, could you give me some 
perspective of what you think? Would Circuit City have done 
better if we hadn't changed the code in 2005?
    Mr. Zywicki. The end result would have been the same. I 
think it is almost certainly--it would have been the same. It 
would have just been a much more expensive, painful process 
that would have injured a lot of other people.
    I think Mr. Hurwitz said it perfectly. The uncertainty that 
it would create while we sat around and watched the downward 
spiral of Circuit City, and the damage it would do to vendors, 
to other tenants, to landlords, to employees--would have really 
been, I think, a real shame.
    And I think the writing was on the wall. I think it was 
inevitable. In this economy, it is just not a great economy to 
be in the business of selling big-screen TVs on credit. I think 
we have lived through the experience of people buying big-
screen TVs they couldn't afford. And I don't think that is what 
the near future looks like.
    The economy is bad. What we know is a lot of businesses 
were propped up by cheap access to credit, who probably should 
have disappeared a few years ago. Consumers were living beyond 
their means, buying discretionary, high-end electronic goods 
they couldn't afford. They had incompetent management--by all 
indications, just terrible business decisions. Bankruptcy can't 
fix incompetent management.
    There were changes in the market, as we talked about. Foot 
traffic was going down precipitously. And there is no reason to 
think that was going to be reversed, when you look at the rise 
of online selling. And consumers are going to become much more 
price-conscious. If they are going to buy electronic goods, 
more and more, it is going to be online.
    A lack of vendor confidence, and the final bottom line that 
we talk about was just a lack of available DIP credit. The 
reason why the terms were so onerous was because the lenders 
are in trouble. Circuit City was in trouble.
    And, yes, they are--by all indications, there is a 
reduction in DIP lending out there. The reduction in DIP 
lending, though, is just because of the problems in the credit 
markets.
    So I think it was inevitable. It was just a matter of 
whether or not we were going to allow--keep this company on 
life support for a year or two, and allow it to pull down 
everybody else with it--or whether or not we were going to do 
what we did.
    And, Mr. Hurwitz, I am sure, would vouch that if Circuit 
City was a company worth saving, they would be more than happy 
to negotiate an extension of the deadline, if they think that 
that is the best tenants for their particular location, in any 
given mall. That is an option. It is not 210 days. It is 210-
day, unless they agree to an extension.
    So I think this was probably the right thing at the right 
time.
    Mr. Franks. Well, thank you, Mr. Chairman.
    Not to belabor the point, but when business entities make 
an agreement with each other, you know, the end result, 
hopefully, is productivity. And it is so easy for us to 
forget--and especially in the challenging times that we face--
that the monetary system is merely to facilitate that 
productivity; and, that, in the absence of creating a system 
that ultimately results in the best productivity possible, we 
are getting less than the best that we can out of the economy.
    So, with that in mind, I just think that the person who has 
kept their part of the bargain in any agreement--that there 
should be, you know, a tendency to favor them in the bankruptcy 
proceedings. And there is a balance, and I don't know where it 
is sometimes, but the bottom line is, if we miss that, then we 
undermine our entire system.
    So with that, I am going to ask a last question to Mr. 
Zywicki.
    You note the downturn in the Chapter 11 organizations began 
before the 2005 Bankruptcy Act. Do you think that if we repeal 
those today, that that downturn would be reversed? And, 
perhaps, I would pass that along to Mr. Hurwitz, if he is 
inclined, as well.
    Mr. Zywicki. I can't see that it could possibly make any 
difference, because there are--what it does is it expedites the 
process. What it does is it helps resolve companies that are 
likely to fail. But I can't see that it could have any impact 
on companies that are likely to reorganize. What we save in the 
process is a couple tens or hundreds of millions of dollars of 
lawyers' fees, but--and maybe those are the jobs that we are 
trying to preserve, here.
    But I think that, in the end--I just don't think that the 
amendments can be said to have had any real impact in this case 
or the other case.
    Mr. Hurwitz. I agree. I think that the amendments are 
helpful in the sense and, in fact, I know that this won't be a 
popular comment, but I think that the 210 days, in a tougher 
economy, should be shorter, not longer, because I think you 
need to bring people to the table.
    You don't have the luxury of time. You are sitting with 
your vendors, and their clock is ticking. You are sitting with 
the landlords, your clock is ticking. Certainly, the employees 
have a right to know what their future is going to be. And we 
know there is no real capital out there to keep this business 
afloat.
    Now, there are a lot of ways that we can address that 
issue, if we believe in the business plan. See, at the end of 
the day, this is a retail business. And the consumer votes 
every day with its dollar. And the American people are smart. 
And they voted this company out of business a long, long time 
ago--long before they even entered into bankruptcy, quite 
frankly.
    So I think that the 2005 amendments would not have been--if 
they were not there, would not have been able to save any of 
the tenants, quite frankly, that we are currently looking at 
now, that are liquidating.
    Mr. Franks. Well, thank you, Mr. Chairman.
    Thank you, gentlemen.
    Thank you for allowing me to save South America. I 
appreciate it.
    Mr. Cohen. You are welcome. Thank you. Thank you, Mr. 
Franks.
    We will have a second round.
    Mr. Hurwitz, there have been companies that have gone into 
Chapter 11 in the past, prior to 2005, in particular, that have 
come out of it strong, right? So would you have said that the 
voters--the consumers were the voters, and they voted them out 
of business then, and somehow they came back to life? They were 
resurrected?
    Because, you know, if--under the current law, a lot of 
those businesses that were brought back to health through 
Chapter 11, under this present 2005 amendments, they probably 
would have just been voted off the island. I think you 
represented Mr. Trump--or somebody did, here--and they would 
have been voted out of the--you know, not made the ground--or 
whatever that game show is.
    Mr. Hurwitz. I think, Mr. Chairman, the difference between 
those companies that survive and those companies that fail is 
if they have a reason to be.
    For example, prior to 2005, if you look at the Macy's 
bankruptcy, clearly Macy's had too much debt. They had over-
leveraged the company. But they were outstanding merchants. 
They were outstanding merchants, and they ran a very, very good 
business, and were an important part of the American retail 
fabric.
    So when they went into bankruptcy, there was no question 
that the industry rallied to bring Macy's out of bankruptcy, 
because they had a purpose.
    With due respect to Mr. Miller's comments about Montgomery 
Ward, they came out and failed because they were lousy 
merchants.
    Mr. Cohen. Let me ask you this: How many leases did you 
have of Circuit City?
    Mr. Hurwitz. Fifty.
    Mr. Cohen. And how many of those did you lease to a new 
tenant within the next 6 months?
    Mr. Hurwitz. Well, we don't have them back yet, sir, 
because they are still doing their liquidation.
    Mr. Cohen. Are they?
    Mr. Hurwitz. So the answer is zero.
    Mr. Cohen. Do you have any leases for when they finish 
their liquidations?
    Mr. Hurwitz. We have letters of intent that we are working 
on, but we have no executed leases right now in the----
    Mr. Cohen. How many letters of intent do you have?
    Mr. Hurwitz. About six or seven of the 50.
    Mr. Cohen. So, at some point, you might have six or seven 
of--occupancies?
    Mr. Hurwitz. That is correct.
    Mr. Cohen. Might it had been better if Circuit City could 
have survived, or something similar to Circuit City, through 
Chapter 11? And, at least, while they might have been 
reorganizing and on life support--that you had at least had 50 
tenants?
    Mr. Hurwitz. No, sir, because----
    Mr. Cohen. You don't think so?
    Mr. Hurwitz [continuing]. I think it would have--speaking 
to Professor Zywicki's point, which--it just delays the 
inevitable. It was a poorly-run organization that had no reason 
to be.
    Mr. Cohen. And that may not be the best example.
    Mr. Pachulski, the younger----
    Mr. Richard Pachulski. Thank you.
    Mr. Cohen. You are welcome, sir.
    Do you believe there are businesses that went through a 
reorganization prior to 2005 in Chapter 11 that could not 
have--would not have survived under the laws--with the 
amendments of 2005?
    Mr. Richard Pachulski. Absolutely. Absolutely, Mr. 
Chairman.
    Mr. Cohen. What are the different provisions in the 2005 
law that, looking at the economy in 2009, do you believe should 
be changed to keep American jobs?
    Mr. Richard Pachulski. Well, Mr. Chairman, just to give an 
example--and I do want to address something that Professor 
Zywicki said in response to your question.
    I actually did a survey within our firm of how many 
companies would likely have reorganized if 503(b)(9) did not 
exist after 2005, versus how many of them would have survived 
pre-2005. And just within our firm, there are seven companies 
that could not reorganize because their 503(b)(9) 
administrative claims were dramatically too high. It was 
impossible.
    And even if there was enough money to pay the 503(b)(9) 
claims, you couldn't prove feasibility under a plan, because 
there was no money to pay for capital expenditures, labor 
upgrades or other necessary expenses. And my experience is 
probably no different than others.
    In fact, Mr. Chairman, what I find is troubling about 
Professor Zywicki's testimony is I don't believe the 
legislative history of Section 503(b)(9) actually addresses 
critical-vendor status. And the reason it doesn't is it didn't 
change it.
    So let me give you, Mr. Chairman, a piece of information 
that was absolutely public in the Circuit City case, because I 
actually know a lot about it, both publicly and not publicly. 
And I will provide the public information.
    But most of the vendors in that case--and I certainly 
understood it--not only wanted their Section 503(b)(9) claims, 
they wanted critical-vendor status. So not only did you have a 
$215 million problem or $350 million problem, you still had 
critical-vendor status.
    BAPCPA did not get rid of critical-vendor status. Cases 
today still have critical-vendor status. So this concept that 
somehow the 2005 amendments had anything to do with that is, 
frankly, preposterous. And the concept--which, I must say, I 
take some offense--that somehow this was done to keep Circuit 
City alive to promote professional fees, your honor--I 
apologize--Mr. Chairman, nine out of 10 of our firm's largest-
fee cases in its 26-year history--nine out of 10 were 
liquidations.
    Professionals make more on liquidations. Our firm will make 
more on the Circuit City liquidation than it would have made on 
a reorganization. Those are facts. It will happen in Lehman 
Brothers. It happened in Enron. It will happen in other cases.
    But this concept that somehow 503(b)(9) settled the 
critical-vendor status isn't the case whatsoever. And what you 
effectively did is took one group of unsecured creditors and 
preferred them over other groups.
    If someone provides services within 20 days, they are not 
given that status. If I give unsecured credit during the 20 
days, a bank loan, they don't get that same priority. One group 
of parties has received the priority which helps certain 
vendors in certain cases, and hurts them in other cases.
    But the fact of the matter is, Mr. Chairman, there is no 
doubt that Section 503(b)(9) has had a detrimental effect on 
reorganizations, and will continue. I know there is a lot of 
histrionics about the 210-day period. And, frankly, in Circuit 
City, it was not an issue. It probably will be issues in other 
retailers. It was not in Circuit City because we never got far 
enough for that to be an issue, because the banks put the 
squeeze, because they knew a reorganization was impossible.
    And answering Mr. Miller--what Mr. Miller was asked--having 
lived it, while I don't think Circuit City could have been 
reorganized as a whole, I think if there had been additionally 
time, potentially, there would have been pieces of it that 
actually would have survived. And I think the landlords and the 
vendors would have appreciated a going concern business, in all 
fairness.
    So the simple answer is yes, Mr. Chairman. In direct 
response to your question, the fact that--what may have made 
sense in 2005, in a better economy absolutely does not make 
sense in today's economy, particularly with Section 503(b)(9). 
It is death to retailers on Day One, just because certain 
vendors will get priority over other unsecured creditors.
    And the critical-vendor status is with us, will be with us 
forever. It is not gone, not withstanding what Professor 
Zywicki said.
    Mr. Cohen. With Mr. Franks' indulgence, I want to follow 
up. One of the witnesses had some statistics--and I don't 
recall which--in their testimony, as far as how many retail 
bankruptcies there have been--retailers.
    Who was that? Was that--Professor?
    Mr. Williams. Yes, I did have a number.
    Mr. Cohen. Yes. How many professional retail bankruptcies 
were there?
    Mr. Williams. Well, all I counted, at this point, were 
major retailers----
    Mr. Cohen. All right.
    Mr. Williams [continuing]. That had filed.
    There are a lot of very small outfits with one, two, three, 
four stores that wouldn't be in these numbers. For calendar 
year 2009, which is just a couple of months now, we have had 
eight major retailers that have filed for bankruptcy.
    And calendar year 2008, major retail filings were at 27. 
And that is the largest number since 2001, where we had 32 
major retail bankruptcy filings.
    As I pointed out, of the 27 major retailers that filed in 
2008, 30 percent of the--37 percent of those filings took place 
in the fourth quarter of 2008, which is--that is the Christmas 
season, which is typically the quarter in which as much as 50 
percent or more of revenues will be generated. That was an 
unusual number and an unusual time, that a retailer would file.
    Mr. Cohen. Do you expect more bankruptcies in the retail 
sector in this coming year?
    Mr. Williams. Absolutely. Our research at the ABI would 
support that we don't see any turnaround in 2009, involving 
retail. Bankruptcy filings, themselves, are a lagging economic 
indicator.
    Typically, the economy will begin to turn before the 
bankruptcy numbers start to flatten out. For retail bankruptcy, 
we estimate close to a 50 percent or more increase in 
bankruptcy filings.
    Mr. Cohen. And do you have any recommendations for this 
Subcommittee, on what this Subcommittee could suggest or 
propose in the way of changes to the bankruptcy law, to help 
the economy, based on the number of retail bankruptcies we 
foresee?
    Mr. Williams. Yes, I do.
    Again, I think a number of the panelists have pointed this 
out. The 2005 amendments made sense in a system or an economy 
that was good. But a bankruptcy system has to pass the test, 
both in good times and in bad times. We are in bad times.
    This is a weak economy, and consumer demand is down. The 
consumer interface is most directly with the retail sector, and 
we don't expect an increase in revenue--an increase in margins 
or anything of that nature, in the short term.
    And what we are looking for--what I would suggest is taking 
a look at the 2005 amendments and, first, addressing the 
liquidity hit that the 503(b)(9) claims take, because cash is 
the lifeblood of any successful reorganization.
    So a revisiting of that, and simply taking us back to the 
pre-2005 era, I think, would be a major step in preparing a 
system that, when the economy begins to turn, can provide the 
type of flexibility and adaptability that will allow a greater 
success as far as retailers are concerned--that keeps 
customers--that is, the retailer itself--in business. It keeps 
their vendors in business. It preserves an employer. It 
preserves a state and local tax base, as well as a tax base for 
Federal taxes as well.
    It can certainly be, with the changes that have been 
suggested here, an excellent system for addressing the needs 
that we are going to see, both in short and long term.
    And I think one other thing you have to keep in mind is 
that the 2005 amendments created a bankruptcy code--a system, 
if you will--that is unpalatable for business, because of, 
among other things, a direct hit on cash, the concern about the 
limitation on lease extensions, the utilities issue that Mr. 
Pachulski pointed out, as well as the period of exclusivity and 
its limitations.
    Consequently, as Mr. Miller pointed out, businesses aren't 
seeking bankruptcy relief at a time when we can make a better 
go of it. Bankruptcy is not only the--it is a last resort for a 
carcass, for a zombie business. And making bankruptcy 
unpalatable helps no one in that situation.
    Mr. Cohen. Thank you, sir.
    Mr. Hurwitz or Professor Zywicki, do either of you differ--
not so much on the 210-day rule, but--and Mr. Zywicki is going 
to the buzzer quickly--he knows the answer--to what Professor 
Williams or Mr. Pachulski has said, other than the fact that 
lawyers shouldn't go first?
    Not for Goody's Family Clothing, Inc.
    Mr. Zywicki [continuing]. And on the business side.
    But at the same time, what we see are companies, like Wal-
Mart, who have been struggling the past few years--really, they 
have been struggling--companies like Wal-Mart and that sort of 
thing are going to be growing, just like Target grew to replace 
Montgomery Ward's.
    So I think we need to be careful about thinking that the 
way we have things now is the only way to have it, when it has 
been sustained on cheap credit by both consumers and 
businesses.
    Mr. Cohen. And let me ask you this--and this is for the--
Mr. Pachulski, Isaac Pachulski, did have some statements of 
some retailers in his testimony.
    I don't know these retailers. But let me guess, Professor 
Zywicki, that K.B. Toys, Inc., Goody's Family Clothing, Inc., 
Against All Odds USA, Inc., S&K Famous Brands, Inc., are not 
exactly Bergdorf's.
    Mr. Zywicki. I have not studied--I don't know whether they 
had management problems in those companies. I know a lot of 
them did.
    All I am saying is that, yes, we are going to have retailer 
casualties in the next few years. If we want to focus on a 
problem, let us focus on problems in the credit market. And, 
maybe, there are possibilities that DIP financing is not as 
available as it should be.
    But, I think, to sort of go off on this wild-goose chase 
that somehow the 2005 amendments are the problem here--I think 
is going to--is not going to make any difference at all in 
sorting out these----
    Mr. Cohen. Thank you, sir.
    If the Ranking Member doesn't mind, if somebody wants to 
make a comment, I would appreciate it.
    Mr. Miller. Hi, Mr. Chairman. It is Harvey Miller.
    Mr. Cohen. Yes, sir.
    Mr. Miller. May I say something?
    Mr. Cohen. Please.
    Mr. Miller. References were made to the Macy's case, and 
that Macy's had great merchandising when it went into Chapter 
11. Having represented Macy's in that case, at the beginning of 
that case, that was not true at all.
    But the point I want to make is that neither Macy's nor 
Federated department Stores were the two biggest retail 
department stores at that time--could have survived in a 
Chapter 11 with the 2005 amendments.
    First, there was enormous opposition from landlords in 
those cases. The cases went well beyond 210 days. The 
amendments that were made in 2005 would have severely 
restricted the ability of either one of those chains to survive 
and come out of Chapter 11, employing thousands of people, and 
still be in business today, as a consolidated unit.
    In addition, the 503(b)(9) 20-day rule for goods--as other 
speakers have pointed out, has not solved the critical-vendor 
situation. A key to the critical-vendor situation is the 
debtor-in-possession saying to the vendor, ``Yes, you are 
critical to me, but I am not going to make you a critical 
vendor unless you give me the best credit terms that I had 
before Chapter 11.'' You don't get that out of 503(b)(9). All 
503(b)(9) does is give you an obstacle to confirmation.
    The same is true with Section 366, with the utility 
department. Here we are, a company which is cash-starved, that 
has to turn around--and a retail chain normally has many 
utility companies it deals with, and has to place deposits all 
over the country, if it is a big retail chain, which takes away 
operating capital, in a situation where, for all kinds of 
reasons, we have a difficulty in getting debtor-in-possession 
financing. So it makes the ability to reorganize and 
rehabilitate a company very, very difficult.
    Unfortunately, I think we have a bad example with Circuit 
City, because, as a number of speakers have pointed out, 
because of its narrow product--merchandise-inventory line, and 
the changes that it made--it may have been preordained.
    But if you looked at Circuit City--and we are talking about 
landlords--long before it ever filed for Chapter 11, it had 
probably more than 200 non-productive, or closed stores. And, 
for years, it was paying rent on closed stores--many millions 
of dollars.
    Every effort that the company made at that time to get 
concessions from landlords fell on deaf ears. So this process 
before a filing, to smooth the way in, sometimes doesn't work.
    If Circuit City had filed 3 years ago, with those 200-odd 
stores that were unproductive or closed, they could have 
rejected those leases. They could have organized around a core 
universe of stores. And, as Mr. Pachulski pointed out, there 
might have been a core company that came out, that had a basis 
for rehabilitation.
    Once we got into 2005, that became almost impossible, and 
we not only had to think in terms of the debtor, but the 
lender, who has the lien on the inventory, and what it is 
thinking about, and its desire to convert that inventory into 
proceeds of cash that will satisfy it.
    The other aspect of it is the prohibitive expense of 
debtor-in-possession financing--notwithstanding what Professor 
Zywicki says--sometimes it exceeds the legal fees. Also there 
has to be some examination, some review, as to how, in a 
society which is based upon credit--how are we to deal with 
failure--we have to have an escape valve when there is a 
downturn in the economy, where there are companies that need 
assistance and help, to rehabilitate.
    Either we have a goal of rehabilitation, or, as I think 
Professor Zywicki would like, a very speedy process, where all 
these companies get liquidated. That is the issue we have. Are 
we going to have a process that assists and supports 
rehabilitation, saves jobs, particularly in this kind of an 
economy, or are we going to have this process where, within 60 
days, most of these cases--if it has any kind of liquid 
collateral--ends up with the secured creditor pushing the 
company into liquidation, sometimes, in coordination with the 
landlords.
    But I thank you, Mr. Chairman.
    Mr. Cohen. Thank you--appreciate your remarks.
    Now, I would like to yield to the Ranking Member, Mr. 
Franks.
    Mr. Franks. Well, thank you, Mr. Chairman.
    Professor Zywicki, with all due respect to your fellow 
panel members, your name has been taken in vain here, pretty 
profusely. And I wanted to give you a chance to respond in any 
direction you would like to, here to begin with.
    Mr. Zywicki. Well, thank you. Thanks for that opportunity.
    First, I just want to say I am not in favor of speedy 
liquidations in every case. What I am in favor of is a process 
that winnows companies that are in financial distress, and can 
be fixed and live to fight another day, from those that cannot. 
And with those that cannot, I think that those are ones that we 
should have a speedy liquidation so that we don't have to bear 
the cost and delay and uncertainty associated with that.
    I believe that the code had been tilted too far in one 
direction prior to the 2005 amendments. Father Robert Drinan, 
for instance, when he was in Congress, voting on the 1978 act, 
referred to it at the time as, ``the full-employment bill for 
lawyers.'' And it was a litigation process that was very 
heavily tilted toward the debtor.
    And all the things we have talked about--the greater 
secured-creditor control--all those sorts of things were ad hoc 
attempts to try to rebalance it. The 2005 amendments, I think, 
were an effort to try to rebalance the statute to do it.
    Second, with respect to critical vendors and 503(b)(9), I 
acknowledge that there are still judges out there, and vendors, 
who want even more. And it would be good if the judges would 
tell them, ``No.'' 503(b)(9), as I understand it, was an effort 
to try to get rid of all that critical-vendor rigmarole, and 
the unfair treatment that arose under it.
    And so maybe it didn't. But the answer, I think, is to get 
out of the critical-vendor game at this point, because I think 
that what it was trying to do is, by and large, satisfied in a 
more fair and efficient way by 503(b)(9).
    Mr. Franks. Well, thank you, sir.
    Mr. Hurwitz, other than, you know, the bankruptcy-law 
changes, do you think there are other things that government 
could do to implement--they could implement that would lead to 
more reorganizations, rather than liquidations?
    Mr. Hurwitz. I do.
    I think, particularly, in this environment--and I know this 
is something that you keep hearing from everybody that sits 
before you--but the availability of capital is key.
    I happen to agree, for example, with what Mr. Miller said, 
about Macy's coming out of liquidation today, because they 
could never have gotten the capital to come out--I mean coming 
out of bankruptcy--they never would have gotten the capital to 
come out of bankruptcy today.
    In 2006, they would have. They would have come out of 
bankruptcy. They would have been just fine. In 2008, 2009, it 
is very doubtful, because of the lack of liquidity in the 
market.
    I think, as a practical matter, there does need to be a 
look--and I do agree--at some of the fees that are charged at 
these bankruptcy proceedings, because, at the end of the day, 
the employees and the operating company, and the debtor, is 
severely limited in what it could do, because of the enormous 
amount of fees that are paid to professionals throughout the 
entire process.
    But where we are today, and where we sit today, I think it 
is very tough to say who would or wouldn't come out of 
bankruptcy, when there is no liquidity in the market. And there 
is no liquidity for the operator, and there is no liquidity for 
the vendor, either, because the vendor has lenders that are 
also putting the tight squeeze on the vendor.
    So there really is no place to go, and we put ourselves, 
due to a lack of liquidity, in this box.
    Mr. Franks. Well, I think you make a lot of sense.
    If a lack of DIP financing was a main issue in the Circuit 
City case, are there things that government could do to free up 
that financing? And I will just throw this out to you, first, 
Mr. Hurwitz, and, then, Mr. Zywicki and anybody else who wants 
to take a shot at it.
    Should we make TARP funds available for something like 
that?
    Mr. Hurwitz. I don't think we should. I don't think we 
should, because, at the end of the day, when you look at who 
should or shouldn't survive, it is an analysis of a business 
plan.
    It really could, and has been, in the past--and Montgomery 
Ward is a great example--throwing very, very good money after 
bad. And that business plan really should be made by the 
professionals who are closest to the industry; and that is, 
certainly, the vendors; the lenders who study retail on a day-
to-day basis; the landlords who do business and see what the 
traffic counts are, and see what the sales volumes are, and see 
what the trends are in that retailer.
    And as a practical matter, I think it would force the 
government to be in a position where it has to make the 
judgment as to who is and who is not a good merchant. And I 
don't think that is the business the government wants to be in.
    Mr. Franks. Well, some of us have been making that point 
for a long time.
    Mr. Zywicki?
    Mr. Zywicki. I would disagree a little bit, which is it 
seems to me that a reasonable case--I will let you decide 
whether you should do it--but a reasonable case could be made 
for something like making TARP funds available for DIP lending.
    And the logic is--we are on about the 14th iteration of 
explanations for what the TARP is supposed to do--but from what 
I recall, the initial explanation was to deal with liquidity 
problems in the banking sector, which is not, you know, 
propping up the zombie, dead banks, but, basically, to deal 
with the situation of liquidity problems, and allowing healthy 
banks to lend.
    And that is what is going on in the DIP market in the--or 
potentially could be going on in some of these cases. It is not 
what is going on in Circuit City.
    But take an example--in December, I wrote a column in the 
Wall Street Journal where I criticized the bailout of General 
Motors and called for--that Chapter 11 was the right way to 
resolve the General Motors bankruptcy.
    And their response was, ``Well, there is no DIP funds out 
there.'' And that could be true, but I think that illustrates 
the point, which is that if General Motors liquidated, it would 
be because they couldn't get DIP financing. And the only reason 
they couldn't get DIP financing would be because of a liquidity 
problem.
    Obviously, there is a healthy business there to be 
reorganized. So if you think of that stylized example, this is 
a situation where, clearly, a business that has core value 
could potentially fail because of lack of DIP lending. That is 
clearly--to my mind, at least, that is a liquidity problem that 
would be appropriate for something like TARP funds, in some 
sort of way, to be used to help get us over that hump, if that 
makes sense.
    Mr. Franks. Thank you, Mr. Chairman.
    Mr. Cohen. Thank you.
    Mr. Zywicki, do you see any problems with the 2005 law at 
all?
    Mr. Zywicki. When it comes to this question, to the Chapter 
11 questions? Not that I can think of, from the standpoint that 
it was--again, it was an attempt to balance certain aspects of 
the system.
    So the issues we are talking about today, I am very 
satisfied with the balance that was struck on the issues that 
we have talked about today.
    I will confess: I haven't thought that much about utility 
payments, for instance. So I would have to get back to you on 
the question----
    Mr. Cohen. Has the system changed, though? I mean, hasn't 
the system changed drastically in the last 4 years, with the 
number of creditors and debtors, and the amount of 
bankruptcies, and the threat to our economy?
    So, shouldn't the balance, the fulcrum, have to move some 
to make it a balance?
    Mr. Zywicki. No. The law was rebalanced. And I believe that 
it moved the law in a productive direction. And so the economic 
circumstances have changed, but I think that the law is set up 
to deal with this particular situation.
    What we are dealing with are macroeconomic problems in an 
economy that has been afloat on cheap credit for too long. And 
trying to keep that rising tide of cheap credit alive, I don't 
think makes any sense.
    And so I think, to the extent that the law helps us--that 
the law, in general, helps the situation that were--or it 
certainly doesn't hurt the situation that we are in.
    So I would say no, with respect to the issues we have 
discussed. I think that the balance now is pretty much right.
    Mr. Cohen. Does anybody disagree with that thinking--that 
the change of circumstances moves the balance point?
    Mr. Miller. Yes, sir--Harvey Miller, again.
    I would disagree with that contention.
    Professor Altman has recently--from the NYU Business 
School--recently issued a report on default rates. And he noted 
that, for 2009, the consensus default rate for high-yield debt 
is going to be an average rate of 13.63 percent. That is a very 
high default rate, considering that in 2008, it was 4.6 
percent. And in 2007, it was 0.51 percent.
    We are going to see a lot of defaults in retailing, and in 
other industries, at the rate we are going.
    The lack of capital and the prohibitive cost of a DIP 
financing--just think of what other speakers have said about 
how much it cost Circuit City to get $100 million--or less than 
$100 million--of new money.
    There is a system today, in DIP financing, where the pre-
Chapter 11 secured creditor rolls up the old debt into a new 
DIP financing. And, then, all of the charges in connection with 
that DIP financing are taking on the whole debt.
    So in the case of Circuit City--I may be off by some 
dollars--there was almost $900 million outstanding, pre-
petition. Facially, there was $1.1 billion DIP financing. All 
the fees were based on $1,100,000,000, when there was only $100 
million or less in new financing.
    So when you hear the fees that were--that had to be paid by 
Circuit City--the amount of new real money that it got was 
minimal. There was no chance for Circuit City to survive.
    If you have a credit-intensive society, as I said before, 
you have to have some means to deal with default. And the 
needle has to move when you are in an economy that is as bad as 
this economy.
    The 2005 amendments passed after a period of a robust 
economy, when the volume of Chapter 11 cases was declining 
every year. It may have been the fault of too much credit, 
which was, I think, sponsored, to a large extent, by financial 
institutions. But, now, we have moved into a different economy. 
We have to see what the Nation needs.
    Is there a virtue to rehabilitation and reorganization? If 
there is, the use of TARP funds to create a facility, where you 
could borrow money at reasonable rates and reasonable fees is 
necessary. The criteria for such financing would not be, ``Is 
this going to be a successful Chapter 11?'' but, ``Is it a 
sound loan?'' Will it give a debtor a reasonable opportunity to 
determine whether there is a core business there that can be 
reorganized, that can benefit the economy?
    We are going into a deep tailspin. I hope it is not going 
to be a period with a capital ``D'' in front of it, but there 
has to be some recognition that there are going to be a lot of 
businesses that are going to be in difficulty. They may be good 
businesses.
    Should they have a reasonable opportunity to try and 
reorganize? Should the Federal law help them in that respect? 
And I think, if we can find some way where a DIP facility can 
be arranged or--supported--I think the example that Professor 
Zywicki gave, in connection with General Motors, is a very good 
one.
    It would be not a question of underwriting the success of a 
reorganization, but giving the opportunity to all of the 
parties to determine, ``Is there something here that should be 
reorganized?'' You cannot make that determination in 60 days. 
That is one of the real difficulties we confront.
    I don't know what we can do about the fees that are now 
being charged. I mean, banks and hedge funds and insurance 
companies who do DIP financing--they are charging, basically, 
1,000 basis points above LIBOR, with a floor on LIBOR of 3 
percent.
    So you are talking about 13 percent. When you factor in all 
of the charges and fees, in many of these cases, the interest 
rate is, effectively, 18 percent or 20 percent.
    Well, you can't run a business on that basis. It is 
impossible. Meanwhile, those organizations, if they are banks--
what are they paying for the cost of their money? Probably less 
than a half a point. The argument that they use in court is, 
``Well, that is market for a company that is risky.''
    Well, if you are in Chapter 11, you are automatically 
deemed to be a risk. But that situation substantially decreases 
the possibility of reorganization. And when you put on top of 
that the utility deposits, the 503(b)(9), the 210-day 
limitation, you are--you are making it a situation in which the 
possibility of reorganization is slim and none.
    That is what we have to face up to. We have to face up to 
whether we want to have a Federal statute which is going to 
assist and enhance the ability to reorganize companies in a 
very bad economy. Thank you.
    Mr. Cohen. You are welcome. I appreciate it.
    And I would now like to yield to the Ranking Member.
    Mr. Franks. Well, Mr. Chairman, thank you.
    And I guess I would start out by saying the minority would 
stipulate that if a company's in bankruptcy, that they, 
perhaps, could be considered a credit risk.
    But having said that, you know, landowners can go bankrupt, 
too. And if we institute greater flexibility for judges to 
decide when retail debtors must accept or reject their stores' 
leases, won't that, potentially, take us back to a time when we 
had, you know, the ``ghost'' term--or ``ghost tenants'' that we 
have talked about?
    And what standards would we use to guide a judge's 
discretion? And what would we insist upon to make sure 
landlords weren't, again, treated unfairly by the code? I mean, 
how do we balance that?
    I mean, I would suggest that, you know, what we are trying 
to do, here, is to create both a desire and a fear on both 
sides to do anything but to analyze this situation very 
carefully, and to do as Mr. Zywicki said, and that is to 
ascertain which companies are viable and which are not.
    And those that are--to do everything possible to bring them 
back to sound operations; and those that are not viable, to do 
everything possible to minimize their damage, both to the 
creditors and to the economy at large.
    So, with that said, how would we guide the judges' 
discretion if we gave them the flexibility to decide when the 
stores, and the landowners have to accept one another's terms.
    Mr. Hurwitz, I will give you a shot at that.
    Mr. Hurwitz. Well, I am probably the least qualified person 
to answer that question, because, you know, we, as an industry, 
felt very victimized by judicial discretion in the past. And 
the 210-day amendment was done to try to give us some more room 
to be part of the process.
    But, again, I will defer to the more scholarly members of 
the panel. But I would add that I think anything that requires 
all the vested and interested parties to meet and discuss it, 
and sit down and talk about it, is the most important component 
you can have in a bankruptcy today.
    And anything that does not require that to happen, or 
excludes one of the major participants who have a vested 
interest in the outcome of the event, would be a mistake, and 
would be imprudent.
    Mr. Franks. Well, listen, Mr. Chairman--is there anyone 
else that wanted to take a shot at it? All right.
    Well, listen, I just wanted to thank the Chairman for his 
indulgence here. I would just, perhaps, just close on the 
thought that, ultimately, you know, bankruptcy is something 
that kind of has a connotation of a bad word to any one of us 
in business. And it is a heartbreak for anybody to have to face 
that.
    And so there are no judgments on my part that would 
diminish anyone in the circumstance. But we do have to 
recognize that the Congress is not able to repeal the laws of 
mathematics here, though we try on a regular basis, and that 
reality always has to be remembered, and will have the last 
word.
    And so I think that it is important that we try to inject 
as much predictability into the system as possible. I believe 
that the amendments of 2005 helped the predictability element 
of it, and that we do everything that we can to create an 
environment where, as Mr. Hurwitz said--that everyone gets a 
chance to sit at the table, and to make their position known, 
and to make sure that we create, if at all possible, a win-win 
situation for everyone, and where everyone has some significant 
investment in the process of losing, as well.
    And with that, I thank the Chairman.
    I thank all of you.
    And I hope we can come up with the right answers, and not 
go backwards, instead of forward. Thank you.
    Mr. Cohen. I would like to thank all the witnesses for 
their testimony today. And I would like for them to know that 
since they started testifying, the Dow went up 60 points. 
Accordingly, if you will come back for the next 99 days--
without objection, Members will have 5 legislative days to 
submit any additional written questions, which we will forward 
to the witnesses and ask they answer as promptly as they can, 
and be made part of the record.
    Also, without objection, the record will remain open for 5 
legislative days for the submission of any other additional 
materials.
    I thank everyone for their time and patience.
    The witnesses, and, Mr. Miller, as witness, by telephone--I 
thank each one for their time and patience.
    This hearing of the Subcommittee on Commercial and 
Administrative Law is adjourned.
    [Whereupon, at 4:43 p.m., the Subcommittee was adjourned.]
                            A P P E N D I X

                              ----------                              


               Material Submitted for the Hearing Record

Prepared Statement of the Honorable John Conyers, Jr., a Representative 
  in Congress from the State of Michigan, Chairman, Committee on the 
 Judiciary, and Member, Subcommittee on Commercial and Administrative 
                                  Law
    Last Sunday, Circuit City, one of the Nation's largest retailers, 
finally shuttered its remaining stores and laid off approximately 
34,000 employees. It did this notwithstanding the fact that the company 
had only recently filed for bankruptcy protection under Chapter 11, a 
form of bankruptcy relief originally enacted to help businesses 
reorganize their debts and retain jobs.
    Unfortunately, Circuit City's demise in Chapter 11 is not unique. 
As we heard at a hearing held last September before this Subcommittee, 
recent experience suggests that Chapter 11 of the Bankruptcy Code may 
not working for our Nation's companies.
    As many of you know, Chapter 11 was amended in several significant 
respects in 2005. I'd like to mention three aspects of Chapter 11 that 
we may want to revisit given the current economic climate.
    First, we should consider whether Chapter 11 needs a major overhaul 
to address developments that may have weakened its ability to promote 
successful reorganizations in the 21st Century. These developments 
include the growing trend for businesses to be highly leveraged and the 
increasing use of state law to make assets ``bankruptcy-remote,'' both 
of which deprive debtors of essential funding sources.
    It is critical to our Nation's economy and our workforce that we 
ensure that Chapter 11 works to save businesses and to save jobs, as it 
was originally intended to do.
    Second, we should consider whether the 2005 amendment imposing a 
hard and fast deadline by which retailers must decide to retain their 
leases is forcing businesses to liquidate rather than reorganize.
    The purpose of Chapter 11 is to give a debtor a financial breathing 
spell so that the company can assess its ability to reorganize and 
propose a plan for economic rehabilitation.
    Since the enactment of this amendment, however, very few retailers 
have successfully emerged from Chapter 11.
    One contributing cause appears to be that the deadline for 
retaining or rejecting a lease may not provide enough flexibility for 
companies to reorganize in light of their unique business cycles. And, 
this has, in turn, caused lenders to restrict credit access to Chapter 
11 debtors.
    I must say that I am not surprised by the problems this provision 
has engendered. My colleagues on this side of the aisle and I 
repeatedly expressed serious concerns about this deadline over the 
seven years it was under consideration.
    As a representative from the AFL-CIO presciently testified in 2001 
before this Subcommittee, this provision is ``designed to encourage 
liquidation which will necessarily lead to job loss.''
    Third, we must also scrutinize whether the 2005 amendments impose 
too many cash demands on a business in financial distress. As a result 
of these amendments, a Chapter 11 debtor must be prepared to make 
various cash outlays.
    For example, the debtor must pay vendors in cash for inventory 
received prior to the filing of the bankruptcy case during a stated 
time period.
    In addition, the debtor must provide utility service providers with 
``adequate assurance of payment''--in essence--a cash deposit. This 
requirement pertains even if the debtor never missed a single payment 
to the utility before filing for bankruptcy.
    For a debtor in financial distress, these additional cash demands 
may be the proverbial straw that breaks the camel's back.
   Letter dated March 11, 2009, from Mallory B. Duncan, Senior Vice 
       President, General Counsel, the National Retail Federation




       Response to Post-Hearing Questions from Harvey R. Miller, 
                      Weil, Gotshal & Manges, LLP




     Response to Post-Hearing Questions from Richard M. Pachulski, 
                   Pachulski Stang Ziehl & Jones, LLP





      Response to Post-Hearing Questions from Daniel B. Hurwitz, 
      President and COO, Developers Diversified Realty Corporation




  Response to Post-Hearing Questions from Todd J. Zywicki, Professor, 
                 George Mason University School of Law




      Response to Post-Hearing Questions from Isaac M. Pachulski, 
                     Strutman, Treister & Glatt, PC




  Response to Post-Hearing Questions from Jack F. Williams, American 
Bankruptcy Institute Resident Scholar, Georgia State University College 
                                 of Law




                                 
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