    [Senate Hearing 111-600]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 111-600

           COULD BANKRUPTCY REFORM HELP PRESERVE SMALL BUSINESS JOBS?

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

                                    HEARING

                                   before the

            SUBCOMMITTEE ON ADMINISTRATIVE OVERSIGHT AND THE COURTS

                                     of the

                           COMMITTEE ON THE JUDICIARY
                              UNITED STATES SENATE

                         ONE HUNDRED ELEVENTH CONGRESS

                                 SECOND SESSION

                                   __________

                                 MARCH 17, 2010

                                   __________

                              Serial No. J-111-80

                                   __________

             Printed for the use of the Committee on the Judiciary

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                           COMMITTEE ON THE JUDICIARY

                      PATRICK J. LEAHY, Vermont, Chairman
    HERB KOHL, Wisconsin                 JEFF SESSIONS, Alabama
    DIANNE FEINSTEIN, California         ORRIN G. HATCH, Utah
    RUSSELL D. FEINGOLD, Wisconsin       CHARLES E. GRASSLEY, Iowa
    CHARLES E. SCHUMER, New York         JON KYL, Arizona
    RICHARD J. DURBIN, Illinois          LINDSEY GRAHAM, South Carolina
    BENJAMIN L. CARDIN, Maryland         JOHN CORNYN, Texas
    SHELDON WHITEHOUSE, Rhode Island     TOM COBURN, Oklahoma
    AMY KLOBUCHAR, Minnesota
    EDWARD E. KAUFMAN, Delaware
    ARLEN SPECTER, Pennsylvania
    AL FRANKEN, Minnesota
                Bruce A. Cohen, Chief Counsel and Staff Director
                      Matt Miner, Republican Chief Counsel
                                     ------

            Subcommittee on Administrative Oversight and the Courts

                   SHELDON WHITEHOUSE, Rhode Island, Chairman
    DIANNE FEINSTEIN, California         JEFF SESSIONS, Alabama
    RUSSELL D. FEINGOLD, Wisconsin       CHARLES E. GRASSLEY, Iowa
    CHARLES E. SCHUMER, New York         JON KYL, Arizona
    BENJAMIN L. CARDIN, Maryland         LINDSEY GRAHAM, South Carolina
    EDWARD E. KAUFMAN, Delaware
                    Sam Goodstein, Democratic Chief Counsel
                      Matt Miner, Republican Chief Counsel

                                C O N T E N T S

                                  ----------

                        STATEMENTS OF COMMITTEE MEMBERS

                                                                       Page

    Feingold, Hon. Russell, a U.S. Senator from the State of
      Wisconsin, prepared statement..................................    99
    Grassley, Chuck, a U.S. Senator from the State of Iowa, prepared
      statement......................................................   100
    Sessions, Hon. Jeff, a U.S. Senator from the State of Alabama....     3
    Whitehouse, Hon. Sheldon, a U.S. Senator from the State of Rhode
      Island.........................................................     1
        prepared statement...........................................   145

                                   WITNESSES

    Bennett, Thomas, Judge, Northern District of Alabama, Birmingham,
      Alabama........................................................    13
    Bullock, Charles D., Esq., Attorney, Southfield, Michigan........     7
    Mason, Joseph, Associate Professor, Department of Finance,
      Louisiana State University, Baton Rouge, Louisiana.............    11
    Mendenhall, Edward D., Jr., Small Business Owner, Warren, Rhode
      Island.........................................................     5
    Small, A. Thomas, Judge, Eastern District of North Carolina, Co-
      Chair National Bankruptcy Conference, Small Business Working
      Group..........................................................     9

                             QUESTIONS AND ANSWERS

    Responses of Thomas B. Bennett to questions submitted by Senator
      Grassley.......................................................    26
    Responses of Joseph Mason to questions submitted by Senators
      Grassley and Sessions..........................................    41

                           SUBMISSIONS FOR THE RECORD

    American Bankers Association, Commercial Finance Association,
      Independent Community Bankers of America, and Financial
      Services Roundtable, joint letter..............................    51
    Bennett, Thomas, Judge, Northern District of Alabama, Birmingham,
      Alabama, statement and attachment..............................    60
    Bullock, Charles D., Esq., Attorney, Southfield, Michigan,
      statement......................................................    92
    Mason, Joseph, Associate Professor, Department of Finance,
      Louisiana State University, Baton Rouge, Louisiana, statement
      and attachment.................................................   102
    Mendenhall, Edward D., Jr., Small Business Owner, Warren, Rhode
      Island, statement..............................................   114
    National Association of Credit Management, Robin Schauseil, CAE,
      president, and Phyllis L. Truitt, Chairman and Director of
      Credit Atlas World Group, Columbia, Maryland, joint letter.....   116
    Small, A. Thomas, Judge, Eastern District of North Carolina, Co-
      Chair National Bankruptcy Conference, Small Business Working
      Group, statement and attachment................................   118

           COULD BANKRUPTCY REFORM HELP PRESERVE SMALL BUSINESS JOBS?

                                  ----------

                           WEDNESDAY, MARCH 17, 2010

                                   U.S. Senate,
      Subcommittee on Administrative Oversight and the
                                                Courts,
                                    Committee on the Judiciary,
                                                         Washington, DC
        The Subcommittee met, pursuant to notice, at 10:33 a.m.,
    Room 226, Dirksen Senate Office Building, Hon. Sheldon
    Whitehouse presiding.
        Present: Senator Sessions.

     OPENING STATEMENT OF HON. SHELDON WHITEHOUSE, A U.S. SENATOR
                     FROM THE STATE OF RHODE ISLAND

        Senator Whitehouse. The hearing will come to order.
        I'm delighted to have the distinguished Ranking Member not
    only of this subcommittee, but of the Senate Judiciary
    Committee, Senator Jeff Sessions of Alabama, with us. I will
    make an opening statement and then recognize the witnesses and
    allow the distinguished Ranking Member to say a few words. Then
    we'll get to the testimony.
        I will warn each of you that we have a 5-minute clock on
    the initial testimony, and I will use the gavel. So for those
    of you who have prepared longer remarks, spend some time to
    think about what your core message is that you can distill into
    5 minutes of oral testimony.
        While some economists have declared that the recession is
    over, its painful aftermath in the form of a prolonged period
    of unemployment continues nationwide. The national unemployment
    rate stands at almost 10 percent, and the situation is even
    worse in some areas; Senator Sessions' home State of Alabama
    has an 11.1 percent unemployment rate, and my home State of
    Rhode Island ranks third nationwide, at 12.7 percent. Job
    retention and preservation should be, and is, the top of our
    legislative agenda.
        Today we are going to explore changes to the Bankruptcy
    Code that could help small companies to reorganize, stay in
    business, and keep employees employed. The ideas we will
    discuss today are worthwhile to consider for two reasons: 1)
    small businesses account for over half of all jobs nationwide;
    and 2) unlike other job-preserving measures like tax cuts and
    government investment, bankruptcy reform can be accomplished
    with zero cost to the Federal budget.
        While small business bankruptcy reforms may prove a
    powerful tool in cutting job losses, the need for a new
    bankruptcy reorganization option has been clear for some time.
    Chapter 11 was designed for large, publicly traded companies
    and does not work well for smaller companies for a number of
    reasons.
        First, Chapter 11 extinguishes equity so the debtor-owners
    exit the bankruptcy not owning their company anymore. A change
    in shareholders may not discourage big corporations from
    reorganizing, but for small businesses the corporate entity and
    its owner are not so easily disaggregated.
        Second, small businesses often have a number of trade
    creditors and other unsecured creditors that do not participate
    in a Chapter 11 because their claims are too small. This
    failure to participate leaves the secured creditors steering
    the bankruptcy, often toward liquidation.
        Finally, the Chapter 11 process is time-consuming and
    expensive and attorneys' fees and other administrative costs
    often eat up so much of the firm's value that there's not
    enough left for the firm to emerge from bankruptcy as a going
    entity.
        The National Bankruptcy Conference has proposed addressing
    these three issues by opening up Chapter 12, a process
    currently available only to family farms and fishermen, to a
    wider group of small businesses. I expect that Judge Small will
    discuss this proposal in his testimony today. I have reviewed
    the NBC's report and believe that they make a strong case for
    the Chapter 12 approach.
        I want to stress, however, that I look forward to hearing
    the thoughts of all the witnesses on positive steps to promote
    small business bankruptcy reform. It appears from the written
    testimony that each of our witnesses acknowledges that certain
    changes to bankruptcy law might help to preserve small business
    value and to save jobs.
        As we discuss the NBC proposal, there are a number of
    variables about which I'm interested in getting the witnesses'
    feedback: is the proposed definition of small business entity
    appropriate; should the reforms be made permanent or enacted on
    a trial basis, as Chapter 12 for family farms initially was?
        Through it all, one thing is clear: small businesses are
    the lifeblood of our economy, particularly in Rhode Island, but
    nationwide. They are hurting now in today's economic climate.
    We should be considering all options, including reforms to our
    Bankruptcy Code, to help small businesses keep their doors open
    and keep their employees on the payroll. I look forward to a
    lively discussion with a distinguished panel of witnesses.
        Ed Mendenhall owned a fitness center in Warren, Rhode
    Island from 1996 to 2009. In his testimony, Mr. Mendenhall will
    describe his efforts to save his business. Mr. Mendenhall is a
    graduate of the University of Rhode Island and has an extensive
    background in personal training, martial arts, and fitness.
        Chuck Bullock practices bankruptcy law in Detroit,
    Michigan, sort of the epicenter, perhaps, for economic distress
    in our country right now. He has represented small business
    debtors and secured and unsecured creditors. A graduate of the
    University of Michigan and the University of Memphis School of
    Law, Mr. Bullock teaches bankruptcy at Cooley Law School.
        Tom Small served as U.S. Bankruptcy Judge for the Eastern
    District of North Carolina from 1982 to 2009. He also served as
    president of the National Conference of Bankruptcy Judges and
    as a board member of the American Bankruptcy Institute. He
    holds degrees from Duke University and Wake Forest University
    School of Law. Judge Small continues to be an active member of
    the National Bankruptcy Conference and serves as co-chair of
    its Small Business Working Group. Judge Small helped Senator
    Grassley to draft the original Chapter 12 back in the 1980's.
        Joseph Mason is the Herman Moyes Louisiana Bankers
    Association chair of Banking at the Louisiana State University,
    and Senior Fellow at the Wharton School. Dr. Mason's academic
    research focuses primarily on investigating liquidity in thinly
    traded assets and illiquid market conditions. A graduate of
    Arizona State University, he has an MS and Ph.D. from the
    University of Illinois.
        Thomas Bennett has been a U.S. Bankruptcy Judge for the
    Northern District of Alabama in Birmingham since 1995. For over
    15 years he was a partner with the law firm of Bowles, Rice,
    McDavid, Graff & Love, PLLC, and served as the head of the
    firm's Bankruptcy, Creditors' Rights, and Commercial Litigation
    practice groups. Judge Bennett graduated from Gerard College in
    Philadelphia, Pennsylvania in 1966 and received his
    undergraduate and graduate degrees in Economics, as well as his
    law degree, in from West Virginia University.
        I now turn to our Ranking Member for any remarks he would
    care to make. Then we will swear the witnesses and proceed with
    the testimony, beginning with Mr. Mendenhall.

    STATEMENT OF HON. JEFF SESSIONS, A U.S. SENATOR FROM THE STATE
                               OF ALABAMA

        Senator Sessions. Thank you, Mr. Chairman.
        Of course, bankruptcy is a Federal court. Our economy
    evolves and bankruptcy rules and procedures, I think, should be
    reviewed by Members of Congress periodically to make sure that
    we are operating on the most effective, efficient level
    possible. Dynamic economic activity is part of the American
    strength, and being able to borrow money at a reasonable rate
    of interest is part of our American strength.
        Business people who fail and just can't make it are able to
    walk away, often usually without--sometimes, at least I'll
    say--personal liability and can start again. Many people who
    have been successful in business have a history of having
    failed businesses before that. So, we are in a dynamic economy.
        I think maybe the Japanese experience should share with us
    that keeping zombie banks and zombie institutions alive that
    really ought to go away and start over again can be a mistake
    also. So, we'll discuss those issues and remember that the
    freedom to succeed is also the freedom to fail, and people who
    wish to become rich 1 day aren't always to be provided
    assistance when they have not been successful.
        So I hope we'll learn something today about how we can
    preserve and create new jobs by helping small businesses
    reorganize in a convenient, effective way, but in doing so I
    hope we'll balance the rights of those who've invested in these
    small businesses, too. Many investors and lenders are small
    businesses themselves and we must be sure that we're not
    robbing Peter to pay Paul. We must make sure that we are not
    using our bankruptcy laws to force one small business to
    subsidize another small business.
        Bear in mind that reorganization is not solely about
    keeping a failing business alive, it's about preserving the
    value of an operating business so that lenders can be paid
    back, if they can be, and also to give that company a chance to
    succeed through bankruptcy protection. So we've got to be
    careful about all of these issues.
        It's great to have Judge Bennett here. He's well-respected
    in our State and throughout the bankruptcy community in
    America. He's been on our bench since 1995. Judge, we
    appreciate you and the resource and insight you've provided to
    me and my staff over the years.
        Of course, we have the current choice between Chapter 7 and
    Chapter 11. Chapter 7 is liquidation and Chapter 11 allows a
    bankruptcy court to help reorganize the company in a way that
    allows it to be successful, to hold off certain creditors, and
    create a situation in which more creditors get paid more money
    than if one or two had come in and liquidated the company or
    destroyed the company just to get their short-term gain. I
    think that's a good policy.
        As to whether we can use the agricultural idea, I guess
    I'll say I'm open to it, but I have some concerns about it.
    There is no doubt in my mind that if you recreate procedures
    that significantly reduce a secured creditor's priority in
    bankruptcy and in liquidation circumstances, then that secured
    creditor in the future will be less likely to loan money, and
    if he or she does, to do so with perhaps higher interest rates
    to guard against the dangers of the erosion of what they
    thought they had when they started out with a secure loan.
    There's just no free lunch here, somebody is going to pay.
        Sometimes I think we should ask ourselves, who would best
    pay, the small business who made the loan? Should that person
    subsidize the failing small business or should we just have the
    taxpayers do it? It's easier for us to maybe require the person
    who made the loan to be responsible because if we would have to
    raise taxes or increase the debt if we do it otherwise. But as
    a matter of economics, I'm not sure which one is more morally
    defensible as a policy.
        So I am open to this. Mr. Chairman, thank you for your
    leadership. I have confidence that we can find some things that
    we can agree on to make the system better, and hopefully we'll
    agree on the big things.
        Thank you very much.
        Senator Whitehouse. Thank you, Senator Sessions.
        If I could ask the witnesses to stand and be sworn.
        [Whereupon, the witness was duly sworn.]
        Senator Whitehouse. Thank you very much. Please be seated.
        I would like to welcome Edward Mendenhall from my home
    State of Rhode Island, a small businessman who for many years
    ran a small business in Warren, Rhode Island.
        Mr. Mendenhall, please proceed.

     STATEMENT OF EDWARD D. MENDENHALL, JR., SMALL BUSINESS OWNER,
                          WARREN, RHODE ISLAND

        Mr. Mendenhall. Chairman Whitehouse and Ranking Member
    Sessions, thank you for the opportunity to appear today before
    the Subcommittee and tell my story, and for looking into ways
    to help small businesses stay open.
        My story begins at the end of 1995, when I decided to open
    a health club in Warren, Rhode Island. I grew up in the area
    and recognized the need for a health club, so I decided to open
    one myself. Shortly thereafter, I secured a reasonably priced
    location, moved into the building, and began to renovate it 24/
    7 with the help of family and friends.
        In October 1996, we officially opened the doors. Though the
    location wasn't ideal and the business was very young, we grew
    into a successful business and we were actually profitable from
    day one. We put every dollar back into the business and
    continued to grow and improve over the years. In 2001, we were
    able to endure the opening of a larger, better funded
    competitor because our customer base had grown so loyal.
        In 2005, things took an unexpected turn when our landlord
    refused to renew our lease. While moving to a new facility and
    a better location was definitely part of our long-term
    strategy, the news was devastating at that time. Our type of
    business requires a large, open floor plan on a main road, and
    there were very few suitable locations in the area. To make
    matters worse, we didn't have the cash necessary to build out a
    new location at the time, so we were on the verge of losing
    everything we had worked so hard for all those years.
        So the first thing we did was to enlist the expertise of a
    health club design and marketing firm to make sure we did it
    right. They began with a marketing analysis and we began the
    search for potential locations. We found ourselves with no
    other option than to lease space. At that time, there were only
    two spaces available for lease.
        In late summer/early fall of 2006, we finally negotiated a
    deal to move into a shopping plaza and applied for the
    financing. Our financing needed to be secured by my personal
    home and assets. Now that we had the financing in place, we
    were waiting on the actual lease documents to be completed.
        We needed to begin the renovations right away in order to
    make the January opening date. In the health club industry, the
    first quarter sets up the rest of the year, as more people are
    inclined to join the club after their New Year's resolutions.
        As negotiations on the lease for the plaza space dragged
    on, another space opened up and we signed a lease with them in
    April of 2007. In the fall of 2007, we had the new space
    completely gutted and began the closing process with our bank.
    We again had hopes of a January opening to seize on the New
    Year's resolutions crowd, and continued to do what we could to
    keep the project moving forward. However, it wasn't until
    January that we were finally ready to close on the loan.
        Days before the closing date, the bank informed us that a
    UCC filing had to be cleared before proceeding with the
    closing. Unfortunately, because my business partner couldn't
    use any collateral, the bank that financed the stock purchase
    filed the UCC against our shares. By the time we found a
    solution and notified the bank that we were going to clear the
    UCC filing, they informed us that our file had been taken out
    of closing and sent to storage in another State.
        We then had to begin the closing process all over again and
    had to resubmit all documentation. We were informed by a bank
    employee that, for the course of our loan, everyone at the bank
    involved with our loan had either been fired or quit during the
    process. Within the bank there was a lot of confusion,
    miscommunication, and misplaced documents. This caused the
    whole process to be far longer and more painful than it should
    have been.
        The delays ultimately caused our original landlord to evict
    us in the summer of 2008. The eviction process began in July
    2008, when our landlord literally began taking over our space
    and renovating around our customers while we were still trying
    to operate. Immediately our sales dropped by $10,000 per month,
    which equated to about 25 percent of our sales.
        Luckily, we found a small vacant building around the end of
    September that was to serve as a temporary location. It wasn't
    ideal, but it did save us. We operated there until we opened
    the new facility in April of 2009. We finally closed on the
    loan in October of 2008 and the club opened in April 2009, 2
    years behind schedule.
        Our average sales prior to the eviction were enough to
    cover the minimal expenses at the new location, including the
    new debt service. A year of normal operations and growth in a
    new facility would have put us back on track. By the time the
    new club was open, we were behind in bills and needed to free
    up cash-flow so we would have a chance to breathe and focus on
    growing. We were looking for help everywhere: the Economic
    Development Corporation, the SBA, our banks, new banks, private
    investors, everywhere.
        We had applied for an ARC loan to pay our equipment leases.
    If approved, it would have freed up $7,000 a month in working
    capital for 5 months. We couldn't even get the banks to take
    the application, never mind consider it. They said they just
    didn't want to be bothered with the paperwork.
        We also applied for a deferment with our bank. We were told
    by the SBA that our bank could approve a deferment for up to 1
    year without SBA approval. It took 4 months and a lot of
    paperwork just to get an answer. We were eventually granted a
    3-month interest-only deferment. Unfortunately, this would not
    be a significant help.
        An ARC loan and a longer loan deferment, by themselves,
    would have been enough to save the business if granted soon
    enough. This would have given us the time we needed to grow and
    catch up on the past-due bills. When we closed our doors, we
    had accumulated approximately $140,000 in past-due bills. Half
    of that amount also would have saved the business while we
    caught up with the rest over time. I guess when you look at the
    big picture, a relatively small amount of help would have
    helped us avoid having to go bankrupt with over $1 million in
    debt. A little flexibility on timing could have saved our
    business.
        Last year we met with a bankruptcy attorney, hoping that if
    we filed we could buy enough time to make it to the first
    quarter of the year and get our business back on track.
    Unfortunately, the attorney told us our business value was too
    small to warrant reorganization in Chapter 11; the only
    bankruptcy option for us was liquidation.
        We have now lost the business, our entire life's savings,
    our credit, and now probably our house, which was used to
    secure the loan, and it didn't have to be that way. Timing
    worked against us. If we had a little more time we could have
    stayed in business, become profitable again, and avoided laying
    off 25 full-and part-time employees. So Senators, please
    consider ways to help small businesses like mine have a
    fighting chance to stay in business.
        Thank you. I am happy to answer any questions.
        Senator Whitehouse. Thank you, Ed. That was incredibly
    important testimony and I appreciate that you have come here to
    deliver it.
        [The prepared statement of Mr. Mendenhall appears as a
    submission for the record.]
        Senator Whitehouse. The next witness, Charles Bullock, is a
    day-to-day practitioner deeply engaged in the practical
    situations of debtors and secured and unsecured creditors in
    our Michigan bankruptcy courts.
        Mr. Bullock.

       STATEMENT OF CHARLES D. BULLOCK, ATTORNEY, SOUTHFIELD, MI

        Mr. Bullock. Mr. Chairman and members of the Senate
    Judiciary Subcommittee on Administrative Oversight and the
    Courts, my name is Charles Bullock. I am a practicing attorney
    and founder of the Michigan-based law firm, Stevenson &
    Bullock, PLC. I am licensed in both Michigan and Tennessee. My
    practice concentrates on individual and small business
    bankruptcy cases, representing trustees, creditors, debtors,
    and other interested parties in Chapters 7, 11, 12 and 13.
        My substantive comments are premised on the firm belief
    that there must be an alternative to the current process set
    forth in Chapter 11 when a small business seeks relief in
    bankruptcy and attempts to reorganize. I do not, however,
    believe that such an alternative would require one to revisit
    the Bankruptcy Abuse Prevention and Consumer Protection Act of
    2005.
        I agree with those who have called on this body to refrain
    from reflexive legislative efforts which do not afford a
    wholesale solution, particularly the comments of the well-
    respected jurist, Hon. Thomas B. Bennett of the U.S. Bankruptcy
    Court in the Northern District of Alabama, who, during his
    December 5, 2007 testimony before the Senate Committee on the
    Judiciary, when discussing the looming foreclosure crisis,
    stated, ``I am here to urge caution and restraint in doing
    anything which attacks what is only a portion of a greater
    problem''. I strongly agree with that premise. Caution and
    restraint must be implemented in doing anything which attacks
    what is only a portion of a greater problem.
        I hold a view that seems to be shared by all experts in the
    field, whether they are for or against a piece of legislation,
    which is that any legislative solution should attempt to
    address the entire problem. With that in mind, I strongly
    support amending Chapter 12 to accommodate small business
    enterprises seeking to reorganize.
        It is my firm belief that the immediate and long-term
    benefits of such Chapter 12 accommodation would address more
    than a portion of the greater problem and would provide little
    risk to those you desire to assist and to those many more not
    contemplated to be affected by the proposed legislation.
        This solution benefits everyone involved in bankruptcy. It
    continues the business operation, retains jobs, and enables
    creditors to be paid. This is a commendable attempt to attain
    balance and increase the potential benefits of a reorganizing
    bankruptcy case. As the Subcommittee is aware, reorganization
    in bankruptcy is attained through Chapters 11, 12 and 13.
        The U.S. Bankruptcy Code provides that a debtor that is not
    an individual may not be a debtor under Chapter 13 of Title 11.
    Stated another way, only an individual may be a Chapter 13
    debtor. Furthermore, only a family farmer or family fisherman
    may be a debtor under Chapter 12.
        Because of these restrictions, debtors engaged in business
    that are not eligible for relief under Chapter 12 or 13 that
    seek to reorganize in bankruptcy are required to file for
    relief under Chapter 11, regardless of size, amount of revenue,
    or the amount of the creditor base.
        Insurmountable challenges are often imposed on both
    creditors and debtors when a small business seeks relief in the
    existing Chapter 11. Significant impediments to successful
    reorganization under Chapter 11 include, among other things,
    the high costs, balloting, and the lack of a standing trustee.
        If the goals of the bankruptcy process are to provide a
    structured environment supervised by the court in which
    financially troubled companies may remain in business, continue
    to provide and create jobs, and restructure and retire debt,
    Chapter 11 fails miserably in addressing small business issues.
        I have represented or closely interacted with nearly every
    party in a typical Chapter 11 reorganizing case. My experience
    dictates that Chapter 11 obligates debtors, creditors, and
    equity security holders to invest limited resources in the
    technical legal process rather than allowing the parties to
    specifically allocate those resources to the substantive
    reorganization efforts.
        In the best legislative solution, a reorganization of a
    small business would assist the debtor and ensure that the
    debtor attends to the critical components of the case. That
    legislative solution would promote expediency, which is
    essential for small business cases to succeed.
        I have marveled at the efficiency of the Chapter 13
    process: the modest administrative expenses in Chapter 13, in
    relation to Chapter 11; the usefulness of a standing trustee;
    and the benefits inuring to both debtor and creditors once a
    plan is confirmed. As a result, I am convinced that Chapter 12
    is a good fit for the small business debtor.
        The Chapter 12 requirements of Section 1222 relating to the
    contents of a plan, Section 1225 relating to confirmation of a
    plan, are well-suited for traditional small business debtors.
    These provisions are quite similar to Chapter 13 requirements
    of Sections 1322 and 1325.
        In light of the cumbersome nature of Chapter 11 and the
    fragile nature of many small business debtors, the resulting
    lower administrative expenses incurred by a debtor in Chapter
    12 recommend this alternative. So, too, creditor costs would be
    lower in Chapter 12. Balloting and unsecured creditors
    committees will give way to an independent and disinterested
    Chapter 12 standing trustee who would represent the interests
    of all creditors.
        Inasmuch as feasibility is a condition of confirmation in
    Chapter 12, a judicial gatekeeper will have a better ability to
    maintain its docket and the integrity of the bankruptcy system
    by confirming, converting, or dismissing these cases. In the
    Eastern District of Michigan where I practice, we have an
    exceptionally diligent, albeit extremely overworked, court.
        In his opening statement, the Ranking Member has made an
    insightful comment about zombie banks. Similarly, Chapter 11
    seems to have the unintended consequence of creating zombie
    debtors because of the administrative process and impediments
    to confirmation. Chapter 12, however, requires that the court
    specifically address feasibility, which is something not
    required in Chapter 11. As a result, this may better address
    the problems of such debtors.
        Thank you.
        Senator Whitehouse. Thank you very much, Mr. Bullock. I
    appreciate your testimony and that you've taken the trouble to
    come here and join us.
        [The prepared statement of Mr. Bullock appears as a
    submission for the record.]
        Senator Whitehouse. Our next witness is Judge Small, who
    was really, I gather, present at the creation of Chapter 12 as
    one of the draftsmen who assisted Senator Grassley when he
    prepared that piece of legislation.
        Without further ado, Hon. Thomas Small.

       STATEMENT OF HON. A. THOMAS SMALL, U.S. BANKRUPTCY JUDGE,
    RETIRED, EASTERN DISTRICT OF NORTH CAROLINA, CO-CHAIR, NATIONAL
          BANKRUPTCY CONFERENCE, SMALL BUSINESS WORKING GROUP

        Judge Small. Thank you, Mr. Chairman and Senator Sessions,
    for inviting the National Bankruptcy Conference to testify this
    morning.
        Before I retired in September of last year, I was a
    Bankruptcy Judge for the Eastern District of North Carolina,
    and most of my Chapter 11 cases that I handled were small
    businesses.
        What I saw from the bench is consistent with the testimony
    of Mr. Mendenhall and Mr. Bullock. Chapter 11 does not work
    well for many small businesses, and unfortunately for some
    debtors like Mr. Mendenhall, it does not help at all.
        Professor Ed Morrison of Columbia Law School and I are co-
    chairs of a National Bankruptcy Conference Working Group to
    recommend ways to remove some of the obstacles to
    reorganization. In my written testimony is our report.
        At first, we considered a separate chapter for small
    businesses, much like Chapter 10 legislation supported by
    Senator Grassley and Senator Hefflin from Alabama in the early
    1990's, but we finally realized that a better solution would be
    to allow small businesses to file for relief under Chapter 12,
    a time-tested chapter of the Bankruptcy Code that has been
    extremely successful in enabling family farmers to reorganize.
    Small businesses face many of the same obstacles that once
    confronted family farmers.
        If Senator Grassley were here today, he would see that my
    testimony is very similar to the testimony I gave almost 25
    years ago on the national farm crisis at a hearing chaired by
    Senator Grassley and Senator John East. Today, the crisis
    facing small business is just as dire and the solution, in our
    opinion, is the same: Chapter 12.
        The problems confronted by distressed small businesses are
    numerous. First, Chapter 11 was designed for large corporations
    and it's very expensive. Most of these costs are professional
    fees. As a judge, I tried to reduce these by streamlining the
    Chapter 11 procedures, but the problems extend far beyond that.
    In Chapter 11, costs must be paid in full at confirmation, and
    this is a very heavy burden for cash-strapped debtors. Chapter
    12, though, allows administrative costs to be paid over time.
        Especially troublesome are Chapter 11's high voting
    requirements, the Absolute Priority rule and restrictions on
    downsizing through the sale of assets. These give secured
    lenders an undue influence over a debtor. Chapter 12 eliminates
    these obstacles. There's no voting, there's no Absolute
    Priority rule, and there are no restrictions on selling assets
    to downsize a business.
        Another virtue of Chapter 12 is that it makes small
    business cases subject to case monitoring. In every Chapter 12
    case there is a standing trustee who gives impartial oversight,
    examines the debtor's affairs, makes recommendations concerning
    plan confirmation, mediates disputes, and monitors plan
    compliance.
        As Mr. Bullock said earlier, this is a great benefit to
    creditors. Another benefit to creditors is that a
    reorganization preserves the going-concern value of collateral,
    which is always higher than what a secured creditor receives
    from a liquidation. Moreover, creditors receive a prompt
    confirmation decision because Chapter 12 moves fast. There are
    no zombie debtors in Chapter 12. Plans must be filed within 90
    days and confirmation hearings take place 45 days thereafter.
    Chapter 12 cases that are not viable are quickly dismissed.
        Now, it is true that secured lenders may not be happy
    giving up their right to vote, but under Chapter 12 they always
    retain the right to object to confirmation of the plan. Chapter
    12 debtors must pay all of their disposal incomes to creditors.
    All plans must meet strict confirmation standards and they must
    survive the scrutiny of an independent trustee.
        The need to address impediments to small business
    reorganization is urgent. Delay in enacting the legislation
    will deny a fair chance to reorganize to thousands of
    financially distressed small businesses. There is no time or
    need for further study.
        Now, this is what I know from my experience. In my
    district, between 1986 and 1999, there were 354 Chapter 12
    cases filed. Seventy-seven percent of those family farmers had
    their plans confirmed, and 50 percent of all of the family farm
    cases were successfully completed. It's actually better than
    that because a lot of the cases that were dismissed were
    dismissed because they entered into arrangements with their
    secured creditors and they didn't need Chapter 12 anymore.
        But Chapter 12 has worked well for family farmers. It is
    the considered view of the National Bankruptcy Conference that
    it will work well also for small businesses. Thank you.
        Senator Whitehouse. Thank you, Judge Small. We appreciate
    your testimony very much.
        [The prepared statement of Judge Small appears as a
    submission for the record.]
        Senator Whitehouse. Dr. Mason is the Louisiana Bankers
    Association Chair of Banking at LSU, which brings him up here
    from Tiger Stadium, a place I have been, and appreciate very
    much that you've come. I particularly appreciate your closing
    remarks that ``a leaner system with simplified filing and
    streamlined procedures for quick recovery will help those who
    have the capacity to get back to business while preserving
    collateral value and saving on legal bills for others. Such a
    system has the potential to be an important impetus for
    economic growth in the coming recovery'', which is the premise
    of this hearing, so we are grateful that you're here.
        Dr. Mason.

     STATEMENT OF JOSEPH MASON, ASSOCIATE PROFESSOR, DEPARTMENT OF
      FINANCE, LOUISIANA STATE UNIVERSITY, BATON ROUGE, LOUISIANA

        Dr. Mason. Well, thank you. I will try to buildup to that
    conclusion and reemphasize that remark. But thank you, Chairman
    Whitehouse. Thank you, Ranking Member Sessions, for inviting me
    to testify on this very important topic today.
        I'm an economist. I have a little different point of view
    than many of the attorneys and judges on the panel. A well-
    designed bankruptcy law, to me, is a crucial stabilizer to
    economic growth. Since the times of Thomas Jefferson, the idea
    has been that the uncertain nature of the farm business
    deserves special consideration.
        Such treatment was accompanied by restrictions on financial
    institutions that lent money to the farms so that those
    institutions would be so undiversified, as well as legally
    hobbled in bankruptcy law, that they had no alternative but to
    forbear on farmers in times of poor harvests.
        As the U.S. economy grew and as industrialization took hold
    the traditional family farm became considered a small business,
    so in some ways it looks sensible to allow small businesses to
    use Chapter 12 as a new bankruptcy alternative. Unfortunately,
    the present approach focuses on preventing bankruptcies rather
    than facilitating them. As a result, the approach under
    consideration will hurt both economic growth as well as small
    business owners.
        One of the main problems in small business bankruptcies is
    that small business and personal assets and liabilities are
    often commingled. It is hard sometimes to see where the
    boundaries of personal lives and business lives exist,
    especially in small businesses. One simple example is the
    prevalence of small business subprime home lending that played
    a part in the run-up to the recent crisis.
        One such firm, American Business Financial Services, was
    the subject of a spectacular bankruptcy and fraud allegations
    in the Philadelphia region. I argue that it is those boundaries
    between the personal and the business obligations that lead to
    the most disruptive losses in small business bankruptcy. The
    causes of small business bankruptcy and personal bankruptcy are
    also commingled.
        While many studies seek to categorize the causes of small
    business bankruptcies, the chief risks are cash-flows and
    lawsuits and what we call key man risk. Cash flows and lawsuits
    speak for themselves. Of course, a skilled manager can help
    guide a business through the minefield, but the skilled manager
    is often the owner or managing partner. Without him or her, the
    business cannot stand.
        Consider, the chief risks facing the key man here in the
    operation are the same personal financial shocks that cause
    personal bankruptcy: divorce, automobile accident, health care
    crisis, and addictive disorders. So we know there's a problem.
    Small business bankruptcies are not like large business or
    personal bankruptcies. But while change may be necessary,
    change is costly.
        We are still dealing with the fallout of changes to
    bankruptcy incentives in the Bankruptcy Abuse Prevention and
    Consumer Protection Act of 2005. Liberal rights granted to
    unsecured consumer creditors under the Act are understood to
    have led to increased credit supply and rampant consumer
    borrowing.
        On the business side, the Act's extension of safe harbor
    provisions led to failed firms being drained of cash and assets
    by margin calls on new financial products, leaving the firm a
    mere shell in the aftermath of the recent crisis.
        Similar dramatic changes occurred with the implementation
    of Chapter 12 when agricultural experts noted that even major
    suppliers of fuel, seed, fertilizer, and chemicals were forced
    into Chapter 7 liquidation as a result of their customers'
    treatment under Chapter 12, a manifestation of what today we
    term ``systemic risk.''
        Each time we tinker with bankruptcy laws we impose
    significant costs on all economic agents. We all know the
    classic tradeoff. Empirical results have shown that higher
    personal bankruptcy exemptions are associated with more
    business ownership, but higher personal bankruptcy exemptions
    are also associated with increased credit rationing and higher
    interest rates.
        The challenge before us, therefore, is not to figure out
    how to prevent bankruptcies. Rather, the challenge is to craft
    a small business bankruptcy law that can be used. If that's
    what we seek, then Chapter 12 is probably not the answer.
    Empirical evidence also shows that very few farmers actually
    use Chapter 12 and that bankruptcy relief has not, and cannot,
    halt the decline in family farming. It won't save small
    businesses from a recession either.
        From an economic point of view, therefore, we want a small
    business bankruptcy law that smooths the transition of the
    serial entrepreneur, allowing them to flow into and out of
    businesses in a way that preserves both creditor and
    entrepreneur value. Economically, the simple key to retaining
    that value is to intervene earlier than is currently the case;
    of course, that means more bankruptcies. But as authors noted
    even before the 2005 Act, the surprising aspect of at least
    personal bankruptcy, which has been researched in this way, is
    not how many people use it, but how few.
        So overall, a leaner Chapter 11 system with simplified
    filing and streamlined procedures for quick recovery will help
    those who have the capacity to get back to business, while
    preserving collateral value and saving on legal bills for
    others. Moreover, such a system has the potential to be an
    important impetus for economic growth in the coming recovery.
    Simplistically extending Chapter 12, however, in the manner
    proposed will not realize that crucial potential.
        Thank you.
        Senator Whitehouse. Thank you, Dr. Mason. We appreciate
    your testimony.
        [The prepared statement of Dr. Mason appears as a
    submission for the record.]
        Senator Whitehouse. Our next witness is the distinguished
    Judge Bennett from the Bankruptcy Court of Northern Alabama. If
    I could take the liberty of highlighting one of his
    conclusions, it is that it is, and has been clear for decades
    if not longer, that Chapter 11 of the Bankruptcy Code does not
    allow some businesses to reorganize their financial affairs in
    a timely and efficient manner and at a cost that is affordable.
    He has great experience in this area and it is very helpful to
    us.
        We look forward to your testimony, Judge Bennett.

       STATEMENT OF HON. THOMAS BENNETT, U.S. BANKRUPTCY JUDGE,
           NORTHERN DISTRICT OF ALABAMA, BIRMINGHAM, ALABAMA

        Judge Bennett. Thank you, Mr. Chairman.
        Let me start off by saying that the right of failure--that
    is, failure--is essential to our economic system. To the extent
    that we change statutes--and in my view some of the 2005
    amendments to the Bankruptcy Code did something
    counterproductive--where we either eliminate the right to fail
    or we delay the right to fail, what happens is a misallocation
    of our resources that is detrimental in the long run to
    everybody at the benefit of a few.
        So what I think needs to be paid attention to is the bigger
    picture here, and that is, we do not want to create a
    disincentive for failure. The best example, if you want to look
    at the best example in recent history, is the inability to fail
    in some of the Eastern bloc countries of Europe, and their
    economic troubles were the result of not being allowed to fail.
        So in the context of the bigger picture, we need to
    structure something that does something that is efficient for
    our system. That means it should be a system that allows
    failure to occur when it should occur much more quickly than
    bankruptcy frequently does. At the same time, it needs to allow
    reorganization and identify those businesses that can
    successfully reorganize in the long run much more quickly.
        To give you a good example, Mr. Chairman, you talk about
    preserving jobs, but there is a price. If you preserve jobs
    that should not be preserved, you lose other jobs. Let me bring
    it a little bit more home to you. You are familiar with Thayer
    Street in Providence. Great dynamic little street, tons of
    little businesses there. And as you're aware, they frequently
    go out of business.
        If you allow businesses to drag out, what's happens is a
    slow demise: inventory gradually decreases, jobs gradually
    decrease over time. When, if it was efficient and that business
    ultimately fails a year or two later and the delay is caused by
    a bankruptcy process, if it were efficiently done the business
    is replaced, more people are hired. That's really the tradeoff
    and why it is very critical, when you do something of the
    nature that's proposed, that you have to look at those sorts of
    dynamics.
        The bigger picture of what's proposed is, and the data is,
    that what we are going to do under the proposed version is move
    somewhere between about 7 to 95 percent plus of all current
    Chapter 11s and make available Chapter 12. I think there's a
    definitional problem. I think that the liability side alone at
    $10 million is far too high because, on the data I've supplied
    to you, you can have at least $3 billion entities in small
    businesses under definition in 2009; 300 and some-odd cases
    with assets of over $10 million would have been small
    businesses. Under the definition, there is a law firm in this
    country that has no debt that has well over 700 lawyers,
    thousands of employees. There are companies that are very large
    companies that would comply.
        When you realize that the structure of the definition
    causes a vast expansion and shifting of bankruptcy potentially
    from Chapter 11 to Chapter 12, and that Chapter 12 does present
    creditors and other interests further risks than they would
    otherwise face in Chapter 11, the market is going to react to
    this. What you don't want to do is cause a market to decrease
    the supply of credit, for instance.
        That's the bigger picture here and the difficulties I have
    with Chapter 12. It is not that we shouldn't do something for
    small businesses, but the question becomes: what is a small
    business? Is it a business that's a mom-and-pop grocery store?
    Sure it is. Is it an entity that has 3,500, 1,000, 2,000
    employees? I think that at some point you have to really keep
    it at small businesses.
        There are structural changes from going from an 11 to a 12
    that implicate, with a lot of the entities that would otherwise
    under the definition of a small business in this Act, changes
    that I don't think Congress contemplates. Do you want them to,
    for instance, be able to reject union contracts and not have
    the same protections that unions have in a Chapter 11? I don't
    know that that's contemplated. But that's the bigger picture.
        A couple of quick, minor points. If this were enacted,
    there are four vehicles for small businesses, very small
    individual cases in 13, the new Chapter 12, the small business
    portion of 11, and a Chapter 11. It's too complex. You ought to
    have one provision that governs small businesses.
        My suggestion is, you don't put it in Chapter 12. The
    reason is, I used to get paid to do amendments and it is very
    complex and very difficult not to make a mistake because you
    can't think in advance of all the interrelationships. It ought
    to be separated. Don't mess with the family farmer provisions
    that people think work, and like. Put them somewhere where it
    won't mess up those provisions, for want of a better term.
        I think that we need to restrict it to truly small
    businesses, not very large businesses. We need to understand
    the broader implications, which include potentially causing
    interest rates to rise if it's not done right because of higher
    systemic risk to lenders, which means potentially less business
    and less employment. I think that the small business provisions
    need to be moved to maybe a new chapter, or within the Chapter
    11 provisions.
        My time is up, so I am going to quit.
        [The prepared statement of Judge Bennett appears as a
    submission for the record.]
        Senator Whitehouse. Well, I'm not going to let you quit
    because I'm very interested in your testimony. So I'm going to
    start with my question right back to you to continue the
    discussion that you've so ably participated in. I'm going to
    unpack a few questions. Is there any harm to the fishermen or
    farm owners who presently enjoy the benefits of Chapter 12 if
    its rules are expanded also to small businesses? Are they hurt
    by doing that or do they just continue on?
        Judge Bennett. To answer your question simply, the answer
    is no, not on the surface. The problem is this, that when you
    amend a statute there are interrelated provisions. Lawyers,
    unfortunately, and judges use words. The reason scientific
    methodology was developed, is they use mathematics. Mathematics
    are far more precise in analyzing and avoiding problems.
        Words are highly imprecise. I might focus on drafting a
    statutory provision thinking about small businesses and not
    contemplate that what it may do is cause future problems in the
    context of other types of businesses. It's not that on its face
    it is an issue, it is that there may be legal issues that come
    up in the future, and why take that chance at the expense of
    farmers and fishermen?
        Senator Whitehouse. So your concern would be that as the
    courts adjudicating Chapter 12 proceedings dealt with small
    business bankruptcies, they would make Court of Common Law
    changes in the way they did business to accommodate this new
    kind of customers.
        Judge Bennett. Could be.
        Senator Whitehouse. And that would reflect back onto the
    farm owners and fishermen.
        Judge Bennett. Could be.
        Senator Whitehouse. OK. You can see that we need to make
    Chapter 11 more efficient for small businesses. I think
    everybody on the panel agrees with that proposition, that it is
    now failing them. Does the general Chapter 12 rubric of having
    a standing trustee and having a confirmation plan that has to
    be filed and approved relatively rapidly for trying to resolve
    the business on a going-forward basis provide the template for
    what should be done with a small business bankruptcy provision,
    assuming that we've correctly defined small business and
    eliminated the sort of definitional errors that you've
    described?
        Judge Bennett. The answer is, if you understand the
    difference in the dynamics between a Chapter 11, which is
    structured to be consensual, and if not consensual there are
    some methodologies that you can use to have a case confirmed,
    versus a Chapter 12 which is not consensual.
        It basically means, the difference is that in a Chapter 11,
    if you get a plan confirmed, you are essentially trying to get
    the participation of unsecured creditors, and secured. The
    difficulty in a Chapter 12 is that that's not the case. It's
    structured so they receive, theoretically, the indubitable
    equivalent of what they had as a secured creditor as of, in
    this case, the confirmation hearing.
        The difficulty that people may not understand is that in
    Chapter 13s and 12s, unsecured creditors can get nothing. It is
    not that unsecured creditors receive full payment or partial
    payment. It could be any of those. That dynamic difference
    between an 11 and 12 is this, that unsecured creditors may not
    want that particular type of plan. Frequently, the chief
    unsecured creditor can be, particularly in small cases, the
    secured lender too whose collateral is at risk on the future
    ongoing operation.
        So with respect to some businesses, depending on the
    definition of small, the dynamic of Chapter 12 is basically a
    forced confirmation, with the risk being mostly on the value of
    the secured creditor's collateral and the unsecured creditors
    may effectively, if the estate otherwise would have had money
    to pay, not get paid anything.
        Senator Whitehouse. I would be interested in your reaction
    to this observation, which is that that may not necessarily be
    a bad thing.
        Judge Bennett. Correct.
        Senator Whitehouse. The experience of a great number of
    debtors, mortgage holders, is that banks have become very
    difficult to work with. In this day and age you spend an
    enormous amount of time waiting on the phone and punching
    through the numbers and trying to find somebody who actually
    has your file and can make a decision, and it's sort of been
    bureaucratized to the point where it's incredibly frustrating,
    at least for Rhode Islanders who I talk to, to deal with their
    creditor, particularly the bank or a secured creditor, whenever
    they have a problem.
        So to me, having a neutral disinterested trustee who can
    make a sensible business decision and enjoys the confidence of
    the court is a better decisionmaker than to leave that poor
    debtor to the tender mercies of the secured creditor who has
    their secured creditor work-out shop grinding through this
    stuff and treating them as basically grist for the mill, and
    what they want to do is grab whatever they can, sell it as
    quick as they can, cut their losses, and move on with very
    little consideration for the well-being of the business itself,
    or its employees, or the larger community.
        Judge Bennett. I don't think that's necessarily the case.
    There are good and bad in all situations. There are good
    bankers, there are bad bankers. There are good bankruptcy
    practitioners, there are bad bankruptcy practitioners. People
    don't shoot themselves in the foot knowingly.
        I will tell you, for instance, today, that what I see in
    the mortgage context is that bankers want to take back
    properties where they're over-secured and they are perfectly
    willing to renegotiate where they're deeply under water. The
    same thing sometimes holds true in the business world, but
    bankers are not necessarily the evil side of this.
        Failures are failures. They are failures for a reason. You
    need to look at why the failure occurred. The idea that a
    trustee who is almost universally a lawyer--and I would suggest
    to you that lawyers are not very good businessmen. I'm sorry,
    but they aren't. They're not trained in it. That's not what we
    focus on.
        The idea that a lawyer, which is the predominant number of
    trustees, has the business abilities on some businesses with
    $10 million in debt and hundreds or a thousand employees, I
    would suggest to you that that's not necessarily the people you
    want looking at it. You want people that have business
    expertise. They're not necessarily dispassionate.
        If you understand how Chapter 13 and 12 trustees are paid,
    they're paid by a percentage of assets that roll through the
    trustee's accounts to pay out to people, so there is an
    incentive to let them potentially last longer than they should.
    My experience, though, is that most trustees try to do a good
    job. They're not business people. They look at the
    technicalities of the Bankruptcy Code and they look at the
    technicalities of whether you're following your plan as
    distinguished from being able to do business analysis.
        Senator Whitehouse. My time has expired. Let me turn to the
    distinguished Ranking Member.
        Senator Sessions. Thank you. Let's follow along with that.
    Mr. Bullock, you've represented parties on both sides and
    you've heard Judge Bennett express reservations about Chapter
    12. I know you could talk about that for my whole 5 minutes,
    but what are your thoughts? I'll just give you a chance to
    respond to that.
        Mr. Bullock. Thank you, Senator. I do take issue with the
    idea that an independent fiduciary, a standing trustee, is not
    suited or up to the task. As this Subcommittee knows, the
    Office of the U.S. Trustee is charged with certain duties,
    including appointing a panel of trustees. My experience has
    been that not only are they generally exceptional
    practitioners, but they are either skilled or become skilled in
    whatever tasks they're responsible for. The one thing, though,
    that I know about the trustee system is there is the
    opportunity to retain experts.
        Senator Sessions. Now, is there a difference in the role of
    the trustee in Chapter 12, the farming chapter, as opposed to
    Chapter 11?
        Mr. Bullock. Yes. In context, we generally don't see a
    trustee appointment in a Chapter 11. There are times:
    malfeasance, fraud, basically getting the debtor out.
        Senator Sessions. So one of the big changes--I'm just
    getting this in my head. One of the big changes if you go to
    12, you'll have a trustee in every case?
        Mr. Bullock. No different than you would in a Chapter 13
    case, where there is a standing trustee who is a fiduciary, has
    defined responsibilities and, again, from my perspective,
    benefits the system a great deal because of their independence.
        Something else that I would like to point at, and this is
    an observation being on all sides of the table in Detroit, is
    that the creditors' bar, as tasked as the debtors' bar is
    currently, their clients, frankly, don't necessarily know what
    to do with the collateral that they have and often,
    inreflexively, they simply liquidate it, not because they're
    trying to be difficult, not because they're trying to be nasty
    or mean or do anything that would affect the debtor for any
    reason other than, they just don't want to hold onto the
    property.
        Senator Sessions. But the question to me would be, what do
    you do with the property? If the creditors who presumably loan
    money and are into this company pretty deeply can't see any
    viable way for it to be successful, maybe they're better than a
    trustee in making that decision.
        Mr. Bullock. Respectfully, Senator, I believe that through
    the Chapter 12 process, what we have is something called
    feasibility, which is really important. In Chapter 11, there is
    not a feasibility requirement. The judges, our courts, don't
    have the defined role of looking at the plan and saying, is
    this or is this not feasible. In Chapter 12, they do.
        So looking at a 90-day window where a plan has to be in,
    where in Chapter 11 you're well north of 100 days, I believe
    that because the judges are looking at feasibility, and because
    under a case that's called Rash, it's a Supreme Court case that
    talks about how we value collateral, we look at a part of the
    Bankruptcy Code.
        And to leave the Code sections out I'll simply say you look
    at the Code and we're looking at, rather than liquidation
    value, which is I think the lowest value, we're looking at, how
    are we using the collateral, the intended use of the
    collateral, which is a higher value, and then the courts are
    charged with determining what the value is. I've read in some
    of the material, there was a thought that maybe judges aren't
    well-suited to do that.
        Respectfully, our Supreme Court has said that's exactly
    what they're supposed to do, and I for one, speaking only for
    myself, would say if there's a bankruptcy judge in the United
    States who is not capable of valuing collateral, I would
    encourage whoever is responsible for that judge to remove that
    judge. That's their job.
        Senator Sessions. Well, Judge Small, I'll let you--now, the
    Bankruptcy Conference, which you're speaking on behalf of, or
    at least their analysis, favors the Chapter 12 solution. The
    National Bankruptcy Review Commission does not. But are there
    ways--is it important to you that it be precisely adopting the
    Chapter 12 route, or could there be a reform of Chapter 11, as
    I understand Judge Bennett to be suggesting?
        Judge Small. There could be. That's how it started out.
        Senator Whitehouse. Your microphone, Judge Small. I'm not
    sure it's on.
        Judge Small. That's how we started out. As I said, we
    thought about a separate chapter, but the more we thought about
    it, we realized it was modeled on Chapter 12, why not do
    Chapter 12? We've go the body of case law, we know it works. I
    mean, it works really well.
        If I could follow up on just one thing that Judge Bennett
    said about the consensual plans, there are no consensual
    Chapter 12 plans. That's not exactly true. The creditors have
    the right to object to confirmation. They don't vote, but they
    do object to confirmation. That's what happened in Chapter 12
    cases, they would object. The Chapter 12 trustee then would
    bring the parties together, and most of our Chapter 12 cases
    were consensual plans. They resolved the objection and worked
    out a way that was satisfactory to both the creditor and the
    debtor. So, I just wanted to make that point.
        Senator Whitehouse. Thank you. I think we may go back and
    forth for a while, because I think this is an issue of interest
    to both of us.
        Mr. Mendenhall, let me ask you a specific question about
    your situation. Do you believe that if you had had the
    opportunity to reorganize your business based on the way it was
    going, your customer loyalty, and all that, that you would have
    been able to continue successfully and pay back your creditors
    in full?
        Mr. Mendenhall. Yes. Absolutely. We had the history behind
    us. We had already been in business for over 10 years at the
    time we started the relocation. With the relocation, we had a
    brand-new facility that was almost twice the size of our
    original facility. So, everything was just all the better. So,
    absolutely. We just needed that time to regroup from that
    eviction and that whole process there.
        Senator Whitehouse. And the cost, as you have said, of the
    fact that the system could not accommodate you in that way has
    resulted presumably in fairly significant losses to your
    creditors and having to----
        Mr. Mendenhall. Yes. Absolutely. It totaled over $1
    million. Yes.
        Senator Whitehouse. And in addition, your own credit, your
    own savings, and potentially your own home are also lost.
        Mr. Mendenhall. Yes. Exactly.
        Senator Whitehouse. So, pretty considerable economic
    devastation around you, all for what one might call the want of
    a nail to keep the process supporting your business.
        Mr. Mendenhall. Exactly. Yes.
        Senator Whitehouse. OK. And is that what--I'll ask, I
    guess, Judge Small first. But both you and Counselor Bullock
    referred to the benefits inuring to creditors from moving to a
    Chapter 12-type model. Could you elaborate on what you meant by
    benefits inuring to creditors, and is it Mr. Mendenhall's
    situation?
        Judge Small. I really think there are a lot of benefits to
    creditors, and primarily it makes reorganization easier.
    Reorganization has got to be better where that secured lender
    gets the going concern value of the property rather than a
    liquidation value. If you're looking at those two alternatives,
    liquidation value is always lower than a reorganizational
    value.
        I think the Chapter 12 trustee brings a lot to this
    procedure. I mean, it's monitoring. Unsecured creditors don't
    participate in Chapter 11, small business Chapter 11 cases.
    There's a provision that says there should always be a Chapter
    11 creditors committee. There's never a Chapter 11 creditors
    Committee in small business cases because you can't get the
    interests of the small business--the small businesses that are
    the creditors. You can't get them to vote, even though they
    would support the plan. I'm sure Mr. Bullock can speak to that,
    but it's almost impossible to get creditor participation in
    these small business cases.
        That's why it's so important to have a Chapter 12 trustee
    to monitor, to make recommendations to the court: is this
    business feasible? If it's not, it's not a zombie debtor, we
    get the debtor out of the system. But if there is a chance of
    viability, then you have this trustee monitoring what goes on
    and he monitors after confirmation to make sure the debtor does
    what the debtor has promised to do in that plan.
        Senator Whitehouse. And Mr. Bullock, you represent both
    secured and unsecured creditors. What's your thought on the
    benefits inuring to creditors from reform?
        Mr. Bullock. I'm in agreement with Judge Small, and I'd
    like to make an observation. I enjoyed the material that all of
    the parties submitted to this body. One of the things that I--
    one of the packets that I enjoyed the most was Dr. Mason's.
    Within that, there is a footnote, it's footnote 5, and it
    brings an article from 1989 to our attention called ``Chapter
    12 and Farm Bankruptcy in California.''
        If you take that article, which is really at the height of
    when this family farming crisis was and it was coming to an end
    almost, and you look at Judge Small's material, where there's a
    graph on page 14 which shows, back in that time line we have
    filings up here, and then all of a sudden they taper down
    quickly, I mean, like a bullet, straight down. We have to ask
    ourselves, why? What was it that debtors and creditors were
    doing differently?
        I think what happened is, on page 29 of the article,
    someone played Nostradamus and said one might expect, as more
    information becomes available on the court's interpretation and
    implementation of Chapter 12 regulations, farmers and lenders
    will increasingly turn to privately negotiated reorganizations
    to avoid the administrative costs of a formal bankruptcy
    proceeding. The pattern of filing lends some support to this
    hypothesis.
        I think what happens, and whether it's intended or
    unintended, is if we have a process like this, the reason we're
    not seeing an awful lot of work going on in the bankruptcy
    courts is because the parties figure out, here's what's going
    to happen, here's what should happen, and in Chapter 12 we have
    some evidence that that's what did happen. People starting
    working outside of court rather than in court, and I for one--
    at least I submit to this body--believe that's a better way of
    handling these things. But until we get there, I think this
    Chapter 12 fit works.
        Senator Whitehouse. Judge Small, do you agree with Judge
    Bennett's concerns about the manner in which small business is
    defined, and would you be willing to work to make the
    definition more specific so we're not getting the sort of huge
    cases that he suggested that seem to be a misfit for this
    process?
        Judge Small. Absolutely. The $10 million number was
    somewhat arbitrary. I think it could be lower. I don't think it
    ought to be any lower than $5 million. That was the number that
    the Bankruptcy Review Commission recommended. I, frankly, don't
    know where that number should be. If you overlay $10 million on
    the Administrative Office's statistics, I think it would show
    that like 77 percent of the Chapter 11 cases that were filed
    last year in 2009 would qualify for Chapter 12. Maybe that's
    too high, but I think maybe $5 million or $7.5 million.
    Unfortunately, when the AO collects that information there's a
    big gap: they have $1 million to $10 million. It doesn't draw
    the distinctions between what would happen at $5 million or
    $7.5 million.
        Senator Whitehouse. Senator Sessions.
        Senator Sessions. Well, Dr. Mason, just briefly, anything
    that significant impairs the priority and the security right of
    a secured creditor is likely, is it not, in an economic sense,
    to cause lenders to be less likely to lend to any business and/
    or charge higher interest rates if they do so?
        Dr. Mason. Disentangling that is a little bit tough because
    the value, the reduced value to one set of lenders, for
    instance, does not just disappear economically. It would go to
    another set of lenders or the borrower. That is part of what
    we've seen here in Chapter 12. Some of the problems that have
    arisen in Chapter 12 have arisen because Chapter 12 is
    specifically designed for a unique kind of small business that
    has a single large fixed asset that's an input to production,
    and because of that application, Chapter 12 doesn't exactly
    generalize.
        I think that the discussion we've had here is extremely
    valuable because I think we all agree that some factors of
    Chapter 12 do provide a template, in particular, the speed of
    moving through the process, the certainty.
        Senator Sessions. I'm kind of being self-limited here, but
    as a matter--if you sign a mortgage that gives you a guaranteed
    right upon failure to pay to take the property back, and that
    is eroded significantly through a bankruptcy rule change, does
    that ripple through the system, as some have told us in the
    past, and make lenders more nervous about lending and therefore
    rates could go up for everyone? Is that the economic sense of
    it?
        Dr. Mason. Very much so.
        Senator Sessions. Now, Judge Bennett, do you think that the
    Chapter 12 procedure that's been suggested here, does that
    erode any in any noticeable way the security rights of the
    lender who's got a secured mortgage?
        Judge Bennett. Bankruptcy impacts on security rights
    regardless of the chapter. To the extent that a procedure such
    as Chapter 12 is faster in identifying the failures and the
    successes, it can improve the process. To the extent, though,
    that it pushes through failures that should not be pushed
    through and it is easier in the context of the 13s and the 12s
    because they are so quick to push through failures, you could
    have a negative impact on the collateral value because of delay
    and the stretching out of the creditor during the course of the
    plan if the entity ultimately fails. So the answer is, it
    really depends on the context of the case and the context of
    what's going on, but the answer is, yes, it could.
        Senator Sessions. Well, if you did this through Chapter 11,
    and you've expressed concern about cost and speed, I think
    you're exactly correct--exactly correct--to say, as decisively
    and with as much clarity as possible, the decision needs to be
    made that a company has a chance to succeed or it does not.
    Would you agree, that's a high priority of small business
    reorganization?
        Judge Bennett. I think, big or small, the quicker we
    identify the failures and let them fail, it improves the
    process and it furthers our economic interests.
        Senator Sessions. And so that being the case, do you think
    that could be achieved more with reform of Chapter 11 than
    going to Chapter 12? Obviously you and the National Bankruptcy
    Review Commission apparently feels that way. Specifically, how
    could you make that occur, effectively? Any ideas for specific
    reform?
        Judge Bennett. I think you can adopt portions of what is in
    12 and 13 on timing. I think there needs to be more looking at
    whether it should be consensual, less consensual, or non-
    consensual. The idea that you can object to a plan is
    significantly different than being intimately involved in
    forming a business plan. So, I think you can work with those
    aspects.
        I got paid in private practice to amend statutes. I have
    amended a lot of statutes. It is a huge danger--I mean, I've
    done amendments on Uniform Commercial Code and other areas,
    some of the--a lot of banking-type of legislation in private
    practice.
        What you don't think about when you're drafting these
    amendments is how it interrelates to 15, or 20, or 30, or 40
    other areas because you're focused on what you're doing. That's
    why I have a bias against partial amendments to anything, and
    it's cleaner usually and less dangerous to go in and do
    something new in toto than it is to go in and modify existing
    provisions.
        Senator Sessions. Well, thank you all for your thoughts on
    this.
        Judge Bennett. Senator, could I say one thing?
        Senator Sessions. Yes.
        Judge Bennett. What we've done here today has looked at a
    process where we are absent critical data. If there's nothing
    else that could be done, there is a treasure trove of data that
    can be obtained off of bankruptcy filings if they are complete
    and they are inputted.
        What we need so we don't have discussions on theories and
    ideas is to go in and collect data that is available if it is
    properly inputted and properly designed for retraction by non-
    lawyers. The design ought to be done by non-lawyers and non-
    judges, the people that know what it is we need to extract and
    how to extract it.
        Lawyers and judges can participate, but we would no longer
    have some of what goes on in the discussions of mortgage
    reform, on the BAPSIPA reforms that occurred. A lot of things
    were said that were inaccurate, but you can't prove it other
    than by theory.
        Senator Sessions. Dr. Mason, I see, nods his head to that.
    Well, who would do that?
        Judge Bennett. Who would do what? I'm sorry.
        Senator Sessions. Who would identify what data you need and
    what entity could be involved in retrieval of it?
        Judge Bennett. Well, I think it's mostly in the realm of
    those that deal in economics, that may deal in other areas. I
    think you have to have people that could pinpoint how and what
    it is you want to do. That's really beyond--you know, I'm a
    slow country boy from West Virginia that moved to Alabama, and
    it's beyond my capabilities. But it really is a travesty, a
    major travesty, that we've had the ability for decades to
    accumulate valuable data that would give us insights into a
    whole range of things and we don't do it, and it's something we
    really should do.
        Senator Sessions. Well, I just thank you.
        Senator Whitehouse. Let me just say that when Mountaineers
    starts talking about slow country boys, you'd better watch
    yourself.
        [Laughter.]
        Senator Sessions. I would say this.
        Judge Bennett. Well, I understand that you spent a little
    time in the Mountaineer State, Senator.
        Senator Whitehouse. I did. I did, sir, and I enjoyed it
    immensely.
        Senator Sessions. Just briefly, to raise that point, what
    percentage of the individual bankruptcy filers in the Northern
    District of Alabama filed Chapter 13? Do you recall what that
    number is?
        Judge Bennett. It used to be about 70 percent-plus. In the
    last 5 years, it became about 60/40, and the trend is now going
    back a little bit more for 13s.
        Senator Sessions. And that's quite different than most
    bankruptcy courts around the country. Some are--less than 20
    percent are Chapter 13s, aren't they?
        Senator Whitehouse. Some of the areas are very low Chapter
    13s and high Chapter 7s for individual bankruptcies. Correct.
        Senator Sessions. I guess I'm making the point here, and
    this is driven by the lawyers for the creditors, judges don't
    make them normally going to----
        Judge Bennett. I think it may be, in some instances, driven
    by the debtor's lawyers, not necessarily the creditor's
    lawyers.
        Senator Sessions. Excuse me. I mean the debtor's lawyer.
    The debtor's lawyers. They think that's best for the debtor,
    and the debtor will come out in a better position through that
    mechanism than through Chapter 7. All I'm saying is, that's
    odd. We've got the same law in every district, so there are
    some subtleties in all of this, there's just no doubt about it.
    How we maneuver a deal with the difficulties of bankruptcy
    law--I guess you've all warned us to be careful, Mr. Bullock,
    all the way through, as one that we should be careful about.
        Thank you.
        Senator Whitehouse. Let me offer some closing thoughts as
    our time runs out. The first, is that I would appreciate very
    much, the hearing will stay open for--the record of the hearing
    will stay open for an additional week.
        I read both Dr. Mason's testimony and Judge Bennett's
    testimony as recognizing substantial problems with Chapter 11
    as a vehicle for small businesses that could reorganize but for
    the delay in cost and inefficiency of the Chapter 11 process as
    it presently is constituted, and you have reservations about
    Chapter 12 as a complete and adequate response to that problem,
    but you don't contest that the problem is a real and a
    significant one.
        I would appreciate it if you would take a moment, if you
    would not mind, and put your thoughts in writing back to this
    Committee as to what positive changes you would recommend. It
    doesn't necessarily have to be in legislative-type format--I
    know, Judge Bennett, you've done statutory amendment before--
    but more from a policy point of view what you think are the key
    elements that would help facilitate reorganization of small
    businesses like Mr. Mendenhall's when they are in distress.
        I take it, from everybody's testimony, there seemed to be
    some unanimous opinions. One is that there is a universe of
    small businesses represented here by Edward Mendenhall that are
    reorganizable and that could continue, and continue to employ
    people and be profitable, that Chapter 11 puts under because of
    the cost and the delay and, some would argue, the secured
    creditor-driven nature of Chapter 11.
        I think that's an important universe for us to keep our eye
    on in this process and try to find a way to improve the process
    to serve, and whether it's through Chapter 12 or through a
    modified Chapter 11, however, I think both of our minds are
    very open to that. But I think we're also both keenly
    interested in this problem of unnecessary small business
    failure driven by a Federal process and not by the underlying
    economics of the business.
        So I look forward to continuing to work with all of the
    witnesses as we go forward on this process. I hope that you
    will not object if our staffs continue to be in touch with you
    as we try to work through these issues. I think this is
    important. I think this has been a valuable exploratory hearing
    and I look forward to persevering along these lines.
        I would like to, without objection, ask for Senator Russ
    Feingold of Wisconsin's comments to be added to the record of
    the hearing.
        [The prepared statement of Senator Feingold appears as a
    submission for the record.]
        Senator Whitehouse. I would like to recognize two important
    guests who are with us: Edward Mendenhall's wife Kim is with
    us, and has traveled down from Rhode Island. I'm delighted that
    she is here. And Chuck Bullock's son David has been with us,
    sitting patiently through all of these proceedings, and I
    appreciate that he has taken the trouble to come.
        I look forward to continuing to work with all of you. Judge
    Small, what you and the Bankruptcy Conference have done, I
    think, is enormously valuable. I think that to me your focus on
    this has been commendable and much appreciated, and I think you
    are the core of the solution here and we really look forward to
    working with you as this continues.
        I thank you all for your testimony and your participation
    in the hearing. As I said, the record will remain open for a
    week after this.
        The hearing is adjourned.
        Senator Sessions. Mr. Chairman.
        Senator Whitehouse. Yes?
        Senator Sessions. I was going to offer for the record----
        Senator Whitehouse. The hearing is not adjourned.
        Senator Sessions. Senator Grassley, who has expressed his
    concern about the addition. He says there are now 345 Chapter
    12 filings and 10,000 Chapter 11 filings, so it would have a
    great impact on a Chapter 12 farmer in a bankruptcy proceeding
    that he, as one of the architects--the prime architect--of.
        I would offer the International Council of Shopping
    Centers, who warned that this could have an immediate impact in
    terms of the credit crisis we're in. They have some specific
    concerns about a change like this, how it could cause concern.
    In general, they oppose it. I guess in many ways they are one
    of the more prominent creditors in so many of these cases of
    small business. Thank you. I would offer both of those for the
    record.
        Senator Whitehouse. Both will be accepted into the record,
    particularly Senator Grassley's comments will be accepted with
    great interest because of his long experience in there, as you
    pointed out, as the architect of Chapter 12.
        [The prepared statement of Senator Grassley appears as a
    submission for the record.]
        [The letter from the International Council of Shopping
    Centers appears as a submission for the record.]
        Senator Whitehouse. As I said, I think we're at the
    beginning of a process here in which a great number of
    interests will be engaged, but I am confident that we can find
    a way through, given the universality of you that there is a
    substantial universe of businesses that are reorganizable, that
    fail unnecessarily due to the inefficiency of Chapter 11, and
    that that is something we're in a position to remedy.
        So, thank you all very much.
        We are adjourned.
        [Whereupon, at 11:57 a.m. the Subcommittee was adjourned.]
        [Questions and answers and submissions for the record
    follow.]

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