[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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