Forum Shopping and Chapter 11

Insofar as laws vary across jurisdictions, certain regions will always be more favorable to some than others; it is no mere coincidence why over half of Fortune 500 companies are incorporated in the state of Delaware.[1] Even holding statute constant, other factors can drastically change the outcome of a case. Take intellectual property law for example: the Eastern District of Texas is known for its speedy litigation process. Many will file patent infringement claims there, knowing that the accused will have a lesser amount of time to prepare an adequate defense strategy when compared to other forums. Distressed debtors too have their favorites when it comes to choosing a venue for bankruptcy. Although the US Bankruptcy Code is identical in all 91 districts, Delaware boasts 35% of all petitions filed for relief since 1980, while Southern District of New York constitutes 18.5%. The third most popular venue: Chicago, with only 3%. [2] This vast disparity has led to an ongoing debate about the rules governing where companies are allowed to file their claims. Most recently, Judge Steven Rhodes, who presided over the landmark Detroit Chapter 9 case, criticized the ABI Commission to Study the Reform of Chapter 11 for refusing to recommend changes to the venue rules for Chapter 11 cases. Still, many have claimed that the constant cries for reform is much ado about nothing. This essay will evaluate on what grounds reform is being called for, but also show why it is likely that the present rules are here to stay.

Chapter 11 of the US Bankruptcy Code is the most well developed insolvency regime in the world for helping troubled companies restructure their affairs. [3] The language and terms of bankruptcy codes of other nations are enough to instill fear in any company facing financial distress. Historically, Canada’s Companies’ Creditors Arrangement Act featured what was called the “Guillotine Rule”, which afforded the bankrupt company’s management only one chance to present a plan of reorganization. If the plan were not approved or submitted in a timely fashion, the firm would be liquidated.[4] In 1998, Russia enacted a new bankruptcy law that allows a company with as little as $5,000 in debts to be subject to a hostile takeover if late in its payments by three months.[5] In some nations, company management is legally obligated to suspend business operations during periods of insolvency and can be held personally, and sometimes criminally, responsible if the business continues to operate.[6] Not all codes feature consequences as severe as the ones I have mentioned when compared to US Chapter 11, but no other system is as commercially oriented as Chapter 11 either.[7]

The wide latitude granted to domestic companies in selecting a district in which to file is even a smaller slice of what the Chapter 11 process allows. While an enterprise need not have its headquarters, significant assets or employees in the US, each entity seeking Chapter 11 protection must have property in the United States. Property, loosely defined, can be as little as a bank account with only $100.[8] And so many foreign enterprises with little to no operations within the US are able to engage in balance sheet restructurings with the help of the US Bankruptcy Code. On one hand, foreign companies are merely taking advantage of the opportunity presented to them. On the other, the requirements are indubitably lax. Such is why Judge Rhodes argues the law should be changed to require that a Chapter 11 case must be filed either in the district of the debtor’s principal place of business or assets, or in the district where an affiliate has filed for bankruptcy relief when the affiliate owns a majority of the debtor’s voting shares.[9]

The goal of restricting venue selection in bankruptcy is to safeguard creditors from the debtor’s “unfair or inconvenient” venue choice. Fairness and convenience are the same conditions that govern civil procedure. Bankruptcy proceedings involve extensive involvement on behalf of various creditor committees; so Rhodes argues that venue shopping adversely affects certain creditors’ ability to participate. However, the Bankruptcy Code allows for the venue transfers when the initially chosen forum does not serve the interests of justice, although bankruptcy judges rarely grant motions to transfer. This fact is often cited by reform advocates, but is likely more reflective of the fact that any district is fully capable of promoting the reorganization efforts of whichever cases are filed there than suggestive of any degree of tyranny.

Still, Rhodes claims it is unreasonable to say that a debtor based in Fairbanks, Alaska, with a collective bargaining agreement with its union in Fairbanks, ought to be able to reject that agreement determined under Second Circuit case law simply because it is incorporated in New York or has a subsidiary that filed there first. Not only does this argument undermine the complex composition of claimholders, of which labor agreements are one of many, including retirees, trade creditors, lenders and shareholders, and their representatives, but the connection between the principal place of business and the residence of debt holders is often too weak to begin with, especially in the case of large multinational corporations. Shareholders will be spread across multiple jurisdictions,[10] and so claims about the diminution of the adjudicative process fall short. Given the global nature of our economy, there is usually not one location where a company “should” file its petitions.[11] No single venue location will be the most convenient for all of the many parties involved. One suggested remedy is to allow a debtor to expense creditor travel to the estate. But administrative expenses related to the bankruptcy case take priority over all over claims in the process; so to do so would only cut away at claimholder recovery anyway.

Advocates of venue reform seem to have lost sight of the fact that allowing the debtor a wide choice of venue can benefit the firm, its creditors, and the economy. The goal of chapter 11 is to reorganize businesses, maximizing the return to stakeholders while providing due process to associated parties.[12] Managers and shareholders alike prefer the company to move through bankruptcy as quickly and efficiently as possible.[13] A longer process means a more expensive one. Judges who handle complex cases regularly will frequently see some of the same issues and will act more intelligently than if the issue is foreign to them. Additionally, attorneys with depth of experience with a particular district or judge can better predict the path of the bankruptcy. Law firms often maintain elaborate charts detailing the conflicting rulings of particular districts on issues concerning clients. Attorneys and judges alike will only get better with practice, and with so many of the largest corporate bankruptcy cases heard in Wilmington, Delaware and the Southern District of New York, both are more likely to be at their best.[14]

A plan of reorganization in Chapter 11 may only be approved if it is deemed fair and feasible. The fairness condition refers to compliance with the rule of absolute priority. This states that no claimholder receives any recovery until all more senior claimholders are paid in full. The feasibility condition means once the plan is approved, the business is unlikely to require liquidation or reorganization in the future. That is, if the plan is successful, the company will not face the same excessive debt burdens going forward that may have caused the distress in the first place. Repeat reorganizations are cleverly referred to as Chapter 22 cases, and typically result from the company retaining too much leverage post-bankruptcy. Investors and lenders concerned with preserving the value of their claims in the present may only be prolonging a more drastic loss unless the proper measures are taken to rid the struggling company of a sufficient amount of its debt load. Maybe lenders and investors will come around to the fact that the risk they bear is in fact real risk of loss of principal in the bad times, not just paper risk that offers a higher return in the good times. Or maybe we can allow managers to abide by the rule that governs them most broadly in their role: namely, sound business judgment. And deciding where to file based on what district might maximize enterprise value, reduce execution risk, and ensure a successful recovery as a result of experienced courts and judges sounds like good business judgment to me.

  1. Lewis S. Black, Why Corporations Choose Delaware, 2007.  ↩

  2. Sara Randazzo, It’s Delaware’s World; We’re All Just Living in It, 2015  ↩

  3. Mark S. Chehi, Jay M. Goffman, Chris Mallon and Mark A. McDermott, Skadden Arps Slate Meagher & Flom LLP, Non-US Cos. Can Effectively Restructure Using Ch. 11, 2014.  ↩

  4. Stuart Gilson, Creating Value through Corporate Restructuring, 2001.  ↩

  5. Patrick A. Gaughan, Mergers, Acquisitions and Corporate Restructurings, 2007.  ↩

  6. Supra note 3.  ↩

  7. Supra note 3.  ↩

  8. Supra note 3.  ↩

  9. Steven Rhodes, The Baffling Rejection of Venue Reform by the ABI Chapter 11 Reform Commission, 2015.  ↩

  10. Marshal Huebner, Laws Permit Cost-Effective and Convenient Forum Selection, 2015.  ↩

  11. Id.  ↩

  12. Jay Goffman, Current Venue Laws are Appropriate, 2015.  ↩

  13. Mark Roe, Venue Choice Has Pros and Cons but Shouldn’t Be Reformed, 2015.  ↩

  14. Id.  ↩