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New Bill Could Dramatically Shape Bankruptcy Filings

1/28/2018 12:00:00 AM

bankruptcy filings

Two U.S. senators have proposed a new bill that could potentially affect where bankruptcies will be filed in the future. The bill serves as a reminder to American businesses that one swift change can have a dramatic impact on them, their bottom line, and their rights. Although the proposal is focused on venue changes, it could potentially reshape how corporate bankruptcies are primarily filed in this country.

Push for Change

The Commercial Law League of America recently suggested that American lawmakers consider bankruptcy reform that would change the proper venue of such filings. This proposed reform would require a business to file for bankruptcy where its principal place of business resides or where its principal assets are located. The current rule is that a business bankruptcy filing must be maintained where the business is incorporated, where an affiliate is located, or where a significant asset is located.

Elizabeth Warren and John Cornyn supported this plan and proposed a bill that could dramatically effect the venue where bankruptcies are filed.

Possible Effect of New Proposal

Many businesses are incorporated in Delaware. Therefore, many bankruptcy filings have commenced in this state. Due to this commonplace strategy, Delaware is frequently at or near the top of the country’s states for the most annual bankruptcy filings. Some parties with vested interests perceive Delaware to be more favorable to debtors because the state may rely on the incorporated businesses for additional revenues.

The other rules, the affiliate rule, and significant asset rule have allowed companies to file for bankruptcy in other jurisdictions even when the company is incorporated in Delaware. These additional rules have allowed large corporations like GM Motors or Chrysler to file for bankruptcy in states where they do not perform their principal business.

Debtors often choose the site where a bankruptcy is filed, so they will try to select a venue that will give them the most advantages. Favorable corporate and debtor-favorable attributes are important to these filers. Therefore, if venue is restricted, those places that benefit most from the massive bankruptcy filings may be surprisingly affected. In large part, these places include Delaware and the Southern District of New York.

Venue Considerations for Filers

The bankruptcy system is federal. However, every state has its own unique processes. Some states may have procedures that historically favor debtors while others may have more creditor-friendly rules. These differences can have a significant impact on the relief that bankruptcy can provide. For example, a restructuring support agreement may be a powerful tool in one jurisdiction while not given any respect in another. Because debtors mainly get to choose their venue based on the current rules, they often select a state that has precedent in their favor.

Reason for Change

The senators behind the proposed change believe that workers, creditors, and consumers are victims when corporations get to freely select the venue for their bankruptcy case. They have referred to the corporations’ ability to “cherry-pick” as a manipulative tactic to change the system and to get courts that will rule in their favor. They argue that the changes will help curb corporate abuse of the country’s bankruptcy laws and strengthen the bankruptcy system’s integrity. Rather than allowing big businesses to select the court of their choosing, they are seeking to have consumers, small businesses, and creditors to have access to their home court.

Economic Effect

Because Delaware and the Southern District of New York are the primary beneficiaries of the massive bankruptcy filings, other states may encourage change. Bankruptcy filings may bring in professionals from other states along with the economic increase they create. Individuals and governments in other jurisdictions may prefer more filings to occur within their own territories.

Some states have influenced more bankruptcy filings with the passing of standing orders. After oil and gas companies filed bankruptcy petitions in 2015 in Texas that did not have a positive effect on the corporations, more filings were made in Delaware courts. However, when standing orders were issued, this indicated to the organizations that Texas bankruptcy courts were ready to tackle these issues. The ultimate effect was that local Texas firms could become local counsel and be paid for these services. Both the Texas Bankruptcy Bar Association and Texas Hotel & Lodging Association backed the proposed change, potentially due to the economic influx that it could create.

Reaction from the Bankruptcy Bar

Those heavily invested in the bankruptcy rules have long held that forum shopping is merely a myth and that it is not a problem. Others say that allowing officers to exercise their business judgment is their job and something that they should continue to do. Others argue that there is no clear indication that the current rules create any problems.

 

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