New Code Tries To Balance Interests Of Debtors And Creditors

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The intention of the bankruptcy code reformers during the 1970s was to modernize what had become an unwieldy and unresponsive process for both creditors and debtors. It was not unusual under the repealed law for bankruptcy cases to drag on for several years until the debtor eventually had to be liquidated and the unsecured creditors ended up receiving little or nothing.

The revised Bankruptcy Code, which went into effect October 1, 1979, is still too new for an accurate assessment of how well it balances the interests of all parties involved. However, certain provisions of the new Chapter 11 clearly do benefit one side more than the other. Below is a quick summary of several of these changes.

Advantages to debtors

* Under the new code, if a reorganization plan is accepted by a specified majority of each class of creditors and is approved by the bankruptcy judge, that plan is binding on all creditors, even those who may oppose it. Moreover, there are provisions by which a debtor can more easily force an unconsenting creditor to go along with the plan.

* Under the old act, the debtors' ability to use collateral of a secured creditor during the reorganization case was severely limited. Under the new act, a debtor can use collateral in the day-to-day running of his business, including cash collateral such as money or letters of credit, provided he has court approval. The debtor, however, has to prove that the secured creditor is adequately protected while his (the creditor's) assets are being used.

* Under the old Chapter X, a trustee -- whose services were billed to the debtor -- was automatically appointed to oversee the company. Under the new code, a trustee is appointed only if there is evidence of fraud or gross mismanagement or if a creditor can prove that the presence of such an outside manager is warranted for the good of the company and its creditors.

* Under the new code, an automatic stay -- more comprehensive than the one under the old law -- goes into effect immediately and can be lifted only by court order. The stay protects the debtor from lawsuits and seizure of his property, and is designed to give the debtor time to negotiate his reorganization plan without pressure from creditors.

* Under the old act, the jurisdiction of the bankruptcy court was limited; the new code allows the court to handle every dispute arising in relation to the bankruptcy case -- a reform of great benefit to the debtor.

* Under both the old and the new acts, a debtor can recover payments or transfers he made that in effect defrauded himself or preferred one creditor unfairly over others, according to New York attorney Rees Morrison. These "avoiding" powers have been clarified and simplified by the new code. They insure that creditors are fairly treated, but also allow the debtor to increase the size of the bankruptcy estate.

Advantages to creditors

Those provisions of the new code generally agreed to help creditors include the following:

* Under the old act, only the debtor could file a reorganization plan, and there were no requirements that he do so within a specified time period. In some cases, debtors delayed their filings indefinitely as a way of gaining leverage over creditors.

Under the new code, a debtor has 120 days in which to file his plan, and 60 days from that filing to get acceptances from the creditors. If those deadlines pass without extensions, any creditor or third party (such as a stockholder) can then file his own reorganization plan, including one that removes the organization's present management, or one that liquidates the company.

* Under the old act, creditors filing an involuntary petition trying to force a company into bankruptcy had to prove that the debtor had committed a so-called act of bankruptcy, such as fraudulently concealing assets or admitting its insolvency in writing. Under the new code, creditors need only prove that a debtor is generally not paying his debts as they come due. (However, the code also provides strict penalties for creditors who file for an involuntary bankruptcy without adequate reason.)

* Under the new law, the creditor is guaranteed a preliminary hearing within 30 days on its request to have the automatic stay lifted. This prevents a debtor from filing a bankruptcy petition and indefinitely stopping a creditor from foreclosing.

* Under the old law, certain creditors of a business may have had undue influence over a reorganization. The new law, however, provides for the appointment by the court or by the U.S. trustee of one or more representative creditors' committees determined by the size of their claims, and designed to protect the interests of the various creditors.

Verdict still out

Various provisions of the new Chapter 11 remain controversial to the point that some observers already claim the code has failed to meet certain key objectives.

One often-cited objection is the failure of the creditors' committee to supervise the debtor's reorganization plan adequately. "Creditors' committees in small business cases often don't get that involved in working with the debtor," notes David Blaylock, a Memphis attorney. The result is the debtor could end up proposing a plan that favors his interests over that of the creditors.

Les Kirschbaum, head of Mid-Continent Adjustment Co. in Morton Grove, Ill., and a secretary on 10 creditors' committees under the new code, criticizes these committees for being less active than they were under the repealed law. "Creditors' committees often know of creative opportunities but don't follow them through," he says, citing as one example a committee's failure to help arrange for the acquisition of a Chapter 11 company by a larger company known to be interested in expansion.

Others claim the secured lenders in a Chapter 11 case aren't always adequately protected, especially in instances where a bankruptcy judge rules that a debtor can use cash collateral in the operation of the company. Under the new code, states Marvin L. Barman, vice-president of North Carolina National Bank, "secured lenders don't always feel that they are treated properly." For example, many creditors whose security is accounts receivable and inventory object to the court's giving them an equity cushion of real estate as adequate protection.

Despite these criticisms, the new law is generally considered an improvement over its predecessor. "The old Chapter 11 permitted an irresponsible debtor to do some severe damage, and it didn't necessarily help the responsible debtor," says Patrick A. Murphy, a San Francisco bankruptcy attorney. "The new law serves a dual purpose: the rehabilitation of the business and fair treatment of the creditor."