ABI Commission to Study the Reform of Chapter 11

October 8, 2013 Field Hearing

Santa Fe, N.M.

Transcript of Proceedings

Keach: Welcome. I am Bob Keach. I’m one of the co-chairs of the ABI Commission to Study the Reform Chapter 11. First, I want to thank the NAAG and the SABA conference for hosting the hearing and specifically to Karen [Cordry] for assisting in the identification and the coordination with all of today’s witnesses. We’re going to hear from a number of witnesses presenters today on a number of topics of importance to state governments including regulatory authority and its interface with the Bankruptcy Code, sales of estate property, taxes, workers compensation, section 525 issues, national admission of attorneys general and others, committee membership -- an issue that I’m going through right now actually in my railroad case -- enforcement of judgment and orders, among other topics.

I’d like to begin with some brief remarks about the mission of the Commission and its activities to date as well as about today’s what we call field hearing. Then we’ll hear from the witnesses one at a time and there’ll be inquiries from the commissioners. Before we get started, first Mr. Klee’s plane I gather has just landed. He’ll be rushing into this hearing room momentarily.

I want to pass along the regrets of Co-chair Al Togut whose father passed away recently and therefore Al had to stay in New York to deal with funeral arrangements and other issues. Also Geoff Berman, a Commissioner who’s unexpectedly dealing with some health issues of his own that don’t permit him to travel right now. They regret that they can’t be here and they wanted me to pass along those regrets.

Why the need for Chapter 11 reform or business bankruptcy reform in general and why now? Briefly it’s been over 30 years since the current Bankruptcy Code was enacted, something new and dear to my heart because it roughly tracks my personal career. A consensus has emerged that the current law needs an overhaul. The 1978 Bankruptcy Code has been amended in numerous occasions has served us very well for those 30 years.

Some would contend that the original 1978 Code offered a balance between creditor and debtor interests establishing what was often referred to as a level playing field for restructurings. When first enacted, supporters of the

1978 Code argued that it served the interest of all those impacted by a debtor in distress including employees, the surrounding community, the public interest, creditor interest, but did so in a flexible way that balanced those interests while meeting the debtor’s goal of succeeding in saving its business.

Others, it is fair to say, did not see the balance. Detractors contended that the 1978 code was too debtor friendly, that it led to long and inefficient cases, and it provided too much discretion to bankruptcy judges. To the extent that the Code was amended after 1978, and it was, of course, amended on a number of occasions, the detractors largely prevailed in legislative battles.

For better or worse, most of the changes to the Bankruptcy Code since 1978 have (a) exempted categories of claimants or transactions from the reach of bankruptcy law; (b) added additional categories of administrative or priority claims, thus arguably burdening the already strained liquidity of distressed companies; (c) limited or eliminated the discretion of the courts and administering Chapter 11 cases; and (d) provided for shorter time periods and faster, more-truncated cases.

Supporters of the original 1978 Code contend that many changes to the Code throughout the years have not helped further the goal of restructuring or have had unintended consequences. However arguing about who won or lost in terms of the recent history of the Code or the amendments of the Code is we think, at this juncture, largely beside the point. Primarily, the world, including the financial environment and the operation of the market simply changed and the Code even as amended was not designed to deal with these changes. For the most part, we believe a series of external factors drive the need for rethinking Chapter 11.

There are few things in particular. Since the Code’s enactment, there has been a marked increase in the use of secured credit, placing secured debt at all levels of a debtor’s capital structure. Many of the 1978 Code's provisions assume the presence of net asset value above the secured debt -- asset value that you all know is not present in many of today’s Chapter 11 cases. These debt and capital structures are more complex, with multiple levels of secured and unsecured debt often governed by equally complex inter-creditor arrangements.

We don’t point this out to say that there’s anything wrong with the growth of collateralized debt per se. Indeed, that growth brought credit to many companies who could not have obtained it otherwise. However, the 1978 Code’s baseline assumption of value above the amount of liens on assets was challenged if not completely cast asunder. Another huge development is the growth of distressed debt markets and claims trading.

In fact they were not present when the ‘78 Code was enacted and are factors which challenge many premises underlying the 1978 Code. Again in many ways, this development was a net positive offering creditors a means of monetizing their claims, rather than waiting the case. However, the 1978 Code clearly did not envision some of the collateral consequences that result from an active distressed debt market.

Another significant development is that today’s companies are different and you all I’m sure see this. They’re less dependent on hard assets such as real estate, machinery, equipment, and inventory, and more dependent on contracts and intellectual property as principal assets. The Code simply doesn’t provide for the efficient treatment of these assets and their affected counterparties. Today’s typical debtor or even small debtors like many of the companies we see in the Northeast have multinational if not multistate enterprises bringing international law and choice of law to bear.

The way that the courts have talked about the purpose of Chapter 11 over the years has also changed. Early on the 1978 Code focused on its importance in saving jobs and preserving the tax base that might exist in a particular state or particular community by preserving that business and those are the predominant factors.

Over time, the courts and the practitioners began to talk about maximizing the value for all stakeholders as an equally important if competing value. If you look at the way courts now talk about the purposes of the Code, there’s a far greater focus on the maximization of value than there might be on the preservation of jobs or tax bases or a factory staying in a particular community. In light of all that, what is it we’re doing and how are we doing it? First, we did spend a lot of time actually thinking about this and after about three or four or five hours of debate, adopted this mission statement.

You can see it on the screen, and it is: “in light of the expansion of the use of secured credit, the growth of distressed debt markets and other externalities that have affected the effectiveness of the current bankruptcy Code, the commission will study and propose reforms of Chapter 11 and related statutory provisions that will better balance the goals of effectuating the effective reorganization of business debtors with the attendant preservation and expansion of jobs and the maximization and realization of asset values for all creditors and stakeholders.”

That’s a mouthful with a lot of negative pregnants and we’ll get to all of those. We have found that simply mentioning that you want to look at issues arising out of secured debt will get your attention. Certainly we’ve been happy beneficiaries of that attention. Almost two years ago, then-President Geoff Berman, asked us to, asked Al Togut and I, to assist him in putting together a working group of the best and brightest among Chapter 11

practitioners, academics, bankers and including members of congress to study bankruptcy reforms. With the Commission, we think we’ve at least come close to that aspiration.

The Commission members, you can see on the screen. They’re listed on my printed opening remarks. I won’t bother to introduce them all, but I think everybody would agree that it’s a select group from amongst some very experienced bankruptcy practitioners and jurists as well as members of the financial community. The commission is assisted by our reporter Prof. Michelle Harner.

Michelle is a professor of law and co-director of the business law program at the University of Maryland Francis King Carey School of law. She is overseeing the work of our advisory committees, critical research assistant. She records our deliberations and she will be spending a lot of time by helping us write the final work product. I would be remiss if I didn’t mention that the work of the Commission is underwritten by the ABI Anthony H.N. Schnelling Endowment Fund and the ABI.

I would be equally remiss if I didn’t mention the tireless work of the gentleman to my left, ABI Executive Director, Sam Gerdano.

One of the first things we did was appoint a series of advisory committees after we selected a series of topics for study. We now have over 150 people working on 13 different advisory committees generating reports on what appears to us sometimes to be an infinite series of topics. I’ll go through quickly what these general topic areas are, but you’ll quickly see that they each could spawn six or eight or 10 or more subtopics.

We are looking carefully at governance and supervision of Chapter 11 cases and companies that deals with trustees, committees, the membership of which we’re going to talk about today, multiple enterprise cases and issues, financial contracts, derivatives and safe harbors, obviously something that we’ve all struggled with, executory contracts and leases, the administrative claim expansion, critical vendors and other pressures on liquidity, labor and benefits, avoiding powers, sales, including sales of potentially all the assets, plan issues, both procedural and plan issues distributional, bankruptcy remote entities, bankruptcy proofing and public policy and evaluation.

How we’ve gone about doing this work? I won’t get into specific details of how many we’ve held or what we’re going to do but we’ve held this series of field hearings. I think we held seven if I’m not mistaken this year. We’re going to be holding … we’ve held seven already this year and we’re going to do at least three, more maybe four, more. You see three scheduled already on the screen.

We’re going to go into a whole series of topics. I would note that at the Westbrook conference in Austin, Texas, we are finally going to get to the topic that we intentionally put off to the end, because we knew if we talk about it first we’d never talk about anything else which is venue Chapter 11 cases. We will be having I’m sure a spirited discussion of venue that day. In today’s hearing as I said we’re going to talk about a number of issues I hope of importance to all of you and I appreciate all of you coming.

I think outside of the plenary session at the annual spring meeting of the ABI, this is one of the largest crowds we’ve had and we appreciate your attention. Bankruptcy policy and policies critical to state governments I’ve said in my remarks, written remarks are often concordant. We do get along sometimes.

However, there are obviously times when friction occurs in areas of enforcement of the police powers or the priority of environmental tax or other claims. I could mention a few examples. To the extent possible and consistent with our mission statement, reform should look for ways to reduce those points of friction between bankruptcy policy and legitimate state interests.

This hearing is beginning of that effort. With that we’ll start by introducing the eminent Karen Cordry who is going to be our first presenter. The way this will work is there’ll be a presentation by the witness. We’ll then have the panel ask questions and then we’ll move on to the next victim after that and we’ll ask him questions. I do want to make one very important point and that is because this is at time’s been misconstrued intentionally or otherwise.

Questions are not positions of the commission. If we ask a question, even if it seems particularly prosecutorial when we ask it, it’s really not a position of the commission or reflective of a position. We really are just trying to get information at the test ideas and I hope you’ll all be patient with us as we do that. Karen, thank you.

Cordry: Thank you. I would very much like to thank Sam for scheduling this Commission hearing here. I looked at the Commission discussions when they were first coming up and I said I don’t really see enough government issues in here. He said we’re open to everything. He came back and suggested we should try to schedule the hearing with our conference. That’s what we’re doing here. I want to thank you all for coming as well. I know you’re all very busy and Bob, you’re trying to save that railroad that blew up the town and a few things like that.

In presenting these statements today, I would note that this is not only a hearing before the Commission, but it’s also an integral part of our seminar that we’re holding. We have a number of people here who are very experienced bankruptcy counsel. We also have a number of real novices. We

are going to try when we put some of these issues up to also use it as part of the teaching experience for them.

There may be some things that we say that I’m quite sure that you’re well aware of, for instance the definition of claims and so forth. We’re trying to run this at all levels for both the groups. Sometimes it also helps to go back to the beginning and really start with the words of the Code and so forth. I note your point about the questions to the commission. I would make somewhat the same point which is that the persons speaking here are presenting topics, outlining issues, trying to put some disputes up into the record. and put them out as part of the deliberations of the commissions going to take.

None of these are official positions of their office. None of these are official positions of NAAG. This may not be quite a “Great Debate” position where we’re told that we’re expected to be deliberately provocative, but there may be occasionally that some of these things are just put up for discussion purposes. We would certainly welcome feedback from the commission and other discussions before people try to settle on what a final resolution is of these issues. We think we are highlighting some issues that have been of concern for government council and we think are of concern to debtors as well.

Keach: We welcome provocation of all kinds.

Cordry: Great.

Keach: As long as we can reciprocate then we’re fine.

Cordry: That sounds fine. I would offer just a short introductory piece here, that I think government's primary concern often in bankruptcy cases is the degree to which they feel that bankruptcy is this sealed little environment; that it works to deal with debtors and perhaps secondarily creditors and perhaps mostly secured creditors, but with much less sense than in the old days that the decision is going to affect other parties, non-secured creditors, employees, the community, competitors of the debtor.

Government often feels this way most acutely when they’ve been chasing what we often may call the “black hat” defendant, the crook, the criminal, the fraud defendant and we’ve gotten really close. We’ve nailed them down. Maybe we’ve got an injunction. We’re just about to put them out of business and the person files bankruptcy. We get the feeling and, I think accurately sometimes, that simply by going into bankruptcy, the person has now stopped being a defendant and has become a debtor. All debtors are automatically poor, but honest.

We spend the first part of a number of months in some cases trying to get past the point that just because you’re broke doesn’t necessarily mean you’re a good guy. One of the concerns we have here is trying to make sure that we can actually get the protections that the Code actually writes in to protect government actions.

We do try to make sure that we can exercise those actions and continue to protect the public in the cases where the debtor is not a poor but honest debtor. On the other hand I do spend a lot of time at these conferences pointing out to people that our view is sometimes a little jaundiced because we see a fairly small selection of all of the debtors that come before the bankruptcy courts. The fact that most debtors are poor but honest does give the court a view as to how to look at the cases before them.

What we see here is that even though as I said there are many places where the Code protects governmental regulatory interest, there are some places where we now have been seeing over the years ambiguities in language, unforeseen scenarios, places where the debtors have found some ability to evade compliance with the law. Sometimes we’re left to rely on generalized provisions such as “good faith” and “prevention of abuse” to protect our legitimate regulatory interests.

We are concerned because those are often fairly weak reeds to really try to rely on, particularly when you have a number of cases coming out from courts saying “If you do what the Code allows you to do, it must be in good faith.” We are surprised at those holdings because there’s many areas of the law where there are sham transactions and recognition that just because you were doing what the literal letter of the law says, doesn’t necessarily mean you’re in good faith.

Sometimes that seems to get lost in the translation in the Code, which means in those cases we would like to come back and actually try to make the Code say what people think it’s going to do. I.e., where judges often tell us, “don’t worry, we’ll take care of this based on good faith and so forth,” we’d actually prefer to have a little more clarity in the law in some of those issues.

In this segment, we’ve got a number of recurring issues that come up. You’ve seen the topics. We’ve provided you with some advance information and we’re going to try to go through those and talk about them in a little more detail. We’d love to get your feedback on those as we go along and see what you think about our positions. To keep those rolling along, let me pull up the first session here.

I took a really narrow topic called “Protecting Governmental Regulatory Powers in Bankruptcy.” I thought that would be pretty focused and wouldn’t

have too much to deal with it and we wouldn’t have any problems getting through that.

Keach: Not a loaded topic at all.

Cordry: Some of this is governmental issues. Actually some of this first part here is not always just governmental. Some of these issues affect the government but they also can affect others as well. I’m going to start with a really simple topic which is, “let’s rethink the entire basis of what is a claim.” The definition has not been changed since 1978. It’s pretty simple. It only has 71 words when I counted them up and it only really states two basic propositions. A claim is a right to payment. A claim is a right to an equitable remedy for a breach of performance if such breach gives rise to a right to payment.

We basically have two kinds of rights to payment and all of the rest of that whole description of a claim is just a bunch of descriptive adjectives that enlarge what those two rights to payment are. If you’re going to try read those rights narrowly, all those adjectives say “no, read them as broadly as you possibly can.”

I always tell people when I’m doing my training session that claims essentially has two axes. One is chronological” “When are the facts sufficiently developed that you have some right against the debtor? When it is sufficiently choate that if you don’t assert it in the bankruptcy case it’s going to be discharged?”

The other really perpendicular axis is remedial. What kinds of relief, what kinds of remedy does a party have? Which are these monetary rights to payment that are going to be subject to discharge and which are non-monetary? What are injunctive rights whose exercise cannot be precluded by the discharge?

One of the problems of course in dealing with any of these issues is if you read the bankruptcy claims code’s definition of a claim, it pretty much sweeps everything in the world under its coverage, which raises really serious Fifth Amendment issues about how can you really bring that broad of a definition of “right to payment” into any judicial system.

I don’t think it’s really a coincidence here. When I read Chateaugay,1 I said this reminds me of something. I went back and reminded myself of what it is. I don’t believe it’s by accident that the court in the Chateaugay case took the example of a company that builds bridges. I think somebody there had read The Bridge of San Luis Rey and was thinking to themselves about why did those people end up on that bridge? How do they get there?

1 In re Chateaugay Corp., 944 F.2d 997, 1003 (2nd Cir. 1991).

When they died, why were they the ones who died and not anyone else because Chateaugay talks about a company that builds bridges and of the 10,000 bridges it builds, one’s going to fall down and cause death. Is there a claim on behalf for those 10 people who will be killed? Who knows which bridge? Who knows which 10 people? Who knows when? How can we possibly determine what to do with those potential rights?

Yet if you read the definition of a claim, if it just simply depends on the prepetition negligence of the debtor who built that bridge and if that’s all it takes to have that person who dies eventually now immediately has a claim when the bankruptcy is filed, as the Second Circuit said, there’s enormous practical and perhaps constitutional problems from recognition of such a claim because sheer fortuity will determine who will be on that bridge when it crashes.

What the court was trying to do in Chateaugay was to try to find some line of division between that idea of “everything until the end of time is a claim” and the other much more simple “I ran into you with my car and knocked you down and now your leg is broken and I filed bankruptcy because you’re filing a lawsuit against me.” The problem here is how do you identify who are the persons who are going to suffer the consequences from the debtor’s action at the point when a bar date is imposed?

Again it’s not really a question what the words of the Code says, but it’s a question of whether those words can pass Constitutional muster. I wouldn’t want to remind anybody of a sore subject like Stern v. Marshall, but the point being “yes, we can read what the Code says, but sometimes the Code is unconstitutional. You have to reel it back and bring it into something that is potentially consistent with the Fifth Amendment and due process rights.

These issues have come up since the very beginning of the Code and also in outside litigation as well. There was quite a bit of litigation in the early 1990s that really addressed the number of these issues and came up with a lot of results. Those seemed to have somewhat disappeared back into the background and we’re now coming back to some of those issues again, but without necessarily seeming to really remember the old case law.

In looking at these issues about “future claims” which is the way they used to be described, that title that came up with them came up in the context of asbestos cases, but certainly not only asbestos cases. In reading all the cases I basically, it seemed to me, could identify three paradigms. First, a defective product that was external to the body, a plane, a bridge, a forklift, building materials that failed, concrete pipes that leaked and so forth.

Second category: a defective product that was taken into the body: the asbestos, the Dalkon Shield, or the sponge left in the body after an operation.

You’ve been exposed to the injurious element. You’ve had the contact with it but it has not actually caused any harm yet or you don’t know that it’s caused the harm or you don’t even know that you have it, but it’s there. It could be said to be present but it has not become manifest in a way that you can really deal with it in terms of reacting to it.

The third kind is environmental contamination issues which are a lot like the second case, but instead of a person’s mother being contaminated with some kind of toxic product it’s Mother Earth. Same problem, when do you know about this in terms of being able to do something with it?

The issues that arise from all this are how can you give meaningful notice to the person to allow them to do something? Assuming you can even identify the victims, what notice is due? These cases I cited here are a whole collection that came out as I say in the middle 1990s.2 There were some efforts. both with the bankruptcy courts in which a number of cases were brought, but also outside of bankruptcy. There were attempts to do some very sweeping settlements to deal with asbestos litigation through mandatory class actions and limited funds that looked a whole lot like a bankruptcy case but weren’t a bankruptcy case.

The amount of notice that was given in those cases was simply extraordinary. There was newspaper advertising. There was TV advertising. There was notice through every union. There was mailed out notice. It was an extraordinary effort to give notice. When it went up to the courts, although the actual final resolution of these cases did not necessarily turn specifically on the lack of notice or the degree to which the notice would serve to bind parties, both the Third Circuit and the Supreme Court expressed grave doubts about whether trying to give notice to someone who is not yet actually manifesting an illness, whether that really could ever satisfy the ability to give the person the capacity to do something.

As I say, “could it ever be given to legions so unselfconscious and amorphous?” “Okay, you tell me that asbestos is here and you might have even been exposed to it, but if nothing is happening, if I’m fine, what am I supposed to do with that notice?” That brings up the corollary problem. If, in fact, the person wanted to try to file a claim in a bankruptcy case if you gave this notice, what is the court supposed to do with it?

If I gave notice to every single purchaser of a defective product and told them okay, you can file claims, what do I do then? There’s a case we’re going to get to in just a moment which was Owens Corning which makes fiber glass

2 Georgine v. Amchem Prods., 83 F.3d 610, 617, 620 (3rd Cir. 1996); Anchem Prods. v. Windsor, 521 U.S. 591 (1997); Ortiz v. Fibreboard Corp., 527 U.S. 815 (1997). “[W]e recognize the gravity of the question whether class action notice sufficient under the Constitution and Rule 23 could ever be given to legions so unselfconscious and amorphous.” Anchem, 521 U.S. at 628

shingles. Owens tells every single shingle purchaser, those shingles might be defective. So, they’re on my roof. My roof is fine. It’s not leaking, nothing is happening. If I came into the bankruptcy court and said I want to file a claim about my shingles, what is my claim? What are my damages? What is the court supposed to find in terms of liability? How is it supposed to come up with some award of money to be paid to me? That’s really one of these problems with these future claims. I know this has been talked about under the Code and forests of trees have died to provide paper to discuss this, but no one’s ever really gotten as far as actually trying to do anything in terms of writing the Code to put anything in here to really resolve these issues.

Here are some cases that have been recently decided. The Jeld-Wen case,3 when the Third Circuit finally decided to join the rest of the fold and say that “Okay, all right, if it is a matter of pre-petition negligence, we are going to find product liability, we’re going to find that it’s a claim, but they explicitly said we’re not deciding if that claim is discharged precisely because of some of these due process issues.

And, in turn, the due process issues you may get to are very well illustrated by these other two cases. The Owens Corning case, they had the usual “oh yes, we’re going to recognize our product warranties all the way during the case,”4 but then when they got the confirmation, the order said we’ll recognize them if we want to. They weren’t required to recognize them afterwards and, of course, they then stopped recognizing a number of them if they didn’t like the liabilities that might have been incurred thereunder. These buyers bought their shingles, one of them before the case was ever filed, one of them long after the bar date, but before confirmation. The shingles in both cases didn’t fail until two years after the plan was confirmed and the court held they’re both bound by the discharge. They should have somehow filed a plain for shingles that had no problems whatsoever at the time of the bar date, at the time of confirmation.

In Placid Oil,5 an employee’s wife died of mesothelioma 15 years after a plan was confirmed for a company that filed bankruptcy for reasons that had nothing to do with asbestos. There was no provision made for future asbestos claims because in fact none had occurred at the time and actually none until this employee’s wife died 15 years later. The resolution was that it was too speculative for the company to have to give notice about asbestos, but it wasn’t too speculative for the employee to somehow foreseen that he should be filing a claim for the death of his wife 15 years after the bankruptcy cases ended.

3 JeldWen, Inc. v. Van Brunt (In re Grossman’s), 607 F.3d 114 (3rd Cir. 2010) (en banc).4 Wright v. Owens Corning, 450 B.R. 541 (W.D. Penn. 2011).5 In re Placid Oil Company (Placid Oil Company v. Williams), 450 B.R. 606 (Bankr. N.D. Tex. 2011)

This is the problem with the definition of a claim that looks to the question of what did the debtor do and says that somehow that would be sufficient to make everything a claim. A couple of thoughts, what can you do with this problem? Some courts have looked to narrowing the definition of a claim itself, trying to at least make sure that there’s some sort of pre-petition, pre-confirmation relationship between the debtor and the claimant, but is even that enough as we come back to seeing in the the Jeld-Wen case, and the Owens Corning, and Wright cases.

In all of them, there was some relationship, but is mere ownership of a defective product enough? Particularly, in the context of the cases where it’s the external product, the forklift, the plane and so forth? The answer is generally been “no, it’s not enough that you simply owned the product or had some exposure to it.”

There’s the “fair contemplation” test, the Natural Gypsum test,6 but again is it what the debtor contemplates? It is what the creditor is contemplating in terms of a problem? Or both parties? In the environmental context, there’s been the definition that’s come out as early as 1992 in this Chicago Milwaukee case,7 essentially, that an environmental claim arises when a potential claimant can tie the bankruptcy debtor to a known release of a hazardous substance, which has got a lot to be said for it in terms of analogizing that approach in other contexts.

The other way to come at it is from the other direction, in terms of narrowing the discharge definition. It looks at “okay, there’s a claim, but there are constitutional dimensions that will limit the discharge.” The Fairchild Aircraft case basically said “you can only discharge these claims if they are recognized and dealt with in the case in some fashion.”8 If you don’t deal with them, you’re essentially saying let them flow through. You have all the cases, especially with these external product cases again the aircraft, the forklift, the defective pipes in Fogel that generally say that until there’s an actual injury, you don’t have a discharge.9

As I say you can start with it from either end. It might be simpler to deal with it from the discharge side because then you look at it as akin to a statute of limitations provision; i.e., what happens with your cause of for the classic “sponge left in the operating wound.” Of course you, in a sense, have a cause of action from the minute that happens, but we usually don’t start the statute of limitations running until you could have reasonably discovered your injury and the causation thereof.

6 In re National Gypsum Co., 139 B.R. 397 (N.D. Tex. 1992). 7 In re Chicago, Milwaukee, St. Paul & Pac. R.R. Co., 974 F.2d 775, 786 (7th Cir. 1992).8 In re Fairchild Aircraft Corporation, 184 B.R. 910 (Bankr. W.D. Tex. 1995).9 Fogel v. Zell, 221 F.3d 955 (7th Cir. 2000).

Coming back with this concept of tying the debtor to a known release of a hazardous substance could be a good starting point for a discharge. You’re looking at, “is there an actual injury i.e. the known release? Is it known, like what’s the knowledge of the injury? And is there a knowledge of the debtor’s relationship to the injury that has occurred?

One point of course in all this is that you also want to distinguish reorganization from liquidation cases because when you’re reorganizing, you obviously want to continue to cover these claims and give them some more of the “float through” capacity. If you’re liquidating, you’ve got to get in as much as you can into the process or it’s gone. Just a couple other points here …

Butler: Can we stop there for a moment?

Cordry: Yes, sure.

Butler: I’d like to take a step back because there are lots of potential solutions to these issues. I want to go back and explore from, why is there an issue and what is the issue? What’s the harm and what’s the interest of the state in trying to deal with this? What interest is the state regulator, as a state attorney general as someone who has a state interest, what’s the state interest that we’re looking to protect?

Cordry: Certainly on the environment side, this continues to be a question that comes up all the time from the point where if you take the claim definition at its broadest capacity, if you buy a hazardous substance and it’s sitting in your warehouse, there’s a theoretical possibility that it could get spilled, go on the ground, get into the groundwater and so forth all the way to the point where somebody died from drinking that contaminated water.

I always get as a question, “where in that continuum do I have a claim?” One of the things I say is, “it’s really hard to tell and hopefully that Milwaukee case is a good test, but at the very least I say, if you know enough to worry about it, you probably have a claim.” Maybe that’s a good rule of thumb, but the states really never know precisely where they can say what they have to do and what they have to know. That’s one piece of it.

Keach: Karen, let’s break that one into pieces too because on the one hand you’ve got the interest of the state as the regulator and as the entity responsible for cleanup in the last resort. That’s a set of interests. It’s possible that the state as an entity in both of those capacities would become aware of the problem sooner than another class of claimants.

I think that’s the one concern that those are the people you’re just referring to, which is the people who may have their property or their health affected

by an unknown discharge or migration of waste that occurs or that manifests itself sometime later. I assume in the latter instance the state’s interest is in protecting the ability of those people to either make claims or not have their claims discharged if they’re not aware that they have claims to assert.

Cordry: You certainly have the general parens patriae view of the state in terms of both environmental issues, consumer protection issues, all of these matters in terms of being concerned about these things for their citizens. It’s really difficult to tell; the state might know sooner if they have some reporting regulations or if they’re out there making regular inspections.

On the other hand, if I live next to a facility and I see the green ooze coming across the ground from the tank, the holding tank as it overflows, I may know about that and the state may have no idea that it’s existing, but in both cases the question is, what do we know, when did we know it, how do we know these things, and when should that be used to cut off our rights?

Certainly all these other issues as well. The Fogel vs Zell case,10 I think it was a city that owned the pipe, it can buy defective products like anyone else and again the question is what should have to be shown to determine that they have a claim in that matter.

Keach: Why should it be any different than for any other party?

Cordry: I’m not asking for it to be any different. My concern here is exactly what the question is of when does any party know that it has a claim? When can any party be held to have to file something in a bankruptcy case on pains of having a inchoate matter discharged that has not really come to any manifested injury yet?

Keach: Karen, my sense is I certainly saw, you certainly see this in GM and Chrysler, the struggle. I think they’re also seen in a batch of the subsequent cases. I think you certainly saw that in the Third Circuit’s attempts around this which is it seems to me that there’s a trend that it’s towards what you were talking about which is, “recognize the very broad definition of claims so that bankruptcy cases are not left with affording partial relief essentially, but also recognize that there are due process limits to notice.”

I think it was, I know Judge Gerber who struggled with this in GM where he said essentially, “I’m going to give the broadest discharge and the broadest injunction available, consistent with due process and I’m not going to decide today what that is, I’m going to let individual cases whose facts have fully matured come forward and we’ll deal with those or the courts will deal with

10 See footnote 9.

those as they arise. “What’s defective about that approach dealing with this issue?

Cordry: It may not be. That may be in fact the approach due, but it’s a question of do you do that by case law or do you do that by actually resolving that that is in fact the way the discharge provision should read? The question, for instance, the discovery rule in statute of limitations I expect was done by courts initially and then in most cases has been codified. That’s really what we’re talking about, putting some of these things, thinking through them, thinking through the consequences and putting them into the law.

There’s just a couple other pieces here that I would put in here that they come to some other parts of dealing with this. One of these is there’s this question of the problem when you have a bankruptcy that isn’t really dealing with the issue that ends up getting cut off. Owens Corning was an asbestos case and yet here it is dealing with shingles years later.11 It certainly made no point during its case of trying to tell people that its shingles might be defective. In fact it continued its warranties and everything else. It’s only after its bankruptcy plan is confirmed that it uses it as a backdoor way of getting at some products liability.

The Texaco case, it files a bankruptcy solely because it has the big fight with Pennzoil about this purchase and yet it gets a full scale discharge. Years later in this case that I mentioned for instance, there’s an environmental claim that comes up many years later that is barred because Texaco got a full discharge. 12 Often times these cases don’t make a lot of of headlines, if they’re in for a particular sole purpose, they don’t try to make a big point that you should, consumers and everybody else, should get worried about these other issues and should come in and file a claim.

Some of the question is just, should the courts be really looking at this more carefully in terms of courts, trustees, creditors, committees, everyone looking at these plans that people are putting together and say shouldn’t they be required – and this goes back to what Leif Clark said in Fairchild Aircraft.13 Shouldn’t you be required to affirmatively consider what potential future claims you have and indicate what you’re going to do and how you’re going to deal with them? If you don’t do that, then you shouldn’t be able to walk away from them.

It’s all kinds of ways to deal with these: insurance, warranties, future claims representative, setting aside escrows and reserves. Some claims should probably just float through. Environmental claims often do in some of these cases. Giving a claim a specific notice. I’m not just putting out a notice of the

11 See footnote 4.12 See footnote 5.13 See footnote 8.

word bankruptcy. If I want to discharge a claim that somebody’s probably not thinking about, maybe I need to give them some really specific notice about what’s going on here.

Keach: That really changes the fundamental nature of the discharge and the law and reallocates the burden from the creditor to the debtor. I guess what you’re saying is a matter of fairness, the commission ought to consider amending the law because the company has the knowledge of where it’s broken the law as potential exposure and should give broader notice.

Cordry: Who better to actually know? There’s a case called Savage Arms as I recall 15, 20 years ago or so and it was a company where the company knew it was being sued for these product liabilities, but wasn’t giving specific notice back to someone that had indemnity rights against it.14 The First Circuit, I believe, said look, you knew that you had these things. You knew that this was creating liabilities against this third party, but you didn’t tell him that. You just maybe put out a generalized bar notice and we’re not going to rely on that.

Klee: I know knowledge of the claim has not been prerequisite to the discharge. If the events that gave rise to the liability took place prepetition and the debtor gives notice of the case, the interest in granting the debtor a discharge and a fresh start or the purchaser of the assets if you’re selling the assets or the creditors if they’re taking stock in the reorganized entity has been held to trump the rights of the individual claimant.

Cordry: It certainly under the current Code is written to do that, but we of course are talking about whether this is what the Code should say. What I said before you just got here was that I went back to some cases where the Supreme Court and other courts were looking at some of these asbestos cases, where they were trying to do settlements and trying to do this global resolution.

They had given extensive notice. Everybody knew these potential injuries could occur from asbestos , but the courts are saying if you do not yet have the injury, if you have not yet manifested it, we don’t really think that it’s really possible to give a notice that means anything in that case, at least in part because, “what are we going to do with those claims?”

Klee: It varies depending on state laws. You know from having looked at this, some states require manifestation in order for there to be a claim and others don’t. Are you suggesting that we have a federal national bankruptcy standard that trumps state law?

Cordry: You mean a uniform national bankruptcy law?

14 Western Auto Supply v. Savage Arms, Inc. (In re Savage Industries, Inc.), 43 F.3d 714 (1st Cir. 1994).

Klee: Or whether a claim exists.

Butler: Let me jump in there for a minute because … a couple things. One, you raised a number of issues relating to constitutionality things. I just want to observe, I think it’s a legitimate question. I think it’s a thoughtful question and it’s a one that the Commissioners thought is of sufficient gravity that in fact we’re holding a symposium on just that issue in April in Chicago that is going to have some of the … probably 15 or 18 of the leading scholars in the country to come talk about the constitutionality issues.

Keach: Remarkably much is talked about around constitutionality or a lack thereof of bankruptcy provisions. Very little is actually written about it. There’s very little genuine thinking about it. It tends to be talked as, well, we’re close to or this might be, and we’re going to try to drill down on that, but go ahead.

Butler: My colleague over here is far more schooled on some of these issues than I am on constitutionality of issues. Your reference to uniform issues of bankruptcy law, that provision of the constitution never suggested that there was uniform treatment among … depending upon where the bankruptcy is filed. In fact the Supreme Court I think in 1901 if I remember …

Klee: ’03

Butler: ‘03 talked to that issue, basically said uniformity means, uniformity based on geographical treatment, if you’re in Michigan, you are in bankruptcy in Michigan and Michigan law applies, you ought to be treated uniformly, not that the treatment has to be the same in every state. Because there was a big debate at the time as we all know when the Constitution was put together as to what powers would be reserved to the state.

There are elements of underlying state law that’s reserved to the states. One of the concerns frankly I have I think that the commission is looking at is the race amongst states to figure out how to change their own laws to get a preference essentially and how they are treated vis-à-vis other states in bankruptcies that are cross border, that affect multiple states. I’ll tell you one of the reasons I actually came personally, as one of the commissioners that came to this hearing and participated, Karen, had a lot to do with my respect for this organization. Frankly a three-decade relationship working with you and having you be masterful in getting people across states to talk with each other and to make it possible to solve these issues.

I’m just not sure as I look at some of these things that you have to narrow the claim or you have to narrow in the statute to discharge. Isn’t it sufficient that what Judge Gerber did or beyond that, that the discharge can only reach its constitutional limits whatever those are and that can be sorted out case by case?

Cordry: Two points. One, the point is to the extent I’m saying you deal with the discharge that I’m not changing what the definition is of a claim in the states. The discharge is the bankruptcy construct, not the state law construct. So it is not unreasonable to provide that we do in fact have a uniform discharge. Secondly, certainly a lot of states have provisions tolling the statute of limitations. The discharge is essentially the equivalent of a statute of limitation. It’s just accelerating statute of limitations. You already are overriding state limitations that would normally put in this discovery rule to determine when a claim exists. We already are doing that.

The question is just how much do you do that and how careful are you to make sure you’re dealing with these problems? As I said, part of my notion here is some of this is just really the courts and everyone should be much more sensitive to these things. Before you put a plan into effect, you really should be saying, “look,” to the Owens Cornings of the world. “What are you going to do with your warranties for your products?”

You didn’t come in to this case because you were falling apart because your shingles weren’t working. You came in here because you had asbestos issues. Why all of a sudden should you be able to walk away from your warranties when you spent your whole time in the bankruptcy selling your product with a warranty and now you get this discharge and you’re walking away from those warranties? Why should we be allowing that?

Klee: Every debtor in bankruptcy has the right to reject an executory contract, including a contractual warranty if it wants to and can pay the damage claim. Giving the notice and being more sensitive to it isn’t really the issue. I think everybody should agree that if we can shine a bright light on things and make things easier to understand and more user friendly for creditors and debtors, we should do so. The dilemma that we face is, that in the chapter seven case where you’re liquidating the debtor and there’s a pot of money, you want to have a claim because you want to participate in the distribution and who cares about the discharge that’s going out of business?

In the chapter 11 case where there’s going to be a discharge, you may just prefer not to have a claim to have something ride through the bankruptcy so you can get hundred cent dollars post reorganization rather than to participate in the bankruptcy and get 15 or 20 cents. I think what you need to tell us is how we solve that problem of you wanting a claim in some cases, but not in other cases. The discharge and the claim are two sides of the same coin. We discharge claims. Debts.

Cordry: No. You have claims, and then you discharge some of them. That’s really my point here is that I think that the most practical solution here is that you always have a claim, but you have to put into effect the constitutional

concerns about when you discharge it. When you go through a liquidation, you don’t discharge it.

When you go through a reorganization, you may, but then there are these concerns. Should you be discharging these liabilities? Are there times when you should be limiting what you should discharge based on the claim, the fact that you know it hasn’t really developed, yet you know it should be brought into the case and it should be dealt with.

Keach: The dichotomy you just talked about, the liquidation/reorganization dichotomy is obviously the link between the discharge and the scope of the discharge and the so-called fresh start principle. That’s one place to start, but what I thought you were actually getting at was an attempt to narrow those circumstances where the discharge for lack of a better phrase is used as a sword and not a shield.

Cordry: That’s one of the places, yes.

Keach: When you start talking about saying that we’ll keep the definition of claim broad, but the discharge will only apply to those instances where the creditor has (a) actually suffered an injury of some kind and (b) either knows about that injury or reasonably should have known about that injury and that we still get a gray area in the “reasonably should have known” area that I think is unavoidable.

The reason I thought you were trying to carve the piece out and if you start lining up the examples that we give, they tend to be instances where there is, it’s not fair to say unintended. There is a perceptively unfair application of the discharge to a claimant who may even have been collateral to the case who wasn’t aware of the claim, therefore didn’t protect itself, himself or herself through the process. If I were looking at that focused area where I thought you were trying to get at, that was it. Am I reading that correctly?

Cordry: I think that’s right. I think one of the things I keep going back to Leif Clark and his discussion in Fairchild. One of the things he said is the best you can do is the best you can do. If certain things like toxic tort claims are involved, the reason they can use future claims and representatives and things like that is there’s enough of them that you can make a epidemiologically reasonable assertion. You can figure out reserves that you should set aside. You can set up those things.

Maybe if you can’t do that because you have an individual hurt by a forklift that will fail and so forth, maybe the approach is you don’t do that. You let it flow through, but again it’s really the concept of saying I think there needs to be much more attention paid to this. I know we’ve come at it. I’m not really trying at this point to say this analysis is the the be all and end all, but that it’s

an issue there that’s comes up over and over again. I think it’s one that continues to raise issues for us.

Keach: We should probably talk about your injunctive piece because actually there’s a lot going on there as well.

Cordry: We’ve finished that timing axis and now we’re on the cross axis there, the question about what are the claims and remedies? The second definition, obviously a right to payment is fairly straightforward. Where the issue comes up is the right to an equitable remedy for breach of performance if such breach gives rise to a right to payment. You might think maybe it was only dealing with contractual violations but no, the courts say no, no, it’s much broader than that.

Does the same breach for statutory violation give rise to both some payment right and some equitable remedy and, if so, what’s the relationship between those two rights? If the only remedy available under a statute or contract is equitable, then it seems fairly clear that there’s no claim, but if both may be available in some circumstances, then what happens? Must one be a substitute for the other? What if both are available, but they remedy different aspects of the breach?

How does state law play into this determination in terms of what it says you do with these different remedies? In particular, who decides which alternative remedy is provided or allowed? If state law allows the plaintiff to elect a desired remedy, does filing bankruptcy automatically somehow transfer that right to the debtor? Is the issue different for contract violations versus statutory violations? For instance one statute may not have a monetary remedy, but perhaps there’s an alternative statute that would allow a right.

RCRA, which on the environmental side deals with waste dumps, as I recall, basically only uses equitable remedies, but this overlapping statute of CERCLA, which also deals with the superfund sites and so forth, has both monetary and equitable remedies. Does the state decide whether to use one or the other? Normally, certainly, the state would decide which statute it proceeds under. Does that somehow get change if the bankruptcy case is filed? Or what if there’s no statute, but there’s perhaps a common law right to get a monetary remedy in some way?

For instance, a statute such as RCRA only has injunctive remedies, but the debtor argues, “State, you could go out and do the cleanup yourself and remove an imminent hazard and then you could seek payment under a nuisance theory or unjust enrichment theory or some way of getting the money back from me.” Does that possibility now somehow turn my

injunctive remedy into a claim because I theoretically could have gone and done it and asked to get paid for it?

Or what if the law clearly allows the equitable remedy, but the plaintiff could decide to accept payment in lieu? You take the classic specific performance case of buying a house or buying a piece of land, and yet I can choose to accept money damages instead. Does that mean that now in bankruptcy what would ordinarily be a right of specific performance under state law has somehow been turned into a claim simply because I have the theoretical right to choose something other than specific performance?

Here’s some of the case law that’s come up in this context, Chateaugay which talked about an order to end continuing pollution is not a claim because the state has no option to accept payment in lieu of stopping the continuing pollution.15 The Davis case from the Fifth Circuit, the creditors are not obligated to select a suboptimal remedy.16 I really like that line actually about money damages. The Udell case from the Seventh Circuit in terms of a non-compete issue there.17 If the rights are cumulative, then the injunctive relief is not an alternative to payment. It’s an addition to payment.

Apex Oil out of the Seventh Circuit suggests a general understanding that the discharge must be limited to cases in which the claim gives rise to a right to payment because the equitable decree cannot be executed.18 In other words it’s not whether the debtor wants the state to do one or the other, but only if you can no longer actually implement the equitable remedy. Therefore the only thing that’s left to you is to try to take perhaps a suboptimal remedy of damages.

Keach: I remember, when I’m reading these materials on the way out here, I’m of the belief that in general there are some places around the fringes where the law is not all that unclear as to what you do here, but you can have a legitimate policy debate about whether it’s doing the right thing, which is what we’re about now as the commission. That is that I think, I’ve always thought that if the underlying state law permits, either compels or permits a monetary remedy as an alternative, then bankruptcy turns that into compels.

We basically monetize as much as we can monetize in the bankruptcy code. That’s of the one of the basic components, but if the underlying state law doesn’t either compel or permit a monetary alternative, then it remains injunctive relief and it’s not subject to discharge. If that’s the principle and we can talk around the edges, there’s specific examples where that principle is less clearly applied. If that’s the principle, is it your belief that we should

15 See footnote 1.16 Sheerin v. Davis (In re Davis), 3 F.3d 113 (5th Cir. 1993).17 In re Udell, 18 F.3d 403 (7th Cir. 1994). 18 United States v. Apex Oil Company, 579 F.3d 734 (7th Cir. 2009).

change that principle or that that we just need to clarify when that principle applies?

Cordry: What I’m saying is I think that it’s not necessarily the principle. I think these cases I’m citing here take the opposite viewpoint that there’s not, especially in the environmental side, which is one of the major places this comes up for us, but that it’s not necessarily that principle. I think there should be a difference between statutory issues and contractual issues.

I think having a debtor be able to file bankruptcy and then, by filing bankruptcy, determine that the considered policy legislative choices of a governmental entity as to how regulatory mandates should be put into place, that the debtor can simply turn that on its head and say I get to do whatever I want by filing bankruptcy. I don’t have to do these things that everybody else does. I think that is definitely problematic and I think most of the cases actually in the environmental area don’t go that way.

Keach: Let’s play that out in practice because as Peter [Roth] knows,19 I’ve spent a lot of time thinking about environmental claims lately. It does seem to me that this is an area where you go through lots of gradients depending on facts. I don’t think anybody questions the ability of states to order debtors to comply with an environmental law or for that matter to clean up environmental problems that continue to pose some threat to health, safety and welfare, whether those originated pre or post-petition.

I think the case law is settling up pretty nicely which is if that’s the context and you do go clean-up, that there’s an administrative claim expense to that cleanup expense. You get to go clean up and you get to have a claim and that claim may very well have an administrative claim priority if there was an imminent threat to health, safety and welfare that caused you to clean it up.

Klee: Where it’s pre-petition, it could be discharged. Are you advocating for us to change the result in Ohio vs. Kovacs?

Cordry: No, Ohio vs. Kovacs is a case that is extremely often mis-cited. What Kovacs said is when the state chose to …

Klee: Clean up.

Cordry: Stop dealing with a recalcitrant debtor and stop trying to make him do the cleanup itself, dispossessed him, told him don’t darken our doors again, decided as the state chose to do the clean-up itself and seek a monetary remedy, the Court said, “when you're asking for money you’re asking for money.” Kovacs is practically a tautology. That case also said, “We’re not

19 Peter Roth, NH Office of the Attorney General, speaker below.

saying that anybody can maintain a nuisance. We’re not saying that you can just walk away from these things.” No, I don’t view Kovacs as in any way inconsistent with the position I’m taking here.

Keach: Let’s take that …

Klee: You don’t want non dischargeability then for all governmental claims, just to be clear.

Cordry: No, I don’t think I’ve said all governmental claims are non-dischargeable. I think I’m talking about claims where there is a equitable remedy that the state is entitled to choose to enforce; under statutes, is entitled to choose to enforce them as an equitable remedy outside of bankruptcy. We have very strong concerns with the notion that you can be forced to walk away from that in bankruptcy simply by the debtor choosing to say, “I’m not going to do it. Either you go do it yourself and hope you can get an administrative claim,” or to the extent that he says “Oh, it’s all prepetition and I’m going to argue this it’s not really administrative either.” Part of the thing here is the litigation issues here.

Keach: Let’s take that example because I think Ken’s question and mine are similar, which is you’re saying, if it starts with an injunction, the state starts with an order, “You shall clean this up. Number one, you stop doing it and two, you’ll clean it up.” The debtor doesn’t do so. Let’s assume the debtor doesn’t do so not because of a lack of desire, but because of lack of funds. Its bank won’t let it use cash collateral to do that, whatever the reason it can’t be done. It seems to me the state reacts in one of two ways in that circumstance.

Either the circumstance is such that the state must step in and clean it up because it’s a real threat, in which case the state does that. Or the state doesn’t in which case there’s still a cost that’s attributable to it. Is your point that if it starts as injunctive relief, no matter how it tracks that it should never become a claim that can be discharged?

Cordry: No, I’m certainly not saying that, I’m not saying anything different than what Kovacs did which is, when the state chooses to walk away from trying to get injunctive relief for any one of a number of reasons – and that’s really what Apex says – is that when the case gets to be a right to payment because the equitable degree cannot be executed, that’s exactly what Apex is saying.

What Kovacs dealt with was a case in which the state decided it was more trouble than it was worth trying to pursue this guy and they wanted to go in there and do it. They took the chance to try and get the money paid back or not, but that’s really the approach we’re working towards.

Butler: The fundamental policy question I think you’re saying is that where there is an injury that is the subject of both a monetary claim potentially or equitable relief, the state should retain forever its opportunity to make the decision of what to do and it should not be affected by the plan. That’s your position?

Cordry: Yes, I think in general.

Butler: Back to Ken’s question, that would essentially alter that world of claims that would exempt all those from treatment in the bankruptcy plan, correct?

Keach: Make them non-dischargeable.

Butler: Make them non-dischargeable and therefore flow through and be dealt with outside of the plan. In my way of thinking bankruptcy doesn’t impact them? The state keeps those rights?

Cordry: I would say in most environmental cases that’s the way it’s happening.

Butler: Here’s my question. If we adopted and Congress adopted that perspective and codified it, wouldn’t you agree with me that what would follow is legislation in all 50 states going through all sorts of different statutes and rights and amending them to match that theory or that prescription so that by doing it, the state legislatures would essentially exempt everything they were interested in from ever being impacted in bankruptcy, notwithstanding the fact that the federal constitution talks about a uniform bankruptcy law.

Cordry: We’re back to uniform, but no. I think …

Butler: No. I said earlier my concern, one of the reasons I wanted to come here to hear about this, is my concern is that there can be … no offense intended, there can be abuse by the states. I’m concerned about just what I posited here as to whether that isn’t the likely result of this approach.

Keach: The reason that comes up, just to put it in context for everybody, is that, take the states out of it. One of the things you see consistently on the second prong of the claims definition, and this comes up all the time for example in the area of covenants running with the land. I’ve seen this epidemic of situations where parties enter into contracts. They take a piece of the contract and they make it into a recordable instrument and they record it.

This seems to be true when people sell plants and they don’t want their competitors to do something that will be competitive. They’ll put a use restriction in the contract to sell and they’ll record the use restriction, this plant that I just sold you will never, ever be used to manufacture this kind of paper from now to the end of time and we’ll record that. That’s normally just

thought of as a contractual provision that could be rejected in the subsequent bankruptcy.

Now we get the argument that it’s a covenant running with the land. It’s something you can’t get rid of. It’s now a property interest, not a contractual interest. We see it in private parties attempting to fit themselves into the thing you can’t get rid of. I think Jack’s point is if we have a principle that says that certain claims, because they’re inherently injunctive or inherently regulatory, can’t be dealt with, then legislatures will just make everything injunctive or inherently regulatory.

Cordry: We have had 500 years or more probably of legislatures deciding what specific performance should be and what it should not. There’s a lot of competing pressures against this. Going back to non-compete agreements – most legislatures have put limits on non-competing agreements, specifically because they don’t want to let an individual party decide these things. I think the fact is, if you keep things the same inside and outside of bankruptcy, there are many competing pressures pushing back against these ideas.

The notion that somehow it will just automatically become this way either for the state itself or for private parties I think is very unrealistic. Right now state law doesn’t make everything a specific performance. There’s very good reasons for that. There are many limitations. I think those pressures will continue to bear there. Let me move on.

Butler: What are the competing pressures because this is the part I don’t understand. If you had this prescriptive formula we’re talking about, this was the principle. You could opt out of bankruptcy treatment by changing statutes to include both monetary and injunctive relief. What’s the pressure operating against the state from having that optionality? In the private world, in the business world, people love optionality. Wherever you can have optionality, you try to create it. If states are given the opportunity to create optionality i.e. more power for themselves to make choices, what are the pressures stopping them from doing that? Why would they not opt for optionality?

Cordry: For instance, there are businesses that don’t want to have these other pressures put on them. Like I say, going back to the question of non-compete agreement for instance. Some businesses would like to do it, but other businesses would like to be able to hire the person and so forth. You have that back and forth pressure.

Can we go on to some of the other pieces?

Keach: Of course.

Cordry: Okay, because we can take any one of these topics for four hours. Let me quickly run through one other piece here and then we’ll get to the third part of this session. The other concern we have is the idea of some of these non-monetary remedies in other contexts that are being forced into being monetary equivalents.

The TWA case which is one of the ones that also figures in the sale issue that we’re going to be getting to, this was a settlement of an EEOC case.20 The attendants were given standby flight vouchers. All it was, was if there was nobody taking a seat on a plane, they could use this voucher and it was a compensation for sex discrimination that these flight attendants had faced. When they went through in the 363 sale, there was a refusal to recognize those. The court said, we can turn those into a monetary equivalent, even though the whole point of them was to have the company not be paying money, to have something that was essentially a free thing, where the person could get something that was of value to them, but really didn’t cost the company any money. Yet the court turned this into a monetary value which was far less compensation and far less value to the flight attendants, even though there’s almost no cost to either the buyer or the seller. That’s a problem.

What’s even more problematic for me are these couple of cases, Rederford and Dalvit which are talking about reinstatement rights and say that, because there’s a possibility of being able to get front pay in lieu of being reinstated for violation of a statutory discrimination issue, the courts say “I am going to force you to take front pay.”21

“I’m going to deny you a right to reinstatement.” Even though the public policy underlying these employment discrimination cases absolutely says that reinstatement is the appropriate and proper remedy and we do front pay as a disfavored remedy for those very reasons i.e., perhaps you might not be able to go back or something. The basic concept is not only to benefit you, but as a recognition for other people that you can get reinstated, to tell other employees that “you shouldn’t be intimidated because you can be protected under this law.”

Now we’re telling these employees, “you can’t come back.” Because your employer is bankrupt, we’re going to disregard those statutory policies and give you only “front pay” which is not going to be paid in full. I think these cases are absolutely terrifying in terms of being willing to just say that a bankruptcy right overrides everything and especially because reinstating this employee didn’t necessarily take any money away from other creditors.

20 In re TWA, 322 F.3d 283 (3rd Cir. 2003).21 Rederford v. US Airways, Inc., 589 F.3d 30 (1st Cir. 2009); Dalvit v. United Airlines, Inc., 359 Fed. Appx. 904 (10th Cir. 2009).

Keach: How would you feel about them if they were liquidation cases?

Cordry: If it was a liquidation case then again it goes …

Keach: TWA and the other cases you’ve cited in here. If, they were liquidation cases. You’d want the flight attendants to have a claim for their certificates.

Butler: Because they can’t be reinstated.

Keach: The employee should have a front pay because they can’t be reinstated.

Cordry: Again, I’ll go back to the same point – that that I’d cite the Apex case which I think is a fine approach to it. You should be able to use the equitable remedy. If the equitable remedy cannot be enforced because a company has gone out of business or because the person is no longer capable of going back to work, that’s why you do have front pay as an alternative. Again it comes back to it’s not the wrongdoer’s choice to be able to force the person to take the suboptimal remedy, to take the policy choice that doesn’t protect the victim.

You should be able to get the remedy that the statute says you should get, unless you can’t get it, not just because the debtor wants to only pay you money and give you less than what you’re entitled to. Again I say, the worst part about some of these is that they’re … it’s almost a “dog in the manger” sort of thing. You shouldn’t get 100% from a right to go back to work and get your salary because some other creditors aren’t getting paid in full, even though your reinstatement isn’t going to affect those other creditors at all.

I have real concerns about that kind of cases. I think again, just these questions, especially in the context of statutory violations, there’s some real issues in terms of recognizing that there are other policies beyond just reorganizing debtors at all cost. The effects on other employees or other competitors, the race to the bottom, the idea that “okay well, if I can get away with this by filing bankruptcy, maybe my competitor will think that’s a good idea to do too.” Those are all concerns we have there.

Keach: In a larger context and I’ll just take it back to my opening remarks and that is one of the problems that we’re trying to address in the ‘78 Code or actually amendments to the ‘78 Code was, as the code progressed through the last 30 years, people who had a big enough lobby excluded themselves from the Code. We’ve started with security safe harbors. Security safe harbors broadened. I’ve said bankruptcy is at its heart an involuntary collective sacrifice.

Everybody does it because one, we make them, but they’re willing to accept being made to sacrifice because everybody else is sacrificing equally, at least those people in the same class as them. Then once you erode that principle,

that all claims are going to get treated alike, because people are able to get legislative exceptions, you begin to break down the whole principle and then you have this parade of people coming to ask for exceptions.

You get the 503(b)(9) administrative claim priority which again, I can argue separately, that’s a good thing. I can give you the reasons for it, but we begin to get this accumulation of “we’re excepted from the Code.” If we begin to except state interests, like we’ve excepted other private interests, don’t we perpetuate that problem? Don’t we have the problem of people excepting themselves from the Code and we have a bigger erosion of the fresh start principle rather than a restoration of the principle?

How do we get away from that problem; if we keep carving out for people who individually have legitimate claims to be carved out, don’t we just end up with a lot of carve outs and we end up with … as Rich Levin [name correct?] said, we could have a Bankruptcy Code on an index card. It could say “pay everybody.” It would be a Bankruptcy Code. It just wouldn’t work very well.

Cordry: What we currently have is a Bankruptcy Code that says sell the company and assume any liabilities you want to and pay them a 100% in full and anybody you don’t like leave behind in the old company with about 10 cents of the value of the deal being directed back as the sale price and pay them 10 cents on a dollar.

Keach: I don’t love that model either. That’s one of the reasons I’m here, frankly.

Karen: Exactly, but the notion that at this point that we have equality of treatment of creditors I think is somewhat of an imaginary idea as well.

Keach: Also agreed. I just don’t think we make it better by creating inequality.

Klee: Would you support repealing all priorities then so that we could have equality?

Karen: No, not necessarily. I don’t think that’s what I was suggesting here. I think that the notion that there’s this idea that we somehow have this pristine, if ever was this pristine Code then we’ve certainly have gotten far away from that in terms of where we go with sales. Here’s one suggestion …

Keach: I’d like to arrest the slide rather than further it. That’s what I mean.

Klee: I know you’ve got more to cover, but I have a pretty interesting area here. Would you be comfortable, as an alternative, that there be an opt out provision that said that the statute was re-written to say state interests will in fact be treatable in a plan or be a claim be treatable in plan unless the state

by 90 day within a 90 day period, files a motion to opt out and say I want to keep the choice and make the choice.

Then the determination of whether that’s acceptable, whether that can be done in that particular case has to be decided under some set of criteria by the court so that people are able to look at the rule. There’s some type of flexibility built in, but you don’t end up having people try to make as I’ve encountered people making those choices in the middle of the process that interfere with the process.

Cordry: We’ll certainly take that under advisement as well. I think it’s an interesting concept. Here’s the alternative one which is another way of getting certainty here, which is taking on the claim definition and tying it back to in many respects to the 363 sale definition and having these be treated the same way, that if an entity could be compelled in a legal or equitable procedure under applicable non-bankruptcy law to accept the monetary satisfaction with interest, then so be it, that would be a claim.

Keach: You would only have compel in those situations where state law compels but not where state law merely permits it?

Cordry: Right. In other words under 363, you can sell free and clear of interests – which now somehow turns into being a claim under logic I don’t quite follow.

Keach: We’re going to get into that in a minute I think.

Cordry: Right, which we’ll get to, but if that’s the theory that those things which you can sell free and clear of, are where you can be compelled to accept a monetary satisfaction, that’s the suggestion is there is the way to deal with the claim definition as well. That then would tie them together would then make those what you can sell free and clear. Those are claims. Those are monetary interests. Those are rights.

Keach: This approach lets each of the 50 states write their own tickets?

Cordry: In some respects, but of course that’s what Butner does.22 It says state law rights govern in most regards Bob: That is a compelling federal interest to the part?

Karen: Right.

Klee: There’s a long history against adding priorities. What the states have been required to do is to make something a property interest that’s good against the bona fide purchaser. If they want to put a priority and say per statutory

22 Butner v. United States, 440 U.S. 48 (1979).

lien or something like that, they can’t just have a priority that only applies in bankruptcy. Bankruptcy law overrides that. I know that they will do this though and even though it’s non-enforceable. Years ago I had a case with Meredith Jury, now a judge, on the other side representing grape growers. I was representing a winery.

We invalidated some of her grape growing liens because they weren’t good against the bona fide purchaser. They went to the California legislature, got a law passed saying that the grape grower lien follows the wine into the bottle, onto the shelf, onto your table so that if a grape grower wasn’t paid and they could find the bottle on your table, they could get it back. You’d think the business community would have thrown up their arms about this or the public would have expressed outrage.

Keach: That’s essentially a PACA lien.23

Klee: The grape growers … yeah, exactly in a broader range.

Cordry: For much the same reason because grape growers and grape workers have no protection and maybe people thought that was a fair …

Keach: The difference is PACA is federal.

Cordry: In any case, I’ve got the rationales behind the proposal on these slides, but let’s move on to the third piece. I’m going to try to wrap up fairly quickly so everybody else in here can really get a chance as well.

Bob: You are the timekeeper and the gatekeeper.

Cordry: Yeah and I’m running over my time. The third question here is, again, should plant be able to preempt non-bankruptcy law? We used to think it was fairly clear looking at cases like Baker and Drake that of, course not, that you have to follow the law.24 If there’s something in the Code that specifically overrides your law, a specific provision yes, but in general that you have to continue to operate under the law.

Speaking of Judge Jury, Davis Industries was a case that I had out in California in 2000, a company making these Saturday Night Specials. They proposed this plan that was going to say we’ll do certain things about how we reform our operations going forward and you can’t make us do anything else in the future after confirmation.

23 Perishable Agricultural Commodities Act, 7 U.S.C. § 499e(c)(2) (giving suppliers a right to payment before all other creditors, including secured lenders with blanket liens). 24 Baker & Drake, Inc. v. Public Serv. Comm'n 35 F.3d 1348 (9th Cir. 1994).

She literally looked down over the bench at him in that little peering way she has and says Mr. (I’ll call him Smith), “Mr. Smith, what on earth makes you think I have the authority to do that?” His only real answer was “That’s what we need to survive.” She said that wasn’t a good enough answer. He didn’t get his plan confirmed, but he actually was missing a bet because now it turns out that there’s an argument that he probably should have made.

Walking through the Code language, you didn’t initially have any general preemption provision. You had section 1142 that talked about carrying out the plan not withstanding otherwise applicable non-bankruptcy law relating to financial condition. And Section 1129(a)(3), the plan had been proposed in good faith and not by any means forbidden by law.

We like to argue that means the plan has to comply with the law. There are other cases that say no, that’s maybe reading the provision too broadly, but, at least, the good faith we thought we were fine. There’s almost no cases out there – because believe me I went looking for them – that construe what that “financial condition” means. These days it’s only mentioned in passing

Klee: You’re talking about net capital rules?

Cordry: Not necessarily, because I’ll get in a minute to what financial condition means, because it’s used through the Code, but it doesn’t mean the same thing in almost any place where it’s used. In any case in 1984, section 1123 gets amended. That’s the section that says what a plan has to do, what it has to have, what it can have. It has to have among other things adequate means for the plan’s implementation, such things as retaining or transferring property, satisfying liens. It seemed like “blah, blah, blah.”

Keach: They also had the very important words, “notwithstanding otherwise applicable nonbankruptcy law,”

Cordry: It didn’t have that before.

Keach: They added that.

Cordry: Right. In 1984 they amended it and it already … all these various things that were dealt with in section 1123, virtually all of them already have specific provisions in the code that talk about those things. 363 talks about how you sell property and 1129(b)(2) talks about how you deal with liens and so forth. You could read section 1123 as simply saying that, in the first place we’re pulling together all these things that are in different places of Code. In 1978 they apparently thought was all they needed.

In 1984 as part of a package of technical corrections – and nobody disputes that this was described as a technical correction, that it was not intended to

change substantive law, this was no big deal – they added these words, “notwithstanding any otherwise applicable non-bankruptcy law” with no particular explanation as to what they actually meant that to do. If it wasn’t meant to be a substantive change, what it was meant as a technical correction to do.

Gerdano: I didn’t do it.

Keach: Certainly I thought it was a good idea.

Cordry: Yes. It’s certainly not limited to financial conditions. It certainly could be any provision adequate for implementing a plan, even if it’s blatantly illegal under otherwise applicable state law. In fact if you think you have to have adequate means for implementing the plan, maybe that means you have to put anything you want whatsoever into the plan that will make it helpful.

Keach: Let’s just jump to the point which is another area where the courts have written a little bit about this just recently. What’s wrong with the Federal Mogul standard here which says, no, this isn’t limitless?25 We could talk about whether we should put those limits in the Code. I think that your paper does that and I think well. What’s wrong with that standard which basically says, and again we ought to put this context, because what Public Service said,26 I think pretty clearly was this isn’t permanent suspension of the application of state law to the debtor. This is temporary suspension of the application of certain provisions of state law that prevent emergence of the debtor pursuant to its plan.

Cordry: No, that’s PG&E I think.27

Keach: No. I can tell you I’ve read Judge Yacos's decisions many, many times. What he said was essentially when the debtor emerges, what he was going to allow, didn’t end up having to allow, but what he was going to allow was to allow the decoupling of the nuclear plant from state regulation, place them under federal regulation by virtue of ignoring a provision of state law that would not have allowed that to happen.

Even then to allow that to happen for purposes of emergence, but upon emergence the debtor or debtors and in that case the reorganized entities still had to comply with state law on a go forward basis. They still had to comply with federal law on a go forward basis. It wasn’t a permanent get out of jail free card. It was allowing that restructuring activity to take place. If we allow that limitation, if we say that’s always been there.

25 In re Federal-Mogul Global, 684 F.3d 355 (3rd Cir. 2012).26 In re Public Svc Co. of N.H. (Public Svc. Co. of N.H. v. State of N.H.), 108 B.R. 854 (Bankr. D. N.H. 1989). 27 In re Pac. Gas & Elec. Co, 283 B.R. 41 (N.D. Cal. 2003).

I think Public Service is in many ways the outer reach of 1123(a)(5) jurisprudence. If you then combine that with the Federal Mogul standard which says that’s one limitation. The other limitation is obviously we’re not going to allow this to excuse the debtor from laws that otherwise protect health, safety and welfare.

I think we can have a whole lot of discussion about what laws those are. I think the First Circuit BAP completely got that wrong in a case I was involved in, but that’s just another debate for another day. If we allow that limitation, for example the debtor can’t stop complying with environmental laws because it needs to conserve cash in order to reorganize. You’ve got to not pollute and there is no excuse from doing so. There are other examples obviously where that would be true.

You can’t run a hospital that doesn’t comply with certain safety laws just because you want to conserve cash. If we allow those two limitations and we can talk about how we would write them in, but if we allow those to recognize limitations on otherwise very, very broad language 1123(a)(5) what would be wrong with that construct?

Cordry: Let me back up two paces and say, “not a whole lot.” The concern I have with Public Service, I’d have to read that case again and really read it that way as opposed to PG&E. But the point I was making was that district court in PG&E was taking somewhat the same approach – that I’m only going to override things right at the time of plan implementation and you’ll have to obey the law up to there. You have to obey the law after that, but right at that point, I can disregard the laws. I forget whether he called it that or whether the state referred to it as the “big bang” theory.

Keach: It’s structural basically.

Cordry: Of course once they change that, yes you have to obey state law going forward, but you’re no longer under state law. I mean it wasn’t like they were going to come back under the state regulation.

Keach: They were under a different regime.

Cordry: Exactly. It really wasn’t going to be like some cases, there are these decisions where you temporarily don’t get to sue the officers, but then after the plan is confirmed you go back to suing the officers. This isn’t that kind of a temporary change. It’s a permanent change that they would now no longer be under the state.

Keach: They didn’t become a non-regulated entity. They just become regulated by the United States.

Cordry: No, but it was a change that they were not allowed to do under state law. So, I don’t necessarily agree with that particular piece of it but certainly the other part. Yes, basically the Federal Mogul standard I think, that you have to deal with police and regulatory powers and keep them in place. I agree. I think that’s probably about right. I think, I hope weren’t disagreeing Irving Tanning because I think that’s an absolutely correct case.28

Keach: I’m very much in disagreement with Irving. I was on the other side, but not necessarily with the principle. I think the Federal Mogul principle was the right principle. I have a problem with the way it was applied.

Cordry: Our concern, just these two cases here, in Montgomery County, Maryland, my home county, the case talked about regulating taxi cabs and how you could go from being a fleet to individual cabs, which is actually very much what Baker and Drake was doing.29 Irving Tanning had to do with workers’ comp funds and whether or not you could require them to accelerate the amount you’d spent on benefit claims or whether the funds stayed outside the case.

In both cases, the district court and then the BAP said we’re not going to just accept this broad preemption argument. We’re going to say these are police and regulatory and you have to continue to abide by those state laws. I agree that I think that that’s pretty much the right approach.

What my concern is both of them are saying notwithstanding that you have this extraordinarily broad language in 1123(a)(5), we’re going to find these limitations in there and we’re going to do them based on good faith. I do not feel that good faith is a sufficient protection when as I say when you have case after case coming out of Courts of Appeal saying if the bankruptcy code says you can do it, it must be good faith to do.

Keach: I don’t think either of those cases relies on good faith. Irving for example was actually about an alternative method of determine surplus actually and whether you could do it faster than the state law would let you do it. That’s really all that case was about but let’s assume that we put in statutory language to incorporate the Federal Mogul standard, to put in to the statute the Federal Mogul standard and if we could find a way to articulate what I call the Public Service standard which is … we’re talking about emergence, a suspension during emergence, but not a permanent suspension. Assuming we could build in those two limitations expressly, wouldn’t then 1123(a)(3) be all right the way it is?

Cordry: Yes, when you put in the parts where you’re continuing to recognize state regulatory authority.

28 Irving Tanning Company (Irving Tanning Company v. Maine Supt. Of Insurance), 2013 Bankr. LEXIS 3350 (1st Cir. BAP 2013).29 Montgomery County, MD v. Barwood, Inc. 422 B.R. 40 (D. Md. 2009).

Keach: I don’t think Federal Mogul goes that far. I think Federal Mogul is much narrower than that. Federal Mogul basically says you cannot suspend laws when the suspension of those laws would create an imminent threat to health, safety and welfare but I don’t think it’s nearly as broad as you think it is.

Cordry: Let’s put it this way. We need to discuss where it is. I don’t think Federal Mogul had anything nearly as narrow as an “imminent threat to public safety” standard. It talks about welfare which is not usually imminent because we’re also looking at consumer protection issues too and not simply environmental protection. We’re looking at financial regulation.

Keach: I agree with that, yes. We couldn’t basically allow them to sell products that were dangerous or even for that matter fraudulent just because they needed to raise money. I agree with that.

Cordry: I think actually probably we’re pretty much on the same page with there just in terms of exactly how far you go. I would have concerns with this idea that you can use bankruptcy to just eliminate state control on transferring property issues there.

Klee: I’d like to interject to pose a specific hypothetical. Suppose the state law requires a merger to be approved by a vote of the shareholders, not uncommon. Suppose the debtor proposes a plan that proposes for a merger. Are you saying that the only way that plan can be confirmed is if it’s sent out for a vote of the out of the money shareholders?

Cordry: I’m not sure whether I consider that police and regulatory or not but …

Klee: That’s what I’m asking because that was the same case in the Supreme Court in 1946 said the plan could not be confirmed even though it was a creditor plan without a vote of the shareholders. The reason the notwithstanding language was put in 1984 was to deal with cases like that.

Cordry: Yes, I think that’s the thing that you can deal with much more narrowly by putting a specific provision into the Code that says that and I think you actually have. You have all the requirements of approving a plan and they don’t require necessarily compliance with every bit of those pieces of state law.

Klee: It doesn’t say Karen who can act on behalf of the debtor. I mean everybody assumes it’s the debtor’s lawyer or the Board of Directors. The state law says it’s the shareholders. Without a provision like 1123(a)(5) perhaps or something else like it, I’m not sure …

Cordry: I think that’s the thing that would be better dealt with as a tailored provision, dealing with part of the plan approval process. Just the last piece here is in the 9th Circuit it used an analysis that said one of the ways we’ll limit this is by saying we’ll limit it to financial conditions (as in Section 1142).30 I would suggest and I went through this and I was trying to think whether that would solve the problem. If you look at the definition of a financial condition as it’s used throughout the Code it is completely inconsistent in all places.

There is a “financial condition” in terms of the 523(a)(2)(B) exception to the personal discharge. There are financial conditions that seem to be referring to insolvency.31 There are financial conditions that are used in terms of executory contracts that you have to assure that you have the same financial conditions as the one you’re replacing.32 I think one thing you might want to look at is look at the definition, at creating a definition. There is no definition of financial condition in the Code and it’s used in a dozen different ways that are completely inconsistent with each other. My main conclusion was you can’t use that term to solve the problem because it’s used in a dozen different ways. We don’t know what it means and I for one – if the definition would mean that you could override a net worth requirement, or financial stability requirement, or escrow requirement, we'd really have serious problems with that in many cases because we’ve seen what happened with banks and so forth when they didn’t have to have net worth requirements.

Keach: I think I agree with you there. I think financial condition both proves too little and proves too much. It could be worse for you.

Butler: I know we have to move on, but a thematic question I’d like your reaction to. One theme we’ve had in field hearing after field hearing, no matter which stakeholder is sitting in your seat, it has been the suggestion that we need to make adjustments to the Bankruptcy Code because the bankruptcy judge has too much discretion on a particular topic whatever the topic might be. The solution is to transfer that discretion to the stakeholder.

That seems to be in some respects the theme of your testimony which is let the states have the discretion of writing these issues of how they want to proceed but leave very little discretion to the judge. We’ve heard it from secured creditors. We’ve heard it from a whole litany of other stakeholders who’ve come to these hearings.

I’d just ask you to reflect on that. Is that really the system we’re trying to get to? One where the judge is not really a judge, they’re simply applying a series of rules or are we supposed to have more tailored discretion? Or is this really

30 PG&E Co. v. Cal. ex rel. Cal. Dept of Toxic Substances Control, 350 F.3d 932 (9th Cir. 2003).31 See, e.g., Sections 363(l)(1); 365(b)(2); 365(e)(1); and 541(c)(1)(B).32 Section 363(b)(3).

a battle among stakeholders in a bankruptcy case, public and private, as to who is going to be able to have discretion and control?

Cordry: We’ll look at that some more. I guess just a couple of sentences. One I think in several respects what we’re saying is not so much taking away discretion from the judge, as saying that it doesn’t go to the debtor to be able to make determinations about whether laws apply or not. I think the other piece which I’ve almost managed to forget at this point is I’ll have to probably have to think about that.

I lost track of the other piece of that but I think our concern here is not necessarily taking away the discretion from the judges but that, often times, this goes back to my very first point. That the bankruptcy system often times only looks to the debtor’s interests and I think judges get captured in the system.

It becomes this, is it the debtor uber alles? Is reorganizing a debtor the sole goal? And maybe it even just selling the assets at the highest price and paying the secured lender the highest amount of money on a secured loan which has now made it impossible for anybody else to participate in the case. Is that the be all and end all and does that control over every other potential interest out there? We in particular again continue to look at the fact that we’re also looking at their competitors.

We’re looking at the effects of what happens if everybody looks at this as a good way to solve their problems as to go into bankruptcy. That’s one of our concerns with these broad readings. We’re trying to not necessarily take discretion away but we’re trying to expand the question of what is it that the global consideration should take into account.

Butler: The reason I asked that question is because the Bankruptcy Code as it’s currently conceived is a contested hearing type of system. The idea is, it’s not just the debtor that has all these powers. Stakeholders get to come and express their point of view and then judges get to decide. In your gun case in front of Judge Jury you were able to describe it to us because you were there. You disagreed with what that debtor was trying to do. The judge agreed with you, exercised her discretion in your favor because it was a ridiculous proposal.

They’d taken it to a point of being ridiculous. All I’m trying to say is I’m trying to search as to why that system is so flawed and trying to reconcile all these recommendations that are coming in on how we change, which at least seem to have this theme of “remove the discretion from the judge and invest it in stakeholders.”

Cordry: I guess the last, the only other point I’d say, with that is one concern is “the more discretion you have, the more litigation you have.” The more uncertainty you have, the more inability for people to predict what’s going to happen. To some extent, if you continue to use non-bankruptcy rules for instance then people know what the rules are. They don’t have to go in and litigate over them.

Keach: Until they get changed.

Cordry: Till they get changed, but then they can participate in that process too.

Keach: The one thing that I’m hearing. I think probably there is an end. Let me just add and this is to all the participants today including frankly members of the audience. The input doesn’t stop when the hearing ends. We love to get written materials, emails, everything from people. To the extent that you reflect on any of these and you want to supplement an answer or give us more stuff. We’ll take anything from anybody and take it into consideration.

The one thing that I think I am hearing though seems to come up consistently. We’ve seen it otherwise, is that you expressed a frustration I think a lot of people expressed, which is when there is liquidation and some of these principles that were designed to be married to “fresh start” like the breadth of the discharge and otherwise. Those principles become uncoupled from their goal which was to let the ongoing business operate in a way that created new employment.

When we have liquidation and that happens, those justifications don’t seem as that any longer. Maybe we have to start thinking whether the rules that apply to boost reorganizations and it made sense in those cases, whether those should apply to sales, to liquidating cases or otherwise. I’d love to hear and maybe we can’t do it today but I’d love to hear your thoughts on some of that.

Cordry: We definitely do intend to send you some further formalized materials after this. Let me bring up our next speaker. We’re segueing to sales.

Leary: Good afternoon. My name is Maureen Leary. I’m with the New York Attorney General’s office. As Karen said, the views I express today are not necessarily those and in fact they are not those of the Attorney General.

Cordry: Hopefully he doesn’t completely disagree.

Leary: Because I haven’t discussed them with him. However, this is a collaborative effort among the states. We trust that you will accept our comments as such. Just an incredible group of questions that came from you, I’m really struck by the last one and the state’s interests and so forth. Let me just say this, I thank

you very much for the opportunity. Thank you, Karen, for setting this up. I am an environmental lawyer. I have been practicing bankruptcy law for 20 years in the context of environmental law, which I’ve been doing for 30 years. It is a fascinating area and I really enjoy it. I very much enjoy people who also like it as you do.

I’m going to talk a little bit today about 363 sales. I want to go very quickly because I think I can trust my colleagues in our sessions today and yesterday to have discussed with the newer lawyers to bankruptcy what asset sales are about. I’m going to focus my comments today on those that involve the sale of substantially all of the debtor’s assets. These we think present particular problems and especially problems for state governments as well as the United States perhaps, but obviously I can’t speak for them now. They’re not speaking at all.

Klee: Actually in Chrysler and GM they spoke.

Leary: Indeed.

Klee: They were the debt financer. They had a different view.

Cordry: Which we found out, yes.

Leary: I cannot comment on that but I want to draw everyone’s attention to a couple of things, one of which is the 363(m) statutory mootness provision which I’m going to talk a little bit about and the rule 6004(h), 14-day stay period unless otherwise ordered . Obviously everyone knows an asset sale requires notice and there are issues with notice and there are issues with transparency which I will cover. I’m really going to focus our presentation today on what courts are doing in construing the term “interest in such property” under 363(f).

This is really the area that has just gotten out of control. I don’t know if you’ll agree with that but I think we can fix it and we’ll propose some solutions, some radical, some not so radical. This is about a dialogue though, and that’s important to us and just as a result of the questions you were asking Karen I felt things formulating a lot more on our end. I can’t speak for Karen but that’s where I was going. It’s a very positive result. The criteria I just want to remind everybody and this is the concern, the biggest problem I have with this provision is the gap that exists between subdivisions one to four and five.

The criteria for selling assets free and clear is only if one) applicable non bankruptcy law permits a sale free and clear of the interest; two) if the entity holding the interest consents; three) the interest is a lien and the proceeds are greater than the value of all liens on the assets sold; four) the interest is

in bona fide dispute;, or five) an entity could be forced to accept a monetary satisfaction of the interest. Again, hearkening back to Ms. Cordry’s discussion about defining a claim as an equitable interest where the holder can be compelled to accept money.

I start with some concepts that hopefully no one will disagree with. Obviously the concept of a fresh start doesn’t mean a free pass. It means a fresh start. The code is intended to be equitable and fair to all. Everybody gets hurt the same, everybody benefits the same at least in theory, and the code protects debtors, their estate and creditors to the degree possible.

The code does not necessarily expressly protect a third party purchaser of assets. That’s an important thing that I don’t see in 363. There is no provision that says we can really protect this purchaser. I do agree however that you want to maximize the value of the assets being sold., That’s an important concept.

Klee: You would agree that if you could sell free and clear of successor liability it would increase the value of the assets where there was significant successor liability risk.

Leary: I don’t necessarily agree with that assumption and I’ll tell you why I don’t see an analysis of what it means particularly in a business plan, someone who’s the purchaser really identifying all those assets, quantifying them, and so forth. I can’t yet agree with that assumption without a basis for that analysis, not yet. We might get there but I don’t necessarily think it kills a sale and I’ve been an objector to a sale on that very provision in the Northern District of New York in which it was clear from the bench that the judge agreed with me and the party folded and proceeded with a major asset purchase without the successor liability protection.

They wanted that asset and that’s really what it comes down to. If a company really wants the asset it’s all about risk. It’s all about managing risk and that’s what businesses do, they manage risk. There is no reason they can’t manage that risk.

Keach: What Ken explained is that I assumed there was no [good end ?] to that case. I don’t know the case but I assume what they did was they actually assessed the facts on the ground and said there is really not that much risk, we’ll take our chances but if you take Ken’s example which is, there is real risk, there is no doubt that if there is real risk I’m going to discount if you make me assume that risk versus if you don’t. I think that’s a rather irrefutable proposition actually.

Leary: I would tend to agree with you. I guess my question to you is, “How do you know what the risk is, particularly since, in most states, at least in New York,

to prove successorship is a pretty heavy lift . New York law applies to a lot of contracts . You really have to prove quite a number of elements to find a company a successor, because a corporation acquiring assets does not per se acquire liabilities. It’s really the exceptions you have to prove. The burden of proof is significant and therefore I don’t think the risk is huge. That’s just the way I look at it.

Keach: That’s under state law.

Klee: If you represented the purchaser you might have a different view.

Leary: There’s no question about that.

Butler: When you look at 363(f) and 363(m), you made the statement earlier that the code’s not intended to protect third party purchasers. Actually those provisions do, they do it for some and result in arguably raising the value that flows into the estate.

Leary: Those provisions historically have been all about administering the estate’s assets That’s what those provisions were designed to do to - free up the cloud on the title, not to benefit the third party coming in. It was really to benefit the debtor to be able to liquidate those assets quickly.

Keach: You don’t get rid of successor liability to benefit the seller. You get rid of successor liabilities so the seller will pay more and that benefits the estate, right?

Leary: Yes.

Keach: That’s the point.

Leary: Yes, and parenthetically, I do want to say one thing. I don’t think there is a state sitting in this room or across the country that does not support a sale happening. There’s no question it’s good for the state to have that economic engine continue, and to have those jobs continue. That’s not the issue. The issue is what liability of the debtor follows from that, what happens as a result of the sale ? In some respects yes we want “to have our cake and to eat it too,” but we think that there is a better way to proceed. We think that there is a better way to get to serve both interests. I really do.

Similarly there is no question that we want plans to work. We want companies to emerge. That works for states, but again at what cost?. What follows in the meantime? It’s an important concept I don’t think anybody would disagree with in this room. Going back to the concepts, I view 363 as an enabling statute. It does not preempt, or otherwise override or affect

applicable state laws, recognizing the Tougher Industries case in the Northern District did consider the issue of preemption.33

In fact I read Tougher to say a state may be preempted from imposing experience ratings under non-bankruptcy law. That’s a pretty heavy lift when one of the 363 criteria is that applicable non bankruptcy law allow the sale free and clear. It doesn’t make sense to me that Congress would put that provision in 363(f) if it intended to preempt applicable state laws, such as the experience rating in unemployment insurance calculations at issue in Tougher.

The Code sets forth limits of a debtor’s rights as well as the court’s jurisdiction, and bankruptcy is not a haven for debtors or purchasers to avoid compliance with applicable non-bankruptcy law. I’m hearing pretty much consensus on both your end and ours that that is true. Here is a newer concept. It involves Espinoza and I’m extending Espinoza to …

Butler: I was actually going to stop you here.

Leary: I may just then move to Stern because I’m extending Stern too.

Keach: We’re just hoping that goes away soon.

Butler: First of all I mean and the Stern v. Marshall issues are all things we can debate but I think we could also leave Stern v. Marshall to the side because that’s not the Bankruptcy Code, that’s just which judge decides, right? Let’s put the issue for today - at least the issue of what judge decides aside - and get to the policy questions which are really the valuable things we’re learning from you if we could. I do want to hear why you think …

Keach: On that point I fully expect the United States district judges en masse to file an amicus in Bellingham in support of the reversal of the decision.34

Butler: I do want to hear out your rationale pertaining to Espinoza, a case I spent a lot of time with.

Leary: Let’s put that aside though. I agree with you and let’s go basically with what’s developing in the last 10 or 15 years, what’s going on with 363 sales? In the old days I guess there used to be this concept called a sub rosa plan. Not sure what happened to that concept, but obviously plans have particular protections that in a sale are not necessarily afforded to creditors; things like

33 In re Tougher Industries, 2013 Bankr. LEXIS 1228 (Bankr. N.D.N.Y. 2013) (enforcing free and clear sale order and holding that bankruptcy sale bars application of state law that applied debtor’s experience rating to purchaser for purposes of calculating unemployment insurance rates).34 Executive benefits Ins. Agency, Inc. v. Arkinson (In re Bellingham Ins. Agency, Inc.), 702 F.3d 553, 566 (9th Cir. 2012), cert. granted, No. 12-1200.

full disclosure and so forth and other safeguards, such as good faith. Those are not always evident in a 363 sale..

Keach: Interestingly enough actually there are some, I wrote some of this stuff for the Collier's chapter I write. There have been some actually interesting new decisions out of the Southern District that I think have done a pretty good job of trying to incorporate sub rosa plan principles back into the 363 test. I would encourage you to look at them because I think that courts are trying.

What I’ve seen in this area, actually New Hampshire, Peter Roth’s case is one of the first. Judge Yacos years ago required that if you were going to sell free and clear all of the assets of the business you had to have a sale motion that looks a lot like a disclosure statement. You had to get the information out to people. I do think that courts are developing those rules on their own.

Leary: Pretty recently.

Keach: Yes, relatively and it’s a recent pushback I think against some of this stuff you’re talking about.

Leary: Right and it’s heartening to see that. It doesn’t mean things will change. It just means that somebody on the bench or a number of people on the bench are recognizing it. The fairness concept, remember the 363 business justification is what you need to show; that’s really not necessarily the best interest of creditors test. It’s a different showing, we think, and relates to who really benefits from the sale?

In the sales I’ve seen I definitely think the debtor and the professionals and the purchaser benefit. I can’t really see, I can’t track exactly how the creditors benefit because I can’t necessarily track what happens and is recovered in a 363 sale going into a plan. I can’t track those dollars and I think you’re …

Keach: Let’s define some terms there because I think it’s interesting, because whenever I read because I represent a lot of debtors and whenever I read that the debtor is benefitting from all these changes, I’m always amazed because I want to find those people who have that practice because my debtors don’t seem to be benefitting from this. It seems to me that it depends on how you define the debtor.

The debtor is defined as the shareholders. I think we can all agree that most recent developments had not been great for shareholders and bankruptcy equity interests are probably not doing well under many current plans. If the debtor is management I suppose we can argue case by case whether or not they’re doing better. I think we have to be careful when we toss that term around, but in terms of creditors I guess the question is what creditors are you talking about?

Secured creditors I think, think they’re doing pretty well under that existing system. If you’re a contracting party whose lease or contract got assumed by the purchaser you’ve done really well. You’ve got the ultimate preference where you got paid 100 cents.

Leary: The “cherry picked” creditors ?

Keach: Yes, exactly. I guess when you say creditors aren’t doing well, we’re talking about unsecured creditors, at least some of them.

Leary: Not the “cherry picked” ones.

Keach: Not the ones that get picked by the purchaser.

Leary: That’s exactly right. The key issue and the threshold issue I would promote has to do with transparency in the sale process. You have the potentially prepackaged or pre-bankruptcy planning party coming in to purchase, moving the case into the bankruptcy. The whole thing is a done deal. There is superior access to information by that purchaser which shows that there is not a level playing field among purchasers and that does not promote true bidding, true maximization of the asset.

It might. There may not be other purchasers, but questions like what marketing efforts were done? What happened behind the curtain is a really important inquiry. Where I think the disclosure statement at least in theory would address those things and maybe this developing case law eventually will get there, and debtors will get there.

Butler: Precisely, that question is something there’s a question the Commission has posed to its sale advisory committee. That is one of the 13 committees that’s focusing on this issue. One of the ways these committees work is the Commission started by the group of us, actually the 20 commissioners posing a series of questions. Not that they were exclusive but a series of questions. The questions are on areas said that I think we are very focused on which because all sales aren’t equal. I don’t think anyone, people could take shots at the Lehman sale, for example, but Lehman, when the plug got pulled, was in crisis. There was no stalking horse.

Keach: That was probably the ultimate “melting ice cube” sale.

Klee: The ultimate “melting ice cube” because there was no choice.

Leary: That’s right and GM was no different. You’ve got a confluence of factors.

Butler: You take that, at the end of this spectrum there is the sale to the creditor group who’ve been negotiating for 18 months what that deal is and then they

walk in to the courtroom and say we’ve got to do this right away. Those are the book ends. I think that the question is what we’re trying to figure out.

We’re trying to sort out is how does the Code address those book ends, because on the one hand, you’ve got to allow, a debtor will be in big trouble at least in my view if we don’t take care of the really true melting ice cubes. On the other hand the issue of transparency when there’s an opportunity for transparency is the other question.

Keach: Let me pose a question to you to focus this because this is an area where we are really struggling, because for one thing I will tell you that one thing, the sale you just talked about that we all agree is not a good thing. We’ve actually determined it’s actually not a sale problem as much as it’s a financing problem.

Leary: I think that’s right.

Keach: Right because those cases are often loan to own deals. Whether their person was the original person or bought this debt and negotiates a set of milestones that says you have to sell this thing in 30 days or I’m going to stop lending you money. If I stop lending you money you have no cash collateral. You’re going out of business. One of the ways we’ve tried to address it is to not permit certain provisions in DIP agreements.

Leary: I was just going to say that. I mean it’s a real problem and the first day orders are issued based on that urgency. Once the first day order is issued, there is not a lot to be done. I’m not sure that that’s going to solve the problem but I appreciate that this is an issue on your radar screen.

Klee: It would if the law precluded it.

Leary: I’m sorry.

Klee: If the law was amended to preclude that provision then it would solve the problem.

Leary: Mr. Gerdano and I had an interesting conversation about the complexity of financing these days and how the market has changed and how the code hasn’t changed to address these things. It’s pretty complicated. Far be it for me to … I mean the Commission would be in a better position to say what is and is not going to tank the markets, that we really need to keep the economic engines going and keep these sales going. But it’s certainly something we would be very much interested in.

Keach: The pushback obviously you get is from credit markets. But let me go back to the question I was going to ask you which is the cherry thinking problem.

Ken was not being entirely facetious when he pointed out that the US government liked being in the cherry picking position when it was in GM.

Leary: Yes, I was cherry picked.

Keach: I guess the answer is, though, there is one immutable principle in bankruptcy that we’re never going to be able to do anything about and that’s that money actually talks. What happens when you have the purchaser who is saying I’m more than happy to buy these assets and I’ll pay a significant price for these assets but I don’t want all the contracts. I want this one and that one and that one and I do want to pay for those assets. I want to set some money aside for the employees even though they’re not the next in line in priority because I need those employees.

Those are the employees that are going to make my widgets after I buy this company.

Gerdano: Certain employees. Favored employees.

Keach: Certain of them and I want to buy those people. There are some other things I want to do that don’t actually fit with the priority scheme either but they fit with my business plan and that’s all I care about. If you want me to buy the assets these are my conditions. What do we do about that? Why would we try, would we legislate around that if we could? If we could, how would we?

Leary: Let me say a couple of things because what came up for me when you were just discussing these deals was the successorship issue, the successor liability issue, and putting aside how much you pay for the assets when you’re the purchaser. It seems to me that a purchasing company like the new GM that looks like a duck and quacks like a duck and walks likes a successor duck is in fact a successor duck. Cherry picking aside, if all of the assets are moving to that duck, how fair is it to leave nothing behind for the non-cherry picked creditors?

My answer is that this issue has to be addressed. How you address it is a more difficult question. One way to address it might be to take the issue of successorship off the table, Part of that is that successor liability is a state law concept. It arises under state law. It is not a concept that we’re going to allow bankruptcy courts or a debtor or a purchaser to dictate. When a sale order eliminates successor liability, it is dictating by fiat in a factual vacuum. What happened in GM and in Chrysler and many other cases is somebody just bangs the gavel and says you’re not the successor.

How do you come up with that factually? What are the due process implications? I think the Chrysler and GM courts both recognized this but did it anyway I think there was a failure to actually address why GM and

Chrysler were factually not successors – because they sure looked like successors.

Keach: Let me take process that even for a second. I remember once I was in front of Judge Kornreich and I was representing a purchaser. We asked for and received a particularly outrageous breakup fee.

Leary: That is another “unlevel playing field” problem.

Keach: We got it because we were at that point the only bidder and we asked for it and he blessed it and some people got very upset about it and he basically said that my client had no obligation to be fair. They were a purchaser. They came in from outside of the process and they basically could ask for what they wanted. You set up the circumstances to give it to them and they took it but there’s nothing that actually mandates that the purchaser act fairly, right? Your point I guess is that we should as a matter of public policy mandate that the estate take less money in order to achieve fairness for the people who weren’t picked.

Leary: I’m not saying that.

Keach: I’m not saying that’s a bad thing. I’m just saying that’s the principle.

Leary: No. I’m questioning whether you really would take less money. That’s what I’m questioning. I mean honestly breakup fees … I haven’t even covered that issue today. They are really a disincentive to any other purchaser being interested and the estate cannot sell the assets to anybody else because it is going to have to pay this breakup fee. That’s a separate problem but I guess we’re …

Keach: We’re all in favor of the next person in and in this case, there was a next person in and they paid the breakup fee. It didn’t chill anything it just actually turned out to be the right number.

Leary: Is your point that …

Keach: My point is that do we really want to police purchaser behavior? Do we really want to make things less attractive for purchasers? I’m not saying that’s wrong. It seems to me it’s a basic policy judgment. We could say we’re going to say it’s okay for purchasers to pay less, because we think there are real important public policy issues like not screwing up the priorities that exist in the bankruptcy code, like making sure that environmental claims ride through.

You could make a whole series of policy judgments but I guess what we’re saying is, who makes those policy judgments, are those state level judgments that get made or should we build them into the bankruptcy code?

Butler: One of the questions I had. This is like the opt out question I gave Karen and this proposal just as I’m throwing out there’s a suggestion is one I think. I’m not sure that Ken would agree with let alone you agree with it, but it is the concept of does it help with this if you had a provision in the Code that said that you can’t have an order, a sale order provided that there would be no successor liability except under the following circumstances A, B, C and D. The sale occurs 60 days after the case. There is X amount of transparency.

You could set standards up under which you would say if you do these three things, whatever the three things might be. That we all might all agree would address some of the most egregious behaviors we’ve seen. Then the court has the discretion to include that no successor liability in its order but if you don’t follow those rules you don’t. It’s a procedural approach but it has substance to it. Would that help address your issues?

Your solution that we let 50 states’ successor liability statutes apply to multi- state sales has its own set of issues associated with it because to suggest that it doesn’t impact value, I just don’t know how you reach that conclusion, but I’m just saying could you address some of the immediate issues by having that temporal provision added to the Code?

Leary: I don’t think so and the reason is because you’re not ever going to be able to envision in that context every single kind of potential liability.

Butler: I never let the perfect be the enemy of the good. If we could agree on the three things that are the most egregious things and say, because we all talked about transparency, it’s that sale in the first week of the case. It’s not a melting ice cube but we said look. You can do it in the first week in the case but the order can’t have in it a provision of no successor liability. Doesn’t mean that there is successor liability, it just means that it’s left to some other determination but if you do it 45 days in on notice you can and other similar provisions, I’m just saying.

Leary: Karen and I had a conversation in this very vein and I said I’m not willing to concede that but I really am. I mean there’s no question. One of the things that needs to happen is that the court has to have some criteria on which to apply its finding. If the debtor thinks and the purchaser thinks successor liability does not apply in A, B, C and D situation, let them prove that. Let that be litigated in the context of that sale. The question of the court’s jurisdiction is a separate one. I’ll leave that aside because I think you get dangerously close to the court acting outside of its jurisdiction in making such a determination.

No question, 363 is a core proceeding. No one can dispute that, but where you start moving when you do that type of thing is into jurisdictional questions about the application of state and federal common law successorship issues. That’s a problem because it’s this gray area you’re creating.

Butler: In a plan you might be able to solve that problem as opposed to in the Section 363 sale..

Leary: That’s right.

Keach: I was going to say but largely that is … it’s largely a procedural distinction. The whole issue around 363 sales and interest versus claim, this is the problem you cite in PBBPC, the experience rating case. The interest vs. claim distinction is interesting but is really is ultimately only a procedural one because as the Second Circuit said in the now vacated Chrysler case, they would like to see the 363 and plan sale, the free and clear provisions, come together. In other words treat them the same.

The way you would be to amend the 363 to allow you to sell free and clear of interest and claims because if you do a sale in a plan, you can get rid of claims, not just interest. It really is a question of plan versus 363 sales. If we made 363 sales have the procedural protections of plans then it would make that problem go away presumably.

Leary: I’m not sure that helps the government, but I do agree.

Keach: If you start with the premise at least that plans let you sell free of successor reliability because it does encompass claims and not just interests, then one way to solve the problem would be to make 363 co-terminus with that, but add in some of the procedural protection, right?

Karen: Use my claim definition.

Keach: That might help too.