On Monday, December 8, 2014, the American Bankruptcy Institute’s Chapter 11 Reform Commission, which is tasked with recommending reforms to the nearly 40-year-old bankruptcy regime, released a report which found that the current Chapter 11 system has fallen behind the times. The Commission’s report urges Congress to provide troubled businesses with a better chance at rebuilding through Chapter 11.
The report is three years in the making, and is in direct response to practitioners’ and lawmakers’ observations that the Chapter 11 system has not kept pace with changing financial trends and modern finance, which leaves struggling businesses with diminished opportunities to reorganize. Of the nearly two hundred and forty recommendations, many seek to streamline the Chapter 11 process, making the reorganization process cheaper, fairer and more effective.
Commentators have noted that this sweeping reform is sure to cause heartburn in the commercial lending industry, which has largely suggested that the Chapter 11 system merely needs tweaks instead of a complete overhaul. This consternation is due in part to the recommendation of the elimination of a key requirement for cramming down a contested restructuring over the objections of senior creditors, which also creates a mechanism to “funnel” recoveries to junior classes of creditors. Still other recommendations would change the way that certain creditors’ payments are valued, potentially cutting into the senior creditors’ recoveries. One of the more concrete recommendations of interest to the brick-and-mortar retailers considering bankruptcy is a proposal to extend the deadline for debtors to keep or reject commercial property leases.
Of particular note to commercial lenders, senior creditors may be required to pay “out-of-the-money” junior lenders, even when the first-out creditors are not paid in full. Under this proposal, the junior creditors would receive a recovery if a court determines that the debtor’s business might be worth more over a three-year stretch than at the current moment. This proposal is aimed to hand junior creditors some of the long-term restructuring value that only senior currently receive.
According to the Commission, the reforms are required because secured creditors have increasingly driven a great number of reorganizations to a quick, pre-negotiated “fire sale” liquidation, instead of comprehensive reorganizations into “smaller but healthier” entities. The Commission notes that the goal of the reform is to make Chapter 11 not a deterrent to struggling companies, but instead a mechanism to save jobs during restructuring. Secured creditors have warned that such reform is likely to raise credit costs across the economy, especially if the absolute priority rule is affected as proposed.
Commercial lenders and secured creditors should not fret immediately, as the Commission notes that it is likely that the recommendations would not be ready for congressional action until at least 2018 – exactly forty years since the last major bankruptcy reform. During this time, there will be significant opportunity for banks and secured lenders to negotiate with the Commission and Congress to ameliorate some of the less palatable changes which may have significant impacts on commercial lending.