Debatable point: who takes the hit under bankruptcy reform?

MUCH of the debate surrounding the broad changes in U.S. bankruptcy law that becomes effective Oct. 17 has focused on the increased difficulty in filing for personal protection.

Banks, credit card companies and other lenders lobbied heavily for the bill, claiming that widespread abuses of the bankruptcy system forced them to write off increasing amounts of consumer debt, so the changes were seen as a win for business.

But largely lost in the debate have been significant changes in business bankruptcies.

For companies reorganizing under Chapter 11, the new law will shorten the time provided to develop a plan--unlike in the past when businesses could seek nearly unlimited delays. Businesses also will have less time to decide whether to renew or break real estate leases, a key issue for retailers.

Many business owners are not happy with the changes, although vendors and suppliers of companies under bankruptcy protection say that the law will relieve them of having to wait out proceedings for years.

Also complaining are the bankruptcy attorneys, who must personally certify that financial documents they file on behalf of Chapter 7 clients are accurate. Some lawyers claim they will be forced to leave the field to escape the liability or cost of verifying filings, although the extent of their exposure is unclear.

Background: Bankruptcy Reform

Since 1997, lenders and credit card companies have lobbied to reform the U.S. Bankruptcy Code. Near the end of his presidency, former President Clinton vetoed the first major bill to reform the bankruptcy laws, saying that it was too harsh on debtors.

Reform efforts picked up speed after President Bush's election in 2000, and in the past five years a coalition of banks and credit card companies spent tens of millions of dollars in campaign contributions to push federal reforms of the law.

Bush signed the bill, called the Bankruptcy Abuse Prevention and Consumer Protection Act, on April 20. While the legislation affects all forms of bankruptcy protection, most of the attention has focused on Chapter 7, which allows individuals to wipe out their personal debts and start over.

The new rules now require that individuals and families pass a "means test" in which salaries, assets and liabilities are calculated before they can qualify for Chapter 7. Those who don't qualify will have to file under Chapter 13, which requires some repayments to creditors.

But the new law also changed the rules for businesses, which had been accused in some quarters as being granted too much leeway in reorganization plan extensions. One of the most famous cases involved Manville Corp., which took six years to emerge from a Chapter 11 reorganization that was first filed in 1982.

Just last week UAL Corp.'s United Airlines filed a reorganization plan with a target to emerge from bankruptcy in February 2006--nearly three years after first filing for Chapter 11 protection.

Supporting the New Law

Under the new rules, Chapter 11 bankruptcies will speed up payments to creditors because of limits on how long a company has to reorganize. Companies will have 120 days to come up with their own reorganization plan, with an extension of up to 18 months. Small businesses would have 180 days that can be extended an additional 120 days.

Similar schedules would exist for lease obligations, a change that has been praised by landlords. Under current law, companies filing for Chapter 11 may receive unlimited extensions to decide whether to renew or break leases. In the new legislation, those companies would have 120 days to decide, with a single 90-day extension permissible.

Landlords say that bankrupt tenants have held them hostage by refusing to make a decision about their leases for months or even years. During that time they must pay utilities and taxes--and sometimes forgive the rent--while a tenant is going through reorganization.

"In some cases, the property is boarded up," said Charles Achilles, vice president of legislation of the Institute of Real Estate Management. "You, as the owner of the property, want to fill that space as much as possible."

The International Council of Shopping Centers, which lobbied heavily for the reforms, said the sites of bankrupt tenants often remain vacant, creating blight, and negatively affect nearby tenants that depend on foot traffic for business.

Opposing the New Law

Bankruptcy attorneys and some economists maintain that the shortened Chapter 11 timeframes may unfairly hurt large companies that have many creditors and must sort through large amounts of litigation. They also note that many companies seek to delay their reorganizations to wait out economic downturns. This is especially true for the airlines, as the industry suffered from a slowdown in air travel following the 2001 terrorist attacks and a recent spike in jet fuel prices.

Critics also fear that the new law will put creditors at an unfair advantage, allowing them to take over the reorganization process if it is not approved within the deadline. Furthermore, creditors can sue the bankrupt company for their share of the assets outside a comprehensive reorganization. And lease deadlines could hurt large retailers with multiple locations who generally pay their rents while in bankruptcy.

"The time to deal with lease assignments is terribly short and will make reorganizing a retail case very difficult," said Kenneth Klee, a partner at Klee Tuchin Bogdanoff & Stern LLP.

The new rules also limit the amount of bonuses paid to executives of a bankrupt firm. Currently, there are no limits on bonuses, which are often used to convince executives to stay on through the reorganization. Now, companies must justify such bonuses, and they can total no more than 10 times the salary of non-management employees.

Outlook: Limited Change

Most companies that file for reorganization under Chapter 11 should be able to come up with a plan within 18 months. But major public companies, particularly those with complex union negotiations, such as the airlines, may face difficulties.

Retailers could suffer greatest from the changes, since they must decide the fate of hundreds of stores within a shorter time frame. From a business perspective, the biggest benefit would be for landlords, who would be able to take back property sooner from bankrupt tenants.

As for bankruptcy lawyers, it seems unlikely that they will leave the field en masse, especially considering the hefty fees from Chapter 7 filings. The American Bar Association asserts that lawyers may have to hire private investigators or assessors to certify the accuracy of Chapter 7 financial filings.