Why Has Chapter 11 Failed as a Reorganizing Chapter?

The ABI has spent thousands of hours on its Chapter 11 Commission Report; the National Bankruptcy Conference is hard at work on its "Rethinking Chapter 11" project. Underlying these and other such efforts is an overwhelming frustration with the failure of Chapter 11, under current circumstances to empower true reorganization. Hard to believe but it was not always this way. During the first decade or two of the Bankruptcy Code it seemed to be working pretty well; in fact many courts were unwilling to consider quick sales of the entire business. Many large cases resulted in a confirmed reorganization plan although some led to further chapter 11 efforts or failure; the results in smaller or medium-sized cases were more uneven with a healthy percentage being dismissed or converted to Chapter 7.  There was almost no discussion of Section 363 at the Ten Year Retrospective on Chapter 11 in Williamsburg and there was little commentary on its use. Indeed, the 1997 report of the Bankruptcy Review Commission did not focus on this issue. 

Beginning sometime between the Code's tenth and twenty-fifth birthdays the tide shifted; not only did most courts back off from their legal position that Chapter 11 was for reorganization and that any sale of the entire business needed to be done within a Plan, but the vast majority of cases seemed to shift to quick 363 sales to a suitor that was identified before the filing with an auction possible if there were competing bidders. 

Current efforts at reform look carefully at the Section 363 process, the DIP lending process, the expense problems in small and medium size cases and various other important topics. Yet, they do not spend much time investigating the reasons that the 1978 goal of promoting true reorganization failed sometime in its first twenty-five years.

Seems to me that such an inquiry is an important factor in figuring out what to change and in deciding that it is or is not time to abandon that goal for either large or medium or small businesses in financial trouble or for all of them. 

Some of the changed circumstances are obvious. The emergence and domination of "loan-to-own" hedge funds and private equity funds and the reduced roles of traditional financial institutions and the growth in claims trading. The 2002 modification of Article 9 of the UCC that left the DIP with virtually no unencumbered assets. During the first years of the agricultural crisis of the 1980's and before the enactment of Chapter 12, judges worked hard to confirm farm chapter 11 cases.  After a few years of seeing the post-confirmation results, most of those same judges became more cautious. Is this same phenomenon one of the reasons that there seem to be so few efforts at reorganization in non-farm cases? My friend Dan Keating wonders if it is the market speaking; that is, the market must have concluded that the 363 process is more efficient for maximizing  value. That could be because they generate more value, or it could be that 363 sales do not generate more value, but are much less expensive than traditional chapter 11 plans.

It seems as if the creditors have powered these moves from Chapter 11 to Chapter 363 and that either:

1.The creditors have always had the power to impose quick 363 sales but did not  decide to do so until 1995 or so; and/or

2. They would have always preferred 363 sales but did not previously have the necessary power; and/or

3. The shift away from traditional financial institutional lenders to "loan to own" has changed the mix.

One of the key questions that needs to be answered in the various reform efforts is "what is the goal in 2015 and beyond?" Have we given up on the US Bankruptcy Code ideal of reorganization?  If it is all about a quick sale, then is the current structure the best one?