The Examiners: Allow Smaller Businesses More Options to Reorganize

If you could make one change to the bankruptcy code, what would it be?

This month’s inquiry on national bankruptcy reform was not unexpected—after all, the question comes on the eve of the release of the report from the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11. Nor should anyone be surprised that the question was directed to a group that includes several of the commissioners (including myself) who have spent the last three years considering bankruptcy reform alongside several hundred business leaders, investors, lenders, suppliers, lessors, judges, lawyers, financial advisers, academics, consultants and other constituents. When issued, the report will speak for itself—this Examiners response represents only a personal point of view.

It is, however, fascinating that the inquiry has expressly limited responses to a single bankruptcy reform. The intentional narrowness of the question led to some quiet reflection about how our bankruptcy system has served businesses and their stakeholders (as opposed to consumer bankruptcy, which is an important topic for another day) and what single reform opportunity might stand out above all the others.

Today’s global economy and financial markets, and the manner in which they function, are very different than those that existed when the bankruptcy code was adopted in 1978. Substantial bankruptcy reform is required to better balance the goals articulated by the commission to effectively reorganize business debtors—with the attendant preservation and expansion of jobs—while maximizing and realizing asset values for all creditors and stakeholders.

So, personally speaking, what one thing should be done if nothing else could be changed in the short term?

Congress should fix what is most broken by implementing alternative restructuring principles for small and medium-sized businesses that would encourage them to utilize the federal bankruptcy reorganization system on a timely and cost-effective basis (and perhaps avoiding the liquidations and sales that are prevalent today). Small and middle-market companies file most of the bankruptcy cases in this country, yet they are the least well-served and most subject to failure in our current system. We must make it more efficient for the bankruptcy court and all stakeholders to navigate small and middle-market reorganizations to an appropriate resolution. We must also provide incentives to everyone involved to compromise and settle upon effective solutions that will rehabilitate businesses whenever practicable and reasonable to do so.

Congress well understands the importance of rehabilitating distressed small and middle-market companies and since 1978 has twice addressed the obstacles faced by them in our bankruptcy system through amendments to the bankruptcy code in 1994 and 2005. However, these earlier amendments have not produced the desired results. Small and middle-market companies are failing at alarming rates in Chapter 11, and many are avoiding the federal system altogether in favor of a patchwork of state laws authorizing receiverships and assignments for the benefit of creditors. While these state-law alternatives are sometimes attractive and even preferable solutions, they are also often less transparent and more subject to abuse by insiders and/or dominant stakeholders. This trending flight to state law remedies is likely to continue absent effective federal bankruptcy reform.

Jack Butler is an executive vice president with Hilco Global, where he provides advisory services to healthy and distressed companies, creditors and other stakeholders.