Saturday, October 4, 2008

The Bankruptcy Code Today...

The Bankruptcy Code Today
The present Bankruptcy Code, which became law in 1978, combines three previous reorganization chapters into one, Chapter 11. Chapter 11 is designed to be a flexible tool for the reorganization of the business and debts of corporations, partnerships and individuals. The goals of the reorganization process are many: to maintain the going concern value of the enterprise; to protect workers, their jobs and their retirement benefits; to realize greater value for creditors than a straight liquidation of assets would make possible; to avoid the ripple effects of a failed enterprise. In exchange for opening its books and records, a debtor obtains an automatic stay of any action to commence or continue civil litigation, or to collect an indebtedness, by any creditor in any court anywhere in the United States. Upon the filing of a petition, the previous entity or person becomes a new legal entity, called the debtor in possession, which is charged with fiduciary responsibility for the proper administration of the case for the benefit of creditors and equity holders. A trustee is appointed in a Chapter 11 case only if the debtor in possession is found to have engaged in fraudulent activities or gross mismanagement. The goal and purpose of the reorganization process is the filing of a plan of reorganization that will provide for the repayment of claims on a fair and equitable basis while at the same time permitting the debtor entity to continue its operations.

A reorganization plan must be accompanied by a disclosure statement that has been approved by the bankruptcy court as containing adequate information to enable a creditor to make an informed decision to vote to accept or reject the plan. As in the old composition agreements, confirmation of the plan requires that the majority in number but only two-thirds in amount of creditor claims in each impaired class must vote to accept it. If a debtor is unable to achieve the requisite number of votes to obtain acceptance of its plan by the acceptance method, it may ask the court to confirm the plan over the objections of creditors. The court must evaluate whether the plan is fair and equitable and does not discriminate unfairly with respect to each class of claims impaired under the plan. Upon confirmation of a reorganization plan, property of the estate vests in the reorganized debtor, and the plan becomes a new contract between the debtor and its creditors.

Chapter 11 reorganization has come to be seen as the vehicle of choice for addressing mass tort claims. Cases have been filed, for example, by manufacturers of asbestos-containing building materials, Agent Orange, and the Dalkon Shield birth control device. The focus of these cases was the development of a process that would permit all interested parties, including victims, lenders, debtors and shareholders, to come together to develop an equitable method of compensating victims while permitting the debtor to continue in operation. The formation of various official committees, each with its own advisers, facilitates the process.

Chapter 11 and the U.S. Catholic Church
These are the principles that have led to the filing of the diocesan reorganization cases. In each case, the bishops have cited the need for a process that permits equitable and compassionate treatment of victims while permitting the diocese to return to its role as a church. From its first pages, the disclosure statement in the Tucson case emphasizes that the purpose of the filing was to “fairly, justly, and equitably compensate the victims of sexual abuse by clergy or others associated with the Diocese and bring healing to victims, parishioners and others affected by the past acts of sexual abuse committed by clergy and others while allowing the Diocese to continue its ministry and mission.” The proposed plan provides for the creation of two trusts to be funded by settlements from insurers and the liquidation of certain diocesan assets, exclusive of parish and school property. Trustees for each of these trusts are to be given responsibility for resolving all pre-petition tort claims, investing and managing settlement funds, and making payments to holders of allowed claims.

One issue that has received much attention in these cases is whether the assets of the parishes are assets of the bankruptcy estates. While it does not define property rights, the Bankruptcy Code does prescribe which assets become property of the bankruptcy estate upon the filing of a petition for relief. Property of the estate is very broadly defined to include “all legal and equitable interests of the debtor in property as of the commencement of the case.” There are certain exceptions to this broad definition. Property of the estate does not include property in which the debtor holds, as of the commencement of the case, only legal title and not an equitable interest. Pursuant to canon law, all clerics and lay persons who take part in the administration of ecclesiastical goods are bound to fulfill their functions in the name of the church according to the norms of law. But the Code of Canon Law does not specify how title to the temporal goods of the church is to be held, and the practice varies from state to state.

It has been argued that pursuant to canon law, the bishop’s interest in parish assets is a bare legal title and that parish assets are therefore not property of a diocese’s bankruptcy estate. This is far from clear, however, and trial and appeal of this issue could take years. But through the plan negotiation process, it may be possible for interested parties to agree upon an adequate amount to fund a plan in lieu of liquidating parish assets. Victims and parishes, through their representatives, may fully participate in the plan negotiation process.

Other questions have arisen about the role of the bankruptcy judge in supervising diocesan activities and the administration of diocesan assets, and whether this would impermissibly interfere with the free exercise of religion. In point of fact, the bankruptcy judge has no responsibility for case administration under the present Bankruptcy Code. That role is placed upon the trustee. While it is possible under the Bankruptcy Code for a judge to appoint an operating trustee for a nonprofit debtor in the event of gross mismanagement or fraud, it is more likely that a judge would first address specific creditor concerns through the appointment of an examiner. An examiner may be a lawyer or an accountant, but need not be, and is charged with investigating allegations concerning fraud, dishonesty, incompetence, misconduct, mismanagement or irregularities in the management of the affairs of the debtor, and with making a report of his findings to the court and other interested parties. If the report of the examiner reveals the need for the appointment of a trustee, a person is elected to serve as trustee by non-insider creditors holding allowable, undisputed, fixed and liquidated unsecured claims.

In a Chapter 11 case, however, there ordinarily is no trustee. Rather, the debtor in possession is clothed with the rights, duties and powers of a case trustee. So long as a diocese remains in possession of its property, the bishop of that diocese, together with his consultors, will continue to make decisions concerning the operation of the diocese. While a debtor may not use, sell or lease property outside the ordinary course of its business without the approval of the bankruptcy court, this approval is routinely given where there are no objections to the proposed action by affected parties. Whether in connection with obtaining confirmation of a plan or during the administrative phase of a case, the role of the bankruptcy judge is limited to deciding whether a proposed action does or does not meet the requirements of the Bankruptcy Code. In deciding that question, the judge generally has no power to compel an alternative action.

Bankruptcy law is certainly not the solution for all problems, and I am not urging a rush to the bankruptcy courts. But more Catholics need to become familiar with the reorganization process and value it for the creative solution it can provide for some very difficult problems now being faced by the church in the United States.

Jennie D. Latta is a United States bankruptcy judge for the Western District of Tennessee.

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