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Small Business Bankruptcy Reform:
Codifying Best Practices
by Linda Ekstrom Stanley
United States Trustee for Region 17
San Francisco, California
Not to be overlooked in the avalanche of criticism following the June
10, 1998, passage of H.R.3150 are the provisions for small business bankruptcy
reform. A companion bill in the Senate, S.1914, contains similar provisions.
Unlike the legislative proposals addressing consumer bankruptcy, the small
business provisions for Chapter 11 cases in H.R.3150 and S.1914 emerged from the
National Bankruptcy Review Commission with near consensus. The provisions
reform, but do not radically change, the fundamental processes of Chapter 11.
Some commentators inaccurately criticize the small business provisions as
"untested." Others, unaware that United States Trustees currently perform many
duties set forth in the legislation, substantially overstate the provisions'
effect on United States Trustee offices. Still others overlook the valuable
tools in the bills for debtors, not just third parties, to evaluate their
In reality, the provisions in H.R.3150 and S.1914 for business
bankruptcy reform codify the current best practices of United States Trustees.
The proposed small business provisions will place into law a system that United
States Trustees already use in many parts of the country to help the debtor
assess its prospects for success early in the case and understand Chapter 11. In
my opinion, based on 16 years of practice representing debtors, creditors, and
creditors' committees in Chapter 11 cases and four years as a United States
Trustee, the small business provisions will result in quicker business
reorganizations, help the courts and the United States Trustees weed out
businesses that have no hope of succeeding, and shift the focus of Chapter 11
from costly and slow litigation to the debtor's business, where it belongs.
The Need for Chapter 11 Reform
Chapter 11 is a valuable tool. It gives small and
largebusinesses alike a breathing space from their creditors, a chance to
reorganize, a "fresh start." It provides a unique opportunity to restructure the
results of past mistakes for future success. But Chapter 11 is not a miracle or
a panacea. To succeed in Chapter 11, current management must quickly put an end
to business as usual.
Since June 1994, I have served as United States Trustee in Region 17,
which covers the federal judicial districts of Northern and Eastern California
and of Nevada. I am responsible for supervising the administration of the
bankruptcy cases filed in the region--85,000 cases filed over the last 12
months--including 700 pending Chapter 11 cases. Since my appointment as United
States Trustee, I have established a few "non-lawyer" facts about Chapter 11.
First, many Chapter 11 cases are really about people. Too
often, the debtor's principals are stressed-out disorganized entrepreneurs
accustomed to operating in an unstructured environment. Chapter 11 is like a
bucket of cold water.
Second, cases are frequently the direct result of
disorganization and failed management. Failure to cover payroll taxes, answer a
lawsuit, or resolve cash flow problems precipitates the Chapter 11 filing.
Third, the debtor almost always lacks a meaningful management
information system. Rare indeed is the debtor who can produce an accurate
profit-and-loss statement or who knows the profit margins on particular lines of
products. In the course of trying to define "small business," the Small Business
Working Group of the National Bankruptcy Review Commission asked me to research
the income levels of Chapter 11 debtors. I found that almost 50 percent of
Chapter 11 debtors in San Francisco could not state their gross income from the
year prior to the filing; they simply left blank the space for income on the
Statement of Financial Affairs. United States Trustees in other regions report
the same practice.
Finally, debtors rarely have an exit strategy for Chapter 11.
The Chapter 11 filing alone is the solution to their problems.
H.R.3150 and S.1914 acknowledge these problems and call for several
changes: (1) early evaluation of the case's financial viability by the United
States Trustee; (2) prompt plan filing and plan confirmation deadlines; (3)
under certain circumstances, a debtor's showing of ability to reorganize; and
(4) uniform financial reporting.
United States Trustee's Early Intervention
The small business provisions in H.R.3150 and S.1914 will improve the
administration of Chapter 11 cases because they codify the best practices of
United States Trustees, the administrators of the Bankruptcy Code. In large
cases, creditors' committees keep the debtor moving, but creditors' committees
are either non-existent or inactive in small cases. Only five Chapter 11 cases
filed last year in San Francisco had active creditors' committees represented by
counsel. It is the United States Trustee who is left to move the cases along and
make the debtors accountable.
The legislation calls for quicker resolution of Chapter 11 cases by
focusing, in the initial stages of the case, on the debtor's ability to
reorganize. H.R.3150 and S.1914 require the debtor to file its latest balance
sheet and tax return with the petition or explain why they are not available.
Both bills require that, after filing, the debtor attend an interview with the
United States Trustee, file periodic financial reports projecting cash receipts
and disbursements, file timely tax returns, pay post-petition taxes, and file
timely a plan and disclosure statement. These requirements may be new to the
Bankruptcy Code, but they are not new to the practice of United States Trustees
in many regions.
United States Trustees have long endorsed early evaluation of the
viability of Chapter 11 cases. It has been the practice of many United States
Trustees to conduct an initial debtor interview ("IDI") with the debtor's
principal and often its financial officer shortly after the case is filed and
prior to the §341(a) meeting. On January 1, 1995, six months after I became
United States Trustee, Region 17 started conducting IDIs. Since then, the San
Francisco office alone has conducted 330 IDIs in cases large and small. Debtors'
attorneys praise the IDI, stating that it reinforces the advice they give their
clients and impresses upon the debtors the need to focus on successfully exiting
Here is how the IDI works. After a Chapter 11 case is filed, a United
States Trustee Program bankruptcy analyst--often a certified public
accountant--reviews the debtor's schedules and statements and asks the debtor to
provide specific materials such as profit-and-loss statements, balance sheets,
tax returns, and bank statements. The analyst examines the debtor's record of
profitability, assets, expenditures, and financial trends.
The analyst then meets with the debtor and debtor's counsel to discuss
the reasons for the filing, debtor's management procedures, and the likely path
toward successful reorganization. This process has two goals. First, the IDI
provides the opportunity to discuss what the debtor will be required to do in
Chapter 11 and how it is going to get out of Chapter 11. Second, the IDI allows
the United States Trustee to assess the debtor's financial viability.
In addition to specific questions about the financial records, what
does the United States Trustee analyst ask the debtor? The analyst asks
questions like: Why did you have to file a Chapter 11 case? What are your
business plans? Where are your books and records? Are your tax payments current?
Are your assets insured? Most important, what steps will you take to turn around
What kind of answers does the bankruptcy analyst receive? Not
surprisingly, the books and records of many Chapter 11 debtors are often in such
poor condition that the debtor cannot answer the questions, let alone manage the
Early intervention in Chapter 11 cases has proven very successful. In
San Francisco, only 17 percent of Chapter 11 cases filed in 1992 resulted in
confirmed plans of reorganization. Since the San Francisco office started
conducting IDIs and became more active in filing motions to dismiss or convert
based on our increased knowledge of the debtors' core businesses, the
confirmation rate in San Francisco has increased to 33 percent for cases filed
in 1996. Additionally, the time for resolution--either by confirmation,
dismissal, or conversion--of Chapter 11 cases filed in 1996 decreased by five
months. About 65 percent of Chapter 11 cases filed in Region 17 are now resolved
within a year--an increase of more than 20 percent from 1994 when I was
My experience with these practices mirrors that of United States
Trustees throughout the country. Recent data confirm that Chapter 11 cases of
all types are moving through the system more quickly and that a substantial
percentage are being confirmed. Chapter 11 cases are not languishing as they
used to, and United States Trustees have been essential in moving these cases
Requirement of Timely Reorganization
A second change proposed by the small business provisions is to limit
the period the debtor may stay in Chapter 11 without demonstrating the ability
to reorganize. Both H.R.3150 and S.1914 allow 90 days to file a plan and 150
days to confirm it.
The concept of deadlines for filing and confirming a plan is
controversial but not new. Under the seldom-used small business election
provisions added by Congress in the Bankruptcy Reform Act of 1994, debtors must
file a plan within 160 days. The Bankruptcy Code permits the court to shorten
the period, but does not allow the electing small business to extend it.
The deadlines for filing and confirming a plan in H.R.3150 and S.1914
are not absolute. Unlike the deadlines imposed by the 1994 Reform Act, both can
be extended by the debtor. The extension comes at a price consistent with the
goals of early case disposition and debtor responsibility. To obtain the
extension, the debtor has the burden of showing a reorganization is likely.
S.1914 requires the debtor to make this showing by clear and
convincing evidence. The United States Trustee Program suggests changing the
standard to a "preponderance of the evidence"--that it is more likely than not
the debtor can confirm a plan--consistent with the other provisions in S.1914
that place a burden upon the debtor and consistent with H.R.3150.
To simplify the process of filing a plan for small businesses, both
H.R.3150 and S.1914 permit the small business debtor to use standard form
disclosure statements and plans and, where appropriate, eliminate the disclosure
Debtor's Burden of Proof
In its report, the National Bankruptcy Review Commission noted that
"perhaps the most difficult problem in reforming Chapter 11 for small business
cases is to find a way to identify promptly and reliably those cases that have
no genuine prospects for reorganization." The hallmark of these cases is that
once the petition and schedules are filed, the debtor fades from view.
H.R.3150 and S.1914 deal with this problem by amending §1112(b) to add
explicit benchmarks for the debtor's performance. The statutory change applies
to all Chapter 11 cases, both large and small. Along with the traditional
grounds for converting or dismissing a case such as continuing losses or failure
to confirm a plan, the legislation compels the debtor to keep current on
administrative taxes, file timely schedules and statements, and provide
documents and attend meetings requested by the United States Trustee.
The amendment includes a subtle but important change intended to
expedite the process of disposing of the large number of Chapter 11 cases
unlikely to reorganize. Under current law, if the debtor delays or fails to
progress in the Chapter 11 case, the United States Trustee and other parties in
interest must file motions under §1112(b) to advance the case. As movants, these
parties bear the burden of proving the company cannot reorganize.
H.R.3150 and S.1914 alter the burden. If a party in interest
establishes "cause" to convert a case, such as the failure to file schedules or
to meet with the United States Trustee, the burden of proof shifts to the
debtor. This shift will change the culture in Chapter 11. To remain in Chapter
11 and retain the benefits of the automatic stay, the debtor will have
to justify the omission and prove the likelihood of confirming a plan within the
established time frame. The focus is on the debtor and its ability to
reorganize, just as it ought to be.
Periodic Financial Reports
Another important tool for the small business debtor in H.R.3150 and
S.1914 is the creation of uniform periodic financial reporting to show the
debtor's profitability, cash receipts and disbursements, and the timeliness of
tax returns and payments of administrative claims. United States Trustees across
the country have long used monthly operating reports to help the debtor assess
and monitor its financial condition. United States Trustees have found that
debtors who regularly file these reports are better able to cope with Chapter 11
and to reorganize their businesses. Conversely, debtors who do not file monthly
operating reports or file inaccurate or incomplete reports are likely not to
On January 1, 1995, the United States Bankruptcy Court for the
Northern District of California adopted new monthly operating report forms. The
forms resulted from the joint efforts of the courts, the United States Trustee,
insolvency accountants, and attorneys. They are based on accrual accounting and
tailored for three broad categories of cases--real estate, individual, and
general business. Shortly after the forms were adopted, the United States
Trustee's offices in San Francisco, Oakland, and San Jose began offering classes
on how to complete and analyze the monthly operating reports. At the IDI, the
bankruptcy analyst now gives the debtor an interactive computer disk to guide
the debtor through the process of completing the operating report. The debtor is
encouraged to call the analyst throughout the case and especially during the
preparation of the first monthly operating report.
Reforms for a "Fresh Start"
To get on the right track--to make Chapter 11 work--a small business
debtor must put its books and records in order, provide periodic financial
reports on business operations, keep current on obligations incurred
post-petition, and determine what revenue its core business is generating. In
short, the small business debtor has to know whether its business can be
United States Trustees support the reforms in S.1914 and H.R.3150 for
Chapter 11 business debtors. No debtor will be able to sit idle. The expanded
grounds for conversion and dismissal and the shifting of the burden to the
debtor to justify retaining control of the business will help all parties in
interest. The small business provisions codify the best practices developed by
United States Trustees to move cases along. They streamline the Chapter 11
process and place the emphasis where it belongs--on the debtor--if a business is
to emerge successfully from Chapter 11.
In short, the provisions strengthen the integrity of the Chapter 11
process so that Chapter 11 cases provide a genuine opportunity for a fresh
Bankruptcy Basics - For Cases Filed on or after October 17, 2005 (pdf)
Basics - For Cases Filed before October 17, 2005 (pdf)
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