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The secret history of forum shopping by bankrupt businesses

This week, in its Congressional fly-in, the Commercial Law League of America will be proposing to change the rules that govern where businesses can file for bankruptcy.  The effort by CLLA is to prevent businesses from filing for bankruptcy in locations remote from the site of their primary business operations, generally Delaware or Manhattan. This issue, known as “venue,” to lawyers and judges, raises a crucial public policy issue that highlights an old conflict between two competing public policy considerations. 

Currently, businesses can file for bankruptcy in one of three venues: where the business is incorporated (likely Delaware), where its principal assets are located, or where its headquarters are located.

{mosads}A related rule permits a parent company to file where a subsidiary has previously declared bankruptcy.  Under this provision, some insolvent businesses will deliberately put a subsidiary into bankruptcy in one location, often New York or Delaware, to satisfy the venue requirements for itself.  For instance, in 2014 Energy Future Holdings of Dallas, Texas (where its corporate headquarters is located) successfully filed for bankruptcy in Delaware, prompting objections from lenders and others that the company should have used a court closer to home.

One the one hand, the proponents of changing the venue rules complain that permitting businesses to file for bankruptcy far away from its true base of operations imposes unfair costs on local stakeholders.  Local creditors must find and hire new attorneys and pay travel costs.  Basic fairness, this argument holds, requires a business to use a court that is proximate to its real world home.

On the other hand, the defenders of the current system assert that business insolvency cases are often complex and that the courts in Delaware and Manhattan have developed a specialized expertise in difficult financial issues.  Efficiency that inures to the benefit of all stakeholders is the product of this specialization.  Changing the venue rules would toss difficult corporate bankruptcies into courts with little experience in business issues, with costly delays likely.

This debate is not new.  Prior to 1987, a business filing for bankruptcy was required to do so where either where its principal place of business was located, or where its assets were located.   Going back to at least the late 1990s, Congress has wrestled with whether the bankruptcy venue rules could be misused in some way and should be changed. 

In 1999, the House of Representatives passed a comprehensive bankruptcy reform bill, HR. 833 that included Section 1408.  Section 1408 would have prevented businesses from filing for bankruptcy in a particular state merely because it was incorporated in that state.  The provision was plainly targeted at the State of Delaware, where many companies choose to incorporate.  It was stripped by the Senate when it considered HR. 833 and was never enacted.

In 2005, Senator John Cornyn of Texas introduce the Fairness in Bankruptcy Litigation Act.  This legislation would have removed both the place of incorporation and the subsidiary rules, effectively forcing companies to file for bankruptcy close to its business operations.  The proposal never received a vote.

Most recently, in 2011, then-Chairman of the House Judiciary Committee Lamar Smith and the Committee’s top Democrat, Rep. John Conyers Jr., D-Mich., introduced HR. 2533, the Chapter 11 Bankruptcy Venue Reform Act of 2011.  This bill was the subject of a Congressional hearing, but the bill itself never passed.

Comes now 2015 and the debate is revived once again.  Based on prior legislative efforts, Congress will not likely changes the rules.  Bankruptcy is a technical area and, particularly in the Senate, it seems far-fetched to think that leadership will devote the floor time necessary to pass venue changes for corporate bankruptcies.  However, the new Majority Whip was once very active on this issue, and there are serious arguments made by the proponents of venue reform.

McMickle is a former counsel to the Senate Judiciary Committee for bankruptcy issues.

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