Bankruptcy Reform: A Bust?

The National Association of Consumer Bankruptcy Attorneys has recently reported on early statistics, which confirm the concerns espoused by opponents of much of the recent Bankruptcy “Reform.” The report provides the first analysis of the over 60,000 consumers who have filed for bankruptcy protection since the enactment of the “Bankruptcy Abuse Prevention and Consumer Protection Act” (“BAPCA”) (editors note: the use of the term ‘Consumer Protection’ in the title of this statute is nothing short of Orwellian) in October of 2005. The full text of this report, entitled: Bankruptcy Reform's Impact: Where Are All the Deadbeats, may be found by following this link.

In its report, the NACB concludes that the changes put in place by Congress are not working as intended. Among other things, the report finds that of the 61,335 consumers seen so far by credit counseling firms nearly all (97%) are unable to repay any debts, and four out of five would-be filers were forced into dire financial straits by circumstances beyond their control, such as the loss of a job, catastrophic medical expenses or the death of a spouse. It is almost certain that, due to the dramatic increase in administrative expenses and new hurtles to recovery of preferential transfers created in the new legislation, unsecured creditors are likely to be receiving less, not more, in bankruptcy dividends and distributions.

And now, in a recent development, the National Association of Consumer Bankruptcy Attorneys, together with the Connecticut Bar Association has brought suit to have portions of the law, relating to debt counseling, declared unconstitutional. This, alas, is what comes of Congress’s having abdicated its legislative function and having given a drafting pen and a free hand to the credit card industry. Unfortunately for that industry, the legislation it wrought is sloppily drafted, and more importantly, will hurt consumers and not help the issuers of credit cards. Nobody is benefited, and, in the opinion of this author, much of this legislation will ultimately be undone.

One does not ordinarily think of Otto von Bismarck (or any German leader, for that matter) as a wit. But his well-known and pithy quote to the effect of: “If you love laws and sausages, you should never see either one made,” seems particularly apropos. One would hope that our future legislators will, if they want to sell their votes, at least do the drafting themselves.

Warren Graham
Copyright 2006

***YOU SEE??? I TOLD YOU!!!***

Ignore this at your peril

Warren

LATE PAYMENTS ON MORTGAGES RISE
Soaring housing prices and aggressive mortgage lending have saddled home buyers with ever greater levels of debt, and early signs are now emerging that more people are unable to keep up with their monthly mortgage payments, the Wall Street Journal reported today. The increase in late loan payments comes as more buyers have been forced to stretch financially to afford ever costlier houses in recent years, and many homeowners have increased debt by tapping their home's equity. Analysts say that more relaxed lending standards on the part of mortgage lenders also resulted in higher debt loads, which some borrowers are now struggling to repay. With the housing market cooling and interest rates rising, "by the end of the year you could see a substantial increase in delinquency rates" for mortgages, says Thomas Lawler, a former Fannie Mae economist and now a private housing consultant. An analysis by Bear Stearns found that delinquencies on loans originated in 2005 were in most cases far higher than on loans issued in previous years at the same point in their life cycle. Credit Suisse found that borrowers who took out adjustable-rate mortgages (ARMs) in 2005 were three times as likely to be delinquent on their payments after the first year as those who took out ARMs in 2003 and 2004.

Smelling Blood in the Water

So the statistics are finally starting to emerge, and nobody but the spokespersons for our real estate brokerage industry, our debonair denizens of denial and flagrant fanners of fantasy can gainsay the obvious: the housing market is softening, and it is doing so quickly and rather dramatically. Prices are softening, unsold inventory is rising quickly, and new construction is clearly on the decline. The New York Times pointed all this out in its May 9 Business Section and, as we all know, once the “Old Grey Lady” spots a trend, it’s well underway or, perhaps, very nearly over.

Real estate investors, over the last couple of years, are the equivalent of the late 1990’s high-tech moguls, persuaded beyond any reason that profits were limitless and that the market would, indeed, go up forever. Yes, folks, it’s the tulips again! For those who may not recall 17th Century Holland (all evidence to the contrary notwithstanding, even I can’t remember back that far), irrational and maniacal speculation in tulip bulbs in that era drove the prices up exponentially, until, predictably, the market crashed. I say, “predictably,” even though every time speculative frenzy overtakes society, whether it be a dotcom investment environment “unburdened by earnings” or a frothy real estate market which must go up forever because “they ain’t making any more,” we seem to have to learn the same lesson over and over again.

Is it a lack of intergenerational memory? We certainly don’t have much sense of history, yet most of us know at least something about the Great Depression and Stock Market crashes of the past. Is it mere self-deception, i.e., the determination to think ourselves so clever that we’ve all become real estate moguls? In the late 1990’s, I remember clearly being surrounded at my tennis club by 20-somethings, knee-deep in internet-land, sipping well-aged single-malt scotch, and puffing on expensive cigars, secure and, indeed, smug, in their status as “captains of industry.”

I wonder what happened to those guys?

In truth, it is hard to say why we seem to have to keep learning the same lessons over and over again. This is, perhaps, a question better put to sociologists, and not to lawyers and financial people. But the consequences are, as ever, predictable, to those who see the writing on the wall.

In a previous article, I pointed out that the decline in housing values, coupled with other developments in banking, consumer lending and revisions to the Bankruptcy Code all portended very poorly for the American Middle Class. Depending on what happens in this area in the near future, a similar prognosis may, I am afraid, await the Upper Middle Class who also have a great deal of their wealth tied up in their homes.

Until only a few months ago, clients and colleagues were begging me to find them deals in “distressed” properties. There was, at the time, virtually no such thing, because no sooner had someone gotten wind of a property owner with a financial problem, that the bidding war began, raising “distressed” properties fully to market value (there may well have been no such thing as “market value” either). Now I have the very clear sense that those properties may soon be plentiful. Those who have had the sense to “keep their powder dry” and who have the foresight over the next year or two to begin nibbling at opportunities and the patience to hold the properties they acquire, will, in this writer’s opinion, be well-rewarded. Much as the good leavings of the dotcom meal were feasted upon by so-called “vulture funds,” the sharks may soon be smelling the blood in real estate, and might be slowly, oh, so slowly, beginning to circle.



Warren R. Graham
Copyright 2006

New York Times Article

Below is an excerpt from a 2002 New York Times Article on the subject of, among other things, retail Chapter 11 Cases, in which I was quoted extensively. I am in the process of preparing an analysis of whether the article's conclusions would change materially under the subtantial revisions to the Federal Bankruptcy Code

MONEY AND BUSINESS/FINANCIAL DESK

Chapter 11? Or Time To Close The Books?

By DANIEL ALTMAN (NYT) 2791 wordsPublished: December 15, 2002

IN the last two years, more than 150 of the nation's large public companies have trooped into bankruptcy court, seeking protection from creditors while they reorganize. The process, under Chapter 11 of the bankruptcy code, has long been praised as one that gives American capitalism an advantage over systems in other wealthy countries, which are more likely to force insolvent companies to liquidate.

But that hardly means that there is no room for improvement.

A growing number of experts, having witnessed the damage to companies involved in drawn-out bankruptcy proceedings, want courts to move the cases along more quickly. Others see their point, but note that companies that have restructured in the nation's fastest-moving courts -- in Delaware and New York -- are the most likely to fail again. And experts in both camps agree that liquidation happens too infrequently.

''We tend to be biased toward saving failing firms,'' said Michelle J. White, an economics professor at the University of California at San Diego. ''The general view is that the United States system tends to overdo it. Often, firms tend to end up failing again after bankruptcy and probably should have been shut down in the first place.''

To thwart the gradual erosion of a company's value during years of legal wrangling, some academics have proposed an entirely new system to deal with insolvent companies. They would use auctions to assess and parcel out quickly the valuable parts of the company.

Yet in the decade since they began publicizing their ideas, Chapter 11 has only grown in use, especially among big, complex companies.

The next year will be telling for the bankruptcy system. When United Airlines filed for protection under Chapter 11 last week, it not only joined the list of the 10 biggest bankruptcies in history but also brought to 7 the number of those now in legal proceedings. How those cases unfold may well influence investors and creditors, hampering the markets' recovery in 2003.
Though only eight years have passed since Congress last revised procedures for corporate bankruptcies, some recent cases suggest that more work on Chapter 11 is in order.

Consider Caldor, the former discount retailer based in Norwalk, Conn., that filed for protection in September 1995 but did not announce that it was going out of business until January 1999.
The company's assets -- including 166 stores -- were worth about $1.2 billion in 1995, versus debts of $883 million, and it ranked fourth in sales among the nation's discount chains. Most analysts expected the company, which did not have a long history of financial problems, to reorganize and survive.

Instead, the chain lost money throughout the late 1990's. By the time it folded, Caldor had sold about half its stores for about $375 million and had received $223 million for its merchandise from liquidators.

What happened to the other $600 million in value?

''Caldor made the decision to liquidate too far down the road to really maximize the value of its assets,'' said Warren R. Graham, who was involved with the case and is co-head of the bankruptcy practice at Duval & Stachenfeld in New York. ''If they had decided Day 1 that they were going to liquidate,'' he said in hindsight, ''they probably would have done pretty well.''
The bankruptcy process allowed Caldor's leaders to keep control of the company, however, and their strategies were not radical enough to keep up with the changing retailing environment. What's more, in the first two years of its bankruptcy, the company paid its lawyers and accountants $15 million. Its executives extracted an extra $8 million to oversee the liquidation and paid its lawyers an additional $10 million.

Mr. Graham said that not even the creditors pushed for immediate liquidation. But it might have allotted Caldor's assets to more competitive companies sooner and saved millions in fees. By the time the liquidation decision was made, the value of Caldor's stores had declined significantly.

BY holding off creditors and protecting assets from sale or seizure, Chapter 11 was intended to give insolvent companies breathing room as they tried to restructure their operations into profitable businesses. Courts oversee their affairs, and companies finance their operations with short-term loans from lenders who move to the head of the line for repayment. Creditors vote on management's plan, and only if they disapprove -- and neither side comes up with an agreeable plan -- does a company liquidate.

But the process has a huge weakness. In the last two decades, several companies -- from airlines like T.W.A. to retailers like Grand Union to building materials giants like USG -- have emerged from bankruptcy only to file again under Chapter 11. That suggests that liquidation or a harsher restructuring might have been merited the first time.

The trouble is, Chapter 11 does not prevent various stakeholders and hired-hand advisers from pursuing their own interests at the expense of the company's value -- and lengthening the whole process.

And the longer a company is in bankruptcy, the more its brand value tends to dissipate. ''When T.W.A. was in bankruptcy, it wasn't the choice airline,'' said Lucian A. Bebchuk, a professor of law and economics at Harvard who has studied the bankruptcy process. Relations with suppliers often suffer, too. ''When companies are in insolvency proceedings, then any business partner would have to deal with it with more precautions,'' he said.

Executives, meanwhile, may no longer have incentives to make good business decisions during a bankruptcy. ''There isn't really any good way to do effective corporate governance in insolvency,'' Mr. Bebchuk said. ''Most of the mechanisms that you hope would do the work outside the insolvency are not there.'' Stocks and stock options, for example, which are traditional mainstays of executive pay, offering incentives to produce profits, become virtually worthless when a company is in bankruptcy. In addition, Mr. Bebchuk said, outsiders can no longer take over the company by buying up its stock -- a powerful way of enforcing investors' will.

The actions of shareholders, who are last in line for payment when a company is bankrupt, often combine with poor management incentives to extend the process, Ms. White said. Shareholders have to agree to any restructuring plan, she said, ''so they often want to drag their feet until, just to get things done, the other groups are willing to give some slice'' of the company to them.
Managers can also have an interest in stretching out the proceedings, said James J. White, a law professor at the University of Michigan (and no relation to Ms. White). They can, and often do, offer several plans for reorganization to try to stave off liquidation and the loss of their high-paying jobs -- even though their actions can be self-defeating.

''Because value is being dissipated,'' Mr. Bebchuk said, ''the ability of the company to be a viable, going concern and compete when it comes out of Chapter 11 might be hurt.''

That destruction of value hurts all creditors; they may have recovered more of their debts, sooner. Eastern Airlines, which filed for protection in 1989, was a case in point. ''They went in front of a judge who viewed bankruptcy as an institution for saving firms, so they were allowed to operate for quite a while,'' Ms. White said. ''The managers had the right to propose reorganization plans. They just kept operating, kept losing money, and there just wasn't anything left. Eventually, they were liquidated.''

Almost two years passed, filled with battles among Eastern's management, employees and creditors, before the airline stopped flying. While Eastern's unsecured creditors lost about $240 million, the company paid out at least $67 million in legal fees. Eastern, once the name of the biggest airline in the noncommunist world by several measures, became a byword for corporate failure of the most grinding and humiliating sort.

Mr. White argues that liquidation should come quickly in many cases. ''It depends on whether the company is in a business that is fatally flawed because of changes in the economy,'' he said, ''versus one that just had a financial problem.''

Airlines have usually fallen into the first category. ''Rarely have airlines that were run well made much money in the last 10 years,'' he said.

An example of the second type was Federated Department Stores, which filed for bankruptcy protection in 1990. Proving that Federated should remain intact was not easy, said Carol A. Sanger, who is now its vice president for corporate affairs. ''It was a matter of providing an awful lot of information to an awful lot of committees in a very short time frame,'' she said. At the beginning of negotiations, she added, liquidation was definitely a possibility. ''Everything was on the table at that point,'' she said.

FEDERATED'S bankruptcy process, however, reached a turning point in bizarre fashion. A judge's decision to allow charitable donations by the company to continue during its insolvency -- a matter of paying out a small but symbolic amount -- acted as the acid test. Federated exited bankruptcy in January 1992. It earned $795 million on $16 billion in sales in 2000, but lost $276 million on $15.7 billion in sales in 2001, as the economy slumped.

But properly categorizing companies at the time of their distress may be difficult, said Randall S. Eisenberg, senior managing director of FTI Consulting and president of the Turnaround Management Association, a trade group. ''Certainly, things occur that weren't anticipated,'' he said, including economic trends, terrorism and changes in technology or competitive pressures. ''I'm not sure that the current process could, by itself, identify them -- nor could any process.''
''Every company is different,'' Mr. Eisenberg said. ''I don't know whether it's fair to say that a company should go through quickly or slowly. The dynamics dictate it.''

Mr. Eisenberg recounted the bankruptcy of a furniture manufacturer he advised several years ago. ''Right after we filed, the industry went into a deep recession,'' he said. ''The judge supported the company's view that it should not rush out of Chapter 11.'' The company reorganized at a moderate pace, left bankruptcy and is still in business.

Speed may have other drawbacks that are more difficult to identify. Delaware and New York courts have traditionally dealt with bankruptcies fastest, according to Ms. White. Yet they may render the process too easy on restructuring companies.

Lynn M. LoPucki, a professor of law at the University of California at Los Angeles, tracked the outcomes of big public companies that emerged from bankruptcy from 1991 to 1996. More than 4 in 10 that exited Chapter 11 in Delaware ended up back in bankruptcy within five years; in New York, the figure was close to 2 in 10. In courts elsewhere, only 4 percent of bankruptcy survivors filed again within five years.

This recidivism has led many experts to argue that there are efficiencies to be gained by tilting the process in favor of liquidation.

Oliver Hart of Harvard and John H. Moore of the London School of Economics, innovators in bankruptcy theory, recognized the single source of these problems of vested interests, speed of resolution and efficient choice of liquidation. Bankruptcy laws around the world, they wrote in 1997 with two colleagues, fail to separate two fundamental decisions: how to best preserve the economic value of a company and how to split up that value among its claimants. When those two conflict, insolvent companies that are economically viable can deteriorate and disappear, and weaker companies can stumble along too long.

The professors offered a new way to resolve bankruptcies, based on a two-tiered auction. As in Chapter 11, it would begin with a court's protecting the company's assets. The court would appoint a receiver to catalog all claims against the company in classes: from the creditors with the strongest rights to the company's assets (the most senior) down to its shareholders (the most junior).

The receiver then asks for offers -- either in cash or in promised shares in the company's future profit -- to buy and restructure all or part of the company. In the meantime, the receiver either operates the company or oversees its existing managers.

After making public the list of claims and any offers for the company, the receiver would issue 100 ''reorganization rights'' to the most senior creditors, based on the relative size of their claims. Next, the more junior creditors and investors, starting with shareholders, could buy the reorganization rights at auction.

The prices for the rights must equal or exceed shares in the more senior classes' claims on the company. The bidding claimants may buy a number of reorganization rights equal to their own share of their class's claims. An owner of 18 percent of one class of debt, for instance, could buy up to 18 reorganization rights at a unit price not lower than one-hundredth of all the more senior creditors' claims.

If the shareholders do not buy all the reorganization rights, then the next most junior class has its chance. A creditor with 7 percent of the next class of debt could buy up to seven reorganization rights, at a price not lower than one-hundredth of all the more senior classes' debts.

The creditors always make their offers to the class directly above them in seniority, whose members are then obliged to buy the rights from the next class up (keeping any leftover cash), to complete the chain of transactions.

Consider a simple example with three classes: senior creditors and junior creditors who are each owed $100 as a class, and shareholders. If shareholders offer to buy 20 reorganization rights, they must pay $2 each for a total of $40, which they give to the junior creditors. The junior creditors must buy rights from the senior creditors, who are obliged to sell them at $1 each -- enough to pay off their debts. The junior creditors receive 40 rights, of which they deliver 20 to shareholders and keep 20 for themselves. They may then buy the remaining 60 rights from the senior creditors at $1 each. The most senior creditors are always paid first, because they hold the reorganization rights initially.

After the auction among the creditors, another auction takes place that allows outside investors to buy reorganization rights. Again, the prices paid must cover the holders' claims. When this auction ends, all the company's stocks, bonds and loans are canceled; only the reorganization rights remain. The final holders of the rights vote on the announced restructuring plans, which may include liquidation, and the company's bankruptcy process has ended.

The whole process should take about four months, the professors estimated. No one can draw it out, and the rights to reorganize the business are sold to the highest bidder.

The auctions-based approach has received much attention in academic circles, yet it has not gained much support among policy makers. ''It's not clear who is the strong, organized body of interests who would support such a reform,'' Mr. Bebchuk said, ''because the benefits would be diffused in a very big way.''

LAWYERS who earn millions in fees under the current system, and managers who can cling to control of their companies, may provide powerful political opposition. ''They are very organized,'' Mr. Bebchuk said, ''and they don't have an interest in reforming the system.''

Nonetheless, he said, the professors' system and later models of its kind could stand up to the naysayers. ''Some people criticize market-based approaches as leading excessively to liquidation, and liquidation has this negative connotation. But it might lead to a more efficient restructuring.''



Copyright 2006 The New York Times Company

Financial "Perfect Storm" Brewing Over America's Middle Class, Says Bankruptcy Expert

New York, NY (PRWEB) April 30, 2006 --

"A weakening housing market, together with other financial currents in the U.S. Economy, represents the potential final impetus to a ‘Perfect Storm’ brewing over the American Middle Class, and, without luck or prompt legislative action, may lead to disaster, especially for homeowners.” So says Warren R. Graham, a New York Bankruptcy Attorney. The other prevailing currents threatening to collide over the heads of an unsuspecting public, claims Graham, include rising interest rates, limited recourse to bankruptcy relief and the virtual elimination of usury and other restrictions on credit card issuers.

For many millions of Americans, who live “paycheck to paycheck,” the only thing defining their status as Middle Class, and differentiating them from the so-called “Working Class” is their ownership of a home, and the equity accumulated in it. Graham points out that that equity is being eroded by two factors: the first is the threat of declining home values, and the second is the propensity of homeowners, over the last few years, to refinance their homes or take out home equity loans at very low adjustable rates to pay off high interest credit card debt. Now, Graham says, the equity is at risk, because of the softening in the market, the fact that the adjustable rates have risen consistently (and are expected to continue to do so), and the reality that much of it has already been borrowed out to pay off credit card debt, and for other purposes, such as home improvement.

Coupled with the risk of declining home equity, Graham argues, is an enormous, and, to date, largely invisible swinging of the pendulum toward the credit card issuers, and their sponsoring banks. After years of intense lobbying (on both sides of the political aisle) by that constituency, the bankruptcy laws have been extensively rewritten, so as to restrict, severely, access to certain kinds of bankruptcy relief, especially for those who, while certainly not well-off, earn above their respective state’s median income. “Credit card holders, of course, had no lobbyists on retainer,” says Graham.

At the same time, the same financial institutions have found creative ways, by re-domiciling themselves in states hungry for their business, such as South Dakota, to avoid the restrictions of usury laws. So now, observes Graham, it is not unusual for your credit card interest rate, if you are carrying a balance, to rise suddenly from that 5% “teaser rate,” to an unprecedented 32%, in the event of a default. “And worse,” Graham points out, “a ‘default’ doesn’t have to be non-payment. Your cardholder agreement, which you likely have not read, allows periodic review of debt to income ratios, and problems with other creditors as a justification to change rates on almost no notice.”

Add to that the changes in banking procedures, by which banks have restructured their “minimum payment” requirements on cardholders carrying balances, “and that monthly $250 minimum payment has now jumped to $600, or more, multiplied by the number of cards the consumer may be carrying.” The homeowner who wants to do something about this has a much harder time doing so, according to Graham. “His or her house has less equity, because of a softening market, or because it has already been tapped by the homeowner, and the cost of borrowing against it is higher, by virtue of climbing mortgage rates.”

In the meantime, the Middle Class homeowner’s income has not even remotely kept pace with these increased costs, Graham points out. “And this does not even take into account the likely substantial effect of rising gasoline and energy costs.” “And when the homeowner finally reaches the end of his or her tether,” says Graham, “ his or her income level may prevent recourse to bankruptcy. Chapter 7 liquidation may be unavailable altogether, and Chapter 13, in which a percentage of creditor obligations are paid over time, while mortgage debt remains intact, may not be feasible, because the income may simply not support the cost of financing a repayment plan.” Thus, Graham concludes, bankruptcies may be dismissed, and homeowners may have to dispose of their properties, or worse, lose them to creditors in satisfaction of their mounting debts.

According to Graham, “one does not need a crystal ball to see that a potential debacle is looming for the Middle Class homeowner.” Unless pure luck prevents these currents in the economy from coming together, or unless the U.S. Congress revisits its ill-conceived bankruptcy reform (especially that part of it geared to consumer debt) and state banking departments review their willingness to ignore usury prohibitions that date back to biblical times, disaster may await.

“The credit card industry, in the flush days of the late 1990’s started down this path,” says Graham, “and may have overplayed its hand. But without attention and intervention by legislators and regulators, the victim is likely to be the backbone of this Country—the American Middle Class.”

Bankruptcy Backfire! Is Bankruptcy “Reform” Biting the Hand that Fed it?

by: Warren Graham

As anyone who follows the world of bankruptcy knows, as of October 17, 2005, substantial and, from the point of view of consumers, painful changes were made to the Federal Bankruptcy Laws. At the behest, primarily, of the credit card providers and banks, who had been lobbying for years, new legislation was drafted and approved setting the stage for stricter requirements governing (primarily, though not exclusively) personal bankruptcy. This legislation came at great cost to its proponents, and it was expected that it would lead to fewer defaults and more repayment plans, all of which would redound to the benefit of the banks and credit card issuers.

While it is still too early to say, with any certainty, what the overall effect on defaults will be, it seems that, statistically, Chapter 7 filings are rising again, and the expected relative increase of Chapter 13 repayment plans may not, in fact, be materializing. Fewer debtors than one might expect have been disqualified from Chapter 7 relief by “means testing.”

In addition, at the same time that the new bankruptcy laws were taking effect, credit card issuers and banks were finding creative ways to avoid usury problems by domiciling themselves in creditor-friendly states, such as South Dakota, and default rates for consumers now exceed 30% in some cases. Defaults, for those consumers (virtually all of them, I daresay) who have not read the fine print in their credit card disclosures, may be caused not only by late payments, but by high debt to income ratios observed in periodic reviews by card issuers, and defaults under other credit card agreements. The consolidation of issuers, of course, means that there are only a few issuers out there now. Coupled with this have been changes to “minimum payment” rules, so that where a credit card holder carrying a balance might have been able to carry a $250 per month minimum payment, the combination of 30+% APR’s and higher minimum payment rules may have increased that to $600, or more. Multiply that by the 5 or 6 cards that a consumer might be holding, and, well, one can easily see where this is going. But that same cardholder is now facing higher obstacles to Chapter 7 filings, simply by being, statistically, in the “middle class” and exceeding his or her state’s median income.

What will the result of this be? It’s hard to tell, but one likely scenario is higher defaults with no bankruptcy option. For those cardholders who own a home, with equity, Chapter 13 may not be a viable option because of the sheer amount of debt they are now carrying, relative to their incomes, so the risk of losing their homes may be substantially enhanced. If this happens on a large-scale basis, there will surely be an outcry to “reform” the “reform.” The credit card issuers and banks, having paid dearly for this legislation, may well have overplayed their hand.

Furthermore, those cardholder who can, have, in large numbers, been paying off their balances, outraged as they are by being socked with APR’s exceeding 30%. This has already hurt the bottom line of credit card issuers and their bank affiliates, who make nothing on cardholders who don’t carry a balance. The pot of gold for them is in cardholders carrying balances and paying high rates, and even better, those consumers paying late fees when they get in over their heads, or overlimit fees when, as in many cases, the suddenly increased interest rates take them unexpectedly over their limits. Late fees and overlimit fees are often now in the $40-$50 range.

The result? Less income for the creditors as consumers have wised up. MBNA and Capital One, two huge credit card providers, are seeing their profits sink. Other credit card providers are reporting similar results. Highly dependent on your desire to run up debt, these companies are now seeing their profit margins drop sharply. In a nutshell: high consumer debt equals big profits; low consumer debt levels equals low profits.

During the last five to ten years, beginning in the halcyon days of the late 1990’s when, it seems, everyone was an internet or high tech millionaire on paper, Congress was amenable to bankruptcy reform to address real or perceived abuses. The banks had the will and the cash to finance legislation and, after years of almost getting there, finally crossed over to the “Promised Land” in 2005. By contrast, consumers, many of them unsophisticated, who had been given credit cards with low “teaser” rates, just couldn’t resist the lure of easy credit, big screen TV’s. Predictably, they acted irresponsibly.

But while the lobbyists worked their magic for MBNA and Chase, the consumer had no lobby with which to oppose bankruptcy reform. I’m sure that for the most part, they had no clue as to what was in store for them. Those consumers in the lower economic strata still have no lobby, but they will still be eligible for Chapter 7 relief. The challenge for the banks is that the pain is moving up the ladder to the middle class homeowner. The howling is bound to be heard, and soon.

Warren R. Graham Copyright 2006

Landlords Rejoice! The Bankruptcy Code Loves You

Landlords Rejoice! The Bankruptcy Code Loves You



"In the wake of the recent and very substantial changes to the nation's bankruptcy laws, the most significant beneficiaries are likely to be commercial landlords." So says Warren R. Graham, a bankruptcy lawyer with 25 years of experience, much of it representing both landlords and tenants in large Chapter 11 reorganizations."Most of the public attention, in the enactment of the new law, has been paid to consumer matters and credit card debt, given that the prime movers for the new legislation were consumer credit issuers," says Graham. "But many changes have been made in the area of business bankruptcies, which are profound, and which have received virtually no reportage."

Much of this did not seem so important since the new law took effect in October, 2005, in the midst of a vibrant economy and explosive real estate market. "But," Graham argues, "with the potential confluence of a weakening economy and softer real estate values, the prospect for commercial lease dispositions in bankruptcy cases is likely to increase dramatically, and soon.

"The new law gives a commercial tenant in bankruptcy 120 days, with a possible one-time 90 additional days, to 'assume' or 'reject' its lease. After that, unless the landlord consents, the lease reverts to the landlord. "Under prior law," said Graham, "landlords could get stuck for many months, or even years, as debtors marketed valuable leases for the benefit of their creditors, often at the expense and risk of the landlords. The uncertainty occasioned by being held 'in legal limbo' created problems for landlords wishing to sell their properties, refinance, or even, in the case of shopping centers, lease adjoining space, because of 'cross-default' and 'use-clause' provisions."

This is a particularly important phenomenon in large retail Chapter 11 cases, in which hundreds, or even thousands of leases may be implicated, and the values realized by their sales often determine the success or failure of the reorganization effort.Graham's own experience, in fact, includes the representation of one shopping center landlord, whose single lease was marketed out of three separate bankruptcies: W.T Grant, Caldor and Ames Department Stores.

According to Graham, the consensus among bankruptcy professionals is that the jury is still very much out on the benefits of the new law for issuers of consumer credit. It has, in fact, been argued that, even as those entities lobbied hard for the changes in the law, the likelihood is that their recoveries will not be materially enhanced by them.

"But there is little doubt," Graham claims, "that landlords will benefit greatly by being able to rely on a swift and certain disposition of their property interests in Chapter 11 Cases. Next year's Christmas season may come earlier for retail landlords than for their retail tenants. And the role of Santa Claus may be played by the United States Congress, with bankruptcy lawyers in the supporting roles of his elves."

Source: The Leading Articles

Copyright 2006

You're Suing ME?! Adding Insult to Injury to Creditors of Bankrupt Debtors

By Warren Graham

In the course of managing a bankruptcy-centered law practice, one notices that certain themes tend to recur. One of the things that seems, repeatedly and quite understandably, to make the blood of credit managers in bankruptcy cases boil, is the prospect of being sued for a 'preference' while they are already stuck with a bad account receivable. This seems to many vendors to be the ultimate outrage. Having shipped goods, or rendered services on credit, in good faith, and in the expectation of being paid, and then, having already been burned (often for substantial sums) by the bankruptcy filing itself, they may find themselves pursued by a trustee or other estate representative, to give back the smaller amount they received on account of their claim within the 90-day period preceding the bankruptcy filing.

After 25-odd years of minor tinkering with the preference laws as drafted in the Bankruptcy Code, which came into effect in 1979, Congress has, for the first time, and in response to intense lobbying by creditor-based interest groups, made significant, and wide-ranging changes which will, in the view of this author, work a sea change in this area.

First of all, we need to understand what a preferential payment is, and why the bankruptcy laws allow for their recovery, before exploring, in very broad strokes, for purposes of this article, how and why the recent amendments to the Bankruptcy Code have helped 'level the playing field.'
The purpose of making preferential payments recoverable is to promote equality (or, more accurately, "equitable-ness") of distribution among creditors. In other words, the pain should be shared on a reasonably equitable basis by those who are on the receiving end of bad receivables.

To that end, certain payments made by troubled debtors, during the 90-day window preceding the bankruptcy filing are subject to being brought back into the estate for redistribution, on an equitable basis, to the creditor body at large. There are a number of other technical requirements for a payment to be preferential, but these are beyond the scope of this article, and creditors are encouraged to seek appropriate legal counsel as needed.

On the surface, this seems reasonably fair. After all, why should creditors who have a closer relationship with the bankrupt company, or who just scream louder, be paid while the other guy gets left holding the bag. But, alas, here's the dirty little secret of preference claims. For the most part, though not exclusively, they are pursued, by trustees in liquidation cases, in which there will ultimately be little or no recovery for unsecured creditors. So who gets the money recovered in these preference litigations? Why, the trustees, their lawyers and accountants, of course, whose rights to payment come before everyone else. So rather than being a vehicle for equitable redistribution of limited funds of an insolvent debtor, the preference statute has been used as a tool for trustees and their professionals to build an estate as a source of trustee fees, and legal and accounting fees. In most such cases, the creditors end up with nothing at all, except the privilege of paying twice.

On the other hand, the drafters of prior legislation wanted to encourage vendors to continue selling goods to troubled companies so as not to exacerbate an already difficult situation and bring on unnecessary or premature bankruptcies. So various defenses to preference claims were introduced, to exempt certain payments made contemporaneously, or in the ordinary course of business and within invoice terms, from preference attack. These concepts, however, still left the burden on the creditor/defendant to prove these defenses, and they often found that it was easier and cheaper just to 'pay up' or settle the claims, however distasteful it seemed to them
So what has the new bankruptcy law done for these creditors? Well, it has, among other significant changes, substantially tightened up the 'ordinary course' defense, making it substantially easier for creditors to establish them, by creating both a 'subjective' and an 'objective test' (again, the details of this are too technical for the scope of this article).

Perhaps even more importantly, Congress has now exempted smaller payments from the reach of preference attack and changed venue provisions for others, thus requiring trustees or other estate representatives to sue where the preference recipient is located, rather than in the 'home' bankruptcy court. Previously, the daunting prospect of defending on the other side of the country might well induce a creditor to settle a case even of dubious merit because of the expense involved of travel and the hiring of local counsel in a far-off district. Now, in many cases, the economics of this situation have been turned on their heads, and it might well be the trustee who will have to think twice, or three times, about bringing 'nuisance' preference cases when they have to be prosecuted in foreign jurisdictions.

Thus, although this legislation is very new, and largely untested, it seems that creditors in bankruptcy cases will, at least from their viewpoint, be getting a fairer shake, and will less often be having insult added to injury by having to enlarge the size of their already uncollectible receivables.

Warren R. Graham is an attorney with the New York Law Firm of Cohen Tauber Spievack & Wagner LLP. He specializes in the field of Bankruptcy and Creditors' Rights. He is a frequent writer, contributor and commentator on legal, business, political and religious affairs. The views expressed by him in this article are his own, and do not necessarily reflect those of his Firm or its Members. Additional professional information on him may be found at: http://www.ctswlaw.com/templates/page3_attorney.asp?docid=667

E-mail: wgraham@ctswlaw.com

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