By Katy Stech

September 8, 2011

Weighing legislation that would divert large corporate bankruptcy cases away from the two top courts that now handle most of that work, federal lawmakers heard testimony from an expert panel that largely countered the doomsday predictions from the legal community over the consequences of such a change.

Listening to a panel of academics, legal professionals and a bankruptcy judge, lawmakers on a House Judiciary subcommittee Thursday explored whether banning the practice of corporate bankruptcy "forum shopping" would give a voice to lower-profile stakeholders in bankruptcy cases, including employees, businesses owed small sums of money and retirees.

"Creditors can get left behind when cases are filed in a remote court," said Peter Califano, a San Francisco bankruptcy attorney who spoke for the Commercial Law League of America advocacy group.

The rule would remove the language loophole that allows companies to file for bankruptcy protection where they're incorporated or where they operate much-smaller affiliates. If passed, corporations would have to file in a court near their principal place of business or where most of their assets are located.

For years, the bankruptcy courts in Manhattan, the epicenter of the bankruptcy bar, and Delaware, where many U.S. businesses are incorporated, have handled nearly all of the headline-garnering bankruptcy work. The proposed legislation has rattled the legal infrastructure that has built up around those cases, even though earlier attempts to change the rule have failed.

The hearing drew one spectator who would normally be among those asking the questions: Democratic Rep. John Carney of Delaware. Unable to officially speak at the hearing because he's not a member of the subcommittee, Carney attended out of concern for his district, where hundreds of legal professionals are on edge.

He later defended forum shopping, likening it to a patient who seeks out a top surgeon to execute a major medical procedure.

"From a business perspective, companies are choosing the court that they want to use to get restructured and running again," said Carney, adding that creditors already have a voice through a committee that typically forms to represent their interest. "This is the venue of choice for Corporate America."

Still, lawmakers at the hearing made it clear how unsettling it has been to watch marquee corporations of their regions---Detroit's auto makers and the Los Angeles Dodgers baseball team, to name a few---seek the shelter of bankruptcy protection in a faraway court. Panelists empathized with them.

"Communities identify strongly with their corporate citizens," said Judge Frank J. Bailey of the U.S. Bankruptcy Court in Boston. He added that the ability of "iconic" companies to pick their bankruptcy court "undermines confidence in the process."

Bailey counted more than 30 Massachusetts companies---including camera maker Polaroid Corp. and solar panel manufacturer Evergreen Solar Inc.---that have sought protection outside the commonwealth's courts since 2000. By his estimate, those corporations employed 30,000 workers all told.

Critics of the current system say forum shopping is so accepted that companies barely bother to justify where they chose to seek protection from creditors. Borders Group Inc. of Ann Arbor, Mich., filed for Chapter 11 protection in Manhattan because of the handful of bookstores it operated there. Chrysler pointed to assets held by an affiliate in New York when it chose to file there.

Democratic Rep. John Conyers Jr. of Michigan filed the legislation along with cosponsor Republican Rep. Lamar Smith of Texas, who noted during the hearing that disgraced Houston energy company Enron Corp. sought Chapter 11 protection in New York.

The proposal has left lawmakers trying to figure out just how problematic it would be for bankruptcy judges in far-flung courts unaccustomed to handling high-profile cases to sort out a major company's financial problems.

Some bankruptcy-law academics have speculated if eliminating forum shopping would lead to an escalation of bankruptcy costs--a fluctuation that could ultimately cut into the money that creditors would recover.

Would bankruptcy judges in outside courts scrutinize the eye-popping hourly rates that bankruptcy professionals charge, arguing that they stand as a struggling company's last hope? Or would legal costs stay high because the top restructuring professionals would have to travel to hearings away from their firm headquarters?

The proposal's lone critic at the hearing, University of Pennsylvania Law School professor David Skeel, called the change "an enormous but well-intentioned mistake." He argued that concerns over creditor protections were overblown and that judges in the two main courts have expertise that makes the process efficient.

"Most small creditors don't want to be active in a case," he said. "It takes time and often money."

Rep. Trey Gowdy (R., S.C.) challenged Skeel to identify bankruptcy judges outside of New York and Delaware who lack experience to handle major cases. Later, Bailey, the Massachusetts bankruptcy judge, defended his colleagues.

"There are complications in any case," he told Bankruptcy Beat.

Though the proposal has secured sponsors from both political parties, it's unclear whether there's enough legislative interest in the matter for it to pass. Thursday's hearing only attracted a handful of lawmakers on the Judiciary Subcommittee on Courts, Commercial and Administrative Law. Subcommittee Chairman Howard Coble (R., N.C.) had to delay the start until enough lawmakers showed up to create a quorum.