The Debtor Is Dead, Long Live the Debtor
Volume 85, No. 3, Spring 2013
By Daniel S. Mozes

Bankruptcy reorganization in the United States has traditionally offered a bankrupt debtor the opportunity to seek a “fresh start” from its creditors and reorder its affairs to move forward without the pressure of outstanding debts. Though this may be just one of many aims promoted by the current bankruptcy framework, the architecture of the present-day Bankruptcy Code (the Code)—as designed by the Bankruptcy Reform Act of 1978—is described by one commentator as a system whereby “an inadequate pie” is divided among creditors to share in the remains of a bankrupt enterprise.

Under this framework, debtors may use the Code to address a number of economic issues facing a struggling corporation, all in an effort to preserve the corporate enterprise under the debtor’s same management. There are a number of recent examples demonstrating that debtors control their fate as they reach the precipice of bankruptcy, even though we might intuitively expect debtors to seek legal protection only after creditors come in search of repayment. Indeed, the legislative history surrounding the Bankruptcy Reform Act emphatically rejected any proposition that creditors dominated the bankruptcy reorganization process:

                The notion of creditor control, while still theoretically sound, has failed in practical terms. Creditor control in bankruptcy cases is a myth. Creditors take little interest in pursuing a bankrupt debtor. They are unwilling to throw good money after bad. As a result, creditor participation in bankruptcy cases is very low. . . .

. . . . In practice, creditor control has become attorney control, and the bankruptcy system operates more for the benefit of attorneys than for the benefit of creditors. The practices that have grown out of this shift of control often work to the detriment of both debtors and creditors. They benefit only those administering bankruptcy cases.

In spite of congressional skepticism regarding the creditor’s role in reorganization, congressional faith in the debtor seems misplaced; creditors retain significant protection of their interests under the Code.

Recent analyses of corporate bankruptcies demonstrate that creditors have taken a more prominent role in the bankruptcy process, becoming a driving factor in corporate reorganizations filed under Chapter 11. Though Congress may have manifested an initial intent that the debtor would be the driver of the bankruptcy process, examples in recent years have demonstrated the immense powers retained by secured creditors. The dominance of the secured creditor in the bankruptcy process should come as no surprise—a security interest bestows tremendous advantage on a creditor to ensure the protection of its loan to a debtor. Despite the fact that secured creditor control may appear to be an inequitable outcome for a process designed to be friendly to a debtor’s fresh start, the institutional protections guaranteed to secured creditors in bankruptcy are institutional advantages bestowed by a system in which security interests are granted to creditors. In recent years, various commentators have proposed changes to the Code in an effort to prevent abuses that seem to further entrench the powers granted to secured creditors. However, the Code fundamentally manifests advantages for secured creditors in its structure, and reforms to the Code would ultimately fail to make the debtor dominant so long as secured creditors can still retain these institutional advantages. Though proposed changes might attempt to improve a debtor’s standing in the bankruptcy reorganization process to better effectuate Congress’s 1978 belief that creditor control is merely a “myth,” the structure of the Code empowers secured creditors to dominate the reorganization process.

This Comment addresses the advantages of creditor control by tracing bankruptcy legislation dating to Congress’s first statutes under its constitutional authority to make laws governing bankruptcy. After examination of the influence of nineteenth century bankruptcy legislation and New Deal reforms, the 1978 Bankruptcy Reform Act, as codified and adopted today, is examined in detail to highlight the various tools available to both debtors and creditors seeking to reorganize a bankrupt corporate entity. With a firm understanding of the Code and its underpinnings, this Comment addresses the advantages bestowed on secured creditors in bankruptcies by examining two recent bankruptcies, reviewing the important role of secured creditors in each case. In light of these case studies, Section III reviews these case studies and proposals to reform the Code with an eye towards elements of creditor control. Part III.E concludes that efforts to address creditor advantages through reforms of the Code are ultimately inadequate, as the Code institutionalizes structural advantages under the system of secured credit. Part IV concludes.

Read Comment …