My name is Professor Kathryn Heidt and I have been designated to present the American Bar Association’s views on the trend of certain federal government agencies seeking new claim priorities under the Bankruptcy Code.

The ABA adopted a policy in 1991 regarding amendments to the Bankruptcy Code and new priorities. In this policy, the ABA (1) opposed amendments to the bankruptcy code without the opportunity for open hearings, on well-publicized notice, before the House and Senate Judiciary Committees; and (2) opposed the enactment of new priorities absent compelling circumstances.

THE GOVERNMENT AS REGULATOR IN A BANKRUPTCY PROCEEDING

First, due to an exception to the automatic stay, the government is permitted to continue to regulate those in bankruptcy. Second, the ABA believes that legislation may be necessary, rather than non-uniform court decisions with respect to the government as regulator or creditor in a bankruptcy proceeding.

For legal reasons involving due process and other constitutional considerations, and also for reasons of basic fairness for those that arrange their legal affairs with a view towards existing law, the ABA believes that any legislation in this important area should be prospective only.

The ABA policy is to promote deliberate decision-making when making significant changes to the Bankruptcy Code, and in particular, to the priority scheme of the Code. The ABA’s policy is also to dissuade, absent compelling circumstances, the creation of new priorities or retroactive legislation.

Mr. Chairman and Members of the Subcommittee:

My name is Professor Kathryn Heidt and I have been designated to present the American Bar Association’s views on the trend of certain federal government agencies seeking new claim priorities under the Bankruptcy Code.

I am a visiting professor at the University of Pennsylvania Law School and a professor at the University of Pittsburgh School of Law. I also serve as the current vice chair of the Business Bankruptcy Committee of the Business Law Section of the American Bar Association, a committee consisting of 1,500 bankruptcy lawyers, professors, and judges representing all aspects of the legal profession concentrating on business bankruptcy law. In that capacity, I have been authorized to express the position of the American Bar Association, and its more than 400,000 members, on the important issues raised in this oversight hearing.

The ABA appreciates the opportunity to present testimony to this distinguished Subcommittee. We welcome the opportunity to work with you and your staff to improve the law and serve the interests of the public.

The ABA House of Delegates has deliberated on bankruptcy policy regarding priorities and regarding the best procedures for amending the Bankruptcy Code in this regard. In 1991, the House of Delegates passed the following resolution:

RESOLVED, that the American Bar Association opposes the amendment of the Bankruptcy Code by a legislative process which avoids fair opportunity for open hearings, on well-publicized notice, before the Judiciary Committees of Congress (the Committees in whose jurisdiction bankruptcy legislation is vested); and it is

FURTHER RESOLVED, that the American Bar Association opposes the enactment, in the absence of the most compelling circumstances, of special interest legislation designed to increase the types of claims entitled to priority under the Bankruptcy Code.

A copy of the ABA’s policy and the accompanying report is attached as Appendix A.

The first part of this resolution is about process. The ABA believes that bankruptcy legislation should be enacted only after an opportunity for full and deliberate hearings before the House and Senate Judiciary Committees and their relevant subcommittees.

The second part of this resolution recognizes that Congress has always given priorities to certain governmental claims to a limited extent. However, the ABA resolution takes the position that no new priorities should be granted without careful consideration and in the absence of compelling circumstances.

The primary function of the bankruptcy process is to gather together an insolvent debtor’s assets and to distribute those assets fairly among the debtor’s creditors. This policy is modified somewhat by the establishment of priorities--payments "off the top"--to accomplish certain limited goals.

The Bankruptcy Code allows, for example, a first priority for costs of administration, i.e. costs incurred during the administration of the bankruptcy estate after the bankruptcy petition is filed. This historical priority recognizes that, in order to encourage suppliers to provide the goods and services needed to preserve or enhance the bankruptcy estate, and in order to encourage lawyers and others to perform required services, they will have to be paid in cash or at least be promised "good payment."

Although some priorities are necessary in the Bankruptcy Code, a major reason that the bankruptcy laws, and particularly the Chapter 11 reorganization process, have worked well in the United States is that priority payments are relatively limited. For these and other reasons, the ABA believes that new priorities should not be created under the Bankruptcy Code absent compelling policy or practical circumstances.

When priorities are created, two factors are important:

1. In a case where the debtor is liquidating, a priority takes money out of the pool for other creditors. This includes trade creditors whose business may depend upon some recovery.
2. In a reorganization case, these priorities must be paid up front, which hampers—and sometimes may even preclude--the ability to reorganize.

When Congress considers whether a new priority is necessary and appropriate, these factors should be taken into account. As discussed below, we believe that Congress, not the courts, should make these important decisions.

Section 362(b)(4) is intended to allow governmental units to continue their regulatory roles despite bankruptcy. Of course, no one wants bankruptcy to be a haven for lawbreakers. Nonetheless, the current statute contains an ambiguity. The text of the section is as follows:

2. The filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay…

(4) under paragraph (1), (2), (3), or (6) of subsection (a) of this section, of the commencement or continuation of an action or proceeding by a governmental unit or any organization exercising authority under the Convention on the Prohibition of the Development, Production, Stockpiling and Use of Chemical Weapons and on Their Destruction, opened for signature on January 13, 1993, to enforce such governmental unit’s or organization’s police and regulatory power, including the enforcement of a judgment other than a money judgment, obtained in an action or proceeding by the governmental unit’s or organization’s policy or regulatory power.

The basic ambiguity is when the regulatory interest is intermeshed with the regulatory agency’s pecuniary interest. For example, everyone would agree that the regulatory interest would allow an agency to continue to enforce anti-pollution laws. However, the question arises with regard to the costs of cleanup of pre-bankruptcy environmental regulations.

There are two ways to deal with the regulator or government as creditor. Congress can legislate on the issue. Alternatively, bankruptcy judges can decide issues as they come before them. The ABA believes that we need legislation on this subject to resolve, on a uniform national basis, the important policy and social issues involved. The ABA believes that a legislative solution, arrived at in the deliberative manner referred to above, is the best solution.

For legal reasons involving due process and other constitutional considerations, and also for reasons of basic fairness for those that arrange their legal affairs with a view towards existing law, the American Bar Association believes that any legislation in this important area should be prospective only.

Most American laws are designed to operate prospectively. Although Article 1, Section 9 of the U.S. Constitution only expressly prohibits the enactment of retroactive criminal statutes, the same equitable principles should apply to many retroactive civil statutes as well. Generally speaking, it is fundamentally unfair to change rights that existed, and on which citizens relied, prior to the time that Congress changed the law.

When the Bankruptcy Reform Act of 1978 was enacted in November, 1978, it was to govern bankruptcy cases prospectively. The Act specified an effective date of October 1, 1979, and all bankruptcy cases in existence prior to that date continued to be governed by the Bankruptcy Act of 1898. Congress’ decision to make the new law prospective was entirely appropriate and proper, and it allowed businesses throughout the country to plan accordingly.

For these reasons, the ABA encourages Congress to avoid retroactive amendments to the Bankruptcy Code.

The ABA policy is to promote deliberate decision-making when significant changes to the Bankruptcy Code are made. Such deliberations are necessary with respect to the Bankruptcy Code in general and the Code’s priority scheme in particular. The ABA’s policy is also to dissuade, absent compelling circumstances, the creation of new claim priorities, and to dissuade the creation of Bankruptcy Code amendments that are retroactive in nature.

Should you wish further input on this or other bankruptcy subjects, the ABA and the Business Bankruptcy Committee would be pleased to provide them.

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