Courting Failure: How Competition for Big Cases Is Corrupting the Bankruptcy Courts

Courting Failure: How Competition for Big Cases Is Corrupting the Bankruptcy Courts

by Lynn LoPucki

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ISBN-13: 9780472031702
Publisher: University of Michigan Press
Publication date: 02/14/2006
Pages: 336
Product dimensions: 6.00(w) x 9.00(h) x 1.00(d)

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Courting Failure

How Competition for Big Cases Is Corrupting the Bankruptcy Courts
By Lynn M. LoPucki

The University of Michigan Press

Copyright © 2005 University of Michigan
All right reserved.

ISBN: 978-0-472-03170-2


Chapter One

New York's Game: 1980-86

Were [transacting business in the jurisdiction] enough [to make venue proper] large corporations would be free to roam the entire country in search of venues which might provide them with what, in their opinion, would be a more favorable hearing. -United States Court of Appeals for the First Circuit (1982)

For decades before 1980, big company bankruptcies had been rare. Some said it was because modern firms were "too big to fail." The bankruptcy lawyers saw it differently. Bankruptcy was not a financial condition. Bankruptcy was a legal proceeding. Firms filed bankruptcy when bankruptcy was in the interests of the people who made the decision: top management. Under the antiquated, Depression-era law then in effect, bankruptcy seldom was. Large public companies were supposed to file under Chapter X of the Bankruptcy Act. That chapter required the managers to surrender control of the firm to a court-appointed trustee. There were ways of getting around the law, but they were awkward and risky.

The bankruptcy lawyers complained about the trustee requirement. After a decade of study and debate, Congress gave in. In 1978, it enacted a new, "modern" bankruptcy code that gave top managers the right to remain in control of their firms during bankruptcy. The House committee that reviewed the bill was remarkably frank about the reasons for the change.

Debtors' lawyers that participated in the development of a standard for the appointment of a trustee were adamant that a standard that led to too frequent appointment would prevent debtors from seeking relief under [the reorganization law] and would leave the [law] largely unused except in extreme cases.

In other words, Congress concluded that if top managers could not remain in charge during bankruptcy, those managers would not take their firms into bankruptcy at all.

The new law took effect October 1, 1979, and the procession of big cases began a few months later. Three big firms filed in 1980. The annual number of big firm filings climbed steadily through the decade, reaching 16 in 1989. Each of those cases was a bonanza for the law firms involved, with fees in the millions and often the tens of millions of dollars. The largest of those filings-by Johns Manville-alone generated court-awarded fees and expenses of $82 million. Before the new code, silk-stocking law firms in New York and elsewhere had shunned bankruptcy practice as sleazy and unprofitable. In the years following enactment, those same firms began building and advertising their bankruptcy departments.

The National Science Foundation Study

In 1986, Bill Whitford and I received a grant from the National Science Foundation to study big bankruptcy reorganization cases. Bill was a colleague of mine on the University of Wisconsin Law School faculty. Neither of us knew much about big bankruptcy reorganizations, but we figured we could learn.

The Securities and Exchange Commission helped us compile a list of every case filed in the United States by or against a public company with assets of $100 million or more. Over the next four years, Bill and I read what had been written about the cases in the financial press, obtained and analyzed the plans of reorganization, conducted about 120 interviews with lawyers in the cases, and constructed a database. Ultimately, the study covered all cases filed after October 1, 1979, in which the court confirmed a plan by March 15, 1988-a total of 43 cases.

In looking over our list of cases, we noticed that many of them had been filed in New York. That did not seem odd. New York is the financial center of the United States, and many of the country's largest firms are headquartered there. But as we learned more about the firms that filed in New York, it became apparent that many of them had only the most tenuous connections to that city. The Johns Manville Corporation, for example, filed in New York shortly after building and moving into a $40 million headquarters building in Colorado and changing its place of incorporation to Delaware. The center of Manville's operations was in Colorado; the firm had no apparent connection with New York at all. HRT, a chain of retail stores with its headquarters and center of operations in California, and Towle Manufacturing, a firm with nearly all of its operations in Massachusetts, also filed in New York. Eventually it dawned on us that many of the firms we were studying were forum shoppers.

Forum Shopping

Literally, "forum shopping" means only that a party to litigation is choosing among courts. As previously noted, the law sometimes deliberately allows such choices. Rarely do those choices threaten the legal system. Most parties use their freedom to choose courts convenient for themselves. If the courts they choose are particularly inconvenient for other parties or witnesses, the chosen courts can transfer the cases to more convenient courts.

Nevertheless, the phrase "forum shopping" is generally used as a pejorative. The phrase implies that the party choosing the court is by that choice seeking some unfair advantage. The advantage sought is usually a judge or jury biased (the squeamish may read "inclined" each time this word appears) in some manner that will benefit the party.

Laws are deliberately vague and subject to interpretation. They leave plenty of room for judges to do what they think is right, best, or expedient. The judges' decisions may be reversed on appeal. But appeals are expensive and difficult to win, so losing parties seldom take them. Even if reversal occurs, the new decision will more likely be the result of the appellate court judges' biases than law. Good lawyers know that the identity of the judge is a crucial determinant of the outcome of the case, and they seek the judge who will be best for their client.

Judicial biases are not subtle. In the courtrooms of federal judges (and death penalty opponents) Marilyn Hall Patel and William Ingram, for example, death penalty cases are likely to remain pending for over a decade, while in the courtrooms of federal judges (and death penalty proponents) Manuel Real and Edward Rafeedie, death penalties are likely to be approved in as little as two years. Debtors filing for Chapter 13 bankruptcy in San Antonio, Texas, in the early 1990s generally had to pay 100 percent of their debts, while debtors filing the same kind of case in Dayton, Ohio, generally had to pay only 10 percent of their debts. The supply of such examples is virtually unlimited.

One might expect lawmakers to respond to bias by tightening the instructions to judges on how they should rule. If done effectively, that would insure the law's ideal: rules that are the same for everyone. Instead, the law's response is so peculiar that most people do not even connect it with the bias problem. Courts randomize the assignment of judges.

Most courts consist of a "panel" of judges to whom the clerk of the court can assign a particular kind of case. The number of judges on a panel commonly ranges from two to 20 or 30. Each clerk has some mechanism for assigning cases randomly among the members of the panel. For example, in the courts of Florida's Eighth Judicial Circuit, where I practiced, the clerk used tokens. Each was inscribed with the division letter of a particular judge. The clerk mixed a large number of those tokens in a drawer. When someone filed a case, the clerk reached into the drawer-while looking at the ceiling-and drew one of the tokens. The clerk assigned the case to the judge whose division letter appeared on the drawn token. Today, clerks more frequently use computers to make random assignments, but the principle remains the same.

Any effort to evade the randomness of the draw is considered a serious ethical breach. That does not keep some lawyers from trying. A lawyer may be able to evade the draw by filing the case with a particular judge at the judge's home on the weekend. To do that, the lawyer must assert some "emergency" requiring that the case be filed before the clerk's office opens on Monday morning. Another technique is to assert that a newly filed case is so closely related to a case already assigned to the desired judge that the new case should be assigned to that judge without a draw. Sometimes a feared judge goes out of the draw temporarily because the judge is ill or overloaded with cases. Lawyers wait for these opportunities to file. The lawyers learn about them from friends who work in the clerks' offices.

Another way to beat the draw is to file several cases and then dismiss all but the one assigned to the desired judge. For example, Geoffrey Feiger is a Southfield, Michigan, plaintiff's lawyer famous for his successful representation of Dr. Jack Kevorkian, who assisted suicides in the 1990s. When Feiger sought to challenge a ruling of the Michigan Supreme Court in a federal district court, he filed 13 lawsuits. On the thirteenth, Feiger must have drawn the judge he wanted. He dismissed the first 12, leaving just that one pending. When the court figured out what he had done, the court sanctioned Feiger, imposing a $7,500 fine. In another case, Mayer Brown & Platt, the prominent Chicago firm, was sanctioned by a Cook County circuit court. A partner and an associate of the firm filed five identical complaints in an attempt to draw one of three preferred judges. In imposing a total of $5,000 in fines, the judge expressed dismay that Mayer Brown "would cheapen itself in this fashion."

What is peculiar about random judge assignments as a remedy for judicial bias is that the remedy does nothing to cure or even mitigate the problem. Random assignment makes judges no less biased. What it does is distribute the effects of judges' biases randomly among litigants. Every litigant has an equal chance of falling victim to every kind of bias. As the editors of the Harvard Law Review put it: "Forum shopping violate[s] fair play by allowing parties to circumvent fate."

To prevent parties from circumventing their fate with respect to judges, the system must do more than prevent them from choosing among the members of a panel. The system must also prevent them from choosing among panels. The choice of a city is the choice of one panel of judges over another. That is merely a stochastic circumvention of fate but nevertheless an important one. If the city chosen has only a single judge, the choice of city is a choice of judge, just as surely as in the scheme Geoffrey Feiger used.

Preventing litigants from choosing among judges by choosing among cities is more difficult than preventing them from choosing among judges within a city. Cases can't be randomly assigned to cities; they must be heard in cities that are reasonably convenient to the parties, their lawyers, and the witnesses. But the most convenient city for a particular case may be difficult to determine, even after a case is well under way. That is particularly true in big bankruptcy cases. At the time a big bankruptcy case is filed, even the debtor may not know who will be an active participant. The uncertainty provides cover for lawyers who choose courts for their judges' biases but claim they have chosen them for the geographical convenience of the parties.

The Bankruptcy Venue Game

Bill Whitford and I decided to look further into bankruptcy forum shopping. What we found was a highly permissive venue statute, an imaginative array of strategies for taking advantage of the statute, and a high judicial tolerance for those who simply ignored the statute and filed their cases wherever they pleased.

In the mid-1980s, approximately 300 bankruptcy judges were distributed among approximately 200 panels in the 98 federal court districts. In less populated areas, the panel often consisted of a single judge. In large cities, there were usually three or four. The panel in Los Angeles was the largest with eight; New York had five.

The bankruptcy venue statute, which has not changed since 1978, recognizes four connections between a debtor and a court, any of which makes the court a proper venue for the debtor's bankruptcy. The four connections are that the court is (1) at the "domicile or residence" of the debtor, (2) at the debtor's "principal place of business," (3) at the location of the debtor's principal assets, or (4) where the bankruptcy case of an affiliate is already pending. The first of these choices, domicile or residence, would later play a major role in the forum shopping. That role is explained in chapter 2. In the 1980s cases Bill and I studied, however, it played no role at all.

Principal Place of Business

Imagine the "principal place of business" of a major corporation and you may get an image of a big industrial plant with an executive office building at the front. But even by the 1980s, that image was largely obsolete. Major U.S. corporations typically did business at numerous locations, whether those locations were industrial plants, chains of hotels or restaurants, or airline hubs.

If the bankruptcy courts were writing on a clean slate, they might have interpreted "principal place of business" to refer to the largest of those operations or the one through which the most business was done. But "principal place of business" is what the lawyers call a "term of art"-a phrase that originated in the English language but has a different meaning when used as legal jargon. Long before it appeared in the bankruptcy venue statute, "principal place of business" had been interpreted to mean the headquarters of the firm-the so-called nerve center from which the firm's operations were directed.

Now the image you get of a firm's "principal place of business" may be a gleaming skyscraper bearing the firm's name. Many firm headquarters fit that image. But the nerve center of a firm can be little more than the office of the chief executive, remote from the rest of top management. Move the chief executive officer and you at least arguably move the principal place of business. AM International, for example, had most of its operations in the Chicago area. But in the five years before it filed its first bankruptcy in 1982, the firm moved its headquarters from Chicago to Cleveland to Los Angeles and back to Chicago. The purpose of these moves was not to manipulate venue but merely to accommodate a series of chief executive officers who did not want to move to Chicago. Each managed the business from his or her home city. Another of the 43 firms we studied, Evans Products, moved its headquarters from Portland, Oregon, to Miami, Florida, about a year before filing in Miami. Evans Products had been taken over by Miami financier Victor Posner. Posner lived in Miami and chose to run the Oregon firm from his home city.

Some of the firms we studied did move their headquarters to manipulate venue. Tacoma Boatbuilding owned and operated a shipyard in Tacoma, Washington. The shipyard was the firm's sole place of business. Not surprisingly, prior to the financial difficulties that brought Tacoma Boatbuilding to bankruptcy, the firm's headquarters were at the shipyard.

Tacoma is one of the approximately 200 cities in the United States that has both a bankruptcy court and a clerk's office. That court was certainly Tacoma Boatbuilding's natural venue. But Tacoma is in the Ninth Circuit, and the Ninth Circuit Court of Appeals at that time required firms to pay interest on their secured debts while the firms remained in bankruptcy. Tacoma Boatbuilding wanted to file in Second Circuit, where the Second Circuit Court of Appeals made debts of the kind Tacoma Boatbuilding owed interest free.

Tacoma Boatbuilding rented a small office in Manhattan, declared that office the firm's headquarters, waited the 90 days a new connection must exist before it is recognized for venue purposes, and filed its bankruptcy case in New York. The banks objected to New York venue, but Judge Burton R. Lifland ruled in favor of the company. The case stayed in New York. Among other advantages, Tacoma Boatbuilding was not required to pay interest on about $5 million in bank loans-interest the company would have been required to pay if the case had been transferred to Washington. Through the entire episode, Tacoma Boatbuilding continued to list Tacoma, Washington, as its "principal executive offices" on the annual reports the firm filed with the Securities and Exchange Commission. Nobody seemed to have noticed.

Baldwin-United was another big debtor that sought to choose its bankruptcy court by moving its headquarters. That company was a Cincinnati, Ohio, conglomerate that had begun life as a piano maker. When Baldwin-United filed in 1983 with $9 billion in assets, the firm was by that measure the largest ever to file bankruptcy. Six months before filing, Baldwin-United named Victor Palmieri, a well-known distressed property liquidator, as its chief executive officer. Instead of moving to Baldwin-United's Cincinnati headquarters, Palmieri moved into New York offices of BaldwinUnited, saying that New York "was a good location for negotiation with the various Baldwin creditors." Because Palmieri was in New York and directed the firm's operations from New York, New York was arguably both the nerve center of the company and a proper venue for the firm's bankruptcy filing. Baldwin-United filed in New York.

(Continues...)



Excerpted from Courting Failure by Lynn M. LoPucki Copyright © 2005 by University of Michigan . Excerpted by permission.
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Table of Contents

Contents

A Note on the Statistics in This Book....................xi
Prologue....................1
Introduction....................9
1. New York's Game: 1980-86....................25
2. The Rise of Delaware: 1990-96....................49
3. The Federal Government Strikes Back....................77
4. Failure....................97
5. The Competition Goes National....................123
6. Corruption....................137
7. The Competition Goes Global....................183
8. Global and Out of Control?....................207
9. Ideology....................233
10. Conclusions....................245
Notes....................261
Glossary....................301
Index....................309

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