Terminating the Technicality: Venue Reform, Why It’s Important, and What You Can Do About It

Posted on: November 15th, 2021 by Kate Langworthy, ABLS Blog Contributor

Bankruptcy is a legislative creation aimed at giving debtors the opportunity for a fresh start while still recognizing the rights of their creditors to be paid. Chapter 11 Bankruptcy allows an entity experiencing financial distress, typically a corporation or partnership, to seek relief through reorganization, while retaining their business in hopes of generating revenue to pay debts as completely as possible. The debtor first files its bankruptcy petition and proposes a plan for repayment. Creditors are given the opportunity to vote on whether the plan is acceptable, and after considering those votes, the court may or may not confirm the plan. The expectation is that a company will file bankruptcy where it is actually located. Unfortunately, many large companies have found a way to circumvent the statutory requirements and file in a jurisdiction with which they have no meaningful connection in hopes of obtaining a more favorable outcome.

The Technicality

The current law requires an entity to file its bankruptcy in one of two places: (1) the district where the entity’s place of incorporation, residence, principal place of business, or principal assets in the United States have been located for at least 180 days or (2) the district where an affiliate of the entity has a pending bankruptcy matter. The second option is where companies found an opportunity for creativity. Say Company X wants to file bankruptcy in front of a judge who is historically more likely to accept its arguments. By setting up a subsidiary in that judge’s district, having that subsidiary guarantee the debts of the already-struggling company, and then having the subsidiary file for bankruptcy, Company X suddenly has an affiliate with a pending bankruptcy matter there, albeit a manufactured one. Company X is then legally entitled to file its bankruptcy petition in that judge’s district and potentially have its plan confirmed when other judges would have declined.

Gymboree, Inc (San Francisco, CA to Richmond, VA)
Lee Enterprises (Davenport, IA to Wilmington, DE)
Mesa Airlines (Phoenix, AZ to White Plains, NY)
Chrysler Corporation (Auburn Hills, MI to White Plains, NY)

Purdue Pharma’s Filing

In re Purdue Pharma, L.P. is a textbook case of this tactic. Opioid manufacturer Purdue Pharma sought to use bankruptcy as a mechanism to compel acceptance of a global settlement by the plaintiffs in numerous civil actions brought against it and various members of the Sackler family who indirectly owned the corporation, as those were the company’s only major creditors. Among other things, its reorganization plan included what is known as a third-party release, which would shield the Sackler family from liability relating to Purdue’s role in the opioid crisis. Bankruptcy courts are split over whether third-party releases are an appropriate inclusion in reorganization plans, and those that allow them do so on a very limited basis. Appearing in front of the “right” judge in the “right” jurisdiction is paramount. Purdue recognized an opportunity and worked to get its matter into the Southern District of New York in front of the Honorable Judge Robert D. Drain, who had previously indicated an openness to entering a third-party release as part of a Chapter 11 reorganization plan. Over multiple creditor objections, Judge Drain approved Purdue’s reorganization plan, including the third-party release that protects the Sacklers from current and future litigation relating to the opioid epidemic. The bankruptcy plan sets aside funds for programs to be established by cities, counties, and other entities, as well as money to be paid to individuals affected by opioids after an adjudication process. However, holding members of the Sackler family liable for their role is no longer an available avenue. In exchange for paying a fraction of their estimated personal profits from the opioid epidemic over nearly a decade, the Sacklers have immunized themselves from further liability, despite objections from those harmed by the opioid epidemic.

Exploitation

The creative maneuvering employed by these companies, known as “forum shopping”, is an exploitation of flexibility purposefully built into the bankruptcy venue statute by its drafters, and Purdue is not alone in the practice. When the statute was adopted back in 1974, the committee fully expected that allowing companies multiple options for choice of venue would get the cases placed in the most appropriate court. This expectation rested on a belief that judges who found bankruptcy cases filed in their courts without a meaningful connection to the district would kick those cases to the court where it should have been originally filed “in the interest of justice or for the convenience of the parties” as they are authorized to do under 28 U.S. Code § 1412. The unfortunate reality is that judges tend not to exercise that discretion, and even if they do it often doesn’t occur until many of the most important decisions in the case have been made and after significant expenditures of money and effort by objectors. These realities only serve to encourage forum shopping.

Termination

Current legislation takes aim at closing the loophole and strengthening the integrity of the bankruptcy system while increasing public confidence and fairness. The Bankruptcy Venue Reform Act of 2021 (H.R. 4193), introduced in June of 2021, and the identical Senate bill (S.2827), introduced in September of 2021, acknowledge the practice of forum shopping and the resulting concentration of bankruptcy cases into just a few districts. The bill’s text also notes that not only does forum shopping prevent important stakeholders from fully participating in the bankruptcy process, it removes the possibility of the unchosen district participating meaningfully in the development of the bankruptcy law that will inevitably affect its constituents. In hopes of removing the enticement to forum shop, H.R. 4193 and S.2827 propose to add significantly more detail to the venue statute. Along with formatting changes that would make the statute more readable, the legislation includes important changes, including: specifically defining the term “principal place of business”; significantly limiting the option to file in a district where an affiliate has a case pending; placing the burden of proving correct venue on the entity that files the bankruptcy; and requiring cases filed in an improper venue be either dismissed or moved to the appropriate district rather than leaving it to the judge’s discretion. Leaving limited room for interpretation will go a long way to cut down on manipulation of the bankruptcy system and allow the original purpose of balancing the interests of the debtors and creditors to be accomplished.

Take Action

As Congress considers the Bankruptcy Venue Reform Act of 2021, Representatives must understand the importance of venue reform in protecting their constituents right to participate fully in bankruptcy proceedings that directly affect them. Individuals are a key factor in insuring that understanding. Contact your Senator or Representative today to encourage them to vote in favor of venue reform and closing the forum shopping loophole in Chapter 11 Bankruptcy. You may do so either by reaching out to them directly or by calling the United States Capitol switchboard at (202) 224-3121.

Sources

Lynn M. LoPucki, Chapter 11’s Descent into Lawlessness, American Bankruptcy Law Journal (forthcoming, June 2022).

https://thehill.com/blogs/congress-blog/judicial/566729-now-is-the-time-for-bankruptcy-venue-reform?rl=1

https://www.washingtonpost.com/business/2021/09/01/purdue-pharma-bankruptcy-judge-ruling/

Categories: Legislation Venue

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