COVID to Test Bankruptcy Infrastructure

The COVID pandemic prompted  global economic problems that many predicted would lead to an unprecedented number of corporate bankruptcies. The predictions were wrong, largely because governments responded with extraordinary measures. Congress, for example, pumped trillions of dollars into the U.S. economy in the form of both grants and loans, and the Federal Reserve kept interest rates historically low. Companies received enough money to continue operating despite their lack of cash flow, yet many were left with unprecedentedly large amounts of debt on their balance sheets.

Perhaps a robust economy will allow the companies to grow out of their debt burden. If not, a spike in interest rates or a recovery less vibrant than expected would force many large businesses to seek to restructure their debts under Chapter 11. To prepare for the possible increase in bankruptcies, Congress should act now to build up a bankruptcy infrastructure sufficient to handle them. In particular, Congress should require that every federal circuit create a “business bankruptcy panel” designed to administer the Chapter 11 filing of large companies. These panels would be staffed by a small number of existing bankruptcy judges drawn from the circuit.

As is well-known, three bankruptcy districts handle the largest share of big cases – the District of Delaware, the Southern District of New York, and the Southern District of Texas. It is by no means clear that the three of them could deal with a significant increase in caseloads. By creating expertise across the country, though, the system would be prepared for any future rise in cases – and would not require additional resources. Instead, a small number of sitting judges would be tapped in each circuit by its Judicial Council to staff the panel. If a rise in cases did not come, these judges would continue to handle their normal dockets. But if cases filings did increase, there would be sufficient judicial capacity to ensure that the cases were managed with expertise.

This change would also have a positive effect on the on-going – some may say never-ending – debate over bankruptcy venue. Serious concerns have been raised over the years that the dominance of a small number of venues for large corporate cases is skewing corporate bankruptcy law in deleterious direction. For example, it has been pointed out that having only three courts handle large cases means that important issues of statutory interpretation often are not considered by a wide range of judges. If more courts handled these cases, this worry would be ameliorated.

A major concern with the creation of specialized panels in each circuit could be that it would exacerbate what some view as an already existing race to the bottom, with 12 jurisdictions rather than just three competing for cases; the race to the bottom would become a sprint. Yet distressed companies understandably want their cases handled by experienced judges. Rather than prevent a company from choosing the most favorable venue only after it is in distress and arguably in conflict with its creditors, companies could specify a venue in their corporate charters, thus ensuring that creditors could ascertain where a future Chapter 11 case would be heard.

Indeed, the Delaware Supreme Court’s decision in Salzberg v. Sciabucucchi suggests that such a provision would be upheld under current Delaware law. The court ruled that Delaware’s corporate law allows a company to specify in its charter that any future securities action be filed in federal court. The validity of such a forum selection clause strongly suggests that a requirement that a Chapter 11 case be filed in a particular venue would be valid as well.

This post comes to us from Professor Robert K. Rasmussen at the University of Southern California’s Gould School of Law. It is based on his recent article, “COVID-19 Debt and Bankruptcy Infrastructure,” available here.