Testimony Submitted to the American Bankruptcy Institute Commission to Study the Reform

TESTIMONY SUBMITTED TO THE AMERICAN BANKRUPTCY INSTITUTE COMMISSION TO STUDY THE REFORM OF CHAPTER 11

Mark A. Gittelman, Esquire

Chief Practice Counsel – Asset Recovery

PNC Bank, National Association

November 1, 2013

My name is Mark Gittelman. I am the chief internal bankruptcy lawyer at PNC Bank, National Association and have been employed in that, or a similar, capacity by PNC for 20 years. During the course of my tenure at PNC, I have been involved, directly or indirectly, in thousands of workout matters, many of them involving a bankruptcy filing by one or more obligors. In the large majority of those matters, PNC has been in the role of senior secured creditor.

Prior to my time at PNC, I learned my craft at the Blank Rome law firm under the supervision of such noted bankruptcy lawyers as Leon Forman, Ray Shapiro, Harvey Forman, Mort Newman and Tom Biron. In addition to working as an associate for these practitioners, I honed my knowledge of bankruptcy law, practice and creative thinking under each of them.

I would like to thank the Commission for this opportunity to share my personal experiences and observations about the operations and current state of the Bankruptcy Code and current bankruptcy/workout practices with them. While there are other lawyers who may be more experienced in the court system or studied in the law than I am, I would like to share the observations of a lawyer who is also steeped in a business setting and who sees these cases not only as a lawyer but also with a direct business focus. That focus must also be taken into account when considering changes to the law or court structure to encourage use of the overall process. Unlike many other areas of the law, the business and financial focus has a significant and direct impact on the operations of the bankruptcy process.

I should add that these views do not represent statements, positions or opinions of PNC Bank, National Association or The PNC Financial Services Group, Inc. They are offered solely as my own personal views and observations, as focused and shaped by my excellent team of bankruptcy lawyers at PNC.

Finally, I would like to thank Judge Kevin Carey for inspiring and encouraging me to offerthese observations. Given the charge to this Commission, Judge Carey suggested to me that the Commission would be very interested to hear the thoughts of a secured creditor from the creditor’s (and not the creditors’ lawyer’s) point of view.

The charge of the Commission is as follows:

In light of the expansion of the use of secured credit, the growth of distressed-debt markets and other externalities that have affected the effectiveness of the current Bankruptcy Code, the Commission will study and propose reforms to Chapter 11 and related statutory provisions that will better balance the goals of effectuating the effective reorganization of business debtors—with the attendant preservation and expansion of jobs—and the maximization and realization of asset values for all creditors and stakeholders.

It is a true statement that secured credit now permeates many capital structures, especially among distressed companies. In addition to seeking credit for normal working capital, borrowers obtain syndicated secured financing (using one or more tranches), secured equipment financing, secured real estate financing, secured derivative exposure, secured second lien or mezzanine financing, focused factoring on selected receivables, securitized financing using a range of different structures and financing vehicles, along with other very sophisticated financing methods. In fact, it is not unusual to have more than one creditor holding collateral at the outset of a bankruptcy case.

According to statistics released by the Commercial Finance Association, outstanding asset based loans (to the riskiest customers), aggregated $325.9 Billion at the end of 2002 and $545 Billion at the end of 2007. However, at the end of 2011, during an economic downturn, outstanding asset based loans totaled only $69.5 Billion. All of that working capital formerly manifested as asset based loans needed to be replaced from other sources – meaning that other forms of secured debt were now appearing on leveraged balance sheets. These new creditors can be very sophisticated and are often not regulated, meaning that the creditor can insist upon a much more intrusive role (i.e., Board seats, option kickers, etc.) than traditional secured lenders.

When a borrower struggles with liquidity, the unregulated secured lender has far more restructuring options than traditional workout/bankruptcy strategies. These secured creditors are generally pushing for a swift resolution for a return on investment (or reduction in reserves), and want to avoid a long and costly bankruptcy case. Traditional secured creditors have similar desires, but may not want to be as intrusive in the debtor’s operations.

Further, secured lenders have no clear expectations on case outcomes when bankruptcy is involved, unless an articulated reorganization plan or sale is in place. Venue, judge choice, local rules and practices, and even long ago prior experiences and lore built over time may color these expectations. So, when it is not clear that a quick resolution is easily obtainable via Chapter 11, the workout is often run through some other reorganization means, such as a receivership, an Assignment for the Benefit of Creditors or some consensual out-of-court process instead, mainly for cost, certainty of result or efficiency reasons. Finally, as secured lenders have more roles in a borrower’s capital structure, a distressed or illiquid borrowerdoes not often have the capital or cash flow to withstand a long case, making expediency an overriding factor ahead of a more reasoned outcome.

Consequently, Chapter 11 is no longer being used for true reorganizations in the manner it was envisioned when originally enacted. Now, the “normal” Chapter 11 leads either to a fairly quick 363 sale or to a forced or orderly liquidation of assets, even though some courts do not recognize this methodology as proper in completing a liquidation of the estate and distribution of proceeds. Even General Motors was up and running as a new entity within weeks of its initial petition date, via an orchestrated 363 sale. It would appear that the time of the two-to-three year reorganization case has passed.

However, in my view, the growth of secured debt and heightened sophistication of creditors in the capital structure does not lead to the conclusion that changes in the Bankruptcy Code are needed to accommodate or offset these new facets of commercial finance and workout. In fact, the growth of the role of the sophisticated investor in each capital structure could be considered to be a benefit to the overall reorganization process, if the process can be accessed and used properly.

Thomas Jefferson wrote (as these words appear on the walls of the Jefferson Memorial):

I am not an advocate for frequent changes in laws in constitutions, but laws and institutions must go hand in hand with the progress of the human mind. As that becomes more developed, more enlightened, as new discoveries are made, new truths discovered and manners and opinions change, with the change of circumstances, institutions must advance also to keep pace with the times. . .

My view is that the reorganization process, not the governing law, must be modified to account for the more sophisticated investor and the needier borrower to provide a swifter and more efficient resolution to a prospective reorganization.

One of the things I have learned as an in-house lawyer at a financial institution is that a designed process gains its highest and best use when it is transparent, accessible and relatively efficient, with a level of certainty of result. When a process and its outcome appear to be inconsistent, unintelligible, opaque or overly expensive or long, the process is ignored when other alternatives are available, or only used with the understanding that the process itself will include these painful characteristics (notwithstanding the outcome). My view is that creditors and debtors are now avoiding the bankruptcy reorganization process specifically for those reasons. Unless the process provides some level of certainty in result (i.e., a liquidation or a quick sale, when the buyer insists on the protection of a Section 363(m) sale order), other reorganization means are being explored.

And while other reorganization means certainly provide a healthy and competitive counterbalance to the bankruptcy process (and their use should be encouraged), modifications to the current bankruptcy process will only aid the overall ability of distressed debtors to obtain a “fresh start”.

Accordingly, my recommendations to this Commission are to consider changes to the Chapter 11 reorganization administrative process, not to the underlying governing law. Specifically, changes to the court system, to the Committee process, to the initial stages of the case and to the fee structure in each case, as detailed below, will encourage more transparency, consistency and efficiency in reorganization cases. These changes should encourage greater use of the system.

The immediate goal of these recommendations is to create more consistency and transparency in procedures and practices to encourage use of the bankruptcy process. Many of the recommendations are aimed at the structure of the court and committee system, to emphasize the strengths of the bankruptcy professionals working in the system itself and to give a level of continuity and consistent expectations to debtors, creditors, equity holders and their respective lawyers who opt to use the process. Once the system has clearer processes, access points and expected outcomes and the costs and time constraints have expectation horizons, then all parties can gain greater confidence in the system itself.

To the extent that the Code itself is deficient in some way, given new types of creditors and debtors, I am confident that Bankruptcy Judges and other professionals will craft opinions to use the current legal structure to account for those deficiencies, rather than advocating for wholesale changes to the Code itself. New and untested laws and procedures will only further undermine debtor and creditor confidence in the system, while no serious dysfunction in the Code exists.

RECOMMENDATION 1: New Court Structure

Currently, our Bankruptcy Judges are drawn from all practices, some primarily consumer, some primarily commercial and some having practiced in both areas. However, as the courts are structured, these professionals hear cases from both the commercial and consumer sides of the law, notwithstanding their practice expertise. Observationally, there does not appear to be any standard for the assignment of cases based on experience or expertise, such that a judge, who is traditionally trained in consumer protection (or consumer collection) could be hearing an adversary proceeding regarding interest rate derivatives while a judge, who is traditionally known as a commercial bankruptcy expert, potentially with no experience in the Chapter 13 arena, could primarily hear Chapter 13 confirmation cases. My recommendation is to create a clear separation between commercial cases and consumer cases to capitalize on the particular proficiencies of the judges sitting in that Bankruptcy district.

A number of state and municipal court systems have addressed these same issues by establishing “Commercial Court” systems, so that the judges sitting on these courts have significant commercial experience to adjudicate complex commercial cases. Two such examples exist in Philadelphia County, PA and Orange County, FL, making those jurisdictions (and venue choices) more palatable to parties seeking to resolve a commercial dispute.

Under this new structure, each Bankruptcy district could be similarly bifurcated to create a commercial bankruptcy court and a consumer bankruptcy court. Jurisdiction would be determined by the type of case filed – an individual case would fit into the consumer court jurisdiction unless a sole proprietorship were involved and non-individual debtors would be placed in the commercial court system. While the initial filing issues and time periods in the Code and Rules for administering and completing a case need not change, specific consumer and commercial rules reflective of the inherent differences in the cases could be established.

RECOMMENDATION 2: Creation of a Mega-Court for Large and Complex Bankruptcy Cases

In addition to the bifurcation of commercial court and consumer courts, the court system needs to recognize, formally, the need for courts specifically designated to handle the most difficult and complex cases. That recognition informally exists now, as the largest cases tend to file in New York or Wilmington and occasionally stretch the rules of jurisdiction and venue to be accepted there. The Bankruptcy system should establish specifically trained courts to process these difficult cases, and allow for jurisdiction in such courts for all of these cases. The prospect of the next “General Motors” or “Worldcom” case being heard by a court primarily hearing consumer cases in a jurisdiction with a low volume of commercial cases, is a daunting one for all potential parties.

As to size or complexity of the case to fit within this new court’s jurisdiction and the location of these “mega-courts”, I would leave both decisions to the Commission’s deliberations. But it does appear somewhat clear that there are already ad hoc “mega-courts” in New York, Wilmington, Chicago, and perhaps Dallas and Los Angeles. Those are logical and well-located venues for these types of cases.

RECOMMENDATION 3: Bankruptcy Judges Should Rotate Among Jurisdictions

As an employee in a large company with a growing footprint, I have observed that the most efficient way to effect standardization and uniformity among various markets is to rotate superior performers with organizational knowledge to different cities or markets, to share expertise and to conform practices across the entire system. I have also learned that a Pittsburgh workout is very different from a New Jersey workout or a Raleigh workout or an Orlando workout, as each region has different business practices, economic conditions, and frankly, social expectations of the parties.

However, the Bankruptcy court system need not be so regionally idiosyncratic. The first day practices, expectations on use of cash collateral, expectations on plan confirmation, etc. in a Chapter 11 case in Orlando should be the exact same in Raleigh, Pittsburgh or Newark and the filings and expected outcomes should be similarly uniform, to discourage forum shopping and to promote confidence in the system by all parties. Rotation of judges among different cities or districts, even within the same circuit, would be an efficient method of accomplishing this goal.

RECOMMENDATION 4: The Selection Process for Estate Professionals and Their Fee Structures Should be Transparent and Uniform

One of the most frequent concerns that I hear about the bankruptcy process from both creditors and debtors is the potential for large and unabated professional fees, especially those of attorneys and other financial professionals. We all know that law firm rates are high and increasing. Further, even while fee applications for professionals retained under Section 327 of the Code are reviewed, as dictated by the Code, the rate structures and actions taken by some professionals can damage ongoing revenues for a struggling debtor and potentially render a case administratively insolvent.

Along the lines of predictability and transparency, I believe that the issue of professional fees must be addressed to entice increased use of the process.

Law firms and other professionals are always willing to discuss appropriate fee adjustments and arrangements for long time clients. When entering into these arrangements with established clients, many firms consider alternative fee arrangements (“AFA’s”) to address continuing and similar engagements, which promote uniformity and predictability of cost to the client, along with efficiency of the actions of professionals. In my experience, debtors and creditor committees do not readily explore the use of AFA’s on an ongoing basis as their cases are “one off” events, so there is no “long term” basis for the relationship. However, the US Trustee’s office could impose rate and AFA arrangements for firms seeking to represent committees (and perhaps debtors) as a condition for eligibility or approval (along with a mandated and complete disclosure of disinterestedness) under Section 327 of the Code.

AFA arrangements take many forms and professional firms are creative to explore new methods for each set of circumstances. There are many articles and reports covering this topic generally. However, I believe that each court or US Trustee’s office could set a rate or fixed fee schedule for firms to be approved as a committee professional (which may be a sliding scale, based on the size and complexity of a case) and the firm to be appointed must agree to the schedule to gain approval of the Trustee’s office to be eligible for appointment. This type of arrangement sets forth the expectations of the estate and of the firm up front, avoids runaway fees or unusually high rate structures.

RECOMMENDATION 5: Promote Transparency in the Process by Enforcing Filing of Required Schedules and Operating Reports