Spring 2006 • Issue 21, page 1

The Origins & Effects of the 2005 Bankruptcy Reform Act: An Interview with Chief Judge Randall J. Newsome

By Oliner, Ron*

(The recent changes to bankruptcy law discussed by Judge Newsome affect, directly or indirectly, most members of the receivership community and the interplay of bankruptcy and receivership law. Ron Oliner, Esq. of the Buchalter Nemer firm’s San Francisco office conducted this interview for the Receivership News.)

The Receivership News is extremely pleased to present the following interview with the distinguished jurist the Honorable Randall J. Newsome, Chief Judge of the United States Bankruptcy Court for the Northern District of California. RN asked Judge Newsome about the impact of and implementation of the recent watershed changes to the United States Bankruptcy Code.

Judge Newsome is the right person to address this issue. He is among the nation’s most experienced bankruptcy judges, having been originally appointed in October 1982 to the Bankruptcy Court for the Southern District of Ohio, where he served until May 1988.

Judge Newsome joined California’s Northern District bench in June 1988, and was elevated to Chief Bankruptcy Judge on January 1, 2004.

He earned his B.A. from Boston University in 1972 and his Juris Doctor degree from the University of Cincinnati College of Law in 1975. Judge Newsome practiced with the Dinsmore and Shohl firm in Cincinnati prior to his elevation to the bench.

Judge Newsome has been widely honored by his peers and the community. From 1998 to 1999, he was President of the National Conference of Bankruptcy Judges. He is a fellow of the American College of Bankruptcy and is a frequent panelist and lecturer on bankruptcy issues for the Federal Judicial Center, the American Law Institute -American Bar Association and many other organizations.

RN: Judge Newsome, we would like to ask you about the Bankruptcy Reform Act, how it came into being and where it is going in practical terms. To begin, we understand that you testified before Congress in connection with the process some years ago. Can you tell us a bit about that?

NEWSOME: Well, first let me start by saying that this all started back in 1994 with Congress setting up a commission to investigate revision of the bankruptcy laws. At the time, it was advertised as essentially fine-tuning the law rather than completely changing it. Without going into a lot of detail, the lending community became disenchanted with the commission process and came up with its own bill. The first one was introduced in the House in September of 1997. The second one was introduced in the Senate on October 20, 1997, the day the Bankruptcy Review Commission issued its report. A third bill, which more closely resembled what ultimately was enacted, was introduced in the House in February of 1998.

“The sponsors of the study refused to release their supporting data...So I decided to launch our own empirical study...”

I was asked to testify on that third bill by the House Committee on Commercial and Administrative Law. I was asked on a Friday to testify on Tuesday and to have my testimony submitted by Monday. So to say that I worked all weekend on it doesn’t really do justice to what I actually had to do. While I had gone over the bill, I hadn’t really tried to apply it and once I did I found it almost impossible to do. By the way, that hasn’t changed.

I ended up testifying on a panel with Judge Edith Jones from the Fifth Circuit and Lloyd Cutler of Wilmer, Cutler & Pickering. Both of them were testifying essentially on behalf of the creditor community and in favor of the bill. I was the only spoilsport on that panel. Ultimately that bill wasn’t enacted.

I became President of the NCBJ in October, 1998. I realized that we had been caught completely off guard by what happened earlier that year and that we weren’t prepared to respond as an organization to what was being said.

There were three or four big themes that were promoted as justification for the bill. First they claimed there was no stigma left to filing for bankruptcy. Second, they argued that there are lots of bankruptcy debtors that can afford to pay. In support of this proposition, they trotted out a study that said that at least 15% of the people in Chapter 7 could afford to pay in a chapter 13. The sponsors of the study refused to release their supporting data, however.

So I decided to launch our own empirical study. I had close to 66 judges participate with randomly selected Chapter 7 cases that were pulled in their districts. We presented data on 17 or 18 different categories of information. We ended up with about 5,000 cases, 3,000 of which were from 1997. The long and the short of it was that our data showed that a maximum of probably 3% of the people in Chapter 7 could actually afford to repay something in Chapter 13.

The median income of the people that were filing Chapter 7 from all over the country was about $21,000 and the median unsecured debt, meaning credit card debt and so forth, not priority debt, was like $23,000. These numbers were totally contrary to the numbers previously presented to Congress, and were consistent with the numbers arrived at in other studies.

I presented our findings in testimony before the House Committee on Commercial and Administrative Law in March of 1999. My testimony is a matter of record. I thought we were involved in a principled debate. Although I was told that the deal was already done, I didn’t really believe it until later. But that really was the case. Essentially no one was listening. My testimony and that of others from the bankruptcy community was really window dressing, and I probably wasted everybody’s time putting all this data together, although I didn’t and don’t regret it.

The bill stumbled along and I believe that 1999 was the year that President Clinton vetoed the bill. Well, we had an election in 2000. The bill was reintroduced and I was asked to testify yet again, this time before the full Senate Judiciary Committee in 2001. My feeling was “Oh God, not this again. Why am I doing this?” But it’s hard to say no to the Senate Judiciary Committee. So I showed up and stumbled around and basically said the same stuff I said two years before. Predictably, the proposed bill passed by a huge margin, just as it had in the past. Once President Bush was re-elected in 2004, my feeling was that the ballgame was over, and that the bill would finally pass and the President would sign it. And he did, in April of 2005.

RN: Generally speaking, in your view, what’s good about the Bankruptcy Reform Act insofar as substantive changes?

NEWSOME: What’s good about the Act? You know, this is going to make me pretty unpopular I suppose, but I’m used to that. I don’t think some of the Chapter 11 changes are that bad. I don’t think it was ever right for a chain store to come into bankruptcy and sit on leases forever and ever and ever. I think that’s wrong. Landlords should have the right to know what’s going to happen to them within a reasonable period of time. It got so bad I had cases in Delaware where the debtor didn’t want to assume the leases or decide whether to assume the leases until after confirmation. And I refused to go along with that. After confirmation of course, there is no debtor-in-possession and 365 doesn’t even address what happens after confirmation. So I think that’s an example of a worthwhile change.

I think the intent of some of the changes to the Act as to consumers isn’t totally bad. Like the desire to cut down on frequent filings to stop foreclosures. Unfortunately, and everybody was told this, the manner in which the drafters of the Act tried to do it doesn’t work because no matter whether you say that there’s an automatic stay or there isn’t an automatic stay, no title company is going to go forward with a foreclosure until they get an order from the Court that memorializes the fact that there is no stay. This is true even if the Act itself says there is no stay.

RN: Any thoughts about exclusivity, another big Chapter 11 substantive change?

NEWSOME: Well, there’s a good point. Back when I first started in this business in 1982, nobody ever anticipated that exclusivity was going to go on forever. Suddenly, it became an entitlement in big cases that it would go on forever. The first time I heard of anybody threatening to lift exclusivity in a big case was in Texaco. And it got the job done, too.

In any event, nobody anticipated that the debtor would continue to hold all the cards for years and years and years in Chapter 11. So did they make it too short? I think they probably did in terms of the amount of exclusivity. You’ll never be able to do a plan in an asbestos case in that much time, for example. But is the limitation reasonable in a lot of other kinds of cases? Probably. So I don’t think that was all bad and I think it was something that was kind of a festering sore in the creditor community. I don’t think it is a bad change.

RN: Looking at the kinds of issues you are dealing with post-October 17, what about this whole concept of consumer counseling before someone is entitled to file a bankruptcy? A prospective debtor has to go talk to a sanctioned counselor about his or her financial options and so forth. Are consumers complying with that? To the extent they are not, are you kicking them out of bankruptcy as the new Act seems to require?

NEWSOME: Well the answer is that apparently some of them are. The fact is we have very few cases. We had a combined total of only about 400 cases filed in this district in November and December of last year. I haven’t seen the statistics for January and February. But you’re talking about a district that traditionally had, before 2005, around 20,000 cases a year. To have 400 cases filed in the whole district for two months gives you an indication as to what happened. I might note that we had 9,000 cases filed in the first two weeks of October. So we kind of flushed out, if you will, those people who were on the fence. If they were trying to decide whether to file, they obviously decided by October 16. In any event, the credit counseling requirement is an example of the way the statute is structured.

The Act was structured in a way to keep people out of bankruptcy, not to move them into Chapter13, which was its claimed purpose. The real purpose of the bill was to keep them out altogether. And if they got in, to throw them out and if they got thrown out, to keep them out. That’s what the bill’s intent was notwithstanding what everybody was saying the bill’s intent was. So the credit-counseling requirement has turned out to do an excellent job at that. Many people don’t think about filing until the last minute, just before the hammer drops on a foreclosure, for example. They don’t try to get credit counseling within five days prior to the filing. They try to get it the day of the filing and by that time they may not be able to get it.

If they file without unsuccessfully having sought credit counseling within 5 days prior thereto, the Code seems to say we have to dismiss the case for lack of eligibility. Numerous published decisions have been issued so interpreting the statute, the most recent one being authored by Judge Montali of this District. For most of these people, what is the penalty? It probably won’t be any more than a new filing fee, which by the way is going up to $299.

RN: Many creditors’ lawyers may find themselves on your relief from stay calendar more seldom that under the prior law. There were always a number of bad faith filers in the system. How do you feel about the in rem provision? [Ed. Note: This refers to new section 362(d)(4) that in appropriate circumstances makes the granting of relief from stay prospective for a period of two years regardless of changes in ownership to the real property in question. This provision is designed to avoid serial bad-faith filings for the purpose of forestalling foreclosure by secured lenders.]

NEWSOME: That’s a good thing.

RN: Are you of the view — and it may be too soon to tell and the cases too few to draw any conclusions yet — but are you of the view that the unworthy debtor who is just trying to save real property he can’t afford and is not paying for is not filing as frequently now?

NEWSOME: I don’t know. It’s too soon to tell. It’s too soon to really tell what’s going on with this bill. We haven’t had enough cases filed. I have had a couple of instances where I’ve thought to myself you know I am glad there is no stay in this particular case because this guy shouldn’t have a stay. But I know the creditor is still going to file the motion and seek an order that says there’s no stay.

RN: What’s going on in Chapter 11 in your court? The generally held assumption is that there isn’t a whole lot of Chapter 11 work.

“The trends that I see are that this Act isn’t going to make any difference at all in the long run.”

NEWSOME: I wouldn’t know. I don’t have any Chapter 11s to speak of. My Chapter 11s consist of maybe a guy with a small plant and 15 employees. He doesn’t exactly qualify for what’s going on in Chapter 11 as far as I’m concerned. And I only get one of those every six months. So I really don’t know what’s going on in Chapter 11.

RN: Can you rub your crystal ball and glean any kind of longer-range trends that are going to arise as a result of the Act? How is the world going to look different to you from your desk and from the bench?

NEWSOME: The trends that I see are that this Act isn’t going to make any difference at all in the long run. And the reason is that I believe we may be cooking up a really perfect financial storm. Adjustable mortgage rates are going up, and house prices are flat or declining, which means that people who probably couldn’t even afford the tickler rate they got when they bought the house will be really struggling to pay the new rate, and they may have a hard time refinancing to a rate they can afford.

Second, we’ve now had an increase in minimum payments on credit cards, which in some cases may mean the minimum payments will double. That’s a tough nut for a nation where the average family is carrying about a $10,000 balance on their credit cards.

Third, we may be moving into a weaker economy going forward, but people continue to incur more debt. At some point the piper has to be paid. So I think eventually filings are going to creep right back up to where they once were. Now, could I be wrong about that? Obviously I could. I don’t have a crystal ball. But one thing I know is, this bill didn’t change mathematical principles. If your debt burden has outstripped your income, your choices are few and they’re all bad, the most obvious being bankruptcy, regardless of what it takes to file. And I think that’s probably the bottom line.